JUST OUT...MUST READ
Fear And Confusion Related To FPA Medical' s Recent Bankruptcy Filing, Other PPMC Meltdowns Impacts All PPMCs - PMCO Outlook Positive - Strong Buy Reiterated - $18 Price Target - Focus And Discipline Distinguish ProMedCo>>>>>>>>>
Summary - The demise of FPA Medical Management (FPA - #) and continuing issues with other key PPM company players (PhyCor (PHYC - #@), MedPartners (MDM - #@), PhyMatrix (PHMX - #@) et al.) over the past several months has further eroded the already tenuous position of PPMCs with investors. As a result, shares of many PPM company stocks have fallen sharply recently. ProMedCo's shares have been hit hard in the process. While PMCO and FPAM are both PPMCs, the differences between the two companies are enormous and it is not, in our opinion, appropriate to lump the two companies together on any level. In particular, ProMedCo is attacking attractive markets, has a clear and focused strategy built around affiliations with successful primary care-based multispecialty groups in premanaged care secondary markets, has strong management with public company experience, has specifically avoided capitated risk (approximately 5% of income comes from such contracts), and has a solid balance sheet with no debt. FPAM was almost diametrically opposite on each key point noted above.
ProMedCo Management Company June 23, 1998 - Page 2 of 5
One similarity shared by all PPMCs at this phase of industry consolidation is that growth is driven primarily through acquisitions. Among PPMCs, there is significant variation in the acquisition model. Since each physician group is unique, most PPMCs have been willing to adjust many of the acquisition variables to fit the circumstances of the Company and each respective group. ProMedCo has been both flexible and creative in structuring affiliations to meet its needs and those of physicians with whom the Company has affiliated. This has enabled PMCO to win deals in competition with other PPMCs that have been larger, with stronger currency, and which may have been willing to pay a higher absolute consideration.
A few questions have been raised recently regarding ProMedCo's use of interim service agreements and consulting/ implementation fees in structuring certain of its affiliations. We are comfortable with such arrangements, they are not new news, have been fully disclosed in the Company's financial statements (10-Qs, 10-K, prospectuses), and the Company's auditors (Arthur Andersen) have carefully reviewed each such arrangement, and have opined that they are in conformance with generally accepted accounting practices. The balance of this note is an attempt to ensure that investors have a basis for evaluating the facts and circumstances surrounding this practice.
Dissecting Revenues - We believe that there has been some confusion related to the manner in which ProMedCo reports revenues in its financial statements. In the consolidated statements of operations, the Company reports both physician groups revenue and management fees revenue. Physician groups revenue represents the revenue of the physician groups, reported at the estimated realizable amount, net of contractual and other adjustments (such as payor discounts). Management fees revenue represents revenue earned by ProMedCo for providing services to its affiliated groups and IPAs. Management fees revenue is equal to physician groups revenue, less amounts retained by physician groups. The amounts retained by physician groups represent amounts paid to the physicians pursuant to the service agreements between the groups and the Company, typically 80% to 85% of the physician group's operating income. Therefore, the Company's management fee revenues are dependent upon the operating income of the physician groups.
In the footnotes to its financial statements, ProMedCo provides a more detailed breakdown of management fee revenue. Management fees revenue includes four components: 1) the component based upon percentage of physician groups operating income, 2) reimbursement of clinic expense, 3) revenue from non-affiliated physician groups, and 4) other revenue. The component based upon percentage of physician groups operating income is that portion of operating income (typically 15% to 20%) not paid to physician groups. Reimbursement of clinic expenses is an amount equal to 100% of clinic expenses. Revenues from non-affiliated physician groups are fees paid by IPAs. Other revenue represents supplemental fees that are paid by affiliated groups to ProMedCo for management consulting and supplemental services related to acquisition and transition activities.
Revenues from each of the categories noted above can be derived either from continuing or interim contracts with physician groups. Interim agreements have been used since ProMedCo was founded to allow the Company to begin providing services to a group while the closing process is underway. Typically (but not exclusively), these are short-term (a few months) contracts, which in many regards mirror the contract which will apply post-deal. Since there is an intense period of service required at the outset of the affiliation, the management fee from interim agreements is often somewhat higher than that which will apply post-deal. ProMedCo does not break out interim fees in its financial statements. We are not aware of a case where an interim agreement did not become a continuing agreement as a result of the closing of the affiliation transaction.
Other revenues are fees that are negotiated at the time of affiliation for services provided during and after the deal process. ProMedCo prepares an in-depth market analysis and complete business plan in conjunction with its deal due diligence. This has distinguished the Company from many of its competitors. It also provides a road map for the group and the Company to follow in creating value in the practice. In payment for these services, PMCO charges newly affiliated groups an implementation fee. While the Company anticipates that it will continue to generate similar fees from future acquisitions, these fees are not a recurring source of revenue from individual groups with which the Company is already affiliated.
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