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Accretive Health (NYSE:AH)

Q2 2012 Earnings Call

August 08, 2012 8:30 am ET

Executives

Gary Rubin

Mary A. Tolan - Founder, Chief Executive Officer, President and Director

John T. Staton - Chief Financial Officer and Treasurer

Analysts

Atif A Rahim - JP Morgan Chase & Co, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

Ryan Daniels - William Blair & Company L.L.C., Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Stephen B. Shankman - UBS Investment Bank, Research Division

Sean W. Wieland - Piper Jaffray Companies, Research Division

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Accretive Health, Inc. Earnings Conference Call. My name is Stephanie, and I'll be your coordinator today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today to Mr. Gary Rubin, Investor Relations Officer. Please proceed.

Gary Rubin

Good morning, and thank you for joining us. With me on the call today are Mary Tolan, Accretive Health's Founder and Chief Executive Officer; and John Staton, our Chief Financial Officer.

Earlier this morning, we issued a press release announcing Accretive Health's Second Quarter 2012 results. A copy of that release is available in the Investor Relations section of our website at www.accretivehealth.com. Please note that certain statements contained in this conference call may be considered forward looking as defined by the Private Securities Litigation Reform Act of 1995. In particular, any statements made about Accretive Health's expectations for future financial and operational performance, expected growth, new services, profitability or business outlook are forward-looking statements. Investors are cautioned not to place undue reliance on such forward-looking statements. No assurance that the matters contained in such statements will occur since these statements involve various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. These risks and uncertainties include those listed under the heading Risk Factors in the company's quarterly report on Form 10-Q for the quarter ended March 31, 2012, filed on May 9, 2012, which is available on our website, as well as the SEC's website. The forward-looking statements made on today's call are based on Accretive Health's beliefs and expectations as of today, August 8, 2012, only and should not be relied upon as representing the company views as in 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 even if our views change.

Please note that today's discussion will include references to certain non-GAAP financial measures. Please refer to today's earnings release for more information on these non-GAAP measures and the reconciliations to the appropriate GAAP measures. After the conclusion of Mary's and John's prepared remarks, they will be available to answer your questions.

At this time, I'd like to turn the call over to Mary Tolan, Accretive Health's CEO. Mary, please go ahead.

Mary A. Tolan

Thank you, Gary. Good morning, everyone, and thank you for joining today's call. Despite a challenging quarter, we have a number of promising updates to share with you. We recently signed our 5-year renewal with Ascension Health with a total contract value of $1.6 billion to $1.7 billion. As you know, Ascension Health is the nation's largest Catholic and non-profit healthcare system. We're proud of the strong working partnership that we've formed with Ascension, and we believe that this is a leading indicator of the sound and growing relationships we establish with our clients. We look forward to the next productive chapter of our partnership, and with this contract, we'll be providing expanding value.

Our intra-stay quality program continues to move forward, and we are now in final contracting with a multi-hospital roll out. This is a great opportunity to establish the value of intra-stay with one of our largest clients and to promote this offering to other hospital systems.

Regarding Quality and Total Cost of Care, we are now in final contracting with a leading national cancer physician network. This organization's identified Accretive as the right partner to help their practice group members provide and monitor care through a coordinated and integrated approach that delivers better outcomes for patients while controlling costs.

As far as the pipeline. We're very pleased that our pipeline in final contracting remains a robust $100 million to $120 million in annual PCARR, and we see an even greater book of business beyond the final contracting stage. To give you some more insight in how we view our pipeline, we're going to explain the stage right before final contracting, which we call "solution." In the solution portion of our pipeline, these prospects have already gained executive sponsorship behind the decision to engage Accretive as a partner. We've completed the long vetting process, and the top decision makers have decided to move forward, but we have not yet started the actual legal contracting. When we estimate the potential PCARR in the solution stage, it's another $100 million to $120 million in addition to the $100 million to $120 million in final contracting. So this gives us a line of sight to $200 million to $240 million in PCARR growth.

Our dedication to process excellence requires us to carefully examine our own practices to ensure that we're setting very high standards for our own performance in achieving the best possible outcomes for hospitals, patients and communities. To that end, we're committed to achieving the highest standards in confidentiality of patient health information through actively pursuing the high trust certification of our data security practices and procedures. We are targeting the end of October for being able to achieve this high-trust certification.

Further, we took a leadership role in the formation of an independent blue ribbon committee, whose purpose is to develop objective standards and practices for addressing patient financial obligations for the care they receive. It's chaired by Michael Leavitt, the former Secretary of the Department of Health and Human Services, and committee members include some of our nation's top experts in government and health care. We will seek full certification under the new standards when they're issued.

On the talent front, we recently filled key positions with incredibly talented people who recognize the impact of the work we do and want to be part of the innovation. Over the last few months, Dr. Scott Nicholson joined us as our Chief Data Scientist; and Todd Frech is our Chief Information Officer. Scott comes to us from LinkedIn where he was the Senior Data Analyst -- or Senior Data Scientist and is assembling a team at Accretive to pursue big data insights and building productive models and solutions. Todd was formerly a leading technology partner at Accenture who lead engagements for Fortune 100 clients and is a great addition to our leadership team. We continue to recruit world-class experts to take our business to higher levels of performance.

Before I turn the call over to John Staton, I want to say a few remarks on our settlement with the Minnesota Attorney General. We believe the allegations against our company were unfounded and politically motivated. While we strongly believe that we would have prevailed in court, the reality of the litigation and political process today, unfortunately, makes settling this dispute the wiser course. We strive every day to be a constructive and positive contributor to the American health care system, and we're extremely proud of our record in helping hospitals find all available coverage for patients and ensuring that insurance companies and government programs pay our clients what is due for the care they provide. In the end, there was some fallout and due to the regulatory environment, we chose to remove our operations in the state. This distraction is behind us now, and it's time to get back to business.

Now our Chief Financial Officer, John Staton, will review our second quarter results and outlook for 2012. John?

John T. Staton

Thanks, Mary. Good morning, everyone, and thanks for joining our call today.

Beginning with net services revenue for the quarter. Our results grew by 29% to $236 million in revenue, an increase of $53 million over the second quarter of 2011. The revenue breakdown is as follow: net-base fee revenue was $195 million, an increase of $45.6 million over the second quarter of 2011; in incentive revenue, which are share of the benefit we generate for our clients, was $27.5 million, an increase of $1.6 million over the second quarter of 2011; Other Services revenue, which is driven by the continued strong performance of our Physician Advisory Services offering, was $14.4 million, an increase of $6 million over the same period 2011.

PCARR is the projected contracted annual run rate of revenue that represents the expected total revenues for the coming 12 months for all our clients under contract. We are estimating that PCARR, as of today, will be in the range of $867 million to $884 million. The change from May 9 predominantly reflects the impact of Minnesota litigation and resulting contract terminations.

For the second quarter, there were 2 key factors that had a total negative impact of $14.6 million on our financial performance. First, lost operating margin in stranded personnel cost arising from the Minnesota litigation and resulting contract terminations aggregated $12.7 million. Direct legal defense and crisis management costs associated with litigation aggregated $1.9 million net of estimated insurance recoveries. Our operating margin for the second quarter was $45.3 million compared with $47.1 million in the second quarter of 2011. The contraction in operating margin reflects the negative impacts previously identified.

Moving down the income statement. Infused management technology expense for the second quarter of 2012 was $25.9 million or 10.9% of net services revenues compared with $21.2 million or 11.6% net services revenue for the second quarter of 2011.

Selling, general and administrative expenses were $20.6 million for the second quarter of 2012, or 8.7% of net services revenue compared to -- compared with $12.6 million or 6.9% of net services revenue for the second quarter of 2011. The increase in SG&A includes $1.9 million in crisis cost, ongoing investments in our business development team and costs associated with our high-trust certification process and other investments.

Turning to adjusted EBITDA, a non-GAAP measure. For the second quarter of 2012, adjusted EBITDA was $7.3 million compared with $20.7 million for the second quarter 2011. Again, this reflects the negative impacts I reviewed earlier.

For the first 2 quarters of 2012, operating cash flow totaled $6.2 million compared with negative operating cash flow of $28.5 million for the same period of 2011, primarily due to the timing of payments from customers and to vendors. For similar reasons, free cash flow, defined as operating cash flow less capital expenditures and the acquisition of software, was a negative $4 million for the first 2 quarters of 2012 compared with a negative free cash flow of $35.1 million for the same period of 2011. And at June 30, 2012, our balance sheet remains strong with a total cash balance of $200.9 million compared with $196.7 million at December 31, 2011. Accounts receivable totaled $124.9 million at the end of June, an increase of $32.9 million from the second quarter of 2011. Our second quarter DSOs are 48 days. However, if Fairview's outstanding AR had been paid on time, DSOs would've been 38 days, in line with our objective of maintaining DSOs at 40 days or less.

Now turning to fiscal 2012 guidance. We are revising the guidance issued on May 9, 2012, for the fiscal year 2012. First, we are reaffirming our guidance that PCARR at year end will be the range of $960 million to $1,005,000,000. Our revised guidance for 2012 net services revenue will be in the range of $948 million to $980 million reflecting the wind down of the remaining Minnesota clients.

Fiscal year 2012 non-GAAP adjusted EBITDA will be in the range of $50 million to $55 million. The following factors impacting 2012 non-GAAP adjusted reflect an additional $15 million to $19 million of anticipated drag for the remainder of 2012 based on 3 factors: First, the lost operating margin and stranded personnel costs arising from the Minnesota litigation resulting contract terminations. These are non-recurring costs and will primarily impact Q3. Direct legal defense and crisis management costs resulting from the Minnesota litigation, this will primarily, again, impact Q3 and is also non-recurring. A one-time $4 million to $6 million of seasonal incentive revenues that are anticipated to record in the first quarter of 2013 instead of the fourth quarter of 2012 due to the elimination of seasonal effects in the incentive revenue measure and provisions of the new Ascension contract. We estimate that our existing contracts would have a run rate adjusted EBITDA of $78 million to $82 million for 2013. New contracts signed between now and the end of the year will be additive. Finally, we're revising our guidance for non-GAAP adjusted diluted earnings per share for the year ending 2012 to be in the range of $0.23 to $0.27 a share. We continue to actively pursue new business opportunities, and we'll provide updates as appropriate.

Now I'd like to open the call to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Atif Rahim with JPMorgan.

Atif A Rahim - JP Morgan Chase & Co, Research Division

First question is on the updated guidance that you're issuing. So John, if I heard you correctly towards the end, you said $78 million to $82 million is for 2013. Would that -- I guess, first, is that correct or the way I'd read it in the press release was perhaps the next 12 months, so just a clarification on that. And then in terms of the pipeline that you have, what's the timeline around that converting?

John T. Staton

Yes, in terms of the $78 million to $82 million, Atif, we are really looking at that in terms of what our core business under contract today would deliver for us in 2013. Obviously, new contracts would be additive to that number.

Atif A Rahim - JP Morgan Chase & Co, Research Division

Okay, okay, got it. And then the second question on the conversion pipeline, then I have another one on Ascension, the $1.6 billion to $1.7 billion that you're referring to over a 5-year period. The run rate there is not very much different from the $335 million or so that you generated in 2011. So what are the puts and takes there that we should be thinking about? And if you can comment at all on how the margin structure is for that going forward?

Mary A. Tolan

In terms of the puts and takes on the projection, we didn't add in the optional new areas of services at this stage. So as those come on, that would affect any PCARR for Ascension. And so that's basically a conservative based on the current contracted scope and the expected growth in that. And in terms of your second question was on the margin, so the margin in the contract is a function of both base fees and gain share. The base fees actually are going to go up now in a predictable fashion as actual cash or net services revenue goes up. And then we will be giving them a guaranteed cost reduction in the first 3 years. So we will then be able to harvest all of the additional cost reduction that we actually drive. So it essentially allows for more risk, more reward, and to the extent that we actually are extremely effective in the cost reduction and the plans that we have, we would actually be able to do better than the historic 50-50 sharing on cost reduction. On the gain share side, we actually have an ability, if we had good performance, and we actually are able to produce the additional value that we expect, to be able to maintain or even improve our margins.

Operator

Your next question comes from the line of Glen Santangelo with Credit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Just a couple of quick questions. Mary, if I take a look at the PCARR that you guys projected 6 months ago, so on the December quarter, the PCARR was $1,027,000,000, and now your PCARR is in the midpoint and your range is $876 million. So your PCARR is now down over $150 million, is in the midpoint of your new guidance. Is that all just strictly Minnesota? Was there anything else in there, because I didn't think they were that big?

Mary A. Tolan

Well, it's really the full effects of all of Fairview, including Quality and Total Cost of Care and all of North Memorial. So it is actually, primarily, just Minnesota.

John T. Staton

And there's Maple Grove in there -- Maple Grove and our Physician Advisory Services and other lines of business that we also had in the state.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Okay. And then if I look at your adjusted EBITDA that you reported this quarter, $7.3 million, was that $14.6 million that you called out in the press release all -- did that all impact you in this current quarter? Because it seems to suggest you're expecting there is going to be some additional impact coming in Q3?

John T. Staton

Yes, $14.6 million, absolutely impacted us all in this quarter.

Glen J. Santangelo - Crédit Suisse AG, Research Division

So there's going to be a great -- and so the aggregate impact is going to increase next quarter as you incur some additional charges or whatever, however you want to characterize them?

John T. Staton

Yes.

Mary A. Tolan

In the release, Glen, we have the $15 million to $19 million of anticipated impact for the remainder of 2012.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Yes, okay, all right. And then lastly, maybe could you comment on what you saw with respect to your incentive payments this quarter? As I look at kind of that run rate, $27.5 million, I mean it was up sequentially but up only slightly versus 4 quarters ago. I would have thought that growth would have been a little bit bigger. I'm not sure if some of the gain share was impacted by Minnesota or could you give us any additional color around that?

John T. Staton

Yes. Substantially was associated with Minnesota and the wind down there, particularly in our quality business, as well as the RCM business that we had associated with that, and we've taken a conservative stance relative to the contract terminations that are a result of the Minnesota litigation as well.

Operator

Your next question comes from the line of Ryan Daniels with William Blair.

Ryan Daniels - William Blair & Company L.L.C., Research Division

A quick follow-up on your commentary about the EBITDA run rate. If we go back to last quarter, I know you had guided $80 million to $95 million in EBITDA for this year, which obviously, has to come down given the expenses with Fairview and Minnesota in general. But looking at the run rate of $72 million to $80 million, I guess, I'm surprised that it's below that number, which incorporated already the Fairview kind of wind down and some legal costs. I'm curious, what's pressuring the EBITDA kind of above and beyond the run rate last quarter?

John T. Staton

First of all, it was $78 million to $82 million, is the range that we are providing for the adjusted EBITDA. And I think if we think about the business here, again, this is what we have under contract today. So a couple of factors were the additional reduction in our business associated with the -- our voluntary leaving the state of Minnesota. That has impacted us, and what not also in there, we continue to sign new Physician Advisory Services clients, we continue to sign new business in the back half this year that would be additive to that run rate of adjusted EBITDA.

Mary A. Tolan

Yes, so any of the -- we spoke about what's in the pipeline in any of those deals that are closing that are in contracting or in the solution space between now and the end of the year are not in that number.

Ryan Daniels - William Blair & Company L.L.C., Research Division

No, I appreciate that, maybe I'm looking at it wrong. But just when you guys have the $80 million to $95 million guidance before, and now you're saying $72 million to $80 million is kind of the run rate, still kind of...

Mary A. Tolan

Well, I guess, in that guidance, it has the first 4 months of the year of the Fairview contribution, so that would be your primary delta.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Got you, okay, that makes sense. I wasn't considering that. And then you talked a little bit about the solution pipeline, which is a metric that's helpful, and that we haven't heard. I'm trying to get a flavor on what that maybe looked like in the prior-quarter or the year-ago period, just to see how that compares to what you've seen in the past. Do you have that data?

Mary A. Tolan

I do. It was roughly half the size it is right now. So it was running more like $50 million to $60 million. And really, if you look at the 2 pieces combined, what's in contracting and what's in solution, the 2 together are up about $50 million to $60 million.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay, perfect. And then one last one, I'll hop off. Just if you look at the pipeline, obviously, you have a much broader service offering today with kind of the core revenue cycle. You have the intra-stay quality, you have the quality Total Cost of Care, Physician Advisory, kind of a big portfolio. If you look at that pipeline, is it delineated or skewed towards one of them more than others or is it kind of as balanced as it's been in the past?

Mary A. Tolan

That's a great question. I would say it is in PCARR right now, still skewed towards the base revenue cycle business. As we mentioned, we've got the 2 new contracts in quality now in contracting. But as they come on, they're relatively small contributor to PCARR in the near term. And then Physician Advisory is at a run rate, right now, of about $55 million, and it's growing very rapidly. But it would not be at the same level as the core revenue cycle PCARR. I mean not even close.

Operator

Your next question comes from the line of Charles Rhyee with Cowen.

Charles Rhyee - Cowen and Company, LLC, Research Division

Maybe circling back to the Ascension renewal and just trying to understand a little bit more about how we think the pricing here works and just understanding maybe some changes relative to the prior contract. First on the base fee, you're talking about giving sort of a guaranteed cost savings to Ascension for the first 3 years, but you keep all the savings. How can we -- can you help us sort of box the magnitude of that change and how does that -- John, does that run through our income statement? If I recall, you used to say in over the first 4 to 5 years, we're going to save roughly 20%, and we keep 2/3, give 1/3 back. And that kind of ramps up over time. If we think about the first 3 years, are we talking about sort of an average of maybe 7%, 8% savings and we give some of that straight to Ascension first? Can you help us kind of frame how big this -- we should think about it?

John T. Staton

I think a couple of key points to consider here, Charles, and first of all, good morning, is that we have a base fee structure that's based on where our run rate was coming into the new contract. And so that mechanism is basically the same as we go forward. What has really happened here is a transfer of the risk to execution to us. So to the extent that we continue to execute in a very strong way, we'll continue to get very similar economics for Accretive Health. What has happened here is there's guaranteed savings now for Ascension versus before they participated in a share of what we were able to deliver. So to the extent that we can execute better and continue to improve our gain, we'll be able to make equivalent margin if not more resulting from our base fee.

Charles Rhyee - Cowen and Company, LLC, Research Division

I see. So it's not like you're shifting out any of the base fees savings. It's more that if you were expected to save 2, they're going to automatically get 1. But if you did 3 that year, you keep 2. Is that the right way to think about it?

Mary A. Tolan

Exactly. And I think to be clear, I think the way we structured it is it used to be a 50/50. So we took what would have been expected, and their 50% portion of the expected has now been guaranteed. To the extent that we actually perform any better than expected, that's where the upside is to us.

Charles Rhyee - Cowen and Company, LLC, Research Division

Can you give us any historical flavor on how you've actually performed on the past on the base fee?

Mary A. Tolan

On the base fee, we've been able to hit or exceed our cost reduction targets. And remember, a lot of this is now mature and so the targets, once you get to the mature end, are not very significant sequentially year-on-year.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. So it shouldn't really be that big at this point, you're saying.

Mary A. Tolan

Exactly.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. Maybe a question then on the incentive fee. If I read the language in the 8-K that you put out, you kind of talk about now the improvement over on cash collections relative to sort of standard operating metrics. And if I recall from the prior, that was a little bit of a change because I think it used to be sort of a gross yield improvement. Can you talk about how we should think about how that affects incentive payments and what does that really entail at this point?

Mary A. Tolan

What really has happened is that the -- there's been an addition of metrics that go beyond yield into balance sheet and then also some operating metrics that would relate to, let's say, something like credit balances, which is actually an operating metric. So what we now have is the ability to earn base fee -- or incentive fees on more than just yield improvement by actually improving balance sheet strength and operating metrics as well.

Charles Rhyee - Cowen and Company, LLC, Research Division

Is then the weighting now -- so before, it used to be 100% yield improvement and now it's, I don't know, 60% yield improvement, 40% operating [indiscernible], something like that?

Mary A. Tolan

Exactly.

John T. Staton

It will vary [indiscernible].

Charles Rhyee - Cowen and Company, LLC, Research Division

Is that a function more that because yield improvement itself can be a little bit of -- I don't have, what's the right word, it's not like a necessarily a solid figure like a balance sheet metric is? Or is that really not the issue here?

Mary A. Tolan

I think there was actually a really great process of involving the broad constituency of CFOs within Ascension and as a they thought about all the things that were important to them and what they wanted to make sure is that the partnership was incentivized to achieve, they wanted to add some more traditional metrics. And so it was really about getting everybody's good thinking in how they wanted to build the balanced scorecard.

Charles Rhyee - Cowen and Company, LLC, Research Division

And when you look at what the balanced scorecard should drive in sort of incentive fees for you based on the historical performance, how would that compare to what you actual actually reported?

Mary A. Tolan

We think it's a very comparable sort of mechanism. So as we look at what our projected performance is, if we are able to hit that performance, we should be able to maintain our margins. And if we're able to do better, we should be able to improve them.

Operator

Your next question comes from the line of Bret Jones with Oppenheimer.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

I just wanted to follow-up on Ascension. You've talked about how you should be able to at least maintain the margin and potentially exceed it. I was just wondering, if we think about 2013, as you look at the margin profile of Ascension, would you expect the base fee margin to be at least the same as what you expect in 2012 or is there a decrement in the first year and then you have to work your way back up?

Mary A. Tolan

No. I think the base fee would be comparable. I mean, that's basically what we've been saying that we projected what kinds of cost savings that would have been sort of typical and took a look at what the 50-50 sharing would have been and just locked in the 50% that would have been there for our partner.

John T. Staton

And the same could be said for incentive fee as you look at what you expect in 2013 versus 2012?

Mary A. Tolan

Yes, with the expected performance that we are planning to drive, we believe that we should be -- which will create more value for them and we'll be able to maintain our margins. And if we can do even better, we can improve our margins.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Right. And then I just wanted also to touch on the decline of PCARR in the current quarter. It looks like it came down by $45 million over what you reported at the end of last quarter, and we talked about Minnesota being about, I think, $23 million to $25 million of that. Would the balance essentially be the change in the base fee structure with Ascension?

John T. Staton

There is a component -- no, it's basically driven by Maple Grove, which was something that happened before the voluntary departure from the state as well some other lines of business that were associated with that. But the drop is substantially all, or substantially a component of that is tied to the Minnesota voluntary departure and the Minnesota litigation.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

And then just the last question, I just wanted to touch on the final contracting. In terms of the timeline of when they should come online, you've talked about 90 days historically. And then after the last quarter, with the whole issue with Minnesota, you talked about that lengthening out. As you've now got a settlement, you go back to some of the customers within final contracting, I guess what's the new timeline of when you would expect some of that to move into PCARR?

Mary A. Tolan

With the intra-stay and the Quality and Total Cost of Care deals, I think they're actually moving along very well and it may be within 30 days of completion. And we have pieces of the rev cycle PCARR as well that would be in that timeframe. And so I think that the 90 days for the contracting pipeline is probably, at this stage, a good way of thinking about it.

Operator

Your next question comes from the line of Jamie Stockton with Wells Fargo.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Maybe just a follow-up on one of Bret's. It sounds like with your PCARR goal by the end of the year that you're assuming that essentially, all of what's currently in the final contracting phase closes by the end of the year. Is that the right way to look at it?

Mary A. Tolan

Yes, I think so.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. Did you have any new business that closed in the June quarter?

John T. Staton

We had the Catholic Health East business that we mentioned that was closed prior to our earnings announcement on May 9.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay, all right. And then maybe going back to Ascension. Could you just give us an update on how penetrated within their system you are today?

Mary A. Tolan

Today, on the basically acute care hospital revenue, we're about 2/3 penetrated, about 67%.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. And then lastly, you've talked about how with the Ascension renewal, you guys are moving toward a little more of a guaranteed savings with the potential of more upside for you if you can exceed your savings targets or what you've agreed upon with them as far as the base fees are concerned. Would you anticipate that more of your incremental contracts would move in that direction?

Mary A. Tolan

I think it actually could be a very good approach. We haven't had anyone else talk about it, but the advantage to the customer is that they have plannable cost structure and they have a partner who is just making it happen as opposed to reconciliations that say, "Here's what did happen in terms of our gain share and here's how we split it." It becomes very plannable and predictable. And I think a lot of people in the market are looking for that given all the challenges that our hospital clients are facing. And so getting that is an attractive thing. To the extent that we can create something that's attractive to the customer and creates more upside for us, I think it could be a very good evolution. But we don't actually have any other contracts right now that we are actively talking about doing it this way. But it could be a good evolution.

Operator

Your next question comes from the line of Stephen Shankman with UBS.

Stephen B. Shankman - UBS Investment Bank, Research Division

So I did want to dig in to the intra-stay quality offering a little bit. First thing, I was hoping to clarify whether the intra-stay quality pilot that you've mentioned on past calls, whether that was at Ascension or another client?

Mary A. Tolan

It is at Ascension.

Stephen B. Shankman - UBS Investment Bank, Research Division

Okay. And could you remind us how the economics work for intra-stay, whether it requires a big investment upfront? Just trying to get a sense of the margin impact if this offering is rolled out to a bunch of additional hospitals next year?

Mary A. Tolan

It is an offering that actually does not require a significant upfront investment. The way that the results are actually measured are based on charges and how charges are being reduced per DRG. And so it's actually something that is based on our pilot results, you really begin to bend the cost curve very quickly and the measurement is very clear, so there's no trailing or sort of measurement learning curve. It really sort of occurs based on existing systems and existing data that the hospitals have. And so it actually is cash flow breakeven pretty rapidly within even the first quarter. And it might run at cash flow breakeven for another quarter and then begin to throw off margins.

Stephen B. Shankman - UBS Investment Bank, Research Division

Okay, that's helpful. Did you recognize any intra-stay quality revenue so far in 2012?

Mary A. Tolan

We didn't. We were in a pilot mode and investment mode.

Stephen B. Shankman - UBS Investment Bank, Research Division

Okay. So you wouldn't expect to generate any of that revenue for the rest of the year either?

Mary A. Tolan

No. I think as we move beyond final contracting into a contracted state, we would be generating revenue.

Stephen B. Shankman - UBS Investment Bank, Research Division

Got it. got it. And then switching gears a little bit. I was curious as to what you're seeing from clients as it relates to ICD-10?

Mary A. Tolan

Well, ICD-10 is an area that everybody really wants to make sure that they are very prepared for, and so we've been making significant investments. We've brought in national experts onto our team to lead that effort. And one of the big things that people are looking for is to the extent that your technology and your advanced training of the workforce can help ameliorate what others are projecting to be an increased cost hit of ICD-10 of 25%, that's a great value. So we're actually gearing up for ICD-10 in advance and being able to prove how that 25% cost hit that everybody's expecting does not have to be the case. And to the extent that we're able to prove that, that's going to be a great incremental value proposition. Because everybody out there is literally thinking of this as something that's just going to be a 25% cost increase.

Stephen B. Shankman - UBS Investment Bank, Research Division

Okay. So that kind of leads into my next question. It was whether you would expect ICD-10 next year, 2013, to be a net headwind or a net tailwind? It sounds like it's kind of maybe in that headwind but probably not as much as some of your competitors might see?

Mary A. Tolan

Well, for our business, we will get adjusters for the actual cost increases to ICD-10. And so that, from that standpoint, it's not a headwind. To the extent that we can do better than benchmarks for both our clients and ourselves, that would be a positive contributor to margin. So first, there's an adjustment to cost based on benchmarks, and then there is how do you actually produce against that.

Operator

Your next question comes from the line of Sean Wieland with Accretive Health (sic) [Piper Jaffray].

Sean W. Wieland - Piper Jaffray Companies, Research Division

I think I'm still with Piper. So if you exclude the what -- kind of one-time adjustment from $4 million to $6 million of seasonal revenues under the Ascension renewal, is the contribution to your 2013 EBITDA from Ascension higher or lower than it was in 2012?

John T. Staton

We expect it to be, at this point, the ability to earn back to the levels we have in 2012 by getting to greater operating performance and expanded operating performance against the new operating metrics that are part of the new contracts.

Mary A. Tolan

So it's expected to be comparable. If we can do better than expected on cost reduction, there'd be upside.

Sean W. Wieland - Piper Jaffray Companies, Research Division

Okay. So what's baked into the $78 million to $82 million is comparable. Now given that you've been working so hard there for 5 years or so, what is the -- what are the kind of functional areas or operational areas that -- where you would see being able to drive further improvements in efficiencies? I tend to think about a lot of the low-hanging fruit is picked earlier on in the contract. After all this time, what's left there to continue to drive efficiencies?

Mary A. Tolan

Well, there's always opportunity to drive efficiencies, but process excellence is constantly identifying the source of defects. And what you have in your cost structure, I think as you know pretty well, Sean, is a lot of costs that are really trying to take a defect that's been created earlier in the process and make sure that it doesn't turn into actual yield loss. So a lot of activities that are happening in the business office in terms of claims follow-up is actually trying to fix a defect. So what we're constantly looking at is the causality of those defects and how to actually reduce their being originated in the first place. We actually have first-time clean claim rates that are continuing to go up. And that's one of the key determiners of our total cost structure. So as we take a look at what we're doing in the future, what we plan is continual process excellence and improving first-time clean claim rates.

Sean W. Wieland - Piper Jaffray Companies, Research Division

Okay. So as has already been noted, the new preliminary 2013 EBITDA guidance is back to where you were in 2011. I would think that Intermountain Healthcare and some of the other large deals that you've signed since then would more than offset your exit from Minnesota. So can you help me understand that a little bit?

Mary A. Tolan

Well, I think the way we really want to think about the $78 million to $82 million is first of all, it does not include any other business that's going to be signed between now and the end of the year. And we've talked about the pipeline and what's in final contracting. So that would all be additive. So the first thing I want to correct is that's not the guidance for 2013. The second thing is that you're right, although those contracts continue to mature, but one of the things that people were comparing against was a number that had 4 quarters of a very -- of a mature contract of Fairview, as well as a lot of quality contribution in that number. So that's the puts and takes on it.

Operator

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

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

My strategic questions have been covered, but maybe just some housekeeping items here. Could we get the hospitals under contract at the end of the quarter? I think it was 90 last quarter.

Mary A. Tolan

John is looking for it, do you have it, John? Why don't you ask your next one and he's looking...

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

John, while you're looking at that, also contracts under management. And then sorry if I missed it, but could we get the Ascension-related revenue for the quarter?

John T. Staton

Sure. The number of clients under contract as of June 30 was 32. The number of hospital sites was 85, Eric.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

85, okay. And then Ascension-related revenue?

John T. Staton

Give me just a sec.

Mary A. Tolan

We have a fact checker here looking for it. Do you have another question while they're looking?

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Sure. Last one, Mary, is I know that you had the stranded personnel cost in Minnesota and you kept a lot of staff onboard until you got through this resolution process and obviously, there's a wind down period. How many heads will ultimately be removed from Minnesota in total? And maybe give us a sense on how many of those today are, for lack of a better word, unproductive?

Mary A. Tolan

I would say a total of about 150 FTEs, Eric. And help me understand, what do you mean by unproductive? I would say that -- I would say right now, they're excess capacity because we haven't had a material end in the meantime to absorb it.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

So we'll call it excess capacity. I'm just curious, I guess it's a hard question to answer because I know you haven't been growing the business there, while you've been working through this resolution process, and you probably could've been more proactive in cutting heads if you weren't dealing with this situation. If you just had a natural contract loss, you could have been more aggressive in your cost reduction [indiscernible].

Mary A. Tolan

I think that's fair to say. I think that's fair. But I think there was sort of a desire not to be creating any other footfalls on labor laws or anything else in the state.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Right, right. And if you have that Ascension number, either now or maybe you can come back to it later.

John T. Staton

I do, Eric. Its $81 million in the quarter.

Operator

[Operator Instructions] Your follow-up question comes from the line of Charles Rhyee with Cowen.

Charles Rhyee - Cowen and Company, LLC, Research Division

I just want to have a follow-up question. When you look across the rest of your client book, does anyone else, like maybe like an Intermountain have any sort of favored-nation status in their contract that would allow them to piggyback off the Ascension contract?

Mary A. Tolan

No, nobody has anything that allows them to piggyback off of Ascension.

Operator

[Operator Instructions] With no further questions in queue, I would now like to turn the conference over to Ms. Mary Tolan for any closing remarks. Please proceed.

Mary A. Tolan

Thank you. Well, I'd like to thank everyone for participating in today's call. I want to assure you that we are back to business with incredible energy and industriousness. We have a winning franchise and winning people. And in closing, I want to let you know that we're planning an Investor Summit on October 30 in New York City. Invitations will go out shortly, and I look forward to seeing many of then. Thanks, and have a great day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.

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