================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q/A
(AMENDMENT NO. 1)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JANUARY 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-19019
PRIMEDEX HEALTH SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
NEW YORK 13-3326724
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1510 COTNER AVENUE
LOS ANGELES, CALIFORNIA 90025
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(310) 478-7808
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 of 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the registrant's common stock as of
February 27, 2006 was 41,406,813 (excluding treasury shares).
================================================================================
1
Explanatory Note: This Amendment No. 1 on Form 10-Q/A (this "Amendment") to our
Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 2006
includes a new discussion in Item 2. under "Overview" with respect to our
evaluation of disclosure controls and procedures, clarifies our discussion in
Item 4. and adds a paragraph to our CEO and CFO certifications filed as Exhibits
31.1 and 31.2.
PART 1 -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED BALANCE SHEETS
OCTOBER 31, JANUARY 31,
2005 2006 (UNAUDITED)
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,000 $ 2,000
Accounts receivable, net 22,319,000 21,942,000
Unbilled receivables and other receivables 476,000 1,076,000
Other 1,799,000 1,800,000
------------- -------------
Total current assets 24,596,000 24,820,000
------------- -------------
PROPERTY AND EQUIPMENT, NET 68,107,000 64,886,000
------------- -------------
OTHER ASSETS
Accounts receivable, net 1,267,000 1,245,000
Goodwill 23,099,000 23,099,000
Trade name and other 4,164,000 4,535,000
------------- -------------
Total other assets 28,530,000 28,879,000
------------- -------------
Total assets $ 121,233,000 $ 118,585,000
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Cash disbursements in transit $ 3,425,000 $ 5,717,000
Line of credit 13,341,000 468,000
Accounts payable and accrued expenses 22,469,000 21,580,000
Short-term notes expected to be refinanced:
Notes payable 69,066,000 --
Obligations under capital lease 56,927,000 --
Notes payable 1,101,000 860,000
Obligations under capital lease 1,697,000 1,667,000
------------- -------------
Total current liabilities 168,026,000 30,292,000
------------- -------------
LONG-TERM LIABILITIES
Subordinated debentures payable 16,147,000 16,147,000
Notes payable to related party 3,533,000 3,575,000
Notes payable, net of current portion -- 135,769,000
Obligations under capital lease, net of current portion 4,129,000 3,732,000
Accrued expenses 31,000 30,000
------------- -------------
Total long-term liabilities 23,840,000 159,253,000
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT (70,633,000) (70,960,000)
------------- -------------
Total liabilities and stockholders' deficit $ 121,233,000 $ 118,585,000
============= =============
The accompanying notes are an integral part of these financial statements
2
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED
JANUARY 31, 2005 2006
----------- ------------ ------------
NET REVENUE $ 34,110,000 $ 38,538,000
OPERATING EXPENSES
Operating expenses 26,865,000 29,169,000
Depreciation and amortization 4,323,000 4,087,000
Provision for bad debts 909,000 1,349,000
------------ ------------
Total operating expenses 32,097,000 34,605,000
------------ ------------
INCOME FROM OPERATIONS 2,013,000 3,933,000
OTHER EXPENSE (INCOME)
Interest expense 4,235,000 4,461,000
Other income (110,000) (51,000)
Other expense 86,000 --
------------ ------------
Total other expense 4,211,000 4,410,000
------------ ------------
NET LOSS $ (2,198,000) $ (477,000)
============ ============
BASIC AND DILUTED NET LOSS PER SHARE $ (.05) $ (.01)
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
Basis and diluted 41,106,813 41,406,813
============ ============
The accompanying notes are an integral part of these financial statements
3
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
THREE MONTHS ENDED JANUARY 31, 2006
COMMON STOCK $.01 PAR VALUE,
100,000,000 SHARES AUTHORIZED TREASURY STOCK, AT COST
----------------------------- PAID-IN ----------------------------- ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL SHARES AMOUNT DEFICIT DEFICIT
------------- ------------- ------------- ------------- ------------- ------------- -------------
BALANCE--
OCTOBER 31, 2005 43,231,813 $ 433,000 $ 100,590,000 (1,825,000) $ (695,000) $(170,961,000) $ (70,633,000)
Issuance of warrant -- -- 110,000 -- -- -- 110,000
Share-based payments -- -- 40,000 -- -- -- 40,000
Net Loss -- -- -- -- -- (477,000) (477,000)
------------- ------------- ------------- ------------- ------------- ------------- -------------
BALANCE--
JANUARY 31, 2006
(UNAUDITED) 43,231,813 $ 433,000 $ 100,740,000 (1,825,000) $ (695,000) $(171,438,000) $ (70,960,000)
============= ============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these financial statements
4
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED JANUARY 31, 2005 2006
----------------------------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,675,000 $ 2,504,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (885,000) (834,000)
Proceeds from sale of equipment 65,000 --
----------- -----------
Net cash used by investing activities (820,000) (834,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash disbursements in transit (550,000) 2,292,000
Principal payments on notes and leases payable (1,292,000) (4,663,000)
Proceeds from short and long-term borrowings 987,000 701,000
----------- -----------
Net cash used by financing activities (855,000) (1,670,000)
----------- -----------
NET INCREASE IN CASH -- --
CASH, beginning of period 2,000 2,000
----------- -----------
CASH, end of period $ 2,000 $ 2,000
----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 3,714,000 $ 4,111,000
=========== ===========
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES
During the three months ended January 31, 2005, we entered into additional capital leases
for $2,067,000. No new capital leases were entered into during the same period in fiscal 2006.
The accompanying notes are an integral part of these financial statements
5
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
NATURE OF BUSINESS
Primedex Health Systems, Inc., or Primedex, incorporated on October 21,
1985, provides diagnostic imaging services in the state of California. Imaging
services include magnetic resonance imaging, or MRI, computer tomography, or CT,
positron emission tomography, or PET, nuclear medicine, mammography, ultrasound,
diagnostic radiology, or X-ray, and fluoroscopy. Our operations comprise a
single segment for financial reporting purposes.
The consolidated financial statements of Primedex include the accounts of
Primedex, its wholly owned direct subsidiary, Radnet Management, Inc., or
Radnet, and Beverly Radiology Medical Group III, or BRMG, which is a
professional corporation, all collectively referred to as "us" or "we". The
consolidated financial statements also include Radnet Sub, Inc., Radnet
Management I, Inc., Radnet Management II, Inc., or Modesto, SoCal MR Site
Management, Inc., and Diagnostic Imaging Services, Inc., or DIS, all wholly
owned subsidiaries of Radnet.
The operations of BRMG are consolidated with us as a result of the
contractual and operational relationship among BRMG, Dr. Berger and us. We are
considered to have a controlling financial interest in BRMG pursuant to the
guidance in EITF 97-2. Medical services and supervision at most of our imaging
centers are provided through BRMG and through other independent physicians and
physician groups. BRMG is consolidated with Pronet Imaging Medical Group, Inc.
and Beverly Radiology Medical Group, both of which are 99%-owned by Dr. Berger.
Radnet provides non-medical, technical and administrative services to BRMG for
which they receive a management fee.
Operating activities of subsidiary entities are included in the
accompanying financial statements from the date of acquisition. All intercompany
transactions and balances have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X and, therefore, do not include all information and footnotes
necessary for a fair presentation of financial position, results of operations
and cash flows in conformity with accounting principles generally accepted in
the United States for complete financial statements; however, in the opinion of
our management, all adjustments consisting of normal recurring adjustments
necessary for a fair presentation of financial position, results of operations
and cash flows for the interim periods ended January 31, 2006 and 2005 have been
made. The results of operations for any interim period are not necessarily
indicative of the results for a full year. These interim consolidated financial
statements should be read in conjunction with the consolidated financial
statements and related notes thereto contained in our Annual Report on Form 10-K
for the year ended October 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
We had a working capital deficit of $5.5 million at January 31, 2006
compared to a $143.4 million deficit at October 31, 2005, and had losses from
operations of $0.5 million and $2.2 million during the three months ended
January 31, 2006 and 2005, respectively. We also had a stockholders' deficit of
$71.0 million at January 31, 2006 compared to a $70.6 million deficit at October
31, 2005.
The working capital deficit increased in fiscal 2005 due to the
reclassification of approximately $109 million in notes and capital lease
obligations as current liabilities expected to be refinanced. We were subject to
financial covenants under our debt agreements and believed we may have been
unable to continue to be in compliance with our existing financial covenants
during fiscal 2006. As such, the associated debt was reclassified as a current
liability.
6
Effective March 9, 2006, we completed the issuance of a $161 million senior
secured credit facility that we used to refinance substantially all of our
existing indebtedness (except for $16.1 million of outstanding subordinated
debentures and approximately $5 million of capital lease obligations). Included
in the $161 million senior secured credit facility were fees and expenses for
the transaction of approximately $5.2 million. The facility provides for a $15
million five-year revolving credit facility, an $86 million term loan due in
five years and a $60 million second lien term loan due in six years. The loans
are subject to acceleration on December 27, 2007, unless we have made
arrangements to discharge or extend our outstanding subordinated debentures by
that date. We intend to retire the subordinated debentures prior to their due
date of June 30, 2008. Under the terms and conditions of the new Second Lien
Term Loan, subject to achieving certain leverage ratios, we have the right to
raise up to $16.1 million in additional funds as part of the Second Lien Term
Loan for the purposes of redeeming the subordinated debentures. Additionally,
under the current facilities, we have the ability to pursue other funding
sources to refinance the subordinated debentures. The loans are payable interest
only monthly except for the $86 million term loan that requires amortization
payments of 1.0% per annum.
The revolving credit facility and the $86 million term loan bear interest
at a base rate ("base rate" means corporate loans posted by at least 75% of the
nation's 30 largest banks as quoted by the Wall Street Journal) plus 2.5%, or at
our election, the LIBOR rate plus 4.0% per annum, payable monthly. The $60
million second lien term loan bears interest at the base rate plus 7.0%, or at
our election, the LIBOR rate plus 8.5% per annum, payable monthly. The $86
million term loan includes amortization payments of 1.0% per annum, payable in
quarterly installments of $215,000. Upon the close of the refinancing on March
9, 2006, we utilized approximately $1.5 million of the new $15 million revolving
credit facility.
As part of the refinancing, we are required to swap at least 50% of the
aggregate principal amount of the facilities to a floating rate within 90 days
of the close of the agreement on March 9, 2006. We have not yet entered into the
swap arrangement or decided on how much of the loans will be swapped. In
addition, as a requirement of the deal, 75% of our excess cash flow is to be
used to repay principal on the $86 million term loan once per year within 105
days after our fiscal year end. Excess cash flow is defined as earnings before
interest, taxes, depreciation and amortization plus decreases in working capital
and extraordinary gains minus: (i) capital expenditures; (ii) interest expense;
(iii) scheduled principal payments on existing debt; (iv) income taxes; (v)
increases in working capital; (vi) extraordinary losses; (vii) voluntary
prepayments of the $86 million term loan; (vii) and amounts paid for
acquisitions.
Under the new facility, we are subject to various financial covenants
including a limitation on capital expenditures, maximum days sales outstanding,
minimum fixed charge coverage ratio, maximum leverage ratio and maximum senior
leverage ratio. Availability under our $15 million revolving credit facility is
governed by the margins calculated under the maximum senior leverage ratio and
maximum total leverage ratio covenants. Borrowings under the historical Bridge
credit facility were calculated from a formula based upon our net eligible
accounts receivable. As of March 9, 2006, after giving effect to the
approximately $1.5 million balance on our revolving credit facility, we had
approximately $13.5 million of availability. As a result of the completed
financing, we were able to reclassify the majority of our notes and capital
lease obligations as noncurrent as of January 31, 2006 and improve our working
capital significantly.
We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations. In addition to operations, we
require significant amounts of capital for the initial start-up and development
expense of new diagnostic imaging facilities, the acquisition of additional
facilities and new diagnostic imaging equipment, and to service our existing
debt and contractual obligations. Because our cash flows from operations have
been insufficient to fund all of these capital requirements, we have depended on
the availability of financing under credit arrangements with third parties.
Historically, our principal sources of liquidity have been funds available for
borrowing under our existing lines of credit, now with General Electric Capital
Corporation. We finance the acquisition of equipment mainly through capital and
operating leases. As of January 31, 2006 and October 31, 2005, our line of
credit liabilities were $14.0 million and $13.3 million, respectively. As of
January 31, 2006, $468,000 of line of credit liabilities were classified as
current liabilities for the unpaid balance at the closing of the refinancing
transaction.
7
As of January 31, 2006, Howard G. Berger, M.D., our president, director and
largest shareholder had outstanding advances to us of $1,370,000. Our obligation
to Dr. Berger was repaid as part of our March 9, 2006 refinancing.
The interim disclosures regarding liquidity and capital resources should be
read in conjunction with the consolidated financial statements and related notes
thereto contained in our Annual Report of Form 10-K for the year ended October
31, 2005. There were no material changes in our financing agreements from
October 31, 2005 to January 31, 2006.
Our business strategy with regard to operations will focus on the
following:
o Maximizing performance at our existing facilities;
o Focusing on profitable contracting;
o Expanding MRI and CT applications
o Optimizing operating efficiencies; and
o Expanding our networks.
Due to the March 9, 2006 refinancing, we will be able to use the cash
savings generated from the deferral of required principal payments on notes
payable and capital lease obligations of approximately $1.2 million per month to
invest in the infrastructure and to pursue future growth opportunities.
Our ability to generate sufficient cash flow from operations to make
payments on our debt and other contractual obligations will depend on our future
financial performance. A range of economic, competitive, regulatory, legislative
and business factors, many of which are outside of our control, will affect our
financial performance. Taking these factors into account, including our
historical experience and our discussions with our lenders to date, although no
assurance can be given, we believe that through implementing our strategic plans
and continuing to restructure our financial obligations, we will obtain
sufficient cash to satisfy our obligations as they become due in the next twelve
months.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION--Revenue consists of net patient fee for service
revenue and revenue from capitation arrangements, or capitation revenue.
Net patient service revenue is recognized at the time services are provided
net of contractual adjustments based on our evaluation of expected collections
resulting from their analysis of current and past due accounts, past collection
experience in relation to amounts billed and other relevant information.
Contractual adjustments result from the differences between the rates charged
for services performed and reimbursements by government-sponsored healthcare
programs and insurance companies for such services.
Capitation revenue is recognized as revenue during the period in which we
were obligated to provide services to plan enrollees under contracts with
various health plans. Under these contracts, we receive a per enrollee amount
each month covering all contracted services needed by the plan enrollees.
The following table summarizes net revenue for the three months ended
January 31, 2005 and 2006:
2005 2006
----------- -----------
Net patient service $24,860,000 $27,739,000
Capitation 9,250,000 10,799,000
----------- -----------
Net revenue $34,110,000 $38,538,000
=========== ===========
Accounts receivable are primarily amounts due under fee-for-service
contracts from third party payors, such as insurance companies and patients and
government-sponsored healthcare programs geographically dispersed throughout
California.
8
Accounts receivable as of October 31, 2005 are presented net of allowances
of approximately $59,491,000, of which $56,296,000 is included in current and
$3,195,000 is included in noncurrent. Accounts receivable as of January 31,
2006, are presented net of allowances of approximately $61,871,000, of which
$58,549,000 is included in current and $3,322,000 is included in noncurrent.
CREDIT RISKS - Financial instruments that potentially subject us to credit
risk are primarily cash equivalents and accounts receivable. We have placed our
cash and cash equivalents with one major financial institution. At times, the
cash in the financial institution is temporarily in excess of the amount insured
by the Federal Deposit Insurance Corporation, or FDIC.
With respect to accounts receivable, we routinely assess the financial
strength of our customers and third-party payors and, based upon factors
surrounding their credit risk, establish a provision for bad debt. Net revenue
by payor for the three months ended January 31, 2005 and 2006 were:
Net Revenue
--------------------
2005 2006
-------- --------
Capitation contracts 27% 28%
HMO/PPO/Managed care 21% 24%
Medicare 14% 15%
Blue Cross/Shield/Champus 14% 15%
Special group contract 10% 8%
Commercial insurance 5% 3%
Medi-Cal 3% 3%
Workers compensation 3% 2%
Other 3% 2%
Management believes that its accounts receivable credit risk exposure,
beyond allowances that have been provided, is limited.
STOCK-BASED COMPENSATION EXPENSE - On November 1, 2005, we adopted
Statement of Financial Accounting Standards No. 123 (revised 2004), "
Share-Based Payment," ("SFAS 123(R)") which requires the measurement and
recognition of compensation expense for all share-based payment awards made to
employees and directors. SFAS 123(R) supersedes our previous accounting under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") for period beginning in fiscal 2006. In March 2005, the
Securities and Exchange Commission issued Staff Accounting Bulletin No. 107
("SAB 107") relating to SFAS 123(R). We have applied the provisions of SAB 107
in our adoption of SFAS 123(R).
We adopted SFAS 123(R) using the modified prospective transition method,
which requires that application of the accounting standard as of November 1,
2005, the first day of our fiscal year 2006. Our consolidated financial
statements as of and for the three months ended January 31, 2006 reflect the
impact of SFAS 123(R). In accordance with the modified prospective transition
method, our consolidated financial statements for prior periods have not been
restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based
compensation expense recognized under SFAS 123(R) for the three months ended
January 31, 2006 was $40,000. There was no stock-based compensation expense
related to employee stock options recognized during the three months ended
January 31, 2005.
The following table illustrates the effect on net income and earnings per
share if we had applied the fair value recognition principles of SFAS No. 123 to
stock-based employee compensation during fiscal 2005.
Three Months Ended January 31, 2005
-----------
Net loss as reported $(2,198,000)
Deduct: Total stock-based employee compensation expense
determined under fair value-based method (46,000)
-----------
Pro forma net loss $(2,244,000)
===========
Loss per share:
Basic and diluted loss per share - as reported $ (0.05)
===========
Basic and diluted loss per share - pro forma $ (0.05)
===========
9
SFAS 123(R) requires companies to estimate the fair value of share-based
payment awards on the date of grant using an option-pricing model. The value of
the portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in our statement of operations. Prior
to the adoption of SFAS 123(R), we accounted for stock-based awards to employees
and directors using the intrinsic value method in accordance with APB 25 as
allowed under Statement of Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). Under the intrinsic value method, no
stock-based compensation had been recognized in our statement of operations,
because the exercise price of our stock options granted to employees and
directors equaled the fair market value of the underlying stock at the date of
grant.
Stock-based compensation expense recognized during the period is based on
the value of the portion of share-based payment awards that is ultimately
expected to vest during the period. Stock-based compensation expense recognized
in our statement of operations for the three months ended January 31, 2006
included compensation expense for share-based payment awards granted prior to,
but not yet vested as of October 31, 2005 based on the grant date fair value
estimated in accordance with the pro forma provisions of SFAS 123. We use the
straight-line method of attributing the value of stock-based compensation to
expense. SFAS 123(R) requires forfeitures to be estimated at the time of grant
and revised, if necessary, in subsequent periods if actual forfeitures differ
from those estimates. In our pro forma information required under SFAS 123 for
the periods prior to November 1, 2005, we accounted for forfeitures as they
occurred.
The fair value of each option granted is estimated on the grant date using
the Black-Scholes option pricing model which takes into account as of the grant
date the exercise price and expected life of the option, the current price of
the underlying stock and its expected volatility, expected dividends on the
stock and the risk-free interest rate for the term of the option. The following
is the average of the data used to calculate the fair value:
Risk-free Expected Expected
January 31, interest rate Expected life Volatility dividends
----------- ------------- ------------- ---------- ---------
2005 3.00% 5 years 216.32% ---
2006 4.55% 4 years 87.50% ---
RECLASSIFICATIONS - Certain prior year amounts have been reclassified to
conform with the current period presentation. These changes have no effect on
net income.
NOTE 3 - ACQUISITIONS AND DIVESTITURES
ACQUISITIONS AND OPENINGS OF IMAGING CENTERS
In December 2005, we entered into a new building lease in Encino,
California for approximately 10,425 square feet to begin the development of a
new center, San Fernando Interventional Radiology and Imaging Center, which is
expected to open by the end of this fiscal year. The center will offer MRI, CT,
ultrasound and x-ray services as well as biopsy, angiography, shunt, and pain
management procedures. The monthly rent is approximately $19,600 and the first
month's rent will be due no later than September 2006.
At various times, we may open or close small x-ray facilities acquired
primarily to service larger capitation arrangements over a specific geographic
region. Over time, patient volume from these contracts may vary, or we may end
the arrangement, resulting in the subsequent closures of these smaller satellite
facilities.
NOTE 4 - CAPITAL TRANSACTIONS
On December 19, 2003, we issued a $1.0 million convertible subordinate note
payable to Galt Financial, Ltd., at a stated rate of 11% per annum with interest
payable quarterly. The note payable was convertible at the holder's option
anytime after January 1, 2006 at $0.50 per share. As additional consideration
for the financing, we issued a warrant for the purchase of 500,000 shares at an
exercise price of $.50 per share. We allocated $0.1 million to the value of the
warrants. In November 2005, the right to convert the $1.0 million obligation
into 2,000,000 shares of common stock was waived in exchange for the issuance of
a five-year warrant to purchase 300,000 shares of our common stock at a price of
$0.50 per share, the public market price on the date of the warrant, as
consideration for the note being extended to July 1, 2006. We recorded $0.1
million for the estimated fair value of these warrants as a deferred cost which
will be amortized as interest expense to the extended date of maturity. The note
was repaid as part of our March 9, 2006 refinancing.
10
During the three months ended January 31, 2006, we issued to one employee a
five-year option exercisable at $0.50 per share, which was the public market
closing price for our common stock on the transaction date, to purchase 15,000
shares of our common stock. We allocated approximately $2,000 to the value of
these options. In addition, during the same period, we retired options to
purchase 32,000 shares at a weighted average price of $0.40 per share upon one
employee's termination.
NOTE 5 - SUBSEQUENT EVENTS
Effective February 1, 2006, upon the inception of a new capitation
arrangement, we opened an additional satellite office in Yucaipa, California
that provides x-ray services for our Riverside location.
Effective February 1, 2006, we entered into a facility use agreement for an
open MRI center in Vallejo, California. The agreement provides for the use of
the equipment and facility for a monthly fee.
Effective February 1, 2006, we invested $237,000 for a 47.5% membership
interest in an entity that operates a PET center in Palm Springs, California.
The center will provide PET services for our existing facilities in the area
replacing a prior arrangement where PET services were provided by a mobile unit
for a "per use" fee.
The Deficit Reduction Act of 2005 (DRA) was approved by Congress and signed
into law on February 9, 2006. The DRA provides that reimbursement for the
technical component for imaging services (excluding diagnostic and screening
mammography) in non-hospital based freestanding facilities will be capped at the
lesser of reimbursement under the Medicare Part B physician fee schedule or the
Hospital Outpatient Prospective Payment System (HOPPS) schedule. Currently, the
technical component of our imaging services is reimbursed under the Part B
physician fee schedule, which for certain modalities like MRI and CT, allows for
higher reimbursement on average than under the HOPPS. For other imaging exams,
such as x-ray and ultrasound, reimbursement under the HOPPS is greater on
average. Under the DRA, we will be reimbursed at the lower of the two schedules,
beginning January 1, 2007.
The DRA also codifies the reduction in reimbursement for multiple images on
contiguous body parts previously announced by the Centers for Medicare and
Medicaid Services (CMS). In November 2005, CMS announced that it will pay 100%
of the technical component of the higher priced imaging procedure and 50% for
the technical component of each additional imaging procedure involving
contiguous body parts when performed in the same session. Under current
methodology, Medicare pays 100% of the technical component of each procedure.
This rate reduction will occur in two steps, so that the reduction will be 25%
for each additional imaging procedure in 2006 and another 25% in 2007. For the
fiscal year ended October 31, 2005, Medicare revenue from our imaging centers
represented approximately 15% of our total revenue. Of this amount,
approximately 54% was from MRI and CT, the modalities affected more
significantly by the reimbursement reductions. If both the HOPPS and contiguous
body part reimbursement reductions contained in the DRA had been in effect
during fiscal year 2005, we estimate that our revenue would have been reduced by
approximately $2.5-$3.0 million.
On February 28, 2006, we issued a five-year warrant for the purchase of
200,000 shares of our common stock at a price of $0.40 per share to one
physician.
Effective March 9, 2006, we completed the issuance of a $161 million senior
secured credit facility that we used to refinance substantially all of our
existing indebtedness (except for $16.1 million of outstanding subordinated
debentures and approximately $5 million of capital lease obligations). Included
in the $161 million senior secured credit facility were fees and expenses for
the transaction of approximately $5.2 million. The facility provides for a $15
million five-year revolving credit facility, an $86 million term loan due in
five years and a $60 million second lien term loan due in six years. The loans
are subject to acceleration on December 27, 2007, unless we have made
arrangements to discharge or extend our outstanding subordinated debentures by
that date. We intend to retire the subordinated debentures prior to their due
date of June 30, 2008. Under the terms and conditions of the new Second Lien
Term Loan, subject to achieving certain leverage ratios, we have the right to
raise up to $16.1 million in additional funds as part of the Second Lien Term
Loan for the purposes of redeeming the subordinated debentures. Additionally,
under the current facilities, we have the ability to pursue other funding
sources to refinance the subordinated debentures. The loans are payable interest
only monthly except for the $86 million term loan that requires amortization
payments of 1% per annum.
11
The revolving credit facility and the $86 million term loan bear interest
at a base rate ("base rate" means corporate loans posted by at least 75% of the
nation's 30 largest banks as quoted by the Wall Street Journal) plus 2.5%, or at
our election, the LIBOR rate plus 4.0% per annum, payable monthly. The $60
million second lien term loan bears interest at the base rate plus 7.0%, or at
our election, the LIBOR rate plus 8.5% per annum, payable monthly. The $86
million term loan includes amortization payments of 1.0% per annum, payable in
quarterly installments of $215,000. Upon the close of the refinancing on March
9, 2006, we utilized approximately $1.5 million of the new $15 million revolving
credit facility.
As part of the refinancing, we are required to swap at least 50% of the
aggregate principal amount of the facilities to a floating rate within 90 days
of the close of the agreement on March 9, 2006. We have not yet entered into the
swap arrangement or decided on how much of the loans will be swapped. In
addition, as a requirement of the deal, 75% of our excess cash flow is to be
used to repay principal on the $86 million term loan once per year within 105
days after our fiscal year end. Excess cash flow is defined as earnings before
interest, taxes, depreciation and amortization plus decreases in working capital
and extraordinary gains minus: (i) capital expenditures; (ii) interest expense;
(iii) scheduled principal payments on existing debt; (iv) income taxes; (v)
increases in working capital; (vi) extraordinary losses; (vii) voluntary
prepayments of the $86 million term loan; (vii) and amounts paid for
acquisitions.
Under the new facility, we are subject to various financial covenants
including a limitation on capital expenditures, maximum days sales outstanding,
minimum fixed charge coverage ratio, maximum leverage ratio and maximum senior
leverage ratio. Availability under our $15 million revolving credit facility is
governed by the margins calculated under the maximum senior leverage ratio and
maximum total leverage ratio covenants. Borrowings under the historical Bridge
credit facility were calculated from a formula based upon our net eligible
accounts receivable. As of March 9, 2006, after giving effect to the
approximately $1.5 million balance on our revolving credit facility, we had
approximately $13.5 million of availability. As a result of the completed
financing, we were able to reclassify the majority of our notes and capital
lease obligations as noncurrent as of January 31, 2006 and improve our working
capital significantly.
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We operate a group of regional networks comprised of 60 fixed-site
freestanding outpatient diagnostic imaging facilities in California. We believe
our group of regional networks is the largest of its kind in California. We have
strategically organized our facilities into regional networks in markets, which
have both high-density and expanding populations, as well as attractive payor
diversity.
All of our facilities employ state-of-the-art equipment and technology in
modern, patient-friendly settings. Many of our facilities within a particular
region are interconnected and integrated through our advanced information
technology system. Thirty four of our facilities are multi-modality sites,
offering various combinations of MRI, CT, PET, nuclear medicine, ultrasound,
X-ray and fluoroscopy services. Twenty six of our facilities are single-modality
sites, offering either X-ray, MRI or PET services. Consistent with our regional
network strategy, we locate our single-modality sites near multi-modality sites
to help accommodate overflow in targeted demographic areas.
We derive substantially all of our revenue, directly or indirectly, from
fees charged for the diagnostic imaging services performed at our facilities.
During the three months ended January 31, 2005 and 2006, we derived 58% of our
net revenue from MRI and CT scans. Over the past years, we have increased net
revenue primarily through improvements in net reimbursement, expansions of
existing facilities, upgrades in equipment and development of new facilities.
The fees charged for diagnostic imaging services performed at our
facilities are paid by a diverse mix of payors, as illustrated for the three
months ended January 31, 2006 by the following table:
PERCENTAGE
OF NET
PAYOR TYPE REVENUE
---------- ----------
Insurance(1) 42%
Managed Care Capitated Payors 28
Medicare/Medi-Cal 18
Other(2) 9
Workers Compensation/Personal Injury 3
----------
(1) Includes Blue Cross/Blue Shield, which represented 15% of our net revenue
for the three months ended January 31, 2006.
(2) Includes co-payments, direct patient payments and payments through
contracts with physician groups and other non-insurance company payors.
Our eligibility to provide service in response to a referral often depends
on the existence of a contractual arrangement between the radiologists providing
the professional medical services or us and the referred patient's insurance
carrier or managed care organization. These contracts typically describe the
negotiated fees to be paid by each payor for the diagnostic imaging services we
provide. With the exception of Blue Cross/Blue Shield and government payors, no
single payor accounted for more than 5% of our net revenue for the three months
ended January 31, 2006. Under our capitation agreements, we receive from the
payor a pre-determined amount per member, per month. If we do not successfully
manage the utilization of our services under these agreements, we could incur
unanticipated costs not offset by additional revenue, which would reduce our
operating margins.
The principal components of our fixed operating expenses, excluding
depreciation, include professional fees paid to radiologists, except for those
radiologists who are paid based on a percentage of revenue, compensation paid to
technologists and other employees, and expenses related to equipment rental and
purchases, real estate leases and insurance, including errors and omissions,
malpractice, general liability, workers' compensation and employee medical. The
principal components of our variable operating expenses include expenses related
to equipment maintenance, medical supplies, marketing, business development and
corporate overhead. Because a majority of our expenses are fixed, increased
revenue as a result of higher scan volumes per system can significantly improve
our margins, while lower scan volumes can result in significantly lower margins.
BRMG strives to maintain qualified radiologists and technologists while
minimizing turnover and salary increases and avoiding the use of outside
staffing agencies, which are considerably more expensive and less efficient. In
recent years, there has been a shortage of qualified radiologists and
technologists in some of the regional markets we serve. As turnover occurs,
competition in recruiting radiologists and technologists may make it difficult
for our contracted radiology practices to maintain adequate levels of
radiologists and technologists without the use of outside staffing agencies. At
times, this has resulted in increased costs for us.
13
As part of our evaluation of the effectiveness of the design and operation
of our disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) for the fiscal year ended October 31, 2005, we
concluded that we had insufficient personnel resources and technical accounting
expertise within the accounting function to resolve the following non-routine or
complex accounting matters: the recording of non-typical cost-based investments
and unusual debt-related transactions and the appropriate analysis of the
amortization lives of leasehold improvements in accordance with GAAP. We are
committed to establishing the necessary environment to ensure the effectiveness
of these controls in the future and quality financial reporting. We experienced
no impact on our financial statements for the year ended October 31, 2005 or for
the three months ended January 31, 2006 as a result of the ineffective controls
over non-routine matters.
OUR RELATIONSHIP WITH BRMG
Howard G. Berger, M.D. is our President and Chief Executive, a member of
our Board of Directors, and owns approximately 30% of Primedex's outstanding
common stock. Dr. Berger also owns, indirectly, 99% of the equity interests in
BRMG. BRMG provides all of the professional medical services at 42 of our
facilities under a management agreement with us, and contracts with various
other independent physicians and physician groups to provide all of the
professional medical services at most of our other facilities. We obtain
professional medical services from BRMG, rather than providing such services
directly or through subsidiaries, in order to comply with California's
prohibition against the corporate practice of medicine. However, as a result of
our close relationship with Dr. Berger and BRMG, we believe that we are able to
better ensure that professional medical services are provided at our facilities
in a manner consistent with our needs and expectations and those of our
referring physicians, patients and payors than if we obtained these services
from unaffiliated practice groups.
Under our management agreement with BRMG, which expires on January 1, 2014,
BRMG pays us, as compensation for the use of our facilities and equipment and
for our services, a percentage of the gross amounts collected for the
professional services it renders. The percentage, which was 79% at January 31,
2006, is adjusted annually, if necessary, to ensure that the parties receive
fair value for the services they render. In operation and historically, the
annual revenue of BRMG from all sources closely approximates its expenses,
including Dr. Berger's compensation, fees payable to us and amounts payable to
third parties. For administrative convenience and in order to avoid
inconveniencing and confusing our payors, a single bill is prepared for both the
professional medical services provided by the radiologists and our non-medical,
or technical, services, generating a receivable for BRMG. BRMG financed these
receivables under a working capital facility with Bridge Healthcare Finance LLC,
or Bridge, and regularly advanced to us the funds that it drew under this
working capital facility, which we used for our own working capital purposes. We
repaid or offset these advances with periodic payments from BRMG to us under the
management agreement. We guaranteed BRMG's obligations under this working
capital facility. Subsequent to year-end, effective March 9, 2006, the existing
line of credit with Bridge was paid and closed with the issuance of a new $161
million senior secured credit facility.
As a result of our contractual and operational relationship with BRMG and
Dr. Berger, we are required to include BRMG as a consolidated entity in our
consolidated financial statements.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
that certain items in the statement of operations bears to net revenue.
THREE MONTHS ENDED JANUARY 31,
------------------------------
2005 2006
-------- --------
Net revenue 100.0% 100.0%
Operating expenses:
Operating expenses 78.7 75.7
Depreciation and amortization 12.7 10.6
Provision for bad debts 2.7 3.5
-------- --------
Total operating expense 94.1 89.8
Income from operations 5.9 10.2
Other expense (income):
Interest expense 12.4 11.5
Other income (0.3) (0.1)
Other expense 0.2 --
-------- --------
Total other expense 12.3 11.4
-------- --------
Net loss (6.4) (1.2)
======== ========
14
THREE MONTHS ENDED JANUARY 31, 2006 COMPARED TO THE THREE MONTHS ENDED JANUARY
31, 2005
During the last twelve months, we continued our efforts to enhance our
operations and expand our network, while improving our financial position and
cash flows. Our results for the three months ended January 31, 2006 were
affected by the opening and integration of new facilities, the improvement in
reimbursement from our managed care capitated payors, our increased marketing
efforts, and our continuing focus on controlling operating expenses. As a result
of these factors and the other matters discussed below, we experienced an
increase in income from operations of $1.9 million and a net loss decrease of
$1.7 million when comparing the results for the three months ended January 31,
2005 to the same period this year.
Effective March 9, 2006, we completed the issuance of a $161 million senior
secured credit facility that we used to refinance substantially all of our
existing indebtedness (except for $16.1 million of outstanding subordinated
debentures and approximately $5 million of capital lease obligations). The
facility provides for a $15 million five-year revolving credit facility, an $86
million term loan due in five years and a $60 million second lien term loan due
in six years. The loans are subject to acceleration on December 27, 2007, unless
we have made arrangements to discharge or extend our outstanding subordinated
debentures by that date. We intend to retire the subordinated debentures prior
to their due date of June 30, 2008. Under the terms and conditions of the new
Second Lien Term Loan, subject to achieving certain leverage ratios, we have the
right to raise up to $16.1 million in additional funds as part of the Second
Lien Term Loan for the purposes of redeeming the subordinated debentures.
Additionally, under the current facilities, we have the ability to pursue other
funding sources to refinance the subordinated debentures. The loans are payable
interest only monthly except for the $86 million term loan that requires
amortization payments of 1.0% per annum. As a result of the completed financing,
we were able to reclassify the majority of our notes and capital lease
obligations as noncurrent as of January 31, 2006 and improve our working capital
significantly. We had a working capital deficit of $5.5 million at January 31,
2006 compared to a $143.4 million deficit at October 31, 2005.
NET REVENUE
Net revenue for the three months ended January 31, 2006 was $38.5 million
compared to $34.1 million for the same period in fiscal 2005, an increase of
approximately $4.4 million, or 13%.
The largest increases were at the facilities in Temecula, Tarzana, Thousand
Oaks, Modesto, Los Coyotes, Desert and Orange with combined net revenue
increases of approximately $4.4 million when comparing results for the three
months ended January 31, 2006 with the same period last year. The improvement at
Temecula and Thousand Oaks was due to the expansion and opening of additional
facilities in Murrieta and Westlake, California that opened in December 2004 and
March 2005, respectively. The increase at the Tarzana facilities is due to the
upgrade of the MRI equipment and the increased focus on the expansion of its PET
business. The improvements at Modesto were due to a new capitation arrangement
entered into in May 2005. The increase at the Desert, Los Coyotes and Orange
facilities is due to a variety of factors including their physical locations,
improvements in contracted reimbursement and increases in patient volume and
throughput.
OPERATING EXPENSES
Operating expenses for the three months ended January 31, 2006 increased
approximately $2.5 million, or 8%, from $32.1 million in the first quarter of
fiscal 2005 to $34.6 million in the same quarter this year.
The following table sets forth our operating expenses for the three months
ended January 31, 2005 and 2006 (dollars in thousands):
Three Months Ended January 31,
------------------------------
2005 2006
---------- ----------
Salaries and professional reading fees $ 16,705 $ 18,275
Building and equipment rental 1,973 2,082
General administrative expenses 8,187 8,812
---------- ----------
Total operating expenses 26,865 29,169
Depreciation and amortization 4,323 4,087
Provision for bad debt 909 1,349
15
o SALARIES AND PROFESSIONAL READING FEES
Salaries and professional reading fees increased $1.6 million for the three
months ended January 31, 2006 when compared to the same period last year.
The increase in salaries is primarily due to the higher costs associated
with recruiting and retaining key personnel, staffing the centers to manage
their respective increase in volume, the hiring of key physicians and
specialists in certain regions, the hiring of physician assistants, and the
costs of additional personnel necessary to open additional satellite
locations and operate the new centers in Murrieta and Westlake. Salaries
and professional reading fees increased $1.4 million at the centers with
the largest increases in net revenue that included Temecula, Tarzana,
Thousand Oaks, Modesto, Los Coyotes, Desert and Orange.
o BUILDING AND EQUIPMENT RENTAL
Building and equipment rental expenses increased $109,000 for the three
months ended January 31, 2006 when compared to the same period last year.
The increase is primarily due to the addition of building rental expense
for the new centers in Murrieta and Westlake coupled with annual increases
in base rentals from existing leased facilities.
o GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include billing fees, medical supplies,
office supplies, repairs and maintenance, insurance, business tax and
license, outside services, utilities, marketing, travel and other expenses.
Many of these expenses are variable in nature. These expenses increased
$625,000, or 8%, for the three months ended January 31, 2006 when compared
to the same period last year. The majority of the increase is attributable
to those variable expenses that increased with net revenue, including
medical supplies, repairs and maintenance (per the percentage of revenue
agreement), billing fees, and transcription and other outside services.
o DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased by $236,000 for the three months
ended January 31, 2006 when compared to the same period last year. Certain
medical equipment and other intangible assets, including patient lists,
were fully amortized during the period.
o PROVISION FOR BAD DEBT
The $440,000 increase in provision for bad debt for the three months ended
January 31, 2006 when compared to the same period last year was primarily a
result of increased net revenue and changes in payor mix during the period.
OTHER EXPENSE (INCOME)
Other expense increased $199,000 for the three months ended January 31,
2006 when compared to the same period last year.
o INTEREST EXPENSE
Interest expense for the three months ended January 31, 2006 increased
$226,000 when compared to the same period last year. The increase was
primarily due to increased borrowings on lines of credit coupled with
increases in the prime rate of interest during the period. The outstanding
line of credit liability was $14.0 million and $9.9 million as of January
31, 2006 and 2005, respectively.
o OTHER INCOME
In the three months ended January 31, 2005 and 2006, we earned other income
of $110,000 and $51,000, respectively, principally comprised of sublease
income, record copy income, the extinguishments of certain liabilities and
deferred rent income. In addition, during the three months ended January
31, 2005, we recognized gains from write-offs of liabilities previously
expensed in fiscal 2004 for approximately $62,000.
o OTHER EXPENSE
In the three months ended January 31, 2005, we incurred other expense of
$86,000 principally comprised of write-offs of other assets.
16
LIQUIDITY AND CAPITAL RESOURCES
We had a working capital deficit of $5.5 million at January 31, 2006
compared to a $143.4 million deficit at October 31, 2005, and had losses from
operations of $0.5 million and $2.2 million during the three months ended
January 31, 2006 and 2005, respectively. We also had a stockholders' deficit of
$71.0 million at January 31, 2006 compared to a $70.6 million deficit at October
31, 2005.
The working capital deficit increased in fiscal 2005 due to the
reclassification of approximately $109 million in notes and capital lease
obligations as current liabilities expected to be refinanced. We were subject to
financial covenants under our debt agreements and believed we may have been
unable to continue to be in compliance with our existing financial covenants
during fiscal 2006. As such, the associated debt was reclassified as a current
liability.
Effective March 9, 2006, we completed the issuance of a $161 million senior
secured credit facility that we used to refinance substantially all of our
existing indebtedness (except for $16.1 million of outstanding subordinated
debentures and approximately $5 million of capital lease obligations). Included
in the $161 million senior secured credit facility were fees and expenses for
the transaction of approximately $5.2 million. The facility provides for a $15
million five-year revolving credit facility, an $86 million term loan due in
five years and a $60 million second lien term loan due in six years. The loans
are subject to acceleration on December 27, 2007, unless we have made
arrangements to discharge or extend our outstanding subordinated debentures by
that date. We intend to retire the subordinated debentures prior to their due
date of June 30, 2008. Under the terms and conditions of the new Second Lien
Term Loan, subject to achieving certain leverage ratios, we have the right to
raise up to $16.1 million in additional funds as part of the Second Lien Term
Loan for the purposes of redeeming the subordinated debentures. Additionally,
under the current facilities, we have the ability to pursue other funding
sources to refinance the subordinated debentures. The loans are payable interest
only monthly except for the $86 million term loan that requires amortization
payments of 1.0% per annum.
The revolving credit facility and the $86 million term loan bear interest
at a base rate ("base rate" means corporate loans posted by at least 75% of the
nation's 30 largest banks as quoted by the Wall Street Journal) plus 2.5%, or at
our election, the LIBOR rate plus 4.0% per annum, payable monthly. The $60
million second lien term loan bears interest at the base rate plus 7.0%, or at
our election, the LIBOR rate plus 8.5% per annum, payable monthly. The $86
million term loan includes amortization payments of 1.0% per annum, payable in
quarterly installments of $215,000. Upon the close of the refinancing on March
9, 2006, we utilized approximately $1.5 million of the new $15 million revolving
credit facility.
Under the new facility, we are subject to various financial covenants
including a limitation on capital expenditures, maximum days sales outstanding,
minimum fixed charge coverage ratio, maximum leverage ratio and maximum senior
leverage ratio. Availability under our $15 million revolving credit facility is
governed by the margins calculated under the maximum senior leverage ratio and
maximum total leverage ratio covenants. Borrowings under the historical Bridge
credit facility were calculated from a formula based upon our net eligible
accounts receivable. As of March 9, 2006, after giving effect to the
approximately $1.5 million balance on our revolving credit facility, we had
approximately $13.5 million of availability. As a result of the completed
financing, we were able to reclassify the majority of our notes and capital
lease obligations as noncurrent as of January 31, 2006 and improve our working
capital significantly.
We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations. In addition to operations, we
require significant amounts of capital for the initial start-up and development
expense of new diagnostic imaging facilities, the acquisition of additional
facilities and new diagnostic imaging equipment, and to service our existing
debt and contractual obligations. Because our cash flows from operations have
been insufficient to fund all of these capital requirements, we have depended on
the availability of financing under credit arrangements with third parties.
Historically, our principal sources of liquidity have been funds available for
borrowing under our existing lines of credit, now with General Electric Capital
Corporation. We finance the acquisition of equipment mainly through capital and
operating leases. As of January 31, 2006 and October 31, 2005, our line of
credit liabilities were $14.0 million and $13.3 million, respectively. As of
January 31, 2006, $468,000 of line of credit liabilities were classified as
current liabilities for the unpaid balance at the closing of the refinancing
transaction.
17
As of January 31, 2006, Howard G. Berger, M.D., our president, director and
largest shareholder had outstanding advances to us of $1,370,000. Our obligation
to Dr. Berger was repaid as part of our March 9, 2006 refinancing.
The interim disclosures regarding liquidity and capital resources should be
read in conjunction with the consolidated financial statements and related notes
thereto contained in our Annual Report of Form 10-K for the year ended October
31, 2005. There were no material changes in our financing agreements from
October 31, 2005 to January 31, 2006.
Our business strategy with regard to operations will focus on the
following:
o Maximizing performance at our existing facilities;
o Focusing on profitable contracting;
o Expanding MRI and CT applications
o Optimizing operating efficiencies; and
o Expanding our networks.
Due to the March 9, 2006 refinancing, we will be able to use the cash
savings generated from the deferral of required principal payments on notes
payable and capital lease obligations of approximately $1.2 million per month to
invest in the infrastructure and to pursue future growth opportunities.
Our ability to generate sufficient cash flow from operations to make
payments on our debt and other contractual obligations will depend on our future
financial performance. A range of economic, competitive, regulatory, legislative
and business factors, many of which are outside of our control, will affect our
financial performance. Taking these factors into account, including our
historical experience and our discussions with our lenders to date, although no
assurance can be given, we believe that through implementing our strategic plans
and continuing to restructure our financial obligations, we will obtain
sufficient cash to satisfy our obligations as they become due in the next twelve
months.
SOURCES AND USES OF CASH
Cash provided by operating activities for the three months ended January
31, 2006 was $2.5 million compared to $1.7 million for the same period in 2005.
The primary reason for the increase in cash was due to the improvement in net
income from operations
Cash used by investing activities for the three months ended January 31,
2006 was $834,000 compared to $820,000 for the same period in 2005. For the
three months ended January 31, 2006 and 2005, we purchased property and
equipment for approximately $834,000 and $885,000, respectively, and during the
three months ended January 31, 2005, we received proceeds from the sale of
equipment of $65,000.
Cash used for financing activities for fiscal 2006 was $1,670,000 compared
to $855,000 for the same period in 2005. For fiscal 2006 and 2005, we made
principal payments on capital leases, notes payable and lines of credit of
approximately $4,663,000 and $1,292,000, respectively, and received proceeds
from borrowings under existing lines of credit and refinancing arrangements of
approximately $701,000 and $987,000, respectively. During the three months ended
January 31, 2006, we increased cash disbursements in transit by $2,292,000
compared to a decrease in cash disbursements in transit of $550,000 during the
same period in 2005. During the third quarter of fiscal 2004, we renegotiated
our existing notes and capital lease obligations with our three primary lenders,
General Electric, or GE, DVI Financial Services and U.S. Bank. As part of the
restructure, interest only payments were required for the majority of the first
quarter of fiscal 2005.
18
CONTRACTUAL COMMITMENTS
Effective March 9, 2006, we completed the issuance of a $161 million senior
secured credit facility that we used to refinance substantially all of our
existing indebtedness (except for $16.1 million of outstanding subordinated
debentures and approximately $5 million of capital lease obligations). The
facility provides for a $15 million five-year revolving credit facility, an $86
million term loan due in five years and a $60 million second lien term loan due
in six years. The loans are subject to acceleration on December 27, 2007, unless
we have made arrangements to discharge or extend our outstanding subordinated
debentures by that date. We intend to retire the subordinated debentures prior
to their due date of June 30, 2008. Under the terms and conditions of the new
Second Lien Term Loan, subject to achieving certain leverage ratios, we have the
right to raise up to $16.1 million in additional funds as part of the Second
Lien Term Loan for the purposes of redeeming the subordinated debentures.
Additionally, under the current facilities, we have the ability to pursue other
funding sources to refinance the subordinated debentures. The loans are payable
interest only monthly except for the $86 million term loan that requires
amortization payments of 1.0% per annum.
The revolving credit facility and the $86 million term loan bear interest
at a base rate ("base rate" means corporate loans posted by at least 75% of the
nation's 30 largest banks as quoted by the Wall Street Journal) plus 2.5%, or at
our election, the LIBOR rate plus 4.0% per annum, payable monthly. The $60
million second lien term loan bears interest at the base rate plus 7.0%, or at
our election, the LIBOR rate plus 8.5% per annum, payable monthly. The $86
million term loan includes amortization payments of 1.0% per annum, payable in
quarterly installments of $215,000. Upon the close of the refinancing on March
9, 2006, we utilized approximately $1.5 million of the new $15 million revolving
credit facility.
As part of the refinancing, we are required to swap at least 50% of the
aggregate principal amount of the facilities to a floating rate within 90 days
of the close of the agreement on March 9, 2006. We have not yet entered into the
swap arrangement or decided on how much of the loans will be swapped. In
addition, as a requirement of the deal, 75% of our excess cash flow is to be
used to repay principal on the $86 million term loan once per year within 105
days after our fiscal year end. Excess cash flow is defined as earnings before
interest, taxes, depreciation and amortization plus decreases in working capital
and extraordinary gains minus: (i) capital expenditures; (ii) interest expense;
(iii) scheduled principal payments on existing debt; (iv) income taxes; (v)
increases in working capital; (vi) extraordinary losses; (vii) voluntary
prepayments of the $86 million term loan; (vii) and amounts paid for
acquisitions.
Under the new facility, we are subject to various financial covenants
including a limitation on capital expenditures, maximum days sales outstanding,
minimum fixed charge coverage ratio, maximum leverage ratio and maximum senior
leverage ratio. Availability under our $15 million revolving credit facility is
governed by the margins calculated under the maximum senior leverage ratio and
maximum total leverage ratio covenants. Borrowings under the historical Bridge
credit facility were calculated from a formula based upon our net eligible
accounts receivable. As of March 9, 2006, after giving effect to the
approximately $1.5 million balance on our revolving credit facility, we had
approximately $13.5 million of availability. As a result of the completed
financing, we were able to reclassify the majority of our notes and capital
lease obligations as noncurrent as of January 31, 2006 and improve our working
capital significantly.
In addition, we have an arrangement with GE Medical Systems under which it
has agreed to be responsible for the maintenance and repair of the majority of
our equipment for a fee that is based upon a percentage of our revenue, subject
to a minimum payment. Net revenue is reduced by the provision for bad debt,
mobile PET revenue and other professional reading service revenue to obtain
adjusted net revenue. The fiscal 2005 annual service fee was the higher of 3.50%
of our adjusted net revenue, or $4,970,000. The fiscal 2006 annual service rate
is the higher of 3.62% of our adjusted net revenue, or $5,393,800. For the
fiscal years 2007, 2008 and 2009, the annual service fee will be the higher of
3.62% of our adjusted net revenue, or $5,430,000. We believe this framework of
basing service costs on usage is an effective and unique method for controlling
our overall costs on a facility-by-facility basis.
19
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements reflect, among other things, management's current
expectations and anticipated results of operations, all of which are subject to
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements, or industry results, to differ
materially from those expressed or implied by such forward-looking statements.
Therefore, any statements contained herein that are not statements of historical
fact may be forward-looking statements and should be evaluated as such. Without
limiting the foregoing, the words "believes," "anticipates," "plans," "intends,"
"will," "expects," "should" and similar words and expressions are intended to
identify forward-looking statements. Except as required under the federal
securities laws or by the rules and regulations of the SEC, we assume no
obligation to update any such forward-looking information to reflect actual
results or changes in the factors affecting such forward-looking information.
The factors included in "Risks Relating to Our Business," among others, could
cause our actual results to differ materially from those expressed in, or
implied by, the forward-looking statements.
Specific factors that might cause actual results to differ from our
expectations, include, but are not limited to:
o economic, competitive, demographic, business and other conditions in
our markets;
o a decline in patient referrals;
o changes in the rates or methods of third-party reimbursement for
diagnostic imaging services;
o the enforceability or termination of our contracts with radiology
practices;
o the availability of additional capital to fund capital expenditure
requirements;
o burdensome lawsuits against our contracted radiology practices and us;
o reduced operating margins due to our managed care contracts and
capitated fee arrangements;
o any failure on our part to comply with state and federal anti-kickback
and anti-self-referral laws or any other applicable healthcare
regulations;
o our substantial indebtedness, debt service requirements and liquidity
constraints;
o the interruption of our operations in certain regions due to
earthquake or other extraordinary events;
o the recruitment and retention of technologists by us or by
radiologists of our contracted radiology groups; and
o other factors discussed in the "Risk Factors" section or elsewhere in
this report.
All future written and verbal forward-looking statements attributable to us
or any person acting on our behalf are expressly qualified in their entirety by
the cautionary statements contained or referred to in this section. In light of
these risks, uncertainties and assumptions, the forward-looking events discussed
in this report might not occur.
RISKS RELATING TO OUR BUSINESS
WE MAY NOT BE ABLE TO GENERATE SUFFICIENT CASH FLOW TO MEET OUR DEBT SERVICE
OBLIGATIONS.
Our ability to generate sufficient cash flow from operations to make
payments on our debt and other contractual obligations will depend on our future
financial performance. A range of economic, competitive, regulatory, legislative
and business factors, many of which are outside of our control, will affect our
financial performance. Our inability to generate sufficient cash flow to satisfy
our debt and other contractual obligations would adversely impact our business,
financial condition and results of operations. Effective March 9, 2006, we
completed the issuance of a $161 million senior secured credit facility that we
used to refinance substantially all of our existing indebtedness (except for
$16.1 million of outstanding subordinated debentures and approximately $5
million of capital lease obligations). The facility provides for a $15 million
five-year revolving credit facility, an $86 million term loan due in five years
and a $60 million second lien term loan due in six years. The loans are subject
to acceleration on December 27, 2007, unless we have made arrangements to
discharge or extend our outstanding subordinated debentures by that date. As a
result of the completed financing, we were able to reclassify the majority of
our notes and capital lease obligations as noncurrent as of January 31, 2006 and
improve our working capital significantly.
20
OUR ABILITY TO GENERATE REVENUE DEPENDS IN LARGE PART ON REFERRALS FROM
PHYSICIANS.
A significant reduction in referrals would have a negative impact on our
business. We derive substantially all of our net revenue, directly or
indirectly, from fees charged for the diagnostic imaging services performed at
our facilities. We depend on referrals of patients from unaffiliated physicians
and other third parties who have no contractual obligations to refer patients to
us for a substantial portion of the services we perform. If a sufficiently large
number of these physicians and other third parties were to discontinue referring
patients to us, our scan volume could decrease, which would reduce our net
revenue and operating margins. Further, commercial third-party payors have
implemented programs that could limit the ability of physicians to refer
patients to us. For example, prepaid healthcare plans, such as health
maintenance organizations, sometimes contract directly with providers and
require their enrollees to obtain these services exclusively from those
providers. Some insurance companies and self-insured employers also limit these
services to contracted providers. These "closed panel" systems are now common in
the managed care environment, including California. Other systems create an
economic disincentive for referrals to providers outside the system's designated
panel of providers. If we are unable to compete successfully for these managed
care contracts, our results and prospects for growth could be adversely
affected.
CHANGES IN THIRD-PARTY REIMBURSEMENT RATES OR METHODS FOR DIAGNOSTIC IMAGING
SERVICES COULD RESULT IN A DECLINE IN OUR NET REVENUE AND NEGATIVELY IMPACT OUR
BUSINESS.
The fees charged for the diagnostic imaging services performed at our
facilities are paid by insurance companies, Medicare and Medi-Cal, workers
compensation, private and other payors. Any change in the rates of or conditions
for reimbursement from these sources of payment could substantially reduce the
amounts reimbursed to us or to our contracted radiology practices for services
provided, which could have an adverse effect on our net revenue. For example,
recent legislative changes in California's workers compensation rules had a
negative impact on reimbursement rates for diagnostic imaging services, although
because we derive only a small portion of our net revenue from workers
compensation, we did not experience a significant impact.
The Deficit Reduction Act of 2005 (DRA) was approved by Congress and signed
into law on February 9, 2006. The DRA provides that reimbursement for the
technical component for imaging services (excluding diagnostic and screening
mammography) in non-hospital based freestanding facilities will be capped at the
lesser of reimbursement under the Medicare Part B physician fee schedule or the
Hospital Outpatient Prospective Payment System (HOPPS) schedule. Currently, the
technical component of our imaging services is reimbursed under the Part B
physician fee schedule, which for certain modalities like MRI and CT, allows for
higher reimbursement on average than under the HOPPS. For other imaging exams,
such as x-ray and ultrasound, reimbursement under the HOPPS is greater on
average. Under the DRA, we will be reimbursed at the lower of the two schedules,
beginning January 1, 2007.
The DRA also codifies the reduction in reimbursement for multiple images on
contiguous body parts previously announced by the Centers for Medicare and
Medicaid Services (CMS). In November 2005, CMS announced that it will pay 100%
of the technical component of the higher priced imaging procedure and 50% for
the technical component of each additional imaging procedure involving
contiguous body parts when performed in the same session. Under current
methodology, Medicare pays 100% of the technical component of each procedure.
This rate reduction will occur in two steps, so that the reduction will be 25%
for each additional imaging procedure in 2006 and another 25% in 2007. For the
fiscal year ended October 31, 2005, Medicare revenue from our imaging centers
represented approximately 15% of our total revenue. Of this amount,
approximately 54% was from MRI and CT, the modalities affected more
significantly by the reimbursement reductions. If both the HOPPS and contiguous
body part reimbursement reductions contained in the DRA had been in effect
during fiscal year 2005, we estimate that our revenue would have been reduced by
approximately $2.5-$3.0 million.
21
PRESSURE TO CONTROL HEALTHCARE COSTS COULD HAVE A NEGATIVE IMPACT ON OUR
RESULTS.
One of the principal objectives of health maintenance organizations and
preferred provider organizations is to control the cost of healthcare services.
Managed care contracting has become very competitive, and reimbursement
schedules are at or below Medicare reimbursement levels. The development and
expansion of health maintenance organizations, preferred provider organizations
and other managed care organizations within the geographic areas covered by our
network could have a negative impact on the utilization and pricing of our
services, because these organizations will exert greater control over patients'
access to diagnostic imaging services, the selections of the provider of such
services and reimbursement rates for those services.
IF BRMG OR ANY OF OUR OTHER CONTRACTED RADIOLOGY PRACTICES TERMINATE THEIR
AGREEMENTS WITH US, OUR BUSINESS COULD SUBSTANTIALLY DIMINISH.
Our relationship with BRMG is an integral part of our business. Through our
management agreement, BRMG provides all of the professional medical services at
42 of our 60 facilities, contracts with various other independent physicians and
physician groups to provide all of the professional medical services at most of
our other facilities, and must use its best efforts to provide the professional
medical services at any new facilities that we open or acquire. In addition,
BRMG's strong relationships with referring physicians are largely responsible
for the revenue generated at the facilities it services. Although our management
agreement with BRMG runs until 2014, BRMG has the right to terminate the
agreement if we default on our obligations and fail to cure the default. Also,
BRMG's ability to continue performing under the management agreement may be
curtailed or eliminated due to BRMG's financial difficulties, loss of physicians
or other circumstances. If BRMG cannot perform its obligation to us, we would
need to contract with one or more other radiology groups to provide the
professional medical services at the facilities serviced by BRMG. We may not be
able to locate radiology groups willing to provide those services on terms
acceptable to us, if at all. Even if we were able to do so, any replacement
radiology group's relationships with referring physicians may not be as
extensive as those of BRMG. In any such event, our business could be seriously
harmed. In addition, BRMG is party to substantially all of the managed care
contracts from which we derive revenue. If we were unable to readily replace
these contracts, our revenue would be negatively affected.
Except for our management agreement with BRMG, most of the agreements we, or
BRMG, have with contracted radiology practices typically have terms of one year,
which automatically renew unless either party delivers a non-renewal notice to
the other within a prescribed period. Most of these agreements may be terminated
by either party under some conditions, including, with respect to some of those
agreements, the right of either party to terminate the agreement without cause
upon 30 to 120 days notice. For example, in October 2003, our management
agreement with Tower Imaging Medical Group, Inc. was terminated as the result of
the settlement of litigation between Tower and us. The termination or material
modification of any of the agreements we, or BRMG, have with the radiologists
that provide professional medical services at our facilities could reduce our
revenue, at least in the short term.
IF OUR CONTRACTED RADIOLOGY PRACTICES, INCLUDING BRMG, LOSE A SIGNIFICANT NUMBER
OF THEIR RADIOLOGISTS, OUR FINANCIAL RESULTS COULD BE ADVERSELY AFFECTED.
Recently, there has been a shortage of qualified radiologists in some of
the regional markets we serve. In addition, competition in recruiting
radiologists may make it difficult for our contracted radiology practices to
maintain adequate levels of radiologists. If a significant number of
radiologists terminate their relationships with our contracted radiology
practices and those radiology practices cannot recruit sufficient qualified
radiologists to fulfill their obligations under our agreements with them, our
ability to maximize the use of our diagnostic imaging facilities and our
financial results could be adversely affected. For example, in fiscal 2002, due
to a shortage of qualified radiologists in the marketplace, BRMG experienced
difficulty in hiring and retaining physicians and thus engaged independent
contractors and part-time fill-in physicians. Their cost was double the salary
of a regular BRMG full-time physician. Increased expenses to BRMG will impact
our financial results because the management fee we receive from BRMG, which is
based on a percentage of BRMG's collections, is adjusted annually to take into
account the expenses of BRMG. Neither we, nor our contracted radiology
practices, maintain insurance on the lives of any affiliated physicians.
22
WE MAY NOT BE ABLE TO SUCCESSFULLY GROW OUR BUSINESS.
As part of our business strategy, we intend to increase our presence in
California through selectively acquiring facilities, developing new facilities,
adding equipment at existing facilities, and directly or indirectly through BRMG
entering into contractual relationships with high-quality radiology practices.
However, our ability to successfully expand depends upon many factors,
including our ability to:
o Identify attractive and willing candidates for acquisitions;
o Identify locations in existing or new markets for development of
new facilities;
o Comply with legal requirements affecting our arrangements with
contracted radiology practices, including California prohibitions
on fee-splitting, corporate practice of medicine and
self-referrals;
o Obtain regulatory approvals where necessary and comply with
licensing and certification requirements applicable to our
diagnostic imaging facilities, the contracted radiology practices
and the physicians associated with the contracted radiology
practices;
o Recruit a sufficient number of qualified radiology technologists
and other non-medical personnel;
o Expand our infrastructure and management; and
o Compete for opportunities. We may not be able to compete
effectively for the acquisition of diagnostic imaging facilities.
Our competitors may have more established operating histories and
greater resources than we do. Competition also may make any
acquisitions more expensive.
Acquisitions involve a number of special risks, including the following:
o Obtain adequate financing.
o Possible adverse effects on our operating results;
o Diversion of management's attention and resources;
o Failure to retain key personnel;
o Difficulties in integrating new operations into our existing
infrastructure; and
o Amortization or write-offs of acquired intangible assets.
WE MAY BECOME SUBJECT TO PROFESSIONAL MALPRACTICE LIABILITY.
Providing medical services subjects us to the risk of professional
malpractice and other similar claims. The physicians that our contracted
radiology practices employ are from time to time subject to malpractice claims.
We structure our relationships with the practices under our management
agreements with them in a manner that we believe does not constitute the
practice of medicine by us or subject us to professional malpractice claims for
acts or omissions of physicians employed by the contracted radiology practices.
Nevertheless, claims, suits or complaints relating to services provided by the
contracted radiology practices have been asserted against us in the past and may
be asserted against us in the future. In addition, we may be subject to
professional liability claims, including, without limitation, for improper use
or malfunction of our diagnostic imaging equipment. We may not be able to
maintain adequate liability insurance to protect us against those claims at
acceptable costs or at all.
Any claim made against us that is not fully covered by insurance could be
costly to defend, result in a substantial damage award against us and divert the
attention of our management from our operations, all of which could have an
adverse effect on our financial performance. In addition, successful claims
against us may adversely affect our business or reputation. Although California
places a $250,000 limit on non-economic damages for medical malpractice cases,
no limit applies to economic damages.
23
SOME OF OUR IMAGING MODALITIES USE RADIOACTIVE MATERIALS, WHICH GENERATE
REGULATED WASTE AND COULD SUBJECT US TO LIABILITIES FOR INJURIES OR VIOLATIONS
OF ENVIRONMENTAL AND HEALTH AND SAFETY LAWS.
Some of our imaging procedures use radioactive materials, which generate
medical and other regulated wastes. For example, patients are injected with a
radioactive substance before undergoing a PET scan. Storage, use and disposal of
these materials and waste products present the risk of accidental environmental
contamination and physical injury. We are subject to federal, California and
local regulations governing storage, handling and disposal of these materials.
We could incur significant costs and the diversion of our management's attention
in order to comply with current or future environmental and health and safety
laws and regulations. Also, we cannot completely eliminate the risk of
accidental contamination or injury from these hazardous materials. In the event
of an accident, we could be held liable for any resulting damages, and any
liability could exceed the limits of or fall outside the coverage of our
insurance.
WE EXPERIENCE COMPETITION FROM OTHER DIAGNOSTIC IMAGING COMPANIES AND HOSPITALS.
THIS COMPETITION COULD ADVERSELY AFFECT OUR REVENUE AND BUSINESS.
The market for diagnostic imaging services in California is highly
competitive. We compete principally on the basis of our reputation, our ability
to provide multiple modalities at many of our facilities, the location of our
facilities and the quality of our diagnostic imaging services. We compete
locally with groups of radiologists, established hospitals, clinics and other
independent organizations that own and operate imaging equipment. Our major
national competitors include Radiologix, Inc., Alliance Imaging, Inc.,
Healthsouth Corporation and Insight Health Services. Some of our competitors may
now or in the future have access to greater financial resources than we do and
may have access to newer, more advanced equipment.
In addition, in the past some non-radiologist physician practices have
refrained from establishing their own diagnostic imaging facilities because of
the federal physician self-referral legislation. Final regulations issued in
January 2001 clarify exceptions to the physician self-referral legislation,
which created opportunities for some physician practices to establish their own
diagnostic imaging facilities within their group practices and to compete with
us. In the future, we could experience significant competition as a result of
those final regulations.
TECHNOLOGICAL CHANGE IN OUR INDUSTRY COULD REDUCE THE DEMAND FOR OUR SERVICES
AND REQUIRE US TO INCUR SIGNIFICANT COSTS TO UPGRADE OUR EQUIPMENT.
The development of new technologies or refinements of existing modalities
may require us to upgrade and enhance our existing equipment before we may
otherwise intend. Many companies currently manufacture diagnostic imaging
equipment. Competition among manufacturers for a greater share of the diagnostic
imaging equipment market may result in technological advances in the speed and
imaging capacity of new equipment. This may accelerate the obsolescence of our
equipment, and we may not have the financial ability to acquire the new or
improved equipment. In that event, we may be unable to deliver our services in
the efficient and effective manner that payors, physicians and patients expect
and thus our revenue could substantially decrease. During fiscal 2005, we
traded-in and upgraded our existing MRI at Tarzana Advanced to increase
throughput and patient volume and compete in the marketplace. We incurred a loss
on disposal of equipment of approximately $696,000 for the upgrade.
WE HAVE EXPERIENCED OPERATING LOSSES AND WE HAVE A SUBSTANTIAL ACCUMULATED
DEFICIT. IF WE ARE UNABLE TO IMPROVE OUR FINANCIAL PERFORMANCE, WE MAY BE UNABLE
TO PAY OUR OBLIGATIONS.
We have incurred net losses of $2.2 million and $0.5 million during the
three months ended January 31, 2005 and 2006, respectively, and at January 31,
2006 we had an accumulated stockholders' deficit of $71.0 million. Also, in
recent periods, we have suffered liquidity shortfalls which have led us to,
among other things, undertake and complete a "pre-packaged" Chapter 11 plan of
reorganization and modify the terms of various of our financial obligations.
While we believe that by taking these and other actions in the future we be able
to address these issues and solidify our financial condition, we cannot give
assurances that we will be able to generate sufficient cash flow from operations
to satisfy our debt obligations.
24
A FAILURE TO MEET OUR CAPITAL EXPENDITURE REQUIREMENTS COULD ADVERSELY AFFECT
OUR BUSINESS.
We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations, particularly the initial
start-up and development expenses of new diagnostic imaging facilities and the
acquisition of additional facilities and new diagnostic imaging equipment. We
incur capital expenditures to, among other things, upgrade and replace existing
equipment for existing facilities and expand within our existing markets and
enter new markets. To the extent we are unable to generate sufficient cash from
our operations, funds are not available from our lenders or we are unable to
structure or obtain financing through operating leases, long-term installment
notes or capital leases, we may be unable to meet our capital expenditure
requirements.
BECAUSE WE HAVE HIGH FIXED COSTS, LOWER SCAN VOLUMES PER SYSTEM COULD ADVERSELY
AFFECT OUR BUSINESS.
The principal components of our expenses, excluding depreciation, consist
of compensation paid to technologists, salaries, real estate lease expenses and
equipment maintenance costs. Because a majority of these expenses are fixed, a
relatively small change in our revenue could have a disproportionate effect on
our operating and financial results depending on the source of our revenue.
Thus, decreased revenue as a result of lower scan volumes per system could
result in lower margins, which would adversely affect our business.
OUR SUCCESS DEPENDS IN PART ON OUR KEY PERSONNEL AND WE MAY NOT BE ABLE TO
RETAIN SUFFICIENT QUALIFIED PERSONNEL. IN ADDITION, FORMER EMPLOYEES COULD USE
THE EXPERIENCE AND RELATIONSHIPS DEVELOPED WHILE EMPLOYED WITH US TO COMPETE
WITH US.
Our success depends in part on our ability to attract and retain qualified
senior and executive management, managerial and technical personnel. Competition
in recruiting these personnel may make it difficult for us to continue our
growth and success. The loss of their services or our inability in the future to
attract and retain management and other key personnel could hinder the
implementation of our business strategy. The loss of the services of Dr. Howard
G. Berger, our President and Chief Executive Officer, or Norman R. Hames, our
Chief Operating Officer, could have a significant negative impact on our
operations. We believe that they could not easily be replaced with executives of
equal experience and capabilities. We do not maintain key person insurance on
the life of any of our executive officers with the exception of a $5.0 million
policy on the life of Dr. Berger. Also, if we lose the services of Dr. Berger,
our relationship with BRMG could deteriorate, which would adversely affect our
business.
Unlike many other states, California does not enforce agreements that
prohibit a former employee from competing with the former employer. As a result,
any of our employees whose employment is terminated is free to compete with us,
subject to prohibitions on the use of confidential information and, depending on
the terms of the employee's employment agreement, on solicitation of existing
employees and customers. A former executive, manager or other key employee who
joins one of our competitors could use the relationships he or she established
with third party payors, radiologists or referring physicians while our employee
and the industry knowledge he or she acquired during that tenure to enhance the
new employer's ability to compete with us.
CAPITATION FEE ARRANGEMENTS COULD REDUCE OUR OPERATING MARGINS.
For the three months ended January 31, 2006, we derived approximately 28%
of our net revenue from capitation arrangements, and we intend to increase the
revenue we derive from capitation arrangements in the future. Under capitation
arrangements, the payor pays a pre-determined amount per-patient per-month in
exchange for us providing all necessary covered services to the patients covered
under the arrangement. These contracts pass much of the financial risk of
providing diagnostic imaging services, including the risk of over-use, from the
payor to the provider. Our success depends in part on our ability to negotiate
effectively, on behalf of the contracted radiology practices and our diagnostic
imaging facilities, contracts with health maintenance organizations, employer
groups and other third-party payors for services to be provided on a capitated
basis and to efficiently manage the utilization of those services. If we are not
successful in managing the utilization of services under these capitation
arrangements or if patients or enrollees covered by these contracts require more
frequent or extensive care than anticipated, we would incur unanticipated costs
not offset by additional revenue, which would reduce operating margins.
25
WE MAY BE UNABLE TO EFFECTIVELY MAINTAIN OUR EQUIPMENT OR GENERATE REVENUE WHEN
OUR EQUIPMENT IS NOT OPERATIONAL.
Timely, effective service is essential to maintaining our reputation and
high use rates on our imaging equipment. Although we have an agreement with GE
Medical Systems pursuant to which it maintains and repairs the majority of our
imaging equipment, this agreement does not compensate us for loss of revenue
when our systems are not fully operational and our business interruption
insurance may not provide sufficient coverage for the loss of revenue. Also, GE
Medical Systems may not be able to perform repairs or supply needed parts in a
timely manner. Therefore, if we experience more equipment malfunctions than
anticipated or if we are unable to promptly obtain the service necessary to keep
our equipment functioning effectively, our ability to provide services would be
adversely affected and our revenue could decline.
DISRUPTION OR MALFUNCTION IN OUR INFORMATION SYSTEMS COULD ADVERSELY AFFECT OUR
BUSINESS.
Our information technology system is vulnerable to damage or interruption
from:
o Earthquakes, fires, floods and other natural disasters;
o Power losses, computer systems failures, internet and
telecommunications or data network failures, operator negligence,
improper operation by or supervision of employees, physical and
electronic losses of data and similar events; and
o Computer viruses, penetration by hackers seeking to disrupt
operations or misappropriate information and other breaches of
security.
We, and BRMG, rely on this system to perform functions critical to our and
its ability to operate, including patient scheduling, billing, collections,
image storage and image transmission. Accordingly, an extended interruption in
the system's function could significantly curtail, directly and indirectly, our
ability to conduct our business and generate revenue.
OUR ACTUAL FINANCIAL RESULTS MAY VARY SIGNIFICANTLY FROM THE PROJECTIONS WE
FILED WITH THE BANKRUPTCY COURT.
In connection with our "pre-packaged" Chapter 11 plan of reorganization
that was confirmed by the Bankruptcy Court on October 20, 2003, we were required
to prepare projected financial information to demonstrate to the Bankruptcy
Court the feasibility of the plan of reorganization and our ability to continue
operations upon our emergence from bankruptcy. As indicated in the disclosure
statement with respect to the plan of reorganization and the exhibits thereto,
the projected financial information and various estimates of value discussed
therein should not be regarded as representations or warranties by us or any
other person as to the accuracy of that information or that those projections or
valuations will be realized. We, and our advisors, prepared the information in
the disclosure statement, including the projected financial information and
estimates of value. This information was not audited or reviewed by our
independent accountants. The significant assumptions used in preparation of the
information and estimates of value were included as an exhibit to the disclosure
statement.
Those projections are not included in this report and you should not rely
upon them in any way or manner. We have not updated, nor will we update, those
projections. At the time we prepared the projections, they reflected numerous
assumptions concerning our anticipated future performance with respect to
prevailing and anticipated market and economic conditions which were and remain
beyond our control and which may not materialize. Projections are inherently
subject to significant and numerous uncertainties and to a wide variety of
significant business, economic and competitive risks and the assumptions
underlying the projections may be wrong in many material respects. Our actual
results may vary significantly from those contemplated by the projections. As a
result, we caution you not to rely upon those projections.
WE ARE VULNERABLE TO EARTHQUAKES AND OTHER NATURAL DISASTERS.
Our headquarters and all of our facilities are located in California, an
area prone to earthquakes and other natural disasters. An earthquake or other
natural disaster could seriously impair our operations, and our insurance may
not be sufficient to cover us for the resulting losses.
26
COMPLYING WITH FEDERAL AND STATE REGULATIONS IS AN EXPENSIVE AND TIME-CONSUMING
PROCESS, AND ANY FAILURE TO COMPLY COULD RESULT IN SUBSTANTIAL PENALTIES.
We are directly or indirectly through the radiology practices with which we
contract subject to extensive regulation by both the federal government and the
State of California, including:
o The federal False Claims Act;
o The federal Medicare and Medicaid anti-kickback laws, and
California anti-kickback prohibitions;
o Federal and California billing and claims submission laws and
regulations;
o The federal Health Insurance Portability and Accountability Act
of 1996;
o The federal physician self-referral prohibition commonly known as
the Stark Law and the California equivalent of the Stark Law;
o California laws that prohibit the practice of medicine by
non-physicians and prohibit fee-splitting arrangements involving
physicians;
o Federal and California laws governing the diagnostic imaging and
therapeutic equipment we use in our business concerning patient
safety, equipment operating specifications and radiation exposure
levels; and
o California laws governing reimbursement for diagnostic services
related to services compensable under workers compensation rules.
If our operations are found to be in violation of any of the laws and
regulations to which we or the radiology practices with which we contract 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. For a more detailed discussion of the various federal and California
laws and regulations to which we are subject, see "Business - Government
Regulation."
IF WE FAIL TO COMPLY WITH VARIOUS LICENSURE, CERTIFICATION AND ACCREDITATION
STANDARDS, WE MAY BE SUBJECT TO LOSS OF LICENSURE, CERTIFICATION OR
ACCREDITATION, WHICH WOULD ADVERSELY AFFECT OUR OPERATIONS.
Ownership, construction, operation, expansion and acquisition of our
diagnostic imaging facilities are subject to various federal and California
laws, regulations and approvals concerning licensing of personnel, other
required certificates for certain types of healthcare facilities and certain
medical equipment. In addition, freestanding diagnostic imaging facilities that
provide services independent of a physician's office must be enrolled by
Medicare as an independent diagnostic testing facility to bill the Medicare
program. Medicare carriers have discretion in applying the independent
diagnostic testing facility requirements and therefore the application of these
requirements may vary from jurisdiction to jurisdiction. We may not be able to
receive the required regulatory approvals for any future acquisitions,
expansions or replacements, and the failure to obtain these approvals could
limit the opportunity to expand our services.
Our facilities are subject to periodic inspection by governmental and other
authorities to assure continued compliance with the various standards necessary
for licensure and certification. If any facility loses its certification under
the Medicare program, then the facility will be ineligible to receive
reimbursement from the Medicare and Medi-Cal programs. For the year ended
October 31, 2005, approximately 18% of our net revenue came from the Medicare
and Medi-Cal programs. A change in the applicable certification status of one of
our facilities could adversely affect our other facilities and in turn us as a
whole.
27
OUR AGREEMENTS WITH THE CONTRACTED RADIOLOGY PRACTICES MUST BE STRUCTURED TO
AVOID THE CORPORATE PRACTICE OF MEDICINE AND FEE-SPLITTING.
California law prohibits us from exercising control over the medical
judgments or decisions of physicians and from engaging in certain financial
arrangements, such as splitting professional fees with physicians. These laws
are enforced by state courts and regulatory authorities, each with broad
discretion. A component of our business has been to enter into management
agreements with radiology practices. We provide management, administrative,
technical and other non-medical services to the radiology practices in exchange
for a service fee typically based on a percentage of the practice's revenue. We
structure our relationships with the radiology practices, including the purchase
of diagnostic imaging facilities, in a manner that we believe keeps us from
engaging in the practice of medicine or exercising control over the medical
judgments or decisions of the radiology practices or their physicians or
violating the prohibitions against fee-splitting. However, because challenges to
these types of arrangements are not required to be reported, we cannot
substantiate our belief. There can be no assurance that our present arrangements
with BRMG or the physicians providing medical services and medical supervision
at our imaging facilities will not be challenged, and, if challenged, that they
will not be found to violate the corporate practice prohibition, thus subjecting
us to potential damages, injunction and/or civil and criminal penalties or
require us to restructure our arrangements in a way that would affect the
control or quality of our services and/or change the amounts we receive under
our management agreements. Any of these results could jeopardize our business.
FUTURE FEDERAL LEGISLATION COULD LIMIT THE PRICES WE CAN CHARGE FOR OUR
SERVICES, WHICH WOULD REDUCE OUR REVENUE AND ADVERSELY AFFECT OUR OPERATING
RESULTS.
In addition to extensive existing government healthcare regulation, there
are numerous initiatives affecting the coverage of and payment for healthcare
services, including proposals that would significantly limit reimbursement under
the Medicare and Medi-Cal programs. Limitations on reimbursement amounts and
other cost containment pressures have in the past resulted in a decrease in the
revenue we receive for each scan we perform.
THE REGULATORY FRAMEWORK IN WHICH WE OPERATE 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. We cannot assure you, however, that
we will be able to adapt our operations to address new regulations or that new
regulations will not adversely affect our business. In addition, although we
believe that we are operating in compliance with applicable federal and
California laws, neither our current or anticipated business operations nor the
operations of the contracted radiology practices have been the subject of
judicial or regulatory interpretation. We cannot assure you that a review of our
business by courts or regulatory authorities will not result in a determination
that could adversely affect our operations or that the healthcare regulatory
environment will not change in a way that restricts our operations.
Certain states have enacted statutes or adopted regulations affecting risk
assumption in the healthcare industry, including statutes and regulations that
subject any physician or physician network engaged in risk-based managed care
contracting to applicable insurance laws and regulations. These laws and
regulations, if adopted in California, may require physicians and physician
networks to meet minimum capital requirements and other safety and soundness
requirements. Implementing additional regulations or compliance requirements
could result in substantial costs to us and the contracted radiology practices
and limit our ability to enter into capitation or other risk sharing managed
care arrangements.
OUR SUBSTANTIAL DEBT COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND PREVENT
US FROM FULFILLING OUR OBLIGATIONS.
Our current substantial indebtedness and any future indebtedness we incur
could have important consequences by adversely affecting our financial
condition, which could make it more difficult for us to satisfy our obligations
to our creditors. Our substantial indebtedness could also:
o Require us to dedicate a substantial portion of our cash flow
from operations to payments on our debt, reducing the
availability of our cash flow to fund working capital, capital
expenditures and other general corporate purposes;
28
o Increase our vulnerability to adverse general economic and
industry conditions;
o Limit our flexibility in planning for, or reacting to, changes in
our business and the industry in which we operate;
o Place us at a competitive disadvantage compared to our
competitors that have less debt; and
o Limit our ability to borrow additional funds on terms that are
satisfactory to us or at all.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
------ ----------------------------------------------------------
We sell our services exclusively in the United States and receive payment
for our services exclusively in United States dollars. As a result, our
financial results are unlikely to be affected by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
The majority of our interest expense is not sensitive to changes in the
general level of interest in the United States because the majority of our
indebtedness has interest rates that were fixed when we entered into the note
payable or capital lease obligation. None of our long-term liabilities have
variable interest rates. Our credit facility, classified as a current liability
on our financial statements, is interest expense sensitive to changes in the
general level of interest because it is based upon the current prime rate plus a
factor.
ITEM 4 CONTROLS AND PROCEDURES
------ -----------------------
As of the end of the period covered by this report, we performed an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based
upon that evaluation, our Chief Executive Officer and our Chief Financial
Officer concluded that our disclosure controls and procedures are not effective
in alerting them prior to the end of a reporting period to all material
information required to be included in our periodic filings with the SEC because
we identified the following material weakness in the design of internal controls
over financial reporting. We concluded that we had insufficient personnel
resources and technical accounting expertise within the accounting function to
resolve the following non-routine or complex accounting matters: the recording
of non-typical cost-based investments and debt-related transactions and the
appropriate analysis of the amortization lives of leasehold improvements in
accordance with generally accepted accounting principles. The incorrect
accounting for the foregoing was sufficient to lead management to conclude that
a material weakness in the design of internal controls over the accounting for
non-routine transactions existed at October 31, 2005.
We are in the process of remediating this weakness. Subsequent to October
31, 2005, we determined to change the design of our internal controls over
non-routine accounting matters by the identification of an outside resource at a
recognized professional services company that we can consult with on non-routine
transactions or the employment of qualified accounting personnel to deal with
this issue together with the utilization of other senior corporate accounting
staff, who are responsible for reviewing all non-routine matters and preparing
formal reports on their conclusions, and conducting quarterly reviews and
discussions of all non-routine accounting matters with our independent public
accountants. We believe we will substantially address the identified weakness
through the change in the design of our internal controls, and subject to
confirmation of the effectiveness of our implementation of these remediation
measures, anticipate that the material weakness should be remediated prior to
the end of fiscal 2006. We are continuing to evaluate additional controls and
procedures that we can implement and may add additional accounting personnel
during fiscal 2006 to enhance our technical accounting resources. We do not
anticipate that the cost of this remediation effort will be material to our
financial statements. We experienced no impact on our financial statements for
the year ended October 31, 2005 or for the three months ended January 31, 2006
as a result of the ineffective controls over non-routine matters.
The above identified material weakness in internal control was determined
by management during our year-end audit to be a material change in our internal
control over financial reporting during the quarter ended October 31, 2005.
It should be noted that any system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system will be met. In addition, the design of any control
system is based in part upon certain assumptions about the likelihood of future
events.
29
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are engaged from time to time in the defense of lawsuits arising out of
the ordinary course and conduct of our business. We believe that the outcome of
our current litigation will not have a material adverse impact on our business,
financial condition and results of operations. However, we could be subsequently
named as a defendant in other lawsuits that could adversely affect us.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In November 2005, we issued to a lender in consideration of its agreement
to waive its right to convert our $1,000,000 obligation into 2,000,000 shares of
our common stock a five-year warrant exercisable at a price of $0.50 per share,
which was the public market closing price for our common stock on the
transaction date, to purchase 300,000 shares of our common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There are no matters to be reported under this heading.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There are no matters to be reported under this heading.
ITEM 5. OTHER INFORMATION
There are no matters to be reported under this heading.
ITEM 6. EXHIBITS
a) Exhibit 31.1 -- Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
b) Exhibit 31.2 -- Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
c) Exhibit 32.1 -- Certification Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
d) Exhibit 32.2 -- Certification Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRIMEDEX HEALTH SYSTEMS, INC.
---------------------------------------------
(Registrant)
Date: September 28, 2006 By /s/ HOWARD G. BERGER, M.D.
---------------------------------------------
Howard G. Berger, M.D., President andDirector
Date: September 28, 2006 By /s/ MARK D. STOLPER
---------------------------------------------
Mark D. Stolper, Chief Financial Officer
(Principal Accounting Officer)
31