**DRAFT**

** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

| **(Mark  One)**                                        |   |                                                                                          |
|--------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
| **ý**                                             |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                   |   |                                                                                          |
| **For  the quarterly period ended September 30, 2001** |
|                                                   |   |                                                                                          |
| **OR**                                                 |
|                                                   |   |                                                                                          |
| **o**                                                  |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from                  to                 .**

** **

**Commissionfile number 0-28622**

 

**INSIGHT HEALTH SERVICES CORP.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                       |   | **33-0702770**      |
|------------------------------------|--------|---------------------|
| (State or other  jurisdiction      |   | (I.R.S. Employer    |
| of incorporation or  organization) |   | Identification No.) |

 

**4400MacArthur Blvd., Suite 800, Newport Beach, CA 92660**

(Address ofprincipal executive offices)                  (Zip code)

 

**(949)476-0733**

(Registrant’stelephone number including area code)

 

**N/A**

(Former name,former address and former fiscal year, if changed since last report)

 

               Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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   o   No  ý

 

 

               Indicate the number of sharesoutstanding of each of the registrant’s classes of common stock, as of thelatest practicable date: 1 share of Common Stock as of November 9, 2001.

 

 

 

**INSIGHT HEALTH SERVICES CORP. ANDSUBSIDIARIES**

 

**INDEX**

 

 

 
| PART I.    | FINANCIAL INFORMATION |
|------------|-----------------------|
|       |                  |   |
|       | ITEM 1.               | FINANCIAL STATEMENTS |
|       |                  |   |
|       |                  | Condensed  Consolidated Balance Sheets as of September 30, 2001 and June 30, 2001  (unaudited) |
|       |                  |   |
|       |                  |   |
|       |                  | Condensed  Consolidated Statements of Income for the three months ended September 30,  2001 and 2000 (unaudited) |
|       |                  |   |
|       |                  |   |
|       |                  | Condensed  Consolidated Statements of Comprehensive Income for the three months ended  September 30, 2001 and 2000 (unaudited) |
|       |                  |   |
|       |                  |   |
|       |                  | Condensed  Consolidated Statements of Cash Flows for the three months ended September  30, 2001 and 2000 (unaudited) |
|       |                  |   |
|       |                  |   |
|       |                  | Notes  to Condensed Consolidated Financial Statements |
|       |                  |   |
|       | ITEM  2.              | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|       |                  |   |
|       | ITEM  3.              | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
|       |                  |   |
| PART II.   | OTHER INFORMATION     |
|       |                  |   |
|       | ITEM 6.               | EXHIBITS AND  REPORTS ON FORM 8-K |
|       |                  |   |
| SIGNATURES |                  |

 

ITEM1.  FINANCIAL STATEMENTS

 

**INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCESHEETS (Unaudited)(Amounts in thousands, except share and per share data)**

 
|                                                                                                                                                                                               |   | **September 30,  2001** |    | **June 30,  2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|--------------------|--------|
| ASSETS                                                                                                                                                                                             |   |                    |    |               |   |
| CURRENT ASSETS:                                                                                                                                                                                    |   |                    |    |               |   |
| Cash and cash equivalents                                                                                                                                                                          |   | $                       | 13,684  |               | $      | 23,254 |   |
| Trade accounts receivables,  net                                                                                                                                                                   |   | 43,069                  |    | 43,355             |   |
| Other current assets                                                                                                                                                                               |   | 10,533                  |    | 8,379              |   |
| Total current assets                                                                                                                                                                               |   | 67,286                  |    | 74,988             |   |
|                                                                                                                                                                                               |   |                    |    |               |   |
| PROPERTY AND EQUIPMENT, net  of accumulated depreciation and amortization of $93,669 and $87,964,  respectively                                                                                    |   | 154,276                 |    | 148,255            |   |
|                                                                                                                                                                                               |   |                    |    |               |   |
| INVESTMENTS IN PARTNERSHIPS                                                                                                                                                                        |   | 1,788                   |    | 1,783              |   |
| OTHER ASSETS                                                                                                                                                                                       |   | 6,562                   |    | 6,828              |   |
| INTANGIBLE ASSETS, net                                                                                                                                                                             |   | 90,373                  |    | 89,202             |   |
|                                                                                                                                                                                               |   | $                       | 320,285 |               | $      | 321,056 |   |
|                                                                                                                                                                                               |   |                    |    |               |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                          |   |                    |    |               |   |
| CURRENT LIABILITIES                                                                                                                                                                                |   |                    |    |               |   |
| Current portion of  equipment, capital leases  and other  notes                                                                                                                               |   | $                       | 34,703  |               | $      | 33,862 |   |
| Accounts payable and other  accrued expenses                                                                                                                                                       |   | 26,885                  |    | 24,335             |   |
| Total current liabilities                                                                                                                                                                          |   | 61,588                  |    | 58,197             |   |
|                                                                                                                                                                                               |   |                    |    |               |   |
| LONG-TERM LIABILITIES:                                                                                                                                                                             |   |                    |    |               |   |
| Equipment, capital leases  and other notes, less current portion                                                                                                                                   |   | 185,103                 |    | 194,391            |   |
| Other long-term liabilities                                                                                                                                                                        |   | 3,693                   |    | 2,997              |   |
| Total long-term liabilities                                                                                                                                                                        |   | 188,796                 |    | 197,388            |   |
|                                                                                                                                                                                               |   |                    |    |               |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                         |   |                    |    |               |   |
| Preferred stock, $.001 par  value, 3,500,000 shares authorized: Convertible Series B preferred stock, no  shares outstanding at September 30, 2001 and 25,000 shares outstanding at  June 30, 2001 |   | -                       |    | 23,923             |   |
| Convertible Series C  preferred stock, no shares outstanding at September 30, 2001 and 27,953  shares outstanding at June 30, 2001                                                                 |   | -                       |    | 13,173             |   |
| Convertible Series D  preferred stock, 632,266 shares outstanding at September 30, 2001 and no  shares outstanding at June 30, 2001                                                                |   | 37,096                  |    | -                  |   |
| Common stock, $.001 par  value, 25,000,000 shares authorized: 3,025,567 and 3,011,656 shares  outstanding at September 30, 2001 and June 30, 2001, respectively                                    |   | 3                       |    | 3                  |   |
| Additional paid-in capital                                                                                                                                                                         |   | 24,071                  |    | 23,926             |   |
| Accumulated other  comprehensive loss                                                                                                                                                              |   | (682                    | )       | -                  |   |
| Retained earnings                                                                                                                                                                                  |   | 9,413                   |    | 4,446              |   |
| Total stockholders’ equity                                                                                                                                                                    |   | 69,901                  |    | 65,471             |   |
|                                                                                                                                                                                               |   | $                       | 320,285 |               | $      | 321,056 |   |

 

Theaccompanying notes are an integral part of these condensed consolidated balancesheets.

 

**INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)**

**(Amounts in thousands, except per share data)**

 
|                                                                 |   | **Three Months Ended** |   |
|----------------------------------------------------------------------|--------|------------------------|--------|
|                                                                 |   | **September 30,**      |   |
|                                                                 |   | **2001**               |   | **2000** |   |
| REVENUES:                                                            |   |                   |   |   |   |
| Contract services                                                    |   | $                      | 24,786 |   | $ | 26,279 |   |
| Patient services                                                     |   | 28,165                 |   | 25,711 |   |
| Other                                                                |   | 166                    |   | 230 |   |
| Total revenues                                                       |   | 53,117                 |   | 52,220 |   |
|                                                                 |   |                   |   |   |   |
| COSTS OF OPERATIONS:                                                 |   |                   |   |   |   |
| Costs of services                                                    |   | 26,709                 |   | 27,084 |   |
| Provision for doubtful  accounts                                     |   | 931                    |   | 833 |   |
| Equipment leases                                                     |   | 2,148                  |   | 2,292 |   |
| Depreciation and  amortization                                       |   | 8,283                  |   | 10,340 |   |
| Total costs of operations                                            |   | 38,071                 |   | 40,549 |   |
|                                                                 |   |                   |   |   |   |
| Gross profit                                                         |   | 15,046                 |   | 11,671 |   |
|                                                                 |   |                   |   |   |   |
| CORPORATE OPERATING  EXPENSES                                        |   | 2,660                  |   | 2,702 |   |
|                                                                 |   |                   |   |   |   |
| Income from company  operations                                      |   | 12,386                 |   | 8,969 |   |
|                                                                 |   |                   |   |   |   |
| EQUITY IN EARNINGS OF  UNCONSOLIDATED PARTNERSHIPS                   |   | 334                    |   | 126 |   |
|                                                                 |   |                   |   |   |   |
| Operating income                                                     |   | 12,720                 |   | 9,095 |   |
|                                                                 |   |                   |   |   |   |
| INTEREST EXPENSE, net                                                |   | 5,336                  |   | 6,032 |   |
|                                                                 |   |                   |   |   |   |
| Income before income taxes                                           |   | 7,384                  |   | 3,063 |   |
|                                                                 |   |                   |   |   |   |
| PROVISION FOR INCOME TAXES                                           |   | 2,417                  |   | 306 |   |
|                                                                 |   |                   |   |   |   |
| Net income                                                           |   | $                      | 4,967  |   | $ | 2,757 |   |
|                                                                 |   |                   |   |   |   |
| INCOME PER COMMON AND  PREFERRED SHARE:                              |   |                   |   |   |   |
| Basic                                                                |   | $                      | 0.53   |   | $ | 0.30 |   |
| Diluted                                                              |   | $                      | 0.49   |   | $ | 0.29 |   |
|                                                                 |   |                   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF  COMMON AND PREFERRED SHARES OUTSTANDING: |   |                   |   |   |   |
| Basic                                                                |   | 9,343                  |   | 9,312 |   |
| Diluted                                                              |   | 10,168                 |   | 9,501 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

 

 

**INSIGHTHEALTH SERVICES CORP. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME (Unaudited)(Amounts in thousands)**

 
|                                                                 |   | **Three Months Ended** |   |
|----------------------------------------------------------------------|--------|------------------------|--------|
|                                                                 |   | **September**          |   |
|                                                                 |   | **2001**               |   | **2000** |   |
| Net income                                                           |   | $                      | 4,967  |   | $ | 2,757 |   |
| Other comprehensive loss,  net of tax:                               |   |                   |   |   |   |
| Unrealized holding loss  arising during the period                   |   | (1,158                 | )      | - |   |
| Less: reclassification  adjustment for losses included in net income |   | 184                    |   | - |   |
|                                                                 |   |                   |   |   |   |
| Total other comprehensive  loss, before tax                          |   | (974                   | )      | - |   |
| Income tax benefit related  to items of other comprehensive income   |   | 292                    |   | - |   |
|                                                                 |   |                   |   |   |   |
| Total other comprehensive  loss, net of tax                          |   | (682                   | )      | - |   |
|                                                                 |   |                   |   |   |   |
| Comprehensive income                                                 |   | $                      | 4,285  |   | $ | 2,757 |   |
|                                                                 |   |                   |   |   |   |

 

Theaccompanying notes are an integral part of those condensed consolidatedfinancial statements.

 

**INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)**

**(Amounts in thousands)**

 
|                                                                               |   | **Three Months Ended** |   |
|------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                               |   | **September 30,**      |   |
|                                                                               |   | **2001**               |   | **2000** |   |
| OPERATING ACTIVITIES:                                                              |   |                   |   |   |   |
| Net income                                                                         |   | $                      | 4,967  |   | $ | 2,757 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |   |                   |   |   |   |
| Depreciation and  amortization                                                     |   | 8,283                  |   | 10,340 |   |
| Cash provided by (used in)  changes in operating assets and liabilities:           |   |                   |   |   |   |
| Trade accounts receivables,  net                                                   |   | 286                    |   | (5,509 | ) |
| Other current assets                                                               |   | (2,154                 | )      | (237 | ) |
| Accounts payable and other  accrued expenses                                       |   | 2,550                  |   | 258 |   |
| Net cash provided by  operating activities                                         |   | 13,932                 |   | 7,609 |   |
|                                                                               |   |                   |   |   |   |
| INVESTING ACTIVITIES:                                                              |   |                   |   |   |   |
| Additions to property and  equipment                                               |   | (14,178                | )      | (12,469 | ) |
| Other                                                                              |   | (1,036                 | )      | 140 |   |
| Net cash used in investing  activities                                             |   | (15,214                | )      | (12,329 | ) |
|                                                                               |   |                   |   |   |   |
| FINANCING ACTIVITIES:                                                              |   |                   |   |   |   |
| Proceeds from stock options  and warrants exercised                                |   | 145                    |   | 81 |   |
| Principal payments of debt  and capital lease obligations                          |   | (8,447                 | )      | (7,512 | ) |
| Other                                                                              |   | 14                     |   | 286 |   |
| Net cash used in financing  activities                                             |   | (8,288                 | )      | (7,145 | ) |
|                                                                               |   |                   |   |   |   |
| DECREASE IN CASH AND CASH  EQUIVALENTS                                             |   | (9,570                 | )      | (11,865 | ) |
|                                                                               |   |                   |   |   |   |
| Cash, beginning of period                                                          |   | 23,254                 |   | 27,133 |   |
| Cash, end of period                                                                |   | $                      | 13,684 |   | $ | 15,268 |   |
|                                                                               |   |                   |   |   |   |
| SUPPLEMENTAL DISCLOSURE OF  CASH FLOW INFORMATION:                                 |   |                   |   |   |   |
| Interest paid                                                                      |   | $                      | 2,831  |   | $ | 2,879 |   |
| Income taxes paid                                                                  |   | 921                    |   | 132 |   |
| Equipment additions under  capital leases                                          |   | -                      |   | 7,404 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

**INSIGHT HEALTH SERVICES CORP. ANDSUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**1. NATURE OF BUSINESS**

 

InSight Health Services Corp. (Company) was incorporated in Delaware inFebruary 1996.  The Company’spredecessors, InSight Health Corp. (formerly American Health Services Corp.)(IHC), and Maxum Health Corp. (MHC), became wholly owned subsidiaries of theCompany on June 26, 1996, pursuant to an Agreement and Plan of Merger among theCompany, IHC and MHC.

 

The Company provides diagnostic imaging, treatment and relatedmanagement services in 28 states throughout the United States.  The Company has two reportable segments:Eastern Division and Western Division. The Company’s services are provided through a network of 82 mobilemagnetic resonance imaging (MRI) facilities, five mobile positron emission tomography(PET) facilities, four mobile lithotripsy facilities (collectively, MobileFacilities), 38 fixed–site MRI facilities (Fixed Facilities), 27 multi–modalityimaging centers (Centers), one Leksell Stereotactic Gamma Knife treatmentcenter, one PET Fixed Facility, and one radiation oncology center.  An additional radiation oncology center isoperated by the Company as part of one of its Centers.  The Company has a substantial presence inCalifornia, Texas, New England, the Carolinas, Florida and the Midwest (Indianaand Ohio).

 

At its Centers, the Company typically offers other services in additionto MRI including computed tomography (CT), diagnostic and fluoroscopic x–ray,mammography, diagnostic ultrasound, nuclear medicine, bone densitometry,nuclear cardiology, and cardiovascular services.

 

**2. INTERIM FINANCIAL STATEMENTS**

 

The unauditedcondensed consolidated financial statements of the Company included herein havebeen prepared in accordance with accounting principles generally accepted inthe United States for interim financial statements and do not include all ofthe information and disclosures required by accounting principles generallyaccepted in the United States for annual financial statements.  These financial statements should be read inconjunction with the consolidated financial statements and related footnotesincluded as part of the Company’s Annual Report on Form 10-K for the periodended June 30, 2001 filed with the Securities and Exchange Commission (SEC) onSeptember 14, 2001.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals) necessaryfor fair presentation of results for the period have been included.  The results of operations for the threemonths ended September 30, 2001 are not necessarily indicative of the resultsto be achieved for the full fiscal year.

 

Certainreclassifications have been made to conform prior year amounts to the currentyear presentation.

 

**3. INVESTMENTS IN AND TRANSACTIONS WITH PARTNERSHIPS**

 

The consolidated financial statements include the accounts of theCompany and its wholly owned subsidiaries. The Company’s investment interests in partnerships or limited liabilitycompanies (Partnerships) are accounted for under the equity method ofaccounting for ownership of 50% or less when the Company does not exercisesignificant control over the operations of the Partnerships and does not haveprimary responsibility for the Partnerships’ long-term debt.  The Company’s investment interests inPartnerships are consolidated for ownership of 50% or greater owned entitieswhen the Company exercises significant control over the operations and isprimarily responsible for the associated long-term debt.

Set forth below is the summarized combined financial data of theCompany’s 50 percent controlled entity which is consolidated (amounts inthousands):

 
|                                    |   | **September 30,** |   | **June 30,** |       |
|-----------------------------------------|--------|-------------------|--------|--------------|------------|
|                                    |   | **2001**          |   | **2001**     |       |
|                                    |   | **(unaudited)**   |   |
| Condensed  Combined Balance Sheet Data: |   |              |   |         | ** ** |
| Current  assets                         |   | $                 | 1,687  |         | $          | 1,622 |   |
| Total  assets                           |   | 1,940             |   | 1,844        |       |
| Current liabilities                     |   | 411               |   | 426          |       |
| Minority interest equity                |   | 663               |   | 608          |       |
|                                         |        |                   |        |              |            |  |  |

 
|                                          |   | **Three Months Ended** |   |
|-----------------------------------------------|--------|------------------------|--------|
|                                          |   | **September 30,**      |   |
|                                          |   | **2001**               |   | **2000** |   |
|                                          |   | **(unaudited)**        |   |
| Condensed Combined  Statement of Income Data: |   |                   |   |   |   |
| Net revenues                                  |   | $                      | 1,430  |   | $ | 1,464 |   |
| Expenses                                      |   | 920                    |   | 1,000 |   |
| Provision for center profit  distribution     |   | 255                    |   | 232 |   |
| Net income                                    |   | $                      | 255    |   | $ | 232 |   |
|                                               |        |                        |        |  |  |  |  |  |  |

 

The provision forcenter profit distribution shown above represents the minority interest in theincome of this entity.

 

**4. INCOME PER COMMON AND CONVERTED PREFERRED SHARE**

 

The number of shares used in computing EPS is equal to the weighedaverage number of common and preferred shares outstanding during the respectiveperiod.  The preferred stock has certainrights, including conversion into common stock (Series B and Series C on aone-to-one basis and Series D on a ten-to-one basis), voting rights, no stateddividend rate and participates in any dividends paid with respect to the commonstock.  Accordingly, the preferred stockis included in the computation of basic EPS only if the effect on EPS isdilutive as required by SFAS No. 128, “Earnings per Share” and Emerging IssuesTask Force Topic D-95.  The Company usesthe as-if converted method in computing EPS. There were no adjustments to net income (the numerator) for purposes ofcomputing EPS.

 

A reconciliation of basic and diluted share computations is as follows:

 
|                                           |   | **Three Months Ended** |   |
|------------------------------------------------|--------|------------------------|--------|
|                                           |   | **September 30,**      |   |
|                                           |   | **2001**               |   | **2000** |   |
|                                           |   | **(unaudited)**        |   |
| Average common stock  outstanding              |   | 3,020                  |   | 2,989 |   |
| Effect of preferred stock                      |   | 6,323                  |   | 6,323 |   |
| Denominator for basic EPS                      |   | 9,343                  |   | 9,312 |   |
| Dilutive effect of stock  options and warrants |   | 825                    |   | 189 |   |
|                                           |   | 10,168                 |   | 9,501 |   |
|                                                |        |                        |        |  |  |  |

 

**5. SEGMENT INFORMATION**

 

The Company has two reportable segments: Western Division and EasternDivision.  The Company’s reportablesegments are geographical business units defined by management’s division ofresponsibility between two executive vice presidents – operations, who areresponsible for the Western and Eastern Divisions and who report directly tothe Company’s chief operating decision maker. Each segment owns and operates Centers, Fixed and Mobile Facilitieswithin their respective geographic areas. The Company does not allocate incometaxes to the two Divisions.  The Companymanages cash flows and assets on a consolidated basis, and not by segment, anddoes not allocate or report assets and capital expenditures by segment.

The following tables summarize the operating results by segment for thethree months ended September 30, 2001 and 2000 (amounts inthousands)(unaudited):

 
| **Three  months ended September 30, 2001:**       |   | **Eastern** |   | **Western** |   | **Other** |   | **Consolidated** |   |
|---------------------------------------------------|--------|-------------|--------|-------------|--------|-----------|--------|------------------|--------|
| Contract services revenues                        |   | $           | 21,901 |        | $      | 1,217     |   | $                | 1,668  |   | $ | 24,786 |   |
| Patient services revenues                         |   | 9,840       |   | 18,079      |   | 246       |   | 28,165           |   |
| Other revenues                                    |   | 120         |   | 13          |   | 33        |   | 166              |   |
| Total revenues                                    |   | 31,861      |   | 19,309      |   | 1,947     |   | 53,117           |   |
| Depreciation and amortization                     |   | 4,946       |   | 2,170       |   | 1,167     |   | 8,283            |   |
| Total costs of operations                         |   | 21,704      |   | 13,161      |   | 3,206     |   | 38,071           |   |
| Equity in earnings of unconsolidated partnerships |   | 312         |   | 22          |   | -         |   | 334              |   |
| Operating income (loss)                           |   | 10,474      |   | 6,165       |   | (3,919    | )      | 12,720           |   |
| Interest expense, net                             |   | 3,283       |   | 880         |   | 1,173     |   | 5,336            |   |
| Income (loss) before income taxes                 |   | 7,191       |   | 5,285       |   | (5,092    | )      | 7,384            |   |
|                                              |   |        |   |        |   |      |   |             |   |
| **Three months ended September 30,  2000:**       |   | **Eastern** |   | **Western** |   | **Other** |   | **Consolidated** |   |
| Contract services revenues                        |   | $           | 22,938 |        | $      | 1,478     |   | $                | 1,863  |   | $ | 26,279 |   |
| Patient services revenues                         |   | 9,790       |   | 15,590      |   | 331       |   | 25,711           |   |
| Other revenues                                    |   | 81          |   | 13          |   | 136       |   | 230              |   |
| Total revenues                                    |   | 32,809      |   | 17,081      |   | 2,330     |   | 52,220           |   |
| Depreciation and amortization                     |   | 6,332       |   | 2,343       |   | 1,665     |   | 10,340           |   |
| Total costs of operations                         |   | 22,644      |   | 13,172      |   | 4,733     |   | 40,549           |   |
| Equity in earnings of unconsolidated partnerships |   | 162         |   | (36         | )      | -         |   | 126              |   |
| Operating income (loss)                           |   | 10,327      |   | 3,873       |   | (5,105    | )      | 9,095            |   |
| Interest expense, net                             |   | 3,618       |   | 905         |   | 1,509     |   | 6,032            |   |
| Income (loss) before income taxes                 |   | 6,709       |   | 2,968       |   | (6,614    | )      | 3,063            |   |

 

**6.  HEDGING ACTIVITIES**

 

Statement ofFinancial Accounting Standards No. 133, “Accounting for Derivative Instrumentsand Hedging Activities” (SFAS 133), was issued during the second quarter of1998 and was adopted by the Company as of July 1, 2000. SFAS 133 requires thatall derivatives be recorded at their current fair value on the balance sheets.Certain derivatives may be designated as either cash flow or fair valueaccounting hedged or in accumulated other comprehensive income. Changes in thefair value of derivatives that are not related to specific instruments and donot meet the criteria for hedge accounting are included in net income.

 

The Company hasestablished policies  and procedures topermit limited types and amounts of off-balance sheet hedges to help manageinterest rate risk. The Company has entered into interest rate swaps to pay afixed rate of interest to the counterparty and receives a floating rate ofinterest. Such swaps have the effect of converting variable rate borrowingsinto fixed rate borrowings. The swap in place at the end of the first quarterof fiscal 2002 is related to the senior credit facilities and qualifies as acash flow hedge. The notional amount of this swap at September 30, 2001 was$36.0 million with a fair value loss of approximately $1.7 million.

 

**7.  COMPREHENSIVE INCOME**

 

Components ofcomprehensive income are changes in equity other than those resulting frominvestments by owners and distributions to owners. Net income is the primarycomponent of comprehensive income. For the Company, the only component ofcomprehensive income other than net income is the unrealized gain or loss onderivatives qualifying for hedge accounting, net of tax. The aggregate amountof such changes to equity that have not yet been recognized in net income arereported in the equity portion of the condensed consolidated balance sheets asaccumulated other comprehensive loss.

**8.  ACQUISITION AND RELATED FINANCINGTRANSACTIONS**

 

On October 17, 2001, the Company merged with a wholly-owned subsidiary ofInSight Health Services Holdings Corp. (InSight Holdings).  The Company was the surviving corporationand became a wholly-owned subsidiary of InSight Holdings.  The Company is deemed to be the predecessorfor future reporting purposes.  J.W.Childs Equity Partners II (Childs) and an affiliate own approximately 80% ofthe outstanding common stock of InSight Holdings and Halifax Capital Partners(Halifax) and an affiliate own approximately 20% of the outstanding commonstock of InSight Holdings.  In addition,certain members of senior management rolled over portion of their Company stockoptions into stock options of InSight Holdings at the consummation of the acquisition.  Upon consummation of the acquisition, eachof the Company’s stockholders became entitled to receive $18.00 in cash foreach share of Company common stock that they owned prior to the acquisition.  Holders of options and warrants, which priorto the acquisition were exercisable for Company common stock, received thedifference between $18.00 and the exercise price for each share of common stockthe holder could have acquired pursuant to the terms of the options orwarrants, and the options and warrants were terminated.  This resulted in a charge of approximately$19.7 million, which will be reflected in the second quarter of fiscal2002.  The Company’s stockholders, optionholders and warrant holders immediately prior to the acquisition became entitledto receive aggregate cash consideration of approximately $187.7 million as aresult of the acquisition.

 

Concurrently with the acquisition, the Company (i) repurchased by tenderoffer all of its 9 5/8% senior subordinated notes due 2008 (Existing Notes) inan aggregate principal amount of $100 million, (ii) repaid its then outstandingsenior credit facilities and certain other indebtedness and (iii) paid fees andexpenses relating to the acquisition and related financing transactions.  The Company will record an extraordinaryloss on extinguishment of existing indebtedness of approximately $20.0 millionin the second quarter of fiscal 2002.

 

These transactions were financed through:

 

·        Borrowingsof $150 million under $275 million of new senior credit facilities;

 

·        A$200 million senior subordinated bridge financing;

 

·        Theinvestment by Childs, Halifax and certain of their affiliates of $98.1 million;management options and common stock rollover with a total net value ofapproximately $1.9 million; and

 

·        Cashof approximately $3.9 million

 

The acquisitionwill be accounted for as a purchase of the Company by Insight Holdings.  As such, the recorded amounts of theCompany's assets and liabilities will change significantly as a result of theapplication of purchase accounting. Management is currently in the process of evaluating the appropriatepurchase accounting adjustment.

 

On October 30,2001, the Company issued new 9 7/8% senior subordinated notes due 2011 (NewNotes) in the aggregate principal amount of $225 million. The net proceeds fromthe issuance of the New Notes was approximately $211.5 million, $200 million ofwhich was used to retire in full the senior subordinated bridge financing andthe balance is being used for general corporate purposes.  The Company will record in extraordinaryloss an extinguishment of the senior subordinated bridge financing ofapproximately $7.8 million in the second quarter of fiscal 2002.

 

Set forth below isan unaudited pro forma condensed consolidated balance sheet as of September 30,2001, as if the transactions described above had occurred on September 30, 2001(amounts in thousands):

 
|                         |   |            |    | **Pro Forma**   |   |
|------------------------------|--------|-----------------|---------|-----------------|--------|
|                         |   | **As Reported** |    | **Adjustments** |   | **Total** |   |
|                         |   |            |    | **(unaudited)** |   |
| Current assets               |   | $               | 67,286  |            | $      | 15,745 |   | $ | 83,031 |   |
| Property and equipment,  net |   | 154,276         |    | -               |   | 154,276 |   |
| Investments in  partnerships |   | 1,786           |    | -               |   | 1,788 |   |
| Other assets                 |   | 6,562           |    | 16,225          |   | 22,787 |   |
| Intangible  assets           |   | 90,373          |    | 137,121         |   | 227,494 |   |
|                         |   | $               | 320,286 |            | $      | 169,091 |   | $ | 489,376 |   |
|                         |   |            |    |            |   |   |   |
| Current  liabilities         |   | $               | 61,588  |            | $      | (31,544 | ) | $ | 30,044 |   |
| Long-term  liabilities       |   | 188,796         |    | 192,257         |   | 381,053 |   |
| Stockholders’  equity   |   | 69,901          |    | 8,378           |   | 78,279 |   |
|                         |   | $               | 320,285 |            | $      | 169,091 |   | $ | 489,376 |   |

 

The unaudited pro forma condensed consolidated balance sheet as ofSeptember 30, 2001 gives effect to the investment by Childs, Halifax andcertain of their affiliates of $98.1 million, the draw down of the $150 millionterm loan, the $200 million senior subordinated bridge financing, and theissuance of $225 million under the New Notes, which collectively was used topurchase the common stock, options and warrants of the Company of approximately$187.7 million, repay $214 million in outstanding indebtedness, repay the $200million senior subordinated bridge financing, and to pay approximately $55million in transaction costs related to the acquisition and related financingactivities.

 

**9. SUPPLEMENTAL CONDENSED CONSOLIDATED FINANCIAL INFORMATION**

 

The Company’s payment obligations under the Existing Notes areguaranteed by certain of the Company’s wholly owned subsidiaries (the GuarantorSubsidiaries).  Such guarantees arefull, unconditional and joint and several. The following supplemental financial information sets forth, on anunconsolidated basis, balance sheets, statements of income, and statements ofcash flows information for the Company (Parent Company Only), for the GuarantorSubsidiaries and for the Company’s other subsidiaries (the Non-GuarantorSubsidiaries).  The supplemental financialinformation reflects the investments of the Company and the GuarantorSubsidiaries in the Guarantor and Non-Guarantor Subsidiaries using the equitymethod of accounting.

 

**INSIGHTHEALTH SERVICES CORP. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**SUPPLEMENTALCONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)**

**SEPTEMBER30, 2001**

**(Amounts inthousands)**

 
|                                                             |   |                |    |             |   |              |   |             |   |             |   |
|------------------------------------------------------------------|--------|---------------------|---------|------------------|--------|-------------------|--------|------------------|--------|------------------|--------|
|                                                             |   | **PARENT  COMPANY** |    | **GUARANTOR**    |   | **NON-GUARANTOR** |   |             |   |             |   |
|                                                             |   | **ONLY**            |    | **SUBSIDIARIES** |   | **SUBSIDIARIES**  |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
| ASSETS                                                           |   |                |    |             |   |              |   |             |   |             |   |
| Current assets:                                                  |   |                |    |             |   |              |   |             |   |             |   |
| Cash and cash equivalents                                        |   | $                   | -       |             | $      | 10,521            |   | $                | 3,163  |             | $      | - |   | $ | 13,684 |   |
| Trade accounts receivables,  net                                 |   | -                   |    | 32,406           |   | 10,663            |   | -                |   | 43,069           |   |
| Other current assets                                             |   | -                   |    | 10,361           |   | 172               |   | -                |   | 10,533           |   |
| Intercompany accounts  receivable                                |   | 235,751             |    | 27,496           |   | -                 |   | (263,247         | )      | -                |   |
| Total current assets                                             |   | 235,751             |    | 80,784           |   | 13,998            |   | (263,247         | )      | 67,286           |   |
| Property and equipment, net                                      |   | -                   |    | 130,036          |   | 24,240            |   | -                |   | 154,276          |   |
| Investments in partnerships                                      |   | -                   |    | 1,788            |   | -                 |   | -                |   | 1,788            |   |
| Investments in consolidated  subsidiaries                        |   | 292                 |    | 9,120            |   | -                 |   | (9,412           | )      | -                |   |
| Other assets                                                     |   | -                   |    | 6,562            |   | -                 |   | -                |   | 6,562            |   |
| Intangible assets, net                                           |   | -                   |    | 85,550           |   | 4,823             |   | -                |   | 90,373           |   |
|                                                             |   | $                   | 236,043 |             | $      | 313,840           |   | $                | 43,061 |             | $      | (272,659 | ) | $ | 320,285 |   |
|                                                             |   |                |    |             |   |              |   |             |   |             |   |
| LIABILITIES AND STOCKHOLDERS' EQUITY                             |   |                |    |             |   |              |   |             |   |             |   |
| Current liabilities:                                             |   |                |    |             |   |              |   |             |   |             |   |
| Current portion of  equipment, capital leases and other notes    |   | $                   | 21,537  |             | $      | 12,371            |   | $                | 795    |             | $      | - |   | $ | 34,703 |   |
| Accounts payable and other  accrued expenses                     |   | -                   |    | 25,574           |   | 1,311             |   | -                |   | 26,885           |   |
| Intercompany accounts payable                                    |   | -                   |    | 235,751          |   | 27,496            |   | (263,247         | )      | -                |   |
| Total current liabilities                                        |   | 21,537              |    | 273,696          |   | 29,602            |   | (263,247         | )      | 61,588           |   |
| Equipment, capital leases  and other notes, less current portion |   | 143,923             |    | 39,255           |   | 1,925             |   | -                |   | 185,103          |   |
| Other long-term liabilities                                      |   | 682                 |    | 597              |   | 2,414             |   | -                |   | 3,693            |   |
| Stockholders' equity                                             |   | 69,901              |    | 292              |   | 9,120             |   | (9,412           | )      | 69,901           |   |
|                                                             |   | $                   | 236,043 |             | $      | 313,840           |   | $                | 43,061 |             | $      | (272,659 | ) | $ | 320,285 |   |

 

 

**INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET(Unaudited)**

**JUNE 30, 2001**

**(Amounts in thousands)**

 
|                                                             |   | **PARENT**  |    |             |   |              |   |             |   |             |   |
|------------------------------------------------------------------|--------|-------------|---------|------------------|--------|-------------------|--------|------------------|--------|------------------|--------|
|                                                             |   | **COMPANY** |    | **GUARANTOR**    |   | **NON-GUARANTOR** |   |             |   |             |   |
|                                                             |   | **ONLY**    |    | **SUBSIDIARIES** |   | **SUBSIDIARIES**  |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
| ASSETS                                                           |   |        |    |             |   |              |   |             |   |             |   |
| Current assets:                                                  |   |        |    |             |   |              |   |             |   |             |   |
| Cash and cash equivalents                                        |   | $           | -       |             | $      | 19,921            |   | $                | 3,333  |             | $      | - |   | $ | 23,254 |   |
| Trade accounts receivables,  net                                 |   | -           |    | 32,758           |   | 10,597            |   | -                |   | 43,355           |   |
| Other current assets                                             |   | -           |    | 8,273            |   | 106               |   | -                |   | 8,379            |   |
| Intercompany accounts  receivable                                |   | 241,016     |    | 27,590           |   | -                 |   | (268,606         | )      | -                |   |
| Total current assets                                             |   | 241,016     |    | 88,542           |   | 14,036            |   | (268,606         | )      | 74,988           |   |
| Property and equipment, net                                      |   | -           |    | 123,579          |   | 24,676            |   | -                |   | 148,255          |   |
| Investments in partnerships                                      |   | -           |    | 1,783            |   | -                 |   | -                |   | 1,783            |   |
| Investments in consolidated  subsidiaries                        |   | (4,882      | )       | 9,328            |   | -                 |   | (4,446           | )      | -                |   |
| Other assets                                                     |   | -           |    | 6,828            |   | -                 |   | -                |   | 6,828            |   |
| Intangible assets, net                                           |   | -           |    | 84,358           |   | 4,844             |   | -                |   | 89,202           |   |
|                                                             |   | $           | 236,134 |             | $      | 314,418           |   | $                | 43,556 |             | $      | (273,052 | ) | $ | 321,056 |   |
|                                                             |   |        |    |             |   |              |   |             |   |             |   |
| LIABILITIES AND STOCKHOLDERS' EQUITY                             |   |        |    |             |   |              |   |             |   |             |   |
| Current liabilities:                                             |   |        |    |             |   |              |   |             |   |             |   |
| Current portion of  equipment, capital leases and other notes    |   | $           | 20,810  |             | $      | 12,275            |   | $                | 777    |             | $      | - |   | $ | 33,862 |   |
| Accounts payable and other  accrued expenses                     |   | -           |    | 23,033           |   | 1,302             |   | -                |   | 24,335           |   |
| Intercompany accounts  payable                                   |   | -           |    | 241,016          |   | 27,590            |   | (268,606         | )      | -                |   |
| Total current liabilities                                        |   | 20,810      |    | 276,324          |   | 29,669            |   | (268,606         | )      | 58,197           |   |
| Equipment, capital leases  and other notes, less current portion |   | 149,853     |    | 42,409           |   | 2,129             |   | -                |   | 194,391          |   |
| Other long-term liabilities                                      |   | -           |    | 567              |   | 2,430             |   | -                |   | 2,997            |   |
| Stockholders' equity  (deficit)                                  |   | 65,471      |    | (4,882           | )      | 9,328             |   | (4,446           | )      | 65,471           |   |
|                                                             |   | $           | 236,134 |             | $      | 314,418           |   | $                | 43,556 |             | $      | (273,052 | ) | $ | 321,056 |   |

 

 

**INSIGHTHEALTH SERVICES CORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**SUPPLEMENTALCONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001(Amounts in thousands)**

 
|                                                         |   | **PARENT**  |   |             |   |              |   |            |   |             |   |
|--------------------------------------------------------------|--------|-------------|--------|------------------|--------|-------------------|--------|-----------------|--------|------------------|--------|
|                                                         |   | **COMPANY** |   | **GUARANTOR**    |   | **NON-GUARANTOR** |   |            |   |             |   |
|                                                         |   | **ONLY**    |   | **SUBSIDIARIES** |   | **SUBSIDIARIES**  |   | **ELIMINATION** |   | **CONSOLIDATED** |   |
| Revenues                                                     |   | $           | -      |             | $      | 41,565            |   | $               | 11,552 |             | $      | - |   | $ | 53,117 |   |
| Costs of operations                                          |   | -           |   | 29,127           |   | 8,944             |   | -               |   | 38,071           |   |
| Gross profit                                                 |   | -           |   | 12,438           |   | 2,608             |   | -               |   | 15,046           |   |
|                                                         |   |        |   |             |   |              |   |            |   |             |   |
| Corporate operating expenses                                 |   | -           |   | 2,660            |   | -                 |   | -               |   | 2,660            |   |
| Income from company  operations                              |   | -           |   | 9,778            |   | 2,608             |   | -               |   | 12,386           |   |
|                                                         |   |        |   |             |   |              |   |            |   |             |   |
| Equity in earnings of  unconsolidated partnerships           |   | -           |   | 334              |   | -                 |   | -               |   | 334              |   |
| Operating income                                             |   | -           |   | 10,112           |   | 2,608             |   | -               |   | 12,720           |   |
|                                                         |   |        |   |             |   |              |   |            |   |             |   |
| Interest expense, net                                        |   | -           |   | 4,711            |   | 625               |   | -               |   | 5,336            |   |
| Income before income taxes                                   |   | -           |   | 5,401            |   | 1,983             |   | -               |   | 7,384            |   |
|                                                         |   |        |   |             |   |              |   |            |   |             |   |
| Provision  for income taxes                             |   | -           |   | 2,417            |   | -                 |   | -               |   | 2,417            |   |
| Income before equity in  income of consolidated subsidiaries |   | -           |   | 2,984            |   | 1,983             |   | -               |   | 4,967            |   |
|                                                         |   |        |   |             |   |              |   |            |   |             |   |
| Equity in income of  consolidated subsidiaries               |   | 4,967       |   | 1,983            |   | -                 |   | (6,950          | )      | -                |   |
|                                                         |   |        |   |             |   |              |   |            |   |             |   |
| Net income                                                   |   | $           | 4,967  |             | $      | 4,967             |   | $               | 1,983  |             | $      | (6,950 | ) | $ | 4,967 |   |

 

 

**INSIGHTHEALTH SERVICES CORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**SUPPLEMENTALCONDENSED CONSOLIDATING STATEMENT OF INCOME (Unaudited)FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000(Amounts in thousands)**

 
|                                                         |   | **PARENT**  |   |             |   |              |   |            |         |             |   |
|--------------------------------------------------------------|--------|-------------|--------|------------------|--------|-------------------|--------|-----------------|--------------|------------------|--------|
|                                                         |   | **COMPANY** |   | **GUARANTOR**    |   | **NON-GUARANTOR** |   |            |         |             |   |
|                                                         |   | **ONLY**    |   | **SUBSIDIARIES** |   | **SUBSIDIARIES**  |   | **ELIMINATION** |         | **CONSOLIDATED** |   |
| Revenues                                                     |   | $           | -      |             | $      | 40,248            |   | $               | 11,972  |             | $      | - |   | $ | 52,220 |   |
| Costs of operations                                          |   | -           |   | 31,394           |   | 9,155             |   | -               |         | 40,549           |   |
| Gross profit                                                 |   | -           |   | 8,854            |   | 2,817             |   | -               |         | 11,671           |   |
|                                                         |   |        |   |             |   |              |   |            |         |             |   |
| Corporate operating expenses                                 |   | -           |   | 2,702            |   | -                 |   | -               |         | 2,702            |   |
| Income from company  operations                              |   | -           |   | 6,152            |   | 2,817             |   | -               |         | 8,969            |   |
|                                                         |   |        |   |             |   |              |   |            |         |             |   |
| Equity in earnings of  unconsolidated partnerships           |   | -           |   | 126              |   | -                 |   | -               |         | 126              |   |
| Operating income                                             |   | -           |   | 6,278            |   | 2,817             |   | -               |         | 9,095            |   |
|                                                         |   |        |   |             |   |              |   |            |         |             |   |
| Interest expense, net                                        |   | -           |   | 5,258            |   | 774               |   | -               |         | 6,032            |   |
| Income before income taxes                                   |   | -           |   | 1,020            |   | 2,043             |   | -               |         | 3,063            |   |
|                                                         |   |        |   |             |   |              |   |            |         |             |   |
| Provision  for income taxes                             |   | -           |   | 306              |   | -                 |   | -               |         | 306              |   |
| Income before equity in  income of consolidated subsidiaries |   | -           |   | 714              |   | 2,043             |   | -               |         | 2,757            |   |
|                                                         |   |        |   |             |   |              |   |            |         |             |   |
| Equity in income of  consolidated subsidiaries               |   | 2,757       |   | 2,043            |   | -                 |   | (4,800          | )            | -                |   |
|                                                         |   |        |   |             |   |              |   |            |         |             |   |
| Net income                                                   |   | $           | 2,757  |             | $      | 2,757             |   | $               | 2,043        |             | $      | (4,800 | ) | $ | 2,757 |   |

 

 

**INSIGHTHEALTH SERVICES CORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**SUPPLEMENTALCONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001(Amounts in thousands)**

 
|                                                                               |   | **PARENT**  |    |             |   |              |   |             |        |             |   |
|------------------------------------------------------------------------------------|--------|-------------|---------|------------------|--------|-------------------|--------|------------------|-------------|------------------|--------|
|                                                                               |   | **COMPANY** |    | **GUARANTOR**    |   | **NON-GUARANTOR** |   |             |        |             |   |
|                                                                               |   | **ONLY**    |    | **SUBSIDIARIES** |   | **SUBSIDIARIES**  |   | **ELIMINATIONS** |        | **CONSOLIDATED** |   |
| OPERATING ACTIVITIES:                                                              |   |        |    |             |   |              |   |             |        |             |   |
| Net income                                                                         |   | $           | 4,967   |             | $      | 4,967             |   | $                | 1,983       |             | $      | (6,950 | ) | $ | 4,967 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |        |    |             |   |              |   |             |        |             |   |
| Depreciation and amortization                                                      |   | -           |    | 6,857            |   | 1,426             |   |             |        | 8,283            |   |
| Equity in income of  consolidated subsidiaries                                     |   | (4,967      | )       | (1,983           | )      | -                 |   | 6,950            |        | -                |   |
| Cash provided by (used in)  changes in operating assets and liabilities:           |   |        |    |             |   |              |   |             |        |             |   |
| Trade accounts receivables                                                         |   | -           |    | 352              |   | (66               | )      | -                |        | 286              |   |
| Intercompany receivables,  net                                                     |   | 5,058       |    | (2,773           | )      | (2,285            | )      | -                |        | -                |   |
| Other current assets                                                               |   | -           |    | (2,088           | )      | (66               | )      | -                |        | (2,154           | )      |
| Accounts payable and other  accrued expenses                                       |   | -           |    | 2,541            |   | 9                 |   | -                |        | 2,550            |   |
| Net cash provided by  operating activities                                         |   | 5,058       |    | 7,873            |   | 1,001             |   | -                |        | 13,932           |   |
|                                                                               |   |        |    |             |   |              |   |             |        |             |   |
| INVESTING ACTIVITIES:                                                              |   |        |    |             |   |              |   |             |        |             |   |
| Additions to property and  equipment                                               |   | -           |    | (13,209          | )      | (969              | )      | -                |        | (14,178          | )      |
| Other                                                                              |   | -           |    | (1,036           | )      | -                 |   | -                |        | (1,036           | )      |
| Net cash used in investing  activities                                             |   | -           |    | (14,245          | )      | (969              | )      | -                |        | (15,214          | )      |
|                                                                               |   |        |    |             |   |              |   |             |        |             |   |
| FINANCING ACTIVITIES:                                                              |   |        |    |             |   |              |   |             |        |             |   |
| Proceeds from stock options  and warrants exercised                                |   | 145         |    | -                |   | -                 |   | -                |        | 145              |   |
| Principal payments of debt  and capital lease obligations                          |   | (5,203      | )       | (3,058           | )      | (186              | )      | -                |        | (8,447           | )      |
| Other                                                                              |   | -           |    | 30               |   | (16               | )      | -                |        | 14               |   |
| Net cash used in financing  activities                                             |   | (5,058      | )       | (3,028           | )      | (202              | )      | -                |        | (8,288           | )      |
|                                                                               |   |        |    |             |   |              |   |             |        |             |   |
| DECREASE IN CASH AND CASH  EQUIVALENTS                                             |   | -           |    | (9,400           | )      | (170              | )      | -                |        | (9,570           | )      |
|                                                                               |   |        |    |             |   |              |   |             |        |             |   |
| CASH AND CASH EQUIVALENTS:                                                         |   |        |    |             |   |              |   |             |        |             |   |
| Cash, beginning of period                                                          |   | -           |    | 19,921           |   | 3,333             |   | -                |        | 23,254           |   |
| Cash, end of period                                                                |   | $           | -  |             | $      | 10,521            |   | $                | 3,163  |             | $      | - |   | $ | 13,684 |   |

 

 

**INSIGHTHEALTH SERVICES CORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**SUPPLEMENTALCONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000(Amounts in thousands)**

 
|                                                                               |   | **PARENT**  |    |             |   |              |   |             |   |             |   |
|------------------------------------------------------------------------------------|--------|-------------|---------|------------------|--------|-------------------|--------|------------------|--------|------------------|--------|
|                                                                               |   | **COMPANY** |    | **GUARANTOR**    |   | **NON-GUARANTOR** |   |             |   |             |   |
|                                                                               |   | **ONLY**    |    | **SUBSIDIARIES** |   | **SUBSIDIARIES**  |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
| OPERATING ACTIVITIES:                                                              |   |        |    |             |   |              |   |             |   |             |   |
| Net income                                                                         |   | $           | 2,757   |             | $      | 2,757        |   | $                | 2,043  |             | $      | (4,800 | ) | $ | 2,757 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |        |    |             |   |              |   |             |   |             |   |
| Depreciation and  amortization                                                     |   | -           |    | 9,100            |   | 1,240             |   | -                |   | 10,340           |   |
| Equity in income of consolidated  subsidiaries                                     |   | (2,757      | )       | (2,043           | )      | -                 |   | 4,800            |   | -                |   |
| Cash provided by (used in)  changes in operating assets and liabilities:           |   |        |    |             |   |              |   |             |   |             |   |
| Trade accounts receivables                                                         |   | -           |    | (3,299           | )      | (2,210            | )      | -                |   | (5,509           | )      |
| Intercompany receivables,  net                                                     |   | 4,517       |    | (5,208           | )      | 691               |   | -                |   | -                |   |
| Other current assets                                                               |   | -           |    | (261             | )      | 24                |   | -                |   | (237             | )      |
| Accounts payable and other  accrued expenses                                       |   | -           |    | 148              |   | 110               |   | -                |   | 258              |   |
| Net cash provided by  operating activities                                         |   | 4,517       |    | 1,194            |   | 1,898             |   | -                |   | 7,609            |   |
|                                                                               |   |        |    |             |   |              |   |             |   |             |   |
| INVESTING ACTIVITIES:                                                              |   |        |    |             |   |              |   |             |   |             |   |
| Additions to property and  equipment                                               |   | -           |    | (11,359          | )      | (1,110            | )      | -                |   | (12,469          | )      |
| Other                                                                              |   | -           |    | 140              |   | -                 |   | -                |   | 140              |   |
| Net cash used in investing  activities                                             |   | -           |    | (11,219          | )      | (1,110            | )      | -                |   | (12,329          | )      |
|                                                                               |   |        |    |             |   |              |   |             |   |             |   |
| FINANCING ACTIVITIES:                                                              |   |        |    |             |   |              |   |             |   |             |   |
| Proceeds from stock options  and warrants exercised                                |   | 81          |    | -                |   | -                 |   | -                |   | 81               |   |
| Principal payments of debt  and capital lease obligations                          |   | (4,598      | )       | (2,791           | )      | (123              | )      | -                |   | (7,512           | )      |
| Other                                                                              |   | -           |    | 115              |   | 171               |   | -                |   | 286              |   |
| Net cash provided by (used  in) financing activities                               |   | (4,517      | )       | (2,676           | )      | 48                |   | -                |   | (7,145           | )      |
|                                                                               |   |        |    |             |   |              |   |             |   |             |   |
| INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS                                  |   | -           |    | (12,701          | )      | 836               |   | -                |   | (11,865          | )      |
|                                                                               |   |        |    |             |   |              |   |             |   |             |   |
| CASH AND CASH EQUIVALENTS:                                                         |   |        |    |             |   |              |   |             |   |             |   |
| Cash, beginning of period                                                          |   | -           |    | 25,375           |   | 1,758             |   | -                |   | 27,133           |   |
| Cash, end of period                                                                |   | $           | -  |             | $      | 12,674            |   | $                | 2,594  |             | $      | - |   | $ | 15,268 |   |

**ITEM2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The statementscontained in this report that are not purely historical or which might beconsidered an opinion or projection concerning the Company or its business,whether express or implied, are "forward-looking statements" withinthe meaning of the Private Securities Litigation Reform Act of 1995.  These statements may include statementsregarding the Company's expectations, intentions, plans or strategies regardingthe future.  All forward-lookingstatements included in this report are based upon information available to theCompany on the date hereof, and the Company assumes no obligation to update anysuch forward-looking statements.  It isimportant to note that the Company's actual results could differ materiallyfrom those described or implied in such forward-looking statements because ofcertain factors which could affect the Company.  Such forward-looking statements should be evaluated in light ofthe following factors: availability of financing; limitations and delays inreimbursement by third-party payors; contract renewals and financial stabilityof customers; the potential for rapid and significant changes in technology andtheir effect on the Company's operations; operating, legal, governmental andregulatory risks; conditions within the health care environment; adverseutilization trends for certain diagnostic imaging procedures; economic,political and competitive forces affecting the Company's business; competitionin the Company's markets; the Company's ability to successfully integrateacquisitions; and the risk factors described in the Company's periodic filingswith the SEC on Forms 10-K, 10-Q and 8-K (if any).

 

**ACQUISITIONAND RELATED FINANCING TRANSACTIONS**

 

On October 17, 2001, the Company merged with a wholly-owned subsidiary ofInSight Health Services Holdings Corp. (InSight Holdings).The Company was thesurviving corporation and became a wholly-owned subsidiary of InSightHoldings.  The Company is deemed to bethe predecessor for future reporting purposes. J.W. Childs Equity Partners II (Childs) and an affiliate ownapproximately 80% of the outstanding common stock of InSight Holdings andHalifax Capital Partners (Halifax) and an affiliate own approximately 20% ofthe outstanding common stock of InSight Holdings.  In addition, certain members of senior management rolled over aportion of their Company stock options into stock options of InSight Holdingsat the consummation of the acquisition. Upon consummation of the acquisition, each of the Company’s stockholdersbecame entitled to receive $18.00 in cash for each share of Company common stockthat they owned prior to the acquisition. Holders of options and warrants, which prior to the acquisition wereexercisable for Company common stock, received the difference between $18.00and the exercise price for each share of common stock the holder could haveacquired pursuant to the terms of the options or warrants, and the options andwarrants were terminated.  This resultedin a charge of approximately $19.7 million, which will be reflected in thesecond quarter of fiscal 2002.  TheCompany’s stockholders, option holders and warrant holders immediately prior tothe acquisition became entitled to receive aggregate cash consideration ofapproximately $187.7 million as a result of the acquisition.

 

Concurrently with the acquisition, the Company (i) repurchased by tenderoffer all of its 9 5/8% senior subordinated notes due 2008 (Existing Notes) inan aggregate principal amount of $100 million, (ii) repaid its then outstandingsenior credit facilities and certain other indebtedness and (iii) paid fees andexpenses relating to the acquisition and related financing transactions.  The Company will record an extraordinaryloss on extinguishment of existing indebtedness of approximately $20.0 millionin the second quarter of fiscal 2002.

 

These transactions were financed through:

 

·        Borrowingsof $150 million under $275 million of new senior credit facilities (New CreditFacilities);

 

·        A$200 million senior subordinated bridge financing;

 

·        Theinvestment by Childs, Halifax and certain of their affiliates of $98.1 million;management options and common stock rollover with a total net value ofapproximately $1.9 million; and

 

·        Cashof approximately $3.9 million

 

The acquisitionwill be accounted for as a purchase of the Company by Insight Holdings.  As such, the recorded amounts of theCompany's assets and liabilities will change significantly as a result of theapplication of purchase accounting. Management is currently in the process of evaluating the appropriatepurchase accounting adjustment.

 

On October 30, 2001, the Company issued new 9 7/8% senior subordinatednotes due 2011 (New Notes) in the aggregate principal amount of $225million.  The net proceeds from theissuance of the New Notes was approximately $211.5 million, $200 million ofwhich was used to retire in full the senior subordinated bridge financing andthe balance of which is being used for general corporate purposes.  The Company will record an extraordinaryloss on extinguishment of the senior subordinated bridge financing ofapproximately $7.8 million in the second quarter of fiscal 2002.

**ACQUISITIONS**

 

The Company's objective is to be the leading provider of outsourceddiagnostic imaging services in its target markets by further developing andexpanding its regional diagnostic imaging networks that emphasize quality ofcare, produce cost–effective diagnostic information and provide superiorservice and convenience to its customers. The strategy is focused on three components.   Firstly, the Company intends to maximize utilization of itsexisting facilities by (i) broadening its physician referral base andgenerating new sources of revenues through selective marketing activities; (ii)focusing its marketing efforts on attracting additional managed care customers;(iii) adding new modalities such as CT, ultrasound and bone densitometry at itsexisting facilities to realize economies of scale and increase overallprocedure volume; (iv) expanding current imaging applications of existingmodalities to increase overall procedure volume; (v) focusing on its ability toconvert developing Mobile Facilities to Fixed Facilities; and (vi) maximizingcost efficiencies through increased purchasing power and by continued reductionof expenses.

 

Secondly, the Company intends to pursue expansion opportunities withinits existing regional networks by opening new Fixed Facilities, Centers anddeveloping Mobile Facilities where attractive returns on investment can beachieved and sustained.  Managementbelieves that Mobile PET Facilities present a growth opportunity due toincreased physician acceptance of PET as a diagnostic tool, recently expandedMedicare coverage of PET procedures and favorable reimbursement levels.  The Company also intends to pursue jointventure opportunities with hospitals because management believes that they havethe potential to provide the Company with a steady source of procedurevolume.  In addition, managementbelieves that this will be an area for additional growth because the Companyexpects hospitals to respond to recent federal health care regulatory changesby outsourcing radiology services to imaging centers that are jointly owned andmanaged with third parties.

 

Finally, the Company intends to continue to increase its marketpresence in its existing regional markets where it can increase economies ofscale or new markets where it believes it can establish a strong regionalnetwork, through disciplined and strategic acquisitions.  The Company believes it is well positionedto capitalize on the ongoing consolidation of the imaging industry.  The Company believes that the expansion ofits business through such acquisitions is a key factor in improvingprofitability.  Generally, acquisitionopportunities are aimed at increasing revenues and operating income, andmaximizing utilization of existing capacity and increasing economies ofscale.  Incremental operating incomeresulting from future acquisitions will vary depending on geographic location,whether facilities are Mobile or Fixed, the range of services provided and theCompany's ability to integrate the acquired businesses into its existinginfrastructure.  Since 1996, the Companyhas completed 12 acquisitions.  Noassurance can be given, however, that the Company will be able to identifysuitable acquisition candidates and thereafter complete such acquisitions onterms acceptable to the Company.   Inconnection with the acquisition and related financing transactions discussedabove, the Company has a $75 million delayed draw term loan facility availableto pursue acquisition opportunities.  Asof November 9, 2001, there were no borrowings under this facility.

 

In fiscal 2001,the Company opened in the Western Division a radiology co-source outpatientFixed Facility in Marina Del Rey, California, which was financed withinternally generated funds and a capital lease from General Electric Company(GE); and in the Eastern Division a PET Fixed Facility in Louisville, Kentucky,which was financed with outside financing.

 

In fiscal 2002,the Company opened in the Eastern Division a radiology co-source outpatientFixed Facility in Largo, Florida, which is expected to be financed with outsidefinancing.

 

**FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES**

 

The Company operates in a capital intensive, high fixed cost industrythat requires significant amounts of working capital to fund operations,particularly the initial start-up and development expenses of new operations;and yet is constantly under external pressure from both customers andcompetitors to contain costs and reduce prices.

In connection with the acquisition, the Company entered into New CreditFacilities with Bank of America, N.A. and a syndication of other lendersconsisting of (i) a $150 million seven year term loan B, (ii) a $75 millionseven year delayed-draw term loan facility, and (iii) a $50 million six yearrevolving credit facility.  The entire$150 million term loan B from the New Credit Facilities was used to consummatethe acquisition.  Borrowings under theNew Senior Credit Facilities bear interest at LIBOR plus 3.5%.  The Company is required to pay an annual unusedfacility fee of between 0.5% and 2.0%, payable quarterly, on unborrowed amountsunder both facilities.  The Companyexpects to use the delayed-draw facility, which is available through the secondanniversary of the consummation of the acquisition, to fund future acquisitionsand capital expenditures. The Company expects to use the revolving creditfacility primarily to fund its future working capital needs.

 

The New Credit Facilities contain various restrictive covenants whichprohibit the Company from prepaying other indebtedness, including the NewNotes, and require the Company to maintain specified financial ratios andsatisfy financial condition tests.  Inaddition, the New Senior Credit Facilities prohibit the Company from declaringor paying any dividends and prohibit it from making any payments with respectto the New Notes if the Company fails to perform its obligations under, orfails to meet the conditions of, the New Credit Facilities or if paymentcreates a default under the New Credit Facilities.

 

In addition to theindebtedness under the New Credit Facilities, the Company issued $225 millionaggregate principal amount of the New Notes in a private placement exempt fromregistration under the Securities Act of 1933, as amended.  The indenture governing the New Notes amongother things, (i) restricts the ability of the Company and certainsubsidiaries, including the guarantors of the New Notes, to incur additionalindebtedness, issue shares of preferred stock, incur liens, pay dividends or makecertain other restricted payments and enter into certain transactions withaffiliates, (ii) places certain restrictions on the ability of certainsubsidiaries, including the guarantors of the New Notes, to pay dividends ormake certain payments to the Company, and (iii) places restrictions on theability of the Company and certain subsidiaries, including the guarantors ofthe New Notes, to merge or consolidate with any other person or sell, assign,transfer, lease, convey or otherwise dispose of all or substantially all of theassets of  the Company.  The Company intends to register notes havingsubstantially identical terms as the New Notes with the SEC on a registrationstatement on Form S-4.

 

Net cash provided by operating activities was approximately $13.9million for the three months ended September 30, 2001.  Cash provided by operating activitiesresulted primarily from net income before depreciation and amortization(approximately $13.3 million), an increase in accounts payable and otheraccrued expenses (approximately $2.6 million) and a decrease in trade accountsreceivables, net (approximately $0.3 million), partially offset by an increasein other current assets (approximately $2.2 milion)..

 

Net cash used in investing activities was approximately $15.2 millionfor the three months ended September 30, 2001. Cash used in investing activities resulted primarily from the Companypurchasing or upgrading diagnostic imaging equipment at its existing facilities(approximately $14.2 million).

 

Net cash used in financing activities was approximately $8.3 millionfor the three months ended September 30, 2001, resulting primarily fromprincipal payments of debt and capital lease obligations (approximately $8.4million).

 

The Company has committed to purchase or lease in connection with thedevelopment of new Fixed and Mobile Facilities and replacement or upgrades ofdiagnostic imaging equipment at Centers, Fixed and Mobile Facilities, at anaggregate cost of approximately $26.3 million, 19 diagnostic imaging systemsfor delivery through January 2002.  TheCompany expects to use either internally generated funds or leases from GE andothers to finance the purchase of such equipment.  The Company may purchase, lease or upgrade other diagnosticimaging systems as opportunities arise to place new equipment into service whennew contract services agreements are signed, existing agreements are renewed,acquisitions are completed, or new Centers, Fixed and Mobile Facilities aredeveloped in accordance with the Company's business strategy.

 

In addition, in connection with the implementation of the electronictransaction, security and privacy standards mandated by the Health InsurancePortability And Accountability Act (HIPAA), the Company expects to spendapproximately $1.5 million to make necessary software upgrades to its radiologyinformation system to make the system compliant with HIPAA transactionstandards by late 2002 and with the privacy standards by 2003.

 

The Companybelieves that, based on current levels of operations and anticipated growth,its cash from operations, together with other available sources of liquidity,will be sufficient through September 30, 2002 to fund anticipated capitalexpenditures and make required payments of principal and interest on its debt,including payments due on the New Notes and obligations under the New CreditFacilities.   In addition, the Companycontinually evaluates potential acquisitions and expects to fund suchacquisitions from its available sources of liquidity, as discussed above.  The Company's acquisition strategy mayrequire sources of capital in addition to that currently available to theCompany.   No assurance can be giventhat such necessary additional funds will be available to the Company on termsacceptable to the Company or at all.

**RESULTSOF OPERATIONS**

 

For the threemonths ended September 30, 2001 and 2000, the Company has focused on theresults of operations through the division of its diagnostic imaging businessinto two geographical regions of the United States: Western and EasternDivisions.  The Company has divided itsoperations into two Divisions only for the purposes of the separation ofinternal management responsibilities and does not focus on each of these Divisionsas a separate business or make financial decisions as if they are separatebusinesses.  Each Division providesdiagnostic imaging services and generates both contract services and patientservices revenues.  In addition,resources are allocated by the Company on an overall basis to each Division tomaximize returns on investment.

 

**THREE MONTHS ENDED SEPTEMBER 30, 2001AND 2000**

 

REVENUES:  Revenues increased approximately 1.7% from approximately $52.2million for the three months ended September 30, 2000, to approximately $53.1million for the three months ended September 30, 2001.  This increase was due primarily to theopened Fixed Facilities discussed above (approximately $0.5 million) and anincrease patient services revenues (approximately $2.0 million) at existingfacilities, partially offset by a decrease in contract services and otherrevenues (approximately $1.6 million) at existing facilities.  Revenues for the Eastern and WesternDivision represented approximately 60% and 36%, respectively, of total revenuesfor the three months ended September 30, 2001. However, the percentages will be affected by future acquisitions and theestablishment of Centers, Fixed and Mobile Facilities.

 

Contract services revenues decreased approximately 5.7% fromapproximately $26.3 million for the three months ended September 30, 2000, toapproximately $24.8 million for the three months ended September 30, 2001.  The decrease was due to the loss of certainhigh volume contracts which were replaced by contracts which initially havelower volumes.  Contract servicesrevenues for the Eastern and Western Division represented approximately 88% and5%, respectively, of contract services revenues for the three months endedSeptember 30, 2001.  However, thepercentages will be affected by future acquisitions and the establishment ofCenters, Fixed and Mobile Facilities.

 

Contract services revenues, primarily earned by the Company's MobileFacilities, represented approximately 47% of total revenues for the threemonths ended September 30, 2001.  Eachyear approximately one–quarter to one–third of the contractservices agreements for Mobile Facilities are subject to renewal.  It is expected that some high volumecustomer accounts will elect not to renew their contracts and instead willpurchase or lease their own diagnostic imaging equipment and some customers maychoose an alternative services provider. In the past, when such contracts have not been renewed, the Company hasbeen able to obtain replacement contracts. While some replacement accounts have initially been smaller than thelost accounts, such replacement accounts' revenues have generally increasedover the term of the contract; however, new and renewal contracts may notoffset revenues from customers electing not to renew their contracts with theCompany.  No single source accounts formore than 10% of the Company's total revenues. The non­renewal of a single customer contract would not have a materialimpact on the Company's contract services revenues, although non–renewalof several contracts could have a material impact on contract servicesrevenues.

 

As a result of the implementation of the new Outpatient ProspectivePatient System (OPPS) for outpatient services, effective August 1, 2000Medicare began paying hospitals for outpatient services based on ambulatorypayment classification (APC) groups rather than on a hospital’s costs. Each APChas been assigned a payment weight by the Centers for Medicare and MedicaidServices (CMS). Under the new OPPS, the payment due a hospital for performingan outpatient service will be an amount based on the APC weight, a dollar basedconversion factor, a geographic adjustment factor to account for area laborcost differences and any other adjustments applicable to the hospital or case.Because the new OPPS appeared to have a severe adverse economic effect onhospitals, Congress enacted additional legislation in the Balanced BudgetRefinement Act of 1999 (BBA) to ease such effect through 2003. Under the BBA,hospitals may receive additional payments for new technologies, transitionalpass-through for innovative medical devices, drugs and biologics, outlieradjustments and transitional payment corridors. In addition, the BenefitsImprovement and Protection Act of 2000 included certain provisions requiringCMS to revise the APCs to separate contrast-enhanced diagnostic imagingprocedures from those that are not contrast-enhanced, and payment forunenhanced diagnostic procedures may be reduced as a result of implementationof these provisions. On August 21, 2001, CMS published proposed changes tohospital OPPS rates, effective January 1, 2002, which reduce payment forunenhanced diagnostic procedures but increase payment for enhanced diagnosticprocedures.

 

As a result of the implementation of the new OPPS, the Company believesthat its hospital customers may seek reductions in contractual rates to theextent the hospital believes it will pay more to the Company than it willreceive from Medicare and other third-party payors.  The reduction of contractual rates for a single customer or lossof a single customer to a competitor prepared to reduce contractual rates wouldnot have a material adverse impact on the Company's contract services revenues;however, the reduction in contractual rates for several customers or loss of severalcontracts could have a material impact on the Company's business, financialcondition and results of operations.

On the other hand, the Company believes that the impact of the new OPPSon hospital payments for diagnostic imaging services, especially for MRI and CTservices, may cause hospitals to consider restructuring their diagnosticoutpatient imaging services as freestanding centers which are unaffected by thenew OPPS.  This may provide the Companywith additional opportunities for its radiology co-source product whichinvolves the joint ownership and management of single and multi-modalityimaging centers with hospitals.  Giventhe infancy and complexity of the new OPPS, it is difficult to determinewhether hospitals will be receiving less from Medicare (after they takeadvantage of the transitional payments that may be available under the BBA) andto what extent they will attempt to renegotiate existing contractualarrangements.

 

Patient services revenues, primarily earned by the Company's Fixed Facilitiesand Centers, represented approximately 53% of total revenues for the threemonths ended September 30, 2001. Patient services revenues increased approximately 9.7% fromapproximately $25.7 million for the three months ended September 30, 2000, toapproximately $28.2 million for the three months ended September 30, 2001.  This increase was due primarily to theacquisitions and opened Fixed Facilities discussed above (approximately $0.5million) and an increase in revenues at existing facilities (approximately $2.0million). The increase at existing facilities was due to higher utilization(approximately 7%), and a nominal increase in reimbursement from third-partypayors.  Patient services revenues forthe Eastern and Western Division represented approximately 35% and 64%,respectively, of patient services revenues for the three months ended September30, 2001.  However, the percentages willbe affected by future acquisitions and the establishment of Centers, Fixed andMobile Facilities.  The Company believesits patient services revenues received from Medicare will not be materiallyimpacted by the new OPPS because it primarily operates freestanding FixedFacilities and Centers which are unaffected thereby.

 

Management believes that any future increases in revenues at existingfacilities can only be achieved by higher utilization and not by increases inprocedure prices; however, slower start-ups of new operations, excess capacityof diagnostic imaging equipment, competition, and the expansion of managed caremay impact utilization and make it difficult for the Company to achieve revenueincreases in the future, absent the execution of provider agreements withmanaged care companies and other payors, and the execution of the Company'sbusiness strategy, particularly acquisitions.

 

COSTS OF OPERATIONS:  Costs of operations decreased approximately5.9% from approximately $40.5 million for the three months ended September 30,2000, to approximately $38.1 million for the three months ended September 30,2001.  This decrease was due primarilyto the elimination of amortization as a result of the adoption of SFAS 142discussed below (approximately $1.4 million), and reduced costs at existingfacilities (approximately $1.4 million), partially offset by costs related tothe opened Fixed Facilities discussed above (approximately $0.4 million). Thedecrease at existing facilities was due primarily to reduced supply, vehicleoperations and depreciation costs, partially offset by increased salary andbenefits.

 

Costs of operations, as a percentage of total revenues, decreased toapproximately 71.7% for the three months ended September 30, 2001 fromapproximately 77.7% for the three months ended September 30, 2000.  The percentage decrease is primarily due tothe elimination of goodwill amortization (discussed below) and reduced costs inequipment lease, equipment maintenance, occupancy, consulting andcommunications costs, partially offset by higher salary and benefit costs.  The Company is continuing to improve operatingefficiencies through cost reduction initiatives.  The cost reduction initiatives are focused primarily on costs fordiagnostic imaging equipment, including lease, depreciation and maintenance,occupancy, marketing and salary and benefits.

 

CORPORATE OPERATING EXPENSES:  Corporate operating expenses decreasedapproximately 3.7% from approximately $2.70 million for the three months endedSeptember 30, 2000, to approximately $2.66 million for the three months endedSeptember 30, 2001. The decrease was due primarily to reduced salary andbenefits associated with the Company's acquisition and development activities,consulting and travel costs, partially offset by additional information systemscosts.   Corporate operating expenses,as a percentage of total revenues, decreased from approximately 5.2% for thethree months ended September 30, 2000, to approximately 5.0% for the threemonths ended September 30, 2001.

INTEREST EXPENSE, NET:  Interest expense, net decreasedapproximately 11.7% from approximately $6.0 million for the three months endedSeptember 30, 2000, to approximately $5.3 million for the three months endedSeptember 30, 2001.  This decrease wasdue to principal payments of long-term debt and a reduction in the Company’seffective interest rate on its variable rate debt.

 

PROVISION FOR INCOME TAXES:  For the three months ended September 30,2001, the effective tax rate increased to approximately 33% from approximately10% for the three months ended September 30, 2000, primarily as a result of recognizingin fiscal 2001 the benefits from previously unused net operating loss carryforwards.  At the beginning of eachfiscal year, the Company estimates its effective tax rate for the fiscal year.  In addition, the Company periodicallyreviews the effective tax rate in light of certain factors, including actualoperating income, acquisitions completed and new facilities opened, and theeffects of benefits from the Company's net operating loss carry forwards.  This review may result in an increase ordecrease in the effective tax rate during the fiscal year.  The Company expects its effective tax ratewill continue to increase in the future as previously unused net operating losscarryforwards are used.

 

EBITDA:  Earnings before interest, taxes, depreciation and amortization(EBITDA) increased approximately 8.2% from approximately $19.4 million for thethree months ended September 30, 2000, to approximately $21.0 million for thethree months ended September 30, 2001. This increase was primarily due to lower costs of services as a resultof the cost reduction initiatives described above.  EBITDA for the Western Division increased approximately 33.9%from approximately $6.2 million for the three months ended September 30, 2000to approximately $8.3 million for the three months ended September 30,2001.  EBITDA for the Eastern Divisiondecreased approximately 7.8% from approximately $16.7 million for the threemonths ended September 30, 2000 to approximately $15.4 million for the threemonths ended September 30, 2001.  Thereduction in EBITDA in the Eastern Division is due primarily to the reductionin contract services revenues discussed above and to start-up costs relating tofive Mobile PET Facilities.

 

INCOME PER COMMON AND PREFERRED SHARE:  On a diluted basis, net income per commonand preferred share was $0.49 for the three months ended September 30, 2001,compared to net income per common and preferred share of $0.29 for the threemonths ended September 30, 2000.  Theincrease in net income per common and preferred share is the result of (i)increased income from company operations, (ii) an increase in earnings fromunconsolidated partnerships and (iii) reduced interest expense, partiallyoffset by an increase in provision for income taxes.

**NEWPRONOUNCEMENTS**

 

In March 2000, theFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 44,"Accounting for Certain Transactions Involving Stock Compensation"(FIN 44).  FIN 44 provides guidance for issuesarising in applying APB Opinion No. 25, "Accounting for Stock Issued toEmployees."  FIN 44 appliesspecifically to new awards, exchanges of awards in a business combination,modifications to outstanding awards and changes in grantee status that occur onor after July 1, 2001, except for the provisions related to repricings and thedefinition of an employee which apply to awards issued after December 15,1998.  The requirements of FIN 44 didnot have a material impact on the Company's financial condition and results ofoperations.

 

In June 2001, theFASB issued SFAS No. 141, "Business Combinations."  SFAS 141 addresses financial accounting andreporting for business combinations and supersedes APB Opinion No. 16,"Business Combinations," and FASB Statement No. 38, "Accountingfor Preacquisition Contingencies of Purchased Enterprises."  All business combinations in the scope ofSFAS 141 are to be accounted for using the purchase method of accounting.  The Company will adopt SFAS 141 for allbusiness combinations initiated after June 30, 2001.

 

Also in June 2001,the FASB issued SFAS No. 142, "Goodwill and Other IntangibleAssets."  SFAS 142 addressesfinancial accounting and reporting for acquired goodwill and other intangibleassets and supersedes APB Opinion No. 17, "Intangible Assets."  SFAS 142 addresses, among other things, howgoodwill and other intangible assets should be accounted for after they havebeen initially recognized in the financial statements.  Goodwill is no longer be amortized but isassessed at least annually for impairment using a fair value methodology.  The Company adopted SFAS 142 for allgoodwill and other intangible assets acquired after June 30, 2001 and for allexisting goodwill and other intangible assets beginning July 1, 2001.  As a result of the adoption of SFAS 142 onJuly 1, 2001 the Company ceased recording annual goodwill amortization ofapproximately $5.4 million.  For theyear ending June 30, 2002, SFAS 142 also changes the methodology and potentialtiming of impairment charges; however, the effect of these charges (if any)cannot be determined at this time. Under the transition arrangements of SFAS 142, the Company is requiredto complete a preliminary evaluation of impairment charges by December 31, 2001and recognize the effects of any impairment charges prior to June 30,2002.  Such amounts would be recorded asa cumulative effect of a change in accounting principle, effective in the firstquarter of fiscal 2002.

Also in June 2001,the FASB issued SFAS No. 143, "Accounting for Asset RetirementObligations."  SFAS 143 addressesfinancial accounting and reporting for obligations associated with theretirement of tangible long-lived assets and the associated asset retirementcosts. It applies to legal obligations associated with the retirement oflong-lived assets that result from the acquisition, construction, developmentand/or the normal operation of a long-lived asset, except for certainobligations of lessees.  SFAS 143requires that the fair value of a liability for an asset retirement obligationbe recognized in the period in which it is incurred if a reasonable estimate offair value can be made.  The associatedasset retirement costs are capitalized as part of the carrying amount of thelong-lived asset. SFAS 143 is effective for financial statements issued forfiscal years beginning after June 15, 2002 (with earlier application beingencouraged).  The Company does notexpect the adoption of SFAS 143 to have a material impact on the Company'sfinancial condition and results of operations.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS 144 addresses financialaccounting and reporting for the impairment or disposal of long-lived assets.SFAS 141 supersedes SFAS No. 121, “Accounting for the Impairment of Long-LivedAssets and for Long-Lived Assets to Be Disposed Of,” and the accounting andreporting provisions of APB Opinion No. 30, “Reporting the Results ofOperations – Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions,” forthe disposal of a segment of a business (as previously defined in thatOpinion). The provisions of SFAS 144 are effective for financial statementsissued for fiscal years beginning after December 15, 2001, with earlyapplication encouraged and generally are to be applied prospectively. TheCompany does not expect the adoption of SFAS 144 to have a material impact onthe Company’s financial condition and results of operations.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

The Company provides its services in the United States and receivespayment for its services exclusively in United States dollars.  Accordingly, the Company's business isunlikely to be affected by factors such as changes in foreign market conditionsor foreign currency exchange rates.

 

The Company's market risk exposure relates primarily to interest rates,where the Company will periodically use interest rate swaps to hedge variableinterest rates on long-term debt under its New Credit Facilities.  The Company does not engage in activitiesusing complex or highly leveraged instruments.

 

In fiscal 1998, in the normal course of business, the Company enteredinto an interest rate swap with a notional amount of $40.0 million, for thepurpose of fixing the interest rate of a corresponding amount of $40.0 millionof floating rate debt.  This swap had athree year term and was extendable for an additional three years at the optionof the bank.  Under SFAS 133, extendableswaps do not meet the criteria for hedge accounting and changes in fair valueare recognized currently in earnings. During the year ended June 30, 2001, the Company recorded additionalinterest expense of approximately $0.7 million due to changes in the fair valueof the swap.  In March 2001, the swapwas extended for an additional three years by the bank and the Company expectsthe swap to qualify for hedge accounting through its maturity.

 

At September 30, 2001, the Company had outstanding long-term debt ofapproximately $65.5 million, which has floating rate terms.  The Company had outstanding an interest rateswap, converting $36.0 million of its floating rate debt to fixed rate debt.  Under the terms of the interest rate swapagreement, the Company is exposed to credit loss in the event of nonperformanceby the swap counterparty; however, the Company does not anticipatenonperformance by the counterparty.

**PART II  -  OTHER INFORMATION**

 

**ITEM6.     EXHIBITS AND REPORTS ON FORM 8-K**

 
|   | (a)    | Exhibits             |
|--------|--------|----------------------|
|   |   |                 |
|   |   | There are none.      |
|   |   |                 |
|   | (b)    | Reports on Form  8-K |
|   |   |                 |
|   |   | There are none.      |

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

|   | **INSIGHT  HEALTH SERVICES CORP.**                                     |
|--------|------------------------------------------------------------------------|
|   |                                                                   |
|   |                                                                   |
|   |                                                                   |
|   | /S/ Steven T. Plochocki                                                |
|   | Steven T. Plochocki, President and  Chief Executive Officer            |
|   |                                                                   |
|   |                                                                   |
|   | /S/ Thomas V. Croal                                                    |
|   | Thomas V. Croal, Executive Vice  President and Chief Financial Officer |
|   |                                                                   |
|   |                                                                   |
|   | November 14, 2001                                                      |