PHYSICIANS CLINICAL LABORATORY INC, 10-K, 1997-06-10

PHYSICIANS CLINICAL LABORATORY INC
10-K, 1997-06-10
MEDICAL LABORATORIES

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<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended February 28, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-20678

PHYSICIANS CLINICAL
LABORATORY, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 68-0280528
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

3301 C STREET, SUITE 100E, SACRAMENTO, CA 95816
(Address of principal executive offices)

(916) 444-3500
(Registrant's telephone number, including area code)

---------------

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $ .01 per share

Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in any amendment to this Form 10-K. [ ]

The aggregate market value of the registrant's voting common stock
held by non-affiliates of the registrant at May 19, 1997 based on the bid and
asked prices in the over-the-counter market average that date was approximately
$948,659.

The registrant had 6,071,419 shares of common stock, $.01 par value
per share, outstanding at May 19, 1997.

Documents Incorporated by Reference:
None.
<PAGE> 2
PHYSICIANS CLINICAL LABORATORY, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

<TABLE>
<S> <C> <C>
PART I PAGE
----

Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1

Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-26

Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-27

Item 4. Submission of Matters to a Vote of Security-Holders . . . . . . . . . . . . . . . . . . . . . I-32

PART II

Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters . . . . . . . . . . II-1

Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II-3

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . II-5

Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . II-22

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . II-57

PART III

Item 10. Directors of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III-1

Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III-5

Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . III-11

Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . III-15

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . IV-1

SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IV-3
</TABLE>

<PAGE> 3
PART I

ITEM 1. BUSINESS

The principal business of Physicians Clinical Laboratory, Inc., a
Delaware corporation and a debtor in possession ("PCL"), and its subsidiaries is
to provide clinical laboratory services in the State of California. As of April
30, 1997, PCL and its subsidiaries (other than Medical Science Institute)
operated one full service clinical laboratory in Sacramento, 13 "STAT"
laboratories and approximately 140 patient service centers located in close
proximity to referral sources throughout PCL's service areas. PCL operates a
full service laboratory and approximately 50 patient service centers in the
Sacramento area. PCL is a "hybrid" among clinical laboratory companies in that
it serves both as a traditional reference laboratory for office-based
physicians/clients and as an independent clinical laboratory to acute hospital
customers.

RECENT DEVELOPMENTS

Chapter 11 Reorganization.

BACKGROUND. On November 8, 1996 (the "Petition Date"), PCL and its
subsidiaries, Quantum Clinical Laboratories, Inc., Regional Reference Laboratory
Governing Corporation, Diagnostic Laboratories, Inc. and California Regional
Reference Laboratory (collectively, the "Debtors") commenced reorganization
cases (the "Bankruptcy Cases") by filing voluntary petitions for relief under
chapter 11, Title 11 of the United States Code (the "Bankruptcy Code") in the
United States Bankruptcy Court for the Central District of California, San
Fernando Valley Division (the "Bankruptcy Court"). For purposes of this Report,
unless otherwise referenced, the defined term "Company" shall apply to PCL and
its consolidated group of subsidiaries.

During the fiscal year ended February 28, 1997, the liquidity and
operations of PCL continued to be adversely affected by downward pressure on
reimbursement reserves, billing system/process challenges and accounts
receivable collection problems. As previously disclosed, the Company has been
in default since September 1995 with respect to principal and interest
judgments with respect to approximately $80.9 million of secured indebtedness.
The Company has also been in default since September 1995 with respect to
interest payments related to its $40 million 7.5% Convertible Subordinated
Debentures due 2000 (the "Debentures") and the Notes issued by the Company in
connection with the acquisition of Medical Group Pathology Laboratory and
Pathologists' Clinical Laboratories of Glendale, Inc.

From September 1995 through the Petition Date, the Company experienced
severe cash flow problems, a reduction in third-party payor reimbursement
rates, billing and collection problems and effects of significant changes in
the health care industry. As a result of its inability to pay its obligations
when they became due, as well as the poor industry conditions referred to
above, the Company began taking steps to seek an infusion of new capital or a
strategic transaction (e.g., a merger or sale of the business). The Company
concluded that absent the provision of new capital or consummation of a
strategic transaction, the Company would not be likely to be able to continue
to exist.

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Accordingly, in June 1995, the Company retained the investment banking
firm of Donaldson, Lufkin & Jenrette ("DLJ") to seek either a strategic
transaction or a capital infusion for the Company. From June 1995 through the
Petition Date, DLJ and the Company's Board of Directors engaged in discussions
with numerous industry parties as well as financial institutions, with respect
to a potential transaction or transactions that could provide the Company with
sufficient liquidity to survive as a going concern.

PREPETITION NEGOTIATIONS AND THE PREPETITION TERMSHEET. As a result of
the efforts of the Company and DLJ, only one offer to make an investment in the
Company surfaced that the Company believed was favorable to its creditors and
shareholders. This offer was made by Nu-Tech Bio-Med, Inc. ("Nu-Tech") in
conjunction with the Company's senior lenders, Oaktree Capital Management, LLC,
The Copernicus Fund, L.P., DDJ Overseas Corp., Belmont Fund, L.P., Belmont
Capital Partners, II, L.P. and Cerberus Partners, L.P. (collectively, the
"Senior Lenders"). After months of negotiations, on November 7, 1996, the
Company, Nu-Tech and the Senior Lenders entered into an agreement providing for
a new investment of approximately $15 million into the Company and an overall
restructuring of the Company's balance sheet (the "Prepetition Termsheet").

The Prepetition Termsheet formed the basis for the Company's plan of
reorganization, and paved the way for the Company's chapter 11 filing, the
restructuring of the Company's debt and the acquisition of a majority of the
Company by Nu-Tech, all of which the Company hopes to consummate while in
chapter 11. Representatives of each of the respective Debtors determined that
filing the chapter 11 petitions would best give the Debtors the needed time and
flexibility to consummate the restructuring of the Company contemplated in the
Prepetition Termsheet.

The willingness of Nu-Tech to invest new capital into the Company, and
the willingness of the Senior Lenders to support a restructuring that provided
value for the Company's unsecured creditors and shareholders, was subject to
numerous conditions which, after lengthy negotiations, were agreed to by the
Company in the Prepetition Termsheet. These conditions included: (a) the
filing of a reorganization plan consistent with the Prepetition Termsheet by
December 2, 1996; (b) the hiring of Nu-Tech's chief executive officer, J.
Marvin Feigenbaum, as Chief Operating Officer of PCL, effective immediately
prior to the Petition Date; and (c) obtaining an order approving certain
break-up fee and overbid protections for Nu-Tech (described below) within 60
days of the Petition Date.

On November 18, 1996, the United States Trustee appointed an official
committee (the "Committee") of unsecured creditors appointed pursuant to
section 1102 of the Bankruptcy Code. The Committee has the right to review and
object to certain business transactions and participated in the negotiation of
the Company's plan of reorganization. Under the Bankruptcy

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Code, the Company will be required to pay legal and other advisory fees of the
Committee associated with the Bankruptcy Cases until the effective date of the
Company's plan of reorganization.

Critical to the Company's ability to restructure its businesses and to
emerge from chapter 11 was its ability to maintain liquidity to meet operating
needs during the Bankruptcy Cases. As a result of filing for chapter 11
protection, cash generated from services rendered prior to the Bankruptcy Cases
is "cash collateral" of the Senior Lenders, pursuant to their security
interests therein. Under the Bankruptcy Code, this cash collateral could not
be used by the Company without the Senior Lenders' consent or Bankruptcy Court
approval. Accordingly, and as contemplated by the Prepetition Termsheet, on
November 12, 1996, the Bankruptcy Court entered an interim order and on
December 3, 1996, the Bankruptcy Court entered a final order authorizing the
Company to use the cash collateral under specified conditions, as consented to
by the Senior Lenders.

Use of cash collateral would not have provided the Company with
sufficient liquidity to sustain their operations during the Bankruptcy Cases.
Thus, to provide additional necessary liquidity, as contemplated by the
Prepetition Termsheet, the Company entered into a Stipulation and Amended
Stipulation: (1) Regarding Terms and Conditions of Use of Cash Collateral
Pursuant to 11 U.S.C. Section 363; (2) Regarding Terms and Conditions of
Post-Petition Secured Financing from Senior Lenders Pursuant to 11 U.S.C.
Section 364; (3) Validating Pre-Bankruptcy Liens, Security Interests and
Claims; (4) Providing Adequate Protection; (5) Granting Post-Petition Liens and
Security Interests; (6) Granting Claims Pursuant to 11 U.S.C Section Section
503 and 507(b); and (7) Granting Relief from The Automatic Stay (the "DIP
Financing Facility") with the Senior Lenders. The DIP Financing Facility
provided the Company with up to $9.8 million of borrowing capacity during the
Bankruptcy Cases, for ordinary working capital purposes and to fund the plan of
reorganization as contemplated by the Prepetition Termsheet. On November 12,
1996, the Bankruptcy Court entered an interim order approving borrowings of up
to $2.0 million under the DIP Financing Facility. On December 3, 1996, the
Bankruptcy Court entered a final order approving all aspects of the DIP
Financing Facility.

Under the DIP Financing Facility, the Senior Lenders agreed to make
loans to the Company in an aggregate principal amount not to exceed $9.8
million. The obligations of the Company under the DIP Financing Facility are
secured by a first priority lien on and security interest in all of the
Company's assets and are also allowed administrative expenses under the
Bankruptcy Code, with priority over most administrative expenses of the kind
specified in sections 503(b) and 507(b) of the Bankruptcy Code. Funds for the
DIP Financing Facility were obtained by the Senior Lenders from Nu-Tech, which
purchased approximately $13.33 million of the Senior Lenders' claims against the
Company for $10 million in cash, just prior to the Petition Date. Borrowings
under the DIP Financing Facility will be forgiven under the plan of
reorganization without any payment by the Company, provided that no event of
default occurs and continues under the DIP Financing Facility. In such case,
$10 million of Nu-Tech's $15 million investment into the Debtors will have been
made at the outset of the Bankruptcy Cases. The Company's plan of
reorganization, as more fully discussed below, provides that on the effective
date of the Company's plan of reorganization, the $5.0 million promissory note
issued by PCL to Nu-Tech in connection with

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the MSI Stock Purchase will be forgiven, in exchange for which Nu-Tech will
receive an additional 17% of the common stock of the reorganized Company (the
"New Common Stock"). See "--MSI Stock Purchase," herein.

The DIP Financing Facility provides that interest on advances to the
Company accrues at the rate of 2% above the prime rate and is only payable upon
an event of default described below or at the end of the term of the DIP
Financing Facility if the Company's plan of reorganization is not confirmed.
Upon the effective date of the Company's plan of reorganization, accrued
interest under the DIP Financing Facility will be forgiven.

The DIP Financing Facility imposes an annual commitment fee of 1% on
the unused portion of the $9.8 million limit. This commitment fee is only
payable upon an event of default described below or at the end of the term of
the DIP Financing Facility if the Company's plan of reorganization is not
confirmed. Upon the effective date of the Company's plan of reorganization,
accrued commitment fees will be forgiven.

In addition to other terms and conditions customary for
debtor-in-possession financings of this type, the DIP Financing Facility
required the Company to obtain Bankruptcy Court approval of the following: (a)
provisions acknowledging the amount and validity of certain senior secured
claims and security interests, the amount and validity of the Debentures, and
that such debt and security interests are not subject to challenge, dispute or
avoidance in the Bankruptcy Cases; (b) provisions waiving and releasing any
known or unknown claims of the chapter 11 estates arising out of (i) the Credit
Agreement, dated as of April 1, 1994, among PCL, Wells Fargo Bank, National
Association, as agent ("Wells Fargo Bank, N.A."), and other financial
institutions party thereto, and the first through fifth amendments to the
Credit Agreement (as amended, the "Credit Agreement"); (ii) the Term Notes by
PCL in favor of the banks party to the Credit Agreement, dated April 4, 1994;
(iii) the Overline Revolving Notes by PCL in favor of the Banks party to the
Credit Agreement, dated May 10, 1995; (iv) the Indenture Regarding $40 Million
of 7.5% Convertible Subordinated Documents Due In 2000, dated as of August 24,
1993, by and among PCL, Donaldson, Lufkin & Jenrette Securities Corporation and
Smith Barney Shearson, Inc.; (v) the Collateral and Security Agreement, dated
as of April 1, 1994, among PCL, Wells Fargo Bank, N.A., as agent for the other
financial institutions party thereto; (vi) the Trademark and Service Mark
Security Agreement, dated as of April 1, 1994, between Wells Fargo Bank, N.A.,
and California Regional Reference Laboratory; (vii) the Guaranty and Security
Agreement, dated as of April 1, 1994, between Quantum Clinical Laboratories,
Inc. and Wells Fargo Bank, N.A., as agent for the financial institutions party
to the Credit Agreement; (viii) the Guaranty and Security Agreement, dated as
of April 1, 1994, between Regional Reference Laboratory Governing Corporation
and Wells Fargo, Bank, N.A., as agent for the financial institutions party to
the Credit Agreement; and (ix) the Guaranty and Security Agreement, dated as of
April 1, 1994, between California Regional Reference Laboratory and Wells Fargo
Bank, N.A., as agent for the financial institutions party to the Credit
Agreement (the "Existing Lender Agreements"); (c) provisions waiving any rights
of surcharge under section 506(c) of the Bankruptcy Code and rights of recovery
under section 502(d) of the Bankruptcy Code; and (d) provisions stating that
upon an event of default by the Company under the DIP Financing Facility, the
Senior Lenders will have the right to seek an order from the Bankruptcy Court,
on five days' notice, providing for the termination of all stays, including the
automatic stay of section 362 of the Bankruptcy Code, to

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permit the Senior Lenders to exercise their rights and remedies under the DIP
Financing Facility as if no bankruptcy stay were in effect.

Moreover, the DIP Financing Facility contains the following events of
default, designed to ensure that the Company performs its obligations under the
Prepetition Termsheet: (i) failure of the breakup/overbid protections
(described below) to be approved by the Bankruptcy Court; (ii) withdrawal of
the Company's plan of reorganization by the Company or proposal by the Company
of a plan of reorganization inconsistent with the terms of the Prepetition
Termsheet; (iii) termination of the Company's exclusive right to file and
solicit acceptances with respect to the Company's plan of reorganization for
the benefit of any party other than the Proponents (as hereinafter defined);
(iv) removal or termination of J. Marvin Feigenbaum as Chief Operating Officer
of the Company other than in accordance with his employment agreement or
modification by the Company of his employment agreement without the Proponents'
written consent; and (v) termination by J. Marvin Feigenbaum of his employment
agreement in accordance with its terms. In addition, the DIP Financing
Facility contains events of default customary for debtor-in-possession
financings of this type.

The DIP Financing Facility terminates upon an event of default
described above or on the first anniversary of the Petition Date if the
Company's plan of reorganization is not confirmed. Provided no event of
default occurs and is continuing immediately prior to the effective date of the
Company's plan of reorganization, the unused principal availability under the
DIP Financing Facility will be fully drawn. Upon the effective date of the
Company's plan of reorganization, the principal balance of the DIP Financing
Facility, all accrued interest and all fees will be forgiven without any
payment by the Company. If an event of default occurs under the DIP Financing
Facility, the Senior Lenders and Nu-Tech will have the right to seek to
foreclose on their security interests in the Company's assets. The Company
believes that if the Senior Lenders and Nu-Tech foreclose on their security
interests in the Company's assets, no other creditors or shareholders will
receive any recovery on their claims against or interests in the Company. In
addition, even if the Senior Lenders and Nu-Tech do not foreclose on their
security interests, absent the ability to borrow funds under the DIP Financing
Facility, the Company is unlikely to have sufficient working capital to
continue to operate its businesses.

The Prepetition Termsheet also required the Company to seek entry of an
order from the Bankruptcy Court approving its agreement to transfer its assets
or stock to a third party other than as contemplated by the Plan or confirm any
other plan of reorganization only if: (a) the Bankruptcy Court finds that such a
transfer to a third party or alternative plan has an aggregate present value to
creditors and shareholders of the Company of at least $3.75 million higher than
the present value of the Plan to creditors and shareholders (the "Overbid
Protection") and (b) on the effective date of such third party transfer or
alternative plan of reorganization, Nu-Tech is paid $1.88 million in cash as
compensation for time and expenses incurred in pursuing the Plan and such
compensation is entitled to administrative expense priority (the "Breakup
Protection"). Failure to obtain an order of the Bankruptcy Court approving
these provisions would have been an event of default under the DIP Financing
Facility.

On January 6, 1997, the Bankruptcy Court entered an order approving
the Breakup and Overbid Protections, modified in certain respects from the
provisions outlined in the

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Prepetition Termsheet. These modifications to the Overbid Protections, approved
by Nu-Tech and the Senior Lenders, provide that the Company may transfer their
assets or stock to a third party other than as contemplated by the Plan if such
transfer provides aggregate present value to creditors and shareholders of the
Company of at least $2.5 million (as opposed to $3.75 million as set forth in
the Prepetition Termsheet) higher than the present value of the Plan to
creditors and shareholders. To date, the Debtors have not received any offers
to purchase their stock or assets from any entity other than as set forth in
the Plan.

Finally, the Prepetition Termsheet required that the Company's plan of
reorganization provide that holders of general unsecured claims and Debenture
claims and holders of common stock interests will only be entitled to a
distribution under the Plan if a certain voting condition (the "Voting
Condition") was satisfied. The Voting Condition, which has been satisfied (as
discussed below), required the holders of such general unsecured claims and
Debenture claims to accept the plan of reorganization.

On December 2, 1996, the Company, Nu-Tech and the Senior Lenders
(collectively, the "Proponents") filed a joint plan of reorganization with the
Bankruptcy Court. The December 2 plan embodied certain changes to the economic
terms contained in the Prepetition Termsheet, based upon negotiations with the
Committee and certain orders entered by the Bankruptcy Court during the
Bankruptcy Cases. On January 17, 1997, the Proponents filed an amended joint
reorganization plan with the Bankruptcy Court, which contained certain
amendments to the plan filed on December 2, 1996. On February 7, 1997, the
Proponents filed the Second Amended Joint Plan of Reorganization of Physicians
Clinical Laboratory, Inc. and Its Affiliated Debtors (the "Plan") with the
Bankruptcy Court, which contained certain amendments to the plan filed on
January 17, 1997. The Plan is jointly proposed by the Proponents.

By order of the Bankruptcy Court entered on February 14, 1997, a
Disclosure Statement (the "Disclosure Statement") describing, among other
things, the terms and conditions of the Plan was approved by the Bankruptcy
Court as containing "adequate information" within the meaning of section 1125
of the Bankruptcy Code. On February 20, 1997, the Company began soliciting its
shareholders and certain creditors to vote on the Plan by providing each with a
solicitation package (each, a "Solicitation Package") containing: (i) written
notice of (a) the Bankruptcy Court's approval of the Disclosure Statement, (b)
the commencement date of the confirmation hearing on the Plan, (c) the deadline
and procedures for filing objections to confirmation of the Plan, and (d) other
related issues; (ii) the Plan; (iii) the Disclosure Statement; (iv) a letter
from the Committee soliciting acceptances of the Plan; and (v) a ballot and a
ballot return envelope. February 11, 1997 was fixed by the Bankruptcy Court as
the voting record date for purposes of determining creditors and equity
security holders entitled to receive a Solicitation Package and to vote on the
Plan, subject to the disallowance of such creditors' claims and equity holders'
interests for voting purposes under certain circumstances.

The Plan was confirmed by the Bankruptcy Court at a hearing on April
18, 1997. Accordingly, on April 23, 1997 (the "Confirmation Date"), the
Bankruptcy Court entered the Findings of Fact, Conclusions of Law and Order
Confirming Second Amended Plan of Reorganization of Physicians Clinical
Laboratory, Inc. and Its Affiliated Debtors (the "Confirmation Order"). The
Plan provides that each of the conditions to the Effective Date of the Plan, as
herein defined, must be satisfied or waived as provided in the Plan by July 22,
1997. The Effective Date shall mean a business day, determined by the Company,
after which all such conditions have been satisfied or waived.

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Moreover, the Company's shareholders and creditors voted to approve the Plan,
and accordingly, the Voting Condition was satisfied.

On the Effective Date, the Company will settle its obligations to its
impaired creditors as follows: (A) Nu-Tech will receive 35.6% of the New Common
Stock in exchange for its holdings of approximately $13.0 million in senior
secured debt (which debt it purchased from the Senior Lenders just prior to the
Petition Date), and 17% of the New Common Stock in exchange for Nu-Tech's
cancellation of a note executed by the Company in the principal amount of $5.0
million (the "Nu-Tech Stock Purchase") (which note comprised part of the
purchase price paid by the Company to Nu-Tech in connection with the MSI Stock
Purchase -- see "--MSI Stock Purchase," herein), (B) the Senior Lenders, which
presently own an aggregate of approximately $80.0 million of secured debt, will
receive $55.0 million in new senior secured debt and 38.1% of the New Common
Stock, (C) the holders of the Debentures will receive 9.3% of the New Common
Stock, (D) the Company's shareholders will receive warrants to purchase 5% of
the New Common Stock for a period of up to five years, at a purchase price of
$13.30 per share, and (E) the Company's remaining general unsecured creditors
will receive a pro rata share of each of $2.45 million in cash and an unsecured
note in the principal amount of $400,000 due on the first anniversary of the
Effective Date, without interest. The Plan also provides that all of the
Company's wholly-owned subsidiaries will be merged with and into the Company
immediately prior to the Effective Date.

Under the terms of the Plan, the Senior Lenders will receive, among
other things, $55 million in Senior Secured Notes (the "New Senior Notes") to be
issued by the reorganized Company. Although the reorganized Company and the
Senior Lenders are still engaged in negotiations with respect to the Senior
Notes, the reorganized Company and the Senior Lenders expect that the principal
terms of the indenture governing the New Senior Notes (the "Indenture") will be
substantially as follows: First, the New Senior Notes will bear interest at the
rate of either 10% per annum in cash or 12% per annum in kind, at the option of
the reorganized Company, for the first two years after issuance and 11% per
annum per year through maturity. Second, the New Senior Notes will mature seven
years after issuance. Third, each holder of the New Senior Notes may require
the reorganized Company to repurchase such holder's New Senior Notes upon (i)
the occurrence of a Change in Control (as defined in the Indenture); (ii) the
sale of assets of the reorganized Company yielding net unapplied proceeds of a
certain amount; and (iii) the consummation of an underwritten public offering of
the reorganized Company's capital stock. Fourth, the New Senior Notes will be
secured by a first priority security interest in all existing and future assets
of the reorganized Company, except that it is anticipated that the Senior
Lenders will agree to subordinate such security interests in the receivables of
the reorganized Company to security interests granted to the lender providing
the Exit Financing Facility (as herein defined). Finally, the Indenture will
contain customary covenants, representations and warranties and customary
provisions regarding defaults, remedies and modifications.

The Company has also agreed that the reorganized Company will issue
registration rights with respect to the New Common Stock and the New Senior
Notes in substantially the forms hereinafter described. Under the New Senior
Notes Registration Rights Agreement, during the duration of this agreement and
after a period of 15 months from its date, Senior Lenders holding at least a
majority of certain of the New Senior Notes may request the reorganized Company
to register such New Senior Notes. The terms of the New Common Stock
Registration Rights Agreement provide that during the duration of the New Common
Stock Registration Rights Agreement and after the earlier of (i) 30 months from
its date, or (ii) six months after the date that the reorganized Company files
its first registration of its New Common Stock, those Senior Lenders holding at
least a majority of certain of the New Common Stock shall have the right to
request the registration of such New Common Stock.

In addition, it is anticipated that certain of the shareholders of the
reorganized Company will enter into a shareholders agreement, pursuant to which
the right of such shareholders to dispose of their shares in the reorganized
Company will be restricted to (i) dispositions to successors in interest who
agree to be bound by the shareholders agreement; (ii) dispositions under a
registered public offering; (iii) dispositions to an affiliate of the
transferring shareholder ("affiliate" defined as a person with the power to
direct the management or a 10% beneficial owner of the reorganized Company); and
(iv) dispositions by Nu-Tech made solely in a pro rata distribution of
securities to Nu-Tech's shareholders. Further, the shareholders will agree not
to transfer any of their securities in the reorganized Company to any entity
which owns 5% or more of an entity which conducts clinical or specialized
laboratory services as its principal business.

Under the terms of the Plan, Nu-Tech, the Senior Lenders and the
holders of the Debentures will receive 52.6%, 38.1% and 9.3%, respectively, of
the New Common Stock of the reorganized Company. Additionally, the holders of
the Common Stock of the Company will receive warrants to purchase 5% of the New
Common Stock to be issued and outstanding immediately after the Effective Date,
on a fully diluted basis, at the price of $13.30 per share. Because the
reorganized Company will have less than 300 shareholders after the Effective
Date, the reorganized Company intends to de-register the New Common Stock under
the Securities Exchange Act of 1934. Notwithstanding the foregoing, the
reorganized Company will continue to file periodic reports with the United
States Securities and Exchange Commission on a voluntary basis, as will be
required by the terms of the Indenture.

Section 5.2.4 of the Plan, more fully discussed below, contemplates
that the reorganized Company may enter into an exit financing facility on or
after the Effective Date in an aggregate amount up to $10 million to be secured
by accounts receivable of the reorganized Company and the proceeds thereof.
Prior to the confirmation of the Company's Plan of reorganization, more fully
discussed below, the Company obtained a post-Effective Date commitment for exit
financing from Daiwa Securities America, Inc. ("Daiwa") to provide a working
capital credit facility to the Company. On April 18, 1997, the Bankruptcy Court
approved a commitment letter with Daiwa and authorized the Company to pay a
$250,000 advisory fee to Daiwa. The Company has reached an agreement in
principle with Daiwa to provide the reorganized Company with a post-Effective
Date working capital facility, subject to certain conditions, of up to $10
million (the "Exit Financing Facility"). Negotiations between the Company and
Daiwa with respect to the Exit Financing Facility are continuing.

On April 18, 1997, the Bankruptcy Court granted the Company's request
to substantively consolidate the Bankruptcy Cases into a single chapter 11 case
for purposes of the Plan and the distribution provisions thereunder. Pursuant
to such ruling, on the Confirmation Date: (1) all intercompany claims by and
among the Debtors were deemed eliminated; (2) all assets and liabilities of the
Debtors were merged or treated as though they were merged; (3) any obligations
of any Debtor and all guaranties thereof executed by one or more of the Debtors
were deemed to be one obligation of the reorganized Company; (4) any claims
filed or to be filed in connection with any such obligation and guaranties were
deemed one claim against the reorganized Company; (5) each claim filed in the
Bankruptcy Case of any Debtor was deemed filed against the reorganized Company
in the consolidated Bankruptcy Case on the Confirmation Date, in accordance with
the substantive

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<PAGE> 10
consolidation of the assets and liabilities of the Debtors and all claims based
on guaranties of payment, collection or performance made by the Debtors as to
obligations of any other Debtor were discharged, released and of no further
force and effect; and (6) all transfers, disbursements and distributions made
by any Debtor were deemed to be made by all of the Debtors.

The Plan provides for the substantive consolidation of the estates, so
that the assets and liabilities of the Debtors are treated as if the assets
were held by, and the liabilities incurred by, a single entity.

The effectiveness of the Plan is subject to certain conditions set
forth in the Plan, including, but not limited to, the execution of a
shareholders agreement between Nu-Tech and certain of the Senior Lenders and the
consummation of the Nu-Tech Stock Purchase by Nu-Tech and the reorganized
Company.

The foregoing description of the principal terms of the Plan is
qualified in its entirety by the full text of such document, which is filed as
Exhibit 2.1, hereto and incorporated herein by this reference. In addition, as
described above, the Disclosure Statement relating to the Plan was mailed to
holders of record of the Company's common stock on or about February 20, 1997.

Liquidity and Operating Results.

Approximately 61% of the Company's net revenue for the fiscal year
ended February 28, 1997, was received from third-party payors that determine
themselves the rate at which they will reimburse the Company for services
provided to individuals insured by them. As a result of declining
reimbursement rates and other industry changes, the Company's operating income
as a percentage of net revenue has decreased substantially. The Company's
operating income (loss) as a percentage of net revenue, excluding nonrecurring
items, was 9.2%, (13.5%) and (37.8%) for the years ended February 28 (29),
1995, 1996 and 1997, respectively.

For the year ended February 28, 1997, the Company incurred a net loss
of $98.7 million. In addition, as of February 28, 1997, the Company had a
negative shareholder equity position of $163.3 million. The net loss of $98.7
million included the write-off of intangibles of $59.4 million, a provision of
$4.4 million for lease obligations abandoned in the fiscal year and $1.6
million of credit restructuring expense.

Following the Petition Date, the Company has continued implementation
of the operational restructuring that began prior to the Petition Date. Such
operational restructuring consisted of actions taken in an effort to reduce
operating costs, improve cash collections, streamline the billing process and
increase revenue flows. These actions include:

- Elimination of 425 (approximately 32%) full time equivalent
employee positions.

- Consolidation of facilities. The Fresno hub laboratory was
closed in June 1995 and consolidated into the Sacramento
laboratory. The Company's Southern

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<PAGE> 11

California hub laboratory was downsized in June 1996 and
consolidated into the Sacramento laboratory. Both locations
maintain expanded STAT facilities.

- Use of dedicated internal teams for concentrated account
receivable collection efforts in the Medicare, MediCal, client
and patient payor categories.

- Completion of centralized billing capabilities.

- Data processing system changes to improve billing and
collection efforts.

- Reductions in overhead by, among other things, closing
unprofitable locations.

- Moving the Company's principal executive offices from its
current location at 2495 Natomas Park Drive in Sacramento (the
"Headquarters") to the Company's main laboratory facility,
located at 3301 C Street, in Sacramento, and the Company will
be moving the Company's billing department to a new facility,
located at 201 Lathrop Way in Sacramento (the "Lathrop
Premises") and rejecting the Headquarters Lease. The
Bankruptcy Court authorized the Company to enter into a lease
for the Lathrop Premises on February 28, 1997. The Company
expects to vacate the Headquarters in June 1997 and, on May 21,
1997, the Bankruptcy Court granted the Company's motion
requesting authority to reject the Headquarters lease on ten
days' notice to the Headquarters lessor. See "Item 3. Legal
Proceedings," herein.

During and subsequent to the third quarter of Fiscal 1996, the Company has
reduced expenses and consolidated a significant portion of the testing done at
its South Hub Lab into the Sacramento facility. As of March 1997, these efforts
have resulted in labor and infrastructure eliminations yielding approximately
$1.9 million per month in expense reductions since August of 1996. In addition
to 425 full time employee equivalent reductions, certain unprofitable patient
service centers have been closed, certain unprofitable capitated contracts have
been eliminated and certain courier routes have been restructured.

MSI Stock Purchase

On February 24, 1997, the Company entered into an Agreement for
Purchase and Sale of Stock (the "MSI Stock Purchase Agreement") with Nu-Tech,
whereby PCL acquired all issued and outstanding shares (the "Shares") of
Medical Science Institute, Inc. ("MSI") from Nu-Tech, the beneficial and record
owner of all issued and outstanding shares of MSI (the "MSI

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<PAGE> 12
Stock Purchase"). The closing of the transactions contemplated by the MSI
Stock Purchase Agreement (the "Closing") occurred on February 26, 1997.

In consideration for the Shares, the Company paid to Nu-Tech an
aggregate amount in cash equal to $2,643,183.03. The Company also issued and
delivered a Promissory Note to Nu-Tech in the principal amount of $5,000,000.
Pursuant to the Plan, the Promissory Note will be forgiven by Nu-Tech on the
Effective Date, in exchange for which forgiveness Nu-Tech will acquire 17% of
the New Common Stock. The aggregate consideration and other payments to be
made in connection with the foregoing transaction were arrived at pursuant to
arms' length negotiations between the Company and Nu-Tech.

As the Company was a debtor-in-possession in the chapter 11 case
before the Bankruptcy Court on the Closing Date, Bankruptcy Court approval was
required with respect to the purchase of the Shares and the related
transactions, and such approval was granted by court order on January 29, 1997.

GENERAL

The Company was incorporated in Delaware in April 1992 to succeed to
the business of California Regional Reference Laboratory, a California limited
partnership (the "Predecessor Partnership"), which was formed in 1986. The
Company completed an initial public offering of 1,725,000 shares of its Common
Stock in October 1992, the net proceeds to the Company of which were
approximately $12.6 million. The Company operates in one industry segment,
clinical laboratory testing.

The Company provides clinical laboratory services in the State of
California. As of April 30, 1997, the Company operated one full service
clinical laboratory in Sacramento, 13 "STAT" laboratories and approximately 140
patient service centers located in close proximity to referral sources
throughout the Company's service areas. The Company operates a full service
laboratory and approximately 50 patient service centers in the Sacramento area.
The Company is a "hybrid" among clinical laboratory companies in that it serves
both as a traditional reference laboratory for office-based physicians/clients
and as an independent clinical laboratory to acute hospital customers.

See "Item 6. Selected Financial Data" for the Company's net revenue
and operating income (loss) and total assets for each of the last three years.

THE CLINICAL LABORATORY TESTING INDUSTRY

Laboratory tests are used generally by physicians and other health
care providers to diagnose and monitor diseases and other medical conditions
through the detection of substances in blood, tissue and other specimens.
Laboratory testing is generally categorized as either clinical testing, which
is performed on bodily fluids including blood and urine, or anatomical
pathology testing, which is performed on tissue and other samples. Clinical
and anatomical pathology tests are frequently performed as part of regular
physical examinations and hospital admissions in connection with the diagnosis
and treatment of illnesses. The most frequently

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<PAGE> 13
requested tests include blood chemistry analyses, blood cholesterol level
tests, urinalyses, blood cell counts, PAP smears, AIDS tests, and alcohol and
other substance-abuse tests.

OPERATING STRATEGY

The Company's operating strategy is to be a leading regional provider
of high quality, cost-efficient clinical laboratory testing services to a
diversified group of customers and payor sources. To implement this strategy,
the Company's key operating objectives are as follows:

- - Provide Full Range of Services. The Company currently performs over
900 different tests internally, with special expertise in microbiology,
virology and immunology, as well as a wide range of "esoteric" testing
services. Approximately 96% of the Company's tests are performed internally.

- - Provide High Level of Responsiveness. The Company is committed to
providing its customers with the highest level of responsiveness in the
reporting of testing results. The industry standard is for test results to be
communicated to the requesting physician by the next business day. The Company
currently reports or makes available greater than 95% of all test results by
9:00 a.m. the next day. The Company maintains the laboratory information
systems for two Sacramento acute-care hospitals. For these two hospitals, the
Company currently reports 98% of routine test results within three hours from
arrival of the specimen at the Company's laboratory. A key element of the
Company's business strategy is to continue to develop innovative service
techniques, such as the Company's Lab Line(TM) direct access telephone service.
See "--Reporting of Test Results."

- - Produce Services at Low Cost. The Company provides quality testing
services in a cost-effective manner through the high volume of testing services
it performs, its automated testing equipment, its significant investment in
management information systems and its experienced sales and service staff.

- - Maintain Commitment to Quality. The Company has invested extensively
in equipment, training and quality control programs to ensure the accuracy of
its testing services. The Company's emphasis on quality includes an automated
quality control program, a full-time quality control director, and a program
which continually compares testing results with benchmark indicators. In
addition, the Company believes its reputation for quality is enhanced with its
physician customers due to the Company's relationship with its hospital
customers. The Company is fully accredited by the College of American
Pathologists.

- - Maintain Diversified Customer Base and Payor Services. Independent
clinical laboratories often focus on service to only one customer segment:
office-based physicians, hospitals or HMOs. This strategy is typically
utilized because each customer type requires specialized services. The
Company's strategy is to diversify its customer and payor services across all
customer types. This strategy offers several key advantages. For example, the
Company's contracts with HMOs allows the Company to provide a wide range of
services to physicians in the service areas and to gain access to physicians
who are members of the HMOs' network for the purpose of "cross-selling" those
physicians for their non- HMO business. See "--Clients and Payors--HMOs."

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<PAGE> 14
LABORATORY TESTING SERVICES

The Company's clinical laboratory tests measure the levels of chemical
and cellular components in human body fluids and tissue. They include
procedures in the areas of blood chemistry, hematology, urine chemistry,
immunology, virology, serology, histology, microbiology, endocrinology and
cytology. Commonly ordered individual tests include red and white blood cell
counts, PAP smears and procedures to measure blood glucose levels and to
determine pregnancy. As of fiscal year-end, the Company's laboratories handled
approximately 37,000 patient specimens per week and performed approximately
81,000 tests per week. Approximately 96% of the Company's revenues are derived
from tests performed by the Company internally.

The Company performs both routine clinical tests and so-called
"esoteric" tests at its Sacramento laboratory. Routine tests generally include
clinical tests capable of being performed and reported within a 24-hour period,
whereas esoteric tests include more complex and labor- intensive tests,
generally requiring more sophisticated technology and a higher degree of
technical skill and knowledge. The Company believes that there are
approximately 1,250 tests available in the industry today, of which the Company
considers approximately 50% to be routine. Routine tests include, among
others, tests to determine the function of the kidney, heart, liver and
thyroid, as well as other organs, and a general health screen that measures
several important body health parameters. Of the approximately 81,000 tests
the Company performed weekly, as of year end, the Company considered
approximately 70% to be routine. Many of the routine tests offered are
performed by sophisticated, computerized laboratory testing equipment. Esoteric
tests, which often require manual techniques and more sophisticated equipment,
can be quite complex and generally are carried out by a highly trained
technician. As a consequence, esoteric tests are relatively higher priced. The
number of esoteric tests continually increases as new medical discoveries are
made although improved technology can also automate esoteric tests and,
depending upon the volume of test requests, convert esoteric tests to routine
procedures. Some examples of esoteric tests are immunoelectrophoresis, used for
the diagnosis of auto immune disorders and myelomas, and hepatitis markers, used
for the diagnosis of acute hepatitis A and B and for identification of chronic
carriers of these diseases.

The Company is a "hybrid" provider, in that it provides testing
services to both office-based physicians and acute-care hospitals. Generally,
service requirements and expectations of hospitals greatly exceed those of
office-based physicians, since hospitals ordinarily treat patients who are
unquestionably ill whereas office-based physicians often see patients for
routine examinations and for less serious illnesses. Clinical testing on
behalf of acute-care hospitals requires extremely high levels of quality and
service. The Company's standard turnaround time is three hours for most
hospital tests, and the results of these tests generally reveal a much higher
percentage of abnormalities than is encountered in other sectors of the
clinical testing business. The Company believes that its office-based
physician customers benefit from the

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<PAGE> 15
hybrid nature of the Company's business, since they generally receive services
that have been disciplined by the more stringent timing and quality
requirements demanded by hospitals.

LABORATORY OPERATIONS

As of April 30, 1997, the Company conducted its operations through one
full-service laboratory in Sacramento, 13 "STAT" laboratories and approximately
140 patient service centers. Effective June 1996, the Company discontinued
full-service operations in its Burbank laboratory and consolidated its
operations with those of its Sacramento full-service laboratory, while
maintaining expanded STAT capabilities at the Burbank facility. Effective
November 1996, the Company relocated its STAT facilities from Burbank to
Ontario. In February of 1997, the Company acquired Medical Science Institute,
Inc., further expanding its Southern California laboratory operations. See
"-- MSI Stock Purchase," herein. Patient service centers (which are often
referred to as "draw stations") are facilities maintained by the Company, often
in or adjacent to a medical professional building, staffed with phlebotomists
and other personnel and at which patient specimens are drawn and stored pending
pickup and delivery to the central laboratory. Samples for tests ordered by
office-based physicians are generally drawn by phlebotomists at one of the
Company's patient service centers, to which the patient is referred by the
attending physician. Samples for tests ordered by the Company's hospital
customers are drawn by hospital personnel. The Company maintains a fleet of
service vehicles which collect specimens from each draw station at least twice
daily, from five Sacramento hospitals approximately every 90 minutes, and from
certain of the Company's office-based physician customers and hospitals
periodically during the day. Although specimens arrive at the full-service
laboratories throughout the day, the vast majority are received in the late
evening.

Upon arrival at the full-service laboratories, each specimen is logged
for testing and billing purposes into the Company's computer system. Each
specimen is labeled and is verified to be the correct type and quantity
required for the requested tests. The tests are then performed on the
specimens by the Company's technologists, and the results are entered into the
Company's computer systems, either manually or directly through computer
interface, depending upon the complexity and type of test and the type of
equipment used to perform the test.

Six of the Company's Sacramento-area hospital clients generally
require a maximum three hour turnaround on ordered testing, and to service
these customers the Company is equipped to perform tests on a STAT basis. The
Company performs an average of approximately 110 physician-requested STAT tests
each day at its Sacramento facilities, including blood cell counts and
chemistry tests such as glucose analyses. The Company believes that this
capability provides a competitive advantage in marketing its services to
office-based physicians by enhancing the Company's reputation among such
physicians.

REPORTING OF TEST RESULTS

Rapid turnaround of test results is critical to the successful
operation of any clinical laboratory. Accordingly, the Company strives to
furnish test results to its customers in the most efficient and expeditious
manner possible. For the fiscal year ended February 28, 1997, the Company
reported or made available to its customers approximately 95% of all test
results by 9:00 a.m. the next morning. The Company reports test results to its
customers in the following ways:

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<PAGE> 16
- - The Company has furnished specifically dedicated electronic printers
and telephone modems to some of the Company's customers, enabling the Company to
transmit test results to such customers by 9:00 a.m. the next day.

- - The Company reports results to certain customers by courier, generally
by 9:00 a.m. the next day.

- - Results of STAT tests, as well as all testing results that exceed
prescribed thresholds, are telephoned to physician-customers 24 hours a day
immediately upon completion.

- - Results of routine tests are incorporated into the Company's
interactive Lab Line(TM) telephone system, which permits customers, using
pre-assigned numerical codes, to access test results 24 hours a day over the
telephone or to direct that test results be sent to a facsimile machine.

- - Six of the 10 acute-care hospitals served by the Company generally
require a three-hour turnaround on tests ordered by them. For two of these
hospitals, the results of the tests performed by the Company, together with the
results of tests performed by each hospital's own testing laboratory, are
maintained and reported to the respective hospital computers by the Company's
computers through interface software and are recorded directly in the patient
records. For three of these hospitals, the results of the tests performed by
the Company are interfaced directly into the hospital's laboratory information
system thereby allowing for a real-time delivery of test results. For the
remainder of these hospitals, the results are transmitted via modem to a
hospital-based printer.

QUALITY ASSURANCE

The Company believes it has developed high standards for the provision
of its testing services through quality assurance programs implemented at every
level of the Company's operations. The Company has implemented quality
assurance programs that are intended to ensure that specimens are collected and
transported properly, tests are performed accurately, and client, patient and
test information is reported, billed and filed correctly. The quality
assurance programs include testing of specimens of known concentration or
reactivity in order to ensure accuracy and precision of testing results,
routine checks and preventive maintenance of laboratory testing equipment and
administration of proficiency tests intended to ensure that only qualified
personnel perform testing.

The operations of the Company's Sacramento full-service laboratory and
all of its STAT laboratories are each directed by Medical Directors.

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<PAGE> 17
The Company participates in several voluntary independent proficiency
testing programs. Under these programs, the testing authority submits
pre-tested samples to a laboratory in order to measure the laboratory's test
results against known proficiency test values. Such proficiency programs are
conducted by groups such as the College of American Pathologists (the "CAP")
and state and federal government regulatory agencies. The Company's Sacramento
Medical Director is responsible for ensuring the Company's continued
accreditation under the CAP program and other voluntary and mandatory
accreditation programs. The CAP accreditation program involves both periodic
inspections of the laboratory and participation in the CAP's proficiency
testing program for all categories in which the laboratory seeks to attain or
maintain accreditation. The CAP accreditation standards are more stringent
than licensing standards set by state and federal regulatory agencies. The
Company is also certified by Medicare and MediCal, holds all required
California state licenses and is licensed by the federal government. See
"--Government Regulation."

CLIENTS AND PAYORS

The Company's principal customers are its office-based
physician-customers, its 10 acute-care hospital customers and other HMOs and
managed care entities. The Company receives payment for its services from these
customers, as well as from patients and third-party payors such as insurance
companies, HMOs, Medicare and MediCal. The Company's mix of billings over time
will be influenced by, among other factors, regulatory developments,
cost-containment efforts on the part of payors and the types of clients
serviced.

Fees for clinical laboratory testing services rendered for physicians
are typically charged on a fee-per-test basis and are billed to the physician,
directly to the patient or to the patient's third-party payor, such as an
insurance company, an HMO, Medicare or MediCal. Third-party payors generally
reimburse the Company according to their own fee schedules. The Company also
has agreed to provide testing services to certain HMOs pursuant to capitated fee
arrangements that provide for a fixed fee per member per month rather than fees
for services actually performed. See "--HMOs."

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<PAGE> 18

Hospital Customers. Approximately 4% of the Company's net revenue in
fiscal 1997 was derived from clinical laboratory testing and information system
management services provided to hospital clients. Hospitals affiliated with
SACC and Sutter Health, Mercy Healthcare and Methodist Hospital, Sacramento
(the Company's principal stockholders) accounted for approximately 1.5%, 2.0%
and 0.5%, respectively, of such net revenue. While the mix of referrals to the
Company by each hospital is different, the Company generally performs from 15%
to 20% of the total tests required by these hospitals. The Company bills the
hospitals for testing services on a fee-per-test basis in accordance with an
agreed-upon price schedule. The Company also maintains an information system
that interfaces with the hospital's computers and automatically records test
results in patients' hospital records.

Physicians. The Company currently provides clinical testing services
to office-based physician clients. Services rendered as a result of referrals
from physician clients (including those affiliated with HMOs and managed care
entities) represented approximately 96% of the Company's net revenue in fiscal
1997. Fees for clinical laboratory testing services rendered for physicians are
typically charged on a fee-per-test basis and are billed to the physician,
directly to the patient or to the patient's third-party payor, such as an
insurance company, an HMO, Medicare or MediCal. Third-party payors generally
reimburse the Company according to their own fee schedules.

HMOs. The Company has agreements with several HMOs throughout the
state under which the Company has agreed to provide testing services that may
be required by the HMOs' members. The Company is compensated for these
services on a capitated basis (i.e., a fixed fee per member per month).

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SALES AND MARKETING

The Company's full-time sales, marketing and service staff (including
those employees acquired as a result of the MSI acquisition -- see "-- MSI Stock
Purchase," herein) currently consists of 50 employees. The Company also
maintains a staff of customer service personnel to assist customers.

The Company has developed detailed management information systems that
monitor the performance of each sales person on a monthly basis. The Company's
three regional sales managers receive bonuses only if the entire sales
department for their region meets or exceeds an established quota on a quarterly
basis. Each sales person must achieve a standard based upon actual new sales
added on a monthly basis. Sales employees are paid a base salary, a car
allowance, and commission.

GOVERNMENT REGULATION

The Company will continue to be subject to government regulation,
at both the Federal and State level, in many areas. Material areas of
government regulation of the Company's businesses are described below.

THE STARK BILL AND OTHER RESTRICTIONS ON SELF-REFERRAL

Section 1877 of the Social Security Act, commonly known as the "Stark
Bill," which became effective January 1, 1992, generally prohibits clinical
laboratories from billing for tests covered by Medicare if the physician
ordering the test (or an immediate relative of such physician) has a direct or
indirect ownership or investment interest in, or compensation arrangement with,
the Company. Effective January 1, 1995, this prohibition also applies to
preclude the Company from billing the Medi-Cal program for tests ordered by
such physicians. Ownership interests would include ownership of the New Senior
Notes or shares of the New Common Stock. It does not appear that there is an
exception from the Stark Bill for which the Company will qualify.

The Stark Bill requires laboratories such as the Company to
provide the United States Department of Health and Human Services ("HHS") with
the names and unique physician identification numbers of all physicians who
have (or whose immediate relatives have) a direct or indirect ownership or
investment interest in, or compensation relationship with the Company.
Under the law, the Company is also required to identify the referring
physicians on each of their claims for Medicare payment and to indicate whether
the physician or the physician's relative has an ownership or compensation
relationship with the Company.

On August 14, 1995, the Secretary of HHS issued final regulations to
those provisions of the Stark Bill, which were effective January 1, 1992
("Stark Regulations"). The Stark Regulations contain provisions that mirror
the statutory reporting requirements described above.

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<PAGE> 20
Individuals or entities who are found to have violated the Stark Bill
may be subject to severe monetary civil penalties and possible exclusion from
the Medicare and Medi-Cal programs. Items or services that are billed and paid
for in violation of the Stark Bill are subject to refund. The Company intends
to institute appropriate programs to ensure compliance with the Stark Bill to
the fullest extent possible and not to bill for laboratory tests referred by
physicians whom PCL knows to be shareholders of PCL.

In 1993, the California legislature enacted Assembly Bill 919,
generally known as the "Speier Bill." The Speier Bill, which took effect on
January 1, 1995, generally prohibits all laboratories from billing for
laboratory tests if the physicians ordering the test (or an immediate relative
of the physician) has a direct or indirect ownership or investment interest in,
or compensation agreement with, the Company. Unlike the Stark Bill as
presently enacted, the Speier Bill applies regardless of who will pay for the
ordered service. Therefore, the Company is generally unable to bill
third-party payors for services performed on referral from financially related
physicians, even if the services are not to be paid for by Medicare or
Medi-Cal.

It does not appear that the Company qualifies for any exemption
under the Speier Bill. Thus, the Company intends not to bill for
laboratory testing referred by physicians whom the Company knows to be
shareholders of the Company.

In 1995, the Speier Bill was amended to provide an exception for a
one-time sale of a practice or property or other financial interest between a
licensee and the recipient of the referral if the sale or transfer is (i) for
commercially reasonable terms and (ii) the consideration is not affected by
either party's referral of any person or the volume of services provided by
either party.

Under the Speier Bill, a physician who receives price discounts on
clinical laboratory services that the physician purchases from the Company may
be considered to be financially related to the Company. The impact of this
provision requires further clarification, as does the meaning of the term
"discount" in this context. However, this provision may prevent the Company
from billing for services provided to persons who are referred to the Company by
physicians who purchase discounted clinical laboratory services from the
Company. Currently, approximately 9% of the Company's net revenues are derived
from selling laboratory services to physicians at a discount from the Company's
standard prices. Physicians who receive such discounts generally refer their
Medicare patients directly to an independent clinical laboratory such as the
Company for laboratory services, since physicians are generally prohibited by
law from billing the Medicare program for laboratory testing that is actually
provided by an independent clinical laboratory. This feature of the Speier Bill
parallels proposed revisions to the Stark Bill previously considered by
Congress. Under these proposed Stark Bill revisions, the Company could not bill
for services provided to Medicare and Medi-Cal patients on referral from
physicians who purchased laboratory services from the Company at less than fair
market value. To date, the Company is unaware of any guidance issued by
California regulatory or judicial authorities which clarifies the meaning of the
Speier Bill's apparent prohibition on billing for services rendered on referral
from physicians who receive price discounts from the Company. In a related
context, the California Attorney General and the Laboratory Field Services
Division of the California

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<PAGE> 21
Department of Health Services ("DHS") have opined that the term "discount" does
not include price reductions which are passed along from physician to consumer.
California law currently requires physicians to extend the benefit of
discounted laboratory pricing to their patients.

PROHIBITIONS ON MARK-UP OF LABORATORY SERVICES

Clinical laboratories (including those in hospitals), physicians,
hospitals and certain other health care providers in California are subject to
Section 655.5 of the California Business and Professions Code. This statute,
which became effective January 1, 1993, prohibits those subject to its
provisions from marking up charges for any clinical laboratory services not
actually rendered by the clinical laboratory, physician or other health care
provider, unless the additional charge is for a service actually rendered to
the patient by the person billing for the service and is itemized in the bill.
Further, this statute requires that if a person subject to the statute other
than a hospital or other health facility bills for clinical laboratory services
actually rendered by another provider, the bill must clearly indicate the name
and address of the laboratory that actually performed the services, that
laboratory's charges to the person billing for the services, and whether or not
the performing laboratory's charges are included in the bill submitted to the
patient or third-party payor.

Effective July 1, 1994, Section 655.5 requires the Company to
provide a fee schedule (a) to referring providers on request, and (b) to
referring physicians or to potential referring providers whenever a list of
laboratory services is furnished to the referring provider or potential
provider. On September 29, 1996, California Governor Pete Wilson approved
Assembly Bill No. 2588, which amended 655.5 to provide for easier disclosure
requirements and lowered the penalties for physicians for the commission of
first offenses under the statute with certain conditions.

In signing the legislation, Governor Wilson expressed concerns about
the bill's potential to provide a reduced penalty to physicians who knowingly
and willfully break the law against marked-up billings. Thus, to address his
concerns, he directed the Department of Consumer Affairs to work with the
Medical Board of California among others to (i) develop legislation for
introduction in January 1997, which will assure that physicians who knowingly
commit fraud are criminally prosecuted for first-time offenses; and (ii) create
a defined plan of action for timely and effective enforcement of the provisions
of this bill and the current law governing marked-up billings.

FRAUD AND ABUSE LAWS

Clinical laboratories participating in the Medicare and Medicaid
programs (including California's Medi-Cal program), are subject to a wide
variety of laws intended to eliminate the effects of fraud and abuse in these
programs. These laws include prohibitions on: (a) submitting false claims or
false information to the programs; (b) deceptive or fraudulent conduct; (c) the
provision of excessive or unnecessary services, or services at excessive
prices; and (d) inducing the referral of program patients through the offer or
receipt of remuneration. This latter statutory prohibition is often referred
to as the "antikickback statute." Penalties for violation of these federal
laws include exclusion from participation in the Medicare and Medicaid
programs, asset forfeitures, civil monetary penalties and criminal penalties.
Civil penalties for

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a wide range of offenses may include fines of up to $2,000 for each item or
service plus twice the amount claimed for such service.

These provisions have been liberally interpreted and aggressively
enforced by the relevant enforcement authorities. The detection and punishment
of health care fraud and abuse has recently been elevated to one of the highest
priorities of the United States Department of Justice. In addition, the
federal "whistleblower" statute permits private litigants to bring a "qui tam"
action on behalf of the United States government in connection with the
submission of allegedly false claims. The Department of Justice is required to
investigate claims raised by such qui tam litigants, who are entitled to
receive a percentage of any recoveries obtained in the action they initiate.

The governmental and third-party payor reimbursement system for
clinical laboratory services is complex and subject to variances among payors
and to variances in interpretation of billing regulations and guidelines. In
recognition of this, the Company will engage in ongoing review of its
billing practices. In this regard, the Company has engaged counsel to
assist the Company in developing its ongoing compliance program to meet the
requirements of the applicable federal guidelines.

The Office of Inspector General ("OIG") of the Department of Health
and Human Services, one of the federal agencies responsible for enforcing the
laws against fraud and abuse, has asserted that the antikickback statute is
violated by various practices that the OIG believes are common in the clinical
laboratory industry. These practices include installment payments and earn-out
provisions under agreements for the acquisition of physician owned
laboratories, inducing the ordering of unnecessary tests through test
requisition form design or test pricing to physicians, and "unbundling" a
package of generally automated tests to secure higher reimbursement.

In October 1994, the OIG issued a Special Fraud Alert entitled
"Arrangements for the Provision of Clinical Lab Services." The Fraud Alert
listed a number of practices that may violate the antikickback statute,
including the provision of computers and fax machines to physicians, free
laboratory testing for healthcare providers, their families and employees,
collection of bio-hazardous wastes from physician's offices unrelated to the
collection of specimens by the laboratory, waiver of charges to managed care
patients, and other examples.

California law also prohibits payments being made to physicians by
clinical laboratories as compensation or inducement for referrals of patients
or test specimens, regardless of the source of payment for such testing.
Laboratories which violate the California antikickback laws may be subject to
loss of licensure and substantial fines. In addition, a provider convicted
under such laws would be excluded from participation in the Medicare and
Medicaid programs. The Company believes that it does not violate these
requirements.

The "Health Insurance Portability and Accountability Act of 1996" was
signed into law on August 21, 1996. Most of its provisions became effective
January 1, 1997. The legislation contains significant changes in the scope,
enforcement and penalties for violations of the federal fraud and abuse laws.
It includes additional funding for programs to combat health care fraud,

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<PAGE> 23

higher penalties for violations, mandatory exclusions from participation in
Medicare and Medicaid for those convicted of health care fraud, and new
healthcare fraud offenses.

QUALITY ASSURANCE

CLIA 1967 and 1988. The Clinical Laboratory Improvement Act of 1967
("CLIA 1967") provides for the certification and regulation by HHS of certain
clinical laboratories, including those operated by the Company. The
Clinical Laboratory Improvement Amendments of 1988 ("CLIA 1988") subjects
virtually all clinical laboratories to the jurisdiction of HHS by establishing
national standards for assuring the quality of laboratory performance. The
Health Care Financing Administration within HHS ("HCFA") issued final
regulations applicable to all laboratories certified under CLIA 1967, which
became effective in 1990 and 1991. The regulations also included
self-implementing requirements of CLIA 1988.

HCFA has published several sets of final and proposed regulations to
implement CLIA 1988. Final regulations include those setting national
performance standards and establishing enforcement procedures and penalties.
The Company believes that it is in compliance in all material respects with
CLIA 1967, CLIA 1988 and all final regulations thereunder.

Although the CLIA 1988 requirements are expected to be phased in over
a period of several years, CLIA 1988 could have a substantial effect on the
laboratory testing industry. The recently issued regulations will establish
standards for the day-to-day operation of laboratories, and subject large
numbers of previously exempt facilities to government regulation for the first
time. The Company believes that compliance with the new law should not pose a
significant burden on the Company because it is already subject to
comprehensive regulation.

Among the classes of laboratories that may be most affected by the
implementation of CLIA 1988, however, are those laboratories located in
physicians' offices. The Company believes that many physician office
laboratories ("POLs") will choose to cease operation or to be acquired by an
independent laboratory rather than assume the expense and administrative burden
of complying with these quality standards.

Proposed legislation and regulations may ease the burden of compliance
with CLIA for POLs. CLIA 1988 already establishes categories of laboratories
for which compliance with the national standards will be waived. New
regulations make an exception for certain microscopy tests performed by
physicians for their own patients from certain provisions of the regulations.
The American Medical Association supports federal legislation which would
repeal the application of CLIA to POLs. If such legislation is passed, it
would be expected that physicians would operate POLs and not use independent
clinical laboratories for testing, which may adversely impact the business of
the Company.

Recently, HHS has also proposed or adopted various rules which will
ease some of the administrative burden of complying with CLIA. On September
13, 1995, HHS proposed new criteria to categorize specific laboratory tests as
waived from certain requirements of CLIA. As a result, it is expected that
more tests will be approved for waiver for use by laboratories. On September
15, 1995, HHS proposed a new subcategory of moderate procedures to be called

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<PAGE> 24
accurate and precise technology tests, which would be subject to less stringent
requirements. In addition, under the Alternative Quality Assessment Survey,
HCFA has extended the period between CLIA on-site surveys to four years with
self-assessments in certain situations where the laboratory has received good
results from an on-site survey. These developments would be helpful to POLs in
reducing the administrative burden of complying with CLIA.

CLIA ENFORCEMENT

HCFA will enforce its regulations by periodic, often unannounced,
inspections. Laboratories subject to these regulations also have to process
certain proficiency testing samples to ensure that the laboratory properly
performs testing. The Company has passed all such proficiency tests to date.
Currently, any failure to pass an inspection or meet the requirements of the
proficiency testing program could result in denial or cancellation of the
laboratory's approval to receive Medicare payments and/or the suspension,
revocation, or limitation of its license to engage in interstate commerce. Any
of these failures could result in the laboratory's losing its right to perform
certain types of testing, cancellation of the laboratory's approval to receive
Medicare payments for its services, or its being subjected to civil money
penalties, on-site monitoring or a plan of correction.

The OIG Work Plan for 1997 provides that the OIG will determine how
HCFA is enforcing CLIA and any recommendations for improvements. At HCFA's
request, the OIG will assess the extent to which cytotech workload records may
be falsified and the reliability of procedures in workload recordkeeping.

PROPOSED EXEMPTION FROM CLIA FOR CALIFORNIA

Under CLIA, states may be granted an exemption if a state's licensure
program and accreditation/licensure process are equal to or more stringent than
those of CLIA. Currently only two states, Washington and Oregon, have been
granted a CLIA exemption for all of their laboratories. In August 1995, New
York was granted a CLIA exemption for all but its POLs.

California's Department of Health Services submitted an application to
HCFA in late spring of 1996 for a CLIA exemption. As of December of 1996,
California was still waiting to see if its application would be approved. A
decision is expected by the Spring or Summer of 1997. If California is granted
an exemption, clinical laboratories would need to meet only California
standards, not those standards set by CLIA.

CERTIFICATION AND LICENSES

The federal government and the State of California impose various
certification and licensure obligations on clinical laboratory companies such as
the Company. The applicable certification and licensure programs establish
standards for the day-to-day operation of a clinical laboratory including, among
other things, the training and skills required of personnel and quality control.
Compliance with such standards is verified by periodic inspections by inspectors
representing the appropriate federal or state regulatory agencies. In addition,
federal and state law mandates proficiency testing, which involves testing of
control and comparison of actual results with established standards. The
Company believes it has all federal and state licenses,

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<PAGE> 25
certifications and permits necessary to conduct their business as a clinical
laboratory. The Company's laboratories will continue to be certified under
the Medicare and Medi-Cal programs as well as under CLIA 1988. Licensure will
also be maintained for the Company's laboratories under the laws of the
State of California.

OTHER REGULATIONS

Infectious Waste. Certain federal and state laws govern the handling
and disposal of infectious and hazardous wastes. Although the Company believes
that it is currently in compliance in all material respects with such federal
and state laws, failure to comply could subject the Company to fines, criminal
penalties and/or other enforcement actions.

Protection of Workers. Pursuant to the Federal Occupational Safety and
Health Act, laboratories have a general duty to provide a workplace to their
employees that is safe from hazard. Over the past years, the Occupational
Safety and Health Administration ("OSHA") has issued rules relevant to certain
hazards that are found in the laboratory. In addition, OSHA has adopted
regulations applicable to protection of workers from blood-borne pathogens.
Failure to comply with any final standard relating to blood-borne pathogens,
other applicable OSHA rules or with the general duty to provide a safe workplace
could subject an employer, including a laboratory employer, to substantial fines
and penalties. The Company believes that it is in compliance in all material
respects with applicable OSHA requirements.

HEALTH CARE REFORM

The entire health care industry is undergoing significant change.
While all third party payors are attempting to increase their control over the
cost, utilization and delivery of health care services, budgetary pressure on
the federal and state governments has led to calls for significant cutbacks in
reimbursement under the Medicare and Medicaid programs. Reductions in the
reimbursement rates of other third-party payors are also occurring. Many of
the laws discussed above continue to be subject to change under proposed
legislation. The Company cannot predict the effect health care reform or
changes in reimbursement practices may have on its business if
enacted or implemented, and there can be no assurance that such reforms or
practice changes would not have a material adverse effect on the Company.

COST CONTAINMENT PROGRAMS

a. Medicare/Medi-Cal Reimbursement

Fees for laboratory testing services to be reimbursed by Medicare or
Medi-Cal are required to be billed to Medicare or Medi-Cal directly and the
provider is required to accept Medicare or Medi-Cal reimbursement as payment in
full. In 1984, Congress established a reimbursement fee schedule for clinical
laboratory testing performed for Medicare beneficiaries (excluding hospital
in-patients). State Medicaid programs are prohibited from paying more than the
amount stipulated by the Medicare fee schedule for testing on behalf of
Medicaid beneficiaries. When initially established, the Medicare fee schedules
were set at 60% of prevailing local charges. Medicare reimbursement rates for
clinical laboratory testing have subsequently been reduced several times
pursuant to Congressional mandate. A ceiling on

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<PAGE> 26
payments to laboratories, commonly referred to as the "national cap" amount,
became effective in 1986. The national cap was initially set at 115% of the
nationwide median of local fee schedule rates for each test. Effective April
1, 1988, January 1, 1990, and January 1, 1991, the national cap was reduced to
100%, 93% and 88%, respectively, of the local fee schedule medians. The
Omnibus Budget Reconciliation Act of 1993 reduced the national cap for 1994,
1995, 1996 and thereafter to 84%, 80% and 76%, respectively of the local fee
schedule medians. In addition, for approximately 25 commonly performed tests,
the fee schedules were reduced by 8.3% on April 1, 1988. The reductions in
Medicare reimbursement rates described above have been offset to some extent by
increases in both the national cap and local fee schedules tied to the Consumer
Price Index ("CPI"). Laboratory fee increases tied to the CPI have been
limited to 2% for each of the years 1991, 1992 and 1993, and were eliminated
entirely for fiscal 1994 and 1995 but were reinstated for 1996 and 1997. The
effect of reduced reimbursement rates on the Company's revenues to date has been
significant, and will continue to effect the revenues of the Company.

In November of 1994, HCFA issued a proposal to change Medicare
policies concerning reimbursement for blood chemistry profiles. The proposed
changes would expand the list of tests that are considered to be parts of
automated panels. If adopted, such a proposal could have an adverse effect on
the Company's revenues. Another proposed change would require laboratories
performing certain automated blood chemistry profiles to obtain and document
the medical necessity of each test included in each profile test performed for
a Medicare beneficiary. If such a requirement were to be implemented,
the Company (and laboratories generally) would incur significant additional
costs associated with compliance. In addition, such a change could result in
more unreimbursed testing, since the necessary information may not always be
available from physicians to permit the Company to file valid claims with
Medicare. The Company cannot predict when or if these proposals will be
adopted. If enacted, such provisions could have a material adverse effect on
the Company.

DHS has asserted in a number of laboratory audits that the Medi-Cal
program is required to pay no more for testing than the lowest amount which a
laboratory charges any of its physician customers. A California appellate court
recently upheld this position. DHS has not made such a challenge to the Company
to date. Because the Company's payments from the Medi-Cal program do not
substantially exceed its charges to physicians, the Company does not expect
that the financial results of the Company would be adversely affected as a
result of a successful assertion of this position by DHS. Reimbursement
received by the Company from the Medi-Cal program represented approximately 13%
of the Company's net revenue during its last fiscal year.

b. Proposed Changes to Medicare/Medi-Cal Reimbursement

Several proposals have been made in recent years which could reduce
the level of Medicare reimbursement received by the Company.

In October 1996, under pressure from physicians and health industry
manufacturers, HCFA retreated from a directive that would have resulted in
lower Medicare payments for clinical laboratory tests that are not subject to
regulation under CLIA. The agency is continuing to study the issue and may
issue such regulations in the future for these procedures. The

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<PAGE> 27
American Medical Association opposes the change since many POLs perform waived
tests, which do not require certification under CLIA. These changes could lead
to a lower level of reimbursement for the Company for waived tests;
however, it will impact POLs disproportionately since they are often unwilling
to go to the expense to become certified under CLIA in order to perform
nonexempt tests.

A recent General Accounting Office ("GAO") Report would seek to
equalize profit rates on laboratory services provided to Medicare beneficiaries
and all other patients. The GAO concluded from its study that Medicare payment
policies overcompensate clinical laboratories because they provide profit rates
from Medicare which substantially exceed the laboratories' overall profit
rates. In January 1990, and again in January of 1995, the OIG called for
legislation that would permit Medicare to receive the benefit of discounts
furnished to physicians and other so-called "wholesale" accounts.

Another set of proposals, if enacted, would reimburse clinical
laboratory testing services as part of a larger "bundle" of healthcare
services. An October 1990 OIG monograph concluded that elimination of separate
Medicare reimbursement for clinical laboratory testing would reduce Medicare
expenditures. Under the OIG's "laboratory roll in" proposal, physicians would
be reimbursed an additional amount for each office visit they had with a
Medicare beneficiary. The physician would be responsible for paying for the
laboratory services out of this sum, and would presumably seek favorable
pricing arrangements. In addition, Congress has directed HHS to study and
report on the advisability of adopting certain "bundled" payment systems for
reimbursement of services provided by hospital outpatient departments. These
payment systems could be applied to other outpatient sites, including
independent clinical laboratories, at some point in the future. HCFA has also
proposed restricting Medicare coverage of diagnostic tests to those ordered by
the physician treating the patient.

In May 1995 a conflict arose between the California Medi-Cal program
and the OIG. The OIG found that Medi-Cal had overpaid providers $8 million in
1993 and 1994 and recommended that Medi-Cal recover the overpayments from
providers. The state agency disagreed, responding that it was not required to
follow Medicare guidelines. HHS holds that the Medicaid program must observe
Medicare rules governing reimbursement of clinical diagnostic laboratory
services, including schemes for bundling tests into automated panels. If this
dispute is resolved in HHS's favor, and bundling and other Medicare guidelines
are adopted in California, it could have a material adverse effect on
the Company's net revenue.

DHS has discussed negotiated laboratory service contracting for the
Medi-Cal program as a means of reducing Medi-Cal expenditures for laboratory
testing. For many testing procedures, a laboratory holding such a contract
would be the only laboratory in its area that Medi-Cal would compensate.
Non-contracting laboratories could still perform and receive compensation only
for those tests not included within the contracting program. California
currently has the statutory authority to implement such a program, but has not
done so. On April 2, 1993, DHS released its revised Strategic Plan for
Medi-Cal Managed Care to expand managed care access to Medi-Cal beneficiaries.
Under this plan, DHS would contract with only two managed care plans for each
of specified regions of the state. A pilot program is currently in place in
Sacramento County, and in 13 additional counties. It is unclear how Medi-Cal
managed care will affect the Company. However, the Company's
fee-for-service

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<PAGE> 28
business has always made a higher contribution to its operating margins than
its managed care business.

Medicare/Medi-Cal reimbursement accounted for approximately 33% of the
Company's net revenue in fiscal year 1997, and a substantial reduction in
Medicare/Medi-Cal payments to the Company could have a material adverse
effect on its operating results.

Non-Governmental Efforts. In an effort to control costs,
non-governmental health care payors may implement cost containment programs
which could adversely affect the Company's net revenue. For example, persons
enrolled in prepaid health care plans often do not have free choice as to where
they obtain laboratory services. Rather, the health plan may provide laboratory
services directly or contract with laboratories at favorable rates and require
its enrollees to obtain service only from such contracted laboratories. Some
insurance companies and self-insured employers also limit service to contracted
laboratories. To the extent such "closed" payment systems become more common in
the future and payors operate their own laboratories or the Company is unable to
obtain contracts to provide service or must discount its services to obtain such
contracts, the Company's results of operations could be materially adversely
affected. In fiscal 1997, 4% of the Company's net revenue was derived from
closed payment systems.

COMPETITION

The clinical laboratory testing industry in California is
characterized by intense competition. The Company faces competition from
numerous independent clinical laboratories, physician-owned laboratories and
hospital laboratories. Some of the Company's competitors operate on a regional
or nationwide basis and are larger and have substantially greater financial
resources than the Company.

The Company competes primarily on the basis of quality and service,
with a particular emphasis on accurate and rapid reporting of test results and
responsiveness to customers. Some of PCL's competitors compete on the basis of
discounted price and, as the Company has expanded into areas beyond Sacramento,
it increasingly has been exposed to such competition. The Company seeks to be
the most cost-effective producer wherever it competes, and believes that it
will be able to compete in markets where price is an important determinant in
laboratory selection. The Company's growth strategy may take it into markets
where competitive pressures may differ from those in its current service areas.

EMPLOYEES

As of May 15, 1997, and including employees acquired pursuant to the
MSI acquisition -- See "--MSI Stock Purchase" herein, the Company employed
approximately 1,166 people in the operation of its business. This total
consists of approximately 963 full time and 203 part time employees. Of such
1,166 employees, 141 were certified medical technologists.

ITEM 2. PROPERTIES

The Company's executive offices and all of its laboratories are
located in facilities held under operating leases expiring over varying
periods. The Company's patient service centers are

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<PAGE> 29
also held under leases expiring in one to ten years, many of which provide for
renewal options. See Note 6 of Notes to Financial Statements. Under the
Bankruptcy Code, the Company has the right, subject to the approval of the
Bankruptcy Court, under relevant provisions of the Bankruptcy Code, to assume
or reject unexpired real property leases. Certain parties to such real
property leases may file motions with the Bankruptcy Court seeking to require
the Company to assume or reject those leases. See "Item 3. Legal Proceedings,"
herein.

In this context, "assumption" requires that the Company cure, or
provide adequate assurance that it will cure, all existing defaults under the
lease and provide adequate assurance of future performance under the lease and
provide adequate assurance of future performance under relevant provisions of
the Bankruptcy Code; and "rejection" means that the Company is relieved from
its obligations to perform further under the lease. Rejection of a lease may
constitute a breach and may afford the non-debtor party the right to assert a
claim against the bankruptcy estate for damages arising out of the breach,
which claim shall be allowed or disallowed as if such claim had arisen before
the Petition Date.

The Company is in the process of moving its principal executive offices
from its previous location at 2495 Natomas Park Drive in Sacramento (the
"Headquarters") to the Company's main laboratory facility, located at 3301 C
Street, in Sacramento, and will be moving the Company's billing department to a
new facility, located at 201 Lathrop Way in Sacramento (the "Lathrop Premises").
The Bankruptcy Court authorized the Company to enter into a lease for the
Lathrop Premises on February 28, 1997. On May 21, 1997, the Bankruptcy Court
granted the Company's motion requesting authority to reject the Headquarters
lease on ten days' notice to the Headquarters lessor.

By order of the Bankruptcy Court, effective February 14, 1997, the
Company received approval to (a) reject 62 nonresidential real property leases;
(b) assume 149 nonresidential real property leases; and (c) extend the time,
through and including the Confirmation Date of its plan of reorganization,
within which it may assume or reject 16 of its remaining nonresidential real
property leases. As more fully described in "Item 3 - Legal Proceedings" herein,
assumption of leases requires the Company to cure, or provide adequate assurance
that it will cure, all existing defaults under the lease. On April 14, 1997, the
Bankruptcy Court entered an order approving certain procedures for assuming the
Company's remaining leases not previously assumed, rejected or slated for
rejection pursuant to the Plan (the "Remaining Leases").

ITEM 3. LEGAL PROCEEDINGS

Chapter 11 Reorganization

The Company, which has been experiencing significant operating losses
and facing severe liquidity problems, determined that it was not likely to meet
its cash repayment obligations on existing indebtedness, including
approximately $80.9 million of secured indebtedness due under the Credit
Agreement, and interest payments related to the Debentures. The Company
believed that further refinancings of its existing indebtedness would not be
sufficient to enable the Company to exist.

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<PAGE> 30
Accordingly, on November 8, 1996, the Company and its subsidiaries
commenced reorganization cases by filing voluntary petitions for relief under
chapter 11 of the Bankruptcy Code in the Bankruptcy Court. See "Item 1.
Business --Recent Developments --Chapter 11 Reorganization," above. Under
chapter 11, actions to enforce certain claims against the Company are stayed if
the claims arose, or are based on, events that occurred on or before the
Petition Date. The ultimate terms of settlement of these claims will be
determined in accordance with the terms of the Plan confirmed by the Bankruptcy
Court on April 18, 1997.

Since the Petition Date, the Debtors have continued in possession of
their properties and, as debtors in possession, are authorized to operate and
manage each of their respective businesses and enter into all transactions,
including obtaining services, supplies and inventories, that each could have
entered into in the ordinary course of business had there been no bankruptcy
filings. As debtors in possession, the Debtors may not engage in transactions
outside of the ordinary course of business without approval of the Bankruptcy
Court, after notice and hearing. The Company has sought and obtained orders
from the Bankruptcy Court intended to facilitate the normal operations of the
Company, including orders (i) authorizing the Company to maintain its
consolidated cash management system, (ii) authorizing the payment of certain
prepetition claims, including claims for employee business expenses, wages,
salaries, employee benefits and certain rent obligations, (iii) authorizing the
Company to use cash collateral and approving the Company's DIP Financing
Facility, as previously described, and (iv) approving certain premium financing
agreements.

On November 18, 1996, the United States Trustee appointed the
Committee pursuant to section 1102 of the Bankruptcy Code. The Committee has
the right to review and object to certain business transactions and
participated in the negotiation of the Company's plan of reorganization. See
"Item 1. Business --Recent Developments --Chapter 11 Reorganization," above.
Under the Bankruptcy Code, the Company will be required to pay legal and other
advisory fees of the Committee associated with the Bankruptcy Cases until the
Effective Date.

The Company has the right, subject to the approval of the Bankruptcy
Court, under relevant provisions of the Bankruptcy Code, to assume or reject
executory contracts and unexpired leases, including real property leases.
Certain parties to such executory contracts and unexpired leases with the
Company, including parties to such real property leases, may file motions with
the Bankruptcy Court seeking to require the Company to assume or reject those
contracts or leases.

In this context, "assumption" requires that the Company cure, or
provide adequate assurance that it will cure, all existing defaults under the
contract or lease and provide adequate assurance of future performance under
the contract or lease and provide adequate assurance of future performance
under relevant provisions of the Bankruptcy Code; and "rejection" means that
the Company is relieved from its obligations to perform further under the
contract or lease. Rejection of an executory contract or lease may constitute
a breach of that contract and may afford the non-debtor party the right to
assert a claim against the bankruptcy estate for damages arising out of the
breach, which claim shall be allowed or disallowed as if such claim had arisen
before the Petition Date.

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<PAGE> 31
By order of the Bankruptcy Court, effective February 14, 1997, the
Company received approval to (a) reject 62 nonresidential real property leases;
(b) assume 149 nonresidential real property leases; and (c) extend the time,
through and including the Confirmation Date of its plan of reorganization,
within which it may assume or reject 16 of its remaining nonresidential real
property leases. On April 14, 1997, the Bankruptcy Court entered an order
approving certain procedures for assuming the Company's remaining leases not
previously assumed, rejected or slated for rejection pursuant to the Plan (the
"Remaining Leases").

On December 19, 1996, the Bankruptcy Court entered an order
establishing January 31, 1997 as the Original Bar Date. On April 3, 1997, the
Bankruptcy Court entered an order establishing April 30, 1997 as the deadline
for filing proofs of claim with respect to plaintiffs in certain lawsuits who
did not receive notice of the Original Bar Date. All creditors (with certain
limited exceptions) must file proofs of claim against the Company with respect
to prepetition claims on or before the applicable bar dates or be forever
barred from (1) asserting claims that such person or entity possesses against
the Company and (2) voting upon, or receiving distribution under, any plan of
reorganization.

Prepetition claims that were contingent, unliquidated, or disputed as
of the Petition Date, including, without limitation, those that arise in
connection with rejection of executory contracts or unexpired leases, may be
allowed or disallowed depending on the nature of the claim. Such claims may be
fixed by the Bankruptcy Court or otherwise settled or agreed upon by the
parties and approved by the Bankruptcy Court.

Described below are certain legal proceedings involving the Company
that were in existence as of the Petition Date. All such proceedings have been
stayed pursuant to section 362 of the Bankruptcy Code, and can only proceed
with the approval of the Bankruptcy Court. As a general matter, the treatment
of claims arising prior to the Petition Date, including claims on account of
litigation, will be determined and paid pursuant to the terms of the Plan.
The Plan provides that following the Effective Date, such prepetition
litigation, as well as postpetition litigation involving claims based upon
prepetition events, will become subject to a permanent injunction. The Plan
further provides that the Company, the reorganized Company or the Committee may
resolve or adjudicate the amount of a prepetition litigation claim in the
manner in which such claim would have been resolved if the Company had not
instituted the Bankruptcy Cases. Additionally, the Bankruptcy Court may enter
orders modifying the automatic stay and/or permanent injunction to permit
certain matters to continue to be prosecuted in the courts or before
arbitrators where or before whom such matters are pending, generally for the
purpose of pursuing payment of such claims as are insured from third-party
insurers. Because of the bankruptcy proceedings, the Company's financial
exposure with respect to the prepetition litigation claims set forth in actions
currently pending against the Company is limited by the Plan and should not
have a material financial impact on the Company.

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<PAGE> 32
Prepetition Litigation

As previously disclosed in the Company's Annual Report on Form 10-K
for the fiscal year ended February 29, 1996, and in the Company's subsequent
Form 10-Q reports, there are several material pending legal proceedings against
the Company. On June 20, 1996, an action was filed against the Company in the
Superior Court of Sacramento under the caption Maintenance Management
Corporation v. Physicians Clinical Laboratory, Inc., Case No. 96AS03171. This
lawsuit relates to a management contract entered into by and between the
Company and Maintenance Management Corporation ("MMC"), and alleges breach of
contract and fraudulent and negligent misrepresentation. The complaint seeks
compensatory damages in excess of $3.0 million, interest and expenses, as well
as exemplary damages. Notwithstanding the limitations on the Company's
liability exposure resulting from the bankruptcy proceedings, as described
above, the Company does not believe that either the merits of these claims, if
any, justify the amount of damages sought, or that this lawsuit, if adversely
determined, would have had a material adverse effect on the financial condition
of the Company.

There is a dispute pending between the Company and Medical Group
Pathology Laboratory, Inc. ("MGPL"), the seller of the Santa Barbara facility
which the Company acquired in 1992 (the "Acquisition"), relating to the payment
obligations under the Agreement of Purchase and Sale of Assets between the
Company and MGPL (the "MGPL Agreement"). On November 8, 1995, MGPL commenced
an action (the "Litigation") against the Company in the Superior Court of the
State of California, Santa Barbara County, captioned Medical Group Pathology
Laboratory, Inc. v. Physicians Clinical Laboratory, Inc. (Case No. 210318).
The complaint alleges breach of the promissory note executed by the Company in
connection with the Acquisition and failure to pay amounts due thereunder
equalling $1,169,505 plus interest and late fees, and seeks compensatory
damages in the amount of sums allegedly due, in addition to unspecified general
damages and attorney's fees. In December, 1995, a default was entered against
the Company in the Litigation. The Company has no substantive defenses to the
Litigation. The Company was able to have the default set aside before a
judgment was entered in connection therewith. As of the Petition Date (at
which time the Litigation was stayed), a standstill agreement with MGPL was in
effect, pursuant to which the parties agreed to attempt in good faith to
determine the precise amount owed to MGPL by the Company under the MGPL
Agreement. As of November 30, 1996, the outstanding principal amount of the
Note issued by the Company to MGPL in connection with the MGPL Agreement was
$890,000.

In the ordinary course of business, several lawsuits have been filed
against the Company by former employees alleging, among other things,
employment discrimination and harassment, fraud, wrongful (including
retaliatory) discharge in violation of public policy, and related claims,
including intentional and negligent infliction of emotional distress, loss of
consortium, breach of contract and breach of the covenant of good faith and
fair dealing. A number of such suits include claims against current employees
of the Company. Any existing indemnification arrangements between any such
employees and the Company with respect to such claims are subject to the terms
of the Plan as prepetition claims, as described above.

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<PAGE> 33
Additionally, several lawsuits have been filed against the Company by
former patients alleging medical malpractice and requesting punitive damages.
Notwithstanding the limitations on the Company's liability exposure resulting
from the bankruptcy proceedings, as described above, the Company does not
expect these matters, either individually or in the aggregate, to have a
material adverse effect on the financial condition of the Company. Moreover,
the Company believes that its insurance policies may cover some or all
judgments against the Company, if any, in these matters.

To date, the Company has not experienced any significant liability
with respect to such claims.

Postpetition Litigation

On or about January 22, 1997, Taylor R. McKeeman, the Company's former
Vice President for Laboratory Operations, filed a Request for Payment of
Administrative Expense with respect to a prepetition Separation Agreement
between the Company and Mr. McKeeman. Under the Separation Agreement, Mr.
McKeeman is entitled to receive a severance payment in the event he is
terminated after a "Change in Control" occurs, as such term is defined in the
Separation Agreement. This request was denied by order of the Bankruptcy
Court, entered on March 19, 1997, because (i) no Change in Control occurred
prior to the termination of Mr. McKeeman's employment and (ii) any claim of Mr.
McKeeman against the Company's bankruptcy estates arising out of the Separation
Agreement constitutes a prepetition claim. Mr. McKeeman filed a notice of
appeal on or about March 5, 1997. If Mr. McKeeman were to prevail on appeal,
the Company would incur an administrative claim against their estates in the
approximate amount of $300,000.

I-31
<PAGE> 34
The Company maintains property, casualty, liability and other types of
insurance on various aspects of its business and properties. The Company
believes, based on its past experience, that its insurance coverage is adequate
for its business.

Regulatory Investigation

In April of 1997, the Company received a subpoena to furnish certain
documents to the United States Department of Defense ("DOD") with respect to the
Company's Civilian Health and Medical Program of Uniformed Services ("CHAMPUS")
billing practices. The Company has produced and will continue to produce
documents in response to the DOD's subpoena. In late May 1997, the Company was
notified that its Medicare and Medi-Cal billing practices also were undergoing
review by the United States Department of Health and Human Services ("HHS"), and
in early June of 1997, the Company received a subpoena to furnish certain
documents to HHS in connection with such review. The Company is cooperating with
DOD and HHS in such investigations. The Company believes that these
investigations may be similar to investigations being conducted by DOD and HHS
with respect to the billing practices of the clinical laboratory testing
industry. The Company further believes that these investigations are in their
early stages. There can be no assurance that the result of such investigations
as they relate to the Company would not subject the Company to significant civil
or criminal liability (which could include substantial fines, penalties or
forfeitures, and mandatory or discretionary exclusion from participation in
Medicare, Medi-Cal and other government funded healthcare programs), which could
have a material adverse effect on the financial condition of the Company. See
"Item 1. Business - Government Regulation - Fraud and Abuse Laws," above.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company did not hold its annual meeting and did not submit any
matters to a vote of security holders during the fiscal year 1997. Accordingly,
each Director whose term was to expire in 1996 will continue to serve until the
Effective Date.

I-32
<PAGE> 35
PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS

MARKET INFORMATION

The Company's Common Stock was traded over-the-counter on the National
Association of Securities Dealers Automated Quotation (Nasdaq) National Market
System under the symbol "PCLI". On October 13, 1995, the Company was notified
by the Nasdaq Stock Market Listing Qualification Committee (the "Listing
Committee") that the Company's common stock would be removed from listing on
the Nasdaq National Market but will be listed on the Nasdaq SmallCap Market due
to the Company's inability to satisfy the Nasdaq National Market's net tangible
assets requirement. The Company had been granted a temporary exception to the
Nasdaq National Market's net tangible asset requirement, which exception
expired on October 12, 1995. The Company's common stock began to trade on the
Nasdaq SmallCap Market on Monday, October 16, 1995. On October 25, 1995, the
Listing Committee determined not to extend certain exceptions to the applicable
listing requirements, and the Company's common stock was removed from trading
on the Nasdaq SmallCap Market. The Company's common stock currently trades in
the over-the-counter market. The following table sets forth the range of high
and low reported sale prices per share for the fiscal periods indicated, and
reported on the Nasdaq National Market System and the Nasdaq SmallCap Market,
as applicable. Quotations represent prices between dealers and do not reflect
retail markups, mark-downs or commissions and may not necessarily represent
actual transactions. Under the Plan, the Company's stockholders will only be
entitled to receive a pro rata share of the New Warrants, which, in the
aggregate, comprise the right to purchase 131,579 shares of New Common Stock,
which constitutes 5% of the New Common Stock to be issued and outstanding
immediately after the Effective Date, on a fully diluted basis, at the price of
$13.30 per share.

After the Effective Date, the reorganized Company will have less than
300 shareholders. Accordingly the reorganized Company intends to de-register
the New Common Stock under the Securities Exchange Act of 1934.
Notwithstanding the foregoing, the reorganized Company will continue to file on
a voluntary basis periodic reports with the United States Securities and
Exchange Commission as required by the terms of the Indenture.

<TABLE>
<CAPTION>
PRICE RANGE
OF COMMON STOCK
<S> <C> <C>
LOW HIGH
--- ----
YEAR ENDED FEBRUARY 29, 1996:
First Quarter . . . . . . . . . . . . . . . 5 3/4 10 1/4
Second Quarter . . . . . . . . . . . . . . . 2 3/8 6 3/4
Third Quarter . . . . . . . . . . . . . . . 1/4 3 1/4(1)
Fourth Quarter . . . . . . . . . . . . . . . 5/16(1) 2 3/8(1)

YEAR ENDED FEBRUARY 28, 1997:
First Quarter . . . . . . . . . . . . . . . 3/4(1) 1 5/8(1)
Second Quarter . . . . . . . . . . . . . . . 3/8(1) 1(1)
Third Quarter . . . . . . . . . . . . . . . 3/32(1) 7/8(1)
Fourth Quarter . . . . . . . . . . . . . . . 1/8(1) 5/8(1)
</TABLE>

On May 19, 1997, the reported closing sale price per share was 5/32.

__________________________

(1) Reflects high and low reported bid price in the over-the-counter market.

II-1

<PAGE> 36
HOLDERS

The number of holders of record of the Company's Common Stock as of
February 7, 1997 was 194.

DIVIDENDS

The Company has not paid dividends to its shareholders since it became
a public company. The Company is subject to restrictions in the Credit
Agreement, which currently forbid payment of dividends. Based on the Company's
current financial situation, the Company is unable to pay dividends to its
shareholders.

CERTAIN CORPORATE GOVERNANCE MATTERS

Pursuant to Section 2115 of the California General Corporation Law, as
amended to date, certain provisions of California law are applicable to a
corporation not incorporated in California (a "foreign corporations") if such
foreign corporation has more than one-half of its business conducted in
California (determined by certain property, payroll, and sales factors) and
more than one-half of its outstanding voting securities held of record by
persons having addresses in California (excluding "street name" shares except
in certain circumstances). Section 2115 provides that if a foreign
corporation, such as the Company, meets the foregoing criteria, then provisions
of the California law relating primarily to shareholders' voting rights,
corporate distributions, and the election, removal and indemnification of
officers and others, will apply to such corporation "to the exclusion of the
law of the jurisdiction in which it is incorporated." The purpose of this law
is to afford certain protections to California creditors and shareholders of
foreign corporations that have specified minimum contacts in California. The
applicability of Section 2115 to foreign corporations is to be redetermined
annually, and the provisions of Section 2115 will cease to apply if the
specified criteria are not met. In addition, Section 2115 does not apply to a
corporation which has outstanding securities listed on the New York Stock
Exchange or the American Stock Exchange, or to a corporation which has
outstanding securities designated as qualified for trading as a national market
security on the Nasdaq Stock Exchange if such corporation has at least 800
holders of its equity securities as of the record date of its most recent
annual meeting of shareholders.

As the Company's common stock was removed from listing on the Nasdaq
National Market as of October 16, 1995, the Company no longer qualifies for this
exemption from the provisions of Section 2115. Section 2115 provides that
Section 2115 will be inapplicable to foreign corporations with respect to which
a final order has been entered by a court of competent jurisdiction declaring
that such corporation no longer meets all of the required criteria for the
application of Section 2115. Section I of the Confirmation Order, entered by
the Bankruptcy Court on April 23, 1997, declared that Section 2115 will be
inapplicable to the reorganized Company by virtue of the fact that as of the
Effective Date, over

II-2
<PAGE> 37
50% of the common stock of the reorganized Company will be held of record by
persons having addresses outside of the State of California, constitutes a
final order within the meaning of Section 2115(d).

ITEM 6. SELECTED FINANCIAL DATA

SELECTED FINANCIAL DATA

The selected financial data presented below at February 28 or 29, 1993,
1994, 1995, 1996 and 1997, and for each of the five fiscal years in the period
ended February 28, 1997, have been derived from the audited financial statements
of the Company. The selected financial data set forth below should be read in
conjunction with the financial statements of the Company and related notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Annual Report.

II-3
<PAGE> 38
<TABLE>
<CAPTION>
Fiscal Year Ended February 28 (29),
----------------------------------- -------------------------------
1993 1994 1995 1996 1997
-------- -------- --------- --------- ---------
(In thousands, except ratios and per share amounts)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue ................................ $ 40,685 $ 67,795 $ 111,111 $ 90,392 $ 62,831

Direct laboratory costs .................... 13,676 21,821 35,335 31,881 23,117
Laboratory support costs ................... 7,310 13,652 24,741 26,509 20,014
-------- -------- --------- --------- ---------
Laboratory profit .......................... 19,699 32,322 51,035 32,002 19,700

Selling, general and administrative ........ 7,970 17,008 26,627 27,739 24,881
Provision for doubtful accounts ............ 1,586 2,502 4,319 30,539 8,843
Depreciation, amortization and write down
of intangible assets ..................... 2,624 4,797 9,881 36,327 69,070

Credit restructuring costs ................. -- -- -- 4,904 1,559
Non-recurring acquisition
integration expense ...................... -- -- 9,250 -- --
-------- -------- --------- --------- ---------
Operating income (loss) .................... 7,519 8,015 958 (67,507) (84,653)
Interest expense ........................... (1,012) (2,981) (9,013) (12,899) (15,839)

Non operating income (expense), net ........ (155) 299 270 (322) (1,687)
Litigation settlement ...................... -- (792) -- -- --
-------- -------- --------- --------- ---------

Income (loss) before income taxes .......... 6,352 4,541 (7,785) (80,728) (102,179)
Provision (benefit) for income taxes ....... 2,800 1,831 (2,189) (1,543) --
-------- -------- --------- --------- ---------
Loss before extraordinary gain ............. 3,552 2,710 (5,596) (79,185) (102,179)

Extraordinary gain on extinguishment of debt -- -- -- -- 3,500
-------- -------- --------- --------- ---------
Net income (loss) .......................... 3,552 2,710 (5,596) (79,185) (98,679)
======== ======== ========= ========= =========

Net income (loss) per share ................ $ 0.72 $ 0.44 $ (0.93) $ (13.13) $ (16.28)

Weighted average common shares
outstanding .............................. 4,919 6,220 6,013 6,030 6,063
======== ======== ========= ========= =========

Ratio of earnings to fixed charges (1) ..... 7.28 2.52 0.14 N/A N/A
Dividends declared per share ............... $ -- $ -- $ -- $ -- $ --
BALANCE SHEET DATA:

Working capital ............................ $ (479) $ 9,861 $ 17,243 $(135,931) $ (7,132)
Total assets ............................... 42,784 78,813 158,044 91,412 25,772
Total long-term indebtedness ............... 9,381 46,703 114,397 3,570 631
Stockholders' equity ....................... 17,302 19,992 14,548 (64,613) (163,257)
</TABLE>

___________________

(1) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" consists of income before income taxes, interest on
indebtedness and imputed interest on capital lease obligations; "fixed
charges" consists of interest on indebtedness and imputed interest on
capital lease obligations.

II-4
<PAGE> 39
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the
financial statements of the Company and related notes included elsewhere in
this Annual Report.

CHAPTER 11 REORGANIZATION

On November 8, 1996, the Company and its subsidiaries commenced
reorganization cases by filing voluntary petitions for relief under chapter 11
of the Bankruptcy Code in the Bankruptcy Court. (See "Liquidity and Capital
Resources," below).

During the fiscal year ended February 28, 1997, the liquidity and
operations of the Company continued to be adversely affected by downward
pressure on reimbursement reserves, billing system/process challenges and
accounts receivable collection problems. As previously disclosed, the Company
has been in default since September 1995 with respect to principal and interest
judgments with respect to approximately $80.9 million of secured indebtedness.
The Company has also been in default since September 1995 with respect to
interest payments related to its $40 million 7.5% Convertible Subordinated
Debentures due 2000 (the "Debentures") and the Notes issued by the Company in
connection with the acquisition of Medical Group Pathology Laboratory and
Pathologists' Clinical Laboratories of Glendale, Inc.

From September 1995 through the Petition Date, the Company experienced
severe cash flow problems, a reduction in third-party payor reimbursement
rates, billing and collection problems and effects of significant changes in
the health care industry. As a result of their inability to pay their
obligations when they became due, as well as the poor industry conditions
referred to above, the Company began taking steps to seek an infusion of new
capital or a strategic transaction (e.g., a merger or sale of the business).
The Company concluded that absent the provision of new capital or consummation
of a strategic transaction, the Company would not be likely to be able to
continue to exist as a going concern.

Accordingly, in June 1995, the Company retained the investment banking
firm of DLJ to seek either a strategic transaction or a capital infusion for
the Company. From June 1995 through the Petition Date, DLJ and the Company's
Board of Directors engaged in discussions with numerous industry parties as
well as financial institutions, with respect to a potential transaction or
transactions that could provide the Company with sufficient liquidity to
survive as a going concern.

As a result of the efforts of the Company and DLJ, only one offer to
make an investment in the Company surfaced that the Company believed was
favorable to its creditors and shareholders. This offer was made by Nu-Tech in
conjunction with the Senior Lenders. After months of negotiations, on November
7, 1996, the Company, Nu-Tech and the Senior Lenders entered into the
Prepetition Termsheet providing for a new investment of approximately $15
million into the Company.

The Prepetition Termsheet formed the basis for the Company's plan of
reorganization (see "Note 2. Plan of Reorganization," herein), and paved the
way for the Company's chapter 11

II-5
<PAGE> 40
filing, the restructuring of the Company's debt and the acquisition of a
majority of the Company by Nu-Tech. Representatives of each of the respective
Debtors determined that filing the chapter 11 petitions would best give the
Debtors the needed time and flexibility to consummate the restructuring of the
Company contemplated in the Prepetition Termsheet.

BACKGROUND

The Company was incorporated in April 1992 to succeed to the business
of the Predecessor Partnership, which was formed in 1986 to perform a portion
of the laboratory testing required by three Sacramento-based hospital groups.
Together with a group of individual pathologists, the three hospital groups
formed the Predecessor Partnership which acquired the assets of a reference
laboratory.

The Predecessor Partnership incurred expenses in excess of revenues in
each of its fiscal years through fiscal year 1990. In the fourth quarter of
fiscal year 1990, the Company commenced implementation of a program designed to
increase revenues both through internal growth and acquisitions, and to improve
profitability by enhancing operating efficiencies. Since the fourth quarter of
fiscal year 1990, the Company has restructured its sales and marketing
function, established a field service organization dedicated to supporting
customer relations, and opened or acquired more than 140 new patient service
centers. During this period, the Company also implemented a variety of
measures designed to improve operating efficiencies and completed 27
acquisitions. The Company's net revenue increased from $40.7 million to $111.1
million (approximately 173%) from fiscal 1993 to fiscal 1995, and declined from
$111.1 million to $62.8 million (approximately 43%) from fiscal 1995 to fiscal
1997. Operating margins have declined from 18.5% in fiscal 1993, to 0.9% in
fiscal year 1995, and to (134.7%) in fiscal year 1997.

In April 1994, the Company completed its acquisition of the California
laboratory operations of Damon. This acquisition increased the Company's net
revenue and testing volume by approximately 51% and 71%, respectively. The
Company tried to integrate the Damon operations into the Company's existing
business through the establishment of a regional laboratory in Burbank. The
cost of integration of the acquisition of Damon's California operations was
approximately $9.3 million (primarily for redundant payroll, facility and
outside services costs) for the fiscal year ended February 28, 1995. This
amount is included in the Company's Statements of Operations in nonrecurring
acquisition integration expense.

As a result of delays due to poor planning in the integration of
certain of the Damon operations, declining reimbursements from insurance payers,
Medicare and MediCal and billing and collection problems, the Company began to
experience severe cash flow problems in the second half of fiscal 1995. The
Company failed to make the March 31, 1995 principal and interest payment under
the Credit Agreement and the due date was extended by its bank group, led by
Wells Fargo Bank, N.A., to April 24, 1995. When the April 24, 1995 due date was
not met, the Company entered into negotiations for the restructuring of its bank
debt. The negotiations resulted in the third and fourth amendment to the Credit
Agreement. As a result of insufficient cash flows caused by, among other
things, billing and collection problems and failure to integrate the Damon
operations and, to a lesser extent, reductions in third party payor
reimbursement rates, and effects and changes in the health care industry, the
Company has failed to comply with the terms of the Credit Agreement, as amended.
In addition, the Company failed to make four interest payments each in the
amount of $1.5 million in respect of its Debentures

II-6
<PAGE> 41
due on August 15, 1995, February 15, 1996, August 15, 1996 and February 17,
1997. Failure to pay the interest with respect to the Debentures, as well as
failure to timely pay principal and interest with respect to the loans under
the Credit Agreement, constituted defaults under the Credit Agreement and the
Indenture governing the Debentures.

The removal of the Company's common stock from listing on the Nasdaq
National Market System in October of 1995 constituted a Redemption Event under
the Company's Indenture governing its Debentures. Such Redemption Event
required the Company to offer to repurchase the Debentures from the holders
thereof at a redemption price equal to 101% of the principal amount thereof
plus accrued and unpaid interest, if any. Written notice of the occurrence of
such Redemption Event was given to the registered holders of the Debentures on
November 2, 1995, and no such holder perfected its right to redeem such
Debentures within the period provided under the Indenture. In addition, under
the terms of the Registration Rights Agreement between the Company and the
holders of the Debentures, the Company is obligated to maintain an effective
registration statement covering the Debentures and the Company's common stock
with respect to which the Debentures are convertible.

CONSOLIDATED RESULTS OF OPERATIONS

The condensed consolidated financial statements have been presented on
the basis that the Company is a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. As a result of the chapter 11 filing and circumstances relating
to this event, realization of assets and satisfaction of liabilities is subject
to uncertainty. The accompanying condensed consolidated financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities and commitments in the ordinary
course of business. The condensed consolidated financial statements do not
include any of the adjustments to the assets or liabilities that may result
from the outcome of the bankruptcy proceedings. The ability of the Company to
continue as a going concern is dependent on, among other things, future
profitable operations, compliance, until the Effective Date, with the DIP
Financing Facility and the ability to generate sufficient cash from operations
and obtain financing sources to meet future obligations.

II-7
<PAGE> 42
RESULTS OF OPERATIONS

The following table sets forth for the periods indicated certain
financial data as a percentage of net revenue:

<TABLE>
<CAPTION>
Year Ended February 28 (29),
-----------------------------------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net revenue .................. 100.0% 100.0% 100.0% 100.0% 100.0%
Direct laboratory costs ...... 33.6 32.2 31.8 35.3 36.8

Laboratory support
costs ...................... 18.0 20.1 22.3 29.3 31.8
----- ----- ----- ----- -----
Laboratory profit ............ 48.4 47.7 45.9 35.4 31.4
Selling, general and
administrative ............. 19.6 25.1 24.0 30.7 39.6
Provision for doubtful
accounts ................... 3.9 3.7 3.9 33.8 14.1
Depreciation and amortization 6.4 7.1 8.9 40.2 109.9

Credit restructuring
costs ...................... -- -- -- 5.4 2.5

Non recurring acquisition
integration expense ........ -- -- 8.3 -- --
----- ----- ----- ----- -----
Operating income (loss) ...... 18.5 11.8 0.9 (74.7) (134.7)
Interest expense ............. (2.5) (4.4) (8.1) (14.3) (25.2)
Non operating income
(expense), net ............. (0.4) 0.4 0.2 (0.4) (2.7)

Litigation settlement ........ -- (1.2) -- -- --
----- ----- ----- ----- -----
Income (loss) before income
taxes ...................... 15.6 6.6 (7.0) (89.3) (162.6)
Provision (benefit) for income
taxes ...................... 6.9 2.6 (2.0) (1.7) --
----- ----- ----- ----- -----
Loss before extraordinary gain 8.7 4.0 (5.0) (87.6) (162.6)
Extraordinary gain ........... -- -- -- -- 5.6
----- ----- ----- ----- -----
Net income (loss) ............ 8.7 4.0 (5.0) (87.6) (157.0)
===== ===== ===== ===== =====
</TABLE>

II-8
<PAGE> 43
The Company recognizes revenue based on amounts billed or levels of
reimbursement sustained by third-party payors.

Direct laboratory costs represents variable costs directly
attributable to the performance of laboratory testing. Laboratory support
costs represents costs indirectly attributable to laboratory testing, including
patient service center expense, courier and vehicle expense, and customer
service expense.

Inflation has had no material impact on the Company's net revenue or
net income. Since insurance companies, HMOs, Medicare and MediCal, and other
third-party payors are the principal source of payments for the Company's
services, the identity of those payors and the prices which such payors have
established or are willing to pay for the Company's services have been the
principal factors for price changes which may affect the Company's net revenue.
Inflation has not had a material impact on the Company's costs of operations.
Due to increased efficiency and volume of testing, the Company's costs per test
declined in the 1991 and 1992 fiscal years as fixed costs were spread over a
greater testing volume. The Company's cost per test did not materially change
from fiscal year 1995 to fiscal year 1996 or from fiscal year 1996 to fiscal
year 1997.

Reform of the U.S. health care delivery system continues to be an
important issue for government, the public and healthcare providers. The
ultimate effect of any such reforms on the industry and the Company is
uncertain at this time. See "Item 1. Business --Government Regulation
- --Health Care Reform," above.

Effective August 1, 1992, the reorganization of the Company resulted in
the Company becoming a taxable corporation.

FISCAL YEAR ENDED FEBRUARY 28, 1997 COMPARED TO FISCAL YEAR ENDED FEBRUARY 29,
1996

Net Revenue fell from $90.4 million in fiscal year 1996 to $62.8
million in fiscal year 1997, a decrease of 30.5%. The revenue reduction is the
result of the loss of customers, decreased reimbursement from third party payors
and the elimination of some unprofitable capitated contracts.

Direct laboratory expense fell from $31.9 million for the fiscal year
ended February 29, 1996, to $23.1 million for the fiscal year ended February
28, 1997. This represents a 27.6% decrease in expense. As a percent of net
revenue, direct laboratory expense increased from 35.3% for fiscal year 1996 to
36.8% for fiscal year 1997. The reduction in direct expense is the result of
the reduction of related direct expenses as accessions were reduced. Direct
laboratory expenses as a percentage of net revenues increased because of the
reduction in net revenues represented by reduced reimbursement rates.

Laboratory support expense fell from $26.5 million in fiscal year 1996
to $20.0 million in fiscal year 1997, a decrease of 24.5%. As a percent of net
revenue, laboratory support expense

II-9
<PAGE> 44
increased from 29.3% in fiscal year 1996 to 31.9% in fiscal year 1997. As
accessions are reduced, the Company continues to reduce these expenses but the
reduction in net revenues represented by reduced reimbursement rates outweighs
such expense reduction.

Selling, general and administrative expense decreased from $27.7
million for fiscal year 1996 to $24.9 million for fiscal year 1997. Fiscal year
1997 included a provision of $3.7 million for lease liability of abandoned
premises. As a percent of net revenue, selling, general and administrative
expense increased from 30.7% to 39.6% for fiscal years ended February 29, 1996
and February 28, 1997, respectively, as a result of the fact that the Company
failed to reduce such expenses commensurate with reduced accessions and as a
result of the lease liability provision referred to above.

Provision for doubtful accounts decreased from $30.5 million for
fiscal year 1996 to $8.8 million for the fiscal year 1997. Fiscal year 1996
included a $25.4 million write down of uncollectible accounts receivable. The
fiscal year 1997 provision has been recorded based upon actual collection
history and management's assessment of the health of the California market and
the economy as a whole.

Depreciation, amortization and write down of intangible assets
increased from $36.3 million for fiscal year 1996 to $69.1 million for fiscal
year 1997. The Company has evaluated the future value of its intangible assets
as of February 28, 1997, considering the significant effects of third party
payor reimbursement declines and the significant changes in the health care
industry, which have caused adverse effects upon cash flow and results of
operations. As of February 28, 1997, the Company recorded a write down of
$59.4 million, thus eliminating all intangible assets on its books.

Operating income fell from a loss of $67.5 million for the fiscal year
ended February 29, 1996, to a loss of $84.7 million for the fiscal year ended
February 28, 1997. For fiscal year 1997, $1.6 million of the loss is related
to credit restructuring expense, $59.4 million is related to the write-off of
intangibles and $4.4 million is related to lease liability related to abandoned
premises.

Interest expense increased from $12.9 million in fiscal year 1996 to
$15.8 million in fiscal year 1997. The increase is related to penalties
associated with defaults on existing loan balances.

Extraordinary gain on debt existing of $3.5 million for fiscal year
1997 results from a payment made by a guarantor of the Company's loans for such
guarantee.

Net income decreased from a loss of $79.2 million for fiscal year 1996
to a loss of $98.7 million for fiscal year 1997.

II-10
<PAGE> 45
FISCAL YEAR ENDED FEBRUARY 29, 1996 COMPARED TO FISCAL YEAR ENDED FEBRUARY 28,
1995

Net revenue fell from $111.1 million in fiscal year 1995 to $90.4
million in fiscal year 1996, a decrease of 18.6%. This decrease is the result
of reduced reimbursement from third party payors, the elimination of some Damon
acquired accounts as a part of the Damon acquisition and inclement weather
experienced in California in the first quarter of fiscal year 1996.

Direct laboratory costs fell from $35.3 million for fiscal year 1995
to $31.9 million in fiscal year 1996. This represents a 9.6% reduction in
expense. As a percent of net revenue, direct laboratory costs increased from
31.8% in fiscal year 1995 to 35.3% in fiscal year 1996. The increase in direct
laboratory expense as a percent of net revenue is the result of reduced
reimbursement from third party payors while volumes were held essentially
constant. Additionally, poor weather in the first fiscal quarter of 1996
resulted in reduced revenue while staffing was maintained.

Laboratory support expense grew from $24.7 million in fiscal year 1995
to $26.5 million in fiscal year 1996. As a percent of net revenue laboratory
support expense increased from 22.3% in fiscal year 1995 to 29.3% in fiscal
year 1996. The increased laboratory support expense came as a result of
increased expenditures on patient service centers as services were expanded to
cover areas served by the Damon acquisition. Reduced reimbursement also
affected these percentages.

Selling, general and administrative expense increased from $26.6
million to $27.7 million for fiscal years 1995 and 1996, respectively. As a
percent of net revenue, selling, general and administrative expense increased
from 24.0% for fiscal year 1995 to 30.7% for fiscal year 1996. This increase
is an administrative expense related to fees associated with unconsummated
acquisitions, rent liability for abandoned premises and an accrual for
maintenance contracts in dispute.

Provision for doubtful accounts increased from $4.3 million for fiscal
year 1995 to $30.5 million for fiscal year 1996. Due to the significant
changes occurring in the health care industry related to managed care, billing
system/process challenges and accounts receivable collection problems, the
Company has written down its accounts receivable by $25,440,000. During the
year, intensive efforts were put forth to gather billing and eligibility
information in order to process unbilled claims and collect past due accounts.
The Company was able to bill and collect some past due accounts receivable, but
the remainder was considered uncollectible. Because the factors listed above
continue to occur, it is reasonably possible that the Company's estimate of the
net realizable value of accounts receivable will change in the near term.

Depreciation, amortization and write down of intangible assets
increased from $9.9 million in fiscal year 1995 to $36.3 million in fiscal year
1996. The Company has evaluated the future value of its intangible assets as
of February 29, 1996, considering the significant effects of third party payor
reimbursement declines and the significant changes in the health care industry,
which have caused adverse effects upon cash flow and results of operations. As
of February 29, 1996, the Company recorded a write-down of $25,000,000 to
intangible assets which was allocated to Goodwill. The amount of the
write-down was based upon a Board-approved restructuring plan

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<PAGE> 46
prepared by investment bankers engaged to assist and advise the Company on a
proposed restructuring of the Company's indebtedness. Because the
restructuring plan is proposed and has not been accepted by all parties, it is
reasonably possible that the Company's estimate of the recoverable amount of
goodwill will change in the near term.

Operating income fell from $958,000 for fiscal year 1995 to a loss of
$67.5 million for fiscal year 1996. As a percent of net revenue, operating
income fell from 0.9% to (74.7%) for fiscal years 1995 and 1996, respectively.
This decrease resulted from the loss of revenue associated with reduced
reimbursement from third party payors and increased laboratory support cost
associated with servicing Damon acquisition associated accounts. Additionally,
$4.9 million of the fiscal year 1996 expense is related to credit restructuring
costs, $25.4 million provided for uncollectible accounts receivable, and $25.0
million related to write down of Goodwill and customer lists.

Interest expense increased from $9.0 million in fiscal year 1995 to
$12.9 million in fiscal year 1996, an increase of 43.3%. This increase is due
to having a full year of interest expense related to the Damon acquisition in
fiscal year 1996 (approximately $3.0 million) and included penalties associated
with defaults on existing loan balances (approximately $.09 million).

Net income decreased from a loss of $5.6 million in fiscal year 1995
to a loss of $79.2 million in fiscal year 1996.

REORGANIZATION COSTS

Reorganization costs includes all costs associated with the Bankruptcy
Cases. Pursuant to the guidance provided in Statement of Position (SOP) 90-7
the Company segregated on its statement of operations for the fiscal year ended
February 28, 1997 a one-time non-recurring expense related to the credit
restructuring and preparations for the chapter 11 filing in the amount of
$1,558,820 for professional consultants' fees and out-of-pocket expenses.

LIQUIDITY AND CAPITAL RESOURCES

Chapter 11 Filing

As discussed previously, PCL and its subsidiaries filed voluntary
petitions for relief under chapter 11 of the Bankruptcy Code on November 8,
1996. Under chapter 11, actions to enforce certain claims against the Company
are stayed if the claims arose, or are based on, events that occurred on or
before the Petition Date. The ultimate terms of settlement of these claims
will be determined in accordance with the terms of the Plan, which was
confirmed by the Bankruptcy Court on April 18, 1997. (See Note 2 - "Plan of
Reorganization," herein).

Until the Effective Date, only such payments on prepetition
obligations that are approved or required by the Bankruptcy Court will be made.
Except as approved by the Bankruptcy Court, principal and interest payments on
prepetition debt have not been made since the Petition Date and will not be
made without the Bankruptcy Court's approval. Other liabilities may arise or
be

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<PAGE> 47
subject to compromise as a result of rejection of executory contracts and
unexpired leases or the Bankruptcy Court's resolution of claims for
contingencies and other disputed amounts.

Inherent in a successful plan of reorganization is a capital structure
which permits the Company to generate sufficient cash flow after reorganization
to meet its restructured obligations and to fund the current obligations of the
reorganized Company. Under the Bankruptcy Code, the rights of and ultimate
payment to prepetition creditors may be substantially altered and, as to some
classes, eliminated.

Under the DIP Financing Facility, the Senior Lenders agreed to make
loans to the Company in an aggregate principal amount not to exceed $9.8
million. The obligations of the Company under the DIP Financing Facility are
secured by a first priority lien on and security interest in all of the
Company's assets and are also allowed administrative expenses under the
Bankruptcy Code, with priority over administrative expenses of the kind
specified in sections 503(b) and 507(b) of the Bankruptcy Code. Funds for the
DIP Financing Facility were obtained by the Senior Lenders from Nu-Tech, which
purchased approximately $13.33 million of the Senior Lenders' claims against
the Company for $10 million in cash, just prior to the Petition Date.
Borrowings under the DIP Financing Facility will be forgiven under the Plan
without any payment by the Company, provided that no event of default occurs
and continues under the DIP Financing Facility. In such case, $10 million of
Nu-Tech's $15 million investment into the Debtors will have been made at the
outset of the Bankruptcy Cases. The Plan provides for the final $5 million of
Nu-Tech's investment to be made on the Effective Date pursuant to the MSI Stock
Purchase. Accordingly, on the Effective Date, the $5.0 million promissory note
issued by PCL to Nu-Tech in connection with the MSI Stock Purchase will be
forgiven, in

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<PAGE> 48
exchange for which Nu-Tech will receive an additional 17% of the New Common
Stock. See "Item 1. Business --Recent Developments --MSI Stock Purchase."

The DIP Financing Facility provides that interest on advances to the
Company accrues at the rate of 2% above the prime rate and is only payable upon
an event of default described below or at the end of the term of the DIP
Financing Facility if the Company's plan of reorganization is not confirmed.
On the Effective Date, accrued interest under the DIP Financing Facility will
be forgiven.

The DIP Financing Facility imposes an annual commitment fee of 1% on
the unused portion of the $9.8 million limit. This commitment fee is only
payable upon an event of default described below or at the end of the term of
the DIP Financing Facility if the Company's plan of reorganization is not
confirmed. On the Effective Date, accrued commitment fees will be forgiven.

In addition to other terms and conditions customary for debtor in
possession financings of this type, the DIP Financing Facility required the
Company to obtain Bankruptcy Court approval of the following: (i) provisions
acknowledging the amount and validity of certain senior secured claims and
security interests, the amount and validity of the Debentures, and that such
debt and security interests are not subject to challenge, dispute or avoidance
in the Bankruptcy Cases; (ii) provisions waiving and releasing any known or
unknown claims of the chapter 11 estates arising out of (a) the Credit
Agreement, dated as of April 1, 1994, among PCL, Wells Fargo Bank, National
Association, as agent ("Wells Fargo Bank, N.A."), and other financial
institutions party thereto, and the first through fifth amendments to the
Credit Agreement (as amended, the "Credit Agreement"); (b) the Term Notes by
PCL in favor of the banks party to the Credit Agreement, dated April 4, 1994;
(c) the Overline Revolving Notes by PCL in favor of the Banks party to the
Credit Agreement, dated May 10, 1995; (d) the Indenture Regarding $40 Million
of 7.5% Convertible Subordinated Documents Due In 2000, dated as of August 24,
1993, by and among PCL, Donaldson, Lufkin & Jenrette Securities Corporation and
Smith Barney Shearson, Inc.; (e) the Collateral and Security Agreement, dated
as of April 1, 1994, among PCL, Wells Fargo Bank, N.A., as agent for the other
financial institutions party thereto; (f) the Trademark and Service Mark
Security Agreement, dated as of April 1, 1994, between Wells Fargo Bank, N.A.,
and California Regional Reference Laboratory; (g) the Guaranty and Security
Agreement, dated as of April 1, 1994, between Quantum Clinical Laboratories,
Inc. and Wells Fargo Bank, N.A., as agent for the financial institutions party
to the Credit Agreement; (h) the Guaranty and Security Agreement, dated as of
April 1, 1994, between Regional Reference Laboratory Governing Corporation and
Wells Fargo, Bank, N.A., as agent for the financial institutions party to the
Credit Agreement; and (i) the Guaranty and Security Agreement, dated as of
April 1, 1994, between California Regional Reference Laboratory and Wells Fargo
Bank, N.A., as agent for the financial institutions party to the Credit
Agreement (the "Existing Lender Agreements"); (iii) provisions waiving any
rights of surcharge under section 506(c) of the Bankruptcy Code and rights of
recovery under section 502(d) of the Bankruptcy Code; and (iv) provisions
stating that upon an event of default by the Company under the DIP Financing
Facility, the Senior Lenders will have the right to seek an order from the
Bankruptcy Court, on five days' notice, providing for the termination of all
stays, including the automatic stay of section 362 of the Bankruptcy Code, to
permit the Senior Lenders to exercise their rights and remedies under the DIP
Financing Facility as if no bankruptcy stay were in effect.

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<PAGE> 49
Moreover, the DIP Financing Facility contains the following events of
default, designed to ensure that the Company perform its obligations under the
Prepetition Termsheet: (a) failure of the Breakup/Overbid protections to be
approved by the Bankruptcy Court; (b) withdrawal of the Company's plan of
reorganization by the Company or proposal by the Company of a plan of
reorganization inconsistent with the terms of the Prepetition Termsheet; (c)
termination of the Company's exclusive right to file and solicit acceptances
with respect to the Company's plan of reorganization for the benefit of any
party other than the Proponents; (d) removal or termination of J. Marvin
Feigenbaum as Chief Operating Officer of the Company other than in accordance
with his employment agreement or modification by the Company of his employment
agreement without the Proponents' written consent; and (e) termination by J.
Marvin Feigenbaum of his employment agreement in accordance with its terms. In
addition, the DIP Financing Facility contains events of default customary for
debtor in possession financings of this type.

As set forth in more detail above, the DIP Financing Facility contains
numerous provisions requiring the Company to perform its obligations under the
Prepetition Termsheet. If the Company fails to do so, it will be in default
under the DIP Financing Facility, which will give the Senior Lenders and
Nu-Tech the right to seek to foreclose on their security interests in the
Company's assets. The Company believes that if the Senior Lenders and Nu-Tech
foreclose on their security interests in the Company's assets, no other
creditors or shareholders will receive any recovery on their claims against or
interests in the Company. In addition, even if the Senior Lenders and Nu-Tech
do not foreclose on their security interests, absent the ability to borrow
funds under the DIP Financing Facility, the Company is unlikely to have
sufficient working capital to continue to operate its businesses as a going
concern.

Finally, the Prepetition Termsheet required that the Company's plan of
reorganization provide that holders of general unsecured claims and Debenture
claims and holders of common stock interests will only be entitled to a
distribution under the Plan if the Voting Condition was satisfied. The Voting
Condition, which has been satisfied (as discussed below), required the holders
of such general unsecured claims and Debenture claims to accept the Plan.

II-15
<PAGE> 50
By order of the Bankruptcy Court entered February 14, 1997, the
Disclosure Statement describing, among other things, the terms and conditions
of the Plan was approved by the Bankruptcy Court as containing "adequate
information" within the meaning of section 1125 of the Bankruptcy Code. On
February 20, 1997, the Company began soliciting its shareholders and certain
creditors to vote on the Plan by providing each with a solicitation package
(each, a "Solicitation Package") containing: (i) written notice of (a) the
Bankruptcy Court's approval of the Disclosure Statement, (b) the commencement
date of the confirmation hearing on the Plan, (c) the deadline and procedures
for filing objections to confirmation of the Plan, and (d) other related
issues; (ii) the Plan; (iii) the Disclosure Statement; (iv) a letter from the
Committee soliciting acceptances of the Plan; and (v) a ballot and a ballot
return envelope. February 11, 1997 was fixed by the Bankruptcy Court as the
voting record date for purposes of determining creditors and equity security
holders entitled to receive a Solicitation Package and to vote on the Plan,
subject to the disallowance of such creditors' claims and equity holders'
interests for voting purposes under certain circumstances.

The Plan was confirmed by the Bankruptcy Court on the Confirmation
Date. The Plan provides that each of the conditions to the Effective Date must
be satisfied or waived as provided in the Plan by July 22, 1997. Moreover, the
Company's shareholders and creditors voted to approve the Plan, and accordingly,
the Voting Condition was satisfied.

On the Effective Date, the Company will settle its obligations to its
impaired creditors as follows: (A) Nu-Tech will receive 35.6% of the New Common
Stock in exchange for its holdings of approximately $13.0 million in senior
secured debt (which debt it purchased from the Senior Lenders just prior to the
Petition Date), and 17% of the New Common Stock in exchange for Nu-Tech's
cancellation of a note executed by the Company in the principal amount of $5.0
million (the "Nu-Tech Stock Purchase") (which note comprised part of the
purchase price paid by the Company to Nu-Tech in connection with the MSI Stock
Purchase -- See Part II, Item 5 - "Other Information," herein), (B) the Senior
Lenders, which presently own an aggregate of approximately $80.0 million of
secured debt, will receive $55.0 million in new senior secured debt and 38.1% of
the New Common Stock, (C) the holders of the Debentures will receive 9.3% of the
New Common Stock, (D) the Company's shareholders will receive warrants to
purchase 5% of the New Common Stock for a period of up to five years, at a
purchase price of $13.30 per share, and (E) the Company's remaining general
unsecured creditors will receive a pro rata share of each of $2.45 million in
cash and an unsecured note in the principal amount of $400,000 due on the first
anniversary of the Effective Date, without interest. The Plan also provides
that all of the Company's wholly-owned subsidiaries will be merged with and into
the Company immediately prior to the Effective Date of the Plan.

Under the terms of the Plan, the Senior Lenders will receive, among
other things, $55 million in Senior Secured Notes (the "New Senior Notes") to
be issued by the reorganized Company. Although the reorganized Company and the
Senior Lenders are still engaged in negotiations with respect to the Senior
Notes, the reorganized Company and the Senior Lenders expect that the principal
terms of the indenture governing the New Senior Notes (the "Indenture") will be
substantially as follows: First, the New Senior Notes will bear interest at the
rate of either 10% per annum in cash or 12% per annum in kind, at the option of
the reorganized Company, for the first two years after issuance and 11% per
annum per year through maturity. Second, the New Senior Notes will mature seven
years after issuance. Third, each holder of the New Senior Notes may require
the reorganized Company to repurchase such holder's New Senior Notes upon (i)
the occurrence of a Change in Control (as defined in the Indenture); (ii) the
sale of assets of the reorganized Company yielding net unapplied proceeds of a
certain amount; and (iii) the consummation of an underwritten public offering
of the reorganized Company's capital stock. Fourth, the New Senior Notes will
be secured by a first priority security interest in all existing and future
assets of the reorganized Company, except that it is anticipated that the
Senior Lenders will agree to subordinate such security interests in the
receivables of the reorganized Company to security interests granted to the
lender providing the Exit Financing Facility (as herein defined). Finally, the
Indenture contains customary covenants, representations and warranties and
customary provisions regarding defaults, remedies and modifications.

The Company has also agreed to issue registration rights with respect
to the New Common Stock and the New Senior Notes in substantially the forms
hereinafter described. Under the New Senior Notes Registration Rights
Agreement, during the duration of this agreement and after a period of 15
months from its date, Senior Lenders holding at least a majority of certain of
the New Senior Notes may request the reorganized Company to register such New
Senior Notes. The terms of the New Common Stock Registration Rights Agreement
provide that during the duration of the New Common Stock Registration Rights
Agreement and after the earlier of (i) 30 months from its date, or (ii) six
months after the date that the reorganized Company files its first registration
of its New Common Stock, those Senior Lenders holding at least a majority of
certain of the New Common Stock shall have the right to request the
registration of such New Common Stock.

In addition, it is anticipated that certain of the shareholders of the
Company will enter into a shareholders agreement, pursuant to which the right of
such shareholders to dispose of their shares in the Company will be restricted
to (i) dispositions to successors in interest who agree to be bound by the
shareholders agreement, (ii) dispositions under a registered public offering,
(iii) dispositions to an affiliate of the transferring shareholder
("affiliate" defined as a person with the power to direct the management or a
10% beneficial owner of the Company) and (iv) dispositions by Nu-Tech made
solely in a pro rata distribution of securities to Nu-Tech's shareholders.
Further, the shareholders will agree not to transfer any of their securities in
the Company to any entity which owns 5% or more of an entity which conducts
clinical or specialized laboratory services as its principal business.

Under the terms of the Plan, Nu-Tech, the Senior Lenders and the
holders of the Debentures will receive 52.6%, 38.1% and 9.3%, respectively, of
the New Common Stock of the reorganized Company. Additionally, the holders of
the Common Stock of the Company will receive warrants to purchase 5% of the New
Common Stock to be issued and outstanding immediately after the Effective Date,
on a fully diluted basis, at the price of $13.30 per share. Because the
reorganized Company will have less than 300 shareholders after the Effective
Date, the reorganized Company intends to de-register the New Common Stock under
the Securities Exchange Act of 1934. Notwithstanding the foregoing, the
reorganized Company will continue to file on a voluntary basis periodic reports
with the United States Securities and Exchange Commission as required by the
terms of Indenture.

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<PAGE> 51
to be one obligation of the reorganized Company, (4) any claims filed or to be
filed in connection with any such obligation and guaranties were deemed one
claim against the reorganized Company, (5) each claim filed in the Bankruptcy
Case of any Debtor were deemed filed against the reorganized Company in the
consolidated Bankruptcy Case on the Confirmation Date, in accordance with the
substantive consolidation of the assets and liabilities of the Debtors and all
claims based on guaranties of payment, collection or performance made by the
Debtors as to obligations of any other Debtor were discharged, released and of
no further force and effect, and (6) all transfers, disbursements and
distributions made by any Debtor were deemed to be made by all of the Debtors.

The effectiveness of the Plan is subject to certain conditions set
forth in the Plan, including, but not limited to, the execution of a
shareholders agreement between certain shareholders of the reorganized Company
and the consummation of the Nu-Tech Stock Purchase by Nu-Tech and the
reorganized Company.

Section 5.2.4 of the Plan contemplates that the reorganized Company
may, in the exercise of its business judgment, enter into an exit financing
facility on or after the Effective Date in an aggregate amount up to $10 million
to be secured by accounts receivable of the reorganized Company and the proceeds
thereof. Prior to the Confirmation Date, the Company obtained commitments for
exit financing from Daiwa to provide a working capital credit facility to the
Company. Accordingly, on April 18, 1997, the Bankruptcy Court approved a
commitment letter with Daiwa and authorized the Company to pay a $250,000
advisory fee to Daiwa. The Company has reached an agreement in principle with
Daiwa to provide the Reorganized Company with a post-Effective Date working
capital credit facility, subject to certain conditions, of up to $10 million.
Negotiations between the Company and Daiwa with respect to the Exit Financing
Facility are continuing.

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<PAGE> 52
GENERAL

As a result of insufficient cash flows caused by, among other things,
billing and collection problems and failure to integrate the Damon operations
and, to a lesser extent, reductions in third-party payor reimbursement rates and
effects and changes in the health care industry, the Company was unable to make
interest payments due monthly under the Credit Agreement since September 1995,
each in the amount of approximately $660,000 (excluding penalties on unpaid
amounts), principal amortization payments due on September 13, 1995 and October
6, 1995, each in the amount of $600,000, principal amortization payments due on
November 3, 1995 and December 29, 1995, each in the amount of $1.2 million, and
principal amortization payments due on February 7, 1996, June 30, 1996,
September 30, 1996 and December 31, 1996 and March 31, 1997, each in the amount
of $3.6 million. In addition, the Company failed to make four interest payments
each in the amount of $1.5 million in respect of its Debentures due on August
15, 1995, February 16, 1996, August 15, 1996 and February 17, 1997,
respectively. Failure to pay the interest with respect to the Debentures, as
well as failure to timely pay principal and interest with respect to the loans
under the Credit Agreement, constitute defaults under the Credit Agreement and
the Indenture governing the Debentures. Thus, all amounts owed under the Credit
Agreement and the Debentures have been classified as current liabilities in the
balance sheet since November 30, 1995.

- Elimination of 425 (approximately 33%) full time equivalent
employee positions.

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<PAGE> 53
- Consolidation of facilities. The Fresno hub laboratory was
closed in June 1995 and consolidated into the Sacramento
laboratory. The Company's Southern California hub laboratory
was downsized in June 1996 and consolidated into the
Sacramento laboratory. Both locations maintain expanded STAT
facilities.

- Use of dedicated internal teams for concentrated account
receivable collection efforts in the Medicare, Medi-Cal, client
and patient payor categories.

- Completion of centralized billing capabilities.

- Data processing system changes to improve billing and
collection efforts.

- Reductions in overhead by, among other things, closing
unprofitable locations.

During fiscal years 1995, 1996 and 1997, the Company realized negative
net cash flow from operating activities of ($900,000), ($2.5 million) and
($1.1 million), respectively. Cash flows from investing activities generally
have been negative through the periods prior to and including fiscal year 1996,
due almost wholly to the Company's laboratory

II-19
<PAGE> 54
acquisitions and purchases of equipment and leasehold improvements. Uses of
cash from investing activities fell from $69.8 million for fiscal 1995 to $2.0
million for fiscal year 1996, and to $1.3 million in fiscal 1997. The decrease
in cash used in investing activities in fiscal 1996 is due to reduced
acquisitions. The decrease in cash used in investing activities in fiscal 1997
is due to reduced equipment and tenant improvement purchases. The cash used in
fiscal year 1996 was for equipment and tenant improvement expenditures. The
cash used in fiscal year 1997 was for equipment and tenant improvement
expenditures and the acquisition of MSI in southern California.

Cash flows from financing activities have reflected borrowings and
repayments of long-term debt. Cash provided by financing activities was $69.7
million for fiscal 1995, reflecting borrowings to finance the Damon acquisition
and various capital projects. Cash provided by financing activities decreased
to $4.7 million for fiscal year 1996 and was used primarily for operating
activities and to finance costs associated with the revised bank financing
agreements. Cash provided by financing activities decreased to $2.5 million for
fiscal year 1997, reflecting reduced borrowings, and gain on extinguishment of
debt resulting from a $3.5 million payment by a guarantor of the Company's debt
on its guaranty of the Company's debt.

As of February 28, 1997, the Company had approximately $132.3 million
of indebtedness of which $40 million represents the Debentures; approximately
$77.6 million represents bank borrowings under certain term loans and lines of
credit; approximately $2.4 million is owed to the former owners of acquired
laboratories; approximately $1.0 million is owed to vendors whose debt has been
converted to notes payable; approximately $5.2 million is owed the Senior
Lenders under the DIP Financing Facility in relation to the November 8, 1996
chapter 11 filing, which facility will be forgiven on the Effective Date;
approximately $150,000 is owed to the City of Burbank as a redevelopment loan;
approximately $0.85 million is owed under capital lease obligations; and $5
million to Nu- Tech for the purchase of MSI. Of such indebtedness, $40 million
bears interest at 7.5% and is due by its terms in August 2000; $43.9 million in
bank borrowings bears interest at prime plus 3% and is due by its terms in March
2000; $33.7 million in bank borrowings bears interest at prime plus 3% and is
due by its terms in March 1997; $2.4 million bears rates ranging from 6.0% to
6.7% and is due by its terms in July 1996; $150,000 is non-interest bearing and
is due by its terms in September 2005; $5.2 million bears interest at prime plus
2%. $5.0 million bears interest at 10%. All of such indebtedness (other than
the $5.0 million due Nu-Tech) is currently in default. The Company currently
has no resources to repay such indebtedness; however, the Plan provides that the
Company will pay such liabilities, as compromised, after the Effective Date.

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<PAGE> 55
The Company failed to make the interest payments due monthly under the
Credit Agreement since September, 1995, each in the amount of approximately
$660,000, (excluding penalties on unpaid amounts), and also failed to make the
principal amortization payments under the Credit Agreement due on September 13,
1995 and October 6, 1995 (each in the amount of $600,000), the principal
amortization payments due on November 3, 1995, December 29, 1995 and March 31,
1996 (each in the amount of $1.2 million), and principal amortization payments
due on February 7, 1996, June 30, 1996, September 30, 1996, December 31, 1996
and March 31, 1997 (each in the amount of $3.6 million). The Company has been
in default since September of 1995 with respect to its secured indebtedness
under the Credit Agreement.

At February 28, 1997, the Company had approximately $501,000 in cash
plus approximately $4.6 million is available under the DIP Financing Facility.
In addition, after the Effective Date, the Plan contemplates the availability of
up to $10.0 million under the Exit Financing Facility. Negotiations with respect
to the Exit Financing Facility are continuing. The Company's business does not
generally require significant expenditures for property, plant and equipment.
Expenditures related to such capital items were approximately 2.0% of net
revenues for the fiscal year ended February 28, 1997. As of February 28, 1997,
the Company had no material commitments for capital expenditures.

The Company anticipates that its operating cash needs for the near term
will be met by accounts receivable collection, operating cash and, until the
Effective Date, amounts available under the DIP Financing Facility; after the
Effective Date, the DIP Financing Facility will be forgiven and the remaining
amounts available thereunder will be available to the Company as additional
capital. In addition, the Company is negotiating with Daiwa for an Exit
Financing Facility of up to $10.0 million. The foregoing statements constitute
forward-looking information, and no assurance can be given that such collections
will be sufficient to satisfy the Company's operating cash needs for the near
term. Among the factors that could cause actual results to differ materially
from such expectations are that the Company continues to experience severe cash
flow problems, reductions in third-party payor reimbursement rates, billing and
collection problems and effects of significant changes in the health care
industry.

II-21

<PAGE> 56
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT AUDITORS

To the Stockholders of Physicians Clinical Laboratory, Inc.:

We have audited the accompanying balance sheet of Physicians Clinical
Laboratory, Inc. (a Delaware corporation) as of February 28, 1997, and the
related statements of operations, changes in stockholders' deficit and
cash flows for the year ended February 28, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Physicians Clinical
Laboratory, Inc. as of February 28, 1997, and the results of its operations and
its cash flows for the year ended February 28, 1997 in conformity with
generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.

Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in the index of financial
statements is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
The schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements as a whole.

As discussed in Note 3 to the combined financial statements, effective March 1,
1996, Physicians Clinical Laboratory, Inc. adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of."

Ernst & Young LLP
Sacramento, California
May 9, 1997

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<PAGE> 57
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders of Physicians Clinical Laboratory, Inc.:

We have audited the accompanying balance sheet of Physicians Clinical
Laboratory, Inc. (a Delaware corporation) as of February 29, 1996, and the
related statements of operations, changes in stockholders' equity (deficit) and
cash flows for each of the two years in the period ended February 29, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Physicians Clinical
Laboratory, Inc. as of February 29, 1996, and the results of its operations and
its cash flows for each of the two years in the period ended February 29, 1996
in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has experienced a
significant decline in operating income margins, a substantial net loss on
operations, a negative operating cash flow, a negative working capital position
and is in default under the terms of substantially all of its loan agreements.
As a result, the lenders have the right to demand immediate payment of
approximately $123.2 million of indebtedness and to foreclose on the Company's
assets. The Company does not have sufficient resources to repay the
indebtedness and has engaged an adviser to seek a proposed restructuring of the
Company's indebtedness. All of these factors and others discussed in Notes 1
and 2 raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also
described in Note 2. The financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying amounts or
the amount and classification of liabilities that might result should the
Company be unable to continue as a going concern.

Arthur Andersen LLP
Sacramento, California
June 28, 1996

II-23

<PAGE> 58
PHYSICIANS CLINICAL LABORATORY, INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED BALANCE SHEETS

AS OF FEBRUARY 29 (28), 1996 AND 1997

<TABLE>
<CAPTION>
February 29, February 28,
Assets 1996 1997
- ---------------------------------------------------------------- ----------- -----------
<S> <C> <C>
CURRENT ASSETS:

Cash $ 391,815 $ 500,516
Trade accounts receivable --

Third parties 17,948,681 18,998,025
Related parties 476,923 322,964
----------- -----------

Total accounts receivable 18,425,604 19,320,989

Less -- Allowance for doubtful accounts 4,632,000 9,729,785
----------- -----------
Net accounts receivable 13,793,604 9,591,204

Notes receivable -- current 350,000 361,650

Supplies inventory 1,370,742 1,534,592
Prepaid costs and other assets 618,287 1,501,298
----------- -----------

Total current assets 16,524,448 13,489,260
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, less accumulated
depreciation and amortization of $19,196,157 and $23,238,541,
respectively 16,929,581 11,595,900

INTANGIBLE ASSETS:

Leasehold interest, less accumulated amortization of $1,452,045 1,525,704 --
Customer lists, less accumulated amortization of $5,104,303 22,278,986 --

Covenants not to compete, less accumulated amortization of
$ 3,482,760 2,140,231 --
Goodwill, less accumulated amortization of $6,692,555 31,525,140 --
----------- -----------

Total net intangible assets 57,470,061 --

OTHER LONG-TERM ASSETS 488,289 686,855
----------- -----------
Total assets $91,412,379 $25,772,015
=========== ===========
</TABLE>

The accompanying notes are an integral part of these statements.

II-24
<PAGE> 59
PHYSICIANS CLINICAL LABORATORY, INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED BALANCE SHEETS

AS OF FEBRUARY 29 (28), 1996 AND 1997

<TABLE>
<CAPTION>
February 29, February 28,
Liabilities and Stockholders' Equity 1996 1997
- ---------------------------------------------------------------- ----------- -----------
<S> <C> <C>
CURRENT LIABILITIES:

Current installments of long-term debt $ 123,880,031 $ 283,687
Note payable to related party -- 5,000,000

Line of credit ($4,556,818 available to be drawn) -- 5,243,182
Accounts payable 12,185,439 1,237,338

Accrued payroll 1,954,271 1,857,352

Accrued paid time-off 1,255,634 170,201

Accrued interest 8,544,639 5,121,598

Other accrued expenses 4,635,019 1,708,074
------------- -------------
Total current liabilities 152,455,033 20,621,432

LONG-TERM DEBT, less current installments 955,393 631,309

OTHER LONG-TERM LIABILITIES 2,614,537 --
LIABILITIES SUBJECT TO COMPROMISE (Note 3) -- 167,776,289
------------- -------------

Total liabilities 156,024,963 189,029,030

COMMITMENTS AND CONTINGENCIES (Notes 2, 5, 8 and 14)
STOCKHOLDERS' DEFICIT

Preferred stock, par value $0.01 per share -- 20,000,000 shares
authorized; none issued or outstanding -- --
Common stock, par value $0.01 per share -- 30,000,000 shares
authorized; 6,033,087 and 6,071,419 shares issued and
outstanding as of February 29 (28), 1996 and 1997,
respectively 60,331 60,714

Additional paid-in capital 15,536,906 15,570,802

Retained deficit (80,209,821) (178,888,531)
------------- -------------
Total stockholders' deficit (64,612,584) (163,257,015)
------------- -------------
Total liabilities and stockholders' deficit $ 91,412,379 $ 25,772,015
============= =============
</TABLE>

The accompanying notes are an integral part of these statements.

II-25
<PAGE> 60
PHYSICIANS CLINICAL LABORATORY, INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED FEBRUARY 28 (29), 1995, 1996 AND 1997

<TABLE>
<CAPTION>
Year Ended February 28 (29),
--------------------------------------------------
1995 1996 1997
------------- ------------ -------------
<S> <C> <C> <C>
NET REVENUE
Net revenue from third parties $ 107,565,433 $ 86,828,901 $ 60,422,858

Net revenue from related parties 3,546,012 3,562,950 2,407,989
------------- ------------ -------------
Total net revenue 111,111,445 90,391,851 62,830,847
DIRECT LABORATORY COSTS 35,335,270 31,881,339 23,117,090
------------- ------------ -------------

Gross profit 75,776,175 58,510,512 39,713,757
LABORATORY SUPPORT COSTS 24,741,263 26,509,055 20,013,962
------------- ------------ -------------
Laboratory profit 51,034,912 32,001,457 19,699,795

SELLING, GENERAL AND ADMINISTRATIVE 26,626,847 27,739,434 24,880,448
PROVISION FOR DOUBTFUL ACCOUNTS (NOTE 3) 4,318,516 30,538,625 8,843,252

DEPRECIATION, AMORTIZATION AND WRITE DOWN OF INTANGIBLES
(NOTE 3) 9,881,687 36,326,689 69,070,097

CREDIT RESTRUCTURING COSTS -- 4,903,436 --
REORGANIZATION CHARGES -- -- 1,558,820

NONRECURRING ACQUISITION INTEGRATION
EXPENSE 9,250,188 -- --
------------- ------------ -------------
Operating income (loss) 957,674 (67,506,727) (84,652,822)

INTEREST EXPENSE (9,012,583) (12,898,919) (15,838,895)

INTEREST INCOME 88,269 61,285 21,855
NONOPERATING INCOME (EXPENSE), net 181,291 (383,375) (1,708,848)
------------- ------------ -------------
Loss before benefit for income taxes (7,785,349) (80,727,736) (102,178,710)
BENEFIT FOR INCOME TAXES 2,189,112 1,543,250 --
------------- ------------ -------------

Loss before extraordinary gain (5,596,237) (79,184,486) (102,178,710)
------------- ------------ -------------
EXTRAORDINARY GAIN ON EXTINGUISHMENT
OF DEBT, net of taxes of $0 -- -- 3,500,000
------------- ------------ -------------
NET LOSS $ (5,596,237) $(79,184,486) $ (98,678,710)
============= ============ =============
LOSS BEFORE EXTRAORDINARY GAIN
PER COMMON SHARE $ (0.93) $ (13.13) $ (16.85)
============= ============ =============
NET LOSS PER COMMON SHARE $ (0.93) $ (13.13) $ (16.28)
============= ============ =============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 6,013,000 6,030,000 6,063,000
============= ============ =============

</TABLE>

The accompanying notes are an integral part of these statements.

II-26
<PAGE> 61
PHYSICIANS CLINICAL LABORATORY, INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED FEBRUARY 28 (29), 1995, 1996 AND 1997

<TABLE>
<CAPTION>
Year Ended February 28 (29),
------------------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss $ (5,596,237) $(79,184,486) $(98,678,710)

Adjustments to reconcile net income to
net cash provided by operating
activities --

Depreciation, amortization and write down
of intangible assets 9,881,687 36,326,689 69,070,097

Provision for doubtful accounts 4,318,516 30,538,625 8,843,252

Credit Restructuring Costs -- 3,118,592 --

Net change in income tax refund
receivable (5,181,785) 5,181,785 --

Net changes in operating assets and
liabilities (4,322,761) 1,487,822 19,626,940
------------ ------------ ------------
Net cash used in operating activities (900,580) (2,530,973) (1,138,421)
------------ ------------ ------------

CASH FLOWS FROM INVESTING
ACTIVITIES:

Increase of intangible assets in
connection with acquisitions (2,739,413) -- (1,632,968)

Purchase of Damon net of cash acquired (58,111,866) -- --

Net acquisitions and disposals of equipment
and leasehold improvements (8,989,249) (1,963,463) 366,613
------------ ------------ ------------

Net cash used in investing activities (69,840,528) (1,963,463) (1,266,355)
------------ ------------ ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:

Borrowings of long-term debt 83,438,587 6,266,763 5,443,182
Payments of principal on long-term debt--

Third parties (13,934,416) (1,586,407) 536,016

Gain on extinguishment of debt -- -- (3,500,000)
Proceeds from exercise of stock options 41,250 -- --

Proceeds from sale of capital stock 111,224 23,999 34,279
------------ ------------ ------------
Net cash provided by financing activities 69,656,645 4,704,355 2,513,477
------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents (1,084,463) 209,919 108,701

CASH AND CASH EQUIVALENTS,
beginning of year 1,266,359 181,896 391,815
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
end of year $ 181,896 $ 391,815 $ 500,516
============ ============ ============
</TABLE>

The accompanying notes are an integral part of these statements.

II-27
<PAGE> 62

PHYSICIANS CLINICAL LABORATORY, INC.

(DEBTOR-IN-POSSESSION)

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

FOR THE YEARS ENDED FEBRUARY 28 (29), 1995, 1996 AND 1997

<TABLE>
<CAPTION>
Common Common Additional Retained
Stock Shares Stock Amount Paid-In Capital Earnings (Deficit)
------------ ------------ --------------- ------------------
<S> <C> <C> <C> <C>
BALANCE AT MARCH 1, 1994 6,006,606 $ 60,066 $ 15,360,704 $ 4,570,902

Net loss -- -- -- (5,596,237)

Proceeds from exercise of stock options 7,500 75 41,175 --

Proceeds from sale of capital stock 13,603 136 111,082 --
--------- ----------- ------------ -------------
BALANCE AT FEBRUARY 28, 1995 6,027,709 $ 60,277 $ 15,512,961 $ (1,025,335)

Net loss -- -- -- (79,184,486)

Proceeds from sale of capital stock 5,378 54 23,945 --
--------- ----------- ------------ -------------
BALANCE AT FEBRUARY 29, 1996 6,033,087 $ 60,331 $ 15,536,906 $ (80,209,821)
--------- ----------- ------------ -------------
Net loss -- -- -- (98,678,710)

Proceeds from sale of capital stock 38,332 383 33,896 --
--------- ----------- ------------ -------------
BALANCE AT FEBRUARY 28, 1997 6,071,419 $ 60,714 $ 15,570,802 $(178,888,531)
========= =========== ============ =============

</TABLE>

The accompanying notes are an integral part of these statements.

II-28
<PAGE> 63

PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) BUSINESS AND OPERATIONS:

Physicians Clinical Laboratory, Inc. ("PCL" or the "Company") provides
clinical laboratory services in the State of California. The Company is a
"hybrid" among clinical laboratory companies in that it serves both as a
traditional reference laboratory for office based physician-clients and as an
independent clinical laboratory for regional acute care hospitals. PCL
operates within the health care industry which is undergoing significant
changes such as managed care (including capitated payment arrangements),
proposed federal and state health care reform measures, third party payor
reimbursement decreases (including Medicare, MediCal and private insurance),
industry consolidation and increasing regulation of laboratory operations.

On November 8, 1996, the Company filed a petition for relief under
Chapter 11 of the Federal Bankruptcy Laws in the United States Bankruptcy
Court. Under Chapter 11, certain claims against the Company in existence prior
to the filing of the petition for relief under the Federal Bankruptcy Laws are
stayed while the Company continues business operations as debtor-in-possession.
These claims are reflected in the balance sheets as "liabilities subject to
compromise" (Note 3). Additional claims ("liabilities subject to compromise")
may arise subsequent to the filing date resulting from rejection of executory
contracts, including leases, and from the determination by the court (or agreed
to by parties in interest) of allowed claims for contingencies and other
disputed amounts. Claims secured against the Company's assets ("secured
claims") also are stayed, although the holders of such claims have the right to
move the court for relief from the stay. Secured claims are secured primarily
by liens on the Company's assets. Liabilities not subject to compromise
reported in the accompanying balance sheets will be continuing obligations of
the Company subsequent to the Company's emergence from bankruptcy.

The Company received approval from the Bankruptcy Court to pay or
otherwise honor certain of its prepetition obligations, including employee
wages. Credit arrangements entered into subsequent to the Chapter 11 filings
are described in Note 2.

BASIS OF PRESENTATION

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. Recurring losses, an accumulated
deficit and lack of liquidity caused the Company to seek protection under the
Federal Bankruptcy Laws in 1996. Management's Plan of Reorganization has been
effectuated, as described in Note 2. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.

(2) PLAN OF REORGANIZATION:

On April 18, 1997 the Bankruptcy Court confirmed the Company's Plan of
Reorganization (Plan). Before the Company can emerge from bankruptcy (Effective
Date) certain conditions of the Plan must be met. The Plan is the result of
extensive negotiations, both prior to and during the pendency of the Company's
Chapter 11 cases among the Company, the Senior Lenders, certain of the Company's
Subordinated Debenture holders, the Creditors' Committee and other
parties-in-interest. The Plan reflects the results of negotiations with Nu-Tech
Bio-Med, Inc. ("Nu-Tech"), which resulted in Nu-Tech's commitment to invest
$14.8 million into the Company in return for the majority of the reorganized
Company's common stock.

The confirmed Plan provides for the following:

- Nu-Tech to receive 35.6% of the reorganized Company's common
stock in exchange for its holdings of senior secured debt.

II-29
<PAGE> 64
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

- Nu-Tech to receive 17% of the reorganized Company's common
stock as a result of the purchase of Medical Science Institute
(MSI) by the Company from Nu-Tech (see Note 15).

- Senior Lenders to receive $55 million in new senior secured
promissory notes and 38.1% of the reorganized Company's common
stock.

- The holders of the Company's Subordinated Debentures to
receive 9.3% of the reorganized Company's common stock.

- The Company's general unsecured claims to receive a pro rata
share of (i) $2.45 million in cash and (ii) a $400,000
noninterest-bearing note due one year after the Effective Date.

- The Company's existing shareholders to receive warrants to
purchase up to 5% of the shares of the reorganized Company's
common stock at a price of $13.30 per share.

ADMINISTRATIVE CLAIMS

On the Effective Date, each holder of an Allowed Administrative Claim shall
receive Cash equal to the amount of such Allowed Administrative Claim, unless
the holder and Company agree to other terms or a Final Order of the Bankruptcy
Court provides for other terms. However, Allowed Administrative Claims
representing obligations incurred in the ordinary course of business or
otherwise assumed by the Company pursuant to the Plan (including Administrative
Claims of governmental units for taxes) shall be assumed on the Effective Date
and paid, performed or settled by the reorganized Company when due in
accordance with the terms and conditions of the particular agreements governing
the obligations.

Priority Tax Claims

Pursuant to section 1129(a)(9)(C) of the Bankruptcy Code, unless otherwise
agreed by the holder of a Priority Tax Claim and the Company or the reorganized
Company, each holder of a Priority Tax Claim will receive in full satisfaction
of such Claim, deferred cash payments over a period not exceeding six years
from the date of assessment of such Claim. Payments will be made in equal
quarterly installments of principal, plus simple interest accruing from the
Effective Date at 8% per annum on the unpaid portion of each Priority Tax
Claim.

Unless otherwise agreed by the holder of a Priority Tax Claim and the Company or
the reorganized Company, the first payment will be payable one year after the
Effective Date or, if the Priority Tax Claim is not allowed within one year
after the Effective Date, the first day of the quarter following the date on
which (a) an order allowing such Claim becomes a Final Order or (b) a
Stipulation regarding the Amount and Nature of Claim is executed by the
reorganized Company and the Claim holder.

Debtor-in-Possession (DIP) Financing Facility Claims

Immediately prior to the Effective Date, provided that no unwaived events of
default exist under the DIP Financing Facility, any amount available under the
DIP Financing Facility shall be borrowed by the Company so that the total
outstanding principal balance thereunder is $9,800,000. On the Effective Date,
all amounts owing under the DIP Financing Facility shall be forgiven without
any payment by the Company or further action by any party.

Quarterly Fees to U.S. Trustee

The reorganized Company shall pay all quarterly fees payable to the U.S.
Trustee's Office for the Company after Confirmation, consistent with applicable
provisions of the Bankruptcy Code and Bankruptcy Rules.

II-30
<PAGE> 65
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CLASSIFIED CLAIMS AND INTERESTS

All Claims and Interest, except Administrative Claims and Priority Tax Claims,
are placed in the Classes described below.

Each Claim or Interest is classified in a particular Class only to the extent
that the Claim or Interest qualifies within the description of that Class and
is classified in other Classes to the extent that any remainder of the Claim or
Interest qualifies within the description of other Classes. A Claim or
Interest is also classified in a particular Class only to the extent that such
Claim or Interest is an Allowed Claim or Allowed Interest in that Class and has
not been paid, released or otherwise satisfied prior to the Effective Date.

CLASS 1 - PRIORITY CLAIMS

Classification: Class 1 consists of all Priority Claims against the Company.

Treatment: On the Effective Date, each holder of an Allowed Class 1 claim
shall receive Cash equal to the amount of the Claim, unless the holder and the
reorganized Company agree to a different treatment. Any Allowed Class 1 Claim
not due and owing on the Effective Date will be paid in full in Cash by the
reorganized Company when such Claim becomes due.

CLASS 2 - SENIOR DEBT CLAIMS

Classification: Class 2 consists of all Senior Debt Claims against the
Company.

Treatment: On the Effective Date, the existing lender agreements shall
automatically be terminated without further action by any party and shall no
longer be of any force or effect. Each holder of an allowed Senior Debt claim
shall receive, on or as soon as practicable after the Effective Date, its Pro
Rata Share of 952,000 shares of New Common Stock, which constitutes 38.1% of
the amount of New Common Stock to be issued and outstanding on the Effective
Date and the $55 million of New Senior Notes.

CLASS 3 - NU-TECH SENIOR DEBT CLAIMS

Classification: Class 3 consists of all Nu-Tech Senior Debt Claims.

Treatment: On the Effective Date, the existing lender agreements shall
automatically be terminated without further action by any party and shall no
longer be of any force or effect. Nu-Tech shall receive, on or as soon as
practicable after the Effective Date, 890,000 shares of New Common Stock, which
constitutes 35.6% of the amount of New Common Stock to be issued and
outstanding on the Effective Date.

CLASS 4 - OTHER SECURED CLAIMS

Classification: Class 4 consists of all Other Secured Claims against the
Company.

Treatment: On the Effective Date, at the option of the reorganized Company,
each Allowed Class 4 Claim shall be treated pursuant to either (i) or (ii)
below:

(i) the reorganized Company may transfer the property securing the
Claim to the holder of the Claim, in full satisfaction of the Claim; or

II-31
<PAGE> 66
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(ii) the Claim may be Reinstated as follows: (A) any default,
other than a default of a kind specified in section 365(b)(2) of Bankruptcy
Code, shall be cured; (B) the maturity of the Claim shall be reinstated as the
maturity existed before any default; (C) the holder of the Claim shall be
compensated for any damages incurred as a result of any reasonable reliance by
the holder on any contractual provision that entitled the holder to demand or
receive accelerated payment of the Claim; and (D) the other legal, equitable or
contractual rights to which the claim entitles the holder shall not otherwise
be altered.

CLASS 5 - UNSECURED CLAIMS

Classification: Class 5 consists of all Unsecured Claims against the Company,
including the CEO Claims.

Treatment: On the Effective Date, the Company will deliver to the Third-Party
Disbursing Agent, to be held in the Class 5 Disbursement Account for the
benefit of holders of Allowed Class 5 Claims, $2.45 million in Cash and a New
Unsecured Note in the amount of $400,000. Each holder of an Allowed Class 5
Claim, in full and final satisfaction of such Allowed Claim, shall receive its
Pro Rata share of the assets held in the Class 5 Disbursement Account in
accordance with the provisions of the Plan.

CLASS 6 - OLD SUBORDINATED DEBENTURE CLAIMS

Classification: Class 6 consists of all Old Subordinated Debenture Claims
against the Company.

Treatment: On the Effective Date, the Old Indenture and the Old Subordinated
Debentures shall be automatically terminated without further action by any
party and shall no longer be of any force and effect. Each holder of an
Allowed Old Subordinated Debenture Claim, in full and final satisfaction of
such Allowed Claim, shall receive, on or as soon as practicable after the
Effective Date, its Pro Rata Share of 232,500 shares of New Common Stock, which
constitutes 9.3% of the amount of New Common Stock to be issued and outstanding
on the Effective Date.

CLASS 7 - INTERESTS OF HOLDERS OF OLD COMMON STOCK IN PCL

Classification: Class 7 consists of the interests of holders of Old Common
Stock in PCL.

Treatment: Each holder of an Allowed Class 7 interest shall receive, in full
and final satisfaction of such Interest, its Pro Rata Share of the New Warrants
issued pursuant to the New Warrant Agreement. The New Warrants will allow
existing shareholders to purchase up to 5% of the shares of the Reorganized
Company's common stock at a price of $13.30 per share.

CLASS 8 - INTERESTS OF HOLDERS OF INTERESTS IN SUBSIDIARIES

Classification: Class 8 consists of the Interests of the Subsidiary Debtors.

Treatment: In full and final satisfaction of the Allowed Class 8 Interests,
the Company shall retain its Interests in each of the Subsidiary Debtors. Each
Subsidiary Debtor shall be merged into the Reorganized Company on the Effective
Date.

CLASS 9 - INTERESTS OF HOLDERS OF OLD STOCK OPTIONS AND OLD WARRANTS

Classification: Class 9 consists of the Interests of the holders of Old Stock
Options and Old Warrants.

Treatment: The holders of Class 9 Interests shall not receive or retain any
property under the Plan on account of such Interests.

II-32
<PAGE> 67
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CONSOLIDATION--

The accompanying consolidated financial statements include the accounts of
Physicians Clinical Laboratory, Inc. and its subsidiaries (Physicians Clinical
Laboratory, Inc. and its subsidiaries are collectively referred to hereinafter
as the "Company"). All significant intercompany accounts and transactions have
been eliminated in consolidation.

CASH EQUIVALENTS--

Cash and cash equivalents include cash in bank and on hand and liquid
investments with original maturities of three months or less.

SUPPLIES INVENTORY--

Supplies inventory is stated at cost, which approximates market value, on a
first-in, first-out (FIFO) basis. Supplies inventory consists primarily of
laboratory supplies.

EQUIPMENT AND LEASEHOLD IMPROVEMENTS--

Equipment and leasehold improvements are carried at cost. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets, except for leasehold improvements which are being amortized over the
life of the lease. When assets are retired or otherwise disposed of, the cost
and related accumulated depreciation or amortization are removed from the
accounts and any resulting gain or loss is recognized in operations for the
period. The cost of maintenance and repairs is charged to income as incurred,
significant renewals and betterments are capitalized.

II-33
<PAGE> 68
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The estimated useful lives of the equipment and leasehold improvements are as
follows:

<TABLE>
<CAPTION>
Estimated
Useful Lives
------------
<S> <C>
Leasehold improvements 5-12 years

Laboratory equipment 5-20 years
Computer equipment 5-12 years

Furniture and fixtures 5-12 years
Automobiles 1-5 years
</TABLE>

INTANGIBLE ASSETS--

All amortization is calculated using the straight-line method over the
following lives:

<TABLE>
<CAPTION>
Life
-----------------
<S> <C>
Customer list 19 years
Covenant not to compete Life of Agreement

Goodwill 19 years
Leasehold interest Life of Lease
</TABLE>

Prior to fiscal 1995, the Company used a 36 year amortization life for
goodwill. Effective March 1, 1994, the Company adopted a goodwill life of 19
years due to the rapid changes occurring in the healthcare industry. The 19
years has also been applied on a remaining life basis for goodwill relating to
acquisitions made prior to March 1, 1994. The effect of reducing the life to
19 years was to increase amortization expense for fiscal 1995 by approximately
$1,300,000.

Subsequent to its acquisitions, the Company continually evaluates whether later
events and circumstances have occurred that indicate the remaining estimated
useful life of goodwill may warrant revision or that the remaining balance of
goodwill may not be recoverable. When factors indicate that goodwill should be
evaluated for possible impairment, the Company uses an estimate of the related
business segment's enterprise value and deducts the fair value of all tangible
and intangible assets to arrive at the recoverable value of goodwill. Using this
approach, the Company recorded a write-down of $25,000,000 to intangible assets
which was allocated to Goodwill as of February 29, 1996. The amount of the
write-down was based upon a Board-approved restructuring plan prepared by
investment bankers engaged to assist and advise the Company on a proposed
restructuring of the Company's indebtedness.

During 1997, the Company continued to experience customer losses, significant
reduction in third party reimbursements and other changes in the health care
industry having adverse effects on the Company's operations. These factors have
resulted in significant cash flow deficits and continued operating losses. As a
result, management has reevaluated the recoverability of goodwill and other
intangible assets and concluded they have no continuing value. Accordingly,
the Company has recorded a $59.4 million write-off of those assets.

II-34
<PAGE> 69
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Amortization expense less the write-down of intangibles, for leasehold interest
was $277,189, $257,983 and $250,813, covenants not to compete, $1,114,835,
$1,070,242 and $1,027,598, goodwill, $2,765,197, $3,367,445 and $2,011,458, and
customer lists $1,410,399, $1,431,449 and $1,441,226 in fiscal 1995, 1996 and
1997, respectively.

DEBT ISSUANCE COSTS--

Costs incurred in connection with the issuance of the convertible subordinated
debentures, notes payable to banks and lines of credit are deferred and
amortized over the life of the related debt using an effective interest rate
method. During fiscal year 1996, the debt issuance costs related to the bank
debt and the Convertible Subordinated Debentures was expensed due to defaults
with covenants in the lending agreement and the Indenture. The amounts were
$1,450,140 and $1,668,466, respectively and are included in credit
restructuring costs in the Statement of Operations.

EARNINGS PER SHARE --

Weighted average shares outstanding include common stock equivalents computed
using the treasury stock method except for periods in which their inclusion
would be anti-dilutive. It is probable that the Plan of Reorganization will
require the issuance of common stock or common stock equivalents, thereby
diluting current equity interests.

LIABILITIES SUBJECT TO COMPROMISE --

Liabilities subject to compromise consist of the following:

<TABLE>
<CAPTION>
February 28, 1997
-----------------
<S> <C>
Long-term debt $121,984,291
Accounts payable 15,737,121

Accrued paid time-off 1,123,185

Accrued interest 18,993,764
Other accrued expenses 9,937,928
-----------------
Total liabilities subject to compromise $167,776,289
=================
</TABLE>

REORGANIZATION CHARGES--

Reorganization charges consist primarily of professional fees incurred as part
of the Chapter 11 bankruptcy.

II-35
<PAGE> 70
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DIRECT LABORATORY AND LABORATORY SUPPORT COSTS--

Direct laboratory costs consist of labor costs, supplies expense, reference and
pathology fees, utilities and other expenses. Included in reference and
pathology fees are charges from related parties of $362,851, $391,926 and
$326,920 for the years ended February 28 (29), 1995, 1996 and 1997,
respectively.

Laboratory support costs consist of patient service center costs, courier costs,
laboratory administration expenses, customer service costs, materials management
costs and management service charges from related parties. Management service
charges from related parties were $876,004, $868,338 and $405,419 for the years
ended February 28 (29), 1995, 1996 and 1997, respectively.

II-36
<PAGE> 71
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REPAIRS AND MAINTENANCE EXPENSE--

Repairs and maintenance expense was $1,140,424, $1,174,077 and $908,795 in
fiscal 1995, 1996 and 1997, respectively.

INCOME TAXES--

The provision for income taxes and related tax assets and liabilities have been
computed in accordance with SFAS No. 109, "Accounting for Income Taxes."

STATEMENTS OF CASH FLOWS--

Net changes in operating assets and liabilities consist of the following:
<TABLE>
<CAPTION>
Year Ended February 28 (29),
-----------------------------------------------
1995 1996 1997
------------ ----------- ------------
<S> <C> <C> <C>
Increase in accounts receivable $(12,402,033) $(9,917,080) $ (4,640,852)
Net (increase) decrease in supplies
inventory, prepaid costs, deposits and
other assets (952,735) 2,017,177 (1,257,077)

Increase in accounts payable and accrued
expenses 9,032,007 9,387,725 25,524,869
------------ ----------- ------------
Net change in operating assets and liabilities $ (4,322,761) $ 1,487,822 $ 19,626,940
============ =========== ============

</TABLE>

Supplemental disclosure of cash flow information is as follows:

<TABLE>
<CAPTION>
Year Ended February 28 (29),
----------------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Cash paid for interest--

Third parties $8,199,578 $4,400,969 $ 26,277
</TABLE>

II-37
<PAGE> 72
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Non-cash transactions consist of the following:

<TABLE>
<CAPTION>
Year Ended February 28 (29),
----------------------------------------
1995 1996 1997
-------- -------- ----------
<S> <C> <C> <C>
Gain on extinguishment of debt paid by a related party $ -- $ -- $3,500,000
Note payable to related party resulting from MSI acquisition $ -- $ -- $5,000,000
</TABLE>

II-38
<PAGE> 73
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

RECLASSIFICATIONS--

Certain reclassifications to prior years' financial statements have been made
to conform to the 1997 presentation.

REVENUE RECOGNITION--

Revenues are recognized when services are performed. Revenues under capitated
agreements are recognized monthly as earned. Expenses are accrued on a monthly
basis as services are provided.

Services under government programs represent approximately 29%, 30%
and 33% of net revenue for the year ended February 28 (29), 1995, 1996 and
1997, respectively. The Company's primary concentration of credit risk is
accounts receivable, which consist of amounts owed by various governmental
agencies, insurance companies and private patients. Significant concentrations
of gross accounts receivable at February 29 (28), 1996 and 1997, reside in
receivables from governmental agencies of 48% and 52%, respectively.

Due to the significant changes occurring in the health care industry
related to managed care, billing system/process challenges and accounts
receivable collection problems, it is reasonably possible that the Company's
estimate of the net realizable value of accounts receivable will change in the
near term. No estimate can be made of a range of amounts of loss that are
reasonably possible.

Services under government programs represent approximately 29%, 30%
and 33% of net revenue for the year ended February 28 (29), 1995, 1996 and
1997, respectively. The Company's primary concentration of credit risk is
accounts receivable, which consist of amounts owed by various governmental
agencies, insurance companies and private patients. Significant concentrations
of gross accounts receivable at February 28 (29), 1996 and 1997, reside in
receivables from governmental agencies of 48% and 52%, respectively.

FAIR VALUES OF FINANCIAL INSTRUMENTS --

The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate the value:

NOTES RECEIVABLE

The carrying amount approximates fair value.

II-39
<PAGE> 74
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

It was not practicable to estimate the fair value of the Company's
debt due to the debt being in default. See Note 1 and 5.

USE OF ESTIMATE IN THE PREPARATION
OF FINANCIAL STATEMENTS --

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.

NEW ACCOUNTING PRONOUNCEMENTS --

In 1997, the Company adopted Statements of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of." The pronouncement requires that
assets to be held and used, and assets held for sale be reviewed for
impairment. Any loss resulting from the impairment of such assets held and
used is included as a component of continuing operations.

Also in 1997, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." In accordance with the provisions of the
pronouncement, the Company elected to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its employee stock option plans.

In February 1997, the Financial Accounting Standards Board issued
SFAS No. 128, "Earnings per Share," which is required to be adopted on
December 31, 1997. At that time, the Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. The Company has not yet
determined what the impact of Statement 128 will be on the calculation of fully
diluted earnings per share.

II-40
<PAGE> 75
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(4) EQUIPMENT AND LEASEHOLD IMPROVEMENTS:

Equipment and leasehold improvements consist of the following:

<TABLE>
<CAPTION>
February 29, 1996
-----------------
Cost
-----------
<S> <C>
Equipment $27,417,178

Furniture and fixtures 2,614,725

Leasehold improvements 6,093,835
-----------
Total 36,125,738

Less - Accumulated depreciation
and amortization 19,196,157
-----------
Net book value 16,929,581
===========
</TABLE>

<TABLE>
<CAPTION>
February 28, 1997
-----------------
Cost
-----------
<S> <C>
Equipment $28,259,918

Furniture and fixtures 2,194,510

Leasehold improvements 4,380,013
-----------
Total 34,834,441

Less - Accumulated depreciation
and amortization 23,238,541
-----------
Net book value 11,595,900
===========
</TABLE>

Depreciation expense relating to equipment and leasehold improvements charged to
operations was $9,881,687, $11,326,689 and $4,967,068 for fiscal years ended
1995, 1996 and 1997, respectively. As of February (29) 28, 1996 and 1997,
respectively, the Company recorded a write down of $25,000,000 and $59,371,935
to intangible assets.

II-41
<PAGE> 76
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(5) LONG-TERM DEBT:

Long-term debt consists of the following:
<TABLE>
<CAPTION>
February 29 (28),
-----------------------------
1996 1997
------------ ------------
<S> <C> <C>
Convertible subordinated debentures, currently in default, par
value $1,000 per debenture, bearing interest at 7.5% due 2000
The debentures are convertible into shares of common stock at
any time before maturity at a conversion price of $12.20 per
share $ 40,000,000 $ 40,000,000

Variable interest rate notes payable to banks, currently in
default, bearing interest at prime plus 3% plus 2% for penalties
and interest; unpaid principal payments are bearing interest and
penalties of prime plus 3% plus 2%, principal due in aggregate
monthly and quarterly installments, with final payments due
March 2000, secured by all assets of the Company 47,359,476 43,859,476

Various lines of credit, currently in default, which allow
aggregate borrowings up to $33,700,000 bearing interest at prime
plus 3% plus 2% for penalties and interest; unpaid principal
payments are bearing interest and penalties of prime plus 3%
plus 2%, interest due monthly and quarterly with principal due
through March 1997, secured by all assets of the Company 33,500,000 33,700,000

Notes payable to former owners of acquired laboratories,
currently in default, with interest rates ranging from 6.0% to
6.7%, with additional late charges of 3% and 6%, respectively,
due monthly with principal due through July 1996; secured by
assets acquired from the related laboratories 2,383,493 2,376,113

Notes payable for Accounts Payable vendors converted to notes,
currently in default, with interest rates ranging from 8% to
12%, principal due in monthly and quarterly installments due
through April 1988 -- 1,047,767

Note payable to the City of Burbank, non-interest bearing, due
annually through September 2005 (annual payments forgiven if
building is still occupied) 150,000 150,000

Capital lease obligations (Note 8) 1,442,455 850,935
------------ ------------
Liabilities subject to compromise in 1997 -- 121,984,291

</TABLE>

II-42
<PAGE> 77
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
February 28 (29),
----------------------------
1996 1997
------------ ----------
<S> <C> <C>
Note payable to related party, bearing interest at 10%,
principal to be satisfied by issuance of 17% of issued and
outstanding stock of reorganized company; secured by property,
assets, and rights of any kind. -- 5,000,000

Note payable to the Internal Revenue Service, bearing interest
at 9%, principal due in monthly installments of $5,301 through
May 2002. -- 261,732

Note payable bearing interest at 10%, principal due in monthly
installments of $11,886 through May 1997 -- 35,075

Capital lease obligations (Note 8) -- 618,189
------------ ----------
124,835,424 5,914,996

Less - Current installments 123,880,031 5,283,687
------------ ----------
Long-term debt, less current installments $ 955,393 $ 631,309
============ ==========

</TABLE>

II-43
<PAGE> 78
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of February 28, 1997, the prime rate was 8.25%. All assets of the Company
are pledged as collateral to secure its borrowings. The loan agreements with
the Bank are conditional upon the Company's ongoing ability to comply with
certain covenants. The covenants include the maintenance of specified working
capital and debt-to-worth ratios.

The Company has been in default since September of 1995 with respect to
principal and interest payments and certain covenants under its credit
agreement with respect to approximately $80.9 million of secured indebtedness.
The secured indebtedness under the Credit Agreement is classified as a Class 2
claim under the Plan. The Company has also been in default since September of
1995 with respect to interest payments on its $40 million 7.5% Convertible
Subordinated Debentures due 2000 and the Note issued by the Company in
connection with the acquisition of Medical Group Pathology Laboratory. The
Debentures are classified as a Class 3 claim under the Plan. The Company does
not have available cash or other cash resources available to cure the defaults
under the Credit Agreement or the Indenture covering the Debentures, or
otherwise to make interest or principal payments with respect to its debt
obligations.

During the second quarter of fiscal 1996, the Company entered into negotiations
for the restructuring of its bank debt. The negotiations resulted in the third
and fourth amendment to its Credit Agreement with a group of banks led by Wells
Fargo Bank National Association (the holders of the Company's debt obligations
pursuant to the Credit Agreement hereinafter are referred to as the "Bank
Group"). As a result of insufficient cash flows caused by, among other things,
reductions in third party payor reimbursement rates, billing and collection
problems and effects and changes in the health care industry, the Company was
unable to make interest payments under its Credit Agreement due monthly since
September 1995, each in the amount of approximately $660,000 (excluding
penalties on unpaid amounts), principal amortization payments due on September
13, 1995 and October 6, 1995, each in the amount of $600,000, principal
amortization payments due on November 3, 1995, December 29, 1995 and March 31,
1996, each in the amount of $1,200,000, principal amortization payments due on
February 7, 1996, June 30, 1996, September 30, 1996, December 31, 1996 and
March 31, 1997, each in the amount of $3.6 million. In addition, the Company
failed to make four interest payments each in the amount of $1.5 million in
respect of its Debentures due on August 15, 1995, February 15, 1996, August 15,
1996 and February 17, 1997, respectively. Failure to pay the interest with
respect to the Debentures, as well as failure to timely pay principal and
interest with respect to the loans under the Credit Agreement, constitute
defaults under the Credit Agreement and the Indenture governing the Debentures.
The deferred financing costs related to the Credit Agreement and the Debentures
of $1,450,140 and $1,668,466 were written off as of August 31, 1995 and
February 29, 1996, respectively. The costs associated with the Credit
Agreement restructuring and write off of the deferred financing costs has been
reflected in the statement of operations as Credit Restructuring costs.

As a result of the Company's failure to make principal and interest payments
under its existing Lender Agreements, the Company and its Senior Lenders entered
into the Third Amendment to the Credit Agreement in May 1995. In connection
with the Third Amendment to the Credit Agreement, the lenders required the
Company's guarantor, one of the Company's largest shareholders, to provide a
guaranty of the Company's borrowings in the amount of $3.5 million. In
December 1996, the Company's guarantor paid the full amount of the guaranty to
the Senior Lenders. This extraordinary item resulted in a net gain per common
share of $.57.

On October 13, 1995, the Company was notified by the Nasdaq Stock Market
Listing Qualification Committee (the "Listing Committee") that the Company's
common stock would be removed from listing on the Nasdaq National Market but
would be listed on the Nasdaq SmallCap Market due to the Company's inability to
satisfy the Nasdaq National Market's net tangible assets requirement. The
Company had been granted a temporary exception to the Nasdaq National Market's
net tangible asset requirement, which exception expired on October 12, 1995.
The Company's common stock began to trade on the Nasdaq SmallCap Market on
Monday October 16, 1995. On October 25, 1995, the Listing Committee determined
not to extend certain exceptions to the applicable listing requirements, and
the Company's common stock was removed from trading on the Nasdaq SmallCap
Market. The Company's common stock currently trades in the over-the-counter
market.

II-44
<PAGE> 79
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The removal of the Company's common stock from listing on the Nasdaq National
Market System constituted a Redemption Event under the Company's Indenture
governing its Debentures. Such Redemption Event required the Company to offer
to repurchase the Debentures from the holders thereof at a redemption price
equal to 101% of the principal amount thereof plus accrued and unpaid interest,
if any. Written notice of the occurrence of such Redemption Event was given to
the registered holders of the Debentures on November 2, 1995, and no such
holder perfected its right to redeem such Debentures within the period provided
under the Indenture. In addition, under the terms of the Registration Rights
Agreement between the Company and holders of the Debentures, the Company is
obligated to maintain an effective registration statement covering the
Debentures and the Company's common stock with respect to which the Debentures
are convertible.

Maturities of long-term debt, excluding capital lease obligations, in each of
the next five fiscal years are as follows:

<TABLE>
<CAPTION>
Year Ended
February 28 (29),
-----------------
<S> <C>
1998 $ 126,210,043
1999 45,542

2000 49,843

2001 54,549
2002 59,701

Thereafter 10,485
---------------
$ 126,430,163
===============
</TABLE>

The above table reflects maturities of long-term debt before the effects of
changes under the Plan that will occur on the Effective Date. On the Effective
Date, substantially all of the existing long-term debt will be replaced with $55
million of New Senior Notes and common stock of the New Company, as described in
Note 2.

On November 4, 1993, the Company entered into an interest rate swap with an
investment bank. The swap is for $10,000,000 notional amount with a fixed rate
of 4.5625% received by the Company and a floating rate paid by the Company at
the six-month London Interbank Offered Rate (LIBOR). The rate adjustment
dates are November 8 and May 8 each year and the payment dates are six months
after the rate adjustment date. The swap contract expired November 8, 1996.

As of February 29, 1996 six month LIBOR was 5.297%. The Company did not make
its May 8, 1995, November 8, 1995 and May 8, 1996 semi-annual payments of
$76,684, $93,750 and $59,375 based upon six month LIBOR of 6.094% as of
November 8, 1994, 6.061% as of May 8, 1995 and 5.75% as of November 8, 1995.
As of February 28, 1997 the fair value of this contract was a liability of the
Company of approximately $150,000.

The Company entered into the swap to convert a portion of its fixed rate
subordinated debentures to a variable rate. As such, the Company had been
accruing the net payments to be made on the contract as an adjustment to
interest expense.

II-45
<PAGE> 80
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(6) LINE OF CREDIT:

The company has a line of credit with a financial institution which provides for
maximum borrowings of $9,800,000 under the DIP Financing Facility bearing
interest at prime plus 2%. As of February 28, 1997, $5,243,182 had been
withdrawn on the line, and $4,556,818 was available to be withdrawn.
Immediately prior to the Effective Date, provided that no unwaived event of
default exists under the DIP Financing Facility, any amounts available under the
DIP Financing Facility will be borrowed by the Company so that the total
outstanding principal balance thereunder is $9,800,000. On the Effective Date,
all amounts owing under DIP Financing Facility will be forgiven without any
payment by the Debtors or further action by any party. The line is secured by a
first priority lien and security interest in all assets of the company.

(7) INCOME TAXES:

The provision (benefit) for income taxes consists of the following:

<TABLE>
<CAPTION>
Year Ended February 28 (29),
----------------------------------------------------
1995 1996 1997
----------- ----------- --------------
<S> <C> <C> <C>
Current--
Federal $(2,947,750) $ (141,820) $ --

State -- (42,842) --
----------- ----------- --------------
(2,947,750) (184,662) --
Deferred--

Federal 531,783 (1,043,396) --
State 226,855 (315,192) --
----------- ----------- --------------
758,638 (1,358,588) --
----------- ----------- --------------
$(2,189,112) $(1,543,250) $ --
=========== =========== ==============
</TABLE>

The effective tax rate and statutory federal income tax rate are reconciled as
follows:

<TABLE>
<CAPTION>
Year Ended February 28 (29),
-------------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Federal statutory income tax rate (34.0%) (34.0%) (34.0%)
State franchise taxes, net of (6.1%) (6.1%) (6.1%)
federal income tax benefit

Change in valuation allowance 5.8% 38.3% 40.1%

Additional provision for
intangible assets 4.5% -- --
Other 1.7% (0.2%) --
----- ----- -----
(28.1%) (2.0%) --%
===== ===== =====
</TABLE>

II-46
<PAGE> 81
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At February 28, 1997, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $76,670,000 and
$38,370,000 respectively. The loss carryforwards expire between the years 1997
and 2012 for federal and state income tax purposes.

Significant components of the Company's deferred tax assets and liabilities for
federal and state income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 29 (28),
------------------------------
1996 1997
------------ ------------
<S> <C> <C>
DEFERRED TAX (ASSETS)/LIABILITIES
Current
Accrued Expenses $ (1,114,146) $ (1,039,480)
Bad Debt (4,765,504) (8,842,877)
Prepaid Expenses 65,021 (282,184)
Other 499,304 214,915
------------ ------------

Total Current Deferred (Assets)/Liabilities (5,315,325) (9,949,626)
Valuation Allowance 5,315,325 9,949,626
------------ ------------

Net Current Deferred (Assets)/Liabilities -- --

Non-Current
Amortization (9,598,474) (30,247,568)
Depreciation (448,365) (843,566)
Net Operating Loss (15,037,165) (29,190,589)
Sec. 481(a) Cash to Accrual 44,032 --
------------ ------------
Total Non-Current Deferred (Assets)/Liabilities (25,039,972) (60,281,723)

Valuation Allowance 25,039,972 60,281,723
------------ ------------
Net Non-Current Deferred (Assets)/Liabilities -- --

TOTAL NET DEFERRED (ASSETS)/LIABILITIES $ -- $ --
============ ============
</TABLE>

As discussed in Note 2, the Company has filed petition for relief under Chapter
11 of the Federal Bankruptcy Laws. To the extent that the Company is
insolvent, cancellation of indebtedness income arising from the Plan of
Reorganization will be offset against the federal net operating losses.
Additionally, as a result of the "change in ownership" provisions of the Tax
Reform Act of 1986, a portion of any remaining federal net operating loss
carryover may be subject to an annual limitation regarding their utilization
against taxable income in future periods.

(8) LEASES:

The Company is obligated under capital leases for certain computer and
laboratory equipment that expire at various dates during the next five years.
Equipment under capital leases was $3,928,355 and $4,002,622, and related
accumulated amortization was $2,218,837 and $2,913,010 as of February 29, 1996
and February 28, 1997.

The Company also leases its laboratories and patient service centers under
operating leases expiring over various terms. Many of the monthly lease
payments are subject to increases based on the Consumer Price Index from the
base year.

II-47
<PAGE> 82
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Beginning March 1, 1989, the Company began subletting one of its unoccupied
facilities. The sublease term coincides with that of the remaining primary
lease of eight years with rent for the year ended February 28, 1997 equal to
$217,795 and subject to annual increases based on the Consumer Price Index not
to exceed 10% per year.

The Company also leases remote draw station space, several automobiles and
other equipment, which have been classified as operating leases and expire over
the next 9 years. Many of the draw station leases have renewal options and
monthly lease payment subject to annual increases.

Future minimum lease payments under noncancelable operating leases and the
present value of future minimum capital lease payments as of February 28, 1997
are:

<TABLE>
<CAPTION>
Year Ended Capital Operating
February 28 (29), Leases Leases
----------------- ------ ------
<S> <C> <C>
1998 $ 772,117 $ 2,778,390
1999 569,517 1,790,159
2000 309,002 1,057,639

2001 -- 223,408
2002 -- 81,849

Thereafter -- 42,050
----------------- ----------------
Total minimum lease payments 1,650,636 $ 5,973,495
================

Less -- Amount representing
Interest (at rates ranging from
7.2% to 20.7%) 181,512
-----------------
Present value of net minimum
capital lease payments $ 1,469,124
=================

</TABLE>

Total rental expense under operating leases was $7,178,089, $10,199,909 and
$6,113,445 for fiscal years 1995, 1996 and 1997, respectively.

II-48
<PAGE> 83
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(9) RELATED PARTY TRANSACTIONS:

The Company provides laboratory and computer services to certain of its
stockholders (and their affiliated entities). Laboratory and computer service
charges are billed to and paid by the stockholders at negotiated rates. The
following laboratory and computer service revenue was billed by the Company to
stockholders (and their affiliated entities).
<TABLE>
<CAPTION>
Year Ended February 28 (29),
----------------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Laboratory and computer service
revenue from stockholders $3,546,012 $3,562,950 $2,407,989
========== ========== ==========
</TABLE>

Amounts due from stockholders and included in accounts receivable were as
follows:

<TABLE>
<CAPTION>
February 29 (28),
-----------------------
1996 1997
-------- --------
<S> <C> <C>
Amounts due from stockholders $476,923 $322,964
======== ========
</TABLE>

The Company received management services from Diagnostic Pathology Medical
Group, Inc. (DPMG), a stockholder of the Company. The services of certain
management personnel were provided to the Company for management fees at a cost
of $326,000, $256,253 and $104,010 for fiscal years 1995, 1996 and 1997,
respectively.

In addition, the Company received professional services from the former owners
of certain of its acquisitions. Professional service fees paid in connection
with the related professional service agreements were $550,000, $188,000 and
$9,333 in fiscal years 1995, 1996 and 1997, respectively.

II-49
<PAGE> 84
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company occasionally uses the specialized laboratory services of one of its
owners and several of its owners' stockholders. Most of these services are
billed to the Company at negotiated discounts from the billing entities'
customary charges. Amounts billed to the Company were as follows:

<TABLE>
<CAPTION>
Year Ended February 28 (29),
----------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Billings from stockholders $362,851 $391,926 $326,920
======== ======== ========
</TABLE>

The Company has loaned the President and CEO funds at various times as follows:

<TABLE>
<CAPTION>
Date Interest Rate Amount
-------------- ----------------- ----------
<S> <C> <C>
October 1990 10% $ 50,000

October 1993 7% 150,000

August 1994 7% 150,000
-------
Total outstanding as of February 28, 1997 $350,000
========
</TABLE>

As of February 28, 1997, no payments have been received.

The Company also leases draw station space and purchases other services and
various supplies from several of its stockholders. The total amount paid by the
Company for these items was $123,944, $97,137 and $26,691 for fiscal years 1995,
1996 and 1997, respectively.

II-50
<PAGE> 85
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(10) EMPLOYEE BENEFIT PLAN:

As of January 1, 1989, the Company adopted a 401(k) profit sharing plan under
which employees may contribute between 1% and 20% of their annual compensation
to the Plan. A minimum of 90 days of service is required prior to
participation in the Plan by an employee. On April 30, 1990, the plan was
amended to provide that the Company would contribute 50% of employee
contributions up to 6% of their annual gross compensation for those employee
who have at least one full year of service. The Company contribution to the
401(k) plan was discontinued effective December 31, 1995. The Company
contributed $398,906 and $288,219 in fiscal years 1995 and 1996, respectively.

(11) STOCK OPTION PLAN AND WARRANTS:

STOCK OPTION PLAN

In March 1992 and February 1994, the Board of Directors adopted and the
stockholders of the Company subsequently approved two separate stock option
plans (the "1992 Plan" and the "1994 Plan," respectively and together, the
"Stock Option Plans"). These Stock Option Plans provide for the granting to
employees and directors of nonqualified stock options to purchase authorized
but unissued common stock. The maximum number of shares that may be sold under
the 1992 Plan and the 1994 Plan is 590,649 and 300,000, respectively, subject
to anti-dilution adjustments. The Board of Directors has designated the
Compensation Committee to administer the Stock Option Plans. The Committee is
empowered to designate the employees who will receive options and to determine
the number of shares, vesting schedule, option price (which may not be less
than 85% of the fair market value of the optioned shares), and option term
(which may not exceed ten years except in limited circumstances). Options may
provide for payment of the option price in cash, by application of vested
deferred compensation credits, or by the surrender of shares owned by the
optionee for more than one year. Options are not transferable except upon
death and may be exercised during the lifetime only by the optionee or his
legal representative. Options will terminate 180 days or 270 days after
termination of the optionee's employment under the 1992 Plan and the 1994 Plan,
respectively, or two years after permanent disability or death. The Board of
Directors may amend the Stock Option Plan in any respect. The Committee may
modify outstanding options or may accept the cancellation of existing options
in return for the grant of new options (which may be for the same or a
different number of shares and specify the same or a different option price).
No option may be granted under the 1992 Plan or the 1994 Plan after July 28,
2002, or January 12, 2004, respectively.

In connection with the acquisition of MGPL, PCLG and San Joaquin Diagnostic
Laboratories (SJDL), options were granted under a plan (the "Acquisition Stock
Option Plan") separate from the 1992 Plan and the 1994 Plan. The Stock Option
Plans are classified as class 9 claims under the Plan.

II-51
<PAGE> 86
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

STOCK OPTIONS OUTSTANDING

<TABLE>
<CAPTION>
1992 1994 Acquisition Total Option
Plan Plan Plan Options Price
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Outstanding at February 28, 1994 564,645 36,667 50,842 652,154 $5.50 - $14.25

Granted 188,000 30,000 -- 218,000 $8.88 - $11.50

Exercised (7,500) -- -- (7,500) $5.50

Forfeited (15,000) -- -- (15,000) $10.25 - $11.50

Expired -- -- (26,035) (26,035) $14.25
------------------------------------------------------------------

Outstanding at February 28, 1995 730,145 66,667 24,807 821,619 $5.50 - $14.25

Granted 10,000 -- -- 10,000 $4.25

Forfeited (94,845) -- -- (94,845) $5.50 - $11.50
------------------------------------------------------------------

Outstanding at February 29, 1996
and February 28, 1997 645,300 66,667 24,807 736,774 $5.50 - $11.50
</TABLE>

ADDITIONAL INFORMATION REGARDING STOCK OPTIONS:

<TABLE>
<CAPTION>
2/28/95 2/29/96 2/28/97
--------------------------------
<S> <C> <C> <C>
Authorized shares 941,491 941,491 941,491

Shares available for granting 119,872 204,717 204,717

Exercisable shares 293,683 372,787 451,891
</TABLE>

In addition to the shares reflected above, 5,000 options each were granted to
each member of the Board of Directors, subject to shareholder approval. The
exercise price of these options will be 85% of the greater of the market price
of the Company's common stock on November 14, 1994 and the price on the date of
shareholder approval.

WARRANTS

In connection with a revision to the Company's Credit Agreement with the Bank
Group (the Third Amendment), two warrants were issued to Sutter Health in
exchange for a guaranty of $3,500,000 of borrowings from the Bank Group. In
December 1996, Sutter Health paid the $3,500,000 guaranty as the Company was in
default of the Credit Agreement.

II-52
<PAGE> 87
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In exchange for the guaranty, Sutter Health received a warrant to purchase up
to 1,200,000 shares of the Company's common stock (Warrant A) and a second
warrant to purchase up to 300,000 shares of the Company's common stock (Warrant
B). The exercise prices of Warrant A are as follows:

<TABLE>
<S> <C>
Tranche 1: 125,000 shares at $4.2219 per share
Tranche 2: 687,500 shares at $5.1266 per share
Tranche 3: 387,500 shares at $5.1266 per share
</TABLE>

Tranches 1 and 2 became exercisable May 10, 1995. Tranche 3 became exercisable
June 10, 1995.

Warrant B became exercisable as of June 10, 1995. Rights to purchase shares
under Warrant B may be exercised under the same terms as Tranche 3. Both
warrants expired 90 days from the expiration date of the guaranty.

(12) EMPLOYEE STOCK PURCHASE PLAN:

In March 1993, the Board of Directors adopted, and the shareholders approved,
an employee stock purchase plan ("ESPP") which provide employees of the Company
with an opportunity to purchase common stock of the Company at 85% of fair
market value through payroll deductions. The maximum number of shares that may
be sold under the ESPP is 225,000 subject to adjustments upon changes in
capitalization of the Company. During fiscal 1995, 1996 and 1997, 13,603,
5,378 and 38,332 shares respectively of Common Stock were purchased through
this plan for $111,623, $24,090 and $34,279, respectively. The Board of
Directors has designated the Compensation Committee to administer the ESPP. On
February 29, 1996 198,883 shares were available to be granted under the plan.
The ESPP was discontinued effective June 30, 1996.

(13) EMPLOYMENT AGREEMENT:

The Company's CEO entered into an employment agreement with the Company with a
term expiring on February 28, 1999, which provides for his employment as Chief
Executive Officer. This agreement provides for a base salary of $375,000
annually and for quarterly bonuses of up to 3% of pre-tax net profits dependent
on the achievement of pre-tax net profit and other performance objectives. The
Company may terminate the agreement before the end of its term if certain
performance objectives have not been achieved. The Company may also terminate
the agreement without any cause by providing severance pay equal to two times
current base salary plus bonus for the four preceding quarterly periods.

The CEO also entered into two compensation agreements with the Company. Under
one of these agreements, the CEO received the sum of $155,000 in cash on March
1, 1992, representing payment of accrued deferred compensation, and an
additional deferred compensation credit of $100,000 that may be applied only to
offset the purchase price of stock options awarded to the CEO which are
described in Note 9.

Under the other agreement, a deferred compensation account in the amount of
$1,855,000 was established for the CEO which vests at the rate of one seventh
on March 1 in each of the years 1993 through 1999. The vested portion, in
general, may be applied only to offset the purchase price of stock options
granted to the CEO. If, on any March 1 vesting date, the fair market value of
the Company is determined to be less than $40 million, the vesting schedule is
delayed by one year.

Under the Plan, all employment contracts or agreements between the CEO and the
Company will be treated as a single Class 5 claim, in an allowed amount not
exceeding $390,000.

II-53
<PAGE> 88
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(14) LEGAL PROCEEDINGS:

As discussed previously, on November 8, 1996 (Petition Date), the Company and
its subsidiaries commenced reorganization cases by filing voluntary petitions
for relief under chapter 11 of the Bankruptcy Code in the Bankruptcy Court.
Under chapter 11, actions to enforce certain claims against the Company are
stayed if the claims arose, or are based on, events that occurred on or before
the Petition Date. The ultimate terms of settlement of these claims will be
determined in accordance with the terms of the Plan confirmed by the Bankruptcy
Court on April 18, 1997.

Prepetition claims that were contingent, unliquidated, or disputed as of the
Petition Date, including, without limitation, those that arise in connection
with rejection of executory contracts or unexpired leases, may be allowed or
disallowed depending on the nature of the claim. Such claims may be fixed by
the Bankruptcy Court or otherwise settled or agreed upon by the parties and
approved by the Bankruptcy Court.

Described below are certain legal proceedings involving the Company that were
in existence as of the Petition Date. All such proceedings have been stayed
pursuant to section 362 of the Bankruptcy Code, and can only proceed with the
approval of the Bankruptcy Court. As a general matter, the treatment of claims
arising prior to the Petition Date, including claims on account of litigation,
will be determined and paid pursuant to the terms of the Plan. The Plan
provides that following the Effective Date, such prepetition litigation, as
well as postpetition litigation involving claims based upon prepetition events,
will become subject to a permanent injunction. The Plan further provides that
the Company, the reorganized Company or the Committee may resolve or adjudicate
the amount of a prepetition litigation claim in the manner in which such claim
would have been resolved if the Company had not instituted the Bankruptcy
Cases. Additionally, the Bankruptcy Court may enter orders modifying the
automatic stay and/or permanent injunction to permit certain matters to
continue to be prosecuted in the courts or before arbitrators where or before
whom such matters are pending, generally for the purpose of pursuing payment of
such claims as are insured from third-party insurers. Because of the
bankruptcy proceedings, the Company's financial exposure with respect to the
prepetition litigation claims set forth in actions currently pending against
the Company is limited by the Plan and should not have a material financial
impact on the Company.

A dispute has arisen between the Company and Medical Group Pathology
Laboratory, Inc. ("MGPL"), the seller of the Santa Barbara facility which the
Company acquired in 1992 (Acquisition), relating to the payment obligations
under the Agreement of Purchase and Sale of Assets between the Company and
MGPL. The Company and MGPL have been unable to reach successful negotiations
with respect to this matter. On November 8, 1995, MGPL commenced an action
(Litigation) against the Company in the Superior Court of the State of
California, Santa Barbara County, captioned Medical Group Pathology Laboratory,
Inc. v. Physicians Clinical Laboratory, Inc. (Case No. 210318). The complaint
alleges breach of the promissory note executed by the Company in connection
with the Acquisition and failure to pay amounts due thereunder equalling
$1,169,505 plus interest and late fees, and seeks compensatory damages in the
amount of sums allegedly due, in addition to unspecified general damages and
attorney's fees. In December, 1995, a default was entered against the Company
in the Litigation. The Company has no substantive defenses to the Litigation.
The Company was able to have the default set aside before a judgment was
entered in connection therewith. As of the Petition Date (at which time the
Litigation was stayed), a standstill agreement with MGPL was in effect,
pursuant to which the parties agreed to attempt in good faith to determine the
precise amount owed to MGPL by the Company under the MGPL Agreement. As of
February 28, 1997, the outstanding principal amount of the Note issued by the
Company to MGPL in connection with the MGPL Agreement was $890,107.

On June 20, 1996, suit was filed against the Company in the Superior Court of
Sacramento under the caption Maintenance Management Corporation v. Physicians
Clinical Laboratory, Inc., Case No. 96AS03171. This lawsuit relates to a
management contract entered into among the Company and the plaintiff therein,
and alleges breach of contract and fraudulent and negligent misrepresentation.
The complaint seeks compensatory damages in excess of

II-54
<PAGE> 89
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

$3.0 million, interest and expenses, as well as exemplary damages. However,
based upon the facts presently known to the Company, it does not believe that
the merits of these claims, if any, justify the amount of damages sought, and
the Company does not believe that this lawsuit, if adversely determined, would
have a material adverse effect on the financial condition of the Company.

In the ordinary course of business, several lawsuits have been filed against
the Company by former employees alleging, among other things, employment
discrimination and harassment, fraud, wrongful (including retaliatory)
discharge in violation of public policy, and related claims, including
intentional and negligent infliction of emotional distress, loss of consortium,
breach of contract and breach of the covenant of good faith and fair dealing.
A number of such suits include claims against current employees of the Company.
Any existing indemnification arrangements between any such employees and the
Company with respect to such claims are subject to the terms of the Plan as
prepetition claims, as described above.

Additionally, several lawsuits have been filed against the Company by former
patients alleging medical malpractice and requesting punitive damages.
Notwithstanding the limitations on the Company's liability exposure resulting
from the bankruptcy proceedings, as described above, the Company does not
expect these matters, either individually or in the aggregate, to have a
material adverse effect on the financial condition of the Company. Moreover,
the Company believes that its insurance policies may cover some or all
judgments against the Company, if any, in these matters.

To date, the Company has not experienced any significant liability with respect
to such claims.

Postpetition Litigation

On or about January 22, 1997, Taylor R. McKeeman, the Company's former Vice
President for Laboratory Operations, filed a Request for Payment of
Administrative Expense with respect to a prepetition Separation Agreement
between the Company and Mr. McKeeman. Under the Separation Agreement, Mr.
McKeeman is entitled to receive a severance payment in the event he is
terminated after a "Change in Control" occurs, as such term is defined in the
Separation Agreement. This request was denied by order of the Bankruptcy
Court, entered on March 19, 1997, because (i) no Change in Control occurred
prior to the termination of Mr. McKeeman's employment and (ii) any claim of Mr.
McKeeman against the Company's bankruptcy estates arising out of the Separation
Agreement constitutes a prepetition claim. Mr. McKeeman filed a notice of
appeal on or about March 5, 1997. If Mr. McKeeman were to prevail on appeal,
the Company would incur an administrative claim against their estates in the
approximate amount of $300,000.

Regulatory Investigation

In April of 1997, the Company received a subpoena to furnish certain
documents to the United States Department of Defense ("DOD") with respect to the
Company's Civilian Health and Medical Program of Uniformed Services ("CHAMPUS")
billing practices. The Company has produced and will continue to produce
documents in response to the DOD's subpoena. In late May 1997, the Company was
notified that its Medicare and Medi-Cal billing practices also were undergoing
review by the United States Department of Health and Human Services ("HHS"), and
in early June of 1997, the Company received a subpoena to furnish certain
documents to HHS in connection with such review. The Company is cooperating
with DOD and HHS in such investigations. The Company believes that these
investigations may be similar to investigations being conducted by DOD and HHS
with respect to the billing practices of the clinical laboratory testing
industry. The Company further believes that these investigations are in their
early stages. There can be no assurance that the result of such investigations
as they relate to the Company would not subject the Company to significant civil
or criminal liability (which could include substantial fines, penalties or
forfeitures, and mandatory or discretionary exclusion from participation in
Medicare, Medi-Cal and other government funded healthcare programs), which could
have a material adverse effect on the financial condition of the Company.

(15) ACQUISITIONS AND INTANGIBLE ASSETS:

In February 1997, the Company purchased 100% of the common stock of MSI from
Nu-Tech for $7,643,183.

II-55
<PAGE> 90
PHYSICIANS CLINICAL LABORATORY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company accounted for the transaction using the purchase method of
accounting and has included MSI in the accompanying financial statements. There
is no operating activity of MSI included in the statement of operations of the
Company for the year ended February 28, 1997. Pro forma results of operations
are as follows for the year ended February 28 (29):

<TABLE>
<CAPTION>
Year Ended February 28 (29),
--------------------------------
1996 1997
------------- -------------
(Unaudited)
<S> <C> <C>
Net revenue $ 105,093,420 $ 75,125,077

Net loss $ (81,920,908) $(102,004,130)

Net loss per common share $ (13.58) $ (16.82)
</TABLE>

II-56
<PAGE> 91
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

As reported on the Company's Current Report on Form 8-K for January
24, 1997, on January 2, 1997, the Company's Board of Directors voted to accept
the proposal of the independent certified public accounting firm of Ernst &
Young LLP to audit the consolidated financial statements of the Company for the
fiscal year ending February 28, 1997. Accordingly, the engagement of Arthur
Andersen LLP as the Company's independent auditors was discontinued effective
January 17, 1997. For further information, see the Company's Current Report on
Form 8-K for January 24, 1997.

II-57
<PAGE> 92
PART III

ITEM 10. DIRECTORS OF THE REGISTRANT.

Set forth below is certain information relating to the members of the
Board of Directors of the Company as of February 28, 1997. The Company's
directors are divided into three classes, and serve three-year terms, expiring
in successive years. As discussed below, certain directors have been selected
pursuant to the terms of the Amended and Restated Voting Agreement among SACC,
Mercy and Methodist (the "Voting Agreement"). See "Item 13. Certain
Relationships and Related Transactions -- Voting Agreement." On the Effective
Date of the Plan, the terms of office of the current members of the Company's
Board of Directors will cease. On and after the Effective Date of the Plan, the
following individuals will become members of the reorganized Company's Board of
Directors: Mr. J. Marvin Feigenbaum (Chairman), Mr. David Sterling, Mr. Leonard
Green and Mr. Matthew Barrett. Pursuant to the terms of the Plan, the remaining
initial Board member will be designated by the Senior Lenders.

J. MARVIN FEIGENBAUM. For additional information regarding Mr.
Feigenbaum, including his employment history, see "-- Executive Officers,"
herein.

DAVID A. STERLING, 40, has been President of Sterling & Sterling,
Inc., a general insurance agency, for over seven years. Mr. Sterling also
serves on the Board of Directors of Nu-Tech, a position he has held since
December 1994.

LEONARD GREEN, 70, has been the President and Chief Executive Officer
of Green Management and Investment Co., a New York private investment firm,
since 1985. Mr. Green also serves on the Board of Directors of Nu-Tech, a
position he has held since December 1994, and on the Board of Directors of
Apria Healthcare, Inc. From 1980 to 1985, Mr. Green was President and Chief
Executive Officer of Yuma Management Corp. From 1972 to 1980, Mr. Green served
as President and Chief Executive Officer of Quality Care, Inc.

MATHEW S. BARRETT is a managing director of Oaktree Capital Management,
LLC. Prior to joining Oaktree, from 1991 to April 1995, Mr. Barrett was Senior
Vice President of TCW Asset Management Company.

CURRENT DIRECTORS

STEPHEN N. BAUER, M.D., 47, has been a pathologist and a director and
the President of Lieb and Paoletti Pathology Medical Group, Inc., Sacramento,
California, since 1990. From 1979 to 1989 he was a pathologist employed by
Diagnostic Pathology Medical Group, Inc. ("DPMG"), Sacramento, California.
Pursuant to an agreement between DPMG and PCL he served as Chief Executive
Officer of the Company in 1987. Dr. Bauer also is a trustee of The Mercy
Foundation. Dr. Bauer was nominated to be a director by Mercy, and was
selected pursuant to the Voting Agreement. Dr. Bauer has served as a director
of the Company since April 1992, and will continue to serve until the Effective
Date.

NATHAN L. HEADLEY, 61, has been PCL's President and Chief Executive
Officer since 1989. Mr. Headley has over 20 years of executive experience in
the clinical laboratory industry. From 1976 until 1985, he held various
positions with National Health Laboratories, serving as Executive Vice
President from 1983 to 1985. Mr. Headley served as Senior Vice President for
the Western Region of Roche Biomedical Laboratories from 1986 to 1987 and as
Chief Operating Officer for Meris Laboratories from 1987 to 1989. Mr. Headley
has served as a director of the Company since April 1992, and will continue to
serve until the Effective Date.

TODD A. MURRAY, 45, has been a partner in the law firm of Hefner,
Stark & Marois since 1985 and has been its managing partner since 1994. Mr.
Murray is Chairman of the Board of Trustees of Sutter Community Hospitals. Mr.
Murray was nominated to be a director by SACC, and was selected pursuant to the
Voting Agreement. Mr. Murray has served as a director of the Company since
August 1994, and will continue to serve until the Effective Date.

RAYMOND NELSON, 54, is Vice President for Business Development for
Catholic Healthcare West, the sole corporate member of Mercy Healthcare
Sacramento. From 1986 to 1989, he held various positions with Mercy General
Hospital, Sacramento, California, serving as Executive Vice President and Chief
Operating Officer from 1986 to 1987, Acting Chief Executive Officer from 1987
to 1988 and Chief Operating Officer from 1988 to 1990. Mr. Nelson is a
director of the Northern California Regional Positron Emission Tomography
Center. Mr. Nelson was nominated to be director by Mercy, and was selected
pursuant to the Voting Agreement. Mr. Nelson has served as a director of the
Company since April 1992, and will continue to serve until the Effective Date.

NEIL L. PENNINGTON, 74, is self-employed as a technical consultant.
Mr. Pennington served as Vice Chairman-Finance of the Sutter Health Board of
Directors in 1993 and served as its Chairman from 1987 through 1992 and in
1995. He has served over fourteen years on the Board of Directors of Vallejo
General Hospital (now Sutter Solano Medical Center), twelve years as an elected
member of the Governing Board of the Vallejo City Unified School District and
three years as Director of the Vallejo City Chamber of Commerce. Mr.
Pennington was Vice President - Refinery Operations of C&H Sugar Company until
February 1986. Mr. Pennington was nominated to be a director by SACC, and was
selected pursuant to the Voting Agreement. Mr. Pennington has served as a
director of the Company since July 1993, and will continue to serve until the
Effective Date.

III-1
<PAGE> 93
VINCENT H. SCHMITZ, 50, has been Senior Vice President and Chief
Financial Officer of Mercy Healthcare Sacramento since 1987. From 1972 to
1987, he held various positions with Mercy Healthcare Bakersfield, Bakersfield,
California, serving as Chief Financial Officer from 1973 to 1987. Mr. Schmitz
is Chief Financial Officer of Mercy Senior Housing, Chief Financial Officer of
Mercy Medical Foundation and a director and Chief Financial Officer of the
Northern California Regional Positron Emission Tomography Center. Mr. Schmitz
was nominated to be a director by Mercy, and was selected pursuant to the
Voting Agreement. Mr. Schmitz has served as a director of the Company since
April 1992, and will continue to serve until the Effective Date.

DENNIS H. TOOTELIAN, 50, has been a Professor of Marketing at
California State University, Sacramento since 1973 and is a partner in the
University Consulting Group. Mr. Tootelian has been Director of the California
State University, Sacramento Center of Management Services since 1992 and
Director of the California State University, Sacramento Center for Small
Business since 1975. He is also Chairman of the Board of Directors of
Methodist Hospital of Sacramento and a director of Mercy Healthcare Sacramento
and of Methodist. Mr. Tootelian was nominated to be a director by Methodist,
and was selected pursuant to the Voting Agreement. Mr. Tootelian served as a
director of the Company since August 1994, and resigned his position as a
director of the Company effective October 8, 1996.

JOHN R. WHEATON, 59, has been President of Mariposa Petroleum Company
since 1990 and is also a director of Mariposa. Prior to that, he was Vice
President and Chief Operating Officer of Dowdell Corporation from 1984 to 1989.
Mr. Wheaton is also an Investment Executive for PaineWebber since 1995 and
Member of the Board of Methodist Hospital Foundation of Sacramento. Mr.
Wheaton is an Independent Director. Mr. Wheaton has served as a director of
the Company since January 1993, and will continue to serve until the Effective
Date.

JOHN R. BURGIS, 58, has been Senior Vice President, Financial
Services, and Chief Financial Officer of Catholic Healthcare West, San
Francisco, California (an affiliate of Mercy), since 1987. Mr. Burgis is a
Certified Public Accountant. From 1978 to 1987 he worked in various management
and advisory capacities in the venture capital business. Mr. Burgis was
nominated to be a director by Mercy, and was selected pursuant to the Voting
Agreement. Mr. Burgis has served as a director of the Company since June 1995,
and will continue to serve until the Effective Date.

MICHAEL T. KUTZMAN, 47, has been in private practice as a lawyer in
Auburn, California, since 1980, specializing in tax and corporate law. Mr.
Kutzman is Vice-Chairman of the Board of Trustees of Auburn Faith Community
Hospital (an affiliate of Sutter Health and SACC), and has served on the Board
of Trustees of the Hospital since 1989. He serves on the Sutter/CHS
Center-Placer County Advisory Board and has been its director since June 1,
1996. He has also served as Chairman of the Finance Committee and Governance
Committee, and as a member of the Quality Review Committee and the Executive
Committee, of the Hospital from June 1995 to June 1, 1996. Mr. Kutzman was
nominated to be a director by SACC, and was selected pursuant to the Voting
Agreement. Mr. Kutzman has served as a director of the Company since June
1995, and will continue to serve until the Effective Date.

Following is a list, as of February 28, 1997, of the names and ages of
the executive officers of the Company together with the date of their election
to corporate office. There are no family relationships between the following
officers of the Company, except as set forth below, nor are there any
arrangements or understandings between any officer and any other person
pursuant to which he was selected as an officer.

III-2
<PAGE> 94
EXECUTIVE OFFICERS

<TABLE>
<CAPTION>
POSITION WITH THE OFFICER
NAME AGE COMPANY SINCE
- --------------------------- --- ------------------------------------- ------------------------
<S> <C> <C> <C>
Nathan L. Headley 61 President, Chief Executive Officer December 1989

J. Marvin Feigenbaum 46 Chief Operating Officer November 1996

Richard M. Brooks 43 Senior Vice President, January 1995
Chief Financial Officer

Wayne E. Cottrell 47 Vice President, April 1987
Finance

Nancy Frisco 47 Vice President, March 1994
General Manager

Joseph L. 56 Senior Vice President, November 1992
Gallagher (1) General Manager

Robert P. Headley (2) 36 Vice President, September 1993
Sales and Marketing

Taylor R. 45 Vice President, December 1989
McKeeman (3) Laboratory Operations

David G. Shafer 50 Vice President, October 1987
Information Systems
</TABLE>

_________________________

(1) Employment with the Company concluded effective November 15, 1996.
(2) Resigned effective February 13, 1997.
(3) Employment with the Company concluded effective December 6, 1996.

Each of the officers listed above has served the Company and its
subsidiaries in various executive capacities for the past five years except for
Messrs. Feigenbaum, Brooks, Gallagher, R. Headley and Ms. Frisco. Mr. Brooks
was formerly a consultant, providing services to various institutions relating
to mergers and acquisitions, financing, and crisis management and interim
management. Mr. Gallagher was formerly the General Manager of MetWest
Laboratories for the Arizona Region. Mr. R. Headley was formerly a Division
Manager of Astro Office Products, Inc., a subsidiary of Canon U.S.A. Nathan
Headley is the father of Robert Headley. Ms. Frisco was formerly Chief
Operating Officer of Bio Diagnostics Laboratory in Torrance, California.

III-3
<PAGE> 95
Mr. Feigenbaum also currently serves as Chairman of the Board of
Directors, President, Chief Executive Officer and Chief Financial Officer of
each of Nu-Tech and Analytical Biosystems Corp. ("ABC"), Nu-Tech's wholly-owned
operating subsidiary. Mr. Feigenbaum was first elected to the Board of
Directors of Nu-Tech in June 1994, at which time he was also elected to the
Board of Directors of ABC and appointed Chief Executive Officer of Nu-Tech and
of ABC. From August 1993 to June 1994, Mr. Feigenbaum served as a consultant
to Nu-Tech, primarily with respect to Nu-Tech's business development and plans
and programs relating to the marketing and exploitation of Nu-Tech's laboratory
and medical testing services. From 1987 to June 1994, Mr. Feigenbaum acted as
an independent consultant in the medical and health care industry. He has over
20 years of experience in the health care industry. Prior to being an
independent consultant, Mr. Feigenbaum, from 1982 to mid-1987, served as
Chairman, President and Chief Executive Officer of Temco Home Health Care
Products, Inc., a durable medical equipment manufacturer. Mr. Feigenbaum
presently serves as a member of the Board of Directors and Vice-Chairman of
Comprehensive Care Corp., a publicly owned company engaged in the health care
business, which is listed on the New York Stock Exchange. Pursuant to the
Plan, Mr. Feigenbaum will serve as Chairman of the Board, President and Chief
Executive Officer of the reorganized Company from and after the Effective Date.

FILING DISCLOSURE

Section 16(a) of the Securities Exchange Act of 1934 and the rules
thereunder require the Company's officers and directors and persons who own
more than 10% of the Company's Common Stock to file reports of ownership and
changes in the ownership with the Securities and Exchange Commission and to
furnish the Company with copies.

Based upon its review of the copies of such forms received by it, or
written representation from certain reporting persons, the Company believes
that, during the last fiscal year, all filing requirements applicable to its
officers, directors, and greater than 10% beneficial owners were complied with.

III-4
<PAGE> 96
ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE
CASH COMPENSATION

EXECUTIVE COMPENSATION. The following table sets forth compensation received
for the three fiscal years ended February 28, 1997 by the Company's Chief
Executive Officer, the four remaining most highly paid executive officers,
other than the Chief Executive Officer, and one additional individual who would
have been among the four most highly paid executive officers, other than the
Chief Executive Officer, but for the fact that he was not serving as executive
officers of the Company at the end of fiscal 1997 (collectively, the "Named
Executives").

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
Long-Term Compensation
--------------------------
Awards Payouts
------------ -------

ANNUAL COMPENSATION Stock Option
Name and Fiscal ------------------------- Awards LTIP All other
Principal Position Year SALARY BONUS (in shares) Payouts Compensation
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Nathan L. Headley 1997 $440,481 $ - - - -
President, Chief 1996 408,260 - - - -
Executive Officer 1995 410,468 281,456(1) 75,000(2) - -

Richard Brooks 1997 $182,591 $ - - - -
Senior Vice 1996 181,873 - 10,000 - -
President 1995 - - 20,000 - -

Wayne Cottrell 1997 $142,564 $ - - - -
Vice President, Finance 1996 141,404 - - - -
1995 130,043 24,250 10,000(2) - -

Nancy Frisco 1997 $144,004 $ - - - -
Vice President, General 1996 143,198 - - - -
Manager 1995 114,527 9,975 - - -

Robert P. Headley 1997 $170,053 $ - - - -
Vice President, Sales and 1996 180,034 8,320 - - -
Marketing (3) 1995 138,925 35,500 20,000(2) - -

Taylor P. McKeeman 1997 $125,685 $ - - - -
Vice President, Laboratory 1996 175,555 - - - -
Operations (4) 1995 155,888 22,200 _ - -

David G. Shafer 1997 94,997 $ - - - -
Vice President, 1996 98,194 _ _ - -
Information Systems 1995 107,500 10,478 _ - -
------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Of such amount, $233,000 will be credited against future bonus
payments to Mr. Headley to be paid under the terms of his employment
agreement. See "-- Employment Agreements and Arrangements."
(2) These amounts include options to purchase shares of Common Stock
granted in November 1994, in the following amounts: Mr. N. Headley
(75,000), Mr. R. Headley (10,000) and Mr. W. Cottrell (10,000). Such
grants remain subject to Shareholder approval.
(3) Resigned effective February 13, 1997.

III-5
<PAGE> 97
(4) Employment with the Company concluded as of December 6, 1996.

OPTION GRANTS IN LAST FISCAL YEAR

During the 1997 fiscal year, the Company did not grant stock options
to any of the Named Executives.

AGGREGATED OPTION EXERCISES AND
FISCAL YEAR-END OPTION VALUE TABLE

Shown below is information with respect to the option exercises in
fiscal 1997 and unexercised options to purchase Common Stock of the Company
granted in fiscal 1997 and prior years to the Named Executives.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED,
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES ACQUIRED VALUE FISCAL YEAR-END (#) FISCAL YEAR-END ($)
ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) ($) UNEXERCISABLE(1) UNEXERCISABLE
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Nathan L. Headley (2) - - 439,389/0 0/0
Richard M. Brooks - - 8,000/22,000 0/0
Wayne E. Cottrell - - 28,407/10,851 0/0
Nancy Frisco - - 6,000/4,000 0/0
Robert P. Headley (3) - - 8,000/12,000 0/0
Taylor P. McKeeman (4) - - 29,178/7,296 0/0
David G. Shafer - - 16,066/4,016 0/0
</TABLE>

________________

(1) These amounts include options to purchase shares of Common Stock granted in
November 1994 in the following amounts: Mr. N. Headley (75,000), Mr.
Cottrell (10,000) and Mr. R. Headley (10,000). Such grants remain subject
to shareholder approval.

(2) The Board of Directors recommended Mr. Headley's options vest 100% on
December 31, 1995 subject to shareholder approval.

(3) Resigned effective February 13, 1997.

(4) Employment with the Company concluded effective December 6, 1996.

III-6
<PAGE> 98
LONG-TERM INCENTIVE PLAN AWARD TABLE

Shown below is information with respect to awards made under the
Company's deferred compensation agreement with Nathan L. Headley. See
"--Employment Agreements and Arrangements."

LONG-TERM INCENTIVE PLAN - ESTIMATED PAYOUTS
UNDER DEFERRED COMPENSATION AGREEMENTS

<TABLE>
<CAPTION>
Performance Estimated Future Payouts
----------------------------------------------
LTIP Period
Name Payouts Until Payout
Threshold ($) Target ($) Maximum ($)
<S> <C> <C> <C> <C> <C>
Nathan L. Headley (1) $0 March 1, 1993- $0 $1,855,000 $1,855,000
March 1, 1999
- -----------------
</TABLE>
(1) Under this agreement the payout consists of $1,855,000 which has
vested or will vest at the rate of one-seventh on March 1 in each of
the years 1993 through 1999. The vested portion in general may be
applied only to offset the exercise price of stock options granted to
Mr. N. Headley. If, on any March 1 vesting date, the fair market
value of the Company is determined to be less than $40 million, the
vesting schedule is delayed by one year for each scheduled vesting
date. See "--Employment Agreements and Arrangements."

COMPENSATION OF DIRECTORS

In fiscal year 1997, non-employee directors received a retainer fee of
$16,000 per year, together with fees equal to $1,000 for each Board meeting and
$500 for each committee meeting attended. Directors who are employees of the
Company receive no additional compensation for serving as directors.

EMPLOYMENT AGREEMENTS AND ARRANGEMENTS

Nathan L. Headley entered into an amended and restated employment
agreement with the Company for a term expiring on February 28, 1999, which
provides for his employment as Chief Executive Officer. This agreement, as
amended, provided for an initial base salary of $375,000 annually, subject to
increases at the Company's discretion, and for annual bonuses (paid each fiscal
quarter) as follows: 3% of pre-tax net profit if the pre-tax net profit for a
fiscal year is less than or equal to $7,333,333; $220,000 plus 2% of pre-tax
net profit in excess of $7,333,333 if pre-tax net profit is greater than
$7,333,333 but less than or equal to $22,000,000; $440,000 plus 1% of pre-tax
net profit if pre-tax net profit is greater than $22,000,000 but less than or
equal to $66,000,000; and $660,000 if pre-tax net profit is greater than or
equal to $66,000,000. The annual bonus, and quarterly payments, are reduced in
the event that: (i) the Company fails for any quarter to meet budgeted pre-tax
net profit, as established by the Board of Directors; or (ii) the Company fails
for any quarter to meet performance objectives (relating to such areas as
general administration, data processing, operations, etc.) for the quarter, as
established by the Board of Directors. The agreement also provides that the
Company will

III-7
<PAGE> 99
maintain a life insurance policy on Mr. Headley's life in the face amount of
twice his base salary, with the beneficiaries of such policy to be designated
by Mr. Headley. The Company may terminate the agreement before the end of its
term upon occurrence of certain events which constitute termination "for
cause," including if the pre-tax net profits and net revenues of the Company in
each of two consecutive 12-month periods shall have increased less than 85% of
the average pre-tax net profit and net revenue increases of comparable
companies (or if the Company's pre-tax net profit and net revenue in such
periods shall have decreased more than 85% of the average pre-tax net profit
and net revenue decreases of comparable companies). The Company may also
terminate the agreement without cause by providing severance pay equal to two
times current base salary plus bonus for the four preceding quarterly periods.
Mr. Headley also entered into a deferred compensation agreement with the
Company effective March 1, 1992, pursuant to which a deferred compensation
account in the amount of $1,855,000 was established for Mr. Headley which has
vested or will vest at the rate of one-seventh on March 1 in each of the years
1993 through 1999. The vested portion in general may be applied only to offset
the purchase price of the stock options granted to Mr. Headley. If, on any
March 1 vesting date, the fair market value of the Company is determined to be
less than $40 million, the vesting schedule is delayed by one year for each
scheduled vesting date. Of the $281,456 bonus payment paid to Mr. Headley in
fiscal year 1995, $233,000 will be credited against future bonus payments to be
paid to Mr. Headley.

Mr. Headley entered into a Separation Agreement with the Company on
March 1, 1994 (the "Separation Agreement"). The Separation Agreement provides
for certain payments to be made to Mr. Headley following his termination upon a
"Change of Control" of the Company, subject to certain limitations. A Change
of Control is defined to include: (i) a merger or consolidation when the
holders of the Company's voting stock immediately prior to the merger or
consolidation hold less than a majority of the voting stock, directly or
indirectly, of the surviving corporation immediately after the merger or
consolidation; (ii) any sale, lease, exchange, transfer of all, or
substantially all, of the assets of the Company; and (iii) the approval by the
Company's shareholders of a plan or proposal for the liquidation or dissolution
of the Company. In the event of termination upon a Change of Control, the
Separation Agreement provides that Mr. Headley will receive a separation
payment, equal to the difference between 2.99 times Mr. Headley's salary and
the amount determined to be "contingent upon a change of ownership or control,"
within the meaning of the Internal Revenue Code, arising from acceleration of
stock options granted to Mr. Headley. Mr. Headley is further entitled to full
benefit coverage under the Company's life insurance and health plans for a
period of three years following a change of control. See "Item 12. Certain
Relationships and Related Transactions," herein.

Richard M. Brooks entered into an employment agreement with the
Company for a term expiring on January 22, 2000, which provides for his
employment as Senior Vice President and Chief Financial Officer. This
agreement provided for an initial base salary of $175,000 annually, subject to
increases at the Company's discretion, and for quarterly bonuses in an amount
equal to 5% of base salary, 75% of which is payable if the Company meets
certain financial projections approved by the Board of Directors for the
applicable quarter, and 25% of which is payable based upon a performance
evaluation by the Chief Executive Officer. This agreement also provided for
the grant of options to Mr. Brooks to purchase 20,000 shares of the Company's
Common Stock at an exercise price of $10.50 per share, to vest 20% per year
over

III-8
<PAGE> 100
a five year period, and for the Company to request the Compensation Committee
of the Board of Directors to grant the additional options to Mr. Brooks to
purchase up to 10,000 shares of the Company's Common Stock upon the sixth and
twelfth month anniversaries of his employment with the Company, pursuant to
which Mr. Brooks was granted options to purchase an additional 10,000 shares of
the Company's Common Stock, at an exercise price of $4.25 per share. The
Company may terminate the agreement before the end of its term upon occurrence
of certain events which constitute termination "for cause." In the event of
termination of the agreement, Mr. Brooks shall be entitled to all accrued and
unpaid salary, bonus, vacation and expenses under the agreement.

J. Marvin Feigenbaum entered into an employment agreement (the
"Feigenbaum Employment Agreement") with the Company effective as of November 8,
1996, which provides for his employment as Chief Operating Officer and Crisis
Manager. The Company was obligated to enter into the Feigenbaum Employment
Agreement pursuant to the Prepetition Termsheet, and execution of the
Feigenbaum Employment Agreement was a condition to the availability of funds
under the DIP Financing Facility. See "Item 1. Business --Recent Developments
- --Chapter 11 Reorganization," above. The term of the Feigenbaum Employment
Agreement expires on the Effective Date, at which time, pursuant to the Plan,
the reorganized Company will enter into the New Feigenbaum Employment Agreement
(as herein defined), described below. The Feigenbaum Employment Agreement
provides for an annual salary of $104,000 and reimbursement of reasonable
out-of-pocket expenses. The Company may terminate the Feigenbaum Employment
Agreement before the end of its term upon occurrence of certain events which
constitute termination "for cause." In the event of termination of the
agreement, Mr. Feigenbaum shall be entitled to all accrued and unpaid
compensation (including expenses) under the agreement.

The Plan provides that on the Effective Date, Mr. Feigenbaum will
enter into a new employment agreement with the reorganized Company (the "New
Feigenbaum Employment Agreement"), which will be a three-year employment
agreement pursuant to which Mr. Feigenbaum will be retained as Chairman of the
Board of Directors, Chief Executive Officer and President of the reorganized
Company. Under the terms of the agreement, Mr. Feigenbaum will receive an
annual salary of $104,000.00 for the first year of the agreement. The
agreement also provides that Mr. Feigenbaum will receive options to purchase
shares of New Common Stock.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION IN COMPENSATION DECISIONS

The Compensation Committee consists of three nonemployee directors.
Currently, the members of the Compensation Committee are Dr. Bauer and Messrs.
Nelson (Chairman) and Pennington. None of the executive officers of the
Company serves as a director of another corporation in a case where an
executive officer of such other corporation serves as a director of the
Company.

III-9
<PAGE> 101
Messrs. Nelson and Schmitz, directors of the Company, are each
executive officers of Mercy. Mr. Kutzman, a director of the Company, is a
member of the Board of Trustees of Auburn Faith Community Hospital, an
affiliate of Sutter Health. Mr. Murray, a director of the Company, is a member
of the Board of Trustees of Sutter Community Hospitals, an affiliate of Sutter
Health and SACC. Mr. Burgis is an executive officer of Catholic Healthcare
West, an affiliate of Mercy. Sutter Health and SACC, Mercy, and Methodist, as
successor to Valley Health Care Corporation (collectively, the "Hospital
Stockholders") currently own approximately 38.4%, 20.8% and 14.0%,
respectively, of the outstanding shares of the Company's Common Stock.
Hospitals affiliated with the Hospital Stockholders have contracts with the
Company for provision of clinical laboratory testing services.

III-10

<PAGE> 102
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following table sets forth, at May 15, 1997, certain information
with respect to the beneficial ownership of the Company's Common Stock by (i)
each person known by the Company to own beneficially more than five percent of
the total number of outstanding shares of Common Stock, (ii) each director and
nominee for director of the Company, (iii) each of the Named Executives, and
(iv) all directors and officers of the Company, as a group.

<TABLE>
<CAPTION>
AMOUNT AND
NATURE PERCENT
BENEFICIAL OF
OWNERSHIP(1)(2) CLASS(3)
---------------- ---------
<S> <C> <C>
BENEFICIAL OWNERS OF 5% OR MORE:
Sutter Health(4). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,893,714 38.5%
SACC(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,393,714 23.0
Mercy Healthcare Sacramento(5). . . . . . . . . . . . . . . . . . . . . . . . . 1,258,714 21.0
Methodist Hospital of Sacramento(6) . . . . . . . . . . . . . . . . . . . . . . 845,809 14.5
Oppenheimer Management Corporation(7) . . . . . . . . . . . . . . . . . . . . . 737,705 12.3
Donaldson, Lufkin & Jenrette Securities Corporation(8). . . . . . . . . . . . . 678,589 10.1
OppenheimerFunds, Inc.(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . 655,738 9.8
FMR Corp.(9). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508,950 7.8
Oppenheimer Total Return Fund, Inc.(7). . . . . . . . . . . . . . . . . . . . . 327,869 5.5
Oppenheimer Discovery Fund(7) . . . . . . . . . . . . . . . . . . . . . . . . . 327,869 5.5

DIRECTORS:
Stephen N. Bauer(10). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260,687 4.3
John R. Burgis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - -
Nathan L. Headley(11) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439,389 7.2
Michael T. Kutzman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - -
Todd A. Murray(12). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,333 *
Raymond Nelson(12). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,666 *
Neil L. Pennington(12). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,667 *
Vincent Schmitz(12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,667 *
John R. Wheaton(13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,267 *

NAMED EXECUTIVES OTHER THAN MR. HEADLEY:
Richard M. Brooks(12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 *
Wayne E. Cottrell(14) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,258 *
</TABLE>

III-11
<PAGE> 103
<TABLE>
<CAPTION>
AMOUNT AND
NATURE PERCENT
BENEFICIAL OF
OWNERSHIP (1)(2) CLASS (3)
---------------- ---------
<S> <C> <C>
Nancy Frisco (12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000 *
Robert P. Headley (12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 *
Taylor P. McKeeman (12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,483 *
David G. Shafer (12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,082 *
DIRECTORS AND OFFICERS AS GROUP:
-------------------------------
All directors and officers
as a group (15 persons) (15) . . . . . . . . . . . . . . . . . . . . . . . . . 844,499 13.9
</TABLE>

___________________________
* - Less than one percent

(1) As of May 10, 1995 and June 10, 1995, the Company issued warrants
("Warrants") to purchase up to a total of 1,500,000 shares of Common
Stock, which became exercisable for all such shares as of June 10, 1995.
The right to purchase 125,000 of such shares is exercisable at $4.2219 per
share. The right to purchase the remaining 1,375,000 of such shares is
exercisable at $5.1266 per share. On August 24, 1993, the Company issued
its Debentures in the aggregate principal amount of $40,000,000, which are
immediately convertible into the Company's Common Stock at a conversion
price of $12.20 per share. As indicated below and in accordance with Rule
13d-3 under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), beneficial ownership information with respect to holders of
Warrants and Debentures assumes conversion of Warrants or Debentures,
respectively, into shares of Common Stock.

(2) Unless otherwise indicated in these footnotes, each stockholder has sole
voting and investment power with respect to the shares beneficially owned.
All share amounts reflect beneficial ownership determined pursuant to Rule
13d-3 under the Exchange Act.

(3) Percentage amounts reflect exercise of Warrants, conversion of Debentures,
or exercise of options only as to holders of such Warrants, Debentures, or
options, respectively, in accordance with Rule 13d-3(d)(1)(i) under the
Exchange Act.

(4) As of May 10, 1995 and June 10, 1995, the Company issued the Warrants to
Sutter Health to purchase up to a total of 1,500,000 shares of Common
Stock, which became exercisable for all such shares as of June 10, 1995.
See "Item 12. Certain Relationships and Related Transactions -- Issuance
of Warrants to Sutter Health." Sutter Health filed a Schedule 13D with
the SEC for May 10, 1995 and Sutter Health filed a Schedule 13D with the
SEC for June 22, 1995, both pursuant to the Exchange Act, reporting
issuance of the Warrants and stating that Sutter Health is the sole
corporate member of Sutter Ambulatory Care Corporation ("SACC"), which
itself owns 1,393,714 shares of Common Stock. According to these filings,
Sutter Health has the right to appoint all of the directors of SACC. As a
result, Sutter Health owns beneficially a total of 2,893,714 shares of
Common Stock, 1,500,000 shares for which it possesses sole voting power
and sole dispositive power, and 1,393,714 shares for which it shares
voting power and dispositive power with SACC. SACC owns beneficially
1,393,714 shares of Common Stock, with respect to none of which it
possesses sole voting power and sole dispositive power, and with respect
to 1,393,714 of which it shares voting power and dispositive power with
Sutter Health. The power to dispose of and vote the shares of Common
Stock held by Sutter Health resides with its Board of Directors as a group
and not with any one individual. The Sutter Health Board of Directors is
composed of Mr. Ralph Andersen, Ms. Mary Jane Armacost, Dr. Paul J.
Feldstein, Mr. Kenni Friedman, Mr. Van Johnson, Mr. Lawrence G. Mohr, Jr.,
Mr. Dennis J. O'Connell,

III-12
<PAGE> 104
Dr. Harold Ray, Mr. Steven H. Oliver, Mr. Michael A. Roosevelt, Mr. Toby
Rosenblatt, Dr. Robert J. Swanson, and Ms. Annita Watson. All such
individuals thus may be deemed to have voting and dispositive power with
respect to such shares. Such individuals disclaim beneficial ownership of
such shares. The power to dispose of and to vote the shares of Common
Stock held by SACC resides with its Board of Directors as a group and not
with any one individual. The SACC Board of Directors is comprised of Mr.
Pat Fry, Mr. Ralph Andersen, and Ms. Annita Watson. All of such
individuals thus may be deemed to have voting and dispositive power with
respect to such shares. Such individuals disclaim beneficial ownership of
such shares. The address for Sutter Health and SACC is One Capitol Mall,
Suite 410, Sacramento, California 95814.

(5) The power to dispose of and to vote the shares of Common Stock held by
Mercy Healthcare Sacramento ("Mercy") resides with its Board of Directors
as a group and not with any one individual. The Board of Directors is
comprised of Dr. Jose Abad, Mr. Alvan D. Arthur, Mr. Richard Koppes, Dr.
Richard Heater, Ms. Adrienne Crowe, Sr. Eileen Enright, Dr. James Kiley,
Ms. Eleanor Langpaap, Dr. William Hicks, Sister Bridget McCarthy, Dr. Tom
March, Sister Patricia Mulderrig, Mr. Richard Keller, Dr. Queen Randall,
Dr. Dennis Tootelian, Mr. Mark Lund and Mr. Larry Wilson. All of such
individuals thus may be deemed to have voting and dispositive power with
respect to such shares. Such individuals disclaim beneficial ownership of
such shares. Mercy is the sole corporate member of Methodist Hospital of
Sacramento ("Methodist"). Methodist has the ability to select 3 of the 14
members of the Board of Directors of Mercy and Mercy has the ability to
select 3 of the 16 members of the Board of Directors of Methodist and has
approval rights regarding the remaining 13 directors. Mercy may be deemed
to be the beneficial owner under the federal securities laws of shares of
Common Stock held by Methodist. The address for Mercy is 10540 White Rock
Road, Sacramento, California 95670.

(6) The power to dispose of and to vote the shares of Common Stock held by
Methodist resides with its Board of Directors as a group and not with any
one individual. The Board of Directors is comprised of Dr. Jose Abad, Mr.
Gil Albiani, Mr. Alvan Arthur, Ms. Doreen T. Chan, Dr. John R. Cox, Dr.
Richard DeFelice, Ms. Goldie Hall, Ms. Eleanor Langpaap, Dr. Leonard Lehr,
Sister Bridget McCarthy, Dr. Queen Randall, Dr. Franklin Robinson, Mr.
Robert J. Rose, Ms. Dana C. Smith, Dr. Dan L. Stewart, Dr. Dennis H.
Tootelian and Dr. John Yen. All of such individuals thus may be deemed to
have voting and dispositive power with respect to such shares. Such
individuals disclaim beneficial ownership of such shares. The address for
Methodist is 7500 Timberlake Way, Sacramento, California.

(7) OppenheimerFunds, Inc. ("OFI"), previously known as Oppenheimer Management
Corporation ("OMC"), filed a Schedule 13G dated February 8, 1996 with the
SEC pursuant to the Exchange Act. The Schedule 13G states that OFI owns
beneficially 655,738 shares, with respect to none of which it has sole
voting power, shared voting power as to no shares, sole dispositive power
as to no shares and shared dispositive power as to 655,738 shares. Such
shares are issuable upon conversion of the Company's Debentures. OMC,
Oppenheimer Discovery Fund ("ODF"), and Oppenheimer Total Return Fund,
Inc. ("OTR") filed a Schedule 13G dated February 10, 1995 with the SEC
pursuant to the Exchange Act. The February 10, 1995 Schedule 13G states
that OMC owns beneficially 737,705 shares of which it has sole voting
power as to no shares, shared voting power as to no shares, sole
dispositive power as to no shares and shared dispositive power as to
737,705 shares. Such shares are issuable upon conversion of the Company's
Debentures. OMC disclaims beneficial ownership as to such shares. The
Schedule 13G also states that ODF and OTR each own beneficially 327,869
shares of which they each have sole voting power as to 327,869 shares,
shared voting power as to no shares, sole dispositive power as to no
shares and shared dispositive power as to 327,869 shares. Such shares are
issuable upon conversion of the Company's Debentures. The address for
OFI, OMC, ODF and OTR is Two World Trade Center, New York, New York.

(8) AXA Assurances I.A.R.D. Mutuelle, AXA Assurances Vie Mutuelle, Alpha
Assurances I.A.R.D. Mutuelle, Alpha Assurances Vie Mutuelle, AXA Courtage
Assurance Mutuelle (collectively, "Mutuelles AXA"), AXA, and The Equitable
Companies Incorporated jointly filed Schedule 13G, dated February 14,
1997, with the SEC pursuant to the Exchange Act. Mutuelles AXA, as a
group, owns a majority interest in AXA. AXA owns a majority interest in
The Equitable Companies Incorporated. The Schedule 13G states that
Donaldson, Lufkin & Jenrette Securities Corporation, which is a subsidiary
of the Equitable Companies Incorporated, beneficially

III-13
<PAGE> 105
owns 678,589 shares of Common Stock, of which it has sole voting power as
to 677,089 shares, shared voting power as to no shares, sole dispositive
power as to 677,089 shares, and shared dispositive power as to 1,500
shares. Of such 678,589 shares, 677,047 shares are issuable upon
conversion of Debentures owned beneficially by Donaldson, Lufkin &
Jenrette Securities Corporation. Alpha Assurances I.A.R.D. Mutuelle and
Alpha Assurances Vie Mutuelle are located at 100-101 Terrasse Boieldieu
92042, Paris La Defense, France. AXA Assurances I.A.R.D. Mutuelle and AXA
Assurances Vie Mutuelle are located at 21, rue de Chateaudun, 75009 Paris,
France. AXA Courtage Assurance Mutuelle is located at 26, rue Louis le
Grand, 75002, Paris, France. AXA is located at 23, avenue Matignon,
75008, Paris, France. The Equitable Companies Incorporated is located at
787 Seventh Avenue, New York, New York, 10019.

(9) FMR Corp. ("FMR") filed a Schedule 13D dated November 21, 1996 with the
SEC pursuant to the Exchange Act. The Schedule 13D states that FMR,
Fidelity Management & Research Company ("Fidelity"), a wholly-owned
subsidiary of FMR, and Fidelity Management Trust Company ("FMTC"), a
wholly-owned subsidiary of FMR, own beneficially 508,950 shares, of which
FMR has sole voting power as to 508,950 shares, shared voting power as to
no shares, sole dispositive power as to 508,950 shares and shared
dispositive power as to no shares. Such shares are issuable upon
conversion of Debentures owned beneficially by FMR through Fidelity. The
principal offices of FMR, Fidelity and FMTC are located at 82 Devonshire
Street, Boston, Massachusetts.

(10) Includes 6,667 shares issuable upon exercise of stock options. Dr. Bauer
has sole voting power as to 219,020 shares, shared voting power as to
35,000 shares, sole dispositive power as to 219,020 shares and shared
dispositive power as to 35,000 shares.

(11) Such shares are issuable upon exercise of stock options with approval of
the Company's shareholders.

(12) Such shares are issuable upon exercise of stock options.

(13) Includes 6,667 shares issuable upon exercise of stock options.

(14) Includes 6,000 shares issuable upon exercise of stock options with
approval of the Company's shareholders, and 29,258 shares upon exercise of
stock options.

(15) Includes 354,654 shares issuable upon exercise of stock options.

Under the terms of the Plan, Nu-Tech, the Senior Lenders and the
holders of the Debentures will receive 52.6%, 38.1% and 9.3%, respectively, of
the New Common Stock of the reorganized Company.

III-14
<PAGE> 106
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

VOTING AGREEMENT

The Hospital Stockholders have entered into a Voting Agreement which
extends to March 1, 2002 under which they have agreed that the Board of
Directors of the Company shall consist of:

- Its Chief Executive Officer (currently Nathan L. Headley);

- Two directors who are independent under standards
established by the National Association of Securities
Dealers for Nasdaq National Market System companies (which
presently exclude officers and employees as well as
individuals who have relationships that, in the opinion of
the board of directors, would interfere with the exercise of
independent judgment) or by any stock exchange on which the
Common Stock is listed and who are not employed by the
Hospital Stockholders or any of their affiliates
("Independent Directors"); and

- Eight directors agreed upon by the Hospital Stockholders in
the manner described below ("Hospital Representatives").

The Company's directors are divided into three classes. The Voting
Agreement assigns the Independent Directors to Classes I and II and the Chief
Executive Officer to Class III. The Hospital Representatives are assigned two
to Class I, three to Class II and three to Class III.

Sutter and Mercy are each entitled to designate one Hospital
Representative and the Nominating Committee of the Board of Directors is
entitled to nominate an Independent Director to serve in Class I. Sutter,
Mercy and Methodist are each entitled to designate one Hospital Representative
to serve, together with the Chief Executive Officer, in Class III.

Of the Company's current directors, eight are Hospital
Representatives. Dr. Bauer and Messrs. Burgis, Nelson and Schmitz were
designated by Mercy, Mr. Tootelian (who resigned from the Board effective
October 8, 1996) was designated by Methodist, and Messrs. Kutzman, Murray and
Pennington were designated by SACC. Mr. Wheaton is an Independent Director,
and one Independent Director seat remains vacant.

If any Hospital Stockholder's voting power in the Company should
decline relative to the voting power of the others, its rights to designate
Hospital Representatives within any class of directors may diminish. In Class
I, a Hospital Stockholder which owns shares representing more than 66-2/3% of
the voting power represented by all shares of Common Stock held by all Hospital
Stockholders, or a Hospital Stockholder which owns shares representing at least
33-1/3% of such voting power in a case where no other Hospital Stockholder owns
shares representing at least 29% of such voting power, would be entitled to
designate both Hospital Representatives in that class. In Classes II and III,
a Hospital Stockholder which owns shares representing more than 80% of such
voting power, or a Hospital Stockholder which owns shares representing more
than 60% of such voting power in a case where no other Hospital Stockholder

III-15
<PAGE> 107
owns shares representing at least 20% of such voting power, would be entitled
to designate all three Hospital Representatives in the particular class, and
there are intermediate situations in which a particular Hospital Stockholder
would be able to designate two Hospital Representatives in Class II or III or
where, in the case of deadlock between two Hospital Stockholders having equal
voting power, such designation would be made by coin toss.

A Hospital Stockholder who ceases to own beneficially at least 5% of
the issued and outstanding shares of Common Stock on a fully diluted basis
would cease to have any rights or obligations under the Voting Agreement, and
the rights of the remaining Hospital Stockholders to designate Hospital
Representatives would be adjusted in accordance with a formula.

While the Hospital Stockholders agree to vote their shares of Common
Stock for directors selected as described above, the Voting Agreement would not
apply to elections where a Hospital Stockholder has failed to designate a
Hospital Representative which it is entitled to designate or where the
Nominating Committee has failed to designate an Independent Director.

If Methodist should undergo a change in control (as defined in the
Voting Agreement), neither SACC nor Mercy would be required to vote its shares
of Common Stock for Hospital Representatives designated by Methodist. If the
person assuming control of Methodist is not a party to the Voting Agreement,
Methodist would cease to have any rights of obligations thereunder; if such
person is a party to the Voting Agreement, Methodist's shares would be added to
its own for purposes of designating Hospital Representatives under the
provisions described above in accordance with a formula.

ISSUANCE OF WARRANTS TO SUTTER HEALTH

On May 10, 1995, the Company entered into an agreement with Sutter
Health whereby Sutter Health guaranteed $3.5 million of the Company's
indebtedness to its lending syndicate (pursuant to the "Sutter Guaranty") in
exchange for the issuance by the Company of warrants (the "Warrants") to
purchase up to 1.5 million shares of the Company's Common Stock. Immediately
prior to these transactions, SACC owned approximately 23.1% of the outstanding
Common Stock. The Warrants provide for the right to purchase Common Stock
prior to the Expiration Date (as defined below). Upon execution of the
Guaranty, the Company issued a Warrant for the right to purchase up to 1.2
million shares (or approximately 19.9%) of the Common Stock outstanding in
three tranches. The first tranche consists of the right to purchase 125,000
shares of Common Stock, which became exercisable upon execution of the Guaranty
(May 10, 1995), at $4.2219 per share (70% of the Reference Value, as defined
below). The second tranche consists of the right to purchase 687,500
additional shares of Common Stock, which also became exercisable on May 10,
1995, at $5.1266 per share (85% of the Reference Value). The third tranche
consists of the right to purchase 387,500 additional shares of Common Stock,
which became exercisable on June 10, 1995, also at $5.1266 per share (85% of
the Reference Value).

The Reference Value is defined as the lower of the average closing
price per share of the Common Stock for the five trading days ending on May 9,
1995 ($7.25000) and the average closing price per share of the Common Stock for
the twenty trading days beginning May 10,

III-16
<PAGE> 108
1995 ($6.03125). The Expiration Date is defined as the ninetieth day following
the date that the Guaranty expires pursuant to its terms, which is the date on
which all indebtedness and payment obligations under the Credit Agreement are
satisfied.

The Company issued a second Warrant to Sutter Health, covering the
remaining shares, as of June 10, 1995. The second Warrant provides for the
right to exercise, on terms identical to those of the third tranche of the
first Warrant, of up to 300,000 additional shares of Common Stock.

As more fully described above, holders of Warrants in the Company are
classified in Class 9 of the Plan. Accordingly, holders of Warrants in the
Company will not receive or retain any property on account of their Warrants
under the Plan.

All shares of Common Stock that may be issued pursuant to the terms of
the Warrants carry registration rights, pursuant to which Sutter Health or its
registered assigns (each a "Warrant Holder") may: (i) prior to the Expiration
Date, require the Company to take actions necessary to permit the Warrant
Holder to sell shares of Common Stock issued pursuant to the Warrants (but may
not require the Company to file more than two registration statements relating
thereto); and (ii) prior to the date that is three years following the
Expiration Date, require the Company to include shares of Common Stock held by
the Warrant Holder in any registration, subject to certain exceptions, to be
effected by the Company. Other than fees of the Warrant Holder's counsel and
applicable filing fees and underwriting discounts, the Company is obligated to
pay all fees and expenses in connection with any registration effected pursuant
to these provisions.

The Company agreed to pay reasonable fees and expenses of Sutter
Health's outside advisors in connection with the Guaranty, up to $50,000.

On December 30, 1996, Sutter Health paid $3.5 million to Nu-Tech and
the Senior Lenders in respect of the senior secured claims pursuant to the
Sutter Guaranty, due to the fact that the Company was in default of the Credit
Agreement. This payment reduced the amount of the senior secured claims to
approximately $90.8 million.

INDEBTEDNESS

On October 31, 1990, the Company loaned Mr. Headley, the President and
Chief Executive Officer of the Company, $50,000. The loan, which matured in
October 1996, bears interest at 10% per annum. On October 4, 1993, the Company
loaned Mr. Headley $150,000. The loan, which matured in October 1996, bears
interest at 7% per annum. On April 28, 1994, the Company loaned Mr. Headley
$150,000. The loan, which matured in October 1996, bears interest at 7% per
annum. Mr. Headley is currently in default of his payment obligations under
all of these loans. As of April 30, 1997, Mr. Headley remained indebted to the
Company in the amount of $350,000. See "--Miscellaneous," below.

MISCELLANEOUS

The Company is in the process of negotiating an agreement with Nathan
L. Headley which would provide for Mr. Headley's resignation as President and
Chief Executive Officer of the Company and his release of all present and
future claims against the Company of the reorganized Company. However,
definitive terms have not yet been reached as to any such agreement.

J. Marvin Feigenbaum, the Company's Chief Operating Officer and the
future Chairman of the Board, President and Chief Executive Officer of the
reorganized Company, is the beneficial owner of approximately 13.8% of the
issued and outstanding common stock of Nu-Tech, and also currently serves as
Chairman of the Board of Directors, President, Chief Executive

III-17
<PAGE> 109
Officer and Chief Financial Officer of each of Nu-Tech and Analytical
Biosystems Corp., Nu-Tech's wholly-owned operating subsidiary. Pursuant to the
Plan, Nu-Tech will receive 35.6% of the New Common Stock in exchange for its
holdings of approximately $13.0 million in senior secured debt (which debt it
purchased from the Senior Lenders just prior to the Petition Date). In
addition, on February 26, 1997, the Company consummated the MSI Stock Purchase,
whereby the Company acquired all issued and outstanding shares of MSI from
Nu-Tech. See "Item 1. Business --Recent Developments --MSI Stock Purchase,"
above. In consideration for the Shares, the Company paid to Nu-Tech an
aggregate amount in cash equal to $2,643,183.03. The Company also issued and
delivered a Promissory Note to Nu-Tech in the principal amount of $5,000,000,
pursuant to the Plan, the Promissory Note will be forgiven by Nu-Tech on the
Effective Date, in exchange for which forgiveness Nu-Tech will acquire 17% of
the New Common Stock. The aggregate consideration and other payments to be
made in connection with the MSI Stock Purchase were arrived at pursuant to
arms' length negotiations between the Company and Nu-Tech.

The Company provides laboratory testing and information services to
hospitals affiliated with the Hospital Stockholders. In addition, these
hospitals occasionally provide specialized laboratory services to the Company
and bill the Company at negotiated rates representing a discount to the
hospitals' customary charge. The Company also leases patient service center
space and purchases other services and supplies from affiliates of the Hospital
Stockholders.

Lieb and Paoletti Medical Group, Inc., a California professional
corporation ("Lieb and Paoletti"), currently serves as Clinical Pathology
Medical Director and Cytology Medical Director of certain of the Company's
facilities. Dr. Stephen Bauer, a director of the Company, is the President of
Lieb and Paoletti. During fiscal year 1997, the Company has made payments to
Loeb and Paoletti in the aggregate amount of $83,333.00 for such medical
director services.

In June 1995, Tiger Creations, Inc. a company in which Cecilia
Gallagher, the wife of Joseph T. Gallagher, formerly a Senior Vice President
and General Manager of the Company, has a financial interest, entered into an
arrangement to purchase certain vehicles from P.H.H.

III-18
<PAGE> 110
Vehicle Management Services. These vehicles, which had previously been leased
by the Company and were surplus to the Company's needs, were purchased for the
purpose of repairing and restoring the vehicles for resale. The aggregate
purchase price paid by Tiger Creations, Inc. to P.H.H. Vehicle Management
Services was $64,009.00 and the net profit to Tiger Creations, Inc. from the
resale of such vehicles was approximately $2,750.00. Mr. Gallagher concluded
his employment with the Company effective November 15, 1996.

III-19
<PAGE> 111
PART IV

<TABLE>
<CAPTION>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K PAGE
<S> <C> <C>

(a) Financial Statements, Schedules and Exhibits.

1. Financial Statements included in Part II of this Annual
Report:

Report of Independent Auditors II-22

Report of Independent Public Accountants II-23

Balance Sheets as of February 28 or 29, 1996 and 1997 II-24, II-25

Statements of Operations for years ended February 28 or 29,
1995, 1996, and 1997 II-26

Statements of Cash Flows for years ended February 28 or 29,
1995, 1996 and 1997 II-27

Statements of Changes in Shareholders' Equity (Deficit) for
years ended February 28 or 29, 1995, 1996 and 1997. II-28

Notes to Financial Statements II-29 - II-57

2. Financial Statement Schedules as of February 28, 1997 and for
years ended February 28 or 29, 1995, 1996 and 1997, included
in Part IV of this Annual Report:

Schedule VIII -- Valuation and Qualifying Accounts

Financial statement schedules other than those listed above
are omitted because they are not required or are not
applicable, or the required information is given in the
financial statements including the notes thereto and
Management's Discussion and Analysis of Financial Condition
and Results of Operations. Captions and column headings have
been omitted where not applicable.

3. Exhibits:

The exhibits to this Annual Report are listed in the Exhibit
Index beginning on page IV-6 of this Annual Report.
</TABLE>

(b) Reports on Form 8-K:

During the quarter ended February 28, 1997, the Company filed a
Current Report on Form 8-K on January 24, 1997 to report a change in
the Company's certifying accountant. See "Item 9 - Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure," herein.

IV-1
<PAGE> 112
During the quarter ended February 28, 1997, the Company filed a
current report on Form 8-K on March 13, 1997 to report the Company's
purchase of all outstanding shares of stock of Medical Science
Institute, Inc. ("MSI") from Nu-Tech Bio-Med, Inc. ("Nu-Tech")
pursuant to an Agreement for Purchase and Sale of Stock, dated
February 24, 1997, between the Company, MSI and Nu-Tech.

The Company filed a current report on Form 8-K on June 6, 1997 to
report the confirmation by the Bankruptcy Court of the Company's
Second Amended Joint Plan of Reorganization of Physicians Clinical
Laboratory and its Affiliated Debtors.

IV-2
<PAGE> 113
SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on June 10, 1997.

PHYSICIANS CLINICAL LABORATORY, INC.

By: /s/ J. MARVIN FEIGENBAUM
J. Marvin Feigenbaum
Chief Operating Officer

Pursuant to the requirements of the Securities Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ J. MARVIN FEIGENBAUM Chief Operating Officer (Principal May 29, 1997
- ------------------------------------------ Executive Officer)
J. Marvin Feigenbaum

/s/ RICHARD M. BROOKS Senior Vice President and Chief May 29, 1997
- ------------------------------------------ Financial Officer (Principal Financial
Richard M. Brooks Officer)

/s/ WAYNE E. COTTRELL Vice President, Finance (Principal May 28, 1997
- ------------------------------------------ Accounting Officer)
Wayne E. Cottrell

/s/ JOHN R. BURGIS Chairman of the Board of Directors May 29, 1997
- ------------------------------------------
John R. Burgis

/s/ STEPHEN N. BAUER Director May 28, 1997
- ------------------------------------------
Stephen N. Bauer

/s/ NATHAN L. HEADLEY Director May 29, 1997
- ------------------------------------------
Nathan L. Headley

/s/ TODD A. MURRAY Director May 28, 1997
- ------------------------------------------
Todd A. Murray

/s/ RAYMOND NELSON Director May 28, 1997
- ------------------------------------------
Raymond Nelson

/s/ NEIL L. PENNINGTON Director May 28, 1997
- ------------------------------------------
Neil L. Pennington
</TABLE>

IV-3
<PAGE> 114

<TABLE>
<S> <C> <C>
/s/ VINCENT SCHMITZ Director May 28, 1997
- ------------------------------------------
Vincent Schmitz

/s/ JOHN R. WHEATON Director May 29, 1997
- ------------------------------------------
John R. Wheaton

/s/ MICHAEL T. KUTZMAN Director May 28, 1997
- ------------------------------------------
Michael T. Kutzman
</TABLE>

IV-4
<PAGE> 115
PHYSICIANS CLINICAL LABORATORY, INC.

FINANCIAL STATEMENT SCHEDULES

SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNT

<TABLE>
<CAPTION>
3/1/94 CHARGED 2/28/95
BEGINNING TO ENDING
DESCRIPTION BALANCE EXPENSE (WRITE-OFFS) RECOVERIES BALANCE
----------- ------- ------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful
accounts $607,341 $4,318,516 $(4,000,000) $322,094 $603,763
</TABLE>

<TABLE>
<CAPTION>
3/1/95 CHARGED 2/29/96
BEGINNING TO ENDING
DESCRIPTION BALANCE EXPENSE (WRITE-OFFS) RECOVERIES BALANCE
----------- ------- ------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful
accounts $603,763 $29,659,625 $(27,068,323) $1,436,935 $4,632,000
</TABLE>

<TABLE>
<CAPTION>
3/1/96 CHARGED 2/28/97
BEGINNING TO ENDING
DESCRIPTION BALANCE EXPENSE (WRITE-OFFS) RECOVERIES BALANCE
----------- ------- ------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful
accounts $4,632,000 $8,843,252 $(16,225,891) $12,480,424 $9,729,785
</TABLE>

IV-5
<PAGE> 116
EXHIBIT INDEX

Exhibits marked with an asterisk are filed herewith, the remainder of the
exhibits have heretofore been filed with the Commission and incorporated herein
by reference.

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION PAGE
------- ----------- ----
<S> <C> <S>

2.1 Agreement of Purchase and Sale of Assets among the Company,
CLSI, MetPath, Inc., California Regional Reference Laboratory,
DCL-CA and Redwood, dated as of February 28, 1994 (without
exhibits and schedules; filed as Exhibit 2.1 to the Company's
Current Report on Form 8-K for February 24, 1994 and
incorporated herein by reference).

2.2 Side-Letter, dated April 4, 1994, among the parties set forth
in Exhibit 2.1 (without exhibits and schedules; filed as
Exhibit 2.2 to the Company's Current Report on Form 8-K for
April 4, 1994 and incorporated herein by reference).

2.3 Agreement for Purchase and Sale of Stock, dated February 24,
1997, between the Company, Medical Science Institute, Inc. and
Nu-Tech Bio-Med, Inc. (without exhibits and schedules; filed
as Exhibit 2.1 to the Company's Current Report on Form 8-K for
March 13, 1997 and incorporated herein by reference).

2.4 Second Amended Joint Plan of Reorganization of Physicians
Clinical Laboratory and its Affiliated Debtors filed with the
Bankruptcy Court on February 7, 1997 (without exhibits; filed
as Exhibit 2.1 to the Company's Current Report on Form 8-K for
June 6, 1997 and incorporated herein by reference).

2.5 Findings of Fact, Conclusions of Law and Order Confirming
Second Amended Plan of Reorganization of Physicians Clinical
Laboratory, Inc. and Its Affiliated Debtors, dated April 23,
1997 (filed as Exhibit 2.2 to the Company's Current Report on
Form 8-K for June 6, 1997 and incorporated herein by
reference).

3(i).1 Certificate of Incorporation of the Company, as amended (filed
as Exhibit 3.1 to the Company's Registration Statement on Form
S-1 (File No. 33-50812) and incorporated herein by reference).

3(ii).1 Amended and Restated Bylaws of the Company (filed as Exhibit
3.2 to the Company's Registration Statement on Form S-1 (File
No. 33-50812) and incorporated herein by reference).

4.1 Registration Rights Agreement, dated as of September 10, 1992,
between the Company and Medical Group Pathology Laboratory,
Inc. (filed as Exhibit 10.24 to the Company's Registration
Statement on Form S-1 (File No. 33-50812) and incorporated
herein by reference).
</TABLE>

IV-6
<PAGE> 117
<TABLE>
<S> <C>

4.2 Registration Rights Agreement between the Company and
Pathologist Clinical Laboratories of Glendale, Inc. (filed as
Exhibit 4.1 to the Company's Current Report on Form 8-K for
January 29, 1993 and incorporated herein by reference).

4.3 Registration Rights Agreement between the Company and San
Joaquin Diagnostics Inc. (filed as Exhibit 4.2 to the
Company's Current Report on Form 8-K for January 29, 1993 and
incorporated herein by reference).

4.4 Indenture, dated as of August 24, 1993 among the Company,
Donaldson, Lufkin & Jenrette Securities Corporation and Smith
Barney Shearson Inc. (filed as Exhibit 4.4 to the Company's
Form S-3 Registration Statement (File No. 33-71374) and
incorporated herein by reference).

4.5 Registration Rights Agreement, dated as of August 24, 1993,
among the Company, Donaldson, Lufkin & Jenrette Securities
Corporation and Smith Barney Shearson Inc. (filed as Exhibit
4.2 to the Company's Current Report on Form 8-K dated
September 9, 1993 and incorporated herein by reference).

4.6 Credit Agreement, dated as of April 1, 1994, between the
Company and the Banks (incorporated by reference to Exhibit
4.1 of the Company's Current Report on Form 8-K for April 4,
1994) (without exhibits and schedules).

4.7 First Amendment to Credit Agreement, dated as of July 28, 1994
(incorporated by reference to Exhibit 4.2 of the Company's
Current Report on Form 8-K for May 8, 1995) (without exhibits
and schedules).

4.8 Second Amendment to Credit Agreement, dated as of September
27, 1994 (incorporated by reference to Exhibit 4.3 of the
Company's Current Report on Form 8-K for May 8, 1995) (without
exhibits and schedules).

4.9 Third Amendment to Credit Agreement, dated as of May 10, 1995
(incorporated by reference to Exhibit 4.4 of the Company's
Current Report on Form 8-K for May 8, 1995) (without exhibits
and schedules).

4.10 Fourth Amendment to Credit Agreement, dated as of July 31,
1995 (incorporated by reference to Exhibit 4.13 of the
Company's Annual Report on Form 10-K for the fiscal year ended
February 28, 1995) (without exhibits and schedules).

4.11 Fifth Amendment to Credit Agreement, dated as of February 20,
1996 (without exhibits and schedules; filed as Exhibit 4.5 to
the Company's Quarterly Report on Form 10-Q for the quarter
ended August 31, 1996 and incorporated herein by reference).
</TABLE>

IV-7
<PAGE> 118
<TABLE>
<S> <C>
4.12 Guaranty, dated as of May 10, 1995, granted by Sutter Health
to the Banks (incorporated by reference to Exhibit 4.5 of the
Company's Current Report on Form 8-K for May 8, 1995).

4.13 Form of Guaranty executed by Diagnostic Laboratories, Inc.,
Regional Reference Laboratory Governing Corporation, and
Quantum Clinical Laboratories, Inc., each a subsidiary
corporation of the Company, and California Regional Reference
Laboratory, a limited partnership of which the Company is,
indirectly, the sole general partner and limited partner
(incorporated by reference to Exhibit 4.6 of the Company's
Current Report on Form 8-K for May 8, 1995).

4.14 Agreement, dated as of May 10, 1995, between the Company and
Sutter Health (incorporated by reference to Exhibit 4.7 of the
Company's Current Report on Form 8-K for May 8, 1995).

4.15 Warrant W-001, dated as of May 10, 1995 (incorporated by
reference to Exhibit 4.8 of the Company's Current Report on
Form 8-K for May 8, 1995).

4.16 Warrant W(A)-001, dated as of June 9, 1995 (incorporated by
reference to Exhibit 4.1 of the Company's Current Report on
Form 8-K for July 14, 1995).

4.17 Collateral and Security Agreement, dated as of April 1, 1994,
among the Company, Wells Fargo Bank, National Association, as
Agent, and the Financial Institutions party thereto (filed as
Exhibit 4.2 to the Company's Current Report on Form 8-K for
April 4, 1994 and incorporated herein by reference).

4.18 Guaranty and Security Agreement, dated as of April 1, 1994,
among Diagnostic Laboratories, Inc., a California corporation,
Wells Fargo Bank, National Association, as Agent, and the
financial institutions party thereto (filed as Exhibit 4.3 to
the Company's Current Report on Form 8-K for April 4, 1994 and
incorporated herein by reference).

4.19 Guaranty and Security Agreement, dated as of April 1, 1994,
among Quantum Clinical Laboratories, Inc., a California
corporation, Wells Fargo Bank, National Association, as Agent,
and the financial institutions party thereto (filed as Exhibit
4.4 to the Company's Current Report on Form 8-K for April 4,
1994 and incorporated herein by reference).

4.20 Guaranty and Security Agreement, dated as of April 1, 1994,
among Regional Reference Laboratory Governing Corporation, a
California corporation, Wells Fargo Bank, National
Association, as Agent, and the financial institutions party
thereto (filed as Exhibit 4.5 to the Company's Current Report
on Form 8-K for April 4, 1994 and incorporated herein by
reference).
</TABLE>

IV-8
<PAGE> 119
<TABLE>
<S> <C>
4.21 Guaranty and Security Agreement, dated as of April 1, 1994,
among California Regional Reference Laboratory Governing
Corporation, a California limited partnership, Wells Fargo
Bank, National Association, as Agent, and the financial
institutions party thereto (filed as Exhibit 4.6 to the
Company's Current Report on Form 8-K for April 4, 1994 and
incorporated herein by reference).

4.22 Leasehold Deed of Trust, Assignment of Rents and Security
Agreement, dated as of April 1, 1994, by and among the
Company, as trustor, First American Title Insurance Company,
as trustee, and Wells Fargo Bank, National Association, as
Agent for the financial institutions party to the Credit
Agreement, as beneficiary related to leased property located
at 1011 Rancho Conejo Boulevard, Newbury Park, California
(filed as Exhibit 4.7 to the Company's Current Report on Form
8-K for April 4, 1994 and incorporated herein by reference).

4.23 Leasehold Deed of Trust, Assignment of Rents and Security
Agreement, dated as of April 1, 1994, by and among the
Company, as trustor, First American Title Insurance Company,
as trustee, and Wells Fargo Bank, National Association, as
Agent for the financial institutions party to the Credit
Agreement, as beneficiary related to leased property located
at 2495 Natomas Park Drive, Suite 600, Sacramento, California
(filed as Exhibit 4.25 to the Company's Annual Report on Form
10-K for the Fiscal Year Ended February 28, 1995 and
incorporated herein by reference).

10.1 Amended and Restated 1992 Nonqualified Stock Option Plan of
the Company (filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (File No. 33-50812) and
incorporated herein by reference).

10.2 Hospital Reference Laboratory Agreement, dated as of July 1,
1990, between the Company and Sutter General Hospital (filed
as Exhibit 10.4 to the Company's Registration Statement on
Form S-1 (File No. 33-50812) and incorporated herein by
reference).

10.3 Hospital Reference Laboratory Agreement, dated as of July 20,
1990, between the Company and Methodist Hospital of Sacramento
(filed as Exhibit 10.5 to the Company's Registration Statement
on Form S-1 (File No. 33-50812) and incorporated herein by
reference).

10.4 Hospital Reference Laboratory Agreement, dated as of July 1,
1990, between the Company and Sutter Memorial Hospital (filed
as Exhibit 10.6 to the Company's Registration Statement on
Form S-1 (File No. 33-50812) and incorporated herein by
reference).

</TABLE>

IV-9
<PAGE> 120
<TABLE>
<S> <C>
10.5 Hospital Reference Laboratory Agreement, dated as of July 1,
1990, between the Company and Mercy General Hospital (filed as
Exhibit 10.7 to the Company's Registration Statement on Form
S-1 (File No. 33-50812) and incorporated herein by reference).

10.6 Hospital Reference Laboratory Agreement, dated as of June 27,
1990, between the Company and Mercy San Juan Hospital (filed
as Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File No. 33-50812) and incorporated herein by
reference).

10.7 Regional Laboratory Medical Director Agreement, dated December
1, 1990, amended pursuant to a letter agreement dated March
15, 1993, between the Company and Diagnostic Pathology Medical
Group, Inc. (filed as Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (File No. 33-50812) and
Exhibit 10.23 to the Company's Annual Report on form 10-K for
the Fiscal Year Ended February 28, 1993 respectively, and
incorporated herein by reference).

10.8 Cytology Services Medical Director Agreement, dated March 1,
1989, between the Company and Outpatient Pathology Associated
Medical Group, Inc., as amended (filed as Exhibit 10.10 to the
Company's Registration Statement on Form S-1 (File No.
33-50812) and incorporated herein by reference).

10.9 Agreement, dated March 12, 1992, between the Company and HAI
Financial, Inc. (filed as Exhibit 10.14 to the Company's
Registration Statement on Form S-1 (File No. 33-50812) and
incorporated herein by reference).

10.10 Agreement, dated March 20, 1992, between the Company and HAI
Financial, Inc. (filed as Exhibit 10.15 to the Company's
Registration Statement on Form S-1 (File No. 33-50812) and
incorporated herein by reference).

10.11 Lease, dated March 8, 1994, between the Company, as lessee,
and 2495 Natomas Park Investors as lessors, relating to
property located at 2495 Natomas Park Drive, Sacramento,
California (filed as Exhibit 10.12 to the Company's Annual
Report on Form 10-K for the Fiscal Year Ended February 28,
1995 and incorporated herein by reference).

10.12 Amended and Restated Voting Agreement, among Mercy Healthcare
Sacramento, Sutter Ambulatory Care Corporation and Methodist
Hospital of Sacramento (filed as Exhibit 10.15 to the
Company's Annual Report on Form 10-K for the year ended
February 28, 1993 and incorporated herein by reference).

10.13 Laboratory Director Agreement (Santa Barbara), dated as of
September 10, 1992, between the Company and John P.
</TABLE>

IV-10
<PAGE> 121
<TABLE>
<S> <C>
Blanchard, M.D., Inc. (filed as Exhibit 10.25 to the Company's
Registration Statement on Form S-1 (File No. 33-50812) and
incorporated herein by reference).

10.14 Agreement of Purchase and Sale of Assets, dated as of February
28, 1994, among the Company, CLSI, Metpath, Reference, DCL-CA
and Redwood and side letter dated April 4, 1994, among the
parties (filed as Exhibit 2.1 to the Current Report on Form
8-K for February 24, 1994, and Exhibit 2.3 to the Company's
Current Report on Form 8-K for April 4, 1994, respectively,
and incorporated here by reference).

10.15 Agreement for Purchase and Sale of Corporate Stock, dated as
of January 28, 1994, among the Company and the shareholders of
Diagnostic Laboratories, Inc. (filed as Exhibit 2.1 to the
Company's Current Report on Form 8-K for January 28, 1994 and
incorporated herein by reference).

10.16 Technical Equipment Maintenance Management Agreement, dated as
of January 12, 1996, among the Company and Maintenance
Management Corporation (filed as Exhibit 10.16 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended
February 29, 1996 and incorporated herein by reference).
</TABLE>

MANAGEMENT CONTRACT OR COMPENSATORY PLAN OR ARRANGEMENT WHICH IS SEPARATELY
IDENTIFIED IN ACCORDANCE WITH ITEM 14(A)(3) OF FORM 10-K.

10.17 Amended and Restated Employment Agreement, dated March 1,
1994, between the Company and Nathan L. Headley (filed as
Exhibit 10.18 to the Company's Annual Report on Form 10-K for
the Fiscal Year Ended February 28, 1995 and incorporated
herein by reference).

10.18 Amended and Restated 1990 Deferred Compensation Agreement
dated March 1, 1992, between the Company and Nathan L. Headley
(filed as Exhibit 10.12 to the Company's Registration
Statement on Form S-1 (File No. 33- 50812) and incorporated
herein by reference).

10.19 Deferred Compensation Agreement, dated March 1, 1992, between
the Company and Nathan L. Headley (filed as Exhibit 10.13 to
the Company's Registration Statement on Form S-1 (File No.
33-50812) and incorporated herein by reference).

10.20 Separation Agreement, dated March 1, 1994, between the Company
and Nathan L. Headley (filed as Exhibit 10.21 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended February
28, 1995 and incorporated herein by reference).

10.21 Employment Agreement, dated September 8, 1995, between the
Company and Richard M. Brooks (filed as Exhibit 10.21 to the
</TABLE>

IV-11
<PAGE> 122
<TABLE>
<S> <C>

Company's Annual Report on Form 10-K for the Fiscal Year
Ended February 29, 1996 and incorporated herein by
reference).

10.22 Employment Agreement between the Company and J. Marvin
Feigenbaum, dated as of November 7, 1996 (filed as Exhibit
10.1 to the Company's Current Report on Form 8-K for November
13, 1996 and incorporated herein by reference).

12.1* Statement regarding calculation of ratios of earnings to fixed
charges.

21.1* Subsidiaries of the Company.

23.1* Consent of Ernst & Young LLP.

23.2* Consent of Arthur Andersen LLP.

99 Text of the Company's press release dated April 21, 1997
relating to the confirmation of the Company's Plan of
Reorganization (attached as Exhibit 99 to the Company's
Current Report on Form 8-K for June 6, 1997).
</TABLE>

IV-12

<PAGE> 1
EXHIBIT 12.1

RATIO OF EARNINGS TO FIXED CHARGES
(Amounts in thousands of dollars, except ratio information)

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28(29),
----------------------------

1996 1997
-------- --------
<S> <C> <C>
1. Loss
Pre-tax Loss (79,184) (98,679)
Interest Expense 1 12,899 15,839
------- -------
(66,285) (82,840)
======= =======

2. Fixed Charges
Interest Expense 1 12,899 15,839
======= =======

3. Ratio (1 divided by 2) N/A(A) N/A(A)
======= =======
</TABLE>

(A) Earnings are inadequate to cover fixed charges. The amount of the
deficiency is $79,184, and $98,679 for the year ended February 28(29),
1996 and 1997, respectively.

- -------------------------
1 Consists of interest on debt and imputed interest on capital
leases.

<PAGE> 1
EXHIBIT 21.1

SUBSIDIARIES OF THE COMPANY

Quantum Clinical Laboratories, Inc.
Regional Reference Laboratory Governing Corporation
Diagnostic Laboratories, Inc.
California Regional Reference Laboratory
Medical Science Institute, Inc.

<PAGE> 1
EXHIBIT 23.1

Consent of Independent Auditors

We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-62360) pertaining to the 1993 Employee Stock Purchase Plan of
Physicians Clinical Laboratory, Inc. of our report dated May 9, 1997, with
respect to the financial statements and schedule of Physicians Clinical
Laboratory, Inc. included in the Form 10-K for the year ended February 28, 1997.

ERNST & YOUNG LLP

Sacramento, California
May 9, 1997

<PAGE> 1

Consent of Independent Public Accountants

As independent public accountants, we hereby consent to the incorporation of
our report included in this form 10-K into the Company's previously filed
registration Statement File No. 33-62360.

ARTHUR ANDERSEN LLP

Sacramento, California
June 5, 1997

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1997
<PERIOD-START> MAR-01-1996
<PERIOD-END> FEB-28-1997
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 19,320,989
<ALLOWANCES> 9,729,785
<INVENTORY> 1,534,592
<CURRENT-ASSETS> 13,489,260
<PP&E> 34,834,441
<DEPRECIATION> 23,238,541
<TOTAL-ASSETS> 25,772,015
<CURRENT-LIABILITIES> 20,621,432
<BONDS> 0
0
0
<COMMON> 60,714
<OTHER-SE> (163,317,729)
<TOTAL-LIABILITY-AND-EQUITY> 25,772,015
<SALES> 62,830,847
<TOTAL-REVENUES> 62,830,847
<CGS> 147,483,669
<TOTAL-COSTS> 161,509,557
<OTHER-EXPENSES> 1,708,848
<LOSS-PROVISION> 8,843,252
<INTEREST-EXPENSE> 15,838,895
<INCOME-PRETAX> (98,678,710)
<INCOME-TAX> 0
<INCOME-CONTINUING> (98,678,710)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (98,678,710)
<EPS-PRIMARY> (16.23)
<EPS-DILUTED> 0

</TABLE>