ADAC struggles to regain footing as financial woes discourage investors

Prospects strongest in PET, therapy planning, and HIS

Nuclear medicine vendor ADAC Laboratories is enduring a tough period of business right now, particularly in its relationship with investors and the financial markets. The company no longer enjoys the dominant position in the gamma camera market that it once held, and is still suffering from the fallout of an earnings restatement announced in late 1998. As a result, investors have shed the company’s stock, which is trading at less than a third of its price a year ago.

ADAC executives remain bullish on the company’s long-term future, however. ADAC faces growing sales prospects in areas such as PET imaging and its non-nuclear business lines of radiation therapy planning and healthcare information systems.

Standard nuclear medicine continues to grow but also remains a competitive market in terms of product introductions and price pressures.

“The nuclear medicine market is certainly healthy,” said Andrew Eckert, chairman and CEO of ADAC. “I would guess it is up 5% or 6% from last year after a very robust growth year in ’98.”

Pricing of nuclear medicine equipment continues to trend down, although at a pace no greater than the last three or four years, he said. Competition in terms of new product introductions is up modestly but has not changed markedly since a slow period five years ago.

“The company has acknowledged that the nuclear imaging equipment market has gotten more competitive,” said Juan Noble, an analyst with securities firm Fahnestock & Co. of New York City. “Some of that stems from consolidation in the hospital industry.”

ADAC, which continues to lead the U.S. nuclear medicine market, has seen the price of its shares slip somewhat in recent years, Eckert acknowledged. At one time, ADAC claimed 50% of annual nuclear medicine sales in the U.S. That is believed to be lower today. However, the vendor is investing in new nuclear medicine product development at a record pace.

ADAC’s U.S. nuclear medicine market share “has come down a bit, perhaps five or seven percentage points, but I think our profit share has probably gone up over the last couple of years,” Eckert told SCAN. “We introduced the Forte (gamma camera) in December and have had the most successful first two quarters probably in the history of our business for a new product in terms of unit bookings. We are bullish about the future.”

Investor displeasure has been brought on by ADAC’s discovery of past inappropriate accounting practices and the need to revamp accounting in its financial reports, which has served to depress results. ADAC’s stock is trading above its 52-week low of $5.75 but remains significantly depressed from its yearly high of $22.75.

The firm had a pre-tax loss of $11.1 million in its second quarter (end-April 4) excluding extraordinary charges, and a loss of $20.8 million including the extraordinary charges. This compares with a pre-tax profit of $8.8 million in the second quarter of 1998. Second-quarter revenues this year were up 17% from $74.5 million in 1998 to $87.4 million. However, the company anticipates a decline in revenues for the third quarter due both to the accounting changes and market competition.

“Our overall level of operating expenses has been greatly inflated due to events in the past,” Eckert said. “We have had strong support from our customers. Our organization is determined to get all of this behind us. It is certainly a difficult period but one we are working through.”

It may take some time before investors regain their confidence in ADAC, Noble said.“It is going to be rocky for the next couple of quarters,” he said. “From a basic business standpoint, their plan is to keep as competitive as possible and at the same time come to grips with the new accounting procedures they have to work with. From a stock standpoint, it is going to take several months before investors regain the same confidence they had in the stock say eight months ago.”

A tougher marketMarket pressure has come in the form of both declining prices and more favorable credit terms for customers, Noble said. ADAC, as a relatively small vendor, may have a hard time competing with its larger multimodality competitors, such as GE and Siemens, when offering purchase terms and package deals to hospitals.

“As far as imaging equipment goes, nuclear medicine is it (for ADAC), whereas GE can offer a fuller spectrum of equipment,” he said. “That might appeal at least to the administrators in hospitals, although I have yet to talk to a physician or radiologist familiar with ADAC equipment who has not given it very high marks.”

ADAC is not looking to either be acquired or expand into other imaging modalities to assist in this competition with the larger companies, Eckert said.

“All we can do is our best and the results will speak for themselves,” he said.

Strategically, ADAC is focusing attention on areas that offer strong growth and profit potential in the future, he said. These include positron imaging, both in the form of its molecular coincidence detection (MCD) technology for gamma cameras and as a dedicated PET system supplied by a third party. Another new product is ADAC’s Envoy Web-based medical image management software product, which is built around the company’s QuadRIS radiology information system.

“Nuclear medicine, while it represents probably half of our revenues, represents well less than half of our profits,” Eckert said.

ADAC’s two other major businesses apart from nuclear medicine, radiation therapy planning and hospital information systems, offer significant growth potential, he said.

The vendor has a 55% to 60% share of the radiation therapy planning market in the U.S. This is a market that has doubled in size for each of the past three years, he said.

While the information technology market in general is having a slow year, it is poised for growth. ADAC has about 100 client-server systems operational in radiology suites, compared to about 10 for its next-largest competitor, Eckert said.

Positron imaging has received a boost in demand brought about by recent favorable reimbursement decisions, he said. While ADAC is active in both MCD positron imaging and dedicated PET, volume remains higher for the less expensive gamma cameras.

“We will still sell five or six times more MCD systems than PET systems,” he said. “There are probably 80 or 85 PET systems in the U.S. (altogether). We have about 200 MCD systems installed and will probably see that MCD number double over the next year to 18 months.”

While investing in growth areas, ADAC will also work hard to cut costs. It expects to take a $2.4 million charge in the third quarter of this year related to the restructuring of its ADAC Medical Technologies (AMT) gamma camera refurbishing business. The firm will reduce the number of brands it refurbishes, shut down its refurbishing facility in Washington, MO, and consolidate operations in Milpitas, CA.

The refurbishing business was not very profitable and tended to diffuse ADAC’s business efforts, Eckert said. By consolidating operations, reducing costs, and sticking to fewer types of equipment, the company hopes to improve that business’s performance. On the service side, ADAC continues to support between 500 and 600 gamma cameras in the field, manufactured by various OEMs.

“We still believe in that business,” he said, “but we want to consolidate and improve efficiencies in a very cost-sensitive market.”