Westcliff Labs Announces BK and Sale to LabCorp

Chapter 11 bankruptcy reveals huge losses at what was once a profitable independent lab

CEO SUMMARY: Subject to court approval, Laboratory Corporation of America is poised to acquire the assets of California-based Westcliff Medical Laboratories, Inc., which just filed a Chapter 11 bankruptcy action in federal court on May 19. In a separate transaction, LabCorp has an agreement to acquire Diamond Reference Laboratory of Diamond Bar, California. The two acquisitions will build LabCorp’s share of the market for laboratory testing in California.

IT IS LIKELY THAT THE CONCLUDING CHAPTER for Westcliff Medical Laboratories, Inc., as an independent laboratory company is playing out in California. On May 19, Westcliff filed Chapter 11 bankruptcy and announced an agreement to be acquired by Laboratory Corporation of America.

It is an ignominious end to the third largest laboratory company serving physicians’ offices in California. Its current owners failed to find a way to operate the company in a profitable manner, despite Westcliff ’s strong multi-year financial performance prior to its purchase by a private equity group in 2006.

Westcliff Medical Laboratories and its parent BioLabs, Inc., filed a Chapter 11 bankruptcy petition on Wednesday, May 19. For the years 2008 and 2009, Westcliff reported eye-popping losses. In its bankruptcy petition, Westcliff said 2008 expenses and write offs totaled $171 million against total revenue of $83 million. This produced an $87 million loss for 2008.

That pattern continued in 2009. Westcliff stated that expenses and write offs totaled $110 million for the year. When posted against revenue of $97 million, the total loss was $13 million in 2009.

Thus, over the 24 months of 2008 and 2009, Westcliff generated $180 million in cumulative revenue. Against that, it incurred expenses and write offs for a cumulative total of $281 million!

Since 2009, Westcliff Medical Laboratory has shopped itself to potential buyers. As early as last fall, LabCorp was identified as willing to pay the strongest price for Westcliff. In its bankruptcy filing,
Westcliff stated that it has entered into an asset purchase agreement (APA) with LabCorp.

To acquire Westcliff, LabCorp will pay $57.5 million for designated assets. Westcliff is keeping its accounts payable, which it believes will generate $8 million for the debtor estate in the bankruptcy.

Other Bidders For Westcliff

An upcoming step in the Chapter 11 bankruptcy action is for the court to solicit other bids for Westcliff Medical Laboratories. Westcliff stated that a successful overbid must exceed the $57.5 sales price negotiated with LabCorp by a minimum of $2.95 million. Were another bidder to step up and pay more for Westcliff, LabCorp is entitled to a $2.25 million break-up fee. LabCorp has already put $4 million of the purchase price on deposit.

Westcliff Medical Laboratories’ senior secured debt totals as much as $56 million and GE Business Financial Services, Inc., acts as the agent for the lenders. Westcliff stated that it has not been able to service this debt since early in 2009. Insiders say that GE has funneled between $10 million and $14 million of cash into Westcliff during 2009 and 2010 year-to-date to keep the laboratory afloat.

Debtors In Possession

Sometime in 2009, the holders of the senior debt became “debtors in possession” of Westcliff Medical Laboratories. These debt holders have placed at least two Chief Restructuring Officers (CROs) at Westcliff to represent their interests. On April 1, 2010, Matthew Pakkala become the current CRO. Pakkala is a Managing Director of FTI Consulting, Inc., a company with headquarters in Baltimore, Maryland, and an office in Los Angeles, California.

One major roadblock that prevented an earlier sale of Westcliff Medical Laboratories by its current owners is the ongoing qui tam lawsuit against Westcliff and six other California laboratory companies involving claims that the laboratories systematically overcharged the Medi-Cal program (California’s Medicaid program) by failing to offer Medi-Cal the lowest price for lab tests that they offer to physicians and other providers.

It was in April, 2009, when Attorney General Edmund G. Brown announced that California had joined this whistle-blower lawsuit. The state is seeking to recover hundreds of millions of dollars in alleged overcharges. (See TDR, April 6, 2009.) However, Westcliff stated in its bankruptcy documents that it has settled this lawsuit with the State of California. It said that an agreement had been signed on May 13, 2010—less than a week before the bankruptcy filing—that resolves these claims against it.

Medi-Cal Fraud Allegations

Westcliff described the allegations as follows: “By way of the Qui Tam Action, Plaintiffs and California asserted that, Westcliff submitted false claims for payment to Medi-Cal because Westcliff (1) charged Medi-Cal more for laboratory tests than Westcliff charged to other cus- tomers for the same laboratory tests, and (2) improperly offered discounts to other customers to induce them to refer more Medi-Cal business to Westcliff. Westcliff faces billions of dollars in potential liability in the Qui Tam Action.”

At issue were 1,321,436 Medi-Cal claims submitted by Westcliff between November 1995 and December 31, 2008. As calculated by the Attorney General, this represented a claim of $56 million before any additional civil fines or penalties.

Because a civil penalty of between $5,000 and $10,000 for each alleged false claim could be assessed upon successful legal action, Westcliff acknowledged it faced additional fines that could reach between $6 billion and $12 billion. Until it could resolve this lawsuit, no buyer wanted to acquire Westcliff and assume this potential liability.

According to Westcliff, it will be released from the qui tam claims in return for putting $400,000 into an interest-bearing trust account to the benefit of California, the whistleblower, and the debtors. It will then pay 10% of the net proceeds from the sale of Westcliff ’s assets.

By completing the settlement agreement with the State of California on May 13 to resolve those liabilities, Westcliff Medical Laboratories removed one major hurdle to its sale. Westcliff ’s Chapter 11 bankruptcy filing, which took place six days later, was the required next step before its proposed acquisition by LabCorp can take place.

Swift Resolution Sought

Assuming that no other buyer steps forward and outbids LabCorp for the assets of Westcliff Medical Laboratories, Westcliff ’s existing owners are pressing the bankruptcy court for a swift resolution. LabCorp may take ownership of Westcliff ’s assets in as little as 30 days.

In a separate transaction, it has become known that LabCorp has also acquired Diamond Reference Laboratories of Diamond Bar, California. It is estimated that Diamond handles approximately 1,200 patient requisitions per day. By contrast, Westcliff handles 8,500 clinical laboratory requisitions daily.

Collectively, both acquisitions boost LabCorp’s share of the clinical lab testing market in California. In fact, Westcliff told the bankruptcy court that it estimates the market for laboratory testing in California to be approximately $2 billion annually. With its almost $100 million in revenue per year, Westcliff estimates that it holds a 5% market share of lab testing in the state.

Already, pathologists and lab executives in California are speculating as to how LabCorp may consolidate testing across Southern California as it absorbs and integrates these two clinical laboratory acquisitions.

LabCorp’s major testing facility is in San Diego. It has a smaller laboratory in Torrance, California, that was part of an acquisition early last decade. There is also the US Labs’ facility in Irvine, California. It is known that this facility’s lease will soon run out.

Lab Consolidation Options

Just down the road from the US Labs facility is the recently opened, 80,000 square foot laboratory operated by Westcliff. This gives LabCorp some interesting options as it takes ownership of Westcliff Medical Laboratories and Diamond Reference Laboratories and decides how to handle the space needs of its US Labs business unit.

It is also not known whether LabCorp will continue to use the Westcliff and Diamond names for any extended length of time following its acquisition of both laboratory companies. Clients of acquired laboratories are most prone to switch their business to competing laboratories in the months immediately following a laborator y acquisition. For that reason, in recent years, each of the two Blood Brothers have been more deliberate in their integration and consolidation of newly-acquired lab companies.

WestCliff As A Case Study

It may also turn out that the rapid financial decline of Westcliff Medical Laboratories between the years 2006 and 2010 becomes a classic business case study for the entire laboratory industry. Prior to its acquisition in 2006, Westcliff had a recognized, multi-year track record of sustained financial performance.

The period of 2006 and 2007 saw the new owners consolidate the operations of Westcliff with Health Line Clinical Laboratories. Then a new management team pursued different strategies in 2008 and 2009 that failed to produce profits at Westcliff.

Westcliff’s Path to Chapter 11 Bankruptcy

IT WAS JUNE, 2006 WHEN BIOLABS, INC., was created as a partnership between Parthenon Capital Holdings; Douglas Harrington, M.D.; and Dan Angress. BioLabs then acquired Westcliff Medical Laboratories of Santa Ana, California, and Health Line Clinical Laboratories of Burbank, California. The two laboratory companies were consolidated into a new, purpose-built lab facility of 80,000 square feet in Santa Ana.

After the summer of 2007, Harrington left as CEO, followed a few months later by Angress. Westcliff’s owners assembled a new management team. Brian Urban, then Westcliff’s CFO, took over as CEO. In the following months, Kip Vernaglia came aboard in the role of Senior Vice President of Sales and Marketing and by year’s end Bob Whalen had become Chairman.

A timeline of significant events at BioLabs/Westcliff is presented on pages 9-13, along with information about the financial performance of the labortory company during the years 2006 through 2009. A string of disappointing financial results led BioLabs/Westcliff to file a Chapter 11 bankruptcy petition on May 19, 2010. Laboratory Corporation of America has entered into an agreement to acquire Westcliff’s assets, subject to approval by the bankruptcy court.

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