Pathology, Inc. Sells Equity to Raise Capital

Pathology group accesses growth capital by selling shares to professional investors

CEO SUMMARY: In looking how to propel its business to the next level, the partners at Pathology, Inc., opted not to sell their pathology group practice. Instead, they chose to raise capital by selling equity in their company to a group of investors. In this exclusive interview, executives from Pathology, Inc., share their business strategy. Among the priorities are expansion of the sales and marketing program, possible acquisitions of other lab companies, and acquiring sophisticated information technology.

IS IT A COINCIDENCE THAT, in the space of a few weeks, two of the nation’s pathology supergroups raised substantial amounts of capital by selling a significant interest in their pathology groups to professional investors?

Alternatively, do these two transactions signal the leading edge of an emerging trend in the pathology profession? To learn more, THE DARK REPORT caught up with the executive team from Pathology Inc. of Torrance, California.

As reported on pages 13-14, Pathology, Inc., raised an undisclosed, but substantial, amount of capital by selling a majority interest in its pathology corporation to a consortium of investment companies that included ABS Capital Partners, England & Company, and Orix Venture Finance LLC. This agreement was signed in October.

Participating in the following interview were Alfred Lui, M.D., Chairman of the Board; Vicki DiFrancesco, Pathology Inc.’s new CEO and President; and a new board member, Mark Anderson, who is General Partner at ABS Capital.

EDITOR: Let’s begin this discussion with how Pathology, Inc., intends to use these funds? Does your business strategy include acquisitions of other anatomic pathology laboratories?

DIFRANCESCO: Yes. We intend to pursue acquisition opportunities that would support our business plan. Since we are still in the midst of evaluating all our business options, I can’t be more specific. We are looking at acquisition targets that include companies in diagnostics and in IT, as well as other pathology groups.

EDITOR: As a pathology company with strong roots in Southern California, do you have plans to expand into new regions across the country?

DIFRANCESCO: We definitely want to expand in the West and have already invested in additional sales and marketing personnel specifically to pursue the goal of expanding outside of California. Several different regions are under evaluation.

EDITOR: Vicki, you have a reputation for moving swiftly and aggressively to exploit sales and marketing opportunities. What has changed already with Pathology Inc.’s management team?

DIFRANCESCO: At the executive level, Rob Albert came aboard as our Executive Vice President, and COO. He was most recently with Laboratory Corporation of America and brings over 20 years of experience in operations, business development, and strategic planning. Another new member to the team is Ron Blum, Ph.D., who is Vice President of Marketing and Research & Development. Ron was with Specialty Laboratories for 11 years and most recently with Diagnocure and Exiqon Diagnostics. These individuals bring important management skills and experience to our company.

EDITOR: Any changes to the sales force?

DIFRANCESCO: Certainly. Previously, we had nine people in sales at Pathology, Inc., and within the next six months that number should increase to about 15 sales professionals. We have already added what I consider to be several “high-powered” sales professionals, including Michael Mosunic as the new Director of Sales.

EDITOR: Pathologists reading this interview will be interested in why the partner pathologists felt this was an auspicious time to restructure their lab company, accept money from professional investors, and put the pathology business into a faster growth mode. What are the key elements in your strategic thinking?

DIFRANCESCO: My answer may surprise some of your readers. We consider these developments to be a natural progression in the business development of Pathology Inc. in response to ongoing evolution in the marketplace. The company needed additional capital to invest in new technologies to stay at the leading edge of clinical practice.

EDITOR: What technology areas are priorities for you?

DIFRANCESCO: Ongoing advances in molecular and genetics testing require a state-of-the-art pathology company to make regular investments to acquire both the equipment and the skilled personnel to perform such assays. These services must be supported by sophisticated information technology and digital pathology capabilities.

LUI: I agree with Vicki and would like to comment on this point. One obvious trend in healthcare is to improve outcomes and be proactive in disease prevention and management of chronic conditions. Our partners at Pathology, Inc., recognized that we needed more resources if we were to continually compete successfully in these areas.

“Ongoing advances… require a state-of-the-art pathology company to make regular investments to acquire both the equipment and the skilled personnel to perform such assays.”

EDITOR: Is personalized medicine and companion diagnostics on Pathology, Inc.’s radar screen?

LUI: Without question. Pathology testing will expand rapidly in support of personalized medicine. Pathologists already see a steady expansion in the number of companion diagnostic tests that support specific therapeutic drugs. We will be investing to maintain our capabilities in these clinical areas.

EDITOR: Could you address what kind of spending is planned for information technology (IT) improvements and digital pathology systems?

DIFRANCESCO: Information technology is a cornerstone of the high service pathology laboratory and the recapitalization now gives us the resources to further develop what is already a robust IT capability. We want our use of advanced IT to be a source of competitive advantage in the marketplace.

EDITOR: Pathology, Inc., already has significant expertise in digital pathology. Do you plan to leverage this new funding to increase or change the way you use digital pathology technologies in your practice?

DIFRANCESCO: Currently, we have the ability to do digital consultations. We are preparing to launch a virtual imaging system in the near future. We want to be on the leading edge of digital pathology. Eric F. Glassy, M.D., a previous owner and current shareholder here at Pathology, Inc., sits on the advisory board of Aperio Technologies, Inc., of Vista, California. This keeps him plugged in to the newest digital pathology technologies.

EDITOR: I’d like to shift gears for a moment, and ask why investors were interested in Pathology, Inc.? Would you explain why ABS Capital Partners and the other equity partners made this investment at this time?

ANDERSON: At ABS Capital Partners, we are big believers in the lab market (both anatomic and clinical). Previously, we were investors in U.S. Labs and American Esoteric Laboratories, which were sold to LabCorp and Sonic Healthcare, respectively. We believe Pathology, Inc., has established a good platform. Vicki has put together an excellent management team, each with a proven track record of growing a company with a focus on customer service.

EDITOR: You are obviously optimistic about the prospects for laboratory testing.

ANDERSON: That is true. We believe the demand for laboratory testing will continue to increase in coming years. Moreover, the fact that lab tests influence between 60% to 70% of all medical decisions is one factor that makes labs an essential element within the healthcare delivery system.

EDITOR: Do demographics contribute to your confidence that investments in laboratory testing have solid potential?

ANDERSON: When you combine the essential role of laboratory testing to support accurate diagnosis with projected long-term demographic trends, including the aging of the population, then you can see that these two factors will have a direct effect on utilization. Couple these elements with the shift in healthcare’s emphasis on prevention and early detection of disease, and it makes for a very compelling opportunity. These trends are among the reasons we believe the laboratory market is quite attractive from an investment perspective.

EDITOR: With a major healthcare reform bill pending, do you believe that an emphasis on illness prevention and early detection of disease would boost the fortunes of laboratories?

ANDERSON: Predicting what Washington will do is best left to the experts. However, my view is that the lab industry would benefit from expanded coverage because of the emphasis on both wellness and preventative medicine. Further, I believe any lab that provides superior service and delivers a broad range of testing services will emerge as one of the leaders, regardless of what happens with healthcare reform.

EDITOR: As an investor, what do you consider the strengths of Pathology, Inc.?

ANDERSON: We think the company is particularly well positioned. One main objective of Pathology, Inc., is to be a leader in the women’s health market by providing superior service and rapid turnaround times. This builds upon the lab’s strong reputation in Southern California as a respected provider of integrated diagnostic services created by Dr. Lui and his colleagues. Looking at long-term growth opportunities, they include further penetration into the existing markets that we serve with current and newly developed tests, in addition to appraising strategic acquisitions.

EDITOR: Mark, as a professional investor, could you comment on what is happening with valuations of clinical labs and pathology groups in recent years?

ANDERSON: There has been an interesting change in how investors value a laboratory company. It was common for a laboratory valuation to be based on a multiple of revenue. That is less true today. Now investors want to look at the lab’s EBITDA (earnings before interest, taxes, depreciation, and amortization) and base the value on a multiple of the company’s EBITDA.

“Investors tend to use a higher multiple when valuing labs and pathology groups that
demonstrate sustained growth and profits.”

EDITOR: Is there a reason for this change?

ANDERSON: This shift occurred in part because of the recent market correction. Laboratories are like a lot of other businesses in that profitability and cash flow are key indicators of the health of a company. EBITDA can often be a more accurate indicator of a company’s valuation than revenue.

EDITOR: What helps a laboratory earn a higher valuation?

ANDERSON: Lab companies that show a multi-year track record of strong growth and EBITDA margins are generally rewarded with a premium valuation.

EDITOR: What multiple of EBITDA can be expected by a lab seller?

ANDERSON: Historically, EBITDA multiples have been in the single-digit range. Investors tend to use a higher multiple when valuing labs and pathology groups that demonstrate sustained growth and profits.

EDITOR: Staying on the theme of valuation and lab mergers and acquisitions, it was known that your group had discussions with interested buyers. With other pathology groups around the country considering their different business options, would you tell us why Pathology, Inc., chose this vehicle for accessing capital?

LUI: In part, the timing of this transaction is related to the career planning of several of the previous major shareholders. Some of the previous partners recognized that their retirement was not far off. Thus, issues like the possibility of future increases to the capital gains tax rate were a factor.

EDITOR: Given the decision not to sell, I assume that one consideration was the future of the lab staff and people who have been part of Pathology, Inc., for many years.

LUI: That is true, and it is connected to another goal that I want to emphasize here. By recapitalizing Pathology, Inc., in this manner, it becomes a platform laboratory for sustained growth. That would not happen if our lab was acquired and consolidated or merged by the buyer.

EDITOR: The insights the three of you have shared about the pathology marketplace and how Pathology, Inc., is positioning itself for ongoing growth are quite useful. Thank you for taking the time to provide this information.

LUI: You are welcome. As you have learned, we are quite bullish about all the opportunities in pathology testing and Pathology, Inc., is ready to set a high standard in the marketplace.


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