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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
___________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended October 31, 2002 Commission File Number 0-19019
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PRIMEDEX HEALTH SYSTEMS, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
New York 13-3326724
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1510 Cotner Avenue
Los Angeles, California 90025
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (310) 478-7808
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Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities and 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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [X]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant was approximately $12,398,113
on January 21, 2003 based on the closing price for the common stock in the
over-the-counter bulletin board bulletin board market on said date.
The number of shares of the registrant's common stock outstanding on January 21,
2003 was 41,100,734 shares (excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits are incorporated herein by reference as set forth in Item
14(b), Exhibits, in Part IV.
PART I
ITEM 1. BUSINESS
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BACKGROUND
Primedex Health Systems, Inc. ["PHS" or the "Company"] is a New York
corporation organized in 1985 with its executive offices located at 1510 Cotner
Avenue, Los Angeles, California 90025 where its telephone number is
310-478-7808.
Through its 58 California diagnostic imaging facilities (eight of
which are wholly-owned by the Company's 91% owned Diagnostic Imaging Services,
Inc. ["DIS"] subsidiary and three in partnerships or limited liability companies
with radiologists who provide services at the partnership or limited liability
company location), the Company operates a network of centers through its RadNet
(R) Management, Inc. subsidiary which arranges for the non-medical aspects of
medical imaging offering MRI, CT, PET, ultrasound, mammography, nuclear medicine
and general diagnostic radiology to the public.
CENTER MANAGEMENT
The Company's wholly-owned subsidiary, RadNet (R) Management, Inc.
["RadNet (R)"], manages the Company's network of 58 medical imaging centers. 50
of the imaging centers are located in Southern California [with three centers
located in Beverly Hills and known as the Tower Imaging Division] with the
remaining eight centers located in northern California. At all the centers,
except three, the Company provides the imaging center facilities and equipment
as well as all non-medical operational, management, financial and administrative
services. At the three partnership or limited liability company centers, RadNet
(R) performs non-medical management services. At all of the Company's centers,
the medical services and medical supervision are provided by various independent
physicians and physician groups [at most of the centers, the medical services
are provided by Beverly Radiology Medical Group ["BRMG"] [see "Item 13"]]. As
compensation for its management and other services at the various centers,
RadNet (R) receives a management fee. In connection with the imaging centers in
which it is a partner, RadNet (R), in addition to a management fee, also shares
in the entity's net income.
DIAGNOSTIC IMAGING MODALITIES
Diagnostic imaging involves the use of less-invasive techniques to
generate representations of internal anatomy that can be recorded on film or
digitized for display on a video monitor. Diagnostic imaging procedures
facilitate the early diagnosis of diseases and disorders, often minimizing the
cost and amount of care required for patients. Diagnostic imaging procedures
include: magnetic resonance imaging (or MRI), computed tomography (or CT),
positron emission tomography (or PET), nuclear medicine, ultrasound,
mammography, general radiography (or x-ray) and fluoroscopy.
The following are the principle medical diagnostic procedures performed
on patients at the various imaging centers owned by the Company. The patient is
normally referred to the center for such diagnostic procedures by his or her
treating physician who may be independent or may be affiliated with an
Independent Physician Association ["IPA"], a Health Maintenance Organization
["HMO"], a Preferred Provider Organization ["PPO"], or a similar organization
which has contracted for such services. See "Marketing" herein. Not all of such
procedures are performed at each center. X-ray and fluoroscopy are the most
frequently used imaging modalities.
DIAGNOSTIC RADIOLOGY OR X-RAY- X-ray employing x-ray radiation on two
planes; including fluoroscopy and endoscopy. X-ray is the most common energy
source used in imaging the body and is utilized in the following modalities (i)
conventional x-ray typically used to image bones and contrast enhanced
vasculature and organs; (ii) CT scanners utilize computers to produce
cross-sectional images of particular organs or areas of the body; and (iii)
digital x-ray systems add computer image processing capability to conventional
x-ray systems.
2
COMPUTED AXIAL TOMOGRAPHY [CT] - CT is 100 times more sensitive than
conventional x-ray. It is used to view inside any of the body's organs,
including the brain, to detect abnormalities and disease. CT focuses an x-ray on
a specific plane of the body, processes the image by computer, and constructs a
picture on a monitor, and later on film. Tissues of various density appear as
different shades of gray, bone [the most dense] as white, and air and fluid is
black. The procedure is painless and takes between 15 minutes and 45 minutes per
study; more than one study is often ordered on each patient. The patient simply
lies on a special, monitored table which is guided into the scanner. Some CT
studies involve the use of an injected contrast agent to better visualize
anatomy and pathology. Although it is very unusual, some patients may develop a
significant reaction to the contrast and in rare cases fatalities have resulted.
To determine patients most likely to have an adverse reaction all patients are
required to answer a questionnaire. Additionally, the Company primarily uses
non-ionic CT contrast agents to minimize contrast reactions. A CT system costs
in the range of $300,000 to $1,200,000, depending upon the specific performance
characteristics of the system.
MAGNETIC RESONANCE IMAGING [MRI] - Diagnostic imaging based on
magnetism rather than radiation or conventional x-ray. MRI has become widely
accepted as the standard diagnostic tool for a wide and fast-growing variety of
clinical applications for soft tissue anatony (as found in the brain, spinal
cord and interior ligaments of body joints such as the knee). MRI takes between
20 to 45 minutes per examination and is painless, requiring only that the
patient lie still on a motorized table that slides into a long cylinder. On some
MRI studies, an injected contrast agent is used, and some require the use of
special "coils," permitting highly accurate scanning of a particular part of the
body. MRI systems cost between $900,000 and $2,500,000 each, depending upon the
system configuration, magnet design and field strength. There are no presently
known hazards to the general population in connection with normal use of MRI
(although the scanning of pregnant women is only done under limited
circumstances and patients with cardiac pacemakers or ferrous clips used in
surgical procedures are generally excluded from MRI procedures as well as the
area surrounding the MRI).
OPEN MRI - Technological advances in software and equipment technology
for MRI systems have allowed open design equipment to offer significantly
improved image quality. Most open MRI systems use permanent electromagnetic
technology, which substantially lowers both sitting and service costs, but does
not provide images as efficiently as high-field MRI systems. Recently, reliable
high-field open MRI systems have also become available. The open design allows
for studies not normally possible in conventional MRI systems, including exams
of infants, pediatric patients, claustrophobic patients, large or obese patients
and patients suffering from post-traumatic stress syndrome. Open MRI is also
capable of conducting musculoskeletal exams that require the patient to move or
flex, such as kinematic knee studies. A typical open MRI non-kinematic exam
takes from 45 to 90 minutes. Open MRI systems are priced in the range of
$600,000 to $1,500,000 each.
POSITION EMISSION TOMOGRAPHY (PET). PET scanning involves the
administration of a radiopharmaceutical agent with a positron-emitting isotope
and the measurement for the distribution of that isotope to create images for
diagnostic purposes. PET scans provide the capability to determine how metabolic
activity impacts other aspects of physiology in the disease process by
correlating the reading for the PET study with other studies such as CT or MRI.
PET technology has been found highly effective and appropriate in certain
clinical circumstances for the detection and assessment of tumors throughout the
body, the evaluation of certain cardiac conditions and the assessment of
epilepsy seizure sites. The information provided by PET technology often
obviates the need to perform further highly invasive and/or diagnostic surgical
procedures. Interest in PET scanning has increased recently due to several
factors including: expansion of available hardware options through the
introduction of dual head gamma camera coincidence detection; increased payor
coverage and reimbursement; the availability of the isotopes without an in-house
cyclotron; and a growing recognition by clinicians that PET is a powerful
diagnostic tool that can be used to evaluate and guide management of a patient's
disease. PET systems are priced in the range of $1,000,000 to $2,000,000 each.
Distribution networks have been established across the United States to ensure
consistent availability of and access to the isotopes.
MAMMOGRAPHY - Mammography is a specialized form of radiology utilizing
low dosage x-rays to visualize breast tissue and is the primary screening tool
for breast cancer. Mammography procedures and related services assist in the
diagnosis and treatment planning for breast cancer.
3
NUCLEAR MEDICINE - Nuclear medicine involves the use of a small amount
of radioactive material and is used to obtain information about the anatomy and
functioning of various organs. Nuclear medicine is based on the principle that
organs absorb or concentrate scientific minerals or hormones. These substances
are not visualized on conventional x-ray, but if they are made radioactive by
the addition of a radioisotope, they can be seen. If an organ is not functioning
properly, too little or too much of the substance will be taken up or
concentrated in some parts of the organ, but not other parts. The organ will
thus appear different on a screen. The amount of radiation is extremely low, and
the isotope usually disappears from the body within a day or less.
ULTRASOUND - Ultrasound imaging that uses sound waves and their echoes
to visualize and locate internal organs. It is particularly useful in viewing
soft tissues that do not x-ray well. Ultrasound is used in pregnancy to avoid
x-ray exposure as well as in gynecological, urologic, vascular, cardiac and
breast applications.
BUSINESS STRATEGY
The Company believes that the diagnostic imaging services industry
will continue to grow as a result of:
THE ESCALATING DEMAND FOR HEALTHCARE SERVICES FROM AN AGING
POPULATION. There has been strong demand for healthcare services due to an aging
population in the United States. According to the United States Census Bureau,
one of the fastest growing segments of the population is the group over 65 years
of age, which is expected to increase as much as 16% from 2000 to 2010. The
Company believes the aging population will help drive the growth for diagnostic
imaging procedures over the coming years because diagnostic imaging utilization
tends to increase as a person ages.
THE INCREASING ROLE OF DIAGNOSTIC IMAGING IN HEALTHCARE. Advanced
imaging equipment and modalities are allowing physicians to diagnose a wide
variety of diseases and injuries quickly and accurately without exploratory
surgery or other surgical or invasive procedures, which are usually more
expensive, involve greater risk to patients and result in longer rehabilitation
time. The Company believes that future technological advances will continue to
enhance the ability of radiologists to diagnose and influence treatment. In
addition, advanced imaging systems are gaining wider acceptance among payors, as
they are increasingly seen and accepted as a tool for reducing long-term
healthcare costs.
GREATER CONSUMER AWARENESS OF AND DEMAND FOR PREVENTIVE DIAGNOSTIC
SCREENING. Diagnostic imaging is increasingly being used as a screening tool for
preventative care. Consumer awareness of and demand for diagnostic imaging as a
less-invasive and preventive screening method has added to the growth in
diagnostic imaging procedures. Consumers are now more aware of the advanced
procedures that area available to them and are requesting them as preventive
procedures from their physicians and healthcare providers. The Company believes
that, with increased technological advancements, there will be greater consumer
awareness of and demand for diagnostic imaging procedures as preventive and
less-invasive procedures for early diagnosis of diseases and disorders.
AN INCREASED NUMBER OF HIGH-END PROCEDURES THAT UTILIZE ADVANCEMENTS
IN TECHNOLOGY. Recent technological advancements include: magnetic resonance
spectroscopic imaging, which can differentiate malignant from benign lesions;
magnetic resonance angiography, which can produce three-dimensional images of
body parts and assess the status of blood vessels; and enhancements in
teleradiology systems, which permit the digital transmission of radiological
images from one location to another for interpretation. Additional improvements
in imaging technologies, contrast agents and scanning capabilities are leading
to new, less invasive methods of diagnosing diseases and certain vascular
abnormalities without exploratory surgery.
4
The Company's strategy is to further develop and expand its
California regional diagnostic imaging network emphasizing quality of care,
producing cost-effective diagnostic information and providing superior service
and convenience to its customers. The strategy of the Company is focused on the
following components: (i) to further participate in the consolidation occurring
in the diagnostic imaging industry by continuing to build its market presence in
its existing California diagnostic imaging networks through geographically
disciplined acquisitions; (ii) to continue to market diagnostic imaging
applications through its existing facilities to optimize and increase overall
procedure volume; (iii) to further develop its network communication systems so
as to efficiently transfer imaging data from one location to another as a tool
in addressing the continuing radiologist shortage and improving the overall
quality of care; and (iv) to strengthen and improve its marketing to managed
care customers on a regional basis. Additionally, the Company will consider
developing or acquiring additional regional networks outside California in
strategic locations where the Company can offer a broad range of services to
customers and realize increased economies of scale utilizing the management
programs developed in California.
RECENT IMAGING CENTER OPENINGS AND ACQUISITIONS
In late November, 2001, the Company opened a new facility located in
Burbank, California. The Company owns 75% of the facility with the radiologists
providing services at the center owning the remaining 25%. The center offers
MRI, Open MRI, CT, ultrasound and x-ray services.
In January 2002, the Company opened a second facility located in
Tarzana, California. The new center offers Open MRI, CT and PET.
In May, 2002, the Company acquired Grove Diagnostic Imaging located in
Rancho Cucamonga, California. The center offers MRI, CT, ultrasound, mammography
and x-ray.
In September, 2002, the Company opened two additional locations in
Orange, California. One new center offers MRI, PET, nuclear medicine and x-ray.
The second location, a Women's Center offers ultrasound and mammography.
In December, 2002, the Company opened a new facility located in Rancho
Bernardo, California. The Company owns 75% of the facility with the radiologists
providing services at the center owning the remaining 25%. The center offers
MRI, CT, ultrasound and x-ray services.
5
IMAGING CENTERS AND EQUIPMENT
The following table indicates as of October 31, 2002, the quantity of
principal diagnostic equipment available at each of the imaging centers in which
the Company has a management and/or ownership interest.
Mammo- Ultra- Diagnostic Nuclear
Center MRI Open MRI CT PET graphy sound Radiology Medicine
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Tower Division:
Roxsan 1 - 1 - - - - 3
Wilshire 2 1 1 - - 3 4 -
Women's - - - - 4 1 - -
Antelope Valley 1 - - - - - - -
Burbank 1 1 1 - - 2 1 -
Camarillo* - - - - 1 2 2 -
Chino 1 - - - - - - -
Emeryville - 1 - - - - - -
Fresno 1 - 1 - 1 2 3 -
La Habra 1 - 1 - - - - -
Lancaster
[Four Sites] - 1 1 - 3 4 6 -
Long Beach
[Seven Sites] 1 - 1 - 2 6 10 -
Modesto 1 - 1 - 2 4 3 -
Northridge 1 - 1 - 1 3 3 1
Oceanside*
[North County] 1 - 1 - - - - -
Orange
[Four Sites] 2 - 1 1 3 6 5 1
Oxnard - 1 - - 2 1 2 -
Palm Desert
[Three Sites] 1 - 1 - 1 2 4 -
Palm Springs
[Two Sites] - 1 - - 2 3 3 -
Rancho
Bernardo - 1 1 - - 1 1 -
Rancho
Cucamonga
[Two Sites] 1 - 1 - 2 2 4 -
Riverside*
[Two Sites] 1 1 1 - 2 3 4 -
Sacramento 1 - 1 - 1 1 2 -
San Francisco - 1 - - - - - -
San Gabriel
Valley 1 - 1 - - 1 - -
Santa Clarita - 1 1 - 2 1 1 -
Santa Rosa 1 - 1 - - 1 - -
Stockton - 1 1 - 1 2 2 -
Tarzana
[Two Sites] 1 1 - 1 - - - -
Temecula*
[Three Sites] 1 - 1 - 3 3 5 -
Thousand
Oaks* 1 - 1 - 2 3 2 2
Tustin - 1 - - - - 1 -
Vacaville - 1 1 - 1 1 1 -
Ventura
[Four Sites] 1 - 1 1 3 5 8 1
Westchester 1 1 1 - 1 1 2 -
*Indicates a DIS facility
The Company also has two mobile MRI's currently at locations near Westchester
and Tarzana.
6
MANAGEMENT SERVICES AND COMPENSATION
The Company has entered into management agreements with respect to its
imaging centers with various physicians and physician groups [the "Physician
Group"]. Pursuant to the typical management agreement, the Company makes
available the imaging center facilities and all of the furniture and medical
equipment at such facilities for use by the Physician Group and the Physician
Group is responsible for staffing the center with qualified medical personnel.
In addition, the Company provides management services and administration of the
non-medical functions and services relating to the medical practice at the
center including among other functions, provision of clerical and administrative
personnel, bookkeeping and accounting services, billing and collection,
provision of medical and office supplies, secretarial, reception and
transcription services, maintenance of medical records, advertising, marketing
and promotional activities and the preparation and filing of all forms, reports
and returns required in connection with unemployment insurance, workers'
compensation insurance, disability, social security and similar laws. As
compensation for the services furnished under the management agreement, the
Company is paid a management fee equal to an agreed percentage of the medical
practice billings, as and when collected, varying between 70% to 85% of such
collections.
At the partnership and limited liability company imaging centers,
RadNet has entered into a management agreement to provide management,
administrative and billing and collection services for a management fee which is
a percent of the gross monthly receipts received for services performed at the
center. In addition, as a joint venture partner, the Company is entitled to 50%
to 75% of income after a deduction of all expenses including amounts paid for
medical services and medical supervision, varying based upon the Company
ownership interest.
At most of the Company's imaging centers, the medical services
including medical supervision are supplied by Beverly Radiology Medical Group
["BRMG"]. BRMG is 99% owned by Dr. Howard Berger [see "Items 11, 12 and 13"].
RadNet (R) has a Management and Services Agreement with BRMG for a ten-year term
until June 2012, terminable prior thereto at RadNet's election upon the
occurrence of certain events including a change in BRMG's ownership such that
Dr. Berger is no longer an owner in the aggregate of at least 60% of the equity
ownership of BRMG. As compensation for its services furnished under the
Management and Services Agreement, BRMG has agreed to pay a management fee to
the Company equal to 74% of its medical practice receipts at the contracted
centers, as and when collected.
EQUIPMENT
The most expensive types of diagnostic medical equipment found at the
imaging centers owned or managed by the Company are the MRI, CT and PET systems.
As set forth in the chart under "Imaging Centers and Equipment" above, 34
centers provide MRI services 25 centers provide CT services and three centers
provide full PET services. The majority of the MRI systems, CT systems and PET
systems at the Company's imaging centers are manufactured by General Electric.
The acquisition of these systems as well as the acquisition of the other
relatively expensive diagnostic medical equipment at the various imaging centers
has been effected through various financing arrangements directly with the
manufacturer involving the use of capital leases with purchase options at
minimal prices at the end of the lease term, the issuance of long term
installment notes and the use of operating leases with purchase options at
substantial prices at the end of the lease term. At October 31, 2002, capital
lease obligations totaled approximately $64 million through October 2009
including current installments totaling approximately $11.6 million. Also at
October 31, 2002, installment notes payable totaled approximately $93 million
through August 2008 including current installments of approximately $24.6
million [including line of credit balances of approximately $10 million].
Commitments under equipment operating leases at October 31, 2002, were
approximately $8.0 million through July 2007 [excluding fair market value buyout
options at the end of the lease term], including current obligations of
approximately $2.3 million. To the extent additional imaging centers are opened
or acquired, these obligations could materially increase.
7
The MRI, CT and PET systems and the other diagnostic medical equipment at the
imaging centers owned or managed by the Company are subject to technological
obsolescence as medical imaging is a field in which there is constant
development of new techniques and technologies. As a result the Company
continues to evaluate the mix of its equipment in response to changes in
technology and to maximize utilization of its equipment. The overall
competitiveness of the Company's equipment continually improves through
upgrades, disposal and/or trade-in of older equipment and the purchase or
leasing of new equipment. Timely, effective maintenance is essential for
achieving high utilization rates of equipment. Most equipment is first covered
by a one year warranty from the manufacturer. Thereafter, the Company maintains
an agreement with GE Medical Systems ("GEMS") whereby GEMS has agreed to be
responsible for the maintenance and repair of a majority of the Company's
equipment based upon a percentage of the Company's revenues. The Company
believes this to be an effective method for controlling this cost.
MARKETING
The patients who undergo diagnostic medical imaging procedures at the
various Company owned or managed imaging centers are generally referred by
individual independent physicians, by Independent Physician Associations
["IPAs"] consisting of groups of physicians, and by Health Maintenance
Organizations ["HMOs"], Preferred Provider Organizations ["PPOs"], and similar
organizations which enroll subscribers on a contractual basis to whom they
deliver healthcare services. Such organizations attempt to control the cost of
healthcare services by directing their enrollees to participating physicians and
institutions and often through aggressive utilization review and limitations on
access to physician specialists, attempt to further limit the cost of medical
service delivery. Such organizations typically develop, on a regional basis,
where an appropriate enrollee population and mix of participating physicians and
institutions are available.
The Company currently employs 15 full-time marketing and sales
personnel who are compensated on a salary or salary plus commission basis and
who periodically inform the medical community including individual physicians
and the administrators of IPAs, HMOs, PPOs, and similar organizations throughout
California as to the services provided at the Company's imaging centers.
Patients are obtained by direct referral or through contract. Some contracts,
referred to as "capitation contracts", provide for a fixed fee per organization
member, which is paid to the medical service provider. Under a "capitation"
contract, the provider agrees to provide specified services to the organization
members for a fixed, predetermined payment per member for a specified time
period [usually one year], regardless of how many times the member uses the
service. No assurances can be given that any of the current or future
"capitation" contracts will be profitable as there is a possibility that
management could underestimate the number of times the services at its imaging
centers will be used by the contracting organization's members during the
contract term.
COMPETITION
The health care industry in general, and the market for diagnostic
imaging services in particular, is highly competitive. The Company competes
principally on the basis of its reputation for productive and cost-effective
quality services. The Company's operations must compete with groups of
radiologists, established hospitals and certain other independent organizations,
including equipment manufacturers and leasing companies, that own and operate
imaging equipment. The Company's major competitors include Radiologix, Inc.,
Alliance Imaging, Inc., HEALTHSOUTH Corporation, Insight Health Services and
Syncor International Corporation. Many of the Company's direct competitors that
provide contract diagnostic imaging services may have access to greater
financial resources than the Company.
In addition, in the past some non-radiologist physician practices have
refrained from establishing their own diagnostic imaging centers because of the
federal physician self-referral legislation. Final regulations issued in January
2001 clarify certain of the exceptions to the physician self-referral
legislation, which may create opportunities for and encourage some physician
practices to establish their own diagnostic imaging centers within their group
practices which may compete with the Company.
8
COMPETITIVE STRENGTHS
The Company believes that it is well-positioned to take advantage of
favorable demographic and diagnostic imaging services industry trends by
capitalizing on the following strengths:
A LEADING MARKET POSITION IN SOUTHERN AND CENTRAL CALIFORNIA. The
Company has a concentrated presence in its core Southern California and Central
California markets, which enables it to offer patients, referring physicians and
payors a higher degree of responsiveness and convenience than independent
operators or hospitals. The Company provides flexible scheduling and convenient
locations, as well as the expeditious delivery of radiology reports to referring
physicians. The Company believes that payors contract with it because of its
strong market presence, the high quality of services and its ability to provide
a single point of contact and centralized administration. In addition, its
leading position enables it to increase procedure volume, optimize equipment
utilization, benefit from economies of scale in purchasing and negotiation of
payor contracts and leverage its administrative and information technology
infrastructure in its market.
COMPREHENSIVE, LEADING-EDGE DIAGNOSTIC IMAGING SERVICES. The Company
provides a broad range of diagnostic imaging services within its market. The
Company's 58 centers enable it to offer one-stop shopping to patients, referring
physicians and payors. In the Company's experience, referring physicians and
payors prefer to enter into relationships with diagnostic imaging providers that
offer a broad spectrum of services at convenient locations, benefiting referring
physicians and patients who require more than one type of diagnostic imaging
procedure.
STRONG RELATIONSHIPS WITH LEADING RADIOLOGY PRACTICES. In each of the
Company's markets, the Company contracts with leading radiology practices to
provide professional radiology services in connection with its diagnostic
imaging centers. Its close affiliation with Beverly Radiology Medical Group
permits it to influence the employment of excellent radiologists by that Group.
Additionally, the Company believes that its affiliation with these leading
radiology practices enhances its reputation with referring physicians and their
patients. In light of a recent shortage of radiologists, the Company believes
that its contractual relationship with large, established radiology practices
are important to maintaining its high quality services. Furthermore, the
Company's acquisition of sophisticated communication equipment permits it to
move professional interpretation services from a busy location to a less busy
location and to effectively utilize preeminent specialist radiologists with
respect to certain issues regardless of the location of the patients.
EXPERIENCED MANAGEMENT TEAM. The Company has a highly experienced
management team with an average in excess of 20 years of healthcare services
experience. Management has successfully generated growth by increasing same
center revenue and executing a disciplined expansion strategy.
CUSTOMERS AND FEES
The Company's operations are principally dependent on the Company's
ability to attract referrals from physicians and other health care providers.
The Company's eligibility to provide service in response to a referral is often
dependent on the existence of a contractual arrangement with the referred
patient's insurance carrier or other payor organization. The Company currently
has in excess of 600 contracts with various payor organizations for diagnostic
imaging services provided at the Company's centers primarily on a discounted
fee-for-service basis. Managed care contracting has become very competitive and
reimbursement schedules are at or below Medicare reimbursement levels. A
significant decline in referrals and/or reimbursement rates would adversely
affect the Company's business, financial condition and results of operations. In
this regard, Medicare has determined to reduce its reimbursement rates for
calendar year 2003 diagnostic imaging services on an average of 4.4% for the
various procedures involved. The impact of this decrease will be offset to some
extent by a significant increase in the practice expense for technical component
services. A review of the reduction in relation to the services offered by the
Company indicates that the impact on the Company will likely be about a 2%
reduction in Medicare payments, although its exact impact cannot presently be
determined.
9
REIMBURSEMENT OF HEALTH CARE COSTS
MEDICARE AND MEDICAID REIMBURSEMENT PROGRAM. The Company's revenue is
derived through its ownership, operation and management of diagnostic imaging
centers and from service fees paid to it by contracted radiology practices.
During the year ended October 31, 2002, approximately 15% of net revenue
generated at the Company's diagnostic imaging centers was derived from
government sponsored healthcare programs (principally, Medicare and Medicaid).
As of January 2002, Medicare decreased reimbursement rates for
physician and outpatient services, including diagnostic imaging services. In
March 2003, the Centers for Medicare and Medicaid Services ("CMS"), formerly
known as the Health Care Financing Administration, Department of Health and
Human Services, will reduce reimbursement for certain diagnostic imaging
services by up to approximately 4.4% depending on the type of diagnostic imaging
services provided. The Company has reviewed the procedures involved and does not
believe the reduction will have a material negative impact on the Company's
revenues. The Company's centers are principally dependent on the Company's
ability to attract referrals from primary care physicians, specialists and other
healthcare providers. The referral often depends on the existence of a
contractual agreement with the referred patient's health benefit plan.
Any further change in Medicare or Medicaid rates or conditions for
reimbursement could substantially reduce the amounts reimbursed to the Company
or its contracted radiology practices for services provided. These reductions
could have a significant adverse effect on Company revenue and financial results
by creating downward pricing pressure.
MANAGED CARE. Health Maintenance Organizations ("HMOs") and Preferred
Provider Organizations ("PPOs") attempt to control the cost of health care
services. Managed care contracting has become very competitive and reimbursement
schedules are at or below Medicare reimbursement levels. The development and
expansion of HMOs, PPOs and other managed care organizations within the
Company's network could have a negative impact on utilization of the Company's
services and/or affect the revenue per procedure which the Company can collect,
since such organizations will exert greater control over patients' access to
diagnostic imaging services, the selections of the provider of such services and
the reimbursement thereof. The Company also expects that the excess capacity of
equipment in California may negatively impact operations because of the
competition among health care providers for contracts with all types of managed
care organizations. As a result of such competition, the term length of any
contracts in which the Company may obtain, and the payment to the Company for
such services, may also be negatively affected.
PRIVATE INSURANCE. Private health insurance programs generally have
authorized the payment for the Company's services on satisfactory terms and CMS
has authorized reimbursement under the federal Medicare program for
substantially all diagnostic imaging and treatment services currently being
provided by the Company. However, if Medicare reimbursement is reduced, the
Company believes that private health insurance programs will also reduce
reimbursement in response to reductions in government reimbursement, which could
have an adverse impact on the Company's business, financial condition and
results of operations.
CORPORATE LIABILITY AND INSURANCE
The Company may be subject to professional liability claims including,
without limitation, for improper use or malfunction of its diagnostic imaging
equipment. The Company maintains insurance policies with coverages that it
believes are appropriate in light of the risks attendant to its business and
consistent with industry practice. The Company also requires the contracted
radiology practices to maintain sufficient professional liability insurance
consistent with industry practice. Currently, the Company and BRMG maintain
medical malpractice coverage of $1,000,000 per claim per doctor and $3,000,000
in the aggregate, with a $10,000 deductible, with other non BRMG contracted
radiologists required to carry at least similar coverage. However, adequate
liability insurance may not always be available to the Company and the
contracted radiology practices in the future at acceptable costs or at all.
10
Providing medical services entails the risk of professional malpractice
and other similar claims. The physicians employed by the contracted radiology
practices are from time to time subject to malpractice claims. The Company
structures its relationships with the practices under its agreements with them
in a manner that the Company believes does not constitute the practice of
medicine by it nor subject the Company to professional malpractice claims for
acts or omissions of physicians in the contracted radiology practices.
Nevertheless, claims, suits or complaints relating to services provided by the
contracted radiology practices may be asserted against the Company in the
future, including malpractice.
Any claim made against the Company not fully covered by insurance could
be costly to defend against, result in a substantial damage award against the
Company and divert the attention of management from operations, which could have
an adverse effect on its financial performance. In addition, claims might
adversely affect the Company's business or reputation.
The Company maintains general liability and umbrella coverage in
commercially reasonable amounts. Additionally, it maintains workers'
compensation insurance on all employees. Coverage is placed on a statutory basis
and responds to California's specific requirements.
EMPLOYEES
At October 31, 2002, the Company had a total of 913 full-time and 311
part-time or per-diem employees of whom 12 served in executive positions, 488
supplied technical and managerial services at the various imaging centers, and
724 provided administrative, transcription, clerical and similar services.
None of the Company's employees are subject to a collective bargaining
agreement nor had the Company experienced any work stoppages. The Company
believes that its employee relations are good.
GOVERNMENT REGULATION
GENERAL. The healthcare industry is highly regulated, and the Company
can give no assurance that the regulatory environment in which it operates will
not change significantly in the future. The Company's ability to operate
profitably will depend in part upon the Company, the contracted radiology
practices and their affiliated physicians obtaining and maintaining all
necessary licenses, and other approvals and operating in compliance with
applicable healthcare regulations. The Company believes that healthcare
regulations will continue to change. Therefore, the Company monitors
developments in healthcare law and modifies its operations from time to time as
the business and regulatory environment changes. Although the Company intends to
continue to operate in compliance, it cannot ensure that it will be able to
adequately modify its operations so as to address changes in the regulatory
environment.
LICENSING AND CERTIFICATION LAWS. Ownership, construction, operation,
expansion and acquisition of diagnostic imaging centers are subject to various
federal and state laws, regulations and approvals concerning licensing of
centers and personnel.
FEE-SPLITTING; CORPORATE PRACTICE OF MEDICINE. The law of California
prohibits the Company from exercising control over the medical judgments or
decisions of physicians and from engaging in certain financial arrangements,
such as splitting professional fees with physicians. A component of the
Company's business has been to enter into service agreements with radiology
practices. The Company provides management, administrative, technical and other
non-medical services to the radiology practices in exchange for a service fee.
The structure of the relationships with the radiology practices, including the
purchase of diagnostic imaging centers, in a manner that the Company believes
keeps it from engaging in the practice of medicine or exercising control over
the medical judgments or decisions of the radiology practices or their
physicians or violating the prohibitions against fee-splitting. State regulatory
authorities or other parties may assert that the Company is engaged in the
corporate practice of medicine or that the payment of service fees to it by the
radiology practice of medicine or that the payment of service fees to it by the
radiology practices constitutes fee-splitting. If such a claim were successfully
asserted, the Company could be subject to civil and criminal penalties and could
11
be required to restructure or terminate the applicable contractual arrangements.
This result or the Company's inability to successfully restructure its
relationships to comply with these statutes could jeopardize the Company's
business strategy.
MEDICARE AND MEDICAID FRAUD AND ABUSE. Federal law prohibits the
knowing and willful offer, payment, solicitation or receipt of any form of
remuneration in return for, or to induce (i) the referral of a person, (ii) the
furnishing or arranging for the furnishing of items or services reimbursable
under the Medicare, Medicaid or other governmental programs or (iii) the
purchase, lease or order or arranging or recommending, purchasing, leasing or
ordering of any item or service reimbursable under the Medicare, Medicaid or
other governmental programs. Enforcement of this anti-kickback law is a high
priority for the federal government, which has substantially increased
enforcement resources and is scheduled to continue increasing such resources.
The applicability of the anti-kickback law to many business transactions in the
healthcare industry has not yet been subject to judicial or regulatory
interpretation. Noncompliance with the federal anti-kickback legislation can
result in exclusion from the Medicare, Medicaid or other governmental programs
and civil and criminal penalties.
The Company receives fees under its service agreements for management
and administrative services, which include contract negotiation and marketing
services. The Company does not believe it is in a position to make or influence
referrals of patients or services reimbursed under Medicare, Medicaid or other
governmental programs to radiology practices or their affiliated physicians or
to receive referrals. However, the Company may be considered to be in a position
to arrange for items or services reimbursable under a federal healthcare
program. Because the provisions of the federal anti-kickback statutes are
broadly worded and have been broadly interpreted by federal courts, it is
possible that the government could take the position that the Company's
arrangements with the contracted radiology practices implicate the federal
anti-kickback statute. Violation of the law can result in monetary fines, civil
and criminal penalties, and exclusion from participation in federal or state
healthcare programs, any of which could have an adverse effect on the Company's
business and results of operations. While the Company's service agreements with
the contracted radiology practices will not meet a "safe harbor" to the federal
anti-kickback statute, failure to meet a "safe harbor" does not mean that
agreements violate the anti-kickback statute. The Company has sought to
structure its agreements to be consistent with fair market administrative
services rendered. For these reasons, the Company does not believe that service
fees payable to it should be viewed as remuneration for referring or influencing
referrals of patients or services covered by such programs as prohibited by
statute.
Significant prohibitions against physician referrals have been enacted
by Congress. These prohibitions are commonly known as the "Stark Law." The Stark
Law prohibits a physician from referring Medicare or Medicaid patients to an
entity providing "designated health services," including, without limitations,
radiology services, in which the physician has an ownership or investment
interest or with which the physician has entered into a compensation
arrangement. The penalties for violating the Stark Law include a prohibition on
payment by these governmental programs and civil penalties of as much as $15,000
for each violative referral and $100,000 for participation in a "circumvention
scheme." The Company believes that, although it receives fees under its service
agreements for management and administrative services, it is not in a position
to make or influence referrals of patients.
On January 4, 2001, the CMS, published final regulations to implement
the Stark Law. Under the final regulations, radiology and certain other imaging
services and radiation therapy services and supplies are services included in
the designated health services subject to the self-referral prohibition. Under
the final regulations, such services include the professional and technical
components of any diagnostic test or procedure using x-rays, ultrasound or other
imaging services, computerized axial tomography, MRI, radiation therapy and
diagnostic mammography services (but not screening mammography services). The
final regulations, however, exclude from designated health services: (i) x-ray,
fluoroscopy or ultrasonic procedures that require the insertion of a needle,
catheter, tube or probe through the skin or into a body orifice; (ii) radiology
procedures that are integral to the performance of, and performed during
nonradiological medical procedures; (iii) nuclear medicine procedures; and (iv)
"invasive" or "interventional" radiology, because the radiology services in
these procedures are merely incidental or secondary to another procedure that
the physician has ordered.
12
The Stark Law provides that a request by a radiologist for diagnostic
radiology services or a request by a radiation oncologist for radiation therapy,
if such services are furnished by or under the supervision of such radiologist
or radiation oncologist pursuant to a consultation requested by another
physician, does not constitute a "referral" by a "referring physician." If such
requirements are met, the Stark Law self-referral prohibition would not apply to
such services. The effect of the Stark Law on the radiology practice, therefore,
will depend on the precise scope of services furnished by each such practice's
radiologists and whether such services derive from consultations or are
self-generated. The Company believes that (other than self-referred patients)
all of the services covered by the Stark Law provided by the contracted
radiology practices derive from requests for consultation by non-affiliated
physicians. Therefore, the Company believes that the Stark Law is not implicated
by the financial relationships between it and the contracted radiology
practices.
In addition, the Company believes that it had structured its
acquisitions of the assets of existing practices, and the Company intends to
structure any future acquisitions, so as not to violate the anti-kickback and
Stark Law and regulations. Specifically, the Company believes the consideration
paid by it to physicians to acquire the tangible and intangible assets
associated with their practices is consistent with fair market value in arms'
length transactions and is not intended to induce the referral of patients.
Should any such practice be deemed to constitute an arrangement designed to
induce the referral of Medicare or Medicaid patients, then the Company's
acquisitions could be viewed as possibly violating anti-kickback and
anti-referral laws and regulations. A determination of liability under any such
laws could have an adverse effect on the Company's business, financial
conditions and results of operations.
The federal government recently announced an initiative to audit all
Medicare carriers, which are the companies that adjudicate and pay Medicare
claims. These audits are expected to intensify governmental scrutiny of
individual providers. An unsatisfactory audit of any of the Company's diagnostic
imaging centers or contracted radiology practices could result in significant
repayment obligations, exclusion from the Medicare, Medicaid, or other
governmental programs and/or civil and criminal penalties.
Federal regulatory and law enforcement authorities have recently
increased enforcement activities with respect to Medicare and Medicaid fraud and
abuse regulations and other reimbursement laws and rules, including laws and
regulations that govern the Company's activities and the activities of the
radiology practices. The Company's or the radiology practices' activities may be
investigated, claims may be made against the Company or the radiology practices
and these increased enforcement activities may directly or indirectly have an
adverse effect on the Company's business, financial conditions and results of
operations.
CALIFORNIA ANTI-KICKBACK AND PHYSICIAN SELF-REFERRAL LAWS. California
has adopted a form of anti-kickback law and a form of Stark Law. The scope of
these laws and the interpretations of them are enforced by California courts and
regulatory authorities with broad discretion. Generally, California law covers
all referrals by all healthcare providers for all healthcare services. A
determination of liability under such laws could result in fines and penalties
and restrictions on the Company's ability to operate.
FEDERAL FALSE CLAIMS ACT. The Federal False Claims Act provides, in
part, that the federal government may bring a lawsuit against any person whom it
believes has knowingly presented, or caused to be presented, a false or
fraudulent request for payment from the federal government, or who has made a
false statement or used a false record to get a claim approved. The Federal
False Claims Act further provides that a lawsuit thereunder may be initiated in
the name of the United States by an individual who is an original source of the
allegations. The government has taken the position that claims presented in
violation of the federal anti-kickback law or Stark Law may be considered a
violation of the Federal False Claims Act. Penalties include civil penalties of
not less than $5,500 and not more than $11,000 for each false claim, plus three
times the amount of damages that the federal government sustained because of the
act of that person. The Company believes that it is in compliance with the rules
and regulations that apply to the Federal False Claims Act. However, the Company
could be found to have violated certain rules and regulations resulting in
13
sanctions under the Federal False Claims Act, and if the Company is so found in
violation, any sanctions imposed could result in fines and penalties and
restrictions on and exclusion from participation in federal and California
healthcare programs that are integral to the Company's business.
HEALTHCARE REFORM INITIATIVES. Healthcare laws and regulations may
change significantly in the future. The Company continuously monitors these
developments and modifies its operations from time to time as the regulatory
environment changes. The Company cannot be assured that it will be able to adapt
its operations to address new regulations or that new regulations will not
adversely affect the Company's business. In addition, although the Company
believes that it is operating in compliance with applicable federal and state
laws, neither the Company's current or anticipated business operations nor the
operations of the contracted radiology practices has been the subject of
judicial or regulatory interpretation. The Company cannot be assured that a
review of its business by courts or regulatory authorities will not result in a
determination that could adversely affect its operations or that the healthcare
regulatory environment will not change in a way that restricts the Company's
operations.
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996. In an
effort to combat healthcare fraud, Congress enacted the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA"). HIPAA, among other things,
amends existing crimes and criminal penalties for Medicare fraud and enacts new
federal healthcare fraud crimes, including actions affecting non-governmental
payors. Under HIPAA, a "healthcare benefit program" includes any private plan or
contract affecting interstate commerce under which any medical benefit, item or
services is provided. A person or entity that knowingly and willfully obtains
the money or property of any healthcare benefit program by means of false or
fraudulent representations in connection with the delivery of healthcare
services is subject to a fine and/or imprisonment. In addition, HIPAA authorizes
the imposition of civil money penalties against entities that employ or enter
into contracts with excluded Medicare or Medicaid program participants if such
entities provide services to federal health program beneficiaries. A finding of
liability under HIPAA could have a material adverse effect on the Company's
business, financial conditions and results of operations.
Further, HIPAA requires healthcare providers and their business
associates to maintain the privacy and security of individually identifiable
health information. HIPAA imposes federal standards for electronic transactions
with health plans, the security of electronic health information and for
protecting the privacy of individually identifiable health information. The
government recently published regulations to implement the privacy standards
with an initial compliance date of April 14, 2003. The Company may encounter
certain costs associated with complying with the primary provisions. A finding
of liability under HIPAA's privacy or security provisions may also result in
criminal and civil penalties, and could have a material adverse effect on the
Company's business, financial condition, and results of operations.
COMPLIANCE PROGRAM. The Company has implemented a program to monitor
compliance with federal and state laws and regulations applicable to healthcare
entities. The Company appointed a compliance officer who is charged with
implementing and supervising the compliance program, which includes the adoption
of (i) "Standards of conduct" for employees and affiliates and (ii) a process
that specifies how employees, affiliates and others may report regulatory or
ethical concerns to the Company's compliance officer. The Company believes that
its compliance program meets the relevant standards provided by the Office of
Inspector General of the Department of Health and Human Services. An important
part of the compliance program consists of conducting periodic audits of various
aspects of Company operations and that of the contracted radiology practices.
The Company also conducts mandatory educational programs designed to familiarize
employees with the regulatory requirements and specific elements of the
compliance program.
FDA. The U.S. Food and Drug Administration ("FDA") has issued the
requisite premarket approval for all of the MRI and CT systems utilized by the
Company. The Company does not believe that any further FDA approval is required
in connection with equipment currently in operation or proposed to be operated;
except under regulations issued by the FDA pursuant to the Mammography Quality
Standards Act of 1992, all mammography facilities are required to be accredited
by an approved non-profit organization or state agency. Pursuant to the
accreditation process each facility providing mammography services must comply
with certain standards including annual inspection.
14
Compliance with theses standards is required to obtain payment for
Medicare services and to avoid various sanctions, including monetary penalties,
or suspension of certification. Although all of the Company's facilities which
provide mammography services are currently accredited by the Mammography
Accreditation Program of the American College of Radiology and the Company
anticipates continuing to meet the requirements for accreditation, the
withdrawal of such accreditation could result in the revocation of
certification. Congress has extended Medicare benefits to include coverage of
screening mammography subject to the prescribed quality standards described
above. The regulations apply to diagnostic mammography and image quality
examination as well as screening mammography.
RADIOLOGIST LICENSING. The radiologists with whom the Company enters
into agreements to provide professional services are subject to licensing and
related regulations by the State of California. As a result, the Company
requires its radiologists to have and maintain appropriate licensure. The
Company does not believe that such laws and regulations will either prohibit or
require licensure approval of its business operations, although no assurances
can be made that such laws and regulations will not be interpreted to extend
such prohibitions or requirements to the Company's operations.
CORPORATE PRACTICE OF MEDICINE. In California, a lay person or any
entity other than a professional corporation is not allowed to practice any of
the healing arts including by employing professional persons or have any
ownership interest or profit participation in or control over any healing arts
professional practice. This doctrine is commonly referred to as the prohibition
on the "corporate practice" of medicine. The Company believes that arrangements
for the management of medical practices have, in fact, become quite common in
California, and have not generally been challenged with regard to the corporate
practice issue. However, because these types of arrangements are not required to
be reported, the Company cannot substantiate its belief. There can be no
assurance that the Company's present arrangements with BRMG or the physicians
providing medical services and medical supervision at the Company's imaging
centers will not be challenged, and, if challenged, that they will not be found
to violate the corporate practice prohibition, thus subjecting the Company to
potential damages, injunction and/or civil and criminal penalties.
The Company has not received a legal opinion from counsel with regard
to the effect of the corporate practice prohibition on its business as described
herein, and counsel has advised that such an opinion could not be given, because
of the lack of court cases relevant to the issue.
ENVIRONMENTAL. The facilities operated or managed by the Company
generate hazardous and medical waste subject to federal and state requirements
regarding handling and disposal.
The Company believes that the facilities that it operates and manages
are currently in compliance in all material respects with applicable federal,
state and local statutes and ordinances regulating the handling and disposal of
such materials. The Company does not believe that it will be required to expend
any material amounts in order to remain in compliance with these laws and
regulations or that compliance will materially affect its capital expenditures,
earnings or competitive position.
The Company has not received a legal opinion from counsel with regard
to the effect of the prohibitions discussed above on its business as described
herein, and counsel has advised that such an opinion could not be given, because
of the fluid interpretation of the law relevant to the issue.
15
ITEM 2. PROPERTIES
All of the imaging centers owned or managed by the Company are located
in leased facilities or in owned facilities on leased land. Certain information
with respect to the imaging centers is as follows:
Center
------
Wholly-Owned Approx. Sq. Ft.
------------ ---------------
of Center Lease Expiration
--------- ----------------
Tower Division:
[Beverly Hills and Environs]
Roxsan 10,774 Various through 2012
Women's 3,830 February 2014
Wilshire 13,778 September 2018
Antelope Valley 2,890 In negotiation
Chino 2,700 June 2007
Emeryville 2,086 June 2003
Fresno 5,360 June 2008
La Habra 3,034 December 2007
Lancaster [four sites] 11,327 In negotiation
Long Beach-Redondo [three sites] 6,000 In negotiation
Long Beach-Los Coyotes [four sites] 10,338 Various through 2006
Modesto 17,852 December 2004
Northridge 7,800 March 2012
Orange [four sites] 15,955 Various through 2012
Oxnard 5,100 In negotiation
Palm Desert [three sites] 11,082 Various through 2006
Palm Springs [two sites] 9,442 June 2008
Rancho Cucamonga [two sites] 12,518 May 2009
Sacramento 8,083 June 2003
San Francisco 1,240 In negotiation
San Gabriel Valley 3,871 December 2004
Santa Clarita 5,782 June 2009
Santa Rosa 4,235 July 2011
Stockton 4,808 December 2006
Tarzana [three sites] 6,320 Various through 2009
Tustin 2,139 January 2004
Vacaville 5,927 March 2007
Ventura 12,032 July 2007
Ventura-Loma Vista [three sites] 1,449 In negotiation
DIS Centers
-----------
Camarillo 2,035 May 2002
Oceanside [North County] 2,314 November 2005
Riverside [two sites] 13,834 Various through 2007
Temecula [three sites] 10,175 Various through 2006
Thousand Oaks 8,300 November 2007
Partnership/LLC
---------------
Burbank 5,787 March 2008
Westchester 6,763 July 2006
Rancho Bernardo 9,557 May 2012
Other Facilities
----------------
RadNet [Corp. offices] 16,500 June 2007
Warehouse/Other 33,447 Various
16
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
The Company is involved in the following litigation:
RADNET MANAGEMENT II, INC. V. HCT MODESTO, LLC
Alameda County Superior Court Case No. RG 03080062
--------------------------------------------------
RADNET MANAGEMENT II, INC. V. US DIAGNOSTIC, INC.
AND MODESTO IMAGING SERVICES, INC.
American Arbitration Association No. 72 Y 115 99029 01EP
--------------------------------------------------------
These matters arise out of RadNet Management II, Inc.'s acquisition of
substantially all of the assets and liabilities of Modesto Imaging Center, Inc.,
including, without limitation, Modesto Imaging Center, a diagnostic radiology
and imaging center. As of May 10, 2001, the date the acquisition closed, Modesto
Imaging Center, Inc., its parent company, US Diagnostic Inc., and HCT Modesto
LLC, the landlord under the lease for the property on which the Center is
situated, which lease had been assumed by and assigned to RadNet Management II,
Inc., had disclosed to RadNet Management II, Inc. that the lease had a present
expiration date of December 31, 2004, subject to two three-year extensions in
favor of the tenant. Two weeks after the acquisition closed, however, RadNet
Management II, Inc. learned from a third party that a document purporting to
extend the lease to December 31, 2014 (i.e., by ten years) had been in the
possession of Modesto Imaging Center, Inc., US Diagnostic Inc. and HCT Modesto
LLC at the time the improper disclosures were made to RadNet Management II, Inc.
RadNet Management II, Inc. believes that the lease is substantially in excess of
the fair rental value of the property.
On or about September 14, 2001, RadNet Management II, Inc. commenced an
arbitration proceeding against US Diagnostic Inc. and Modesto Imaging Center,
Inc. before the American Arbitration Association, seeking to reduce the price of
the acquisition by $1,000,000 pursuant to the Asset Purchase Agreement and
Escrow Agreement entered into between and among the parties, and also seeking
additional damages resulting from RadNet Management II, Inc.'s assumption of the
lease. US Diagnostic Inc. subsequently filed a Chapter 11 bankruptcy petition in
the United States District Court for the Southern District of Florida, and
Modesto Imaging Center, Inc. is believed to have few or no assets available to
pay an arbitration award.
On or about January 23, 2003, RadNet Management II, Inc. filed a complaint in
the Superior Court of the State of California, County of Alameda, seeking legal,
equitable and declaratory relief as against HCT Modesto LLC. Among other things,
RadNet Management II, Inc. seeks (1) cancellation of the document purporting to
extend the present lease expiration date from December 31, 2004 to December 31,
2014, (2) a declaration that RadNet Management II, Inc. is not bound by the
lease beyond December 31, 2004, and/or (3) damages in excess of $1,800,000.
RadNet Management II, Inc. anticipates that HCT Modesto LLC will serve it with a
Cross-Complaint seeking a declaration that RadNet Management II, Inc. is bound
by the lease through December 31, 2014, and also seeking damages in an amount
that is currently unknown.
At this point, it is too early to predict how the matter will conclude. However,
RadNet Management II, Inc. disputes any claim that it is bound to the lease
beyond December 31, 2004 and/or that it is liable to HCT Modesto LLC for any
amount of damages at all. It intends to pursue its claims vigorously against HCT
Modesto LLC and to vigorously defend against the anticipated cross-complaint.
17
Additionally, the Company is engaged from time to time in the defense of
lawsuits arising out of the ordinary course and conduct of its business and has
insurance policies covering such potential insurable losses. The Company
believes that the outcome of any such lawsuits will not have a material adverse
impact on the Company's business, financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
The Company did not submit any matters to a vote of security holders
during the fourth fiscal quarter of 2002.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON
- ------- ----------------------------------
STOCK AND RELATED STOCKHOLDER MATTERS
PHS Common Stock is traded in the over-the-counter market on the OTC
Bulletin Board [symbol, "PMDX"]. The following table indicates the high and low
prices for PHS Common Stock for the periods indicated based upon information
supplied by the National Quotation Bureau, Inc. Such quotations reflect
interdealer prices without adjustment for retail mark-up, mark-down or
commission, and may not necessarily represent actual transactions.
Quarter Ended Low High
------------- --- ----
January 31, 2002 .95 1.45
April 30, 2002 1.10 1.91
July 31, 2002 .97 1.51
October 31, 2002 .49 1.20
January 31, 2001 .31 .56
April 30, 2001 .38 .60
July 31, 2001 .55 .78
October 31, 2001 .60 .95
The last reported closing high and low prices for PHS Common Stock on the
OTC Bulletin Board on January 21, 2003, were $.48 and $.45, respectively. As of
January 21, 2003, the number of holders of record of PHS Common Stock was 4,028.
However, a substantial number of PHS' outstanding shares of Common Stock were
owned of record on said date by "Cede & Co.," the nominee for Depository Trust
Company, the clearing agency for most broker-dealers. Management believes that
these shares are beneficially owned by customers of these broker-dealers and
that the number of beneficial owners of PHS Common Stock is substantially
greater than 4,028.
CONVERTIBLE SUBORDINATED DEBENTURES
-----------------------------------
The Company has $16,291,000 convertible subordinated debentures
outstanding which mature June 30, 2003, and bears interest, payable quarterly,
at an annual rate of 10%. The debentures are convertible into PHS common stock
at a price of $10 per share. The Company plans to offer the debenture holders
the right to extend the debenture for three (3) years in which event the
conversion price would be reduced to $4. Remaining debentures will be required
to be redeemed. The Company intends to utilize its financing resources to effect
such redemption. There can be no guarantee those resources will be sufficient or
available at all when required.
18
Recent Sales of Unregistered Securities
---------------------------------------
During the fiscal year ended October 31, 2002, the following securities
were sold by the Company pursuant to the exemption to registration provided
under Section 4(2) of the Securities Act of 1933, as amended:
(1) In November 2001, the Company issued to one individual, a 5
year warrant exercisable at a price of $.95 per share (the
public market price closing price on the transaction date) to
purchase 75,000 shares of the Company's common stock.
(2) In February 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $1.26 per share (the
public market price closing price on the transaction date) to
purchase 500,000 shares of the Company's common stock.
(3) In April 2002, the Company issued to one individual, a 5 year
warrant exercisable at a price of $1.61 per share (the public
market closing price on the transaction date) to purchase
30,000 shares of the Company's common stock.
(4) In April 2002, an officer of the Company exercised an option
to purchase 300,000 shares of common stock. As part of the
transaction, the officer delivered to the Company 30,201
previously acquired shares of the Company's common stock with
a value of $45,000 (based upon $1.49 per share public market
closing price on the transaction date).
(5) In May 2002, the Company issued to one individual, a 5 year
warrant exercisable at a price of $1.45 per share (the public
market closing price on the transaction date) to purchase
9,000 shares of the Company's common stock.
(6) In June 2002, the Company issued to one individual, a 5 year
warrant exercisable at a price of $1.10 per share (the public
market closing price on the transaction date) to purchase
100,000 shares of the Company's common stock.
(7) In September 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $1.09 per share (the
public market closing price on the transaction date) to
purchase 50,000 shares of the Company's common stock.
(8) In September 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $0.80 per share (the
public market closing price on the transaction date) to
purchase 30,000 shares of the Company's common stock.
(9) In October 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $0.79 per share (the
public market closing price on the transaction date) to
purchase 30,000 shares of the Company's common stock.
19
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
- ------- ------------------------------------
The following selected consolidated financial data presented as of and
for the years ended October 31, 2002, 2001, 2000, 1999 and 1998 has been derived
from the Company's consolidated financial statements and should be read in
conjunction with such consolidated financial statements and related notes, and
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations," included elsewhere in this report.
YEARS ENDED
OCTOBER 31,
----------------------------------------------------------------------
(000's except per share amounts)
OPERATING DATA: 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Gross Revenues $ 378,942 $ 284,981 $ 229,598 $ 170,518 $ 132,595
Net Revenues after Contractual Allowances 139,281 111,837 87,965 72,258 58,821
Operating Expenses 127,965 92,735 73,368 70,359 75,329
Income [Loss] Before Extraordinary Items (5,552) 13,947 1,102 (10,627) (29,497)
Extraordinary Items- Gain 1 554 1,512 1,556 955
Net Income [Loss] (5,551) 14,501 2,614 (9,071) (28,543)
Income [Loss] Per Common share before (.14) .35 .03 (.27) (.75)
Extraordinary Items
Income [Loss] Per Common Share from .00 .01 .04 .04 .02
Extraordinary Item
Net Income [Loss] Per Common Share (.14) .36 .07 (.23) (.73)
BALANCE SHEET DATA:
Cash and Cash Equivalents 36 40 36 3 59
Total Assets 151,639 128,429 90,625 72,247 62,656
Total Long-Term Liabilities 121,830 110,188 82,693 79,023 79,282
Total Liabilities 202,560 174,071 151,538 136,604 118,016
Working Capital [Deficit] (44,668) (26,987) (44,588) (38,007) (20,191)
Stockholders' Equity [Deficit] (50,921) (45,642) (60,913) (64,357) (55,360)
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Primedex Health Systems, Inc., through its wholly-owned subsidiary, Radnet
Management, Inc. and its 91% owned subsidiary, Diagnostic Imaging Services,
Inc., is a leading California provider of diagnostic imaging services through
its ownership and operation of 58 outpatient diagnostic imaging centers. The
Company 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), position emission tomography (or PET), nuclear
medicine, ultrasound, mammography, general radiography (or x-ray) and
fluoroscopy. The Company's revenues are derived from the ownership, management
and operation of its radiology and imaging center network. Professional medical
services and supervision are provided through Beverly Radiology Medical Group
("BRMG") and through other independent physicians and physician groups with
which the Company contracts. Inasmuch as BRMG is 99% owned by the majority
stockholder and president of the Company its revenues are consolidated with that
of the Company. As of October 31, 2002, the Company owned, operated or provided
management services.
The Company focuses on providing quality patient care and service to ensure
patient and referring physician satisfaction. The Company's concentration in
California permits it to invest in technologically advanced imaging equipment,
including MRI, open MRI, spiral CT and PET and organize the Company's imaging
centers into coordinated networks to improve response time, increase overall
patient accessibility, and permits the Company to standardize certain customer
relations procedures and permit the Company to develop "best practices" for its
diagnostic imaging centers. The Company's coordinated programs allow it to
provide administrative, management and information services to develop best
practices and to improve productivity and the quality of services. By focusing
on its communication systems the Company believes it can increase patient and
referring physician satisfaction, which should lead to increased referrals and
increased utilization of its diagnostic imaging centers.
The Company contracts with radiology practices including BRMG to provide
professional services, including the supervision and interpretation of
diagnostic imaging procedures performed in its diagnostic imaging centers. In
this regard, BRMG has begun assembling a group of physicians located at the
Company's corporate offices who utilize adjusted communication equipment for the
purposes of relieving radiologists located at the Company's centers who fall
behind in interpreting medical imaging as well as providing a group of well
recognized radiologists specializing in particular areas to provide backup for
referring physicians requiring specialized review. The Company believes that it
does not engage in the practice of medicine nor does it employ physicians. The
radiology practices maintain full control over the provision of professional
radiological services.
Payment for diagnostic imaging services comes primarily from private payors (22%
including Blue Cross, Blue Shield and Commercial insurance), managed care
contract arrangements (21% including fee for service, hmo and ppo insurance),
capitation arrangements (20%), and governmental payors (15% including Medicare
and Medicaid).
As of January 2002, Medicare decreased reimbursement rates for physician and
outpatient services, including diagnostic imaging services. The Company's
centers are principally dependent on its 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.
21
The Company's revenue is dependent upon the operating results of the diagnostic
imaging centers. Service fees due under the service agreements for the
contracted radiology practices are derived from two distinct revenue streams:
(1) a negotiated percentage (typically 70% to 85%) of the center revenues as
defined in the service agreements; and (2) 100% of the technical revenues as
defined in the service agreements.
The Company's operations 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 the
diagnostic imaging centers.
The following information consists of issues you should consider in reviewing
the financial information provided. In this regard, Westchester Imaging Group is
a 50% owned Company partnership and both Burbank Advanced Imaging Center and
Rancho Bernardo Advanced Imaging Center are 75% owned with the minority
interests owned by the radiologists providing professional services in the
respective facilities. The Company committed to a capital contribution of
$750,000 to fund the building of a facility in Rancho Bernardo, California,
which opened in December 2002. Westchester Imaging Group is consolidated with
the Company based upon the criteria of both SFAS 94 and EITF 97-2. All
intercompany transactions and balances have been eliminated in consolidation and
combinations.
22
RESULTS OF OPERATIONS FOR THE YEAR ENDED OCTOBER 31, 2002 COMPARED TO THE YEAR
ENDED OCTOBER 31, 2001
The following table sets forth, for the periods indicated, the percentage that
certain items in the statement of income bear to net revenue and the percentage
dollar increase (decrease) of such items from period to period.
PERCENTAGE
PERCENT OF NET REVENUE DOLLAR INCREASE
YEARS ENDED OCTOBER 31, (DECREASE)
--------------------------------------- ---------------------
2002 2001 `01 TO `02
------------------- ------------------- ---------------------
Revenue 272.1% 254.8 % 33.0%
Less: Allowances (172.1) (154.8) 38.4
------------------- ------------------- ---------------------
Net revenue 100.0 100.0 24.5
Operating expense
Operating expenses (75.7) (69.8) 35.2
Depreciation and amortization (11.0) (9.6) 43.0
Provision for bad debts (5.2) (3.6) 78.6
------------------- ------------------- ---------------------
Total operating expense (91.9) (82.9) 38.0
------------------- ------------------- ---------------------
Income from operations 8.1 17.1 (40.8)
Interest expense, net (12.0) (12.2) 22.6
Gain (loss) on sale of assets or (.2) 3.1 (108.5)
centers
Other, net .4 0.2 187.1
------------------- ------------------- ---------------------
Income before provision for income (3.7) 8.2 (156.3)
taxes, minority interest and
extraordinary item
Income tax benefit -- 4.6 (100.0)
------------------- ------------------- ---------------------
Income before minority interest (3.7) 12.8 (136.1)
and extraordinary item
Minority interest (0.3) (0.3) 12.8
------------------- ------------------- ---------------------
Income before extraordinary item (4.0) 12.5 (139.8)
Extraordinary item .0 .5 (99.8)
------------------- ------------------- ---------------------
Net income (4.0) 13.0 (138.3)
=================== =================== =====================
The following discussion explains in greater detail the consolidated operating
results and financial condition of the Company for the year ended October 31,
2002 compared to the year ended October 31, 2001.
2002 2001
---- ----
NET REVENUE $139,281,000 $ 111,837,000
- -----------
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. The Company utilizes historical collection experience in
23
estimating contractual allowances. 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.
Net revenue increased approximately $27,444,000, or 24.5%, for the year ended
October 31, 2002, compared to the same period in the previous year. Of the net
revenue increase, 25% was due to three new sites which opened, Burbank [late
November 2001] and Tarzana Advanced [January 2002], or were acquired, Grove
Diagnostic [May 2002]. During fiscal 2002, 31% was due to the full effect of the
acquisition of Modesto [May 2001] and Palm Springs and Palm Desert [June 2001],
offset by a 2% decrease due to the sale of the Company's sole radiation oncology
facility ("VROC") in March 2001. The remaining 46% increase was due to new
contracts, renegotiation of existing contracts to more favorable rates, an
improved economy with increasing population, and increased throughput at many
sites due to the addition and continued upgrade of medical equipment. In
particular were improvements at the following facilities primarily due to the
entry into new capitation agreements coupled with the addition and upgrade of
medical equipment increasing throughput at each of the sites: Riverside [HCIC]
where net revenue increased approximately 43%, or $1,717,000, Temecula [TVIC]
where net revenue increased approximately 99%, or $2,691,000, and Los Coyotes
where net revenue increased approximately 50%, or $1,514,000. In addition, the
expansion of Orange Imaging in late fiscal 2002 with the opening of Orange
Advanced and Orange Women's Centers contributed to its increase in net revenue
of approximately 13%, or $1,030,000.
OPERATING EXPENSES 2002 2001
- ------------------ ---- ----
OPERATING EXPENSES $ 105,473,000 $ 78,008,000
DEPRECIATION AND AMORTIZATION 15,309,000 10,705,000
PROVISION FOR BAD DEBTS 7,183,000 4,022,000
-------------- -------------
TOTAL OPERATING EXPENSES $ 127,965,000 $ 92,735,000
Operating expenses for the year ended October 31, 2002 increased approximately
$27,465,000, or 35%, compared to the same period in the previous year. Of this
increase, 46% was due to the full effect of five new sites acquired or opened
during the previous two years including Modesto, Desert Advanced, Burbank,
Tarzana Advanced and Grove coupled with the start-up costs associated with the
planned opening of Rancho Bernardo [offset by a 1% decrease due to the sale of
the VROC facility in March 2001]. The remaining 55% increase in operating
expenses was primarily due to an increase in net revenue which effects the
Company's percentage of revenue agreements relating to physician reading fees
and the GE repair and maintenance expense which increased contracted fees from
3.22% to 3.64% of net revenue effective November 1, 2001. In addition, the
Company had variable increases in expenditures for billing, medical supplies,
office supplies, utilities and other expenses with the increase in business.
Due to a shortage of qualified radiologists in the marketplace, BRMG experienced
difficulty in hiring and retaining physicians at the individual sites during
most of fiscal 2002. This required the engagement of independent contractors and
locum tenens (part-time fill-in physicians) to interpret patient films. The cost
of these individuals was double the salary of a regular BRMG full-time physician
with additional costs for travel and lodging required. Recently, BRMG hired a
new nationally prominent medical director who oversees physician recruitment and
staffing. In order to reduce the substantial increased cost associated with
part-time fill-in physicians, the new director has already arranged for BRMG to
hire over twelve new physicians during the last two quarters of fiscal 2002.
BRMG is working to solidify its physicians at the majority of the Company's
24
sites while increasing the volume of interpretations done by physicians at the
Company's main offices utilizing the Company's computer and PACS systems. In
solidifying its physician staff, the Company has revised some of its physician
agreements from a fixed fee to a percentage of revenue arrangement. With these
types of arrangements, future increases in net revenue increase the cost of
physician reading fees proportionately and thereby negatively impact the
Company's overall operating income. During the year ended October 31, 2002, the
overall increase in physician reading fees was approximately $3.4 million
compared to fiscal year 2001's average expense [net of the effect of the
increase in net revenue in fiscal year 2002].
In addition, during the year ended October 31, 2002, the Company experienced
significant increases in expenditures for insurance with carriers requesting
greater fees upon renewal coupled with the significant growth the Company has
recently experienced with increased revenue, staffing and additions of new
equipment. General liability rates increased approximately 50% in October 2002,
workers compensation rates increased approximately 45% in July 2002, and
malpractice rates approximately 80% in September 2002. Medical insurance
increases were somewhat offset with employees contributing more per pay period.
The Company is reviewing various alternatives to reduce its expenditures for
insurance and minimize the increases it may incur in the future. However,
increases in insurance costs are being experienced by companies all over the
United States and reductions are not likely for the foreseeable future.
Included in operating expenses for the years ended October 31, 2002 and 2001 are
approximately $62,389,000 and $44,765,000, respectively, for salaries and
professional reading fees, approximately $8,799,000 and $7,344,000,
respectively, for building and equipment rentals, and approximately $34,285,000
and $25,899,000, respectively, in general and administrative expenditures. The
Company's general and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business tax and
license, outside services, utilities and other expenses including marketing and
travel. The majority of these expenses are variable and increase with net
revenue. Net revenue for the year ended October 31, 2002 increased 24.5% and
resulted in increases in general and administrative expenses of approximately
$6.0 million. The remaining increase was primarily for insurance and repairs and
maintenance, discussed above, and utilities [due to the increase in medical
equipment].
Depreciation and amortization for the year ended October 31, 2002 increased
approximately $4,604,000, or 43%, compared to the same period in the previous
year. This increase was offset by approximately $1,354,000 due to the
elimination of goodwill amortization with the implementation of Statement of
Financial Accounting Standards No. 141, Business Combinations and No. 142,
Goodwill and Other Intangible Assets effective November 1, 2001. Of the increase
in depreciation and amortization, 37% was due to the acquisition of equipment or
improvement in leaseholds for same store facilities, and 64% was due to the full
effect of the opening or acquisition of five sites during fiscal 2001 and fiscal
2002 [offset by a 1% decrease upon the sale of VROC in March 2001].
Provision for bad debt for the year ended October 31, 2002 increased
approximately $3,161,000, or 79%, compared to the same period last year. The
primary reason for the increase was due to the growth in revenue coupled with
the write-off of approximately $850,000 in net accounts receivable primarily due
to one contracted payor's dissolution and default on amounts due.
2002 2001
---- ----
INTEREST EXPENSE, NET $ 16,693,000 $ 13,620,000
- ---------------------
25
Net interest expense for the year ended October 31, 2002 increased approximately
$3,073,000, or 23%, compared to the same period last year. The increase is
primarily a result of acquisitions coupled with new equipment financing. During
fiscal 2002, the Company acquired Grove Diagnostic Imaging for approximately
$1,441,000 and entered into new capital lease obligations of approximately
$30,846,000.
2002 2001
---- ----
GAIN (LOSS) ON SALE OF SUBSIDIARIES, $(299,000) $ 3,520,000
- ------------------------------------
DIVISIONS AND ASSETS
- --------------------
During fiscal 2002, the Company sold the land and building at Northridge (and
leased it back), disposed of an MRI at Vacaville and disposed of a variety of
other assets at various sites generating a loss on sale or disposal of equipment
of approximately $299,000. During the year ended October 31, 2001, the Company
sold its VROC facility for $4,000,000 cash and recognized a gain on the sale of
approximately $3,527,000, and recognized losses on the sale or disposal of
equipment of approximately $7,000.
2002 2001
---- ----
OTHER INCOME, NET $ 511,000 $ 178,000
- -----------------
Other income for the year ended October 31, 2002 increased approximately
$333,000, or 187%. Other income consists primarily of professional reading fee
income, rental income, record copying income and miscellaneous reimbursements.
During fiscal 2002, the Company received approximately $240,000 in insurance
reimbursements for its business interruption and general business liability
policies for losses it sustained at its Tustin, Tower Roxsan and Northridge
facilities due primarily to water leaks and water damage.
2002 2001
---- ----
INCOME TAX BENEFIT $ -- $ 5,110,000
- ------------------
For the year ended October 31, 2001, the Company recorded a deferred tax asset
of $5,235,000 offset by an income tax payable of $125,000 (See Note 9 to the
Company's Financial Statements).
2002 2001
---- ----
MINORITY INTEREST $ (387,000) $ (343,000)
- -----------------
Minority interest in joint venture represents the minority investor's 50% share
of the Westchester Imaging Group, 25% share of the Burbank Advanced Imaging
Center LLC and 25% share of Rancho Bernardo Advanced LLC income for the period.
Minority interest expense for the year ended October 31, 2002 increased
approximately $44,000, or 13%, compared to the same period the previous year.
The increase is primarily due to the increased earnings of Westchester Imaging
Group.
2002 2001
---- ----
EXTRAORDINARY ITEM $ 1,000 $ 554,000
- ------------------
Extraordinary gains decreased $553,000 for the year ended October 31, 2002.
Extraordinary gains represent the repurchase of subordinated bond debentures and
the write-off or settlement of limited partner notes at a discount. During the
year ended October 31, 2001, the Company was able to write-off a portion of its
limited partner note obligations when they reached their statute of limitations
for claim. In addition, as the subordinated bond debentures get closer to
maturity in June 2003, the opportunity to repurchase them at a discount becomes
less probable and little to no offers materialized during the year ended October
31, 2002.
26
RESULTS OF OPERATIONS FOR THE YEARS ENDED OCTOBER 31, 2001 COMPARED TO THE YEAR
- -------------------------------------------------------------------------------
ENDED OCTOBER 31, 2000
- ----------------------
The following table sets forth, for the periods indicated, the percentage that
certain items in the statement of income bear to net revenue and the percentage
dollar increase (decrease) of such items from period to period.
PERCENTAGE
PERCENT OF NET REVENUE DOLLAR INCREASE
YEARS ENDED OCTOBER 31, (DECREASE)
--------------------------------------- ---------------------
2001 2000 `00 TO `01
------------------- ------------------- ---------------------
Revenue 254.8 % 261.0 % 24.1%
Less: Allowances (154.8) (161.0) 22.2
------------------- ------------------- ---------------------
Net revenue 100.0 100.0 27.1
Operating expense
Operating expenses (69.7) (70.7) 25.4
Depreciation and amortization (9.6) (9.8) 24.8
Provision for bad debts (3.6) (2.9) 55.8
------------------- ------------------- ---------------------
Total operating expense (82.9) (83.4) 26.4
------------------- ------------------- ---------------------
Income from operations 17.1 16.6 30.9
Interest expense, net (12.2) (14.9) 3.7
Other, net 3.3 (0.1) (3952.1)
------------------- ------------------- ---------------------
Income before provision for income 8.2 1.6 574.5
taxes, minority interest and
extraordinary item
Income tax benefit 4.6 -- 100.0
Income before minority interest 12.8 1.6 950.0
and extraordinary item
Minority interest (0.3) (0.3) 32.4
------------------- ------------------- ---------------------
Income before extraordinary item 12.5 1.3 1165.6
Extraordinary item 0.5 1.7 (63.4)
------------------- ------------------- ---------------------
Net income 13.0 3.0 454.7
=================== =================== =====================
The following discussion explains in greater detail the consolidated operating
results and financial condition of the Company for the year ended October 31,
2001 compared to the year ended October 31, 2000.
27
2001 2000
---- ----
NET REVENUE $ 111,837,000 $ 87,865,000
- -----------
Net revenue increased approximately $23,872,000, or 27.1%, for the year ended
October 31, 2001, compared to the same period the previous year. Of the net
revenue increase, 29% was due to the full effect of five new sites acquired in
June 2000 [Chino, San Gabriel and Tarzana] and September 2000 [San Francisco and
Emeryville], and 25% was due to the acquisition of three new sites in May 2001
[Modesto] and June 2001 [Palm Springs and Palm Desert], offset by a 6% decrease
due to the sale of the VROC facility in March 2001. The remaining 52% of the
increase was due to new contracts, renegotiation of existing contracts to more
favorable rates, an improved economy with increasing population, and increased
throughput at many sites due to the addition and continued upgrade of medical
equipment. In particular were improvements at the Company's Riverside [HCIC]
facility where net revenues increased approximately 113%, or $2,107,000, due to
the entry into a new capitation agreement coupled with the addition and upgrade
of medical equipment.
OPERATING EXPENSES 2001 2000
- ------------------ ---- ----
OPERATING EXPENSES $ 78,008,000 $ 62,207,000
DEPRECIATION AND AMORTIZATION 10,705,000 8,580,000
PROVISION FOR BAD DEBTS 4,022,000 2,581,000
------------- -------------
TOTAL OPERATING EXPENSES $ 92,735,000 $ 73,368,000
Operating expenses for the year ended October 31, 2001 increased approximately
$15,801,000, or 25%, compared to the same period the previous year. Of this
increase, 19% was due to the full effect of five new sites acquired in June 2000
and September 2000, 31% was due to the acquisition of three new sites in May
2001 and June 2001 and the start-up costs associated with the future openings of
Burbank Advanced and Tarzana Advanced, offset by a 4% decrease due to the sale
of the VROC facility in March 2001. The remaining 54% of the increase in
operating expenses was primarily due to an increase in the net revenues
including a 34% increase in salaries and professional reading fees, a 7%
increase for the impact of a repair and maintenance contract agreement entered
into on March 1, 2000 which resulted in increased fees from 2.82% to 3.22% of
net revenue effective November 1, 2000, a 5% increase in outside services
including legal, accounting, billing, labor and transcription services, and an
8% increase in other expenses including utilities, insurance and business taxes.
Even with the 27.1% increase in net revenue, medical supply expenditures
increased only 16.8% from the same period last year primarily due to additional
acquisitions of filmless digital equipment at many of the sites and increased
purchase discounts.
Included in operating expenses for the years ended October 31, 2001 and 2000 are
approximately $44,765,000 and $35,402,000, respectively, for salaries and
professional reading fees, approximately $7,344,000 and $6,334,000,
respectively, for building and equipment rentals, and approximately $25,899,000
and $20,471,000, respectively, in general and administrative expenditures. The
Company's general and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business tax and
license, outside services, utilities and other expenses including marketing and
travel. The majority of these expenses are variable and increase with net
revenue. Net revenue for the year ended October 31, 2001 increased 27.1% and
resulted in increases in general and administrative expenses of approximately
$5.5 million.
Depreciation and amortization for the year ended October 31, 2001 increased
approximately $2,125,000, or 25%, compared to the same period the previous year.
Of this increase, 29% was due to the acquisition of equipment, 46% was due to
the full effect of the acquisition of five new sites during fiscal 2000, and 29%
was due to the acquisition of three new sites in fiscal 2001, offset by a 4%
decrease upon the sale of VROC in March 2001.
28
Provision for bad debt for the year ended October 31, 2001 increased
approximately $1,441,000, or 56%, compared to the same period the previous year.
The primary reason for the increase was due to the growth in revenue coupled
with the Company's overall bad debt percentage increasing from 1.79% of the
contractual adjustments during fiscal 2000 to 2.27% of the contractual
adjustments during fiscal 2001.
2001 2000
---- ----
INTEREST EXPENSE, NET $ 13,620,000 $ 13,140,000
- ---------------------
Net interest expense for the year ended October 31, 2001 increased approximately
$480,000, or 4%, compared to the same period the previous year. The increase is
primarily a result of acquisitions coupled with new equipment financing offset
by decreases in line of credit interest charges with the corresponding
reductions in the lines of credit balances and the prime interest rate during
the respective periods.
2001 2000
---- ----
OTHER INCOME (LOSS), NET $ 3,698,000 $ (96,000)
- ------------------------
Other income (loss) for the year ended October 31, 2001 increased approximately
$3,794,000 compared to the same period in the previous year. During the year
ended October 31, 2001, the Company sold its VROC facility for $4,000,000 cash
and recognized a gain on the sale of approximately $3,527,000, recognized losses
on the sale or disposal of equipment of approximately $7,000 and generated other
income, net of other expense, of approximately $178,000. During the year ended
October 31, 2000, the Company recognized losses on the sale or disposal of
equipment of approximately $335,000 and generated other income, net of other
expense, of approximately $239,000.
2001 2000
---- ----
INCOME TAX BENEFIT $ 5,110,000 $ --
- ------------------
For the year ended October 31, 2001, the Company recorded a deferred tax asset
of $5,235,000 offset by an income tax payable of $125,000 (See Note 9).
2001 2000
---- ----
MINORITY INTEREST $ (343,000) $ (259,000)
- -----------------
Minority interest in joint venture represents the minority investor's 50% share
of the Westchester Imaging Group and 25% share of the Burbank Advanced Imaging
Center LLC income for the period. Minority interest expense for the year ended
October 31, 2001 increased approximately $84,000, or 32%, compared to the same
period the previous year. The increase is due to the increased earnings of
Westchester Imaging Group.
2001 2000
---- ----
EXTRAORDINARY ITEM $ 554,000 $ 1,512,000
- ------------------
Extraordinary gains represent the repurchase of subordinated bond debentures and
the write-off or settlement of limited partner notes at a discount.
29
SUMMARY OF OPERATIONS BY QUARTER
- --------------------------------
The following table presents unaudited quarterly operating results for each of
the Company's last eight fiscal quarters. The Company believes that all
necessary adjustments have been included in the amounts stated below to present
fairly the quarterly results when read in conjunction with the consolidated
financial statements. Results of operations for any particular quarter are not
necessarily indicative of results of operations for a full year or predictive of
future periods.
2001 Quarter Ended 2002 Quarter Ended
(000's except per share amounts) (000's except per share amounts)
Jan 31 Apr 30(a) Jul 31 Oct 31(b) Jan 31 Apr 30 Jul 31(c) Oct 31
------ --------- ------ --------- ------ ------ --------- ------
Statement of Income Data:
Net Revenue $24,110 $26,104 $29,464 $32,159 $32,441 $33,722 $35,580 $37,538
Operating Expenses $19,897 $21,122 $24,121 $27,595 $28,104 $28,989 $35,765 $35,107
Income (Loss) before
Extraordinary Item $918 $5,107 $2,081 $5,841 $917 $836 ($5,123) ($2,182)
Extraordinary Item $5 $108 $0 $441 $0 $0 $1 $0
Net Income (Loss) $923 $5,215 $2,081 $6,282 $917 $836 ($5,122) ($2,182)
Basic Earnings Per Share:
Income (loss) before Extraordinary $0.02 $0.12 $0.05 $0.14 $0.02 $0.02 (0.12) (0.05)
Item
Extraordinary Item $0.00 $0.00 $0.00 $0.01 $0.00 $0.00 0.00 0.00
Basic Earning Per Share $0.02 $0.12 $0.05 $0.16 $0.02 $0.02 (0.12) (0.05)
Diluted Earnings Per Share:
Income (loss) before Extraordinary $0.02 $0.11 $0.04 $0.13 $0.02 $0.02 (0.12) (0.05)
Item
Extraordinary Item $0.00 $0.00 $0.00 $0.01 $0.00 $0.00 0.00 0.00
Diluted Earning Per Share $0.02 $0.11 $0.04 $0.14 $0.02 $0.02 (0.12) (0.05)
Weighted Average Shares Outstanding:
Basic 39,284 40,133 40,147 40,306 40,733 40,760 41,001 41,006
Diluted 40,164 46,133 47,593 44,171 41,435 45,664 41,001 41,006
(a) Net income for the quarter ended April 30, 2001 includes a $3.5 million
gain from the sale of VROC to an unaffiliated third party.
(b) Net income for the quarter ended October 31, 2001 includes a $5.1
million gain from the recording of a deferred tax asset.
(c) Net income for the quarter ended July 31, 2002 includes a $850,000
expense for the write-off of accounts receivable upon the dissolution
of a contract and a $220,000 loss for the disposal of equipment.
30
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash decreased for the year ended October 31, 2002 by $4,000 and increased for
the year ended October 31, 2001 by $4,000.
Cash used by investing activities for the years ended October 31, 2002 was
$6,176,000 compared to $2,833,000 for the same period in 2001. For the years
ended October 31, 2002 and 2001, the Company purchased property and equipment
for approximately $7,815,000 and $7,469,000, respectively, received proceeds
from the sale of centers or trade-in of equipment for $1,700,000 and $5,050,000,
respectively, paid loan fees of $22,000 and $20,000, respectively, and loaned
$39,000 and $233,000, respectively, to related parties. In addition, during the
year ended October 31, 2001, the Company invested $100,000 in VROC, purchased
59,000 shares of DIS common stock for approximately $30,000, and acquired some
of the assets of Sadler Radiology for approximately $31,000.
Cash used for financing activities for the years ended October 31, 2002 was
$7,524,000 compared to $10,749,000 for the same period in 2001. For the years
ended October 31, 2002 and 2001, the Company made principal payments on capital
leases and notes payable of approximately $20,675,000 and $16,764,000,
respectively, received proceeds from borrowing under existing lines of credit
and refinancing arrangements of approximately $12,295,000 and $3,883,000,
respectively, purchased subordinated debentures for approximately $10,000 and
$36,000, respectively, increased its cash disbursements in transit by $809,000
and $1,771,000, respectively, received joint venture proceeds of $250,000 and
$400,000, respectively, made joint venture distributions of $275,000 and
$100,000, respectively, and received proceeds from the issuance of common stock
of approximately $82,000 and $97,000, respectively.
At October 31, 2002, the Company had a working capital deficit of $44,668,000 as
compared to a working capital deficit of $26,987,000 at October 31, 2001,
representing an increased deficit of $17,681,000. Over the past several years,
management has been addressing the issues that have led to these deficiencies,
and the results of management's plans and efforts have been positive in two of
the last three years. However, the results of this last fiscal period show that
continued effort is needed in the future to allow the Company to return to
profitable operations. Such actions and plans include:
o Increase revenue by selectively opening imaging centers in
areas currently not served by the Company.
o In late November 2001, the Company opened a new
center in Burbank, California
o In January 2002, the Company opened a new center in
Tarzana, California
o In May 2002, the Company acquired Grove Diagnostic
Imaging in Rancho Cucamonga, California
o In December 2002, the Company opened its Rancho
Bernardo joint venture facility.
o Increase revenue by expanding existing facilities or opening
new locations close to existing sites. In order to obtain
certain new large contracts, nearby x-ray offices may be
acquired to meet the increase in patient volume. In addition,
the Company may consolidate certain procedures into one
location predominately with women's centers offering
mammography and ultrasound services.
31
o In September 2002, the Company opened Orange Advanced
Imaging Center and Orange Women's Center across the
street from its existing Orange Imaging Center.
o Effective January 1, 2002, the Company entered into a
new capitation agreement for approximately 62,000
lives primarily benefiting the Company's Temecula
facility ["TVIC"]. The Company opened two additional
smaller facilities in Sun City and Lake Elsinore,
California which will provide x-ray services to
support the new contract. Subsequent to year end, the
Company plans to relocate its Lake Elsinore location
to nearby Wildomar, California.
o In June 2002, the Company entered into a new
capitation contract for approximately 25,000 lives
primarily benefiting the Company's Los Coyotes'
facility. To service the contract, the Company
assumed the offices of three x-ray facilities in
nearby cities.
o In October 2001 and July 2002, the Company entered
into two separate capitation agreements for
approximately 80,000 lives and 15,000 lives,
respectively, primarily benefiting the Company's
Desert Advanced facilities. To service these
contracts, the Company opened three adjacent x-ray
facilities in Palm Springs, Indio and Bermuda Dunes,
California.
o In August 2002, the Company entered into a new
capitation contract for approximately 53,000 lives
primarily benefiting the Company's new Grove facility
in Rancho Cucamonga, California. To service the
contract, the Company assumed a nearby facility
providing x-ray services.
o Increase revenue by renegotiating existing capitation and
managed care contracts for additional services and more
favorable terms. Effective November 1, 2002, the Company
renegotiated one of its existing capitation contracts
primarily benefiting the Company's Orange facilities
increasing its reimbursement by approximately 15%, or
$500,000.
o Increase net revenue and decrease operating losses by
eliminating poor performing capitation and managed care
contracts where reimbursement falls short of the Company's
costs. In November 2002, the Company ceased doing business
under one capitation contract in Orange County where renewal
reimbursement would have fallen short of cost.
o Continue to evaluate all facilities' operations and trim
excess operating and general and administrative costs where it
is feasible to do so including consolidating underperforming
facilities to reduce operating cost duplication and improve
operating income. Due to a shortage of qualified radiologists
in the marketplace, BRMG experienced difficulty in hiring and
retaining physicians at the individual sites during most of
fiscal 2002. This required the engagement of independent
contractors and locum tenens (part-time fill-in physicians) to
interpret patient films. The cost of these individuals was
double the salary of a regular BRMG full-time physician with
additional costs for travel and lodging required. Recently,
BRMG hired a new nationally prominent medical director who
oversees physician recruitment and staffing. The new director
has already arranged for BRMG to hire over twelve new
physicians during the last two quarters of fiscal 2002. BRMG
is working to solidify its physicians at the majority of the
Company's sites while increasing the volume of interpretations
done by physicians at the Company's main offices utilizing the
Company's computer and PACS systems.
32
o Continue to selectively acquire new medical equipment and
replace old and obsolete equipment in order to increase
service volume and throughput at many facilities. In the past
two years, the Company has replaced or upgraded the majority
of its equipment and increased throughput at most of its
locations.
o Continue to work with lessors and lenders to extend terms of
leases and financing to accommodate cash flow requirements for
ongoing agreements and upon the expiration of leases and
notes. The Company has demonstrated continued success in
renegotiation of many of its existing notes payable and
capital lease obligations by extending payment terms, reducing
interest rates, reducing or eliminating monthly payments and
creating long-term balloon payments. The Company's long-term
relationships with its lenders and their continued confidence
in their extensions of credit is critical to the Company's
success.
o During the year ended October 31, 2002, the Company
renegotiated several notes payable with DVI to obtain
working capital of $2,000,000 and extend payment
terms.
o During the year ended October 31, 2002, the Company
financed previously accrued maintenance charges with
General Electric for approximately $1,108,000 with
payment terms of 35 months at 9.5%.
o During the third quarter of fiscal 2002, the Company
obtained $17 million in working capital from DVI to
provide a secured source of financing in advance of
the June 30, 2003 date for retirement of the
remaining $16,291,000 of the Company's 10% Series A
Convertible Subordinated Debentures. Initially, the
funds were utilized to reduce outstanding revolving
credit lines improving the negative effect on the
Company's working capital position when the
debentures became current liabilities in June 2002.
o Continue to settle historical notes payable,
subordinated bond debentures and other debt at
discounts. The Company plans to offer the debenture
holders the right to extend the debenture for three
(3) years, in which event the conversion price would
be reduced to $4. Any remaining debentures shall be
redeemed on their due date of June 30, 2003. The
Company intends to utilize its financing lines to
effect the majority of the redemptions.
o Depending on price, market circumstances and
strategic buyers, the Company may look to liquidate
non core assets. In March 2001, the Company sold its
only radiation therapy center ("VROC") for
$4,000,000, resulting in a gain of approximately
$3,527,000.
Notwithstanding the continued working capital deficiency, doubt about the
entity's ability to continue as a going concern is alleviated by mitigating
factors. Those mitigating factors include the aforementioned actions and plans
by management combined with the positive cash flow from operations and the
continued willingness of existing lenders to offer alternative debt financing
and payment plans.
33
The Company's future obligations for existing notes payable, equipment under
capital lease, lines of credit, subordinated bond debentures and equipment and
building operating leases for the next five years and thereafter include
(numbers in thousands):
There-
2003 2004 2005 2006 2007 after Total
---- ---- ---- ---- ---- ----- -----
Notes payable $ 14,434 $ 14,588 $ 15,104 $ 22,358 $ 10,864 $ 5,357 $ 82,705
Interest $ 8,348 $ 6,734 $ 5,141 $ 2,920 $ 1,504 $ 584 $ 25,231
--------- --------- --------- --------- --------- --------- ---------
Total $ 22,782 $ 21,322 $ 20,245 $ 25,278 $ 12,368 $ 5,941 $107,936
Capital leases $ 11,644 $ 12,199 $ 12,541 $ 11,354 $ 8,573 $ 8,093 $ 64,404
Interest $ 5,724 $ 4,567 $ 3,375 $ 2,184 $ 1,199 $ 547 $ 17,596
--------- --------- --------- --------- --------- --------- ---------
Total $ 17,368 $ 16,766 $ 15,916 $ 13,538 $ 9,772 $ 8,640 $ 82,000
========= ========= ========= ========= ========= ========= =========
Lines of credit $ 10,200 $ -- $ -- $ -- $ -- $ -- $ 10,200
========= ========= ========= ========= ========= ========= =========
Bond debentures $ 16,291 $ -- $ -- $ -- $ -- $ -- $ 16,291
========= ========= ========= ========= ========= ========= =========
Operating Leases:
Building $ 6,977 $ 5,974 $ 5,497 $ 5,157 $ 4,111 $ 16,294 $ 44,010
Equipment $ 2,300 $ 2,168 $ 1,906 $ 1,247 $ 402 $ 19 $ 8,042
--------- --------- --------- --------- --------- --------- ---------
Total $ 9,277 $ 8,142 $ 7,403 $ 6,404 $ 4,513 $ 16,313 $ 52,052
========= ========= ========= ========= ========= ========= =========
The Company's line of credit with Coast Business Credit, due December 2003, is
classified as a current liability primarily because it is collateralized by
account receivable and the eligible borrowing base is also classified as a
current asset. On February 10, 2003, the Company was advised that the Federal
Deposit Insurance Corporation ("FDIC") had elected to close Coast Business
Credit ("Coast") and liquidate its accounts. While the FDIC has agreed that the
Company's facility shall continue through its December 2003 term, it has reduced
the amount available from $22 million to $15 million. The Company intends to
seek an alternate lending source. While the Company has not been fully utilizing
its Coast line, nevertheless, the reduction may impact future liquidity. The
Company believes it will be able to obtain a replacement for the Coast line
before December, but there can be no assurance a replacement will be available
for the full $22 million or at all. Accordingly, the Company has entered into
discussions with a third party for sale of four of the Company's facilities
(three in northern California and one southern California hospital site
location) which the Company considers non core locations. The Company
anticipates the sale will result in a net cash increase of approximately $10
million. The discussions are preliminary in nature and there can be no assurance
of their success.
Effective March 1, 2000, the Company entered into an agreement with GE Medical
Systems for the maintenance of the majority of its medical equipment for a fee
based upon a percentage of net revenues with minimum aggregate net revenue
requirements. In August 2001, the agreement was amended and expires on October
31, 2005. The service fee ranges from 2.82% to 3.74% of net revenue [less
provisions for bad debt] and the aggregate minimum net revenue ranges from
$85,000,000 to $125,000,000 during the term of the agreement. For the year ended
October 31, 2002, the monthly service fees were 3.64% of net revenue and will
increase to 3.74% of net revenue in fiscal 2003.
On August 31, 2001, the Company entered into a sale-leaseback transaction in
which it sold its Orange Imaging facility for $2,250,000 and leased it back for
10 years. Rental commenced at $18,750 per month and increases by 3% per annum
34
each year. The Company has an option to repurchase the property at any time
prior to August 31, 2006, at fair market value (but not less than $2,350,000 nor
more than $2,550,000).
On March 18, 2002, the Company entered into a sale-leaseback transaction in
which it sold its Northridge Imaging facility for $1,700,000 and leased it back
for 10 years. Rental commenced at $13,458 per month and increases to $14,167 in
2003 to $14,167 in 2004 to $14,875 in 2005 to $15,583 in 2006 and thereafter
based upon a cost of living adjustment. The Company has an option to repurchase
the property from 2004 until 2007 at an exercise price commencing at $1,775,000
and increasing by $25,000 in the next year and an additional $50,000 in the
third year.
The Company's working capital needs currently are provided under two lines of
credit. Under one agreement with Coast Business Credit, due December 31, 2003,
the Company may borrow the lesser of 75% to 80% of eligible accounts receivable,
the prior four months' cash collections, or $15,000,000. In any scenario, the
Company may borrow up to the aggregate collection of receivables in the prior
four months as long as the collections in any one month do not decrease by more
than 25% from the prior month. Interest on outstanding borrowings is payable
monthly at the greater of 8% or the bank's prime rate plus 2.5%, with a minimum
interest paid each month of $30,000. At October 31, 2002 approximately
$8,454,000 was outstanding under this line. The lender holds a first lien
position on substantially all of Radnet's assets. The president and C.E.O. of
the Company has personally guaranteed $10,000,000 of the line. The line is
further secured by a $5,000,000 life insurance policy on the life of the
president and C.E.O..
Under the second agreement with DVI Business Credit, the Company may borrow the
lesser of 110% of eligible accounts receivable or $5,000,000. Interest on the
outstanding balance is payable monthly at the bank's prime rate plus 1%. At
October 31, 2002, approximately $1,746,000 was outstanding on this line. This
line of credit is on a month-to-month basis. This credit line is collateralized
by approximately 80% of the Tower division's eligible accounts receivable. A
third line with the same lender was eliminated during the year ended October 31,
2001 by restructuring two of the lender's existing notes payable with the
Company distributing the combined balances over 72 months.
The banks prime rate at October 31, 2002 was 4.75%. The total funds available
for borrowing under the two lines are approximately $8,746,000 at October 31,
2002. For the year ended October 31, 2001 and 2002, the weighted average
interest rate on short-term borrowings was 9.0% and 7.6%, respectively.
The Company's convertible subordinated debentures mature in June 2003. The
aggregate balance due at the time will be $16,698,275 (including quarterly
interest). The Company intends to offer each debenture holder the right to
extend the term by three years together with a reduction in the conversion rate
from $10 per share to $4 per share. The Company believes it will have sufficient
funds under its available financing resources to purchase the majority of the
debentures, if necessary, but such action will severely affect the Company's
liquidity.
The Company operates 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 the Company is unable to generate sufficient cash from operations, or
the Company is unable to structure or obtain operating leases, it may be unable
to meet its capital expenditure requirements. Furthermore, the Company 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 it, if at all.
35
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires the use of judgments and
estimates. The Company's critical accounting policies are described below to
provide a better understanding of how the Company develops judgments about
future events and related estimations and how they can impact the financial
statements. A critical accounting policy is one that requires the Company's most
difficult, subjective or complex estimates and assessments and is fundamental to
the Company's results of operations. The Company has identified its most
critical accounting policies to be:
- estimation of contractual allowances and bad debts of accounts
receivable; and
- evaluation of intangible and long-lived asset for impairment.
CONTRACTUAL ALLOWANCES AND BAD DEBT
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 estimated
contractual allowances. Service fee revenue is recorded net of estimated
contractual allowances and amounts retained by the contracted radiology
practices under the terms of the service agreements. The Company estimates
contractual allowances based on the patient mix at each diagnostic imaging
center, impact of managed care contract pricing, and historical collection
information. The Company operates 58 facilities, each of which has multiple
managed care contracts and a differing patient mix. The Company reviews monthly
the estimated contractual allowance rates for each diagnostic imaging center.
The contractual allowance rate is adjusted as changes to the factors discussed
above become known. The Company records bad debt expenses based on historical
collection rates and its evaluation of each diagnostic imaging center.
IMPAIRMENT OF INTANGIBLE AND LONG-LIVED ASSETS
Subsequent to an acquisition, the Company 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. The Company 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, the Company 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, the Company uses an estimate of the related diagnostic imaging
services' undiscounted cash flows over the remaining lives of the intangible
assets of the property and equipment and compare it to the diagnostic imaging
centers' intangible assets or property and equipment balances. When an
adjustment is required, the Company 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. The
Company recorded no impairment charges during 2000, 2001 or 2002.
NEW AUTHORITATIVE PRONOUNCEMENTS
- --------------------------------
During 2002, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 147 ("Acquisitions of Certain
Financial Institutions--an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9"), No. 146 ("Accounting for Costs Associated with Exit or
Disposal Activities") and No. 145, ("Rescission of FAS Nos. 4, 44, and 64,
36
Amendment of FAS 13, and Technical Corrections as of April 2002"). SFAS No. 147
is effective for acquisitions on or after October 1, 2002. SFAS No. 146 is
effective for exit or disposal activities initiated after December 31, 2002.
SFAS No. 145 is effective for financial statements issued after May 15, 2002.
Management does not believe the adoption of SFAS 145, SFAS 146, and SFAS 147
will have material impact on the financial statements.
In December 2002, the FASB issued SFAS No. 148 ("Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of FASB Statement No.
123"), which amends SFAS No. 123. SFAS No. 148, for which certain provisions are
effective for fiscal years ending after December 15, 2002, provides alternative
methods of transition for a voluntary change to the fair value method of
accounting for stock based employee compensation and amends certain disclosure
provisions of SFAS No. 123. Management does not believe the adoption of SFAS No.
148 will have a material impact on the financial statements.
INFLATION
- ---------
To date, inflation has not had a material effect on the Company's operations.
SPECIFIC FACTORS THAT MIGHT CAUSE ACTUAL RESULTS TO DIFFER FROM EXPECTATIONS,
- -----------------------------------------------------------------------------
INCLUDE, BUT ARE NOT LIMITED TO:
- --------------------------------
- economic, competitive demographic, business and other
conditions in the Company's markets;
- a decline in patient referrals;
- change in the rates or methods of third-party reimbursement
for diagnostic imaging services;
- the termination of contracts with third party payers;
- the availability of additional capital to fund capital
expenditure requirements;
- burdensome lawsuits against contracted radiology practices and
the Company;
- reduced operating margins due to managed care contracts and
capitated fee arrangements;
- any failure on the Company's part to comply with state and
federal anti-kickback and anti-self-referral laws or any other
applicable healthcare regulations;
- the Company's substantial indebtedness, debt service
requirements and liquidity constraints and the Company's
inability to obtain a replacement lender for its Coast
Business Credit line or the failure of the Company to sell
some of its assets to reduce its credit line dependence;
- risks related to convertible subordinated debentures and
healthcare securities generally;
- unforeseen technological changes; and
- other factors discussed elsewhere in this report.
37
All future written and verbal forward-looking statements attributable to the
Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this report might not occur.
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------- --------------------------------------------------------
The Company sells its services exclusively in the United States and
receives payment for its services exclusively in United States dollars. As a
result, the financial results are unlikely to be affected by factors such as
changes in foreign currency exchange rates or weak economic conditions in
foreign markets.
The majority of the Company's interest expense is not sensitive to
changes in the general level of interest in the United States because the
majority of the Company's indebtedness has interest rates which were fixed when
the Company entered into the note payable or capital lease obligation. None of
the Company's long-term liabilities have variable interest rates. Only the
Company's lines of credit, classified as current liabilities on the Company's
financial statements, is interest expense sensitive to changes in the general
level of interest because it is based upon the current prime rate plus a factor.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------
The Financial Statements are attached hereto and begin on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
- ------- ---------------------------------------------
Inapplicable.
38
PRIMEDEX HEALTH SYSTEMS, INC.
INDEPENDENT AUDITORS' REPORT
AND
FINANCIAL STATEMENT
OCTOBER 31, 2002 AND 2001
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors of
Primedex Health Systems, Inc.
We have audited the accompanying consolidated balance sheets of Primedex Health
Systems, Inc. and affiliates as of October 31, 2002 and 2001 and the related
consolidated statements of operations, stockholders' deficit and cash flows for
each of the years in the three-year period ended October 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Primedex Health Systems, Inc.
and affiliates as of October 31, 2002 and 2001, and the consolidated results of
their operations and cash flows for each of the years in the three-year period
ended October 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
/S/ MOSS ADAMS LLP
Los Angeles, California
January 22, 2003
- --------------------------------------------------------------------------------
F-1
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED BALANCE SHEETS
OCTOBER 31, 2001 2002
- ----------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 40,000 $ 36,000
Accounts receivable, net 28,764,000 29,453,000
Unbilled receivables and other receivables 133,000 1,451,000
Due from related party 94,000 --
Deferred income taxes 5,235,000 2,100,000
Other 1,328,000 1,518,000
-------------- --------------
Total current assets 35,594,000 34,558,000
-------------- --------------
PROPERTY AND EQUIPMENT, net 65,368,000 87,875,000
OTHER ASSETS
Accounts receivable, net 2,499,000 2,366,000
Due from related parties 60,000 --
Goodwill 24,064,000 23,064,000
Deferred income taxes -- 3,135,000
Other 844,000 641,000
-------------- --------------
Total other assets 27,467,000 29,206,000
-------------- --------------
$ 128,429,000 $ 151,639,000
-------------- --------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Cash disbursement in transit $ 3,804,000 $ 4,613,000
Accounts payable and accrued expenses 19,361,000 20,871,000
Income taxes payable 125,000 --
Subordinated debentures payable -- 16,291,000
Notes payable to related party 119,000 1,173,000
Current portion of notes and leases payable 39,172,000 36,278,000
-------------- --------------
Total current liabilities 62,581,000 79,226,000
LONG-TERM LIABILITIES
Subordinated debentures payable 16,303,000 --
Notes payable to related party 1,330,000 105,000
Notes and leases payable, net of current portion 90,569,000 121,031,000
Accrued expenses 1,986,000 694,000
-------------- --------------
Total long-term liabilities 110,188,000 121,830,000
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY 1,142,000 1,504,000
REDEEMABLE STOCK 160,000 --
STOCKHOLDERS' DEFICIT (45,642,000) (50,921,000)
-------------- --------------
$ 128,429,000 $ 151,639,000
-------------- --------------
- ----------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-2
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED OCTOBER 31, 2000 2001 2002
- ----------------------------------------------------------------------------------------------------------------------
REVENUE
Revenue $ 229,598,000 $ 284,981,000 $ 378,942,000
Less: Allowances 141,633,000 173,144,000 239,661,000
-------------- -------------- --------------
Net revenue 87,965,000 111,837,000 139,281,000
OPERATING EXPENSES
Operating expenses 62,207,000 78,008,000 105,473,000
Depreciation and amortization 8,580,000 10,705,000 15,309,000
Provision for bad debts 2,581,000 4,022,000 7,183,000
Total operating expenses 73,368,000 92,735,000 127,965,000
Income from operations 14,597,000 19,102,000 11,316,000
-------------- -------------- --------------
OTHER EXPENSE
Interest expense, net (13,140,000) (13,620,000) (16,693,000)
Gain (loss) on sale of subsidiaries, divisions and assets (335,000) 3,520,000 (299,000)
Other 239,000 178,000 511,000
Total other expense (13,236,000) (9,922,000) (16,481,000)
-------------- -------------- --------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES,
MINORITY INTEREST AND EXTRAORDINARY ITEM 1,361,000 9,180,000 (5,165,000)
INCOME TAX BENEFIT -- 5,110,000 --
-------------- -------------- --------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND
EXTRAORDINARY ITEM 1,361,000 14,290,000 (5,165,000)
MINORITY INTEREST IN EARNINGS OF SUBSIDIARIES (259,000) (343,000) (387,000)
-------------- -------------- --------------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM 1,102,000 13,947,000 (5,552,000)
EXTRAORDINARY ITEM - GAIN FROM EXTINGUISHMENT
OF DEBT (NET OF INCOME TAXES OF $0) 1,512,000 554,000 1,000
-------------- -------------- --------------
NET INCOME (LOSS) $ 2,614,000 $ 14,501,000 $ (5,551,000)
============== ============== ==============
BASIC EARNINGS PER SHARE
Income (loss) before extraordinary gain $ 0.03 $ 0.35 $ (0.14)
Extraordinary gain 0.04 0.01 0.00
BASIC NET INCOME (LOSS) PER SHARE $ 0.07 $ 0.36 $ (0.14)
-------------- -------------- --------------
DILUTED EARNINGS PER SHARE
Income (loss) before extraordinary gain $ 0.03 $ 0.32 $ (0.14)
Extraordinary gain 0.04 0.01 0.00
-------------- -------------- --------------
DILUTED NET INCOME (LOSS) PER SHARE $ 0.07 $ 0.33 $ (0.14)
============== ============== ==============
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 38,992,323 39,960,972 40,875,695
============== ============== ==============
Diluted 39,843,422 44,170,547 40,875,695
============== ============== ==============
- ----------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-3
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED OCTOBER 31, 2000, 2001 AND 2002
- ------------------------------------------------------------------------------------------------------------------------
Common Stock, $.01 par value,
100,000,000 shares authorized Treasury Stock, at cost
------------------------------ Paid-in -------------------------------
Shares Amount Capital Shares Amount
-------------- -------------- -------------- -------------- --------------
BALANCE - OCTOBER 31, 1999 40,757,760 $ 408,000 $ 99,337,000 (1,825,000) $ (695,000)
Issuance of common stock 200,000 2,000 28,000 -- --
Discounted note, used to retire
subordinated debentures -- -- -- -- --
Net income -- -- -- -- --
-------------- -------------- -------------- -------------- --------------
BALANCE - OCTOBER 31, 2000 40,957,760 410,000 99,365,000 (1,825,000) (695,000)
Issuance of common stock 1,474,250 15,000 743,000 -- --
Payment of subscription receivable -- -- -- -- --
Net income -- -- -- -- --
-------------- -------------- -------------- -------------- --------------
BALANCE - OCTOBER 31, 2001 42,432,010 425,000 100,108,000 (1,825,000) (695,000)
Issuance of common stock 398,724 4,000 60,000 -- --
Payment of subscription receivable -- -- -- -- --
Retirement of redeemable stock 160,000 160,000
Net loss -- -- -- -- --
BALANCE - OCTOBER 31, 2002 42,830,734 $ 429,000 $ 100,328,000 (1,825,000) $ (695,000)
============== ============== ============== ============== ==============
(CONTINUED BELOW)
Stock Total
Accumulated Due from Subscription Stockholders'
Deficit Related Party Receivable Deficit
-------------- -------------- -------------- --------------
BALANCE - OCTOBER 31, 1999 $(162,547,000) $ (830,000) $ (30,000) $ (64,357,000)
Issuance of common stock -- -- (30,000) --
Discounted note, used to retire
subordinated debentures -- 830,000 -- 830,000
Net income 2,614,000 -- -- 2,614,000
-------------- -------------- -------------- --------------
BALANCE - OCTOBER 31, 2000 (159,933,000) -- (60,000) (60,913,000)
Issuance of common stock -- -- -- 758,000
Payment of subscription receivable -- -- 12,000 12,000
Net income 14,501,000 -- -- 14,501,000
-------------- -------------- -------------- --------------
BALANCE - OCTOBER 31, 2001 (145,432,000) -- (48,000) (45,642,000)
Issuance of common stock -- -- 18,000 82,000
Payment of subscription receivable -- -- 30,000 30,000
Retirement of redeemable stock
Net loss (5,551,000) -- -- (5,551,000)
BALANCE - OCTOBER 31, 2002 $(150,983,000) $ -- $ -- $ (50,921,000)
============== ============== ============== ==============
- ------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-4
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED OCTOBER 31, 2000 2001 2002
- -------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 2,614,000 $ 14,501,000 $ (5,551,000)
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Depreciation and amortization 8,580,000 10,705,000 15,309,000
Provision for bad debts and allowance adjustments (25,000) 3,297,000 1,811,000
Gain (loss) on write-downs, amortization
and disposals of other assets and accrued liabilities 417,000 (116,000) 1,000
Loss (gain) on sale of assets, subsidiaries and divisions -- (3,527,000) 299,000
Imputed interest expense 1,169,000 1,154,000 1,427,000
Minority interest in earnings of subsidiaries 259,000 343,000 387,000
Extraordinary gain (1,512,000) (554,000) (1,000)
Changes in assets and liabilities:
Accounts receivable (1,798,000) (12,157,000) (2,367,000)
Unbilled receivables (1,271,000) 1,556,000 (1,318,000)
Other assets (458,000) (495,000) (86,000)
Deferred income taxes -- (5,235,000) --
Accounts payable and accrued expenses 131,000 3,989,000 3,910,000
Income taxes payable -- 125,000 (125,000)
------------- ------------- -------------
Net cash provided by operating activities 8,106,000 13,586,000 13,696,000
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of imaging centers - net of cash acquired -- (61,000) --
Purchase of property and equipment (4,559,000) (7,469,000) (7,815,000)
Proceeds from sale of divisions, centers, and equipment 1,540,000 5,050,000 1,700,000
Loan fees (70,000) (20,000) (22,000)
Investment in center -- (100,000) --
Payments to related parties (205,000) (233,000) (39,000)
------------- ------------- -------------
Net cash used by investing activities (3,294,000) (2,833,000) (6,176,000)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash overdraft (321,000) 1,771,000 809,000
Principal payments on notes and leases payable (11,652,000) (16,764,000) (20,675,000)
Proceeds from short and long-term borrowings 7,516,000 3,883,000 12,295,000
Purchase of subordinated debentures (122,000) (36,000) (10,000)
Proceeds from issuance of common stock -- 97,000 82,000
Joint venture proceeds -- 400,000 250,000
Joint venture distributions (200,000) (100,000) (275,000)
------------- ------------- -------------
Net cash used by financing activities (4,779,000) (10,749,000) (7,524,000)
------------- ------------- -------------
NET INCREASE/(DECREASE) IN CASH 33,000 4,000 (4,000)
CASH, beginning of year 3,000 36,000 40,000
CASH, end of year $ 36,000 $ 40,000 $ 36,000
------------- ------------- -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for
Interest $ 12,981,000 $ 12,646,000 $ 14,953,000
============= ============= =============
Income taxes $ -- $ -- $ --
------------- ------------- -------------
- -------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-5
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED OCTOBER 31, 2000, 2001 AND 2002
- --------------------------------------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES -
The Company entered into capital leases or financed equipment through notes
payable for approximately $5,135,000, $21,753,000 and $30,846,000 for the years
ended October 31, 2000, 2001 and 2002, respectively.
Effective May 1, 2002, the Company acquired the assets and business of
Grove Diagnostic Imaging ["Grove"] in Rancho Cucamonga, California for
approximately $1,454,000 in assumed liabilities. The Company recorded net
property and equipment of approximately $1,441,000 and other current assets of
approximately $13,000 as part of the transaction.
Effective March 1, 2001, the Company's DIS subsidiary sold it Valley
Regional Oncology Center ["VROC"] and recognized a gain on the sale of
$3,527,000. As part of the sale, the Company wrote off $404,000 in net property
and equipment and $75,000 in net other current assets.
During the year ended October 31, 2001, the Company acquired three
imaging centers. Effective May 10, 2001, the Company acquired the assets and
business of Modesto Imaging Center and recorded net property and equipment of
$1,868,000, notes payable of $6,886,000, other liabilities of $1,032,000 and
goodwill of $6,050,000. Effective June 1, 2001, the Company acquired a portion
of the equipment of two imaging centers located in Palm Springs and Palm Desert,
California and recorded net property and equipment of $376,000, notes payable of
$342,000 and other liabilities of $35,000.
Effective July 2, 2002, the Company renegotiated twelve of its
outstanding notes payable with DVI, obtained working capital and incurred $2.8
million in refinancing charges which will be amortized over the six year life of
the notes.
During the year ended October 31, 2001, the Company restructured a
portion of its debt with DVI transferring the liquidation value of its preferred
stock into other notes payable. As part of the transaction, accrued interest of
approximately $235,000 was accumulated into the new notes payable balances.
In November 2001, the Company issued 132,850 shares of common stock as a
bonus to 274 employees under the long-term incentive stock option plan ($.60 per
share public closing price on the authorization date). As part of the
transaction, approximately $80,000 was recorded as operating expenses.
In April 2002, an officer of the Company exercised his option to
purchase 300,000 shares of common stock at $.15 per share. As part of the
transaction, the officer surrendered to the Company 30,201 mature shares of
common stock with a fair market value of $45,000 ($1.49 per share public closing
price on the transaction date). In addition, the officer surrendered to the
Company an additional 13,424 shares of common stock with a fair market value of
$20,000 in payment of his note payable with accumulated interest (classified as
Stock Subscription Receivable on the Company's financial statements). By
combining the transaction, the Company issued a net 256,375 shares of common
stock to the officer for his option exercise.
- --------------------------------------------------------------------------------
F-6
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED OCTOBER 31, 2000, 2001 AND 2002
- --------------------------------------------------------------------------------
During the year ended October 31, 2001, warrants for 920,100 shares of
common stock were exercised for approximately $230,000. As part of the
transaction, the Company deducted the exercise price from its notes payable
payment due to the same individuals.
During the year ended October 31, 2001, a cashless exercise of warrants
occurred, and 65,484 shares of common stock were issued to eight note holders of
the Company. In fiscal 1996, these warrants were issued to the note holders with
options for a cashless exercise for common stock if the Company's stock prices
exceeded certain levels.
During the year ended October 31, 2001, the Company exchanged a $635,000
notes receivable from a related party and recorded a related party payable for
approximately $119,000 for the purchase of $1,159,000 of the Company's
subordinated debentures. The Company recorded a $405,000 extraordinary gain as a
result of the transaction.
The accompanying notes are an integral part of these financial statements
- --------------------------------------------------------------------------------
F-7
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1 - NATURE OF BUSINESS
Primedex Health Systems, Inc., incorporated on October 21, 1985,
provides diagnostic imaging services in the state of California. Imaging
services include MRI, CT, PET, ultrasound, mammography, nuclear medicine and
general diagnostic radiology. The operations of the Company comprise a single
segment for financial reporting purposes.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPALS OF CONSOLIDATION - The consolidated financial statements
include the accounts of Primedex Health Systems, Inc.; Radnet Management, Inc.
["Radnet"]; Diagnostic Imaging Services, Inc. ["DIS"] and Radnet Managed Imaging
Services, Inc.["RMIS"] (collectively referred to as "the Company"). Radnet
Management, Inc. is combined with Beverly Radiology Medical Group III ["BRMG"]
and consolidated with Radnet Sub, Inc., Westchester Imaging Group (a joint
venture), Radnet Management I, Inc., Radnet Management II, Inc. ["Modesto"],
Burbank Advanced LLC, Rancho Bernardo Advanced LLC and SoCal MR Site Management,
Inc.. Diagnostic Imaging Services is also combined with BRMG.
Operating activities of subsidiary entities are included in the
accompanying financial statements from the date of acquisition. All intercompany
transactions and balances have been eliminated in consolidation and
combinations. Westchester Imaging Group is consolidated with the Company based
upon the criteria of both SFAS 94 and EITF 97-2.
Medical services and supervision at most of the Company's imaging
centers are provided through BRMG and through other independent physicians and
physician groups. BRMG is consolidated with Pronet Imaging Medical Group, Inc.
and Beverly Radiology Medical Group, both of which are 99% owned by a
shareholder and president of Primedex Health Systems, Inc. Radnet and DIS
provide non-medical, technical and administrative services to BRMG for which
they receive a management fee.
CASH AND CASH EQUIVALENTS - For purposes of the statement of cash
flows, the Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The carrying
amount of cash and cash equivalents approximates their fair market value.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost,
less accumulated depreciation and amortization and valuation impairment
allowances. Depreciation and amortization of property and equipment are provided
using the straight-line method over the estimated useful lives, which range from
3 to 15 years. Leasehold improvements are amortized over their estimated useful
life, which range from 3 to 20 years.
- --------------------------------------------------------------------------------
F-8
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLE AND ALLOWANCES - Accounts receivable are stated at
gross amounts billed, less allowances. A significant portion of the Company's
accounts receivable involve third-party payors, primarily insurance companies.
The collection cycle on accounts receivable from continuing operations extends
up to 36 months with most personal injury cases having the longest collection
cycle. The current portion of accounts receivable are the amounts which are
reasonably expected to be collected within one year, based upon historical
collection data.
Accounts receivable as of October 31, 2002, are shown net of
contractual allowances and allowances for doubtful accounts of approximately
$59,150,000, of which $54,751,000 has been deducted from current receivables and
$4,399,000 has been deducted from noncurrent receivables. Accounts receivable as
of October 31, 2001, are shown net of contractual allowances and allowances for
doubtful accounts of approximately $54,211,000, of which $49,878,000 has been
deducted from current receivables and $4,333,000 has been deducted from
noncurrent receivables.
GOODWILL - Goodwill is recognized in certain business combinations and
represents the excess of the purchase price over the fair value of net assets
acquired. In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets," which supersedes APB Opinion No. 17, "Intangible
Assets." Under the new rules, goodwill (and intangible assets deemed to have
indefinite lives) will no longer be amortized but subject to annual impairment
tests in accordance with the statements. Intangible assets with finite lives
will continue to be amortized over their useful lives. SFAS 142 applies to
goodwill and intangible assets arising from transactions completed before and
after the Statement's effective date. The Company has adopted this Standard as
of November 1, 2001. In implementing SFAS 142, the Company has performed the
transitional reassessment and impairment tests required as of November 1, 2001,
and determined that there was no impairment on goodwill. The Company ceased
amortizing these assets on November 1, 2001.
REVENUE RECOGNITION -
UNBILLED RECEIVABLES - Unbilled receivables represents the amount of
service revenue earned during the period for which billings did not occur until
the subsequent period. During the year ended October 31, 2002, the Company
continued to convert many of its sites to one billing and collection system with
one uniform gross fee schedule and phase-out its involvement with external
collection companies and multiple internal systems with different gross fee
schedules. As a result, when sites are converted to the new system, delays due
to learning new procedures have increased the Company's unbilled receivables at
month end. Billings are generally completed in the month following. During the
last two quarters of fiscal 2002, the Company converted its Orange, Tustin, Los
Coyotes and Redondo facilities to the new system, and as a result, delays in
billing occurred.
- --------------------------------------------------------------------------------
F-9
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
NET PATIENT SERVICE REVENUE - Net patient service revenue is reported
at the estimated net realizable amounts from patients, third-party payors, and
others for services in the period in which services are provided. Provision for
bad debt is reported separately on the Company's financial statements. Service
revenue is comprised of premium revenue and prepaid plan revenue ["capitation"].
Net premium revenue, less provisions for bad debt, for the year ended October
31, 2001 and 2002 was approximately $88,685,000 and $105,898,000, respectively.
Gross premium revenue for the year ended October 31, 2001 and 2002 was
approximately $217,736,000 and $279,676,000, respectively.
Revenue under third-party payor agreements is subject to audit and
retroactive adjustment. Provisions for estimated third-party payor settlements
are provided in the period the related services are rendered. Differences
between the estimated amounts accrued and interim and final settlements are
reported in operations in the year of settlement.
PREPAID PLAN REVENUE - The Company contracts with health maintenance
organizations and other third parties to provide health care services to plan
enrollees. Under the various contracts, the Company receives a per enrollee
amount (capitated payment) each month covering all contracted services needed by
the plan enrollees. Capitation payments are recognized as service revenue during
the period in which the Company is obligated to provide services to the plan
enrollees. Net prepaid plan revenue for the year ended October 31, 2001 and 2002
was approximately $19,130,000 and $26,200,000, respectively. Gross prepaid plan
revenue for the year ended October 31, 2001 and 2002 was approximately
$67,245,000 and $99,266,000, respectively.
INCOME TAXES - Income tax expense is computed using an asset and
liability method, using expected annual effective tax rates. Under this method,
deferred income taxes are recorded resulting from differences in the financial
reporting basis and the income tax reporting basis of assets and liabilities.
Income taxes are further explained in Note 9.
CONCENTRATION OF CREDIT RISK - Financial instruments that potentially
subject the Company to credit risk are primarily cash equivalents and accounts
receivable. The Company has placed its cash and cash equivalents with one major
financial institution. At times, the cash in the financial institution is
temporarily in excess of the amount insured by the Federal Deposit Insurance
Corporation (FDIC).
- --------------------------------------------------------------------------------
F-10
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK (CONTINUED)
With respect to accounts receivable, the Company routinely assesses the
financial strength of its customers and third-party payors and, based upon
factors surrounding their credit risk, establishes a provision for bad debt.
Contractual adjustments represent the normal and customary reimbursement
adjustments based on the site's current gross fee schedule. Gross and net
charges by payor for the year ended October 31, 2001 and 2002 were:
Gross Charges Net Charges
------------- -----------
2001 2002 2001 2002
---- ---- ---- ----
Capitation contracts 23.6% 26.2% 17.8% 19.8%
HMO/PPO/Managed care 21.2% 19.8% 21.7% 20.5%
Special group contract 17.8% 17.0% 13.8% 12.4%
Medicare 11.0% 11.3% 12.2% 12.9%
Blue Cross/Shield/Champus 9.3% 9.5% 10.9% 11.8%
Commercial insurance 7.2% 6.9% 10.6% 10.5%
Workers Compensation 4.0% 4.0% 6.6% 6.2%
Medi-Cal 2.7% 2.9% 1.9% 2.4%
Other 3.2% 2.4% 4.5% 3.5%
Management believes that its accounts receivable credit risk exposure,
beyond allowances that have been provided, is limited.
USE OF ESTIMATES - The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
IMPAIRMENT ON LONG-LIVED ASSETS - Certain long-lived assets of the
Company are reviewed at least annually as to whether their carrying values have
become impaired in accordance with Statement of Financial Accounting Standards
(SFAS) 144, "Accounting for Impairment or Disposal of Long-Lived Assets."
Management considers assets to be impaired if the carrying value exceeds the
undiscounted projected cash flows from operations. If impairment exists, the
assets are written down to fair value or the projected cash flows from related
operations. As of October 31, 2002, the Company expects the remaining carrying
value of assets to be fully recoverable.
- --------------------------------------------------------------------------------
F-11
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS - As permitted by SFAS 123, "Accounting for Stock-Based
Compensation", the Company continues to apply APB Opinion No. 25 (APB 25) and
related Interpretations in accounting for its option plans. Under SFAS 123, a
fair value method is used to determine compensation cost for stock options or
similar equity instruments. Compensation is measured at the grant date and is
recognized over the service or vesting period. Under APB 25, compensation cost
is the excess, if any, of the quoted market price of the stock at the
measurement date over the amount that must be paid to acquire the stock. The new
standard allows the Company to continue to account for stock-based compensation
under APB 25, with disclosure of the effects of the new standard. The proforma
effect on income as if the Company had adopted SFAS 123 is disclosed in Note 10.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified
to conform with the current year presentation. These changes have no effect on
net earnings.
EARNINGS PER SHARE - Earnings per share are based upon the weighted
average number of shares of common stock and common stock equivalents
outstanding, net of common stock held in treasury as follows:
Year Ended October 31,
-------------------------------------------
2000 2001 2002
------------- ------------- -------------
Net income (loss) for earnings
per share computation $ 2,614,000 $ 14,501,000 $ (5,551,000)
BASIC
Weighted average number of
common shares outstanding
during the year 38,992,323 39,960,972 40,875,695
------------- ------------- -------------
Basic earnings per share $ 0.07 $ 0.36 $ (0.14)
============= ============= =============
DILUTED
Weighted average number of common
shares outstanding used in
calculating basic earnings per share 38,992,323 39,960,972 40,875,695
Add additional shares issuable
upon exercise of stock options,
warrants and convertible securities 851,099 4,209,575 --
Weighted average number of
common shares used in calculating
diluted earnings per share 39,843,422 44,170,547 40,875,695
============= ============= =============
Diluted earnings per share $ 0.07 $ 0.33 $ (0.14)
- --------------------------------------------------------------------------------
F-12
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE (CONTINUED)
For the year ended October 31, 2000, the Company has included 2,571,963
of options and warrants in the calculation of dilutive earnings per share.
Common stock equivalents, which are exercisable into 4,156,790 shares of common
stock at October 31, 2000, have been excluded because their effect would be
antidilutive. For the year ended October 31, 2001, the Company has included
7,724,350 options and warrants in the calculation of diluted earnings per share.
The Company has excluded 3,483,822 options and warrants in the calculation of
diluted earnings per share because their effect would be antidilutive as of
October 31, 2001. For the year ended October 31, 2002, the Company has excluded
all options and warrants in the calculation of diluted earnings per share
because their effect would be antidilutive. However, these instruments could
potentially dilute earnings per share in future years.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS AND PROPOSED ACCOUNTING
CHANGES - During 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 147 ("Acquisitions of
Certain Financial Institutions--an amendment of FASB Statements No. 72 and 144
and FASB Interpretation No. 9"), No. 146 ("Accounting for Costs Associated with
Exit or Disposal Activities") and No. 145, ("Rescission of FAS Nos. 4, 44, and
64, Amendment of FAS 13, and Technical Corrections as of April 2002"). SFAS No.
147 is effective for acquisitions on or after October 1, 2002. SFAS No. 146 is
effective for exit or disposal activities initiated after December 31, 2002.
SFAS No. 145 is effective for financial statements issued after May 15, 2002.
Management does not believe the adoption of SFAS 145, SFAS 146, and SFAS 147
will have material impact on the financial statements.
In December 2002, the FASB issued SFAS No. 148 ("Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123"), which amends SFAS No. 123. SFAS No. 148, for which certain
provisions are effective for fiscal years ending after December 15, 2002,
provides alternative methods of transition for a voluntary change to the fair
value method of accounting for stock based employee compensation and amends
certain disclosure provisions of SFAS No. 123. Management does not believe the
adoption of SFAS No. 148 will have a material impact on the financial
statements.
NOTE 3 - ACQUISITIONS, SALES AND DIVESTITURES
Future openings of imaging center:
- ----------------------------------
In December 2002, the Company opened a joint venture center in Rancho
Bernardo, California. Prior to its opening, in late November 2001, the Company
entered into a new building lease arrangement for 9,557 square feet in Rancho
Bernardo in anticipation of opening the new multi-modality imaging center. The
center, Rancho Bernardo Advanced Imaging Center ["RB"], is 75%-owned by the
Company and 25%-owned by two physicians who invested $250,000.
- --------------------------------------------------------------------------------
F-13
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3 - ACQUISITIONS, SALES AND DIVESTITURES (Continued)
Sale of imaging center:
- -----------------------
Effective March 1, 2001, the Company's DIS subsidiary sold its Valley
Regional Oncology Center ["VROC"] to Summit Health Enterprises, LLC, an
unaffiliated third party, for $4,000,000 cash and recognized a gain on the sale
of approximately $3,527,000. In addition, the Company invested an additional
$100,000 in the center for which it received an 8.89% interest which was
subsequently sold for $105,000 in October 2002. For the four months ended
February 28, 2001, the center generated net revenue of approximately $570,000
and net income of approximately $190,000.
Acquisitions and openings of imaging centers:
- ---------------------------------------------
In the second quarter of fiscal 2002, the Company entered into two new
building leases for approximately 10,000 square feet of space in the building
across the street from Orange Imaging Center to open Orange Advanced and Orange
Women's Imaging Centers. Orange Advanced will offer MRI, PET, nuclear medicine
and x-ray services and Orange Women's will offer ultrasound and mammography
services. The centers opened in late September 2002.
Effective May 1, 2002, the Company acquired certain assets and related
liabilities of Grove Diagnostic Imaging Center ["Grove"] in Rancho Cucamonga,
California for approximately $1,454,000. The transaction was financed by DVI.
The center provides MRI, CT, ultrasound, mammography and x-ray services.
Effective January 1, 2002, the Company entered into a new capitation
arrangement with Primecare Medical Group for approximately 62,000 lives
primarily benefiting the Company's Temecula ["TVIC"] facility. The Company
entered into two new building leases in Sun City and Lake Elsinore, California
which provide x-ray services to support the new contract. Subsequent to
year-end, the Company will close Lake Elsinore and move the location to nearby
Wildomar, California.
In January 2002, the Company opened Tarzana Advanced Imaging Center
which provides MRI, CT and PET services.
In late November 2001, the Company opened Burbank Advanced Imaging
Center, LLC ["Burbank"], which provides MRI, CT, ultrasound and x-ray services.
Burbank is a joint venture with two physicians and is 75%-owned by the Company.
Effective June 1, 2001, the Company acquired a portion of the assets
and related liabilities of Sadler Radiology, Inc.. The results of operations
have been included in the consolidated financial statements as of that date.
Sadler Radiology, Inc. is the provider of radiology services in two imaging
centers in Palm Springs and Palm Desert, California. The aggregate purchase
price was $407,000, consisting of a cash purchase price of $31,000 and the
assumption of debt and liabilities totaling $376,000. The purchase price has
been allocated to property and equipment.
- --------------------------------------------------------------------------------
F-14
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3 - ACQUISITIONS, SALES AND DIVESTITURES (Continued)
Effective May 9, 2001, the Company acquired certain assets and related
liabilities of Modesto Imaging Center, Inc. ["Modesto"]. The results of
operations have been included in the consolidated financial statements as of
that date. Modesto provides MRI, CT, ultrasound, mammography and x-ray services.
The aggregate purchase price was $7,918,000, consisting of cash and notes
payable of $6,357,000, and assumption of debt totaling $561,000.
The following summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition of Modesto.
Property and equipment $ 1,868,000
Goodwill 6,050,000
------------
Total assets acquired 7,918,000
Current liabilities (32,000)
Long-term debt (529,000)
------------
Total liabilities assumed (561,000)
------------
Net assets acquired $ 7,357,000
============
The $6,050,000 of goodwill has been assigned to the acquired imaging
center based on the relative asset values and expected contributions to the
Company. The total goodwill is expected to be deductible for tax purposes.
During the year ended October 31, 2002, the Company wrote-off $1,000,000 of the
goodwill due to the elimination of a contingent liability which was not required
to be paid.
The following represents the unaudited pro forma results of operations
as if the acquisition had been acquired as of the beginning of the respective
reporting periods presented:
Years ending October 31,
------------------------------
2000 2001
------------- --------------
Net revenue $ 99,255,000 $ 118,518,000
Net income before extraordinary item 2,899,000 14,516,000
Net income 4,411,000 15,070,000
EPS 0.11 0.34
- --------------------------------------------------------------------------------
F-15
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment and accumulated depreciation and amortization as
of October 31, 2001 and 2002 are:
2001 2002
-------------- --------------
Land $ 1,764,000 $ --
Buildings 2,476,000 600,000
Medical equipment 20,965,000 24,523,000
Office equipment, furniture and fixtures 6,879,000 6,443,000
Leasehold improvements 18,173,000 23,449,000
Equipment under capital lease 50,167,000 78,664,000
100,424,000 133,679,000
Accumulated depreciation and amortization (35,056,000) (45,804,000)
-------------- --------------
$ 65,368,000 $ 87,875,000
-------------- --------------
Depreciation and amortization expense on property and equipment for the
year ended October 31, 2000, 2001 and 2002 was approximately $7,315,000,
$9,052,000 and $15,052,000, respectively. Accumulated amortization under capital
leases for the years ended October 31, 2001 and 2002 was approximately
$15,197,000 and $22,822,000, respectively. Amortization expense under capital
leases for the years ended October 31, 2000, 2001 and 2002 was approximately,
$3,530,000, $4,216,000, and $8,913,000, respectively. During the year ended
October 31, 2002, the Company sold the land and building at its Northridge
facility for $1,700,000 and entered into a ten-year lease for the same location
with monthly rentals ranging from $13,458 to $18,607 during the lease term. The
sale resulted in a loss of approximately $147,000.
NOTE 5 - GOODWILL
Intangible assets consist of goodwill recorded at cost of $30,330,000
and $29,330,000, less accumulated amortization of $6,266,000 for each of the
years ended October 31, 2001 and 2002, respectively. Amortization expense of
approximately $903,000, $1,354,000 and $-0- was recognized for the years ended
October 31, 2000, 2001 and 2002, respectively.
Application of the non-amortization provisions of the Statement
resulted in an increase in income of approximately $1,505,000 ($.04 per share)
for the year ended October 31, 2002. During the year ended October 31, 2002, the
Company wrote-off $1,000,000 of the goodwill associated with the acquisition of
Modesto Imaging Center due to the elimination of a contingent liability, which
was not required to be paid.
- --------------------------------------------------------------------------------
F-16
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5 - GOODWILL (CONTINUED)
The following is the reconciliation of reported income (loss) before
extraordinary items to the adjusted income (loss) before extraordinary items
exclusive of amortization expense relating to goodwill.
Years ending October 31,
------------------------------------------------------------------------------------------------
2000 2001 2002
--------------------------------------- --------------------------------------- ------------
Per Share Amount Per Share Amount
--------------------- ---------------------
Amount Basic Diluted Amount Basic Diluted Amount
------------ --------- --------- ------------ --------- --------- ------------
Reported income (loss) before
extraordinary item $ 1,102,000 $ 0.03 $ 0.03 $13,947,000 $ 0.35 $ 0.32 $(5,552,000)
Add back: Goodwill amortization 930,000 0.02 0.02 1,653,000 0.04 0.04 --
------------ --------- --------- ------------ --------- --------- ------------
Adjusted income (loss) before
extraordinary item $ 2,032,000 $ 0.05 $ 0.05 $15,600,000 $ 0.39 $ 0.36 $(5,552,000)
------------ --------- --------- ------------ --------- --------- ------------
The following is the reconciliation of reported net income (loss) to the
adjusted income (loss) exclusive of amortization expense relating to goodwill.
Years ending October 31,
------------------------------------------------------------------------------------------------
2000 2001 2002
--------------------------------------- --------------------------------------- ------------
Per Share Amount Per Share Amount
--------------------- ---------------------
Amount Basic Diluted Amount Basic Diluted Amount
------------ --------- --------- ------------ --------- --------- ------------
Reported net income (loss) $ 2,614,000 $ 0.07 $ 0.07 $14,501,000 $ 0.36 $ 0.33 $(5,551,000)
Add back: Goodwill amortization 930,000 0.02 0.02 1,653,000 0.04 0.04 --
------------ --------- --------- ------------ --------- --------- ------------
Adjusted net income (loss) $ 3,544,000 $ 0.09 $ 0.09 $16,154,000 $ 0.40 $ 0.37 $(5,551,000)
============ ========= ========= ============ ========= ========= ============
NOTE 6 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
2001 2002
------------- -------------
Accounts payable $ 7,423,000 $ 8,213,000
Accrued expenses 10,116,000 8,956,000
Accrued professional fees 2,163,000 2,565,000
Accrued loss on legal judgments 412,000 347,000
Other 1,233,000 1,484,000
------------- -------------
21,347,000 21,565,000
Less long-term portion of accrued
expenses, professional fees,
accrued losses and other (1,986,000) (694,000)
------------- -------------
$ 19,361,000 $ 20,871,000
============= =============
Accrued professional fees consist of outside professional agreements,
which are paid out of net cash collections. The long-term portion relates to the
accounts receivable classified as long-term.
- --------------------------------------------------------------------------------
F-17
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7 - NOTES PAYABLE, LONG-TERM DEBT AND CAPITAL LEASES
Notes payable, long-term debt and capital lease obligations at October
31, 2002 and 2001 consists of the following:
2001 2002
-------------- --------------
Revolving lines of credit $ 20,752,000 $ 10,199,000
Notes payable at interest rates ranging from
6.6% to 11.5%, due through 2008, collateralized
by medical equipment 66,024,000 80,986,000
Note payable bearing interest at 9.5%, due in
2005, collateralized by real estate 1,701,000 1,662,000
Obligations from a Company acquisition bearing
interest at 8%, due through 2003 278,000 58,000
Obligations under capital leases at interest
rates ranging from 8.0% to 13.6%, due through
2009, collateralized by medical and office
equipment 40,986,000 64,404,000
-------------- --------------
129,741,000 157,309,000
Less: current portion (39,172,000) (36,278,000)
-------------- --------------
$ 90,569,000 $ 121,031,000
-------------- --------------
The Company's working capital needs currently are provided under two
lines of credit. Under one agreement with Coast Business Credit, due December
31, 2003, the Company may borrow the lesser of 75% to 80% of eligible accounts
receivable, the prior four months' cash collections, or $15,000,000. In any
scenario, the Company may borrow up to the aggregate collection of receivables
in the prior four months as long as the collections in any one month do not
decrease by more than 25% from the prior month. Interest on outstanding
borrowings is payable monthly at the greater of 8% or the bank's prime rate plus
2.5%, with a minimum interest paid each month of $30,000. At October 31, 2002
approximately $8,454,000 was outstanding under this line. The lender holds a
first lien position on substantially all of Radnet's assets. The president and
C.E.O. of the Company personally guaranteed $10,000,000 of the line. The line is
further secured by a $5,000,000 life insurance policy of the president and C.E.O
[See Note 16].
- --------------------------------------------------------------------------------
F-18
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7 - NOTES PAYABLE, LONG-TERM DEBT AND CAPITAL LEASES (CONTINUED)
Under the second agreement with DVI Business Credit, the Company may
borrow the lesser of 110% of eligible accounts receivable or $5,000,000.
Interest on the outstanding balance is payable monthly at the bank's prime rate
plus 1%. At October 31, 2002, approximately $1,746,000 was outstanding on this
line. This line of credit is on a month-to-month basis. This credit line is
collateralized by approximately 80% of the Tower division's eligible accounts
receivable. A third line with the same lender was eliminated during the year
ended October 31, 2001 by restructuring two of the lender's existing notes
payable with the Company distributing the combined balances over 72 months.
The banks prime rate at October 31, 2002 was 4.75%. The total funds
available for borrowing under the two lines are approximately $8,746,000 at
October 31, 2002. For the year ended October 31, 2001 and 2002, the weighted
average interest rate on short-term borrowings was 9.0% and 7.6%, respectively.
Annual principal maturities of long-term obligations exclusive of
capital leases, for future years ending October 31, are:
2003 $24,634,000
2004 14,588,000
2005 15,104,000
2006 22,358,000
2007 10,864,000
Thereafter 5,357,000
------------
$92,905,000
============
- --------------------------------------------------------------------------------
F-19
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7 - NOTES PAYABLE, LONG-TERM DEBT AND CAPITAL LEASES (CONTINUED)
The Company leases equipment under capital lease arrangements. Future
minimum lease payments under capital leases as of October 31, 2002 are:
2003 $ 17,368,000
2004 16,766,000
2005 15,917,000
2006 13,538,000
2007 9,772,000
Thereafter 8,639,000
-------------
Total minimum payments 82,000,000
Amount representing interest (17,596,000)
-------------
Present value of net minimum lease payments 64,404,000
Current portion (11,644,000)
-------------
Long-term portion $ 52,760,000
=============
At October 31, 2002, the Company is in default on approximately
$317,000 under various note agreements, pertaining to the acquisition of imaging
centers, for non-payment of principal and interest. These notes have been
classified as current payables.
During the years ended October 31, 2000, 2001 and 2002, the Company
paid off and renegotiated various obligations at discounts resulting in
extraordinary gains of $20,000, $117,000 and $-0-, respectively.
NOTE 8 - SUBORDINATED DEBENTURES
In June of 1993, the Company's registration for a total of $25,875,000
of 10% Series A Convertible subordinated debentures due 2003 was declared
effective by the Securities and Exchange Commission. The net proceeds to the
Company were approximately $23,000,000. Costs of $3,000,000 associated with the
original offering are being amortized over ten years to result in a constant
yield. The unamortized portion is classified as other assets. The debentures are
convertible into shares of common stock at any time before maturity into $1,000
principal amounts at a conversion price of $10 per share through June 1999 and
$12 per share thereafter. As debentures are being converted or retired, a
pro-rata share of the offering costs are written-off.
- --------------------------------------------------------------------------------
F-20
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 8 - SUBORDINATED DEBENTURES (CONTINUED)
Amortization expense of the offering costs for the years ended October
31, 2000, 2001 and 2002 was $230,000, $202,000 and $188,000, respectively.
Interest expense for the years ended October 31, 2000, 2001 and 2002 was
approximately $1,984,000, $1,720,000 and $1,630,000, respectively. There were no
conversions during the years ended October 31, 2001 and 2002.
During the years ended October 31, 2000, 2001 and 2002, the Company
repurchased debentures with face amounts of $234,000, $68,000 and $12,000, for
$122,000, $37,000 and $11,000, respectively, resulting in gains on early
extinguishments of $112,000, $31,000 and $1,000, respectively. During the year
ended October 31, 2000, the Company exchanged a $893,000 note receivable from a
related party for $2,273,000 in subordinated debentures. The Company recorded a
$1,380,000 extraordinary gain as a result of this transaction. During the year
ended October 31, 2001, the Company exchanged a $634,000 note receivable from a
related party and recorded a $119,000 related party payable for $1,159,000 in
subordinated debentures. The Company recorded a $406,000 extraordinary gain as a
result of this transaction. In connection with these transactions, $76,000,
$23,000 and $-0- of net offering costs were written-off during the years ended
October 31, 2000, 2001 and 2002, respectively.
The Company plans to offer the debenture holders the right to extend
the debenture for three (3) years, in which event the conversion price would be
reduced to $4. Any remaining debentures shall be redeemed on their due date of
June 30, 2003. The Company intends to utilize its financing lines to effect the
majority of the redemptions.
NOTE 9 - INCOME TAXES
Income taxes have been recorded under SFAS No. 109, "Accounting for
Income Taxes." Deferred income taxes reflect the net tax effects of temporary
differences between carrying amounts of assets and liabilities for financial and
income tax reporting purposes and operating loss carryforwards.
The components of the income tax provisions are as follows:
2000 2001 2002
------------ ------------ ------------
Current tax provision
Federal $ -- $ 100,000 $ --
State -- 25,000 --
------------ ------------ ------------
-- 125,000 --
Deferred tax benefit -- (5,235,000) --
------------ ------------ ------------
$ -- $(5,110,000) $ --
============ ============ ============
- --------------------------------------------------------------------------------
F-21
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES (CONTINUED)
Reconciliation between the effective tax rate and the statutory tax
rates for the years ended October 31, 2000, 2001 and 2002 are as follows:
2000 2001 2002
-------- -------- --------
Federal tax (34.0)% (34.0)% (34.0)%
State franchise tax, net of federal benefit (5.8) (5.8) (5.8)
Change in valuation allowance 39.8 90.6 39.8
Other -- (0.2) --
Income tax benefit -- % 50.6 % -- %
======== ======== ========
At October 31, 2001 and 2002, the Company's deferred tax assets are
comprised of the following items:
2001 2002
------------- -------------
DEFERRED TAX ASSETS, current
Net operating loss carryforwards $ 5,235,000 $ 2,100,000
Other 1,462,000 1,366,000
------------- -------------
6,697,000 3,466,000
Valuation allowance (1,462,000) (1,366,000)
------------- -------------
$ 5,235,000 $ 2,100,000
============= =============
DEFERRED TAX ASSETS, noncurrent
Fixed and intangible assets $ 2,054,000 $ 402,000
Other -- 2,773,000
Net operating loss carryforwards 39,269,000 43,445,000
------------- -------------
41,323,000 46,620,000
Valuation allowance (41,323,000) (43,485,000)
------------- -------------
$ -- $ 3,135,000
============= =============
The valuation allowance of $42,785,000 and $44,851,000 at October 31,
2001 and 2002, respectively, represents a decrease of $9,812,000 and a
$2,066,000 respectively, over the preceding year.
- --------------------------------------------------------------------------------
F-22
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES (CONTINUED)
The Company has net operating loss carryforwards of approximately
$121,400,000, which expire as follows:
2007 $ 8,000,000
2008 21,500,000
2009 16,200,000
2010 15,700,000
2011 16,900,000
2012 1,700,000
2013 15,300,000
2014 12,300,000
2015 5,800,000
2017 8,000,000
-------------
Total $121,400,000
=============
As of October 31, 2002, $24,700,000 of the Company's federal net
operating loss carryforwards are subject to limitations related to their
utilization under Section 382 of the Internal Revenue Code.
NOTE 10 - CAPITAL STRUCTURE AND CAPITAL TRANSACTIONS
PREFERRED STOCK
The Company has authorized the issuance of 10,000,000 shares of
preferred stock with a par value of $.01 per share. There are no preferred
shares issued or outstanding at October 31, 2000, 2001 or 2002. Shares may be
issued in one or more series. During the year ended October 31, 2001, the
Company issued 5,542,018 preferred shares in settlement of certain debt
obligations and subsequently retired the stock by restructuring existing notes
payable and combining the preferred stock balance due of approximately
$5,542,000 plus accrued interest of approximately $235,000. In conjunction with
this refinancing, the Company issued five-year warrants to purchase 1,000,000
shares of common stock at an exercise price of $1 per share.
- --------------------------------------------------------------------------------
F-23
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10 - CAPITAL STRUCTURE AND CAPITAL TRANSACTIONS (CONTINUED)
REDEEMABLE STOCK
In January 1998, the Company entered into a five-year agreement with a
former officer of the Company whereby the Company agreed to purchase up to
600,000 shares of the Company's common stock from the former officer at $.40 per
share, in minimum increments of 100,000 shares, upon his election any time prior
to February 28, 2003. In January 1999, the Company repurchased 200,000 shares
under this agreement. In November 2001, the Company paid the former officer
$40,000 to eliminate his rights to have the Company repurchase the remaining
400,000 shares.
STOCK OPTION INCENTIVE PLANS
The Company has a long-term incentive stock option plan which reserves
2,000,000 shares of common stock. Options granted under the plan are intended to
qualify as incentive stock options under existing tax regulations. In addition,
the Company has issued non-qualified stock options from time to time in
connection with acquisitions and for other purposes and has also issued stock
under the plan. During the year ended October 31, 2002, the Company issued
132,800 shares as a bonus to 274 employees ($.60 per share public closing price
on authorization date). The following table summarizes the activity for the
three years ended October 31, 2002:
Outstanding Options
------------------------------
Number Exercise Price
----------- --------------
Balance, October 31, 1999 1,461,863 0.21
Granted 500,000 0.40
Canceled or expired (235,000) 0.15
Balance, October 31, 2000 1,726,863 0.28
Granted 607,000 0.48
Exercised (588,666) 0.15 - 0.25
Canceled or expired (243,197) 0.32 - 0.53
----------- -------------
Balance, October 31, 2001 1,502,000 $ 0.38
Granted 29,000 1.67
Exercised (309,499) 0.15 - 0.46
Canceled or expired (39,584) 0.46 - 1.67
----------- -------------
Balance, October 31, 2002 1,181,917 $ 0.46
=========== =============
- --------------------------------------------------------------------------------
F-24
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10 - CAPITAL STRUCTURE AND CAPITAL TRANSACTIONS (CONTINUED)
The following summarizes information about stock options outstanding
at October 31, 2002:
Outstanding Options
-------------------------------------------------------------------
Range of exercise Number Weighted average remaining Weighted average
prices outstanding contractual life exercise price
- --------------------------------------------------------------------------------------------------
$.15 - $.30 99,167 1.51 years $0.29
$.31 - $.60 955,750 6.21 years $0.42
$.61 - $1.70 127,000 8.49 years $0.92
----------- ------------ -------
1,181,917 6.06 years $0.60
----------- ------------ -------
Had compensation cost for the Company's options granted been
determined consistent with SFAS 123, the Company's earnings per share would be
affected as follows:
Year Ended October 31,
---------------------------------------------------------
2000 2001 2002
-------------- --------------- --------------
Net income (loss)
As reported $ 2,614,000 $ 14,501,000 $ (5,551,000)
-------------- --------------- --------------
Pro Forma $ 2,454,000 $ 11,696,000 $ (6,534,000)
-------------- --------------- --------------
Income (loss) per share (basic and diluted):
As reported $ .07 $ .36 $ (.14)
============== =============== ==============
Pro Forma $ .06 $ .29 $ (.16)
============== =============== ==============
The fair value of each option granted is estimated on grant date using
the Black-Scholes option pricing model which takes into account as of the grant
date the exercise price and expected life of the option, the current price of
the underlying stock and its expected volatility, expected dividends on the
stock and the risk-free interest rate for the term of the option. The following
is the average of the data used to calculate the fair value:
Risk-free Expected Expected
October 31, interest rate Expected life volatility dividends
----------- ------------- ------------- ---------- ---------
2002 3.66% 5 years 78.93% N/A
2001 4.17% 5 years 98.54% N/A
2000 6.60% 5 years 104.60% N/A
- --------------------------------------------------------------------------------
F-25
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10 - CAPITAL STRUCTURE AND CAPITAL TRANSACTIONS (CONTINUED)
From time to time, the Company has issued warrants under various types
of transactions, including in exchange for outside services and debt financing.
Warrants outstanding at October 31, 2002 expire at various times through October
2007. All warrants are issued at fair market value. The following table
summarizes the activity in outstanding stock purchase warrants:
Outstanding warrants
-----------------------------------
Shares Price range
----------- ----------------
Balance, October 31, 1999 5,001,890 $ 0.25 - $ 0.60
Granted -- --
----------- ----------------
Balance, October 31, 2000 5,001,890 0.25 - 0.60
Granted 6,428,655 0.38 - 1.00
Exercised (920,100) 0.25
Canceled or expired (3,832,560) 0.60
----------- ----------------
Balance, October 31, 2001 6,677,885 0.38 - 1.00
Granted 1,093,250 0.60 - 1.61
Canceled or expired (309,000) 0.40 - 1.35
----------- ----------------
Balance, October 31, 2002 7,462,135 $ 0.38 - $ 1.61
=========== ================
CAPITAL TRANSACTIONS
During the year ended October 31, 2002, five individuals exercised
their options to purchase 9,499 shares of common stock at $.46 per share, or
approximately $4,000.
In April 2002, an officer of the Company exercised his option to
purchase 300,000 shares of common stock at $.15 per share. As part of the
transaction, the officer surrendered to the Company 30,201 mature shares of
common stock with a fair market value of $45,000 ($1.49 per share public closing
price on the transaction date). In addition, the officer surrendered to the
Company an additional 13,424 mature shares of common stock with a fair market
value of $20,000 in payment of his note payable with accumulated interest
(classified as Stock Subscription Receivable on the Company's financial
statements). By combining the transaction, the Company issued a net 256,375
shares of common stock to the officer for his option exercise.
In November 2001, the Company issued 132,850 shares of common stock as
a bonus to 274 employees under the long-term incentive stock option plan ($.60
per share public closing price on the authorization date). As part of the
transaction, approximately $80,000 was recorded as operating expenses.
- --------------------------------------------------------------------------------
F-26
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10 - CAPITAL STRUCTURE AND CAPITAL TRANSACTIONS (CONTINUED)
CAPITAL TRANSACTIONS (CONTINUED)
Effective November 1, 2001, the Company paid $40,000 to a former
officer eliminating his options to require the Company to repurchase 400,000
shares under his separation agreement (stock put was classified as Redeemable
Stock on the Company's financial statements). The $40,000 was charged to other
expenses.
Effective January 19, 2001, the Company settled five of its outstanding
notes payable relating to the historical acquisition of DIS common stock from
unrelated third parties. Warrants issued with the notes were exercised for
920,100 shares of the Company's common stock at $.25 per share, or $230,000. As
part of the settlement, the Company issued a total of 150,000 warrants at $1.00
per share.
On December 29, 2000, the Company renegotiated two of its existing
notes with General Electric Company aggregating $3,130,000 into a new promissory
note with interest at 8.0% payable along with unpaid interest on December 29,
2005 for $4,664,000. As part of the renegotiation, the company issued five-year
warrants to purchase 779,000 shares of the Company's common stock at a price of
$1.00 per share. The Company allocated approximately $225,000 of the
renegotiated notes to the warrants which represented the interest discount GE
gave the Company in consideration for the warrants when the rate was compared to
other recent financing.
Effective December 13, 2000, the Company's major lender, DVI Financial
Services, Inc., agreed to convert a $5,542,000 note payable into a new series of
non-voting convertible preferred stock on the basis of one share of preferred
stock for each one dollar of debt canceled. Subsequent to July 2001, but before
October 2001, the Company converted the preferred stock back into notes payable
with accrued interest of approximately $235,000 accumulated into the new notes
payable balances.
- --------------------------------------------------------------------------------
F-27
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company estimates the fair value of financial instruments as of
October 31, follows:
2001 2002
---------------------------- ----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
Accounts receivable, current $28,764,000 $28,764,000 $29,453,000 $29,453,000
Accounts receivable, long term $ 2,499,000 $ 2,499,000 $ 2,366,000 $ 2,366,000
Due from related party -
long-term $ 60,000 $ 60,000 $ -- $ --
Debt maturing within one year $31,789,000 $31,789,000 $24,634,000 $24,634,000
Long-term debt $56,966,000 $51,826,000 $68,271,000 $65,093,000
Notes payable related parties, $ 119,000 $ 119,000 $ 1,173,000 $ 1,173,000
current
Notes payable related parties, $ 1,330,000 $ 1,179,000 $ 105,000 $ 119,000
long-term
Subordinated debentures $16,303,000 $16,537,000 $16,291,000 $16,532,000
In assessing the fair value of these financial instruments, the
Company has used a variety of methods and assumptions, which were based on
estimates of market conditions and risks existing at that time. For certain
instruments, including cash and cash equivalents, cash overdraft, current
accounts receivable, due from/to related parties and current and short-term
debt, it was assumed that the carrying amount approximated fair value for the
majority of these instruments because of their short maturities. The fair value
of the long term amounts for accounts receivable, due from related party, notes
payable related parties and debt is based on current rates at which the Company
could borrow funds with similar remaining maturities. The fair value of the
subordinated debentures is the estimated value of debentures available to
repurchase at current market rates over the bond term including an estimated
interest payment stream.
NOTE 12 - RELATED PARTY TRANSACTIONS
The amount due from related parties at October 31, 2001 consisted of
notes to a current officer of the Company of approximately $18,000 (classified
as Stock Subscription Receivable), short-term loans made to a current officer of
the Company of approximately $94,000, notes to a prior officer of the Company
for $70,000 bearing interest at 6.5% (including $30,000 classified as Stock
Subscription Receivable), and accrued interest of approximately $20,000. The
amount due from related parties as of October 31, 2002 is $-0-.
- --------------------------------------------------------------------------------
F-28
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 12 - RELATED PARTY TRANSACTIONS (CONTINUED)
During the year ended October 31, 2002, the Company received $38,000
from the prior officer as payment of his Stock Subscription Receivable and
$8,000 of accumulated interest, and forgave an additional note with accumulated
interest due from him of approximately $50,000 in consideration of his prior
efforts. In addition, another officer repaid short-term loans of $94,000, and an
additional officer settled his obligation by giving 13,424 mature shares of
common stock with a fair market value of $20,000 ($1.49 per share public trading
price on the date of the transaction) as payment in full of his note payable
(classified as Stock Subscription Receivable) with accumulated interest.
The amount due to related parties at October 31, 2001 primarily
consisted of notes due to an officer and employee of the Company for the
purchase of DIS common stock in 1996. The notes bear interest at 6.58% paid
annually. At October 31, 2001, the officer had outstanding notes payable of
approximately $1,225,000 (due June 2003) and the employee had notes payable of
approximately 105,000 (due June 2004). In addition, the Company incurred a
short-term related party payable of approximately $119,000 for the purchase of
subordinated debentures.
During the year ended October 31, 2002, the Company repaid the officer
$119,000 for the purchase of subordinated debentures and repaid a portion of its
outstanding obligation with the other officer of approximately $52,000.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
LEASES - The Company leases various operating facilities and certain
medical equipment under operating leases expiring through 2018. Certain leases
contain renewal options from two to ten years and escalation based primarily on
the consumer price index. Future minimum annual payments under noncancellable
operating leases are as follows:
Year ending October 31, Facilities Equipment
----------------------- ---------- ---------
2003 $ 6,977,000 $ 2,300,000
2004 5,974,000 2,168,000
2005 5,497,000 1,906,000
2006 5,157,000 1,247,000
2007 4,111,000 402,000
Thereafter 16,294,000 19,000
------------ ------------
$44,010,000 $ 8,042,000
------------ ------------
- --------------------------------------------------------------------------------
F-29
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES (CONTINUED) - Total rent expense, including equipment rentals,
for the years ended October 31, 2000, 2001 and 2002 amounted to approximately
$6,334,000, $7,344,000 and $8,799,000, respectively.
SALARIES AND CONSULTING AGREEMENTS - The Company has a variety of
arrangements for payment of professional and employment services. The agreements
provide for the payment of professional fees to physicians under various
arrangements including a percentage of revenue collected from 15% to 30%, fixed
amounts per periods and combinations thereof.
The Company also has employment agreements with officers and key
employees at annual compensation rates ranging from $48,000 to $350,000 and for
periods extending up to five years. Total commitments under the agreements are
approximately $9,482,000 for the next twelve-month period.
The Company renegotiated and bought out the remaining years of an
employment contract with one officer. Terms of the settlement include the
establishment of a legal consulting arrangement which expires February 2003. The
remaining commitment under this agreement is approximately $20,000.
Additionally, the Company was required to repurchase, at the former officer's
option, up to 600,000 shares of common stock at $.40 per share any time through
February 2003. During the year ended October 31, 1999, the Company repurchased
200,000 shares under this agreement. During the year ended October 31, 2002, the
Company paid $40,000 to this former officer eliminating his option to require
the Company to repurchase the remaining 400,000 shares under his agreement.
PURCHASE COMMITMENT - On February 19, 1999 the Company entered into a
five year purchase agreement with an imaging film provider whereby the Company
must purchase $9,990,000 of film at a rate of approximately $2,000,000 annually
over the term of the agreement.
EQUIPMENT SERVICE CONTRACTS - On March 1, 2000, the Company entered
into an equipment maintenance service contract through October 2005 with GE
Medical Systems to provide maintenance on the majority of its medical equipment
for a fee based upon a percentage of net revenues with minimum aggregate net
revenue requirements. The percent of revenue to be billed ranges from 2.82% to
3.74% and the aggregate minimum net revenue ranges from $85,000,000 to
$125,000,000 during the term of the agreement. The Company has met or exceeded
the minimum required revenue for fiscal 2001 and 2002.
LITIGATION - In the ordinary course of the business, from time to time
the Company becomes involved in certain legal proceedings, the majority of which
are covered by insurance. Management is not aware of any pending material legal
proceedings.
- --------------------------------------------------------------------------------
F-30
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 14 - EMPLOYEE BENEFIT PLAN
The Company has adopted a profit-sharing/savings plan pursuant to
Section 401(k) of the Internal Revenue Code, that covers substantially all
employees. Eligible employees may contribute on a tax deferred basis a
percentage of compensation, up to the maximum allowable under tax law. Employee
contributions vest immediately. The plan does not require a matching
contribution by the Company. There was no expense for the years ended October
31, 2000, 2001 or 2002.
NOTE 15 - MALPRACTICE INSURANCE
The Company and physicians employed by the Company are insured by TIG
Insurance. TIG Insurance provides claims-based malpractice insurance coverage
which covers only asserted malpractice claims within policy limits. Tail
insurance coverage is included in the cost of the premiums. Management does not
believe there are material uninsured malpractice costs at October 31, 2002.
NOTE 16 - SUBSEQUENT EVENTS
In November 2002, the Company issued 100,000 five-year warrants
exercisable at $.75 per share. In December 2002, the Company issued 50,000 five
year warrants exercisable at $.41 per share.
On December 2, 2002, the Company opened its new center, Rancho Bernardo
Advanced, LLC in Rancho Bernardo, California (near San Diego) which will provide
MRI, CT, ultrasound and x-ray services. During the year ended October 31, 2002,
the joint venture partners invested $250,000 and the Company has contributed
approximately $950,000 which was primarily used for leasehold improvements.
On February 10, 2003, the Company was advised that the Federal Deposit
Insurance Corporation ("FDIC") had elected to close Coast Business Credit
("Coast") and liquidate its accounts. While the FDIC has agreed that the Company
facility shall continue through its December 2003 term, it has reduced the
amount available from $22 million to $15 million. The Company intends to seek an
alternative lending source.
- --------------------------------------------------------------------------------
F-31
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 17 - LIQUIDITY
The accompanying financial statements have been prepared in conformity
with generally accepted accounting principles, which contemplates continuation
of the Company as a going concern and realization of assets and settlement of
liabilities and commitments in the normal course of business. As of October 31,
2002, the Company has a deficiency in equity of $50,921,000 compared to
$45,642,000 as of October 31, 2001. The working capital deficiency of
$44,668,000 as of October 31, 2002, has increased by $17,681,000, from the
deficiency of $26,987,000 as of October 31, 2001. Over the past several years,
management has been addressing the issues that have lead to these deficiencies,
and the results of management's plans and efforts have been positive in two of
the last three years. However, the results of this last fiscal period show that
continued effort is needed in the future to allow the Company to continue to
operate profitably. Such actions and plans include:
o Increase revenue by selectively opening imaging centers in
areas currently not served by the Company.
o In late November 2001, the Company opened a new
center in Burbank, California
o In January 2002, the Company opened a new center in
Tarzana, California
o In May 2002, the Company acquired Grove Diagnostic
Imaging in Rancho Cucamonga, California
o In December 2002, the Company opened its Rancho
Bernardo joint venture facility.
o Increase revenue by expanding existing facilities or opening
new locations close to existing sites. In order to obtain
certain new large contracts, nearby x-ray offices may be
acquired to meet the increase in patient volume. In addition,
the Company may consolidate certain procedures into one
location predominately with women's centers offering
mammography and ultrasound services.
o In September 2002, the Company opened Orange Advanced
Imaging Center and Orange Women's Center across the
street from the existing Orange Imaging Center.
o Effective January 1, 2002, the Company entered into a
new capitation agreement for approximately 62,000
lives primarily benefiting the Company's Temecula
facility ["TVIC"]. The Company opened two additional
facilities in Sun City and Lake Elsinore, California
which will provide x-ray services to support the new
contract. Subsequent to year end, the Company
relocated its Lake Elsinore location to nearby
Wildomar, California.
o In June 2002, the Company entered into a new
capitation contract for approximately 25,000 lives
primarily benefiting the Company's Los Coyotes'
facility. To service the contract, the Company
assumed the leases of three x-ray facilities in
nearby cities.
- --------------------------------------------------------------------------------
F-32
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 17 - LIQUIDITY (CONTINUED)
o In October 2001 and July 2002, the Company entered
into two separate capitation agreements for
approximately 80,000 lives and 15,000 lives,
respectively, primarily benefiting the Company's
Desert Advanced facilities. To service these
contracts, the Company opened three adjacent x-ray
facilities in Palm Springs, Indio and Bermuda Dunes,
California.
o In August 2002, the Company entered into a new
capitation contract for approximately 53,000 lives
primarily benefiting the Company's new Grove facility
in Rancho Cucamonga, California. To service the
contract, the Company assumed a nearby facility
providing x-ray services.
o Increase revenue by renegotiating existing capitation and
managed care contracts for additional services and more
favorable terms. Effective November 1, 2002, the Company
renegotiated one of its existing capitation contracts
primarily benefiting the Company's Orange facilities
increasing its reimbursement by approximately 15%, or
$500,000.
o Increase net revenue and decrease operating losses by
eliminating poor performing capitation and managed care
contracts where reimbursement falls short of the Company's
costs. In November 2002, the Company ceased doing business
with one capitation contract in Orange County where renewal
reimbursement would have fallen short of cost.
o Continue to evaluate all facilities' operations and trim
excess operating and general and administrative costs where it
is feasible to do so including consolidating underperforming
facilities to reduce operating cost duplication and improve
operating income. Due to a shortage of qualified radiologists
in the marketplace, the Company experienced difficulty in
hiring and retaining physicians by its affiliated medical
group [BRMG] at the individual sites during most of fiscal
2002. This required the engagement of independent contractors
and locum tenens (part-time fill-in physicians) to interpret
patient films. The cost of these individuals was approximately
double the salary of a regular BRMG full-time physician with
additional costs for travel and lodging required. Recently,
BRMG hired a new medical director who oversees physician
recruitment and staffing. The new director has already
arranged for BRMG to hire over twelve new physicians during
the last two quarters of fiscal 2002. BRMG is working to
solidify its physicians at the majority of the Company's sites
while increasing the volume of interpretations done by
physicians at the Company's main offices utilizing the
Company's computer and PACS systems.
o Continue to selectively acquire new medical equipment and
replace old and obsolete equipment in order to increase
service volume and throughput at many facilities. In the past
two years, the Company has replaced or upgraded the majority
of its equipment and increased throughput at most of its
locations.
- --------------------------------------------------------------------------------
F-33
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 17 - LIQUIDITY (CONTINUED)
o Continue to work with lessors and lenders to extend terms of
leases and financing to accommodate cash flow requirements for
ongoing agreements and upon the expiration of leases and
notes. The Company has demonstrated continued success in
renegotiation of many of its existing notes payable and
capital lease obligations by extending payment terms, reducing
interest rates, reducing or eliminating monthly payments and
creating long-term balloon payments. The Company's long-term
relationships with its lenders and their continued confidence
in their extensions of credit is critical to the Company's
success.
o During the year ended October 31, 2002, the Company
renegotiated several notes payable with DVI to obtain
working capital of $2,000,000 and extend payment
terms.
o During the year ended October 31, 2002, the Company
financed previously accrued maintenance charges with
General Electric for approximately $1,108,000 with
payment terms of 35 months at 9.5%.
o During the third quarter of fiscal 2002, the Company
obtained $17 million in working capital from DVI to
provide a secured source of financing in advance of
the June 30, 2003 date for retirement of the
remaining $16,291,000 Series A Convertible
Subordinated Debentures.
o Continue to settle historical notes payable, subordinated bond
debentures and other debt at discounts. The Company plans to
offer the debenture holders the right to extend the debenture
for three (3) years, in which event the conversion price would
be reduced to $4. Any remaining debentures shall be redeemed
on their due date of June 30, 2003. The Company intends to
utilize its financing lines to effect the majority of the
redemptions.
o Depending on price, market circumstances and strategic buyers,
the Company may look to liquidate non core assets. In March
2001, the Company sold its only radiation therapy center
("VROC") for $4,000,000, resulting in a gain of approximately
$3,527,000.
Notwithstanding the continued working capital deficiency, substantial
doubt about the entity's ability to continue as a going concern is alleviated by
mitigating factors. Those mitigating factors include the aforementioned actions
and plans by management combined with the positive cash flow from operations and
the willingness of existing lenders to offer alternative debt financing and
payment plans.
- --------------------------------------------------------------------------------
F-34
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------------------------------
NOTE 18 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter Ended
-----------------------------------------------------------------
January 31 April 30 July 31 October 31
------------- ------------- ------------- -------------
FISCAL 2002
Net revenue $ 32,441,000 $ 33,722,000 $ 35,580,000 $ 37,538,000
Income (loss) before
extraordinary item 917,000 836,000 (5,123,000) (2,182,000)
Net income (loss) 917,000 836,000 (5,122,000) (2,182,000)
Earnings (loss) per share
Basic 0.02 0.02 (0.12) (0.05)
Diluted 0.02 0.02 (0.12) (0.05)
January 31 April 30 July 31 October 31
------------- ------------- ------------- -------------
FISCAL 2001
Net revenue $ 24,110,000 $ 26,104,000 $ 29,464,000 $ 32,159,000
Income (loss) before
extraordinary item 918,000 5,107,000 2,081,000 5,841,000
Net income 923,000 5,215,000 2,081,000 6,282,000
Earnings per share
Basic 0.02 0.12 0.05 0.16
Diluted 0.02 0.11 0.04 0.14
- --------------------------------------------------------------------------------------------------------
F-35
INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTAL SCHEDULE
To the Stockholders and Board of Directors of
Primedex Health Systems, Inc.
Our report on the consolidated financial statements of Primedex Health Systems,
Inc. and its affiliates, as of October 31, 2002 and 2001 and for the three years
ended October 31, 2002, is included on page F-1 of this Form 10-K. In connection
with our audits of such financial statements, we have also audited the related
accompanying financial statements Schedule II - Valuation and Qualifying
Accounts for the years ended October 31, 2002, 2001, and 2000. In our opinion,
the financial statement schedule referred to above, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information required to be included therein.
/S/ MOSS ADAMS LLP
Los Angeles, California
January 22, 2003
- --------------------------------------------------------------------------------
S-1
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------------------------------------------------------------------------------------------------------
Additions
--------------
Balance at Charged Deductions from Balance at
Beginning of Year Against Income Reserves (a) End of Year
----------------- -------------- ------------ -----------
YEAR ENDED OCTOBER 31, 2002:
Accounts receivable-contractual allowances -current $ 48,746,000 $221,840,000 $217,428,000 $ 53,158,000
------------- ------------- ------------- -------------
Accounts receivable-bad debt allowances -current $ 1,132,000 $ 6,649,000 $ 6,188,000 $ 1,593,000
============= ============= ============= =============
Accounts receivable-contractual allowances-noncurrent $ 4,235,000 $ 17,821,000 $ 17,785,000 $ 4,271,000
============= ============= ============= =============
Accounts receivable-bad debt allowances -noncurrent $ 98,000 $ 534,000 $ 504,000 $ 128,000
------------- ------------- ------------- -------------
Goodwill amortization $ 6,265,000 $ -- $ -- $ 6,265,000
------------- ------------- ------------- -------------
YEAR ENDED OCTOBER 31, 2001:
Accounts receivable-contractual allowances -current $ 28,579,000 $159,303,000 $139,136,000 $ 48,746,000
============= ============= ============= =============
Accounts receivable-bad debt allowances -current $ 521,000 $ 3,701,000 $ 3,090,000 $ 1,132,000
============= ============= ============= =============
Accounts receivable-contractual allowances-noncurrent $ 2,960,000 $ 13,841,000 $ 12,566,000 $ 4,235,000
------------- ------------- ------------- -------------
Accounts receivable-bad debt allowances -noncurrent $ 54,000 $ 321,000 $ 277,000 $ 98,000
Goodwill amortization $ 4,912,000 $ 1,353,000 $ -- $ 6,265,000
------------- ------------- ------------- -------------
YEAR ENDED OCTOBER 31, 2000:
Accounts receivable-contractual allowances -current $ 24,514,000 $128,339,000 $124,274,000 $ 28,579,000
------------- ------------- ------------- -------------
Accounts receivable-bad debt allowances -current $ 791,000 $ 2,339,000 $ 2,609,000 $ 521,000
============= ============= ============= =============
Accounts receivable-contractual allowances-noncurrent $ 4,645,000 $ 13,294,000 $ 14,979,000 $ 2,960,000
============= ============= ============= =============
Accounts receivable-bad debt allowances -noncurrent $ 150,000 $ 242,000 $ 338,000 $ 54,000
------------- ------------- ------------- -------------
Goodwill amortization $ 4,009,000 $ 903,000 $ -- $ 4,912,000
------------- ------------- ------------- -------------
(a) Deductions include sales and divestitures
- ------------------------------------------------------------------------------------------------------------------------------------
S-2
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------- --------------------------------------------------
The following table sets forth certain information with respect to each
of the directors and those executive officers of the Company performing a
policy-making function for the Company as of January 17, 2003:
Name Age Director or Officer Since Position with Company
- ---- --- ------------------------- ---------------------
Howard G. Berger, M.D.* 57 1992 President, Treasurer, Chief Executive
and Chief Financial Officer, and
Director
Norman R. Hames 47 1996 Vice President, Secretary, Chief Operating
Officer and Director
John V. Crues, III, M.D.* 53 2000 Vice President and Director
Michael J. Krane, M.D. 58 1992 Vice President, Director of Medical
Operations
Jeffrey L. Linden 60 2001 Vice President, General Counsel
________
*Member of the Stock Option Committee
The following is a brief account of the business experience of each PHS
director and executive officer during the past five years.
HOWARD G. BERGER, M.D. is the President and Chief Executive Officer and
Chief Financial Officer of the Company. Dr. Berger is the 99% owner of Beverly
Radiology Medical Group ("BRMG") which provides the professional medical
services at a number of the Company's imaging centers. Dr. Berger has been
principally engaged since 1987 in the same capacities for the Company and its
predecessor entities. (See Item 13.)
NORMAN R. HAMES was a founder of Diagnostic Imaging Services, Inc. and
has since 1986, served as the president and a director of that entity. Mr. Hames
has been the chief operating officer of the Company since 1996.
JOHN V. CRUES, III, M.D. has been a medical doctor specializing in
radiology, since 1982.
MICHAEL J. KRANE, M.D. is the vice president and director of medical
operations at RadNet. Dr. Krane has been principally engaged since 1987 in the
same capacities for the Company and its predecessor entities.
JEFFREY L. LINDEN joined the Company in 2001 as its vice president and
general counsel. He is also associated with Cohen & Lord, a professional
corporation, outside general counsel to the Company. Prior to joining the
Company, Mr. Linden had been engaged in the private practice of law for in
excess of 30 years.
None of the Company's directors serve as directors of any other
corporation with a class of securities registered pursuant to Section 12 of the
Securities Exchange Act of 1934 or subject to the requirements of Section 15(d)
of that Act. Furthermore, none of the events described in Item 401(f) of
Regulation S-K involving a director or an executive officer of the Company
occurred during the past five years.
The officers are elected annually and serve at the discretion of the
Board of Directors. There are no family relationships among any of the officers
and directors. During the fiscal year ended October 31, 2002, while the Board of
Directors held numerous meetings, they took board action by unanimous written
consent, which was done on 10 occasions. All directors participated in all such
action.
39
At present the Board of Directors acts as an Audit Committee, which
reviews the results and scope of the audit and other services provided by the
Company's independent auditors, and as a Compensation Committee, which
determines salaries and incentive compensation for employees of and consultants
to the Company. The Company intends for such committees to be composed of
independent directors at such time as it is able to locate qualified individuals
willing and able to serve on the Company's Board of Directors.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 ("Exchange Act")
requires the Company's directors and officers and persons who own more than 10%
of a registered class of the Company's equity securities to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
("SEC"). Directors and officers and greater than 10% stockholders are required
by SEC regulation to furnish the Company with copies of the reports they file.
Based solely on the review of the copies of such reports and written
representations from certain persons that certain reports were not required to
be filed by such persons, the Company believes that all its directors, officers
and greater than 10% beneficial owners complied with all filing requirements
applicable to them with respect to transactions for the period November 1, 2001
through October 31, 2002.
40
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
The following table sets forth information concerning the annual,
long-term and all other compensation for services rendered in all capacities to
the Company and its subsidiaries for the years ended October 31, 2002, 2001 and
2000, of (i) the person who served as the Company's chief executive officer
during the year ended October 31, 2002, and (ii) the four most highly
compensated executive officers (other than the chief executive officer) of the
Company serving as executive officers at October 31, 2002 ("Other Executive
Officers"), and whose aggregate cash compensation exceeded $100,000 for the year
ended October 31, 20021 (collectively, "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Compensation
------------------- ----------------------
Other Securities Restricted
Name and Year Ended Annual Underlying Stock LTIP All Other
Principal Position 10/31 Salary($) Bonus($) Comp.($)(1) Options (#) Awards($) Pay-outs($) Comp($)
- ------------------ ----- --------- -------- ----------------------- --------- ----------- -------
Howard G. Berger, M.D 2002 $ 75,000(3) -- -- -- -- -- --
Chief Executive Officer 2001 $ 75,000(2) -- -- -- -- -- --
2000 $ 75,000(3) -- -- -- -- -- --
Norman R. Hames 2002 $ 225,000 -- -- -- -- -- --
Vice President, Secretary 2001 $ 154,875 -- -- 3,000,000 -- -- --
Chief Operating Officer 2000 $ 150,000 -- -- -- -- -- --
Michael J. Krane, M.D 2002 $ 100,000(4) -- -- -- -- -- --
Vice President 2001 $ 100,000(4) -- -- -- -- -- --
2000 $ 100,000(4) -- -- -- -- -- --
John V. Crues, III, M.D 2002 $ 175,000(4) -- -- -- -- -- --
Vice President 2001 $ 150,000(5) -- -- -- -- -- --
2000 $ 145,000(6) -- -- 500,000 -- -- --
Jeffrey L. Linden 2002 $ 350,000(7) -- -- 1,075,000 -- -- --
Vice President and 2001 $ 149,369(7) -- -- 1,075,000 -- -- --
General Counsel
(1) The dollar value of perquisites and other personal benefits, if any, for
each of the named executive officers was less than $50,000 or 10% of salary and
bonus, the reporting thresholds established by the Securities and Exchange
Commission.
(2) Does not include $130,000 received from Beverly Radiology Medical Group (see
"Employment Contracts").
(3) Does not include $300,000 received from Beverly Radiology Medical Group (see
"Employment Contracts").
(4) Does not include $175,000 received from Beverly Radiology Medical Group.
(5) Does not include $150,000 received from Beverly Radiology Medical Group.
(6) Does not include $145,000 received from Beverly Radiology Medical Group.
(7) On June 1, 2001, Mr. Linden became the vice president and general counsel of
the Company. Cohen & Lord, a professional corporation, a law firm with which Mr.
Linden is associated, received $309,000 in fees from the Company during the
fiscal year ended October 31, 2002. Mr. Linden has specifically waived any
interest in Company fees since becoming an officer of the Company.
41
COMPENSATION PURSUANT TO STOCK OPTIONS
None of the Named Executive Officers received stock option grants in
the fiscal year ended October 31, 2002. As of October 31, 2002, the Company had
8,644,052 in options and warrants outstanding to purchase shares of common
stock.
AGGREGATED OPTION EXERCISES IN LAST
FISCAL YEAR AND FISCAL YEAR END
OPTION VALUES
The following table provides information on option exercises in the
fiscal year ended October 31, 2002 by the Named Executive Officers and the value
of such officer's unexercised options at October 31, 2002:
Number of Shares Value of
Shares Underlying Unexercised Unexercised In-the
Acquired on Value Options at Money Options at
Name Exercise (#) Realized ($)(1) Fiscal Year End (#) Fiscal Year End ($)(1)
- ---- ------------ --------------- ------------------- ----------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Norman R. Hames -- -- 3,000,000(2) 0 $ 750,000 0
John V. Crues, III, M.D. 269,798 $215,838 500,000 0 $ 200,000 0
Jeffrey L. Linden -- -- 1,367,365(3) 0 $ 481,723 0
______________________
(1) Based on the closing price reported on the Over-the-Counter Bulletin Board
Market for the Common Stock on that date, $.80 per share.
(2) Represents warrant issued to Mr. Hames.
(3) Includes warrants issued to Mr. Linden.
EMPLOYMENT CONTRACTS
Beverly Radiology Medical Group entered into a Management Consulting
Agreement with Howard G. Berger, M.D. which renews annually whereby Dr. Berger
serves as the chief executive for the partnership entities for $300,000 per
year.
John V. Crues, III, M.D. has a renewable one year employment agreement
with the Company and with Beverly Radiology Medical Group which began in 1996
and require him to devote one-half of his time to each entity in exchange for
annual combined remuneration of $350,000.
On April 16, 2001, the Company entered into a five year employment
agreement with Jeffrey L. Linden whereby Mr. Linden became vice president and
general counsel. The agreement provides for annual compensation of $350,000,
together with a five year warrant to purchase 1,000,000 shares of the Company's
Common Stock at a price of $0.43 per share (the closing price reported on the
Over-the-Counter Bulletin Board Market on the date the agreement was executed).
On May 1, 2001, the Company entered into a three year employment
agreement with Norman R. Hames. Pursuant to the agreement Mr. Hames agreed to
continue his employment with the Company as its vice president and chief
operating officer. The agreement provides for Mr. Hames to receive annual
compensation of $225,000. Additionally, in consideration of his entry into the
agreement Mr. Hames received a five year warrant to purchase 3,000,000 shares of
the Company's Common Stock at a price of $0.55 per share (the closing price
reported on the Over-the-Counter Bulletin Board Market on the date the agreement
was executed). The Company also agreed to provide a bonus to Mr. Hames of $0.20
per share upon exercise of the warrant up to a maximum of $600,000.
42
STOCK PLANS
The Company has one stock incentive plan-the 2000 Long-Term Incentive
Plan pursuant to which 2,000,000 shares of Common Stock have been reserved for
issuance. The material features of the 2000 Plan are as follows:
ADMINISTRATION
The Plan is presently administered by the Board of Directors, but upon
the Company locating non-employee directors who have the requisite
qualifications will then be administered by a committee appointed by
the Board which will consist of two or more non-employee Directors (the
"Compensation Committee"). Subject to the terms of the Plan, the Board
(and the Committee, if established) has full authority to administer
the Plan in all respects, including: (i) selecting the individuals who
are to receive Awards under the Plan; (ii) determining the specific
form of any Award; and (iii) setting the specific terms and conditions
of each Award. The Company's senior legal and human resources
representatives are also authorized to take ministerial actions as
necessary to implement the Plan and Awards issued under the Plan.
ELIGIBILITY
Employees, directors and other individuals who provide services to the
Company, its affiliates and subsidiaries who, in the opinion of the
Board (or its appointed Committee), are in a position to make a
significant contribution to the success of the Company, its affiliates
and subsidiaries are eligible for Awards under the Incentive Plan.
AMOUNT OF AWARDS
The value of shares or other Awards to be granted to any recipient
under the Incentive Plan are not presently determinable. However, the
Plan restricts the number of shares and the value of Awards not based
on shares which may be granted to any individual during a calendar year
or performance period. In order to facilitate the Company's compliance
with Section 162(m) of the Internal Revenue Code of 1986, as amended
(the "Code"), which deals with the deductibility of compensation for
any of the chief executive officer and the four other most highly-paid
executive officers, the Plan limits to 500,000 the number of shares for
which options, stock appreciation rights or other stock Awards may be
granted to an individual in a calendar year and limits to $1,000,000
the value of non-stock-based Awards that may be paid to an individual
with respect to a performance period. These restrictions were adopted
by the Board of Directors as a means of complying with Code section
162(m) and are not indicative of historical or contemplated Awards made
or to be made to any individual under the Plan.
STOCK OPTIONS
The Plan authorizes the grant of options to purchase shares of common
stock, including options to employees intended to qualify as incentive
stock options within the meaning of Section 422 of the Code, as well as
non-statutory options. The term of each option will not exceed ten
years and each option will be exercisable at a price per share not less
than 100% of the fair market value of a share of common stock on the
date of the grant. Generally, optionees will pay the exercise price of
an option in cash or by check, although the Board (and the Committee,
if established) may permit other forms of payment including payment
through the delivery of shares of common stock. Options granted under
the Plan are generally not transferable (except at death or as gifts to
certain Family Members (as defined in the Plan)). At the time of grant
43
or thereafter, the Board (and the Committee, if established) may
determine the conditions under which stock options vest and remain
exercisable.
Unless otherwise determined by the Board (and the Committee, if
established), unexercised options will terminate if the holder ceases
for any reason to be associated with the Company, its affiliates and
subsidiaries. Options generally remain exercisable for a specified
period following termination for reasons other than for Cause (as
defined in the Plan), particularly in circumstances of death,
Disability and Retirement (as defined in the Plan). In the event of a
Change in Control or Covered Transaction (as defined in the Incentive
Plan) of the Company, options become immediately exercisable and/or are
converted into options for securities of the surviving party as
determined by the Board (and the Committee, if established).
OTHER AWARDS
The Board (and the Committee, if established) may grant stock
appreciation rights which pay, in cash or common stock, an amount
generally equal to the difference between the fair market values of the
common stock at the time of exercise of the right and at the time of
grant of the right. In addition, the Board (and the Committee, if
established) may grant Awards of shares of common stock at a purchase
price less than fair market value at the date of issuance, including
zero. A recipient's right to retain these shares may be subject to
conditions established by the Board (and the Committee, if
established), if any, such as the performance of services for a
specified period or the achievement of individual or Company
performance targets. The Board (and the Committee, if established) may
also issue shares of common stock or authorize cash or other payments
under the Plan in recognition of the achievement of certain performance
objectives or in connection with annual bonus arrangements.
PERFORMANCE CRITERIA
The Board (and the Committee, if established) may condition the
exercisability, vesting or full enjoyment of an Award on specified
Performance Criteria. For purposes of Performance Awards (as defined in
the Plan) that are intended to qualify for the performance-based
compensation exception under Code Section 162(m), Performance Criteria
means an objectively determinable measure of performance relating to
any of the following as specified by the Board (and the Committee, if
established) (determined either on a consolidated basis or, as the
context permits, on a divisional, subsidiary, line of business, project
or geographical basis or in combinations thereof): (i) sales; revenues;
assets; liabilities; costs; expenses; earnings before or after
deduction for all or any portion of interest, taxes, depreciation,
amortization or other items, whether or not on a continuing operations
or an aggregate or per share basis; return on equity, investment,
capital or assets; one or more operating ratios; borrowing levels,
leverage ratios or credit rating; market share; capital expenditures;
cash flow; working capital requirements; stock price; stockholder
return; sales, contribution or gross margin, of particular products or
services; particular operating or financial ratios; customer
acquisition, expansion and retention; or any combination of the
foregoing; or (ii) acquisitions and divestitures (in whole or in part);
joint ventures and strategic alliances; spin-offs, split-ups and the
like; reorganizations; recapitalizations, restructurings, financings
(issuance of debt or equity) and refinancings; transactions that would
constitute a change of control; or any combination of the foregoing.
Performance Criteria measures and targets determined by the Board (and
the Committee, if established) need not be based upon an increase, a
positive or improved result or avoidance of loss.
44
AMENDMENTS
The Board (and the Committee, if established) may amend the Plan or any
outstanding Award for any purpose permitted by law, or may at any time
terminate the Plan as to future grants of Awards. The Board (and the
Committee, if established) may not, however, increase the maximum
number of shares of common stock issuable under the Plan or change the
description of the individuals eligible to receive Awards. In addition,
no termination of or amendment to the Plan may adversely affect the
rights of a Participant with respect to any Award previously granted
under the Plan without the Participant's consent, unless the
Compensation Committee expressly reserves the right to do so in writing
at the time the Award is made. To the extent the Board (and the
Committee, if established) desires the Plan to qualify under the Code,
certain amendments may require shareholder approval.
DIRECTOR COMPENSATION
Directors do not receive a fee for their services as a director.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During fiscal 2000 all executive compensation has been determined by
the three member board of directors of PHS, Howard G. Berger, M.D., Norman R.
Hames and John V. Crues, III, M.D. In addition, no individual who served as an
executive officer of the Company during fiscal 2002, served during fiscal 2002
on the board of directors or compensation committee of another entity where an
executive officer of the other entity also served on the board of directors of
the Company.
45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock as of February 1, 2003, by
(i) each holder known by the Company to beneficially own more than five percent
of the outstanding Common Stock, (ii) each of the Company's directors and
executive officers [including officers listed in the Summary Compensation Table]
as a group. The percentages set forth in the table have been calculated on the
basis of treating as outstanding, for purposes of computing the percentage
ownership of a particular holder, all shares of PHS Common Stock outstanding at
such date and all shares of Common Stock purchasable upon exercise of options
and warrants owned by such holder which are exercisable at or within 60 days
after such date.
Name of Shares of Common Stock
Beneficial Owner Beneficially Owned(1) Percent of Class
- ---------------- --------------------- ----------------
Howard G. Berger, M.D.* 12,490,128(2) 25.1%
John V. Crues, III, M.D. * 993,875(3) 2.0%
Norman R. Hames* 3,000,000(4) 6.0%
Michael J. Krane, M.D. * 2,216,228 4.5%
Jeffrey L. Linden* 1,367,365(5) 2.7%
All directors and executive officers of
the Company as a group [five persons] 20,067,596(6) 40.3%
___________
*The address of all of the Company's officers and directors is c/o the
Company, 1510 Cotner Avenue, Los Angeles, California 90025.
(1) Subject to applicable community property statutes and except as
otherwise noted, each holder named in the table has sole voting and investment
power with respect to all shares of Common Stock shown as beneficially owned.
(2)Includes 23,900 shares issuable upon conversion of the Company's
outstanding convertible debentures convertible at $10 per share.
(3)Includes options for 500,000 shares exercisable at $.40 per share.
(4)Represents warrants exercisable at $.55 per share.
(5)Includes 1,272,365 options and warrants exercisable at prices
between $.43 and $.60 per share.
(6)See the above footnotes. Includes 15,014,956 shares owned of record
and 5,052,640 shares issuable upon exercise of presently exercisable options,
warrants and convertible debentures.
As a result of his stock ownership and his positions as president and a director
of the Company, Howard G. Berger, M.D. may be deemed to be a controlling person
of the Company.
46
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
Howard G. Berger, M.D. [see "Items 10 and 12"] is the 99% owner of
Beverly Radiology Medical Group, Inc. and Pronet Imaging Medical Group, Inc.,
who together have formed the partnership known as Beverly Radiology Medical
Group, which has executed a Management and Services Agreement with RadNet and
DIS pursuant to which it supplies the professional medical services at most of
the Company's imaging centers [see "Item 1] through 2012. The fees paid to the
Company by BRMG for services rendered is 74% of total revenues. In fiscal 2002,
Dr. Berger was paid $300,000 and Dr. Krane was paid $150,000 by BRMG.
On August 1, 1996, the Company acquired from Norman Hames, [not then an
officer or director of the Company] all of his common stock and warrants to
purchase shares of common stock of Diagnostic Imaging Services, Inc., a Delaware
corporation ("DIS") which then represented 21.6% of the outstanding shares of
that entity in exchange for five year warrants to purchase 2,913,550 shares of
the Company's common stock at $.60 per share as well as the Company's promissory
note, payable interest only annually at 6.58% for $2,448,862 and due June 15,
2001. At October 31, 2001, the note was renegotiated so as to now be due in June
2003. At October 31, 2002, the Company was indebted on account of said note in
the amount of $1,173,000. The warrant expired unexercised.
At October 31, 2001, the Company was indebted to Jeffrey L. Linden in
the amount of $104,992 in connection with the Company's acquisition of his
interest in DIS. The obligation incurs interest at the rate of 6.58% per annum
and is due June 30, 2004. In the acquisition transaction the Company issued to
Mr. Linden its warrants to purchase 197,365 shares of Common Stock at a price of
$.60 per share expiring June 30, 2004.
ITEM 14. CONTROLS AND PROCEDURES
- -------- -----------------------
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their
evaluation as of a date within 90 days of the filing date of this Annual Report
on Form 10-K, the Company's principal executive officer and principal financial
officer has concluded that the Company's disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934 (the "Exchange Act") are effective to ensure that information required to
be disclosed by the Company in reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.
(b) CHANGES IN INTERNAL CONTROLS. There were no significant changes in
the Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation. There were no
significant deficiencies or material weaknesses, and therefore there were no
corrective actions taken.
47
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- -------- ---------------------------------------------------------------
(a) FINANCIAL STATEMENTS - The following financial statements are filed
herewith:
Page No.
--------
Independent Auditor's Report....................................................................... F-1
Consolidated Balance Sheets........................................................................ F-2
Consolidated Statements of Operations.............................................................. F-3
Consolidated Statements of Stockholders' Deficit................................................... F-4
Consolidated Statements of Cash Flows.............................................................. F-5 to F-7
Notes to Consolidated Financial Statements......................................................... F-8 to F-35
SCHEDULES - The Following financial statement schedules are filed herewith:
Independent Auditor's Report on Supplemental Schedule.............................................. S-1
Schedule II - Valuation and Qualifying Accounts.................................................... S-2
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements
or notes thereto.
(b) EXHIBITS - The following exhibits are filed herewith or incorporated
by reference herein:
Incorporated by
Exhibit No. Description of Exhibit Reference to
- ----------- ---------------------- ------------
3.1.1 Certificate of Incorporation as amended (A)
3.1.2 November 17, 1992 amendment to the Certificate of Incorporation (A)
3.1.3 December 27, 2000 amendment to the Certificate of Incorporation (H)
3.2 By-laws
4.1 Form of Common Stock Certificate (AA)
4.2 Form of Indenture between Registrant and American Stock Transfer
and Trust Company as Incorporated by Indenture Trustee with respect
to the 10% Series A Convertible Subordinated Debentures due 2003 (B)
4.3 Form of 10% Series A Convertible Subordinated Debenture Due 2003
[Included in Exhibit 4.2] (B)
10.1 Employment Agreement dated as of June 12, 1992 between RadNet
and Howard G. Berger. [Dr. Krane executed a substantially
identical employment agreement with New RadNet on said date.] (C)
10.2 Separation Agreement dated January 31, 1995 between PHS and CareAd (D)
10.3 Separation Agreement dated April 20, 1995 between PHS and CareAd (E)
48
10.4 Stock Purchase Agreement made as of June 2, 1995 among PHS,
CareAd, Howard G. Berger and Robert E. Brennan (E)
10.5 Stock Purchase Agreement dated as of November 14, 1995 among
PHS, RadNet Managed Imaging Services, Inc. ["RMIS"], Future
Diagnostics, Inc. ["FDI"] and the shareholders of FDI relating to the
purchase by RMIS of all of the outstanding stock of FDI (F)
10.6 Securities Purchase Agreement dated March 22, 1996, between the
Company and Diagnostic Imaging Services, Inc. (F)
10.7 Stockholders Agreement by and among the Company, Diagnostic
Imaging Services, Inc. and Norman Hames (F)
10.8 Securities Purchase Agreement dated June 18, 1996 between the
Company and Norman Hames (F)
10.9 Stock Purchase Agreement dated September 3, 1997 between the
Company and Preferred Health Management, Inc. whereby the
Company sold its Future Diagnostics, Inc. subsidiary (G)
10.10 DVI Securities Purchase Agreement (H)
10.11 General Electric Note Purchase Agreement (H)
a. Securities Purchase Agreement between the Company and
Howard G. Berger, M.D. (H)
10.13 2000 Long-Term Incentive Plan (I)
10.14 Employment Agreement dated April 16, 2001, with Jeffrey L. Linden (J)
10.15 Employment Agreement with Norman R. Hames dated May 1, 2001 (J)
__________________
(A) Incorporated by reference to exhibit filed with PHS' Registration
Statement on Form S-1 [File No. 33-51870].
(AA) Incorporated by reference to exhibit filed with PHS' Registration
Statement on Form S-3 [File 33-73150].
(B) Incorporated by reference to exhibit filed with PHS' Registration
Statement on Form S-3 [File No. 33-59888].
(C) Incorporated by reference to exhibit filed in an amendment to Form
8-K report for June 12, 1992.
(D) Incorporated by reference to exhibit filed with PHS' annual report
on Form 10-K for the year ended October 31, 1994.
(E) Incorporated by reference to exhibit filed with PHS' Form 8-K
report for June 5, 1995.
(F) Incorporated by reference to exhibit filed with Form 10-K for the
year ended October 31, 1996.
(G) Incorporated by reference to exhibit filed with Form 8-K report for
September 8, 1997.
(c) Incorporated by reference to exhibit filed with the Form 10-K for
the year ended October 31, 2000.
(d) Incorporated by reference to exhibit filed with PHS' Form 10-Q for
the quarter ended January 31, 2000.
(e) Incorporated by reference to exhibit filed with the Form 10-K for
the year ended October 31, 2001.
49
21 Subsidiaries PHS % Ownership State of Incorporation
------------ --------------- ----------------------
RadNet Management, Inc. 100% California
RadNet Managed Imaging Services, Inc. 100% California
Diagnostic Imaging Services, Inc. 91% Delaware
Primedex Corporation 100% California
Radnet Heartcheck Management, Inc. 100% California
Radnet Management I, Inc. 100% California
Radnet Management II, Inc. 100% California
Radnet Sub, Inc. 100% California
SoCal MR Site Management, Inc. 100% California
Burbank Advanced Imaging Center, LLC 75% California
Rancho Bernardo Advanced Imaging Center, LLC 75% California
23 Consent of Independent Public Accountants, filed herewith.
(c) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during
the quarter ended October 31, 2002.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PRIMEDEX HEALTH SYSTEMS, INC.
Date: February 11, 2003 /s/ Howard G. Berger, M.D.
-----------------------------------------
Howard G. Berger, M.D., President,
Treasurer and Principal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
By /s/ Howard G. Berger, M.D.
----------------------------------
Howard G. Berger, M.D., Director
Date: February 11, 2003
By /s/ John V. Crues, III, M.D.
----------------------------------
John V. Crues, III, M.D., Director
Date: February 11, 2003
By /s/ Norman R. Hames
----------------------------------
Norman R. Hames, Director
Date: February 11, 2003
51
CERTIFICATION
I, Howard G. Berger, M.D., certify that:
1. I have reviewed this annual report on Form 10-K of Primedex Health
Systems, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report.
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls.
52
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Dated: February 11, 2003
/s/ Howard G. Berger, M.D.
-----------------------------------------
Howard G. Berger, M.D.
President, and Principal Financial Officer
53