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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
___________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended October 31, 2002 Commission File Number 0-19019
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PRIMEDEX HEALTH SYSTEMS, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
New York 13-3326724
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1510 Cotner Avenue
Los Angeles, California 90025
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (310) 478-7808
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Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [X]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant was approximately $12,398,113
on January 21, 2003 based on the closing price for the common stock in the
over-the-counter bulletin board bulletin board market on said date.
The number of shares of the registrant's common stock outstanding on January 21,
2003 was 41,100,734 shares (excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits are incorporated herein by reference as set forth in Item
14(b), Exhibits, in Part IV.
PART I
ITEM 1. BUSINESS
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BACKGROUND
Primedex Health Systems, Inc. ["PHS" or the "Company"] is a New York
corporation organized in 1985 with its executive offices located at 1510 Cotner
Avenue, Los Angeles, California 90025 where its telephone number is
310-478-7808.
Through its 58 California diagnostic imaging facilities (eight of
which are wholly-owned by the Company's 91% owned Diagnostic Imaging Services,
Inc. ["DIS"] subsidiary and three in partnerships or limited liability companies
with radiologists who provide services at the partnership or limited liability
company location), the Company operates a network of centers through its RadNet
(R) Management, Inc. subsidiary which arranges for the non-medical aspects of
medical imaging offering MRI, CT, PET, ultrasound, mammography, nuclear medicine
and general diagnostic radiology to the public.
CENTER MANAGEMENT
The Company's wholly-owned subsidiary, RadNet (R) Management, Inc.
["RadNet (R)"], manages the Company's network of 58 medical imaging centers. 50
of the imaging centers are located in Southern California [with three centers
located in Beverly Hills and known as the Tower Imaging Division] with the
remaining eight centers located in northern California. At all the centers,
except three, the Company provides the imaging center facilities and equipment
as well as all non-medical operational, management, financial and administrative
services. At the three partnership or limited liability company centers, RadNet
(R) performs non-medical management services. At all of the Company's centers,
the medical services and medical supervision are provided by various independent
physicians and physician groups [at most of the centers, the medical services
are provided by Beverly Radiology Medical Group ["BRMG"] [see "Item 13"]]. As
compensation for its management and other services at the various centers,
RadNet (R) receives a management fee. In connection with the imaging centers in
which it is a partner, RadNet (R), in addition to a management fee, also shares
in the entity's net income.
DIAGNOSTIC IMAGING MODALITIES
Diagnostic imaging involves the use of less-invasive techniques to
generate representations of internal anatomy that can be recorded on film or
digitized for display on a video monitor. Diagnostic imaging procedures
facilitate the early diagnosis of diseases and disorders, often minimizing the
cost and amount of care required for patients. Diagnostic imaging procedures
include: magnetic resonance imaging (or MRI), computed tomography (or CT),
positron emission tomography (or PET), nuclear medicine, ultrasound,
mammography, general radiography (or x-ray) and fluoroscopy.
The following are the principle medical diagnostic procedures performed
on patients at the various imaging centers owned by the Company. The patient is
normally referred to the center for such diagnostic procedures by his or her
treating physician who may be independent or may be affiliated with an
Independent Physician Association ["IPA"], a Health Maintenance Organization
["HMO"], a Preferred Provider Organization ["PPO"], or a similar organization
which has contracted for such services. See "Marketing" herein. Not all of such
procedures are performed at each center. X-ray and fluoroscopy are the most
frequently used imaging modalities.
DIAGNOSTIC RADIOLOGY OR X-RAY- X-ray employing x-ray radiation on two
planes; including fluoroscopy and endoscopy. X-ray is the most common energy
source used in imaging the body and is utilized in the following modalities (i)
conventional x-ray typically used to image bones and contrast enhanced
vasculature and organs; (ii) CT scanners utilize computers to produce
cross-sectional images of particular organs or areas of the body; and (iii)
digital x-ray systems add computer image processing capability to conventional
x-ray systems.
2
COMPUTED AXIAL TOMOGRAPHY [CT] - CT is 100 times more sensitive than
conventional x-ray. It is used to view inside any of the body's organs,
including the brain, to detect abnormalities and disease. CT focuses an x-ray on
a specific plane of the body, processes the image by computer, and constructs a
picture on a monitor, and later on film. Tissues of various density appear as
different shades of gray, bone [the most dense] as white, and air and fluid is
black. The procedure is painless and takes between 15 minutes and 45 minutes per
study; more than one study is often ordered on each patient. The patient simply
lies on a special, monitored table which is guided into the scanner. Some CT
studies involve the use of an injected contrast agent to better visualize
anatomy and pathology. Although it is very unusual, some patients may develop a
significant reaction to the contrast and in rare cases fatalities have resulted.
To determine patients most likely to have an adverse reaction all patients are
required to answer a questionnaire. Additionally, the Company primarily uses
non-ionic CT contrast agents to minimize contrast reactions. A CT system costs
in the range of $300,000 to $1,200,000, depending upon the specific performance
characteristics of the system.
MAGNETIC RESONANCE IMAGING [MRI] - Diagnostic imaging based on
magnetism rather than radiation or conventional x-ray. MRI has become widely
accepted as the standard diagnostic tool for a wide and fast-growing variety of
clinical applications for soft tissue anatony (as found in the brain, spinal
cord and interior ligaments of body joints such as the knee). MRI takes between
20 to 45 minutes per examination and is painless, requiring only that the
patient lie still on a motorized table that slides into a long cylinder. On some
MRI studies, an injected contrast agent is used, and some require the use of
special "coils," permitting highly accurate scanning of a particular part of the
body. MRI systems cost between $900,000 and $2,500,000 each, depending upon the
system configuration, magnet design and field strength. There are no presently
known hazards to the general population in connection with normal use of MRI
(although the scanning of pregnant women is only done under limited
circumstances and patients with cardiac pacemakers or ferrous clips used in
surgical procedures are generally excluded from MRI procedures as well as the
area surrounding the MRI).
OPEN MRI - Technological advances in software and equipment technology
for MRI systems have allowed open design equipment to offer significantly
improved image quality. Most open MRI systems use permanent electromagnetic
technology, which substantially lowers both sitting and service costs, but does
not provide images as efficiently as high-field MRI systems. Recently, reliable
high-field open MRI systems have also become available. The open design allows
for studies not normally possible in conventional MRI systems, including exams
of infants, pediatric patients, claustrophobic patients, large or obese patients
and patients suffering from post-traumatic stress syndrome. Open MRI is also
capable of conducting musculoskeletal exams that require the patient to move or
flex, such as kinematic knee studies. A typical open MRI non-kinematic exam
takes from 45 to 90 minutes. Open MRI systems are priced in the range of
$600,000 to $1,500,000 each.
POSITION EMISSION TOMOGRAPHY (PET). PET scanning involves the
administration of a radiopharmaceutical agent with a positron-emitting isotope
and the measurement for the distribution of that isotope to create images for
diagnostic purposes. PET scans provide the capability to determine how metabolic
activity impacts other aspects of physiology in the disease process by
correlating the reading for the PET study with other studies such as CT or MRI.
PET technology has been found highly effective and appropriate in certain
clinical circumstances for the detection and assessment of tumors throughout the
body, the evaluation of certain cardiac conditions and the assessment of
epilepsy seizure sites. The information provided by PET technology often
obviates the need to perform further highly invasive and/or diagnostic surgical
procedures. Interest in PET scanning has increased recently due to several
factors including: expansion of available hardware options through the
introduction of dual head gamma camera coincidence detection; increased payor
coverage and reimbursement; the availability of the isotopes without an in-house
cyclotron; and a growing recognition by clinicians that PET is a powerful
diagnostic tool that can be used to evaluate and guide management of a patient's
disease. PET systems are priced in the range of $1,000,000 to $2,000,000 each.
Distribution networks have been established across the United States to ensure
consistent availability of and access to the isotopes.
MAMMOGRAPHY - Mammography is a specialized form of radiology utilizing
low dosage x-rays to visualize breast tissue and is the primary screening tool
for breast cancer. Mammography procedures and related services assist in the
diagnosis and treatment planning for breast cancer.
3
NUCLEAR MEDICINE - Nuclear medicine involves the use of a small amount
of radioactive material and is used to obtain information about the anatomy and
functioning of various organs. Nuclear medicine is based on the principle that
organs absorb or concentrate scientific minerals or hormones. These substances
are not visualized on conventional x-ray, but if they are made radioactive by
the addition of a radioisotope, they can be seen. If an organ is not functioning
properly, too little or too much of the substance will be taken up or
concentrated in some parts of the organ, but not other parts. The organ will
thus appear different on a screen. The amount of radiation is extremely low, and
the isotope usually disappears from the body within a day or less.
ULTRASOUND - Ultrasound imaging that uses sound waves and their echoes
to visualize and locate internal organs. It is particularly useful in viewing
soft tissues that do not x-ray well. Ultrasound is used in pregnancy to avoid
x-ray exposure as well as in gynecological, urologic, vascular, cardiac and
breast applications.
BUSINESS STRATEGY
The Company believes that the diagnostic imaging services industry
will continue to grow as a result of:
THE ESCALATING DEMAND FOR HEALTHCARE SERVICES FROM AN AGING
POPULATION. There has been strong demand for healthcare services due to an aging
population in the United States. According to the United States Census Bureau,
one of the fastest growing segments of the population is the group over 65 years
of age, which is expected to increase as much as 16% from 2000 to 2010. The
Company believes the aging population will help drive the growth for diagnostic
imaging procedures over the coming years because diagnostic imaging utilization
tends to increase as a person ages.
THE INCREASING ROLE OF DIAGNOSTIC IMAGING IN HEALTHCARE. Advanced
imaging equipment and modalities are allowing physicians to diagnose a wide
variety of diseases and injuries quickly and accurately without exploratory
surgery or other surgical or invasive procedures, which are usually more
expensive, involve greater risk to patients and result in longer rehabilitation
time. The Company believes that future technological advances will continue to
enhance the ability of radiologists to diagnose and influence treatment. In
addition, advanced imaging systems are gaining wider acceptance among payors, as
they are increasingly seen and accepted as a tool for reducing long-term
healthcare costs.
GREATER CONSUMER AWARENESS OF AND DEMAND FOR PREVENTIVE DIAGNOSTIC
SCREENING. Diagnostic imaging is increasingly being used as a screening tool for
preventative care. Consumer awareness of and demand for diagnostic imaging as a
less-invasive and preventive screening method has added to the growth in
diagnostic imaging procedures. Consumers are now more aware of the advanced
procedures that area available to them and are requesting them as preventive
procedures from their physicians and healthcare providers. The Company believes
that, with increased technological advancements, there will be greater consumer
awareness of and demand for diagnostic imaging procedures as preventive and
less-invasive procedures for early diagnosis of diseases and disorders.
AN INCREASED NUMBER OF HIGH-END PROCEDURES THAT UTILIZE ADVANCEMENTS
IN TECHNOLOGY. Recent technological advancements include: magnetic resonance
spectroscopic imaging, which can differentiate malignant from benign lesions;
magnetic resonance angiography, which can produce three-dimensional images of
body parts and assess the status of blood vessels; and enhancements in
teleradiology systems, which permit the digital transmission of radiological
images from one location to another for interpretation. Additional improvements
in imaging technologies, contrast agents and scanning capabilities are leading
to new, less invasive methods of diagnosing diseases and certain vascular
abnormalities without exploratory surgery.
4
The Company's strategy is to further develop and expand its
California regional diagnostic imaging network emphasizing quality of care,
producing cost-effective diagnostic information and providing superior service
and convenience to its customers. The strategy of the Company is focused on the
following components: (i) to further participate in the consolidation occurring
in the diagnostic imaging industry by continuing to build its market presence in
its existing California diagnostic imaging networks through geographically
disciplined acquisitions; (ii) to continue to market diagnostic imaging
applications through its existing facilities to optimize and increase overall
procedure volume; (iii) to further develop its network communication systems so
as to efficiently transfer imaging data from one location to another as a tool
in addressing the continuing radiologist shortage and improving the overall
quality of care; and (iv) to strengthen and improve its marketing to managed
care customers on a regional basis. Additionally, the Company will consider
developing or acquiring additional regional networks outside California in
strategic locations where the Company can offer a broad range of services to
customers and realize increased economies of scale utilizing the management
programs developed in California.
RECENT IMAGING CENTER OPENINGS AND ACQUISITIONS
In late November, 2001, the Company opened a new facility located in
Burbank, California. The Company owns 75% of the facility with the radiologists
providing services at the center owning the remaining 25%. The center offers
MRI, Open MRI, CT, ultrasound and x-ray services.
In January 2002, the Company opened a second facility located in
Tarzana, California. The new center offers Open MRI, CT and PET.
In May, 2002, the Company acquired Grove Diagnostic Imaging located in
Rancho Cucamonga, California. The center offers MRI, CT, ultrasound, mammography
and x-ray.
In September, 2002, the Company opened two additional locations in
Orange, California. One new center offers MRI, PET, nuclear medicine and x-ray.
The second location, a Women's Center offers ultrasound and mammography.
In December, 2002, the Company opened a new facility located in Rancho
Bernardo, California. The Company owns 75% of the facility with the radiologists
providing services at the center owning the remaining 25%. The center offers
MRI, CT, ultrasound and x-ray services.
5
IMAGING CENTERS AND EQUIPMENT
The following table indicates as of October 31, 2002, the quantity of
principal diagnostic equipment available at each of the imaging centers in which
the Company has a management and/or ownership interest.
Mammo- Ultra- Diagnostic Nuclear
Center MRI Open MRI CT PET graphy sound Radiology Medicine
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Tower Division:
Roxsan 1 - 1 - - - - 3
Wilshire 2 1 1 - - 3 4 -
Women's - - - - 4 1 - -
Antelope Valley 1 - - - - - - -
Burbank 1 1 1 - - 2 1 -
Camarillo* - - - - 1 2 2 -
Chino 1 - - - - - - -
Emeryville - 1 - - - - - -
Fresno 1 - 1 - 1 2 3 -
La Habra 1 - 1 - - - - -
Lancaster
[Four Sites] - 1 1 - 3 4 6 -
Long Beach
[Seven Sites] 1 - 1 - 2 6 10 -
Modesto 1 - 1 - 2 4 3 -
Northridge 1 - 1 - 1 3 3 1
Oceanside*
[North County] 1 - 1 - - - - -
Orange
[Four Sites] 2 - 1 1 3 6 5 1
Oxnard - 1 - - 2 1 2 -
Palm Desert
[Three Sites] 1 - 1 - 1 2 4 -
Palm Springs
[Two Sites] - 1 - - 2 3 3 -
Rancho
Bernardo - 1 1 - - 1 1 -
Rancho
Cucamonga
[Two Sites] 1 - 1 - 2 2 4 -
Riverside*
[Two Sites] 1 1 1 - 2 3 4 -
Sacramento 1 - 1 - 1 1 2 -
San Francisco - 1 - - - - - -
San Gabriel
Valley 1 - 1 - - 1 - -
Santa Clarita - 1 1 - 2 1 1 -
Santa Rosa 1 - 1 - - 1 - -
Stockton - 1 1 - 1 2 2 -
Tarzana
[Two Sites] 1 1 - 1 - - - -
Temecula*
[Three Sites] 1 - 1 - 3 3 5 -
Thousand
Oaks* 1 - 1 - 2 3 2 2
Tustin - 1 - - - - 1 -
Vacaville - 1 1 - 1 1 1 -
Ventura
[Four Sites] 1 - 1 1 3 5 8 1
Westchester 1 1 1 - 1 1 2 -
*Indicates a DIS facility
The Company also has two mobile MRI's currently at locations near Westchester
and Tarzana.
6
MANAGEMENT SERVICES AND COMPENSATION
The Company has entered into management agreements with respect to its
imaging centers with various physicians and physician groups [the "Physician
Group"]. Pursuant to the typical management agreement, the Company makes
available the imaging center facilities and all of the furniture and medical
equipment at such facilities for use by the Physician Group and the Physician
Group is responsible for staffing the center with qualified medical personnel.
In addition, the Company provides management services and administration of the
non-medical functions and services relating to the medical practice at the
center including among other functions, provision of clerical and administrative
personnel, bookkeeping and accounting services, billing and collection,
provision of medical and office supplies, secretarial, reception and
transcription services, maintenance of medical records, advertising, marketing
and promotional activities and the preparation and filing of all forms, reports
and returns required in connection with unemployment insurance, workers'
compensation insurance, disability, social security and similar laws. As
compensation for the services furnished under the management agreement, the
Company is paid a management fee equal to an agreed percentage of the medical
practice billings, as and when collected, varying between 70% to 85% of such
collections.
At the partnership and limited liability company imaging centers,
RadNet has entered into a management agreement to provide management,
administrative and billing and collection services for a management fee which is
a percent of the gross monthly receipts received for services performed at the
center. In addition, as a joint venture partner, the Company is entitled to 50%
to 75% of income after a deduction of all expenses including amounts paid for
medical services and medical supervision, varying based upon the Company
ownership interest.
At most of the Company's imaging centers, the medical services
including medical supervision are supplied by Beverly Radiology Medical Group
["BRMG"]. BRMG is 99% owned by Dr. Howard Berger [see "Items 11, 12 and 13"].
RadNet (R) has a Management and Services Agreement with BRMG for a ten-year term
until June 2012, terminable prior thereto at RadNet's election upon the
occurrence of certain events including a change in BRMG's ownership such that
Dr. Berger is no longer an owner in the aggregate of at least 60% of the equity
ownership of BRMG. As compensation for its services furnished under the
Management and Services Agreement, BRMG has agreed to pay a management fee to
the Company equal to 74% of its medical practice receipts at the contracted
centers, as and when collected.
EQUIPMENT
The most expensive types of diagnostic medical equipment found at the
imaging centers owned or managed by the Company are the MRI, CT and PET systems.
As set forth in the chart under "Imaging Centers and Equipment" above, 34
centers provide MRI services 25 centers provide CT services and three centers
provide full PET services. The majority of the MRI systems, CT systems and PET
systems at the Company's imaging centers are manufactured by General Electric.
The acquisition of these systems as well as the acquisition of the other
relatively expensive diagnostic medical equipment at the various imaging centers
has been effected through various financing arrangements directly with the
manufacturer involving the use of capital leases with purchase options at
minimal prices at the end of the lease term, the issuance of long term
installment notes and the use of operating leases with purchase options at
substantial prices at the end of the lease term. At October 31, 2002, capital
lease obligations totaled approximately $64 million through October 2009
including current installments totaling approximately $11.6 million. Also at
October 31, 2002, installment notes payable totaled approximately $93 million
through August 2008 including current installments of approximately $24.6
million [including line of credit balances of approximately $10 million].
Commitments under equipment operating leases at October 31, 2002, were
approximately $8.0 million through July 2007 [excluding fair market value buyout
options at the end of the lease term], including current obligations of
approximately $2.3 million. To the extent additional imaging centers are opened
or acquired, these obligations could materially increase.
7
The MRI, CT and PET systems and the other diagnostic medical equipment at the
imaging centers owned or managed by the Company are subject to technological
obsolescence as medical imaging is a field in which there is constant
development of new techniques and technologies. As a result the Company
continues to evaluate the mix of its equipment in response to changes in
technology and to maximize utilization of its equipment. The overall
competitiveness of the Company's equipment continually improves through
upgrades, disposal and/or trade-in of older equipment and the purchase or
leasing of new equipment. Timely, effective maintenance is essential for
achieving high utilization rates of equipment. Most equipment is first covered
by a one year warranty from the manufacturer. Thereafter, the Company maintains
an agreement with GE Medical Systems ("GEMS") whereby GEMS has agreed to be
responsible for the maintenance and repair of a majority of the Company's
equipment based upon a percentage of the Company's revenues. The Company
believes this to be an effective method for controlling this cost.
MARKETING
The patients who undergo diagnostic medical imaging procedures at the
various Company owned or managed imaging centers are generally referred by
individual independent physicians, by Independent Physician Associations
["IPAs"] consisting of groups of physicians, and by Health Maintenance
Organizations ["HMOs"], Preferred Provider Organizations ["PPOs"], and similar
organizations which enroll subscribers on a contractual basis to whom they
deliver healthcare services. Such organizations attempt to control the cost of
healthcare services by directing their enrollees to participating physicians and
institutions and often through aggressive utilization review and limitations on
access to physician specialists, attempt to further limit the cost of medical
service delivery. Such organizations typically develop, on a regional basis,
where an appropriate enrollee population and mix of participating physicians and
institutions are available.
The Company currently employs 15 full-time marketing and sales
personnel who are compensated on a salary or salary plus commission basis and
who periodically inform the medical community including individual physicians
and the administrators of IPAs, HMOs, PPOs, and similar organizations throughout
California as to the services provided at the Company's imaging centers.
Patients are obtained by direct referral or through contract. Some contracts,
referred to as "capitation contracts", provide for a fixed fee per organization
member, which is paid to the medical service provider. Under a "capitation"
contract, the provider agrees to provide specified services to the organization
members for a fixed, predetermined payment per member for a specified time
period [usually one year], regardless of how many times the member uses the
service. No assurances can be given that any of the current or future
"capitation" contracts will be profitable as there is a possibility that
management could underestimate the number of times the services at its imaging
centers will be used by the contracting organization's members during the
contract term.
COMPETITION
The health care industry in general, and the market for diagnostic
imaging services in particular, is highly competitive. The Company competes
principally on the basis of its reputation for productive and cost-effective
quality services. The Company's operations must compete with groups of
radiologists, established hospitals and certain other independent organizations,
including equipment manufacturers and leasing companies, that own and operate
imaging equipment. The Company's major competitors include Radiologix, Inc.,
Alliance Imaging, Inc., HEALTHSOUTH Corporation, Insight Health Services and
Syncor International Corporation. Many of the Company's direct competitors that
provide contract diagnostic imaging services may have access to greater
financial resources than the Company.
In addition, in the past some non-radiologist physician practices have
refrained from establishing their own diagnostic imaging centers because of the
federal physician self-referral legislation. Final regulations issued in January
2001 clarify certain of the exceptions to the physician self-referral
legislation, which may create opportunities for and encourage some physician
practices to establish their own diagnostic imaging centers within their group
practices which may compete with the Company.
8
COMPETITIVE STRENGTHS
The Company believes that it is well-positioned to take advantage of
favorable demographic and diagnostic imaging services industry trends by
capitalizing on the following strengths:
A LEADING MARKET POSITION IN SOUTHERN AND CENTRAL CALIFORNIA. The
Company has a concentrated presence in its core Southern California and Central
California markets, which enables it to offer patients, referring physicians and
payors a higher degree of responsiveness and convenience than independent
operators or hospitals. The Company provides flexible scheduling and convenient
locations, as well as the expeditious delivery of radiology reports to referring
physicians. The Company believes that payors contract with it because of its
strong market presence, the high quality of services and its ability to provide
a single point of contact and centralized administration. In addition, its
leading position enables it to increase procedure volume, optimize equipment
utilization, benefit from economies of scale in purchasing and negotiation of
payor contracts and leverage its administrative and information technology
infrastructure in its market.
COMPREHENSIVE, LEADING-EDGE DIAGNOSTIC IMAGING SERVICES. The Company
provides a broad range of diagnostic imaging services within its market. The
Company's 58 centers enable it to offer one-stop shopping to patients, referring
physicians and payors. In the Company's experience, referring physicians and
payors prefer to enter into relationships with diagnostic imaging providers that
offer a broad spectrum of services at convenient locations, benefiting referring
physicians and patients who require more than one type of diagnostic imaging
procedure.
STRONG RELATIONSHIPS WITH LEADING RADIOLOGY PRACTICES. In each of the
Company's markets, the Company contracts with leading radiology practices to
provide professional radiology services in connection with its diagnostic
imaging centers. Its close affiliation with Beverly Radiology Medical Group
permits it to influence the employment of excellent radiologists by that Group.
Additionally, the Company believes that its affiliation with these leading
radiology practices enhances its reputation with referring physicians and their
patients. In light of a recent shortage of radiologists, the Company believes
that its contractual relationship with large, established radiology practices
are important to maintaining its high quality services. Furthermore, the
Company's acquisition of sophisticated communication equipment permits it to
move professional interpretation services from a busy location to a less busy
location and to effectively utilize preeminent specialist radiologists with
respect to certain issues regardless of the location of the patients.
EXPERIENCED MANAGEMENT TEAM. The Company has a highly experienced
management team with an average in excess of 20 years of healthcare services
experience. Management has successfully generated growth by increasing same
center revenue and executing a disciplined expansion strategy.
CUSTOMERS AND FEES
The Company's operations are principally dependent on the Company's
ability to attract referrals from physicians and other health care providers.
The Company's eligibility to provide service in response to a referral is often
dependent on the existence of a contractual arrangement with the referred
patient's insurance carrier or other payor organization. The Company currently
has in excess of 600 contracts with various payor organizations for diagnostic
imaging services provided at the Company's centers primarily on a discounted
fee-for-service basis. Managed care contracting has become very competitive and
reimbursement schedules are at or below Medicare reimbursement levels. A
significant decline in referrals and/or reimbursement rates would adversely
affect the Company's business, financial condition and results of operations. In
this regard, Medicare has determined to reduce its reimbursement rates for
calendar year 2003 diagnostic imaging services on an average of 4.4% for the
various procedures involved. The impact of this decrease will be offset to some
extent by a significant increase in the practice expense for technical component
services. A review of the reduction in relation to the services offered by the
Company indicates that the impact on the Company will likely be about a 2%
reduction in Medicare payments, although its exact impact cannot presently be
determined.
9
REIMBURSEMENT OF HEALTH CARE COSTS
MEDICARE AND MEDICAID REIMBURSEMENT PROGRAM. The Company's revenue is
derived through its ownership, operation and management of diagnostic imaging
centers and from service fees paid to it by contracted radiology practices.
During the year ended October 31, 2002, approximately 15% of net revenue
generated at the Company's diagnostic imaging centers was derived from
government sponsored healthcare programs (principally, Medicare and Medicaid).
As of January 2002, Medicare decreased reimbursement rates for
physician and outpatient services, including diagnostic imaging services. In
March 2003, the Centers for Medicare and Medicaid Services ("CMS"), formerly
known as the Health Care Financing Administration, Department of Health and
Human Services, will reduce reimbursement for certain diagnostic imaging
services by up to approximately 4.4% depending on the type of diagnostic imaging
services provided. The Company has reviewed the procedures involved and does not
believe the reduction will have a material negative impact on the Company's
revenues. The Company's centers are principally dependent on the Company's
ability to attract referrals from primary care physicians, specialists and other
healthcare providers. The referral often depends on the existence of a
contractual agreement with the referred patient's health benefit plan.
Any further change in Medicare or Medicaid rates or conditions for
reimbursement could substantially reduce the amounts reimbursed to the Company
or its contracted radiology practices for services provided. These reductions
could have a significant adverse effect on Company revenue and financial results
by creating downward pricing pressure.
MANAGED CARE. Health Maintenance Organizations ("HMOs") and Preferred
Provider Organizations ("PPOs") attempt to control the cost of health care
services. Managed care contracting has become very competitive and reimbursement
schedules are at or below Medicare reimbursement levels. The development and
expansion of HMOs, PPOs and other managed care organizations within the
Company's network could have a negative impact on utilization of the Company's
services and/or affect the revenue per procedure which the Company can collect,
since such organizations will exert greater control over patients' access to
diagnostic imaging services, the selections of the provider of such services and
the reimbursement thereof. The Company also expects that the excess capacity of
equipment in California may negatively impact operations because of the
competition among health care providers for contracts with all types of managed
care organizations. As a result of such competition, the term length of any
contracts in which the Company may obtain, and the payment to the Company for
such services, may also be negatively affected.
PRIVATE INSURANCE. Private health insurance programs generally have
authorized the payment for the Company's services on satisfactory terms and CMS
has authorized reimbursement under the federal Medicare program for
substantially all diagnostic imaging and treatment services currently being
provided by the Company. However, if Medicare reimbursement is reduced, the
Company believes that private health insurance programs will also reduce
reimbursement in response to reductions in government reimbursement, which could
have an adverse impact on the Company's business, financial condition and
results of operations.
CORPORATE LIABILITY AND INSURANCE
The Company may be subject to professional liability claims including,
without limitation, for improper use or malfunction of its diagnostic imaging
equipment. The Company maintains insurance policies with coverages that it
believes are appropriate in light of the risks attendant to its business and
consistent with industry practice. The Company also requires the contracted
radiology practices to maintain sufficient professional liability insurance
consistent with industry practice. Currently, the Company and BRMG maintain
medical malpractice coverage of $1,000,000 per claim per doctor and $3,000,000
in the aggregate, with a $10,000 deductible, with other non BRMG contracted
radiologists required to carry at least similar coverage. However, adequate
liability insurance may not always be available to the Company and the
contracted radiology practices in the future at acceptable costs or at all.
10
Providing medical services entails the risk of professional malpractice
and other similar claims. The physicians employed by the contracted radiology
practices are from time to time subject to malpractice claims. The Company
structures its relationships with the practices under its agreements with them
in a manner that the Company believes does not constitute the practice of
medicine by it nor subject the Company to professional malpractice claims for
acts or omissions of physicians in the contracted radiology practices.
Nevertheless, claims, suits or complaints relating to services provided by the
contracted radiology practices may be asserted against the Company in the
future, including malpractice.
Any claim made against the Company not fully covered by insurance could
be costly to defend against, result in a substantial damage award against the
Company and divert the attention of management from operations, which could have
an adverse effect on its financial performance. In addition, claims might
adversely affect the Company's business or reputation.
The Company maintains general liability and umbrella coverage in
commercially reasonable amounts. Additionally, it maintains workers'
compensation insurance on all employees. Coverage is placed on a statutory basis
and responds to California's specific requirements.
EMPLOYEES
At October 31, 2002, the Company had a total of 913 full-time and 311
part-time or per-diem employees of whom 12 served in executive positions, 488
supplied technical and managerial services at the various imaging centers, and
724 provided administrative, transcription, clerical and similar services.
None of the Company's employees are subject to a collective bargaining
agreement nor had the Company experienced any work stoppages. The Company
believes that its employee relations are good.
GOVERNMENT REGULATION
GENERAL. The healthcare industry is highly regulated, and the Company
can give no assurance that the regulatory environment in which it operates will
not change significantly in the future. The Company's ability to operate
profitably will depend in part upon the Company, the contracted radiology
practices and their affiliated physicians obtaining and maintaining all
necessary licenses, and other approvals and operating in compliance with
applicable healthcare regulations. The Company believes that healthcare
regulations will continue to change. Therefore, the Company monitors
developments in healthcare law and modifies its operations from time to time as
the business and regulatory environment changes. Although the Company intends to
continue to operate in compliance, it cannot ensure that it will be able to
adequately modify its operations so as to address changes in the regulatory
environment.
LICENSING AND CERTIFICATION LAWS. Ownership, construction, operation,
expansion and acquisition of diagnostic imaging centers are subject to various
federal and state laws, regulations and approvals concerning licensing of
centers and personnel.
FEE-SPLITTING; CORPORATE PRACTICE OF MEDICINE. The law of California
prohibits the Company 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. A component of the
Company's business has been to enter into service agreements with radiology
practices. The Company provides management, administrative, technical and other
non-medical services to the radiology practices in exchange for a service fee.
The structure of the relationships with the radiology practices, including the
purchase of diagnostic imaging centers, in a manner that the Company believes
keeps it 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. State regulatory
authorities or other parties may assert that the Company is engaged in the
corporate practice of medicine or that the payment of service fees to it by the
radiology practice of medicine or that the payment of service fees to it by the
radiology practices constitutes fee-splitting. If such a claim were successfully
asserted, the Company could be subject to civil and criminal penalties and could
11
be required to restructure or terminate the applicable contractual arrangements.
This result or the Company's inability to successfully restructure its
relationships to comply with these statutes could jeopardize the Company's
business strategy.
MEDICARE AND MEDICAID FRAUD AND ABUSE. Federal law prohibits the
knowing and willful offer, payment, solicitation or receipt of any form of
remuneration in return for, or to induce (i) the referral of a person, (ii) the
furnishing or arranging for the furnishing of items or services reimbursable
under the Medicare, Medicaid or other governmental programs or (iii) the
purchase, lease or order or arranging or recommending, purchasing, leasing or
ordering of any item or service reimbursable under the Medicare, Medicaid or
other governmental programs. Enforcement of this anti-kickback law is a high
priority for the federal government, which has substantially increased
enforcement resources and is scheduled to continue increasing such resources.
The applicability of the anti-kickback law to many business transactions in the
healthcare industry has not yet been subject to judicial or regulatory
interpretation. Noncompliance with the federal anti-kickback legislation can
result in exclusion from the Medicare, Medicaid or other governmental programs
and civil and criminal penalties.
The Company receives fees under its service agreements for management
and administrative services, which include contract negotiation and marketing
services. The Company does not believe it is in a position to make or influence
referrals of patients or services reimbursed under Medicare, Medicaid or other
governmental programs to radiology practices or their affiliated physicians or
to receive referrals. However, the Company may be considered to be in a position
to arrange for items or services reimbursable under a federal healthcare
program. Because the provisions of the federal anti-kickback statutes are
broadly worded and have been broadly interpreted by federal courts, it is
possible that the government could take the position that the Company's
arrangements with the contracted radiology practices implicate the federal
anti-kickback statute. Violation of the law can result in monetary fines, civil
and criminal penalties, and exclusion from participation in federal or state
healthcare programs, any of which could have an adverse effect on the Company's
business and results of operations. While the Company's service agreements with
the contracted radiology practices will not meet a "safe harbor" to the federal
anti-kickback statute, failure to meet a "safe harbor" does not mean that
agreements violate the anti-kickback statute. The Company has sought to
structure its agreements to be consistent with fair market administrative
services rendered. For these reasons, the Company does not believe that service
fees payable to it should be viewed as remuneration for referring or influencing
referrals of patients or services covered by such programs as prohibited by
statute.
Significant prohibitions against physician referrals have been enacted
by Congress. These prohibitions are commonly known as the "Stark Law." The Stark
Law prohibits a physician from referring Medicare or Medicaid patients to an
entity providing "designated health services," including, without limitations,
radiology services, in which the physician has an ownership or investment
interest or with which the physician has entered into a compensation
arrangement. The penalties for violating the Stark Law include a prohibition on
payment by these governmental programs and civil penalties of as much as $15,000
for each violative referral and $100,000 for participation in a "circumvention
scheme." The Company believes that, although it receives fees under its service
agreements for management and administrative services, it is not in a position
to make or influence referrals of patients.
On January 4, 2001, the CMS, published final regulations to implement
the Stark Law. Under the final regulations, radiology and certain other imaging
services and radiation therapy services and supplies are services included in
the designated health services subject to the self-referral prohibition. Under
the final regulations, such services include the professional and technical
components of any diagnostic test or procedure using x-rays, ultrasound or other
imaging services, computerized axial tomography, MRI, radiation therapy and
diagnostic mammography services (but not screening mammography services). The
final regulations, however, exclude from designated health services: (i) x-ray,
fluoroscopy or ultrasonic procedures that require the insertion of a needle,
catheter, tube or probe through the skin or into a body orifice; (ii) radiology
procedures that are integral to the performance of, and performed during
nonradiological medical procedures; (iii) nuclear medicine procedures; and (iv)
"invasive" or "interventional" radiology, because the radiology services in
these procedures are merely incidental or secondary to another procedure that
the physician has ordered.
12
The Stark Law provides that a request by a radiologist for diagnostic
radiology services or a request by a radiation oncologist for radiation therapy,
if such services are furnished by or under the supervision of such radiologist
or radiation oncologist pursuant to a consultation requested by another
physician, does not constitute a "referral" by a "referring physician." If such
requirements are met, the Stark Law self-referral prohibition would not apply to
such services. The effect of the Stark Law on the radiology practice, therefore,
will depend on the precise scope of services furnished by each such practice's
radiologists and whether such services derive from consultations or are
self-generated. The Company believes that (other than self-referred patients)
all of the services covered by the Stark Law provided by the contracted
radiology practices derive from requests for consultation by non-affiliated
physicians. Therefore, the Company believes that the Stark Law is not implicated
by the financial relationships between it and the contracted radiology
practices.
In addition, the Company believes that it had structured its
acquisitions of the assets of existing practices, and the Company intends to
structure any future acquisitions, so as not to violate the anti-kickback and
Stark Law and regulations. Specifically, the Company believes the consideration
paid by it to physicians to acquire the tangible and intangible assets
associated with their practices is consistent with fair market value in arms'
length transactions and is not intended to induce the referral of patients.
Should any such practice be deemed to constitute an arrangement designed to
induce the referral of Medicare or Medicaid patients, then the Company's
acquisitions could be viewed as possibly violating anti-kickback and
anti-referral laws and regulations. A determination of liability under any such
laws could have an adverse effect on the Company's business, financial
conditions and results of operations.
The federal government recently announced an initiative to audit all
Medicare carriers, which are the companies that adjudicate and pay Medicare
claims. These audits are expected to intensify governmental scrutiny of
individual providers. An unsatisfactory audit of any of the Company's diagnostic
imaging centers or contracted radiology practices could result in significant
repayment obligations, exclusion from the Medicare, Medicaid, or other
governmental programs and/or civil and criminal penalties.
Federal regulatory and law enforcement authorities have recently
increased enforcement activities with respect to Medicare and Medicaid fraud and
abuse regulations and other reimbursement laws and rules, including laws and
regulations that govern the Company's activities and the activities of the
radiology practices. The Company's or the radiology practices' activities may be
investigated, claims may be made against the Company or the radiology practices
and these increased enforcement activities may directly or indirectly have an
adverse effect on the Company's business, financial conditions and results of
operations.
CALIFORNIA ANTI-KICKBACK AND PHYSICIAN SELF-REFERRAL LAWS. California
has adopted a form of anti-kickback law and a form of Stark Law. The scope of
these laws and the interpretations of them are enforced by California courts and
regulatory authorities with broad discretion. Generally, California law covers
all referrals by all healthcare providers for all healthcare services. A
determination of liability under such laws could result in fines and penalties
and restrictions on the Company's ability to operate.
FEDERAL FALSE CLAIMS ACT. The Federal False Claims Act provides, in
part, that the federal government may bring a lawsuit against any person whom it
believes has knowingly presented, or caused to be presented, a false or
fraudulent request for payment from the federal government, or who has made a
false statement or used a false record to get a claim approved. The Federal
False Claims Act further provides that a lawsuit thereunder may be initiated in
the name of the United States by an individual who is an original source of the
allegations. The government has taken the position that claims presented in
violation of the federal anti-kickback law or Stark Law may be considered a
violation of the Federal False Claims Act. Penalties include civil penalties of
not less than $5,500 and not more than $11,000 for each false claim, plus three
times the amount of damages that the federal government sustained because of the
act of that person. The Company believes that it is in compliance with the rules
and regulations that apply to the Federal False Claims Act. However, the Company
could be found to have violated certain rules and regulations resulting in
13
sanctions under the Federal False Claims Act, and if the Company is so found in
violation, any sanctions imposed could result in fines and penalties and
restrictions on and exclusion from participation in federal and California
healthcare programs that are integral to the Company's business.
HEALTHCARE REFORM INITIATIVES. Healthcare laws and regulations may
change significantly in the future. The Company continuously monitors these
developments and modifies its operations from time to time as the regulatory
environment changes. The Company cannot be assured that it will be able to adapt
its operations to address new regulations or that new regulations will not
adversely affect the Company's business. In addition, although the Company
believes that it is operating in compliance with applicable federal and state
laws, neither the Company's current or anticipated business operations nor the
operations of the contracted radiology practices has been the subject of
judicial or regulatory interpretation. The Company cannot be assured that a
review of its business by courts or regulatory authorities will not result in a
determination that could adversely affect its operations or that the healthcare
regulatory environment will not change in a way that restricts the Company's
operations.
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996. In an
effort to combat healthcare fraud, Congress enacted the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA"). HIPAA, among other things,
amends existing crimes and criminal penalties for Medicare fraud and enacts new
federal healthcare fraud crimes, including actions affecting non-governmental
payors. Under HIPAA, a "healthcare benefit program" includes any private plan or
contract affecting interstate commerce under which any medical benefit, item or
services is provided. A person or entity that knowingly and willfully obtains
the money or property of any healthcare benefit program by means of false or
fraudulent representations in connection with the delivery of healthcare
services is subject to a fine and/or imprisonment. In addition, HIPAA authorizes
the imposition of civil money penalties against entities that employ or enter
into contracts with excluded Medicare or Medicaid program participants if such
entities provide services to federal health program beneficiaries. A finding of
liability under HIPAA could have a material adverse effect on the Company's
business, financial conditions and results of operations.
Further, HIPAA requires healthcare providers and their business
associates to maintain the privacy and security of individually identifiable
health information. HIPAA imposes federal standards for electronic transactions
with health plans, the security of electronic health information and for
protecting the privacy of individually identifiable health information. The
government recently published regulations to implement the privacy standards
with an initial compliance date of April 14, 2003. The Company may encounter
certain costs associated with complying with the primary provisions. A finding
of liability under HIPAA's privacy or security provisions may also result in
criminal and civil penalties, and could have a material adverse effect on the
Company's business, financial condition, and results of operations.
COMPLIANCE PROGRAM. The Company has implemented a program to monitor
compliance with federal and state laws and regulations applicable to healthcare
entities. The Company appointed a compliance officer who is charged with
implementing and supervising the compliance program, which includes the adoption
of (i) "Standards of conduct" for employees and affiliates and (ii) a process
that specifies how employees, affiliates and others may report regulatory or
ethical concerns to the Company's compliance officer. The Company believes that
its compliance program meets the relevant standards provided by the Office of
Inspector General of the Department of Health and Human Services. An important
part of the compliance program consists of conducting periodic audits of various
aspects of Company operations and that of the contracted radiology practices.
The Company also conducts mandatory educational programs designed to familiarize
employees with the regulatory requirements and specific elements of the
compliance program.
FDA. The U.S. Food and Drug Administration ("FDA") has issued the
requisite premarket approval for all of the MRI and CT systems utilized by the
Company. The Company does not believe that any further FDA approval is required
in connection with equipment currently in operation or proposed to be operated;
except under regulations issued by the FDA pursuant to the Mammography Quality
Standards Act of 1992, all mammography facilities are required to be accredited
by an approved non-profit organization or state agency. Pursuant to the
accreditation process each facility providing mammography services must comply
with certain standards including annual inspection.
14
Compliance with theses standards is required to obtain payment for
Medicare services and to avoid various sanctions, including monetary penalties,
or suspension of certification. Although all of the Company's facilities which
provide mammography services are currently accredited by the Mammography
Accreditation Program of the American College of Radiology and the Company
anticipates continuing to meet the requirements for accreditation, the
withdrawal of such accreditation could result in the revocation of
certification. Congress has extended Medicare benefits to include coverage of
screening mammography subject to the prescribed quality standards described
above. The regulations apply to diagnostic mammography and image quality
examination as well as screening mammography.
RADIOLOGIST LICENSING. The radiologists with whom the Company enters
into agreements to provide professional services are subject to licensing and
related regulations by the State of California. As a result, the Company
requires its radiologists to have and maintain appropriate licensure. The
Company does not believe that such laws and regulations will either prohibit or
require licensure approval of its business operations, although no assurances
can be made that such laws and regulations will not be interpreted to extend
such prohibitions or requirements to the Company's operations.
CORPORATE PRACTICE OF MEDICINE. In California, a lay person or any
entity other than a professional corporation is not allowed to practice any of
the healing arts including by employing professional persons or have any
ownership interest or profit participation in or control over any healing arts
professional practice. This doctrine is commonly referred to as the prohibition
on the "corporate practice" of medicine. The Company believes that arrangements
for the management of medical practices have, in fact, become quite common in
California, and have not generally been challenged with regard to the corporate
practice issue. However, because these types of arrangements are not required to
be reported, the Company cannot substantiate its belief. There can be no
assurance that the Company's present arrangements with BRMG or the physicians
providing medical services and medical supervision at the Company's imaging
centers will not be challenged, and, if challenged, that they will not be found
to violate the corporate practice prohibition, thus subjecting the Company to
potential damages, injunction and/or civil and criminal penalties.
The Company has not received a legal opinion from counsel with regard
to the effect of the corporate practice prohibition on its business as described
herein, and counsel has advised that such an opinion could not be given, because
of the lack of court cases relevant to the issue.
ENVIRONMENTAL. The facilities operated or managed by the Company
generate hazardous and medical waste subject to federal and state requirements
regarding handling and disposal.
The Company believes that the facilities that it operates and manages
are currently in compliance in all material respects with applicable federal,
state and local statutes and ordinances regulating the handling and disposal of
such materials. The Company does not believe that it will be required to expend
any material amounts in order to remain in compliance with these laws and
regulations or that compliance will materially affect its capital expenditures,
earnings or competitive position.
The Company has not received a legal opinion from counsel with regard
to the effect of the prohibitions discussed above on its business as described
herein, and counsel has advised that such an opinion could not be given, because
of the fluid interpretation of the law relevant to the issue.
15
ITEM 2. PROPERTIES
All of the imaging centers owned or managed by the Company are located
in leased facilities or in owned facilities on leased land. Certain information
with respect to the imaging centers is as follows:
Center
------
Wholly-Owned Approx. Sq. Ft.
------------ ---------------
of Center Lease Expiration
--------- ----------------
Tower Division:
[Beverly Hills and Environs]
Roxsan 10,774 Various through 2012
Women's 3,830 February 2014
Wilshire 13,778 September 2018
Antelope Valley 2,890 In negotiation
Chino 2,700 June 2007
Emeryville 2,086 June 2003
Fresno 5,360 June 2008
La Habra 3,034 December 2007
Lancaster [four sites] 11,327 In negotiation
Long Beach-Redondo [three sites] 6,000 In negotiation
Long Beach-Los Coyotes [four sites] 10,338 Various through 2006
Modesto 17,852 December 2004
Northridge 7,800 March 2012
Orange [four sites] 15,955 Various through 2012
Oxnard 5,100 In negotiation
Palm Desert [three sites] 11,082 Various through 2006
Palm Springs [two sites] 9,442 June 2008
Rancho Cucamonga [two sites] 12,518 May 2009
Sacramento 8,083 June 2003
San Francisco 1,240 In negotiation
San Gabriel Valley 3,871 December 2004
Santa Clarita 5,782 June 2009
Santa Rosa 4,235 July 2011
Stockton 4,808 December 2006
Tarzana [three sites] 6,320 Various through 2009
Tustin 2,139 January 2004
Vacaville 5,927 March 2007
Ventura 12,032 July 2007
Ventura-Loma Vista [three sites] 1,449 In negotiation
DIS Centers
-----------
Camarillo 2,035 May 2002
Oceanside [North County] 2,314 November 2005
Riverside [two sites] 13,834 Various through 2007
Temecula [three sites] 10,175 Various through 2006
Thousand Oaks 8,300 November 2007
Partnership/LLC
---------------
Burbank 5,787 March 2008
Westchester 6,763 July 2006
Rancho Bernardo 9,557 May 2012
Other Facilities
----------------
RadNet [Corp. offices] 16,500 June 2007
Warehouse/Other 33,447 Various
16
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
The Company is involved in the following litigation:
RADNET MANAGEMENT II, INC. V. HCT MODESTO, LLC
Alameda County Superior Court Case No. RG 03080062
--------------------------------------------------
RADNET MANAGEMENT II, INC. V. US DIAGNOSTIC, INC.
AND MODESTO IMAGING SERVICES, INC.
American Arbitration Association No. 72 Y 115 99029 01EP
--------------------------------------------------------
These matters arise out of RadNet Management II, Inc.'s acquisition of
substantially all of the assets and liabilities of Modesto Imaging Center, Inc.,
including, without limitation, Modesto Imaging Center, a diagnostic radiology
and imaging center. As of May 10, 2001, the date the acquisition closed, Modesto
Imaging Center, Inc., its parent company, US Diagnostic Inc., and HCT Modesto
LLC, the landlord under the lease for the property on which the Center is
situated, which lease had been assumed by and assigned to RadNet Management II,
Inc., had disclosed to RadNet Management II, Inc. that the lease had a present
expiration date of December 31, 2004, subject to two three-year extensions in
favor of the tenant. Two weeks after the acquisition closed, however, RadNet
Management II, Inc. learned from a third party that a document purporting to
extend the lease to December 31, 2014 (i.e., by ten years) had been in the
possession of Modesto Imaging Center, Inc., US Diagnostic Inc. and HCT Modesto
LLC at the time the improper disclosures were made to RadNet Management II, Inc.
RadNet Management II, Inc. believes that the lease is substantially in excess of
the fair rental value of the property.
On or about September 14, 2001, RadNet Management II, Inc. commenced an
arbitration proceeding against US Diagnostic Inc. and Modesto Imaging Center,
Inc. before the American Arbitration Association, seeking to reduce the price of
the acquisition by $1,000,000 pursuant to the Asset Purchase Agreement and
Escrow Agreement entered into between and among the parties, and also seeking
additional damages resulting from RadNet Management II, Inc.'s assumption of the
lease. US Diagnostic Inc. subsequently filed a Chapter 11 bankruptcy petition in
the United States District Court for the Southern District of Florida, and
Modesto Imaging Center, Inc. is believed to have few or no assets available to
pay an arbitration award.
On or about January 23, 2003, RadNet Management II, Inc. filed a complaint in
the Superior Court of the State of California, County of Alameda, seeking legal,
equitable and declaratory relief as against HCT Modesto LLC. Among other things,
RadNet Management II, Inc. seeks (1) cancellation of the document purporting to
extend the present lease expiration date from December 31, 2004 to December 31,
2014, (2) a declaration that RadNet Management II, Inc. is not bound by the
lease beyond December 31, 2004, and/or (3) damages in excess of $1,800,000.
RadNet Management II, Inc. anticipates that HCT Modesto LLC will serve it with a
Cross-Complaint seeking a declaration that RadNet Management II, Inc. is bound
by the lease through December 31, 2014, and also seeking damages in an amount
that is currently unknown.
At this point, it is too early to predict how the matter will conclude. However,
RadNet Management II, Inc. disputes any claim that it is bound to the lease
beyond December 31, 2004 and/or that it is liable to HCT Modesto LLC for any
amount of damages at all. It intends to pursue its claims vigorously against HCT
Modesto LLC and to vigorously defend against the anticipated cross-complaint.
17
Additionally, the Company is engaged from time to time in the defense of
lawsuits arising out of the ordinary course and conduct of its business and has
insurance policies covering such potential insurable losses. The Company
believes that the outcome of any such lawsuits will not have a material adverse
impact on the Company's business, financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
The Company did not submit any matters to a vote of security holders
during the fourth fiscal quarter of 2002.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON
- ------- ----------------------------------
STOCK AND RELATED STOCKHOLDER MATTERS
PHS Common Stock is traded in the over-the-counter market on the OTC
Bulletin Board [symbol, "PMDX"]. The following table indicates the high and low
prices for PHS Common Stock for the periods indicated based upon information
supplied by the National Quotation Bureau, Inc. Such quotations reflect
interdealer prices without adjustment for retail mark-up, mark-down or
commission, and may not necessarily represent actual transactions.
Quarter Ended Low High
------------- --- ----
January 31, 2002 .95 1.45
April 30, 2002 1.10 1.91
July 31, 2002 .97 1.51
October 31, 2002 .49 1.20
January 31, 2001 .31 .56
April 30, 2001 .38 .60
July 31, 2001 .55 .78
October 31, 2001 .60 .95
The last reported closing high and low prices for PHS Common Stock on the
OTC Bulletin Board on January 21, 2003, were $.48 and $.45, respectively. As of
January 21, 2003, the number of holders of record of PHS Common Stock was 4,028.
However, a substantial number of PHS' outstanding shares of Common Stock were
owned of record on said date by "Cede & Co.," the nominee for Depository Trust
Company, the clearing agency for most broker-dealers. Management believes that
these shares are beneficially owned by customers of these broker-dealers and
that the number of beneficial owners of PHS Common Stock is substantially
greater than 4,028.
CONVERTIBLE SUBORDINATED DEBENTURES
-----------------------------------
The Company has $16,291,000 convertible subordinated debentures
outstanding which mature June 30, 2003, and bears interest, payable quarterly,
at an annual rate of 10%. The debentures are convertible into PHS common stock
at a price of $10 per share. The Company plans to offer the debenture holders
the right to extend the debenture for three (3) years in which event the
conversion price would be reduced to $4. Remaining debentures will be required
to be redeemed. The Company intends to utilize its financing resources to effect
such redemption. There can be no guarantee those resources will be sufficient or
available at all when required.
18
Recent Sales of Unregistered Securities
---------------------------------------
During the fiscal year ended October 31, 2002, the following securities
were sold by the Company pursuant to the exemption to registration provided
under Section 4(2) of the Securities Act of 1933, as amended:
(1) In November 2001, the Company issued to one individual, a 5
year warrant exercisable at a price of $.95 per share (the
public market price closing price on the transaction date) to
purchase 75,000 shares of the Company's common stock.
(2) In February 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $1.26 per share (the
public market price closing price on the transaction date) to
purchase 500,000 shares of the Company's common stock.
(3) In April 2002, the Company issued to one individual, a 5 year
warrant exercisable at a price of $1.61 per share (the public
market closing price on the transaction date) to purchase
30,000 shares of the Company's common stock.
(4) In April 2002, an officer of the Company exercised an option
to purchase 300,000 shares of common stock. As part of the
transaction, the officer delivered to the Company 30,201
previously acquired shares of the Company's common stock with
a value of $45,000 (based upon $1.49 per share public market
closing price on the transaction date).
(5) In May 2002, the Company issued to one individual, a 5 year
warrant exercisable at a price of $1.45 per share (the public
market closing price on the transaction date) to purchase
9,000 shares of the Company's common stock.
(6) In June 2002, the Company issued to one individual, a 5 year
warrant exercisable at a price of $1.10 per share (the public
market closing price on the transaction date) to purchase
100,000 shares of the Company's common stock.
(7) In September 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $1.09 per share (the
public market closing price on the transaction date) to
purchase 50,000 shares of the Company's common stock.
(8) In September 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $0.80 per share (the
public market closing price on the transaction date) to
purchase 30,000 shares of the Company's common stock.
(9) In October 2002, the Company issued to one individual, a 5
year warrant exercisable at a price of $0.79 per share (the
public market closing price on the transaction date) to
purchase 30,000 shares of the Company's common stock.
19
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
- ------- ------------------------------------
The following selected consolidated financial data presented as of and
for the years ended October 31, 2002, 2001, 2000, 1999 and 1998 has been derived
from the Company's consolidated financial statements and should be read in
conjunction with such consolidated financial statements and related notes, and
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations," included elsewhere in this report.
YEARS ENDED
OCTOBER 31,
----------------------------------------------------------------------
(000's except per share amounts)
OPERATING DATA: 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Gross Revenues $ 378,942 $ 284,981 $ 229,598 $ 170,518 $ 132,595
Net Revenues after Contractual Allowances 139,281 111,837 87,965 72,258 58,821
Operating Expenses 127,965 92,735 73,368 70,359 75,329
Income [Loss] Before Extraordinary Items (5,552) 13,947 1,102 (10,627) (29,497)
Extraordinary Items- Gain 1 554 1,512 1,556 955
Net Income [Loss] (5,551) 14,501 2,614 (9,071) (28,543)
Income [Loss] Per Common share before (.14) .35 .03 (.27) (.75)
Extraordinary Items
Income [Loss] Per Common Share from .00 .01 .04 .04 .02
Extraordinary Item
Net Income [Loss] Per Common Share (.14) .36 .07 (.23) (.73)
BALANCE SHEET DATA:
Cash and Cash Equivalents 36 40 36 3 59
Total Assets 151,639 128,429 90,625 72,247 62,656
Total Long-Term Liabilities 121,830 110,188 82,693 79,023 79,282
Total Liabilities 202,560 174,071 151,538 136,604 118,016
Working Capital [Deficit] (44,668) (26,987) (44,588) (38,007) (20,191)
Stockholders' Equity [Deficit] (50,921) (45,642) (60,913) (64,357) (55,360)
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Primedex Health Systems, Inc., through its wholly-owned subsidiary, Radnet
Management, Inc. and its 91% owned subsidiary, Diagnostic Imaging Services,
Inc., is a leading California provider of diagnostic imaging services through
its ownership and operation of 58 outpatient diagnostic imaging centers. The
Company utilizes sophisticated technology and technical expertise to perform a
broad range of imaging procedures, such as magnetic resonance imaging (or MRI),
computed tomography (or CT), position emission tomography (or PET), nuclear
medicine, ultrasound, mammography, general radiography (or x-ray) and
fluoroscopy. The Company's revenues are derived from the ownership, management
and operation of its radiology and imaging center network. Professional medical
services and supervision are provided through Beverly Radiology Medical Group
("BRMG") and through other independent physicians and physician groups with
which the Company contracts. Inasmuch as BRMG is 99% owned by the majority
stockholder and president of the Company its revenues are consolidated with that
of the Company. As of October 31, 2002, the Company owned, operated or provided
management services.
The Company focuses on providing quality patient care and service to ensure
patient and referring physician satisfaction. The Company's concentration in
California permits it to invest in technologically advanced imaging equipment,
including MRI, open MRI, spiral CT and PET and organize the Company's imaging
centers into coordinated networks to improve response time, increase overall
patient accessibility, and permits the Company to standardize certain customer
relations procedures and permit the Company to develop "best practices" for its
diagnostic imaging centers. The Company's coordinated programs allow it to
provide administrative, management and information services to develop best
practices and to improve productivity and the quality of services. By focusing
on its communication systems the Company believes it can increase patient and
referring physician satisfaction, which should lead to increased referrals and
increased utilization of its diagnostic imaging centers.
The Company contracts with radiology practices including BRMG to provide
professional services, including the supervision and interpretation of
diagnostic imaging procedures performed in its diagnostic imaging centers. In
this regard, BRMG has begun assembling a group of physicians located at the
Company's corporate offices who utilize adjusted communication equipment for the
purposes of relieving radiologists located at the Company's centers who fall
behind in interpreting medical imaging as well as providing a group of well
recognized radiologists specializing in particular areas to provide backup for
referring physicians requiring specialized review. The Company believes that it
does not engage in the practice of medicine nor does it employ physicians. The
radiology practices maintain full control over the provision of professional
radiological services.
Payment for diagnostic imaging services comes primarily from private payors (22%
including Blue Cross, Blue Shield and Commercial insurance), managed care
contract arrangements (21% including fee for service, hmo and ppo insurance),
capitation arrangements (20%), and governmental payors (15% including Medicare
and Medicaid).
As of January 2002, Medicare decreased reimbursement rates for physician and
outpatient services, including diagnostic imaging services. The Company's
centers are principally dependent on its ability to attract referrals from
primary care physicians, specialists and other healthcare providers. The
referral often depends on the existence of a contractual arrangement with the
referred patient's health benefit plan.
21
The Company's revenue is dependent upon the operating results of the diagnostic
imaging centers. Service fees due under the service agreements for the
contracted radiology practices are derived from two distinct revenue streams:
(1) a negotiated percentage (typically 70% to 85%) of the center revenues as
defined in the service agreements; and (2) 100% of the technical revenues as
defined in the service agreements.
The Company's operations are comprised of the ownership and operation of
diagnostic imaging centers and the provision of administrative, management and
information services to the contracted radiology practices that provide
professional interpretation and supervision services in connection with the
diagnostic imaging centers.
The following information consists of issues you should consider in reviewing
the financial information provided. In this regard, Westchester Imaging Group is
a 50% owned Company partnership and both Burbank Advanced Imaging Center and
Rancho Bernardo Advanced Imaging Center are 75% owned with the minority
interests owned by the radiologists providing professional services in the
respective facilities. The Company committed to a capital contribution of
$750,000 to fund the building of a facility in Rancho Bernardo, California,
which opened in December 2002. Westchester Imaging Group is consolidated with
the Company based upon the criteria of both SFAS 94 and EITF 97-2. All
intercompany transactions and balances have been eliminated in consolidation and
combinations.
22
RESULTS OF OPERATIONS FOR THE YEAR ENDED OCTOBER 31, 2002 COMPARED TO THE YEAR
ENDED OCTOBER 31, 2001
The following table sets forth, for the periods indicated, the percentage that
certain items in the statement of income bear to net revenue and the percentage
dollar increase (decrease) of such items from period to period.
PERCENTAGE
PERCENT OF NET REVENUE DOLLAR INCREASE
YEARS ENDED OCTOBER 31, (DECREASE)
--------------------------------------- ---------------------
2002 2001 `01 TO `02
------------------- ------------------- ---------------------
Revenue 272.1% 254.8 % 33.0%
Less: Allowances (172.1) (154.8) 38.4
------------------- ------------------- ---------------------
Net revenue 100.0 100.0 24.5
Operating expense
Operating expenses (75.7) (69.8) 35.2
Depreciation and amortization (11.0) (9.6) 43.0
Provision for bad debts (5.2) (3.6) 78.6
------------------- ------------------- ---------------------
Total operating expense (91.9) (82.9) 38.0
------------------- ------------------- ---------------------
Income from operations 8.1 17.1 (40.8)
Interest expense, net (12.0) (12.2) 22.6
Gain (loss) on sale of assets or (.2) 3.1 (108.5)
centers
Other, net .4 0.2 187.1
------------------- ------------------- ---------------------
Income before provision for income (3.7) 8.2 (156.3)
taxes, minority interest and
extraordinary item
Income tax benefit -- 4.6 (100.0)
------------------- ------------------- ---------------------
Income before minority interest (3.7) 12.8 (136.1)
and extraordinary item
Minority interest (0.3) (0.3) 12.8
------------------- ------------------- ---------------------
Income before extraordinary item (4.0) 12.5 (139.8)
Extraordinary item .0 .5 (99.8)
------------------- ------------------- ---------------------
Net income (4.0) 13.0 (138.3)
=================== =================== =====================
The following discussion explains in greater detail the consolidated operating
results and financial condition of the Company for the year ended October 31,
2002 compared to the year ended October 31, 2001.
2002 2001
---- ----
NET REVENUE $139,281,000 $ 111,837,000
- -----------
Revenue of the contracted radiology practices and diagnostic imaging centers is
recorded when services are rendered by the contracted radiology practices and
diagnostic imaging centers based on established charges and reduced by
contractual allowances. The Company utilizes historical collection experience in
23
estimating contractual allowances. The factors influencing the historical
collection experience include the contracted radiology practices' and diagnostic
imaging centers' patient mix, impact of managed care contract pricing and
contract revenue and the aging of patient accounts receivable balances. As these
factors change, the historical collection experience is revised accordingly in
the period known.
Net revenue increased approximately $27,444,000, or 24.5%, for the year ended
October 31, 2002, compared to the same period in the previous year. Of the net
revenue increase, 25% was due to three new sites which opened, Burbank [late
November 2001] and Tarzana Advanced [January 2002], or were acquired, Grove
Diagnostic [May 2002]. During fiscal 2002, 31% was due to the full effect of the
acquisition of Modesto [May 2001] and Palm Springs and Palm Desert [June 2001],
offset by a 2% decrease due to the sale of the Company's sole radiation oncology
facility ("VROC") in March 2001. The remaining 46% increase was due to new
contracts, renegotiation of existing contracts to more favorable rates, an
improved economy with increasing population, and increased throughput at many
sites due to the addition and continued upgrade of medical equipment. In
particular were improvements at the following facilities primarily due to the
entry into new capitation agreements coupled with the addition and upgrade of
medical equipment increasing throughput at each of the sites: Riverside [HCIC]
where net revenue increased approximately 43%, or $1,717,000, Temecula [TVIC]
where net revenue increased approximately 99%, or $2,691,000, and Los Coyotes
where net revenue increased approximately 50%, or $1,514,000. In addition, the
expansion of Orange Imaging in late fiscal 2002 with the opening of Orange
Advanced and Orange Women's Centers contributed to its increase in net revenue
of approximately 13%, or $1,030,000.
OPERATING EXPENSES 2002 2001
- ------------------ ---- ----
OPERATING EXPENSES $ 105,473,000 $ 78,008,000
DEPRECIATION AND AMORTIZATION 15,309,000 10,705,000
PROVISION FOR BAD DEBTS 7,183,000 4,022,000
-------------- -------------
TOTAL OPERATING EXPENSES $ 127,965,000 $ 92,735,000
Operating expenses for the year ended October 31, 2002 increased approximately
$27,465,000, or 35%, compared to the same period in the previous year. Of this
increase, 46% was due to the full effect of five new sites acquired or opened
during the previous two years including Modesto, Desert Advanced, Burbank,
Tarzana Advanced and Grove coupled with the start-up costs associated with the
planned opening of Rancho Bernardo [offset by a 1% decrease due to the sale of
the VROC facility in March 2001]. The remaining 55% increase in operating
expenses was primarily due to an increase in net revenue which effects the
Company's percentage of revenue agreements relating to physician reading fees
and the GE repair and maintenance expense which increased contracted fees from
3.22% to 3.64% of net revenue effective November 1, 2001. In addition, the
Company had variable increases in expenditures for billing, medical supplies,
office supplies, utilities and other expenses with the increase in business.
Due to a shortage of qualified radiologists in the marketplace, BRMG experienced
difficulty in hiring and retaining physicians at the individual sites during
most of fiscal 2002. This required the engagement of independent contractors and
locum tenens (part-time fill-in physicians) to interpret patient films. The cost
of these individuals was double the salary of a regular BRMG full-time physician
with additional costs for travel and lodging required. Recently, BRMG hired a
new nationally prominent medical director who oversees physician recruitment and
staffing. In order to reduce the substantial increased cost associated with
part-time fill-in physicians, the new director has already arranged for BRMG to
hire over twelve new physicians during the last two quarters of fiscal 2002.
BRMG is working to solidify its physicians at the majority of the Company's
24
sites while increasing the volume of interpretations done by physicians at the
Company's main offices utilizing the Company's computer and PACS systems. In
solidifying its physician staff, the Company has revised some of its physician
agreements from a fixed fee to a percentage of revenue arrangement. With these
types of arrangements, future increases in net revenue increase the cost of
physician reading fees proportionately and thereby negatively impact the
Company's overall operating income. During the year ended October 31, 2002, the
overall increase in physician reading fees was approximately $3.4 million
compared to fiscal year 2001's average expense [net of the effect of the
increase in net revenue in fiscal year 2002].
In addition, during the year ended October 31, 2002, the Company experienced
significant increases in expenditures for insurance with carriers requesting
greater fees upon renewal coupled with the significant growth the Company has
recently experienced with increased revenue, staffing and additions of new
equipment. General liability rates increased approximately 50% in October 2002,
workers compensation rates increased approximately 45% in July 2002, and
malpractice rates approximately 80% in September 2002. Medical insurance
increases were somewhat offset with employees contributing more per pay period.
The Company is reviewing various alternatives to reduce its expenditures for
insurance and minimize the increases it may incur in the future. However,
increases in insurance costs are being experienced by companies all over the
United States and reductions are not likely for the foreseeable future.
Included in operating expenses for the years ended October 31, 2002 and 2001 are
approximately $62,389,000 and $44,765,000, respectively, for salaries and
professional reading fees, approximately $8,799,000 and $7,344,000,
respectively, for building and equipment rentals, and approximately $34,285,000
and $25,899,000, respectively, in general and administrative expenditures. The
Company's general and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business tax and
license, outside services, utilities and other expenses including marketing and
travel. The majority of these expenses are variable and increase with net
revenue. Net revenue for the year ended October 31, 2002 increased 24.5% and
resulted in increases in general and administrative expenses of approximately
$6.0 million. The remaining increase was primarily for insurance and repairs and
maintenance, discussed above, and utilities [due to the increase in medical
equipment].
Depreciation and amortization for the year ended October 31, 2002 increased
approximately $4,604,000, or 43%, compared to the same period in the previous
year. This increase was offset by approximately $1,354,000 due to the
elimination of goodwill amortization with the implementation of Statement of
Financial Accounting Standards No. 141, Business Combinations and No. 142,
Goodwill and Other Intangible Assets effective November 1, 2001. Of the increase
in depreciation and amortization, 37% was due to the acquisition of equipment or
improvement in leaseholds for same store facilities, and 64% was due to the full
effect of the opening or acquisition of five sites during fiscal 2001 and fiscal
2002 [offset by a 1% decrease upon the sale of VROC in March 2001].
Provision for bad debt for the year ended October 31, 2002 increased
approximately $3,161,000, or 79%, compared to the same period last year. The
primary reason for the increase was due to the growth in revenue coupled with
the write-off of approximately $850,000 in net accounts receivable primarily due
to one contracted payor's dissolution and default on amounts due.
2002 2001
---- ----
INTEREST EXPENSE, NET $ 16,693,000 $ 13,620,000
- ---------------------
25
Net interest expense for the year ended October 31, 2002 increased approximately
$3,073,000, or 23%, compared to the same period last year. The increase is
primarily a result of acquisitions coupled with new equipment financing. During
fiscal 2002, the Company acquired Grove Diagnostic Imaging for approximately
$1,441,000 and entered into new capital lease obligations of approximately
$30,846,000.
2002 2001
---- ----
GAIN (LOSS) ON SALE OF SUBSIDIARIES, $(299,000) $ 3,520,000
- ------------------------------------
DIVISIONS AND ASSETS
- --------------------
During fiscal 2002, the Company sold the land and building at Northridge (and
leased it back), disposed of an MRI at Vacaville and disposed of a variety of
other assets at various sites generating a loss on sale or disposal of equipment
of approximately $299,000. During the year ended October 31, 2001, the Company
sold its VROC facility for $4,000,000 cash and recognized a gain on the sale of
approximately $3,527,000, and recognized losses on the sale or disposal of
equipment of approximately $7,000.
2002 2001
---- ----
OTHER INCOME, NET $ 511,000 $ 178,000
- -----------------
Other income for the year ended October 31, 2002 increased approximately
$333,000, or 187%. Other income consists primarily of professional reading fee
income, rental income, record copying income and miscellaneous reimbursements.
During fiscal 2002, the Company received approximately $240,000 in insurance
reimbursements for its business interruption and general business liability
policies for losses it sustained at its Tustin, Tower Roxsan and Northridge
facilities due primarily to water leaks and water damage.
2002 2001
---- ----
INCOME TAX BENEFIT $ -- $ 5,110,000
- ------------------
For the year ended October 31, 2001, the Company recorded a deferred tax asset
of $5,235,000 offset by an income tax payable of $125,000 (See Note 9 to the
Company's Financial Statements).
2002 2001
---- ----
MINORITY INTEREST $ (387,000) $ (343,000)
- -----------------
Minority interest in joint venture represents the minority investor's 50% share
of the Westchester Imaging Group, 25% share of the Burbank Advanced Imaging
Center LLC and 25% share of Rancho Bernardo Advanced LLC income for the period.
Minority interest expense for the year ended October 31, 2002 increased
approximately $44,000, or 13%, compared to the same period the previous year.
The increase is primarily due to the increased earnings of Westchester Imaging
Group.
2002 2001
---- ----
EXTRAORDINARY ITEM $ 1,000 $ 554,000
- ------------------
Extraordinary gains decreased $553,000 for the year ended October 31, 2002.
Extraordinary gains represent the repurchase of subordinated bond debentures and
the write-off or settlement of limited partner notes at a discount. During the
year ended October 31, 2001, the Company was able to write-off a portion of its
limited partner note obligations when they reached their statute of limitations
for claim. In addition, as the subordinated bond debentures get closer to
maturity in June 2003, the opportunity to repurchase them at a discount becomes
less probable and little to no offers materialized during the year ended October
31, 2002.
26
RESULTS OF OPERATIONS FOR THE YEARS ENDED OCTOBER 31, 2001 COMPARED TO THE YEAR
- -------------------------------------------------------------------------------
ENDED OCTOBER 31, 2000
- ----------------------
The following table sets forth, for the periods indicated, the percentage that
certain items in the statement of income bear to net revenue and the percentage
dollar increase (decrease) of such items from period to period.
PERCENTAGE
PERCENT OF NET REVENUE DOLLAR INCREASE
YEARS ENDED OCTOBER 31, (DECREASE)
--------------------------------------- ---------------------
2001 2000 `00 TO `01
------------------- ------------------- ---------------------
Revenue 254.8 % 261.0 % 24.1%
Less: Allowances (154.8) (161.0) 22.2
------------------- ------------------- ---------------------
Net revenue 100.0 100.0 27.1
Operating expense
Operating expenses (69.7) (70.7) 25.4
Depreciation and amortization (9.6) (9.8) 24.8
Provision for bad debts (3.6) (2.9) 55.8
------------------- ------------------- ---------------------
Total operating expense (82.9) (83.4) 26.4
------------------- ------------------- ---------------------
Income from operations 17.1 16.6 30.9
Interest expense, net (12.2) (14.9) 3.7
Other, net 3.3 (0.1) (3952.1)
------------------- ------------------- ---------------------
Income before provision for income 8.2 1.6 574.5
taxes, minority interest and
extraordinary item
Income tax benefit 4.6 -- 100.0
Income before minority interest 12.8 1.6 950.0
and extraordinary item
Minority interest (0.3) (0.3) 32.4
------------------- ------------------- ---------------------
Income before extraordinary item 12.5 1.3 1165.6
Extraordinary item 0.5 1.7 (63.4)
------------------- ------------------- ---------------------
Net income 13.0 3.0 454.7
=================== =================== =====================
The following discussion explains in greater detail the consolidated operating
results and financial condition of the Company for the year ended October 31,
2001 compared to the year ended October 31, 2000.
27
2001 2000
---- ----
NET REVENUE $ 111,837,000 $ 87,865,000
- -----------
Net revenue increased approximately $23,872,000, or 27.1%, for the year ended
October 31, 2001, compared to the same period the previous year. Of the net
revenue increase, 29% was due to the full effect of five new sites acquired in
June 2000 [Chino, San Gabriel and Tarzana] and September 2000 [San Francisco and
Emeryville], and 25% was due to the acquisition of three new sites in May 2001
[Modesto] and June 2001 [Palm Springs and Palm Desert], offset by a 6% decrease
due to the sale of the VROC facility in March 2001. The remaining 52% of the
increase was due to new contracts, renegotiation of existing contracts to more
favorable rates, an improved economy with increasing population, and increased
throughput at many sites due to the addition and continued upgrade of medical
equipment. In particular were improvements at the Company's Riverside [HCIC]
facility where net revenues increased approximately 113%, or $2,107,000, due to
the entry into a new capitation agreement coupled with the addition and upgrade
of medical equipment.
OPERATING EXPENSES 2001 2000
- ------------------ ---- ----
OPERATING EXPENSES $ 78,008,000 $ 62,207,000
DEPRECIATION AND AMORTIZATION 10,705,000 8,580,000
PROVISION FOR BAD DEBTS 4,022,000 2,581,000
------------- -------------
TOTAL OPERATING EXPENSES $ 92,735,000 $ 73,368,000
Operating expenses for the year ended October 31, 2001 increased approximately
$15,801,000, or 25%, compared to the same period the previous year. Of this
increase, 19% was due to the full effect of five new sites acquired in June 2000
and September 2000, 31% was due to the acquisition of three new sites in May
2001 and June 2001 and the start-up costs associated with the future openings of
Burbank Advanced and Tarzana Advanced, offset by a 4% decrease due to the sale
of the VROC facility in March 2001. The remaining 54% of the increase in
operating expenses was primarily due to an increase in the net revenues
including a 34% increase in salaries and professional reading fees, a 7%
increase for the impact of a repair and maintenance contract agreement entered
into on March 1, 2000 which resulted in increased fees from 2.82% to 3.22% of
net revenue effective November 1, 2000, a 5% increase in outside services
including legal, accounting, billing, labor and transcription services, and an
8% increase in other expenses including utilities, insurance and business taxes.
Even with the 27.1% increase in net revenue, medical supply expenditures
increased only 16.8% from the same period last year primarily due to additional
acquisitions of filmless digital equipment at many of the sites and increased
purchase discounts.
Included in operating expenses for the years ended October 31, 2001 and 2000 are
approximately $44,765,000 and $35,402,000, respectively, for salaries and
professional reading fees, approximately $7,344,000 and $6,334,000,
respectively, for building and equipment rentals, and approximately $25,899,000
and $20,471,000, respectively, in general and administrative expenditures. The
Company's general and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business tax and
license, outside services, utilities and other expenses including marketing and
travel. The majority of these expenses are variable and increase with net
revenue. Net revenue for the year ended October 31, 2001 increased 27.1% and
resulted in increases in general and administrative expenses of approximately
$5.5 million.
Depreciation and amortization for the year ended October 31, 2001 increased
approximately $2,125,000, or 25%, compared to the same period the previous year.
Of this increase, 29% was due to the acquisition of equipment, 46% was due to
the full effect of the acquisition of five new sites during fiscal 2000, and 29%
was due to the acquisition of three new sites in fiscal 2001, offset by a 4%
decrease upon the sale of VROC in March 2001.
28
Provision for bad debt for the year ended October 31, 2001 increased
approximately $1,441,000, or 56%, compared to the same period the previous year.
The primary reason for the increase was due to the growth in revenue coupled
with the Company's overall bad debt percentage increasing from 1.79% of the
contractual adjustments during fiscal 2000 to 2.27% of the contractual
adjustments during fiscal 2001.
2001 2000
---- ----
INTEREST EXPENSE, NET $ 13,620,000 $ 13,140,000
- ---------------------
Net interest expense for the year ended October 31, 2001 increased approximately
$480,000, or 4%, compared to the same period the previous year. The increase is
primarily a result of acquisitions coupled with new equipment financing offset
by decreases in line of credit interest charges with the corresponding
reductions in the lines of credit balances and the prime interest rate during
the respective periods.
2001 2000
---- ----
OTHER INCOME (LOSS), NET $ 3,698,000 $ (96,000)
- ------------------------
Other income (loss) for the year ended October 31, 2001 increased approximately
$3,794,000 compared to the same period in the previous year. During the year
ended October 31, 2001, the Company sold its VROC facility for $4,000,000 cash
and recognized a gain on the sale of approximately $3,527,000, recognized losses
on the sale or disposal of equipment of approximately $7,000 and generated other
income, net of other expense, of approximately $178,000. During the year ended
October 31, 2000, the Company recognized losses on the sale or disposal of
equipment of approximately $335,000 and generated other income, net of other
expense, of approximately $239,000.
2001 2000
---- ----
INCOME TAX BENEFIT $ 5,110,000 $ --
- ------------------
For the year ended October 31, 2001, the Company recorded a deferred tax asset
of $5,235,000 offset by an income tax payable of $125,000 (See Note 9).
2001 2000
---- ----
MINORITY INTEREST $ (343,000) $ (259,000)
- -----------------
Minority interest in joint venture represents the minority investor's 50% share
of the Westchester Imaging Group and 25% share of the Burbank Advanced Imaging
Center LLC income for the period. Minority interest expense for the year ended
October 31, 2001 increased approximately $84,000, or 32%, compared to the same
period the previous year. The increase is due to the increased earnings of
Westchester Imaging Group.
2001 2000
---- ----
EXTRAORDINARY ITEM $ 554,000 $ 1,512,000
- ------------------
Extraordinary gains represent the repurchase of subordinated bond debentures and
the write-off or settlement of limited partner notes at a discount.
29
SUMMARY OF OPERATIONS BY QUARTER
- --------------------------------
The following table presents unaudited quarterly operating results for each of
the Company's last eight fiscal quarters. The Company believes that all
necessary adjustments have been included in the amounts stated below to present
fairly the quarterly results when read in conjunction with the consolidated
financial statements. Results of operations for any particular quarter are not
necessarily indicative of results of operations for a full year or predictive of
future periods.
2001 Quarter Ended 2002 Quarter Ended
(000's except per share amounts) (000's except per share amounts)
Jan 31 Apr 30(a) Jul 31 Oct 31(b) Jan 31 Apr 30 Jul 31(c) Oct 31
------ --------- ------ --------- ------ ------ --------- ------
Statement of Income Data:
Net Revenue $24,110 $26,104 $29,464 $32,159 $32,441 $33,722 $35,580 $37,538
Operating Expenses $19,897 $21,122 $24,121 $27,595 $28,104 $28,989 $35,765 $35,107
Income (Loss) before
Extraordinary Item $918 $5,107 $2,081 $5,841 $917 $836 ($5,123) ($2,182)
Extraordinary Item $5 $108 $0 $441 $0 $0 $1 $0
Net Income (Loss)