<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 MARCH 31, 1999
COMMISSION FILE NO. 0-20440
MEDICAL RESOURCES, INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C>
DELAWARE 13-3584552
State of Incorporation) (IRS Employer Identification No.)
125 STATE STREET, SUITE 200, HACKENSACK, 07601
NJ (Zip Code)
(Address of Principal Executive Office)
</TABLE>
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.
<TABLE>
<S> <C>
Yes /X/ No / /
</TABLE>
At April 30, 1999, 9,335,918 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 $15,456,876.
DOCUMENTS INCORPORATED BY REFERENCE
Not Applicable.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
MEDICAL RESOURCES, INC.
INDEX
<TABLE>
<CAPTION>
PAGES
---------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets at March 31, 1999 and December 31, 1998......................... 3
Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998.... 4
Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998.... 5
Notes to Consolidated Financial Statements.................................................. 6-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 12-18
PART II. OTHER INFORMATION........................................................................... 19
</TABLE>
2
<PAGE>
MEDICAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 1999 AND DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
---------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............................................................ $ 11,984 $ 20,997
Restricted cash...................................................................... 900 1,182
Accounts receivable, net............................................................. 58,453 54,451
Other receivables.................................................................... 10,271 8,140
Prepaid expenses..................................................................... 3,995 3,819
Income taxes recoverable............................................................. 2,076 2,322
---------- ------------
Total current assets............................................................... 87,679 90,911
Property and equipment, net............................................................ 47,970 50,791
Goodwill and other intangible assets, net.............................................. 139,128 141,079
Other assets........................................................................... 3,085 3,133
---------- ------------
Total assets......................................................................... $ 277,862 $ 285,914
---------- ------------
---------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of notes and mortgages payable....................................... $ 7,762 $ 11,019
Current portion of capital lease obligations......................................... 8,494 9,355
Accounts payable..................................................................... 10,486 10,946
Accrued expenses and other current liabilities....................................... 24,324 23,356
Accrued shareholder settlement cost.................................................. 5,250 5,250
---------- ------------
Total current liabilities.......................................................... 56,316 59,926
Notes and mortgages payable, less current portion...................................... 91,101 92,556
Obligations under capital leases, less current portion................................. 13,353 15,101
Other long term liabilities............................................................ 952 1,061
---------- ------------
Total liabilities.................................................................. 161,722 168,644
Minority interest...................................................................... 5,342 5,047
Stockholders' equity:
Common stock, $.01 par value; authorized 50,000 shares; issued and outstanding 9,336
shares............................................................................. 93 93
Series C Convertible Preferred Stock, $1,000 per share stated value; issued and
outstanding 16 shares; liquidation preference 3% per annum......................... 15,658 15,547
Additional paid-in capital........................................................... 146,098 146,165
Accumulated deficit.................................................................. (51,051) (49,582)
---------- ------------
Total stockholders' equity......................................................... 110,798 112,223
---------- ------------
Total liabilities and stockholders' equity............................................. $ 277,862 $ 285,914
---------- ------------
---------- ------------
</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 MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------
<S> <C> <C>
1999 1998
--------- ---------
Net service revenues........................................................................ $ 41,888 $ 47,022
Cost of operations:
Cost of services.......................................................................... 27,263 30,203
Provision for doubtful accounts........................................................... 2,202 3,621
Equipment leases.......................................................................... 2,036 1,373
Depreciation and amortization............................................................. 5,606 6,477
--------- ---------
Total cost of operations.............................................................. 37,107 41,674
--------- ---------
Gross profit.............................................................................. 4,781 5,348
Corporate general and administrative expenses............................................... 2,664 3,216
Stock-option based compensation............................................................. 46 114
Unusual charges............................................................................. 280 3,760
--------- ---------
Operating income (loss)................................................................... 1,791 (1,742)
Interest expense, net....................................................................... 2,805 3,486
--------- ---------
Loss from continuing operations beforeminority interest and income taxes.................. (1,014) (5,228)
Minority interest (benefit)................................................................. 324 181
--------- ---------
Loss from continuing operations before income taxes....................................... (1,338) (5,409)
Provision for income taxes.................................................................. 130 79
--------- ---------
Loss from continuing operations........................................................... (1,468) (5,488)
Income from discontinued operations, net of tax............................................. -- 749
--------- ---------
Net loss.................................................................................. (1,468) (4,739)
Charges related to convertible preferred stock.............................................. (111) (135)
--------- ---------
Net loss applicable to common stockholders................................................ $ (1,579) $ (4,874)
--------- ---------
--------- ---------
Basic and diluted income (loss) per common share applicable to common stockholders:
Continuing operations..................................................................... $ (0.17) $ (0.77)
Discontinued operations................................................................... -- 0.10
--------- ---------
Net loss per common share............................................................. $ (0.17) $ (0.67)
--------- ---------
--------- ---------
</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 THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
<S> <C> <C>
1999 1998
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................................... $ (1,468) $ (4,739)
---------- ----------
Adjustments to reconcile net income to cash used in operations--
Depreciation and amortization..................................................... 5,606 6,648
Provision for uncollectible accounts receivable................................... 2,022 3,693
Issuance of warrants and notes to preferred stockholders.......................... -- 2,094
Other, net........................................................................ 326 370
Changes in operating assets and liabilities:
Accounts receivable............................................................... (7,014) (9,102)
Other receivables................................................................. (1,981) (2,527)
Prepaid expenses.................................................................. (193) 57
Income taxes recoverable or payable............................................... 246 229
Other assets...................................................................... 28 175
Accounts payable and accrued expenses............................................. 833 (2,831)
Other liabilities................................................................. (109) 908
---------- ----------
Total adjustments............................................................... (236) (286)
---------- ----------
Net cash used in operating activities......................................... (1,704) (5,025)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of diagnostic imaging centers, net of cash sold................................ 631 --
Contingent consideration related to prior year acquisitions......................... -- (334)
Purchase of property and equipment.................................................. (1,159) (919)
Other, net.......................................................................... (95) --
---------- ----------
Net cash used in investing activities......................................... (623) (1,253)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes and mortgages payable................................... (4,077) (1,878)
Principal payments under capital lease obligations.................................. (2,609) (2,438)
Borrowings under line of credit..................................................... -- 2,847
Repurchase of Common Stock subject to redemption.................................... -- (2,547)
Other, net.......................................................................... -- 128
---------- ----------
Net cash used in financing activities......................................... (6,686) (3,888)
---------- ----------
Net decrease in cash and cash equivalents........................................... (9,013) (10,166)
Cash and cash equivalents at beginning of year...................................... 20,997 23,198
---------- ----------
Cash and cash equivalents at end of period.......................................... $ 11,984 $ 13,032
---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash refunded by (paid for) income taxes.......................................... $ 15 $ (77)
Cash paid for interest............................................................ (3,145) (5,185)
</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
Medical Resources, Inc., (herein referred to as "MRII" and collectively with
its subsidiaries, affiliated partnerships and joint ventures, referred to herein
as the "Company") specializes in the operation and management of diagnostic
imaging centers. The Company operates and manages primarily fixed-site,
free-standing outpatient diagnostic imaging centers (herein referred to as
"centers"), and provides diagnostic imaging network management services to
managed care providers. The Company also develops and sells radiology industry
information systems through its subsidiary, Dalcon Technologies, Inc.
The accompanying unaudited consolidated financial statements of 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/A filed with the
Securities and Exchange Commission (the "SEC") for the year ended December 31,
1998.
On April 22, 1999, due to the Company's failure to meet the continued
listing requirements of the Nasdaq National Market or the Nasdaq SmallCap
Market, the Company's Common Stock was delisted by Nasdaq. The Company's Common
Stock is now traded on the OTC Bulletin Board, an electronic quotation service
for NASD Market Makers.
COST OF SERVICES
Cost of services as shown on the Consolidated Statement of Operations for
the three month periods ended March 31, 1999 and 1998 consist of the following
(in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
<S> <C> <C>
1999 1998
--------- ---------
Operations payroll and related.......................................... $ 9,930 $ 11,582
Equipment maintenance expense........................................... 2,307 2,934
Contract radiology fees................................................. 2,264 2,301
Medical supplies........................................................ 2,689 2,999
Facilities rent and related............................................. 2,823 2,831
Other center level costs................................................ 7,027 7,446
--------- ---------
Total Diagnostic Imaging............................................ 27,040 30,093
Dalcon Technologies, Inc................................................ 223 110
--------- ---------
Total Company....................................................... $ 27,263 $ 30,203
--------- ---------
--------- ---------
</TABLE>
6
<PAGE>
MEDICAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
1. DESCRIPTION OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to the current
year presentation.
EARNINGS PER SHARE
The computations of basic earnings per share and diluted earnings per share
for the three months ended March 31, 1999 and 1998 were as follows (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
<S> <C> <C>
1999 1998
--------- ---------
Basic and diluted earnings (loss) per share information
Loss from continuing operations.......................................... $ (1,468) $ (5,488)
Income from discontinued operations...................................... -- 749
--------- ---------
Net loss................................................................. (1,468) (4,739)
Charges related to convertible preferred stock........................... (111) (135)
--------- ---------
Net loss applicable to common stockholders............................... $ (1,579) $ (4,874)
--------- ---------
--------- ---------
Weighted average number of common shares................................. 9,336 7,286
--------- ---------
--------- ---------
Basic and diluted income (loss) per common share:
Continuing operations.................................................. $ (0.17) $ (0.77)
Discontinued operations................................................ -- 0.10
--------- ---------
Net income (loss) per common share....................................... $ (0.17) $ (0.67)
--------- ---------
--------- ---------
</TABLE>
2. UNUSUAL CHARGES
During the three months ended March 31, 1999, the Company recorded unusual
charges of $280,000 attributable to defense costs relating to the shareholder
class action lawsuit. The Company could incur additional unusual charges during
the remainder of 1999 relating to the ultimate finalization of the settlement of
the shareholder class action lawsuit.
Unusual charges for the three months ended March 31, 1998 consisted of
$2,227,000 related to Convertible Preferred Stock penalties, $883,000 for costs
of the investigation of related party transactions, $313,000 associated with the
shareholder class action lawsuit and other charges of $337,000.
7
<PAGE>
MEDICAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
3. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net, is comprised of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
----------- ------------
<S> <C> <C>
Diagnostic Imaging
Management fee receivables (net of contractual allowances)
Due from unaffiliated physicians (Type I revenues).............. $ 37,859 $ 33,810
Due from affiliated physicians (Type III revenues).............. 5,087 5,436
Patient and third party payor accounts receivable (Type II
revenues)....................................................... 28,181 28,884
----------- ------------
71,127 68,130
Dalcon Technologies, Inc............................................ 1,456 346
----------- ------------
Accounts receivable before allowance for doubtful accounts.......... 72,583 68,476
Less: Allowance for doubtful accounts............................... (14,130) (14,025)
----------- ------------
Total accounts receivable, net...................................... $ 58,453 $ 54,451
----------- ------------
----------- ------------
</TABLE>
Accounts receivable is net of contractual allowances, which represent
standard fee reductions negotiated with certain third party payors. Contractual
allowances, recorded as a reduction in deriving net service revenues, were
$34,987,000 and $28,850,000 for the three months ended March 31, 1999 and 1998,
respectively.
4. 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 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 then Chairman of
8
<PAGE>
MEDICAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the Board ("712 Advisory"), 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 712 Advisory 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 Company. In addition, the Special Committee recommended and
712 Advisory agreed to allow the Company to terminate its relationship with 712
Advisory.
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) 712 Advisory
performed acquisition advisory services fully consistent with the expectations
and understanding of the committee of outside directors that had approved 712
Advisory's acquisition fees; and (iv) the acquisition advisory fees paid to 712
Advisory 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.
On December 18, 1998, attorneys for the plaintiffs in the pending class
actions reached an agreement in principle with the Company and certain of the
other defendants to settle all of the pending class actions in consideration
primarily of (i) a payment of $2.75 million to be provided from the Company's
insurer and (ii) the issuance of $5.25 million of Convertible subordinated
promissory notes (the "Convertible Subordinated Notes"). The $5.25 million of
Convertible Subordinated Notes will bear interest at the rate of 8% per annum,
will be due on the earlier of August 1, 2005 or when the Company's presently
outstanding Senior Notes are paid in full, and may be prepaid in cash by the
Company at any time after issuance subject to the payment of a prepayment
premium which begins at 8% and decreases over time. Additionally, the
Convertible Subordinated Notes are convertible into shares of the Company's
Common Stock beginning February 15, 2000 at a price per share equal to the
greater of $3.00 or 120% of the ten day average closing price of the Company's
Common Stock as of the date of the court hearing to be scheduled to approve the
agreement in principle. The court hearing to approve the agreement in principle
is expected to occur in July 1999.
The agreement-in-principle and the class action settlement contemplated
thereby are further subject to (1) consent to the issuance of the Convertible
Subordinated Notes by the Company's Senior Noteholders and (2) the right of
either the Company or the attorneys representing the class plaintiffs to
terminate the agreement-in-principle if the ten day average closing price of the
Company's Common Stock as of the court hearing date is less than $1.75 per
share. If such settlement is not approved or consummated, the Company intends to
defend vigorously against the allegations.
As previously disclosed 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 referenced above. In addition as
previously disclosed, the Company has received an inquiry from the SEC, but no
formal proceedings have been commenced by the SEC. The Company has cooperated
fully with these authorities and provided all information requested by them.
On November 7, 1997, William D. Farrell resigned from his position as
President and Chief Operating Officer of the Company and as Director, and Gary
I. Fields resigned from his position 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
9
<PAGE>
MEDICAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 allegedly 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 14, 1997, Mr. John P. O'Malley III, the former Chief Financial
Officer of the Company, filed a complaint in the Superior Court of New Jersey,
Law Division, Essex County, against the Company and Gary N. Siegler, Neil H.
Koffler, Stephen M. Davis, Gary L. Fuhrman, John H. Josephson and Lawrence
Ramaekers, as defendants, claiming retaliatory discharge under the New Jersey
Conscientious Employee Protection Act and defamation. Mr. O'Malley alleged 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, the
plaintiff alleged that the Company published false and defamatory statements
about him. Mr. O'Malley sought 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.
On December 18, 1998, Mr. O'Malley, the Company and the other defendants
reached an agreement to settle the O'Malley claims in consideration of (i) the
payment to Mr. O'Malley of approximately $117,000 from a letter of credit
established by the Company in 1996 for the benefit of Mr. O'Malley, (ii) the
Company's agreement to indemnify Mr. O'Malley in connection with future
litigation and (iii) the execution of mutual releases by all parties.
On June 2, 1998, Mr. Ronald Ash filed a complaint against the Company, its
wholly-owned subsidiaries, StarMed Staffing, Inc. and Wesley Medical Resources,
Inc. (the latter hereinafter referred to as "Wesley", and both companies
collectively, "StarMed"), and certain officers and directors of the Company in
the United States District Court for the Northern District of California. On
June 24, 1997, the Company, acquired the assets of Wesley, a medical staffing
company in San Francisco, California, from Mr. Ash and another party for 45,741
shares of the Company's Common Stock valued at $2,000,000 and contingent
consideration based on the company achieving certain financial objectives during
the three year period subsequent to the transaction. The Ash 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 adverse material 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, rescission of the sale of Wesley.
On October 7, 1998, upon motion by the Company, the Ash action was
transferred from the United States District Court for the Northern District of
California and consolidated with the pending securities class actions in the
United States District Court for the District of New Jersey. The Company
believes that it has meritorious defenses to the claims asserted by plaintiff,
and intends to defend itself vigorously.
10
<PAGE>
MEDICAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 the normal course of business, the Company is subject to claims and
litigation other than those set forth above. Management believes that the
outcome of 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.
In connection with certain of the Company's 1997 acquisitions, the Company
agreed with the sellers to pay to the seller (in additional shares and/or cash)
an amount equal to the shortfall, if any (the "Price Protection Shortfall"), in
the value of the issued shares and the market value of such shares on the
effective date of the Company's registration statement. Based upon the closing
sales price of the Company's Common Stock on October 2, 1998 ($2.67 per share),
the date on which the Company's registration statement was declared effective,
the Company issued 590,147 shares of Common Stock and became obligated to pay
during 1999 an additional $1,659,000 with respect to all such Price Protection
Shortfall obligations.
In connection with certain of the Company's acquisitions, the Company has
also agreed with certain 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 differs 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. Contingent consideration associated
with acquisitions is recorded as additional purchase price when resolved.
During 1997, 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 International, LDC ("RGC"). 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 five (5) consecutive trading days ending five (5) trading days
prior to the date of conversion. Pursuant to the Preferred Stock 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 or such other mutually agreed upon date and provided for monthly
penalties ("RGC Registration Penalties") in the event that the Company failed to
register the Conversion Shares prior to such date.
As a result of the Company's failure to register the RGC Conversion Shares
until October 3, 1998, the Company: (i) issued warrants to RGC to acquire (a)
272,333 shares of Common Stock at an exercise price equal to $34.86 per share
(the "December 1997 Warrants") and (b) 116,666 share of Common Stock at an
exercise price of $38.85 per share (the "January 1998 Warrants") (such warrants
having an estimated value of $3,245,000), and (ii) issued promissory notes
bearing interest at 13% per annum (the "RGC Penalty Notes") in the aggregate
principal amount of $2,451,000 due and payable, as amended, in eleven monthly
payments beginning on December 1, 1998 and ending on October 1, 1999. Pursuant
to an agreement with RGC, entered into as of May 1, 1998, the exercise price of
certain December 1998 RGC Warrants to
11
<PAGE>
MEDICAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
acquire 77,667 shares of Common Stock was reduced to $2.73 per share, and the
exercise price of all of the January 1998 RGC Warrants was reduced to $2.73 per
share. 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.
In addition, as a result of the Company's failure to register the RGC
Conversion Shares prior to September 15, 1998, RGC may demand a one-time penalty
of $1,490,000 (the "Registration Default Penalty"), payable, at the option of
RGC, in cash or additional shares of Common Stock. As of the date hereof, RGC
has not demanded the Registration Default Penalty. Purchasers of Common Stock
could experience substantial dilution upon conversion of the Series C Preferred
Stock, the RGC Penalty Notes and the exercise of December 1997 RGC Warrants and
January 1998 RGC Warrants.
5. DISCONTINUED OPERATIONS
On August 18, 1998, the Company sold 100% of its stockholdings in StarMed
(the "StarMed Sale") for net cash proceeds at closing of $15,028,000, plus the
elimination of $13,786,000 of StarMed's outstanding third party debt. Due to the
StarMed Sale, the results of operations of StarMed for the first quarter of 1998
are herein reflected in the Company's Consolidated Statements of Operations as
discontinued operations.
The following table shows the summary statement of operations for StarMed
for the three months ended March 31, 1998 (in thousands):
<TABLE>
<S> <C>
Net service revenues............................................... $ 19,816
Office level operating costs and provisions for uncollectible
accounts receivable.............................................. 15,797
Corporate general and administrative............................... 2,856
Depreciation and amortization...................................... 171
---------
Operating income............................................... 992
Interest expense, net.............................................. 182
---------
Income before income taxes......................................... 810
Provision for income taxes......................................... 61
---------
Income after income taxes.......................................... $ 749
---------
---------
</TABLE>
12
<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(s)"), 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, (typically including billing and collection of
receivables), and technical imaging services to the Interpreting Physician(s).
Net service revenues are reported, when earned, at their estimated net
realizable amounts from third party payors, patients 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 and various State and
Federal regulations, imaging centers operated or managed by the Company
recognize revenue under one of the three following types of agreements with
Interpreting Physician(s):
Type I--Pursuant to facility service agreements with Interpreting
Physician(s) or Physician Group, 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(s) or Physician Group 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 Physician(s) either (i) a fixed
percentage of fees collected for services performed 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(s) 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--Pursuant to a facility service agreement, 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 Physician(s). 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
Physician(s) 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.
Revenues derived from Medicare and Medicaid are subject to audit by such
agencies. The Company is not aware of any pending audits.
13
<PAGE>
The Company also recognizes revenue from the licensing and/or sale of
software and hardware comprising radiology information systems which the Company
has developed. Such revenues are recognized on an accrual basis as earned.
For the three months ended March 31, 1999, the fees received or retained by
the Company under the three types of agreements with Interpreting Physician(s)
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 87% for the Type
III agreements. These agreements generally have terms ranging from one to ten
years.
QUARTER ENDED MARCH 31, 1999 COMPARED TO THE QUARTER ENDED MARCH 31, 1998
For the quarter ended March 31, 1999, total Company net service revenues
were $41,888,000 versus $47,022,000 for the quarter ended March 31, 1998, a
decrease of $5,134,000 or 11%. The decrease in net service revenues was due
principally to an expected decrease in personal injury claims business and a
continuing gradual decline in reimbursement rates. In addition, during 1998, the
Company closed or sold eight imaging centers.
Net service revenues from personal injury claims, mainly involving
automobile accidents, comprised approximately 11% of diagnostic imaging net
revenues in the first quarter of 1999, down from approximately 18% in the first
quarter of 1998. Management believes this decrease resulted principally from the
effects of the Company's intentional reduction in reliance on personal injury
revenues due to the high bad debt rate and very long collection cycle associated
with such business. In addition, recent legislation in New Jersey and Florida
aimed at curtailing auto insurance spending also contributed to the decline in
personal injury revenues for the period. This trend, if it continues over time,
could have a material adverse effect on the financial results of the Company.
Management believes that past and future declines in revenues from personal
injury claims business will be offset, over time, with other payor class
revenues, especially as the Company completes its equipment replacement and
upgrade program. Under this equipment replacement program, the Company expects
to replace or upgrade approximately 22 MRI systems in its centers by the end of
1999. While not necessarily indicative of future performance at the same or
other centers, annualized procedure volumes have increased an average of
approximately 46% at three of the Company's centers where new MRI systems were
installed during 1998. While the Company intends to finance new diagnostic
equipment via operating leases, there can be no assurance that such financing
will remain available over the course of the planned equipment upgrade program.
Consequently, if such financing or alternate financing were to become
unavailable, the Company's future procedure volumes and net revenues could be
materially adversely affected over time.
The industry in which the Company participates has been experiencing gradual
reimbursement rate declines and this is expected to continue for some period of
time due to factors such as the expansion of managed care in the United States
and reimbursement cuts by U.S. government agencies. The Company will attempt to
mitigate the impact of any further decline in reimbursement rates by decreasing
its costs and increasing patient referral volumes. Nevertheless, if the rate of
decline in reimbursement rates were to materially increase, or if the Company is
unsuccessful in reducing its costs or increasing its volumes, the Company's
results could be materially and adversely affected over time.
Costs of services for the three months ended March 31, 1999 were $27,263,000
compared to $30,203,000 for the three months ended March 31, 1998, a decrease of
$2,940,000 or 10%. This decrease was due to the closure or sale of eight centers
during 1998 and early 1999, and center-level cost reduction initiatives
implemented since the beginning of 1998.
The provision for uncollectible accounts receivable for the quarter ended
March 31, 1999 was $2,202,000, or 5% of related net service revenues, compared
to the first quarter 1998 provision of
14
<PAGE>
$3,621,000, or 8% of related net service revenues. The decrease in the provision
for uncollectible accounts receivable, as a percentage of net service revenues,
was due to a decline in personal injury claims business which carries higher
than average bad debt rates, and improvements made by the Company in billing and
collection systems and procedures during late 1998 and early 1999.
Depreciation and amortization expense for the quarter was $5,606,000,
compared to $6,477,000 for the first quarter of 1998, or a decrease of $871,000.
The decrease was due primarily to lower medical equipment depreciation, which
was partially the result of the Company entering into operating leases
throughout 1998 in connection with medical equipment replacements.
Gross profit margins, which represent net service revenue less center costs
as a percent of net service revenue, for both of the quarters ended March 31,
1999 and 1998 was 11%.
Corporate general and administrative expense for the three months ended
March 31, 1999 was $2,664,000, a decrease of $552,000 from the $3,216,000
recorded for the three months ended March 31, 1998 due primarily to lower
professional fees and payroll costs.
During the three months ended March 31, 1999, the Company recorded unusual
charges of $280,000 attributable to defense costs relating to the shareholder
class action lawsuit. The Company could incur additional unusual charges during
the remainder of 1999 relating to the ultimate finalization of the settlement of
the shareholder class action lawsuit.
Unusual charges for the three months ended March 31, 1998 consisted of
$2,227,000 related to Convertible Preferred Stock penalties, $883,000 for costs
of the investigation of related party transactions, $313,000 associated with the
shareholder class action lawsuit and other charges of $337,000.
Net interest expense for the three months ended March 31, 1999 was
$2,805,000 as compared to $3,486,000 for the three months ended March 31, 1998,
a decrease of $681,000. This decrease was primarily attributable to the
retirement of notes payable and capitalized lease obligations.
The Company's loss for the quarter ended March 31, 1999 was increased by
$324,000 attributable to minority interests, as compared to an increase in the
Company's loss of $181,000 for the quarter ended March 31, 1998.
The provision for income taxes for the three months ended March 31, 1999 was
$130,000 as compared to $79,000 for the comparable period last year. The
provision for income taxes for the three months ended March 31, 1999 and 1998
consists entirely of estimated state income taxes. For both quarters, a benefit
for income taxes related to the Company's losses has not been recorded due to
the uncertainty regarding the realization of the full amount of the Company's
deferred tax assets.
The Company's net loss from continuing operations for the quarter ended
March 31, 1999 was $1,468,000 compared to the quarter ended March 31, 1998 of
$5,488,000.
The net loss applicable to common stockholders (used in computing loss per
common share) in the quarters ended March 31, 1999 and 1998 includes charges of
$111,000 and $135,000, respectively, as a result of the accretion of the
Company's convertible preferred stock.
STARMED SALE
On August 18, 1998, the Company sold 100% of its stockholdings in StarMed
(the "StarMed Sale") for net cash proceeds at closing of $15,028,000, plus the
elimination of $13,786,000 of StarMed's outstanding third party debt. Due to the
StarMed Sale, the results of operations of StarMed for the first quarter of 1998
are herein reflected in the Company's Consolidated Statements of Operations as
discontinued operations.
15
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
During the first quarter of 1999, the Company's primary source of cash flow
was from reductions in the Company's cash balances of $9,013,000. The primary
uses of cash in the first quarter of 1999 were the repayment of debt of
$6,686,000, and operating activities which used $1,704,000 of cash. Cash flow
from operating activities during the first quarter of 1999 was adversely
impacted by an increase in accounts receivable, net of provision for doubtful
accounts, of $4,992,000, of which $3,882,000 related to the Company's diagnostic
imaging business and $1,110,000 related to Dalcon Technologies, Inc. The
increase attributable to the Company's diagnostic imaging business was due to
lower than expected cash collections in the first quarter of 1999, in part
related to identified delays in claims processing at certain imaging centers.
During April and the first week of May, collections have improved from the
levels experienced during the first quarter of 1999 and, during this period,
outstanding accounts receivable have decreased.
During the first quarter of 1998, the Company's primary source of cash flow
was from reductions in the Company's cash balances of $10,166,000. The primary
uses of cash in the first quarter of 1998 were operating activities which used
$5,025,000 of cash, the repurchase of Common Stock subject to redemption of
$2,547,000 and the net repayment of debt of $1,469,000.
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.
WORKING CAPITAL
The Company had a working capital surplus of $31,363,000 at March 31, 1999
compared to $30,985,000 at December 31, 1998.
OTHER OBLIGATIONS OF THE COMPANY
In connection with certain of the Company's 1997 acquisitions, the Company
agreed with the sellers to pay to the seller (in additional shares and/or cash)
an amount equal to the shortfall, if any (the "Price Protection Shortfall"), in
the value of the issued shares and the market value of such shares on the
effective date of the Company's registration statement. Based upon the closing
sales price of the Company's Common Stock on October 2, 1998 ($2.67 per share),
the date on which the Company's registration statement was declared effective,
the Company issued 590,147 shares of Common Stock and became obligated to pay
during 1999 an additional $1,659,000 with respect to all such Price Protection
Shortfall obligations.
In connection with certain of the Company's acquisitions, the Company has
also agreed with certain 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 differs 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. Contingent consideration associated
with acquisitions is recorded as additional purchase price when resolved.
During 1997, 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 International, LDC ("RGC"). 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 five (5) consecutive trading days ending five (5) trading days
prior to the date of conversion. Pursuant to the Preferred Stock agreements, the
Company was required to use its
16
<PAGE>
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 or such other mutually agreed
upon date and provided for monthly penalties ("RGC Registration Penalties") in
the event that the Company failed to register the Conversion Shares prior to
such date.
As a result of the Company's failure to register the RGC Conversion Shares
until October 3, 1998, the Company: (i) issued warrants to RGC to acquire (a)
272,333 shares of Common Stock at an exercise price equal to $34.86 per share
(the "December 1997 Warrants") and (b) 116,666 share of Common Stock at an
exercise price of $38.85 per share (the "January 1998 Warrants") (such warrants
having an estimated value of $3,245,000), and (ii) issued promissory notes
bearing interest at 13% per annum (the "RGC Penalty Notes") in the aggregate
principal amount of $2,451,000 due and payable, as amended, in eleven monthly
payments beginning on December 1, 1998 and ending on October 1, 1999. Pursuant
to an agreement with RGC, entered into as of May 1, 1998, the exercise price of
certain December 1998 RGC Warrants to acquire 77,667 shares of Common Stock was
reduced to $2.73 per share, and the exercise price of all of the January 1998
RGC Warrants was reduced to $2.73 per share. 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.
In addition, as a result of the Company's failure to register the RGC
Conversion Shares prior to September 15, 1998, RGC may demand a one-time penalty
of $1,490,000 (the "Registration Default Penalty"), payable, at the option of
RGC, in cash or additional shares of Common Stock. As of the date hereof, RGC
has not demanded the Registration Default Penalty. Purchasers of Common Stock
could experience substantial dilution upon conversion of the Series C Preferred
Stock, the RGC Penalty Notes and the exercise of December 1997 RGC Warrants and
January 1998 RGC Warrants.
In addition to matters discussed above, the Company is subject to litigation
that may require additional future cash outlays.
FINANCIAL RESOURCES
Prior to 1998, the Company incurred substantial debt in connection with
acquisitions of imaging centers. As of March 31, 1999, the Company's debt,
including capitalized lease obligations, totaled $120,710,000. Cash available to
Medical Resources, Inc. for general corporate use declined from $13,479,000 at
December 31, 1998 to $7,078,000 as of March 31, 1999 (both balances exclude cash
held by non-wholly owned affiliates as of the indicated dates, since such cash
amounts are not readily available to Medical Resources, Inc. for general
corporate purposes). However, some portion of such excluded cash is expected to
be available to satisfy that portion of the Company's remaining 1999 short term
debt which is attributable to non-wholly owned affiliates.
Other than operating lease obligations to finance new diagnostic equipment,
the Company does not expect to incur significant additional debt in the near
future. Additionally, due to ongoing cost reduction initiatives and due to
improvements made and being made to the Company's billing and collections
systems and procedures, the Company expects 1999 cash flows from operations to
improve from the level achieved in 1998 and the first quarter of 1999. Based on
these factors, management believes that existing available cash balances, plus
expected 1999 cash flows from operations, will be adequate to fund the Company's
1999 cash requirements.
COMMON STOCK
On April 22, 1999, due to the Company's failure to meet the continued
listing requirements of the Nasdaq National Market or the Nasdaq SmallCap
Market, the Company's Common Stock was delisted by Nasdaq. The Company's Common
Stock is now traded on the OTC Bulletin Board, an electronic quotation service
for NASD Market Makers. There can be no assurance that the Company's Common
Stock will continue to trade on the OTC Bulletin Board. It is the Company's
intention to again seek to be
17
<PAGE>
listed on Nasdaq or a national securities exchange if and when the Company
satisfies the requirements for listing.
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 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 adverse effect on
the financial results of the Company.
IMPACT OF YEAR 2000 ON COMPANY'S COMPUTER SOFTWARE
The Company is preparing for the impact of the arrival of the Year 2000 on
its business, as well as on the businesses of its customers, suppliers and
business partners. The "Year 2000 Problem" is a term used to describe the
problems created by systems that are unable to accurately interpret dates after
December 31, 1999. These problems are derived predominately from the fact that
certain computer hardware and many software programs historically recorded a
date's "year" in a two-digit format (i.e., "98" for 1998) and therefore may
recognize the year "00" as 1900 instead of the Year 2000. The Year 2000 Problem
creates potential risks for the Company, including the inability to recognize or
properly treat dates occurring on or after January 1, 2000, which may result in
computer system failures or miscalculations of critical financial or operational
information as well as failures of equipment controlling date-sensitive
microprocessors or influencing patient care.
In addition to it's internal systems, the Company relies heavily on third
parties in operating its business. Such third parties include (1) vendors who
supply software, hardware and other equipment to the Company, (2) intermediaries
that process claims and payments on behalf of various payors, (3) insurance
companies, HMO's and other private payors, (4) utilities which provide
electricity, water, natural gas and telephone services and (5) vendors of
medical supplies and pharmaceuticals used in patient care.
The Company began formulating a plan in 1998 to address the Year 2000
Problem and to ensure that all relevant systems had been subject to a full Year
2000 review and, if necessary, remediation, replacement or upgrade. Under the
plan, the Company has focused on (i) internal financial, operational and medical
software and equipment and (ii) the Year 2000 compliance of all third party
suppliers and intermediaries doing business with the Company. In connection with
its Year 2000 compliance activities, the Company has contacted all outside
vendors and intermediaries with which the Company has material relationships and
engaged in discussions which will continue throughout 1999 in furtherance of the
Company's stated goal of minimizing any adverse impact related to the Year 2000
Problem.
The Company has completed its assessment of all material financial and
billing computer systems. In connection with this review, the Company upgraded
its financial accounting systems to Year 2000 compliant systems in January 1999.
This system is currently being tested to verify Year 2000 compliance, and such
testing should be completed by May 31, 1999. The Company's ICIS billing and
collection system will be upgraded in June 1999, and is expected to be fully
installed and tested by September 1999. The costs and expenses incurred or
expected to be incurred relating to Year 2000 compliance for these systems is
currently not expected to be material. Software sold by the Company's
wholly-owned subsidiary, Dalcon Technologies, Inc. is expected to be fully Year
2000 compliant and fully installed and tested at all 300 sites supported by
Dalcon by September 1999. Computer equipment at Dalcon Technologies, Inc. has
been
18
<PAGE>
inventoried and testing is underway for Year 2000 compliance. This testing is
expected to be completed by June 1999.
The Company is in the process of completing its review of all diagnostic
imaging equipment in operation at the Company's centers. Each piece of
diagnostic equipment in operation has computer systems and applications, and in
many cases, embedded computer processors. The Company is in communication with
all of the manufacturers of such equipment and believes that a majority of the
equipment is either currently Year 2000 compliant or can be upgraded (either
through software modifications or hardware replacement) to become Year 2000
compliant. The Company expects to complete its review of all diagnostic imaging
equipment no later than June 1999, and expects all necessary upgrades or other
remediation to be completed no later than September 1999. In the event that
certain diagnostic imaging equipment is not Year 2000 compliant and no upgrade
or remediation is available, the Company expects to provide for the replacement
of such equipment prior to December 1999.
With regard to third parties, 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. Compliance letters have been sent
to all such payors and suppliers, and follow up will continue throughout 1999. A
significant portion of the Company's revenues are derived from the Medicare
program, which is administered by the Health Care Financing Administration
(HCFA). HCFA employs more than 60 carriers and intermediaries to process
Medicare fee-for-service claims throughout the nation. There are several hundred
different computer systems involved in the everyday work of HCFA, its carriers
and intermediaries.
HCFA has announced the establishment of target dates to complete testing of
its mission critical systems and to certify to the Secretary of Health and Human
Services that its mission critical systems will be Year 2000 compliant. There
can be no assurance that HCFA will meet the established timetable or that it
will have its mission critical systems, which most directly affect the Company,
Year 2000 compliant in time to prevent disruptions to the Medicare payments
received by the Company. Moreover, HCFA has announced the delayed implementation
of certain new regulations as well as the possible postponement of scheduled
rate increases while its resources are redirected towards Year 2000 compliance.
While certain members of Congress have taken strong exception to HCFA's
announcement to delay rate increases, it is possible that rate increases, which
were scheduled to take effect on October 1, 1999, could be delayed until after
December 31, 1999.
The Company estimates that costs and expenses associated with completing the
outlined Year 2000 compliance plan will range from $500,000 to $900,000. The
Company presently believes that it will substantially complete its internal Year
2000 compliance program prior to January 1, 2000, and that there should be no
material adverse impact at such time related to Year 2000 Problems associated
with the Company's systems or software. Based on communications with its vendors
and suppliers, the Company also believes that each third party or intermediary
with whom the Company has a material relationship is currently Year 2000
compliant or scheduled to be Year 2000 compliant by January 1, 2000.
Despite the Company's best efforts, there can be no assurance that (i) the
Company's assessments regarding the Year 2000 Problem are correct; (ii) the
Company will be able to successfully complete its Year 2000 review and implement
such upgrades and/or remediation as is necessary or (iii) third parties or
suppliers with whom the Company does business will avoid Year 2000 Problems
which might adversely affect the Company business or operations. While the
Company is developing contingency plans to address such failures or unexpected
problems (such plans to include identification of alternative suppliers or
intermediaries), there can be no assurance that such contingency plans will be
adequate to resolve these problems. The Company's contingency plan is expected
to be completed by approximately August 31, 1999.
The Year 2000 Problem involves substantial risk to the Company. The Company
believes today that the likely worst case scenario regarding the Year 2000
Problem will involve (1) malfunctions in clinical computer software and hardware
at certain of the imaging centers operated and/or managed by the Company, (2)
malfunctions in biomedical equipment at certain of the imaging centers operated
and/or
19
<PAGE>
managed by the Company, (3) temporary disruptions in delivery of medical
supplies and utility services at certain of the imaging centers operated and/or
managed by the Company and (4) temporary disruptions in payments, especially
payments from Medicare and other government programs. The Company expects these
events will result in increased expense as the affected facilities refer tests
and other procedures to other parties, access alternative suppliers and increase
staffing to assure adequate patient care. These events may also cause lost
revenue for procedures which certain of the imaging centers operated and/or
managed by the Company are unable to perform.
The foregoing assessment is based on information currently available to the
Company. The Company will revise its assessment as it implements its Year 2000
compliance plan. The Company can provide no assurances that applications and
equipment believed to be Year 2000 compliant will not experience difficulties or
the Company will not experience difficulties obtaining resources needed to make
modifications to or replace the Company's affected systems and equipment.
Failure by the Company or third parties, on which it relies to resolve Year 2000
issues, could have a material adverse effect on the Company's results of
operations and its ability to provide health care services as described more
fully herein.
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; the ability of the Company to generate net positive cash flows
from operations; the payment timing and ultimate collectibility of 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 ability of the Company to meet all of the
conditions precedent to final settlement of the class action litigation against
the Company and certain of its Directors pursuant to the settlement
agreement-in-principle entered into December 1998; the ultimate economic impact
of 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; the availability of lease financing,
in general and on reasonable terms, for the replacement or upgrade of the
Company's diagnostic equipment as required to remain competitive; 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.
20
<PAGE>
II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
a. None
REPORTS ON FORM 8-K
b. On January 22, 1999, the Company filed a Current Report of Form 8-K
reporting (i) the agreement in principle to settle the class action
litigation pending against the Company and (ii) the grant of a hearing
before the Nasdaq Qualifications Hearing Panel relating to the Company's
request to move its stock listing from the Nasdaq National Market to the
Nasdaq SmallCap Market.
21
<PAGE>
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.
<TABLE>
<S> <C> <C>
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)
</TABLE>
Date: May 13, 1999
22
