Accretive Health, Inc. (OTCPK:ACHI) Q2 2016 Earnings Conference Call August 4, 2016 5:00 PM ET
Atif Rahim - Head, Investor Relations
Joe Flanagan - President and Chief Executive Officer
Chris Ricaurte - Chief Financial Officer and Treasurer
James Auh - Cowen
Good day, ladies and gentlemen and welcome to the Accretive Health Second Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now like to introduce your first speaker for today, Atif Rahim, Head of Investor Relations. You have the floor, sir.
Thank you, Andrew and good afternoon everyone. With us today we have Joe Flanagan, Accretive Health’s President and CEO and Chris Ricaurte, CFO and Treasurer. We will start with prepared remarks from them and turn it over to Q&A.
As a reminder, today’s conference call is being recorded and certain statements contained in this conference call maybe considered forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. In particular, any statements about the benefits, expectations and financial impacts of our deployment with Ascension or cost reduction measures or future growth plans and performance are forward-looking statements. 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. Our actual results and outcomes could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the factors set forth in our annual report on Form 10-K for the year ended December 31, 2015, under the heading Risk Factors. The forward-looking statements made on today’s call are based on Accretive Health’s current expectations and projections of our future events as of today only and should not be relied upon as representing the company’s views as of any subsequent date. While the company may elect to update these forward-looking statements at some point in the future, Accretive Health specifically disclaims any obligation to do so to reflect actual results or changes in factors or assumptions affecting such forward-looking statements.
Now I’d like to turn the call over to Joe.
Thanks, Atif. Good afternoon, everyone. Thank you for joining us and welcome to the call. This is the first time Chris and I are speaking to you since I took on the CEO role just over 60 days ago. We are both very excited to lead this company and I strongly believe Accretive Health has the capability that is unmatched in the market. We also have an extremely talented, devoted and passionate employee base eager to serve our customers. My goal, the leadership team’s goal and the entire company’s goal will be to maximize the true potential of the company over the long-term.
With that in mind, what I would like to do on this call is to frame for you the areas of critical importance that we are focused on in the near term and the logic around the sequencing of our efforts in these areas. I’d like to do this with an eye towards shifting the focus of our dialogue to more strategic views of the company and establishing a consistent framework to provide progress updates against. My foremost priorities in the near term are to balance the necessary investments for a successful Ascension deployment and reignite our growth engine outside of Ascension. This involves the need to establish the right cost structure and organizational capabilities now to enable effective scaling of our company operations to maximize long-term profitability. This should result in cost reductions in certain areas while simultaneously making investments in other areas.
Over the past 60 days, we have been squarely focused on this priority. About a month ago, we announced the plans to reduce costs in certain functional areas. As a result, we expect annualized savings of approximately $16 million per year when you compare the run rate cost structure as we exit 2016 relative to our 2015 exit rate. Two-thirds of the cost savings will come from corporate and administrative functions. Our operations functions are largely unchanged with the exception of some small volume-related reductions. As we make these cost reductions, we find it equally important to continue to invest in strategic organizational capabilities that are key to driving growth.
In addition to the previous communications related to our investments to build a world-class deployment function, last week, we announced the appointment of Doug Berkson, as Senior Vice President of Strategy and New Product Development. Doug joins us with 15 years of healthcare experience, working with payers and providers in the value-based care world on contracting, reimbursement models, interventions and strategy. As payment models evolve in healthcare, Doug’s role will be instrumental in helping us leverage our technology, manage services and operating platform to help current and prospective clients successfully navigate value-based contracts. Many of our large hospital and IDN clients are engaged at varying degrees with risk-based models and Doug’s expertise will help us to build out our capabilities in these areas.
In addition to Doug, we also brought on board Bob Luse to lead the company’s human resource organization, which is a critical capability related to talent management to enable effective scaling as well the successful integration of employees as part of our end-to-end outsourcing offering. Bob joined us from Nuveen Investments, where he was Chief Human Resources Officer for over 8 years. Prior to that, Bob was CHRO globally at Sears Holdings and at Dade Behring. At Nuveen, Bob led a culture initiative working with other executives and employees, which produced core values and leadership alignment on how work gets done at the firm.
As discussed on our Q1 call, a priority of ours is to create a clear and unified cultural identity for the company. Having a unified culture is a key to a high-performing organization and will be important to our overall execution and being responsive to customer and market needs. Bob is a great addition to the team and I am looking forward to his leadership in driving this priority forward.
Turning to Ascension, our deployment with Ascension is on track and gaining momentum as a result of the investments we have made in our deployment function as well as the execution framework we have created. We have fully transitioned the equivalent of roughly 200 employees over the past month and are on schedule to onboard another 1,500 employees by the end of the year. To put this into perspective, this is a 50% increase in our workforce within the calendar year 2016. And with that increase, we are gaining key capacity and capability.
In addition, we have essentially completed the standardization work across our current book ministry operations which has resulted in standardizing 160 plus processes. Finally, we are well underway on the technology implementation across the Phase 1 of the additional book ministries, which involves the rationalization of existing technology vendors and full implementation of the Accretive Health technology suite. Clearly, this outsourced offering with Ascension has greater deployment complexity and associated startup investment compared to our historical co-managed offering. This provides a higher degree of control and the ability to drive superior financial and operational outcomes over the long run that are mutually beneficial for our customers and Accretive. In addition to Ascension, we remain focused on our broader customer base. We have an important renewal underway with our second largest customer and we will update you on this front on future calls.
The next area of strategic focus is our sales approach and go-to-market strategy. As a company, we have not done a great job articulating our capabilities to the market. This is largely due to distractions over the last few years ranging from the restatement to the recent strategic process, which resulted in the company being very internally focused. Now that those distractions are clearly behind us, we go to market with three types of model: an outsourced model, where we transition the customers’ employees to Accretive and exercise full control over revenue cycle operations; two, a co-managed or infused management model, where we deploy complementary talent to work side by side with the customers revenue cycle team; and third, modular solutions focused on specific functions of the revenue cycle. Under this model, our goal is to eventually transition the customers to an outsourced model or co-managed model to realize the full benefit of our capabilities. In all three models, we deploy our operational excellence roadmap inclusive of our full suite of technology applications to drive results. The key difference in these three models is the level of operational control and process coverage that we oversee, which ultimately determines our fee or incentive structure.
While we refine our go-to-market approach and communications, our sales process is not on hold. The pipeline remains active and we are in discussions with a number of large IDNs, which is the sweet spot of the market for us. We have the capacity to onboard new business beyond the Ascension business we are currently on-boarding. The deployment office I discussed in detail on the last call has purposely been designed as a strategic function with the ability to scale and support simultaneous implementations across multiple customers.
Finally, given the amount of ongoing change we are seeing in the industry, such as customer M&A activity, the shift to new value-based reimbursement models and increasing regulatory complexity, the third area of focus over the coming months will be to develop a process framework to regularly assess and enhance our capabilities and offerings. Key areas that are strategically important for us include physician RCM, value-based reimbursement and patient engagement. With the cash we have on our balance sheet, there are investments we can make in these areas, which stand to broaden our offerings and improve our earnings power.
Before I turn it over to Chris to discuss financials, I would like to update you on our re-listing process. I am pleased to say our Board of Directors completed the evaluation of the timing of our re-listing and unanimously voted to begin the re-listing process at this time. One of the re-listing requirements on both major exchanges is a $4 minimum stock price. This may require reverse stock split, which in turn would require shareholder approval. We expect to file the proxy statement for the annual meeting in the next couple of months. We anticipate holding the Annual Shareholder Meeting in early December, which would support a listing on one of the major exchanges in early 2017.
In closing, I want to say that we are firmly committed to making the right investments to build on our strong foundation that will enable the company to prosper over the long-term. I am pleased with our pace of execution against the near-term objectives and feel confident that we have a clear strategic focus going forward.
Now, I would like to turn the call over to Chris.
Thank you, Joe. Good afternoon, everyone. As I settle into the CFO role, I have been pleased by the strength of our controls environment, which allows me to focus on one of my goals to build a finance organization that partners with our operation teams at shared service centers and our customers’ sites that helps forecast and identify critical interdependencies that will help us achieve our financial and strategic objectives. We started making progress on this in the second quarter by making adjustments to improve the visibility of financial performance to the managers in the business. This helped facilitate the process of the announced restructuring at the end of the second quarter to align our workforce to our current customer needs while balancing future growth needs. These changes are an important step in placing us on a path back to profitability. We now have a more efficient company cost structure, which provides us with better operating leverage as we grow. We will continue to look for ways to ensure we have the most efficient cost structure possible to deliver sustainable growth and return for our shareholders.
Last quarter, I discussed moving away from providing net patient revenue, or NPR, under management as a quarterly metric we provide to investors. NPR on its own can be an indicator of the size of a hospital or health system, but it also presents some complexity. For one, as health systems expand and acquire physician groups, rehab facilities, ambulatory, surgical centers, etcetera, the line starts to get blurred at the system-wide level as to what exactly constitutes NPR in our focus area, which is primarily the inpatient area and in some cases, affiliated physician groups and ambulatory clinics.
Secondly and more importantly, the revenue and profitability under the three go-to-market models that Joe referenced varies to considerable degrees. For example, revenue per $1 billion in NPR under a fully outsourced arrangement, such as the one we have with Ascension, is significantly higher than what we have under our co-managed or infused management model we have at other customers. By the same token, profitability under our modularized arrangement is different than what it is under our fully outsourced or co-managed model. As our fully outsourced model and modularized book of business grows, NPR on its own becomes less relevant of a metric. As such, we will stop providing it on a quarterly basis. We will continue to provide hospital count as the measure of our traction, but please keep in mind that not all hospitals are created equal. We may evaluate this metric in the future as well, but it’s worth providing in the near term as the measure of our traction in the market. We currently serve 72 hospitals, down from 77 as of the last call due to a couple of non-renewals. This was factored into the revenue projections for 2016 which I provided on the last call and are within our expectations.
Now, let me turn to second quarter results. Before I walk you through the results, I would like to remind you that we will be referencing non-GAAP numbers and a reconciliation to the most comparable GAAP measures is included in this afternoon’s press release. We use two non-GAAP measures to supplement our GAAP results and to provide a better view of our operations. The first measure we use is gross cash generated from customer contracting activities, which is our reported GAAP revenue plus the change in deferred customer billing. The second measure is net cash generated from customer contracting activities, which is our reported net income before interest, taxes, depreciation and amortization, share-based compensation, reorganization-related expenses and certain other items as well as the change in deferred customer billing. Effectively, it is our adjusted EBITDA plus the change in deferred customer billing. These two measures are primarily how we internally measure our financial performance and we believe it’s important for investors to look at our results on this non-GAAP basis as well.
The reason we use these non-GAAP measures is GAAP revenue recognition for our customer contracts is typically deferred until substantially later than when we deliver services, bill and collect cash from our customers. Starting in 2017, we plan to early adopt FASBs new revenue recognition standard, which should simplify our GAAP accounting and potentially reduce the need for non-GAAP measures. While we have not yet finalized all the potential effects of the new standard on our consolidated financial statements, the result should be that revenue for base fees will be recognized as services are provided and incentive fee revenue will be recognized after the measurement period end. Ultimately, this will result in an alignment of our GAAP reported revenue when services are provided and hence an improved matching with expenses. We will keep you updated on this on future calls.
Turning to Q2 results, gross cash generated from customer contracting activities was $38.3 million compared to $47.2 million for the second quarter of 2015. This decrease was largely a result of reasons we discussed last quarter mainly transition of customers to fixed fee contracts, a reduction in scope at certain customers and M&A related customer attrition. Our PAS business has started to turn the corner and generated $0.7 million increase relative to the second quarter of last year and sequential growth of 31%. Cost of services increased $1.6 million over the prior year to $41.4 million primarily due to higher ICD-10 costs and the expansion on our shared service centers and technology expenditures. The restructuring we announced in late June should help mitigate the increase to a certain degree, but as we onboard new Ascension business, we do expect the cost of services line to increase.
SG&A expenses increased slightly by $0.2 million from the prior year to $14.3 million. The savings realized from functional areas were offset by severance cost of $3 million related to the departure of our former CEO. Net cash generated from customer contracting activity was negative $17.4 million in the quarter compared to a negative $6.6 million a year ago. The decrease was primarily driven by the decrease in gross cash generated coupled with an increase in cost of services and SG&A costs that I just mentioned. Again, the actions we took in June to address our cost structure are expected to lower costs and improve our results in the second half of the year. One-time costs and other costs amounted to $8.7 million primarily due to transaction-related costs associated with the Ascension TowerBrook transaction and restructuring costs.
Our cash position at the end of June, inclusive of restricted cash, was $223.2 million, down from $283.5 million at the end of March. The decrease was driven by the negative net cash generated from customer activities coupled with changes in working capital and investments in property, equipment and software.
Turning to 2016 and beyond, our cost structure is something we continue to evaluate and there continues to be some moving parts around our deployment and onboarding costs related to the Ascension contract. That said we remain comfortable with the top line indication that we provided last quarter, which implied gross cash generated of $200 million to $220 million for the full year. Again, we expect an improvement in our net cash generated in the second half of 2016 relative to the first half.
Lastly, I have had an opportunity to review the long-range outlook that was provided in December 2015, which targeted top line of approximately $700 million to $900 million and net cash generated margin in the mid to high teens when the Ascension contract is fully rolled out combined with organic growth. We have reaffirmed that the economics of the Ascension contract still holds and we are comfortable with the projections that were provided. We plan to continue to update that view as we firm up our strategic plans over the coming months.
In closing, the company is making progress for a return to profitability. We remain well positioned with a 10-year contract with Ascension, and we are confident we can deliver a low-cost RCM solution for our customers and the hospital IDN market in general while delivering sustainable profitability and consistent results for shareholders. We are making progress, and I look forward to updating you on the financial implications of that progress in the future.
Now, I would like to turn the call over to the operator for Q&A. Operator?
[Operator Instructions] Our first question comes from the line of James Auh from Cowen. Your line is open.
Hi, thanks for taking the question. The question is, were these three go-to-market models available before or is this something new?
Hi, James, it’s Joe. The three go-to-market models were available before, but let me give some color and context on that. Clearly, the co-managed model on an end-to-end basis is something that the company was formed on and we continue to have a very vibrant and competitive offering along those lines. What I would say is as we think about modular services, we have done a lot of work over the past couple of months to sharpen the focus on the definition of those modules and how we compartmentalize those services, which involves the connection of our technology platforms into the services that are associated with that particular scope of the revenue cycle. So, it was always available. What I would say in a compare and contrast sense is we spend a good amount of time productizing that portion of the model. And then finally, the fully outsourced end-to-end model is something that we are fully deploying with Ascension. And on the basis of that deployment, we feel confident in that offering as we look broader into the market going forward.
So, I guess the main point is you are just, I guess, better articulating your capabilities in the market and has that been resonating with new clients or prospective clients?
Yes, I think it’s correct. And I said this in my remarks and I still think we have work to do here. But we have got a healthy amount of focus getting the company externally focused. I would say that as a headline statement, very important and long overdue. We have been internally focused driven by some of the things we have been working through internally. The second thing I would say is I am encouraged by the progress we have made over the past two months doing a better job articulating our value proposition to the market. I am not pleased or I don’t think we are where we need to be fully yet and that was some of the comments in my opening remarks, but I am very encouraged. And based on that work, even though it’s early innings, we are very encouraged with the response we are getting from prospective customers and that fuels some of the vibrancy that we referenced in our pipeline outside of Ascension. But I would say, this is an area – as we look forward over the next couple of months, we intend to maintain as a priority for the company.
And the last question is, so SG&A was higher, I think you said about $3 million due to severance, I guess to Emad. So, looking at second half, you guys are supposed to benefit from your restructuring effort. So, should we expect, I mean, backing out that $3 million of the $14.3 million and then a further reduction in 3Q and 4Q on a quarterly basis?
Yes, this is Chris Ricaurte. Yes, the – we do expect a decline in our SG&A run-rate in the third and fourth quarter. That will be partially offset as we continue to make investments primarily in our HR area for the on-boarding of the Ascension ministries, but we do expect a decline quarter-over-quarter.
Okay, thank you.
[Operator Instructions] And that looks like all the questioners that we have in the queue at this time. So, I would like to turn the call back over to Joe Flanagan for closing remarks.
Thank you very much. In closing, I would just emphasize very pleased with the pace of execution the past couple of months. I am encouraged. I think the workforce is engaged and has a clear focus and just very, very excited to continue to update you on the progress in future calls. Thank you very much.
Ladies and gentlemen, thank you again for your participation in today’s conference. This now concludes the program and you may all disconnect at this time. Everyone, have a great day.
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