424B4 1 d424b4.htm 424(B)(4) 424(b)(4)
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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-136504

4,000,000 Shares

LOGO

Virtual Radiologic Corporation

Common Stock

 


This is an initial public offering of shares of common stock of Virtual Radiologic Corporation. All of the shares of common stock are being sold by the Company.

Prior to this offering, there has been no public market for our common stock. The initial public offering price of our common stock is $17.00 per share. Our common stock has been approved for listing on the NASDAQ Global Market under the symbol “VRAD.”

 


See “ Risk Factors” on page 11 to read about factors you should consider before buying shares of the common stock.

 


Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 


 

     Per Share    Total

Initial public offering price

   $ 17.00    $ 68,000,000

Underwriting discount

   $ 1.19    $ 4,760,000

Proceeds, before expenses, to Virtual Radiologic Corporation

   $ 15.81    $ 63,240,000

To the extent that the underwriters sell more than 4,000,000 shares of common stock, the underwriters have the option to purchase up to an additional 600,000 shares from the selling stockholders named in this prospectus at the initial public offering price less the underwriting discount. We will not receive any proceeds from the sale of shares by the selling stockholders.

 


The underwriters expect to deliver the shares against payment in New York, New York on November 20, 2007.

Goldman, Sachs & Co.

Merrill Lynch & Co.

William Blair & Company

 


Prospectus dated November 14, 2007.


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

Prospectus
     Page

Prospectus Summary

 

   1

Risk Factors

 

   11

Special Note Regarding Forward-Looking Statements

 

   29

Our Corporate Structure and Affiliated Radiologists

 

   30

Use of Proceeds

 

   33

Dividend Policy

 

   33

Capitalization

 

   34

Dilution

 

   35

Selected Consolidated Financial Data

 

   37

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

 

   40

Business

   73

Management

   95

Compensation Discussion and Analysis

   100

Executive Compensation

   107

Certain Relationships and Related Party Transactions

   123

Principal and Selling Stockholders

   128

Description of Capital Stock

   131

Shares Eligible for Future Sale

   135

Material United States Tax Consequences to Non-United States Holders

   137

Underwriting

   140

Validity of the Common Stock

   144

Experts

   144

Changes in Certifying Accountants

   144

Where You Can Find More Information

   145

Index to Financial Statements

   F-1

 


        Through and including December 9, 2007 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 


No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 


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PROSPECTUS SUMMARY

The following prospectus summary does not contain all information that may be important to you and is qualified in its entirety by, and should be read in conjunction with, the more detailed information and our financial statements and the related notes appearing elsewhere in this prospectus. Virtual Radiologic Professionals of California, P.A., Virtual Radiologic Professionals of Illinois, S.C., Virtual Radiologic Professionals of Michigan, P.C., Virtual Radiologic Professionals of Minnesota, P.A., Virtual Radiologic Professionals of New York, P.A. and Virtual Radiologic Professionals of Texas, P.A. are collectively referred to as the “Professional Corporations.” Virtual Radiologic Professionals, LLC and the Professional Corporations are collectively referred to as the “Affiliated Medical Practices.” The terms “Company,” “we,” “us,” and “our” as used in this prospectus refer to Virtual Radiologic Corporation and our Affiliated Medical Practices.

Our Business

We believe we are one of the leading providers of remote diagnostic image interpretation, or teleradiology, services in the United States. According to Frost & Sullivan, we are the second largest provider of teleradiology services in the United States. We serve our customers—radiology practices, hospitals, clinics and diagnostic imaging centers—by providing diagnostic image interpretations, or reads, 24 hours a day, seven days a week, 365 days a year. Our unique distributed operating model provides our qualified team of American Board of Radiology-certified radiologists with the flexibility to choose the location from which they work, primarily within the United States, and allows us to serve customers located throughout the country. We provide these services through a robust, highly scalable communications network incorporating encrypted broadband internet connections and proprietary workflow management software. We have developed a strong customer base and have experienced significant revenue growth from $12.9 million in 2004 to $27.0 million in 2005 and $54.1 million in 2006. We have incurred net losses of $1.4 million, $1.5 million and $0.5 million for the same periods, respectively. In addition, our revenues grew from $37.9 million for the nine months ended September 30, 2006 to $63.3 million for the nine months ended September 30, 2007. We have incurred a net loss of $1.8 million and net income of $2.2 million for the same periods, respectively.

In recent years, the United States healthcare industry has experienced increasing demand for diagnostic imaging services. The increase in diagnostic imaging procedures is being driven by an aging population, advances in diagnostic imaging technologies and the growing availability of imaging equipment in hospitals and clinics, as well as by more frequent physician referrals for diagnostic imaging warranted by additional medical indications. According to Frost & Sullivan, digital diagnostic image procedure volume is expected to continue to grow 15% annually to over 500 million procedures by 2009. Additionally, advances in digital technology now allow for the transmission of images in a high quality, standardized, cost-effective and encrypted format, allowing radiologists to read remotely.

The number of radiologists in practice is expected to increase by less than 2% annually, according to the American Journal of Roentgenology, despite the expected growth in digital diagnostic image procedure volume. This relatively slow growth in radiologists, which is due, in part, to the retirement of existing radiologists and the limited number of positions in accredited radiology residency programs, is expected to exacerbate the radiologist shortage that currently exists. The shortage of radiologists and the growing imaging procedure volume are further compounded by the fact that contracted radiology practices are required to provide their hospital customers with services 24 hours a day, seven days a week in order to accommodate the growing number of off-hour procedures. Consequently, radiology practices and hospitals have begun to seek supplemental services to assist their own radiology staffs with both day and night coverage.

 

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We address this industry need by providing radiology practices, hospitals, clinics and diagnostic imaging centers an attractive way to improve service levels, streamline underlying practice economics and enhance physician efficiency, without sacrificing the quality of work. We assist our customers by providing them with access to subspecialty-trained radiologists to perform reads, day or night, thereby improving the quality of patient care. Our services include both preliminary reads, which are performed for emergent care purposes, and final reads, which are performed for both emergent and non-emergent care purposes. Our ability to provide coverage 24 hours a day supports our customers when their workloads increase during the day and relieves the burden of performing reads overnight, and during holidays, weekends and other difficult-to-staff times. We believe this allows our customers to provide seamless patient care and to better attract and retain radiologists in their practices.

Our unique distributed operating model and proprietary workflow management software provide our affiliated radiologists with a flexible choice of work location, predictable schedule and competitive compensation. Our affiliated radiologists, substantially all of whom are located in the United States, are certified by the American Board of Radiology, licensed by the states in which they practice and credentialed by the hospitals for which they perform reads. We have a large number of United States-based affiliated radiologists dedicated to the practice of teleradiology. Our affiliated radiologists collectively hold licenses in all 50 states, the District of Columbia and Puerto Rico. As of September 30, 2007, we had 106 radiologists providing services for us and had contracted with an additional 15 radiologists who had not yet begun servicing our customers.

Our primary customers are local radiology practices that have already contracted with hospitals and clinics and require diagnostic image interpretation services for a range of imaging modalities, including computed tomography, or CT, magnetic resonance imaging, or MRI, and ultrasound. We are compensated by our customers and do not directly depend on reimbursement from patients or third party payers. As of September 30, 2007, our affiliated radiologists provided services to 457 customers serving 787 medical facilities, which includes 736 hospitals, representing approximately 13% of hospitals in the United States. This represented an increase of 32% of medical facilities served and an increase of 35% in customers under contract since September 30, 2006. Since our inception, over 98% of our customer contracts up for renewal have been renewed.

Our Solution

We believe we are one of the leading providers of teleradiology services to radiology practices, hospitals, clinics and diagnostic imaging centers throughout the United States. According to Frost & Sullivan, we are the second largest provider of teleradiology services in the United States. Our services and technology enable our customers to provide a high quality of medical care to their patients. We serve our customers by providing reads 24 hours a day, seven days a week, 365 days a year. Utilizing our proprietary workflow management software and secure broadband internet connections, we connect our customers and our affiliated radiologists through an easy-to-use, robust and scalable communications network. We believe that the following are our key competitive advantages:

Leading Presence in Attractive Market

Our established presence, comprehensive service offering and technology allow us to create a critical solution for medical care providers faced with shortages in radiology resources. We focus on quality patient care and industry-leading service levels. We believe our brand name, reputation and ability to deliver quality results drive customer relationships and retention, in turn attracting the best radiology talent and performance. Since our inception, we have played an integral role in the development of the teleradiology services market and we maintain a growing customer base with recurring revenue.

 

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Improved Quality of Patient Care

We provide our customers with an attractive and economical way to improve service levels, increase the effectiveness of their work environment and enhance the quality of patient care. We enable our customers to provide patient care with 24 hour access to critical radiology services needed to effectively diagnose and treat patients. Since a majority of fellowship-trained specialists have traditionally located in metropolitan areas, patient access to required expertise is often limited in rural areas. Patient access to subspecialists is also limited in urban areas during off-hour, or emergency care, coverage periods when such subspecialists may not be locally available. We believe our services appropriately address this need, thereby improving the quality of patient care.

Our ability to rapidly assign reads to appropriately credentialed and trained specialists permits us to deliver high quality and specialized radiology services, including subspecialty services, to our customers. Our affiliated radiologists include subspecialty fellowship-trained radiologists in areas such as neuroradiology, abdominal imaging, musculoskeletal radiology, pediatric radiology, thoracic imaging and ultrasound, enabling us to match the appropriately skilled radiologist with the patient images we receive. We believe that the broad access and quality of the radiology services we provide to our customers have allowed us to achieve a high customer retention rate to date.

Sizable Group of U.S.-Based Radiologists Dedicated to Teleradiology

We have a large group of United States-based radiologists dedicated to the practice of teleradiology. While our technology platform allows radiologists to be located in any part of the world with high-speed internet access, we believe the United States presence of our affiliated radiologists affords us advantages in recruiting and retaining American Board of Radiology-certified physicians. Without requiring these physicians to relocate either domestically or internationally, we provide our affiliated radiologists with a flexible choice of location, predictable schedule and competitive compensation. In addition, the location of our affiliated radiologists allows us to respond to opportunities in the market for final reads, which must be performed by United States domiciled radiologists to comply with Medicare reimbursement rules. Finally, our group of affiliated radiologists enables us to serve customers who prefer utilizing radiologists practicing within the United States to perform their reads. To date, we have experienced radiologist retention rates (excluding those radiologists we have elected to terminate for non-compliance with the terms of their contracts) of 97%, 98% and 97% for the years ended December 31, 2005 and 2006 and for the nine months ended September 30, 2007, respectively. As of September 30, 2007, we had 106 radiologists providing services for us, and had contracted with an additional 15 radiologists who had not yet begun servicing our customers.

Unique Distributed Operating Model

Our operating model provides radiologists with digital access to images and allows instant delivery of their reports and direct communication with attending physicians, when required. We employ our proprietary Radiology Information System, or RIS, workflow management software, and operations center to maximize the efficiency of our affiliated radiologists while maintaining a high standard of quality, service and response time. Our systems efficiently:

 

  Ÿ  

prioritize and monitor the distribution of orders and images to radiologists;

 

  Ÿ  

facilitate the review and interpretation of images and the preparation of written study reports;

 

  Ÿ  

provide for rapid exchange of information between the radiologist and attending physician, if necessary;

 

  Ÿ  

permit rapid consultations among our affiliated radiologists in a computer work environment known as our “virtual reading room”; and

 

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  Ÿ  

provide our customers with immediate electronic access to a radiologist’s written report and an immediate follow-on report in hard copy.

Our proprietary workflow software manages our radiology caseload by matching the patient’s need with a properly licensed and credentialed radiologist with expertise to most adequately provide patient care. Our software optimizes the assignment of cases across our affiliated radiologists to minimize read turnaround times. Finally, our centralized administrative and operations support functions allow our affiliated radiologists to focus solely on providing reads without the distraction of administrative duties.

Scalable Technology Platform

Our substantial investment in designing, developing and installing our distributed network, proprietary workflow management software and radiologist reading tools has allowed us to complement rapid customer growth with new radiologist hires to meet growing customer demand. In addition to developing our proprietary RIS system, we have integrated additional technological solutions—such as a 3-D capable viewer and a voice recognition system—and ergonomically advanced reading stations, to maximize radiologist efficiency. We have also developed automation tools for all workflow processes for radiologist recruitment and deployment, licensing and credentialing, scheduling, finance and management reporting. Our wide area network efficiently connects our customers’ facilities to our distributed group of affiliated radiologists. In November 2006, we contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers. For the nine months ended September 30, 2007, our revenue from providing support services was $205,000. Our robust and highly reliable technological infrastructure is designed to manage volume levels several times our current size with modest additional capital investment.

Experienced Management Team

Our management team includes founding members who have designed our business model, infrastructure and platform necessary to deliver significant growth and execute our business plan. Dr. Sean Casey, a co-founder of our Company, has served as the Chief Executive Officer and a director of our Company and VRP’s predecessor since May 2001. Dr. Casey was formerly a clinical associate professor at the University of Minnesota and has published numerous professional journal articles on radiology. An American Board of Radiology-certified radiologist and neuroradiologist, Dr. Casey is a pioneer in the clinical use of cerebral CT angiography and venography. In addition to Dr. Casey’s extensive medical expertise, he is primarily responsible for the development of our service offerings and business model. Dr. Eduard Michel, a co-founder of our Company, has served as a director of our Company and VRP’s predecessor since May 2001. He has served as our Company’s Medical Director since July 2006, managing the engagement and performance of radiologists and overseeing the quality of radiology services. An American Board of Radiology-certified radiologist and neuroradiologist, Dr. Michel has published several professional articles on radiology and was formerly a clinical associate professor at the University of Minnesota. Dr. Michel also has significant experience in the private practice of radiology. We recently appointed Robert Kill as our President and Chief Operating Officer and Richard W. Jennings as our Chief Technology Officer. Mr. Kill has over 20 years of sales, marketing, operations and general management experience primarily in the healthcare services and technology sectors. Most recently, Mr. Kill was President of a leading software and services provider to the ambulatory market. Mr. Jennings has more than 25 years of information technology-related experience and has extensive management experience in technology focused companies.

Our Strategy

Our goal is to broaden our position as a leading teleradiology services provider by continuing to offer comprehensive services to our customers, 24 hours a day, seven days a week, 365 days a year.

 

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We intend to build upon our industry-leading service levels, innovative and scalable technology and highly regarded team of affiliated radiologists to expand our footprint. Our focus will remain on improving patient care while providing a compelling value proposition to both our customers and our affiliated radiologists. In order to achieve our objectives, we plan to:

 

  Ÿ  

increase our sales and marketing efforts to further expand our customer base;

 

  Ÿ  

advance our recruitment and deployment of U.S.-based qualified radiologists to meet increased demand for both preliminary and final reads;

 

  Ÿ  

expand services and increase utilization by our existing customer base, including final reads;

 

  Ÿ  

develop additional applications that permit expanded use of our technology platform by customers and hospitals; and

 

  Ÿ  

pursue acquisitions opportunistically.

Business Risks

Through the operation of our business and in connection with this offering, we are subject to certain risks related to our industry, our business and this transaction. The risks set forth under the section entitled “Risk Factors” beginning on page 11 of this prospectus reflect risks and uncertainties that could significantly and adversely affect our business, prospects, financial condition, operating results and growth strategy. In summary, significant risks related to our business include:

 

  Ÿ  

our ability to effectively manage our growth and development;

 

  Ÿ  

competition in the teleradiology market;

 

  Ÿ  

our ability to recruit and retain qualified radiologists; and

 

  Ÿ  

regulatory requirements, including the regulation of the corporate practice of medicine, that could impair our operations and profitability.

In connection with your investment decision, you should review the section of this prospectus entitled “Risk Factors.”

Corporate History and Information

Virtual Radiologic Corporation, or VRC, was formed through a merger between Virtual Radiologic Consultants, Inc., a Minnesota corporation, and Virtual Radiologic Consultants, Inc., a Delaware corporation, that was consummated on May 2, 2005. On January 1, 2006, Virtual Radiologic Consultants, Inc., a Delaware corporation and the surviving entity in the merger, changed its name to Virtual Radiologic Corporation.

Virtual Radiologic Professionals, LLC, or VRP, a Delaware limited liability company, is the successor by merger to Virtual Radiologic Professionals, PLC, a Minnesota professional limited liability company, which was the successor to Virtual Radiologic Consultants, LLC, a Delaware limited liability company organized in 2001 to engage in the provision of teleradiology. VRP is the physician-owned practice that contracts with our affiliated radiologists for the provision of their services to fulfill customer contracts held by VRC or our other Affiliated Medical Practices. See “Our Corporate Structure and Affiliated Radiologists.”

Our executive offices are located at 5995 Opus Parkway, Suite 200, Minnetonka, Minnesota 55343 and our telephone number is (952) 392-1100. Our website address is http://www.virtualrad.com. Our website and the information contained on, or that can be accessed through, our website are not part of this prospectus.

 

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The Offering

 

Common stock offered

4,000,000 shares

 

Over-allotment option

Sean Casey, Eduard Michel and Mark Marlow have each granted the underwriters an option for a period of 30 days to purchase up to 402,500, 172,500 and 25,000 additional shares of our common stock, respectively, or a total of 600,000 additional shares of our common stock, on the same terms and conditions set forth on the cover of this prospectus to cover over-allotments, if any.

 

Common stock to be outstanding after this offering

16,399,442 shares

 

Use of proceeds

We anticipate that we will use the net proceeds we receive from this offering for general corporate purposes, including the repayment of the outstanding debt under the term loan under our Senior Credit Facility, further development and expansion of our service offerings, the recruitment of additional radiologists, increased sales and marketing initiatives, and possible acquisitions of complementary businesses, technologies or other assets. We also plan to make improvements to our infrastructure, including continued development of our technology platform and increasing our corporate office space. We will not receive any proceeds from the sale of shares by the selling stockholders. See “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior Credit Facility.”

 

Listing

Our common stock has been approved for listing on the NASDAQ Global Market under the symbol “VRAD.”

 


The number of shares of our common stock to be outstanding after this offering excludes:

 

  Ÿ  

1,837,058 shares of common stock issuable upon exercise of options outstanding as of October 31, 2007, at a weighted average exercise price of $6.40 per share;

 

  Ÿ  

515,150 options to purchase shares of our common stock awarded to certain officers, directors, employees and independent contractor physicians, which are to be granted on the effective date of our registration statement on Form S-1, with an exercise price equal to the initial public offering price of one share of our common stock; and

 

  Ÿ  

613,020 shares of common stock reserved for future grants under our Amended and Restated Equity Incentive Plan, which will be in effect upon completion of this offering.

 

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Except as otherwise noted, all information in this prospectus:

 

  Ÿ  

gives effect to the conversion of the 3,626,667 outstanding shares of our preferred stock into 3,626,667 shares of our common stock; and

 

  Ÿ  

gives effect to our amended and restated certificate of incorporation and amended and restated bylaws, which will be in effect upon the completion of this offering.

 

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Summary Consolidated Financial Data and Operating Data

The following tables summarize historical financial data prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, 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” and our financial statements and related footnotes included elsewhere in this prospectus. The consolidated balance sheets and statements of operations data for the nine months ended September 30, 2006 and September 30, 2007, as set forth below, are derived from our unaudited consolidated financial statements. We have prepared the unaudited interim consolidated financial statements and related unaudited financial information in accordance with GAAP and the rules and regulations of the Securities and Exchange Commission, or SEC, for interim financial statements. These interim financial statements reflect all adjustments consisting of normal recurring accruals, which, in the opinion of management, are necessary to present fairly our consolidated financial position and results of operations for the interim periods. The statements of operations data for the years ended December 31, 2004, 2005 and 2006 and the consolidated balance sheet data as of December 31, 2005 and 2006 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The balance sheet data as of December 31, 2004 is derived from audited financial statements not included in this prospectus. The financial data presented below as of and for the years ended December 31, 2004 and December 31, 2005 reflects the consolidated operations of Virtual Radiologic Consultants, Inc., our predecessor corporation, and Virtual Radiologic Professionals, LLC. The financial data presented below as of and for the year ended December 31, 2006, and as of and for the nine months ended September 30, 2006 and 2007 reflects the consolidated operations of Virtual Radiologic Corporation and the Affiliated Medical Practices. The historical results presented below are not necessarily indicative of financial results to be expected in future periods.

 

    Year Ended December 31,       Nine Months Ended  
    2004     2005     2006    

September 30,

2006

   

September 30,

2007

 
    (in thousands, except per share data)  

Consolidated Statement of Operations Data:

         

Revenue

  $ 12,899     $ 26,991     $ 54,099     $ 37,934     $ 63,298  

Operating costs and expenses(1)

    14,142       29,816       53,594       37,961       56,272  
                                       

Operating (loss) income

    (1,243 )     (2,825 )     505       (27 )     7,026  

Other (expense) income

         

Interest expense

    (95 )     (131 )     (37 )     (28 )     (442 )

Interest income

          187       254       200       252  
                                       

Other (expense) income

    (95 )     56       217       172       (190 )
                                       

(Loss) income before non-controlling interest and income tax

    (1,338 )     (2,769 )     722       145       6,836  

Non-controlling interest expense (income)

    62       (1,362 )     25       285       2,091  

Income tax expense

          58       1,226       1,680       2,579  
                                       

Net (loss) income

    (1,400 )     (1,465 )     (529 )     (1,820 )     2,166  

Cash dividends paid:

         

Preferred

    —         —         —         —         (13,597 )

Series A Cumulative Redeemable Convertible Preferred Stock accretion

          (28,181 )     (11,437 )     (18,281 )     (25,068 )
                                       

Net loss available to common stockholders

  $ (1,400 )   $ (29,646 )   $ (11,966 )   $ (20,101 )   $ (36,499 )
                                       

Loss per common share

         

Basic and Diluted

  $ (0.25 )   $ (4.74 )   $ (1.80 )   $ (3.04 )   $ (4.91 )

Weighted average common shares outstanding:

         

Basic and Diluted(2)(3)

    5,659       6,254       6,640       6,617       7,436  

 

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Selected Operating Data:

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
    2004(4)   2005     2006     2006     2007  

Same site volume growth(5)

       24 %      20 %      20 %      17 %

 

    As of December 31,   As of
September 30,
    2004   2005   2006   2006   2007

Affiliated radiologists providing services

  34   53   72   67   106

Customers

  123   238   374   338   457

Hospitals and other medical facilities served

    216     446     663     596     787

 

    As of December 31,     As of
September 30,
 
    2004     2005     2006     2007  
   

(in thousands)

 

Consolidated Balance Sheet Data:

       

Cash and cash equivalents

  $ 484     $ 3,088     $ 5,958     $ 11,476  

Short-term investment

          5,092              

Restricted cash

          300       700       700  

Working capital(6)

    (927 )     10,319       11,658       19,024  

Total current assets

    2,955       13,948       19,670       31,866  

Long-term debt (including current portion)

                      41,000  

Total long-term capital lease obligations (less current portion)

    104       20              

Total liabilities

    4,078       3,849       8,532       51,068  

Non-controlling interest

    1,362             25       2,116  

Series A Cumulative Redeemable Convertible Preferred Stock

          40,090       51,527       76,596  

Total stockholders’ (deficiency) equity

    (1,089 )     (26,385 )     (34,435 )     (88,891 )

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
    2004     2005    

2006

   

2006

    2007  
    (in thousands)  

Cash Flow Data:

         

Net cash provided by (used in):

         

Operating activities

  $ 203     $ (1,794 )   $ 3,977     $ 4,131     $ 5,194  

Investing activities

    (360 )     (7,754 )     1,208       2,785       (3,574 )

Financing activities

    566       12,151       (2,315 )     (2,131 )     3,897  

 

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(1) Includes the non-cash stock-based compensation and depreciation and amortization charges set forth in the following table:

 

     Year Ended December 31,   

Nine Months Ended

September 30,

     2004    2005    2006    2006    2007

Professional services

              

    Non-cash stock-based compensation

   $ 154    $ 1,995    $ 3,416    $ 3,250    $ 2,928

Sales, general and administrative
Non-cash stock-based compensation

               115      49      408

Depreciation and amortization

     230      586      1,351      942      1,701
                                  

Total

   $ 384    $ 2,581    $ 4,882    $ 4,241    $ 5,037
                                  

 

(2) The calculation of weighted average common shares outstanding for the year ended December 31, 2004 assumes the five-for-one common stock split, which was effected in 2004, was effected on January 1, 2004.

 

(3) The calculation of weighted average common shares outstanding for the years ended December 31, 2005 and 2006, and the nine months ended September 30, 2006 and 2007 excludes the assumed conversion of the shares of Series A Cumulative Redeemable Convertible Preferred Stock into shares of common stock, because they are anti-dilutive. The calculation of weighted average common shares for the years ended December 31, 2004, 2005 and 2006 and the nine months ended September 30, 2006 and 2007 also excludes any other potential common stock equivalents that were outstanding during the relevant periods, calculated using the treasury stock method, because they are anti-dilutive.

 

(4) Our systems did not track same site volume in the year ended December 31, 2003 and therefore, we cannot calculate the same site volume for the year ended December 31, 2004.

 

(5) Same site volume growth is calculated as the percentage increase in the number of reads over the comparable prior year period generated by a facility that has been under contract for at least three months at the beginning of the measurement period and remains a customer throughout that period.

 

(6) Working capital is defined as current assets minus current liabilities.

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information in this prospectus, prior to making a decision to purchase shares of our common stock. This prospectus contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed herein. If any of the following risks occur, our business, results of operations or financial condition could be materially adversely affected.

Risks Related to Our Business

We have incurred operating losses and net losses in the past and may incur additional losses in the future. If we fail to increase our revenues to offset our expenses, we may not become profitable.

We have incurred operating losses in the past and we may incur additional operating losses in the future. We incurred operating losses of approximately $1.2 million in 2004 and $2.8 million in 2005, while generating operating income of $0.5 million in 2006. We have also incurred net losses of approximately $1.4 million in 2004, $1.5 million in 2005 and $0.5 million in 2006. As of September 30, 2007, we had an accumulated deficit of approximately $41.1 million. In addition, we expect our operating expenses to increase in the future as we expand our sales and marketing activities, increase our technology development efforts, hire additional personnel and comply with the requirements related to being a public company. If we cannot increase our revenues enough to offset these expected increased expenses, or the increase in expenses exceeds our expectations, we may never become profitable.

The industry in which we operate is highly 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 teleradiology is new, rapidly evolving and intensely competitive. We expect competition may intensify in the future, since barriers to entry for any licensed radiologist are not significant and the necessary technology is reasonably accessible. We compete directly with both large and small-scale service providers who offer local, regional and national operations. We believe that our principal competitor is NightHawk Radiology Holdings, Inc., or NightHawk, which completed its initial public offering in 2006 and, as a result, raised a significant amount of capital and currently has greater financial resources than we have. Certain of our competitors, including NightHawk, may be better known in the marketplace. Some of our competitors may offer their services at a lower price, which may result in pricing pressure. If we are unable to maintain our current pricing, our operating results could be negatively impacted. Moreover, pricing pressures and increased competition could result in reduced revenue and reduced profits.

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 have, 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 could lead to lower prices, reduced revenue and, ultimately, reduced market share. NightHawk acquired our other principal competitor, The Radlinx Group, in 2007.

 

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We have a limited operating history, and the industry in which we operate continues to develop.

We have a limited operating history in an emerging industry. As a result, our current business and future prospects are difficult to evaluate. You should consider us a company that is in the development stage, and subject to all of the ordinary risks associated with a new company in a rapidly evolving market. These risks include our need to:

 

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attract additional customers;

 

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continue to provide high levels of service quality to customers as we expand our business;

 

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quickly engage and integrate new radiologists and other key personnel;

 

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manage rapid growth in personnel and operations;

 

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respond to changing technologies and customer preferences;

 

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effectively manage our medical liability risk; and

 

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develop new services that complement our existing business.

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 be negatively impacted. Furthermore, our limited operating history has resulted in revenue growth rates that we may not be able to sustain, and therefore may not be indicative of our future results of operations. As a result, the price of our common stock could decline.

Our inability to effectively manage our growth could adversely affect our business and our operating results.

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, including our new President and Chief Operating Officer and our new Chief Technology Officer, to effectively manage this growth, as well as to effectively manage the transition to being a publicly traded company. Our management will be required to devote considerable time to this process, which will reduce the time our management will have to implement our business and expansion plans.

To effectively manage our business and planned growth, we must continue to improve our operational, financial and management processes and controls and our reporting systems and procedures. Furthermore, the additional headcount we are adding 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 are unable to effectively manage our growth, our expenses may increase more than expected, our revenues could decline or grow more slowly than expected and we may be unable to implement our business strategy.

We are currently subject to, and we may in the future become subject to additional, 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. On July 31, 2007, Merge eMed, Inc., or Merge, filed a complaint against VRC in the United States District Court for the Northern District of Georgia, Atlanta Division, alleging that VRC has willfully infringed on certain of Merge’s patents relating to teleradiology. Merge is seeking treble damages as well as its costs and legal fees in pursuing the action. Merge has asked the court for an injunction, ordering us to cease the alleged infringement of their patents, and also that the case be tried before a jury. While we are continuing to evaluate Merge’s allegations, we intend

 

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to defend against its claim. We may incur substantial costs defending against this claim. On September 14, 2007, we filed a Request for Reexamination with the United States Patent and Trademark Office, or US PTO, for the patents that Merge has asserted against us, which asks the US PTO to reexamine the validity of those Merge patents. There is no assurance that the US PTO will grant our request. In addition, on September 17, 2007, we filed a motion with the United States District Court for the Northern District of Georgia, Atlanta Division, asking the court to stay the proceeding that Merge had commenced in that court pending the outcome of our request for reexamination. There is no assurance the court will grant our motion. On October 2, 2007, Merge filed a response to our motion stating that it does not oppose our request to stay the proceeding pending the decision on our request for reexamination. We are unable to predict the outcome of this proceeding and we may become subject to a damage award, which could cause us to incur additional losses and adversely impact our financial position, results of operations and/or our cash flows. In addition, we may be required to seek to re-engineer our technology, to obtain licenses from Merge to continue using our technology without substantial re-engineering, or to seek to remove the accused functionality or feature as a result of the Merge claim. We could also be forced to take similar measures in the event that another party asserts that our technology violates that party’s proprietary rights or if a court holds that our technology violates such rights.

In addition, we license software and systems from third parties under agreements that typically provide that the licensor will indemnify us against infringement claims by third parties. Notwithstanding such indemnification, if we become involved in intellectual property litigation it will be expensive and time consuming and could divert management’s attention away from running our business.

Monitoring potential infringement of our intellectual property rights 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.

If we are unable to recruit and retain a sufficient number of qualified radiologists, our future growth would be limited and our business and operating results would be negatively impacted.

Our success is highly dependent upon our continuing ability to recruit and retain qualified radiologists through VRP or similar affiliated practices to perform radiological services for us despite the current shortage of radiologists in the medical profession. We face competition for radiologists from other healthcare providers, including radiology practices, research and academic institutions, government entities and other organizations. The competitive demand for radiologists may require us in the future to offer higher compensation in order to secure the services of radiologists. As a result, our compensation expense for our affiliated radiologists may increase and if we were not able to offset any such increase by increasing our prices, this could have a material adverse effect on our results of operations. 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.

If we are unable to obtain proper physician licenses or hospital credentials on behalf of our affiliated radiologists, or if our affiliated radiologists lose those licenses or credentials, our business, financial condition and results of operations may be negatively impacted.

Pursuant to hospital policies, each of our affiliated radiologists must be granted credentials to practice at each hospital from which the radiologist receives radiological images and, pursuant to state regulations, each of our affiliated radiologists must hold a license in good standing to practice medicine in the state in which the hospital is located and in the state in which the doctor is located. The requirements for obtaining and maintaining hospital credentials and state medical licenses vary significantly among hospitals and states. If a hospital or state restricts or impedes the ability of physicians located outside that particular state to obtain credentials or a license to practice medicine at

 

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that hospital or in that state, the market for our services could be reduced. For the nine months ended September 30, 2007, approximately 45.0% of our revenues from reads were generated from customers located in Texas (11.7%), New York (8.5%), Massachusetts (8.1%), Missouri (6.4%), California (5.2%) and Illinois (5.1%). Thus, any change in the requirements for obtaining and maintaining physician licenses and hospital credentials in those states in particular could have an adverse effect on our results of operations. While we maintain a staff of specially trained employees to process the necessary applications to obtain these licenses and credentials, any delay in obtaining new licenses or credentials could create a shortage of affiliated radiologists available to perform reads for a particular customer. In addition, any loss of existing credentials or medical licenses held by our affiliated radiologists could impair our ability to serve our existing customers and could have a material adverse effect on our business, financial condition and results of operations.

If our affiliated radiologists are characterized as employees, we would be subject to employment and withholding liabilities.

Through our Affiliated Medical Practices, we structure our relationships with our affiliated radiologists in a manner that we believe results in independent contractor relationships, not employee relationships. 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. If tax or regulatory authorities or state or federal 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. As a result, any determination that our affiliated radiologists are our employees would materially harm our business and operating results.

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

The independent contractor agreements with our affiliated radiologists typically provide that the radiologists may not engage in the teleradiology business, subject to certain exceptions, 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 of 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 non-competition covenants against our affiliated radiologists. Because our success depends in substantial part on our ability to preserve the services of our affiliated radiologists, a determination that these provisions are not enforceable could have a material adverse effect on us.

We are dependent upon certain key employees and the loss of their services may prevent us from implementing our business plan in a timely manner.

Our success depends largely upon the continued services of Sean Casey, M.D., our Chief Executive Officer, Chairman of the Board of Directors and founder. The loss of Dr. Casey could have a material adverse effect on our business, financial condition and results of operations. We are also dependent, to a lesser extent, on the services of our other executives and employees, the loss of whose services may also have such effects. 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.

 

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If we are unable to implement and maintain an effective system of internal controls, our ability to report our financial results in a timely and accurate manner, and to comply with Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, may be adversely affected.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls over financial reporting, including disclosure controls and procedures. In particular, we must perform system and process evaluation and testing on our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act commencing with the year ending December 31, 2008.

In connection with their audit of our consolidated financial statements for the year ended December 31, 2005 and reviews of our financial statements for certain interim quarterly periods in 2006, our independent registered public accounting firm determined material weaknesses existed in our internal controls over financial reporting because we lacked a sufficient complement of accounting personnel with an appropriate level of knowledge to account for certain complex, non-routine transactions, including non-employee stock-based compensation, variable interests and preferred stock financing transactions. These material weaknesses resulted in the previously disclosed restatement of our 2004 and 2005 consolidated annual financial statements, and the restatement of our financial statements for certain interim periods in 2006. Our management has taken steps to address these material weaknesses and improve our internal controls over financial reporting, including the hiring and training of additional experienced financial personnel and the implementation of additional internal control policies and procedures; accordingly, as of June 30, 2007, we were able to remediate the previously identified material weaknesses.

We may in the future discover areas of our internal controls that need improvement. We cannot be certain that any remedial measures we take will ensure that we are able to implement and maintain adequate internal controls over our financial reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our financial reporting obligations. If we are unable to conclude that we have effective internal controls over financial reporting, or if our independent registered public accounting firm is unable to provide us with an unqualified opinion regarding the effectiveness of our internal controls over financial reporting for the year ending December 31, 2008 and in future periods as required by Section 404, investors could lose confidence in the reliability of our consolidated financial statements, which could result in a decrease in the value of our common stock. Failure to comply with Section 404 could potentially subject us to sanctions or investigations by the Securities and Exchange Commission or other regulatory authorities.

Interruptions or delays in our or our customers’ 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 dependent in part on systems provided by third parties over which we have little control. Failure to maintain reliable information systems, or the occurrence of disruptions in our information systems, could cause delays in our business operations that could have a material adverse effect on our business, financial condition and results of operations. We have infrequently experienced downtime due to disruptions in services provided by a third party or associated with implementation of improvements to our system. Although our systems have been designed around industry-standard architecture to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to risks such as internet service denial attacks, security breaches, natural catastrophes affecting the geographic availability of internet access, unreliable internet performance due to

 

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increased traffic over the internet, or changes in internet protocols that render the technologies we rely on inefficient. Despite any precautions that we may take, the occurrence of such risks or other unanticipated problems could result in lengthy interruptions in our services. Frequent or persistent interruptions in our services could cause permanent harm to our reputation and brand and could cause customers to believe that our systems are unreliable, leading them to switch to our competitors. In addition, if any of our customers experience any problems with respect to their own internal information technology infrastructure, this could lead to a decrease in the number of reads they ask us to perform on their behalf. Because our customers use our services for critical healthcare needs, any system failures could result in damage to our customers’ businesses and reputations. These customers could seek significant compensation from us for their losses. Any claim for compensation, even if unsuccessful, would likely be time consuming and costly for us to resolve.

If our security measures are breached and unauthorized access is obtained to patient or customer data, we may face liabilities and our system may be perceived as not being secure, causing customers to curtail or stop using our services, which could lead to a decline in revenues.

We are required to implement administrative, physical and technological safeguards to ensure the security of the patient data that we create, process or store. These safeguards may fail to ensure the security of patient or customer data, thereby subjecting us to liability, including civil monetary penalties and possible criminal penalties. If our security measures are breached, whether as a result of third party action, employee error, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to patient or customer data, our reputation will be damaged, our business may suffer and we could incur significant liability. Because techniques used to obtain unauthorized access to systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures.

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 proprietary workflow software to transmit radiological images to the appropriately licensed and credentialed radiologist who is best able to provide the necessary clinical insight in the least amount of turnaround time. If we fail to adequately protect our intellectual property rights, our competition may gain access to our technology and our business may be harmed. We currently do not hold any patents with respect to our technology. We have filed seven provisional patent applications, one utility patent application and one international patent application covering certain aspects of our business processes and proprietary workflow software and we may file additional applications in the future. However, we may be unable to obtain patent protection for this technology. Many of our intellectual property rights, including licenses for certain software and systems, are not exclusive or proprietary and may be imitated or purchased by competitors.

Our ability to update our workflow technology may be limited because we are dependent upon a third party to make corresponding enhancements to its software.

We license certain image management software from Fujifilm Medical Systems U.S.A., or Fujifilm, a minority stockholder of VRC. We do not own the source code for the software that we license from Fujifilm. Therefore, when we make certain updates or enhancements to our workflow system, we are dependent upon Fujifilm to provide similar enhancements to the licensed software in order to accommodate the enhancements to our system. Fujifilm owns all rights in its software and all enhancements and modifications to its software. In the event that Fujifilm fails, or is unable, to make any such enhancements to the licensed software, our ability to effectively update and enhance our workflow system could be limited.

 

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

The laws of many states, including states in which our affiliated radiologists perform medical services, 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 they 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 substantial civil and criminal penalties and could be required to restructure or terminate the applicable contractual arrangements and our contractual arrangements may be unenforceable in that particular state. A determination that our arrangements with our affiliated radiologists and our customers violate state statutes, or our inability to successfully restructure these arrangements to comply with these statutes, could eliminate customers located in certain states from the market for our services, which would have a material adverse effect on our business, financial condition and operations.

As a result of our corporate structure, we are entirely dependent upon our Affiliated Medical Practices, which we do not own.

Our services are provided to our customers by VRC and our Affiliated Medical Practices. See “Our Structure and Affiliated Radiologists.”

We provide our services through contracts between our customers and VRC, and through contracts between our customers and one of our Affiliated Medical Practices. However, we do not own our Affiliated Medical Practices. VRP is owned by Dr. Sean Casey, Dr. Eduard Michel, Dr. Gary Weiss and Dr. David Hunter. In addition, each of the Professional Corporations is wholly-owned by Dr. Casey. While the ownership of our Affiliated Medical Practices is subject to certain restrictions contained in management agreements between VRC and each of them, any change in our relationship, whether resulting from a dispute between the entities, a change in government regulation, or the loss of these Affiliated Medical Practices, could impair our ability to provide services and could have a material adverse affect on our business, financial condition and operations.

Because many states prohibit the practice of medicine by a general business corporation, we have structured our operations and our relationship with our Affiliated Medical Practices such that approximately 47% of our revenue is generated from our Professional Corporations that perform services in such states. Accordingly, our revenue may be adversely affected by a change in our relationship with the Professional Corporations. Additionally, all of the medical services provided on behalf of us and the Professional Corporations are performed by independent contractor physicians under contract to VRP, and all compensation paid to such radiologists in consideration of those services is paid by VRP. Any disruption of the arrangement between us and VRP or our other Affiliated Medical Practices, whether resulting from a dispute between the entities, a change in government regulation, or otherwise, could have a material adverse effect on our business, financial condition and operations.

We have concluded that VRC is required to consolidate the Affiliated Medical Practices for financial reporting purposes. Through consolidation, we recognize all net losses of each Affiliated

 

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Medical Practice in excess of the equity of that Affiliated Medical Practice. We recognize net earnings of each Affiliated Medical Practice only to the extent we are recovering losses previously recognized with respect to that Affiliated Medical Practice. Earnings of each Affiliated Medical Practice in excess of losses previously recognized by us with respect to that Affiliated Medical Practice are excluded from our earnings and are attributed to the respective equity owners of that Affiliated Medical Practice by recording such earnings as non-controlling interest on our consolidated financial statements. As a result of this ownership structure among VRC and its Affiliated Medical Practices, certain future profits or losses may not inure to the stockholders of VRC.

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

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. There is a risk that an investment in our shares by our affiliated radiologists, including the distribution of any profits to our affiliated radiologists, the use of our equipment by physicians who own our securities, any assistance from healthcare providers in acquiring, maintaining or operating digital diagnostic imaging equipment, the marketing of our affiliated radiologists’ services or our compensation arrangements with our affiliated radiologists may be considered a violation of these laws. 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. If we are excluded from federal or state healthcare programs, our customers who participate in those programs would not be permitted to continue doing business with us. We believe that we are operating in compliance with applicable law and believe that 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.

Federal or state self-referral regulations could impact our arrangements with our affiliated radiologists.

The federal physician self-referral statute, known as the “Stark” statute, prohibits a physician from making a referral for certain designated health services, including radiology services, to any entity with which the physician has a financial relationship, unless there is an exception in the statute that allows the referral. The entity that receives a prohibited referral from a physician may not submit a bill to Medicare for that service. Many state laws prohibit physician referrals to entities in which the physician has a financial interest, or require that the physician provide the patient notice of the physician’s financial relationship before making the referral. There is a risk that an investment in our shares by our affiliated radiologists, including the distribution of any profits to our affiliated radiologists, the use of our equipment by physicians who own our securities, any assistance from healthcare providers in acquiring, maintaining or operating digital diagnostic imaging equipment, the marketing of our affiliated radiologists’ services or our compensation arrangements with our affiliated radiologists, could be interpreted as a violation of the federal Stark statute or similar state laws, if we were to accept referrals from our affiliated radiologists. Violation of the Stark statute can result in substantial civil penalties and can be the basis for claims under the Federal False Claims Act for both the referring physician and any entity that submits a claim for a healthcare service made pursuant to a prohibited referral. In addition, federal courts have ruled that violations of the Stark statute can be the basis for a legal claim under the Federal False Claims Act. We believe that all of our customer arrangements are in compliance with the Stark statute. However, these laws could be interpreted in a manner inconsistent with our operations.

 

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Because we and 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 results of 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 knowingly made a false statement or knowingly used a false record to have a claim approved. Federal courts have ruled that a violation of the anti-kickback provision of the Stark statute can serve as the basis for the Federal False Claims Act suit. 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 of which we are unaware. 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 the violator.

Historically, our customers, and not us, billed and received payments from Medicare and/or Medicaid for the professional services provided by our affiliated radiologists. In some instances, our customers and affiliated radiologists indicated that the practice location where the professional services occurred was the same as the address of the medical facility where the image was obtained for the purposes of submitting the applicable claims for reimbursement. It is possible that The Center for Medicare and Medicaid Services, or CMS, may take the position that claims submitted for reimbursement indicating the practice location as the same as the address of the medical facility where the image was obtained were not properly filed and, in such event, the Federal False Claims Act may be implicated. In 2006 and 2007, we revised our billing practices and we, instead of our customers, began in most cases to submit claims for reimbursement to Medicare and Medicaid directly. In those claims, we identify the practice location as the location where the image is interpreted by our affiliated radiologists and we remit the collected proceeds to our customers.

Under the Federal False Claims Act, we may be liable if we or one of our customers submitted a false claim. If we were found to have violated these rules and regulations and, as a result, submitted or caused our customers to submit a false claim, 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. If we are excluded from participation in federal or state healthcare programs, our customers who participate in those programs could not do business with us.

Federal regulatory and law enforcement authorities have recently increased enforcement activities with respect to Medicare and Medicaid fraud and abuse regulations and other reimbursement laws and regulations, including laws and regulations that govern our activities and the activities of teleradiologists. These increased enforcement activities may have a direct or indirect adverse affect on our business, financial condition and results of operations.

Additionally, some state statutes contain prohibitions similar to and possibly even more restrictive than the Federal False Claims Act. These state laws may also empower state administrators to adopt regulations restricting financial relationships or payment arrangements involving healthcare providers under which a person benefits financially by referring a patient to another person. We believe that we are operating in compliance with these laws. However, if we are found to have violated such laws, our business, results of operations and financial condition would be harmed.

 

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Future changes in healthcare regulation are difficult to predict and may constrain or require us to restructure our operations, which could negatively impact our business and operating results.

The healthcare industry is heavily regulated and subject to frequent changes in governing laws and regulations as well as to evolving administrative interpretations. Our business could be adversely affected by regulatory changes at the federal or state level that impose new requirements for licensing, new restrictions on reimbursement for medical services by government programs, new pretreatment certification requirements for patients seeking radiology procedures, or new limitations on services that can be performed by us. In addition, federal, state and local legislative bodies have adopted and continue to consider medical cost-containment legislation and regulations that have restricted or may restrict reimbursement to entities providing services in the healthcare industry and referrals by physicians to entities in which the physicians have a direct or indirect financial interest or other relationship. For example, Medicare recently adopted a regulation that limits the technical component of the reimbursement for multiple diagnostic tests performed during a single session at medical facilities other than hospitals. Any of these or future reimbursement regulations or policies could limit the number of diagnostic tests our customers order and could have a material adverse effect on our business.

Although we monitor legal and regulatory developments and modify our operations from time to time as the regulatory environment changes, we may not be able to adapt our operations to address every new regulation, and such regulations may adversely affect our business. In addition, we cannot assure you that a review of our 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 will restrict our operations.

Enforcement of state and federal regulations concerning the 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 which 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.

 

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Medicare and Medicaid rules governing reassignment of payments could affect our customers’ ability to collect fees for services provided by our affiliated radiologists and our ability to market our services to our customers.

The majority of our customers are radiology practices. These customers, and not us, bill and receive payments from Medicare and/or Medicaid for the professional services provided by our affiliated radiologists. Medicare and Medicaid payments may comprise a significant portion of the total payments received by our customers for the services of our affiliated radiologists. Medicare and Medicaid generally prohibit a physician who performs a covered medical service from “reassigning” to anyone else (including to other physicians) the performing physician’s right to receive payment directly from Medicare or Medicaid, except in certain circumstances. We believe we satisfy one or more of the exceptions to this prohibition, but the various Medicare carriers and state Medicaid authorities may interpret these exceptions differently than we do. Our customers could be prohibited from billing Medicare and/or Medicaid for the services of our affiliated radiologists if it were determined that we do not qualify for an exception, and this would cause a material adverse effect on our ability to market our services and on our business and results of operations. Future laws or regulations, moreover, may require that we bill Medicare or Medicaid directly for services we provide to certain prospective customers. Should this occur, we would either be required to forgo business with such customers or be required to design, develop and implement an appropriate recordkeeping and billing system to bill Medicare and Medicaid.

Medicare reimbursement rules generally provide that the proper Medicare carrier to pay physician claims is the Medicare carrier for the region in which the physician or practice providing the service is located rather than the Medicare carrier for the region in which the patient receiving the services is located. Many of our affiliated radiologists are located in a Medicare region that is different from the Medicare region in which the patient and treating hospital are located. It may be necessary for our customers to enroll with additional Medicare carriers in order to properly submit claims for reimbursement. Alternatively, we may submit those claims. Under such circumstances, we would continue to be paid by our customers, but would remit to them any funds that we received from Medicare. In order to accomplish this, it is necessary that we and our affiliated radiologists properly comply with the Medicare carrier claims submission procedures and properly remit funds to our customers.

Historically, our customers, and not us, billed and received payments from Medicare and/or Medicaid for the professional services provided by our affiliated radiologists. In some instances, our customers and affiliated radiologists indicated that the practice location where the professional services occurred was the same as the address of the medical facility where the image was obtained for the purposes of submitting the applicable claims for reimbursement. It is possible that CMS may take the position that claims submitted for reimbursement indicating the practice location as the same as the address of the medical facility where the image was obtained were not properly filed and, in such event, the Federal False Claims Act may be implicated. In 2006 and 2007, we revised our billing practices and we, instead of our customers, began in most cases to submit claims for reimbursement to Medicare and Medicaid directly. In those claims, we identify the practice location as the location where the image is interpreted by our affiliated radiologists and we remit the collected proceeds to our customers. We may be liable for any false claims submitted by us or one of our customers. See “—Because we and 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 results of operations.”

We have only recently completed all of the steps permitting us to file claims with some Medicare carriers and are awaiting approval from other carriers to begin submitting claims. We are unable to

 

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estimate when we will receive permissions from the remaining Medicare carriers, and extended delays could have a material adverse effect on our customers or our relationship with our customers and in turn on our business and results of operations. CMS has recently stated that for certain interpretation services provided to certain customers, reimbursement will be based upon the location of the interpreting physician, yet that reimbursement will be made by the Medicare carrier for the region in which the patient and facility are located. Whether this policy will be expanded to other types of interpretation services and facilities is unclear.

CMS recently published a proposed rule intended to eliminate a markup on the cost of radiology services that are purchased from outside suppliers, including VRC. The proposed rule would limit the reimbursable amount to the lowest of: (i) the amount paid to the physician for the service; (ii) the billing entity’s actual charge; or (iii) the Medicare physician fee schedule amount for the specific service. The proposed rule contains an exception from the limitation for the amount paid to the physician if the physician is a full time employee of the billing entity. If adopted in its present form, the rule would limit the amount our customers could obtain in reimbursement for final reads that we perform to the amount our affiliated radiologist receives rather than the amount our customer pays us for such reads. Unless we are able to restructure our relationship with our affiliated radiologists so that they become full time employees, the proposed rule could have a material adverse effect on our relationship with customers and, in turn, our operations and our revenues. The proposed rule does not define the term “full time employee,” nor does the rule provide any method of calculating the “amount paid to the physician” where the compensation arrangement between a physician and the billing entity is not based on a specific amount per read. CMS has solicited comments on the proposed rule. We cannot predict whether the proposed rule will be adopted or what the final rule may be and as a result, we cannot predict how the rule may affect our operations, including what modifications we might be required to make in our relationship with our affiliated radiologists and whether those modifications would be acceptable to our affiliated radiologists.

Changes in the rules and regulations governing Medicare and Medicaid’s payment for medical services could affect our revenues, particularly with respect to final reads.

Although most reads we provide are preliminary reads rather than final reads, we are providing an increasing number of final reads. Cost-containment pressures on Medicare and Medicaid could result in a reduction in the amount that the government will pay for a final read, which could cause pricing pressure on our services. Should that occur, we could be required to lower our prices, or our customers could elect to provide the final reads themselves or obtain such services from one of our competitors, and not utilize the services of our affiliated radiologists, which would have a material adverse effect on our business, results of operations and financial condition.

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

In its Fiscal Year 2004 Work Plan, the U.S. Department of Health & Human Services Office of Inspector General, or 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 read contemporaneously with the patient’s treatment. It is possible that, in the final report, the HHS-OIG could recommend to CMS that it change its reimbursement rules to clearly indicate that CMS will only pay for reads performed contemporaneously with a patient’s treatment by a physician located within the United States. If CMS were to adopt this recommendation, final reads would no longer be eligible for reimbursement if performed by a physician other than the one who performed the preliminary read. In turn, if our customers were no longer able to be reimbursed for certain final reads, our customers

 

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may seek alternative arrangements for the performance of their preliminary reads, which could adversely impact our business. For the nine months ended September 30, 2007, approximately 76% of our reads were preliminary reads.

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 reducing 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 that require physicians to pre-clear orders for diagnostic radiology procedures before those procedures can be performed. If pre-clearance protocols are broadly instituted 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. Litigation reform could lead to a reduction in 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.

Although we maintain medical liability insurance covering all of our affiliated radiologists, our Affiliated Medical Practices and our Company, we are subject to medical malpractice claims and other harmful lawsuits that may require us to pay significant damages if not covered by insurance.

Our business entails an inherent risk of claims of medical malpractice against our affiliated radiologists and us, and we may also be subject to other lawsuits that may involve large claims and significant defense costs. We may also be liable to our customers for certain medical malpractice claims. Although we currently maintain liability insurance coverage intended to cover professional liability and other claims, there can be no assurance that such insurance coverage will be adequate to cover liabilities arising out of claims asserted against us where the outcomes of such claims are unfavorable. In addition, this insurance coverage generally must be renewed annually and may not continue to be available to us in future years at acceptable costs and on favorable terms. Liabilities in excess of insurance coverage could have a material adverse effect on our business, financial condition and results of operations. Moreover, any adverse claims may negatively affect our reputation.

Our medical liability insurance policy provides coverage of up to $2 million dollars per incident, $4 million per physician and $20 million in total claims filed within the period of the policy term, subject to a $350,000 deductible per claim.

If we are unable to retain our customers because they terminate their contracts with us or allow those contracts to lapse, our operating results and financial condition may be adversely affected.

The contracts we have signed with our radiology practice, hospital, clinic and digital imaging center customers generally provide for an initial term of one year and automatically renew for successive terms unless earlier terminated pursuant to the terms of the contract. Many of the customer contracts also provide that either party may terminate the agreement without cause upon 90 days’ notice to the other party. 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

 

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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 practice customers’ agreements with the hospitals that they serve are terminated, our business, financial condition and results of operations could be adversely affected.

Because our contracts with our customers contain fixed prices, we are unable to pass along any increase in our expenses to our customers during their contract term.

We enter into multi-year, fixed-price contracts with our customers, pursuant to which we have agreed to perform our services for a fixed price. Accordingly, we realize all of the benefit or detriment resulting from any decrease or increase in expenses that we incur in providing our services during the term of such agreements. Our customer contracts do not permit us to recover any increases in our expenses from our customers during the contract term. As a result, any such increase in our expenses would result in a corresponding decrease in our profitability (or an increase in our losses).

We may be subject to less favorable levels of payment based upon third party payer fee schedules.

Many patients are covered by some form of private or government health insurance or other third party payment program. Third party payers generally establish fee schedules or other payment authorization methods for various procedures that govern which procedures will be reimbursed by the third party payers and the amount of reimbursement. In most cases, we are indirectly rather than directly impacted by such fee schedules, to the extent that such schedules impact the rates at which third party payers are willing to pay the healthcare providers with whom we contract to provide imaging services. However, if we were to negotiate direct payment arrangements with third party payers in the future, we would be directly impacted by such schedules. In addition, there is no guarantee that Medicare, state Medicaid programs, or commercial third party payers will continue to cover teleradiology services. Any reduction or elimination in coverage for our services could substantially impact 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.

An element of our strategy is to pursue strategic acquisitions or investments that are complementary to our business or offer us other strategic benefits. Any acquisitions or investments in which we may engage involve numerous risks, including:

 

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difficulties in integrating operations, technologies, services and personnel;

 

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diversion of financial and management resources from existing operations;

 

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risk of entering new markets;

 

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potential write-offs of acquired assets;

 

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potential loss of key employees; and

 

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inability to generate sufficient revenue to offset acquisition costs.

We may experience these difficulties as we integrate the operations of companies that we acquire with our current operations.

In addition, if we finance acquisitions by issuing convertible debt or equity securities, the shares owned by existing stockholders may be diluted, which could affect the market price of our stock. We

 

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have not made any acquisitions to date, and our management has limited experience in completing acquisitions and integrating acquired businesses into our operations. If we fail to properly evaluate and execute acquisitions, our business and prospects may be harmed.

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

We have historically experienced increased demand for our services and higher revenue growth during the second and third quarters of each year. For example, our same site volume growth, which we define as the percentage increase in the number of reads over the comparable prior year period generated by a facility that has been under contract for at least three months at the beginning of the measurement period and remains a customer throughout that period, was approximately 11% higher for the three months ended June 30, 2006 than for the three months ended March 31, 2006 and approximately 23% higher for the three months ended September 30, 2006 than for the three months ended March 31, 2006. In addition, same site volume growth was approximately 11% higher for the three months ended June 30, 2007 compared to the three months ended March 31, 2007 and approximately 21% higher for the three months ended September 30, 2007 than for the three months ended March 31, 2007. We believe that these increases are a result of increased outdoor and transportation activities during summer months, which leads to more hospital visits, as well as more frequent vacation time taken by our customers’ radiologists. During the first and fourth quarters of each year, when weather conditions are colder for a large portion of the United States, we have historically experienced lower revenue growth than that 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. Additionally, our ability to schedule adequate radiologist coverage during the seasonal period of increased demand for our services may affect our ability to provide faster turnaround times in our services to clients.

The Senior Credit Facility that we entered into in August 2007 may restrict our current and future operations.

We entered into a senior secured credit facility, or the Senior Credit Facility, in August 2007 that is comprised of a $4.0 million senior secured revolving credit facility, or the revolver, which is undrawn as of the date hereof, and a $41.0 million senior secured term loan, or the term loan, of which $41.0 million was outstanding as of September 30, 2007. The proceeds of the term loan after the payment of fees and expenses incurred in connection with the Senior Credit Facility, together with cash on hand, were used to fund a one-time dividend of $3.00 per share that was declared by our Board of Directors on August 10, 2007. On September 5, 2007, we paid an aggregate of approximately $39.9 million in respect of the dividend to all of our stockholders of record as of August 29, 2007.

The Senior Credit Facility contains restrictive covenants that may impose significant operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interests. Our Senior Credit Facility also provides that we may not pay any dividends other than stock dividends during the term of the agreement. In addition, the Senior Credit Facility requires compliance with certain financial ratios and covenants, including a leverage ratio, a fixed charge coverage ratio and a minimum Consolidated Adjusted EBITDA (as defined therein), including a minimum trailing twelve-month Consolidated Adjusted EBITDA. Our compliance with these financial covenants are material terms of the Senior Credit Facility and the failure to comply with these financial covenants could result in an event of default thereunder. The Senior Credit Facility allows the lenders certain remedies if an event of default occurs, including, but not limited to, the ability to terminate any commitments they have to provide further borrowings and the acceleration of amounts due thereunder. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior Credit Facility.”

 

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Risks Related to the Offering

There is currently no public market for shares of our common stock, and if a public market does not develop, you will not be able to sell your stock.

Prior to this initial public offering, there has not been a public market for shares of our common stock. We cannot predict the extent to which investor interest in us will lead to an active trading market, and if such a market does not develop, it will be difficult or impossible for you to sell the shares of common stock you acquire in this offering. Additionally, the initial public offering price for shares of our common stock may not be indicative of the prices that will prevail in the open market following completion of this initial public offering.

The following factors, in addition to the other risks described in this prospectus, may have a significant impact on the market price of our common stock:

 

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variations in our operating results;

 

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announcements of new services, new customers, strategic alliances or acquisitions by us or by our competitors;

 

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regulatory developments;

 

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market conditions in our industry and the industries of our customers;

 

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the loss of any of our key personnel;

 

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changes in financial estimates or recommendations by securities analysts;

 

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sales of large blocks of our common stock; and

 

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sales of our common stock by our executive officers, directors and significant stockholders.

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.

If we are not the subject of securities analyst reports or if any securities analyst downgrades our common stock or our sector, the price of our common stock could be negatively affected.

Securities analysts may publish reports about us or our industry containing information about us that may affect the trading price of our common stock. There are many publicly-traded companies active in the healthcare industry, which may mean it will be less likely that we receive analysts’ coverage, which in turn could affect the price of our common stock. In addition, if a securities or industry analyst downgrades the outlook for our stock or one of our competitors’ stocks, the trading price of our common stock may also be negatively affected.

Future sales of our common stock by our existing stockholders may negatively impact the trading price of our common stock.

If a substantial number of our existing stockholders decide to sell shares of their common stock in the public market following the completion of this offering, the price at which our common stock trades could decline. Additionally, the public market’s perception that such sales might occur may also depress the price of our common stock. Our directors, executive officers, and certain of our other existing stockholders have agreed to enter into lock-up agreements pursuant to which they have agreed not to sell shares of our common stock in the public market for a period of 180 days following the completion of this initial public offering. Our amended and restated certificate of incorporation,

 

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which will be in effect upon the completion of this offering, will authorize us to issue up to 100,000,000 shares of common stock, of which 16,399,442 shares will be outstanding and 2,352,208 shares will be issuable upon the exercise of outstanding stock options. Of the 16,399,442 shares outstanding upon the completion of this initial public offering, 4,546,799 shares will be freely tradeable without restriction (excluding any shares sold under the reserved share program, see “Underwriting” for a description of the reserved share program) and 11,852,643 shares will be freely tradeable following the expiration of the 180-day lock-up period. Following the completion of this initial public offering, we also anticipate filing a registration statement to register those authorized but unissued shares of common stock reserved for issuance under our equity incentive plan that will be in effect upon completion of this offering. In addition, some of our stockholders have the right to require us to register common stock for resale in certain circumstances. See “Certain Relationships and Related Party Transactions—Investor Rights Agreement.”

We will have broad discretion in how we use the proceeds of this offering and we may not use them effectively, which could affect our results of operations and cause our stock price to decline, or we may use the proceeds in ways with which you disagree.

We will have considerable discretion in applying the net proceeds of this offering. We anticipate that we will use the net proceeds we receive from this offering for the repayment of the outstanding debt under the term loan under our Senior Credit Facility, general corporate purposes, including further development and expansion of our service offerings, the recruitment of additional radiologists, improvement of our infrastructure, increased sales and marketing initiatives, and possible acquisitions of complementary businesses, technologies or other assets. Because of the number and variability of factors that determine our use of proceeds from this offering, our actual uses for the proceeds of this offering may vary substantially from our currently planned uses. Stockholders may not deem such uses desirable. In particular, in order to avoid regulation as an investment company under the Investment Company Act of 1940, as amended, and pending the use of the proceeds in the development and expansion of our business, we will be limited as to the ability to invest a substantial amount of our proceeds in assets other than cash items, such as cash, demand deposits with banks, shares of money market funds, government securities, securities issued by employees’ securities companies and certain certificates of deposit. Our use of proceeds in this manner may not yield a significant return for our stockholders.

You will experience immediate dilution in the book value of the shares of common stock you purchase in this offering.

After giving effect to the shares of common stock to be sold in this offering, the price per share that you pay will be higher than the book value of that share. As a result, you will incur immediate dilution in net tangible book value per share of $14.28. For a description of how dilution is calculated, see “Dilution” in this prospectus.

We do not intend to pay dividends on shares of our common stock for the foreseeable future.

We intend to use earnings in the future to fund and develop our business and, other than the dividend declared by our Board of Directors on August 10, 2007, which was paid on September 5, 2007 to all of our stockholders of record as of August 29, 2007, we have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to fund the operation, development and expansion of our business and we do not anticipate paying any cash dividends in the foreseeable future. See “Dividend Policy.” In addition, our Senior Credit Facility provides that we may not pay any dividends other than stock dividends during the term of the agreement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior Credit Facility.” Your potential gain from your investment in our common stock, therefore, will be solely the capital appreciation, if any, of our common stock.

 

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Our executive officers, directors and principal stockholders own a significant percentage of our Company and could exert significant influence over matters requiring stockholder approval.

We anticipate that our executive officers, directors and principal stockholders will together beneficially own approximately 61% of our common stock outstanding after this offering, or approximately 58% if the underwriters exercise their over-allotment option in full. Accordingly, our executive officers, directors, principal stockholders and affiliated entities, acting as a group, 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 may be taken even if other stockholders, including those who purchase shares in this offering, oppose such action. 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.

Certain provisions of our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law may have the effect of delaying or preventing an acquisition by a third party.

Our amended and restated certificate of incorporation and amended and restated bylaws, which will be in effect upon the completion of this offering, will contain several provisions that may make it more difficult for a third party to acquire control of our Company, even if such acquisition would be beneficial to our stockholders. For example, our amended and restated certificate of incorporation will authorize our Board of Directors to issue up to 6,370,000 shares of “blank check” preferred stock. Without stockholder approval, the Board of Directors will have the authority to attach special rights, including voting and dividend rights, to this preferred stock. With these rights, preferred stockholders could make it more difficult for a third party to acquire us. In addition, our amended and restated certificate of incorporation will provide for a staggered Board of Directors, whereby directors serve for three-year terms, with approximately one-third of the directors coming up for re-election each year. Having a staggered board will make it more difficult for a third party to obtain control of our Board of Directors through a proxy contest, which may be a necessary step in an acquisition of us that is not favored by our Board of Directors. Our amended and restated certificate of incorporation will also provide that the affirmative vote of the holders of at least 75% of the voting power of our issued and outstanding capital stock, voting together as a single class, is required for the alteration, amendment or repeal of certain provisions of our amended and restated certificate of incorporation, including the provisions authorizing a staggered board, and certain provisions of our amended and restated bylaws, including the provisions relating to our stockholders’ ability to call special meetings, notice provisions for stockholder business to be conducted at an annual meeting, requests for stockholder lists and corporate records, nomination and removal of directors, and filling of vacancies on our Board of Directors.

In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, or DGCL. Under these provisions, if anyone becomes an “interested stockholder,” we may not enter into a “business combination” with that person for three years without special approval, which could discourage a third party from making a takeover offer and could delay or prevent a change of control. For the purposes of Section 203, “interested stockholder” means, generally, someone owning 15% or more of our outstanding voting stock or an affiliate of ours that owned 15% or more of our outstanding voting stock during the past three years, subject to certain exceptions as described in Section 203.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. The forward-looking statements are contained primarily in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms including “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties.

Factors that could cause our actual results to differ materially from those expressed or implied in such forward-looking statements include, but are not limited to:

 

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the competition in the teleradiology market, including the possibility of pricing pressure resulting from that competition;

 

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our ability to effectively manage our growth and development;

 

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the outcome of the intellectual property claim against us by Merge, and any other future intellectual property claims;

 

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our ability to recruit and retain qualified radiologists;

 

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the loss of key members of management and personnel;

 

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our ability to obtain proper physician licenses and hospital credentials on behalf of our affiliated radiologists;

 

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the regulation of the corporate practice of medicine;

 

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our dependence on our Affiliated Medical Practices, which we do not own;

 

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our ability to enforce the non-competition agreements with our affiliated radiologists;

 

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new technologies;

 

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the breach of our security measures that safeguard patient and customer data;

 

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the performance of our information systems, which are dependent on systems provided by third parties; and

 

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our ability to comply with government regulations.

We discuss many of the foregoing risks in this prospectus in greater detail under the heading “Risk Factors.” Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions as of the date of this prospectus. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement of which this prospectus is a part completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

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OUR CORPORATE STRUCTURE AND AFFILIATED RADIOLOGISTS

Generally, laws regarding the corporate practice of medicine prohibit anyone but a duly licensed physician from exercising control over the medical judgments or decisions rendered by another physician. In certain states, only licensed physicians may own an interest in a professional corporation or association that provides medical services. Our corporate structure and contractual relationships with our affiliated radiologists and Affiliated Medical Practices have been designed to facilitate compliance with the various corporate practice of medicine laws in each jurisdiction in which we do business. These contractual relationships are also governed by federal law that requires that the prices we pay to, or receive from, our Affiliated Medical Practices must be based on fair market value and remain fixed for at least one year. We believe that we are in compliance with the corporate practice of medicine laws in each state in which our Affiliated Medical Practices and affiliated radiologists provide medical services. A more detailed description of our structure and relationships with our affiliates is set forth below.

The following diagram is a visual description of the structure between VRC and the Affiliated Medical Practices.

LOGO

The structure outlined above was created by us in order to facilitate compliance with corporate practice of medicine laws in the states in which we conduct our business. The organizations bear the following characteristics:

 

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VRC and the Affiliated Medical Practices are independent contractors of each other. As a result, neither is the employee or employer of the other.

 

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VRC owns the proprietary information technology structure and related intellectual property necessary to receive and transmit radiologic images to the properly licensed and credentialed physicians and to receive and transmit diagnostic reports to the proper facility.

 

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VRC participated significantly in the creation of the Affiliated Medical Practices.

 

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All independent contractor physician contracts are maintained by VRP. VRP pays all independent contractor physician compensation and medical malpractice insurance on behalf of these independent contractor physicians.

 

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Our services are provided to our customers by VRC and our Affiliated Medical Practices. VRC owns and operates the technical infrastructure over which our business is conducted. VRC contracts with our customers for the provision of our services in those jurisdictions in which we believe that it is lawful for a business corporation to contract for the provision of medical services, including providing reads. The services we provided directly through contracts between VRC and our customers represented $33.9 million, or 53% of our revenues for the nine months ended September 30, 2007. In those states in which only a physician-owned professional corporation may contract to provide medical services, the Professional Corporations contract with our customers to provide teleradiology services in those jurisdictions. The Professional Corporations collectively hold customer contracts that represented $29.4 million, or 47% of our revenues for the nine months ended September 30, 2007.

VRP is VRC’s affiliated medical practice that provides all radiologist services necessary to fulfill customer contracts held by VRC and the Professional Corporations. VRP is owned by Dr. Sean Casey, Dr. Eduard Michel, Dr. Gary Weiss and Dr. David Hunter. Dr. Casey is currently the Chief Executive Officer and Chairman of the Board of Directors of VRC, and Dr. Michel is currently the Medical Director of VRC and is a member of the Board of Directors of VRC. Dr. Casey, Dr. Michel, Dr. Weiss and Dr. Hunter are each stockholders of VRC and collectively held approximately 44% of VRC’s common stock on a fully diluted basis (without giving effect to the offering contemplated hereby) as of September 30, 2007.

In order to comply with applicable healthcare laws that require any agreement by a healthcare provider, such as VRP, and a management company or customer, such as VRC, to be in writing, to specifically identify the services being purchased or provided and to have a minimum term of one year, we have entered into a professional and management services agreement and license with VRP. Pursuant to this agreement and license, VRC provides all of the management services necessary for the operations of VRP and licenses VRC’s technology infrastructure to VRP for use by our affiliated radiologists. VRP provides physician services to fulfill VRC’s customer contracts. VRC pays VRP a fixed fee per read performed, which is intended to cover the cost of physician compensation paid to our affiliated radiologists and a portion of the costs of malpractice insurance. The fee rate is established by agreement between VRC’s Board of Directors and VRP with consideration for the fair market value of VRP’s use of VRC’s systems, technology infrastructure and management services. See Note 11 to our consolidated financial statements included in this prospectus for the fees paid under this agreement. Dr. Casey and Dr. Michel will recuse themselves from participation in the determination of this fee by VRC’s Board of Directors.

Under the professional and management services agreement and license, VRC has a right of first refusal with respect to the sale of any ownership interests in VRP and, in the event of a termination of the professional and management services agreement and license, is entitled to acquire or designate a buyer to acquire the ownership interests at a purchase price equal to the lesser of the amount paid for such membership interests or their book value. The professional and management services agreement and license remains in effect until terminated and is terminable by VRP only in the event of gross negligence, fraud or other illegal acts by VRC. The professional and management services agreement and license may be terminated by VRC with or without cause upon 60 days’ prior written notice.

The Professional Corporations are professional corporations wholly-owned by Dr. Casey. Each of the Professional Corporations is incorporated or qualified to do business in a state where only a physician-owned professional corporation may contract to provide medical services, including providing reads. Pursuant to management services agreements between VRC and each of the Professional Corporations, VRC provides all of the management services necessary for the operations of each of the Professional Corporations and licenses VRC’s technology infrastructure to each of the Professional Corporations. Each of the Professional Corporations pays VRC a management and license fee for each read performed on its behalf over VRC’s teleradiology systems. In addition, each of the Professional Corporations has contracted with VRP for the provision of physician services to fulfill

 

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customer contracts held by the Professional Corporation and pays VRP a fixed fee per read performed, which is established annually by the Board of Directors of VRC and the Professional Corporations and is intended to cover the cost of physician compensation paid to our affiliated radiologists and a portion of the costs of malpractice insurance. See Note 11 to our consolidated financial statements included in this prospectus for the fees paid under these agreements. Dr. Casey and Dr. Michel will recuse themselves from participation in the determination of this fee by VRC’s Board of Directors.

Pursuant to the agreement between VRC and each of the Professional Corporations, VRC is entitled to nominate successors in the event of the death or disqualification of any of the Professional Corporations’ stockholders, including any disqualification due to the loss of any such stockholders’ medical license as required by the law applicable to professional corporations in the jurisdiction of incorporation of such Professional Corporation. The purchase price for such stockholder’s shares is equal to the book value of the shares at the end of the month immediately preceding the stockholder’s death or disqualification. The management services agreements remain in effect until terminated and are terminable by the Professional Corporations only in the event of gross negligence, fraud or other illegal acts by VRC. Each Agreement may be terminated by VRC with or without cause upon 60 days’ prior written notice.

If, on an annual basis, the aggregate per-read fees received by VRP under the agreements with VRC and the Professional Corporations exceed the costs incurred by VRP in providing the services to VRC and the Professional Corporations, VRP will recognize a profit that will inure to its owners and not to VRC. Similarly, should the cost of providing the services exceed the aggregate of fees received by VRP, VRP will incur a loss that will also inure to its owners and not to VRC. Likewise, should the aggregate of the amounts paid by a Professional Corporation to VRC and VRP be less than the revenue received from customer contracts held by that Professional Corporation, the resulting profit will inure to the benefit of the owner of the Professional Corporation and not to VRC, as will any loss in case the amounts paid exceed revenues received. The Company and its Affiliated Medical Practices annually review and renegotiate fees payable under these agreements in light of the prior year’s results and expected results for the current year.

In January 2007, the agreements for the provision of physician services that were effective for the twelve months ended December 31, 2006 between VRP and VRC, and between VRP and each of the Professional Corporations, were amended to reflect an increase in the professional services fee charged by VRP to VRC and to each of the Professional Corporations for the year ended December 31, 2006. The increase in the fixed price per read was a result of higher than expected final read volume and the cost of providing our physician services that was not contemplated when the original fees were established. The change in the fees charged did not have a material effect on our consolidated financial position or results of operations.

 

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USE OF PROCEEDS

We will receive net proceeds from the sale of shares of our common stock in this offering of approximately $61.7 million, after deducting underwriting discounts, commissions and estimated offering expenses payable by us, excluding offering expenses of approximately $3.3 million that have already been paid.

The purposes of this offering are to create a public market for our common stock, to facilitate future access to the public equity markets and to obtain additional capital. We intend to invest the net proceeds of this offering in cash items, such as cash, demand deposits with banks, shares of money market funds, government securities, securities issued by employees’ securities companies and certain certificates of deposit, pending the use of the funds in the development and expansion of our business. We expect that the amount of proceeds held in these assets will decrease over time as our business expands. We anticipate that we will use the proceeds from sales of these assets for general corporate purposes. We estimate using the proceeds of this offering for:

 

  Ÿ  

the repayment of the outstanding debt under the term loan under our Senior Credit Facility (approximately $41.0 million of the proceeds);

 

  Ÿ  

the further development and expansion of our service offerings, including, among other things, capital and marketing expenditures related to licensing the use of our technology infrastructure and providing management and support services to our customers, including but not limited to the provision of licensing and credentialing services, separately from our provision of reads (approximately $5.0 million of the proceeds);

 

  Ÿ  

the recruitment of additional radiologists and increased sales and marketing initiatives, including, among other things, expansion to new markets (approximately $2.0 million of the proceeds); and

 

  Ÿ  

working capital and general corporate purposes (approximately $13.7 million of the proceeds).

We will not receive any proceeds from the sale of shares by the selling stockholders pursuant to the exercise of the underwriters’ over-allotment option, if it is exercised. For a description of our Senior Credit Facility, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior Credit Facility.”

DIVIDEND POLICY

Other than the dividend declared by our Board of Directors on August 10, 2007, which was paid on September 5, 2007 to all of our stockholders of record as of August 29, 2007, we have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to fund the operation, development and expansion of our business and we do not anticipate paying any cash dividends in the foreseeable future. In addition, our Senior Credit Facility provides that we may not pay any dividends other than stock dividends during the term of the agreement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Senior Credit Facility.”

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2007:

 

  Ÿ  

on an actual basis;

 

  Ÿ  

on a pro forma to reflect the following event as if it had occurred on September 30, 2007:

 

  (i) the conversion of the 3,626,667 outstanding shares of our preferred stock into 3,626,667 shares of our common stock (see “Description of Capital Stock” and “Certain Relationships and Related Party Transactions—Series A Preferred Stock Purchase Agreement”);

 

  Ÿ  

on a pro forma as adjusted to reflect the following events as if they had occurred on September 30, 2007:

 

  (i) the pro forma adjustment discussed above;

 

  (ii) the issuance and sale of 4,000,000 shares of our common stock by us in this offering less underwriting discounts and commissions and estimated offering expenses payable by us; and

 

  (iii) the repayment of the $41.0 million outstanding under the term loan under our Senior Credit Facility with the proceeds from this offering.

You should read the information below in conjunction with the financial statements and the related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

     As of September 30, 2007  
     Actual     Pro Forma     Pro Forma
As
Adjusted
 
    

(in thousands,

except per share data)

 

Cash and cash equivalents(1)

   $ 11,476     $ 11,476     $ 32,216  
                        

Debt:

      

Senior Credit Facility(2)

     41,000       41,000        

Series A Cumulative Redeemable Convertible Preferred Stock

     76,596              

Stockholders’ (deficiency) equity

      

Common stock, $.001 par value 21,500,000 shares authorized, 8,772,775 shares issued and outstanding, actual; 21,500,000 shares authorized, 12,399,442 shares issued and outstanding, pro forma; and 100,000,000 shares authorized, 16,399,442 shares issued and outstanding, pro forma as adjusted

     9       13       17  

Additional paid-in capital

     (47,764 )     28,828       87,276  

Accumulated deficit

     (41,136 )     (41,136 )     (41,136 )
                        

Total stockholders’ (deficiency) equity

     (88,891 )     (12,295 )     46,157  
                        

Total capitalization

   $ 28,705     $ 28,705     $ 46,157  
                        

 


(1) The actual, pro forma and pro forma as adjusted cash and cash equivalents reflect the payment of approximately $3.3 million in offering expenses that had already been paid by us as of September 30, 2007.

 

(2) The Senior Credit Facility consists of a $4.0 million revolver, which is undrawn as of the date hereof, and a $41.0 million term loan, of which $41.0 million which was outstanding as of September 30, 2007. We used the proceeds of the term loan after the payment of fees and expenses incurred in connection with the Senior Credit Facility, together with cash on hand, to fund a one-time dividend of $3.00 per share, which was declared by our Board of Directors on August 10, 2007. On September 5, 2007, we paid an aggregate of approximately $39.9 million in respect of the dividend to all of our stockholders of record as of August 29, 2007.

 

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DILUTION

Our net tangible book value as of September 30, 2007 was approximately $(93.8) million, or $(10.69) per share of common stock based on 8,772,775 shares of common stock outstanding. Net tangible book value per share represents the amount of our total tangible assets less the amount of our total liabilities and our Series A Cumulative Redeemable Convertible Preferred Stock, divided by the number of shares of common stock outstanding at September 30, 2007, prior to this offering. Our pro forma net tangible book value as of September 30, 2007 was approximately $(17.2) million or $(1.39) per share based on 12,399,442 shares of common stock outstanding after giving effect to the conversion of all outstanding shares of our Series A Cumulative Redeemable Convertible Preferred Stock into 3,626,667 shares of common stock. Pro forma net tangible book value per share represents our total tangible assets less our total liabilities divided by the pro forma number of common shares before giving effect to this offering. Dilution in net tangible book value per share represents the difference between the amount per share paid by investors in this offering and the pro forma, as adjusted, net tangible book value per share of our common stock immediately after this offering.

After giving effect to the sale of the 4,000,000 shares of common stock offered by us in this offering (after deducting underwriting discounts and estimated offering expenses payable by us), our pro forma net tangible book value, as adjusted, as of September 30, 2007 would have been approximately $44.6 million, or $2.72 per share of common stock. This represents an immediate increase in pro forma net tangible book value, as adjusted, to our existing stockholders of $4.11 per share and an immediate dilution to new investors in this offering of $14.28 per share.

The following table illustrates the per share dilution to new investors as of September 30, 2007:

 

Initial public offering price per share

      $ 17.00

Net tangible book value per share as of September 30, 2007

   $ (10.69 )   

Increase per share attributable to Series A Cumulative Redeemable Convertible Preferred Stock conversion

     9.30     
           

Pro forma net tangible book value per share as of September 30, 2007

     (1.39 )   

Increase per share attributable to new investors

     4.11     
           

Pro forma net tangible book value per share as of September 30, 2007, as adjusted

      $ 2.72
         

Dilution in net tangible book value per share to new investors

      $ 14.28
         

The following table summarizes, as of September 30, 2007, on a pro forma basis, as adjusted, the differences between our existing stockholders and new investors in this offering with respect to the total number of shares of common stock purchased from us, the aggregate cash consideration paid or deemed paid to us, and the average price per share paid or deemed paid. The calculation below reflects the initial public offering price of $17.00 per share, before deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

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     Shares Purchased     Total Consideration     Average Price
Per Share
     Number    Percent     Amount    Percent    

Existing stockholders(1)(2)

   12,399,442    76 %   $ 18,600,469    21 %   $ 1.50

New investors

   4,000,000    24       68,000,000    79       17.00
                          

Total

   16,399,442    100 %   $ 86,600,469    100 %   $ 5.28
                          

(1) The shares presented give effect to the conversion of our Series A Cumulative Redeemable Convertible Preferred Stock.
(2) Total consideration paid by existing stockholders does not give effect to approximately $39.9 million in dividends paid to holders of our Series A Cumulative Redeemable Convertible Preferred Stock and common stock. After payment of this dividend, total consideration paid by existing stockholders would have been approximately $(21.3) million or $(1.72) per share.

The number of shares of common stock outstanding in the table above is based on the number of shares outstanding as of September 30, 2007, on a pro forma, as adjusted, basis. If the underwriters’ over-allotment option is exercised in full, the number of shares outstanding held by existing stockholders will be reduced to 72% of the total number of shares of common stock outstanding after this offering and the number of shares of common stock held by new investors will be increased to 4.6 million, or 28% of the total number of shares of common stock outstanding after this offering.

As of October 31, 2007, there were options outstanding to purchase 1,837,058 shares of our common stock, with exercise prices ranging from $1.00 to $19.23 per share and a weighted average exercise price of $6.40 per share, and 515,150 options to purchase shares of our common stock awarded to certain officers, directors, employees and independent contractor physicians, which are to be granted on the effective date of our registration statement on Form S-1, with an exercise price equal to the initial public offering price of one share of our common stock. The tables and calculations above assume that those options have not been exercised. To the extent outstanding options are exercised, you would experience further dilution if the exercise price is less than our net tangible book value per share. In addition, if we grant options, warrants, preferred stock, or other convertible securities or rights to purchase our common stock in the future with exercise prices below the initial public offering price, new investors will incur additional dilution upon exercise of such securities or rights.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data was prepared in accordance with GAAP and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related footnotes included elsewhere in this prospectus. The consolidated balance sheets and statements of operations data for the nine months ended September 30, 2006 and September 30, 2007, as set forth below, are derived from our unaudited consolidated financial statements. We have prepared the unaudited interim consolidated financial statements and related unaudited financial information in accordance with GAAP and the rules and regulations of the SEC for interim financial statements. These interim financial statements reflect all adjustments consisting of normal recurring accruals, which, in the opinion of management are necessary to present fairly our consolidated financial position and results of operations for the interim periods. The statements of operations data for the years ended December 31, 2004, 2005 and 2006 and the consolidated balance sheets data as of December 31, 2005 and 2006 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The balance sheet data as of December 31, 2003 and 2004 and the statement of operations data for the year ended December 31, 2003 is derived from our audited financial statements not included in this prospectus. The financial data presented below as of and for the year ended December 31, 2002 is derived from our unaudited financial statements not included in this prospectus. The financial data presented below as of and for the years ended December 31, 2002 and 2003 reflects the results of operations of Virtual Radiologic Professionals, LLC (previously known as Virtual Radiologic Professionals, PLC and Virtual Radiologic Consultants, LLC). The financial data presented below as of and for the years ended December 31, 2004 and December 31, 2005 reflects the consolidated operations of Virtual Radiologic Consultants, Inc., our predecessor corporation, and Virtual Radiologic Professionals, LLC. The financial data presented below as of and for the year ended December 31, 2006, and as of and for the nine months ended September 30, 2006 and 2007 reflects the consolidated operations of Virtual Radiologic Corporation and the Affiliated Medical Practices. The historical results presented below are not necessarily indicative of financial results to be expected in future periods.

 

    Year Ended December 31,       Nine Months Ended  
    2002     2003     2004     2005    

2006

    September 30,
2006
    September 30,
2007
 
    (in thousands, except per share data)  

Consolidated Statement of Operations Data:

             

Revenue

  $ 1,033     $ 5,872     $ 12,899     $ 26,991     $ 54,099     $ 37,934     $ 63,298  
                                                       

Operating costs and expenses(1)

             

Professional services

    462       2,786       7,013       16,416       29,973       21,855       32,434  

Sales, general and administrative

    368       2,138       6,899       12,814       22,270       15,164       22,137  

Depreciation and amortization

    7       72       230       586       1,351       942       1,701  
                                                       

Total operating costs and expenses

    837       4,996       14,142       29,816       53,594       37,961       56,272  
                                                       

Operating income (loss)

    196       876       (1,243 )     (2,825 )     505       (27 )     7,026  

Other (expense) income

             

Interest expense

    (3 )     (14 )     (95 )     (131 )     (37 )     (28 )     (442 )

Interest income

                      187       254       200       252  
                                                       

Total other (expense) income

    (3 )     (14 )     (95 )     56       217       172       (190 )
                                                       

Income (loss) before non-controlling interest and income tax

    193       862       (1,338 )     (2,769 )     722       145       6,836  

Non-controlling interest expense (income)

                62       (1,362 )     25       285       2,091  
                                                       

Income (loss) before income tax expense

    193       862       (1,400 )     (1,407 )     697       (140 )     4,745  

Income tax expense

                      58       1,226       1,680       2,579  
                                                       

Net income (loss)

    193       862       (1,400 )     (1,465 )     (529 )     (1,820 )     2,166  

Cash dividends paid:

             

Preferred

                                        (13,597 )

Series A Cumulative Redeemable Convertible Preferred Stock accretion

                      (28,181 )     (11,437 )     (18,281 )     (25,068 )
                                                       

Net income (loss) available to common stockholders

  $ 193     $ 862     $ (1,400 )   $ (29,646 )   $ (11,966 )   $ (20,101 )   $ (36,499 )
                                                       

Loss per common share

             

Basic and Diluted

  $ 0.04     $ 0.16     $ (0.25 )   $ (4.74 )   $ (1.80 )   $ (3.04 )   $ (4.91 )

Weighted average common shares outstanding:

             

Basic and Diluted(2)(3)(4)

    5,475       5,475       5,659       6,254       6,640       6,617       7,436  

 

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     As of December 31,     As of
September 30,
2007
 
     2002    2003    2004     2005     2006    
     (in thousands)  

Consolidated Balance Sheet data:

              

Cash and cash equivalents

   $ 124    $ 75    $ 484     $ 3,088     $ 5,958     $ 11,476  

Short-term investment

                     5,092              

Restricted cash

                     300       700       700  

Working capital(5)

     123      662      (927 )     10,319       11,658       19,024  

Total current assets

     335      1,682      2,955       13,948       19,670       31,866  

Long term debt (including current portion)

                                 41,000  

Total long-term capital lease obligations (less current portion)

     25           104       20              

Total liabilities

     237      1,144      4,078       3,849       8,532       51,068  

Non-controlling interest

               1,362             25       2,116  

Series A Cumulative Redeemable Convertible Preferred Stock

                     40,090       51,527       76,596  

Total stockholders’ equity (deficiency)(6)

     218      1,081      (1,089 )     (26,385 )     (34,435 )     (88,891 )

 

     Year Ended December 31,     Nine Months Ended
September 30, 2006
 
     2002     2003     2004     2005     2006     2006     2007  
     (in thousands)  

Cash Flow Data:

              

Net cash provided by (used in):

              

Operating activities

   $ 149     $ 303     $ 203     $ (1,794 )   $ 3,977     $ 4,131     $ 5,194  

Investing activities

     (98 )     (290 )     (360 )     (7,754 )     1,208       2,785       (3,574 )

Financing activities

     47       (61 )     566       12,151       (2,315 )     (2,131 )     3,897  

(1) Includes the non-cash stock-based compensation and depreciation and amortization charges set forth in the following table:

 

     Year Ended December 31,    Nine Months Ended
September 30,
       2002        2003        2004        2005      2006    2006
(Restated)(1)
   2007
     (in thousands)

Professional services

                    

Non-cash stock-based compensation

   $    $    $ 154    $ 1,995    $ 3,416    $ 3,250    $ 2,928

Sales, general and administrative

                    

Non-cash stock-based compensation

                         115      49      408

Depreciation and amortization

     7      72      230      586      1,351      942      1,701
                                                

Total

   $ 7    $ 72    $ 384    $ 2,581    $ 4,882    $ 4,241    $ 5,037
                                                

 

(2) The calculations of weighted average common shares outstanding for the years ended December 31, 2002 and 2003 are based on the assumed conversion of the members’ equity interests of Virtual Radiologic Consultants, LLC, into common stock of VRC utilizing the conversion ratio established when the Company was capitalized during 2004. In addition, the calculations of weighted average common shares outstanding for the years ended December 31, 2002 and 2003 assume the five-for-one common stock split, which was effected in 2004, was effected on January 1, 2002 and 2003, respectively.

 

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(3) The calculation of weighted average common shares outstanding for the year ended December 31, 2004 assumes the five-for-one common stock split, which was effected in 2004, was effected on January 1, 2004.

 

(4) The calculation of weighted average common shares outstanding for the years ended December 31, 2005 and 2006 and the nine months ended September 30, 2006 and 2007, excludes the assumed conversion of the shares of Series A Cumulative Redeemable Convertible Preferred Stock into shares of common stock, because they are anti-dilutive. The calculation of weighted average common shares for the years ended December 31, 2004, 2005 and 2006 and the nine months ended September 30, 2006 and 2007 also excludes any other potential common stock equivalents that were outstanding during the relevant periods, calculated using the treasury stock method, because they are anti-dilutive.

 

(5) Working capital is defined as current assets minus current liabilities.

 

(6) For the year ended December 31, 2003, this item refers to members’ equity of Virtual Radiologic Consultants, LLC.

 

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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 and unaudited 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 we are one of the leading providers of teleradiology services in the United States. According to Frost & Sullivan, we are the second largest provider of teleradiology services in the United States. We serve our customers—radiology practices, hospitals, clinics and diagnostic imaging centers—by providing diagnostic image interpretations, or reads, 24 hours a day, seven days a week, 365 days a year. Our unique distributed operating model provides our qualified team of American Board of Radiology-certified radiologists with the flexibility to choose the location from which they work, primarily within the United States, and allows us to serve customers located throughout the country. Our services include both preliminary reads, which are performed for emergent care purposes, and final reads, which are performed for both emergent and non-emergent care. We provide these services through a robust, highly scalable communications network incorporating encrypted broadband internet connections and proprietary workflow management software. In November 2006, we also contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers. We have developed a strong customer base and have experienced significant revenue growth from $12.9 million in 2004 to $54.1 million in 2006. In addition, our revenues grew from $37.9 million for the nine months ended September 30, 2006 to $63.3 million for the nine months ended September 30, 2007.

Basis of Presentation

We consolidate our financial results under the principles of FIN 46R, which requires a primary beneficiary to consolidate entities determined to be variable interest entities, or VIEs, in which an enterprise funds, and as a result recognizes, a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interest in the entity. Our Affiliated Medical Practices are consolidated VIEs, that were formed as our business expanded, to facilitate compliance with the corporate practice of medicine laws in the various states in which VRC operates. Although VRC holds no legal ownership in the Affiliated Medical Practices, as a result of the pricing structure in the management agreements that exist between the entities, VRC has funded losses of certain Affiliated Medical Practices totaling $6.6 million between January 1, 2005 and September 30, 2007. Prior to January 1, 2005, VRC funded no losses of the Affiliated Medical Practices and will only receive residual returns up to the amount of previously recognized losses. In addition, the management of VRC was involved significantly in the design and creation of the Affiliated Medical Practices and, with the exception of rendering medical judgments, holds significant influence over their continuing operations. We have therefore determined that the Affiliated Medical Practices are VIEs and that VRC is their primary beneficiary as defined by FIN 46R. As a result, we have concluded that VRC is required to consolidate the Affiliated Medical Practices. Through consolidation, we recognize all net losses of each Affiliated Medical Practice in excess of the equity of that Affiliated Medical Practice. We recognize net earnings of each Affiliated Medical Practice only to the extent we are recovering losses previously recognized by us with respect to that Affiliated Medical Practice. Earnings of each Affiliated Medical Practice in excess of losses previously recognized by us with respect to that Affiliated Medical Practice are excluded from our earnings and are attributed to the respective equity owners of that Affiliated Medical Practice by recording such

 

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earnings as non- controlling interest in our consolidated financial statements. During the year ended December 31, 2005, we had only one Affiliated Medical Practice, which experienced net losses that changed the Affiliated Medical Practice’s equity position to a net deficit. As a result, we did not have a non-controlling interest as of December 31, 2005. During 2006, additional Affiliated Medical Practices were formed and for the year ended December 31, 2006, one of those Affiliated Medical Practices experienced net income that resulted in a non-controlling interest relating to that Affiliated Medical Practice of approximately $25,000. In addition, certain of our Affiliated Medical Practices experienced net income that resulted in a non-controlling interest of approximately $2.1 million as of September 30, 2007.

Factors Affecting Our Results of Operations

Revenue

We generate substantially all of our revenue from the radiology services that we provide our customers. We provide these services pursuant to contracts that typically have a one-year term and automatically renew for successive one-year terms unless terminated by the customer or by us. The amount that we charge for our radiology services varies by customer and is based upon a number of factors, including the hours of coverage, the number of reads, whether the reads are preliminary reads or final reads, and the technical and administrative services provided. We recognize revenue when a read has been completed and we determine that payment for the read is reasonably assured. We typically bill our customers at the beginning of the month following the month in which the services were provided. Because we contract directly with our customers and are paid directly by our customers, we do not currently depend upon payment by third party payers such as Medicare, Medicaid, private insurance or patients.

We have experienced significant revenue growth from $12.9 million in 2004, to $27.0 million in 2005 and $54.1 million for the year ended December 31, 2006. In addition, our revenues grew from $37.9 million for the nine months ended September 30, 2006 to $63.3 million for the nine months ended September 30, 2007. This growth in revenue resulted from:

 

  Ÿ  

an increase in our customer base;

 

  Ÿ  

an increase in our affiliated radiologist base;

 

  Ÿ  

an increase in utilization of our services by our customers;

 

  Ÿ  

an expansion of our service hours;

 

  Ÿ  

an increase in provision of higher-priced final reads; and

 

  Ÿ  

high customer and affiliated radiologist retention rates.

As of September 30, 2007, our affiliated radiologists provided services to 457 customers serving 787 medical facilities, which includes 736 hospitals representing approximately 13% of hospitals in the United States. In addition to the current customers described above, as of September 30, 2007, we had contractual arrangements with 42 customers, serving 42 facilities, for which we expect to begin to provide services upon completion of the credentialing, independent physician licensing and other implementation procedures. These additional implementation procedures ordinarily require up to 90 days to complete, at which time we begin providing services to the customer. Since our inception, over 98% of our customer contracts up for renewal have been renewed.

Operating Expenses

Our operating expenses consist of professional services expense and sales, general and administrative expense.

 

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Professional Services Expense.    Professional services expense is our most significant expense as a percentage of revenue. Our professional services expense consists of the fees we pay to our affiliated radiologists for their services, physician stock-based compensation and medical liability expense, which consists of medical liability insurance premiums expense and medical liability loss contingency expense.

Physician Cash Compensation Expense.     Physician cash compensation expense is the result of engaging independent radiologists to provide reads for our customers. Each of our affiliated radiologists provides and is compensated for reads in accordance with his or her independent physician agreement. We structure our relationships with our affiliated radiologists such that they generally have control over their schedule and the location from which they work. We compensate our affiliated radiologists using a formula that includes a base level of compensation and additional amounts with regard to the number of hours worked and the number and type of reads performed. We recognize physician cash compensation expense in the month in which our affiliated radiologists perform the reads for our customers. Physician cash compensation also includes amounts paid for quality assurance services.

Physician Stock-Based Compensation Expense.    We record stock-based compensation expense in connection with any award of stock options or other compensatory issuance of shares of our common stock to our affiliated radiologists and include that expense in our consolidated statement of income as part of our professional services expense. We calculate the stock-based compensation expense associated with these awards in accordance with Emerging Issues Task Force, or EITF, 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, by determining the fair value using a Black-Scholes model. EITF Issue No. 96-18 requires that the cost of equity instruments issued to these affiliated radiologists be initially measured at their fair value at the date the equity instruments were issued and adjusted over the service period, until vested or forfeited, to their then-current fair value in every subsequent reporting period. Accordingly, if the value of our common stock increases over a given period, this accounting treatment will generally result in physician stock-based compensation expense that exceeds the expense we would have recorded if these individuals were employees. See “—Critical Accounting Policies.”

Medical Liability Expense.    Medical liability expense relates to the procurement of medical malpractice insurance coverage and medical liability loss contingency expense, including payments of deductibles. We amortize medical liability insurance premiums over the term of the policy to which they relate and expense medical liability loss contingency expense in the month in which we deem such liability to be probable and reasonably estimable.

Sales, General and Administrative Expense.    Sales, general and administrative expense is our second most significant expense as a percentage of revenue. Sales, general and administrative expense consists primarily of employee compensation expense, sales and marketing expense, information technology expense, the costs associated with licensing and credentialing our affiliated radiologists and costs associated with maintaining our facilities.

Other (Expense) Income

Other (expense) income consists of non-operating expenses and income, such as interest expense incurred from borrowings on our senior secured term loan under our Senior Credit Facility, our former revolving credit facility and from equipment financing, and interest income earned on cash balances and investments held in short-term government securities.

 

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Redeemable Preferred Stock Accretion

On May 2, 2005, we issued our Series A Cumulative Redeemable Convertible Preferred Stock, or Series A Preferred Stock, which is redeemable on or after March 31, 2010, at the greater of the Redemption Price, as defined in our Certificate of Incorporation, or the fair value of the Series A Preferred Stock. As a result, we adjust the value of the Series A Preferred Stock to its fair value at each reporting date. Upon the completion of this offering, all outstanding shares of our Series A Preferred Stock will automatically convert into shares of our common stock and the rights of the holders of Series A Preferred Stock to exercise redemption rights will terminate. Therefore, the adjustments relating to changes in the fair value our Series A Preferred Stock will terminate and we will not record future charges to our earnings per share related to the Series A Preferred Stock.

Trends in Our Business and Results of Operations

Revenue

Our business has grown rapidly since inception. This growth has been driven by an increase in the demand for our services and a corresponding increase in our customer base. We have also experienced an increase in the utilization of our services by our existing customers, through expansion of our service hours, the provision of final reads, a high customer retention rate and the growth in the use of diagnostic imaging technologies and procedures in the healthcare market. Our revenue growth has resulted primarily from increased volumes across a growing customer base and favorable read mix. We expect that our customers will continue to contract with us for additional services, including the performance of final reads, as well as to contract for additional hours of service coverage.

Our revenues are affected by seasonality. While our revenues have continued to grow each year, we typically experience increased demand for our services and higher revenue growth during the second and third quarters of each year. We believe that these increases are a result of increased outdoor and transportation activities during summer months, which leads to more hospital visits, as well as more frequent vacation time taken by our customers’ radiologists. During the first and fourth quarters of each year, when weather conditions are colder for a large portion of the United States, we have historically experienced lower revenue growth than that experienced during the second and third quarters. We expect this seasonality with respect to our revenues to continue. See “Risk Factors—Risks Related to Our Business—Our operating results may be subject to seasonal fluctuations, which makes our results difficult to predict and could cause our performance to fall short of quarterly expectations.” We also expect to derive revenue in the future from contracts we have recently entered into for the licensing of our technology infrastructure and the provision of management and support services.

The table below illustrates the quarter-by-quarter percentage change in the average revenue per read for lower price plain film reads and all other modalities for the past eight quarters:

Quarter-by-Quarter Variation in Average Revenue Per Read by Modality

 

    Three Months Ended  
     December 31,
2005
    March 31,
2006
    June 30,
2006
    September 30,
2006
    December 31,
2006
    March 31,
2007
    June 30,
2007
   

September 30,
2007

 

Plain film(1)

  0.9 %   1.8 %   4.4 %   (3.3 )%   (3.6 )%   (3.0 )%   1.5 %   (2.0 )%

All other modalities(2)

  1.0 %   0.2 %   0.4 %   1.0 %   (0.3 )%   (0.2 )%  

0.1


%

  (0.7 )%

(1) Plain film modality includes all x-ray technology images.
(2) All other modalities are primarily comprised of CT, MRI and ultrasound images.

 

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The total number of reads we performed has continued to grow on a quarter-by-quarter basis for the past eight quarters as follows:

 

    Three Months Ended  
     December 31,
2005
    March 31,
2006
    June 30,
2006
    September 30,
2006
    December 31,
2006
    March 31,
2007
    June 30,
2007
    September 30,
2007
 

Total reads

  154,767     184,608     237,271     302,497     309,151     352,149     413,167     473,263  

Percentage growth over prior year quarter

  107.4 %   98.1 %   107.3 %   105.9 %   99.8 %   90.8 %   74.1 %   56.5 %

In November 2006, we also contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers. This will permit our radiology group customers that cover multiple hospitals to perform reads over our infrastructure regardless of what equipment is in use at each hospital and without having to travel between hospitals. We have contracted with the Massachusetts General Physician’s Organization, a subsidiary of Massachusetts General Hospital and a teaching affiliate of Harvard Medical School, to market and manage their deployment of specialized radiology services using our technology infrastructure. We have recognized revenue of approximately $73,000 for the twelve months ended December 31, 2006 and $205,000 for the nine months ended September 30, 2007, related to support services, but have not yet begun to provide services or recognize revenue from the use of our technology infrastructure. We do not anticipate that revenue recognized from these activities will be material in the near future.

Physician Cash Compensation Expense

Since our inception, our physician cash compensation expense has increased each year as we have added more affiliated radiologists to fulfill the increased demand for our services as our business and customer base has grown. However, physician cash compensation expense as a percentage of revenue has decreased due to the increased productivity of our affiliated radiologists. The increases in productivity by the existing affiliated radiologists have been, and may continue to be, offset, in part, by significant increases in newly engaged affiliated radiologists and the costs associated with the typical 90- to 180-day period during which newly engaged affiliated radiologists obtain necessary state licenses and hospital credentials, and thereafter become accustomed to our workflow technology. We expect that our physician cash compensation expense will continue to increase, but will decrease as a percentage of revenues as our expanding base of affiliated radiologists continues to grow.

Physician Stock-Based Compensation Expense

Physician stock-based compensation expense is a non-cash expense that fluctuates based upon the fair value of our common stock underlying the awards at the close of each reporting period as required by EITF Issue No. 96-18. As the value of an award is based on the underlying common stock, we may record additional expense or income based on fluctuations in value of the underlying common stock. Our physician stock-based compensation expense may increase in future periods if we issue additional options and other stock-based awards to our affiliated radiologists. However, the amount of expense for any period attributable to physician stock-based compensation fluctuates and is difficult to predict.

Medical Liability Expense

Our medical liability expense has increased each year since inception due to the increases in our medical liability insurance premiums primarily associated with the increased volume of reads our affiliated radiologists performed, as well as for payment of deductibles.

 

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Sales, General and Administrative Expense

Our sales, general and administrative expense has increased each year since our inception as a result of increased employee compensation expenses in connection with the management, operations, development and maintenance of our expanding business. In addition to increased employee compensation expense, our sales, general and administrative expenses have increased due to increases in expenses relating to information technology, facilities, licensing and credentialing, sales and marketing and other general and administrative expense. We expect sales, general and administrative expense to continue to increase in future periods as a result of expenses associated with the performance of management and support services we have recently begun to provide to some of our customers and as a result of expenses related to being a public company, including legal and accounting fees and costs incurred in complying with the Sarbanes-Oxley Act of 2002.

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 GAAP. The preparation of these financial statements in accordance with 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 of significant judgment and the use of estimates on the part of management in its application. We believe the following to be our critical accounting policies because they are important to the presentation of our financial condition and results of operations, and require critical management judgment and estimates about matters that are uncertain:

 

  Ÿ  

principles of consolidation;

 

  Ÿ  

revenue recognition and allowance for doubtful accounts;

 

  Ÿ  

accounting for stock-based compensation;

 

  Ÿ  

accounting for redeemable preferred stock; and

 

  Ÿ  

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.

Principles of Consolidation

Effective January 1, 2004, we consolidate our financial results in accordance with FIN 46R, which requires a primary beneficiary to consolidate entities determined to be VIEs. Although VRC holds no legal ownership in the Affiliated Medical Practices, as a result of the pricing structure in the management agreements that exist between the entities, VRC has funded losses of certain Affiliated Medical Practices totaling $6.6 million between January 1, 2005 and September 30, 2007. Prior to January 1, 2005, VRC funded no losses of the Affiliated Medical Practices and will only receive residual returns up to the amount of previously recognized losses. VRC expects to continue to fund the majority of the losses of these Affiliated Medical Practices for the foreseeable future. In addition, the management of VRC was involved significantly in the design and creation of the Affiliated Medical Practices and, with the exception of rendering medical judgments, holds significant influence over their continuing operations and the management agreements among the parties. We have determined that

 

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VRC is the primary beneficiary of the Affiliated Medical Practices, as defined by FIN 46R. As a result, we have concluded that VRC is required to consolidate the Affiliated Medical Practices. Through consolidation, we recognize all net losses of each Affiliated Medical Practice in excess of the equity of that Affiliated Medical Practice. We recognize net earnings of each Affiliated Medical Practice only to the extent we are recovering losses previously recognized with respect to that Affiliated Medical Practice. Earnings of each Affiliated Medical Practice in excess of losses previously recognized by us with respect to that Affiliated Medical Practice are excluded from our earnings and are attributed to the respective equity owners of that Affiliated Medical Practice by recording such earnings as non-controlling interest in our consolidated financial statements. As a result, these earnings or losses may not inure to the owners of VRC. During the year ended December 31, 2005, we had only one Affiliated Medical Practice, which experienced net losses that changed the Affiliated Medical Practice’s equity position to a net deficit. As a result, we did not have a non-controlling interest as of December 31, 2005. During 2006, additional Affiliated Medical Practices were formed and for the year ended December 31, 2006, one of those Affiliated Medical Practices experienced net income that resulted in a non-controlling interest relating to that Affiliated Medical Practice of approximately $25,000. In addition, certain of our Affiliated Medical Practices experienced net income that resulted in a non-controlling interest of approximately $2.1 million as of September 30, 2007.

The following tables show the unaudited condensed consolidating balance sheets as of December 31, 2005 and 2006 and as of September 30, 2007, and the unaudited condensed consolidating statements of operations for the years ended December 31, 2004, 2005 and 2006 and for the nine months ended September 30, 2006 and 2007. The amounts reflected in the eliminations columns of the condensed consolidating financial statements represent affiliated party management and professional fees and non-controlling interest. The following tables should be read together with our consolidated financial statements and related footnotes included elsewhere in this prospectus.

 

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Condensed Consolidating Balance Sheets

 

     As of December 31, 2005  
     VRC     Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Cash and cash equivalents

   $ 1,758     $ 1,330     $     $ 3,088  

Short-term investments

     5,092                   5,092  

Other current assets

     8,420       5,319       (7,971 )     5,768  

Non-current assets

     3,607                   3,607  
                                

Total assets

   $ 18,877     $ 6,649     $ (7,971 )   $ 17,555  
                                

Current liabilities

   $ 1,865     $ 9,735     $ (7,971 )   $ 3,629  

Non-current liabilities

     220                   220  
                                

Total liabilities

     2,085       9,735       (7,971 )     3,849  

Series A Cumulative Redeemable Convertible Preferred Stock

     40,090                   40,090  

Total stockholders’ (deficiency) equity

     (23,298 )     (3,086 )           (26,384 )
                                

Total liabilities and stockholders’ equity

   $ 18,877     $ 6,649     $ (7,971 )   $ 17,555  
                                
     As of December 31, 2006  
     VRC     Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Cash and cash equivalents

   $ 5,887     $ 71     $     $ 5,958  

Other current assets

     28,339       27,605       (42,232 )     13,712  

Non-current assets

     5,979                   5,979  
                                

Total assets

   $ 40,205     $ 27,676     $ (42,232 )   $ 25,649  
                                

Current liabilities

   $ 17,647     $ 32,597     $ (42,232 )   $ 8,012  

Non-current liabilities

     520                   520  
                                

Total liabilities

     18,167       32,597       (42,232 )     8,532  

Non-controlling interest

                 25       25  

Series A Cumulative Redeemable Convertible Preferred Stock

     51,527                   51,527  

Total stockholders’ (deficiency) equity

     (29,489 )     (4,921 )     (25 )     (34,435 )
                                

Total liabilities and stockholders’ equity

   $ 40,205     $ 27,676     $ (42,232 )   $ 25,649  
                                
     As of September 30, 2007  
     VRC     Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Cash and cash equivalents

   $ 11,115     $ 361     $     $ 11,476  

Other current assets

     30,802       43,089       (53,501 )     20,390  

Non-current assets

     9,023                   9,023  
                                

Total assets

   $ 50,940     $ 43,450     $ (53,501 )   $ 40,889  
                                

Current liabilities

     18,452       47,891       (53,501 )     12,842  

Long term debt

     38,000                   38,000  

Other non-current liabilities

     226                   226  
                                

Total liabilities

     56,678       47,891       (53,501 )     51,068  

Non-controlling interest

                 2,116       2,116  

Series A Cumulative Redeemable Convertible Preferred Stock

     76,596                   76,596  

Total stockholders’ (deficiency) equity

     (82,334 )     (4,441 )     (2,116 )     (88,891 )
                                

Total liabilities and stockholders’ equity

   $ 50,940     $ 43,450     $ (53,501 )   $ 40,889  
                                

 

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Condensed Consolidating Statements of Operations

      Year Ended December 31, 2004  
     VRC     Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Revenue

   $ 3,656     $ 12,899     $ (3,656 )   $ 12,899  

Operating costs and expenses

     5,004       12,794       (3,656 )     14,142  
                                

Operating (loss) income

     (1,348 )     105             (1,243 )

Other expense

     (52 )     (43 )           (95 )
                                

(Loss) income before non-controlling interest

     (1,400 )     62             (1,338 )

Non-controlling interest expense

                 62       62  
                                

Net (loss) income

   $ (1,400 )   $ 62     $ (62 )   $ (1,400 )
                                

 

     Year Ended December 31, 2005  
     VRC    Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Revenue

   $ 15,050    $ 26,991     $ (15,050 )   $ 26,991  

Operating costs and expenses

     13,457      31,409       (15,050 )     29,816  
                               

Operating income (loss)

     1,593      (4,418 )           (2,825 )

Other income (expense)

     87      (31 )           56  
                               

Income (loss) before non-controlling interest and income tax

     1,680      (4,449 )           (2,769 )

Non-controlling interest income

                (1,362 )     (1,362 )

Income tax expense

     58                  58  
                               

Net income (loss)

   $ 1,622    $ (4,449 )   $ 1,362     $ (1,465 )
                               
     Year Ended December 31, 2006  
     VRC    Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Revenue

   $ 42,277    $ 54,148     $ (42,326 )   $ 54,099  

Operating costs and expenses

     39,951      55,969       (42,326 )     53,594  
                               

Operating income (loss)

     2,326      (1,821 )           505  

Other income

     217                  217  
                               

Income (loss) before non-controlling interest and income tax

     2,543      (1,821 )           722  

Non-controlling interest expense

                25       25  

Income tax expense

     1,213      13             1,226  
                               

Net income (loss)

   $ 1,330    $ (1,834 )   $ (25 )   $ (529 )
                               
     Nine Months Ended September 30, 2006  
     VRC    Affiliated
Medical
Practices
    Eliminations     Consolidated  
     (in thousands)  

Revenue

   $ 29,690    $ 33,319     $ (25,075 )   $ 37,934  

Operating costs and expenses

     25,972      37,064       (25,075 )     37,961  
                               

Operating income (loss)

     3,718      (3,745 )           (27 )

Other income

     172                  172  
                               

Income (loss) before non-controlling interest and income tax

     3,890      (3,745 )           145  

Non-controlling interest expense

                285       285  

Income tax expense

     1,493      187             1,680  
                               

Net income (loss)

   $ 2,397    $ (3,932 )   $ (285 )   $ (1,820 )
                               

 

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     Nine Months Ended September 30, 2007  
     VRC     Affiliated
Medical
Practices
   Eliminations     Consolidated  
     (in thousands)  

Revenue

   $ 48,071     $ 65,440    $ (50,213 )   $ 63,298  

Operating costs and expenses

     41,524       64,961      (50,213 )     56,272  
                               

Operating income (loss)

     6,547       479            7,026  

Other income

     (190 )                (190 )
                               

Income (loss) before non-controlling interest and income tax

     6,357       479            6,836  

Non-controlling interest expense

                2,091       2,091  

Income tax expense

     2,579                  2,579  
                               

Net income (loss)

   $ 3,778     $ 479    $ (2,091 )   $ 2,166  
                               

Revenue Recognition and Allowance for Doubtful Accounts

We sell our services to radiology practices, hospitals, clinics and diagnostic imaging centers, and recognize revenue when a read or service has been completed and we determine that payment for the read or service is reasonably assured. Accounts receivable are recorded at the invoiced amount and generally do not bear interest.

We maintain an allowance for doubtful accounts at a level that our management estimates to be sufficient to absorb future losses due to accounts that are potentially uncollectible. The allowance is based on the current aging of past due accounts, our historical experience, the financial condition of the customer and the general economic conditions of each customer’s market place. Management uses all information available to them in establishing what we believe is an adequate allowance to absorb future losses. While our historical credit losses have not differed materially from our estimates, and we do not currently believe any material changes in estimates are likely in the near future, actual future results could differ materially from current estimates resulting in an increase or decrease in cash flows from receivable collections and/or in the allowance for doubtful accounts and the corresponding provision for bad debt expense. Any such changes in estimates could have a material impact on our consolidated balance sheets, statements of operations and/or cash flows in subsequent periods. We maintained an allowance for doubtful accounts of approximately $268,000, $304,000, and $273,000 as of December 31, 2005 and 2006, and September 30, 2007, respectively.

We record an allowance for sales credits that our management estimates to be adequate to cover future sales credits granted which primarily relate to maintaining customer satisfaction with our services. The allowance is based on our historical experience related to sales credits granted. Although we have not historically made any material adjustments to prior period estimates, and we do not anticipate any material impact on future results of operations or cash flows, actual results could differ materially from these estimates resulting in an increase in the allowance for sales credits and the corresponding provision for sales credits. We maintained an allowance for sales credits of approximately $10,000, $11,000 and $16,000 as of December 31, 2005 and 2006, and September 30, 2007, respectively.

Accounting for Stock-Based Compensation

Physician Stock-Based Compensation.    We record stock-based compensation expense in connection with any equity instrument awarded to our affiliated radiologists in accordance with EITF Issue No. 96-18. We calculate the stock-based compensation expense related to such issuance by determining the then current fair value of the award using a Black-Scholes model at the date of grant and at the end of each subsequent financial reporting period thereafter. Physician stock-based compensation expense is included in professional services expense.

 

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Employee Stock-Based Compensation.    We also record stock-based compensation expense in connection with any award of stock options to employees and directors. We calculate the stock- based compensation expense associated with such awards to our employees and directors granted prior to January 1, 2006, in accordance with Accounting Principles Board (“APB”) No. 25, Accounting for Stock Issued to Employees, using the intrinsic value method and in accordance with Statement of Financial Accounting Standards No. 123R, Accounting for Stock Based Compensation, or SFAS 123R, for awards granted on or after January 1, 2006, by determining the fair value using a Black-Scholes model. We calculate the stock-based compensation expense related to awards to our employees and directors based on the fair value of awards on the date granted. Employee stock-based compensation expense is included in sales, general and administrative expense.

Determination of Fair Value of Our Stock Options.     As discussed above, we record stock-based compensation expense associated with our awards of stock options in accordance with SFAS 123R, and EITF Issue No. 96-18, as applicable, which require us to calculate the expense associated with such awards by determining their fair value. To determine the fair value, we use a Black-Scholes model that takes into account the exercise price of the award, the fair value and volatility of the common stock underlying the award, the risk-free interest rate and the contractual life of the award as determined at the date of grant.

In order to establish the exercise price of our stock options at various grant dates, our Board of Directors considered a number of relevant factors, including arm’s length equity transactions, current developments in the business, our financial prospects, the market performance of our primary competitor and our Board’s independent judgment.

Upon its review and analysis of these factors, our Board of Directors established the exercise price for the options being granted. The following table shows the fair value of one share of our common stock and the exercise price of one option granted on all of the stock option grant dates between January 1, 2004 and September 30, 2007.

 

Grant Date

   Fair Value of One
Share of
Common Stock
   Exercise Price
of One Option
Granted

January 2, 2004

   $ 1.00    $ 1.00

May 15, 2004

     1.00      1.00

July 7, 2004

     1.00      1.00

October 20, 2004

     2.00      2.00

November 23, 2004

     2.00      2.00

June 22, 2005

     3.75      3.75

June 30, 2005

     3.75      4.75

October 21, 2005

     4.50      5.50

March 30, 2006

     11.02      12.00

April 18, 2006

     11.02      12.00

July 1, 2006

     11.92      12.00

April 1, 2007

     12.00      12.00

April 2, 2007

     12.00      12.00

May 9, 2007

     12.00      12.00

May 29, 2007

     12.00      12.00

June 20, 2007

     19.23      19.23

On September 14, 2007 and October 26, 2007, our Board of Directors approved the grant of an aggregate of 515,150 options to purchase shares of our common stock (net of all forfeitures to date) to certain officers, directors, employees and independent contractor physicians, which are to be granted

 

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on the effective date of our registration statement on Form S-1, with an exercise price equal to the initial public offering price of one share of our common stock.

Since January 2004, when we first began to grant stock options, the fair value of our common stock, as established by our Board of Directors, has primarily increased. As described above, the change in our fair value reflects a number of factors, including increases in our actual and projected revenue and cash flow growth and decreases in the discount factor for a lack of liquidity in our common stock.

In connection with the preparation of our financial statements as of December 31, 2005, and for every quarterly period thereafter, our Board of Directors, or our management in the event that a stock option grant did not occur in conjunction with those quarterly periods, established what it believes to be a fair market value of our Series A Preferred Stock and common stock. The following table shows the fair value of one share of our Series A Preferred Stock and common stock at those dates.

 

     Fair Value of One Share of
     Series A
Preferred Stock
   Common
Stock

December 31, 2005

   $ 11.05    $ 7.85

March 31, 2006

     13.75      11.02

June 30, 2006

     14.83      11.92

September 30, 2006

     16.10      14.53

December 31, 2006

     14.21      13.26

March 31, 2007

     12.89      12.00

June 30, 2007

     19.76      19.23

September 30, 2007

     21.12      20.58

The above determination of the fair value of our Series A Preferred Stock and common stock for the periods ended December 31, 2006 and prior was based primarily on the use of two valuation methodologies, which included the “income approach” and the “market approach.” The “income approach” estimates the present fair value of our Series A Preferred Stock and common stock based primarily upon a projection of our future revenues and cash flows, while the “market approach” estimates those same fair values 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.

In conjunction with use of the “income approach” and the “market approach,” in determining the fair value of our Series A Preferred Sock and common stock as of March 31, 2007, we considered the following factors:

 

  Ÿ  

Stock Purchase Between Certain Stockholders.    On April 23, 2007, Dr. Sean Casey, Dr. Eduard Michel, Dr. David Hunter, Dr. Gary Weiss, Brent J. Backhaus, Lorna J. Lusic and Dr. Ranie Pendarvis sold a total of 1,330,700 shares of the Company’s common stock at a price of $12.00 per share to Generation Capital Partners VRC LP and Generation Members Fund II LP for an aggregate purchase price of approximately $16.0 million pursuant to the terms of a stock purchase agreement. See “Certain Relationships and Related Party Transactions—Stock Purchase Between Certain Stockholders.” Some of the significant features of this transaction are as follows:

 

  - the seven selling stockholders that sold shares of our common stock consisted of two current members of management, three independent contractor physicians, and two former employees;

 

  -

the buyers included Generation Capital Partners VRC LP, an entity that previously did not own any shares of the Company’s stock and that purchased approximately 87% of the

 

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shares of common stock sold in the transaction. The remaining 13% of the stock sold in the transaction was purchased by Generation Members’ Fund II LP;

 

  - the Company was not a buyer or a seller in the transaction; and

 

  - certain of our stockholders had contractual rights to participate in this transaction pursuant to the terms of the stockholders’ agreement, and, after being given an opportunity to participate, certain of our stockholders elected to exercise their contractual rights and participate in the transaction and certain of our other stockholders elected not to exercise their contractual rights and did not participate in the transaction.

 

  Ÿ  

Our Competitor’s Valuation.    Our principal competitor, NightHawk, experienced an approximate 29% decline in the market value of its common stock between December 31, 2006 and March 31, 2007. As NightHawk is the only publicly-traded competitor of which we are aware, the decline in NightHawk’s market value significantly influenced the assumed trading multiples in the valuation of our Series A Preferred Stock and common stock as of March 31, 2007; and

 

  Ÿ  

Separation Agreements with Certain Executive Officers.    Between December 2006 and January 2007, we entered into separation agreements with our former Chief Operating Officer and former Chief Technology Officer. Our Board of Directors determined that it would be necessary to complete a search process for a new Chief Operating Officer and a new Chief Technology Officer prior to the consummation of our initial public offering. These positions were not filled as of March 31, 2007 and, as a result, the absence of such officers and the lack of proximity to our initial public offering were factors in the March 31, 2007 valuation of our Series A Preferred Stock and common stock.

In conjunction with the use of the “income approach” and the “market approach,” in determining the fair value of our Series A Preferred Stock and common stock as of June 30, 2007, September 30, 2007 and through the date of this offering, we considered the following factors:

 

  Ÿ  

Improved Financial Performance.    Our Consolidated Adjusted EBITDA increased from approximately $2.8 million for the three months ended March 31, 2007 to approximately $4.1 million for the three months ended June 30, 2007 and approximately $5.7 million for the three months ended September 30, 2007. These approximately 43% and 39% increases, respectively, in Consolidated Adjusted EBITDA were significant drivers in the increase in the fair value of our Series A Preferred Stock and common stock between March 31, 2007 and June 30, 2007 and between June 30, 2007 and September 30, 2007. For a discussion of how we define Consolidated Adjusted EBITDA and a reconciliation of Consolidated Adjusted EBITDA to net cash provided by operating activities, please see “—Senior Credit Facility”;

 

  Ÿ  

Additions to the Management Team.    We were successful in hiring a new President and Chief Operating Officer and a new Chief Technology Officer during the three months ended June 30, 2007. As a result of these additions to the Company’s management team, our Board of Directors determined that we were in a position to move towards the consummation of our initial public offering;

 

  Ÿ  

Anticipated Timing of Our Initial Public Offering.    The decision by our Board of Directors to move forward with our initial public offering resulted in the establishment of the anticipated price range for our common stock to be sold in our initial public offering. This range was considered in the valuation of our Series A Preferred Stock and common stock as of June 30, 2007, September 30, 2007 and through the date of this offering; and

 

  Ÿ  

Our Competitor’s Valuation.    Our principal competitor, NightHawk, experienced an approximate 35% increase in the market value of its common stock between March 31, 2007 and September 30, 2007. As discussed above, NightHawk is the only publicly-traded

 

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competitor of which we are aware, and as a result the increase in NightHawk’s market value significantly influenced the assumed trading multiples in the valuation of our Series A Preferred Stock and common stock as of June 30, 2007, September 30, 2007 and through the date of this offering.

The “income approach” and the “market approach” are then weighted based on the likely exit strategy for a potential investor. Accordingly, as we have moved closer to our initial public offering we have placed a greater weighting on the “market approach” compared to the “income approach.” The valuation ranges established from these weightings are combined to determine an aggregate enterprise value of the Company. We allocate enterprise value to our Series A Preferred Stock and common stock primarily using the probability-weighted expected return method. We believe that investors typically seek disproportionately higher returns and significant control or influence over a company’s activities, as well as certain rights and preferences depending on the class of security and the risk associated with such security. In order to allocate enterprise value to our Series A Preferred Stock and common stock we have evaluated the specific features of the Series A Preferred Stock and common stock, including all risks, rights and preferences related to each class of stock, and assigned enterprise value in accordance with those features. The additional enterprise value that is attributed to the Series A Preferred Stock as compared with the common stock results from the increased risk and preferential rights associated with the Series A Preferred Stock and a preferred stockholder’s expectation of higher returns, along with a more significant level of control that such stockholders may have over the activities of the Company. Upon completion of our initial public offering, the Series A Preferred Stock will convert into common stock and all preferential rights associated with the Series A Preferred Stock will terminate. Accordingly, as we have moved closer to our initial public offering, the additional enterprise value attributable to the Series A Preferred Stock has decreased.

The totality of these factors were analyzed by our management and/or Board of Directors to determine a value for each share of our Series A Preferred Stock and common stock, assuming free marketability in each case.

In order to establish the fair value of our Series A Preferred Stock and common stock, as a privately held company, our management and/or Board of Directors then applied an appropriate discount factor to account for the lack of liquidity of our 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 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. Based on this analysis, our management and/or our Board of Directors applied the following discount factors:

 

     Applied
Discount Factor
 

December 31, 2005

   15 %

March 31, 2006

   10  

June 30, 2006

   5  

September 30, 2006

   0  

December 31, 2006

   15  

March 31, 2007

   14  

June 30, 2007

   0  

September 30, 2007

   0  

To the extent we have experienced changes in the anticipated timing of our initial public offering, the applied marketability discounts have been increased or decreased to reflect that fact. The decrease in the discount factor between December 31, 2005 and September 30, 2006 reflected our progress

 

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towards an anticipated initial public offering during the fourth quarter of 2006. The increase in the discount factor between September 30, 2006 and March 31, 2007 was due to the delay in the then anticipated timing of our initial public offering, which resulted from the decision by our Board of Directors regarding the completion of a search process for certain new executive officers prior to the consummation of our initial public offering, as discussed above. The decrease in the discount factor between March 31, 2007 and September 30, 2007 reflects progress towards an anticipated initial public offering during the fourth quarter of 2007.

Accounting for Series A Preferred Stock

On May 2, 2005, we issued 3,626,667 shares of Series A Preferred Stock, in an arm’s length transaction, for total consideration of approximately $13.6 million. Each share of Series A Preferred Stock is convertible, at the option of the holder, into one share of common stock. In June 2005, we began recording the current estimated fair value of the Series A Preferred Stock on a quarterly basis based on the fair market value of that stock as determined by management and/or our Board of Directors as described above. In accordance with Accounting Series Release No. 268, Presentation in Financial Statements of “Redeemable Preferred Stocks” and EITF Abstracts, Topic D-98, Classification and Measurement of Redeemable Securities, we record changes in the current fair value of the Series A Preferred Stock in the consolidated statements of changes in stockholders’ (deficiency) equity as accretion of Series A Cumulative Redeemable Convertible Preferred Stock and as additional paid-in capital, and in the consolidated statements of operations as Series A Cumulative Redeemable Convertible Preferred Stock accretion.

Upon completion of this offering, all outstanding shares of Series A Preferred Stock will automatically convert into common stock and the rights of the holders of our Series A Preferred Stock to exercise redemption rights will terminate. As a result, the amount reported as fair value of the Series A Preferred Stock at that time will be converted into additional paid-in capital in the consolidated statement of changes in stockholders’ equity. Furthermore, upon completion of this offering, the holders of the Series A Preferred Stock will have no right to receive dividends in respect thereof unless a dividend is previously declared by the Board of Directors.

Income Taxes

VRC recognizes income taxes under the asset and liability method. As such, deferred taxes are based on the temporary differences, if any, between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts. The deferred taxes are determined using the enacted tax rates that are expected to apply when the temporary differences reverse. Income tax expense is the tax payable for the period plus the change during the period in deferred income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Developing a provision for income taxes, including the effective tax rate and the 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. Our judgment and tax strategies are subject to audit by various taxing authorities. While we believe we have provided adequately for our income tax liabilities in the consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on our consolidated financial condition, results of operations, and/or cash flows.

As previously noted, we consolidate our financial results under the provisions of FIN 46R. For income tax purposes, however, we are not considered a consolidated entity. As a result, income generated by the Affiliated Medical Practices, as well as any losses they are able to fund, are excluded from VRC’s calculation of income tax liability. In addition, losses generated by the Affiliated Medical Practices that are funded by VRC result in temporary differences between VRC’s book and tax bases

 

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of accounting. These temporary differences will reverse in future periods to the extent those losses are able to be recovered by VRC.

The 2005 federal income tax return of VRC recently underwent examination by the Internal Revenue Service, or the IRS. The IRS examination has now been closed, and the result of this examination was immaterial.

Results of Operations

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

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
    2004     2005     2006     2006     2007  

Revenue

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
                             

Operating costs and expenses:

         

Professional services

  54.4     60.8     55.4     57.6     51.2  

Physician cash compensation

  50.6     50.6     47.2     47.2     44.8  

Physician stock-based compensation

  1.2     7.4     6.3     8.6     4.6  

Medical liability expenses

  2.6     2.8     1.9     1.8     1.8  

Sales, general and administrative

  53.5     47.5     41.2     40.0         35.0  

Depreciation and amortization

  1.7     2.2     2.5     2.5     2.7  
                             

Total operating costs and expenses

  109.6     110.5     99.1     100.1     88.9  
                             

Operating (loss) income

  (9.6 )   (10.5 )   0.9     (0.1 )   11.1  

Interest (expense) income, net

  (0.8 )   0.3     0.4     0.5     (0.3 )

Non-controlling interest (expense) income

  (0.5 )   5.0         (0.8 )   (3.3 )

Income tax expense

      (0.2 )   (2.3 )   (4.4 )   (4.1 )
                             

Net (loss) income

  (10.9 )   (5.4 )   (1.0 )   (4.8 )   3.4  
                             

Cash dividends paid on preferred stock

                  (21.5 )

Series A Cumulative Redeemable Convertible Preferred Stock accretion

      (104.4 )   (21.1 )   (48.2 )   (39.6 )
                             

Net loss available to common stockholders

  (10.9 )%   (109.8 )%   (22.1 )%   (53.0 )%   (57.7 )%
                             

Comparison of Nine Months Ended September 30, 2006 and September 30, 2007

Revenue

 

    

Nine Months Ended

September 30,

   Change  
     2006    2007    In Dollars    Percentage  
     (dollars in thousands)  

Revenue from reads

   $ 37,732    $ 62,760    $ 25,028    66.3 %

Other revenue

     202      538      336    166.3  
                       

Total revenue

   $ 37,934    $ 63,298    $ 25,364    66.9  

The 66.9% increase in revenue for the nine months ended September 30, 2007, as compared to the nine months ended September 30, 2006, resulted primarily from an increase in the number of customers to whom we provided services, increased volume from new and existing customers and an increased number of higher-priced final reads. The number of customers to whom we provided services increased to 457 as of September 30, 2007 from 338 as of September 30, 2006. The number of medical facilities to whom we provided services increased to 787 as of September 30, 2007 from 596 as of September 30, 2007. For the nine months ended September 30, 2007, approximately 75% of

 

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our revenues from reads were derived from preliminary reads and approximately 25% from final reads, compared with approximately 83% from preliminary reads and approximately 17% from final reads for the nine months ended September 30, 2006. Same site volume growth increased approximately 17% for the nine months ended September 30, 2007, as compared to the nine months ended September 30, 2006. Same site volume growth measures the percentage increase in the number of reads over the comparable prior year period generated by a facility that has been under contract for at least three months at the beginning of the measurement period and remains a customer throughout that period. Other revenue, primarily representing revenue from technical support services to our customers, grew with the addition of new customers.

Operating Costs and Expenses

Professional Services

 

    

Nine Months
Ended

September 30,
2006

  

Percentage

of Revenue

   

Nine Months
Ended

September 30,
2007

  

Percentage

of Revenue

    Change  
               In Dollars      Percentage  
     (dollars in thousands)  

Physician cash compensation expense

   $ 17,903    47.2 %   $ 28,379    44.8 %   $ 10,476      58.5 %

Physician stock-based compensation expense

     3,250    8.6       2,928    4.6       (322 )    (9.9 )

Medical liability expense

     702    1.8       1,127    1.8       425      60.5  
                                     

Professional services

   $ 21,855    57.6 %   $ 32,434    51.2 %   $ 10,579      48.4  

The 48.4% increase in professional services expense for the nine months ended September 30, 2007, compared to the nine months ended September 30, 2006, resulted primarily from a $10.5 million increase in physician cash compensation expense associated with our increased number of radiologists and a significant increase in the number of reads performed by these radiologists. As of September 30, 2007, the number of physicians performing reads increased 58.2%, from 67 as of September 30, 2006 to 106 as of September 30, 2007.

Sales, General and Administrative

 

    

Nine Months

Ended

September 30,

2006

  

Percentage

of Revenue

   

Nine Months

Ended

September 30,
2007

  

Percentage

of Revenue

    Change  
               In Dollars    Percentage  
     (dollars in thousands)  

Sales, general and administrative

   $ 15,164    40.0 %   $ 22,137    35.0 %   $ 6,973    46.0 %

The 46.0% increase in sales, general and administrative expense for the nine months ended September 30, 2007, compared to the nine months ended September 30, 2006, resulted from increased expenses related to employee compensation, sales and marketing, licensing and credentialing and other general and administrative expense.

 

  Ÿ  

Employee Compensation. Our employee compensation increased from $8.6 million for the nine months ended September 30, 2006 to $12.6 million for the nine months ended September

 

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30, 2007. The 46.5% increase resulted primarily from the hiring of additional administrative and operations personnel to manage, operate and maintain our business, and from performance-based bonus compensation. As of September 30, 2007, the number of administrative and operations personnel increased 24.4%, from 168 as of September 30, 2006 to 209 as of September 30, 2007.

 

  Ÿ  

Sales and Marketing. Our sales and marketing expenses increased from $1.8 million for the nine months ended September 30, 2006 to $2.1 million for the nine months ended September 30, 2007. The 16.7% increase resulted primarily from higher commissions on increased revenue amounts, scheduled annual salary increases and expanded efforts in sales and marketing activities.

 

  Ÿ  

Licensing and Credentialing. Our licensing and credentialing related expenses increased from $633,000 for the nine months ended September 30, 2006 to $1.2 million for the nine months ended September 30, 2007. The 89.6% increase relates primarily to the amount and timing of initial and renewal license applications. As of September 30, 2007, the number of physicians performing reads increased 58.2%, from 67 as of September 30, 2006 to 106 as of September 30, 2007. In addition, the number of radiologists under contract but not yet reading increased 66.7% from 9 as of September 30, 2006 to 15 as of September 30, 2007. These factors resulted in the increase in licensing and credentialing costs.

 

  Ÿ  

Other General and Administrative. Our other general and administrative expenses increased from $2.9 million for the nine months ended September 30, 2006 to $4.8 million for the nine months ended September 30, 2007. The 65.5% increase resulted primarily from an increase in facilities expense and outside professional expense as well as other general operating expense commensurate with our increased activities.

We believe that sales, general and administrative expense, including the costs associated with the performance of the management services we have recently begun to provide to some of our customers and expenses related to being a public company, will increase as we continue to grow, but will decrease as a percentage of revenue.

Depreciation and Amortization Expense. Depreciation and amortization expense increased from $942,000 for the nine months ended September 30, 2006 to $1.7 million for the nine months ended September 30, 2007. This 80.5% increase was primarily due to the increase in depreciation expense related to additional capital equipment purchased for our operations.

Interest (Expense) Income, Net. Interest (expense) income, net decreased from income of $172,000 for the nine months ended September 30, 2006 to expense of $190,000 for the nine months ended September 30, 2007. This 210.5% increase resulted primarily from interest expense incurred on our term loan.

Non-Controlling Interest Expense (Income). Through consolidation, we recognize all net losses of the Affiliated Medical Practices in excess of the equity of those Affiliated Medical Practices and recognize income only to the extent we recover previously recognized losses. For the nine months ended September 30, 2006 and 2007, the non-controlling interest expense was $285,000 and $2.1 million, respectively, which reflects income generated by certain of our Affiliated Medical Practices for the periods then ended in excess of losses we previously recognized. The increase in the non-controlling interest expense for the nine months ended September 30, 2007 represents additional income generated by one of our Affiliated Medical Practices.

Income Tax Expense. Income tax expense increased from $1.7 million for the nine months ended September 30, 2006 to $2.6 million for the nine months ended September 30, 2007. This resulted primarily from the significant increase in both actual and projected taxable income used in calculating the tax expense for the nine months ended September 30, 2007.

 

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Preferred Stock Accretion. Preferred stock accretion increased from $18.3 million for the nine months ended September 30, 2006 to $25.1 million for the nine months ended September 30, 2007. This accretion relates to our Series A Preferred Stock, which was issued on May 2, 2005, and is calculated based on the difference between the estimated fair value of the Series A Preferred Stock as of the consolidated balance sheet date compared to the fair value of the stock on the previous consolidated balance sheet date. The increase in the value of the Series A Preferred Stock between the two periods resulted in the change in the Preferred Stock accretion during the nine months ended September 30, 2007.

Comparison of the Years Ended December 31, 2005 and December 31, 2006

Revenue

 

     Year Ended
December 31,
   Change  
     2005    2006    In Dollars    Percentage  
     (dollars in thousands)  

Revenue from reads

   $ 26,813    $ 53,485    $ 26,672    99.5 %

Other revenue

     178      614      436    244.9  
                       

Total revenue

   $ 26,991    $ 54,099    $ 27,108    100.4  

The 100.4% increase in revenue for the year ended December 31, 2006, as compared to the year ended December 31, 2005, resulted primarily from an increase in the number of customers to whom we provided services, increased volume from new and existing customers and an increased number of higher-priced final reads. For the year ended December 31, 2006, approximately 81% of our revenues from reads were derived from preliminary reads and approximately 19% from final reads, compared with approximately 91% from preliminary reads and approximately 9% from final reads for the year ended December 31, 2005. The number of customers to whom we provided services increased to 374 as of December 31, 2006, from 238 as of December 31, 2005. The number of medical facilities to whom we provided services increased to 663 as of December 31, 2006, from 446 as of December 31, 2005. Same site volume growth increased approximately 20% for the year ended December 31, 2006, as compared to the year ended December 31, 2005. Same site volume growth measures the percentage increase in the number of reads over the comparable prior year period generated by a facility that has been under contract for at least three months at the beginning of the measurement period and remains a customer throughout that period. Other revenue, primarily representing revenue from technical support services to our customers, grew with the addition of new customers.

Operating Costs and Expenses

Professional Services

 

     Year Ended
December 31,
2005
  

Percentage

of Revenue

   Year Ended
December 31,
2006
  

Percentage

of Revenue

    Change  
                In Dollars    Percentage  
     (dollars in thousands)  

Physician cash compensation expense

   $ 13,670    50.6%    $ 25,505    47.2 %   $ 11,835    86.6 %

Physician stock-based compensation expense

     1,995      7.4         3,415    6.3       1,420    71.2  

Medical liability expense

     751      2.8         1,053    1.9       302    40.2  
                                  

Professional services

   $ 16,416    60.8%    $ 29,973    55.4 %   $ 13,557    82.6  

 

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The 82.6% increase in professional services expense for the year ended December 31, 2006, compared to the year ended December 31, 2005, resulted from increases in physician cash and non-cash compensation expense associated with our increased number of radiologists and a significant increase in the number of reads performed by radiologists together with additional medical liability insurance premiums. The increase in the non-cash component of professional service expense resulted from physician stock-based compensation related primarily to the increased fair value of our common stock. For the year ended December 31, 2006, the number of physicians performing reads increased 35.8%, from 53 for the year ended December 31, 2005 to 72 for the year ended December 31, 2006. The decrease in physician cash compensation expense as a percentage of revenue from 50.6% for the year ended December 31, 2005 to 47.2% for the year ended December 31, 2006 primarily resulted from our rapid engagement of physicians in the first half of 2005 in anticipation of significant sales growth and seasonal demand, and our better matching of capacity with demand for the first half of 2006.

Sales, General and Administrative

 

   

Year Ended

December 31,

2005

 

Percentage

of Revenue

    Year Ended
December 31,
2006
 

Percentage

of Revenue

    Change  
            In Dollars   Percentage  

Sales, general and administrative

  $ 12,814   47.5 %   $ 22,270   41.2 %   $ 9,456   73.8 %

The 73.8% increase in sales, general and administrative expense for the year ended December 31, 2006, compared to the year ended December 31, 2005, resulted from increased expenses for employee compensation, information technology, facilities, licensing and credentialing, sales and marketing and other general administrative expense.

 

  Ÿ  

Employee Compensation. Our employee compensation expense increased from $6.8 million for the year ended December 31, 2005 to $11.8 million for the year ended December 31, 2006. The 73.5% increase resulted primarily from the hiring of additional administrative and operations personnel to manage, operate and maintain our business, and from performance-based bonus compensation. As of December 31, 2006, the number of administrative and operations personnel increased 44.2% from 129 as of December 31, 2005 to 186 as of December 31, 2006.

 

  Ÿ  

Sales and Marketing. Our sales and marketing expenses increased from $1.5 million for the year ended December 31, 2005 to $3.1 million for the year ended December 31, 2006. The 106.7% increase resulted from an increase in the number of our sales and marketing personnel and expanded efforts in sales and marketing activities and programs. As of December 31, 2006, the number of sales and marketing personnel increased 22.7%, from 22 as of December 31, 2005 to 27 as of December 31, 2006.

 

  Ÿ  

Information Technology. Our information technology expense increased from $1.3 million for the year ended December 31, 2005 to $1.7 million for the year ended December 31, 2006. The 30.8% increase resulted from increased provisioning costs for communications bandwidth and additional radiologist network connections together with increases in software transactional costs associated with increased volumes, partially offset by a decrease in software transactional costs resulting from our implementation of our own RIS in February 2006.

 

  Ÿ  

Licensing and Credentialing. Our licensing and credentialing related expenses increased from $886,000 for the year ended December 31, 2005 to $938,000 for the year ended December 31, 2006. The 5.9% increase relates primarily to the amount and timing of initial and renewal license applications and was partially offset by the comparatively lower costs of renewal applications.

 

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  Ÿ  

Other General and Administrative. Our other general and administrative expenses increased from $2.2 million for the year ended December 31, 2005 to $4.7 million for the year ended December 31, 2006. The 113.6% increase resulted from an increase in facilities expense, outside professional expense as well as other general operating expense commensurate with our increased activities.

We believe that sales, general and administrative expenses, including the costs associated with the performance of the management services we have recently begun to provide to some of our customers and as a result of expenses related to being a public company, will increase as we continue to grow, but will decrease as a percentage of revenue.

Depreciation and Amortization Expense. Depreciation and amortization expense increased from $586,000 for the year ended December 31, 2005 to $1.4 million for the year ended December 31, 2006. This 138.9% increase was primarily due to the increase in depreciation expense related to additional capital equipment purchased for our operations. We believe that depreciation and amortization expense will increase in the future, but will decrease as a percentage of revenue.

Interest (Expense) Income, Net. Interest (expense) income, net, increased from income of $56,000 for the year ended December 31, 2005 to income of $217,000 for the year ended December 31, 2006. This increase resulted from interest income earned on the net proceeds of our sale of Series A Preferred Stock in May 2005, net of interest expense on our revolving line of credit repaid from the proceeds of that sale.

Non-Controlling Interest Expense (Income). Through consolidation, we recognize all net losses of the Affiliated Medical Practices in excess of the equity of the Affiliated Medical Practices. For the period ended December 31, 2005 VRP experienced net losses that changed VRP’s equity position to a net deficit and, as a result we recognized non-controlling interest income of $1.4 million relating to losses previously absorbed by VRC. During the year ended December 31, 2006, the non-controlling interest expense was $25,000, which reflects income generated by one of our Affiliated Medical Practices during that period.

Income Tax Expense. Income tax expense increased from $58,000 for the year ended December 31, 2005 to $1.2 million for the year ended December 31, 2006. As previously discussed, we consolidate our financial results in accordance with FIN 46(R). However, for income tax purposes, VRC is a single tax entity that is taxed as a corporation and is not included in a tax consolidated group with the Affiliated Medical Practices. As a result, tax losses of the Affiliated Medical Practices are not available to offset taxable income of VRC. The difference in the consolidated group for financial statement purposes and tax purposes, combined with the valuation allowances established for deferred tax assets related to net operating loss carryforwards of certain of the Affiliated Medical Practices, resulted in the increase in income tax expense for the year ended December 31, 2006 compared to the year ended December 31, 2005. In addition, the increase also resulted from the utilization of the net operating loss carry-forwards previously not recognized which eliminated VRC’s taxable income for the year ended December 31, 2005. There were no operating loss carry-forwards to be utilized for the year ended December 31, 2006. These factors resulted in an effective tax rate of 175.9% for the year ended December 31, 2006 compared to a negative 4.1% for the year ended December 31, 2005.

Preferred Stock Accretion. Preferred stock accretion decreased from $28.2 million for the year ended December 31, 2005 to $11.4 million for the year ended December 31, 2006. This accretion relates to our Series A Preferred Stock, which was issued on May 2, 2005, and is calculated based on the difference between the estimated fair value of the Series A Preferred stock as of the consolidated balance sheet date compared to the fair value of the stock on the previous consolidated balance sheet date.

 

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Comparison of Years Ended December 31, 2004 and December 31, 2005

Revenue

 

     Year Ended
December 31,
   Change  
     2004    2005    In Dollars    Percentage  
     (dollars in thousands)  

Revenue from reads

   $ 12,808    $ 26,813    $ 14,005    109.3 %

Other revenue

     91      178      87    95.6  
                       

Total revenue

   $ 12,899    $ 26,991    $ 14,092    109.2  

The 109.2% increase in revenue for the year ended December 31, 2005, as compared to the year ended December 31, 2004, resulted primarily from an increase in the number of customers to whom we provided services, increased volume from new and existing customers and the provision of higher-priced final reads beginning in December 2004. For the year ended December 31, 2005, approximately 91% of our revenues from reads were derived from preliminary reads and approximately 9% from final reads. We began providing final reads in December 2004 and as a result, during the year ended December 31, 2004, the revenues derived from final reads were immaterial. The number of customers to whom we provided services increased to 238 for the year ended December 31, 2005 from 123 for the year ended December 31, 2004. The number of medical facilities to whom we provided services increased to 446 for the year ended December 31, 2005 from 216 for the year ended December 31, 2004. Same site volume growth increased 24% for the year ended December 31, 2005, as compared to the year ended December 31, 2004. Same site volume growth measures the percentage increase in the number of reads over the comparable prior year period generated by a facility that has been under contract for at least three months at the beginning of the measurement period and remains a customer throughout that period. Other revenue, primarily representing revenue from technical support services to our customers, grew with the addition of new customers.

Operating Costs and Expenses

Professional Services

 

    Year Ended
December 31,
2004
  Percentage
of Revenue
    Year Ended
December 31,
2005
  Percentage
of Revenue
    Change  
            In Dollars   Percentage  
    (dollars in thousands)  

Physician cash compensation expense

  $ 6,523   50.6 %   $ 13,670   50.6 %   $ 7,147   109.6 %

Physician stock-based compensation expense

    154   1.2       1,995   7.4       1,841   1,195.5  

Medical liability expense

    336   2.6       751   2.8       415   123.5  
                               

Professional Services

  $ 7,013   54.4 %   $ 16,416   60.8 %   $ 9,403   134.1  

The 134.1% increase in professional service expense for the year ended December 31, 2005, compared to the year ended December 31, 2004, resulted from increases in physician cash and non-cash compensation expense associated with our increased number of radiologists and the initiation of day coverage for the provision of final reads, as well as increased services performed by radiologists. The increase in professional service expense also includes additional medical liability insurance premiums. The increase in the non-cash component of professional services expense resulted from physician stock-based compensation related primarily to the increased fair value of our common stock. For the year ended December 31, 2005, the number of physicians performing reads increased 55.9%, from 34 for the year ended December 31, 2004 to 53 for the year ended December 31, 2005.

 

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Sales, General and Administrative

 

    Year Ended
December 31,
2004
 

Percentage
of Revenue

    Year Ended
December 31,
2005
  Percentage
of Revenue
    Change  
            In Dollars   Percentage  
    (dollars in thousands)  

Sales, general and administrative

  $ 6,899   53.5 %   $ 12,814   47.5 %   $ 5,915   85.7 %

The 85.7% increase in sales, general and administrative expense for the year ended December 31, 2005 compared to the year ended December 31, 2004 resulted from increased expenses for employee compensation, information technology, facilities, licensing and credentialing, sales and marketing and other general administrative expense.

 

  Ÿ  

Employee Compensation.    Our employee compensation expense increased from $3.3 million for the year ended December 31, 2004 to $6.8 million for the year ended December 31, 2005. The 106.1% increase resulted primarily from the hiring of additional administrative and operations personnel to manage, operate and maintain our growing business, and to performance-based bonus compensation. As of December 31, 2005, the number of administrative and operations personnel increased 111.5%, from 61 as of December 31, 2004 to 129 as of December 31, 2005.

 

  Ÿ  

Sales and Marketing.    Our sales and marketing expenses increased from $815,000 for the year ended December 31, 2004 to $1.5 million for the year ended December 31, 2005. The 84.0% increase resulted from an increase in the number of our sales and marketing personnel and expanded efforts in sales and marketing activities and programs. As of December 31, 2005, the number of sales and marketing personnel increased 214.3%, from seven as of December 31, 2004 to 22 as of December 31, 2005.

 

  Ÿ  

Information Technology.    Our information technology expenses increased from $764,000 for the year ended December 31, 2004 to $1.3 million for the year ended December 31, 2005. The 70.2% increase resulted from increased provisioning costs for communications bandwidth and additional radiologist network connections together with increases in software transactional costs associated with increased read volumes.

 

  Ÿ  

Licensing and Credentialing.    Our licensing and credentialing expenses increased from $669,000 for the year ended December 31, 2004 to $886,000 for the year ended December 31, 2005. The 32.4% increase relates primarily to the amount and timing of initial and renewal license applications.

 

  Ÿ  

Other General and Administrative.    Our other general administrative expenses increased from $1.3 million for the year ended December 31, 2004 to $2.2 million for the year ended December 31, 2005. The 69.2% increase resulted primarily from increased facility expenses incurred, increased professional fees as well as other general operating expense commensurate with our increased operating activities.

We believe that sales, general and administrative expenses, including the costs associated with becoming a public company, will increase in dollars as we continue to grow, but will decrease as a percentage of revenue.

Depreciation and Amortization Expense.    Depreciation and amortization increased from $230,000 for the year ended December 31, 2004, to $586,000 for the year ended December 31, 2005. This 154.8% increase was primarily due to the increase in depreciation expense related to additional capital equipment purchased for our operations.

Interest (Expense) Income, Net.    Interest (expense) income, net, increased from expense of $95,000 for the year ended December 31, 2004, to income of $56,000 for year ended December 31,

 

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2005. This 158.9% increase resulted from interest income earned on the net proceeds of our sale of Series A Preferred Stock in May 2005, net of interest expense on our revolving line of credit repaid from the proceeds of that sale.

Non-Controlling Interest Expense (Income).    Through consolidation, we recognize all net losses of each Affiliated Medical Practice in excess of the equity of that Affiliated Medical Practice. We recognize net earnings of each Affiliated Medical Practice only to the extent we are recovering losses previously recognized by us with respect to that Affiliated Medical Practice. Earnings of each Affiliated Medical Practice in excess of losses previously recognized by us with respect to that Affiliated Medical Practice are excluded from our earnings and are attributed to the respective equity owners of that Affiliated Medical Practice by recording such earnings as non-controlling interest on our consolidated financial statements. During the year ended December 31, 2004, we had only one Affiliated Medical Practice, which had earnings that exceeded losses previously recognized by us resulting in non-controlling interest expense of $62,000. During the year ended December 31, 2005, that Affiliated Medical Practice experienced net losses that changed its equity position to a net deficit. As a result, we recognized non-controlling interest income of $1.4 million relating to losses previously absorbed by VRC.

Preferred Stock Accretion.    Preferred stock accretion was $28.2 million for the year ended December 31, 2005. This accretion relates to our Series A Preferred Stock, which was issued on May 2, 2005, and is calculated based on the difference between the estimated fair value of the Series A Preferred Stock as of the consolidated balance sheet date compared to the fair value of the stock on the date it was issued.

 

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Quarterly Results of Operations

The following table presents our unaudited consolidated results of operations and other financial data for the last eight quarters. The financial data presented below for the three months ended December 31, 2005 reflects the consolidated operations of Virtual Radiologic Consultants, Inc., our predecessor corporation, and Virtual Radiologic Professionals, LLC. The financial data presented below for the three months ended March 31, 2006, June 30, 2006, September 30, 2006, December 31, 2006, March 31, 2007, June 30, 2007 and September 30, 2007 reflects the consolidated operations of Virtual Radiologic Corporation and the Affiliated Medical Practices. You should read the following table in conjunction with the consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited interim consolidated financial statements in accordance with GAAP, and the rules and regulations of the SEC for interim financial statements. These interim financial statements reflect all adjustments consisting of normal recurring accruals, which, in the opinion of management, are necessary to present fairly the results of our operations for the interim periods.

 

    Three Months Ended  
    December 31,
2005
   

March 31,
2006

    June 30,
2006
    September 30,
2006
    December 31,
2006
    March 31,
2007
    June 30,
2007
    September 30,
2007
 
    (in thousands)  

Consolidated Statements of Operations Data:

               

Revenue

  $ 8,226     $ 9,674     $ 12,383     $ 15,877     $ 16,165     $ 18,102     $ 21,163     $ 24,033  

Operating costs and expenses(1)

    9,656       10,971       12,199       14,791       15,633       16,026       20,002       20,244  
                                                               

Operating (loss) income

    (1,430 )     (1,297 )     184       1,086       532       2,076       1,161       3,789  

Other (expense) income

               

Interest expense

    (14 )     (9 )     (12 )     (7 )     (9 )     (6 )     (1 )     (435 )

Interest income

    70       60       65       75       54       43       71       138  
                                                               

Other income (expense)

    56       51       53       68       45       37       70       (297 )
                                                               

(Loss) income before non-controlling interest and income tax

    (1,374 )     (1,246 )     237       1,154       577       2,113       1,231       3,492  

Non-controlling interest (income) expense

    (339 )     95       100       90       (260 )     680       (341 )     1,752  

Income tax expense (benefit)

    58       209       413       1,058       (454 )     392       995       1,192  
                                                               

Net income (loss)

    (1,093 )     (1,550 )     (276 )     6       1,291       1,041       577       548  

Cash dividends paid:

               

Preferred

    —         —         —         —         —         —         —         (13,597 )

Series A Cumulative Redeemable Convertible Preferred Stock (accretion) decretion

    (21,376 )     (9,768 )     (3,924 )     (4,589 )     6,844       4,774       (24,892 )     (4,950 )
                                                               

Net (loss) income available to common stockholders

  $ (22,469 )   $ (11,318 )   $ (4,200 )   $ (4,583 )   $ 8,135     $ 5,815     $ (24,315 )   $ (17,999 )
                                                               

(1) Includes the non-cash stock-based compensation and depreciation and amortization charges set forth in the following table:

 

    Three Months Ended
    December 31,
2005
 

March 31,
2006

  June 30,
2006
  September 30,
2006
  December 31,
2006
  March 31,
2007
    June 30,
2007
  September 30,
2007
    (in thousands)

Professional services
Non-cash stock-based compensation

  $ 1,571   $ 1,500   $ 653   $ 1,097   $ 166   $ (105 )   $ 2,158   $ 875

Sales, general and administrative

               

Non-cash stock-based compensation

        9     22     19     65     27       89     292

Depreciation and amortization

    219     268     327     347     409     498       549     654
                                                 
  $ 1,790   $ 1,777   $ 1,002   $ 1,463   $ 640   $ 420     $ 2,796   $ 1,821
                                                 

 

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Liquidity and Capital Resources

Cash, Cash Equivalents and Short-Term Investments

Our financial position includes cash and cash equivalents of $6.0 million and $11.5 million at December 31, 2006 and September 30, 2007, respectively.

We have historically funded our operations from cash flows generated by our operating activities, proceeds from the sale of our Series A Preferred Stock and common stock, and borrowings under our revolving credit facility. The reported changes in cash and cash equivalents for the years ended December 31, 2004, 2005 and 2006 and for the nine months ended September 30, 2006 and 2007, are summarized below:

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
    2004     2005       2006       2006     2007  
    (in thousands)  

Net cash provided by (used in) operating activities

  $ 203     $ (1,794 )   $ 3,977     $ 4,131     $ 5,194  

Net cash (used in) provided by investing activities

    (360 )     (7,754 )     1,208       2,785       (3,574 )

Net cash provided by (used in) financing activities

    566       12,151       (2,315 )     (2,131 )     3,897  
                                       

Increase in cash and cash equivalents

  $ 409     $ 2,603     $ 2,870     $ 4,785     $ 5,517  
                                       

Cash Flows from Operating Activities

For the nine months ended September 30, 2007, we generated $5.2 million of net cash from operating activities from net income of $2.2 million. Our net cash provided by operations during this period included an increase in our accounts receivable of $5.2 million, which resulted primarily from the growth in our business and a $1.9 million increase in current taxes receivable as a result of a projected taxable loss for the year ended December 31, 2007. In addition, the net cash provided by operating activities included an increase in accrued expenses of $2.1 million resulting primarily from an increase in professional services compensation, and a decrease in prepaid expenses of $1.2 million resulting primarily from the amortization of our prepaid medical malpractice insurance.

For the year ended December 31, 2006, we generated $4.0 million of net cash from operating activities from a net loss of $529,000. Our net cash from operations during this period included an increase in our accounts receivable of $4.6 million, which resulted primarily from the growth in our business and an increase in the average number of days our sales were outstanding from approximately 46 days for the year ended December 31, 2005 to 48 days for the year ended December 31, 2006. The net cash from operating activities included an increase in accounts payable and accrued expenses of $4.0 million, which related primarily to increases in accrued compensation expense and accrued professional fees for employees and independent contractor physicians. In addition, the net cash from operating activities included an increase in current taxes payable of $608,000.

Cash Flows from Investing Activities

Net cash used in investing activities was $3.6 million for the nine months ended September 30, 2007. The cash used was primarily for capital expenditures associated with the purchase of equipment and continued investment in our information technology infrastructure.

 

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Net cash provided by investing activities was $1.2 million for the year ended December 31, 2006, which was comprised primarily of the maturation of a short-term investment, partially offset by capital expenditures associated with purchases of equipment and continued investment in our information technology infrastructure.

Cash Flows from Financing Activities

Net cash provided by financing activities was $3.9 million for the nine months ended September 30, 2007. Our net cash provided by financing activities included an increase of $3.6 million as a result of tax benefits generated by the disqualified disposition of stock options during the period. In addition, cash flows from financing activities included net proceeds from the issuance of common stock of $1.2 million that resulted from the exercise of stock options and warrants during the period, and payments related to the costs associated with our anticipated initial public offering of $674,000. Our net cash provided by financing activities also included an increase of $41.0 million related to the incurrence of debt under the term loan under our Senior Credit Facility, which was partially offset by an approximately $1.2 million decrease in cash provided by financing activities resulting from the payment of debt issuance costs and an approximately $39.9 million decrease resulting from the payment of a dividend declared by our Board of Directors.

Net cash used in financing activities was $2.3 million for the year ended December 31, 2006. During this period the net cash provided by financing activities included payment on a related party payable of $200,000 relating to the concurrent receipt of the same amount from one of our affiliated radiologists in connection with the concurrent redemption and resale of shares of our common stock. In addition, net cash used in financing activities for the twelve month period also included $1.8 million of payments related to the costs associated with our anticipated initial public offering and $292,000 of payments on capital leases.

Future Liquidity Requirements

We believe that our cash balances and the expected cash flow from operations, along with the anticipated proceeds from this offering, will be sufficient to fund our operating activities, working capital and capital expenditure requirements for at least the next eighteen months. We expect our long-term liquidity needs to consist primarily of working capital and capital expenditure requirements. We intend to fund these long-term liquidity needs from cash generated from operations along with cash generated by potential future financing transactions. 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. See “—Senior Credit Facility.” If additional funds are obtained by issuing equity securities, substantial dilution to existing stockholders may result. 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 debt or equity financing. Additional funds may not be available on terms favorable to us or at all.

 

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Contractual Obligations and Commitments

The following table presents a summary of our contractual obligations and commitments as of September 30, 2007, excluding our Series A Preferred Stock. Upon the completion of this offering, all outstanding shares of our Series A Preferred Stock will convert into shares of our common stock and the rights of the holders of our Series A Preferred Stock to receive accreted dividends will terminate. The professional services agreements that we entered into with our affiliated radiologists are not included in the following table because those contracts, subject to certain notice provisions, may be terminated by either party.

 

     Total    Less Than
1 Year
   1-3 Years    3-5 Years    More than
5 Years
     (in thousands)

Operating Lease Commitments(1)

   $ 1,691    $ 567    $ 986    $ 138    $

Debt(2)

   $ 41,000    $ 3,000    $ 13,000    $ 25,000    $

(1) Operating lease commitments primarily consist of leases for our office facilities in Minnetonka, Minnesota, Eden Prairie, Minnesota, Maui, Hawaii and Mountainview, California.
(2) Debt consists of the current and long term payment obligations under the term loan under our Senior Credit Facility.

We did not have any current or future capital lease commitments as of September 30, 2007.

Revolving Credit Facility with Associated Bank

In December 2006, we terminated our revolving credit facility with Associated Commercial Finance, Inc. and entered into a new revolving credit facility with Associated Bank, National Association. Pursuant to the terms of the new revolving credit facility, up to $2.0 million was available to us provided that such amount did not exceed 80% of our outstanding accounts receivable. Our obligations under the new revolving credit facility were secured by a pledge of our accounts receivable and a security interest in our other property. We were able to voluntarily prepay any amounts outstanding under the new revolving credit facility without penalty or fees. Any amounts outstanding under the new revolving credit facility incurred interest at a rate equal to the greater of 5% or the prime rate. We were required to pay a non-use fee for any unborrowed amounts under the new revolving credit facility at a rate of 0.25% per annum. Under the terms of the new revolving credit facility, we were subject to, among other things, restrictions on incurring additional debt, liens and encumbrances. We terminated the new revolving credit facility, which was undrawn as of the date of its termination, in August 2007 in connection with the closing of our Senior Credit Facility described below.

Senior Credit Facility

We entered into the Senior Credit Facility on August 29, 2007 that is comprised of a $4.0 million revolver, which is undrawn as of the date hereof, and a $41.0 million term loan, of which $41.0 million was outstanding as of September 30, 2007. The proceeds of the term loan after the payment of fees and expenses incurred in connection with the Senior Credit Facility, together with cash on hand, were used to fund a one-time dividend of $3.00 per share that was declared by our Board of Directors on August 10, 2007. On September 5, 2007, we paid an aggregate of approximately $39.9 million in respect of the dividend to all of our stockholders of record as of August 29, 2007. Upon repayment of the amounts outstanding under the term loan under the Senior Credit Facility, which we expect to repay with the proceeds from this offering, the term loan will be terminated and will not be available for borrowing. For an amortization schedule of the Senior Credit Facility, see page F-21.

The following is a summary of certain material provisions of the Senior Credit Facility; however, the following is not intended to summarize all of the material provisions of the Senior Credit Facility. A copy of the agreement governing the Senior Credit Facility has been filed as an exhibit to the Registration Statement of which this prospectus forms a part.

 

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Interest Rate and Fees

The interest rates per annum applicable to the loans under the Senior Credit Facility will be, at our option, equal to either a base rate or an adjusted LIBO rate, in each case, plus an applicable margin percentage. The base rate will be the greater of: (i) 50 basis points above the weighted average of rates on overnight Federal funds as published by the Federal Reserve Bank of New York and (ii) Bloomberg’s prime rate as published by Bloomberg Professional Service. The adjusted LIBO rate will be determined by reference to settlement rates established for deposits in dollars in the London interbank market for a period equal to the interest period of the loan as adjusted for the maximum reserve requirement established by the Board of Governors of the Federal Reserve System. The applicable margin percentage is a percentage per annum equal to: (x) 3.00% for base rate loans and 4.25% for LIBO rate loans until the first business day after the administrative agent’s receipt of our consolidated financial statements for the quarter ending September 30, 2007; and (y) a percentage ranging from 2.50% to 3.00% for base rate loans and 3.75% to 4.25% for LIBO rate loans, in each case depending upon our leverage ratio as of the relevant date of determination, for the period thereafter. As of September 30, 2007, the applicable interest rate, including the margin percentage, was 10.75%.

Accrued interest on the term loan is payable quarterly and at the date of maturity. Accrued interest on the revolver is payable quarterly from the date that the funds are drawn under the revolver.

Under the terms of the Senior Credit Facility, we are required to pay the administrative agent certain fees. In addition, we are required to pay a commitment fee of 50 basis points per annum on any unused commitments under the revolver.

Mandatory Prepayments

Subject to certain exceptions, the Senior Credit Facility requires mandatory prepayments of the term loan based on certain percentages of Excess Cash Flow (as defined therein) commencing 20 days after the completion of the audit of the annual financial statements for the year ending December 31, 2008. In addition, mandatory prepayments are required under the terms of the Senior Credit Facility based on the Net Available Proceeds (as defined therein) from asset sales and from the issuance of certain equity or debt securities, which includes the issuance of equity securities pursuant to this offering.

Collateral and Guarantors

The indebtedness outstanding under the Senior Credit Facility is guaranteed by the Affiliated Medical Practices, and is secured by a security interest in substantially all of the existing and future property and assets, including, but not limited to, accounts receivable, inventory, equipment, general intangibles, intellectual property and other personal property, of Virtual Radiologic Corporation and the Affiliated Medical Practices.

Certain Covenants

The Senior Credit Facility requires compliance with certain financial ratios and covenants, including a leverage ratio, a fixed charge coverage ratio and a minimum Consolidated Adjusted EBITDA, including a minimum trailing twelve-month Consolidated Adjusted EBITDA.

Leverage ratio is defined in the Senior Credit Facility, as of any date, as the ratio of the total indebtedness of Virtual Radiologic Corporation on a consolidated basis to Consolidated Adjusted EBITDA for the period of the four consecutive fiscal quarters most recently ended. The Senior Credit Facility provides that the leverage ratio may not be greater than 3.75 to 1.0 for September 30, 2007; 3.25 to 1.0 for December 31, 2007; 2.75 to 1.0 for March 31, 2008; 2.50 to 1.0 for June 30, 2008; 2.25 to 1.0 for September 30, 2008 and December 31, 2008; 2.00 to 1.0 for March 31, 2009 and June 30, 2009; 1.75 to 1 for September 30, 2009 and December 31, 2009; and 1.50 to 1 for March 31, 2010 and thereafter.

 

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Fixed charge coverage ratio is defined in the Senior Credit Facility, as of the date of determination, the ratio of Consolidated Cash Flow (as defined therein) for the period of the four consecutive fiscal quarters ending on or most recently ended prior to such date of determination to Consolidated Debt Service (as defined therein) for such period. The Senior Credit Facility provides that the fixed charge coverage ratio, as of the last day of the applicable period, may not be less than 1.15 to 1.0 for September 30, 2007, December 31, 2007, March 31, 2008 and June 30, 2008; 1.20 to 1.0 for September 30, 2008, December 31, 2008, March 31, 2009 and June 30, 2009; and 1.35 to 1.0 for September 30, 2009, December 31, 2009, March 31, 2010 and thereafter.

The Senior Credit Facility defines Consolidated Adjusted EBITDA as consolidated net income (loss) excluding the effect of income tax expense, non-controlling interest, interest expense (income), net, depreciation and amortization and certain other non-recurring expenses or charges and the effect of employee and physician non-cash stock-based compensation expense. The Senior Credit Facility requires a minimum trailing twelve-month Consolidated Adjusted EBITDA of $11.0 million for the twelve months ended September 30, 2007. For the nine months ended September 30, 2006, the year ended December 31, 2006 and the nine months ended September 30, 2007, our Consolidated Adjusted EBITDA was approximately $4.4 million, $6.0 million and $12.5 million, respectively. In addition, our Consolidated Adjusted EBITDA for the trailing twelve-months ended September 30, 2007 was approximately $14.3 million. The Senior Credit Facility provides that the Consolidated Adjusted EBITDA for the period of the four consecutive fiscal quarters ending on or most recently ended prior to such date of determination may not be less than $12.75 million for December 31, 2007; $14.75 million for March 31, 2008; $16.0 million for June 30, 2008; $17.0 million for September 30, 2008; $17.5 million for December 31, 2008; $18.0 million for March 31, 2009; $18.5 million for June 30, 2009; $19.0 million for September 30, 2009; $19.25 million for December 31, 2009; and $19.5 million for March 31, 2010 and thereafter.

Consolidated Adjusted EBITDA is not a recognized term under GAAP and does not purport to be an alternative to net cash provided by (used in) operating activities or any other GAAP measure as an indicator of liquidity. Because not all companies use identical calculations, this presentation of Consolidated Adjusted EBITDA may not be comparable to other similarly titled measures of other companies.

Consolidated Adjusted EBITDA is not intended to be a measure of free cash flow for management’s discretionary use since it does not consider certain cash requirements, such as interest payments, tax payments, non-controlling interest, debt service requirements and capital expenditures.

 

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The following is a reconciliation of Consolidated Adjusted EBITDA to net cash provided by operating activities:

 

    

Year Ended
December 31,

2006

   

Nine Months Ended

September 30,

     Twelve Months
Ended
September 30,
 
       2006     2007      2007  
    

(in thousands)

     (in thousands)  

Net cash provided by (used in) operating activities

   $ 3,977     $ 4,131     $ 5,194      $ 5,040  

Provision for doubtful accounts and sales allowance

     191       60       188        319  

Interest and discount amortization

     (67 )     (67 )     26        26  

Loss on disposal of property, plant and equipment

     90       55       12        47  

Interest (expense) income, net

     217       172       (190 )      (145 )

Income tax expense

     (1,226 )     (1,680 )     (2,579 )      (2,125 )

Deferred income taxes, net

     64       —         (52 )      12  

Changes in operating assets and liabilities, net

     (679 )     1,376       (4,273 )      (6,328 )

Other non-recurring expenses(1)

     (683 )     (153 )     (486 )      (1,016 )
                                 

Consolidated Adjusted EBITDA

   $ 6,070     $  4,368     $  12,548      $ 14,250  
                                 

(1) Other non-recurring expenses includes the following:

 

    

Year Ended
December 31,

2006

   

Nine Months
Ended

September 30,

     Twelve Months
Ended
September 30,
 
       2006     2007      2007  
    

(in thousands)

     (in thousands)  

Other non-recurring expenses:

         

Non-capitalized offering costs

   $ (266 )   $ (153 )   $ (133 )    $ (246 )

Executive severance costs

     (330 )     —         (168 )      (498 )

Executive placement costs

     (87 )     —         (185 )      (272 )
                                 

Total

   $ (683 )   $ (153 )   $ (486 )    $ (1,016 )
                                 

The Company’s compliance with the foregoing financial covenants are material terms of the Senior Credit Facility as the failure to comply with such financial covenants could result in an event of default thereunder.

In addition, the Senior Credit Facility includes negative covenants restricting or limiting our ability to, among other things:

 

  Ÿ  

create, incur, assume or permit additional indebtedness or guarantees;

 

  Ÿ  

create, incur, assume or permit to exist additional liens;

 

  Ÿ  

engage in mergers, consolidations and certain other transactions;

 

  Ÿ  

dispose of assets;

 

  Ÿ  

enter into sale leaseback transactions;

 

  Ÿ  

pay any dividends other than stock dividends;

 

  Ÿ  

alter the business that the Company is currently engaged in;

 

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  Ÿ  

make investments; and

 

  Ÿ  

enter into transactions with affiliates.

Such negative covenants are subject to certain exceptions. We are currently in compliance with all of the covenants contained in the Senior Credit Facility.

Certain Events of Default

The Senior Credit Facility provides for certain events of default, including, but not limited to, the following:

 

  Ÿ  

the failure to pay any principal of any loan when and as due and payable;

 

  Ÿ  

the failure to pay any interest on any loan or any fee or any other amount payable under any Financing Document (as defined therein) when due and payable;

 

  Ÿ  

any representation made in any Financing Document (as defined therein) or in any document furnished pursuant to or in connection with any Financing Document is incorrect in any material respect when made;

 

  Ÿ  

defaults under covenants contained in the Senior Credit Facility, with certain covenant defaults providing for no cure period and other covenant defaults providing for a cure period of 30 days after notice to Virtual Radiologic Corporation or after one of the specified executive officers becomes aware of such failure, subject to certain exceptions;

 

  Ÿ  

one or more judgments in an aggregate amount in excess of $750,000 is rendered against Virtual Radiologic Corporation or the Affiliated Medical Practices and such judgment remains undischarged or unstayed for a period of 45 days;

 

  Ÿ  

default under any other indebtedness in an aggregate amount in excess of $750,000;

 

  Ÿ  

the occurrence of a Change in Control (as defined therein); and

 

  Ÿ  

certain bankruptcy related events.

If such an event of default occurs, the lenders under the Senior Credit Facility would be entitled to take various actions, including, but not limited to, the ability to terminate any commitments they have to provide further borrowings and the acceleration of amounts due thereunder.

This offering will not constitute a Change in Control under the Senior Credit Facility.

Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risk

We currently do not have significant exposure to foreign currency exchange rates as all of our transactions are denominated in U.S. dollars.

Interest Rate Market Risk

Our cash is invested in bank deposits and money market funds denominated in U.S. dollars. The carrying value of our cash, restricted cash, accounts receivable, other current assets, trade accounts payable, accrued expenses and customer deposits, and borrowings under the term loan under our Senior Credit Facility approximate fair value because of the short period of time to maturity.

 

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Recent Accounting Pronouncements

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting treatment (recognition and measurement) for an income tax position taken in a tax return and recognized in a company’s financial statement. The new standard also contains guidance on “de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.” The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. Our adoption of FIN 48 did not have a material impact on our consolidated results of operations or financial position.

In September 2006, the Securities and Exchange Commission Staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). This SAB addresses diversity in practice of quantifying financial statement misstatements. It establishes an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. The SAB is effective for financial statements issued for fiscal years ending after November 15, 2006. We believe the adoption of SAB 108 will not have a material impact on our consolidated results of operations or financial position.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. This standard is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of this statement. We do not believe the adoption of SFAS No. 157 will have a material impact on our consolidated results of operations or financial position.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). This standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. We do not believe the adoption of SFAS No. 159 will have a material impact on our consolidated results of operations or financial position.

 

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BUSINESS

Overview

We believe we are one of the leading providers of teleradiology services in the United States. According to Frost & Sullivan, we are the second largest provider of teleradiology services in the United States. We serve our customers—radiology practices, hospitals, clinics and diagnostic imaging centers—by providing reads 24 hours a day, seven days a week, 365 days a year. Our unique distributed operating model provides our qualified team of American Board of Radiology-certified radiologists with the flexibility to choose the location from which they work, primarily within the United States, and allows us to serve customers located throughout the country. We provide these services through a robust, highly scalable communications network incorporating encrypted broadband internet connections and proprietary workflow management software. We have developed a strong customer base and experienced significant revenue growth from $12.9 million in 2004 to $27.0 million in 2005 and $54.1 million in 2006. We have incurred net losses of $1.4 million, $1.5 million and $0.5 million in 2004, 2005 and 2006, respectively. In addition, our revenues grew from $37.9 million for the nine months ended September 30, 2006 to $63.3 million for the nine months ended September 30, 2007. We incurred a net loss of $1.8 million and net income of $2.2 million over the same periods, respectively.

In recent years, the United States healthcare industry has experienced increasing demand for diagnostic imaging services. The increase in diagnostic imaging procedures is being driven by an aging population, advances in diagnostic imaging technologies and the growing availability of imaging equipment in hospitals and clinics, as well as by more frequent physician referrals for diagnostic imaging warranted by additional medical indications. According to Frost & Sullivan, digital diagnostic image procedure volume is expected to continue to grow 15% annually to over 500 million procedures by 2009. Additionally, advances in digital technology now allow for the transmission of images in a high quality, standardized, cost-effective and encrypted format, allowing radiologists to read remotely.

The number of radiologists in practice is expected to increase by less than 2% annually, according to the American Journal of Roentgenology, despite the expected growth in digital diagnostic image procedure volume. This relatively slow growth in radiologists, which is due, in part, to the retirement of existing radiologists and the limited number of positions in accredited radiology residency programs, is expected to exacerbate the radiologist shortage that currently exists. The shortage of radiologists and the growing imaging procedure volume are further compounded by the fact that contracted radiology practices are required to provide their hospital customers with services 24 hours a day, seven days a week in order to accommodate the growing number of off-hour procedures. Consequently, radiology practices and hospitals have begun to seek supplemental services to assist their own radiology staffs with both day and night coverage.

We address this industry need by providing radiology practices, hospitals, clinics and diagnostic imaging centers an attractive way to improve service levels, streamline underlying practice economics and enhance physician efficiency, without sacrificing the quality of work. We assist our customers by providing them with access to subspecialty-trained radiologists to perform reads, day or night, thereby improving the quality of patient care. Our services include both preliminary reads, which are performed for emergent care purposes, and final reads, which are performed for both emergent and non-emergent care purposes. Our ability to provide coverage 24 hours a day supports our customers when their workloads increase during the day and relieves the burden of performing reads overnight, and during holidays, weekends and other difficult-to-staff times. We believe this allows our customers to provide seamless patient care and to better attract and retain radiologists in their practices. In November 2006, we also contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers.

 

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Our unique distributed operating model and proprietary workflow management software provide our affiliated radiologists with a flexible choice of location, predictable schedule and competitive compensation. Our affiliated radiologists, substantially all of whom are located in the United States, are certified by the American Board of Radiology, licensed by the states in which they practice and credentialed by the hospitals for which they perform reads. We have a large number of United States-based affiliated radiologists dedicated to the practice of teleradiology. Our affiliated radiologists collectively hold licenses in all 50 states, the District of Columbia and Puerto Rico. As of September 30, 2007, we had 106 radiologists providing services for us and had contracted with an additional 15 radiologists who had not yet begun servicing our customers.

Our primary customers are local radiology practices that have already contracted with hospitals and clinics and require diagnostic image interpretation services for a range of imaging modalities including CT, MRI and ultrasound. We are compensated by our customers and do not directly depend on reimbursement from patients or third party payers. As of September 30, 2007, our affiliated radiologists provided services to 457 customers serving 787 medical facilities, which includes 736 hospitals, representing approximately 13% of hospitals in the United States. This represented an increase of 32% of medical facilities served and an increase of 35% in customers under contract since September 30, 2006. Since our inception, over 98% of our customer contracts up for renewal have been renewed.

Industry Overview

Teleradiology is the practice of transmitting digital diagnostic images to a location, remote from the site of image origination, for interpretation by a radiologist. Due to recent advances in technology, images can be transmitted from the point of origination to the location of the radiologist in a reliable, standardized, cost-effective and encrypted manner. This process differs from traditional radiology services in which radiologists typically live near the hospitals or clinics with which they are employed or affiliated, and must travel to those locations to read the images, resulting in significant inefficiencies. Teleradiology removes the physical constraint for radiologists to perform reads at the point of image origination and permits a remotely located radiologist to perform reads. Common examples of digital diagnostic images include CT, MRI and ultrasound images.

The teleradiology services industry has developed rapidly within the last few years, and we expect it will continue to develop due to an increasing volume of diagnostic imaging procedures, significant shortages in the number of radiologists, advances in digital diagnostic imaging technologies, advances in communication technologies and a wider acceptance of teleradiology services in hospital and clinical settings. In addition, teleradiology contributes to improved patient care through increased efficiency, accessibility to subspecialty expertise and optimized timing between the request for a radiographic image read and its interpretation.

Increasing Volume of Diagnostic Imaging Procedures

According to Frost & Sullivan, digital diagnostic imaging procedure volume is expected to continue to grow at a rate of 15% per year from approximately 300 million images in 2004 to over 500 million images in 2009. The increase in diagnostic imaging procedures is driven by an aging population, advances in diagnostic imaging technologies, the growing availability of imaging equipment in hospitals and clinics, and more frequent physician referrals for diagnostic imaging warranted by additional medical indications.

Significant Shortages in the Number of Radiologists

According to studies published by the American College of Radiology and the American Roentgen Ray Society, there is a nationwide shortage of radiologists when measured against the

 

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number of advertised positions and the increasing number of radiology studies performed. The American College of Radiology’s April 2004 study reported that the number of physicians in radiology residency programs decreased by 11% from 1996 to 2004. Further, according to a 2002 American Journal of Roentgenology study, the number of radiologists in practice was estimated to be 25,557 in 2001 and is expected to increase to 29,174 in 2010, implying an annual growth rate of only 1.5%. In addition, the study estimated that, assuming traditional practice and education models, the shortage of radiologists necessary to fulfill projected demand for radiology services could increase as much as 50% to a shortage of approximately 15,000 radiologists by the year 2020.

Compounding the radiologist shortage, approximately 50% of radiologists are now over the age of 50, according to the Recruiter News, and are now beginning, as they approach retirement age, to reduce their hours and/or demand more time off. For new radiologists, the overall shortage has put them in a position to demand better working hours, fewer nights and increased compensation and has given them the ability to be more selective in choosing a practice location. We believe that radiologist practices are overburdened due to understaffing and the increasing volume of reads. We also believe that the shortages are particularly acute outside major metropolitan areas.

Advances in Digital Diagnostic Imaging and Communication Technologies

Advances in digital diagnostic imaging and broadband communication technologies, capable of rapidly transmitting and storing digital images without degradation, have permitted a more timely and more efficient review of radiology images by remotely located radiologists. The industry wide acceptance of standardized transmission protocols known as Digital Imaging and Communications in Medicine, or DICOM, allows for the interoperability of various image acquisition modalities, such as CT or MRI, with image storage, management and viewing systems, such as Picture Archival Communications Systems, or PACS, thereby permitting the exchange of data among hospitals and providers. The advances in broadband communication technologies now permit reliable, secure, encrypted and cost effective transmission of image data files. Moreover, as a result of government mandated upgrades to electronic patient data systems and the relative affordability of these technology advances, hospitals and other health care facilities are upgrading their legacy computer systems to new equipment capable of generating and transmitting the digital images necessary for teleradiology. The convergence of these trends allows for efficiencies in the provision of radiology services by permitting the aggregation of radiology requirements from a number of hospitals, which results in cost saving and increased accessibility to more highly-trained and qualified radiologists.

Wider Acceptance in Hospital and Clinical Settings

As a result of advances in digital technology and improvements in standards of quality and reliability, teleradiology services have gained wider acceptance in hospitals and clinics. Historically, medical care has been administered by local providers and clinicians. Localization of care was driven by the need to maintain a patient’s medical history, perform physical examinations, apply complex procedures and share the information quickly. However, in recent years, advances in technology have facilitated a reliable alternative for gathering information and providing patient diagnoses. Initially, this type of remote care occurred among local physicians during off-hours as a matter of convenience. However, this solution implemented by individual practices and physicians has not solved the broader workload allocation issues associated with shortages of trained radiologists. As the practice of teleradiology has become more common and the results comparable to on-site care, local radiology practices and hospitals are increasingly turning to contracted teleradiology services to provide radiological services for emergency care and to supplement their physician coverage. Furthermore, this helps local radiology practices compete for the hiring of radiologists because of the ability to provide their own radiologists with more favorable working conditions.

 

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Our Solution

We believe we are one of the leading providers of teleradiology services to radiology practices, hospitals, clinics and diagnostic imaging centers throughout the United States. According to Frost & Sullivan, we are the second largest provider of teleradiology services in the United States. Our services and technology enable our customers to provide a high quality of medical care to their patients. We serve our customers by providing reads 24 hours a day, seven days a week, 365 days a year. Utilizing our proprietary workflow management software and secure broadband internet connections, we connect our customers and our affiliated radiologists through an easy-to-use, robust and scalable communications network. We believe that the following are our key competitive advantages:

Leading Presence in Attractive Market

Our established presence, comprehensive service offering and technology allow us to create a critical solution for medical care providers faced with shortages in radiology resources. We focus on quality patient care and industry-leading service levels. We believe our brand name, reputation and ability to deliver quality results drive customer relationships and retention, in turn attracting the best radiology talent and performance. Since our inception, we have played an integral role in the development of the teleradiology services market and we maintain a growing customer base with recurring revenue.

Improved Quality of Patient Care

We provide our customers with an attractive and economical way to improve service levels, increase the effectiveness of their work environment and enhance the quality of patient care. We enable our customers to provide patient care with 24 hour access to critical radiology services needed to effectively diagnose and treat patients. Since a majority of fellowship-trained specialists have traditionally located in metropolitan areas, patient access to required expertise is often limited in rural areas. Patient access to subspecialists is also limited in urban areas during off-hour, or emergency care, coverage periods when such subspecialists may not be locally available. We believe our services appropriately address this need, thereby improving the quality of patient care.

Our ability to rapidly assign reads to appropriately credentialed and trained specialists permits us to deliver high quality and specialized radiology services, including subspecialty services, to our customers. Our affiliated radiologists include subspecialty fellowship-trained radiologists in areas such as neuroradiology, abdominal imaging, musculoskeletal radiology, pediatric radiology, thoracic imaging and ultrasound, enabling us to match the appropriately skilled radiologist with the patient images we receive. We believe that the broad access and quality of the radiology services we provide to our customers have allowed us to achieve a high customer retention rate to date.

Sizable Group of U.S.-Based Radiologists Dedicated to Teleradiology

We have a large group of United States-based radiologists dedicated to the practice of teleradiology. While our technology platform allows radiologists to be situated in any part of the world with high-speed internet access, we believe the United States presence of our affiliated radiologists affords us advantages in recruiting and retaining American Board of Radiology-certified physicians. Without requiring these physicians to relocate either domestically or internationally, we provide our affiliated radiologists with a flexible choice of location, predictable schedule and competitive compensation. In addition, the location of our affiliated radiologists allows us to respond to opportunities in the market for final reads, which must be performed by United States domiciled radiologists to comply with Medicare reimbursement rules. Finally, our group of affiliated radiologists enables us to serve customers who prefer utilizing radiologists practicing within the United States to perform their reads. To date, we have experienced radiologist retention rates (excluding those

 

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radiologists we have elected to terminate for non-compliance with the terms of their contracts) of 97%, 98% and 97% for the years ended December 31, 2005 and 2006 and for the nine months ended September 30, 2007, respectively. As of September 30, 2007, we had 106 radiologists providing services for us, and had contracted with an additional 15 radiologists who had not yet begun servicing our customers.

Unique Distributed Operating Model

Our operating model provides radiologists with digital access to images and allows instant delivery of their reports and direct communication with attending physicians, when required. We employ our RIS, workflow management software, and operations center to maximize the efficiency of our affiliated radiologists while maintaining a high standard of quality, service and response time. Our systems efficiently:

 

  Ÿ  

prioritize and monitor the distribution of orders and images to radiologists;

 

  Ÿ  

facilitate the review and interpretation of images and the preparation of written study reports;

 

  Ÿ  

provide for rapid exchange of information between the radiologist and attending physician, if necessary;

 

  Ÿ  

permit rapid consultations among our affiliated radiologists in a computer work environment known as our “virtual reading room”; and

 

  Ÿ  

provide our customers with immediate electronic access to a radiologist’s written report and an immediate follow-on report in hard copy.

Our proprietary workflow software manages our radiology caseload by matching the patient’s need with a properly licensed and credentialed radiologist with expertise to most adequately provide patient care. Our software optimizes the assignment of cases across our affiliated radiologists to minimize read turnaround times. Finally, our centralized administrative and operations support functions allow our affiliated radiologists to focus solely on providing reads without the distraction of administrative duties.

Scalable Technology Platform

Our substantial investment in designing, developing and installing our distributed network, proprietary workflow management software and radiologist reading tools has allowed us to complement rapid customer growth with new radiologist hires to meet growing customer demand. In addition to developing our proprietary RIS system, we have integrated additional technological solutions—such as a 3-D capable viewer and a voice recognition system—and ergonomically advanced reading stations, to maximize radiologist efficiency. We have also developed automation tools for all workflow processes for radiologist recruitment and deployment, licensing and credentialing, scheduling, finance and management reporting. Our wide area network efficiently connects our customers’ facilities to our distributed group of affiliated radiologists. In November 2006, we also contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers. For the nine months ended September 30, 2007, our revenue from providing support services was $205,000. Our robust and highly reliable technological infrastructure is designed to manage volume levels several times our current size with modest additional capital investment.

Experienced Management Team

Our management team includes founding members who have designed our business model, infrastructure and platform necessary to deliver significant growth and execute our business plan.

 

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Dr. Sean Casey, a co-founder of our Company, has served as the Chief Executive Officer and a director of our Company and its predecessor since May 2001. Dr. Casey was formerly a clinical associate professor at the University of Minnesota and has published numerous professional journal articles on radiology. An American Board of Radiology-certified radiologist and neuroradiologist, Dr. Casey is a pioneer in the clinical use of cerebral CT angiography and venography. In addition to Dr. Casey’s extensive medical expertise, he is primarily responsible for the development of our service offerings and business model. Dr. Eduard Michel, a co-founder of our Company, has served as a director of our Company and VRP’s predecessor since May 2001. He has served as our Medical Director since July 2006, managing the engagement and performance of radiologists and overseeing the quality of radiology services. An American Board of Radiology-certified radiologist and neuroradiologist, Dr. Michel has published several professional articles on radiology and was formerly a clinical associate professor at the University of Minnesota. Dr. Michel also has significant experience in the private practice of radiology. We recently appointed Robert Kill as our President and Chief Operating Officer and Richard W. Jennings as our Chief Technology Officer. Mr. Kill has over 20 years of sales, marketing, operations and general management experience primarily in the healthcare services and technology sectors. Most recently, Mr. Kill was President of a leading software and services provider to the ambulatory market. Mr. Jennings has more than 25 years of information technology-related experience and has extensive management experience in technology focused companies.

Our Strategy

Our goal is to broaden our position as a leading teleradiology services provider by continuing to offer comprehensive services to our customers, 24 hours a day, seven days a week, 365 days a year. We intend to build upon our industry-leading service levels, innovative and scalable technology and highly-regarded team of affiliated radiologists to expand our footprint. Our focus will remain on improving patient care while providing a compelling value proposition to both our customers and our affiliated radiologists.

In order to achieve our objectives, we plan to:

 

  Ÿ  

Increase our sales and marketing efforts to further expand our customer base.    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.

 

  Ÿ  

Advance our recruitment and deployment of U.S.-based qualified radiologists to meet increased demand for both preliminary and final reads.    As we add new customers and continue to increase the utilization of our services by our current customers, we intend to accelerate our recruitment of American Board of Radiology-certified radiologists in order to meet this anticipated growth.

 

  Ÿ  

Expand services and increase utilization by our existing customer base, including final reads.    We believe that there are significant opportunities to expand our service offerings to our installed customer base. We intend to maintain our industry-leading service levels and 24 hour full-service coverage by leveraging our unique distributed operating model to address our customers’ needs, including, but not limited to, offering them the option of final reads and advanced subspecialty radiology coverage.

 

  Ÿ  

Develop additional applications that permit expanded use of our technology platform by customers and hospitals.    We believe that there may be an opportunity to market our proprietary workflow management technology and encrypted communications network to radiology practices and hospitals. We provide a managed radiology workflow system, including our RIS that permits our affiliated radiologists and several thousand hospital technologists to routinely, reliably and securely send and receive diagnostic images and patient data over a

 

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technology-neutral wide area encrypted communications network. In November 2006, we also contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers.

 

  Ÿ  

Pursue acquisitions opportunistically.    We intend to selectively pursue strategic acquisitions of businesses, technologies or other assets that are complementary to our business or offer us other strategic benefits, such as broadening our service offerings or strengthening our market position.

Our Service Offerings

We serve our customers—radiology practices, hospitals, clinics and diagnostic imaging centers—by providing reads 24 hours a day, seven days a week, 365 days a year. We provide both preliminary and final reads for a broad range of digital diagnostic imaging modalities, including CT, MRI and ultrasound. We generally contract with radiology practices to provide coverage for the hospitals that are their customers; although, in some instances, we contract directly with hospitals. Our affiliated radiologists typically perform the reads from their home offices using a high-speed encrypted internet connection that connects them to our network. Occasionally, our affiliated radiologists read from our two reading room facilities located in Maui, Hawaii and Minnetonka, Minnesota.

In November 2006, we also contracted to begin licensing the use of our technology infrastructure and began providing support services to our radiology group customers. For example, our radiology group customers that cover multiple hospitals may perform reads over our infrastructure regardless of what equipment is in use at each hospital and without having to travel between hospitals. We recently entered into a limited management services agreement with the Massachusetts General Physician’s Organization, a subsidiary of Massachusetts General Hospital and a teaching affiliate of Harvard Medical School, to market and manage their deployment of specialized radiology services, including quality over-reads, second opinions and subspecialty reads, using our technology infrastructure and operations center.

Diagnostic Imaging Modalities

Diagnostic radiology aids in the diagnosis and treatment of injuries, diseases and other medical conditions by interpreting images of the human body. Our affiliated radiologists collectively have the expertise, including subspecialty fellowship training, necessary to permit us to read all diagnostic imaging modalities, including CT, MRI, ultrasound, nuclear medicine, Positron Emission Tomography, or PET, and X-ray technologies. Currently, almost all of the reads performed by our affiliated radiologists are CT, MRI, ultrasound, nuclear medicine and X-ray technologies.

 

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Computed Tomography (CT).    CT scans utilize a computer to direct the movement of an X-ray tube to produce high-resolution, three-dimensional, cross-sectional images of organs and tissue, and are typically used to detect tumors and other conditions affecting bones and internal organs.

 

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Magnetic Resonance Imaging (MRI).    MRI utilizes a strong magnetic field in conjunction with low energy electromagnetic waves that are processed by a computer to produce high- resolution, three-dimensional, cross-sectional images of body tissue, including the brain, spine, abdomen, heart and extremities.

 

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Ultrasound.    Ultrasound imaging utilizes high-frequency sound waves to produce images of internal organs, fetuses and the vascular system.

 

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Digital/Computed Radiography.     Digital/computed radiography uses computer image creation and processing technology to capture x-ray images as digital images.

For the nine months ended September 30, 2007, 78% of the reads we performed were CT scans.

 

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Off-Hours and Daytime Services

We provide coverage to our customers 24 hours per day, seven days a week, 365 days a year. We offer daytime service typically between the hours of 8 a.m. to 5 p.m., local time, Monday through Friday, and off-hours service between the hours of 5 p.m. to 8 a.m., local time, Monday through Friday, and 24 hours a day service on weekends and holidays. A majority of the services that we provide are preliminary reads performed during off-hours for hospital emergency rooms during evenings, nights and weekends. Off-hours coverage typically consists of preliminary reads of diagnostic images, which are performed in order to immediately treat a patient’s condition in an emergency setting. We also provide our customers with emergent final reads in lieu of or ancillary to preliminary reads, as well as final reads performed for routine daytime coverage for non-emergent purposes. We assist our customers’ own radiology practices by providing them with additional capacity to meet their patient demand and additional coverage for periods when their own radiologists may be on vacation or otherwise unavailable due to illness or emergency. Our affiliated radiologists also provide subspecialty capabilities that may not otherwise be available to our customers.

Preliminary and Final Reads; Report Delivery

A preliminary read is intended primarily to address an emergent condition, i.e. those requiring prompt medical attention. Preliminary reads may be less detailed than final reads, since they are intended to address emergent symptoms and must be available in a short period of time in order to provide proper patient care in emergency situations. A final read is a definitive read relating to any abnormality appearing in the radiographic image and requires a more thorough review of a patient’s clinical history and comparison of the current radiographic images with any earlier images, if available. A final read report typically contains detailed findings, including an analysis of the images with measurements of each abnormality found and a diagnosis of the condition evidenced by the images. Final reads are not typically delivered for emergency treatment and, therefore, the traditional industry turnaround time between receipt of the patient images and delivery of a final report is ordinarily not as critical to patient care.

The generally accepted turnaround time for preliminary reads is 30 minutes, while the generally accepted turnaround time for final reads is 72 hours. Using voice recognition dictation systems, we are generally able to provide preliminary reads more closely resembling the contents of a final read. We typically provide preliminary and final reads in emergent care settings within approximately 20 minutes from receipt of order. We typically provide final reads in non-emergent cases within 24 hours from receipt of patient images. Final reads, unlike preliminary reads, may be reimbursed by Medicare and other third party payers and, therefore, in order to comply with Medicare rules, must be performed by U.S.-based radiologists.

Our Operations

Our Affiliated Radiologists

As of September 30, 2007, we had 106 affiliated radiologists who were providing services for us, and an additional 15 radiologists who had entered into contracts with VRP but had not yet begun serving our customers. We structure our relationships with our affiliated radiologists in a manner that we believe results in an independent contractor relationship, and VRC has no control over the reads rendered by the radiologists or their independent judgment concerning the practice of medicine. In addition, we do not prescribe a location from which our affiliated radiologists must work and do not limit the other professional activities of our affiliated radiologists, other than prohibiting them from working for a competitor engaged in teleradiology. Although we believe that we are their principal engagement for the practice of radiology, several of our affiliated radiologists hold part-time academic appointments with teaching institutions or provide local radiology services. We typically enter into a one-year

 

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professional services contracts with our affiliated radiologists that automatically renew unless terminated by either party pursuant to the terms of the agreement. The contracts generally provide for an agreed upon work schedule, typically between approximately 1,600 to 2,200 hours per year. Our affiliated radiologists are able to exchange schedules among themselves, provided that they notify us within a reasonable time in advance of their scheduled shift and that they have the appropriate licenses and hospital credentials to ensure that we have adequate coverage for all of our customers at all times.

Our compensation policies target the average radiologist compensation at traditional private radiology practices and are designed to accommodate varying levels of productivity. We offer our affiliated radiologists what we believe to be a desirable and unique benefit of being able to live where they choose within the United States, to work from home or, in certain instances, a local office. In addition, we offer them the ability to obtain real-time consultations from their colleagues while working on-line, and to earn performance-based compensation competitive with private practice compensation without the interruption or distraction ordinarily associated with a hospital-based practice. We also offer our affiliated radiologists the opportunity to obtain equity ownership in VRC via our stock purchase plan.

Our affiliated radiologists have received residency training at some of the most prestigious institutions in the country, including Harvard Medical School, The Johns Hopkins University, Duke University School of Medicine, University of Pennsylvania School of Medicine, Cleveland Clinic Lerner College of Medicine and Stanford University School of Medicine. Specifically, 23 of our 106 affiliated radiologists held the position of chief resident during their residency. In addition, 82 of our 106 affiliated radiologists received subspecialty fellowship training, including training at, among others, the following institutions: Harvard Medical School, University of Pennsylvania School of Medicine, University of California San Francisco School of Medicine, New York University School of Medicine, Duke University School of Medicine and The Johns Hopkins University School of Medicine. Three of our affiliated radiologists also hold part-time academic appointments at Beth Israel Deaconess Medical Center, a teaching affiliate of the Harvard Medical School, The George Washington School of Medicine and Health Services and University of Arizona College of Medicine.

We endeavor, through written and frequent personal communications, to maintain a sense of collegiality and cohesiveness in order to offset their physical distance. Our “virtual reading room” model permits our affiliated radiologists the consultative support associated with central reading facilities without the disruptions involved in physically moving around an office to obtain a consultation. We provide technical support to our affiliated radiologists, including training, trouble shooting, system maintenance and upgrades. In addition, our physician relations department maintains regular contact with our affiliated radiologists in order to provide them with non-technical support. We believe that our high rate of retention for our affiliated radiologists is due in part to our unique relationship with our affiliated radiologists.

Recruitment of Radiologists

Our goal is to recruit highly qualified radiologists who are certified by the American Board of Radiology and offer them the opportunity to work from locations of their choice within the United States.

Our affiliated radiologists undergo an extensive screening process that involves personal interviews with several of our staff members at our headquarters and a review of the candidate’s credentials and prior experience, including whether the candidate has been subject to malpractice claims. In addition, candidates are assigned to a licensing and credentialing specialist, who obtains the necessary documentation in order to admit the candidate to practice with VRP and to apply for state medical licenses and hospital credentials. We schedule our recruitment of radiologists to match our anticipated case study volumes, and assist our new radiologists in obtaining the required state medical licenses and hospital credentials.

 

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We believe that our affiliated radiologists consider the flexibility of our model an attractive and unique aspect of their relationship with us. We also believe that our affiliated radiologists prefer the work environment and business opportunities that we provide. As such, we have experienced a very high retention rate of our affiliated radiologists. We believe that the benefits we offer and our screening process allow us to recruit highly qualified radiologists with subspecialty training.

Licensing and Credentialing

Our affiliated radiologists are required to hold a current license in good standing to practice medicine from each of the states in which they read and from which they receive radiological images. In addition, our affiliated radiologists are required to have credentials at each hospital from which those images originate. Due to these requirements, and because we were serving 787 medical facilities as of September 30, 2007, our affiliated radiologists are each licensed to practice medicine in an average of 28 states and each has been granted credentials at an average of 209 hospitals.

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 to maintain minimum thresholds of medical liability insurance.

To comply with these requirements, we obtain primary source verification documentation for each of our affiliated radiologists that is necessary for them to obtain state medical licenses and hospital credentials in the states and for the hospitals where they will be providing services. Our affiliated radiologists are required to provide copies of their birth certificates and documentation regarding their educational and work history, including diplomas, transcripts, employment verifications and references. We use that information to obtain direct, or primary, verification from each institution or other source identified to us by the applicant. When we have obtained the necessary verification, we use the verified information to prepare state medical license application forms and hospital credential application forms. We also monitor state license renewal due dates and particular state continuing medical education, or CME, requirements. Our licensing and credentialing personnel monitor medical liability insurance coverage matters particular to each state and other ongoing licensing-related obligations.

The credentialing requirements of hospitals may vary significantly. However, hospitals that are accredited by The Joint Commission (formerly referred to as the Joint Commission on Accreditation of Healthcare Organizations), are permitted to rely upon the information and procedures from other Joint Commission-accredited institutions. We have been a Joint Commission-accredited entity since 2004. As a result, Joint Commission-accredited hospitals can accept our verified credentialing information and procedures without duplicating our verification processes, thus significantly reducing the expense and period of time before we can begin providing reads for those hospitals.

Network and Workflow Overview

We deliver our services to our customers through a workflow process that utilizes public network infrastructures, virtual private networks, our web-based RIS and proprietary workflow technologies. Our network has been designed to be secure, scalable, efficient and reliable. The following is a description of our workflow process:

 

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Requisition of Reads.    When a radiological procedure is performed, the radiology technologist at the hospital transmits the patient images to us. A corresponding order is created within our web-based RIS that is accessible on the technologist’s computer screen at the hospital. The technologist supplies any necessary information, including procedural information

 

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and relevant clinical data, and verifies the order. The order is then automatically tracked and monitored by, and its status is available to, the hospital technologist at all times.

 

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Image Transmission and Assignment.    Radiological images and related data initially access the internet via the hospital’s internet service provider and traverse the internet by encrypted transmission through public network infrastructure to our central servers. The images and data are directed via encrypted transmission to an affiliated radiologist that is properly licensed in the relevant state and credentialed at the applicable hospital, and has the appropriate subspecialty training for the particular read, if required. Our operations center and our systems constantly monitor radiologist case loads and the status of orders, and oversee assignment of additional subspecialty radiologists to the order at predetermined intervals in order to shorten turnaround times.

 

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Reports and Delivery.    Our affiliated radiologist selects from among the orders on his work list based on aging, examines the images and uses the voice recognition dictation system integrated with our RIS to dictate a detailed report including findings, impressions and diagnosis. If a consultation, or consult, is required, the radiologist may use our secure instant messaging system to request a consult from any colleague with the appropriate subspecialty training who is then also online, and may include the text of the proposed report with the consult request. When the report has been completed, the radiologist electronically signs the report and activates the “send” function, which immediately posts the report on the hospital computer’s RIS screen for viewing and simultaneously faxes the report to the proper destinations at the hospital. In some cases, the information contained within the report is also directly entered into the patient’s file residing on the hospital’s own internal information system through an integration interface between our RIS and the hospital’s own system. The customer may also print a copy on demand from our RIS.

 

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Quality Assurance Processes.    We have a standing Quality Assurance, or QA, Committee composed entirely of radiologists who are responsible for overseeing the quality of services performed by our affiliated radiologists. When a customer’s radiologist who performs the final read notes discrepancies with the preliminary read performed by our affiliated radiologists, those discrepancies are reported to the QA Committee. The QA Committee reviews each discrepancy report to determine whether the discrepancy is significant to patient treatment, and may recommend remedial steps, including appropriate CME courses. The QA Committee also performs sample reviews of final reads for our affiliated radiologists whose final reads are not typically over-read by our customer’s radiologist.

 

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Technical Infrastructure.    We have designed, implemented and maintained our technical infrastructure to be robust, reliable, secure and scalable. We operate our production infrastructure from a data center in a Minneapolis facility utilizing redundant fail-safe connections. We also use fully redundant fail-safe network hardware and redundant load-balanced fail-safe servers. We have designed our technical infrastructure and network architecture to permit significant capacity expansion by the addition of standard equipment modules, such as servers and routers, without having to redesign or reconfigure our systems. We employ a staff of network engineers and systems engineers to provide coverage of our systems 24 hours a day, seven days a week, 365 days a year. This staff monitors operations of all systems, including connections to each hospital and to each of our affiliated radiologists.

 

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HIPAA Compliance/Disaster Recovery.    Our network architecture and technical infrastructure are designed to comply with the requirements of HIPAA, and we have recently undergone a HIPAA Risk Assessment and Audit conducted by an independent third party. The results of the audit concluded that we were in full compliance with all applicable HIPAA requirements. In accordance with HIPAA requirements, we also maintain a disaster recovery program in case of disaster or extended electrical outage at our headquarters in Minnetonka,

 

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Minnesota, where our operations center is located. This program allows our non-medical office functions to be marginally functional within one hour, reasonably functional within six hours and fully functional in temporary quarters within 48 hours. Due to the geographical dispersion of our affiliated radiologists, the occurrence of a local disaster or extended electrical outage in any other geographic area is not likely to directly impact our medial service delivery functions.