California’s Lab Market To Undergo More Change

Rumors of potential acquisitions are a sign of continuing financial challenges in that state

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CEO SUMMARY: Every laboratory in California continues to operate in a financially-punishing environment. Further shake-outs must occur as the economic forces unleashed by managed care take their toll on clinical laboratories. Expect radical changes to occur within the next 12 months.

RUMORS OF A DEAL BETWEEN Laboratory Corporation of America and Unilab, Inc. have no substance, according to executives at both companies. Yet even the rumors themselves are evidence that difficult financial pressure confronts all laboratories operating in California.

If California’s advanced managed care marketplace is the model for managed care in other cities of the United States, then the future is grim. More financial pain awaits California laboratories as the sustained effects of rock-bottom reimbursement rates and excess laboratory capacity continue to deny laboratories in that state sufficient revenue to cover costs.

As reported by THE DARK REPORT during the past 24 months, at least four sizeable laboratories filed bankruptcy in California. Medical Sciences, Inc. (MSI) and Physicians Clinical Laboratories (PCL) filed Chapter 11 bankruptcy actions. Watson Medical Laboratories and Diversified Medical Laboratories were put into Chapter 7 bankruptcy, terminating operations and liquidating all assets.

At least one more laboratory already announced its intention to file a Chapter 11 bankruptcy. That is Meris Laboratories of San Jose. THE DARK REPORT predicts that another surprise bankruptcy may be filed in California during the next 12 months. Among smaller laboratories, expect to see some mergers, consolidations and bankruptcy actions during the same period as they struggle to remain in operation.

…during the past 24 months, at least four sizable laboratories filed bankruptcy in California.

The announcement by Meris of an impending Chapter 11 bankruptcy is surprising only because it took so long to occur. Observers say that the laboratory is bleeding significant red ink. Estimates are that the company requires a monthly cash infusion in excess of $500,000 to maintain operations. If true, this means that outside investors were willing to pump some $6 million per year into a laboratory operation which is doing less than $25 million in annual sales.

Another laboratory that might find itself in difficulty a second time is the former Physicians Clinical Laboratories in Sacramento. Once a public company with annual revenues of $110 million, PCL was forced into Chapter 11 bankruptcy in November, 1996.

At that time a white knight appeared in the form of J. Marvin Feigenbaum. Feigenbaum used a public company he controlled called Nu-Tech Bio Med, Inc. to acquire a 52.6% interest in PCL. As part of this transaction, Nu-Tech invested about $10 million of capital into PCL through the purchase of senior debt.

Meanwhile, Feigenbaum entered the bankruptcy proceedings of Medical Sciences, Inc. of Burbank and purchased this laboratory with the goal of merging it into PCL. The bankruptcy court discharged PCL’s Chapter 11 action on April 18, 1997. After downsizing PCL and folding in MSI, it is estimated that PCL’s revenues currently total less than $60 million annually. PCL now operates under the name Bio-Cypher Laboratories.

Negative Cash Flow

Those familiar with Bio-Cypher and its finances say that the laboratory is currently operating with a negative cash flow. They estimate that expenses could exceed revenue by as much as $1 million per month.

If true, Bio-Cypher faces a genuine dilemma. Unless current management can cut operating losses, find additional working capital or do both, they may find themselves forced to go to bankruptcy court for the second time in two years. Since the laboratory has already endured three years of extensive cost-cutting, options to squeeze out additional costs are limited.

Finding more working capital may prove to be impossible. Wall Street and lenders are still smarting from the financial damage they suffered as public laboratories hit financial bottom. Any capital extended to Bio-Cypher will come with a heavy price.

Regardless of whether Bio-Cypher finds itself in bankruptcy court a second time, it is clear that should Meris and Bio-Cypher fail to develop a positive cash flow, their financial problems may lead to further merger/acquisition activity among laboratories in California.

Laboratory Creditor Sells Debt At Profit

ONE KEY PLAYER has effectively exited the California laboratory scene. In the process, it is probably the only investor to make money on California laboratories in recent years.

Oak Tree Financial purchased a major portion of bank debt owed by Physicians Clinical Laboratories (PCL). Oak Tree sold a big chunk, at a profit, to Marvin Feigenbaum as part of PCL’s financial restructuring.

Oak Tree also purchased $23 million of Unilab’s outstanding debt in January of this year when the debt was discounted to 63.As Unilab restored its debt service capability, discounts on Unilab’s debt increased back into the 90’s. Oak Tree recently took the opportunity to sell that debt and book a healthy profit of almost $5 million for its ten-month investment.

During the time that Oak Tree held significant debt in both PCL and Unilab, it was recognized as having both the motive and the legal power to attempt a consolidation between Unilab and PCL, if ever both those companies defaulted on their debt convenants. After liquidating its holdings in Unilab, Oak Tree effectively removed itself from any future involvement in Unilab. However, because it still owns a considerable piece of PCL’s debt, it sits on the creditors committee and remains involved in PCL’s financial affairs.

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