R1 RCM Inc. (NASDAQ:RCM) Q3 2023 Earnings Call Transcript

R1 RCM Inc. (NASDAQ:RCM) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Thank you for standing by. My name is Sydney and I will be your conference operator today. At this time, I would like to welcome everyone to the R1 RCM Q3 Earnings Call. [Operator Instructions] Thank you. Evan Smith, you may now begin your conference.

Evan Smith: Good morning, everyone. Certain statements made during this call maybe 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 strategic and cost-saving initiatives, our liquidity position and our growth opportunities and our future financial performance are forward-looking statements. These statements are often identified by the use of words such as anticipate, believe, estimate, 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 may differ materially from those included in these forward-looking statements as a result of various factors, including, but not limited to, economic downturns and market conditions beyond our control, including inflation and high interest rates the quality of global financial markets, regulatory changes impacting us and our customers and our ability to timely and successfully achieve the anticipated benefits and potential synergies of the acquisition of Cloudmed and factors discussed under the heading Risk Factors in our most recent annual report on Form 10-K and our quarterly reports on Form 10-Q.

We will also be referencing non-GAAP metrics on this call. For a reconciliation of non-GAAP metrics to the most closely comparable GAAP metrics, please refer to our press release. Now let me turn the call over to Lee Rivas, our CEO. Lee?

Lee Rivas: Thank you Evan. Good morning, everyone and thank you for joining us. Our sequential and year-over-year third quarter results demonstrate the strength of R1’s innovative technology-driven operating model and our commitment to delivering value to our customers. We continue to drive performance through a focus on operational execution, synergy realization with Cloudmed and investments in intelligent automation and our generative AI across our environments and business processes. Jennifer will cover the financials in more detail, but we are pleased with the performance this quarter and progress on our strategic priorities to drive shareholder value. First, I want to share my perspective on industry dynamics. We continue to work closely with our provider partners to more effectively address two items that are critical to their success, revenue optimization and workforce management.

These are being exacerbated by changes to payer time frames, increased coding complexity, regulatory shifts and macroeconomic pressures. By leveraging a constant supply of structured and unstructured data from all payer and provider types across U.S. care settings, we deliver highly integrated analytics that uncover new opportunities to drive revenue optimization and cost savings for our customers. This, in turn, drives value for our shareholders. And most importantly, we save our customers time and money by simplifying the enormous amount of fragmented health care data to eliminate their need to stitch together a complex set of disconnected solutions for multiple vendors. On the payer side, turnaround times remain mostly stable on a sequential basis.

We anticipate continued improvement over the next several years as normal cycles return following COVID. Improvements continue to positively impact our AR trends. Similarly, patient volumes have continued to stabilize, implying a constructive environment for our ability to collect cash on behalf of our customers. We believe our strategy continues to position us well to leverage and respond to industry dynamics. We combine best-in-class technology and services to deliver superior outcomes at every stage of the revenue cycle workflow. With more than 500 trusted partners representing over $900 billion of covered NPR, we have a growing structured and unstructured data set based on over 500 million patient encounters annually. Our operating scale and access to this real-time performance data empowers our intelligent automation and now generative AI initiatives to deliver optimized revenue yield at a lower cost more quickly.

This maximizes revenue while alleviating our customers’ operating expense and capital cost burden while improving patient satisfaction. While large-scale deployments are not without troubleshooting and change management, our operating model is battle tested, it allows us to sign multiyear contracts with significant embedded earnings as contracts mature, and we help our customers with their goals. We believe this model will drive long-term sustainable growth by expanding our total addressable market and our pipeline through continued advancement of our modular and fully integrated solutions to meet more customers where they are on the revenue cycle management optimization journey. Our relationships with over 500 clients across the RCM workflow continuum, combined with our global captive resources, deep experience in technology development and deployment and our access to significant data distinctly positions R1 to deliver innovation at scale.

An example of how we have leveraged these vast data resources to the count pre summarization, and AI bought reviews account-specific data inputs and summarizes key account notes and AR events, improving productivity by saving our expert’s time on each open account receivables. We remain focused on three areas of technology investments that are critical to client success, intelligent automation, patient experience and scaled analytics. Across all three, we use a variety of technologies, including robotic process automation, or RPA, machine learning and GenAI to build solutions that aim to lower cost, improve yield and enhance the patient experience. Intelligent automation removed steps from highly manual processes to increase efficiency. Embedded intelligence and broad data visibility have helped and will continue to help us build predictive AI and machine learning models to improve processes, eliminate unnecessary steps and drive efficiency and yield.

Our track record of bringing new and innovative technologies to the sector showcases our leadership and revenue management. For example, as you saw in this morning’s press release, we announced the expansion of our Microsoft relationship. This collaboration will integrate Microsoft’s open AI service into the R1 platform to bring enterprise-level generative AI into health care revenue cycle management. We have started to deploy generative AI solutions and tools live in production in a few targeted areas, including physician coding quality, payer follow-up and enhancement of revenue integrity rule productivity. We believe we are ideally positioned to leverage and apply GenAI across revenue management, and we intend to lead this evolution.

Our first large language model or LLM application was recently introduced and significantly increases the productivity of physician coding quality assurance, integrating tools for Microsoft’s Azure AI studio. The application evaluates complex medical records to predict physician evaluation and management codes and improve coding quality across patient charts. Historically, our team manually coded approximately 50,000 physician charts per week and sampled around 5% of those to assess quality. Now we were able to automatically compare our 50,000 manually coded charts to the automated code. R1 recently finalized the automation of quality assurance for 100% of its coding volume in this area, resulting in improved coding quality and more satisfied physicians.

We conceived and delivered the application in under 4 months. We have developed a product road map with a catalog of generative AI use cases planned for testing and deployment through the remainder of the year and into 2024. Along with our existing platform, data assets and access and technical agility, we expect our investments in GenAI will further extend our competitive advantage. Finally, I would like to discuss our commercial progress with a few examples of cross-selling and up-selling across our business. Today, R1 scale which was enhanced significantly by the acquisition of Cloudmed supports a broader range of clients by size and at every stage of the revenue cycle with best-in-class solutions to deliver improved performance. R1 has the flexibility to meet immediate to long-term client needs with the capabilities and global scale to expand the partners over time.

I am pleased with our progress in building a deep pipeline of active opportunities, including a number at the final stages of negotiations. While we are confident in signing $4 billion or more of NPR in the coming months, our priority is structuring a long-term collaborative partnership with terms that create optimal value for R1 and our partners. To drive performance and value for both our customers and shareholders, we regularly review our partnerships to ensure alignment on goals and objectives. As such, we have been in active discussions with one of our physician clients to determine a mutually agreed upon path forward. In the interim, they have sent us a notice of their intent to terminate the contract. This client is not material to our financial performance.

On the modular side, we’ve continued to see accelerated bookings because of macroeconomic pressures, positioning us well for continued growth. Now let me give you an example of how we can meet the customer anywhere on their journey by leveraging our suite of modular solutions. One example of cross-sell of an R1 solution is a long-standing Cloudmed customer who had increased their usage to several Cloudmed solutions over the past 3 years. The customer is exploring additional patient payment solutions which presented an opportunity to showcase our entry pay solution, a fully integrated and intuitive patient payment experience via a personalized self-service platform. They selected R1 based on our strong performance over the past several years and the capabilities of the Entri Pay solution.

We have also had success adding Cloudmed solutions to the end-to-end customer base to provide advanced reporting and analytics for improved performance. As our existing and potential customers continue to experience financial and macroeconomic pressures, we believe our modular and end-to-end offerings, leveraging technology and services on a global scale will create new opportunities to drive pipeline growth and increased bookings. Our diversified portfolio ensures we can solve the most complex problems our customers face, either on an individual or comprehensive basis. In closing, we are confident our innovative solutions will continue to exceed our customers’ increasingly complex needs, driving growth and shareholder value. Our team remains focused on delivering on our priorities and finishing 2023 with a strong fourth quarter.

We are committed to our mission to make health care better for all. Now I’d like to turn the call over to Jennifer to review the financials.

Jennifer Williams: Thank you, Lee and good morning everyone. As Lee mentioned, we delivered another strong quarter with revenue of $572.8 million and adjusted EBITDA of $161.5 million. Adjusted EBITDA in the quarter grew 30% year-over-year and was ahead of our expectations. Total revenue in the third quarter grew 15.5% year-over-year driven by continued growth across both our end-to-end and modular services. Let me provide a little more color on revenue. Net operating fees of $368 million grew approximately 14% or $43.8 million year-over-year. Growth was driven by the onboarding of our record new business wins from 2022 in our end-to-end business. It also included low single-digit growth in cash collections from our existing end-to-end customer base, and that was in line with our expectations.

Incentive fees were $30.1 million in the third quarter. Let me point out a couple of onetime drivers of incentive fees in the current quarter. The first is a $4 million payment for a modular client whose contract ended in Q3 instead of Q4. This was offset by a $2 million impact of a customer contract change that reclassified revenue to net operating fees. The net impact was $2 million of incremental incentive fees in the current quarter. On a normalized basis with these adjustments, incentive fees were in line with our expectations. We are pleased with the continued progress here and with the results we are delivering for our clients. Our other revenue generated mostly from our modular business, including Cloudmed posted another strong quarter with revenue of $174.7 million.

As Lee mentioned, revenue growth year-over-year is primarily driven by cross selling new solutions to our 500-plus customers. Also, revenue this quarter includes fees earned through our wind-down support of the previously discussed physician customer. We have been paid for these services, so there is no future collection risk. In addition, Cloudmed continues to perform in line with our growth expectations for 2023. Now turning to expenses for the quarter. Non-GAAP cost of services in Q3 was $364.7 million, up $37.8 million year-over-year and roughly flat to the prior quarter. The year-over-year increase was primarily driven by costs related to onboarding new end-to-end customers, continued growth in our modular business as well as investments in technology.

Non-GAAP SG&A expenses were $46.6 million in the third quarter, up approximately 3.3% from the prior year and down $6.7 million from the second quarter. The current quarter included an allowance for credit losses of $7.5 million primarily related to aged receivables for two customers, one end-to-end and one modular in light of their specific business outlook and current environment. Our adjusted EBITDA reported for the quarter was $161.5 million. Revenue growth, combined with continued cost discipline, and execution of our integration priorities drove these results. We continue to perform in line with our expectations for the year. Lastly, we incurred $29.4 million in other expenses primarily related to Cloudmed integration costs and strategic growth initiatives.

The current quarter includes approximately $12 million related to restructuring the organization to better align to our long-term growth strategy. The quarter also includes a charge of $7.2 million for the last large facility exit. As a result, we remain on track to achieve approximately $30 million in realized cost synergies this year. Now let me provide a couple of comments on the balance sheet. Cash and cash equivalents at the end of September were $164.9 million compared to $123.1 million at the end of June. We generated $109.2 million in cash from operations in the current quarter. We also incurred $32.4 million for capital spend. Net debt at the end of the quarter was $1.57 billion, down $84.2 million from the end of June. Given the strength of our cash flow year-to-date, we paid down an incremental $40 million of debt above our required repayments for the year, including $30 million this quarter.

Our liquidity also remained strong with approximately $704 million of liquidity at the end of September, both from cash on our balance sheet and availability on our revolver. Now let me go to our outlook. Given our solid performance in the quarter and year-to-date, we remain in a good position to reiterate our 2023 guidance. We expect 2023 revenue to be $2.255 billion to $2.275 billion and adjusted EBITDA to be in the range of $600 million to $615 million. We plan to provide our initial 2024 guidance as we normally do in early January. Let me close with a few key points on the overall business. Number one, performance across the core business remained strong with additional opportunities for growth within our existing customer base. Number two, we continue to have strong bookings in our modular business.

We expect these deals will have strong margins and faster time to revenue as deals are implemented. Our end-to-end pipeline is deep and provides a runway for future growth. Number three, there is a real need for our solutions in the industry. We hear it from hospital executives every day. This need creates incredible opportunity for us to deliver value for both our customers and R1 shareholders. In closing, I would like to thank our global team for their continuous commitment to delivering value to our customers every day. And with that, I’ll now turn the call over to the operator for Q&A.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from Charles Rhyee.

Charles Rhyee: Yes. Hi, thanks for taking my question guys. I wanted to ask a little bit more about pediatrics here. I know you guys talked about it being immaterial to the results here. Just trying to get a better understanding what might have happened here. And I know you guys put in a lot of resources, including staffing overseas to support the onboarding earlier this year. Just trying to get a better sense on some of the dynamics here. Thanks.

Lee Rivas: Hi. Thanks, Charles. This is Lee. A couple of things I’d say here. First of all, we are very appreciative of pediatric mission supporting newborns and mothers. It’s a very important mission. I personally enjoyed working with the team in my here first 10 months. The thing I’d point out about their mission, Charles, it is very unique and distinct relative to our broader physician customers. Just to give you a sense of the complexity of their model different workflows related to newborns and mothers, billing is different, reimbursement is different, systems are different. And as you know, the initial onboarding didn’t get off to a great start. And there are clearly things we can improve. And all that said, what we could control on the metrics progress significantly over the last several months this year.

And to your point, we did actually invest incremental resources for pediatrics. And I would highlight that we will absolutely continue to work with them to ensure a smooth transition, which should take the next 12 months. And the last thing I’d point out, Charles, to your point, is this is not material to our financial performance.

Charles Rhyee: Great. And if I could just follow-up. You did mention sort of you closed on new wins. Maybe give us a little bit more color around what final stages are? And do you think pediatrics, you don’t expect us to have any impact on those discussions?

Lee Rivas: Yes, to your last point, absolutely not, Charles. But let me just point out a couple of things, and I should probably just elaborate here. The first thing is kind of building off what Jennifer said at the end of her comments around our value proposition, particularly in today’s time of need around the financial pressures on providers is our value proposition is absolutely resonating the scale of our model, the technology, just being able to meet providers where they are. And we are clearly leveraging some of the commercial activity in our Cloudmed business to get access to see if it does some of the CFOs and CEOs. The second thing I’d say more specifically is we’re pleased with the progress and development in our pipeline and have a number of systems in late stages of negotiations.

And so what I’d say is just – and this is a bit of a nuanced part, Charles, while we’re confident in signing $4 billion or more – in the coming months, our priority is structuring long-term partnerships that create optimal value for our customers and for R1. So while we move closer to signing one or more, what I don’t want to do is apply – put additional constraints on the commercial team. These negotiations are complex and I don’t want to unduly impact final terms. So I’ll leave it at that, but we’re feeling very good about where we are.

Charles Rhyee: Great. And just to clarify, the added resources for pediatrics, I mean, was this contract even profitable? I mean, because it sounds like as this could maybe be a positive from a financial standpoint.

Jennifer Williams: Yes. Yes, we had said that we had added costs and we had done that and we’ve kept them on through the first 9 months of the year. I would say that Lee mentioned it’s immaterial. I would say it’s kind of in the 1% to 2% EBITDA range as a percentage of our EBITDA, so not a lot of profitability.

Charles Rhyee: Okay, thanks. Appreciate that.

Operator: Your next question comes from Elizabeth Anderson. The next question comes from Jailendra Singh.

Jailendra Singh: Yes. Good morning, thanks for taking my questions. Can you guys, hear me?

Lee Rivas: Yes, yes.

Jailendra Singh: I wanted to follow-up on this allowance for credit losses of $7.5 million. You guys called out it relates to age receivables for two customers, one end-to-end and one modular. Can you give a little bit more color? And kind of related to that, maybe broadly just there have been some concerns around some of your customers’ financial conditions. Maybe talk about your customer health and how you feel about the market in general way?

Jennifer Williams: Sure. From our credit reserve perspective, it’s something that we look at every quarter. As we look at our results, we’re taking an approach of – in our CECL model, which is looking at the ultimate collectability of our AR. So based on the aging of our AR, we always take a reserve. So there can be movement there just based on the aging across all customers. The other thing that we do is we look at specific customers where we know that there may be risk based on specific outlook with the particular customer, things going on in their business, discussions that we’re having, things that we know about them in addition to perhaps the outstanding receivables that we have. So in the current quarter, we did take a small increase related to our overall CECL reserve across all customers.

And then we – in addition, we took two specific reserves related to the customer’s mission, one enterprise and one modular. As far as overall health on customers, Jailendra, customers are under an incredible amount of pressure coming out of COVID, post recovery, volumes, cash collections, inflationary dynamics. It creates a lot of tailwinds for us from a need perspective in the market, but they do have incredible challenges. So we’re doing what we believe is the right thing to do from balance sheet perspective and taking the reserves, and we’re continuing to closely monitor it.