Computer Programs and Systems, Inc. (NASDAQ:CPSI) Q2 2023 Earnings Conference Call August 9, 2023 4:30 PM ET
Chris Fowler – President and Chief Executive Officer
Matt Chambless – Chief Financial Officer
Conference Call Participants
Jeff Garro – Stephens
George Hill – Deutsche Bank
Good afternoon, and welcome to the CPSI Second Quarter 2023 Earnings Conference Call. Leading today’s call are Chris Fowler, President and Chief Executive Officer; and Matt Chambless, Chief Financial Officer.
This call may include statements regarding future operating plans, expectations and performance that constitute forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The company cautions you that any such forward-looking statements only reflect management expectations and predictions based upon currently available information and are not guarantees of future results or performance.
Actual results might differ materially from those expressed or implied by such forward-looking statements as a result of known and unknown risks, uncertainties and other factors including those described in public releases and reports filed with the Securities and Exchange Commission, including but not limited to the most recent Annual Report on Form 10-K.
The company also cautions investors that the forward-looking information provided in this call represents their outlook only as of this date, and they undertake no obligation to update or revise any forward-looking statements to reflect events or developments after the date of this call.
At this time, I will now turn the call over to Mr. Chris Fowler, President and Chief Executive Officer. Please go ahead, sir.
Thank you, Dru, and thank you to everyone for joining us this afternoon. These are not the results that I’d hope to be sharing with you all today. There are bright spots in the quarter and we are still confident about our strategy and optimistic about our future, but while this has always been a story about transformation and change. The change is taking a little longer than we forecasted.
The lesson learned is results from change take time, and we simply were too optimistic about how quickly the payoff would start to show in our results. As I’ve taken the time to reflect on the year so far and on our planning for 2023, our message should have been that this was our year from investment and change and establishing a foothold for our future. Instead, I felt [indiscernible] of wanting to show positive results [indiscernible] change this year significant. We’ve reorganized our sales team. We’ve transitioned to the public cloud.
We’ve moved to a global workforce and focused on becoming a people first organization focused on talent. These initiatives have been successful and have put us in a position of strength for our next phase, but they have come at a cost including both an add to the bottom line and a longer lead time to show results. This has been a valuable lesson for me and for our team regarding optimism versus realism.
We have been guilty far too long of being overly optimistic when it comes to our results, and that ends now. I’m going to share an overview of what happened in the second quarter and touch briefly on guidance and then let Matt delve into the nuances of both topics. Our revenue in the second quarter came in at $84.6 million. While the EHR business was in line with our expectations, our RCM business was lighter than we projected.
Digging deeper half of the RCM this was due to a couple of recent True Code contract wins. We initially thought these were going to be term licenses where GAAP costs for mostly upfront revenue recognition, but when it was finalized as a SaaS deal, the revenue was instead smoothed out evenly over the next few years.
The other main source of the problem in our RCM business was a result of over optimism as it relates to volume. We saw volume out performance in the first quarter and modeled a continuing trend into the second quarter, but the volume shifted back towards the mean as some short-term projects that we hoped would continue actually lasted.
And the final piece patient engagement license, which – under plan as well. Adjusted EBITDA for the second quarter was $11.2 million also below our expectations. The relatively fixed cost in our model get tough to absorb the lower revenue and much of the miss flowed through to the bottom line.
While we have the leverage to scale our cost structure, depending on anticipated demand over the next few quarters, it’s admittedly challenging to do into the quarter if a significant fluctuation has been detected. Now to be clear, it’s not all doom and gloom. Despite the choppy financial results, we did make progress on several fronts during the second quarter.
I previously shared that customer retention and cross-selling are critical to our long-term growth, and I’m pleased to report we performed well in both areas in the quarter. Halfway through the year, EHR retention is coming in on the higher end of our projections. From a cross-selling standpoint, we signed two RCM contracts with existing EHR customers each worth over $1 million of annual recurring revenue.
Additionally, we signed a large EBO contract with a non-EHR customer, Ozark Medical in Missouri. Lastly, just subsequent to the close of the second quarter, we signed a $1.5 million EHR agreement that was a competitive takeaway.
On another positive note in May, we wrapped up a voluntary retirement program that we initiated to help streamline our organization with roughly 130 of our employees accepting the offer. By our estimates, this will lead to roughly $3 million in savings this year and around $6 million on an annualized basis.
To summarize, our pipeline continues to grow. We are seeing stability in our EHR customer base, and we have taken the necessary measures inside the organization to better position us for the future. That said, our missteps in the quarter led us to rethink the remainder of 2023. As we think about the second half of the year, we remain confident in our revenue forecast, but there are a couple of factors that have caused us to deviate from our initial EBITDA forecast. I’ll share some initial thoughts and Matt will discuss each and more detail.
In terms of cost pressures, we are seeing for the back half of the year, I think about this two primary buckets. First on the RCM side. Over the course of the first half of the year, we saw certain RCM deals take longer to close compared to our historical rate and hindsight, we were far too bullish on our sales force expectations following our reorganization last fall. We should have taken into account that sales is a relationship business and that it would take a few quarters for the reorg sales force to establish the new contacts needed to close new business.
As a result, bookings are coming in just shy of expected levels, but we are up the learning curve now and back on track for the second half of the year. As it relates to the RCM bookings that we signed in the first half of 2023, the mix between pure technology solutions and tech-enabled services is skewing more towards the services than we expected.
While we think our technology solutions are great standalone products that complement in-house RCM, our target market of small to mid-size hospitals often have staffing challenges and look to us for more than just tech-enabled services because they don’t have the people [indiscernible] glad we can provide this service to our market, it does have an impact on our revenue mix and ultimately on our margin.
Finally, at the same time that bookings are tilting more towards services, we are seeing outpaced labor pressure in our domestic market. While we believe our voluntary retirement program and the ramping of our offshore initiatives should alleviate some of this pressure over time, it is not enough for the current year.
All of the RCM factors combined account for an approximate $6 million of EBITDA headwind in the back half of the year. The other area where we are seeing expenses come in higher than we initially projected is around our cloud migration to Azure, which began earlier this year. It is proceeding faster than we anticipated, and unfortunately, the associated costs are increasing as well as the result of having to pay for duplicative cloud services during this migration period. While we anticipated the redundant services to a degree, we did not correctly estimate the length of time we need to operate these redundant environments.
This migration has caused an additional EBITDA headwind of around $2 million for the year. And while we expect these costs to continue to scale throughout 2024 with the migration of our hosted customer data, we anticipate that the duplicative spend for redundant public cloud environments will effectively wind down by the end of the year. While it is a bit of an undertaking, we feel that is ultimately the right thing for our customers.
Given our second quarter financial results and where we stand in the year, there’s not enough time to make up the difference. So we are reducing our adjusted EBITDA outlook accordingly. We now expect EBITDA to be between $52.5 million and $54.5 million.
Lastly, before I turn the call to Matt, I’d like to welcome our newest Board member, Mark Anquillare. Mark joins us after almost 30 years with Verisk. While at Verisk, Mark served as CFO and COO playing a key role in their IPO and their subsequent outsized growth. We welcome his decades of experience and insight and look forward to leverage his growth minded approach coupled with thoughtful execution. We’re thrilled to have him on the team as we continue our evolution as an organization.
I’ll now hand it over to Matt.
Thanks, Chris, and thanks to everyone joining the call. I’ll now review the second quarter results. Net patient revenue, which represents our total NPR of just our end-to-end RCM customers was $3.2 billion, an increase of 9% year-over-year. Total bookings in the quarter were $21.9 million. RCM bookings of $13.6 million, comprised 62% of total bookings and were the second highest in our history behind only the second quarter of last year.
Cross-selling RCM to our EHR customers, which is a key factor in our success, represented 74% of total RCM bookings in the quarter. Total revenue of $84.6 million increased just 2% compared to last year. For the quarter, RCM represented 56% of total revenue, EHR was 41% and patient engagement rounded out the remaining 2%.
Gross margins in the quarter of 47.8%, decreased compared to 49.2% due in part to the labor pressure that Chris noted. We believe globalizing efforts will begin to relieve the labor pressure as we scale. Operating expenses as a percentage of revenue was 50.1% in the quarter compared to 43.6%. We saw an uptick as a percentage of revenue in product development due to our cloud migration and other modernization efforts and general and administrative costs related to increased severance in other non-recurring charges.
These all resulted in adjusted EBITDA of $11.2 million compared to $13.2 million a year ago. Adjusted EBITDA margin of 13.3% was down 260 basis points due to the expense pressure that Chris highlighted earlier in the call. Wrapping up the financials, operating cash flow for the second quarter was $700,000.
Turning to guidance, Chris gave you a rundown of some areas where we expect to see outsized expenses in the back half of the year, but provide a little more context on each factor we’ve taken into consideration. First, our domestic labor market costs increased roughly 10%. [Indiscernible] RCM business, we saw labor costs increase 13% versus the 2% increase in revenues, despite our successes in the global workforce initiative.
As Chris mentioned, we’ve put in place a strategy to alleviate the labor pressure by leveraging our global workforce, but it won’t be enough to offset the impact in 2023. As added context, we ended the quarter with 203 offshore team members [indiscernible] compared to 100 at the beginning of the year, and the goal of 400 by year end.
Second, our RCM bookings are coming in at a different mix of services and technology than we expected. We initially thought our bookings would be more of a balance split between tech and services, but so far this year, our actual bookings mix was much more heavily weighted towards services. As a reminder, our tech RCM solutions typically have a gross margin in the 70 percentile ranges compared to our tech enabled services, which are more labor based for the gross margin in the 30s.
Third, as Chris mentioned, our sales force reorg last fall caused a temporary elongation of RCM deals. As these new relationships need time to gel, but we believe it was a necessary phenomenon and temporary phenomenon given the data that we’re seeing. For example, our average decision timeframe, which we measure from open – opportunity open to close for end-to-end RCM deals doubled from the first half of 2023 compared to full year 2022.
We started to see that trend down meaningfully over the past couple of months. Those three factors combined equate to an approximately $6 million impact to our EBITDA this year. Giving everything I just covered, as well as the incremental cost of our cloud migration this year and the half year benefit of the voluntary early retirement program, we are approaching our guidance as follows.
We’re reiterating our revenue range of $340 million to $350 million, reducing our adjusted EBITDA range of $59 million to $63 million to between $52.5 million and $54.5 million, introducing a non-GAAP net income range of $25.6 million to $27.6 million. Looking at the distribution between the remaining quarters this year. For Q3, we see revenue relatively flat compared to Q2 with revenue gains and low margin RCM lines offset by lowered non-recurring revenues from EHR and patient engagement. In terms of profitability, we expect a sequential increase likely in the low double digits with lower seasonal costs in the third quarter.
Thank you all for your interest in our story, and I’ll hand it back to Chris for some closing remarks.
Thanks, Matt. To close, let me just say that while we’re taking a step back in 2023. I know our organization is stronger and better prepared to capitalize on the opportunities in front of us. Like I said in the beginning, this has always been a story of transformation and change, and it still is. I thank you for your interest in CPSI. I sincerely look forward to sharing an update on our progress in the coming quarters. That concludes our prepared remarks. Rob, let’s open up the call to questions.
Thank you. [Operator Instructions] Thank you. And our first question is from the line of Jeff Garro with Stephens. Please proceed with your questions.
Yes, good afternoon and thanks for taking the questions. Maybe we’ll start out on the demand side of things, and you talked about the pipeline continuing to grow. But was hoping you could comment on how pipeline conversion has been and what you could do to accelerate that in the future, realize that it might be a bit of a balance that you’re not always in competitive procurements, but that lends itself to maybe less urgency on behalf of your customers and prospects. So we appreciate your comments there.
Yes. Hey, thanks a lot, Jeff. I’ll start and then Matt may have some additional color on the back end of that. I think it’s a great point to call out that we’ve seen this all elongation in the pipeline, and I think a big portion of that is the fact that, again, remember that we’re selling something to your point, where it’s not necessarily competitive we’re creating the demand as well. So we’re going to these opportunities, which aren’t even opportunities in the beginning, and so we’re having to first sell them on the idea of outsourcing and then sell them on the idea of TruBridge.
And so I think that there’s always going to be a natural additional link to that compared to our historical process on the EHR side. But as we continue to refine that value proposition and show the benefit of this being one of the things that the hospital can take out of their operation, I think we’ll see that shortened. I also think there’s going to be a natural acceleration on the buying side of this, because the pressures are only intensifying from a labor standpoint specifically. And so as those labor challenges continue to be emphasized at the facilities, I think that’s going to have a natural acceleration to the timeline.
Yes. And Jeff, I think the question around pipeline conversion is really getting to what’s happening in win rates and in the competitive market. And the competitive landscape here hasn’t really changed all that much from when we entered the year. And that story kind of holds true on the win rates as well. For a little bit of context, we win roughly 90% or more of the opportunities where we get a chance to – what we call demoing TruBridge’s RCM services. So situations where the prospect is really taking the service seriously.
And that’s been our historical rate. It’s been pretty consistent and that consistency is maintained throughout the first couple of quarters of this year. So what we’re seeing on the pipeline and booking side of things is really just an elongation of that decision timeframe, but the outcomes themselves haven’t really changed all that much.
Got it. All very helpful. And then maybe to switch over to the margin side of things, and certainly, it’s a little bit related that you’re seeing a relatively healthy demand environment, but facing labor pressures. So I think the natural question is, how would you describe your ability to capture more price from your customers while also trying to accelerate some of that conversion we just talked about? And then the second question there is on the labor pressures and looking to globalization as an offset. Is there any weariness of moving too fast on globalization efforts given the pressures that you’re seeing?
So I’ll take the second question first and then may ask for some clarification on the first question. We’ve said from the very beginning that we were going to be very intentional about our conversion to the global market. We’ve always been prideful in the service that our team has put forward. It’s highly referenceable. Our retention rate is very strong there. And so we wanted to be mindful that while we were undertaking this initiative that we were thoughtful of the impact on the service to our existing customer base. So with that said, we were looking at on pace for our 400 employees by the end of this year and looking at potentially 800 employees by the end of 2024. That was the original plan at the beginning of the year.
As we continue to feel the same pressure that’s creating the opportunity for us with the new business, and we’re looking at how can we potentially accelerate that opportunity, while not deteriorating the service that we’re creating. And so we will continue to be very thoughtful about making sure that the service is high level, while seeing what levers we have to be able to put our foot on the gas, for lack of a better term, about seeing this conversion happen sooner rather than later. And on the first question, come back to – if you don’t mind helping me out again, you said it an opportunity to take more price from the customer.
Yes. Maybe a bit of a concern that labor pressures are causing demand for your services, but they’re also pressuring your profitability. So if you could speak to your ability to deliver these offerings more efficiently – these services more efficiently than your customers can and not just kind of take on their labor pressures.
Yes, absolutely. And so I think that speaks right into the heart of the globalization and then also automation. I would say, those are the two main levers we have the opportunity to pull from a providing this at a more efficient rate than our customers can. One dynamic that we’ve really another learning of the year is we were anticipating the ability to start with a higher offshore model from the beginning with our customers. And what we’re seeing is that as we take their employees on. That ramp is taking a little bit longer than we maybe had thought it would. So for an example of that, if we take on a customer that’s got 20 employees in their business office, we will take those employees on our own – as our employees and either continue to keep them on the account, find opportunities to up train them and place them throughout the organization.
And that just creates another dynamic for us to continue to keep that right-size of the percentage of onshore to offshore of cut of employees. But again, I think that’s a big part to our future success is again remember in these small, mid-size towns that they’re a crucial part of the employment process in the community, big part of the economic development.
And so we’ve got to continue to be mindful of that to some extent. And so as have learned more of what that looks like, I think we’ve refined the approach of what the ramp to get to that maximum utilization is. And while it may take a little longer than we thought, I think over the long-term, as we sign three and five-year contracts, we’re going to be better, better down the road.
Got it. That helps. I’ll jump back into queue.
Thank you. [Operator Instructions] The next question is from the line of George Hill, Deutsche Bank. Please proceed with your question.
Hey, good evening, guys, and thanks for taking the questions. I’ll say, Chris and Matt, you guys talk faster than I can take notes. So some of this might be a little bit repetitive. On the impact of the sale, that was a license sale that you guys thought was going to be a license sale that went SaaS, was that EMR or TruBridge, and I missed if you talked about what the revenue impact was I guess for both the quarter and the expectation for the year.
Yes. So as far as the license mix impact, you are calling out an important nuance here and that these were not EHR contracts. EHR contracts have been 100% SaaS. That’s all we’ve signed and probably the last three years. Instead these were large TruBridge contracts, specifically the True Code product, large True Code deals that frankly were a lot bigger than our average deal size that we see in total.
Average deal size, average contract value for True Code arrangements is fairly small in the grand scheme of things. So these were kind of outliers. But that’s the context between these couple of sites that we were talking about. And sorry, what was the back half of that question, George?
Well, you clarified my first question on the product, which is I knew what it was. I guess what was the – what’s the financial impact for the year? So how do we think about, what is the – because you guys kept the revenue guidance the same, but you also indicated a slowing revenue recognition from the nature of this contract. So how do we think about the headwinds and the puts and takes on the top line? And then I have a couple more questions.
Yes. So the puts and takes on the top line, while we did see this headwind stir up with regards to these couple of True Code contracts. We have had some tailwinds on the top line. They’re going to help offset some of the overall top line impact from the year. And I think Chris mentioned it earlier, one of the positive surprises I say – I would say for this year has been that the EHR retention of that customer base, while we expected it to be strong coming into the year.
It’s outpaced even our expectations, and this is probably the second or third straight year where that business unit’s been stronger and more stable than what we had even expected. So that’s kind of what’s offsetting that and resulting in a top line guidance that’s kind of unchanged right now.
Okay. That’s helpful. And then if I think about the SG&A in the quarter came in about $7 million higher than what I had modeled, and that kind of that’s pretty close to the EBITDA guide down for the year. I guess, so should we look at Q2 as kind of the high watermark from a discretionary expense perspective as we go through the balance of the year? You guys kind of indicated the cost cutting initiatives that that should kind of like lead for that number to go through with the employee retirement programs and stuff like that?
Yes. So if you’re looking at SG&A, there are a couple of items that are making that really pop in the second quarter. First of all, we do have some seasonal costs in there with our National Client Conference that takes place in May of every year. And as much as we’d love to be able to smooth that cost out throughout the year, the costs have to be booked when they’re actually incurred and that all happens in the second quarter.
And I think that was for somewhere between $1.2 and $1.3 million in SG&A. And frankly, the rest of the SG&A cost increase in the second quarter was really all EBITDA neutral stuff from non-recurring charges partly related to the severance event that Chris mentioned on the voluntarily retirement program.
Okay. And then my last one will be given what you guys discussed as it relates to inflation, and this kind of piggybacks on Jeff’s last line of questions a little bit is, how does this change how you guys were thinking about the longer-term guidance of the reaccelerating the revenue growth profile and the earnings profile, given that it looks like we’re going to be operating from a higher cost basis as we go through 2024 – 2023, probably into 2024 and 2025?
Yes. I’ll start there and then Matt can fill in any blanks that, that I leave. What I would say is that, we have taken a really hard look at the second half of this year and really, really sharpened the pencil to make sure that we are fine tuned on where we’re going to come in. We continue to do work on what we have understood or what we have seen happen through the first half of this year, and what we know will happen in the back half and what impact that’ll have on next year.
So I don’t think that we’re ready to give any guidance into 2024, but that’s something that we’ll be doing in the next call or two, but know that we understand that that’s something that we’ve got to get out there. I will say, as we look at it, big picture, and I’m not going to put a date on this, we still feel like the levers that we have in front of us as it relates to the offshore initiative and what we had talked about the first of this year, the offshore initiative, our opportunities with automation that we still see a path to get to those 20%-plus EBITDA margin grows. And we still see that opportunity to see the revenue growth continue, but let’s stay tuned on sharpening what 2024 looks like for the next call.
Okay. Well, stay tuned. Thanks guys.
Thank you. At this time, we’ve reached the end of our question-and-answer session. I’ll turn the call over to Chris Fowler for closing remarks.
Thanks, Rob, and thanks for everybody for your continued interest in CPSI. Have a wonderful evening.