Teleradiology: Getting the picture: Virtual Radiologic delivered a solid first-quarter. Yet uncertainties leave investors cautious about the field.

Sat. May 02, 2009; Posted: 10:46 PM

Virtual Radiologic Corporation's unexpected removal of founder and chairman Dr. Sean Casey from the board just weeks before it released first-quarter earnings unsettled already squeamish investors.

Yet the results were actually good.

Better than good. The Eden Prairie-based company, which contracts with U.S. radiologists to interpret and analyze imaging data sent over encrypted broadband networks, said last week that first-quarter sales grew 23 percent to $28.6 million while operating profits jumped 40 percent to $5.6 million.

Virtual's shares have soared nearly 50 percent to close Friday at $8.85. The company, which made its Wall Street debut in November 2007, was the last Minnesota firm to go public.

"Despite operating amid tough economic conditions and facing debilitating pricing competition, it appears Virtual Radiologic is faring relatively well," Lauren Migliore, an analyst at Morningstar, wrote in a research note. "We continue to believe that Virtual Radiologic is well positioned to provide an efficient, cost-effective solution to a growing radiologist shortage."

So what about Casey, a radiologist and company founder? The company's executives won't say much, but it's not unusual for a growing company to push out its entrepreneurial founder in favor of a professional manager. (Casey could not be reached for comment; he remains the company's largest shareholder, with 27 percent.)

Despite their recent surge, Virtual shares are still down 64 percent from their high of nearly $25 in 2007. Investors continue to lump Virtual with its larger but weaker rival NightHawk Radiology Holdings Inc., whose struggles taint both companies.

"NightHawk's problems have weighed in on Virtual," said analyst Brooks O'Neil with Dougherty & Co. in Minneapolis.

Founded in 1999 by Casey, Virtual's performance has been comparable to a strong-armed rookie pitcher with control problems. Using high-speed broadband connections and a proprietary software system, Virtual's technology enables short-staffed emergency rooms to outsource "image reads" to radiologists around the country working out of offices or their homes.

Yet in late 2006, Virtual was struggling to manage its burgeoning caseload, resulting in severe delays in returning "reads" to its customers. The company delayed its IPO and its chief operating officer and chief technology officer soon left the start-up.

Virtual raised $68 million from its IPO but soon disappointed Wall Street. CEO Robert Kill said Virtual lowered its sales and profit forecasts several times, damaging its credibility with investors.

"We paid the price," said Kill, a seasoned executive who joined Virtual in May 2007 as president and COO. "We have to deliver results we say we can deliver."

Part of the problem is that teleradiology is new and measuring the performance of an emerging technology can be tricky. "I think people in the industry are still trying to get their arms around it," O'Neil said.

Take NightHawk. The company overpaid for its acquisitions and is struggling to grow sales amid a pricing war made worse by the economic recession, O'Neil said. NightHawk, which recently replaced its CEO founder, said first-quarter sales fell 7 percent to $38.8 million.

By contrast, Virtual has grown sales and profit by attacking the more lucrative "final read" market, which requires more complete analysis and expertise than preliminary reads given to emergency rooms. KLAS, an independent research firm that measures customer satisfaction, named Virtual the top teleradiology firm of 2008.

"Over time, investors will realize we can't be lumped together," Kill said. "We are performing at a different rate."

Kill replaced Casey as CEO in January in what the company called a "succession plan designed for the company's next phase of growth." Casey, though, remained as chairman and oversees strategy.

However, less than three months later, Virtual said in its proxy statement that its board removed Casey as chairman and decided not to recommend him for re-election "based upon considerations of board size, board relationships and functionality, board composition and the desire to have Mr. Kill elected as a director."

Asked to elaborate, Kill replied: "The proxy speaks for itself."

Despite its strong first quarter, Virtual will have to navigate a highly uncertain economy, Kill said. "What's changed is the market environment," Kill said. "We have the right strategy. But strategy doesn't mean anything unless you execute."

Because numbers don't lie.

Thomas Lee --612-673-7744

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