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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Tuesday, July 24, 2018

Question sent from reader (QRHC)

I haven't posted in awhile. Companies I've written about and own haven't been operating as expected and their stocks aren't working either, which has lead to some combination of reflection (a good thing) and hiding under a rock (a less good thing). I've been struggling to sincerely articulate the experiences and painful lessons of "getting punched in the face" and hope to post something on that soon.

But I wanted to share my recent response to an email received from a reader on QRHC who asked questions around ...

executive comp ("Do you have any idea what the executive comp plan actually is?"),
commodity exposure ("I am trying to get a sense if it's possible that the recent increase in GM’s is related to commodity prices rather then fundamental profitability improvement"),
the Chairman selling ("it sure does look like Saltz is running for the exits as soon as the stock popped")
and finally about the lack of insider buying ("I can’t seem to find any evidence of Hatch buying stock on the open market even as it traded to $1.00.").

... I'll take the last one first.

On the lack of insider buying, I asked the CEO this exact question the last time I spoke with him, and it was the last time he spoke with me. Putting aside the slight frustration with getting ghosted by management over a layup question, all managers should be aware that avoiding questions is an "amateur hour" technique that's about as useful as a concrete life preserver. It doesn't make questions go away, it just means the askers have to find other sources.

Having poked around some, I don't know why the CEO hasn't been buying shares but I do feel comfortable that he is in his wheelhouse building a mid-market focused business, and that he is surrounded by good executives who know what they're doing.

I'm blind however to whether or not they have the right technology to grow the business, and that worries me, b/c this business needs good technology to scale.

I know that at Oakleaf, technology was key to the turnaround, but they had a CTO who was an MIT grad and is now CIO of XPO logistics. In contrast, it doesn't look like QRHC even has a CTO. A search on LinkedIn reveals two people who fit tech related roles but I'm not familiar enough with the technology departments at Fairfield University nor East Central University in Ada, Oklahoma to judge their pedigree.

According to the CF statement, in 2015 they spent $2M on capitalized software and that should be enough, if well spent, for a good system, but that's all I know. Growing revenues much faster than COGS would indicate a good tech system that obviates the need for more people touching invoices / receivables. Without that, this doesn't work.

In contrast to a management team that appears experienced and well-suited for a small mid-market focused business, the Board appears non-functioning. It is controlled by Mitch Saltz, the Chairman and majority shareholder, even as he sells shares into a guidance # I don't believe they will hit. Presuming he too wants a return on his investment, I wrote letters asking him they re-incorporate from NV to DE to better attract institutional investors and that they add an experienced industry expert to the Board to better monitor management, but he said no.

The exec comp - if that's what you want to call it - can be viewed as an example of the non-functioning Board, something that easily could be fixed if the Board wanted to, but they don't appear to care.

Want to see a vague exec comp plan?

"One or more of the following business criteria for our company, on a consolidated basis, and/or for Related Entities, or for business or geographical units of our company and/or a Related Entity (except with respect to the total stockholder return and earnings per share criteria), will be used by the committee in establishing performance goals for such awards:
(1) total stockholder return;
(2) such total stockholder return as compared to total return (on a comparable basis) of a publicly available index such as, but not limited to, the Standard & Poor’s 500 Stock Index or the S&P Specialty Retailer Index;
(3) net income;
(4) pretax earnings;
(5) earnings before all or some of the following items: interest, taxes, depreciation, amortization, stock-based compensation, ASC 718 expense, or any extraordinary or special items;
(6) pretax operating earnings after interest expense and before bonuses, service fees, and extraordinary or special items;
(7) operating margin;
(8) earnings per share;
(9) return on equity;
(10) return on capital;
(11) return on investment;
(12) operating earnings;
(13) working capital or inventory;
(14) operating earnings before the expense for share based awards; and
(15) ratio of debt to stockholders’ equity."

I think we'd all prefer to see a Board pick three of these and consistently pay on those parameters, at least so shareholders know the targets.

Getting to the last remaining question on commodity exposure, since the company doesn't own fixed assets, I don't believe commodity exposure on its own is a material driver of revenues or margins. A processor that owns fixed assets drives their business on the bill / pay spread of waste oil but here the broker only takes their margin on the total value.

In conclusion, with this investment, I've been focused almost exclusively on the three things that I think make this business work ...

right people
right market
right technology

... in short, management. I am confident on the first two. I have limited visibility into the latter. I've long said that as investors we need to hang our hats on facts that endure even when the market tells us we're wrong or when operations temporarily aren't performing as expected. I feel comfortable knowing what I know and hanging my hat on "this is a simple business with experienced people running it".

But I do think it might be time to elevate some Board and corporate governance issues in my investment weighing process. It certainly can be a more nuanced and potentially effective way of further separating the wheat from the chaff.

-- END --

ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

1 comment:

  1. Here's the letter re: redomiciling, from April

    Dear Chairman:

    Over the years I have encountered a number of smart, successful, focused and professional micro-cap investors who won’t invest in companies domiciled in Nevada due to the laxity in the state’s Corporate Laws.

    The Board could remove this obstacle, improve our company’s standing in the capital markets and help make the company more attractive to outside investors by re-domiciling to Delaware. I am writing to request that you please propose a motion to do so at the upcoming shareholder meeting.

    A few additional reasons to justify the move:

    • Delaware General Corporation Law is generally acknowledged to be the most advanced and flexible corporate statute in the country. It is more comprehensive, widely-used and extensively interpreted than the corporate laws of any other jurisdiction, with a well-established case law developed over the last century, providing businesses with greater clarity and predictability.

    • The Delaware Court of Chancery has exclusive jurisdiction over matters relating to the DGCL. Cases are heard by judges who have many years of experience with corporate issues, and without juries, which can lead to quick and effective resolution of corporate litigation.

    • Delaware’s body of law on the fiduciary duties of directors provides appropriate protection for stockholders from possible abuses by directors and officers.

    Our management is operating the business towards growth and cash flow. We are seeing some early signs of success. They have a solid team in place and if the technology is right, much more could come.

    The Board should support these efforts by taking steps to generate wider capital market acceptance. Re-domiciling to Delaware is an easy and essential step in that process.

    Sincerely,

    ReplyDelete