RADIOLOGIX INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM _______________________________________________

COMMISSION FILE NO. 0-23311

RADIOLOGIX, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 75-2648089
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)

2200 ROSS AVENUE
3600 JP MORGAN CHASE TOWER
DALLAS, TEXAS 75201-2776
(Address of principal executive offices, including zip code)

(214) 303-2776
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.

Class Outstanding at August 9, 2002
- ---------------------------------------- -----------------------------------
COMMON STOCK, $0.0001 PAR VALUE 21,461,479 SHARES

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RADIOLOGIX, INC.

FORM 10-Q

INDEX

RADIOLOGIX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

See accompanying notes to unaudited consolidated financial statements.

1

RADIOLOGIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)

See accompanying notes to unaudited consolidated financial statements.

2

RADIOLOGIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

See accompanying notes to unaudited consolidated financial statements.

3

RADIOLOGIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. DESCRIPTION OF BUSINESS

Radiologix, Inc. (together with its subsidiaries, "Radiologix" or the
"Company"), a Delaware corporation, is a leading national provider of diagnostic
imaging services through its ownership and operation of free-standing,
outpatient diagnostic imaging centers. Radiologix utilizes sophisticated
technology and technical expertise to perform a broad range of imaging
procedures, such as magnetic resonance imaging (or MRI), computed tomography (or
CT), positron emission tomography (or PET), nuclear medicine, ultrasound,
mammography, bone densitometry (or DEXA), general radiography (or X-ray) and
fluoroscopy. Radiologix operates 117 diagnostic imaging centers located in 17
states, with a concentration of diagnostic imaging centers in markets located in
California, Florida, Kansas, Maryland, New York, Texas and Virginia. Radiologix
offers multi-modality imaging services at 70 of its diagnostic imaging centers,
which provide patients and referring physicians access to advanced diagnostic
imaging services in one convenient location.

Radiologix also provides administrative, management and information
services to certain radiology practices that provide professional services in
connection with its diagnostic imaging centers and to hospitals and radiology
practices with which the Company operates joint ventures. The services
Radiologix provides leverage its existing infrastructure and improve radiology
practice or joint venture profitability, efficiency and effectiveness.

Radiologix has two models by which it contracts with radiology practices: a
comprehensive services model and a technical services model. Under the
comprehensive services model, the Company enters into a long-term agreement with
a radiology practice group (typically 40 years). Under this arrangement, in
addition to obtaining technical fees for the use of Radiologix's diagnostic
imaging equipment and the provision of technical services, the Company provides
management services and receives a fee based on the practice group's
professional revenue, including revenue derived from outside of our diagnostic
imaging centers. Under the technical services model, the Company enters into a
shorter-term agreement with a radiology practice group (typically 10 to 15
years) and pays them a fee based on cash collections from reimbursements for
imaging procedures. In both the comprehensive services and technical services
models, the Company owns the diagnostic imaging assets, and, therefore, receives
100% of the technical reimbursements associated with imaging procedures.
Additionally, in most instances, both the comprehensive services and the
technical services models contemplate an incentive technical bonus for the
radiology group if the net technical income exceeds specified thresholds. The
service agreements cannot be terminated by either party without cause,
consisting primarily of bankruptcy or material default. However, under certain
conditions, Radiologix can terminate the service agreement if the number of
physicians in a practice falls below a certain percentage of the total
physicians of the radiology practice. Two physicians of two of the contracted
radiology practices are members of the Board of Directors of the Company.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

We have prepared the consolidated financial statements without audit. In
management's opinion, these financial statements include all normal recurring
adjustments necessary for a fair presentation of the results of operations for
the three months and six month periods ended June 30, 2002 and 2001 in
accordance with the rules and regulations of the Securities and Exchange
Commission. The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
and include the accounts of the Company and its wholly owned and majority owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation.

Use of Estimates in the Preparation of the Financial Statements

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, results of operations and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates.

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Impairment of Long-Lived Assets

Subsequent to an acquisition, Radiologix continually evaluates whether
events and circumstances have occurred that indicate the remaining balance of
the intangible assets and property and equipment may not be recoverable or that
the remaining useful lives may warrant revision. Radiologix evaluates the
potential impairment of intangibles separately from property and equipment. When
factors indicate that intangible assets or property and equipment should be
evaluated for possible impairment, Radiologix determines whether the intangible
assets or property and equipment are recoverable or if impairment exists, in
which case an adjustment is made to the carrying value of the related asset. In
making this determination, Radiologix uses an estimate of the related contracted
radiology practices' and diagnostic imaging services' discounted cash flows over
the remaining lives of the intangible assets or the property and equipment and
compare it to the contracted radiology practices' and diagnostic imaging
centers' intangible assets or property and equipment balances. When an
adjustment is required, Radiologix evaluates the remaining amortization periods.
An impairment loss recognized would be measured as the amount by which the
carrying amount of the asset exceeds the fair value of the asset. Radiologix
recorded no impairment charges during 2001 or 2002.

Recent Accounting Pronouncement

Radiologix adopted Statement of Financial Accounting Standards ("SFAS")
"Accounting for the Impairment or Disposal of Long-Lived Assets" effective
January 1, 2002. SFAS 144 addresses financial accounting and reporting for the
impairment of long-lived assets and for long-lived assets to be disposed of.
This statement supersedes SFAS 121; however, SFAS 144 retains the fundamental
provisions of SFAS 121 for (a) recognition and measurement of the impairment of
long-lived assets to be held and used and (b) measurement of long-lived assets
to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" for segments of a
business to be disposed of.

Radiologix adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
effective January 1, 2002. Under SFAS 142, goodwill and other intangible assets
with an indefinite useful life are no longer amortized as expenses of
operations, but rather carried on the balance sheet as permanent assets. These
intangible assets are to be subject to at least annual assessments for
impairment by applying a fair value based test. The Company's service
agreements, included in the consolidated balance sheets as intangible assets,
net, are not considered to have an indefinite useful life and will continue to
be amortized over a useful life of 25 years.

As required by SFAS No. 142, intangible assets that do not meet the criteria
for recognition apart from goodwill must be reclassified. As a result, $28.5
million of intangible assets, primarily relating to acquired intangible assets,
were transferred to goodwill as of January 1, 2002.

With the adoption of the statement, Radiologix ceased amortization of
goodwill as of January 1, 2002. The following table presents the quarterly
results on a comparable basis (in thousands):

5

As of January 1, 2002, Radiologix completed a goodwill impairment test. This
test involved the use of estimates related to the fair market value of
Radiologix's reporting units with which the goodwill was associated. No
impairment was indicated at that time.

Revenue Presentation

The Financial Accounting Standards Board's Emerging Issues Task Force issued
its abstract, Issue 97-2, "Application of FASB Statement No. 94 and Accounting
Principles Board ("APB") Opinion No. 16 to Physician Practice Management
Entities and Certain Other Entities with Contractual Arrangements" ("EITF
97-2"). Since Radiologix has not established a "controlling financial interest"
under EITF 97-2, Radiologix does not consolidate the contracted radiology
practices.

The following table sets forth the amounts of revenue for the contracted
radiology practices and diagnostic imaging centers that would have been
presented in the consolidated statements of income had Radiologix met the
provisions of EITF 97-2 (in thousands):

Revenue of the contracted radiology practices and diagnostic imaging centers
is recorded when services are rendered by the contracted radiology practice and
diagnostic imaging center based on established charges and reduced by
contractual allowances. In addition, bad debt expense related to established
charges is recognized as costs and expenses rather than a deduction from
revenue. The Company uses historical collection experience in estimating its
contractual allowances and bad debt expense. The factors influencing the
historical collection experience include the contracted radiology practices' and
diagnostic imaging centers' patient mix, impact of managed care contract pricing
and contract revenue and the aging of patient accounts receivable balances. As
these factors change, the historical collection experience is revised
accordingly in the period known.

Service fee revenue represents contracted radiology practices' and
diagnostic imaging centers' revenue less amounts retained by contracted
radiology practices. The amounts retained by contracted radiology practices
represents amounts paid to the physicians pursuant to the service agreements
between Radiologix and the contracted radiology practices. Under the service
agreements, the Company provides each contracted radiology practice with the
facilities and equipment used in its medical practice, assumes responsibility
for the management of the operations of the practice, and employs substantially
all of the non-physician personnel utilized by the contracted radiology
practice. Although Radiologix assists in negotiating managed care contracts for
the contracted radiology practices, it assumes no risk under these arrangements.

The Company's service fee revenue is dependent upon the operating results of
the contracted radiology practices and diagnostic imaging centers. Where state
law allows, service fees due under the service agreements for the contracted
radiology practices are derived from two distinct revenue streams: (1) a
negotiated percentage (typically 20% to 30%) of the adjusted professional
revenues as defined in the service agreements; and (2) 100% of the adjusted
technical revenues as defined in the service agreements. In states where the law
requires a flat fee structure, Radiologix has negotiated a base service fee,
which is equal to the estimated fair market value of the services provided under
the service agreements and which is renegotiated each year to equal the fair
market value of the services provided under the service agreements. The fixed
fee structure results in Radiologix receiving substantially the same amount of
service fee as it would have received under its negotiated percentage fee
structure. Adjusted professional revenues and adjusted technical revenues are
determined by deducting certain contractually agreed-upon expenses
(non-physician salaries and benefits, rent, depreciation, insurance, interest
and other physician costs) from the contracted radiology practices' revenue.
Questar revenues are primarily derived from technical revenues generated from
its diagnostic imaging centers.

6

Service fee revenues consists of the following (in thousands):

3. LONG TERM DEBT

Senior Notes

In December 2001, the Company terminated its senior credit facility with
proceeds from a $160 million senior notes ("Senior Notes") issuance, due
December 15, 2008. In connection with the repayment, the Company recorded in
December 2001 an extraordinary loss from the early extinguishment of its senior
credit facility in the amount of $4.7 million, $2.8 million after tax. The
Senior Notes bear interest at an annual rate of 10 1/2% payable semiannually in
arrears on June 15 and December 15 of each year, and commenced June 15, 2002.
The Senior Notes are redeemable on or after December 15, 2005 at various
redemption prices, plus accrued and unpaid interest to the date of redemption.
The Senior Notes are unsecured obligations which rank senior in right of payment
to all of our subordinate indebtedness and equal in right of payment with all
other senior indebtedness. The Senior Notes are unconditionally guaranteed on a
senior unsecured basis by certain restricted existing and future subsidiaries.

Credit Facility

In addition to the Senior Notes issuance in December 2001, the Company
entered into a credit facility whereby the Company can borrow up to $35 million.
At June 30, 2002, no borrowings were outstanding under the credit facility.
Under the credit facility the interest rate is (i) an adjusted LIBOR rate, plus
an applicable margin which can vary from 3.0% to 3.5% or (ii) the prime rate,
plus an applicable margin which can vary from 1.75% to 2.25%. In each case, the
applicable margin varies based on financial ratios maintained by the Company.
The credit facility includes certain restrictive covenants including
prohibitions on the payment of dividends, limitations on capital expenditures
and the maintenance of certain financial ratios (including minimum fixed charge
coverage ratio and maximum leverage ratio, as defined). Borrowings under the
senior credit facility are secured by all service agreements, which the Company
is or becomes a party to, a pledge of the stock of the Company's subsidiaries
and all of the Company's and its wholly owned subsidiaries' assets.

Convertible Subordinated Debt

The Company has a $14.7 million convertible junior subordinated note, which
matures July 31, 2009, and bears interest, payable quarterly in cash or payment
in kind securities, at an annual rate of 8.0%. If by August 1, 2003 the closing
price of Radiologix's common stock has not exceeded $7.52 for 45 of the 60 days
of the determination period, the interest rate will be increased to 8.25% and
8.5%, respectively. For the three months ended June 30, 2002, approximately $4.5
million of the convertible junior subordinated note was converted into 590,338
shares. For the six months ended June 30, 2002, approximately $9.5 million of
the convertible junior subordinated note was converted into 1,261,677 shares.

4. EARNINGS PER SHARE

Radiologix adopted SFAS No. 128, "Earnings per Share" ("EPS") effective
December 31, 1997. SFAS No. 128 simplifies the computation of EPS by replacing
the presentation of primary EPS with a presentation of basic EPS. Basic EPS is
calculated by dividing income available to common stockholders by the weighted
average number of common shares outstanding during the period (including shares
to be issued). Options, warrants, and other potentially dilutive securities are
excluded from the calculation of basic EPS. Diluted EPS includes the options,
warrants, and other potentially dilutive securities that are excluded from basic
EPS using the treasury stock method to the extent that these securities are not
anti-dilutive. For the three months ended June 30, 2001 and 2002, 221,099 and
1,390,471 shares, respectively, related to stock options were included in
diluted EPS. In addition, diluted EPS includes the effect of the convertible
note (see Note 3) using the "if converted" method to the extent the securities
are not anti-dilutive. For the three months ended June 30, 2001, and 2002, under
the "if converted" method, $277,000 and $208,000,

7

respectively, of tax effected interest savings and 2,318,841 and 2,153,802,
respectively, weighted average shares were included in the calculation of
diluted EPS as an addition to net income and weighted average shares
outstanding, respectively.

For the six months ended June 30, 2001 and 2002, 268,412 and 1,275,008
shares, respectively, related to stock options were included in diluted EPS. In
addition, diluted EPS includes the effect of the convertible note (see Note 3)
using the "if converted" method to the extent the securities are not
anti-dilutive. For the six months ended June 30, 2001, and 2002, under the "if
converted" method, $546,000 and $470,000, respectively, of tax effected interest
savings and 2,318,841 and 2,468,717, respectively, weighted average shares were
included in the calculation of diluted EPS as an addition to net income and
weighted average shares outstanding, respectively.

5. SEGMENT REPORTING

The Company reports the results of its operations through four designated
regions of the United States: Mid-Atlantic, Northeastern, Central and Western
regions. In addition, the Company reports the results of its operations of the
imaging centers of its subsidiary, Questar. The Company's operations in each of
the four designated regions are comprised of the ownership and operation of
diagnostic imaging centers and the provision of administrative, management and
information services to the contracted radiology practices that provide
professional interpretation and supervision services in connection with its
diagnostic imaging centers and to hospitals and radiology practices with which
the Company operates joint ventures. The Company's services leverage our
existing infrastructure and improve radiology practice or joint venture
profitability, efficiency and effectiveness. The Company has divided the
operations into the four regions and Questar only for purposes of the division
of internal management responsibilities, but does not focus on each of these
regions as a separate product line or make financial decisions as if they were
separate product lines. The Questar operations are looked at as a separate group
only from the perspective that the imaging centers of Questar do not have the
same type of management service agreement with physicians as we have with each
of the contracted radiology practices in the four designated regions. In
addition, any imaging centers of Questar that are in the same region as the
operations of the contracted radiology practices in the four designated regions
are not included in the service agreements of the contracted radiology
practices. The following is a table, which summarizes the operating results and
assets by the five reportable segments (in thousands):

(1) Includes the Baltimore/Washington, D.C. Metropolitan area.

(2) Includes Rochester, New York, Rockland County, New York and the surrounding
areas.

(3) Includes San Antonio, Texas, St. Lucie County, Florida, Topeka, Kansas,
Northeast Kansas and the surrounding areas.

(4) Includes the San Francisco/Oakland/San Jose, California and surrounding
areas.

(5) Includes diagnostic imaging centers in Arizona, California, Colorado,
Delaware, Florida, Georgia, Illinois, Kansas, Minnesota, Missouri,
Nebraska, Nevada, Ohio and Pennsylvania that were acquired as part of the
Questar acquisition and that have not been integrated into pre-existing
Radiologix market areas.

Corporate assets, including intangible assets, as of June 30, 2001 and 2002 were
$95,051 and $113,142, respectively.

The following is a reconciliation of income before taxes and purchases of
property and equipment by the Company's five reportable segments to the
Company's consolidated financial statements for the six months ended June 30 (in
thousands):

9

6. SUPPLEMENTAL GUARANTOR INFORMATION

In connection with the Senior Notes, certain of the Company's subsidiaries
("Subsidiary Guarantors") guaranteed, jointly and severally, the Company's
obligation to pay principal and interest on the Senior Notes on a full and
unconditional basis.

The following supplemental condensed consolidating financial information
presents the balance sheet as of December 31, 2001 and June 30, 2002, and the
statements of income and cash flows for the six months ended June 30, 2001 and
2002. In the consolidating condensed financial statements, the Subsidiary
Guarantors account for their investment in the non-guarantor subsidiaries using
the equity method.

The non-guarantor subsidiaries include Advanced PET Imaging of Maryland,
L.P., Lakewood OpenScan MR, LLC, Lexington MR, Ltd., Montgomery Community
Magnetic Imaging Center Limited Partnership, Tower OpenScan MRI, and MRI at St.
Joseph Medical Center LLC. The Guarantor Subsidiaries include all wholly owned
subsidiaries of Radiologix, Inc. (the "Parent").

10

RADIOLOGIX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET (UNAUDITED)

JUNE 30, 2002
(IN THOUSANDS)

11

RADIOLOGIX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET (AUDITED)

DECEMBER 31, 2001
(IN THOUSANDS)

12

RADIOLOGIX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF INCOME (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2002
(IN THOUSANDS)

13

RADIOLOGIX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF INCOME (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2001
(IN THOUSANDS)

14

RADIOLOGIX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2002
(IN THOUSANDS)

15

RADIOLOGIX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2001
(IN THOUSANDS)

16

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion of the results of operations and financial
condition of the Company should be read in conjunction with the Company's
consolidated financial statements and notes thereto included in the Annual
Report on Form 10-K for the year ended December 31, 2001, and with the Company's
consolidated financial statements and notes included in this Form 10-Q.

OVERVIEW

We are a leading national provider of diagnostic imaging services through
our ownership and operation of free-standing, outpatient diagnostic imaging
centers. We utilize sophisticated technology and technical expertise to perform
a broad range of imaging procedures, such as magnetic resonance imaging (or
MRI), computed tomography (or CT), positron emission tomography (or PET),
nuclear medicine, ultrasound, mammography, bone densitometry (or DEXA), general
radiography (or X-ray) and fluoroscopy. For the six months ended June 30, 2002,
we derived 80% of our service fee revenue from the ownership, management and
operation of our radiology and imaging center network and 20% of our service fee
revenue from the administrative, management and information services provided to
contracted radiology practices. As of June 30, 2002, we owned, operated or
maintained an ownership interest in imaging equipment at 117 locations and
provided management services to ten radiology practices. As of June 30, 2002,
our imaging centers are located in 17 states, with concentrated geographic
coverage in markets located in California, Florida, Kansas, Maryland, New York,
Texas and Virginia.

We focus on providing quality patient care and service to ensure patient and
referring physician satisfaction. Our development of comprehensive radiology
networks permits us to invest in technologically advanced imaging equipment,
including MRI, open MRI, spiral CT and PET. Our consolidation of diagnostic
imaging centers into coordinated networks improves response time, increases
overall patient accessibility, permits us to standardize certain customer
relations procedures and permits us to develop "best practices" for our
diagnostic imaging centers. We seek the input and participation of the
contracted radiology practices to which we provide administrative, management
and information services to develop best practices and to improve productivity
and the quality of services. By focusing on further improving and, where
appropriate, standardizing the operations of our diagnostic imaging centers, we
believe that we can increase patient and referring physician satisfaction, which
should lead to increased referrals and increased utilization of our diagnostic
imaging centers.

We contract with radiology practices to provide professional services,
including the supervision and interpretation of diagnostic imaging procedures
performed in our diagnostic imaging centers. We believe that we do not engage in
the practice of medicine nor do we employ physicians. The radiology practices
maintain full control over the provision of professional radiological services.
The contracted radiology practices generally have outstanding physician and
practice credentials and reputations; strong competitive market positions; a
broad sub-specialty mix of physicians; a history of growth and potential for
continued growth; and a willingness to embrace our strategy for the delivery of
diagnostic imaging services.

For the six months ended June 30 2002, payment for diagnostic imaging
services comes primarily from commercial third-party payors (65%), governmental
payors (27%, including Medicare and Medicaid) and private and other payors (8%).
In August 2000, Medicare made significant changes in the reimbursement
methodology for hospital outpatient services. We believe that we will have
opportunities to increase the use of our diagnostic imaging services through
additional joint venture or outsourcing arrangements with hospitals, in part
because such federal healthcare regulatory changes favor outpatient centers that
are managed or owned in joint venture or outsourcing arrangements with third
parties. As of January 2002, Medicare decreased reimbursement rates for
physician and outpatient services, including diagnostic imaging services. Our
centers are principally dependent on our ability to attract referrals from
primary care physicians, specialists and other healthcare providers. The
referral often depends on the existence of a contractual arrangement with the
referred patient's health benefit plan. For the six months ended June 30, 2002,
approximately 5% of our revenue generated at our diagnostic imaging centers was
generated from capitated arrangements.

Our service fee revenue is dependent upon the operating results of the
contracted radiology practices and diagnostic imaging centers. Where state law
allows, service fees due under the service agreements for the contracted
radiology practices are derived from two distinct revenue streams: (1) a
negotiated percentage (typically 20% to 30%) of the adjusted professional
revenues as defined in the service agreements; and (2) 100% of the adjusted
technical revenues as defined in the service agreements. In states where the law
requires a flat fee structure, we have negotiated a base service fee, which is
equal to the estimated fair market value of the services provided under the
service agreements and which is renegotiated each year to equal the fair market
value of the services provided under the service agreements. The fixed fee
structure results in us receiving substantially the same amount of service fee
as we would have received under a negotiated percentage fee structure. Adjusted
professional revenues and adjusted technical revenues are determined by
deducting certain contractually agreed-upon expenses (non-physician salaries and
benefits,

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rent, depreciation, insurance, interest and other physician costs) from the
contracted radiology practices' revenue. Revenues of our subsidiary, Questar
Imaging, Inc. ("Questar") are primarily derived from technical revenues
generated from those imaging centers.

RESULTS OF OPERATIONS

We report the results of our operations through four designated regions of
the United States: Mid-Atlantic, Northeastern, Central and Western regions. In
addition, we report separately the results of our operations of the imaging
centers of our subsidiary, Questar. Our operations in each of the four
designated regions are comprised of the ownership and operation of diagnostic
imaging centers and the provision of administrative, management and information
services to the contracted radiology practices that provide professional
interpretation and supervision services in connection with our diagnostic
imaging centers and to hospitals and radiology practices with which we operate
joint ventures. Our services leverage our existing infrastructure and improve
radiology practice or joint venture profitability, efficiency and effectiveness.
We have divided the operations into the four regions and Questar only for
purposes of the division of internal management responsibilities, but do not
focus on each of these regions as a separate product line or make financial
decisions as if they were separate product lines. The Questar operations are
treated as a separate group only from the perspective that the imaging centers
of Questar do not have the same type of management service agreement with
physicians as we have with the contracted radiology practices in the four
designated regions. In addition, any imaging centers of Questar that are in the
same region as the operations of the contracted radiology practices in the four
designated regions are not included in the service agreements of the contracted
radiology practices.

For discussion and analysis purposes, the operating margin is defined as
service fee revenue less operating expenses ("operating income") as a percent of
service fee revenue. The operating margin for the Mid-Atlantic region of 31% for
the six months ended June 30, 2001 increased to 33% in 2002. The increase in the
operating margin is primarily attributable to further growth in technical volume
and, therefore, technical revenues, as well as management of operating expenses.
The operating margin of the Northeastern region increased from 26% for the six
months ended June 30, 2001 to 28% in 2002. The increase in the operating margin
is primarily attributable to the growth in technical volume and, therefore,
technical revenues. In addition, the operating margin increased partially as a
result of higher reimbursement on a managed care contract and was also impacted
by the higher fixed fee recognized at the New York practices compared to 2001.
The operating margin for the Central region of 35% for the six months ended June
30, 2001 decreased to 33% in 2002. The decrease in the operating margin is
primarily attributable to increased salaries and benefits, as well as
malpractice insurance costs. This is partially offset by decreased purchased
billing services and by increased technical revenues in the Central region
overall. The operating margin for the Western region increased from 22% for the
six months ended June 30, 2001 to 23% in 2002. The increase in the operating
margin is primarily attributable to the purchase in December 2001 of equipment
previously held under operating leases. This is partially offset by an increase
in salaries and benefits. The operating margin for Questar increased from 17%
for the six months ended June 30, 2001 to 25% for the six months ended June 30,
2002. The increase in the operating margin is primarily attributable to improved
collections, which decreased estimated contractual allowances and, therefore,
increased service fee revenue.

THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002

Service Fee Revenue

Revenue of the contracted radiology practices and diagnostic imaging centers
is recorded when services are rendered by the contracted radiology practices and
diagnostic imaging centers based on established charges and reduced by
contractual allowances. In addition, bad debt expense related to established
charges is recognized as costs and expenses rather than a deduction from
revenue. We use historical collection experience in estimating contractual
allowances and bad debt expense. The factors influencing the historical
collection experience include the contracted radiology practices' and diagnostic
imaging centers' patient mix, impact of managed care contract pricing and
contract revenue and the aging of patient accounts receivable balances. As these
factors change, the historical collection experience is revised accordingly in
the period known. Service fee revenue represents contracted radiology practices'
and diagnostic imaging centers' revenue less amounts retained by contracted
radiology practices. The amounts retained by contracted radiology practices
represents amounts paid

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to the physicians pursuant to the service agreements between us and the
contracted radiology practices. Under the service agreements, we provide each
contracted radiology practice with the facilities and equipment used in its
medical practice, assume responsibility for managing the operations of the
practice, and employ substantially all of the non-physician personnel utilized
by the contracted radiology practice. Although we assist in negotiating managed
care contracts for the contracted radiology practices, we assume no risk under
these arrangements.

The following table sets forth the amounts of revenue from the contracted
radiology practices and diagnostic imaging centers and the amounts retained by
contracted radiology practices (in thousands):

Revenue from contracted radiology practices and diagnostic imaging centers,
net of contractual allowances, increased $3.2 million, from $97.2 million in
2001 to $100.4 million in 2002. This increase was primarily due to increased
technical revenues. Amounts retained by contracted radiology practices decreased
from $28.9 million in 2001 to $27.0 million in 2002. The increase in revenue
from contracted radiology practices and diagnostic imaging centers, net of
contractual allowances and the decrease in amounts retained by contracted
radiology practices, resulted in service fee revenue increasing $5.2 million,
from $68.2 million in 2001 to $73.4 million, in 2002.

Salaries and Benefits

Salaries and benefits increased $1.8 million, from $18.7 million in 2001 to
$20.5 million in 2002. Salaries and benefits increased as volume and revenues
increased and as salaries and benefits for technologists increased. As a
percentage of service fee revenue, these costs increased from 27.4% in 2001 to
28.0% in 2002.

Field Supplies

Field supplies increased $500,000, from $4.1 million in 2001 to $4.6 million
in 2002. As a percentage of service fee revenue, these costs remained relatively
constant at 6.0% and 6.3% in 2001 and 2002, respectively.

Field Rent and Lease Expense

Field rent and lease expense decreased $300,000, from $8.5 million in 2001
to $8.2 million in 2002. As a percentage of service fee revenue, these costs
were 12.5% and 11.2% in 2001 and 2002, respectively. The decrease in the rent
and lease expense is primarily attributable to the purchase in December 2001 of
equipment previously held under operating leases.

Other Field Expenses

Other field expenses remained constant at $11.5 million in 2001 and 2002,
respectively, as these costs do not increase in proportion with increases in
volume and revenues. However, as a percentage of service fee revenue, these
costs decreased from 16.8% in 2001 to 15.7% in 2002. Purchased billing services
decreased approximately $560,000 due to (i) the conversion of these services to
an in-house billing department at one of the Northeastern contracted radiology
practices at the end of 2001 and (ii) billing services no longer provided for
professional services at two of the contracted radiology practices.

Bad Debt Expense

Bad debt expense remained constant at $6.3 million in 2001 and 2002,
respectively. As a percentage of service fee revenue, these costs were 9.3% and
8.5% in 2001 and 2002, respectively. Since service fee revenue represents
contracted radiology practices' and diagnostic imaging centers' revenue less
amounts retained by contracted radiology practices, these percentages are

19

inherently at a higher stated value. Therefore, bad debt expense should be
compared for 2001 and 2002 as a percentage of revenue of the contracted
radiology practices and diagnostic imaging centers, net of contractual
allowances, rather than as a percentage of service fee revenue. As a percentage
of revenue of the contracted radiology practices and diagnostic imaging centers,
bad debt expense was 6.5% and 6.2% in 2001 and 2002, respectively.

Corporate General and Administrative

Corporate general and administrative expenses increased $500,000, from $3.5
million in 2001 to $4.0 million in 2002. As a percentage of service fee revenue,
these costs were 5.2% and 5.4% in 2001 and 2002, respectively. The increase in
these costs is primarily due to the further development of our infrastructure at
the corporate office during the latter part of 2001, including additional
employees and associated employee benefits and incentive compensation.

Depreciation and Amortization

Depreciation and amortization expense increased $400,000, from $5.9 million
in 2001 to $6.3 million in 2002. As a percentage of service fee revenue, these
costs were relatively constant at 8.6% and 8.7% in 2001 and 2002, respectively.
The increase in depreciation expense is primarily attributable to the purchase
in December 2001 of equipment previously held under operating leases. This is
partially offset by a decrease in amortization due to the adoption at Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" effective January 1, 2002. As a result, $28.5 million of
intangible assets, primarily related to acquired intangible assets with an
indefinite useful life, are no longer amortized as expenses of operations, but
rather carried on the balance sheet as permanent assets.

Interest Expense, net

Interest expense, net, increased $700,000, from $4.1 million in 2001 to $4.8
million in 2002. The increase is due to higher interest costs associated with
our senior notes issued in December 2001.

Income Tax Expense

Income tax expense of $2.6 million in 2001 and $3.2 million in 2002 was
based on a 40% effective tax rate.

Net Income

Net income increased from $4.0 million in 2001 to $4.8 million in 2002. Net
income as a percentage of service fee revenue was 6.5% in 2002, which increased
from 5.8% in 2001.

SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002

Service Fee Revenue

Revenue of the contracted radiology practices and diagnostic imaging centers
is recorded when services are rendered by the contracted radiology practices and
diagnostic imaging centers based on established charges and reduced by
contractual allowances. In addition, bad debt expense related to established
charges is recognized as costs and expenses rather than a deduction from
revenue. We use historical collection experience in estimating contractual
allowances and bad debt expense. The factors influencing the historical
collection experience include the contracted radiology practices' and diagnostic
imaging centers' patient mix, impact of managed care contract pricing and
contract revenue and the aging of patient accounts receivable balances. As these
factors change, the historical collection experience is revised accordingly in
the period known. Service fee revenue represents contracted radiology practices'
and diagnostic imaging centers' revenue less amounts retained by contracted
radiology practices. The amounts retained by contracted radiology practices
represents amounts paid to the physicians pursuant to the service agreements
between us and the contracted radiology practices. Under the service agreements,
we provide each contracted radiology practice with the facilities and equipment
used in its medical practice, assume responsibility for managing the operations
of the practice, and employ substantially all of the non-physician personnel
utilized by the contracted radiology practice. Although we assist in negotiating
managed care contracts for the contracted radiology practices, we assume no risk
under these arrangements.

20

The following table sets forth the amounts of revenue from the contracted
radiology practices and diagnostic imaging centers and the amounts retained by
contracted radiology practices (in thousands):

Revenue from contracted radiology practices and diagnostic imaging centers,
net of contractual allowances, increased $10.5 million, from $189.4 million in
2001 to $199.9 million in 2002. This increase was primarily due to increased
technical revenues. Amounts retained by contracted radiology practices decreased
from $55.3 million in 2001 to $53.9 million in 2002. The increase in revenue
from contracted radiology practices and diagnostic imaging centers, net of
contractual allowances and the decrease in amounts retained by contracted
radiology practices, resulted in service fee revenue increasing $12 million,
from $134.1 million in 2001 to $146.1 million, in 2002.

Salaries and Benefits

Salaries and benefits increased $4.0 million, from $37.1 million in 2001 to
$41.1 million in 2002. Salaries and benefits increased as volume and revenues
increased and as salaries and benefits for technologists increased. As a
percentage of service fee revenue, these costs were comparable at 27.7% and
28.1% in 2001 and 2002, respectively.

Field Supplies

Field supplies increased $1.0 million, from $7.9 million in 2001 to $8.9
million in 2002. As a percentage of service fee revenue, these costs remained
relatively constant at 5.9% and 6.1% in 2001 and 2002, respectively.

Field Rent and Lease Expense

Field rent and lease expense decreased $500,000, from $16.8 million in 2001
to $16.3 million in 2002. As a percentage of service fee revenue, these costs
were 12.5% and 11.1% in 2001 and 2002, respectively. The decrease in the rent
and lease expense is primarily attributable to the purchase in December 2001 of
equipment previously held under operating leases.

Other Field Expenses

Other field expenses increased $700,000, from $22.9 million in 2001 to $23.6
million in 2002. Generally, these costs do not increase in proportion with
increases in volume and revenues. However, as a percentage of service fee
revenue, these costs decreased from 17.1% in 2001 to 16.1% in 2002. Purchased
billing services decreased approximately $1.1 million due to (i) the conversion
of these services to an in-house billing department at one of the Northeastern
contracted radiology practices in 2002 and (ii) billing services no longer
provided for professional services at two of the contracted radiology practices.

Bad Debt Expense

Bad debt expense decreased $300,000, from $12.7 million in 2001 to $12.4
million in 2002. As a percentage of service fee revenue, these costs were 9.5%
and 8.5% in 2001 and 2002, respectively. Since service fee revenue represents
contracted radiology practices' and diagnostic imaging centers' revenue less
amounts retained by contracted radiology practices, these percentages are
inherently at a higher stated value. Therefore, bad debt expense should be
compared for 2001 and 2002 as a percentage of revenue of the contracted
radiology practices and diagnostic imaging centers, net of contractual
allowances, rather than as a percentage of service fee revenue. As a percentage
of revenue of the contracted radiology practices and diagnostic imaging centers,
bad debt expense was 6.7% and 6.2% in 2001 and 2002, respectively.

21

Corporate General and Administrative

Corporate general and administrative expenses increased $1.4 million, from
$6.5 million in 2001 to $7.9 million in 2002. As a percentage of service fee
revenue, these costs were 4.9% and 5.4% in 2001 and 2002, respectively. The
increase in these costs is primarily due to the further development of our
infrastructure at the corporate office during the latter part of 2001, including
additional employees and associated employee benefits and incentive
compensation.

Depreciation and Amortization

Depreciation and amortization expense increased $1.1 million, from $11.5
million in 2001 to $12.6 million in 2002. As a percentage of service fee
revenue, these costs were 8.5% and 8.6% in 2001 and 2002, respectively. The
increase in depreciation expense is primarily attributable to the purchase in
December 2001 of equipment previously held under operating leases. This is
partially offset by a decrease in amortization due to the adoption at SFAS No.
142, "Goodwill and Other Intangible Assets" effective January 1, 2002. As a
result, $28.5 million of intangible assets, primarily related to acquired
intangible assets with an indefinite useful life, are no longer amortized as
expenses of operations, but rather carried on the balance sheet as permanent
assets.

Interest Expense, net

Interest expense, net, increased $1.2 million, from $8.5 million in 2001 to
$9.7 million in 2002. The increase is due to higher interest costs associated
with our senior notes issued in December 2001.

Income Tax Expense

Income tax expense of $5.0 million in 2001 and $6.1 million in 2002 was
based on a 40% effective tax rate.

Net Income

Net income increased from $7.5 million in 2001 to $9.2 million in 2002. Net
income as a percentage of service fee revenue was 6.3% in 2002, which increased
from 5.6% in 2001.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity for the six months ended June 30, 2002, was derived principally
from net cash proceeds from operating activities. As of June 30, 2002, we had
net working capital of $63 million, including cash and cash equivalents of $18.4
million. We had current assets of $102 million and current liabilities of $39
million, including current maturities of long-term debt and capital lease
obligations of $4.6 million. For the six months ended June 30, 2002, we
generated $20.4 million in net operating cash flow, invested $9.6 million and
used cash of $3.2 million in financing activities.

Net cash from operating activities for the six months ended June 30, 2002 of
$20.4 million decreased slightly from the $22 million for the same period in
2001 due to the effect of higher interest costs paid in 2002 versus 2001.
Increased collections of accounts receivable, as well as the implementation of
certain cash management strategies, resulted in a decrease in accounts
receivable days outstanding from 70 days at June 30, 2001 to 68 days at June 30,
2002.

Net cash used in investing activities for the six months ended June 30, 2002
was $9.6 million. Net cash used in investing activities for the six months ended
June 30, 2001 was $2.5 million. Purchases of property and equipment during the
six months ended June 30, 2001 and 2002 were $3.6 million and $10.1 million,
respectively.

Net cash flows used in financing activities for the six months ended June
30, 2001 and 2002 were $22.6 million and $3.2 million, respectively. At June 30,
2002, we had outstanding borrowings of $160 million under our senior notes,
$14.7 million outstanding under our convertible debt obligations and an
additional $8.5 million in other debt obligations.

22

In December 2001, we terminated our senior credit facility with proceeds
from a $160 million senior notes ("Senior Notes") issuance, due December 15,
2008. In connection with the repayment at December 2001, we recorded an
extraordinary loss from the early extinguishment of our senior credit facility
in the amount of $4.7 million, $2.8 million after tax. The Senior Notes bear
interest at an annual rate of 10 1/2% payable semiannually in arrears on June 15
and December 15 of each year, and commenced June 15, 2002. The Senior Notes are
redeemable on or after December 15, 2005 at various redemption prices, plus
accrued and unpaid interest to the date of redemption. The Senior Notes are
unsecured obligations which rank senior in right of payment to all of our
subordinated indebtedness and equal in right of payment with all other senior
indebtedness. The Senior Notes are unconditionally guaranteed on a senior
unsecured basis by certain restricted existing and future subsidiaries.

In addition to the Senior Notes issuance in December 2001, we entered into a
credit facility whereby we can borrow up to $35 million. At June 30, 2002, no
borrowings were outstanding under the credit facility. Under the credit
facility, the interest rate is (i) an adjusted LIBOR rate, plus an applicable
margin, which can vary from 3.0% to 3.5%, or (ii) the prime rate, plus an
applicable margin, which can vary from 1.75% to 2.25%. In each case, the
applicable margin varies based on financial ratios maintained by us. The credit
facility includes certain restrictive covenants, including prohibitions on the
payment of dividends, limitations on capital expenditures and the maintenance of
certain financial ratios (including minimum fixed charge coverage ratio and
maximum leverage ratio, as defined). Borrowings under the credit facility are
secured by all service agreements to which we are a party, a pledge of the stock
of our subsidiaries and all of our assets.

We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations, particularly the initial
start-up and development expense of new diagnostic imaging centers and the
acquisition of additional centers and new diagnostic imaging equipment. To the
extent we are unable to generate sufficient cash from our operations, funds are
not available under our credit facility or we are unable to structure or obtain
operating leases, we may be unable to meet our capital expenditure requirements.
Furthermore, we may not be able to raise any necessary additional funds through
bank financing or the issuance of equity or debt securities on terms acceptable
to us, if at all.

Forward-Looking Statements

Throughout this report we make "forward-looking statements" within the
meaning of Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking
statements include words such as "may," "will," "would," "could," "likely,"
"estimate," "intend," "plan," "continue," "believe," "expect" or "anticipate"
and other similar words and include all discussions about our acquisition and
development plans. We do not guarantee that the transactions and events
described in this report will happen as described or that any positive trends
noted in this report will continue. The forward-looking statements contained in
this report are generally located in the material set forth under the heading
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", but may be found in other locations as well. These forward-looking
statements generally relate to our plans, objectives and expectations for future
operations and are based upon management's reasonable estimates of future
results or trends. Although we believe that our plans and objectives reflected
in or suggested by such forward-looking statements are reasonable, we may not
achieve such plans or objectives. You should read this report completely and
with the understanding that actual future results may be materially different
from what we expect. We will not update forward-looking statements even though
our situation may change in the future.

Specific factors that might cause actual results to differ from our
expectations include, but are not limited to:

o economic, competitive, demographic, business and other conditions in
our markets;

o a decline in patient referrals;

o changes in the rates or methods of third-party reimbursement for
diagnostic imaging services;

o the termination of our contracts with radiology practices;

o the availability of additional capital to fund capital expenditure
requirements;

o burdensome lawsuits against our contracted radiology practices and us;

o reduced operating margins due to our managed care contracts and
capitated fee arrangements;

o any failure by us to comply with state and federal anti-kickback and
anti-self referral laws or any other applicable healthcare
regulations;

o our substantial indebtedness, debt service requirements and liquidity
constraints; and

o risks related to our notes and healthcare securities generally.

23

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's cash equivalents, Credit Facility, and its
convertible notes.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Radiologix's 2002 annual stockholders meeting was held on June 11, 2002. The
following individuals were elected as directors and the appointment of Ernst &
Young LLP as independent public accountants was ratified, by the votes indicated
below:

Appointment of Ernst & Young LLP For: 18,332,953 Against: 185,901 Abstain: 142

24

PART II: OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits. The list of exhibits filed as part of this report is
incorporated by reference to the Index to Exhibits at the end of this
report.

(b) Reports on Form 8-K. The registrant filed no Current Reports on Form
8-K during the quarter for which this report is filed.

25

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

RADIOLOGIX, INC.

Date: August 14, 2002 /s/ MARK L. WAGAR
-------------------------------------
Mark L. Wagar
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)

Date: August 14, 2002 /s/ SAMI S. ABBASI
-------------------------------------
Sami S. Abbasi
Chief Financial Officer and
Executive Vice President
(Principal Accounting Officer)

26

INDEX TO EXHIBITS

- ----------

* Filed herewith.

** Incorporated by reference to Exhibits 4.1, 10.1, 10.3 and 10.5 through
10.19, respectively, to the registrant's Registration Statement No.
333-31611 on Form S-4.

*** Incorporated by reference to the corresponding Exhibit number to the
registrant's Registration Statement No. 333-30205 on Form S-1.

@ Incorporated by reference to Exhibits 2.1, 4.1 and 4.2, respectively,
to the Registrant's Form 8-K filed on August 3, 1999.

27