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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

For the transition period from                     

Commission File No. 0-23311

RADIOLOGIX, INC.

(Exact name of registrant as specified in its charter)

3600 JP Morgan Chase Tower

2200 Ross Avenue

Dallas, Texas 75201-2776

(Address of principal executive offices, including zip code)

(214) 303-2776

(Registrant’s telephone number, including area code)

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

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

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

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RADIOLOGIX, INC.

FORM 10-Q

INDEX

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PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

RADIOLOGIX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

See accompanying notes to consolidated financial statements.

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RADIOLOGIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

See accompanying notes to unaudited consolidated financial statements

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RADIOLOGIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes to unaudited consolidated financial statements.

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RADIOLOGIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2004

(Unaudited)

Note 1. Basis of Presentation

Radiologix, Inc. (together with its subsidiaries, “Radiologix” or the “Company”), a Delaware corporation, is a leading national provider of diagnostic imaging services through its ownership and operation of free-standing, outpatient diagnostic imaging centers. This quarterly report for Radiologix supplements our annual report to security holders on Form 10-K, as amended, for the fiscal year ended December 31, 2003. As permitted by the Securities and Exchange Commission for interim reporting, we have omitted certain notes and disclosures that substantially duplicate those in the annual report on Form 10-K. Accordingly, these consolidated financial statements do not include all disclosures associated with the annual consolidated financial statements. In the opinion of management, all adjustments necessary for a fair presentation have been included in the accompanying consolidated financial statements and are of a normal recurring nature, other than those adjustments related to impairments, discontinued operations, the sales of operations and severance and other related costs, which adjustments are discussed separately in the notes below. Interim results for the three and nine-month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year. Variability may be due to changes in modality mix and the volume of procedures performed, physician referral and vacation patterns, the impact of hospital and physician-affiliated imaging centers that compete in our operating markets, the timing and negotiation of managed care and service contracts, the availability of technologists and other personnel resources, and trends in receivable collectibility, including the ability of payors to convert to HIPAA electronic payment standards. For further information, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited consolidated financial statements and notes included in our annual report to security holders on Form 10-K, as amended, for the year ended December 31, 2003.

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of the Company and its wholly owned and majority owned subsidiaries. All significant intercompany transactions have been eliminated. Investments in entities that the Company does not control, but in which it has a substantial ownership interest and can exercise significant influence, are accounted for using the equity method.

We have reclassified certain previously reported amounts, including (1) our results of operations to a “gross profit” presentation and (2) balances and results of operations related to subsequently discontinued operations to conform to the current period presentation. These reclassifications have no impact on total assets, liabilities, stockholders’ equity, net income (loss), or cash flows.

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

Note 2. Impairment of Goodwill, Intangible and Long-Lived Assets

Goodwill is not subject to amortization; however it is subject to periodic valuation assessments. Under the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, the Company is required to perform at least an annual impairment test and to consider other indicators that may arise throughout the year to reevaluate carrying value. To the extent book value exceeds fair value, at the date an impairment is determined, the Company reduces goodwill by recording a charge to operations.

Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), requires impairment losses to be recognized for long-lived assets through operations when indicators of impairment exist and the underlying cash flows are not sufficient to support the assets’ carrying value. In addition, SFAS No. 144 requires that a long-lived asset (disposal group) to be sold that meets certain recognition criteria be classified as “held for sale” and measured at the lower of carrying amount or fair value less cost to sell. SFAS No. 144 also requires that a long-lived asset subject to closure (abandonment) before the end of its previously estimated useful life continue to be classified as “held and used” until disposal, with depreciation estimates revised to reflect the use of the asset over its shortened useful life.

In addition to continually assessing the financial viability of our imaging centers, management also evaluates the businesses surrounding our relationships with radiologists and radiology practice groups that have reading privileges at our facilities. These businesses may include Radiologix imaging centers and/or professional reading agreements involving another entity’s inpatient or outpatient imaging centers.

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In most cases, individual radiologists and radiology practice groups serve in our facilities pursuant to medical services agreements entered into when Radiologix acquired the practice group’s assets. The value of these arrangements is recorded as intangible assets when acquired. Although the agreements may extend for longer periods, the value of the intangible assets is amortized over 25 years based on SEC guidance.

During the third quarter of 2004, management determined that the ability of one of the radiology groups to perform in accordance with a medical services agreement administered by one of our Mid-Atlantic subsidiaries had diminished significantly. With several owned imaging centers covered by the medical services agreement operating at financial losses, deteriorating financial conditions at hospitals involving professional reading arrangements, and the resignation from the practice of two physician leaders, management concluded that the value of our intangible asset had become significantly impaired.

Radiologix and the radiology group have agreed to terminate the medical services agreement. The Company has decided to dispose of three unprofitable imaging centers and to transfer the professional reading responsibility for certain other centers to another radiology group that operates under a medical services agreement with us. We also are in the process of determining the best disposition of professional reading arrangements at certain hospitals.

Based on our assessment and the actions that we have undertaken, the Company recorded impairment charges of: $6.5 million to write off the unamortized portion of intangible assets related to this group’s medical services agreement, and $800,000 to write off long-lived assets related to the centers planned for disposition.

Continuing operations include revenue and pretax income (loss) for the three centers planned for disposition as follows (in thousands):

In June 2004, after performing an extensive assessment of our Questar imaging center portfolio, management concluded that certain centers were not strategic to our future plans and would be unable to meet and sustain our profitability requirements going forward. That assessment considered: location, contracting leverage, expected capital requirements, the single modality nature of most of these centers, current operating trends, and the sale of our most profitable Questar center on June 21, 2004. Plans for disposition were enacted before June 30, 2004, with five centers reclassified to discontinued operations. Two other Questar centers were scheduled for closure of which one was closed in July 2004 and one is scheduled for sale in the fourth quarter of 2004.

The Company’s decision to dispose of this group of imaging centers created an event that required us to reassess the carrying value of the assets related to these centers, including goodwill at our Questar segment. This reassessment considered the impact on the value of the ongoing, deteriorating operating trends in these centers, as well as the implications of disposing of individual centers versus operating those centers as part of an ongoing operating enterprise.

To assist us in that reassessment, we engaged an independent valuation firm to estimate the fair value of our combined Questar sites that currently remain in continuing operations as of June 30, 2004. The valuation performed by this firm was based on a blending of: (1) discounted cash flows and an exit multiple for the business, (2) a market approach using public company information, discounted to reflect the nature of the Questar operations, and (3) individual transactions experienced by Radiologix and similar companies in recent months. At management’s recommendation, the valuation firm applied a high (70%) weighting factor to the valuation derived under the individual transaction method described in (3) above.

Based on the independent valuation, Radiologix recognized an impairment charge to continuing operations of $8.7 million in the three months ended June 30, 2004 to reduce the Questar goodwill carrying value to estimated fair value. This charge is in addition to the $5.5 million charge we recorded in the first quarter of 2004 related to Questar in connection with our annual assessment of goodwill. The first quarter valuation included the operating results of our most profitable Questar center and also gave equal weighting factors to an income and market approach. The balance of goodwill, which relates entirely to Questar, is approximately $3.7 million at September 30, 2004.

The Company regularly considers whether events or circumstances may affect either the fair value of recorded intangible assets or their associated useful lives. At September 30, 2004, the combined operations of our remaining Questar centers are generating

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positive cash flow; and the Company does not believe there are any additional indicators that the carrying values or the useful lives of these assets need to be adjusted. However, in the event we decide to dispose of any remaining Questar centers, additional charges may result depending on cash flow and market conditions at the time of disposal.

The components of our impairment charges are as follows (in thousands):

These impairment charges are currently not deductible for income tax purposes. Consequently, we have significant noncurrent deferred tax assets at September 30, 2004. Management believes that the realization of these deferred tax assets is more likely than not based on fiscal 2003 taxable income, projected future taxable income and potential tax strategies we may employ in the future.

In the third quarter of 2004, we also recorded $315,000 for lease termination costs related to diagnostic equipment no longer in use; $200,000 to write-off software costs associated with canceling a software contract and $295,000 for a litigation settlement with a physician related to our Southeastern operations. For the nine months ended September 30, 2003, we recorded a $500,000 charge for regulatory matters.

Note 3. Discontinued Operations

We are in discussions to sell our 80% joint venture interest in our Questar Tampa operations, including accounts receivable, to our venture partner. The discussions are subject to normal due diligence and other customary considerations and a final agreement is expected to close in the fourth quarter of 2004 at which time these operations will be reclassified to discontinued operations.

In August 2004, we sold three Questar centers previously placed in discontinued operations for an aggregate $959,000 and recognized a net loss of $50,000 on these sales which loss is included in discontinued operations.

In June 2004, management concluded that five Questar centers would be designated as discontinued operations and two other centers would be closed. We also sold one center for $3.1 million in cash and recognized a gain on this sale of $682,000 ($0.03 per dilutive share), which gain is included in discontinued operations.

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The results of operations of imaging centers in discontinued operations are as follows (in thousands):

Assets and liabilities of discontinued operations as of September 30, 2004 and 2003 were as follows (in thousands):

Long-lived assets classified as assets held for sale in the accompanying balance sheets are included in the assets above. The remainder of the above Assets and Liabilities will remain with Radiologix at disposition.

Note 4. Gain on Sale of Operations

Effective April 30, 2004, we completed the sale of our operations in San Antonio, Texas. The purchase price was $10.5 million, resulting in a gain on sale of approximately $4.7 million or $3.1 million net of taxes ($0.14 per dilutive share). Net cash received was $9.7 million after purchase price adjustments. The sale included (1) assets we owned and leased in our operation of M&S Imaging Partners, Inc., (2) a diagnostic imaging center, and (3) certain partnership interests, but did not include accounts receivable aggregating approximately $4.7 million, which we retained.

Results of operations for the San Antonio operations were as follows (in thousands):

The net loss from operations for the three months ended September 30, 2004 resulted primarily from costs associated with outsourcing the billing and collection function and from weaker than expected collection performance on accounts receivable assumed in the sale of these operations.

Note 5. Severance and Other Related Costs

Effective September 20, 2004 our chief executive officer resigned his positions as CEO, President and director of the Company. The Board of Directors is currently directing a search for a successor CEO. Severance and other related costs aggregated $405,000 in September 2004 related to this matter. For the nine months ended September 30, 2003, we recognized $1.3 million in connection with severance and other related costs for changes in the Company’s senior management team.

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Note 6. Revenue Recognition

Service fee revenue is comprised of billed charges for both the technical and professional components of service, reduced by estimated contractual adjustments and by amounts retained by contracted radiology practice groups under the medical service agreements. Revenue is recognized when services are rendered by contracted radiology practice groups the imaging centers, or both. Provision for doubtful accounts related to established charges is reflected as an operating expense rather than a reduction of revenue. Contractual adjustments and provision for doubtful accounts are estimated based on historical collection experience as adjusted for increases or decreases in allowances for doubtful accounts as determined by our accounts receivable aging model. Because Radiologix has no financial controlling interest in the radiology practice groups, as defined in Emerging Issues Task Force Issue 97-2 (“EITF 97-2”), the Company does not consolidate the financial statements of those practices in its consolidated financial statements.

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

Note 7. Long-Term Debt

Senior Notes

The Company’s $158.3 million in senior notes due December 15, 2008, bear interest at 10.5% payable semiannually in arrears on June 15 and December 15. The senior notes are redeemable on or after December 15, 2005 at various redemption prices, plus accrued interest to the date of redemption. These notes are unsecured obligations, which rank senior in right of payment to all subordinated indebtedness and equal in right of payment with all other senior indebtedness. The senior notes are unconditionally guaranteed on a senior unsecured basis by certain restricted existing and future subsidiaries. In the 2004 second quarter, the Company retired $1.73 million of these senior notes at a price equal to 103.25% of face value.

Convertible Junior Subordinated Note

The Company has a $12.0 million convertible junior subordinated note, which matures July 31, 2009, and bears interest, payable quarterly in cash or in-kind securities, at an annual rate of 8.0%. The note holder may convert borrowings under the note to common stock at $7.52 per share.

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Master Lease Agreement

Radiologix maintains operating leases for certain imaging equipment under an Amended and Restated Master Lease Agreement with GE Healthcare Financial Services (GE). Through this arrangement, GE has agreed to fund up to $60.0 million of equipment leases through December 31, 2006, and requires that at least two-thirds of the outstanding balance represent GE healthcare equipment.

In connection with the Master Lease Agreement, the Company is required to provide additional cash collateral in a restricted account equal to 20% of the aggregate amounts outstanding under the Master Lease Agreement. The accompanying September 30, 2004 balance sheet includes $4.8 million of restricted cash under this provision.

The Master Lease Agreement also contains certain covenants related to financial leverage, fixed charge coverage, and total indebtedness to GE. Failure to comply with these covenants would restrict our ability to lease additional equipment under the Master Lease Agreement until the covenants are met. At September 30, 2004, Radiologix was in compliance with these covenants.

At September 30, 2004 applicable amounts outstanding under the Master Lease Agreement totaled $24.5 million; and $35.5 million remained available for future leases. Commitments for leases signed but not placed in service under the Master Lease Agreement were $4.8 million at September 30, 2004.

Revolving Credit Facility

The Company also maintains a revolving credit facility with GE, enabling the Company to borrow up to 85% of eligible accounts receivable, as defined, with a maximum borrowing limit of $35.0 million. Borrowings under the credit facility are secured by substantially all of the Company’s assets, including the capital stock of our wholly owned subsidiaries. The credit facility expires December 31, 2008 and bears a commitment fee ranging from 0.50% to 0.75% of the unused balance, based on amounts borrowed.

Under the revolving credit facility, borrowings bear interest, at the option of the Company, either (i) at a fixed rate comprised of LIBOR plus a margin ranging from 3.0% to 3.5%, depending on monthly amounts outstanding or (ii) at a variable rate based on prime plus a margin ranging from 1.75% to 2.25%, depending on monthly amounts outstanding.

At September 30, 2004, applicable amounts considered outstanding under the revolving credit facility totaled $750,000 related to a letter of credit in connection with our high retention workers’ compensation program; and $34.2 million, subject to eligible accounts receivable, remained available for borrowings.

Note 8. Variable Interest Entities

In January 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 41 (“FIN 46”). In December 2003, the FASB modified FIN 46 to make certain technical corrections and address certain implementation issues that had arisen. FIN 46 provides a new framework for identifying variable interest entities (VIEs) and determining when a company should include the assets, liabilities, non-controlling interests and results of activities of a VIE in its consolidated financial statements.

In general, a VIE is a corporation, partnership, limited liability corporation, trust or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (2) has a group of equity owners that are unable to make significant decisions about its activities, or (3) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns generated by its operations. However, FIN 46 specifically excludes a VIE that is a business if the variable interest holder did not participate significantly in the design or redesign of the entity.

We adopted the provisions of FIN 46 as of March 31, 2004. We have reviewed the Company’s non-consolidated joint ventures under the provision and have determined that none of the joint ventures meets the definition of a variable interest entity at September 30, 2004.

Note 9. Stock-Based Awards

As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), the Company does not currently recognize compensation expense related to stock option grants to its employees under any of its stock award plans; however it does account for stock-based compensation of non-employees under the provisions of SFAS 123.

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Option awards have generally been granted under the terms of the 1996 Stock Option Plan, as amended, and are priced at fair market value on the date granted. On July 15, 2004, the Company’s stockholders approved the adoption of the 2004 Long-Term Incentive Plan. As a result, all future grants will be made under the 2004 Plan and no more grants will be made under the 1996 Plan.

During the nine months ended September 30, 2004, the Company granted 610,000 options to purchase the Company’s common stock, primarily as employment inducements for key executives. Of these options, 410,000 vest over a five-year period, and 200,000 vest in specified increments, based on the performance (at stock prices ranging from $5.00 to $17.50 per share) of the Company’s common stock for consecutive 20-day periods applicable to the increment. None of these options has vested to date.

The summary below presents the pro-forma financial results that would have been reported if the Company had applied the provisions of SFAS No. 123, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (dollars are presented in thousands, except per share amounts):

The fair value of each option grant is estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for grants at September 30, 2004 and 2003, respectively: risk-free interest rate of 4.13% and 4.27%; expected life of 5.4 and 7.5 years; expected volatility of 54.2% and 67.5%; and dividend yield of zero. The weighted-average grant-date fair value of new grants during the nine months ended September 30, 2004 and 2003 was $2.22 per share and $2.56 per share, respectively. The stock-based compensation expense determined under fair value based method presented on a pro forma basis includes an adjustment during the three months ended September 30, 2004 to reverse expenses related to certain variable options that were cancelled. As permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”), the Company originally reported an expense for the total estimated amount for these options on a pro forma basis in the period the options were granted.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

Note 10. Earnings Per Share

Basic earnings per share (EPS) is calculated by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding increased during the nine months ended September 30, 2004 and 2003 primarily due to the exercise of stock options. Stock options exercised were 48,433 and 66,666, respectively.

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Diluted EPS includes options, warrants, and other potentially dilutive securities, using the treasury stock method for options and warrants to the extent that these securities are not anti-dilutive. Diluted EPS also includes the effect of the convertible junior subordinated note using the “if converted” method to the extent these securities are not anti-dilutive.

For the three months ended September 30, 2004 and 2003, approximately $144,000 and $145,000, respectively, of tax-effected interest and 1,593,040 of weighted average shares related to the convertible junior subordinated note were not included in the computation of diluted EPS because to do so would be anti-dilutive. Also, for the three months ended September 30, 2004, 530,677 shares related to stock options were not included in the computation of dilutive EPS because to do so would be anti-dilutive. For the three months ended September 30, 2003, 482,592 shares related to stock options were included in the computation of dilutive EPS.

For the nine months ended September 30, 2004 and 2003, approximately $431,000 and $435,000, respectively, of tax-effected interest and 1,593,040 of weighted average shares related to the convertible junior subordinated note were not included in the computation of diluted EPS because to do so would be anti-dilutive. Also, for the nine months ended September 30, 2004, 495,600 shares related to stock options were not included in the computation of dilutive EPS because to do so would be anti-dilutive. For the nine months ended September 30, 2003 196,079 shares related to stock options were included in the computation of dilutive EPS.

Note 11. Segment Reporting

The Company’s primary operations consist of owning and operating diagnostic imaging centers and providing administrative, management and information services to the contracted radiology practice groups that provide professional interpretation and supervision services in connection with the Company’s diagnostic imaging centers and to hospitals and radiology practices with which the Company operates joint ventures.

The Company previously reported its primary operations through four reportable segments comprised of four designated regions of the United States of America. As a result of an assessment of these operations, including how resources are allocated by members of our senior management team (the “chief operating decision maker” function), and because the four designated regions have: (1) substantially all resources allocated to them, (2) similar economic characteristics, (3) similar operations and (4) similar regulatory environments, we have aggregated them into a single reportable operating segment.

Because of different characteristics from our primary operations, including location, market concentration, contracting leverage, capital requirements, the single modality nature of most of the centers and the structure of the management service agreements with physicians related to the Company’s Questar operations, senior management makes resource allocation decisions separately for Questar and its primary operations.

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The following table summarizes the operating results, including continuing and discontinued operations, and assets of the primary and Questar operations (in thousands):