UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

COMMISSION FILE NUMBER 333-75984-12

 

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 if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes þ     No o

 

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 þ

 

Indicate by check mark whether the registrant (1) has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of December 31, 2009 (based on the price at which the common stock was last sold on the Over-The-Counter Bulletin Board on the last business day of the registrant’s most recent completed second fiscal quarter) was $984,086.

 

Indicate by check mark whether the Registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes þ     No o

 

The number of shares outstanding of the Registrant’s common stock as of September 23, 2010 was 8,644,444.

 

 

INSIGHT HEALTH SERVICES HOLDINGS CORP.
ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

 

 

OVERVIEW

 

All references to “we,” “us,” “our,” “our company” or the “Company” in this annual report on Form 10-K, or Form 10-K, mean Insight Health Services Holdings Corp., a Delaware corporation incorporated in 2001, and all entities and subsidiaries owned or controlled by Insight Health Services Holdings Corp. All references to “Holdings” in this Form 10-K mean Insight Health Services Holdings Corp. by itself. All references to “Insight” in this Form 10-K mean Insight Health Services Corp., a Delaware corporation and a wholly owned subsidiary of Holdings, by itself. All references to “fiscal 2010” mean our fiscal year ended June 30, 2010.

 

We are a provider of diagnostic imaging services through a network of fixed-site centers and mobile facilities. Our services are noninvasive procedures 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.

 

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 operate in more than 30 states including the following targeted regional markets: Arizona, certain markets in California, the Carolinas, Florida, New England, and the Mid-Atlantic states. We generated approximately 68% of our total revenues from MRI services during fiscal 2010, as well as provided a comprehensive offering of diagnostic imaging services, including PET/CT, CT, mammography, bone densitometry, ultrasound and x-ray.

 

As of June 30, 2010, our network consisted of 62 fixed-site centers and 104 mobile facilities. This combination allows us to provide a full range of imaging services to better meet the varying needs of our customers. Our fixed-site centers include freestanding centers and joint ventures with hospitals and radiology groups. 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 do not engage in the practice of medicine; instead we contract with radiologists to provide professional services, including supervision, interpretation and quality assurance.

 

We have three reportable segments: contract services, patient services and other operations. Please see “Segments” below for a discussion of our segments. In our contract services segment we generate revenue principally from 99 mobile units and 17 fixed sites. In our patient services segment we generate revenues principally from 45 fixed-site centers and 5 mobile units. In our other operations segment, we generate revenues principally from agreements with customers to provide management services and technical solutions.

 

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.

 

We file annual, quarterly and special reports and other information with the SEC. You may read and copy materials that we have filed with the SEC at the following SEC public reference room:

 

100 F Street, N.E. Washington, D.C. 20549

 

Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public on the SEC’s internet website at http://www.sec.gov.

 

Reorganization

 

On May 29, 2007, Holdings and Insight filed voluntary petitions to reorganize their business under chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware (Case No. 07-10700). The filing was in connection with a prepackaged plan of reorganization and related exchange offer. The other subsidiaries of Holdings were not included in the bankruptcy filing and continued to operate their business. On July 10, 2007, the

bankruptcy court confirmed Holdings’ and Insight’s Second Amended Joint Plan of Reorganization pursuant to chapter 11 of the Bankruptcy Code. The plan of reorganization became effective and Holdings and Insight emerged from bankruptcy protection on August 1, 2007, or the effective date. Pursuant to the confirmed plan of reorganization and the related exchange offer, (1) all of Holdings’ common stock, all options for Holdings’ common stock and all of Insight’s 9.875% senior subordinated notes due 2011, or senior subordinated notes, were cancelled, and (2) holders of Insight’s senior subordinated notes and holders of Holdings’ common stock prior to the effective date received 7,780,000 and 864,444 shares of newly issued Holdings’ common stock, respectively, in each case after giving effect to a one for 6.326392 reverse stock split of Holdings’ common stock.

 

This reorganization significantly deleveraged our balance sheet and improved our projected cash flow after debt service. However, we still have a substantial amount of debt, which requires significant interest and principal payments. As of June 30, 2010, we had total indebtedness of approximately $298.1 million in aggregate principal amount, including Insight’s $293.5 million of senior secured floating rate notes due 2011, or floating rate notes, which come due in November 2011. Additionally, the opinion of our independent registered public accounting firm, relating to our financial statements for our fiscal year ended June 30, 2010 contains an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern. Our revolving credit facility requires us to deliver audited financial statements without such an explanatory paragraph within 120 days following the end of our fiscal year. We will not be able to deliver audited financial statements for our fiscal year end without such an explanatory paragraph, and as a result, we will not be in compliance with the revolving credit facility. We have executed an amendment to our revolving credit agreement with our lender whereby the lender has agreed to forbear from enforcing the default under the agreement and allow us full access to the revolver until December 1, 2010. If we have not remedied this noncompliance by December 1, 2010, our lenders could terminate their commitments under the revolver and could cause all amounts outstanding thereunder to become immediately due and payable. We did not have any borrowings outstanding on the revolver as of June 30, 2010 and do not currently have any borrowings outstanding on the revolver. We have approximately $1.6 million outstanding in letters of credit which would need to be cash collateralized in the event our revolver is eliminated.

 

We believe that future net cash provided by operating activities will be adequate to meet our operating cash and debt service requirements through December 1, 2010. If our cash requirements exceed the cash provided by our operating activities, then we would look to our cash balance, asset sales and revolving credit line to satisfy those needs. However, following December 1, 2010, we may not be able to access our existing revolver if we are in default under our revolving credit agreement and our lender refuses to extend the forbearance period. In the event net cash provided by operating activities declines further than we have anticipated, or if the availability under our revolving credit facility is reduced or eliminated by our lender in light of the existing default under that facility, any future defaults or otherwise, we are prepared to take steps to conserve our cash, including delaying or further restricting our capital projects and sale of certain assets. In any event, we will likely need to restructure or refinance all or a portion of our indebtedness on or before the maturity of such indebtedness. In the event such steps are not successful in enabling us to meet our liquidity needs or to restructure or refinance our outstanding indebtedness when due, we may need to seek protection under chapter 11 of the Bankruptcy Code. We have engaged a financial advisory firm and are working closely with them to develop and finalize a restructuring and refinancing plan to significantly reduce our outstanding debt and improve our cash and liquidity position.

 

Nevertheless, the floating rate notes mature in November 2011 and require substantial quarterly interest payments leading up to maturity. Unless our financial performance significantly improves, we can give no assurance that we will be able to meet our interest payment obligations on the floating rate notes, refinance or restructure the floating rate notes on commercially reasonable terms, or redeem or retire the floating rate notes when due, which could cause us to default on our indebtedness and cause a material adverse effect on our liquidity and financial condition. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more restrictive covenants, which could further restrict our business operations and have a material adverse effect on our results of operations. Although we are prepared to take additional steps as necessary to improve our liquidity and financial condition, we cannot be certain such steps would be effective.

 

Segments

 

Effective July 1, 2009, we redefined our business segments based on how our chief operating decision maker views the businesses and assesses the performance of our business managers. We now have three reportable segments: contract services, patient services and other operations, which are business units defined primarily by the type of service provided.

 

Contract Services.  Contract services consist of centers (primarily mobile units) which generate revenues from fee-for-service arrangements and fixed-fee contracts billed directly to our healthcare provider customers, such as hospitals, which we refer to as wholesale operations. Hospitals, physician groups and other healthcare providers can access our diagnostic imaging technology through our network of 99 mobile facilities and 17 fixed-site centers currently serving our wholesale customers. We currently have contracts with approximately 200 hospitals, physician groups and other healthcare providers. We enable hospitals, physician groups and other healthcare providers to benefit from our imaging equipment without investing their own capital directly. Interpretation services are generally provided by the hospital’s radiologists or physician groups and not by us. Our contract services revenue is generated primarily from fee-for-service arrangements and fixed-fee contracts billed directly to our wholesale customers. We handle the billing and collections for our contract services internally at a relatively low cost, and we do not bear the direct risk of collections from third party-payors or patients.

 

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 facilities while controlling the costs to transport the mobile facilities from one location to another. 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 our mobile customers under which they assume responsibility for billing directly to patients and payors, and collections. Our mobile customers directly pay us a contracted amount for our services, regardless of whether they are reimbursed.

 

Our mobile facilities provide a significant advantage for establishing long-term 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 equipment or 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 contract services customers once the local market matures and sufficient patient volume is achieved to support a fixed-site center.

 

Patient Services.  Patient services consist of centers (primarily fixed-sites) that primarily generate revenues from services billed, on a fee-for-service basis, directly to patients or third-party payors, such as Medicare, Medicaid, insurance companies and health maintenance organizations, which we refer to as our retail operations. We have primarily outsourced the billing and collections for our patient services to Dell Perot Systems, and we bear the direct risk of collections from third-party payors and patients. Our patient services centers provide a full range of diagnostic imaging services to patients, physicians, insurance payors and managed care organizations. Of our 45 fixed-site patient services centers, 15 offer MRI services. Our remaining 30 fixed-site centers are multi-modality sites typically offering MRI and one or more of CT, PET/CT, x-ray, mammography, ultrasound, nuclear medicine, bone densitometry and nuclear cardiology. Our five mobile units within our patient services are single modality units offering MRI services. Diagnostic services are provided to a patient upon referral by a physician. Physicians refer patients to our patient services centers based on our service reputation, equipment, breadth of managed care contracts and convenient locations. Our patient services centers provide the equipment and technologists for the procedures, contract with radiologists to interpret the procedures, and bill payors directly. We have contracts with managed care organizations for our patient services centers, which 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. Our joint ventures allow us to charge a management and billing fee for supporting their day-to-day operations.

 

Other Operations.  Other operations generate revenues primarily from agreements with customers to provide management services, which could include field operations, billing and collections, and accounting and other office services. We refer to this revenue as generated from our solutions business. In addition to our traditional offerings of

equipment and management services, we believe that we have the ability to offer packaged technology solutions to hospitals and other medical imaging services providers. Besides our traditional offerings, these customers would have a broad spectrum of systems and services, including, but not limited to, image archiving and Picture Archiving Communication System (PACS) services, patient registration portals, radiology information systems, receivables and collections management services, and financial and operational tools. We launched this offering of solutions in fiscal 2010 and we recently extended a contract with an existing customer, implemented a new contract, and have three additional contracts with implementation dates within our first fiscal quarter of 2011.

 

Additional Information.  Financial information concerning our three segments is set forth in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in Note 19 of our consolidated financial statements, all of which are incorporated herein by reference.

 

DIAGNOSTIC IMAGING TECHNOLOGY

 

Our diagnostic imaging systems consist of MRI systems, PET/CT systems, CT systems, ultrasound systems, x-ray, analog and digital mammography, radiography/fluoroscopy systems and bone densitometry. Each of these types of imaging systems (other than analog mammography) represents the marriage of computer technology and various medical imaging modalities. The following highlights our primary imaging systems:

 

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, breast tissue, spinal cord and interior ligaments of body joints such as the knee) with superior clarity, 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 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 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 systems are typically priced in the range of $0.9 million to $2.5 million each.

 

Computed Tomography or CT

 

In CT imaging, a computer analyzes the information received from x-ray beams 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 five to 20 minutes. CT systems are typically priced in the range of $0.4 million to $1.5 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. PET/CT systems fuse together the results of a PET scan and CT scan, 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/CT systems are typically priced in the range of $1.3 million to $2.0 million each.

 

Other Imaging Technologies

 

 

 

STRATEGY

 

Patient Services Strategy

 

We have pursued a strategy based on core markets in our patient services segment. We believe this strategy will allow us more operating efficiencies and synergies than are available in a nationwide strategy. Our core market is determined by many factors, including, without limitation, demographic and population trends, utilization and reimbursement rates, existing and potential market share, the potential for profitability and return on assets, competition within the surrounding area, regulatory restrictions, such as certificates of need, and potential for alignment with radiologists, hospitals or payors. This strategy has resulted in us exiting some markets while increasing our presence in others or establishing new markets through acquisitions and dispositions. In implementing our core market strategy, we have taken the following actions:

 

 

Contract Services Strategy

 

Within our contract services segment we have pursued a strategy based on optimizing our mobile MRI and PET/CT routes, and of converting strategic mobile imaging customers to fixed site accounts. We have targeted our contract services sales efforts in regions where we have an existing presence, taking into account such factors as demographic and population trends, utilization and reimbursement rates, existing and potential market share, the potential for profitability and return on assets, competition within the surrounding area and regulatory restrictions, such as certificates of need, which provide a barrier to competition.

 

As a result of implementing our core market strategy in the patient services segment, we have reduced our overall cost of services as a percentage of revenues from 67.4% for fiscal 2009 to 67.0% for fiscal 2010. The decrease is primarily due to disposing of low margin patient services centers, which had an average cost of services as a percentage of revenues of approximately 125%. Notwithstanding the overall growth in the industry in which we operate, as a result of the various factors that affect our industry generally and our business specifically, we have experienced declines in Adjusted EBITDA as compared to prior fiscal year periods. See our discussion regarding results of operations, our definition of Adjusted EBITDA and reconciliation of net cash provided by operating activities to Adjusted EBITDA in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

We are continuously evaluating opportunities for the acquisition and disposition of certain businesses. There can be no assurance that we can complete sales and/or purchases of these businesses on terms favorable to us in a timely manner to replace the loss of Adjusted EBITDA related to the businesses we sell.

BUSINESS DEVELOPMENT

 

Our objective is to be a leading provider of diagnostic imaging services in our core markets. Our efforts are focused on two components.

 

First, we strive to maximize utilization of our existing facilities by:

 

 

Second, we continuously refine our core market strategy by:

 

 

Generally, these activities are aimed at increasing revenues and gross profit, maximizing utilization of existing capacity and increasing economies of scale. Incremental gross profit resulting from such activities will vary depending on geographic area, whether facilities are mobile or fixed, the range of services provided and the strength of our joint venture partners. We believe that our core market strategy is a key factor to improve our operating results.

 

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:  The federal False Claims Act and, in particular, the False Claims Act’s “qui tam” or “whistleblower” provisions allow a private individual to bring actions in the name of the government alleging that a 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 whether the government intervened in the case and other factors. In recent years 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 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. The False Claims Act defines the term “knowingly” broadly. Though simple negligence will not give rise to liability under the False Claims Act, submitting a claim with reckless disregard to its truth or falsity constitutes a “knowing” submission under the False Claims Act and, therefore, will qualify for liability. Examples of the other actions which may lead to liability under the False Claims Act:

 

 

In addition, recent changes to the federal False Claims Act have increased the compliance risks faced by healthcare providers furnishing Medicare and Medicaid services. These changes were enacted through the passage of the Fraud Enforcement Recovery Act of 2009. The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the False Claims Act by, among other things, broadening protections for whistleblowers and creating liability for knowingly retaining a government overpayment, acting in deliberate ignorance of a government overpayment or acting in reckless disregard of a government overpayment. The recently enacted healthcare reform bills in the form of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”) expanded on changes made by the 2009 Fraud Enforcement and Recovery Act with regard to such “reverse false claims.” Under PPACA, the knowing failure to report and return an overpayment within 60 days of identifying the overpayment or by the date a corresponding cost report is due, whichever is later, constitutes a violation of the False Claims Act. Because Medicare and Medicaid overpayments can be predicated on a wide array of conduct, there is increased risk that we may incur substantial legal fees and other costs related to investigating any possible government overpayments, and making the appropriate repayment to the government.

 

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. Under PPACA, knowledge of the anti-kickback statute or the specific intent to violate the law is not required. Violation of the anti-kickback statute may result in civil or criminal penalties and exclusion from the Medicare, Medicaid and other federal healthcare programs, and according to PPACA, now provides a basis for liability under the False Claims Act. In addition, it is possible that private parties may file “qui tam” actions based on claims resulting from relationships that violate the anti-kickback 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 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 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 be assured 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 a new federal crime: healthcare fraud and 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 and false statements 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 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. A violation of HIPAA’s standard transactions, privacy and security provisions may result in criminal and civil penalties, which could adversely affect our financial condition and results of operations.

 

Stark and 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. Since 1995, the Centers for Medicare and Medicaid Services, or CMS, has published numerous sets of regulations implementing the Stark Law with more to come. With each set of regulations, CMS’s 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 participation, 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 financial condition and results of operations.

 

FDA:  The Food and Drug Administration, or FDA, has issued the requisite premarket approval for all of our MRI, 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; however, under FDA regulations related 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 financial condition and results of operations.

Liability Insurance:  The hospitals, physician groups and other healthcare providers 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 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 adversely affect our 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, which must comply with certain certification standards. In addition, the Medicare Improvements for Patients and Providers Act of 2008 requires imaging centers to be accredited by 2012. Although we expect our IDTFs to meet these certification and accreditation standards, increased oversight by CMS could adversely affect our financial condition and results of operations.

 

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 projects and/or the acquisition of major medical equipment including MRI and PET/CT systems. We believe that we have complied or will comply with applicable requirements in those states where we operate. Nevertheless, this is an area of continuing legislative activity, and statutes and regulations may be modified in the future in a manner that could adversely affect our financial condition and results of operations.

 

Environmental, Health and Safety Laws:  Our PET/CT services 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 sales and marketing activities to obtain new sources of revenues, expand business relationships, grow revenues at existing facilities, and maintain present business alliances and contractual relationships. Sales and marketing activities for our fixed operations include educating physicians on new applications and uses of the technology and customer service programs. In addition, we seek to leverage our core market concentration to continue to develop contractual relationships with managed care payors to increase patient volume. Sales and 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 our mobile operations 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 hospitals, physician groups 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 Healthcare Services, Inc., Radnet, Inc., Diagnostic Health Corporation, MedQuest, Inc., Shared Imaging and Otter Tail Corporation doing business as DMS Imaging. Some of our direct competitors may have access to greater financial resources than we do and have less debt in relation their operating profit.

 

Certain hospitals, particularly the larger or more financially stable hospitals, have and may be expected to directly acquire and operate imaging equipment on-site as part of their overall inpatient servicing capability. Historically, smaller hospitals have been reluctant to purchase imaging equipment, but some have chosen to do so with attractive financing offered by equipment manufacturers. Some physician practices have also established diagnostic imaging centers or purchased imaging equipment for their own offices, and we anticipate that others will as well. In addition, attractive financing from equipment manufacturers, as well as attractive gross margins, have caused hospitals and physician groups who have utilized mobile services from our company and our competitors to purchase and operate their own equipment. Although reimbursement reductions and reduced access to credit may dissuade physician groups from operating their own equipment, we expect that some high volume customer accounts will continue to elect not to renew their contracts with us and instead acquire their own diagnostic imaging equipment.

 

CUSTOMERS AND CONTRACTS

 

Our revenues are primarily generated from patient services and contract services. Our fixed-site centers primarily generate patient services revenues from services billed, on a fee-for-service basis, directly to patients or third-party payors, which we refer to as our retail operations. With respect to our retail operations we bear the direct risk of collections from third-party payors and patients. 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, which we refer to as our wholesale operations. With respect to our wholesale operations we do not bear direct risk of collections from third- party payors or patients. Contract services revenues are primarily earned through mobile facilities pursuant to contracts with a term from one to five years. A significant number of our mobile contracts will expire each year. We expect that some high volume customer accounts will elect not to renew their contracts and instead will purchase or lease their own diagnostic imaging equipment and some customers may choose an alternative services provider.

 

During fiscal 2010, approximately 49% of our revenues were generated from patient services, approximately 50% were generated from contract services and approximately 1% was generated from other operations.

 

DIAGNOSTIC IMAGING AND OTHER EQUIPMENT

 

As of September 23, 2010, we owned or leased 223 diagnostic imaging systems, with the following classifications: 3.0 Tesla MRI, 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 an MRI system. If the magnetic field strength is increased the image quality of scans is improved and the time required to complete scans is decreased. Magnetic field strength on our MRI systems currently ranges from 0.2 to 3.0 Tesla. Of our 174 conventional MRI systems, three have a magnetic field strength of 3.0 Tesla, while 136 have a magnetic field strength of 1.5 Tesla, which is the industry standard magnetic strength for conventional fixed and mobile MRI systems. Other than ultra-high field MRI systems and 256-slice CT systems, we are aware of no substantial technological changes; however, should such changes occur, we may not be able to acquire the new or improved systems.

 

We continue to evaluate the mix of our diagnostic imaging equipment in response to changes in technology and to any overcapacity in the marketplace. We improve our equipment through upgrades, disposal and/or trade-in of older equipment and the purchase or execution of leases for new equipment in response to market demands.

 

Several large companies presently manufacture MRI (including Open MRI), PET/CT, CT and other diagnostic imaging equipment, including General Electric Healthcare, Hitachi Medical Systems, Siemens Medical Systems, Toshiba American Medical Systems and Phillips Medical Systems. We have acquired systems that were manufactured by each of the foregoing companies. 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. We have recently purchased new billing system software to substantially replace the billing and collection component of IRIS and we expect to implement the new software in late calendar year 2010. We use picture archiving and communication systems, or PACS, at certain of our fixed-site centers for the digital management of diagnostic images.

 

COMPLIANCE PROGRAM

 

We have voluntarily implemented a program to monitor compliance with federal and state laws and regulations applicable to healthcare organizations. 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 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 June 30, 2010, we had approximately 1,094 full-time and 456 part-part time 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 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 projects, financing needs, debt repurchases, plans or intentions relating to asset dispositions, acquisitions and new fixed-site developments, 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. When used in this Form 10-K 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 Form 10-K. Important factors that could cause our actual results to differ materially from the forward-looking statements made in this Form 10-K are set forth in this Form 10-K, including the factors described in Item 1A. “Risk Factors” below and the following:

 

 

 

If any of these risks or uncertainties materializes, 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 disclaim any intention or obligation to update or revise forward-looking statements to reflect future events or circumstances.

 

 

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 occurs, our financial condition and results of operations could be adversely affected.

 

RISKS RELATING TO OUR INDEBTEDNESS AND FINANCIAL CONDITION

 

Our recurring losses from operations and net capital deficiency raise substantial doubt as to our ability to continue as a going concern.

 

In their report dated September 23, 2010, which is also included in this Form 10-K, our independent registered public accounting firm stated that our consolidated financial statements were prepared assuming we would continue as a going concern; however, our recurring losses from operations and net capital deficiency raise substantial doubt about our ability to continue as a going concern. Our accompanying financial statements have been prepared assuming that we will continue as a going concern. These financial statements do not include any adjustments that might result from the outcome of this uncertainty. We currently are evaluating steps to conserve our cash, including delaying or further restricting our capital projects and sale of certain assets. In any event, we have a large amount of indebtedness outstanding that will mature in November 2011. We will likely need to restructure or refinance all or a portion of our indebtedness on or before the maturity of such indebtedness. In the event such steps were not successful in enabling us to meet our liquidity needs or refinancing this indebtedness, we may need to seek protection under chapter 11 of the Bankruptcy Code. We have engaged a financial advisory firm and are working closely with them to develop and finalize a restructuring and refinancing plan to significantly reduce our outstanding debt and improve our cash and liquidity position.

 

Our substantial indebtedness could adversely affect our financial condition.

 

We have a substantial amount of debt, which requires significant interest and principal payments. As of June 30, 2010, we had total indebtedness of approximately $298.1 million in aggregate principal amount. Most of this indebtedness will come due in November 2011. In addition, subject to the restrictions contained in the indenture governing the floating rate notes and in our other debt instruments, we may be able to incur additional indebtedness from time to time to finance working capital, capital projects, investments or acquisitions, or for other purposes. If we do so, the risks related to our high level of debt could intensify. Specifically, our high level of debt could have important consequences, including the following:

 

 

 

Some or all of these factors may be beyond our control. We also cannot give assurance that we will continue to maintain covenant compliance under our credit facilities and meet our interest payment obligations on the floating rate notes, the failure of which would have a material adverse effect on our business, financial condition and operating results. Additionally, the opinion of our independent registered public accounting firm for our fiscal year ended June 30, 2010 contains an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern. Our revolving credit facility requires us to deliver audited financial statements without such an explanatory paragraph within 120 days following the end of our fiscal year. We will not be able to deliver audited financial statements for our fiscal year end without such an explanatory paragraph, and as a result, we will not be in compliance with the revolving credit facility. We have executed an amendment to our revolving credit agreement with our lender whereby the lender has agreed to forbear from enforcing the default under the agreement and allow us full access to the revolver until December 1, 2010. If we have not remedied this noncompliance by December 1, 2010, our lenders could terminate their commitments under the revolver and could cause all amounts outstanding thereunder to become immediately due and payable, which would have a material adverse effect on our business, financial condition and operating results. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources — Liquidity” for additional information regarding our liquidity.

 

We may be unable to service our debt.

 

Our ability to make scheduled payments on or to refinance our obligations with respect to our debt, including, but not limited to, the floating rate notes, will depend on our financial and operating performance, which will be affected by general economic, financial, competitive, business and other factors beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to service our debt, including, but not limited to, the floating rate notes, or to fund our other liquidity needs.

 

If we are unable to meet our debt obligations or fund our other liquidity needs, we may need to sell certain of our assets, restructure or refinance all or a portion of our debt on or before maturity, including, but not limited to, the floating rate notes. The floating rate notes mature in November 2011 and unless our financial performance significantly improves, we can give no assurance that we will be able to meet our interest payment obligations on the floating rate notes, refinance or restructure the floating rate notes on commercially reasonable terms, or redeem or retire the floating rate notes when due, which could cause us to default on our indebtedness and due to cross-default and cross-acceleration provisions, could result in a default under our other debt instruments. Upon the occurrence of an event of default under our debt instruments, the lenders may be able to elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit. Such event would have a material adverse effect on our liquidity and financial condition and we may not, in such event, be able to continue as a going concern.

 

If our cash provided by operating and financing activities continues to be insufficient to fund our cash requirements, we will face substantial liquidity problems without a restructuring.

 

Our working capital requirements and the cash provided by operating activities can vary greatly from quarter to quarter and from year to year, depending in part on the level, variability and timing of our sales and our ability to execute our cash management plans as expected.

 

We currently believe that, unless our floating rate notes are restructured in a manner that will decrease our cash requirements, including funding their maturity in November 2011 and if Bank of America terminates the line of

credit commitment on December 1, 2010, we may not be able to satisfy our cash requirements including funding minimum capital expenditures required to maintain the business beyond December 1, 2010 from cash provided by operating activities. If our cash requirements exceed the cash provided by our operating activities, then we would look to our cash balance, assets sales and revolving credit line to satisfy those needs. However, we may not be able to access our existing revolver if we are in default under our revolving credit agreement and our lender refuses to extend the forbearance period beyond December 1, 2010. Current credit and capital market conditions combined with our recent history of operating losses and negative cash flows are likely to restrict our ability to access capital markets in the near-term and any such access would likely be at an increased cost and under more restrictive terms and conditions.

 

Absent access to additional liquidity from credit markets or other sources of external financial support, we expect that we may not have the minimum levels of cash necessary to operate the business after December 1, 2010. We may need to delay capital expenditures, curtail, eliminate or dispose of substantial assets or operations, or undertake significant restructuring measures, including protection under Chapter 11 of the Bankruptcy Code.

 

Our operations may be restricted by the terms of our debt, which could adversely affect us and increase our credit risk.

 

The agreements governing our material indebtedness include a number of significant restrictive covenants. These covenants could adversely affect us, and adversely affect investors, by limiting our ability to plan for or react to market conditions or to meet our capital needs. These covenants, among other things, restrict our ability to:

 

 

A breach of a covenant or other provision in any debt instrument governing our current or future indebtedness could result in a default under that instrument and, due to cross-default and cross-acceleration provisions, could result in a default under our other debt instruments. Upon the occurrence of an event of default under our debt instruments, the lenders may be able to elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit. If we are unable to repay those amounts, the lenders could proceed against the collateral granted to them, if any, to secure the indebtedness. If the lenders under our current or future indebtedness accelerate the payment of the indebtedness, we can give no assurance that our assets or cash flow would be sufficient to repay in full our outstanding indebtedness. Substantially all of our assets, other than those assets consisting of accounts receivables and related assets or cash accounts related to receivables, which secure our credit facility, and a portion of Insight’s stock and the stock of its subsidiaries, are subject to the liens in favor of the holders of the floating rate notes. This may further limit our flexibility in obtaining secured or unsecured financing in the future. Such event would have a material adverse effect on our liquidity and financial condition and we may not, in such event, be able to continue as a going concern.

 

We may not have sufficient funds to purchase all outstanding floating rate notes and our other debt upon a change of control.

 

Upon a change of control, we will be required to make an offer to purchase all outstanding floating rate notes at a price equal to 101% of their principal amount plus accrued and unpaid interest. Under the terms of the indenture for the floating rate notes, a change of control includes, among things, if a person or group becomes directly or indirectly the beneficial owner of 35% or more of Holdings’ common stock. We believe that as of September 23, 2010, one person holds beneficial ownership in excess of 20% of Holdings’ common stock and another holds beneficial ownership in excess of 10% of Holdings’ common stock. Because of the low trading price of our common stock, $0.10, as of June 30, 2010, a person or group may be able to acquire 35% or more of Holdings’ common stock

for a relatively small amount of money. We cannot assure you that we will have or will be able to borrow sufficient funds at the time of any change of control to make any required purchases of such notes or our other debt. If we failed to make a change of control offer and to purchase all of the tendered notes, it would constitute an event of default under the indenture for the floating rate notes, and potentially, other debt. Any future credit arrangements or other debt agreements to which we become party may contain similar agreements.

 

If there is a default under the agreements governing our material indebtedness, the value of our assets may not be sufficient to repay our creditors.

 

Our property and equipment (other than land, building and leasehold improvements and assets securing our capital lease obligations), which make up a significant portion of our tangible assets, had a net book value as of June 30, 2010 of approximately $56.8 million. The book value of these assets should not be relied on as a measure of realizable value for such assets. The realizable value of our assets may be greater or lower than such net book value. The value of our assets in the event of liquidation will depend upon market, credit and economic conditions, the availability of buyers and similar factors. A sale of these assets in a bankruptcy or similar proceeding would likely be made under duress, which would reduce the amounts that could be recovered. Furthermore, such a sale could occur when other companies in our industry also are distressed, which might increase the supply of similar assets and therefore reduce the amounts that could be recovered. Our intangible assets had a net book value as of June 30, 2010 of approximately $20.0 million. As a result, in the event of a default under the agreements governing our material indebtedness or any bankruptcy or dissolution of our company, the realizable value of these assets will likely be substantially lower and may be insufficient to satisfy the claims of our creditors.

 

The condition of our assets will likely deteriorate during any period of financial distress preceding a sale of our assets. In addition, a material amount of our assets consist of illiquid assets that may have to be sold at a substantial discount in an insolvency situation.

 

Accordingly, the proceeds of any such sale of our assets may not be sufficient to satisfy, and may be substantially less than, amounts due to our creditors.

 

We may be unable to obtain necessary capital to finance certain projects or refinance our existing indebtedness because of conditions in the financial markets and economic conditions generally.

 

Our ability to obtain necessary capital is affected by conditions in the financial markets and economic conditions generally. Slowing growth, contraction of credit, increasing energy prices, declines in business or investor confidence or risk tolerance, increases in inflation, higher unemployment, outbreaks of hostilities or other geopolitical instability, corporate, political or other scandals that reduce investor confidence in capital markets and natural disasters, among other things, can affect the financial markets and economic conditions generally. If we are unable to obtain sufficient capital at commercially reasonable rates, we may be unable to fund certain capital projects or refinance our existing indebtedness, including the floating rate notes, which may erode our competitive positions in various markets and may have a material adverse effect on our financial condition.

 

A refinancing or restructuring of our floating rate notes may require a debt-for-equity exchange in which case we may be required to issue a substantial number of shares of our common stock and substantially dilute the equity ownership of existing stockholders, as well as possibly cause a change in control under the indenture governing our floating rate notes.

 

A refinancing or restructuring of our floating rate notes may involve a debt-for-equity exchange, in which case we may be required to issue to the holders of our floating rate notes shares of our common stock representing a significant portion of the equity ownership of our Company. In such an event, the equity ownership of our existing stockholders would be substantially diluted. We also cannot predict what the demand for our common stock will be following any debt-for-equity exchange, how many shares of our common stock will be offered for sale or be sold following any such exchange or the price at which our common stock will trade following any such exchange. Sales of a large number of shares of common stock after any such exchange could materially depress the trading price of our common stock.

Increases in interest rates could adversely affect our financial condition and results of operations.

 

An increase in prevailing interest rates would have an immediate effect on the interest rates charged on our variable rate indebtedness, which rise and fall upon changes in interest rates. At June 30, 2010, approximately 98% of our indebtedness was variable rate indebtedness. We have an interest rate hedging agreement with a notional amount to which the agreement applies of $190 million, on which the agreement provided for a LIBOR cap of 3.0%. As a result of this contract our exposure on variable rate indebtedness was reduced by $190 million, or to approximately 35% of our indebtedness as of June 30, 2010. Increases in interest rates could also impact the refinancing of our existing indebtedness, including the floating rate notes. Moreover, the increased interest expense would adversely affect our cash flow and our ability to service our indebtedness. 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, subject us to the risk that the other parties to the agreements may not perform their obligations thereunder or that the agreements could be unenforceable.

 

RISKS RELATING TO OUR BUSINESS

 

Our efforts to implement initiatives to enhance revenues and reduce costs may not be adequate or successful.

 

We have implemented steps to improve our financial performance, including, a core market strategy, optimizing our mobile route, converting mobile to fixed sites, as well as various operations and cash flow initiatives in response to these losses. We have focused on implementing, and will continue to develop and implement, various revenue enhancement, receivables and collections management and cost reduction initiatives. Revenue enhancement initiatives have and will continue to focus on our sales and marketing efforts to maintain or improve our procedural volume and contractual rates, and our solutions initiative. Receivables and collections management initiatives have and will continue to focus on collections at point of service, technology improvements to create greater efficiency in the gathering of patient and claim information when a procedure is scheduled or completed, and our initiative with Dell Perot Systems. Cost reduction initiatives have and will continue to focus on streamlining our organizational structure and expenses including enhancing and leveraging our technology to create greater efficiencies, and leveraging relationships with strategic vendors. While we have experienced some improvements through our receivables and collections management and cost reduction initiatives, benefits from our revenue enhancement initiatives have yet to materialize and our revenues have continued to decline. Moreover, future revenue enhancement initiatives will face significant challenges because of the continued overcapacity in the diagnostic imaging industry, reimbursement reductions and the effects of the country’s recession, including higher unemployment. We can give no assurance that these steps will be adequate to improve our financial performance.. Unless our financial performance significantly improves, we can give no assurance that we will be able to meet our interest payment obligations on the floating rate notes, refinance or restructure the floating rate notes, which mature in November 2011, on commercially reasonable terms, or redeem or retire the floating rate notes when due, which could cause us to default on our indebtedness, and cause a material adverse effect on our liquidity and financial condition.

 

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 condition and results of operations.

 

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, lease payments, depreciation and amortization, salaries and benefit obligations, equipment maintenance expenses, insurance and vehicle operations costs. As a result, a relatively small reduction in the prices we charge for our services or procedural volume could have a disproportionate negative effect on our financial condition and results of operations.

 

Technological change in our industry could reduce the demand for our services and our ability to maintain a competitive position.

 

We operate in a competitive, capital intensive, high fixed-cost industry. The development of new technologies or refinements of existing ones have made and continue to make our existing systems technologically or

economically obsolete, or reduce the need for our systems. Competition among manufacturers has resulted in and likely will continue to result in technological advances in the speed and imaging capacity of new systems. Consequently, the obsolescence of our systems may be accelerated. Other than ultra-high field MRI systems and 256-slice CT systems, we are aware of no 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 or equipment vendor financing, the issuance of equity or debt securities, and operating leases, we may be unable to maintain a competitive equipment base. In addition, advancing technology may enable hospitals, physicians or other diagnostic imaging service providers to perform procedures without the assistance of diagnostic imaging service providers such as ourselves. As a result of the age of our imaging equipment, we may not be able to maintain our competitive position in our core markets or expand our business.

 

Changes in the rates or methods of third-party reimbursements for our services could result in reduced demand for our services or create downward pricing pressure, which would result in a decline in our revenues and adversely affect our financial condition and results of operations.

 

For fiscal 2010, we derived approximately 49% of our revenues from direct billings to patients and third-party payors such as Medicare, Medicaid, managed care and private health insurance companies. Certain third-party payors have proposed and implemented changes in the methods and rates of reimbursement that have had the effect of substantially decreasing reimbursement for diagnostic imaging services that we provide. Moreover, our healthcare provider customers, which provided approximately 50% of our revenues during fiscal 2010, generally rely on reimbursement from third-party payors. To the extent our healthcare provider customers’ reimbursement from third-party payors is reduced, it will likely have an adverse impact on the rates they pay us as they would seek to offset such decreased reimbursement rates. Furthermore, many commercial health care insurance arrangements are changing, so that individuals bear greater financial responsibility through high deductible plans, co-insurance and higher co-payments, which may result in patients delaying or foregoing medical procedures. We expect that any further changes to the rates or methods of reimbursement for our services, whether directly through billings to third-party payors or indirectly through our healthcare provider customers, will result in a further decline in our revenues and adversely affect our financial condition and results of operations. See our discussion regarding reimbursement changes in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Reimbursement”.

 

Negative trends could continue to adversely affect our financial condition and results of operations.

 

As a result of the various factors that affect our industry generally and our business specifically, we have experienced declines in Adjusted EBITDA as compared to prior fiscal year periods (see our definition of Adjusted EBITDA and reconciliation of net cash provided by operating activities to Adjusted EBITDA in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources”). Our Adjusted EBITDA for fiscal 2010, declined approximately 25.7% as compared to our Adjusted EBITDA for the year ended June 30, 2009. Our Adjusted EBITDA declined approximately 1.2% for the year ended June 30, 2009 as compared to the year ended June 30, 2008. We have had a negative historical trend of declining Adjusted EBITDA for the past five fiscal years, which may continue and be exacerbated by negative effects of the recession and the reimbursement reductions discussed in the subsection entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Reimbursement.”

 

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

 

Our financial condition and results of operations 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 on favorable terms. For our mobile facilities, we generally enter into contracts with hospitals having one to five year terms. A significant number of our mobile contracts will expire each year. 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, with lower procedural volumes. Recently, there has been an increase in the amount of available equipment for lease within the industry. This increase in availability has caused a decline in demand for

our contract services mobile systems, which has resulted in (1) a lower than normal success rate in replacing lost revenues, (2) lower contractual reimbursement as compared to prior periods and (3) an increase in the number of our idle mobile systems. In addition, attractive gross margins have caused hospitals and physician groups who have utilized mobile services from our company and our competitors to purchase and operate their own equipment. Although reimbursement reductions may dissuade physician groups from operating their own equipment, we expect that some high volume customer accounts will continue to elect not to renew their contracts with us and instead acquire their own diagnostic imaging equipment. As a result of the age of our imaging equipment, we may not be able to renew contracts of existing customers or attract new customers on favorable terms. This would adversely affect our financial condition and results of operations.

 

We have experienced, and will continue to experience, competition from hospitals, physician groups and other diagnostic imaging companies and this competition could adversely affect our financial condition and results of operations.

 

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 hospitals, physician groups and certain other independent organizations, including equipment manufacturers and leasing companies that own and operate imaging equipment. We have encountered and we will continue to encounter competition from hospitals and physician groups that purchase their own diagnostic imaging equipment. Some of our direct competitors may have access to greater financial resources than we do. If we are unable to successfully compete, our customer base would decline and our financial condition and results of operations would be adversely affected.

 

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 core market strategy, we have pursued, and may continue to pursue, selective acquisitions and arrangements through partnerships and joint ventures with hospitals and other healthcare providers. Acquisitions and joint ventures require substantial capital which may exceed the funds available to us from internally generated funds and our available financing arrangements. We may not be able to raise any necessary additional funds through bank or equipment vendor 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:

 

 

If we do not successfully identify, complete and 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 acquisitions will depend upon our ability to manage their operations and to eliminate excess costs.

Our efforts to implement initiatives to enhance revenues and reduce costs may not be adequate or successful

 

We have implemented steps to improve our financial performance, including, our core market strategy, optimizing our mobile routes, and various operations and cash flow initiatives in response to our declining financial performance. Unless our financial performance significantly improves, we can give no assurance that we will be able to meet our interest payment obligations on the floating rate notes, refinance or restructure the floating rate notes, which mature in November 2011, on commercially reasonable terms, or redeem or retire the floating rate notes when due, which could cause us to default on our indebtedness, and cause a material adverse effect on our liquidity and financial condition.

 

Consolidation in the imaging industry could adversely affect our financial condition and results of operations.

 

We compete with several national and regional providers of diagnostic imaging services, as well as local providers. As a result of the reimbursement reductions by Medicare and other third-party payors, some of these competitors may consolidate their operations in order to obtain certain cost structure advantages and improve equipment utilization. Certain of our competitors have certain advantages over us including larger financial and business resources, economies of scale, breadth of service offerings, and favored relationships with equipment vendors, hospital systems, leading radiologists and third-party payors. We may be forced to exit certain markets, reduce our prices or provide state-of-the-art equipment in order to retain and attract customers. These pressures could adversely affect our financial condition and results of operations.

 

Failure to attract and retain qualified employees and contracted radiologists could hinder our business strategy and negatively impact our financial condition and results of operations.

 

Our future success depends on our continuing ability to identify, hire or contract with, develop, motivate and retain highly skilled persons for all areas of our organization, including senior executives and contracted radiologists. Competition in our industry for qualified employees is intense. There is a very high demand for qualified technologists, particularly MRI and PET/CT technologists, and we may not be able to hire and retain a sufficient number of technologists. Failure to attract and retain qualified employees and contracted radiologists could hinder our business strategy and negatively impact our financial condition and results of operations.

 

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

 

Our fixed-site centers are dependent on our ability to attract referrals from physicians and other healthcare providers representing a variety of specialties. Our eligibility to provide services in response to a referral is often dependent on the existence of a contractual arrangement with the referred patient’s managed care organization. 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. A significant decline in referrals would have a material adverse effect on our financial condition and results of operations. Moreover, our aging equipment and declining financial performance may increase the likelihood of managed care organizations opting not to renew existing contracts or enter into new contracts with our centers.

 

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

 

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 our liability insurance, could have a material adverse effect on our financial condition and results of operations. In addition 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 financial condition and results of operations.

 

Our PET/CT 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/CT services and some of our other imaging services require the use of radioactive materials to produce 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 which would adversely affect our financial condition and results of operations.

 

We may not receive payment from some of our healthcare provider customers because of their financial circumstances.

 

Some of our healthcare provider customers do not have significant financial resources, liquidity or access to capital. If these customers experience financial difficulties they may be unable to pay us for the equipment and services that we provide. We have experienced, and expect to continue to experience, write-offs of accounts receivables from healthcare provider customers that become insolvent, file for bankruptcy or are otherwise unable to pay amounts owed to us. A significant deterioration in general or local economic conditions could have a material adverse affect on the financial health of certain of our healthcare provider customers. As a result, we may have to increase the amounts of accounts receivables that we write-off, which would adversely affect our financial condition and results of operations.

 

We may be unable to generate revenue when our equipment is not operational.

 

Timely, effective service is essential to maintaining our reputation and utilization rates on our imaging equipment. Our warranties and maintenance contracts do not compensate us for the loss of revenue when our systems are not fully operational. Equipment manufacturers may not be able to perform repairs or supply needed parts in a timely manner. Thus, if we experience more equipment malfunctions than anticipated or if we are unable to promptly obtain the service necessary to keep our equipment functioning effectively, our financial condition and results of operations would be adversely affected.

 

Natural disasters and harsh weather conditions could adversely affect our business and operations.

 

Our corporate headquarters, including our information technology center, and a material number of our fixed-site centers are located in California, which has a high risk for natural disasters, including earthquakes and wildfires. Depending upon its severity, a natural disaster could severely damage our facilities or our information technology system, interrupt our business or prevent potential patients from traveling to our centers, each of which would adversely affect our financial condition and results of operations. We currently do not maintain a secondary disaster recovery facility for our information technology system. In addition, while we presently carry earthquake and business interruption 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. We may discontinue some or all of this insurance coverage on some or all of our centers in the future if the cost of premiums 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 centers as well as the anticipated future cash flows from those centers.

 

To the extent severe weather patterns affect the regions in which we operate (e.g., hurricanes and snow storms), potential patients may find it difficult to travel to our centers and we may have difficulty moving our mobile facilities along their scheduled routes. As a result, we would experience a decrease in procedural volume during that period. Accordingly, harsh weather conditions could adversely impact our financial condition and results of operations.

 

High fuel costs would adversely affect our financial condition and results of operations.

 

Fuel costs constitute a significant portion of our mobile operating expenses. Historically, fuel costs have been subject to wide price fluctuations based on geopolitical issues and supply and demand. Fuel availability is also affected by demand for home heating oil, diesel, gasoline and other petroleum products. Because of the effect of these events on the price and availability of fuel, the cost and future availability of fuel cannot be predicted with any degree of certainty. In the event of a fuel supply shortage or further increases in fuel prices, we may need to curtail certain mobile routes or redeploy our mobile facilities. There have been significant fluctuations in fuel costs and any further increases to already high fuel costs would adversely affect our financial condition and results of operations.

 

If we fail to comply with various licensure, certification and accreditation standards we may be subject to loss of licensure, certification or accreditation which would adversely affect our financial condition and results of operations.

 

All of the states in which we operate require that technologists who operate our CT and PET systems be licensed or certified. Also, each of our fixed-site centers must continue to meet various requirements in order to receive payments from Medicare. In addition, our mobile facilities are currently accredited by The Joint Commission, formerly the Joint Commission on Accreditation of Healthcare Organizations, an independent, non-profit organization that accredits various types of healthcare providers, such as hospitals, nursing homes, outpatient ambulatory care centers and diagnostic imaging providers. If we were to lose such accreditation for our mobile facilities, it could adversely affect our mobile operations because some of our mobile customer contracts require accreditation by The Joint Commission and one of our primary competitors has such accreditation.

 

Managed care providers prefer to contract with accredited organizations. Any lapse in our licenses, certifications or accreditations, or those of our technologists, or the failure of any of our fixed-site centers to satisfy the necessary requirements under Medicare could adversely affect our financial condition and results of operations.

 

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 and adversely affect our ability to operate our business and our financial condition and results of operations.

 

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:

 

 

 

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, exclusion from Medicare, Medicaid or other governmental programs 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 condition and results of operations. 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. Moreover, if we are unsuccessful in defending against such action, the imposition of certain penalties would adversely affect our financial condition and results of operations. If we were excluded from Medicare, Medicaid or other governmental programs, not only would we lose the revenues associated with such payors, but we anticipate that our other customers and partners would terminate their contracts or relationships with us.

 

The regulatory and political 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 financial condition and results of operations. 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 or restrict our operations.

 

On March 23, 2010, President Obama signed into law healthcare reform legislation in the form of PPACA. The implementation of this law will likely have a profound impact on the healthcare industry. Most of the provisions of PPACA will be phased in over the next four years and can be conceptualized as a broad framework not only to provide health insurance coverage to millions of Americans, but to fundamentally change the delivery of care by bringing together elements of health information technology, evidence-based medicine, chronic disease management, medical “homes,” care collaboration and shared financial risk in a way that will accelerate industry adoption and change. There are also many provisions addressing cost containment, reductions of Medicare and other payments and heightened compliance requirements and additional penalties, which will create further challenges for providers. We are unable to predict the full impact of PPACA at this time due to the law’s complexity and current lack of implementing regulations or interpretive guidance. Moving forward, we believe that the federal government will likely have greater involvement in the healthcare industry than in prior years, and such greater involvement may adversely affect our financial condition and results of operations. See our discussion regarding the impact of PPACA in “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Reimbursement”.

 

RISKS RELATED TO RELATIONSHIPS WITH STOCKHOLDERS, AFFILIATES AND RELATED PARTIES

 

A small number of stockholders control a significant portion of Holdings’ common stock.

 

A significant portion of Holdings’ outstanding common stock is held by a small number of holders. We believe that as of September 23, 2010, one person holds beneficial ownership in excess of 20% of Holdings’ common stock and another holds beneficial ownership in excess of 10% of Holdings’ common stock. As a result, these stockholders will have significant voting power with respect to the ability to:

 

 

 

The extent of ownership by these stockholders may also discourage a potential acquirer from making an offer to acquire us. This could reduce the value of Holdings’ common stock.

 

 

As of September 23, 2010, we lease approximately 30,000 square feet of office space for our corporate headquarters at 26250 Enterprise Court, Lake Forest, California 92630. The lease for this location expires in 2013.

 

As of September 23, 2010, in addition to our corporate headquarters we leased approximately 68 facilities or offices and owned one facility. A substantial majority of these facilities and offices were in the following states: California, Arizona, Texas, Maine and Virginia.

 

 

On January 5, 2010, Holdings, InSight and InSight Health Corp., a wholly-owned subsidiary of InSight, were served with a complaint filed in the Los Angeles County Superior Court alleging claims on behalf of current and former employees. In Kevin Harold and Denise Langhoff, on their own behalf and on behalf of others similarly situated v. InSight Health Services Holdings Corp., et al., the plaintiffs allege violations of California’s wage, overtime, meal period, break time and business practice laws and regulations. Plaintiffs seek recovery of unspecified economic damages, statutory penalties, punitive damages, interest, attorneys’ fees and costs of suit. We are currently evaluating the allegations of the complaint and are unable to predict the likely timing or outcome of this lawsuit. In the meantime, we intend to vigorously defend this lawsuit. We are engaged from time to time in the defense of other lawsuits arising out of the ordinary course and conduct of our business and have insurance policies covering certain potential insurable losses where such coverage is cost-effective. We do not believe that the outcome of any such other lawsuit will have a material adverse impact on our financial condition and results of operations

 

 

 

Holdings’ common stock is listed on the Over-The-Counter Bulletin Board, or the OTCBB, under the symbol “ISGT”. As of September 23, 2010, there were six record holders of Holdings’ common stock and we believe approximately 350 beneficial holders of Holdings’ common stock. Holdings’ has never paid a cash dividend on its common stock and does not expect to do so in the foreseeable future. The agreements governing our material indebtedness contain restrictions on Holdings’ ability to pay dividends on its common stock.

 

The following table sets forth the high and low prices as reported by the OTCBB for Holdings’ common stock for each of the fiscal quarters indicated. Holdings’ common stock began trading on the OTCBB on August 3, 2007. The prices represent quotations between dealers without adjustment for mark-up, mark-down or commission, and may not necessarily represent actual transactions.

 

 

 

In their report dated September 23, 2010, which is also included in this Form 10-K, our independent registered public accounting firm stated that our consolidated financial statements were prepared assuming we would continue as a going concern; however, our recurring losses from operations and net capital deficiency raise substantial doubt about our ability to continue as a going concern. The following Selected Financial Data taken from our accompanying financial statements have been prepared assuming that we will continue as a going concern. The following financial data do not include any adjustments that might result from the outcome of this uncertainty.

 

The selected consolidated financial data presented as of, and for the years ended, June 30, 2010 and 2009, the eleven months ended June 30, 2008, the one month ended July 31, 2008, and the years ended June 30, 2007 and 2006 has been derived from our audited consolidated financial statements. 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 Form 10-K.

 

On August 1, 2007, we implemented fresh-start reporting in accordance with Accounting Standards Codifications (ASC) 852, “Financial Reorganizations” (ASC 852). The provisions of fresh-start reporting required that we revalue our assets and liabilities to fair value, reestablish stockholders’ equity and record any applicable reorganization value in excess of amounts allocable to identifiable assets as an intangible asset. Under fresh-start reporting, our asset values are remeasured using fair value, and are allocated in conformity with ASC Topic 805 “Business Combinations” (ASC 805). Fresh-start reporting also requires that all liabilities, other than deferred taxes, should be stated at fair value or at the present value of the amounts to be paid using appropriate market interest rates. Deferred taxes are determined in conformity with ASC 740 “Income Taxes” (ASC 740).

 

References to “Successor” refer to our company on or after August 1, 2007, after giving effect to (1) the cancellation of Holdings’ common stock prior to the effective date; (2) the issuance of new Holdings’ common stock in exchange for all of Insight’s senior subordinated notes and the cancelled Holdings’ common stock; and (3) the application of fresh-start reporting. References to “Predecessor” refer to our company prior to August 1, 2007.

 

 

 

 

 

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 Form 10-K. 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 Form 10-K, particularly under the headings “Forward-Looking Statements Disclosure” and Item 1A. “Risk Factors”.

 

Overview

 

We are a provider of retail and wholesale diagnostic imaging services. Our services are noninvasive procedures 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.

 

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 operate in more than 30 states including the following targeted regional markets: Arizona, certain markets in California, Texas, New England, the Carolinas, Florida and the Mid-Atlantic states. While we generated approximately 68% of our total revenues from MRI services during fiscal 2010, we provide a comprehensive offering of diagnostic imaging services, including PET/CT, CT, mammography, bone densitometry, ultrasound and x-ray.

 

As of June 30, 2010, our network consists of 62 fixed-site centers and 104 mobile facilities. This combination allows us to provide a full range of imaging services to better meet the varying needs of our customers. Our fixed-site centers include freestanding centers and joint ventures with hospitals and radiology groups. 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 do not engage in the practice of medicine, instead we contract with radiologists to provide professional services, including supervision, interpretation and quality assurance. We have three reportable segments; contract services, patient services and other operations. Please see below for a discussion of our segments. In our contract services segment we generate revenue principally from 99 mobile units and 17 fixed sites. In our patient services segment we generate revenues principally from 45 fixed-site centers and 5 mobile units. In our other operations segment, we generate revenues principally from agreements with customers to provide management services and technical solutions.

 

The diagnostic imaging industry has grown, and we believe will continue to grow, because of (1) an aging population, (2) the increasing acceptance of diagnostic imaging, particularly PET/CT and (3) expanding applications of CT, MRI and PET technologies. Notwithstanding the growth in the industry, as a result of the various factors that affect our industry generally and our business specifically, we have experienced declines in Adjusted EBITDA as compared to prior fiscal year periods (see our definition of Adjusted EBITDA and reconciliation of net cash provided by operating activities to Adjusted EBITDA in the subsection “Financial Condition, Liquidity and Capital Resources” below). Our Adjusted EBITDA for fiscal 2010 declined approximately 25.7% as compared to our Adjusted EBITDA for the year ended June 30, 2009. Our Adjusted EBITDA declined approximately 1.2% for the year ended June 30, 2009 as compared to the year ended June 30, 2008. We have had a negative historical trend of declining Adjusted EBITDA for the past six fiscal years, which may continue and be exacerbated by negative effects of the country’s economic condition, increased competition in our contract services segment and the reimbursement reductions discussed in the subsection “Reimbursement” below.

 

We have implemented the following steps in an attempt to reverse the negative trend in Adjusted EBITDA:

 

Core Market Strategy.  We have pursued a strategy based on core markets in our patient services segment. We believe this strategy will provide us more operating efficiencies and synergies than are available in a nationwide strategy. A core market is based on many factors, including, without limitation, demographic and population trends, utilization and reimbursement rates, existing and potential market share, the potential for profitability and return on assets, competition within the surrounding area, regulatory restrictions, such as certificates of need, and potential

for alignment with radiologists, hospitals or payors. This strategy has resulted in our exiting some markets while increasing our presence in others or establishing new markets through acquisitions and dispositions. In implementing our core market strategy, we have taken the following actions:

 

 

Contract Services Strategy

 

Within our contract services segment we have pursued a strategy based on optimizing our mobile MRI and PET/CT routes, and of converting strategic mobile imaging customers to fixed site accounts. We have targeted our contract services sales efforts in regions where we have an existing presence, taking into account such factors as demographic and population trends, utilization and reimbursement rates, existing and potential market share, the potential for profitability and return on assets, competition within the surrounding area and regulatory restrictions, such as certificates of need, which provide a barrier to competition.

 

As a result of implementing our core market strategy in our patient services segment, we have reduced our cost of services as a percentage of revenues from 67.4% for the year ended June 30, 2009 to 67.0% for fiscal 2010. The decrease is primarily due to disposing of low margin patient services centers, which had an average cost of services as a percentage of revenues of approximately 125%.

 

We are continuously evaluating opportunities for the acquisition and disposition of certain businesses. There can be no assurance that we can complete purchases of these businesses on terms favorable to us in a timely manner to replace the loss of Adjusted EBITDA related to the businesses we sell.

 

Initiatives.  We have attempted to implement, and will continue to develop and implement, various revenue enhancement, receivables and collections management and cost reduction initiatives:

 

 

While we have experienced some improvements through our receivables and collections management and cost reduction initiatives, benefits from our revenue enhancement initiatives have yet to materialize and our revenues have continued to decline. Moreover, future revenue enhancement initiatives will face significant challenges

because of the continued overcapacity in the diagnostic imaging industry, reimbursement reductions and the country’s economic condition, including higher unemployment.

 

In February 2009, we entered into a seven-year agreement with Dell Perot Systems to provide enhanced revenue cycle services and assist in the implementation of upgraded technology and IT services, which will provide new technology to manage our back-office billing, accounts receivable and collections functions. As a result of this agreement, we, terminated certain employees and transitioned certain other employees to Dell Perot Systems. We implemented the revenue cycle services in June 2009 and we expect to implement the new upgraded technology and IT services in the first half of fiscal year 2011. We estimate start-up costs (excluding internal capitalized salary costs) of this initiative to be approximately $3.8 million (including $3.3 million of capital expenditures), of which $3.3 million (including $2.8 million of capital expenditure) has been incurred as of June 30, 2010.

 

In addition to our traditional offerings of equipment and management services, we believe that we have the ability to offer packaged technology solutions to hospitals and other medical imaging services providers. Besides our traditional offerings, these customers would have a broad spectrum of systems and services, including, but not limited to, image archiving and Picture Archiving Communication System (PACS) services, patient registration portals, radiology information systems, receivables and collections management services, and financial and operational tools. We launched our solutions initiative in fiscal 2010 and we recently extended a contract with an existing customer, implemented a new contract, and have and three additional contracts with implementation dates within our first fiscal quarter of 2011.

 

Reorganization

 

On May 29, 2007, Holdings and Insight filed voluntary petitions to reorganize their business under chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware (Case No. 07-10700). The filing was in connection with a prepackaged plan of reorganization and related exchange offer. The other subsidiaries of Holdings were not included in the bankruptcy filing and continued to operate their business. On July 10, 2007, the bankruptcy court confirmed Holdings’ and Insight’s Second Amended Joint Plan of Reorganization pursuant to chapter 11 of the Bankruptcy Code. The plan of reorganization became effective and Holdings and Insight emerged from bankruptcy protection on August 1, 2007, or the effective date. Pursuant to the confirmed plan of reorganization and the related exchange offer, (1) all of Holdings’ common stock, all options for Holdings’ common stock and all of Insight’s senior subordinated notes were cancelled, and (2) holders of Insight’s senior subordinated notes and holders of Holdings’ common stock prior to the effective date received 7,780,000 and 864,444 shares of newly issued Holdings’ common stock, respectively, in each case after giving effect to a one for 6.326392 reverse stock split of Holdings’ common stock.

 

This reorganization significantly deleveraged our balance sheet and improved our projected cash flow after debt service. However, we still have a substantial amount of debt, which requires significant interest and principal payments. As of June 30, 2010, we had total indebtedness of approximately $298.1 million in aggregate principal amount, including Insight’s $293.5 million of senior secured floating rate notes due 2011, or floating rate notes, which come due in November 2011. Additionally, the opinion of our independent registered public accounting firm for our fiscal year ended June 30, 2010 contains an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern. Our revolving credit facility requires us to deliver audited financial statements without such an explanatory paragraph within 120 days following the end of our fiscal year. We will not be able to deliver audited financial statements for our fiscal year end without such an explanatory paragraph, and as a result, we will not be in compliance with the revolving credit facility. We have executed an amendment to our revolving credit agreement with our lender whereby the lender has agreed to forbear from enforcing the default under the agreement and allow us full access to the revolver until December 1, 2010. If we have not remedied this noncompliance by December 1, 2010, our lenders could terminate their commitments under the revolver and could cause all amounts outstanding thereunder to become immediately due and payable. We did not have any borrowings outstanding on the revolver as of June 30, 2010 and do not currently have any borrowings outstanding on the revolver. We have approximately $1.6 million outstanding in letters of credit which would need to be cash collateralized in the event our revolver is eliminated.

 

We believe that future net cash provided by operating activities will be adequate to meet our operating cash and debt service requirements through December 1, 2010. If our cash requirements exceed the cash provided by our operating activities, then we would look to our cash balance, asset sales and revolving credit line to satisfy those needs. However, following December 1, 2010, we may not be able to access our existing revolver if we are in default under our revolving credit agreement and our lender refuses to extend the forbearance period. In the event net cash

provided by operating activities declines further than we have anticipated, or if the availability under our revolving credit facility is reduced or eliminated by our lender in light of the existing default under that facility, any future defaults or otherwise, we are prepared to take steps to conserve our cash, including delaying or further restricting our capital projects and sale of certain assets. In any event, we will likely need to restructure or refinance all or a portion of our indebtedness on or before the maturity of such indebtedness. In the event such steps are not successful in enabling us to meet our liquidity needs or to restructure or refinance our outstanding indebtedness when due, we may need to seek protection under chapter 11 of the Bankruptcy Code. We have engaged a financial advisory firm and are working closely with them to develop and finalize a restructuring and refinancing plan to significantly reduce our outstanding debt and improve our cash and liquidity position.

 

Nevertheless, the floating rate notes mature in November 2011 and require substantial quarterly interest payments leading up to maturity. Unless our financial performance significantly improves, we can give no assurance that we will be able to meet our interest payment obligations on the floating rate notes, refinance or restructure the floating rate notes on commercially reasonable terms, or redeem or retire the floating rate notes when due, which could cause us to default on our indebtedness and cause a material adverse effect on our liquidity and financial condition. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more restrictive covenants, which could further restrict our business operations and have a material adverse effect on our results of operations. Although we are prepared to take additional steps as necessary to improve our liquidity and financial condition, we cannot be certain such steps would be effective.

 

Segments

 

Effective July 1, 2009, we redefined the business segments based on how our chief operating decision maker views the businesses and assesses the performance of our business managers. We now have three reportable segments: contract services, patient services and other operations, which are business units defined primarily by the type of service provided. Contract services consist of centers (primarily mobile units) which generate revenues from fee-for-service arrangements and fixed-fee contracts billed directly to our healthcare provider customers, such as hospitals, which we refer to as wholesale operations. We internally handle the billing and collections for our contract services at relatively low cost, and we do not bear the direct risk of collections from third party-payors or patients. Patient services consist of centers (mainly fixed-sites) that primarily generate revenues from services billed, on a fee-for-service basis, directly to patients or third-party payors, such as Medicare, Medicaid, insurance companies and health maintenance organizations, which we refer to as our retail operations. We have primarily outsourced the billing and collections for our patient services to Dell Perot Systems, and we bear the direct risk of collections from third-party payors and patients. We allocate corporate overhead, depreciation related to our billing system and income taxes to other operations. Other operations generate revenues primarily from agreements with customers to provide management services, which could include field operations, billing and collections and accounting and other office services. We refer to this revenue as generated from our solutions business. Other operations include all unallocated corporate expenses. We manage cash flows and assets on a consolidated basis, and not by segment.

 

Negative Trends

 

Our operations have been and will continue to be adversely affected by the following negative trends:

 

 

Recently there has been an increase in the amount of available equipment for lease within the industry. This has caused a decline in demand for our contract services mobile systems, which has resulted in (1) a lower than normal success rate in replacing lost revenues, (2) lower contractual reimbursement as compared to prior periods and (3) an increase in the number of our underutilized mobile systems.

 

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 other individuals. Providers are paid by the federal government in accordance with regulations promulgated by HSS and generally accept the payment with nominal deductible and co-insurance amounts required to be paid by the service recipient, as payment in full. Hospital inpatient services are reimbursed under a prospective payment system. Hospitals receive a specific prospective payment for inpatient treatment services based upon the diagnosis of the patient.

 

Under Medicare’s prospective payment system for hospital outpatient services, 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. Each year the Centers for Medicare and Medicaid Services, or CMS, publishes new APC rates that are determined in accordance with the promulgated methodology.

 

In recent years, CMS modified the OPPS with the effect of reducing the reimbursement received by hospitals for certain outpatient radiological services, including PET/CT, and CMS continues to examine imaging with a view toward potential further reductions. Because unfavorable reimbursement policies constrict the profit margins of the mobile customers we bill directly, we have and may continue to lower our fees to retain existing PET/CT customers and attract new ones. Although CMS continues to expand reimbursement for new applications of PET/CT, broader applications are unlikely to significantly offset the anticipated overall reductions in PET/CT reimbursement. Any modifications under OPPS further reducing reimbursement to hospitals may adversely impact our financial condition and results of operations since hospitals will seek to offset such modifications.

 

Services provided in non-hospital based freestanding facilities, such as independent diagnostic treatment facilities, are paid under the Medicare Physician Fee Schedule, or MPFS. The MPFS is updated on an annual basis. Several years ago, CMS reduced the reimbursement for certain diagnostic procedures performed together on the same day. They did so by modifying Medicare to pay 100% of the technical component of the higher priced procedure and 75% for the technical component of each additional procedure for procedures involving contiguous body parts within a family of codes when performed in the same session. Under the recently enacted PPACA, CMS further reduced the payment for contiguous body parts within the same session from 75% to 50% for the technical component of CT, MRI and ultrasound services, effective July 1, 2010. These reductions in payment by CMS may adversely impact our financial condition and results of operations since they result in lower reimbursement for our services and the services of our non-hospital clients. In fact, on June 25, 2010, CMS issued the proposed MPFS for 2011. Under the proposed rule, CMS is now proposing to apply this payment reduction to the technical component of all studies of these three imaging modalities that are performed on a patient in the same session, even if they are non-contiguous.

 

CMS has also published proposed regulations for hospital outpatient services that would implement the same multi procedure reimbursement methodology set forth under the MPFS; however it has delayed the implementation of this reimbursement methodology for an indefinite period of time. As a result Medicare continues to pay 100% of the technical component of each procedure for hospital outpatient services. If CMS implements this reimbursement methodology, it would adversely impact our financial condition and results of operations since our hospital customers would seek to offset their reduced reimbursement through lower rates with us.

 

We have experienced significant reimbursement reductions for radiology services provided to Medicare beneficiaries, including reductions pursuant to the Deficit Reduction Act, or DRA. The DRA, which became effective in 2007, set reimbursement for the technical component for imaging services (excluding diagnostic and screening mammography) in non-hospital based freestanding facilities at the lesser of OPPS or the MPFS.

 

Medicare reimbursement rates under the MPFS are calculated in accordance with a statutory formula. As a result, for calendar years 2008, 2009 and 2010, CMS published regulations decreasing the fee schedule rates by 10.1% 5.4% and 21.2% respectively. In each instance, Congress enacted legislation preventing the decreases from taking effect and in fact on June 25, 2010, the “Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010”

prevented the rate reduction and also established a 2.2% payment rate increase to the MPFS retroactive from June 1 through Nov. 30, 2010. Under the proposed MPFS for 2011, however, CMS proposes to reduce rates in 2011 by an additional 6.1%. This cut does not account for the 2010 legislative changes to the MPFS and would be added to the 21.2% cut that was previously delayed. We anticipate that CMS will continue to release regulations for decreases in fee schedule rates under the MPFS until the statutory formula is changed through enactment of new legislation. We do not know if Congress will continue to enact legislation to prevent future decreases under the statutory formula, but if Congress failed to act, there could be significant decreases to the MPFS.

 

On Nov. 25, 2009, CMS released the 2010 MPFS final rule (the “Final Rule”) which updated the payment policies and rates for the MPFS, for calendar year 2010. In addition to other changes to the physician payment formulae, the MPFS reduces payment rates for services using equipment costing more than $1.0 million by increasing the usage assumptions from the current 50% usage rate to a 90% usage rate. This change in the usage rate was to be phased in over a four year period and primarily impacted MRI and CT services. The Final Rule was superseded, however, by passage of PPACA, but only with respect to the usage assumptions. All other CMS issued updates for 2010 remain in effect. Under PPACA, beginning Jan. 1, 2011, the usage rate assumption for diagnostic imaging equipment priced at more than $1 million will be set at 75% for 2011 and subsequent years.

 

In addition to the foregoing changes to the usage assumptions, CMS’ 2010 regulatory changes to the MPFS also included a downward adjustment to services primarily involving the technical component rather than the physician work component, by adjusting downward malpractice payments for these services. The reductions will affect the services we provide, primarily impacting radiology and other diagnostic tests. As noted above, the changes to the MPFS will be transitioned over a four-year period such that beginning in 2013, CMS will fully implement the revised payment rates. This change to the MPFS, could have an adverse effect on our financial condition and results of operations. For our fiscal year ended June 30, 2010, Medicare revenues represented $17.6 million, or approximately 9.7% of our total revenues for such period. If the Final Rule had been fully phased in during our fiscal year ended June 30, 2010, we estimate that our total revenues would have been reduced by approximately $2.6 million, or 1.1%. The impact of the new MPFS will increase over the four-year transition period unless mitigated by future legislation (either currently proposed or pledged by Congress and the federal government administration).

 

In addition to reimbursement cuts, the new MPFS confirms that suppliers of technical component advanced imaging services must be accredited by January 1, 2012. Our fixed-site centers are currently accredited by American College of Radiology or ACR, which has been designated by CMS as an authorized accrediting body. In addition, our mobile facilities are currently accredited by The Joint Commission. We are currently unable to assess what, if any, impact the accreditation requirements may have on future results of operations and our financial position.

 

Many of PPACA’s provisions will not take effect for months or several years, while others are effective immediately. Many provisions also will require the federal government and individual state governments to interpret and implement the new requirements. In addition, PPACA remains the subject of significant debate, and proposals to repeal, block or amend the law have been introduced in Congress and many state legislatures. Finally, a number of state attorneys general have filed legal challenges to PPACA seeking to block its implementation on constitutional grounds. Because of the many variables involved, we are unable to predict how many of the legislative mandates contained in PPACA will be implemented or in what form, whether any additional or similar changes to statutes or regulations (including interpretations), will occur in the future, or what effect any future legislation or regulation would have on our business. We do believe, however, that there will likely be changes to reimbursement for services provided to Medicare patients, and the federal government will likely have greater involvement in the healthcare industry than in prior years, and such reimbursement changes and greater involvement may adversely affect our financial condition and results of operations.

 

All of the congressional and regulatory actions described above reflect industry-wide cost-containment pressures that we believe will continue to affect healthcare providers for the foreseeable future.

 

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 and Private Insurance.  Health Maintenance Organizations, or HMO’s, 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 and mandating less costly treatment alternatives. Managed care contracting is competitive and reimbursement schedules are at or below Medicare reimbursement levels. However, some managed care organizations have reduced or otherwise limited, and we believe that other managed care organizations may reduce or otherwise limit, reimbursement in response to reductions in government reimbursement. These reductions have had, and any future reductions could have, an adverse impact on our financial condition and results of operations. These reductions have been, and any future reductions may be, similar to the reimbursement reductions proposed by CMS, Congress and the current federal government administration. The development and expansion of HMOs, PPOs and other managed care organizations within our core markets could have a negative impact on utilization of our services in certain markets and/or affect the revenues per procedure 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.

 

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 health insurance programs generally have authorized payment for our services on satisfactory terms. However, we believe that private health insurance programs may also reduce or otherwise limit reimbursement in response to reductions in government reimbursement, which could have an adverse impact on our financial condition and results of operations.

 

Several significant third-party payors implemented the reduction for multiple images on contiguous body parts (as currently in effect under CMS regulations) and additional payors may propose to implement this reduction as well. If the government implements a discount on the technical component discount on imaging of contiguous body parts third-party payors may follow this practice and implement a similar reduction. Such reduction would further negatively affect our financial condition and results of operations.

 

Furthermore, certain third-party payors have proposed and implemented initiatives which have the effect of substantially decreasing reimbursement rates for diagnostic imaging services provided at non-hospital facilities, and payors are continuing to monitor reimbursement for diagnostic imaging services. A third-party payor has instituted a requirement of participation that requires freestanding imaging center providers to offer multi-modality imaging services and not simply offer one type of diagnostic imaging service. Other third-party payors have instituted specific credentialing requirements on imaging center providers and physicians performing interpretations and providing supervision. Similar initiatives enacted in the future by a significant number of additional third-party payors may have a significant adverse impact on our financial condition and results of operations.

 

Revenues

 

We earn revenues by providing services to patients, hospitals and other healthcare providers. Our patient services revenue is 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, collectively, payors. Patient services revenues also include balances due from patients, which are primarily collected at the time the procedure is performed. We refer to our patient services revenues as our retail operations. With respect to our retail operations, we bear the direct risk of collections from third-party payors and patients. Our charge for a procedure is 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.

Historically and through fiscal 2009, reports from our billing system did not generate contractual adjustments. Consequently, contractual adjustments had been manual estimates based upon an analysis of historical experience of contractual payments from payors and the outstanding accounts receivables from payors. In July 2009, we completed the implementation of a new report that extracts data from our billing system and automatically generates the contractual adjustments based on actual contractual rates with our payors in effect at the time the service is provided to the patient. Contractual adjustments are written-off against contractual fee rates with our payors in effect when the service was provided to the patient.

 

We report net the payments due to radiologist from our revenue because (1) we are not the primary obligor for the provision of professional services and (2) because the radiologists receive contractually agreed upon percentage of collections, the radiologists bear the risk of non-collection. In the past we had arrangements with certain radiologists pursuant to which we paid the radiologists for their professional services at an agreed upon contractual rate irrespective of the ultimate collections. With respect to these arrangements, the professional component is included in our revenues, and our payments to the radiologists are included in costs of services. These type of arrangements were in effect in fiscal 2008 and fiscal 2009. In fiscal 2010, we no longer had these types of arrangements.

 

Our collection policy is to obtain all required insurance information at the time a procedure is scheduled, and to submit an invoice to the payor immediately after a procedure is completed. Most third-party payors require preauthorization before an MRI, CT or PET/CT procedure is performed on a patient.

 

We refer to our revenues from hospitals, physician groups and other healthcare providers as contract services revenues or our wholesale operations. 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 service revenues are generally billed to our customers on a monthly basis and revenues are recognized when the service is provided. Revenues collected in advance are recorded as unearned revenue. Fee for services revenues are affected by the timing of holidays, patient and referring physicians vacation schedules and inclement weather.

 

The provision for doubtful accounts is reflected as an operating expense and represents our estimate of amounts that are legally owed to us but will be uncollectible from patients, payors, hospitals, physician groups and other healthcare providers. The provision for doubtful accounts includes amounts to be written off with respect to specific accounts involving customers that are financially unstable or materially fail to comply with the payment terms of their contracts and other accounts based on our historical collection experience, including payor mix and the aging of patient accounts receivables balances. Estimates of uncollectible amounts are revised each period, and changes are recorded in the period they become known. Receivables deemed to be uncollectible, either through a customer default on payment terms or after reasonable collection efforts have been exhausted, are fully written-off against their corresponding asset account, with a reduction to the allowance for doubtful accounts to the extent such an allowance was previously recorded. Our historical write-offs for uncollectible accounts are not concentrated in a specific payor class.

 

The following illustrates our payor mix based on revenues for fiscal 2010:

 

Percentage of Total Revenues

 

 

 

 

The aging of our gross and net trade accounts receivables as of June 30, 2010 is as follows (amounts in thousands):

 

 

As of June 30, 2010, our days sales outstanding, or DSO’s, for trade accounts receivables on a net basis was 41 days as compared to 43 days at June 30, 2009. We believe that this decrease in DSO’s is primarily a result of lower denial rates and improved collections times due to increased use of billing applications and improved collection practices.

 

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 depreciation and amortization, debt service, lease payments, salaries and benefit obligations, equipment maintenance expenses, insurance and vehicle operations costs. Because a large portion of our operating expenses are fixed, any increase in our procedure volume or reimbursement rates disproportionately increases our operating cash flow. Conversely, any decrease in our procedure volume or reimbursement rates disproportionately decreases our operating cash flow. Our variable costs, which comprise only a small portion of our total operating expenses, include billing fees related to patient services, bad debt expense and the cost of service supplies such as film, contrast media and radiopharmaceuticals.

 

Results of Operations

 

Upon Holdings’ and Insight’s emergence from chapter 11, we adopted fresh-start reporting in accordance with ASC Topic 852, formerly SOP 90-7 “Financial Reporting by Entities in Reorganization under the Bankruptcy Code”. The adoption of fresh-start reporting results in our becoming a new entity for financial reporting purposes. Accordingly, our consolidated financial statements on or after August 1, 2007 are not comparable to our consolidated financial statements prior to that date. The adoption of fresh-start reporting primarily affects depreciation and amortization and interest expense in the consolidated statements of operations. The accompanying consolidated statements of operations for the year ended June 30, 2008 combine the results of operations for the one month ended July 31, 2007 of the Predecessor and the eleven months ended June 30, 2008 of the Successor. We then compare the combined results of operations with the corresponding period in the ensuing year.

 

Presentation of the combined results of operations for all of fiscal 2008 does not comply with accounting principles generally accepted in the United States; however, we believe the combined results of operations for the year ended June 30, 2008 provide management and investors with a more meaningful perspective on our financial performance and operating trends than if we did not combine the results of operations of Predecessor and Successor in this manner. Similarly, we combine the financial results of Predecessor and Successor when discussing sources and uses of cash for the year ended June 30, 2008.

The following table sets forth the results of operations for the years ended June 30, 2010, 2009 and 2008. The combined results for the year ended June 30, 2008 have been prepared for comparative purposes only and do not purport to be indicative of what results of operations would have been, and are not indicative of future operating results (amounts in thousands):

 

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

 

 

Years ended June 30, 2010 and 2009

 

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

 

 

 

 

 

Non-GAAP Measure — Revenues and costs of operations (including costs of services, provision for doubtful accounts, equipment leases and depreciation and amortization), net of acquisitions and dispositions as presented herein is defined as revenue and services excluding the effects of acquisitions and dispositions. We believe this metric is a useful financial measure for investors in evaluating our operating performance for the periods presented, as when read in conjunction with our revenues and costs of services, it presents a useful tool to evaluate our ongoing operations and provides investors with a tool they can use to evaluate our management of assets held from period to period. In addition, revenues and costs of services net of acquisitions and dispositions is one of the factors we use in internal evaluations of the overall performance of our business. This metric, however, is not a measure of financial performance under accounting principles generally accepted in the United States (“GAAP”) and should not be considered a substitute for revenues and costs of services as determined in accordance with GAAP and may not be comparable to similarly titled measures reported by other companies.

 

Revenues:  Net of acquisitions and dispositions, revenues decreased $27.0 million or 13% to $181.0 million for the year ended June 30, 2010, from $208.0 million for the year ended June 30, 2009. This decrease was primarily due to lower contract services revenues ($19.0 million), lower revenues from existing patient services centers ($7.8 million) and lower revenues from other operations ($0.2 million).

 

Our patient services revenues, net of acquisitions and dispositions, decreased 8.6% from $90.8 million for the year ended June 30, 2009, to $83.0 million for the year ended June 30, 2010. This decrease was primarily a result of a decrease in scan volumes, which we attribute to various factors, including high unemployment rates and the impact of high deductible health plans. The decrease is also due to a decline in the percentage of scans related to more expensive procedures, coupled with reimbursement rate reductions from various payors.

 

Our contract services revenues decreased 16.5% from $115.1 million for the year ended June 30, 2009 to $96.1 million for the year ended June 30, 2010. This decrease was partially due to the closure of a fixed-site center related to a large healthcare provider contract ($5.1 million) in conjunction with the renewal of the continuing four centers under a multi-year agreement. The remaining decrease from our contract services operations is a result of a reduction in the number of active contracts and reductions in reimbursement from our contract services customers for all modalities. The reductions in reimbursement are primarily the result of competition from other contract services providers and fewer mobile units in service. Our aging mobile fleet also contributed to the decline in revenues as did the continued propensity for customers to take their business in-house.

 

We believe we may continue to experience declining revenues due to the negative trends discussed above, which may be intensified by the negative effects of the country’s economic condition, including higher unemployment, higher deductible plans, fewer individuals with healthcare insurance and reductions in third-party payor reimbursement.

 

Costs of services:  As a percentage of revenues, costs of services decreased 0.4% to 67.0% for the year ended June 30, 2010 as compared to 67.4% for fiscal 2009. Cost of services decreased $25.6 million to $127.9 million for the year ended June 30, 2010 from $153.5 million for the year ended June 30, 2009. The decrease is attributable partially to lower costs in our contract services ($8.5 million) and in our existing patient services ($7.7 million) coupled with the disposition of certain of our patient services centers ($12.8 million), partially offset by acquisitions ($3.4 million).

As a percentage of revenues, costs of services at our patient services centers decreased 2.9% to 79.4% for the year ended June 30, 2010 from 82.3% for the prior fiscal year. The decrease is partially the result of the disposition of patient services centers with costs of services as a percentage of revenue of over 87%. Total costs of services in our patient services segment decreased $17.1 million to $73.8 million in fiscal 2010 from $90.9 million in fiscal 2009. Our dispositions eliminated $12.8 million of costs in our patient services segment from the year ended June 30, 2009 to the current year, which was partially offset by acquisitions ($3.4 million). Additionally we also reduced the cost of services for our existing patient services centers by $7.7 million. The decrease in costs of services for our existing patient services centers was due primarily to decreased salary related expenses ($2.6 million), reading fees ($1.0 million), billing fees ($1.3 million), equipment maintenance ($1.0 million), and other operating costs ($1.5 million). Net of acquisitions and dispositions, as a percentage of revenues, our cost of services decreased 1.6% to 80.2% for the year ended June 30, 2010 from 81.8% for the year ended June 30, 2009.

 

As a percentage of revenues our cost of services in our contract services segment increased 1.7% to 55.5% for the year ended June 30, 2010 from 53.8% for the prior fiscal year. The increase is attributable to the decline in revenues. Costs of services in our contract services segment decreased $8.6 million to $53.3 million for the year ended June 30, 2010 from $61.9 million for the prior fiscal year. The decrease was due partially to the closure of a fixed-site center related to a large health care provider contract ($2.2 million) in conjunction with the renewal of the continuing four centers under a multi-year agreement. The remaining decrease in costs of services for our contract services operations is a result of our cost reduction initiatives. Notable variances included a decrease in salary related expenses ($3.0 million), a decrease in our mobile fleet related costs ($2.8 million), and decreases in supplies, insurance, and taxes and license fees ($0.5 million) as compared to the prior fiscal year.

 

Provision for doubtful accounts:  The provision for doubtful accounts increased by $0.4 million for the year ended June 30, 2010 to $4.4 million for the fiscal year ended June 30, 2010 from $4.0 million as compared to the prior fiscal year. Net of acquisitions and dispositions, our provision for doubtful accounts increased $0.6 million to $4.1 million for the year ended June 30, 2010 as compared to $3.5 million in the prior fiscal year, related primarily to patient services operations. We attribute the negative trend to the increase in the patient portion of our receivables due to the high unemployment rate coupled with higher deductible plans.

 

Equipment leases:  Equipment leases decreased $0.3 million for the year ended June 30, 2010 as compared to the prior fiscal year. Equipment leases, net of acquisitions and dispositions, decreased $0.3 million, to $10.2 million from $10.5 million for the years ended June 30, 2010 and 2009, respectively.

 

Depreciation and amortization:  Depreciation and amortization expense decreased $12.4 million for the year ended June 30, 2010 to $33.2 million from $45.6 million for the prior fiscal year. Net of acquisitions and dispositions, depreciation and amortization decreased $9.8 million to $32.2 million for the year ended June 30, 2010 as compared to $42.0 million in the prior fiscal year. The decrease can be primarily attributed to the age of our equipment resulting in more fully depreciated equipment during the year ended June 30, 2010 than the prior fiscal year, partially offset by purchases of new property and equipment.

 

Corporate Operating Expenses:  Corporate operating expenses decreased $1.4 million, or 6.4%, to $20.2 million for the year ended June 30, 2010 from $21.6 million for the year ended June 30, 2009. Our cost reduction initiatives primarily contributed to decreases in office related expenses ($0.7 million) and professional and regulatory costs ($0.3 million). In addition, during the year ended June 30, 2009, we incurred a $1.1 million charge relating to a contingent non-income tax liability which did not recur in fiscal 2010. After taking into consideration the $1.1 million one-time charge for the non-income tax liability in the prior fiscal year, corporate operating expenses as a percentage of revenues increased by 1.6% to 10.6% for the year ended June 30, 2010 from 9.0% for the prior fiscal year. This increase is primarily due to the decline in revenues as discussed above, exceeding our reduction in costs. During the quarter ended June 30, 2010, our corporate operating expenses included approximately $0.7 million of costs related to our recent acquisition of eight retail centers and severance and disposal costs primarily associated with planned sales and closures of several retail centers.

 

Equity in Earnings of Unconsolidated Partnerships:  Equity in earnings in our unconsolidated partnerships decreased $0.3 million in fiscal 2010 as compared to the prior fiscal year because of lower earnings in the unconsolidated partnerships as our unconsolidated partnerships are experiencing some of the same fiscal and operating challenges that we are.

Interest Expense, Interest expense, net decreased $4.6 million from $30.2 million for the year ended June 30, 2009, to $25.6 million for the year ended June 30, 2010. The decrease was due primarily to lower interest rates ($6.2 million) on the floating rate notes coupled with lower debt balances resulting from our purchase of $21.5 million of floating rate notes in fiscal year 2009 partially offset by increased payments on our interest rate collar ($1.1 million) and amortization of the bond discount ($0.5 million). Our interest rate collar matured on February 1, 2010.

 

Gain on Sales of Centers:  During fiscal 2009, we sold six fixed-site centers in California, one fixed-site center in Illinois and one fixed-site center in Tennessee and our equity interest in three joint ventures in New York and California that operated five fixed-site centers. We received $20.0 million, net of cash sold, from these sales and recorded a gain of $7.9 million. In addition, we deferred recognition of a $0.3 million contingent payment upon the satisfaction of a certain guaranty as measured on the first anniversary of the transaction. During fiscal 2010, the contingency was satisfied and we recognized the deferred gain on sale of center, which was partially offset by a $0.2 million loss on sale of a fixed-site center in California.

 

Gain on Purchase of Notes Payable:  During fiscal 2009, we purchased $21.5 million in principal amount of our floating rate notes for approximately $8.4 million. We realized a gain of approximately $12.1 million, after the write-off of unamortized discount of approximately $1.0 million.

 

Impairment of Other Long-Lived Assets.  Impairment of other long-lived assets decreased $0.9 million from $5.3 million for the year ended June 30, 2009 to $4.4 million for the year ended June 30, 2010. Based on our annual evaluation of the carrying value of our indefinite-lived intangible assets as of December 31, 2009, we concluded that impairments had occurred and we recorded a non-cash impairment charge of $1.9 million in our contract services segment related to our trademark ($0.8 million) and our certificates of need ($0.9 million) and our patient services segment related to our certificates of need ($0.2 million). This impairment charge primarily resulted from a decline in our mobile business within our contract services segment. As of June 30, 2010, we completed an analysis of our operations and determined that there were indications of possible impairment of our indefinite lived assets including our certificates of need and our trademark due to the decline in our revenues and EBITDA in both our patient services and contract services segments during the second half of fiscal 2010. Our contract services decline primarily relates to our mobile operations. We did not note any indication of impairment of our goodwill. Accordingly, we completed a valuation of our certificates of need and trademark and recorded an impairment charge of $1.4 million for our patient services certificates of need and $0.3 million for our contract services certificates of need, and $0.8 million related to our trademark. (see Note 10)

 

Loss before Income Taxes:  Loss before income taxes increased from $20.7 million for the year ended June 30, 2009, to $32.9 million for the year ended June 30, 2010. An analysis of the change in loss before income taxes is as follows (amounts in thousands)

 

Benefit for Income Taxes:  For the year ended June 30, 2010, we recorded a benefit for income taxes of $1.8 million as compared to a benefit for income taxes of $1.7 million for the year ended June 30, 2009. The benefit for income taxes is related to a decrease in our deferred income tax liability of approximately $1.4 million due to the impairment of our indefinite-lived intangible assets, and a decrease in income taxes associated with uncertain tax positions of $0.7 million, offset partially by a provision primarily related to state income taxes of $0.1 million and interest expense related to the uncertain tax positions.

 

Years Ended June 30, 2009 and 2008

 

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

 

 

 

 

Revenues:  Net of acquisitions and dispositions, revenues decreased $9.5 million or 4.2% to $214.8 million for the year ended June 30, 2009, from $224.3 million for the year ended June 30, 2008. This decrease was primarily due to lower revenues from existing patient services revenues ($4.2 million) and contract services revenues ($5.5 million), partially offset by an increase from other operations ($0.2 million).

 

Net of acquisitions and dispositions, our patient services revenues decreased 4.1% from $101.8 million for the year ended June 30, 2008, to $97.6 million for the year ended June 30, 2009. This decrease was primarily a result of a decrease in scan volumes, which we attribute to various factors, including high unemployment rates and the impact of high deductible health plans. The decrease is also due to a decline in the percentage of scans related to more expensive procedures, coupled with reimbursement rate reductions from various payors.

 

Our contract services revenues decreased $5.5 million or 4.6% to $115.1 million for the year ended June 30, 2009 from $120.6 million for the year ended June 30, 2008. This decrease was partially due to the closure of a fixed-site center related to a large healthcare provider ($2.6 million) in conjunction with the renewal of the continuing four centers under a multi-year agreement. The remaining decrease in our contract services operations is a result of a

reduction in the number of active contracts and reductions in reimbursement from our contract services customers for all modalities. The reductions in reimbursement are primarily the result of competition from other contract services providers and fewer mobile units in service. Our aging mobile fleet also contributed to the decline in revenues as did the continued propensity for customers to take their business in-house.

 

Costs of services:  As a percentage of revenues, costs of services decreased 1.2% to 67.4% for the year ended June 30, 2009 as compared to 68.6% for fiscal 2008. Cost of services decreased $26.9 million to $153.5 million for the year ended June 30, 2009 from $180.4 million for the year ended June 30, 2008. The decrease was attributable to our patient services centers ($20.5 million) and contract services ($6.4 million).

 

As a percentage of revenues, costs of services at our patient services centers increased 2.9% to 82.3% for the year ended June 30, 2009 from 79.3% for the prior fiscal year due to a decline in revenues. Our dispositions were related to patient services centers with costs of services as a percentage of revenues of over 87% for the year ended June 30, 2009 as compared to 84.8% for the prior fiscal year. Total costs of services for patient services decreased $20.5 million. Our dispositions eliminated $23.5 million of costs from the year ended June 30, 2008 to the year ended June 30, 2009, which was partially offset by acquisitions ($1.7 million) and an increase in cost of services for our existing patient services centers ($1.3 million). The increase in costs of services for our existing patient services centers was due to severance and closing costs ($1.0 million) and start-up costs relating to the implementation of the revenue cycle services ($0.5 million). Net of acquisitions and dispositions, as a percentage of revenues, our cost of services increased 4.7% to 82.0% for the year ended June 30, 2009 from 77.3% for the year ended June 30, 2008, however, after considering the effect of the $1.5 million charge for severance, closing costs and start-up costs during fiscal 2009, costs of services increased 3.2%.

 

As a percentage of revenues our contract services costs of services decreased 2.9% to 53.8% for the year ended June 30, 2009 from 56.6% for the prior fiscal year. The decrease is attributable primarily to our cost reduction initiatives. Costs of services in our contract services operations decreased $6.4 million for the year ended June 30, 2009 as compared to the prior fiscal year. The decrease was due partially to the closure of a fixed-site center related to a large health care provider contract ($0.5 million) in conjunction with the renewal of the continuing four centers under a multi-year agreement. The remaining decrease in costs of services for our contract services operations is a result of our cost reduction initiatives. Notable variances included a decrease in salary related expenses ($4.2 million), a decrease in our mobile fleet related costs ($0.9 million), and decreases in supplies, insurance and taxes and license fees ($0.6 million).

 

Provision for doubtful accounts:  The provision for doubtful accounts decreased by $2.2 million for the year ended June 30, 2009 as compared to the prior fiscal year. Net of acquisitions and dispositions, our provision for doubtful accounts decreased $1.2 million to $3.7 million for the year ended June 30, 2009 as compared to $4.9 million in the prior fiscal year, related primarily to increased efficiencies in, and effectiveness of, our collections process on current receivables and the collection of old receivables within our patient services operations.

 

Equipment leases:  Equipment leases increased $0.9 million for the year ended June 30, 2009 as compared to the prior fiscal year. Equipment leases, net of acquisitions and dispositions, increased $1.4 million, to $10.5 million from $9.1 million for the years ended June 30, 2009 and 2008, respectively. The increase was primarily attributable to our contract services operations acquiring equipment through leases.

 

Depreciation and amortization:  Depreciation and amortization expense decreased $12.6 million for the year ended June 30, 2009 to $45.6 million from $58.2 million for the prior fiscal year. Net of acquisitions and dispositions, depreciation and amortization decreased $6.5 million for the year ended June 30, 2009 as compared to prior fiscal year. The decrease is attributable to the age of our equipment resulting in more fully depreciated equipment during the year ended June 30, 2009 than the prior fiscal year, partially offset by purchases of new property and equipment.

 

Corporate Operating Expenses:  Corporate operating expenses decreased $5.9 million, or 21.4%, to $21.6 million for the year ended June 30, 2009 from $27.4 million for the year ended June 30, 2008. Our cost reduction initiatives primarily contributed to decreases in salaries and benefits related expenses ($2.8 million) and professional and regulatory fees expenses ($0.6 million), after considering the effects of $2.2 million of litigation costs incurred in fiscal 2008 that did not recur in fiscal 2009. As a percentage of revenues corporate operating

expenses decreased by 0.9% to 9.5% for the year ended June 30, 2009 from 10.4% for the prior fiscal year. This decrease is attributable to our cost reduction initiatives exceeding the decline in revenues. During the year ended June 30, 2009, our corporate operating expenses included $0.3 million of transaction costs associated with our acquisitions.

 

Equity in Earnings of Unconsolidated Partnerships:  Equity earnings in our unconsolidated partnerships increased $0.6 million in fiscal 2009 as compared to the prior fiscal year period because of greater earnings in the unconsolidated partnerships.

 

Interest Expense, net:  Interest expense, net decreased $5.2 million from $35.4 million for the year ended June 30, 2008, to $30.2 million for the year ended June 30, 2009. The decrease was due primarily to lower interest rates ($6.0 million) on the floating rate notes coupled with lower debt balances resulting from our purchase of $21.5 million of floating rate notes in fiscal year 2009 partially offset by increased amortization of the bond discount ($0.8 million).

 

Gain (Loss) on Sales of Centers:  During fiscal 2008, we sold seven fixed-site centers in California and our majority ownership interest in a joint venture that operated a fixed-site center in Ohio. We received $9.1 million, net of cash sold, from the sales and recorded a loss of $0.6 million. During fiscal 2009, we sold six fixed-site centers in California, one fixed-site center in Illinois and one fixed-site center in Tennessee and our equity interest in three joint ventures in New York and California that operated five fixed-site centers. We received $20.0 million, net of cash sold, from the sales and recorded a gain of $7.9 million. In addition, we deferred recognition of a $0.3 million contingent payment upon the satisfaction of a certain guaranty as measured on the first anniversary of the transaction.

 

Impairment of Goodwill:  For the year ended June 30, 2008, we recorded a non-cash impairment charge of $107.4 million. This charge is a reduction in the carrying value of goodwill.

 

Impairment of Other Long-Lived Assets:  Impairment of other long-lived assets decreased $7.1 million from $12.4 million for the year ended June 30, 2008 to $5.3 million for the year ended June 30, 2009. For fiscal 2009 we completed our annual evaluation of the carrying value of our indefinite-lived intangible assets as of December 31, 2008, based on this evaluation we concluded that impairments had occurred and we recorded a non-cash impairment charge of $4.6 million in our contract services segment related to our trademark ($2.2 million) and our certificates of need ($2.4 million). This impairment charge primarily resulted from a decline in our mobile business within our contract services segment. Additionally, as of June 30, 2009, we made the decision to sell certain assets related to two fixed-site centers in Pennsylvania for an amount expected to be less than their then-current carrying amount. As a result, we recorded an impairment loss of $0.7 million to write down the assets associated with these two fixed-site centers to their estimated realizable value. These assets were subsequently sold in July 2009.

Loss Before Reorganization Items, net and Income Taxes:  Loss before reorganization items, net and income taxes decreased to $20.7 million for the year ended June 30, 2009, from $173.0 million for the year ended June 30, 2008. An analysis of the change in loss before reorganization items, net and income taxes is as follows (amounts in thousands)

 

 

Reorganization Items, net:  During the one month ended July 31, 2007, Predecessor recorded net gains of $199.0 million for items in accordance with ASC 852 related to Holdings’ and Insight’s reorganization, primarily due to a gain on debt discharge, revaluation of assets and liabilities, professional fees and consent fees.

 

Benefit for Income Taxes:  For the year ended June 30, 2009, we recorded a benefit for income taxes of $1.7 million as compared to a benefit for income taxes of $1.9 million for the year ended June 30, 2008. The benefit for income taxes is related to a decrease in our deferred income tax liability due to the impairment of our indefinite-lived intangible assets discussed above.

 

Financial Condition, Liquidity and Capital Resources

 

We have historically funded our operations and capital project requirements from net cash provided by operating activities and capital and operating leases. We expect to fund future working capital and capital project requirements from cash on hand, sales of fixed-site centers and mobile facilities, net cash provided by operating activities and our credit facility. To the extent available, we will also use capital and operating leases, but the current conditions in the capital markets and our high level of leverage have limited our ability to obtain attractive lease financing. Our operating cash flows have been negatively impacted by the sales and closures of certain centers and the negative trends we have experienced within each of our segments. If our operating cash flows continue to be negatively impacted by these and other factors and we are unable to offset them with cost savings and other initiatives, it will result in:

 

 

Liquidity:

 

We have suffered recurring losses from operations and have a net capital deficiency that raises substantial doubt about our ability to continue as a going concern. Additionally, the opinion of our independent registered public accounting firm for our fiscal year ended June 30, 2010 contains an explanatory paragraph regarding

substantial doubt about our ability to continue as a going concern. Our revolving credit facility requires us to deliver audited financial statements without such an explanatory paragraph within 120 days following the end of our fiscal year. We will not be able to deliver audited financial statements for our fiscal year end without such an explanatory paragraph, and as a result, we will not be in compliance with the revolving credit facility. We have executed an amendment to our revolving credit agreement with our lender whereby the lender has agreed to forbear from enforcing the default under the agreement and allow us full access to the revolver until December 1, 2010. If we have not remedied this noncompliance by December 1, 2010, our lenders could terminate their commitments under the revolver and could cause all amounts outstanding thereunder, if any, to become immediately due and payable. We did not have any borrowings outstanding on the revolver as of June 30, 2010 and do not currently have any borrowings outstanding on the revolver. We have approximately $1.6 million outstanding in letters of credit that would need to be cash collateralized in the event our revolver is eliminated. The amendment reduces the total facility size from $30 million to $20 million and reduces the letter of credit limit from $15 million to $5 million, and also increases our interest rate on outstanding borrowings to Prime +2.75% or LIBOR +3.75%, at our discretion. The unused line fee is increased to 0.75%.

 

We have a substantial amount of debt, which requires significant interest and principal payments. As of June 30, 2010, we had total indebtedness of $298.1 million in aggregate principal amount, including $293.5 million of floating rate notes which come due in November 2011. We believe that future net cash provided by operating activities will be adequate to meet our operating cash and debt service requirements through December 1, 2010. If our cash requirements exceed the cash provided by our operating activities, then we would look to our cash balance, proceeds from asset sales and revolving credit line to satisfy those needs. However, following December 1, 2010, we may not be able to access our existing revolver if we are in default under our revolving credit agreement and our lender refuses to extend the forbearance period. In the event net cash provided by operating activities declines further than we have anticipated, or if the availability under our revolving credit facility is reduced or eliminated by our lender in light of the existing default, any future defaults or otherwise, we are prepared to take steps to conserve our cash, including delaying or further restricting our capital projects and sale of certain assets. In any event, we will likely need to restructure or refinance all or a portion of our indebtedness on or before maturity of such indebtedness. In the event such steps are not successful in enabling us to meet our liquidity needs or to restructure or refinance our outstanding indebtedness when due, we may need to seek protection under chapter 11 of the Bankruptcy Code. We have engaged a financial advisory firm and are working closely with them to develop and finalize a restructuring and refinancing plan to significantly reduce our outstanding debt and improve our cash and liquidity position.

 

Nevertheless, the floating rate notes mature in November 2011 and unless our financial performance significantly improves, we can give no assurance that we will be able to meet our interest payment obligations on the floating rate notes, refinance or restructure the floating rate notes on commercially reasonable terms, or redeem or retire the floating rate notes when due, which could cause us to default on our indebtedness, and cause a material adverse effect on our liquidity and financial condition. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more restrictive covenants, which could further restrict our business operations and have a material adverse effect on our results of operations. Although we are prepared to take additional steps as necessary, we cannot be certain such steps would be effective.

 

We reported net losses attributable to Holdings of approximately $31.8 million, $19.8 million and $169.2 million for the years ended June 30, 2010 and 2009, and the eleven months ended June 30, 2008, respectively. We have implemented steps in response to these losses, including a core market strategy and various revenue cycle enhancement and cost reduction initiatives. We have focused on implementing, and will continue to develop and implement, various revenue enhancement, receivables and collections management and cost reduction initiatives:

 

 

 

While we have experienced some improvements through our receivables and collections management and notable improvements due to our cost reduction initiatives, benefits from our revenue enhancement initiatives have yet to materialize and our revenues continue to decline. Moreover, future revenue enhancement initiatives will face significant challenges because of the continued overcapacity in the diagnostic imaging industry, reimbursement reductions and the country’s economic condition, including higher unemployment. We can give no assurance that these steps will be adequate to improve our financial performance. Unless our financial performance significantly improves, we can give no assurance that we will be able to refinance the floating rate notes, which mature in November 2011, on commercially reasonable terms, if at all.

 

Our short-term liquidity needs relate primarily to:

 

 

Our long-term liquidity needs relate primarily to the maturity of the floating rate notes in November 2011.

 

As mentioned above, in the past we have from time to time purchased a portion of our outstanding floating rate notes. Any such purchases shall be in accordance with the terms of agreements governing our material indebtedness. During fiscal 2009, we purchased $21.5 million in principal amount of floating rate notes for approximately $8.4 million. We realized a gain of approximately $12.1 million, after the write-off of unamortized discount of approximately $1.0 million.

 

Cash, cash equivalents and restricted cash as of June 30, 2010 were $9.4 million (including $0.3 million that was subject to the lien for the benefit of the floating rate note holders, and may only be used for wholly owned capital projects or under certain circumstances the purchase of floating rate notes). Our primary source of liquidity is typically cash provided by operating activities. Our ability to generate cash flows from operating activities is based upon several factors including the following:

 

 

A summary of cash flows is as follows (amounts in thousands):

 

Net cash provided by operating activities was $5.3 million for the year ended June 30, 2010 and resulted primarily from our Adjusted EBITDA ($29.5 million) (see reconciliation below) less cash paid for interest and taxes ($20.1 million) and changes in certain assets and liabilities ($4.1 million). The changes in certain assets and liabilities primarily consist of a decrease in accounts payable and other accrued expenses of $9.0 million. Of this $9.0 million, $0.4 million relates to a decrease in accrued costs related to capital expenditures, $0.8 million relates to a reduction in accrued interest on notes payable due to the termination of an interest rate collar agreement, $0.7 million is due to a decline in accrued disposal costs, $0.5 million relates to payment of a tax matter which was accrued at June 30, 2009, with the remaining $6.6 million variance and due to a decline in the Company’s operating costs and normal short term timing of payments. The decrease in accounts payable and accrued liabilities was partially offset by a decrease in net accounts receivable of $3.0 million, due principally to the decline in our revenue, and a decrease in other assets of $1.9 million, of which $0.5 million relates to the collection of an escrow deposit from the sale of a fixed-site center in fiscal 2009 and $0.6 million which relates to an increase in collections of our receivables from unconsolidated partnerships.

 

Net cash used in investing activities was $14.2 million for the year ended June 30, 2010 and resulted primarily from the purchase or upgrade of diagnostic imaging equipment and construction projects at certain of our centers ($23.5 million), the acquisition of a fixed-site center ($0.9 million) and cash contributions into joint ventures ($0.7 million), partially offset by proceeds from the sales of certain centers ($2.9 million) and equipment sales ($1.8 million), and a decrease in restricted cash ($6.2 million).

 

Net cash used in financing activities was $1.7 million for the year ended June 30, 2010 and resulted primarily from principal payments on notes payable and capital lease obligations, offset partially by borrowings for debt obligations.

 

We define Adjusted EBITDA as our earnings before interest expense, income taxes, depreciation and amortization, excluding impairment of tangible and intangible assets, gain on sales of centers, and gain on purchase of notes payable. Adjusted EBITDA has been included because we believe that it is a useful tool for us and our investors to measure our ability to provide cash flows to meet debt service, capital projects 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 GAAP. We present the discussion of Adjusted EBITDA because covenants in the agreements governing our material indebtedness contain ratios based on this measure. While Adjusted EBITDA is used as a measure of liquidity 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 calculation. Our reconciliation of net cash provided by operating activities to Adjusted EBITDA is as follows (amounts in thousands):

 

Our reconciliation of income (loss) before income taxes to Adjusted EBITDA by segment for the years ended June 30, 2010, 2009 and 2008 is as follows (amounts in thousands):

 

 

Years Ended June 30, 2010 and 2009

 

Adjusted EBITDA decreased 25.7% for the year ended June 30, 2010 compared to the year ended June 30, 2009. This decrease was due primarily to reductions in Adjusted EBITDA from our contract services ($10.0 million) and patient services ($1.4 million) partially offset by a decrease in the negative Adjusted EBITDA in our other operations ($1.2 million). The decrease in the negative Adjusted EBITDA from our other operations is due to reductions in costs mainly attributable to our cost reduction initiatives discussed previously, including a $1.4 million decrease in corporate operating expenses.

 

Adjusted EBITDA from our patient services operations decreased 9.2% to $14.0 million for the year ended June 30, 2010 from $15.4 million for the year ended June 30, 2009. This decrease was due primarily to decreased Adjusted EBITDA from our existing patient services centers ($1.1 million) and our dispositions ($2.2 million), offset by our acquisitions ($1.9 million).

Adjusted EBITDA from our contract services operations decreased 22.4% to $34.4 million for the year ended June 30, 2010 from $44.4 million for the year ended June 30, 2009. This decrease was due to Adjusted EBITDA lost due to the closure of one center serving a large health care provider ($2.8 million) in conjunction with the renewal of the continuing four centers under a multi-year agreement and the reduction in revenues discussed above, partially offset by the reduction in costs additionally discussed above.

 

Years Ended June 30, 2009 and 2008

 

Adjusted EBITDA decreased approximately 1.2% from approximately $40.2 million for the year ended June 30, 2008, to approximately $39.7 million for the year ended June 30, 2009. This decrease was due primarily to reductions in Adjusted EBITDA from our patient services segment (approximately $8.0 million) partially offset by an increase in adjusted EBITDA in our contract services segment (approximately $1.5 million) and other operations (approximately $6.1 million).

 

Adjusted EBITDA from our patient services segment decreased approximately 34.2% from approximately $23.4 million for the year ended June 30, 2008, to approximately $15.4 million for the year ended June 30, 2009. Of the $8.0 million decrease, $2.3 million was related to dispositions of patient services centers, net of acquisitions. The decrease was due primarily to a reduction in Adjusted EBITDA at our existing patient service centers (approximately $5.7 million) attributable to the reduction in revenues, including the reimbursement reductions from the DRA, and a decrease in equity in earnings from unconsolidated partnerships.

 

Adjusted EBITDA from our contract services segment increased approximately 3.5% from approximately $42.9 million for the year ended June 30, 2008, to approximately $44.4 million for the year ended June 30, 2009. This increase was due primarily to cost savings initiatives.

 

Capital Projects:  As of June 30, 2010, we have committed to capital projects of approximately $3.3 million through November 2010. We expect to use either internally generated funds, operating leases, cash on hand, including restricted cash, and the proceeds from the sale of fixed-site centers to finance the acquisition 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 core market strategy. If we are unable to generate sufficient cash from our operations or obtain additional funds through bank financing, the issuance of equity or debt securities, or operating leases, we may be unable to maintain a competitive equipment base. As a result, we may not be able to maintain our competitive position in our core markets or expand our business.

 

Floating Rate Notes and Credit Facility:  As of June 30, 2010, we had outstanding, through Insight, $293.5 million of aggregate principal amount of floating rate notes. The floating rate notes mature in November 2011 and bear interest at LIBOR plus 5.25% per annum, payable quarterly. As of June 30, 2010 interest rate on the floating rate notes was 5.59%. If prior to the maturity of the floating rate notes, we elect to redeem the floating rate notes or are otherwise required to make a prepayment with respect to the floating rate notes for which a redemption price is not otherwise specified in the indenture, regardless of whether such prepayment is made voluntarily or mandatorily, as a result of acceleration upon the occurrence of an event of default or otherwise, we are required to pay 102% of the principal amount plus accrued and unpaid interest. An open-market purchase of floating rate notes would not require a prepayment price at the foregoing rates. In addition, the indenture provides that if there is a change of control, we will be required to make an offer to purchase all outstanding floating rate notes at a price equal to 101% of their principal amount plus accrued and unpaid interest. The indenture provides that a change of control includes, among other things, if a person or group becomes directly or indirectly the beneficial owner of 35% or more of Holdings’ common stock. The fair value of the floating rate notes as of June 30, 2010 was approximately $123.3 million.

 

Holdings’ and Insight’s wholly owned subsidiaries unconditionally guarantee all of Insight’s obligations under the indenture for the floating rate notes. The floating rate notes are secured by a first priority lien on substantially all of Insight’s and the guarantors’ existing and future tangible and intangible property including, without limitation, equipment, certain real property, certain contracts and intellectual property and a cash account related to the foregoing, but are not secured by a lien on their accounts receivables and related assets, cash accounts related to

receivables and certain other assets. In addition, the floating rate notes are secured by a portion of Insight’s stock and the stock or other equity interests of Insight’s subsidiaries.

 

Through certain of Insight’s wholly owned subsidiaries we have an asset-based revolving credit facility of up to $30 million, which matures in June 2011, with the lenders named therein and Bank of America, N.A. as collateral and administrative agent. The credit facility is scheduled to terminate in June 2011. As of June 30, 2010, we had approximately $12.8 million of availability under the credit facility, based on our borrowing base. At June 30, 2010, there were no outstanding borrowings under the credit facility; however, there were letters of credit of approximately $1.6 million outstanding under the credit facility. As a result of our current fixed charge coverage ratio, we would only be able to borrow up to $5.3 million of the $12.8 million of availability under the borrowing base due to a restriction in the future if our liquidity, as defined in the credit facility agreement, falls below $7.5 million.

 

Holdings and Insight unconditionally guarantee all obligations of Insight’s subsidiaries that are borrowers under the credit facility. All obligations under the credit facility and the obligations of Holdings and Insight under the guarantees are secured, subject to certain exceptions, by a first priority security interest in all of Holdings’, Insight’s and the borrowers’: (i) accounts; (ii) instruments, chattel paper (including, without limitation, electronic chattel paper), documents, letter-of-credit rights and supporting obligations relating to any account; (iii) general intangibles that relate to any account; (iv) monies in the possession or under the control of the lenders under the credit facility; (v) products and cash and non-cash proceeds of the foregoing; (vi) deposit accounts established for the collection of proceeds from the assets described above; and (vii) books and records pertaining to any of the foregoing.

 

Borrowings under the credit facility bear interest at a per annum rate equal to LIBOR plus 2.5%, or, at our option, the base rate (which is the Bank of America, N.A. prime rate); however, the applicable margin will be adjusted in accordance with a pricing grid based on our fixed charge coverage ratio, and will range from 2.00% to 2.50% per annum. In addition to paying interest on outstanding loans under the credit facility, we are required to pay a commitment fee to the lenders in respect to unutilized commitments thereunder at a rate equal to 0.50% per annum, subject to reduction based on a performance grid tied to our fixed charge coverage ratio, as well as customary letter-of-credit fees and fees of Bank of America, N.A. There are no financial covenants included in the credit facility, except a minimum fixed charge coverage ratio test which will be triggered if our liquidity, as defined in the credit facility, falls below $7.5 million.

 

At June 30, 2010, there were no borrowings outstanding under the credit facility; however, there were letters of credit of approximately $1.6 million outstanding under the credit facility. The credit facility agreement also contains customary borrowing conditions, including a material adverse effect provision. If we were to experience a material adverse effect, as defined by our credit facility agreement, we would be unable to borrow under the credit facility. On September 10, 2010, we entered into the First Amendment to our Second Amended and Restated Loan and Security Agreement. The opinion of our independent registered public accounting firm for our fiscal year ended June 30, 2010 contains an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern. Our revolving credit facility requires us to deliver audited financial statements without such an explanatory paragraph within 120 days following the end of our fiscal year. We will not be able to deliver audited financial statements for our fiscal year end without such an explanatory paragraph, and as a result, we will not be in compliance with the revolving credit facility. We have executed an amendment to our revolving credit agreement with our lender whereby the lender has agreed to forbear from enforcing the default under the agreement and allow us full access to the revolver until December 1, 2010. If we have not remedied this noncompliance by December 1, 2010, our lenders could terminate their commitments under the revolver and could cause all amounts outstanding thereunder to become immediately due and payable and any outstanding letters of credit, currently $1.6 million, would need to be cash collateralized. The amendment reduces the total facility size from $30 million to $20 million and reduces the letter of credit from $15 million to $5 million, and also increases our interest rate on outstanding borrowings to Prime + 2.75% or LIBOR + 3.75% at our discretion. The unused line fee is increased to 0.75%.

 

The agreements governing our credit facility and floating rate notes contain restrictions on among other things, our ability to incur additional liens and indebtedness, engage in mergers, consolidations and asset sales, make dividend payments, prepay other indebtedness, make investments and engage in transactions with affiliates.

Contractual Commitments:  Our contractual obligations as of June 30, 2010 are as follows (amounts in thousands):

 

 

The long-term debt obligations and capital lease obligations include both principal and interest commitments for the periods presented. The interest commitment on the floating rate notes is based on the effective interest rate at June 30, 2010 (5.59%).

 

Off-Balance Sheet Arrangements

 

There are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital projects or capital resources.

 

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 Form 10-K 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 a part of this Form 10-K.

 

Reorganization value and equity value:  To facilitate the calculation of reorganization value and equity value, management, with the assistance of outside financial advisors, developed an estimate of the enterprise value of the successor entity, including $322.5 million in aggregate principal amount of total debt and capital leases as of the date of consummation of the confirmed plan of reorganization.

 

In establishing an estimate of enterprise value, management primarily focused on the market value of the two publicly traded securities that were most affected by the confirmed plan of reorganization:

 

 

 

Management considered the above values in light of various relevant market comparables, which are not specific to our publicly traded securities, such as (A) the market values of comparable companies and (B) recent transactions in our industry.

 

To a lesser extent, management considered the estimated present value of projected future cash flows in order to validate the determinations it made through the market comparable methods described above. Management estimated that the discounted cash flow value of the Company’s two reporting segments was slightly less than the low point of the enterprise range determined by the trading value of the common stock. The projected future cash flows were particularly sensitive to our assumptions regarding revenues because of (a) the high fixed cost nature of our business, and (b) the difficulty of estimating changes in reimbursement and procedure volume for future years. In developing these estimates, management assumed, among other things (i) a decline in revenues for the Company’s fiscal year ending June 30, 2008 as a result of reimbursement reductions, and (ii) for the Company’s fiscal years ending June 30, 2009 and 2010, (I) modest increases in revenues (approximately 3.0% each year) for its fixed operations segment as a result of the anticipated deceleration in the growth of additional imaging capacity within the Company’s industry, and (II) an insignificant increase in the Company’s revenues for its mobile operations segment (an approximate 1.0% increase each year). If known and unknown risks materialize, or if our revenue assumptions were incorrect, our future cash flows could differ significantly from our projections. The sensitivity of the revenue assumptions contributed to management’s decision to focus on market values (observable inputs) in determining the Company’s enterprise value. Management believed that the projected cash flows were appropriately discounted to reflect, among other things, the capital structure and cost of capital (both debt and equity) for the Company’s two operating segments at the time as well as industry risks.

 

Utilizing the methodologies described above, management determined that the enterprise value of the successor entity was estimated to be in the range of $344 million to $396 million. Based on this range, management deemed $360 million to be an appropriate estimate of the enterprise value of the successor entity. The enterprise value estimate of $360 million fell within the range established above, and management believed the estimate was appropriate since the value was primarily derived from the trading value of the common stock and senior subordinated notes described above. Management believed that the enterprise value of $360 million best reflected the value of the successor entity because trading activity reflected market based judgments as to the current business and industry challenges the successor entity faces, including the negative trends and numerous risks described elsewhere in this Form 10-K. Furthermore, in estimating the enterprise value of $360 million management determined that a valuation at the low end of the value range based on the trading price of the common stock was appropriate because (i) a substantial majority of transactions in the common stock from August 3, 2007 through September 30, 2007, were for prices between $4.00 and $5.15 per share, and (ii) there was limited volume in the trading activity in the common stock. If the long-term debt and capital leases of $322.5 million in aggregate principal amount as of August 1, 2007, the effective date of the confirmed plan of reorganization and exchange offer, without giving effect to the net fair value discount associated with Insight’s $315 million in aggregate principal amount of senior secured floating rate notes due 2011, were subtracted from the successor entity’s estimated enterprise value of $360 million the resulting equity value was $37.5 million.

 

The foregoing estimates of enterprise value and corresponding equity value were based upon certain projections and assumptions. Neither the projections nor the assumptions are incorporated into this Form 10-K.

 

Goodwill and Other Intangible Assets:  As of August 1, 2007, goodwill represented the reorganization value of the Successor in excess of the fair value of tangible and identified intangible assets and liabilities from our adoption of fresh-start reporting. We recorded approximately $110.1 million of goodwill upon Holdings’ and Insight’s emergence from bankruptcy (see Note 2). As of June 30, 2010 goodwill represented the excess in purchase price over the fair value of the assets of certain acquisitions we have made since August 1, 2007. Identified

intangible assets consist primarily of our trademark, certificates of need, customer relationships and wholesale contracts. The intangible assets, excluding the wholesale contracts and customer relationships, are indefinite-lived assets and are not amortized. Wholesale contracts and customer relationships are definite-lived assets and are amortized over the expected term of the respective contracts and relationships, respectively. In accordance with ASC 350, “Goodwill and Other Intangible Assets”, the goodwill and indefinite-lived intangible asset balances are not being amortized, but instead are subject to an annual assessment of impairment by applying a fair-value based test.

 

We evaluate the carrying value of goodwill and other indefinite-lived intangible assets in the second quarter of each fiscal year. Additionally, we review the carrying amount of goodwill and other indefinite-lived intangible assets whenever events and circumstances indicate that their respective carrying amounts may not be recoverable. Impairment indicators include, among other conditions, cash flow deficits, historic or anticipated declines in revenue or operating profit and adverse legal or regulatory developments. At June 30, 2010, we completed an analysis of our operations and determined that there were indication of possible impairment of our indefinite lived assets including our certificates of need and our trademark due to the decline in our revenues and EBITDA in both our patient services and contract services segments during the second half of fiscal 2010. We did not note any indication of impairment of our goodwill. Accordingly, we completed a valuation of our certificates of need and trademark and recorded an impairment charge of $1.4 million for our patient services certificates of need and $0.3 million for our contract services certificates of need, and $0.8 million related to our trademark.

 

As of June 30, 2010, we had goodwill of $1.6 million. In evaluating goodwill, we complete the two-step impairment test as required by ASC 350. In the first of a two-step impairment test, we determine the fair value of our reporting units (defined as our operating centers) using a discounted cash flow valuation model, market multiple model or appraised values, as appropriate. ASC 350 requires us to compare the fair value for the reporting unit to its carrying value on an annual basis to determine if there is potential impairment. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is considered not impaired and no further testing is required. If the fair value does not exceed the carrying value, the second step of the impairment test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of the goodwill with the carrying amount of that goodwill. Impairment losses, if any, are reflected in the consolidated statements of operations.

 

We assess the ongoing recoverability of our intangible assets subject to amortization in accordance with SFAS No. 144 which has been incorporated into ASC Topic 360, “Property, Plant and Equipment” by determining whether the long-lived asset can be recovered over the remaining amortization period through projected undiscounted future cash flows. If projected future cash flows indicate that the long-lived asset balances will not be recovered, an adjustment is made to reduce the asset the estimated fair value. 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.

 

Revenue recognition:  Revenues from contract services and from patient services are recognized when services are provided. Patient services revenues are presented net of 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, these adjustments are estimates based on the actual contract, or in cases where there is no contract, the estimate is based on historical collections. Additionally, we record revenues net of payments due to radiologists because (i) we are not the primary obligor for the provision of professional services, (ii) the radiologists receive contractually agreed upon amounts from collections and (iii) the radiologists bear the risk of non-collection. The recorded amount due to radiologists is an estimate based on our recorded revenue, net of contractual allowances. We have entered into arrangements with certain radiologists pursuant to which we pay the radiologists directly for their professional services at an agreed upon contractual rate which does not depend upon the ultimate collections. With respect to these arrangements, the professional component billed is included in our revenues, and our payments to the radiologists are included in costs of services. Contract services revenues are recognized over the applicable contract period. Revenues collected in advance are recorded as unearned revenue.

New Pronouncements

 

FASB ASC Topic 805 “Business Combinations” formerly SFAS 141(R) (ASC 805) establishes principles and requirements for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed and any noncontrolling interest in an acquisition, at their fair value as of the acquisition date. ASC 805 is effective for fiscal years beginning after December 15, 2008. The adoption of ASC 805 did not have a material effect on our financial position or cash flows.

 

ASC 805 formerly FSP No. FAS 141(R)-1 is effective for contingent assets or contingent liabilities acquired in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this standard did not have a material impact on our consolidated financial statements.

 

FASB ASC Topic 810 “Consolidation” formerly SFAS 160 (ASC 810) establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. ASC 810 is effective for fiscal years beginning after December 15, 2008. On July 1, 2009 we adopted ASC 810. As of June 30, 2010, ASC 810 only effected our financial statement presentation and therefore had no impact on our consolidated financial position, results of operations or cash flows.

 

FASB ASC Topic 815 “Derivatives and Hedging” formerly SFAS 161 (ASC 815) requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under this topic, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. We adopted ASC 815 on January 1, 2009. As ASC 815 only requires enhanced disclosures, it had no impact on our consolidated financial statements.

 

FASB ASC Topic 810 “Amendments to FASB Interpretation No. 46(R)” formerly SFAS No. 167 (ASC 810) enhances the current guidance on disclosure requirements for companies with financial interest in a variable interest entity. This statement amends Interpretation 46(R) to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (a) the obligation to absorb losses of the entity or (b) the right to receive benefits from the entity. This statement requires an additional reconsideration event when determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance. It also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity. This statement amends Interpretation 46(R) to require additional disclosures about an enterprise’s involvement in variable interest entities. ASC 810 is effective for fiscal years beginning after November 15, 2009, with early application prohibited. We are currently evaluating the impact of the adoption of ASC 810 on our consolidated financial statements.

 

FASB ASC Topic 105 “Generally Accepted Accounting Principles” formerly SFAS 168 (ASC 105) is the single source of authoritative Generally Accepted Accounting Principles (“GAAP”) in the United States. The previous GAAP hierarchy consisted of four levels of authoritative accounting and reporting guidance levels. The ASC 105 eliminated this hierarchy and replaced the previous GAAP with just two levels of literature: authoritative and non-authoritative. The ASC 105 was effective as of July 1, 2009.

 

In August 2009, the FASB issued Accounting Standards Update (ASU) 2009-05 to provide guidance on measuring the fair value of liabilities. The ASU provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques:

 

(i) a valuation technique that uses the quoted price of the identical liability when traded as an asset; or, quoted prices for similar liabilities, or similar liabilities when traded as assets, or

 

(ii) another valuation technique consistent with the principles of ASC Topic 820 — Fair Value Measurements and Disclosures, such as an income approach or market approach.

Additionally, when estimating the fair value of a liability, a reporting entity is not required to make an adjustment relating to the existence of a restriction that prevents the transfer of the liability. This ASU also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments are required, are Level 1 fair value measurements under ASC Topic 820. The adoption of this standard did not have a material impact on our consolidated financial statements.

 

In September 2009, the FASB issued ASU 2009-13, which eliminates the criterion for objective and reliable evidence of fair value for the undelivered products or services. Instead, revenue arrangements with multiple deliverables should be divided into separate units of accounting provided the deliverables meet certain criteria. ASU 2009-13 provides a hierarchy for estimating the selling price for each of the deliverables. ASU 2009-13 eliminates the use of the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables based on their relative selling price. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 Early adoption is permitted. We are currently assessing the impact of this accounting standards update on our consolidated financial position and results of operation.

 

 

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 relating to the floating rate notes and our credit facility. As a result, we will periodically use interest rate swaps, caps and collars to hedge variable interest rates on long-term debt. We believe there was not a material quantitative change in our market risk exposure during the quarter ended June 30, 2010, as compared to prior periods. At June 30, 2010, approximately 98% of our indebtedness was variable rate indebtedness; however, as a result of the interest rate cap contract discussed below our exposure on variable rate indebtedness was reduced by $190 million, to approximately 35% of our total indebtedness as of June 30, 2010. 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 indebtedness 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.

 

We had an interest rate hedging agreement with Bank of America, N.A. which effectively provided us with an interest rate collar. The notional amount to which the agreement applied was $190 million, and it provided for a LIBOR cap of 3.25% and a LIBOR floor of 2.59% on that amount. Our obligations under the agreement were secured on a pari passu basis by the same collateral that secures our credit facility, and the agreement was cross-defaulted to our credit facility. This agreement expired on February 1, 2010.

 

In August 2009, we entered into an interest rate cap agreement with Bank of America, N.A. with a notional amount of $190 million and a three-month LIBOR cap of 3.0% effective between February 1, 2010 and January 31, 2011. The terms of the agreement call for us to pay a fee of approximately $0.5 million over the contract period. The contract exposes us to credit risk in the event that the counterparty to the contract does not or cannot meet its obligations; however, Bank of America, N.A. is a major financial institution and we expect that it will perform its obligations under the contract. We designated this contract as a highly effective cash flow hedge of the floating rate notes under ASC 815. Accordingly, the value of the contract is marked-to-market quarterly, with effective changes in the intrinsic value of the contract included as a separate component of other comprehensive income (loss). The net effect of the hedge is to cap interest payments for $190 million of our debt at a rate of 8.25%, because our floating rate notes incur interest at three-month LIBOR plus 5.25%. As of June 30, 2010, the asset value and fair market value offset one another and the net value is zero.

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, 2010, a 1.0% increase in interest rates on our $293.5 million of floating rate debt would affect annual future earnings and cash flows by approximately $1.0 million. Since the interest on our floating rates notes is based on LIBOR, and LIBOR was less than 1.0% as of June 30, 2010, if LIBOR were to drop to zero, our annual future earnings and cash flows would be affected by approximately $0.4 million. The interest rate on the floating debt as of June 30, 2010, including the effects of the interest rate hedging agreement was 5.59%.

 

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.