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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2004
Commission File Number 0-19019
PRIMEDEX HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
NEW YORK 13-3326724
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1510 COTNER AVENUE
LOS ANGELES, CALIFORNIA 90025
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 478-7808
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities 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 or any amendment to this
Form 10-K. ~
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes [ ] No [X]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant was approximately $12,647,303 on April 30, 2004
(the last business day of the registrant's most recently completed second
quarter) based on the closing price for the common stock on the Nasdaq
Over-the-Counter Bulletin Board on said date.
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [X] No [ ]
The number of shares of the registrant's common stock outstanding on January 19,
2005, was 41,106,813 shares (excluding treasury shares).
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PART I
ITEM 1. BUSINESS
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BUSINESS OVERVIEW
We operate a group of regional networks comprised of 56 fixed-site,
freestanding outpatient diagnostic imaging facilities in California. We believe
our group of regional networks is the largest of its kind in California. We have
strategically organized our facilities into regional networks in markets which
have both high-density and expanding populations, as well as attractive payor
diversity.
All of our facilities employ state-of-the-art equipment and technology
in modern, patient-friendly settings. Many of our facilities within a particular
region are interconnected and integrated through our advanced information
technology system. Thirty three of our facilities are multi-modality sites,
offering various combinations of magnetic resonance imaging, or MRI, computed
tomography, or CT, positron emission tomography, or PET, nuclear medicine,
mammography, ultrasound, diagnostic radiology, or X-ray and fluoroscopy. Twenty
three of our facilities are single-modality sites, offering either X-ray or MRI.
Consistent with our regional network strategy, we locate our single-modality
facilities near multi-modality sites to help accommodate overflow in targeted
demographic areas.
At our facilities, we provide all of the equipment as well as all
non-medical operational, management, financial and administrative services
necessary to provide diagnostic imaging services. We give our facility managers
authority to run our facilities to meet the demands of local market conditions,
while our corporate structure provides economies of scale, corporate training
programs, standardized policies and procedures and sharing of best practices
across our networks. Each of our facility managers is responsible for meeting
our standards of patient service, managing relationships with local physicians
and payors and maintaining profitability.
Howard G. Berger, M.D. is our President and Chief Executive Officer, a
member of our Board of Directors and owns approximately 30% of our outstanding
common stock. Dr. Berger also owns, indirectly, 99% of the equity interests in
Beverly Radiology Medical Group III, or BRMG. BRMG provides all of the
professional medical services at 42 of our facilities under a management
agreement with us, and contracts with various other independent physicians and
physician groups to provide the professional medical services at most of our
other facilities. We obtain professional medical services from BRMG, rather than
provide such services directly or through subsidiaries, in order to comply with
California's prohibition against the corporate practice of medicine. However, as
a result of our close relationship with Dr. Berger and BRMG, we believe that we
are able to better ensure that medical service is provided at our facilities in
a manner consistent with our needs and expectations and those of our referring
physicians, patients and payors than if we obtained these services from
unaffiliated physician groups.
We derive substantially all of our revenue, directly or indirectly,
from fees charged for the diagnostic imaging services performed at our
facilities. For the year ended October 31, 2004, we performed 946,928 diagnostic
imaging scans and generated net revenue from continuing operations of $137.3
million.
The following table illustrates our work performed over the five-year period
ended October 31, 2004:
YEAR ENDED OCTOBER 31,
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2000 2001 2002 2003 2004
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Total number of MRI, CT and PET systems (at end of year)* 45 52 60 63 68
Total number of scans performed* 600,667 690,484 877,574 947,032 946,928
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* Excludes discontinued operation.
INDUSTRY OVERVIEW
Diagnostic imaging involves the use of non-invasive procedures to
generate representations of internal anatomy and function that can be recorded
on film or digitized for display on a video monitor. Diagnostic imaging
procedures facilitate the early diagnosis and treatment of diseases and
disorders and may reduce unnecessary invasive procedures, often minimizing the
cost and amount of care for patients. Diagnostic imaging procedures include MRI,
CT, PET, nuclear medicine, ultrasound, mammography, X-ray and fluoroscopy.
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While general X-ray remains the most commonly performed diagnostic
imaging procedure, the fastest growing and higher margin procedures are MRI, CT
and PET. The rapid growth in PET scans is attributable to the recent
introduction of reimbursement by payors of PET procedures. The number of MRI and
CT scans continues to grow due to their wider acceptance by physicians and
payors, an increasing number of applications for their use and a general
increase in demand due to the aging population in the United States.
IMV, a provider of database and market information products and services
to the analytical, clinical diagnostic, biotechnology, life science and medical
imaging industries, estimates that over 21.9 million MRI procedures and 45.4
million CT procedures were conducted in the United States in 2002, representing
a 22% and 15% increase over the 2001 volume of MRI and CT procedures,
respectively, and that approximately 9% of those MRI procedures and 8% of those
CT procedures were performed in California. IMV indicates that the number of MRI
procedures in the United States has increased at a rate of 12% per year since
1998. This data is particularly relevant to us, given that revenue from MRI and
CT scans constituted approximately 63% of our net revenue for the year ended
October 31, 2004.
INDUSTRY TRENDS
We believe that the diagnostic imaging services industry will continue to
grow as a result of a number of factors, including the following:
ESCALATING DEMAND FOR HEALTHCARE SERVICES FROM AN AGING POPULATION
Persons over the age of 65 comprise one of the fastest growing segments
of the population in the United States. According to the United States Census
Bureau, this group is expected to increase as much as 14% from 2000 to 2010.
Because diagnostic imaging use tends to increase as a person ages, we believe
the aging population will generate more demand for diagnostic imaging
procedures.
NEW EFFECTIVE APPLICATIONS FOR DIAGNOSTIC IMAGING TECHNOLOGY
New technological developments are expected to extend the clinical uses
of diagnostic imaging technology and increase the number of scans performed.
Recent technological advancements include:
o MRI spectroscopy, which can differentiate malignant from benign
lesions;
o MRI angiography, which can produce three-dimensional images of
body parts and assess the status of blood vessels;
o Enhancements in teleradiology systems, which permit the digital
transmission of radiological images from one location to another
for interpretation by radiologists at remote locations; and
o The development of combined PET/CT scanners, which combine the
technology from PET and CT to create a powerful diagnostic imaging
system.
Additional improvements in imaging technologies, contrast agents and scan
capabilities are leading to new non-invasive methods of diagnosing blockages in
the heart's vital coronary arteries, liver metastases, pelvic diseases and
vascular abnormalities without exploratory surgery. We believe that the use of
the diagnostic capabilities of MRI and other imaging services will continue to
increase because they are cost-effective, time-efficient and non-invasive, as
compared to alternative procedures, including surgery, and that newer
technologies and future technological advancements will continue the increased
use of imaging services. In addition, we believe the growing popularity of
elective full-body scans will further increase the use of imaging services. At
the same time, we believe the industry has increasingly used upgrades to
existing equipment to expand applications, extend the useful life of existing
equipment, improve image quality, reduce image acquisition time and increase the
volume of scans that can be performed. We believe this trend toward equipment
upgrades rather than equipment replacements will continue, as we do not foresee
new imaging technologies on the horizon that will displace MRI, CT or PET as the
principal advanced diagnostic imaging modalities.
WIDER PHYSICIAN AND PAYOR ACCEPTANCE OF THE USE OF IMAGING
During the last 30 years, there has been a major effort undertaken by the
medical and scientific communities to develop higher quality, cost-effective
diagnostic imaging technologies and to minimize the risks associated with the
application of these technologies. The thrust of product development during this
period has largely been to reduce the hazards associated with conventional X-ray
and nuclear medicine techniques and to develop new, harmless imaging
technologies. As a result, the use of advanced diagnostic imaging modalities,
such as MRI, CT and PET, which provide superior image quality compared to other
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diagnostic imaging technologies, has increased rapidly in recent years. These
advanced modalities allow 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. Because advanced imaging
systems are increasingly seen as a tool for reducing long-term healthcare costs,
they are gaining wider acceptance among payors.
GREATER CONSUMER AWARENESS OF AND DEMAND FOR PREVENTIVE DIAGNOSTIC
SCREENING
Diagnostic imaging is increasingly being used as a screening tool for
preventive care such as elective full-body scans. 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. We believe that
further technological advancements will create demand for diagnostic imaging
procedures as less invasive procedures for early diagnosis of diseases and
disorders.
DIAGNOSTIC IMAGING SETTINGS
Diagnostic imaging services are typically provided in one of the
following settings:
FIXED-SITE, FREESTANDING OUTPATIENT DIAGNOSTIC FACILITIES
These facilities range from single-modality to multimodality facilities
and are not generally owned by hospitals or clinics. These facilities depend
upon physician referrals for their patients and generally do not maintain
dedicated, contractual relationships with hospitals or clinics. In fact, these
facilities may compete with hospitals or clinics that have their own imaging
systems to provide services to these patients. These facilities bill third-party
payors, such as managed care organizations, insurance companies, Medicare or
Medi-Cal. All of our facilities are in this category.
HOSPITALS OR CLINICS
Many hospitals provide both inpatient and outpatient diagnostic imaging
services, typically on site. These inpatient and outpatient centers are owned
and operated by the hospital or clinic or jointly by both and are primarily used
by patients of the hospital or clinic. The hospital or clinic bills third-party
payors, such as managed care organizations, insurance companies, Medicare or
Medi-Cal.
MOBILE FACILITIES
Using specially designed trailers, imaging service providers transport
imaging equipment and provide services to hospitals and clinics on a part-time
or full-time basis, thus allowing small to mid-size hospitals and clinics that
do not have the patient demand to justify an on-site setting access to advanced
diagnostic imaging technology. Diagnostic imaging providers contract directly
with the hospital or clinic and are typically reimbursed directly by them.
DIAGNOSTIC IMAGING MODALITIES
The principal diagnostic imaging modalities we use at our facilities are:
MRI
MRI has become widely accepted as the standard diagnostic tool for a wide
and fast-growing variety of clinical applications for soft tissue anatomy, such
as those found in the brain, spinal cord and interior ligaments of body joints
such as the knee. MRI uses a strong magnetic field in conjunction with low
energy electromagnetic waves that are processed by a computer to produce
high-resolution, three-dimensional, cross-sectional images of body tissue,
including the brain, spine, abdomen, heart and extremities. A typical MRI
examination takes from 20 to 45 minutes. MRI systems can have either open or
closed designs, routinely have magnetic field strength of 0.2 Tesla to 3.0 Tesla
and are priced in the range of $0.6 million to $2.5 million.
CT
CT provides higher resolution images than conventional X-rays, but
generally not as well-defined as those produced by MRI. CT uses a computer to
direct the movement of an X-ray tube to produce multiple cross-sectional images
of a particular organ or area of the body. CT is used to detect tumors and other
conditions affecting bones and internal organs. It is also used to detect the
occurrence of strokes, hemorrhages and infections. A typical CT examination
takes from 15 to 45 minutes. CT systems are priced in the range of $0.3 million
to $1.2 million.
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PET
PET scanning involves the administration of a radiopharmaceutical agent
with a positron-emitting isotope and the measurement of 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 with
other tools 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 some cardiac
conditions and the assessment of epilepsy seizure sites. The information
provided by PET technology often obviates the need to perform further highly
invasive or diagnostic surgical procedures. PET systems are priced in the range
of $0.8 million to $2.5 million. We provide PET-only services through the rental
of mobile equipment at a few of our sites. Combined PET/CT systems, which we
offer, blend the PET and CT imaging modalities into one scanner. These combined
systems are priced in the range of $1.8 million to $2.2 million.
NUCLEAR MEDICINE
Nuclear medicine uses short-lived radioactive isotopes that release small
amounts of radiation that can be recorded by a gamma camera and processed by a
computer to produce an image of various anatomical structures or to assess the
function of various organs such as the heart, kidneys, thyroid and bones.
Nuclear medicine is used primarily to study anatomic and metabolic functions.
Nuclear medicine systems are priced in the range of $300,000 to $400,000.
X-RAY
X-rays use roentgen rays to penetrate the body and record images of
organs and structures on film. Digital X-ray systems add computer image
processing capability to traditional X-ray images, which provides faster
transmission of images with a higher resolution and the capability to store
images more cost-effectively. X-ray systems are priced in the range of $50,000
to $250,000.
ULTRASOUND
Ultrasound imaging 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.
Ultrasound systems are priced in the range of $90,000 to $250,000.
MAMMOGRAPHY
Mammography is a specialized form of radiology using 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 of and
treatment planning for breast cancer. Mammography systems are priced in the
range of $70,000 to $100,000.
FLUOROSCOPY
Fluoroscopy uses ionizing radiation combined with a video viewing system
for real time monitoring of organs. Fluoroscopy systems are priced in the range
of $100,000 to $300,000.
COMPETITIVE STRENGTHS
SIGNIFICANT AND KNOWLEDGEABLE PARTICIPANT IN THE NATION'S LARGEST ECONOMY
We believe our group of regional networks of fixed-site, freestanding
outpatient diagnostic imaging facilities is the largest of its kind in
California, the nation's largest economy and most populous state. Our two
decades of experience in operating diagnostic imaging facilities in almost every
major population center in California gives us intimate, first-hand knowledge of
these geographic markets, as well as close, long-term relationships with key
payors, radiology groups and referring physicians within these markets.
ADVANTAGES OF REGIONAL NETWORKS WITH BROAD GEOGRAPHIC COVERAGE
The organization of our diagnostic imaging facilities into regional
networks around major population centers offers unique benefits to our patients,
our referring physicians, our payors and us.
o We are able to increase the convenience of our services to
patients by implementing scheduling systems within geographic
regions, where practical. For example, many of our diagnostic
imaging facilities within a particular region can access the
patient appointment calendars of other facilities within the same
regional network to efficiently allocate time available and to
meet a patient's appointment, date, time or location preferences.
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o We have found that many third-party payors representing large
groups of patients often prefer to enter into managed care
contracts with providers that offer a broad array of diagnostic
imaging services at convenient locations throughout a geographic
area. We believe that our regional network approach and our
utilization management system make us an attractive candidate for
selection as a preferred provider for these third-party payors.
o Through our advanced information technology systems, we can
electronically exchange information between radiologists in real
time, enabling us to cover larger geographic markets by using the
specialized training of other practitioners in our networks. In
addition, many of our facilities digitally transmit to our
headquarters, on a daily basis, comprehensive data concerning the
diagnostic imaging services performed, which our corporate
management closely monitors to evaluate each facility's
efficiency. Similarly, BRMG uses our advanced information
technology system to closely monitor radiologists to ensure that
they consistently perform at expected levels.
o The grouping of our facilities within regional networks enables us
to easily move technologists and other personnel, as well as
equipment, from under-utilized to over-utilized facilities on an
as-needed basis. This results in operating efficiencies and better
equipment utilization rates and improved response time for our
patients.
COMPREHENSIVE DIAGNOSTIC IMAGING SERVICES
At each of our multi-modality facilities, we offer patients and referring
physicians one location to serve their needs for multiple procedures.
Furthermore, we have complemented many of our multi-modality sites with
single-modality sites to accommodate overflow and to provide a full range of
services within a local area consistent with demand. This can help patients
avoid multiple visits or lengthy journeys between facilities, thereby decreasing
costs and time delays.
STRONG RELATIONSHIPS WITH EXPERIENCED AND HIGHLY REGARDED RADIOLOGISTS
Our contracted radiologists generally have outstanding credentials and
reputations, strong relationships with referring physicians, a broad mix of
sub-specialties and a willingness to embrace our approach for the delivery of
diagnostic imaging services. The collective experience and expertise of these
radiologists translates into more accurate and efficient service to patients.
Moreover, as a result of our close relationship with Dr. Berger and BRMG, we
believe that we are able to better ensure that medical service is provided at
our facilities in a manner consistent with our needs and expectations and those
of our referring physicians, patients and payors than if we obtained these
services from unaffiliated practice groups. We believe that physicians are drawn
to BRMG and the other radiologist groups with whom we contract by the
opportunity to work with the state-of-the-art equipment we make available to
them, as well as the opportunity to receive specialized training through our
fellowship programs, and engage in clinical research programs, which generally
are available only in university settings and major hospitals. Also, through the
use of options and warrants, we have made available to many of BRMG's key
physicians the opportunity to own an equity stake in our company, which we
believe further strengthens the commonality of their interests with ours.
DIVERSIFIED PAYOR MIX
Our revenue is derived from a diverse mix of payors, including private
payors, managed care capitated payors and government payors. We believe our
payor diversity mitigates our exposure to possible unfavorable reimbursement
trends within any one payor class. In addition, our experience with capitation
arrangements over the last several years has provided us with the expertise to
manage utilization and pricing effectively, resulting in a predictable stream of
profitable revenue. With the exception of Blue Cross/Blue Shield and government
payors, no single payor accounted for more than 5% of our net revenue for the
year ended October 31, 2004.
EXPERIENCED AND COMMITTED MANAGEMENT TEAM
Dr. Howard Berger, Norman Hames, our Chief Operating Officer, and Dr.
John Crues III, a Vice President of our company, together have close to 75 years
of healthcare management experience. Our executive management team has created
our differentiated approach based on their comprehensive understanding of the
diagnostic imaging industry and the dynamics of our regional markets. Our
management beneficially owns approximately 32% of our common stock.
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BUSINESS STRATEGY
MAXIMIZING PERFORMANCE AT OUR EXISTING FACILITIES
We intend to enhance our operations and increase scan volume and revenue
at our existing facilities by:
o Establishing new referring physician and payor relationships;
o Increasing patient referrals through targeted marketing efforts to
referring physicians;
o Adding modalities and increasing imaging capacity through
equipment upgrades to existing machinery, additional machinery and
relocating machinery to meet the needs of our regional markets;
o Leveraging our multi-modality offerings to increase the number of
high-end procedures performed; and
o Building upon our capitation arrangements to obtain
fee-for-service business.
FOCUSING ON PROFITABLE CONTRACTING
We regularly evaluate our contracts with third-party payors and radiology
groups, as well as our equipment and real property leases, to determine how we
may improve the terms to increase our revenues and reduce our expenses. Because
many of our contracts have one-year terms, we can regularly renegotiate these
contracts, if necessary. We believe our position as a leading provider of
diagnostic imaging services in California, our experience and knowledge of the
various geographic markets in California, and the benefits offered by our
regional networks enable us to obtain more favorable contract terms than would
be available to smaller or less experienced organizations.
EXPANDING MRI AND CT APPLICATIONS
We intend to continue to use expanding MRI and CT applications as they
become commercially available. Most of these applications can be performed by
existing MRI and CT systems with upgraded software and hardware enhancements. By
way of example, in January 2005, we placed into service a new piece of equipment
which functions in conjunction with the MRI and utilizes focused ultrasound as a
completely non-invasive procedure to treat symptomatic uterine fibroids. The
equipment costing $750,000 received FDA approval in late October 2004 and we are
the first organization in the Western United States to acquire the equipment. We
also intend to introduce applications that will decrease scan and image-reading
time to increase our productivity.
OPTIMIZING OPERATING EFFICIENCIES
We intend to maximize our equipment utilization by adding, upgrading and
re-deploying equipment where we experience excess demand. We will continue to
trim excess operating and general and administrative costs where it is feasible
to do so, including consolidating, divesting or closing underperforming
facilities to reduce operating costs and improve operating income. We also may
continue to use, where appropriate, highly-trained radiology physician
assistants to perform, under appropriate supervision of radiologists, basic
services traditionally performed by radiologists. We will continue to upgrade
our advanced information technology system to create cost reductions for our
facilities in areas such as image storage, support personnel and financial
management.
EXPANDING OUR NETWORKS
We intend to expand our networks of facilities through new developments
and acquisitions, using a disciplined approach for evaluating and entering new
areas, including consideration of whether we have adequate financial resources
to expand. We perform extensive due diligence before developing a new facility
or acquiring an existing facility, including surveying local referral sources
and radiologists, as well as examining the demographics, reimbursement
environment, competitive landscape and intrinsic demand of the geographic
market. We generally will only enter new markets where:
o There is sufficient patient demand for outpatient diagnostic
imaging services;
o We believe we can gain significant market share;
o We can build key referral relationships or we have already
established such relationships; and
o Payors are receptive to our entry into the market.
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OUR SERVICES
We offer the following services: MRI, CT, PET, nuclear medicine, X-ray,
ultrasound, mammography and fluoroscopy. Our facilities provide standardized
services, regardless of location, to ensure patients, physicians and payors
consistency in service and quality. We monitor our level of service, including
patient satisfaction, timeliness of services to patients and reports to
physicians.
The key features of our services include:
o Patient-friendly, non-clinical environments;
o A 24-hour turnaround on routine examinations;
o Interpretations within one to two hours, if needed;
o Flexible patient scheduling, including same-day appointments;
o Extended operating hours, including weekends;
o Reports delivered via courier, fax or email;
o Availability of second opinions and consultations;
o Availability of sub-specialty interpretations at no additional
charge;
o Standardized fee schedules by region; and
o Fees that are more competitive than hospital fees.
RADIOLOGY PROFESSIONALS
In California, a lay person or any entity other than a professional
corporation is not allowed to practice medicine, including by employing
professional persons or by having any ownership interest or profit participation
in or control over any medical professional practice. This doctrine is commonly
referred to as the prohibition on the "corporate practice" of medicine. In order
to comply with this prohibition, we contract, directly or through BRMG, with
radiologists to provide professional medical services in our facilities,
including the supervision and interpretation of diagnostic imaging procedures.
The radiology practice maintains full control over the physicians it employs.
Pursuant to each management contract, we make available the imaging facility and
all of the furniture and medical equipment at the facility for use by the
radiology practice, and the practice is responsible for staffing the facility
with qualified professional medical personnel. In addition, we provide
management services and administration of the non-medical functions relating to
the professional medical practice at the facility, 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, and advertising, marketing and promotional activities. As
compensation for the services furnished under contracts with radiologists, we
generally receive an agreed percentage of the medical practice billings for, or
collections from, services provided at the facility, typically varying between
74% to 84% of net revenue or collections.
At 42 of our facilities, BRMG is our contracted radiology group. At
October 31, 2004, BRMG employed approximately 53 fulltime and 8 part-time
radiologists. At the balance of our facilities we contract, directly or through
BRMG, with other radiology groups to provide the professional medical services.
Two imaging facilities previously owned by Burbank Advanced Imaging Center LLC
and Rancho Bernardo Advanced Imaging Center LLC were charged a fee, for our
services as manager of the limited liability companies, of 10% of the collected
revenue of each company after deduction of the professional fees. In addition,
as a member owning 75% of the equity interests of those limited liability
companies, we were entitled to 75% of income after a deduction of all expenses,
including amounts paid for medical services and medical supervision. In the
fourth quarter of fiscal 2004, we purchased the interest we did not own in both
centers.
Under our management agreement with BRMG, BRMG pays us, as compensation
for the use of our facilities and equipment and for our services, a percentage
of the gross amounts collected for the professional services it renders. The
percentage is adjusted annually to ensure that the parties receive the fair
value for the services they render.
The following are the other principal terms of our management agreement with
BRMG:
o The agreement expires on January 1, 2014. However, the agreement
automatically renews for consecutive 10-year periods, unless
either party delivers a notice of non-renewal to the other party
no later than six months prior to the scheduled expiration date.
In addition, either party may terminate the agreement if the other
party defaults under its obligations, after notice and an
opportunity to cure, and we may terminate the agreement if Dr.
Berger no longer owns at least 60% of the equity of BRMG.
o At its expense, BRMG employs or contracts with an adequate number
of physicians necessary to provide all professional medical
services at all of our facilities.
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o At our expense, we provide all furniture, furnishings and medical
equipment located at the facilities and we manage and administer
all non-medical functions at, and provide all nurses and other
non-physician personnel required for the operation of, the
facilities.
o If BRMG wants to open a new facility, we have the right of first
refusal to provide the space and services for the facility under
the same terms and conditions set forth in the management
agreement.
o If we want to open a new facility, BRMG must use its best efforts
to provide medical personnel under the same terms and conditions
set forth in the management agreement. If BRMG cannot provide such
personnel, we have the right to contract with other physicians to
provide services at the facility.
o BRMG must maintain medical malpractice insurance for each of its
physicians with coverage limits not less than $1 million per
incident and $3 million in the aggregate per year. BRMG also has
agreed to indemnify us for any losses we suffer that arise out of
the acts or omissions of BRMG and its employees, contractors and
agents.
PAYORS
We derive substantially all of our revenue, directly or indirectly, from
fees charged for the diagnostic imaging services performed at our facilities.
These fees are paid by a diverse mix of payors, as illustrated for the year
ended October 31, 2004 by the following table:
PERCENTAGE OF
PAYOR TYPE NET REVENUE
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Insurance(1) 40%
Managed Care Capitated Payors 25%
Medicare/Medi-Cal 16%
Other(2) 14%
Workers Compensation/Personal Injury 5%
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(1) Includes Blue Cross/Blue Shield, which represented 13% of our net revenue
for the year ended October 31, 2004.
(2) Includes co-payments, direct patient payments and payments through
contracts with physician groups and other non-insurance company payors.
With the exception of Blue Cross/Blue Shield and government payors, no
single payor accounted for more than 5% of our net revenue for the year ended
October 31, 2004.
We have described below the types of reimbursement arrangements we have,
directly or indirectly, including through BRMG, with third-party payors.
INSURANCE
Generally, insurance companies reimburse us, directly or indirectly,
including through BRMG, on the basis of agreed upon rates. These rates are on
average approximately the same as the rates set forth in the Medicare Fee
Schedule for the particular service. The patients are generally not responsible
for any amount above the insurance allowable amount.
MANAGED CARE CAPITATION AGREEMENTS
Under these agreements, which are generally between BRMG and the payor,
typically an independent physicians group or other medical group, the payor pays
a pre-determined amount per-member per-month in exchange for BRMG providing all
necessary covered services to the managed care members included in the
agreement. These contracts pass much of the financial risk of providing
outpatient diagnostic imaging services, including the risk of over-use, from the
payor to BRMG and, as a result of our management agreement with BRMG, to us.
We believe that through our comprehensive utilization management, or UM,
program we have become highly skilled at assessing and moderating the risks
associated with the capitation agreements, so that these agreements are
profitable for us. Our UM program is managed by our UM department, which
consists of administrative and nursing staff as well as BRMG medical staff who
are actively involved with the referring physicians and payor management in both
prospective and retrospective review programs. Our UM program includes the
following features, all of which are designed to manage our costs while ensuring
that patients receive appropriate care:
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o PHYSICIAN EDUCATION
At the inception of a new capitation agreement, we provide the new
referring physicians with binders of educational material comprised of
proprietary information that we have prepared and third-party information
we have compiled, which are designed to address diagnostic strategies for
common diseases. We distribute additional material according to the
referral practices of the group as determined in the retrospective
analysis described below.
o PROSPECTIVE REVIEW
Referring physicians are required to submit authorization requests
for non-emergency high-intensity services: MRI, CT, special procedures
and nuclear medicine studies. The UM medical staff, according to accepted
practice guidelines, considers the necessity and appropriateness of each
request. Notification is then sent to the imaging facility, referring
physician and medical group. Appeals for cases not approved are directed
to us. The capitated payor has the final authority to uphold or deny our
recommendation.
o RETROSPECTIVE REVIEW
We collect and sort encounter activity by payor, place of service,
referring physician, exam type and date of service. The data is then
presented in quantitative and analytical form to facilitate understanding
of utilization activity and to provide a comparison between
fee-for-service and Medicare equivalents. Our Medical Director prepares a
quarterly report for each payor and referring physician, which we send to
them. When we find that a referring physician is overutilizing services,
we work with the physician to modify referral patterns.
MEDICARE/MEDI-CAL
Medicare is the national health insurance program for people age 65 or
older and people under age 65 with certain disabilities. Medi-Cal is the
California health insurance program for qualifying low income persons. Medicare
and Medi-Cal reimburse us, directly or indirectly, including through BRMG, in
accordance with the Medicare Fee Schedule, which is a schedule of rates
applicable to particular services and annually adjusted upwards or downwards,
typically, within a 4-8% range. Medicare patients are not responsible for any
amount above the Medicare allowable amount. Medi-Cal patients are not
responsible for any unreimbursed portion.
CONTRACTS WITH PHYSICIAN GROUPS AND OTHER NON-INSURANCE COMPANY PAYORS
These payors reimburse us, directly or indirectly, on the basis of agreed
upon rates. These rates are typically set at 70-80% of the rates set forth in
the Medicare Fee Schedule for the particular service. However, we often agree to
a specified rate for MRI and CT procedures which is not tied to the Medicare Fee
Schedule. The patients are generally not responsible for the unreimbursed
portion.
FACILITIES
Through our wholly owned subsidiaries, we operate 56 fixed-site,
freestanding outpatient diagnostic imaging facilities in California. We lease
the premises at which these facilities are located, with the exception of two
facilities located in buildings we own. We lease the land on which both of those
buildings are located.
Our facilities are located in regional networks that we refer to as
regions. Thirty three of our facilities are multi-modality sites, offering
various combinations of MRI, CT, PET, nuclear medicine, ultrasound, X-ray and
fluoroscopy services. Twenty three of our facilities are single-modality sites,
offering either X-ray or MRI services. Consistent with our regional network
strategy, we locate our single-modality facilities near multi-modality
facilities, to help accommodate overflow in targeted demographic areas.
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The following table sets forth the number of our facilities for each year during
the five-year period ended October 31, 2004:
YEAR ENDED OCTOBER 31,
-------------------------------------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
Total facilities owned or managed (at beginning of year) 37 42 46 58 55
Facilities added by:
Acquisition 5 3 1 -- --
Internal development 1 4 11 3 4
Facilities closed or sold (1) (3) -- (6) (3)
Total facilities owned (at end of year) 42 46 58 55 56
DIAGNOSTIC IMAGING EQUIPMENT
The following table indicates as of December 31, 2004, the quantity of
principal diagnostic equipment available at our facilities, by region:
MRI OPEN CT PET/CT MAMMO- ULTRA- X-RAY NUCLEAR TOTAL
MRI GRAPHY SOUND MEDICINE
--- ---- ---- ------ ------ ------ ----- -------- -----
Tower 3 1 2 1 3 6 5 2 23
Ventura 2 1 2 1 5 8 14 2 35
San Fernando Valley 4 3 3 1 2 6 7 1 27
Antelope Valley 1 1 1 -- 1 1 2 1 8
Central California 3 3 5 -- 5 11 12 2 41
Northern California 1 2 2 -- -- -- 1 -- 6
Orange 2 1 1 1 3 6 4 1 19
Long Beach 1 -- 1 -- 3 4 7 1 17
Northern San Diego -- 1 1 -- -- -- 1 -- 3
Palm Springs 1 1 2 -- 2 4 7 1 18
Inland Empire 6 1 4 1 7 8 13 2 42
Total 24 15 24 5 31 54 73 13 239
The average age of our MRI and CT units is less than five years, and the
average age of our PET units is less than two years. The useful life of our MRI,
CT and PET units is typically ten years.
INFORMATION TECHNOLOGY
Our corporate headquarters and substantially all of our 56 facilities are
interconnected through a state-of-the-art information technology system. This
system, which is compliant with the Health Insurance Portability and
Accountability Act of 1996, is comprised of a number of integrated applications,
provides a single operating platform for billing and collections, electronic
medical records, practice management and image management.
This technology has created cost reductions for our facilities in areas
such as image storage, support personnel and financial management and has
further allowed us to optimize the productivity of all aspects of our business
by enabling us to:
o Capture all necessary patient demographic, history and billing
information at point-of-service;
o Automatically generate bills and electronically file claims with
third-party payors;
o Record and store diagnostic report images in digital format;
o Digitally transmit on a real time basis diagnostic images from one
location to another, thus enabling networked radiologists to cover
larger geographic markets by using the specialized training of
other networked radiologists;
o Perform claims, rejection and collection analysis; and
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o Perform sophisticated financial analysis, such as analyzing cost
and profitability, volume, charges, current activity and patient
case mix with respect to each of our managed care contracts.
Currently diagnostic reports and images are accessible via the Internet
to our referring providers. We have worked with some of the larger medical
groups with whom we have contracts to provide access to this content via their
web portals.
PERSONNEL
At October 31, 2004, we had a total of 610 full-time, 54 part-time and
118 per-diem employees. These numbers do not include the 53 full-time and 6
part-time radiologists or the 248 full-time and 53 part-time technologists and
191 per-diem technologists.
We employ a site manager who is responsible for overseeing day-to-day and
routine operations at each of our facilities, including staffing, modality and
schedule coordination, referring physician and patient relations and purchasing
of materials. In turn, our 8 regional managers and directors are responsible for
oversight of the operations of all facilities within their region, including
sales, marketing and contracting. The regional managers and directors, along
with our directors of contracting, marketing, facilities, management/purchasing
and human resources report to our chief operating officer. Our chief financial
officer, director of information services and our medical director report to our
chief executive officer.
None of our employees is subject to a collective bargaining agreement nor
have we experienced any work stoppages. We believe our relationship with our
employees is good.
MARKETING
Our marketing team, which consists of one director of marketing, five
territory sales managers and eighteen customer service representatives, three of
whom are part-time, employs a multi-pronged approach to marketing:
PHYSICIAN MARKETING
Each customer service representative is responsible for marketing
activity on behalf of one or more facilities. The representatives act as a
liaison between the facility and referring physicians, holding meetings
periodically and on an as-needed basis with them and their staff to present
educational programs on new applications and uses of our systems and to address
particular patient service issues that have arisen. In our experience,
consistent hands-on contact with a referring physician and his or her staff
generates goodwill and increases referrals. The representatives also continually
seek to establish referral relationships with new physicians and physician
groups. In addition to a base salary and a car allowance, each representative
receives a quarterly bonus if the facility or facilities on behalf of which he
or she markets meets specified net revenue goals for the quarter.
PAYOR MARKETING
Our marketing team regularly meets with managed care organizations and
insurance companies to solicit contracts and meet with existing contracting
payors to solidify those relationships. The comprehensiveness of our services,
the geographic location of our facilities and the reputation of the physicians
with whom we contract all serve as tools for obtaining new or repeat business
from payors.
SPORTS MARKETING PROGRAM
We employ a sports marketing program designed to increase our public
profile. We provide X-ray equipment and a technician for all of the games of the
Lakers, Clippers, Kings, Avengers and Sparks held at the Staples Center in Los
Angeles, Mighty Ducks games held at the Arrowhead Pond in Anaheim, and
University of Southern California football games held in Los Angeles. In
exchange for this service, we receive an advertisement in each team program
throughout the season. In addition, we have a close relationship with the
physicians for some of these teams.
SUPPLIERS
Historically, we have acquired almost all of our diagnostic imaging
equipment from GE Medical Systems, Inc., and we purchase medical supplies from
various national vendors. We believe that we have excellent working
relationships with all of our major vendors. However, there are several
comparable vendors for our supplies that would be available to us if one of our
current vendors becomes unavailable.
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We acquire our equipment primarily through various financing arrangements
directly with an affiliate of General Electric Corporation, or GE, involving the
use of capital leases with purchase options at minimal prices at the end of the
lease term. At October 31, 2004, capital lease obligations totaled approximately
$67.4 million through 2009, including current installments totaling
approximately $8.8 million. During fiscal 2004, we converted some of our
operating leases into capital leases of approximately $6.2 million. If we open
or acquire additional imaging facilities, we may have to incur material capital
lease obligations.
Timely, effective maintenance is essential for achieving high utilization
rates of our imaging equipment. We maintain an agreement with GE Medical Systems
under which it has agreed to be responsible for the maintenance and repair of a
majority of our equipment for a fee that is based upon a percentage of our
revenue, subject to a minimum payment. The fiscal 2004 and 2005 annual service
fee is currently the higher of 3.74% of our net revenue (less provisions for bad
debt) or approximately $4.7 million. This agreement terminates on October 31,
2005 and may be terminated earlier under specified circumstances. We believe
this framework of basing service costs on usage is an effective and unique
method for controlling our overall costs on a facility-by-facility basis.
COMPETITION
The market for diagnostic imaging services in California is highly
competitive. We compete principally on the basis of our reputation, our ability
to provide multiple modalities at many of our facilities, the location of our
facilities and the quality of our diagnostic imaging services. We compete
locally with groups of radiologists, established hospitals, clinics and other
independent organizations that own and operate imaging equipment. Our major
national competitors include Radiologix, Inc., Alliance Imaging, Inc.,
Healthsouth Corporation and Insight Health Services. Some of our competitors may
now or in the future have access to greater financial resources than we do and
may have access to newer, more advanced equipment.
In addition, in the past some non-radiologist physician practices have
refrained from establishing their own diagnostic imaging facilities because of
the federal physician self-referral legislation. Final regulations issued in
January 2001 clarify exceptions to the physician self-referral legislation,
which created opportunities for some physician practices to establish their own
diagnostic imaging facilities within their group practices and to compete with
us. In the future, we could experience significant competition as a result of
those final regulations.
INSURANCE
We maintain insurance policies with coverage that we believe are
appropriate in light of the risks attendant to our business and consistent with
industry practice. However, adequate liability insurance may not be available to
us in the future at acceptable costs or at all. We maintain general liability
insurance and professional liability insurance in commercially reasonable
amounts. Additionally, we maintain workers' compensation insurance on all of our
employees. Coverage is placed on a statutory basis and responds to California's
requirements.
Pursuant to our agreements with physician groups with whom we contract,
including BRMG, each group must maintain medical malpractice insurance for the
group, having coverage limits of not less than $1.0 million per incident and
$3.0 million in the aggregate per year.
California's medical malpractice cap further reduces our exposure.
California places a $250,000 limit on non-economic damages for medical
malpractice cases. Non-economic damages are defined as compensation for pain,
suffering, inconvenience, physical impairment, disfigurement and other
non-pecuniary injury. The cap applies whether the case is for injury or death,
and it allows only one $250,000 recovery in a wrongful death case. No cap
applies to economic damages.
We maintain a $5.0 million key-man life insurance policy on the life of
Dr. Berger. We are the beneficiary under the policy.
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REGULATION
GENERAL
The healthcare industry is highly regulated, and we can give no assurance
that the regulatory environment in which we operate will not change
significantly in the future. Our ability to operate profitably will depend in
part upon us, and 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. We believe
that healthcare regulations will continue to change. Therefore, we monitor
developments in healthcare law and modify our operations from time to time as
the business and regulatory environment changes. Although we intend to continue
to operate in compliance, we cannot ensure that we will be able to adequately
modify our operations so as to address changes in the regulatory environment.
LICENSING AND CERTIFICATION LAWS
Ownership, construction, operation, expansion and acquisition of
diagnostic imaging facilities are subject to various federal and state laws,
regulations and approvals concerning licensing of facilities and personnel. In
addition, free-standing diagnostic imaging facilities that provide services not
performed as part of a physician office must meet Medicare requirements to be
certified as an independent diagnostic testing facility to bill the Medicare
program. We may not be able to receive the required regulatory approvals for any
future acquisitions, expansions or replacements, and the failure to obtain these
approvals could limit the market for our services.
CORPORATE PRACTICE OF MEDICINE
In California, a lay person or any entity other than a professional
corporation is not allowed to practice medicine, including by employing
professional persons or by having any ownership interest or profit participation
in or control over any medical professional practice. The laws of the State of
California also prohibit a lay person or a non-professional entity 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. We structure our relationships with the radiology
practices, including the purchase of diagnostic imaging facilities, in a manner
that we believe keeps us from engaging in the practice of medicine or exercising
control over the medical judgments or decisions of the radiology practices or
their physicians or violating the prohibitions against fee-splitting. However,
because challenges to these types of arrangements are not required to be
reported, we cannot substantiate our belief. There can be no assurance that our
present arrangements with BRMG or the physicians providing medical services and
medical supervision at our imaging facilities will not be challenged, and, if
challenged, that they will not be found to violate the corporate practice
prohibition, thus subjecting us to a potential combination of damages,
injunction and civil and criminal penalties or require us to restructure our
arrangements in a way that would affect the control or quality of our services
or change the amounts we receive under our management agreements, or both.
MEDICARE AND MEDICAID FRAUD AND ABUSE
Our revenue is derived through our ownership, operation and management of
diagnostic imaging centers and from service fees paid to us by contracted
radiology practices. During the year ended October 31, 2004, approximately 16%
of our revenue generated at our diagnostic imaging centers was derived from
government sponsored healthcare programs (principally Medicare and Medicaid).
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.
We receive fees under our service agreements for management and
administrative services, which include contract negotiation and marketing
services. We do not believe we are in a position to make or influence referrals
of patients or services reimbursed under Medicare or other governmental programs
to radiology practices or their affiliated physicians or to receive referrals.
However, we 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 statute are broadly worded and have been broadly
interpreted by federal courts, it is possible that the government could take the
position that our 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 our
business
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and results of operations. While our 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. We have sought to structure our agreements to be
consistent with fair market value in arms' length transactions for the nature
and amount of management and administrative services rendered. For these
reasons, we do not believe that service fees payable to us 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 patients to an entity providing
designated health services, as defined under the Stark Law, including, without
limitation, 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. We believe that, although we receive fees under our service agreements
for management and administrative services, we are not in a position to make or
influence referrals of patients.
On January 4, 2001, the Centers for Medicare and Medicaid Services
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, CT, 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 ultrasound 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.
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 practices,
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. We believe 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, we believe that the Stark Law is not implicated by the financial
relationships between us and the contracted radiology practices.
In addition, we believe that we have structured our acquisitions of the
assets of existing practices, and we intend to structure any future
acquisitions, so as not to violate the anti-kickback and Stark Law and
regulations. Specifically, we believe the consideration paid by us 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 our 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 our business,
financial condition and results of operations.
The federal government embarked on 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 our diagnostic imaging facilities or
contracted radiology practices could result in any or all of the following:
significant repayment obligations, exclusion from the Medicare, Medicaid or
other governmental programs, and civil and criminal penalties.
Federal regulatory and law enforcement authorities have recently increased
enforcement activities with respect to Medicare, Medicaid fraud and abuse
regulations and other reimbursement laws and rules, including laws and
regulations that govern our activities and the activities of the radiology
practices. Our or the radiology practices' activities may be investigated,
claims may be made against us or the radiology practices and these increased
enforcement activities may directly or indirectly have an adverse effect on our
business, financial condition 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 by 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 our ability to operate.
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FEDERAL FALSE CLAIMS ACT
The Federal False Claims Act provides, in part, that the federal government
may bring a lawsuit against any person who 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.
We believe that we are in compliance with the rules and regulations that apply
to the Federal False Claims Act. However, we could be found to have violated
certain rules and regulations resulting in sanctions under the Federal False
Claims Act, and if we are 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
our business.
HEALTHCARE REFORM INITIATIVES
Healthcare laws and regulations may change significantly in the future. We
continuously monitor these developments and modify our operations from time to
time as the regulatory environment changes. We cannot assure you, however, that
we will be able to adapt our operations to address new regulations or that new
regulations will not adversely affect our business. In addition, although we
believe that we are operating in compliance with applicable federal and state
laws, neither our current or anticipated business operations nor the operations
of the contracted radiology practices has been the subject of judicial or
regulatory interpretation. We cannot assure you that a review of our business by
courts or regulatory authorities will not result in a determination that could
adversely affect our operations or that the healthcare regulatory environment
will not change in a way that restricts our operations.
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, or 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-government payors. Under HIPAA, a healthcare benefit program includes any
private plan or contract affecting interstate commerce under which any medical
benefit, item or service 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 or imprisonment, or potentially both.
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 our business, financial condition 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. Organizations such
as ours were obligated to be compliant with the initial HIPAA regulations by
April 14, 2003, and with the electronic data interchange mandates by October 16,
2003. The final security regulations were issued in February 2003 with a
compliance date of April 2005. We believe that we are in compliance with the
current requirements, but we anticipate that we may encounter certain costs
associated with future compliance. 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 our business, financial condition, and
results of operations.
Although our electronic systems are HIPAA compatible, consistent with the
HIPAA regulations, we cannot guarantee the enforcement agencies or courts will
not make interpretations of the HIPAA standards that are inconsistent with ours,
or the interpretations of the contracted radiology practices or their affiliated
physicians. A finding of liability under the HIPAA standards may result in
criminal and civil penalties. Noncompliance also may result in exclusion from
participation in government programs, including Medicare and Medicaid. These
actions could have a material adverse effect on our business, financial
condition, and results of operations.
COMPLIANCE PROGRAM
We implemented a program to monitor compliance with federal and state laws
and regulations applicable to healthcare entities. We have appointed a
compliance officer who is charged with implementing and supervising our
compliance program, which includes the adoption of (i) Standards of Conduct for
our employees and affiliates and (ii) a process that specifies how employees,
affiliates and others may report regulatory or ethical concerns to our
compliance officer. We believe that our compliance program meets the relevant
standards provided by the Office of Inspector General of the Department of
Health and Human Services.
15
An important part of our compliance program consists of conducting periodic
audits of various aspects of our operations and that of the contracted radiology
practices. We also conduct mandatory educational programs designed to
familiarize our employees with the regulatory requirements and specific elements
of our compliance program.
U.S. FOOD AND DRUG ADMINISTRATION OR FDA
The FDA has issued the requisite premarket approval for all of the MRI and
CT systems we use. We do not believe that any further FDA approval is required
in connection with the majority of 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, where 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.
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 the Mammography Accreditation Program
of the American College of Radiology currently accredits all of our facilities,
which provide mammography services, and we anticipate 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 providing professional medical services at our facilities
are subject to licensing and related regulations by the State of California. As
a result, we require BRMG and the other radiology groups with which we contract
to require those radiologists to have and maintain appropriate licensure. We do
not believe that such laws and regulations will either prohibit or require
licensure approval of our business operations, although no assurances can be
made that such laws and regulations will not be interpreted to extend such
prohibitions or requirements to our operations.
INSURANCE LAWS AND REGULATION
California has adopted certain laws and regulations affecting risk
assumption in the healthcare industry, including those that subject any
physician or physician network engaged in risk-based managed care to applicable
insurance laws and regulations. These laws and regulations may require
physicians and physician networks to meet minimum capital requirements and other
safety and soundness requirements. Implementing additional regulations or
compliance requirements could result in substantial costs to the contracted
radiology practices, limiting their ability to enter into capitated or other
risk-sharing managed care arrangements and indirectly affecting our revenue from
the contracted practices.
ENVIRONMENTAL MATTERS
The facilities we operate or manage generate hazardous and medical waste
subject to federal and state requirements regarding handling and disposal. We
believe that the facilities that we operate and manage 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.
We do not believe that we will be required to expend any material additional
amounts in order to remain in compliance with these laws and regulations or that
compliance will materially affect our capital expenditures, earnings or
competitive position.
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ITEM 2. PROPERTIES
- ------- ----------
Information with respect to our facilities within our regional networks is as
follows:
NUMBER OF APPROXIMATE
REGIONAL NETWORKS FACILITIES(1) SQUARE FOOTAGE LEASE EXPIRATION
- ----------------- ------------- -------------- ----------------
TOWER (3):
Roxsan 1 8,031 Various through 2012
Wilshire 1 13,778 September 2018
Women's 1 3,830 February 2014
VENTURA (9):
Camarillo 2 2,035 Various Month-to-month
Oxnard 2 5,622 Various Month-to-month
Thousand Oaks 2 12,914 Various through November 2007
Ventura 3 12,959 Various through July 2007
SAN FERNANDO VALLEY (8):
Burbank 2 6,500 Various through August 2008
Northridge 2 9,050 Various through February 2015
Santa Clarita 2 7,293 One through June 2009; other Month-to-month
Tarzana 2 6,320 Various through February2009
ANTELOPE VALLEY (3):
Antelope Valley 1 2,890 Month-to-month
Lancaster 2 6,827 Various through August 2005
CENTRAL CALIFORNIA (5):
Fresno 1 7,231 June 2008
Modesto 1 17,852 December 2014
Sacramento 1 8,083 June 2013
Stockton 1 4,808 December 2006
Vacaville 1 5,927 March 2007
NORTHERN CALIFORNIA (3):
Emeryville 1 2,086 June 2008
San Francisco 1 1,240 Month-to-month
Santa Rosa 1 4,235 July 2011
ORANGE (5):
Orange 4 15,955 Various through August 2012
Tustin 1 2,139 January 2007
LONG BEACH (4):
Long Beach 4 16,338 Various through December 2006
NORTHERN SAN DIEGO (1):
Rancho Bernardo 1 9,557 May 2012
PALM SPRINGS (5):
Palm Desert 3 9,024 Various through May 2006
Palm Springs 2 9,042 June 2008
INLAND EMPIRE (10):
Chino 1 2,700 June 2007
Rancho Cucamonga 3 11,128 Various through May 2009
Riverside 1 12,534 Various through January 2008
San Gabriel Valley 1 2,871 December 2004
Temecula 4 14,496 Various through February 2011
--------
TOTAL 56
========
- ----------
(1) Includes leased facilities and three facilities operated pursuant
to managed care capitation agreements.
Our corporate headquarters are located in adjoining premises at 1510 and
1516 Cotner Avenue, Los Angeles, California 90025, in approximately 16,500
square feet occupied under leases, which expire on June 30, 2007. In addition,
we lease 33,987 square feet of warehouse and other space under leases, which
expire at various dates between May 2005 and February 2011.
17
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
We are involved in the following litigation:
(a) In Re DVI, Inc. Securities Litigation
United States District Court, Eastern District of PA, Docket No.
----------------------------------------------------------------
2:03-CV-05336-LDD
-----------------
This is a class action securities fraud case under Section 10(b) of the
Securities Exchange Act and Rule 10b-5. It was brought by shareholders of DVI,
Inc. ("DVI"), one of our former major lenders, against DVI officers and
directors and a number of third party defendants, including us. The case arises
from bankruptcy proceedings instituted by DVI in August 2003. We were named as a
defendant in the Third Amended Complaint filed in July 2004.
The putative plaintiff class consists of those persons who purchased or
otherwise acquired DVI, Inc. securities between August of 1999 and August of
2003. Plaintiffs allege that in 2000, we acquired from a third party one or more
unprofitable imaging centers in order to help DVI conceal the fact that existing
DVI loans on the centers were delinquent. Plaintiffs argue that we should have
known that DVI was engaging in fraudulent practices to conceal losses, and our
alleged "lack of due diligence" in investigating DVI's finances in the course of
these acquisitions amounted to complicity in deceptive and misleading practices.
This matter is in the initial pleading stages. We intend to vigorously
contest the allegations and have filed a motion to dismiss the Third Amended
Complaint for failure to state a claim. No hearing date has been set, but an
initial ruling on our motion to dismiss is expected in early 2005.
(b) Fleet Nat'l Bank v. Boyle et. al., U.S. District Court for the Eastern
----------------------------------------------------------------------
District of Pennsylvania, Docket No. 04-CV-1277
-----------------------------------------------
This case is related to In re DVI Securities Litigation, but was filed
by several of DVI's lenders. It, too, arises from the DVI bankruptcy (referenced
in the matter above) and was brought against DVI officers and directors and a
number of third party defendants, including us. We were named in the First
Amended Complaint filed in this action in September 2004.
The plaintiff alleges violations of the Racketeering Influenced and
Corrupt Organizations Act, 18 U.S.C. 1961 et seq., ("RICO"), and common-law
claims, including conspiracy to commit fraud, tortious interference with a
contract, conspiracy to commit tortious interference with a contract, conspiracy
to commit conversion and aiding and abetting fraud. Plaintiffs allege that in
2000, we acquired from a third party one or more unprofitable imaging centers in
order to help DVI conceal the fact that existing DVI loans on the centers were
delinquent.
GENERAL
We are engaged from time to time in the defense of lawsuits arising out
of the ordinary course and conduct of our business. We believe that the outcome
of our current litigation will not have a material adverse impact on our
business, financial condition and results of operations. However, we could be
subsequently named as a defendant in other lawsuits that could adversely affect
us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of security holders during the
fourth fiscal quarter of fiscal 2004.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK, RELATED STOCKHOLDER MATTERS
- ------- ---------------------------------------------------------------------
AND ISSUER OF PURCHASES OF EQUITY SECURITIES
---------------------------------------------
Our common stock is quoted on the Nasdaq Over-the-Counter, or OTC,
Bulletin Board under the symbol "PMDX.OB". The following table indicates the
high and low prices for our 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, markdown or
commission, and may not necessarily represent actual transactions.
QUARTER ENDED LOW HIGH
------------- --- ----
January 31, 2004 $0.40 $0.71
April 30, 2004 0.41 0.70
July 31, 2004 0.27 0.45
October 31, 2004 0.30 0.67
January 31, 2003 0.36 0.76
April 30, 2003 0.19 0.45
July 31, 2003 0.19 0.38
October 31, 2003 0.15 0.50
The last reported closing high and low prices for our common stock on the
OTC Bulletin Board on January 19, 2005 were $0.58 and $0.56, respectively. As of
January 10, 2005, the number of holders of record of our common stock was 3,986.
However, Cede & Co., the nominee for The Depository Trust Company, the clearing
agency for most broker-dealers, owned a substantial number of our outstanding
shares of common stock of record on that date. Our management believes that
customers of these broker-dealers beneficially own these shares and that the
number of beneficial owners of our common stock is substantially greater than
3,986.
We did not pay dividends in fiscal 2003 or 2004 and we do not expect to
pay any dividends in the foreseeable future.
CONVERTIBLE SUBORDINATED DEBENTURES
At October 31, 2004, we had $16.2 million convertible subordinated
debentures outstanding which mature June 30, 2008 and bear interest, payable
quarterly, at an annual rate of 11.5%. The debentures are convertible into our
common stock at a price of $2.50 per share.
RECENT SALES OF UNREGISTERED SECURITIES
During the fiscal year ended October 31, 2004, we sold the following
securities pursuant to an exemption from registration provided under Section
4(2) of the Securities Act of 1933, as amended:
o In December 2003, we issued to one of BRMG's radiologists a five-year
warrant exercisable at a price of $0.41 per share, which was the public
market closing price for our common stock on the transaction date, to
purchase 100,000 shares of our common stock.
o In December 2003, we issued to two of BRMG's radiologists/directors
five-year warrants exercisable at a price of $0.46 per share, which was
the public market closing price for our common stock on the transaction
date, to purchase a combined 2,000,000 shares of our common stock.
o In December 2003, we issued to one of our external lenders a five-year
warrant exercisable at a price of $0.50 per share, which was the public
market closing price for our common stock on the transaction date, to
purchase 500,000 shares of our common stock.
o In January 2004, we issued to one of BRMG's radiologists a five-year
warrant exercisable at a price of $0.55 per share, which was the public
market price closing price for our common stock on the transaction date,
to purchase 100,000 shares of our common stock.
19
o In January 2004, we issued to two of BRMG's radiologists five-year
warrants exercisable at a price of $0.65 per share, which was the public
market closing price for our common stock on the transaction date, to
purchase a combined 200,00 shares of our common stock.
o In January 2004, we issued to one of BRMG's radiologists a five-year
warrant exercisable at a price of $0.70 per share, which was the public
market closing price for our common stock on the transaction date, to
purchase 200,000 shares of our common stock.
o In March 2004, we issued to two of our independent directors five-year
warrants exercisable at $0.60 per share, which was the public market
price for our common stock on the transaction date, to purchase a
combined 100,000 shares of our common stock.
o In July 2004, we issued to two of our officers five-year warrants
exercisable at $0.30 per share, which was the public market price for our
common stock on the transaction date, to purchase a combined 850,000
shares of our common stock.
o In August 2004, we issued to one of BRMG's radiologists a five-year
warrant exercisable at a price of $0.35 per share, which was the public
market price for our common stock on the transaction date, to purchase
100,000 shares of our common stock.
o In September 2004, we issued to one of our independent directors a
five-year warrant exercisable at a price of $0.49 per share, which was
the public market closing price for our common stock on the transaction
date, to purchase 50,000 shares of our common stock.
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes information with respect to options,
warrants and other rights under our equity compensation plans at October 31,
2004:
NUMBER OF SECURITIES NUMBER OF SECURITIES
TO BE ISSUED UPON WEIGHTED-AVERAGE REMAINING AVAILABLE
EXERCISE OF EXERCISE PRICE OF FOR FUTURE ISSUANCE
OUTSTANDING OPTIONS OUTSTANDING OPTIONS UNDER EQUITY
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS
------------- ------------------- ------------------- ------------------
Equity compensation plans approved by security
holders(1) 1,201,417 $ 0.47 1,289,084
Equity compensation plans not approved by security
holders 12,004,770 $ 0.61 N/A
------------- --------- ------------
Total 13,206,187 $ 0.59 1,289,084
============= ========= ============
- ----------
(1) 500,000 options at $0.40 per share to one employee expiring in March 2005
remain outstanding under the Incentive Plan, as defined in "Executive
Compensation - Stock Incentive Plans." We no longer issue any options
under our Incentive Plan.
20
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
- ------- ------------------------------------
The following table sets forth our selected historical consolidated
financial data. The selected consolidated statements of operations data set
forth below for each of the years in the three year period ended October 31,
2004 and the consolidated balance sheet data set forth below as of October 31,
2003 and 2004 are derived from our audited consolidated financial statements and
notes thereto included elsewhere herein. The selected historical consolidated
statements of operations data set forth below for the years ended October 31,
2000 and 2001, and the consolidated balance sheet data set forth below as of
October 31, 2000, 2001 and 2002 are derived from our audited consolidated
financial statements not included herein. The selected historical consolidated
financial data set forth below should be read in conjunction with and is
qualified in its entirety by reference to the audited consolidated financial
statements and the related notes included elsewhere in this Form 10-K and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The financial data set forth below and discussed in this Annual Report
are derived from the consolidated financial statements of Primedex, its
subsidiaries and certain affiliates. As a result of the contractual and
operational relationship among BRMG, Dr. Berger and us, we are considered to
have a controlling financial interest in BRMG pursuant to guidance issued by the
Emerging Issues Task Force, or EITF, of the Financial Accounting Standards
Board, or FASB, in EITF's release 97-2. Due to the deemed controlling financial
interest, we are required to include BRMG as a consolidated entity in our
consolidated financial statements. This means, for example, that revenue
generated by BRMG from the provision of professional medical services to our
patients, as well as BRMG's costs of providing those services, are included as
net revenue in our consolidated statement of operations, whereas the management
fee that BRMG pays to us under our management agreement with BRMG is eliminated
as a result of the consolidation of our results with those of BRMG. Also,
because BRMG is a consolidated entity in our financial statements, any
borrowings or advances we have received from or made to BRMG are not reflected
in our consolidated balance sheet. If BRMG were not treated as a consolidated
entity in our consolidated financial statements, the presentation of certain
items in our income statement, such as net revenue and costs and expenses, would
change but our net income would not, because in operation and historically, the
annual revenue of BRMG from all sources closely approximates its expenses,
including Dr. Berger's compensation, fees payable to us and amounts payable to
third parties.
YEAR ENDED OCTOBER 31,
----------------------------------------------------------------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA: (DOLLARS IN THOUSANDS)
Net revenue $ 84,483 $ 107,567 $ 134,078 $ 140,259 $ 137,277
Operating expenses:
Operating expenses 60,121 75,457 102,286 106,078 105,828
Depreciation and amortization 8,210 10,315 15,010 16,874 17,762
Provision for bad debts 2,476 3,851 6,892 4,944 3,911
Income (loss) from continuing operations 2,090 13,813 (6,435) (5,464) (14,576)
Income from discontinued operation 524 688 884 3,197 --
Net income (loss) 2,614 14,501 (5,551) (2,267) (14,576)
BALANCE SHEET DATA:
Cash and cash equivalents $ 36 $ 40 $ 36 $ 30 $ 1
Total assets 90,625 128,429 151,639 142,035 127,451
Total long-term liabilities 82,693 110,188 121,830 122,096 139,980
Total liabilities 151,538 174,071 202,560 195,122 195,006
Working capital (deficit) (44,588) (26,987) (44,668) (44,615) (32,172)
Stockholders' equity (deficit) (60,913) (45,642) (50,921) (53,087) (67,555)
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- ---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
OVERVIEW
We operate a group of regional networks comprised of 56 fixed-site,
freestanding outpatient diagnostic imaging facilities in California. We believe
our group of regional networks is the largest of its kind in California. We have
strategically organized our facilities into regional networks in markets, which
have both high-density and expanding populations, as well as attractive payor
diversity.
All of our facilities employ state-of-the-art equipment and technology in
modern, patient-friendly settings. Many of our facilities within a particular
region are interconnected and integrated through our advanced information
technology system. Thirty three of our facilities are multi-modality sites,
offering various combinations of MRI, CT, PET, nuclear medicine, ultrasound,
X-ray and fluoroscopy services. Twenty three of our facilities are
single-modality sites, offering either X-ray or MRI services. Consistent with
our regional network strategy, we locate our single-modality sites near
multi-modality sites to help accommodate overflow in targeted demographic areas.
We derive substantially all of our revenue, directly or indirectly, from
fees charged for the diagnostic imaging services performed at our facilities.
For the year ended October 31, 2004, we derived 63% of our net revenue from MRI
and CT scans. Over the past three fiscal years, we have increased net revenue
primarily through acquisitions, expansions of existing facilities, upgrades in
equipment and development of new facilities.
The fees charged for diagnostic imaging services performed at our
facilities are paid by a diverse mix of payors, as illustrated for the year
ended October 31, 2004 by the following table:
PERCENTAGE OF
PAYOR TYPE NET REVENUE
---------- -----------
Insurance(1) 40%
Managed Care Capitated Payors 25
Medicare/Medi-Cal 16
Other(2) 14
Workers Compensation/Personal Injury 5
- ----------
(1) Includes Blue Cross/Blue Shield, which represented 13% of our net revenue
for the year ended October 31, 2004.
(2) Includes co-payments, direct patient payments and payments through
contracts with physician groups and other non-insurance company payors.
Our eligibility to provide service in response to a referral often
depends on the existence of a contractual arrangement between the radiologists
providing the professional medical services or us and the referred patient's
insurance carrier or managed care organization. These contracts typically
describe the negotiated fees to be paid by each payor for the diagnostic imaging
services we provide. With the exception of Blue Cross/Blue Shield and government
payors, no single payor accounted for more than 5% of our net revenue for the
year ended October 31, 2004. Under our capitation agreements, we receive from
the payor a pre-determined amount per member, per month. If we do not
successfully manage the utilization of our services under these agreements, we
could incur unanticipated costs not offset by additional revenue, which would
reduce our operating margins.
The principal components of our fixed operating expenses, excluding
depreciation, include professional fees paid to radiologists, except for those
radiologists who are paid based on a percentage of revenue, compensation paid to
technologists and other facility employees, and expenses related to equipment
rental and purchases, real estate leases and insurance, including errors and
omissions, malpractice, general liability, workers' compensation and employee
medical. The principal components of our variable operating expenses include
expenses related to equipment maintenance, medical supplies, marketing, business
development and corporate overhead. Because a majority of our expenses are
fixed, increased revenue as a result of higher scan volumes per system can
significantly improve our margins, while lower scan volumes can result in
significantly lower margins.
BRMG strives to maintain qualified radiologists and technologists while
minimizing turnover and salary increases and avoiding the use of outside
staffing agencies, which are considerably more expensive and less efficient. In
recent years, there has been a shortage of qualified radiologists and
technologists in some of the regional markets we serve. As turnover occurs,
competition in recruiting radiologists and technologists may make it difficult
for our contracted radiology practices to maintain adequate levels of
radiologists and technologists without the use of outside staffing agencies. At
times, this has resulted in increased costs for us.
22
For a discussion of other factors that may have an impact on our business
and our future results of operations, see "Risks Related to our Business."
OUR RELATIONSHIP WITH BRMG
Howard G. Berger, M.D. is our President and Chief Executive, a member of
our Board of Directors, and owns approximately 30% of Primedex's outstanding
common stock. Dr. Berger also owns, indirectly, 99% of the equity interests in
BRMG. BRMG provides all of the professional medical services at 42 of our
facilities under a management agreement with us, and contracts with various
other independent physicians and physician groups to provide all of the
professional medical services at most of our other facilities. We obtain
professional medical services from BRMG, rather than providing such services
directly or through subsidiaries, in order to comply with California's
prohibition against the corporate practice of medicine. However, as a result of
our close relationship with Dr. Berger and BRMG, we believe that we are able to
better ensure that professional medical services are provided at our facilities
in a manner consistent with our needs and expectations and those of our
referring physicians, patients and payors than if we obtained these services
from unaffiliated practice groups.
Under our management agreement with BRMG, which expires on January 1,
2014, BRMG pays us, as compensation for the use of our facilities and equipment
and for our services, a percentage of the gross amounts collected for the
professional services it renders. The percentage, which was 79% at October 31,
2004, is adjusted annually, if necessary, to ensure that the parties receive
fair value for the services they render. In operation and historically, the
annual revenue of BRMG from all sources closely approximates its expenses,
including Dr. Berger's compensation, fees payable to us and amounts payable to
third parties. For administrative convenience and in order to avoid
inconveniencing and confusing our payors, a single bill is prepared for both the
professional medical services provided by the radiologists and our non-medical,
or technical, services, generating a receivable for BRMG. BRMG finances these
receivables under a working capital facility with Wells Fargo Foothill and
regularly advances to us the funds that it draws under this working capital
facility, which we use for our own working capital purposes. We repay or offset
these advances with periodic payments from BRMG to us under the management
agreement. We guarantee BRMG's obligations under this working capital facility.
As a result of our contractual and operational relationship with BRMG and
Dr. Berger, we are required to include BRMG as a consolidated entity in our
consolidated financial statements. See "Selected Consolidated Financial Data."
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
We had a working capital deficit of $32.2 million at October 31, 2004 and
had losses from continuing operations of $5.5 million and $14.6 million during
fiscal 2003 and 2004, respectively. The loss in fiscal 2004 includes a $5.2
million expense resulting from the increase in the valuation allowance for
deferred income taxes. We also had a stockholders' deficit of $67.6 million at
October 31, 2004. We operate in a capital intensive, high fixed-cost industry
that requires significant amounts of capital to fund operations. In addition to
operations, we require significant amounts of capital for the initial start-up
and development expense of new diagnostic imaging facilities, the acquisition of
additional facilities and new diagnostic imaging equipment, and to service our
existing debt and contractual obligations. Because our cash flows from
operations are insufficient to fund all of these capital requirements, we depend
on the availability of financing under credit arrangements with third parties.
Historically, our principal sources of liquidity have been funds available for
borrowing under our existing lines of credit, now with Wells Fargo Foothill.
Even though the line of credit matures in 2008, we classify the line of credit
as a current liability primarily because is is collateralized by accounts
receivable and the eligible borrowing base is classified as a current asset. We
finance the acquisition of equipment mainly through capital and operating
leases.
During fiscal 2004, we took the actions described below to continue to
fund our obligations. In addition, some of our plans to provide the necessary
working capital in the future are summarized below.
BRMG and Wells Fargo Foothill are parties to a credit facility under
which BRMG may borrow the lesser of 85% of the net collectible value eligible
accounts receivable plus one month of average capitation receipts for the prior
six months, two times the trailing month cash collections, or $20,000,000.
Eligible accounts receivable shall exclude those accounts older than 150 days
from invoice date and will be net of customary reserves. In addition, Wells
Fargo Foothill set up a term loan where they can advance up to the lesser of
$3,000,000 or 80% of the liquidation value of the equipment value servicing the
loan. The five-year term loan must be drawn prior to December 31, 2004 with
interest only payments through February 28, 2005 with the first quarterly
principal payments due on March 1, 2005. As of December 31, 2004, we had not
borrowed under the term loan.
23
Under the $20,000,000 revolving loan, an overadvance subline will be
available not to exceed $2,000,000, or one month of the average capitation
receipts for the prior six months, until September 30, 2005. Beginning the
earlier of October 1, 2005 or when the term loan funds, the maximum overadvance
cannot exceed the lesser of $1,000,000 or one month of the average capitation
receipts for the prior six months. Also under the revolving loan, we are
entitled to request that Wells Fargo Foothill issue guarantees of payment with
respect to letters of credit issued by an issuing bank in an aggregate amount
not to exceed $5,000,000 at any one time outstanding. At October 31, 2004, we
had $7.1 million of available borrowing under the Wells Fargo Foothill revolving
loan.
Advances outstanding under the revolving loan bear interest at the base
rate plus 1.5%, or the LIBOR rate plus 3.0%. Advances under the overadvance
subline and term loan bear interest at the base rate plus 4.75%. Letter of
credit fees bear interest of 3.0% per annum times the undrawn amount of all
outstanding lines of credit. The base rate refers to the rate of interest
announced within Wells Fargo Bank at its principal office in San Francisco as it
prime rate. The line is collateralized by substantially all of the Company's
assets and requires the Company to meet certain financial covenants including
minimum levels if EBITDA, net worth, fixed charge coverage ratios and maximum
senior debt/EBITDA ratios as well as limitations on annual capital expenditures.
We also had a line of credit with an affiliate of DVI. At October 31,
2004, the Company had $3.4 million outstanding under this line. Interest on the
outstanding balance was payable monthly at our lender's prime rate plus 1.0%.
Future borrowings under this line of credit were no longer available and the
balance was being paid down by collections on historical accounts receivable and
variable monthly installment payments in the future. Subsequent to year-end, we
and Post Advisory Group, LLC, a Los Angeles-based investment advisor, issued
$4.0 million in principal amount of notes to repurchase the DVI affiliate's line
of credit facility with the residual funds utilized by us as working capital.
The new note payable has monthly interest only payments at 12% per annum until
its maturity in July 2008.
On December 19, 2003, we issued a $1.0 million convertible subordinate
note payable at a stated rate of 11% per annum with interest payable quarterly.
The note payable is convertible at the holder's option anytime after June 19,
2005 at $0.50 per share. As additional consideration for the financing we issued
a warrant for the purchase of 500,000 shares at an exercise price of $.50 per
share. We have allocated $0.1 million to the value of the warrants and believe
the value of the conversion feature is nominal.
In July 2004, we renegotiated our existing notes and capital lease
obligations with our three primary lenders, General Electric ("GE"), DVI
Financial Services and U.S. Bank extending terms and reducing monthly payments
on approximately $135 million of combined outstanding debt.
At the time of the debt restructuring, outstanding principal balances for
DVI and GE were $15.2 million and $54.3 million respectively.
DVI's restructured note payable is six payments of interest only from
July to December 2004 at 9%, 41 payments of principal and interest of $273,988,
and a final balloon payment of $7.6 million on June 1, 2008 if and only if the
Company's subordinated bond debentures, then due, are not extended and paid in
full. If the bond debenture payment is deferred, the Company would make monthly
payments of $290,785 to DVI for the next 29 months. Effective November 30, 2004,
Post Advisory Group, LLC, ("Post"), acquired the DVI note payable and the
indebtedness was restructured by Post and the Company. The new note payable has
monthly interest only payments at 11% per annum until its maturity in June 2008.
The assignment of the note payable to Post will not result in any actual total
dollar savings to the Company over the term of the new obligation, but it will
defer cash outlays of approximately $1.3 million per year until its maturity.
GE's restructured note payable is six payments of interest only at 9%, or
$407,210, beginning on August 1, 2004, 40 payments of principal and interest at
$1,127,067 beginning on February 1, 2005, and a final balloon payment of $21
million due on June 1, 2008 if and only if our subordinated bond debentures,
then due, are not extended and paid in full. If the bond debenture payment is
deferred, we will continue to make monthly payments of $1,127,067 to GE for the
next 20 months.
At the time of the debt restructuring, the outstanding principal balance,
including accrued interest, due U.S. Bank was $65.6 million. U.S. Bank's
restructured note payable is six payments of interest only at 9%, or $491,933,
beginning on August 1, 2004, 40 payments of principal and interest of $1,055,301
beginning on February 1, 2005, and a final balloon payment of $39.7 million due
on June 1, 2008 if and only if our subordinated bond debentures, then due, are
not extended and paid in full. If the bond debenture payment is deferred, we
will continue to make monthly payments of $1,055,301 to U.S. Bank for the next
44 months.
In addition, during fiscal 2003, in order to provide us additional
liquidity, Dr. Berger advanced to us $1.0 million, some of our executive
officers have forgone a portion of their salary, an affiliate of GE began making
short-term working capital loans in the amount of $0.2 million per month for
nine months, and we sold Westchester Imaging Group for net cash proceeds of
approximately $1.4 million. See "Significant Events - Sale of Joint Venture
Interest - Discontinued Operation".
24
In October 2003, we successfully consummated a "pre-packaged" Chapter 11
plan of reorganization with the United States Bankruptcy Court, Central District
of California, in order to modify the terms of our convertible subordinated
debentures by extending the maturity to June 30, 2008, increasing the annual
interest rate from 10.0% to 11.5%, reducing the conversion price from $12.00 to
$2.50 and restricting our ability to redeem the debentures prior to July 1,
2005. The plan of reorganization did not affect any of our operations or
obligations, other than the subordinated debentures.
Our business strategy with regard to operations will focus on the
following:
o Maximizing performance at our existing facilities;
o Focusing on profitable contracting;
o Expanding MRI and CT applications
o Optimizing operating efficiencies; and
o Expanding our networks.
Our ability to generate sufficient cash flow from operations to make
payments on our debt and other contractual obligations will depend on our future
financial performance. A range of economic, competitive, regulatory, legislative
and business factors, many of which are outside of our control, will affect our
financial performance. Taking these factors into account, including our
historical experience and our discussions with our lenders to date, although no
assurance can be given, we believe that through implementing our strategic plans
and continuing to restructure our financial obligations, we will obtain
sufficient cash to satisfy our obligations as they become due in fiscal 2005.
SOURCES AND USES OF CASH
Cash decreased for fiscal 2004 and 2003 by $29,000 and $6,000,
respectively.
Cash provided by operating activities for the year ended October 31, 2004
was $17.1 million compared to $22.0 million for the same period in 2003. The
primary reason for the decrease in cash was due to reductions in accounts
payable and