UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-19019
RADNET, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN 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
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 whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Exchange Act Rule 12b-2) Yes No X
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes X No
--- ---
The number of shares of the registrant's common stock outstanding on November
10, 2007, was 34,789,558 shares (excluding treasury shares).
1
Table of Contents
RADNET, INC.
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at September 30, 2007 (unaudited)
and December 31, 2006
Consolidated Statements of Operations (unaudited) for the
Three and Nine Months ended September 30, 2007 and 2006
Consolidated Statement of Stockholders' Deficit (unaudited)
for the Nine Months ended September 30, 2007
Consolidated Statements of Cash Flows (unaudited) for the Nine
Months Ended September 30, 2007 and 2006
Notes to Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 4. Controls and Procedures
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
ITEM 1A. Risk Factors
ITEM 6 Exhibits
SIGNATURES
INDEX TO EXHIBITS
2
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
RADNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
September 30, December 31,
2007 2006
--------- ---------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ -- $ 3,221
Restricted cash 6,909 --
Accounts receivable, net 92,662 70,794
Due from affiliates -- 1,427
Refundable income taxes 105 6,464
Other current assets 9,115 7,518
--------- ---------
Total current assets 108,791 89,424
PROPERTY AND EQUIPMENT, NET 160,186 158,542
OTHER ASSETS
Goodwill 83,476 61,607
Other intangible assets, net 58,961 60,484
Deferred financing cost`, net 9,160 9,422
Investment in joint ventures 9,633 10,125
Trade name and other 3,758 4,751
--------- ---------
Total other assets 164,988 146,389
--------- ---------
Total assets $ 433,965 $ 394,355
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 13,610 $ 23,038
Accrued expenses 41,295 26,854
Notes payable 3,066 2,969
Current portion of deferred rent 331 559
Due to affiliates 323 --
Obligations under capital leases 9,361 4,626
--------- ---------
Total current liabilities 67,986 58,046
--------- ---------
LONG-TERM LIABILITIES
Line of credit -- 22
Notes payable, net of current portion 382,230 360,083
Obligations under capital lease, net of current portio 23,109 11,305
Deferred rent, net of current portion 5,248 991
Other non-current liabilities 8,464 9,650
--------- ---------
Total long-term liabilities 419,051 382,051
--------- ---------
COMMITMENTS AND CONTINGENCIES
MINORITY INTERESTS 997 1,254
STOCKHOLDERS' DEFICIT
Preferred stock - $.0001 par value, 30,000,000 shares -- --
authorized, none issued
Common stock - $.0001 par value, 200,000,000 shares authorized;
34,789,558 and 34,973,780 shares issued at September 30, 2007
and December 31, 2006, respectively; 34,789,558
and 34,061,281 shares outstanding at September 30, 2007
and December 31, 2006, respectively 4 3
Paid-in-capital 148,793 146,056
Accumulated other comprehensive loss (1,819) (73)
Accumulated deficit (201,047) (192,287)
--------- ---------
(54,069) (46,301)
Less: Treasury stock - 912,500 shares at cost -- (695)
--------- ---------
Total stockholders' deficit (54,069) (46,996)
--------- ---------
Total liabilities and stockholders' deficit $ 433,965 $ 394,355
========= =========
The accompanying notes are an integral part of these financial statements.
3
RADNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2007 2006 2007 2006
--------- --------- --------- ---------
NET REVENUE $ 110,209 $ 40,038 $ 323,051 $ 120,043
OPERATING EXPENSES
Operating expenses 83,503 30,323 244,405 90,148
Depreciation and amortization 11,405 4,131 32,495 12,186
Provision for bad debts 6,395 1,697 20,810 5,022
Loss on sale of equipment (4) 305 -- 373
Severance costs 30 -- 815 --
--------- --------- --------- ---------
Total operating expenses 101,329 36,456 298,525 107,729
--------- --------- --------- ---------
INCOME FROM OPERATIONS 8,880 3,582 24,526 12,314
OTHER EXPENSES (INCOME)
Interest expense 11,675 6,135 32,449 15,518
Loss on debt extinguishment, net -- (21) -- 2,097
Other expense (income) (21) 28 (72) 770
--------- --------- --------- ---------
Total other expense 11,654 6,142 32,377 18,385
--------- --------- --------- ---------
LOSS BEFORE INCOME TAXES, MINORITY
INTEREST AND EARNINGS FROM
JOINT VENTURES (2,774) (2,560) (7,851) (6,071)
Provision for income taxes (86) -- (115) --
Minority interest in income of subsidiaries (198) -- (483) --
Earnings from joint ventures 1,103 83 3,080 83
--------- --------- --------- ---------
NET LOSS $ (1,955) $ (2,477) $ (5,369) $ (5,988)
========= ========= ========= =========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.06) $ (0.12) $ (0.16) $ (0.29)
========= ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and diluted 34,749 21,238 34,567 20,971
The accompanying notes are an integral part of these financial statements.
4
RADNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
NINE MONTHS ENDED SEPTEMBER 30, 2007
(IN THOUSANDS EXCEPT PER SHARE DATA)
Common Stock $.0001 par
value, 200,000,000 shares
authorized Treasury stock, at cost
---------------------- Paid-in ------------------------
Shares Amount Capital Shares Amount
------ ------ ------- ------ ------
BALANCE - DECEMBER 31, 2006 34,973,780 $ 3 $ 146,056 (912,500) $ (695)
Cumulative effect adjustment pursuant
to adoption of SAB No. 108 -- -- -- -- --
Issuance of common stock
upon exercise of stock options 728,278 1 549 -- --
Retirement of treasury shares (912,500) -- (695) 912,500 695
Share-based payments -- 2,883 -- -- --
Change in fair value of -- --
cash flow hedging -- -- -- -- --
Net loss -- -- -- -- --
---------------------------------------------------------------------------------
BALANCE - SEPTEMBER 30, 2007
(UNAUDITED) 34,789,558 $ 4 $ 148,793 -- $ --
=================================================================================
[table continued]
Accumulated Other Total
Accumulated Comprehensive Stockholders'
Deficit Income (loss) Deficit
------- ------------- -------
BALANCE - DECEMBER 31, 2006 $ (192,287) $ (73) $ (46,996)
Cumulative effect adjustment pursuant --
to adoption of SAB No. 108 (3,391) -- (3,391)
Issuance of common stock
upon exercise of stock options -- -- 550
Retirement of treasury shares -- -- --
Share-based payments -- 2,883
Change in fair value of
cash flow hedging -- (1,746) (1,746)
Net loss (5,369) -- (5,369)
------------ ----------- -----------
BALANCE - SEPTEMBER 30, 2007
(UNAUDITED) $ (201,047) $ (1,819) $ (54,069)
============ =========== ===========
The accompanying notes are an integral part of these financial statements.
5
RADNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
2007 2006
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (5,369) $ (5,988)
Adjustments to reconcile net loss to net cash
flows provided by operating activities:
Depreciation and amortization 32,495 12,186
Provision for bad debts and allowance adjustments 20,810 5,022
Minority interests in income of subsidiaries 483 --
Distributions to minority interests (740) --
Equity in earnings of joint ventures (3,080) (83)
Distributions from joint ventures 3,572 --
Deferred rent 638 --
Amortization of deferred financing cost 1,428 --
Net loss on disposal of assets -- 373
Loss on extinguishment of debt -- 2,097
Employee stock compensation 2,883 392
Deferred revenue from sale of building -- (60)
Changes in operating assets and liabilities, net of assets
acquired and liabilities assumed in purchase transactions:
Accounts receivable (40,776) (8,897)
Refundable income taxes 6,359 --
Other current assets (1,478) (1,035)
Other assets 1,815 (314)
Accounts payable and accrued expenses 1,660 4,047
--------- ---------
Net cash provided by operating activities 20,700 7,740
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of imaging facilities (15,665) (3,388)
Purchase of property and equipment (19,439) (7,488)
Purchase of Radiologix (370) --
Proceeds from sale of imaging facility 1,300 --
Purchase of covenant not to compete contract (250) --
Payments collected on notes receivable 111 --
--------- ---------
Net cash used in investing activities (34,313) (10,876)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes and leases payable (7,159) (3,429)
Repayment of debt upon extinguishments -- (141,243)
Proceeds from borrowings upon refinancing -- 146,468
Debt issue costs (1,167) (5,608)
Change in restricted cash (6,909) --
Proceeds from borrowings on notes payable & revolving credit 28,865 5,495
Payments on line of credit (3,787) --
Proceeds from issuance of common stock 549 1,453
--------- ---------
Net cash generated from financing activities 10,392 3,136
--------- ---------
NET DECREASE IN CASH (3,221) --
CASH, BEGINNING OF PERIOD 3,221 2
--------- ---------
CASH, END OF PERIOD $ -- $ 2
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 30,953 $ 11,331
The accompanying notes are an integral part of these financial statements.
6
RADNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
We entered into capital leases for approximately $16.6 million and $3.6
million for the nine months ended September 30, 2007 and 2006, respectively.
7
RADNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION
RadNet, Inc. or RadNet (formerly Primedex Health Systems, Inc.), was
incorporated on October 21, 1985. Since our acquisition of Radiologix on
November 15, 2006, we have operated a group of regional networks comprised of
143 diagnostic imaging facilities located in seven states with operations
primarily in California, the Mid-Atlantic, the Treasure Coast area of Florida,
Kansas and the Finger Lakes (Rochester) and Hudson Valley areas of New York,
providing diagnostic imaging services including magnetic resonance imaging
(MRI), computed tomography (CT), positron emission tomography (PET), nuclear
medicine, mammography, ultrasound, diagnostic radiology, or X-ray, and
fluoroscopy. The Company's operations comprise a single segment for financial
reporting purposes.
The results of operations of Radiologix and its wholly-owned
subsidiaries have been included in the consolidated financial statements from
the date of acquisition. The consolidated financial statements also include the
accounts of Radnet Management, Inc., or RadNet Management, and Beverly Radiology
Medical Group III (BRMG), which is a professional partnership, all collectively
referred to as "us" or "we". The consolidated financial statements also include
Radnet Sub, Inc., Radnet Management I, Inc., Radnet Management II, Inc., SoCal
MR Site Management, Inc., and Diagnostic Imaging Services, Inc. (DIS), all
wholly owned subsidiaries of RadNet Management.
Howard G. Berger, M.D. is our President and Chief Executive Officer, a
member of our Board of Directors and owns approximately 17% of our outstanding
common stock. Dr. Berger also owns, indirectly, 99% of the equity interests in
BRMG. BRMG provides all of the professional medical services at 52 of our
facilities located in California 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 California
facilities. We obtain professional medical services from BRMG in California,
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 California 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. At eleven former Radiologix
centers in California and at all of the former Radiologix centers which are
located outside of California, we have entered into long-term contracts with
prominent radiology groups in the area to provide physician services at those
facilities. The operations of BRMG are consolidated with us as a result of the
contractual and operational relationship among BRMG, Dr. Berger, and us. We are
considered to have a controlling financial interest in BRMG pursuant to the
guidance in Emerging Issues Task Force Issue 97-2 (EITF 97-2). BRMG is a
partnership of Pronet Imaging Medical Group, Inc. and Beverly Radiology Medical
Group, both of which are 99%-owned by Dr. Berger. RadNet provides non-medical,
technical and administrative services to BRMG for which it receives a management
fee.
Radiologix, our wholly-owned subsidiary, contracts with radiology
practices to provide professional services, including supervision and
interpretation of diagnostic imaging procedures, in its diagnostic imaging
centers. The radiology practices maintain full control over the provision of
professional radiological services. The contracted radiology practices generally
have outstanding physician and practice credentials and reputations; strong
competitive market positions; a broad sub-specialty mix of physicians; a history
of growth and potential for continued growth.
Radiologix enters into long-term agreements with radiology practice
groups (typically 40 years). Under these arrangements, in addition to obtaining
technical fees for the use of our diagnostic imaging equipment and the provision
of technical services, it provides management services and receives a fee based
on the practice group's professional revenue, including revenue derived outside
of its diagnostic imaging centers. Radiologix owns the diagnostic imaging assets
and, therefore, receives 100% of the technical reimbursements associated with
imaging procedures. Radiologix has no financial controlling interest in the
contracted radiology practices, as defined in EITF 97-2; accordingly, we do not
consolidate the financial statements of those practices in our consolidated
financial statements.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X and, therefore, do not include all information and footnotes
necessary for a fair presentation of financial position, results of operations
and cash flows in conformity with accounting principles generally accepted in
the United States for complete financial statements; however, in the opinion of
our management, all adjustments consisting of normal recurring adjustments
necessary for a fair presentation of financial position, results of operations
and cash flows for the interim periods ended September 30, 2007 and 2006 have
been made. The results of operations for any interim period are not necessarily
indicative of the results for a full year. These interim consolidated financial
statements should be read in conjunction with the
8
consolidated financial statements and related notes thereto contained in our
Annual Report on Form 10-K for the year ended October 31, 2006 and our
transition report on Form 10-K/T for the two months ended December 31, 2006.
Certain prior period amounts have been reclassified to conform to the
current period presentation. These changes have no effect on net income.
LIQUIDITY AND CAPITAL RESOURCES
We had a working capital balance of $40.8 million at September 30, 2007
compared to $31.4 million at December 31, 2006, and a net loss of $2.0 million
and $5.4 million during the three and nine months ended September 30, 2007,
respectively. We also had a stockholders' deficit of $54.1 million at September
30, 2007 compared to $47.0 million at December 31, 2006.
We operate in a capital intensive, high fixed-cost industry that
requires significant amounts of capital to fund operations. In addition to
operations, we require significant amounts of capital for the initial start-up
and development expense of new diagnostic imaging facilities, the acquisition of
additional facilities and new diagnostic imaging equipment, and to service our
existing debt and contractual obligations. Because our cash flows from
operations have been insufficient to fund all of these capital requirements, we
have depended on the availability of financing under credit arrangements with
third parties.
Our business strategy with regard to operations will focus on the
following:
|X| Maximizing performance at our existing facilities;
|X| Focusing on profitable contracting;
|X| Expanding MRI, CT and PET applications; |X| Optimizing
operating efficiencies; and
|X| 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 the next twelve
months.
NOTE 2 - BUSINESS ACQUISITION
On November 15, 2006, we completed our acquisition of Radiologix, Inc.
as a stock purchase. Under the terms of the merger agreement, Radiologix
shareholders received aggregate consideration of 11,310,950 shares (or
22,621,900 shares before the one-for-two reverse stock split effected in late
November 2006) of our common stock and $42,950,000 in cash.
The total purchase price and the allocation of the estimated purchase
price discussed below are preliminary and have not been finalized. The
preliminary estimated total purchase price of the merger is as follows:
(IN THOUSANDS)
--------------
Value of stock given by RadNet to Radiologix* $39,400
Cash 42,950
Estimated transaction fees and expenses** 15,208
-------
Total purchase price $97,558
=======
(*) Calculated as 11,310,950 shares multiplied by $3.48 (average closing price
of $1.74 from June 28, 2006 to July 13, 2006, adjusted for the one-for-two
reverse stock split).
(**) Includes $8,274,000 in assumed liabilities of Radiologix, including
$3,210,000 in merger and acquisition fees and $5,064,000 in Radiologix bond
prepayment penalties.
Under the purchase method of accounting, the total estimated purchase
price as shown above and based on our consultation with an external valuation
expert is allocated to Radiologix's net tangible and intangible assets based on
their estimated fair values as of the date of acquisition. The following table
summarizes the preliminary purchase price allocation at the date of acquisition.
9
(IN THOUSANDS)
--------------
Current assets $ 114,764
Property and equipment, net 78,173
Identifiable intangible assets 61,000
Goodwill 47,956
Investments in joint ventures 9,482
Other assets 974
Current liabilities (25,191)
Accrued restructuring charges (314)
Contracts (8,994)
Assumption of debt (177,358)
Long-term liabilities (1,725)
Minority interests in consolidated subsidiaries (1,209)
---------
Total purchase price $ 97,558
=========
CASH, MARKETABLE SECURITIES, INVESTMENTS AND OTHER ASSETS: We valued
cash, marketable securities, investments and other assets at their respective
carrying amounts as we believe that these amounts approximated their current
fair values.
IDENTIFIABLE INTANGIBLE ASSETS: Identifiable intangible assets acquired
include management service agreements and covenants not to compete. Management
service agreements represent the underlying relationships and agreements with
certain professional radiology groups. Covenants not to compete are contracts
entered into with certain former members of management of Radiologix on the date
of acquisition.
Identifiable intangible assets consist of:
ESTIMATED
ESTIMATED AMORTIZATION ANNUAL
(IN THOUSANDS) FAIR VALUE PERIOD AMORTIZATION
-------------- ---------- ------ ------------
Management service agreements $57,880 25 years $ 2,315
Covenants not to compete 3,120 1 to 2 years 1,810
Estimated useful lives for the intangible assets were based on the
average contract terms, which are greater than the amortization period that will
be used for management contracts. Intangible assets are being amortized using
the straight-line method, considering the pattern in which the economic benefits
of the intangible assets are consumed.
GOODWILL: Approximately $47,956,000 has been allocated to goodwill.
This is an increase of approximately $5.6 million from our estimate at June 30,
2007 based on a further refinement of our purchase price allocation. This amount
may change when we finalize our estimate. The increase in goodwill includes a
$4.9 million decrease to property and equipment and a $692,000 increase to
accrued liabilities. Goodwill represents the excess of the purchase price over
the fair value of the underlying net tangible and identifiable intangible
assets. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets"
goodwill will not be amortized but instead will be tested for impairment at
least annually. We perform this test annually on December 1. In the event that
management determines that the value of goodwill has become impaired, we will
incur an accounting charge for the amount of impairment during the fiscal
quarter in which the determination is made, which would normally be the fourth
quarter. Because this goodwill was established through a stock purchase, no
amount is deductible for tax purposes.
OPERATING LEASES: We assumed certain operating leases for both
equipment and facilities. All related historical deferred rent liabilities have
been eliminated. The establishment of any assets or liabilities associated with
the Company's assumption of these operating leases is contingent upon final
analysis from our external valuation experts.
10
NOTE 3 - FACILITY ACQUISITIONS AND DIVESTITURES
In September 2007, we acquired the assets and business of Walnut Creek
Open MRI located in Walnut Creek, CA for $225,000. The center provides MRI
services. The leased facility associated with this center includes a monthly
rental of approximately $6,800 per month. Approximately $50,000 of goodwill was
recorded with respect to this transaction.
In September 2007, we acquired the assets and business of three
facilities comprising of Valley Imaging Center, Inc. located in Victorville, CA
for $3.3 million in cash plus the assumption of approximately $866,000 of debt.
The acquired centers offer a combination of MRI, CT, X-ray, Mammography,
Fluoroscopy and Ultrasound. The physician who provided the interpretive
radiology services to these three locations joined BRMG. The leased facilities
associated with these centers includes a total monthly rental of approximately
$18,000. Approximately $2.8 million of goodwill was recorded with respect to
this transaction.
In July 2007, we acquired the assets and business of Borg Imaging Group
located in Rochester, NY for $11.7 million in cash plus the assumption of
approximately $2.4 million of debt. Borg was the owner and operator of six
imaging centers, five of which are multimodality, offering a combination of MRI,
CT, X-ray, Mammography, Fluoroscopy and Ultrasound. After combining the Borg
centers with RadNet's existing centers in Rochester, New York, RadNet has a
total of 11 imaging centers in Rochester. The leased facilities associated with
these centers includes a total monthly rental of approximately $71,000 per
month. Approximately $9.2 million of goodwill was recorded with respect to this
transaction.
In March 2007, we acquired the assets and business of Rockville Open
MRI, located in Rockville, Maryland, for $540,000 in cash and the assumption of
a capital lease of $1.1 million. The center provides MRI services. The center is
3,500 square feet with a monthly rental of approximately $8,400 per month.
Approximately $365,000 of goodwill was recorded with respect to this
transaction.
Our allocation of the purchase price with respect to our 2007
acquisitions to the fair value of the assets acquired and liabilities assumed is
preliminary and subject to change upon completion of our allocation analysis.
In June 2007 we divested a non-course center in Duluth, Minnesota to a
local multi-center operator for $1.3 million. This was the only facility that we
operated in Minnesota.
NOTE 4 - ADOPTION OF RECENT ACCOUNTING STANDARDS AND PRONOUNCEMENTS
In September 2006, the SEC issued Staff Accounting Bulletin No. 108
("SAB No. 108"), "Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements." SAB No. 108
specifies how the carryover or reversal of prior year unrecorded financial
statement misstatements should be considered in quantifying a current year
misstatement. SAB No. 108 requires an approach that considers the amount by
which the current year Consolidated Statement of Operations is misstated
("rollover approach") and an approach that considers the cumulative amount by
which the current year Consolidated Balance Sheet is misstated ("iron curtain
approach").
Prior to the issuance of SAB No. 108, either the rollover or iron
curtain approach was acceptable for assessing the materiality of financial
statement misstatements. Prior to the Company's application of the guidance in
SAB No. 108, management used the rollover approach for quantifying financial
statement misstatements.
Initial application of SAB No. 108 allows registrants to elect not to
restate prior periods but to reflect the initial application in their annual
financial statements covering the first fiscal year ending after November 15,
2006. The cumulative effect of the initial application should be reported in the
carrying amounts of assets and liabilities as of the beginning of that fiscal
year and the offsetting adjustment, net of tax, should be made to the opening
balance of retained earnings for that year. We elected to record the effects of
applying SAB No. 108 using the cumulative effect transition method. The
misstatement that has been corrected is described below.
Subsequent to the completion of the financial statement close process
for the three and six months ended June 30, 2007, we determined that certain
lease rate escalation clauses had not been properly accounted for in accordance
with generally accepted accounting principles for the fiscal years ended October
31, 2004, 2005 and 2006 as well as for the two months ended December 31, 2006
(our transition period) and for the quarter ended March 31, 2007. The Company
had been recording rent expense based on the contractual terms of the lease
agreements. We reviewed Statement of Financial Accounting Standards No. 13 (SFAS
No. 13) and its related interpretations including Financial Accounting Standards
Board Technical Bulletin 85-3 "Accounting for Operating Leases with Scheduled
Rent Increases" (FTB 85-3), scheduled rent increases and rent holidays in an
operating lease should be recognized by
11
the lessee on a straight-line basis over the lease term unless another
systematic and rational allocation is more representative of the time pattern in
which leased property is physically employed. FTB 85-3 specifically states that
scheduled rent increases designed to reflect the anticipated effects of
inflation is not a justification to support not straight lining the lease cost
over the lease term. Based on our review, we have concluded that the
straight-line method is required.
In accordance with the transition provisions of SAB No. 108, we
recorded a $3.4 million cumulative effect adjustment to retained earnings and an
offsetting amount to long-term deferred rent as of January 1, 2007. In addition,
we recognized an additional $697,000 of facility rent expense for the six months
ended June 30, 2007 related to the application of the straight-line methodology
to certain leases with rent escalators.
Based on the nature of these adjustments and the totality of the
circumstance surrounding these adjustments, we have concluded that these
adjustments are immaterial to prior years' consolidated financial statements
under our previous method of assessing materiality, and therefore, have elected,
as permitted under the transition provisions of SAB No. 108, to reflect the
effect of these adjustments in opening liabilities as of January 1, 2007, with
the offsetting adjustment reflected as a cumulative effect adjustment to opening
retained earnings as of January 1, 2007.
In July 2006, the FASB issued SFAS Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes - an interpretation of SFAS Statement No. 109"
("FIN 48"), and effective January 1, 2007, we adopted FIN 48. FIN 48 applies to
all "tax positions" accounted for under SFAS 109. FIN 48 refers to "tax
positions" as positions taken in a previously filed tax return or positions
expected to be taken in a future tax return which are reflected in measuring
current or deferred income tax assets and liabilities reported in the financial
statements. FIN 48 further clarifies a tax position to include, but not be
limited to, the following:
o an allocation or a shift of income between taxing
jurisdictions,
o the characterization of income or a decision to exclude
reporting taxable income in a tax return, or
o a decision to classify a transaction, entity, or other
position in a tax return as tax exempt.
FIN 48 clarifies that a tax benefit may be reflected in the financial
statements only if it is "more likely than not" that a company will be able to
sustain the tax return position, based on its technical merits. If a tax benefit
meets this criterion, it should be measured and recognized based on the largest
amount of benefit that is cumulatively greater than 50% likely to be realized.
This is a change from current practice, whereby companies may recognize a tax
benefit only if it is probable a tax position will be sustained.
FIN 48 also requires that we make qualitative and quantitative
disclosures, including a discussion of reasonably possible changes that might
occur in unrecognized tax benefits over the next 12 months; a description of
open tax years by major jurisdictions and a roll-forward of all unrecognized tax
benefits, presented as a reconciliation of the beginning and ending balances of
the unrecognized tax benefits on an aggregated basis.
We are subject to tax audits in several tax jurisdictions within the
U.S. and will remain subject to examination until the statute of limitations
expires for each respective tax jurisdiction. Tax audits by their very nature
are often complex and can require several years to complete. Information
relating to our tax examinations by jurisdiction is as follows:
o Federal -- we are subject to U.S. federal tax examinations by
tax authorities for the tax years ended 2003 to 2007
o State -- we are subject to state tax examinations by tax
authorities for the tax years ended 2002 to 2007
The adoption of FIN 48 did not have a material impact on our financial
statements or disclosures. As of January 1, 2007 and September 30, 2007 we did
not recognize any assets or liabilities for unrecognized tax benefits relative
to uncertain tax positions. We do not currently anticipate that any significant
increase or decrease to the gross unrecognized tax benefits will be recorded
during the next 12 months. Any interest or penalties resulting from examinations
will continue to be recognized as a component of the income tax provision;
however, since there are no unrecognized tax benefits as a result of tax
positions taken, there is no accrued interest and penalties.
Additionally, the future utilization of the Company's net operating
loss carryforwards to offset future taxable income may be subject to a
substantial annual limitation as a result of ownership changes that may have
occurred previously or that could occur in the future.
12
NOTE 5 - COMPREHENSIVE LOSS
The following table summarizes total comprehensive loss for the
applicable periods (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ---------------------
2007 2006 2007 2006
------- ------- ------- -------
Net loss $(1,955) $(2,477) $(5,369) $(5,988)
Change in fair value of cash flow hedging (2,864) -- (1,746) --
------- ------- ------- -------
Total comprehensive loss $(4,819) $(2,477) $(7,115) $(5,988)
======= ======= ======= =======
NOTE 6 - EARNINGS PER SHARE
Earnings per share is based upon the weighted average number of shares
of common stock and common stock equivalents outstanding, net of common stock
held in treasury, and includes the effect of the one-for-two reverse stock split
effective November 28, 2006, as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2007 2006 2007 2006
------- ------- ------- -------
Net loss $(1,955) $(2,477) $(5,369) $(5,988)
======= ======= ======= =======
BASIC LOSS PER SHARE
Weighted average number of common shares
outstanding during the period 34,749 21,238 34,567 20,971
======= ======= ======= =======
Basic loss per share $ (0.06) $ (0.12) $ (0.16) $ (0.29)
======= ======= ======= =======
DILUTED LOSS PER SHARE
Weighted average number of common shares
outstanding during the period 34,749 21,238 34,567 20,971
Add additional shares issuable upon exercise of stock
options and warrants calculated using the treasury
stock method -- -- -- --
------- ------- ------- -------
Weighted average number of common shares used in
calculating diluted earnings per share 34,749 21,238 34,567 20,971
======= ======= ======= =======
Diluted loss per share $ (0.06) $ (0.12) $ (0.16) $ (0.29)
======= ======= ======= =======
For the three and nine months ended September 30, 2007 and 2006, we
excluded all options and warrants in the calculation of diluted earnings per
share because their effect is antidilutive.
NOTE 7 - INVESTMENT IN JOINT VENTURES
We have eight unconsolidated joint ventures with ownership interests
ranging from 22% to 50%. These joint ventures represent partnerships with
hospitals, health systems or radiology practices and were formed for the purpose
of owning and operating diagnostic imaging centers. Professional services at the
joint venture diagnostic imaging centers are performed by contracted radiology
practices or a radiology practice that participates in the joint venture. Our
investment in these joint ventures is accounted for under the equity method.
Total assets at September 30, 2007 include notes receivable from certain
unconsolidated joint ventures aggregated $376,000. Interest income related to
these notes receivable was approximately $14,000 and $51,000 for the three and
nine months ended September 30, 2007, respectively. We also received management
service fees of $1.4 million and $3.6 million for the three and nine months
ended September 30, 2007, respectively, in connection with operating the centers
underlying these joint ventures.
The following table is a summary of key financial data for these joint
ventures as of and for the nine months ended September 30, 2007 (in thousands):
13
Balance Sheet Data:
Current assets $15,531
Noncurrent assets 11,345
Current liabilities 2,018
Noncurrent liabilities 558
Net assets:
Radnet joint venture interests 9,633
Other joint venture partners
interests 14,667
Income Statement Data:
Net revenue 44,080
Net Income 9,669
NOTE 8 - STOCK BASED COMPENSATION
We have three long-term incentive stock option plans. The 1992 plan has
not issued options since the adoption of the 2000 plan and the 2000 plan has not
issued options since the adoption of the 2006 plan. We reserved 1,000,000 shares
of common stock for grants of options under our 2006 plan. We have issued
non-qualified stock options from time to time in connection with acquisitions
and for other purposes and have also issued stock under the plans. Employee
stock options generally vest over three to five years and expire five to ten
years from date of grant.
As of September 30, 2007, 202,750, or approximately 68%, of all
outstanding stock options are fully vested. Options to acquire 95,000 shares of
common stock were granted during the three and nine months ended September 30,
2007.
We have issued warrants under various types of arrangements to
employees, as well as to non-employees in conjunction with debt financing and in
exchange for outside services. All warrants are issued with an exercise price
equal to the fair market value of the underlying common stock on the date of
issuance. The warrants expire from five to seven years from the date of grant.
Warrants issued to employees can vest immediately or up to seven years. Vesting
terms are determined by the board of directors at the date of issuance. We
issued no warrants during the three months ended September 30, 2007 and
1,450,000 warrants during the nine months ended September 30, 2007. As of
September 30, 2007, warrants to acquire 3,753,667 shares, or approximately 73%,
of all the outstanding warrants are fully vested.
As of November 1, 2005, we adopted SFAS No. 123(R), "Share-Based
Payment," applying the modified prospective method. This Statement requires all
equity-based payments to employees, including grants of employee options, to be
recognized in the consolidated statement of earnings based on the grant date
fair value of the award. Under the modified prospective method, we are required
to record equity-based compensation expense for all awards granted after the
date of adoption and for the unvested portion of previously granted awards
outstanding as of the date of adoption. The fair values of all options were
valued using a Black-Scholes model.
In anticipation of the adoption of SFAS No. 123(R), we did not modify
the terms of any previously granted awards.
Mssrs. Linden, Hames and Stolper who hold the positions of Executive
Vice President and General Counsel, Executive Vice President and Chief Operating
Officer, Western Operations and Executive Vice President and Chief Financial
Officer, respectively, were issued certain warrants in prior periods which fully
vest upon the sooner of their respective multi-year vesting schedules or at such
time as the 30 day average closing stock price of our shares in the public
market in which it trades equals or exceeds $6.00. For the 30 day trading period
ended March 7, 2007, the average closing price exceeded $6.00 per share.
Accordingly, these warrants fully vested resulting in the full expensing of the
remaining unamortized fair value of these warrants of $1.7 million in the first
quarter of 2007.
The compensation expense recognized for all equity-based awards is net
of estimated forfeitures and is recognized over the awards' service period. In
accordance with Staff Accounting Bulletin ("SAB") No. 107, we classified
equity-based compensation in operating expenses with the same line item as the
majority of the cash compensation paid to employees.
The following tables illustrate the impact of equity-based compensation
on reported amounts (in thousands):
14
THREE MONTHS ENDED SEPTEMBER 30,
2007 2006
---- ----
IMPACT OF EQUITY-BASED IMPACT OF EQUITY-BASED
AS REPORTED COMPENSATION AS REPORTED COMPENSATION
----------- ------------ ----------- ------------
Income from operations $ 8,880 $ (281) $ 3,582 $ (116)
Net loss (1,955) (281) (2,477) (116)
Net basic and diluted loss per share (0.06) (0.01) (0.12) (0.01)
NINE MONTHS ENDED SEPTEMBER 30,
2007 2006
---- ----
IMPACT OF EQUITY-BASED IMPACT OF EQUITY-BASED
AS REPORTED COMPENSATION AS REPORTED COMPENSATION
----------- ------------ ----------- ------------
Income from operations $ 24,526 $ (2,883) $ 12,314 $ (392)
Net loss (5,369) (2,883) (5,988) (392)
Net basic and diluted loss per share (0.16) (0.08) (0.29) (0.01)
The following summarizes all of our option and warrant activity for the
nine months ended September 30, 2007:
WEIGHTED AVERAGE
WEIGHTED AVERAGE REMAINING AGGREGATE
EXERCISE PRICE CONTRACTUAL LIFE INTRINSIC
OUTSTANDING OPTIONS SHARES PER COMMON SHARE (IN YEARS) VALUE
------------------- ------ ---------------- ---------- -----
Balance, December 31, 2006 350,625 $1.01
Granted 95,000 9.50
Exercised (138,125) 0.85
Canceled or expired (7,250) 3.26
Balance, September 30, 2007 300,250 $3.72 5.11 $1,612,545
-------
Exercisable at September 30, 2007 202,750 $1.02 1.93 $1,553,295
-------
WEIGHTED AVERAGE
WEIGHTED AVERAGE REMAINING AGGREGATE
EXERCISE PRICE PER CONTRACTUAL LIFE INTRINSIC
OUTSTANDING WARRANTS SHARES COMMON SHARE (IN YEARS) VALUE
-------------------- ------ ------------ ---------- -----
Balance, December 31, 2006 4,590,667 $1.20
Granted 1,450,000 5.32
Exercised (612,000) 0.93
Canceled or expired (282,000) 2.47
Balance, September 30, 2007 5,146,667 $2.32 3.48 $30,749,003
----------
Exercisable at September 30, 2007 3,753,667 $3.61 1.16 $28,012,003
----------
The aggregate intrinsic value in the table above represents the total
pretax intrinsic value (the difference between our closing stock price on
September 30, 2007 and the exercise price, multiplied by the number of
in-the-money options/warrants) that would have been received by the holder had
all holders exercised their options/warrants on September 30, 2007. Total
intrinsic value of options and warrants exercised during the nine months ended
September 30, 2007 was approximately $6.1 million. As of September 30, 2007,
total unrecognized share-based compensation expense related to non-vested
employee awards was approximately $4.9 million, which is expected to be
recognized over a weighted average period of approximately 4.4 years.
15
The fair value of each option/warrant granted is estimated on the grant
date using the Black-Scholes option pricing model which takes into account as of
the grant date the exercise price and expected life of the option/warrant, the
current price of the underlying stock and its expected volatility, expected
dividends on the stock and the risk-free interest rate for the term of the
option/warrant. The weighted-average grant date fair value of stock options and
warrants granted during the nine months ended September 30, 2007 was $3.80 and
was $0.47 for the nine months ended September 30, 2006. The following is the
weighted average data used to calculate the fair value:
Risk-free Expected Expected Expected
Interest Rate Life Volatility Dividends
------------- ---- ---------- ---------
September 30, 2007 4.64% 4.1 years 94.65% ---
September 30, 2006 4.73% 4.72 years 99.36% ---
We have determined the expected term assumption under the "Simplified
Method" as defined in SAB 107. The expected stock price volatility is based on
the historical volatility of our stock. The risk-free interest rate is based on
the U.S. Treasury yield in effect at the time of grant with an equivalent
remaining term. We have not paid dividends in the past and do not currently plan
to pay any dividends in the near future.
NOTE 9 - SUBSEQUENT EVENTS
On October 9, 2007, we completed our purchase of Liberty Pacific
Imaging located in Encino, California for $2.8 million. The center operates a
successful MRI practice utilizing a 3T MRI unit, the strongest magnet strength
commercially available at this time. The center was founded in 2003, and has
since been a fixture in the Encino/Tarzana market of the San Fernando Valley in
Los Angeles. The acquisition allows us to consolidate a portion of our
Encino/Tarzana MRI volume onto the existing Liberty Pacific scanner. This
consolidation will make available our existing 3T MRI unit in that market, which
will be moved to our Squadron facility in Rockland County, New York.
On October 15 2007 we divested a non-course center in Golden, Colorado
for $325,000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
----------------------------------------------------------------------
OVERVIEW
Since our acquisition of Radiologix on November 15, 2006, we have
operated a group of regional networks comprised of 143 diagnostic imaging
facilities located in seven states with operations primarily in California, the
Mid-Atlantic, the Treasure Coast area of Florida, Kansas and the Finger Lakes
(Rochester) and Hudson Valley areas of New York, providing diagnostic imaging
services including MRI, CT, PET, nuclear medicine, mammography, ultrasound,
X-ray, and fluoroscopy. The Company's operations comprise a single segment for
financial reporting purposes.
The results of operations of Radiologix and its wholly-owned
subsidiaries have been included in the consolidated financial statements from
the date of acquisition. The consolidated financial statements also include the
accounts of RadNet, Inc., Radnet Management, Inc., or Radnet Management, and
BRMG, which is a professional partnership, all collectively referred to as "us"
or "we". The consolidated financial statements also include Radnet Sub, Inc.,
Radnet Management I, Inc., Radnet Management II, Inc., SoCal MR Site Management,
Inc., and Diagnostic Imaging Services, Inc., or DIS, all wholly owned
subsidiaries of Radnet Management.
Howard G. Berger, M.D. is our President and Chief Executive Officer, a
member of our Board of Directors and owns approximately 17% of our outstanding
common stock. Dr. Berger also owns, indirectly, 99% of the equity interests in
BRMG. BRMG provides all of the professional medical services at 52 of our
facilities located in California 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 California
facilities. We obtain professional medical services from BRMG in California,
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 California 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. At eleven former Radiologix
centers
16
in California and at all of the former Radiologix centers which are located
outside of California, we have entered into long-term contracts with prominent
radiology groups in the area to provide physician services at those facilities.
The operations of BRMG are consolidated with us as a result of the contractual
and operational relationship among BRMG, Dr. Berger, and us. We are considered
to have a controlling financial interest in BRMG pursuant to the guidance in
Emerging Issues Task Force Issue 97-2 (EITF 97-2). BRMG is a partnership of
Pronet Imaging Medical Group, Inc. and Beverly Radiology Medical Group, both of
which are 99%-owned by Dr. Berger. RadNet provides non-medical, technical and
administrative services to BRMG for which it receives a management fee.
Radiologix, our wholly-owned subsidiary, contracts with radiology
practices to provide professional services, including supervision and
interpretation of diagnostic imaging procedures' performed in its diagnostic
imaging centers. The radiology practices maintain full control over the
provision of professional radiological services. The contracted radiology
practices generally have outstanding physician and practice credentials and
reputations; strong competitive market positions; a broad sub-specialty mix of
physicians; a history of growth and potential for continued growth.
Radiologix enters into long-term agreements with radiology practice
groups (typically 40 years). Under these arrangements, in addition to obtaining
technical fees for the use of our diagnostic imaging equipment and the provision
of technical services, it provides management services and receives a fee based
on the practice group's professional revenue, including revenue derived outside
of its diagnostic imaging centers. Radiologix owns the diagnostic imaging assets
and, therefore, receives 100% of the technical reimbursements associated with
imaging procedures.
Radiologix has no financial controlling interest in the contracted
radiology practices, as defined in EITF 97-2; accordingly, we do not consolidate
the financial statements of those practices in our consolidated financial
statements.
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. One hundred-four 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.
Thirty-nine 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.
We derive substantially all of our revenue, directly or indirectly, from
fees charged for the diagnostic imaging services performed at our facilities.
ADOPTION OF THE PROVISIONS OF STAFF ACCOUNTING BULLETIN NO. 108 ("SAB NO. 108")
In September 2006, the SEC issued Staff Accounting Bulletin No. 108
("SAB No. 108"), "Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements." SAB No. 108
specifies how the carryover or reversal of prior year unrecorded financial
statement misstatements should be considered in quantifying a current year
misstatement. SAB No. 108 requires an approach that considers the amount by
which the current year Consolidated Statement of Operations is misstated
("rollover approach") and an approach that considers the cumulative amount by
which the current year Consolidated Balance Sheet is misstated ("iron curtain
approach").
Prior to the issuance of SAB No. 108, either the rollover or iron
curtain approach was acceptable for assessing the materiality of financial
statement misstatements. Prior to the Company's application of the guidance in
SAB No. 108, management used the rollover approach for quantifying financial
statement misstatements.
Initial application of SAB No. 108 allows registrants to elect not to
restate prior periods but to reflect the initial application in their annual
financial statements covering the first fiscal year ending after November 15,
2006. The cumulative effect of the initial application should be reported in the
carrying amounts of assets and liabilities as of the beginning of that fiscal
year and the offsetting adjustment, net of tax, should be made to the opening
balance of retained earnings for that year. We elected to record the effects of
applying SAB No. 108 using the cumulative effect transition method. The
misstatement that has been corrected is described below.
17
Subsequent to the completion of the financial statement close process
for the three and six months ended June 30, 2007, we determined that certain
lease rate escalation clauses had not been properly accounted for in accordance
with generally accepted accounting principles for the fiscal years ended October
31, 2004, 2005 and 2006 as well as for the two months ended December 31, 2006
(our transition period) and for the quarter ended March 31, 2007. The Company
had been recording rent expense based on the contractual terms of the lease
agreements. We reviewed Statement of Financial Accounting Standards No. 13 (SFAS
No. 13) and its related interpretations including Financial Accounting Standards
Board Technical Bulletin 85-3 "Accounting for Operating Leases with Scheduled
Rent Increases" (FTB 85-3), scheduled rent increases and rent holidays in an
operating lease should be recognized by the lessee on a straight-line basis over
the lease term unless another systematic and rational allocation is more
representative of the time pattern in which leased property is physically
employed. FTB 85-3 specifically states that scheduled rent increases designed to
reflect the anticipated effects of inflation is not a justification to support
not straight lining the lease cost over the lease term. Based on our review, we
have concluded that the straight-line method is required.
In accordance with the transition provisions of SAB No. 108, we
recorded a $3.4 million cumulative effect adjustment to retained earnings and an
offsetting amount to long-term deferred rent as of January 1, 2007. In addition,
we recognized an additional $697,000 of facility rent expense for the six months
ended June 30, 2007 related to the application of the straight-line methodology
to certain leases with rent escalators.
Based on the nature of these adjustments and the totality of the
circumstance surrounding these adjustments, we have concluded that these
adjustments are immaterial to prior years' consolidated financial statements
under our previous method of assessing materiality, and therefore, have elected,
as permitted under the transition provisions of SAB No. 108, to reflect the
effect of these adjustments in opening liabilities as of January 1, 2007, with
the offsetting adjustment reflected as a cumulative effect adjustment to opening
retained earnings as of January 1, 2007.
CRITICAL ACCOUNTING ESTIMATES
Our discussion and analysis of financial condition and results of
operations are based on our consolidated financial statements that were prepared
in accordance with U.S. generally accepted accounting principles, or GAAP.
Management makes estimates and assumptions when preparing financial statements.
These estimates and assumptions affect various matters, including:
o Our reported amounts of assets and liabilities in our
consolidated balance sheets at the dates of the financial
statements;
o Our disclosure of contingent assets and liabilities at the
dates of the financial statements; and
o Our reported amounts of net revenue and expenses in our
consolidated statements of operations during the reporting
periods.
These estimates involve judgments with respect to numerous factors that
are difficult to predict and are beyond management's control. As a result,
actual amounts could materially differ from these estimates.
The Securities and Exchange Commission (SEC), defines critical
accounting estimates as those that are both most important to reflect a
company's financial condition and results of operations and require management's
most difficult, subjective or complex judgment, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods.
As of the period covered in this report, there have been no material
changes to the critical accounting estimates we use, and have explained, in both
our annual report on Form 10-K for the fiscal year ended October 31, 2006 and
our transition report on Form 10-K/T for the two months ended December 31, 2006.
18
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
that certain items in the statement of operations bears to net revenue.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2007 2006 2007 2006
------- ------- ------- -------
NET REVENUE 100.0% 100.0% 100.0% 100.0%
OPERATING EXPENSES
Operating expenses 75.8% 75.7% 75.7% 75.1%
Depreciation and amortization 10.3% 10.3% 10.1% 10.2%
Provision for bad debts 5.8% 4.2% 6.4% 4.2%
Loss on sale of equipment 0.0% 0.8% 0.0% 0.3%
Severance costs 0.0% 0.0% 0.3% 0.0%
------- ------- ------- -------
Total operating expenses 91.9% 91.1% 92.4% 89.7%
INCOME FROM OPERATIONS 8.1% 8.9% 7.6% 10.3%
OTHER EXPENSES (INCOME)
Interest expense 10.6% 15.3% 10.0% 12.9%
Loss on debt extinguishment, net 0.0% -0.1% 0.0% 1.7%
Other expense (income) 0.0% 0.1% 0.0% 0.6%
------- ------- ------- -------
Total other expense 10.6% 15.3% 10.0% 15.3%
LOSS BEFORE INCOME TAXES, MINORITY
INTERESTS AND EARNINGS FROM
JOINT VENTURES -2.5% -6.4% -2.4% -5.1%
Provision for income taxes -0.1% 0.0% 0.0% 0.0%
Minority interest in (income) loss of subs -0.2% 0.0% -0.1% 0.0%
Earnings from joint ventures 1.0% 0.2% 1.0% 0.1%
------- ------- ------- -------
NET LOSS -1.8% -6.2% -1.7% -5.0%
======= ======= ======= =======
THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2006
NET REVENUE
Net revenue for the three months ended September 30, 2007 was $110.2
million compared to $40.0 million for the three months ended September
30, 2006, an increase of $70.2 million, or 175.3%. Net revenue from the
acquisition of Radiologix, effective November 15, 2006, was $67.6
million for the three months ended September 30, 2007. Net revenue
excluding Radiologix increased $2.6 million for the three months ended
September 30, 2007 when compared to the same period last year. This
increase is mainly due to an increase in procedure volumes from
existing centers as well as from the addition of new centers and is net
of the effects of reimbursement reductions experienced as a result of
the government's reduction of certain Medicare payments (DRA), which
became effective in January 2007.
OPERATING EXPENSES
Operating expenses for the three months ended September 30, 2007
increased approximately $53.2 million, or 175.4%, from $30.3 million
for the three months ended September 30, 2006 to $83.5 million for the
three months ended September 30, 2007. The following table sets forth
our operating expenses for the three months ended September 30, 2007
and 2006 (in thousands):
19
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2007 2006
------------- ------------
Salaries and professional reading fees (excluding stock based compensation and severance) $ 45,053 $ 19,140
Stock based compensation 281 116
Building and equipment rental 10,927 2,247
General administrative expenses 27,242 8,820
-------- --------
Total operating expenses $ 83,503 $ 30,323
======== ========
Depreciation and amortization $ 11,405 $ 4,131
Provision for bad debts 6,395 1,697
Loss on sale of equipment, net (4) 305
Severance costs 30 --
SALARIES AND PROFESSIONAL READING FEES (EXCLUDING STOCK COMPENSATION
AND SEVERANCE)
Salaries and professional reading fees increased $25.9 million, or
135.4%, to $45.1 million for the three months ended September 30, 2007
compared to $19.2 million for the three months ended September 30,
2006. During the three months ended September 30, 2007, salaries and
professional reading fees were $23.3 million for Radiologix. Salaries
excluding Radiologix increased $2.6 million for the three months ended
September 30, 2007 when compared to the same period last year.
STOCK BASED COMPENSATION
Stock compensation increased $165,000 to $281,000 for the three months
ended September 30, 2007 compared to $116,000 for the three months
ended September 30, 2006. This increase is primarily due to additional
options and warrants granted during the last three months of 2006 and
the first nine months of 2007.
SEVERANCE
During the three months ended September 30, 2007, we recorded severance
costs of $30,000 associated with the integration of Radiologix.
BUILDING AND EQUIPMENT RENTAL
Building and equipment rental expenses increased $8.7 million, or
386.3%, to $10.9 million for the three months ended September 30, 2007
compared to $2.2 million for the three months ended September 30, 2006.
During the three months ended September 30, 2007, building and
equipment rental expense was $7.9 million for Radiologix. Building and
equipment rental expenses excluding Radiologix increased $800,000 for
the three months ended September 30, 2007 when compared to the same
period last year. The increase was due to normal consumer price index
escalations built into existing operating leases as well as additional
facility rent from new centers, including approximately $240,000 from
centers acquired during 2007 (see Note 3 to our consolidated financial
statements).
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business
tax and license, outside services, utilities, marketing, travel and
other expenses. Many of these expenses are variable in nature including
medical supplies and billing fees, which increase with volume and
repairs and maintenance under our GE service agreement at 3.62% of net
revenue for the three-month period. Overall, general and administrative
expenses increased $18.4 million, or 208.9%, for the three months ended
September 30, 2007 compared to the previous period. During the three
months ended September 30, 2007, general and administrative expenses
were $15.5 million for Radiologix. General and administrative expenses
excluding Radiologix increased $2.9 million for the three months ended
September 30, 2007 when compared to the same period last year. The
increase is in line with our increase in procedure volumes at both
existing centers as well as new centers. Also in this increase are
increased expenditures for accounting fees associated with our efforts
towards compliance with the Sarbanes-Oxley Act of 2002 by our deadline
of December 2007.
20
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $7.3 million, or 176.1%, to
$11.4 million for the three months ended September 30, 2007 when
compared to the same period last year. During the three months ended
September 30, 2007, depreciation and amortization expense was $6.5
million for Radiologix, which includes $1.1 million of amortization of
intangible assets associated with the fair value of management service
agreements and covenants not to compete. Depreciation and amortization
expense excluding Radiologix increased $800,000 for the three months
ended September 30, 2007 when compared to the same period last year.
The increase is primarily due to property and equipment additions as
well as the acceleration of the amortization of leasehold improvements
related to our vacated San Gabriel facility of approximately $184,000.
PROVISION FOR BAD DEBT
Provision for bad debts increased $4.7 million, or 276.8%, to $6.4
million, or 5.8% of net revenue, for the three months ended September
30, 2007 compared to $1.7 million, or 4.2% of net revenue, for the
three months ended September 30, 2006. During the three months ended
September 30, 2007, the provision for bad debt was $5.1 million, or
7.6% of net revenue, for Radiologix. Historically, Radiologix has
experienced higher bad debt expense as compared to our business
pre-acquisition due to the higher concentration of business associated
with hospital payers in the markets that Radiologix serves and the poor
collection percentages that are inherent with hospital business.
Provision for bad debts excluding Radiologix decreased $400,000 for the
three months ended September 30, 2007 when compared to the same period
last year.
INTEREST EXPENSE
Interest expense for the three months ended September 30, 2007 increased
approximately $5.5 million, or 90.3%, from the same period in 2006. The increase
was primarily due to the increased indebtedness of $360 million incurred upon
the acquisition of Radiologix as well as an addition to our first lien Term Loan
B of $25 million in August 2007. Also included is the amortization of our
deferred finance costs associated with this new financing which was
approximately $498,000 for the three months ended September 30, 2007 as well as
realized losses on our fair value hedges of $712,000 for the three months ended
September 30, 2007.
MINORITY INTEREST IN INCOME OF SUBSIDIARIES
For the three months ended September 30, 2007, we recognized $198,000 in
minority interest expense related to consolidated joint ventures of Radiologix.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURES
For the three months ended September 30, 2007, we recognized equity in
earnings from unconsolidated joint ventures of $1,103,000, including $1,079,000
from investments of Radiologix and $24,000 from an investment in a PET center in
Palm Desert, California.
NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2006
NET REVENUE
Net revenue for the nine months ended September 30, 2007 was $323.1
million compared to $120.0 million for the nine months ended September
30, 2006, an increase of $203.0 million, or 169.1%. Net revenue from
the acquisition of Radiologix, effective November 15, 2006, was $197.6
million for the nine months ended September 30, 2007. Net revenue
excluding Radiologix increased $5.4 million for the nine months ended
September 30, 2007 when compared to the same period last year. This
increase is mainly due to an increase in procedure volumes from
existing centers as well as from the addition of new centers and is net
of the effects of reimbursement reductions experienced as a result of
the government's reduction of certain Medicare payments (DRA), which
became effective in January 2007.
21
OPERATING EXPENSES
Operating expenses for the nine months ended September 30, 2007
increased approximately $154.3 million, or 171.1%, from $90.1 million
for the nine months ended September 30, 2006 to $244.4 million for the
nine months ended September 30, 2007. The following table sets forth
our operating expenses for the nine months ended September 30, 2007 and
2006 (in thousands):
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2007 2006
-------- --------
Salaries and professional reading fees (excluding stock based compensation and severance) $130,614 $ 56,475
Stock based compensation 2,883 392
Building and equipment rental 31,033 6,484
General administrative expenses 79,755 26,797
NASDAQ one-time listing fee 120 --
-------- --------
Total operating expenses $244,405 $ 90,148
======== ========
Depreciation and amortization $ 32,495 $ 12,186
Provision for bad debts 20,810 5,022
Loss on sale of equipment, net -- 373
Severance costs 815 --
SALARIES AND PROFESSIONAL READING FEES (EXCLUDING STOCK COMPENSATION
AND SEVERANCE)
Salaries and professional reading fees increased $74.1 million, or
131.3%, to $130.6 million for the nine months ended September 30, 2007
compared to $56.5 million for the nine months ended September 30, 2006.
During the nine months ended September 30, 2007, salaries and
professional reading fees were $67.0 million for Radiologix. Salaries
excluding Radiologix increased $7.1 million for the nine months ended
September 30, 2007 when compared to the same period last year, which is
in line with DRA effected increases in net revenue and increases in our
procedure volumes.
STOCK BASED COMPENSATION
Stock compensation increased $2.5 million to $2.9 million for the nine
months ended September 30, 2007 compared to $392,000 for the nine
months ended September 30, 2006. This increase is primarily due to
additional options and warrants granted during the last three months of
2006 and the first nine months of 2007. Also included in this increase
is $1.7 million of additional stock based compensation expense recorded
during the nine months ended September 30, 2007 as a result of the
vesting of warrants.
Messrs. Linden, Hames and Stolper who hold the positions of Executive
Vice President and General Counsel, Executive Vice President and Chief
Operating Officer, Western Operations and Executive Vice President and
Chief Financial Officer, respectively, were issued certain warrants in
prior periods which fully vest upon the sooner of their respective
multi-year vesting schedules or at such time as the 30 day average
closing stock price of our shares in the public market in which it
trades equals or exceeds $6.00. For the 30 day trading period ended
March 7, 2007, the average closing price exceeded $6.00 per share.
Accordingly, these warrants fully vested resulting in the full
expensing of the remaining unamortized fair value of these warrants of
$1.7 million.
SEVERANCE
During the nine months ended September 30, 2007, we recorded severance
costs of $815,000 associated with the integration of Radiologix.
BUILDING AND EQUIPMENT RENTAL
Building and equipment rental expenses increased $24.6 million, or
378.6%, to $31.0 million for the nine months ended September 30, 2007
compared to $6.5 million for the nine months ended September 30, 2006.
During the nine months ended September 30, 2007, building and equipment
rental expense was $22.4 million for Radiologix. Building and equipment
rental expenses excluding Radiologix increased $2.2 million for the
nine months ended September 30, 2007
22
when compared to the same period in the previous year. The increase was
due to normal consumer price index escalations built into existing
operating leases as well as additional facility rent from new centers
including approximately $288,000 from centers acquired during 2007 (see
Note 3 to our consolidated financial statements). Also included in this
increase is $638,000 resulting from straight-lining the built-in rent
escalators existing in some of our lease contracts.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business
tax and license, outside services, utilities, marketing, travel and
other expenses. Many of these expenses are variable in nature,
including medical supplies and billing fees, which increase with volume
and repairs, and maintenance under our GE service agreement at 3.62% of
net revenue for the nine-month period. Overall, general and
administrative expenses increased $53.0 million, or 197.6%, for the
nine months ended September 30, 2007 compared to the previous period.
During the nine months ended September 30, 2007, general and
administrative expenses were $46.5 million for Radiologix. General and
administrative expenses excluding Radiologix increased $6.5 million for
the nine months ended September 30, 2006 when compared to the same
period last year. The increase is in line with our increase in
procedure volumes at both existing centers as well as new centers. Also
in this increase are increased expenditures for accounting fees
associated with our efforts towards compliance with the Sarbanes-Oxley
Act of 2002 by our deadline of December 2007.
NASDAQ ONE-TIME LISTING FEE
During the nine months ended September 30, 2007, we recorded $120,000
for fees associated with listing our common stock with NASDAQ.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $20.3 million, or 166.7%, to
$32.5 million for the nine months ended September 30, 2007 when
compared to the same period last year. During the nine months ended
September 30, 2007, depreciation and amortization expense was $18.1
million for Radiologix, which includes $3.2 million of amortization of
intangible assets associated with the fair value of management service
agreements and covenants not to compete. Depreciation and amortization
expense excluding Radiologix increased $2.2 million for the nine months
ended September 30, 2007 when compared to the same period last year
primarily due to property and equipment additions, as well as the
acceleration of the amortization of leasehold improvements related to
our vacated Orange, Rancho Bernardo and San Gabriel facilities of
approximately $716,000.
PROVISION FOR BAD DEBT
Provision for bad debt increased $15.8 million, or 314.4%, to $20.8
million, or 6.4% of net revenue, for the nine months ended September
30, 2007 compared to $5.0 million, or 4.2% of net revenue, for the nine
months ended September 30, 2006. During the nine months ended September
30, 2007, the provision for bad debt was $15.8 million, or 8.0% of net
revenue, for Radiologix. Historically, Radiologix has experienced
higher bad debt as compared to our business pre-acquisition due to the
higher concentration of business associated with hospital payers in the
markets that Radiologix serves and the poor collection percentages that
are inherent with hospital business. Provision for bad debts excluding
Radiologix was unchanged at $5.0 million for the nine months ended
September 30, 2007 and 2006.
INTEREST EXPENSE
Interest expense for the nine months ended September 30, 2007 increased
approximately $16.9 million, or 109.1%, from the same period in 2006. The
increase was primarily due to the increased indebtedness of $360 million
incurred upon the acquisition of Radiologix as well as an addition to our first
lien Term Loan B of $25 million in August 2007. Also included is the
amortization of our deferred finance costs associated with this new financing
which was approximately $1.5 million for the nine months ended September 30,
2007 as well as realized losses on our fair value hedges of $155,000 for the
nine months ended September 30, 2007.
23
MINORITY INTEREST IN INCOME OF SUBSIDIARIES
For the nine months ended September 30, 2007, we recognized $483,000 in
minority interest expense related to consolidated joint ventures of Radiologix.
EQUITY IN EARNINGS FROM UNCONSOLIDATED JOINT VENTURES
For the nine months ended September 30, 2007, we recognized equity in
earnings from unconsolidated joint ventures of $3,080,000 including $3,008,000
from investments of Radiologix and $72,000 from an investment in a PET center in
Palm Desert, California.
LIQUIDITY AND CAPITAL RESOURCES
On November 15, 2006, we entered into a $405 million senior secured
credit facility with GE Commercial Finance Healthcare Financial Services (the
"November 2006 Credit Facility"). This facility was used to finance our
acquisition of Radiologix, refinance existing indebtedness, pay transaction
costs and expenses relating to our acquisition of Radiologix, and to provide
financing for working capital needs post-acquisition. The facility consists of a
revolving credit facility of up to $45 million, a $225 million first lien Term
Loan and a $135 million second lien Term Loan. The revolving credit facility has
a term of five years, the term loan has a term of six years and the second lien
term loan has a term of six and one-half years. Interest is payable on all loans
initially at an Index Rate plus the Applicable Index Margin, as defined. The
Index Rate is initially a floating rate equal to the higher of the rate quoted
from time to time by The Wall Street Journal as the "base rate on corporate
loans posted by at least 75% of the nation's largest 30 banks" or the Federal
Funds Rate plus 50 basis points. The Applicable Index Margin on each of the
revolving credit facility and the term loan is 2% and on the second lien term
loan is 6%. We may request that the interest rate instead be based on LIBOR plus
the Applicable LIBOR Margin, which is 3.5% for the revolving credit facility and
the term loan and 7.5% for the second lien term loan. The credit facility
includes customary covenants for a facility of this type, including minimum
fixed charge coverage ratio, maximum total leverage ratio, maximum senior
leverage ratio, limitations on indebtedness, contingent obligations, liens,
capital expenditures, lease obligations, mergers and acquisitions, asset sales,
dividends and distributions, redemption or repurchase of equity interests,
subordinated debt payments and modifications, loans and investments,
transactions with affiliates, changes of control, and payment of consulting and
management fees.
On August 23, 2007 we secured an incremental $35 million ("Incremental
Facility") as part of our existing credit facilities with GE Commercial Finance
Healthcare Financial Services. The Incremental Facility consists of an
additional $25 million as part of our first lien Term Loan B and $10 million of
additional capacity under our existing revolving line of credit. The Incremental
Facility will be used to fund certain identified strategic initiatives and for
general corporate purposes. The terms of our first lien term loan as explained
above will remain unchanged.
As part of the financing, we swapped 50% of the aggregate principal
amount of the facilities to a floating rate within 90 days of the closing. On
April 11, 2006, effective April 28, 2006, we entered into an interest rate swap
on $73.0 million fixing the LIBOR rate of interest at 5.47% for a period of
three years. This swap was made in conjunction with the $161.0 million credit
facility that closed on March 9, 2006. In addition, on November 15, 2006, we
entered into an interest rate swap on $107.0 million fixing the LIBOR rate of
interest at 5.02% for a period of three years, and on November 28, 2006, we
entered into an interest rate swap on $90.0 million fixing the LIBOR rate of
interest at 5.03% for a period of three years. Previously, the interest rate on
the above $270.0 million portion of the credit facility was based upon a spread
over LIBOR which floats with market conditions.
The Company documents its risk management strategy and hedge
effectiveness at the inception of the hedge, and, unless the instrument
qualifies for the short-cut method of hedge accounting, over the term of each
hedging relationship. The Company's use of derivative financial instruments is
limited to interest rate swaps, the purpose of which is to hedge the cash flows
of variable-rate indebtedness. The Company does not hold or issue derivative
financial instruments for speculative purposes. In accordance with Statement of
Financial Accounting Standards No. 133, derivatives that have been designated
and qualify as cash flow hedging instruments are reported at fair value. The
gain or loss on the effective portion of the hedge (i.e., change in fair value)
is initially reported as a component of other comprehensive income in the
Company's Consolidated Statement of Stockholders' Equity. The remaining gain or
loss, if any, is recognized currently in earnings. Of the derivatives that were
not designated as cash flow hedging instruments, we recorded an increase to
interest expense of approximately $289,000 for the nine months ended September
30, 2007. The corresponding liability of $442,000 is included in the other
non-current liabilities in the consolidated balance sheet at September 30, 2007.
This liability was $710,000 at December 31, 2006.
24
We operate in a capital intensive, high fixed-cost industry that
requires significant amounts of capital to fund operations. In addition to
operations, we require significant amounts of capital for the initial start-up
and development expense of new diagnostic imaging facilities, the acquisition of
additional facilities and new diagnostic imaging equipment, and to service our
existing debt and contractual obligations. Because our cash flows from
operations have been insufficient to fund all of these capital requirements, we
have depended on the availability of financing under credit arrangements with
third parties.
Our business strategy with regard to operations will focus on the
following:
|X| Maximizing performance at our existing facilities;
|X| Focusing on profitable contracting;
|X| Expanding MRI, CT and PET applications;
|X| Optimizing operating efficiencies; and
|X| 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 the next twelve
months.
SOURCES AND USES OF CASH
Cash decreased during the nine months ended September 30, 2007 to zero
from $3.2 million at December 31, 2006.
Cash provided by operating activities for the nine months ended
September 30, 2007 was $20.7 million compared to $7.8 million for the same
period in 2006.
Cash used by investing activities for the nine months ended September
30, 2007 was $34.3 million compared to cash used of $10.9 million for the same
period in 2006. For the nine months ended September 30, 2007 and 2006, we
purchased property and equipment for approximately $19.4 million and $7.5
million, respectively. During the nine months ended September 30, 2007, we
recorded the purchase of imaging facilities of $15.7 million (see Note 3 to our
consolidated financial statements) compared to $3.4 million during the nine
months ended September 30, 2006. Also, during the nine months ended September
30, 2007, we generated $1.3 million of cash from the sale of one of our imaging
facilities acquired through our purchase of Radiologix.
Cash generated from financing activities for the nine months ended
September 30, 2007 was $10.4 million compared to $3.1 million for the same
period in 2006. The primary source of cash during the nine months ended
September 30, 2007 is our addition to our first lien term loan B with GE of $25
million. This was offset by the classification of $6.9 million as restricted
under the terms of our addition to our first lien term loan B. Also included in
our cash generated from financing was $549,000 of cash from the issuance of our
common stock through the exercise of options and warrants.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 applies under most other accounting
pronouncements that require or permit fair value measurements and does not
require any new fair value measurements. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years, with earlier application
encouraged. The provisions of SFAS No. 157 should be applied prospectively as of
the beginning of the fiscal year in which the Statement is initially applied,
except for a limited form of retrospective application for certain financial
instruments. The Company will adopt this statement for fiscal year 2009.
Management has not determined the effect the adoption of this statement will
have on its consolidated financial position or results of operations.
In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION
FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES, which permits entities to choose
to measure many financial instruments and certain warranty and insurance
contracts at fair value on a contract-by-contract basis. SFAS No. 159 is
effective as of the beginning of an entity's first fiscal year that begins after
November 15, 2007 (January 1, 2008 for calendar year-end companies). Management
has not determined the effect the adoption of this statement will have on its
consolidated financial position or results of operations.
25
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These forward-looking statements reflect, among other things, management's
current expectations and anticipated results of operations, all of which are
subject to known and unknown risks, uncertainties and other factors that may
cause our actual results, performance or achievements, or industry results, to
differ materially from those expressed or implied by such forward-looking
statements. Therefore, any statements contained herein that are not statements
of historical fact may be forward-looking statements and should be evaluated as
such. Without limiting the foregoing, the words "believes," "anticipates,"
"plans," "intends," "will," "expects," "should" and similar words and
expressions are intended to identify forward-looking statements. Except as
required under the federal securities laws or by the rules and regulations of
the SEC, we assume no obligation to update any such forward-looking information
to reflect actual results or changes in the factors affecting such
forward-looking information. The factors included in "Risks Relating to Our
Business," in our Annual Report on Form 10-K for the fiscal year ended October
31, 2006 and our Transition Report on Form 10-K/T for the two month transition
period ended December 31, 2006, among others, could cause our actual results to
differ materially from those expressed in, or implied by, the forward-looking
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We sell our services exclusively in the United States and receive
payment for our services exclusively in United States dollars. As a result, our
financial results are unlikely to be affected by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
A large portion of our interest expense is not sensitive to changes in
the general level of interest in the United States because the majority of our
indebtedness has interest rates that were fixed when we entered into the note
payable or capital lease obligation. On November 15, 2006, we entered into a
$405 million senior secured credit facility with GE Commercial Finance
Healthcare Financial Services. This facility was used to finance our acquisition
of Radiologix, refinance existing indebtedness, pay transaction costs and
expenses relating to our acquisition of Radiologix, and to provide financing for
working capital needs post-acquisition. The facility consists of a revolving
credit facility of up to $45 million, a $225 million term loan and a $135
million second lien term loan. The revolving credit facility has a term of five
years, the term loan has a term of six years and the second lien term loan has a
term of six and one-half years. Interest is payable on all loans initially at an
Index Rate plus the Applicable Index Margin, as defined. The Index Rate is
initially a floating rate equal to the higher of the rate quoted from time to
time by The Wall Street Journal as the "base rate on corporate loans posted by
at least 75% of the nation's largest 30 banks" or the Federal Funds Rate plus 50
basis points. The Applicable Index Margin on each the revolving credit facility
and the term loan is 2% and on the second lien term loan is 6%. We may request
that the interest rate instead be based on LIBOR plus the Applicable LIBOR
Margin, which is 3.5% for the revolving credit facility and the term loan and
7.5% for the second lien term loan. The credit facility includes customary
covenants for a facility of this type, including minimum fixed charge coverage
ratio, maximum total leverage ratio, maximum senior leverage ratio, limitations
on indebtedness, contingent obligations, liens, capital expenditures, lease
obligations, mergers and acquisitions, asset sales, dividends and distributions,
redemption or repurchase of equity interests, subordinated debt payments and
modifications, loans and investments, transactions with affiliates, changes of
control, and payment of consulting and management fees.
As part of the financing, we swapped at least 50% of the aggregate
principal amount of the facilities to a floating rate within 90 days of the
close of the agreement. On April 11, 2006, effective April 28, 2006, we entered
into an interest rate swap on $73.0 million fixing the LIBOR rate of interest at
5.47% for a period of three years. This swap was made in conjunction with the
$161.0 million credit facility closed on March 9, 2006. In addition, on November
15, 2006, we entered into an interest rate swap on $107.0 million fixing the
LIBOR rate of interest at 5.02% for a period of three years, and on November 28,
2006, we entered into an interest rate swap on $90.0 million fixing the LIBOR
rate of interest at 5.03% for a period of three years. Previously, the interest
rate on the above $270.0 million portion of the credit facility was based upon a
spread over LIBOR which floated with market conditions.
In addition, our credit facility, classified as a long-term liability
on our financial statements, is interest expense sensitive to changes in the
general level of interest because it is based upon the current prime rate plus a
factor.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we performed an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based
upon that evaluation, our Chief Executive Officer and our Chief Financial
Officer concluded that our disclosure controls and procedures are not effective
in alerting them prior to the end of a reporting period to all material
information required to be included in our periodic
26
filings with the SEC because we identified the following material weakness in
the design of internal control over financial reporting: We concluded that we
had insufficient processes to identify and resolve non-routine accounting
matters, such as the identification of accrued liabilities associated with
employee retention bonuses earned over specific time periods. The incorrect
accounting for the foregoing was sufficient to lead management to conclude that
a material weakness in the design of internal control over the accounting for
non-routine transactions existed at September 30, 2007.
We determined to change the design of our internal controls over
non-routine accounting matters by the identification of an outside resource at a
recognized professional services company that we can consult with on non-routine
transactions and the employment of qualified accounting personnel to deal with
this issue together with the utilization of other senior corporate accounting
staff, who are responsible for reviewing all non-routine matters and preparing
formal reports on their conclusions, and conducting quarterly reviews and
discussions of all non-routine accounting matters with our independent public
accountants. We engaged MorganFranklin, a consulting firm with the requisite
accounting expertise, to assist us, from time to time, in the evaluation and
application of the appropriate accounting treatment, to provide support in the
form of technical analysis related to accounting and financial reporting matters
that may arise, and to provide management advice with respect to their
preliminary conclusions regarding issues we wish to bring to their attention. To
the extent our Chief Financial Officer identifies any non-routine accounting
matters which require resolution, he will contact MorganFranklin and work
closely with them, our audit committee and our auditors to resolve any issues.
We are continuing to evaluate additional controls and procedures that we can
implement and have added additional accounting personnel during fiscal 2007 to
enhance our accounting processes and technical accounting resources. We do not
anticipate that the cost of this remediation effort will be material to our
financial statements. We believe that the engagement of MorganFranklin and use
of their services should adequately address the identified weakness. With the
acquisition of Radiologix we have added additional technical accounting staff
from their organization which we believe will further reduce any material
weakness.
It should be noted that any system of controls, however well designed
and operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system will be met. In addition, the design of any control
system is based in part upon certain assumptions about the likelihood of future
events.
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
At September 30, 2007, the status of all current legal matters
previously disclosed in Part 1, Item 3, of our Form 10-K/T for the two months
ended December 31, 2006 and Part II, Item 1 of our Form 10-Q for the quarter
ended June 30, 2007 is unchanged.
ITEM 1A RISK FACTORS
In addition to the other information set forth in this report, we urge
you to carefully consider the factors discussed in Part I, "Item 1A Risk
Factors" in our Form 10-K for the year ended October 31, 2006 and our Form
10-K/T for the two months ended December 31, 2006, which could materially affect
our business, financial condition and results of operations. The risks described
in our Forms 10-K and 10-K/T are not the only risks facing our Company.
Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and/or operating results.
ITEM 6 EXHIBITS
The list of exhibits filed as part of this report is incorporated by
reference to the Index to Exhibits at the end of this report.
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
RADNET, INC.
(Registrant)
Date: November 14, 2007 By /s/ Howard G. Berger, M.D.
-----------------------------------
Howard G. Berger, M.D., President,
Chief Executive Officer and Chairman
(Principal Executive Officer)
Date: November 14, 2007 By /s/ Mark D. Stolper
----------------------------------------
Mark D. Stolper, Chief Financial Officer
(Principal Financial and Accounting
Officer)
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1 Amendment No. 3 to Credit Agreement (1)
10.2 Amendment No. 3 to Second Lien Credit Agreement (2)
31.1 Certification of Howard G. Berger, M.D. pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. *
31.2 Certification of Mark D. Stolper pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. *
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 of
Howard G. Berger, M.D. *
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 of
Mark D. Stolper *
--------------------------------------------------------------------------------
* Filed herewith.
(1) Incorporated by reference to exhibit 99.1 filed with Form 8-K
for August 24, 2007.
(2) Incorporated by reference to exhibit 99.2 filed with Form 8-K
for August 24, 2007.
29