2007 Medical Imaging Symposium: Consolidation Underway

Increased imaging center transactional activity, changes in health care regulatory law, increased scrutiny of self referral, and a full year under the Deficit Reduction Act (DRA) conspired for a lively roundtable discussion at the 2007 Medical Imaging Symposium, sponsored by the law firm of McDermott, Will & Emory on November 27 in Chicago.

“The confluence of these events—DRA, increased transactional activity, multiple changes in the laws—have really led to exciting yet very interesting times in the medical imaging industry.” —Jerry J. Sokol, JD, partner, McDermott Will & Emery LLC, Miami, Fla

The program grew from a half day in 2006 to a full day this year, primarily due to the increased transactional activity in the imaging center industry, Sokol said. “When we first contemplated putting this program on, we wanted to have an M&A focus, we wanted to discuss deals, but quite frankly, last year deals had come to a virtual standstill in light of people’s concerns about the impact of DRA,” Sokol revealed. “Because the impact of DRA is being absorbed by the industry, we are clearly seeing this increase in transactional activity that led us to incorporate a number of M & A and transactional topics throughout the day.” This year, as last, the program began with a roundtable discussion moderated by Ira Coleman, JD, managing partner of MWE’s Miami office, featuring Robert V. Baumgartner, CEO, Centers for Diagnostic Imaging (CDI), Minneapolis, Minn, Howard G. Berger, MD, CEO, Primedix Health Systems, which operates Los Angeles-based RadNet Management, and Paul S. Viviano, chairman of the board and CEO, Alliance ImagingViviano The ensuing discussion revealed that it has been a busy year for all three gentlemen, as each company responded to the DRA and worked their respective strategies in a rapidly evolving marketplace. “There is no doubt that a lot of mom-and-pop operators in small markets have been impacted meaningfully by the DRA, and the consolidation that the three of us predicted last year is now beginning in earnest in our industry,” said Viviano. The Players React Alliance’s hospital-centric model insulated the company from the full impact of DRA, but its mobile PET/CT revenue remained exposed. “About 90% of our revenues have not been affected by the DRA, but 10% has been affected by the DRA, almost exclusively PET-CT,” Viviano said. “We provided guidance at the beginning of the year that approximately $14 million of our revenue would be impacted by the DRA, and that turned out to be an accurate prediction. So we’ve worked hard to reduce costs to offset the impact of DRA and to continue to invest in our diversification, to add new products, to add new services, to add new centers. The DRA impact certainly has certainly been meaningful to us at that $14 million dollar level.” Once almost exclusively a mobile MRI company, Alliance has diversified significantly the services it provides to approximately 1,300 hospital customers. Today the company has about 250 mobile MRI units, 81 fixed sites, approximately 85 PET/CTs, most of which are mobile, and is moving aggressively into radiation therapy, having acquired two radiation therapy companies in 2007 with a combined 19 centers, most located in CON states. With $450 million in revenues last year, Alliance has $55-65 million in free cash for acquisitions in 2008, Viviano said. In response to a question about whether his hospital clients were fielding offers from referring physicians to sell their imaging centers, Viviano replied: “We’ve tried to turn those into opportunities, whereby we would work with the hospital to acquire those centers and operate those centers.” RadNet, with approximately $500 million in revenues last year, experienced a similar impact: $16 million. RadNet derives 20% to 25% of revenue from Medicare, but Berger said that RadNet was able to achieve sufficient cost savings through the merger to essentially negate the impact of DRA. However, the $16 million represents an almost dollar for dollar impact on the company’s EBITA line, an impact Berger described as significant. Opportunities to grow company abounded in the latter half of 2007, and RadNet has grown to operate 153 centers nationwide, primarily in five states: California, New York, Maryland, Delaware, and Florida. When asked if he saw any surprises last year, Berger said he was surprised by the delayed reaction to the DRA, and the disintegration of the credit market. Due to 60 to 90 day billing cycles, I don’t think it was until the second and third quarter, that people found themselves in a significant cash flow problem,” Berger said. “That has to be taken into account along with the credit market debacle: it was a side effect of DRA, but more related to the current credit market.” Baumgartner said that CDI anticipated and experienced a 12% impact on the company’s bottom line due to the DRA. CDI, which operates a network of more than 40 outpatient centers in 8 states, responded in three ways, Baumgartner reported. “We went to our vendors and asked for price concessions, including our radiologists,” he said. “Secondly, we retooled our sales force. I think the days are gone when you can have people running around handing out donuts. You really need a professional sales force. We probably turned over a good third of our sales force and grew our same store sales, which is very important. If you are going to make less per transaction, you need more transactions in a high fixed cost industry. Last but not least, we went to private payers and asked for price increases. A lot of us are price takers in this industry, let’s be honest. But in many instances, we were able to get price increases.” When asked if private payers have adopted DRA prices, Baumgartner reported that is happening on a market-dependant basis. “We are now seeing more of the insurers try to adopt some of the DRA,” he said. “Having significant size in a marketplace is very important when you are dealing with the private payers, to be able to have a seat at the table to negotiate. If you’ve got one center in a market, then you have no power, and you are a price taker. If you’ve got concentrated presence in a marketplace, you can work with those private payers and hopefully negotiate a better rate, or just tell them you’ll go out of network. Their choice is keep you in the network or not, and end up paying you a retail rate or have more people go to a hospital.” Plans to Grow All three players expect their companies to grow in 2008. “Our growth will occur both organically and primarily by acquisition not de novo centers,” said Berger. “It is hard to justify on almost any level the creation of a de novo center in a market where you have both overcapacity for many modalities and decreasing reimbursement to justify the capital investment.” Berger also cited the drain on resources de novo builds necessarily incur, both financial and personnel, due to the long lead-times. RadNet will pursue organic growth in primarily two areas: PET/CT and mammography. “We are converting all of our centers into digital mammography, which we think is a critical process of moving imaging onto another level, particularly to deal in any given market with the payers,” Berger said. Nonetheless, he expressed concern regarding further cuts to the PET/CT modality. As for the company’s acquisitions in 2007, Berger said: “We have been acquisitive. As of now we will have completed about $35 million in acquisitions. We anticipate that we will do as much if not more next year primarily in the markets in which we are in.” He said the deal parameters are in the range of 3 to 5 times EBITA, with some more and some less. Factors determining price include the importance of the acquisition to RadNet’s strategy, modalities involved, age of equipment, and the radiology participants in that market. Baumgartner also has all but eliminated de novo builds from the CDI growth strategy. “Most of our growth was de novo up until last year, when it became extremely attractive to do acquisitions,” he reported. “We are doing selective acquisitions primarily in our existing markets where we want to continue to grow our presence in the marketplace. In today’s environment, it is very difficult to go into a new market or even an existing market when there is excess capacity. We are going to be doing more studies for less reimbursement and some of the capacity is going to go away. I think you are seeing a consolidation. People are moving out of less strategic markets and consolidating in their core markets. Right now, we plan to do a couple de novo centers next year, but it will be primarily acquisitions.” Unlike his colleagues on the panel, Viviano said Alliance intends to continue its strategy of de novo builds for hospitals, primarily in converting mobile customers to fixed-site partners. “Our mobile business is declining from 5 to 8% a year and we have taken the cash flow from that still very profitable business and invested it into de novo fixed sites, converting formerly mobile customers to fixed-site customers,” Viviano said. So this year, we’ll build between 15 and 17 de novo fixed sites. Almost all of those will be single modality MRI centers…For radiation therapy we also are building a handful of centers.” Alliance spent $85 million on acquisitions last year, including 19 radiation oncology centers. “Our growth going forward will be a combination of de novo fixed sites in partnership with hospitals, largely converting existing customers from mobile to fixed sites, not adding capacity to the marketplace,” Viviano explained. “And then building new radiation oncology centers and acquiring radiation oncology sites as well, as well as focusing on PET/CT. A Voice in Washington In response to a question that asked panelists whether the radiology lobby in Washington is adequate, two participants felt more effort is required. “Paul and I are actively involved as board members of AQI, formerly NCQDIS, the Association for Quality Imaging,” said Baumgartner. “We really redoubled our efforts. We’ve hired a new executive director, we hired a new lobbying firm in Washington. For the first time, we really have a day-to-day presence in Washington, and I think that is the difference. There’s a lot going on as Congress debates how to fund SCHIP, and other expenditures for Medicare, and certainly imaging remains on the table as do a lot of other industries for cuts. It’s very very important that we are there, and if you are not at the table, you are going to be cut. “We’ve been able get 30 some senators to sign on to a bill that says no more cuts to imaging, we’ve got a bill in the House with 240 signatures asking for no more cuts for imaging,” he continued. “Does that mean there will be no more cuts to imaging? Actually, not. I think there will be more cuts to imaging we are going to see a markup in the next week on the Senate Finance side addressing how they are going to pay for a one year fee schedule fix. I think we’ve come along way but we all need to get more involved. If you think that Congress is done, then you are sorely mistaken.” Berger was the lone dissenter on this topic. “I’ve been in this industry for nearly 30 years now, and I have seen virtually no impact at all of any lobbying efforts whether initiated by the ACR or the current acronyms associated with lobbying efforts today,” he said. “I think it is way too complex an issue to be dealt with at the government level, not just because of the political nature of the lobbying effort but also because of the substantially greater size of the other lobbying groups out there that are fighting like crazy to prevent any changes in the in-office exemption and the self referral capabilities.” Berger believes the best option for imaging companies is to work at the payer level. “We need to…focus on the more mundane players, like the Blue Crosses and UnitedHealthcare plans, that use the excuse of the DRA to try to continue to ratchet down the cost, and which ultimately will have a far bigger impact than what is being done by Medicare,” Berger said. “I hope we can have some impact purely by the leverage and the capabilities that we have of providing access as needed and exercising some control on the process. It may just be that sometime in the future, our centers would decide to go non-participating with Medicare, and ultimately, that is the only card that you have.” Viviano acknowledged a tough political climate in Washington, but believes the lobbying effort begun by AQI represents one of the great successes of 2007. He indicated that the organization is not in it for the short term. “We have years ahead of us to weigh in on those issues, both from a regulatory and a legislative standpoint, “ Viviano said. “We believe it is important to have as much influence as we possibly can given the challenges of our industry.” One of the most pressing issues, said Viviano, is self-referral. “It is difficult to have a meaningful discussion about regulatory or legislative change without shifting gears and talking about self referral and the physician in-office exemption, which is the real focus and crux of many challenges to our industry,” he said. “I think the fact that CMS invited comments this year about the in-office physician exemption specifically is a sign that there is some interest in evaluating the impact of physician self referral on the diagnostic imaging industry. We need to weigh in on that debate, because we think it is one of the most meaningful debates in our industry. We believe that exerting the influence of the industry and making sure that legislators and regulators both are aware of the dramatically different growth profile of the in office imagers versus the rest of us is a really important factor in our future.” Berger characterized self-referral, whether by referring physicians or radiologists, as unethical, and believes the radiology community needs to begin distancing itself from the practice. “We need to start the process of distancing ourselves and countering this whole problem that has become a plague on our house over the last 10 years,” he said. “And the longer we let it continue—whether we as radiologists go out and read for the physicians who are doing it in their offices or we give them access to our equipment because we can’t fill the time through legitimate referral sources—we deserve on some level what has happened.” Baumgartner did not fault referring physicians, but lay blame on the law. “When Stark II came in and allowed in-office imaging, physicians did what I would have done if I was running an orthopedic office: they put in their own imaging equipment as a revenue source,” he said. “You can’t fault anyone from doing that. But it certainly allowed the bulls-eye to occur because the growth in in-office imaging far outpaces what we are seeing in hospitals and imaging centers.” However, Baumgartner sees the beginning of a turning point in Washington, where lawmakers are more receptive to conversations about self-referral. “A few years ago, nobody wanted to hear about self referral,” he said. “Now when I go into a Congressman’s office to have a conversation, they often bring it up: what about self referral, what do you think about that? That pendulum is starting to swing back. I think we need to continue to educate Congress, and we are making progress, but it takes time to turn the battleship around. We are up against a very powerful lobby in the AMA.”