Earnings Call Transcript - MRAI Q3 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the Marpai Second Quarter 2022 Earnings Conference Call in which management will also discuss the Maestro Health acquisition. I would now like to hand the conference over to Simon Lee, Vice President with Marpai. Please go ahead.

Simon Lee, Vice President

Thanks, operator. Welcome, everyone, to our Second Quarter 2022 and Maestro Acquisition Earnings Call. With me on the call today are Marpai's Chief Executive Officer, Edmundo Gonzales; and Chief Financial Officer, Yoram Bibring. Before turning the call over to Edmundo, please note that we'll be discussing certain non-GAAP financial measures that we believe are important when evaluating Marpai's performance. Details on the relationship between these non-GAAP measures to the most comparable GAAP measures and the reconciliations thereof can be found in the press release that is posted on our website. Also, please note that certain statements made during this call will be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause the actual results for Marpai to differ materially from those expressed or implied on this call. For additional information, please refer to our cautionary statement in our press release and our filings with the SEC, all of which are available at marpaihealth.com. And with that, I will turn the call over to Marpai's CEO, Edmundo Gonzales.

Edmundo Gonzales, CEO

Thanks, Simon. Good morning, everyone, and thank you for joining us. It's a pleasure to be here to discuss our acquisition of Maestro Health and review our Q2 2022 results. Now, as you probably know, on August 4, we announced the acquisition of Maestro Health. Yoram will describe the terms of the deal later on, but let me tell you a little bit about Marpai and why I believe this is a transformational acquisition for Marpai. Here are some highlights, first and foremost. First, the acquisition approximately doubles our revenue. Second, we are getting value-added products that we didn't have. Third, the acquisition is non-dilutive and financed entirely by the seller. Fourth, the seller is also leaving almost $60 million of cash on the Maestro balance sheet, and this will fund our integration plan. Fifth, we believe that this acquisition with planned synergies realized propels us closer to our EBITDA breakeven level and beyond. Now, a bit about Maestro Health. Like Marpai, it is a third-party administrator that is well known in the market as a high-quality TPA that does a great job servicing its customer base as evidenced by high retention rates. In many ways, Maestro is very similar to Marpai. Maestro services approximately 80 employers, who self-insure their 25,000 employees. While Marpai currently services also around 80 employers, who self-insure approximately 21,000 employees. In terms of revenues, Maestro's annual revenues are currently approximately $19 million compared to our trailing 12 months of $22 million or so. The reason Maestro's revenues are lower than ours is that they don't resell low-margin third-party services to their customers. Instead, they let their customers contract directly with the third-party providers as needed. Also, they have two important value-added services, which they provide with their own resources. These are clinical management and cost containment. Now, until now, Marpai has been providing these two services to our customers by reselling third-party services. When you resell a third-party service, you keep a fraction of the amount paid by the customer and pass along most of the revenues to that third-party service provider. By providing these services using its own resources, which include its people and proprietary technology, Maestro is keeping all of the revenues from these two services. This is very significant as close to 50% of Maestro's revenues are derived from these two products. Let's dive into these two product lines in a bit more detail. First, care management. This is a service that is billed to clients on an hourly basis. It includes nurses and other clinicians working with members of health plans that require monitoring or need help managing a disease like diabetes or have other health journeys where they require some wellness help, like quitting smoking or losing weight. One of the reasons I'm so excited about this product is that it fits perfectly with Marpai's AI-driven predictions. As you know, Marpai predicts costly events. Care management is all about doing something about these costly events in terms of actively managing the member's journey. This could mean fewer ER visits, proactive matching of care for members. And of course, we know healthier members means lower costs for our clients, the self-insured employers. Now the second big product line is cost containment. This includes services that are largely monetized on a shared savings model. These include pricing and settling of out-of-network claims, where a large network like Aetna or Cigna is not relevant. A claim for $100,000, for example, that is settled for $20,000 generates $80,000 of savings for the client. Maestro would take a percent of that savings as its fee. The same approach is executed for prescription drugs in specialty, meaning high-cost categories. Often, it can get a member into a patient assistance program sponsored by pharma or source the drug at a lower cost. Again, moving a monthly drug bill of, say, $20,000 to $5,000 generates real hard savings for the client, and Maestro takes a percent of that fee or of that savings as its fee. I cannot wait to introduce these products into our client base. In terms of synergies, I think these are clear and obvious for all to see. We expect both revenue and significant expense synergies. On the revenue side, we have Maestro's two homegrown products that we hope to sell to our customer base and our own AI-driven value-added services that we hope to sell into the Maestro customers. On the expense side, we're expecting to become one company over the next 6 to 12 months, which should lead to substantial savings. While the contract closing calls for closing within 60 days, we expect the actual closing to occur soon after Labor Day. The management teams of both companies are now working hard on an integration plan, and my goal is to start executing on the integration plan right after closing. As we stated in the release, we are not providing guidance for the third quarter as it is difficult for us to estimate how much of Maestro's revenues will be included in the third-quarter figures. We hope to resume providing guidance on our Q3 earnings call. Moving on to the second quarter. Our revenues came in at $5.6 million, slightly higher than our guidance. We are continuing to work hard to ensure that we have an excellent January 1, 2023, meaning that we will add a large number of new customers with thousands of new employee lives. I want to stress that we are continuing to push organic growth as a strategic priority for us, and we believe that a bigger and stronger post-deal Marpai with additional in-house products will contribute to stronger organic growth in the long run. I also want to inform you that we have decided to terminate three customers who are related to one broker. Together, these account for approximately 4,000 lives. The termination we have said is effective September 1. The reason for the termination is that, in our opinion, the customers are failing to fulfill their terms of their contract with us. This has nothing to do with Marpai; it's purely an internal issue with these customers, which we were obligated to address through the termination of these contracts. Now, although I always hate to lose a customer, in this case, it is the right thing to do. We are pushing hard so our new lives from organic growth activities, including new adds by 1/1/2023, will far exceed the loss of these. Now, before I hand it over to Yoram to go through the deal terms and quarterly numbers, I want to thank all the people that worked extremely hard to make the Maestro acquisition a reality. Of course, the work is just starting. And yet, I think making the deal happen is indeed transformational. So thank you to all the employees and advisers as well as Maestro employees, consultants and representatives of AXA, who is the seller in this deal. All of them enable this amazing deal to happen, so a big thank you to you all. I truly believe this acquisition represents a huge leap forward for Marpai and brings us closer to fulfilling our strategic goal of capturing a large slice of this $22 billion market segment. And now let me hand it over to Yoram.

Yoram Bibring, CFO

Thank you, Edmundo. And good morning, everyone. Let me start with the Maestro acquisition, which Edmundo talked about. So what are we getting? Number one, we're buying 100% of Maestro in the stock deal. Edmundo describes to you the business assets that Maestro has in which we find extremely appealing, and I'll recap them in a minute. For those who read the 8-K, they will see that we are also buying debt. This is intercompany debt that Maestro owed to its former shareholder and will now owe Marpai. This debt will be eliminated in the consolidation and is of no economic significance outside Marpai and should be ignored. Number two, Maestro will have on its balance sheet at the closing $15.79 million of free cash, which is available to finance the operations of Marpai/Maestro without any restrictions or limitations. Number three, it was agreed that the working capital of Maestro at the closing will be within a certain range, but it usually has been operating with. And also, it was agreed that Maestro will not have any external debt at the closing. So what are we paying? At the closing, we're not paying anything. The consideration of $22.1 million is due on April 1, 2024. If we don't have the cash on that date and assuming we have met our obligations under the contract, which we expect to do, the seller will finance the deal with a 10% annual cost of capital. We are obligated to make minimum payments of $5 million on December 31, '24; $6 million on December 31, '25; $8 million on December 31, '26; and $9 million on December 31, '27. The reason that the total minimum payments are $28 million and not $22.1 million is the 10% annual interest that starts accruing on April 1, 2024. In addition, a minimum of 35% of the proceeds of any equity offering must be used to repay this debt. To the extent we make such payments, these will reduce the minimum payment obligations factoring in the 10% interest, which I just explained. In other words, if we pay earlier than the due date as I just listed, we will be saving on interest costs. But from our perspective, the bottom line is this: we're getting $15.79 million in cash, 80 customers servicing 25,000 employee lives and two strategic products, and our purchase price of $22.1 million is financed over four years by the seller at 10% interest. I believe this is a very good strategic transaction for Marpai, and we are very happy to do it. Moving on to the quarter. Our revenue for the second quarter of 2022 was approximately $5.6 million compared to approximately $6.2 million in the first quarter of 2022 and revenues of $5.9 million for the fourth quarter of 2021. As you recall, our Q2 guidance was $5.2 million to $5.5 million. Moving on to employee lives. As you know, TPAs calculate the fees mostly based on a per employee per month basis. Therefore, employee lives is a key revenue and growth indicator in our business. When we say employee lives, we refer to the employees of our customers who are covered under the self-insured plan that we administer. We finished the second quarter with 21,074 employee lives, almost unchanged from 21,139 on March 31, 2022, and down from 25,195 at the end of 2021. As you can tell from these figures, the reason revenue declined from Q1 was the customers that we actually lost in the first quarter. There is usually some lag in the change in revenues compared to the number of employee lives that we reported. The lag is in part because contracts may have entered during the quarter and not at the start of the quarter and in part because when a customer decides not to renew a contract and to change TPA, they typically appear to process claims that come in after the contract ends. We call this runout revenues. These are short-term revenues with higher margins. Moving on to expenses. I will be comparing the second quarter of 2022 expenses to the 2022 first quarter expenses. Cost of revenues include our cost of processing and adjudication claims, our customer service costs and the amounts charged by third-party vendors for the services that we resell to our customers. Our cost of revenue for Q2, excluding depreciation and amortization, was approximately $4.2 million or 75% of revenues compared to 73% of revenues for the first quarter. The reason for the decline in the gross margin was because in Q1, we had some higher margin runout revenues from the current customers. Gross profit, not including the impact of depreciation and amortization expenses, was approximately $1.4 million compared to $1.7 million in the first quarter. Our second quarter operating expenses, not including cost of revenues, depreciation and amortization and stock-based compensation, increased by approximately $500,000 compared to the first quarter. Approximately $200,000 of this increase was due to decreased capitalization of software expenses. The cost that were previously capitalized were expensed, while other operating expenses increased by $300,000 due to increased investments in technology, product marketing as well as other sales and marketing expenses. Operating loss for the second quarter was $6.7 million compared to a $5.5 million operating loss for the first quarter. Our net loss for the second quarter was approximately $6.7 million or $0.34 per share compared to a net loss of $5.5 million or $0.28 per share for the first quarter. Excluding stock-based compensation of $1.1 million and depreciation and amortization and asset write-off expenses of $776,000, adjusted EBITDA for the second quarter was a negative of approximately $4.7 million compared to a negative of $4 million in the first quarter. In terms of guidance, as Edmundo told you, we are not providing Q3 revenue guidance due to the Maestro acquisition, which we expect to close before the end of the third quarter. And with that, we will open the call for questions.

Operator, Operator

The first question comes from Allen Klee of Maxim Group.

Allen Klee, Analyst

I have a bunch. If there are other people in the queue, let me know and I'll get back or I'll just keep going. The first one is you had a broker summit, and the brokers are who sell your offerings. Can you give some feedback on how that went? What you've heard from the brokers in terms of potential business that you got? And why would a broker consider choosing yourselves versus another TPA?

Edmundo Gonzales, CEO

Thanks, Allen, and thanks for joining our call today. So first and foremost, the broker summit, I think, was a huge success in multiple ways. First, it was a gathering of 50 of the top brokers in America. You'll remember the business that we purchased in 2021, Continental Benefits, the TPA, was an ongoing business with its own history and clients. We have obviously said about transforming that business and creating really a TPA of the future, a payer of the future. The quality of the brokers and the stature of the brokers is quite different from maybe legacy brokers. We are working now with some of the largest national brokers in America. This means that when you're in the machine, you are receiving requests for proposals as a better, of course. It's not just relationship-based or knowing some guy or some executive, but it's in the normal course. That is my goal. We have seen a significant uptick in our RFP level vis-a-vis where we were last year. By our accounting, we now, or at the beginning of this month, had as many RFPs representing as many lives as we did in 2021, all of 2021.

Allen Klee, Analyst

I'm sorry to interrupt you. I apologize. When you say that your RFPs were as many representatives, many lives as '21, did you mean as many lives that you had of employees under coverage in '21?

Edmundo Gonzales, CEO

No, no, no. What I mean is that an RFP is really an invitation to bid, right, and at bat, if you will. So the number of those RFPs and the lives that they represent in our pipeline are currently equal to all of the RFPs that we bid in, in all of 2021. The funnel is developing quite nicely, which I'm obviously very pleased with. And the enthusiasm, I think, from the broker community is most certainly there. That is really what is driving. I mean at the end of the day, they are still the gatekeepers in this industry for who gets business and who does not. To get business, you have to bid on a lot of business. The last point I would make to that is that the sales cycle against January 1, although it has started, it's really at the beginning. So there's a lot more brand new RFPs to mine here over the next two months.

Allen Klee, Analyst

Yes, that's great. Then you talked about, I think, last call about how you've used technology to educate claims more efficiently. Could you go into that a little more in terms of how that's progressing and maybe how you think that compares to your efficiency relative to peers?

Edmundo Gonzales, CEO

Sure. Look, we have made big strides in essentially turning this service provider that pays claims into a technology company. That journey continues, right? So what is the core function of a third-party administrator payer? It's to pay claims, right? So we've introduced a lot of technology and a lot of process improvement to make that journey a lot better and much more efficient. For example, in our core cost per claim when we bought Continental Benefits, we had a cost per claim that was approximately 2.5x to 3x what it is now. I still believe there's a lot more efficiency to gain there. That's the effect of technology when implemented correctly. Meaning you can process many more in our factory of claims, if you will, with the same resources. Why? Because you're employing technology to do that. That's our commitment. We are investing in all areas of this process to make it a lot more efficient, especially at scale, and that work continues.

Allen Klee, Analyst

That's great. And then in terms of your machine learning, can you tell us where that stands in terms of identifying potential high claims and maybe some examples of success you're having?

Edmundo Gonzales, CEO

Most of our machine learning and AI has actually been focused on members, not only the claim flow. A lot of the process improvements that we have made in technology introduction, that we've made on the operating side is just that. It's process people that obviously a lot of technology. A lot of our machine learning and prediction deal with the prediction of disease states. So we are able to look at a population and basically assess who is on a journey on a certain journey. For example, who is on a journey to have an orthopedic procedure? Now why do we want to know that with a lot of certainty? Well, Allen, as you may know, the price variation for a knee replacement, for example, can be 3 to 8 times, not 3% to 8%, but 3 to 8 times. Those variations normally are independent of quality. So what we're doing is predicting that event months and months before it happens, not when the member is already asking for precertification. That gives our team time to intervene, to essentially educate that member that there are certain doctors with different quality metrics and basically help that member make the right choice for his own health, and obviously, there's many interactions here, the best choice also for the company health plan. We can, in some cases, even use incentives. For example, if you go to Doctor A versus Doctor B, some of your co-pays may be waived, essentially absorbed by the client. Why? Because the savings for the overall company plan may be in the tens of thousands of dollars given that choice from Doctor A to Doctor B. But it all starts with the ability to ascertain who is on a journey and what that journey is. We'll continue, obviously, to invest in this. And we are seeking essentially the high-cost event, right? We're seeking that event way before it happens when it is actionable, meaning when we can do something about it. Now, one of the key things that makes me so excited about the Maestro acquisition is that their care management essentially does this without AI. So by focusing a lot on the matchmaking and the selection of members, we think we can actually pinpoint and identify a whole cadre of members that are just not in scope. Now, what that means financially is obviously more utilization of these products. Utilization is monetized on an hourly basis. So more utilization, more revenue.

Allen Klee, Analyst

Fantastic. A financial question. Can you give us a general sense of if to the degree that there were one-time costs in the quarter, potentially related to the transaction or other items?

Edmundo Gonzales, CEO

Yes, I will turn that over to Yoram.

Yoram Bibring, CFO

Yes, we did not have substantial expenses relating to the deal in the second quarter. In terms of one-time, we didn't have any substantial items. We had some one-time costs, but they're not significant and related to certain vendors here and there. The main thing was that we capitalized much less software expenses this quarter than the prior quarter, about $200,000. So basically, cash-wise, we're in the same expenses, except less were capitalized, and this has to do with GAAP. It's not a substantial thing, and about $300,000 of increased expenses were incurred in product marketing, technology, sales, and marketing, things of that nature. Some of them were one-time, but these one-time expenses tend to repeat themselves once every few quarters, so I don't think they're worth mentioning specifically.

Allen Klee, Analyst

That's great. And then the comment around half of Maestro's revenues come from these two offerings they have and that they don't sell third-party solutions at low or no margin. Would that imply that the gross margins of Maestro's business are likely higher than Marpai's? And then second, is there a way to think about the potential additional revenue per employee if those new services could get cross-sold to Marpai?

Yoram Bibring, CFO

So with regard to the gross margin, the way they do their gross margin, if you look at our financials. If you look at our financials, the way we say, and I say it every time we do the call, I explained what's included in cost of goods sold. It's basically those third-party costs, which you just mentioned. We also have the cost of claim processing and customer services there. They do it a little bit differently. They add a lot more people from the operational side. We have information technology, for example, put into one line. They take a lot of this IT and put it into cost of goods sold and other things. I guess they do it a better job. Almost like management accounting because they are a private company after all, so they could do it a little bit differently. If we take what they do and adapt it to what we do, yes, gross margin will go up. Definitely. So yes, the answer is yes. Assuming that's what we'll do. In other words, if we adapt what they do to the way we do it today, which is most likely the case, not 100% sure yet, as we still have to do some GAAP work here. But assuming that's the case, then yes, the gross margin will definitely go up.

Edmundo Gonzales, CEO

Allen, there's a great opportunity to cross-sell these products to our existing base. Currently, I'm overseeing care management and cost containment, but we have partners who carry out these services on behalf of our clients. Our goal is to leverage the resources and products that Maestro offers, as this would allow us to retain all the revenue and gross profit generated from these activities. We are very excited about integrating these offerings into our client base.

Allen Klee, Analyst

To follow up on that, is it the goal to try to get the cross-selling opportunity available for the January 1, 2023 renewals?

Edmundo Gonzales, CEO

It certainly is. We need to assess our position in the sales pipeline before we can begin. The deal isn’t officially ours yet since we need to finalize it in early September. The exciting aspect, Allen, is that for certain segments of the market or parts of our portfolio, we can manage the swaps internally. We will handle the care management ourselves instead of relying on a vendor. While there are other vendors we need to coordinate with for cost containment, we can easily manage the care aspect internally.

Allen Klee, Analyst

I have a challenging question, so I understand if you can't answer it precisely. Is it reasonable to assume that if we were modeling the combined company, and while we don't have the Maestro results yet, we could assume that Maestro's results are quite similar to Marpai's? This way, we could effectively double everything from the top line to the bottom line as a starting point?

Edmundo Gonzales, CEO

Yoram, you want to comment on that?

Yoram Bibring, CFO

Unfortunately, we cannot comment on that at this point. We're in the same business. Obviously, there are a lot of similarities, but we can't go into the details of the numbers beyond the information that we already provided to the public. We will be filing financials within 70 days or so after the closing. And we'll provide more information, obviously, on our next call. But at this point, beyond giving you the employee lives numbers and the revenue numbers, we can't provide additional financial information on this point. Sorry.

Allen Klee, Analyst

Okay. You mentioned that you're terminating three customers related to one broker. Can you tell us the number of employee lives associated with that?

Edmundo Gonzales, CEO

Approximately 4,000. I want to emphasize that this situation is certainly difficult, but it is not an issue with Marpai. The group of customers involved is simply not fulfilling their contractual obligations. This situation is more related to how these groups were underwritten. To safeguard all parties, we made the decision to proceed with this termination. It's not something we take lightly, but I believe it is in the best interest of the company. My aim and hope is that this is not only replaced but replaced multiple times over with new lives coming in the fall and, of course, during the critical January 1st period.

Allen Klee, Analyst

Okay, great. I have one last question to clarify. When you announced the potential acquisition of Maestro, you mentioned that there was enough cash for about 18 months to move towards profitability. Could you elaborate on the strategy behind that? When you refer to profitability, are you talking about just Maestro, cash flow, or the combined entity as a whole?

Edmundo Gonzales, CEO

We're talking about the combined company, the new Marpai with Maestro. That is the goal in our plan of integration. We'll obviously have that as the overall goal here. Yoram, do you want to comment a little further on this?

Yoram Bibring, CFO

I agree 100% with what you said, Edmundo. This is a target for us, which we believe we can meet, but we're not saying anything beyond that. So we're saying that we have a target to get to breakeven within 18 months. We think this transaction is going to help move us towards that, but we're not saying anything beyond that.

Operator, Operator

There are no questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Edmundo Gonzales for closing remarks.

Edmundo Gonzales, CEO

Thank you, operator. And for all participants, thank you so much for your time this morning. We wish you a very good day and look forward to meeting again next quarter, but thank you very much for your participation. We appreciate it.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.