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MedAssets, Inc. (NASDAQ:MDAS)

Q4 2008 Earnings Call

February 25, 2009 5:00 pm ET

Executives

Robert Borchert – Vice President of Investor Relations.

John Bardis – Chief Executive Officer

Neil Hunn – Chief Financial Officer

Analysts

Ross Muken – Deutsche Bank

Eric Coldwell – Robert W. Baird

Corey Tobin – William Blair

Richard Close – Jefferies & Company

Larry Marsh – Barclays Capital

Donald Hooker – UBS Securities

Constantine Davides – JMP

Operator

At this time, I would like to welcome everyone to the MedAssets fourth quarter 2008 financial results conference call. (Operator Instructions). I would now like to introduce Mr. Robert Borchert, Vice President of Investor Relations.

Robert Borchert

Good afternoon and welcome to the MedAssets conference call to discuss our financial and operating results for the fourth quarter and year ended December 31, 2008. With me today are John Bardis, our Chairman, President, and CEO, and Neil Hunn, our Chief Financial Officer.

Before we begin, I would like to remind everyone that this conference call will contain forward-looking statements regarding our company’s expected financial and operating performance for 2009. These forward-looking statements may be affected by important risk factors that are described in MedAssets’ filings with the Securities Exchange Commission and our earnings release issued today. Therefore, actual results may differ materially from our forward-looking statements discussed today or in the future. MedAssets assumes no obligation to update publicly any forward-looking statements whether as a result of new information, future events, or otherwise.

We will discuss certain non-GAAP financial measures in today’s call. Please see our earnings release from today which is now posted in the Investor Relations section of our corporate website www.medassests.com for more information on these measures.

Now, I would like to turn the call over to our CEO, John Bardis.

John Bardis

Thank you, Robert, and good afternoon everyone. I’m pleased to report a very strong finish to 2008. We’re very encouraged by solid business momentum, and 2009 is starting off very strong. All of this is being driven by new customer wins, early success in our cross-selling activities, and the continuing balance and strength of our core recurring revenue business in the revenue cycle and spend management arenas.

We posted fourth quarter financial results that were ahead of consensus analysts’ expectations and at the top end or above our guidance range. Fourth quarter net revenue was $83.7 million, which grew organically over 18% as compared to the same quarter a year ago. Fourth quarter adjusted EBITDA was $29.4 million, up over 38% versus a year ago, and adjusted EPS was $0.19 for the quarter.

These are record quarterly results for MedAssets, and we thank our customers and employees for this terrific performance. Neil will walk us through the details of our financial and operating results in a few minutes, and I will update you on our outlook for 2009 as well, but let me take a moment to update you the current environment and how we believe it is affecting our customers and our business. Then I will highlight a number of recent customer wins that underscore our market relevance and confidence in our expected performance in 2009 and beyond.

Given the continuing disruptions in the broader capital markets, we all recognize the hospitals are dealing with increasing and intense financial pressures that have created greater cash flow challenges for all health care providers, in particular hospitals. These current macroeconomic conditions are dictating that hospitals focus on becoming more operationally efficient given that historical non-operating sources of cash flows such as charitable donations and endowments have substantially declined, and access to capital markets is currently either not an option or cost prohibitive for short term infusions.

In addition, systematic factors such as Medicare RAC audit programs only add to the financial pressure facing our clients. We are extremely cognizant as a company of the continuing challenges of this market environment, and we are monitoring the trends very closely. Cash flow and access to credit continues to deteriorate for many of our customers. Although unfortunate for hospitals, these factors do play into the strength of our strategy, market position, as well as our technology and service offerings. Our financial improvement solutions can help increase revenue capture, better manage supply costs, and both accelerate and increase cash flow in the near term. Ultimately these solutions assist hospital in addressing their core issues around increasing operating profitability.

On balance, we continue to experience significant demand for our solutions in this capital-constrained environment because our technology and service capabilities can deliver improved revenue integrity and cash flow in a matter of months with little or nor upfront costs. Over the past quarter or so, we have seen particular strength in our sales funnel around our revenue cycle solutions that provide a combination of technology and service offerings as many of our hospital customers and prospects have inquired about a comprehensive solution as opposed to individual standalone products.

Our cash return on investment value proposition which generates capital for hospitals, and I repeat, generates capital for hospitals, as opposed to consuming it has a very good traction in the market place, and we are executing well and converting our sales pipeline in the long term contracts. For example, we recently signed a multiyear strategic supply chain agreement with Baylor Health Care System in Texas. Baylor’s system comprises a growing network of hospitals, primary care, and specialty care centers as well as rehabilitation clinics in north Texas.

With annual operating revenue of $2.9 billion, Baylor was an existing MedAssets revenue cycle management customer and will now implement our differentiated supply cost management methodology including our group purchasing service and performance-focused supply chain analytics and medical device consulting services to help lower supply costs. We look forward to putting these practices into place and leading the way to a meaningful financial and operational improvement that produces measurable savings to Baylor.

In January, we signed a multiyear agreement for Atlanta-based Piedmont Healthcare to utilize our GPO and customized supply chain management technology and consolidated billing services as well. Piedmont’s four hospitals care for more than 600,000 patients and generate net revenue of $1.2 billion annually. Moreover, Piedmont Hospital was named best in Atlanta for cardiac care, and its cardiac surgical care is ranked among the top 10 percent nationally. Piedmont was also a very exciting win for MedAssets and a current revenue cycle management client.

We’re also seeing good initial momentum in our decision support solution suite. As you will recall, back in October, we launched our newest release of Alliance decision support for budgeting, cost accounting, and contract management. These products and this suite of products track key performance indicators within the hospital. We continue to be very excited about this highly competitive large-scale and web-based enterprise capability, and recently announced that we signed a multiyear agreement with Memorial Care to implement our decision support solution suite. Memorial Care is a nationally recognized not-for-profit health system with 6 hospitals and over 1500 licensed beds in southern California generating approximately $1 billion in net patient revenue annually. I would also point out that Health Leaders magazine recognized the Memorial Care team over a year ago as the top management team and most wired healthcare executive organization in the US.

I’m proud to emphasize that each of these new transactions is a result of our sales team being able to expand these customer relationships, which highlights our emphasis on organic growth and in particular cross-selling and up-selling initiatives.

Switching gears, we are in the midst of completing the first year of our highly successful transformational supply chain partnership with Sutter Hill, one of the nation’s leading healthcare networks with more than two dozen acute care hospitals in California. Sutter’s hospitals are regional leaders in cardiac care, orthopedics, and advanced patient safety technology and manage over 3 million patient care visits a year. Sutter generates over $7 billion in net patient revenue and spends an aggregate more than $1.6 billion on medical supplies, pharmaceuticals, and purchased services.

Our unprecedented partnership with Sutter which we originally referenced last March is an integrated services and technology delivery model versus a traditional consulting relationship. MedAssets staff is responsible for leading Sutter’s strategic sourcing of supplies as well as clinical utilization and business-driven value analysis which allows Sutter to take advantage of our subject matter expertise, intellectual tools, charge master, and supply data solutions. Together, our plan ensures cost savings and is transforming Sutter’s operations through fundamental process changes while maintaining Sutter’s focus on delivering affordable, accessible and high quality care.

Our initial efforts have exceeded Sutter’s savings expectations at this point in time in the partnership. Our approach has been enthusiastically embraced by Sutter’s senior management and has become a foundational element of the hospital systems long term strategic plan. The momentum and success of this non-GPO transformational relationship continues to reinforce our belief that our value proposition is on point and that MedAssets will become a market leader in the emerging area of strategic supply chain management.

I want to reemphasize one point. MedAssets does not use capital. We create it for hospitals. Each of our customer engagements focuses on delivering measurable and sustainable financial ROI. Again, we do not use capital. We create capital. This is the cornerstone of our strategy which is driven by evidence-based business and clinical processes that are managed and measured by our proprietary technology tool sets. Our key strategic initiatives for 2009 are important to highlight and each and every one of our employees is focuses on helping MedAssets obtained these strategic goals.

They are, first, to continually improve and expand our suite of solutions by leveraging our research and development team, proprietary databases, and industry knowledge to help develop new and integrated financial improvement solutions. Second, to further penetrate our existing client base. With the majority of our customers utilizing a very small percentage of our full solutions suite, we will leverage our longstanding client relationships and experienced sales team to gain a greater share of existing expenditure focused on revenue cycle or supply chain improvement. Third, to attract new customers. Our comprehensive and flexible solutions suite is a key competitive differentiator, and our highly consultative sales approach and demonstrated financial improvement is making terrific inroads as evidenced by the expansion of our sales pipeline. Fourth, to leverage operating efficiencies and economies of scale to enable more efficient deployment of customer-specific solutions while reducing average implementation and support costs, and finally to maintain an internal work environment that fosters a strong and dynamic culture to help drive employee engagement, retention, and recruitment efforts.

So despite this difficult economic environment, we continue to feel great about our strategic and competitive position, our value proposition, and our ability to execute against our 2009 goals and objectives.

With that, I’d like to turn the call over to Neil Hunn.

Neil Hunn

Thank you, John, and good afternoon everyone. As John noted earlier, MedAssets again delivered very solid results in the fourth quarter and full year 2008 that exceeded analysts’ consensus expectation. This afternoon, I will briefly discuss our fourth quarter and year-end financial results, reaffirm our full year 2009 financial outlook, and provide financial guidance for the first quarter of 2009.

Please be aware that we have refined our disclosures so that any past references to pro forma financial results will now be referred to as acquisition affected or organic result in order to provide a clear apples-to-apples comparison. All adjustment remain the exact same as our past adjustment and assume that our XactiMed and MD-X acquisitions were completed on January 1, 2007, and Accuro as part of our operations at the beginning of 2007 and 2008.

As Jon already covered some of our consolidated highlights, I’ll dive into our fourth quarter segment results. Our revenue cycle management segment generated net revenue of $49.5 million, up more than 89% from the fourth quarter of 2007 on a GAAP basis. Fourth quarter 2008 net revenue in our RCM segment grew organically 15.4% when compared to acquisition-affected net revenue of $42.9 million for the fourth quarter of 2007.

Our RCM segment growth was primarily driven by an increase in recurring subscription and service fee revenue from a broad array of our products and services. In addition, we continue to demonstrate success in our ability to drive increased cash collections with our Cook County transformational activities, thus driving revenue during the quarter. We also recognized a full quarter of revenue from our large decision support software implementation with the Ontario Ministry of Health in Canada, and this Ministry-related revenue will be recognized on a ratable basis through the first quarter of 2010.

Adjusted EBITDA in our RCM segment for the fourth quarter was $17.3 million or a 35% margin versus acquisition-affected adjusted EBITDA of $12.1 million or a 28.1% margin in the fourth quarter a year ago. This period over period increase in our fourth quarter adjusted EBITDA margin in the RCM segment was driven primarily by higher subscription fee offerings, the Cook County-related revenue, and the Canadian decision support revenue I mentioned earlier. In addition, as projected, we managed our expenses very tightly in the second half of the year as we invested heavily in our business in the first half of 2008.

Importantly, on a full year basis, our RCM adjusted EBITDA margins increased 140 basis points to 29.7% from the acquisition-effected EBITDA margins in 2007, an early indication of our success with our integration of the Accuro business into our legacy RCM businesses.

Our spend management segment reported net revenue of $34.2 million, a 23% increase over the fourth quarter of 2007 as we continued to experience strength in our GPO and supply chain services led by the Sutter relationship that John discussed earlier. Fourth quarter adjusted EBITDA in the spend management segment was $17.6 million or a 51.6% margin as compared to $13.1 million or a 47.3% margin in the fourth quarter of 2007. The 2008 quarter’s margin expansion was driven primarily by operating leverage led by lower sales and marketing costs as a percentage of segment net revenue.

On a consolidated basis, our fourth quarter revenue was $83.7 million, which grew organically 18.4% as compared to the fourth quarter a year ago. Our consolidated fourth quarter adjusted EBITDA was $29.4 million, or a 35.2% margin versus acquisition-affected adjusted EBITDA of $21.2 million or a 30% margin for the fourth quarter of 2007. Our GAAP net income interstitial he fourth quarter of 2008 was $6 million, or earnings of $0.11 per diluted share which included acquisition-related amortization expense of $7.5 million, which impacted EPS by $0.08 on a tax effective basis.

Our adjusted diluted EPS in the fourth quarter of 2008 was $0.19. We recognized share-based compensation expense of $2 million in the fourth quarter of 2008 which impacted EPS by $0.02 on an after-tax basis resulting in cash earnings per share of $0.21. For full year 2008, total consolidated net revenue came in at $279.7 million. Acquisition-affected net revenue for 2008 was $308.2 million, which grew organically by 12.5% when compared to full year 2007. Full-year adjusted EBITDA was $89.7 million, or a 32.1% margin, with the improvement over 2007 driven by an increase in segment-adjusted EBITDA margin and a year over year reduction of our corporate cost as a percentage of net revenue by approximately 40 basis points.

We are pleased with our organic growth rate and our ability to drive increasing operating profitability, both of which are signs of our integration success, our ability to drive same-store sales growth and operate with structured discipline. We look forward to discussing future successes regarding these items as the strategy and operating plans become more fully executed.

Our effective income tax rate for the full year 2008 was 40.9%. GAAP EPS for 2008 was $0.21 per diluted share, which included acquisition-related amortization and other nonrecurring expense items totaling $30.5 million which impacted EPS by $0.34 on a tax effective basis. Our adjusted diluted EPS for the full year of 2008 was $0.55. We also recognized share-based compensation expense of $8.6 million in the year which impacted EPS by $0.10 on an after tax basis, resulting in cash earnings per share of $0.65.

We ended the year with very strong cash flow from operations of $52.1 million and free cash flow of $34.1 million. Our December 31, 2008, balance sheet reflects about $246 million in total bank debt with a leverage of approximately 2.5 times trailing acquisition-affected adjusted EBITDA as we repaid approximately $10 million of bank debt in the fourth quarter. We are very proud of our ability to continue to de-lever our balance sheet especially in this economic environment. Our term loan matures in October 2013, and since we expect to be able to pay off our entire debt balance with available free cash flow from operations in advance of this date, we have very limited refinancing risk and are very comfortable with this leverage level.

Turning to our financial outlook. At December 31, 2008, MedAssets rolling 12-month contracted revenue was an estimated $301.1 million. This current contracted revenue metric increased approximately 1% sequentially on a consolidated basis as compared to a quarter ago. This 1% increase was anticipated on the strength of our fourth quarter financial results and does not include the impact of the new customer wins John spoke of earlier given these deals were signed in early 2009. Of particular note, we start this year with contracted revenue equaling 86% of the midpoint of our revenue guidance range, consistent with the launch off point for 2008.

Today, we are reaffirming our financial guidance for 2009 which specifically consists of consolidated net revenue of $346 to $354 million, with segment revenue consistent with previous guidance, consolidated adjusted EBITDA of $111 to $117 million, adjusted diluted EPS of $0.56 to $0.64, and share-based compensation expense of $0.18 per share yielding full year 2009 cash EPS guidance of $0.74 to $0.82 per diluted share.

We expect our effective income tax rate for the full year of 2009 to be approximately 40%, which could fluctuate quarter to quarter due to what we previously discussed. We’re also forecasting 2009 capital expenditures inclusive of softer capitalization to be approximately $25 million, again consistent with prior guidance.

Given the predictability and recurring revenue nature of our business, we can tell you that our revenue cycle management in the first quarter is expected to grow organically between 9% and 11% versus the first quarter of 2008 acquisition-affected revenue of $41.6 million. For the remainder of the year, we expect our RCM revenue will grow sequentially on a relatively straight line basis through the end of the year.

Specific to our spend management 2009 outlook, we expect first quarter revenue to be down 6% to 8% from the first quarter of 2008 as our annual customer and vendor meeting is scheduled for the second quarter of this year versus the first quarter a year ago. Adjusting for the impact of this meeting, first quarter revenue is projected to increase between 2% and 4% versus last year. We expect our full segment results to be back half weighted especially in the fourth quarter given the timing of certain performance based contracts. In addition, the revenues associated with our 2009 customer and vendor meeting are expected to be about $3 million and our additional sales and marketing costs associated with this meeting between $4 and $4.5 million.

We anticipate our adjusted EBITDA margins to be lower in the first half of the year, especially during the second quarter due to the margin drag associated with the annual customer and vendor meeting and our first half hiring trends consistent with 2008. Given this, we expect our first quarter GAAP diluted EPS to be in the range of $0.02 to $0.04 per share.

Back in mid January, we filed a Form 8-K that provided details on the financial criteria for vesting our performance-based equity awards in our new long term performance incentive plan. On aggregate, vesting for approximately 59% of these underlying shares granted in January is subject to a 3-year compounded annual EPS growth rate. Our board and management team worked align these incentive equity awards to superior financial performance and shareholder interest. None of these performance-based equity awards will vest unless the company achieves a minimum cash EPS growth rate of 15%, and management is highly incented to achieve a 25% compounded annual growth rate of cash EPS. Our 2009 guidance model assumes 100% achievement and expensing of the underlying shares granted thus far in the plan.

There is one final topic I’d like to cover. This afternoon after the market closed, Welsh Carson Anderson and Stowe, one of our large private equity shareholders, distributed approximately 5 million shares of MedAssets common stock to its 100 plus limited partners. This is the entirety of their remaining ownership in our company and it effectively reduces the share overhang and increases our available public float. Importantly, Scott Mackesy, our Welsh Carson board representative, will remain on the MedAssets board and is not selling any MedAssets shares at this time. We have also consulted with our other two large private equity shareholders, and they both confirmed they are not short term sellers at the current price.

In summary, we are very pleased with our 2008 results and are confident in our 2009 outlook. With that, I’d like to thank you for your time this afternoon. I’d like to now open the call for questions.

Question-and-Answer Session 

Operator 

(Operator Instructions).  Your first question comes from the line of Ross Muken with Deutsche Bank. 

Ross Muken – Deutsche Bank

As we look at the worsening financial crisis, and I know you touched on it on the call, can you give us an idea of the types of discussions that you’re having? Is the urgency to deal with some of the cash collection and bad debt issues that hospitals are having, is it really forcing people to act more or is it this which has caused them the realization that this is software they need to potentially uptake, starting the process of getting them into the sales funnel, think about whether or not this is something the have to have? I am just trying to get the sense of urgency and as this cycle gets worse, and obviously despite what the stimulus is doing, hospitals are still under tremendous pressure. Do you we see a bit more dramatic shift, is this an inflection point in the industry in terms of adoption?

John Bardis

I believe that it is, Ross. While you can’t take any one short period of time as a guarantee of a trend, what we are experiencing is a tremendous expansion of our deal opportunity pipeline, and so that has again more than doubled over prior year, and I personally was in a large hospital system yesterday, and I’m going to be in another one tomorrow, but we’re seeing the following: One, they are seeing a fairly dramatic increase in bad debt. In one large system that I was in yesterday, they had gone from basically 11 of net revenue to 16 in a period of 18 months, so the unemployment rate is having a negative direct effect on collectable dollars, and then two, we know that hospitals are becoming very cautious with their capital, and so while the pipeline has expanded, they’re also equally very careful in how they use capital dollars or even operating dollars, so in some cases this challenge actually creates a longer timeline for the decision. Having said that, the size of our pipeline and the growth of it and the growth of our signed deals has accelerated well over the top of that to increase our growth rate, but the underlying factors of constraint capital has caused everybody to not only look at capital but operating dollars more aggressively. We think the early trends are that this is driving hospitals more in our direction as evidenced by the pipeline growth.

Ross Muken – Deutsche Bank

John, as you are going through all of this, your competitors are saying, well, they’re a niche vendor, they’re not supplying across the spectrum, hospitals are not looking at them, it’s just a relative add-on. To the degree that you’re having conversations with your customers about what your solution means to them relative to everything else they have installed, is that a discussion that’s going on or is that just something from a competitive standpoint that they’re using to basically suggest that everyone else could play in this market too?

John Bardis

I can’t speak for anybody who might be competing with us or hope to compete with us in this space. I would liken the example the large platform software solutions that are out there were necessary investments in platforms and chasis, but not unlike the automobile industry over the course of the last six or seven years and particularly the last two or three, because of extraordinary easy access to capital, we probably have had an over-purchase and over-utilization of the automobile industry of between 15% and 20%, and so back when capital was flowing easy, it was also easy to make major decisions on platform software solutions. That is no longer the case regardless of whether somebody might say that we have niche solutions or not. We happen to have 29 software solutions. I don’t think when you have 29 software solutions that go from the front end to the back end of the revenue cycle, you can call us a niche player, but having said that whether I agree with their position or not, the market speaks for itself relative to available capital which is nonexistent for these kinds of $20, $30, $40, and $50 million capital expenditures to continue, so the question is who’s got the right solution with a limited approach to utilization of capital to take advantage of the existing effectiveness that are in those platform software solutions while enhancing their performance given the realities of today’s environment.

Ross Muken – Deutsche Bank

Neil, on the share dispersion from Welsh, I’m assuming that’s just going to go in terms of it being distributed to the investors in the fund, and in turn they will turn around and sell it. Correct?

Neil Hunn

That’s right. It’s over 100 limited partners. If you draw upon the prior distribution several months, they did a 2 million share distribution, I think the next day we traded a little over 1 million shares, and so we expect to see a fair amount of trading going on tomorrow, but then it just trickles down after that.

Operator

Your next question comes from the line of Eric Coldwell with Robert W. Baird.

Eric Coldwell – Robert W. Baird

The Q1 revenue cycle management, I heard 9% to 10% acquisition-adjusted growth, is that year over year or quarter to quarter?

Neil Hunn

Year over year.

Eric Coldwell – Robert W. Baird

Okay, so you’re targeting roughly $45 to $46 million in Q1. Is that ballpark?

Neil Hunn

Yes, whatever the math works to be.

Eric Coldwell – Robert W. Baird

Same thing for spend management, 2% to 4% year over year adjusted for the annual meeting, so combining those two, Q1 organic growth is looking like it’s in the ballpark of 7%?

Neil Hunn

That may be a touch high.

Eric Coldwell – Robert W. Baird

So, a little under 7?

Neil Hunn

Yes

Eric Coldwell – Robert W. Baird

The question is given the upside that was posted in Q4, were some results in Q1 pulled forward or is there something going on with the timing that leads to the deceleration in organic growth in Q1?

Neil Hunn

Fourth quarter as we talked about, literally from this time a year up until the fourth quarter, there was just a tremendous amount of revenue that initially got recognized in the fourth quarter—the Cook County revenue, the Ministry of Ontario revenue, a very large spend management client guarantee sign-off and then several smaller signoffs from our medical device physician preference consulting practice, and so that was just the way the contracts flowed last year, and the revenues got recognized some in the third quarter and a lot of it in the fourth quarter. Similar sort of pattern is setting up for this year as well. It’s not seasonal for us to say that every year the second half is going to be bigger than the first half; it’s just the way that it has worked out this year and last year based on the timing of our contract signs and the implementation trends associated with them.

Eric Coldwell – Robert W. Baird

As I look at the model, perhaps I’m outside of the norm on this, but it looks to me like other service fees were the big driver of the incremental upside versus us in the street. I think your other service fees were almost $7 million versus $4.5 million in the last quarter, about a 50% increase. Was that related to one of these events you just mentioned?

Neil Hunn

Yes. The majority of what I just outlined would be considered non-administrative fee driven. That’s right.

Eric Coldwell – Robert W. Baird

So it falls into that non-revenue cycle management and also other service fee line.

Neil Hunn

I want to make sure I understand this last statement you said around non-revenue cycle management, because there are two distinctions to revenue. There is spend management and revenue cycle management in one cut, and another cut is admin fees versus the other service fee.

Eric Coldwell – Robert W. Baird

Right, and other service fees came in at $56 million, and that includes almost all of your revenue cycle management is about $49 to $50 million, so the delta there would be about $7 million.

Neil Hunn

That’s right.

Operator

Your next question comes from the line of Corey Tobin with William Blair.

Corey Tobin – William Blair

John, good to hear you mention the pipeline up over 100% again here. I think last quarter your mentioned that that RFP sub-segment of the overall pipeline was up about 70% to 75% year over year. Can you give us a feeling for how that’s trended here in the last quarter and if you’ve seen a pretty significant increase specific to RFPs.

John Bardis

What’s happened is that we’re seeing two things. One, the RFP activity is up; however, the sales funnel continues to grow at an accelerated rate which is indicative of execution of a strategy that we’ve got in place which is get to the client and explain the value proposition well in advance of an RFP. Clients tend to put RFPs together in either times of crisis or on some anniversary date, and so it’s been our objective to get ahead of those events by getting in front of the clients with specific data related commitments around what our products and services can do. From that, the client makes a decision to go forward with us not. The indications that we’re having in the sales funnel commitments and the doubling of its size indicate that we’re doing two things. One, we’re getting ahead of the RFPs, and two, that perhaps as a result of the environment and as a result of our effort to integrate and cross-sell in our existing client base that we’re having success in motivating clients toward these solutions.

Corey Tobin – William Blair

On the pipeline activity, can you give us the mix within the pipeline between existing and new accounts?

Neil Hunn

When you’re fortunate enough to work with 2 out of 3 hospitals, you’d expect that mix to bias pretty dramatically towards existing business in terms of existing customers coming from them, so the goal has always been at least prior to 2009 to be 50:50. The goal this year is to balance more focusing as John went through the priorities of the year, the number two priority up-selling and cross-selling. The number three strategy is adding new customers. They’re prioritized in that order for a reason. We hope to drive 60% to 65% to 70% of our new business coming from existing customers, and that’s natural given the size of the footprint, and pipeline generally reflects that outlook.

Corey Tobin – William Blair

On the decision support product, nice to see the win yesterday. Can you give us a feeling for how the pipeline is rebuilding for that business? Any metrics you can give around that would be great, and can we expect to see more large deals of that nature here in 2009?

John Bardis

I think we’re getting some very good traction in the marketplace with the new decision support tools; however, I want to be really cautious not to begin a trend here of disclosing exactly what we do with individual products at the granular level. I can tell you, however, that the momentum is very good here and the market is excited about the product. We also as you may know just given the ability to cross-sell the clients, we are able to create interesting incentives for clients through savings that we create or improved revenues that we create to then purchase this particular tool set.

Corey Tobin – William Blair

Neil, any guidance you can give us with respect to where do you thing operating cash flow is going to shake out in 2009?

Neil Hunn

Corey, I would think that operating cash flow going by literally the definition of operating cash flow from the cash flow statement divided by EBITDA will stay in the 50% to 60% range where it’s been the last couple of years.

Operator

Your next question comes from the line of Richard Close with Jefferies & Company.

Richard Close – Jefferies & Company

I was wondering if you could talk to us a little about the $30 million current debt on the balance sheet. It didn’t seem to be there last quarter. It didn’t seem to be in the maturities table from the 10-Q, so what exactly is that?

Neil Hunn

What that is is our term loan facility, the team loan B that we have, in that contractual arrangement, we have an annual excess cash flow sweep calculated based on our prior year performance. It’s a pretty detailed calculation. We estimate that cash flow sweep in late first quarter/early second quarter to be about $30 million, and so what we’ll do is we will borrow on the revolver for that $30 million and then pay down the term down, and then once that happens, that revolver will get likely re-classed back to long term, so it’s a year-end event. The reason you didn’t see it on the third quarter balance sheet was because we couldn’t calculate precisely the amount of the excess cash flow sweep, so we didn’t know. You can’t put an unknown number in the table. The final point I will make on this is that we actually on balance prefer to have debt on the revolver because it carries about 100 basis points lower interest versus the term loan, and so from a treasury management point of view, we prefer that.

Richard Close – Jefferies & Company

When we think about the backlog here or the forward 12, I guess, good to hear that Memorial Care, Piedmont, and Baylor were not included in that number. How should we think about those contracts rolling into the backlog number?

John Bardis

They will obviously, but you need to understand the construct of that number. It’s the estimate of what the next forward 12-month revenue is. To the extent that we sign up deals that have guarantees or performance measurements in them, where it takes us 18 months to get to those, they won’t bleed into this contracted revenue number for another couple of quarters, and that’s the case with any business that we sign with guarantees on them. So they will bleed in over the course of next quarter or two. We do expect that the first quarter contracted revenue number will be up more consistent with prior outlook, but the second quarter number will likely be flat to down because we’re dealing with the Ministry revenue that as we’ve talked about for the last two or three quarters will start rolling off on June 30th for 12 months, so this is one that we have a high degree of visibility into, and we have a great confidence in the number because last year at this time, we were 85.1% to the mid point of our guidance, and this year we are at 86%, and so all this is predicted and forecast and here you see it manifesting itself.

Richard Close – Jefferies & Company

Does that mean that Memorial Care, Piedmont, and Baylor are all contracts that are performance based?

John Bardis

No, not all of them are.

Richard Close – Jefferies & Company

With respect to commentary on comprehensive revenue cycle deals, it sounds as though there is the potential for revenue cycle average deal size to be increasing. Can we interchange that comprehensive adjective with transformational? Is that what those are? Are you seeing more transformational opportunities on the revenue cycle in the current environment?

Neil Hunn

Yes.

Richard Close – Jefferies & Company

The final question here would be on market share in 2008. Do you have any commentary along the lines of market share on the spent management side of the equation?

John Bardis

It’s a question you’re asking. The reality is that mathematically market share is a moving target in spend management given the size and scope of the transformational deals right on top of the traditional group purchasing industry. So the reality is nobody knows including us how big the market is, but when you look a single site, that could be from $3 to $8 million a year just on transformational without there being group purchasing component. You know that it’s expanding the size and scope of the market. I think if there is any particularly meaningful news in that for us, it is that we’re learning about the expanded size and scope of the opportunity that makes the overall spend management market bigger than when we entered it. When you look at the spend management market historically, we tended Richard to look at it as a GPO and technology play; however, now as we look at the transformational projects that we’re undertaking, it literally includes in some cases managing the entire supply chain as well as the personnel of hospitals, so you then at that point in time now are looking at a much expanded scope and size of market, and I don’t really know how big that is.

Richard Close – Jefferies & Company

Let me try to ask it in a different way then. You announced two deals in the GPO area, Piedmont and Baylor. I assume that they had relationships prior to spend management relationships with you. Correct?

John Bardis

That’s correct, but I will also point out that the Sutter, Richard, relationship at the scope that we’re doing it today did not exist previously, and that transaction at least the same size as the combined size of Piedmont and Baylor.

Richard Close – Jefferies & Company

My point is it seems to look like you guys are definitely gaining momentum on the spend management side of business.

John Bardis

I think so. I think what’s happening now is that people are looking past traditional relationships that might have been forced in an environment where cooperation and a co-op model made sense for reasons other than the financial pricing or process for the delivery of spend management results, and today’s environment is simply not affording those relationships to get in the way of the demand to improve financial performance.

Operator

Your next question comes from the line of Larry Marsh from Barclays Capital.

Larry Marsh – Barclays Capital

To the extent you can, can you share a little bit of back story, particularly on Baylor which is a new announcement. Was this a situation as you describe it where they couldn’t continue with business as usual? Was there particular issue that really drove home your value proposition?

John Bardis

I think so, Larry. I think there were a number of factors that caused Baylor to make the decision and a number of those are very consistent with past client decisions as to the reasons given for coming to us. However, Baylor is particularly noteworthy because it is one of the original shareholders of the large competitor that we were able to win Baylor from, so when I’m talking about that, we are talking about a handful of very large teaching institutional that were foundational to the formation of that business, and in this case, there were prices being paid at the pump relative to specific product offerings at Baylor which were not just higher but dramatically higher than market results that we had produced for smaller buyers of similar products in the same state of Texas, and those dollars added up to being the multi-tens of millions of dollars in terms of just pure price differential.

Larry Marsh – Barclays Capital

Is it fair to say that this was an examination that you help lead and it sounds like certainly some eye-opening moments for them.

John Bardis

I think so Larry. Having known the CEO of the system for a long period of time and the extraordinary integrity with which he has conducting himself for decades in our industry, being in the meeting when that information was revealed, I can only say that to the degree that you could have a reaction known as professional shock, I think he had it.

Larry Marsh – Barclays Capital

The points you make about the existing relationship with another alliance. In changing the GPO relationship, these systems can still be part of their shareholder of their current alliances and how difficult of a process is that or are they moving toward a more separation event of their existing relationship?

John Bardis

That’s a great question. I think most that we find in this situation try to remain part of the alliance for some of the other less financial, but more clinical and even social common interest of those alliances. However, funding those alliances through dollars that are being applied in some cases because of prices being extraordinarily high or much higher than what they can afford any longer is no longer an option. In another words, these institutions are no longer willing to fund those alliances through the process of purchasing products through those alliances at higher prices.

Larry Marsh – Barclays Capital

Just two other clarifications on data point. Sutter and the transformational deal you talked about last March, is it fair to say that this could be one of your largest customer relationships with this, and if so, what’s the timing? Is this a set 3- to 5-year relationship or is this an evergreen?

John Bardis

To answer your first question, yes, it is one of our largest relationships. No question about it. Larry, I’ve got to go back and look at the detail, and I apologize for not knowing it off the top. I think it is a 3-year relationship, it might be 5, but I have to double check that. The size and scope of what Sutter’s responsibilities here are in the supply chain really quite impressive.

They’ve got a $1.6 billion supply chain alone and over 20 institutions that they have to support, and putting that in perspective with either product changes or code changes or contract pricing changes, our own business at the national scope and level, we negotiate somewhere around 3 to 4 contracts nationally per day, so when you look at that the scope of what a Sutter touches in their supply chain. They simply don’t have the resources to either technically manage and analyze the information associated with those agreements, but equally true, the personnel that implement those contract renegotiations and changes, and as the market moves to a more localized version of group purchasing using information technology to band together a series of both local, regional, and national contracts for the best interest and best pricing available to those institutions, those institutions are simply not empowered through the correct use and availability of technology and personnel to manage a project of that scope, so these transformationals are changing the entire mix of how contracting is done, where the housing of that contracting takes place, and how the data for that contracting is analyzed, and so that no longer can be sequestered to a national group purchasing alliance but a rather a series of local events, and that’s where we think these transformational solutions really find their home.

Larry Marsh – Barclays Capital

Obviously, I’m thinking there’s more to come. They are under this branded model.

John Bardis

I think so Larry. We are feeling positive about the environment in that regard, but I will say the financial environment that’s out there today is nasty and getting worse, and that’s particularly true in environments where those adverse payer mixes being driven by an aging population, where a greater percentage of the hospital dollar is being derived from either Medicare or Medicaid, and that is changing the entire paradigm of cash flow.

Larry Marsh – Barclays Capital

We are going to be hearing more details of a healthcare reform plan. The headlines today, hospitals under the gun and spending cuts, which I guess illustrates your point. Any initial read of what you think you might be seeing and how your customers may be reacting?

John Bardis

What I read in this Larry is more of the same, in particular a regulatory analysis perspective. We’re going to see the regulators, I think, get much more aggressive with hospitals about payment. We are going to see regulators ultimately empowered by these budgets and even with changed laws to be accountable to certain costs and outcomes. I don’t see any of the budgetary changes as it relates to hospitals in particular ultimately being a positive for them, meaning that they are going to get a bolus of cash a result of a budget stimulus. The only place that we see the stimulus affecting the hospital in a positive way is at the state level where state Medicaid coffers have been reenergized and refilled by this stimulus package which will remove some of the zero-based comp care that’s out there but at much lower rates. All in all, we see the environment being created by this new budgetary cycle is being broadly negative for hospitals and pushing them more aggressively towards reducing costs and maximizing efficiency, and having said that, the good hospitals and even those that have been less effected in the past now are starting to look around the corner as opposed to waiting until they reach the intersection without a stop light.

Larry Marsh – Barclays Capital

I appreciate the greater clarification of the performance-based awards that you disclosed back in January. Do we assume share-based compensation to get to that 17-17.5 level? Is it a pretty straight line throughout the year or do we think of that in any sort of seasonality?

Neil Hunn

I would assume it’s a pretty straight line. All the shares that are going to be issued are issued with the exception of some new hires and some promotions that’ll happen, which in the grand scheme are pretty small dollars. The next big slug of shares will be granted in the first quarter next year, so I think you can see them as a pretty straight line.

Larry Marsh – Barclays Capital

So it goes up to 4-4.5 and then straight line from there per quarter?

Neil Hunn

That’s right. And then just to clean up on the Sutter point, it’s a 5-year relationship. That we confirmed while we are waiting here.

Operator

Your next question comes from the line of Donald Hooker with UBS Securities.

Donald Hooker – UBS Securities

You had a Medicare RAC solution you rolled out, I think, in October. Did you get any initial feedback on that or can you give us a sense on how that’s gone?

John Bardis

Yes. Let me turn that to Neil because he gets to actually speak to some very fun numbers here. Go ahead Neil.

Neil Hunn

The RAC solution is a combination of technology solution and a couple of service offerings that we wrap around it, and as you may have heard from prior communications, we’ve held four industry webinars where over 700 hospitals have listened to what we have to say about the RAC issues. As you know, the program is in full scale deployment broadly to all 50 states right now, and it’s early. We have a few beta clients that are up and running on the products that have signed, they are paying, but we are literally in 100s of conservations with prospects around or what we do its helping them with the RAC issue. It’s very early, but there is great momentum.

Donald Hooker – UBS Securities

May this is not a question, but is there any way to quantify the realistic size of the opportunity?

Neil Hunn

It’s hard right now. It’s early stages of little sub-industry that’s forming. Hospitals will probably spend in the neighborhood of $50,000-100,000, maybe $150,000 a year dealing with this issue, so you can size the industry that way. Relative to what that’s going to be for us, it is way too early to know.

Donald Hooker – UBS Securities

The Accuro integration, we should consider that done, right? That’s been done for a while, right? Any kind of integration pain or anything left?

Neil Hunn

The integration is done. There are three components to integration. There is the sales integration. That was completed in October of this past year. There is the administrative integration around technology systems, accounting systems, and billing. That was basically completed in the end of the fourth quarter and into the very beginning of the first quarter this year. Then there is the product and organizational integration, and the leadership team and the organizational structure was done in the fourth quarter, and so in that term, the integration is done, right? Now, we have lots of new products to build, lots of technology-related integration items that we’re working on that we will work on for years, but in terms of the initial stops and starts and sits associated with any integration or acquisition, I think we consider that book closed.

Donald Hooker – UBS Securities

I think you are going to pay a contingency payment later in the year. Is that right?

Neil Hunn

That’s right. It will be in the late second quarter. It will be a $20 million payment, and we’re almost certainly going to pay that with cash.

Donald Hooker – UBS Securities

Did you mention CapEx trend for ’09?

Neil Hunn

We talked about it being $25 million in total capital expenditure including cap software, and you can generally straight line that, maybe slightly back half weighted a little bit, but basically straight line.

Operator

Your last question comes from the line of Constantine Davides from JMP.

Constantine Davides – JMP

Just one more followup on some of the GPS success you’ve announced. I am just wondering what the competitive response has been at this point. Are they getting more aggressive on price or are you seeing some attempted imitation or whatever you can describe there?

John Bardis

Well, first we did not get the fruit basket this Christmas from our competitors. We normally get something. The other is that the attempts have been made to increase share-back dramatically, but as you know, taking a high percentage of 3% of spend and giving it back to the client doesn’t necessarily add up well financially to what can be a 15% improvement on half of their med surg spend, so the dollars that are being thrown back at customers in the traditional group purchasing methodologies are not being received terribly well. I will say that we see two of our larger competitors attempting to come in with some form of financial improvement metric. Whether that’s a target or a guarantee tends to change, but we’ve learned that the way those competitors look at guarantees or identify guarantees is oftentimes substantially different than how we measure them. In other words, a cost avoidance for our competitors versus direct cost reduction in our case, but we are seeing more aggressive attempts to try to mirror the financial improvement approach that we are undertaking.

Constantine Davides – JMP

Just a couple of follow-ups for Neil. The DSOs were up a few days sequentially. Is there anything notable going on there.

Neil Hunn

You are right. They are up by three or four days. Two things, one is we have our first large Cook County invoice that was sent at the end of the quarter, so that’s swinging a little bit, and then we also transitioned the Accuro billing to our operation and our platform late in the fourth quarter and stumbled by three or four weeks getting the initial invoices out, so that will clear itself up in the first quarter.

Operator

We have no further questions at this time.

John Bardis

Thanks again for taking the time to participate in our conference call this afternoon. We believe that MedAssets has the focus, expertise, and value proposition to perform very well in both good and bad environments, and we look forward to sharing our success with you in the weeks and months to come, and thanks once again. I hope you enjoy your evening.

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Source: MedAssets, Inc. Q4 2008 Earnings Call Transcript
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