Pathology Visions 2007 San Diego, California October 21-23, 2007

1. Information as Pathology’s Ultimate Trump Card: Opportunities in the Digital Age ROBERT L. MICHEL Editor In Chief THE DARK REPORT Spicewood, Texas rmichel@darkreport.com ph: 512-264-7103 fax: 512-264-0969 Pathology Visions 2007 San Diego, California October 21-23, 2007

2. My Goals Today! • One: Review primary trends currently reshaping healthcare and lab services. • Two: Relate these trends to appropriate responses in anatomic pathology in coming years. • Three: Evaluate the “evolutionary” versus “revolutionary” potential for change in how pathology uses digital technologies to add value.

3. My Thesis… • For pathology, digitization is a critical path to maintaining and increasing the value propositionto users of lab data. • Multiple healthcare trends will create opportunities for digitized pathology to increase its role and contribution in the clinical continuum.

4. Four Basic Sources of ChangeIn U.S Healthcare Market Discussed at Executive War College • One: Consumers as primary buyers of healthcare. (Private and Medicare/Medicaid.) • Two: Major commitment to universal electronic medical record (EMR) and integration of healthcare data. • Three: New diagnostic & lab technology: genetic-based lab tests, automation, POCT. • Four: Widespread introduction of Deming-based quality management methods into healthcare and clinical laboratory profession.

5. Change Agent Two Drive to Universal EMR • Federal government taking lead role in fostering development of universal EMR (electronic medical record). • Hospitals and health systems scurrying to integrate existing data repositories and create “single view” patient record. • Enterprise IT integration is soaking up majority of hospital IT budgets. • Digitizing radiology images and work processes is another expensive drain on hospital IT dollars.

6. Change Agent Three New Technology in the Lab • Steady stream of new diagnostic tests, many based on molecular technologies. • Point-of-care testing (POCT) growing regularly in tests and capabilities. • Different automation products available for pre-analytical, analytical, post-analytical. (Even middleware as automation.) • Impact of these technologies magnified by enhanced informatics solutions. • Remember: Labs’ end product is info!

7. Change Agent Four Quality Management Methods • Healthcare—pushed by employers—now using quality management systems. • Savvy hospitals and labs are learning that Lean/Six Sigma provides competitive advantage, once the organization embraces these quality methods. • Quality requires accurate measurements, more on this later. • “First mover” to “early adopter” to general adoption by labs and hospitals. • Lab Quality Confab, Atlanta, Sept. 19-20.

8. Importance of Information Technology • Software is more sophisticated. • Storage costs and computing costs are declining steadily. • Wireless connections are ubiquitous and can handle higher volumes of information. • Advances in Internet technology make it feasible to perform more functions using a Web platform. • Interconnectivity and integration continually easier to achieve.

9. IT as Threat and Opportunity • Information is the end product of all clinical labs and pathology groups. • Hospitals working to integrate clinical data into real-time patient EMR. • Office-based physicians are implementing EMR systems. • RHIOs (Regional Health Information Networks) under development across the United States and Canada. • Labs must integrate with these users.

10. Pace of Change Accelerates • Laboratory medicine in the midst of an accelerating cycle of change. • Can identify six specific sectors within laboratory medicine undergoing major realignment. • In each sector, rapid series of events over the past six to 24 months.

11. Lab Sector One: Managed Care Contracting • United Health does 10-year deal with LabCorp, excludes Quest Diagnostics. • Horizon BC/BS does exclusive contract with LabCorp in New Jersey. Quest out. • Aetna does exclusive with Quest, excludes LabCorp. • Cigna renews national contracts with both LabCorp and Quest, and does it early. • LabCorp’s strategy of regional managed care laboratory networks.

12. Lab Sector Two: Clinical Lab Acquisitions • Sonic Healthcare Ltd enters USA. In 24 months, spends $820 million to acquire 8 labs with $500 million in annual revenue. • Apax Partners LP buys Spectrum Lab Network (November, 2005). • Laboratory Partners, Inc. acquires Terre Haute Medical Labs and Cincinnati lab. • New investors bidding aggressively for laboratory assets and reshaping the market.

13. Lab Sector Three: Anatomic Pathology Services • Quest Diagnostics pays $2 billion for AmeriPath (with $750 million in sales). • Aurora Diagnostics acquires nine pathology groups in 12 months, now at $60 million in sales. • Caris buys Pathology Partners. • Water Tower Equity Partners buys Lakewood Pathology Associates. • CBL Path raising lots of capitalto fuel rapid expansion.

14. Lab Sector Four: Molecular Diagnostics • Specialized startups, often with proprietary or patented diagnostic technology. • RedPath Integrated Pathology • Signature Genomic Laboratories • Access Genetics • Roche’s hostile offer of $3 billion for Ventana Medical Systems ($282 million in sales). • Vision Systems Ltd: Ventana enters agreement to buy; Cytyc offers more money. Danaher (Leica) outbids both.

15. Lab Sector Five: In Vitro Diagnostics Firms • 5 of 15 largest IVD firms in world have entered acquisition agreements in past 16 months. • Siemens pays $14 billion for DPC, Bayer Diagnostics, and Dade Behring. • GE buys Abbott for $8.1 billion, then breaks the deal. • Hologix pays $6.1 billion for Cytyc ($606 million in sales).

16. Lab Sector Six: Health IT Companies • Ongoing consolidation and product acquisition among IT companies. • Per Se Technologies acquired by McKesson. • Pathology Service Associates (PSA) acquired by Med3000. • Data Innovations buys P.G.P. s.a. of Brussels, Belgium. • Misys unloads former Sunquest product line to California investment group.

17. Anatomic Path Under Siege • Collectively, these trends and market forces are having substantial impact on anatomic pathology. • Let’s take a closer look…

18. Landscape for Change-2000Big Changes in Anatomic Pathology • Emergence of national AP firms, such as UroCor, DIANON Systems, IMPATH. • Some consolidation of pathology groups in large urban markets (related to consolidation of hospital ownership). • Emergence of first specialty testing companies in molecular diagnostics, such as Myriad Genetics. • As a profitable, growing sector, AP catches attention of two blood brothers.

19. Fast Forward to Year 2007Looking at Anatomic Path Services • Quest Diagnostics and LabCorp expanding into anatomic pathology. (Quest/AmeriPath now employees 800 to 900+ pathologists. LabCorp employs 400+ pathologists.) • Growing number of national AP labs, such as Bostwick Labs, CBL Path, Clarient, Claris, Lakewood Pathology, OUR Labs. • Specialty physicians, such as urologists and GIs, establishing in-house anatomic pathology services. (TC/PC arrangements.)

20. Year 2007Looking at Molecular Diagnostics • Steady growth in numbers of specialty testing companies with proprietary or patent-protected diagnostic technology. • Athena Diagnostics, Clarient, Genomic Health, RedPath Innovative Pathology are just a few examples. • These firms want the specimens so tests can be performed in their laboratories. Business goal is to be exclusive provider of these diagnostic technologies.

21. Looking Forward from 2007 Dominant trends in Healthcare…continued • Patient safety and pay-for-performance have one thing in common: • Providers must closely measure outcomes, increasingly in real time. • Providers must then use this data to improve outcomes. • Integration of healthcare IT makes this increasingly easier and cheaper. • Laboratories produce information…these trends are both threats and opportunities.

22. Looking Forward from 2007 Dominant trends in Healthcare…continued • Increased scrutiny of outcomes and public ranking of providers by quality of outcomes motivates clinicians to use lab tests more effectively. • Example: public release of cardiovascular surgery outcomes, by providers, in New York, starting in early 1990s. • Opportunity for labs and pathology groups to increase their role as laboratory medicine consultants to clinicians.

23. Imaging Intersects with Pathology Consolidation / Integration of In Vitro & In Vivo DIagnostics • Siemens acquires: • Shared Medical Services (SMS)–2000 • Diagnostic Products Corp (DPC)-2006 • Bayer Diagnostics-2006 • Dade Behring-2007 • GE acquires: • Triple G Corporation–2003 • Amersham PLC–2003 (diagnostic imaging agents, protein separations) • Abbott Diagnostics–2007 (deal busts apart) • Philips Corporation—will it also acquire LIS and in vitro diagnostic companies?

24. Let’s Put Things Together • Fact: large purchasers of healthcare are making rapid progress in gathering data about the cost of care and outcomes produced by individual hospitals, physicians, laboratories, and other providers. • These purchasers will use this data to reward superior performers and give poor performers a motive to change or exit as a clinical service provider.

25. That is Lab Opportunity • Laboratories are skilled at collecting data and converting it into information. • Referring physicians, under pressure to improve outcomes and the “cost per healthcare encounter”, will have motive to give greater value to lab testing and consultation services. • Laboratory medicine has the technology, knowledge, and experience to help clinicians improve outcomes, reduce unnecessary costs of care.

26. Quality Management • Pace of these trends will be magnified by wider adoption of Deming-based quality management principles. • As noted, Lean and Six Sigma techniques have passed through “first mover” and “early adopter” stages. • Now gaining acceptance across both the hospital and laboratory industry. • Quality management, by its use of real-time data to measure work processes, reinforces wider trends in healthcare.

27. Evolution or Revolution? • We can argue about pace of change… • …but it is clear that the American healthcare system is preparing to undergo a radical makeover during the next decade. • Change always creates new winners and losers.

28. Comment on Anatomic Pathology • Anatomic pathology is a sector of lab medicine facing wrenching change. • Most threatened: private pathology group practices serving community hospitals. • For “rational reasons”, partners in these groups are reticent to invest in their own business…nor consider regional consolidation. • Growth in pathology profession is already taking the form of salaried positions.

29. Investors Changing Pathology • In general, private pathology groups are not investing adequately in technology and informatics. • Investor-owned pathology groups are investing in technology. • Any opportunity to increase revenues and build market share will be pursued by commercial pathology firms. • Use of enhanced informatics and digitization is consistent with this strategy.

30. Why Investor Interest? • Less money, less time, less regulation to bring a new diagnostic test to market and earn profits. • Pharma: up to 10 years, $500 billion. • IVD: 2-3 years, $30 million • Sales of just $60 million/year make a new lab test a financial home run.

31. And There’s More for Investors! • Investors know demographics and aging baby-boomers will fuel demand for existing and new lab tests. • Priority of early detection, use of personalized medicine, and increase in pharmacogenomics/companion diagnostics only adds more demand. • Value proposition of well-researched clinical benefit of a new lab test is generally accepted by payers—thus, ample reimbursement.

32. Necessary Responses • Pathology groups need to develop subspecialty expertise, especially in genetics and molecular pathology. • Sophisticated informatics strategy is a must! (See next slide.) • Regional consolidation of pathology resources is the right strategy to create critical mass and market clout. • Community hospital-based pathology groups must be willing to invest in their own business (practice).

33. Pathology Informatics • Healthcare is eliminating paper. Pathologists must do the same, in parallel. • Pathology groups need to support not just electronic claims and electronic reports, but direct interfaces with referring physicians. • EMR adoption by large physician groups is key trend and requires bi-directional “interface gateways” with labs and pathology groups.

34. IT in Pathology • With EMR use expanding and electronic patient referrals increasing, demand for full electronic pathology report (with digitized images) will grow. • Within pathology profession, needfor complex molecular work-ups to bring together data from several sources reinforces use of digital images and data. • Pay-for-performance and evidence-based medicine will require full digital pathology record that supports data mining and research analysis.

35. Supporting Efficiency • Pathologists must support both clinical and operational efficiency. • Physicians won’t use labs that don’t support physicians’ clinical workflow and operational workflow. • That requires pathologists to support the physicians’ evolution to full digital implementation. • These are additional reasons why pathology groups should have a sophisticated informatics strategy.

36. It’s A Revolution in Pathology • Status quo strategy no longer sustainable for private pathology groups. • New winners emerging: • Investor-funded pathology companies. • Regional, consolidated pathology “super groups” • Selected academic center pathology departments with a “market mindset.” • Owners of patented or proprietary diagnostic technology. -30-