<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
COMMISSION FILE NO. 0-20440
MEDICAL RESOURCES, INC.
(Exact Name Of Registrant As Specified In Its Charter)
DELAWARE 13-3584552
(State Of Incorporation) (IRS Employer
Identification No.)
155 STATE STREET, HACKENSACK, NJ 07601
(Address Of Principal Executive Office) (Zip Code)
Registrant's Telephone Number, Including Area Code: (201) 488-6230
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
At October 30, 1998, 9,177,374 shares of the registrant's Common Stock, par
value $.01 per share, were outstanding and the aggregate market value of the
Common Stock (based upon the NASDAQ closing price of these shares on that date)
held by non-affiliates was $20,179,000
DOCUMENTS INCORPORATED BY REFERENCE
Not Applicable.
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<PAGE>
MEDICAL RESOURCES, INC.
INDEX
<TABLE>
<CAPTION>
Pages
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets at September 30, 1998 and
December 31, 1997 3
Consolidated Statements of Operations for the three and nine
months ended September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6-15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16-25
PART II. OTHER INFORMATION 26-27
</TABLE>
2
<PAGE>
MEDICAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------------- --------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 16,409 $ 23,198
Cash and short-term investments, restricted 2,016 600
Accounts receivable, net 58,902 65,887
Other receivables 10,852 5,430
Prepaid expenses 6,887 7,027
Income taxes recoverable 6,700 6,504
Deferred tax assets, net 2,090 2,492
---------------- --------------
Total current assets 103,856 111,138
Property and equipment, net 54,384 64,343
Goodwill and other intangible assets, net 143,350 156,460
Deferred tax assets, net - 2,353
Other assets 2,692 4,662
---------------- --------------
Total assets $ 304,282 $ 338,956
================ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Long-term notes and mortgages payable, classified as current $ - $ 81,206
Capital lease obligations, classified as current - 9,555
Current portion of notes and mortgages payable 12,941 13,313
Current portion of capital lease obligations 8,951 10,311
Borrowings under line of credit - 3,744
Accounts payable 11,973 13,141
Accrued expenses 24,046 28,018
Common stock subject to redemption 4,045 9,734
Other current liabilities 1,667 290
---------------- --------------
Total current liabilities 63,623 169,312
Notes and mortgages payable, less current portion 94,178 21,539
Obligations under capital leases, less current portion 17,467 16,361
Other long term liabilities 926 178
---------------- --------------
Total liabilities 176,194 207,390
Minority interest 6,059 4,662
Stockholders' equity:
Common stock, $.01 par value; authorized 50,000 shares; issued
7,687 at September 30, 1998 and 7,296 at December 31, 1997 77 73
Series C Convertible Preferred Stock, $1,000 per share stated
value; issued 16 shares at September 30, 1998 and 18 shares
at December 31, 1997; liquidation preference 3% per annum 16,132 18,242
Additional paid-in capital 143,846 138,810
Accumulated deficit (38,026) (30,221)
---------------- --------------
Total stockholders' equity 122,029 126,904
---------------- --------------
Total liabilities and stockholders' equity $ 304,282 $ 338,956
================ ==============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
<PAGE>
MEDICAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------------- ---------------------------
1998 1997 1998 1997
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net service revenues $ 44,176 $ 42,022 $ 137,824 $ 106,740
Costs of operations:
Costs of services 27,797 21,222 86,129 55,839
Provision for doubtful accounts 3,377 2,042 10,684 5,795
Equipment leases 1,835 1,161 4,840 1,910
Depreciation and amortization 6,109 5,488 18,744 12,567
----------- ----------- ---------- ----------
Total costs of operations 39,118 29,913 120,397 76,111
Gross profit 5,058 12,109 17,427 30,629
Corporate general and administrative expenses 2,979 2,949 8,794 6,555
Stock-option based compensation 76 - 304 2,305
Unusual charges attributable to center closings 3,489 - 3,489 -
Other unusual charges 890 - 6,290 -
----------- ----------- ---------- ----------
Operating income (loss) (2,376) 9,160 (1,450) 21,769
Interest expense, net 3,484 2,543 10,396 5,276
----------- ----------- ---------- ----------
Income (loss) from continuing operations before
minority interest and income taxes (5,860) 6,617 (11,846) 16,493
Minority interest (benefit) 176 (306) 819 (499)
----------- ----------- ---------- ----------
Income (loss) from continuing operations before
income taxes (6,036) 6,923 (12,665) 16,992
Provision for income taxes 160 3,014 461 7,093
----------- ----------- ---------- ----------
Income (loss) from continuing operations (6,196) 3,909 (13,126) 9,899
Discontinued operations:
Gain on sale of discontinued operations, net of tax 3,905 - 3,905 -
Income from discontinued operations, net of tax 465 378 1,806 773
----------- ----------- ---------- ----------
Net income (loss) (1,826) 4,287 (7,415) 10,672
Charges related to convertible preferred stock (116) - (390) -
----------- ----------- ---------- ----------
Net income (loss) applicable to common
stockholders $ (1,942) $ 4,287 $ (7,805) $ 10,672
=========== =========== ========== ==========
Income (loss) per common share applicable to
common stockholders:
Basic -
Continuing operations $ (0.82) $ 0.56 $ (1.82) $ 1.48
Discontinued operations 0.57 0.05 0.77 0.11
----------- ----------- ---------- ----------
Net income (loss) per common share $ (0.25) $ 0.61 $ (1.05) $ 1.59
=========== =========== ========== ==========
Diluted -
Continuing operations $ (0.82) $ 0.49 $ (1.82) $ 1.33
Discontinued operations 0.57 0.05 0.77 0.10
----------- ----------- ---------- ----------
Net income (loss) per common share $ (0.25) $ 0.54 $ (1.05) $ 1.43
=========== =========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
<PAGE>
MEDICAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-------------------
CASH FLOWS FROM OPERATING ACTIVITIES: 1998 1997
---- ----
<S> <C> <C>
Net income (loss) $ (7,415) $ 10,672
---------------- -------------
Adjustments to reconcile net income to cash provided (used) by operations -
Depreciation and amortization 18,744 12,588
Provision for uncollectible accounts receivable 10,684 7,185
Deferred income tax provision - 1,137
Stock-option based compensation 304 2,305
Issuance of warrants and notes to preferred stockholder 3,644 -
Gain on sale of discontinued business (3,905) -
Other, net 1,397 (685)
Changes in operating assets and liabilities:
Accounts receivable (18,895) (29,396)
Other receivables (3,922) (13,372)
Prepaid expenses 139 (2,951)
Income taxes recoverable or payable 2,309 516
Other assets 864 531
Accounts payable and accrued expenses (4,919) 4,201
Other liabilities 2,125 3,951
---------------- -------------
Total adjustments 8,569 (13,990)
---------------- -------------
Net cash provided (used) by operating activities 1,154 (3,318)
---------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net proceeds from sale of discontinued business 28,814 -
Contingent consideration related to prior year acquisitions (2,833) -
Purchase of property and equipment (2,591) (4,542)
Acquisitions, net of cash acquired - (56,132)
Sale of short-term investments, net - 5,822
Other, net (943) (2,285)
---------------- -------------
Net cash provided (used) by investing activities 22,447 (57,137)
---------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of debt in connection with sale of discontinued business (13,786) -
Principal payments on notes and mortgages payable (10,666) (3,800)
Principal payments under capital lease obligations (8,241) (2,274)
Proceeds from issuance of other debt 6,950 2,859
Proceeds from Senior Notes, net of issuance costs - 77,113
Note and capital lease repayments from proceeds of Senior Notes - (13,764)
Proceeds from issuance of preferred stock, net 16,965
Proceeds from sale/leaseback transactions - 9,865
Note and capital lease repayments from proceeds of sale/leasebacks - (4,831)
Note and capital lease repayments in connection with acquisitions - (13,261)
Repurchase of Common Stock subject to redemption (4,775) -
Other, net 128 1,393
---------------- -------------
Net cash provided (used) by financing activities (30,390) 70,265
---------------- -------------
Net increase (decrease) in cash and cash equivalents (6,789) 9,810
Cash and cash equivalents at beginning of year 23,198 15,346
---------------- -------------
Cash and cash equivalents at end of period $ 16,409 $ 25,156
================ =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash refunded by (paid for) income taxes $ 972 $ (3,242)
Cash paid for interest (12,588) (5,240)
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
<PAGE>
MEDICAL RESOURCES, INC.
-----------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
------------------------------------------------------
1. DESCRIPTION OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
General
The accompanying unaudited consolidated financial statements of Medical
Resources, Inc. (the "Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete consolidated financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the interim periods are not necessarily indicative of the
results that may be expected for an entire year.
The unaudited consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
contained in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission (the "SEC") for the year ended December 31, 1997, as
amended, and in conjunction with Form S-1 declared effective by the SEC on
October 1, 1998.
In July 1998, the Company's shareholders approved a reverse stock split of
the Company's outstanding shares of Common Stock. As a result of the reverse
stock split, each three outstanding shares of Common Stock were automatically
converted into one share of new Common Stock. The share data included in this
Form 10-Q have been adjusted to reflect the impact of the reverse stock split.
The Company has been notified by NASDAQ that it is being reviewed for
continued listing on NASDAQ's National Market System due to its failure to
continue to meet the $5.00 minimum bid price requirement. The Company has until
January 15, 1999 to satisfy the listing requirements. In the event it is unable
to meet the requirements for continued listing on the National Market System,
the Company will attempt to move its listing to NASDAQ's SmallCap Market. No
assurance can be given that the Company will be successful in that regard.
The Company
The Company operates and manages primarily fixed-site, free-standing
outpatient medical diagnostic imaging facilities (herein referred to as
"centers"), and provides diagnostic imaging network management services to
managed care providers. The Company, through its wholly owned subsidiary, Dalcon
Technologies, Inc., also develops and markets software products and systems for
the diagnostic imaging industry.
Until August 1998, the Company, through the Per Diem and Travel Nursing
divisions of its wholly-owned subsidiaries, StarMed Staffing, Inc. and Wesley
Medical Resources Inc. ("StarMed"), provided temporary healthcare staffing of
registered nurses and other medical personnel to acute and sub-acute care
facilities nationwide. On August 18, 1998, the Company sold the stock of StarMed
to RehabCare Group, Inc. (the "StarMed Sale"). Due to the StarMed Sale, the
results of operations of StarMed are herein reflected in the Company's
Consolidated Statements of Operations as discontinued operations (see Note 6).
6
<PAGE>
Revenue Recognition
At each of the Company's diagnostic imaging centers, all medical services
are performed exclusively by physician groups (the "Physician Group" or the
"Interpreting Physician"), generally consisting of radiologists with whom the
Company has entered into independent contractor agreements. Pursuant to these
agreements, the Company has agreed to provide equipment, premises, comprehensive
management and administration, including responsibility for billing and
collection of receivables, and technical imaging services to the Interpreting
Physician.
Net service revenues are reported, when earned, at their estimated net
realizable amounts from patients, third party payors and others for services
rendered at contractually established billing rates which generally are at a
discount from gross billing rates. Known and estimated differences between
contractually established billing rates and gross billing rates ("contractual
allowances") are recognized in the determination of net service revenues at the
time services are rendered. Subject to the foregoing, the Company's imaging
centers recognize revenue under one of the three following types of agreements
with Interpreting Physicians:
Type I - The Company receives a technical fee for each diagnostic imaging
procedure performed at a center, the amount of which is dependent upon the
type of procedure performed. The fee included in revenues is net of
contractual allowances. The Company and the Interpreting Physician
proportionally share in any losses due to uncollectible amounts from
patients and third party payors, and the Company has established reserves
for its share of the estimated uncollectible amount.
Type II - The Company bills patients and third party payors directly for
services provided and pays the Interpreting Physicians either (i) a fixed
percentage of fees collected at the center, or (ii) a contractually fixed
amount based upon the specific diagnostic imaging procedures performed.
Revenues are recorded net of contractual allowances and the Company
accrues the Interpreting Physician fee as an expense on the Consolidated
Statements of Operations. The Company bears the risk of loss due to
uncollectible amounts from patients and third party payors, and the
Company has established reserves for the estimated uncollectible amount.
Type III - The Company receives from an affiliated physician association a
fee for the use of the premises, a fee per procedure for acting as billing
and collection agent and a fee for administrative and technical service
performed at the centers. The affiliated physician association contracts
with and pays directly the Interpreting Physicians. The Company's fee, net
of an allowance based upon the affiliated physician association's ability
to pay after the association has fulfilled its obligations (i.e.,
estimated future net collections from patients and third party payors less
facility lease expense and Interpreting Physicians fees), constitutes the
Company's net service revenues. Since the Company's net service revenues
are dependent upon the amount ultimately realized from patient and third
party receivables, the Company's revenue and receivables have been reduced
by an estimate of patient and third party payor contractual allowances, as
well as an estimated provision for uncollectible amounts from patients and
third party payors.
Revenues derived from Medicare and Medicaid are subject to audit by such
agencies. The Company is not aware of any pending audits.
The Company also recognizes revenue from the sale of radiology information
systems. Such revenues are recognized on an accrual basis as earned.
7
<PAGE>
Cost of Services
Cost of services as shown on the Consolidated Statement of Operations for
the three month and nine month periods ended September 30, 1998 and 1997 consist
of the following (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operations payroll and related costs $10,310 $ 9,602 $31,811 $22,192
Equipment maintenance expense 2,884 1,147 8,493 4,533
Contract radiology fees 2,046 1,239 6,393 4,064
Medical supplies 2,368 2,357 8,527 6,241
Facilities rent and related costs 3,022 2,356 8,425 6,009
Sales and marketing expenses and other center level costs 6,777 4,521 21,856 12,800
------- ------- ------- -------
Total Diagnostic Imaging 27,407 21,222 85,505 55,839
Dalcon Technologies, Inc. 390 - 624 -
------- ------- ------- -------
Total Company $27,797 $21,222 $86,129 $55,839
======= ======= ======= =======
</TABLE>
Reclassification and Restatement
The Consolidated Statement of Operations for the nine month period ended
September 30, 1997 has been restated to include a non-cash charge of $2,305,000
for compensation expense resulting from stock options granted in 1996 and early
1997 that were approved by the Company's stockholders in May 1997. In addition,
certain prior year amounts have been reclassified to conform to the current year
presentation.
Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130").
SFAS No. 130 requires an entity to report comprehensive income and its
components and increases financial reporting disclosures. This standard has no
impact on the Company's financial position, cash flows or results of operations
since the Company's comprehensive income is the same as its reported net income.
Earnings Per Share
Effective for the year ended December 31, 1997, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share." This statement requires the presentation of Basic Earnings per Share and
Diluted Earnings per Share. Basic earnings per share is based on the weighted
average number of common shares outstanding during the period. Diluted earnings
per share is based on the weighted average number of common shares outstanding
during the period plus the potentially issuable common shares related to
outstanding stock options, warrants and convertible debt. Earnings per share
amounts for the three and nine months ended September 30, 1997 have been
restated to conform to the requirements of SFAS No. 128.
8
<PAGE>
The computations of basic earnings per share and diluted earnings per share
for the three and nine months ended September 30, 1998 and 1997 were as follows
(in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic earnings (loss) per share information
- -------------------------------------------
Income (loss) from continuing operations $(6,196) $3,909 $(13,126) $ 9,899
Total income from discontinued operations 4,370 378 5,711 773
------- ------ -------- -------
Net income (loss) (1,826) 4,287 (7,415) 10,672
Charges related to convertible preferred stock (116) - (390) -
------- ------ -------- -------
Net income (loss) applicable to common stockholders $(1,942) $4,287 $ (7,805) $10,672
======= ====== ======== =======
Weighted average number of common shares 7,687 6,986 7,433 6,696
======= ====== ======== =======
Net income (loss) per share before discontinued operations $ (0.82) $ 0.56 $ (1.82) $ 1.48
Discontinued operations 0.57 0.05 0.77 0.11
------- ------ -------- -------
Basic earnings (loss) per share $ (0.25) $ 0.61 $ (1.05) $ 1.59
======= ====== ======== =======
Diluted earnings (loss) per share information
- ---------------------------------------------
Income (loss) from continuing operations $(6,196) $3,909 $(13,126) $ 9,899
Total income from discontinued operations 4,370 378 5,711 773
------- ------ -------- -------
Net income (loss) (1,826) 4,287 (7,415) 10,672
Charges related to convertible preferred stock (116) - (390) -
------- ------ -------- -------
Net income (loss) applicable to common
stockholders after assumed conversions $(1,942) $4,287 $ (7,805) $10,672
======= ====== ======== =======
Weighted average number of common shares 7,687 6,986 7,433 6,696
Incremental shares issuable on exercise of warrants
and options - 629 - 435
Incremental shares issuable on conversion of
convertible subordinated debentures - 335 - 335
------- ------ -------- -------
Weighted average number of diluted common shares 7,687 7,950 7,433 7,466
======= ====== ======== =======
Net income (loss) per share before discontinued operations $ (0.82) $ 0.49 $ (1.82) $ 1.33
Discontinued operations 0.57 0.05 0.77 0.10
------- ------ -------- -------
Diluted earnings (loss) per share $ (0.25) $ 0.54 $ (1.05) $ 1.43
======= ====== ======== =======
</TABLE>
2. BASIS OF FINANCIAL STATEMENT PRESENTATION AND ISSUES AFFECTING LIQUIDITY
As a result of its net loss for 1997 and the late filing of its 1997 Annual
Report on Form 10-K, the Company was in default of certain financial covenants
under its $78,000,000 of Senior Notes. The financial covenant defaults under
the Senior Note agreements entitled the lenders to exercise certain remedies
including acceleration of repayment. In addition, certain medical equipment
notes, and operating and capital leases of the Company (the "Cross-Default
Debt"), contain provisions which allow the creditors or lessors to accelerate
their debt or terminate their leases and seek certain other remedies if the
Company is in default under the terms of agreements such as the Senior Notes.
9
<PAGE>
In the event that the Senior Note lenders or the holders of the Cross
Default Debt elected to exercise their right to accelerate the obligations under
the Senior Notes or the other loans and leases, such acceleration would have had
a material adverse effect on the Company, its operations and its financial
condition. Furthermore, if such obligations were accelerated, in whole or in
part, there could be no assurance that the Company would have been successful in
identifying or consummating financing necessary to satisfy the obligations which
would have become immediately due and payable. As a result of the uncertainty
related to the defaults and corresponding remedies described above, the Senior
Notes and the Cross Default Debt were shown as current liabilities on the
Company's Consolidated Balance Sheets at December 31, 1997. As a result of these
matters, as well as other issues, there was substantial doubt about the
Company's ability to continue as a going concern. The report of the Company's
independent auditors, Ernst & Young LLP, on the consolidated financial
statements of the Company for the year ended December 31, 1997 contains an
explanatory paragraph with respect to these issues. The December 31, 1997
financial statements did not include any further adjustments reflecting the
possible future effects on the recoverability and classification of assets or
the amount and classification of liabilities that may have resulted from the
outcome of this uncertainty.
In October 1998, management reached an agreement with the Senior Note
lenders with respect to a waiver of all existing covenant defaults and a
modification of the financial covenants applicable over the remaining term of
the Senior Notes. In consideration for this waiver and amendment, the Company
has agreed to increase the effective blended interest rate on the Senior Notes
from 7.87% to 9.00%, and issued to the Senior Note lenders warrants to acquire
375,000 shares of the Company's Common Stock at an exercise price of $7.67 per
common share. The warrants had an estimated value of $503,000 which will be
recorded as deferred financing expense and amortized over the remaining term of
the Senior Notes. In addition, the Company prepaid $2,000,000 of principal
outstanding on the Senior Notes (without premium) and paid a fee to the Senior
Note lenders of $500,000. As a result of the execution of the waiver and
amendment with respect to the Senior Notes, the Senior Notes and the Cross
Default Debt are no longer in default and have been shown as long-term debt in
the September 30, 1998 Consolidated Balance Sheet.
3. UNUSUAL CHARGES
In July 1998, the Company completed a review of under-performing centers
and determined that it would sell or close eight imaging centers during the
third and fourth quarters of 1998. In most cases, the Company decided to sell
or close these centers due to general competitive pressures and because of their
close proximity to other imaging centers of the Company which have more advanced
imaging equipment. During the three months ended September 30, 1998, the
Company recorded unusual charges attributable to center closings of $3,489,000,
consisting of (i) $1,602,000 for the estimated costs to exit equipment lease and
maintenance agreements and facility lease agreements, (ii) $1,481,000 for the
write-off of fixed assets, goodwill and other intangibles and other assets, and
(iii) $406,000 for estimated equipment removal, facility restoration and related
costs.
In addition, other unusual charges were recorded during the three months
ended September 30, 1998 of $890,000, consisting of (i) $380,000 for
professional fees attributable to obtaining the waiver and amendment under the
Company's Senior Note obligations, (ii) $360,000 for penalties associated with
the delay in the effectiveness of the Company's Registration Statement (which
has now become effective) and (iii) $150,000 for defense costs relating to
shareholder and employee lawsuits.
During the nine months ended September 30, 1998, the Company recorded
unusual charges attributable to center closings of $3,489,000, as described
above, and other unusual charges of $6,290,000, including the $890,000 recorded
during the third quarter of 1998. The other unusual charges consist of (i)
$3,827,000 ($1,194,000 of which was a non-cash charge related to the issuance of
117,000 common stock warrants) for penalties associated with the delay in the
effectiveness the Company's Registration Statement (which has now become
effective), (ii) $863,000 for defense costs relating to shareholder and employee
lawsuits, (iii) $883,000 for costs associated with the investigation of related
party transactions which was concluded in April 1998, (iv) $380,000 for
professional fees attributable to obtaining the waiver and amendment under the
Company's Senior Note obligations and (v) $337,000 for management termination
benefits and related costs.
10
<PAGE>
The Company could incur a substantial additional amount of unusual charges
during the remainder of 1998 depending upon the outcome of shareholder and
employee lawsuits and current negotiations with the holders of the Series C
Preferred Stock regarding additional penalties associated with the failure to
timely register the Company's Common Stock.
4. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net, is comprised of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Management fee receivables (net of contractual allowances)
Due from unaffiliated physicians (Type I revenues) $ 40,426 $ 35,540
Due from affiliated physicians (Type III revenues) 6,209 8,585
Patient and third party payor accounts receivable (Type II
Revenues) 36,173 27,551
-------- --------
Gross diagnostic imaging and Dalcon accounts receivable 82,808 71,676
Less related allowance for doubtful accounts (23,906) (18,445)
-------- --------
Diagnostic imaging and Dalcon accounts receivable, net 58,902 53,231
Temporary staffing service accounts receivable, net - 12,656
-------- --------
$ 58,902 $ 65,887
======== ========
</TABLE>
Accounts receivable is net of contractual allowances, which represent
standard fee reductions negotiated with certain third party payors. Contractual
allowances amounted to approximately $32,849,000 and $25,712,000 for the three
months ended September 30, 1998 and 1997, respectively, and approximately
$92,114,000 and $56,805,000 for the nine months ended September 30, 1998 and
1997, respectively.
5. COMMITMENTS AND CONTINGENCIES
Between November 1997 and January 1998, several lawsuits were commenced
against the Company, certain of the Company's Directors and certain officers
concerning certain related party transactions that have since been investigated
by a Special Committee of the Board of Directors ("Special Committee"). The
complaints in each action assert that the Company and the named defendants
violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934,
alleging that the Company omitted and/or misrepresented material information in
its public filings, including that the Company failed to disclose that it had
entered into acquisitions that were not in the best interest of the Company,
that it had paid unreasonable and unearned acquisition and financial advisory
fees to related parties, and that it concealed or failed to disclose adverse
material information about the Company. Each action seeks unspecified
compensatory damages, with interest, and the costs and expenses incurred in
bringing the action. On February 9, 1998, the above-mentioned class actions were
consolidated for all purposes in federal district court in New Jersey. On March
31, 1998, the lead plaintiffs in the consolidated class actions served their
Consolidated Class Action Complaint, asserting that the Company and the named
defendants violated Section 10(b) of the Exchange Act, and that certain named
defendants violated Sections 20(a) and 20A of the Exchange Act. The Company
intends to defend vigorously against the allegations.
The Special Committee issued the results of its investigation and certain
recommendations in a report to the Company's Board of Directors and on April 6,
1998, the Company's Board of Directors voted to adopt the recommendations
contained in the report. Accordingly, the Special Committee recommended and 712
Advisory Services, Inc., a financial advisory firm and affiliate of the
Company's Chairman of the Board (the "Affiliate"), agreed to reimburse the
Company approximately $1,424,000 in fees for transactions completed after June
1, 1997, to reimburse $112,500 of the retainer paid to the Affiliate for 1997,
to waive payment of an additional $112,500 of fees accrued by the Company for
the third and fourth quarters of 1997, and to pay a substantial amount of the
expenses associated with the Special Committee's investigations. All such
amounts have been paid or reimbursed to the
11
<PAGE>
Company. In addition, the Special Committee recommended and the Affiliate agreed
to allow the Company to terminate its relationship with the Affiliate.
The Special Committee reported to the directors that it had determined
that: (i) there was no evidence of any federal or state crimes or securities law
violations in connection with the related party transactions in question; (ii)
all related-party matters were disclosed in public filings; (iii) the Affiliate
performed acquisition advisory services fully consistent with the expectations
and understanding of the committee of outside directors that had approved the
Affiliate's acquisition fees; and (iv) the acquisition advisory fees paid to the
Affiliate in connection with the Company's acquisitions in 1997 were within the
range of customary acquisition advisory fees paid to investment bankers on
transactions of similar size.
As previously announced by the Company, the U.S. Attorney for the District
of New Jersey commenced an investigation in connection with the disclosures
regarding the related party transactions referred to above. In addition, the
Company has also received an inquiry from the SEC, but there have been no formal
proceedings commenced by the SEC. The Company has cooperated fully with these
authorities and provided all information requested by them.
On November 7, 1997, the Company accepted the resignations of William D.
Farrell, as President and Chief Operating Officer of the Company and as
Director, and Gary I. Fields, as Senior Vice President and General Counsel. On
the same date, Messrs. Farrell and Fields filed a complaint in the Superior
Court of New Jersey, Law Division, Essex County, against the Company and the
members of the Company's Board of Directors, claiming retaliatory discharge
under the New Jersey Conscientious Employee Protection Act and breach of
contract. On December 17, 1997, the plaintiffs amended their complaint to add a
claim for violation of public policy. The plaintiffs allege that they were
constructively terminated as a result of their objection to certain related-
party transactions, the purported failure of the defendants to adequately
disclose the circumstances surrounding such transactions, and the Company's
public issuance of alleged false and misleading accounts concerning or relating
to such related-party transactions. The plaintiffs seek unspecified compensatory
and punitive damages, interest and costs and reinstatement of the plaintiffs to
their positions with the Company. On April 8, 1998, the Company filed its Answer
to the Amended Complaint, and asserted a counterclaim against Messrs. Farrell
and Fields for breach of fiduciary duties. The Company intends to defend
vigorously against the allegations.
On November 8, 1997, the Company removed John P. O'Malley III, the
Company's Chief Financial Officer, for failure to fulfill certain of his
functions as Chief Financial Officer. Mr. O'Malley has filed a complaint in the
Superior Court of New Jersey, Law Division, Essex County, against the Company
and members of the Board of Directors, as defendants, claiming retaliatory
discharge under the New Jersey Conscientious Employee Protection Act and
defamation. Mr. O'Malley alleges that the Company terminated his employment in
retaliation for voicing the concerns of shareholders and senior management
regarding related-party transactions and because the Company did not want to
make full and adequate disclosure of the facts and circumstances surrounding
such transactions. In addition, Mr. O'Malley alleges that the Company published
false and defamatory statements about him. Mr. O'Malley seeks unspecified
compensatory and punitive damages, interest and costs of bringing the action. On
April 8, 1998, the Company filed its Answer to the Complaint, and asserted a
counterclaim against Mr. O'Malley for breach of fiduciary duties. The Company
intends to defend vigorously against the allegations.
The legal proceedings described above are in their preliminary stages.
Although the Company believes it has meritorious defenses to all claims against
it, the Company is unable to predict with any certainty the ultimate outcome of
these proceedings.
In 1996, Lavina Orsi and Pompeo Orsi brought an action in the Supreme Court
of the State of New York, King's County against Advanced MRA Imaging Associates
in Brooklyn, New York, a wholly owned subsidiary of the Company ("MRA Imaging"),
for damages aggregating $12,500,000. The plaintiff alleges negligent operations,
improper supervision and hiring practices and the failure to operate the
premises in a safe manner, as a result of which the individual suffered physical
injury. The Company's general liability and professional negligence insurance
carriers have been notified, and it has been agreed that the general liability
insurance will pursue the defense of this matter, however, such insurers have
reserved the right to claim that the scope of the matter falls outside the
Company's coverage. The parties to this matter are engaged in discovery. The
Company believes it has meritorious
12
<PAGE>
defenses to all claims against it and therefore is of the opinion that the
Company will not incur any material settlement cost, net of insurance proceeds
(if any). Accordingly, the Company has made no accrual for any costs associated
with such litigation under SFAS No. 5.
In the normal course of business, the Company is subject to claims and
litigation other than those set forth above. Management believes that such
other litigation will not have a material adverse effect on the Company's
financial position, cash flows or results of operations. Accordingly, the
Company has made no accrual for any costs associated with such litigation under
SFAS No. 5.
In connection with certain of the Company's 1997 acquisitions in which the
Company issued shares of its Common Stock as partial consideration, the Company
granted rights to have such shares registered for resale pursuant to the federal
securities laws. In certain of such acquisitions, the Company has granted
specific remedies to the sellers in the event that the registration statement
covering the relevant shares is not declared effective by the Securities and
Exchange Commission within an agreed-upon period of time, including the right to
require the Company to repurchase the shares issued to such seller. During
1997, the Company entered into an agreement to set the purchase price per common
share related to certain shares covered by a repurchase agreement to the then
current market price in exchange for additional time to obtain registration of
such shares. The increased amount of such repurchase obligation of $1,696,000
was charged to retained earnings and shown as an increase in the Common Stock
subject to redemption of the Consolidated Balance Sheet. As of September 30,
1998 and December 31, 1997, the Company had reflected $4,045,000 and $9,734,000,
respectively, of Common Stock subject to redemption on its Consolidated Balance
Sheet related to shares that the Company may be required to repurchase. During
the first nine months ended September 30, 1998, the Company paid $4,775,000 to
sellers who exercised their rights to have shares of Common Stock repurchased.
The Company expects to pay an additional $4,045,000 during the remainder of
1998.
In addition, in connection with certain of such acquisitions, the Company
has agreed with the sellers in such acquisitions to pay to the sellers (in
additional shares and/or cash) an amount equal to the shortfall in the value of
the issued shares in the event the market value of such shares at the relevant
effective date of the registration statement or other negotiated date is less
than the market value of such shares as of the closing of the acquisition or, in
other cases, as of the execution of the relevant acquisition agreement (referred
to as "Price Protection"). Any such Price Protection payments will be charged
to stockholders' equity. During October 1998, the Company issued 590,147 shares
related to certain Price Protection obligations and expects to pay an additional
$1,659,000 in cash related to Price Protection obligations, excluding Price
Protection obligations related to the shares which have repurchase obligations,
referred to above.
In addition, in connection with certain of the Company's acquisitions, the
Company has agreed with the relevant sellers that all or a portion of the
consideration for such acquisitions will be paid on a contingent basis based
upon the profitability, revenues or other financial criteria of the acquired
business during an agreed-upon measurement period following the closing of the
acquisition (usually, one to three years). The specific terms of such contingent
consideration differ for each acquisition. In connection with certain
acquisitions, the Company and the relevant sellers have agreed to a maximum
amount of contingent consideration and in other cases the parties have agreed
that any payment of such contingent consideration may be paid in cash or shares
of Common Stock, or a combination of both. Although the Company has the option,
in certain cases, to pay certain of such amounts in shares of Common Stock,
payment of significant cash funds to sellers in the event such earnout
provisions are triggered could have a material adverse effect on the Company's
cash flow and financial condition. In addition, the Company may be required to
finance all or a portion of any such cash payments from third-party sources. No
assurance can be given that such capital will be available on terms acceptable
to the Company. In addition, the issuance by the Company of shares of Common
Stock in payment of any such owed amounts could be dilutive to the Company's
stockholders. Contingent consideration associated with acquisitions is
recorded as additional purchase price when resolved.
Pursuant to the terms of the Series C Convertible Preferred Stock Purchase
Agreement, dated July 21, 1997, and the Registration Rights Agreement dated July
21, 1997, as amended, between the Company and RGC International, LDC ("RGC")
(hereinafter referred to as the "RGC Agreements"), the Company issued 18,000
shares of Series C Convertible Preferred Stock, $1,000 stated value per share
(the "Series C Preferred Stock") to RGC. Under the RGC Agreements, the Company
was required to use its best efforts to include the shares of Common Stock
13
<PAGE>
issuable upon conversion of the Series C Preferred Stock (the "RGC Conversion
Shares") in an effective Registration Statement not later than October 1997. As
amended, the RGC Agreements provided for monthly penalties through July 23, 1998
("RGC Registration Penalties") in the event that the Company failed to register
the Conversion Shares prior to certain dates.
Each share of the Series C Preferred Stock is convertible into such number
of shares of Common Stock as is determined by dividing the stated value ($1,000)
of each share of Series C Preferred Stock plus 3% per annum from the closing
date to the conversion date by the lesser of (i) $62.10 or (ii) the average of
the daily closing bid prices for the Common Stock for the (5) five consecutive
trading days ending five (5) trading days prior to the date of conversion. On
June 18, 1998, 2,500 shares of Series C Preferred Stock were converted into
373,000 shares of Common Stock. Accordingly, as of September 30, 1998, 15,500
shares of the Company's Series C Preferred Stock were issued and outstanding.
On November 10, 1998, an additional 600 shares of Series C Preferred Stock were
converted into 342,000 shares of Common Stock.
As a result of the Company's failure to register the RGC Conversion Shares
until October 1, 1998, the Company: (i) issued warrants to RGC to acquire
389,000 shares of Common Stock at an exercise prices ranging from $34.86 to
$38.85 per share, subject to reset in November 1998 (such warrants having an
estimated value, for accounting purposes, of $3,245,000); and (ii) issued
interest bearing promissory notes (the "RGC Penalty Notes") in the aggregate
principal amount of $2,450,000 due October 15, 1998. The principal amount of and
interest accrued on the RGC Penalty Notes may be converted, at the option of the
Company or RGC in certain circumstances, into additional shares of Series C
Preferred Stock or Common Stock. From and after July 23, 1998, pursuant to an
amendment to the RGC Agreements entered into in June 1998, the Company is no
longer subject to monthly penalties for failure to register the RGC Conversion
Shares, except that RGC may presently elect a one-time penalty of $1,550,000
(the "September 1998 Penalty") because the RGC Conversion Shares were not
registered by September 15, 1998. The September 1998 Penalty, if it shall become
due by election of RGC, shall be payable, at the option of RGC, in cash or
additional shares of Common Stock.
On October 15, 1998, the Company did not pay RGC the $2,450,000 that was
then due and payable under the RGC Penalty Notes. Additional, as discussed
above, RGC may demand the September 1998 Penalty of $1,550,000. The Company and
RGC are currently in discussions regarding the restructuring of the Penalty
Notes and the September 1998 Penalty, but there can be no assurance that the
Company will be successful in restructuring the Penalty Notes on terms favorable
to the Company or its shareholders. Purchasers of Common Stock could therefore
experience substantial dilution upon additional conversion of the Series C
Preferred Stock, any conversion of RGC Penalty Notes into Common Stock and the
impact of the exercise of warrants held by RGC. The shares of Series C
Preferred Stock are not registered and may be sold only with the express written
consent of the Company and if registered under the Act or sold in accordance
with an applicable exemption from registration, such as Rule 144.
6. DISCONTINUED OPERATIONS
On August 18, 1998, the Company sold the stock of StarMed to RehabCare
Group, Inc. for gross proceeds of $33,000,000 (the "StarMed Sale"). Due to the
StarMed Sale, the results of operations of StarMed are herein reflected in the
Company's Consolidated Statements of Operations as discontinued operations.
Net cash proceeds from the StarMed Sale were used as follows: (i)
$13,786,000 was used to retire StarMed's outstanding third-party debt (in
accordance with the terms of sale) (ii) $2,000,000 was placed in escrow to be
available, for a specified period of time, to fund indemnification obligations
that may be incurred by the Company (part or all of this amount may be payable
to the Company over time), (iii) an additional $2,000,000 was applied as a
partial repayment of the Company's $78,000,000 of Senior Notes, and (iv)
$2,186,000 was used to fund cash costs associated with the sale. The remaining
net proceeds of $13,028,000 increased the Company's consolidated cash balances.
For accounting purposes, an after-tax gain on sale of $3,905,000 was reported in
the third quarter of 1998.
The table on the following page shows summary balance sheets for StarMed as
of December 31, 1997 (in thousands):
14
<PAGE>
<TABLE>
<S> <C>
ASSETS
Cash and cash equivalents $ 455
Accounts receivable, net 12,657
Other current assets 279
-------
Total current assets 13,391
Property and equipment, net 428
Goodwill, net 10,442
Other assets 218
-------
Total assets $24,479
=======
LIABILITIES AND STOCKHOLDER'S EQUITY
Current notes and mortgages payable and line of credit $ 4,594
Debt due parent 4,000
Accounts payable and accrued expenses 2,229
-------
Total current liabilities 10,823
Notes and mortgages payable, less current portion 2,827
Debt due parent 6,279
Equity 4,550
-------
Total liabilities and stockholder's equity $24,479
=======
</TABLE>
The following table shows summary statements of operations for StarMed
through August 15, 1998, the date of sale (in thousands):
<TABLE>
<CAPTION>
For the Three For the Nine
Months Ended Months Ended
September 30 September 30
------------ ------------
1998 1997 1998 1997
---- ---- ---- ----
(a) (a)
<S> <C> <C> <C> <C>
Net service revenues $10,780 $15,537 $51,087 $41,484
Office level operating costs and provisions
for uncollectible accounts receivable 8,371 12,310 40,568 33,458
Corporate general and administrative 1,482 2,070 7,394 5,558
Depreciation and amortization 80 163 414 426
------- ------- ------- -------
Operating income 847 994 2,711 2,042
Interest expense, net 382 100 788 216
------- ------- ------- -------
Income before income taxes 465 894 1,923 1,826
Provision for income taxes - 516 117 1,053
------- ------- ------- -------
Income after income taxes 465 378 1,806 773
Gain on sale of StarMed (after tax of $250) 3,905 - 3,905 -
------- ------- ------- -------
Total income from discontinued operations $ 4,370 $ 378 $ 5,711 $ 773
======= ======= ======= =======
</TABLE>
(a) 1998 amounts reflect results through August 15, 1998, the date of
sale of StarMed.
In June 1998, an individual filed a complaint against the Company,
StarMed, Wesley Medical Resources, Inc., a subsidiary of the Company ("Wesley"),
and certain officers and directors of the Company in the United States District
Court for the Northern District of California. The complaint, among other
things, alleges that the defendants omitted and/or misrepresented material
information in the Company's public filings and that they concealed or failed to
disclose material adverse information about the Company in connection with the
sale of Wesley to the Company by the plaintiff. The plaintiff seeks damages in
the amount of $4.25 million or, alternatively, recission of the sale of Wesley.
The Company believes that it has meritorious defenses to the claims asserted by
plaintiff, and intends to defend itself vigorously. In July 1998, the Company
and the named defendants filed a motion to dismiss the plaintiff's complaint on
numerous grounds. On October 7, 1998, the action was transferred for pre-trial
proceedings to the United States District Court of New Jersey. The legal
proceeding described above is in its preliminary stages. Although the Company
believes it has meritorious defenses to all claims against it, the Company is
unable to predict with any certainty the ultimate outcome of such proceeding.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF CONTINUING OPERATIONS
REVENUE RECOGNITION
At each of the Company's diagnostic imaging centers, all medical services
are performed exclusively by physician groups (the "Physician Group" or the
"Interpreting Physician"), generally consisting of radiologists with whom the
Company has entered into independent contractor agreements. Pursuant to these
agreements, the Company has agreed to provide equipment, premises, comprehensive
management and administration, including responsibility for billing and
collection of receivables, and technical imaging services to the Interpreting
Physician.
Net service revenues for the Diagnostic Imaging segment are reported, when
earned, at their estimated net realizable amounts from patients, third party
payors and others for services rendered at contractually established billing
rates which generally are at a discount from gross billing rates. Known and
estimated differences between contractually established billing rates and gross
billing rates (referred to as "contractual allowances") are recognized in the
determination of net service revenues at the time services are rendered. Subject
to the foregoing, the Company's diagnostic imaging centers recognize revenue
under one of the three following types of agreements with Interpreting
Physicians:
Type I - The Company receives a technical fee for each diagnostic imaging
procedure performed at a center, the amount of which is dependent upon the type
of procedure performed. The fee included in revenues is net of contractual
allowances. The Company and the Interpreting Physician proportionally share in
any losses due to uncollectible amounts from patients and third party payors,
and the Company has established reserves for its share of the estimated
uncollectible amount. Type I net service revenues for the three months and nine
months ended September 30, 1998 were $23,035,000 and $73,318,000, respectively,
or 55% and 54% of diagnostic imaging revenues, respectively.
Type II - The Company bills patients and third party payors directly for
services provided and pays the Interpreting Physicians either (i) a fixed
percentage of fees collected at the center, or (ii) a contractually fixed amount
based upon the specific diagnostic imaging procedures performed. Revenues are
recorded net of contractual allowances and the Company accrues the Interpreting
Physician fee as an expense on the Consolidated Statements of Operations. The
Company bears the risk of loss due to uncollectible amounts from patients and
third party payors, and the Company has established reserves for the estimated
uncollectible amount. Type II net service revenues for the three months and
nine months ended September 30, 1998 were $15,818,000 and $51,718,000,
respectively, or 37% and 38% of diagnostic imaging revenues, respectively.
Type III - The Company receives from an affiliated physician association a
fee for the use of the premises, a fee per procedure for acting as billing and
collection agent and a fee for administrative and technical services performed
at the centers. The affiliated physicians association contracts with and pays
directly the Interpreting Physicians. The Company's fee, net of an allowance
based upon the affiliated physician association's ability to pay after the
association has fulfilled its obligations (i.e., estimated future net
collections from patients and third party payors less facility lease expense and
Interpreting Physicians fees), constitutes the Company's net service revenues.
Since the Company's net service revenues are dependent upon the amount
ultimately realized from patient and third party receivables, the Company's
revenue and receivables have been reduced by an estimate of patient and third
party payor contractual allowances, as well as an estimated provision for
uncollectible amounts from patients and third party payors. Type III net
service revenues for the three months and nine months ended September 30, 1998
were $3,394,000 and $10,141,000, respectively, or 8% of diagnostic imaging
revenues.
Revenues derived from Medicare and Medicaid are subject to audit by such
agencies. The Company is not aware of any pending audits.
16
<PAGE>
The fees received or retained by the Company under the three types of
agreements with Interpreting Physicians described above, expressed as a
percentage of gross billings net of contractual allowances for the imaging
services provided, range from 78% to 93% for the Type I agreements, 80% to 93%
for the Type II agreements and 80% to 89% for the Type III agreements. These
agreements generally have terms ranging from one to ten years.
QUARTER ENDED SEPTEMBER 30, 1998 COMPARED TO THE QUARTER ENDED SEPTEMBER 30,
1997
For the quarter ended September 30, 1998, total Company net service
revenues were $44,176,000 versus $42,022,000 for the quarter ended September 30,
1997, an increase of $2,154,000 or 5%.
The increase in net service revenues is due primarily to the impact of 1997
acquisitions made after June 30, 1997, which contributed $7,226,000 of the
increase. Revenues at imaging centers that have been operated by the Company
since July 1, 1997 decreased $5,072,000 or 13%, to $33,106,000 for the quarter
ended September 30, 1998 from $38,178,000 for the same period in 1997,
primarily as a result of higher contractual allowances within comparable payor
groups, lower total procedure volumes, a payor mix change away from person
injury claim business toward more managed care business, and a modality mix
change toward lower priced procedures.
Contractual allowances are largely dependent upon reimbursement rates from
third party payors, including Medicare, Medicaid and managed care providers.
Management believes that it is likely that the Company's overall reimbursement
rates will gradually decline for some period of time, due to factors such as the
expansion of managed care organizations and continued national healthcare reform
efforts. The Company intends to attempt to mitigate the impact of any decline
in reimbursement rates by decreasing costs and increasing referral volumes. If
the rate of decline in reimbursement rates were to increase materially, or if
the Company is unsuccessful in reducing its costs or increasing its volumes, the
Company's results could be materially and adversely affected.
Diagnostic Imaging revenues derived from personal injury claims, mainly
involving automobile accidents, represented approximately 14% of Diagnostic
Imaging business net service revenues for the quarter ended September 30, 1998.
Automobile insurance carriers generally pay the non-deductible non-co-pay
portion of the charge, with the remaining balance payable by the individual.
The timing of collection from the individual is partially dependent upon the
outcome and timing of any settlement or judgment of the injury claim.
Accordingly, such receivables typically require a longer period of time to
collect compared to the Company's other receivables, and in the experience of
the Company incur a higher bad debt expense. In addition, a number of states
have enacted legislation that is intended to curtail auto insurance spending on
personal injury claims. Although the Company recently has intentionally shifted
away from personal injury claim business due to its high bad debt rate and long
collection cycle, if such business were to further materially decline either as
a result of poorer than expected future collections performance or because of
such legislation, the Company's results could be materially adversely affected.
Costs of services for the three months ended September 30, 1998 were
$27,797,000 compared to $21,222,000 for the three months ended September 30,
1997, an increase of $6,575,000 or 31%. This increase was due to the inclusion
of operating costs of $4,318,000 related to centers acquired after July 1, 1997.
Costs of services at imaging centers that have been operated by the Company
since July 1, 1997 increased $2,257,000, to $21,968,000 for the quarter ended
September 30, 1998 from $19,711,000 for the same period in 1997, primarily as a
result of higher equipment maintenance, independent contractor and payroll costs
in the third quarter of 1998.
The provision for uncollectible accounts receivable for the quarter ended
September 30, 1998 was $3,377,000, or 8% of related net service revenues,
compared to the third quarter 1997 provision of $2,042,000, or 5% of related net
service revenues. The increase in the provision for uncollectible accounts
receivable, as a percentage of net service revenues, was due to an increase in
the estimated rate of bad debts. Personal injury claim revenues have declined
during 1998 as a percentage of total net service revenues, which should result
in a reduction in the rate of bad debts over time. However, the Company has
continued to accrue for estimated bad debts at the rate of 8% of diagnostic
imaging net revenues throughout the first nine months of 1998 since diagnostic
imaging receivables remain somewhat higher than the level at the beginning of
year. Cash collections have improved during the third quarter of 1998 relative
to early 1998 collections performance and, provided the Company continues to
improve its collections, the Company expects to accrue bad debts at a lower rate
in the future.
17
<PAGE>
Depreciation and amortization expense for the third quarter of 1998 was
$6,109,000, compared to $5,488,000 for the third quarter of 1997, or an increase
of $621,000. The increase was due primarily to higher equipment depreciation
resulting from 1997 acquisitions and increased goodwill amortization.
Gross profit margins, which represent net service revenue less center costs
as a percent of net revenue, decreased for the quarter ended September 30, 1998
to 11% from 29% for the quarter ended September 30, 1997 due primarily to the
reasons described above.
Corporate general and administrative expense for the three months ended
September 30, 1998 was $2,979,000, an increase of $30,000 from the $2,949,000
recorded for the three months ended September 30, 1997.
In July 1998, the Company completed a review of under-performing centers
and determined that it would sell or close eight imaging centers during the
third and fourth quarters of 1998. In most cases, the Company decided to sell
or close these centers due to general competitive pressures and because of their
close proximity to other imaging centers of the Company which have more advanced
imaging equipment. During the three months ended September 30, 1998, the
Company recorded unusual charges attributable to center closings of $3,489,000,
consisting of (i) $1,602,000 for the estimated costs to exit equipment lease and
maintenance agreements and facility lease agreements, (ii) $1,481,000 for the
write-off of fixed assets, goodwill and other intangibles and other assets, and
(iii) $406,000 for estimated equipment removal, facility restoration and related
costs.
In addition, other unusual charges were recorded during the three months
ended September 30, 1998 of $890,000, consisting of (i) $380,000 for
professional fees attributable to obtaining the waiver and amendment under the
Company's Senior Note obligations, (ii) $360,000 for penalties associated with
the delay in the effectiveness of the Company's Registration Statement (which
has now become effective) and (iii) $150,000 for defense costs relating to
shareholder and employee lawsuits.
The Company could incur a substantial additional amount of unusual charges
during the remainder of 1998 depending upon the outcome of shareholder and
employee lawsuits and current negotiations with the holders of the Series C
Preferred Stock regarding additional penalties associated with the failure to
timely register the Company's Common Stock.
Net interest expense for the three months ended September 30, 1998 was
$3,484,000 as compared to $2,543,000 for the three months ended September 30,
1997, an increase of $941,000. This increase was primarily attributable to debt
assumed in connection with the Company's 1997 acquisitions and borrowings under
notes payable and lines of credit.
The Company's income for the quarter ended September 30, 1998 was decreased
by $176,000 attributable to minority interests, as compared to an increase in
the Company's income of $306,000 for the quarter ended September 30, 1997.
The provision for income taxes for the three months ended September 30,
1998 decreased to $160,000 as compared to $3,014,000 for the comparable period
last year. The provision for income taxes for the three months ended September
30, 1998 consists entirely of estimated state income taxes. During the third
quarter of 1998, a benefit for income taxes has not been recorded due to the
uncertainty regarding the recognition of the full amount of the Company's
deferred tax assets.
The Company's net loss from continuing operations for the quarter ended
September 30, 1998 was $6,196,000 compared to net income from continuing
operations for the quarter ended September 30, 1997 of $3,909,000.
The net loss applicable to common stockholders (used in computing loss per
common share) in the third quarter of 1998 includes charges of $116,000 as a
result of the accretion of the Company's preferred stock.
18
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
For the nine months ended September 30, 1998, total Company's net service
revenues were $137,824,000 versus $106,740,000 for the nine months ended
September 30, 1997, an increase of $31,084,000 or 29%.
The increase in net service revenues is due primarily to the impact of 1997
acquisitions, which contributed $42,376,000 of the increase. Revenues at
imaging centers that have been operated by the Company for all of 1997 decreased
$11,292,000 or 16%, to $60,555,000 for the nine months ended September 30, 1998
from $71,847,000 for the same period in 1997, primarily as a result of higher
contractual allowances within comparable payor groups, lower total procedure
volumes, a payor mix change away from person injury claim business toward more
managed care business, and a modality mix change toward lower priced procedures.
Costs of Services for the nine months ended September 30, 1998 were
$86,129,000 compared to $55,839,000 for the nine months ended September 30,
1997, an increase of $30,290,000 or 54%. This increase was due to the inclusion
of operating costs of $24,145,000 related to centers acquired during 1997.
Costs of services at imaging centers that have been operated by the Company for
all of 1997 increased $6,145,000, to $42,657,000 for the nine months ended
September 30, 1998 from $36,512,000 for the nine months ended September 30,
1997, primarily as a result of higher equipment maintenance and payroll costs in
the nine months ended September 30, 1998.
The provision for uncollectible accounts receivable for the nine months
ended September 30, 1998 was $10,684,000, or 8% of related net service revenues,
compared to the nine months ended September 30, 1997 provision of $5,795,000, or
5% of related net service revenues. The increase in the provision for
uncollectible accounts receivable, as a percentage of net service revenues, was
due to an increase in the estimated rate of bad debts, as described above.
Depreciation and amortization expense for the first nine months of 1998 was
$18,744,000 compared to $12,567,000 for the first nine months of 1997, or an
increase of $6,177,000, due primarily to higher equipment depreciation resulting
from 1997 acquisitions and increased goodwill amortization.
Gross profit margins, which represent net service revenue less center costs
as a percent of net revenue, decreased for the first nine months of 1998 to 13%
from 29% for the first nine months of 1997 due primarily to the reasons
described above.
Corporate general and administrative expense for the nine months ended
September 30, 1998 was $8,794,000, an increase of $2,239,000 from the $6,555,000
recorded for the nine months ended September 30, 1997. This increase was
primarily due to higher payroll and related costs as a result of the expanded
business development activities and the resulting growth experienced during
1997.
Results for the nine months ended September 30, 1998 and 1997 include non-
cash charges of $304,000 and $2,305,000, respectively, for compensation expense
resulting from stock options granted in 1996 and early 1997 that were approved
by the Company's stockholders in May 1997. Such compensation expense represents
the difference between the exercise price of the options and the market price of
the Company Common Stock on the date of plan approval, attributable to vested
shares.
During the nine months ended September 30, 1998, the Company recorded
unusual charges attributable to center closings of $3,489,000, as described
above, and other unusual charges of $6,290,000, including the $890,000 recorded
during the third quarter of 1998. The other unusual charges consist of (i)
$3,827,000 ($1,194,000 of which was a non-cash charge related to the issuance of
117,000 common stock warrants) for penalties associated with the delay in the
effectiveness the Company's Registration Statement (which has now become
effective), (ii) $863,000 for defense costs relating to shareholder and employee
lawsuits, (iii) $883,000 for costs associated with the investigation of related
party transactions which was concluded in April 1998, (iv) $380,000 for
professional fees attributable to obtaining the waiver and amendment under the
Company's Senior Note obligations and (v) $337,000 for management termination
benefits and related costs.
19
<PAGE>
Net interest expense for the nine months ended September 30, 1998 was
$10,396,000 as compared to $5,276,000 for the nine months ended September 30,
1997, an increase of $5,120,000. This increase was primarily attributable to
higher outstanding debt, including the issuance of $78,000,000 of Senior Notes
during 1997 and notes payable and capital lease obligations assumed in
connection with the Company's 1997 acquisitions.
The Company's income for the nine months ended September 30, 1998 was
decreased by $819,000 attributable to minority interests, as compared to an
increase in the Company's income of $499,000 for the nine months ended September
30, 1997.
The provision for income taxes for the nine months ended September 30, 1998
decreased to $461,000 as compared to $7,093,000 for the comparable period last
year. The provision for income taxes for the nine months ended September 30,
1998 consists entirely of estimated state income taxes. During the first nine
months of 1998, a benefit for income taxes has not been recorded due to the
uncertainty regarding the recognition of the full amount of the Company's
deferred tax assets.
The Company's net loss from continuing operations for the nine months ended
September 30, 1998 was $13,126,000 compared to net income from continuing
operations for the nine months ended September 30, 1997 of $9,899,000.
The net loss applicable to common stockholders (used in computing loss per
common share) in the first nine months of 1998 includes charges of $390,000 as a
result of the accretion of the Company's preferred stock.
RESULTS OF DISCONTINUED OPERATIONS
Period from January 1, 1998 to August 15, 1998 Compared to Nine Months Ended
September 30, 1997
Net service revenues for StarMed increased to $51,087,000 for the period
ended August 15, 1998 (which represents seven and one-half months) from
$41,484,000 for the nine months ended September 30, 1997, an increase of
$9,603,000. This increase was primarily related to internal growth in the
staffing business, consisting primarily of the opening of new Per Diem division
offices.
Operating costs for StarMed for the period ended August 15, 1998 were
$40,568,000 compared to $33,458,000 for the nine months ended September 30,
1997, an increase of $7,110,000. This increase was primarily related to
internal growth in the staffing business.
Net earnings related to StarMed increased to $1,806,000 for the period
ended August 15, 1998 from $773,000 for the nine months ended September 30,
1997.
StarMed Sale
On August 18, 1998, the Company sold the stock of StarMed to RehabCare
Group, Inc. for gross proceeds of $33,000,000. Due to the StarMed Sale, the
results of operations of StarMed are herein reflected in the Company's
Consolidated Statements of Operations as discontinued operations.
Net cash proceeds from the StarMed Sale were used as follows: (i)
$13,786,000 was used to retire StarMed's outstanding third-party debt (in
accordance with the terms of sale) (ii) $2,000,000 was placed in escrow to be
available, for a specified period of time, to fund indemnification obligations
that may be incurred by the Company (part or all of this amount may be payable
to the Company over time), (iii) an additional $2,000,000 was applied as a
partial repayment of the Company's $78,000,000 of Senior Notes, and (iv)
$2,186,000 was used to fund cash costs associated with the sale. The remaining
net proceeds of $13,028,000 increased the Company's consolidated cash balances.
For accounting purposes, an after-tax gain on sale of $3,905,000 was reported in
the third quarter of 1998.
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<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
During the nine months ended September 30, 1998, the Company's primary
source of cash flow was proceeds from the sale of the Company's StarMed Staffing
subsidiary of $28,814,000. The primary use of cash was the repayment of
interest bearing debt, including $13,786,000 of the debt of StarMed Staffing (in
accordance with the terms of sale) and other net reductions in debt of
$11,957,000. The Company also used cash of $4,775,000 for the repurchase of
Common Stock subject to redemption as a result of the exercise of puts provided
by the Company in connection with 1997 acquisitions. Operating activities
provided cash of $1,154,000 during the nine months ended September 30, 1998.
Cash flow from operating activities was adversely effected by an increase of
$8,211,000 in accounts receivable, net of allowance for bad debts (such amount
includes an increase of $2,540,000 related to StarMed prior to its sale). The
increase in accounts receivable is the result of difficulties experienced in
integrating the billing and collection systems of the centers acquired during
1997. By July of 1998, the Company completed the planned conversion of over 77%
of its centers to the Company's proprietary radiology information system, ICIS,
and commenced a restructuring of its collection efforts for the purpose of
ultimately consolidating all collections activities into a few regional
collection offices. The restructuring is in response to the need to improve
overall collection results and controls. The Company expects that these efforts
will result in an improved collection rate of accounts receivable and cash
flows. During the third quarter of 1998, cash collections improved relative to
early 1998 collections performance and outstanding diagnostic imaging net
accounts receivable declined $1,700,000 from $59,493,000 at June 30, 1998 to
$57,793,000 at September 30, 1998.
During the nine months ended September 30, 1997, the Company's primary
source of cash flow was from financing activities, including net proceeds from
the issuance of the Senior Notes of $77,113,000 and Series C Preferred Stock of
$16,965,000. The primary use of cash was to fund acquisitions that totaled
$56,132,000 and to fund the repayment of certain notes and capital lease
obligations of $27,025,000. Operating activities resulted in a net use of cash
of $3,318,000 during the first nine months of 1997, primarily as a result of an
increase in net accounts receivable of $22,211,000.
The Company has never declared a dividend on its Common Stock and under the
Company's Senior Note agreement, the payments of such dividends is not
permitted.
Senior Note Defaults
As a result of its net loss for 1997 and the late filing of its 1997 Annual
Report on Form 10-K, the Company was in default of certain financial covenants
under its $78,000,000 of Senior Notes. The financial covenant defaults under
the Senior Note agreements entitled the lenders to exercise certain remedies
including acceleration of repayment. In addition, certain medical equipment
notes, and operating and capital leases of the Company (the "Cross-Default
Debt"), contain provisions which allow the creditors or lessors to accelerate
their debt or terminate their leases and seek certain other remedies if the
Company is in default under the terms of agreements such as the Senior Notes.
In the event that the Senior Note lenders or the holders of the Cross
Default Debt elected to exercise their right to accelerate the obligations under
the Senior Notes or the other loans and leases, such acceleration would have had
a material adverse effect on the Company, its operations and its financial
condition. Furthermore, if such obligations were accelerated, in whole or in
part, there could be no assurance that the Company would have been successful in
identifying or consummating financing necessary to satisfy the obligations which
would have become immediately due and payable. As a result of the uncertainty
related to the defaults and corresponding remedies described above, the Senior
Notes and the Cross Default Debt were shown as current liabilities on the
Company's Consolidated Balance Sheets at December 31, 1997. As a result of these
matters, as well as other issues, there was substantial doubt about the
Company's ability to continue as a going concern. The report of the Company's
independent auditors, Ernst & Young LLP, on the consolidated financial
statements of the Company for the year ended December 31, 1997 contains an
explanatory paragraph with respect to these issues. The December 31, 1997
financial statements did not
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<PAGE>
include any further adjustments reflecting the possible future effects on the
recoverability and classification of assets or the amount and classification of
liabilities that may have resulted from the outcome of this uncertainty.
In October 1998, management reached an agreement with the Senior Note
lenders with respect to a waiver of all existing covenant defaults and a
modification of the financial covenants applicable over the remaining term of
the Senior Notes. In consideration for this waiver and amendment, the Company
has agreed to increase the effective blended interest rate on the Senior Notes
from 7.87% to 9.00%, and issued to the Senior Note lenders warrants to acquire
375,000 shares of the Company's Common Stock at an exercise price of $7.67 per
common share. The warrants had an estimated value of $503,000 which will be
recorded as deferred financing expense and amortized over the remaining term of
the Senior Notes. In addition, the Company prepaid $2,000,000 of principal
outstanding on the Senior Notes (without premium) and paid a fee to the Senior
Note lenders of $500,000. As a result of the execution of the waiver and
amendment with respect to the Senior Notes, the Senior Notes and the Cross
Default Debt are no longer in default and have been shown as long-term debt in
the September 30, 1998 Consolidated Balance Sheet.
Working Capital
The Company has a working capital surplus of $40,233,000 at September 30,
1998 compared to a working capital deficit of $58,174,000 at December 31, 1997.
The improvement in working capital is due primarily to the reclassification of
the Senior Notes and Cross Default Debt as long-term debt in the September 30,
1998 Consolidated Balance Sheet.
Other Obligations of the Company
In connection with certain of the Company's 1997 acquisitions in which the
Company issued shares of its Common Stock as partial consideration, the Company
granted rights to have such shares registered for resale pursuant to the federal
securities laws. In certain of such acquisitions, the Company has granted
specific remedies to the sellers in the event that the registration statement
covering the relevant shares is not declared effective by the Securities and
Exchange Commission within an agreed-upon period of time, including the right to
require the Company to repurchase the shares issued to such seller. During
1997, the Company entered into an agreement to set the purchase price per common
share related to certain shares covered by a repurchase agreement to the then
current market price in exchange for additional time to obtain registration of
such shares. The increased amount of such repurchase obligation of $1,696,000
was charged to retained earnings and shown as an increase in the Common Stock
subject to redemption of the Consolidated Balance Sheet. As of September 30,
1998 and December 31, 1997, the Company had reflected $4,045,000 and $9,734,000,
respectively, of Common Stock subject to redemption on its Consolidated Balance
Sheet related to shares that the Company may be required to repurchase. During
the first nine months ended September 30, 1998, the Company paid $4,775,000 to
sellers who exercised their rights to have shares of Common Stock repurchased.
The Company expects to pay an additional $4,045,000 during the remainder of
1998.
In addition, in connection with certain of such acquisitions, the Company
has agreed with the sellers in such acquisitions to pay to the sellers (in
additional shares and/or cash) an amount equal to the shortfall in the value of
the issued shares in the event the market value of such shares at the relevant
effective date of the registration statement or other negotiated date is less
than the market value of such shares as of the closing of the acquisition or, in
other cases, as of the execution of the relevant acquisition agreement (referred
to as "Price Protection"). Any such Price Protection payments will be charged
to stockholders' equity. During October 1998, the Company issued 590,147 shares
related to certain Price Protection obligations and expects to pay an additional
$1,659,000 in cash related to Price Protection obligations, excluding Price
Protection obligations related to the shares which have repurchase obligations,
referred to above.
In addition, in connection with certain of the Company's acquisitions, the
Company has agreed with the relevant sellers that all or a portion of the
consideration for such acquisitions will be paid on a contingent basis based
upon the profitability, revenues or other financial criteria of the acquired
business during an agreed-upon measurement period following the closing of the
acquisition (usually, one to three years). The specific terms of such contingent
consideration differ for each acquisition. In connection with certain
acquisitions, the Company and the relevant
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<PAGE>
sellers have agreed to a maximum amount of contingent consideration and in other
cases the parties have agreed that any payment of such contingent consideration
may be paid in cash or shares of Common Stock, or a combination of both.
Although the Company has the option, in certain cases, to pay certain of such
amounts in shares of Common Stock, payment of significant cash funds to sellers
in the event such earnout provisions are triggered could have a material adverse
effect on the Company's cash flow and financial condition. In addition, the
Company may be required to finance all or a portion of any such cash payments
from third-party sources. No assurance can be given that such capital will be
available on terms acceptable to the Company. In addition, the issuance by the
Company of shares of Common Stock in payment of any such owed amounts could be
dilutive to the Company's stockholders. Contingent consideration associated with
acquisitions is recorded as additional purchase price when resolved.
Pursuant to the terms of the Series C Convertible Preferred Stock Purchase
Agreement, dated July 21, 1997, and the Registration Rights Agreement dated July
21, 1997, as amended, between the Company and RGC International, LDC ("RGC")
(hereinafter referred to as the "RGC Agreements"), the Company issued 18,000
shares of Series C Convertible Preferred Stock, $1,000 stated value per share
(the "Series C Preferred Stock") to RGC. Under the RGC Agreements, the Company
was required to use its best efforts to include the shares of Common Stock
issuable upon conversion of the Series C Preferred Stock (the "RGC Conversion
Shares") in an effective Registration Statement not later than October 1997. As
amended, the RGC Agreements provided for monthly penalties through July 23, 1998
("RGC Registration Penalties") in the event that the Company failed to register
the Conversion Shares prior to certain dates.
Each share of the Series C Preferred Stock is convertible into such number
of shares of Common Stock as is determined by dividing the stated value ($1,000)
of each share of Series C Preferred Stock plus 3% per annum from the closing
date to the conversion date by the lesser of (i) $62.10 or (ii) the average of
the daily closing bid prices for the Common Stock for the (5) five consecutive
trading days ending five (5) trading days prior to the date of conversion. On
June 18, 1998, 2,500 shares of Series C Preferred Stock were converted into
373,000 shares of Common Stock. Accordingly, as of September 30, 1998, 15,500
shares of the Company's Series C Preferred Stock were issued and outstanding.
On November 10, 1998, an additional 600 shares of Series C Preferred Stock were
converted into 342,000 shares of Common Stock.
As a result of the Company's failure to register the RGC Conversion Shares
until October 1, 1998, the Company: (i) issued warrants to RGC to acquire
389,000 shares of Common Stock at an exercise prices ranging from $34.86 to
$38.85 per share, subject to reset in November 1998 (such warrants having an
estimated value, for accounting purposes, of $3,245,000); and (ii) issued
interest bearing promissory notes (the "RGC Penalty Notes") in the aggregate
principal amount of $2,450,000 due October 15, 1998. The principal amount of
and interest accrued on the RGC Penalty Notes may be converted, at the option of
the Company or RGC in certain circumstances, into additional shares of Series C
Preferred Stock or Common Stock. From and after July 23, 1998, pursuant to an
amendment to the RGC Agreements entered into in June 1998, the Company is no
longer subject to monthly penalties for failure to register the RGC Conversion
Shares, except that RGC may presently elect a one-time penalty of $1,550,000
(the "September 1998 Penalty") because the RGC Conversion Shares were not
registered by September 15, 1998. The September 1998 Penalty, if it shall become
due by election of RGC, shall be payable, at the option of RGC, in cash or
additional shares of Common Stock.
On October 15, 1998, the Company did not pay RGC the $2,450,000 that was
then due and payable under the RGC Penalty Notes. Additional, as discussed
above, RGC may demand the September 1998 Penalty of $1,550,000. The Company and
RGC are currently in discussions regarding the restructuring of the Penalty
Notes and the September 1998 Penalty, but there can be no assurance that the
Company will be successful in restructuring the Penalty Notes on terms favorable
to the Company or its shareholders. Purchasers of Common Stock could therefore
experience substantial dilution upon additional conversion of the Series C
Preferred Stock, any conversion of RGC Penalty Notes into Common Stock and the
impact of the exercise of warrants held by RGC. The shares of Series C
Preferred Stock are not registered and may be sold only with the express written
consent of the Company and if registered under the Act or sold in accordance
with an applicable exemption from registration, such as Rule 144.
In addition to matters discussed above, the Company is subject to
litigation that may require additional future cash outlays.
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<PAGE>
Financial Resources
During 1997, the Company incurred substantial debt in connection with
acquisitions of imaging centers. As of September 30, 1998, the Company's debt,
including capitalized lease obligations, totaled $133,537,000. The Company does
not expect to incur significant additional debt in the near future and expects
to rely on its existing cash balances of $16,409,000 at September 30, 1998 and
its ability to enter into operating leases to fund expansions and equipment
replacement at its centers. As a result of improvements in the Company's
billing and collection systems, the Company expects its cash flow from
operations, including improved collections of accounts receivable, to increase
from the level achieved in the nine months ended September 30, 1998. Management
believes that the positive cash flow from operations and the Company's existing
cash balances will provide it with sufficient funds available to finance its
needs in the near term.
Common Stock
In July 1998, the Company's shareholders approved a reverse stock split of
the Company's outstanding shares of Common Stock. As a result of the reverse
stock split, each three outstanding shares of Common Stock were automatically
converted into one share of new Common Stock. The share data included in this
Form 10-Q have been adjusted to reflect the impact of the reverse stock split.
The Company has been notified by NASDAQ that it is being reviewed for
continued listing on NASDAQ's National Market System due to its failure to
continue to meet the $5.00 minimum bid price requirement. The Company has until
January 15, 1999 to satisfy the listing requirements. In the event it is unable
to meet the requirements for continued listing on the National Market System,
the Company will attempt to move its listing to NASDAQ's SmallCap Market. No
assurance can be given that the Company will be successful in that regard.
Seasonality and Inflation
The Company believes that its business is only moderately affected by
seasonality. The third quarter is typically the slowest quarter of the year
because the months of July and August are the principal vacation months of the
year. The impact of inflation and changing prices on the Company has been
primarily limited to salary, medical and film supplies and rent increases and
has not been material to date to the Company's operations. Notwithstanding the
foregoing, general inflation trends and continuing reimbursement rate pressures
in the future may cause the Company not to be able to raise the prices for its
diagnostic imaging procedures by an amount sufficient to offset the negative
effects of increasing costs. While the Company has responded to these concerns
in the past by increasing the volume of its business, there can be no assurance
that the Company will be able to increase its volume of business in the future.
These trends, if continued over time, could have a material effect on the
financial results of the Company.
Impact of Year 2000 On Company's Computer Software
The computer programming code utilized in the Company's financial, billing
and imaging equipment systems were generally written using two digits rather
than four to define the applicable year. As a result, those computer programs
have time-sensitive software that recognizes a date using 00's as the year 1900
rather than the year 2000. This could cause a system failure or miscalculations
resulting in disruptions of operations, including, among other things, a
temporary inability to process transactions, send invoices or engage in other
normal business activities.
The Company has completed an assessment of its material financial and
billing computer systems. The Company is in the process of upgrading these
systems to be Year 2000 compliant and expects to complete this process by late
1998 or early 1999. The cost to be incurred related to Year 2000 compliance for
these systems is currently not expected to be material.
The Company has initiated a program to determine whether the computer
applications of its significant payors and suppliers will be upgraded in a
timely manner. The Company has also initiated a program to determine whether
embedded applications that control certain medical and other equipment will be
affected. The Company has not yet completed these reviews. The nature of the
Company's business is such that any failure to these types of applications
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<PAGE>
may have a material adverse effect on its business. If the Company determines
that certain of its suppliers will not be Year 2000 compliant, then the Company
will endeavor to find alternative suppliers; however, there can be no assurance
that the Company will be able to find alternative suppliers.
Because of the many uncertainties associated with Year 2000 compliance
issues, and because the Company's assessment is necessarily based on information
from third party-vendors, payors and suppliers, there can be no assurance that
the Company's assessment is correct or as to the materiality or effect of any
failure of such assessment to be correct. The Company is currently developing
contingency plans to address potential Year 2000 non-compliance both internally
and externally to the Company.
Software sold by the Company's wholly owned subsidiary, Dalcon
Technologies, Inc., is expected to be fully Year 2000 compliant in connection
with the annual upgrade planned for late 1998.
Disclosure Regarding Forward Looking Statements
Statements contained in this Report that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Investors are cautioned that forward-looking
statements are inherently uncertain. Actual performance and results may differ
materially from that projected or suggested herein due to certain risks and
uncertainties including, without limitation: the ability of the Company to
effectively integrate the operations and information systems of businesses
acquired in 1997 and earlier; the ability of the Company to generate net
positive cash flows from operations; the payment timing and ultimate
collectibility of accounts receivable (including purchased accounts receivable)
from different payor groups (including Personal Injury type); the economic
impact of involuntary share repurchases and other payments (including price
protection payments and penalty payments) caused by the delay in the
effectiveness of the Company's Registration Statement and by the decline in the
Company's share price; the potential dilution that would result from the
conversion of the Company's Series C Convertible Preferred Stock into common
shares at current share prices; the impact of a changing mix of managed care and
personal injury claim business on contractual allowance provisions, net revenues
and bad debt provisions; the ultimate economic impact of recent litigation
including shareholder and former management lawsuits against the Company and
certain of its Directors; the availability of debt and/or equity capital, on
reasonable terms, to finance operations as needed and to finance growth; and the
effects of federal and state laws and regulations on the Company's business over
time. Additional information concerning certain risks and uncertainties that
could cause actual results to differ materially from that projected or suggested
may be identified from time to time in the Company's Securities and Exchange
Commission filings and the Company's public announcements.
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II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
On July 23, 1998, the Company held its 1998 Annual Meeting of stockholders
(the "Annual Meeting"). The matters voted upon at the Annual Meeting and the
votes cast for such matters were as follows:
1. The Company's stockholders elected Sally W. Crawford, Peter B. Davis,
Gary L. Fuhrman, John H. Josephson, Duane C. Montopoli, Gary N.
Siegler and D. Gordon Strickland as Directors to serve until the 1999
Annual Meeting. Voting for the nominees for director was as follows:
Sally W. Crawford; 18,789,722 shares FOR and 521,358 shares WITHHELD;
Peter B. Davis; 18,786,716 shares FOR and 524,364 shares WITHHELD;
Gary L. Fuhrman; 15,904,485 shares FOR and 3,406,595 shares WITHHELD;
John H. Josephson; 15,917,315 shares FOR and 3,393,765 shares
WITHHELD; Duane C. Montopoli; 18,675,803 shares FOR and 535,277 shares
WITHHELD; Gary N. Siegler; 15,897,387 shares FOR and 3,413,693 shares
WITHHELD; D. Gordon Strickland; 18,775,218 shares FOR and 535,862
shares WITHHELD.
2. The Company's stockholders approved the adoption of the Company's 1998
Stock Option Plan. Regarding the approval of the 1998 Stock Option
Plan, the vote was 9,388,877 shares FOR; 2,483,167 shares AGAINST; and
283,102 shares ABSTAINING.
3. The Company's stockholders approved the adoption of the Company's 1998
Non-Employee Director Plan. Regarding the approval of the 1998 Non-
Employee Director Plan, the vote was 11,454,985 shares FOR; 638,637
shares AGAINST; and 61,524 shares ABSTAINING.
4. The Company's stockholders approved a Reverse Stock Split of the
Company's stock. Regarding the approval of the Reverse Stock Split,
the vote was 18,704,894 shares FOR; 571,794 shares AGAINST; and
102,577 shares ABSTAINING.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
a. Exhibits
--------
10.1 Waiver and Amendment regarding the Company's Senior Note Agreement,
between the Company and the institutional investors party thereto,
dated September 23, 1998.
b. Reports on Form 8-K
-------------------
On July 10, 1998, the Company filed a Current Report on Form 8-K,
reporting the execution of definitive documents regarding the sale of its
StarMed Staffing subsidiary.
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SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Medical Resources, Inc.
/s/ Duane C. Montopoli
------------------------
Duane C. Montopoli
Chief Executive Officer
(Principal Executive Officer)
/s/ Geoffrey A. Whynot
------------------------
Geoffrey A. Whynot
Chief Financial Officer and Senior
Vice President - Finance
(Principal Accounting Officer)
Date: November 16, 1998
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<PAGE>
EXHIBIT 10.1
WAIVER AND AMENDMENT AGREEMENT
THIS WAIVER AND AMENDMENT AGREEMENT (this "Agreement") is entered into on
---------
September 23, 1998 among Medical Resources, Inc. (the "Company") and the
-------
institutional investors party hereto (the "Purchasers"). The Purchasers are
----------
collectively the holders of $52,000,000 in aggregate principal amount of the
Company's 7.77% Senior Notes due February 20, 2005 (the "7.77 Notes") issued
----------
pursuant to a Note Purchase Agreement dated as of February 20, 1997 (the
"February Note Agreement"), $20,000,000 in aggregate principal amount of the
- ------------------------
Company's 8.10% Senior Notes due February 20, 2005 (the "8.10% Notes") and
-----------
$6,000,000 in aggregate principal amount of the Company's 8.01% Senior Notes due
February 20, 2005 (the "8.01% Notes" and together with the 7.77% Notes and the
-----------
8.10% Notes, the "Notes") issued pursuant to a Note Purchase Agreement dated as
-----
of June 26, 1997 (the "June Note Agreement" and together with the February Note
-------------------
Agreement, the "Note Agreements"). Capitalized terms not otherwise defined in
---------------
this Agreement have the meanings given therefor in the Note Agreements.
The Company has advised the Purchasers that it is not currently in
compliance with certain of its covenants set forth in the Note Agreements and
that it is or may be obligated to make payments in connection with its
Repurchase Obligations (as defined in Section 2(6) below) which, if made, would
constitute Restricted Payments not permitted under paragraph 6B of the Note
Agreements. The Company has requested that the Purchasers waive the Company's
covenant defaults through the date hereof, waive any default under paragraph 6B
of the Note Agreements as a result of it making such Restricted Payments and to
otherwise amend certain of its financial covenants. The Purchasers are willing
to do so on the terms and conditions of this Agreement.
NOW, THEREFORE, the parties agree:
1. WAIVERS. Subject to the delivery by the Company of the items set
forth in Section 4, the Purchasers hereby waive:
(1) all Defaults and Events of Default under the Note Agreements arising
out of the Company's failure to comply with its covenants set forth in
paragraphs 5 and 6 thereof occurring prior to the date hereof provided such
--------
waiver shall not constitute a waiver of any Default or Event of Default
occurring or continuing on or after the date hereof under the Note Agreements,
after giving effect to the amendments contemplated hereby, the Waiver granted by
the Purchasers on June 25, 1998 and the Consent granted by the Purchasers on
August 12, 1998.
(2) any Make Whole Amount which would otherwise be due pursuant to
paragraph 4A of the Note Agreements as a result of the prepayment of principal
required under Section 4(1) and any requirement under the Note Agreements that
such prepayment of principal be applied against the Company's obligation to make
scheduled payments of principal on the Notes other than in accordance with such
Section 4(1).
2. AMENDMENT TO NOTE AGREEMENTS. Subject to the delivery by the Company
of the items set forth in Section 4, the Note Agreements are hereby amended:
(1) Interest Rate.
-------------
(a) From and after July 25, 1998, the 7.77% Notes shall bear interest on
the unpaid principal balance at the annual rate of 8.8969%, the 8.10% Notes
shall bear interest on the unpaid principal balance at the annual rate of
9.2269% and the 8.01% Notes shall bear interest at the annual rate of 9.1369%
and each of the Notes shall bear interest on overdue principal, overdue Make
Whole Amount and, to the extent permitted by law, overdue interest at a rate
which is 200
<PAGE>
-2-
basis points over the then applicable rate of interest under such Note for
principal not overdue. From and after August 20, 1998, accrued interest on the
Notes will be due and payable monthly in arrears on the 20th day of each month
commencing September 20, 1998.
(b) If the aggregate amount of cash payments by the Company or its
Restricted Subsidiaries on the Contingent Obligations (as defined in Section
2(6)) made between June 30, 1998 and (i) December 31, 1998 exceeds $4,000,000,
(ii) March 31, 1999 exceeds $6,000,000, or (iii) June 30, 1999, exceeds
$8,000,000 (such amounts being "Target Amounts"), the annual rate of interest on
--------------
the Notes (as previously adjusted pursuant to subparagraph (a) of this Section
2(1)) shall be increased by an additional 50 basis points from and after the
date on which the applicable Target Amount is first exceeded, provided, if the
--------
interest rate on the Notes has been increased as a result of cash payments on
the Contingent Obligations exceeding the Target Amounts during the period ending
December 31, 1998 or during the period ending March 31, 1999 but at June 30,
1999 the aggregate amount of cash payments on the Contingent Obligations from
June 30, 1998 through June 30, 1999 does not exceed $8,000,000 for such period,
the annual rate of interest on the Notes shall be reduced from and after June
30, 1999 to 15 basis points over the interest rates set forth in subparagraph
(a) of this Section 2(1).
(2) Calculation of Make Whole Amount. Notwithstanding the increase in
--------------------------------
interest rates provided for in Section 2(1), the amount of interest which would
have accrued on Called Principal if such Called Principal were not paid prior to
its scheduled due date for the purposes of determining the Make Whole Amount due
on any prepayment or acceleration of the Notes shall be calculated using the
interest rates set forth in the Note Agreements prior to this Agreement.
(3) Reporting. The following clause (x) is added to paragraph 5A:
---------
"(x) promptly, but not later than 20 days following the end of each
calendar month, a cash flow report for such month accompanied by a
reconciliation of the actual versus projected cash flows and promptly, but
not later than the seventh day following the end of each second week
through September 30, 1998, a cash flow report for such biweekly period."
(4) Financial Covenants. Paragraphs 6A(2), 6A(3) and 6A(4) are deleted
-------------------
and the following substituted therefor:
"6A(2) INTEREST EXPENSE COVERAGE. As of the last day of any fiscal
quarter ending on or after September 30, 1998, the ratio of (a)
Consolidated EBITA to (b) Consolidated Interest Expense, for the three
most recently ended fiscal quarters taken as a single accounting period in
the case of the quarter ended September 30, 1998 and, thereafter, for the
four most recently ended fiscal quarters taken as a single accounting
period, shall not be less than the ratio specified below for such fiscal
quarter:
<TABLE>
<CAPTION>
Fiscal Quarters Ending Ratio
---------------------- -----
<S> <C>
September 30, 1998 1.43 to 1.00
December 31, 1998 1.56 to 1.00
March 31, 1999 1.82 to 1.00
June 30, 1999 2.02 to 1.00
</TABLE>
<PAGE>
-3-
<TABLE>
<S> <C>
September 30, 1999 2.20 to 1.00
December 31, 1999 and any
fiscal quarter ending thereafter 2.25 to 1.00
</TABLE>
6A(3) LIMITATION ON CONSOLIDATED TOTAL DEBT.
(a) The Company shall not permit on, or at any time from and after the
date hereof through, September 30, 1998, Total Debt to exceed 54.02% of
Consolidated Total Capitalization.
(b) The Company and the Restricted Subsidiaries shall not incur,
create, issue, assume, guarantee or otherwise become liable in respect of
any Debt after September 30, 1998 unless (i) no Default or Event of Default
exists immediately before or immediately after the incurrence of such Debt
or would otherwise reasonably be expected to result therefrom; and (ii)
immediately after giving effect to the incurrence of such Debt on a pro
forma basis, Total Debt does not exceed the applicable percentage set forth
below of Consolidated Total Capitalization determined as of the most recent
fiscal quarter end:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
DATE DEBT IS INCURRED PERCENTAGE OF CONSOLIDATED
--------------------- TOTAL CAPITALIZATION
---------------------------
- ---------------------------------------------------------------------
<S> <C>
On or after September 30, 1998 but 54.02%
prior to December 31, 1998
- ---------------------------------------------------------------------
On or after December 31, 1998 but 51.62%
prior to March 31, 1999
- ---------------------------------------------------------------------
On or after March 31, 1999 but 50.61%
prior to June 30, 1999
- ---------------------------------------------------------------------
On or after June 30, 1999 but prior 49.50%
to September 30, 1999
- ---------------------------------------------------------------------
On or after September 30, 1999 but 48.29%
prior to December 31, 1999
- ---------------------------------------------------------------------
On or after December 31, 1999 but 47.04%
prior to March 31, 2000
- ---------------------------------------------------------------------
On or after March 31, 2000 52.50%
- ---------------------------------------------------------------------
</TABLE>
For the purposes of this PARAGRAPH 6A(3): (i) the outstanding Debt of
any Person which becomes a Restricted Subsidiary after June 30, 1998 shall
be deemed to have been incurred at the time it becomes a Restricted
Subsidiary; (ii) if any outstanding Debt of the Company owned by a
Restricted Subsidiary or any outstanding Debt of a Restricted Subsidiary
owned by the Company or another Restricted Subsidiary is sold or otherwise
transferred to a Person who is not the Company or a Restricted Subsidiary,
such Debt shall be deemed to have been incurred on the date of such sale or
transfer; (iii) any Debt which is extended, renewed or refunded or
refinanced after the Closing Date shall be deemed incurred on the date of
such extension, renewal, refunding or refinancing; (iv) in making any
<PAGE>
-4-
determination of Consolidated Total Capitalization, any payments made by
the Company in satisfaction of its obligations to Presgar and Grajo/Bleggi
set forth on SCHEDULE 10B (other than payments made through the issuance
of capital stock of the Company) shall be deemed to have been made by the
issuance of shares of the Company's common stock, regardless of the actual
manner of payment; and (v) if the Company is able to defer the due date of
any of the Debt set forth on SCHEDULE 10B due RGC International LTD or to
Presgar to a date after December 31, 1998, then the amount of any such
deferred Debt shall not be included in the determination of Total Debt
through the sooner of the date such Debt becomes due or September 30, 1999.
6A(4) LIMITATION ON PRIORITY DEBT.
(a) The Company shall not permit on, or at any time after the date
hereof through September 30, 1998, Priority Debt to exceed 39.74% of
Consolidated Net Worth.
(b) The Company and the Restricted Subsidiaries shall not incur,
create, issue, assume, guarantee or otherwise become liable in respect of
any Priority Debt after September 30, 1998 unless (i) no Default or Event
of Default exists immediately before or immediately after the incurrence of
such Priority Debt or would otherwise reasonably be anticipated to result
therefrom; (ii) such Priority Debt is used solely to acquire fixed assets
after September 30, 1998 and is incurred at the time of such acquisition or
within 180 days following such date or is a renewal, refunding or
refinancing of such Priority Debt provided the principal amount of such
Priority Debt is not increased or the maturity thereof accelerated; (iii)
any Lien securing such Priority Debt is confined solely to the fixed assets
acquired with such Priority Debt, secures only the purchase price for such
fixed assets and the Priority Debt secured thereby does not exceed the
lesser of the fair market value or the purchase price of such fixed assets;
(iv) the aggregate amount of Priority Debt of the Company and its
Restricted Subsidiaries incurred after June 30, 1998 does not exceed
$10,000,000 and (v) immediately after giving effect to the incurrence of
such Debt on a pro forma basis, Priority Debt does not exceed the
applicable percentage set forth below of Consolidated Net Worth determined
as of the most recent fiscal quarter end:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
DATE DEBT IS INCURRED PERCENTAGE OF CONSOLIDATED
- ------------------------------------- NET WORTH
---------------------------
- --------------------------------------------------------------------
<S> <C>
On or after September 30, 1998 but 39.74%
prior to December 31, 1998
- --------------------------------------------------------------------
On or after December 31, 1998 but 36.25%
prior to March 31, 1999
- --------------------------------------------------------------------
On or after March 30, 1999 but 33.81%
prior to June 30, 1999
- --------------------------------------------------------------------
On or after June 30, 1999 but prior 31.35%
to September 30, 1999
- --------------------------------------------------------------------
On or after September 30, 1999 but 28.91%
prior to December 31, 1999
- --------------------------------------------------------------------
</TABLE>
<PAGE>
-5-
<TABLE>
<S> <C>
--------------------------------------------------------------------
On or after December 31, 1999 but 26.57%
prior to March 31, 2000
--------------------------------------------------------------------
On or after March 31, 2000 24.51%
but prior to June 30, 2000
--------------------------------------------------------------------
On or after June 30, 2000 but prior 22.54%
to September 30, 2002
--------------------------------------------------------------------
On or after September 30, 2002 20.00%
--------------------------------------------------------------------
</TABLE>
For the purposes of this PARAGRAPH 6A(4): (i) the outstanding Debt of
any Person which becomes a Restricted Subsidiary after June 30, 1998 shall
be deemed to have been incurred at the time it becomes a Restricted
Subsidiary; (ii) if any outstanding Debt of the Company owned by a
Restricted Subsidiary or any outstanding Debt of a Restricted Subsidiary
owned by the Company or another Restricted Subsidiary is sold or otherwise
transferred to a Person who is not the Company or a Restricted Subsidiary,
such Debt shall be deemed to have been incurred on the date of such sale or
transfer; (iii) any Debt which is extended, renewed, refunded, refinanced
after the Closing Date shall be deemed incurred on the date of such
extension, renewal, refunding or refinancing; and (iv) in making any
determination of Consolidated Total Capitalization, any payments made by
the Company in satisfaction of its obligations to Presgar and Grajo/Bleggi
set forth on SCHEDULE 10B (other than payments made through the issuance
of capital stock of the Company) shall be deemed to have been made by the
issuance of shares of the Company's common stock, regardless of the actual
manner of payment.
(c) Notwithstanding the foregoing, if prior to December 31, 1999 the
Company has obtained and thereafter maintains a ratio of (a) Consolidated
EBITA to (b) Consolidated Interest Expense, for the four most recently
ended fiscal quarters taken as a single accounting period, of not less than
2.50 to 1.00; and after incurrence thereof, Priority Debt does not exceed
20% of Consolidated Net Worth as at the most recent fiscal quarter end, the
Restricted Subsidiaries may incur up to $5,000,000 in the aggregate of
Priority Debt in addition to that permitted under SUBPARAGRAPH (A) of this
PARAGRAPH 6A(4) provided: (a) no Default or Event of Default exists
--------
immediately before or immediately after the incurrence of such additional
Priority Debt or would otherwise reasonably be anticipated to result
therefrom; (b) such Priority Debt is used solely for working capital
purposes; (c) any Lien securing such Priority Debt is solely on assets
acquired by such Restricted Subsidiary after December 31, 1999; and (d)
such Priority Debt is not directly or indirectly Guaranteed by the
Company."
(4) Capital Expenditures. The following paragraph 6A(5) is added:
--------------------
"6A(5) CAPITAL EXPENDITURES. The Company will not incur aggregate
capital expenditures in excess of $4,000,000 during the period July 1, 1998
through December 31, 1998."
(5) Additional Covenants. The following paragraph 6E is added to the Note
--------------------
Agreements:
"6E. ADDITIONAL COVENANTS
<PAGE>
-6-
6E(1). EQUITY RELATED PAYMENTS. The Company will not after July 31,
1998, whether in connection with the issuance of Equity Interests in
consideration for an Acquisition, for the raising of capital or otherwise,
enter into or become obligated in respect of any price protection
agreements, repurchase or redemption obligations, or any penalty payments
in respect of any Equity Interests as a result of a failure of the Company
to register (or to timely register) such Equity Interests under the
Securities Act or any other similar obligations, in each case, which are
or might be payable in cash. The Company will not after July 31, 1998
enter into any amendment of the Repurchase Obligations or the Contingent
Obligations which would increase the aggregate amounts due thereunder which
are, or might be required to be, paid in cash.
6E(2). USE OF PROCEEDS OF SALES OF UNRESTRICTED SUBSIDIARIES. The
Company will, after payment of usual and customary transaction costs and
expenses and repayment of obligations of StarMed Staffing, Inc. required by
the terms of the Stock Purchase Agreement among the Company, RehabCare
Group, Inc. and Healthcare Staffing Solutions, Inc. dated as of July 8,
1998 (the "Stock Purchase Agreement") use the amounts received (or to be
------------------------
received) by the Company thereunder only to pay those obligations set forth
on SCHEDULE 6E(2) and for working capital purposes."
6E(3). UPDATING OF REPRESENTATIONS AND WARRANTIES. On or before
November 15, 1998, the Company will provide each Holder with an Officers'
Certificate to the effect that, subject to the disclosure schedules
attached to the June Note Agreement and the updated disclosure schedules
attached to such Officers' Certificate, each of the representations and
warranties set forth in paragraph 8B, 8D, 8E, 8G, 8H, 8K, 8M, 8N, 8O, 8Q
and 8S of the Note Agreements are true and correct in all material respects
on and as if made as of the date thereof.
(6) Definitions.
-----------
(a) The following definitions to the Note Agreements are amended and
restated as follows:
"CONSOLIDATED EBITA" means for any period the amount of which is to be
determined, Consolidated Net Income for such period plus (but only to the
extent such amounts were included in the computation of Consolidated Net
Income and without duplication) (i) Consolidated Interest Expense, (ii)
income tax expense (including deferred income tax expense in each case),
(iii) amortization expense of the Company and its Restricted Subsidiaries
for such period, (iv) minority interest, (v) the aggregate amount of
charges associated with (A) ongoing expenses and/or charges related to
litigation commenced against the Company prior to January 1, 1998, but
excluding such expenses paid in cash after the date hereof in excess of
$1,000,000, in the aggregate (to the extent of such excess) (reduced by any
insurance proceeds paid to the Company in respect of such expenses), (B)
closings or dispositions, publicly announced prior to August 1, 1998, of
Company facilities, but excluding expenses paid in cash in excess of
$1,500,000 in the aggregate, to the extent of such excess, (C) aggregate
penalty payments not exceeding $2,520,000 (exclusive of interest) incurred
as a result of the failure of the Company to timely fulfill its
registration obligations with respect to the shares of the Company's common
stock into which the Company's preferred stock issued to RGC International
LTD is convertible, as set forth on SCHEDULE 10B; (D) stock option-based
compensation relating to employee stock options granted on or before
December 31, 1997 and (E) charges associated with the issuance of the
Warrants, less (but only to the extent included in the
<PAGE>
-7-
computation of Consolidated Net Income) any gain recognized by the Company
associated with the sale of stock of certain of its Unrestricted
Subsidiaries pursuant to the Stock Purchase Agreement, such amounts being
determined in each case on a consolidated basis in accordance with GAAP.
"RESTRICTED PAYMENTS" means the declaration, payment or making,
directly or indirectly, of any dividend, payment or other distribution on
or in respect of any Equity Interest of the Company or any Restricted
Subsidiary (other than the payment of a dividend, payment or other
distribution to the Company or Wholly-Owned Restricted Subsidiary or the
setting apart of any funds or property therefor, or the making of any
payment on account of the purchase, redemption, retirement or other
acquisition, direct or indirect, of any Equity Interest of the Company or
any Restricted Subsidiary (other than any such Equity Interest owned by the
Company or a Wholly-Owned Restricted Subsidiary) including without
limitation, (x) the forgiveness or foreclosure by the issuer of any Debt
secured by a pledge of such capital stock, (y) any purchase, redemption or
other acquisition or retirement for value prior to any scheduled maturity,
any scheduled prepayment of principal or any scheduled sinking fund payment
or, in any event, during the continuance of any Default, or Event of
Default of any Debt that is subordinated in right of payment to the Notes
and (z) cash payments after June 30, 1998 in excess of $1,000,000 in the
aggregate (net of any insurance proceeds paid to the Company in respect
thereof) in respect of shareholder litigation. The Repurchase Obligations
shall not constitute Restricted Payments
(b) The following definitions are added to the Note Agreements in the
appropriate alphabetical order:
"CONTINGENT OBLIGATIONS" means any and all obligations of the Company
or a Restricted Subsidiary, other than the Repurchase Obligations, which
pursuant to the terms of such obligations may be or could have been
satisfied by the Company or such Restricted Subsidiary by the issuance of
Equity Interests (even if such ability was conditioned upon the Company
having in effect a registration statement for such Equity Interest or such
Equity Interest having a minimum trading price) and (but without
duplication) the aggregate amount of cash paid by the Company or a
Restricted Subsidiary after July 31, 1998 to any Person in respect of a
penalty for failing to have a registration statement under the Securities
Act in effect for the benefit of such Person.
"REPURCHASE OBLIGATIONS" means the obligations of the Company to
Capstone, Novick/Rossi and O'Connor/San Jose and set forth on SCHEDULE 10B
to repurchase or redeem shares of its Common Stock issued in connection
with Acquisitions, whether or not now represented by a promissory note, up
to an aggregate amount of $9,500,000, inclusive of any interest, premium or
penalties due in connection therewith.
"WARRANTS" means the Warrants for an aggregate of 375,000 shares of
the Company's common stock, $.01 par value per share issued to the
Purchasers on September 23, 1998.
(7) Exhibits. SCHEDULE 10B in the form of EXHIBIT A to this Agreement is
--------
added to the Note Agreement.
3. REPRESENTATIONS AND WARRANTIES.
<PAGE>
-8-
(1) Subject to the disclosure schedules attached to the June Note
Agreement, each of the representations and warranties set forth in paragraphs 8A
and 8F of the Note Agreements are true and correct in all material respects on
and as if made as of the date hereof and after giving effect to the transactions
contemplated by this Agreement.
(2) Except for the Contingent Obligations and the Repurchase Obligations
(as such terms are defined in Section 2 (6)) set forth on Exhibit A, the Company
----------
does not have any repurchase or redemption obligations, price protection
obligations or penalty obligations relating to any Equity Interests or any
obligation to register any Equity Interests. Exhibit A accurately sets forth
---------
the financial obligations of the Company in respect of its Contingent
Obligations and Repurchase Obligations as of the date hereof.
(3) Since June 30, 1998, neither the Company nor any of the Restricted
Subsidiaries has incurred any Debt.
(4) The Company has furnished the Purchasers with the audited balance sheet
of the Consolidated Group dated as of December 31, 1997 and the related
statements of operations, cash flows and stockholders' equity for the 12 months
ended on such date and the unaudited balance sheet of the Company as of June 30,
1998 and the related statement of operations, cash flows and stockholders'
equity for the six months ended on such date. The audited financial statements
fairly present in all material respects the financial condition of the
Consolidated Group and the results of its operations and cash flows for the
respective periods specified thereby and the unaudited financial statements
fairly present in all material respects the assets and liabilities of the
Company as of the date thereof. The financial statements have been prepared in
accordance with GAAP, consistently applied throughout the periods involved
except as set forth in the notes thereto. Since June 30, 1998, there have been
no developments or changes affecting the business, assets, liabilities,
condition (financial or otherwise) of the Company or any Restricted Subsidiary
which has had or is reasonably expected to have, either individually or in the
aggregate, a Material Adverse Effect.
(5) As of the date hereof, the Company has no direct or indirect equity or
beneficial ownership in any Unrestricted Subsidiary.
4. DELIVERIES. Concurrently with the execution and delivery of this
Agreement by the Company, the Company shall deliver to the Purchasers:
(1) Principal Prepayment By wire transfer of immediately available funds
--------------------
in accordance with the instructions set forth on Exhibit A to the Note
Agreements, a prepayment of principal of the Notes, without Make Whole Amount,
in the aggregate amount of $2,000,000. Such prepayment of principal is to be
allocated among the Purchasers in proportion to the aggregate principal amount
of the Notes held by each. Each Purchaser agrees to apply such prepayment of
principal to the scheduled payment of principal due on February 20, 2001. The
parties hereto acknowledge that such payment is to be made from the Escrow Funds
(as such term is defined in the Escrow Agreement, dated as of August 14, 1998,
by and between the Company, IBJ Schroder Bank & Trust Company, as Escrow Agent
(the "Escrow Agent"), and the Purchasers (the "Escrow Agreement"). The Company
------------ ----------------
and the Purchasers shall provide the Escrow Agent with joint written
instructions in the form of Exhibit B hereto in order to effect such payment.
(2) Restructuring Fee. By wire transfer of immediately available funds in
-----------------
accordance with the instructions set forth on Exhibit A to the Note Agreements,
a restructuring fee in the
<PAGE>
-9-
aggregate amount of $500,000. Such restructuring fee is to be allocated among
the Purchasers in proportion to the aggregate principal amount of the Notes held
by each.
(3) Warrants. Warrants in the form attached as EXHIBIT C for an aggregate
-------- ---------
of 375,000 shares of the Company's common stock, $.10 par value per share. Such
Warrants are to be allocated among the Purchasers in proportion to the aggregate
principal amount of the Notes held by each. Each Purchaser's Warrants shall be
registered in such Purchaser's name or the name of its nominee as specified in
Exhibit A to the Note Agreements.
(4) Registration Rights Agreement. An executed Registration Rights
-----------------------------
Agreement in the form of EXHIBIT D.
---------
(5) Allonges to Notes. An executed allonge to such Purchaser's Note(s) in
-----------------
the form of EXHIBIT E.
---------
(6) Opinion of Counsel. An opinion of Wilkie, Farr & Gallagher as to (i)
------------------
the legal existence and corporate power and authority of the Company, (ii) the
due authorization, execution, delivery and enforceability of this Agreement, the
Warrants, the Registration Rights Agreement and the Allonges, (iii) the absence
of conflicts with or creation of liens under applicable law in connection
therewith and (iv) the absence of any required governmental consents in
connection therewith, in form and substance satisfactory to the Purchasers.
(7) Payment of Expenses. All Expenses, including those of Special Counsel,
-------------------
as set forth in invoices delivered to the Company prior to the date hereof shall
have been paid in full.
(8) Interest Payment. Except to the extent previously paid, by wire
----------------
transfer of immediately available funds in accordance with the instructions set
forth on Exhibit A to the Note Agreements, interest accrued on each Note from
February 20, 1998 through August 20, 1998 reflecting the increase in interest
rate provided for in Section 2(1) and the accrued monthly interest on the Notes
due September 20, 1998.
(9) Warrant Valuation. The amendments to the financial covenants set forth
-----------------
in Section 2(4) of this Agreement have been agreed to on the express
understanding that the value of the Warrants as of the date of issuance will be
$500,000. If the value of the Warrants on such date is materially different
from $500,000, the parties agree that the financial covenants set forth in 2(4)
of this Agreement will be appropriately adjusted to reflect the actual valuation
of the Warrants on such date.
5. NO OTHER WAIVERS. Except as expressly set forth herein or as
previously amended, the Note Agreements shall continue in full force and effect
without alteration or amendment and except as expressly set forth herein no
other waiver of any Default or Event of Default is hereby granted.
6. GOVERNING LAW. THIS AGREEMENT IS TO BE CONSTRUED AND ENFORCED IN
ACCORDANCE WITH, AND THE RIGHTS OF THE PARTIES SHALL BE GOVERNED BY, THE LAWS OF
THE STATE OF NEW YORK (WITHOUT GIVING EFFECT TO ANY LAWS OR RULES RELATING TO
CONFLICTS OF LAWS THAT WOULD CAUSE THE APPLICATION OF THE LAWS OF ANY
JURISDICTION OTHER THAN THE STATE OF NEW YORK).
<PAGE>
-10-
7. COUNTERPARTS. This Agreement may be executed simultaneously in two or
more counterparts, each of which shall be deemed an original, and it shall not
be necessary in making proof of this Agreement to produce or account for more
than one such counterpart.
This Agreement is executed under seal as of the date first above written.
MEDICAL RESOURCES, INC.
By: /s/ Christopher J. Joyce
---------------------------------
Title: Senior Vice President - Legal
Affairs and Administration
Purchasers under the February
Note Agreement:
JOHN HANCOCK MUTUAL LIFE
INSURANCE COMPANY
By: /s/ Stephen J. Blewitt
---------------------------------
Name: Stephen J. Blewitt
Title: Senior Investment Officer
JOHN HANCOCK VARIABLE LIFE
INSURANCE COMPANY
By: /s/ Stephen J. Blewitt
---------------------------------
Name: Stephen J. Blewitt
Title: Senior Investment Officer
INVESTORS PARTNER LIFE INSURANCE
COMPANY
By: /s/ Stephen J. Blewitt
---------------------------------
Name: Stephen J. Blewitt
Title: Senior Investment Officer
Mellon Bank, N.A., solely in its capacity
as Trustee for The Long Term Investment
Trust, (as directed by John Hancock
Mutual Life Insurance Company), and not
in its individual capacity
By: /s/ Bernadette Rist
---------------------------------
Name: Bernadette Rist
Title: Authorized Signatory
AUSA LIFE INSURANCE COMPANY, INC.
By: /s/ Gregory W. Theobald
---------------------------------
Name: Gregory W. Theobald
Title: V.P. and Asst. Secretary
<PAGE>
-11-
LIFE INVESTORS INSURANCE COMPANY
OF AMERICA
By: /s/ Gregory W. Theobald
------------------------------
Name: Gregory W. Theobald
Title: V.P. and Asst. Secretary
GREAT AMERICAN LIFE INSURANCE
COMPANY
By: /s/ Mark F. Muething
------------------------------
Name: Mark F. Muething
Title: Senior Vice President
GREAT NORTHERN INSURED ANNUITY
CORPORATION
By: /s/ Jon M. Lucia
------------------------------
Name: Jon M. Lucia
Title: Vice President
AMERICAN BANKERS INSURANCE COMPANY
OF FLORIDA
By: /s/ Robert L. Kisiel
------------------------------
Name: Robert L. Kisiel
Title: Director of Investments
COVA FINANCIAL SERVICES LIFE INSURANCE
COMPANY
By: CONNING ASSET MANAGEMENT
COMPANY
By: /s/ Laura R. Caro
------------------------------
Name: Laura R. Caro
Title: Senior Vice President
HARE & CO. (with respect to Senior Note
N12 as nominee of Lincoln National Life
Insurance Company)
By: /s/ Donna Steineman
------------------------------
Name: Donna Steineman
Title: Asst. Vice President
<PAGE>
-12-
Purchasers under the June Note Agreement:
JOHN HANCOCK MUTUAL LIFE
INSURANCE COMPANY
By: /s/ Stephen J. Blewitt
------------------------------
Name: Stephen J. Blewitt
Title: Senior Investment Officer
JOHN HANCOCK VARIABLE LIFE
INSURANCE COMPANY
By: /s/ Stephen J. Blewitt
------------------------------
Name: Stephen J. Blewitt
Title: Senior Investment Officer
GREAT NORTHERN INSURED ANNUITY
CORPORATION
By: /s/ Jon M. Lucia
------------------------------
Name: Jon M. Lucia
Title: Vice President
OCCIDENTAL LIFE INSURANCE
COMPANY OF NORTH CAROLINA
By: CONNING ASSET MANAGEMENT
By: /s/ Laura R. Caro
------------------------------
Name: Laura R. Caro
Title: Senior Vice President
PENINSULAR LIFE INSURANCE CO.
By: CONNING ASSET MANAGEMENT
By: /s/ Laura R. Caro
------------------------------
Name: Laura R. Caro
Title: Senior Vice President
EXECUTIVE RISK INDEMNITY INC.
By: /s/ Laura R. Caro
------------------------------
Name: Laura R. Caro
Title: Senior Vice President
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
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0
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