Specialty Labs Struggles To Maintain Operations

Troubled company has new executive team that must fix regulatory and business problems

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CEO SUMMARY: In April, Specialty Laboratories, Inc. disclosed that state and federal regulators had placed sanctions on the esoteric testing company, including revocation of its CLIA-88 license, subject to legal appeal. One main source of concern is the fact that, over the past 10 weeks, a sizeable number of Specialty Labs’ customers have begun redirecting specimens to other reference and esoteric laboratories.

IT’S BEEN TOUGH TIMES at Specialty Laboratories, Inc. since the April 15 announcement that state and federal lab regulators issued multiple sanctions because of deficiencies in the lab’s operation.

It’s a laboratory management crises without precedent. On one hand, Specialty Laboratories faces revocation of its CLIA-88 license, subject to a legal appeal which is pending. Thus, considerable management resources must be directed to developing a POC (plan of correction) that is acceptable to the California Department of Health Services (DHS) and Centers for Medicare and Medicaid (CMS).

On the other hand, Specialty Labs must deal with a steady and significant decline in the daily volume of specimens referred by its clients. Based on rumors and comments made by departing employees, the decline in specimen volume has been significant since April 15. Calls to Specialty Labs on this subject were not returned.

If these estimates are accurate, the precipitous decline in specimen volume means an equally significant reduction in revenues. To maintain financial viability, Specialty Labs must swiftly prune back expenses. But cost reduction efforts also require significant management resources.

Thus, Specialty Laboratories is literally in the jaws of a vice. The squeeze on one side involves a plan to return to regulatory compliance. The squeeze on the other side is the urgency to slash expenses so they stay in line with declining revenues.

What makes this doubly challenging is the turnover in Specialty Labs’ executive ranks. On June 7, President and COO Paul Beyer resigned. He will keep his director’s position on the board and the position of COO will be eliminated. About this same time, several more senior executives also left the company’s employ.

Medical Director’s Role

The new corporate medical director is Douglas S. Harrington, M.D., who also holds the position of Chairman and CEO. (See TDR, May 13, 2002.) He was elected by the board following the resignation of founder James X. Peters, M.D., Ph.D. on April 22, 2002.

As noted in earlier issues of THE DARK REPORT, Dr. Harrington has unique experience with laboratory regulators. While with Nichols Institute during the 1988-91 period, he developed a POC to address identified areas of non-compliance and successfully guided implementation of the POC. As corporate Medical Director of Specialty Laboratories, it is hoped that his goodwill and experience with lab regulators will help speed a return to compliance.

Daunting Challenges

By any business standard, Specialty Laboratories is a company in crisis. The list of challenges reveals the seriousness of this crisis.

First, it faces revocation of its CLIA-88 operating license. It must devote full attention to curing deficiencies and restoring the confidence of lab regulators so that this sanction, as well as the others, are removed.

Second, as the daily volume of specimens declines, Specialty Labs must slash expenses. In its own right, this is a stressful, complex management task and requires the full attention of management—even though management must also address regulatory issues.

Third, a substantial number of managers who have valuable knowledge and experience are now gone. New managers face the daunting task of learning about the company, its operations, and its customers—while simultaneously fixing all the problems.

Fourth, the magnitude of the decline in daily specimen volume means that Specialty Laboratories will not have the cash flow necessary to pay for all the corrective actions it must take. It must be assumed that the company is now in a negative cash flow situation that creates additional pressure.

In addressing this situation, Specialty announced on June 18 that it would lay off 10% of its workforce. It has also trimmed the number of tests it performs and is referring some specimens to other labs. This is one source of the decline in daily specimen volume.

A Test Of Customer Loyalty

Five, time now works against the company. Each day brings a further unraveling of its existing customer relationships. The primary value of a laboratory is its customer base, not the physical laboratory, instruments, and employees. Thus, the longer it takes Specialty to effect a solution to its current situation, the less value the company will have—either to its shareholders or to prospective buyers.

What are the options for Specialty Laboratories? Reaction of its customers to the unwelcome news of regulatory sanctions was swift. The immediate financial impact of their defection must be coupled with the fact that, over the long term, it will take years and lots of money for Specialty Labs to rebuild its client base.

In fact, the swift decline in specimen volumes may actually be causing potential merger partners or acquirers to stand aside. On one hand, competitors are gaining Specialty’s clients without having to buy them. On the other hand, likely buyers probably consider it smart to allow events to run their course. They can then make an acquisition offer to a diminished Specialty Labs. Alternatively, were Specialty to seek protection by filing Chapter 11 bankruptcy, buyers could then bid for the troubled company at that time, following a process supervised by the court.

Loss of Reputation Triggers “Crisis of Confidence” With Huge Consequences for All Laboratories

SPECIALTY LABORATORY’S WOES provide a chilling reminder that should not be ignored by lab executives and pathologists.

Any clinical laboratory is only as good as its reputation with the public. If events cause the public to lose faith in a laboratory, the ensuing reaction can severely and swiftly damage the financial stability of the laboratory and possibly even lead to its demise.

This is certainly one possible consequence now facing Specialty Laboratories since it became public knowledge on April 15 that both state and federal lab regulators had issued multiple sanctions against the lab company, located in Santa Monica, California.

Based on what facts were disclosed, many customers of Specialty Labs have voiced a host of concerns. These include questions about the way the company has performed lab tests, whether certain specific sanctions raise compliance issues that affect laboratory customers referring tests to Specialty Labs, and even about whether the company will be able to survive financially.

Not surprisingly, these concerns have led many lab administrators and pathologists to begin directing referral testing to other sources. They are taking their business elsewhere until problems within Specialty Laboratories are resolved.

Another example of how quickly the public can become alarmed about a laboratory’s problems was in April 1999. SmithKline Beecham Clinical Laboratories (SBCL) caused a national sensation when it admitted that a phlebotomist it employed in its Palo Alto, California patient service center (PSC) had reused butterfly needles when drawing blood from patients. (See TDR, April 26, 1999.)

To allay public concerns, SBCL and the California Department of Health Services notified as many as 15,000 people that they should come in for blood testing because they had visited a PSC during time periods when this phlebotomist was known to be on duty.

The story was given wide play nationally. Daily newspaper and television stories ran for weeks in the San Francisco Bay area, keeping SmithKline Beecham’s name in the headlines. A number of lawsuits were filed and some may still be winding their way through the courts.

In the case of SmithKline Beecham Clinical Labs, it was recognized that the actions of this one phlebotomist were a “rogue event” and the company’s business in San Francisco did not suffer greatly.

In the case of Specialty Laboratories, the story is still unfolding. As its customers redirect specimens to competing labs, it remains to be seen whether Specialty Labs will have the financial staying power to successfully deal with this crises and remain an independent laboratory company.

However, both these examples reinforce two important points. First, any clinical laboratory is only as good as its reputation. Second, that reputation can evaporate instantly.

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