University General Health Services: A Good Short

| About: University General (UGHSQ)
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[Editor's Note, August 27: This article has been revised since original publication, as the author has made changes to the content]

University General Health Systems (UGHS.OB) is a regional multi-specialty health care provider that is based in Houston. While I believe that the UGHS business model once showed promise, issues have plagued the company. UGHS is currently trading at $.56/share and has a market cap of $185 million. At these levels, I don't believe that the market has priced in the issues facing UGHS properly, leaving it overvalued.

Business Model

The UGHS business model is as follows:

"A diversified, integrated, multi-specialty health care provider that delivers concierge physician and patient oriented services providing timely and innovative health solutions that are competitive, efficient and adaptive in today's health care delivery environment. The UGHS business model anticipates the acquisition of acute care "host" hospitals and the development and operation of regional health networks within a defined radius of each host hospital that can provide services under the Company's acute care licenses. Such regional health networks and ancillary services will reflect a vertically integrated, diversified system, which will include provider-based "Hospital Outpatient Departments" (HOPDs) of the host hospitals and may consist of Ambulatory Surgical Centers, Free-Standing Emergency Rooms, Free-Standing Procedure Facilities, Diagnostic Imaging Treatment Facilities, HBOT/Wound Care Centers, and/or other ancillary service provider."

UGHS operates through three separate business segments; the Hospital segment, the Senior Living segment, and the Support Services segment. UGHS seeks to acquire smaller (50-150 beds) acute care hospitals. These hospitals have lower capital costs, lower operating costs, and higher margins. While these are positives, the negatives that I will highlight below far outweigh the positives.

In an article on the website, the author suggests that he has had contact with the CEO and that the audited numbers are close to coming out. I have had no personal contact with the company or management and am relying on the author of for this information.

I've interviewed the CEO, and he assured me all their filings would be brought up to date by the Q2 deadline. This means the company has to file its 2012 annual 10k, Q1'13 March quarterly numbers, and Q2'13 June quarterly numbers- all by August 15th. The stock appears to me to behaving as if the audited numbers are close to coming out, and the market will know the company is back on track. This stock could go considerably higher- likely a reverse split would occur followed by an immediate up-listing. It's quietly creeping higher, and as you know- my theme is to get you in before the breakout. I believe the numbers will show a company delivering about $200 million in annual revenues and world class profits.

The submission deadline for filing a 10-Q on time was August 9th, and the deadline for late filing was August 14th.

UGHS has missed the SEC filing deadline, which has been a common occurrence for this company as of late.

Unable To Get An Audit

UGHS has late filing with the SEC because of the struggles UGHS has had with auditing. From a Notification of Late Filing filed with the SEC on August 16th. Here is what the management had to say.

"The Company has not yet completed its financial statements for the year ended December 31, 2012 due to an ongoing audit and review of the accounting treatment of certain non-operating items related to 2012 acquisitions and federal income tax calculations. The Company requires additional time to complete the Form 10-K for the fiscal year ended December 31, 2012 and the Form 10-Q for the quarter ended June 30, 2013. The Company anticipates filing its Form 10-K and Form 10-Q as soon as practicable."

Because of the inability to get an audit, UGHS has not filed a current 10-K or 10-Q since November 15th of last year. In that 10-Q which was for the third quarter of 2012, UGHS restate numbers.

To be fair, the issue did not drastically affect the company. Here is what was changed.

The correction of the errors decreased originally reported assets by $0.3 million and mezzanine equity by $0.6 million, and increased originally reported shareholders' equity by $0.3 million at September 30, 2012. In addition, other expense increased by $0.3 million, direct investor expense increased by $0.9 million, derivative expense decreased by $0.6 million, and net income attributable to the Company decreased by $0.6 million for the three months ended September 30, 2012. For the nine months ended September 30, 2012, other expense increased by $0.4 million, direct investor expense increased by $5.5 million, derivative expense decreased by $1.7 million and net income attributable to the Company decreased by $4.2 million. Basic and diluted earnings per share remained unchanged at $0.01 for both the three and nine months ended September 30, 2012

Because of that the only real information that we have gotten from the company is this presentation, which unfortunately provides no real insight into the current state of the company. It is simply a glossy overview of the business potential. The lack of auditing is a serious concern. A press release published on April 16th, UGHS highlighted the reasons for the delay in getting a 10-K out.

University General stated that the delay if filing the Form 10-K was associated with an earlier change in auditors; completion of the accounting treatment of certain non-operating items related to 2012 acquisitions, including the acquisition of University General Hospital - Dallas in December 2012; the calculation of derivative liabilities associated with the Company's Series C preferred stock; and federal income tax calculations. The Company requires additional time to complete the Form 10-K and to announce fourth quarter and full year 2012 financial and operating results.

In a similar report from the OTC Journal, the author states that the company has faced delays because the previous auditor was unable to understand the business and UGHS has since returned to its previous auditor.

"Chronicles the difficulty they've had getting their audit for 2012 done. It was due several months ago. They changed auditors, only to discover the new auditor was incapable of understanding their business, and changed back to their original auditor. Hence, the delay and temporary lack of interest in the stock."

Some of the issues have arisen from the companies acquisitions. One acquisition I would like to focus on is the acquisition of the South Hampton Community Hospital in December of 2012. According to a press release the hospital, which will be re-branded as University General Hospital-Dallas in 2013, was purchased for $30 million and will also receive a $1 million cash infusion. The hospital, however, was the only hospital in North Texas to receive an "F" rating from the Leapfrog Group.

Will It Get An "E" It Already Has A "F"?

A big red flag for me is the "Yield" sign on the OTC Markets website.

According to OTC Markets, these are some of the potential reasons for having a yield sign (Which signifies limited information) next to a companies name.

Limited Information

Designed for companies with financial reporting problems, economic distress, or in bankruptcy to make the limited information they have publicly available. The Limited Information category also includes companies that may not be troubled, but are unwilling to provide disclosure pursuant to OTC Pink Basic Disclosure Guidelines.

Source: OTC Markets

Given that UGHS has not filed a 10-Q or 10-K in so long, it is at risk of having an "E" put on to the end of its ticker. On the OTC Market, an "E" as the last letter of the ticker signifies that the company is delinquent in filings. From the OTCBB FAQ section:

What does a fifth character "E" indicate for an OTCBB security?

The fifth character "E" on an OTCBB trading symbol indicates that FINRA does not have information which demonstrates that the issuer of the security is compliant with the filing requirements of Rule 6530, either because the issuer is delinquent in the required filings, has filed an incomplete filing, or, for non-EDGAR filers, such as banks filing with the Office of the Comptroller of the Currency and certain insurance companies where FINRA has not been provided a copy of the most recent filing. The purpose of appending an "E" to the security symbol is to alert all interested parties that the security will be removed from the OTCBB unless evidence of compliance is provided prior to the end of the applicable grace period (30 days for EDGAR filers, 60 days for non-EDGAR filers). Anyone possessing evidence of compliance with Rule 6530 may provide that information by contacting the OTCBB Issuer Filings Department

The OTJ Journal report suggested that it was possible that this would happen to UGHS:

Here's what might happen. At some point, the stock might get the dreaded "e" at the end of their symbol, signifying the company has gone past its reasonably allotted time to file its 10-K. That would happen around the end of the month. The stock would then trade under the symbol "UGHSE".

I don't believe that UGHS will trade with an "e" after it because it is listed on the Pink Sheets. Stocks can only trade with an "e" on the OTCBB market. This is an important distinction.

Notwithstanding the foregoing paragraphs, a member shall not be permitted to quote a security if:

(NYSE:A) while quoted on the OTCBB, the issuer of the security has failed to file a complete required annual or quarterly report by the due date for such report (including, if applicable, any extensions permitted by SEA Rule 12b-25) three times in the prior two-year period.

The last time that UGHS filed a quarterly report was for the third quarter last year. It filed a 10-Q on May 30th of this year, however, that was the report that restated the 2012 third quarter numbers. UGHS has failed to file an annual report for 2012, and has failed to file quarterly reports for Q4 2012, Q1 2013, and Q2 2013. While I don't believe it will be delisted, I think that there is a real possibility that quotes will be suspended due to lack of filings.

Why Is The Stock Up During All Of This?

One would think that given the lack of SEC filings and lack of information coming from the company, the stock would be down this year. UGHS is actually up 46% this year.

So why is the stock up? UGHS has paid research firms to cover the stock. I hesitate to call this company a pump and dump, as it is not a typical pump; it has assets, a real (as much as I could verify) business. NBT Equities Research, which was involved with the Polar Petroleum promotion (halted by the SEC). NBT Equities Research has published several articles about UGHS, which you can view here. As always, check the disclaimer:

You can see it right there: "NBT Equities Research has been compensated $50,000 for sponsored equity research and market awareness advertising by University General Health Services." Whatever the reason for the promotion, it is clear to me that it has inflated the price artificially.

Shorting OTC Stocks

While I believe that UGHS is a real company and is in a solid industry, until UGHS can a) get audited numbers and b) file those numbers with the SEC, the downside risk far outweighs the upside. It is always risky shorting OTC stocks, but shares are currently available to short through Interactive Brokers and firms that clear through them such as PlaceTrade.

The biggest concern for a short should be that the company releases positive audited numbers and the stock rises.

Disclosure: I am short UGHS.OB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.