InSight Health Services Corp.

Insight Health Services Corp. currently owns and operates 166 fixed and mobile centers in 32 states. Formed in 1996 by the merger of American Health Services Corp. (Newport Beach, Calif.) and Maxum Health Corp. (Dallas), InSight serves managed-care organizations, hospitals and physician practice management companies in five major U.S. markets: California, the Southwest, Midwest, Southeast and Northeast. In its first three fiscal years, the company’s revenues have grown from $40 million to $162 million. After the first six months of FY2000, ending Dec. 31, 1999, InSight is on a pace to reach $200 million in revenues.

The publicly owned company (Nasdaq: IHSC) is in the process of bolstering its infrastructure to grow its national operation. InSight is looking to move swiftly toward this goal by developing new policies, operating and sales models, and billing and collection processes, without sacrificing opportunities for new acquisitions.

New InSight President and CEO Steven Plochocki brings extensive experience with multi-location businesses. He was COO of Abbey Healthcare Group Inc., which merged with Homedco Group Inc. in 1995 to create the Apria HealthCare Group (Costa Mesa, Calif.). As president and COO of Apria, Plochocki was instrumental in building the billion-dollar national home healthcare company. Earlier in his career, as senior vice president of sales and marketing and director of operations, Plochocki played a big part in the merger of Upjohn Healthcare Services with Olsten Healthcare (Melville, N.Y.), which created the first national homecare health agency business in the country.

Chief Competitors
InSight competes with other well-established companies of comparable scale ($100 million to $300 million in revenues). They include U.S. Diagnostics (West Palm Beach, Fla.), Medical Imaging Resources Inc. (Hackensack, N.J.), Radiologix Inc. (Dallas) and Alliance Imaging (Anaheim, Calif.), a $300 million mobile business purchased last September by the investment group, Kohlberg Kravis Roberts (KKR of New York).

The Alliance transaction caught the eye of the investment community, which has become increasingly aware of the potential for profitability in the medical imaging market. This kindling of investor interest has sparked a flurry of activity in the industry and InSight has benefited from the attention. InSight’s executives believe their case is more compelling than the competition’s, and the company has capitalized on this interest by taking its story on the road in a series of meetings with potential investors and presentations at various investor conferences.

Principal Products
Active in 32 states, InSight manages the operations of 79 mobile centers, 36 fixed-site MRI facilities, 23 multi-modality imaging centers, five mobile lithotripsy facilities, one Leksell stereotactic Gamma Knife treatment center and one radiation oncology center. Within its regional networks, InSight provides all forms of medical imaging services. The fixed sites are equipped for MRI, CT, ultrasound, mammography and fluoroscopy and general radiographic units. The company’s 166 medical imaging and treatment systems include 114 conventional MRI units, 24 open MRI systems and 20 CT systems, as well as five lithotripters and two radiation oncology systems.

InSight is in the process of developing a proprietary radiology information system (RIS) that will meet its operating needs. The new system will make it possible to bill directly from the facility after a scan is done, rather than from one of six billing centers that the company uses today. The company believes the ability to immediately drop a bill at the point of exam completion will be a big advantage, not only in producing swifter payments, but also in developing the reporting capabilities to collect accurate and timely management reports. The system is being developed and managed internally, with the help of outside consultants, and should be live by the end of this year.

Strengths
InSight has the wherewithal to manage mobile sites and convert them to permanent fixed-site operations once “critical mass” is achieved. This characteristic – the cornerstone of company growth plans – is a selling point with investors, because InSight believes it separates the company from its major competitors. The expense of opening a fixed-site facility is steep; many hospitals are, therefore, reluctant to make the investment. The success of a mobile facility beforehand, and resultant partnership opportunity with Insight, already has been attractive to several hospitals and medical facilities, which have entered into co-source agreements with Insight. It assures that the company will be a permanent and major presence in local markets.

InSight also identifies six core business strengths – site design, marketing, operations management, logistics, billing and collections, and information services.

Add to this list a solid capital position, bolstered by a $275 million infusion from Bank of America, N.A. (Charlotte, N.C.), the Carlyle Group (Washington, D.C.) and General Electric Co. (GE of Fairfield, Conn.), a principal manufacturer of the medical imaging units InSight uses. GE Capital, the financing arm of General Electric, and Carlyle, a global investment firm, own 70 percent of Insight stock.

Since November 1999, when its new management team came into place, InSight has received positive reaction from analysts. In a February report, Morgan Stanley Dean Witter analysts took notice of the company’s “aggressive attitude toward cost reduction and margin enhancement.” The firm added that it expects InSight to perform at higher EBITDA (earnings before interest, taxes, depreciation and amortization) margins in coming quarters, confirming Morgan Stanley’s strong buy rating on InSight.

With more than $60 million of acquisition money to spend, InSight is in a comfortable capital position. It considers itself among the handful of major players which have the market presence and financial strength to become the first national entity in a rapidly growing medical imaging market.

According to a report from Technology Marketing Group (Des Plaines, Ill.), the MRI and CT business is growing at a rate of 20 percent a year; 45 million MRI and CT scans will be performed this year in the United States alone. According to the Health Institute of America and several other sources, the industry accounts for 6 to 8 percent of all money spent in the U.S. on healthcare, or as much as $80 billion.

Such prognoses and InSight’s wide geographic presence have emboldened the company, which now seeks to achieve 18 percent volume growth.

In its analysts’ report, Morgan Stanley is more cautious, maintaining that new technology and competitors will slow InSight’s growth to a level closer to 10 percent, a figure that should be sufficient to drive an impressive cash flow.

The last two quarters of profitability are a clear strength for InSight. Size and market presence is another one. InSight believes this is the right combination to propel its efforts. Investors seem to agree. Since November, InSight stock price has almost doubled. Taking the story on the road, as senior management has done in the past several months, has been a winning strategy. Major presentations at the Warburg Dillon Read conference and more recently, the DLJ (Donaldson Lufkin and Jenrette) conference, both in New York, were well received and helped to generate favorable press in the Wall Street Corporate Reporter.

For its part, Warburg maintains its buy recommendation, based on InSight’s “improving fundamentals in an attractive growth business.”

The company has implemented a three-tiered sales approach, with staff dedicated to either the mobile business, fixed-site partnerships or radiology department management services or managed-care contracting. Marketing activities include direct physician contact, customer education on new applications and technology, customer service programs and volume discounts for insurance companies.

A new incremental scan plan, begun in January, boosts profits and offsets equipment costs, because it provides incentives for schedulers and technicians at the centers to keep calendars full. Technicians receive incentives for calling patients two days in advance to answer their questions and put them at ease. This practice has reduced cancellations by 50 percent, it gets staff involved in the business and has received positive feedback from patients.

Par levels are set daily, based on historic numbers, and incentives are tied to the number of scans that exceed the level. Hours have been expanded to compete with smaller local firms which, in some instances, are open until midnight.

Weaknesses
The first priority for the new InSight team is to adopt policies that are more congruent to the multi-locational organization that Insight has become in recent years. Lower expenses and higher margins will be the key.

The new management team recognizes that the company needs to be better organized and more efficient to compete effectively on a national level and take full advantage of opportunities. Expenses need to be tightened. In the latter part of 1999, while InSight experienced continued revenue and EBITDA growth, its operating income was starting to suffer as expenses bloated and internal growth slowed down.

The company’s equity has not performed well in the last 12 months, noted Morgan Stanley in its look at second quarter FY2000 results. The firm cited InSights’s “extremely small float and operating problems in prior periods” in its analysis, while viewing recent belt-tightening initiatives and financial and investment support from Carlyle and GE as positive factors

InSight has expanded quickly through acquisition, but wasn’t growing as rapidly as needed through same-store growth. To correct this weakness, the sales force has been reorganized at both the corporate and local levels, new customer service practices have been implemented, and the staff incentives were introduced.

DLJ, in an otherwise positive report, expressed its concern with the fact that one-third of InSight’s contract services renew annually. “With the decline in the price of MRI technology, many hospitals and providers may elect to invest in their own MRI facility,” the DLJ report states (except in certificate of need state where that would be difficult). Some facilities may no longer outsource to companies, such as InSight. Still, DLJ notes, an MRI unit is a $2 million investment and would be justified only if patient volume were high enough.

Outlook
Investors have taken notice of the imaging center marketplace and its potential for consolidation. That’s one primary reason that Insight’s stock has risen so dramatically. Now, InSight wants to present itself as the optimal company with which to do business.

To achieve its corporate goal to have an optimal operating model, InSight is making a transition to a performance-based system. It will take time and will not be easy, upper management concedes. Such a system is culturally different than the internal operation of a company that grew through mergers and acquisitions, and InSight’s centers are still making this adjustment.

Expense reduction is No. 1 on InSight’s agenda. It is expected that costs will be contained through several initiatives already in motion. Labor, a high fixed cost, is being managed by a move to stagger shifts and eliminate overtime payments. Insight also hopes to be more competitive with smaller local and regional competitors by remaining open for longer hours, with all appointment slots filled.

Because millions of dollars are spent on maintaining equipment, the company plans to sign contracts with fewer vendors than it has today and will consolidate in the same way for the purchase of medical supplies. In addition, it is taking measures to reduce occupancy and construction costs, fleet costs and travel and entertainment expenses. Management also plans to pare insurance fees.

The outlook for the industry appears to be promising right now. In November, Congress and the Clinton Administration approved legislation that appropriates $16 billion to Medicare over the next five years. The funding allows ample time for long-range strategic planning in a healthcare services industry that has been hurt by government cuts over the past several years.

Secondly, the fact that managed-care companies have begun to raise premiums significantly again – after several years of relative stagnation – makes the outlook brighter for imaging service providers, such as InSight. The impression among many companies and investors in the services sector is that the down cycle has reversed itself.

Plochocki readily admits that “whenever managed care is getting its margins through premium increases, it is easier to work with.” As a result of these developments, he opines that there will be “renewed interest in the services sector of healthcare,” which creates a fertile landscape for a national company to take root.

Insight could be in the right position for such a leap, with profit, growth, market reach and versatility in its favor. Now, the company is stabilizing its foundation to support the weight of prospective, new acquisitions – and the company vows to be very selective and careful when prospecting.

A major operational goal is to be No. 1 or No. 2 in every market where it has a presence. A strong regional market position and wide geographic reach would allow InSight to contract directly with managed-care payers, rather than with brokers who still play a role in the relationship between providers of MRI and CT services and insurers.

Hospital outpatient radiology centers have evolved into a $50 billion dollar business, a segment with which InSight believes it is well-situated. The company hopes to forge new relationships with hospitals through its two-step process of establishing mobile site locations that are converted eventually to new fixed sites. These joint ventures are part of what management calls its “co-sourcing” strategy. InSight would make capital available, purchase equipment, manage the operation and market it to the external community as well. The company and the hospital would then share in the profits of these outpatient radiology centers.

Further on the horizon, InSight hopes to form joint venture relationships with large hospital systems and has established a beach head for this effort by working with many hospitals that are already part of larger systems. The logic is that hospitals are continually searching for new revenue streams and medical imaging is an attractive possibility, either on a contract service or partnership basis. InSight promotes its ability to operate hospital radiology departments more efficiently and less expensively than the hospitals themselves.

Acquisitions have been a big part of InSight’s past and will be in the future. In February, the company solidified its presence in Indiana by acquiring a fixed-site center in Indianapolis and one center in Clarksville. Both facilities offer open MRI and bone densitometry services.

Last May, InSight purchased five centers in Phoenix to become the dominant player in that market. Two years ago, the company gained a stronger foothold in the Northeast when it purchased Signal Medical Services Inc. (Farmington, Conn.).

Other major acquisitions in California, Nevada, Kentucky and Tennessee, as well as partnerships with hospitals and medical facilities in many states, provide the type of ballast that instills confidence in investors. Given the opportunities in a fragmented market, the financial sector’s prediction that it will grow, and the dearth of companies large enough to fill the void, InSight sees itself as the obvious choice to be the consolidator of the industry over the next several years.