SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

 

Commission File Number 333-101399

 

 

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

 

Yes  ý     No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  ý

 

Indicate the number of shares outstanding of each of MQ Associates, Inc.’s classes of common stock, as of the latest practicable date.

 

At August 6, 2004, the number of shares outstanding of each of MQ Associates, Inc.’s classes of common equity were as follows: 72,100,000 shares of Class A common stock, $.001 par value per shares, and 28,605,000 shares of common stock, $.001 par value per share.

 

 

MQ ASSOCIATES, INC.

 

QUARTERLY REPORT ON FORM 10-Q

 

INDEX

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003
	Consolidated Statements of Operations (unaudited) for each of the three and six months ended June 30, 2004 and June 30, 2003
	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2004 and June 30, 2003
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
	Signatures

 

2

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MQ ASSOCIATES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		June 30, 2004			December 31, 2003
		(unaudited)			(derived from audited financial statements)
ASSETS
Current assets
Cash and cash equivalents		$	2,418		$	6,731
Patient receivables, net of allowance for doubtful accounts of $1,974 and $1,685		67,342			61,490
Related party receivables		1,299			782
Other receivables		1,766			2,049
Prepaid expenses and other		4,006			2,619
Deferred income taxes		594			594
Total current assets		77,425			74,265
Property and equipment, net		87,527			82,107
Goodwill		34,415			33,855
Intangible assets, net		14,158			10,722
Debt issuance costs, net		12,302			13,384
Other		6,788			9,148
Total assets		$	232,615		$	223,481

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3

 

MQ ASSOCIATES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		June 30, 2004			December 31, 2003
		(unaudited)			(derived from audited financial statements)
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities
Accounts payable		$	2,833		$	6,596
Accrued payroll and related taxes		6,273			5,371
Accrued interest		7,334			7,278
Accrued radiologist fees		4,014			3,359
Other accrued expenses		6,265			4,321
Current portion of long-term debt		600			600
Current portion of obligations under capital leases		1,917			1,584
Total current liabilities		29,236			29,109
Long-term debt		248,542			244,966
Obligations under capital leases		2,678			2,517
Deferred income taxes		9,713			8,174
Other long-term liabilities		1,507			499
Total liabilities		291,676			285,265
Commitments and contingencies
Redeemable preferred stock
Series A Convertible, $.001 par value; nonvoting; 35,000,000 shares authorized, issued and outstanding		35,000			35,000
Series B Convertible, $.001 par value; nonvoting; 15,000,000 shares authorized, issued and outstanding		15,000			15,000
		50,000			50,000
Stockholders’ deficit
Class A common stock, $.001 par value; voting; 115,000,000 shares authorized; 72,100,000 issued and outstanding		72			72
Common stock, $.001 par value; voting; 195,000,000 shares authorized; 28,605,000 issued and outstanding		29			29
Additional paid-in capital		63,389			63,389
Accumulated deficit		(172,551		)	(175,274		)
Total stockholders’ deficit		(109,061		)	(111,784		)
Total liabilities and stockholders’ deficit		$	232,615		$	223,481

 

The accompanying notes are an integral part of the consolidated financial statements.

 

4

 

MQ ASSOCIATES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands)

 

		Three months ended June 30,						Six months ended June 30,
		2004			2003			2004			2003
Net revenues from services		$	71,012		$	59,613		$	138,032		$	115,360
Costs and expenses
Operating expenses, excluding depreciation		29,580			25,815			57,635			50,394
Marketing, general and administrative expenses		25,765			18,922			47,499			36,619
Depreciation and amortization		7,921			7,301			15,619			14,182
Income from operations		7,746			7,575			17,279			14,165
Interest expense		6,396			6,061			12,853			11,875
Interest income		9			(4		)	(4		)	(8		)
Equity in earnings of unconsolidated joint venture		(35		)	—			(108		)	—
Income before provision for income taxes		1,376			1,518			4,538			2,298
Provision for income taxes		550			608			1,815			920
Net income		$	826		$	910		$	2,723		$	1,378

 

The accompanying notes are an integral part of the consolidated financial statements.

 

5

 

MQ ASSOCIATES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

		Six months ended June 30,
		2004			2003
Cash flows from operating activities
Net income		$	2,723		$	1,378
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities
Depreciation and amortization		15,619			14,182
Amortization of bond discount		120			36
Amoritzation of debt issue costs		974			792
Bad debt expense		6,185			4,816
Equity in earnings of unconsolidated joint venture		(108		)	—
Changes in operating assets and liabilities
Patient receivables		(12,037		)	(9,963		)
Related party and other receivables		(280		)	207
Prepaid expenses and other current assets		(1,387		)	(423		)
Other assets		(371		)	(360		)
Accounts payable		(3,763		)	(990		)
Accrued payroll and related taxes		902			1,068
Other accrued expenses		4,253			2,743
Net cash and cash equivalents provided by operating activities		12,830			13,486
Cash flows from investing activities
Purchases of property and equipment		(15,827		)	(9,539		)
Acquisitions of businesses, net of cash acquired		(5,485		)	(3,441		)
Proceeds from loan repayments		69			55
Net cash and cash equivalents used in investing activities		(21,243		)	(12,925		)
Cash flows from financing activities
Payments on capital leases		(708		)	(661		)
Payment of debt issuance costs		(29		)	(520		)
Other		137			—
Payments on long-term debt		(300		)	—
Proceeds from senior credit facility		23,500			13,688
Payments on senior credit facility		(18,500		)	(13,532		)
Net cash and cash equivalents provided by (used in) financing activities		4,100			(1,025		)
Net decrease in cash and cash equivalents		$	(4,313	)	$	(464	)
Cash and cash equivalents, beginning of period		$	6,731		$	3,230
Cash and cash equivalents, end of period		$	2,418		$	2,766
Supplemental disclosure of cash flow information
Cash paid for interest		$	11,705		$	11,322
Cash paid for taxes		$	862		$	304
Supplemental schedule of non-cash investing and financing activities
Acquisition of businesses
Fair value of assets acquired		$	5,485		$	5,441
Less deposit paid in prior year		—			(2,000		)
		$	5,485		$	3,441
Equipment acquired through capital leases		$	1,203		$	1,917

 

The accompanying notes are an integral part of the consolidated financial statements.

 

6

 

MQ Associates, Inc.

Notes to Consolidated Financial Statements

(unaudited)

(in thousands, except share data)

 

1.  Basis of Presentation, Principles of Consolidation, Use of Estimates and Reclassifications

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared by MQ Associates, Inc. and its subsidiaries (collectively, the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, the consolidated financial statements do not include all information and notes required by generally accepted accounting principles for complete financial statements.  The accompanying consolidated financial statements should be read in conjunction with the annual consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.  In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.  Operating results for the three and six months ended June 30, 2004, are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2004.

 

Principles of Consolidation

 

MedQuest, Inc. (“MedQuest”) is a wholly-owned subsidiary of MQ Associates, Inc.  MQ Associates, Inc. has no material assets or operations other than its ownership of 100% of the outstanding capital stock of MedQuest.  The consolidated financial statements of the Company include the assets, liabilities, revenue and expenses of all majority owned subsidiaries over which the company exercises direct or indirect control.  All intercompany transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of 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 reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Reclassifications

 

Certain reclassifications have been made to the consolidated balance sheet at December 31, 2003 to conform to the presentation at June 30, 2004.

 

7

 

2.  Long-Term Debt

 

Long-term debt consists of the following:

 

		June 30, 2004			December 31, 2003
Revolving credit facility, due August 2007		$	13,000		$	8,000
Tranche B term facility, due through September 2009		59,400			59,700
117/8% senior subordinated notes, net of discount of $3,418 and $3,538, due August 2012		176,581			176,462
		248,981			244,162
Fair value adjustment related to 117/8% senior subordinated notes		161			1,404
Less current portion		600			600
		$	248,542		$	244,966

 

Future maturities of long-term debt, including the effects of the bond discount, are as follows:

 

Year ending December 31,		Amount
2004		$	300
2005		600
2006		600
2007		13,600
2008		28,800
Thereafter		205,081
		$	248,981

 

Senior credit facility

 

In September 2003, the Company amended its senior credit facility to allow for borrowings not to exceed $60,000 under a Tranche B term facility (as amended, the “Senior Credit Facility”).  Concurrent with the amendment of the Senior Credit Facility, the Company also borrowed $60,000 under the Tranche B term facility and applied the net proceeds against the borrowings outstanding under the Senior Credit Facility.

 

The Senior Credit Facility provides for a revolving credit facility not to exceed $80,000 and a Tranche B term facility of $60,000.  The Senior Credit Facility is guaranteed by MQ Associates, Inc. and each of MQ Associates’ and MedQuest’s existing and future domestic subsidiaries and certain foreign subsidiaries.  MedQuest’s obligations under the Senior Credit Facility and the guarantors’ obligations under the guarantees are collateralized by substantially all of the assets of MedQuest and the guarantors.

 

The Senior Credit Facility has certain financial covenants related to the maintenance of minimum/maximum levels of consolidated leverage, senior leverage and fixed charge coverage ratios.  The Company was in compliance with all covenants under the Senior Credit Facility at June 30, 2004.

 

8

 

Revolving credit facility

 

Borrowings under the revolving credit facility accrue interest at the option of MedQuest, at either: (a) the greater of (i) the prime rate or (ii) the Federal funds effective rate (subject to certain adjustments) plus ½ of 1%, in either case, plus an applicable margin of 1.50% per annum, or (b) the Eurodollar rate, plus an applicable margin of 2.50% per annum.  Borrowings at June 30, 2004 are based upon the Eurodollar rate (i.e. 1.94% at June 30, 2004) and amounted to $13,000 at June 30, 2004. The revolving credit facility also provides for a commitment fee equal to ½ of 1% per annum.  The margins related to the prime rate and Eurodollar rate borrowings and commitment fee are subject to adjustment based upon the Company’s consolidated leverage ratio, as defined.  Borrowings available under the revolving credit facility, net of $618 in letters of credit, amount to $66,382 at June 30, 2004.

 

Tranche B term facility

 

Borrowings under the Tranche B term facility accrue interest at the option of MedQuest, at either: (a) the greater of (i) the prime rate or (ii) the Federal funds effective rate (subject to certain adjustments) plus 1/2 of 1%, in either case, plus an applicable margin of 2.75% per annum, or (b) the Eurodollar rate, plus an applicable margin of 3.75% per annum.  Borrowings were based upon the Eurodollar rate (i.e. 1.94% at June 30, 2004) and amounted to $59,400 at June 30, 2004.

 

Commencing with the fiscal year ending December 31, 2004, and annually thereafter, not more than 75% of excess cash flows, as defined, must be applied against certain outstanding borrowings under the Senior Credit Facility.

 

Senior subordinated notes

 

The 11⁷/₈% senior subordinated notes (“Notes”), due in August of 2012, were issued in the aggregate principal amount of $180,000, net of a discount of $3,832, which is being amortized as interest expense over the life of the Notes.  The Notes also provide for an optional early redemption by MedQuest upon a change in control, as defined, prior to August 15, 2007 at 100% of the principal amount, or on or after August 15, 2007 at the redemption prices expressed as a percentage of the principal amount, plus accrued and unpaid interest as follows:

 

Twelve months beginning August 15,		Optional Redemption Percentage
2007		105.938	%
2008		103.958	%
2009		101.979	%
2010 and thereafter		100.000	%

 

Prior to August 15, 2005, MedQuest may also redeem up to 35% of the Notes with the net cash proceeds of one or more equity offerings at a redemption price of 111.875% of the principal amount thereof, plus accrued and unpaid interest, provided that at least 65% of the original principal amount of the Notes remains outstanding after such redemptions and the redemptions occur within 120 days of the closing of the equity offerings.

 

The Notes are fully and unconditionally, jointly and severally guaranteed by MQ Associates, Inc. and each of MedQuest’s domestic subsidiaries (See Note 5).  The Notes contain certain covenants, including covenants limiting the Company’s ability to incur additional indebtedness and make restricted payments.  The Company was in compliance with all covenants under the Notes at June 30, 2004.

 

9

 

Debt issuance costs amounting to $19,090, with respect to the Senior Credit Facility and Notes, were capitalized and are being amortized using the straight line method into interest expense over the lives of the related debt instruments.

 

3.  Related Party Transactions

 

The Company had the following related party transactions:

 

(a) The Company incurred expenses related to certain aviation services in the amount of $188 and $66 during the three months ended June 30, 2004 and 2003, respectively and in the amount of $260 and $160 for the six months ended June 30, 2004 and 2003, respectively, related to services provided by Image Aviation, LLC, a company owned by two of the Company’s stockholders who also are the Chief Executive Officer and President.

 

(b) The Company rents office space for 19 of its centers and its headquarters through rental agreements with Image Properties, L.L.C. (“Image”), a company owned by two of the Company’s shareholders who also are the Chief Executive Officer and President.  The rental agreements provide for rental payments in amounts ranging from $6 to $77 monthly.  The rental agreements typically are for ten-year terms, with five-year renewal options, and expire at various dates through 2008.  Rent expense for related party leases was $933 and $886 for the three months ended June 30, 2004 and 2003, respectively, and was $1,866 and $1,768 for the six months ended June 30, 2004 and 2003, respectively.

 

(c) The Company makes advances to Image for building and leasehold improvements made on behalf of the Company.  The Company had related party receivables of $1,299 and $782 at June 30, 2004 and December 31, 2003, for costs incurred on behalf of Image.  The Company earns interest income on the balance at a rate of approximately 6% per annum of the outstanding receivable balance.

 

4.  Commitments and Contingencies

 

The Company was engaged from time to time in the defense of lawsuits and administrative proceedings arising in the ordinary course and conduct of its business and has insurance policies covering potential insurable losses where this coverage is cost-effective.

 

In February 2003, the Company received a request for documents from the United States Department of Justice regarding the Company’s billing and other practices.  While the Company believes it is in material compliance with applicable governmental laws and regulations, in the event that the United States government believes that any wrongdoing has occurred, the Company could be subject to fines and penalties and could be excluded from government reimbursement programs. However, substantive negotiations have progressed towards conclusion on this matter and management believes that this matter will not have a material adverse affect on the Company’s financial position and results of operations.

 

In February 2003, a purported class action lawsuit was filed in the State Court of Fulton County in the State of Georgia against the Company, and its officers and directors, as well as various physician groups that conduct business with the Company.  This lawsuit raised questions concerning the legality of the purchase service agreements under the Georgia Patient Self-Referral Act of 1993.  This lawsuit was dismissed without prejudice, in conjunction with a settlement, in May 2004.

 

Legal expenses related to the above mentioned matters amounted to $2.4 and $2.7 million for the three months and six months ended June 30, 2004.

 

10

 

5.  Consolidating Financial Statements

 

The following tables present consolidating financial information for the three months and six months ended June 30, 2004 and 2003 for:  1) MQ Associates, Inc. (parent); 2) MedQuest, Inc. (issuer); 3) the guarantors (on a combined basis) of MedQuest, Inc.’s notes (which represent all of MedQuest’s subsidiaries) and 4) all eliminating adjustments.  The consolidating financial statements presented reflect the legal entity compositions at the respective dates.  Separate financial statements of MedQuest, Inc., as issuer of the Notes, and the subsidiary guarantors are not presented because: 1) each subsidiary guarantor is 100% owned by MQ Associates, Inc., 2) all guarantees are full and unconditional, and 3) all guarantees are joint and several.

 

The Senior Credit Facility and the indenture governing the Notes impose certain restrictions on the Company, including restrictions on the ability to incur indebtedness, pay dividends, make investments, grant liens, sell assets and engage in certain other activities. In addition, the Senior Credit Facility requires the Company to maintain certain financial ratios.  The Company’s indebtedness under the Senior Credit Facility is secured by substantially all of the Company’s assets, including inventory, accounts receivable, real and personal property, intellectual property and other intangibles, and is guaranteed by MQA and all of MedQuest’s domestic subsidiaries.

 

11

 

MQ ASSOCIATES, INC.

CONSOLIDATING BALANCE SHEETS

(in thousands, except share data)

(unaudited)

June 30, 2004

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor Subsidiaries		Eliminations		Consolidated
ASSETS
Current Assets
Cash and cash equivalents		$	—				2,418				$	2,418
Patient receivables, net of allowance for doubtful accounts							67,342				67,342
Related party receivables							1,299				1,299
Other receivables							1,766				1,766
Prepaid expenses and other							4,006				4,006
Deferred income taxes							594				594
Total current assets							77,425				77,425
Property and equipment, net							87,527				87,527
Goodwill							34,415				34,415
Intangible assets, net							14,158				14,158
Intercompany receivable		15,775			57,605				(73,380	)
Debt issuance costs, net					12,302						12,302
Other					161		6,627				6,788
Total assets		15,775			70,068		220,152		(73,380	)	232,615
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current Liabilities
Accounts payable							2,833				2,833
Accrued payroll and related taxes							6,273				6,273
Accrued interest					7,334						7,334
Accrued radiologist fees							4,014				4,014
Income taxes payable
Other accrued expenses					161		6,104				6,265
Current portion of long-term debt					600						600
Current portion of obligations under capital leases							1,917				1,917
Total current liabilities					8,095		21,141				29,236
Intercompany payable		74,836			(202,344	)	127,508
Long-term debt					248,542						248,542
Obligations under capital leases							2,678				2,678
Other long-term liabilities							1,507				1,507
Deferred income taxes							9,713				9,713
Total liabilities		$	74,836		54,293		162,547				$	291,676
Commitments and contingencies
Redeemable preferred stock
Series A Convertible, $.001 par value; nonvoting; 35,000,000 shares authorized, issued and outstanding		$	35,000								$	35,000
Series B Convertible, $.001 par value; nonvoting; 15,000,000 shares authorized, issued and outstanding		15,000									15,000
		50,000									50,000
Stockholders’ deficit
Class A common stock, $.001 par value; voting; 115,000,000 shares authorized; 72,100,000 issued and outstanding		72									72
Common stock, $.001 par value; voting; 195,000,000 shares authorized; 28,605,000 issued and outstanding		29									29
Additional paid-in capital		63,389									63,389
Accumulated deficit		(172,551		)	15,775		57,605		(73,380	)	(172,551		)
Total stockholders’ deficit		(109,061		)	15,775		57,605		(73,380	)	(109,061		)
Total liabilities and stockholders’ deficit		$	15,775		70,068		220,152		(73,380	)	$	232,615

 

12

 

MQ ASSOCIATES, INC.

CONSOLIDATING BALANCE SHEETS

(in thousands, except share data)

(unaudited)

December 31, 2003

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
ASSETS
Current Assets
Cash and cash equivalents		$	—				6,731				$	6,731
Patient receivables, net of allowance for doubtful accounts							61,490				61,490
Related party receivables							782				782
Income taxes receivable
Other receivables							2,049				2,049
Prepaid expenses and other							2,619				2,619
Deferred income taxes							594				594
Total current assets							74,265				74,265
Property and equipment, net							82,107				82,107
Goodwill							33,855				33,855
Intangible assets, net							10,722				10,722
Investment in subsidiary		11,138			42,130				(53,268	)
Debt issue costs, net					13,384						13,384
Other					1,404		7,744				9,148
Total assets		11,138			56,918		208,693		(53,268	)	223,481
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current Liabilities
Accounts payable							6,596				6,596
Accrued payroll and related taxes							5,371				5,371
Other accrued expenses					7,278		7,680				14,958
Current portion of long-term debt					600						600
Current portion of obligations under capital leases							1,584				1,584
Total current liabilities					7,878		21,231				29,109
Intercompany payable		72,922			(207,064	)	134,142
Long-term debt					244,966						244,966
Obligations under capital leases							2,517				2,517
Other long-term liabilities							499				499
Deferred income taxes							8,174				8,174
Total liabilities		$	72,922		45,780		166,563				$	285,265
Commitments and contingencies
Redeemable preferred stock
Series A Convertible, $.001 par value; nonvoting; 35,000,000 shares authorized, issued and outstanding		$	35,000								$	35,000
Series B Convertible, $.001 par value; nonvoting; 15,000,000 shares authorized, issued and outstanding		15,000									15,000
		50,000									50,000
Stockholders’ deficit
Class A common stock, $.001 par value;  voting; 115,000,000 shares authorized;  72,100,000 issued and outstanding		72									72
Common stock, $.001 par value; voting;  195,000,000 shares authorized;  28,605,000 issued and outstanding		29									29
Additional paid-in capital		63,389									63,389
Accumulated deficit		(175,274		)	11,138		42,130		(53,268	)	(175,274		)
Total stockholders’ deficit		(111,784		)	11,138		42,130		(53,268	)	(111,784		)
Total liabilities and stockholders’ deficit		$	11,138		56,918		208,693		(53,268	)	$	223,481

 

13

 

MQ ASSOCIATES, INC.

CONSOLIDATING STATEMENTS OF OPERATIONS

(unaudited)

(in thousands)

Three months ended June 30, 2004

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
Net revenues from services		$	—				71,012				$	71,012
Costs and expenses
Operating expenses, excluding depreciation							29,580				29,580
Marketing, general and administrative expenses							25,765				25,765
Depreciation and amortization							7,921				7,921
Income from operations							7,746				7,746
Interest expense		956			5,389		51				6,396
Interest income							9				9
Equity in earnings of unconsolidated joint venture							(35	)			(35		)
Income (loss) before provision for income taxes		(956		)	(5,389	)	7,721				1,376
Provision for income taxes							550				550
Equity in earnings of consolidated subsidiaries		1,782			7,171				(8,953	)
Net income (loss)		$	826		1,782		7,171		(8,953	)	$	826

 

14

 

MQ ASSOCIATES, INC.

CONSOLIDATING STATEMENTS OF OPERATIONS

(unaudited)

(in thousands)

Three months ended June 30, 2003

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
Net revenues from services		$	—				59,613				$	59,613
Costs and expenses
Operating expenses, excluding depreciation							25,815				25,815
Marketing, general and administrative expenses							18,922				18,922
Depreciation and amortization							7,301				7,301
Income from operations							7,575				7,575
Interest expense		653			5,313		95				6,061
Interest income							(4	)			(4		)
Income (loss) before provision for income taxes		(653		)	(5,313	)	7,484				1,518
Provision for income taxes							608				608
Equity in earnings of consolidated subsidiaries		1,563			6,876				(8,439	)
Net income (loss)		$	910		1,563		6,876		(8,439	)	$	910

 

15

 

MQ ASSOCIATES, INC.

CONSOLIDATING STATEMENTS OF OPERATIONS

(unaudited)

(in thousands)

Six months ended June 30, 2004

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
Net revenues from services		$	—				138,032				$	138,032
Costs and expenses
Operating expenses, excluding depreciation							57,635				57,635
Marketing, general and administrative expenses							47,499				47,499
Depreciation and amortization							15,619				15,619
Income from operations							17,279				17,279
Interest expense		1,914			10,838		101				12,853
Interest income							(4	)			(4		)
Equity in earnings of unconsolidated joint venture							(108	)			(108		)
Income (loss) before provision for income taxes (benefit)		(1,914		)	(10,838	)	17,290				4,538
Provision for income taxes (benefit)							1,815				1,815
Equity in earnings of consolidated subsidiaries		4,637			15,475				(20,112	)
Net income (loss)		$	2,723		4,637		15,475		(20,112	)	$	2,723

 

16

 

MQ ASSOCIATES, INC.

CONSOLIDATING STATEMENTS OF OPERATIONS

(unaudited)

(in thousands)

Six months ended June 30, 2003

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
Net revenues from services		$	—				115,360				$	115,360
Costs and expenses
Operating expenses, excluding depreciation							50,394				50,394
Marketing, general and administrative expenses							36,619				36,619
Depreciation and amortization							14,182				14,182
Income from operations							14,165				14,165
Interest expense		1,337			10,407		131				11,875
Interest income							(8	)			(8		)
Income (loss) before provision for income taxes		(1,337		)	(10,407	)	14,042				2,298
Provision for income taxes							920				920
Equity in earnings of consolidated subsidiaries		2,715			13,122				(15,837	)
Net income (loss)		$	1,378		2,715		13,122		(15,837	)	$	1,378

 

17

 

MQ ASSOCIATES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

Six months ended June 30, 2004

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
Cash flows from operating activities
Net income (loss)		$	2,723		4,637		15,475		(20,112	)	$	2,723
Adjustments to reconcile net income (loss) to net cash and cash equivalents provided by operating activities
Depreciation and amortization							15,619				15,619
Amortization of bond discount					120						120
Amortization of debt issuance costs					974						974
Bad debt expense							6,185				6,185
Equity in earnings of unconsolidated joint venture							(108	)			(108		)
Equity in earnings of consolidated subsidiaries		(4,637		)	(15,475	)			20,112
Changes in operating assets and liabilities
Patient receivables							(12,037	)			(12,037		)
Related party and other receivables							(280	)			(280		)
Intercompany receivable					(1,255	)	(12,752	)	14,007
Intercompany payable		1,914			10,838		1,255		(14,007	)
Prepaid expenses and other current assets							(1,387	)			(1,387		)
Other assets							(371	)			(371		)
Accounts payable							(3,763	)			(3,763		)
Accrued payroll and related taxes							902				902
Other accrued expenses					161		4,092				4,253
Net cash and cash equivalents provided by operating activities							12,830				12,830
Cash flows from investing activities
Purchases of property and equipment							(15,827	)			(15,827		)
Acquisitions of businesses, net of cash acquired							(5,485	)			(5,485		)
Proceeds from loan repayments							69				69
Net cash and cash equivalents used in investing activities							(21,243	)			(21,243		)
Cash flows from financing activities
Payments on capital leases							(708	)			(708		)
Intercompany receivable					(23,500	)	(18,692	)	42,192
Intercompany payable		—			18,692		23,500		(42,192	)	—
Payment of debt issuance costs					(29	)					(29		)
Other					137						137
Proceeds from senior credit facility					23,500						23,500
Payments on senior credit facility					(300	)					(300		)
Payment on long-term debt					(18,500	)					(18,500		)
Net cash and cash equivalents provided by financing activities							4,100				4,100
Net (decrease) increase in cash and cash equivalents							(4,313	)			(4,313		)
Cash and cash equivalents, beginning of period							6,731				6,731
Cash and cash equivalents, end of period							2,418				2,418
Supplemental disclosure of cash flow information
Cash paid for interest							11,705				11,705
Cash paid for taxes							862				862
Supplemental schedule of non-cash investing and financing activities
Acquisition of businesses
Fair value of assets acquired							5,485				5,485
Less deposit paid in prior year
							5,485				5,485
Equipment acquired through capital leases		$	—				1,203				$	1,203

 

18

 

MQ ASSOCIATES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

Six months ended June 30, 2003

 

		MQ Associates, Inc.			MedQuest, Inc.		Guarantor subsidiaries		Eliminations		Consolidated
Cash flows from operating activities
Net income (loss)		$	1,378		2,715		13,122		(15,837	)	1,378
Adjustments to reconcile net income (loss) to net cash and cash equivalents provided by (used in) operating activities
Depreciation and amortization							14,182				14,182
Amortization of bond discount					36						36
Amortization of debt issuance costs					792						792
Bad debt expense							4,816				4,816
Equity in earnings of consolidated subsidiaries		(2,715		)	(13,122	)			15,837
Changes in operating assets and liabilities
Patient receivables							(9,963	)			(9,963		)
Related party and other receivables							207				207
Intercompany receivable							(1,337	)	1,337
Intercompany payable		1,337							(1,337	)
Prepaid expenses and other current assets							(423	)			(423		)
Other assets							(360	)			(360		)
Accounts payable							(990	)			(990		)
Accrued payroll and related taxes							1,068				1,068
Other accrued expenses					7,350		(4,607	)			2,743
Net cash and cash equivalents provided by (used in) operating activities					(2,229	)	15,715				13,486
Cash flows from investing activities
Purchases of property and equipment							(9,539	)			(9,539		)
Acquisitions of businesses, net of cash acquired							(3,441	)			(3,441		)
Proceeds from loan repayments							55				55
Net cash and cash equivalents used in investing activities		$	—				(12,925	)			$	(12,925	)
Cash flows from financing activities
Payments on capital leases		$					(661	)			$	(661	)
Intercompany receivable		—			(13,688	)	(14,052	)	27,740
Intercompany payable					14,052		13,688		(27,740	)
Payment of debt issuance costs					(520	)					(520		)
Proceeds from senior credit facility					13,688						13,688
Payments on senior credit facility					(13,532	)					(13,532		)
Net cash and cash equivalents provided by (used in) financing activities							(1,025	)			(1,025		)
Net (decrease) increase in cash and cash equivalents					(2,229	)	1,765				(464		)
Cash and cash equivalents, beginning of period							3,230				3,230
Cash and cash equivalents, end of period					(2,229	)	4,995				2,766
Supplemental disclosure of cash flow information
Cash paid for interest							11,322				11,322
Cash paid for taxes							304				304
Supplemental schedule of noncash investing and financing activities
Acquisition of businesses
Fair value of assets acquired							5,441				5,441
Less deposit paid in prior year							(2,000	)			(2,000		)
							3,441				3,441
Equipment acquired through capital leases		$					1,917				$	1,917

 

19

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The purpose of this section is to discuss and analyze the consolidated financial condition, liquidity and capital resources and results of operations of MQ Associates, Inc. This analysis should be read in conjunction with the consolidated financial statements and notes which appear elsewhere in this Form 10-Q.                                          This section contains certain “forward-looking statements” within the meaning of federal securities laws that involve risks and uncertainties, including statements regarding our plans, objectives, goals, strategies and financial performance. The actual results achieved by MQ Associates, Inc. could differ materially from the results anticipated in these forward-looking statements as a result of factors set forth below under “— Cautionary Statement for Forward-Looking Statements.”

 

Overview

 

We are a leading independent operator of fixed-site, outpatient diagnostic imaging centers (each a “FIC”) in the United States.  We currently operate a network of 91 centers in 13 states primarily throughout the southeastern and southwestern United States of America. For the six months ended June 30, 2004, approximately 70.2% of our net revenue was derived from magnetic resonance imaging (“MRI”) services and approximately 16.3% was derived from computed tomography (“CT”) services. The remainder of our revenue was derived from nuclear medicine, general radiology (fluoroscopy and x-ray), ultrasound, and mammography.

 

Our revenue is generated by providing patient services. Generally, we directly bill patients or third-party payors (e.g. Medicare, Medicaid, commercial payors and workers compensation funds) on a fee-for-service basis.  For the six months ended June 30, 2004, approximately 61.4% of our net revenue came from commercial payors, 23.2% from government payors, 7.0% from workers compensation and 8.4% from other sources, including payments made directly by patients. Additionally, we have entered into purchase service agreements with physicians through which we provide diagnostic imaging services to a physician’s patients for a set fee which is paid by the physician, who then directly bills payors. These purchase service agreements represented approximately 7.0% of the Company’s net revenue for the six months ended June 30, 2004, and were reflected as revenue from commercial payors, workers compensation and other sources.  We have over 180 different contracts with commercial payors, and no single commercial payor accounted for more than 5% of net revenue for the six months ended June 30, 2004. Each of these contracts is renegotiated every two years. These contracts describe the negotiated fees to be paid by each payor for the diagnostic imaging services we provide to their members (our patients).

 

The principal components of operating costs, excluding depreciation and amortization, are compensation paid to radiologists, technologists and transcriptionists, annual equipment maintenance costs, medical supplies, real estate rental expenses and equipment rental costs, which include rental costs for mobile units and operating expenses for certain equipment. Operating costs excluding depreciation, as a percentage of net revenue, decreased from 43.7% for the six months ended June 30, 2003 to 41.7% for the six months ended June 30, 2004.  The decrease was primarily the result of a decrease, as a percentage of net revenues, in radiologist, technologists and repairs and maintenance costs.

 

The principal components of our marketing, general and administrative (“MG&A”) expenses are compensation paid to center managers, marketing managers, billers, collectors and other administrative personnel, marketing costs, business development expenses, corporate overhead costs and bad debt expense.  MG&A costs, as a percentage of net revenue, increased from 31.7% for six months ended June 30, 2003 to 34.4% for the six months ended June 30, 2004.  The increase was primarily the result of an increase, as a percentage of net revenues, in wages and related expenses and other general and administrative expenses.

 

From January 2001 to December 2003, for centers that were in operation for 24 months or longer preceding the end of the period, we have increased average daily scan

 

20

 

volumes across all modalities by 40.8%.  Average daily scan volume per machine for MRI machines and CT machines increased at compound annual growth rates of 5.0% and                    15.3%, respectively.

 

The average fee per scan for MRI and CT increased by 5.0% and 1.7%, respectively, from fiscal 2002 to fiscal 2003 and declined by 3.8% and 1.8%, respectively, from fiscal 2001 to fiscal 2002, in each case due to pricing variations among the geographic markets we serve and competition.  Medicare payments for most diagnostic imaging services covered by Medicare were increased by 4.5% for fiscal 2004, increased by 1.6% for services performed after March 1, 2003 and decreased by approximately 11.0% for fiscal 2002.  To the extent that commercial payors with which we contract base their payments for diagnostic imaging services on current Medicare reimbursement levels, any changes in Medicare reimbursement rates will result in a corresponding change in reimbursement from our commercial payors.

 

Our growth has come from same center revenue, de novo development and strategic acquisitions.  We increase our same center revenue by attracting new referring physicians, extending hours of operations, managing our scan and payor mix and adding capacity and modalities to meet local market needs. De novo development generally comes through expansion within our local markets. Strategic acquisitions allow us to quickly enter new markets as well as round out our regional networks of existing centers.

 

Results of operations

 

The following table sets forth operating expenses, MG&A, depreciation and amortization, net interest expense and other expenses, and these amounts as a percentage of net revenue for the periods indicated:

 

		Three months ended June 30,										Six months ended June 30,
(in millions)		2004			%		2003			%		2004			%		2003			%
Net revenues from services		$	71.0		100.0		$	59.6		100.0		$	138.0		100.0		$	115.4		100.0
Operating expenses, excluding depreciation		29.6			41.7		25.8			43.3		57.6			41.7		50.4			43.7
Marketing, general and administrative expenses		25.8			36.4		18.9			31.7		47.5			34.4		36.6			31.7
Depreciation and amortization		7.9			11.1		7.3			12.2		15.6			11.3		14.2			12.3
Income from operations		7.7			10.8		7.6			12.8		17.3			12.6		14.2			12.3
Interest expense, net		6.3			8.9		6.1			10.2		12.9			9.4		11.9			10.3
Equity in earnings of unconsolidated joint venture		—			0.0		—			0.0		(0.1		)	(0.1	)	—			0.0
Provision for income taxes		0.6			0.8		0.6			1.0		1.8			1.3		0.9			0.8
Net income		$	0.8		1.1		$	0.9		1.6		$	2.7		2.0		$	1.4		1.2

 

Three months ended June 30, 2004 compared to three months ended June 30, 2003

 

Net revenue was $71.0 million for the three months ended June 30, 2004, representing an increase of $11.4 million, or 19.1%, from revenues of $59.6 million for the three months ended June 30, 2003.  The increase was the result of growth in the number of scans performed at existing centers and an increase in the number of centers from 81 at June 30, 2003 to 90 at June 30, 2004.

 

Operating expenses, excluding depreciation, were $29.6 million for the three months ended June 30, 2004, representing an increase of $3.8 million, or 14.7%, as compared to $25.8 million for the three months ended June 30, 2003.  Operating expenses, excluding depreciation, as a percentage of net revenues decreased to 41.7% for

 

21

 

the three months ended June 30, 2004, as compared to 43.3% for the three months ended June 30, 2003.  The decrease, as a percentage of net revenues, was due to the effects of the semi-fixed portion of radiologist and technologist costs given the increase in net revenues for the comparison periods.  There was also a decrease, as a percentage of net revenues, in repair and maintenance expenses which was partially off-set by an increase in equipment rental costs.  Repair and maintenance costs decreased, as a percentage of net revenues, due to a decrease in the level of repair and maintenance costs not covered by the Phillips repair and maintenance agreement and equipment rental costs increased, as a percentage of net revenues, due to the addition of several mobile units.

 

MG&A expenses were $25.8 million for the three months ended June 30, 2004, representing an increase of $6.9 million, or 36.5%, as compared to $18.9 million for the three months ended June 30, 2003.  MG&A expenses, as a percentage of net revenues, were 36.4% for the three months ended June 30, 2004, as compared to 31.7% for the three months ended June 30, 2003.  The increases, as a percentage of net revenues, were a result of an increase in wages and related expenses and other general and administrative expenses.  Wages and related expenses increased primarily due to the addition of certain middle management and support level personnel in the areas of operations and information technology.  Wages and related expenses also increased as a result of the transfer of certain billing center costs from an external provider to an internal provider.  General and administrative expenses increased as a result of $2.4 million of legal expenses related to: 1) attorney fees, expenses and associated costs incurred in connection with the legal matters subsequently discussed; 2) management’s estimated of the final costs related to the anticipated settlement of the United States Department of Justice investigation; and 3) dismissal without prejudice in May 2004, in conjunction with a settlement, of the class action lawsuit which was initially filed against the Company in February 2003. General and administrative also increased as a result of expenses related to the ongoing implementation of the Radiology Information System.

 

Depreciation and amortization was $7.9 million, or 11.1% of net revenues, for the three months ended June 30, 2004 as compared to $7.3 million, or 12.2% of net revenues, for the three months ended June 30, 2003.  This decrease, as a percentage of net revenues, was primarily the result of the significant increases in revenues for the comparison periods.

 

Interest expense, net, increased to $6.3 million for the three months ended June 30, 2004 from $6.1 million for the three months ended June 30, 2003.  Interest expense, net, increased primarily due to an increased level of indebtedness as a result of an amendment to our Senior Credit Facility in September 2003, allowing us to borrow an additional $60.0 million under a Tranche B term facility.  Total debt at June 30, 2004 amounted to $253.7 million as compared to $241.6 million at June 30, 2003.

 

Income taxes were $0.6 million for the three months ended June 30, 2004 and 2003.  The effective tax rate was 40.0% for the three months ended June 30, 2004 and for the three months ended June 30, 2003.  Income taxes are provided for on an interim basis using an approximate tax rate of 40.0%, which represents our effective tax rate.  There were Federal and State net operating loss carryforwards amounting to approximately $15.7 million and $40.3 million at December 31, 2003.

 

As a result of the foregoing factors, we had net income of $0.8 million for the three months ended June 30, 2004, as compared to net income of $0.9 million for the three months ended June 30, 2003.

 

Six months ended June 30, 2004 compared to six months ended June 30, 2003

 

Net revenue was $138.0 million for the six months ended June 30, 2004, representing an increase of $22.6 million, or 19.6%, from revenue of $115.4 million for the six months ended June 30, 2003.  The increase was the result of an increase in the number of scans performed at existing centers and an increase in the number of centers from 81 at June 30, 2003 to 90 at June 30, 2004.

 

Operating expenses, excluding depreciation, were $57.6 million for the six months ended June 30, 2004, representing an increase of $7.2 million, or 14.3%, as compared to $50.4 million for the six months ended June 30, 2003.  Operating expenses, excluding depreciation, as a percentage of net revenues decreased to 41.7% for the six months ended June 30, 2004, as compared to 43.7% for the six months ended June 30, 2003.  The decrease,

 

22

 

as a percentage of net revenue, was due primarily to the effects of the semi-fixed portion of radiologist and technologist costs given the increase in net revenue for the comparison periods.  There was also a decrease, as a percentage of net revenue, in repair and maintenance expenses, due to a decrease in the level of repair and maintenance costs not covered by the repair and maintenance agreement entered into with Philips Medical Systems North America in January 2003, which linked the level of repair and maintenance expenses to an operating factor.

 

MG&A expenses were $47.5 million for the six months ended June 30, 2004, representing an increase of $10.9 million, or 29.8%, as compared to MG&A expenses of $36.6 million for the six months ended June 30, 2003.  MG&A expenses, as a percentage of net revenue were 34.4% for the six months ended June 30, 2004, as compared to 31.7% for the six months ended June 30, 2003.  Wages and related expenses increased primarily due to the addition of certain middle management and support level personnel in areas of operations and information technology.  Wages and related expenses also increased as a result of the transfer of certain billing center costs from an external provider to an internal provider.  General and administrative expenses increased as a result of $2.7 million of legal expenses related to: 1) attorney fees, expenses and associated costs incurred in connection with the legal matters subsequently discussed; 2) management’s estimate of the final costs related to the anticipated settlement of the United States Department of Justice investigation; and 3) dismissal without prejudice in May 2004, in conjunction with a settlement, of the class action lawsuit which was initially filed against the Company in February 2003.  General and administrative also increased as a result of expenses related to the ongoing implementation of the Radiology Information System.

 

Depreciation and amortization was $15.6 million, or 11.3% of net revenue, for the six months ended June 30, 2004 as compared to $14.2 million, or 12.3% of net revenue, for the six months ended June 30, 2003.  This decrease, as a percentage of net revenue, was primarily the result of the increase in revenue for the period.

 

Interest expense, net, increased to $12.9 million for the six months ended June 30, 2004 from $11.9 million for the six months ended June 30, 2003.  Interest expense, net, increased primarily due to an increased level of indebtedness as a result of an amendment to the senior credit facility in September 2003, allowing us to borrow an additional $60.0 million under a Tranche B term facility.  Total debt at June 30, 2004 amounted to $253.7 million as compared to $241.6 million at June 30, 2003.

 

Income taxes were $1.8 million for the six months ended June 30, 2004, as compared to $0.9 million for the six months ended June 30, 2003.  The effective tax rate was 40.0% for the six months ended June 30, 2004 and for the six months ended June 30, 2003.  Income taxes are provided for on an interim basis using an approximate tax rate of 40.0%, which represents our effective tax rate.  There were federal and state net operating loss carryforwards amounting to approximately $15.7 million and $40.3 million at December 31, 2003.

 

As a result of the foregoing factors, we had net income of $2.7 million for the six months ended June 30, 2004, as compared to net income of $1.4 million for the six months ended June 30, 2003.

 

Liquidity and Capital Resources

 

The principal uses of liquidity are to finance our capital expenditures and make acquisitions, as well as to fund our operations.  We operate in a capital-intensive, high fixed-cost industry that requires significant amounts of working capital to fund operations, particularly the initial start-up and development expenses of our de novo centers and the acquisition of additional centers.

 

Our primary sources of liquidity to fund operations and capital expenditures and satisfy our debt service obligations are cash flow from operating activities and borrowings under our revolving credit facility.

 

Net cash provided by operating activities was $12.8 million for the six months ended June 30, 2004, representing a decrease of $0.7 million from $13.5 million for the six months ended June 30, 2003.

 

Net cash used in investing activities was $21.2 million for the six months ended June 30, 2004, representing an increase of $8.3 million from $12.9 million for the six months ended June 30, 2003.  This increase is primarily the result of an increase in capital expenditures during the six months ended June 30, 2004.

 

Net cash provided by financing activities was $4.1 million for the six months ended June 30, 2004, representing an increase of $5.1 million from $1.0 million used in financing activities for the six months ended June 30, 2003.

 

23

 

This increase resulted primarily from an increase in level of borrowings under the Senior Credit Facility during the six months ended June 30, 2004.

 

In September 2003, the Company amended its Senior Credit Facility to allow for borrowings not to exceed $60.0 million under a Tranche B term facility.  Concurrent with the amendment of the Senior Credit Facility, the Company also borrowed $60.0 million under the Tranche B term facility and applied the net proceeds against borrowings outstanding under our revolving credit facility.

 

The Senior Credit Facility provides for a revolving credit facility not to exceed $80.0 million and a Tranche B term facility of $60.0 million.  The Senior Credit Facility is guaranteed by MQ Associates, Inc. and each of MQ Associates, Inc.’s and MedQuest’s existing and future subsidiaries, with limited exceptions for foreign subsidiaries.  MedQuest’s obligations under the Senior Credit Facility and the guarantors’ obligations under the guarantees are collateralized by substantially all of the assets of MedQuest, Inc. and the guarantors.

 

At June 30, 2004, we had $253.7 million of indebtedness outstanding, as compared to $249.7 million at December 31, 2003.  Our indebtedness at June 30, 2004 primarily consisted of $180 million due under our 11⁷/₈% senior subordinated notes and $59.4 million due under our Tranche B term loan.  At June 30, 2004, we would have been able to borrow an additional $66.4 million (after giving effect to $0.6 million in outstanding letters of credit) under our revolving credit facility to fund our working capital requirements and future acquisitions.

 

Borrowings under the revolving credit facility accrue interest, at our option, at either: (a) in the case of loans where the rate of interest is based on the ABR rate, an applicable margin of 1.50% per annum plus the higher of (i) Wachovia Bank’s prime rate and (ii) the Federal funds effective rate plus ½ of 1.0%, or (b) in the case of loans where the rate of interest is based on the Eurodollar rate, the Eurodollar rate plus an applicable margin of 2.50% per annum.  Borrowings under the revolving credit facility at June 30, 2004 were based upon the Eurodollar rate (i.e. 1.94% at June 30, 2004) and amounted to $13.0 million at June 30, 2004.  The revolving credit facility also provides for a commitment fee, payable quarterly in arrears on any unused commitments hereunder, equal to ½ of 1% per annum.  The margins related to the prime rate and Eurodollar rate borrowings under the revolving credit facility and the commitment fee are subject to adjustment based upon our consolidated leverage ratio, as defined in the Senior Credit Facility.

 

Borrowings under the Tranche B term facility accrue interest at our option at either: (a) in the case of loans where the rate of interest is based on the ABR rate, an applicable margin of 2.75% per annum plus the higher of (i) Wachovia Bank’s prime rate and (ii) the Federal funds effective rate plus ½ of 1% or (b) in the case of loans where the rate of interest is based on the Eurodollar rate, Eurodollar rate plus an applicable margin of 3.75% per annum.  Borrowings were based upon the Eurodollar rate (i.e. 1.94% at June 30, 2004) and amounted to $59.4 million at June 30, 2004.

 

Commencing with the fiscal year ending December 31, 2004, and annually thereafter, we are required to prepay outstanding term loans (or if all outstanding term loans are paid in full, to reduce commitments under the revolving credit facility) with 75% (or if we meet a certain consolidated total leverage ratio, 50%) of our “Excess Cash Flow”, as defined in the Senior Credit Facility for such fiscal year.  Notwithstanding the foregoing, we may use up to $20 million of net cash proceeds from certain asset dispositions and up to $20 million of Excess Cash Flow, in each case that we would otherwise have to use to prepay term loans, to prepay outstanding loans under the revolving credit facility (without a corresponding reduction in commitments).  We do not anticipate excess cash flows, as defined, for the year ending December 31, 2004.

 

In August 2002, MedQuest, Inc. issued $180.0 million of 11⁷/₈% senior subordinated notes to fund, in part, our recapitalization.  The 11⁷/₈% senior subordinated notes bear interest at the rate of 11⁷/₈% per annum.  Interest on the 11⁷/₈% senior subordinated notes is payable semi-annually on each February 15 and August 15.  The 11⁷/₈% senior subordinated notes mature on August 15, 2012.  In February 2003, MedQuest registered an identical series of 11⁷/₈% senior subordinated notes with the Securities and Exchange Commission and subsequently exchanged the unregistered $180 million principal amount 11⁷/₈% senior subordinated notes for 11⁷/₈% registered senior subordinated notes.

 

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The Senior Credit Facility and the indenture governing the 11^7/8% senior subordinated notes impose certain restrictions on us, including restrictions on our ability to incur indebtedness, pay dividends, make investments, grant liens, sell our assets and engage in certain other activities. In addition, the Senior Credit Facility requires us to maintain certain financial ratios. We were in compliance with all covenants under the Senior Credit Facility at June 30, 2004.  Our indebtedness under the Senior Credit Facility is collateralized by substantially all of our assets, including our inventory, accounts receivable, real and personal property, intellectual property and other intangibles, and guaranteed by all of our domestic subsidiaries.  The 11^7/8% senior subordinated notes are senior subordinated unsecured obligations of MedQuest, ranking junior in right of payment to all of its existing and future senior debt, and are guaranteed by MQ Associates, Inc. and each of MedQuest’s subsidiaries.

 

The Series A Preferred Stock and Series B Preferred Stock of MQ Associates may be redeemed at the option of the holder upon the consummation of an underwritten public offering at a redemption price of $35.0 million for all of the Series A Preferred Stock and $15.0 million for all of the Series B Preferred Stock. Additionally, in the case of such redemption, the holders of Series B Preferred Stock will receive 2,295,000 shares of Common Stock. In the event that (i) MQ Associates and its underwriters determine that the redemption of the Series B Preferred Stock would adversely affect the planned underwritten public offering or (ii) the holders of shares of Series B Preferred Stock elect not to redeem shares of Series B Preferred Stock, MQ Associates may convert all shares of Series B Preferred Stock into 17,295,000 shares of Common Stock. We have not accreted the fair value of the additional shares of Common Stock to be issued upon redemption of the Series B Preferred Stock because we do not believe that the redemption trigger is probable as of June 30, 2004.

 

Our high level of debt may make it more difficult for us to borrow funds in the future. Based on our current level of operations and anticipated growth, we believe that our cash flows from operations, together with future borrowings under our Senior Credit Facility, will be sufficient over the next year to meet our liquidity requirements, including our debt service obligations, working capital needs and capital expenditures. However, there can be no assurance that this will be the case.

 

Our expansion and acquisition strategy may require substantial capital, and no assurance can be given that we will be able to raise any necessary funds in addition to those currently available to us through bank financing or the issuance of equity or debt securities on terms acceptable to us, if at all. Moreover, if we were to engage in one or more significant acquisition transactions, it may be necessary for us to restructure our existing credit arrangements.

 

Our ability to fund our working capital needs, planned capital expenditures and scheduled debt payments, to implement our expansion plans, to refinance our indebtedness and to comply with our financial covenants under the Senior Credit Facility depends on our future operating performance and cash flows from operations, which in turn are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control.

 

Capital expenditures

 

We incur capital expenditures for the purposes of:

 

•                  purchasing new equipment and incurring leasehold improvements for de novo centers;

 

•                  acquiring the assets of existing centers;

 

•                  upgrading existing equipment to increase volume and/or quality;

 

•                  replacing less advanced equipment; and

 

•                  upgrading information technology systems.

 

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Capital expenditures (excluding acquisitions) totaled $18.6 million, including deposits of $1.6 million paid in 2003, for the six months ended June 30, 2004, and $9.5 million for the six months ended June 30, 2003.  Capital expenditures related to acquisitions amounted to $5.5 million for the six months ended June 30, 2004, compared to $5.4 million for the six months ended June 30, 2003, including a $2.0 million deposit paid in 2002.  Capital expenditures, in the aggregate, amounted to $24.1 million for the six months ended June 30, 2004 as compared to $14.9 million for the six months ended June 30, 2003.

 

We believe that capital expenditures will range between $41.0 and $46.0 million for the year ending December 31, 2004, with $3.0 million to $4.0 million of these capital expenditures related to information technology.  The amount of capital expenditures may vary based upon the level of unanticipated growth opportunities that present themselves during the fiscal year.

 

During fiscal 2001, 2002 and 2003, we were engaged in the development of the Radiology Information System, through the use of third-party and internal software developers, and spent $0.6 million, $1.1 million and $0.4 million, respectively, during fiscal 2001, 2002 and 2003 in relation to this development.  During fiscal 2003, we successfully implemented certain phases of the RIS into a number of centers within our network.

 

As part of our ongoing evaluation process, we identified in fiscal 2003 certain third-party software packages that could be used to complete our RIS project in a more cost and time effective manner.  As a result, during the fourth quarter of fiscal 2003, we elected to implement certain third-party software in place of developing like systems under the RIS framework.  We spent $0.5 million in fiscal 2003 for these software packages.

 

We anticipate completion of a roll-out of the billing phase of our fully integrated system by the third quarter of fiscal 2004, with roll-out of the remaining phases of the system to be completed no later than the end of fiscal 2005.  We have budgeted $0.9 million for the year ending December 31, 2004 related to this implementation.

 

In January 2003, we entered into a contract for the servicing of substantially all of our diagnostic imaging equipment with Philips Medical Systems North America. This contract has an initial term of five years and is priced at a fixed annual amount of $8.4 million, which amount is subject to increase based on our achieving certain levels of annual net patient revenue.

 

We continuously evaluate acquisition opportunities, and from time to time we may enter into non-binding letters of intent.  There were no outstanding non-binding letters of intent at June 30, 2004.

 

Seasonality

 

We experience seasonality in our revenue. For example, our sales typically decline from our third fiscal quarter to our fourth fiscal quarter. Fourth quarter revenue is typically lower than revenue from the first, second and third quarters. Fourth quarter revenue is affected primarily by holiday and client and patient vacation schedules and inclement weather, the results of which are fewer patient scans during the fourth quarter. As a result, our revenue may significantly vary from quarter to quarter, and quarterly results may be below market expectations.

 

Cautionary Statement for Forward-Looking Statements

 

This quarterly report contains or may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements include, without limitation, statements regarding our future growth and profitability, growth strategy and trends in the industry in which we operate. These forward-looking statements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions. We can give no assurance that such forward-looking statements will prove to be correct.  Among the important factors that could cause our actual results to differ significantly from those expressed or implied by such forward-looking statements are general economic and business conditions, the effect of healthcare industry trends on third-party reimbursement rates and demand for our services, limitations and delays in reimbursement

 

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by third-party payors; changes in governmental regulations that affect our ability to do business, actions of our competitors, introduction of new technologies, risks associated with our acquisition strategy and integration costs and the additional factors and risks contained in our Registration Statement on Form S-1 declared effective on May 14, 2004.

 

All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this filing and are expressly qualified in their entirety by the cautionary statements included in this filing.  We undertake no obligations to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

We sell our services exclusively in the United States of America and receive payment for services exclusively in United States dollars. As a result, our 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 our indebtedness bears interest at fixed rates. However, management may in its judgment determine that it is advisable to enter into interest rate swaps to convert a portion of the fixed interest rate debt to floating interest rate debt. To the extent management decides to do so, the interest expense payable or the floating rate portion of our indebtedness will be sensitive to changes in the general level of interest rates in the United States. The recorded carrying amount for $47.5 million of our long-term debt approximates fair value as these borrowings have variable rates, as a result of an interest rate swap agreement, that reflect currently available terms and conditions for similar debt.  Additionally, $59.4 million of our borrowings under the Tranche B term facility bear interest at a variable rate.

 

Our interest income is sensitive to changes in the general level of interest rates in the United States of America, particularly because the majority of our investments are in short-term instruments.

 

The recorded carrying amounts of cash and cash equivalents approximate fair value due to their short-term maturities.

 

The table below provides information about our financial instruments that are sensitive to changes in interest rates. For long-term debt obligations, the table presents principal cash flows and related weighted average interest rates by expected (contractual) maturity dates. All amounts are in United States dollars (in millions). Under our current policies, we use interest rate derivative instruments to manage certain exposure to interest rate changes.

 

Long-term debt		2005			2006			2007			2008			2009			2012			Total			Fair Value
Fixed rate		—			—			—			—			—			$	132.5		$	132.5		$	134.0
Average interest rate		—			—			—			—			—			11.875		%	11.875		%	10.42		%
Variable rate		$	0.6		$	0.6		$	13.6		$	28.8		$	28.5		$	47.5		$	119.6		$	119.6
Average interest rate		5.70		%	5.70		%	3.97		%	5.70		%	5.70		%	8.47		%	6.42		%	6.42		%

 

In August 2002, we entered into an interest rate swap agreement related to the fixed interest rate obligations on the notes. The agreement requires us to pay interest at a variable rate based on six-month LIBOR plus 6.525% on a notional amount of $47.5 million for a term of ten years. This derivative instrument has been accounted for as a fair value hedge of the fair market value of the notes and was 100% effective for the six months ended June 30, 2004.  As a result, the change in fair market value related to this derivative instrument has been entirely offset by the change in fair market value of the notes.  The fair market value of this derivative instrument was $0.2 million at June 30, 2004 and $1.4 million at December 31, 2003 and has been presented as a component of Other Assets in the consolidated balance sheets at June 30, 2004 and December 31, 2004, respectively.

 

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Item 4.  Controls and Procedures

 

At the end of the period covered by this quarterly report on Form 10-Q, the chief executive officer and chief financial officer (collectively, the “certifying officers”) of MQ Associates, Inc. (the “Company”) evaluated the effectiveness of the Company’s disclosure controls and procedures.  These disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in its periodic reports is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms, and that the information is communicated to the certifying officers on a timely basis.

 

Our management, including the certifying officers, does not expect that our disclosure controls or our “internal controls over financial reporting” (“Internal Controls”) will prevent all error and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

The certifying officers concluded, based on their evaluation, that the Company’s disclosure controls and procedures are effective.

 

There have been no changes in the Company’s Internal Controls that have occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s Internal Controls.

 

PART II.                                                OTHER INFORMATION

 

Item 1.                                                           Legal Proceedings

 

We are engaged from time to time in the defense of lawsuits and administrative proceedings arising in the ordinary course and conduct of our business and have insurance policies covering potential insurable losses where this coverage is cost-effective.

 

In February 2003, we received a request for documents from the United States Department of Justice regarding the Company’s billing and other practices.  While we believe we are in material compliance with applicable governmental laws and regulations, in the event that the United States government believes that any wrongdoing has occurred, we could be subject to fines- and penalties and could be excluded from government reimbursement programs.  However, substantive negotiations have progressed towards conclusion on this matter and management believes that this matter will not have a material adverse affect on our financial position and results of operations.

 

In February 2003, a purported class action lawsuit was filed in the State Court of Fulton County in the State of Georgia against us, our subsidiaries, officers and directors, as well as various physician groups that conduct business with us.  This lawsuit raised questions concerning the legality of the purchase service agreements under the Georgia Patient Self-Referral Act of 1993.  This lawsuit was dismissed without prejudice, in conjunction with a settlement, in May 2004.

 

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Item 5.                                                           Other Information

 

On August 9, 2004, we announced by press release, among other things, our intention to make a proposed private placement offering of senior discount notes and to use the net proceeds of such offering to pay dividends to our stockholders.  We filed such press release as an exhibit to a Current Report on Form 8-K on August 9, 2004 (the Form “8-K”).  Reference is made to the Form 8-K for information concerning the proposed private placement offering.

 

The senior discount notes to be offered will not be registered under the Securities Act of 1933, as amended, or any state securities laws, and may not be offered or sold in the United Sates absent registration or an application exemption from registration requirements.  This Current Report on Form 8-K shall not constitute an offer to sell or a solicitation of an offer to buy the senior discount notes.

 

Item 6.                                                           Exhibits and Reports on Form 8-K

 

(a)                                                                                  Exhibits

 

Number		Description of Exhibits
31.1		Certification of Gene Venesky pursuant to 18 U.S.C. Section 1350, as approved pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Thomas C. Gentry pursuant to 18 U.S.C. Section 1350, as approved pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Gene Venesky pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Thomas C. Gentry pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b)		Reports on Form 8-K.  The registrant filed the following Current Report on Form 8-K during the second quarter of 2004:
		(1)          Report dated May 5, 2004, announcing the registrant’s earnings for the three months ended March 31, 2004 and 2003.

 

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SIGNATURES

 

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

 

 

	MQ ASSOCIATES, INC.
Date:  August 9, 2004	By:	/s/ Gene Venesky
		Gene Venesky
		Chairman and Chief Executive Officer
Date:  August 9, 2004	By:	/s/ Thomas C. Gentry
		Thomas C. Gentry
		Chief Financial Officer

 

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