Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

For the transition period from          to          .

 

Commission file number 333-75984

 

 

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                            ý                                    No                                o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes                            o                                    No                                ý

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 5,468,814 shares of Common Stock as of May 7, 2004.

 

The number of pages in this Form 10-Q is 40.

 

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

 

INDEX

 

PART I.  FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
	Condensed Consolidated Balance Sheets as of March 31, 2004 and June 30, 2003 (unaudited)
	Condensed Consolidated Statements of Income for the nine months ended March 31, 2004 and 2003 (unaudited)
	Condensed Consolidated Statements of Income for the three months ended March 31, 2004 and 2003 (unaudited)
	Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2004 and 2003 (unaudited)
	Notes to Condensed Consolidated Financial Statements (unaudited)

 

In accordance with SEC Rule 3-10 of Regulation S-X, the consolidated financial statements of InSight Health Services Holdings Corp. (Company) are included herein and separate financial statements of InSight Health Services Corp. (InSight), the Company’s wholly owned subsidiary, and InSight’s subsidiary guarantors are not included.  Condensed financial data for InSight and its subsidiary guarantors is included in Note 12 to the Condensed Consolidated Financial Statements.

 

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4.	CONTROLS AND PROCEDURES
PART II.  OTHER INFORMATION
ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES

 

2

 

ITEM 1.                             FINANCIAL STATEMENTS

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Amounts in thousands, except share data)

 

		March 31, 2004			June 30, 2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	61,109		$	19,554
Trade accounts receivables, net		49,780			46,096
Other current assets		6,631			10,149
Total current assets		117,520			75,799
PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $107,794 and $67,982, respectively		224,030			219,121
INVESTMENTS IN PARTNERSHIPS		2,850			2,734
OTHER ASSETS		20,417			19,371
OTHER INTANGIBLE ASSETS, net		36,237			36,470
GOODWILL		256,182			223,822
		$	657,236		$	577,317
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of notes payable		$	2,520		$	2,009
Current portion of capital lease obligations		5,175			5,696
Accounts payable and other accrued expenses		40,397			35,514
Total current liabilities		48,092			43,219
LONG-TERM LIABILITIES:
Notes payable, less current portion		494,061			420,239
Capital lease obligations, less current portion		15,103			18,175
Other long-term liabilities		4,810			4,070
Total long-term liabilities		513,974			442,484
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Common stock, $.001 par value, 10,000,000 shares authorized, 5,468,814 shares issued and outstanding at March 31, 2004 and June 30, 2003		5			5
Additional paid-in capital		87,081			87,081
Retained earnings		8,166			4,931
Accumulated other comprehensive loss		(82		)	(403		)
Total stockholders’ equity		95,170			91,614
		$	657,236		$	577,317

 

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

 

3

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts in thousands)

 

		Nine Months Ended March 31,
		2004			2003
REVENUES		$	209,454		$	173,055
COSTS OF OPERATIONS:
Costs of services		120,412			90,417
Provision for doubtful accounts		3,333			3,059
Equipment leases		624			770
Depreciation and amortization		42,801			36,292
Total costs of operations		167,170			130,538
Gross profit		42,284			42,517
CORPORATE OPERATING EXPENSES		10,550			9,699
Income from company operations		31,734			32,818
GAIN ON SALE OF CENTER		2,129			—
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS		1,705			1,214
Operating income		35,568			34,032
INTEREST EXPENSE, net		30,175			27,937
Income before income taxes		5,393			6,095
PROVISION FOR INCOME TAXES		2,158			2,438
Net income		$	3,235		$	3,657

 

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

 

4

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts in thousands)

 

		Three Months Ended March 31,
		2004			2003
REVENUES		$	70,736		$	56,134
COSTS OF OPERATIONS:
Costs of services		41,328			30,397
Provision for doubtful accounts		1,098			989
Equipment leases		198			226
Depreciation and amortization		14,556			12,014
Total costs of operations		57,180			43,626
Gross profit		13,556			12,508
CORPORATE OPERATING EXPENSES		3,555			3,378
Income from company operations		10,001			9,130
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS		453			499
Operating income		10,454			9,629
INTEREST EXPENSE, net		9,985			9,201
Income before income taxes		469			428
PROVISION FOR INCOME TAXES		188			171
Net income		$	281		$	257

 

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

 

5

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Amounts in thousands)

 

		Nine Months Ended March 31,
		2004			2003
OPERATING ACTIVITIES:
Net income		$	3,235		$	3,657
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Gain on sale of Center		(2,129		)	—
Depreciation and amortization		42,801			36,292
Changes in operating assets and liabilities, net of assets and liabilities acquired:
Trade accounts receivables, net		(3,225		)	3,054
Other current assets		2,660			1,475
Accounts payable and other accrued expenses		5,092			3,339
Net cash provided by operating activities		48,434			47,817
INVESTING ACTIVITIES:
Acquisition of Centers, Fixed Facilities and Mobile Facilities		(52,834		)	—
Proceeds from sale of Center		5,413			—
Additions to property and equipment		(28,307		)	(39,556		)
Other		(854		)	(439		)
Net cash used in investing activities		(76,582		)	(39,995		)
FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease obligations		(6,174		)	(5,616		)
Proceeds from issuance of notes payable		76,125			—
Other		(248		)	756
Net cash provided by (used in) financing activities		69,703			(4,860		)
INCREASE IN CASH AND CASH EQUIVALENTS		41,555			2,962
Cash, beginning of period		19,554			17,783
Cash, end of period		$	61,109		$	20,745
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid		$	22,680		$	21,337
Income taxes paid (received)		145			(353		)
Equipment additions under capital leases		—			25,455

 

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

 

6

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1.              ORGANIZATION AND NATURE OF BUSINESS

 

InSight Health Services Holdings Corp. (Company), a Delaware corporation, was incorporated on June 13, 2001 under the name JWC/Halifax Holdings Corp.   The Company was funded through an equity contribution from J.W. Childs Equity Partners II, L.P., Halifax Capital Partners, L.P. and certain of their affiliates.  On June 29, 2001, the Company’s name was changed to InSight Health Services Holdings Corp.  The Company and its former wholly owned subsidiary, InSight Health Services Acquisition Corp. (Acquisition Corp.), were created to acquire all the outstanding shares of InSight Health Services Corp. (InSight).  On October 17, 2001, the Company acquired InSight pursuant to an agreement and plan of merger dated June 29, 2001, as amended, among the Company, Acquisition Corp. and InSight (the 2001 Acquisition).

 

The Company, through InSight and its subsidiaries, provides diagnostic imaging, treatment and related management services in 34 states throughout the United States.  The Company has two reportable segments:  the Mobile Division and Fixed-Site Division.  The Company’s services are provided through a network of 93 mobile magnetic resonance imaging (MRI) facilities, 18 mobile positron emission tomography (PET) facilities, four mobile lithotripsy facilities, three mobile computed tomography (CT) facilities (collectively, Mobile Facilities), 56 fixed-site MRI facilities (Fixed Facilities), 32 multi-modality fixed-site imaging centers (Centers), two PET fixed-site centers, one CT fixed-site center, one fixed-site catheterization lab, one Leksell Stereotactic Gamma Knife fixed-site treatment center and one radiation oncology fixed-site center.  Subsequent to March 31, 2004, the Company completed the acquisition of twenty-one (21) Centers and Fixed Facilities located in California, Arizona, Texas, Kansas, Pennsylvania and Virginia, states (other than Kansas) in which the Company already has Mobile Facilities, Fixed Facilities or Centers (Note 11).  The Company has a substantial presence in California, Arizona, New England, the Carolinas, Florida and the Mid-Atlantic states.

 

At its Centers, the Company typically offers other services in addition to MRI, including CT, diagnostic and fluoroscopic x-ray, mammography, diagnostic ultrasound, nuclear medicine, bone densitometry, nuclear cardiology, and cardiovascular services.

 

2.              INTERIM FINANCIAL STATEMENTS

 

The unaudited condensed consolidated financial statements of the Company included herein have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and do not include all of the information and disclosures required by accounting principles generally accepted in the United States for annual financial statements.  These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included as part of the Company’s annual report on Form 10-K for the period ended June 30, 2003 filed with the Securities and Exchange Commission (SEC) on September 26, 2003.  In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for fair presentation of results for the period have been included.  The results of operations for the nine months and three months ended March 31, 2004 are not necessarily indicative of the results to be achieved for the full fiscal year.

 

Certain reclassifications have been made to conform prior year amounts to the current year presentation.

 

3.              INVESTMENTS IN AND TRANSACTIONS WITH PARTNERSHIPS

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.  The Company’s investment interests in partnerships or limited liability companies (Partnerships) are accounted for under the equity method of accounting when the Company’s ownership is 50 percent or less.  The Company’s investment interests in Partnerships are consolidated for ownership of 50 percent or greater owned entities when the Company exercises control over the operations and is primarily responsible for the associated long-term debt.   Total assets as of March 31, 2004 for the Company’s 50 percent controlled entity, which is consolidated, were approximately $2.8 million.  Revenues for the nine and three months ended March 31, 2004 for the Company’s 50 percent controlled entity were approximately $5.5 million and $1.9 million, respectively.

 

7

 

4.              ACQUISITIONS

 

In April 2003, the Company acquired 13 diagnostic imaging centers located in Southern California, which are included in the Fixed-Site Division.  The acquisition consists of certain tangible and intangible assets, including diagnostic imaging equipment, customer contracts and other agreements.  The aggregate purchase price was approximately $46.5 million, which included approximately $39.0 million paid to the seller and the payment of debt and transaction costs of approximately $7.9 million, and is subject to certain post-closing adjustments.  The excess purchase price paid by the Company over its estimates of the fair market value of the tangible and other intangible assets as of the date of acquisition was approximately $25.4 million and is reflected as goodwill in the accompanying consolidated balance sheets.  In accordance with SFAS 141, the new intangible asset balance has been allocated between identifiable intangible assets and remaining goodwill.  The purchase price allocation was based upon evaluations and other studies of the fair value of the net assets acquired.  Goodwill is not amortized but is subject to an ongoing assessment for impairment.

 

In August 2003, the Company acquired 22 Mobile Facilities operating primarily in the Mid-Atlantic states.  The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, customer contracts and other agreements.  The aggregate purchase price was approximately $49.9 million, which included approximately $28.1 million paid to the seller and approximately $21.8 million for the payment of debt and transaction costs.  The excess purchase price paid by the Company over its estimate of the fair value of the tangible and other intangible assets as of the date of the acquisition was approximately $29.1 million and is reflected as goodwill in the accompanying condensed consolidated balance sheet as of March 31, 2004.  In accordance with Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations”, the new intangible asset balance will be allocated between identifiable intangible assets and remaining goodwill.  Goodwill will not be amortized but is subject to an ongoing assessment for impairment.  The determination of the fair value of assets and liabilities as well as the identification of other intangible assets is continuing, and the final allocation may be significantly different.

 

 

Unaudited pro-forma combined results of operations of the Company, assuming the acquisition had occurred as of July 1, 2002, are presented below.  The pro-forma combined results of operations for the nine and three months ended March 31, 2004 and 2003, include pro-forma results of operations for the acquisitions described above and adjustments to interest expense and amortization of identified intangible assets, and the consolidation of certain joint ventures in which the Company purchased a 100% interest.  The pro-forma combined results of operations for the nine and three months ended March 31, 2004 and 2003 contain the use of certain estimates and adjustments to reflect the results of operations for the acquisitions discussed above.  The pro-forma results of operations for the nine and three months ended March 31, 2003 include revenues of $20.5 million and $6.4 million, respectively, and net income of approximately $0.2 million and $0.3 million, respectively, for the acquisition completed in April 2003.  The pro-forma results of operations for the nine and three months ended March 31, 2003 also include revenues of approximately $15.3 million and $5.3 million, respectively, and net income of $1.3 million and $0.2 million, respectively, for the acquisition completed in August 2003.  These combined results have been prepared for comparison purposes only and do not purport to be indicative of what operating results would have been, and may not be indicative of future operating results (amounts in thousands):

 

8

 

		Nine Months Ended March 31,						Three Months Ended March 31,
		2004			2003			2004			2003
		(unaudited)
Revenues		$	211,301		$	208,902		$	70,736		$	67,846
Costs of operations		168,178			156,409			57,180			52,816
Gross profit		43,123			52,493			13,556			15,030
Corporate operating expenses		10,550			13,708			3,555			3,983
Income from company operations		32,573			38,785			10,001			11,047
Gain on sale of Center		2,129			—			—			—
Equity in earnings of unconsolidated partnerships		1,705			1,214			453			499
Operating income		36,407			39,999			10,454			11,546
Interest expense, net		30,347			31,542			9,985			10,176
Income before income taxes		6,060			8,457			469			1,370
Provision for income taxes		2,425			3,382			188			548
Net income		$	3,635		$	5,075		$	281		$	822

 

A reconciliation of goodwill for the nine months ended March 31, 2004 is as follows:

 

		Mobile			Fixed-Site			Consolidated
Goodwill, June 30, 2003		$	79,079		$	144,743		$	223,822
Acquired in acquisitions		29,135			2,953			32,088
Adjustments to goodwill		3			269			272
Goodwill, March 31, 2004		$	108,217		$	147,965		$	256,182

 

5.              NOTES PAYABLE

 

The Company, through InSight, has credit facilities (Credit Facilities) with a bank and a syndication of other lenders consisting of (i) a term loan B, (ii) a $50 million revolving credit facility, and (iii) a $50 million second delayed-draw term loan facility.  In October 2003, a $75 million delayed-draw term loan was combined with a $150 million term loan B.  As of March 31, 2004, there were approximately $220.6 million in borrowings under the term loan B, approximately $25.0 million in borrowings under the second delayed-draw term loan facility and no borrowings under the revolving credit facility.  Borrowings under the Credit Facilities bear interest at LIBOR plus 3.5% to 3.75%. The Company is required to pay an annual unused facility fee of between 0.5% and 2.5%, payable quarterly, on unborrowed amounts under the facilities.  The Company expects to use the revolving credit facility to fund its future working capital needs.

 

The Company, through InSight, also has outstanding $225 million in unsecured senior subordinated notes (Notes).  The Notes bear interest at 9.875%, with principal due November 2011.  Additionally, in March 2004, the Company issued $25 million in a private placement of unsecured senior subordinated notes (New Notes) to partially fund the acquisition of twenty-one (21) Centers and Fixed Facilities in California, Arizona, Texas, Kansas, Pennsylvania and Virginia (Note 11).  The New Notes have terms identical to the Notes, but have not yet been registered with the SEC.

 

Subsequent to March 31, 2004, the Company borrowed the remaining $25 million under the second delayed-draw term loan facility to partially fund the acquisition of 21 Centers and Fixed Facilities in California, Arizona, Texas, Kansas, Pennsylvania and Virginia (Note 11).

 

The credit agreement related to the Credit Facilities and the indenture related to the Notes and the New Notes contain limitations on additional borrowings, capital expenditures, dividend payments and certain financial covenants.  As of March 31, 2004, the Company was in compliance with these covenants.

 

6.              HEDGING ACTIVITIES

 

The Company accounts for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended by SFAS No. 137, SFAS No. 138 and SFAS No. 149 (collectively SFAS 133).  SFAS 133 requires that entities recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value.  Under SFAS 133 an entity may designate a derivative as a hedge of exposure to either changes in:  (i) the fair value of a recognized asset or liability or firm commitment; (ii) cash flows of a recognized or forecasted transaction; or (iii) foreign currencies of a net investment in foreign operations, firm commitments, available-for-sale securities or a forecasted transaction.  Additionally, any ineffective portion of the hedging transaction is recorded currently in net income with the remainder deferred in accumulated other comprehensive income (loss).

 

The Company has established policies and procedures to permit limited types and amounts of hedges to help manage interest rate risk.  InSight has entered into an interest rate swap to pay a fixed rate of interest to the counterparty and

 

9

 

received a floating rate of interest and had designated the interest rate swap as a cash flow hedge of its floating rate debt.  Such swaps have the effect of converting variable rate borrowings into fixed rate borrowings.  Subsequent to the 2001 Acquisition, the Company re-designated the acquired swap as a cash flow hedge and established a new hedging relationship with the Credit Facilities.  At March 31, 2004, the notional amount of this swap was $10.0 million with a fair value loss of approximately $0.2 million.  The swap expires in September 2004.  The fair value of the swap at the time of the 2001 Acquisition was approximately $1.8 million and represented hedge ineffectiveness that will be recognized in net income over the remaining life of the swap.  Approximately $0.4 million of hedge ineffectiveness was recognized as a reduction to interest expense for the nine months ended March 31, 2004.

 

7.              COMPREHENSIVE INCOME (LOSS)

 

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

 

		Nine Months Ended March 31,						Three Months Ended March 31,
		2004			2003			2004			2003
		(unaudited)						(unaudited)
Net Income		$	3,235		$	3,657		$	281		$	257
Unrealized gain (loss) attributable to change in fair value of derivative		321			(280		)	74			80
Comprehensive income		$	3,556		$	3,377		$	355		$	337

 

8.              CAPITAL STOCK

 

The Company accounts for the options issued to employees in accordance with Accounting Principles Board Opinion No. 25, and has adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock Based Compensation”.  SFAS 123 requires that the Company present pro-forma disclosures of net income as if the Company had recognized compensation expense equal to the fair value of options granted, as determined at the date of grant.  On December 31, 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock Based Compensation – Transition and Disclosure”, which amends SFAS 123 and requires more prominent and frequent disclosures about the effects of stock based compensation.  If compensation expense had been recognized, the Company’s net income would have reflected the following pro-forma amounts (amounts in thousands):

 

				Nine Months Ended March 31,						Three Months Ended March 31,
				2004			2003			2004			2003
				(unaudited)						(unaudited)
Net income:		As reported		$	3,235		$	3,657		$	281		$	257
		Expense		(300		)	(300		)	(100		)	(100		)
		Pro-forma		$	2,935		$	3,357		$	181		$	157

 

Options for 27,500 shares were granted during the nine months ended March 31, 2004.  The pro-forma amounts were estimated using the Black-Scholes options-pricing model under the minimum-value method with the following assumptions:

 

Expected term (years)		10
Volatility		0.00		%
Annual dividend per share		$	0.00
Risk-free interest rate		3.99		%
Weighted-average fair value of options granted		$	6.22

 

9.              SEGMENT INFORMATION

 

The Company has two reportable segments:  the Mobile Division and Fixed-Site Division, which are business units defined primarily by the type of service provided.  The Mobile Division operates primarily Mobile Facilities while the Fixed-Site Division operates primarily Centers and Fixed Facilities, although each Division generates both contract services and patient services revenues.  The Company does not allocate corporate and billing related costs, depreciation related to the Company’s billing system and amortization related to other intangible assets to the two segments.  The Company also does not allocate income taxes to the two segments.  The Company manages cash flows and assets on a consolidated basis, and not by segment.

 

10

 

The following tables summarize the operating results by segment for the nine and three months ended March 31, 2004 and 2003 (amounts in thousands)(unaudited):

 

Nine months ended March 31, 2004:

 

		Mobile			Fixed-Site			Other			Consolidated
Revenues		$	84,437		$	125,017		$	—		$	209,454
Depreciation and amortization		21,836			14,955			6,010			42,801
Total costs of operations		63,713			90,879			12,578			167,170
Equity in earnings of unconsolidated partnerships		—			1,705			—			1,705
Operating income (loss)		20,724			37,972			(23,128		)	35,568
Interest expense, net		8,795			5,183			16,197			30,175
Income (loss) before income taxes		11,929			32,789			(39,325		)	5,393
Additions to property and equipment		15,949			9,350			3,008			28,307

 

Nine months ended March 31, 2003:

 

		Mobile			Fixed-Site			Other			Consolidated
Revenues		$	73,913		$	99,142		$	—		$	173,055
Depreciation and amortization		18,132			12,424			5,736			36,292
Total costs of operations		49,950			70,715			9,873			130,538
Equity in earnings of unconsolidated partnerships		84			1,130			—			1,214
Operating income (loss)		24,047			29,557			(19,572		)	34,032
Interest expense, net		8,507			6,240			13,190			27,937
Income (loss) before income taxes		15,540			23,317			(32,762		)	6,095
Additions to property and equipment		21,351			16,831			1,374			39,556

 

Three months ended March 31, 2004:

 

		Mobile			Fixed-Site			Other			Consolidated
Revenues		$	29,027		$	41,709		$	—		$	70,736
Depreciation and amortization		7,710			4,885			1,961			14,556
Total costs of operations		22,618			30,098			4,464			57,180
Equity in earnings of unconsolidated partnerships		—			453			—			453
Operating income (loss)		6,409			12,064			(8,019		)	10,454
Interest expense, net		2,881			1,587			5,517			9,985
Income (loss) before income taxes		3,528			10,477			(13,536		)	469
Additions to property and equipment		2,923			2,659			1,149			6,371

 

Three months ended March 31, 2003:

 

		Mobile			Fixed-Site			Other			Consolidated
Revenues		$	23,523		$	32,611		$	—		$	56,134
Depreciation and amortization		6,054			4,203			1,757			12,014
Total costs of operations		17,048			23,474			3,104			43,626
Equity in earnings of unconsolidated partnerships		—			499			—			499
Operating income (loss)		6,475			9,636			(6,482		)	9,629
Interest expense, net		2,723			1,981			4,497			9,201
Income (loss) before income taxes		3,752			7,655			(10,979		)	428
Additions to property and equipment		2,072			4,435			(344		)	6,163

 

10.       NEW PRONOUNCEMENTS

 

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

 

(1)          Special purpose entities (SPEs) created prior to February 1, 2003:  The Company must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the first interim reporting period ended March 31, 2004.  The Company has completed its assessment and determined that the Company has no SPEs.

 

11

 

(2)          Non-SPEs created prior to February 1, 2003:  The Company is required to adopt FIN 46-R at the end of the first interim reporting period ended March 31, 2004.  The Company did not enter into any significant joint venture or partnership agreements prior to February 1, 2003 which are not included in the consolidated financial statements for the nine months ended March 31, 2004 and 2003.

 

(3)          All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003:  The Company is required to apply the provisions of FIN 46 unless it elects to early adopt the provisions of FIN 46-R as of the first interim reporting period ended March 31, 2004.  If the Company does not elect to early adopt FIN 46-R, then it is required to apply FIN 46-R to these entities as of the end of the first interim reporting period ended March 31, 2004.  The Company did not enter into any SPE, joint venture or partnership agreements subsequent to January 31, 2003 that would have a material impact on the consolidated financial statements for the nine months ended March 31, 2004.

 

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

 

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

 

11.       SUBSEQUENT EVENT

 

Effective April 1, 2004, the Company acquired twenty-one (21) Centers and Fixed Facilities located in California, Arizona, Texas, Kansas, Pennsylvania and Virginia, states (other than Kansas) in which the Company already has Mobile Facilities, Fixed Facilities or Centers.  The aggregate purchase price was approximately $46.5 million, which included $1.2 million of transaction related costs.  The Company paid approximately $35.9 million to the seller and approximately $10.6 million for the payment of debt.   The Company issued $25 million in a private placement of senior subordinated notes and borrowed the remaining $25 million under the second delayed-draw term loan facility to fund the purchase price.

 

12.       SUPPLEMENTAL CONDENSED CONSOLIDATED FINANCIAL INFORMATION

 

InSight’s payment obligations under the Notes and the New Notes (Note 5) are guaranteed by the Company (Parent Company) and all of InSight’s 100% owned subsidiaries (the Guarantor Subsidiaries).  These guarantees are full, unconditional and joint and several.  The following condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 “Financial statements of guarantors and issuers of guaranteed securities registered or being registered.”  The Company accounts for its investment in InSight and its subsidiaries under the equity method of accounting.  Dividends from InSight to the Company are restricted under the Credit Facilities and the indenture relating to the Notes.  This information is not intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with accounting principles generally accepted in the United States.

 

12

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)

MARCH 31, 2004

(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
ASSETS
Current assets:
Cash and cash equivalents		$	—		$	—		$	57,295		$	3,814		$	—		$	61,109
Trade accounts receivables, net		—			—			40,892			8,888			—			49,780
Other current assets		—			—			6,396			235			—			6,631
Intercompany accounts receivable		87,004			495,613			20,270			—			(602,887		)	—
Total current assets		87,004			495,613			124,853			12,937			(602,887		)	117,520
Property and equipment, net		—			—			205,003			19,027			—			224,030
Investments in partnerships		—			—			2,850			—			—			2,850
Investments in consolidated subsidiaries		8,166			8,166			10,306			—			(26,638		)	—
Other assets		—			—			20,312			105			—			20,417
Goodwill and other intangible assets, net		—			—			284,963			7,456			—			292,419
		$	95,170		$	503,779		$	648,287		$	39,525		$	(629,525	)	$	657,236
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of notes payable and capital lease obligations		$	—		$	2,327		$	4,662		$	706		$	—		$	7,695
Accounts payable and other accrued expenses		—			—			39,035			1,362			—			40,397
Intercompany accounts payable		—			—			582,617			20,270			(602,887		)	—
Total current liabilities		—			2,327			626,314			22,338			(602,887		)	48,092
Notes payable and capital lease obligations, less current portion		—			493,036			13,798			2,330			—			509,164
Other long-term liabilities		—			250			9			4,551			—			4,810
Stockholders’ equity		95,170			8,166			8,166			10,306			(26,638		)	95,170
		$	95,170		$	503,779		$	648,287		$	39,525		$	(629,525	)	$	657,236

 

13

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET (unaudited)

JUNE 30, 2003

(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
ASSETS
Current assets:
Cash and cash equivalents		$	—		$	—		$	15,965		$	3,589		$	—		$	19,554
Trade accounts receivables, net		—			—			37,431			8,665			—			46,096
Other current assets		—			—			9,697			452			—			10,149
Intercompany accounts receivable		86,683			422,248			21,661			—			(530,592		)	—
Total current assets		86,683			422,248			84,754			12,706			(530,592		)	75,799
Property and equipment, net		—			—			196,792			22,329			—			219,121
Investments in partnerships		—			—			2,734			—			—			2,734
Investments in consolidated subsidiaries		4,931			4,931			10,572			—			(20,434		)	—
Other assets		—			—			19,201			170			—			19,371
Goodwill and other intangible assets, net		—			—			255,789			4,503			—			260,292
		$	91,614		$	427,179		$	569,842		$	39,708		$	(551,026	)	$	577,317
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of notes payable and capital lease obligations		$	—		$	2,009		$	5,218		$	478		$	—		$	7,705
Accounts payable and other accrued expenses		—			—			34,449			1,065			—			35,514
Intercompany accounts payable		—			—			508,932			21,660			(530,592		)	—
Total current liabilities		—			2,009			548,599			23,203			(530,592		)	43,219
Notes payable and capital lease obligations, less current portion		—			420,239			16,230			1,945			—			438,414
Other long-term liabilities		—			—			82			3,988			—			4,070
Stockholders’ equity		91,614			4,931			4,931			10,572			(20,434		)	91,614
		$	91,614		$	427,179		$	569,842		$	39,708		$	(551,026	)	$	577,317

 

14

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)

FOR THE NINE MONTHS ENDED MARCH 31, 2004

(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATION			CONSOLIDATED
Revenues		$	—		$	—		$	173,214		$	36,240		$	—		$	209,454
Costs of operations		—			—			135,600			31,570			—			167,170
Gross profit		—			—			37,614			4,670			—			42,284
Corporate operating expenses		—			—			10,550			—			—			10,550
Income from company operations		—			—			27,064			4,670			—			31,734
Gain on sale of Center		—			—			2,129			—			—			2,129
Equity in earnings of unconsolidated partnerships		—			—			1,705			—			—			1,705
Operating income		—			—			30,898			4,670			—			35,568
Interest expense, net		—			—			28,993			1,182			—			30,175
Income before income taxes		—			—			1,905			3,488			—			5,393
Provision for income taxes		—			—			2,158			—			—			2,158
Income (loss) before equity in income of consolidated subsidiaries		—			—			(253		)	3,488			—			3,235
Equity in income of consolidated subsidiaries		3,235			3,235			3,488			—			(9,958		)	—
Net income		$	3,235		$	3,235		$	3,235		$	3,488		$	(9,958	)	$	3,235

 

15

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)
FOR THE NINE MONTHS ENDED MARCH 31, 2003
(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATION			CONSOLIDATED
Revenues		$	—		$	—		$	140,601		$	32,454		$	—		$	173,055
Costs of operations		—			—			102,997			27,541			—			130,538
Gross profit		—			—			37,604			4,913			—			42,517
Corporate operating expenses		—			—			9,699			—			—			9,699
Income from company operations		—			—			27,905			4,913			—			32,818
Equity in earnings of unconsolidated partnerships		—			—			1,214			—			—			1,214
Operating income		—			—			29,119			4,913			—			34,032
Interest expense, net		—			—			26,462			1,475			—			27,937
Income before income taxes		—			—			2,657			3,438			—			6,095
Provision for income taxes		—			—			2,438			—			—			2,438
Income before equity in income of consolidated subsidiaries		—			—			219			3,438			—			3,657
Equity in income of consolidated subsidiaries		3,657			3,657			3,438			—			(10,752		)	—
Net income		$	3,657		$	3,657		$	3,657		$	3,438		$	(10,752	)	$	3,657

 

16

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2004
(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATION			CONSOLIDATED
Revenues		$	—		$	—		$	58,394		$	12,342		$	—		$	70,736
Costs of operations		—			—			46,547			10,633			—			57,180
Gross profit		—			—			11,847			1,709			—			13,556
Corporate operating expenses		—			—			3,555			—			—			3,555
Income from company operations		—			—			8,292			1,709			—			10,001
Equity in earnings of unconsolidated partnerships		—			—			453			—			—			453
Operating income		—			—			8,745			1,709			—			10,454
Interest expense, net		—			—			9,619			366			—			9,985
Income (loss) before income taxes		—			—			(874		)	1,343			—			469
Provision for income taxes		—			—			188			—			—			188
Income (loss) before equity in income of consolidated subsidiaries		—			—			(1,062		)	1,343			—			281
Equity in income of consolidated subsidiaries		281			281			1,343			—			(1,905		)	—
Net income		$	281		$	281		$	281		$	1,343		$	(1,905	)	$	281

 

17

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2003
(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATION			CONSOLIDATED
Revenues		$	—		$	—		$	45,393		$	10,741		$	—		$	56,134
Costs of operations		—			—			34,406			9,220			—			43,626
Gross profit		—			—			10,987			1,521			—			12,508
Corporate operating expenses		—			—			3,378			—			—			3,378
Income from company operations		—			—			7,609			1,521			—			9,130
Equity in earnings of unconsolidated partnerships		—			—			499			—			—			499
Operating income		—			—			8,108			1,521			—			9,629
Interest expense, net		—			—			8,742			459			—			9,201
Income (loss) before income taxes		—			—			(634		)	1,062			—			428
Provision for income taxes		—			—			171			—			—			171
Income (loss) before equity in income of consolidated subsidiaries		—			—			(805		)	1,062			—			257
Equity in income of consolidated subsidiaries		257			257			1,062			—			(1,576		)	—
Net income		$	257		$	257		$	257		$	1,062		$	(1,576	)	$	257

 

18

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED MARCH 31, 2004

(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income		$	3,235		$	3,235		$	3,235		$	3,488		$	(9,958	)	$	3,235
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Gain on sale of Center		—			—			(2,129		)	—			—			(2,129		)
Depreciation and amortization		—			—			38,680			4,121			—			42,801
Equity in income of consolidated subsidiaries		(3,235		)	(3,235		)	(3,488		)	—			9,958			—
Changes in operating assets and liabilities, net of assets and liabilities acquired:
Trade accounts receivables, net		—			—			(3,002		)	(223		)	—			(3,225		)
Intercompany receivables, net		—			(72,627		)	80,725			(8,098		)	—			—
Other current assets		—			—			2,443			217			—			2,660
Accounts payable and other accrued expenses		—			—			4,795			297			—			5,092
Net cash provided by (used in) operating activities		—			(72,627		)	121,259			(198		)	—			48,434
INVESTING ACTIVITIES:
Acquisitions of Centers, Fixed Facilities and Mobile Facilities		—			—			(52,834		)	—			—			(52,834		)
Proceeds from sale of Center		—			—			5,413			—			—			5,413
Additions to property and equipment		—			—			(27,553		)	(754		)	—			(28,307		)
Other		—			—			(854		)	—			—			(854		)
Net cash used in investing activities		—			—			(75,828		)	(754		)	—			(76,582		)
FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease obligations		—			(1,635		)	(4,028		)	(511		)	—			(6,174		)
Proceeds from issuance of notes payable		—			75,000			—			1,125			—			76,125
Other		—			(738		)	(73		)	563			—			(248		)
Net cash provided by (used in) financing activities		—			72,627			(4,101		)	1,177			—			69,703
INCREASE IN CASH AND CASH EQUIVALENTS		—			—			41,330			225			—			41,555
Cash, beginning of period		—			—			15,965			3,589			—			19,554
Cash, end of period		$	—		$	—		$	57,295		$	3,814		$	—		$	61,109

 

19

 

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED MARCH 31, 2003
(Amounts in thousands)

 

		PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income		$	3,657		$	3,657		$	3,657		$	3,438		$	(10,752	)	$	3,657
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		—			—			32,057			4,235			—			36,292
Equity in income of consolidated subsidiaries		(3,657		)	(3,657		)	(3,438		)	—			10,752			—
Changes in operating assets and liabilities, net of assets and liabilities acquired:
Trade accounts receivables, net		—			—			3,124			(70		)	—			3,054
Intercompany receivables, net		—			1,125			3,511			(4,636		)	—			—
Other current assets		—			—			1,554			(79		)	—			1,475
Accounts payable and other accrued expenses		—			—			3,300			39			—			3,339
Net cash provided by operating activities		—			1,125			43,765			2,927			—			47,817
INVESTING ACTIVITIES:
Additions to property and equipment		—			—			(36,111		)	(3,445		)	—			(39,556		)
Other		—			—			(439		)	—			—			(439		)
Net cash used in investing activities		—			—			(36,550		)	(3,445		)	—			(39,995		)
FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease obligations		—			(1,125		)	(4,182		)	(309		)	—			(5,616		)
Other		—			—			(83		)	839			—			756
Net cash provided by (used in) financing activities		—			(1,125		)	(4,265		)	530			—			(4,860		)
INCREASE IN CASH AND CASH EQUIVALENTS		—			—			2,950			12			—			2,962
Cash, beginning of period		—			—			14,451			3,332			—			17,783
Cash, end of period		$	—		$	—		$	17,401		$	3,344		$	—		$	20,745

 

20

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

InSight Health Services Holdings Corp. (“Company”), a Delaware corporation, was incorporated on June 13, 2001 under the name JWC/Halifax Holdings Corp.   The Company was funded through an equity contribution from J.W. Childs Equity Partners II, L.P., Halifax Capital Partners, L.P. and certain of their affiliates.  On June 29, 2001, the Company’s name was changed to InSight Health Services Holdings Corp.  The Company and its former wholly owned subsidiary, InSight Health Services Acquisition Corp. (“Acquisition Corp.”), were created to acquire all the outstanding shares of InSight Health Services Corp. (“InSight”).  On October 17, 2001, the Company acquired InSight pursuant to an agreement and plan of merger dated June 29, 2001, as amended, among the Company, Acquisition Corp. and InSight (the “Acquisition”).

 

OPERATIONS

 

The Company, through InSight and its subsidiaries, provides diagnostic imaging, treatment and related management services in 34 states throughout the United States.  The Company has two reportable segments:  the Mobile Division and Fixed-Site Division.  The Company’s services are provided through a network of 93 mobile magnetic resonance imaging (MRI) facilities, 18 mobile positron emission tomography (PET) facilities, four mobile lithotripsy facilities, three mobile computed tomography (CT) facilities (collectively, Mobile Facilities), 56 fixed-site MRI facilities (Fixed Facilities), 32 multi-modality fixed-site imaging centers (Centers), two PET fixed-site centers, one CT fixed-site center, one fixed-site catheterization lab, one Leksell Stereotactic Gamma Knife fixed-site treatment center and one radiation oncology fixed-site center.  Subsequent to March 31, 2004, the Company completed the acquisition of twenty-one (21) Centers and Fixed Facilities located in California, Arizona, Texas, Kansas, Pennsylvania and Virginia, states (other than Kansas) in which the Company already has Mobile Facilities, Fixed Facilities or Centers.  The Company has a substantial presence in California, Arizona, New England, the Carolinas, Florida and the Mid-Atlantic states.

 

At its Centers, the Company typically offers other services in addition to MRI, including CT, diagnostic and fluoroscopic x-ray, mammography, diagnostic ultrasound, nuclear medicine, bone densitometry, nuclear cardiology, and cardiovascular services.

 

BUSINESS DEVELOPMENT

 

The Company’s objective is to be the leading provider of outsourced diagnostic imaging services in its target markets by further developing and expanding its regional diagnostic imaging networks that emphasize quality of care, produce cost-effective diagnostic information and provide superior service and convenience to its customers.  The strategy is focused on three components.   Firstly, the Company intends to maximize utilization of its existing facilities by:  (i) broadening its physician referral base and generating new sources of revenues through selective marketing activities; (ii) focusing its marketing efforts on attracting additional managed care customers; (iii) focusing on its ability to convert Mobile Facilities to Fixed Facilities; (iv) expanding current imaging applications of existing modalities to increase overall procedure volume; and (v) maximizing cost efficiencies through increased purchasing power and continued reduction of expenses.

 

Secondly, the Company intends to pursue expansion opportunities within its existing regional networks by opening new Fixed Facilities and Centers and developing Mobile Facilities where attractive returns on investment can be achieved and sustained.  In addition, management believes that Mobile PET Facilities present a growth opportunity due to increased physician acceptance of PET as a diagnostic tool, expanded Medicare coverage of PET procedures and favorable reimbursement levels.  The Company also intends to pursue joint venture opportunities with hospitals because management believes that they have the potential to provide the Company with a steady source of procedure volume.  Management believes that this will be an area for growth because the Company expects hospitals and other health care providers to respond to recent federal health care regulatory changes by outsourcing radiology services to imaging centers that are jointly owned and managed with third parties, notwithstanding the Special Advisory Bulletin issued by the Office of the Inspector General (“OIG”) on April 23, 2003 that raised concerns throughout the health care industry about the legality of provider joint ventures and other contractual agreements.  According to the OIG Bulletin, the suspect arrangement involves a health care provider expanding into a related service line by contracting with an existing provider of that service (“Supplier”) to serve the provider’s existing patient population.  In the OIG’s view, the provider contracts out the entire operation of a related line of business to what would otherwise be a

 

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competitor.  The OIG asserts that the provider’s share of the profits from the new venture constitutes remuneration for the referral of the provider’s Medicare/Medicaid patients to the Supplier and may violate the federal anti-kickback statute.  The Company believes that providers contemplating participation in joint ventures will be carefully reviewing the OIG’s Bulletin to ensure compliance, but that the Bulletin will not have the effect of prohibiting joint ventures between providers.

 

Finally, the Company intends to continue to increase its market presence in its existing regional markets where it can increase economies of scale or new markets where it believes it can establish a strong regional network, through disciplined and strategic acquisitions.  The Company believes it is well positioned to capitalize on the ongoing consolidation of the imaging industry.  The Company believes that the expansion of its business through such acquisitions is a key factor in improving profitability.  The Company expects to pursue acquisitions of one or more individual centers which will round out its existing expanded regional markets.  No assurance can be given, however, that the Company will be able to identify suitable acquisition candidates, raise any necessary additional financing and thereafter complete such acquisitions on terms acceptable to the Company.  Since 1996, the Company has completed 16 acquisitions, including the acquisition completed on April 1, 2004.  The Company has a $50 million second delayed-draw term loan facility, of which $25 million was still available as of March 31, 2004.  In April 2004, the Company borrowed the remaining $25 million to complete the April 2004 acquisition discussed below.

 

In fiscal 2003, the Company opened a joint venture Fixed Facility in Encinitas, California, which was financed with internally generated funds and a capital lease; a Fixed Facility in Lemont, Illinois, which was financed with internally generated funds; a Fixed Facility in Fremont, California, which was financed with internally generated funds; and a joint venture Fixed Facility in Brunswick, Maine, which was financed with internally generated funds.

 

In fiscal 2003, the Company also acquired thirteen (13) Centers and Fixed Facilities located in Southern California.  The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, customer contracts and other agreements.  The aggregate purchase price was approximately $47 million, which included approximately $39 million paid to the seller and the payment of debt and transaction costs of approximately $8 million.  The Company borrowed $50 million under a $75 million delayed-draw term loan facility to fund the purchase price and future capital expenditures related to the acquisition.

 

In August 2003, the Company acquired twenty-two (22) Mobile Facilities primarily operating in the Mid-Atlantic states.  The acquisition consisted of certain tangible assets, including diagnostic imaging equipment, customer contracts and other agreements.  The aggregate purchase price was approximately $49.9 million, which included approximately $28.1 million paid to the seller and approximately $21.8 million for the payment of debt and transaction costs.  The Company borrowed the remaining $25 million under a $75 million delayed-draw term loan facility and $25 million under a $50 million second delayed-draw term loan facility to fund the purchase price and future capital expenditures related to the acquisition.

 

In August 2003, the Company acquired a joint venture interest in a CT Fixed Facility located in Hammonton, New Jersey, which was financed with internally generated funds.  In December 2003, the Company sold a Center located in Hobart, Indiana.  In February 2004, the Company acquired the remaining interest in one of its partnership investments in a Center in Henderson, Nevada.

 

Effective April 1, 2004, the Company acquired twenty-one (21) Centers and Fixed Facilities located in California, Arizona, Texas, Kansas, Pennsylvania and Virginia, states (other than Kansas) in which the Company already has Mobile Facilities, Fixed Facilities or Centers.  The aggregate purchase price was approximately $46.5 million, which included $1.2 million of transaction costs.  The Company paid approximately $35.9 million to the seller and approximately $10.6 million for the payment of debt.  The Company issued $25 million in a private placement of senior subordinated notes and borrowed the remaining $25 million under the second delayed-draw term loan facility to fund the purchase price and future capital expenditures related to the acquisition.

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

The Company operates in a capital intensive, high fixed cost industry that requires significant amounts of working capital to fund operations, particularly the initial start-up and development expenses of new operations and yet is constantly under external pressure from both customers and competitors to contain costs and reduce prices.

 

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The Company, through InSight, has credit facilities with Bank of America, N.A. and a syndication of other lenders consisting of:  (i) a term loan B, (ii) a $50 million revolving credit facility, and (iii) a $50 million second delayed-draw term loan facility (“Credit Facilities”).  In October 2003, a $75 million delayed-draw term loan was combined with a $150 million term loan B.  Borrowings under the Credit Facilities bear interest at LIBOR plus 3.5% to 3.75%.  The Company is required to pay an annual unused facility fee of between 0.5% and 2.5%, payable quarterly, on unborrowed amounts under these facilities.  The Company paid approximately $0.7 million during the nine months ended March 31, 2004 for unused facility fees on unborrowed amounts under the facilities.  The Company used the $75 million delayed-draw term loan facility and the $50 million second delayed-draw loan facility to complete certain acquisitions discussed above.  The Company expects to use the revolving credit facility primarily to fund its future working capital needs.  As of May 7, 2004, there were no borrowings under the revolving credit facility.

 

In addition to the indebtedness under the Credit Facilities, the Company, through InSight, has outstanding $225 million of 9 7/8% senior subordinated notes (the “Notes”).  Additionally, in March 2004, the Company issued $25 million in a private placement of senior subordinated notes (the "New Notes") with identical terms as the Notes.  The Notes and the New Notes mature in November 2011, with interest payable semi-annually and are redeemable at the option of the Company, in whole or in part, on or after November 1, 2006.  At any time prior to November 1, 2004, the Company may redeem up to 35% of the Notes and the New Notes at a specified redemption price if the Company is involved in an initial public offering of its capital stock.  The Notes and the New Notes are unsecured senior obligations of the Company and are subordinated in right of payment to all existing and future indebtedness, as defined in the indenture, of the Company, including borrowings under the Credit Facilities described above.  The indenture governing the Notes and the New Notes among other things:  (i) restricts the ability of InSight and certain subsidiaries, including the guarantors of the Notes and the New Notes, to incur additional indebtedness, issue shares of preferred stock, incur liens, pay dividends or make certain other restricted payments and enter into certain transactions with affiliates; (ii) places certain restrictions on the ability of certain subsidiaries, including the guarantors of the Notes and the New Notes, to pay dividends or make certain payments to InSight; and (iii) places restrictions on the ability of InSight and certain subsidiaries, including the guarantors of the Notes and the New Notes, to merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the assets of InSight.

 

The credit agreement related to the Credit Facilities and the indenture related to the Notes and the New Notes contain certain covenants which require the Company to maintain specified financial ratios and satisfy financial condition tests, including debt leverage, interest and fixed charge coverage ratios.  The Credit Facilities also contain various restrictive covenants which prohibit the Company from prepaying other indebtedness, including the Notes.  In addition, the Credit Facilities prohibit the Company from declaring or paying any dividends and prohibit it from making any payments with respect to the Notes and the New Notes if the Company fails to perform its obligations under, or fails to meet the conditions of, the Credit Facilities or if payment creates a default under the Credit Facilities.  As of March 31, 2004, the Company was in compliance with these covenants.

 

Cash and cash equivalents as of March 31, 2004 were approximately $61.1 million.  Net cash provided by operating activities was approximately $48.4 million for the nine months ended March 31, 2004.  Cash provided by operating activities resulted primarily from net income before depreciation and amortization and the gain on sale of Center described above (approximately $43.9 million), an increase in accounts payable and other accrued expenses (approximately $5.1 million), a decrease in other current assets (approximately $2.7 million), partially offset by an increase in trade accounts receivables, net (approximately $3.2 million).

 

Net cash used in investing activities was approximately $76.6 million for the nine months ended March 31, 2004.  Cash used in investing activities resulted primarily from the Company’s acquisitions of Mobile and Fixed Facilities and Centers (approximately $52.8 million), the purchase or upgrading of diagnostic imaging equipment at its existing facilities (approximately $28.3 million) and deferred acquisition costs related to the April 1, 2004 acquisition discussed above (approximately $0.9 million), partially offset by proceeds from the sale of Center described above (approximately $5.4 million).

 

Net cash provided by financing activities was approximately $69.7 million for the nine months ended March 31, 2004.  Cash provided by financing activities resulted primarily from borrowings of notes payable (approximately $76.1 million), partially offset by principal payments of notes payable and capital lease obligations (approximately $6.2 million).

 

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The Company has committed to purchase or lease in connection with the development of new Fixed and Mobile Facilities and replacement of diagnostic imaging equipment at Centers, Fixed and Mobile Facilities, at an aggregate cost of approximately $5.4 million, four diagnostic imaging systems for delivery through August 2004.  The Company expects to use either internally generated funds, its Credit Facilities or leases to finance the purchase of such equipment.  The Company 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 Centers, Fixed and Mobile Facilities are developed in accordance with the Company’s business strategy.

 

The Company’s contractual obligations for long-term debt, capital lease obligations and noncancelable operating leases as of March 31, 2004 are as follows (amounts in thousands):

 

					Payments Due by Period
		Total			Less than 1 Year			1-3 Years			4-5 Years			After 5 Years
Notes payable		$	496,581		$	2,520		$	5,452		$	238,609		$	250,000
Capital lease obligations		20,278			5,175			10,657			4,347			99
Operating lease obligations		37,882			7,167			12,989			8,946			8,780
Purchase commitments		5,375			5,375			—			—			—
Total contractual obligations		$	560,116		$	20,237		$	29,098		$	251,902		$	258,879

 

In addition, in connection with the implementation of the electronic transactions, security and privacy standards mandated by the Health Insurance Portability and Accountability Act (“HIPAA”), the Company has spent approximately $1.1 million as of March 31, 2004 to make necessary software upgrades to its radiology information system to make the system conform with the privacy and electronic standards.  The Company expects to spend an additional $0.4 million to conform with the security standards by February 2005.

 

The Company believes that, based on current levels of operations and anticipated growth, its cash from operations, together with amounts available under existing Credit Facilities, will be sufficient through the foreseeable future to fund anticipated capital expenditures and make required payments of principal and interest on its debt, including payments due on the Notes and obligations under the Credit Facilities.  In addition, the Company has funded its acquisitions from its available sources of liquidity, as discussed above,  however, any further acquisition activity will require additional sources of capital.  No assurance can be given that such necessary additional funds will be available to the Company on terms acceptable to the Company or at all.

 

RESULTS OF OPERATIONS

 

The Company’s revenues are primarily generated from contract services and patient services revenues.  Contract services revenues are generally earned from services billed to a hospital or other health care provider which include: (i) fee for-service arrangements in which revenues are based upon a contractual rate per procedure; (ii) equipment rental in which revenues are generally based upon a fixed rental amount; and (iii) management fees.  Contract services revenues are primarily earned through Mobile Facilities and certain Fixed Facilities and are generally paid pursuant to hospital contracts with a term of up to five years.

 

Patient services revenues are generally earned from services billed directly to patients or third-party payors (generally managed care organizations, Medicare, Medicaid, commercial insurance carriers and workers’ compensation funds), on a fee-for-service basis and are primarily earned through Centers, Fixed Facilities and certain Mobile Facilities.

 

The Company has two reportable segments:  the Mobile Division and Fixed-Site Division, which are business units defined primarily by the type of service provided.  The Mobile Division operates primarily Mobile Facilities while the Fixed-Site Division operates primarily Centers and Fixed Facilities, although each Division generates both contract services and patient services revenues.  The Company does not allocate corporate and billing related costs, depreciation related to the Company’s billing system and amortization related to other intangible assets to the two segments.  The Company also does not allocate income taxes to the two segments.  The Company manages cash flows and assets on a consolidated basis, and not by segment.

 

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The Company’s revenues are affected by seasonality.  Revenues for the second and third fiscal quarters can be affected by holidays and inclement weather in certain areas of the United States where the Company has Centers, Fixed Facilities and Mobile Facilities, which can result in lower utilization during the period.  Due to the fixed nature of certain of the Company’s costs, lower utilization directly impacts the Company’s operating income.

 

In addition, during the nine months ended March 31, 2004, revenues at Mobile Facilities were adversely impacted by (i) increased competition from original equipment manufacturers that are selling imaging systems to certain of the Company’s high volume customers, which has resulted in a decrease in contract renewals; (ii) the Company’s hospital mobile customers have reported reduced inpatient volumes, which has affected the revenues at certain Mobile Facilities which have fee-for-service arrangements; (iii) a decrease in the Company’s short-term rental activities; and (iv) an increase in the number of fixed rental contracts.  Additionally, during the nine months ended March 31, 2004, revenues at Centers and Fixed Facilities were adversely impacted by (i) increased pre-authorization requirements by certain managed care payors; (ii) a decrease in managed care enrollment; (iii) increased deductibles and co-payments, and (iv) increased competition, all of which have resulted in lower utilization.  There can be no assurance that these factors will not continue to have an adverse effect on the Company’s financial condition and results of operations.

 

NINE MONTHS ENDED MARCH 31, 2004 AND 2003

 

REVENUES:  Revenues increased approximately 21.0% from approximately $173.1 million for the nine months ended March 31, 2003, to approximately $209.5 million for the nine months ended March 31, 2004.  This increase was due to an increase in revenues at the Mobile Division (approximately $10.5 million) and an increase in revenues at the Fixed-Site Division (approximately $25.9 million).   Revenues for the Mobile Division and the Fixed-Site Division represented approximately 40% and 60%, respectively, of total revenues for the nine months ended March 31, 2004.  However, the percentages will be affected by future acquisitions and the establishment of Centers, Fixed and Mobile Facilities.

 

Revenues at the Mobile Division increased approximately 14.2% from approximately $73.9 million for the nine months ended March 31, 2003, to approximately $84.4 million for the nine months ended March 31, 2004.  The increase was due to the August 2003 acquisition of Mobile Facilities discussed above (approximately $15.0 million), partially offset by reduced revenues associated with the Company’s short-term rental activities (approximately $1.4 million) and reduced revenues at the Company’s existing Mobile Facilities (approximately $3.0 million).  The decrease at the Company’s existing Mobile Facilities was due primarily to terminated high volume customer contracts, partially offset by an increase in volume at replacement accounts, which initially have lower volumes.

 

Revenues at the Fixed-Site Division increased approximately 26.1% from approximately $99.1 million for the nine months ended March 31, 2003, to approximately $125.0 million for the nine months ended March 31, 2004.  The increase was due to (i) the fiscal 2003 acquisition discussed above (approximately $20.1 million); (ii) revenues at the Fixed Facilities opened in 2003 discussed above (approximately $2.7 million) and (iii) revenues at existing Fixed Facilities and Centers (approximately $3.7 million), partially offset by a decrease in revenues from the sale of a Center discussed above (approximately $0.6 million).  The increased revenue of existing facilities was the result of a 1% increase in reimbursement from third-party payors, partially offset by a nominal decrease in utilization.

 

Approximately 46% of the Company’s total revenues for the nine months ended March 31, 2004 were generated from contract services revenues.  Contract services revenues for the Mobile Division and Fixed-Site Division represented approximately 87% and 13%, respectively, of contract services revenues for the nine months ended March 31, 2004.  Approximately 49% of the Company's total revenues for the nine months ended March 31, 2003 were generated from contract services revenue.  Contract services revenue for the Mobile Division and Fixed-Site Division represented approximately 86% and 14%, respectively, of contract services revenues for the nine months ended March 31, 2003.  However, the percentages will be affected by future acquisitions and the establishment of Centers, Fixed and Mobile Facilities.  Each year approximately one-third of the contract services agreements are subject to renewal.  It is expected 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.  In the past, where agreements have not been renewed, the Company has been able to obtain replacement contracts.  While some replacement accounts have initially been smaller than the lost accounts, such replacement accounts’ revenues have generally increased over the term of the agreement.  The nonrenewal of a single customer agreement would not have a material adverse impact on the Company’s contract services revenues; however, non-renewal of several contracts could have a material adverse impact on contract services revenues.

 

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The Centers for Medicare and Medicaid Services (“CMS”) has implemented a prospective payment system for hospital outpatient services (“OPPS”).  As a result of the implementation of the OPPS, effective August 1, 2000, Medicare began paying hospitals, except cancer and children’s hospitals, for outpatient services based on ambulatory payment classification (“APC”) groups rather than on a hospital’s costs.  Because the OPPS appeared to have a severe adverse economic effect on hospitals, Congress enacted additional legislation in the Balanced Budget Refinement Act of 1999 (“BBRA”) to soften the negative financial effects.  Under the BBRA, hospitals may receive additional payments for new technologies, transitional pass-through for innovative medical devices, drugs and biologics, outlier adjustments and transitional payment corridor adjustments through 2003.  In addition, the Benefits Improvement and Protection Act of 2000 included certain provisions requiring CMS to revise the APCs to separate contrast-enhanced diagnostic imaging procedures from those that are not contrast-enhanced.   Effective January 1, 2003, CMS reduced the payment for unenhanced diagnostic procedures and increased payment for contrast-enhanced diagnostic procedures.  The extent to which this disparity in reimbursement will continue is unclear.   For 2004, CMS changed certain CT, MRI and ultrasound guidance procedures from a bundled status to separately payable.  The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, enacted on December 8, 2003, made additional changes to OPPS.  There will be reductions in payments for outpatient drugs, including radiopharmaceutical agents that had transitional pass-through status on or before March 31, 2004, and separately payable drugs will be excluded from outlier payments.

 

As a result of the implementation of the OPPS, the Company believes that its hospital customers may seek reductions in contractual rates to the extent the hospital believes it will pay more to the Company than it will receive from Medicare and other third-party payors.  To date, no material reductions have been sought.  The reduction of contractual rates for a single customer or loss of a single customer to a competitor prepared to reduce contractual rates would not have a material adverse impact on the Company’s contract services revenues; however, the reduction in contractual rates for several customers or loss of several contracts could have a material adverse impact on the Company’s business, financial condition and results of operations.

 

On the other hand, the Company believes that the impact of the OPPS on hospital payments for diagnostic imaging services, especially for MRI and CT services, may cause hospitals to consider restructuring their diagnostic outpatient imaging services as freestanding centers which are unaffected by the OPPS.  Notwithstanding the OIG’s Special Advisory Bulletin discussed above, this may provide the Company with additional opportunities for joint ventures which involve the joint ownership and management of single and multi-modality imaging centers with hospitals.  Given the complexity of the OPPS, it is difficult to determine whether hospitals will be receiving less reimbursement from Medicare (after they take advantage of the transitional payments that may be available under the BBRA) in 2004 and later years than they did in 2003, and to what extent they will attempt to renegotiate existing contractual arrangements.

 

Approximately 54% of the Company’s total revenues for the nine months ended March 31, 2004 were generated from patient services revenues. Patient services revenues for the Mobile Division and Fixed-Site Division represented approximately 1% and 99%, respectively, of patient services revenues for the nine months ended March 31, 2004.  Approximately 51% of the Company's total revenues for the nine months ended March 31, 2003 were generated from patient services revenues.  Patient services revenues for the Mobile Division and Fixed-Site Division represented approximately 2% and 98%, respectively, of patient services revenues for the nine months ended March 31, 2003.  However, the percentages will be affected by future acquisitions and the establishment of Centers, Fixed and Mobile Facilities.  The Company believes its patient services revenues received from Medicare will not be materially impacted by the OPPS because it primarily operates freestanding Fixed Facilities and Centers which are unaffected thereby.

 

The Company’s Fixed Facilities and Centers are principally dependent on the Company’s ability (either directly or indirectly through its hospital customers) to attract referrals from physicians and other health care providers representing a variety of specialties.  The Company’s eligibility to provide service in response to a referral is often dependent on the existence of a contractual arrangement with the referred patient’s insurance carrier (primarily if the insurance is provided by a managed care organization).  The Company currently has approximately 1,000 contracts with managed care organizations for diagnostic imaging services provided at the Company’s Fixed Facilities and Centers primarily on a discounted fee-for-service basis.  Managed care contracting has become very competitive and reimbursement schedules are at or below Medicare reimbursement levels.  A significant decline in referrals and/or reimbursement rates would adversely impact the Company’s business, financial condition and results of operations.

 

Management believes that any future increases in revenues can only be achieved by higher utilization and not by increases in procedure prices; however, slower start-ups of new operations, excess capacity of diagnostic imaging equipment, competition, and the expansion of managed care may impact utilization and make it difficult for the

 

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Company to achieve revenue increases in the future, absent the execution of provider agreements with managed care companies and other payors, and the execution of the Company’s business strategy.

 

COSTS OF OPERATIONS:  Costs of operations increased approximately 28.0% from approximately $130.5 million for the nine months ended March 31, 2003, to approximately $167.2 million for the nine months ended March 31, 2004.  This increase was due primarily to (i) the fiscal 2003 and 2004 acquisitions discussed above (approximately $24.7 million), (ii) costs at the Fixed Facilities opened in 2003 (approximately $2.6 million), and (iii) increased costs at existing facilities (approximately $9.8 million), partially offset by reduced costs from the sale of a Center discussed above (approximately $0.4 million).  The increase at existing facilities is due primarily to higher salaries and benefits, equipment maintenance costs, insurance and depreciation expense, partially offset by reduced medical supply costs, equipment lease costs and provision for doubtful accounts.

 

Costs of operations at the Mobile Division increased approximately 27.6% from approximately $50.0 million for the nine months ended March 31, 2003, to approximately $63.7 million for the nine months ended March 31, 2004.  The increase was due to (i) the fiscal 2004 acquisition of Mobile Facilities discussed above (approximately $9.8 million), (ii) higher salaries and benefits and vehicle operations costs as a result of the reduction in the Company’s short-term rental activities, (iii) higher salaries and benefits, equipment maintenance costs, insurance, depreciation expense, and (iv) an increase in the Company’s mobile sales personnel, partially offset by reduced equipment lease costs.

 

Costs of operations at the Fixed-Site Division increased approximately 28.5% from approximately $70.7 million for the nine months ended March 31, 2003, to approximately $90.9 million for the nine months ended March 31, 2004.  The increase was due primarily to (i) the fiscal 2003 acquisition discussed above (approximately $14.9 million), (ii) costs at the Fixed Facilities opened in 2003 (approximately $2.3 million), and (iii) higher salaries and benefits, equipment maintenance and insurance costs, partially offset by reduced medical supply costs as the result of more favorable pricing and provision for doubtful accounts at the Company’s existing facilities.  The increase in costs was partially offset by reduced costs from the sale of a Center discussed above (approximately $0.4 million).

 

Costs of operations, as a percentage of total revenues, increased from approximately 75.4% for the nine months ended March 31, 2003, to approximately 79.8% for the nine months ended March 31, 2004.  The percentage increase is primarily due to the higher percentage of Fixed Facilities and Centers as a result of the fiscal 2003 acquisition discussed above, reduced revenues at the Company’s existing Mobile Facilities and higher salaries and benefits and depreciation expense.

 

CORPORATE OPERATING EXPENSES:  Corporate operating expenses increased approximately 8.8% from approximately $9.7 million for the nine months ended March 31, 2003, to approximately $10.6 million for the nine months ended March 31, 2004. The increase was due primarily to higher salaries and benefits to support the fiscal 2003 and 2004 acquisitions discussed above and to make the Company’s systems conform with HIPAA requirements, partially offset by reduced consulting costs related to the Company’s acquisition and development activities.  Corporate operating expenses, as a percentage of total revenues, decreased from approximately 5.6% for the nine months ended March 31, 2003, to approximately 5.0% for the nine months ended March 31, 2004.

 

GAIN ON SALE OF CENTER:  In December 2003, the Company sold a Center located in Hobart, Indiana for approximately $5.4 million.  The Company realized a gain of approximately $2.1 million on the sale.

 

INTEREST EXPENSE, NET:  Interest expense, net increased approximately 8.0% from approximately $27.9 million for the nine months ended March 31, 2003, to approximately $30.2 million for the nine months ended March 31, 2004.  This increase was due primarily to additional debt related to the fiscal 2003 and 2004 acquisitions discussed above, partially offset by principal payments on notes payable and capital lease obligations.

 

PROVISION FOR INCOME TAXES:  Provision for income taxes decreased from $2.4 million for the nine months ended March 31, 2003, to approximately $2.2 million for the nine months ended March 31, 2004.  The Company has recorded a tax provision at the statutory rate of 40% for the nine months ended March 31, 2004 and 2003, respectively.  At the beginning of each fiscal year, the Company estimates its effective tax rate for the fiscal year.  In addition, the Company periodically reviews the effective tax rate in light of certain factors, including actual operating income, acquisitions completed and new facilities opened, and the effects of benefits from the Company’s net operating loss carryforwards.  The Company expects its effective tax rate will be approximately 40% in the future.

 

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EBITDA:  Earnings before interest, taxes, depreciation and amortization (“EBITDA”) increased approximately 11.4% from approximately $70.3 million for the nine months ended March 31, 2003, to approximately $78.4 million for the nine months ended March 31, 2004.  This increase was primarily due to the acquisitions discussed above (approximately $14.8 million) partially offset by a reduction in EBITDA at the Company’s existing Mobile Facilities.  EBITDA for the Fixed-Site Division increased approximately 26.1% from approximately $42.0 million for the nine months ended March 31, 2003, to approximately $52.9 million for the nine months ended March 31, 2004 primarily due to (i) the fiscal 2003 acquisition discussed above (approximately $7.4 million), (ii) the gain on sale of Center described above (approximately $2.1 million), (iii) the Fixed Facilities opened in 2003 (approximately $0.5 million) and (iv) increased EBITDA at existing facilities (approximately $1.2 million), partially offset by reduced EBITDA from the sale of a Center discussed above (approximately $0.3 million).  EBITDA for the Mobile Division increased approximately 0.9% from approximately $42.2 million for the nine months ended March 31, 2003, to approximately $42.6 million for the nine months ended March 31, 2004 primarily due to an increase in EBITDA from the fiscal 2004 acquisition of Mobile Facilities (approximately $7.4 million), partially offset by a decrease in EBITDA of existing Mobile Facilities (approximately $7.0 million).  EBITDA should not be considered an alternative to, or more meaningful than, income from company operations or other traditional indicators of operating performance and cash flow from operating activities determined in accordance with accounting principles generally accepted in the United States.  The Company believes EBITDA is a useful indicator of its ability to meet debt service requirements and it's also a significant measure used in evaluating compliance with the Company's debt covenants.  While EBITDA is used as a measure of operations and the ability to meet debt service requirements, it is not necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculations.  The reconciliation of net income to EBITDA is as follows (in thousands):

 

		Nine Months Ended March 31,
		2004			2003
		(unaudited)
Net income, as reported		$	3,235		$	3,657
Provision for income taxes		2,158			2,438
Interest expense		30,175			27,937
Depreciation and amortization		42,801			36,292
EBITDA		$	78,369		$	70,324

 

THREE MONTHS ENDED MARCH 31, 2004 AND 2003

 

REVENUES:  Revenues increased approximately 26.0% from approximately $56.1 million for the three months ended March 31, 2003, to approximately $70.7 million for the three months ended March 31, 2004.  This increase was due to an increase in revenues at the Mobile Division (approximately $5.5 million) and an increase in revenues at the Fixed-Site Division (approximately $9.1 million).   Revenues for the Mobile Division and the Fixed-Site Division represented approximately 41% and 59%, respectively, of total revenues for the three months ended March 31, 2004.

 

Revenues at the Mobile Division increased approximately 23.4% from approximately $23.5 million for the three months ended March 31, 2003, to approximately $29.0 million for the three months ended March 31, 2004.  The increase was due to the fiscal 2004 acquisition of Mobile Facilities discussed above (approximately $6.0 million) and increased revenues associated with the Company’s short-term rental activities (approximately $0.2 million) partially offset by a reduction in revenues at the Company’s existing Mobile Facilities (approximately $0.7 million).  The decrease at the Company’s existing Mobile Facilities was due primarily to terminated high volume customer contracts, partially offset by an increase in volume at replacement accounts, which initially have lower volumes.

 

Revenues at the Fixed-Site Division increased approximately 27.9% from approximately $32.6 million for the three months ended March 31, 2003, to approximately $41.7 million for the three months ended March 31, 2004.  The increase was due to (i) the fiscal 2003 acquisition discussed above (approximately $6.4 million); (ii) revenues at the Fixed Facilities opened in 2003 (approximately $1.0 million) and (iii) revenues at existing Fixed Facilities and Centers (approximately $2.2 million) as the result of a 1% increase in reimbursement from third-party payors, partially offset by a nominal decrease in utilization and by reduced revenues from the sale of Center discussed above (approximately $0.5 million).

 

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COSTS OF OPERATIONS:  Costs of operations increased approximately 31.0% from approximately $43.6 million for the three months ended March 31, 2003, to approximately $57.2 million for the three months ended March 31, 2004.  This increase was due primarily to (i) the fiscal 2003 and 2004 acquisitions discussed above (approximately $9.4 million), (ii) costs at the Fixed Facilities opened in 2003 (approximately $0.9 million) and (iii) increased costs at existing facilities (approximately $3.8 million).  The increase at existing facilities is due primarily to higher salaries and benefits, equipment maintenance costs, occupancy, insurance and depreciation expense, partially offset by reduced medical supply costs, equipment lease costs and provision for doubtful accounts.  The increase in costs is partially offset by reduced costs from the sale of a Center discussed above (approximately $0.5 million).

 

Costs of operations at the Mobile Division increased approximately 32.7% from approximately $17.0 million for the three months ended March 31, 2003, to approximately $22.6 million for the three months ended March 31, 2004.  The increase was due to (i) the fiscal 2004 acquisition of Mobile Facilities discussed above (approximately $4.4 million), (ii) higher salaries and benefits and vehicle operations costs as a result of the reduction in the Company’s short-term rental activities, and (iii) higher salaries and benefits, insurance and depreciation expense, partially offset by reduced equipment lease costs.

 

Costs of operations at the Fixed-Site Division increased approximately 28.2% from approximately $23.5 million for the three months ended March 31, 2003, to approximately $30.1 million for the three months ended March 31, 2004.  The increase was due primarily to (i) the fiscal 2003 acquisition discussed above (approximately $5.0 million), (ii) costs at the opened Fixed Facilities (approximately $1.2 million) and (iii) higher salary and benefits, equipment maintenance and insurance costs, partially offset by reduced medical supply costs and provision for doubtful accounts at the Company’s existing facilities.

 

Costs of operations, as a percentage of total revenues, increased from approximately 77.7% for the three months ended March 31, 2003, to approximately 80.8% for the three months ended March 31, 2004.  The percentage increase is primarily due to the higher percentage of Fixed Facilities and Centers as a result of the fiscal 2003 acquisition discussed above, reduced revenues at the Company’s existing Mobile Facilities, higher salaries and benefits and depreciation expense.

 

CORPORATE OPERATING EXPENSES:  Corporate operating expenses increased approximately 5.2% from approximately $3.4 million for the three months ended March 31, 2003, to approximately $3.6 million for the three months ended March 31, 2004. The increase was due primarily to higher salaries and benefits to support the acquisitions described above and to make the Company’s systems conform with HIPAA requirements, partially offset by reduced consulting costs related to the Company’s acquisition and development activities.  Corporate operating expenses, as a percentage of total revenues, decreased from approximately 6.0% for the three months ended March 31, 2003, to approximately 5.0% for the three months ended March 31, 2004.

 

INTEREST EXPENSE, NET:  Interest expense, net increased approximately 8.5% from approximately $9.2 million for the three months ended March 31, 2003, to approximately $10.0 million for the three months ended March 31, 2004.  This increase was due primarily to additional debt related to the fiscal 2003 and 2004 acquisitions discussed above, partially offset by principal payments on notes payable and capital lease obligations.

 

PROVISION FOR INCOME TAXES:  Provision for income taxes was $0.2 million for the three months ended March 31, 2003 and the three months ended March 31, 2004.  The Company has recorded a tax provision at the statutory rate of 40% for the three months ended March 31, 2004 and March 31, 2003, respectively.

 

EBITDA:  Earnings before interest, taxes, depreciation and amortization (“EBITDA”) increased approximately 15.6% from approximately $21.6 million for the three months ended March 31, 2003, to approximately $25.0 million for the three months ended March 31, 2004.  This increase was primarily due to the fiscal 2003 and 2004 acquisitions discussed above (approximately $4.5 million), partially offset by a reduction in EBITDA at existing Mobile Facilities.  EBITDA for the Fixed-Site Division increased approximately 22.4% from approximately $13.8 million for the three months ended March 31, 2003, to approximately $16.9 million for the three months ended March 31, 2004 primarily due to (i) the fiscal 2003 acquisition discussed above (approximately $2.0 million), (ii) the Fixed Facilities opened in 2003 (approximately $0.2 million) and (iii) increased EBITDA at existing facilities (approximately $1.1 million), partially offset by reduced EBITDA from the sale of a Center discussed above (approximately $0.2 million).  EBITDA for the Mobile Division increased approximately 12.7% from approximately $12.5 million for the three months ended March 31, 2003, to approximately $14.1 million for the three months ended March 31, 2004 primarily due to an increase in EBITDA from the fiscal 2004 acquisition of Mobile Facilities

 

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(approximately $2.5 million), partially offset by a reduction in EBITDA at existing Mobile Facilities (approximately $0.9 million).   EBITDA should not be considered an alternative to, or more meaningful than, income from company operations or other traditional indicators of operating performance and cash flow from operating activities determined in accordance with accounting principles generally accepted in the United States.  The Company believes EBITDA is a useful indicator of its ability to meet debt service requirements.  While EBITDA is used as a measure of operations and the ability to meet debt service requirements, it is not necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculations.  The reconciliation of net income to EBITDA is as follows (in thousands):

 

 

 

NEW PRONOUNCEMENTS

 

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

 

(1)          Special purpose entities (SPEs) created prior to February 1, 2003:  The Company must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the first interim reporting period ended March 31, 2004.  The Company has completed its assessment and determined that the Company has no SPEs.

 

(2)          Non-SPEs created prior to February 1, 2003:  The Company is required to adopt FIN 46-R at the end of the first interim reporting period ended March 31, 2004.  The Company did not enter into any significant joint venture or partnership agreements prior to February 1, 2003 which are not included in the consolidated financial statements for the nine months ended March 31, 2004 and 2003.

 

(3)          All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003:  The Company is required to apply the provisions of FIN 46 unless it elects to early adopt the provisions of FIN 46-R as of the first interim reporting period ended March 31, 2004.  If the Company does not elect to early adopt FIN 46-R, then it is required to apply FIN 46-R to these entities as of the end of the first interim reporting period ending March 31, 2004.  The Company did not enter into any SPE, joint venture or partnership agreements subsequent to January 31, 2003 that would have a material impact on the consolidated financial statements for the period ended March 31, 2004.

 

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

 

In May 2003, the FASB issued SFAS No. 150, “Certain Financial Instruments with Characteristics of Both Liabilities and Equity.”  SFAS 150 establishes standards for how a company clarifies and measures certain financial

 

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instruments with characteristics of both liabilities and equity.  It requires a company to classify such instruments as liabilities, whereas they previously may have been classified as equity.  SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003.  The Company adopted SFAS 150 on July 1, 2003, which did not have a material impact on the Company’s financial condition and results of operations.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Management’s discussion and analysis of financial condition and results of operations, as well as disclosures included elsewhere in this report on Form 10-Q are based upon the Company’s unaudited condensed consolidated financial statements.  The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported.  Actual results could differ from those estimates.  Information with respect to the Company’s critical accounting policies which the Company believes could have the most significant effect on the Company’s reported results and require subjective or complex judgments by management is contained on page 39 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of the Company’s annual report on Form 10-K for the year ended June 30, 2003.  Management believes that at March 31, 2004, there has been no material change to this information.

 

FORWARD-LOOKING STATEMENTS

 

This report on Form 10-Q includes “forward-looking statements,”  Forward-looking statements include statements concerning the Company’s plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, its competitive strengths and weaknesses, its business strategy, the trends the Company anticipates in the industry and economies in which the Company operates and other information that is not historical information.  When used in this report the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” and variations of such words or similar expressions are intended to identify forward-looking statements.  All forward-looking statements, including, without limitation, the Company’s examination of historical operating trends, are based upon the Company’s current expectations and various assumptions.  The Company’s expectations, beliefs and projections are expressed in good faith, and the Company believes there is a reasonable basis for them, but there can be no assurance that the Company’s expectations, beliefs and projections will be realized.

 

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

 

If any of these risks or uncertainties materialize, or if any of the Company’s underlying assumptions are incorrect, the Company’s actual results may differ significantly from the results that it expresses in or implies by any of its forward-looking statements.  The Company does not undertake any obligation to revise these forward-looking statements to reflect future events or circumstances.

 

 

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RISK FACTORS

 

RISKS RELATING TO THE COMPANY AND THE DIAGNOSTIC IMAGING INDUSTRY

 

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

 

For the nine months ended March 31, 2004, the Company derived approximately 54% of its revenues from direct billings to patients and third-party payors such as Medicare, Medicaid, managed care and private health insurance companies.  Changes in the rates or methods of reimbursement for the services the Company provides could have a significant negative impact on those revenues. Moreover, the Company’s health care provider customers on whom the Company depends for approximately 46% of its revenues generally rely on reimbursement from third-party payors.  In the past, initiatives have been proposed and implemented which have had the effect of substantially decreasing reimbursement rates for diagnostic imaging services provided at non-hospital facilities.  Similar initiatives enacted in the future may have an adverse impact on the Company’s financial condition and operations.

 

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

 

The Company’s revenues may fluctuate or be unpredictable and this may harm its financial results.

 

The amount and timing of revenues that the Company may derive from its business will fluctuate based on:

 

•                  variations in the rate at which customers renew their contracts;

 

•                  the extent to which the Company’s mobile customers convert into a fixed-site operation and choose not to continue using its services;

 

•                  changes in the number of days of service the Company can offer with respect to a given diagnostic imaging or therapeutic system due to equipment malfunctions or seasonal factors;

 

•                  the mix of contract services and patient services revenues; and

 

•                  general economic conditions.

 

The Company’s failure to respond to declines in revenue would make its business difficult to operate and would harm its financial results.

 

Because a high percentage of the Company’s operating expenses are fixed, a relatively small decrease in revenue could have a significant negative impact on its financial results.

 

A high percentage of the Company’s expenses are fixed, meaning they do not vary significantly with the increase or decrease in revenue.  Such expenses include, but are not limited to, debt service and capital lease payments, rent and operating lease payments, salaries, maintenance, insurance and vehicle operations costs.  As a result, a relatively small reduction in the prices the Company charges for its services or in the amount of services that it provides could have a disproportionate effect on its financial results.

 

A failure to meet the Company’s capital expenditure requirements can adversely affect its business.

 

The Company operates in a capital intensive, high fixed cost industry that requires significant amounts of capital to fund operations, particularly the initial start-up and development expenses of new Fixed and Mobile Facilities, or new operations, and the acquisition of additional businesses and new imaging equipment.  The Company incurs capital expenditures to, among other things:

 

•                  upgrade its imaging systems and software;

 

•                  purchase systems upon termination of operating leases; and

 

•                  purchase new systems.

 

To the extent the Company is unable to generate sufficient cash from its operations or funds are no longer available under its Credit Facilities, it may be unable to meet its capital expenditure requirements and therefore unable to

 

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achieve the Company’s estimates of operating income growth.  Furthermore, there can be no assurance that the Company will be able to raise any necessary additional funds through bank financing or the issuance of equity or debt securities on terms acceptable to it, if at all.

 

The Company may experience competition from hospitals, radiology groups and other diagnostic imaging companies and this competition could adversely affect its revenues and business.

 

The health care industry in general, and the market for diagnostic imaging services in particular, is highly competitive and fragmented, with only a few national providers.  The Company competes principally on the basis of its reputation for productive and cost-effective quality services.  The Company’s operations must compete with groups of radiologists, established hospitals and certain other independent organizations, including equipment manufacturers and leasing companies that own and operate imaging equipment.  The Company will continue to encounter substantial competition from hospitals and independent organizations.  Some of the Company’s direct competitors that provide contract diagnostic imaging services may have access to greater financial resources.  If the Company is unable to successfully compete, its customer base would decline and its business, financial condition and results of the operations would be harmed.

 

Certain hospitals, particularly the larger hospitals, may be expected to directly acquire and operate imaging and treatment equipment on-site as part of their overall inpatient servicing capability, assume the associated financial risk, employ the necessary technologists and satisfy applicable CON and licensure requirements, if any.  Historically, smaller hospitals have been reluctant to purchase imaging and treatment equipment.  This reluctance, however, has in the past encouraged the entry of start-up ventures and other established business operations into the diagnostic imaging business.  As a result, there have been periods in the recent past when there has been significant excess capacity in the diagnostic imaging business in the United States, which can negatively affect utilization and reimbursement.  In addition, some physician practices that have not purchased imaging equipment may decide to do so, in light of the flexibility provided by the final Physician Self-Referral regulations adopted in January 2001 and the increased availability of lower-cost specialty MRI systems and in so doing would compete with the Company.  Attractive financing from original equipment manufacturers may cause hospitals and physician practices who have utilized shared mobile services from the Company and its competitors, to purchase and operate their own equipment.   If the cost of acquiring and operating imaging equipment falls to such a level that it makes more sense for hospitals and physician practices to do so rather than utilize the Company’s shared mobile services, the Company’s business, financial condition and results of operations would be materially adversely affected.

 

Managed care organizations may prevent health care providers from using the Company’s services, causing it to lose current and prospective customers.

 

Health care providers participating as providers under managed care plans may be required to refer diagnostic imaging procedures to specific imaging service providers depending on the plan in which each covered patient is enrolled.  These requirements currently inhibit health care providers from using the Company’s diagnostic imaging services in some cases.  The proliferation of managed care may prevent an increasing number of health care providers from using the Company’s services in the future, which would cause its revenues to decline.

 

The Company’s Centers and Fixed Facilities depend on physician referrals and contractual arrangements with managed care organizations for their business.

 

The Company’s Centers and Fixed Facilities are principally dependent on their ability to attract referrals from physicians and other health care providers representing a variety of specialties.  The Company’s eligibility to provide service in response to a referral is often dependent on the existence of a contractual arrangement with the referred patient’s health plan.  The Company currently has approximately 1,000 contracts with managed care organizations for diagnostic imaging services provided at the Company’s Centers and Fixed Facilities, primarily on a discounted fee-for-service basis.  A significant decline in referrals would have a material adverse effect on the Company’s business, financial condition and results of operations.

 

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The Company may be unable to renew or maintain its customer contracts, which would harm its business and financial results.

 

Upon expiration of the Company’s customer contracts, there is a risk that customers will cease using its imaging services and purchase or lease their own imaging systems or use the Company’s competitors’ imaging systems.  Approximately one-third of the Company’s Mobile MRI contracts expire each fiscal year.  If these contracts are not renewed or are renewed at lower prices, the Company could experience a significant negative impact on its business.  The Company’s mobile contract renewal rate for the fiscal year ended June 30, 2003 was approximately 80%.  It is not always possible to immediately obtain replacement customers, and historically many replacement customers have been smaller facilities which have a lower number of scans than the number of scans of the lost customers.  Although the non-renewal of a single customer contract would not have a material impact on the Company’s contract services revenues, non-renewal of several contracts could have a material impact on contract services revenues.

 

The Company may be subject to professional liability risks which could be costly and negatively impact its business and financial results.

 

The Company has not experienced any material losses due to claims for malpractice.  However, claims for malpractice have been asserted against the Company 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 the Company to the extent not covered by its liability insurance, could have a material adverse affect on its business, financial condition and results of operations.  In addition to being exposed to claims for malpractice, there are other professional liability risks to which the Company is exposed through its operation of diagnostic imaging systems.

 

To protect against possible professional liability either from malpractice claims or the other risks described above, the Company maintains professional liability insurance.  However, if the Company is unable to maintain insurance in the future at an acceptable cost or at all or if its insurance does not fully cover it, and a successful malpractice or other professional liability claim was made against the Company, the Company could incur substantial losses.  Any successful malpractice or other professional liability claim made against the Company not fully covered by insurance could be costly to defend against, result in a substantial damage award against the Company and divert the attention of its management from its operations, which could have a material adverse effect on its business, financial condition and results of operations.

 

Technological change in the Company’s industry could reduce the demand for its services and require it to incur significant costs to upgrade its equipment.

 

Technological change in the MRI industry has been gradual.  Although the Company believes that substantially all of its MRI and other diagnostic imaging systems are upgradeable to maintain their state-of-the-art character, the development of new technologies or refinements of existing ones might make its existing systems technologically or economically obsolete, or cause a reduction in the value of, or reduce the need for, its systems.  MRI and other diagnostic imaging systems are currently manufactured by numerous companies.  Competition among manufacturers for a greater share of the MRI and other diagnostic imaging systems market may result in technological advances in the speed and imaging capacity of these new systems.  Consequently, the obsolescence of the Company’s systems may be accelerated.  Although the Company is aware of no imminent substantial technological changes, other than ultra-high field MRI systems and PET/CT or “fusion” scanners (a PET/CT scanner costs approximately 35% to 50% more than a standard PET scanner, in addition to higher annual maintenance costs), should such changes occur, there can be no assurance that it would be able to acquire the new or improved systems.

 

The development of new scanning technology or new diagnostic applications for existing technology may require the Company to adapt its existing technology or acquire new or technologically improved systems in order to successfully compete.  In the future, however, it may not have the financial resources to do so, particularly given its indebtedness.  In addition, advancing technology may enable hospitals, physicians or other diagnostic service providers to perform procedures without the assistance of diagnostic service providers such as the Company.

 

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The Company’s failure to effectively make or integrate acquisitions and establish joint venture arrangements through partnerships with hospitals and other health care providers could impair its business.

 

As part of the Company’s business strategy, it has pursued and intends to continue to pursue strategic acquisitions and establish arrangements through partnerships and joint ventures with hospitals and other health care providers.  It is continuously evaluating acquisition opportunities and consolidation possibilities, and, at any given time, may be in various stages of due diligence or preliminary discussions with respect to a number of potential transactions.  There can be no assurance that the Company will succeed in identifying suitable acquisition or joint venture candidates or in consummating any such acquisitions or joint venture arrangements.  The Company’s acquisition and joint venture strategies require substantial capital which may exceed the funds available to it from internally generated funds and under the Company’s Credit Facilities.  There can be no assurance that the Company will be able to raise any necessary additional funds through bank financing or through the issuance of equity or debt securities on terms acceptable to it, if at all.

 

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

 

•                  demands on management related to the increase in the Company’s size after an acquisition;

 

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

 

•                  integration of information systems;

 

•                  difficulties in the assimilation and retention of employees;

 

•                  potential adverse effects on operating results; and

 

•                  challenges in retaining customers and referral sources.

 

Although the Company believes that it has successfully integrated acquisitions in the past, there can be no assurance that it will be able to successfully integrate the operations of any future acquisitions.  If it does not successfully integrate acquisitions, the Company may not realize anticipated operating advantages, economies of scale and cost savings.  Also, the Company may not be able to maintain the levels of operating efficiency acquired companies would have achieved or might have achieved separately.  Successful integration of each of their operations will depend upon the Company’s ability to manage those operations and to eliminate redundant and excess costs.

 

Loss of key executives and failure to attract qualified managers, technologists and salespersons could limit the Company’s growth and negatively impact its operations.

 

The Company depends upon its management team to a substantial extent.  As the Company grows, it will increasingly require field managers and salespersons experienced in its industry and skilled technologists to operate its diagnostic equipment.  It is impossible to predict the availability of qualified field managers, salespersons and technologists or the compensation levels that will be required to hire or retain them.  In particular, there is a very high demand for qualified technologists who are necessary to operate the Company’s systems.  The Company may not be able to hire and retain a sufficient number of technologists, and it may be required to pay bonuses and higher salaries to its technologists, which would increase its expenses.  The loss of the services of any member of the Company’s senior management or the Company’s inability to hire qualified field managers, salespersons and skilled technologists at economically reasonable compensation levels could adversely affect its ability to operate and grow its business.

 

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The Company’s PET services and some of its other imaging services require the use of radioactive materials, which could subject the Company to regulation, related costs and delays and potential liabilities for injuries or violations of environmental, health and safety laws.

 

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

 

The Company may be unable to effectively maintain its imaging and therapeutic systems or generate revenues when its systems are not fully operational.

 

Timely, effective service is essential to maintaining the Company’s reputation and high utilization rates on its imaging systems.  Repairs to one of its systems can take up to two weeks and result in a loss of revenues.  The Company’s warranties and maintenance contracts do not compensate it for loss of revenues when its systems are not fully operational.  The principal components of its operating costs include depreciation, salaries paid to technologists and drivers, annual equipment maintenance costs, lease payments, rents and insurance and transportation costs.  Because the majority of these expenses are fixed, a reduction in the number of procedures performed due to out-of-service equipment will result in lower revenues and margins.  Repairs of the Company’s equipment are performed for it by the equipment manufacturers.  These manufacturers may not be able to perform repairs or supply needed parts in a timely manner.  Thus, if the Company experiences more system malfunctions than anticipated or if it is unable to promptly obtain the service necessary to keep its systems functioning effectively, its revenues could decline and its ability to provide services would be harmed.

 

The Company’s substantial indebtedness could adversely affect its financial health.

 

As of March 31, 2004, the Company had total indebtedness of approximately $517.1 million which comprised approximately 84.4% of the Company’s total capitalization.  Upon completion of the acquisition of twenty-one (21) Centers and Fixed Facilities in April 2004, the Company had total indebtedness of approximately $542.1 million which comprised 84.9% of the Company’s total capitalization.  The Company’s substantial indebtedness could have important consequences to the Company.  For example, it could:

 

•                  make it more difficult for the Company to satisfy its obligations with respect to the Notes and its Credit Facilities;

 

•                  increase the Company’s vulnerability to general adverse economic and industry conditions;

 

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

 

•                  limit the Company’s flexibility in planning for, or reacting to, changes in its business and the markets in which it operates;

 

•                  place the Company at a competitive disadvantage compared to its competitors that have less debt; and

 

•                  limit, among other things, the Company’s ability to borrow additional funds.

 

In addition, the Company may incur substantial additional indebtedness in the future.  The terms of the indenture governing the Notes and the Company’s credit agreement allow it to issue and incur additional debt upon satisfaction of certain conditions.  If new debt is added to current debt levels, the related risks described above could intensify.

 

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RISKS RELATING TO GOVERNMENT REGULATION OF THE COMPANY’S BUSINESS

 

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

 

The Company is directly or indirectly through its customers subject to extensive regulation by both the federal government and the states in which it conducts its business, including:

 

•                  the federal False Claims Act;

 

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

 

•                  the federal Civil Money Penalty Law;

 

•                  the federal HIPAA;

 

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

 

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

 

•                  federal FDA requirements;

 

•                  state licensing and certification requirements; and

 

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

 

If the Company’s operations are found to be in violation of any of the laws and regulations to which it or its customers are subject, it may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines and the curtailment of its operations.  Any penalties, damages, fines or curtailment of the Company’s operations, individually or in the aggregate, could adversely affect the Company’s ability to operate the Company’s business and its financial results.  The risks of the Company 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 the Company for violation of these laws or regulations, even if the Company successfully defends against it, could cause it to incur significant legal expenses and divert its management’s attention from the operation of its business.

 

ITEM 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company provides its services in the United States and receives payment for its services exclusively in United States dollars.  Accordingly, the Company’s business is unlikely to be affected by factors such as changes in foreign market conditions or foreign currency exchange rates.

 

The Company’s market risk exposure relates primarily to interest rates, where the Company will periodically use interest rate swaps to hedge variable interest rates on long-term debt under its Credit Facilities.  The Company does not engage in activities using complex or highly leveraged instruments.

 

As of March 31, 2004, the Company had outstanding long-term debt of approximately $245.6 million, which has floating rate terms.  The Company has outstanding an interest rate swap, converting $10.0 million of its floating rate debt to fixed rate debt.  The effect on pre-tax income of a 0.125% variance in interest rates would be approximately $0.3 million on an annual basis.  Under the terms of the interest rate swap agreement, the Company is exposed to credit loss in the event of nonperformance by the swap counterparty; however, the Company does not anticipate nonperformance by the counterparty.

 

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ITEM 4.                             CONTROLS AND PROCEDURES

 

The Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (pursuant to Rule 15d-15 under the Securities Exchange Act of 1934) as of the end of the period covered by this report.  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.  There has been no change in the Company’s internal control over financial reporting during the quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II  -  OTHER INFORMATION

 

ITEM 6.                             EXHIBITS AND REPORTS ON FORM 8-K

 

(a)		Exhibits
4.6		Third Supplemental Indenture, dated as of March 8, 2004, with respect to 9 7/8% Senior Subordinated Notes due 2011 by and among InSight Health Services Corp. (“InSight”), the Company, the Subsidiary Guarantors (named therein), and U.S. Bank Trust National Association, a national banking association, as trustee, filed herewith.
4.7		Registration Rights Agreement, dated March 8, 2004, by and among InSight, the Company, the Subsidiary Guarantors (named therein), and Banc of America Securities LLC with respect to $25 million of 9 7/8% Senior Subordinated Notes due 2011, filed herewith.
10.18		Third Amendment to Credit Agreement, Waiver and Consent, dated as of February 26, 2004, by and among InSight, the Company, the Subsidiary Guarantors (named therein), Bank of America, N.A., as Administrative Agent, Wachovia Bank, National Association, as Syndication Agent, and The CIT Group/Business Credit, Inc. as Documentation Agent, filed herewith.
10.19		Purchase Agreement, dated February 26, 2004, by and among InSight, the Guarantors (named therein), and Banc of America Securities LLC with respect to the $25 million of 9 7/8% Senior Subordinated Notes due 2011, filed herewith.
31.1		Certification of Steven T. Plochocki, the Company’s Chief Executive Officer, pursuant to Rule 15d-14 of the Securities Exchange Act of 1934, filed herewith.
31.2		Certification of Brian G. Drazba, the Company’s Chief Financial Officer, pursuant to Rule 15d-14 of the Securities Exchange Act of 1934, filed herewith.
32.1(+)		Certification of Steven T. Plochocki, the Company’s Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
32.2(+)		Certification of Brian G. Drazba, the Company’s Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
(b)		Reports on Form 8-K
		The Company filed with the SEC (i) a current report on Form 8-K on February 17, 2004, under Item 9 announcing that its wholly-owned subsidiary, InSight Health Corp., had entered into a stock purchase agreement to acquire diagnostic imaging centers, (ii) a current report on Form 8-K on March 5, 2004, under Item 7 with financial statements and pro-forma financial information relating to an acquisition and (iii) a current report on Form 8-K on April 8, 2004, under Item 2 announcing the completion of an acquisition and under Item 7 with financial statements and pro-forma financial information relating to an acquisition.

 

(+)         In accordance with SEC Release No. 33-8212, this exhibit is being furnished, and is not being filed as part of this report or as a separate disclosure document, and is not being incorporated by reference into any Securities Act of 1933 registration statement.

 

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SIGNATURES

 

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

 

 

Date:  May 13, 2004
	INSIGHT HEALTH SERVICES HOLDINGS CORP.
	By:	/s/  Steven T. Plochocki
		Steven T. Plochocki
		President and Chief Executive Officer
	By:	/s/  Brian G. Drazba
		Brian G. Drazba
		Executive Vice President and Chief Financial Officer

 

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