Medical Arts Lab Opts To File For Chapter 11 Bankruptcy

Oklahoma City-based lab company wants to clear the decks for growth

CEO SUMMARY: Dissident shareholders and a crushing debt burden are the reason Medical Arts Laboratory decided to file for reorganization under Chapter 11 bankruptcy laws. Both factors are the legacy of an ill-fated attempt to create a national laboratory organization between 1994 and 1997. It’s the story of a business strategy that brought Medical Arts Labs to the financial brink more than once.

DESPITE ITS RECENT Chapter 11 bankruptcy filing, Medical Arts Laboratory, Inc. of Oklahoma City, Oklahoma remains optimistic about its financial future.

Southern Medical Arts Companies, Inc., along with two business subsidiaries, Medical Arts Laboratory, Inc. and Southern Medical Arts Laboratory, Inc. filed bankruptcy papers in federal court on October 26, 2000.

In filing bankruptcy, Medical Arts Laboratory hopes to end, once and for all, the lingering consequences of the ill-fated PathCor business venture. Launched back in 1994 by a group of former shareholders. PathCorp was an attempt to create a national laboratory and pathology company. (See TDR, April 21, 1997.)

Two Specific Problems

By filing bankruptcy, Medical Arts Laboratory expects to resolve two specific business problems. First, the company, with estimated revenues of $25 million per year, is saddled with as much as $20 million in debt. Existing cash flow was not sufficient to properly service this debt.

Second, for almost four years, Medical Arts Laboratory has been forced to deal with hostile actions by several dissident shareholders. Lawsuits filed by some of these dissident shareholders impacted laboratory operations. These lawsuits required management to divert limited resources of both time and capital away from the laboratory’s core testing business.

“In recent years, like all laboratories across the United States, we’ve been dealing with the negative impact of declining test reimbursement and onerous regulations and guidelines initiated by both government and private payers,” stated Robert T. Savasten, President and CEO of Medical Arts.

“Our independent efforts to deal with these factors were disrupted by the actions of certain dissident shareholders and creditors,” Savasten continued. “The lab testing business at Medical Arts is fundamentally sound. But our management team has been unable to concentrate on the day-today details of running the laboratory.

Develop A Plan of Action

“On a go-forward basis, this Chapter 11 reorganization gives us time to develop a plan of action which will be beneficial to the various medical communities served by our laboratory company,” added Savasten.

Medical Arts Laboratory is one of a shrinking number of independent commercial labs which continue to operate within the United States. Founded in 1923, it is among the oldest continuously-operating lab companies still in existence. It has been a long-time member of The Independent Pathology Institute, Inc. (TIPII). TIPII is a trade organization that serves a number of the remaining pathologist-owned independent commercial lab companies.

It remains the dominant commercial laboratory in Oklahoma. Company executives estimate that Medical Arts Laboratory has a statewide market share in excess of 40%. It employs about 600 people.

Despite this solid business position within Oklahoma, Medical Arts Laboratory has never made a full financial recovery following the dissolution of PathCor in 1997. (See sidebar below.)

Accumulated Net Worth

Its accumulated net worth was stripped out over a four-year period to: a) buy out certain shareholders in 1994 and create PathCorp; b) underwrite the on-going business losses of PathCor; and c)buy out certain other shareholders in 1997. Since 1997, Medical Arts Laboratory has struggled to simultaneously service its debt and deal with multiple lawsuits filed by dissident shareholders.

This put the executive team at Medical Arts in a quandary. The core testing business of Medical Arts has always been profitable. But the demands of servicing debt and responding to shareholder lawsuits prevented executives from concentrating full-time on building the laboratory testing business.

By filing a Chapter 11 bankruptcy action, Medical Arts Laboratory gains two business advantages. First, it gets the time it needs to develop an equitable plan of reorganization for creditors. Second, it “freezes” any impact that existing lawsuits might have on company assets. Such legal claims will be limited to assets involved in the Chapter 11 bankruptcy action.

Medical Arts’ owners believe that, once the Chapter 11 bankruptcy action is discharged by the judge, their company will be able to concentrate on the primary objective of growing their lab testing business.

Lab Industry Truth

For laboratory executives and pathologists, the story of Medical Arts Laboratory once again reinforces an important truth about the clinical laboratory industry. Strong, independent clinical laboratories have virtually unshakable client loyalty.

This client loyalty can be so strong that it survives even the most horrendous business mistakes by laboratory owners and managers. In the case of Medical Arts Laboratory, the cumulative impact of seven years of missteps did not erode the core laboratory testing revenues generated by long-time physician clients.

There is another element to the Medical Arts Laboratory story which may be worth watching. Despite the fact that Medical Arts Laboratory has filed for bankruptcy, THE DARK REPORT believes the story won’t end with the bankruptcy court discharge.

As clients of THE DARK REPORT know, professional investors are combing the clinical lab industry looking for investment opportunities. Once its bankruptcy is discharged, Medical Arts Laboratory company would make a tantalizing investment prospect.

THE DARK REPORT believes that professional investors would be interested in a lab company that has virtually no competition in its state, holds a sizeable market share that can be expanded, has a long-standing reputation for service and quality, and has the goodwill of many long-standing physician-clients.

Add all these attributes up, and it becomes clear that, post-bankruptcy, Medical Arts Laboratory should be an attractive target for professional investors. THE DARK REPORT also observes that, given Dynacare’s lab acquisitions in neighboring Arkansas and Texas, Medical Arts Laboratory might well draw attention from the Canadian-based lab company.

Woes at Medical Arts Laboratory Left Over From PathCorp Venture

LINGERING PROBLEMS WITH EXCESSIVE DEBT and dissident shareholders at Medical Arts Laboratory are rooted in an ill-fated business venture that is familiar to long-time clients and readers of THE DARK REPORT.

Back in 1993, a group of pathologist- shareholders at Medical Arts decided to transform the lab company into a national laboratory organization. This initiative was led by Medical Arts’ Chairman and CEO, Perry Lambird, M.D., who was a well-known figure in the pathology profession. Another key figure in the PathCor story was Aaron Korngold, a newcomer to Medical Arts and Oklahoma City. Korngold had previously worked with the MDS Laboratory operations in New York State during the late 1980s.

The original business plan was to create a corporate holding company, called PathCor. PathCor would grow by acquiring or merging with independent pathology laboratory companies. Medical Arts Laboratory became a division of PathCor.

However, throughout 1994 and into 1995, the clinical laboratory industry was at its financial nadir. PathCor’s timing in attempting to create another commercial lab “roll-up” company could not have been worse. PathCor spent lots of money attempting to develop this business concept, but only succeeded in closing a couple of small lab acquisitions.

Dr. Lambird and Korngold then decided to recast PathCor as a pathology practice management company. During 1995 and 1996, they traveled throughout the country attempting to recruit pathology group practices into their revamped business model.

This effort also proved futile. In 1997, PathCor’s sustained negative cash flow finally caught up to the would-be national consolidators. Shareholders at PathCor restructured the company. Most pathologists sold their interest in the clinical laboratory company and continued with their affiliated pathology group practice. Dr. Lambird remained with Medical Arts Laboratory.

Throughout the 1994-1997 period, Medical Arts Laboratory maintained a profitable business. But the excess cash flow had been diverted to finance the PathCor project. Since 1997, Medical Arts Laboratory has maintained profitable laboratory testing operations, but the overhang of debt from PathCor’s activities has limited management’s options for growth and expansion.

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