Intermagnetics wins contract to supply Philips with MR magnets

Enhanced alliance delegates inventory control to supplier

Philips Medical Systems has tightened its supply chain for MR scanners, making Intermagnetics its exclusive supplier of superconducting magnets and putting the Latham, NY, company in charge of magnet inventory. These key changes, announced May 14, have been written into a long-term agreement structured with automatically renewing options that promise to provide Intermagnetics with unprecedented stability and responsibility in its relationship with Philips.

With this agreement, Intermagnetics becomes the exclusive supplier of superconducting magnets for Philips' commercial MR systems. The agreement also gives Intermagnetics the exclusive right to develop superconducting magnets for any new Philips' MR offerings.

The deal adds two years to the front end of the usual five-year term of the supply contract. After the first two years, the contract will automatically renew each year. After the initial seven-year contract, the agreement turns into a renewing five-year contract.

"In effect, it is a perpetual rolling five-year contract," said Glenn H. Epstein, chairman and CEO of Intermagnetics.

To close the deal, Intermagnetics had to make some price concessions, according to Epstein. How much he would not say.

"When have you seen a commercial negotiation where there weren't price considerations?" Epstein asked. "But we believe we can grow revenues and maintain margins and grow earnings."

Epstein and Michael K. Burke, executive vice president and CFO, described the deal in a conference call during which they reaffirmed expected earnings of 25¢ to 26¢ per diluted share for Q4 of the current fiscal year, which ends May 25. MR equipment is the biggest but not the only contributor of revenue to Intermagnetics. The others address instrumentation and energy. Its MR business, however, provides the bulk of the company's revenues and is the most profitable.

Intermagnetics had been Philips' exclusive provider of superconducting magnets prior to Philips' acquisition of Marconi Medical, which included the Infinion 1.5T MR scanner with its ultrashort-bore magnet supplied by U.K.-based Oxford Magnet Technology. The new agreement cuts Oxford out of the picture. It restores Intermagnetics' exclusivity by assigning the manufacture of magnets for the Infinion-now part of Philips' "Enterprise" line of MR scanners-to it and increases the company's role and responsibility in delivering products to the end user.

Previously, Philips had ordered magnets to be held in its own inventory. The new agreement calls for Intermagnetics to handle inventory and ship the superconducting magnets to end-user sites, where the products are assembled.

"We can place inventory where it is needed much faster than (Philips) can," Epstein said. "As the manufacturer of the magnet, we can hold magnets of different field strength and of different configurations at various stages of production. We can keep them cold or warm and, as Philips needs them in various locations, we can respond to those needs at a lower overall cost than Philips could themselves."

And there may be more. Executives from the two companies have agreed to look for ways to enhance Intermagnetics contributions beyond the traditional bounds of providing superconducting technology. The new products or services would involve MR, Epstein said, but he provided no details.

As in any change affecting the work protocol of two companies, there will be a transition. Part of that transition will mean near-term revenue losses to Intermagnetics, as Philips absorbs its current inventory of magnets before turning over inventory control to Intermagnetics. This changeover will lead Intermagnetics to shut down its production line of magnets for much of the summer, imposing a drop in revenues for the current period, which is the company's first quarter of fiscal 2004.

The firm might have negotiated a slower transition to the new business model, Burke said, thereby easing the drop in both revenue and earnings anticipated in its current quarter. But doing so would not have been in the spirit of the alliance.

"The faster we do this, the faster the benefits accrue to both parties," he said.

Burke expects Intermagnetics to break even in Q1, 2004. He predicts earnings will then ramp up with an enhanced run rate of magnets during the rest of the fiscal year. And the future will be even better, according to Epstein.

The exclusivity achieved under the new contract could bring Intermagnetics an additional $20 million or more in annual revenue by fiscal 2006, he said. This would include magnet orders resulting from the sale of Philips Enterprise (formerly Infinion) scanners, rising demand for 3T magnets, and a steady growth of the overall market due to escalating clinical use of MR. Industry observers expect the global MR market to grow between 9% and 10% annually for the foreseeable future, a forecast based partly on the introduction of newly configured MR systems and new applications in neurology and cardiology.

Intermagnetics may gain further when its 1T open magnets begin shipping commercially. This could happen around 2005, Epstein said, although the actual date will depend on product introduction decisions made principally by Philips.

More revenue may come from new development activities. These activities, decided in collaboration with Philips, could evolve into new products or services that would add incremental revenues to Intermagnetics' bottom line. Together, anticipated revenue should allow Intermagnetics to achieve long-term annual earnings growth of 10% to 15%, Epstein said.

Epstein and Burke refused to speculate on the character of extended responsibilities that Philips might assign in the future. They noted, however, that the assignments would be outside superconducting and radio-frequency technology, the company's core areas of expertise in MR. These responsibilities might involve equipment ancillary to the superconducting magnets.

"There are lots of things that touch an MR system and go into an MR suite," Epstein said. "Whether we take over additional supply chain responsibilities or whether Philips outsources more to us will depend on the collaboration."