424B4 1 d424b4.htm FINAL PROSPECTUS FILED PURSUANT TO RULE 424(B)(4) Final Prospectus filed Pursuant to Rule 424(b)(4)
Table of Contents

Filed Pursuant to Rule 424(b)(4)
Registration Nos. 333-128820 and 333-131685

PROSPECTUS

 

6,300,000 Shares

 

LOGO

 

COMMON STOCK

 


 

NightHawk Radiology Holdings, Inc. is offering 5,800,000 shares of its common stock and certain selling stockholders are offering an aggregate of 500,000 shares. We will not receive any proceeds from the sale of shares by the selling stockholders. This is our initial public offering and no public market exists for our shares.

 


 

Our common stock has been approved for quotation on the Nasdaq National Market under the symbol “NHWK.”

 


 

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 9.

 


 

PRICE $16.00 A SHARE

 


 

    

Price to

Public


  

Underwriting

Discounts and

Commissions


  

Proceeds to

NightHawk


   Proceeds to
Selling
Stockholders


Per Share

   $16.00    $1.12    $14.88    $14.88

Total

   $100,800,000    $7,056,000    $86,304,000    $7,440,000

 

The selling stockholders have granted the underwriters the right to purchase up to an additional 945,000 shares of common stock to cover over-allotments.

 

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers on February 14, 2006.

 


 

MORGAN STANLEY

 

BANC OF AMERICA SECURITIES LLC

 

PIPER JAFFRAY

 

SG COWEN & CO.

 

MONTGOMERY & CO., LLC

 

February 8, 2006


Table of Contents

 

 

 

LOGO

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   9

Special Note Regarding Forward-Looking Statements and Industry Data

   22

Use of Proceeds

   23

Dividend Policy

   23

Capitalization

   24

Dilution

   26

Unaudited Pro Forma Condensed Combined Financial Data

   28

Selected Consolidated Financial Data

   30

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   32

Business

   58

Management

   72

Certain Relationships and Related Party Transactions

   82

Principal and Selling Stockholders

   85

Description of Capital Stock

   87

Shares Eligible For Future Sale

   91

Material United States Federal Tax Considerations for Non-U.S. Holders of Common Stock

   93

Underwriters

   96

Legal Matters

   99

Experts

   99

Where You Can Find Additional Information

   99

Index to Financial Statements

   F-1

 


 

You should rely only on the information contained in this prospectus. We and the selling stockholders have not authorized anyone to provide you with information different from that contained in this prospectus. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of shares of our common stock.

 

Until March 5, 2006 (25 days after the commencement of this offering), all dealers that effect transactions in shares of our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside of the United States.

 

i


Table of Contents

PROSPECTUS SUMMARY

 

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. You should read this summary together with the more detailed information, including our financial statements and the related notes, elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in “Risk Factors.”

 

NIGHTHAWK RADIOLOGY HOLDINGS, INC.

 

Our Business

 

We believe that we are the leading provider of nighttime and weekend, or off-hours, emergency radiology services to radiology groups and hospitals across the United States. Our team of American Board of Radiology-certified, U.S. state-licensed and hospital-privileged radiologists uses our proprietary workflow technology to provide radiological interpretations, or reads, remotely to our customers in the United States primarily from our centralized reading facilities located in Sydney, Australia and Zurich, Switzerland. By locating our affiliated radiologists in Australia and Switzerland, we can provide off-hours reads in the United States during our radiologists’ local daylight hours. The reads that we currently provide to our customers primarily consist of preliminary diagnoses of emergency trauma and non-traumatic emergency conditions.

 

As of September 30, 2005, our affiliated radiologists provided services to 383 customers serving 746 hospitals, or approximately 13% of all hospitals in the United States. Most of these customers do not currently contract for all of the hours of coverage that we are able to provide. Based on a 2003 survey conducted by the American College of Radiology which estimated the total number of annual reads performed in the United States during all time periods, we believe that we are the leading provider of reads during off-hours periods. Since our first full year of operations, we have experienced significant revenue growth, from $4.7 million in 2002 to $16.2 million in 2003 to $39.3 million in 2004 and to $45.6 million for the nine month period ended September 30, 2005.

 

The U.S. healthcare market is experiencing a substantial increase in the development and use of diagnostic imaging technologies and procedures. From 1993 to 2003, the volume of diagnostic radiology procedures increased at an average annual rate of 3.2%. From 2000 to 2003, computed tomography procedures, commonly known as CT scans, which currently comprise approximately 89% of the reads performed by our affiliated radiologists, increased at an average annual rate of 14.0%. In contrast, the number of radiologists is only increasing by approximately 1.5% annually. In addition, U.S. hospitals generally require their contracted radiology groups to provide services 24-hours per day, seven days a week. As a consequence, radiologists have experienced, and we believe will continue to experience, increased workloads and increased demands to provide reads during off-hours periods.

 

For radiology groups, providing off-hours reads often results in the allocation of scarce physician resources to periods during which the volume of diagnostic imaging procedures for any one radiology group is typically low, resulting in operating inefficiencies and related costs. In addition, requirements to provide off-hours reads often limit the growth of radiology groups because of the difficulty of recruiting new radiologists into radiology groups that have off-hours coverage commitments. These radiology groups, which provide substantially all emergency radiology services in the United States, comprise the principal market for our services. By reducing the burdens associated with providing off-hours reads, we believe that we can improve the efficiency and productivity of radiology groups by enabling them to allocate their scarce physician resources to regular business hours, which typically are periods of higher demand. We also believe that our services enable radiology groups to recruit and retain radiologists more effectively, which permits them to pursue additional growth opportunities.

 

1


Table of Contents

For individual radiologists, providing off-hours reads often results in a significant quality-of-life burden. During an on-call period, a radiologist may be required to perform reads several times during a night, often waking the radiologist or otherwise disrupting the radiologist’s evening. By providing off-hours reads on behalf of radiologists, we believe that our service improves their quality of life.

 

The substantial majority of the reads that we provide are preliminary diagnoses used by a treating physician to determine whether any immediate action is required in response to symptoms being presented by a patient. Typically, the preliminary diagnosis is followed the next morning by a more exhaustive final, or primary, read preformed by a local radiologist affiliated with our customer.

 

We provide services to our customers typically pursuant to one-year service contracts. Our customer contracts provide for service fees that vary by customer based on a number of factors, including hours of coverage, volume of reads and technical and administrative services provided. Since our inception, more than 97% of our contracts up for renewal have been renewed.

 

Recent Developments—Fourth Quarter Financial Performance

 

We estimate that our revenue for the fourth quarter of 2005 was approximately $18.5 million, resulting in annual revenue of approximately $64.1 million and pro forma revenue of approximately $67.3 million (which amount gives effect to our acquisition of American Teleradiology Nighthawks, Inc. as if the acquisition had occurred January 1, 2004) each for the year ended December 31, 2005. Although the audit of our financial statements for the year ended December 31, 2005 is not yet complete, we expect that the operating costs and expenses we incurred during the fourth quarter of 2005 were generally consistent with the quarterly operating costs and expenses reflected in our audited financial statements for the nine month period ended September 30, 2005 appearing elsewhere in this prospectus and the trends described in the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” As of December 31, 2005, we provided services to 463 customers serving 860 hospitals, or approximately 15% of all hospitals in the United States.

 

As of December 31, 2005, we had 47 affiliated radiologists who were providing services for us, and an additional 13 radiologists who had entered into contracts with us but had not yet begun to provide services.

 

Our Solution

 

We primarily provide off-hours emergency radiology services to our radiology group and hospital customers across the United States from 5:00 p.m. to 8:00 a.m., U.S. local time, on weekdays and 24-hours per day during weekends and holidays primarily from our centralized reading facilities located in Australia and Switzerland.

 

We believe that our solution offers the following benefits to our radiology group customers and the hospitals and patients that they serve:

 

  ·   improved efficiency,

 

  ·   enhanced quality of patient care,

 

  ·   enhanced ability to recruit and retain radiologists,

 

  ·   highly-qualified radiologists providing services,

 

  ·   efficient delivery of services, and

 

  ·   no additional cost to patient and third-party payors.

 

2


Table of Contents

We believe that our business model has resulted in a market-leading position within our industry and several associated benefits for our business, including:

 

  ·   first-mover advantage,

 

  ·   strong customer retention,

 

  ·   enhanced ability to recruit and retain radiologists,

 

  ·   capital-efficient scalability, and

 

  ·   licensing and privileging expertise.

 

Our Strategy

 

Our objective is to expand on our position as the leading provider of off-hours emergency radiology services to radiology groups across the United States. We intend to capitalize on our strong customer relationships, scalable business model and team of affiliated radiologists to provide high-quality services to our radiology group customers so that they are better able to efficiently manage and expand their practices. Key elements of our strategy include:

 

  ·   target new customers and territories with expanded sales and marketing efforts,

 

  ·   expand our customers’ utilization of our current service hours,

 

  ·   extend our service offering to provide greater hours of coverage and provide primary as well as preliminary reads,

 

  ·   pursue strategic acquisitions, and

 

  ·   develop a market for our proprietary software technology.

 

Our Challenges

 

Our business is subject to numerous risks, which are highlighted in the section entitled “Risk Factors” immediately following this prospectus summary. These risks represent challenges to the successful implementation of our operating strategy. For instance, the market in which we participate is competitive and rapidly changing and barriers to entry are relatively low. As a result, we expect competition to intensify in the future, which may make it more difficult for us to successfully sell our services to new customers, expand into new territories and expand our customers’ utilization of our current service offerings. Increased competition may also result in pricing pressure, reduced revenue and reduced market share. In addition, the current shortage of radiologists has resulted in a very competitive market for their services. If we are unable to continue to recruit and retain qualified radiologists, we may not be able to extend our service offerings to provide greater hours of coverage and to provide primary as well as preliminary reads. As a result, our future growth, including through strategic acquisitions, would be limited and our business and operating results would be harmed.

 

Also, our ability to successfully develop a market for our proprietary software depends in part on our ability to protect our intellectual property rights in our workflow technology. If we do not obtain patent protection for our technology or we cannot otherwise prevent third parties from using or misappropriating it, our future growth could be harmed.

 

If we are unable to successfully address these challenges, and the other risks described in this prospectus, our business and operating results will be harmed.

 

Corporate Information

 

Nighthawk Radiology Services, LLC, which is a wholly-owned subsidiary of NightHawk Radiology Holdings, Inc., was founded in Coeur d’Alene, Idaho in 2001 as an Idaho limited liability company and is

 

3


Table of Contents

currently the entity through which we primarily conduct our operations. In March 2004, NightHawk Radiology Holdings, Inc., was formed to facilitate a recapitalization of Nighthawk Radiology Services, LLC. Our principal executive offices are located at 250 Northwest Boulevard, Suite 202, Coeur d’Alene, Idaho 83814, and our telephone number is (208) 676-8321. Our website address is www.nighthawkrad.net. The information on our website is not part of this prospectus.

 

Except where the context requires otherwise, in this prospectus the “Company,” “NightHawk,” “NightHawk Radiology,” “we,” “us” and “our” refer to NightHawk Radiology Holdings, Inc., a Delaware corporation, and, where appropriate, its subsidiaries. NightHawk Radiology, Nighthawk Radiology Services and NightHawk Radiology Holdings are unregistered trademarks of NightHawk Radiology in the United States and other countries. This prospectus also includes other trademarks of NightHawk Radiology and other persons.

 

4


Table of Contents

THE OFFERING

 

Shares of common stock offered by us

5,800,000 shares

 

Shares of common stock offered by certain selling stockholders

500,000 shares

 

Shares of common stock to be outstanding after this offering

29,809,571 shares

 

Use of proceeds

We plan to use the net proceeds of the offering to repay approximately $31.4 million of outstanding indebtedness and for general corporate purposes, including for further development and expansion of our service offerings as well as for possible acquisitions of complementary businesses, technologies or other assets. We will not receive any of the proceeds of the sale of shares by the selling stockholders. See “Use of Proceeds.”

 

Nasdaq National Market symbol

NHWK

 


 

The number of shares of common stock that will be outstanding after this offering is based on the number of shares outstanding at September 30, 2005, and excludes:

 

  ·   1,582,850 shares of common stock issuable upon the exercise of options outstanding at September 30, 2005, at a weighted average exercise price of $2.83 per share,

 

  ·   263,908 shares of common stock issuable upon exercise of options granted after September 30, 2005, at a weighted average exercise price of $10.25 per share,

 

  ·   6,247 shares of common stock reserved for future issuance under our 2004 Stock Plan,

 

  ·   1,600,000 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan, and

 

  ·   the additional shares of common stock that may be issued in connection with our acquisition of American Teleradiology Nighthawks, Inc. based upon the future financial performance of the ATN businesses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Acquisition.”

 

Unless otherwise indicated, all information in this prospectus assumes:

 

  ·   the conversion of all outstanding shares of our redeemable preferred stock into 6,500,003 shares of common stock effective upon the completion of this offering, and

 

  ·   no exercise by the underwriters of their right to purchase up to 945,000 shares of common stock from the selling stockholders to cover over-allotments.

 

5


Table of Contents

SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following tables summarize historical, pro forma and pro forma as adjusted consolidated financial data and certain operating data regarding our business and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements and our pro forma financial statements included elsewhere in this prospectus. The consolidated statement of operations data for the nine months ended September 30, 2004 set forth below are derived from our unaudited historical consolidated financial statements included elsewhere in this prospectus. In the opinion of management, our unaudited consolidated financial statements have been prepared on a basis consistent with our audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of results for these periods. The consolidated statement of operations data for the fiscal years ended December 31, 2002, 2003, and 2004 and the nine months ended September 30, 2005 and the consolidated balance sheet data as of September 30, 2005 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods. The pro forma financial data gives effect to our acquisitions of DayHawk Radiology Services, LLC, or DayHawk, and American Teleradiology Nighthawks, Inc., or ATN, as if the acquisitions occurred on January 1, 2004. The pro forma as adjusted consolidated financial data gives effect to these acquisitions and excludes the non-cash charges associated with the change in fair value of the redeemable preferred stock conversion feature and the accretion of our redeemable preferred stock and the effect of the September 2005 special distribution with respect to our redeemable preferred stock.

 

    Year Ended December 31,

    Nine Months Ended
September 30,


    Pro Forma As Adjusted (2)

 
   

2002


    2003

    2004

    Pro forma
2004 (1)


    2004

    2005

    Pro forma
2005 (1)


    Year Ended
December 31,
2004


    Nine Months
Ended
September 30,
2005


 
    (in thousands, except per share data)    

(in thousands, except

per share data)

 

Consolidated Statement of Operations Data:

                                                                       

Service revenue

  $ 4,666     $ 16,216     $ 39,283     $ 42,969     $ 27,673     $ 45,588     $ 48,791     $ 42,969     $ 48,791  

Operating costs and expenses (3)

    3,625       11,456       27,569       30,931       18,671       33,420       36,431       30,931       36,431  
   


 


 


 


 


 


 


 


 


Operating income (loss)

    1,041       4,760       11,714       12,038       9,002       12,168       12,360       12,038       12,360  

Other income (expense):

                                                                       

Interest expense

    (40 )     (7 )     (881 )     (881 )     (605 )     (723 )     (723 )     (881 )     (723 )

Interest income

          4       41       41       20       35       35       41       35  

Other, net

    (3 )     28       (29 )     (29 )     (52 )     (61 )     (61 )     (29 )     (61 )

Change in fair value of redeemable preferred stock conversion feature

                (3,857 )     (3,857 )     (2,567 )     (28,110 )     (28,110 )            
   


 


 


 


 


 


 


 


 


Total other income (expense)

    (43 )     25       (4,726 )     (4,726 )     (3,204 )     (28,859 )     (28,859 )           (869 )     (749 )
   


 


 


 


 


 


 


 


 


Income (loss) before income taxes

    998       4,785       6,988       7,312       5,798       (16,692 )     (16,499 )     11,169       11,611  

Income tax expense

                3,663       4,323       2,705       4,430       4,505       4,324       4,505  
   


 


 


 


 


 


 


 


 


Net income (loss)

    998       4,785       3,325       2,988       3,093       (21,122 )     (21,004 )     6,845       7,106  

Redeemable preferred stock accretion

                (765 )     (765 )     (506 )     (790 )     (790 )            

Preferred dividends

                                  (5,487 )     (5,487 )            
   


 


 


 


 


 


 


 


 


Net income (loss) applicable to common stockholders

  $ 998     $ 4,785     $ 2,560     $ 2,223     $ 2,587     $ (27,399 )   $ (27,281 )   $ 6,845     $ 7,106  
   


 


 


 


 


 


 


 


 


Earnings (loss) per common share:

                                                                       

Basic

  $ .02     $ .10     $ .11     $ .09     $ .10     $ (1.59 )   $ (1.56 )   $ .22     $ .30  

Diluted

  $ .02     $ .10     $ .11     $ .09     $ .10     $ (1.59 )   $ (1.56 )   $ .22     $ .29  

Weighted averages of common shares outstanding (4):

                                                                       

Basic

    49,732       49,732       24,196       24,943       26,644       17,194       17,510       31,443       24,010  

Diluted

    49,732       49,732       24,196       24,943       26,644       17,194       17,510       31,443       24,259  

 

6


Table of Contents
     As of December 31,

   As of September 30,

     2002

   2003

   2004

   2004

   2005

Selected Operating Data:

                        

Affiliated radiologists providing services

   8    15    27    21    39

Radiology group customers

   42    143    249    230    313

Hospital customers

   7    22    48    38    70

Total customers

   49    165    297    268    383

Hospitals served

   105    319    588    543    746

 

     As of September 30, 2005

     Actual

    Pro Forma (5)

    Pro Forma As
Adjusted (6)


     (in thousands)

Consolidated Balance Sheet Data:

                      

Cash and cash equivalents

   $ 7,917     $ 7,917     $ 60,857

Working capital (7)

     2,280       9,280       67,364

Total current assets

     21,882       21,882       74,823

Total long-term debt (including current portion)

     24,382       31,382      

Total liabilities

     73,294       73,294       8,275

Total stockholders’ equity (deficit)

     (66,534 )     (66,534 )     76,658

(1) Reflects our acquisitions of DayHawk Radiology Services, LLC and American Teleradiology Nighthawks, Inc.

 

(2) Reflects (i) our acquisitions of DayHawk Radiology Services, LLC and American Teleradiology Nighthawks, Inc., (ii) the conversion of all outstanding shares of our redeemable preferred stock into common stock upon the completion of the offering, resulting in the termination of the redeemable preferred stock conversion feature and the accretion of our redeemable preferred stock and (iii) the elimination of the effect of the September 2005 special distribution with respect to our redeemable preferred stock. We believe that this pro forma as adjusted data is useful to investors because the charges associated with the change in fair value of the redeemable preferred stock conversion feature, the accretion of our redeemable preferred stock and distributions with respect to our redeemable preferred stock will terminate as a result of the conversion of our redeemable preferred stock into common stock upon the completion of this offering. The following table provides a reconciliation of the historical data to the pro forma as adjusted data.

 

     Year Ended
December 31,
2004


    

Nine Months Ended
September 30,

2005


 
     (in thousands)  

Pro forma As Adjusted Service Revenue and Reconciliation

                 

Service revenue

   $ 39,283      $ 45,588  

Add: service revenue of DayHawk (for 2004 only) and ATN

     3,686        3,203  
    


  


Pro forma as adjusted service revenue

   $ 42,969      $ 48,791  
    


  


Pro forma As Adjusted Operating Costs and Expenses and Reconciliation

                 

Operating costs and expenses

   $ 27,569      $ 33,420  

Add: operating costs and expenses of DayHawk (for 2004 only) and ATN and related pro forma adjustments for the acquisitions

     3,362        3,011  
    


  


Pro forma as adjusted operating costs and expenses

   $ 30,931      $ 36,431  
    


  


Pro forma As Adjusted Income Tax Expense and Reconciliation

                 

Income tax expense

   $ 3,663      $ 4,430  

Add: income tax expense of DayHawk (for 2004 only) and ATN and related pro forma adjustments for the acquisitions

     661        75  
    


  


Pro forma as adjusted income tax expense

   $ 4,324      $ 4,505  
    


  


Pro forma As Adjusted Net Income (Loss) and Reconciliation

                 

Net income (loss)

   $ 3,325      $ (21,122 )

Add: net income (loss) of DayHawk (for 2004 only) and ATN and related pro forma adjustments for the acquisitions

     (337 )      118  

Add back: change in fair value of redeemable preferred stock conversion feature

     3,857        28,110  
    


  


Pro forma as adjusted net income

   $ 6,845      $ 7,106  
    


  


 

7


Table of Contents
     Year Ended
December 31,
2004


    

Nine Months Ended
September 30,

2005


 
     (in thousands)  

Pro Forma As Adjusted Net Income (Loss) Applicable to Common Stockholders and Reconciliation

                 

Income (loss) applicable to common stockholders

   $ 2,560      $ (27,399 )

Add: net income (loss) applicable to common stockholders of DayHawk (for 2004 only) and ATN and related pro forma adjustments for the acquisitions

     (337 )      118  

Add back: change in fair value of redeemable preferred stock conversion feature

     3,857        28,110  

Add back: preferred stock accretion

     765        790  

Add back: preferred dividends

            5,487  
    


  


Pro forma as adjusted income (loss) applicable to common stockholders

   $ 6,845      $ 7,106  
    


  


 

(3) Includes the non-cash stock-based compensation charges set forth in the following table (which amounts include a non-recurring, non-cash professional services charge of approximately $1.5 million in 2004 associated with the issuance of shares of our common stock to one of our affiliated radiologists and a non-recurring, non-cash sales, general and administrative charge of approximately $2.9 million in the nine months ended September 30, 2005 associated with the full acceleration of shares of common stock held by a member of our board of directors).

 

     Year Ended December 31,

   Nine Months Ended
September 30,


     2002

   2003

   2004

   2004

   2005

Professional services

                                  

Non-cash stock-based compensation

   $ 262,765    $ 653,050    $ 1,544,781    $ 857,068    $ 521,807

Sales, general and administrative

                                  

Non-cash stock-based compensation

               144,822      35,302      3,175,063
    

  

  

  

  

Total non-cash stock-based compensation

   $ 262,765    $ 653,050    $ 1,689,603    $ 892,370    $ 3,696,870
    

  

  

  

  

 

(4) The weighted average shares of common stock outstanding for the years ended December 31, 2002, 2003 and 2004 are based on the assumed conversion of LLC units into common stock at the beginning of 2002 based on the conversion ratio from the recapitalization transaction.

 

(5) Reflects our special distribution to our stockholders of $7 million declared in September 2005 to be distributed prior to the completion of this offering and funded by long-term debt.

 

(6) Reflects (i) the pro forma adjustment described in footnote (5) above, (ii) the conversion of all outstanding shares of our redeemable preferred stock into shares of common stock upon the completion of this offering, resulting in the termination of the redeemable preferred stock conversion feature and the accretion of our redeemable preferred stock, (iii) the termination of the redemption rights associated with 1,671,429 shares of our common stock upon the completion of this offering, (iv) the receipt of net proceeds from the sale of 5,800,000 shares of common stock by us in this offering at the initial public offering price of $16.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, as set forth under “Use of Proceeds” and “Capitalization,” and (v) the application of $31.4 million of the net proceeds from this offering to repay all outstanding indebtedness under our term loan facility.

 

(7) Defined as current assets minus current liabilities.

 

8


Table of Contents

RISK FACTORS

 

You should carefully consider the risks described below before making an investment decision. Our business, prospects, financial condition or operating results could be materially adversely affected by any of these risks, as well as other risks not currently known to us or that we currently deem immaterial. The trading price of our common stock could decline due to any of these risks and you may lose all or part of your investment. In assessing the risks described below, you should also refer to the other information contained in this prospectus, including our consolidated financial statements and the related notes, before deciding to purchase any shares of our common stock.

 

Risks Related to Our Business and Industry

 

We have a short operating history in an emerging market, which makes it difficult to evaluate our business and prospects.

 

We have a short operating history in an emerging market. As a result, our current business and future prospects are difficult to evaluate. You must consider our business and prospects in light of the risks and difficulties we encounter as an early-stage company in a rapidly evolving market. Some of these risks relate to our potential inability to:

 

  ·   effectively manage our business and technology,

 

  ·   recruit and retain radiologists and other key personnel,

 

  ·   acquire additional customers,

 

  ·   successfully provide high levels of service quality as we expand the scale of our business,

 

  ·   manage rapid growth in personnel and operations,

 

  ·   effectively manage our medical liability risk,

 

  ·   develop new services that complement our existing business, and

 

  ·   successfully address the other risks described throughout this prospectus.

 

We may not be able to successfully address these risks. Failure to adequately do so would harm our business and cause our operating results to suffer.

 

Our growth strategy depends on our ability to recruit and retain qualified radiologists and other skilled personnel. If we are unable to do so, our future growth would be limited and our business and operating results would be harmed.

 

Our success is dependent upon our continuing ability to recruit and retain qualified radiologists to work at our reading facilities located in Australia and Switzerland. An inability to recruit and retain radiologists would have a material adverse effect on our ability to grow and would adversely affect our results of operations. We face competition for radiologists from other healthcare providers, including radiology groups, research and academic institutions, government entities and other organizations. In addition, our affiliated radiologists are typically U.S. citizens who must obtain visas to work in Australia or Switzerland. We have worked with the government of Australia to establish a visa program and have assisted our affiliated radiologists in the visa application process with the government of Switzerland, and to date all of our professionals have successfully obtained work visas in a timely manner. However, any future inability to obtain or difficulty in obtaining work visas for our affiliated radiologists, due to changing immigration regulations or otherwise, would jeopardize our business and harm our results.

 

9


Table of Contents

In addition to recruiting radiologists for our facilities in Australia and Switzerland, we must identify, recruit and retain skilled executive, technical, administrative, sales, marketing and operations personnel to our headquarters in Coeur d’Alene, Idaho. Competition for highly qualified and experienced personnel is intense due to the limited number of people available with the necessary skills. In addition, Coeur d’Alene has a relatively small pool of potential employees with the skills that we require, and is a small city in a relatively rural part of the country, making it difficult for us to recruit employees from larger metropolitan areas of the country. Failure to attract and retain the necessary personnel would inhibit our growth and harm our business.

 

The market in which we participate is competitive and we expect competition to increase in the future, which will make it more difficult for us to sell our services and may result in pricing pressure, reduced revenue and reduced market share.

 

The market for off-hours emergency radiology services is competitive and rapidly changing, barriers to entry are relatively low, and with the introduction of new technologies and market entrants, we expect competition to intensify in the future. If we fail to compete effectively, our operating results will be harmed. Some of our principal competitors offer their services at a lower price, which has resulted and will continue to result in pricing pressure. If we are unable to maintain our current pricing, our operating results could be negatively impacted. In addition, pricing pressures and increased competition could result in reduced revenue, reduced profits or the failure of our service to achieve or maintain more widespread market acceptance, any of which could harm our business.

 

In addition, if one or more of our competitors were to merge or partner with another of our competitors, or if companies larger than we are enter the market through internal expansion or acquisition of one of our competitors, the change in the competitive landscape could adversely affect our ability to compete effectively. These competitors could have established customer relationships and greater financial, technical, sales, marketing and other resources than we do, and could be able to respond more quickly to new or emerging technologies or devote greater resources to the development, promotion and sale of their services. This competition could harm our ability to sell our services, which may lead to lower prices, reduced revenue and, ultimately, reduced market share.

 

If our arrangements with our affiliated radiologists or our customers are found to violate state laws prohibiting the corporate practice of medicine or fee splitting, our business, financial condition and our ability to operate in those states could be adversely impacted.

 

The laws of many states, including states in which our customers are located, prohibit us from exercising control over the medical judgments or decisions of physicians and from engaging in certain financial arrangements, such as splitting professional fees with physicians. These laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. We enter into agreements with our affiliated radiologists pursuant to which the radiologists render professional medical services. In addition, we enter into agreements with our customers to deliver professional radiology interpretation services in exchange for a service fee. We structure our relationships with our affiliated radiologists and our customers in a manner that we believe is in compliance with prohibitions against the corporate practice of medicine and fee splitting. While we have not received notification from any state regulatory or similar authorities asserting that we are engaged in the corporate practice of medicine or that the payment of service fees to us by our customers constitutes fee splitting, if such a claim were successful, we could be subject to civil and criminal penalties and could be required to restructure or terminate the applicable contractual arrangements. A determination that these arrangements violate state statutes, or our inability to successfully restructure our relationships with our affiliated radiologists to comply with these statutes, could eliminate customers located in certain states from the market for our services, which would have a materially adverse effect on our business, financial condition and operations.

 

10


Table of Contents

If our affiliated radiologists are characterized as employees, we would be subject to employment and withholding liabilities and may be subject to prohibitions against the corporate practice of medicine.

 

We structure our relationships with our affiliated radiologists in a manner that we believe results in an independent contractor relationship, not an employee relationship. An independent contractor is generally distinguished from an employee by his or her degree of autonomy and independence in providing services. A high degree of autonomy and independence is generally indicative of a contractor relationship, while a high degree of control is generally indicative of an employment relationship. Although we believe that our affiliated radiologists are properly characterized as independent contractors, tax or other regulatory authorities may in the future challenge our characterization of these relationships. If such regulatory authorities or state, federal or foreign courts were to determine that our affiliated radiologists are employees, and not independent contractors, we would be required to withhold income taxes, to withhold and pay social security, Medicare and similar taxes and to pay unemployment and other related payroll taxes. We would also be liable for unpaid past taxes and subject to penalties. In addition, such a determination may also result in a finding that we are engaged in the corporate practice of medicine in violation of the laws of many states. As a result, any determination that our affiliated radiologists are our employees would materially harm our business and operating results.

 

We have been subject to medical liability claims and may become subject to additional claims, which could cause us to incur significant expenses and may require us to pay significant damages if not covered by insurance.

 

Our business entails the risk of medical liability claims against our affiliated radiologists and us. We or our affiliated radiologists are currently subject to five medical liability claims, and, in the past, have been subject to a medical liability claim for which a settlement was paid by our insurance carrier. None of the five medical liability claims to which we are currently subject has alleged a dollar amount of damages. Although we maintain medical liability insurance for ourselves and our affiliated radiologists with coverages that we believe are appropriate in light of the risks attendant to our business, successful medical liability claims could result in substantial damage awards which exceed the limits of our insurance coverage. In addition, medical liability insurance is expensive and insurance premiums may increase significantly in the future, particularly as we expand our services to include primary reads. As a result, adequate medical liability insurance may not be available to our affiliated radiologists or us in the future at acceptable costs or at all.

 

Any claims made against us that are not fully covered by insurance could be costly to defend against, result in substantial damage awards against us and divert the attention of our management and our affiliated radiologists from our operations, which could adversely affect our operations and financial performance. In addition, any claims might adversely affect our business or reputation.

 

We indemnify our radiology group and hospital customers against damages or liabilities that they may incur as a result of the actions of our affiliated radiologists or us. We also indemnify some of our affiliated radiologists against medical liability claims. Our indemnification obligations are typically payable only to the extent that damages incurred are not covered by insurance.

 

We have also assumed and succeeded to substantially all of the obligations of some of the operations that we have acquired. Medical liability claims may be asserted against us for events that occurred prior to these acquisitions. In connection with our acquisitions, the sellers of the operations that we have acquired have agreed to indemnify us for certain claims. However, we may not be able to collect payment under these indemnity agreements, which could affect us adversely.

 

Our customers may terminate their agreements with us, or their agreements with the hospitals that they serve may be terminated, either of which could adversely affect our financial condition and operating results.

 

Our revenue is derived primarily from fee-for-service billings to our radiology group customers. Our agreements with our customers generally provide for one-year terms and automatically renew for successive one-

 

11


Table of Contents

year terms unless terminated by our customers or us upon 30 days’ prior notice. Following the first anniversary of the agreements, the agreements typically may be terminated at any time by our customers or us upon 60 days’ prior notice. Our customers may elect not to renew their contracts with us, they may seek to renegotiate the terms of their contracts or they may choose to reduce or eliminate our services in the future. If our arrangements with our customers are canceled, or are not renewed or replaced with other arrangements having at least as favorable terms, our business, financial condition and results of operations could be adversely affected. In addition, to the extent that our radiology group customers’ agreements with the hospitals that they serve are terminated, our business, financial condition and results of operations could be adversely affected.

 

Enforcement of federal and state laws regarding privacy and security of patient information may adversely affect our business, financial condition or operations.

 

The use and disclosure of certain healthcare information by healthcare providers and their business associates have come under increasing public scrutiny. Recent federal standards under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, establish rules concerning how individually-identifiable health information may be used, disclosed and protected. Historically, state law has governed confidentiality issues and HIPAA preserves these laws to the extent they are more protective of a patient’s privacy or provide the patient with more access to his or her health information. As a result of the implementation of the HIPAA regulations, many states are considering revisions to their existing laws and regulations that may or may not be more stringent or burdensome than the federal HIPAA provisions. We must operate our business in a manner that complies with all applicable laws, both federal and state and that does not jeopardize the ability of our customers to comply with all applicable laws to which they are subject. We believe that our operations are consistent with these legal standards. Nevertheless, these laws and regulations present risks for healthcare providers and their business associates that provide services to patients in multiple states. Because these laws and regulations are recent and few have been interpreted by government regulators or courts, our interpretations and activities may be challenged. If a challenge to our activities is successful, it could have an adverse effect on our operations, may require us to forgo relationships with customers in certain states, and may restrict the territory available to us to expand our business. In addition, even if our interpretations of HIPAA and other federal and state laws and regulations are correct, we could be held liable for unauthorized uses or disclosures of patient information as a result of inadequate systems and controls to protect this information or due to the theft of information by unauthorized computer programmers who penetrate our network security.

 

Our business could be adversely affected if additional patient privacy restrictions are imposed through federal or state legislation or regulation.

 

On April 14, 2005, U.S. Senator Hillary Clinton and U.S. Representative Edward Markey reintroduced legislation that, if enacted, would prohibit healthcare organizations from sharing patient information with foreign affiliates or subcontractors without first obtaining consent from patients. A similar type of provision was proposed, but was not enacted, in the 2004 California legislative session. If a provision such as this were passed, it could impede our ability to obtain service contracts with radiology group practices or hospitals, as those providers would be required to obtain patient consent prior to transmitting the patient’s information to any of our reading facilities located outside of the United States.

 

Changes in the regulatory environment may constrain or require us to restructure our operations, which may harm our revenue and operating results.

 

Healthcare laws and regulations change frequently and may change significantly in the future. We monitor legal and regulatory developments and modify our operations from time to time as the regulatory environment changes. However, we may not be able to adapt our operations to address every new regulation, and new regulations may adversely affect our business. In addition, although we believe that we are operating in compliance with applicable foreign, federal and state laws, neither our current nor anticipated business operations have been scrutinized or assessed by judicial or regulatory agencies. We cannot assure you that a review of our

 

12


Table of Contents

business by courts or regulatory authorities would not result in a determination that adversely affects our operations or that the healthcare regulatory environment will not change in a way that restricts our operations.

 

Our growth and our transition to a publicly-traded company could strain our personnel, management and infrastructure resources, which may harm our business.

 

We are currently experiencing a period of rapid growth in our headcount and operations, which has placed, and will continue to place, a significant strain on our management, administrative, operational and financial infrastructure. We also anticipate that further growth will be required to address increases in the scope of our operations and size of our customer base. Our success will depend in part upon the ability of our current senior management team to manage this growth, as well as to manage the transition to a publicly-traded company effectively. None of our executive officers has previously held a senior management position at a publicly-traded company.

 

To effectively manage our anticipated growth, we will need to continue to improve our operational, financial and management processes and controls and our reporting systems and procedures. In addition, the additional headcount we are adding and capital investments we are making will increase our costs, which will make it more difficult for us to offset any future revenue shortfalls by offsetting expense reductions in the short term. If we fail to successfully manage our growth and our transition to a publicly-traded company, our business and operating results will be harmed.

 

Our operating results may be subject to seasonal fluctuation, which makes our results difficult to predict and could cause our performance to fall short of quarterly expectations.

 

We have experienced increased demand for and revenues from our services during the second and third fiscal quarters of each year. We believe that these increases are a result of increased outdoor and transportation activities during summer months. During the first and fourth quarters of each fiscal year, when weather conditions are colder for a large portion of the United States, we have historically experienced relatively lower revenues than those experienced during the second and third quarters. We may continue to experience this or other seasonality in the future. These seasonal factors may lead to unpredictable variations in our quarterly operating results and cause the trading price of our common stock to decline.

 

We are exposed to foreign currency exchange risks, which could harm our business and operating results.

 

We maintain significant operations in Australia and Switzerland, and are exposed to adverse changes in exchange rates associated with the expenses of our operations in these countries. However, we do not currently engage in any hedging transactions to mitigate these risks. Although from time to time we review our foreign currency exposure and evaluate whether we should enter into hedging transactions, we may not adequately hedge against any future volatility in currency exchange rates and, if we engage in hedging transactions, the transactions will be based on forecasts which later may prove to be inaccurate. Any failure to hedge successfully or anticipate currency risks properly could adversely affect our operating results.

 

In addition, most of our affiliated radiologists live in Australia and Switzerland, but receive compensation from us in U.S. dollars. Any relative weakness in the U.S. dollar compared to the Australian dollar or Swiss franc may increase the cost of living for our affiliated radiologists and make it less attractive for our affiliated radiologists to sign or renew their service contracts with us. For instance, between September 30, 2003 and September 30, 2005 the exchange rate for the Australian Dollar fluctuated between 1.2524 AUD per 1.00 USD and 1.4774 AUD per 1.00 USD and the exchange rate for the Swiss Franc fluctuated between 1.1334 CHF per 1.00 USD and 1.3710 CHF per 1.00 USD. As a result, foreign currency exchange fluctuations may make it difficult for us to attract and retain qualified radiologists to work in our reading centers in Australia and Switzerland.

 

13


Table of Contents

Interruptions or delays in our information systems or in network or related services provided by third-party suppliers could impair the delivery of our services and harm our business.

 

Our operations depend on the uninterrupted performance of our information systems, which are substantially dependent on systems provided by third parties over which we have little control. Failure to maintain reliable information systems, or disruptions in our information systems, could cause disruptions and delays in our business operations which could have a material adverse effect on our business, financial condition and results of operations.

 

We rely on broadband connections provided by third party suppliers to route digital images from hospitals in the United States to our facilities in Australia, Switzerland and Coeur d’Alene, Idaho. Any interruption in the availability of the network connections between the hospitals and our reading facilities would reduce our revenue and profits. Frequent or persistent interruptions in our services could cause permanent harm to our reputation and brand and could cause current or potential customers to believe that our systems are unreliable, leading them to switch to our competitors. Because our customers may use our services for critical healthcare services, any system failures could result in damage to our customers’ businesses and reputation. These customers could seek significant compensation from us for their losses, and our agreements with our customers do not limit the amount of compensation that they may receive. Any claim for compensation, even if unsuccessful, would likely be time-consuming and costly for us to resolve.

 

Although our systems have been designed around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses, break-ins, sabotage, and acts of vandalism. In addition, the connections from hospitals to our reading facility in Australia rely on two cables that link the west coast of the United States with Australia. Despite any precautions that we may take, the occurrence of a natural disaster or other unanticipated problems at our reading facilities or in the networks that connect our reading facilities with our hospitals could result in lengthy interruptions in our services. We do not carry business interruption insurance to protect us against losses that may result from interruptions in our service as a result of system failures.

 

Hospital privileging requirements or physician licensure laws may limit our market, and the loss of hospital privileges or state medical licenses held by our affiliated radiologists could have a material adverse affect on our business, financial condition and results of operations.

 

Each of our affiliated radiologists must be granted privileges to practice at each hospital from which the radiologist receives radiological images and must hold a license in good standing to practice medicine in the state in which the hospital is located. The requirements for obtaining and maintaining hospital privileges and state medical licenses vary significantly among hospitals and states. If a hospital or state restricts or impedes the ability of physicians located outside of the United States to obtain privileges or a license to practice medicine at that hospital or in that state, the market for our services could be reduced. In addition, any loss of existing privileges or medical licenses held by our affiliated radiologists could impair our ability to serve our existing customers and have a material adverse affect on our business, financial condition and results of operations.

 

Changes in the healthcare industry or litigation reform could reduce the number of diagnostic radiology procedures ordered by physicians, which could result in a decline in the demand for our services, pricing pressure and decreased revenue.

 

Changes in the healthcare industry directed at controlling healthcare costs and perceived over-utilization of diagnostic radiology procedures could reduce the volume of radiological procedures performed. For example, in an effort to contain increasing imaging costs, some managed care organizations and private insurers are instituting pre-authorization policies which require physicians to pre-clear orders for diagnostic radiology procedures before those procedures can be performed. If pre-clearance protocols are broadly instituted

 

14


Table of Contents

throughout the healthcare industry, the volume of radiological procedures could decrease, resulting in pricing pressure and declining demand for our services. In addition, it is often alleged that many physicians order diagnostic procedures even when the procedures may have limited clinical utility in large part to establish a record for defense in the event of a medical liability claim. Changes in litigation law could reduce the number of radiological procedures ordered for this purpose and therefore reduce the total number of radiological procedures performed each year, which could harm our operating results.

 

We may not have adequate intellectual property rights in our brand, which could limit our ability to enforce such rights.

 

Our success depends in part upon our ability to market our services under the “NightHawk” brand. However, we believe that the term “NightHawk” cannot be afforded trademark protection as it is a generic term used to describe the provision of off-hours radiology services. Other than “DayHawk,” we have not secured registrations of our other marks. Other businesses may have prior rights in the brand names that we market under or in similar names, which could limit or prevent our ability to use these marks, or to prevent others from using similar marks. If we are unable to prevent others from using our brand names, or if others prohibit us from using them, our revenue could be adversely affected. Even if we are able to protect our intellectual property rights in such brands, we could incur significant costs in doing so.

 

Any failure to protect our intellectual property rights in our workflow technology could impair its value and our competitive advantage.

 

We rely heavily on our workflow technology to distribute radiological images to the appropriately licensed and privileged radiologist best able to provide the necessary clinical insight in the least amount of turnaround time. If we fail to protect our intellectual property rights adequately, our competitors may gain access to our technology, and our business may be harmed. We currently do not hold any patents with respect to our technology. Although we have recently filed an application for a patent covering our workflow technology, we may be unable to obtain patent protection for this technology. In addition, any patents we may obtain may be challenged by third parties. Accordingly, despite our efforts, we may be unable to prevent third parties from using or misappropriating our intellectual property.

 

We may in the future become subject to intellectual property rights claims, which could harm our business and operating results.

 

The information technology industry is characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. If a third party asserts that our technology violates that third-party’s proprietary rights, or if a court holds that our technology violates such rights, we may be required to re-engineer our technology, obtain licenses from third parties to continue using our technology without substantial re-engineering or remove the infringing functionality or feature. In addition, we may incur substantial costs defending against any such claim. We may also become subject to damage awards, which could cause us to incur additional losses and hurt our financial position.

 

Monitoring potential infringement of and defending or asserting our intellectual property rights may entail significant expense. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel.

 

15


Table of Contents

We are dependent on our management team, and the loss of any key member of this team may prevent us from implementing our business plan in a timely manner.

 

Our success depends largely upon the continued services of our executive officers, particularly Dr. Paul Berger, our Chief Executive Officer and Chairman of the Board. The loss of Dr. Berger, Christopher R. Huber, our Chief Financial Officer and Vice President of Operations, or Jon D. Berger, our Vice President of Sales, Marketing and Business Development, could have a material adverse effect on our business, financial condition, results of operations and the trading price of our common stock. Each of these named executives is employed on an “at-will” basis. In addition, the search for replacements could be time consuming and could distract our management team from the day-to-day operations of our business.

 

If we acquire any companies or technologies in the future, they could prove difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results.

 

A key element of our strategy is to pursue strategic acquisitions that are complementary to our business or offer us other strategic benefits. For example, in September 2005, we acquired American Teleradiology Nighthawks, Inc., or ATN. Our acquisition of ATN, as well as other acquisitions in which we may engage, involve numerous risks, including:

 

  ·   difficulties in integrating operations, technologies, services and personnel,

 

  ·   diversion of financial and management resources from existing operations,

 

  ·   risk of entering new markets,

 

  ·   potential write-offs of acquired assets,

 

  ·   potential loss of key employees, and

 

  ·   inability to generate sufficient revenue to offset acquisition costs.

 

We may experience these difficulties as we integrate the operations of ATN, or the operations of future companies we acquire, with our operations.

 

In addition, if we finance acquisitions by issuing convertible debt or equity securities, our existing stockholders may be diluted which could affect the market price of our stock. We have only made two acquisitions to date, and our management has limited experience in completing acquisitions and integrating acquired businesses with our operations. If we fail to properly evaluate and execute acquisitions, our business and prospects may be harmed.

 

We may be unable to successfully expand our services beyond the off-hours emergency radiology market.

 

We have focused our business on providing emergency radiology services during the hours of 5:00 p.m. to 8:00 a.m. and 24-hours per day on weekends and holidays. We have recently expanded our hours of service to enter into other markets beyond the off-hours emergency radiology market. However, any efforts to expand beyond the off-hours emergency radiology market may not result in significant revenue growth for us. In addition, efforts to expand our services beyond the off-hours emergency radiology market may divert management resources from existing operations and require us to commit significant financial resources to an unproven business, or may be resisted by our radiology group customers, which in each case may harm our business and operating results or impair our growth.

 

16


Table of Contents

If we fail to implement and maintain an effective system of internal controls, we may not be able to report our financial results in an accurate or timely manner, prevent fraud or comply with Section 404 of the Sarbanes-Oxley Act of 2002, which may harm our business and affect the trading price of our stock.

 

Effective internal controls are necessary for us to provide reliable financial reports in a timely manner and to prevent fraud. As a private company, we have had limited accounting personnel and other resources with which to design and implement our internal controls and procedures. As a result, in their audit of our fiscal 2004 financial statements, our auditors identified in their report to our audit committee material weaknesses relating to the adequacy and competency of our financial reporting personnel. Following receipt of our auditor’s report, we consulted with our audit committee and undertook remedial steps to address these deficiencies, including hiring additional staff and training our new and existing staff. Although our auditors did not identify material weaknesses in our internal controls in connection with their audit of our financial statements as of and for the nine-month period ended September 30, 2005, we cannot assure you that we will maintain an effective system of internal controls in the future. Beginning with our annual report on Form 10-K for our fiscal year ending December 31, 2007, we will be required to comply with the requirement of Section 404 of the Sarbanes-Oxley Act of 2002 to include in each of our annual reports an assessment by our management of the effectiveness of our internal controls over financial reporting and a report of our independent registered public accounting firm addressing these assessments. If we fail to adequately staff our accounting and finance function to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act of 2002, or fail to maintain adequate internal controls, any resulting material weakness in internal controls could prevent our management from concluding the internal controls are effective and impair our ability to prevent material misstatements in our financial statements, which could cause our business to suffer. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements in a timely manner or prevent fraud may negatively affect the trading price of our stock or result in stockholder litigation.

 

We may be unable to enforce non-compete agreements with our affiliated radiologists.

 

Our independent contractor agreements with our affiliated radiologists typically provide that the radiologists may not compete with us for a period of time, typically one year, after the agreements terminate. These covenants not to compete are enforceable to varying degrees from jurisdiction to jurisdiction. In most jurisdictions, a covenant not to compete will be enforced only to the extent that it is necessary to protect the legitimate business interest of the party seeking enforcement, that it does not unreasonably restrain the party against whom enforcement is sought and that it is not contrary to the public interest. This determination is made based upon all the facts and circumstances of the specific case at the time enforcement is sought. It is unclear whether our interests will be viewed by courts as the type of protected business interest that would permit us to enforce a non-competition covenant against the radiologists. Since our success depends in substantial part on our ability to preserve the business of our affiliated radiologists, a determination that these provisions are not enforceable could have a material adverse effect on us.

 

Enforcement of state and federal anti-kickback laws may adversely affect our business, financial condition or operations.

 

Various federal and state laws govern financial arrangements among healthcare providers. The federal anti-kickback law prohibits the knowing and willful offer, payment, solicitation or receipt of any form of remuneration in return for, or with the purpose to induce, the referral of Medicare, Medicaid, or other federal healthcare program patients, or in return for, or with the purpose to induce, the purchase, lease or order of items or services that are covered by Medicare, Medicaid, or other federal healthcare programs. Similarly, many state laws prohibit the solicitation, payment or receipt of remuneration in return for, or to induce the referral of patients in private as well as government programs. Violation of these anti-kickback laws may result in substantial civil or criminal penalties for individuals or entities and/or exclusion from participating in federal or state healthcare programs. We believe that we are operating in compliance with applicable law and believe that

 

17


Table of Contents

our arrangements with providers would not be found to violate the anti-kickback laws. However, these laws could be interpreted in a manner inconsistent with our operations.

 

Because our customers submit claims to the Medicare program based on the services we provide, it is possible that a lawsuit could be brought against us or our customers under the federal False Claims Act, and the outcome of any such lawsuit could have a material adverse effect on our business, financial condition and operations.

 

The Federal False Claims Act provides, in part, that the federal government may bring a lawsuit against any person whom it believes has knowingly presented, or caused to be presented, a false or fraudulent request for payment from the federal government, or who has made a false statement or used a false record to get a claim approved. The government has taken the position that claims presented in violation of the federal anti-kickback law may be considered a violation of the Federal False Claims Act. The Federal False Claims Act further provides that a lawsuit brought under that act may be initiated in the name of the United States by an individual who was the original source of the allegations, known as the relator. Actions brought under the Federal False Claims Act are sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the federal government and the court. Therefore, it is possible that lawsuits have been filed against us that we are unaware of or which we have been ordered by the court not to discuss until the court lifts the seal from the case. Penalties include fines ranging from $5,500 to $11,000 for each false claim, plus three times the amount of damages that the federal government sustained because of the act of that person. We believe that we are operating in compliance with the Medicare rules and regulations, and thus, the Federal False Claims Act. However, if we were found to have violated certain rules and regulations and, as a result, submitted or caused our customers to submit allegedly false claims, any sanctions imposed under the Federal False Claims Act could result in substantial fines and penalties or exclusion from participation in federal and state healthcare programs which could have a material adverse effect on our business and financial condition.

 

Our business could be materially affected if a U.S. Department of Health & Human Services Office of Inspector General, or HHS-OIG, study results in a recommendation that Medicare only pay for interpretations performed contemporaneously in an emergency room setting.

 

In its Fiscal Year 2004 Work Plan, the HHS-OIG indicated that it would conduct a study and issue a report assessing the appropriateness of Medicare billings for diagnostic tests performed in hospital emergency rooms. Part of the assessment will include a determination as to whether the tests were interpreted contemporaneously with the patient’s treatment. It is possible that in the final report, the HHS-OIG could recommend to the Medicare program that it change its reimbursement rules to clearly indicate that Medicare will only pay for interpretations performed contemporaneously with the patient’s treatment by a physician located within the United States. If the HHS-OIG makes such a recommendation, it could adversely impact our business, financial condition and operations.

 

Risks Related to this Offering

 

The trading price of our common stock may be volatile, and you might not be able to sell your shares at or above the initial public offering price.

 

The trading prices of many newly publicly-traded companies are highly volatile, particularly companies such as ours that have limited operating histories. Accordingly, the trading price of our common stock may be subject to wide fluctuations. Further, our common stock has no prior trading history. Factors affecting the trading price of our common stock will include:

 

  ·   variations in our operating results,

 

  ·   announcements of new services, strategic alliances or significant agreements by us or by our competitors,

 

  ·   recruitment or departure of key personnel,

 

18


Table of Contents
  ·   changes in the estimates of our operating results or changes in recommendations by any securities analysts that follow our common stock, and

 

  ·   market conditions in our industry, the industries of our customers and the economy as a whole.

 

In addition, if the market for healthcare stocks or healthcare services or the stock market in general experiences loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us.

 

Failure to comply with the Nasdaq’s requirements regarding the composition of our board of directors and audit committee could result in the delisting of our common stock from the Nasdaq National Market and adversely affect the market for our common stock.

 

In order for our common stock to continue to be listed on the Nasdaq National Market, we must comply with listing standards regarding the independence of our board of directors and members of our audit committee. In particular, the Nasdaq’s rules require that a majority of our directors and all of the members of our audit committee be “independent,” as defined under the Nasdaq’s rules, by no later than the first anniversary following the completion of this offering. We do not currently meet these requirements, as only three of our seven directors and two of our three audit committee members currently satisfy the standards for independence under the Nasdaq’s rules. Compliance with the Nasdaq’s listing requirements will require us to increase the number of independent directors on our board of directors and audit committee, seek the resignation of directors who are not independent, or some combination thereof. If we are unable to change the composition of our board of directors and our audit committee to comply with these requirements, our common stock may be delisted from the Nasdaq National Market and the liquidity and trading price of common stock may be adversely affected.

 

If securities analysts do not publish research or reports about our business, or if they downgrade our stock, the price of our stock could decline.

 

The trading market for our common stock will rely in part on the availability of research and reports that third-party industry or financial analysts publish about us. There are many large, publicly-traded companies active in the healthcare services industry, which may mean it will be less likely that we receive widespread analyst coverage. Furthermore, if one or more of the analysts who do cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.

 

Future sales of shares by existing stockholders could cause our stock price to decline.

 

If our existing stockholders sell, or indicate an intent to sell, substantial amounts of our common stock in the public market after the 180-day contractual lock-up agreements (which may be extended by up to 34 days under certain conditions) and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline. Based on shares outstanding as of September 30, 2005, upon completion of this offering, we will have outstanding 29,809,571 shares of common stock. Of these shares, only the 6,300,000 shares of common stock sold in this offering will be freely tradable, without restriction, in the public market as of the date of this offering. Morgan Stanley & Co. Incorporated may, in its sole discretion, permit our officers, directors, employees and current stockholders who are subject to the 180-day contractual lock-up to sell shares prior to the expiration of the lock-up agreements.

 

After the lock-up agreements pertaining to this offering expire, up to an additional 23,194,292 shares will be immediately eligible for sale in the public market, 20,323,657 of which are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act and various vesting agreements. In addition, the 1,582,850 shares that are subject to options outstanding as of September 30,

 

19


Table of Contents

2005 under our 2004 Stock Plan and the 1,600,000 shares reserved for future issuance under our 2006 Equity Incentive Plan will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the lock-up agreements and Rules 144 and 701 under the Securities Act of 1933, as amended, or the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

 

Our management will have broad discretion over the use of the proceeds to us from this offering and might not apply the proceeds of this offering in ways that increase the value of your investment.

 

We intend to use the net proceeds from this offering to repay in full approximately $31.4 million of indebtedness that will be outstanding under our loan and security agreement with Comerica Bank at the completion of this offering, and for general corporate purposes, including for further development and expansion of our service offerings as well as for possible acquisitions of complementary businesses, technologies or other assets. We used the proceeds of the loan from Comerica Bank for repayment of a $3 million credit facility with Silicon Valley Bank, repayment of approximately $9 million of subordinated promissory notes held by entities affiliated with Summit Partners and payment of special distributions to the holders of our common stock and redeemable preferred stock totaling $20 million. Other than with respect to the repayment of debt, we have not allocated these net proceeds for any specific purposes. Our management will have broad discretion to use the net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. They might not apply the net proceeds of this offering in ways that increase the value of your investment, and may not be able to yield a significant return, if any, on any investment of these net proceeds.

 

You will experience immediate and substantial dilution in the net tangible book value of the shares you purchase in this offering.

 

The initial public offering price of our common stock is substantially higher than the book value per share of the outstanding common stock after this offering. As a result, investors who purchase shares in this offering will contribute approximately 87% of the total amount of equity capital raised by us through the date of the offering, but will only own approximately 21% of the outstanding share capital and approximately 21% of the voting rights. If outstanding options to purchase our common stock are exercised, you will experience additional dilution.

 

The concentration of our capital stock ownership with insiders upon the completion of this offering will likely limit your ability to influence corporate matters.

 

We anticipate that our executive officers, directors, current five percent or greater stockholders and affiliated entities will together beneficially own approximately 68% of our common stock outstanding after this offering. As a result, these stockholders, acting together, will have control over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. Corporate action might be taken even if other stockholders, including those who purchase shares in this offering, oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

 

Provisions in our certificate of incorporation and bylaws and Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.

 

Our certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:

 

  ·   establish a classified board of directors so that not all members of our board are elected at one time,

 

  ·   provide that directors may only be removed “for cause,”

 

20


Table of Contents
  ·   authorize the issuance of “blank check” preferred stock that our board could issue to increase the number of outstanding shares and to discourage a takeover attempt,

 

  ·   eliminate the ability of our stockholders to call special meetings of stockholders,

 

  ·   prohibit stockholder action by written consent, which has the effect of requiring all stockholder actions to be taken at a meeting of stockholders,

 

  ·   provide that the board of directors is expressly authorized to make, alter or repeal our bylaws, and

 

  ·   establish advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.

 

In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company.

 

21


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

 

This prospectus includes forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short term and long term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors.” In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. In addition, neither we nor other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. We are under no duty to update any of these forward-looking statements after the date of this prospectus to confirm these statements to actual results or revised expectations.

 

You may rely only on the information contained in this prospectus. Neither we nor the selling stockholders nor any of the underwriters have authorized anyone to provide information different from that contained in this prospectus. Neither the delivery of this prospectus, nor the sale of our common stock, means that information contained in this prospectus is correct after the date of this prospectus. This prospectus is not an offer to sell or solicitation of an offer to buy shares of common stock in any circumstances under which the offer or solicitation is unlawful.

 

Information contained in this prospectus concerning our industry and the historic growth rate of the markets in which we participate is based on industry publications, surveys and forecasts generated by Frost & Sullivan, the American College of Radiology and other sources. Such industry publications, surveys and forecasts generally indicate that their information has been obtained from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. Although we believe that the reports are reliable, we have not independently verified their data.

 

22


Table of Contents

USE OF PROCEEDS

 

We estimate that we will receive net proceeds of $84.3 million from our sale of the 5,800,000 shares of common stock offered by us in this offering, based upon the initial public offering price of $16.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any of the proceeds of the sale of shares of our common stock by the selling stockholders.

 

We intend to use approximately $31.4 million of the net proceeds from this offering to repay in full the principal and accrued interest that will be outstanding on our loan and security agreement with Comerica Bank at the completion of this offering. The loan and security agreement is subject to a variable interest rate equal to either the prime rate announced by Comerica Bank or the LIBOR rate per annum plus up to 3.25% per annum, and has a final maturity date of August 2009. We used the proceeds of the loan for repayment of a $3 million credit facility with Silicon Valley Bank, repayment of approximately $9 million in subordinated promissory notes held by entities affiliated with Summit Partners and payment of special distributions to the holders of our common stock and redeemable preferred stock totaling $20 million.

 

Additional purposes of this offering are to create a public market for our common stock, to facilitate our future access to the public equity markets and to obtain additional capital. Except as set forth above, we currently have no specific plans for the use of the net proceeds of this offering. We anticipate that we will use the net proceeds received by us from this offering after repayment of indebtedness for general corporate purposes, including further development and expansion of our service offerings as well as possible acquisitions of complementary businesses, technologies or other assets. We have no current agreements or commitments with respect to any material future acquisitions. Pending such uses, we plan to invest the remaining portion of the net proceeds in highly liquid, investment grade securities.

 

DIVIDEND POLICY

 

In September 2005, we borrowed $13 million under our term loan facility with Comerica Bank and distributed the full amount as a special distribution to the holders of our common stock and redeemable preferred stock. Immediately prior to this offering, we borrowed an additional $7 million under our term loan facility with Comerica Bank and will distribute the full amount as another special distribution to the holders of our common stock and redeemable preferred stock prior to the completion of this offering. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview.” Our loan and security agreement with Comerica Bank limits our ability to pay other dividends or distributions.

 

Except for the special distributions noted above, we have never declared or paid any cash dividend on our capital stock. We currently intend to retain future earnings and do not expect to pay any dividends in the foreseeable future.

 

23


Table of Contents

CAPITALIZATION

 

The following table sets forth our cash and cash equivalents and our capitalization as of September 30, 2005, as follows:

 

  ·   On an actual basis.

 

  ·   On a pro forma basis to give effect to the declaration in September 2005 of a special distribution to the holders of our common stock and redeemable preferred stock of $7 million which will be distributed immediately prior to the completion of this offering and will be funded by long-term debt.

 

  ·   On a pro forma as adjusted basis to give effect to (i) the pro forma adjustment described above, (ii) the conversion of all outstanding shares of our redeemable preferred stock into shares of common stock upon the completion of this offering, resulting in the termination of the redeemable preferred stock conversion feature and the accretion of our redeemable preferred stock, (iii) the termination of the redemption rights associated with 1,671,429 shares of our common stock upon the completion of this offering, (iv) the receipt of net proceeds from the sale of 5,800,000 shares of common stock by us in this offering at the initial public offering price of $16.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, (v) the filing of our amended and restated certificate of incorporation immediately prior to the completion of this offering, and (vi) the application of approximately $31.4 million of the net proceeds from this offering to repay all outstanding indebtedness under our term loan facility, including amounts we borrowed immediately prior to this offering to effect a $7 million special distribution to our stockholders as described above.

 

You should read this table together with the sections of this prospectus entitled “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements included elsewhere in this prospectus.

 

     As of September 30, 2005

 
     Actual

    Pro Forma

   

Pro Forma

As Adjusted


 

Cash and cash equivalents

   $ 7,916,674     $ 7,916,674     $ 60,857,432  
    


 


 


Long-term debt (including current portion)

   $ 24,381,702     $ 31,381,702     $  

Fair value of redeemable preferred stock conversion feature

     33,637,500       33,637,500        

Redeemable common stock

     12,347,681       12,347,681        

Redeemable convertible preferred stock

     12,884,475       12,884,475        

Stockholders’ equity (deficit):

                        

Preferred stock, $0.001 par value per share;
no shares authorized, issued or outstanding, actual; no shares authorized, issued or outstanding, pro forma; 5,000,000 shares authorized, no shares issued or outstanding, pro forma as adjusted

                  

Common stock, $0.001 par value per share;
40,000,000 shares authorized, 15,838,139 shares issued and outstanding, actual; 40,000,000 shares authorized, 15,838,139 shares issued and outstanding, pro forma; 150,000,000 shares authorized, 29,809,571 shares issued and outstanding, pro forma as adjusted

     15,838       15,838       29,809  

Additional paid-in capital

     8,942,032       8,942,032       152,120,177  

Retained earnings (deficit)

     (75,492,412 )     (75,492,412 )     (75,492,412 )
    


 


 


Total stockholders’ equity (deficit)

     (66,534,542 )     (66,534,542 )     76,657,574  
    


 


 


Total capitalization

   $ 16,716,816     $ 23,716,816     $ 76,657,574  
    


 


 


 

24


Table of Contents

The table above excludes the following shares:

 

  ·   1,582,850 shares of common stock issuable upon the exercise of options outstanding at September 30, 2005, at a weighted average exercise price of $2.83 per share,

 

  ·   263,908 shares of common stock issuable upon exercise of options granted after September 30, 2005, at a weighted average exercise price of $10.25 per share,

 

  ·   6,247 shares of common stock reserved for future issuance under our 2004 Stock Plan,

 

  ·   1,600,000 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan, and

 

  ·   the additional shares of common stock that may be issued in connection with our acquisition of American Teleradiology Nighthawks, Inc. based upon the future financial performance of the ATN businesses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Acquisition.”

 

 

25


Table of Contents

DILUTION

 

If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the as adjusted pro forma net tangible book value per share of our common stock upon completion of this offering.

 

Our historical net tangible book value as of September 30, 2005 was $(46.2) million, or $(2.64) per share, based on 17,509,568 shares of our common stock outstanding as of September 30, 2005. Historical net tangible book value per share represents the amount of our total tangible assets less total liabilities (which liabilities do not include our shares of redeemable common stock or redeemable convertible preferred stock, which are not recorded as liabilities but as mezzanine equity) divided by the actual number of outstanding shares of our common stock. Our pro forma net tangible book value as of September 30, 2005 was approximately $(12.5) million, or $(0.52) per share, based on 24,009,571 shares of common stock outstanding after giving effect to the conversion of our redeemable preferred stock into common stock and the termination of the redeemable preferred stock conversion feature. Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the pro forma number of shares of common stock outstanding before giving effect to this offering.

 

After giving effect to the sale by us of 5,800,000 shares of common stock in this offering at the initial public offering price of $16.00 per share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our as adjusted pro forma net tangible book value at September 30, 2005 would have been $71.8 million, or $2.41 per share of common stock. This represents an immediate increase in pro forma net tangible book value of $2.93 per share to our existing stockholders and an immediate dilution of $13.59 per share to the new investors purchasing shares in this offering. The following table illustrates this per share dilution:

 

Initial public offering price per share of common stock

          $ 16.00

Historical net tangible book value per share at September 30, 2005

  $ (2.64 )      

Pro forma increase per share attributable to the automatic conversion of all outstanding shares of redeemable preferred stock as of September 30, 2005

    2.12        
   


     

Pro forma net tangible book value per share of common stock at September 30, 2005

  $ (0.52 )      

Increase in pro forma net tangible book value per share attributable to this offering

    2.93        
   


     

As adjusted pro forma net tangible book value per share after the offering

            2.41
           

Dilution per share to new investors

          $ 13.59
           

 

26


Table of Contents

The following table sets forth, on an as adjusted basis as of September 30, 2005, the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing holders of common stock and by the new investors, at the initial public offering price of $16.00 per share, before deducting underwriting discounts and estimated offering expenses payable by us. The share numbers presented below give effect to the conversion of all outstanding shares of our redeemable preferred stock.

 

     Shares Purchased

    Total Consideration

   

Average

Price Per

Share


     Number

   Percent

    Amount

   Percent

   

Existing stockholders (1)

   24,009,571    81 %   $ 13,329,436    13 %   $ 0.56

New investors

   5,800,000    19       92,800,000    87     $ 16.00
    
  

 

  

     

Total

   29,809,571    100 %   $ 106,129,436    100 %      
    
  

 

  

     

(1) Gives effect to special distributions to our stockholders totaling $20 million, which amount reduces the total consideration paid by our existing stockholders from $33,329,436 to $13,329,436 and the average price per share paid by our existing stockholders from $1.39 to $0.56.

 

After giving effect to the sale of 500,000 shares by the selling stockholders in this offering and if the underwriters exercise their over-allotment option in full, our existing stockholders would own 76% and our new investors would own 24% of the total number of shares of our common stock outstanding after this offering.

 

The discussion and tables above are based on the number of shares of common stock outstanding at September 30, 2005, and reflect the conversion of all of our redeemable preferred stock into an aggregate of 6,500,003 shares of our common stock. The discussion and tables above exclude the following shares:

 

  ·   1,582,850 shares of common stock issuable upon the exercise of options outstanding at September 30, 2005, at a weighted average exercise price of $2.83 per share,

 

  ·   263,908 shares of common stock issuable upon exercise of options granted after September 30, 2005, at a weighted average exercise price of $10.25 per share,

 

  ·   6,247 shares of common stock available for future issuance under our 2004 Stock Plan,

 

  ·   1,600,000 shares of common stock available for future issuance under our 2006 Equity Incentive Plan, and

 

  ·   the additional shares of common stock that may be issued in connection with our acquisition of American Teleradiology Nighthawks, Inc. based upon the future financial performance of the ATN businesses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Acquisition.”

 

To the extent outstanding options are exercised, new investors will experience further dilution.

 

27


Table of Contents

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA

 

The following tables summarize our unaudited pro forma condensed combined statements of operations for the year ended December 31, 2004 and for the nine months ended September 30, 2005. You should read this financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements included elsewhere in this prospectus and the financial statements of DayHawk Radiology Services, LLC, or DayHawk, and American Teleradiology Nighthawks, Inc., or ATN, included elsewhere in this prospectus.

 

The unaudited pro forma condensed combined statements of operations data gives effect to our November 2004 acquisition of DayHawk and our September 2005 acquisition of ATN as if the acquisitions had occurred on January 1, 2004.

 

The unaudited pro forma condensed combined financial data is presented for illustrative purposes only and does not represent what our results of operations actually would have been if the transactions referred to above had occurred as of the dates indicated or what our results of operations will be for future periods.

 

Unaudited Pro Forma Condensed Combined Statements Of Operations

 

    Year Ended December 31, 2004

 
   

Historical
NightHawk Radiology

Holdings, Inc.


   

Historical
DayHawk Radiology

Services, LLC

1/1/2004 - 11/11/2004


 

Historical

American Teleradiology

Nighthawks, Inc.


  Pro Forma
Adjustments for
Acquisitions


    Pro Forma
Combined


 

Service revenue

  $ 39,283,002     $ 2,126,713   $ 1,559,191   $     $ 42,968,906  

Operating costs and expenses:

                                   

Professional services

    15,049,399       621,677     645,535           16,316,611  

Sales, general, and administrative

    11,991,386       1,011,224     655,965           13,658,575  

Depreciation and amortization (1)

    528,126       1,080     7,368     419,658       956,232  
   


 

 

 


 


Total operating cost and expenses

    27,568,911       1,633,981     1,308,868     419,658       30,931,418  
   


 

 

 


 


Operating income

    11,714,091       492,732     250,323     (419,658 )     12,037,488  

Other income (expense):

                                   

Interest expense

    (880,671 )                   (880,671 )

Interest income

    40,835       5     10           40,850  

Other, net

    (28,953 )                   (28,953 )

Change in fair value of redeemable preferred stock conversion feature

    (3,857,500 )                   (3,857,500 )
   


 

 

 


 


Total other income (expense)

    (4,726,289 )     5     10           (4,726,274 )
   


 

 

 


 


Income before income taxes

    6,987,802       492,737     250,333     (419,658 )     7,311,214  

Income tax expense (2)

    3,662,563           91,173     570,011       4,323,747  
   


 

 

 


 


Net income

    3,325,239       492,737     159,160     (989,669 )     2,987,467  

Redeemable preferred stock accretion

    (764,742 )                   (764,742 )
   


 

 

 


 


Income applicable to common stockholders

  $ 2,560,497     $ 492,737   $ 159,160   $ (989,669 )   $ 2,222,725  
   


 

 

 


 


Earnings per common share:

                                   

Basic

  $ .11                         $ .09  

Diluted

  $ .11                         $ .09  

Weighted averages of common shares outstanding:

                                   

Basic

    24,196,437                   746,754       24,943,191  

Diluted

    24,196,437                   746,754       24,943,191  

 

28


Table of Contents

Unaudited Pro Forma Condensed Combined Statements Of Operations

 

    Nine Months Ended September 30, 2005

 
    Historical
NightHawk Radiology
Holdings, Inc.


    Historical
American Teleradiology
Nighthawks, Inc.


    Pro Forma
Adjustments
for Acquisitions


    Pro Forma
Combined


 

Service revenue

  $ 45,587,587     $ 3,203,685     $     $ 48,791,272  

Operating costs and expenses:

                               

Professional services

    15,796,222       1,185,243             16,981,465  

Sales, general, and administrative

    16,794,642       1,630,200             18,424,842  

Depreciation and amortization (1)

    829,378       14,851       181,003       1,025,232  
   


 


 


 


Total operating costs and expenses

    33,420,242       2,830,294       181,003       36,431,539  
   


 


 


 


Operating income

    12,167,345       373,391       (181,003 )     12,359,733  

Other income (expense):

                               

Interest expense

    (723,254 )                 (723,254 )

Interest income

    34,236       568             34,804  

Other, net

    (60,815 )     (30 )           (60,845 )

Change in fair value of redeemable preferred stock conversion feature

    (28,109,723 )                 (28,109,723 )
   


 


 


 


Total other income (expense)

    (28,859,556 )     538             (28,859,018 )
   


 


 


 


Income (loss) before income taxes

    (16,692,211 )     373,929       (181,003 )     (16,499,285 )

Income tax expense (3)

    4,430,020             75,241       4,505,261  
   


 


 


 


Net income (loss)

    (21,122,231 )     373,929       (256,244 )     (21,004,546 )

Redeemable preferred stock accretion

    (790,010 )                 (790,010 )

Preferred dividends

    (5,486,555 )                 (5,486,555 )
   


 


 


 


Income (loss) applicable to common stockholders

  $ (27,398,796 )   $ 373,929     $ (256,244 )   $ (27,281,111 )
   


 


 


 


Earnings (loss) per common share:

                               

Basic

  $ (1.59 )                   $ (1.56 )

Diluted

  $ (1.59 )                   $ (1.56 )

Weighted averages of common shares outstanding:

                               

Basic

    17,194,286               315,279       17,509,565  

Diluted

    17,194,286               315,279       17,509,565  

(1) Amortization expense for intangible assets associated with the acquisitions. This amortization represents the pro forma amortization expense in 2004 for ATN ($241,337) plus the pro forma amortization expense in 2004 for DayHawk ($178,321) based upon the actual historical intangible assets of ATN and the actual historical intangible assets of DayHawk. The amortization is calculated using the useful life of each intangible asset on a straight-line basis over the useful life of each asset as follows:

 

     DayHawk

   ATN

     Acquired
Value


  

Estimated
Useful Life


   Acquired
Value


  

Estimated
Useful Life


Customer lists and relationships

   $ 740,000    10 years    $ 1,880,000    10 years

Tradename and trademarks

     150,000    10 years      640,000    Indefinite life

Customer contracts

     100,000    7 months      None    None

Noncompete agreements

     50,000    2 years      160,000    3 years
    

       

    
     $ 1,040,000         $ 2,680,000     
    

       

    

 

(2) Income tax expense for DayHawk’s 2004 income utilizing our statutory tax rate of 39% and the tax effect of the pro forma adjustment for the additional amortization expense. This pro forma adjustment gives effect to our change in tax status as if it were a taxable entity for the entire year of 2004 utilizing our statutory rate of 39%. The calculated pro forma tax expense for the first quarter of 2004 was $534,989.

 

(3) Income tax expense for ATN’s income utilizing our statutory tax rate of 39% for the nine months ended September 30, 2005 along with the tax effect of the pro forma adjustment for the additional amortization expense. This pro forma adjustment reflects ATN as a C corporation for 2005.

 

29


Table of Contents

SELECTED CONSOLIDATED FINANCIAL DATA

 

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements included elsewhere in this prospectus. The consolidated statements of operations data for the fiscal years ended December 31, 2002, 2003 and 2004 and for the nine months ended September 30, 2005 and the consolidated balance sheet data as of December 31, 2003 and 2004 and as of September 30, 2005 were derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated balance sheet data as of December 31, 2002 was derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for the fiscal year ended December 31, 2001 and for the nine months ended September 30, 2004 and the consolidated balance sheet data as of December 31, 2001 were derived from our unaudited consolidated financial statements. The unaudited consolidated financial statements were, in the opinion of management, prepared on a basis consistent with our audited consolidated financial statements and include, in the opinion of management, all adjustments necessary for the fair presentation of the financial information contained in those statements. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods.

 

    Year Ended December 31,

   

Nine Months Ended

September 30,


 
    2001 (1)

    2002

    2003

    2004

    2004

    2005

 
    (unaudited)                       (unaudited)        

Consolidated Statements of Operations data:

                                               

Service revenue

  $ 38,355     $ 4,666,645     $ 16,216,322     $ 39,283,002     $ 27,673,630     $ 45,587,587  

Operating costs and expenses (2):

                                               

Professional services

    219,464       1,941,452       6,417,803       15,049,399       10,267,883       15,796,222  

Sales, general and administrative

    367,840       1,624,654       4,862,452       11,991,386       8,082,478       16,794,642  

Depreciation and amortization

    9,392       59,063       175,780       528,126       320,897       829,378  
   


 


 


 


 


 


Total operating costs and expenses

    596,696       3,625,169       11,456,035       27,568,911       18,671,258       33,420,242  
   


 


 


 


 


 


Operating income (loss)

    (558,341 )     1,041,476       4,760,287       11,714,091       9,002,372       12,167,345  

Other income (expense):

                                               

Interest expense

    (7,312 )     (40,072 )     (6,915 )     (880,671 )     (604,931 )     (723,254 )

Interest income

                3,927       40,835       19,819       34,236  

Other, net

          (3,001 )     28,266       (28,953 )     (52,054 )     (60,815 )

Change in fair value of redeemable preferred stock conversion feature

                      (3,857,500 )     (2,566,991 )     (28,109,723 )
   


 


 


 


 


 


Total other income (expense)

    (7,312 )     (43,073 )     25,278       (4,726,289 )     (3,204,157 )     (28,859,556 )
   


 


 


 


 


 


Income (loss) before income taxes

    (565,653 )     998,403       4,785,565       6,987,802       5,798,215       (16,692,211 )

Income tax expense

                      3,662,563       2,705,337       4,430,020  
   


 


 


 


 


 


Net income (loss)

    (565,653 )     998,403       4,785,565       3,325,239       3,092,878       (21,122,231 )

Redeemable preferred stock accretion

                      (764,742 )     (505,849 )     (790,010 )

Preferred dividends

                                  (5,486,555 )
   


 


 


 


 


 


Net income (loss) applicable to common stockholders

  $ (565,653 )   $ 998,403     $ 4,785,565     $ 2,560,497     $ 2,587,029     $ (27,398,796 )
   


 


 


 


 


 


Earnings (loss) per common share:

                                               

Basic

  $ (.01 )   $ .02     $ .10     $ .11     $ .10     $ (1.59 )

Diluted

  $ (.01 )   $ .02     $ .10     $ .11     $ .10     $ (1.59 )

Weighted averages of common shares outstanding (3):

                                               

Basic

    49,732,156       49,732,156       49,732,156       24,196,437       26,643,874       17,194,286  

Diluted

    49,732,156       49,732,156       49,732,156       24,196,437       26,643,874       17,194,286  

 

30


Table of Contents
    As of December 31,

    As of
September 30,
2005


 
    2001

    2002

  2003

  2004

   
    (unaudited)                      

Consolidated Balance Sheet data:

                                   

Cash and cash equivalents

  $ 7,824     $ 53,269   $ 2,184,120   $ 5,813,861     $ 7,916,674  

Working capital (4)

    (676,478 )     267,248     4,350,332     4,181,402       2,279,845  

Total current assets

    66,299       999,005     5,267,631     12,226,876       21,882,194  

Total long-term debt (including current portion)

                  12,000,000       24,381,702  

Total liabilities

    701,797       731,757     917,299     23,468,421       73,294,486  

Total stockholders’ equity (deficit)

    (565,653 )     695,515     5,634,130     (22,708,950 )     (66,534,542 )

Dividend information:

                                   

Cash dividends paid per common and preferred share

                      $ 0.549  

Cash dividends declared but not yet paid per common and preferred share

                      $ 0.295  

(1) NightHawk Radiology Services, LLC was founded in August 2001.

 

(2) Includes the non-cash stock-based compensation charges set forth in in the following table (which amounts include a non-recurring, non-cash professional services charge of approximately $1.5 million in 2004 associated with the issuance of shares of our common stock to one of our affiliated radiologists and a non-recurring, non-cash sales, general and administrative charge of approximately $2.9 million in the nine months ended September 30, 2005 associated with the full acceleration of shares of common stock held by a member of our board of directors).

 

    

Year Ended December 31,


   Nine Months Ended
September 30,


     2001

   2002

   2003

   2004

   2004

   2005

     (unaudited)                   (unaudited)     

Professional services

                                         

Non-cash stock-based compensation

   $    $ 262,765    $ 653,050    $ 1,544,781    $ 857,068    $ 521,807

Sales, general and administrative

                                         

Non-cash stock-based compensation

      —                144,822      35,302      3,175,063
    

  

  

  

  

  

Total non-cash stock-based compensation

   $    $ 262,765    $ 653,050    $ 1,689,603    $ 892,370    $ 3,696,870
    

  

  

  

  

  

 

(3) The weighted average shares of common stock outstanding for the years ended December 31, 2001, 2002, 2003 and 2004 and the nine months ended September 30, 2004 and 2005, are based on the assumed conversion of LLC units into common stock at the beginning of 2001 based on the conversion ratio from the recapitalization transaction.

 

(4) Defined as current assets minus current liabilities.

 

31


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with our audited consolidated financial statements that appear elsewhere in this prospectus. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including those set forth in the section entitled “Risk Factors” and elsewhere in this prospectus.

 

Overview

 

We believe that we are the leading provider of off-hours, emergency radiology services to radiology groups and hospitals across the United States. Our team of American Board of Radiology-certified, U.S. state-licensed and hospital-privileged radiologists uses our proprietary workflow technology to provide radiological interpretations to our customers in the United States primarily from centralized reading facilities located in Sydney, Australia and Zurich, Switzerland. The interpretations that we currently provide consist primarily of preliminary diagnoses of emergency trauma and non-traumatic emergency conditions.

 

Nighthawk Radiology Services, LLC, an Idaho limited liability company, was founded in August 2001 and began providing off-hours emergency radiology services in October 2001. On March 31, 2004, our management team, along with entities affiliated with Summit Partners, consummated a series of related transactions that resulted in the creation and capitalization of NightHawk Radiology Holdings, Inc., a Delaware corporation, and its acquisition of all the outstanding membership units of Nighthawk Radiology Services, LLC. These transactions resulted in Nighthawk Radiology Services, LLC becoming a wholly-owned subsidiary of NightHawk Radiology Holdings, Inc. NightHawk Radiology Holdings, Inc. conducts its operations primarily through Nighthawk Radiology Services, LLC.

 

In November 2004, we acquired all of the outstanding membership units of DayHawk Radiology Services, LLC, a Delaware limited liability company. This resulted in DayHawk Radiology Services, LLC becoming our wholly-owned subsidiary. We acquired DayHawk Radiology Services, LLC, primarily for the purpose of expanding our service hours. The operations of DayHawk Radiology Services, LLC have been integrated into our operations. Historical financial statements for DayHawk Radiology Services, LLC appear elsewhere in this prospectus.

 

In April 2005 and August 2005, we entered into a series of transactions with Comerica Bank that provided us a $32 million term loan facility and a $3 million revolving line of credit. In April 2005, we borrowed $12 million under the term loan facility and used the proceeds to repay all outstanding indebtedness to certain entities affiliated with Summit Partners and to repay a revolving credit facility with Silicon Valley Bank. In September 2005, we borrowed $13 million under the term loan facility and distributed the full amount as a special distribution to the holders of our common stock and redeemable preferred stock. Immediately prior to this offering, we borrowed an additional $7 million under the term loan facility and will distribute the full amount as another special distribution to the holders of our common stock and redeemable preferred stock prior to the completion of this offering. We intend to use a portion of the proceeds from this offering to repay our obligations under the term loan facility with Comerica Bank.

 

Recent Developments—Fourth Quarter Financial Performance

 

We estimate that our revenue for the fourth quarter of 2005 was approximately $18.5 million, resulting in annual revenue of approximately $64.1 million and pro forma revenue of approximately $67.3 million (which amount gives effect to our acquisition of American Teleradiology Nighthawks, Inc. as if the acquisition had occurred January 1, 2004) each for the year ended December 31, 2005. Although the audit of our financial statements for the year ended December 31, 2005 is not yet complete, we expect that operating costs and expenses we incurred during the fourth quarter of 2005 were generally consistent with the quarterly operating costs and

 

32


Table of Contents

expenses reflected in our audited financial statements for the nine month period ended September 30, 2005 appearing elsewhere in this prospectus and the trends described in this section. As of December 31, 2005, we provided service to 463 customers serving 860 hospitals, or approximately 15% of all hospitals in the United States.

 

As of December 31, 2005, we had 47 affiliated radiologists who were providing services for us, and an additional 13 radiologists who had entered into contracts with us but had not yet begun to provide services.

 

Recent Acquisition

 

On September 30, 2005, we acquired American Teleradiology Nighthawks, Inc., or ATN. We regard the ATN acquisition as an acquisition of two distinct businesses: an off-hours teleradiology business that is supplemental to our current business, and an early-stage business that will focus on the provision of teleradiology services to hospitals that do not currently have adequate coverage from radiologists located in their vicinities. The consideration to the ATN stockholders in connection with the acquisition is based primarily upon the future financial performance of these two businesses. Specifically, the consideration to the stockholders of ATN consists of:

 

  ·   315,279 shares of our common stock issued at the completion of the acquisition,

 

  ·   additional shares of our common stock that may be issued in an amount equal to (a) the quotient obtained by dividing (i) revenue generated by the off-hours teleradiology business from ATN customers during the twelve month period ending September 30, 2006 by (ii) $12.69, which was the value per share of our common stock on the date of completion of the acquisition (as agreed by the parties) minus (b) 315,279, which was the number of shares of our common stock issued to the stockholders of ATN at the completion of the acquisition, and

 

  ·   additional shares of our common stock that may be issued in an amount equal to the sum of (a) the quotient obtained by dividing (i) earnings before interest, taxes, depreciation and amortization, or EBITDA, generated by the hospital business during the twelve month period ending March 31, 2007 by (ii) $12.69, which was the value per share of our common stock on the date of completion of the acquisition (as agreed by the parties), plus (b) the quotient obtained by dividing (A) three times (3x) the EBITDA amount described in clause (i) by (B) the fair market value of our common stock, determined on a per share basis, on March 31, 2007.

 

The number of additional shares of our common stock which may be paid based on the future financial performance of ATN is currently not determinable, as the earnout formulas do not contain any minimum or maximum limitation with respect to the number of shares of common stock, if any, to be issued. The operations of ATN have not yet been fully integrated into our operations. Historical financial statements for ATN appear elsewhere in this prospectus.

 

The 315,279 shares of common stock that were issued at the completion of the acquisition will be recorded at par value as common stock with additional amounts up to fair value recorded as “Additional Paid-In Capital.” The shares that may be issued as a result of the future financial performance of ATN are considered contingent consideration and will be recorded in a similar manner upon issuance, if any.

 

Critical Accounting Policies

 

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The preparation of these financial statements in accordance with U.S. GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements and the reported amounts of revenue and expenses during a fiscal period. The SEC considers an accounting policy to be critical if it is important to a company’s financial condition and results of operations, and if it requires the exercise

 

33


Table of Contents

of significant judgment and the use of estimates on the part of management in its application. We have discussed the selection and development of the critical accounting policies with the audit committee of our board of directors, and the audit committee has reviewed our related disclosures in this prospectus. Although we believe that our judgments and estimates are appropriate, actual results may differ from those estimates.

 

We believe the following to be our critical accounting policies because they are both important to the portrayal of our financial condition and results of operations and they require critical management judgment and estimates about matters that are uncertain:

 

  ·   revenue recognition and allowance for doubtful accounts,

 

  ·   accounting for redeemable preferred stock,

 

  ·   stock-based compensation,

 

  ·   use of estimates,

 

  ·   long-lived assets including goodwill and other acquired intangible assets, and

 

  ·   income taxes.

 

If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected. See “Risk Factors” for certain matters that may affect our future results of operations or financial condition.

 

Revenue Recognition and Allowance for Doubtful Accounts

 

We enter into services contracts with our customers. These contracts typically have a one year term, and automatically renew for each successive year unless terminated by the customer or by us. The amount we charge for our radiology services varies by customer based on a number of factors, including the hours of coverage we provide for the customer, the number of reads we provide to the customer and the technical and administrative services we provide to the customer. We recognize revenue when we have satisfied all of our significant contractual obligations to our customers and we determine that the collection of the resulting receivable is reasonably assured. Revenue from services is recognized in the fiscal month in which the radiological interpretation is complete and forwarded to the customer. We review our historical collection experience on a quarterly basis to determine the necessity of a provision for doubtful accounts. As of September 30, 2005, we had reserved $254,000 for doubtful accounts based on our estimate of the collectibility of outstanding receivables as of that date.

 

Accounting for Redeemable Preferred Stock

 

We account for derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. We record derivative financial instruments as assets or liabilities in our consolidated balance sheets, measured at fair value. We record the change in fair value of such instruments as non-cash gains or losses in our consolidated statements of operations. We do not enter into derivative contracts for trading purposes.

 

On March 31, 2004, in connection with the organization and capitalization of NightHawk Radiology Holdings, Inc., we issued 6,500,003 shares of redeemable preferred stock for a total consideration of $13 million. Each share of redeemable preferred stock is convertible, at the option of the holder, into one share of common stock. The conversion feature of the redeemable preferred stock is considered an embedded derivative under the provisions of SFAS No. 133, and accordingly is accounted for separately from the redeemable preferred stock. We determined the fair value of the redeemable preferred stock conversion feature based upon the fair value of the underlying common stock. On the date of issuance, the estimated fair value of the conversion feature was $1,670,277 which was recorded as a liability on the date of issuance, thus reducing the recorded value of the redeemable preferred stock to $11,329,723. At each balance sheet date, we adjust the carrying value of the

 

34


Table of Contents

embedded derivative to estimated fair value and recognize the change in such estimated value in our consolidated statements of operations.

 

We also classify the redeemable preferred stock as mezzanine equity. As such, we accrete the carrying value of such stock to its redemption value using the effective interest method through the redemption period. In addition, the redeemable preferred stock has accrued dividends since the date of issuance. We recognize these two types of accretion of redeemable preferred stock in our consolidated statement of operations as a decrease in net income available to common stockholders.

 

Upon completion of this offering, all outstanding shares of redeemable preferred stock will convert into common stock, and, as a result, we will not record any additional expenses associated with the change in fair value of the conversion feature. The amount reported as fair value of the redeemable preferred stock conversion feature will be reported as additional paid-in capital in the equity section of the balance sheet. Also, the rights of the holders of redeemable preferred stock to receive accrued dividends or to exercise redemption rights will terminate. As a result, the accretion of redeemable preferred stock will also terminate. Following the completion of this offering, these amounts will be reported within stockholders’ equity.

 

Stock-Based Compensation

 

Physician Stock-Based Compensation.    We currently record stock-based compensation expense in connection with any grant of stock options, warrants or other issuance of shares of common stock to our affiliated radiologists. We calculate the stock-based compensation expense associated with the issuance of stock options and warrants to our affiliated radiologists in accordance with SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123 (SFAS No. 148) and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (EITF No. 96-18), by determining the fair value using a Black-Scholes model. See “—Recent Accounting Pronouncements.” We calculate the stock-based compensation expense related to issuance of common stock to our affiliated radiologists based on the fair value of common stock at the date the shares are issued. Stock-based compensation to our affiliated radiologists is included in professional services expense. In accordance with EITF No. 96-18, because our radiologists are treated as independent contractors and not as employees, we calculate the stock-based compensation expense related to issuance of common stock to our affiliated radiologists by determining the fair value of the option at the end of each period and record the increase in value of the option as an expense during such period. If the price of our common stock increases over a given period, this accounting treatment results in compensation expense that exceeds the expense we would have recorded if these individuals were employees.

 

Non-Physician Stock-Based Compensation.    We also record stock-based compensation expense in connection with any grant of stock options, warrants or other issuance of shares of common stock to employees, directors and non-physician contractors. We calculate the stock-based compensation expense associated with the issuance of stock options and warrants to our employees and directors in accordance with SFAS No. 123 and SFAS No. 148 by determining the fair value using a Black-Scholes model. We calculate the stock-based compensation expense related to the issuance of common stock to our employees, directors and non-physician contractors based on the fair value of common stock on the date the shares are issued. Stock-based compensation to employees and non-physician contractors is included in sales, general and administrative expense.

 

Determination of Fair Value of our Stock Options.    As indicated above, we record stock-based compensation expense associated with our stock options in accordance with SFAS No. 123, SFAS No. 148, and EITF No. 96-18, as applicable, which require us to calculate the expense associated with our stock options by determining the fair value of the options. To determine the fair value of our stock options, the Company uses a Black-Scholes model which takes into account the exercise price of the stock option, the fair value of the common stock underlying the stock option, as measured on the date of grant (or at each reporting date for grants

 

35


Table of Contents

to non-employees that require future service), and an estimation of the volatility of the common stock underlying the stock option.

 

To establish the exercise price of our stock options at various grant dates, our Board considered a number of relevant factors, including a calculation of our earnings before interest, taxes, depreciation and amortization, or EBITDA, for the twelve month period ending on the grant date, a review of the market values of companies determined by the Board to be comparable health care services companies and an analysis of the EBITDA multiples at which those companies’ stocks were trading in the market, and an analysis of the appropriate discount factor to apply to such multiple to reflect our status as a private company. Upon its review and analysis of these factors, the Board established the exercise price for the options being granted on that day.

 

In addition, to assist us in our analysis of the fair value of the stock options being granted, we engaged an independent valuation specialist to assist us in our determination of the fair value of our common stock on each grant date. The following table shows the fair value of one share of our common stock on each stock option grant date during the nine month period ended September 30, 2005.

 

Grant Date


   Fair Value of One
Share of Common Stock


February 9, 2005

   $ 2.83

March 22, 2005

   $ 3.03

May 11, 2005

   $ 4.05

June 9, 2005

   $ 4.74

September 9, 2005

   $ 6.79

 

These valuations were generally prepared at the end of the fiscal quarter preceding the grant date. The independent valuation specialist applied a number of different valuation methodologies to assist us in our determination of fair value. The methodologies primarily employed were (i) an “income approach” which estimates the present fair value of our common stock based upon a projection of our future cash flows, and (ii) a “market approach” which estimates the fair value of our common stock based upon comparisons to publicly held companies whose stocks are actively traded and an analysis of the multiples at which those stocks are trading in the market (including revenue, EBITDA, and earnings multiples). These values were then analyzed and given the appropriate weight to determine a value for each share of our common stock (assuming free marketability). To establish the fair value of our common stock as a privately-held company, an appropriate discount factor was then applied to account for the lack of liquidity of our common stock. The discount factor applied at each date was determined through an analysis of (i) the restrictions on the transferability of the shares of our common stock, (ii) the generally accepted range for such discount factors for privately-held companies considering an initial public offering, (iii) our progress toward completing our initial public offering, and (iv) the inherent risk that our offering would not be consummated. As we approached the consummation of our initial public offering, the discount factor for lack of liquidity decreased from 35% at the beginning of 2005 to 15% at the end of September 2005. This decrease primarily resulted from our progress toward the completion of our initial public offering and the related decrease in the risk that our initial public offering would not be consummated.

 

Each of the methodologies employed relies upon estimations that can evolve over a period of time. For example, the “income approach” relies upon projections of future cash flows and estimations of appropriate discount rates to determine present value. During 2005, our cash flow projections evolved as our operating results increased over this period. In addition, our acquisition of American Teleradiology Nighthawks, Inc. on September 30, 2005 had a positive impact on our future cash flow projections and, thus, on the fair value of our common stock. As described elsewhere in this prospectus, the acquisition of ATN allowed us to supplement our off-hours teleradiology business and to acquire an early-stage business that will focus on providing services to under-served facilities. Likewise, the “market approach” relies on fluctuations in the market and how the market is valuing companies deemed to be appropriately comparable to ours. In other words, as the trading multiples increase in the market, this would have the effect of increasing the fair value of our common stock using the “market approach.”

 

36


Table of Contents

Since October 2004, when we first began to grant stock options, the fair value of our common stock has generally increased at each grant date. As described above, these increases are a reflection of a number of factors, including increases in projected cash flows as our operating results have increased over time and a continuing decrease in the discount factor for a lack of liquidity of our common stock described more fully above. The increase in the fair value of our common stock from September 2005 to our initial offering price of $16.00 has resulted primarily from (i) an increase in our revenue in the fourth quarter 2005, (ii) an increase in revenue in the fourth quarter of 2005 and the related increase in our cash flow projections due to the additional customers we acquired as a result of our acquisition of ATN, (iii) increases in the market performances of certain companies deemed to be comparable to us and the resulting increase in fair value resulting from the “market approach” and (iv) a removal of any discount for lack of liquidity in the formulation of our estimated offering price.

 

Use of Estimates

 

On an ongoing basis, we evaluate our estimates relating to the items described below. We generally base our estimates on our historical experience (which is limited) and on various other assumptions that are believed to be reasonable along with the guidance provided by Statement of Financial Accounting Standard, or SFAS, No. 5, Accounting for Contingencies, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

 

Accounts receivable allowance.    We monitor customer payments and maintain a reserve for estimated losses resulting from our customers’ inability to make required payments. In estimating the reserve, we evaluate the collectibility of our accounts receivable from a specific customer when we become aware of circumstances that may impair the customer’s ability to meet its financial obligations and record an allowance against amounts due. To date, we have not experienced any material difficulties in collecting payments from our customers and only began maintaining a reserve for customer nonpayment during 2005. We believe that the potential aggregate amount of nonpayment by our customers is limited in part by the frequency of our billing cycle and the ease with which we may discontinue service to customers during periods of nonpayment. However, actual future losses from uncollectible accounts may differ from our estimates due to our limited experience in establishing reserves for nonpayment, our limited history of noncollection and the difficulty in predicting the future payment practices of a large number of customers.

 

Fair value of redeemable preferred stock conversion feature.    To date, our estimates of the fair value of our redeemable preferred stock conversion feature have been determined by management with the assistance of an independent valuation specialist. However, because our outstanding redeemable preferred stock will convert into common stock upon the completion of this offering, we will not record any additional charges associated with the change in fair value of the conversion feature. As a result, following this offering, we will no longer be required to make these estimates.

 

Loss contingency for medical liability claims.    We record a loss contingency for a medical liability claim in the month in which we deem such liability to be probable. Our determination of the probability of the liability is based upon a review of the claim by our medical staff, legal counsel and insurance carrier. Upon the determination that the liability is probable, we record a loss contingency for the claim up to the amount of the deductible specified in our medical liability insurance policy. To date, we have not experienced any liabilities for claims that were in excess of our prior loss contingency estimates for such claims. However, actual future losses from medical liability claims may differ from our estimates to the extent that we suffer an adverse determination for a claim that we did not deem the liability probable, did not record a loss contingency up to the maximum amount of our insurance deductible, or do not have insurance coverage.

 

Long-Lived Assets Including Goodwill and Other Acquired Intangible Assets

 

The value of goodwill and intangible assets is stated at the lower of cost or fair value. Goodwill is not subject to amortization; however it is subject to periodic impairment assessments. Under the provisions of SFAS

 

37


Table of Contents

No. 142, Goodwill and Other Intangible Assets, we are required to perform at least an annual impairment test and to consider other indicators that may arise throughout the year to re-evaluate carrying value. Some factors we consider important, which could trigger an interim impairment review, include:

 

  ·   significant underperformance relative to historical or projected future operating results,

 

  ·   significant changes in the manner of our use of acquired assets or the strategy for our overall business, and

 

  ·   significant negative industry or economic trends.

 

If we determine through the impairment review process that goodwill or intangible assets have been impaired, we reduce goodwill and intangible assets by recording an impairment charge in our consolidated statement of operations in an amount equal to the amount that book value exceeds fair value at the date impairment is determined. We perform our annual impairment test in the last quarter of each fiscal year. SFAS No. 142 also requires that intangible assets with definite lives be amortized over their estimated useful lives. We are currently amortizing our acquired intangible assets with definite lives over periods ranging from seven months to ten years.

 

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires impairment losses to be recognized for long-lived assets through operations when indicators of impairment exist and the underlying cash flows are not sufficient to support the assets’ carrying value. In addition, SFAS No. 144 requires that a long- lived asset (disposal group) to be sold that meets certain recognition criteria be classified as “held for sale” and measured at the lower of carrying amount or fair value less cost to sell. SFAS No. 144 also requires that a long- lived asset subject to closure (abandonment) before the end of its previously estimated useful life continue to be classified as “held and used” until disposal, with depreciation estimates revised to reflect the use of the asset over its shortened useful life.

 

We regularly evaluate the carrying value of intangible and long-lived assets for events or changes in circumstances that indicate that the carrying amount may not be recoverable or that the remaining estimated useful life should be changed. Potential indicators of impairment can include, but are not limited to (1) history of operating losses or expected future losses, (2) significant adverse change in legal factors, (3) changes in the extent or manner in which the assets are used, (4) current expectations to dispose of the assets by sale or other means, and (5) reductions or expected reductions of cash flow. If we determine there is an indication of impairment, we compare undiscounted net cash flows to the carrying value of the respective asset. If the carrying value exceeds the undiscounted net cash flows, we perform an impairment calculation using discounted cash flows, valuation analysis from independent valuation specialists or comparisons to recent sales or purchase transactions to determine estimated fair value.

 

Income Taxes

 

As a limited liability company, or LLC, for all periods from inception through March 31, 2004, we were not subject to federal income taxes directly. Rather, the LLC members were subject to federal income taxation based on their respective allocation of the LLC’s net taxable income or loss.

 

Since our recapitalization, we have recognized income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities.

 

Developing our provision for income taxes, including our effective tax rate, and analysis of potential tax exposure items, if any, requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and any estimated valuation allowances we deem necessary to value deferred tax assets. Our judgments and tax strategies are subject to audit by various taxing authorities. While we believe we have provided adequately for our income tax liabilities in our consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on our consolidated financial condition, results of operations or cash flows.

 

38


Table of Contents

How We Generate Revenue

 

We generate substantially all of our revenue from the radiology services that we provide our customers. We typically provide these services pursuant to one-year services contracts that automatically renew for each successive year unless terminated by the customer or by us. The amount we charge for our radiology services varies by customer based upon a number of factors, including the hours of coverage we provide for the customer, the number of reads we provide to the customer and the technical and administrative services we provide to the customer.

 

We recognize revenue generated by our services during the month in which services are provided and we bill our customers at the beginning of the following month. Because the invoices are paid directly by our customers, we do not currently depend upon payment by third-party payors or patients.

 

Since our first full year of operations, we have experienced significant revenue growth, from $4.7 million in 2002 to $16.2 million in 2003 to $39.3 million in 2004 and to $45.6 million for the nine month period ended September 30, 2005. This growth in service revenue resulted primarily from:

 

  ·   an increase in our customer base,

 

  ·   an increase in utilization of our service by our customers,

 

  ·   an expansion of our service hours, and

 

  ·   a high customer retention rate.

 

As of September 30, 2005, our affiliated radiologists provided services to 383 customers serving 746 hospitals. The total number of hospitals we cover represents approximately 13% of all hospitals in the United States. Most of our customers do not currently contract for all of the hours of coverage that we are able to provide.

 

In addition to the current customers described above, as of September 30, 2005 we had services contracts with 12 radiology groups for which we expected to begin to provide services upon completion of the credentialing, privileging and other implementation procedures at those sites. Once we receive an executed customer contract, it typically takes approximately 90 days to fully implement the site and begin deriving revenue from the customer. This implementation period provides us with reasonable visibility of future revenue associated with these customer contracts.

 

Since inception, we have experienced a high rate of customer retention, with more than 97% of our customer contracts up for renewal being renewed.

 

Our Operating Expenses

 

Our operating expenses consist primarily of professional services expense, sales, general and administrative expense, interest expense and income tax expense. We record stock compensation expense in connection with equity issuances to our affiliated radiologists (which we refer to as physician stock-based compensation) and in connection with equity issuances to our employees, directors and non-physician contractors (which we refer to as non-physician stock-based compensation). In our consolidated statement of income, we present our physician stock-based compensation expense as part of our professional services expenses and our non-physician stock-based compensation as part of our sales, general and administrative expense.

 

Professional Services Expense.    Our professional services expense consists primarily of the fees we pay to our affiliated radiologists for their services (which we refer to as physician compensation), physician stock-based compensation, the premiums we pay for medical liability insurance and medical liability loss contingency expense. Our affiliated radiologists are highly trained professionals and we compensate them accordingly. As a result, physician compensation is our most significant expense. We structure our relationships with our affiliated radiologists such that they have control over the number of hours that they work. We compensate our affiliated radiologists using a formula that is generally based upon the number of hours worked and the workload completed, and we also provide discretionary bonuses. We recognize physician compensation expense in the

 

39


Table of Contents

month in which the services are performed. We recognize expenses associated with medical liability premiums in the month in which the expense is incurred. We record medical liability loss contingency expense in the month in which we deem such liability to be probable.

 

Physician Stock-Based Compensation Expense.    We record physician stock-based compensation expense in connection with any grant of stock options, warrants or other issuance of shares of our common stock to our affiliated radiologists and present this expense in our consolidated statements of operations as part of our professional services expense. We calculate the stock-based compensation expense associated with the issuance of stock options and warrants to affiliated radiologists in accordance with SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123 (SFAS No. 148) and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (EITF No. 96-18), by determining the fair value using a Black-Scholes model. See “—Recent Accounting Pronouncements.” We calculate the stock-based compensation expense related to issuance of common stock to our affiliated radiologists based on the fair value of common stock at the date the shares were issued. In accordance with EITF No. 96-18, because our radiologists are treated as independent contractors and not as employees, we calculate the stock-based compensation expense related to issuance of common stock to our affiliated radiologists by determining the fair value of the option at the end of each period and record the increase in price of the option as an expense during such period. If the value of our common stock increases over a given period, this accounting treatment results in compensation expense that generally exceeds the expense we would have recorded if these individuals were employees.

 

Sales, General and Administrative Expense.    Sales, general and administrative expense consists primarily of salaries and related expenses for all employees and non-physician contractors, non-physician stock-based compensation, information technology and telecommunications expenses, costs associated with licensing and privileging our affiliated radiologists, facilities and office-related expenses, sales and marketing expenses and other general and administrative expenses.

 

Non-Physician Stock-Based Compensation Expense.    We record non-physician stock-based compensation expense in connection with any grant of stock options, warrants or other issuance of shares of our common stock to our employees, directors and non-physician contractors and present this expense in our consolidated statement of income as part of our sales, general and administrative expense. We calculate the stock-based compensation expense associated with the issuance of stock options and warrants to our employees, directors and non-physician contractors in accordance with SFAS No. 123 and SFAS No. 148 by determining the fair value using a Black- Scholes model. We calculate the stock-based compensation expense related to the issuance of common stock to our employees, directors and non-physician contractors based on the fair value of common stock at the date the shares were issued.

 

Our Non-Operating Expenses

 

In addition to our operating expenses, we record the following non-operating expenses.

 

Interest Expense.    Interest expense is directly attributable to the principal amount of debt we have outstanding. We expect that we will use the proceeds of this offering to repay all currently outstanding debt obligations other than long-term capital lease obligations.

 

Change in Fair Value of Redeemable Preferred Stock Conversion Feature.    We have entered into a stockholders agreement with the holders of our Series A preferred stock pursuant to which we have agreed to repurchase all or any portion of the shares of redeemable preferred stock then held by such holders at any time after seven years from the date of issuance. The stockholders agreement provides that the repurchase price for such shares of redeemable preferred stock shall be the greater of (i) the market value of the common stock issuable upon conversion of the redeemable preferred stock or (ii) the liquidation value of such shares of redeemable preferred stock (including all accrued and unpaid dividends). The conversion feature of the redeemable preferred stock is considered an embedded derivative under the provisions of SFAS No. 133, and

 

40


Table of Contents

accordingly is accounted for separately from the redeemable preferred stock. On the date of issuance, the estimated fair value of the conversion feature was $1,670,277 which was recorded as a liability on the balance sheet date on the date of issue thus reducing the recorded value of the redeemable preferred stock to $11,329,723. At each balance sheet date, we adjust the carrying value of the embedded derivative to estimated fair value and recognize the change in such estimated value in our consolidated statements of operations.

 

Upon completion of this offering, all outstanding shares of redeemable preferred stock will convert into common stock, and, as a result, we will not record any additional expenses associated with the change in fair value of the conversion feature of our redeemable preferred stock.

 

Income Tax Expense.    We became subject to federal income taxes upon the formation and capitalization of NightHawk Radiology Holdings, Inc. Prior to that time, we operated our business as a limited liability company and, as such, were not subject to income taxes.

 

Redeemable Preferred Stock Accretion.    Shares of our redeemable preferred stock have accrued dividends since the date of issuance. The redeemable preferred stock dividends are cumulative and accrue at a rate of 6% per annum based on the sum of the liquidation value of each share of redeemable preferred stock, $2.00, plus all accumulated and unpaid dividends. Dividends accumulate at the end of each calendar quarter. In addition to accruing dividends, we also accrue the carrying amount of the redeemable preferred stock to its redemption value using the effective interest method through the redemption period. We recognize these two types of accretion of redeemable preferred stock in our consolidated statements of operations as a decrease in net income available to common stockholders.

 

Upon the completion of this offering, all outstanding shares of redeemable preferred stock will convert into shares of common stock and the rights of the holders of redeemable preferred stock to receive accrued dividends or to exercise redemption rights will terminate. As a result, the accretion relating to our redeemable preferred stock will also terminate. Following the completion of this offering, these amounts will be reported within stockholders’ equity.

 

Trends in our Business and Results of Operations

 

Revenue Trends.    Our business has grown rapidly since inception. This growth has been driven primarily by an increase in our customer base, an increase in utilization of our service by our customers, an expansion of our service hours, a high customer retention rate and the growth in the use of diagnostic imaging technologies and procedures in the healthcare market. Our strategy is to expand on our position as the leading provider of off-hours emergency radiology services by:

 

  ·   targeting new customers,

 

  ·   expanding our radiology group customers’ utilization of our services as they implement coverage of additional hospitals,

 

  ·   marketing to our customers the additional available hours of coverage,

 

  ·   expanding our service offerings to include primary interpretations,

 

  ·   pursuing strategic acquisitions, and

 

  ·   developing a market for our software technology.

 

Our revenue has increased in absolute dollars each year since inception and our revenue growth rate has been strong. However, our revenue growth rate declined from 2003 to 2004 and will likely continue to decline as a result of the increased revenue base against which future periods will be compared. We expect that a number of our customers will implement coverage for additional hospitals as well as begin to use additional hours of our service, resulting in an overall increase in the utilization of our service by those customers.

 

Historically, we have seen an increase in revenues during the second and third quarters of each fiscal year, when weather conditions tend to be warmer in much of the United States. We believe these increases are a result

 

41


Table of Contents

of increased outdoor and transportation activities during summer months. During the first and fourth quarters of each fiscal year, when weather conditions are colder for a large portion of the United States, we have historically experienced relatively lower revenues than those experienced during the second and third quarters. We expect this seasonality to continue.

 

Trends in Physician Compensation Expense.    Since inception, our physician compensation expense has increased in absolute dollars each year, primarily due to the addition of new radiologists to perform an increased workload as our business has grown. However, physician compensation expense as a percentage of revenue has decreased each year since inception primarily due to increased productivity of our affiliated radiologists as well as increased efficiency due to improvements in our workflow technology. These increases in productivity and improved efficiencies have been offset in part by an increase in the hourly compensation we pay to our affiliated radiologists. We expect that our physician compensation will continue to increase in absolute dollars as we contract with additional radiologists to meet the increasing demand for our services, as we begin to offer services that we do not currently provide, and as a result of scheduled increases in hourly compensation under our existing professional services agreements with our affiliated radiologists.

 

Our medical liability expense has also increased in absolute dollars each year since inception, primarily due to increases in our medical liability premiums as our business has grown. Also, in 2004, we recorded our first claims loss contingency expense associated with two currently outstanding medical liability claims. We expect our medical liability premiums and, as a result, our medical liability expenses, to continue to increase in future periods as our business grows.

 

Trends in Physician Stock-Based Compensation Expense.    We recorded significant physician stock-based compensation expense in 2004, primarily as a result of a warrant we issued in 2003 to one of our affiliated radiologists and the related issuance of 1,007,500 fully vested shares of our common stock to the radiologist in the fourth quarter of 2004 in satisfaction of that warrant. In addition, we recorded physician stock-based compensation expense in connection with the grant of options to purchase an aggregate of 554,500 shares of our common stock to our affiliated radiologists in October and November 2004. These options were the first option grants we had made to our affiliated radiologists since inception and were granted at exercise prices equal to the fair value of our common stock on the date of grant as determined by our board of directors. As a result, we granted a relatively large number of options to our affiliated radiologists at one time, which we do not anticipate will occur again. Instead, we anticipate granting options to new radiologists as well as radiologists renewing their contracts with us at the end of their initial term. However, as a result of the accounting treatment required by SFAS No. 123 and EITF No. 96-18, we expect that our physician stock-based compensation expense will increase in future periods if we continue to issue additional grants to our radiologists and if the price of our common stock increases over such periods.

 

Trends in Sales, General and Administrative Expense.    Our sales, general and administrative expense has increased in absolute dollars each year since inception primarily as a result of increased payroll expenses in connection with the addition of key management personnel, software development professionals and the implementation of executive and employee bonuses. We expect that these payroll expenses will continue to increase as we continue to increase headcount as our business grows. In addition to increased payroll expense, we expect that our general and administrative expense will increase in absolute dollars due to increases in telecommunications and information technology costs and licensing and privileging costs. Also, we expect that our general and administrative expense will increase in absolute dollars due to increases in legal, accounting, consulting, staffing and insurance costs associated with being a public company. Accordingly, we expect sales, general and administrative expense to increase in absolute dollars in future periods.

 

Trends in Non-Physician Stock-Based Compensation Expense.    We recorded relatively modest non-physician stock-based compensation expense in 2004. In 2004, our non-physician stock-based compensation expense consisted primarily of an expense recorded in connection with the issuance of 638,876 unvested shares of our common stock to one of the members of our board of directors, and an expense recorded in connection with the grant of options to our employees, directors and non-physician contractors to purchase shares of our common stock. In June 2005, our board of directors agreed to accelerate the vesting of the 638,876 shares of common stock held by

 

42


Table of Contents

one of our directors which resulted in a non-physician stock-based compensation expense of approximately $2.9 million, which contributed to a relatively significant non-physician stock-based compensation expense in the first half of 2005. However, because we do not anticipate issuing any shares of our common stock other than pursuant to the grant of options to our employees, directors and non-physician contractors in the ordinary course, we expect our non-physician stock-based compensation expense to decline in periods after 2005.

 

Trends in Interest Expense.    Our interest expense is attributable to the principal amount of debt we have outstanding. In April 2005, we entered into a loan agreement with Comerica Bank that provided us a $12 million term loan facility and a $3 million revolving line of credit. We used the proceeds from the term loan facility to repay in full all outstanding indebtedness under the promissory notes held by entities affiliated with Summit Partners and the revolving credit facility with Silicon Valley Bank. In August 2005 we amended our loan agreement with Comerica Bank to provide an additional $20 million under the term loan facility. In September 2005, we borrowed $13 million under the term loan facility and distributed the full amount as a special distribution to the holders of our common stock and redeemable preferred stock. Immediately prior to this offering, we borrowed an additional $7 million under the term loan facility and will distribute the full amount as another special distribution to the holders of our common stock and redeemable preferred stock prior to the completion of this offering.

 

Trends and Treatment of Redeemable Preferred Stock.    Upon the completion of this offering, all outstanding shares of redeemable preferred stock will convert into shares of common stock and the rights of the holders of redeemable preferred stock to receive accrued dividends or to exercise redemption rights will terminate. As a result, we will not record any additional expenses associated with the change in fair value of the conversion feature of our redeemable preferred stock, and the accretion relating to our redeemable preferred stock will terminate. Following the completion of this offering, these amounts will be reported within stockholders’ equity.

 

Results of Operations

 

The following table sets forth selected consolidated statements of operations data for each of the periods indicated as a percentage of service revenue.

 

     Fiscal Year Ended December 31,

   

Nine Months
Ended

September 30,


 
         2002    

        2003    

        2004    

    2004

    2005

 

Service revenue

   100 %   100 %   100 %   100 %   100 %

Operating costs and expenses:

                              

Professional services (1)

   42     39     38     37     34  

Sales, general and administrative (2)

   35     30     31     29     36  

Depreciation and amortization

   1     1     1     1     2  
    

 

 

 

 

Total operating costs and expenses

   78     70     70     67     72  
    

 

 

 

 

Operating income

   22     30     30     33     28  

Other income (expense):

                              

Interest expense

   (1 )       (2 )   (2 )   (2 )

Interest income

                    

Other, net

                    

Change in fair value of redeemable preferred stock conversion feature

           (10 )   (9 )   (62 )
    

 

 

 

 

Total other income (expense)

   (1 )       (12 )   (12 )   (64 )
    

 

 

 

 

Income (loss) before income taxes

   21     30     18     21     (36 )

Income tax expense

           9     10     10  
    

 

 

 

 

Net income (loss)

   21     30     9     11     (46 )

Redeemable preferred stock accretion

           (2 )   (2 )   (2 )

Preferred dividends

                   (12 )
    

 

 

 

 

Net income (loss) applicable to common stockholders

   21 %   30 %   7 %   9 %   (60 )%
    

 

 

 

 

 

43


Table of Contents

(1) Includes non-cash stock-based compensation expense of $262,765 for 2002, $653,050 for 2003, $1,544,781 (which amount includes a non-recurring, non-cash professional services expense of approximately $1.5 million associated with the issuance of shares of our common stock to one of our affiliated radiologists) for 2004, $857,068 for the nine months ended September 30, 2004 and $521,807 for the nine months ended September 30, 2005.

 

(2) Includes non-cash stock-based compensation expense of $0 for 2002, $0 for 2003, $144,822 for 2004, $35,302 for the nine months ended September 30, 2004 and $3,175,063 (which amount includes a non- recurring, non-cash sales, general and administrative expense of approximately $2.9 million associated with the full acceleration of shares of common stock held by a member of our board of directors) for the nine months ended September 30, 2005.

 

Comparison of Nine Months Ended September 30, 2004 and September 30, 2005

 

Service Revenue

 

     Nine Months Ended
September 30,


   Change

 
     2004

   2005

   In Dollars

   Percentage

 

Service revenue

   $ 27,673,630    $ 45,587,587    $ 17,913,957    65 %

 

The increase in service revenue from the nine months ended September 30, 2004 to the nine months ended September 30, 2005 resulted primarily from an increase in the number of our radiology group customers and their affiliated hospitals. The number of radiology group and hospital customers to which we provided service increased from 268 as of September 30, 2004 to 383 as of September 30, 2005, a 43% increase in customers. The increase in the number of our customers resulted primarily from increased market acceptance of teleradiology as a solution, an increase in the recognition by the marketplace of the quality of our service offerings, the success by our sales professionals in generating new customers, and an improvement in our ability to meet the increased demand for our service, primarily through the addition of affiliated radiologists and the expansion of our hours of service. In addition, although we are not able to accurately calculate the impact on a factor-by-factor basis due to a lack of sufficient data, our increase in service revenue during this period also resulted from an increased utilization by our customers of our hours of service and the growth in the use of diagnostic imaging technologies and procedures in the healthcare market during this period. For example, as of September 30, 2004, we provided service from 8 p.m. to 8 a.m. for hospitals located in the eastern time zone. As of September 30, 2005, we had expanded our service offering to 5 p.m. to 8 a.m. local time for all time zones in the continental United States as well as 24-hours per day on weekends and holidays. We were able to provide these additional hours of coverage in part due to our acquisition of DayHawk Radiology Services, LLC as well as the establishment of an additional reading facility in Zurich, Switzerland. The increase in service revenue was offset partially by pricing pressure resulting from increased competition.

 

Operating Costs and Expenses

 

Professional Services

 

     Nine Months Ended
September 30,


    Change

 
     2004

    2005

    In Dollars

   Percentage

 

Professional services (1)

   $ 10,267,883     $ 15,796,222     $ 5,528,339    54 %

Percentage of service revenue

     37 %     34 %             

(1) Includes non-cash stock-based compensation expense of $857,068 for the nine months ended September 30, 2004 and $521,807 for the nine months ended September 30, 2005.

 

44


Table of Contents

The increase in professional services expense from the nine months ended September 30, 2004 to the nine months ended September 30, 2005 resulted primarily from an increase in the number of our affiliated radiologists providing service as well as an increase in the service fees we paid to our affiliated radiologists as a result of scheduled increases in hourly compensation under the terms of the professional services agreements with our affiliated radiologists. From September 30, 2004 to September 30, 2005, we increased the number of our affiliated radiologists from 21 to 39. This increase was driven primarily by the increased demand for our services and was attributable to our ability to effectively recruit additional radiologists to meet such demand. While our professional services expense increased by 54% for the period, our professional services expense as a percentage of service revenue decreased from 37% for the nine months ended September 30, 2004, to 34% for the nine months ended September 30, 2005. This has resulted primarily from the following factors:

 

  ·   Physician Compensation Expense.    While our physician compensation expense increased from $7.5 million for the nine months ended September 30, 2004 to $13.4 million for the nine months ended September 30, 2005, a 79% increase, our physician compensation expense as a percentage of service revenue increased from 27% to 29% during that same period. This increase as a percentage of service revenue resulted primarily from contractual increases in hourly compensation for our affiliated radiologists offset in part by increased workload efficiencies of our affiliated radiologists and improvements in our workflow technologies.

 

  ·   Medical Liability Expense.    Our medical liability expense increased from approximately $633,000 for the nine months ended September 30, 2004 to approximately $703,000 for the nine months ended September 30, 2005, an 11% increase. Of the approximately $633,000 expense recorded in the nine months ended September 30, 2004, $200,000 was attributable to a claims loss contingency expense on two medical liability claims. We had no claims loss contingency expense for the nine months ended September 30, 2005.

 

  ·   Physician Stock-Based Compensation Expense.    Physician stock-based compensation expense decreased from approximately $857,000 for the nine months ended September 30, 2004 to approximately $522,000 for the nine months ended September 30, 2005. The physician stock-based compensation expense recorded for the nine months ended September 30, 2004 resulted entirely from a warrant we had issued to one of our affiliated radiologists. In November 2004, we issued shares of our common stock in satisfaction of such warrant and, therefore, did not record any additional compensation expense related to that warrant after that time. In the nine months ended September 30, 2005, we recorded physician stock-based compensation expense only as a result of options granted to our affiliated radiologists.

 

Sales, General and Administrative

 

     Nine Months Ended September 30,

    Change

 
             2004        

            2005        

    In Dollars

   Percentage

 

Sales, general and administrative (1)

   $ 8,082,478     $ 16,794,642     $ 8,712,164    108 %

Percentage of service revenue

     29 %     36 %             

(1) Includes non-cash stock-based compensation expense of $35,302 for the nine months ended September 30, 2004 and $3,175,063 for the nine months ended September 30, 2005.

 

The increase in our sales, general and administrative expense from the nine months ended September 30, 2004 to the nine months ended September 30, 2005 resulted primarily from increases in payroll expense due to increases in executive bonuses as well as our increased number of personnel in our management, software development, quality control and licensing and privileging departments. In addition, our sales, general and administrative expense for this period increased as a result of increases in information technology and telecommunications expenses, facilities and office-related expenses, licensing and privileging expenses, sales and marketing expenses and other general and administrative expenses. Finally, as described more fully below under “Non-Physician Stock-Based Compensation Expense,” our sales, general and administrative expense for the nine

 

45


Table of Contents

months ended September 30, 2005 expressed as a percentage of service revenue would have been 30% had it not been for an expense of approximately $2.9 million associated with the acceleration of vesting on shares of stock held by one of our directors.

 

  ·   Payroll and Related Expense.    Our sales, general and administrative headcount increased from 87 at September 30, 2004 to 145 at September 30, 2005, a 67% increase, and resulted in an increase in payroll expense from $4.9 million for the nine months ended September 30, 2004 to $7.9 million for the nine months ended September 30, 2005, a 61% increase. This increase in payroll expense resulted primarily from the implementation of an executive bonus plan as well as personnel additions in our quality control, information technology, finance, and licensing and privileging departments. Expressed as a percentage of service revenue, our sales, general and administrative payroll and related expenses were approximately 17% of service revenue for both the nine months ended September 30, 2004 and the nine months ended September 30, 2005.

 

  ·   Information Technology and Telecommunications Expense.    Our non-payroll information technology and telecommunications expense increased from approximately $546,000 for the nine months ended September 30, 2004 to approximately $1.3 million for the nine months ended September 30, 2005, a 138% increase. This increase resulted primarily from continued investment in the redundancy and reliability of our network as well as increased costs associated with implementing and supporting an increased number of customer sites.

 

  ·   Facilities Expense.    Our facilities and office-based expense increased from approximately $584,000 for the nine months ended September 30, 2004 to $1.1 million for the nine months ended September 30, 2005, an 88% increase. The increase in facilities and office-based expense was driven primarily by increased facilities occupancy expenses associated with office expansions in Sydney, Australia and Coeur d’Alene, Idaho, and the addition of our facility in Zurich, Switzerland.

 

  ·   Licensing and Privileging Expense.    Our non-payroll licensing and privileging expense consists primarily of fees paid in connection with the state medical licenses and hospital privileges we obtain on behalf of our affiliated radiologists. Our affiliated radiologists are licensed to practice medicine in an average of 39 states and have been granted privileges at an average of 368 hospitals. As a result of our efforts to obtain these medical licenses and staff privileges for our affiliated radiologists, we incur administrative expenses as well as fees payable to the states and hospitals. Each state typically requires a fee to be paid in connection with the issuance of a medical license as well as an additional annual fee that must be paid to maintain the medical license. In addition, many hospitals have annual fees associated with the granting of medical staff privileges. Non-payroll licensing and privileging expenses decreased from approximately $748,000 for the nine months ended September 30, 2004 to approximately $713,000 for the nine months ended September 30, 2005, a 5% decrease. We believe this decrease in licensing and privileging expenses resulted primarily from the fact that annual renewal fees for our affiliated radiologists are typically lower than initial licensing and privileging fees.

 

  ·   Other General and Administrative Expense.    Our other general and administrative expense consists primarily of professional accounting and legal expenses. Other general and administrative expense increased from approximately $1.0 million for the nine months ended September 30, 2004 to approximately $2.4 million for the nine months ended September 30, 2005, a 140% increase. The increase in other general and administrative expense was driven primarily by increased accounting and legal fees related to the costs of preparing to be a publicly-traded company.

 

  ·  

Non-Physician Stock-Based Compensation Expense.    Our non-physician stock-based compensation expense increased from approximately $35,000 for the nine months ended September 30, 2004 to approximately $3,175,000 for the nine months ended September 30, 2005. This increase resulted primarily from a non-physician stock-based compensation expense of approximately $2.9 million associated with the acceleration of vesting on 638,876 shares of common stock held by one of our directors. In addition, during the nine months ended September 30, 2005, we granted options to purchase 394,600 shares of common stock to our employees and non-physician contractors, resulting in an

 

46


Table of Contents
 

additional stock compensation expense of approximately $249,000. As of September 30, 2004, we had not adopted a stock option plan and had not issued any options or any other equity securities to our employees and non-physician contractors.

 

Other Income (Expense)

 

Interest Expense

 

     Nine Months Ended September 30,

    Change

 
             2004        

            2005        

    In Dollars

   Percentage

 

Interest expense

   $ 604,931     $ 723,254     $ 118,323    20 %

Percentage of service revenue

     2 %     2 %             

 

The interest expense for the nine months ended September 30, 2004 and for the nine months ended September 30, 2005 consisted primarily of interest payable under outstanding promissory notes issued to certain affiliates of Summit Partners and interest payable under a $3 million revolving line of credit with Silicon Valley Bank. The aggregate principal balance of the outstanding promissory notes was approximately $9 million through April 20, 2005. The aggregate principal balance of our revolving credit facility with Silicon Valley Bank was $3 million through April 20, 2005. On April 20, 2005, we entered into a loan agreement with Comerica Bank that provided us a $12 million term loan facility and a $3 million revolving line of credit. We used the proceeds from the term loan facility to repay in full all outstanding indebtedness under the promissory notes held by entities affiliated with Summit Partners and the revolving credit facility with Silicon Valley Bank.

 

Change in Fair Value of Redeemable Preferred Stock Conversion Feature

 

     Nine Months Ended September 30,

    Change

 
             2004        

            2005        

    In Dollars

   Percentage

 

Change in fair value of redeemable preferred stock conversion feature

   $ 2,566,991     $ 28,109,723     $ 25,542,732    995 %

Percentage of service revenue

     9 %     62 %             

 

We first issued shares of our redeemable preferred stock on March 31, 2004. The fair value of the redeemable preferred stock conversion feature was determined to be approximately $1,670,277 on March 31, 2004 and was recorded as a liability at the date of issuance, reducing the recorded value of redeemable preferred stock. From March 31, 2004 to September 30, 2004, the fair value of the redeemable preferred stock conversion feature increased from $1,670,277 at March 31, 2004 to $4,237,268 at September 30, 2004, resulting in a non-cash expense of $2,566,991 for the nine months ended September 30, 2004. In the nine months ended September 30, 2005, the fair value of the embedded conversion feature increased from $5,527,777 at December 31, 2004 to $33,637,500 at September 30, 2005, resulting in a non-cash expense of $28,109,723. Upon completion of this offering, all outstanding shares of redeemable preferred stock will convert into common stock, and, as a result, we will not record any additional expenses associated with the change in fair value of the conversion feature of our redeemable preferred stock.

 

Income Tax Expense

 

     Nine Months Ended September 30,

    Change

 
             2004        

            2005        

    In Dollars

   Percentage

 

Income tax expense

   $ 2,705,337     $ 4,430,020     $ 1,724,683    64 %

Percentage of service revenue

     10 %     10 %             

 

We recorded an income tax expense of approximately $2.7 million for the nine months ended September 30, 2004 and approximately $4.4 million for the nine months ended September 30, 2005. Because we operated

 

47


Table of Contents

as a limited liability company during the first quarter of 2004, we were subject to federal income taxes for only a portion of the nine months ended September 30, 2004, resulting in a lower income tax expense as compared to the same period for 2005.

 

Preferred Stock Accretion

 

     Nine Months Ended September 30,

    Change

 
             2004        

            2005        

    In Dollars

   Percentage

 

Preferred stock accretion

   $ 505,849     $ 790,010     $ 284,161    56 %

Percentage of service revenue

     2 %     2 %             

 

The preferred stock accretion is comprised of two types of accretion based on the underlying redeemable convertible preferred stock. For the nine months ended September 30, 2004, the preferred stock accretion consisted of $394,010 as a result of the accretion of dividends at a daily rate of 6% per annum, and $111,389 as a result of the amortization of the carrying amount of the redeemable convertible preferred to its redemption value using the effective interest method through the redemption period. For the nine months ended September 30, 2005, the preferred stock accretion consisted of $619,342 as a result of the accretion of dividends at a daily rate of 6% per annum, and $170,668 as a result of the amortization of the carrying amount of the redeemable convertible preferred to its redemption value using the effective interest method through the redemption period.

 

Preferred dividends

 

     Nine Months Ended September 30,

    Change

 
             2004        

            2005        

    In Dollars

   Percentage

 

Preferred dividends

   $   —     $ 5,486,555     $ 5,486,555    %

Percentage of service revenue

     %     12 %             

 

In September 2005, we borrowed $13 million under our term loan facility with Comerica Bank and distributed the full amount as a special distribution to the holders of our common stock and redeemable preferred stock. Of this amount, approximately $5.5 million was distributed to the holders of our redeemable preferred stock. Immediately prior to this offering, we borrowed an additional $7 million under our term loan facility with Comerica Bank and will distribute the full amount as another special distribution to the holders of our common stock and redeemable preferred stock prior to the completion of this offering. Of this amount, we anticipate that approximately $3.0 million will be distributed to the holders of our redeemable preferred stock.

 

Comparison of Fiscal Years Ended December 31, 2003 and December 31, 2004

 

Service Revenue

 

     Fiscal Year Ended December 31,

   Change

 
             2003        

           2004        

   In Dollars

   Percentage

 

Service revenue

   $ 16,216,322    $ 39,283,002    $ 23,066,680    142 %

 

The increase in service revenue from 2003 to 2004 resulted primarily from an increase in the number of our radiology group and hospital customers. The number of radiology group and hospital customers to which we provided service increased from 165 as of December 31, 2003 to 297 as of December 31, 2004, an 80% increase. The increase in the number of our customers resulted primarily from increased market acceptance of teleradiology as a solution, an increase in the recognition by the marketplace of the quality of our service offerings, the success by our sales professionals in generating new customers, and an improvement in our ability to meet the increased demand for our service, primarily through the addition of affiliated radiologists and the expansion of our hours of service. In addition, although we are not able to accurately calculate the impact on a factor-by-factor basis due to lack of sufficient data, our increase in service revenue during this period also

 

48


Table of Contents

resulted from increased utilization by our customers of our hours of service and the growth in the use of diagnostic imaging technologies and procedures in the healthcare market during this period. For example, as of December 31, 2003, we provided service from 8 p.m. to 8 a.m. for hospitals located in the eastern time zone. As of December 31, 2004, we had expanded our service offering to 5 p.m. to 8 a.m. local time for all time zones in the continental United States as well as 24 hours-a-day coverage on weekends and holidays. We were able to provide these additional hours of coverage in part due to our acquisition of DayHawk Radiology Services, LLC as well as the establishment of an additional reading facility in Zurich, Switzerland. The increase in service revenue was offset partially by pricing pressure resulting from increased competition.

 

Operating Costs and Expenses

 

Professional Services

 

     Fiscal Year Ended December 31,

    Change

 
               2003          

              2004          

    In Dollars

   Percentage

 

Professional services (1)

   $ 6,417,803     $ 15,049,399     $ 8,631,596    134 %

Percentage of total revenue

     39 %     38 %             

(1) Includes non-cash stock-based compensation expense of $653,050 for 2003 and $1,544,781 for 2004.

 

The increase in professional services expense from 2003 to 2004 resulted primarily from the following factors:

 

  ·   Physician Compensation Expense.    Our physician compensation expense increased from $5.3 million for 2003 to $12.7 million for 2004, a 140% increase. This increase resulted primarily from an increase in the number of our affiliated radiologists providing service as well as an increase in the service fees we paid to our affiliated radiologists as a result of scheduled increases in hourly compensation under the terms of the professional services agreements with our affiliated radiologists. From December 31, 2003 to December 31, 2004, we increased the number of our affiliated radiologists from 15 to 27. This increase was driven primarily by the increased demand for our services and was attributable to our ability to effectively recruit additional radiologists to meet such demand. However, our physician compensation expense as a percentage of service revenue decreased from 33% to 32% from 2003 to 2004. This decrease as a percentage of service revenue resulted primarily from increased workload efficiencies of our affiliated radiologists and improvements in our workflow technologies, offset in part by contractual increases radiologist hourly compensation.

 

  ·   Medical Liability Expense.    Our medical liability insurance related expense increased from approximately $491,000 for 2003 to $792,000 for 2004, a 61% increase. Of the approximately $792,000 expense recorded in 2004, $200,000 was attributable to a claims loss contingency expense on two medical liability claims. We had no claims loss contingency expense for 2003.

 

  ·   Physician Stock-Based Compensation Expense.    In 2003, we recorded physician stock-based compensation expense of approximately $653,000 in connection with the issuance of warrants to purchase membership units in Nighthawk Radiology Services, LLC to two of our affiliated radiologists. In 2004, one of these warrants remained outstanding, which we satisfied by issuing 1,007,500 shares of our common stock to that radiologist, resulting in a stock compensation expense of approximately $1.5 million. In addition, in 2004, we granted options to purchase an aggregate of 554,500 shares of our common stock to our affiliated radiologists, resulting in a stock compensation expense of approximately $46,000.

 

49


Table of Contents

Sales General and Administrative

 

     Fiscal Year Ended December 31,

    Change

 
               2003          

              2004          

    In Dollars

   Percentage

 

Sales, general, and administrative (1)

   $ 4,862,452     $ 11,991,386     $ 7,128,934    147 %

Percentage of service revenue

     30 %     31 %             

(1) Includes non-cash stock-based compensation expense of $0 for 2003 and $144,822 for 2004.

 

The increase in our sales, general and administrative expense from 2003 to 2004 resulted primarily from increases in payroll expense due to the implementation of our executive bonus plan as well as increases in personnel in our management, software development, quality control and licensing and privileging departments. In addition, sales, general and administrative expense for this period increased as a result of increases in information technology and telecommunications expenses, facilities and office-related expenses, licensing and privileging expenses, sales and marketing expenses and other general and administrative expenses. Finally, sales general and administrative expense was greater for 2004 than for 2003 due to certain equity issuances in 2004 that resulted in non-physician stock compensation expense.

 

  ·   Payroll and Related Expense.    Our sales, general and administrative headcount increased from 53 at December 31, 2003 to 98 at December 31, 2004, an 85% increase. This resulted in an increase in payroll expense from approximately $2.6 million for 2003 to $7.1 million for 2004, a 173% increase. This increase in payroll expense resulted primarily from the implementation of our executive bonus plan as well as personnel additions in our quality control, information technology, finance, and licensing and privileging departments. Expressed as a percentage of service revenue, sales, general and administrative payroll expense increased from 16% of service revenue for 2003 to 18% of service revenue for 2004. This increase in sales, general and administrative payroll expense, expressed as a percentage of service revenue, resulted primarily from the implementation of the executive bonus plan.

 

  ·   Information Technology and Telecommunications Expense.    Our non-payroll information technology and telecommunications expense increased from approximately $381,000 for 2003 to $904,000 for 2004, a 137% increase. This increase resulted primarily from our continued investment in the redundancy and reliability of our network as well as increased costs associated with implementing and supporting an increased number of operating sites.

 

  ·   Facilities Expense.    Our facilities and office-based expense increased from approximately $431,000 for 2003 to $949,000 for 2004, a 120% increase. The increase in facilities and office based expense was driven primarily by increased facilities occupancy expenses associated with our office expansions in Sydney, Australia and Coeur d’Alene, Idaho, and the establishment of our reading facility in Zurich, Switzerland and our office in Milwaukee, Wisconsin.

 

  ·   Licensing and Privileging Expense.    Our non-payroll licensing and privileging expense consists primarily of fees paid in connection with the state medical licenses and hospital privileges we obtain on behalf of our affiliated radiologists. Non-payroll licensing and privileging expenses increased from $593,000 for 2003 to $931,000 for 2004, a 57% increase.

 

  ·   Other General and Administrative Expense.    Our other general and administrative expense increased from approximately $603,000 for 2003 to $1.6 million for 2004, or a 165% increase. The increase in other general and administrative expense was driven primarily by increased legal, consulting, accounting, and travel expenses.

 

  ·  

Non-Physician Stock Compensation Expense.    We recorded non-physician stock compensation expense of zero in 2003 because we did not issue any options or other equity securities to our employees, directors or non-physician contractors. In October 2004, we adopted the 2004 Stock Plan and began issuing options to employees and certain of our non-physician contractors. In 2004, we issued options to purchase an aggregate of 490,400 shares of our common stock to our employees, directors and non-physician

 

50


Table of Contents
 

contractors, resulting in stock compensation expense of $35,000. In addition, in June 2004, we issued 638,876 unvested shares of our common stock to an individual who now serves as a member of our board of directors. This resulted in a stock compensation expense of approximately $100,000 in 2004.

 

Other Income (Expense)

 

Interest Expense

 

     Fiscal Year Ended December 31,

    Change

 
               2003          

              2004          

    In Dollars

   Percentage

 

Interest expense

   $ 6,915     $ 880,671     $ 873,756    12,636 %

Percentage of service revenue

     %     2 %             

 

Our interest expense in 2003 consisted primarily of interest paid on an outstanding $1.1 million line of credit, while our interest expense in 2004 consisted primarily of interest payable under outstanding promissory notes issued to entities affiliated with Summit Partners as well as interest payable under a $3 million revolving line of credit with Silicon Valley Bank. The aggregate principal balance of the outstanding promissory notes was approximately $9 million at December 31, 2004. The aggregate balance of our revolving credit facility with Silicon Valley Bank was $3 million at December 31, 2004.

 

Change in Fair Value of Redeemable Preferred Stock Conversion Feature

 

     Fiscal Year Ended December 31,

    Change

 
               2003          

              2004          

    In Dollars

   Percentage

 

Change in fair value of redeemable preferred stock conversion feature

   $  —     $ 3,857,500     $ 3,857,500    %

Percentage of service revenue

     %     10 %             

 

There were no shares of redeemable preferred stock outstanding in 2003 and, as a result, we did not record any expense related to the redeemable preferred stock conversion feature in 2003. We first issued shares of our redeemable preferred stock on March 31, 2004. The fair value of the redeemable preferred stock conversion feature was approximately $1,670,277 on March 31, 2004 and approximately $5,527,777 at December 31, 2004. This increase in fair value of the redeemable preferred stock conversion feature resulted in expense of $3,857,500 for 2004. Upon completion of this offering, all outstanding shares of redeemable preferred stock will convert into common stock, and, as a result, we will not record any additional expense associated with the change in fair value of the conversion feature of our redeemable preferred stock.

 

Income Tax Expense

 

     Fiscal Year Ended December 31,

    Change

 
               2003          

              2004          

    In Dollars

   Percentage

 

Income tax expense

   $  —     $ 3,662,563     $ 3,662,563    %

Percentage of service revenue

     %     9 %             

 

We recorded an income tax provision of $0 for 2003 and approximately $3.7 million for 2004. Because we operated as a limited liability company, or LLC, during 2003, we were not subject to federal income taxes and therefore did not record an income tax provision for that period.

 

Redeemable Preferred Stock Accretion

 

     Fiscal Year Ended December 31,

    Change

 
               2003          

              2004          

    In Dollars

   Percentage

 

Redeemable preferred stock accretion

   $  —     $ 764,742     $ 764,742    %

Percentage of service revenue

     %     2 %             

 

51


Table of Contents

The redeemable preferred stock accretion is comprised of two types of accretion based on the underlying redeemable preferred stock: (1) $168,171 represents the accretion of dividends at a daily rate of 6% per annum, and (2) $596,571 represents the accretion of the carrying amount of the redeemable preferred to its redemption value using the effective interest method through the redemption period.

 

Comparison of Fiscal Years Ended December 31, 2002 and December 31, 2003

 

Service Revenue

 

     Fiscal Year Ended December 31,

   Change

 
               2002          

             2003          

   In Dollars

   Percentage

 

Service revenue

   $ 4,666,645    $ 16,216,322    $ 11,549,677    247 %

 

The increase in service revenue from 2002 to 2003 resulted primarily from an increase in the number of our radiology group and hospital customers. The number of radiology group and hospital customers to whom we provided service increased from 49 as of December 31, 2002 to 165 as of December 31, 2003, a 237% increase. The increase in the number of our customers that we provided service to resulted primarily from increased market acceptance of teleradiology as a solution, an increase in the recognition by the marketplace of the quality of our service offerings, the success by our sales professionals in generating new customers, as well as an improvement in our ability to meet the increased demand for our service, primarily through the addition of affiliated radiologists. In addition, although we are not able to accurately calculate the impact on a factor-by-factor basis due to lack of sufficient data, our increase in service revenue during this period also resulted from increased utilization by our customers of our hours of service and the growth in the use of diagnostic imaging technologies and procedures in the healthcare market during this period.

 

Operating Costs and Expenses

 

Professional Services

 

     Fiscal Year Ended December 31,

    Change

 
               2002          

              2003          

    In Dollars

   Percentage

 

Professional services (1)

   $ 1,941,452     $ 6,417,803     $ 4,476,351    231 %

Percentage of service revenue

     42 %     39 %             

(1) Includes non-cash stock-based compensation expense of $262,765 for 2002 and $653,050 for 2003.

 

The increase in professional services expense from 2002 to 2003 resulted primarily from the following factors:

 

  ·   Physician Compensation Expense.    Our physician compensation expense increased from $1.5 million for 2002 to $5.3 million for 2003, a 253% increase. This increase resulted primarily from an increase in the number of affiliated radiologists providing service as well as an increase in the service fees we paid to affiliated radiologists as a result of scheduled increases in hourly compensation under the terms of the professional services agreements with our affiliated radiologists. From December 31, 2002 to December 31, 2003, we increased the number of affiliated radiologists from 8 to 15. This increase was driven primarily by the increased demand for our services and was attributable to our ability to effectively recruit additional radiologists to meet such demand.

 

  ·   Medical Liability Expense.    Our medical liability insurance related expense increased from approximately $144,000 for 2002 to $491,000 for 2003, a 241% increase.

 

  ·   Physician Stock-Based Compensation Expense.    In 2002, we recorded physician stock-based compensation expense of approximately $263,000 in connection with the issuance of a warrant to purchase membership units in Nighthawk Radiology Services, LLC to one of our affiliated radiologists. In 2003, we issued an additional warrant to purchase membership units in Nighthawk Radiology Services, LLC to one of our affiliated radiologists, resulting in stock compensation expense of $653,000 in 2003.

 

52


Table of Contents

Sales General and Administrative Expense

 

     Fiscal Year Ended December 31,

    Change

 
               2002          

              2003          

    In Dollars

   Percentage

 

Sales, general, and administrative (1)

   $ 1,624,654     $ 4,862,452     $ 3,237,798    199 %

Percentage of service revenue

     35 %     30 %             

(1) Includes non-cash stock-based compensation expense of $0 for 2002 and $0 for 2003.

 

The increase in our sales, general and administrative expense from 2002 to 2003 resulted primarily from increases in payroll expense due to increases in personnel in our software development, quality control and licensing and privileging departments. In addition, sales, general and administrative expense for this period increased as a result of increases in information technology and telecommunications expense, facilities and office-related expense, licensing and privileging expense, sales and marketing expense and other general and administrative expense.

 

  ·   Payroll and Related Expense.    Our sales, general and administrative headcount increased from 17 at December 31, 2002 to 53 at December 31, 2003, a 212% increase resulting in an increase in payroll expense from approximately $814,000 for 2002 to $2.6 million for 2003, a 219% increase. This increase in payroll expense resulted primarily from the personnel additions in our quality control, information technology, finance, and licensing and privileging departments. Expressed as a percentage of service revenue, sales, general and administrative payroll expense decreased from 17% of service revenue for 2002 to 16% of service revenue for 2003.

 

  ·   Information Technology and Telecommunications Expense.    Our non-payroll information technology and telecommunications expense increased from approximately $98,000 for 2002 to $381,000 for 2003, a 289% increase. This increase resulted primarily from continued investment in the redundancy and reliability of our network as well as increased costs associated with implementing and supporting an increased number of operating sites.

 

  ·   Facilities Expense.    Our facilities and office-based expense increased from approximately $235,000 for 2002 to $431,000 for 2003, a 83% increase. The increase in facilities and office based expense was driven primarily by increased facilities occupancy expense associated with office expansions in Sydney, Australia and Coeur d’Alene, Idaho.

 

  ·   Licensing and Privileging Expense.    Our non-payroll licensing and privileging expense consists primarily of fees paid in connection with the state medical licenses and hospital privileges we obtain on behalf of our affiliated radiologists. Our non-payroll licensing and privileging expense increased from $201,000 for 2002 to $593,000 for 2003, a 195% increase.

 

  ·   Other General and Administrative Expense.    Our other general and administrative expense increased from approximately $210,000 for 2002 to $603,000 for 2003, a 187% increase. The increase in other general and administrative expense was driven primarily by increased legal, travel and radiologist recruiting expenses.

 

Other income (expense)

 

Interest Expense

 

     Fiscal Year Ended December 31,

    Change

 
               2002          

              2003          

    In Dollars

     Percentage

 

Interest expense

   $ 40,072     $ 6,915     $ (33,157 )    (83 )%

Percentage of service revenue

     1 %     %               

 

Interest Expense.    Our interest expense in both 2002 and 2003 consisted primarily of interest incurred on amounts outstanding under a line of credit. Interest expense decreased from 2002 to 2003 because we did not

 

53


Table of Contents

utilize the line of credit in 2003 to the same extent that we did in 2002, primarily because we were able to use the revenue generated from our services to fund our operating expenses.

 

Liquidity and Capital Resources

 

Cash and Cash Equivalents

 

Our financial position includes cash and cash equivalents of $7.9 million and $5.8 million at September 30, 2005 and December 31, 2004, respectively.

 

Operating Activities

 

Since our inception in August 2001, we have funded our operations primarily from cash flows generated by our operating activities. Net cash from operations in 2002, 2003 and 2004 was approximately $468,000, $4.3 million and $10.2 million, respectively. Net cash from operations was $7.9 million for the nine months ended September 30, 2004, and $6.2 million for the nine months ended September 30, 2005, a decrease of 22%.

 

For the nine months ended September 30, 2005, we generated net cash from operations of approximately $6.2 million from a net loss of approximately $21.1 million (which net loss reflects approximately $31.8 million of non-cash charges that did not impact our net cash from operations during this period). Our net cash from operations during this period included an increase in our accounts payable and accrued expenses of approximately $1.1 million, an increase in accrued payroll and related benefits of approximately $342,000 and an increase in our provision for doubtful accounts and sales credits of approximately $296,000 and was offset by an increase in accounts receivable of approximately $4.6 million, an increase in prepaid expenses and other assets of approximately $1.6 million, a decrease in deferred income taxes of approximately $653,000 and a decrease in our accrued interest payable of approximately $244,000. These changes can be attributed primarily to the growth in our business as well as other factors described more fully below.

 

For the nine months ended September 30, 2004, we generated net cash from operations of approximately $7.9 million from net income of approximately $3.1 million (which reflects approximately $3.5 million of non-cash charges that did not impact our net cash from operations during this period). Our net cash from operations during this period included an increase in our accounts payable and accrued expenses of approximately $2.1 million, an increase in our accrued payroll and related benefits of approximately $1.5 million and an increase in our deferred income taxes of approximately $279,000 and was offset by an increase in accounts receivable of approximately $2.5 million and an increase in prepaid expenses and other assets of approximately $249,000. These changes can be attributed primarily to the growth in our business.

 

The changes in our operating assets and liabilities, net of acquisitions, and the associated impacts on our net cash from operations during the nine months ended September 30, 2004 as compared to the changes during the nine months ended September 30, 2005 are primarily due to the following factors:

 

  ·   Accounts Receivable.    Accounts receivable increased by $4.6 million during the nine months ended September 30, 2005 compared to a $2.5 million increase during the nine months ended September 30, 2004. Increases in accounts receivable decrease cash from operations. This change was attributable primarily to increased service revenues during the nine months ended September 30, 2005 coupled with an increase in our days sales outstanding, or DSO, from 45 to 53. We calculate our DSO based upon a three month average of accounts receivable and revenue. The increase in our DSO was primarily due to an increase in the amount of time required to prepare and issue our monthly customer invoices during the transition period associated with our implementation of an automated billing system. We completed implementation of this automated billing process in September 2005 and believe it, together with an increased focus on the collection process, will enable us to prepare and deliver invoices more quickly.

 

  ·  

Accounts Payable and Accrued Expenses.    Accounts payable and accrued expenses increased by $1.1 million during the nine months ended September 30, 2005 compared to $2.1 million during the nine

 

54


Table of Contents
 

months ended September 30, 2004. Increases in accounts payable and accrued expenses increase cash from operations. This increase was primarily due to the expansion of our operations and the change in the timing of our payment of physician compensation. Prior to January 1, 2004, we paid our affiliated radiologists on the last day of the month during which services were rendered. In January 2004, we began to compensate our affiliated radiologists in the first week following the month in which the radiologists rendered the professional services. This change in the timing of payments to our affiliated radiologists resulted in an accrual for physician compensation at the end of the nine months ended September 30, 2004 that was not present at the beginning of that period.

 

  ·   Accrued Payroll and Related Benefits.    Our accrued payroll and related benefits increased by $342,000 during the nine months ended September 30, 2005 compared to a $1.5 million increase during the nine months ended September 30, 2004. Increases in accrued payroll and related benefits increase cash from operations. This change was due primarily to the implementation of an expanded executive, employee, and physician bonus plan and the timing of the payments of these liabilities. Prior to 2004, we did not accrue any liabilities associated with staff or physician bonuses as these bonuses were entirely discretionary and were declared and satisfied at the end of 2003. In 2004, we implemented a bonus plan for our executives, employees and physicians and accrued a liability for these bonuses throughout the year.

 

  ·   Prepaid Expenses and Other Assets. Our prepaid expense and other assets decreased by $1.6 million during the nine months ended September 30, 2005 compared to a decrease of $249,000 during the nine months ended September 30, 2004. Decreases in prepaid expenses and other assets decrease cash from operations. This change was due primarily to an increase in expenses related to this offering as well as an increase in prepaid medical liability premiums.

 

Net Cash Used in Investing Activities

 

Net cash used in investing activities was $2.4 million for the nine months ended September 30, 2005 compared to $1.5 million for the nine months ended September 30, 2004. This increase in net cash used in investing activities over this period resulted primarily from increased capital expenditures associated with purchases of equipment and continued investment in our information technology infrastructure. Net cash used in investing activities was $418,000 in 2002, $1.0 million in 2003 and $2.8 million in 2004. In November 2004, we acquired DayHawk Radiology Services, LLC for $1.2 million in cash (of which $500,000 was issued in the form of a promissory note which was repaid in May 2005) and the issuance of 480,000 shares of our common stock.

 

Net Cash Used in Financing Activities

 

Net cash used in financing activities was $1.7 million for the nine months ended September 30, 2005 compared to $3.2 million for the nine months ended September 30, 2004. In 2004, cash provided from financing activities included $12 million in proceeds from the issuance of promissory notes and $13 million in proceeds from the issuance of redeemable preferred stock in connection with our recapitalization in March 2004. Of these proceeds, approximately $24.7 million was used to purchase all of the outstanding units in Nighthawk Radiology Services, LLC, held by persons other than our executive officers and approximately $1.5 million was used to satisfy expenses incurred in connection with the recapitalization. In addition, in 2004, we distributed approximately $2.2 million to the members of Nighthawk Radiology Services, LLC as a distribution of the LLC’s earnings in fiscal 2003 and the first quarter of 2004. Finally, in 2004, we entered into a $3.5 million revolving credit facility with Silicon Valley Bank, the proceeds of which we used to satisfy an aggregate of $3 million of the promissory notes issued in March 2004 to the holders of our redeemable preferred stock.

 

In April 2005, we entered into a term loan facility and revolving line of credit with Comerica Bank pursuant to a loan and security agreement, the proceeds from which we used to repay all outstanding indebtedness under the promissory notes held by entities affiliated with Summit Partners and the revolving credit facility with Silicon Valley Bank. In June 2005, we paid $750,000 to Comerica Bank as our first principal payment under our term loan facility. Any borrowing under this loan agreement is secured by a first priority security interest in all of our

 

55


Table of Contents

assets. The loan and security agreement includes customary affirmative and negative covenants and we are required to maintain certain leverage and coverage ratios. As of the date of this prospectus, we were not in default of any such restrictions or covenants.

 

In August 2005 we amended our term credit facility with Comerica Bank to provide for an additional $20 million of indebtedness. We borrowed an aggregate of $13 million under our term facility and distributed the amount as a special dividend to our common and preferred stockholders. Immediately prior to this offering, we borrowed an additional $7 million under our term loan facility and will distribute the amount as a special dividend to our common and preferred stockholders prior to the completion of this offering. We anticipate repaying all outstanding indebtedness to Comerica Bank with the proceeds of this offering.

 

We believe that our cash balances and the expected cash flow from operations will be sufficient to fund our operating activities, working capital, acquisitions and capital expenditure requirements for the next eighteen months. We expect our long-term liquidity needs to consist primarily of working capital, capital expenditure requirements and future acquisitions. We intend to fund these long-term liquidity needs from cash generated from operations. However, our ability to generate cash is subject to our performance, general economic conditions, industry trends and other factors. Many of these factors are beyond our control and cannot be anticipated at this time. To the extent that funds generated by this public offering, together with existing cash and securities and cash from operations, are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. If additional funds are obtained by issuing equity securities, substantial dilution to existing stockholders may result. Other than our agreement with ATN, we are not currently a party to any agreement or letter of intent with respect to potential investments in, or acquisitions of, complementary businesses, services or technologies, although we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

 

Contractual Obligations and Commitments

 

The following table presents a summary of our contractual obligations and commitments as of September 30, 2005 excluding the redeemable preferred stock and redeemable common stock. Upon the completion of this offering all outstanding shares of redeemable preferred stock will convert into shares of common stock, the rights of the holders of redeemable preferred stock to receive accrued dividends will terminate and the redemption rights of certain holders of common stock will terminate. Professional services agreements with our affiliated radiologists are not included because they are terminable by either party, subject to certain notice provisions. We intend to use a portion of the proceeds from this offering to repay in full all outstanding long term debt and accrued interest.

 

    Payments Due Within

   

1 Year


 

2-3

Years


 

4-5

Years


  More than 5
Years


  Total

Long term debt (including current portion)

  $ 5,143,421   $ 13,671,877   $ 5,566,404         —   $ 24,381,702

Interest on long term debt (1)

    1,480,165     2,064,034     322,790         3,866,989

Operating and capital lease commitments

    993,076     1,973,527     1,149,703     2,632,746     6,749,052
   

 

 

 

 

Total contractual obligations

  $ 7,616,662   $ 17,709,438   $ 7,038,897   $ 2,632,746   $ 34,997,743
   

 

 

 

 


(1) Future interest payments are calculated based on the assumption that all debt is outstanding until maturity. Interest has been calculated for all future periods using a rate of 6.5%.

 

56


Table of Contents

Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Currency Exchange Risk

 

Although our affiliated radiologists primarily work from our centralized reading facilities in Australia and Switzerland, the professional service fees we pay to our affiliated radiologists are primarily denominated in U.S. dollars. As such, only our operating leases in those countries represent foreign currency exchange risks. As a result, we are not currently subject to material foreign currency exchange risk, and we have not, to date, entered into any hedging contracts. If a weakening U.S. dollar requires us to increase the amounts we pay to our affiliated radiologists in the future, our results of operations and cash flows may be affected. Primarily, these risks are related to the foreign currency exchange rates between the U.S. dollar, the Australian dollar and the Swiss franc.

 

Interest Rate Sensitivity

 

We had cash and cash equivalents totaling $2.2 million at December 31, 2003, $5.8 million at December 31, 2004 and $7.9 million at September 30, 2005. These amounts were invested primarily in interest-bearing money market accounts. The cash and cash equivalents are held for working capital purposes. We do not enter into investments for trading or speculative purposes. We believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. However, any declines in interest rates will reduce future investment income. In addition, because we intend to use the proceeds of this offering to repay all currently outstanding debt obligations other than long-term capital lease obligations, we have determined that our debt is not subject to material interest rate risk.

 

Recent Accounting Pronouncements

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123(R)) which is a revision of SFAS No. 123. SFAS No. 123(R) and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123(R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments. Upon adoption, the fair value of all employee stock option awards will be expensed in our statement of income, typically, over the related vesting period of the options. SFAS No. 123(R) requires use of fair value to measure share-based awards issued to employees, computed at the date of grant. SFAS No. 123(R) will be effective beginning January 1, 2006. We have not yet completed our assessment and have not yet determined the effect of adopting SFAS No. 123(R).

 

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29 and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for the fiscal periods beginning after June 15, 2005. We have not determined the effect of adopting SFAS No. 153.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3.” This Statement replaces APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principles. This Statement applies to all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. The provisions of SFAS No. 154 are effective for fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS No. 154 in 2006 to have a material impact on our results of operations or financial position.

 

57


Table of Contents

BUSINESS

 

Overview

 

We believe that we are the leading provider of nighttime and weekend, or off-hours, emergency radiology services to radiology groups and hospitals across the United States. Our team of American Board of Radiology-certified, U.S. state-licensed and hospital-privileged radiologists uses our proprietary workflow technology to provide radiological interpretations, or reads, to our customers in the United States primarily from our centralized reading facilities located in Sydney, Australia and Zurich, Switzerland. By locating our affiliated radiologists in Australia and Switzerland, we can provide off-hours reads in the United States during our radiologists’ local daylight hours. The reads that we provide to our customers primarily consist of preliminary diagnoses of emergency trauma and non-traumatic emergency conditions.

 

As of September 30, 2005, our affiliated radiologists provided services to 383 customers serving 746 hospitals, or approximately 13% of all hospitals in the United States. Most of these customers do not currently contract for all of the hours of coverage that we are able to provide. Based on a 2003 survey conducted by the American College of Radiology which estimated the total number of annual reads performed in the United States during all time periods, we believe that we are the leading provider of reads during off-hours periods. Since our first full year of operations, we have experienced significant revenue growth, from $4.7 million in 2002 to $16.2 million in 2003 to $39.3 million in 2004 to $45.6 million for the nine month period ending September 30, 2005.

 

The U.S. healthcare market is experiencing a substantial increase in the development and use of diagnostic imaging technologies and procedures. From 2000 to 2003, computed tomography procedures, which currently comprise approximately 89% of the reads performed by our affiliated radiologists, increased at an average annual rate of 14.0%. In contrast, the number of radiologists is only increasing by approximately 1.5% annually. In addition, U.S. hospitals now generally require their contracted radiology groups to provide services 24-hours per day, seven days a week. As a consequence, radiologists have experienced, and we believe will continue to experience, increased workloads and increased demands to provide reads during off-hours periods.

 

For radiology groups, providing off-hours reads often results in the allocation of scarce physician resources to periods during which the volume of diagnostic imaging procedures for any one radiology group is typically low, resulting in operating inefficiencies and related costs. In addition, requirements to provide off-hours reads often limit the growth of radiology groups because of the difficulty of recruiting new radiologists into radiology groups that have off-hours coverage commitments. These radiology groups, which provide substantially all emergency radiology services in the United States, comprise the principal market for our services. By reducing the burdens associated with providing off-hours reads, we believe that we can improve the efficiency and productivity of radiology groups by enabling them to allocate their scarce physician resources to regular business hours, which typically are periods of higher demand. We also believe that our services enable radiology groups to recruit and retain radiologists more effectively, which permits them to pursue additional growth opportunities.

 

For individual radiologists, providing off-hours reads often results in a significant quality-of-life burden. During an on-call period, a radiologist may be required to perform reads several times during a night, often waking the radiologist or otherwise disrupting the radiologist’s evening. By providing off-hours reads on behalf of radiologists, we believe that our service improves their quality of life.

 

The substantial majority of the reads that we provide are preliminary diagnoses used by a treating physician to determine whether any immediate action is required in response to symptoms being presented by a patient. Typically, the preliminary diagnosis is followed the next morning by a more exhaustive final, or primary, read performed by a local radiologist affiliated with our customer. Because third-party payors and patients pay only for the primary reads performed by our customers and not the preliminary reads that we provide, our services do not result in any incremental costs to third-party payors or patients nor are we currently dependent on payments by them. All of our customers are located in the United States and, as a result, all of our service revenue to date has been generated from the United States.

 

58


Table of Contents

Industry Background

 

Diagnostic Imaging

 

The practice of diagnostic radiology involves the interpretation of images of the human body to aid in the diagnosis and treatment of diseases, conditions and injuries. Diagnostic imaging procedures include computed tomography, or CT, magnetic resonance imaging, or MRI, ultrasound, nuclear medicine and X-ray technologies. Diagnostic radiologists correlate imaging findings with clinical information and other medical examinations, make diagnoses and may recommend further examinations or treatments. Frost & Sullivan, a research firm, estimates that 420.7 million diagnostic imaging procedures were performed in the United States in 2003.

 

Due to significant advances in imaging quality and technology, diagnostic imaging procedures are becoming increasingly essential components of the practice of medicine in most medical centers and hospitals. The non-invasive nature of most diagnostic imaging procedures, combined with faster digital processing capabilities and rapid broadband connectivity that allows for the transmission of images to radiology experts, has made the performance of these procedures in the emergency room and in other treatment venues more appealing and practical. As a result, physicians are relying more heavily on imaging procedures and radiological interpretations provided by radiologists as a standard of care to aid in patient care management decisions, resulting in continuing growth in the volume of radiological procedures performed. According to Frost & Sullivan, the volume of diagnostic radiology procedures increased during the periods indicated as follows:

 

Type:


  

Procedures

in 2000


  

Procedures

in 2003


   Average
Annual
Increase (1)


   

Description


Computed Tomography (CT)

   34.1 million    50.6 million    14.0 %   Uses specialized X-ray equipment to create cross-sectional views of internal anatomy
Magnetic Resonance Imaging (MRI)    14.5 million    21.0 million    13.0 %   Uses radio frequency waves and a strong magnetic field to produce images of internal anatomy

Type:


  

Procedures

in 1993


  

Procedures

in 2003


   Average
Annual
Increase (1)


   

Description


Computed Tomography (CT)

   20.0 million    50.6 million    9.7 %   Uses specialized X-ray equipment to create cross-sectional views of internal anatomy

Ultrasound

   40.0 million    60.0 million    4.1 %   Uses high-frequency sound waves to obtain images of internal anatomy
Magnetic Resonance Imaging (MRI)    7.9 million    21.0 million    10.3 %   Uses radio frequency waves and a strong magnetic field to produce images of internal anatomy

X-ray

   231.5 million    270.1 million    1.6 %   Uses radiation passing through the body to produce images of internal anatomy

(1) Percentages calculated by NightHawk Radiology Holdings, Inc.

 

59


Table of Contents

The diagnostic imaging services industry is expected to continue to grow as a result of:

 

Positive market dynamics.    Increasing physician awareness and utilization of imaging as a standard of care to aid in patient diagnosis, including its use as a preventive screening method, as well as an increased availability of diagnostic imaging equipment in medical centers and hospitals, has fueled the growth of the diagnostic imaging industry. Also, the use of diagnostic imaging procedures has risen with the increased provision of healthcare services generally due to an aging population in the United States. In addition, hospital emergency rooms are increasingly the first point of entry into the healthcare system for patients, resulting in a greater number of radiological procedures being ordered by emergency room physicians. Finally, diagnostic imaging procedures are being ordered more frequently than in the past as physicians seek to better manage medical liability risks by gathering as much data as possible to support their diagnoses and treatment protocols.

 

Advances in diagnostic imaging technologies.    Advances in diagnostic imaging technologies and techniques have resulted in higher quality images, which facilitate the diagnosis of a wide variety of diseases and injuries quickly and accurately without exploratory surgery or other invasive procedures that are typically more expensive and result in higher risk and rehabilitation time to the patient. New imaging technologies and techniques have also permitted radiologists to make additional diagnoses not previously possible and have resulted in broader applications for diagnostic imaging technologies.

 

Advances in diagnostic-quality image transmission technologies.    The advent of the Digital Imaging and Communications in Medicine, or DICOM, standard for transferring images and associated information, high-speed broadband internet connections, digitization and picture archival and communication systems, or PACS, has contributed to increased utilization of diagnostic imaging technologies by permitting radiologists to practice remotely. As a result of these improvements in image transmission technologies, the time needed for an offsite radiologist to complete a read has generally decreased. Particularly in an emergency room setting, more rapid diagnosis of acute medical problems aids in the prompt identification of patients that need urgent surgery or hospital admission, decreases mortality and morbidity, and reduces healthcare costs by averting unnecessary hospital admissions and surgery.

 

The Current Approach to Off-hours Radiology

 

Emergency room physicians increasingly consider radiological interpretations a necessary resource that must be immediately available to them, including during off-hours periods, to aid their diagnoses. As a result, hospitals typically contract with outside radiology groups to provide radiological interpretations 24-hours per day, seven days a week.

 

At most hospitals, when an emergency occurs outside regular business hours and a radiological procedure has been performed, either the emergency room physician or a radiologist from the contracted radiology group will interpret the radiological images. For certain simple procedures, such as an X-ray of a broken bone, the emergency room physician often performs the interpretation. For more complex images of intricate anatomy generated by CT, MRI, ultrasound and nuclear medicine procedures, the on-call radiologist, rather than the emergency room physician, typically performs the interpretation. When an on-call radiologist is required to perform the read, emergency room personnel will contact the radiologist, often waking the radiologist or otherwise disrupting the radiologist’s evening, and then transmit the images, often to the radiologist’s home office. The radiologist will interpret the images and call or fax preliminary findings to the emergency room physician for appropriate patient management. During any given night, an on-call radiologist may repeat this routine several times. The following morning, a primary interpretation is performed by the same or a different radiologist in order to confirm the overnight analysis.

 

This approach presents certain challenges to radiology groups, including:

 

  ·  

Decreased productivity and efficiency.    As a consequence of the interrupted sleep patterns that often result from performing off-hours reads, a radiologist may be less productive or may not work at all the

 

60


Table of Contents
 

following day. In addition, providing off-hours reads requires the allocation of scarce physician resources to off-hours periods that for any one radiology group are typically characterized by lower volumes of procedures, which results in operating inefficiencies and related costs for a radiology group.

 

  ·   Recruitment and retention.    The on-call paradigm, characterized by nighttime and weekend service requirements, results in a compromised quality of life for on-call radiologists. The current shortage of radiologists has resulted in a job market where radiologists can be selective regarding professional opportunities and has increased the challenges associated with recruiting and retaining radiologists willing to provide off-hours reads. As a consequence, radiology groups are increasingly finding it difficult to retain radiologists or increase the size of their practice groups if they have off-hours coverage commitments.

 

Some radiology groups and hospitals have responded to these challenges by designating certain radiologists to work exclusively during the night. This approach also presents challenges due to the scarcity of radiologists interested in working nighttime shifts, high turnover rates and higher salary demands for such work. Also, there is often less camaraderie and onsite interaction with colleagues.

 

Our Solution

 

We believe we are the leading provider of off-hours emergency radiology services to radiology groups and hospitals across the United States. Our team of American Board of Radiology-certified, U.S. state-licensed and hospital-privileged radiologists provides radiological interpretations to our customers in the United States primarily from our centralized reading facilities located in Sydney, Australia and Zurich, Switzerland. We contract with radiology groups and hospitals in the United States to cover their off-hours radiology needs.

 

Key benefits of our solution to radiologists, hospitals and patients include:

 

  ·   Improved efficiency for our customers.    By using our services, radiology groups with off-hours coverage commitments may allocate scarce physician resources to periods during which the volume of radiological procedures is typically higher than during off-hours periods. This reallocation of resources can reduce the operating inefficiencies and related costs typically associated with providing off-hours coverage.

 

  ·   Enhanced quality of patient care.    We believe that our solution enhances the ability of our customers to provide high-quality healthcare services to their patients 24-hours per day, seven days a week as a result of the following:

 

  °   Focus on emergency radiology.    As of September 30, 2005, our affiliated radiologists received emergency radiological examinations from more than 746 hospitals, resulting in our affiliated radiologists devoting their working hours almost exclusively to performing emergency radiology interpretations. Due to this focus, we consider our affiliated radiologists to be specialists in the area of emergency radiology.

 

  °   Multiple physician review.    Our affiliated radiologists typically perform preliminary reads in order to assist emergency room physicians in determining what immediate care, if any, is necessary for emergency room patients. Following our preliminary read, a radiologist associated with the radiology group servicing the applicable hospital will typically perform a primary, or final, read. Because two independent radiologists review each set of radiological images, we believe that the expertise brought to each examination and the resulting quality of patient care is increased.

 

  °   Wider access to care.    Any hospital that has or installs a DICOM image server and that has broadband internet access can utilize our services. As a result, patients in underserved or rural communities, which are often challenged in recruiting radiologists to practice in their locales, can have the same access to radiological services as patients in other areas.

 

  °   Practice during daylight hours.    U.S. radiologists typically provide reads during nighttime shifts as a result of on-call coverage commitments. Our affiliated radiologists work primarily in our reading facilities located in Sydney, Australia and Zurich, Switzerland where, due to geographic time differences, they perform off-hours reads for our customers during the radiologists’ local daylight hours.

 

61


Table of Contents
  ·   Recruitment and retention of radiologists by our customers.    Our solution enhances the quality of life of our customers’ radiologists by reducing their off-hours coverage commitments. As a consequence, we believe that our customers can more effectively recruit and retain highly-qualified radiologists in a competitive job market where off-hours coverage commitments often result in lower job satisfaction.

 

  ·   Highly-qualified radiologists.    Our affiliated radiologists are American Board of Radiology-certified in the United States and have received their medical training at some of the most respected medical schools in the United States. These radiologists include former chief residents and fellows from Cornell University, Harvard University, New York University, Northwestern University, the University of Pennsylvania, Stanford University and Vanderbilt University. In recognition of the expertise that our affiliated radiologists have developed in emergency radiology, Harvard’s Brigham & Women’s Hospital has established a program that places their emergency radiology fellows in our Sydney facility in order to train with our affiliated radiologists.

 

  ·   Efficient delivery of services.    We have developed proprietary workflow technology that is designed to distribute radiological images and data to the appropriately licensed and privileged radiologist best able to provide the radiological interpretation in the least amount of turnaround time. As a result of this technology, together with the support provided by our administrative professionals, our affiliated radiologists can better focus on the interpretation of radiological images without the burden of dedicating valuable time to administrative matters, resulting in more efficient delivery of our services to our customers and their patients.

 

  ·   Centralized reading facilities.    We deliver our solution primarily from centralized reading facilities located in Sydney, Australia and Zurich, Switzerland. By utilizing a centralized approach to the provision of radiology services, we believe that we are able to enhance the quality, efficiency and reliability of the services that we provide to our customers in the following ways:

 

  °   Quality-control professionals.    Our quality-control professionals relieve much of the administrative and technical burden typically associated with a radiology practice by coordinating the communication and transmission of images with the originating hospitals, remediating any technology failures, and finalizing and delivering the results of our affiliated radiologists’ reads. By reducing administrative burdens on our affiliated radiologists, our quality-control professionals enable our affiliated radiologists to better focus on the interpretation of radiological images, which we believe enhances the quality and efficiency of our solution.

 

  °   Quality-assurance professionals.    Our quality-assurance professionals serve as liaisons to our customers and evaluate and respond to any feedback that we may receive. We believe that these professionals enable us to quickly and effectively improve our services in order to respond to the changing needs of our customers.

 

  °   Collaboration among radiologists.    When working in our centralized facilities, our affiliated radiologists are able to collaborate with one another regarding their reads, which we believe can increase the expertise that can be brought to any particular read.

 

  °   Technology infrastructure and technical-support professionals.    Our approach enables us to centrally deploy the computers and servers that comprise our technical infrastructure and to maintain a staff of on-site, technical-support personnel. As a result, we are able to monitor our computer systems and to take appropriate actions to prevent or respond to technical problems quickly and efficiently. We believe that this limits downtime and enhances the reliability of our services. Since our inception, our systems and our online connections to our customers have been operational during more than 99.9% of our service periods.

 

  ·   No additional cost to patient or third-party payors.    We currently contract directly with radiology groups and hospitals to provide radiology coverage, and bill the customer for the reads that we perform. Because the contracts between our customers and third-party payors typically permit the radiologists to charge a prescribed fixed fee only for primary reads, there are no additional costs for our services to the patients or third-party payors.

 

62


Table of Contents

Key benefits of our business model include:

 

  ·   First-mover advantage.    Our early entry into the emerging field of off-hours emergency radiology services has permitted us to become well-established with our customers and to establish a brand that we believe has become synonymous with off-hours radiology coverage. As a consequence of the relationships that we have developed with our customers, the current shortage of radiologists, and the burdens associated with licensing and privileging radiologists for a multi-state, multi-hospital practice, we believe that we can leverage our current market position to effectively compete with existing and future market entrants. In addition, we believe that newer market entrants may have difficulty recruiting and retaining the number of highly-qualified radiologists necessary to provide the breadth of off-hours coverage that we provide, and that they may be unable to efficiently manage the licensing and privileging requirements necessary to rapidly increase the size and geographic scope of their businesses.

 

  ·   Strong customer retention.    Since our formation in 2001, we have secured approximately 383 radiology groups and 91 hospitals as customers. Our customer contracts typically have one-year terms that automatically renew each successive year unless terminated by the customer or by us. Since our inception, more than 97% of our contracts up for renewal have been renewed. We believe that our outstanding customer retention rate confirms the economic and other benefits that our solution provides to our customers and their patients.

 

  ·   Recruitment and retention of radiologists by us.    We have been able in the past, and believe that we will continue to be able in the future, to recruit and retain radiologists as necessary to meet increasing demand for our services and the growth of our business. We believe that our success in recruiting and retaining radiologists in a competitive labor market is largely a result of our ability to provide our affiliated radiologists with flexible schedules that permit them to avoid nighttime work and our competitive compensation packages. In addition, we have strategically located our primary reading facilities in Sydney and Zurich in an effort to provide opportunities for radiologists to work in attractive, cosmopolitan cities.

 

  ·   Capital-efficient scalability.    We have designed our technology, workflow processes and facilities to accommodate continuing growth in our business and the volume of diagnostic images delivered to our affiliated radiologists for interpretation. We believe that we can accommodate future growth in our business in a capital-efficient manner because our fixed costs are a relatively small portion of our expenses and are largely unaffected by the volume of diagnostic images transmitted to our facilities or the distance of the transmissions. In addition, we believe that we can increase our number of affiliated radiologists and associated administrative professionals in a timely manner in response to increased demand for our services.

 

  ·   Licensing and privileging expertise.    All of our affiliated radiologists have the necessary licenses and privileges to read the images that are delivered to them, and we have developed a staff of more than 30 full-time professionals dedicated to obtaining and renewing the necessary licenses and privileges. We are accredited by the Joint Commission on the Accreditation of Healthcare Organizations, or JCAHO, which permits our customers’ hospitals, to the extent that they are also JCAHO-accredited, to rely on our internal privileging processes for our affiliated radiologists. This enables us to streamline a privileging process that otherwise can vary significantly among hospitals and to reduce the time required to launch services to a new customer. Our affiliated radiologists are licensed to practice medicine in an average of 39 states and have been granted privileges at an average of 368 hospitals.

 

Our Strategy

 

Our objective is to expand on our position as the leading provider of off-hours emergency radiology services to radiology groups across the United States. We believe that our brand has become synonymous with off-hours radiology coverage and that we have established a position as a leading innovator and thought-leader in the industry. We intend to capitalize on our brand and reputation to facilitate greater acceptance and expansion of

 

63


Table of Contents

teleradiology services while at the same time improving the overall quality of patient care. Key elements of our strategy include:

 

  ·   Target new customers with expanded sales and marketing efforts.    We intend to increase our customer base through a combination of sales and marketing initiatives, continued focus on customer service and the provision of services and technologies that meet our customers’ needs. We recently increased the number of direct sales professionals that we employ from five to twelve in order to continue to aggressively target radiology groups of all sizes.

 

  ·   Expand our customers’ utilization of our current service hours.    Our customers currently have the flexibility to contract with us for coverage commitments between the hours of 5 p.m. and 8 a.m., local time, Monday through Friday, and up to 24-hours per day on weekends and holidays. Most of our customers do not currently contract for all of the hours of coverage that we are able to provide. Through our sales and marketing efforts, we will seek to convince these customers to use additional hours of coverage during these time periods.

 

  ·   Expand our service offering.    Our centralized approach enables us to expand the hours of coverage that we make available to our customers. We intend to expand our hours of coverage beyond our current offerings. In addition, we intend to expand our services to include the provision of primary, not just preliminary, reads of radiological images. For example, we recently entered into a contract with U.S. Department of Veterans Affairs hospitals located in New York and New Jersey to provide primary reads to those hospitals.

 

  ·   Pursue strategic acquisitions.    We regularly consider, and intend to continue to pursue, strategic acquisitions that are complementary to our business or offer us other strategic benefits, such as broadening our service offerings, expanding our technology platform or strengthening our position in existing markets. For example, in November 2004, we acquired DayHawk Radiology Services, LLC, a teleradiology service provider, primarily to facilitate the expansion of our service hours. Also, in September 2005, we acquired American Teleradiology Nighthawks, Inc. This acquisition provided us with a business that allows us to increase our customer base by acquiring the customer contracts previously held by ATN, and we believe will accelerate our entry into a complementary teleradiology business in which we will provide radiological services to hospitals across the United States that are currently underserved by the radiologists located in their vicinities. We have integrated the operations of DayHawk and are in the process of integrating the operations of ATN into our operations. Because of the recent nature of the acquisition of ATN, we are in the process of identifying which of our operational procedures and efficiencies will integrate best with those of ATN. In addition to the benefits described above, strategic acquisitions may also facilitate our entry into other domestic or international markets.

 

  ·   Develop a market for our software technology.    We believe that there may be an opportunity to market our proprietary information management technology to radiology groups in the United States and around the world. Our software is designed to optimally distribute radiological images to the appropriately licensed and privileged radiologist best able to provide the radiological interpretation in the least amount of turnaround time, enabling the radiology group to operate its practice more efficiently and effectively.

 

Operations

 

Hours of service.    We primarily contract directly with radiology groups to provide off-hours radiology coverage for the hospitals that are their customers. We currently offer our off-hours services to our customers between the hours of 5 p.m. and 8 a.m., local time, Monday through Friday, and up to 24-hours per day on weekends and holidays. Our affiliated radiologists perform these off-hours reads primarily from our centralized reading facilities located in Australia and Switzerland where, due to geographic time differences, they are working during daylight hours. By locating our affiliated radiologists in Australia and Switzerland, we can provide off-hours reads in the United States during local daylight hours at our reading facilities. We also maintain a smaller reading facility in Coeur d’Alene, Idaho in order to provide daytime reads on weekends and holidays and to supplement the coverage that we provide from Australia and Switzerland.

 

64


Table of Contents

Affiliated radiologists.    As of September 30, 2005, we had 39 affiliated radiologists who were providing services for us, and an additional 6 radiologists who had entered into contracts with us but had not yet begun to provide services. We structure our relationships with our affiliated radiologists in a manner that we believe results in an independent contractor relationship, and we have no control over the radiological services or interpretations rendered by the radiologists or their independent judgment concerning the practice of medicine. We typically enter into two- or three-year professional services contracts with our affiliated radiologists. The contracts typically provide that we will make available a minimum number of hours that the radiologists can work per year and specify which of our reading facilities the radiologist will work from. In some cases, a contract will also provide that the radiologist may perform some work from the radiologist’s home in the United States. In each case, the contract is structured so that the radiologist has significant flexibility in determining, and control of, the radiologist’s work schedule.

 

We believe that our affiliated radiologists consider this flexibility an attractive and unique aspect of their relationship with us. Although we believe that our affiliated radiologists are satisfied with their relationships with us, due to our limited operating history, we are unable to predict our future retention rate with any certainty.

 

Our goal is to recruit the best radiologists in the United States and to afford them the opportunity to re-locate and work in one of our centralized reading facilities. Our current affiliated radiologists include former chief residents and fellows from Cornell University, Harvard University, New York University, Northwestern University, the University of Pennsylvania, Stanford University and Vanderbilt University. By locating our primary reading facilities in Sydney and Zurich, we believe that we are able to provide opportunities for radiologists to work in attractive, cosmopolitan cities. In addition, by utilizing a centralized approach, we offer radiologists the opportunity to work together and collaborate in a professional atmosphere intended to enhance their job satisfaction.

 

Our affiliated radiologists are required to hold a current license in good standing to practice medicine in each of the states from which they receive radiological images. In addition, our affiliated radiologists are required to have been granted privileges at each hospital from which those images originate. Due to these requirements, and because we were serving more than 746 hospitals as of September 30, 2005, our affiliated radiologists are licensed to practice medicine in an average of 39 states and have been granted privileges at an average of 368 hospitals.

 

Network and workflow.    We deliver our off-hours solution through a workflow process that utilizes public network infrastructures, virtual private networks, on-site servers, and proprietary workflow technologies. Our network has been designed to be secure, scalable, efficient and redundant. The following is a description of our workflow process:

 

  ·   Requisition of interpretations.    When a radiological procedure is performed on a patient, the radiology technologist at the hospital will order an interpretation by either faxing a requisition to our toll-free telephone number or sending the requisition electronically utilizing our software. The information faxed or sent electronically contains basic patient and procedural information and relevant clinical data. Upon completion of the procedure, the technologist transfers the images to us via an established virtual private network, or VPN. Upon receipt of the requisition order and images, one of our designated quality-control professionals faxes a confirmation of the receipt of the images and order to the technologist at the hospital.

 

  ·   Image transmission.    We process all incoming images and patient data at one of our centralized facilities located in Sydney, Australia, Zurich, Switzerland or Coeur d’Alene, Idaho, depending on the time of day. These facilities are connected to hospitals through VPNs, which encrypt the patient and clinical data for secure delivery. Typically, the radiological images are initially transferred to the internet via the hospital’s internet service provider. The images and data then traverse the internet through standard networking infrastructure and are automatically directed to one of our reading facilities.

 

We have designed our networks, server infrastructure, and workflow technologies to be efficient and redundant. In the event of a network or server failure, the originating hospital has been instructed to deliver the images and data set to an assigned radiologist from our radiology group customer. As a result,

 

65


Table of Contents

our processes are intended to ensure that a radiologist is always available to perform the necessary services for the hospital and the emergency room patient.

 

  ·   Order acceptance and assignment.    After the images and data sets are received at our reading facilities, they are processed for interpretation by our quality-control professionals using our proprietary workflow technology. We employ quality-control professionals who perform many of the administrative functions associated with performing radiological interpretations. These administrative tasks include ensuring the accuracy of patient information, coordinating and communicating with the emergency room and radiology department staff, ensuring the full receipt of the radiological-image data set, using our proprietary workflow solutions to distribute the images to one of our affiliated radiologists, and delivering the results back to the requesting physician.

 

  ·   Interpretation and delivery of report.    After the images and data sets have been received by our quality-control professionals, the assigned radiologist interprets the images, dictates his or her findings, reviews the transcription and submits a report back to the designated quality-control professional. The quality-control professional then proofreads the radiologist’s report and transmits it back to the requesting physician. After the report has been transmitted, the quality-control professional contacts the originating hospital to confirm that the report has been received. In certain cases, the quality-control professional will verbally communicate the findings to the healthcare professional at the originating hospital.

 

  ·   Quality-assurance processes.    We employ quality-assurance professionals whose primary responsibility is to serve as liaisons to our customers. Our quality-assurance professionals also process any feedback from our customers on any discrepancies between the preliminary reads by our affiliated radiologists and the primary reads by our customers’ radiologists.

 

Licensing and Privileging

 

For each hospital from which an affiliated radiologist receives radiological images, the affiliated radiologist must hold a current license in good standing to practice medicine in the state in which the hospital is located and must have been granted privileges to practice at that particular hospital. As a result, and because we were providing services to more than 746 hospitals as of September 30, 2005, we have licensed each of our affiliated radiologists in an average of 39 states and have privileged each of our affiliated radiologists at an average of 368 hospitals. By ensuring that our affiliated radiologists are licensed and privileged at many of our hospital sites, we design redundancy into our solution in order to minimize or eliminate the periods of time during which we do not have an affiliated radiologist available to provide services to a particular hospital.

 

The licensing procedures and requirements vary according to each state’s laws and regulations governing the issuance of medical licenses. These procedures typically include an extensive application process that covers significant aspects of the applicant’s professional and personal life. In addition, to maintain a license to practice medicine in a given state, the state will often require the physician to undergo continuing education and training and maintain minimum thresholds of medical liability insurance.

 

To facilitate compliance with the licensing requirements of the various states to which we provide services, we employ licensing specialists to manage the state medical license application processes for our affiliated radiologists. These state-licensing specialists perform a number of functions, including tracking expiration dates, implementing procedures to renew licenses, and tracking continuing medical education, medical liability insurance coverage and other ongoing licensing-related obligations.

 

As with state licensing procedures, the privileging requirements of each hospital can vary significantly. However, hospitals that are accredited under the Joint Commission on Accreditation of Healthcare Organizations, or JCAHO, are permitted to rely upon the privileging information and procedures from other JCAHO-accredited institutions. We have been a JCAHO-accredited entity since October 2003. As a result, JCAHO hospitals can accept our privileging information and procedures, which reduces the period of time before we can begin providing reads for those hospitals.

 

66


Table of Contents

Technology and Development

 

Site implementation.    After we enter into a contract with a new customer, our site-implementation professionals work with the technology personnel of the hospital that will provide images to us to configure a virtual private network, or VPN, connection and DICOM routing information to transfer images. Upon successful testing of the encryption and transfer of images via the VPN connection, we provide the hospital with written operating procedures that prescribe how to order a radiological interpretation, including through our proprietary online ordering system. Typically, we also conduct a telephonic, workflow training session to educate the appropriate hospital personnel about this process.

 

Systems and network administration.    We employ information technology professionals to maintain our systems and network and to provide technical support to our customers. Our customers may contact us for technical support 24-hours per day, seven days a week.

 

Software development.    We focus our research and development efforts on improving and enhancing our existing workflow solutions as well as on developing new solutions to enable us to more efficiently and effectively deliver our services to our customers. Our proprietary workflow solutions were developed by software engineers located in our Sydney, Australia and Milwaukee, Wisconsin offices.

 

Customers

 

Since our formation in 2001, we have secured approximately 372 radiology groups and 91 hospitals as customers. Our customer contracts typically have a one-year term that automatically renews for each successive year unless terminated by the customer or by us. Since our inception, more than 97% of our contracts that have been up for renewal have been renewed. We believe that our customer retention rate confirms the benefits that our solution provides to our customers. We do not have any one customer that represents more than 4% of our annual revenue.

 

Sales and Marketing

 

Sales.    We sell our services primarily through our direct sales force comprised of 12 telesales and field sales personnel who are organized by geographic regions in the United States. Our sales professionals focus their efforts on radiology groups of all sizes in addition to imaging centers and, in some cases, directly with hospitals. In addition, we have experienced in the past, and expect to experience in the future, the acquisition of new customers as a result of communications among radiology groups. We do not pay any fees or discounts associated with customers who generate new customer leads for us.

 

Marketing.    Our marketing objectives are to generate qualified sales leads, build our brand and raise awareness of NightHawk as the leading provider of off-hours emergency radiology services to radiology groups across the United States.

 

Our principal marketing initiatives include:

 

  ·   direct mail campaigns,

 

  ·   participation in, and sponsorship of, radiology conferences and trade shows, and

 

  ·   using our website to provide service and company information.

 

Competition

 

The market for off-hours radiology services is highly competitive, rapidly evolving and fragmented, and subject to changing technology and market dynamics. Our primary competitors include both large and small scale service providers, some of which have only a local or regional presence while others have a more national presence.

 

67


Table of Contents

We believe the principal competitive factors in our market include:

 

  ·   quality of the service provided,

 

  ·   turnaround time required to complete and return interpretations,

 

  ·   reputation of service provider,

 

  ·   number of states and hospitals in which radiologists are licensed and privileged,

 

  ·   market acceptance by radiology groups and hospitals,

 

  ·   quality and reliability of service-provider technology and workflow infrastructure,

 

  ·   quality of customer support,

 

  ·   sales and marketing capabilities of the service provider,

 

  ·   financial stability of the service provider, and

 

  ·   price of services.

 

We believe that we compete favorably on these factors. While some of our competitors offer similar types of radiological services to those that we provide, we believe that none of them has been able to capture all of the benefits of our solution. We cannot assure you that our competitors will not offer or develop services that are more attractive than ours or that will achieve greater market acceptance.

 

Government Regulation and Supervision

 

General.    The healthcare industry is highly regulated. Our ability to operate profitably will depend in part upon the ability of us, our affiliated radiologists, and our customers and their radiologists to obtain and maintain all necessary licenses and other approvals and operating in compliance with applicable healthcare regulations. We believe that healthcare regulations will continue to change. Therefore, we monitor developments in healthcare law and are likely to be required to modify our operations from time to time as the business and regulatory environment changes. Although we believe that we are operating in compliance with applicable federal and state laws, neither our current nor anticipated business operations has been the subject of judicial or regulatory interpretation. We cannot assure you that a review of our business by courts or regulatory authorities will not result in a determination that could adversely affect our operations or that the healthcare regulatory environment will not change in a way that restricts our operations.

 

Physician licensure laws.    The practice of medicine, including the practice of radiology and teleradiology, is subject to state licensure laws, regulations and approvals. Physicians who provide professional medical services to a patient via a telemedicine system must, in most instances, hold a valid license to practice medicine in the state in which the patient is located. We have established a system for ensuring that our affiliated radiologists are appropriately licensed under applicable state law.

 

Corporate practice of medicine; fee splitting.    The laws of many states, including states in which our customers are located, prohibit us from exercising control over the medical judgments or decisions of our affiliated radiologists and from engaging in certain financial arrangements, such as splitting professional fees with physicians. These laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. We structure our relationships with our affiliated radiologists and our customers in a manner that we believe is in compliance with prohibitions against the corporate practice of medicine and fee splitting, and in a manner that requires that our affiliated radiologists exercise complete control over their own medical judgments and decisions.

 

Medicare and Medicaid reimbursement programs.    Professional radiology interpretation services performed from a location outside of the United States are generally not reimbursable by the Medicare program

 

68


Table of Contents

and certain state Medicaid programs. Accordingly, we do not bill Medicare or Medicaid programs for professional services performed by our affiliated radiologists located outside of the United States. Instead, our revenue is primarily derived from service fees paid to us by our customer radiology groups and hospitals. As a result, our service fees do not fluctuate or change based solely on changes in Medicare or Medicaid reimbursement levels.

 

Federal and state anti-kickback prohibitions.    Various federal and state laws govern financial arrangements among healthcare providers. The federal anti-kickback law prohibits the knowing and willful offer, payment, solicitation or receipt of any form of remuneration in return for, or with the purpose to induce, the referral of Medicare, Medicaid, or other federal healthcare program patients, or in return for, or with the purpose to induce, the purchase, lease or order of items or services that are covered by Medicare, Medicaid, or other federal healthcare programs. Similarly, many state laws prohibit the solicitation, payment or receipt of remuneration in return for, or to induce the referral of patients in private as well as government programs. Violation of these anti-kickback laws may result in substantial civil or criminal penalties for individuals or entities and/or exclusion from participating in federal or state healthcare programs. We believe that we are operating in compliance with applicable federal and state anti-kickback laws and that our contractual arrangements with our customers are structured in a manner that is compliant with such laws.

 

Health Insurance Portability and Accountability Act of 1996.    HIPAA authorizes the imposition of civil money penalties against entities that employ or enter into contracts with individuals or entities who have been excluded from participation in the Medicare or Medicaid programs. We perform background checks on our affiliated radiologists, and do not believe that we employ or contract with any excluded individuals or entities. However, a finding that we have violated this provision of HIPAA could have a material adverse effect on our business and financial condition.

 

HIPAA also established several separate criminal penalties for making false or fraudulent claims to insurance companies and other non-governmental payors of healthcare services. These provisions are intended to punish some of the same conduct in the submission of claims to private payors as the Federal False Claims Act covers in connection with governmental health programs. We believe that our services have not historically been provided in a way that would place either our clients or ourselves at risk of violating the HIPAA anti-fraud statutes. We have recently entered into an agreement with a hospital that involves the indirect reimbursement of the services we provide, and we may enter into similar agreements in the future or agreements that provide for direct reimbursement of the services we provide. We could be vulnerable to prosecution under these statutes if any of our customers deliberately or recklessly submits claims that contain false, misleading or incomplete information.

 

In addition, the Administrative Simplification provisions of HIPAA require the promulgation of regulations establishing national standards for, among other things, certain electronic healthcare transactions, the use and disclosure of certain individually identifiable patient health information, and the security of the electronic systems maintaining this information. These are commonly known as the HIPAA transaction and code set standards, privacy standards, and security standards, respectively.

 

The administrative provisions of HIPAA direct the federal government to adopt national electronic standards for automated transfer of certain healthcare data among healthcare payors, plans and providers. HIPAA is designed to enable the entire healthcare industry to communicate electronic data using a single set of standards. We are a “covered entity” under HIPAA and, as such, we must operate in compliance with the electronic transaction code standards, privacy standards and security standards. Further, because we only provide treatment services to patients of our contracted radiology groups and hospitals that are either independent or jointly provided with services rendered by those entities, we do not fall within the definition of a “business associate.” A “business associate” is an entity that performs services for or on behalf of a covered entity and is required to enter into an agreement with that covered entity to comply with certain components of the HIPAA administrative simplification provisions. We have developed policies, procedures and systems for handling patient health information that we believe are in compliance with the requirements of HIPAA.

 

69


Table of Contents

In addition to HIPAA, Australia and many U.S. states have adopted statutes and regulations that are similar to or, in some cases, more stringent than HIPAA. We believe that our operations are consistent with these statutes and regulations.

 

Intellectual Property

 

Our principal intellectual property assets include our brand and our proprietary software technology. We rely primarily on trade secret and unfair competition laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect these assets. We believe that the name “NightHawk” cannot be afforded trademark protection as it is a generic term used to describe the provision of off-hours radiology services. However, we intend to pursue all protections available, including common law claims for unfair competition practices, for improper use of the NightHawk name. We also hold the registered trademark “DayHawk,” which is used internally to represent our hours of coverage during weekends and holidays.

 

In addition to our trade names, we have filed one patent application covering certain aspects of our proprietary workflow technology.

 

We enter into confidentiality and proprietary rights agreements with our employees, affiliated radiologists, consultants and other third parties and control access to software, documentation and other proprietary information.

 

If a claim is asserted that we have infringed the intellectual property of a third party, we may be required to seek licenses to that technology. In addition, we license third-party technologies that are incorporated into some elements of our services. Licenses from third-party technologies may not continue to be available to us at a reasonable cost, or at all. Additionally, the steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our proprietary rights. Competitors may also independently develop technologies that are substantially equivalent or superior to the technologies we employ in our services. If we fail to protect our proprietary rights adequately, our competitors could offer similar services, potentially significantly harming our competitive position and decreasing our revenue.

 

Legal Proceedings

 

We are involved in various legal proceedings arising in the ordinary course of our business activities. We are currently subject to five medical malpractice claims and, in the past, have been subject to a malpractice claim for which a settlement was paid by our insurance carrier. We maintain insurance policies with coverages that we believe are appropriate in light of the risks attendant to our business, and believe that the resolution of the current claims will not have a material adverse impact on our consolidated results of operations, cash flows or our financial position. However, depending on the amount of damages resulting from a current or future claim, an unfavorable resolution of a claim could materially affect our future results of operations, cash flows or financial position.

 

Employees and Independent Contractors

 

As of September 30, 2005, we had 145 employees. In addition, as of September 30, 2005, we had 39 affiliated radiologists who provide services to our customers and an additional 6 radiologists who had entered into contracts with us but had not yet begun to provide services. None of our employees is represented by a labor union. We consider our relationships with our employees and independent contractors to be good.

 

70


Table of Contents

Facilities and Assets

 

Our executive offices and principal office for marketing, sales and administration occupy approximately 10,600 square feet in Coeur d’Alene, Idaho under leases that expire in July and September 2006. Our reading facility and support staff operations in Sydney, Australia occupy approximately 6,900 square feet under two subleases that expire in October 2008. Our reading facility and support staff operations in Zurich, Switzerland occupy approximately 8,000 square feet under leases that expire in August 2009 and November 2010. Our office for information technology development occupies approximately 1,650 square feet in Milwaukee, Wisconsin under a lease that expires in February 2007. If we require additional space, we believe that we will be able to obtain such space on acceptable, commercially reasonable terms.

 

Our long-lived assets, including goodwill and other acquired intangible assets but excluding deferred tax assets, are located primarily in the United States. The following table sets forth the location of these long-lived assets, by value, as of the dates indicated.

     December 31,
2002


   December 31,
2003


   December 31,
2004


   September 30,
2005


United States

   $ 407,446    $ 883,968    $ 3,411,346    $ 7,843,030

Australia

     20,821      399,830      1,600,264      1,851,266

Switzerland

               23,842      415,610
    

  

  

  

Total

   $ 428,267    $ 1,283,798    $ 5,035,452    $ 10,109,906
    

  

  

  

 

71


Table of Contents

MANAGEMENT

 

Executive Officers, Directors and Key Employees

 

The following table provides information regarding our executive officers, directors and key employees as of September 30, 2005:

 

Executive Officers, Directors and Key Employees


  Age

  

Position(s)


Executive Officers:

        

Paul E. Berger, M.D.

  63   

President, Chief Executive Officer and Director

Christopher R. Huber

  37   

Chief Financial Officer, Vice President of Operations and Director

Jon D. Berger

  38   

Vice President of Sales, Marketing and Business
Development and Director

Other Directors:

        

David J. Brophy, Ph.D. (1)(2)(3)

  69   

Director

Peter Y. Chung (2)(3)

  37   

Director

Timothy M. Mayleben (1)(2)

  45   

Director

William G. Bradley M.D., Ph.D (1)

  57   

Director

Key Employees:

        

Paul E. Cartee

  32   

Vice President, General Counsel and Secretary

Andrea Clegg

  38   

Vice President of Finance

Peter Hausback

  46   

Vice President and Chief Accounting Officer


(1) Member of the audit committee

 

(2) Member of the compensation committee

 

(3) Member of the nominating and governance committee

 

Paul E. Berger, M.D. is one of our founders and has served as a director and as our President and Chief Executive Officer since 2004. From 2001 to 2004, Dr. Berger served as President of Nighthawk Radiology Services, LLC, our predecessor. Prior to joining us, Dr. Berger served as President of MD3 Corporation, a provider of radiological picture archiving and communications services, from 2000 to 2001. From 1996 to 2003, he served as President of Berger & Associates, a medical expert witness consulting firm, and as a physician with Radiology Associates of Northern Idaho. From 1989 through 1995, he served as President and Chief Executive Officer of MEMRAD Medical Group, Inc., the largest radiology group in the state of California. Dr. Berger received a B.S. from Tufts University and an M.D. from the State University of New York-Downstate. He received his radiology training at