I received this comment from a reader in response to my post about ExamWorks and their recent financials. It is quite thorough and well worth consideration on its own merits.
Thanks Joe for a very interesting post. The market is always right, but not necessarily at the right time. The recent conference call for EW was posted on the SEC site.
See:
http://sec.gov/Archives/edgar/data/1498021/000118811211000517/ex99-2.htm
Here are some excerpts:
Richard Perlman – ExamWorks Group, Inc. – Executive Chairman: Notwithstanding what we believe to be a fantastic year for ExamWorks as reflected by our guidance, we feel that it is important to share what we believe will be lower than expected Q1 results due primarily to the severe weather conditions that impacted many of our geographical markets. We have repeatedly referenced that the IME business did not exhibit much seasonality and that it is immune to the cycles of the general economy; however, it isn’t immune to weather.
The high incidents of storm-related issues was quite significant. In some locations, every link of our logistical chain was challenged, whether it involved clients closing operational centers, doctors travel to their officers or, most importantly, claimants travels to their appointments. Obviously, not all service centers were affected and we did state that in markets like Florida and California we expect to have solid first quarter results that are in line with our internal plans.
However, as we sit here today, we believe that this could have a 5% to 8% negative impact on our Q1 revenue plan and an even higher impact on EBITDA, due to the reverse operating leverage these revenues imply. That being said, we are confident that almost all of this business will or has been rescheduled and will be recognized in the subsequent periods.
Jim Price – ExamWorks Group, Inc. – CEO: To wrap up the progress report, we have a few comments on our go-forward marketing strategy. MES is a formidable, premium brand with a long operating history. Because of this, we will retain the MES brand, providing assurances to the MES clients that their high quality service and support to which they are accustomed will continue…One of the distinguishing features of the IME business is that it is very relationship-driven. The current marketing and support teams will continue to service their respective accounts.
ANALYST QUESTION: Great. Thanks for taking my question. I guess I’d like to spend a little bit more time on the opportunity to maintain the MES brand and what it means for markets where there’s geographic overlap between the two companies…I guess my question centers around basically if insurance companies in a given market are using a variety of different vendors; I had assumed it would treat the ExamWorks Company in a market as a consolidated entity with the MES Company now that the merger is completed. Can you let me know if that is not going to be the case? And also, I’ve love to just get your thoughts on where there is the geographic overlap, and any assumptions for cannibalization of revenues in the guidance.
Richard Perlman – ExamWorks Group, Inc. – Executive Chairman: Yes… But, let me talk about the cannibalization. I think what we’ve tried to do in our guidance is be fairly conservative, and really we’ve built something in that in our conservatism. We have no reason to believe that it will occur….
Jim Price – ExamWorks Group, Inc. – CEO: In a lot of the insurance carriers and partners, they have multiple — we’ll call them baskets, where the adjusters will put files to be picked up or received. If they’re not going electronically, they’ll be in a partner’s basket. So there may be a MES basket, there may be an ExamWorks basket, or it may even be one of our local or regional companies’ names on that basket. So, the goal is to keep the existing structure and flow working well…. we are keeping both entities’ sales structure going forward…
ANALYST: Okay. So can I just be sure I’m understanding. The assumptions — so even though — please let me know if I’m capturing this correctly. Your conversations with the insurers where there is market overlap have indicated some comfort that they will continue to treat the MES — they will treat MES separately from the ExamWorks company and they will not treat it as one consolidated entity where there’s market overlap.
Richard Perlman – ExamWorks Group, Inc. – Executive Chairman: That is correct.
————-
This call is an example of the challenges they are facing. First of all, anyone who knows the IME and claims business knows that weather issues quickly result in rescheduling of events. ExamWorks has a national footprint, including many areas where there were no weather issues. Furthermore, issues with weather were quite temporary. Claims shops closed at best for a day or two. Exams would likewise see very limited cancellations. Most importantly is that weather is an annual event somewhere, and even more critically is the fact that claims are time sensitive and the vast majority of weather related issues in January and February would be rescheduled and completed well before the end of the quarter. Yet management is already trying to manage a 5-8% decline in revenue attributing this to the weather. Looks like they are having other challenges. I think there is no other way to say it on the weather excuse: ExamWorks management is likely not being truthful. They are not meeting their projections and it is not about the weather.
The other excerpts are about the MES acquisition and revenue cannibalization. They claim that they will keep two brands and teams. Help me understand how this will work in reality. Will there be two sets of sales people selling the same product to the same customers, presumably telling these customers why one is better than the other? Are the hundreds of staff and management members of the combined companies willing to buy off and capable of executing on this strategy?
Joe, your posting links to ExamWorks financials. One of their comps that we know in our managed care space is Corvel. Corvel has real income, about 44 million pretax on revenues of 366 million, with a market cap of 586 million.
[Paduda note – I haven’t written about Corvel in a long while; their P/E is around 21 which is pretty awfully very high for a company with decent but not great revenue growth in a mature market with declining claims frequency that hasn’t sold a big national account in quite a while. WIll remedy this oversight shortly.]
See: http://www.google.com/finance?q=NASDAQ:CRVL&fstype=ii
ExamWorks on the other hand has negative income, claims a run rate of about 350 million but has no real evidence of achieving it, and has a market cap of about 700 million. If investors really believe that they are capable of converting their challenges, based upon their current strategy and clear revenue challenges to profit, have at it.

ExamWorks’ latest financials were published last week. After taking a quick look, and reflecting back on a couple conversations with folks who know their business, I’m a bit puzzled.
For those unfamiliar with the company, ExamWorks is a relatively new publicly traded company that provides Independent Medical Exams and related services throughout the US. Their strategy is acquisition-driven; they are ‘rolling up’ other IME companies and seeking to reduce costs, thereby driving increased profits.
Their management profile is intriguing. Executives have similar backgrounds – looks like they all worked together in the past at companies such as PracticeWorks (a dental practice software company) and TurboChef. Doesn’t seem to be much workers comp or auto IME experience among the senior folks.
So here’s what’s got me puzzled.
First, ExamWorks reports something called ‘adjusted EBITDA’, a non GAAP (generally accepted accounting principle) measure. For we non-accountants, adjusted EBITDA is one of those nebulous reporting categories used by companies (often those growing thru acquisition) trying to show financial results when using GAAP numbers would produce numbers that, according to the companies using them, would not be representative of their real financial status. In terms of actual expenditures, it’s hard to figure out what exactly is included, and not included in ‘adjusted EBITDA’.
Here’s how ExamWorks defines the term – “Adjusted EBITDA [is] earnings before interest, taxes, depreciation, amortization, acquisition-related transaction costs, share-based compensation expenses, and other non-recurring costs.” Two terms stand out – “acquisition-related transaction costs” and “other non-recurring costs.”
Fortunately, as a publicly traded company, ExamWorks is required to use GAAP standards; when these are used the numbers become a bit more clear – for 2010, their actual net was a loss of $5.4 million. That’s not necessarily a problem, after all this is a high-growth company expanding thru acquisition, a strategy that necessarily results in higher costs early on, costs that hopefully disappear and are overtaken by the fruits of the acquisitions.
That is, if the growth-by-acquisition strategy actually works.
ExamWorks (EW) embarked on a massive acquisition spree a while back, with the biggest recent deal involving MES, which was acquired for $170 million in cash and more in stock. That deal, and the many others EW has consummated over the last year plus, is an attempt to own the market, to become the dominant national provider of IME and related services.
The problem with the strategy, and more to the point the future of the company, lies in two areas – revenue cannibalization and scale.
Revenue cannibalization – or, the whole is less than the sum of the parts.
Most workers comp payers like to spread their IME business among at least two, if not several vendors. Now that EW has bought up many of its competitors, these payers don’t look at EW and MES or BME Gateway or any of their other acquired companies as different; the payers, quite logically, consider them to be one and the same. As a result, business that was going to, say MES because it was a competitor of EW is now going to go somewhere else. Not all of the business, and perhaps not even much of it – but certainly some.
The implication is clear – the companies EW is buying may well see declining revenues as a result of the acquisition. And, it follows, the revenues produced by EW may well be less than the sum of the revenues generated by all the companies they acquired.
In the most recent earnings call, EW execs stated words to the effect that they were going to maintain the MES sales force as a separate and distinct entity, perhaps as a way to address this issue. While we in the work comp business may be slow, most of us will eventually figure out it’s the same company, and payers will shift business around to ensure they spread it amongst different vendors.
Which leads us to the next issue, scale.
We’ll leave aside the question of how expenses can be reduced if the company is paying for two competing sales forces, and focus on the Cost of Goods Sold.
The IME and peer-review services business has a cost structure that is based to a large degree on variable costs – primarily, what they have to pay the physicians who deliver the expert opinions. As a ‘craft business’, this doesn’t lend itself to scale-driven profit increases – the more IMEs they sell, the higher their variable costs are. Sure, there are some benefits to scale, such as smaller sales forces, consolidated IT and corporate administrative functions and the like, but these are small potatoes compared to the physician expense.
I suppose EW could try to negotiate better deals with their physician experts, but that isn’t likely to meet with much success. IME docs are a) in short supply; b) can offer their services through a rival IME company; c) payers like opinions from ‘good docs’ and will go to the IME provider who has those good docs on their list; and on a related note, d) quality is really important to most payers, who won’t like it if their IMEs are done by docs who don’t ‘get’ workers comp/auto.
EW’s investment proposition is to a large extent focused on generating outsize margins from a pretty labor-intensive business. Their forecasts call for EBITDA numbers approaching, and eventually surpassing, the 20% of revenue mark. I don’t see how this is possible. People in the business today who run companies in the same space, and do it quite well, can’t come near this figure. Most are pretty darn pleased with an EBITDA in the low teens, and a ten percent figure is pretty much industry standard.
If this was a high-fixed-cost/low-variable-cost business like the PPO industry or software, or relatively new (MSAs), we could reasonably expect a very well run, large player could deliver outsize margins. The IME business is neither. It is a mature industry, with companies operating in a highly competitive market with high variable costs.
In fact, as claims frequency continues its structural decline, the underlying driver of their business – the number of work comp claims – will continue to shrink year after year. Add that to the very real issue of regulatory risk, and you get an investment picture that’s rather risky.
I don’t doubt the management of EW has successfully built companies in dental practice management software and commercial and residential cooking. I’m not so sure they’re going to have much success in the IME business.
Finally, I’m completely befuddled by Wall Street’s apparent inability to understand these issues. For example, Goldman raised their six month share price target by a buck after the numbers came out. I would note that Goldman was a lead underwriter of their IPO…
Thanks to WorkCompWire for the heads’ up.