Specialty Labs Prepares For Public Stock Offering

National reference lab hopes to raise up to $86.3 million by selling its stock

CEO SUMMARY: Stock prices for public lab companies zoomed upwards through 2000. For this reason, executives at Specialty Laboratories, Inc. believe it is an auspicious time for their laboratory to bring an initial public offering (IPO) to market. Company officials recently filed a stock registration document with the SEC which provides new insights about the internal workings of this fast-growing laboratory.

SOON THERE WILL BE ANOTHER publicly-traded laboratory company. On September 12, 2000, Specialty Laboratories, Inc. filed to raise as much as $86.3 million through an initial public offering (IPO) of its common stock.

If successful, Specialty Labs will not only become the first clinical testing laboratory company to go public since UroCor, Inc.’s IPO of 1995, but it will open the door for other private lab companies to do their own IPOs. (See pages 6-7).

Based in Santa Monica, California, Specialty Laboratories has high name recognition within the laboratory industry. It’s a leading source of esoteric and reference testing to hospitals and other commercial laboratories throughout the United States. In filing its S-1 registration papers with the Securities and Exchange Commission (SEC), Specialty Labs provides new details about its management strategies and business operations. It also opens a new window on undisclosed aspects of the market for esoteric and reference testing.

Of all the clinical lab testing segments, probably the least is known about the market niche for esoteric and reference testing. The reason is simple. This market is served by: 1) private lab companies which do not disclose their financial and operational performance; and 2) divisions of public lab companies, where the esoteric/reference testing business operations are not dis- closed in much detail.

Examples of the first category are companies such as Specialty Labs, Mayo Medical Laboratories, ARUP Laboratories, and American Medical Laboratories. Examples of the second category are Quest Diagnostics Incorporated (including Nichols Institute) and Laboratory Corporation of America.

Founded In 1975

Originally incorporated in 1975 as Clinical Immunologies, Inc., Specialty Labs took its current name in 1985. It is a company which closely reflects the vision of its founder, CEO and Chairman of the Board, James B. Peter, M.D., Ph.D.

Most laboratorians know that Specialty Laboratories created a unique business niche in the lab industry. It originally offered high-quality esoteric and reference assays with an added twist. Unlike most existing sources of esoteric testing at the time, Specialty ran these esoteric tests several times per week.

When esoteric tests were referred to Specialty Labs, it offered faster turnaround times. Since information is the added-value of the lab world, Specialty, as the new kid on the block, gained a competitive sales edge.

This business strategy paid off. By the mid-1990s, virtually every laboratory of any size was referring at least some esoteric or reference specimens to Specialty Labs. This included the three blood brothers. Specialty had a secure national reputation at that time.

Story Gets Interesting

But here is where the story gets interesting. In 1996, Specialty Labs expanded its sales force and offered to become a primary provider of reference and esoteric testing to hospital laboratories. By the end of 1996, Specialty was the primary send-out lab provider for 67 hospitals.

Buoyed by this success, Specialty Labs decided it would become a full-blown competitor to the existing national reference labs, including ARUP, Mayo, Corning Clinical Labs (now Quest/Nichols), SmithKline Beecham Clinical Laboratories (SBCL), and LabCorp.

Hospital lab send outs became a full- scale sales and marketing effort at the growing company. In 1997, Specialty had 33 sales people. Hospital customers generated 32.5% of its revenues. By June 2000, Specialty had 60 sales people in the field. In public filings, Specialty claims it has 2,100 hospital clients, of which it is the primary provider of esoteric testing for 300 hospitals. Hospital revenues now account for over 50% of Specialty’s net revenues.

Strong Revenue Growth

During the past few years, Specialty has enjoyed strong revenue growth. From a revenue base of $39 million in 1995, Specialty is on track to exceed $148 million in revenues for 2000.

For clients and readers of THE DARK REPORT, Specialty Labs’ public filings provide a fascinating peek into the management strategies of a lab familiar to many, but understood by few.

First, Specialty believes that its expertise in diagnostic assay research and development differentiates it from its lab competitors.

Second, Specialty is investing heavily in laboratory information products and services. It sees an added-value advantage in being first to market with sophisticated lab information capabilities.

Third, Specialty is automating its laboratory testing processes to reduce costs while improving productivity and accuracy.

Fourth, Specialty Labs is emphasizing a well-funded and aggressively managed sales and marketing program.

The strategy of being first with cutting-edge diagnostic assays is the linchpin supporting Specialty Labs’ other business strategies. The company is feeding a steady stream of new esoteric assays into the marketplace. During the past five years, its R&D group has developed about 600 new diagnostic assays.

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Branded Esoteric Assays

More importantly, for the first six months of 2000, about 43% of Specialty Labs’ revenues came from its branded esoteric assays! This means that, unlike other national reference labs, Specialty Laboratories is creating a substantial added-value business based on its particular “brand” of esoteric assay.

These branded esoteric assays also support Specialty Labs’ second business strategy—offering customers enhanced lab information services. Among national reference labs, Specialty has been in the forefront of offering ASP-based, Internet-enabled lab information products.

Its DataPassportMD™ product is now used by 1,200 of its customers. Specialty’s success in efforts to elec- tronically connect with its clients is demonstrated by an interesting fact: 85% of the transactions between Specialty Labs and its customers are electronic; 50% of the transactions are Internet-based.

This “automation” of a traditionally paper-based system for ordering and reporting tests also supports Specialty Labs’ third strategy: automation of pre-analytical, analytical, and post-analytical work flow processes.

In this regard, Specialty Labs has a unique problem. It must handle specimens involving 3,500 different esoteric assays and another 300 common routine reference assays.

Self-Engineered Solutions

To automate specific lab testing work processes, Specialty is self-engineering its own automation solutions. It’s using automation software and equipment developed for manufacturing and industrial applications.

The first automation project went live this summer. Specialty calls it “Total Accessioning Re-organization system” (TARO™). It automates certain aspects of pre-analytical and post-analytical specimen management. Next in the works is an automated solution for high-throughput, precise alliquotting. It is expected to become operational in 2001.

It takes a productive sales program to feed the increased volume of specimens needed to support these other strategies. Most hospital lab administrators will acknowledge that Specialty Labs has a well-organized sales force constantly calling on hospitals throughout the United States.

Professional Sales Force

It is this sales force which is feeding the sustained growth in specimen volume and revenues at Specialty Labs over the past five years. Specialty’s experience is additional proof that professional sales and marketing in the lab industry can deliver profitable results.

Specialty Laboratories is about to initiate another strategic management program that can have positive impact on its operations and customer service levels. Beginning in 2001, Specialty Labs intends to pursue ISO-9000 certification. When Specialty accomplishes this goal, it will join Quest Diagnostics as the only other laboratory company in the United States to have ISO-9000 certification.

It should be expected that, if Specialty Laboratories successfully completes its IPO, the resulting war chest of $86.3 million will make Specialty Laboratories an even tougher competitor in the esoteric and reference testing marketplace.

With the filing of its stock registration, Specialty Laboratories now enters a quiet period. SEC “gun-jumping” rules preclude company officials from making statements which would be construed as promoting the company during the time prior to a public equity offering. Until the IPO is completed, company officials will decline to comment in lab industry publications at meetings.

“News Blackout” In Force

However, despite this “news blackout,” the company’s public filings have already provided interesting insights into the competitive battles going on between national reference labs in the esoteric and reference testing market niche.

THE DARK REPORT believes that competition for esoteric and reference testing will be one of the most hotly-contested segments of diagnostic laboratory testing during this decade. In fact, esoteric testing figured prominently in the strategic growth plans disclosed by public lab companies presenting at U S Bancorp Piper Jaffray’s “Diagnostics Services” conference in New York last week.

With the specter of increased competition for esoteric and reference testing looming, Specialty Laboratories’ IPO offering may turn out to be a shrewdly-timed strategic move.

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