RadNet (RDNT)

 

States in which we operate have adopted certain laws and regulations affecting risk assumption in the healthcare industry, including those that subject any physician or physician network engaged in risk-based managed care to applicable insurance laws and regulations. These laws and regulations may require physicians and physician networks to meet minimum capital requirements and other safety and soundness requirements. Implementing additional regulations or compliance requirements could result in substantial costs to the contracted radiology practices, limiting their ability to enter into capitated or other risk-sharing managed care arrangements and indirectly affecting our revenue from the contracted practices.

 

Environmental Matters

 

The facilities we operate or manage generate hazardous and medical waste subject to federal and state requirements regarding handling and disposal. We believe that the facilities that we operate and manage are currently in compliance in all material respects with applicable federal, state and local statutes and ordinances regulating the handling and disposal of such materials. We do not believe that we will be required to expend any material additional amounts in order to remain in compliance with these laws and regulations or that compliance will materially affect our capital expenditures, earnings or competitive position.

 

 

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Deficit Reduction Act of 2005 (DRA)

 

On February 8, 2006, the President signed into law the DRA.  Effective January 1, 2007, the DRA provides that Medicare reimbursement for the technical component for imaging services (excluding diagnostic and screening mammography) performed in freestanding facilities will be capped.  Payment will be the lesser of the Medicare Physician Fee Schedule or the Hospital Outpatient Prospective Payment System (HOPPS) rates.  Implementation of these reimbursement reductions contained in the DRA has had a significant adverse effect on our business, financial condition and results of operations.

 

The DRA also codified the reduction in reimbursement for multiple images on contiguous body parts previously announced by CMS, the agency responsible for administering the Medicare program.  In November 2005, CMS announced that it would pay 100% of the technical component of the higher priced imaging procedure and 50% of the technical component of each additional imaging procedure for imaging procedures involving contiguous body parts within a family of codes when performed in the same session.  CMS had indicated that it would phase in this 50% rate reduction over two years, so that the reduction was 25% for each additional imaging procedure in 2006 and another 25% in 2007.  To date, CMS has implemented the 25% reduction for each additional procedure but has not yet implemented the additional 25% reduction scheduled for 2007.  However, for services furnished on or after July 1, 2010, the PPACA which, as stated above, was signed into law on March 23, 2010, requires the full 50% reduction to be implemented.  We have determined that the impact of this final 25% reduction is, and will be in the future, immaterial to our operating results.

Item 1A.

Risk Factors

 

If BRMG or any of our other contracted radiology practices terminate their agreements with us, our business could substantially diminish.

 

 Our relationship with BRMG is an integral part of our business. Through our management agreement, BRMG provides all of the professional medical services at 91 of our 101 California facilities. Professional medical services are provided at the balance of our other facilities through management contracts with other radiology groups. BRMG and these other radiology groups contract with various other independent physicians and physician groups to provide all of the professional medical services at most of our facilities, and they must use their best efforts to provide the professional medical services at any new facilities that we open or acquire in their areas of operation. In addition, BRMG and the other radiology groups’ strong relationships with referring physicians are largely responsible for the revenue generated at the facilities they service. Although our management agreement with BRMG runs until 2014, and for terms as long, if not longer, with the other groups, BRMG and the other radiology groups have the right to terminate the agreements if we default on our obligations and fail to cure the default. Also, the various radiology groups’ ability to continue performing under the management agreements may be curtailed or eliminated due to the groups’ financial difficulties, loss of physicians or other circumstances. If the radiology groups cannot perform their obligations to us, we would need to contract with one or more other radiology groups to provide the professional medical services at the facilities serviced by the group. We may not be able to locate radiology groups willing to provide those services on terms acceptable to us, if at all. Even if we were able to do so, any replacement radiology group’s relationships with referring physicians may not be as extensive as those of the terminated group. In any such event, our business could be seriously harmed. In addition, the radiology groups are party to substantially all of the managed care contracts from which we derive revenue. If we were unable to readily replace these contracts, our revenue would be negatively affected.

 

Adverse changes in general domestic and worldwide economic conditions and instability and disruption of credit markets could adversely affect our operating results, financial condition, or liquidity.

 

We are subject to risk arising from adverse changes in general domestic and global economic conditions, including recession or economic slowdown and disruption of credit markets. Recent global market and economic conditions have been unprecedented and challenging with tighter credit conditions and recession in most major economies continuing into 2010. Continued concerns about the systemic impact of potential long-term and wide-spread recession, inflation, energy costs, geopolitical issues, the availability and cost of credit and the United States mortgage market have contributed to increased market volatility and diminished expectations for the United States economy. Added concerns fueled by the United States government's financial assistance to certain companies and other federal government’s interventions in the United States financial system has led to increased market uncertainty and instability in both United States and international capital and credit markets. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have contributed to volatility of unprecedented levels. We believe our MRI and PET/CT scan volumes were impacted in 2009 and 2010 by rising unemployment rates, the number of under-insured or uninsured patients and other conditions arising from the global economic conditions described above.

 

As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers.

 

 

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Continued turbulence in the United States and international markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability, and the ability of our customers, to timely replace maturing liabilities, and access the capital markets to meet liquidity needs, resulting in adverse effects on our financial condition and results of operations.

 

We have experienced operating losses and we have a substantial accumulated deficit. If we are unable to improve our financial performance, we may be unable to pay our obligations.

 

We have incurred net losses of $12.9 million, $2.3 million and $12.8 million, for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, our accumulated deficit was $82.5 million. We have been successful in significantly reducing our net losses over the past two years. Our net loss for the year ended December 31, 2010 included a $9.9 million loss on extinguishment of debt related to our debt refinancing completed on April 6, 2010.  We expect to continue this trend and to begin generating net income. However, we cannot provide any assurances as to the likelihood, timing, or extent of our ability to achieve net income from operations. If we cannot generate income from operations in sufficient amounts, we will not be able to pay our obligations as they become due. Our inability to generate income from operations to pay our obligations could adversely impact our business, financial condition and results of operations.

 

Our substantial debt could adversely affect our financial condition and prevent us from fulfilling our obligations under our unsecured senior notes.

Our current substantial indebtedness and any future indebtedness we incur could adversely affect our financial condition. We are highly leveraged. As of December 31, 2010, our total indebtedness was $504.6 million, $482.9 million of which constituted senior secured indebtedness. Our substantial indebtedness could also:

	●	make it difficult for us to satisfy our obligations with respect to our outstanding indebtedness;
	●	require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes;
	●	expose us to the risk of interest rate increases on our variable rate borrowings, including borrowings under our new senior secured credit facilities;
	●	increase our vulnerability to adverse general economic and industry conditions;
	●	limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
	●	place us at a competitive disadvantage compared to our competitors that have less debt; and
	●	limit our ability to borrow additional funds on terms that are satisfactory to us or at all.

We may not be able to finance future needs or adapt our business plan to changes because of restrictions placed on us by our New Credit Facilities, the indenture governing our senior unsecured notes and instruments governing our other indebtedness.

 

The indenture governing the senior unsecured notes and our New Credit Facilities contain affirmative and negative covenants which restrict, among other things, our ability to:

 

●

pay dividends or make certain other restricted payments or investments;

 

●

incur additional indebtedness and issue preferred stock;

 

●

create liens (other than permitted liens) securing indebtedness or trade payables unless the notes are secured on an equal and ratable basis with the obligations so secured, and, if such liens secure subordinated indebtedness, the notes are secured by a lien senior to such liens;

 

●

sell certain assets or merge with or into other companies or otherwise dispose of all or substantially all of our assets;

 

●

enter into certain transactions with affiliates;

 

●

create restrictions on dividends or other payments by our restricted subsidiaries; and

 

●

create guarantees of indebtedness by restricted subsidiaries.

 

 

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All of these restrictions could affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise.  A failure to comply with these covenants and restrictions would permit the relevant creditors to declare all amounts borrowed under the applicable agreement governing such indebtedness, together with accrued interest and fees, to be immediately due and payable.  If the indebtedness under the New Credit Facilities or the senior unsecured notes is accelerated, we may not have sufficient assets to repay amounts due under the New Credit Facilities, the senior unsecured notes or on other indebtedness then outstanding.

 

Our success depends in part on our key personnel and loss of key executives could adversely affect our operations. In addition, former employees and radiology practices we have previously contracted with could use the experience and relationships developed while employed or under contract with us to compete with us.

 

Our success depends in part on our ability to attract and retain qualified senior and executive management, managerial and technical personnel. Competition in recruiting these personnel may make it difficult for us to continue our growth and success. The loss of their services or our inability in the future to attract and retain management and other key personnel could hinder the implementation of our business strategy. The loss of the services of Dr. Howard G. Berger, our President and Chief Executive Officer, and Norman R. Hames or Stephen M. Forthuber, our Chief Operating Officers, west and east coast, respectively, could have a significant negative impact on our operations. We believe that they could not easily be replaced with executives of equal experience and capabilities. We do not maintain key person insurance on the life of any of our executive officers with the exception of a $5.0 million policy on the life of Dr. Berger. Also, if we lose the services of Dr. Berger, our relationship with BRMG could deteriorate, which would materially adversely affect our business.

 

Many of the states in which we operate do not enforce agreements that prohibit a former employee from competing with a former employer. As a result, many of our employees whose employment is terminated are free to compete with us, subject to prohibitions on the use of confidential information and, depending on the terms of the employee’s employment agreement, on solicitation of existing employees and customers. A former executive, manager or other key employee who joins one of our competitors could use the relationships he or she established with third party payors, radiologists or referring physicians while our employee and the industry knowledge he or she acquired during that tenure to enhance the new employer’s ability to compete with us.

 

The agreements with most of our radiology practices contain non-compete provisions however the enforceability of these provisions is determined by a court based on all the facts and circumstances of the specific case at the time enforcement is sought. Our inability to enforce radiologists’ non-compete provisions could result in increased competition from individuals who are knowledgeable about our business strategies and operations.

  

The California budget crisis, if not successfully resolved could have an impact on our revenue.

 

California is experiencing a budget crisis which has resulted in significant state government cutbacks. 101 of our 201 facilities are located in California. One to one-and-one-half percent (1% to 1.5%) of our revenues come from the California Medicaid program ($5 million to $7.5 million). To the extent California is unable to provide these payments on a timely basis, or at all, our revenues will be negatively impacted.

 

Our failure to integrate the businesses we acquire successfully and on a timely basis could reduce our profitability.

 

We may never realize expected synergies, business opportunities and growth prospects in connection with our acquisitions. We may experience increased competition that limits our ability to expand our business. We may not be able to capitalize on expected business opportunities, assumptions underlying estimates of expected cost savings may be inaccurate, or general industry and business conditions may deteriorate. In addition, integrating operations will require significant efforts and expenses on our part. Personnel may leave or be terminated because of an acquisition. Our management may have its attention diverted while trying to integrate an acquisition. If these factors limit our ability to integrate the operations of an acquisition successfully or on a timely basis, our expectations of future results of operations, including certain cost savings and synergies as a result of the acquisition, may not be met. In addition, our growth and operating strategies for a target’s business may be different from the strategies that the target company pursued prior to our acquisition. If our strategies are not the proper strategies, it could have a material adverse effect on our business, financial condition and results of operations.

 

Our ability to generate revenue depends in large part on referrals from physicians.

 

A significant reduction in physician referrals would have a negative impact on our business. We derive substantially all of our net revenue, directly or indirectly, from fees charged for the diagnostic imaging services performed at our facilities. We depend on referrals of patients from unaffiliated physicians and other third parties who have no contractual obligations to refer patients to us for a substantial portion of the services we perform. If a sufficiently large number of these physicians and other third parties were to discontinue referring patients to us, our scan volume could decrease, which would reduce our net revenue and operating margins. Further, commercial third-party payors have implemented programs that could limit the ability of physicians to refer patients to us. For example, prepaid healthcare plans, such as health maintenance organizations, sometimes contract directly with providers and require their enrollees to obtain these services exclusively from those providers. Some insurance companies and self-insured employers also limit these services to contracted providers. These “closed panel” systems are now common in the managed care environment. Other systems create an economic disincentive for referrals to providers outside the system’s designated panel of providers. If we are unable to compete successfully for these managed care contracts, our results and prospects for growth could be adversely affected.

 

 

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The regulatory framework in which we operate is uncertain and evolving.

 

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

 

Certain states have enacted statutes or adopted regulations affecting risk assumption in the healthcare industry, including statutes and regulations that subject any physician or physician network engaged in risk-based managed care contracting to applicable insurance laws and regulations. These laws and regulations, if adopted in the states in which we operate, may require physicians and physician networks to meet minimum capital requirements and other safety and soundness requirements. Implementing additional regulations or compliance requirements could result in substantial costs to us and the contracted radiology practices and limit our ability to enter into capitation or other risk-sharing managed care arrangements.

 

Changes in the method or rates of third-party reimbursement could have a negative impact on our results.>

From time to time, changes designed to contain healthcare costs have been implemented, some of which have resulted in decreased reimbursement rates for diagnostic imaging services that impact our business.  For services for which we bill Medicare directly, we are paid under the Medicare Physician Fee Schedule, which is updated on an annual basis.  Under the Medicare statutory formula, payments under the Physician Fee Schedule would have decreased for the past several years if Congress failed to intervene.  For example, for 2008, the fee schedule rates were to be reduced by approximately 10.1%.  The Medicare, Medicaid and SCHIP Extension Act of 2007 eliminated the 10.1% reduction for 2008 and increased the annual payment rate update by 0.5%.  This increase to the annual Medicare Physician Fee Schedule payment update was effective only for Medicare claims with dates of service between January 1, 2008 and June 30, 2008.  Beginning July 1, 2008, under the Medicare Improvement for Patients and Providers Act of 2008 (MIPPA), the 0.5% increase was continued for the rest of 2008.  In addition, MIPPA established a 1.1% increase to the Medicare Physician Fee Schedule payment update for 2009.  For 2010, CMS projected a rate reduction of 21.2% in the absence of Congressional intervention.  However, over the course of the first six months of 2010, various temporary solutions were enacted by Congress which resulted in delaying any such change to the physician fee schedule.  Ultimately, a 2.2% increase in the conversion factor was passed by Congress effective June 1, 2010, further delaying the pending 21.2% conversion factor reduction to November 30, 2010.  On November 2, 2010, CMS released the calendar year 2011 Medicare Physician Fee Schedule.  The rule would have significantly reduced physician fee schedule payments in 2011 had Congress not acted by passing the Physician Payment and Therapy Relief Act of 2010 and the Medicare and Medicaid Extenders Act of 2010, which together continue the 2.2% update from June 2010 through December 31, 2011.  While Congress has historically provided temporary relief from the formula-driven reductions in the conversion factor, it cannot be guaranteed that Congress will act to provide relief in the future. The failure of Congress to act could adversely impact our revenues and results of operation.

MIPPA also modified the methodology by which the budget neutrality formula was applied to the 2009 physician fee schedule payment rates, resulting in an overall reduction in payment rates for services performed by many specialties, including an estimated 3% reduction for radiation oncology and 1% reduction for nuclear medicine.  The impact of these payment rate reductions could impact the Company's future revenue depending upon our service mix.

 

A number of other legislative changes impact our business.  For example, DRA imposed caps on Medicare payment rates for certain imaging services furnished in physician's offices and other non-hospital based settings.  The caps impact MRI and PET/CT.  Under the cap, payments for specified imaging services cannot exceed the hospital outpatient payment rates for those services.  This change applies to services furnished on or after January 1, 2007.  The limitation is applicable to the technical components of the diagnostic imaging services only, which is the payment we receive for the services for which we bill directly under the Medicare Physician Fee Schedule.

 

The DRA also codified the reduction in reimbursement for multiple images on contiguous body parts, which was previously announced by CMS.  The DRA mandated payment at 100% of the technical component of the higher priced imaging procedure and 50% for the technical component of each additional imaging procedure for multiple images of contiguous body parts within a family of codes performed in the same session.  Beginning in 2006, CMS had only implemented a 25% reduction for each additional imaging procedure on contiguous body parts.  However, for services furnished on or after July 1, 2010, PPACA requires the full 50% reduction to be implemented.

 

 

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Regulatory updates to payment rates for which we bill the Medicare program directly are published annually by CMS in the Federal Register.  For payments under the Physician Fee Schedule for calendar year 2010, CMS changed the way it calculates components of the Medicare Physician Fee Schedule.  First, CMS reduced payment rates for certain diagnostic services using equipment costing more than $1 million through revisions to usage assumptions from the current 50% usage rate to a 90% usage rate.  This change applied to MRI and CT scans.  The Reconciliation Act, signed into law on March 30, 2010, resets the assumed usage rate for diagnostic imaging equipment costing more than $1 million to a rate of 75%, effective for payments made under the 2011 Medicare Physician Fee Schedule and subsequent years.  CMS finalized this change in the Medicare Physician Fee Schedule for calendar year 2011. Further with respect to its 2010 changes, CMS also reduced payment for services primarily involving the technical component rather than the physician work component, including the services we provide, by adjusting downward malpractice payments for these services.  The reductions primarily impacted radiology and other diagnostic tests.  All these changes to the Medicare Physician Fee Schedule will be transitioned over a four year period such that beginning in 2013, CMS will fully implement the revised payment rates.  For the 2010 transitioned payment, CMS estimates the impact of its changes will result in a 5% reduction in radiology, 18% reduction in nuclear medicine and 12% reduction for all suppliers providing the technical component of diagnostic tests generally.

 

 Pressure to control healthcare costs could have a negative impact on our results.>

One of the principal objectives of health maintenance organizations and preferred provider organizations is to control the cost of healthcare services. Healthcare providers participating in managed care plans may be required to refer diagnostic imaging tests to certain providers depending on the plan in which a covered patient is enrolled. In addition, managed care contracting has become very competitive, and reimbursement schedules are at or below Medicare reimbursement levels. The expansion of health maintenance organizations, preferred provider organizations and other managed care organizations within the geographic areas covered by our network could have a negative impact on the utilization and pricing of our services, because these organizations will exert greater control over patients’ access to diagnostic imaging services, the selections of the provider of such services and reimbursement rates for those services.

 

If our contracted radiology practices, including BRMG, lose a significant number of their radiologists, our financial results could be adversely affected.

 

At times, there has been a shortage of qualified radiologists in some of the regional markets we serve. In addition, competition in recruiting radiologists may make it difficult for our contracted radiology practices to maintain adequate levels of radiologists. If a significant number of radiologists terminate their relationships with our contracted radiology practices and those radiology practices cannot recruit sufficient qualified radiologists to fulfill their obligations under our agreements with them, our ability to maximize the use of our diagnostic imaging facilities and our financial results could be adversely affected. For example, in fiscal 2002, due to a shortage of qualified radiologists in the marketplace, BRMG experienced difficulty in hiring and retaining physicians and thus engaged independent contractors and part-time fill-in physicians. Their cost was double the salary of a regular BRMG full-time physician. Increased expenses to BRMG will impact our financial results because the management fee we receive from BRMG, which is based on a percentage of BRMG’s collections, is adjusted annually to take into account the expenses of BRMG. Neither we, nor our contracted radiology practices, maintain insurance on the lives of any affiliated physicians.

 

We may not be able to successfully grow our business, which would adversely affect our financial condition and results of operations.

 

Historically, we have experienced substantial growth through acquisitions that have increased our size, scope and geographic distribution. During the past two fiscal years, we have completed 19 acquisitions. These acquisitions have added 42 centers to our fixed-site outpatient diagnostic imaging services.  Our ability to successfully expand through acquiring facilities, developing new facilities, adding equipment at existing facilities, and directly or indirectly entering into contractual relationships with high-quality radiology practices depends upon many factors, including our ability to:

 

·

identify attractive and willing candidates for acquisitions;

 

·

identify locations in existing or new markets for development of new facilities;

 

·

comply with legal requirements affecting our arrangements with contracted radiology practices, including state prohibitions on fee-splitting, corporate practice of medicine and self-referrals;

 

·

obtain regulatory approvals where necessary and comply with licensing and certification requirements applicable to our diagnostic imaging facilities, the contracted radiology practices and the physicians associated with the contracted radiology practices;

 

 

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·

recruit a sufficient number of qualified radiology technologists and other non-medical personnel;

 

·

expand our infrastructure and management; and

 

·

compete for opportunities.  We may not be able to compete effectively for the acquisition of diagnostic imaging facilities.  Our competitors may have more established operating histories and greater resources than we do.  Competition may also make any acquisitions more expensive.

 

In October 2010, we completed our acquisition of Image Medical Corporation, the parent of eRAD, Inc. We believe the eRAD, Inc. acquisition provides us with access to additional technology to be utilized by our current facilities as well as expanding the products and services we may offer. Our beliefs regarding the merit of this acquisition and others are based upon numerous assumptions that are subject to risks and uncertainties that could deviate materially from our estimates, and could adversely affect our operating results.

Managing the acquisition of eRAD, Inc., as well as any other future acquisitions, will entail numerous operational and financial risks, including:

 

·

inability to obtain adequate financing;

 

·

possible adverse effects on our operating results;

 

·

diversion of management’s attention and resources;

 

·

failure to retain key personnel;

 

·

difficulties in integrating new operations into our existing infrastructure; and

 

·

amortization or write-offs of acquired intangible assets, including goodwill.

 

If we are unable to successfully grow our business through acquisitions it could have an adverse effect on our financial condition and results of operations.

 

The acquisition of eRAD, Inc. results in a new line of business for us that could be difficult to integrate, disrupt our business or harm our results of operations.

Although we offer some services similar to those offered by eRAD, Inc., the acquisition of eRAD, Inc. has provided us with a new line of business that has a large research and development component that is new to our business.  The process of integrating the acquired business, technology, service and research and development component into our business and operations and entry into a new line of business in which we are inexperienced may result in unforeseen operating difficulties and expenditures.  In developing the new line of business as a result of the eRAD, Inc. acquisition, we may invest significant time and resources, including the attention of management’s time that would otherwise be available for ongoing development of our business that may affect our results of operations and we may not be able to take full advantage of the business opportunities available to us as we expand the new line of business. Additionally, there are many competitors in the same business as eRAD, Failure to successfully manage these risks in the development and implementation of new lines of business could have a material, adverse effect on the Company’s business, financial condition, and results of operations.

We may become subject to professional malpractice liability, which could be costly and negatively impact our business.

 

The physicians employed by our contracted radiology practices are from time to time subject to malpractice claims. We structure our relationships with the practices under our management agreements in a manner that we believe does not constitute the practice of medicine by us or subject us to professional malpractice claims for acts or omissions of physicians employed by the contracted radiology practices. Nevertheless, claims, suits or complaints relating to services provided by the contracted radiology practices have been asserted against us in the past and may be asserted against us in the future. In addition, we may be subject to professional liability claims, including, without limitation, for improper use or malfunction of our diagnostic imaging equipment or for accidental contamination or injury from exposure to radiation. We may not be able to maintain adequate liability insurance to protect us against those claims at acceptable costs or at all.

 

 

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Any claim made against us that is not fully covered by insurance could be costly to defend, result in a substantial damage award against us and divert the attention of our management from our operations, all of which could have an adverse effect on our financial performance. In addition, successful claims against us may adversely affect our business or reputation. Although California places a $250,000 limit on non-economic damages for medical malpractice cases, no limit applies to economic damages and no such limits exist in the other states in which we now provide services.

 

We may not receive payment from some of our healthcare provider customers because of their financial circumstances.

 

Some of our healthcare provider customers do not have significant financial resources, liquidity or access to capital. If these customers experience financial difficulties they may be unable to pay us for the equipment and services that we provide. A significant deterioration in general or local economic conditions could have a material adverse effect on the financial health of certain of our healthcare provider customers. As a result, we may have to increase the amounts of accounts receivables that we write-off, which would adversely affect our financial condition and results of operations.

 

Some of our imaging modalities use radioactive materials, which generate regulated waste and could subject us to liabilities for injuries or violations of environmental and health and safety laws.

 

Some of our imaging procedures use radioactive materials, which generate medical and other regulated wastes. For example, patients are injected with a radioactive substance before undergoing a PET scan. Storage, use and disposal of these materials and waste products present the risk of accidental environmental contamination and physical injury. We are subject to federal, state and local regulations governing storage, handling and disposal of these materials. We could incur significant costs and the diversion of our management’s attention in order to comply with current or future environmental and health and safety laws and regulations. Also, we cannot completely eliminate the risk of accidental contamination or injury from these hazardous materials. Although we believe that we maintain professional liability insurance coverage consistent with industry practice in the event of an accident, we could be held liable for any resulting damages, and any liability could exceed the limits of or fall outside the coverage of our professional liability insurance.

 

We experience competition from other diagnostic imaging companies and hospitals, and this competition could adversely affect our revenue and business.

 

The market for diagnostic imaging services is highly competitive. We compete principally on the basis of our reputation, our ability to provide multiple modalities at many of our facilities, the location of our facilities and the quality of our diagnostic imaging services. We compete locally with groups of radiologists, established hospitals, clinics and other independent organizations that own and operate imaging equipment. Our competitors include Alliance Healthcare Services, Inc., Diagnostic Imaging Group, InSight Health Services Corp. and American Radiology Services. Some of our competitors may now or in the future have access to greater financial resources than we do and may have access to newer, more advanced equipment. In addition, some physician practices have established their own diagnostic imaging facilities within their group practices and compete with us. We are experiencing increased competition as a result of such activities, and if we are unable to successfully compete, our business and financial condition would be adversely affected.

 

State and federal anti-kickback and anti-self-referral laws may adversely affect income.

 

Various federal and state laws govern financial arrangements among healthcare providers. The federal Anti-Kickback Law prohibits the knowing and willful offer, payment, solicitation or receipt of any form of remuneration in return for, or to induce, the referral of Medicare, Medicaid, or other federal healthcare program patients, or in return for, or to induce, the purchase, lease or order of items or services that are covered by Medicare, Medicaid, or other federal healthcare programs. Similarly, many state laws prohibit the solicitation, payment or receipt of remuneration in return for, or to induce the referral of patients in private as well as government programs. Violation of these Anti-Kickback Laws may result in substantial civil or criminal penalties for individuals or entities and/or exclusion from federal or state healthcare programs. We believe we are operating in compliance with applicable law and believe that our arrangements with providers would not be found to violate the Anti-Kickback Laws. However, these laws could be interpreted in a manner inconsistent with our operations.

 

Federal law prohibiting physician self-referrals, known as the Stark Law, prohibits a physician from referring Medicare or Medicaid patients to an entity for certain “designated health services” if the physician has a prohibited financial relationship with that entity, unless an exception applies. Certain radiology services are considered “designated health services” under the Stark Law. Although we believe our operations do not violate the Stark Law, our activities may be challenged. If a challenge to our activities is successful, it could have an adverse effect on our operations. In addition, legislation may be enacted in the future that further addresses Medicare and Medicaid fraud and abuse or that imposes additional requirements or burdens on us.

 

In addition, under the DRA, states enacting false claims statutes similar to the federal False Claims Act, which establish liability for submission of fraudulent claims to the State Medicaid program and contain qui tam or whistleblower provisions, receive an increased percentage of any recovery from a State Medicaid judgment or settlement. Adoption of new false claims statutes in states where we operate may impose additional requirements or burdens on us.

 

 

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

 

The development of new technologies or refinements of existing modalities may require us to upgrade and enhance our existing equipment before we may otherwise intend. Many companies currently manufacture diagnostic imaging equipment. Competition among manufacturers for a greater share of the diagnostic imaging equipment market may result in technological advances in the speed and imaging capacity of new equipment. This may accelerate the obsolescence of our equipment, and we may not have the financial ability to acquire the new or improved equipment and may not be able to maintain a competitive equipment base. In addition, advances in technology may enable physicians and others to perform diagnostic imaging procedures without us. If we are unable to deliver our services in the efficient and effective manner that payors, physicians and patients expect and thus our revenue could substantially decrease.

 

A failure to meet our capital expenditure requirements could adversely affect our business.

 

We operate in a capital intensive, high fixed-cost industry that requires significant amounts of capital to fund operations, particularly the initial start-up and development expenses of new diagnostic imaging facilities and the acquisition of additional facilities and new diagnostic imaging equipment. We incur capital expenditures to, among other things, upgrade and replace existing equipment for existing facilities and expand within our existing markets and enter new markets. To the extent we are unable to generate sufficient cash from our operations, funds are not available from our lenders or we are unable to structure or obtain financing through operating leases, long-term installment notes or capital leases, we may be unable to meet our capital expenditure requirements.

 

Because we have high fixed costs, lower scan volumes per system could adversely affect our business.

 

The principal components of our expenses, excluding depreciation, consist of debt service, capital lease payments, compensation paid to technologists, salaries, real estate lease expenses and equipment maintenance costs. Because a majority of these expenses are fixed, a relatively small change in our revenue could have a disproportionate effect on our operating and financial results depending on the source of our revenue. Thus, decreased revenue as a result of lower scan volumes per system could result in lower margins, which could materially adversely affect our business.

 

Capitation fee arrangements could reduce our operating margins.

 

For the year ended December 31, 2010, we derived approximately 15% of our payments from capitation arrangements, and we intend to increase the revenue we derive from capitation arrangements in the future. Under capitation arrangements, the payor pays a pre-determined amount per-patient per-month in exchange for us providing all necessary covered services to the patients covered under the arrangement. These contracts pass much of the financial risk of providing diagnostic imaging services, including the risk of over-use, from the payor to the provider. Our success depends in part on our ability to negotiate effectively, on behalf of the contracted radiology practices and our diagnostic imaging facilities, contracts with health maintenance organizations, employer groups and other third-party payors for services to be provided on a capitated basis and to efficiently manage the utilization of those services. If we are not successful in managing the utilization of services under these capitation arrangements or if patients or enrollees covered by these contracts require more frequent or extensive care than anticipated, we would incur unanticipated costs not offset by additional revenue, which would reduce operating margins.

 

We may be unable to effectively maintain our equipment or generate revenue when our equipment is not operational.

 

Timely, effective service is essential to maintaining our reputation and high use rates on our imaging equipment. Although we have an agreement with GE Medical Systems pursuant to which it maintains and repairs the majority of our imaging equipment, this agreement does not compensate us for loss of revenue when our systems are not fully operational and our business interruption insurance may not provide sufficient coverage for the loss of revenue. Also, GE Medical Systems may not be able to perform repairs or supply needed parts in a timely manner, which could result in a loss of revenue. Therefore, if we experience more equipment malfunctions than anticipated or if we are unable to promptly obtain the service necessary to keep our equipment functioning effectively, our ability to provide services would be adversely affected and our revenue could decline.

  

Disruption or malfunction in our information systems could adversely affect our business.

 

Our information technology system is vulnerable to damage or interruption from:

 

·

earthquakes, fires, floods and other natural disasters;

 

·

power losses, computer systems failures, internet and telecommunications or data network failures, operator negligence, improper operation by or supervision of employees, physical and electronic losses of data and similar events; and

 

 

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·

computer viruses, penetration by hackers seeking to disrupt operations or misappropriate information and other breaches of security.

 

We rely on our information systems to perform functions critical to our ability to operate, including patient scheduling, billing, collections, image storage and image transmission. Accordingly, an extended interruption in the system’s function could significantly curtail, directly and indirectly, our ability to conduct our business and generate revenue.

 

We are vulnerable to earthquakes, harsh weather and other natural disasters.

 

Our corporate headquarters and 101 of our facilities are located in California, an area prone to earthquakes and other natural disasters. Three of our facilities are located in an area of Florida that has suffered from hurricanes. Some of our facilities have been affected by snow and other harsh weather conditions, particularly in February 2010, when winter snow storms in the mid-Atlantic region, including Maryland, Delaware and New Jersey, caused us to close many of our facilities for up to 5 business days. An earthquake, harsh weather conditions or other natural disaster could decrease scan volume during affected periods and seriously impair our operations. Damage to our equipment or interruption of our business would adversely affect our financial condition and results of operations.

 

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

 

We are directly or indirectly through the radiology practices with which we contract subject to extensive regulation by both the federal government and the state governments in which we provide services, including:

 

·

the federal False Claims Act;

 

·

the federal Medicare and Medicaid Anti-Kickback Laws, and state anti-kickback prohibitions;

 

·

federal and state billing and claims submission laws and regulations;

 

·

the federal Health Insurance Portability and Accountability Act of 1996, as amended by the Health Information Technology for Economic and Clinical Health Act of 2009, and comparable state laws;

 

·

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

 

·

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

 

·

federal and state laws governing the diagnostic imaging and therapeutic equipment we use in our business concerning patient safety, equipment operating specifications and radiation exposure levels; and

 

·

state laws governing reimbursement for diagnostic services related to services compensable under workers compensation rules.

 

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

  

If we fail to comply with various licensure, certification and accreditation standards, we may be subject to loss of licensure, certification or accreditation, which would adversely affect our operations.

 

 

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Ownership, construction, operation, expansion and acquisition of our diagnostic imaging facilities are subject to various federal and state laws, regulations and approvals concerning licensing of personnel, other required certificates for certain types of healthcare facilities and certain medical equipment. In addition, freestanding diagnostic imaging facilities that provide services independent of a physician’s office must be enrolled by Medicare as an independent diagnostic treatment facility, or IDTF, to bill the Medicare program. Medicare carriers have discretion in applying the IDTF requirements and therefore the application of these requirements may vary from jurisdiction to jurisdiction. In addition, federal legislation requires all suppliers that provide the technical component of diagnostic MRI, PET/CT, CT, and nuclear medicine to be accredited by an accreditation organization designated by CMS (which currently include the American College of Radiology (ACR), the Intersocietal Accreditation Commission (IAC) and the Joint Commission) by January 1, 2012. Our MRI, CT, nuclear medicine, ultrasound and mammography facilities are currently accredited by the American College of Radiology. We may not be able to receive the required regulatory approvals or accreditation for any future acquisitions, expansions or replacements, and the failure to obtain these approvals could limit the opportunity to expand our services.

 

Our facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensure and certification. If any facility loses its certification under the Medicare program, then the facility will be ineligible to receive reimbursement from the Medicare and Medicaid programs. For the year ended December 31, 2010, approximately 23% of our net revenue came from the Medicare and Medicaid programs. A change in the applicable certification status of one of our facilities could adversely affect our other facilities and in turn us as a whole. We have experienced a slowdown in the credentialing of our physicians over the last several years which has lengthened our billing and collection cycle, and could negatively impact our ability to collect revenue from patients covered by Medicare. Credentialing of physicians is required by our payors prior to commencing payment.

 

Our agreements with the contracted radiology practices must be structured to avoid the corporate practice of medicine and fee-splitting .

 

State law prohibits us from exercising control over the medical judgments or decisions of physicians and from engaging in certain financial arrangements, such as splitting professional fees with physicians. These laws are enforced by state courts and regulatory authorities, each with broad discretion. A component of our business has been to enter into management agreements with radiology practices. We provide management, administrative, technical and other non-medical services to the radiology practices in exchange for a service fee typically based on a percentage of the practice’s revenue. We structure our relationships with the radiology practices, including the purchase of diagnostic imaging facilities, in a manner that we believe keeps us from engaging in the practice of medicine or exercising control over the medical judgments or decisions of the radiology practices or their physicians, or violating the prohibitions against fee-splitting. There can be no assurance that our present arrangements with BRMG or the physicians providing medical services and medical supervision at our imaging facilities will not be challenged, and, if challenged, that they will not be found to violate the corporate practice of medicine or fee splitting prohibitions, thus subjecting us to potential damages, injunction and/or civil and criminal penalties or require us to restructure our arrangements in a way that would affect the control or quality of our services and/or change the amounts we receive under our management agreements. Any of these results could jeopardize our business.

 

Newly enacted and future federal legislation could limit the prices we can charge for our services, which would reduce our revenue and adversely affect our operating results.

The PPACA and the Reconciliation Act introduced certain changes that may result in decreased revenue for the scans we perform. Among other things, the new legislation will adjust Medicare payment rates for physician imaging services in an attempt to better reflect actual usage, by revising upward the assumed usage rate for diagnostic imaging equipment costing more than $1 million. For certain diagnostic services performed on or after January 1, 2011, the legislation reduces the assumed usage rate for such equipment from CMS’s current rate of 90% to a rate of 75%, resulting in an increase in payment rates for such services. The new legislation also adjusts the technical component discount on single-session imaging studies on contiguous body parts from 25% to 50%. These latter changes will reduce payments for the applicable services and thus may result in a decrease in the associated revenues we receive. Other changes in reimbursement for services rendered by Medicare Advantage plans may reduce the revenues we receive for services rendered to Medicare Advantage enrollees.

Possible volatility in our stock price could negatively affect us and our stockholders.

 

The trading price of our common stock on the NASDAQ Global Market has fluctuated significantly in the past. During the period from January 1, 2008 through December 31, 2010, the trading price of our common stock fluctuated from a high of $4.04 per share to a low of $1.00 per share. In the past, we have experienced a drop in stock price following an announcement of disappointing earnings or earnings guidance. Any such announcement in the future could lead to a similar drop in stock price. The price of our common stock could also be subject to wide fluctuations in the future as a result of a number of other factors, including the following:

 

·

changes in expectations as to future financial performance or buy/sell recommendations of securities analysts;

 

 

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·

our, or a competitor’s, announcement of new services, or significant acquisitions, strategic partnerships, joint ventures or capital commitments; and

 

·

the operating and stock price performance of other comparable companies.

 

In addition, the U.S. securities markets have experienced significant price and volume fluctuations.  These fluctuations often have been unrelated to the operating performance of companies in these markets. Broad market and industry factors may lead to volatility in the price of our common stock, regardless of our operating performance.  Moreover, our stock has limited trading volume, and this illiquidity may increase the volatility of our stock price.

 

In the past, following periods of volatility in the market price of an individual company’s securities, securities class action litigation often has been instituted against that company.  The institution of similar litigation against us could result in substantial costs and a diversion of management’s attention and resources, which could negatively affect our business, results of operations or financial condition.

 

Provisions of the Delaware General Corporation Law and our organizational documents may discourage an acquisition of us.

 

In the future, we could become the subject of an unsolicited attempted takeover of our company.  Although an unsolicited takeover could be in the best interests of our stockholders, our organizational documents and the General Corporation Law of the State of Delaware both contain provisions that will impede the removal of directors and may discourage a third-party from making a proposal to acquire us.  For example, the provisions:

 

·

permit the board of directors to increase its own size, within the maximum limitations set forth in the bylaws, and fill the resulting vacancies;

 

·

authorize the issuance of additional shares of preferred stock in one or more series without a stockholder vote;

 

·

establish an advance notice procedure for stockholder proposals to be brought before an annual meeting of our stockholders, including proposed nominations of persons for election to the board of directors; and

 

·

prohibit transfers and/or acquisitions of stock that would result in any stockholder owning greater than 5% of the currently outstanding stock resulting in a limitation on net operating loss carryovers,  capital loss carryovers, general business credit carryovers, alternative minimum tax credit carryovers and foreign tax credit carryovers, as well as any loss or deduction attributable to a "net unrealized built-in loss" within the meaning of Section 382 of the internal revenue code of 1986, as amended.

We are subject to Section 203 of the Delaware General Corporation Law, which could have the effect of delaying or preventing a change in control.

 

Item 1B.

Unresolved Staff Comments

None.

 

Item 2.

Properties

 

Our corporate headquarters is located in adjoining premises at 1508, 1510 and 1516 Cotner Avenue, Los Angeles, California 90025, in approximately 21,500 square feet occupied under leases, which expire (with options to extend) on June 30, 2017. In addition, we lease approximately 60,000 square feet of warehouse and other space under leases nationwide, which expire at various dates through August 2020. We also have a regional office of approximately 39,000 square feet in Baltimore, Maryland under a lease, which expires September 30, 2012. Our facility lease terms vary in length from month to month to 15 years with renewal options upon prior written notice, from 1 year to 10 years depending upon the agreed upon terms with the local landlord. Facility lease amounts generally increase from 1% to 6% on an annual basis. We do not have options to purchase the facilities we rent.

 

Item 3.

Legal Proceedings

 

We are engaged from time to time in the defense of lawsuits arising out of the ordinary course and conduct of our business. We believe that the outcome of our current litigation will not have a material adverse impact on our business, financial condition and results of operations. However, we could be subsequently named as a defendant in other lawsuits that could adversely affect us.

 

Item 4.

(Removed and Reserved)

 

 

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PART II

 

Item 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock is quoted on the NASDAQ Global Market under the symbol “RDNT.”  The following table indicates the high and low prices for our common stock for the periods indicated based upon information supplied by the NASDAQ Global Market.

 

		Low				High
Quarter Ended
December 31, 2010		$	2.00			$	2.96
September 30, 2010			1.83				2.58
June 30, 2010			2.37				4.04
March 31, 2010			2.04				3.18
December 31, 2009		$	1.90			$	3.39
September 30, 2009			2.01				3.18
June 30, 2009			1.00				2.79
March 31, 2009			0.85				3.96

 

The last low and high prices for our common stock on the NASDAQ Global Market on March 7, 2011 were $3.47 and $3.54, respectively.  As of March 7, 2011, the number of holders of record of our common stock was 838.  However, Cede & Co., the nominee for The Depository Trust Company, the clearing agency for most broker-dealers, owned a substantial number of our outstanding shares of common stock of record on that date.  Our management believes that the number of beneficial owners of our common stock is approximately 4,000.

 

Stock Performance Graph

 

The following graph compares the yearly percentage change in cumulative total stockholder return of the Company’s Common Stock during the period from 2005 to 2010 with (i) the cumulative total return of the S&P500 index and (ii) the cumulative total return of the S&P500 – Healthcare Sector index.  The comparison assumes $100 was invested in October 31, 2005 in the Common Stock and in each of the foregoing indices and the reinvestment of dividends through January 1, 2011.  The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

This graph shall not be deemed incorporated by reference by any general statement incorporating by reference this Form 10-K into any filing under the Securities Act or under the Exchange Act, except to the extent that RadNet specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.

 

We did not pay dividends in fiscal 2009 or 2010 and we do not expect to pay any dividends in the foreseeable future.

 

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		ANNUAL RETURN PERCENTAGE Years Ending
Company / Index		10/31/06	12/29/06	12/31/07	12/31/08	12/31/09	12/31/10
RadNet, Inc.		594.59	-10.12	119.70	-67.00	-39.10	38.24
S&P 500 Index		16.34	3.33	5.49	-37.00	26.46	15.06
S&P Health Care Sector		11.36	0.91	7.15	-22.81	19.70	2.90
		INDEXED RETURNS
	Base	Years Ending
	Period
Company / Index	10/31/05	10/31/06	12/29/06	12/31/07	12/31/08	12/31/09	12/31/10
RadNet, Inc.	100	694.59	624.32	1371.62	452.70	275.68	381.08
S&P 500 Index	100	116.34	120.22	126.82	79.90	101.04	116.27
S&P Health Care Sector	100	111.36	112.38	120.41	92.95	111.26	114.48

 

Recent Sales of Unregistered Securities

 

During the fiscal year ended December 31, 2010, we sold the following securities pursuant to an exemption from registration provided under Section 4(2) of the Securities Act of 1933, as amended:

·

In January 2010, we issued 75,000 shares of our common stock, valued at approximately $153,000 on the date of acquisition, to an individual as part of the purchase price for acquisition of a group of imaging center in Union, New Jersey.

 

·

In April 2010, we issued 375,000 shares of our common stock, valued at approximately $1.2 million on the date of acquisition, to an individual as part of the purchase price for acquisition of a group of imaging center in Bakersfield, California.

 

 

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Item 6.

Selected Consolidated Financial Data

 

The following table sets forth our selected historical consolidated financial data.  The selected consolidated statements of operations data set forth below for the years ended December 31, 2010, 2009 and 2008, and the consolidated balance sheet data as of December 31, 2010 and 2009, are derived from our audited consolidated financial statements and notes thereto included elsewhere herein.  The selected historical consolidated statements of operations data set forth below for the years ended December 31, 2007, October 31, 2006 and the two months ended December 31, 2006, and the consolidated balance sheet data set forth below as of December 31, 2008, 2007 and 2006, and October 31, 2006 are derived from our audited consolidated financial statements not included herein.  This data should be read in conjunction with and is qualified in its entirety by reference to the audited consolidated financial statements and the related notes included elsewhere in this Form 10-K and Item 7 -  “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

The financial data set forth below and discussed in this Annual Report are derived from the consolidated financial statements of RadNet, its subsidiaries and certain affiliates.  As a result of the contractual and operational relationship among BRMG, Dr. Berger and us, we are considered to have a controlling financial interest in BRMG pursuant to applicable accounting guidance.  Due to the deemed controlling financial interest, we are required to include BRMG as a consolidated entity in our consolidated financial statements.  This means, for example, that revenue generated by BRMG from the provision of professional medical services to our patients, as well as BRMG’s costs of providing those services, are included as net revenue in our consolidated statement of operations, whereas the management fee that BRMG pays to us under our management agreement with BRMG is eliminated as a result of the consolidation of our results with those of BRMG.  Also, because BRMG is a consolidated entity in our financial statements, any borrowings or advances we have received from or made to BRMG have been eliminated in our consolidated balance sheet.  If BRMG were not treated as a consolidated entity in our consolidated financial statements, the presentation of certain items in our income statement, such as net revenue and costs and expenses, would change but our net income would not, because in operation and historically, the annual revenue of BRMG from all sources closely approximates its expenses, including Dr. Berger’s compensation, fees payable to us and amounts payable to third parties.

		Years Ended																				Two Months Ended				Years Ended
		December 31,																				December 31,				October 31,
		2010				2009				2008				2007				2006				2006				2006
																		(unaudited)
		(dollars in thousands, except per share data)
Statement of Operations Data:
Net revenue		$	548,537			$	524,368			$	498,815			$	423,576			$	192,859			$	57,374			$	161,005
Operating expenses:
Operating expenses			420,973				397,753				384,297				330,550				147,226				46,033				120,342
Depreciation and amortization			53,997				53,800				53,548				45,281				19,542				5,907				16,394
Provision for bad bebts			33,158				32,704				30,832				27,467				10,707				3,907				7,626
Loss (gain) on disposal of equipment, net			1,136				523				516				72				335				(38	)			373
Gain from sale of joint venture interests			-				-				-				(1,868	)			-				-				-
Gain on bargin purchase			-				(1,387	)			-				-				-				-				-
Loss on extinguishment of debt			9,871				-				-				-				-				-				-
Net loss			(12,852	)			(2,267	)			(12,836	)			(18,131	)			(17,722	)			(10,983	)			(6,894	)
Basic and diluted loss per share			(0.35	)			(0.06	)			(0.36	)			(0.52	)			(0.57	)			(0.35	)			(0.33	)
Balance Sheet Data:
Cash and cash equivalents		$	627			$	10,094			$	-			$	18			$	3,221			$	3,221			$	2
Total assets			539,514				480,671				495,572				433,620				394,766				394,766				131,636
Total long-term liabilities			516,723				456,727				469,994				428,743				381,903				381,903				179,288
Total liabilities			621,987				555,432				576,602				503,244				440,508				440,508				210,430
Working capital (deficit)			5,761				9,204				2,720				23,180				31,230				31,230				2,896
Stockholders' deficit			(82,473	)			(74,761	)			(81,030	)			(69,830	)			(46,996	)			(46,996	)			(78,794	)

 

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Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

 

Business Overview

  

With 201 centers, as of December 31, 2010, located in California, Delaware, Maryland, New Jersey, Florida, and New York, we are the leading national provider of freestanding, fixed-site outpatient diagnostic imaging services in the United States based on number of locations and annual imaging revenue. Our centers provide physicians with imaging capabilities to facilitate the diagnosis and treatment of diseases and disorders and may reduce unnecessary invasive procedures, often minimizing the cost and amount of care for patients. Our services include magnetic resonance imaging (MRI), computed tomography (CT), positron emission tomography (PET), nuclear medicine, mammography, ultrasound, diagnostic radiology (X-ray), fluoroscopy and other related procedures. The vast majority of our centers offer multi-modality imaging services, a key point of differentiation from our competitors. Our multi-modality strategy diversifies revenue streams, reduces exposure to reimbursement changes and provides patients and referring physicians one location to serve the needs of multiple procedures.

We seek to develop leading positions in regional markets in order to leverage operational efficiencies. Our scale and density within selected geographies provides close, long-term relationships with key payors, radiology groups and referring physicians. Each of our facility managers is responsible for managing relationships with local physicians and payors, meeting our standards of patient service and maintaining profitability. We provide corporate training programs, standardized policies and procedures and sharing of best practices among the physicians in our regional networks.

We derive substantially all of our revenue, directly or indirectly, from fees charged for the diagnostic imaging services performed at our facilities. For the year ended December 31, 2010, we performed 3,315,019 diagnostic imaging procedures and generated net revenue from continuing operations of $548.5 million. Additional information concerning RadNet, Inc., including our consolidated subsidiaries, for each of the years ended December 31, 2010, 2009 and  2008,  is included in the consolidated financial statements and notes thereto in this Annual Report.

Our revenue is derived from a diverse mix of payors, including private payors, managed care capitated payors and government payors.  We believe our payor diversity mitigates our exposure to possible unfavorable reimbursement trends within any one-payor class.  In addition, our experience with capitation arrangements over the last several years has provided us with the expertise to manage utilization and pricing effectively, resulting in a predictable stream of revenue. As of December 31, 2010, we received approximately 56% of our payments from commercial insurance payors, 15% from managed care capitated payors, 20% from Medicare and 3% from Medicaid.  With the exception of Blue Cross/Blue Shield and government payors, no single payor accounted for more than 5% of our net revenue for the twelve months ended December 31, 2010.

As of December 31, 2010, we had in operation 151 MRI systems, 83 CT systems, 32 PET or combination PET/CT systems, 41 nuclear medicine systems, 168 x-ray systems, 135 mammography systems, 283 ultrasound systems, and 99 fluoroscopy systems.

 

On November 15, 2006, we completed the acquisition of Radiologix, Inc. Radiologix, a Delaware corporation, then employing approximately 2,200 people, through its subsidiaries, was a national provider of diagnostic imaging services through the ownership and operation of freestanding, outpatient diagnostic imaging centers. Radiologix owned, operated and maintained equipment in 69 locations, with imaging centers in seven states, including primary operations in the Mid-Atlantic; the Bay-Area, California; the Treasure Coast area, Florida; Northeast Kansas; and the Finger Lakes (Rochester) and Hudson Valley areas of New York State.

Since that time we have continued to develop our medical imaging business through a combination of organic growth and acquisitions. For a discussion of acquisitions and dispositions of facilities, see “Management’s Discussion and Analysis and Results of Operations—Facility Acquisitions” below.

The consolidated financial statements include the accounts of Radnet Management and BRMG.  The consolidated financial statements also include Radnet Management I, Inc., Radnet Management II, Inc.,  Radiologix, Inc., Radnet Management Imaging Services, Inc., Delaware Imaging Partners, Inc., New Jersey Imaging Partners, Inc. and Diagnostic Imaging Services, Inc. (DIS), all wholly owned subsidiaries of Radnet Management.  All of these affiliated entities are referred to collectively as “RadNet”, “we”, “us,” “our” or the “Company” in this report.

 

 

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Accounting Standards Codification Section 810-10-15-14 stipulates that generally any entity with a) insufficient equity to finance its activities without additional subordinated financial support provided by any parties, or b) equity holders that, as a group, lack the characteristics specified in the Codification which evidence a controlling financial interest, is considered a Variable Interest Entity (“VIE”).  We consolidate all voting interest entities in which we own a majority voting interest and all VIEs for which we are the primary beneficiary. We determine whether we are the primary beneficiary of a VIE through a qualitative analysis that identifies which variable interest holder has the controlling financial interest in the VIE. The variable interest holder who has both of the following has the controlling financial interest and is the primary beneficiary: (1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb losses of, or the right to receive benefits from, the VIE that could potentially be significant to the VIE. In performing our analysis, we consider all relevant facts and circumstances, including: the design and activities of the VIE, the terms of the contracts the VIE has entered into, the nature of the VIE’s variable interests issued and how they were negotiated with or marketed to potential investors, and which parties participated significantly in the design or redesign of the entity.

Recent Developments

On October 1, 2010, we completed our acquisition of Image Medical Corporation, the parent of eRAD, Inc. (see Note 3 to the consolidated financial statements to this Form 10-K).  eRAD, Inc., headquartered in Greenville, South Carolina, has been a premier provider of Picture Archiving and Communications Systems (PACS) and related workflow solutions to the radiology industry since 1999.  Over 250 hospitals, teleradiology businesses, imaging centers and specialty physician groups use eRAD’s technology to distribute, visualize, store and retrieve digital images taken from all diagnostic imaging modalities.  eRAD has approximately 30 employees, including a Research and Development team of 11 software engineers in Budapest, Hungary.

 

In addition, we have assembled an industry leading team of software developers, based out of Prince Edward Island, Canada, to create radiology workflow solutions known as Radiology Information Systems (“RIS”) focused exclusively on RadNet’s internal use.  All members of this Canadian based team have significant software development expertise in radiology, and together with eRAD and its PACS technology, will create fully integrated solutions to manage all aspects of RadNet’s internal information needs. eRAD and the newly hired software development team form a Radiology Information Technology division of RadNet.

 

On January 3, 2011, we consummated the acquisition of Imaging On Call, LLC, a provider of teleradiology services to radiology groups, hospitals and imaging centers located in Poughkeepsie, New York, for $5.5 million cash plus an earn-out of up to an additional $2.5 million.   

On February 14, 2011, we completed an exchange offer where by all of our senior unsecured notes were exchanged for registered publicly tradable notes.

On March 7, 2011, we executed a definitive agreement to acquire five multi-modality imaging centers in Maryland from Diagnostic Health Corporation.  We will pay approximately $7.1 million, in a combination of cash and the assumption of certain capital lease liabilities.  The facilities located in Bowie, Chevy Chase, Frederick, Rockville and Waldorf operate a combination of MRI, CT, ultrasound, mammography, x-ray and other related modalities.

   

Industry Trends

 

Prior to 2007, for services for which we bill Medicare directly, we were paid under the Medicare Physician Fee Schedule, which is updated on an annual basis. Under the Medicare statutory formula, payments under the Physician Fee Schedule would have decreased for the past several years if Congress failed to intervene. For example, for 2008, the fee schedule rates were to be reduced by approximately 10.1%. The Medicare, Medicaid and SCHIP Extension Act of 2007 eliminated the 10.1% reduction for 2008 and increased the annual payment rate update by 0.5%. This increase to the annual Medicare Physician Fee Schedule payment update was effective only for Medicare claims with dates of service between January 1, 2008 and June 30, 2008. Beginning July 1, 2008, under MIPPA, the 0.5% increase was continued for the rest of 2008. In addition, MIPPA established a 1.1% increase to the Medicare Physician Fee Schedule payment update for 2009.

For 2010, CMS projected a rate reduction of 21.2% in the absence of Congressional intervention. However, over the course of the first six months of 2010, various temporary solutions were enacted by Congress which resulted in delaying any such change to the physician fee schedule. Ultimately, a 2.2% increase in the conversion factor was passed by Congress effective June 1, 2010, further delaying the pending 21.2% conversion factor reduction to November 30, 2010. On November 29, 2010, the calendar year 2011 physician fee schedule final rule with comment period was published in the Federal Register. The rule updates payment policies and Medicare payment rates under the Medicare physician fee schedule for physicians’ services and would have significantly reduced physician fee schedule payments in 2011 had Congress not acted by passing the Physician Payment and Therapy Relief Act of 2010 and the Medicare and Medicaid Extenders Act of 2010, which together continue the 2.2% update from June 2010 through December 31, 2011. While Congress has historically provided temporary relief from the formula-driven reductions in the conversion factor, it cannot be guaranteed that Congress will act to provide relief in the future.   The failure of Congress to act could adversely impact our revenues and results of operation.

 

MIPPA also modified the methodology by which the budget neutrality formula was applied to the 2009 physician fee schedule payment rates, resulting in an overall reduction in payment rates for services performed by many specialties, including an estimated 1% reduction for nuclear medicine. The impact of the payment rates on specific companies depends on their service mix. Also with respect to MIPPA, the legislation requires all suppliers that provide the technical component of diagnostic MRI, PET/CT, CT, and nuclear medicine to be accredited by an accreditation organization designated by CMS (which currently include the ACR, the IAC and The Joint Commission) by January 1, 2012. Our MRI, CT, nuclear medicine, ultrasound and mammography facilities are currently accredited by the ACR.

 

 

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A number of other legislative changes impact our retail business. For example, beginning on January 1, 2007, the DRA imposed caps on Medicare payment rates for certain imaging services furnished in physician’s offices and other non-hospital based settings. Under the cap, payments for specified imaging services cannot exceed the hospital outpatient payment rates for those services. The limitation is applicable to the technical components of the diagnostic imaging services only, which is the payment we receive for the services for which we bill directly under the Medicare Physician Fee Schedule. CMS issues on an annual basis the hospital outpatient prospective payment rates, which are used to develop the caps. If the technical component of the service established under the Physician Fee Schedule (without including geographic adjustments) exceeds the hospital outpatient payment amount for the service (also without including geographic adjustments), then the payment is to be reduced. In other words, in those instances where the technical component for the particular service is greater for the non-hospital site, the DRA directs that the hospital outpatient payment rate be substituted for the otherwise applicable Physician Fee Schedule payment rate.

The DRA also codified the reduction in reimbursement for multiple images on contiguous body parts, which was previously announced by CMS. The DRA mandated payment at 100% of the technical component of the higher priced imaging procedure and 50% for the technical component of each additional imaging procedure for multiple images of contiguous body parts within a family of codes performed in the same session. Initially, CMS announced that it would phase in this reimbursement reduction over a two-year period, to include a 25% reduction for each additional imaging procedure on contiguous body parts in 2006 and an additional 25% reduction in 2007. CMS did not implement the additional 25% reduction scheduled for 2007, but for services furnished on or after July 1, 2010, PPACA requires the full 50% reduction to be implemented.

Regulatory updates to payment rates for which we bill the Medicare program directly are published annually by CMS. For payments under the Physician Fee Schedule for calendar year 2010, CMS changed the way it calculates components of the Medicare Physician Fee Schedule. First, CMS reduced payment rates for certain diagnostic services using equipment costing more than $1 million through revisions to usage assumptions from the current 50% usage rate to a 90% usage rate. This change applied to MRI and CT scans. However, for certain diagnostic services performed on or after January 1, 2011, the Reconciliation Act reduces the assumed usage rate for such equipment from CMS’s current rate of 90% to a rate of 75%, resulting in an increase in payment rates for such services.

Recent global market and economic conditions have been unprecedented. Concerns about the potential long-term and widespread recession, inflation, energy costs, geopolitical issues, the availability and cost of credit, the United States mortgage market and a declining real estate market in the United States have contributed to increased market volatility and diminished expectations for the United States economy. These conditions, combined with declining business and consumer confidence and increased unemployment, have contributed to unusual volatility. At this time, it is unclear what impact this might have on our future revenues or business.

As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. If market conditions continue, they may limit our ability to timely access the capital markets to meet liquidity needs, resulting in adverse effects on our financial condition and results of operations.

 

 

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Results of Operations

 

The following table sets forth, for the periods indicated, the percentage that certain items in the statements of operations bears to net revenue.

 

RADNET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

		Years Ended December 31,
		2010				2009				2008
NET REVENUE			100.0%				100.0%				100.0%
OPERATING EXPENSES
Cost of operations			76.7%				75.9%				77.0%
Depreciation and amortization			9.8%				10.3%				10.7%
Provision for bad debts			6.0%				6.2%				6.2%
Loss on sale of equipment			0.2%				0.1%				0.1%
Severance costs			0.2%				0.1%				0.1%
Total operating expenses			93.0%				92.6%				94.1%
INCOME FROM OPERATIONS			7.0%				7.4%				5.9%
OTHER EXPENSES (INCOME)
Interest expense			8.8%				9.5%				10.4%
Gain on bargain purchase			0.0%				-0.3%				0.0%
Loss on extinguishment of debt			1.8%				0.0%				0.0%
Other expenses (income)			0.1%				0.1%				0.0%
Total other expenses			10.7%				9.4%				10.4%
LOSS BEFORE INCOME TAXES AND EQUITY
IN EARNINGS OF JOINT VENTURES			-3.7%				-1.9%				-4.5%
Provision for income taxes			-0.1%				-0.1%				0.0%
Equity in earnings of joint ventures			1.5%				1.6%				2.0%
NET LOSS			-2.3%				-0.4%				-2.6%
Net income attributable to noncontrolling interests			0.0%				0.0%				0.0%
NET LOSS ATTRIBUTABLE TO RADNET, INC.
COMMON STOCKHOLDERS			-2.3%				-0.4%	%			-2.6%

 

 

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Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009

 

Net Revenue

 

Net revenue for the year ended December 31, 2010 was $548.5 million compared to $524.4 million for the year ended December 31, 2009, an increase of $24.2 million, or 4.6%.

 

Net revenue, including only those centers which were in operation throughout the full fiscal years of both 2010 and 2009, decreased $16.2 million, or 3.2%.  This 3.2% decrease is primarily the result of a decline in patient scheduling during the first half of 2010, much of which was due to unusually severe weather conditions on the east coast during the first quarter of 2010. The decline also was the result of lower frequency of office visits to primary care and specialist physicians, our referral sources, in 2010 as a result of a broad based economic slowdown. This comparison excludes revenue contributions from centers that were acquired subsequent to January 1, 2009.  For the year ended December 31, 2010, net revenue from centers that were acquired subsequent to January 1, 2009 and excluded from the above comparison was $51.3 million.  For the year ended December 31, 2009, net revenue from centers that were acquired subsequent to January 1, 2009 and excluded from the above comparison was $10.9 million.

Operating Expenses

 

Cost of operations for the year ended December 31, 2010 increased approximately $23.2 million, or 5.8%, from $397.8 million for the year ended December 31, 2009 to $421.0 million for the year ended December 31, 2010.  The following table sets forth our operating expenses for the years ended December 31, 2010 and 2009 (in thousands):

 

		Years Ended December 31,
		2010				2009
Salaries and professional reading fees, excluding stock-based compensation		$	231,922			$	215,095
Stock-based compensation			3,718				3,607
Building and equipment rental			47,938				43,346
Medical supplies			30,413				32,507
Other operating expenses *			106,982				103,198
Cost of operations			420,973				397,753
Depreciation and amortization			53,997				53,800
Provision for bad debts			33,158				32,704
Loss on sale of equipment			1,136				523
Severance costs			838				731
Total operating expenses		$	510,102			$	485,511

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*            Includes billing fees, office supplies, repairs and maintenance, insurance, business tax and license, outside services, utilities, marketing, travel and other expenses.

 

·

Salaries and professional reading fees, excluding stock-based compensation and severance

 

Salaries and professional reading fees increased $16.8 million, or 7.8%, to $231.9 million for the year ended December 31, 2010, compared to $215.1 million for the year ended December 31, 2009.

 

Salaries and professional reading fees, including only those centers which were in operation throughout the full fiscal years of both 2010 and 2009, decreased $2.2 million, or 1.0%.  This 1.0% decrease is primarily due to cost cutting measures implemented in the third quarter of 2008 and continued throughout 2009.  This comparison excludes contributions from centers that were acquired subsequent to January 1, 2009.  For the year ended December 31, 2010, salaries and professional reading fees from centers that were acquired subsequent to January 1, 2009 and excluded from the above comparison was $22.8 million.  For the year ended December 31, 2009, salaries and professional reading fees from centers that were acquired subsequent to January 1, 2009, and excluded from the above comparison was $3.8 million.  

 

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·

Stock-based compensation

 

Stock-based compensation increased $111,000, or 3.1%, to $3.7 million for the year ended December 31, 2010 compared to $3.6 million for the year ended December 31, 2009.  The increase is primarily due to additional options granted during 2010.

 

·

Building and equipment rental

 

Building and equipment rental expenses increased $4.6 million, or 10.6%, to $47.9 million for the year ended December 31, 2010, compared to $43.3 million for the year ended December 31, 2009.

 

Building and equipment rental expenses, including only those centers which were in operation throughout the full fiscal years of both 2010 and 2009, increased $450,000, or 1.0%.  This 1.0% increase is primarily due to the acquisition, through operating lease contracts, of additional imaging equipment at certain existing imaging centers during 2010.  This comparison excludes contributions from centers that were acquired subsequent to January 1, 2009.  For the year ended December 31, 2010, building and equipment rental expenses from centers that were acquired subsequent to January 1, 2009, and excluded from the above comparison, was $5.9 million. For the year ended December 31, 2009, building and equipment rental expenses from centers that were acquired subsequent to January 1, 2009, and excluded from the above comparison, was $1.7 million.

 

·

Medical supplies

 

Medical supplies expense decreased $2.1 million, or 6.4%, to $30.4 million for the year ended December 31, 2010, compared to $32.5 million for the year ended December 31, 2009.

 

Medical supplies expenses, including only those centers which were in operation throughout the full fiscal years of both 2010 and 2009, decreased $3.8 million, or 11.8%.  This 11.8% decrease is primarily due to a change in vendors supplying certain drugs used in operating our Breastlink centers as well as obtaining certain rebates during 2010.  This comparison excludes contributions from centers that were acquired or divested subsequent to January 1, 2009.  For the year ended December 31, 2010, medical supplies expense from centers that were acquired subsequent to January 1, 2009, and excluded from the above comparison was $2.0 million.  For the year ended December 31, 2009, medical supplies expense from centers that were acquired subsequent to January 1, 2009, and excluded from the above comparison was $315,000.

 

·

Depreciation and amortization expense

 

Depreciation and amortization expense increased $197,000, or 0.4%, to $54.0 million for the year ended December 31, 2010 when compared to the same period last year. The increase is due in part to increases to amortization expense related to certain intangible assets acquired from eRAD.

 

·

Provision for bad debts

 

Provision for bad debts increased $197,000, or 1.4%, to $33.2 million, or 6.0% of net revenue, for the year ended December 31, 2010 compared to $32.7 million, or 6.2% of net revenue, for the year ended December 31, 2009. This increase is in line with the increase in net revenues.

 

·

Loss on sale of equipment

 

Loss on sale of equipment was $1.1 million and $523,000 for the years ended December 31, 2010 and 2009, respectively.  In both years, this loss resulted from the sale of imaging equipment for scrap value upon acquisition of upgraded equipment.

 

·

Severance costs

 

During the year ended December 31, 2010, we recorded severance costs of $838,000 compared to $731,000 recorded during the year ended December 31, 2009.  In each period, these costs were primarily associated with the integration of acquired operations.

 

 

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Interest expense

 

Interest expense for the year ended December 31, 2010 decreased approximately $1.6 million, or 3.2%, to $48.4 million for the year ended December 31, 2010 compared to $50.0 million for the year ended December 31, 2009.  Interest expense for the year ended December 31, 2010 included $917,000 of amortization of Accumulated Other Comprehensive Loss associated with fair value adjustments to our interest rate swaps accumulated prior to April 6, 2010, the date of our debt refinancing.  See “Liquidity and Capital Resources” below for more details on our debt refinancing. Interest expense for the year ended December 31, 2009 included $6.1 million of amortization of Accumulated Other Comprehensive Loss associated with fair value adjustments accumulated prior to our January 28, 2009 modification of interest rate swaps.  Excluding these adjustments to interest expense related to our interest rate swaps in both periods, interest expense increased $3.6 million.  This increase was primarily due to interest expense on the additional borrowings under the debt refinancing completed April 6, 2010.

Loss on extinguishment of debt

For the year ended December 31, 2010, we recorded a $9.9 million loss on extinguishment of debt related to our debt refinancing completed on April 6, 2010.  This loss included a $7.6 million write-off of deferred loan costs associated with our GE debt settled on April 6, 2010 as well as approximately $2.3 million to settle a call premium associated with our prior credit facilities and for interest rate swap related expenses.

Gain on bargain purchase

 

On June 12, 2009, we acquired the assets and business of nine imaging centers located in New Jersey from Medical Resources, Inc. for approximately $2.1 million.  At the time of the acquisition, we immediately sold the assets and business of one of those nine centers to an unrelated third party for approximately $650,000.

 

In accordance with accounting standards, any excess of fair value of acquired net assets over the acquisition consideration results in a gain on bargain purchase. Prior to recording a gain, the acquiring entity must reassess whether all acquired assets and assumed liabilities have been identified and recognized and perform re-measurements to verify that the consideration paid, assets acquired, and liabilities assumed have been properly valued. The Company underwent such a reassessment, and as a result, has recorded a gain on bargain purchase of approximately $1.4 million.

We believe that the gain on bargain purchase resulted from various factors that impacted the sale of those New Jersey assets.  The seller was performing a full liquidation of its assets for the benefit of its creditors.  Upon liquidation of all of its assets, the seller intended to close its business.  The New Jersey assets were the only remaining assets to be sold before a full wind-down of the seller’s business could be completed.  We believe that the seller was willing to accept a bargain purchase price from us in return for our ability to act more quickly and with greater certainty than any other prospective acquirer.  The decline in the credit markets made it difficult for other acquirers who relied upon third party financing to complete the transaction.  The relatively small size of the transaction for us, the lack of required third-party financing and our expertise in completing similar transactions in the past gave the seller confidence that we could complete the transaction expeditiously and without difficulty.

 

Other expenses

For the year ended December 31, 2010, we recorded $132,000 of other expense related to fair value adjustments on our interest rate swaps as well as $373,000 of other expense related to litigation.  For the year ended December 31, 2009, we recorded $823,000 of other income related to fair value adjustments on our interest rate swaps, offset by $1.2 million of other expense primarily related to litigation.

Income tax expense

 

For the year ended December 31, 2010 and 2009, we recorded $576,000 and $443,000, respectively, for state income tax expense primarily related to taxable income generated in the states of Maryland and Delaware.

 

Equity in earnings from unconsolidated joint ventures

 

Equity in earnings from our unconsolidated joint ventures decreased $226,000, or 2.7% to $8.2 million for the year ended December 31, 2010 compared to $8.4 million for the year ended December 31, 2009.  The 2.7% decrease is primarily due to an adjustment in collection rates during 2010, offset in part by the fact that a charge to net revenue was taken during the third quarter of 2009 related to valuation adjustments of accounts receivable at September 30, 2009.

 

 

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Year Ended December 31, 2009 Compared to the Year Ended December 31, 2008

 

Net Revenue

 

Net revenue for the year ended December 31, 2009 was $524.4 million compared to $498.8 million for the year ended December 31, 2008, an increase of $25.6 million, or 5.1%.

 

Net revenue, including only those centers which were in operation throughout the full fiscal years of both 2009 and 2008, increased $8.1 million, or 1.8%. This 1.8% increase is mainly due to an increase in procedure volumes.  This comparison excludes revenue contributions from centers that were acquired or divested subsequent to January 1, 2008.  For the year ended December 31, 2009, net revenue from centers that were acquired subsequent to January 1, 2008 and excluded from the above comparison was $71.0 million.  For the year ended December 31, 2008, net revenue from centers that were acquired subsequent to January 1, 2008 and excluded from the above comparison was $47.7 million.  Also excluded was $5.8 million from centers that were divested subsequent to January 1, 2008.

 

Operating Expenses

 

Cost of operations for the year ended December 31, 2009 increased approximately $13.5 million, or 3.5%, from $384.3 million for the year ended December 31, 2008 to $397.8 million for the year ended December 31, 2009.  The following table sets forth our operating expenses for the years ended December 31, 2009 and 2008 (in thousands):

 

		Years Ended December 31,
		2009				2008
Salaries and professional reading fees, excluding stock-based compensation		$	215,095			$	210,450
Stock-based compensation			3,607				2,902
Building and equipment rental			43,346				43,478
Medical supplies			32,507				29,848
Other operating expenses *			103,198				97,619
Cost of operations			397,753				384,297
Depreciation and amortization			53,800				53,548
Provision for bad debts			32,704				30,832
Loss on sale of equipment, net			523				516
Severance costs			731				335
Total operating expenses		$	485,511			$	469,528

 

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*           Includes billing fees, office supplies, repairs and maintenance, insurance, business tax and license, outside services, utilities, marketing, travel and other expenses.

 

·

Salaries and professional reading fees, excluding stock-based compensation and severance

 

Salaries and professional reading fees increased $4.6 million, or 2.2%, to $215.1 million for the year ended December 31, 2009, compared to $210.5 million for the year ended December 31, 2008.

 

Salaries and professional reading fees, including only those centers which were in operation throughout the full fiscal years of both 2009 and 2008, decreased $1.9 million, or 1.0%.  This 1.0% decrease is primarily due to cost cutting measures implemented in the third quarter of 2008.  This comparison excludes contributions from centers that were acquired or divested subsequent to January 1, 2008.  For the year ended December 31, 2009, salaries and professional reading fees from centers that were acquired subsequent to January 1, 2008 and excluded from the above comparison was $26.6 million.  For the year ended December 31, 2008, salaries and professional reading fees from centers that were acquired subsequent to January 1, 2008, and excluded from the above comparison was $17.1 million.  Also excluded was $3.0 million from centers that were divested subsequent to January 1, 2008.

 

 

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·

Stock-based compensation

 

Stock-based compensation increased $705,000, or 24.3%, to $3.6 million for the year ended December 31, 2009 compared to $2.9 million for the year ended December 31, 2008.  The increase is primarily due to additional options granted during the first half of 2009, some of which were fully vested on the date of grant.

 

·

Building and equipment rental

 

Building and equipment rental expenses decreased $132,000, or 0.3%, to $43.4 million for the year ended December 31, 2009, compared to $43.5 million for the year ended December 31, 2008.

 

Building and equipment rental expenses, including only those centers which were in operation throughout the full fiscal years of both 2009 and 2008, decreased $2.4 million, or 6.1%.  This 6.1% decrease is primarily due to the conversion of certain equipment lease contracts from operating to capital leases in the first quarter of 2009.  This comparison excludes contributions from centers that were acquired or divested subsequent to January 1, 2008.  For the year ended December 31, 2009, building and equipment rental expenses from centers that were acquired subsequent to January 1, 2008, and excluded from the above comparison, was $6.2 million. For the year ended December 31, 2008, building and equipment rental expenses from centers that were acquired subsequent to January 1, 2008, and excluded from the above comparison, was $3.6 million.  Also excluded was $328,000 from centers that were divested subsequent to January 1, 2008.

 

·

Medical supplies

 

Medical supplies expense increased $2.7 million, or 8.9%, to $32.5 million for the year ended December 31, 2009, compared to $29.8 million for the year ended December 31, 2008.

 

Medical supplies expenses, including only those centers which were in operation throughout the full fiscal years of both 2009 and 2008, increased $1.3 million, or 6.4%.  This 6.4% increase is in line with procedure volumes and net revenues generated at these existing centers. This comparison excludes contributions from centers that were acquired or divested subsequent to January 1, 2008.  For the year ended December 31, 2009, medical supplies expense from centers that were acquired subsequent to January 1, 2008, and excluded from the above comparison was $11.5 million.  For the year ended December 31, 2008, medical supplies expense from centers that were acquired subsequent to January 1, 2008, and excluded from the above comparison was $9.6 million.  Also excluded from the above comparison was $500,000 from centers that were divested subsequent to January 1, 2008.

 

·

Depreciation and amortization expense

 

Depreciation and amortization expense increased $252,000, or 0.4%, to $53.8 million for the year ended December 31, 2009 when compared to the same period last year. The increase is due in part to increases to depreciation expense on new imaging equipment offset by the completion of amortization schedules related to covenant-not-to-compete contracts in early 2009.

 

·

Provision for bad debts

 

Provision for bad debts increased $1.9 million, or 6.0%, to $32.7 million, or 6.2% of net revenue, for the year ended December 31, 2009 compared to $30.8 million, or 6.2% of net revenue, for the year ended December 31, 2008. This increase is in line with the increase in net revenues.

 

·

Loss on sale of equipment

 

Loss on sale of equipment was $523,000 and $516,000 for the years ended December 31, 2009 and 2008, respectively.  In both years, this loss resulted from the sale of imaging equipment for scrap value upon acquisition of upgraded equipment.

 

·

Severance costs

 

During the year ended December 31, 2009, we recorded severance costs of $731,000 compared to $335,000 recorded during the year ended December 31, 2008.  In each period, these costs were primarily associated with the integration of Radiologix and other acquired operations.

 

 

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Interest expense

 

Interest expense for the year ended December 31, 2009 was $50.0 million compared to $51.8 million for the year ended December 31, 2008.  The interest expense for the year ended December 31, 2009 includes $6.1 million of amortization associated with a swap agreement that expired in April 2009 and the modification of two interest rate swaps designated as cash flow hedges (see Liquidity and Capital Resources below) and amortization of deferred loan costs of $2.7 million. Excluding the $6.1 million amortization, interest expense for the year ended December 31, 2009 decreased by $7.8 million when compared to the prior year.  This decrease is primarily due to a $9.7 million decrease in interest expense on our senior debt, partially offset by a $1.6 million increase in interest expense on our interest rate swaps for the year ended December 31, 2009 as compared to the prior year.

 

Gain on bargain purchase

 

On June 12, 2009, we acquired the assets and business of nine imaging centers located in New Jersey from Medical Resources, Inc. for approximately $2.1 million.  At the time of the acquisition, we immediately sold the assets and business of one of those nine centers to an unrelated third party for approximately $650,000.

 

In accordance with accounting standards, any excess of fair value of acquired net assets over the acquisition consideration results in a gain on bargain purchase. Prior to recording a gain, the acquiring entity must reassess whether all acquired assets and assumed liabilities have been identified and recognized and perform re-measurements to verify that the consideration paid, assets acquired, and liabilities assumed have been properly valued. The Company underwent such a reassessment, and as a result, has recorded a gain on bargain purchase of approximately $1.4 million.

We believe that the gain on bargain purchase resulted from various factors that impacted the sale of those New Jersey assets.  The seller was performing a full liquidation of its assets for the benefit of its creditors.  Upon liquidation of all of its assets, the seller intended to close its business.  The New Jersey assets were the only remaining assets to be sold before a full wind-down of the seller’s business could be completed.  We believe that the seller was willing to accept a bargain purchase price from us in return for our ability to act more quickly and with greater certainty than any other prospective acquirer.  The decline in the credit markets made it difficult for other acquirers who relied upon third party financing to complete the transaction.  The relatively small size of the transaction for us, the lack of required third-party financing and our expertise in completing similar transactions in the past gave the seller confidence that we could complete the transaction expeditiously and without difficulty.

 

Other expense (income)

 

For the year ended December 31, 2009, we recorded $823,000 of other income related to fair value adjustments on our interest rate swaps, offset by $1.2 million of other expense primarily related to litigation.

 

Income tax expense

 

For the year ended December 31, 2009 and 2008, we recorded $443,000 and $151,000, respectively, for state income tax expense primarily related to taxable income generated in the states of Maryland and Delaware.

 

Equity in earnings from unconsolidated joint ventures

 

For the year ended December 31, 2009, we recognized equity in earnings from unconsolidated joint ventures of $8.5 million compared to $9.8 million for the year ended December 31, 2008.  This variance is due to a combination of decreases in our collection rates and increases in our repair and maintenance costs associated with new equipment transitioning from warranty to maintenance contracts in the third quarter of 2009.

 

 Adjusted EBITDA>

We use both GAAP and non-GAAP metrics to measure our financial results.  We believe that, in addition to GAAP metrics, these non-GAAP metrics assist us in measuring our cash generated from operations and ability to service our debt obligations.  We believe this information is useful to investors and other interested parties because we are highly leveraged and our non-GAAP metrics removes non-cash and nonrecurring charges that occur in the affected period and provides a basis for measuring the Company's financial condition against other quarters.

 

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One non-GAAP measure we believe assists us is Adjusted EBITDA.  We define Adjusted EBITDA as earnings before interest, taxes, depreciation and amortization, each from continuing operations and exclude losses or gains on the disposal of equipment, other income or loss, loss on debt extinguishments, bargain purchase gains and non-cash equity compensation.  Adjusted EBITDA includes equity earnings in unconsolidated operations and subtracts allocations of earnings to non-controlling interests in subsidiaries, and is adjusted for non-cash or extraordinary and one-time events taken place during the period.

Adjusted EBITDA is reconciled to its nearest comparable GAAP financial measure, net income (loss).  Adjusted EBITDA is a non-GAAP financial measure used as an analytical indicator by us and the healthcare industry to assess business performance, and is a measure of leverage capacity and ability to service debt.  Adjusted EBITDA should not be considered a measure of financial performance under GAAP, and the items excluded from Adjusted EBITDA should not be considered in isolation or as alternatives to net income, cash flows generated by operating, investing or financing activities or other financial statement data presented in the consolidated financial statements as an indicator of financial performance or liquidity. As Adjusted EBITDA is not a measurement determined in accordance with GAAP and is therefore susceptible to varying methods of calculation, this metric, as presented, may not be comparable to other similarly titled measures of other companies.

The following is a reconciliation of GAAP net loss to Adjusted EBITDA for the years ended December 31, 2010, 2009, and 2008, respectively:

 

		Years Ended
		December 31,
		2010				2009				2008
Net Loss Attributable to RadNet, Inc. Common Stockholders		$	(12,852	)		$	(2,267	)		$	(12,836	)
Plus Provision for Income Taxes			576				443				151
Plus Other Expenses (Income)			505				416				-
Plus Interest Expense			48,398				50,016				51,811
Plus Severence Costs			838				731				335
Plus Loss on Sale of Equipment			1,136				523				516
Plus Gain on Bargain Purchase			-				(1,387	)			-
Plus Loss on Extinguishment of Debt			9,871				-				-
Plus other one-time expenses			-				-				1,976
Plus Depreciation and Amortization			53,997				53,800				53,548
Plus Non Cash Employee Stock Based Compensation			3,718				3,607				2,902
Adjusted EBITDA		$	106,187			$	105,882			$	98,403

 

Liquidity and Capital Resources

 

We had a working capital balance of $5.8 million and $9.2 million at December 31, 2010 and 2009, respectively.  We had a net loss attributable to RadNet, Inc.’s common stockholders of $12.9 million, $2.3 million and $12.8 million for the years ended December 31, 2010, 2009 and 2008, respectively.  We also had a RadNet, Inc. stockholder equity deficit of $82.5 million and $74.8 million at December 31, 2010 and 2009, respectively.

 

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 a significant amount 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 focuses on the following:

 

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maximizing performance at our existing facilities;

 

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focusing on profitable contracting;

 

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expanding MRI, CT and PET applications;

 

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optimizing operating efficiencies; and

 

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expanding our networks.

 

 

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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 provide financing for working capital needs post-acquisition.  The facility consisted 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.  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 consisted of an additional $25 million as part of our first lien Term Loan and $10 million of additional capacity under our existing revolving line of credit bringing the total capacity to $55 million. On February 22, 2008, we secured a second incremental $35 million (“Second Incremental Facility”) of capacity as part of our existing credit facilities with GE Commercial Finance Healthcare Financial Services, all collectively referred to as our “GE Credit Facility.”  

On April 6, 2010 we completed our debt refinancing plan for an aggregate of $585 million.  The debt refinancing plan included our “New Credit Agreement” which included the issuance of a $285 million senior secured term loan due April 6, 2016, a $100 million senior secured revolving credit facility due April 6, 2015, and our “Senior Notes” which includes $200 million in aggregate principal amount of senior unsecured notes due April 1, 2018.  We used $412.0 million of the proceeds from the debt restructuring to pay off our prior credit facility and an additional $1.7 million to settle a call premium associated with our prior credit facilities. As a result of this refinancing, we recorded during the second quarter of 2010 a loss on extinguishment of debt of approximately $9.9 million which is made up of the $1.7 million call premium, $7.6 million write-off of deferred loan costs associated with the prior credit facility, as well as $600,000 of additional debt settlement costs.

At December 31, 2010, the balance of the senior secured term loan was approximately $282.9 million and the par value of our senior unsecured notes was $200.0 million.

Just prior to our refinancing discussed above, our outstanding indebtedness under our GE credit facility included a $242.0 million senior secured term loan B and a $170.0 million second lien term loan.

New Credit Agreement

As mentioned above, on April 6, 2010, we entered into a new Credit and Guaranty Agreement (the “New Credit Agreement”) pursuant to which we obtained $385 million in senior secured bank financing, consisting of a $285 million, six-year term loan facility and a $100 million, five-year revolving credit facility (the New Credit Facilities). In connection with the New Credit Facilities, we terminated the GE Credit Facility.

Interest. The New Credit Facilities bear interest through maturity at a rate determined by adding the applicable margin to either (a) the Base Rate, which is the highest of the (i) Prime Rate, (ii) the rate which is 0.5% in excess of the Federal Funds Effective Rate, (iii) 3.00% and (iv) 1.00% in excess of the one-month Adjusted Eurodollar Rate at such time, or (b) the Adjusted Eurodollar Rate, which is the higher of (i) the London interbank offered rate, adjusted for statutory reserve requirements, for the respective interest period, as determined by the administrative agent and (ii) 2.00%.  Applicable margin means (i) (a) with respect to Tranche B Term Loans that are Eurodollar Rate Loans, 3.75% per annum and (b) with respect to Tranche B Term Loans that are Base Rate Loans, 2.75% per annum; and (ii) (a) with respect to Revolving Loans that are Eurodollar Rate Loans, 3.75% per annum and (b) with respect to Revolving Loans and Swing Line Loans that are Base Rate Loans, 2.75% per annum.

Payments. Commencing on June 30, 2010, we are required to make quarterly amortization payments on the term loan facility, each in the amount of $712,500, with the remaining principal balance paid at maturity.  Under the New Credit Agreement, we are also required to make mandatory prepayments, subject to specified exceptions, from Consolidated Excess Cash Flow, and upon certain events, including, but not limited to, (i) the receipt of net cash proceeds from the sale or other disposition of any property or assets by us or any of our subsidiaries, (ii) the receipt of net cash proceeds from insurance or condemnation proceeds paid on account of any loss of any property or assets of us or any of our subsidiaries, (iii) the receipt of net cash proceeds from the incurrence of indebtedness by us or any of our subsidiaries (other than certain indebtedness otherwise permitted under the loan documents relating to the New Credit Facilities) and (iv) the receipt of net cash proceeds by us or any of our subsidiaries from Extraordinary Receipts, as defined in the New Credit Agreement.

Guarantees and Collateral. The obligations under the New Credit Facilities are guaranteed by us, all of our current and future wholly-owned domestic restricted subsidiaries and certain of our affiliates.  The obligations under the New Credit Facilities and the guarantees are secured by a perfected first priority security interest in all of Radnet Management’s and the guarantors’ tangible and intangible assets, including, but not limited to, pledges of equity interests of Radnet Management and all of our current and future domestic subsidiaries.

 

 

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Restrictive Covenants. In addition to certain customary covenants, the New Credit Agreement places limits on our ability to declare dividends or redeem or repurchase capital stock, prepay, redeem or purchase debt, incur liens and engage in sale-leaseback transactions, make loans and investments, incur additional indebtedness, amend or otherwise alter debt and other material agreements, engage in mergers, acquisitions and asset sales, enter into transactions with affiliates and alter the business we and our subsidiaries currently conduct.

Financial Covenants. The New Credit Agreement contains financial covenants including a minimum interest coverage ratio, a maximum total leverage ratio and a limit on annual capital expenditures. Failure to comply with these covenants could permit the lenders under the New Credit Facilities to declare all amounts borrowed, together with accrued interest and fees, to be immediately due and payable.

Events of Default. In addition to certain customary events of default, events of default under the New Credit Facilities include failure to pay principal or interest when due, a material breach of any representation or warranty contained in the loan documents, covenant defaults, events of bankruptcy and a change of control.

Senior Unsecured Notes

Also, as mentioned above, on April 6, 2010, we issued $200 million in aggregate amount of senior unsecured Notes which have a coupon of 10.375% and were issued at a price of 98.680%. The Notes were issued by Radnet Management, Inc. and guaranteed jointly and severally on a senior unsecured basis by us and all of our current and future wholly-owned domestic restricted subsidiaries.  The Notes were offered and sold in a private placement exempt from registration under the Securities Act to qualified institutional buyers pursuant to Rule 144A and Regulation S under the Securities Act. The Notes will mature on April 1, 2018, and bear interest at the rate of 10.375% per year.  We will pay interest on the Notes on April 1 and October 1, commencing October 1, 2010. The Notes are governed under an indenture agreement with U.S. Bank National Association as trustee. Under the terms of the indenture agreement, we agreed to file a registration statement with the Securities and Exchange Commission (“SEC”) relating to an offer to exchange the Notes for registered publicly tradable notes that have substantially identical terms as the Notes. On August 30, 2010, we filed a registration statement on Form S-4 with the SEC relating to the offer to exchange the Notes.  On January 13, 2011, our registration statement was declared effective by the SEC.  On February 14, 2011, we completed an exchange offer where by all Notes were exchanged for registered publicly tradable notes.

Ranking. The Notes and the guarantees:

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rank equally in right of payment with any existing and future unsecured senior indebtedness of the guarantors;

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rank senior in right of payment to all existing and future subordinated indebtedness of the Guarantors;

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are effectively subordinated in right of payment to any secured indebtedness of the guarantors (including indebtedness under the New Credit Facilities) to the extent of the value of the assets securing such indebtedness; and

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are structurally subordinated in right of payment to all existing and future indebtedness and other liabilities of any of the Company’s subsidiaries that is not a guarantor of the Notes.