UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

 

FOR THE FISCAL YEAR ENDED JUNE 30, 2004

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM           TO          

 

COMMISSION FILE NUMBER 333-75984

 

INSIGHT HEALTH SERVICES HOLDINGS CORP.

(Exact name of Registrant as specified in its charter)

 

 

(949) 282-6000

(Registrant’s telephone number including area code)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE

(Title of Class)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No ý

 

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 the Registrant’s knowledge, in definitive proxy or informative statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

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

 

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of December 31, 2003 (based on the price at which the common stock was valued on that date) was $141,347.  The number of shares outstanding of the Registrant’s common stock as of August 31, 2004 was 5,468,814.

 

PART I

 

ITEM 1.                                       BUSINESS

 

OVERVIEW

 

All references to “we,” “us,” “our,” “our company,” “the Company” or “InSight Holdings” in this annual report on Form 10-K mean InSight Health Services Holdings Corp., a Delaware corporation, and all entities and subsidiaries owned or controlled by InSight Health Services Holdings Corp. All references to “InSight” in this annual report on Form 10-K mean our wholly owned subsidiary, InSight Health Services Corp., a Delaware corporation, and all entities and subsidiaries owned or controlled by InSight Health Services Corp.

 

We are a provider of diagnostic imaging services. We provide our services through an integrated network of fixed-site centers and mobile facilities focused in targeted regions throughout the United States. Our services include magnetic resonance imaging, or MRI, positron emission tomography, or PET, computed tomography, or CT, and other technologies. These services are noninvasive techniques that generate representations of internal anatomy on film or digital media which are used by physicians for the diagnosis and assessment of diseases and disorders.

 

As of June 30, 2004, our network consists of 118 fixed-site centers and 118 mobile facilities.  This combination allows us to provide a full continuum of imaging services to better meet the needs of our customers, including healthcare providers, such as hospitals and physicians, and payors such as managed care organizations, Medicare, Medicaid and insurance companies. Our fixed-site centers include freestanding centers and joint ventures with hospitals and radiology groups. Physicians refer patients to our fixed-site centers based on our service reputation, equipment, breadth of managed care contracts and convenient locations. Our mobile facilities provide hospitals and physician groups access to imaging technologies when they lack either the resources or patient volume to provide their own imaging services or require incremental capacity. We enter into agreements with radiologists to provide professional services, which include supervision and interpretation of radiological procedures and quality assurance. We do not engage in the practice of medicine.  We operate as two divisions, the mobile division and fixed division, which also constitute our two reportable segments.  Our mobile division includes 29 parked mobile facilities, each of which serves a single customer.  Our fixed division includes four mobile facilities as part of our fixed division operations in Maine.  Certain financial information regarding our reportable segments is included in Note 18 to our consolidated financial statements, which are a part of this Form 10-K

 

We were incorporated in June 2001.  On October 17, 2001, we acquired InSight and InSight became our wholly owned subsidiary.  We refer to our acquisition of InSight as the “Acquisition” in this Form 10-K.  Our consolidated operations after the Acquisition are substantially consistent with the operations of InSight prior to the Acquisition.  In addition, we have no operations other than our investment in InSight.  InSight is considered our predecessor in accordance with Regulation S-X.

 

Our principal executive offices are located at 26250 Enterprise Court, Suite 100, Lake Forest, California 92630, and our telephone number is (949) 282-6000.  Our internet address is www.insighthealth.com. www.insighthealth.com is a textual reference only, meaning that the information contained on the website is not part of this Form 10-K and is not incorporated by reference in this Form 10-K or in any other filings we make with the Securities and Exchange Commission, or SEC.

 

2

 

Fixed-Site Business

 

Our fixed-site centers provide a full spectrum of diagnostic imaging services to patients, physicians, insurance payors and managed care organizations. Of our 118 fixed-site centers, 74 offer MRI services exclusively and four offer either PET or another type of service exclusively.  Our remaining 40 fixed-site centers are multi-modality sites typically offering MRI and one or more of PET, CT, x-ray, mammography, ultrasound, nuclear medicine, bone densitometry, nuclear cardiology and cardiovascular services. Diagnostic services are provided to a patient upon referral by a physician. Physicians refer patients to our fixed-site centers based on our service reputation, equipment, breadth of managed care contracts and convenient locations. Our fixed-site centers provide the equipment and technologists for the procedures, contract with radiologists to interpret the scans, and bill payors directly. We have more than 1,000 managed care contracts with managed care organizations at our fixed-site centers.  These managed care contracts often last for a period of multiple years because (1) they do not have specific terms or specific termination dates or (2) they contain annual “evergreen” provisions that provide for the contract to automatically renew unless either party terminates the contract.

 

In addition to our independent facilities, we enter into joint ventures with hospitals and radiology groups. Under these arrangements, the hospital outsources its radiology function (primarily MRI) to us and we then install the appropriate imaging equipment on the hospital campus. Joint ventures are attractive to hospitals that lack the resources, management expertise or patient volume to provide their own imaging services or require incremental capacity. Joint ventures provide us with motivated partners capable of generating significant in-patient scan volumes through fixed-site centers. Furthermore, our joint ventures allow us to charge a management and billing fee for supporting the day-to-day operations of the jointly owned centers.

 

 

Mobile Business

 

Hospitals can obtain access to our diverse diagnostic imaging technology through our network of 118 mobile facilities. We currently have contracts with more than 300 hospitals, physician groups and other healthcare providers. We enable hospitals, physician groups and other healthcare providers to benefit from our advanced equipment without investing their own capital directly. We do not provide interpretation services for the diagnostic images produced.  Interpretation services are provided by the hospital’s radiologists or physician groups.

 

After reviewing the needs of our customers, route patterns, travel times, fuel costs and equipment utilization, our field managers implement planning and route management to maximize the utilization of our mobile equipment while controlling the costs to locate and relocate the mobile facilities. Our mobile facilities are scheduled for as little as one-half day and up to seven days per week at any particular site. We generally enter into one to five year-term contracts with hospitals, physician groups and other healthcare providers under which they assume responsibility for billing and collections. We are paid directly by the hospitals, physician groups and other healthcare providers on a contracted amount for our services, regardless of their reimbursement.

 

Our mobile business provides a significant advantage for establishing joint venture arrangements with hospitals, physician groups and other healthcare providers and expanding our fixed-site business. We establish mobile routes in selected markets with the intent of growing with our customers. Our mobile facilities give us the flexibility to (1) supplement fixed-site centers operating at or near capacity until volume has grown sufficiently to warrant additional fixed-site centers, and (2) test new markets on a short-term basis prior to establishing new mobile routes or opening new fixed-site centers. Our goal is to enter into long-term joint venture relationships with our mobile customers once the local market matures and sufficient patient volume is attained to support a fixed-site center.

 

DIAGNOSTIC IMAGING TECHNOLOGY

 

The diagnostic imaging systems we currently offer are MRI systems, PET scanners, CT scanners, digital ultrasound systems, computer-based nuclear medicine gamma cameras, x-ray, mammography, radiography/fluoroscopy systems and bone densitometry.  Each of these types of imaging systems (other than x-ray) represents the marriage of computer technology and various medical imaging modalities. The following highlights our primary imaging systems:

 

3

 

Magnetic Resonance Imaging or MRI

 

MRI is a technique that involves the use of high-strength magnetic fields to produce computer-processed, three-dimensional, cross-sectional images of the body. The resulting image reproduces soft tissue anatomy (as found in the brain, spinal cord and interior ligaments of body joints such as the knee) with superior clarity, not available by any other currently existing imaging modality, and without exposing patients to ionizing radiation.  MRI systems are classified into two classes, conventional MRI systems and Open MRI systems.  The structure of conventional MRI systems (including the narrow tubes into which a patient is inserted) allows for higher magnet field strengths, better image quality and faster scanning times than Open MRI systems.  However, Open MRI systems are able to service patients who have access difficulties with the narrow tubes of conventional MRI systems, including pediatric patients and patients suffering from post-traumatic stress, claustrophobia or significant obesity.  A typical conventional  MRI examination takes from 20 to 45 minutes.  A typical Open MRI examination takes from 30 to 60 minutes.  MRI generally reduces the cost and amount of care needed and often eliminates the need for invasive diagnostic procedures.  MRI systems are typically priced in the range of $0.9 million to $2.5 million each.

 

 Positron Emission Tomography or PET

 

PET is a nuclear medicine procedure that produces pictures of the body’s metabolic and biological functions. PET can provide earlier detection as well as monitoring of certain cancers, coronary diseases or neurological problems than other diagnostic imaging systems. The information provided by PET technology often obviates the need to perform further highly invasive or diagnostic surgical procedures. Interest in PET scanning has increased recently due to several factors including a growing recognition by clinicians that PET is a powerful diagnostic tool, increased third-party payor coverage and reimbursement and the availability of the isotopes used for PET scanning.  PET/CT is a “fusion” scanner, which makes it possible to collect both anatomical and biological information during a single procedure.  A typical PET or PET/CT examination takes from 20 to 60 minutes.  PET systems are typically priced in the range of $0.8 million to $1.2 million each. PET/CT systems are typically priced in the range of $1.8 million to $2.3 million each.

 

 Computed Tomography or CT

 

In CT imaging, a computer analyzes the information received from an x-ray beam to produce multiple cross-sectional images of a particular organ or area of the body. CT imaging is used to detect tumors and other conditions affecting bones and internal organs. A typical CT examination takes from 15 to 45 minutes. CT systems are typically priced in the range of $0.3 million to $1.1 million each.

 

Other Imaging Technologies

 

•                  Ultrasound systems use, detect and process high frequency sound waves to generate images of soft tissues and internal body organs.

 

•                  X-ray is the most common energy source used in imaging the body and is now employed in conventional x-ray systems, CT scanners and digital x-ray systems.

 

•                  Mammography is a low-level conventional examination of the breasts. Its primary purpose is to detect lesions in the breast that may be too small or deeply buried to be felt in a regular breast examination. The benefits of digital mammography are lower radiation doses to the breast, higher sensitivity to lesions, and reduced procedure times compared to conventional film mammography.

 

•                  Bone densitometry uses an advanced technology called dual-energy x-ray absorptiometry, or DEXA, which safely, accurately and painlessly measures bone density and the mineral content of bone for the diagnosis of osteoporosis.

 

•                  Nuclear medicine gamma cameras, which are based upon the detection of gamma radiation generated by radioactive pharmaceuticals injected or inhaled into the body, are used to provide information about organ function as opposed to anatomical structure.

 

BUSINESS DEVELOPMENT

 

Our objective is to be the leading provider of outsourced diagnostic imaging services in our existing regional markets.  We plan to further develop and expand our regional markets by continuing to emphasize quality of care,

 

4

 

produce cost-effective diagnostic information and provide superior service and convenience to our customers.  Our strategy is focused on three components.

 

Firstly, we intend to maximize utilization of our existing facilities by:

 

•                  broadening our physician referral base and generating new sources of revenues through selective marketing activities;

 

•                  focusing our marketing efforts on attracting additional managed care customers;

 

•                  focusing on converting mobile facilities to fixed-site centers;

 

•                  expanding current imaging applications of existing modalities to increase overall procedure volume; and

 

•                  maximizing cost efficiencies through increased purchasing power and continued reduction of expenses.

 

Secondly, we intend to pursue expansion opportunities within our existing regional markets by opening new fixed-site centers and developing mobile facilities where attractive returns on investment can be achieved and sustained.  In addition, we believe that mobile PET and PET/CT facilities present a growth opportunity due to increased physician acceptance of PET and PET/CT as a diagnostic tool, expanded Medicare coverage of PET and PET/CT procedures and favorable reimbursement levels.  We also intend to pursue joint venture opportunities with hospitals because we believe that they have the potential to provide us with a steady source of procedure volume.  Management believes that this will be an area for additional growth because we expect hospitals and other healthcare providers to respond to federal healthcare regulatory requirements by outsourcing radiology services to imaging centers that are jointly owned and managed with third parties.

 

Finally, we intend to continue to increase our market presence in our existing regional markets where we can increase economies of scale or new markets where we believe we can establish a strong regional network, through disciplined and strategic acquisitions.  We believe we are well positioned to capitalize on the ongoing consolidation of the imaging industry.  We believe that the expansion of our business through such acquisitions is a key factor in improving profitability.  Generally, acquisition opportunities are aimed at increasing revenues and gross profit, and maximizing utilization of existing capacity and increasing economies of scale.  Incremental gross profit resulting from future acquisitions will vary depending on geographic location, whether facilities are mobile or fixed, the range of services provided and our ability to integrate the acquired businesses into its existing infrastructure.  We cannot assure you, however, that we will be able to identify suitable acquisition candidates, obtain suitable financing for such acquisitions or thereafter complete such acquisitions on terms acceptable to us.

 

GOVERNMENT REGULATION

 

The healthcare industry is highly regulated and changes in laws and regulations can be significant. Changes in the law or new interpretation of existing laws can have a material effect on our permissible activities, the relative costs associated with doing business and the amount of reimbursement by government and other third-party payors. The federal government and all states in which we currently operate regulate various aspects of our business. Failure to comply with these laws could adversely affect our ability to receive reimbursement for our services and subject us and our officers and agents to civil and criminal penalties.

 

Federal False Claims Act: There has been an increase in qui tam actions brought under the federal False Claims Act and, in particular, under the False Claims Act’s “qui tam” or “whistleblower” provisions. Those provisions allow a private individual to bring actions in the name of the government alleging that the defendant has made false claims for payment from federal funds. After the individual has initiated the lawsuit, the government must decide whether to intervene in the lawsuit and to become the primary prosecutor. Until the government makes a decision, the lawsuit is kept secret. If the government declines to join the lawsuit, the individual may choose to pursue the case alone, in which case the individual’s counsel will have primary control over the prosecution, although the government must be kept apprised of the progress of the lawsuit, and may intervene later. Whether or not the federal government intervenes in the case, it will receive the majority of any recovery. If the litigation is successful, the individual is entitled to no less than 15%, but no more than 30%, of whatever amount the government recovers that is related to the whistleblower’s allegations. The percentage of the individual’s recovery varies, depending on

 

5

 

whether the government intervened in the case and other factors. Recently, the number of suits brought against healthcare providers by government regulators and private individuals has increased dramatically. In addition, various states are considering or have enacted laws modeled after the federal False Claims Act, penalizing false claims against state funds. If a whistleblower action is brought against us, even if it is dismissed with no judgment or settlement, we may incur substantial legal fees and other costs relating to an investigation. Actions brought under the False Claims Act may result in significant fines and legal fees and distract our management’s attention, which would adversely affect our business, financial condition and results of operations.

 

When an entity is determined to have violated the federal False Claims Act, it must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 to $11,000 for each separate false claim, as well as the government’s attorneys fees. Liability arises when an entity knowingly submits, or causes someone else to submit, a false claim for reimbursement to the federal government or submits a false claim with reckless disregard for, or in deliberate ignorance of, its truth or falsity. Simple negligence should not give rise to liability. Examples of the other actions which may lead to liability under the False Claims Act:

 

•                  Failure to comply with the many technical billing requirements applicable to our Medicare and Medicaid business.

 

•                  Failure to comply with Medicare requirements concerning the circumstances in which a hospital, rather than we, must bill Medicare for diagnostic imaging services we provide to outpatients treated by the hospital.

 

•                  Failure of our hospital customers to accurately identify and report our reimbursable and allowable services to Medicare.

 

•                  Failure to comply with the prohibition against billing for services ordered or supervised by a physician who is excluded from any federal healthcare programs, or the prohibition against employing or contracting with any person or entity excluded from any federal healthcare programs.

 

•                  Failure to comply with the Medicare physician supervision requirements for the services we provide, or the Medicare documentation requirements concerning physician supervision.

 

•                  The past conduct of the businesses we have acquired.

 

We strive to ensure that we meet applicable billing requirements. However, the costs of defending claims under the False Claims Act, as well as sanctions imposed under the Act, could significantly affect our business, financial condition and results of operations.

 

Anti-kickback Statutes: We are subject to federal and state laws which govern financial and other arrangements between healthcare providers. These include the federal anti-kickback statute which, among other things, prohibits the knowing and willful solicitation, offer, payment or receipt of any remuneration, direct or indirect, in cash or in kind, in return for or to induce the referral of patients for items or services covered by Medicare, Medicaid and certain other governmental health programs. Violation of the anti-kickback statute may result in civil or criminal penalties and exclusion from the Medicare, Medicaid and other federal healthcare programs. In addition, it is possible that private parties may file “qui tam” actions based on claims resulting from relationships that violate this statute, seeking significant financial rewards. Many states have enacted similar statutes, which are not limited to items and services paid for under Medicare or a federally funded healthcare program. In recent years, there has been increasing scrutiny by law enforcement authorities, the Department of Health and Human Services, or HHS, the courts and Congress of financial arrangements between healthcare providers and potential sources of referrals to ensure that such arrangements do not violate the anti-kickback provisions. HHS and the federal courts interpret “remuneration” broadly to apply to a wide range of financial incentives, including, under certain circumstances, distributions of partnership and corporate profits to investors who refer federal healthcare program patients to a corporation or partnership in which they have an ownership interest and to payments for service contracts and equipment leases that are designed, even if only in part, to provide direct or indirect remuneration for patient referrals or similar opportunities to furnish reimbursable items or services. HHS has issued “safe harbor” regulations that set forth certain provisions which, if met, will assure that healthcare providers and other parties who refer patients or other business opportunities, or who provide reimbursable items or services, will be deemed not to

 

6

 

violate the anti-kickback statutes. The safe harbors are narrowly drawn and some of our relationships may not qualify for any “safe harbor”; however, failure to comply with a “safe harbor” does not create a presumption of liability. We believe that our operations materially comply with the anti-kickback statutes; however, because these provisions are interpreted broadly by regulatory authorities, we cannot assure you that law enforcement officials or others will not challenge our operations under these statutes.

 

Civil Money Penalty Law and Other Federal Statutes: The Civil Money Penalty, or CMP, law covers a variety of practices. It provides a means of administrative enforcement of the anti-kickback statute, and prohibits false claims, claims for medically unnecessary services, violations of Medicare participating provider or assignment agreements and other practices. The statute gives the Office of Inspector General of the HHS the power to seek substantial civil fines, exclusion and other sanctions against providers or others who violate the CMP prohibitions.

 

In addition, in 1996, Congress created the new federal crimes of healthcare fraud and making false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs such as the Medicare and Medicaid programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services, including those provided by private payors. A violation of this statute is a felony and may result in fines or imprisonment.

 

We believe that our operations materially comply with the CMP law and the healthcare fraud statutes. These prohibitions, however, are broadly worded and there is limited authority interpreting their parameters. Therefore, we can give no assurance that the government will not pursue a claim against us based on these statutes. Such a claim would divert the attention of management and could result in substantial penalties which could adversely affect our business, financial condition and results of operations.

 

Health Insurance Portability and Accountability Act: In 1996, Congress passed the Health Insurance Portability and Accountability Act, or HIPAA. Although the main focus of HIPAA was to make health insurance coverage portable, HIPAA has become a short-hand reference to new standards for electronic transactions and privacy and security obligations imposed on providers and others who handle personal health information. HIPAA requires healthcare providers to adopt standard formats for common electronic transactions with health plans, and to maintain the privacy and security of individual patients’ health information. The privacy standards went into effect on April 14, 2003 and the electronic standards for transactions went into effect on October 16, 2003. Covered providers must comply with the security standards by April 2005. A violation of HIPAA’s privacy provisions may result in criminal and civil penalties, which could adversely affect our business, financial condition and results of operations.

 

Stark II, State Physician Self-referral Laws: The federal Physician Self-Referral or “Stark” law prohibits a physician from referring Medicare patients for certain “designated health services” to an entity with which the physician (or an immediate family member of the physician) has a financial relationship unless an exception applies. In addition, the receiving entity is prohibited from billing for services provided pursuant to the prohibited referral.

 

Designated health services under Stark include radiology services (MRI, CT, x-ray, ultrasound and others), radiation therapy, inpatient and outpatient hospital services and several other services. A violation of the Stark law does not require a showing of intent. If a physician has a financial relationship with an entity that does not qualify for an exception, the referral of Medicare patients to that entity for designated health services is prohibited and, if the entity bills for such services, the Stark sanctions apply.

 

Sanctions for violating Stark include denial of payment, mandatory refunds, civil money penalties and/or exclusion from the Medicare program. In addition, some courts have allowed federal False Claims Act lawsuits premised on Stark Law violations.

 

The federal Stark Law prohibition is expansive, and its statutory language and implementing regulations are ambiguous. Consequently, the statute has been difficult to interpret. In 1995, the Centers for Medicare and Medicaid Services, or CMS, published final regulations interpreting the Stark prohibition as applied to clinical laboratory services. In 1998, CMS released proposed regulations interpreting Stark as applied to all designated health services. In 2001, CMS published Phase I of the final Stark regulations which went into effect in January 2002. On March 26,

 

7

 

2004, CMS published Phase II of the final Stark regulations which became effective in July 2004. Phase II included some additional regulatory exceptions and definitions providing more flexibility in some areas and more specificity in others, but did not extend designated health services to PET or nuclear medicine.

 

With each set of regulations, CMS’ interpretation of the statute has evolved. This has resulted in considerable confusion concerning the scope of the referral prohibition and the requirements of the various exceptions. It is noteworthy, however, that CMS has taken the position that the Stark Law is self-effectuating and does not require implementing regulations. Thus, the government believes that physicians and others must comply with the Stark Law prohibitions regardless of the state of the regulatory guidance.

 

The Stark Law does not directly prohibit referral of Medicaid patients, but rather denies federal financial participation to state Medicaid programs for services provided pursuant to a tainted referral. Thus, Medicaid referrals are subject to whatever sanctions the relevant state has adopted. Several states in which we operate have enacted or are considering legislation that prohibits “self-referral” arrangements or requires physicians or other healthcare providers to disclose to patients any financial interest they have in a healthcare provider to whom they refer patients. Possible sanctions for violating these state statutes include loss of licensure, civil fines and criminal penalties. The laws vary from state to state and seldom have been interpreted by the courts or regulatory agencies. Nonetheless, strict enforcement of these requirements is likely.

 

We believe our operations materially comply with the federal and state physician self-referral laws. However, given the ambiguity of these statutes, the uncertainty of the regulations and the lack of judicial guidance on many key issues, we can give no assurance that the Stark Law or other physician self-referral regulations will not be interpreted in a manner that could adversely affect our business, financial condition and results of operations.

 

FDA: The U.S. Food and Drug Administration, or FDA, has issued the requisite premarket approval for all of our MRI, PET, PET/CT and CT systems. We do 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 must have a certificate issued by the FDA. In order to obtain a certificate, a mammography facility is required to be accredited by an FDA approved accrediting body (a private, non-profit organization or state agency) or other entity designated by the FDA. Pursuant to the accreditation process, each facility providing mammography services must comply with certain standards including annual inspection.

 

Compliance with these standards is required to obtain payment for Medicare services and to avoid various sanctions, including monetary penalties, or suspension of certification. Although all of our facilities which provide mammography services are currently accredited by the Mammography Accreditation Program of the American College of Radiology and we anticipate continuing to meet the requirements for accreditation, the withdrawal of such accreditation could result in the revocation or suspension of certification by the FDA, ineligibility for Medicare reimbursement and sanctions, including monetary penalties. 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 as well as screening mammography.

 

Radiologist and Facility Licensing: The radiologists with whom we contract to provide professional services are subject to licensing and related regulations by the states, including registrations to use radioactive materials. As a result, we require our radiologists to have and maintain appropriate licensure and registrations. In addition, some states also impose licensing or other requirements on us at our facilities and other states may impose similar requirements in the future. Some local authorities may also require us to obtain various licenses, permits and approvals. We believe that we have obtained all required licenses and permits; however, the criteria governing licensing or permitting may change or additional laws and licensing requirements governing our facilities may be enacted. These changes could adversely affect our business, financial condition and results of operations.

 

Liability Insurance: The hospitals and physicians who use our diagnostic imaging systems are involved in the delivery of healthcare services to the public and, therefore, are exposed to the risk of liability claims. Our position is that we do not engage in the practice of medicine. We provide only the equipment and technical components of diagnostic imaging, including certain limited nursing services, and we have not experienced any material losses due to claims for malpractice. Nevertheless, claims for malpractice have been asserted against us in the past and any future claims, if successful, could entail significant defense costs and could result in substantial damage awards to the claimants, which may exceed the limits of any applicable insurance coverage. We maintain professional liability

 

8

 

insurance in amounts we believe are adequate for our business of providing diagnostic imaging, treatment and management services. In addition, the radiologists or other healthcare professionals with whom we contract are required by such contracts to carry adequate medical malpractice insurance. Successful malpractice claims asserted against us, to the extent not covered by our liability insurance, could have a material adverse effect on our business, financial condition and results of operations.

 

Independent Diagnostic Treatment Facilities: CMS has established a category of Medicare provider referred to as Independent Diagnostic Treatment Facilities, or IDTFs. Imaging centers have the option to participate in the Medicare program as either IDTFs or medical groups. Most of our fixed-site centers are IDTFs. IDTFs are being monitored by CMS, particularly with respect to physician supervision requirements; however, if CMS exercised increased oversight of IDTFs, our business, financial condition and results of operations could be adversely affected.

 

Certificates of Need: Some states require hospitals and certain other healthcare facilities and providers to obtain a certificate of need, or CON, or similar regulatory approval prior to establishing certain healthcare operations or services, incurring certain capital expenditures and/or the acquisition of major medical equipment including MRI and PET systems. We believe that we have complied or will comply with applicable CON requirements in those states where we operate. Nevertheless, this is an area of continuing legislative activity, and CON and licensing statutes may be modified in the future in a manner that may have a material adverse effect on our business, financial condition and results of operations.

 

Environmental, Health and Safety Laws:  Our PET service and some of our other imaging services require the use of radioactive materials, which are subject to federal, state and local regulations governing the storage, use and disposal of materials and waste products. We could incur significant costs in order to comply with current or future environmental, health and safety laws and regulations.  However, we believe that environmental, health and safety laws and regulations will not (1) cause us to incur any material capital expenditures in our current year or the succeeding year, including costs for environmental control facilities or (2) materially impact our revenues or our competitive position.

 

SALES AND MARKETING

 

We engage in marketing activities to obtain new sources of revenues, expand business relationships, grow revenues at existing facilities, and maintain present business alliances and contractual relationships. Marketing activities for the fixed-site business include educating physicians on new applications and uses of the technology and customer service programs. In addition, our sales force leverages our targeted regional market concentration to develop contractual relationships with managed care payors to increase patient volume. Marketing activities for our mobile business include direct marketing to hospitals and developing leads through current customers, equipment manufacturers, and other vendors. In addition, marketing activities for the mobile business include contacting referring physicians associated with hospital customers and educating physicians.

 

COMPETITION

 

The healthcare industry in general, and the market for diagnostic imaging services in particular, is highly competitive and fragmented, with only a few national providers. We compete principally on the basis of our service reputation, equipment, breadth of managed care contracts and convenient locations. Our 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. We will continue to encounter substantial competition from hospitals and independent organizations, including Alliance Imaging, Inc., HEALTHSOUTH Corporation, MedQuest, Inc. and Radiologix, Inc. Some of our direct competitors that provide diagnostic imaging services may have access to greater financial resources than we do.

 

Certain hospitals, particularly the larger hospitals, may be expected to directly acquire and operate imaging and treatment equipment on-site as part of their overall inpatient servicing capability, assume the associated financial risk, employ the necessary technologists and satisfy applicable CON and licensure requirements, if any. In addition, some physician practices that have refrained from establishing diagnostic imaging capability may decide to do so, in light of the increased availability of lower-cost specialty MRI scanners. Historically, smaller hospitals have been reluctant to purchase imaging and treatment equipment, but have chosen to do so with attractive financing offered by original equipment manufacturers.

 

9

 

CUSTOMERS AND CONTRACTS

 

Our revenues are primarily generated from patient services and contract services. Patient services revenues are generally earned from services billed directly to patients or third-party payors (such as managed care organizations, Medicare, Medicaid, commercial insurance carriers and workers’ compensation funds) on a fee-for-service basis. Patient services revenues and management fees are primarily earned through fixed-site centers. Contract services revenues are generally earned from services billed to a hospital, physician group or other healthcare provider, which include fee-for-service arrangements in which revenues are based upon a contractual rate per procedure and fixed fee contracts.  Contract services revenues are primarily earned through mobile facilities and are generally paid pursuant to contracts with a term from one to five years.  Each year approximately 33% of the contract services agreements for mobile facilities are subject to renewal.  Our mobile facility contract renewal rate was 82% for the year ended June 30, 2004.  However, we expect that some high volume customer accounts will elect not to renew their agreements and instead will purchase or lease their own diagnostic imaging equipment and some customers may choose an alternative services provider.

 

During the year ended June 30, 2004, approximately 56% of our revenues were generated from patient services and approximately 44% were generated from contract services.

 

DIAGNOSTIC IMAGING AND OTHER EQUIPMENT

 

As of June 30, 2004, we owned or leased 275 diagnostic imaging and treatment systems, with the following classifications: 1.5 Tesla MRI, 1.0 Tesla MRI, Open MRI, PET, PET/CT, CT and other technology.  Magnetic field strength is the measurement of the magnet used inside the MRI system.  If the magnetic field strength is increased the image quality of the scan is improved and the time required to complete scans is decreased.  Magnetic field strength on MRI systems currently ranges from 0.2 to 3.0 Tesla.  Of our 171 conventional MRI systems, 147 have a magnet field of 1.5 Tesla, which is the industry standard magnet strength for conventional fixed and mobile MRI systems.

 

We continue to evaluate the mix of our diagnostic imaging equipment in response to changes in technology and to any surplus capacity in the marketplace. The overall technological competitiveness of our equipment continues to improve through upgrades, disposal and/or trade-in of older equipment and the purchase or execution of leases for new equipment.

 

Several substantial companies presently manufacture MRI (including Open MRI), PET,  PET/CT, CT and other diagnostic imaging equipment, including General Electric Medical Systems, Hitachi Medical Systems, Siemens Medical Systems, Toshiba American Medical Systems and Phillips Medical Systems. We have acquired MRI and CT systems that were manufactured by each of the foregoing companies.  We have acquired PET or PET/CT systems that were manufactured by General Electric Medical Systems, Siemens Medical Systems and CTI Molecular Imaging, Inc.  We enter into individual purchase orders for each system that we acquire, and we do not have long-term purchase arrangements with any equipment manufacturer.  We maintain good working relationships with many of the major manufacturers to better ensure adequate supply as well as access to those types of diagnostic imaging systems which appear most appropriate for the specific imaging facility to be established.

 

INFORMATION SYSTEMS

 

Our internal information technology systems allow us to manage our operations, accounting and finance, human resources, payroll, document imaging, and data warehousing. Our primary operating system is the InSight Radiology Information System, or IRIS, our proprietary information system. IRIS provides front-office support for scheduling and administration of imaging procedures and back office support for billing and collections. Additional functionality includes workflow, transcription, and image management.

 

In connection with the implementation of the electronic transactions, security and privacy standards mandated by HIPAA, we have spent approximately $1.1 million as of June 30, 2004 to make necessary software upgrades to IRIS to conform it with the privacy and electronic standards. We expect to spend an additional $0.4 million to conform IRIS with the security standards by April 2005.

 

10

 

COMPLIANCE PROGRAM

 

We have voluntarily implemented a program to monitor compliance with federal and state laws and regulations applicable to healthcare entities. We have appointed a compliance officer who is charged with implementing and supervising our compliance program, which includes a code of ethical conduct for our employees and affiliates and a process for reporting regulatory or ethical concerns to our compliance officer, including a toll-free telephone hotline. We believe that our compliance program meets the relevant standards provided by the Office of Inspector General of the HHS. An important part of our compliance program consists of conducting periodic reviews of various aspects of our operations. Our compliance program also contemplates mandatory education programs designed to familiarize our employees with the regulatory requirements and specific elements of our compliance program.

 

EMPLOYEES

 

As of August 31, 2004, we had approximately 1,700 full-time, 110 part-time and 480 per diem employees.  None of our employees is covered by a collective bargaining agreement. Management believes its employee relations to be satisfactory.

 

FORWARD-LOOKING STATEMENTS DISCLOSURE

 

This report on Form 10-K includes “forward-looking statements.”  Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, competitive strengths and weaknesses, business strategy and the trends that we anticipate in the industry and economies in which we operate and other information that is not historical information and, in particular, appear under “Item 1.  Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” When used in this report the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” and variations of such words or similar expressions are intended to identify forward-looking statements.  All forward-looking statements, including, without limitation, our examination of historical operating trends, are based upon our current expectations and various assumptions.  Our expectations, beliefs and projections are expressed in good faith, and we believe there is a reasonable basis for them, but we can give no assurance that our expectations, beliefs and projections will be realized.

 

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report.  Important factors that could cause our actual results to differ materially from the forward-looking statements made in this report are set forth in this report, including the factors described in the section entitled “Risk Factors,” and the following:

 

•                  limitations and delays in reimbursement by third-party payors;

•                  contract renewals and financial stability of customers;

•                  conditions within the healthcare environment;

•                  adverse utilization trends for certain diagnostic imaging procedures;

•                  our ability to successfully integrate acquisitions;

•                  market competition;

•                  the potential for rapid and significant changes in technology and their effect on our operations;

•                  operating, legal, governmental and regulatory risks; and

•                  economic, political and competitive forces affecting our business.

 

If any of these risks or uncertainties materialize, or if any of our underlying assumptions is incorrect, our actual results may differ significantly from the results that we express in or imply by any of our forward-looking statements.  We do not undertake any obligation to revise these forward-looking statements to reflect future events or circumstances.

 

11

 

RISK FACTORS

 

In addition to the other information contained in this Form 10-K, the following risk factors should be carefully considered.  If any of these risks actually occur, our business, financial condition or operating results could be adversely affected.

 

RISKS RELATING TO OUR INDEBTEDNESS

 

Our substantial indebtedness could adversely affect our financial health.

 

As of June 30, 2004, we had total indebtedness of approximately $539.8 million which comprised approximately 85% of our total capitalization.  Our substantial indebtedness could have important consequences to us. For example, it could:

 

•                  make it more difficult for us to satisfy our obligations with respect to our senior subordinated notes and our credit facility;

 

•                  increase our vulnerability to general adverse economic and industry conditions;

 

•                  require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and investments and other general corporate purposes;

 

•                  limit our flexibility in planning for, or reacting to, changes in our business and the markets in which we operate;

 

•                  place us at a competitive disadvantage compared to our competitors that have less debt; and

 

•                  limit our ability to borrow additional funds.

 

In addition, we may incur substantial additional indebtedness in the future.  The terms of the indenture governing our senior subordinated notes and the credit agreement governing our credit facility allow us to issue and incur additional debt subject to certain limitations.  If new debt is added to current debt levels, the related risks described above could increase.

 

We are subject to restrictive debt covenants that impose operating and financial restrictions on our operations and could limit our business flexibility.

 

The agreements governing our indebtedness impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things:

 

•                  the incurrence of additional indebtedness and the issuance of preferred stock and certain redeemable capital stock;

 

•                  a number of other restricted payments, including investments;

 

•                  specified sales of assets;

 

•                  specified transactions with affiliates;

 

•                  the creation of a certain types of liens;

 

•                  consolidations, mergers and transfers of all or substantially all of our assets; and

 

•                  our ability to change the nature of our business.

 

These restrictions could limit our ability to obtain future financing, make acquisitions, withstand downturns in our business or take advantage of business opportunities.

 

12

 

The terms of our credit facility include several restrictive covenants that prohibit us from prepaying our other indebtedness, including the senior subordinated notes, while indebtedness under our credit facility is outstanding. Our credit facility also requires us to maintain certain specified financial ratios and satisfy financial condition tests. Our ability to comply with the ratios or tests may be affected by events beyond our control, including prevailing economic, financial and industry conditions.

 

A breach of any of these covenants, ratios or tests could result in a default under our credit facility or the indenture. Events of default under our credit facility would prohibit us from making payments on the senior subordinated notes in cash, including payment of interest when due. In addition, upon the occurrence of an event of default under our credit facility, the lenders could elect to declare all amounts outstanding under our credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the security granted to them to secure that indebtedness.

 

If we are unable to generate or borrow sufficient cash to make payments on our indebtedness or to refinance our indebtedness on acceptable terms, our financial condition could be materially harmed.

 

Our ability to make payments on our indebtedness will depend on our ability to generate cash flow in the future which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. In addition, future borrowings may not be available to us under our credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other cash needs.  We may not be able to refinance any of our indebtedness, including our credit facility and our senior subordinated notes, on commercially reasonable terms or at all. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants which could further restrict our business operations.

 

The realizable value of our assets upon liquidation may be insufficient to satisfy claims.

 

At June 30, 2004, our assets included approximately $319.5 million of intangible assets, representing approximately 47.3% of our total consolidated assets.  These assets primarily consist of the excess of the acquisition cost over the fair market value of the net assets acquired in purchase transactions. The value of these intangible assets will continue to depend significantly upon the success of our business as a going concern and the growth in future cash flows. As a result, in the event of a default under our credit facility or our indenture or any bankruptcy or dissolution of our company, the realizable value of these assets may be substantially lower and may be insufficient to satisfy the claims of our creditors.

 

Because of the subordinated nature of our senior subordinated notes, holders of our senior subordinated notes may not be entitled to be paid in full, if at all, in a bankruptcy, liquidation or reorganization or similar proceeding.

 

As a result of the subordinated nature of our notes and related guarantees, upon any distribution to our creditors or the creditors of the subsidiary guarantors in bankruptcy, liquidation or reorganization or similar proceeding relating to us or the subsidiary guarantors or our or their property, the holders of our senior indebtedness and senior indebtedness of the subsidiary guarantors will be entitled to be paid in full in cash before any payment may be made with respect to our senior subordinated notes or the subsidiary guarantees.

 

In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the subsidiary guarantors, holders of our senior subordinated notes will participate with all other holders of unsecured indebtedness of ours or the subsidiary guarantors that are similarly subordinated in the assets remaining after we and the subsidiary guarantors have paid all senior indebtedness. However, because of the existence of the subordination provisions, including the requirement that holders of the senior subordinated notes pay over distributions to holders of senior indebtedness, holders of the senior subordinated notes may receive less, ratably, than our other unsecured creditors, including trade creditors. In any of these cases, we and the subsidiary guarantors may not have sufficient funds to pay all of our creditors. Holders of our senior subordinated notes may, therefore, receive less, ratably, than the holders of our senior indebtedness.

 

13

 

 Rises in interest rates could adversely affect our financial condition.

 

An increase in prevailing interest rates would have an immediate effect on the interest rates charged on our variable rate debt, which rise and fall upon changes in interest rates. At June 30, 2004, approximately 52% of our debt was variable rate debt. Increases in interest rates would also impact the refinancing of our fixed rate debt. If interest rates are higher when our fixed debt becomes due, we may be forced to borrow at the higher rates. If prevailing interest rates or other factors result in higher interest rates, the increased interest expense would adversely affect our cash flow and our ability to service our debt. As a protection against rising interest rates, we may enter into agreements such as interest rate swaps, caps, floors and other interest rate exchange contracts. These agreements, however, increase our risks as to the other parties to the agreements not performing or that the agreements could be unenforceable.

 

RISKS RELATING TO OUR BUSINESS

 

Changes in the rates or methods of third-party reimbursements for diagnostic imaging and therapeutic services could result in reduced demand for our services or create downward pricing pressure, which would result in a decline in our revenues and harm our financial position.

 

For the year ended June 30, 2004, we derived approximately 56% of our revenues from direct billings to patients and third-party payors such as Medicare, Medicaid, managed care and private health insurance companies. Changes in the rates or methods of reimbursement for the services we provide could have a significant negative impact on those revenues. Moreover, our healthcare provider customers on whom we depend for approximately 44% of our revenues generally rely on reimbursement from third-party payors. In the past, initiatives have been proposed and implemented which have the effect of substantially decreasing reimbursement rates for diagnostic imaging services provided at non-hospital facilities. Similar initiatives enacted in the future may have an adverse impact on our financial condition and our operations.

 

Under Medicare’s outpatient prospective payment system, or OPPS, a hospital is paid for outpatient services on a rate per service basis that varies according to the ambulatory payment classification group, or APC, to which the service is assigned rather than on a hospital’s costs. OPPS was implemented on August 1, 2000 and due to the anticipated adverse economic effect on hospitals, Congress provided for outlier payments for especially costly cases, as well as transitional payments for new technologies and innovative medical devices, drugs and biologics.  While most of the transitional payments expired in 2003, the CMS continues to make payments for new technology until sufficient data is collected to assign the new technology to an APC.  Each year CMS publishes new APC rates that are determined in accordance with the promulgated methodology.  However, the overall effect of OPPS is to decrease reimbursement rates from those paid under the prior cost-based system.

 

Any changes in the rates of or conditions for reimbursement could substantially reduce the number of procedures for which we or our customers can obtain reimbursement or the amounts reimbursed to us or our customers for services provided by us. If third-party payors reduce the amount of their payments to our customers, our customers may seek to reduce their payments to us or seek an alternate supplier of diagnostic imaging services. Because unfavorable reimbursement policies have constricted and may continue to constrict the profit margins of the hospitals, physician groups and other healthcare providers we bill directly, we have lowered and may continue to need to lower our fees to retain existing customers and attract new ones. These reductions could have a significant adverse effect on our revenues and financial results by decreasing demand for our services or creating downward pricing pressure.

 

If we are unable to renew our existing customer contracts on favorable terms or at all, our financial results would be adversely affected.

 

Our financial results depend on our ability to sustain and grow our revenues from existing customers. Our revenues would decline if we are unable to renew our existing customer contracts or renew these contracts on favorable terms. For our mobile facilities, we generally enter into contracts with hospitals having one to five year terms. Approximately 33% of our mobile contracts will expire each year. Our mobile facility contract renewal rate was 82% for the year ended June 30, 2004. We may not, however, achieve these renewal rates in the future. To the extent we do not renew a customer contract, it is not always possible to immediately obtain replacement customers. Historically, many replacement customers have been smaller facilities which have lower procedure volumes. In addition, attractive financing from original equipment manufacturers may cause hospitals and physician groups who have utilized shared mobile services from our company and our competitors to purchase and operate their own

 

14

 

equipment. If attractive financing causes hospitals and physician groups to establish their own diagnostic imaging centers, our business, financial condition and results of operations would be materially adversely affected. Although the non-renewal of a single customer contract would not have a material impact on our contract services revenues, non-renewal of several contracts on favorable terms or at all could have a significant negative impact on our revenues.

 

We may experience competition from hospitals, physician groups, other diagnostic imaging companies and this competition could adversely affect our revenues and our business.

 

The healthcare industry in general, and the market for diagnostic imaging services in particular, is highly competitive and fragmented, with only a few national providers. We compete principally on the basis of our service reputation, equipment, breadth of managed care contracts and convenient locations. Our 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. We will also encounter competition from hospitals and physician groups that purchase their own diagnostic imaging equipment from original equipment manufacturers who provide low-cost financing. Some of our direct competitors that provide diagnostic imaging services may have access to greater financial resources than we do. If we are unable to successfully compete, our customer base would decline and our business, financial condition and results of operations would be adversely affected.

 

Managed care organizations may limit healthcare providers from using our services, causing us to lose procedure volume.

 

Our fixed-site centers are principally dependent on our ability to attract referrals from physicians and other healthcare providers representing a variety of specialties. Our eligibility to provide service in response to a referral is often dependent on the existence of a contractual arrangement with the referred patient’s managed care organization. We currently have more than 1,000 contracts with managed care organizations for diagnostic imaging services provided at our fixed-site centers. Despite having a large number of contracts with managed care organizations, healthcare providers may be inhibited from referring patients to us in cases where the patient is not associated with one of the managed care organizations with which we have contracted. The loss of patient referrals causes us to lose procedure volume which adversely impacts our revenues. A significant decline in referrals would have a material adverse effect on our business, financial condition and results of operations.

 

Technological change in our industry could reduce the demand for our services and require us to incur significant costs to upgrade our equipment.

 

We operate in a competitive, capital intensive, high fixed-cost industry that requires significant amounts of capital. The development of new technologies or refinements of existing ones might (1) make our existing systems technologically or economically obsolete, or (2) reduce the need for our systems.  MRI and other diagnostic imaging systems are currently manufactured by numerous companies.  Competition among manufacturers for a greater share of the MRI and other diagnostic imaging systems market has resulted in and likely will continue to result in technological advances in the speed and imaging capacity of these new systems. Consequently, the obsolescence of our systems may be accelerated. Other than ultra-high field MRI systems (a 3.0 Tesla MRI scanner costs approximately 40% to 60% more than a 1.5 Tesla MRI scanner and has higher annual maintenance costs) and PET/CT or “fusion” scanners (a PET/CT scanner costs approximately 35% to 50% more than a standard PET scanner and has higher annual maintenance costs), we are aware of no imminent substantial technological changes; however, should such changes occur, we may not be able to acquire the new or improved systems.  In the future,  to the extent we are unable to generate sufficient cash from our operations or obtain additional funds through bank financing or the issuance of equity or debt securities, we may be unable to maintain a competitive equipment base. In addition, advancing technology may enable hospitals, physicians or other diagnostic service providers to perform procedures without the assistance of diagnostic service providers such as ourselves. As a result, we may not be able to maintain our competitive position in our targeted regions or expand our business.

 

Our ability to maximize the utilization of our diagnostic imaging equipment may be adversely impacted by harsh weather conditions.

 

Harsh weather conditions can adversely impact our operations and financial condition. To the extent severe weather patterns affect our targeted regions, potential patients may find it difficult to travel to our centers and we may have

 

15

 

difficulty moving our mobile facilities along their scheduled routes. As a result, we would experience a decrease in procedure volume during that period.  Our equipment utilization, procedure volume or revenues could be adversely affected by similar conditions in the future.

 

Because a high percentage of our operating expenses are fixed, a relatively small decrease in revenues could have a significant negative impact on our financial results.

 

A high percentage of our expenses are fixed, meaning they do not vary significantly with the increase or decrease in revenues. Such expenses include, but are not limited to, debt service and capital lease payments, rent and operating lease payments, salaries, maintenance, insurance and vehicle operation costs. As a result, a relatively small reduction in the prices we charge for our services or procedure volume could have a disproportionate negative effect on our financial results.

 

We may be subject to professional liability risks which could be costly and negatively impact our business and financial results.

 

We have not experienced any material losses due to claims for malpractice. However, claims for malpractice have been asserted against us in the past and any future claims, if successful, could entail significant defense costs and could result in substantial damage awards to the claimants, which may exceed the limits of any applicable insurance coverage. Successful malpractice claims asserted against us, to the extent not covered by its liability insurance, could have a material adverse affect on our business, financial condition and results of operations. In addition to being exposed to claims for malpractice, there are other professional liability risks to which we are exposed through our operation of diagnostic imaging systems, including liabilities associated with the improper use or malfunction of our diagnostic imaging equipment.

 

To protect against possible professional liability from malpractice claims, we maintain professional liability insurance in amounts that we believe are appropriate in light of the risks and industry practice. However, if we are unable to maintain insurance in the future at an acceptable cost or at all or if our insurance does not fully cover us in the event a successful claim was made against us, we could incur substantial losses. Any successful malpractice or other professional liability claim made against us not fully covered by insurance could be costly to defend against, result in a substantial damage award against us and divert the attention of our management from our operations, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our failure to effectively integrate acquisitions and establish joint venture arrangements through partnerships with hospitals and other healthcare providers could impair our business.

 

As part of our business strategy, we have pursued selective acquisitions and arrangements through partnerships and joint ventures with hospitals and other healthcare providers. Our acquisition and joint venture strategies require substantial capital which may exceed the funds available to us from internally generated funds and our credit facility. We may not be able to raise any necessary additional funds through bank financing or through the issuance of equity or debt securities on terms acceptable to us, if at all.

 

Additionally, acquisitions involve the integration of acquired operations with our operations. Integration involves a number of risks, including:

 

•                  demands on management related to the increase in our size after an acquisition;

 

•                  the diversion of our management’s attention from the management of daily operations to the integration of operations;

 

•                  integration of information systems;

 

•                  risks associated with unanticipated events or liabilities;

 

•                  difficulties in the assimilation and retention of employees;

 

•                  potential adverse effects on operating results;

 

16

 

•                  challenges in retaining customers and referral sources; and

 

•                  amortization or write-offs of acquired intangible assets.

 

Although we believe we have successfully integrated acquisitions in the past, we may not be able to successfully integrate the operations from any future acquisitions. If we do not successfully integrate our acquisitions, we may not realize anticipated operating advantages, economies of scale and cost savings. Also, we may not be able to maintain the levels of operating efficiency that the acquired companies would have achieved or might have achieved separately. Successful integration of each of their operations will depend upon our ability to manage those operations and to eliminate excess costs.

 

Loss of, and failure to attract, qualified employees, particularly technologists, could limit our growth and negatively impact our operations.

 

Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization.  Competition in our industry for qualified employees is intense.  In particular, there is a very high demand for qualified technologists who are necessary to operate our systems. We may not be able to hire and retain a sufficient number of technologists, and we may be required to pay bonuses and higher salaries to our technologists, which would increase our expenses.  Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.

 

Our PET service and some of our other imaging services require the use of radioactive materials, which could subject us to regulation, related costs and delays and potential liabilities for injuries or violations of environmental, health and safety laws.

 

Our PET service and some of our other imaging and therapeutic services require the use of radioactive materials to produce the images. While this radioactive material has a short half-life, meaning it quickly breaks down into non-radioactive substances, storage, use and disposal of these materials present the risk of accidental environmental contamination and physical injury. We are subject to federal, state and local regulations governing storage, handling and disposal of these materials and waste products. Although we believe that our safety procedures for storing, handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, we cannot completely eliminate the risk of accidental contamination or injury from those hazardous materials. In the event of an accident, we would be held liable for any resulting damages, and any liability could exceed the limits of or fall outside the coverage of our insurance. In addition, we may not be able to maintain insurance on acceptable terms, or at all. We could incur significant costs in order to comply with current or future environmental, health and safety laws and regulations.

 

An earthquake could adversely affect our business and operations.

 

Our corporate headquarters and a significant portion of our fixed-site centers are located in California, which has a high risk for earthquakes. Depending upon its magnitude, an earthquake could severely damage our facilities or prevent potential patients from traveling to our centers. Damage to our equipment or any interruption in our business would adversely affect our financial condition. While we presently carry earthquake insurance in amounts we believe are appropriate in light of the risks, the amount of our earthquake insurance coverage may not be sufficient to cover losses from earthquakes. In addition, we may discontinue earthquake insurance on some or all of our facilities in the future if the cost of premiums for earthquake insurance exceeds the value of the coverage discounted for the risk of loss. If we experience a loss which is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged facilities as well as the anticipated future cash flows from those facilities.

 

RISKS RELATING TO GOVERNMENT REGULATION OF OUR BUSINESS

 

Complying with federal and state regulations pertaining to our business is an expensive and time-consuming process, and any failure to comply could result in substantial penalties.

 

We are directly or indirectly through our customers subject to extensive regulation by both the federal government and the states in which we conduct our business, including:

 

•                  the federal False Claims Act;

 

17

 

•                  the federal Medicare and Medicaid Anti-kickback Law, and state anti-kickback prohibitions;

 

•                  the federal Civil Money Penalty Law;

 

•                  the federal Health Insurance Portability and Accountability Act of 1996;

 

•                  the federal physician self-referral prohibition commonly known as the Stark Law and the state law equivalents of the Stark Law;

 

•                  state laws that prohibit the practice of medicine by non-physicians, and prohibit fee-splitting arrangements involving physicians;

 

•                  federal FDA requirements;

 

•                  state licensing and certification requirements, including certificates of need; and

 

•                  federal and state laws governing the diagnostic imaging and therapeutic equipment used in our business concerning patient safety, equipment operating specifications and radiation exposure levels.

 

If our operations are found to be in violation of any of the laws and regulations to which we or our customers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines and the curtailment of our operations. Any penalties, damages, fines or curtailment of our operations, individually or in the aggregate, could adversely affect our ability to operate our business and our financial results. The risks of our being found in violation of these laws and regulations is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action brought against us for violation of these laws or regulations, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

 

The regulatory framework is uncertain and evolving.

 

Healthcare laws and regulations may change significantly in the future. We continuously monitor these developments and modify our operations from time to time as the regulatory environment changes. However, we may not be able to adapt our operations to address new regulations, which could adversely affect our business. In addition, although we believe that we are operating in compliance with applicable federal and state laws, neither our current or anticipated business operations nor the operations of our contracted radiology groups have been the subject of judicial or regulatory interpretation. A review of our business by courts or regulatory authorities may result in a determination that could adversely affect our operations or the healthcare regulatory environment may change in a way that restricts our operations.

 

ITEM 2.             PROPERTIES

 

We lease approximately 48,400 square feet of office space for our corporate headquarters and a billing office at 26250 Enterprise Court, Lake Forest, California 92630. The lease for this location expires in 2007.

 

ITEM 3.                                       LEGAL PROCEEDINGS

 

We are engaged from time to time in the defense of lawsuits arising out of the ordinary course and conduct of our business and have insurance policies covering such potential insurable losses where such coverage is cost-effective. We believe that the outcome of any such lawsuits will not have a material adverse impact on our business, financial condition and results of operations.

 

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

 

None.

 

18

 

PART II

 

ITEM 5.             MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

Our common stock is not publicly traded on any exchange or in any market.  At August 31, 2004, we had six record holders of our common stock.  We have never paid a cash dividend on our common stock and do not expect to do so in the foreseeable future.  The credit agreement governing our credit facility and the indenture governing our senior subordinated notes contain restrictions on our ability to pay dividends on our common stock.

 

Information regarding securities authorized for issuance under our equity compensation plans is set forth under “Item 12.  Security Ownership of Certain Beneficial Owners and Management.”

 

ITEM 6.                                       SELECTED FINANCIAL DATA

 

The selected consolidated financial data presented as of and for the years ended June 30, 2004, 2003 and 2002 has been derived from our audited consolidated financial statements.  The selected consolidated financial data presented as of and for the period from July 1, 2001 to October 17, 2001 and for the years ended June 30, 2001 and 2000, has been derived from the audited consolidated financial statements of InSight.  The information in the following table should be read together with our audited 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 on Form 10-K.  Our consolidated operations after our acquisition of InSight are substantially consistent with the operations of InSight.  We have no operations other than our investment in InSight.  InSight is considered our predecessor in accordance with Regulation S-X.

 

		Company									Predecessor
											Period from July 1 to October 17, 2001
		Years Ended June 30,												Years Ended June 30,
		2004			2003			2002 (1)						2001			2000
		(Amounts in thousands)
STATEMENT OF INCOME DATA:
Revenues		$	290,884		$	237,752		$	155,407		$	63,678		$	211,503		$	188,574
Gross profit		57,463			57,708			39,823			17,991			49,631			37,145
Interest expense, net		40,682			37,514			32,546			6,321			23,394			18,696
Net income (loss) (2)(3)(4)		2,924			4,922			9			(4,648		)	13,801			7,189

 

		June 30,											June 30,
		2004			2003			2002					2001			2000
BALANCE SHEET DATA:
Working capital		$	48,116		$	32,580		$	35,907				$	16,791		$	20,814
Property and equipment, net		242,336			219,121			172,056					148,255			148,469
Goodwill and other intangible assets		319,463			260,292			234,644					89,202			93,930
Total assets		675,631			577,317			499,401					321,056			328,872
Total long-term liabilities		537,177			442,484			378,234					197,388			221,307
Stockholders’ equity		94,941			91,614			87,376					65,471			51,487

 

(1)                                  Includes the results of operations of InSight from the date we acquired it.

(2)                                  Includes an acquisition related compensation charge of $15.6 million in the period from July 1, 2001 to October 17, 2001.

(3)                                  Includes an income tax benefit of $2.1 million in the period from July 1, 2001 to October 17, 2001.

(4)                                  No cash dividends have been paid on our or InSight’s common stock for the periods indicated above.

 

19

 

ITEM 7.                                       MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes which appear elsewhere in this report. It contains forward-looking statements that reflect our plans, estimates and beliefs, and which involve risks, uncertainties and assumptions. Please see “Forward-Looking Statements Disclosure” for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly under the headings “Risk Factors” and    “Forward-Looking Statements Disclosure.”

 

Overview

 

We are a provider of diagnostic imaging services. We serve a diverse portfolio of customers, including healthcare providers, such as hospitals and physicians, and payors, such as managed care organizations, Medicare, Medicaid and insurance companies. We provide our services through an integrated network of fixed-site centers and mobile facilities in targeted regions throughout the United States. We operate in 37 states with a substantial presence in California, Arizona, New England, the Carolinas, Florida and the Mid-Atlantic states. While we generated approximately 69% of our total revenues from MRI services during the year ended June 30, 2004, we provide a comprehensive offering of diagnostic imaging and treatment services, including PET, CT, mammography, bone densitometry, diagnostic ultrasound, lithotripsy and x-ray. We have developed and continue to develop strong regional networks of diagnostic imaging centers and facilities, enabling us to effectively serve our customers and maximize utilization of our imaging equipment. We provide our services through 118 fixed-site centers and 118 mobile facilities.

 

Given our size and expertise, we believe we are well positioned to capitalize on the ongoing growth in the diagnostic imaging industry. Growth in the diagnostic imaging industry has been and will continue to be driven by (1) an aging population, (2) the increasing acceptance of diagnostic imaging, particularly PET, (3) expanding applications of MRI and PET technologies, and (4) a currently stable reimbursement environment.

 

Segments

 

We have two reportable segments, the fixed division and mobile division:

 

Fixed Division. Generally, our fixed division operates freestanding imaging centers which we refer to as fixed-site centers.  However, our fixed division also includes four mobile facilities as part of our fixed division in Maine.  Revenues at our fixed-site centers are primarily generated from services billed, on a fee-for-service basis, directly to patients or third-party payors such as managed care organizations, Medicare, Medicaid, commercial insurance carriers and workers’ compensation funds, which we generally refer to as our patient services revenues and management fees.  Our fixed division revenues are dependent on our ability to:

 

•                  attract patient referrals from physician groups and hospitals;

 

•                  increase procedure volume to maximize equipment utilization;

 

•                  maintain our existing contracts and enter into new ones with managed care organizations and commercial insurance carriers; and

 

•                  develop new fixed-site centers.

 

Our fixed division revenues have been and will continue to be driven by the growth in the diagnostic imaging industry discussed above. These positive trends may be offset by:

 

•                  an increase in competition from other freestanding imaging centers within our targeted regions;

 

•                  an increase in deductibles and co-payment charges to patients; and

 

•                  an increase in the pre-authorization requirements applicable to diagnostic imaging services by certain managed care organizations.

 

20

 

Mobile Division. Our mobile division operates mobile facilities, which provide services to hospitals, physician groups and other healthcare providers. Our mobile division includes 29 parked mobile facilities, each of which serves a single customer. Revenues from our mobile division are primarily generated from fee-for-service arrangements and fixed fee contracts billed directly to our hospital, physician group customers and other healthcare providers, which we generally refer to as contract services revenues. Our mobile division revenues are dependent on our ability to:

 

•                  establish new mobile customers within our targeted regions;

 

•                  structure efficient mobile routes that maximize equipment utilization; and

 

•                  renew our existing mobile contracts with our hospital, physician group and other healthcare provider customers.

 

Our mobile division revenues have been and will continue to be driven by the growth in the diagnostic imaging industry as discussed above. These positive trends may be offset by;

 

•                  an increase in competition in our targeted regions from other mobile service providers;

 

•                  attractive financing arrangements by original equipment manufacturers which cause some of our customers to invest in their own diagnostic imaging equipment;

 

•                  a reduction in inpatient volumes at our fee-for-service customers due to higher unemployment rates and increased deductibles and co-payments to patients; and

 

•                  a reduction in short–term rental activities.

 

Our revenues in both divisions could also be affected by the timing of holidays, patient and referring physician vacation schedules and inclement weather.

 

Reimbursement

 

Medicare: The Medicare program provides reimbursement for hospitalization, physician, diagnostic and certain other services to eligible persons 65 years of age and over and certain others. Beginning in late 1983, prospective payment regulations for hospital inpatient services became effective under the federal Medicare program. Providers are paid by the federal government in accordance with regulations promulgated by the Department of Health and Human Services, or HHS, and generally accept the payment with nominal deductible and co-insurance amounts required to be paid by the service recipient, as payment in full. In general, these regulations provide for a specific prospective payment to reimburse hospitals for inpatient treatment services based upon the diagnosis of the patient.

 

In 2000, the Centers for Medicare and Medicaid Services, or CMS, published its final rules concerning the new hospital OPPS for most outpatient services in Medicare-participating hospitals. As a result of the implementation of the OPPS, effective August 1, 2000, Medicare began paying hospitals, except critical access hospitals, for outpatient services on a rate per service basis that varies according to the ambulatory payment classification (APC) group the service is assigned rather than on a hospital’s costs.   Due to OPPS’ anticipated adverse economic effect on hospitals, Congress provided for outlier payments for especially costly cases, as well as transitional payments for new technologies and innovative medical devices, drugs and biologics.  While most of the transitional payments expired in 2003, CMS continues to make payments for new technology until sufficient data is collected to assign the new technology to an APC. Each year CMS publishes new APC rates that are determined in accordance with the promulgated methodology.  However, the overall effect of OPPS is to decrease reimbursement rates from those paid under the prior cost-based system.  Multi-modality and certain fixed-site centers which are freestanding are not directly affected by OPPS, which applies only to hospital-based facilities. Congressional and regulatory actions reflect industry-wide cost-containment pressures that we believe will affect all healthcare providers for the foreseeable future.

 

21

 

CMS has indicated that it will continue to evaluate diagnostic imaging technical component reimbursement. Accordingly, Medicare payment for diagnostic imaging services may be further reduced in the future, which would have a material adverse effect on our financial condition and results of operations.

 

Medicaid: The Medicaid program is a jointly-funded federal and state program providing coverage for low-income persons. In addition to federally-mandated basic services, the services offered and reimbursement methods vary from state to state. In many states, Medicaid reimbursement is patterned after the Medicare program; however, an increasing number of states have established or are establishing payment methodologies intended to provide healthcare services to Medicaid patients through managed care arrangements.

 

Managed Care: Health Maintenance Organizations, or HMOs, and Preferred Provider Organizations, or PPOs, and other managed care organizations attempt to control the cost of healthcare services by a variety of measures, including, imposing lower payment rates, preauthorization requirements, limiting services or mandating less costly treatment alternatives. 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 our targeted regional networks could have a negative impact on utilization of our services in certain markets and/or affect the revenues per procedure which we can collect, since such organizations will exert greater control over patients’ access to diagnostic imaging services, the selection of the provider of such services and the reimbursement thereof.  See “Item 1. Business—Customers and Contracts. “

 

Some states have adopted or expanded laws or regulations restricting the assumption of financial risk by healthcare providers which contract with health plans. While we are not currently subject to such regulation, we or our customers may in the future be restricted in our ability to assume financial risk, or may be subjected to reporting requirements if we do so. Any such restrictions or reporting requirements could negatively affect our contracting relationships with health plans.

 

Private Insurance: Private health insurance programs generally have authorized payment for our services on satisfactory terms. However, if Medicare reimbursement is reduced, we believe that private health insurance programs will also reduce reimbursement in response to reductions in government reimbursement, which could have an adverse impact on our business, financial condition and results of operations.

 

Revenues

 

We receive revenues by providing services to patients, hospitals and other healthcare providers.  Our patient services revenues are billed, on a fee-for-service basis, directly to patients or third-party payors such as managed care organizations, Medicare, Medicaid, commercial insurance carriers and worker’s compensation funds (collectively, “payors”).  Patient services revenues also includes balances due from patients, which are primarily collected at the time the procedure is performed.  Our charge for a procedure is primarily comprised of charges for both the technical and professional components of the service.  Patient services revenues are presented net of (1) related contractual adjustments, which represent the difference between our charge for a procedure and what we will ultimately receive from the payors, and (2) payments due to radiologists for interpreting the results of the diagnostic imaging procedures.  In estimating the amount of contractual adjustments, we rely on a combination of in-house analysis, which includes a review of contractual payment rates from the payors, and our historical experience.

 

We refer to our revenues from hospital, physician groups and other healthcare providers as contract services revenues.   Contract services revenues are primarily generated from fee-for-service arrangements, fixed fee contracts and management fees billed to the hospital, physician group or other healthcare provider.  Contract services revenues are recognized over the applicable contract period.  Revenues collected in advance are recorded as unearned revenue.

 

The provision for doubtful accounts related to revenues is reflected as an operating expense rather than a reduction of revenues and represents our estimate of amounts that will be uncollectible from patients, payors, hospitals and other healthcare providers.  The provision for doubtful accounts includes amounts to be written off on specific accounts and unidentified accounts based on our historical collection experience, including payor mix and the aging of patient accounts receivable balances.  Our historical write-offs for uncollectible accounts is not concentrated in a specific payor class.  As these factors change, revisions are made in the appropriate period.

 

22

 

The following illustrates our payor mix based on revenues for the year ended June 30, 2004:

 

Payor		Percent of Total Revenues
Hospital, physician groups, and other healthcare providers (1)		46	%
Managed Care and Insurance		36	%
Medicare/Medicaid		14	%
Workers’ Compensation		3	%
Other		1	%

 

(1)          No single hospital, physician groups, and other healthcare providers accounted for more than 5% of our total revenues.

 

Operating Expenses

 

We operate in a capital intensive industry that requires significant amounts of capital to fund operations. As a result, a high percentage of our total operating expenses are fixed. Our fixed costs include debt service and capital lease payments, rent and operating lease payments, salaries and benefit obligations, equipment maintenance expenses, and insurance and vehicle operation costs. Because a large portion of our operating expenses are fixed, any increase in our procedure volume disproportionately increases our operating cash flow. Conversely, any decrease in our procedure volume disproportionately decreases our operating cash flow. Our variable costs, which comprise only a small portion of our total operating expenses, include the cost of service supplies such as film and contrast media.

 

Recent Acquisitions

 

On April 1, 2004, we acquired the stock of Comprehensive Medical Imaging, Inc., or CMI, a subsidiary of Cardinal Health, Inc., from Cardinal Health, Inc., which owned and operated 21 fixed-site centers located in California, Arizona, Texas, Kansas, Pennsylvania and Virginia. The aggregate purchase price for these centers was approximately $48.6 million. We refer to this acquisition as the CMI acquisition.

 

On August 1, 2003, we acquired 22 mobile facilities primarily operating in the Mid-Atlantic states from CDL Medical Technologies, Inc. The aggregate purchase price for these facilities was approximately $49.9 million. We refer to this acquisition as the CDL acquisition.

 

On April 2, 2003, we acquired 13 fixed-site centers located in Southern California from CMI. The aggregate purchase price for these centers was approximately $46.5 million. We refer to this acquisition as the Central Valley acquisition.

 

These acquisitions significantly expanded our presence in the Los Angeles, Phoenix and Northern California markets and the Mid-Atlantic states.  The aggregate cost of these acquisitions totaled $145.0 million, none of which was assumed debt.  We funded the consideration through (1) our credit facility and (2) $25 million in a private placement of 9.875% senior subordinated notes due November 2011.

 

In August 2003, we acquired a joint venture interest in a CT fixed-site center located in Hammonton, New Jersey, which was financed with internally generated funds.  In December 2003, we sold a fixed-site center located in Hobart, Indiana.  In February 2004, we acquired the remaining joint venture interest in a fixed-site center in Henderson, Nevada.

 

23

 

Results of Operations

 

Set forth below is historical financial data for us and our predecessor, InSight, for the periods indicated. The results of operations for the year ended June 30, 2002 have been derived by combining our results of operations for the year ended June 30, 2002 with the results of operations of InSight from July 1, 2001 to October 17, 2001, the date we acquired InSight. These combined results of operations have been prepared for comparative purposes only and do not purport to be indicative of what results of operations would have been if we had owned InSight for the entire year ended June 30, 2002.  Our operations after the Acquisition are substantially consistent with the operations of InSight prior to the Acquisition.  In addition, we have no operations other than our investment in InSight.  As such, InSight is considered our predecessor in accordance with Regulation S-X.

 

		Years Ended June 30,
		2004			2003			2002
		(Amounts in thousands)
REVENUES:
Contract services		$	129,193		$	111,921		$	105,179
Patient services		161,691			125,831			113,906
Total revenues		290,884			237,752			219,085
COSTS OF OPERATIONS:
Costs of services		168,700			125,685			113,065
Provision for doubtful accounts		4,998			4,154			3,895
Equipment leases		990			860			8,026
Depreciation and amortization		58,733			49,345			36,285
Total costs of operations		233,421			180,044			161,271
Gross profit		57,463			57,708			57,814
CORPORATE OPERATING EXPENSES		(16,217		)	(13,750		)	(10,889		)
ACQUISITION RELATED COMPENSATION CHARGE		—			—			(15,616		)
GAIN ON SALE OF CENTER		2,129			—			—
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS		2,181			1,744			819
INTEREST EXPENSE, net		(40,682		)	(37,514		)	(38,867		)
Income (loss) before income taxes		4,874			8,188			(6,739		)
PROVISION (BENEFIT) FOR INCOME TAXES		1,950			3,266			(2,100		)
Net income (loss)		$	2,924		$	4,922		$	(4,639	)

 

The following table sets forth historical revenues by segment for the periods indicated (amounts in thousands):

 

		Years Ended June 30,
		2004			2003			2002
Fixed division		$	176,763		$	139,816		$	127,122
Mobile division		114,121			97,936			91,963
Total		$	290,884		$	237,752		$	219,085

 

24

 

The following table sets forth certain condensed historical financial data expressed as a percentage of revenues for each of the periods indicated:

 

		Years Ended June 30,
		2004		2003		2002
Revenues		100.0	%	100.0	%	100.0	%
Costs of operations
Costs of services		58.0		52.9		51.6
Provision for doubtful accounts		1.7		1.7		1.8
Equipment leases		0.3		0.3		3.7
Depreciation and amortization		20.2		20.7		16.6
Totals costs of operations		80.2		75.6		73.7
Gross profit		19.8		24.4		26.3
Corporate operating expenses		(5.6	)	(5.8	)	(5.0	)
Acquisition related compensation charge		—		—		(7.1	)
Gain on sale of center		0.7		—		—
Equity in earnings of unconsolidated partnerships		0.8		0.7		0.4
Interest expense, net		(14.0	)	(15.8	)	(17.7	)
Income (loss) before income taxes		1.7		3.5		(3.1	)
Provision (benefit) for income taxes		0.7		1.4		(1.0	)
Net income (loss)		1.0	%	2.1	%	(2.1	)%

 

The following table sets forth our earnings before interest, taxes, depreciation and amortization excluding the acquisition related compensation charge, or Adjusted EBITDA, for the years ended June 30, 2004, 2003 and 2002.  Adjusted EBITDA has been included because we believe that it is a useful tool for us and our investors to measure our ability to meet debt service, capital expenditure and working capital requirements.  Adjusted EBITDA should not be considered an alternative to, or more meaningful than, income from company operations or other traditional indicators of operating performance and cash flow from operating activities determined in accordance with accounting principles generally accepted in the United States. While Adjusted EBITDA is used as a measure of operations and the ability to meet debt service requirements, it is not necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculations.  We present the discussion of Adjusted EBITDA because convenants in the indenture governing our senior subordinated notes and the credit agreement relating to our credit facility contain ratios based on this measure.  Our calculation of Adjusted EBITDA is as follows:

 

		Years Ended June 30,
		2004			2003			2002
		(Amounts in thousands)
Net income (loss), as reported		$	2,924		$	4,922		$	(4,639	)
Provision (benefit) for income taxes		1,950			3,266			(2,100		)
Interest expense, net		40,682			37,514			38,867
Depreciation and amortization		58,733			49,345			36,285
Acquisition related compensation charge		—			—			15,616
Adjusted EBITDA		$	104,289		$	95,047		$	84,029

 

Results of Operations for Years Ended June 30, 2004 and 2003

 

Revenues: Revenues increased approximately 22.3% from approximately $237.8 million for the year ended June 30, 2003, to approximately $290.9 million for the year ended June 30, 2004. This increase was due to an increase in revenues from our fixed division (approximately $36.9 million) and an increase in revenues from our mobile division (approximately $16.2 million). Revenues for our fixed division and mobile division represented approximately 61% and 39%, respectively, of our total revenues for the year ended June 30, 2004.

 

Revenues from our fixed division increased approximately 26.4% from approximately $139.8 million for the year ended June 30, 2003, to approximately $176.8 million for the year ended June 30, 2004.  The increase was due to (1) the Central Valley acquisition (approximately $20.0 million); (2) the CMI acquisition (approximately $10.3 million); (3) revenues from the fixed-site centers we opened in 2004 and 2003 (approximately $3.6 million); and (4) revenues from our existing fixed-site centers (approximately $4.3 million), partially offset by a decrease in revenues from the sale of a fixed-site center in Hobart, Indiana (approximately $1.2 million). The increase in our revenues from our existing fixed-site centers was the result of a 4% increase in utilization, partially offset by a 1% decrease in reimbursement from third-party payors.

 

25

 

Revenues from our mobile division increased approximately 16.5% from approximately $97.9 million for the year ended June 30, 2003, to approximately $114.1 million for the year ended June 30, 2004. The increase was due to the CDL acquisition (approximately $21.0 million), partially offset by (1) reduced revenues associated with our short-term rental activities (approximately $1.1 million) and (2) reduced revenues from our existing mobile facilities (approximately $3.7 million).  The decrease in revenues associated with our short-term rental activities is the result of fewer upgrades or installations of MRI equipment at hospitals which utilize our mobile facilities on a short-term or interim basis.  The decrease in revenues from our existing mobile facilties was the result of lower MRI and other revenues (approximately $5.9 million), partially offset by higher PET revenues (approximately $2.2 million).  The increase in PET revenues is primarily due to an increase in the number of PET facilities in service.  The decrease in MRI revenues was due to a decrease in the number of MRI facilities in service and the loss of high volume customer contracts, partially offset by an increase in procedure volume at replacement accounts, which initially had lower procedure volumes.  The loss of high volume customers is primarily the result of customers reaching sufficient patient volumes to finance the cost of acquiring their own system.  This has increased in recent years as original equipment manufacturers have offered attractive financing to high volume customers.  We experienced losses of high volume customers across our network and not just in any one region.

 

Approximately 56% of our total revenues for the year ended June 30, 2004 were generated from patient services revenues. Patient services revenues for the fixed division and mobile division represented approximately 99% and 1%, respectively, of total patient services revenues for the year ended June 30, 2004.  Approximately 44% of our total revenues for the year ended June 30, 2004, were generated from contract services revenues. Contract services revenues for the fixed division and mobile division represented approximately 13% and 87%, respectively, of total contract services revenues for the year ended June 30, 2004.

 

Costs of Operations: Costs of operations increased approximately 29.6% from approximately $180.0 million for the year ended June 30, 2003, to approximately $233.4 million for the year ended June 30, 2004. This increase was due primarily to (1) the Central Valley, CDL and CMI acquisitions (approximately $15.2 million, $13.9 million and $7.7 million, respectively); (2) costs at the fixed-site centers we opened in 2004 and 2003 (approximately $3.3 million); and (3) increased costs at our existing fixed-site centers and mobile facilities (approximately $14.3  million), partially offset by reduced costs from the sale of a fixed-site center in Hobart, Indiana (approximately $1.0 million).  The increase in costs of operations is due primarily to higher salaries and benefits (approximately $7.8 million), equipment maintenance costs (approximately $2.6 million), insurance (approximately $1.0 million) and depreciation expense (approximately $2.7 million), partially offset by reduced equipment lease costs (approximately $0.3 million) and provision for doubtful accounts (approximately $0.1 million).

 

Costs of operations at our fixed division increased approximately 29.1% from approximately $99.8 million for the year ended June 30, 2003, to approximately $128.8 million for the year ended June 30, 2004. The increase was due to (1) the Central Valley and CMI acquisitions (approximately $15.2 million and $7.7 million, respectively); (2) costs at the fixed-site centers we opened in 2004 and 2003 (approximately $3.3 million); and (3) increased costs at our existing fixed-site centers (approximately $3.8 million), partially offset by reduced costs from the sale of the fixed-site center discussed above (approximately $1.0 million).  The increase in costs of operations at our existing fixed-site centers was due primarily to higher salaries and benefits (approximately $3.8 million), particularly technologists and additional senior regional management, equipment maintenance costs (approximately $0.9 million), insurance (approximately $0.6 million) and depreciation expense (approximately $0.3 million), partially offset by reduced provision for doubtful accounts (approximately $0.3 million).

 

Costs of operations at our mobile division increased approximately 30.4% from approximately $66.8 million for the year ended June 30, 2003, to approximately $87.1 million for the year ended June 30, 2004. The increase was due to (1) the CDL acquisition (approximately $13.9 million) and (2) increased costs at our existing mobile facilities (approximately $6.4 million).  The increase in costs at our existing mobile facilities was due to higher salaries and benefits (approximately $2.9 million), particularly technologists and additional mobile sales personnel, equipment maintenance costs (approximately $1.0 million), an increase in vehicle costs due to the reduction of our short-term rental activities (approximately $2.2 million), insurance (approximately $0.3 million) and depreciation expense (approximately $1.9 million), partially offset by reduced equipment lease costs (approximately $1.0 million) and other costs (approximately $0.9 million).

 

Corporate Operating Expenses: Corporate operating expenses increased approximately 17.9% from approximately $13.8 million for the year ended June 30, 2003, to approximately $16.2 million for the year ended June 30, 2004. The increase was due primarily to higher salaries and benefits (approximately $0.2 million), additional costs to make

 

26

IRIS conform with HIPAA requirements (approximately $0.1 million), additional occupancy costs (approximately $0.1 million), cost and expenses incurred related to a withdrawn initial public offering (approximately $1.7 million), partially offset by reduced consulting costs related to our acquisition and development activities (approximately $0.3 million).

 

Gain on Sale of Center: In December 2003, we sold a fixed-site center located in Hobart, Indiana for approximately $5.4 million. We realized a gain of approximately $2.1 million on the sale.

 

Interest Expense, net: Interest expense, net increased approximately 8.5% from approximately $37.5 million for the year ended June 30, 2003, to approximately $40.7 million for the year ended June 30, 2004. The increase was due primarily to additional debt related to the Central Valley, CDL and CMI acquisitions, partially offset by principal payments on notes payable and capital lease obligations.

 

Provision for Income Taxes: Provision for income taxes decreased from $3.3 million for year ended June 30, 2003, to approximately $2.0 million for the year ended June 30, 2004. We have recorded a tax provision at an effective rate of 40% for the year ended June 30, 2004 and 2003, respectively.

 

Adjusted EBITDA:  Adjusted EBITDA increased approximately 9.7% from approximately $95.0 million for the year ended June 30, 2003, to approximately $104.3 million for the year ended June 30, 2004.  This increase was due to (1) the Central Valley, CDL and CMI acquisitions (approximately $7.1 million, $10.2 million and $3.8 million, respectively), and (2) Adjusted EBITDA at the fixed-site centers we opened in 2004 and 2003 (approximately $0.7), partially offset by a reduction of EBITDA at existing facilities (approximately $11.9 million) and a reduction of Adjusted EBITDA at the fixed-site center we sold in 2004 (approximately $0.5 million).  Adjusted EBITDA for the fixed division increased approximately 24.2% from approximately $59.1 million for the year ended June 30, 2003, to approximately $73.4 million for the year ended June 30, 2004.  This increase was due primarily to (1) the Central Valley and CMI acquisitions (approximately $7.1 million and $3.8 million, respectively), (2) an increase in Adjusted EBITDA at our existing fixed facilities (approximately $3.3 million) and (3) Adjusted EBITDA at our fixed-site centers we opened in 2004 and 2003 (approximately $0.7 million), partially offset by a reduction of Adjusted EBITDA at the fixed-site center sold in 2004 (approximately $0.5 million).  Adjusted EBITDA for the mobile division increased approximately 1.5% from approximately $55.5 million for the year ended June 30, 2003, to approximately $56.3 million for the year ended June 30, 2004.  This increase was due to (1) the CDL acquisition (approximately $10.2 million), partially offset by a reduction of adjusted EBITDA at our existing mobile facilities (approximately $9.4 million).

 

Results of Operations for Years Ended June 30, 2003 and 2002

 

Revenues: Revenues increased approximately 8.5% from approximately $219.1 million for the year ended June 30, 2002, to approximately $237.8 million for the year ended June 30, 2003. The increase was due primarily to an increase in revenues from our fixed division (approximately $12.7 million) and an increase in revenues from our mobile division (approximately $6.0 million). Revenues from our fixed division and mobile division represented approximately 59% and 41%, respectively, of our total revenues for the year ended June 30, 2003.

 

Revenues from our fixed division increased approximately 10.0% from approximately $127.1 million for the year ended June 30, 2002, to approximately $139.8 million for the year ended June 30, 2003. The increase was due

 

27

 

primarily to (1) the Central Valley acquisition (approximately $6.5 million);  (2) revenues from the fixed-site centers we opened in 2003 (approximately $3.6 million); and (3) higher utilization from our existing fixed-site centers (approximately 6%), partially offset by a nominal decrease in reimbursement rate from third-party payors (approximately 1%).

 

Revenues from our mobile division increased approximately 6.5% from approximately $91.9 million for the year ended June 30, 2002, to approximately $97.9 million for the year ended June 30, 2003. The increase was due to higher utilization at our mobile facilities and an increase in the number of MRI and PET mobile facilities in operation during the year ended June 30, 2003 (approximately six mobile facilities).

 

Approximately 53% of our total revenues for the year ended June 30, 2003 were generated from patient services revenues. Patient services revenues from our fixed division and mobile division represented approximately 98% and 2%, respectively, of total patient services revenues for the year ended June 30, 2003.  Approximately 47% of our total revenues for the year ended June 30, 2003 were generated from contract services revenues. Contract services revenues for our fixed division and mobile division represented approximately 14% and 86%, respectively, of total contract services revenues for the year ended June 30, 2003.

 

Costs of Operations: Costs of operations increased approximately 11.6% from approximately $161.3 million for the year ended June 30, 2002, to approximately $180.0 million for the year ended June 30, 2003. The increase was due primarily to (1) the Central Valley acquisition (approximately $4.7 million), and (2) increased costs at our existing fixed-site centers and mobile facilities (approximately $14.0 million). The increased costs at our existing fixed-site centers and mobile facilities were due primarily to higher salaries and benefits (approximately $3.4 million), occupancy (approximately $1.0 million), equipment maintenance costs (approximately $1.3 million) and depreciation expense (approximately $9.9 million), partially offset by reduced equipment lease costs (approximately $7.3 million).  The increase in depreciation and the reduction of equipment lease costs are due primarily to the buyout of operating leases and the conversion of operating leases to capital leases and to our capital expenditures during the year ended June 30, 2003.

 

Costs of operations at our fixed division increased approximately 11.0% from approximately $89.9 million for the year ended June 30, 2002, to approximately $99.8 million for the year ended June 30, 2003. The increase was due primarily to the Central Valley acquisition (approximately $4.7 million) and higher salaries and benefits (approximately $1.9 million), occupancy (approximately $0.8 million) and depreciation expense (approximately $1.6 million).

 

Costs of operations at our mobile division increased approximately 5.2% from approximately $63.5 million for the year ended June 30, 2002, to approximately $66.8 million for the year ended June 30, 2003. The increase was due primarily to equipment costs related to the additional mobile facilities (approximately $1.0 million) and higher salaries and benefits (approximately $1.5 million), which included additional mobile sales personnel.

 

Corporate Operating Expenses: Corporate operating expenses increased approximately 26.6% from approximately $10.9 million for the year ended June 30, 2002, to approximately $13.8 million for the year ended June 30, 2003. The increase was due primarily to higher salaries and benefits (approximately $2.0 million), which includes one-time severance payments for certain terminated employees, consulting costs associated with our acquisition and development activities (approximately $0.3 million), and additional information technology systems costs to make IRIS conform with HIPAA requirements (approximately $0.2 million).

 

Acquisition Related Compensation Charge: Holders of options and warrants, which prior to our acquisition of InSight were exercisable for InSight common stock, received the difference between $18.00 and the exercise price of each share of common stock the holder could have acquired pursuant to the terms of the options and warrants, and the options and warrants were terminated. This resulted in a charge of approximately $15.6 million, which is reflected in the statement of operations of InSight for the period from July 1, 2001 to October 17, 2001.

 

Interest Expense, net: Interest expense, net decreased approximately 3.6% from approximately $38.9 million for the year ended June 30, 2002, to approximately $37.5 million for the year ended June 30, 2003. The decrease was due primarily to (1) the elimination of the write-off of debt issuance costs as a result of the refinancing of a senior subordinated bridge financing in the year ended June 30, 2002 (approximately $7.4 million); (2) a reduction in our effective interest rate on our variable rate debt; and (3) principal payments on our credit facility, partially offset by

 

28

 

additional debt related to the conversion of operating leases to capital leases and additional debt related to the Central Valley acquisition.

 

Provision For Income Taxes: Provision for income taxes changed from a benefit of approximately $2.1 million for the year ended June 30, 2002, to a provision of approximately $3.3 million for the year ended June 30, 2003. For the year ended June 30, 2003, the provision is due to our recording a tax provision at an effective rate of 40%. For the year ended June 30, 2002, the benefit was due to InSight recording a benefit to recognize the utilization of certain operating loss carrybacks.

 

Adjusted EBITDA:  Adjusted EBITDA increased approximately 13.1% from approximately $84.0 million for the year ended June 30, 2002, to approximately $95.0 million for the year ended June 30, 2003.  This increase was due to: (1) Adjusted EBITDA at our existing facilities (approximately $1.6 million), (2) the buyout of operating leases and the conversion of operating leases to capital leases in 2002 (approximately $7.2 million) and (3) the Central Valley acquisition (approximately $2.2 million).  Adjusted EBITDA for the fixed division increased approximately 10.3% from approximately $53.6 million for the year ended June 30, 2002, to approximately $59.1 million for the year ended June 30, 2003.  Adjusted EBITDA for the mobile division increased approximately 25.0% from approximately $44.4 million for the year ended June 30, 2002, to approximately $55.5 million for the year ended June 30, 2003.

 

Liquidity and Capital Resources

 

We have historically funded our operations and capital expenditure requirements from net cash provided by operating activities, capital and operating leases and our credit facility.  We will fund future working capital and capital expenditure requirements from net cash provided by operating activities, capital and operating leases, and, to the extent necessary, our revolving credit facility.

 

Liquidity: We believe, based on currently available information, that future cash flows from operations will be adequate to meet our anticipated interest expense, federal and state cash tax expense, capital expenditures, working capital, scheduled principal payments and other debt repayments while meeting all covenant requirements under our credit facility for the next 12 months.

 

Cash and cash equivalents as of June 30, 2004 were approximately $30.4 million. Our primary source of liquidity is cash provided by operating activities.  Our ability to generate cash flows from operating activities is based upon several factors including the following:

 

•                  the volume of patients at our fixed-site centers;

•                  the demand for our services in the mobile division;

•                  our ability to control expenses; and

•                  our ability to collect our trade accounts receivables from third-party payors, hospitals, physician groups, other healthcare providers and patients.

 

Net cash provided by operating activities was approximately $60.1 million and resulted primarily from net income before depreciation and amortization (approximately $61.7 million), an increase in accounts payable and accrued expenses (approximately $6.0 million) and a decrease in other current assets (approximately $3.1 million), partially offset by an increase in trade accounts receivables, net (approximately $8.5 million).  The increases in trade accounts receivable, accounts payable and accrued expenses are due primarily to the acquisitions that we completed in 2003 and 2004.  The decrease in other current assets was due to the reduction in amounts due to us from our unconsolidated partnerships.

 

Net cash used in investing activities was approximately $142.3 million for the year ended June 30, 2004. Cash used in investing activities resulted primarily from our Central Valley, CDL and CMI acquisitions (approximately $101.3 million) and our purchase or upgrade of diagnostic imaging equipment at our existing fixed-site centers

 

29

 

(approximately $46.7 million), partially offset by proceeds from the sale of a fixed-site center in Hobart, Indiana discussed above (approximately $5.4 million).

 

Net cash provided by financing activities was approximately $93.0 million for the year ended June 30, 2004. Cash provided by financing activities resulted primarily from borrowings of notes payable (approximately $101.1 million), partially offset by principal payments of notes payable and capital lease obligations (approximately $8.2 million).

 

Our short-term and long-term liquidity needs will arise primarily from:

 

•                  principal and interest payments relating to our credit facility;

 

•                  interest payments relating to our 9.875% senior subordinated notes;

 

•                  capital expenditures;

 

•                  working capital requirements to support business growth; and

 

•                  potential acquisitions.

 

There are no scheduled principal repayments on our senior subordinated notes until 2011.

 

Capital Expenditures: As of June 30, 2004, we have committed to purchase or lease at an approximate aggregate cost of $6.4 million, seven diagnostic imaging systems through January 2005. We expect to use either internally generated funds or leases to finance the purchase of such equipment. We may purchase, lease or upgrade other diagnostic imaging systems as opportunities arise to place new equipment into service when new contract services agreements are signed, existing agreements are renewed, acquisitions are completed, or new fixed-site centers and mobile facilities are developed in accordance with our business strategy.

 

In addition, in connection with the implementation of the electronic transactions, security and privacy standards mandated by HIPAA, we have spent approximately $1.1 million as of June 30, 2004, to make necessary software upgrades to IRIS to make it conform with the privacy and electronic standards.  We expect to spend an additional $0.4 million to conform with the security standards by April 2005.

 

Credit Facility and Senior Subordinated Notes:  As of June 30, 2004, through InSight, we have a credit facility with Bank of America, N.A. and a syndication of other lenders consisting of:  (1) a term loan with a principal balance of approximately $220 million; (2) an additional $50 million term loan and (3) a $50 million revolving credit facility.  Borrowings under the Credit Facility bear interest at LIBOR plus 3.5% to 3.75%.  We are required to pay an annual unused facility fee of between 0.5% and 2.5%, payable quarterly, on unborrowed amounts.  We used the credit facility to complete the Central Valley, CDL and CMI acquisitions.  As of August 31, 2004, there were no borrowings under the revolving credit facility.

 

In addition to the indebtedness under our credit facility, through InSight, we have outstanding $250 million of 9.875% senior subordinated notes. The notes mature in November 2011, with interest payable semi-annually and are redeemable at our option, in whole or in part, on or after November 1, 2006.  At any time prior to November 1, 2004, we may redeem up to 35% of the notes at a redemption price 109.875% of the principal amount of the notes if we are involved in an initial public offering of our capital stock.

 

The credit facility contains various restrictive covenants which prohibit us from prepaying other indebtedness, including the notes, and require us to maintain specified financial ratios and satisfy financial condition tests.  As of June 30, 2004, we were in compliance with these covenants.  In addition, the credit facility prohibits us from declaring or paying any dividends and prohibits us from making any payments with respect to the notes if we fail to perform our obligations under, or we fail to meet the conditions of, the credit facility or if payment creates a default under the credit facility.

 

30

 

Contractual Commitments: As defined by or SEC reporting regulations, our contractual obligations as of June 30, 2004 are as follows (amounts in thousands):

 

					Payments Due by Period
		Total			Less than 1 Year			1-3 Years			3-5 Years			After 5 Years
Long-term debt obligations		$	520,961		$	2,716		$	5,994		$	262,251		$	250,000
Capital lease obligations		21,697			6,399			12,043			3,230			25
Operating lease obligations		43,903			8,566			15,426			9,873			10,038
Purchase commitments		6,354			6,354			—			—			—
Total contractual obligations		$	592,915		$	24,035		$	33,463		$	275,354		$	260,063

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of financial condition and results of operations, as well as disclosures included elsewhere in this report are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingencies. We believe the critical accounting policies that most impact the consolidated financial statements are described below. A summary of our significant accounting policies can be found in the notes to our consolidated financial statements which are included elsewhere in this report.

 

Revenue Recognition: Revenues from patient services and from contract services are recognized when services are provided. Patient services revenues are presented net of (1) related contractual adjustments, which represent the difference between our charge for a procedure and what we will ultimately receive from private health insurance programs, Medicare, Medicaid and other federal healthcare programs, and (2) payments due to radiologists. Contract services revenues are recognized over the applicable contract period. Revenues collected in advance are recorded as unearned revenue.

 

Trade Accounts Receivables: We review our trade accounts receivables and our estimates of the allowance for doubtful accounts and contractual adjustments each period. The amount of the allowance includes management’s estimate of the amounts expected to be written off on specific accounts and for write-offs on other unidentified accounts. In estimating the write-offs and adjustments on specific accounts, management relies on a combination of in-house analysis and a review of contractual payment rates from private health insurance programs or under the federal Medicare program. In estimating the allowance for unidentified write-offs and adjustments, management relies on historical experience. Estimates of uncollectable amounts are revised each period, and changes are recorded in the period they become known. The amounts we will ultimately realize could differ materially from the amounts assumed in arriving at the allowance for doubtful accounts and contractual adjustments.

 

Goodwill and Other Intangible Assets: We evaluate the carrying value of goodwill and identified intangibles not subject to amortization in the second quarter of each year. As part of the evaluation, we compare the carrying value of each intangible asset with its fair value to determine whether there has been impairment. We assess the ongoing recoverability of our intangible assets subject to amortization by determining whether the intangible asset balance can be recovered over the remaining amortization period through projected undiscounted future cash flows. If projected future cash flows indicate that the unamortized intangible asset balances will not be recovered, an adjustment is made to reduce the net intangible asset to an amount consistent with projected future cash flows discounted at our incremental borrowing rate. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions.

 

New Pronouncements

 

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities” (FIN 46) which is an interpretation of Accounting Research Bulletin No. 51, and “Consolidated Financial Statements.”  FIN 46 requires a variable interest entity (VIE) to be consolidated by a company that is considered to be the primary beneficiary of that VIE.  In December 2003, the FASB issued FIN No. 46 (revised December 2003), “Consolidation of Variable

 

31

 

Interest Entities” (FIN 46-R) to address certain FIN 46 implementation issues.  The effective dates and impact of FIN 46 and FIN 46-R for our consolidated financial statements are as follows:

 

(1)          Special purpose entities (SPEs) created prior to February 1, 2003:  We must apply the provisions of FIN 46.  We have completed our assessment and determined that we have no SPEs.

 

(2)          Non-SPEs created prior to February 1, 2003:  We did not enter into any significant joint venture or partnership agreements prior to February 1, 2003 which are not included in the consolidated financial statements for the years ended June 30, 2004 and 2003.

 

(3)          All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003:  We are required to apply the provisions of FIN 46.  We did not enter into any SPE, joint venture or partnership agreements subsequent to January 31, 2003 that would have a material impact on the consolidated financial statements for the years ended June 30, 2004 and 2003.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities.”  SFAS 149 is effective for contracts entered into or modified after September 30, 2003 and for hedging relationships designated after September 30, 2003.  SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities.  SFAS 149 amends SFAS 133 for decisions made as part of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative.  We adopted SFAS 149 on July 1, 2003, which did not have a material impact on our financial condition and results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Certain Financial Instruments with Characteristics of Both Liabilities and Equity.”  SFAS 150 establishes standards for how a company clarifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires a company to classify such instruments as liabilities, whereas they previously may have been classified as equity.  SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003.  We adopted SFAS 150 on July 1, 2003, which did not have a material impact on our financial condition and results of operations.

 

32

 

ITEM 7A.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We provide our services in the United States and receive payment for our services exclusively in United States dollars. Accordingly, our business is unlikely to be affected by factors such as changes in foreign market conditions or foreign currency exchange rates.

 

Our market risk exposure relates primarily to interest rates, where we will periodically use interest rate swaps to hedge variable interest rates on long-term debt under our credit facility. We do not engage in activities using complex or highly leveraged instruments.

 

Interest Rate Risk

 

 In order to modify and manage the interest characteristics of our outstanding debt and limit the effects of interest rates on our operations, we may use a variety of financial instruments, including interest rate hedges, caps, floors and other interest rate exchange contracts. The use of these types of instruments to hedge our exposure to changes in interest rates carries additional risks such as counter-party credit risk and legal enforceability of hedging contracts. We do not enter into any transactions for speculative or trading purposes.

 

Our future earnings and cash flows and some of our fair values relating to financial instruments are dependent upon prevailing market rates of interest, such as LIBOR. Based on interest rates and outstanding balances as of June 30, 2004, a 1% change in interest rates on our $270 million of floating rate debt would affect annual future earnings and cash flows by approximately $2.7 million.  The weighted average interest rate on our floating debt as of June 30, 2004 was 4.78%.

 

Through InSight, we also have outstanding $250 million in senior subordinated notes which mature in November 2011 and bear interest at 9.875%, payable semi-annually.  The fair value of our senior subordinated notes as of June 30, 2004 was approximately $270 million.

 

These amounts are determined by considering the impact of hypothetical interest rates on our borrowing cost. These analyses do not consider the effects of the reduced level of overall economic activity that could exist in that environment. Further, in the event of a change of this magnitude, we would consider taking actions to further mitigate our exposure to any such change. Due to the uncertainty of the specific actions that would be taken and their possible effects, however, this sensitivity analysis assumes no changes in our capital structure.

 

Inflation Risk

 

We do not believe that inflation has had a material adverse impact on our business or operating results during the periods presented. We cannot assure you, however, that our business will not be affected by inflation in the future.

 

33

 

ITEM 8.             FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

Index to Consolidated Financial Statements

for the Years Ended June 30, 2004, 2003 and 2002 and the Period from July 1, 2001 to October 17, 2001

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULE
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

 

In accordance with SEC Rule 3-10 of Regulation S-X, the consolidated financial statements of InSight Health Services Holdings Corp. (Company) are included herein and separate financial statements of InSight Health Services Corp. (InSight), the Company’s wholly owned subsidiary, and InSight’s subsidiary guarantors are not included.  Condensed financial data for InSight and its subsidiary guarantors is included in Note 20 to the Consolidated Financial Statements.

 

34

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of InSight Health Services Holdings Corp.:

 

In our opinion, the accompanying consolidated balance sheets as of June 30, 2004 and 2003 and the related consolidated statements of operations, of stockholders’ equity and of cash flows present fairly, in all material respects, the financial position of InSight Health Services Holdings Corp. and its subsidiaries (the “Company”) at June 30, 2004 and 2003 and the results of their operations and their cash flows for each of the three years in the period then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the accompanying consolidated statements of operations, of stockholders’ equity and of cash flows present fairly, in all material respects, the results of operations and cash flows for InSight Health Services Corp. (Predecessor) for the period from July 1, 2001 through October 17, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.  These financial statements and the financial statement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ PRICEWATERHOUSECOOPERS LLP
Orange County, California
September 23, 2004

 

35

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2004 AND 2003

(Amounts in thousands, except share data)

 

		2004			2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	30,412		$	19,554
Trade accounts receivables, net		55,010			46,096
Other current assets		6,207			10,149
Total current assets		91,629			75,799
PROPERTY AND EQUIPMENT, net		242,336			219,121
INVESTMENTS IN PARTNERSHIPS		2,901			2,734
OTHER ASSETS		19,302			19,371
OTHER INTANGIBLE ASSETS, net		38,518			36,470
GOODWILL		280,945			223,822
		$	675,631		$	577,317
LIABILITIES AND STOCKHOLDERS’  EQUITY
CURRENT LIABILITIES:
Current portion of notes payable		$	2,716		$	2,009
Current portion of capital lease obligations		5,060			5,696
Accounts payable and other accrued expenses		35,737			35,514
Total current liabilities		43,513			43,219
LONG-TERM LIABILITIES:
Notes payable, less current portion		518,245			420,239
Capital lease obligations, less current portion		13,802			18,175
Other long-term liabilities		5,130			4,070
Total long-term liabilities		537,177			442,484
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS’ EQUITY:
Common stock, $.001 par value, 10,000,000 shares authorized, 5,468,814 shares issued and outstanding at June 30, 2004 and 2003		5			5
Additional paid-in capital		87,081			87,081
Retained earnings		7,855			4,931
Accumulated other comprehensive loss		—			(403		)
Total stockholders’  equity		94,941			91,614
		$	675,631		$	577,317

 

The accompanying notes are an integral part of these consolidated balance sheets.

 

36

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED JUNE 30, 2004, 2003 AND 2002 AND THE PERIOD FROM JULY 1 TO OCTOBER 17, 2001

(Amounts in thousands)

 

											Predecessor
											Period from July 1 to October 17,
		Company
		Years Ended June 30,
		2004			2003			2002			2001
REVENUES:
Contract services		$	129,193		$	111,921		$	75,377		$	29,802
Patient services		161,691			125,831			80,030			33,876
Total revenues		290,884			237,752			155,407			63,678
COSTS OF OPERATIONS:
Costs of services		168,700			125,685			80,868			32,197
Provision for doubtful accounts		4,998			4,154			2,785			1,110
Equipment leases		990			860			5,469			2,557
Depreciation and amortization		58,733			49,345			26,462			9,823
Total costs of operations		233,421			180,044			115,584			45,687
Gross profit		57,463			57,708			39,823			17,991
CORPORATE OPERATING EXPENSES		(16,217		)	(13,750		)	(7,705		)	(3,184		)
ACQUISITION RELATED COMPENSATION CHARGE		—			—			—			(15,616		)
GAIN ON SALE OF CENTER		2,129			—			—			—
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS		2,181			1,744			437			382
INTEREST EXPENSE, net		(40,682		)	(37,514		)	(32,546		)	(6,321		)
Income (loss) before income taxes		4,874			8,188			9			(6,748		)
PROVISION (BENEFIT) FOR INCOME TAXES		1,950			3,266			—			(2,100		)
Net income (loss)		$	2,924		$	4,922		$	9		$	(4,648	)

 

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

 

37

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED JUNE 30, 2004, 2003 AND 2002

(Amounts in thousands, except share data)

 

										Accumulated
							Additional			Other
		Common Stock					Paid-In			Comprehensive			Retained
Company		Shares		Amount			Capital			Gain (Loss)			Earnings			Total
BALANCE AT JUNE 30, 2001		—		$	—		$	—		$	—		$	—		$	—
Sale of common stock, net of equity issuance costs		5,461,402		5			85,758			—			—			85,763
Issuance of common stock		7,362		—			133			—			—			133
Issuance of stock options		—		—			1,695			—			—			1,695
Net income		—		—			—			—			9			9
Other comprehensive loss:
Unrealized loss attributable to change in fair value of derivative		—		—			—			(224		)	—			(224		)
Comprehensive loss																(215		)
BALANCE AT JUNE 30, 2002		5,468,764		5			87,586			(224		)	9			87,376
Stock options exercised		50		—			1			—			—			1
Repurchase of stock options		—		—			(506		)	—			—			(506		)
Net income		—		—			—			—			4,922			4,922
Other comprehensive loss:
Unrealized loss attributable to change in fair value of derivative		—		—			—			(179		)	—			(179		)
Comprehensive income																4,743
BALANCE AT JUNE 30, 2003		5,468,814			5			87,081			(403	)		4,931			91,614
Net income		—		—			—			—			2,924			2,924
Other comprehensive gain:
Unrealized gain attributable to change in fair value of derivative		—		—			—			403			—			403
Comprehensive income																3,327
BALANCE AT JUNE 30, 2004		5,468,814		$	5		$	87,081		$	—		$	7,855		$	94,941

 

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

 

38

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR  THE PERIOD FROM JULY 1 TO OCTOBER 17, 2001

(Amounts in thousands, except share data)

 

																									Accumulated
		Preferred Stock																				Additional			Other			Retained
		Series B					Series C					Series D					Common Stock					Paid-In			Comprehensive			Earnings
Predecessor		Shares		Amount			Shares		Amount			Shares		Amount			Shares		Amount			Capital			(Loss)			(Deficit)			Total
BALANCE AT JUNE 30, 2001		25,000		$	23,923		27,953		$	13,173		—		$	—		3,011,656		$	3		$	23,926		$	—		$	4,446		$	65,471
Stock options and warrants exercised		—		—			—		—			—		—			13,911		—			145			—			—			145
Conversion of Series B and Series C to Series D Preferred Stock		(25,000	)	(23,923		)	(27,953	)	(13,173		)	632,266		37,096			—		—			—			—			—			—
Conversion of Series D Preferred Stock to Common Stock		—		—			—		—			(632,266	)	(37,096		)	6,323,660		6			37,090			—			—			—
Acquisition related compensation charge		—		—			—		—			—		—			—					15,616			—			—			15,616
Other comprehensive loss		—		—			—		—			—		—			—		—			—			(682		)	—			(682		)
Net loss		—		—			—		—			—		—			—		—			—			—			(4,648		)	(4,648		)
BALANCE AT OCTOBER 17, 2001		—		$	—		—		$	—		—		$	—		9,349,227		$	9		$	76,777		$	(682	)	$	(202	)	$	75,902

 

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

 

39

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED JUNE 30, 2004, 2003 AND 2002 AND THE PERIOD FROM JULY 1 TO OCTOBER 17, 2001

(Amounts in thousands)

 

											Predecessor
											Period from
		Company									July 1 to
		Years Ended June 30,									October 17,
		2004			2003			2002			2001
OPERATING ACTIVITIES:
Net income (loss)		$	2,924		$	4,922		$	9		$	(4,648	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Write-off of debt issuance costs		—			—			7,378			—
Gain on sale of center		(2,129		)	—			—			—
Depreciation and amortization		58,733			49,345			26,462			9,823
Acquisition related compensation charge		—			—			—			15,616
Cash provided by (used in) changes in operating assets and liabilites:
Trade accounts receivables, net		(8,455		)	(2,237		)	1,874			(2,378		)
Other current assets		3,084			4,907			590			(3,616		)
Accounts payable and other accrued expenses		5,963			4,819			3,288			23
Net cash provided by operating  activities		60,120			61,756			39,601			14,820
INVESTING ACTIVITIES:
Purchase of InSight common stock		—			—			(187,722		)	—
Cash acquired in the Acquisition		—			—			8,429			—
Acquisition of fixed-site centers and mobile facilities		(101,334		)	(46,292		)	—			—
Proceeds from sale of center		5,413			—			—			—
Additions to property and equipment		(46,734		)	(56,967		)	(43,655		)	(20,852		)
Other		405			554			1,385			(740		)
Net cash used in investing activities		(142,250		)	(102,705		)	(221,563		)	(21,592		)
FINANCING ACTIVITIES:
Proceeds from stock options and warrants exercised		—			1			—			145
Purchase of stock options		—			(506		)	—			—
Proceeds from sale of common stock, net of equity issuance costs		—			—			85,763			—
Issuance of common stock		—			—			133			—
Payment of deferred loan fees		—			—			(29,499		)	—
Principal payments of notes payable and capital lease obligations		(8,209		)	(7,500		)	(416,510		)	(8,579		)
Proceeds from issuance of debt		101,125			50,000			575,000			—
Payments made in connection with refinancing notes payable		—			—			(15,109		)	—
Other		72			725			(33		)	381
Net cash provided by (used in) financing activities		92,988			42,720			199,745			(8,053		)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS:		10,858			1,771			17,783			(14,825		)
Cash, beginning of period		19,554			17,783			—			23,254
Cash, end of period		$	30,412		$	19,554		$	17,783		$	8,429
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid		$	38,939		$	36,286		$	20,173		$	6,799
Income taxes paid (refund received)		377			(224		)	4			943
Equipment additions under capital leases		—			25,455			—			—

 

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

 

40

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2004

 

1.  ORGANIZATION

 

The terms “Company”, “us”, “we” and “our” as used in these financial statements refer to InSight Health Services Holdings Corp.  We were incorporated in June 2001 to acquire InSight Health Services Corp, which is referred to as “InSight” in these financial statements.  On October 17, 2001, we acquired InSight and InSight became our wholly owned subsidiary.  We refer to our acquisition of InSight as the “Acquisition” in these financial statements. Our consolidated operations after the Acquisition are substantially consistent with the operations of InSight prior to the Acquisition.  In addition, we have no operations other than our investment in InSight.  As such, prior to October 17, 2001, InSight is considered our predecessor in accordance with Regulation S-X.

 

In connection with the Acquisition each of InSight’s stockholders received $18.00 in cash for each share of common stock they owned prior to the Acquisition.  Holders of options and warrants, which prior to the Acquisition were exercisable for InSight common stock, received the difference between $18.00 and the exercise price of each share of common stock the holder could have acquired pursuant to the terms of the options and warrants, and the options and warrants were terminated.  This resulted in a charge of approximately $15.6 million, which is reflected in the accompanying consolidated statements of operations of InSight.  In addition, certain members of senior management rolled a portion of their InSight common stock options into stock options of for our common stock.  InSight’s stockholders, option holders and warrant holders received aggregate cash consideration of approximately $187.7 million as a result of the Acquisition.

 

Concurrently with the Acquisition, InSight:  (i) repurchased by tender offer all of its 9 5/8% senior subordinated notes due 2008 in an aggregate principal amount of $100 million; (ii) repaid its then outstanding senior credit facilities and certain other indebtedness; and (iii) paid fees and expenses relating to the Acquisition and related financing transactions.

 

These transactions were financed through:

 

•                  Borrowings of $150 million under $275 million of new credit facilities;

 

•                  A $200 million senior subordinated bridge financing; and

 

•                  The investment by us, before equity issuance costs, of approximately $98.1 million; management options and common stock rollover with a total net value of approximately $1.9 million.

 

2.  BASIS OF PREPARATION

 

The accompanying consolidated balance sheets as of June 30, 2004 and 2003, the consolidated statements of operations, and the consolidated statements of cash flows for the years ended June 30, 2004, 2003 and 2002, reflect our consolidated financial position, results of operations and cash flows and also include the consolidated statements of operations and cash flows of InSight from the date of the Acquisition and include all material adjustments required under purchase accounting.  InSight is considered our predecessor in accordance with Regulation S-X.  As such, the historical financial statements of InSight prior to the Acquisition are included in the accompanying consolidated financial statements, including the consolidated statements of operations and the consolidated statements of cash flows for the period from July 1, 2001 to October 17, 2001 (collectively Predecessor financial statements).  We have not adjusted the Predecessor financial statements to reflect the Acquisition.  As such, our consolidated financial statements after the Acquisition are not directly comparable to the Predecessor financial statements prior to the Acquisition.

 

41

 

3.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

a.   NATURE OF BUSINESS

 

Through InSight and its subsidiaries, we provide diagnostic imaging, treatment and related management services in 37 states throughout the United States.  We have two reportable segments:  the mobile division and fixed division.  Our services are provided through a network of 91 mobile magnetic resonance imaging, or MRI, facilities, 19 mobile positron emission tomography, or PET, facilities, four mobile lithotripsy facilities, three mobile computed tomography, or CT, facilities, one mobile catheterization lab (collectively, mobile facilities), 74 fixed-site MRI facilities, 40 multi-modality fixed-site centers, two PET fixed-site centers, one Leksell Stereotactic Gamma Knife fixed-site treatment center and one radiation oncology fixed-site center (collectively, fixed-site centers).  We have a substantial presence in California, Arizona, New England, the Carolinas, Florida and the Mid-Atlantic states.

 

At our multi-modality fixed-site centers, we typically offer other services in addition to MRI, including PET, CT, x-ray, mammography, ultrasound, nuclear medicine and bone densitometry services.

 

b.   CONSOLIDATED FINANCIAL STATEMENTS

 

Our consolidated financial statements include our accounts and those of our wholly owned subsidiaries.  Our investment interests in partnerships or limited liability companies, or Partnerships, are accounted for under the equity method of accounting when our ownership is 50 percent or less.  Our investment interests in Partnerships are consolidated for ownership of 50 percent or greater owned entities when we exercise significant control over the operations and are primarily responsible for the associated long-term debt (Note 15).

 

Significant intercompany balances have been eliminated in consolidation.

 

c.   USE OF ESTIMATES

 

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

 

d.   REVENUE RECOGNITION

 

Revenues from contract services and from patient services are recognized when services are provided.  Patient services revenues are presented net of (1) related contractual adjustments, which represent the difference between our charge for a procedure and what we will ultimately receive from private health insurance programs, Medicare, Medicaid and other federal healthcare programs, and (2) payments due to radiologists.  Contract services revenues are recognized over the applicable contract period.  Revenues collected in advance are recorded as unearned revenue.

 

e.   CASH EQUIVALENTS

 

Cash equivalents are generally composed of liquid investments with original maturities of three months or less, such as certificates of deposit and commercial paper.

 

42

 

f.    LONG-LIVED ASSETS

 

Property and Equipment.  Property and equipment are depreciated and amortized on the straight-line method using the following estimated useful lives:

 

Vehicles		3 to 8 years
Buildings		7 to 20 years
Leasehold improvements		Lesser of the useful life or term of lease
Computer and office equipment		3 to 5 years
Diagnostic and related equipment		5 to 8 years
Equipment and vehicles under capital leases		Lesser of the useful life or term of lease

 

We capitalize expenditures for improvements and major equipment upgrades.  Maintenance, repairs and minor replacements are charged to operations as incurred. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations.

 

Long-lived Asset Impairment.  We review long-lived assets, including identified intangible assets, for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered.  We consider assets to be impaired and write them down to fair value if expected associated undiscounted cash flows are less than the carrying amounts.  Fair value is determined based on the present value of the expected associated cash flows.

 

g.              DEFERRED FINANCING COSTS

 

Costs incurred in connection with financing activities are deferred and amortized using the effective interest method over the terms of the related debt agreements ranging from seven to ten years.  Amortization of these costs is charged to interest expense in the accompanying consolidated statements of operations.  Total costs deferred and included in other assets in the accompanying consolidated balance sheets at June 30, 2004 and 2003 were approximately $19.0 million and $19.0 million, respectively.

 

h.   STOCK-BASED COMPENSATION

 

As permitted under SFAS No. 123, “Accounting for Stock Based Compensation”, we account for the options and warrants issued to employees in accordance with APB Opinion No. 25.  SFAS 123 requires that we present pro-forma disclosures of net income as if we had recognized compensation expense equal to the fair value of options granted, as determined at the date of grant.  Our net income or that of our Predecessor would have reflected the following pro-forma amounts (amounts in thousands):

 

 

												Predecessor
												Period from
			Company									July 1 to
			Years Ended June 30,									October 17,
			2004			2003			2002			2001
Net income (loss):	As reported		$	2,924		$	4,922		$	9		$	(4,648	)
	Expense		(377		)	(652		)	(1,088		)	—
	Pro-forma		2,547			4,270			(1,079		)	(4,648		)

 

The fair value of each option grant and warrant issued is estimated on the date of grant or issuance using the Black-Scholes pricing model with the following assumptions used for the grants and issuances in the years ended  June 30, 2004, 2003 and 2002, respectively:

 

		Years Ended June 30,
Assumptions		2004		2003		2002
Risk-free interest rate		3.58-4.18	%	4.07-4.58	%	4.60	%
Volatility		0.00	%	0.00	%	0.00	%
Expected dividend yield		0.00	%	0.00	%	0.00	%
Estimated contractual life		10.00 years		10.00 years		9.30 years

 

i.    GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill represents the excess purchase price we paid over the fair value of the tangible and intangible assets and liabilities of InSight at October 17, 2001, the date of the Acquisition and the acquisitions completed in 2003 and 2004 (Note 4).  In accordance with Statement of Financial Accounting Standards (“SFAS”) 142, “Goodwill and Other Intangible Assets”, the goodwill and indefinite-lived intangibles balances are not being amortized, but instead will be subject to an annual assessment of impairment by applying a fair-value based test.  Net other intangible assets are amortized on a straight-line basis over the estimated lives of the assets ranging from three to thirty years.

 

A reconciliation of goodwill for the year ended June 30, 2004 is as follows (amounts in thousands):

 

		Mobile			Fixed-Site			Consolidated
Goodwill, June 30, 2003		$	79,079		$	144,743		$	223,822
Acquired in acquisitions		29,135			33,151			62,286
Adjustments to goodwill		(2,150		)	(3,013		)	(5,163		)
Goodwill, June 30, 2004		$	106,064		$	174,881		$	280,945

 

We evaluate the carrying value of goodwill and identified intangibles not subject to amortization in the second quarter of each year.  As part of the evaluation, we compare the carrying value of each intangible asset with its fair value to determine whether there has been impairment.  We assess the ongoing recoverability of our intangible assets subject to amortization by determining whether the intangible asset balance can be

 

43

 

recovered over the remaining amortization period through projected undiscounted future cash flows. If projected future cash flows indicate that the unamortized intangible asset balances will not be recovered, an adjustment is made to reduce the net intangible asset to an amount consistent with projected future cash flows discounted at our incremental borrowing rate. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions.  Adjustments to goodwill result from the reduction of valuation allowance related to utilization of tax attributes acquired in the Acquisition.  As of June 30, 2004, we do not believe any impairment of goodwill or other intangible assets has occurred.

 

j.     INCOME TAXES

 

We account for income taxes using the asset and liability method.  Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using the enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

k.   COMPREHENSIVE INCOME (LOSS)

 

Components of comprehensive income are changes in equity other than those resulting from investments by owners and distributions to owners. Net income (loss) is the primary component of comprehensive income. Our only component of comprehensive income other than net income (loss) is the change in unrealized gain or loss on derivatives qualifying for hedge accounting, net of tax. The aggregate amount of such changes to equity that have not yet been recognized in net income are reported in the equity portion of the accompanying consolidated balance sheets as accumulated other comprehensive income (loss).

 

l.    FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The fair value of financial instruments is estimated using available market information and other valuation methodologies. The fair value of our financial instruments is estimated to approximate the related book value, unless otherwise indicated.

 

m.   NEW PRONOUNCEMENTS

 

In January 2003, the FASB issued FIN No. 46 “Consolidation of Variable Interest Entities” (FIN 46) which is an interpretation of Accounting Research Bulletin No. 51, and “Consolidated Financial Statements. “  FIN 46 requires a variable interest entity (VIE) to be consolidated by a company that is considered to be the primary beneficiary of that VIE.  In December 2003, the FASB issued FIN No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (FIN-46-R) to address certain FIN 46 implementation issues.  The effective dates and impact of FIN 46 and FIN 46-R for the company’s consolidated financial statements are as follows:

 

(1)          Special purpose entities (SPEs) created prior to February 1, 2003:  We must apply the provisions of FIN 46.  We have completed our assessment and determined that we have no SPEs.

 

(2)          Non-SPEs created prior to February 1, 2003:  We did not enter into any significant joint venture or partnership agreements prior to February 1, 2003 which are not included in the consolidated financial statements for the years ended June 30, 2004 and 2003.

 

(3)          All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003:  We are required to apply the provisions of FIN 46.  We did not enter into any SPE, joint venture or partnership agreements subsequent to January 31, 2003 that would have a material impact on the consolidated financial statements for the years ended June 30, 2004 and 2003.

 

44

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities.”  SFAS 149 is effective for contracts entered into or modified after September 30, 2003 and for hedging relationships designated after September 30, 2003.  SFAS 149 amends instruments embedded in other contracts and for hedging activities.  SFAS 149 amends SFAS 133 for decisions made as part of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative.  We adopted SFAS 149 on July 1, 2003, which did not have a material impact on our financial condition and results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Certain Financial Instruments with Characteristics of Both Liabilities and Equity.”  SFAS 150 establishes standards for how a company clarifies and measures certain financial instruments with characteristics of both liabilities and equity.  It required a company to classify such instruments as liabilities, whereas they previously may have been classified as equity.  SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003.  We adopted SFAS 150 on July 1, 2003, which did not have a material impact on our financial condition and results of operations.

 

4.             ACQUISITIONS

 

We accounted for the Acquisition as a purchase.  Our purchase accounting adjustments have been recorded in the accompanying consolidated financial statements as of and for any periods subsequent to October 17, 2001.  The excess purchase price we paid over our estimate of the fair market value of the tangible and other intangible assets and liabilities of InSight as of the date of the Acquisition was approximately $234.2 million and is reflected as goodwill and other intangible assets, net in the accompanying consolidated balance sheets as of June 30, 2004 and 2003.  In accordance with SFAS 141, the new intangible asset balance has been allocated between identifiable intangible assets and remaining goodwill.  Goodwill will not be amortized but is subject to an ongoing assessment for impairment.  A summary of the assets acquired and liabilities assumed in the Acquisition follows (amounts in thousands):

 

Cash purchase price		$	187,722
Estimated fair values
Assets acquired:
Tangible		357,877
Other Intangible Assets		37,870
Liabilities assumed		(385,770		)
Goodwill		$	197,699

 

In April 2003, we acquired thirteen (13) fixed-site centers located in Southern California.  The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, customer contracts and other agreements.  The aggregate purchase price was approximately $46.5 million, which included approximately $39.3 million paid to the seller and approximately $7.2 million for the payment of debt and transaction costs.  The excess purchase price paid by us over our estimate of the fair value of the tangible and other intangible assets as of the date of acquisition was approximately $25.4 million and is reflected as goodwill in the accompanying consolidated balance sheets as of June 30, 2004 and 2003.

 

In August 2003, we acquired twenty-two (22) mobile facilities operating primarily in the Mid-Atlantic states.  The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, customer contracts and other agreements.  The aggregate purchase price was approximately $49.9 million, which included approximately $28.1 million paid to the seller and approximately $21.8 million for the payment of debt and transaction costs.  The excess purchase price paid by us over our estimate of the fair value of the tangible and other intangible assets as of the date of the acquisition was approximately $29.1 million and is reflected as goodwill in the accompanying consolidated balance sheet as of June 30, 2004.

 

45

 

In April 2004, we acquired twenty-one (21) fixed-site centers located in California, Arizona, Kansas, Texas, Pennsylvania and Virginia.  The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, real property, customer contracts and other agreements.  The aggregate purchase price was approximately $48.6 million, which included approximately $35.9 million paid to the seller, approximately $10.6 million for the payment of debt and approximately $2.1 million of transactions costs.  The excess purchase price paid by us over our estimate of the fair value of the tangible and other intangible assets as of the date of the acquisition was approximately $30.2 million and is reflected as goodwill in the accompanying consolidated balance sheet as of June 30, 2004.

 

In accordance with SFAS 141, the intangible asset balance has been allocated between identifiable intangible assets and remaining goodwill for all acquisitions.  The purchase price allocations of the April 2003 and August 2003 acquisitions are based upon evaluations and other studies of the fair value of the net assets acquired.  The purchase price allocation of the April 2004 acquisition is based upon a preliminary evaluation and other studies of the fair value of the net assets acquired.  The financial information related to our August 2003 mobile facilities acquisition was audited and restated by a registered public accounting firm and is included in a Current Report on Form 8-K/A that we filed on July 2, 2004.  Goodwill will not be amortized but is subject to an ongoing assessment for impairment.  Goodwill resulting from the April 2003, August 2003, and April 2004 acquisitions is considered deductible for income tax purposes.  A summary of the assets acquired and liabilities assumed follows (amounts in thousands):

 

		April 2004 Acquisition			August 2003 Acquisition			April 2003 Acquisition
Cash purchase price		$	48,626		$	49,872		$	46,488
Estimated fair values
Assets acquired:
Tangible		15,228			18,337			17,977
Other Intangible Assets		3,200			2,400			3,200
Liabilities assumed		—			—			(82		)
Goodwill		$	30,198		$	29,135		$	25,393

 

Our unaudited pro-forma combined results of operations, assuming our three acquisitions had occurred as of July 1, 2002, are presented below.  The pro-forma combined results of operations for the years ended June 30, 2004 and 2003, include adjustments to interest expense (approximately $1.8 million and $1.6 million, respectively), amortization of identified intangible assets (approximately $0.1 million and $0.1 million, respectively) and the consolidation of fixed-site centers ($1.1 million for the year ended June 30, 2003).  These combined results have been prepared for comparison purposes only and do not purport to be indicative of what operating results would have been, and may not be indicative of future operating results (amounts in thousands):

 

		Years Ended June 30,
		2004			2003
Revenues		$	333,864		$	332,796
Costs of operations		257,665			240,385
Gross profit		76,199			92,411
Corporate operating expenses		(32,436		)	(37,019		)
Gain on sale of center		2,129			—
Equity in earnings of unconsolidated partnerships		2,181			1,744
Impairment and restructuring charges		(1,142		)	(7,143		)
Interest expense, net		(43,429		)	(45,782		)
Income before income taxes		3,502			4,211
Provision for income taxes		1,400			1,684
Net income		$	2,102		$	2,527

 

46

 

5.             TRADE ACCOUNTS RECEIVABLES

 

Trade accounts receivables, net are comprised of the following (amounts in thousands):

 

			June 30,
			2004			2003
Trade accounts receivables			$	115,645		$	93,914
Less: Allowances for contractual adjustments			37,209			28,369
	Allowances for professional fees		15,329			11,545
	Allowances for doubtful accounts		8,097			7,904
Trade accounts receivables, net			$	55,010		$	46,096

 

The allowances for doubtful accounts and contractual adjustments includes management’s estimate of the amounts expected to be written off on specific accounts and for write-offs on other unidentified accounts included in accounts receivables.  In estimating the write-offs and adjustments on specific accounts, management relies on a combination of in-house analysis and a review of contractual payment rates from private health insurance programs or under the federal Medicare program.  In estimating the allowance for unidentified write-offs and adjustments, management relies on historical experience.  The amounts we will ultimately realize could differ materially in the near term from the amounts assumed in arriving at the allowances for doubtful accounts and contractual adjustments in the accompanying consolidated financial statements at June 30, 2004.

 

We reserve a contractually agreed upon percentage at several of our fixed-site centers, averaging 20 percent of the accounts receivables balance from patients and third-party payors for payments to radiologists representing professional fees for interpreting the results of the diagnostic imaging procedures.  Payments to radiologists are only due when amounts are received.  At that time, the balance is transferred from the allowance account to a professional fees payable account.

 

6.             OTHER CURRENT ASSETS

 

Other current assets are comprised of the following (amounts in thousands):

 

		June 30,
		2004			2003
Prepaid expenses		$	5,249		$	7,694
Amounts due from our unconsolidated partnerships		958			2,455
		$	6,207		$	10,149

 

7.             PROPERTY AND EQUIPMENT

 

Property and equipment, net are stated at cost and are comprised of the following (amounts in thousands):

 

		June 30,
		2004			2003
Vehicles		$	4,570		$	3,605
Land, building and leasehold improvements		27,201			23,133
Computer and office equipment		44,373			21,967
Diagnostic and related equipment		207,856			158,972
Equipment and vehicles under capital leases		77,460			79,426
		361,460			287,103
Less: Accumulated depreciation and amortization		119,124			67,982
Property and equipment, net		$	242,336		$	219,121

 

47

 

8.             OTHER INTANGIBLE ASSETS

 

The following reconciliation of other intangible assets is as follows (amounts in thousands):

 

		June 30, 2004						June 30, 2003
		Gross Carrying Value			Accumulated Amortization			Gross Carrying Value			Accumulated Amortization
Amortized intangible assets:
Managed care contracts		$	24,410		$	1,798		$	21,210		$	874
Wholesale contracts		13,580			6,354			11,180			3,726
		37,990			8,152			32,390			4,600
Unamortized intangible assets:
Trademark		8,680			—			8,680			—
Other intangible assets		$	46,670		$	8,152		$	41,070		$	4,600

 

Other intangible assets are amortized on a straight-line method using the following estimated useful lives:

 

Managed care contracts		30 years
Wholesale contracts		5-7 years

 

Amortization of intangible assets was approximately $3.6 million, $3.0 million, $1.6 million and $0.1 million, for the years ended June 30, 2004, 2003 and 2002 and the period from July 1, 2001 to October 17, 2001.

 

Estimated amortization expense for the years ending June 30, are as follows (amounts in thousands):

 

2005		$	3,686
2006		3,686
2007		2,196
2008		1,451
2009		1,095

 

9.             ACCOUNTS PAYABLE AND OTHER ACCRUED EXPENSES

 

Accounts payable and other accrued expenses are comprised of the following (amounts in thousands):

 

		June 30,
		2004			2003
Accounts payable		$	2,968		$	3,090
Accrued equipment related costs		8,144			6,807
Accrued payroll and related costs		8,905			8,047
Accrued interest expense		4,266			4,719
Accrued professional fees		2,539			1,753
Accrued income taxes		468			4,311
Other accrued expenses		8,447			6,787
		$	35,737		$	35,514

 

48

 

10.          NOTES PAYABLE

 

Notes payable are comprised of the following (amounts in thousands):

 

		June 30,
		2004			2003
Notes payable to bank (Credit Facility), bearing interest at LIBOR plus 3.5% (4.78% at June 30, 2004), principal and interest payable quarterly, maturing in October 2008.  The notes are collateralized by substantially all of our assets.		$	270,047		$	197,248
Unsecured senior subordinated notes payable, bearing interest at 9.875%, interest payable semi-annually, principal due in November 2011.  At June 30, 2004, the fair value of the notes was approximately $270 million.		250,000			225,000
Other notes payable		914			—
Total notes payable		520,961			422,248
Less:  Current portion		2,716			2,009
Long-term notes payable		$	518,245		$	420,239

 

Through InSight, we have a credit facility, or Credit Facility, with Bank of America, N.A. and a syndication of other lenders consisting of (1) a $220 million term loan, (2) an additional $50 million term loan, and (3) a $50 million revolving credit facility.  As of June 30, 2004, there were no borrowings under the revolving credit facility.  Borrowings under the Credit Facility bear interest at LIBOR plus 3.5% to 3.75%.  We are required to pay an annual unused facility fee of between 0.5% and 2.5%, payable quarterly, on unborrowed amounts.  We expect to use the revolving credit facility to fund our future working capital needs.

 

Through InSight, we also have outstanding $225 million in unsecured senior subordinated notes, or Notes.  Additionally, in March 2004, we issued $25 million in a private placement of unsecured senior subordinated notes, or New Notes.  The Notes and New Notes mature in November 2011 and bear interest at 9.875% payable semi-annually.  The Notes and New Notes are redeemable at our option, in whole or in part, on or after November 2006.  At any time prior to November 1, 2004, we may redeem up to 35% of the Notes and New Notes at a redemption price of 109.875% of the principal amount if we are involved in an initial public offering of our capital stock.  The New Notes have terms identical to the Notes, but have not yet been registered with the SEC.

 

Scheduled maturities of equipment and other notes payable at June 30, 2004, are as follows (amounts in thousands):

 

 

2005		$	2,716
2006		2,992
2007		3,002
2008		196,923
2009		65,328
Thereafter		250,000
		$	520,961

 

The credit agreement related to the Credit Facility and the indenture related to the Notes and the New Notes contain limitations on additional borrowings, capital expenditures, dividend payments and certain financial covenants.  As of June 30, 2004, we were in compliance with these convenants.

 

During 1998, InSight entered into an interest rate swap agreement with a bank to hedge against the effects of increases in the interest rates associated with floating rate debt on its bank financing.  The initial and June 30, 2004 notional amount of the swap agreement was $40.0 million and $10.0 million, respectively.  The swap agreement expires in September 2004 (Note 16).

 

49

 

11.          LEASE OBLIGATIONS, COMMITMENTS AND CONTINGENCIES

 

We lease diagnostic equipment, certain other equipment and our office, imaging and treatment facilities under various capital and operating leases.  Future minimum scheduled rental payments required under these noncancelable leases at June 30, 2004 are as follows (amounts in thousands):

 

		Capital			Operating
2005		$	6,399		$	8,566
2006		6,340			7,882
2007		5,703			7,544
2008		2,929			5,883
2009		301			3,990
Thereafter		25			10,038
Total minimum lease payments		21,697			$	43,903
Less:  Amounts representing interest		2,835
Present value of capital lease obligations		18,862
Less:  Current portion		5,060
Long-term capital lease obligations		$	13,802

 

Accumulated depreciation on assets under capital lease was $8.4 million and $4.7 million at June 30, 2004 and 2003, respectively.

 

Rental expense for diagnostic equipment and other equipment for the years ended June 30, 2004, 2003 and 2002 and the period from July 1, 2001 to October 17, 2001 was $1.0 million, $0.9 million, $5.5 million and $2.6 million, respectively.

 

We occupy facilities under lease agreements expiring through October 2017.  Some of these lease agreements may include provisions for an increase in lease payments based on the Consumer Price Index or scheduled increases based on a guaranteed minimum percentage or dollar amount.  Rental expense for these facilities for the years ended June 30, 2004, 2003 and 2002 and the period from July 1, 2001 to October 17, 2001 was $7.9 million, $6.5 million, $3.9 million and $1.5 million, respectively.

 

We are engaged from time to time in the defense of lawsuits arising out of the ordinary course and conduct of our business, including claims for malpractice, and have insurance policies covering such potential insurable losses where such coverage is cost-effective.  Management believes that the outcome of any such lawsuits will not have a material adverse impact on our business, financial condition and results of operations.

 

12.          CAPITAL STOCK

 

WARRANTS:       We do not have a formal warrant plan.  All warrants, which had been granted by InSight in connection with previous financing transactions, had been issued with an exercise price of at least the fair market value of its common stock on the issuance date.   All holders of warrants, which at the time of the Acquisition were exercisable for InSight common stock, received the difference between $18.00 and the exercise price of each share of common stock the holder could have acquired pursuant to the terms of the warrants, and the warrants were terminated.  A summary of the status of the InSight warrants at October 17, 2001 follows:

 

		Shares		Weighted Average Exercise Price
Predecessor
Outstanding, June 30, 2001		642,183		$	9.17
Exercised		(7,183	)	5.64
Cancelled at the Acquisition		(635,000	)	9.21
Outstanding, October 17, 2001		—		$	—

 

50

 

STOCK OPTIONS:               We reserved 626,000 shares for the granting of nonstatutory stock options to key employees.  Options are issued with an exercise price of at least the fair market value, as determined by the board of directors, of our common stock on the grant date.  A portion of the options vest cumulatively over various periods up to eight years from the grant date, and a portion are performance based and vest cumulatively upon the achievement of certain performance targets.  The options are exercisable in whole or in installments, and expire ten years from the grant date.

 

We have one stock option plan, which provided for the granting of nonstatutory stock options to four key employees, all of which are fully vested.  Holders of options for 175,990 shares of InSight common stock rolled over their options and received options for our common stock with the same terms under our stock option plan.  In 2003, we purchased vested stock options covering 56,000 shares of our common stock at a price equal to the difference between $19.07 and the exercise price per share.

 

In addition, InSight had five stock option plans.  All holders of options, which at the time of the Acquisition were exercisable for InSight common stock, received the difference between $18.00 and the exercise price of each share of common stock the holder could have acquired pursuant to the terms of the options, and the options were terminated.  As a result of the cancellation of the InSight options and warrants, InSight recorded an acquisition related compensation charge of $15.6 million.

 

As of June 30, 2004, the Company had 142,950 shares available for issuance.  A summary of the status of our and InSight’s stock option plans at June 30, 2004, 2003 and 2002 and changes during the periods is presented below:

 

 

		Shares		Weighted Average Exercise Price
Predecessor
Outstanding, June 30, 2001		1,555,698		$	7.88
Granted		5,000		16.51
Exercised		(6,728	)	15.64
Cancelled at the Acquisition		(1,377,980	)	7.81
Rolled over to Company options		(175,990	)	8.37
Outstanding, October 17, 2001		—		$	—
Company
Outstanding, June 30, 2001		—		$	—
Granted		777,990		15.82
Forfeited		(5,000	)	18.00
Outstanding, June 30, 2002		772,990		15.81
Granted		25,500		19.01
Exercised		(50	)	18.00
Repurchased		(56,000	)	8.97
Forfeited		(109,625	)	18.00
Outstanding, June 30, 2003		632,815		16.16
Granted		30,000		19.07
Forfeited		(59,825	)	18.27
Outstanding, June 30, 2004		602,990		$	16.10
Exercisable at:
June 30, 2002		175,990		$	8.37
June 30, 2003		148,465		$	9.99
June 30, 2004		168,790		$	10.96

 

51

 

Of the 602,990 options outstanding at June 30, 2004, the characteristics are as follows:

 

Exercise Price Range			Weighted Average Exercise Price			Options Exercisable		Total Options Outstanding		Remaining Contractual Life
$	8.37		$	8.37		123,490		123,490		7.33 years
18.00 - 19.07			18.09			45,300		479,500		7.68 years
						168,790		602,990

 

13.          INCOME TAXES

 

We follow SFAS No. 109, “Accounting for Income Taxes”, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, deferred income taxes are recognized for the tax consequences in future years of the difference between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on the enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income.  Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.  The provision for income taxes for the years ended June 30, 2004, 2003 and 2002, and the period from July 1, 2001 to October 17, 2001 represents the tax payable for the period and the change during the period in deferred tax assets and liabilities:

 

								Predecessor
								Period from July 1 to October 17,
		Company
		Years Ended June 30,
		2004		2003		2002		2001
Federal statutory tax rate		34.0	%	34.0	%	34.0	%	34.0	%
State income taxes, net of federal benefit		4.0		4.0		6.0		6.0
Permanent items, including goodwill and non-deductible merger costs		2.0		1.0		1.0		115.0
Changes in valuation allowance		—		1.0		(1.0	)	(186.0	)
Net effective tax rate		40.0	%	40.0	%	40.0	%	(31.0	)%

 

52