Business Valuation Adjustments

1. AGN’s 2009 North American Regional Meeting Business Valuation Adjustments

2. Discussion of business valuation adjustments • Case study – Application of valuation adjustments with a healthcare twist Agenda

3. 10-Physician Hematology/Oncology Practice (Hem/Onc) • Rising costs of drugs (chemotherapy) in recent years creating pressure on practice profitability and take-home pay • Result = Increase in physicians and physician practices approaching hospitals to strategically align to boost practice and ancillary income (e.g. clinical co-management contracts, under arrangements and EMPLOYMENT) • Value on a control, non-marketable basis (for this case) Introduction to Case

4. Cause for Concern

5. Summary Income Statement

6. Summary Balance Sheet

7. Owner’s compensation • Revenue • Workforce in place • Working capital and non-operating/excess assets • Debt /equity structure when using a weighted average cost of capital (WACC) • Rent expense • Built-in capital gains • Patient charts • Many others… Valuation Adjustments to Consider

8. According to Jim Hitchner and Ron Seigneur: • “It is not unusual for the controlling shareholder to take compensation in excess of going market rates that might be paid for the same services. Since the “willing buyer” of a control ownership interest could reduce compensation to market levels, often it is appropriate to add back excess compensation to cash flow to reflect the additional economic benefits that would be available to the “willing buyer.”1 • According to Shannon Pratt, Robert Reilly and Robert Schweihs: • “The general idea of the compensation adjustment is to substitute the cost of hiring and paying a non-owner employee for the compensation actually paid to the owner to perform the same functions.”2 • 1 Financial Valuation: Applications and Models, Second Edition, 2006, p 100. • 2 Valuing Small Business and Professional Practices, 2nd Edition, Year, p 92. Adjustment #1 - Owner’s Compensation

9. Job description • Duties and responsibilities • Performance • Hours worked • Multiple roles • Skill set • Size of organization • Company conditions • Compensation at similar companies • Educational requirements • Work history • Knowledge • Time and effort • Industry • Location • Company characteristics – • Size, profitability, rank amongst competitors, etc. Factors to Consider

10. Salary • Bonus • Benefits (retirement, profit sharing, etc.) • Stock options or other deferred compensation • Does the compensation represent the duties performed or ownership status (return on investment)? • Relevance and reliability (i.e. number of respondents, standard deviation of results, etc.) Understand the Data

11. Bureau of Labor Statistics • Salary information by industry www.bls.gov/OES/ • Employment cost trends by industry www.bls.gov/ect/home.htm • A “price index” for employers’ costs • General pricing information http://stats.bls.gov/ • National and regional pricing information Sources to Consider for Benchmarking

12. Risk Management Association www.estatementstudies.org • Requires username and password • Shows compensation as a percentage of sales Sources to Consider - cont.

13. Robert Half International www.rhi.com • Staffing and Consulting firm • Offers salary guides intended for prospective job seekers • Marketing • Legal • Finance • Information Technology Sources to Consider - cont.

14. Salary.com www.salary.com • Salary data by zip code • Free, but limited data Sources to Consider - cont.

15. # 1 Source • INDUSTRY SURVEY DATA AND/OR PUBLICATIONS Sources to Consider - cont.

16. Sources for healthcare compensation and benchmarking • Medical Group Management Association • Cost Survey for Single Specialty/Multispecialty Practices • Physician Compensation and Production Survey • Management Compensation Survey • Academic Practice Compensation and Production Survey for Faculty and Management • The Healthcare Group, Staff Salary Survey • Hospital & Healthcare Compensation Service, Physician Salary Survey Report • LocumTenens www.locumtenens.com • State Medical Group Management Associations • IMGMA • KMGMA Back to our Case Study – Hem/Onc

17. Overwhelming majority of healthcare entities rely on MGMA survey data • Detailed, comprehensive, high number of respondents, several presentations of data, etc. Compensation Adjustment - cont.

18. Nuances of physician compensation adjustment • Physician buy-in/buy-out • Hospital employed physician Compensation Adjustment - cont.

19. According to Alex Fritz: • “It may be necessary to consider the source(s) of a company’s revenue and determine the effect economic, regulatory, competitive changes, etc. in the market might have on the stability of the historical revenue stream.”1 • 1 Alex Fritz Adjustment #2 – Revenue

20. Loss of contracts from existing clients and/or gain of new contracts from existing and/or new clients • Review of existing contract terms for price increases, inflationary adjustments, term, etc. • Entrance/exit of customer base/clients from the market (e.g. factory closing) Factors to Consider

21. Sources of revenue (i.e. reimbursement from managed care providers and governmental payors (Medicare/Medicaid)) is CRITICAL to cash flow and financial viability of a physician practice • Analyze payor mix: • Evaluate Medicare reimbursement impact on existing procedure volumes • Factor Medicare reimbursement impact into projected revenue stream Back to our Case Study – Hem/Onc

22. Results of analysis Case Study - cont. • For the same level of effort in 2009 Hem/Onc will recognize -3.4% growth in reimbursement from Medicare

23. According to Jim Hitchner: • “The buyer of Target Company obtained an assembled and trained workforce. Considerable expenditures for recruiting, selecting, and training would be required to replace these employees with individuals of comparable skills and expertise. The value of the assembled workforce is represented by the assemblage cost avoided.”1 • 1 Financial Valuation: Applications and Models, p 784 Adjustment #3 – Workforce in Place

24. FAS 141 – In-place workforce - Not a separately identifiable intangible asset for asset allocation purposes and considered to be a component of goodwill and separately identifiable for purposes of calculating contributory asset charges • Cost/asset approach methodology • Inputs into calculation of In-place workforce • Base salary per employee • Fringe benefits • Payroll taxes • Estimated recruiting and training costs • Starting efficiency • Time to full productivity Factors to Consider

25. Back to our Case Study - Calculation of Value A B C D • A = Base salary per employee x benefit factor (e.g. 25% - 30%) • B = Cost to recruit and train (based on actual market data and/or company data, can vary on position) (Average base salary x 20%) • C = ((Time to full productivity / 12) x Estimated total compensation package) x ((1 – starting efficiency)/2) OR ((3/12) x $63,149) x ((1 - .75)/2) • D = B + C

26. Calculation of Value – cont.

27. According to Jim Hitchner: • “Excess working capital can be identified by comparing the working capital ratio of the subject to those of the guideline companies by comparisons to industry norms.”1 • “The application of most commonly accepted income approach methodologies results in a valuation of the company’s operating assets, both tangible and intangible. Therefore, it is often necessary to remove all non-operating items from the company’s balance sheet and income statement.”1 • According to Shannon Pratt, Robert Reilly, & Robert Schweihs: • “The theory of valuing non-operating assets separately from operating assets rests on the assumption that the non-operating assets could be liquidated without impairing operations.”2 • 1 Financial Valuation: Applications and Models, p 91-92, 213 • 2 Valuing a Business: The Analysis and Appraisal of Closely Held Companies Adjustment #4 – Working Capital & Non-Operating Excess Assets

28. What to include in working capital? • Uses of working capital adjustments • Calculation of incremental working capital requirements • Use to calculated non-operating excess assets • Non-operating assets to consider • Investments in unrelated companies • Unsold but replaced plant facilities • Excess cash and/or working capital • Control or minority interest valuation? Factors to Consider

29. What’s included in working capital • RMA = Current Assets – Current Liabilities • Line of credit, current portion of LTD, Notes Payable? Understand the data

30. Risk Management Association www.estatementstudies.org • Recommended for use as GENERAL GUIDELINES • Data not random • Categorized by primary product only • Small samples • Extreme statements • Operational differences Sources to Consider for Benchmarking

31. IRS Corporate Ratios • Source of data = Corporation Source Book • The Corporation Source Book presents balance sheet, income statement, tax, and other selected items by size of total assets for all returns with and without net income. Statistical tables are available by industrial sectors, major groups within a sector, and minor industries within a major group. Industry detail is based on the North American Industry Classification System (NAICS). The Source Book, which underlies the Statistics of Income-Corporation Income Tax Returns publication, (i.e., the Complete Report), is part of an annual series. • Older data Sources to Consider - cont.

32. IRS Corporate Ratios Sources to Consider - cont.

33. Corporation Source Book http://www.irs.gov/taxstats/article/0,,id=167138,00.html#health Sources to Consider - cont.

34. Corporation Source Book http://www.irs.gov/taxstats/article/0,,id=167138,00.html#health Sources to Consider - cont.

35. First Research www.firstresearch.com • Requires username and password • Costly (~$3,500 per year) Sources to Consider - cont.

36. First Research www.firstresearch.com • Dunn & Bradstreet Subsidiary • Source of data = www.fintel.us/firstresearch • Our data is drawn from the Kauffman Financial Statement Database as well as from other sources that we can not reveal in accordance with our license agreements. Sources to Consider - cont.

37. Working capital adjustment applied Back to our Case Study – Hem/Onc

38. Calculation of Non-Operating Excess Assets Case Study – cont.

39. According to Jim Hitchner: • “When valuing a minority interest, it is often appropriate to use the actual capital structure of the enterprise for the weighting of the WACC components because a minority owner is not able to bring about any changes in the company’s capital structure.”1 • According to Shannon Pratt, Robert Reilly, & Robert Schweihs: • “If the company is to be valued as it is (under the strict fair market value standard, assuming the capital structure will remain intact), then the amount of debt in the company’s actual capital structure should be used. Certainly, if a minority ownership interest is to be valued… the company’s actual amount of debt in its capital structure would seem appropriate.”2 • 1 Financial Valuation: Applications and Models, p158. • 2 Valuing a Business: The Analysis and Appraisal of Closely Held Companies, pp. 185 Adjustment #5 – WACC

40. Control vs. minority interest • Actual vs. industry capital structure • Cost of debt (actual vs. industry) • Definition of debt • Line of credit • Notes payable • Current portion of LTD • Interest bearing? Factors to Consider

41. Risk Management Association Sources to Consider for Benchmarking

42. Risk Management Association Sources to Consider – cont.

43. IRS Corporate Ratios Sources to Consider - cont.

44. First Research www.firstresearch.com Sources to Consider - cont.

45. Guideline public companies • KeyValueData www.keyvaluedata.com • Morningstar www.morningstar.com • Edgar Sources to Consider - cont.

46. Guideline Public Companies Considered • Health Net (HNT) • Integrated managed-care organization that delivers managed healthcare services through health plans and government-sponsored, managed-care plans. The company operates within two segments: Health Plan Services and Government Contracts. Back to our Case Study – Hem/Onc

47. Health Net (HNT) Back to our Case Study – Hem/Onc

48. IntegraMed America, Inc. (INMD) • IntegraMed America, Inc., incorporated in June 4, 1985, is a specialty healthcare services company offering products and services to patients and providers in the fertility and vein segments of the healthcare industry. Guideline Public Companies - cont.

49. LCA-Vision, Inc (LCAV) • LCA-Vision Inc. is a provider of fixed-site laser vision correction services at its LasikPlus vision centers. The company’s vision centers provide the staff, facilities, equipment and support services for performing laser vision correction procedures that employ laser technologies to help correct nearsightedness, farsightedness and astigmatism. Independent, board certified ophthalmologists and credentialed optometrists, as well as other healthcare professionals, support the operation of its vision centers. Guideline Companies - cont.

50. Mednax, Inc. (MD) (Formerly Pediatrix Medical Group, Inc.) • Mednax, Inc., formerly Pediatrix Medical Group, Inc. (Pediatrix), incorporated in 1979, is a provider of physician services, including newborn, maternal-fetal, pediatric subspecialty, and anesthesia care. During the year ended December 31, 2008, the company's network was composed of approximately 1,274 affiliated physicians, including 844 neonatal physician specialists who provide clinical care in 32 states and Puerto Rico, primarily within hospital-based neonatal intensive care units (NICUs), to babies born prematurely or with medical complications.   Guideline Companies - cont.