AmeriPath Pursues Ambitious Strategy Of Rapid Expansion

Acquired $49.0 Million of Path Practices in 1999

CEO SUMMARY: As the pathology profession’s only publicly-traded physician practice management company, AmeriPath is the spear point of far-reaching changes now transforming pathology. With an annual revenue run rate of $270 million and an ample war chest of growth capital, AmeriPath intends to continue its steady expansion. In the 28 months since its initial public offering (IPO), the company has generated an unbroken stream of revenue gains and profit increases. AmeriPath’s business goals provide insight into how the entire profession of pathology may evolve in coming years.

MANY NAYSAYERS WITHIN THE pathology profession predicted doom and gloom for the various forms of national anatomic pathology companies that emerged during the last years of the 1990s.

However, without exception, these pioneering anatomic pathology firms have remained in business. Several are flourishing and enjoy revenue growth and profit margins that are the envy of other healthcare business sectors.

The market leader in anatomic pathology is most likely AmeriPath, Inc. of Riviera Beach, Florida. It finished 1999 with revenues of $232.8 million and net income of $23.0 million, or $1.05 per share. No other anatomic pathology company approaches its size.

Next Market Phase

AmeriPath is an example of the next market phase for the PPM business concept: the single-specialty PPM. In the last issue of THE DARK REPORT, we covered the evolution of the physician practice management industry. Currently there are at least six companies organized as single-specialty pathology PPMs. Of this group, only AmeriPath has become a public company.

AmeriPath is one of those companies which is actively shaping the future look of the anatomic pathology profession. Transformational forces of pathology regionalization, centers of excellence, national branding, and centralized management are playing out within AmeriPath.

Long-time clients and readers of THE DARK REPORT know that, since the late 1980s, the American healthcare system has been in transition from a cottage industry of small, independent provider groups, to a consolidated industry comprised of large provider organizations under professional corporate management.

This consolidation is most visible in two sectors of healthcare: concentration of hospital ownership and consolidation of health insurers. AmeriPath represents the strongest example of consolidation within the anatomic pathology profession. It now employs 297 board-certified pathologists, practicing in 30 states. It operates 30 outpatient laboratories, and services 164 hospital locations and 43 outpatient surgery centers.

Acquiring Pathology Groups

AmeriPath reached its size and geographical reach through an ongoing program of pathology group practice acquisitions. In so doing, it demonstrates that there are anatomic pathology groups within the United States willing to join a consolidated management organization.

To grow, AmeriPath had to overcome two large negatives. One, anatomic pathologists are widely recognized as one of the most stubbornly independent of all physician specialties. By nature, pathologists are not “joiners.” Thus, they are highly skeptical of the concept of joining a pathology PPM.

Second, since AmeriPath’s initial public offering (IPO) in October 1997, the PPM industry has endured difficult times. Billion-dollar PPM leaders like MedPartners, PhyCor, and FPA Medical Management literally disappeared from the business marketplace. AmeriPath had to convince both pathologists and investors that it had a viable business plan as a pathology PPM.

Influential Force In Pathology

By overcoming these two negatives and growing rapidly, AmeriPath demonstrates its ability to influence the pathology marketplace. And if AmeriPath is destined to be an influential force in shaping the evolution of anatomic pathology as we know it today, then it should be closely watched by pathologists interested in staying ahead of the curve.

Historically, AmeriPath has kept a low public profile within the pathology profession. Alone among the single-specialty pathology PPM companies, it is one company that has not permitted THE DARK REPORT to visit its corporate headquarters and meet with its executive team.

However, the company does active- ly promote itself to the investment community. During the month of January, AmeriPath participated in a couple of Wall Street events, including Hambrecht & Quist’s 18th Annual Healthcare Conference in New York City on January 12, 2000 and the Wall Street Transcript.

To an audience of financial analysts and investors, AmeriPath Chairman and CEO James C. New openly discussed many of the company’s accomplishments and future plans. He described AmeriPath’s view for the future of anatomic pathology and how it intends to exploit new opportunities.

AmeriPath Pays Good $’s To Buy Pathology Groups

One reason that pathology practices agree to sell to a PPM is to convert their equity capital into liquid assets. Here’s a look at how some recent AmeriPath acquisitions were structured.

On July 26, 1999, Consulting Pathologists, PA of Philadelphia, Pennsylvania (annual revenues: $4.4 million) was acquired by AmeriPath. Its five pathologists received approximately $6.7 million for the practice. Payment was in the form of $3.3 million in cash, AmeriPath shares worth $570,000, and contingent notes totaling $2.3 million.

Closed on September 13, 1999 was the acquisition of Pathology Associates of Texas, located in Dallas (annual revenues: $4.4 million). These nine pathologists received approximately $15.8 million for the practice. Payment was in the form of $8.7 million in cash and contingent notes totaling $7.1 million.

The actual value for each practice will be calculated upon its actual cash flow, such as EBITDA (earnings before interest, taxes, depreciation, amortization), not annual net revenue. These numbers were published in AmeriPath financial filings. The per-pathologist sales price was $1.34 million in the first example and $1.75 million in the second example. It is not known how many pathologists in each example were full partners at the time of each sale.

Strategic Growth Markets

First, AmeriPath will pursue strategic growth in a limited number of healthcare markets in the United States. “The initial market research we did indicated that, of the top ten markets, nine were east of the Rockies,” stated New.

California is largest, “which is only marginally bigger than Florida, the second largest market, or Texas, the third largest market,” New stated. “The remaining seven key markets are in the Northeast and Midwest.

“We developed a regional approach to our business which we implemented and successfully completed in Florida,” he continued. “We now provide [pathology] services throughout the state of Florida. We are finishing that same model in Texas, with our last operation under development in Houston.”

James New is describing AmeriPath’s plans to regionalize its pathology services, market-by-market, state- by-state. Next comes similar expansion “in the states of New York and Pennsylvania and key markets in the Midwest,” he explained. “So we will continue to grow, mostly for the next two years, in the Northeast, the Midwest, and a bit in the Southeast.”

Regionalization Strategy

This strategy of regionalization will be supported by creating anatomic pathology centers of excellence and branding them nationally. This will emphasize esoteric work and higher-end cancer testing. “We have established what we call the Center for Advanced Diagnostics,” said New, “allowing us to participate in that esoteric market. Through our hospital contracts, we currently outsource that work to our competition.

“This totals about $10 million per year,” he continued, “and is a great opportunity for us to bring this work in-house. We will expand product offerings to the urology and gastroenterology marketplaces. These are two new markets for AmeriPath.”

The national branding effort was launched during the summer of 1999. As reported in THE DARK REPORT, AmeriPath has built a national center of excellence in dermatopathology, in conjunction with A. Bernard Ackerman, M.D., located in New York City. It’s called the Ackerman Academy of Dermatopathology.

Value Of Lab Information

AmeriPath is not overlooking the added-value of lab information to the healthcare system. Dermatopathology is an AmeriPath trump card which it intends to play. “Being the largest processor of skin tissue in the country, at over 2.5 million biopsies per year, we have an enormous amount of data that we collect,” commented New.

“We are now putting together a master database that will allow us to mine that information and begin to provide better diagnostic information to our referral sources and to their patients, as well as to the payers, including HMOs.”

AmeriPath is particularly strong in dermatopathology. During its pre-IPO period, it selectively concentrated on acquiring dermpath groups. There were several reasons for this business strategy.

First, dermpaths work outside the hospital, giving AmeriPath more control over business operations. Second, dermpaths primarily serve office- based physicians. This makes it easier for AmeriPath to target sales and marketing efforts.

Third, dermatopathologists tend to generate higher billings per year than hospital-based anatomic pathologists. For 1999, AmeriPath’s annualized net revenues per pathologist full-time equivalent equaled approximately $1 million.

THE DARK REPORT expects to see AmeriPath’s basic “revenue per pathologist” increase in future years. If AmeriPath succeeds as a practice consolidator, its business management team should develop additional added-value products and services which supplement the revenue generated from basic anatomic pathology procedures.

Demographics Portend Bright Future For Pathology

Population demographics will work in favor of anatomic pathology during the coming years. AmeriPath, Inc. believes it is well-positioned to profit from the coming boom.

“Over the next 20 years, the population base [of the United States] of 55-74 years old will grow over 70%,” observed James C. New, Chairman and CEO of AmeriPath. “whereas the base population will grow about 20%. An older individual uses our services three to five times more often than a younger person. So again, for us, that’s a very positive trend.”

Diversified Revenues

AmeriPath is not alone in pursuing this business strategy. IMPATH, Inc., is a New York-based national pathology company focused on providing community hospital-based pathologists with services targeted at hard-to-diagnose cancers. IMPATH is putting biopsy information into a sophisticated database, then selling this information to clinical trials companies, pharmaceutical companies, and other entities. (See TDR, February 1, 1999.)

As a company with national ambitions, AmeriPath must deal with the challenges of contracting for pathology services. In Florida, it parleyed an early regional relationship with SmithKline Beecham Clinical Laboratories (SBCL–now Quest Diagnostics) into a state-wide contract. AmeriPath discloses that about 9%, or $21.3 million, of its total revenues comes from contracts with national laboratories.

Hospital Path Contracts

It has more revenue exposure from some of its hospital contracts. Of AmeriPath’s 164 hospital contracts, at least 27 involve hospitals owned by Columbia/HCA Healthcare. AmeriPath states that approximately 16.8%, or $39.8 million, of its total revenues come from contracts with Columbia/HCA.

THE DARK REPORT believes that AmeriPath is now large enough to influence the market evolution of anatomic pathology. Its size, its interstate reach, and its well-funded acquisition war chest will enable AmeriPath to increase its influence during the next few years.

That does not mean that AmeriPath’s future financial success is guaranteed. As it grows, it must competently handle the same management challenges which torpedoed so many other well-funded, fast-growing, and profitable PPMs.

18 Months To Disappear

Remember that MedPartners, during the first four years of its existence, was highly profitable. It rapidly became a multibillion-dollar company, but then took only 18 months to completely disappear from the PPM marketplace. The financial decline started with a $646.7 million restructuring charge at the end of 1997.

Many challenges facing AmeriPath relate to the difficulties of acquiring independent physician practices and integrating their different operational details into the AmeriPath business model. That is one downside to a reliance on acquisitions as the major engine for revenue growth.

Another challenge is “same store” growth. “Same store” growth in the pathology profession is a difficult proposition. For a local AP practice, growth means either getting more hospital contracts, which involves taking business away from nearby pathology practices, or capturing more specimens from physicians’ offices.

During the last two years, AmeriPath’s same store growth has been 8% (for 1998) and 4% for 1999. During 1999, this growth came from same practice hospital net revenue (+2%) and same practice outpatient net revenue (+3%). Declines in Medicare reimbursement for the year offset these gains by -1%.

Management Challenges

It must be noted that Wall Street remains cautious about AmeriPath’s ability to solve the management challenges facing any fast-growing PPM. AmeriPath’s stock trades at a low price/earnings multiple and is currently valued at under $10 per share.

Being biggest, however, does have some advantages. Within the anatomic pathology profession, AmeriPath is now the company to catch. Unlike other national pathology providers like DIANON Systems, Inc., IMPATH, and UroCor, Inc., AmeriPath is strongly-rooted in a local presence. Its anchors are the hospital-based groups and dermatopathology practices providing local AP services.

Because it is consolidating local practices into regional pathology systems, it provides a real-world experiment in the dynamics of pathology regionalization. None of the private pathology PPMs, such as Pathology Consultants of America, PathSource, PathGroup, USLABs, or Pathology Partners have created a multi-state presence comparable to AmeriPath. That leaves AmeriPath as the main pioneer to watch.

Attitudes within the pathology profession toward consolidation and regionalization may also be changing more significantly than publicly acknowledged. AmeriPath, in acquiring $49.0 million worth of pathology practices during 1999, demonstrates there are a number of thoughtful pathologists who see a future in affiliating with its company.

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Modest Physician Turnover

Further, AmeriPath, as an employee-model PPM, has certainly not experienced the doctor-rebellion predicted by many pathologist naysayers. James New reported last month that the company’s turnover among physicians is currently 8%. That would represent about 24 of its 297 pathologists, an average of two departures per month over the course of a year.

Since going public in October 1997, the experience of AmeriPath validates THE DARK REPORT’s predictions about the pace of consolidation and regionalization within the pathology profession.

Moreover, when combined with the market successes of the national AP companies, private pathology PPMs, and the Pathology Service Associates (PSA) state networks, there is ample demonstration that the pathology marketplace is undergoing several other key trends.

These include aggressive sales and marketing of anatomic pathology services, the emergence of pathology centers of excellence, the branding of anatomic pathology skills, and the attempt to use information, not clinical services, as the added-value profit booster.

Its existing pathology empire gives AmeriPath the clear lead over the anatomic pathology industry. Time will tell whether AmeriPath’s executive team capitalizes on this lead or ends up in the PPM dustbin which has claimed so many other companies.

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