UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q/A
(Amendment No. 1)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended: June 30, 2006

Commission File Number: 1-16609

ALLIANCE  IMAGING, INC.

(Exact name of registrant as specified in its charter)

DELAWARE

 

33-0239910

(State or other jurisdiction of

 

(IRS Employer

incorporation or organization)

 

Identification Number)

 

1900 South State College Boulevard
Suite 600
Anaheim, California 92806

(Address of principal executive office)

(714) 688-7100

(Registrant’s telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o

 

Accelerated filer x

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o   No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 31, 2006:

Common Stock, $.01 par value, 49,871,449 shares

 




ALLIANCE IMAGING, INC.

FORM 10-Q/A

For the Fiscal Quarter Ended June 30, 2006

Explanatory Note

Alliance Imaging, Inc. (the “Company”) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 (the “10-Q”), originally filed on August 9, 2006, to restate its condensed consolidated balance sheets as of June 30, 2006 and December 31, 2005, and its condensed consolidated statements of operations and comprehensive income for the quarter and six months ended June 30, 2006 and 2005, and its condensed consolidated statements of cash flows for the six months ended June 30, 2006 and 2005, and the related disclosures. Please refer to Note 14 to the accompanying condensed consolidated financial statements for additional information.

Subsequent to the filing of the 10-Q, the Company identified an error with respect to the accounting for interest rate swap agreements. The swap agreements were executed in 2004 and mature at various dates in 2007. Since inception the Company had recorded the unrealized gains and losses in fair value of the swap agreements through other comprehensive income (loss). The Company has determined that these transactions do not meet the requirements for hedge accounting treatment and any unrealized gains or losses should have been recognized through earnings.

This Amendment No. 1 does not result in a change in the Company’s previously reported revenues, cash flow from operations or total cash and cash equivalents shown in its condensed consolidated financial statements. Furthermore, the Company has not modified or updated disclosures presented in this Form 10-Q/A, except as required to reflect the effects of the items discussed above. Accordingly, this Form 10-Q/A does not reflect events occurring after the filing of the 10-Q or modify or update those disclosures affected by subsequent events or discoveries. Information not affected by these restatements is unchanged and reflects the disclosures made at the time of the original filing of the 10-Q on August 9, 2006. Events occurring after the filing of the 10-Q or other disclosures necessary to reflect subsequent events are addressed in the Company’s Quarterly Report in Form 10-Q/A for the quarterly period ended September 30 2006, the Company’s Annual Report on Form 10-K/A for the fiscal period ended December 31, 2006 and in the Company’s Quarterly Report in Form 10-Q/A for the quarterly period ended March 31, 2007, which will be filed with the Securities and Exchange Commission concurrently with this 10-Q/A.

The following items have been amended as a result of the restatements described above:

Part I—Item 1—Financial Statements

Part I—Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

Part I—Item 3—Quantitative and Qualitative Disclosures About Market Risk

Part I—Item 4—Controls and Procedures




ALLIANCE  IMAGING,  INC.
FORM 10-Q/A

June 30, 2006

Index

 

Page

PART I—FINANCIAL INFORMATION

 

 

Item 1—Financial Statements:

 

 

Condensed Consolidated Balance Sheets
December 31, 2005 and June 30, 2006 (Unaudited) (as restated)

 

3

 

Condensed Consolidated Statements of Operations and Comprehensive Income
Quarter and six months ended June 30, 2005 and 2006 (Unaudited) (as restated)

 

4

 

Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2005 and 2006 (Unaudited) (as restated)

 

5

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

6

 

Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

 

Item 3—Quantitative and Qualitative Disclosures about Market Risk

 

31

 

Item 4—Controls and Procedures

 

32

 

PART II—OTHER INFORMATION

 

 

 

Item 1—Legal Proceedings

 

33

 

Item 1A—Risk Factors

 

33

 

Item 2—Unregistered Sales of Equity Securities and Use of Proceeds

 

33

 

Item 3—Defaults Upon Senior Securities

 

33

 

Item 4—Submission of Matters to a Vote of Security Holders

 

33

 

Item 5—Other Information

 

34

 

Item 6—Exhibits

 

34

 

SIGNATURES

 

38

 

 

2




PART I—FINANCIAL INFORMATION

ITEM 1.                FINANCIAL STATEMENTS

ALLIANCE IMAGING, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands)

 

 

December 31,

 

June 30,

 

 

 

2005

 

2006

 

 

 

(as restated,
see Note 14)

 

(as restated,
see Note 14)

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

13,421

 

 

 

$

12,423

 

 

Accounts receivable, net of allowance for doubtful accounts

 

 

48,236

 

 

 

53,478

 

 

Deferred income taxes

 

 

6,186

 

 

 

18,157

 

 

Prepaid expenses and other current assets

 

 

3,686

 

 

 

4,998

 

 

Other receivables

 

 

8,983

 

 

 

11,074

 

 

Total current assets

 

 

80,512

 

 

 

100,130

 

 

Equipment, at cost

 

 

752,128

 

 

 

760,475

 

 

Less accumulated depreciation

 

 

(393,179

)

 

 

(404,275

)

 

Equipment, net

 

 

358,949

 

 

 

356,200

 

 

Goodwill

 

 

154,656

 

 

 

154,612

 

 

Other intangible assets, net

 

 

39,071

 

 

 

38,155

 

 

Deferred financing costs, net

 

 

8,236

 

 

 

7,628

 

 

Other assets

 

 

33,918

 

 

 

25,104

 

 

Total assets

 

 

$

675,342

 

 

 

$

681,829

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

 

$

23,672

 

 

 

$

14,646

 

 

Accrued compensation and related expenses

 

 

14,088

 

 

 

15,954

 

 

Accrued interest payable

 

 

4,561

 

 

 

4,689

 

 

Income taxes payable

 

 

87

 

 

 

76

 

 

Other accrued liabilities

 

 

29,064

 

 

 

31,248

 

 

Current portion of long-term debt

 

 

7,781

 

 

 

7,016

 

 

Total current liabilities

 

 

79,253

 

 

 

73,629

 

 

Long-term debt, net of current portion

 

 

418,260

 

 

 

398,158

 

 

Senior subordinated notes

 

 

153,541

 

 

 

153,541

 

 

Minority interests and other liabilities

 

 

4,400

 

 

 

4,229

 

 

Deferred income taxes

 

 

60,144

 

 

 

79,073

 

 

Total liabilities

 

 

715,598

 

 

 

708,630

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

 

 

 

 

Common stock

 

 

496

 

 

 

498

 

 

Additional paid-in deficit

 

 

(11,876

)

 

 

(9,647

)

 

Accumulated comprehensive income

 

 

1,515

 

 

 

2,340

 

 

Accumulated deficit

 

 

(30,391

)

 

 

(19,992

)

 

Total stockholders’ deficit

 

 

(40,256

)

 

 

(26,801

)

 

Total liabilities and stockholders’ deficit

 

 

$

675,342

 

 

 

$

681,829

 

 

 

See accompanying notes.

3




ALLIANCE IMAGING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except per share amounts)

 

 

Quarter Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

 

 

(as restated,
see Note 14)

 

(as restated,
see Note 14)

 

(as restated,
see Note 14)

 

(as restated,
see Note 14)

 

Revenues

 

 

$

108,434

 

 

 

$

115,305

 

 

 

$

214,398

 

 

 

$

230,648

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues, excluding depreciation and amortization

 

 

53,892

 

 

 

62,593

 

 

 

107,828

 

 

 

122,460

 

 

Selling, general and administrative expenses

 

 

13,677

 

 

 

13,611

 

 

 

25,363

 

 

 

27,367

 

 

Employment agreement costs

 

 

92

 

 

 

 

 

 

366

 

 

 

 

 

Severance and related costs

 

 

 

 

 

47

 

 

 

 

 

 

536

 

 

Depreciation expense

 

 

20,463

 

 

 

20,919

 

 

 

40,926

 

 

 

41,920

 

 

Amortization expense

 

 

901

 

 

 

1,229

 

 

 

1,782

 

 

 

2,473

 

 

Interest expense, net of interest income

 

 

10,442

 

 

 

10,022

 

 

 

17,069

 

 

 

19,796

 

 

Other (income) and expense, net

 

 

(55

)

 

 

(256

)

 

 

(387

)

 

 

472

 

 

Total costs and expenses

 

 

99,412

 

 

 

108,165

 

 

 

192,947

 

 

 

215,024

 

 

Income before income taxes, minority interest
expense, and earnings from unconsolidated
investees

 

 

9,022

 

 

 

7,140

 

 

 

21,451

 

 

 

15,624

 

 

Income tax expense

 

 

3,795

 

 

 

3,556

 

 

 

8,901

 

 

 

7,207

 

 

Minority interest expense

 

 

544

 

 

 

495

 

 

 

956

 

 

 

1,035

 

 

Earnings from unconsolidated investees

 

 

(912

)

 

 

(1,977

)

 

 

(1,596

)

 

 

(3,017

)

 

Net income

 

 

$

5,595

 

 

 

$

5,066

 

 

 

$

13,190

 

 

 

$

10,399

 

 

Comprehensive income, net of taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

$

5,595

 

 

 

$

5,066

 

 

 

$

13,190

 

 

 

$

10,399

 

 

Unrealized (loss) gain on hedging
transactions, net of taxes

 

 

(584

)

 

 

273

 

 

 

701

 

 

 

825

 

 

Comprehensive income

 

 

$

5,011

 

 

 

$

5,339

 

 

 

$

13,891

 

 

 

$

11,224

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

0.11

 

 

 

$

0.10

 

 

 

$

0.27

 

 

 

$

0.21

 

 

Diluted

 

 

$

0.11

 

 

 

$

0.10

 

 

 

$

0.26

 

 

 

$

0.21

 

 

Weighted average number of shares of common stock and common stock equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

49,286

 

 

 

49,758

 

 

 

49,210

 

 

 

49,684

 

 

Diluted

 

 

50,270

 

 

 

50,232

 

 

 

50,290

 

 

 

50,107

 

 

 

See accompanying notes.

4




ALLIANCE IMAGING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

 

 

Six Months Ended
June 30,

 

 

 

2005

 

2006

 

 

 

(as restated,
see Note 14)

 

(as restated,
see Note 14)

 

Operating activities:

 

 

 

 

 

 

 

 

 

Net income

 

 

$

13,190

 

 

 

$

10,399

 

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

Provision for doubtful accounts

 

 

1,478

 

 

 

1,593

 

 

Non-cash share-based compensation

 

 

126

 

 

 

1,308

 

 

Depreciation and amortization

 

 

42,708

 

 

 

44,393

 

 

Amortization of deferred financing costs

 

 

1,462

 

 

 

794

 

 

Adjustment of swaps to fair value

 

 

(1,500

)

 

 

(494

)

 

Distributions greater than (less than) equity in undistributed income of investees

 

 

271

 

 

 

(188

)

 

Deferred income taxes

 

 

7,836

 

 

 

6,552

 

 

(Gain) loss on sale of assets

 

 

(387

)

 

 

472

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(1,203

)

 

 

(6,903

)

 

Prepaid expenses and other current assets

 

 

(1,554

)

 

 

(1,312

)

 

Other receivables

 

 

(2,901

)

 

 

(2,091

)

 

Other assets

 

 

(2,243

)

 

 

(848

)

 

Accounts payable

 

 

(11,977

)

 

 

(8,915

)

 

Accrued compensation and related expenses

 

 

(1,379

)

 

 

1,866

 

 

Accrued interest payable

 

 

2,737

 

 

 

128

 

 

Income taxes payable

 

 

(63

)

 

 

(11

)

 

Other accrued liabilities

 

 

3,802

 

 

 

1,934

 

 

Minority interests and other liabilities

 

 

342

 

 

 

(259

)

 

Net cash provided by operating activities

 

 

50,745

 

 

 

48,418

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

Equipment purchases

 

 

(28,948

)

 

 

(43,035

)

 

Decrease in deposits on equipment

 

 

3,419

 

 

 

10,388

 

 

Proceeds from sale of assets

 

 

1,251

 

 

 

2,322

 

 

Net cash used in investing activities

 

 

(24,278

)

 

 

(30,325

)

 

Financing activities:

 

 

 

 

 

 

 

 

 

Principal payments on equipment debt

 

 

(2,972

)

 

 

(1,934

)

 

Principal payments on term loan facility

 

 

(25,000

)

 

 

(2,675

)

 

Principal payments on revolving loan facility

 

 

(15,000

)

 

 

(28,825

)

 

Proceeds from revolving loan facility

 

 

15,000

 

 

 

13,500

 

 

Payments of debt issuance costs

 

 

(211

)

 

 

(186

)

 

Proceeds from exercise of employee stock options

 

 

1,052

 

 

 

1,029

 

 

Net cash used in financing activities

 

 

(27,131

)

 

 

(19,091

)

 

Net decrease in cash and cash equivalents

 

 

(664

)

 

 

(998

)

 

Cash and cash equivalents, beginning of period

 

 

20,721

 

 

 

13,421

 

 

Cash and cash equivalents, end of period

 

 

$

20,057

 

 

 

$

12,423

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

 

Interest paid

 

 

$

14,580

 

 

 

$

19,676

 

 

Income taxes paid, net of refunds

 

 

1,291

 

 

 

767

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

Net book value of assets exchanged

 

 

$

3,679

 

 

 

$

5,439

 

 

Capital lease obligations assumed for the purchase of equipment debt

 

 

 

 

 

1,839

 

 

Equipment debt transferred to unconsolidated investee

 

 

 

 

 

(2,772

)

 

Comprehensive income from hedging transactions, net of taxes

 

 

701

 

 

 

825

 

 

 

See accompanying notes.

5




ALLIANCE IMAGING, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(Unaudited)
(Dollars in thousands, except per share amounts)

1. Basis of Presentation, Principles of Consolidation, and Use of Estimates

Basis of Presentation—The accompanying unaudited condensed consolidated financial statements have been prepared by Alliance Imaging, Inc. (the “Company”) in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial statements for the year ended December 31, 2005.

Principles of Consolidation—The accompanying unaudited condensed consolidated financial statements of the Company include the assets, liabilities, revenues and expenses of all majority owned subsidiaries over which the Company exercises control. Intercompany transactions have been eliminated. The Company records minority interest expense related to its consolidated subsidiaries which are not wholly owned. Investments in unconsolidated investees are accounted for under the equity method.

Use of Estimates—The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

2. Share-Based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123(R) (revised December 2004), “Share-Based Payment” (“SFAS 123(R)”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). This statement requires that the fair value at the grant date resulting from all share-based payment transactions be recognized in the financial statements. Further, SFAS 123(R) requires entities to apply a fair-value based measurement method in accounting for these transactions. This value is recorded over the vesting period. The statement is effective for the first fiscal year beginning after June 15, 2005.

The Company adopted SFAS 123(R) for the fiscal year beginning January 1, 2006, using the modified prospective application transition method and, accordingly, has not restated the consolidated financial statements for prior interim periods or fiscal years. Under SFAS 123(R), the Company now records in its consolidated statements of operations (i) compensation cost for options granted, modified, repurchased or cancelled on or after January 1, 2006 under the provisions of SFAS 123(R) and (ii) compensation cost for the unvested portion of options granted prior to January 1, 2006 over their remaining vesting periods using the amounts previously measured under SFAS 123 for pro forma disclosure purposes.

6




Stock Option Plans and Awards

In December 1997, the Company adopted an employee stock option plan (“1997 Equity Plan”) pursuant to which options with respect to a total of 4,685,450 shares of the Company’s common stock were available for grant. Options were granted at their fair value at the date of grant. All options have 10-year terms. On November 2, 1999, in connection with a series of transactions contemplated by an Agreement and Plan of Merger between Viewer Acquisition Corp and the Company in November 1999 (the “1999 Recapitalization Merger”), all options under the 1997 Equity Plan became fully vested.

In connection with the Company’s acquisition of all of the outstanding common stock of Three Rivers Holding Corporation (“Three Rivers”), the parent corporation of SMT Health Services, Inc., in 1999, outstanding employee stock options under the 1997 Three Rivers Stock Option Plan were converted into options to acquire shares of the Company’s common stock. The Three Rivers stock option plan allowed for options with respect to a total of 2,825,200 shares of the Company’s common stock to be available for grant. Options were granted at their fair value at the date of grant. All options have 10-year terms. On November 2, 1999, in connection with the 1999 Recapitalization Merger, all options under the 1997 Three Rivers Stock Option Plan became fully vested.

In connection with the 1999 Recapitalization Merger, the Company adopted an employee stock option plan (“the 1999 Equity Plan”) pursuant to which options with respect to a total of 6,325,000 shares of the Company’s common stock became available for grant. As of June 30, 2006, a total of 1,346,575 shares are available for grant under the 1999 Equity Plan. Options are granted with exercise prices equal to fair value of the Company’s common stock at the date of grant, except as noted below. All options have 10-year terms. A portion of the options vest in equal increments over five years and a portion vest after eight years (subject to acceleration if certain financial performance targets are achieved). The Company settles stock option exercises with newly issued shares of common stock.

Consistent with the valuation method for the disclosure-only provisions of SFAS 123, the Company is using the Black-Scholes option pricing model to value the compensation expense associated with stock-based awards under SFAS 123(R). The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the table below. In addition, forfeitures are estimated when recognizing compensation expense, and the estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods. For the quarter and six months ended June 30, 2005, the Company recorded $63 and $126, respectively, in non-cash share-based compensation for stock options granted with exercise prices below the fair value of the Company’s common stock at the date of grant and for certain stock options subject to amended performance targets under the 1999 Equity Plan, as discussed below. For the quarter and six months ended June 30, 2006, of the total $593 and $1,308, respectively, in non-cash share-based compensation recorded, $434 and $988, respectively, was incremental share-based compensation as a result of the adoption of SFAS 123 (R).

The following weighted average assumptions were used in the estimated grant date fair value calculations for stock option awards:

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

    2005    

 

    2006    

 

Risk free interest rate

 

 

3.96

%

 

 

3.79

%

 

 

4.55

%

 

Expected dividend yield

 

 

0.00

%

 

 

0.00

%

 

 

0.00

%

 

Expected stock price volatility

 

 

56.4

%

 

 

52.8

%

 

 

56.7

%

 

Average expected life (in years)

 

 

6.50

 

 

 

5.52

 

 

 

6.69

 

 

 

7




There were no stock options granted during the second quarter ended June 30, 2006.

The expected stock price volatility rates are based on a blend of the historical volatility of the Company’s common stock and peer implied volatility. The risk free interest rates are based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option or award. The average expected life represents the weighted average period of time that options or awards granted are expected to be outstanding, as calculated using the simplified method described in the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107.

In November 2000, the Company granted stock options to certain employees at exercise prices below the fair value of the Company’s common stock, of which 35,000 options were outstanding at June 30, 2006. The exercise prices of these options and the fair value of the Company’s common stock on the grant date were $5.60 and $9.52 per share, respectively. The Company recorded non-cash share-based compensation of $6 and $12, respectively, for the quarter and six months ended June 30, 2005, with an offset to paid-in-capital deficit. As the Company adopted SFAS 123 (R) effective January 1, 2006, any non-cash share-based compensation as a result of granting these stock options are included in the Company’s consolidated total of share-based compensation of $593 and $1,308, respectively, for the quarter and six months ended June 30, 2006.

Under the 1999 Equity Plan, a portion of the options granted are “performance options.” These options vest on the eighth anniversary of the grant date if the option holder is still an employee, but the vesting accelerates if the Company meets the operating performance targets specified in the option agreements. On June 20, 2001, the Company’s compensation committee authorized the Company to amend the option agreements under its 1999 Equity Plan to reduce the performance targets for 1,899,600 performance options out of the 2,284,222 performance options outstanding. On May 18, 2004, the Company’s compensation committee authorized the Company to make a second amendment to the option agreements under its 1999 Equity Plan to further reduce the performance targets for all of the 1,914,500 performance options outstanding. As a result of the amendment, if the Company achieves the reduced performance targets but does not achieve the original performance targets, and an option holder terminates employment prior to the eighth anniversary of the option grant date, the Company would be required to record a non-cash stock-based compensation charge equal to the amount by which the actual value of the shares subject to the performance option on the date of the amendment exceeded the option’s exercise price. For the quarter and six months ended June 30, 2005 the Company recorded $57 and $114, respectively, in non-cash share-based compensation as a result of the amendment. As the Company adopted SFAS 123 (R) effective January 1, 2006, any non-cash share-based compensation as a result of these amendments are included in the Company’s consolidated total of non-cash stock-based compensation of $593 and $1,308, respectively, for the quarter and six months ended June 30, 2006.

The following table summarizes the Company’s stock option activity:

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Weighted-

 

Remaining

 

Aggregate

 

 

 

Number of

 

Average

 

Contractual

 

Intrinsic

 

 

 

Shares

 

Exercise Price

 

Term

 

Value

 

Outstanding at December 31, 2005

 

3,571,275

 

 

$

6.25

 

 

 

 

 

 

 

 

 

 

Granted

 

866,500

 

 

4.19

 

 

 

 

 

 

 

 

 

 

Exercised

 

(238,125

)

 

4.32

 

 

 

 

 

 

 

 

 

 

Canceled

 

(313,350

)

 

7.79

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2006

 

3,886,300

 

 

$

5.78

 

 

 

8.76

 

 

 

$

13,184

 

 

Vested and expected to vest in the future at June 30, 2006

 

3,696,748

 

 

$

5.78

 

 

 

7.87

 

 

 

$

12,525

 

 

Exercisable at June 30, 2006

 

1,315,138

 

 

$

5.14

 

 

 

6.63

 

 

 

$

4,244

 

 

 

8




The weighted average grant-date fair value of options granted during the quarter ended June 30, 2005 was $6.20 per share. There were no stock options granted during the quarter ended June 30, 2006. The weighted average grant-date fair value of options granted during the six months ended June 30, 2005 and 2006 was $6.11 per share and $2.58 per share, respectively. The total intrinsic value of options exercised during the quarters ended June 30, 2005 and 2006 was $664 and $298, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2005 and 2006 was $2,306 and $389, respectively. The total cash received from employees as a result of stock option exercises was $447 and $759 for the quarters ended June 30, 2005 and 2006, respectively. The total cash received from employees as a result of stock option exercises was $1,052 and $1,029 for the six months ended June 30, 2005 and 2006, respectively.

The following table summarizes the Company’s unvested stock option activity:

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Grant-Date

 

 

 

Shares

 

Fair Value

 

Unvested at December 31, 2005

 

2,243,851

 

 

$

3.86

 

 

Granted

 

866,500

 

 

2.58

 

 

Vested

 

(311,739

)

 

3.28

 

 

Canceled

 

(227,450

)

 

4.18

 

 

Unvested at June 30, 2006

 

2,571,162

 

 

$

3.47

 

 

 

At June 30, 2006, the total unrecognized fair value compensation cost related to unvested stock options granted to both employees and non-employees was $7,323, which is expected to be recognized over a remaining weighted-average period of 4.38 years. The valuation model applied in this calculation utilizes highly subjective assumptions that could potentially change over time, including the expected forfeiture rate and performance targets. Therefore the amount of unrecognized compensation expense noted above does not necessarily represent the value that will ultimately be realized by the Company in the statements of operations. The total fair value of shares vested during the quarters ended June 30, 2005 and 2006 were $171, and $167, respectively. The total fair value of shares vested during the six months ended June 30, 2005 and 2006 were $673, and $1,024, respectively.

Employee Share-Based Compensation Expense

The table below shows the amounts recognized in the financial statements for the quarter and six months ended June 30, 2006 for awards newly subject to compensation expense under SFAS 123(R). As discussed previously, prior to the adoption of SFAS 123(R), the Company recorded compensation expense for stock options granted with exercise prices below the fair value of the Company’s common stock at the date of grant, certain stock options subject to amended performance targets under the 1999 Equity Plan, and non-employee share-based awards granted to members of the Company’s advisory committee. The table below, therefore, excludes the effect of these awards.

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2006

 

Selling, general, and administrative expenses

 

 

$

434

 

 

 

$

988

 

 

Total cost of non-cash share-based compensation included in income, before income tax

 

 

434

 

 

 

988

 

 

Amount of income tax recognized in earnings

 

 

(179

)

 

 

(404

)

 

Amount charged against income

 

 

$

255

 

 

 

$

584

 

 

Impact on net income per share:

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

$

0.01

 

 

 

$

0.01

 

 

Diluted earnings per share:

 

 

$

0.01

 

 

 

$

0.01

 

 

 

9




Pro Forma Share-Based Compensation

Prior to the adoption of SFAS 123(R), the Company accounted for non-cash share-based compensation awards using the intrinsic value method prescribed under APB 25, and its related interpretations, as permitted by SFAS 123, as amended by SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” Under the intrinsic value method, the difference between the market price on the date of grant and the exercise price is charged to the consolidated statements of operations over the vesting period. Prior to the adoption of SFAS 123(R), the Company recognized compensation cost for only certain awards, as discussed above. All other employee share-based awards were granted with an exercise price equal to the market value of the underlying common stock on the date of grant and no compensation cost is reflected in income from operations for those awards. SFAS 123, as amended by SFAS 148, required presentation of pro forma information regarding net income and earnings per share determined as if the Company had accounted for its employee stock options under the fair value method of that Statement.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ expected vesting period. Had compensation cost for the Company’s stock option plan been determined based on the estimated fair value at the grant dates for awards under the plan consistent with the fair value method of SFAS 123 utilizing the Black-Scholes option-pricing model, the Company’s net income and basic and diluted earnings per share for the quarter and six months ended June 30, 2005 would have approximated the pro forma amount indicated below:

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2005

 

Net income:

 

 

 

 

 

 

 

 

 

As reported

 

 

$

5,595

 

 

 

$

13,190

 

 

Add: Non-cash share-based compensation expense included
in reported net income, net of related tax effects

 

 

38

 

 

 

75

 

 

Deduct: Non- cash share-based compensation expense determined under fair value based method, net of related tax effects

 

 

(367

)

 

 

(725

)

 

Pro forma net income

 

 

$

5,266

 

 

 

$

12,540

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

As reported

 

 

$

0.11

 

 

 

$

0.27

 

 

Pro forma

 

 

0.11

 

 

 

0.25

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

As reported

 

 

$

0.11

 

 

 

$

0.26

 

 

Pro forma

 

 

0.10

 

 

 

$

0.25

 

 

 

3. Recent Accounting Pronouncements

Accounting Changes and Error Corrections—In May 2005, the FASB issued SFAS 154, “Accounting for Changes and Error Corrections” (“SFAS 154”), which is a replacement of APB Opinion No. 20, “Accounting Changes,” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements.” This statement changes the requirements for the accounting for and reporting of all voluntary changes in accounting principle and in the instance that a pronouncement does not include specific transition provisions. This statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors

10




made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 did not have a material impact on the Company’s consolidated financial position or results of operations.

Limited Partnerships—In June 2005, the FASB issued Emerging Issues Task Force Issue No. 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights”(“EITF 04-05”). EITF 04-05 clarifies how general partners in a limited partnership should determine whether they control a limited partnership. A general partner of a limited partnership is presumed to control the limited partnership unless the limited partners have substantive kick-out rights or participating rights. For general partners of all new limited partnerships formed and for existing limited partnerships for which the partnership agreements are modified, EITF 04-05 is effective after June 29, 2005. For general partners in all other limited partnerships, EITF 04-05 is effective for the first period in fiscal years beginning after December 15, 2005. The adoption of EITF 04-05 did not have a material impact on the Company’s consolidated financial position or results of operations.

Uncertainty in Income Taxes—In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”(“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes” (“FASB 109”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB 109. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not believe the adoption of FIN 48 will have a material impact on the Company’s consolidated financial position or results of operations.

4. Transactions

Effective September 1, 2005, the Company acquired certain assets associated with nine multi-modality fixed-site diagnostic imaging centers. The multi-modality fixed-site diagnostic imaging centers include one MRI system, six CT systems, and 29 other modality systems. The purchase price consisted of $7,650 in cash and $826 in assumed liabilities and transaction costs. The acquisition was financed using the Company’s internally generated funds. As a result of this acquisition, the Company recorded goodwill and intangible assets of $2,246 and $2,400, respectively. The intangible assets were recorded at fair value at the acquisition date. All recorded goodwill is deductible for tax purposes and will be amortized over 15 years for tax purposes. The acquisition also includes $246 of contingent payment due to the shareholders of the centers if certain performance targets are met over a three year period. When the contingency is resolved and consideration is distributable, the Company will record the fair value of the consideration as additional purchase price to goodwill. Adjustments to goodwill may occur in future periods as a result of changes in the original valuation of assets and liabilities acquired. During the quarter ended June 30, 2006, the company decreased goodwill by $103 as a result of changes in the original valuation of assets and liabilities acquired. During the six months ended June 30, 2006, the company decreased goodwill by $77 as a result of changes in the original valuation of assets and liabilities acquired. The Company has not included pro forma information as this acquisition did not have a material impact on the Company’s consolidated financial position or results of operations.

Effective October 1, 2005, the Company acquired 100% of the outstanding stock of PET Scans of America Corp. (“PSA”), a mobile provider of PET and PET/CT services primarily to hospitals in 13 states. The purchase price consisted of $36,596 in cash and $3,692 in assumed liabilities and transaction costs. The acquisition was financed using the Company’s revolving line of credit, internally generated funds, and capital leases. As a result of this acquisition the Company acquired intangible assets of $11,400, of which $9,100 was assigned to PSA customer contracts, which will be amortized over 10 years, and $2,100 was

11




assigned to certificates of need held by PSA, which have indefinite useful lives and are not subject to amortization. These assets were recorded at fair value at the acquisition date. The Company recorded total goodwill of $22,472, which includes $3,007 of goodwill related to income tax timing differences as a result of the acquisition. None of the goodwill recorded is deductible for tax purposes. Adjustments to goodwill may occur in future periods as a result of changes in the original valuation of assets and liabilities acquired. There were no adjustments recorded to goodwill during the quarter ended June 30, 2006. During the six months ended June 30, 2006, the company decreased goodwill by $23 as a result of changes in the original valuation of assets and liabilities acquired. The Company has not included pro forma information as this acquisition did not have a material impact on the Company’s consolidated financial position or results of operations.

In late December 2005, the Company purchased an additional equity interest in a joint venture the Company formed in 2004 with the University of Pittsburgh Medical Center. The joint venture, Alliance Oncology (“AO”), is designed to partner with hospitals to build and operate radiation oncology centers, with an emphasis on intensity modulated radiation therapy and image guided radiation therapy. The purchase price for the additional equity interest was $8,000, which was financed through the Company’s revolving line of credit. The Company now owns 80% of AO. As a result of this acquisition the Company recorded goodwill of $6,946, which is deductible for tax purposes and will be amortized over 15 years for tax purposes. Adjustments to goodwill may occur in future periods as a result of changes in the original valuation of assets and liabilities acquired. There were no adjustments recorded to goodwill during the quarter ended June 30, 2006. During the six months ended June 30, 2006, the company increased goodwill by $56 as a result of changes in the original valuation of assets and liabilities acquired. During the quarter and six months ended June 30, 2005 the Company recorded earnings in unconsolidated investees for the Company’s share of AO’s previously unconsolidated earnings. The Company has not included pro forma information as this acquisition did not have a material impact on the Company’s consolidated financial position or results of operations.

5. Goodwill and Intangible Assets

Changes in the carrying amount of goodwill are as follows:

Balance at December 31, 2005

 

$

154,656

 

Decrease to goodwill during the period

 

(44

)

Balance at June 30, 2006

 

$

154,612

 

 

Intangible assets consisted of the following:

 

 

December 31, 2005

 

June 30, 2006

 

 

 

Gross
Carrying

 

Accumulated

 

Intangible

 

Gross
Carrying

 

Accumulated

 

Intangible

 

 

 

Amount

 

Amortization

 

Assets, net

 

Amount

 

Amortization

 

Assets, net

 

Amortizing intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer contracts

 

$

51,063

 

 

$

(18,791

)

 

 

$

32,272

 

 

$

51,063

 

 

$

(20,850

)

 

 

$

30,213

 

 

Other

 

4,467

 

 

(1,910

)

 

 

2,557

 

 

7,087

 

 

(2,324

)

 

 

4,763

 

 

Total amortizing intangible assets

 

$

55,530

 

 

$

(20,701

)

 

 

$

34,829

 

 

$

58,150

 

 

$

(23,174

)

 

 

$

34,976

 

 

Intangible assets not subject to amortization

 

 

 

 

 

 

 

 

$

4,242

 

 

 

 

 

 

 

 

 

$

3,179

 

 

Total other intangible assets

 

 

 

 

 

 

 

 

$

39,071

 

 

 

 

 

 

 

 

 

$

38,155

 

 

 

The Company reviews the recoverability of the carrying value of goodwill on an annual basis or more frequently when an event occurs or circumstances change to indicate an impairment of these assets has

12




possibly occurred. Goodwill is allocated to the Company’s various reporting units which represent the Company’s geographical regions. The Company compares the fair value of the reporting unit to its carrying amount to determine if there is potential impairment. The implied fair value for goodwill is determined based on the fair value of assets and liabilities of the respective reporting units, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” based on discounted cash flows, market multiples, or appraised values as appropriate.

Amortization expense for intangible assets subject to amortization was $901 and $1,229 for the quarters ended June 30, 2005 and 2006, respectively, and $1,782 and $2,473 for the six months ended June 30, 2005 and 2006, respectively. The intangible assets not subject to amortization represent certificate of needs and regulatory authority rights which have indefinite useful lives.

Estimated annual amortization expense for each of the fiscal years ending December 31, is presented below:

2006

 

$

4,929

 

2007

 

4,713

 

2008

 

4,499

 

2009

 

4,178

 

2010

 

4,112

 

 

6. Other Accrued Liabilities

Other accrued liabilities consisted of the following:

 

 

December 31,

 

June 30,

 

 

 

2005

 

2006

 

Accrued systems rental and maintenance costs

 

 

$

5,801

 

 

$

1,921

 

Accrued site rental fees

 

 

1,242

 

 

1,408

 

Accrued property and sales taxes payable

 

 

10,569

 

 

11,895

 

Accrued self-insurance expense

 

 

5,725

 

 

6,342

 

Other accrued expenses

 

 

5,727

 

 

9,682

 

Total

 

 

$

29,064

 

 

$

31,248

 

 

7. Long-Term Debt and Senior Subordinated Credit Facility

Long-term debt consisted of the following:

 

 

December 31,

 

June 30,

 

 

 

2005

 

2006

 

Term loan facility

 

 

$

384,875

 

 

$

382,200

 

Revolving loan facility

 

 

29,500

 

 

14,175

 

Senior subordinated notes

 

 

153,541

 

 

153,541

 

Equipment debt

 

 

11,666

 

 

8,799

 

Long-term debt, including current portion

 

 

579,582

 

 

558,715

 

Less current portion

 

 

7,781

 

 

7,016

 

Long-term debt

 

 

$

571,801

 

 

$

551,699

 

 

13




8. Derivatives

In the second quarter of 2004, the Company entered into interest rate swap agreements, with notional amounts of $56,813, $46,813 and $48,438 to manage the future cash interest payments associated with a portion of the Company’s variable rate bank debt. These agreements are three years in length and mature in 2007. As of June 30, 2005, and 2006, the fair value of the Company’s interest rate swap agreements was $1,036 and $3,318, respectively. Under these arrangements, the Company receives three-month London Interbank Offered Rate (“LIBOR”) and pays a fixed rate of 3.15%, 3.89% and 3.69%, respectively. The net effect is to record interest expense at fixed rates of 5.65%, 6.39% and 6.19 %, respectively, as the debt incurs interest based on three-month LIBOR plus 2.50%. For the quarter and six months ended June 30, 2005 the Company paid net settlement amounts of $268 and $746, respectively. For the quarter and six months ended June 30, 2006, the Company received net settlement amounts of $465 and $771, respectively. Changes in the fair value of the swap agreements are recorded in interest expense each period, as these transactions do not qualify for hedge accounting treatment. For the quarter ended June 30, 2005, the Company recognized interest expense of $934, based on the change in fair value of these instruments. For the quarter ended June 30, 2006, the Company recognized a reduction to interest expense of $52, based on the change in fair value of these instruments. For the six months ended June 30, 2005 and 2006, the Company recognized a reduction to interest expense of $1,500 and $494, respectively, based on the change in fair value of these instruments. The Company will continue to record subsequent changes in the fair value of the swaps through interest expense.

In the first quarter of 2005, the Company entered into multiple interest rate collar agreements for its variable rate bank debt. The total underlying notional amount of the debt was $178,000. Under these arrangements the Company has purchased a cap on the interest rate of 4.00% and has sold a floor of 2.25%. The Company paid a net purchase price of $1,462 for these collars. These agreements are two and three years in length and mature at various dates between January 2007 and January 2008. As of June 30, 2005 and 2006, the fair value of the Company’s interest rate collar agreements was $1,168 and $3,901, respectively. For the quarter and six month period ended June 30, 2005, the Company did not record any net settlement amount. For the quarter and six month period ended June 30, 2006, the Company received a net settlement amount of $287 and $355, respectively. The Company has designated these collars as cash flow hedges of variable future cash flows associated with its long-term debt. For the quarter ended June 30, 2005, the Company recognized comprehensive loss, net of tax, of $584 based on the change in fair value of these instruments. For the quarter ended June 30, 2006, the Company recognized comprehensive gain, net of tax, of $273 based on the change in fair value of these instruments. For the six months ended June 30, 2005 and 2006 the Company recognized an other comprehensive gain, net of tax, of $701 and $825, respectively, based on the change in fair value of these instruments. The Company will record subsequent changes in the fair value of the collars through comprehensive income during the period these instruments are designated as hedges.

The Company accounts for derivative instruments and hedging activities in accordance with the provisions of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS 138, “Accounting for Certain Derivative Instruments and Hedging Activities” (“SFAS 138”), an amendment of SFAS 133. On the date the Company enters into a derivative contract, management may designate the derivative as a hedge of the identified exposure. The Company formally documents all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions. In this documentation, the Company specifically identifies the firm commitment or forecasted transaction that has been designated as a hedged item and states how the hedging instrument is expected to hedge the risks related to the hedged item. The Company formally measures effectiveness of its hedging relationships, both at the hedge inception and on an ongoing basis, in accordance with its risk management policy. The Company would discontinue hedge accounting prospectively (i) if it is determined that the derivative is no longer effective in offsetting change in the cash

14




flows of a hedged item, (ii) when the derivative expires or is sold, terminated or exercised, (iii) because it is probable that the forecasted transaction will not occur, (iv) because a hedged firm commitment no longer meets the definition of a firm commitment, or (v) if management determines that designation of the derivative as a hedge instrument is no longer appropriate. The Company’s derivatives are recorded on the balance sheet at their fair value. For derivatives accounted for as cash flow hedges any unrealized gains or losses on fair value are included in comprehensive income, net of tax, assuming perfect effectiveness. Any ineffectiveness is recognized in earnings.

9. Income Taxes

For the quarter and six months ended June 30, 2006, the Company recorded a provision for income taxes of $3,556 and $7,207, or 41.2% and 40.9% of the Company’s pretax income, respectively. For the quarter and six months ended June 30, 2005, the Company recorded a provision for income taxes of $3,795 and $8,901, or 40.4% and 40.3% of the Company’s pretax income, respectively. The Company’s effective tax rate was higher than statutory rates primarily as a result of state income taxes.

10. Earnings Per Common Share

The following table sets forth the computation of basic and diluted earnings per share (amounts in thousands, except per share amounts):

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2006

 

   2005   

 

   2006   

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

5,595

 

$

5,066

 

$

13,190

 

$

10,399

 

Denominator:

 

 

 

 

 

 

 

 

 

Denominator for basic earnings per share—weighted-average shares

 

49,286

 

49,758

 

49,210

 

49,684

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Employee stock options

 

984

 

474

 

1,080

 

423

 

Denominator for diluted earnings per share—adjusted weighted-average shares

 

50,270

 

50,232

 

50,290

 

50,107

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.11

 

$

0.10

 

$

0.27

 

$

0.21

 

Diluted

 

$

0.11

 

$

0.10

 

$

0.26

 

$

0.21

 

Stock options excluded from the computation of diluted per share amounts:

 

 

 

 

 

 

 

 

 

Weighted-average shares for which the exercise price exceeds average market price of common stock

 

1,223

 

1,141

 

766

 

1,182

 

Average exercise price per share that exceeds average market price of common stock

 

$

11.74

 

$

11.32

 

$

12.40

 

$

11.31

 

 

11. Commitments and Contingencies

The Company has applied the disclosure provisions of FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” to its agreements that contain guarantee or indemnification clauses. These disclosure provisions expand those required by FASB Statement No. 5, “Accounting for Contingencies,” by requiring a guarantor to disclose certain type of guarantees, even if the likelihood of requiring the guarantor’s performance is remote. The following is a description of arrangements in which the Company is the guarantor or indemnifies a party.

15




In the normal course of business, the Company has made certain guarantees and indemnities, under which it may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions. The Company indemnifies other parties, including customers, lessors, and parties to other transactions with the Company, with respect to certain matters. The Company has agreed to hold the other party harmless against losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims arising from a breach of representations or covenants. In addition, the Company has entered into indemnification agreements with its executive officers and directors and the Company’s bylaws contain similar indemnification obligations. Under these arrangements, we are obligated to indemnify, to the fullest extent permitted under applicable law, our current or former officers and directors for various amounts incurred with respect to actions, suits or proceedings in which they were made, or threatened to be made, a party as a result of acting as an officer or director.

It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made related to these indemnifications have been immaterial. At June 30, 2006 the Company has determined that no liability is necessary related to these guarantees and indemnities.

The Company guarantees a portion of a loan on behalf of an unconsolidated investee under an agreement executed prior to 2002. The maximum potential future payment under this financial guarantee is $145 at June 30, 2006. The Company has not recorded an obligation for this guarantee.

On May 5, 2005, Alliance Imaging, Inc. was served with a complaint (the “Class Action Complaint”) filed in Alameda County Superior Court alleging wage and hour claims on behalf of a putative class of approximately 400 former and current California employees of the Company. On August 19, 2005, the plaintiffs filed an amended complaint, which the Company answered on September 23, 2005. In this suit, captioned Linda S. Jones, et al. v. Alliance Imaging, Inc., et al., the plaintiffs allege violations of California’s wage, meal period, and break time laws and regulations. Plaintiffs sought recovery of unspecified economic damages, statutory penalties, attorneys’ fees, and costs of suit. On or about March 10, 2006, plaintiffs filed a second amended complaint (later further amended by a third amended complaint) adding a cause of action for conversion and a plea for punitive damages. The Company has filed a demurrer and motion to strike seeking to dismiss the new claim and plea. On July 19, 2006, the Company and the Plaintiffs entered into a tentative settlement of the Class Action Complaint pursuant to which the Company has agreed to pay $2,500 in exchange for a dismissal with prejudice of all claims brought on behalf of the putative class under the Class Action Complaint. The tentative settlement is subject to court approval, and a preliminary approval and conditional class certification hearing has been scheduled for September 1, 2006.

The Company from time to time is involved in routine litigation and regulatory matters incidental to the conduct of its business. The Company believes that resolution of such matters will not have a material adverse effect on its consolidated results of operations or financial position.

12. Related-Party Transactions

The Company recorded management fees payable to Kohlberg Kravis Roberts & Co (“KKR”) of $163 and $325 for each of the quarters and six months ended June 30, 2005 and 2006, respectively, and will continue to receive financial advisory services from KKR on an ongoing basis. At June 30, 2005 and 2006, the Company has accrued $163 related to these services.

Revenue from management agreements with unconsolidated equity investees was $3,593 and $4,173 for the quarters ended June 30, 2005 and 2006, respectively, and $7,299 and $8,529 for the six months ended June 30, 2005 and 2006, respectively.

16




13. Investments in Unconsolidated Investees

The Company has direct ownership in five investees at June 30, 2006. The Company owns between 33.3 percent and 50 percent of these investees, and provides management services under agreements with four of these investees, expiring at various dates through 2023. As discussed in Note 4, in late December 2005 the Company purchased an additional equity interest in AO, a joint venture formed in 2004, which was an unconsolidated investee prior to purchase of the additional equity interest. The Company’s earnings in unconsolidated investees for the six months ended June 30, 2005 includes the Company’s percentage of AO’s earnings for this period. At June 30, 2006 the Company also has ownership in an unconsolidated investee of AO. AO owns 50% of this investee and provides management services under an agreement which expires in 2025. All of these investees are accounted for under the equity method since the Company does not exercise control over the operations of these investees.

Set forth below is certain financial data of these investees (amounts in thousands):

 

 

December 31,

 

June 30,

 

 

 

2005

 

2006

 

Combined Balance Sheet Data:

 

 

 

 

 

 

 

Current assets

 

 

$

11,232

 

 

$

11,289

 

Noncurrent assets

 

 

31,958

 

 

33,031

 

Current liabilites

 

 

12,230

 

 

9,092

 

Noncurrent liabilites

 

 

12,779

 

 

16,406

 

 

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2006

 

   2005   

 

   2006   

 

Combined Operating Results:

 

 

 

 

 

 

 

 

 

Revenues

 

$

8,170

 

$

10,469

 

$

15,997

 

$

20,750

 

Expenses

 

6,157

 

7,864

 

12,320

 

15,862

 

Net income

 

2,013

 

2,605

 

3,677

 

4,888

 

Equity in earnings of unconsolidated investees

 

912

 

1,977

 

1,596

 

3,017

 

 

14. Restatement of Previously Issued Financial Statements

Subsequent to the filing of its Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2006, the Company identified an error with respect to the accounting for interest rate swap agreements. As discussed in Note 8, the swap agreements were executed in 2004 and mature at various dates in 2007. Since inception the Company had recorded the unrealized gains and losses in fair value of the swap agreements as a component of other comprehensive income (loss). The Company has determined that these transactions do not meet the requirements for hedge accounting treatment and any unrealized gains or losses should have been recognized in the results of operations as interest expense.

Effects of Restatement

To correct this error, the Company has restated the accompanying condensed consolidated balance sheets as of June 30, 2006 and December 31, 2005 and its condensed consolidated statements of operations and comprehensive income for the quarter and six months ended June 30, 2006 and 2005, and its condensed consolidated statements of cash flows for the six months ended June 30, 2006 and 2005, and the notes to the condensed consolidated financial statements for such periods as appropriate.

17




The following is a summary of the corrections described above:

NET INCOME, COMPREHENSIVE INCOME, AND EARNINGS PER COMMON SHARE
(in thousands, except per share amounts)

 

 

Quarter Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Net income as previously reported

 

$

6,155

 

$

5,035

 

$

12,290

 

$

10,103

 

Adjustments:

 

 

 

 

 

 

 

 

 

Interest expense, net of related tax effects

 

(560

)

31

 

900

 

296

 

Net income as restated

 

$

5,595

 

$

5,066

 

$

13,190

 

$

10,399

 

Comprehensive income as previously reported:

 

$

5,011

 

$

5,339

 

$

13,891

 

$

11,224

 

Adjustments:

 

 

 

 

 

 

 

 

 

Adjustments to net income as restated

 

(560

)

31

 

900

 

296

 

Unrealized gain (loss) on hedging transactions, net of related tax effects

 

560

 

(31

)

(900

)

(296

)

Comprehensive income as restated

 

$

5,011

 

$

5,339

 

$

13,891

 

$

11,224

 

Earnings per common share as previously reported:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.12

 

$

0.10

 

$

0.25

 

$

0.20

 

Diluted

 

$

0.12

 

$

0.10

 

$

0.24

 

$

0.20

 

Earnings per common share as restated:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.11

 

$

0.10

 

$

0.27

 

$

0.21

 

Diluted

 

$

0.11

 

$

0.10

 

$

0.26

 

$

0.21

 

 

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

 

 

As previously
reported

 

Adjustments

 

As
restated

 

As of June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Accumulated comprehensive income

 

 

$

4,338

 

 

 

$

(1,998

)

 

$

2,340

 

Accumulated deficit

 

 

(21,990

)

 

 

1,998

 

 

$

(19,992

)

As of December 31, 2005

 

 

 

 

 

 

 

 

 

 

 

Accumulated comprehensive income

 

 

$

3,217

 

 

 

$

(1,702

)

 

$

1,515

 

Accumulated deficit

 

 

(32,093

)

 

 

1,702

 

 

(30,391

)

 

18




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE (LOSS) INCOME
(in thousands, except per share amounts)

 

 

As previously
reported

 

Adjustments

 

As
restated

 

Quarter Ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net of interest income

 

 

$

10,074

 

 

 

$

(52

)

 

$

10,022

 

Total costs and expenses

 

 

108,217

 

 

 

(52

)

 

108,165

 

Income before income taxes, minority interest expense, and earnings from unconsolidated investees

 

 

7,088

 

 

 

52

 

 

7,140

 

Income tax expense

 

 

3,535

 

 

 

21

 

 

3,556

 

Net income

 

 

5,035

 

 

 

31

 

 

5,066

 

Unrealized gain (loss) on hedging transactions, net of taxes

 

 

304

 

 

 

(31

)

 

273

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

0.10

 

 

 

 

 

0.10

 

Diluted

 

 

0.10

 

 

 

 

 

0.10

 

Quarter Ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net of interest income

 

 

$

9,508

 

 

 

$

934

 

 

$

10,442

 

Total costs and expenses

 

 

98,478

 

 

 

934

 

 

99,412

 

Income before income taxes, minority interest expense, and earnings from unconsolidated investees

 

 

9,956

 

 

 

(934

)

 

9,022

 

Income tax expense

 

 

4,169

 

 

 

(374

)

 

3,795

 

Net income

 

 

6,155

 

 

 

(560

)

 

5,595

 

Unrealized (loss) gain on hedging transactions, net of taxes

 

 

(1,144

)

 

 

560

 

 

(584

)

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

0.12

 

 

 

(0.01

)

 

0.11

 

Diluted

 

 

0.12

 

 

 

(0.01

)

 

0.11

 

Six Months Ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net of interest income

 

 

$

20,290

 

 

 

$

(494

)

 

$

19,796

 

Total costs and expenses

 

 

215,518

 

 

 

(494

)

 

215,024

 

Income before income taxes, minority interest expense, and earnings from unconsolidated investees

 

 

15,130

 

 

 

494

 

 

15,624

 

Income tax expense

 

 

7,009

 

 

 

198

 

 

7,207

 

Net income

 

 

10,103

 

 

 

296

 

 

10,399

 

Unrealized gain (loss) on hedging transactions, net of taxes

 

 

1,121

 

 

 

(296

)

 

825

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

0.20

 

 

 

0.01

 

 

0.21

 

Diluted

 

 

0.20

 

 

 

0.01

 

 

0.21

 

Six Months Ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net of interest income

 

 

$

18,569

 

 

 

$

(1,500

)

 

$

17,069

 

Total costs and expenses

 

 

194,447

 

 

 

(1,500

)

 

192,947

 

Income before income taxes, minority interest expense, and earnings from unconsolidated investees

 

 

19,951

 

 

 

1,500

 

 

21,451

 

Income tax expense

 

 

8,301

 

 

 

600

 

 

8,901

 

Net income

 

 

12,290

 

 

 

900

 

 

13,190

 

Unrealized (loss) gain on hedging transactions, net of taxes

 

 

1,601

 

 

 

(900

)

 

701

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

0.25

 

 

 

0.02

 

 

0.27

 

Diluted

 

 

0.24

 

 

 

0.02

 

 

0.26

 

 

19




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 

 

As previously
reported

 

Adjustments

 

As
restated

 

Six Months Ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

$

10,103

 

 

 

$

296

 

 

$

10,399

 

Adjustment of swaps to fair value

 

 

 

 

 

(494

)

 

(494

)

Deferred income taxes

 

 

6,354

 

 

 

198

 

 

6,552

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss from hedging transactions, net of taxes

 

 

1,121

 

 

 

(296

)

 

825

 

Six Months Ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

$

12,290

 

 

 

$

900

 

 

$

13,190

 

Adjustment of swaps to fair value

 

 

 

 

 

(1,500

)

 

(1,500

)

Deferred income taxes

 

 

7,236

 

 

 

600

 

 

7,836

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income from hedging transactions, net of
taxes

 

 

1,601

 

 

 

(900

)

 

701

 

 

20




ITEM 2.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a leading national provider of shared-service and fixed-site diagnostic imaging services, based upon annual revenue and number of diagnostic imaging systems deployed. Our principal sources of revenue are derived from magnetic resonance imaging (MRI) and positron emission tomography and positron emission tomography/computed tomography (PET and PET/CT). We provide imaging and therapeutic services primarily to hospitals and other healthcare providers on a shared and full-time service basis. We also provide services through a growing number of fixed sites primarily to hospitals or health systems. Our services normally include the use of our imaging systems, technologists to operate the systems, equipment maintenance and upgrades and management of day-to-day shared-service and fixed-site diagnostic imaging operations. We also provide non scan-based services, which includes only the use of our imaging systems under a short-term contract. In the first six months of 2006, MRI services and PET and PET/CT services generated 62% and 28% of our revenue, respectively. The remaining revenue was comprised of other modality diagnostic imaging services revenue, primarily computed tomography (CT), and management contract revenue. We had 500 diagnostic imaging systems, including 335 MRI systems and 74 PET or PET/CT systems and served over 1,000 clients in 43 states at June 30, 2006. Of these 500 diagnostic imaging systems, 72 were located in fixed-sites, which constitutes systems installed in hospitals or other buildings on hospital campuses, including modular buildings, systems installed inside medical groups’ offices or medical buildings, and free-standing fixed-sites, which includes systems installed in a medical office building, ambulatory surgical center, or other retail space. Of these 72 fixed-sites, 58 were MRI fixed-sites, 3 PET or PET/CT fixed-sites and 11 other modality fixed sites.

Approximately 87% of our revenues for the first six months ended June 30, 2006 were generated by providing services to hospitals and other healthcare providers, which we refer to as wholesale revenues. Our wholesale revenues are typically generated from contracts that require our clients to pay us based on the number of scans we perform on patients on our clients behalf, although some pay us a flat fee for a period of time regardless of the number of scans we perform. These payments are due to us independent of our clients’ receipt of reimbursement from third-party payors. We typically deliver our services for a set number of days per week through exclusive, long-term contracts with hospitals and other healthcare providers. The initial terms of these contracts’ average approximately three years in length for mobile services and approximately seven to ten years in length for fixed-site arrangements. These contracts often contain automatic renewal provisions and certain contracts have cancellation clauses if the hospital or other healthcare provider purchases their own system. We price our contracts based on the type of system used, the scan volume, and the number of ancillary services provided. Pricing is also affected by competitive pressures.

Approximately 13% of our revenues for the six months ended June 30, 2006 were generated by providing services directly to patients from our sites located at or near hospitals or other healthcare provider facilities, which we refer to as retail revenue. Our revenue from these sites is generated from direct billings to patients or their third-party payors, including Medicare, which are recorded net of contractual discounts and other arrangements for providing services at discounted prices. We typically charge a higher price per scan under retail billing than we do under wholesale billing.

Fixed-sites can be structured as either wholesale or retail. Revenues from these fixed-sites are included in both our wholesale or retail revenues, respectively.

On February 8, 2006, the Deficit Reduction Act of 2005 (“DRA”) was signed into law by President George W. Bush. The DRA imposes caps on Medicare payment rates for certain imaging services, including MRI, PET and CT, 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

21




those services. This change is to apply to services furnished on or after January 1, 2007. The limitation is applicable to the technical components of the services only (which is the payment we receive for the non-professional services for which we bill directly under the Medicare Physician Fee Schedule). 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 at 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 implementation of this reimbursement reduction contained in the DRA will have a significant effect on our financial condition and results of operations beginning in 2007. For full year 2005, approximately 4% of our revenue was billed directly to Medicare contractors. Basing our calculation on our 2005 revenues, if the provisions were in effect for 2005, we estimate that the reduction in Medicare revenue due to DRA payment rate decreases would have totaled approximately $6 million. The estimated percentage reduction in revenue based on 2005 results is consistent with our expectation of what the impact on full year 2006 revenues would be. Because a high percentage of our expenses are fixed, we expect a significant portion of this decrease in revenue to directly effect earnings.

In addition, the DRA also codifies a reduction in Medicare payments for multiple images performed on contiguous body parts which was previously established by CMS in the 2006 Physician Fee Schedule Final Rule. Under that final rule, CMS is to pay 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. Prior to this change, Medicare paid 100% of the technical component of each procedure. CMS is phasing in this reimbursement reduction over a two-year period so that payment rates for the technical components of second and subsequent imaging procedures are to be paid 75% of the otherwise applicable rate in 2006 and 50% of the otherwise applicable rate beginning in 2007. The implementation of this reimbursement reduction did not have a material impact on our consolidated financial position or results of operations for the quarter and six months ended June 30, 2006. We continue to believe that the implementation of this reimbursement reduction will not have a material impact on our consolidated financial position or results of operations in the future.

On July 18, 2006, the U.S. House of Representatives Energy and Commerce Committee’s Subcommittee on Health conducted a hearing regarding quality and utilization of imaging services and the provisions of the DRA that directly effect Medicare payment for imaging services. Many members of Congress have expressed concern about the impact of the DRA, and a legislation bill has been introduced to delay the effective date of the DRA for two years. Our current view is that the two year delay regarding implementation of the DRA is unlikely to be upheld by Congress and that the DRA as it is currently structured will become effective January 1, 2007.

The principal components of our cost of revenues are compensation paid to technologists and drivers, system maintenance costs, medical supplies, system transportation and technologists’ travel costs. Because a majority of these expenses are fixed, increased revenues as a result of higher scan volumes per system significantly improves our margins while lower scan volumes result in lower margins.

The principal components of selling, general and administrative expenses are sales and marketing costs, corporate overhead costs, provision for doubtful accounts, and non-cash share-based compensation.

We record minority interest expense and earnings from unconsolidated investees related to our consolidated and unconsolidated subsidiaries, respectively. These subsidiaries primarily provide shared-service and fixed-site diagnostic imaging and therapeutic services.

In 2005 and the first six months of 2006, the growth rate of MRI industry wide scan volumes has slowed in part due to weak hospital volumes as reported by several investor-owned hospital companies, a

22




growing number of medical groups adding imaging capacity within their practice setting, the increasing trend of third-party payors intensifying their utilization management efforts to control MRI scan volume growth rate and additional patient-related cost-sharing programs. We expect that this trend will continue throughout 2006.

In recent years, we began to see an increase in the competitive climate in the MRI industry, resulting in an increase in activity by original equipment manufacturers, or OEM’s, selling systems directly to certain of our clients. Typically, OEM’s target our higher scan volume clients. This increase in activity by OEM’s has resulted in overcapacity of systems in the marketplace, especially related to medical groups adding imaging capacity within their practice setting. This has caused an increase in the number of our higher scan volume clients deciding not to renew their contracts. We replace these higher volume scan clients typically with lower volume clients. During 2006, our MRI revenues modestly declined compared to 2005 levels and we believe that MRI revenues will continue to modestly decline in future years.

Seasonality

We experience seasonality in the revenues and margins generated for our services. First and fourth quarter revenues are historically lower than those from the second and third quarters. First quarter revenue is affected primarily by fewer calendar days and inclement weather, typically resulting in fewer patients being scanned during the period. Fourth quarter revenue is affected primarily by holiday and client and patient vacation schedules and inclement weather, also resulting in fewer scans during the period. The variability in margins is higher than the variability in revenues due to the fixed nature of our costs.

In 2006, there are five less scanning days in the second half of 2006 compared to the first half of 2006. We generated approximately $1.6 million per scanning day in the first half of 2006. If our revenue per scanning day for the second half of 2006 remains flat with the first half of 2006, this would result in a decrease in revenue of approximately $8.0 million in the second half of 2006 compared to the first half of 2006.

23




Results of Operations

The following table shows our consolidated statements of income as a percentage of revenues for each of the quarters ended June 30: