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Change Healthcare Inc. (CHNG) CEO Neil de…

Change Healthcare Inc. (CHNG) CEO Neil de…

Change Healthcare Inc. (NASDAQ:CHNG) Q1 2023 Earnings Conference Call August 4, 2022 8:00 AM ET

Company Participants

David Elliott – Vice President, Enterprise Strategy and Investor Relations

Neil de Crescenzo – President and Chief Executive Officer

Fredrik Eliasson – Executive Vice President and Chief Financial Officer

Operator

Good morning. Thank you for standing by and welcome to the Change Healthcare’s earnings call for the First Quarter of Fiscal Year 2023. I would now like to hand the conference over to your host today, David Elliott, Change Healthcare Inc.’s Vice President, Enterprise Strategy and Investor Relations. Please go ahead.

David Elliott

Good morning and welcome to Change Healthcare’s earnings call for the first quarter of fiscal 2023, which ended on June 30, 2022. I am joined today by Neil de Crescenzo, Change Healthcare’s President and CEO and Fredrik Eliasson, Change Healthcare’s Executive Vice President and Chief Financial Officer. First, Neil will provide a business update, and then Fredrik will review the financial results for the quarter, followed by closing remarks from Neil. Given the pending transaction with UnitedHealth Group, we will not be taking questions or providing financial guidance.

Before we begin, I would like to remind you that the comments included in today’s conference call include forward-looking statements. Actual results may differ materially from the results suggested by the comments for several reasons, which are discussed in more detail in the company’s SEC filings. Except as required by law, Change Healthcare assumes no obligation to update any forward-looking statements or information. Please also note that where appropriate, we will refer to non-GAAP financial measures to evaluate our business. Reconciliations for non-GAAP financial measures to GAAP financial measures are included in our earnings release in the appendix to the supplemental slides accompanying this presentation. I want to remind everyone that copies of our earnings release and the supplemental slides accompanying this conference call are available in the Investor Relations section of our website at www.changehealthcare.com.

With that, I will turn the call over to Neil. Neil?

Neil de Crescenzo

Thank you, David. Good morning, everyone and thank you for joining us. Our first quarter results demonstrate the underlying strength and momentum of our business. We were faced with difficult year-over-year comparables in the quarter, created by elevated COVID-related activities last year and customer attrition related to the extended UHG merger process. Despite these headwinds, we grew revenue in the quarter and positioned ourselves well to deliver on our 2% to 4% revenue growth expectations for the year. We continue to invest in innovative solutions to create value for our payer, provider and consumer customers. Along with our customers and partners, we remain focused on lowering cost, enhancing access and improving outcomes for the benefit of everyone in the healthcare system.

Now let me provide you with some financial highlights for the quarter and insights into our continued success advancing our solutions to deliver increased value for all healthcare stakeholders. Solutions revenue, adjusted EBITDA and free cash flow were $831 million, $280 million and $4 million, respectively, in the first quarter. This represents year-over-year solutions revenue growth of 1.8% and an adjusted EBITDA decline of 0.9%. Our performance reflects continued new bookings momentum, existing customers expanding their business with Change Healthcare, new product introductions and new business initiatives, partially offset by lower revenue from COVID-related activities, customer attrition related to the extended UHG merger process and our continued investments to support business initiatives.

As the combined year-over-year challenges from COVID-related volumes and the UHG merger-related attrition start to subside in the third quarter, we expect significantly stronger growth starting in the fourth quarter and throughout our next fiscal year, starting in April 2023, our fiscal year ‘24. Fredrik will provide more details on our financial performance shortly.

With regards to the pending transaction with UnitedHealth Group, we remain firm in our belief in the benefits for U.S. healthcare of Change Healthcare becoming part of Optum and we are committed to contesting the legal challenge to this merger. We and UnitedHealth Group are currently detailing the benefits of this combination at a 2-week trial that began earlier this week on August 1.

If the merger closes, we expect that Change Healthcare shareholders will receive $27.75 in cash, comprised of the $25.75 per share deal price along with a special cash dividend of $2 per share. These payments will only occur if the merger closes, and the dividend is subject to final approval of Change Healthcare’s Board at the time of the closing. In the event the merger is unable to be completed due to the court’s decision, UnitedHealth Group will pay a $650 million fee to Change Healthcare.

Now, let me provide an update on our success across our segments, starting with our Software and Analytics segment. We continue to see opportunities across this segment as payers, providers and partners take advantage of our high ROI solutions and realize the benefits of our data, AI models and workflow capabilities. In Payment Accuracy, we again closed several multimillion dollar deals including claims extend secondary editing deals with 2 Blues plan customers. These customers both recognize the value that Change Healthcare can provide in quickly developing and deploying new content via secondary editing to provide them significant savings.

We also signed a multimillion dollar prepayment insight and review deal with a high-growth, technology-enabled health plan with over 1 million members. With prepay insight and review we help customers reduce waste in the payment process by identifying improper payments before they are paid. Our risk adjustment and quality solutions continue to be a strong offering in the market as they help customers close gaps in care more rapidly to improve health outcomes and lower costs.

In Q1, we signed a medical record retrieval and clinical review deal worth over $5 million annually with one of the largest managed care organizations in the country. Continuing our innovation in this field, we also introduced Community Connector in Q1, a new service for payers who want to assess their members’ social determinants of health needs and refer members to community-based organizations to provide social service program assistance. This product reimagines how whole person-focused services such as home environment, housing, education, access to food and transportation can work together to improve people’s health, well-being and quality of life.

In our RCM Technology business, we had a strong bookings quarter for both our clearance and assurance solutions, including a large new deal with a health system in Hawaii. Last quarter, we announced a partnership with Luma Health to develop new patient engagement solutions. We have now launched our patient engagement suite, combining Luma Health’s patient success platform solution with Change Healthcare’s revenue cycle management solutions to give patients and providers a cohesive experience that spans the entire healthcare journey. As evidenced by a large and growing pipeline, the market is excited about this vision to improve the patient and provider experience by keeping patients connected to all aspects of their care and providing communication between staff, providers and patients.

With our clinical decision support solutions, we continue to provide innovative ways for clinicians to leverage real-time, evidence-based guidance as they serve patients. We brought 3 new customers live on InterQual AutoReview in Q1, representing 25 facilities and 6,500 beds. We’ve also seen continued momentum with our CareSelect lab decision support product with 3 new sales in the quarter. Clients are seeing laboratory decision support as a key tool in their expense reduction initiatives.

Moving on to our Network segment, we have seen continued year-over-year growth in transaction volumes across our core networks, driven by new customers and expansions of our business with existing customers, offset by customer attrition and lower COVID-related claims volume. Q1 was a strong new bookings quarter, particularly in our pharmacy network business, where we signed several multimillion dollar deals, including a deal worth nearly $5 million annually with an innovative technology company focused on reducing wasteful pharmacy and patient spending.

We continue to see solid execution in our high-growth strategic priorities like payments, data solutions and our API marketplace. In Q1, we grew our API-related transaction volume by more than 50% versus Q1 of last year. As of the end of Q1, we had a total of 335 API software and hardware products from across our portfolio available in the Change Healthcare marketplace and in multiple online storefronts, including AWS and Azure, Epic App Orchard and the Salesforce AppExchange. Our leadership in providing microservice-based and API-based solutions to the healthcare industry, along with our payments and data solutions businesses are fueling the continued growth of our Network segment beyond underlying transaction volume growth.

Moving to our newly formed Enterprise Imaging segment, in Q1, we established Enterprise Imaging as a standalone reporting segment under its own general manager reporting directly to me. We made this change in connection with Kris Joshi’s promotion to assume the role of President, Software and Analytics, in addition to continuing his role as EVP and President for Network Solutions. Given our market leading, cloud-native Enterprise Imaging platform, establishing Enterprise Imaging as a standalone reporting segment will help our team better address the growing demand and unique market opportunities in imaging while best positioning the imaging team to grow and deliver for our customers. You can find eight quarters of recast results that reflect these segment changes in the appendix of the slides accompanying this presentation. In the quarter, we again signed several multimillion dollar imaging contracts, winning competitive deals over some of the largest imaging companies in the world. As evidenced by our continued new contract wins, the market is embracing our vision of a cloud-native, AI-driven Enterprise Imaging platform.

Now moving on to our Technology-Enabled Services segment, in TES, we are continuing our focus on client performance and value creation. We’ve continued to refine and communicate our value proposition for both payer and provider customers, updating 10 return on investment calculators across TES with our sales and account management teams. We used one of these ROI calculators along with other customer data analysis to help a large national physician group understand the value that Change Healthcare could bring to their practices. This helped us sign our largest contract in this market segment in over 4 years.

We have also been successfully expanding our service contracts in other market segments. We recently increased our communications business substantially with a large payer, closing two deals worth several million dollars combined. And as in prior quarters, we remain focused on expanding the underlying margins in the Technology-Enabled Services businesses through automation and AI to increase our efficiency and drive stronger performance for our customers. Our RCM transformation efforts are on track and remain a top priority alongside navigating the current challenges in the labor market.

In closing, our Q1 results demonstrated our team’s customer and partner focus, their resilience and their ever-increasing innovation. We continued our strong execution in attaining our strategic, operational and financial objectives. Through continued innovation, we are providing greater value by leveraging technology and insights to reduce administrative wait, streamline and accelerate payments and enhance consumer engagement to better drive experiences and outcomes throughout the patient journey. We remain confident that Change Healthcare, which provides best-in-class connectivity, transaction management, insights and integrated experiences, will continue to play a vital role in helping our customers through the continuing transformation of healthcare.

Now let me turn the call over to Fredrik, who will review our financial performance. Fredrik?

Fredrik Eliasson

Thank you, Neil and good morning everyone. Our first quarter growth demonstrates that despite headwinds from lower COVID-related volumes and customer attrition related to the extended UHG merger process, the underlying momentum of our core franchises remain strong. And with our sales pipeline and investments in innovation, we are well positioned to materially accelerate growth as we get to the fourth quarter and the 4 mentioned year-over-year challenges become less impactful.

Starting with Slide 6. For the first quarter, solutions revenue was $831 million compared to $870 million in the same period of the prior fiscal year, which included a $4 million fair value adjustment associated with the McKesson exit. The quarter was positively impacted by volume growth and new sales, partially offset by the aforementioned UHG merger-related attrition and more normalized healthcare activity compared to last year.

Net of the impact of the deferred revenue fair value adjustment in the prior period, solutions revenue increased 1.2% year-over-year. Net loss for the quarter was $23 million, resulting in net loss of $0.07 per diluted share compared to a net loss of $4 million or $0.01 per diluted share for the same period of the prior fiscal year. Adjusted EBITDA for the quarter was $280 million, a decrease of 0.9% over the same period of the prior fiscal year.

Adjusted EBITDA reflects the items outlined relative to revenue and our continued investments to support business initiatives. Adjusted net income was $124 million, resulting in adjusted net income of $0.38 per diluted share compared with adjusted net income of $133 million or $0.41 per diluted share for the first fiscal quarter of the prior year.

Adjusted net income benefited from revenue growth and a slightly lower tax rate, but these improvements were more than offset by higher depreciation and amortization. There were 327 million diluted shares in the first quarter of fiscal ‘23 compared to 323 million diluted shares in the same period of the prior fiscal year.

Now let’s take a look in more detail at the performance of our segments on Slide 7. Starting with revenue, the Software and Analytics segment increased 2.1% year-over-year, driven by new customers, volume growth with existing customers and new product innovations partially offset by attrition related to the pending UHG transaction. Our Network Solutions revenue increased 2.3% year-over-year. Key drivers include volume growth from existing customers and implementation of new customers. The favorable impact from COVID-related activities was significantly smaller in the quarter compared to the prior year.

Revenue in our new Enterprise Imaging segment increased 0.8% year-over-year, driven by new sales growth and partially offset by the timing of implementation revenue. In our Technology-Enabled Services segment, overall revenue decreased 1.7% year-over-year as a result of onetime projects during the prior year that did not recur during the current quarter and lower COVID revenue. We continue to see positive long-term trends in both RCM win rates and deal size.

Turning to adjusted EBITDA, Software and Analytics increased 5.8% year-over-year, driven by the aforementioned revenue growth. Network Solutions adjusted EBITDA decreased 1.9% year-over-year, driven primarily by continued investment to support a significant number of new product launches and market expansion initiatives that we have underway and negative mix as COVID-related activities in the network abated.

Enterprise Imaging adjusted EBITDA decreased $1.3 million year-over-year, driven by hiring to support business growth and research and development expenses. In Technology-Enabled Services, adjusted EBITDA decreased $7 million year-over-year, driven by the same factors that impacted revenue as well as increased wage inflation and hiring challenges in a difficult labor market.

Moving on to cash flow and our balance sheet on Slide 8. Free cash flow for the quarter was $4 million compared to $44 million in the same period of the prior fiscal year. In addition to lower net income, the decline versus last year was due to unfavorable net working capital and CapEx timing, both of which are expected to reverse in the remainder of the year. Total long-term debt, net of cash at quarter end, was $4.4 billion. Net leverage ratio was 4.1% at quarter end. During the quarter, the company repaid $100 million in senior note obligations and subsequent to the end of the quarter we paid an additional $50 million on the senior notes. Our liquidity remained strong, ending the quarter with $94 million of cash and cash equivalents and $780 million in undrawn revolver capacity. As noted in the press release, due to the pending transaction, we will not be providing financial guidance.

With that said, let me provide some color regarding our expectations for the full fiscal year and the second quarter. Starting with the full year, our expectation of 2% to 4% solutions revenue growth is unchanged from what we outlined last quarter. The underlying growth of the business is strong. But as mentioned earlier, we are experiencing headwinds from lower COVID-related activities and customer attrition related to the extended UHG merger process. We expect that these factors, along with negative mix shift and wage inflation within TES, will drive flat to slightly contracting full year adjusted EBITDA margin versus last year.

Our full year free cash flow expectation of $450 million to $500 million remains the same, albeit most likely at the lower end of the range due to the higher litigation costs associated with the merger. As for the full year cadence, we began seeing a material impact from attrition related to the UHG merger in the fourth quarter of fiscal year ‘22, which is why we anticipate more muted year-over-year growth through the first three quarters of the fiscal year. We expect strong growth acceleration in the fourth quarter as the lower combined impact of the attrition and the COVID activities provide for an easier year-over-year comparison. This, coupled with strong bookings performance, will set up nicely for not just a strong fourth quarter, but also a strong FY ‘24.

Specifically to the second fiscal quarter of FY ‘23, we expect flat to low single-digit revenue growth in all four segments due to the aforementioned headwinds. For second quarter adjusted EBITDA, we expect year-over-year declines in all four segments due to the aforementioned revenue headwinds, along with other factors unique to each business unit.

In Software and Analytics, we expect a high single-digit percent decline in adjusted EBITDA year-over-year due to negative mix shift for the quarter. This mix shift is driven by higher growth in lower-margin risk adjustment and quality solutions and customer attrition related to the UHG merger and some higher margin solutions. We expect this mix shift to normalize by the fourth quarter as we lap most of the attrition impact.

In Network, we expect a low single-digit percent decline due to lower high-margin COVID-related revenue. In Enterprise Imaging, we continue to invest in R&D, sales and marketing and implementation staff to fuel growth from our new cloud-native Enterprise Imaging platform. As a result, we expect mid-single-digit million dollar adjusted EBITDA decline in the second quarter.

After that, we expect double-digit percent EBITDA growth for that business unit for the remaining two quarters of the fiscal year as prior year bookings start to drive significant revenue growth. And in Technology-Enabled Services, we expect a low double-digit million dollar decline in adjusted EBITDA due primarily to increased contractor costs, wage inflation and lower COVID volume versus prior year.

Now with that, let me turn it back to Neil for his closing comments.

Neil de Crescenzo

Thank you, Fredrik. In closing, I want to express my appreciation for the dedicated team members of Change Healthcare. They remain focused on developing and delivering innovative solutions for healthcare providers, payers, partners and consumers to improve clinical, financial and care outcomes.

As I’ve stated previously, our goal is to deliver on three key objectives for our stakeholders. First, we will deliver superior consumer experiences. Second, we will drive increased efficiency and accuracy for financial transactions in healthcare. And third, we will deliver solutions that optimize decision-making for our customers on their journey to value-based care. The strength of our financial performance to-date and the ability to continue to deliver innovative value-added solutions to our customers is a testament to our team members’ commitment, innovation and agility. We will continue to partner with our customers to help them lower cost, enhance access and improve outcomes, creating value for everyone in the healthcare system.

Thank you very much for joining us today.

Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.

Question-and-Answer Session

[No Q&A session for this event]

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