Item 1. Business
General
In this report, “we,” “us” and “our” refer to MQ Associates, Inc. and its subsidiaries, while “MQ Associates” refers only to MQ Associates, Inc. MedQuest, Inc. (“MedQuest”) is a wholly-owned subsidiary of MQ Associates and directly or indirectly owns 100% of the capital stock of each of its operating subsidiaries. MQ Associates has no material assets or operations other than its ownership of 100% of the outstanding capital stock of MedQuest.
We are a leading operator of independent, fixed-site, outpatient diagnostic imaging centers (each a “FIC”) in the United States. Our centers provide diagnostic imaging services using a variety of technologies including magnetic resonance imaging (“MRI”), computed tomography (“CT”), nuclear medicine, general radiology (fluoroscopy and x-ray), ultrasound, bone densitometry and mammography. As of December 31, 2006, we operated a network of 90 centers in 13 states primarily throughout the southeastern and southwestern United States.
We provide high quality diagnostic imaging services tailored to each of our local markets. We empower our center managers to run our centers to meet the demands of local market conditions, while our corporate structure provides economies of scale, corporate training programs, standardized policies, payor contracting support and procedures and sharing of best practices across our network. Each of our center managers is responsible for meeting our standards of patient care, managing relationships with local physicians and maintaining profitability.
Business strategy
Our objective is to be the leading provider of outpatient diagnostic imaging services in the geographic markets we serve by:
Providing high quality service to our customers. Our business model is geared toward serving the needs of our three customer groups: (i) referring physicians; (ii) patients; and (iii) payors. We evaluate our customer service measures by focusing on speed of service, quality of images, radiologist report turnaround time and customer experience “exit” surveys.
Referring physicians: We recognize that by providing convenient scheduling for patients, fast turn-around times for procedure results, high quality images and skilled and accessible radiologists, we enable our referring physicians to improve the quality and efficiency of their own medical practices. We develop relationships with referring physicians to increase patient volume and enable us to identify and respond quickly to local market needs. We also provide extended hours and extended days of operation to meet patient volume without significant delay. Our goal is to provide image turnaround and supporting radiologist reports within one business day after a procedure is performed.
Patients: We strive to make the diagnostic imaging procedure convenient and comfortable for our patients. We also address our patients’ needs by offering flexible scheduling with extended operating hours, convenient center locations, short waiting times and a patient-friendly, comfortable environment.
Payors: We believe that payors value our high quality services, efficient operations, cost-effectiveness and our market coverage. Our significant presence in key markets is particularly important to payors as it enables us to satisfy a significant number of their customers’ or beneficiaries’ needs. We believe payors value our cost-effectiveness and quality, as compared to hospital providers and the diagnostic imaging services provided by physicians who own their own equipment. We actively
seek to improve and expand our relationships with every significant payor group within the local markets we serve.
Increasing our current market presence. We build concentrated groups of centers in the local markets we serve in order to establish local market share. This concentration enables us to: (i) build a strong referral base; (ii) establish stronger and more meaningful relationships with commercial payors; (iii) attract and retain highly qualified radiologists; and (iv) provide our patients with convenient locations that offer a range of imaging services. We look to deepen and expand our network by adding centers in our existing or neighboring geographic markets through de novo development and/or acquisitions to strengthen our position as a leading provider of outpatient diagnostic imaging services in these markets.
Improving efficiency and focusing on our core markets. The diagnostic imaging industry, generally, and our business, specifically, is faced with a number of challenges, including reductions in reimbursement and increasing competition, most of which comes from physician self-referral (non-radiologists purchasing and utilizing their own diagnostic imaging equipment). Our strategy is to mitigate the impact of these challenges by reducing our cost structure, increasing efficiencies, focusing on asset allocation within centers and across markets and selectively growing in our core markets where we can leverage our competitive strengths.
Enhancing our existing centers. We pursue same center growth within our existing centers by extending hours and days of operation, adding modalities and increasing imaging capacity through equipment upgrades and additions to meet the needs of our local markets. We also strive to increase the performance of our existing centers through our focus on improving customer service and by expanding our referral sources.
Company History
We were founded in 1993 to provide high quality, fixed-site outpatient single and multi-modality diagnostic imaging services. Since that time, we have selectively expanded our business through development of de novo centers, acquisitions of centers (one to four centers at a time) and expanding existing centers through adding modalities and enhancing or upgrading our current diagnostic imaging equipment.
Facilities and equipment
We segregate our centers into three categories, single modality, dual-modality and multi-modality centers. As of December 31, 2006, we operated: (i) 43 multi-modality centers; (ii) 31 dual-modality centers, the vast majority of which offer MRI and CT; and (iii) 16 single modality centers, the vast majority of which are MRI only. We have the ability to expand service capabilities at each of our centers by increasing the capacity of our existing diagnostic imaging equipment through upgrades, offering multiple pieces of diagnostic imaging equipment within the same modality and adding new modalities, such as nuclear medicine, ultrasound and mammography. As of December 31, 2006, we owned or leased 15 mobile MRI units that we use on a full or part time basis to supplement capacity at our centers from time to time, on an as needed basis, and to evaluate new markets.
At December 31, 2006, we operated 340 pieces of diagnostic imaging equipment, 333 of which we owned and 7 of which we leased on a full or part time basis. The following table sets forth the details of our owned and leased diagnostic imaging equipment at December 31, 2006:
(1) Other modalities include nuclear medicine, x-ray, fluoroscopy, ultrasound, bone densitometry and mammography.
Of $28.3 million of total capital expenditures for the year ended December 31, 2006, we invested approximately: $24.9 million in equipment maintenance and expansion; $1.8 million in information technology; and $1.6 million in the development of de novo centers. During the year ended December 31, 2006, we added ten new MRIs, nine of which were high field, and disposed of fifteen; we added thirteen new CTs, all of which were multi-slice, and disposed of twelve; and we added eight pieces of other modality equipment and disposed of thirteen and placed nine pieces in storage for potential redeployment.
Personnel
As of December 31, 2006, we had 1,604 employees, of which 91 were employed at our headquarters and the remainder were employed at our diagnostic imaging and billing centers. Our employees are not represented by a labor organization, and we are not aware of any activity seeking such organization. We believe that our relationship with our employees is good.
Information Technology Systems
Our information technology systems allow us to efficiently and effectively manage our diagnostic imaging center operations, accounting and finance and payroll functions, and to facilitate DICOM image routing and reading. Our medical practice management system, Centricity, provides us with front office support for scheduling of patient procedures and back office support for billing and collections.
The implementation of our new enterprise transcription and dictation system is substantially complete. We expect this system to enhance operational efficiencies by: (i) standardizing processes and procedures across our entire network of centers; (ii) automating, simplifying and accelerating workflow; and (iii) providing more timely results to our referring physicians, patients and other customers.
Customer service
We provide high quality, diagnostic imaging services to our customers. Our philosophy of delivering high quality patient care and customer service is an important tenet for our entire organization. Our emphasis on customer service enables us to develop strong relationships with referral sources and payors and to attract top radiologists. We focus on conveniently locating our centers and reducing waiting times through extended and weekend hours. In addition, we have set a standard to provide referring physicians with their patients’ scans within one business day after a procedure is performed. We select centers and patients to conduct random or blind customer service tests in order to monitor the level of customer service we provide.
Payors
Our revenue is generated by providing patient services at our diagnostic imaging centers. Patient services revenue is earned from services billed directly to patients or third-party payors (generally Medicare, Medicaid, commercial payors and other third party payors) on a fee-for-service basis. The following table sets forth the percentage of our total gross revenue presented by payor class for the years ended December 31, 2006, 2005 and 2004:
Managed care and commercial payors represent a majority of our customer and revenue base, and we can provide service to their beneficiaries if we have a contractual arrangement with the patient’s managed care or insurance carrier. Our ability to maintain contractual relationships with a broad array of payors is important to our referral physicians and their patients. We have over 490 different contracts with commercial payors, and no one commercial payor accounted for more than 10.0% of our gross revenue during the year ended December 31, 2006. These contracts, which specify the negotiated fees to be paid by each payor for the diagnostic imaging services we provide, enable us to serve patients with insurance coverage through their applicable commercial payors. Our business service centers are responsible for billing our payors in accordance with the terms of these contracts and within our corporate policies.
Marketing
Each of our centers typically has a marketing manager who is fully dedicated to marketing activities. Our center managers also focus on marketing activities. We market to local physicians and payors in an effort to attract new patients, expand and maintain relationships with referring physicians and payors, grow revenue at our existing centers and maintain contractual relationships. Marketing activities include participating in health fairs, organizing and presenting educational programs on new applications and uses of diagnostic imaging technology, developing and conducting customer service programs and calling on managed care organizations and third-party insurance companies to solicit additional contracts. Marketing activities principally focus on referring physicians and managed care entities, while general awareness programs are targeted to patients and referring physicians.
Suppliers
Several substantial companies manufacture MRI (including open and high field MRI), CT and other diagnostic imaging equipment, including Philips Medical Systems, Inc., Siemens Medical Systems, Inc., GE Medical Systems, Inc. and Hitachi Medical Systems America, Inc. We purchase contrast agents, which are used in some of our procedures, and film from major distributors. We believe that we have good working relationships with all of our major suppliers.
Most of our equipment is serviced through an equipment servicing contract with a major manufacturer. That contract requires the service provider to service substantially all of our diagnostic imaging equipment.
Competition
The overall diagnostic imaging services market is highly competitive, with services provided in a variety of settings and by several different types of providers. We compete principally on the basis of our reputation for delivering high quality images and radiologist reports in a timely manner, the comfort and care we provide to patients in our centers and price. We compete with other fixed-site, outpatient diagnostic imaging providers, non-radiologist physician practices, radiologists that own their own equipment, hospitals that own their own equipment and others, including leasing companies that own and operate diagnostic imaging equipment. Other major outpatient diagnostic imaging service providers include HealthSouth Corporation, Radnet, Inc., InSight Health Services Corp. and Alliance Imaging, Inc. Our competition also includes hospitals, medical clinics and physician groups that provide diagnostic imaging services by leasing mobile diagnostic imaging equipment on a full or part-time basis. Some of our competitors that provide diagnostic imaging services may now or in the future have access to greater financial resources than we do and may have access to newer, more advanced equipment. Finally, we face competition from providers of competing technologies that we do not offer, such as PET and PET/CT scans, and may face competition from providers of new technologies in the future.
Increasingly, physician practices that historically have referred patients to our centers or other FICs are installing MRI and CT equipment in their own offices. While we believe we provide a superior package of services with high quality images, typically better equipment, image interpretation by board certified radiologists and other service components, this trend continues to increase the level of competition in our industry and to drive higher utilization.
We operate in a market that is highly fragmented and characterized by the small group of large competitors referred to above and a large number of small competitors. Many of these small competitors are either sole proprietorships or are part of medical practices.
Environmental matters
We are subject to federal, state and local regulations governing the storage, use and disposal of hazardous materials and medical and radioactive waste products. Our diagnostic imaging centers generate small amounts of medical waste or other hazardous materials, and some of our imaging services involve the use of short-lived radioactive materials. Although we believe that our procedures for storing, handling and disposing of these hazardous materials comply with the standards prescribed by law and adequately provide for the safety of our patients, employees and the environment, we cannot completely eliminate the risk of accidental releases, contamination or injury associated with these materials.
Insurance
We may be subject to professional liability claims including, without limitation, for improper use or malfunction of our diagnostic imaging equipment. We maintain insurance policies with coverage that we believe is appropriate in light of the risks related to our business and consistent with industry practice. However, adequate liability insurance may not be available to us in the future at acceptable costs or at all.
We maintain general and professional liability insurance with commercially reasonable deductibles and limits and we maintain excess umbrella coverage. Additionally, we maintain workers’ compensation insurance on all employees. Coverage is placed on a statutory basis and responds to each state’s specific requirements. We have not assumed any material liabilities, known or unknown, of any of the centers we have acquired. However, claims may be asserted against us for events that occurred prior to our acquiring these centers.
The radiologists at our centers may from time to time be subject to malpractice claims. To protect against possible professional liability, we maintain professional liability insurance. We also require all
non-employee radiologists to have malpractice insurance policies at appropriate levels. Nevertheless, claims, suits or complaints relating to services provided by the radiologists at our centers may be asserted against us in the future, including malpractice claims.
Industry overview
Diagnostic imaging services are generally non-invasive procedures that generate images of the internal anatomy. Diagnostic imaging equipment permits physicians to diagnose injuries, diseases and disorders, often reducing the cost, the amount of care required and the need for costly and invasive diagnostic procedures. Diagnostic imaging procedures include MRI, CT, nuclear medicine, ultrasound, mammography, fluoroscopy, bone densitrometry and x-ray.
Diagnostic imaging modalities
Magnetic Resonance Imaging or MRI. MRI involves the use of high-strength magnetic fields to produce computer-processed cross-sectional images of the body. MRI is the preferred imaging technology for evaluating soft tissue and organs, including the brain, spinal cord and other internal anatomy. With advances in MRI technology, MRI is increasingly being used for applications such as imaging of the heart, chest and abdomen. Conditions that can be detected through the use of MRI include multiple sclerosis, tumors, strokes, infections and injuries to the spine, joints, ligaments and tendons. Unlike x-rays and CT, MRI does not expose patients to radiation.
Computed Tomography or CT. In CT imaging, a computer analyzes the information received from an x-ray beam to produce multiple cross-sectional images of a particular area of anatomy. CT imaging is used to detect tumors and other conditions affecting bones and internal organs. It is also used to detect the occurrence of strokes, hemorrhages and infections.
Nuclear Medicine or Gamma Camera. Nuclear medicine, or gamma camera, utilizes short-lived radioactive isotopes that release small amounts of radiation that can be recorded by a gamma camera and processed by a computer to produce an image of various anatomical structures or to assess the function of various organs such as the heart, kidneys, thyroid and bones. Nuclear medicine is used primarily to study anatomic and metabolic functions.
Ultrasound. Ultrasound imaging utilizes high-frequency sound waves to develop images of internal organs, fetuses and the vascular system. Ultrasound has widespread applications, particularly for procedures in obstetrics, gynecology and cardiology.
Mammography. Mammography is a specialized examination utilizing low dosage x-rays to visualize breast tissue and is the primary screening tool for breast cancer.
General Fluoroscopy. Fluoroscopy utilizes ionizing radiation combined with a video viewing system for real-time visualization of anatomy.
Bone Densitometry. Bone densitometry uses an advanced technology called dual-energy x-ray absorptiometry, or DEXA, which safely, accurately and painlessly measures bone density and the mineral content of bone for the diagnosis of osteoporosis.
General X-ray. X-rays utilize high-energy radiation to penetrate the body and record images of organs and structures on film or digital media.
Diagnostic imaging settings
Diagnostic imaging procedures are typically performed in hospitals, FICs, physician offices and mobile/shared-service units.
Hospitals and Clinics. Hospitals provide inpatient and outpatient diagnostic imaging services, typically on site. These inpatient and outpatient centers are owned and operated by the hospital or clinic and are primarily used by patients of the hospital or clinic. The hospital or clinic bills third-party payors, such as health insurers, Medicare or Medicaid, for services performed.
FICs. Independent, fixed-site, outpatient diagnostic imaging centers are not generally owned by hospitals or clinics. These centers depend upon physician referrals for their patient volume and generally do not maintain dedicated, contractual relationships with hospitals or clinics. FICs typically perform their own billing, sales and marketing functions. Freestanding diagnostic imaging centers are generally located in metropolitan areas with established demand for MRI and other imaging services.
Physician Offices. Increasingly, physician practices that have historically referred patients to FICs, hospitals or clinics are installing MRI and CT equipment in their own offices. While we believe we provide a superior package of services with high quality images, typically better equipment, image interpretation by board certified radiologists and other service components, this trend continues to increase the level of competition in our industry and to drive higher utilization.
Mobile Providers. In contrast to FICs, mobile imaging operators operate diagnostic imaging equipment in mobile trailers, providing their customers with shared-service or full-time diagnostic imaging services. Mobile providers often target physician practices and small to mid-size hospitals in non-urban areas in need of advanced imaging technologies but without the procedure volume or customer base to justify a fixed-site location. Mobile providers are generally paid directly by hospitals, or physician practices, which in turn bill third party payors for individual procedures.
Industry trends
Wider acceptance by physicians, payors and patients. Imaging modalities, in particular MRI, continue to gain widespread acceptance from both physicians and payors because of the enhanced diagnostic applications and reduced cost to the payor of early and non-invasive diagnosis of an ailment. Because of the benefits that non-invasive imaging procedures provide, patients have begun to demand faster service and improved access to imaging. With physicians, payors and patients increasingly focused on high quality, easily accessible and more cost-effective care, we believe that the role that diagnostic imaging plays in the delivery of healthcare will continue to increase over the next decade.
Increasing number of applications. The use of imaging modalities such as MRI and CT has increased rapidly in recent years as these technologies enable physicians in a wide variety of specialties, including orthopedics, neurology, cardiology and internal medicine, to diagnose an increasing number of diseases and injuries quickly and accurately without exploratory surgery or other invasive procedures. For instance, whereas MRI has traditionally been used primarily for imaging of the spine, brain and soft tissues, physicians are now utilizing MRI equipment to examine blockages in coronary arteries, a procedure that previously required an invasive procedure. Similarly, new CT applications include advanced chest and abdominal imaging. We believe that future technological advances will continue to enhance the ability of radiologists to diagnose and influence treatment.
Stable technology environment. We do not foresee new imaging technologies on the horizon that will displace MRI or CT. In addition, major equipment manufacturers continue to develop improvements and enhancements to the technologies that we are currently operating and purchasing.
Regulation and Reimbursement
Licensing and certification. Healthcare facility construction and operation is subject to federal, state and local laws relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, compliance with building codes, and environmental
protection laws. Licensing requirements vary among the states in which we operate. Diagnostic imaging centers must meet requirements under these laws in order to participate in government programs, including the Medicare and Medicaid programs, or to contract with certain commercial payors.
In addition, free-standing diagnostic imaging centers that provide services independent of a physician’s office must be enrolled by Medicare as an “Independent Diagnostic Testing Facility” (an “IDTF”) to bill the Medicare program. Medicare fiscal intermediaries have discretion in applying the IDTF requirements and, therefore, the application of these requirements may vary from jurisdiction to jurisdiction. Notwithstanding this complexity, we conduct our operations in compliance, in all material respects, with federal, state and local laws and make every effort to satisfy the IDTF requirements or, where applicable, to operate as a qualified physician’s practice.
Certificates of need. The laws of some of the states in which we operate limit our ability to acquire new diagnostic imaging equipment or expand or replace our existing equipment at diagnostic imaging centers because these states require a site-specific certificate of need (“CON”) or similar regulatory approval prior to the acquisition of high-cost capital items, including diagnostic imaging equipment or provision of diagnostic imaging services by us or by those parties for whom we manage facilities. Six of the 13 states in which we operate generally require CONs, subject to certain exemptions. In some cases, a limited number of these CONs are available in a given state. If we are unable to obtain the applicable CONs or additional certificates or approvals necessary to expand our operations, these regulations may limit or preclude our operations in the relevant jurisdictions.
Conversely, states in which we have obtained a CON may repeal existing CON regulations or liberalize exemptions from the regulations. The repeal of CON regulations in states in which we have obtained CONs or an exemption therefrom would lower barriers to entry for competition in those states and could adversely affect our business.
Our ability to obtain a CON or exemption therefrom in a particular state is not a definitive guarantee that our operations under the applicable CON law will be unchallenged. One or more parties may challenge our CON or exemption therefrom from time to time. While such challenges could be raised on a number of issues, they generally would be based upon the application or interpretation of certain financial formulae contained within the applicable CON statute and either: (i) our adherence to those formulae in the submission of our CON application or exemption therefrom, or (ii) the applicable state agency’s interpretation or application of the CON statute in its review of our application. If we are unable to prevail against challenges to our CONs or exemptions therefrom, we may be limited or precluded from continuing our operations at the relevant locations.
Fee-splitting; corporate practice of medicine. The laws of many states in which we maintain facilities prohibit unlicensed persons or business entities, including corporations, from employing physicians or engaging in certain financial arrangements, such as splitting professional fees between physicians and non-physicians. These laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. Possible sanctions for violations of these restrictions include loss of a physician’s license, civil and criminal penalties and rescission of business arrangements that may violate these restrictions. We structure our relationships with radiologists in a manner that we believe does not constitute the practice of medicine by us. Although we exercise care to structure our arrangements with healthcare providers to comply with relevant state laws, and believe our current arrangements substantially comply with applicable laws, there is no assurance that government officials charged with responsibility for enforcing these laws will not assert that we, or transactions in which we are involved, are in violation of such laws, or that such laws ultimately will be interpreted by the courts in a manner consistent with our interpretations.
Medicare and Medicaid reimbursement programs. Our revenue is derived through our ownership, operation and management of diagnostic imaging centers. During the year ended December 31, 2006,
approximately 26.5% of our gross revenue generated at our diagnostic imaging centers was derived from Medicare and Medicaid.
Medicare. The Medicare program is a social health insurance program that provides health care to Americans who either are 65 years of age or older or have certain qualifying conditions. There are four separate “Parts” to the Medicare program, with the services that we provide being reimbursed under Part B, which covers physician, outpatient ambulatory and ancillary services, such as diagnostic imaging services.
In 1997, the Centers for Medicare and Medicaid Services (“CMS”) created a Medicare enrollment category entitled IDTFs. CMS has created one exception to IDTF enrollment, which applies to radiology group practices. While we generally have enrolled our imaging centers with the Medicare program as IDTFs, some of our centers are enrolled as radiology group practices.
The physician fee schedule (“PFS”) is a statutory formula pursuant to which the Department of Health and Human Services (“HHS”) assigns relative values to Medicare Part B covered medical procedures based on the specific procedure’s ranking relative to the other procedures on the scale. The physician fee schedule is subject to annual updates, which adjust the rates payable per procedure for inflation, subject to further adjustment that assures projected Medicare spending for the year meets allowed spending for that year. Medicare reimbursement totaled $47.9 million of our net revenue for the year ended December 31, 2006.
On February 8, 2006, President Bush signed the Deficit Reduction Act of 2005 (the “DRA”). The DRA codified a payment reduction begun by CMS on January 1, 2006, whereby CMS reduced payment by 25% for certain second and subsequent imaging services performed on contiguous body parts in a single session. The DRA also provided for a significant reduction in reimbursement for radiology services for Medicare Part B beneficiaries. The DRA provided that, effective January 1, 2007, reimbursement for diagnostic imaging services (excluding diagnostic and screening mammography) performed at non-hospital based freestanding facilities, which includes FICs like our centers, is the lesser of the Medicare Part B PFS or Medicare’s outpatient prospective payment system schedule (“OPPS”) for hospitals. Historically, non-hospital based freestanding fixed-site imaging centers were not directly affected by OPPS. OPPS was designed to reimburse hospitals for outpatient services on a rate per service basis that varies according to the ambulatory payment classification group (“APC”) to which the service is assigned rather than on a hospital’s costs. Each year CMS publishes new APC rates that are determined in accordance with the promulgated methodology.
The final PFS was published on November 1, 2006 with changes that became effective on January 1, 2007. As stated above, beginning January 1, 2006, CMS reduced payment by 25% for certain second and subsequent imaging services performed on contiguous body parts in a single session and under the PFS, CMS continued the reduction at 25% for calendar year 2007. CMS reimburses its full rate for the highest priced procedure and reduces payment for each additional procedure by 25% when more than one procedure from the same imaging family is performed during the same session on the same day.
In accordance with the DRA requirements, effective January 1, 2007, CMS capped the PFS payment amount for the technical component (prior to applying the geographic adjustment) by the OPPS payment amount (prior to applying the geographic adjustment). If, as a result of the OPPS cap, an imaging service is paid at the lower OPPS rate (not the PFS payment amount), the OPPS national rate with the physician geographic adjustment is the final payment amount for calendar year 2007. Because IDTFs are paid under the PFS, the OPPS national rate is adjusted by the applicable PFS geographic adjustment factor, not the wage index applicable to hospital outpatient departments. The geographic adjustment factor applied to the OPPS national rate varies across the country according the payment locality in which the IDTF is located. On the other hand, hospital outpatient departments will receive a payment equal to the OPPS national rate adjusted by the applicable wage index under OPPS. The wage index and the geographic adjusters
under the PFS are not the same. Accordingly, IDTFs may be paid less than hospital outpatient departments in the same locality for a procedure capped at the OPPS rate because of the different adjustment factors applicable to IDTFs and hospital outpatient departments. For imaging services subject to both the multiple imaging reductions and the OPPS cap, CMS will first apply the multiple imaging payment reduction and then apply the OPPS cap to the reduced amount. The geographic adjustment is then applied to the payment amount.
CMS and the carriers have developed and published a separate fee schedule within the PFS for outpatient imaging services. The new schedule is entitled 2007 OPPS Payment Cap Amounts for the Technical Component and Global Portion of Imaging Services. The schedule calculates the lesser of formula provided by the statute, as well as, applying the geographic modifier applicable to the IDTF location.
We believe that the DRA reimbursement reductions will have a material adverse impact on our results of operations, cash flows and overall financial condition. If these reimbursement reductions had been in full effect during the year ended December 31, 2006, we estimate that the impact on our financial results would have been an $11.0 million reduction in net revenue. This estimate is based on the following assumptions: (i) 2006 scan volumes and modality mix; (ii) our historic Medicare denial rate; and (iii) published national APC rates for 2006.
We expect the actual impact of the reduction on our Medicare net revenue during 2007 will be comparable to the estimate above although payor mix and scan mix during 2007 could vary from our actual experience in 2006, which would impact the effect of the reimbursement reduction.
The estimated impact of the DRA does not include the impact of third party payors, other than Medicare, implementing comparable reductions in reimbursement. If other payors were to implement reductions, our results of operations, cash flows and overall financial condition would be further adversely affected. We are unable to anticipate or estimate the possibility or extent of potential reductions by non-Medicare payors.
To the extent that commercial payors with which we contract base their payments for diagnostic imaging services on Medicare reimbursement rates, any reduction in Medicare rates could result in a corresponding reduction in reimbursement from our commercial payors. Similarly, any change in significant commercial payor’s reimbursement rates may result in a corresponding change in reimbursement rates with other commercial payors. Future Medicare reimbursement reductions may further reduce the payments we receive for our services. Any change in the rates of or conditions for reimbursement could substantially reduce the number of procedures for which we can obtain reimbursement or the amounts reimbursed to us for services we provide.
Medicaid. The Medicaid program is a jointly-funded federal and state program providing coverage for low-income persons. In addition to federally-mandated basic services, the services offered and reimbursement methods vary from state to state. Both the federal government and many states are currently considering significantly reducing Medicaid funding. In most states in which we operate, Medicaid reimbursement for diagnostic imaging services is lower than the reimbursement rates paid by other payors (including the Medicare program), and some states have established or are establishing payment methodologies intended to provide healthcare services to Medicaid patients through managed care arrangements. Medicaid represented 5.7% of our gross revenue for the year ended December 31, 2006.
Federal Anti-Kickback and Stark Laws. Federal law prohibits the knowing and willful offer, payment, solicitation or receipt of any form of remuneration in return for, or to induce, (i) the referral of a person, (ii) the furnishing or arranging for the furnishing of items or services reimbursable under Medicare, Medicaid or other governmental programs or (iii) the purchase, lease or order or arranging or recommending purchasing, leasing or ordering of any item or service reimbursable under Medicare, Medicaid or other governmental programs.
The Office of Inspector General (“OIG”) at HHS has published safe harbor regulations that outline categories of activities that are deemed protected from prosecution under the anti-kickback statute, provided all applicable criteria are met. The failure to meet all of the applicable safe harbor criteria does not mean, however, that the particular arrangements violate the anti-kickback statute. We have a variety of physician arrangements and, although we do not believe that these agreements violate the law, there is no assurance that regulatory authorities will not determine otherwise or that all of our arrangements meet all of the applicable safe harbor criteria, especially as enforcement of this law historically has been a high priority for the federal government. Noncompliance with the federal anti-kickback legislation can result in exclusion from Medicare, Medicaid or other governmental programs, as well as civil and criminal penalties, any of which could have an adverse effect on our business and results of operations.
The Social Security Act also includes a provision commonly known as the “Stark Law.” This law prohibits a physician from referring Medicare (and to some extent Medicaid) patients to an entity providing “designated health services,” including, without limitation, radiology services, in which the physician has an ownership or investment interest or with which the physician has entered into a compensation arrangement. The penalties for violating the Stark Law include a prohibition on payment by these governmental programs and civil penalties of as much as $15,000 for each violative referral and $100,000 for participation in a “circumvention scheme” as well as civil penalties of twice the dollar value of each service and exclusion from future participation in the Medicare and Medicaid programs.
On January 4, 2001, CMS published final Phase I regulations to implement the Stark Law. Under these final regulations, radiology and certain other imaging services are included in the designated health services subject to the self-referral prohibition. Under the final regulations, such services include the professional and technical components of any diagnostic test or procedure using x-rays, ultrasound or other imaging services, computerized axial tomography, MRI, radiation therapy and diagnostic mammography services (but not screening mammography services). The final regulations, however, exclude from designated health services: (i) x-ray, fluoroscopy or ultrasonic procedures that require the insertion of a needle, catheter, tube or probe through the skin or into a body orifice; (ii) radiology procedures that are integral to the performance of, and performed during, non-radiological medical procedures; (iii) nuclear medicine procedures; and (iv) “invasive” or “interventional” radiology, because the radiology services in these procedures are merely incidental or secondary to another procedure that the physician has ordered.
The Stark Law provides that a request by a radiologist for diagnostic radiology services, if such services are furnished by or under the supervision of such radiologist or another radiologist in the same group practice pursuant to a consultation requested by a third party physician, does not constitute a “referral” by a “referring physician.” The effect of the Stark Law on the radiology practices, therefore, will depend on the precise scope of services furnished by each such practice’s radiologists and whether such services derive from consultations or are self-generated.
On March 26, 2004 CMS published Stark Law Phase II regulations, which took effect July 26, 2004. These regulations offer slightly greater flexibility through the addition of certain limited exceptions and more liberal interpretations of certain Stark requirements, while also establishing certain bright line rules that may make it more difficult to qualify certain arrangements for exceptions to the Stark
self-referral prohibitions. The Stark II changes have not altered the way in which we structure our business operations.
Although we believe that we have structured our acquisitions of the assets of existing practices and our service agreements for management and administrative services to comply with the Stark Law and regulations, a determination of noncompliance under the Stark Law could have an adverse effect on our business, financial condition and results of operations.
Federal False Claims Act. The Federal False Claims Act provides, in part, that the federal government may bring a lawsuit against any person whom it believes has knowingly presented, or caused to be presented, a false or fraudulent request for payment from the federal government, or who has made a false statement or used a false record to get a claim approved. In addition, amendments in 1986 to the Federal False Claims Act have made it easier for private parties to bring “qui tam” whistleblower lawsuits against companies. Penalties include fines ranging from $5,500 to $11,000 for each false claim, plus three times the amount of damages sustained by the federal government.
State Fraud and Abuse Provisions. Most of the states in which our diagnostic imaging centers are located have adopted a form of anti-kickback law, almost all of those states have also adopted a form of Stark Law, and some have adopted separate false claims provisions. The scope of these laws and the interpretations of them vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. Generally, state laws cover all referrals by all healthcare providers for all healthcare services. A determination of liability under such laws could result in fines and penalties and restrictions on our ability to operate in these jurisdictions.
Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996. The Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) required HHS to adopt standards to protect the security and privacy of health-related information. Although HHS issued proposed rules in 1998 concerning the security standards, final rules were not adopted until February 20, 2003. The security standards contained in the final rules do not require the use of specific technologies (e.g., no specific hardware or software is required), but instead require health plans, healthcare clearinghouses and healthcare providers to comply with certain minimum security procedures in order to protect data integrity, confidentiality and availability.
With respect to the privacy standards, HHS published final rules in December of 2000. However, on August 14, 2002, HHS published final modifications to the privacy standards. The final modifications eliminated the need for patient consent when the protected health information is disclosed for treatment payment issues or healthcare operations. In addition, the final modifications clarified the requirements related to authorizations, marketing and minimum necessary disclosures of information. All healthcare providers were required to be compliant with the new federal privacy requirements no later than April 14, 2003. We were compliant, in all material respects, with this federal privacy requirement as of April 14, 2003 and continue to be in compliance in all material respects.
The HIPAA privacy standards contain detailed requirements regarding the use and disclosure of individually identifiable health information. Improper use or disclosure of identifiable health information covered by the HIPAA privacy regulations can result in the following fines and/or imprisonment: (i) civil money penalties for HIPAA privacy violations are $100 per incident, up to $25,000, per person, per year, per standard violated; (ii) a person who knowingly and in violation of the HIPAA privacy regulations obtains individually identifiable health information or discloses individually identifiable health information to another person may be fined up to $50,000 and imprisoned up to one year, or both; (iii) if the offense is committed under false pretenses, the fine may be up to $100,000 and imprisonment for up to five years; and (iv) if the offense is done with the intent to sell, transfer, or use individually identifiable health information for commercial advantage, personal gain, or malicious harm, the fine may be up to $250,000 and imprisonment for up to ten years.
HIPAA also required HHS to adopt national standards establishing electronic transaction standards that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. Although these standards were to become effective October 2002, Congress extended the compliance deadline until October 2003 for organizations, such as ours, that submitted a request for an extension. We were compliant, in all material respects, with these electronic transaction standards as of October 2003 and continue to be in compliance.
Compliance Program. We have a program to monitor compliance with federal and state laws and regulations applicable to healthcare entities. Our program also monitors compliance with our Corporate Compliance Plan, which details our standards for: (i) business ethics; (ii) compliance with applicable federal, state and local laws; (iii) business conduct; and (iv) quality of service. An important part of our compliance program consists of conducting periodic audits of various aspects of our operations and billing practices. We also conduct mandatory educational programs designed to familiarize our employees with the regulatory requirements and specific elements of our compliance program. Our compliance program has been structured in light of the guidance provided by the OIG.
Internal Audit. Our internal audit function monitors compliance with our policies and procedures, including those related to billing and collections. The internal audit function was developed within the framework dictated by the Institute of Internal Auditor’s Standards for the Professional Practice of Internal Auditing and other relevant professional standards.
Item 1A.
Item 1A. Risk Factors
You should carefully consider the risks described below as well as other information and data included in this report.
Risks related to our business
Changes in the rates or methods of third-party reimbursement for diagnostic imaging services could result in downward pricing pressure, which would result in a decline in our revenue and harm our financial position.
We derive a majority of our revenue from direct billings to patients and third-party payors such as Medicare, Medicaid and private health insurance companies. As a result, any significant decreases in the rates or adverse changes in methods of reimbursement for the services we provide would have a significant adverse impact on our net revenue and financial results. CMS periodically updates the reimbursement rates in the Medicare physician fee schedule (including diagnostic imaging services we provide). Medicare reimbursement totaled $47.9 million of net revenue for the year ended December 31, 2006.
On February 8, 2006, President Bush signed the Deficit Reduction Act of 2005 (the “DRA”). The DRA codified a payment reduction begun by CMS on January 1, 2006, whereby CMS reduced payment by 25% for certain second and subsequent imaging services performed on contiguous body parts in a single session. The DRA also provided for a significant reduction in reimbursement for radiology services for Medicare Part B beneficiaries. The DRA provided that, effective January 1, 2007, reimbursement for diagnostic imaging services (excluding diagnostic and screening mammography) performed at non-hospital based freestanding facilities, which includes FICs like our centers, is the lesser of the Medicare Part B PFS or Medicare’s outpatient prospective payment system schedule (“OPPS”) for hospitals. Historically, non-hospital based freestanding fixed-site imaging centers were not directly affected by OPPS. OPPS was designed to reimburse hospitals for outpatient services on a rate per service basis that varies according to the ambulatory payment classification group (“APC”) to which the service is assigned rather than on a hospital’s costs. Each year CMS publishes new APC rates that are determined in accordance with the promulgated methodology.
The final PFS was published on November 1, 2006 with changes that became effective on January 1, 2007. As stated above, beginning January 1, 2006, CMS reduced payment by 25% for certain second and subsequent imaging services performed on contiguous body parts in a single session and under the PFS, CMS continued the reduction at 25% for calendar 2007. CMS makes a full payment for the highest priced procedure and reduces payment for each additional procedure by 25% when more than one procedure from the same imaging family is performed during the same session on the same day.
In accordance with the DRA requirements, effective January 1, 2007, CMS will cap the PFS payment amount for the technical component (prior to applying the geographic adjustment) by the OPPS payment amount (prior to applying the geographic adjustment). If as a result of the OPPS cap, an imaging service is paid at the lower OPPS rate (not the PFS payment amount), the OPPS national rate with the physician geographic adjustment is the final payment amount for calendar year 2007. Because IDTFs are paid under the PFS, the OPPS national rate is adjusted by the applicable PFS geographic adjustment factor, not the wage index applicable to hospital outpatient departments. The geographic adjustment factor applied to the OPPS national rate varies across the country according the payment locality in which the IDTF is located. On the other hand, hospital outpatient departments will receive a payment equal to the OPPS national rate adjusted by the applicable wage index under OPPS. The wage index and the geographic adjusters under the PFS are not the same. Accordingly, IDTFs may be paid less than hospital outpatient departments in the same locality for a procedure capped at the OPPS rate because of the different adjustment factors applicable to IDTFs and hospital outpatient departments. For imaging services subject to both the multiple imaging reductions and the OPPS cap, CMS will first apply the multiple imaging payment reduction and then apply the OPPS cap to the reduced amount. The geographic adjustment is then applied to the payment amount.
CMS and its fiscal intermediaries have developed and published a separate fee schedule within the PFS for outpatient imaging services. The new schedule is entitled 2007 OPPS Payment Cap Amounts for the Technical Component and Global Portion of Imaging Services. The schedule calculates the lesser-of-formula provided by the statute and applies the geographic modifier for the IDTF location.
We believe that the DRA reimbursement reductions will have a material adverse impact on our results of operations, cash flows and overall financial condition. If these reimbursement reductions had been in full effect during the year ended December 31, 2006, we estimate that the impact on our financial results would have been an $11.0 million reduction in net revenue. This estimate is based on the following assumptions: (i) 2006 scan volumes and modality mix; (ii) our historic Medicare denial rate; and (iii) published national APC rates for 2006.
We expect the actual impact of the reduction on our Medicare net revenue during 2007 will be comparable to the estimate above although payor mix and scan mix during 2007 could vary from our actual experience in 2006, which would impact the effect of the reimbursement reduction.
The estimated impact of the DRA does not include the impact of third party payors, other than Medicare, implementing comparable reductions in reimbursement. If other payors were to implement reductions, our results of operations, cash flows and overall financial condition would be further adversely affected. We are unable to anticipate or estimate the possibility or extent of potential reductions by non-Medicare payors.
To the extent that commercial payors with which we contract base their payments for diagnostic imaging services on Medicare reimbursement rates, any reduction in Medicare rates could result in a corresponding reduction in reimbursement from our commercial payors. Similarly, any change in significant commercial payor’s reimbursement rates may result in a corresponding change in reimbursement rates with other commercial payors. Future Medicare reimbursement reductions may further reduce the payments we receive for our services. Any change in the rates of or conditions for
reimbursement could substantially reduce the number of procedures for which we can obtain reimbursement or the amounts reimbursed to us for services we provide.
Our centers depend on physician referrals and contractual arrangements with insurance carriers for their business.
Our centers are principally dependent on our ability to attract referrals from physicians and other healthcare providers representing a variety of specialties. In order to attract patients with commercial insurance coverage from these referral sources, we must maintain a contractual relationship with their insurance carrier or managed care organization. We currently have over 490 different contracts with commercial payors for diagnostic imaging services provided at our centers, primarily on a discounted fee-for-service basis. Consistent with industry standards, a substantial number of our payor contracts permit payors to unilaterally change their fee schedules that are used to determine the amounts we are reimbursed. A significant decline in referrals through the loss of contracts with commercial payors, or otherwise, would have a material adverse effect on our business, financial condition and results of operations. In addition, if our referral sources purchase their own diagnostic imaging equipment and compete against us, our referrals may be temporarily or permanently reduced.
Our net revenues are significantly impacted by estimates of contractual allowances and the collectibility of claims.
We bill the majority of our payors a gross amount for the diagnostic imaging services we provide. These gross charges are reduced by contractual adjustments, since we are reimbursed at an agreed upon rate that is significantly lower than the gross rate we charge. Our gross charges are also reduced by doubtful accounts, or uncollectible amounts. Due to the extended period of time over which our claims are adjudicated, management must estimate the allowance for contractual adjustments and doubtful accounts. These estimates are significant in amount and are complicated by our payor mix and the extended period of time between our provision of services and when we are actually reimbursed by the payor. These estimates are further impacted by increasing deductibles, co-pays and other patient pay amounts, which are more difficult to collect, and secondary insurance. If we are forced to revise our estimates for contractual adjustments or doubtful accounts, or our existing reserves are not adequate, our results of operations and financial condition will be adversely affected.
We compete with other diagnostic imaging companies, referral physicians and hospitals and this competition could adversely affect our revenue and our business.
The overall diagnostic imaging services market is highly competitive, with services provided in a variety of settings and by several different types of providers. We compete principally on the basis of our reputation for delivering high quality images and radiologist reports in a timely manner, the comfort and care we provide to patients in our centers and price. We compete with other fixed-site, outpatient diagnostic imaging providers, non-radiologist physician practices, radiologists that own their own equipment, hospitals that own their own equipment and others, including leasing companies that own and operate diagnostic imaging equipment. Other major outpatient diagnostic imaging service providers include Healthsouth Corporation, Radnet, Inc., InSight Health Services Corp. and Alliance Imaging, Inc. Our competition also includes local hospitals, medical clinics and physician groups that provide diagnostic imaging services by leasing mobile diagnostic imaging equipment on a full or part-time basis.
Some of our competitors that provide diagnostic imaging services may now or in the future have access to greater financial resources than we do and the ability to acquire newer, more advanced equipment. Finally, we face competition from providers of competing technologies that we do not offer, such as PET and PET/CT scans, and may face competition from providers of new technologies in the
future. If we are unable to successfully compete, our customer base would decline and our business, financial condition and results of operations would be harmed.
Certain hospitals, particularly larger hospitals, may directly acquire and operate on-site diagnostic imaging equipment as part of their overall inpatient service offerings. There have been periods in the recent past when there has been significant excess capacity in the diagnostic imaging business in the United States, which can negatively affect utilization and reimbursement.
In addition, there is a growing trend of non-radiologist physician practices establishing their own diagnostic imaging centers within their group practices, pursuant to exceptions to physician self-referral legislation, which is an increasing source of competition.
The growth of utilization management and radiology benefit management companies could negatively impact the volume and mix of diagnostic imaging procedures we perform.
Diagnostic imaging procedures and, more particularly, spending for these diagnostic imaging procedures, is one of the fastest growing categories of healthcare expenditures in the U.S. In response to this trend, a number of insurance companies, managed care organizations, workers compensation carriers and other commercial payors have engaged third-party utilization management intermediaries in an effort to control spending growth. Utilization management companies help payors limit spending through provider credentialing, network management, procedure pre-authorization protocols and, in a limited number of cases, accreditation and quality standards. Further penetration of these practices among payors in our markets could have an adverse effect on our procedure volumes, net revenues, results of operations and financial condition.
We rely on board-certified radiologists to interpret the results of our diagnostic procedures and prepare reports to our referral physicians.
A substantial majority of the radiologists who provide interpretive services to our centers are independent contractors, either individually or as members of group radiology practices. The continued growth in the total number of diagnostic imaging procedures, nationally, has increased the demand for qualified radiologists, who are already in short supply, among hospitals, FICs and other clinical venues. In addition, federal regulations for Independent Diagnostic Testing Facilities require that radiologists supervise the performance of certain procedures performed on patients with governmental benefits, including those procedures requiring the administration of contrast mediums. Given current supply constraints, both the increase in demand for such radiologists and the requirement to have radiologists supervise certain procedures in order to qualify for government reimbursement, or any material disruption in our relationships with our current contracted radiologists, could adversely affect our ability to recruit and retain an adequate number of radiologists at reasonable rates, or at all.
An inability to meet our capital expenditure needs could adversely affect our ability to build and maintain 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 de novo centers, or new operations, and the acquisition of additional businesses and new imaging equipment. As the technology used in diagnostic imaging continues to advance, and as we continue to open or acquire new centers, our capital expenditures will remain substantial. We incur capital expenditures to, among other things:
· upgrade existing equipment to increase volume, quality and/or useful lives;
· purchase new equipment and incur leasehold improvements for de novo centers;
· acquire the assets of centers owned by others;
· replace underperforming equipment; and
· upgrade information technology systems.
To the extent we are unable to generate sufficient cash from our operations, funds are no longer available under our senior credit facility or we are unable to secure additional financing on acceptable terms, or at all, we may be unable to fund our capital expenditure requirements. Furthermore, there is no assurance that we will be able to raise any necessary additional funds through bank financing or the issuances of equity or debt securities on terms acceptable to us, if at all.
Loss of key executives and failure to attract qualified management, technologists, radiologists and sales persons could limit our growth and negatively impact our operations.
We depend heavily upon our management team. We entered into an employment agreement with C. Christian Winkle pursuant to which Mr. Winkle was retained as Chief Executive Officer of each of MQ Associates and MedQuest as of October 24, 2005. We also entered into an employment agreement with Todd E. Andrews pursuant to which Mr. Andrews was retained as Chief Financial Officer of each of MQ Associates and MedQuest as of April 7, 2006. If we lose the services of our executive officers or are unable to attract and retain qualified executive officers to fill these roles, our business, financial condition and results of operations could be materially adversely affected.
We have experienced an increased demand for center managers and marketing personnel with experience in our industry, skilled technologists to operate our diagnostic equipment and qualified radiologists to serve our patients. We compete with other healthcare providers in recruiting and retaining qualified management, marketing personnel, technologists and radiologists responsible for the daily operations of each of our centers. In some of our markets, the availability of skilled and appropriately trained technologists who can operate diagnostic imaging equipment has become a significant operating issue to diagnostic imaging providers. It is impossible to predict the availability of qualified center managers, marketing personnel and technologists or the compensation levels that will be required to hire them. It is equally difficult to predict the availability of qualified radiologists who are essential to reading images and writing the related reports for our referring physicians’ use. We may not be able to retain a sufficient number of technologists and radiologists, and we may be required to pay bonuses and higher compensation, or to hire more expensive temporary personnel, which would increase our expenses. The loss of the services of any members of our senior management or our inability to hire qualified senior management, field managers, marketing personnel, skilled technologists or qualified radiologists at economically reasonable compensation levels would adversely affect our ability to operate and maintain our business.
We are controlled by J.P. Morgan Partners, LLC, which has the ability to exert significant influence over matters requiring board of directors or stockholder approval.
Affiliates of J.P. Morgan Partners, LLC beneficially own approximately 71.6% of the common stock of MQ Associates, Inc. (on a fully diluted basis). We are controlled by MQ Investment Holdings, LLC and MQ Investment Holdings II, LLC, each of which is an affiliate of J.P. Morgan Partners, LLC. Pursuant to a stockholders agreement among us, MQ Investment Holdings, LLC, MQ Investment Holdings II, LLC and our other stockholders, J.P. Morgan Partners, LLC and its affiliates control us and have the power to elect all of our directors, appoint new management and approve any action requiring the approval of the holders of shares of our common stock, including adopting amendments to our certificate of incorporation and approving mergers, consolidations or sales of all or substantially all of our assets. This concentration of ownership may also delay or prevent a change of control of our company or reduce the price investors might be willing to pay for our notes. The interests of J.P. Morgan Partners, LLC may conflict with the interests of our other stakeholders.
Any adverse outcome from the ongoing SEC inquiry could have a material adverse effect on us.
The staff of the SEC has commenced a formal inquiry concerning, among other things, our previous announcement that we expected to restate our financial statements for prior periods and our inability to timely file our 2004 Annual Report and our Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30, 2005. The restatement was effected through the filing of our 2004 Annual Report on Form 10-K in September 2005.
While we are continuing to cooperate with the SEC, we cannot predict the outcome of the inquiry. Such inquiry could have a material adverse effect on our business, financial condition and results of operations.
Because a high percentage of our operating costs are fixed, a relatively small decrease in revenue could have a significant adverse impact on our financial results.
A high percentage of our expenses are fixed, meaning they do not vary significantly with the increase or decrease in revenues. Such expenses include, but are not limited to, debt service and capital lease payments, rent and operating lease payments, salaries, maintenance, and insurance costs. As a result, a relatively small reduction in revenue we receive for our services or procedure volume could have a disproportionately adverse effect on our financial results.
We may be unable to effectively maintain our equipment or generate revenue when our equipment is not working.
Timely, effective service is essential to maintaining our reputation and high utilization rates on our imaging equipment. Repair of a piece of diagnostic imaging equipment can take a week or more and results in a loss of revenue. Our warranties, maintenance contracts and business interruption insurance may not fully compensate us for loss of revenue when our equipment is out-of-service. The principal components of our operating costs include depreciation, salaries paid to technologists, annual equipment maintenance costs and insurance costs. Because such a large portion of these expenses are fixed, a reduction in the number of scans performed due to out-of-service equipment will result in lower revenue and margins. Repairs of our equipment are performed for us by the equipment manufacturers or by parties with whom we contract for service. These manufacturers may not be able to perform repairs or supply needed parts in a timely manner. Thus, if we experience greater than anticipated equipment malfunctions or if we are unable to promptly obtain the service necessary to keep our equipment functioning effectively, our revenue could decline and our ability to provide services would be harmed.
We may be subject to professional liability risks which could be costly and could negatively impact our business and financial results.
We may be subject to professional liability claims. Although there currently are no known hazards associated with diagnostic imaging or our other imaging technologies when used properly, hazards may be discovered in the future. Furthermore, there is a risk of harm to a patient during an MRI or CT scan. Patients are carefully screened to safeguard against this risk, but screening may nevertheless fail to identify the hazard.
We may also be subject to malpractice claims for the work of our radiologists, although most are independent contractors. To protect against the impact of possible professional liability, we maintain professional liability insurance. However, if we are unable to maintain insurance in the future at an acceptable cost, or at all, or if our insurance does not fully cover us and a successful claim is made against us, we could be exposed to liability. While we require our non-employee radiologists to have malpractice insurance policies, we may be subject to malpractice claims related to the work of our non-employee radiologists. Any claim made against us not fully covered by our insurance policies could be costly to
defend, result in a substantial damage award against us and divert the attention of our management from our operations, which could negatively impact our business and financial results.
We may not be able to achieve the expected benefits from any past or future acquisitions, which would adversely affect our financial condition and results.
We have historically relied on acquisitions as one method of expanding our business. As of December 31, 2006, we had completed 44 acquisitions of diagnostic imaging centers. If we do not successfully integrate acquisitions, we may not realize anticipated operating advantages and cost savings. The integration of centers that have previously operated separately involves a number of risks, including:
· demands on management related to the increase in our size as the result of an acquisition;
· the diversion of our management’s attention from the management of daily operations to the integration of operations;
· difficulties in the assimilation and retention of employees; and
· challenges related to converting the acquired entities to our financial and operating systems.
We may not be able to maintain the levels of operating efficiency acquired centers will have achieved or might achieve separately. Successful integration of each of their operations will depend upon our ability to manage those operations and to eliminate redundant or excess costs. Because of difficulties in combining operations, we may not be able to achieve the cost savings and other benefits related to economies of scale that we hoped to achieve after these acquisitions, which would harm our financial condition and results of operations.
We are continuously evaluating acquisition opportunities, and, at any given time, may be in various stages of due diligence or preliminary discussions with respect to a number of potential transactions. From time to time, we may enter into non-binding letters of intent. Some of these potential transactions, if we were to complete our business and legal due diligence and enter into a definitive agreement, could, if consummated, be material to our operations and to our financial condition.
Technological change in our industry could reduce the demand for our services and require us to incur significant costs to upgrade or replace our equipment.
Technological change in the diagnostic imaging services industry may accelerate in the future. The effect of technological change could significantly impact our business. The development of new scanning technology or new diagnostic applications for existing technology may require us to adapt our existing technology or acquire new or technologically improved equipment in order to successfully compete. In the future, however, we may not have the financial resources to adequately upgrade our technology, particularly given our indebtedness. The development of new technologies or refinements of existing ones might make our existing equipment technologically or economically obsolete, or cause a reduction in the value of, or reduce the need for, our equipment.
Our revenue may fluctuate or be unpredictable and this may harm our financial results.
The amount and timing of revenue that we may derive from our business will fluctuate based on:
· changes in the number of days of service we can offer with respect to a given diagnostic imaging equipment due to equipment malfunctions;
· the geographic location of our centers;
· patient pay and deductible obligations; and
· seasonal and weather factors.
We derive a portion of our revenues from patient pay and deductible obligations. These obligations are often greater in the beginning of the calendar year, and thus our revenue related to such patient pay may fluctuate from quarter to quarter. We also experience seasonality and other fluctuations in the volume of our services. Referral source and patient vacation schedules, events and population movements specific to certain of our operating regions and inclement weather may affect our revenues. As a result, our revenue may significantly vary from quarter to quarter, and our quarterly results may be below market expectations. We may not be able to reduce our expenses, including our debt service obligations, quickly enough to respond to these fluctuations in revenue, which would make our business difficult to operate and would harm our financial results.
Some of our imaging services involve the handling of hazardous materials and waste, including the use and disposal of short-lived radioactive materials, which could subject us to regulation, related costs and delays and potential liabilities for violations of environmental, health and safety laws.
We are subject to federal, state and local regulations governing storage, use and disposal of hazardous materials and medical radioactive and other waste products. Our diagnostic centers generate small amounts of medical waste or other hazardous materials, and some of our imaging services involve the use of short-lived radioactive materials. Although we believe that our procedures for storing, handling and disposing of these hazardous materials comply with the standards prescribed by law and adequately provide for the safety of our patients, employees and the environment, we cannot completely eliminate the risk of accidental releases, contamination or injury associated with such materials. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could incur significant costs and the diversion of our management’s attention in order to comply with current or future environmental, health and safety laws and regulations.
Risks related to our high degree of indebtedness
Our substantial level of indebtedness and limitations on our ability to incur additional debt could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under our debt instruments.
We are highly leveraged. Our total indebtedness at December 31, 2006 was $341.9 million. The following chart shows our level of indebtedness at December 31, 2006 (in millions of dollars).
Our high degree of leverage, and covenants contained in the indentures governing our notes and the senior credit facility that limit our ability to incur additional debt, could have important consequences to us, including the following:
· They may limit our ability to obtain additional financing for working capital, capital expenditures, de novo center development, acquisitions of new centers, debt service requirements and general corporate or other purposes;
· A substantial portion of our cash flows from operations must be dedicated to the payment of principal and interest on our indebtedness and is not available for other purposes, including our operations, capital expenditures and future business opportunities;
· Certain of our borrowings, primarily borrowings under our senior credit facility, are at variable rates of interest, exposing us to the risk of increased interest rates;
· They may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt;
· We may be vulnerable to a downturn in general economic conditions or in our business, or we may be unable to carry out capital spending that is important to our growth; and
· We may not have the resources or be able to repay our indebtedness when due and our creditors could take numerous actions against us, including foreclosure proceedings against our assets and forcing us into bankruptcy or liquidation.
We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. These factors include:
· changes in reimbursement rates;
· fluctuations in interest rates;
· increased operating costs;
· trends in diagnostic imaging; and
· regulatory developments.
We cannot make any assurance that we will maintain a level of cash flows from operating activities or that future borrowings will be available under our senior credit facility in amounts sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness or to fund our other liquidity needs. Our required annual debt service in 2006 was $34.8 million and is expected to be approximately $27.9 million in 2007. See “Forward-Looking Statements.”
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. The senior credit facility and the indentures governing our 12¼% Notes and 117¤8% Notes restrict our ability to dispose of assets and use the proceeds from the disposition. We may not be able to consummate those dispositions or to obtain the proceeds which we could realize from them and these proceeds may not be adequate to meet any debt service obligations then due. Any restructuring or refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations.
Restrictive covenants in the indentures governing our notes and our senior credit facility may adversely affect our ability to operate our business, and if we breach the covenants in our senior credit facility, the lenders may foreclose on their collateral.
The indentures governing our 121¤4% Notes and 117¤8% Notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:
· incur additional debt or issue redeemable preferred stock;
· incur liens;
· redeem or repurchase capital stock or subordinated debt;
· sell capital stock of our subsidiaries;
· engage in transactions with affiliates;
· make some types of investments or sell assets; or
· consolidate or merge with or into, or sell substantially all of our assets to, another person.
In addition, our senior credit facility contains restrictive covenants and requires MedQuest and its subsidiaries to maintain specified financial ratios and satisfy other financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control, and there is no assurance that we will continue to meet those tests. A breach of any of these covenants could result in a default under our senior credit facility or the indentures governing our 121¤4% Notes and 117¤8% Notes and the acceleration of all borrowings thereunder, together with accrued and unpaid interest and fees. In addition, upon the occurrence and continuation of an event of default under our senior credit facility, the lenders could elect to terminate all commitments to extend further credit and proceed against the collateral granted to them to secure indebtedness under the senior credit facility. We have pledged a significant portion of our assets as collateral under the senior credit facility. If the lenders under our senior credit facility accelerate the repayment of borrowings, there is no assurance that we will have sufficient assets to repay the senior credit facility and our other indebtedness, including our notes.
If there is a default under the agreements governing our material indebtedness, the value of our assets may not be sufficient to repay our creditors.
Our property and equipment, which make up a significant portion of our tangible assets, had a net book value as of December 31, 2006, of approximately $77.4 million. The book value of these assets should not be relied on as a measure of realizable value for such assets. The realizable value may be greater or lower than such net book value. The value of our assets in the event of liquidation will depend upon market and economic conditions, the availability of buyers and similar factors. Our intangible assets had a net book value as of December 31, 2006 of approximately $50.7 million. These assets primarily consist of the excess of the purchase price over the fair market value of the net assets of acquired companies and certificates of need. The value of these intangible assets will continue to depend significantly upon the success of our business as a going concern and the growth in future cash flows. As a result, in the event of a default under the agreements governing our material indebtedness or any bankruptcy or dissolution of our company, the realizable value of these assets will likely be substantially lower and may be insufficient to satisfy the claims of our creditors.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Certain of our borrowings, primarily borrowings under our senior credit facility, are at variable rates of interest and expose us to interest rate risk. At December 31, 2006, approximately $51.0 million of our total outstanding indebtedness of $341.9 million, or approximately 14.9%, was subject to variable rates of interest. If interest rates increase, our debt service obligations on the variable rate indebtedness would
increase even though the amount borrowed remained the same, and our net income and cash flow available for operations would be adversely affected.
Despite current indebtedness levels, we may still be able to incur substantially more debt. This could further exacerbate the risks described above.
We may be able to incur substantial additional indebtedness in the future. The terms of the indentures governing our notes do not fully prohibit us or our subsidiaries from doing so. As of December 31, 2006, we had borrowing availability under our senior credit facility, net of $0.5 million of outstanding letters of credit, of approximately $79.5 million provided we continue to meet the conditions of our covenants given the effect to any new debt. If new debt is added to our current debt levels, the related risks that we and our subsidiaries now face could intensify.
Risks related to government regulation of our business
We conduct business in a heavily regulated industry and if we fail to comply with these laws and government regulations, we could suffer penalties or be required to make significant changes to our operations.
We are subject to extensive regulation at both the federal and state levels for those states in which we conduct our business. The laws that directly or indirectly affect our ability to operate our business include the following:
· the federal Medicare and Medicaid Anti-Kickback Law;
· federal and state billing and claims submission laws and regulations;
· the federal Health Insurance Portability and Accountability Act of 1996;
· the federal physician self-referral prohibition commonly known as the Stark Law and state equivalents of the Stark Law;
· state laws that prohibit the practice of medicine by non-physicians and prohibit fee-splitting arrangements involving physicians; and
· federal and state laws governing the diagnostic imaging equipment we use in our business concerning patient safety, equipment operating specifications and radiation exposure levels.
If our operations are found to be in violation of any of the laws and regulations described in this risk factor or the other governmental regulations which govern our activities, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines or the curtailment of our operations. Any material penalties, damages, fines or curtailment of our operations, individually or in the aggregate, would adversely affect our ability to operate our business and our financial results. The risk 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 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.
In addition, healthcare laws and regulations may change significantly in the future. We continuously monitor these developments and modify our operations from time to time as necessary and in response to changes in the regulatory environment. There is no assurance, however, that any new healthcare laws or regulations will not adversely affect our business. There is no assurance that a review of our business by judicial 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.
Providers in the healthcare industry have been the subject of federal and state investigations, and if we become the subject of an investigation, our business, financial position and results of operations could be adversely affected.
Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare companies, as well as their executives and managers. In addition, amendments in 1986 to the Federal False Claims Act have made it easier for private parties to bring “qui tam” whistleblower lawsuits against companies. The Federal False Claims Act provides, in part, that an action can be brought against any person or entity who has knowingly presented, or caused to be presented, a false or fraudulent request for payment from the federal government, or who has made a false statement or used a false record to get a claim approved. The government has taken the position that claims presented in violation of the federal anti-kickback law or Stark Law may be considered a violation of the Federal False Claims Act. Penalties include fines ranging from $5,500 to $11,000 for each false claim, plus three times the amount of damages sustained by the federal government. In addition, some states have adopted similar state whistleblower and false claims provisions If we become the subject of an investigation in the future by any federal or state government agency regarding our billing practices or any other aspect of our business, it could have a material adverse effect on our business, financial position and results of operations.
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.
Ownership, construction, operation, expansion and acquisition of diagnostic imaging centers are subject to various federal and state laws, regulations and approvals concerning licensing of centers, personnel, other required certificates for certain types of healthcare centers and major medical equipment. In addition, independent diagnostic imaging centers that provide services outside of a physician’s office must be enrolled by Medicare as an IDTF to bill the Medicare program. Medicare fiscal intermediaries have discretion in applying the IDTF requirements and therefore the application of these requirements may vary from jurisdiction to jurisdiction. We may not be able to receive the required regulatory approvals for any future acquisitions, expansions or replacements, and the failure to obtain these approvals could limit the 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, 2006 approximately 35.5% of our total gross revenue generated at our diagnostic imaging centers was derived from government sponsored healthcare programs (principally Medicare and Medicaid). A change in the applicable license or enrollment status of one of our facilities could adversely affect our other facilities, and in turn, us as a whole. We intend to conduct our operations in compliance with applicable federal, state, and local laws and we monitor developments in healthcare law so that we can modify our operations from time to time as the business and regulatory environment changes.
Our inability to obtain certificates of need, as well as the application of state certificate of need regulations could harm our business and financial results.
Some states require a CON or similar regulatory approval prior to the acquisition of high-cost capital items including diagnostic imaging equipment or provision of diagnostic imaging services. Six of the 13 states in which we operate require a CON (with certain threshold exceptions) and more states may adopt similar licensure frameworks in the future. Accordingly, in states where CONs are required without any threshold exceptions, we must obtain a new CON before we can acquire MRI or CT diagnostic imaging equipment or expand the services that we provide at an existing center by adding additional
diagnostic imaging equipment. In some cases, a limited number of these CONs are available in a given state. For the year ended December 31, 2006, approximately 70.4% of our gross revenue was generated in states in which a CON is required. If we are unable to obtain the applicable CON or additional certificates or approvals necessary to expand our operations, these regulations may limit or preclude our operations in the relevant jurisdictions.
From time to time, challenges have been made, and may continue to arise, with respect to the application of a state’s CON laws to our facilities. If we are unable to succeed against challenges to our CONs or exemptions therefrom, we may be limited or precluded from continuing our operations at affected locations.
Conversely, states in which we have obtained a CON may repeal existing CON regulations or liberalize exemptions from the regulations. The repeal of CON regulations in states in which we have obtained a CON or an exemption therefrom would lower barriers to entry for competition in those states and could adversely affect our business.
If we fail to successfully implement, integrate and secure our information systems at our facilities, we could suffer penalties, be required to make significant changes to our operations and our cash flows could be negatively affected.
The Administrative Simplification Provisions of HIPAA required HHS to adopt standards to protect the security and privacy of health related information. Although HHS issued proposed rules in 1998 concerning the security standards, final rules were not adopted until February 20, 2003. The security standards contained in the final rules do not require the use of specific technologies (e.g., no specific hardware or software is required), but instead require health plans, healthcare clearinghouses and healthcare providers to comply with certain minimum security procedures in order to protect data integrity, confidentiality and availability.
With respect to the privacy standards, HHS published final rules in December of 2000. However, on August 14, 2002, HHS published final modifications to the privacy standards. The final modifications eliminated the need for patient consent when the protected health information is disclosed for treatment payment issues or health care operations. In addition, the final modifications clarified the requirements related to authorizations, marketing and minimum necessary disclosures of information. All healthcare providers were required to be compliant with the new federal privacy requirements no later than April 14, 2003. We believe we are in material compliance with existing state and federal law relating to patient privacy.
The HIPAA privacy standards contain detailed requirements regarding the use and disclosure of individually identifiable health information. Improper use or disclosure of identifiable health information covered by the HIPAA privacy regulations can result in the following fines and/or imprisonment: (i) civil money penalties for HIPAA privacy violations are $100 per incident, up to $25,000, per person, per year, per standard violated; (ii) a person who knowingly and in violation of the HIPAA privacy regulations obtains individually identifiable health information or discloses individually identifiable health information to another person may be fined up to $50,000 and imprisoned up to one year, or both; (iii) if the offense is committed under false pretenses, the fine may be up to $100,000 and imprisonment for up to five years; and (iv) if the offense is done with the intent to sell, transfer, or use individually identifiable health information for commercial advantage, personal gain, or malicious harm, the fine may be up to $250,000 and imprisonment for up to ten years.
HIPAA also required HHS to adopt national standards establishing electronic transaction standards that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. Although these standards were to become effective October 2002, Congress extended the
compliance deadline until October 2003 for organizations, such as ours, that submitted a request for an extension. We believe we are in material compliance with the HIPAA electronic transaction standards.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of December 31, 2006, we leased approximately 32,000 square feet of space in Alpharetta, Georgia for our executive and principal administrative offices. As of December 31, 2006, we operated 90 centers in 13 states as described in the following table:
* Indicates state where certificates of need are required. The State of Missouri has broad exemptions from CON regulations and we do not have any centers in Missouri with a CON.
As of December 31, 2006, we owned one and leased 89 of the properties upon which our 90 centers were located. We lease certain of our properties from related parties (See Item 13).
Item 3.
Item 3. Legal proceedings
We are engaged from time to time in the defense of lawsuits and administrative proceedings arising in the ordinary course and conduct of our business and have insurance policies covering potential insurable losses where this coverage is cost-effective.
The staff of the SEC has commenced a formal inquiry concerning, among other things, our previous announcement that we expected to restate our financial statements for prior periods and our inability to timely file our 2004 Annual Report and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005 (which, in each case, were subsequently filed). While we are continuing to cooperate with the SEC, the Company cannot predict the outcome of the inquiry. Such inquiry could have a material adverse effect on the Company’s business, financial condition and results of operations.
On February 24, 2007, after a failed mediation on an unrelated matter between Phoenix Diagnostic Imaging, Inc. (“PDI”), our Arizona subsidiary, and Analytic Medical Imaging, Ltd. d/b/a/ Arizona Medical Imaging (“AMI”), our exclusive radiology provider in our greater Phoenix, Arizona market, AMI
terminated our 30 year Radiology Interpretive Services and Medical Director Agreement (“ISA”), with only 5 days’ notice. On February, 28, 2007, PDI filed a lawsuit against AMI for breach of the ISA based on AMI’s wrongful termination, insufficient notice of termination and bad faith, as well as for tortious interference with its business relations, along with a motion for temporary restraining order (“TRO”) in the Superior Court, Maricopa County, Arizona. The TRO sought to prohibit AMI from abandoning its staffing of PDI’s centers on such inappropriate and insufficient notice. On February 28, 2007, the Superior Court granted PDI’s motion for a TRO and set a preliminary injunction hearing for March 19, 2007.
On March 1, 2007, AMI filed an appeal of the Superior Court’s TRO with the Arizona Court of Appeals. That appellate action was converted by the Court of Appeals into a Petition for Special Action. On March 2, 2007, AMI filed a motion to stay the TRO in the Superior Court, which motion was denied the same day after oral argument. On March 5, AMI filed a motion to stay the TRO with the Arizona Court of Appeals. The Court of Appeals denied AMI’s motion to stay and summarily dismissed AMI’s petition for special action on March 8, 2007.
At the conclusion of the preliminary injunction hearing on March 19, 2007, the Superior Court extended the TRO through March 26, 2007 and ordered the parties to engage in emergency arbitration to determine whether further injunctive relief was appropriate. The Superior Court also referred the underlying lawsuit to binding AAA arbitration. On March 26, 2007, the parties engaged in an emergency arbitration proceeding. While that proceeding has not yet been completed, the arbitrator did further extend the injunctive relief requiring AMI to staff the PDI centers through April 2, 2007 and PDI may be able to obtain additional staffing through an additional extension of the injunction.
Although AMI has asserted a number of rationales and justifications, which we believe are unjustified and unsupportable, for its termination of the ISA, PDI intends to vigorously pursue its lawsuit against AMI and believes that its suit has merit. We are not able to predict the ultimate outcome of this lawsuit, or the impact the transition to alternate radiology coverage in our greater Phoenix, Arizona market or management’s diverted attention to this matter may have on our operations in the short term.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
There is no established public trading market for the Class A Common Stock and common stock of MQ Associates. There were six owners of record for each of the Class A Common Stock and common stock of MQ Associates at December 31, 2006. MQ Associates does not anticipate paying any dividends in the foreseeable future. The indenture related to the 121¤4% Notes limits the ability of MQ Associates to pay dividends to its stockholders. In addition, the senior credit facility and indenture related to the $180.0 million aggregate principal amount of 117¤8% senior subordinated notes due August 2012 (“117¤8% Notes”) issued by MedQuest limit the ability of MedQuest to pay dividends or make other restricted payments to MQ Associates.
On September 7, 2005, we entered into a securities purchase agreement with MQ Investment Holdings II, LLC, an affiliate of JP Morgan Partners, LLC, pursuant to which MQ Associates issued and sold to MQ Investment Holdings II, LLC 20,000,000 shares of Series A Redeemable Preferred Stock and a warrant to purchase 3,000,000 shares of common stock in exchange for $20.0 million.
We believe that the foregoing issuances of our equity securities did not involve a public offering or sale of securities and were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to the exemption from registration afforded by Section 4(2) of the Securities Act and Regulation D promulgated thereunder. MQ Investment Holdings II, LLC is an accredited investor, and no general solicitation or advertising was used. No underwriters, brokers or finders were involved in these transactions.
Each share of Series A Preferred Stock is convertible, at the holder’s option, immediately prior to the consummation of either a qualified public offering or a liquidation or sale, into that number of fully paid and non-assessable shares of Class A Common Stock equal to the quotient obtained by dividing (x) the aggregate original cost of such shares of the Series A Preferred Stock to be converted by (y) the applicable conversion price for the Series A Preferred Stock. The conversion price per share at which shares of Class A Common Stock shall be issuable upon conversion of Series A Preferred Stock was initially equal to (1) the qualified initial public offering price, in the case of conversion immediately prior to such event, or (2) the original cost, in the case of conversion immediately prior to a liquidation or sale. The warrant is exercisable in whole or part at any time prior to September 7, 2015 into common stock upon payment of the aggregate exercise price. The exercise price for each share of common stock underlying the warrant is $.01 per share, subject to adjustment.
Item 6.
Item 6. Selected Financial Data
The following table sets forth our selected historical consolidated financial data and other data. The selected consolidated historical financial data set forth below should be read in conjunction with and is qualified in its entirety by reference to Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this section is to discuss and analyze our consolidated financial condition, liquidity and capital resources and results of operations. This analysis should be read in conjunction with the consolidated financial statements and notes, which appear elsewhere in this report. This section contains certain “forwardlooking statements” within the meaning of federal securities laws that involve risks and uncertainties, including statements regarding our plans, objectives, goals, strategies and financial performance. The actual results we achieve could differ materially from results anticipated in these forward-looking statements as a result of factors set forth under “Forward-Looking Statements” and “Risk Factors” elsewhere in this report.
Executive Overview
We are a leading provider of diagnostic imaging services through our network of fixed-site, outpatient diagnostic imaging centers. As of December 31, 2006, we operated a network of 90 centers in 13 states primarily throughout the southeastern and southwestern United States and we operate as a single reporting segment. We principally serve patients through physician referrals and bill third party payors such as managed care organizations, Medicare, Medicaid, commercial insurance companies and workers’ compensation insurance funds. We also provide services to healthcare providers such as physicians and hospitals. For the year ended December 31, 2006, 66.8% of our gross revenue was derived from MRI services and 19.0% of our gross revenue was derived from CT services. The remainder of our gross revenue was derived from nuclear medicine, general radiology (fluoroscopy and x-ray), ultrasound, bone densitometry and mammography services.
Our revenue is generated by providing services to patients and other healthcare providers. Generally, we directly bill patients or third-party payors (e.g. Medicare, Medicaid, commercial payors and workers’ compensation funds) on a fee-for-service basis. Patient services revenue is recognized net of contractual and other adjustments, which represent the difference between the standard fee we charge for a procedure and what we will ultimately collect from third party payors. For the year ended December 31, 2006, approximately 55.8% of our gross patient revenues came from managed care and commercial payors, 35.5% from government payors and 8.7% from other sources, including gross revenue from patients who were not insured. We have over 490 different contracts with commercial payors, and no single commercial payor accounted for more than 10.0% of our gross revenue for the year ended December 31, 2006. These contracts describe the negotiated fees to be paid by each payor for the diagnostic imaging services we provide to their members, who are our patients.
We estimate the allowance for contractual adjustments and doubtful accounts using analyses that include evaluations by payor class, short-term and long-term collection trends and matching of patient charges with subsequent collections and claims adjudication. We also review the contractual adjustment rate reflected in the statement of operations in conjunction with the balance sheet reserve rate. This analytic process is validated by an account liquidation analysis that quantifies the actual amount collected against accounts outstanding as of a specific date. Based upon these analyses, management estimates the anticipated collection rate for gross charges outstanding as of the balance sheet date and recognizes the required change in the allowance for contractual adjustments and doubtful accounts as a charge to gross patient revenue for the period.
We derive a majority of our revenue from direct billings to patients and third-party payors such as Medicare, Medicaid and private health insurance companies. As a result, any significant decreases in the rates or adverse changes in methods of reimbursement for the services we provide would have a significant adverse impact on our net revenue and financial results. CMS periodically updates the reimbursement rates in the PFS (including diagnostic imaging services we provide). Medicare reimbursement totaled $47.9 million of net revenue for the year ended December 31, 2006.
On February 8, 2006, President Bush signed the Deficit Reduction Act of 2005 (the “DRA”). The DRA codified a payment reduction begun by CMS on January 1, 2006, whereby CMS reduced payment by 25% for certain second and subsequent imaging services performed on contiguous body parts in a single session. The DRA also provided for a significant reduction in reimbursement for radiology services for Medicare Part B beneficiaries. The DRA provided that, effective January 1, 2007, reimbursement for diagnostic imaging services (excluding diagnostic and screening mammography) performed at non-hospital based freestanding facilities, which includes FICs like our centers, is the lesser of the Medicare Part B PFS or Medicare’s outpatient prospective payment system schedule (“OPPS”) for hospitals. Historically, non-hospital based freestanding fixed-site imaging centers were not directly affected by OPPS. OPPS was designed to reimburse hospitals for outpatient services on a rate per service basis that varies according to the ambulatory payment classification group (“APC”) to which the service is assigned rather than on a hospital’s costs. Each year CMS publishes new APC rates that are determined in accordance with the promulgated methodology.
The final PFS was published on November 1, 2006 with changes that became effective on January 1, 2007. As stated above, beginning January 1, 2006, CMS reduced payment by 25% for certain second and subsequent imaging services performed on contiguous body parts in a single session and under the PFS, CMS continued the reduction at 25% for calendar year 2007. CMS reimburses its full rate for the highest priced procedure and reduces payment for each additional procedure by 25% when more than one procedure from the same imaging family is performed during the same session on the same day.
In accordance with the DRA requirements, effective January 1, 2007, CMS capped the PFS payment amount for the technical component (prior to applying the geographic adjustment) by the OPPS payment amount (prior to applying the geographic adjustment). If as a result of the OPPS cap, an imaging service is paid at the lower OPPS rate (not the PFS payment amount), the OPPS national rate with the physician geographic adjustment is the final payment amount for calendar year 2007. Because IDTFs are paid under the PFS, the OPPS national rate is adjusted by the applicable PFS geographic adjustment factor, not the wage index applicable to hospital outpatient departments. The geographic adjustment factor applied to the OPPS national rate varies across the country according the payment locality in which the IDTF is located. On the other hand, hospital outpatient departments will receive a payment equal to the OPPS national rate adjusted by the applicable wage index under OPPS. The wage index and the geographic adjusters under the PFS are not the same. Accordingly, IDTFs may be paid less than hospital outpatient departments in the same locality for a procedure capped at the OPPS rate because of the different adjustment factors applicable to IDTFs and hospital outpatient departments. For imaging services subject to both the multiple imaging reductions and the OPPS cap, CMS will first apply the multiple imaging payment reduction and then apply the OPPS cap to the reduced amount. The geographic adjustment is then applied to the payment amount.
CMS and the carriers have developed and published a separate fee schedule within the PFS for outpatient imaging services. The new schedule is entitled 2007 OPPS Payment Cap Amounts for the Technical Component and Global Portion of Imaging Services. The schedule calculates the lesser of formula provided by the statute, as well as, applying the geographic modifier applicable to the IDTF location.
We believe that the DRA reimbursement reductions will have a material adverse impact on our results of operations, cash flows and overall financial condition. If these reimbursement reductions had been in full effect during the year ended December 31, 2006, we estimate that the impact on our financial results would have been an $11.0 million reduction in net revenue. This estimate is based on the following assumptions: (i) 2006 scan volumes and modality mix; (ii) our historic Medicare denial rate; and (iii) published national APC rates for 2006.
We expect the actual impact of the reduction on our Medicare net revenue during 2007 will be comparable to the estimate above, although payor mix and scan mix during 2007 could vary from our actual experience in 2006, which would impact the effect of the reimbursement reduction.
The estimated impact of the DRA does not include the impact of third party payors, other than Medicare, implementing comparable reductions in reimbursement. If other payors were to implement reductions, our results of operations, cash flows and overall financial condition would be further adversely affected. We are unable to anticipate or estimate the possibility or extent of potential reductions by non-Medicare payors.
To the extent that commercial payors with which we contract base their payments for diagnostic imaging services on Medicare reimbursement rates, any reduction in Medicare rates could result in a corresponding reduction in reimbursement from our commercial payors. Similarly, any change in significant commercial payor’s reimbursement rates may result in a corresponding change in reimbursement rates with other commercial payors. Future Medicare reimbursement reductions may further reduce the payments we receive for our services. Any change in the rates of or conditions for reimbursement could substantially reduce the number of procedures for which we can obtain reimbursement or the amounts reimbursed to us for services we provide.
The principal components of our costs of services, which were previously identified as operating expenses, are compensation paid to radiologists and technologists, equipment maintenance costs, medical supplies, real estate rental expenses and equipment rental costs (which include rental costs for mobile units and operating expenses for certain equipment). Costs of services, as a percentage of net revenue, decreased to 45.4% for the year ended December 31, 2006 from 46.5% for the year ended December 31, 2005. Costs of services, as a percentage of net revenue, increased to 46.5% for the year ended December 31, 2005 from 45.3% for the year ended December 31, 2004.
Marketing, general and administrative (“MG&A”) expenses are comprised of three major categories: (i) operations overhead; (ii) corporate overhead; and (iii) bad debt expense. Operations overhead includes wages and benefits for center personnel (excluding radiologists and technologists) and transcriptionists, regional management, regional billing centers and local marketing and is relatively proportionate to growth in revenue. Corporate overhead is comprised of corporate wages and benefits and other corporate expenses. The table below sets forth MG&A expenses by category for the years ended December 31, 2006, 2005 and 2004 (in thousands of dollars). MG&A expenses, as a percentage of net revenue, were 35.1% for the year ended December 31, 2006, as compared to 35.8% for the year ended December 31, 2005 and 37.0% for the year ended December 31, 2004.
For the years ended December 31, 2006 and 2005, the corporate overhead component of MG&A of approximately $23.0 million and $26.1 million, respectively, included approximately $0.3 million and $7.5 million of costs for the audit committee review, restatement, consent fees, executive search fees and other related expenses, respectively. In addition, the corporate overhead component of MG&A for the year ended December 31, 2005, included $0.8 million of proceeds from the settlement of an insurance claim. For the year ended December 31, 2004, the corporate overhead component of MG&A of approximately $25.0 million included costs of approximately $1.3 million for certain one-time bonuses paid to
non-executive management employees in connection with our August 2004 121¤4% Note offering and approximately $2.8 million in legal costs related to the settlement of a class action lawsuit and a DOJ billing matter. After consideration of the charges discussed above, corporate overhead increased $3.3 million from 2005 to 2006 and decreased $1.4 million from 2004 to 2005. The increase in 2006 is primarily attributable to an increase in consulting fees for Sarbanes-Oxley compliance activity and legal expenses and the decrease in 2005 is primarily attributable to a decrease in legal expenses in 2005.
Under our patient receivable collections policy, we attempt to collect as much patient pay amounts as possible at the point of service. Any balances remaining due from patients after claims have been adjudicated are collected through a process that includes internal billing and collection efforts. Patient pay amounts are written off to bad debt when they are deemed uncollectible.
The concentration of gross revenue and gross patient receivables by payor class, as a percentage of total gross revenue and total gross patient receivables as of December 31, 2006, is as follows:
(1) DSO represents the days sales outstanding, which measures the number of days of sales included in patient receivables based upon gross revenue and gross patient receivables.
Our growth has come from same center revenue, de novo development and strategic acquisitions. We seek to increase our same center revenue by attracting new referring physicians, extending hours of operations, managing our scan and payor mix and adding capacity and modalities to meet local market needs. De novo development generally comes through expansion within our local markets. Strategic acquisitions allow us to quickly enter new markets, and to further penetrate existing markets with additional centers.
We experience seasonality in our revenue resulting from holidays, inclement weather and referral source and patient vacations, which result in fewer patient scans during certain times of the year.
Results of operations
The following table sets forth our statement of operations data and these amounts as a percentage of net revenues, for the periods indicated:
Year ended December 31, 2006 compared to year ended December 31, 2005
Net revenue was $273.5 million for the year ended December 31, 2006, representing a decrease of $19.5 million, or 6.6%, from net revenue of $293.0 million for the year ended December 31, 2005. The decrease in net revenue was driven in large part by the discontinuance of certain wholesale contracts, fewer lower modality procedures, lower scan volumes generally and a net reduction in centers. We experienced a decrease in same center net revenue of $16.5 million, or 6.0%, for the year ended December 31, 2006 compared to the year ended December 31, 2005. Same centers are defined as centers in operation at the beginning of the prior year and continuing in operation at year end. Our new centers added $3.5 million, or 1.2%, of net revenue growth for the year ended December 31, 2006 compared to the year ended December 31, 2005. New centers are defined as centers opened since the beginning of the prior year. We closed two centers and sold three centers during the year ended December 31, 2006, which reduced net revenue by $5.8 million compared to the prior year. Managed centers and mobile operations accounted for a decrease in net revenue of $0.7 million for the year ended December 31, 2006 compared to the year ended December 31, 2005.
The $16.5 million decrease in net revenue from same centers for the year ended December 31, 2006, resulted from the discontinuance of certain wholesale contracts and lower modality procedures at certain centers, and lower scan volumes generally. Scan volume decreases at our same centers reduced net revenue by $28.3 million for the year ended December 31, 2006. This decrease was partially offset by the impact of pricing changes, which increased net revenue by $8.4 million, and changes in mix by modality, which increased net revenue by $3.4 million.
Costs of services were $124.1 million for the year ended December 31, 2006, representing a decrease of $12.0 million, or 8.8%, as compared to $136.1 million for the year ended December 31, 2005. The decrease in costs of services was primarily driven by lower scan volumes and the one-time reduction in rent and building costs of $1.3 million related to the settlement of a landlord claim. Furthermore, costs of services, as a percentage of net revenue, decreased to 45.4% for the year ended December 31, 2006, as compared to 46.5% for the year ended December 31, 2005. The decrease in costs of services, as a
percentage of net revenue, was primarily the result of lower radiologist fees and lower expenses for operating supplies.
We account for closed center liabilities related to exit and disposal activities in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”). Accordingly, we recorded a charge of $0.3 million for the each of the years ended December 31, 2006 and 2005 for obligations associated with the closing of centers. These costs are reflected in the consolidated statement of operations as costs of services. Additionally, as discussed below, we incurred a loss on disposal of assets related to these closures of $1.4 million for the year ended December 31, 2006, as compared to a loss on disposal of $1.4 million for the year ended December 31, 2005. The centers closed and sold during 2006 had combined operating income of $0.8 million on net revenue of approximately $9.1 million for the year ended December 31, 2005. The centers closed during 2005 had combined operating losses of $1.1 million on net revenue of approximately $3.8 million for the year ended December 31, 2004.
MG&A expenses were $96.0 million for the year ended December 31, 2006, representing a decrease of $8.9 million, or 8.5%, as compared to MG&A expenses of $104.9 million for the year ended December 31, 2005. MG&A expenses, as a percentage of net revenue, were 35.1% for the year ended December 31, 2006, as compared to 35.8% for the year ended December 31, 2005. The decrease in MG&A expenses was largely the result of a $7.3 million decrease in expenses associated with our 2005 audit committee review and restatement and other related expenses, lower employee compensation of $1.5 million and a decrease in bad debt expense of $1.1 million. During the year ended December 31, 2005, we received $0.8 million related to the settlement of an insurance claim, which is included in other income as part of MG&A.
During the year ended December 31, 2006, we recorded a gain on disposal of assets of $0.1 million, compared to losses on disposal of assets of $1.6 million for the year ended December 31, 2005. The gain on disposal of assets of $0.1 million for the year ended December 31, 2006, is primarily attributable to the gain of $2.3 million from the sale of three centers, partially offset by losses on disposal of assets related to the closing of two centers of $1.4 million and losses on disposal of other assets of $0.8 million. The losses on disposal of assets of $1.6 million for the year ended December 31, 2005 were incurred primarily in connection with the closing of six centers, as discussed above.
Depreciation and amortization was $34.1 million, or 12.4% of net revenue, for the year ended December 31, 2006, as compared to $35.9 million, or 12.3% of net revenue, for the year ended December 31, 2005. The $1.8 million decrease in depreciation expense was the result of decreased capital expenditures made in 2005.
Interest expense, net was $40.0 million for the year ended December 31, 2006, representing an decrease of $1.0 million, or 2.4%, from $41.0 million for the year ended December 31, 2005. The decrease in interest expense, net was a result of increased accretion of interest expense related to the 121¤4% Notes, as defined below, offset by a decrease in interest expense on the senior credit facility due to decreased borrowings and a correction of an immaterial non-cash error of $1.9 million in the fourth quarter of 2006. In addition, interest expense, net, for the year ended December 31, 2005, included a gain on the termination of an interest rate swap agreement of approximately $1.6 million. Approximately $1.0 million and $0.4 million of additional interest expense was recorded in 2005 in conjunction with the consent solicitations and the credit facility waivers related to the restatement, respectively, which are described elsewhere in this report.
Income taxes were $2.7 million for the year ended December 31, 2006, as compared to $3.0 million for the year ended December 31, 2005. Tax expense reflects the results of adjustments to the valuation allowance due to anticipated ongoing tax losses. We continue to present deferred tax liabilities related to differences in GAAP and tax accounting for indefinite lived intangible assets. Under GAAP, indefinite
lived intangible assets are not amortized but periodically assessed for impairment, which results in a quasi-permanent difference associated with the difference in book and tax bases. There were federal and state net operating loss carryforwards amounting to approximately $85.8 million and $158.8 million, respectively, at December 31, 2006.
Year ended December 31, 2005 compared to year ended December 31, 2004
Net revenue was $293.0 million for the year ended December 31, 2005, representing an increase of $18.4 million, or 6.7%, from net revenue of $274.6 million for the year ended December 31, 2004. We experienced same center net revenue growth of $3.4 million, or 1.2%, for the year ended December 31, 2005 compared to the year ended December 31, 2004. Same centers are defined as centers in operation at the beginning of the prior year and continuing in operation at year end. Our new centers added $19.2 million, or 6.9%, of net revenue growth for the year ended December 31, 2005 compared to the year ended December 31, 2004. New centers are defined as centers opened since the beginning of the prior year. We closed six centers during the year ended December 31, 2005, which reduced net revenue by $3.7 million compared to the prior year. Managed centers accounted for a decrease in net revenue of $0.5 million for the year ended December 31, 2005 compared to the year ended December 31, 2004.
The increase in net revenue from same centers of $3.4 million for the year ended December 31, 2005, resulted from changes in scan volume, scan mix by modality and pricing, which includes changes in payor mix and contractual rates. During the year ended December 31, 2005, volume at same centers increased, resulting in higher net revenue of $5.0 million. This increase and pricing changes, which increased net revenue by $1.7 million, were partially offset by the impact of changes in scan mix by modality, which reduced net revenue by $3.3 million.
Net revenue for the three months ended December 31, 2005 was $70.2 million compared to $71.1 million for the same period in 2004. The decrease of $0.9 million is attributable to a decline in net revenue from existing, and closed and managed centers of $2.9 million and $1.1 million, respectively, offset by an increase in net revenue from new centers of $3.1 million.
Costs of services were $136.1 million for the year ended December 31, 2005, representing an increase of $11.6 million, or 9.3%, as compared to $124.5 million for the year ended December 31, 2004. Costs of services, as a percentage of net revenue, increased to 46.5% for the year ended December 31, 2005, as compared to 45.3 % for the year ended December 31, 2004. The increase in costs of services, as a percentage of net revenue, was primarily the result of higher radiologist, technician and real estate rental costs. The increase in radiologist costs was driven by an increase in net revenue and a higher mix of lower modality scans. The increase in technician costs was a result of higher demand for these services in our markets. Real estate rental costs increased due to the opening of new centers and recognition of the future obligations associated with closed locations.
We account for closed center liabilities related to exit and disposal activities in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”). Accordingly, we recorded a liability of $0.3 million for the year ended December 31, 2005 for obligations associated with the closing of six centers, compared to $0.7 million for the year ended December 31, 2004. These costs are reflected in the consolidated statement of operations as costs of services. Additionally, as discussed below, we incurred a loss on disposal of assets of $1.4 million related to these closures. The six centers closed during the period had combined operating losses of $1.1 million on net revenue of approximately $3.8 million for the year ended December 31, 2004.
MG&A expenses were $104.9 million for the year ended December 31, 2005, representing an increase of $3.4 million, or 3.3%, as compared to MG&A expenses of $101.5 million for the year ended December 31, 2004. MG&A expenses, as a percentage of net revenue, were 35.8% for the year ended
December 31, 2005, as compared to 37.0% for the year ended December 31, 2004. During the year ended December 31, 2005, we received $0.8 million related to the settlement of an insurance claim, which is included in other income as part of MG&A. MG&A expenses for the year ended December 31, 2005 included expenses of approximately $7.5 million associated with the audit committee review, the restatement, debt holder consent fees, executive search fees and other related expenses. During the year ended December 31, 2004, we had approximately $2.8 million of legal costs related to the settlement of a class action lawsuit and our DOJ billing matter and approximately $1.3 million for certain one-time bonuses paid to non-executive management employees in connection with our August 2004 121¤4% Note offering.
During the year ended December 31, 2004, we recorded losses on disposal of assets of $1.6 million, which included an impairment charge in the amount of approximately $1.9 million related to certain computer software, compared to losses on disposal of assets of $1.6 million for the year ended December 31, 2005. The computer software consisted of a proprietary radiology information system combined with a standalone accounts receivable module. The system was partially implemented in December 2002, but encountered scalability problems that ultimately led to our determination to discontinue its implementation. In 2004, replacement software that satisfied our growth needs was identified and implemented. As a result, an impairment charge was taken for a substantial portion of the cost of the prior software and amortization was accelerated for the portion that remained in use. The charge related to this software is reflected in the loss on disposal of assets and the portion subject to accelerated amortization was fully amortized in June 2005. The losses on disposal of assets of $1.6 million for the year ended December 31, 2005 were incurred primarily in connection with the closing of six centers, as discussed above.
Depreciation and amortization was $35.9 million, or 12.3% of net revenue, for the year ended December 31, 2005, as compared to $31.5 million, or 11.5% of net revenue, for the year ended December 31, 2004. The $4.4 million increase in depreciation expense was the result of increased capacity associated with capital expenditures made in 2004.
Interest expense, net was $41.0 million for the year ended December 31, 2005, representing an increase of $10.6 million, or 34.9%, from $30.4 million for the year ended December 31, 2004. The increase in interest expense, net was a result of a higher level of average outstanding debt and an increase in our weighted average interest rate. The average outstanding debt increased approximately $62.3 million during the year ended December 31, 2005 compared to the year ended December 31, 2004, which resulted in increased interest expense of approximately $6.6 million.
The increase in average outstanding debt was principally the result of the issuance of the 121¤4% Notes which, at December 31, 2005, had an accreted value of $99.6 million. The increase in the weighted average interest rate, from 10.65% for the year ended December 31, 2004 to 11.39% for the year ended December 31, 2005, resulted in approximately $2.6 million of additional interest expense. In addition, approximately $1.0 million and $0.4 million of additional interest expense was recorded in 2005 in conjunction with the consent solicitations and the credit facility waivers related to the restatement, respectively, which are described elsewhere in this report. The increases were partially offset by a $1.6 million gain on the termination of an interest rate swap agreement.
Income taxes were $3.0 million for the year ended December 31, 2005, as compared to $2.1 million for the year ended December 31, 2004. Tax expense reflects the results of adjustments to the valuation allowance due to anticipated ongoing tax losses. We continue to present deferred tax liabilities related to differences in GAAP and tax accounting for indefinite lived intangible assets. Under GAAP, indefinite lived intangible assets are not amortized but periodically assessed for impairment, which results in a quasi-permanent difference associated with the difference in book and tax bases. There were federal and state
net operating loss carryforwards amounting to approximately $72.1 million and $123.8 million, respectively, at December 31, 2005.
Liquidity and Capital Resources
The principal uses of our liquidity are to finance our capital expenditures and fund our operations, as well as to finance acquisitions. We operate in a capital-intensive, high fixed cost industry that requires significant amounts of working capital to fund operations, particularly the initial start-up and development expenses of our de novo centers and the acquisition of additional centers.
Our primary sources of liquidity to fund our operations and capital expenditures and satisfy our debt service obligations are cash flow from operating activities and borrowings under our revolving credit facility.
Our high level of debt may make it more difficult for us to borrow funds in the future. Based on our current level of operations and anticipated growth, we believe that our cash flows from operations, together with future borrowings under our senior credit facility will be sufficient over the next year to meet our liquidity requirements, including our debt service obligations, working capital needs and capital expenditures. However, there can be no assurance that this will be the case.
Any expansion or acquisitions could require substantial capital, and no assurance can be given that we will be able to raise any necessary funds in addition to those currently available to us through bank financing or the issuance of equity or debt securities on terms acceptable to us, if at all. Moreover, if we were to engage in one or more significant acquisition or divestiture transactions, it may be necessary for us to restructure our existing credit arrangements.
Our ability to fund our working capital needs, planned capital expenditures and scheduled debt payments, to implement our expansion plans, to refinance our indebtedness and to comply with our financial covenants under the senior credit facility depends on our future operating performance and cash flows from operations, which in turn are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control.
Cash flows
Year ended December 31, 2006 compared to year ended December 31, 2005
Net cash provided by operating activities was $25.1 million for the year ended December 31, 2006, representing a decrease of $9.4 million, or 27.2%, from $34.5 million for the year ended December 31, 2005. This difference resulted primarily from a decrease in cash from working capital. The impact of non-cash expenses was approximately $3.0 million lower for the year ended December 31, 2006 than for the year ended December 31, 2005. Overall, the changes in working capital assets and liabilities decreased net cash provided by operating activities by $10.6 million for the year ended December 31, 2006 compared to the year ended December 31, 2005.
Net cash used in investing activities was $23.4 million for the year ended December 31, 2006, representing an increase of $3.8 million, or 19.4%, from $19.6 million for the year ended December 31, 2005. The increase was primarily the result of higher capital expenditures for property and equipment, offset by higher proceeds from the sale of property and equipment and lower expenditures on acquisitions of businesses during the year ended December 31, 2006, compared to the year ended December 31, 2005. We spent approximately $11.2 million more on property and equipment during the year ended December 31, 2006 compared to the year ended December 31, 2005. Additionally, we spent approximately $2.2 million less on acquisitions of businesses during the year ended December 31, 2006, compared to the year ended December 31, 2005. Finally, we received approximately $5.2 million more proceeds from the
sale of property and equipment during the year ended December 31, 2006, compared to the year ended December 31, 2005.
Net cash used by financing activities was $8.7 million for the year ended December 31, 2006, compared to $4.3 million for the year ended December 31, 2005. This increase was primarily attributable to an increase in the payments on the Tranche B term loan of $6.9 million during the year ended December 31, 2006, compared to the year ended December 31, 2005, and the decrease in the net payments on the senior credit facility of $22.5 million, offset by the sale of preferred stock of $20.0 million during the year ended December 31, 2005.
Year ended December 31, 2005 compared to year ended December 31, 2004
Net cash provided by operating activities was $34.5 million for the year ended December 31, 2005, representing an increase of $1.2 million, or 3.7%, from $33.3 million for the year ended December 31, 2004. This difference resulted from a higher net loss offset by higher non-cash expenses and changes in working capital. The increased non-cash expenses principally related to depreciation expense and accretion of the discount on notes payable, partially offset by lower bad debt expense. The impact of these non-cash expenses was approximately $10.8 million higher for the year ended December 31, 2005 than for the year ended December 31, 2004. Overall, the changes in working capital assets and liabilities increased net cash provided by operating activities by $2.9 million for the year ended December 31, 2005 compared to the year ended December 31, 2004.
Net cash used in investing activities was $19.6 million for the year ended December 31, 2005, representing a decrease of $33.6 million, or 63.2%, from $53.3 million for the year ended December 31, 2004. The decrease was primarily the result of lower capital expenditures for property and equipment and acquisitions of businesses during the year ended December 31, 2005 compared to the year ended December 31, 2004. We spent approximately $27.7 million less on property and equipment during the year ended December 31, 2005 compared to the year ended December 31, 2004. Additionally, we spent approximately $5.8 million less on acquisitions of businesses during the year ended December 31, 2005 compared to the year ended December 31, 2004.
Net cash used by financing activities was $4.3 million for the year ended December 31, 2005, compared to $14.3 million provided by financing activities for the year ended December 31, 2004. This change resulted from decreased financing needs for funding capital expenditures and the proceeds from a sale of stock, offset by a net paydown of the revolving credit facility of approximately $22.5 million during September 2005.
Financial condition
At December 31, 2006, we had $341.9 million of indebtedness outstanding, as compared to $337.7 million at December 31, 2005. In addition, at December 31, 2006, we had a stockholders’ deficit of $281.3 million, as compared to our stockholders’ deficit of $258.3 million at December 31, 2005. Our indebtedness primarily consists of $177.3 million due under our 117¤8% Notes due 2012, $112.1 million of accreted value due under our 121¤4% Notes and $51.0 million due under our Tranche B term facility. We would have been able to borrow an additional $79.5 million (after giving effect to $0.5 million of outstanding letters of credit) under the revolving credit facility to fund our working capital requirements and future acquisitions at December 31, 2006.
Senior credit facility
Our senior credit facility provides for a revolving credit facility not to exceed $80.0 million and a Tranche B term facility of $60.0 million. The senior credit facility, as amended, is guaranteed by MQ Associates and each of MedQuest’s existing and future domestic subsidiaries. MedQuest’s obligations
under the senior credit facility and the guarantors’ obligations under the guarantees are collateralized by substantially all of the assets of MedQuest and the guarantors.
In August 2004, we amended our senior credit facility to permit, among other things, MQ Associates to issue the 121¤4% Notes and to use the net cash proceeds to pay a dividend to holders of MQ Associates’ common stock and to make distributions to certain key employees who held options for MQ Associates’ common stock. The amendment permits MedQuest to make distributions to MQ Associates under certain specified exceptions and also permits MQ Associates to issue additional indebtedness or preferred stock under certain terms, and subject to MedQuest’s meeting a pro forma consolidated leverage ratio test and certain other conditions, to use the proceeds thereof to, among other things, make distributions on, or repurchase or redeem shares, of MQ Associates capital stock.
In September 2003, we amended our senior credit facility to allow for borrowings under the Tranche B term facility not to exceed $60.0 million. Concurrent with the amendment of the senior credit facility, we also borrowed $60.0 million under the Tranche B term facility and applied the net proceeds against the borrowings outstanding under the revolving credit facility of the senior credit facility.
Subject to adjustments pursuant to the Third Amendment to our senior credit facility, borrowings under the revolving credit facility accrue interest, at the option of MedQuest, at either: (a) the greater of the prime rate or the Federal funds effective rate (subject to certain adjustments) plus an applicable margin of 1.75% per annum, or (b) the Eurodollar rate, plus an applicable margin of 2.75% per annum. There were no borrowings under the revolving credit facility at December 31, 2006 and 2005. The revolving credit facility also provides for an unused commitment fee equal to 1¤2 of 1% per annum. The margins related to the prime rate and Eurodollar rate borrowings and commitment fee are subject to downward adjustment based upon our consolidated leverage ratio, as defined.
Subject to adjustments pursuant to the Third Amendment to our senior credit facility, borrowings under the Tranche B term facility accrue interest at the option of MedQuest, at either: (a) the greater of the prime rate or the Federal funds effective rate (subject to certain adjustments) plus an applicable margin of 2.75% per annum, or (b) the Eurodollar rate, plus an applicable margin of 3.75% per annum. Borrowings were based upon the Eurodollar rate (5.37% and 4.69% at December 31, 2006 and 2005, respectively) and amounted to $51.0 million and $58.5 million at December 31, 2006 and 2005, respectively.
Commencing with the fiscal year ending December 31, 2004, and annually thereafter, a specified percentage (currently 75%, subject to downward adjustment based on our consolidated leverage ratio) of excess cash flows, as defined in the senior credit facility, must be applied against certain outstanding borrowings under the senior credit facility. For the years ended December 31, 2006 and 2005, we generated excess cash flows, as defined in the senior credit facility, of $0 and $9.3 million, respectively.
121¤4% Notes and 117¤8% Notes
In August 2004, MQ Associates issued $136.0 million in principal amount at maturity of 121¤4% Notes and received gross proceeds of $84.8 million. The 121¤4% Notes are uncollateralized obligations of MQ Associates. Interest accrues on the 121¤4% Notes in the form of an increase in accreted value through August 15, 2008. Cash interest accrues from August 15, 2008, and is payable semi-annually in arrears commencing on February 15, 2009. MQ Associates is required to pay generally all accrued but unpaid interest on the 121¤4% Notes in cash on February 15, 2010, or at MQ Associate’s option, on or after August 15, 2008. In October 2004, MQ Associates registered an identical series of senior discount notes with the SEC and subsequently completed an exchange of all of the unregistered $136.0 million aggregate principal amount at maturity senior discount notes for the registered senior discount notes.
In August 2002, MedQuest issued $180.0 million of the 117¤8% Notes, net of a discount of $3.8 million, to fund in part our recapitalization. The 117¤8% Notes bear interest at the rate of 117¤8% per annum that is payable semi-annually in arrears in cash on each February 15 and August 15. In February 2003, MedQuest registered an identical series of senior subordinated notes with the SEC and subsequently completed an exchange of all the unregistered $180.0 million aggregate principal amount senior subordinated notes for the registered senior subordinated notes. The 117¤8% Notes are senior subordinated obligations of MedQuest, ranking junior in right of payment to all of its existing and future senior debt, and are guaranteed by MQ Associates and each of MedQuest’s subsidiaries.
The senior credit facility and the indentures governing the 117¤8% Notes and the 12¼% Notes impose certain restrictions on us, including restrictions on our ability to incur indebtedness, pay dividends, make investments, grant liens, sell our assets and engage in certain other activities. In addition, the senior credit facility requires us to maintain certain financial ratios.
Contractual obligations and commitments
The following table sets forth the contractual obligations under our long-term debt and other material contractual commitments, including capital lease obligations and non-cancelable operating leases as of December 31, 2006 (in millions):
(a) Consists of real estate and equipment leases
Preferred Stock
The Series A Preferred Stock and Series B Preferred Stock of MQ Associates may be redeemed at the option of the holder upon the consummation of an underwritten public offering at a redemption price of $55.0 million for all of the Series A Preferred Stock and $15.0 million for all of the Series B Preferred Stock. Additionally, in the case of such redemption, the holders of Series B Preferred Stock will receive 2,295,000 shares of MQ Associates common stock. In the event that (i) MQ Associates and its underwriters determine that the redemption of the Series B Preferred Stock would adversely affect the planned underwritten public offering or (ii) the holders of shares of Series B Preferred Stock elect not to redeem shares of Series B Preferred Stock, MQ Associates may convert all shares of Series B Preferred Stock into 17,295,000 shares of MQ Associates common stock. We have not accreted the fair value of the additional shares of MQ Associates common stock to be issued upon redemption of the Series B Preferred Stock because we do not believe that the redemption trigger is probable as of December 31, 2006.
Capital expenditures
We incur capital expenditures to, among other things:
· upgrade existing equipment to increase volume and/or quality;
· purchase new equipment and incur leasehold improvements for de novo centers;
· acquire the assets of centers owned by others;
· replace underperforming equipment; and
· upgrade information technology systems.
Capital expenditures, in the aggregate, amounted to $28.3 million for the year ended December 31, 2006, as compared to $17.4 million for the year ended December 31, 2005.
The following table sets forth capital expenditures, in detail, for the years ended December 31, 2006 and 2005 (in millions of dollars):
We believe that capital expenditures will range between $20.0 and $25.0 million for the year ended December 31, 2007. The amount of capital expenditures may vary based upon the level of unanticipated growth opportunities that present themselves during the fiscal year.
We continuously evaluate acquisition opportunities, and from time to time we may enter into nonbinding letters of intent.
Related Party Transactions
At December 31, 2006, we leased space for 14 of our imaging centers through lease agreements between certain of our subsidiaries and Image Properties, L.L.C. (“Image Properties”), a company owned by our former Chief Executive Officer and our former President. We guarantee all real estate leases between our subsidiaries and Image Properties. The leases provide for monthly rent of approximately $0.2 million. The leases were amended in September 2006 and are typically for seven-year terms with two five-year renewal options. The leases expire in 2013 (See Note 13, “Commitments and Contingencies” to our consolidated financial statements located elsewhere in this report for the future minimum payments to be made to Image Properties under these leases). We also leased our corporate headquarters from Image Properties for monthly rent of approximately $0.1 million until that lease expired in October 2006. We made total lease payments under these agreements of approximately $3.9 million, $3.7 million and $3.7 million in the years ended December 31, 2006, 2005 and 2004, respectively.
During the years ended December 31, 2006 and 2005, pursuant to a consulting agreement with Argus Management Corporation, a company owned by John Haggerty, our former interim Chief Financial Officer, and two other principals, we received certain interim management, financial and consulting services related to our restatement and other general corporate matters. Excluding amounts paid to Argus for Mr. Haggerty’s services as former interim Chief Financial Officer, we made aggregate payments in the amount of $0.3 million and $0.8 million to Argus in the years ended December 31, 2006 and 2005, respectively.
Off-Balance Sheet Arrangements
There are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies and Estimates
The preparation of the consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingencies. We believe the critical accounting policies that most impact our consolidated financial statements are described below. A summary of our significant accounting policies can be found in Note 3 to the consolidated financial statements included elsewhere in this report.
Revenue recognition
Revenues consist primarily of net patient service revenues that are recorded based upon established billing rates less allowances for contractual adjustments. Revenues are recorded during the period the services are provided, based upon the estimated amounts due from the patients and third-party payors, including federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, and employers. Our patient accounting system currently does not record contractual adjustments at the time of billing. Instead, contractual adjustments are estimated based on historical collection experience. These estimates are subject to variances associated with changes in composition of payor and scan mix, as well as changes in reimbursement rates. Contractual payment terms are generally based upon predetermined rates per procedure. Settlements under reimbursement agreements with third-party payors are estimated and recorded in the period the related services are rendered and are adjusted in future periods as adjustments become estimable or as the service years are no longer subject to audit, review or investigation.
Patient receivables
We report patient receivables and allowances for doubtful accounts at estimated net realizable amounts for services rendered from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, workers’ compensation fund, and patients. The patient receivables are geographically dispersed, but a significant portion of our revenues and patient receivables are concentrated by type of payors.
The concentration of gross patient receivables by payor class, as a percentage of total gross patient receivables as of the end of each of 2006 and 2005, is as follows:
Due to the nature and complexities associated with estimating the allowances for contractual adjustments, patient receivables by payor class in the above table are presented on a gross basis before such adjustments. The estimated contractual adjustment rate varies across payor classes and should not be uniformly applied on a pro rata-basis to determine net patient receivables.
During the years ended December 31, 2006, 2005, and 2004, approximately 20.8%, 21.3%, and 19.0%, respectively, of our gross revenues related to patients participating in the Medicare program. While we derive significant revenues and accounts receivable from government agencies, we do not believe there are significant credit risks associated with these government agencies. Because Medicare traditionally pays claims faster than our other third-party payors, the percentage of our Medicare charges in patient
receivables differs from the percentage of our Medicare revenues. We do not believe that there are any other significant concentrations of revenues from any particular payor that would subject us to any significant credit risks in the collection of our patient receivables.
Additions to the allowance for doubtful accounts are made by means of the provision for doubtful accounts, which is offset by subsequent recoveries of written-off accounts. We write off uncollectible accounts against the allowance for doubtful accounts when they are deemed uncollectible. Net patient receivables include only those amounts we estimate we will collect.
Bad debt expense is included in MG&A expenses and is set forth in the following table (in thousands).
We perform an analysis of our historical cash collection patterns and consider the impact of any known material events in determining the allowance for doubtful accounts. In performing this analysis, we consider the impact of any adverse changes in general economic conditions, business office operations, payor mix, or trends in federal or state governmental health care coverage.
Goodwill and other intangible assets
Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Under SFAS No. 142, “Goodwill and Other Intangible Assets,” we test goodwill for impairment using a fair value approach, at the reporting unit level. A reporting unit is the operating segment or a business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management at the component level. On an ongoing basis, absent any impairment indicators, we perform our goodwill impairment testing as of December 31 of each year.
In accordance with SFAS No. 142, we amortize the cost of intangible assets with definite useful lives over their respective estimated useful lives to their estimated residual value. As of December 31, 2006, our definite useful lived intangible assets do not have an estimated residual value. We also review those assets for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. As of December 31, 2006, intangible assets with definite useful lives consisted of non-compete agreements. We consider certificates of need, which are required by certain states prior to the acquisition of high cost capital items, including diagnostic imaging equipment, before providing health care services, to be indefinite lived intangible assets.
Long-lived assets
Under SFAS No. 144, we assess the recoverability of long-lived assets (excluding goodwill) and identifiable acquired intangible assets with finite useful lives whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. We measure the recoverability of assets to be held and used by a comparison of the carrying amount of the asset to the expected net future cash flows to be generated by that asset, or, for identifiable intangibles with finite useful lives, by determining whether the amortization of the intangible asset balance over its remaining life can be recovered through undiscounted future cash flows. The amount of impairment of identifiable intangible assets with finite useful lives, if any, to be recognized is measured based on projected discounted future cash flows. We measure the amount of impairment of other long-lived assets (excluding goodwill) by the amount by which the carrying value of the asset exceeds the fair market value of the asset, which is generally determined based on projected discounted future cash flows or appraised values.
In the year ended December 31, 2004, we recorded an impairment charge in the amount of approximately $1.9 million related to certain proprietary computer software. The computer software consisted of a proprietary radiology information system combined with a standalone accounts receivable module. The system was partially implemented in December 2002, but encountered scalability problems that ultimately led to our determination to discontinue its implementation. In 2004, replacement software that satisfied our growth needs was identified and implemented. As a result, an impairment charge was taken for a substantial portion of the cost of the prior software and amortization was accelerated for the portion that remained in use. The portion subject to accelerated amortization was fully amortized in June 2005.
Center closing costs
We provide for closed center liabilities based on the present value of the estimated remaining noncancellable lease payments after the closing date, net of estimated subtenant income. We estimate the net lease liabilities using a discount rate to calculate the present value of the remaining lease payments on closed centers. The closed center lease liabilities usually are paid over the lease terms associated with the closed centers, which generally have remaining terms ranging from 0 to 8 years. Any adjustment to closed center liabilities related to changes in subtenant income or actual exit costs differing from original estimates would be made in the period in which the change becomes known.
The following table summarizes accrual activity for the future lease obligations of centers closed in the normal course of business:
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We sell our services exclusively in the United States and receive payment for our services exclusively in United States dollars. As a result, our financial results are unlikely to be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.
The majority of our indebtedness bears interest at fixed rates. However, management may in its judgment determine that it is advisable to enter into interest rate swaps to convert a portion of the fixed interest rate debt to floating interest rate debt. To the extent management decides to do so, the interest expense payable or the floating rate portion of our indebtedness will be sensitive to changes in the general level of interest rates in the United States.
Our interest income is sensitive to changes in the general level of interest rates in the United States, particularly because the majority of our investments are in short-term instruments.
The recorded carrying amounts of cash and cash equivalents approximate fair value due to their short-term maturities.
The table below provides information about our financial instruments that are sensitive to changes in interest rates. For long-term debt obligations, the table presents principal cash flows and related weighted average interest rates by expected (contractual) maturity dates. All amounts are in United States dollars (in millions).
In August 2002, we entered into an interest rate swap agreement related to the fixed interest rate obligations on the 117¤8% Notes. The agreement required us to pay interest at a variable rate based on six-month LIBOR plus 6.525% on a notional amount of $47.5 million for a term of ten years. This derivative instrument was accounted for as a fair value hedge of the fair market value of the 117¤8% Notes and was 100% effective for the year ended December 31, 2004. As a result, the change in fair market value related to this derivative instrument was entirely offset by the change in fair market value of the 117¤8% Notes. The fair market value of this derivative instrument was approximately $1.5 million at December 31, 2004 and has been presented as a component of Other Assets in the consolidated balance sheet at December 31, 2004. On February 9, 2005, we terminated the interest rate swap associated with the 117¤8% Notes. We received $1.6 million as a termination fee on February 11, 2005.
Item 8.
Item 8. Financial Statements and Supplementary Data
Financial statements and supplementary data required by this Item 8 are set forth at the pages indicated in Item 15(a) below.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None.
Item 9A.
Item 9A. Controls and Procedures
Review of Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness and design of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of December 31, 2006. Based on this evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective as of December 31, 2006. No change in internal control over financial reporting occurred during the quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, such internal controls over financial reporting.
The effectiveness of our or any other system of disclosure controls and procedures and internal control over financial reporting is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events, and the inability to eliminate misconduct completely. As a result, our disclosure controls and procedures and internal control over financial reporting may not prevent all errors or improper acts or ensure that all material information will be made known to appropriate management in a timely fashion. Still, because of the substantial work performed in reviewing our controls and the enhanced procedures and controls we have implemented to help ensure the proper evaluation and disclosure of the financial information for the periods covered by this report, management, including the
principal executive officer and principal financial officer, believes that the financial information for the periods covered by this report and the accompanying consolidated financial statements are fairly stated in all material respects.
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information with respect to persons who are the executive officers and directors of MQ Associates as of March 29, 2007. Pursuant to the current stockholders’ agreement with MQ Associates, the board of directors of MQ Associates contains three members designated by MQ Investment Holdings, LLC, one designated by a member of MQ Investment Holdings, LLC, and two members designated by a majority of the stockholders of MQ Associates.
C. Christian Winkle has served as our Chief Executive Officer and a director since October 2005. Mr. Winkle has held a number of executive positions in the healthcare industry, with particular experience in the skilled nursing, rehabilitation, sub-acute care and post-acute care arenas. Mr. Winkle served as President and Chief Executive Officer of Mariner Health Care, Inc. (“Mariner”), a long-term health care company, from 2000 through the merger of Mariner and National Senior Care, Inc. in December 2004. From January 2005 through July 2005, Mr. Winkle served as President and Chief Executive Officer of SavaSeniorCare, LLC, a newly formed company that leased certain of the former Mariner facilities. Prior to Mariner, Mr. Winkle served in a number of senior operational and financial management roles at a variety of healthcare companies. Mr. Winkle received his B.S. in Accounting from Case Western Reserve University. Pursuant to the MQ Associates’ stockholders’ agreement, Mr. Winkle serves as the Chief Executive Officer Director.
Todd E. Andrews has served as our Chief Financial Officer since April 2006. Prior to joining MQ Associates in February, Mr. Andrews served as Chief Financial Officer from January through August 2005 of SavaSeniorCare, LLC., which was the successor to certain operations of Mariner Health Care, Inc. Mr. Andrews worked for Mariner, a long-term health care company and its predecessor companies from June 1993 through December 2004, during which time he held a variety of financial and operating roles, serving most recently as President of its West Region. From June 1991 through June 1993, Mr. Andrews was an investment analyst in Metropolitan Life Insurance Company’s capital markets division.
Daniel J. Schaefer has served as our Chief Operating Officer since October 2006. He served as one of our Co-Chief Operating Officers from January 2001 to September 2006 and prior to that served as Chief Operating Officer from January 1998 until December 2000. Mr. Schaefer has over 20 years of experience in operations and sales/marketing and was a key executive for Span America Medical Systems from 1975 to 1987 and Alpha ProTech from 1991 to 1995, both publicly traded healthcare manufacturers. His responsibilities there included product development, sales and marketing. Mr. Schaefer is a graduate of Southern Illinois University.
Todd W. Latz has served as our General Counsel since December 2004 and as our Secretary since April 2005. Prior to joining us, Mr. Latz spent over five years as a corporate attorney with King & Spalding LLP, where he represented public and private companies as well as financial institutions in corporate finance transactions and mergers and acquisitions. Mr. Latz received his B.A. in Economics and History summa cum laude from Duke University and his J.D. from the University of Virginia School of Law. Mr. Latz also attended the Humboldt University in Leipzig, Germany as a Fulbright Scholar.
Bruce W. Elder has served as our Vice President, Development since 2001. Previously, Mr. Elder served as Healthcare Client Director for iXL, Inc., a publicly-traded internet consulting firm in Atlanta, Georgia, from May 1999 to December 2000. Prior to joining iXL, Mr. Elder was Vice President, Development for Nashville-based Meridian Corporate Healthcare, Inc., a venture-financed start-up company providing dedicated healthcare services to large employers, from 1996 to 1999. Mr. Elder also served as Coordinator of Business Development for Surgical Care Affiliates, Inc., a publicly-traded outpatient surgery center company based in Nashville, Tennessee, from 1993 to 1996. Mr. Elder holds an MBA from the Owen Graduate School of Management at Vanderbilt University and a B.A. in political science from Vanderbilt University.
Donald C. Tomasso has served as our Interim Chairman since March 2005 and has been one of our directors since December 2002. Mr. Tomasso also served as our Interim Chief Executive Officer from March 2005 to October 2005. From August 2006 to present, he has been a senior advisor to Wakefield Capital Corp., a provider of financing for senior housing. From April 2000 to the present, he has been the Chairman of Metro Offices, Inc., a provider of workplace solutions for entrepreneurs, small to medium-sized corporations and the mobile workforce of large corporations. From 1998 to the present, Mr. Tomasso has also been the President and a co-founder of Scarlet Oak Investments, LLC, a private equity investment firm. From 1991 to 1998, Mr. Tomasso was President of Manor Care Health Services, Inc., a provider of skilled nursing care, assisted living facilities and senior support services, while also serving as Chairman and Chief Executive Officer of Vitalink Pharmacy Services, Inc. from 1991 to 1996. Prior to joining Manor Care Health Services, Inc., Mr. Tomasso had held various positions with Marriott Corporation for fourteen years, most recently serving as Executive Vice President and General Manager of Marriott’s Roy Rogers Restaurant business unit from 1986 to 1990. Mr. Tomasso is a member of the Board of Trustees of Drexel University LeBow College of Business and the Washington College Presidents Advisory Council. Mr. Tomasso received his B.S. in Commerce and Engineering, his Masters Degree in Environmental Engineering and his M.B.A. from Drexel University. Pursuant to the stockholders’ agreement, Mr. Tomasso is a designee of the majority of the stockholders of MQ Associates.
Stephen P. Murray has been one of our directors since April 2005. Mr. Murray is the President and Chief Operating Officer of CCMP Capital Advisors, LLC, a private equity firm formed in August 2006 by the former buyout/growth equity investment team of J.P. Morgan Partners, LLC, a private equity division of J.P. Morgan Chase & Co. Between 1989 and 2006, Mr. Murray was a partner of J.P. Morgan Partners, LLC and prior to 1989, Mr. Murray was a Vice President with the Middle-Market Lending Division of Manufacturers Hanover Trust Company. Mr. Murray currently serves as a director of AMC Entertainment, Inc., Aramark Corporation, Cabela’s Incorporated, CareMore Holdings, Inc., Generac Power Systems, Jetro Cash & Carry, Pinnacle Foods Holding Corp., Quiznos Sub, Strongwood Holdings, Warner Chilcott Corporation, and USA.NET. Mr. Murray holds a B.A. from Boston College and
an M.B.A. from Columbia Business School. Pursuant to the stockholders’ agreement, Mr. Murray is one of MQ Investment Holdings, LLC’s designees to our board of directors.
Nancy-Ann DeParle has been one of our directors since August 2002. From August 2006 to the present, she has been a Managing Director of CCMP Capital Advisors, LLC, a private equity firm formed by the former buyout/growth equity professionals of J.P. Morgan Partners, LLC. From January 2001 until August 2006, she was an independent health care consultant and a Senior Advisor to J. P. Morgan Partners, as well as an Adjunct Professor of Health Care Systems of the Wharton School of the University of Pennsylvania. From August 2002 to the present, she has been a member of the Medicare Payment Advisory Commission (MedPAC). From October 2000 through January 2001, she was a Fellow at the Institute of Politics and the Interfaculty Health Policy Forum at Harvard University. From November 1997 until October 2000, Ms. DeParle served as Administrator of the Health Care Financing Administration (HCFA), now known as the Centers for Medicare and Medicaid Services (CMS). Ms. DeParle currently serves as a director of Boston Scientific, CareMore Holdings, Inc., Cerner Corporation, DaVita, Inc. and Triad Hospitals, Inc. Ms. DeParle received a B.A. from the University of Tennessee and a J.D. from Harvard Law School. She also received an M.A. in Politics and Economics from Balliol College of Oxford University, which she attended as a Rhodes Scholar. Pursuant to the stockholders’ agreement, Ms. DeParle is the designee of a member of MQ Investment Holdings, LLC to our board of directors.
Benjamin B. Edmands has been one of our directors since August 2002. He is currently a Managing Director at CCMP Capital Advisors, LLC, a private equity firm formed in August 2006 by the former buyout/growth equity investment team of J.P. Morgan Partners, LLC. Prior to August 2006, Mr. Edmands was with J.P. Morgan Partners, LLC. And, prior to joining Chase Capital Partners (a predecessor of J.P. Morgan Partners, LLC) in 1993, Mr. Edmands held positions in Chemical Bank’s Acquisition Finance Group. The companies for which Mr. Edmands is a director are CareMore Holdings, Inc., Warner Chilcott Corporation and National Surgical Care. Mr. Edmands holds a B.A. with Honors from Colgate University and an M.B.A. with Honors from Columbia Business School. Pursuant to the stockholders’ agreement, Mr. Edmands is one of MQ Investment Holdings, LLC’s designees to our board of directors.
Anthony R. Masso has been one of our directors since May 2006. Mr. Masso is the President and CEO of Consortium Health Plans, Inc., a coalition of Blue Cross Blue Shield Plans. Prior to joining Consortium Health Plans in 2003, Mr. Masso was President of StongCastle, LLC, a private consulting company specializing in executive assignments, from 2000 to 2003. Mr. Masso currently serves as a director of: Consortium Health Plans, Inc.; Blue Health Intelligence, (Blue Cross Blue Shield Association); the University of Maryland, School of Nursing; and Kauffman Scholars, Inc. Kauffman Foundation. Pursuant to the stockholders’ agreement, Mr. Masso is one of the designees of a majority of the stockholders of MQ Associates.
In 2006, the Board of Directors met 10 times. All of our Directors attended over 75% of the Board meetings and all members of our Board committees attended over 75% of their respective Board committee meetings.
Independent Directors
The Board of Directors has analyzed the independence of each director and has determined that Messrs. Tomasso and Masso meet the standards of independence under the Governance Guidelines and applicable NASDAQ Stock Market listing standards.
Committees of the Board of Directors
Our board of directors currently has an Audit Committee, a Compensation Committee and a Compliance Committee.
During the year ended December 31, 2006, Mr. Tomasso and Mr. Edmands served as members of the Audit Committee.
During the year ended December 31, 2006, Mr. Tomasso, Mr. Edmands and Mr. Winkle served as members of the Compensation Committee.
During the year ended December 31, 2006, Ms. DeParle, Mr. Tomasso and Mr. Winkle served as members of the Compliance Committee.
Audit committee
The principal duties and responsibilities of our audit committee are to:
· monitor our financial reporting process and internal control system;
· appoint and replace our independent outside auditors from time to time, determine their
compensation and other terms of engagement and oversee their work;
· oversee the performance of our internal audit function; and
· oversee our compliance with legal, ethical and regulatory matters.
Compensation committee
The principal duties and responsibilities of the compensation committee are to carry out our board of directors’ overall responsibility relating to executive compensation, including as follows:
· to review, oversee and administer our incentive compensation and other stock-based plans;
· to review and approve the compensation of our chief executive officer, the other executive officers and non-management directors; and
· to provide oversight concerning selection of candidates for executive positions, executive succession planning, performance of individual executives and related matters.
Compliance committee
The principal duties and responsibilities of the compliance committee are to:
· review reports received by the corporate compliance officer of possible legal/regulatory problems;
· review reports generated by corporate audit activities related to our corporate compliance plan; and
· develop recommendations for us as deemed appropriate.
Audit Committee Financial Expert
Our board of directors does not include an “audit committee financial expert” as that term is defined in SEC regulations. Our securities are not listed on any national securities exchange and we are not required to have an independent audit committee.
Code of Ethics
We have a code of ethics for all employees, including the Chief Executive Officer and Chief Financial Officer, known as the Corporate Compliance Plan. The Corporate Compliance Plan is filed as Exhibit 10.26 to this report and is available, without charge, upon written request to:
MQ Associates, Inc.
Preston Ridge Road, Suite 600
Alpharetta, Georgia 30005
Attn: Corporate Compliance Officer
Audit Committee Report
The Audit Committee has reviewed and discussed management and PricewaterhouseCoopers LLP, the independent registered public accounting firm for the Company, the audited financial statements of the Company for the year ended December 31, 2006 (the “Audited Financial Statements”). The Committee has discussed with PricewaterhouseCoopers LLP matters required to be discussed by Statement on Auditing Standards No. 61 (as amended by SAS 89 and SAS 90), as in effect on the date of this report.
The Committee has: (i) considered whether non-audit services provided by PricewaterhouseCoopers LLP are compatible with its independence, (ii) received the written disclosures and the letter from PricewaterhouseCoopers LLP required by Independence Standards Board Standard No. 1, as in effect on the date of this report, and (iii) discussed with PricewaterhouseCoopers LLP its independence.
Based on the reviews and discussions described above, the Committee recommended to the Board of Directors of the Company that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for filing with the Securities and Exchange Commission.
The Board of Directors has adopted a Charter of the Audit Committee, a copy of which is published on the Company’s website at www.mqimaging.com. The Audit Committee Charter requires the Committee to pre-approve all audit engagement fees and terms, as well as all non-audit engagements with the independent accountants. All audit and non-audit fees incurred in 2006 were pre-approved by the Committee.
Donald C. Tomasso
Benjamin B. Edmands
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis
Overall Objectives and Philosophy
The Compensation Committee of our Board of Directors oversees our compensation programs. Our compensation programs include programs that are designed specifically for (1) our senior executive officers (“Senior Executives”), which include our Chief Executive Officer (“CEO”) and each of his direct reports, including the other executive officers named in the Summary Compensation Table (the “Named Executive Officers’ or “NEOs”); (2) employees who are designated as executives of the Company (“Executives”), which includes the Senior Executives and (3) a broad base of company employees. Additionally, the Compensation Committee is charged with the review and approval of all annual compensation decisions relating to Senior Executive Officers, including those for our CEO and NEOs. The Compensation Committee and Board of Directors review and approve all annual incentive plans and review payments to non-executives.
These programs are intended to attract, retain, motivate and reward executive leadership of a caliber and level of experience necessary to achieve our overall business objectives of the company, and we believe that they align executive compensation with the company’s business strategy and management initiatives. We endeavor to implement an integrated, performance-oriented compensation program that balances short- and long-term objectives to enhance stakeholder value and that places our executives in a responsible competitive range of total compensation based on the magnitude of business operations, strategic accomplishments and our performance.
Our Compensation Committee makes recommendations to the Board of Directors with respect to base salary and annual incentive awards. They take into consideration the attainment of both operational short-term and enterprise-wide long-term objectives of the company that may not be reflected in the current period’s earnings.
Elements of Compensation
Our executive compensation programs consist primarily of the following integrated components:
· Base Salary
· Annual Incentive Awards
· Long-Term Incentives; and
· Perquisites.
Each element is further described below.
Base Salary
Base salary is designed to compensate our NEOs competitively based on industry and marketplace standards. When establishing base rates of pay for executives, the Compensation Committee considers marketplace data for comparable positions and the relative performance and contribution of each executive to the business. Base salary levels for the Chief Executive Officer and other executive officers of the company are reviewed and approved by the Compensation Committee annually to ensure competitiveness. Our policy is to maintain base salaries at competitive levels with a peer group established for compensation comparisons. The compensation peer group includes industry competitors as well as other corporations of a similar size and similar geographic placement.
Based on this review and the individual performance of each executive, the Compensation Committee recommends base salary increases, if appropriate. The Compensation Committee does not rely solely on predetermined formulas or a limited set of criteria when it evaluates the performance of the NEOs.
Annual Incentive Awards
Annual incentive awards provide a direct link between executive compensation and our overall performance. Annual awards take into account the financial and operational performance of the business. Executive performance is also assessed against standards of ethical business conduct, leadership competencies, and people-related initiatives.
All executive officers, including the CEO, participate in a performance based incentive plan, which is designed to focus management attention and effort on the attainment of established performance goals. Specific performance goals and weightings are established at the corporate level and encompass goals for overall performance at the beginning of each fiscal year.
Individual awards under our performance based incentive plan reflect an executive’s contribution to the Company’s achievement of established performance goals, as well as the successful achievement of individually tailored annual objectives and the furtherance of ethical business behavior and leadership competencies. Executive officers listed in the Summary Compensation Table received incentive awards based on the accomplishment of certain performance objectives. The Compensation Committee designs the annual incentive component of our compensation program to align Senior Executive pay with our annual (short-term) performance. Incentive bonuses are generally paid in cash in March of each year for the prior fiscal year’s performance.
The Compensation Committee approves a target incentive payout as a percentage of the base salary earned during the incentive period for each Senior Executive, in accordance with existing employment agreements. These target percentages are based on competitive practices for each comparable position in the Survey Data. The incentive target percentage represents the Senior Executive’s annual bonus opportunity if the annual company-specific and individual performance goals of the incentive plan are achieved.
Performance targets are established at levels that are achievable, but require better than expected performance from each Senior Executive. Each of the Senior Executives received a 2006 bonus based on their individual contributions to the company’s performance.
Long-Term Incentives
Stock Options
We believe that granting stock option awards encourages executive officers to manage from the perspective of a stockholder with an equity stake in the business. As the value of the company increases over time, the value of the shares of stock underlying the stock option awards granted to each of the executive officers increases, providing a strong incentive for executive officers to enhance stakeholder value over time. Participation in the stock option program is not limited to executive officers, but extends to a broad range of key employees. Stock options provide recipients with the opportunity to purchase our common stock at a price fixed on the grant date regardless of future price. Stock options generally vest and become exercisable over a five-year vesting period.
Stock option grants have been our principal vehicle for long-term compensation. We issue options at fair market value at the date of grant and the executive will only receive compensation from the grant if the stock appreciates in value. Similar to the process used in making the annual base salary recommendations and the performance based incentive awards, stock option awards are based upon current industry and marketplace compensation data. Award recommendations are made on the basis of a recipient’s level of
responsibility, long-term value to the organization, and contribution to our overall management. The size of each executive’s award is determined by considering norms for comparable positions in the industry and marketplace. Equitable distribution within the company is also considered.
There is a limited term in which the recipient can exercise stock options, known as the “option term.” The option term is generally ten years from the date of grant. At the end of the option term, the right to purchase any unexercised options expires. Option holders generally forfeit any unvested options if their employment with us terminates.
There were no grants of stock options in 2006.
Perquisites
Senior Executives are provided with the following benefits as a supplement to their other compensation:
· Medical, dental and vision insurance: We pay 100% of the premiums for the Senior Executive’s medical, dental and vision insurance.
· Short-Term and Long-Term Disability: We pay 100% of the premium cost for these benefit programs for Senior Executives. The short-term disability program provides income replacement at 60% of base pay, up to a maximum of $1,000 per week, for up to three months or recovery. Upon the expiration of the three month short-term disability period, the long-term disability program provides income replacement at 60% of the base pay level, up to a maximum of $6,000 per month, until age 65 or recovery per the terms and conditions of the program.
· Automobile allowance: We pay Senior Executives an automobile allowance, which generally is $1,000 per month.
The Compensation Committee annually reviews the perquisite program provided to each Senior Executive to determine if adjustments are appropriate.
Interrelationship of Compensation Elements
The above elements of each NEO’s compensation are not inter-related. For example, if the expected level of bonus is not achieved, the base salary is not increased to make up the difference. Similarly, the value of previously granted options is not considered by the Compensation Committee in recommending the other elements of the compensation package, such as base salary and cash incentive bonus.
Employment Agreements
C. Christian Winkle
We have an employment agreement with our CEO, C. Christian Winkle, dated as of October 24, 2005 (the “Winkle Employment Agreement”). The term of the Winkle Employment Agreement is until October 24, 2010, with automatic one-year renewals unless either party provides a notice not to extend the employment agreement at least sixty days prior to the then current expiration date. During the term of the Winkle Employment Agreement, Mr. Winkle is entitled to receive the following, all as established from time to time by the Board of Directors or the Compensation Committee:
· a base salary of $500,000, which is subject to be reviewed at least annually during the term of the employment agreement and may be increased (but not decreased) based upon his performance during the year;
· the opportunity to earn a target annual bonus of 80% of his salary if certain annual objectives are met. Such bonus will be increased or reduced ratably if more than or less than 100%, as applicable,
of the annual objectives are met. Notwithstanding the foregoing, his minimum annual bonus for 2006 was 40% of his then base salary;
· long-term incentives in the form of stock options to purchase 6,500,000 shares of MQ Associates’ common stock at an exercise price of $0.65 per share, with vesting subject to certain time and performance based thresholds; and
· benefits and perquisites that other Senior Executives are entitled to receive.
Upon the termination of Mr. Winkle’s employment, due to his disability or his death, he or his beneficiary is to be paid his then unpaid base salary through the termination date and a portion of his bonus earned through the termination date. Upon termination of Mr. Winkle’s employment by him for good reason or by us without cause, he is entitled to:
· his then monthly base salary for a period of twenty-four months;
· a portion of his annual bonus calculated in accordance with the Winkle Employment Agreement;
· a continuation of certain perquisites and medical insurance benefits for a period of twenty-four months; and
· in the event he has any unvested options, a portion of those unvested options will vest.
If Mr. Winkle’s employment is terminated by him for any reason other than for good reason or by us for cause, he is to receive only (i) his then base salary through the date of termination and (ii) any other amounts due him as of the date of termination, in each case to the extent not already paid.
During the term of the Winkle Employment Agreement and for a period of two years following termination, Mr. Winkle is prohibited from (i) competing with us and (ii) soliciting our customers, employees or consultants.
In addition, pursuant to the Winkle Employment Agreement, all of Mr. Winkle’s unvested options shall vest upon the occurrence of a Sale of the Company.
Todd E. Andrews
We have an employment agreement with our Chief Financial Officer, Todd E. Andrews, dated as of April 7, 2006 (the “Andrews Employment Agreement”). The term of the Andrews Employment Agreement is until April 7, 2009, with automatic one-year renewals unless either party provides a notice not to extend the employment agreement at least 180 days prior to the then current expiration date. During the term of the Andrews Employment Agreement, Mr. Andrews is entitled to receive the following, all as established from time to time by the CEO:
· a base salary of $300,000, which is subject to be reviewed at least annually during the term of the employment agreement and may be increased (but not decreased) based upon his performance during the year;
· the opportunity to earn a target annual bonus of 50% of his salary if certain annual objectives are met. Such bonus will be reduced ratably if less than 100% of the annual objectives are met. In addition, he has the opportunity, based solely on the discretion of the CEO, taking into account certain other criteria, to earn an annual bonus in excess of his target annual bonus;
· long-term incentives in the form of equity-based compensation no less favorable than awards made to other Senior Executives; and
· benefits and perquisites that other Senior Executives are entitled to receive.
Upon the termination of Mr. Andrews’s employment, due to his disability or his death, he or his beneficiary is to be paid his then unpaid base salary through the termination date and a portion of his bonus earned through the termination date. Upon termination of Mr. Andrews’s employment by him for good reason or by us without cause, he is entitled to:
· his then monthly base salary for a period of eighteen months;
· a portion of his annual bonus calculated in accordance with the Andrews Employment Agreement; and
· a continuation of certain perquisites and medical insurance benefits for a period of eighteen months.
If Mr. Andrews’s employment is terminated by him for any reason other than for good reason or by us for cause, he is to receive only (i) his then base salary through the date of termination; (ii) his accrued and unused vacation, not to exceed eight weeks; and (iii) any other amounts due him as of the date of termination, in each case to the extent not already paid.
During the term of the Andrews Employment Agreement and for a period of one year following termination, Mr. Andrews is prohibited from (i) competing with us and (ii) soliciting our customers, employees or consultants.
Daniel J. Schaefer
We have a second amended and restated employment agreement with our Chief Operating Officer, Daniel J. Schaefer, dated as of November 7, 2006 (the “Schaefer Employment Agreement”). The term of the Schaefer Employment Agreement is until November 7, 2009, with automatic one-year renewals unless either party provides a notice not to extend the employment agreement at least 180 days prior to the then current expiration date. During the term of the employment agreement, Mr. Schaefer is entitled to receive the following, all as established from time to time by the CEO:
· a base salary of $325,000, which is subject to be reviewed at least annually during the term of the employment agreement and may be increased (but not decreased) based upon his performance during the year;
· the opportunity to earn a target annual bonus of 50% of his salary if certain annual objectives are met. Such bonus will be reduced ratably if less than 100% of the annual objectives are met. In addition, he has the opportunity, based solely on the discretion of the CEO taking into account certain other criteria, to earn an annual bonus in excess of his target annual bonus; and
· benefits and perquisites that other Senior Executives are entitled to receive.
Upon the termination of Mr. Schaefer’s employment, due to his disability or his death, he or his beneficiary is to be paid his then unpaid base salary through the termination date and a portion of his bonus earned through the termination date. Upon termination of Mr. Schaefer’s employment by him for good reason or by us without cause, he is entitled to:
· his then monthly base salary for a period of eighteen months;
· a portion of his annual bonus calculated in accordance with the Schaefer Employment Agreement; and
· a continuation of certain perquisites and medical insurance benefits for a period of eighteen months.
If Mr. Schaefer’s employment is terminated by him for any reason other than for good reason or by us for cause, he is to receive only (i) his then base salary through the date of termination; (ii) his accrued and
unused vacation, not to exceed eight weeks; and (iii) any other amounts due him as of the date of termination, in each case to the extent not already paid.
During the term of the employment agreement and for a period of two years following termination, Mr. Schaefer is prohibited from (i) competing with us and (ii) soliciting our customers, employees or consultants.
Todd W. Latz
We have an amended and restated employment agreement with our General Counsel, Todd W. Latz, dated as of January 1, 2006 (the “Latz Employment Agreement”). The term of the Latz Employment Agreement is until January 1, 2009, with automatic one-year renewals unless either party provides a notice not to extend the employment agreement at least 60 days prior to the then current expiration date. During the term of the employment agreement, Mr. Latz is entitled to receive the following, all as established from time to time by the CEO:
· a base salary of $250,000, which is subject to be reviewed at least annually during the term of the employment agreement and may be increased (but not decreased) based upon his performance during the year;
· the opportunity to earn a target annual bonus of 50% of his salary if certain annual objectives are met. Such bonus will be reduced ratably if less than 100% of the annual objectives are met. In addition, he has the opportunity, based solely on the discretion of the CEO taking into account certain other criteria, to earn an annual bonus in excess of his target annual bonus;
· long-term incentives in the form of equity-based compensation no less favorable than awards made to other Senior Executives; and
· benefits and perquisites that other Senior Executives are entitled to receive.
Upon the termination of Mr. Latz’s employment, due to his disability or his death, he or his beneficiary is to be paid his then unpaid base salary through the termination date and a portion of his bonus earned through the termination date. Upon termination of Mr. Latz’s employment by him for good reason or by us without cause, he is entitled to:
· his then monthly base salary for a period of twelve months;
· a portion of his annual bonus calculated in accordance with the Latz Employment Agreement; and
· a continuation of certain perquisites and medical insurance benefits for a period of twelve months.
If Mr. Latz’s employment is terminated by him for any reason other than for good reason or by us for cause, he is to receive only (i) his then base salary through the date of termination; (ii) his accrued and unused vacation, not to exceed eight weeks; and (iii) any other amounts due him as of the date of termination, in each case to the extent not already paid.
During the term of the employment agreement and for a period of one year following termination, Mr. Latz is prohibited from (i) competing with us and (ii) soliciting our customers, employees or consultants.
Bruce W. Elder
We have an amended and restated employment agreement with our Vice President-Development, Bruce W. Elder, dated as of March 29, 2007 (the “Elder Employment Agreement”). The term of the Elder Employment Agreement is until March 29, 2010, with automatic one-year renewals unless either party provides a notice not to extend the employment agreement at least 60 days prior to the then current
expiration date. During the term of the employment agreement, Mr. Elder is entitled to receive the following, all as established from time to time by the CEO:
· a base salary of $225,000, which is subject to be reviewed at least annually during the term of the employment agreement and may be increased (but not decreased) based upon his performance during the year;
· the opportunity to earn a target annual bonus of 50% of his salary if certain annual objectives are met. Such bonus will be reduced ratably if less than 100% of the annual objectives are met. In addition, he has the opportunity, based solely on the discretion of the CEO taking into account certain other criteria, to earn an annual bonus in excess of his target annual bonus;
· long-term incentives in the form of equity-based compensation no less favorable than awards made to other Senior Executives; and
· benefits and perquisites that other Senior Executives are entitled to receive.
Upon the termination of Mr. Elder’s employment, due to his disability or his death, he or his beneficiary is to be paid his then unpaid base salary through the termination date and a portion of his bonus earned through the termination date. Upon termination of Mr. Elder’s employment by him for good reason or by us without cause, he is entitled to:
· his then monthly base salary for a period of twelve months;
· a portion of his annual bonus calculated in accordance with the Elder Employment Agreement; and
· a continuation of certain perquisites and medical insurance benefits for a period of twelve months.
If Mr. Elder’s employment is terminated by him for any reason other than for good reason or by us for cause, he is to receive only (i) his then base salary through the date of termination; (ii) his accrued and unused vacation, not to exceed eight weeks; and (iii) any other amounts due him as of the date of termination, in each case to the extent not already paid.
During the term of the employment agreement and for a period of one year following termination, Mr. Elder is prohibited from (i) competing with us and (ii) soliciting our customers, employees or consultants.
Notwithstanding the foregoing, in the event of a termination without cause or for good reason due to a Sale of the Company (as defined in our stockholders’ agreement , or within 180 days thereafter, we are obligated to pay termination benefits, effective on the date of such termination, under each of the employment agreements as follows:
· an amount equal to two times the Senior Executives then base salary; and
· a portion of such Senior Executive’s annual bonus calculated in accordance with such Senior Executives employment agreement.
SUMMARY COMPENSATION
The following table sets froth the compensation earned by the CEO and other NEOs for services rendered to us and our subsidiaries for the fiscal year ended December 31, 2006. Bonuses are paid under our applicable incentive compensation guidelines and are generally paid in the year following the year in which the bonus is earned.
SUMMARY COMPENSATION TABLE
(1) During 2006, the overall bonus objectives for the Company were not met 100%. Therefore, for Messrs. Andrews, Schaefer, Latz and Elder, the Compensation Committee reviewed the overall performance of the Company against the overall performance of the industry and evaluated each executive’s performance against expectations to determine the bonuses to be paid for 2006.
(2) Mr. Winkle’s employment agreement established his minimum annual bonus for 2006 at $200,000.
(3) All other compensation consists of automobile allowances of approximately $13,000 for Messrs. Winkle, Schaefer and Latz, $12,000 for Mr. Andrews, $11,000 for Mr. Villa and $6,500 for Mr. Elder; health and disability benefits of approximately $7,000 for Mr. Winkle, $5,400 for Mr. Andrews, $11,700 for Mr. Schaefer, $7,000 for Mr. Latz, $8,000 for Mr. Villa and $3,800 for Mr. Elder; termination benefits of approximately $24,900 for Mr. Villa; commuting expenses of approximately $15,700 for Mr. Andrews; and contributions to the defined contribution retirement plan.
(4) Mr. Andrews joined each of MQ Associates and MedQuest on February 7, 2006 and became Chief Financial Officer, effective April 7, 2006, replacing Mr. Haggerty, who served as interim Chief Financial Officer from March 14, 2005 until April 7, 2006.
(5) Mr. Villa resigned his position effective October 15, 2006.
GRANTS OF PLAN BASED AWARDS
There were no grants under plan based awards during fiscal 2006.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table shows outstanding stock option awards classified as exercisable and unexercisable as of December 31, 2006 for the CEO and each NEO.
POTENTIAL PAYMENTS UPON TERMINATION OR SALE OF THE COMPANY
Payments in the Event of a Termination of Employment by Us Without Cause or by the Executive for Good Reason
As discussed above, we will pay termination benefits under each of our employment agreements in the event of a termination without cause or a termination by the executive for good reason. The termination benefits we will pay are as follows:
(i) the executive’s then monthly base salary for a specified period;
(ii) a portion of the executive’s annual bonus; and
(iii) a continuation of certain perquisites and medical insurance benefits for a specified period.
We estimate that the value of the payments and benefits described in clauses (i) through (iii) above are as follows:
In addition, in the event Mr. Winkle has any unvested options, a portion of those unvested options will vest in accordance with the Winkle Employment Agreement.
Payments in the Event of a Sale of the Company and Termination of Employment by the Executive for Good Reason or by Us or Our Successor Without Cause
Pursuant to the employment agreements, in the event of a termination without cause or for good reason due to a Sale of the Company (as defined in the stockholders’ agreement, or within 180 days
thereafter, we are obligated to pay termination benefits, effective on the date of such termination, under each of the employment agreements as follows:
(i) an amount equal to two times the executives then base salary; and
(ii) a portion of his annual bonus calculated in accordance with the executive’s employment agreement.
If the executive’s employment were to have been terminated by him for Good Reason or by us (or our successor) without Cause in connection with the Sale of the Company on December 31, 2006, and the Sale of the Company were to have occurred on that date, we estimate that the value of the payments and benefits described in clauses (i) and (ii) above that he would have been eligible to receive is as follows:
Compensation of Directors
Our directors who are not employees of MQ Associates and not employees of CCMP Capital Advisors, LLC (other than Nancy-Ann DeParle, who received compensation in 2006 but will not receive compensation in 2007) receive annual compensation for their services in the form of cash fees and stock options. The level of compensation is dependent upon a number of factors, including level of experience and degree of risk associated with the various board positions. We also reimburse our directors for all out-of-pocket expenses incurred in the performance of their duties as directors. The following table shows total compensation paid to our directors in 2006.
Compensation Committee Report
The Compensation Committee has reviewed the Compensation Discussion and Analysis and discussed that Analysis with management. Based on its review and discussions with management, the committee recommended to our Board of Directors that the Compensation Discussion and Analysis be included in the company’s Annual Report on Form 10-K for the year ended December 31, 2006. This report is provided by the following independent directors, who along with Mr. Winkle comprise the committee:
Donald C. Tomasso
Benjamin B. Edmands
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information with respect to the ownership of the Class A common stock and common stock of MQ Associates as of March 29, 2007 by each person known to own beneficially more than 5% of the common stock and Class A common stock; each of our directors; each of our PEO and NEOs; and all of our executive officers and directors as a group.
The Class A Common Stock and common stock vote together as a single class. Notwithstanding the beneficial ownership of Class A Common Stock and common stock presented below, the stockholders’ agreement with MQ Associates governs the stockholders’ exercise of their voting rights with respect to election of directors and certain other material events. The parties to the stockholders’ agreement have agreed to vote their shares to elect the board of directors as set forth therein.
The amounts and percentages of shares beneficially owned are reported on the basis of SEC regulations governing the determination of beneficial ownership of securities. Under SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares voting power or investment power, which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Securities that can be so acquired are deemed to be outstanding for purposes of computing such person’s ownership percentage, but not for purposes of computing any other person’s percentage. Under these rules, more than one person may be deemed to be a beneficial owner of the same securities and a person may be deemed to be a beneficial owner of securities as to which such person has no economic interest.
Except as otherwise indicated in the footnotes below, each of the beneficial owners listed has, to our knowledge, sole voting and investment power with respect to the indicated shares of common stock. The address for directors and executive officers is: c/o MQ Associates, Inc., 3480 Preston Ridge Road, Suite 600, Alpharetta, Georgia 30005.
* Less than 1%
(1) The address of MQ Investment Holdings, LLC and MQ Investment Holdings II, LLC is c/o CCMP Capital Advisors, LLC, 245 Park Avenue, New York, New York 10167.
(2) Reflects shares held of record by MQ Investment Holdings, LLC and a common stock warrant held by MQ Investment Holdings II, LLC. The general partner of each of MQ Investment Holdings, LLC and MQ Investment Holdings II, LLC is J.P. Morgan Partner (BHCA), L.P. and the general partner of J.P. Morgan Partners (BHCA), L.P. is JPMP Master Fund Manager, L.P. (“MFM”). The general partner of MFM is JPMP Capital Corp. Voting and disposition decisions at JPMP Capital Corp. are made by three or more of its officers, and therefore, no individual officer of JPMP Capital Corp. is the beneficial owner of the securities. The address for JPMP Capital Corp. is 270 Park Avenue, New York, New York, 10017.
(3) Reflects beneficial ownership of 1,083,333 exercisable stock options at March 29, 2007, representing the vested portion of a total grant of 6,500,000 stock options.
(4) The address of Messrs. Venesky and Luke is 4300 North Point Parkway, Suite 350, Alpharetta, Georgia 30022.
(5) Reflects beneficial ownership of 643,749 exercisable stock options at March 29, 2007, representing the vested portion of a total grant of 858,332 stock options.
(6) Reflects beneficial ownership of 12,000 exercisable stock options at March 29, 2007, representing the vested portion of a total grant of 30,000 stock options.
(7) Reflects beneficial ownership of 120,000 exercisable stock options at March 29, 2007, representing the vested portion of a total grant of 200,000 stock options.
(8) Reflects beneficial ownership of 160,000 exercisable stock options at March 29, 2007, representing the vested portion of a total grant of 300,000 stock options.
(9) Ms. DeParle and Mr. Edmands are Managing Directors, and Mr. Murray is the President and Chief Operating Officer, of CCMP Capital Advisors, LLC (“CCMP Capital”), a private equity firm comprised of the former buyout/growth equity professionals of J.P. Morgan Partners, LLC (“JPMP”) who separated from JPMorgan Chase in August 2006 to form an independent private equity platform. CCMP Capital provides investment management services to JPMP and JPMorgan Chase, including with respect to the investment in MQ Associates. Mr. Murray, Ms. DeParle and Mr. Edmands are serving as directors at the request of MQ Investment Holdings, LLC, an affiliate of JPMP. Mr. Murray, Ms. DeParle and Mr. Edmands each disclaims any beneficial ownership of any shares beneficially owned by MQ Investment Holdings, LLC, MQ Investment Holdings II, LLC or their affiliates (including affiliates of JPMP), except to the extent of their respective pecuniary interest therein, if any.
(10) Reflects beneficial ownership of 8,000 exercisable stock options at March 29, 2007, representing the vested portion of a total grant of 10,000 stock options.
(11) Reflects beneficial ownership of 2,027,082 exercisable stock options held by six executive officers or directors at March 29, 2007, representing the vested portion of a total grant of 7,898,332 stock options.
Equity Compensation Plan Information
This table provides certain information as of December 31, 2006 with respect to our equity compensation plans:
(1) Under our 2003 Stock Option Plan, we grant incentive stock options and/or nonqualified stock options to employees and directors. The 2003 Stock Option Plan authorizes us to grant up to 16,999,999 options for shares of our common stock. Each option entitles the holder to purchase one share of common stock at the specified option price. Certain options vest over a five-year period, while others vest over a three-year period, and all of the options expire after ten years. For all options granted to date, the exercise price was equal to the fair market value of the underlying stock on the date of grant. As of December 31, 2006, we had granted 15,332,384 stock options, at exercise prices ranging from $0.65 to $3.00. As of December 31, 2006, we had 9,467,832 options outstanding, of which 2,876,282 stock options were vested. These figures and the figures in the table above give effect to the anticipated grant to Mr. Winkle of options to purchase 6,500,000 shares of common stock.
(2) The number of securities remaining available for future issuance under the 2003 Stock Option Plan includes 5,555,555 options that are only authorized to be granted as “Top-Off Options.” Top-Off Options are only available for grant to then-existing option holders so that they are not diluted in the event that any of our preferred stock is converted into common stock. We currently have 1,976,612 non-Top-Off Options available for future grants under the 2003 Stock Option Plan.
Item 13.
Item 13. Certain Relationships and Related Transactions
During the years ended December 31, 2006 and 2005, pursuant to a consulting agreement with Argus Management Corporation, a company owned by John Haggerty, our former interim Chief Financial Officer, and two other principals, we received certain interim management, financial and consulting services related to our restatement and other general corporate matters. Excluding amounts paid to Argus for Mr. Haggerty’s services as former interim Chief Financial Officer, we made aggregate payments in the amount of $0.3 million and $0.8 million to Argus in the years ended December 31, 2006 and 2005, respectively.
Transactions with Former Officers
At December 31, 2006, we leased space for 14 of our imaging centers through lease agreements between certain of our subsidiaries and Image Properties, L.L.C. (“Image Properties”), a company owned by our former Chief Executive Officer and our former President. We guarantee all real estate leases between our subsidiaries and Image Properties. The leases provide for monthly rent of approximately $0.2 million. The leases were amended in September 2006 and are typically for seven-year terms with two five-year renewal options. The leases expire in 2013 (See Note 13, “Commitments and Contingencies” to
our consolidated financial statements located elsewhere in this report for the future minimum payments to be made to Image Properties under these leases). We also leased our corporate headquarters from Image Properties for monthly rent of approximately $0.1 million until the lease expired in October 2006. We made total lease payments under these agreements of approximately $3.9 million, $3.7 million and $3.7 million in the years ended December 31, 2006, 2005 and 2004, respectively.
Pursuant to our Audit Committee Charter, our Audit Committee is responsible for reviewing the terms and conditions of any transactions that involve the company, one of our directors or executive officers or any of their immediate family members, or any other related person transaction required to be disclosed under SEC rules and regulations. These transactions must be approved or ratified by our Audit Committee. In addition, our Corporate Compliance Policy contains disclosure requirements applicable to all of our employees, including our executive officers, relating to actual or potential conflicts of interest.
Item 14.
Item 14. Principal Accountant Fees and Services
Fees for each of the last two fiscal years for professional services rendered by PricewaterhouseCoopers LLP were as follows:
Audit fees include fees related to the audit of the consolidated financial statements for the years ended December 31, 2006 and 2005 and the reviews of the quarterly reports for each of the respective years then ended. The audit fees for 2006 include fees associated with the review of the registration statement filed on Form S-1 completed in July 2006. Tax fees for the years ended December 31, 2006 and 2005 related to the review of our December 31, 2005 and 2004 federal income tax returns and tax consulting services. Other fees represent costs incurred for licensing of accounting research software.
Our independent auditors meet on a regular basis with the Audit Committee throughout the fiscal year. Annual audit and tax fees are approved in advance by the Audit Committee during its meeting with the independent auditors in the fourth quarter of every fiscal year. All audit-related fees are approved by the Audit Committee prior to their performance.
Part IV
Item 15(a). Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
Report of independent registered public accounting firm
Consolidated financial statements:
Consolidated balance sheets December 31, 2006 and 2005
Consolidated statements of operations Years ended December 31, 2006, 2005 and 2004
Consolidated statements of stockholders’ deficit Years ended December 31, 2006, 2005 and 2004
Consolidated statements of cash flows Years ended December 31, 2006, 2005 and 2004
Notes to consolidated financial statements
(a)(2) Financial Statement Schedule
Valuation and Qualifying Accounts
(a)(3) Exhibits. See Index to Exhibits on page E-1
Report of Independent Registered Public Accounting Firm
To Board of Directors and Stockholders of
MQ Associates, Inc. and Subsidiaries:
In our opinion, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of MQ Associates, Inc and its subsidiaries (the “Company”) at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
MQ Associates, Inc. & Subsidiaries
Consolidated Balance Sheets
December 31, 2006 and 2005
(in thousands, except share data)
The accompanying notes are an integral part of the consolidated financial statements.
MQ Associates, Inc. & Subsidiaries
Consolidated Balance Sheets (Continued)
December 31, 2006 and 2005
(in thousands, except share data)
The accompanying notes are an integral part of the consolidated financial statements.
MQ Associates, Inc. & Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
MQ ASSOCIATES, INC. & SUBSIDIARIES
Consolidated Statements of Stockholders’ Deficit
Years Ended December 31, 2006, 2005 and 2004
(in thousands, except share data)
The accompanying notes are an integral part of the consolidated financial statements.
MQ Associates, Inc. & Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
MQ Associates, Inc. & Subsidiaries
Consolidated Statements of Cash Flows (Continued)
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(in thousands, except share data)
1. Business
MQ Associates, Inc. (“MQA”), through MedQuest, Inc. (“MedQuest”), a wholly owned subsidiary, and MedQuest’s subsidiaries (collectively, the “Company”), as of December 31, 2006 operated 90 outpatient diagnostic imaging centers in locations throughout the United States of America, predominantly in the southeastern and southwestern regions. The outpatient diagnostic imaging centers provide medical imaging services to patients referred by physicians and bill governmental agencies, national and local insurance carriers, as well as individual patients who reside in the respective service areas. The Company operates in one reportable segment.
2. Liquidity and Capital Resources
The Company’s net losses have been approximately $23.0 million, $29.2 million and $16.7 million during the years ended December 31, 2006, 2005 and 2004, respectively, while cash generated from operations has been approximately $25.1 million, $34.5 million, and $33.2 million for those respective years. Total indebtedness at December 31, 2006, net of future accretion and amortization, was approximately $341.9 million, and estimated cash requirements to fund principle and interest payments due in 2007 are approximately $27.9 million. Estimated cash requirements for debt service (principal and interest) in 2008, 2009 and 2010 are approximately $51.0 million, $64.0 million and $78.6 million, respectively.
The Company estimates that it’s 2007 revenue, net losses and cash from operations will be negatively impacted by approximately $11.0 million as a result of Deficit Reduction Act of 2005 (“DRA”) and the lower Medicare reimbursements beginning January 1, 2007.
In response to these and other business matters, the Company has developed its 2007 business plan. The 2007 business plan contemplates a number of performance enhancing initiatives to improve operational efficiency and financial performance. These initiatives involve revenue enhancements and cost savings in nearly every component of its business, including payor contracting, purchasing arrangements, data network efficiency, staffing levels, billing center consolidations, employee benefits redesign, improved collection processes to decrease bad debt and increase cash flow, and scheduling and transcription processes.
While there can be no assurances, based upon its 2007 business plan, management believes the Company will remain in compliance with all of the terms of its debt covenants (as described in Note 9), and will also maintain sufficient liquidity throughout 2007.
If the Company is unable to achieve its planned 2007 business plan results, it will have to consider other actions, including obtaining covenant waivers or amendments from its lenders, delaying or eliminating planned capital expenditures, debt refinancing, additional sources of capital, asset sales and further cost reductions, among others. There can be no assurance the Company will be able to successfully execute these other actions.
The Company has commenced discussions with its lenders regarding the Senior Credit Facility, with a view of extending the term of the Revolving Credit portion beyond its scheduled term of August 2007, modifying the amortization of the Tranche B term loan and modifying certain financial covenants.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
3. Accounting Policies
Principles of consolidation
MedQuest is a wholly-owned subsidiary of MQA. MQA has no material assets or operations other than its ownership of 100% of the outstanding capital stock of MedQuest. The consolidated financial statements of the Company were prepared in accordance with generally accepted accounting principles (“GAAP”) and include the assets, liabilities, revenues and expenses of all majority owned subsidiaries over which the Company exercises control. The Company uses the equity method of accounting for its investment in two joint ventures at December 31, 2006 and 2005. All intercompany transactions have been eliminated in consolidation.
Cash and cash equivalents
The Company considers all highly liquid investments with original maturities of three months or less, when purchased, to be cash equivalents. The Company routinely has deposits at financial institutions which substantially exceed federal depository insurance coverage. Management believes any risks associated with these excess deposits are mitigated by maintaining the deposits at large, highly rated institutions.
Revenue recognition
Revenues consist primarily of net patient service revenues that are recorded based upon established billing rates less allowances for contractual adjustments. Revenues are recorded during the period the services are provided, based upon the estimated amounts due from patients and third-party payors, including federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, and employers. The Company’s patient accounting system currently does not record contractual adjustments at the time of billing. Instead, contractual adjustments are estimated based on historical collection experience. These estimates are subject to variances associated with changes in composition of payor and scan mix, as well as changes in reimbursement rates. Contractual payment terms are generally based upon predetermined contracted rates per procedure. Settlements under reimbursement agreements with third-party payors are estimated and recorded in the period the related services are rendered and are adjusted in future periods as adjustments become known or as the service years are no longer subject to audit, review or investigation.
Patient receivables
The Company reports patient receivables at estimated net realizable amounts from services rendered from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, workers’ compensation funds, and patients. The patient receivables are geographically dispersed, but a significant portion of its revenues and patient receivables are concentrated by type of payors.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The concentration of gross patient receivables by payor class, as a percentage of total gross patient receivables as of December 31, 2006 and 2005 is as follows:
Due to the nature and complexities associated with estimating the allowances for contractual adjustments, patient receivables by payor class are presented on a gross basis before such adjustments. The estimated contractual adjustment rate varies across payor classes and should not be uniformly applied on a pro rata-basis to determine net patient receivables.
During the years ended December 31, 2006, 2005 and 2004, approximately 20.8%, 21.3% and 19.0%, respectively, of our gross revenues related to patients participating in the Medicare program. While the Company derives significant revenues and accounts receivable from government agencies, it does not believe there are significant credit risks associated with these government agencies. Because Medicare traditionally pays claims faster than the Company’s other third-party payors, the percentage of the Company’s Medicare charges in patient receivables differs from the percentage of the Company’s Medicare revenues. The Company does not believe that there are any other significant concentrations of revenues from any particular payor that would subject it to any significant credit risks in the collection of its patient receivables.
Additions to the allowance for doubtful accounts are made by means of the provision for doubtful accounts. The Company writes off uncollectible accounts against the allowance for doubtful accounts after exhausting collection efforts and adding subsequent recoveries. Net patient receivables include only those amounts the Company estimates it will collect.
Bad debt expense is included in marketing, general and administrative expenses and is summarized in the following table.
The Company performs an analysis of its historical cash collection patterns and considers the impact of any known material events in determining the allowance for doubtful accounts. In performing this analysis, the Company considers the impact of any adverse changes in general economic conditions, business office operations, payor mix, or trends in federal or state governmental health care coverage.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Property and equipment
The Company records property and equipment at cost. Assets are depreciated on a straight-line basis over their estimated useful lives and leasehold improvements are amortized over the shorter of their estimated economic lives or the lease term. Useful lives are as follows:
Assets under capital leases are recorded at the present value of the minimum lease payments at the inception of the lease term and are amortized on a straight-line basis over the lease term.
Maintenance and repairs of property and equipment are expensed in the period incurred. All replacements or improvements that increase the estimated useful life of an asset are capitalized. Assets that are sold, retired or otherwise disposed of are removed from the respective asset cost and accumulated depreciation accounts and any gain or loss is included in the results of operations.
Operating leases are accounted for in accordance with SFAS No. 13, “Accounting for Leases,” and FASB Technical Bulletin No. 85-3, “Accounting for Operating Leases with Scheduled Rent Increases.” Those pronouncements require the recognition of fixed rental payments, including rent escalations, on a straight-line basis over the term of the lease.
Goodwill and other intangible assets
Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Under SFAS No. 142, “Goodwill and Other Intangible Assets,” and, beginning January 1, 2002, the Company no longer amortized goodwill and began testing goodwill for impairment using a fair value approach, at the reporting unit level. A reporting unit is the operating segment or business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management at the component level. On an ongoing basis, absent any impairment indicators, the Company performs its goodwill impairment testing as of December 31 of each year. For the year ended December 31, 2006, the loss on disposal of assets related to closed centers included a charge of $1,031 related to goodwill.
In accordance with SFAS No. 142, the Company amortizes the cost of intangible assets with definite useful lives over their respective estimated useful lives to their estimated residual value. As of December 31, 2006, our definite useful lived intangible assets do not have an estimated residual value. The Company also reviews those assets for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-lived Assets,” whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. As of December 31, 2006, intangible assets with definite useful lives consisted primarily of non-compete agreements. The Company considers certificates of
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
need, which are required by certain states prior to the acquisition of high cost capital items, including diagnostic imaging equipment, before providing health care services, to be indefinite lived intangible assets.
Long-lived assets
Under SFAS No. 144, the Company assesses the recoverability of long-lived assets (excluding goodwill) and identifiable acquired intangible assets with finite useful lives whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. The Company measures the recoverability of assets to be held and used by a comparison of the carrying amount of the asset to the expected net future cash flows to be generated by that asset, or, for identifiable intangibles with finite useful lives, by determining whether the amortization of the intangible asset balance over its remaining life can be recovered through undiscounted future cash flows. The amount of impairment of identifiable intangible assets with finite useful lives, if any, to be recognized is measured based on projected discounted future cash flows. The Company measures the amount of impairment of other long-lived assets (excluding goodwill) by the amount by which the carrying value of the asset exceeds the fair market value of the asset, which is generally determined based on projected discounted future cash flows or appraised values.
For the year ended December 31, 2004, the Company recorded an impairment charge of approximately $1,900 related to certain proprietary computer software. The computer software consisted of a proprietary radiology information system combined with a standalone accounts receivable module. The system was partially implemented in December 2002, but encountered scalability problems that ultimately led to the Company’s determination to discontinue its implementation. In 2004, replacement software that satisfied the Company’s growth needs was identified and implemented. As a result, an impairment charge was taken for a substantial portion of the cost of the prior software and amortization was accelerated for the portion that remained in use. The portion subject to accelerated amortization was fully amortized in June 2005.
Center closing costs
The Company provides for closed center liabilities based on the present value of the estimated remaining noncancellable lease payments after the closing date, net of estimated subtenant income. The Company estimates the net lease liabilities using a discount rate to calculate the present value of the remaining lease payments on closed centers. The closed center lease liabilities usually are paid over the lease terms associated with the closed centers, which generally have remaining terms ranging from 0 to 8 years. Any adjustment to closed center liabilities related to changes in subtenant income or actual exit costs differing from original estimates are made in the period in which the change becomes known.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The following table summarizes accrual activity for the future lease obligations of centers closed in the normal course of business:
Costs of services
Costs of services consists of compensation related to radiologists, technicians and transcriptionists, combined with supplies, building rental, utilities and other expenses directly related to generating revenue from services.
Stock based compensation
In December 2004, the FASB issued Statement of Financial Accounting Standard No. 123 (revised 2004), “Share Based Payment,” (“SFAS 123R”). SFAS 123R establishes the accounting for transactions in which an entity pays for employee services in share based payment transactions. SFAS 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for the unique characteristics of those instruments. That cost is recognized over the vesting period during which an employee is required to provide service in exchange for the award. The Company adopted SFAS 123R effective January 1, 2006, using the modified-prospective transition method. Under this method, compensation cost is recognized for awards granted and for awards modified, repurchased or cancelled in the period after adoption. Compensation cost is also recognized for the unvested portion of awards granted prior to adoption during the period when vesting occurs. Prior year financial statements are not restated. The application of SFAS 123R resulted in the Company recognizing a charge of approximately $37 for compensation cost, net of taxes, for the year ended December 31, 2006, based on the estimated grant-date fair value of all awards.
Prior to January 1, 2006, the Company accounted for stock incentives, available to employees and non-employees, under its stock-based compensation plan (the “2003 Stock Option Plan”) using the intrinsic value method prescribed in APB No. 25, “Accounting for Stock Issued to Employees” as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation.” The Company had adopted the provisions of SFAS No. 123, which required disclosure of the pro forma effects on earnings and earnings per share as if SFAS No.123 had been adopted.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The Company has computed the value of all options granted using the Black-Scholes option pricing model with the following assumptions:
(1) Black-Scholes assumptions are not applicable in 2006 since there were no grants of stock options.
In 2004, the Company issued 5,686,384 stock options under the 2003 Stock Option Plan. Of these issuances, 4,863,884 stock options, in the aggregate, were issued to certain executive officers of the Company. These options were issued as incentive stock options with exercise prices ranging from $1.50 to $3.00 and a three year vesting period. Approximately 3,147,220 of the 4,863,884 stock options issued to the executive officers expired in April 2005 in connection with separation agreements with certain executive officers and 858,332 stock options expired in November 2006 upon the resignation of another executive officer. The remaining 802,500 stock options were issued as non-qualified stock options with exercise prices ranging from $0.65 to $1.05 and a five year vesting period.
In 2005, the Company issued, or was contractually obligated to issue, 6,630,000 stock options under the 2003 Stock Option Plan. These include 6,500,000 options that the Company is obligated to issue to an executive officer pursuant to an employment agreement. These options have not yet been issued, but when they are, they will be issued effective October 24, 2005 and will be incentive stock options with an exercise price of $0.65 and a three year vesting period as provided for in his employment agreement dated October 24, 2005.
There were no stock option grants in 2006. The weighted average fair value of options at grant date amounted to $0.00 and $0.02 for the years ended December 31, 2005 and 2004.
Prior to January 1, 2006, the Company used the intrinsic-value method of accounting for stock-based awards granted to employees and, accordingly, did not recognize compensation expense for its stock-based awards to employees. The following table reflects pro forma net income as if the Company had elected to adopt the fair value approach of SFAS No. 123:
Certain other disclosures are required with respect to stock compensation under the provisions of SFAS No. 123 and are included in Note 17.
Advertising expense
The Company expenses all advertising costs as incurred. Advertising expense was $2,432, $2,572 and $3,111 for the years ended December 31, 2006, 2005 and 2004, respectively.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Deferred Financing Costs
The Company capitalizes debt issuance costs and amortizes them into interest expense using the interest method over the lives of the related debt instruments. In the fourth quarter of 2006, the Company corrected an immaterial non-cash error and as a result, reduced 2006 interest expense by $1,748.
Income taxes
The Company provides for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” This approach recognizes the amount of income tax expense or benefit based upon the taxes payable or refundable for the period and the change in deferred income tax assets and liabilities during the year. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, a valuation allowance is established when it is more likely than not that some portion of the deferred tax assets will not be realized.
Use of estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fair value of financial instruments
The carrying value of cash and cash equivalents, patient receivables, accounts payable and accrued expenses approximate their fair value based on the short-term nature of these accounts. Borrowings under the Senior Credit Facility, described in Note 8, bear interest at variable rates, which approximate market. The 117¤8% senior subordinated notes, described in Note 8, bear interest at fixed rates. The 12¼% senior discount notes, described in Note 8, bear interest at fixed rates. The estimates of fair value are based upon quoted market prices for these issues of long-term debt. The estimated fair value of the Company’s long-term debt was $107,625 below its carrying value at December 31, 2006 and $28,959 below its carrying value at December 31, 2005.
Derivative financial instruments
The Company may, from time to time, use derivative financial instruments to reduce exposure to adverse fluctuations in interest rates. When entered into, the Company formally designates and documents the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transactions. The Company formally considers at inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposure. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
offset by changes in the fair value or cash flows of the underlying exposure being hedged. Any ineffective portion of a financial instrument’s change in fair value is immediately recognized in earnings.
New accounting pronouncements
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which revises SFAS No.123 and supersedes APB No. 25. SFAS No. 123R requires that, at the grant-date, the fair value of all share-based payment awards, including employee stock options, be recognized as employee compensation expense in the income statement. SFAS No. 123R is effective for the first annual reporting period beginning after June 15, 2005. The Company adopted SFAS No. 123R effective January 1, 2006, using the modified-prospective transition method. Under this method, compensation cost is recognized for awards granted and for awards modified, repurchased or cancelled in the period after adoption. Compensation cost is also recognized for the unvested portion of awards granted prior to adoption during the period when vesting occurs. Prior year financial statements are not restated. The adoption of SFAS No. 123R did not have a material impact on the Company’s consolidated financial statements.
In March 2005, the FASB issued FASB Interpretation (“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations.” FIN No. 47 clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143 “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company determined that FIN No. 47 did not have a material impact on its consolidated financial statements for the year ended December 31, 2005.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 replaces APB Opinion No. 20 and SFAS No. 3, and changes the requirements for the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting principle and applies to changes required by an accounting pronouncement when the 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 a cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material impact on the Company’s consolidated financial statements.
In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109,” which clarifies the accounting for uncertainty in income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the measurement and financial statement recognition of a tax position taken or expected to be taken in a tax return. The interpretation 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 adoption of FIN 48 is not expected to have a material impact on the Company’s consolidated results of operations, financial position or liquidity.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
In September 2006, the FASB issued SFAS No. 157 (“SFAS No. 157”), “Fair Value Measurements,” which clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures of fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 157 on its consolidated financial statements.
In September 2006, the SEC issued SAB No. 108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements.” SAB No. 108 provides guidance on the consideration of effects of the prior year misstatement in quantifying current year misstatements for the purpose of a materiality assessment. The SEC staff believes registrants must quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a material misstatement, when all relevant quantitative and qualitative factors are considered. SAB No. 108 is effective for the first annual period ending after November 15, 2006 with early application encouraged. The Company adopted SAB No. 108 for its fiscal year-ended December 31, 2006. The adoption of SAB No. 108 did not have a material impact on its consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Standards No. 159 (“SFAS No. 159”), “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 on its consolidated financial statements.
Reclassifications
Certain reclassifications have been made to the consolidated financial statements for the years ended December 31, 2005 and 2004 to conform to the presentation for the year ended December 31, 2006.
4. Acquisitions
During each of the years ended December 31, 2006 and 2005, the Company acquired one entity that provides medical diagnostic imaging services to patients.
The following table summarizes the estimated fair values of the assets acquired and the aggregate purchase price of acquisitions:
The goodwill acquired in relation to the above transactions is expected to be deductible for tax purposes. The acquisitions made during the years ended December 31, 2006 and 2005 were consummated in order to maintain and enhance the Company’s operations in existing markets. There were no acquired
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
intangibles subject to amortization for the acquisition made during the year ended December 31, 2006. The weighted average amortization period for acquired intangibles subject to amortization was 39 months for the acquisition made during the year ended December 31, 2005.
The Company made one acquisition in 2005 and that transaction took place on January 3, 2005, the first business day of the year, therefore, no pro forma information is presented. The unaudited pro forma results of operations, for the year ended December 31, 2004, reflect operations as if MQA and the entities described above had been combined as of January 1, 2004. The unaudited pro forma results include estimates and assumptions which management believes are reasonable. However, pro forma results do not include any anticipated cost savings or other effects of the planned integration of these entities, and are not necessarily indicative of the results which would have occurred if the business combinations had been in effect on the dates indicated, or may result in the future.
5. Patient Receivables
Patient receivables consist of the following:
6. Property and Equipment
Property and equipment, including assets under capital lease obligations, consists of the following:
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Construction in process consists primarily of technical equipment that has not been placed in service and leasehold improvements at centers that had not been completed at the balance sheet date.
Depreciation expense amounted to $33,941, $35,609 and $31,223 for the years ended December 31, 2006, 2005 and 2004, respectively.
Leases
The Company leases certain land, buildings, and equipment under non-cancelable operating leases expiring at various dates through 2018, and certain equipment under capital leases expiring at various dates through 2008. Operating leases generally have 5 to 10 year terms, with one or more renewal options. Various facility leases include provisions for rent escalation or require the Company to pay certain maintenance and utility costs. Contingent rents are included in rent expense in the year incurred. Some facilities are subleased to other parties, and those amounts are not material. Certain leases contain annual escalation clauses based on changes in the Consumer Price Index (“CPI”) while others have fixed escalation terms. The excess of expense over current payments is recognized as straight-line rental accrual payments and is included in other long-term liabilities in the accompanying consolidated financial statements, as follows:
Future minimum lease payments at December 31, 2006, for equipment under capital lease obligations having an initial or remaining non-cancelable lease term in excess of one year are as follows:
Property and equipment under capital leases was $1,440 and $2,479, net of accumulated depreciation of $4,492 and $3,511 at December 31, 2006 and 2005, respectively. Capital lease obligations were initially recorded using discount rates ranging from 5.0% to 6.6%.
Collateralized Assets
Pursuant to the Senior Credit Facility and the indenture for the 117¤8% Notes (as defined below) described in Note 8, the Company’s obligations under those agreements are collateralized by substantially all of the assets of the Company and the common stock of all subsidiaries. Refer to Note 8, Long-Term Debt, for additional information regarding the agreements.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
7. Goodwill and Other Intangible Assets
Goodwill represents the excess of purchase price over the fair value of the net assets of acquired companies. For the year ended December 31, 2006, the loss on disposal of assets related to closed centers included a charge of $1,031 related to goodwill. The following details the changes in the carrying value:
Other intangible assets not subject to amortization, gross carrying amount:
Other intangible assets subject to amortization:
Amortization expense amounted to $167, $246 and $317 for the years ended December 31, 2006, 2005 and 2004, respectively.
Total estimated amortization expense related to the other intangible assets, subject to amortization, for the next five years is as follows:
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
8. Other Accrued Expenses
Other accrued expenses consist of the following:
See Note 13 for information regarding related party transactions.
9. Long-Term Debt
Long-term debt consists of the following:
Senior credit facility
The Company’s Senior Credit Facility (as defined below) provides for a revolving credit facility, not to exceed $80,000, and a Tranche B term facility of $60,000. The Senior Credit Facility is guaranteed by MQA and each of MedQuest’s existing and future domestic subsidiaries. MedQuest’s obligations under the Senior Credit Facility and the guarantors’ obligations under the guarantees are collateralized by substantially all of the assets of MedQuest and the guarantors.
In September 2003, the Company amended the Senior Credit Facility to allow for borrowings under a Tranche B term facility not to exceed $60,000. Concurrent with the amendment of the Senior Credit Facility, the Company borrowed $60,000 under the Tranche B term facility and applied the net proceeds against the outstanding borrowings under the revolving credit facility of the Senior Credit Facility.
In August 2004, the Company amended the Senior Credit Facility to permit, among other things, MQA to issue the $136,000 aggregate principal amount at maturity 12¼% senior discount notes due 2012 and to use the net cash proceeds to pay a dividend to holders of MQA’s common stock and to make distributions to certain key employees and certain employees who held options for MQA’s common stock. The amendment permits the Company to make distributions to MQA under certain specified exceptions
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
and also permits MQA to issue additional indebtedness or preferred stock under certain terms, and, subject to MedQuest meeting a pro forma consolidated leverage ratio test and certain other conditions, to use the proceeds thereof to make distributions on, or repurchase or redeem shares of MQA capital stock.
The Senior Credit Facility has certain financial covenants related to the maintenance of minimum/maximum levels of consolidated leverage, senior leverage and fixed charge coverage ratios.
Equity transaction
On September 7, 2005, in connection with the consummation of the consent solicitations discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, MQA entered into a Securities Purchase Agreement (the “SPA”) with MQ Investment Holdings II, LLC, pursuant to which MQA issued and sold to MQ Investment Holdings II, LLC (i) 20,000,000 shares of Series A Redeemable Preferred Stock and (ii) warrants to purchase 3,000,000 shares of MQA’s Common Stock at an exercise price of $0.01 per share, in exchange for $20,000.
According to the terms of the SPA, the Company has the right, from and after June 1, 2006, to cause MQ Investment Holdings II, LLC to sell to the Company any or all of the Series A Redeemable Preferred Stock or warrants then held by it. In the event of such a repurchase, the purchase price per share with respect to Series A Redeemable Preferred Stock shall be $1.00 plus a premium of 8% per annum and the purchase price per warrant, or share of Common Stock issuable upon the exercise thereof, shall be the fair market value of such warrant or share of Common Stock.
Revolving credit facility
Borrowings under the revolving credit facility accrue interest at the option of MedQuest, at either: (a) the greater of the prime rate or the Federal funds effective rate (subject to certain adjustments) plus an applicable margin of 1.75% per annum, or (b) the Eurodollar rate, plus an applicable margin of 2.75% per annum. There were no borrowings under the revolving credit facility at December 31, 2006 and 2005. The revolving credit facility also provides for a commitment fee equal to ½ of 1% per annum of the amount of unused revolving credit commitments. The margins related to the prime rate and Eurodollar rate borrowings and commitment fee are subject to adjustment based upon the Company’s consolidated leverage ratio, as defined. The available borrowings under the revolving credit facility, net of $533 and $633 in letters of credit at December 31, 2006 and 2005, respectively, amounted to $79,467 and $79,367 at December 31, 2006 and 2005, respectively.
Tranche B term facility
Borrowings under the Tranche B term facility accrue interest at the option of MedQuest, at either: (a) the greater of the prime rate or the Federal funds effective rate (subject to certain adjustments) plus an applicable margin of 2.75% per annum, or (b) the Eurodollar rate, plus an applicable margin of 3.75% per annum. Borrowings are based upon the Eurodollar rate (5.37% and 4.69% at December 31, 2006 and 2005, respectively) and amounted to $50,992 and $58,500 at December 31, 2006 and 2005, respectively.
Commencing with the fiscal year ended December 31, 2004, and annually thereafter, a specified percentage (currently 75%, subject to downward adjustment based on our consolidated leverage ratio) of excess cash flow, as defined in the Senior Credit Facility, must be applied against certain outstanding
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
borrowings under the Senior Credit Facility. For the years ended December 31, 2006 and 2005, the Company generated excess cash flows, as defined in the Senior Credit Facility, of $0 and $9.3 million, respectively. The Company made a mandatory repayment of $7.0 million on April 7, 2006.
117¤8% Senior subordinated notes
In August 2002, MedQuest issued $180,000 aggregate principal amount of 117¤8% senior subordinated notes due August 2012 (“117¤8% Notes”), net of a discount of $3,832, which is being amortized as interest expense over the life of the 117¤8% Notes. The 117¤8% Notes provide for an optional early redemption by MedQuest upon a change in control, as defined, prior to August 15, 2007 at 100% of the principal amount, or on or after August 15, 2007 at the redemption prices expressed as a percentage of the principal amount, plus accrued and unpaid interest as follows:
The 117¤8% Notes are fully and unconditionally, jointly and severally, guaranteed by MQA and each of its existing and future domestic subsidiaries. The 117¤8% Notes contain certain covenants, including covenants limiting the Company’s ability to incur additional indebtedness and make restricted payments.
12¼% Senior discount notes
In August 2004, MQA issued $136,000 aggregate principal amount at maturity 12¼% senior discount notes (“12¼% Notes”) due in August 2012 and MQA received gross proceeds of $84,778, which represented a discount to the aggregate principal amount at maturity. The 12¼% Notes are uncollateralized obligations of MQA. Interest accrues on the 12¼% Notes in the form of an increase in accreted value through August 15, 2008. Cash interest accrues from August 15, 2008, and is payable semi-annually in arrears commencing on February 15, 2009. MQA is required to pay generally all accrued but unpaid interest on the 12¼% Notes in cash on February 15, 2010, or at MQA’s option on August 15, 2008.
The 12¼% Notes also provide for an optional early redemption by MQA, in their entirety, upon a change in control, as defined, on or after August 15, 2005 and prior to August 15, 2008 at the redemption prices expressed as a percentage of accreted value as follows:
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Prior to August 15, 2007, MQA may also redeem up to 35% of the 12¼% Notes with the net cash proceeds of one or more equity offerings at a redemption price of 112.250% of the accreted value, plus accrued and unpaid interest, provided that at least 65% of the original principal amount at maturity of the 12¼% Notes remains outstanding after such redemptions and the redemptions occur within 120 days of the closing of the equity offerings.
On or after August 15, 2008, MQA may redeem all or a part of 12¼% Notes at the redemption prices expressed as a percentage of accreted value, plus accrued and unpaid cash interest as follows:
The 12¼% Notes contain certain covenants, including covenants limiting the Company’s ability to incur additional indebtedness and make restricted payments.
Debt issuance costs amounting to $18,857, with respect to the Senior Credit Facility, the 117¤8% Notes and 12¼% Notes were capitalized and are being amortized into interest expense over the lives of the related debt instruments.
Future maturities of long-term debt, including the effects of the discount, are as follows:
10. Redeemable Preferred Stock
Series A and Series B convertible and redeemable preferred stock
The Series A Preferred Stock is convertible, at the option of the holder, (i) immediately prior to a liquidation or sale of MQA, into a total of 55,000,000 shares of Class A Common Stock or (ii) immediately prior to the consummation of a qualified underwritten public offering (“QPO”), into the number of shares resulting from dividing $55,000 by the QPO price per share. In the event of a liquidation or sale of MQA, the Series A Preferred Stock is entitled to an amount equal to the greater of $1.00 per share or the amount to be paid, per share, as if the Series A Preferred Stock had been converted into Class A Common Stock immediately prior to the liquidation.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The Series B Preferred Stock is convertible, at the option of the holder, immediately prior to a liquidation or sale of MQA, into 17,295,000 shares of Common Stock and immediately prior to the consummation of a QPO, will be deemed automatically converted into the number of shares resulting from dividing $15,000 by the QPO price per share, plus 2,295,000 shares of Common Stock. In the event of a liquidation or sale of MQA, the Series B Preferred Stock is entitled to an amount equal to the greater of $1.00 per share or the amount to be paid, per share, as if the Series B Preferred Stock had been converted into Common Stock immediately prior to the liquidation.
The Series A Preferred Stock and Series B Preferred Stock may be redeemed at the option of the holder upon the consummation of a QPO at a redemption price of $55,000 for all of the Series A Preferred Stock and $15,000 for all of the Series B Preferred Stock. Additionally, in the case of such redemption, the holders of Series B Preferred Stock will receive 2,295,000 shares of Common Stock. In the event that (i) MQA and its underwriters determine that the redemption of the Series B Preferred Stock would adversely affect the planned QPO or (ii) the holders of shares of Series B Preferred Stock elect not to redeem shares of Series B Preferred Stock, MQA may convert all shares of Series B Preferred Stock into 17,295,000 shares of Common Stock. The Company has not accreted to the fair value of the additional shares of Common Stock to be issued upon redemption of the Series B Preferred Stock because the Company does not believe that the redemption trigger is probable as of December 31, 2006.
The conversion provisions related to the Series A Preferred Stock and Series B Preferred Stock are subject to adjustments for certain events. Upon the consummation of any liquidation or sale of MQA, after payment of the preference to the holders of Series A Preferred Stock, the holders of Class A Common Stock will be entitled to receive out of the proceeds of such liquidation or sale, before any payment will be made to the holders of any capital stock ranking junior to the Class A Common Stock, an amount per share of Class A Common Stock equal to the original cost of such share. After payment has been made to the holders of Class A Common Stock of the full amount set forth in the preceding sentence, the holders of Common Stock will be entitled to receive out of the proceeds of such liquidation or sale an amount per share of Common Stock equal to the original cost of each such share of Common Stock pari passu with the payment of the preference to the holders of Series B Preferred Stock. After payment of the amounts set forth above, the holders of Common Stock and the holders of Class A Common Stock will share ratably in the remaining proceeds, if any, of such liquidation or sale.
11. Capital Structure
MQA’s articles of incorporation authorize 385,000,000 shares of capital stock consisting of (i) 195,000,000 shares of Common Stock, par value $.001, (ii) 115,000,000 shares of Class A common stock, $.001 par value, and (iii) 75,000,000 shares of Preferred Stock, par value $.001, of which (a) 55,000,000 shares are designated as Series A Convertible Redeemable Preferred Stock, (b) 15,000,000 shares are designated as Series B Convertible Redeemable Preferred Stock, and (c) 5,000,000 shares are not designated at December 31, 2006.
The Class A common stock is convertible, on a one-for-one basis, into Common Stock at the option of the holder or upon the occurrence of an underwritten public offering, as defined. The Class A common stock and Common Stock have identical rights, except that the Class A common stock ranks senior to the Common Stock in the event of a liquidation or sale of MQA.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
12. Derivative Financial Instrument
In August 2002, the Company entered into an interest rate swap agreement related to the fixed interest obligations on the 117¤8% Notes. The agreement required the Company to pay interest at a variable rate based on six-month LIBOR plus 6.525% on a notional amount of $47,500 for a term of ten years. On February 9, 2005, the Company terminated the interest rate swap and the associated rights and obligations under that derivative. The Company received $1,635 from the swap counterparty as a termination fee on February 11, 2005.
13. Commitments and Contingencies
From time to time, the Company, due to the nature of its business, is subject to litigation and/or regulatory actions, the resolution of which could result in a materially adverse impact upon the Company’s financial position and operating results. At December 31, 2006, the Company was not aware of any such proceedings, other than those disclosed below, that could result in a materially adverse financial impact.
SEC Inquiry
The staff of the SEC has commenced a formal inquiry concerning, among other things, the Company’s previous announcement that it expected to restate its financial statements for prior periods and its inability to timely file our 2004 Annual Report and Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30, 2005 (which, in each case, were subsequently filed). While the Company is continuing to cooperate with the SEC, it cannot predict the outcome of the inquiry. Such inquiry could have a material adverse effect on the Company’s business, financial condition and results of operations.
Future Commitments
The Company’s future commitments at December 31, 2006 were as follows:
(a) The Company leases office space and radiology equipment under non-cancelable operating lease agreements and has certain other maintenance agreements for its various locations. The leases and maintenance agreements expire at various dates through 2018 with options to renew for varying terms. Certain of the leases for office space are with related parties (see Note 14).
The future minimum payments under lease and other agreements are as follows:
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Terms of certain leases include escalation clauses and require payment of costs such as property taxes, utilities, insurance and maintenance. Rent expense for leases with escalation clauses or other lease concessions is accounted for on a straight-line basis beginning with the earlier of the lease commencement date or the date the Company takes possession. Portions of certain properties are subleased to others for periods generally ranging from 1 to 21 months. Rent expense for non-related party leases, which includes equipment rentals, was $14,907, $12,079, and $9,776 for the years ended December 31, 2006, 2005, and 2004, respectively.
Rent expense (under operating leases) consists of:
The Company’s maintenance expense related to the non-cancelable maintenance agreements was $10,199, $10,564, and $8,709 for the years ended December 31, 2006, 2005 and 2004, respectively. Rent expense for related party leases was $3,874, $3,632, and $3,883 for the years ended December 31, 2006, 2005 and 2004, respectively.
(b) The Company has employment agreements with certain of its executive officers that provide for the payment of a base salary plus an annual bonus, and include non-compete provisions for up to two years following the executive officer’s termination of employment. The employment agreements have terms that expire on various dates through October 2010 and provide that if the executive officer is terminated without cause, such executive officer is entitled to receive payments equal to their base salary amount and, in some cases, a portion of their annual bonus, for a specified period of time which could extend up to 24 months, depending upon the executive officer. The base salaries provided for during the entire term of the employment agreements range from $225 to $500 per year.
14. Related Party Transactions
The Company leases space for 14 of its imaging centers through lease agreements between certain of its subsidiaries and Image Properties. The Company guarantees all real estate leases between its subsidiaries and Image Properties. The leases provide for monthly rent in amounts ranging from $7 to $25. The leases were amended in September 2006 and are typically for seven-year term with two five-year renewal options. The leases expire in 2013. The Company also leased its corporate headquarters from Image Properties for monthly rent of approximately $73 until the lease expired in October 2006. The Company made total lease payments under these agreements of $3,874, $3,654, and $3,732, in the years ended December 31, 2006, 2005 and 2004, respectively. The Company also paid management fees of $0, $120 and $249 to Image Properties for the years ended December 31, 2006, 2005 and 2004.
Historically, the Company made advances to Image Properties for building and leasehold improvements made on behalf of the Company. The Company had receivables of $0 and $162 at December 31, 2006 and 2005, for costs incurred on behalf of Image Properties. The Company earned
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
interest income on the balance at a rate of approximately 6% per annum of the outstanding receivable balance.
Pursuant to an agreement with Image Aviation, LLC, a company also owned by the Company’s former Chief Executive Officer and former President, the Company paid expenses of $0, $128 and $683 for the years ended December 31, 2006, 2005 and 2004 for certain aviation services. In March 2005, the Company terminated its agreement with Image Aviation.
The Company paid, from the net proceeds received in connection with the issuance of the 12¼% Notes in August 2004, a dividend to its stockholders in the amount of $80,200.
During the years ended December 31, 2006 and 2005, pursuant to a consulting agreement with Argus Management Corporation, a company owned by John Haggerty, our former interim Chief Financial Officer, and two other principals, we received certain interim management, financial and consulting services related to our restatement and other general corporate matters. Excluding amounts paid to Argus for Mr. Haggerty’s services as former interim Chief Financial Officer, we made aggregate payments in the amount of $315 and $826 to Argus in the years ended December 31, 2006 and 2005, respectively.
15. Income Taxes
The provision for federal and state income taxes is as follows:
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The tax effects of temporary differences that give rise to deferred tax assets and liabilities are:
SFAS No. 109 requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are deductible. In making this determination, management considers all available positive and negative evidence affecting specific deferred tax assets, including the Company’s past and anticipated future performance, reversal of deferred tax liabilities, length of carryback and carryforward periods and implementation of tax planning strategies.
Objective positive evidence is necessary to support a conclusion that a valuation allowance is not needed for all or a portion of deferred tax assets when significant negative evidence exists. Cumulative losses in recent years are the most compelling form of negative evidence considered by management in this determination. For the year ended December 31, 2006, management has determined that based on all available evidence, a valuation allowance of $33,723 is appropriate. Approximately $1,300 of this valuation allowance, if reversed, would result in an increase in additional paid-in capital rather than benefit.
As of December 31, 2006, the Company had approximately $85,833 of federal and $158,845 of state loss carryforwards available to reduce taxable income. The loss carryforwards expire through 2026.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The tax provision/(benefits) differs from the amount that would be calculated by applying the federal statutory rate of 35% to income before income taxes as follows:
16. Retirement Plan
In April 2005, the Company changed service providers for its 401(k) defined contribution plan (the “Plan”) maintained for all eligible employees. There were no substantive changes to the Plan as a result of the change in service providers, other than a reduction in the service requirement from nine months to one month. Under the Plan, employees who have completed the minimum period of service and have met certain other eligibility requirements may make voluntary contributions to the retirement program in the form of salary reductions. The Company, at the discretion of the Board of Directors, may make contributions to the Plan equal to a percentage of each employee’s wages. Employer contributions for the years ended December 31, 2006, 2005 and 2004 amounted to $256, $264 and $208, respectively.
17. Stock Option Plan
In April 2003, the Company adopted an employee stock option plan (“2003 Stock Option Plan”) that provides for the issuance of incentive stock options and non-qualified stock options for the purchase of 16,999,999 shares of the Company’s common stock. The 2003 Stock Option Plan was adopted with an effective date of January 1, 2003 and terminates ten years from the effective date, unless terminated sooner. Options vest ratably over three to five year periods on successive grant date anniversaries and may be issued at a grant price of no less than fair market value on the date of grant.
In 2004, the Company issued 5,686,384 stock options under the 2003 Stock Option Plan. Of these issuances, 4,863,884 stock options, in the aggregate, were issued to certain executive officers of the Company. These options were issued as incentive stock options with exercise prices ranging from $1.50 to $3.00 and a three year vesting period. Approximately 3,147,220 of the 4,863,884 stock options issued to the executive officers expired in April 2005 in connection with separation agreements with certain executive officers and 858,332 stock options expired in November 2006 upon the resignation of another executive officer. The remaining 822,500 stock options were issued as non-qualified stock options with exercise prices ranging from $0.65 to $1.05 and a five year vesting period.
In 2005, the Company issued, or was contractually obligated to issue, 6,630,000 stock options under the 2003 Stock Option Plan. These include 6,500,000 options that the Company is obligated to issue to an executive officer pursuant to an employment agreement. These options have not yet been issued, but when they are, they will be issued effective October 24, 2005 and will be incentive stock options with an exercise price of $0.65 and a three year vesting period. The remaining 130,000 stock options were issued as qualified stock options with an exercise price of $0.65 and a five year vesting period.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
There were no grants of stock options in 2006. The weighted average fair value of options at grant date amounted to $0.00 and $0.02 for the years ended December 31, 2005 and 2004.
The following table summarizes information related to stock options for the years ended December 31, 2004, 2005 and 2006:
(1) The Company’s Chief Executive Officer is entitled, pursuant to his employment contract, to receive a grant of stock options to purchase 6,500,000 shares of MQA’s common stock. Although the definitive documentation with respect to this grant has not yet been executed, when executed, the grant will be effective as of October 24, 2005. The figures in the table above give effect to this anticipated grant.
(2) The number of securities remaining available for future issuance under the 2003 Stock Option Plan includes 5,555,555 options that are only authorized to be granted as “Top-Off Options.” Top-Off Options are only available for grant to then-existing option holders so that they are not diluted in the event that any of our preferred stock is converted into common stock. We currently have 1,976,612 non-Top-Off Options available for future grants under the 2003 Stock Option Plan.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
The following table sets forth information related to options outstanding and exercisable as of December 31, 2006:
(1) The aggregate intrinsic value for all options outstanding and exercisable as of December 31, 2006 was $0, since these options are not in-the-money.
(2) The Company’s Chief Executive Officer is entitled, pursuant to his employment contract, to receive a grant of stock options to purchase 6,500,000 shares of MQA’s common stock. Although the definitive documentation with respect to this grant has not yet been executed, when executed, the grant will be effective as of October 24, 2005. The figures in the table above give effect to this anticipated grant.
Prior to January 1, 2006, the Company used the intrinsic-value method of accounting for stock-based awards granted to employees and, accordingly, did not recognize compensation expense for its stock-based awards to employees. The Company recognized $37 in 2006 for stock based compensation awards which is included in marketing, general and administrative expenses in the Consolidated Statement of Operations.
18. Management and Services Scheduling Agreement
On October 20, 2004, the Company and One Call Medical, Inc. (“One Call”), a non-affiliated third party, entered into a Management and Services Scheduling Agreement (the “Agreement”) with respect to the operations of Occupational Solutions, Inc., a wholly owned subsidiary of the Company (“Occ Sol”). Under the Agreement, the Company licensed certain of Occ Sol’s intellectual property, including the Occupational Solutions name, leased office space and equipment to One Call and assigned all of its service contracts in exchange for which One Call agreed to pay the Company $2,100 in quarterly service fees over the term of the Agreement. According to GAAP, the transaction was deemed a sale of assets with a net book value of $0. This transaction gave rise to a receivable with a present value of approximately $1,500. The balance of this receivable at December 31, 2006 was approximately $598.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
19. Results of Quarterly Operations (unaudited)
Presented below are the unaudited quarterly consolidated statements of operations data for each of the eight quarters beginning January 1, 2005 and ending December 31, 2006. Such information, in the opinion of management, includes all adjustments necessary for a fair presentation of that information. The results of operations for any one quarter are not necessarily indicative of the results to be expected for any future quarter.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
20. Consolidating Financial Statements
The following tables present consolidating financial information as required for the years ended December 31, 2006, 2005 and 2004 for: 1) MQA (parent); 2) MedQuest (issuer); 3) the guarantors (on a combined basis) of the 117¤8% Notes (which represent all MedQuest subsidiaries) and 4) all eliminating adjustments. The consolidating financial statements presented reflect the legal entity compositions at the respective dates. Separate financial statements of MedQuest, as issuer of the 117¤8% Notes, and the subsidiary guarantors are not presented because each subsidiary guarantor is 100% owned by MQA, all guarantees are full and unconditional, and all guarantees are joint and several.
The Senior Credit Facility and the indenture governing the 117¤8% Notes impose certain restrictions on the Company, including restrictions on the Company’s ability to incur indebtedness, pay dividends, make investments, grant liens, sell assets and engage in certain other activities. In addition, the Senior Credit Facility requires the Company to maintain certain financial ratios. The Company’s indebtedness under the Senior Credit Facility is collateralized by substantially all of the Company’s assets, including inventory, accounts receivable, real and personal property, intellectual property and other intangibles, and is guaranteed by MQA and all of MedQuest’s subsidiaries.
MQ Associates. Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Consolidating Balance Sheets December 31, 2006
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share data)
Consolidating Balance Sheets December 31, 2005
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Operations
Year Ended December 31, 2006
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Operations
Year Ended December 31, 2005
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Operations
Year Ended December 31, 2004
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Cash Flows
Year Ended December 31, 2006
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Cash Flows
Year Ended December 31, 2006 (Continued)
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Cash Flows
Year Ended December 31, 2005
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Cash Flows
Year Ended December 31, 2005 (Continued)
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Cash Flows
Year Ended December 31, 2004
MQ Associates, Inc. & Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(in thousands)
Consolidating Statements of Cash Flows
Year Ended December 31, 2004 (Continued)
MQ ASSOCIATES, INC. AND SUBSIDIARIES
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2006
(in thousands)
(1) Includes write-off of contractual adjustments (representing the difference between our charge for a procedure and what we ultimately receive from payors) and write-off of uncollectible accounts.
EXHIBIT
NUMBER
EXHIBITS
2.1(1)
Recapitalization Agreement by and among MQ Investment Holdings, LLC, MQ Associates, the Stockholders of MQ Associates and David Lang and Gene Venesky, as Stockholders’ Representatives dated as of July 16, 2002.
2.2(1)
Amendment No. 1, dated as of August 8, 2002, to Recapitalization Agreement by and among MQ Investment Holdings, LLC, MQ Associates, the Stockholders of MQ Associates and David Lang and Gene Venesky, as Stockholders’ Representatives dated as of July 16, 2002.
3.1(1)
Certificate of Incorporation of MedQuest, Inc.
3.2(1)
By-laws of MedQuest, Inc.
3.3(1)
Fourth Amended and Restated Certificate of Incorporation of MQ Associates.
3.4(1)
Second Amended and Restated By-laws of MQ Associates.
3.5(18)
Certificate of Increase of MQ Associates, Inc.
4.1(1)
Indenture by and among MedQuest, Inc., MQ Associates, as guarantor, the subsidiary guarantors parties thereto, and Wachovia Bank, National Association, as Trustee dated as of August 15, 2002.
4.2(1)
Form of Senior Subordinated Note, Series B, due 2012 (included as exhibit B to the Indenture filed as Exhibit 4.1).
4.3(1)
Registration Rights Agreement by and among MedQuest, Inc., the guarantors listed therein, J.P. Morgan Securities Inc., UBS Warburg LLC and Wachovia Securities, Inc. dated as of August 15, 2002.
4.4(1)
First Supplemental Indenture, dated as of November 13, 2002, by and among MedQuest, Inc., MQ Associates, as guarantor, the subsidiary guarantors party to the Indenture, Town & Country Open MRI, LLC, Clayton Open MRI, LLC, Wisconsin Diagnostic Imaging, Inc., Vienna Diagnostic Imaging, Inc., and Wachovia Bank, National Association, as Trustee.
4.5(2)
Second Supplemental Indenture, dated as of December 20, 2002, by and among MedQuest, Inc., MQ Associates, as guarantor, the subsidiary guarantors party to the Indenture, as supplemented, Brunswick Diagnostic Imaging, LLC, and Wachovia Bank, National Association, as Trustee.
4.6(3)
Third Supplemental Indenture, dated as of June 19, 2003, by and among MedQuest, Inc., MQ Associates, Inc., as guarantor, the subsidiary guarantors party to the Indenture, Illinois Diagnostic Imaging, Inc. and Wachovia Bank, National Association, as Trustee
4.7(5)
Fourth Supplemental Indenture, dated as of December 17, 2003, by and among MedQuest, Inc., MQ Associates, Inc., as guarantor, the subsidiary guarantors party to the Indenture, Medical Scheduling of Missouri, LLC and Wachovia Bank, National Association, as Trustee.
4.8(5)
Fifth Supplemental Indenture, dated as of January 14, 2004, by and among MedQuest, Inc., MQ Associates, Inc., as guarantor, the subsidiary guarantors party to the Indenture, William S. Witt, Inc. and Wachovia Bank, National Association, as Trustee.
4.9(6)
Sixth Supplemental Indenture, dated as of May 10, 2004, by and among MedQuest, Inc., MQ Associates, Inc., as guarantor, the subsidiary guarantors party to the Indenture, Cape Fear Mobile Imaging, LLC and Wachovia Bank, National Association, as Trustee.
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4.10(15)
Seventh Supplemental Indenture dated as of August 15, 2005 among MedQuest, Inc., MQ Associates, Inc., the subsidiary guarantors named therein and Wachovia Bank, National Association, as trustee.
4.11(8)
Indenture by and among MQ Associates, Inc., and Wachovia Bank, National Association, as Trustee dated as of August 24, 2004
4.12(8)
Form of Senior Discount Note, Series B, due 2012 (included as exhibit B to the Indenture filed as Exhibit 4.11).
4.13(8)
Registration Rights Agreement by and among MQ Associates, Inc., J.P. Morgan Securities Inc. and Wachovia Capital Markets, LLC, dated as of August 24, 2004.
4.14(14)
First Supplemental Indenture dated as of August 15, 2005 between MQ Associates, Inc. and Wachovia Bank, National Association, as trustee.
4.15(19)
Stock Subscription Warrant of MQ Associates, Inc.
4.16(22)
Eighth Supplemental Indenture dated as of November 9, 2006, by and among MedQuest, Inc., MQ Associates, Inc., as guarantor, the subsidiary guarantors party to the Indenture, Northwest Diagnostic Imaging, Inc. and Bank of New York, as trustee.
10.1(7)
Amended and Restated Credit Agreement among MQ Associates, MedQuest, Inc., as Borrower, the Several Lenders from time to time parties hereto, JPMorgan Chase Bank, as Syndication Agent and Wachovia Bank, National Association, as Documentation Agent and Administrative Agent dated as of September 3, 2003.
10.2(8)
First Amendment to Amended and Restated Credit Agreement by and among MQ Associates, Inc., Medquest, Inc. as Borrower, the Several Lenders from time to time parties thereto and Wachovia Bank, National Association, as Administrative Agent, dated as of August 16, 2004.
10.3(9)
Limited Waiver and Agreement, dated as of February 14, 2005 among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.4(10)
Second Limited Waiver and Second Amendment to Amended and Restated Credit Agreement, dated as of March 30, 2005 among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.5(11)
Third Limited Waiver to Amended and Restated Credit Agreement, dated as of May 13, 2005, among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.6(12)
Amendment to Third Limited Waiver to Amended and Restated Credit Agreement, dated as of June 30, 2005, among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.7(13)
Restated Amendment to Third Limited Waiver to Amended and Restated Credit Agreement, effective as of July 29, 2005, among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
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10.8(16)
Letter Agreement in respect of Third Limited Waiver to Amended and Restated Credit Agreement, effective as of August 13, 2005, among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.9(17)
Letter Agreement in respect of Third Limited Waiver to Amended and Restated Credit Agreement, effective as of August 31, 2005, among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.10(20)
Fourth Waiver and Third Amendment to the Amended and Restated Credit Agreement, effective as of September 7, 2005, among MQ Associates, Inc., MedQuest, Inc., the Lenders identified on the signature pages thereto, and Wachovia Bank, National Association, as administrative agent for the Lenders.
10.11(1)
Credit Agreement by and among MQ Associates, MedQuest, Inc., as Borrower, the Several Lenders from time to time parties thereto and Wachovia Bank, National Association, as Administrative Agent dated as of August 15, 2002.
10.12(1)
Guarantee and Collateral Agreement by and among MQ Investment Holdings, LLC, MedQuest, Inc., as Borrower and certain of its subsidiaries in favor of Wachovia Bank, National Association, as Administrative Agent dated as of August 15, 2002.
10.13(1)
Registration Rights Agreement by and among MQ Associates and each of its stockholders dated August 15, 2002.
10.14(23)*
Amended and Restated Employment Agreement by and between Michael Villa and MedQuest, Inc. dated as of August 15, 2002.
10.15(24)*
Second Amended and Restated Employment Agreement by and among Daniel J. Schaefer, MQ Associates, Inc. and MedQuest, Inc., dated as of November 7, 2006.
10.16*
Amended and Restated Employment Agreement by and between Bruce W. Elder and MedQuest, Inc. dated as of March 29, 2007.
10.17(25)
Stockholders’ Agreement by and among MQ Associates and each of the stockholders named on Schedule I thereto dated August 15, 2002.
10.18(26)
Land and Building Lease by and between Image Properties, LLC and Palmetto Imaging, Inc. dated as of February 17, 1995 including Schedule I, which identifies substantially similar documents omitted and material differences in omitted documents from the agreement filed as Exhibit 10.11.
10.19(27)
Personal Guaranty by and between Image Properties, LLC and Palmetto Imaging, Inc. dated as of February 17, 1995 including Schedule I, which identifies substantially similar documents omitted and material differences in omitted documents form the agreement filed as Exhibit 10.12.
10.20(28)
Multi-Vendor Program Agreement by and between MedQuest Associates, Inc. and Philips Medical Systems North America, dated as of January 24, 2003. (A request for confidential treatment of certain omitted provisions of this exhibit has been submitted pursuant to Rule 406 of the Securities Act of 1933. The entire agreement has been filed separately with the Securities and Exchange Commission.)
10.21(29)
Service Maintenance Agreement by and between MQ Associates and Hitachi Medical Systems America, Inc., dated as of January 1, 2001.
10.22(4)*
2003 Stock Option Plan.
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10.23(30)
Corporate Compliance Plan.
10.24(31)*
Consulting Agreement by and among MQ Associates, Inc., Argus Management Corp. and John G. Haggerty, dated as of March 14, 2005.
10.25(32)
Amendment No.1 to Stockholders’ Agreement by and among MQ Associates and each of the stockholders named on Schedule I thereto, dated April 28, 2005.
10.26(33)*
First Amendment to MQ Associates, Inc. 2003 Stock Option Plan.
10.27(34)*
Form of Stock Option Agreement pursuant to MQ Associates, Inc. 2003 Stock Option Plan.
10.28(21)
Securities Purchase Agreement dated as of September 7, 2005 between MQ Associates, Inc. and MQ Investment Holdings II, LLC.
10.29(35)*
Employment Agreement by and among C. Christian Winkle, MQ Associates, Inc. and MedQuest, Inc., dated as of October 24, 2005.
10.30 (36)
Amendment No. 2 to Stockholders’ Agreement, by and among MQ Associates, Inc. and each of the stockholders named on Schedule I thereto, dated October 24, 2005.
10.31(37)*
Amended and Restated Employment Agreement by and among Todd W. Latz, MQ Associates, Inc. and MedQuest, Inc., dated as of January 1, 2006.
10.32(38)*
Employment Agreement by and among Todd E. Andrews, MQ Associates, Inc. and MedQuest, Inc., dated as of April 7, 2006.
10.33(39)
Amendment No. 3 to Stockholders’ Agreement, by and among MQ Associates, Inc. and each of the stockholders named on Schedule I thereto, dated May 12, 2006.
10.34(40)
Form of Land and Building Lease by and between Image Properties, LLC and MedQuest, Inc. subsidiaries dated as of August 31, 2006, including Schedule I, which identifies substantially similar documents omitted and material differences in omitted documents from the agreement filed as Exhibit 10.40.
12.1
Statement re: computation of ratios of earning to fixed charges.
21.1
List of subsidiaries of MQ Associates.
31.1
Certification of C. Christian Winkle pursuant to Rule 15d-14(a) of the Securities Exchange Act of 1934.
31.2
Certification of Todd E. Andrews pursuant to Rule 15d-14(a) of the Securities Exchange Act of 1934.
32.1
Certification of C. Christian Winkle pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Todd E. Andrews pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(1) Incorporated by reference to the exhibit of the same exhibit number as filed as an exhibit to Form S-4 as filed with the Commission on November 22, 2002 (Commission file number 333-101399)
(2) Incorporated by reference to the exhibit of the same exhibit number as filed as an exhibit to Amendment No. 1 to Form S-4 as filed with the Commission on December 31, 2002 (Commission file number 333-101399)
(3) Incorporated by reference to Exhibit 4.1 as filed as an exhibit to Form 10-Q for the quarter ended June 30, 2003.
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(4) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to Form 10-Q for the quarter ended June 30, 2003.
(5) Incorporated by reference to the exhibit of the same exhibit number as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2003.
(6) Incorporated by reference to Exhibit 4.9 as filed as an exhibit to MedQuest, Inc., Amendment No. 1 to Form S-1 as filed with the Commission on May 13, 2004 (Commission file number 333-114962).
(7) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 10-Q for the quarter ended September 30, 2003.
(8) Incorporated by reference to the exhibit of the same exhibit number as filed as an exhibit to Form S-4 as filed with the Commission on September 15, 2004 (Commission file number 333-118999).
(9) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed February 15, 2005.
(10) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed March 30, 2005.
(11) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed May 16, 2005.
(12) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed June 30, 2005.
(13) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed July 29, 2005.
(14) Incorporated by reference to Exhibit 4.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed August 15, 2005.
(15) Incorporated by reference to Exhibit 4.2 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed August 15, 2005.
(16) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed August 15, 2005.
(17) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed August 15, 2005.
(18) Incorporated by reference to Exhibit 3.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed September 8, 2005.
(19) Incorporated by reference to Exhibit 4.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed September 8, 2005.
(20) Incorporated by reference to Exhibit 10.1 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed September 8, 2005.
(21) Incorporated by reference to Exhibit 10.2 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed September 8, 2005.
(22) Incorporated by reference to the exhibit of the same exhibit number as filed as an exhibit to MQ Associates, Inc.’s Form 10-Q for the quarter ended September 30, 2006.
(23) Incorporated by reference to Exhibit 10.17 as filed as an exhibit to MQ Associates, Inc.’s Form S-4 as filed with the Commission on November 22, 2002 (Commission file number 333-101399).
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(24) Incorporated by reference to Exhibit 10.18 as filed as an exhibit to MQ Associates, Inc.’s Form 10-Q for the quarter ended September 30, 2006.
(25) Incorporated by reference to Exhibit 10.20 as filed as an exhibit to MQ Associates, Inc.’s Form S-4 as filed with the Commission on November 22, 2002 (Commission file number 333-101399).
(26) Incorporated by reference to Exhibit 10.21 as filed as an exhibit to MQ Associates, Inc.’s Form S-4 as filed with the Commission on November 22, 2002 (Commission file number 333-101399).
(27) Incorporated by reference to Exhibit 10.22 as filed as an exhibit to MQ Associates, Inc.’s Form S-4 as filed with the Commission on November 22, 2002 (Commission file number 333-101399).
(28) Incorporated by reference to Exhibit 10.23 as filed as an exhibit to MQ Associates, Inc.’s Amendment No. 1 to Form S-4 as filed with the Commission on December 31, 2002 (Commission file number 333-101399).
(29) Incorporated by reference to Exhibit 10.24 as filed as an exhibit to MQ Associates, Inc.’s Amendment No. 1 to Form S-4 as filed with the Commission on December 31, 2002 (Commission file number 333-101399).
(30) Incorporated by reference to Exhibit 10.26 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2003.
(31) Incorporated by reference to Exhibit 10.28 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2004.
(32) Incorporated by reference to Exhibit 10.32 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2004.
(33) Incorporated by reference to Exhibit 10.33 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2004.
(34) Incorporated by reference to Exhibit 10.34 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2004.
(35) Incorporated by reference to Exhibit 10.36 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2005.
(36) Incorporated by reference to Exhibit 10.37 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2005.
(37) Incorporated by reference to Exhibit 10.38 as filed as an exhibit to MQ Associates, Inc.’s Form 10-K for the year ended December 31, 2005.
(38) Incorporated by reference to Exhibit 10.39 as filed as an exhibit to MQ Associates, Inc.’s Form 10-Q for the quarter ended March 31, 2006.
(39) Incorporated by reference to Exhibit 10.40 as filed as an exhibit to MQ Associates, Inc.’s Form 8-K filed May 12, 2006.
(40) Incorporated by reference to Exhibit 10.40 as filed as an exhibit to MQ Associates, Inc.’s Form 10-Q for the quarter ended September 30, 2006.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(b) of Form 10-K.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
No annual report to security holders covering MQ Associates, Inc.’s last fiscal year or proxy statement, form of proxy or other proxy soliciting material has been sent to security holders covering the 2006 fiscal year or will be sent to security holders subsequent to the filing of this report.