Diagnostic Health’s search for partner culminates in deal with Medical Alliance

DHS posts big net loss for 1998 due to one-time charges

Imaging services provider Diagnostic Health Services successfully found a corporate partner last month, without straying far from its Dallas turf. The company on Feb. 18 announced a merger deal with Medical Alliance, of Irving, TX, a shared-services provider of office-based surgical procedures. The merger should help both companies improve their growth prospects by giving them access to a broad network of clients.

The companies agreed to a deal in which one share of Medical Alliance stock would be equal to 1.57 shares of Diagnostic Health stock. The new company will carry the Medical Alliance name and will trade under its stock symbol, MAII. The company’s executive suites, to be based in Dallas, will be staffed by officials from both firms, and the merger will be accounted for as a pooling of interests. The deal is expected to close in the second quarter and is subject to governmental and shareholder approval.

Diagnostic Health Services was founded in 1983 and provides medical outsourcing services to hospitals and other healthcare facilities, including radiology and cardiology diagnostic services and equipment and department management services. Founded in 1989, Medical Alliance serves the ob/gyn, plastic surgery, and dermatology markets. Medical Alliance technologists create temporary surgical suites in physician offices and assist physicians in procedures. The company went public in 1996 and employs 155 workers.

The two firms became interested in a merger when they discovered shared aspects of their businesses, according to Brad Hummel, president and CEO of DHS.

“We both have components of our businesses that depend on the moving of equipment and the delivery of technology into alternate-care settings,” Hummel said. “We both depend on highly trained, allied healthcare professionals to assist us in delivering product at value. And we both depend on value-added products and services to integrate ourselves into our host in a way that makes us irreplaceable.”

The merger comes at a time when both companies are seeking ways out of the financial doldrums. DHS grew quickly through acquisition in 1997, buying a number of small cardiology and imaging companies. But the firm’s results began to slow last year, and it began considering other ways to bolster its performance. It publicly announced last year that it would begin looking for a merger partner, and shortly thereafter it found Medical Alliance.

“Our growth slowed in 1998,” Hummel said. “We weren’t able to access the leverage we wanted. There comes a point when you need to retool, and there are a number of ways to do that. We found (the deal with Medical Alliance) to be a reasonable means of reestablishing strength on the balance sheet and gaining valuable operating assets.”

Diagnostic Health’s problems were evident in financial results for the fourth quarter (end-December) that indicated lower revenues and a whopping net loss. Posted on the same day that the merger was announced, DHS reported revenues of $11 million, down 27% compared with $15 million in the fourth quarter of 1997. The company had a net loss for the period of $31.8 million, due in large part to $25.8 million in restructuring charges and $10.8 million in accounting charges related to changes in the way the company recognizes revenue. The charges were offset to some degree by tax benefits related to the charges. DHS had a net profit of $1.5 million in the fourth quarter of 1998.

For the year, DHS had revenues of $44.8 million, compared with $52.9 million in 1997, a drop of 15%. The company’s net loss for 1998 was $41.3 million, compared with net income of $5.7 million in 1997.

Medical Alliance has also seen its performance slow of late. The company’s growth lagged last year after a failed product rollout caused the firm to falter. The merger with DHS is part of Medical Alliance’s efforts to expand its client networks, according to CEO Paul Herchman.

“Part of us coming together with DHS is that they’ve got 400 hospital relationships,” Herchman said. “We’re good at developing a turnkey service in surgery, and if we can take our products through their chain, we’ll be able to take advantage of their networks.”

One of the advantages that Medical Alliance brings to the merger table is about $14 million in cash and no debt, making it an attractive partner. There is little overlap in services, as Medical Alliance has no imaging operations. The companies also have different client bases: Medical Alliance primarily serves physicians’ offices, while DHS primarily serves hospitals.

The two firms expect some changes in the new company’s corporate roster. Hummel, who was named CEO of DHS in January after Max Batzer stepped down (SCAN 2/3/99), will serve as CEO of the new company. Batzer will remain on the board. Chris Turner, Diagnostic Health’s CFO, will serve in this capacity for the new firm, and Bonnie Lankford, vice president of operations at DHS, will be executive vice president of operations at Medical Alliance. Medical Alliance’s president and CEO, Gary Hill, will become president and COO. Herchman will serve as interim president of the office-based division of the new firm and as a board member.

Once the merger is completed, the combined company will have 665 employees and outposts in 45 states across the U.S., and will serve 400 hospital and 3500 physician clients.

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