Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited condensed consolidated financial statements and related notes appearing elsewhere herein.
This discussion and analysis contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified generally by the use of forward-looking terminology and words such as "expects," "anticipates," "estimates," "believes," "predicts," "intends," "plans," "potential," "may," "continue," "should," "will" and words of comparable meaning. Without limiting the generality of the preceding statement, all statements in this report relating to estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and future financial results are forward-looking statements. We caution investors that any such forward-looking statements are only predictions and are not guarantees of future performance. Certain risks, uncertainties and other factors may cause actual results to differ materially from those projected in the forward-looking statements. Such factors may include:
Risks Related to Our Industry
•a public health crisis, such as the COVID-19 pandemic, and related economic disruption;
•saturation of our target market and hospital consolidations;
•unfavorable economic or market conditions that may cause a decline in spending for information technology and services;
•significant legislative and regulatory uncertainty in the healthcare industry;
•exposure to liability for failure to comply with regulatory requirements;
Risks Related to Our Business
•transition to a subscription-based recurring revenue model and modernization of our technology;
•competition with companies that have greater financial, technical and marketing resources than we have;
•potential future acquisitions that may be expensive, time consuming, and subject to other inherent risks;
•our ability to attract and retain qualified personnel;
•disruption from periodic restructuring of our sales force;
•our potential inability to manage our growth in the new markets we may enter;
•exposure to numerous and often conflicting laws, regulations, policies, standards or other requirements through our international business activities;
•potential litigation against us and investigations;
•our use of offshore third-party resources;
Risks Related to Our Products and Services
•potential failure to develop new products or enhance current products that keep pace with market demands;
•exposure to claims if our products fail to provide accurate and timely information for clinical decision-making;
•exposure to claims for breaches of security and viruses in our systems;
•undetected errors or problems in new products or enhancements;
•our potential inability to convince customers to migrate to current or future releases of our products;
•failure to maintain our margins and service rates;
•increase in the percentage of total revenues represented by service revenues, which have lower gross margins;
•exposure to liability in the event we provide inaccurate claims data to payors;
•exposure to liability claims arising out of the licensing of our software and provision of services;
•dependence on licenses of rights, products and services from third parties;
•a failure to protect our intellectual property rights;
•exposure to significant license fees or damages for intellectual property infringement;
•service interruptions resulting from loss of power and/or telecommunications capabilities;
Risks Related to Our Indebtedness
•our potential inability to secure additional financing on favorable terms to meet our future capital needs;
•substantial indebtedness that may adversely affect our business operations;
•our ability to incur substantially more debt;
•pressures on cash flow to service our outstanding debt;
•restrictive terms of our credit agreement on our current and future operations;
Risks Related to Our Common Stock and Other General Risks
•changes in and interpretations of financial accounting matters that govern the measurement of our performance;
•the potential for our goodwill or intangible assets to become impaired;
•quarterly fluctuations in our financial results due to various factors;
•volatility in our stock price;
•failure to maintain effective internal control over financial reporting;
•lack of employment or non-competition agreements with most of our key personnel;
•inherent limitations in our internal control over financial reporting;
•vulnerability to significant damage from natural disasters;
•exposure to market risk related to interest rate changes;
•potential material adverse effects due to macroeconomic conditions; and
•potential material adverse effects due to bank failures or changes in related legislation or regulation.
Additional information concerning these and other factors that could cause differences between forward-looking statements and future actual results is discussed under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2022.
CPSI is a leading provider of healthcare solutions and services for community hospitals, their clinics and other healthcare systems. Founded in 1979, CPSI is the parent of six companies – Evident, LLC ("Evident"), American HealthTech, Inc. ("AHT"), TruBridge, LLC ("TruBridge"), iNetXperts, Corp. d/b/a Get Real Health ("Get Real Health"), TruCode LLC ("TruCode"), and Healthcare Resource Group, Inc. ("HRG"). Our combined companies are focused on helping improve the health of the communities we serve, connecting communities for a better patient care experience, and improving the financial operations of our customers. Evident provides comprehensive acute care electronic healthcare record ("EHR") solutions for community hospitals and their affiliated clinics. AHT is one of the nation’s largest providers of post-acute care EHR solutions and services for post-acute care facilities. TruBridge focuses on providing business, consulting and managed IT services, along with its complete revenue cycle management ("RCM") solution, for all care settings. Get Real Health focuses on solutions aimed at improving patient engagement for individuals and healthcare providers. TruCode provides medical coding software that enables complete and accurate code assignment for optimal reimbursement. HRG provides specialized RCM solutions for facilities of all sizes.
Commencing with the fourth quarter of 2022, the Company operates its business in three operating segments, which are also our reportable segments: RCM, EHR, and Patient Engagement. The individual companies align with the reporting segments and contribute towards the combined focus of improving the health of the communities we serve as follows:
•The RCM reporting segment includes TruBridge, HRG, and TruCode, and focuses on providing business management, consulting, and managed IT services along with its complete RCM solution for all care settings, regardless of their primary healthcare information solutions provider.
•The EHR segment includes Evident and AHT, and provides comprehensive acute and post-acute care EHR solutions and related services for community hospitals, their physician clinics, and skilled nursing and assisted living facilities.
•The Patient Engagement segment offers comprehensive patient engagement and empowerment technology solutions through Get Real Health to improve patient outcomes and engagement strategies with care providers.
Our companies currently support community hospitals and other healthcare systems with a geographically diverse patient mix within the domestic community healthcare market. Our target market for our RCM, EHR, and Patient Engagement solutions includes community hospitals with fewer than 400 acute care beds and their clinics, as well as independent or small to medium sized chains of skilled nursing facilities. 98% of our acute care hospital EHR customer base is comprised of hospitals with fewer than 100 beds. The target market for our post-acute care solutions consists of approximately 15,500 skilled nursing facilities that are either independently owned or part of a larger management group with multiple facilities.
See Note 17 to the condensed consolidated financial statements included herein for additional information on our three reportable segments.
Our core strategy is to achieve meaningful long-term revenue growth by cross-selling RCM services into our existing EHR customer base, expanding RCM market share with sales to new community hospitals and larger health systems, and pursuing competitive EHR takeaway opportunities in the acute and post-acute markets. During 2020, we engaged a top-tier international consulting firm to assess our core growth strategy, with the outcome of this eight-week engagement being the confirmation of our current core strategy and the identification of other innovative potential growth opportunities. We may also seek to grow through acquisitions of businesses, technologies or products if we determine that such acquisitions are likely to help us meet our strategic goals.
The opportunity to cross-sell RCM services is greatest within our Acute Care EHR customer base. As such, retention of existing Acute Care EHR customers is a key component of our long-term growth strategy by protecting this base of potential RCM customers, while at the same time serving as a leading indicator of our market position and stability of revenues and cash flows.
We determine retention rates by reference to the amount of beginning-of-period Acute Care EHR recurring revenues that have not been lost due to customer attrition from our production environment customer base. Production environment customers are those that are using our applications to document live patient encounters, as opposed to legacy environment customers that have view-only access to historical patient records. Since 2019, these retention rates have consistently remained in the mid-to-high 90th percentile ranges. We have increased customer retention efforts by enhancing support services, investing in tooling and instrumentation to proactively monitor for potential disruptions, and deploying in-application experience software that delivers application-specific insights while using our products.
As we pursue meaningful long-term revenue growth by leveraging RCM as a growth agent, we are placing ever-increasing value in further developing our already significant recurring revenue base to further stabilize our revenues and cash flows. As such, maintaining and growing recurring revenues are key components of our long-term growth strategy, aided by the aforementioned focus on customer retention. This includes a renewed focus on driving demand for subscriptions for our existing technology solutions and expanding the footprint for RCM services beyond our EHR customer base.
While the combination of revenue growth and operating leverage results in increased margin realization, we also look to increase margins through specific cost containment measures where appropriate as we continue to leverage opportunities for greater operating efficiencies. However, in the immediate future, we anticipate incremental margin pressure from the continued client transition from perpetual license arrangements to “Software as a Service” ("SaaS") arrangements as described below.
Turbulence in the U.S. and worldwide economies and financial markets impacts almost all industries. While the healthcare industry is not immune to economic cycles, we believe it is more significantly affected by U.S. regulatory and national health initiatives. In recent years, there have been significant changes to provider reimbursement by the U.S. federal government, followed by commercial payers and state governments. There is increasing pressure on healthcare organizations to reduce costs and increase quality while replacing the fee-for-service reimbursement model in part by enrolling in an advanced payment model that incentivizes high-quality, cost effective-care via value-based reimbursement. This pressure could further encourage adoption of healthcare IT and increase demand for business management, consulting, and managed IT services, as the future success of these healthcare providers is greatly dependent upon their ability to engage patient populations and to coordinate patient care across a multitude of settings, while optimizing operating efficiency along the way.
Additionally, healthcare organizations with a large dependency on Medicare and Medicaid populations, such as community hospitals, have been affected by the challenging financial condition of the federal government and many state governments and government programs. Accordingly, we recognize that prospective hospital clients often do not have the necessary capital to make investments in information technology while those with the necessary capital have become more selective in their investments. Despite these challenges, we believe healthcare IT will be an area of continued investment due to its unique potential to improve safety and efficiency and reduce costs while meeting current and future regulatory, compliance and government reimbursement requirements.
Further, it is expected that without Congressional action, the current statutory legal limit on the U.S. debt will be exceeded by June 2023. If the debt ceiling is not raised, the U.S. government may not be able to fulfill its funding obligations and there could be significant disruption to all discretionary programs and wider financial and economic repercussions. The Federal budget and debt ceiling could be the subject of considerable Congressional debate. Future changes in spending priorities arising
from any Congressional action on the Federal budget and debt ceiling or otherwise could adversely affect the business of our customers and our business.
EHR License Model Preferences
Much of the variability in our periodic revenues and profitability has been and will continue to be due to changing demand for different license models for our technology solutions, with variability in operating cash flows further impacted by the financing decisions within those license models. Our technology solutions are generally deployed in one of two license models: (1) perpetual licenses, for which the related revenue is recognized effectively upon installation, and (2) “Software as a Service” or “SaaS” arrangements, including our Cloud Electronic Health Record (“Cloud EHR”) offering, which generally result in revenue being recognized monthly as the services are provided over the term of the arrangement.
The overwhelming majority of our historical EHR installations have been under a perpetual license model, but new customer demand has dramatically shifted towards a SaaS license model in the past several years. SaaS license models made up only 12% of annual new acute care EHR installations in 2018, increasing to 100% during 2022 and the first three months of 2023. These SaaS offerings are attractive to our clients because this configuration allows them to obtain access to advanced software products without a significant initial capital outlay. We expect this trend to continue for the foreseeable future, with the resulting impact on the Company’s financial statements being reduced EHR revenues in the period of installation in exchange for increased recurring periodic revenues (reflected in EHR revenues) over the term of the SaaS arrangement. This naturally places downward pressure on short-term revenue growth and profitability metrics, but benefits long-term revenue growth and profitability which, in our view, is consistent with our goal of delivering long-term shareholder value.
For customers electing to purchase our technology solutions under a traditional perpetual license, we have historically made financing arrangements available on a case-by-case basis, depending on the various aspects of the proposed contract and customer attributes. These financing arrangements have comprised the majority of our perpetual license installations over the past several years, and include short-term payment plans and longer-term lease financing through us or third-party financing companies. The aforementioned shift in customer preference towards SaaS arrangements has significantly reduced the frequency of new financing arrangements for customer purchases under a perpetual license. When combined with scheduled payments on existing financing arrangements, the reduced frequency of new financing arrangements has resulted in a substantial reduction in financing receivables during 2022 and the first three months of 2023.
For those perpetual license clients not seeking a financing arrangement, the payment schedule of the typical contract is structured to provide for a scheduling deposit due at contract signing, with the remainder of the contracted fees due at various stages of the installation process (delivery of hardware, installation of software and commencement of training, and satisfactory completion of a monthly accounting cycle or end-of-month operation by each respective application, as applicable).
Margin Optimization Efforts
Our core growth strategy includes an element geared towards margin optimization by identifying opportunities to further improve our cost structure by executing against initiatives related to organizational realignment, expanded use of offshore partnerships and the use of automation to increase the efficiency and value of our associates' efforts.
Initial organizational realignment efforts began during 2021, when we committed to a reduction in force intended to more effectively align our resources with business priorities. Other related initiatives include our ongoing implementation of the Scaled Agile Framework® throughout our EHR product development, implementation and support functions to enhance cohesion, time-to-market and customer satisfaction. This framework is a set of organization and workflow patterns intended to guide enterprises in scaling lean and agile practices and promotes alignment, collaboration, and delivery across large numbers of agile teams.
The remaining margin optimization initiatives of enhanced leveraging of offshore partnerships and automation have commenced and, to date, have provided meaningful efficiencies to our operations, particularly within RCM. As a service organization, RCM's cost structure is heavily dependent upon human capital, subjecting it to the complexities and risks associated with this resource. Chief among these complexities and risks is the ever-present pressure of wage inflation, which has recently become a reality as national and international economies recover from the economic downturn caused by the COVID-19 pandemic and has compelled the Company to make compensation adjustments that are outside of historical norms. We believe that our efforts towards margin optimization are well-timed, enabling a rapid response to actual or expected wage inflation in order to preserve RCM gross margins, but we cannot guarantee that these efforts will fully eliminate any related margin deterioration.
In addition to wage inflation, we are a party to contracts with certain third-party suppliers and vendors that allow for annual price adjustments indexed to inflation. While we continually seek to proactively manage controllable expenses, inflationary pressure on costs could lead to erosion of margins.
The impact of the COVID-19 pandemic on our operations was broad-sweeping, most notably causing severe deterioration in United States community hospital patient volumes that negatively impacted the revenues, gross margins, and income of our RCM service offerings. While patient volumes have continued to recover and are largely in line with pre-COVID-19 levels, we cannot predict the extent to which our business, results of operations, financial condition or liquidity will ultimately be impacted, including as a result of macro-economic impacts to the global supply chain, labor shortages, and inflationary pressures. However, we continue to assess its impact on our business and continue to actively manage our response. For further details on the potential impact of COVID-19 on our business, refer to "Risk Factors," in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.
Results of Operations
In the fourth quarter of 2022, the Company made a number of changes to its organizational structure and management system to align the Company's operating model to its strategic initiatives. With these changes the Company revised its reportable segments to RCM, EHR, and Patient Engagement, but this realignment of the Company's reportable segments did not impact its consolidated financial statements. Throughout this discussion, prior-year results have been recast to conform with the change in reportable segments noted above.
During the first three months of 2023, we generated revenues of $86.2 million from the sale of our products and services, compared to $77.9 million during the first three months of 2022, an increase of 11% that is due to the combination of inorganic growth through our recent acquisitions of TruCode and HRG and organic growth as RCM solutions continue to gain traction in the domestic healthcare landscape. Despite this substantial increase in revenues, net income decreased by $5.0 million to $3.1 million during the first three months of 2023 from the prior-year period due to the combined effects of (i) increased costs related to our strategy to migrate to a public cloud environment in order to increase business agility and improve security, (ii) increased amortization of capitalized software development costs, (iii) increased benefits costs related to our transition to fully-insured plan model for our employee health benefits plan, and (iv) increased interest expense due to acquisition-fueled growth in long-term debt and a rising interest rate environment. This decline in net income caused net cash provided by operating activities to decrease by $2.3 million from the prior-year period to $9.5 million, as the cash flow headwinds caused by expansion in accounts receivable were partially offset by timing-related expansion in accounts payable.
The following table sets forth certain items included in our results of operations for the three months ended March 31, 2023 and 2022, expressed as a percentage of our total revenues for these periods:
|Three Months Ended March 31,|
|(In thousands)||Amount||% Sales||Amount||% Sales|
|RCM||48,631 ||56.4 ||%||40,511 ||52.0 ||%|
|EHR||35,191 ||40.8 ||%||34,763 ||44.6 ||%|
|Patient engagement||2,411 ||2.8 ||%||2,597 ||3.3 ||%|
|Total sales revenues||86,233 ||100.0 ||%||77,871 ||100.0 ||%|
|Costs of sales:|
|RCM||27,183 ||31.5 ||%||20,398 ||26.2 ||%|
|EHR||16,348 ||19.0 ||%||15,339 ||19.7 ||%|
|Patient engagement||646 ||0.7 ||%||944 ||1.2 ||%|
|Total costs of sales||44,177 ||51.2 ||%||36,681 ||47.1 ||%|
|Gross profit||42,056 ||48.8 ||%||41,190 ||52.9 ||%|
|Product development||9,836 ||11.4 ||%||8,064 ||10.4 ||%|
|Sales and marketing||6,959 ||8.1 ||%||7,042 ||9.0 ||%|
|General and administrative||14,952 ||17.3 ||%||13,426 ||17.2 ||%|
|Amortization of acquisition-related intangibles||4,014 ||4.7 ||%||3,672 ||4.7 ||%|
|Total operating expenses||35,761 ||41.5 ||%||32,204 ||41.4 ||%|
|Operating income||6,295 ||7.3 ||%||8,986 ||11.5 ||%|
|Other income (expense):|
|Other income||267 ||0.3 ||%||157 ||0.2 ||%|
|Gain on contingent consideration||— ||— ||%||1,250 ||1.6 ||%|
|Total other (expense) income||(2,402)||(2.8)||%||490 ||0.6 ||%|
|Income before taxes||3,893 ||4.5 ||%||9,476 ||12.2 ||%|
|Provision for income taxes||809 ||0.9 ||%||1,363 ||1.8 ||%|
|Net income||$||3,084 ||3.6 ||%||$||8,113 ||10.4 ||%|
Three Months Ended March 31, 2023 Compared with Three Months Ended March 31, 2022
Total revenues for the three months ended March 31, 2023 increased by $8.4 million, or approximately 11%, compared to the three months ended March 31, 2022.
RCM revenues increased by $8.1 million, or 20%, compared to the first quarter of 2022, as acquisition-fueled growth added to the organic growth of our RCM offerings. HRG, acquired in March 2022, contributed only $3.8 million in revenues during the first quarter of 2022 compared to $9.9 million during the first quarter of 2023. Organic revenue growth of $2.0 million, or 5%, has materialized as our hospital clients operate in an environment typified by rising costs and increased complexity and are increasingly seeking to alleviate themselves of the ever-increasing administrative burden of operating their own business office functions.
EHR revenues increased by $0.4 million, or 1%, compared to the first quarter of 2022, and were comprised of the following during the respective periods:
|Three Months Ended March 31,|
Recurring EHR revenues (1)
|Acute Care EHR||$||27,613 ||$||27,364 |
|Post-acute Care EHR||3,906 ||3,895 |
|Total recurring EHR revenues||31,519 ||31,259 |
Non-recurring EHR revenues (2)
|Acute Care EHR||3,292 ||3,028 |
|Post-acute Care EHR||380 ||476 |
|Total non-recurring EHR revenues||3,672 ||3,504 |
|Total EHR revenue||$||35,191 ||$||34,763 |
(1) Mostly comprised of support and maintenance, third-party subscriptions, and SaaS revenues.
(2) Mostly comprised of installation revenues from the sale of our acute care and post-acute care EHR solutions and related applications under a perpetual (non-subscription) licensing model.
Recurring EHR revenues increased by $0.3 million, or 1%, compared to the first quarter of 2022. While Post-acute Care EHR recurring revenues were relatively flat compared to the prior-year period, Acute Care EHR recurring revenues increased by $0.2 million, or 1%, as continued efforts to emphasize SaaS arrangements have led to the accumulation of significant sources of recurring revenue.
Non-recurring EHR revenues increased by $0.2 million, or 5%, compared to the first quarter of 2022. While Post-acute Care EHR nonrecurring revenues decreased by $0.1 million compared to the prior-year period, Acute Care EHR non-recurring revenues increased by $0.3 million, or 9%, behind increased strength in add-on sales.
Patient Engagement revenues decreased by $0.2 million, or 7%, as the first quarter of 2022 benefited from non-recurring service revenue related to onboarding two significant clients.
Costs of Sales
Total costs of sales increased by $7.5 million compared to the first quarter of 2022. As a percentage of total revenues, costs of sales increased to 51% of revenues during the first quarter of 2023 compared to 47% during the first quarter of 2022.
Our costs associated with RCM sales and support increased by $6.8 million, or 33%, compared to the first quarter of 2022, primarily driven by our recent acquisition of HRG and the costs necessary to support the related revenues. The remaining cost increases for RCM are organic in nature, caused by resource expansion necessitated by the growing customer base. The gross margin on these services decreased to 44% in the first quarter of 2023 compared to 50% during the first quarter of 2022, with the primary factors being (i) the addition of HRG, which is comprised of mostly lower margin services; (ii) organic revenue growth in the trailing twelve months has largely come from lower margin services revenue streams; (iii) the loss of a single large customer with a margin profile well beyond our typical customer margin profile; (iv) increased costs associated with enhancing our compliance function within the RCM business unit to accommodate scale; and (v) across-the-board wage increases during mid-2022 that were outside of our normal business practice and in response to heightened labor market challenges at that time.
Costs of EHR system sales and support increased by $1.0 million, or 7%, compared to the first quarter of 2022, primarily driven by increased amortization of accumulated contract fulfillment costs. The related gross margins decreased to 54% in the first quarter of 2023 from 56% in the first quarter of 2022.
Costs of Patient Engagement sales and support decreased by $0.3 million, or 32%, as we experienced heightened resource needs during the first quarter of 2022 to support an aggressive onboarding schedule related to recent contract wins. With these costs abating during the trailing twelve months, the related gross margins increased to 73% in the first quarter of 2023 from 64% in the first quarter of 2022.
Product development expenses consist primarily of compensation and other employee-related costs (including stock-based compensation) and infrastructure costs incurred, but not capitalized, for new product development and product enhancements. Product development costs increased by $1.8 million, or 22%, compared to the first quarter of 2022, primarily due to increased costs related to our strategy to migrate to a public cloud environment and increased amortization of capitalized software development costs. While upsizing our development talent caused payroll and related costs to increase by $1.5 million, or 19%, between the first quarter of 2022 and the first quarter of 2023, this cost increase was effectively offset by higher product development labor capitalization.
Sales and Marketing
Sales and marketing costs remained relatively unchanged, decreasing by $0.1 million, or 1%, compared to the first quarter of 2022.
General and Administrative
General and administrative expenses increased by $1.5 million, or 11%, compared to the first quarter of 2022. Prior to 2023, our employee health benefits plan was administered as a self-insured plan, with the Company bearing the risk of claims volatility (partially limited by related stop-loss insurance, as is industry norm). As a result, the related quarterly costs ranged from a low of $2.9 million in the first quarter of 2022 to a high of $4.8 million in the fourth quarter of 2022, with an annual 2022 quarterly average of $4.0 million (averaging $4.4 million per quarter during the last nine months of the year, which included full-period activity related to the HRG acquisition). Effective January 1, 2023, our employee health benefits plan is now administered as a fully-insured plan, with full risk transfer to the health insurance carrier related to claims volatility. The cost of this fully-insured plan during the first quarter of 2023 was $4.2 million, an increase of $1.3 million, or 45%, compared to the costs of the prior self-insured plan during the first quarter of 2022.
Amortization of Acquisition-Related Intangibles
Amortization expense associated with acquisition-related intangible assets increased by $0.3 million, or 9%, compared to the first quarter of 2022, due mostly to the amortization of intangibles acquired in the HRG acquisition.
Total Operating Expenses
As a percentage of total revenues, total operating expenses remained relatively flat, increasing to 41.5% of revenues in the first quarter of 2023, compared to 41.4% in the first quarter of 2022.
Total Other Income (Expense)
Total other income (expense) decreased to expense of $2.4 million during the first quarter of 2023 compared to income of $0.5 million during the first quarter of 2022. A rising interest rate environment and a higher level of funded debt caused a $1.8 million increase in interest expense. Additionally, during the first quarter of 2022, $1.3 million of the original $2.5 million contingent consideration estimated in determining the TruCode purchase price was reversed as updated estimates of TruCode's earnings over the earnout period were less than estimated on the date of acquisition. There were no such adjustments to contingent consideration arrangements recorded during the first quarter of 2023.
Income Before Taxes
As a result of the foregoing factors, income before taxes decreased by $5.6 million, to $3.9 million in the first quarter of 2023 compared to $9.5 million in the first quarter of 2022.
Provision for Income Taxes
Our effective tax rate for the three months ended March 31, 2023 increased to 20.8% from 14.4% for the three months ended March 31, 2022. A non-taxable gain of $1.25 million resulting from a partial reversal of the TruCode earnout benefited our effective tax rate by 2.8% for the three months ended March 31, 2022. Additionally, changes in income tax benefits related to stock based compensation resulted in a 2.5% increase in the first quarter of 2023's effective tax rate compared to the first quarter of 2022, and the first quarter of 2023 experienced a shortfall in income tax benefits related to stock based compensation, increasing the period's effective tax rate by 1.3%. Conversely, the first quarter of 2022 experienced a windfall in income tax benefits related to stock based compensation, decreasing the period's effective tax rate by 1.2%.
Net income for the first quarter of 2023 decreased by $5.0 million to $3.1 million, or $0.21 per basic and diluted share, compared with net income of $8.1 million, or $0.55 per basic and diluted share, for the first quarter of 2022. Net income represented 4% of revenue for the first quarter of 2023, compared to 10% of revenue for the first quarter of 2022.
Supplemental Segment Information
Our reportable segments have been determined in accordance with ASC 280 - Segment Reporting. We have three reportable operating segments: RCM, EHR, and Patient Engagement. We evaluate each of our three operating segments based on segment revenues and segment adjusted EBITDA.
Adjusted EBITDA consists of GAAP net income as reported and adjusts for (i) deferred revenue purchase accounting adjustments arising from purchase allocation adjustments related to business acquisitions; (ii) depreciation expense; (iii) amortization of software development costs; (iv) amortization of acquisition-related intangible assets; (v) stock-based compensation; (vi) severance and other non-recurring charges; (vii) interest expense and other, net; (viii) gain on contingent consideration; and (ix) the provision for income taxes. The segment measurements provided to and evaluated by the chief operating decision makers ("CODM") are described in Note 17 to the condensed consolidated financial statements. These results should be considered in addition to, and not as a substitute for, results reported in accordance with GAAP.
The following table presents a summary of the revenues and adjusted EBITDA of our three operating segments for the three months ended March 31, 2023 and 2022:
|Three Months Ended March 31,||Change|
|Revenues by segment:|
|RCM||$||48,631 ||$||40,511 ||$||8,120 ||20 ||%|
|EHR||35,191 ||34,763 ||428 ||1 ||%|
|Patient Engagement||2,411 ||2,597 ||(186)||(7)||%|
|Adjusted EBITDA by segment:|
|RCM||$||7,898 ||$||9,581 ||$||(1,683)||(18)||%|
|EHR||6,157 ||6,163 ||(6)||— ||%|
|Patient Engagement||588 ||409 ||179 ||44 ||%|
Refer to the corresponding discussion of revenues for each of our reportable segments previously provided under the Revenues heading of this Management's Discussion and Analysis. There are no intersegment revenues to be eliminated in computing segment revenue.
Segment Adjusted EBITDA - Three Months Ended March 31, 2023 Compared with Three Months Ended March 31, 2022
RCM adjusted EBITDA decreased by $1.7 million, or 18%, compared to the first quarter of 2022. Revenue growth of 20% was partially offset by a 550 basis point decrease in gross margins as growth materialized from lower-margin, resource-intensive service lines. This decrease in gross margins combined with expanded operating expenses to exert downward pressure on adjusted EBITDA despite a considerable increase in revenues.
EHR adjusted EBITDA remained relatively flat. Although gross margins decreased by 240 basis points, the EHR segment benefited from decreased sales and marketing and general and administrative expenses in the first quarter of 2023 compared to the first quarter of 2022 as the higher growth RCM segment absorbed an increased proportion of these operating expenses.
Patient Engagement adjusted EBITDA increased by $0.2 million, or 44%. Despite a 7% decrease in revenues, a 950 basis point improvement in gross margins, primarily due to the aforementioned decrease in Patient Engagement costs of sales, positively impacted adjusted EBITDA.
Liquidity and Capital Resources
Sources of Liquidity
As of March 31, 2023, our principal sources of liquidity consisted of cash and cash equivalents of $6.8 million and our remaining borrowing capacity under the revolving credit facility of $86.3 million, compared to $7.0 million of cash and cash equivalents and $86.3 million of remaining borrowing capacity under the revolving credit facility as of December 31, 2022. In January 2016, we entered into a syndicated credit agreement which provided for a $125 million term loan facility and a $50 million revolving credit facility. On June 16, 2020, we entered into an Amended and Restated Credit Agreement that increased the aggregate principal amount of our credit facilities to $185 million, which included a $75 million term loan facility and a $110 million revolving credit facility. On May 2, 2022, we entered into a First Amendment to the Amended Restated Credit Agreement that further increased the aggregate principal amount of our credit facilities to $230 million, which included a $70 million term loan facility and a $160 million revolving credit facility.
As of March 31, 2023, we had $140.2 million in principal amount of indebtedness outstanding under the credit facilities. We believe that our cash and cash equivalents of $6.8 million as of March 31, 2023, the future operating cash flows of the combined entity, and our remaining borrowing capacity under the revolving credit facility of $86.3 million as of March 31, 2023, taken together, provide adequate resources to fund ongoing cash requirements for the next twelve months and beyond. We cannot provide assurance that our actual cash requirements will not be greater than we expect as of the date of filing of this Form 10-Q. If sources of liquidity are not available or if we cannot generate sufficient cash flow from operations during the next twelve months, we may be required to obtain additional sources of funds through additional operational improvements, capital market transactions, asset sales or financing from third parties, a combination thereof or otherwise. We cannot provide assurance that these additional sources of funds will be available or, if available, would have reasonable terms. Aside from normal operating cash requirements, obligations under our Credit Agreement (as discussed below) and operating leases, and opportunistic uses of capital in share repurchases and business acquisition transactions, we do not have any material cash commitments or planned cash commitments. Although the Company currently has no obligations related to planned acquisitions, the Company's strategy includes the potential for future acquisitions, which may be funded thorough draws on the credit facilities or the use of the other sources of liquidity described above.
Operating Cash Flow Activities
Net cash provided by operating activities decreased by $2.3 million from $11.8 million provided by operations for the three months ended March 31, 2022 to $9.5 million provided by operations for the three months ended March 31, 2023. The decrease in cash flows provided by operations is primarily due to the aforementioned decrease in net income, as the cash flow headwinds caused by expansion in accounts receivable were partially offset by timing-related expansion in accounts payable.
Investing Cash Flow Activities
Net cash used in investing activities decreased by $41.4 million, with $6.2 million used in the three months ended March 31, 2023 compared to $47.7 million used during the three months ended March 31, 2022. Most notably, we completed our $43.6 million acquisition of HRG during the first quarter of 2022. Additionally, cash outflows related to capitalized software development efforts increased from $4.3 million during the first three months of 2022 to $6.2 million during the first three months of 2023 as our workload mix has shifted away from addressing deficiencies in legacy code related to existing applications towards adding features and functionalities to our cloud-native solutions and increased development efforts related to non-customer-facing, internal-use software.
Financing Cash Flow Activities
During the three months ended March 31, 2023, our financing activities were a net use of cash in the amount of $3.4 million, as $2.5 million was used to repurchase shares of our common stock, which are treated as treasury stock, while long-term debt principal payments totaled $0.9 million. Financing activities were a net provision of $40.4 million during the three months ended March 31, 2022, as $48.0 million in borrowings from our revolving line of credit were partially offset by long-term principal payments of $5.9 million and $1.7 million used to repurchase shares of our common stock.
On September 4, 2020, our Board of Directors approved a stock repurchase program to repurchase up to $30.0 million in aggregate amount of the Company's outstanding shares of common stock through open market purchases, privately-negotiated transactions, or otherwise in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. On July 27, 2022, our Board of Directors extended the expiration of the stock repurchase program to September 4, 2024. These shares may be purchased from time to time throughout the duration of the stock repurchase program depending upon market conditions. Our ability to repurchase shares is subject to compliance with the terms of our Amended and Restated Credit Agreement. Concurrent with the authorization of this stock repurchase program, the Board of Directors opted to indefinitely suspend all quarterly dividends.
As of March 31, 2023, we had $66.5 million in principal amount outstanding under the term loan facility and $73.7 million in principal amount outstanding under the revolving credit facility. Each of our credit facilities continues to bear interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the Adjusted SOFR rate for the relevant interest period, subject to a floor of 0.50%, (2) an alternate base rate determined by reference to the greater of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus one half of one percent per annum and (c) the one month SOFR rate, subject to the aforementioned floor, plus one percent per annum, or (3) a combination of (1) and (2). The applicable margin for SOFR loans and the letter of credit fee ranges from 1.8% to 3.0%. The applicable margin for base rate loans ranges from 0.8% to 2.0%, in each case based on the Company's consolidated net leverage ratio.
Principal payments with respect to the term loan facility are due on the last day of each fiscal quarter beginning June 30, 2022, with quarterly principal payments of approximately $0.9 million through March 31, 2027, with maturity on May 2, 2027 or such earlier date as the obligations under the Amended and Restated Credit Agreement as amended by the First Amendment become due and payable pursuant to the terms of such agreement. Any principal outstanding under the revolving credit facility is due and payable on the maturity date.
Our credit facilities are secured pursuant to the Amended and Restated Credit Agreement, dated as of June 16, 2020, among the parties identified as obligors therein and Regions, as collateral agent, on a first priority basis by a security interest in substantially all of the tangible and intangible assets (subject to certain exceptions) of the Company and certain subsidiaries of the Company, as guarantors (collectively, the “Subsidiary Guarantors”), including certain registered intellectual property and the capital stock of certain of the Company’s direct and indirect subsidiaries. Our obligations under the Amended and Restated Credit Agreement are also guaranteed by the Subsidiary Guarantors.
The First Amendment provides incremental facility capacity of $75 million, subject to certain conditions. The Amended and Restated Credit Agreement, as amended by the First Amendment, includes a number of restrictive covenants that, among other things and in each case subject to certain exceptions and baskets, impose operating and financial restrictions on the Company and the Subsidiary Guarantors, including the ability to incur additional debt; incur liens and encumbrances; make certain restricted payments, including paying dividends on the Company's equity securities or payments to redeem, repurchase, or retire the Company's equity securities (which are subject to our compliance, on a pro forma basis to give effect to the restricted payment, with the fixed charge coverage ratio and consolidated net leverage ratio described below); enter into certain restrictive agreements; make investments, loans and acquisitions; merge or consolidate with any other person; dispose of assets; enter into sale and leaseback transactions; engage in transactions with affiliates; and materially alter the business we conduct. The First Amendment requires the Company to maintain a minimum fixed charge coverage ratio of 1.25:1.00 throughout the duration of such agreement. Under the First Amendment, the Company is required to comply with a maximum consolidated net leverage ratio of 3.75:1.00 for each quarter through March 31, 2023, after which time the maximum consolidated net leverage ratio will be 3.50:1.00. Further, under the First Amendment, in connection with any acquisition by the Company exceeding $25 million, the Company may elect to increase the maximum permitted consolidated net leverage ratio for the fiscal quarter in which the acquisition occurs and each of the following three fiscal quarters by 0.50:1.00 above the otherwise permitted maximum. If the consolidated net leverage ratio is less than 2.50:1:00, there is no limit on the incremental facility. The Amended and Restated Credit Agreement also contains customary representations and warranties, affirmative covenants and events of default. We believe that we were in compliance with the covenants contained in such agreement as of March 31, 2023. On March 10, 2023, the calculation of the fixed charge coverage ratio was amended to specifically exclude from the definition of fixed charges the Company's share repurchases conducted during the third and fourth quarters of 2022. Any failure by us to comply with this or another covenant in the future may result in an event of default. There can be no assurance that we will be able to continue to comply with this covenant or obtain amendments to avoid future covenant violations, or that such amendments will be available on commercially acceptable terms.
The First Amendment removed the requirement that the Company mandatorily prepay the credit facilities with excess cash flow generated during the prior fiscal year. The Company is permitted to voluntarily prepay the credit facilities at any time without
penalty, subject to customary “breakage” costs with respect to prepayments of SOFR rate loans made on a day other than the last day of any applicable interest period.
Backlog consists of revenues we reasonably expect to recognize over the next twelve months under existing contracts. The revenues to be recognized may relate to a combination of one-time fees for system sales and recurring fees for support and maintenance and RCM services. As of March 31, 2023, we had a twelve-month backlog of approximately $8 million in connection with non-recurring system purchases and approximately $324 million in connection with recurring payments under support and maintenance and RCM services. As of March 31, 2022, we had a twelve-month backlog of approximately $6 million in connection with non-recurring system purchases and approximately $324 million in connection with recurring payments under support and maintenance and RCM services.
Bookings is a key operational metric used by management to assess the relative success of our sales generation efforts, and were as follows for the three months ended March 31, 2023 and 2022:
|Three Months Ended March 31,|
|$||12,100 ||$||8,573 |
|8,318 ||10,246 |
Patient engagement (1)
|476 ||1,578 |
|Total bookings||$||20,894 ||$||20,397 |
(1) Generally calculated as the total contract price (for non-recurring, project-related amounts) and annualized contract value (for recurring amounts).
(2) Generally calculated as the total contract price (for system sales) including annualized contract value (for support) for perpetual license system sales and total contract price for SaaS sales.
RCM bookings during the first quarter of 2023 increased by $3.5 million, or 41%, from the first quarter of 2022 as we experienced strength in bookings from our existing EHR customer base and new sales of our TruCode Encoder products. The increasing complexity of our typical customer's hospital revenue cycle combined with domestic labor shortages have spurred growing demand for outsourced RCM services, which has resulted in increased bookings from within our EHR customer base of $1.7 million, or 41%. TruCode, acquired in May 2021, continues to establish itself as a provider of a competitive solution in an industry heavily dominated by a small number of suppliers. With a renewed focus on selling this high-margin product, bookings related to TruCode increased to $1.8 million in the first quarter of 2023 from slightly more than $0.1 million in the first quarter of 2022.
EHR bookings during the first quarter of 2023 decreased by $1.9 million, or 19%, from the first quarter of 2022, primarily due to a $2.1 million decrease in Acute Care EHR bookings resulting from a challenging decision environment for new Acute Care EHR system sales arrangements.
Patient engagement bookings decreased by $1.1 million, or 70%, compared to the first quarter of 2022. The first quarter of 2022 benefited from one reseller's purchases of block licenses for the deployment of Get Real Health's products in Canada, with no such large purchases in the first quarter of 2023. As a relatively small operator in a still-nascent market, volatility in bookings is expected to remain a characteristic of our patient engagement business as the industry matures and the business grows to scale.
Critical Accounting Policies and Estimates
Our Management Discussion and Analysis is based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make subjective or complex judgments that may affect the reported financial condition and results of operations. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the reported values of assets, liabilities, revenues, expenses and other financial amounts that are not readily apparent from other sources. Actual results may differ from these estimates and these estimates may differ under different assumptions or conditions. We continually evaluate the information used to make these estimates as our business and the economic environment changes.
In our Annual Report on Form 10-K for the year ended December 31, 2022, we identified our critical accounting polices and estimates related to revenue recognition, allowance for credit losses, estimates, business combinations, including purchased intangible assets, and software development costs. There have been no significant changes to these critical accounting policies during the three months ended March 31, 2023.