Diasonics split targets growth of dedicated ultrasound effort

Diasonics plans to separate its worldwide ultrasound businessfrom profitable OEC-Diasonics later this year, establishing ultrasoundas an independent company in an increasingly hard-fought market.The move will allow shareholders to realize the full value ofSalt Lake City-based OEC, a successful provider of C-arms andurological x-ray/interventional equipment, while sharpening marketand product focus within ultrasound, according to Stewart Carrell,chairman and CEO.

Focus has proved to be the key to ultrasound success over thepast decade. Westmark International held similar objectives lastyear when it separated ultrasound vendor ATL from its more profitableSpaceLabs patient monitoring business (SCAN 2/26/92).

Other similarities exist between the two business separations.ATL's launch of its high-definition imaging (HDI) upgrade to theUltramark 9 scanner took off within a year prior to that corporatesplit. Diasonics has had promising initial results from its innovativeSpectra VST (variable summation technology) scanner upgrade, whichbegan shipping in June (SCAN 4/8/92, 5/6/92 and 5/20/92).

Order bookings for Spectra VST rose 20% to 25% during the secondhalf of fiscal 1992 (end-December), said Shawn M. O'Connor, CFOof the Milpitas, CA, company.

But there is one key difference between the separation of ATLand that of Diasonics: the latter's ultrasound business is stilllosing money. ATL released its annual results for 1992 (end-December)this month. Profits rose 16%, from $6.4 million in 1991 (priorto separation) to $7.4 million, despite a $5 million restructuringcharge. Diasonics also released its year-end results, showinga loss of $19 million compared to a profit of nearly the sameamount, $18.9 million, in 1991.

OEC-Diasonics was profitable last year, with revenues of $94million--about a third of the company's $300 million total netsales for 1992.

"OEC has had one incredible record of both sales growthand good profitability for several years," said Larry Haimovitch,a San Francisco-based medical technology consultant. "Diasonics'stock is undervalued because people focus on this company as anultrasound company."

Nearly half of Diasonics' loss last year resulted from theaccrual in the fourth quarter of $9 million in charges relatedto the split. These charges are for restructuring costs yet tobe incurred. Diasonics also took a one-time charge of $3.5 millionlast year to reduce staff and facilities in its U.S. and Europeanultrasound business.

Much of the pain is past, however, and Diasonics' ultrasoundbusiness is well positioned to gain from those measures, Carrellsaid.

"We lowered the break-even for this business," hesaid.

Diasonics has a solid sales team, which has avoided significantturnover, Carrell told SCAN. The technical group responsible forVST has also been maintained. Most staff reductions last yeartook place in administrative and manufacturing functions.

"We have a very clean and well-run manufacturing operationnow, which wasn't the case even a year ago, and we are down toa minimum of administrative people," he said.

Despite red ink, the ultrasound business produced a positivecash flow in the latter part of last year, Carrell said. Diasonicsis well positioned financially, with about $21 million in cashand little debt. Sufficient resources will be injected into theultrasound business to keep it floating as VST finds its wings.Resources will also be available to maintain product developmentefforts, he said.

"There will be adequate liquidity in the ultrasound businessfor it to last under existing conditions for several years, wellbeyond what it will take to establish itself as a success,"Carrell said.

With this corporate split, Diasonics will continue what hasproved to be a successful strategy of slimming down and refocusingthe company's product strategy. Diasonics timed its departurefrom the cash-draining MRI business extremely well. The vendorreaped about $200 million from the sale of that business to Toshibathree years ago, just as the MRI market turned highly competitive.

The firm invested cash from the MRI sale in developing VST'sconfocal imaging technology and composite materials for transducers,which it now builds itself rather than sourcing externally. Morebreakthroughs in Spectra's basic color-flow and gray-scale imagingarchitecture are in the pipeline, Carrell said.

Keeping up with the technological pack in ultrasound has becomeincreasingly expensive, however, as providers of premium radiologyscanners vie for market leadership and plot the next radical productdevelopment with potential to reshuffle the industry.

Acuson, determined to hold onto the leadership position itcreated with its first product introduction in 1983, is settinga vigorous pace for R&D expenditures. That vendor risked thewrath of Wall Street last year by boosting development expenditures45% to $48 million from $33 million in 1991.

Combined with tight price pressures, the boost in R&D droppedAcuson's previously stellar profits down to earth. Acuson's annualnet income dropped 37% in 1992 (end-December), to $36.8 millionfrom $58.5 million in 1991.

Acuson's net sales rose 2% for the year to $343 million from$336 million in 1991. Despite the drop in profits, Acuson's profitas a percent of sales last year was 10.7% for the year and 7%for the fourth quarter. This compares with ATL's 2.8% profit marginfor the year and 6.6% for the fourth quarter.

"Diasonics spent $21 million in R&D last year, ofwhich maybe $15 million was in the ultrasound division,"Haimovitch said. "Acuson has raised an enormous barrier ina sense by throwing so much money into (R&D). This is a verycompetitive market and requires constant innovation. Diasonicsis going to have to keep research productivity growing to be successful.New products and enhanced technology are critical to the successof a company in this market."

But, with VST, Diasonics has regained the solid technical positionit enjoyed when it was the industry leader in the early 1980s,Haimovitch said.

"That is seductive, perhaps dangerously seductive, ifthey don't continue to stay ahead or abreast of the innovationcurve," he said.

Diasonics did a good job developing a solid ultrasound productwith what was probably much less R&D funding than Acuson orATL, said Harvey G. Klein, a New York ultrasound consultant. Butthe vendor is now in a position where it is likely to sell systemsfor less than the competition in order to reestablish its placein the market.

"It is not going to be easy (for Diasonics). The competitionis not sitting still," he said.

Part of Diasonics' $9 million restructuring charge accruedin the fourth quarter involved anticipated increases in salesand marketing expenditures for Spectra, Carrell said.

"We will take advantage (of the restructuring) and getout to our marketplace much more forcefully than we have overthe past six to nine months," he said.

The splitting off of ultrasound--with the resources that willbe devoted to this business--should alert the market that Diasonics'management and board of directors perceive value in its futurebusiness, he said.

"The reward for our shareholders, employees and customerswill be greater with the success of this business, as opposedto looking for some savior in the form of a partner or an acquirer.That is clearly not our objective," Carrell said.

Ultrasound autonomy will also allow Diasonics to better integrateits U.S. and European businesses, he said. Sonotron, the company'sEuropean subsidiary, will be more closely tied to the company'sworldwide product strategy, providing stronger support for theVST technology internationally.

Better integration of the company's worldwide ultrasound businessshould also help build the cardiology ultrasound sales of VingmedSound in the U.S., he said. Vingmed was purchased by Sonotrontwo years ago (SCAN 12/12/90).

Sonotron's European distributor relationships with Hitachiand Aloka will be maintained, Carrell said.

The future of Diasonics' emerging ultrasound ablation business--dubbedfocal surgery--has not yet been determined. The company seeksto maintain autonomy for this effort while taking advantage ofcrossover benefits from diagnostic ultrasound. Focal surgery couldconceivably be spun off as a third company or maintained withinthe ultrasound group, he said.

The proposed split of Diasonics into two public companies issubject to shareholder approval. Which company will continue legallyas Diasonics has not been determined. That will depend more ontax considerations than on strategic factors, Carrell said.

Current ultrasound division president Bruce Moore will becomepresident and CEO of the independent business and OEC-Diasonicspresident and general manager David Rose will take on the CEOposition at that company, he said.

Carrell's position once the companies are split has not yetbeen determined.