MIMEDX GROUP INC MDXG
May 22, 2018 - 10:17am EST by
bluewater12
2018 2019
Price: 7.40 EPS 0.46 0.55
Shares Out. (in M): 111 P/E 16 13
Market Cap (in $M): 821 P/FCF 0 0
Net Debt (in $M): -37 EBIT 0 0
TEV ($): 784 TEV/EBIT 0 0

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Description

I can’t help myself. Another super controversial long. MiMedx. Before you attack and one-star my ass, read and be objective. Please?

 

The backstory
I’ve known of MDXG for years from my short interest screens. It’s a perennially hated stock in a dirty corner of healthcare, wound care. I didn’t know anything, so I ignored. Fast forward to September 2017 when a new round of short attacks began; Viceroy, Aurelius Value, Capital forum, Cohodes, Citron, etc. Boom! The short selling cavalry was here and MDXG was busted!

 

I’m a sucker for a good short story, so I shorted. Strength in numbers, amirite?!  Besides the pages of accusations, other red flags were flying; a defensive CEO who fights shorts and numbers that magically beat expectations. All good signs. Short it and forget it.

 

As the stock drifted higher I told a smart short selling friend he should join the party. Instead of sport shorting like I had done, he proceeded to do work; reading all the arguments, court documents, and talking to doctors. He even ordered their book on Amazon. His response? “Eh, no thanks, it might even be a long.” Whoa, why? Time to dig in and stress test the arguments. After my due diligence, I covered.

 

A busted short thesis can make for a great long, but MDXG wasn’t cheap enough. However, in mid-February I got my shot. The Company announced an internal investigation by a reputable external party to put the shorts allegations to rest. The new auditors, Ernst & Young, were going to delay signing off on the audited results pending the investigation. This is exactly what the bears (and bulls) had asked the company to do, yet the stock got murdered and bears became emboldened. Maximum fear and uncertainty! So I bought and continued to work.

 

Disclaimer: This situation is complicated. MDXG is now my second largest position, but if you are looking for certainty, this idea is not for you (P.S. you’re probably lying to yourself on your other ideas). I think this idea is asymmetric because if I am right the stock goes up 3-4x, and if the bears are right worse case it’s a zero. I see the worst case probability as low because MDXG has a strong cash position and a leadership position in a growing industry. This is not a short squeeze thesis. This is a ‘bears have overplayed their hand’ thesis.

 

MDXG bull thesis

MiMedx is an industry leader in the amniotic and placental tissue market. The Company has grown sales at a brisk 40%+ CAGR over the past four years by taking a controlling position in the high-growth wound care market as well as by expanding their proprietary PURION platform technology to create products for a range of applications including surgical, spine, ortho, sports medicine, and pain management. In layman terms, MDXG has created an organic human growth hormone with strong healing characteristics that have broad-based applications across multiple platforms.

 

While the company is focused on wound care and expects 20+% organic growth for many years, MiMedx continues to forge ahead with clinical trials to get the necessary approvals (BLA licenses) to continue to grow their total addressable market. Doctors love their products and the products work.

 

In 2017, the Company had $325M in sales (~75% wound care) and management projects growing to $560M+ of sales in 2020 (55% wound care, 25% operating room, and 20% pain management) and delivering $1 per share in earnings. Based on MDXG’s dominant industry position, a 5x sales multiple and a 25x earnings multiple seems reasonable and would translate into a $25 share price within 18 months, a 3-4 bagger.

 

The opportunity exists because...


MDXG short thesis

Bears argue MiMedx is a complete fraud and the numbers are fake. The products are unsafe and don’t work. MDXG is stuffing their channels, paying doctors under the table, and using distributors to fake sales. The SEC, DOJ, OIG, FDA, FBI and #Metoo movement are all in the process of shutting down the company and Pete Petit, the CEO, is going to jail.

 

I will quickly summarize these accusations. Thankfully Viceroy recently consolidated a 20+ part series into a greatest hits write-up.

 

MDXG stuffs the channel and fraudulently induces sales.

This happens via 1) PODs that hold unnecessary inventory, 2) employee-owned distributors that hold unnecessary inventory, 3) abusing consignment relationships, 4) assisting customers in manipulating reimbursements, and 5) using illegal sales tactics (gifts, dinners, etc).

 

The primary source of these allegations are lawsuits against MiMedx (Jess Kruchoski, Luke Tornquist, Hal Purdy) and relate to MDXG’s relationship with its ex-Veterans Administration (VA) distributor, AvKARE. Regarding illegal sales tactics, MDXG hired many ex-Advanced BioHealing (ABH) employees after the former industry leader disintegrated when a DOJ indictment resulted in a $350mm False Claims Act fine and a $650mm write down by Shire. Ex-employees and doctors are still getting prosecuted today.

 

MDXG utilizes questionable distributorships and sales agents relationships to fake sales.

Examples include SLR Consulting (Jerry Morrison), StreamLogix (Frank Braly), and Recon Medical (Hal Purdy). A 2016 internal sales report proves the Company is lying about their relationships with their sales agents and they actually purchase products and are not middlemen. In addition, MDXG has relationships with other sales agents and distributors (RedMed, CPM) that have ties to trouble elsewhere where fraud via kickbacks occurred.

 

MDXG is circumventing government regulations and will get shut down.

The FDA is going to remove MDXG’s AmnioFix product from the market because it does not meet the proper criteria under Section 361. MDXG should be voluntarily reporting its payments to physicians under the Sunshine Act and they are not. Last, MDXG is under SEC, DOJ and VA investigations for their bad behavior.

 

Auditor churn and the CEO’s checkered past are additional reasons for concern.

MDXG’s previous auditor, Cherry Bakaert, identified material weaknesses in internal controls and MDXG responded by replacing them for FY2017 with Ernst & Young. Ernst & Young has delayed signing off on MDXG’s financials, pending the results of the internal investigation. Furthermore, CEO Pete Petit has a tainted background with Matria Healthcare and other prior companies.

 

Scary stuff, right? Let’s dig in.

 

 

Bear Case Rebuttal

 

MDXG has industry leading products

I’ve spoken with over a dozen doctors who use MDXG. I have yet to find a doctor that doesn't like these products. Why? MDXG products are shelf stable, store well, are easy to use, reimburse well, and most importantly, they work.

 

I recently attended the key industry event, the Symposium for Advanced Wound Care (SWAC), to talk to MiMedx competitors, customers, and industry participants. I was surprised at how highly competitors spoke of MDXG. It was widely acknowledged MDXG is an industry leader and they were grateful for MiMedx’s investment in R&D, clinical trials, and S&M. MiMedx’s efforts have raised awareness about the effectiveness of amniotic grafts which has benefitted the entire industry. It was odd to hear. Yes the industry is competitive but there is enough growth for everyone.

 

A technical participant, who is a senior director of R&D at a competitor, was positive about MDXG’s strong processing intellectual property and its business strategy of maintaining a  leadership position through aggressive investment in R&D, clinical trials, and marketing.

 

Glassdoor MDXG haters validate the products

MiMedx’s harshest critics, angry reviewers on Glassdoor, are oddly positive. Over 50% of the 1 and 2 star reviews were positive on the products:

 

“Great Product. Patent protected. Actually works. From a sales perspective, it's a great product to sell.” 1 star review

“Amazing product but company culture is horrible… Product is innovative and first rate in the industry.”  2 star review

“Innovative product that actually helps patients.” 2 star review

“Great products and good people.” 2 star review

“Incredible product, good pipeline, coverage.” 1 star review

 

Even one of the key whistleblowers gave a shout out to MDXG’s VP of Product innovation for developing such a strong platform technology.

 

End markets are growing rapidly

In addition to being dismissive of the quality and effectiveness of MDXG’s products, bears ignore the rapid growth of the wound care market. Biologic products, like EpiFix, result in significant healing improvements vs. the normal standard of care (wound dressing protocols + boots, etc) which results in improved outcomes, lowered treatment costs, and saved limbs. This is supported by clinical data and has led to increased reimbursement for Epifix.

 

According to the key industry intelligence firm, SmartTRAK, the wound biologics market will grow in the low double digits for the next three to five years. Integra Life Sciences echoed this sentiment at their December 2017 analyst day and described their advanced wound care business as one of their fastest growing market segments with low double digit growth. I received a lot of unsolicited feedback at the wound care conference about how the industry keeps getting bigger.

 

While bears claim MDXG’s 3-year CAGR of 40% is fake, Osiris’s recently restated financials (after getting busted for channel stuffing) show a 33% growth CAGR over the past three years and up 17% in 1Q18. They are a weaker competitor with a product that is harder to use. Grafix has to be shipped on dry ice, stored in freezer and used almost immediately. Meanwhile, Organogenesis, which purchased the old industry leader Dermagraft (ex ABH) from Shire, is back to growth. Organogenesis is growing at 40% a year and ramping up their sales force.

 

The bears argue ABH imploded because the sales were due to bribes and MDXG will face a similar fate. Certainly Dermagraft lost their “bought sales” as a result of the DOJ crackdown, but the real blow came from a 2014 CMS change that rendered their product uncompetitive on reimbursement. This allowed MDXG to grab the leadership position.

 

For a sanity check regarding MDXG sales it is helpful to look at sales generated per sales rep. Integra has 100 wound care reps and is on a sales run rate of ~$100mm, so ~$1mm/rep. Osiris is generating ~$120mm of sales with ~150 reps, so $0.8mm/rep. Meanwhile MDXG’s 2016 and 2017 results (and 2018 guide) suggest a sales/rep ratio of $0.9mm/rep.

 

CMS continues to increase reimbursement for grafts/procedures and more payors are covering the products. From the recent Osiris 10K (The same information is available in MDXG’s 10-K but we dont have the 2017 10-K yet): “Medicare reimburses skin substitutes only in bundled arrangements...CMS also assigns skin substitutes to either the low cost bundle group or high cost bundle group depending on the product's average weighted mean unit cost...The national average high cost bundle reimbursement for each application was $1,406.87 in 2015, $1,411.21 in 2016 and $1,427.16 in 2017. For 2018, reimbursement is set at $1,568.32 per application.” CMS took pricing up ~10% in 2018, that’s huge!

 

Nefarius sales activity?

Bears argue MDXG’s high S&M expense at ~70% of sales, vs Osiris at ~55% and Integra at ~50%, is evidence of fraud. They argue returned product is being improperly recognized as operating expenses and/or bribes are causing elevated expenses. Why is spending 1500 bps extra on S&M to grow faster and capture share in a land grab market such a problem? Once a doctor picks a product they are unlikely to change unless a new product is cheaper (50+%) or more effective. There aren’t any products on the market with those characteristics to displace MDXG.

 

MiMedx gained a strategic advantage when they hired a significant number of ABH salesforce after Shire acquired ABH. The bears dismiss the hires and argue all of these sales people are dirty in order to further support their idea that sales are driven by fraud. This was despite the fact that ABH salespeople were scattered across the industry and many landed at MDXG competitors. And yes, this was also used as bear bait for Osiris as well.

 

MDXG’s first ABH hire was a senior corporate management employee who knew the good and bad apples at ABH. MDXG made sure to pick the good apples. The industry was under intense scrutiny to behave properly and when MDXG found any problems they were fixed immediately (see Advanced BioHealing Fallout?). Moreover, ex-ABH sales reps and bribed doctors are still being prosecuted today and some were close to facing jail. I find it hard to believe MDXG’s sales team would see their old ABH colleagues get prosecuted and then engage in criminal activity themselves.

 

MDXG initiated procedures and protocols to prevent this from happening. They beefed up their monitoring capabilities two years ago with the addition of Salesforce.com and are able to track every dollar spent. Even disgruntled ex-employees complained about the overly regulated environment; “there doesn't seem to be regulation on how much air you breathe but I could be wrong about that”.

 

None of the official whistleblowers (Kruchoski / Tornquist / Purdy / Fox) made any claims regarding illegals sales tactics (gifts, cash, etc) or the use of distributors to fake sales. Their allegations are channel stuffing at the VA - that’s it! Also, why bother filing lawsuits at all if they could have filed Qui Tam lawsuits and collected 20% of a potentially massive fine?

 

What’s the motive? Why do this?

MiMedx’s controversial CEO, Pete Petit, is a serial healthcare entrepreneur who 1) has extensive experience as public company CEO (over 30+ years), 2) has extensive experience navigating the regulatory complexities of healthcare sectors and 3) has created a significant amount of value for shareholders, including himself. For more info on Pete, see his biography website.

 

Bears have tried to impeach Pete and show a pattern of nefarious behavior by pointing to examples of where Pete missed guidance or where a stock price tumbled. But has he ever crossed any regulatory lines or violated any laws? No. I looked at Matria Healthcare and have not found evidence to impeach Pete’s credibility. The closest he got to trouble was allegedly telling a friend to buy stock in front of a takeout. Instead of just paying a small fine and moving on, Pete vigorously defended himself and the case was dropped by the SEC.

 

Why would a wealthy and successful entrepreneur at the twilight of his career go Walter White and break bad? It doesn’t make sense. He owns 7% of the company and has never sold a share. He bought more stock in mid-2016. Meanwhile, in the last five years the entire management team has sold only about $2mm of stock. Management and directors own ~12.5% and have rarely sold. The company has been GAAP profitable and cash flow positive since 2014, and 2012 and 2013 would have been positive cash flow excluding working capital changes. The last time the company raised money was $37mm in December 2013 and they have repurchased over $100mm worth of stock since. MDXG has no debt and net cash, yet bears tell us they are on the verge of bankruptcy.

 

I’m not saying Pete is a saint either. My work suggests he’s an old-school, litigious, asshole type of guy. Please don’t send a drone over my house, Pete! He has powerful connections and likes to do things his way. He might not be the type of guy you want as your boss, but he’s probably the type of guy you want managing your company. Many successful CEOs are ruthless about protecting relationships and intellectual property.

 

Company behavior doesn’t suggest fraud

It is business as usual at MDXG despite announcing SEC, DOJ, and VA/OIG  investigations. I suspect these investigations are the result of bears’ accusations and behind the scenes maneuvering.The company replaced its regional auditor, Cherry Bekaert, and recently brought in one of the big four, Ernst & Young. They are also running a forensic audit by KPMG and in February 2017 MDXG opened their doors to a thorough internal investigation by a reputable law firm, King and Spalding.

 

Most companies go “dark” during this type of scrutiny, but not MDXG. They are still giving quarterly results (that exceeded expectations), they are still giving guidance, they are still going to investor conferences, Pete is still talking to journalists. Either Pete has a death wish and is accelerating his demise, or MDXG really has little to hide.

 

Earlier I mentioned how 1) Pete’s extremely defensive response to shorts and 2) the inflection in MDXG’s numbers were red flags. Let’s revisit. While I don’t like Pete’s aggressive response to short sellers, and I suspect he wrote most of the company responses himself, I can understand his frustration with getting attacked by short sellers again. MDXG has been a popular short since 2014 and many of today’s allegations are a regurgitation of past allegations (seekingalpha, VIC, cafepharma). These allegations have been investigated and dismissed: the OIG investigation into sales practices in early 2015 and an internal investigation in 2017. Pete is probably tired of these claims and wanted to refute them. I don’t like it, and his naked short accusations are a joke, but it is what it is. MiMedx stopped responding to every short accusation earlier this year and recently removed the short selling commentary from the website, steps I applaud.

 

Regarding my second point, that results continually beat expectations, I think the strong 1Q18 results put this issue to bed. The Company is under a massive amount of scrutiny, would they have been able to cheat and hide it from everyone? Very unlikely. It is much more likely that the company is able to maintain its 30+% growth CAGR due to strength of products, a growing direct sales force, growing end market demand, and reimbursement improvements.

 

ABH/Shire employees quickly jumped ship once the fraud was exposed. How many MDXG executives have left? Zero. A review of Linkedin profiles suggest only a few lower level employees have left per month over the past 12 months. This looks like normal business churn for a company with over 750 employees. Meanwhile, MDXG continues to hire sales reps at a blistering pace and has also added senior personnel. For example, Dr Tettleback joined as an Associate Chief Medical Officer earlier this year but hasn’t updated his Linkedin yet. MDXG had 380 sales reps at YE2017 and then 425 sales reps at the end of the first quarter of 2018, and plans to have 450 reps by the end of the third quarter. The doctors I’ve spoken with speak very highly of their sales reps and all categorized their rep as ethical.

 

It is hard to hire medtech sales reps and impossible to keep them if the product is not selling. There is strong demand for these reps and unemployment is near all time lows.

 

Bear thesis has weak evidence

The bears have primarily built their short case off of evidence from whistleblower lawsuits (Kruchuski, Tornquist, Purdy, Fox) plus 15+ other anonymous contacts / whistleblowers. Would any diligent VIC investors short a stock solely off of conversations with disgruntled ex-employees? This is what bears are doing even as the whistleblowers have been discredited.

 

Despite almost a year of diligence and supposed binders full of evidence from disgruntled current and ex-employees, the strongest evidence of MDXG’s nefarious behavior is...a picture of $180k of inventory in a storage locker, an internal sales memo regarding reconciling inventory properly, an internal sales memo re consignment agreement changes at the VA, a frustrated exchange between a VA hospital that went off a consignment agreement, an email about small inventory control issues, and some documents assisting with common reimbursement question? This “damning evidence” looks like normal work emails.

 

What would concern me would be real evidence of nefarious behavior. Where are the emails and texts from superiors saying to cheat? Where are the emails and texts about gifts and payments? Where is the evidence of doctors and executives getting paid? The bear evidence is actually very weak.

 

At the SAWC conference I couldn’t find any competitor salespeople (even ones that were ex ABH) to provide dirt on MDXG. Two salespeople mentioned that MDXG has dirty sales practices. When pressed for details, they cited online articles. When I asked for first hand examples, they referred me to other industry contacts. These new contacts then told me they didn’t know of any dirty behavior, just that they had read the accusations online. It reminded me of my conversations at The National Postal Forum regarding Stamps.com a year ago. Several industry participants regurgitated the bear thesis but they had zero evidence to corroborate it. The dirtiest behavior I found regarding MDXG is they will rent out all the best restaurants around a conference (all legal) in order to block out competition. And sometimes a sales representative will leave and come back later, when a sales rep is supposed to be officially present the whole time. Turn yourself in, Pete.

 

Why is an ex employee setting up his own distributorship a problem? Why can’t 1099 employees set up their own LLCs? According to my contacts, 1099 employees are common and sales people commonly sell other products (wound dressings, etc) in conjunction with an amniotic product. An LLC structure makes sense. Frank Braly might have chosen this route with MiMedx in order to start selling as a work around to a non-compete agreement with NuTech. And why couldn’t sales ordered through Frank’s SpineLogix website be credited to SpineLogix under Frank’s balance? Is the company really going to these lengths for ~$50k/sales a quarter? It would take a lot of participants (over 200) to create $10mm of fraudulent sales each quarter (just 10% of sales) at this pace.

 

Bears have thrown out an overwhelming amount of information that is light on substance and long on speculation, just like many of their other short attacks that have gone wrong.

 

Whistleblower credibility

The crux of the channel stuffing short thesis comes from two main whistleblower cases; Jess Kruchoski/Luke Tornquist and Hal Purdy. Hal Purdy’s accusations against the company cost him a couple hundred grand and he was forced to apologize and say he was incorrect. The details from Hal’s whistleblower case are included in the MDXG “greatest hits” write up but this makes little sense and is intellectually dishonest.

 

Regarding case #1 (Kruchoski/Tornquist), interested VIC readers should read the arguments between these top ex-sales guys and MDXG. The conflict started because Kruchoski/Tornquist were upset that they weren’t paid their bonus growth commissions from a VA sale where the products were already on the shelves. The company stood its ground, and Kruchoski/Tornquist appear to have tried to extort MDXG, and MDXG got angry and demoted them.

 

How reputable is their story? These guys admitted to selling Academy Medical products while employed by MDXG. Why does that matter? This was one of the reasons their case was dismissed on 2/7/17! Case 1:17-cv-00577-LMM: “Through the pending Motions to Dismiss, the Court has learned that the investigation allegedly revealed that Plaintiff and Tornquist had been selling competitors’ medical products to MiMedx customers”. It gets better. The DOJ recently fined Academy Medical over the False Claims Act! Amazing stuff.

 

AvKARE was a key party in the channel stuffing allegations. AvKARE is a veteran-owned GSA federal supply schedule contractor and when MDXG was not approved to sell to the VA in 2013, AvKARE was a quick way in. MDXG signed a three year deal with three one-year options. As MDXG’s product success grew, the relationship exploded. AvKare was 40%, 56% and 24% of sales in 2013, 2014 and 2015, respectively. Of course MDXG didn’t want to have a middle man, so the ultimately got approval to sell to direct to the VA and the AvKARE relationship expired 6/30/17.

 

Channel stuffing allegations don’t tie to the numbers

Distributor sales are immediately recognized as sales and all VA agreements were initially consignment sales. Could this lead to shady behavior? Sure. AvKARE could put as much MDXG product on the shelves as it wanted and MDXG could recognize it as sales. Is it sustainable? Absolutely not. The relationship with AvKARE and percentage of VA sales became an increasingly smaller part of sales, and the cash flow and balance sheet almost never lie: DSOs and working capital trends have improved, and disproved this thesis.

 

     

 

Kruchoski alleged the VA channel stuffing began in 2014 and by 4Q15 there was $10mm in excess inventory. He also states the channel stuffing ended in June ‘16. While the rise in DSOs supports his case, the excess inventory was worked down thereafter and cash from operations began to surge in mid 2016, likely a result of the number of health plans reimbursing Epifix rising from 160 in late 2015 to 800 by early 2017. We know the ongoing internal audit is looking at sales and distribution practices and this period is probably under intense scrutiny. I think there could be a minor restatement that shifts revenues from 2015 into 2016.

 

Fraud, or miscommunication?

Bears share angry emails between VAs and MDXG to show channel stuffing behavior. This is a gross misrepresentation. Latest 10K:

 

“In 2016, the Department of Veterans Affairs (“VA”) announced a change in its internal purchasing procedures.  Among other things, under the new directive, the VA would require internal pre-authorization by a warranted contracting officer for any implant purchases greater than $3,500, except for implants from VA-owned inventory or a consignment agreement negotiated by a VA contracting officer.  Different VA facilities interpreted the new directive differently, and also began implementing different portions of it at different times. Numerous vendors to the VA, including the Company, have requested that the VA provide clarification to its facilities on the new policy in order to minimize disruption in patient care.”

 

Bears spin any confusion around new agreements as examples of nefarius behavior when it was most likely just a mistake or miscommunication.

 

The bears frequently lie

The bears are entrenched on MDXG with short interest at all-time highs and have made this “personal”. It's hard to remain objective when things get personal. Not surprisingly, this has resulted in the bears continuing to pour out an overwhelming amount of information, lots of which is intellectually dishonest and some of which contains flat out lies.

 

For example, Aurelius claims that MDXG uses a Texas manufacturer named INCELL to produce Orthoflo. They claim the fact that the facility received a warning letter in October 2016 means that 1) the product is unsafe and 2) the FDA is going to shut down use of this product. A quick call to INCELL’s CEO reveals that INCELL hasn’t made any MDXG products in over a year and a half (MDXG took all production in house) and that the FDA issues were fixed within a week.

 

The bears love to smear the reputations of any doctors associated with MDXG. They even spread lies about a doctor getting arrested and escorted from a hospital in handcuffs. A quick call to the hospital confirms this is a lie and that the doctor merely resigned. Moreover, the doctor resigned over the ABH controversy, which has nothing to do with MDXG. It is also easy to track these doctors payments (here), which fell off a cliff in 2014 after ABH got busted.

 

Bears claim ABH prosecutors are lined up to attack MDXG next and link to quotes in articles. However, my conversation with the prosecuting AG revealed that MDXG is not part of any of their current investigations and he is focused on dirty ABH doctors.

 

A major problem with the bear thesis is the lack of insider sales, yet bears dismiss the lack of insider sales as also fraudulent. They argue MDXG’s transfer agent supports of frauds and reported holdings are not to be trusted. Really? MDXG’s transfer agent was acquired by IART and is now a public company. Is IART a short for enabling frauds? I searched for transfer agent fraud and could not find a single example of a transfer agent misrepresenting insider holdings.

 

I’ve also met one of the doctors whose face is most frequently smeared across http://petiteparkerthebarker.com/. This doctor said he could care less what rumors are spread and that he would open his books to anyone. He uses all of the competitive products but MDXG’s products work best. He laughed off the attacks as a distraction and did not care. Could he be lying? Sure, but doubtful. He runs a successful five clinic podiatry group, so would he really jeopardize all of his success over some gifts from MDXG? Unlikely. And the pictures of him at sporting events with MDXG sales rep? He owns those season tickets.

 

Recent grand jury indictment

The indictment of two doctors and one nurse practitioner by the DOJ in South Carolina immediately seemed to confirm the bear thesis; check fucking mate! According to the indictment, Becker received speaker fees of $19,897 over four years and Farrer received $12,200 in speaker fees from 2013 to ‘15 and purchased stock. In addition, there are allegations of gift cards and free use of a beach house. Moreover, the indictment states, “It was further part of the conspiracy the the Defendants caused the excessive use of MiMedx products on VA patients in South Carolina”. However, a close reading of the indictment suggests the DOJ is pursuing Becker and Farrer because they did not disclose they were being paid MiMedx to the VA.

 

MiMedxhas made it clear that they did know about the gift cards or beach house, which were not in expense reports and were a violation of company policy. The speaking fees and meals were within established guidelines. MDXG has attorneys that calculate fair market value to compensate doctors for their speaking engagements and the seven meals ranged from $3-$20. The problem is these items were not properly disclosed by the doctors and the lack of disclosure made them illegal. MDXG also has formal controls for employees that deal with the VA to make sure VA employees have documented proof of approval for speaking engagements. I’m not sure when those went into place, just that it was a “while ago”. In addition, the MDXG employee who oversaw this relationship is no longer with MiMedx.

 

The DOJ has not gone after MDXG, just the doctors, and MDXG has provided information to the DOJ on this case. It seems like they are trying to set an example with these doctors so that all VA doctors closely follow the rules. This was somewhat foreseeable as last September MDXG wrote:

 

Additionally, MiMedx has been aware for some time of an ongoing investigation by the Department of Veterans Affairs ("VA") Office of Inspector General, but the Company is not a target of that investigation.  The Company is assisting with the investigation as requested by the government.

 

Further indictment of VA doctors who have not properly disclosed their relationship with MiMedx are possible (maybe even Dr. Frenchman in Atlanta?), but with the increased scrutiny of payments to doctors after ABH an indictment of MDXG seems unlikely.

 

Even if bears are partly right, the SEC, FDA or DOJ are not going to kill MDXG

Let's assume the previous investigations are disproven and new information proves MDXG stuffed the channel three to four years ago when its revenue base was 1/4 of today's size. So what? They restate some financials like Osiris and move forward.

 

Bears also like to assume the FDA will shut down MDXG’s AmnioFix business (10-15% of sales) because of a 2013 letter alleging the MDXG’s micronized allografts don’t meet the criteria for regulation under Section 361 that requires the product to be minimally manipulated, and would need a BLA license. MDXG strongly disagreed with that ruling and has been in discussions with the FDA while they work towards BLA approval. Experts with extensive FDA experience laughed at the notion the FDA would crack down on a successful and safe cash-pay product (they have helped NBA and NFL players), while MDXG gets licensed. It hasn’t happened in the last five years, why now?

 

The big issue might be False Claims Act fines if the DOJ finds fraudulent activity and goes after MDXG. But the DOJ isn't in the business of killing companies, especially industry leaders with products that save limbs. The DOJ wants “pelts on the walls” and fines are discretionary (i.e. Shire could pay easily $350mm). Even if the DOJ indicts MDXG they will probably settle on a fine. If doctors love the products, which they do, and the market is growing, which it is, MDXG's current business and growth prospects remain intact.

 

Conclusion
Bears love to compare MDXG to Arthrocare where the stock tanked 90% (the timing of financial crisis helped) and the CEO went to prison. A small part of Arthocare was a classic fraud. Bears conveniently leave out the second half of the story. Arthrocare was mainly a legitimate business with real products. The stock quickly snapped back and recovered ~75% of its losses (a 10 bagger off the bottom) and was sold to Smith & Nephew a few years later near previous highs.

 

Could there be more shoes to drop with MDXG? Absolutely. The DOJ could indict more doctors who ignored protocol, and the DOJ might indict MDXG. But I think the Company has real products, real sales, and there is a margin of safety buying at <2x sales and ~15x NTM earnings.

 

Bears have yet to reconcile MDXG’s strong products and strong end markets with their accusations, and operating cash flows contradict many of these accusations. The bears fallback is all of the numbers are fake. Bears have overplayed their hand. I did not see any bears at the key industry conference speaking to doctors and salespeople. I think many shorts are riding on the coattails of Cohodes/Viceroy/Aurelius. Meanwhile, bulls are afraid of the potential career risk associated with buying MDXG while embroiled in this controversy.

 

This makes for a super interesting setup. MiMedx has industry leading products in a rapidly growing market and the Company is to expanding into promising new verticals. I believe MDXG is an asymmetric long which could hit $25 within 18 months.

 

Come join the short OSTK and long MDXG “gang”. The water is warm. PS, it’s just me so far.

 

 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

results. ending of investigations. settlements. etc. 

risks: these should be obvious...

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    Description

    I can’t help myself. Another super controversial long. MiMedx. Before you attack and one-star my ass, read and be objective. Please?

     

    The backstory
    I’ve known of MDXG for years from my short interest screens. It’s a perennially hated stock in a dirty corner of healthcare, wound care. I didn’t know anything, so I ignored. Fast forward to September 2017 when a new round of short attacks began; Viceroy, Aurelius Value, Capital forum, Cohodes, Citron, etc. Boom! The short selling cavalry was here and MDXG was busted!

     

    I’m a sucker for a good short story, so I shorted. Strength in numbers, amirite?!  Besides the pages of accusations, other red flags were flying; a defensive CEO who fights shorts and numbers that magically beat expectations. All good signs. Short it and forget it.

     

    As the stock drifted higher I told a smart short selling friend he should join the party. Instead of sport shorting like I had done, he proceeded to do work; reading all the arguments, court documents, and talking to doctors. He even ordered their book on Amazon. His response? “Eh, no thanks, it might even be a long.” Whoa, why? Time to dig in and stress test the arguments. After my due diligence, I covered.

     

    A busted short thesis can make for a great long, but MDXG wasn’t cheap enough. However, in mid-February I got my shot. The Company announced an internal investigation by a reputable external party to put the shorts allegations to rest. The new auditors, Ernst & Young, were going to delay signing off on the audited results pending the investigation. This is exactly what the bears (and bulls) had asked the company to do, yet the stock got murdered and bears became emboldened. Maximum fear and uncertainty! So I bought and continued to work.

     

    Disclaimer: This situation is complicated. MDXG is now my second largest position, but if you are looking for certainty, this idea is not for you (P.S. you’re probably lying to yourself on your other ideas). I think this idea is asymmetric because if I am right the stock goes up 3-4x, and if the bears are right worse case it’s a zero. I see the worst case probability as low because MDXG has a strong cash position and a leadership position in a growing industry. This is not a short squeeze thesis. This is a ‘bears have overplayed their hand’ thesis.

     

    MDXG bull thesis

    MiMedx is an industry leader in the amniotic and placental tissue market. The Company has grown sales at a brisk 40%+ CAGR over the past four years by taking a controlling position in the high-growth wound care market as well as by expanding their proprietary PURION platform technology to create products for a range of applications including surgical, spine, ortho, sports medicine, and pain management. In layman terms, MDXG has created an organic human growth hormone with strong healing characteristics that have broad-based applications across multiple platforms.

     

    While the company is focused on wound care and expects 20+% organic growth for many years, MiMedx continues to forge ahead with clinical trials to get the necessary approvals (BLA licenses) to continue to grow their total addressable market. Doctors love their products and the products work.

     

    In 2017, the Company had $325M in sales (~75% wound care) and management projects growing to $560M+ of sales in 2020 (55% wound care, 25% operating room, and 20% pain management) and delivering $1 per share in earnings. Based on MDXG’s dominant industry position, a 5x sales multiple and a 25x earnings multiple seems reasonable and would translate into a $25 share price within 18 months, a 3-4 bagger.

     

    The opportunity exists because...


    MDXG short thesis

    Bears argue MiMedx is a complete fraud and the numbers are fake. The products are unsafe and don’t work. MDXG is stuffing their channels, paying doctors under the table, and using distributors to fake sales. The SEC, DOJ, OIG, FDA, FBI and #Metoo movement are all in the process of shutting down the company and Pete Petit, the CEO, is going to jail.

     

    I will quickly summarize these accusations. Thankfully Viceroy recently consolidated a 20+ part series into a greatest hits write-up.

     

    MDXG stuffs the channel and fraudulently induces sales.

    This happens via 1) PODs that hold unnecessary inventory, 2) employee-owned distributors that hold unnecessary inventory, 3) abusing consignment relationships, 4) assisting customers in manipulating reimbursements, and 5) using illegal sales tactics (gifts, dinners, etc).

     

    The primary source of these allegations are lawsuits against MiMedx (Jess Kruchoski, Luke Tornquist, Hal Purdy) and relate to MDXG’s relationship with its ex-Veterans Administration (VA) distributor, AvKARE. Regarding illegal sales tactics, MDXG hired many ex-Advanced BioHealing (ABH) employees after the former industry leader disintegrated when a DOJ indictment resulted in a $350mm False Claims Act fine and a $650mm write down by Shire. Ex-employees and doctors are still getting prosecuted today.

     

    MDXG utilizes questionable distributorships and sales agents relationships to fake sales.

    Examples include SLR Consulting (Jerry Morrison), StreamLogix (Frank Braly), and Recon Medical (Hal Purdy). A 2016 internal sales report proves the Company is lying about their relationships with their sales agents and they actually purchase products and are not middlemen. In addition, MDXG has relationships with other sales agents and distributors (RedMed, CPM) that have ties to trouble elsewhere where fraud via kickbacks occurred.

     

    MDXG is circumventing government regulations and will get shut down.

    The FDA is going to remove MDXG’s AmnioFix product from the market because it does not meet the proper criteria under Section 361. MDXG should be voluntarily reporting its payments to physicians under the Sunshine Act and they are not. Last, MDXG is under SEC, DOJ and VA investigations for their bad behavior.

     

    Auditor churn and the CEO’s checkered past are additional reasons for concern.

    MDXG’s previous auditor, Cherry Bakaert, identified material weaknesses in internal controls and MDXG responded by replacing them for FY2017 with Ernst & Young. Ernst & Young has delayed signing off on MDXG’s financials, pending the results of the internal investigation. Furthermore, CEO Pete Petit has a tainted background with Matria Healthcare and other prior companies.

     

    Scary stuff, right? Let’s dig in.

     

     

    Bear Case Rebuttal

     

    MDXG has industry leading products

    I’ve spoken with over a dozen doctors who use MDXG. I have yet to find a doctor that doesn't like these products. Why? MDXG products are shelf stable, store well, are easy to use, reimburse well, and most importantly, they work.

     

    I recently attended the key industry event, the Symposium for Advanced Wound Care (SWAC), to talk to MiMedx competitors, customers, and industry participants. I was surprised at how highly competitors spoke of MDXG. It was widely acknowledged MDXG is an industry leader and they were grateful for MiMedx’s investment in R&D, clinical trials, and S&M. MiMedx’s efforts have raised awareness about the effectiveness of amniotic grafts which has benefitted the entire industry. It was odd to hear. Yes the industry is competitive but there is enough growth for everyone.

     

    A technical participant, who is a senior director of R&D at a competitor, was positive about MDXG’s strong processing intellectual property and its business strategy of maintaining a  leadership position through aggressive investment in R&D, clinical trials, and marketing.

     

    Glassdoor MDXG haters validate the products

    MiMedx’s harshest critics, angry reviewers on Glassdoor, are oddly positive. Over 50% of the 1 and 2 star reviews were positive on the products:

     

    “Great Product. Patent protected. Actually works. From a sales perspective, it's a great product to sell.” 1 star review

    “Amazing product but company culture is horrible… Product is innovative and first rate in the industry.”  2 star review

    “Innovative product that actually helps patients.” 2 star review

    “Great products and good people.” 2 star review

    “Incredible product, good pipeline, coverage.” 1 star review

     

    Even one of the key whistleblowers gave a shout out to MDXG’s VP of Product innovation for developing such a strong platform technology.

     

    End markets are growing rapidly

    In addition to being dismissive of the quality and effectiveness of MDXG’s products, bears ignore the rapid growth of the wound care market. Biologic products, like EpiFix, result in significant healing improvements vs. the normal standard of care (wound dressing protocols + boots, etc) which results in improved outcomes, lowered treatment costs, and saved limbs. This is supported by clinical data and has led to increased reimbursement for Epifix.

     

    According to the key industry intelligence firm, SmartTRAK, the wound biologics market will grow in the low double digits for the next three to five years. Integra Life Sciences echoed this sentiment at their December 2017 analyst day and described their advanced wound care business as one of their fastest growing market segments with low double digit growth. I received a lot of unsolicited feedback at the wound care conference about how the industry keeps getting bigger.

     

    While bears claim MDXG’s 3-year CAGR of 40% is fake, Osiris’s recently restated financials (after getting busted for channel stuffing) show a 33% growth CAGR over the past three years and up 17% in 1Q18. They are a weaker competitor with a product that is harder to use. Grafix has to be shipped on dry ice, stored in freezer and used almost immediately. Meanwhile, Organogenesis, which purchased the old industry leader Dermagraft (ex ABH) from Shire, is back to growth. Organogenesis is growing at 40% a year and ramping up their sales force.

     

    The bears argue ABH imploded because the sales were due to bribes and MDXG will face a similar fate. Certainly Dermagraft lost their “bought sales” as a result of the DOJ crackdown, but the real blow came from a 2014 CMS change that rendered their product uncompetitive on reimbursement. This allowed MDXG to grab the leadership position.

     

    For a sanity check regarding MDXG sales it is helpful to look at sales generated per sales rep. Integra has 100 wound care reps and is on a sales run rate of ~$100mm, so ~$1mm/rep. Osiris is generating ~$120mm of sales with ~150 reps, so $0.8mm/rep. Meanwhile MDXG’s 2016 and 2017 results (and 2018 guide) suggest a sales/rep ratio of $0.9mm/rep.

     

    CMS continues to increase reimbursement for grafts/procedures and more payors are covering the products. From the recent Osiris 10K (The same information is available in MDXG’s 10-K but we dont have the 2017 10-K yet): “Medicare reimburses skin substitutes only in bundled arrangements...CMS also assigns skin substitutes to either the low cost bundle group or high cost bundle group depending on the product's average weighted mean unit cost...The national average high cost bundle reimbursement for each application was $1,406.87 in 2015, $1,411.21 in 2016 and $1,427.16 in 2017. For 2018, reimbursement is set at $1,568.32 per application.” CMS took pricing up ~10% in 2018, that’s huge!

     

    Nefarius sales activity?

    Bears argue MDXG’s high S&M expense at ~70% of sales, vs Osiris at ~55% and Integra at ~50%, is evidence of fraud. They argue returned product is being improperly recognized as operating expenses and/or bribes are causing elevated expenses. Why is spending 1500 bps extra on S&M to grow faster and capture share in a land grab market such a problem? Once a doctor picks a product they are unlikely to change unless a new product is cheaper (50+%) or more effective. There aren’t any products on the market with those characteristics to displace MDXG.

     

    MiMedx gained a strategic advantage when they hired a significant number of ABH salesforce after Shire acquired ABH. The bears dismiss the hires and argue all of these sales people are dirty in order to further support their idea that sales are driven by fraud. This was despite the fact that ABH salespeople were scattered across the industry and many landed at MDXG competitors. And yes, this was also used as bear bait for Osiris as well.

     

    MDXG’s first ABH hire was a senior corporate management employee who knew the good and bad apples at ABH. MDXG made sure to pick the good apples. The industry was under intense scrutiny to behave properly and when MDXG found any problems they were fixed immediately (see Advanced BioHealing Fallout?). Moreover, ex-ABH sales reps and bribed doctors are still being prosecuted today and some were close to facing jail. I find it hard to believe MDXG’s sales team would see their old ABH colleagues get prosecuted and then engage in criminal activity themselves.

     

    MDXG initiated procedures and protocols to prevent this from happening. They beefed up their monitoring capabilities two years ago with the addition of Salesforce.com and are able to track every dollar spent. Even disgruntled ex-employees complained about the overly regulated environment; “there doesn't seem to be regulation on how much air you breathe but I could be wrong about that”.

     

    None of the official whistleblowers (Kruchoski / Tornquist / Purdy / Fox) made any claims regarding illegals sales tactics (gifts, cash, etc) or the use of distributors to fake sales. Their allegations are channel stuffing at the VA - that’s it! Also, why bother filing lawsuits at all if they could have filed Qui Tam lawsuits and collected 20% of a potentially massive fine?

     

    What’s the motive? Why do this?

    MiMedx’s controversial CEO, Pete Petit, is a serial healthcare entrepreneur who 1) has extensive experience as public company CEO (over 30+ years), 2) has extensive experience navigating the regulatory complexities of healthcare sectors and 3) has created a significant amount of value for shareholders, including himself. For more info on Pete, see his biography website.

     

    Bears have tried to impeach Pete and show a pattern of nefarious behavior by pointing to examples of where Pete missed guidance or where a stock price tumbled. But has he ever crossed any regulatory lines or violated any laws? No. I looked at Matria Healthcare and have not found evidence to impeach Pete’s credibility. The closest he got to trouble was allegedly telling a friend to buy stock in front of a takeout. Instead of just paying a small fine and moving on, Pete vigorously defended himself and the case was dropped by the SEC.

     

    Why would a wealthy and successful entrepreneur at the twilight of his career go Walter White and break bad? It doesn’t make sense. He owns 7% of the company and has never sold a share. He bought more stock in mid-2016. Meanwhile, in the last five years the entire management team has sold only about $2mm of stock. Management and directors own ~12.5% and have rarely sold. The company has been GAAP profitable and cash flow positive since 2014, and 2012 and 2013 would have been positive cash flow excluding working capital changes. The last time the company raised money was $37mm in December 2013 and they have repurchased over $100mm worth of stock since. MDXG has no debt and net cash, yet bears tell us they are on the verge of bankruptcy.

     

    I’m not saying Pete is a saint either. My work suggests he’s an old-school, litigious, asshole type of guy. Please don’t send a drone over my house, Pete! He has powerful connections and likes to do things his way. He might not be the type of guy you want as your boss, but he’s probably the type of guy you want managing your company. Many successful CEOs are ruthless about protecting relationships and intellectual property.

     

    Company behavior doesn’t suggest fraud

    It is business as usual at MDXG despite announcing SEC, DOJ, and VA/OIG  investigations. I suspect these investigations are the result of bears’ accusations and behind the scenes maneuvering.The company replaced its regional auditor, Cherry Bekaert, and recently brought in one of the big four, Ernst & Young. They are also running a forensic audit by KPMG and in February 2017 MDXG opened their doors to a thorough internal investigation by a reputable law firm, King and Spalding.

     

    Most companies go “dark” during this type of scrutiny, but not MDXG. They are still giving quarterly results (that exceeded expectations), they are still giving guidance, they are still going to investor conferences, Pete is still talking to journalists. Either Pete has a death wish and is accelerating his demise, or MDXG really has little to hide.

     

    Earlier I mentioned how 1) Pete’s extremely defensive response to shorts and 2) the inflection in MDXG’s numbers were red flags. Let’s revisit. While I don’t like Pete’s aggressive response to short sellers, and I suspect he wrote most of the company responses himself, I can understand his frustration with getting attacked by short sellers again. MDXG has been a popular short since 2014 and many of today’s allegations are a regurgitation of past allegations (seekingalpha, VIC, cafepharma). These allegations have been investigated and dismissed: the OIG investigation into sales practices in early 2015 and an internal investigation in 2017. Pete is probably tired of these claims and wanted to refute them. I don’t like it, and his naked short accusations are a joke, but it is what it is. MiMedx stopped responding to every short accusation earlier this year and recently removed the short selling commentary from the website, steps I applaud.

     

    Regarding my second point, that results continually beat expectations, I think the strong 1Q18 results put this issue to bed. The Company is under a massive amount of scrutiny, would they have been able to cheat and hide it from everyone? Very unlikely. It is much more likely that the company is able to maintain its 30+% growth CAGR due to strength of products, a growing direct sales force, growing end market demand, and reimbursement improvements.

     

    ABH/Shire employees quickly jumped ship once the fraud was exposed. How many MDXG executives have left? Zero. A review of Linkedin profiles suggest only a few lower level employees have left per month over the past 12 months. This looks like normal business churn for a company with over 750 employees. Meanwhile, MDXG continues to hire sales reps at a blistering pace and has also added senior personnel. For example, Dr Tettleback joined as an Associate Chief Medical Officer earlier this year but hasn’t updated his Linkedin yet. MDXG had 380 sales reps at YE2017 and then 425 sales reps at the end of the first quarter of 2018, and plans to have 450 reps by the end of the third quarter. The doctors I’ve spoken with speak very highly of their sales reps and all categorized their rep as ethical.

     

    It is hard to hire medtech sales reps and impossible to keep them if the product is not selling. There is strong demand for these reps and unemployment is near all time lows.

     

    Bear thesis has weak evidence

    The bears have primarily built their short case off of evidence from whistleblower lawsuits (Kruchuski, Tornquist, Purdy, Fox) plus 15+ other anonymous contacts / whistleblowers. Would any diligent VIC investors short a stock solely off of conversations with disgruntled ex-employees? This is what bears are doing even as the whistleblowers have been discredited.

     

    Despite almost a year of diligence and supposed binders full of evidence from disgruntled current and ex-employees, the strongest evidence of MDXG’s nefarious behavior is...a picture of $180k of inventory in a storage locker, an internal sales memo regarding reconciling inventory properly, an internal sales memo re consignment agreement changes at the VA, a frustrated exchange between a VA hospital that went off a consignment agreement, an email about small inventory control issues, and some documents assisting with common reimbursement question? This “damning evidence” looks like normal work emails.

     

    What would concern me would be real evidence of nefarious behavior. Where are the emails and texts from superiors saying to cheat? Where are the emails and texts about gifts and payments? Where is the evidence of doctors and executives getting paid? The bear evidence is actually very weak.

     

    At the SAWC conference I couldn’t find any competitor salespeople (even ones that were ex ABH) to provide dirt on MDXG. Two salespeople mentioned that MDXG has dirty sales practices. When pressed for details, they cited online articles. When I asked for first hand examples, they referred me to other industry contacts. These new contacts then told me they didn’t know of any dirty behavior, just that they had read the accusations online. It reminded me of my conversations at The National Postal Forum regarding Stamps.com a year ago. Several industry participants regurgitated the bear thesis but they had zero evidence to corroborate it. The dirtiest behavior I found regarding MDXG is they will rent out all the best restaurants around a conference (all legal) in order to block out competition. And sometimes a sales representative will leave and come back later, when a sales rep is supposed to be officially present the whole time. Turn yourself in, Pete.

     

    Why is an ex employee setting up his own distributorship a problem? Why can’t 1099 employees set up their own LLCs? According to my contacts, 1099 employees are common and sales people commonly sell other products (wound dressings, etc) in conjunction with an amniotic product. An LLC structure makes sense. Frank Braly might have chosen this route with MiMedx in order to start selling as a work around to a non-compete agreement with NuTech. And why couldn’t sales ordered through Frank’s SpineLogix website be credited to SpineLogix under Frank’s balance? Is the company really going to these lengths for ~$50k/sales a quarter? It would take a lot of participants (over 200) to create $10mm of fraudulent sales each quarter (just 10% of sales) at this pace.

     

    Bears have thrown out an overwhelming amount of information that is light on substance and long on speculation, just like many of their other short attacks that have gone wrong.

     

    Whistleblower credibility

    The crux of the channel stuffing short thesis comes from two main whistleblower cases; Jess Kruchoski/Luke Tornquist and Hal Purdy. Hal Purdy’s accusations against the company cost him a couple hundred grand and he was forced to apologize and say he was incorrect. The details from Hal’s whistleblower case are included in the MDXG “greatest hits” write up but this makes little sense and is intellectually dishonest.

     

    Regarding case #1 (Kruchoski/Tornquist), interested VIC readers should read the arguments between these top ex-sales guys and MDXG. The conflict started because Kruchoski/Tornquist were upset that they weren’t paid their bonus growth commissions from a VA sale where the products were already on the shelves. The company stood its ground, and Kruchoski/Tornquist appear to have tried to extort MDXG, and MDXG got angry and demoted them.

     

    How reputable is their story? These guys admitted to selling Academy Medical products while employed by MDXG. Why does that matter? This was one of the reasons their case was dismissed on 2/7/17! Case 1:17-cv-00577-LMM: “Through the pending Motions to Dismiss, the Court has learned that the investigation allegedly revealed that Plaintiff and Tornquist had been selling competitors’ medical products to MiMedx customers”. It gets better. The DOJ recently fined Academy Medical over the False Claims Act! Amazing stuff.

     

    AvKARE was a key party in the channel stuffing allegations. AvKARE is a veteran-owned GSA federal supply schedule contractor and when MDXG was not approved to sell to the VA in 2013, AvKARE was a quick way in. MDXG signed a three year deal with three one-year options. As MDXG’s product success grew, the relationship exploded. AvKare was 40%, 56% and 24% of sales in 2013, 2014 and 2015, respectively. Of course MDXG didn’t want to have a middle man, so the ultimately got approval to sell to direct to the VA and the AvKARE relationship expired 6/30/17.

     

    Channel stuffing allegations don’t tie to the numbers

    Distributor sales are immediately recognized as sales and all VA agreements were initially consignment sales. Could this lead to shady behavior? Sure. AvKARE could put as much MDXG product on the shelves as it wanted and MDXG could recognize it as sales. Is it sustainable? Absolutely not. The relationship with AvKARE and percentage of VA sales became an increasingly smaller part of sales, and the cash flow and balance sheet almost never lie: DSOs and working capital trends have improved, and disproved this thesis.

     

         

     

    Kruchoski alleged the VA channel stuffing began in 2014 and by 4Q15 there was $10mm in excess inventory. He also states the channel stuffing ended in June ‘16. While the rise in DSOs supports his case, the excess inventory was worked down thereafter and cash from operations began to surge in mid 2016, likely a result of the number of health plans reimbursing Epifix rising from 160 in late 2015 to 800 by early 2017. We know the ongoing internal audit is looking at sales and distribution practices and this period is probably under intense scrutiny. I think there could be a minor restatement that shifts revenues from 2015 into 2016.

     

    Fraud, or miscommunication?

    Bears share angry emails between VAs and MDXG to show channel stuffing behavior. This is a gross misrepresentation. Latest 10K:

     

    “In 2016, the Department of Veterans Affairs (“VA”) announced a change in its internal purchasing procedures.  Among other things, under the new directive, the VA would require internal pre-authorization by a warranted contracting officer for any implant purchases greater than $3,500, except for implants from VA-owned inventory or a consignment agreement negotiated by a VA contracting officer.  Different VA facilities interpreted the new directive differently, and also began implementing different portions of it at different times. Numerous vendors to the VA, including the Company, have requested that the VA provide clarification to its facilities on the new policy in order to minimize disruption in patient care.”

     

    Bears spin any confusion around new agreements as examples of nefarius behavior when it was most likely just a mistake or miscommunication.

     

    The bears frequently lie

    The bears are entrenched on MDXG with short interest at all-time highs and have made this “personal”. It's hard to remain objective when things get personal. Not surprisingly, this has resulted in the bears continuing to pour out an overwhelming amount of information, lots of which is intellectually dishonest and some of which contains flat out lies.

     

    For example, Aurelius claims that MDXG uses a Texas manufacturer named INCELL to produce Orthoflo. They claim the fact that the facility received a warning letter in October 2016 means that 1) the product is unsafe and 2) the FDA is going to shut down use of this product. A quick call to INCELL’s CEO reveals that INCELL hasn’t made any MDXG products in over a year and a half (MDXG took all production in house) and that the FDA issues were fixed within a week.

     

    The bears love to smear the reputations of any doctors associated with MDXG. They even spread lies about a doctor getting arrested and escorted from a hospital in handcuffs. A quick call to the hospital confirms this is a lie and that the doctor merely resigned. Moreover, the doctor resigned over the ABH controversy, which has nothing to do with MDXG. It is also easy to track these doctors payments (here), which fell off a cliff in 2014 after ABH got busted.

     

    Bears claim ABH prosecutors are lined up to attack MDXG next and link to quotes in articles. However, my conversation with the prosecuting AG revealed that MDXG is not part of any of their current investigations and he is focused on dirty ABH doctors.

     

    A major problem with the bear thesis is the lack of insider sales, yet bears dismiss the lack of insider sales as also fraudulent. They argue MDXG’s transfer agent supports of frauds and reported holdings are not to be trusted. Really? MDXG’s transfer agent was acquired by IART and is now a public company. Is IART a short for enabling frauds? I searched for transfer agent fraud and could not find a single example of a transfer agent misrepresenting insider holdings.

     

    I’ve also met one of the doctors whose face is most frequently smeared across http://petiteparkerthebarker.com/. This doctor said he could care less what rumors are spread and that he would open his books to anyone. He uses all of the competitive products but MDXG’s products work best. He laughed off the attacks as a distraction and did not care. Could he be lying? Sure, but doubtful. He runs a successful five clinic podiatry group, so would he really jeopardize all of his success over some gifts from MDXG? Unlikely. And the pictures of him at sporting events with MDXG sales rep? He owns those season tickets.

     

    Recent grand jury indictment

    The indictment of two doctors and one nurse practitioner by the DOJ in South Carolina immediately seemed to confirm the bear thesis; check fucking mate! According to the indictment, Becker received speaker fees of $19,897 over four years and Farrer received $12,200 in speaker fees from 2013 to ‘15 and purchased stock. In addition, there are allegations of gift cards and free use of a beach house. Moreover, the indictment states, “It was further part of the conspiracy the the Defendants caused the excessive use of MiMedx products on VA patients in South Carolina”. However, a close reading of the indictment suggests the DOJ is pursuing Becker and Farrer because they did not disclose they were being paid MiMedx to the VA.

     

    MiMedxhas made it clear that they did know about the gift cards or beach house, which were not in expense reports and were a violation of company policy. The speaking fees and meals were within established guidelines. MDXG has attorneys that calculate fair market value to compensate doctors for their speaking engagements and the seven meals ranged from $3-$20. The problem is these items were not properly disclosed by the doctors and the lack of disclosure made them illegal. MDXG also has formal controls for employees that deal with the VA to make sure VA employees have documented proof of approval for speaking engagements. I’m not sure when those went into place, just that it was a “while ago”. In addition, the MDXG employee who oversaw this relationship is no longer with MiMedx.

     

    The DOJ has not gone after MDXG, just the doctors, and MDXG has provided information to the DOJ on this case. It seems like they are trying to set an example with these doctors so that all VA doctors closely follow the rules. This was somewhat foreseeable as last September MDXG wrote:

     

    Additionally, MiMedx has been aware for some time of an ongoing investigation by the Department of Veterans Affairs ("VA") Office of Inspector General, but the Company is not a target of that investigation.  The Company is assisting with the investigation as requested by the government.

     

    Further indictment of VA doctors who have not properly disclosed their relationship with MiMedx are possible (maybe even Dr. Frenchman in Atlanta?), but with the increased scrutiny of payments to doctors after ABH an indictment of MDXG seems unlikely.

     

    Even if bears are partly right, the SEC, FDA or DOJ are not going to kill MDXG

    Let's assume the previous investigations are disproven and new information proves MDXG stuffed the channel three to four years ago when its revenue base was 1/4 of today's size. So what? They restate some financials like Osiris and move forward.

     

    Bears also like to assume the FDA will shut down MDXG’s AmnioFix business (10-15% of sales) because of a 2013 letter alleging the MDXG’s micronized allografts don’t meet the criteria for regulation under Section 361 that requires the product to be minimally manipulated, and would need a BLA license. MDXG strongly disagreed with that ruling and has been in discussions with the FDA while they work towards BLA approval. Experts with extensive FDA experience laughed at the notion the FDA would crack down on a successful and safe cash-pay product (they have helped NBA and NFL players), while MDXG gets licensed. It hasn’t happened in the last five years, why now?

     

    The big issue might be False Claims Act fines if the DOJ finds fraudulent activity and goes after MDXG. But the DOJ isn't in the business of killing companies, especially industry leaders with products that save limbs. The DOJ wants “pelts on the walls” and fines are discretionary (i.e. Shire could pay easily $350mm). Even if the DOJ indicts MDXG they will probably settle on a fine. If doctors love the products, which they do, and the market is growing, which it is, MDXG's current business and growth prospects remain intact.

     

    Conclusion
    Bears love to compare MDXG to Arthrocare where the stock tanked 90% (the timing of financial crisis helped) and the CEO went to prison. A small part of Arthocare was a classic fraud. Bears conveniently leave out the second half of the story. Arthrocare was mainly a legitimate business with real products. The stock quickly snapped back and recovered ~75% of its losses (a 10 bagger off the bottom) and was sold to Smith & Nephew a few years later near previous highs.

     

    Could there be more shoes to drop with MDXG? Absolutely. The DOJ could indict more doctors who ignored protocol, and the DOJ might indict MDXG. But I think the Company has real products, real sales, and there is a margin of safety buying at <2x sales and ~15x NTM earnings.

     

    Bears have yet to reconcile MDXG’s strong products and strong end markets with their accusations, and operating cash flows contradict many of these accusations. The bears fallback is all of the numbers are fake. Bears have overplayed their hand. I did not see any bears at the key industry conference speaking to doctors and salespeople. I think many shorts are riding on the coattails of Cohodes/Viceroy/Aurelius. Meanwhile, bulls are afraid of the potential career risk associated with buying MDXG while embroiled in this controversy.

     

    This makes for a super interesting setup. MiMedx has industry leading products in a rapidly growing market and the Company is to expanding into promising new verticals. I believe MDXG is an asymmetric long which could hit $25 within 18 months.

     

    Come join the short OSTK and long MDXG “gang”. The water is warm. PS, it’s just me so far.

     

     

     

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    results. ending of investigations. settlements. etc. 

    risks: these should be obvious...

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