INSIGHT HEALTH SERVICES HOLDINGS CORP - 10-Q Quarterly Report

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Amounts in thousands, except share data)

	September 30, 2004		June 30, 2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	41,277	$	30,412
Trade accounts receivables, net	53,866		55,010
Other current assets	5,683		6,207
Total current assets	100,826		91,629
PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $133,223 and $119,124, respectively	235,203		242,336

INVESTMENTS IN PARTNERSHIPS	2,630		2,901
OTHER ASSETS	18,951		19,302
OTHER INTANGIBLE ASSETS, net	39,361		38,518
GOODWILL	279,536		280,945
	$	676,507	$	675,631

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of notes payable	$	2,843	$	2,716
Current portion of capital lease obligations	5,025		5,060
Accounts payable and other accrued expenses	39,329		35,737
Total current liabilities	47,197		43,513

LONG-TERM LIABILITIES:
Notes payable, less current portion	517,498		518,245
Capital lease obligations, less current portion	12,376		13,802
Other long-term liabilities	5,281		5,130
Total long-term liabilities	535,155		537,177

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ EQUITY:
Common stock, $.001 par value, 10,000,000 shares authorized, 5,468,814 shares issued and outstanding at September 30, 2004 and June 30, 2004	5		5
Additional paid-in capital	87,081		87,081
Retained earnings	7,069		7,855
Total stockholders’ equity	94,155		94,941
	$	676,507	$	675,631

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

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(Amounts in thousands)

	Three Months Ended September 30,
	2004			2003
REVENUES:
Contract services	$	33,568		$	30,740
Patient services	47,286			38,032
Total revenues	80,854			68,772

COSTS OF OPERATIONS:
Costs of services	48,458			38,113
Provision for doubtful accounts	1,606			1,126
Equipment leases	333			181
Depreciation and amortization	16,348			13,802
Total costs of operations	66,745			53,222
Gross profit	14,109			15,550
CORPORATE OPERATING EXPENSES	(4,855		)	(3,503		)
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS	400			759
INTEREST EXPENSE, net	(10,964		)	(10,121		)
Income (loss) before provision (benefit) for income taxes	(1,310		)	2,685
PROVISION (BENEFIT) FOR INCOME TAXES	(524		)	1,075
Net income (loss)	$	(786	)	$	1,610

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

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Amounts in thousands)

	Three Months Ended September 30,
	2004			2003
OPERATING ACTIVITIES:
Net income (loss)	$	(786	)	$	1,610
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	16,348			13,802
Cash provided by (used in) changes in operating assets and liabilities:
Trade accounts receivables, net	1,144			(3,358		)
Other current assets	524			2,574
Accounts payable and other accrued expenses	3,592			2,963
Net cash provided by operating activities	20,822			17,591

INVESTING ACTIVITIES:
Acquisitions of fixed-site centers and mobile facilities	—			(52,515		)
Additions to property and equipment	(8,219		)	(8,386		)
Other	192			(398		)
Net cash used in investing activities	(8,027		)	(61,299		)

FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease obligations	(2,081		)	(1,947		)
Proceeds from issuance of notes payable	—			51,125
Other	151			(50		)
Net cash provided by (used in) financing activities	(1,930		)	49,128

INCREASE IN CASH AND CASH EQUIVALENTS	10,865			5,420
Cash, beginning of period	30,412			19,554
Cash, end of period	$	41,277		$	24,974

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid	$	4,128		$	4,329
Income taxes paid	222			55

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

INSIGHT HEALTH SERVICES HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. NATURE OF BUSINESS

All references to “we,” “us,” “our,” “our company,” “the Company” or “InSight Holdings” in this quarterly report on Form 10-Q mean InSight Health Services Holdings Corp., a Delaware corporation and all entities and subsidiaries owned or controlled by InSight Health Services Holdings Corp. All references to “InSight” in this quarterly report on Form 10-Q mean our wholly owned subsidiary, InSight Health Services Corp., a Delaware corporation. Through InSight and its subsidiaries, we provide diagnostic imaging, treatment and related management services in 37 states throughout the United States. We have two reportable segments: the mobile division and the fixed division. Our services are provided through a network of 85 mobile magnetic resonance imaging, or MRI, facilities, 16 mobile positron emission tomography, or PET, facilities, five mobile lithotripsy facilities, three mobile computed tomography, or CT, facilities, five mobile PET/CT facilities, one mobile catheterization lab (collectively, mobile facilities), 76 fixed-site MRI centers, 40 multi-modality fixed-site centers, two PET fixed-site centers, one Leksell Stereotactic Gamma Knife fixed-site treatment center and one radiation oncology fixed-site center (collectively, fixed-site centers). We have a substantial presence in California, Arizona, New England, the Carolinas, Florida and the Mid-Atlantic states.

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

2. INTERIM FINANCIAL STATEMENTS

The unaudited condensed consolidated financial statements 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 our annual report on Form 10-K for the period ended June 30, 2004 filed with the Securities and Exchange Commission, or SEC, on September 24, 2004. 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 three months ended September 30, 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 our accounts and the accounts of our wholly owned subsidiaries. Our investment interests in partnerships or limited liability companies, or Partnerships, are accounted for under the equity method of accounting when we own 50 percent or less. Our investment interests in Partnerships are consolidated for ownership of 50 percent or greater owned entities when we exercise a controlling financial interest over the operations and are primarily responsible for the associated long-term debt. We have direct ownership in 50 percent of an additional Partnership, which operates a fixed-site center. This Partnership is comprised of two general partners. We are the managing general partner and have significant rights which give us effective control of the Partnership while the other partner has only certain protective rights. In addition, we are primarily responsible for funding working capital of the Partnership and the long-term debt of the Partnership is included in our consolidated financial statements. Total assets as of September 30, 2004 for our 50 percent owned Partnership, which is consolidated, were approximately $2.8 million. Total revenues for this Partnership for the three months ended September 30, 2004 and 2003 were $1.9 million and $1.8 million, respectively.

4. ACQUISITIONS

In August 2003, we acquired twenty-two (22) mobile facilities operating primarily in the Mid-Atlantic states. The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, customer contracts and other agreements. The aggregate purchase price was approximately $49.9 million, which included approximately $28.1 million paid to the seller and

approximately $21.8 million for the payment of debt and transaction costs. The excess purchase price paid by us over our estimate of the fair value of the tangible and other intangible assets as of the date of the acquisition was approximately $27.3 million and is reflected as goodwill in the accompanying condensed consolidated balance sheets as of September 30, 2004.

In April 2004, we acquired twenty-one (21) fixed-site centers located in California, Arizona, Kansas, Texas, Pennsylvania and Virginia. The acquisition consisted of certain tangible and intangible assets, including diagnostic imaging equipment, real property, customer contracts and other agreements. The aggregate purchase price was approximately $49.0 million, which included approximately $35.9 million paid to the seller, approximately $10.6 million for the payment of debt and approximately $2.1 million of transaction costs. The excess purchase price paid by us over our estimate of the fair value of the tangible and other intangible assets as of the date of the acquisition was approximately $30.6 million and is reflected as goodwill in the accompanying condensed consolidated balance sheets as of September 30, 2004.

Our unaudited pro-forma combined results of operations for the three months ended September 30, 2003, assuming our two acquisitions had occurred as of July 1, 2003, are presented below along with our unaudited results of operations for the three months ended September 30, 2004. The pro-forma combined results of operations for the three months ended September 30, 2003, include adjustments to interest expense (approximately $0.3 million) and amortization of identified intangible assets (less than $0.1 million). 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):

	Three Months Ended September 30,
	2004			2003
	(unaudited)
Revenues	$	80,854		$	73,109
Costs of operations	66,745			51,320
Gross profit	14,109			21,789
Corporate operating expenses	(4,855		)	(8,197		)
Equity in earnings of unconsolidated partnerships	400			327
Impairment and restructuring charges	—			(7,143		)
Interest expense, net	(10,964		)	(10,486		)
Income (loss) before income taxes	(1,310		)	(3,710		)
Provision (benefit) for income taxes	(524		)	(1,484		)
Net income (loss)	$	(786	)	$	(2,226	)

5. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess purchase price we paid over the fair value of the tangible and intangible assets and liabilities acquired in acquisitions. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, the goodwill and indefinite-lived intangible asset balances are not being amortized, but instead are subject to an annual assessment of impairment by applying a fair-value based test. Net other intangible assets are amortized on a straight-line basis over the estimated lives of the assets ranging from five to thirty years.

A reconciliation of goodwill for the three months ended September 30, 2004 is as follows (amounts in thousands):

	Mobile				Fixed		Consolidated
	(unaudited)
Goodwill, June 30, 2004	$		106,064		$	174,881	$	280,945
Adjustments to goodwill	(1,800			)	391		(1,409			)
Goodwill, September 30, 2004	$	104,264			$	175,272	$		279,536

We evaluate the carrying value of goodwill and identified intangibles not subject to amortization in the second quarter of each fiscal year. As part of the evaluation, we compare the carrying value of each intangible asset with its fair value to determine whether there

has been impairment. We assess the ongoing recoverability of our intangible assets subject to amortization by determining whether the intangible asset balance can be recovered over the remaining amortization period through projected undiscounted future cash flows. If projected future cash flows indicate that the unamortized intangible asset balances will not be recovered, an adjustment is made to reduce the net intangible asset to an amount consistent with projected future cash flows discounted at our incremental borrowing rate. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. Adjustments to goodwill result from the allocation of amounts to other intangible assets was based on a completed valuation of our August 2003 acquisition. As of September 30, 2004, we do not believe any impairment of goodwill or other intangible assets has occurred.

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

	September 30, 2004				September 30, 2003
	Gross Carrying Value		Gross Accumulated Amortization		Carrying Value		Accumulated Amortization
	(unaudited)
Amortized intangible assets:
Managed care contracts	$	24,410	$	1,964	$	18,010	$	1,065
Wholesale contracts	15,380		7,145		11,180		4,286
	39,790		9,109		29,190		5,351

Unamortized intangible assets:
Trademark	8,680		—		8,680		—
Other intangible assets	$	48,470	$	9,109	$	37,870	$	5,351

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

Managed care contracts		30 years
Wholesale contracts		5-7 years

Amortization of intangible assets was approximately $1.0 million and $0.8 million for the three months ended September 30, 2004 and 2003, respectively.

6. NOTES PAYABLE

Through InSight, we have a credit facility, or Credit Facility, with Bank of America, N.A. and a syndicate of other lenders consisting of (1) a term loan with a principal balance of approximately $219.5 million, (2) an additional term loan with a principal balance of approximately $50.0 million, and (3) a $50.0 million revolving credit facility. As of September 30, 2004, there were no borrowings under the revolving credit facility. Borrowings under the Credit Facility bear interest at LIBOR plus 3.5% to 3.75%. We are required to pay an annual unused facility fee of between 0.5% and 2.5%, payable quarterly, on unborrowed amounts. We expect to use the revolving credit facility to fund our future working capital needs.

Through InSight, we also have outstanding $225 million in unsecured senior subordinated notes, or Notes. Additionally, in March 2004, we issued $25 million in a private placement of unsecured senior subordinated notes, or New Notes. The Notes and New Notes mature in November 2011 and bear interest at 9.875% payable semi-annually. The Notes and New Notes are redeemable at our option, in whole or in part, on or after November 1, 2006. The New Notes have terms identical to the Notes, but our pending exchange offer registration statement on Form S-4 which was filed with the SEC on November 3, 2004 has not yet become effective.

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

7. HEDGING ACTIVITIES

We account for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended by SFAS No. 137 and SFAS No. 138 (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.

We have established policies and procedures to permit limited types and amounts of off-balance sheet hedges to help manage interest rate risk. InSight had entered into an interest rate swap to pay a fixed rate of interest to a counterparty and received a floating rate of interest and had designated the interest rate swap as a cash flow hedge of its floating rate debt. The swap agreement expired in September 2004. We have no other off-balance sheet hedging activities.

8. CAPITAL STOCK

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

		Three Months Ended September 30,
		2004			2003
		(unaudited)
Net income (loss):	As reported	$	(786	)	$	1,610
	Expense	(66		)	(100		)
	Pro-forma	$	(852	)	$	1,510

An option for 20,000 shares was granted during the three months ended September 30, 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	4.27		%
Weighted-average fair value of options granted	$	6.82

9. SEGMENT INFORMATION

We have two reportable segments: the mobile division and the fixed division, which are business units defined primarily by the type of service provided. The mobile division operates primarily mobile facilities while the fixed division operates primarily fixed-site centers, although each division generates both contract services and patient services revenues. We do not allocate corporate and billing related costs, depreciation related to our billing system and amortization related to other intangible assets to the two segments. We also do not allocate income taxes to the two segments. We manage cash flows and assets on a consolidated basis, and not by segment.

The following tables summarize our operating results by segment (amounts in thousands):

Three months ended September 30, 2004 (unaudited):

	Mobile			Fixed			Other			Consolidated
Contract services revenues	$	29,660		$	3,908		$	—		$	33,568
Patient services revenues	396			46,890			—			47,286
Total revenues	30,056			50,798			—			80,854
Depreciation and amortization	(7,815		)	(6,272		)	(2,261		)	(16,348		)
Total costs of operations	(23,760		)	(37,914		)	(5,071		)	(66,745		)
Corporate operating expenses	—			—			(4,855		)	(4,855		)
Equity in earnings of unconsolidated partnerships	—			400			—			400
Interest expense, net	(2,474		)	(1,735		)	(6,755		)	(10,964		)
Income (loss) before income taxes	3,822			11,549			(16,681		)	(1,310		)

Additions to property and equipment	2,964			4,504			661			8,129

Three months ended September 30, 2003 (unaudited):

	Mobile			Fixed			Other			Consolidated
Contract services revenues	$	26,565		$	4,175		$	—		$	30,740
Patient services revenues	514			37,518			—			38,032
Total revenues	27,079			41,693			—			68,772
Depreciation and amortization	(6,737		)	(4,983		)	(2,082		)	(13,802		)
Total costs of operations	(19,422		)	(29,766		)	(4,034		)	(53,222		)
Corporate operating expenses	—			—			(3,503		)	(3,503		)
Equity in earnings of unconsolidated partnerships	—			759			—			759
Interest expense, net	(2,934		)	(1,872		)	(5,315		)	(10,121		)
Income (loss) before income taxes	4,723			10,814			(12,852		)	2,685

Additions to property and equipment	2,260			4,588			1,538			8,386

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 our condensed consolidated financial statements are as follows:

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

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

(3) All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003: We must apply to apply the provisions of FIN 46. We do not have any entity that qualifies as a VIE.

11. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION

We and all of InSight’s wholly owned subsidiaries, or guarantor subsidiaries, guarantee InSight’s payment obligations under the Notes and the New Notes (Note 6). 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.” We account for our investment in InSight and its subsidiaries under the equity method of accounting. Dividends from InSight to us are restricted under the Credit Facility. 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.

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)

SEPTEMBER 30, 2004

(Amounts in thousands)

	PARENT COMPANY ONLY		INSIGHT		GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES		ELIMINATIONS			CONSOLIDATED
ASSETS
Current assets:
Cash and cash equivalents	$	—	$	—	$	36,438		$	4,839	$	—		$	41,277
Trade accounts receivables, net	—		—		45,838			8,028		—			53,866
Other current assets	—		—		5,526			157		—			5,683
Intercompany accounts receivable	87,086		519,720		19,570			—		(626,376		)	—
Total current assets	87,086		519,720		107,372			13,024		(626,376		)	100,826
Property and equipment, net	—		—		212,376			22,827		—			235,203
Investments in partnerships	—		—		2,630			—		—			2,630
Investments in consolidated subsidiaries	7,069		7,069		11,154			—		(25,292		)	—
Other assets	—		—		18,888			63		—			18,951
Goodwill and other intangible assets, net	—		—		314,394			4,503		—			318,897
	$	94,155	$	526,789	$	666,814		$	40,417	$	(651,668	)	$	676,507

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of notes payable and capital lease obligations	$	—	$	2,639	$	4,488		$	741	$	—		$	7,868
Accounts payable and other accrued expenses	—		—		37,722			1,607		—			39,329
Intercompany accounts payable	—		—		606,567			19,809		(626,376		)	—
Total current liabilities	—		2,639		648,777			22,157		(626,376		)	47,197
Notes payable and capital lease obligations, less current portion	—		516,842		11,096			1,936		—			529,874
Other long-term liabilities	—		239		(128		)	5,170		—			5,281
Stockholders’ equity	94,155		7,069		7,069			11,154		(25,292		)	94,155
	$	94,155	$	526,789	$	666,814		$	40,417	$	(651,668	)	$	676,507

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)

JUNE 30, 2004

(Amounts in thousands)

	PARENT COMPANY ONLY		INSIGHT		GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES		ELIMINATIONS			CONSOLIDATED
ASSETS
Current assets:
Cash and cash equivalents	$	—	$	—	$	25,820		$	4,592	$	—		$	30,412
Trade accounts receivables, net	—		—		47,048			7,962		—			55,010
Other current assets	—		—		6,058			149		—			6,207
Intercompany accounts receivable	87,086		520,047		19,865			—		(626,998		)	—
Total current assets	87,086		520,047		98,791			12,703		(626,998		)	91,629
Property and equipment, net	—		—		219,584			22,752		—			242,336
Investments in partnerships	—		—		2,901			—		—			2,901
Investments in consolidated subsidiaries	7,855		7,855		10,864			—		(26,574		)	—
Other assets	—		—		19,218			84		—			19,302
Goodwill and other intangible assets, net	—		—		314,960			4,503		—			319,463
	$	94,941	$	527,902	$	666,318		$	40,042	$	(653,572	)	$	675,631

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of notes payable and capital lease obligations	$	—	$	2,514	$	4,540		$	722	$	—		$	7,776
Accounts payable and other accrued expenses	—		—		34,304			1,433		—			35,737
Intercompany accounts payable	—		—		607,133			19,865		(626,998		)	—
Total current liabilities	—		2,514		645,977			22,020		(626,998		)	43,513
Notes payable and capital lease obligations, less current portion	—		517,289		12,622			2,136		—			532,047
Other long-term liabilities	—		244		(136		)	5,022		—			5,130
Stockholders’ equity	94,941		7,855		7,855			10,864		(26,574		)	94,941
	$	94,941	$	527,902	$	666,318		$	40,042	$	(653,572	)	$	675,631

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004

(Amounts in thousands)

	PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATION		CONSOLIDATED

Revenues	$	—		$	—		$	68,757		$	12,097		$	—	$	80,854
Costs of operations	—			—			56,199			10,546			—		66,745
Gross profit	—			—			12,558			1,551			—		14,109

Corporate operating expenses	—			—			(4,855		)	—			—		(4,855		)

Equity in earnings of unconsolidated partnerships	—			—			400			—			—		400
Interest expense, net	—			—			(10,636		)	(328		)	—		(10,964		)
Income (loss) before income taxes	—			—			(2,533		)	1,223			—		(1,310		)

Provision (benefit) for income taxes	—			—			(524		)	—			—		(524		)
Income (loss) before equity in income (loss) of consolidated subsidiaries	—			—			(2,009		)	1,223			—		(786		)

Equity in income (loss) of consolidated subsidiaries	(786		)	(786		)	1,223			—			349		—
Net income (loss)	$	(786	)	$	(786	)	$	(786	)	$	1,223		$	349	$	(786	)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003

(Amounts in thousands)

	PARENT COMPANY ONLY		INSIGHT		GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATION			CONSOLIDATED

Revenues	$	—	$	—	$	57,023		$	11,749		$	—		$	68,772
Costs of operations	—		—		43,247			9,975			—			53,222
Gross profit	—		—		13,776			1,774			—			15,550

Corporate operating expenses	—		—		(3,503		)	—			—			(3,503		)

Equity in earnings of unconsolidated partnerships	—		—		759			—			—			759

Interest expense, net	—		—		(9,695		)	(426		)	—			(10,121		)
Income before income taxes	—		—		1,337			1,348			—			2,685

Provision for income taxes	—		—		1,075			—			—			1,075
Income before equity in income of consolidated subsidiaries	—		—		262			1,348			—			1,610

Equity in income of consolidated subsidiaries	1,610		1,610		1,348			—			(4,568		)	—
Net income	$	1,610	$	1,610	$	1,610		$	1,348		$	(4,568	)	$	1,610

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004

(Amounts in thousands)

	PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income (loss)	$	(786	)	$	(786	)	$	(786	)	$	1,223		$	349		$	(786	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	—			—			15,050			1,298			—			16,348
Equity in income (loss) of consolidated subsidiaries	786			786			(1,223		)	—			(349		)	—
Cash provided by (used in) changes in operating assets and liabilities:
Trade accounts receivables , net	—			—			1,210			(66		)	—			1,144
Intercompany receivables, net	—			571			708			(1,279		)	—			—
Other current assets	—			—			532			(8		)	—			524
Accounts payable and other accrued expenses	—			—			3,418			174			—			3,592
Net cash provided by operating activities	—			571			18,909			1,342			—			20,822

INVESTING ACTIVITIES:
Additions to property and equipment	—			—			(6,864		)	(1,355		)	—			(8,219		)
Other	—			—			(101		)	293			—			192
Net cash used in investing activities	—			—			(6,965		)	(1,062		)	—			(8,027		)

FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease obligations	—			(566		)	(1,334		)	(181		)	—			(2,081		)
Other	—			(5		)	8			148			—			151
Net cash used in financing activities	—			(571		)	(1,326		)	(33		)	—			(1,930		)

INCREASE IN CASH AND CASH EQUIVALENTS	—			—			10,618			247			—			10,865
Cash, beginning of period	—			—			25,820			4,592			—			30,412
Cash, end of period	$	—		$	—		$	36,438		$	4,839		$	—		$	41,277

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003

(Amounts in thousands)

	PARENT COMPANY ONLY			INSIGHT			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED

OPERATING ACTIVITIES:
Net income	$	1,610		$	1,610		$	1,610		$	1,348		$	(4,568	)	$	1,610
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	—			—			12,463			1,339			—			13,802
Equity in income of consolidated subsidiaries	(1,610		)	(1,610		)	(1,348		)	—			4,568			—
Cash provided by (used in) changes in operating assets and liabilities:
Trade accounts receivables , net	—			—			(3,235		)	(123		)	—			(3,358		)
Intercompany receivables, net	—			(49,497		)	54,098			(4,601		)	—			—
Other current assets	—			—			2,410			164			—			2,574
Accounts payable and other accrued expenses	—			—			2,944			19			—			2,963
Net cash provided by (used in) operating activities	—			(49,497		)	68,942			(1,854		)	—			17,591

INVESTING ACTIVITIES:
Acquisitions of fixed-site centers and mobile facilities	—			—			(52,515		)	—			—			(52,515		)
Additions to property and equipment	—			—			(8,177		)	(209		)	—			(8,386		)
Other	—			—			(398		)	—			—			(398		)
Net cash used in investing activities	—			—			(61,090		)	(209		)	—			(61,299		)

FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease obligations	—			(503		)	(1,295		)	(149		)	—			(1,947		)
Proceeds from issuance of notes payable	—			50,000			—			1,125			—			51,125
Other	—			—			(1,130		)	1,080			—			(50		)
Net cash provided by (used in) financing activities	—			49,497			(2,425		)	2,056			—			49,128

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	—			—			5,427			(7		)	—			5,420
Cash, beginning of period	—			—			15,965			3,589			—			19,554
Cash, end of period	$	—		$	—		$	21,392		$	3,582		$	—		$	24,974

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

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

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

• contract renewals and financial stability of customers;

• conditions within the healthcare environment;

• adverse utilization trends for certain diagnostic imaging procedures;

• our ability to successfully integrate acquisitions;

• market competition;

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

• operating, legal, governmental and regulatory risks; and

• economic, political and competitive forces affecting our business.

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

OVERVIEW

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

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

We serve a diverse portfolio of customers, including healthcare providers, such as hospitals and physicians, and payors, such as managed care organizations, Medicare, Medicaid and insurance companies. We provide our services

through an integrated network of fixed-site centers and mobile facilities in targeted regions throughout the United States. We operate in 37 states with a substantial presence in California, Arizona, New England, the Carolinas, Florida and the Mid-Atlantic states. While we generated approximately 72% of our total revenues from MRI services during the three months ended September 30, 2004, we provide a comprehensive offering of diagnostic imaging and treatment services, including PET, CT, mammography, bone densitometry, diagnostic ultrasound, lithotripsy and x-ray. We have developed and continue to develop strong regional networks of diagnostic imaging centers and facilities, enabling us to effectively serve our customers and maximize utilization of our imaging equipment.

As of September 30, 2004, our network consists of 120 fixed-site centers and 115 mobile facilities. This combination allows us to provide a full continuum of imaging services to better meet the needs of our customers, including healthcare providers, such as hospitals and physicians, and payors such as managed care organizations, Medicare, Medicaid and insurance companies. Our fixed-site centers include freestanding centers and joint ventures with hospitals and radiology groups. Physicians refer patients to our fixed-site centers based on our service reputation, equipment, breadth of managed care contracts and convenient locations. Our mobile facilities provide hospitals and physician groups access to imaging technologies when they lack either the resources or patient volume to provide their own imaging services or require incremental capacity. We enter into agreements with radiologists to provide professional services, which include supervision and interpretation of radiological procedures and quality assurance. We do not engage in the practice of medicine. We operate as two divisions, the mobile division and the fixed division, which also constitute our two reportable segments. Our mobile division includes 30 parked mobile facilities, each of which serves a single customer. Our fixed division includes four mobile facilities as part of our fixed division operations in Maine. Certain financial information regarding our reportable segments is included in Note 9 to our condensed consolidated financial statements, which are a part of this Form 10-Q.

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

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

Recent Developments

On April 1, 2004, we acquired the stock of Comprehensive Medical Imaging, Inc., or CMI, a subsidiary of Cardinal Health, Inc., from Cardinal Health, Inc., which owned and operated 21 fixed-site centers located in California, Arizona, Texas, Kansas, Pennsylvania and Virginia. The aggregate purchase price for these centers was approximately $49.0 million. We refer to this acquisition as the CMI acquisition.

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

In August 2003, we acquired a joint venture interest in a CT fixed-site center located in Hammonton, New Jersey. In February 2004, through a joint venture we opened a fixed-site center in Columbus, Ohio. In April 2004, we opened a fixed-site center in Simi Valley, California. All three of these transactions were financed with internally generated funds.

RESULTS OF OPERATIONS

Segments

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

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

• attract patient referrals from physician groups and hospitals;

• increase procedure volume to maximize equipment utilization;

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

• develop new fixed-site centers.

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

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

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

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

Mobile Division: Our mobile division operates mobile facilities, which provide services to hospitals, physician groups and other healthcare providers. Our mobile division includes 30 parked mobile facilities, each of which serves a single customer. Revenues from our mobile division are primarily generated from fee-for-service arrangements and fixed fee contracts billed directly to our hospital, physician group and other healthcare provider customers, which we generally refer to as contract services revenues. Our mobile division revenues are dependent on our ability to:

• establish new mobile customers within our targeted regions;

• structure efficient mobile routes that maximize equipment utilization; and

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

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

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

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

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

• a reduction in short-term rental activities.

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

Reimbursement

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

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

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

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

Managed Care: Health Maintenance Organizations, or HMOs, and Preferred Provider Organizations, or PPOs, and other managed care organizations attempt to control the cost of healthcare services by a variety of measures, including, imposing lower payment rates, preauthorization requirements, limiting services or mandating less costly treatment alternatives. Managed care contracting has become very competitive and reimbursement schedules are at or below Medicare reimbursement levels. The development and expansion of HMOs, PPOs and other managed care organizations within our targeted regional networks could have a negative impact on utilization of our services in certain markets and/or affect the revenues per procedure which we can collect, since such organizations will exert greater control over patients’ access to diagnostic imaging services, the selection of the provider of such services and the reimbursement thereof.

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

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

Revenues

We receive revenues by providing services to patients, hospitals and other healthcare providers. Our patient services revenues are billed, on a fee-for-service basis, directly to patients or third-party payors such as managed care organizations, Medicare, Medicaid, commercial insurance carriers and worker’s compensation funds (collectively, “payors”). Our collection policy is to obtain all required insurance information at the time a procedure is scheduled, and to submit an invoice to the payor immediately after a procedure is completed. Most third-party payors require preauthorization before an MRI or PET procedure is performed on a patient. Patient services revenues also includes balances due from patients, which are primarily collected at the time the procedure is performed. Our charge for a procedure is comprised of charges for both the technical and professional components of the service. Patient services revenues are presented net of (1) related contractual adjustments, which represent the difference between our charge for a procedure and what we will ultimately receive from the payors, and (2) payments due to radiologists for interpreting the results of the diagnostic imaging procedures. Our billing system does not generate contractual adjustments. Contractual adjustments are manual estimates based upon an analysis of (i) historical experience of contractual payments from payors and (ii) the outstanding accounts receivables from payors. Contractual adjustments are written off against their corresponding asset account at the time a payment is received from a payor, with a reduction to the allowance for contractual adjustments to the extent such an allowance was previously recorded.

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

The provision for doubtful accounts related to revenues is reflected as an operating expense rather than a reduction of revenues and represents our estimate of amounts that will be uncollectible from patients, payors, hospitals and other healthcare providers. The provision for doubtful accounts includes amounts to be written off with respect to (1) specific accounts involving customers which are financially unstable or materially fail to comply with the payment terms of their contract and (2) other accounts based on our historical collection experience, including payor mix and the aging of patient accounts receivables balances. Estimates of uncollectible amounts are revised each period, and changes are recorded in the period they become known. Receivables deemed to be uncollectible, either through a customer default on payment terms or after reasonable collection efforts have been exhausted, are fully written off against their corresponding asset account, with a reduction to the allowance for doubtful accounts to the extent such an allowance was previously recorded. Our historical write-offs for uncollectible accounts are not concentrated in a specific payor class.

The following illustrates our payor mix based on revenues for the three months ended September 30, 2004 (unaudited):

Payor	Percent of Total Revenues

Hospitals, physician groups, and other healthcare providers (1)	43	%
Managed Care and Insurance	38	%
Medicare/Medicaid	14	%
Workers’ Compensation	4	%
Other	1	%

(1) No single hospital, physician group or other healthcare provider accounted for more than 5% of our total revenues.

Operating Expenses

We operate in a capital intensive industry that requires significant amounts of capital to fund operations. As a result, a high percentage of our total operating expenses are fixed. Our fixed costs include debt service and capital lease payments, rent and operating lease payments, salaries and benefit obligations, equipment maintenance expenses, and insurance and vehicle operation costs. Due to the increase in mobile PET and PET/CT facilities, which are moved more frequently, our vehicle operation costs will continue to increase until we can maximize geographic operating efficiencies. Because a large portion of our operating expenses are fixed, any increase in our procedure volume disproportionately increases our operating cash flow. Conversely, any decrease in our

procedure volume disproportionately decreases our operating cash flow. Our variable costs, which comprise only a small portion of our total operating expenses, include the cost of service supplies such as film, contrast media and radiopharmaceuticals used in PET procedures.

Results of Operations

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

	Three Months Ended September 30,
	Three Months Ended September 30,
	2004		2003
	(unaudited)

REVENUES:	100.0	%	100.00	%

COSTS OF OPERATIONS:
Costs of services	59.9		55.4
Provision for doubtful accounts	2.0		1.6
Equipment leases	0.4		0.3
Depreciation and amortization	20.2		20.1
Total costs of operations	82.5		77.4

Gross profit	17.5		22.6

CORPORATE OPERATING EXPENSES	(6.0	)	(5.1	)

EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS	0.5		1.1

INTEREST EXPENSE, net	(13.6	)	(14.7	)

Income (loss) before income taxes	(1.6	)	3.9

PROVISION (BENEFIT) FOR INCOME TAXES	(0.6	)	1.6

Net income (loss)	(1.0	)%	2.3	%

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

	Three Months Ended September 30,
	2004		2003
	(unaudited)

Fixed division	$	50,798	$	41,693
Mobile division	30,056		27,079
Total	$	80,854	$	68,772

Three Months Ended September 30, 2004 and 2003

Revenues: Revenues increased approximately 17.6% from approximately $68.8 million for the three months ended September 30, 2003, to approximately $80.9 million for the three months ended September 30, 2004. This increase was due to an increase in revenues from our fixed division (approximately $9.1 million) and an increase in revenues from our mobile division (approximately $3.0 million). Revenues for our fixed division and mobile division represented approximately 63% and 37%, respectively, of our total revenues for the three months ended September 30, 2004.

Revenues from our fixed division increased approximately 21.8% from approximately $41.7 million for the three months ended September 30, 2003, to approximately $50.8 million for the three months ended September 30, 2004. The increase was due to (1) the CMI acquisition (approximately $9.9 million) and (2) revenues from the fixed-site

centers we opened in 2004 and 2003 (approximately $0.7 million), partially offset by a reduction in (1) revenues from our existing fixed-site centers (approximately $0.9 million) and (2) revenues from the center we sold in 2003 (approximately $0.6 million). The decrease in our revenues from our existing fixed-site centers was the result of a 2% decrease in utilization.

Revenues from our mobile division increased approximately 11.0% from approximately $27.1 million for the three months ended September 30, 2003, to approximately $30.1 million for the three months ended September 30, 2004. The increase was due to (1) the CDL acquisition (approximately $1.9 million) and (2) revenues from our existing mobile facilities (approximately $1.1 million). The increase in revenues from our existing mobile facilities was the result of higher PET revenues (approximately $1.3 million), partially offset by lower MRI and other revenues (approximately $0.2 million). The increase in PET revenues was primarily due to an increase in the number of PET facilities in service. The decrease in MRI revenues was due to a decrease in the number of MRI facilities in service, partially offset by an increase in procedure volume at existing mobile facilities.

Approximately 58% of our total revenues for the three months ended September 30, 2004 were generated from patient services revenues. Patient services revenues for the fixed division and mobile division represented approximately 99% and 1%, respectively, of total patient services revenues for the three months ended September 30, 2004. Approximately 42% of our total revenues for the three months ended September 30, 2004, were generated from contract services revenues. Contract services revenues for the fixed division and mobile division represented approximately 12% and 88%, respectively, of total contract services revenues for the three months ended September 30, 2004.

Costs of Operations: Costs of operations increased approximately 25.4% from approximately $53.2 million for the three months ended September 30, 2003, to approximately $66.7 million for the three months ended September 30, 2004. This increase was due primarily to (1) the CDL and CMI acquisitions (approximately $1.2 million and $7.8 million, respectively), (2) increased costs at our existing fixed-site centers and mobile facilities (approximately $4.3 million) and (3) costs at the fixed-site centers we opened in 2004 and 2003 (approximately $0.7 million), partially offset by reduced costs from the center we sold in 2003 (approximately $0.5 million). The increase in costs of operations at our existing fixed-site centers and mobile facilities is due primarily to higher salaries and benefits (approximately $2.2 million), depreciation and amortization expense (approximately $1.1 million), an increase in vehicle costs (approximately $0.5 million), and higher insurance costs (approximately $0.3 million).

Costs of operations at our fixed division increased approximately 27.4% from approximately $29.8 million for the three months ended September 30, 2003, to approximately $37.9 million for the three months ended September 30, 2004. The increase was due to (1) the CMI acquisition (approximately $7.8 million), (2) costs at the fixed-site centers we opened in 2004 and 2003 (approximately $0.7 million), and (3) a charge for one-time severance payments for terminated employees (approximately $0.3 million), partially offset by (1) reduced costs from the sale of a fixed-site center in Hobart, Indiana (approximately $0.5 million) and (2) a decrease in costs at our existing fixed-site centers (approximately $0.2 million). The decrease in costs of operations at our existing fixed-site centers was due primarily to a reduction in medical supply costs (approximately $0.2 million) and a reduction in the provision for doubtful accounts (approximately $0.1 million).

Costs of operations at our mobile division increased approximately 22.3% from approximately $19.4 million for the three months ended September 30, 2003, to approximately $23.8 million for the three months ended September 30, 2004. The increase was due to (1) the CDL acquisition (approximately $1.2 million) and (2) increased costs at our existing mobile facilities (approximately $3.2 million). The increase in costs at our existing mobile facilities was due to higher salaries and benefits (approximately $1.1 million), particularly technologists, an increase in vehicle costs (approximately $0.4 million), an increase in medical supply costs (approximately $0.2 million), higher depreciation and amortization expense (approximately $0.8 million) and an increase in the provision for doubtful accounts (approximately $0.2 million). The increase in costs of operations at existing mobile facilities results primarily from an increase in costs to operate our PET and PET/CT facilities which have higher (1) medical supply costs relating to the use of radiopharmaceuticals, (2) technologist salaries relating to the shortage of PET technologists and the increase in the number of technologists needed to operate PET/CT facilities and (3) vehicle operation costs relating to the fact that PET and PET/CT facilities are moved more frequently. We believe that these higher costs will continue as we add additional PET and PET/CT facilities.

Corporate Operating Expenses: Corporate operating expenses increased approximately 38.6% from approximately $3.5 million for the three months ended September 30, 2003, to approximately $4.9 million for the three months ended September 30, 2004. During the three months ended September 30, 2004, we recorded a charge for one-time severance payments for terminated employees (approximately $0.8 million). The remaining increase was also due primarily to higher salaries and benefits (approximately $0.2 million), additional legal and accounting costs (approximately $0.2 million), and additional occupancy costs (approximately $0.1 million).

Interest Expense, net: Interest expense, net increased approximately 8.3% from approximately $10.1 million for the three months ended September 30, 2003, to approximately $11.0 million for the three months ended September 30, 2004. The increase was due primarily to additional debt related to the CDL and CMI acquisitions, partially offset by principal payments on notes payable and capital lease obligations.

Provision (Benefit) for Income Taxes: Provision (benefit) for income taxes decreased from a provision of $1.1 million for the three months ended September 30, 2003, to a benefit of approximately $0.5 million for the three months ended September 30, 2004, due to the pretax loss for the three months ended September 30, 2004. We have recorded a tax provision (benefit) at an effective rate of 40% for the three months ended September 30, 2004 and 2003.

Financial Condition, Liquidity and Capital Resources

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

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

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

• principal and interest payments relating to our credit facility;

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

• capital expenditures;

• working capital requirements to support business growth; and

• potential acquisitions.

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

Cash and cash equivalents as of September 30, 2004 were approximately $41.3 million. Our primary source of liquidity is cash provided by operating activities. Our ability to generate cash flows from operating activities is based upon several factors including the following:

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

• the demand for our services in the mobile division;

• our ability to control expenses; and

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

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

	Three Months Ended September 30,
	2004			2003
	(unaudited)
Net cash provided by operating activities	$	20,822		$	17,591
Net cash used in investing activities	(8,027		)	(61,299		)
Net cash provided by (used in) financing activities	(1,930		)	49,128

Net cash provided by operating activities was approximately $20.8 million for the three months ended September 30, 2004 and resulted primarily from net income before depreciation and amortization (approximately $15.6 million), an increase in accounts payable and accrued expenses (approximately $3.6 million), a decrease in other current assets (approximately $0.5 million) and a decrease in trade accounts receivables, net (approximately $1.1 million). The increase in accounts payable and accrued expenses is due to an increase in accrued interest primarily related to the timing of interest payments on our senior subordinated notes.

Net cash used in investing activities was approximately $8.0 million for the three months ended September 30, 2004. Cash used in investing activities resulted primarily from our purchase or upgrade of diagnostic imaging equipment at our existing fixed-site centers (approximately $8.2 million).

Net cash used in financing activities was approximately $1.9 million for the three months ended September 30, 2004. Cash used in financing activities resulted primarily from principal payments of notes payable and capital lease obligations (approximately $2.1 million).

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

	Three Months Ended September 30,
	2004			2003
	(unaudited)
Net cash provided by operating activities	$	20,822		$	17,591
Provision (benefit) for income taxes	(524		)	1,075
Interest expense, net	10,964			10,121
Net change in operating assets and liabilities	(5,260		)	(2,179		)
EBITDA	$	26,002		$	26,608

EBITDA decreased approximately 2.3% from approximately $26.6 million for the three months ended September 30, 2003, to approximately $26.0 million for the three months ended September 30, 2004. This decrease was due primarily to (1) a reduction at existing facilities (approximately $3.2 million), (2) a reduction at the fixed-site center we sold in 2003 (approximately $0.2 million) and (3) an increase in corporate operating and other expenses (approximately $1.7 million), partially offset by increases due to (1) the CDL and CMI acquisitions (approximately $1.1 million and $3.3 million, respectively) and (2) the fixed-site centers we opened in 2004 and 2003 (approximately $0.1 million). EBITDA for the fixed division increased approximately 10.7% from approximately

$17.7 million for the three months ended September 30, 2003, to approximately $19.6 million for the three months ended September 30, 2004. This increase was due primarily to (1) the CMI acquisition (approximately $3.3 million) and (2) the fixed-site centers we opened in 2004 and 2003 (approximately $0.1 million), partially offset by a decrease at our existing fixed-site centers (approximately $1.3 million) and a decrease at the fixed-site center we sold in 2003 (approximately $0.2 million). EBITDA for the mobile division decreased approximately 2.0% from approximately $14.4 million for the three months ended September 30, 2003, to approximately $14.1 million for the three months ended September 30, 2004. This decrease was due to a reduction at our existing mobile facilities (approximately $1.3 million), partially offset by the CDL acquisition (approximately $1.1 million).

Capital Expenditures: As of September 30, 2004, we have committed to purchase or lease at an approximate aggregate cost of $8.0 million, six diagnostic imaging systems through February 2005. We expect to use either internally generated funds or leases to finance the purchase of such equipment. We may purchase, lease or upgrade other diagnostic imaging systems as opportunities arise to place new equipment into service when new contract services agreements are signed, existing agreements are renewed, acquisitions are completed, or new fixed-site centers and mobile facilities are developed in accordance with our business strategy.

In addition, in connection with the implementation of the electronic transactions, security and privacy standards mandated by the Health Insurance Portability and Accountability Act of 1996, we have spent approximately $1.8 million as of September 30, 2004, to make necessary software upgrades to our proprietary information system to make it conform with the privacy and electronic standards. We expect to spend an additional $0.5 million to conform with the security standards by April 2005.

Credit Facility and Senior Subordinated Notes: As of September 30, 2004, through InSight, we have a credit facility with Bank of America, N.A. and a syndicate of other lenders consisting of: (1) a term loan with a principal balance of approximately $219.5 million, (2) an additional term loan with a principal balance of approximately $50.0 million and (3) a $50.0 million revolving credit facility. Borrowings under the credit facility bear interest at LIBOR plus 3.5% to 3.75%. We are required to pay an annual unused facility fee of between 0.5% and 2.5%, payable quarterly, on unborrowed amounts. As of November 5, 2004, there were no borrowings under the revolving credit facility.

In addition to the indebtedness under our credit facility, through InSight, we have outstanding $250 million of 9.875% senior subordinated notes. The notes mature in November 2011, with interest payable semi-annually and are redeemable at our option, in whole or in part, on or after November 1, 2006.

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

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 condensed consolidated financial statements are as follows:

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

RISK FACTORS

RISKS RELATING TO OUR INDEBTEDNESS

Our substantial indebtedness could adversely affect our financial health.

As of September 30, 2004, we had total indebtedness of approximately $537.7 million which comprised approximately 85.1% of our total capitalization. Our substantial indebtedness could have important consequences to us. For example, it could:

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

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

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

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

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

• limit our ability to borrow additional funds.

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

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

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

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

• a number of other restricted payments, including investments;

• specified sales of assets;

• specified transactions with affiliates;

• the creation of a certain types of liens;

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

• our ability to change the nature of our business.

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

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

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

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

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

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

At September 30, 2004, our assets included approximately $318.9 million of intangible assets, representing approximately 47% of our total consolidated assets. These assets primarily consist of the excess of the acquisition cost over the fair market value of the net assets acquired in purchase transactions. The value of these intangible assets will continue to depend significantly upon the success of our business as a going concern and the growth in future cash flows. As a result, in the event of a default under our credit facility or our indenture or any bankruptcy or dissolution of our company, the realizable value of these assets may be substantially lower and may be insufficient to satisfy the claims of our creditors.

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

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

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

Rises in interest rates could adversely affect our financial condition.

An increase in prevailing interest rates would have an immediate effect on the interest rates charged on our variable rate debt, which rise and fall upon changes in interest rates. At September 30, 2004, approximately 51.9% of our debt was variable rate debt. Increases in interest rates would also impact the refinancing of our fixed rate debt. If interest rates are higher when our fixed debt becomes due, we may be forced to borrow at the higher rates. If prevailing interest rates or other factors result in higher interest rates, the increased interest expense would adversely affect our cash flow and our ability to service our debt. As a protection against rising interest rates, we may enter into agreements such as interest rate swaps, caps, floors and other interest rate exchange contracts. These agreements, however, increase our risks as to the other parties to the agreements not performing or that the agreements could be unenforceable.

RISKS RELATING TO OUR BUSINESS

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

For the three months ended September 30, 2004, we derived approximately 58% of our revenues from direct billings to patients and third-party payors such as Medicare, Medicaid, managed care and private health insurance companies. Changes in the rates or methods of reimbursement for the services we provide could have a significant negative impact on those revenues. Moreover, our healthcare provider customers on whom we depend for approximately 42% of our revenues generally rely on reimbursement from third-party payors. In the past, initiatives have been proposed and implemented which have the effect of substantially decreasing reimbursement rates for diagnostic imaging services provided at non-hospital facilities. Similar initiatives enacted in the future may have an adverse impact on our financial condition and our operations.

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

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

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

Our financial results depend on our ability to sustain and grow our revenues from existing customers. Our revenues would decline if we are unable to renew our existing customer contracts or renew these contracts on favorable terms. For our mobile facilities, we generally enter into contracts with hospitals having one to five year terms. Approximately 33% of our mobile contracts will expire each year. Our mobile facility contract renewal rate was 80% for the three months ended September 30, 2004. We may not, however, achieve these renewal rates in the future. To the extent we do not renew a customer contract, it is not always possible to immediately obtain replacement customers. Historically, many replacement customers have been smaller facilities which have lower procedure volumes. In addition, attractive financing from original equipment manufacturers may cause hospitals and physician groups who have utilized shared mobile services from our company and our competitors to purchase and operate their own equipment. If attractive financing causes hospitals and physician groups to establish their own diagnostic imaging centers, our business, financial condition and results of operations would be materially adversely affected. Although the non-renewal of a single customer contract would not have a material impact on our contract services revenues, non-renewal of several contracts on favorable terms or at all could have a significant negative impact on our revenues.

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

The healthcare industry in general, and the market for diagnostic imaging services in particular, is highly competitive and fragmented, with only a few national providers. We compete principally on the basis of our service reputation, equipment, breadth of managed care contracts and convenient locations. Our operations must compete with groups of radiologists, established hospitals and certain other independent organizations, including equipment manufacturers

and leasing companies that own and operate imaging equipment. We will also encounter competition from hospitals and physician groups that purchase their own diagnostic imaging equipment from original equipment manufacturers who provide low-cost financing. Some of our direct competitors that provide diagnostic imaging services may have access to greater financial resources than we do. If we are unable to successfully compete, our customer base would decline and our business, financial condition and results of operations would be adversely affected.

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

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

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

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

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

Harsh weather conditions can adversely impact our operations and financial condition. To the extent severe weather patterns affect our targeted regions, potential patients may find it difficult to travel to our centers and we may have difficulty moving our mobile facilities along their scheduled routes. As a result, we would experience a decrease in procedure volume during that period. Our equipment utilization, procedure volume or revenues could be adversely affected by similar conditions in the future.

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

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

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

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

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

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

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

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

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

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

• integration of information systems;

• risks associated with unanticipated events or liabilities;

• difficulties in the assimilation and retention of employees;

• potential adverse effects on operating results;

• challenges in retaining customers and referral sources; and

• amortization or write-offs of acquired intangible assets.

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

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

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

higher salaries to our technologists, which would increase our expenses. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.

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

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

An earthquake could adversely affect our business and operations.

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

RISKS RELATING TO GOVERNMENT REGULATION OF OUR BUSINESS

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

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

• the federal False Claims Act;

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

• the federal Civil Money Penalty Law;

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

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

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

• United States Food and Drug Administration requirements;

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

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

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

The regulatory framework is uncertain and evolving.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

Interest Rate Risk

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

Our future earnings and cash flows and some of our fair values relating to financial instruments are dependent upon prevailing market rates of interest, such as LIBOR. Based on interest rates and outstanding balances as of September 30, 2004, a 1% change in interest rates on our $269.5 million of floating rate debt would affect annual future earnings and cash flows by approximately $2.7 million. The weighted-average interest rate on our floating debt as of September 30, 2004 was approximately 5.1%.

Through InSight, we also have outstanding $250 million in senior subordinated notes which mature in November 2011 and bear interest at 9.875%, payable semi-annually. The fair value of our senior subordinated notes as of September 30, 2004 was approximately $252.5 million.

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

Delaware	04-3570028
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

26250 Enterprise Court, Suite 100, Lake Forest, CA 92630
(Address of principal executive offices) (Zip code)

(949) 282-6000
(Registrant’s telephone number including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

PART I. FINANCIAL INFORMATION

	ITEM 1.	FINANCIAL STATEMENTS

		Condensed Consolidated Balance Sheets as of September 30, 2004 and June 30, 2004 (unaudited)

		Condensed Consolidated Statements of Operations for the three months ended September 30, 2004 and 2003 (unaudited)

		Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2004 and 2003 (unaudited)

		Notes to Condensed Consolidated Financial Statements (unaudited)

	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 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

	ITEM 6.	EXHIBITS

SIGNATURES

	INSIGHT HEALTH SERVICES HOLDINGS CORP.
	(Registrant)


	By:	/s/ Michael N. Cannizzaro
		Michael N. Cannizzaro
		President and Chief Executive Officer
		(Principal Executive Officer)


	By:	/s/ Brian G. Drazba
		Brian G. Drazba
		Executive Vice President and
		Chief Financial Officer
		(Principal Financial and Accounting Officer)