LabCorp Struggling To Regain Financial, Operational Balance

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CEO SUMMARY: 1997 will be a “make or break” year for Laboratory Corporation of America. The company is challenged on many fronts. As LabCorp’s management focuses on internal issues, nimble laboratory competitors have an opportunity to capture additional market share.

STABILITY CONTINUES to elude Laboratory Corporation of America. Wracked by a variety of setbacks over the last 12 months, LabCorp is working feverishly to regain financial and operational balance.

On one hand, LabCorp must address financial issues to the satisfaction of its lenders. On the other hand, LabCorp must continue to revamp operations and deal with changes to the clinical laboratory marketplace.

A careful study of LabCorp’s situation reveals three basic problem areas which need resolution…

This creates a dichotomy for LabCorp within the competitive marketplace. At the regional level, LabCorp employees continue to service clients on a daily basis. Clients and laboratory competitors see few visible signs of problems.

But internally, LabCorp’s management team is preoccupied with solving the financial and operational problems now facing the company. This handicaps their ability to bring new services into the marketplace. It also means that senior executives are not giving business development the same daily priority as their competitors.

In the short term, there will be little perceptible change to LabCorp’s market position. However, over the next 18 to 24 months, visible market share losses may occur. Nichols Institute, during the last three years of its independent existence, underwent the parallel experience which LabCorp is enduring today. Nichols never did solve its business problems and was eventually sold to Quest Diagnostics Incorporated (formerly Corning/MetPath).

A careful study of LabCorp’s situation reveals three basic problem areas which need resolution: 1) capital, credit and net worth; 2) operational concerns; and 3) employee morale.

ISSUE NUMBER ONE
Capital, Credit & Net Worth

Since the merger between National Health Laboratories and Roche Biomedical Laboratories became effective in the spring of 1995, LabCorp’s financial position has steadily eroded.

One measure of that deterioration is stockholder equity. As of December 31, 1995, stockholder equity was $411 million. By December 31, 1996, it had shrunk to $257 million. Although most of this relates to the $189 million settlement with the federal government, during 1996 LabCorp experienced declining operating profit margins common to the laboratory industry.

LabCorp’s financial deterioration during the second half of 1996 caused its lenders to become concerned. Lender concern was heightened when it was recognized that LabCorp did not have the $189 million in cash to pay the federal settlement. LabCorp was forced to borrow the money from a subsidiary of Roche.

Pressing Problem

As a result, LabCorp’s most pressing problem is probably now with their lenders. Since violating debt covenants last summer, the company has signed at least six waivers with its creditors.

As of December 31, 1996, the company had $998 million in debt. It is now classified as “current” on LabCorp’s balance sheet, which means that it is expected to be repaid (or refinanced) within 12 months. LabCorp’s lenders are disquieted and it is easy to see why. Bankers are uncomfortable with the fact that only $258 million of net worth backs LabCorp’s $998 million debt!

LabCorp’s solution to their money woes is to raise $500 million by offering 10 million shares of convertible stock to the public. Since the company’s common stock now trades at $3.00 per share, LabCorp would dilute existing stockholders if it issued additional shares of common stock.

What is interesting about the $500 million offering is that Roche, LabCorp’s parent company, committed to purchase $250 million worth of shares. Because the proceeds will be used to retire the $189 million loan from the Roche subsidiary, Roche is basically paying themselves back.

However, Roche’s actions are seen by Wall Street investors as a sign that Roche will not allow LabCorp to fail. Stock analysts tell THE DARK REPORT that investors believe Roche will stand behind LabCorp with deep pockets.

It remains to be seen whether LabCorp’s $500 million stock offering is fully subscribed. If investors take all of the offering, it means that LabCorp’s executives will have kept the creditors away from their door for at least some period of time.

ISSUE NUMBER TWO
Operational Concerns

Like its two national competitors, LabCorp continues to pursue the economies of scale which they believe their national laboratory system provides them. This means consolidation, standardization and unification throughout the national system, regardless of regional needs or local marketplace preferences.

Many of these corporate initiatives have not gone smoothly. For example, during the first quarter of 1997, LabCorp had difficulty submitting reimbursement claims to Medicare. At one point it was rumored that 38% of the company’s Medicare claims were denied at first submission.

This created havoc with LabCorp’s “days sales outstanding” ratio, reported to have risen to as much as 120 days. It directly affected LabCorp’s cash flow at a time when every dollar was needed.

The company attempted to centralize billing from all regions into one location. When the project failed to deliver satisfactory results, billing was returned to the regions. Experienced laboratory executives know that billing problems are a major source of lost clients. Because it takes several months for lost client patterns to appear, it will be interesting to watch LabCorp’s financials for first and second quarter 1997 to see if the company experienced significant client turnover.

At the regional level, competing laboratories report a variety of operational or strategic difficulties by the LabCorp divisions in their area. These are understood to be the result of regular waves of staffing cutbacks and the closure of satellite laboratories. Pullbacks of local resources which affect client service, such as stat labs and phlebotomy stations, also have a negative impact on client service levels.

With senior management in Burlington preoccupied with financial problems, it means that operational issues are not receiving the same degree of attention as would be true in a normal operating environment.

ISSUE NUMBER THREE
Employee Morale

LabCorp, along with Quest and SmithKline Beecham Clinical Laboratories, has been implementing different waves of staff cutbacks during the last two years. This has a major impact on employee morale. It is particularly damaging because surviving employees are uncertain whether or not they may be laid off whenever future staff cutbacks occur.

LabCorp was also forced to take another difficult step last summer. After reporting a loss for second quarter 1996, the company implemented a six-month deferral on wage rate increases. Traditionally, such a maneuver devastates employee morale and loyalty.

Adding to employee uncertainty is the regular departure of senior executives since the merger. As Roche executives prevailed in the game of corporate politics, many executives from National Health Labs either resigned or were cut loose. Not only has this engendered bad feelings among employees loyal to the departed managers, but it creates turmoil while new managers transition into their responsibilities.

LabCorp’s employee morale is a major problem because it prevents the company from attaining high levels of quality and service. Until the financial situation is resolved, morale will probably not improve.

These three serious problems within LabCorp must be resolved before the company can regain financial health and restore operational stability. Thomas Mac Mahon, LabCorp’s new President and CEO, faces a daunting task to turn things around.

Interesting Fact:
Why Hospital Alliances Are A Slow-Growth Strategy

LabCorp, like Quest and SmithKline, made hospital alliances and joint ventures a major corporate priority. As a result, hospital laboratory administrators receive a continual stream of sales calls from marketing reps of the three national labs.

But how successful have these laboratories been after three years of concentrated effort? LabCorp’s financial documents provide a revealing look at the results:

“One of the Company’s primary growth strategies is to develop an increasing number of hospital alliances… In 1996, the Company added 6 alliance agreements with hospitals, physician groups and other care provider organizations representing approximately $20 million of annual sales which increased the total number of alliances to 20 from 14 in 1995.”

This is a revealing statement. LabCorp, with $1.6 billion in annual revenues, added 6 hospital laboratory alliances representing $20 million, and only has a total of 20 active alliances. For 1996, the average new alliance generated $3.34 million in revenue to LabCorp.

With 20 alliances outstanding, that projects to be about $67 million, or 4.2% of LabCorp’s $1.6 billion in sales. LabCorp’s experience is not dissimilar to that of Quest and SmithKline. It means that after three years of intense, and expensive, marketing, the three national labs have not gained much market share with hospital laboratory alliances.

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