R1 RCM Inc.
Q2 2019 Earnings Call Transcript

Published: 6 Aug 2019

[Operator:]

Good morning. My name is Beth, and I will be your conference operator today. At this time, I would like to welcome everyone to the R1 RCM Second Quarter 2019 Earnings Call. [Operator Instructions]/Atif Rahim, Head of Investor Relations, you may begin your conference.

[Atif Rahim:]

Good morning, everyone, and welcome to the call. With me on today's call are Joe Flanagan, President and CEO; and Chris Ricaurte, CFO and Treasurer. Certain statements made during this call may be considered forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In particular, any statements about our future growth, plans and performance, including statements about our forecast for 2019 and 2020, our ability to successfully implement new technologies and platforms, expected uses of cash, expected timing of new business deployment and expected new business are forward-looking statements. These statements are often identified by the use of words such as anticipate, believe, estimate, expect, intend, design, may, plan, project, would and similar expressions or variations. Investors are cautioned not to place undue reliance on such forward-looking statements.All forward-looking statements made on today's call involve risks and uncertainties. While we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so, except to the extent required by applicable law. Our actual results and outcomes could differ materially from those included in these forward-looking statements as a result of various factors including, but not limited to, the factors discussed under the heading Risk Factors in our annual report on our latest Form 10-K.Now I'd like to turn the call over to Joe.

[Joseph Flanagan:]

Thanks, Atif. Good morning, everyone, and thank you for joining us. I'm pleased to report another strong quarter driven by continued execution across our customer base. Revenue for the second quarter was $295 million, up 42% year-over-year and adjusted EBITDA was $40.6 million, up from $9.2 million in the second quarter of last year.I'm very proud of the team. In addition to announcing the Quorum win last quarter, we are now in a position to update our full year adjusted EBITDA guidance. As you'll recall, at the beginning of this year, we provided 2019 adjusted EBITDA guidance of $145 million to $155 million inclusive of the upfront investments for $3 billion in new NPR from end-to-end contract wins. We are raising adjusted EBITDA guidance for this scenario to $155 million to $165 million. We continue to see a healthy progression of deals in our pipeline and anticipate closing out 2019 with at least $3 billion in new NPR inclusive of Quorum.Our messaging and value proposition are resonating well in the industry and feedback from prospective customers is very encouraging. We're seeing increased market momentum, which is manifested in an increase in new enterprise opportunities we're being invited to participate in, in addition to our existing pipeline of qualified pursuits.This, coupled with the increasing number of large and strategic modular engagements we're working on, instills confidence in our approach, differentiated value proposition and ability to deliver on our growth targets. I'd like to take a moment to reflect on the progress we're making.With our updated view, we expect to grow adjusted EBITDA by about $100 million year-over-year. This trajectory provides us increased visibility into the steady-state margin profile on our contracted book of business. We believe our contract pricing is very competitive and delivers a sustainable advantage for our customers.Looking forward, we feel good about our value proposition and ability to grow the business. As a reminder, our 2020 guidance does not assume we are at optimized contract profitability. Embedded within our profitability projections are structural investments designed to position the company for continued growth.Some of these investments are as follows

[Christopher Ricaurte:]

Thank you, Joe, and thank you all for joining us. I'd like to remind everyone that we will be referencing non-GAAP metrics on today's call. The adjusted cost of services and adjusted SG&A numbers exclude stock-based compensation and D&A expense. Adjusted EBITDA excludes stock-based compensation expense, debt extinguishment charges and acquisition-related costs, a portion of DTO-related expenses, severance and certain other costs. A reconciliation of GAAP to non-GAAP financials is available in today's earnings press release.Now turning to Q2 results. Revenue for the quarter was $295 million, up $87.1 million or 42% year-over-year, driven by new business onboarded over the course of 2018 and contribution from Intermedix. Relative to Q1 2019, revenue was up $19.1 million, driven primarily by continued onboarding of Presence and AMITA Health as well as Ascension Medical Group.From a cost standpoint, adjusted cost of services in Q2 was $232.5 million compared to $223.5 million last quarter and $181.1 million a year ago. The sequential increase was primarily driven by costs associated with the onboarding of Presence and AMITA Health. Relative to Q2 of 2018, cost of services increased due to cost associated with onboarding new customers, along with a full quarter of costs from Intermedix. Adjusted SG&A expenses in Q2 were $21.9 million, up $2.9 million sequentially, primarily due to investments in corporate IT and human resources infrastructure to support our growing footprint. On a year-over-year basis, SG&A expenses increased $4.1 million primarily due to Intermedix SG&A and investments in corporate IT and HR infrastructure as well as expansion of our commercial efforts.Adjusted EBITDA for the second quarter was $40.6 million compared to $33.4 million in the first quarter and up $31.4 million from $9.2 million a year ago. The sequential and year-over-year increases were driven by increased profitability from new customers onboarded over the past couple of years and the contribution from Intermedix, offset by costs associated with onboarding new customers. Lastly, we incurred $10.7 million in acquisition related and other costs in Q2, primarily related to strategic initiatives and our digital transformation office. We also incurred $18.8 million in charges for extinguishment of debt related to our announced refinancing, which were primarily noncash. These costs are not reflected in the adjusted EBITDA but are reflected in our GAAP income statement.Turning to the balance sheet. Net debt at the end of June, inclusive of restricted cash, was $304.4 million compared to net debt of $260.2 million at the end of March. This change was driven by cash used for operations of $27.1 million and CapEx of $17.5 million related to the purchases of software licenses and computer equipment as well as capitalized software. As a reminder, our cash balance was higher than normal in Q1 due to the timing of reimbursable payments to customers and the timing of incentive compensation payments, both of which were paid in Q2. We expect to use cash to pay down debt in the second half of 2019, including making mandatory amortization payments under the credit agreement.Net interest expense for the second quarter was $9.9 million, down slightly from the first quarter due to favorability from lower LIBOR rates. At the end of June, we refinanced all of our Term Loan B and subordinated debt into Term Loan A and a revolver with $385 million in gross debt outstanding at the end of June. As the result of the refinancing, we expect our quarterly interest expense to decline approximately $5 million before any debt paydown, which is a quarterly savings of approximately $5 million.Turning to our outlook for the remainder of 2019. We are reaffirming our guidance of $1.15 billion to $1.25 billion, and we are raising the low end of our adjusted EBITDA guidance to $155 million. As you may recall, our prior guidance was $145 million to $165 million and guidance under the growth scenario, which factored the upfront costs associated with onboarding $3 billion and new NPR in 2019 was $145 million to $155 million. Our updated guidance of $155 million to $165 million continues to incorporate upfront costs as well as our expectation of continued strong underlying performance in business contracted prior to 2019. In effect, we expect business contracted prior to 2019 to now generate $165 million to $175 million in adjusted EBITDA without taking into account upfront costs associated with new growth. In closing, I'm proud of our team's ability to consistently execute on operational commitments and deliver strong customer results. With a strong start to the first half of 2019, we remain confident in our ability to deliver on our performance and growth goals.Now I'll turn the call over to the operator for Q&A. Operator?

[Operator:]

[Operator Instructions]. Your first question comes from the line of Charles Rhyee from Cowen.

[Charles Rhyee:]

Congratulations on the quarter. A quick question here though. Obviously, you've upped the guidance and the core guidance excluding the upfront costs for new business this year meaningfully higher than when we started the year. Obviously that implies a much higher adjusted EBITDA margin as well. Are you prepared here yet to talk about sort of -- you talked a bit about digital transformation, but where do you think the steady-state margins down the road are? Obviously, we're heading to that kind of run rate a little bit faster than we would have anticipated. Any comments where you think -- is our ceiling getting a little bit higher here, I guess, is the question?

[Joseph Flanagan:]

Yes. Thanks, Charles. I'll take the start of this question. I think we're not yet ready to talk in specific details on the digital transformations, the efforts, the investments we've been making there, how that translates into longer-term guidance or margin model, so to speak. I do expect, and we've been pretty consistent on this, we do expect to be in a position to provide additional color on that as we head into the back half of the year and on some of our upcoming calls. And really what's driving that timing is -- we -- as I said in my prepared comments, we're being very careful to make sure we understand the translation of these efforts into our ledger. And so we're testing that as we speak with the automations that we brought online already and we're operationalizing and that we're in the midst of bringing online. And that involves making sure that we're confident that those automations are reliable, resilient, can handle all of the different permutations of our operating environment. And as we progress through that, there will be a point in time where we're actually able to start structurally modeling the implications of that. And we're entering that phase as we speak. So I think that's how we're thinking about it from a timing standpoint.Now generally or directionally, what I would say is, we are very encouraged with what we're seeing so far relative to the applicability and the financial return on this. And so we would expect to see that in our longer-range view of the business from a financial performance standpoint.Most of our -- there's a little bit of DTO that we're seeing in our financials, but -- in our year-to-date numbers, but I would characterize it as very, very small. The majority of what we're seeing driving our current underlying financial performance is just strong execution on our core operating system, whether that be getting our technology in, which allows us to take advantage of our central infrastructure, normalizing those workflows; getting the work that has to remain locally to the right productivity standards; and then really looking at rationalizing our third-party spend, as we commented. We're very, very encouraged by the execution on those fronts, and I do think separate from DTO, as we look to 2020, that bodes well for our visibility in the upcoming year. And then I do think we should be driving our teams to get some additional scale leverage just out of core execution. And so the combination of those two major levers will contribute to us having a more specific discussion on margin models long range.The other thing I would emphasize and we tried to comment on the call, Charles, this is against the backdrop of very competitively priced contracts. And what I mean by that is, we do not feel like we're sitting on contracts that are not serving our customers well and giving them a competitive advantage. So in a way, we're earning our way into steady-state margin models by driving the efficiencies we should be driving, and that's driving real value to our customers, and we continue to get good feedback on our value prop and the ability as we sit today to extend an advantage, both from a financial performance standpoint, but also just from a patient satisfaction standpoint pretty quickly to the current customers or our target customers in the pipeline.

[Charles Rhyee:]

I have one follow-up. Just when you look at the market out there and some of the work at least we've done suggests you have a lot of hospitals really looking to make decisions over the next, let's say, a couple of years, but when you look at sort of brand awareness, I think R1 still kind of falls through the middle of the table. Obviously, some obvious names like an Optum or something kind of rise to the top just because of their, I would think, maybe just name awareness. Can you talk a little bit -- and obviously your pipeline though -- your comments sound very positive, but if we think back to sort of how you talked about the Quorum deal, kind of coming in sort of midway through it, can you talk a little bit more about what we are -- what we can be doing to sort of improve the awareness in the market of the R1 offering? And you talked about some direct investments, is some of that into more of a larger direct field force? Or what other avenues are you pursuing here to increase the awareness of the company's offering?

[Joseph Flanagan:]

No, I think you make a really important point, Charles. We do think this is an opportunity for us to improve. And so some things that I would comment along those lines

[Operator:]

Your next question comes from the line of Matthew Gillmor, Baird.

[Matthew Gillmor:]

Joe, I was hoping you can give us a little bit more color on the pipeline commentary. The commentary from the press release and the slide deck seemed pretty positive. So just update us in terms of the composition of the deals you're seeing, the average deal size? And you also made a commentary or made a comment about getting invited into more enterprise opportunities, and I was kind of curious what was behind that comment?

[Joseph Flanagan:]

Yes. Thanks, Matt. Just on the pipeline, what I would say on the enterprise side, it's not lost on us, that these -- and we talk about this a lot. These -- the timing of these deals are so hard for us to predict and in a way, you do your best to model all the statistics on it, but to some degree, it's a binary decision that typically you don't know which way it's going to go until you've got the deal done, so to speak.So with that being said, what drives our continued focus, underlying assumption that we will get an additional $1.4 billion is just activity. And so breaking that down a little bit, we've got volume up on our end-to-end pipeline double digit on a dollar basis. The pipeline is very healthy, meaning what we've progressed is, we've increased the number of opportunities that we have in, what we call, impact assessment 100%. So in effect, we've doubled that in the second quarter. That means that we're deploying all resources, the customers are allocating their resources. We have all the legal frameworks in place to be able to do analysis of the customer's data to produce a very committed pricing construct and value-creation view. That, as I said, is up 100% in just the second quarter over the first quarter. And so that's really what drives our continued view that we should be operating out of the bases that we're going to convert another $1.4 billion of opportunity.The other thing I would say is, from a sizing standpoint, we continue to see, very consistent with our prior comments, most of the activity in the $1 billion to $5 billion target market on an NPR basis, that seems to be a market that's very active. A fair amount of interest that I would say is increasing every quarter based on what we've seen.The other thing I would highlight is our modular pipeline is up quite a bit and this is strategic because in many ways, this is an opportunity for us to evolve with those into more enterprise-type deals. And so if you look at our total modular pipeline, vis-à-vis the second quarter, it's up 20%. We're up higher than that in our physician offering. And if you look at that modular pipeline against our target markets, whether that be physician or modular services into the IDN, roughly 78% of that pipeline is where we want it to be. And so that bodes well for us getting a foot in the door, but more importantly, allocating our internal capacity to opportunities that have the ability to evolve into something more broad. So in general, we've got a lot of activity on all of our offerings, which is encouraging.

[Matthew Gillmor:]

Got it. That's helpful. But as a follow-up, I wanted to ask about the strategic initiatives and DTO investments. Now it seemed like those were -- maybe indicate a little bit higher, and I know you add those back to EBITDA, but in the reconciliation, I think it was $30 million to $35 million in the current outlook versus previously being at $15 million to $20 million. And I was curious if that just reflects higher DTO spending and the confidence around that or if there's other investments to call out that are within those numbers?

[Christopher Ricaurte:]

Yes, Matt. This is Chris. It's really a couple of things

[Joseph Flanagan:]

And one thing I would say is, on the restructuring front, and we don't take this lightly, but what I would say is, I'm generally very encouraged by the execution of our operators, driving our footprint to the optimized footprint. And so as we think about restructuring on an ongoing basis, there's a fairly high return that we see on those events or on those activities. And so a lot of times, we -- obviously, we watch headcount very closely, it's 80% of the cost structure. That's really in a way a big part of the value prop that we can drive as we think about the scale leverage, et cetera.

[Christopher Ricaurte:]

Yes. And most of those restructuring activities are effectively moving things into our shared service centers, whether it's in the U.S. or in India.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Stephanie Demko, Citi.

[Stephanie Demko:]

The last time we connected, you guys had 8 to 10 active deals in the pipeline. Could you give us an update on any progress since June? And is there any change to the active pipeline just in kind of where they are?

[Joseph Flanagan:]

Yes. As I said, Stephanie, the overall pipeline is up double digits for our enterprise opportunities, and we've doubled the opportunities that are in full impact assessment or financial assessment, as I commented before. And that's just commenting on the end-to-end pipeline. As you think about the modular pipeline, again, depending on whether that's the physician offering or some of our modular offerings into the acute care setting. Depending on which one, it's anywhere from 18% to 22% up on a quarter-over-quarter basis. So -- and as I said, it's almost 80% at our target market. So we're very just encouraged by the health and progress from Q1 to Q2 on the growth dimension.

[Stephanie Demko:]

And I think of that compared to the patient experience we just had, how much of that was driven by maybe inbound or interest in the PX platform? Or how much of it is more stand-alone kind of just word of mouth [indiscernible]?

[Joseph Flanagan:]

I would say on the modular side, I would draw the PX platform and that solution architecture as a module that has high interest right now based on what we're seeing in, in market discussions. And then the other thing I would highlight on the modular side is, we continue -- and we spent a bit of time updating on this call on the underlying capability just a physician modular activity, I would also highlight as something that we're particularly seeing some encouraging signs on.

[Stephanie Demko:]

Got it. And just one quick follow-up for the PX platform, could you help us quantify any type of uplift and growth advantage you're getting from it?

[Joseph Flanagan:]

On the PX platform?

[Stephanie Demko:]

Yes.

[Joseph Flanagan:]

Well, in terms of growth, what I would say right now is, we're in the midst of fully deploying that across Ascension. We're -- I don't know technically exactly how far we are in deployment, but getting close to halfway through maybe of that footprint. And it's primarily right now on scheduled visits, okay? As we commented on, we're looking to expand that into the ED setting and into the walk-in setting. So right now, what we're deploying is that on scheduled visits. We have a system on the West Coast we're deploying it at; we have a system on the East Coast that are new systems that we're deploying it at, which we don't generally talk about in terms of kind of headline press releases or not, but those are activities that have converted.And then we're in the process of launching it at the acute care setting in Intermountain, as we speak. And so -- and we'll be transitioning it to Quorum as well in the second half of the year. So the reason I had a comment on that is pretty quickly, we should have not only the most comprehensive offering but the broadest installed base of actually running that solution at scale that will only help us as we think about going forward value proposition.

[Operator:]

We have a follow-up question from the line of Matthew Gillmor, Baird.

[Matthew Gillmor:]

On the DTO side, I had a follow-up. So you mentioned in the last several calls that this will obviously enhance margins and you will provide some visibility over the next couple of quarters in terms of what that means. And Joe, you've also said that your price point right now is very competitive and you're delivering all the value to clients. So understanding all that, I was curious does the DTO make you think about your pricing model and whether it makes sense to drop pricing to catalyze growth or do you think the pricing is competitive enough for it makes more sense for you just to capture the margin as the value delivering to client is still so strong? So just if you had any kind of thoughts, I'd be curious.

[Joseph Flanagan:]

No, thanks, Matt. We feel really good. If you think about our pricing and the value we're able to create for clients vis-à-vis alternatives to us, so think about it from a competitive landscape, we feel really good about our position along those lines. As we think about DTO and as we think about catalyzing growth, you have to take into consideration that more often than not, the discussion we're having with the potential customer is not necessarily a competitive discussion, but it's a discussion of what does that customer think their organization can do on its own compared to what we can do.And the tie goes to doing nothing, right? Because it's a less risky decision. So if we come in with a value prop that says, "Listen, inclusive of our margins, we can generate this much financial value." And that customer has an internal plan that says, "No, we can get this much value on our own." There's some other factors that we can work on

[Operator:]

There are no further questions. I will turn the call back to Joe Flanagan for closing remarks.

[Joseph Flanagan:]

Thanks, operator. And I'd like to thank everybody for joining us today. As we said in our comments, we're very pleased with the strong first half performance, and we feel good about the market and our competitive positioning as we head into the second half of the year. As I mentioned in my comments, we remain optimistic. We continue to invest in the business for the long term. We look forward to updating everybody on future calls. Operator, as always, thanks for all your help, and we can close the call.

[Operator:]

This concludes today's conference call. Thank you for joining us today. You may now disconnect.