Nobils - NHCThe Emperor Has No Integrity It seems that the Emperor is not only missing his clothes, he is also missing his Integrity. There are few things that we leave this world with, and Integrity is one of them. In North America we pride ourselves on well-regulated financial markets where well researched investment ideas, both long and short, make successful investors. Market manipulation, on the other hand, is something that comes to mind when we think about the Chinese or Russian markets. And, while it arguably is a rare occurrence in our stock markets, it looks like a blatant manipulation of the markets has occurred in our backyard. One must question the validity of information presented in an article when the author of the work will not even put to their name behind it and they choose to remain anonymous. For me, this raises many concerns. Why doesnt the author want to stand behind the information presented? Do they have something to hide? Are they trying to manipulate the markets? What does the Emperor have to hide? Why doesnt he or she want us to know their identity? Some of the largest and most highly respected short sellers such as Jim Chanos, George Soros, and Bill Ackman all explicitly detail the reasoning their shorts in a highly public fashion. They do so standing front and center, presenting the facts, not opinion or half-truth, but the cold hard facts. They deliver and then stand in while they defend their investment thesis not only with facts and their own money, but also with their name their integrity. The Emperor, on the other hand, is not prepared to put his name behind his convictions, and you have to wonder why? Lets take a close look at the Emperors argument and examine his or her one sided opinions point by point as presented. Fear the Roll Up? Emperor you claim, Roll ups have a recurring pattern of being bad stock market investments. Hold on Emperor, based on your ability to manipulate markets, we know this isnt your first rodeo. You have experience in the investment markets, so how do you explain, Constellation Software, Boyd Income Fund, Paladin Labs, Parkland Fuel, Linamar and Descartes Systems? Examples of successful Roll Ups with a combination of growth by acquisition as well as organic growth. The Dangers of Failure Emperor you try to imply that past failure equates to future failure and the past guarantees that future shareholder value will be destroyed. Let be honest here, both you and I know that this is not always the case. In fact, one example with many of the same similarities to Nobilis immediately comes to mind. In 1983, a 28 year old CEO was introducing a new revolutionary product. His stock was trading at $0.85. The product created a new category and it was difficult for the market to understand its potential. The stock immediately started to drop, falling greater than 65% ($0.8728 to $0.2813) over the coming months. In this example from 1985, the board took action and asked the now 30 year old CEO to resign (similar to your quote kicked to the curb from his CEO position). The Board had a difficult time trusting a young CEO with vision that nearly bankrupt the company. In 1997 that same failed former CEO return to the CEO position of the company (just like you state occurred at Nobilis), but in my example Apple purchased Mr. Jobs NeXT computer platform. A former CEO, being bought out by the company who he previously led. In your words, Suffice to say that the CEO proved very adept at making money for himself, even if his shareholders did not fare as well. Of course we all know the history of value creation from a near bankrupt company in 1997 to todays Apple, the largest public company in the world. This example clearly illustrates how a failed CEO can produce significant shareholder value. Wouldnt you agree Emperor? Dj vu or just your imaginary dream? Emperor, you attempt to make the case, poorly I might add, that Nobilis has picked up undervalued assets from bankruptcy and therefore, they are garbage. Im sure you have heard of turnaround situations before, havent you? In fact Nobilis management makes several references to this in both the Q1 2015 and Q2 2015 conference calls. CEO Chris Lloyds opening comments in the Q2 2015 conference call was First Nobilis provides a great example of our ability to turnaround distressed assets utilizing our unique direct-to-patient marketing platform and robust physician engagement programs. When we acquired it, the hospital was producing 24 million of revenue annually. In 2015, in its first full year of operation under our ownership, First Nobilis Hospital produced over 60 million in revenue. By my math thats a 150% annual growth rate. Garbage, I say not! Emperor, you try to question these distressed acquisitions with the statement the reality is that these assets were undervalued and bankrupt for a reason. Of course from participating in the Q2 2015 conference call you would have known why, when Chris Lloyd answered Analyst Russell Stanleys question by stating, And thats where, when you talk about the fragmentation of this industry and over 70% of ASCs and surgical hospitals are owned by individual physician partnerships, and a lot of them are struggling. The formula for success is purchase the distressed assets from local physician partnerships who are struggling, then apply the direct to patient marketing to increase sales. It is not just a concept in Nobilis case, they have the 150% growth to prove it. But, if you are feeling particularly adversarial Emperor, you may question, if thats so easy why isnt every doing it? Again going back to the Q2 2015 conference call, Chris Lloyd states And a lot of our competitors cant really move the needle by buying one or two of these at a time where we can. Turns out, size does matter after all. Selling Miracles, or patients wanting a quick fix? Emperor you make the point, by citing a Chicago Tribune article, suggesting that the Mayo Clinic has warned of the risks of laser spine surgery. A point that you in fact failed to present accurately. The fact is that the Mayo Clinics website warns about ALL back surgery not simply laser spine surgery. Their website states, Back surgery can help relieve some causes of back pain, but it's rarely necessary. Most back pain resolves on its own within two months. Just in case you need some further information for your next slandering article Emperor, here is the link to the original source, Mayo Clinics website https://www.mayoclinic.org/back-surgery/art-20048274?pg=1. Hopefully next time, you will present your facts correctly. Further to my point, Nobilis agrees with the Mayo Clinic. Nobilis would only recommend back surgery as a last resort procedure. In the same Q2 2015 Earnings Call, CEO Chris Lloyd states but in spine, you know, we absolutely want people to try physical therapy before they have an injection. Were going to try an injection before they try, you know, minimally invasive surgery. We want minimally invasive surgery before they have a fusion. In the same May 2011 article that you cited Emperor, https://www.bloomberg.com/news/articles/2011-05-04/laser-spine-surgery-more-profitable-than-google-sees-surge-in-complaints states, Many Laser Spine patients knew they were paying a premium for the surgery but did so of the promise of a quick and easy fix for their back or neck pain Our instant gratification world has resulted in patients looking for a quick fix. Just look what Dr. Steven Atlas, an assistant professor at the world renowned Harvard Medical School cites the problems as, And they face pressure from patients who expect quick and complete results from modern medicine. Doctors and patients used to be satisfied if back pain could be relieved enough to allow a return to work and daily activities https://www.tampabay.com/news/health/for-back-pain-surgery-can-be-less-than-a-fix/1132456 Emperor you spend a great deal of your critique discussing the AccuraScope procedure. It seems that you spent an inordinate amount of time attempting to discredit this one procedure; one of many that Nobilis performs. Youve attempted to scare investors about the AccuraScope procedure by implying adverse financial results due to insurance companies not paying for the procedure. But, the fact is that the AccuraScope procedure is included under the musculoskeletal interventions procedures in Nobilis accounting. The entire musculoskeletal intervention cases and procedures (not just AccuraScope, but all surgeries) accounted for only 7% of the H1 2015 case and procedure volumes. Pain Management at 31% and Bariatrics at 20% are significantly larger caseload categories, I question why these two werent highlighted. Oh right, they are fully covered by the insurance companies so no need to scare investor about that. Who is paying for this? Insurance companies are in the business of maximizing profits, so it comes as no surprise that you claim the AccuraScope TYPE procedures are not covered. But then again no branded procedures are covered by the large insurance companies. The US HealthCare system is built on reimbursement codes. An entire industry has been built on submitting and collecting Health Insurance payments. So much so that Health Care practitioners are finding collection becoming more and more difficult with accounts receivables being stretched out for longer periods of time. You Emperor dont specifically question this because you already know the answer but, for those of you who dont know the answer, Nobilis has been very consistent in collecting their accounts receivable. In fact, it is incredibly easy to track by reviewing an entry in the financial statements. The number of days it takes them to collect their accounts receivable look like this: Q2 2015 96 days Q1 2015 96 days Q4 2014 95 days Q4 2014 99 days Hardly an alarming trend of the insurance companies either not covering the procedure or the insurance companies unwilling to pay in a timely manner. Wouldnt you agree? Emperor, you claim that these arent procedures that insurance companies will pay, but then you turn around and contradict yourself saying it appears that the company is getting it through insurance somehow I just cannot see how. Somebody is Getting Paid and Somebody doesnt understand Accounting Emperor you claim that Chris could have made over $20 million in 2014, please tell me you dont actually believe this. Lets be straight on this one, this is a pure scare tactic on your part. In your valuation section, you present EBITDA figures, but you are talking Net Income in the compensation argument; the classic flip flop. We know you understand the difference between Cash Compensation (Salary) and Total Compensation (Salary plus Share Based Awards and Option Based awards). We know that you read the Annual Information Form where it states Chris Lloyd 2014 Salary $46,154, and Option based Awards $1,826,481 We know you saw the stock price move from $1.96 at the end of November to $3.50 by the end of December increasing the companys market value by over $91.5 Million dollars in one month. We know you understand that stock options are an accounting entry and the companys auditors use a methodology to calculate the fair value of the companys options based on share price. Therefore, knowing all of this, wouldnt you expect that the value of options would increase at an expedited rate if the stock appreciated by 78% in a one month period. You are effectively trying to imply that cash compensation is the same as accounting compensation. Shame on you Emperor, both you and I know that is simply not true. Lets break down the compensation not based on total compensation but on cash based compensation (Salary received). When we break it down it looks like this: Donald Kramer $365,250 Harry Fleming $330,651 Kenneth Efird $222,805 Chris Lloyd $46,154 Andy Chen $160,174 Total $1,125,034 Guidance review or were you overly optimistic to jump to conclusions Emperor you accused the CEO, Chris Lloyd, of giving vague guidance, but during the Q2 2015 conference call he unequivocally stated, when you think of our case breakdown, you talk about the largest percentages coming from physician partners and those are fairly predictable, both annually and seasonally. During the same Q2 2015 call, Kenny Klein, CFO says in response to a question from Charles Haff on guidance so this is critical piece of our business. And our team, looks at cases every single day. So we know how were driving by facility, by day, the types of cases in all our volumes. So every single day. CEO Chris Lloyd goes on to state, that the balances reporting to you guys, you know, being reasonable in our reporting and keeping credibility. You know, what we tell you we think is achievable and reasonable and then we set goals that are more aggressive than that internally Emperor you attempt to make the claim that guidance on share based compensation was different from what management stated. You claim that the increase in share based compensation was a surprise. You are critical of the increase in share based compensation quoting Andy Chens response. But on the same call just before the CFOs response, the CEO spoke on share based compensation in the Q1 2015 stating, It will be lumpy I think as we continue to integrate the team. Im trying to get, the executives and employees to appropriate levels so theres probably likely one more sort of normalization brand and then going forward it will kind of be routine and fairly small in nature Given this, it should come as no surprise that the Q2 number was also higher. The CEO told us that directly in Q1 2015. Insider Sales and Financing Emperor, you attempt to portray that it was a surprise that prior management was selling shares. However, it is a well-known fact that this is previously disclosed information. In fact Schedule A of the Nobilis Health Corp Offering of Units, April 21, 2015 details: Selling Shareholders, Donald L. Kramer, Co-Founder and Chairman of the Company and associates and affiliates of Donald L. Kramer, and Harry Flemming, President & Director of the Company. This was disclosed over 5 months previous to you making issue of it. At this point in time, this certainly wasnt a surprise. More importantly, is what the CEO is doing with his shares. In your shareholders table, you show Chris Lloyd selling 422,688 shares. I have to question how you could think this is remotely possible. In fact, Chris Lloyds shares were received as part of the sale of Athas to Nobilis and, as a result are common stock which means they are subject to a lock up of up to 2 years. Given that, he is unable to sell the shares until December 1, 2016. The bottom line Emperor is that the information you reported surrounding CEO Chris Lloyds holdings is not accurate; or dare I say a blatant lie. As reported on the System for Electronic Disclosure by Insiders (SEDI) Chris Lloyds holdings increased from 2,066,434 shares on 2014-11-26 to 3,143,746 shares on 2015-07-02. Thats an increase of 1,077,312 at an acquisition price of $6.80 for a total of $7,325,721.60. Based on his annual cash salary of $600,000 that would be 12.2 years of cash compensation to purchase the shares that he added at $6.80 USD. I suppose none of this matters to you Emperor. You shorted the stock, produced an inaccurate and slanderous report on a company, watched the share price drop, covered your short and high fived your buddies, all the while making a profit at the sake of your integrity. Shame on you Emperor! Bruce Campbell StoneCastle Investment Management