R1 RCM Inc (RCM) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Accretive Health, Inc. Earnings Conference Call. My name is Ann, and I will be your coordinator for today's call. As a reminder, this conference is being recorded for replay purposes. At this time all participants are in listen-only mode.

(Operator Instructions)

We will be facilitating a question and answer session following the presentation. I would now like to turn the presentation over to Mr. Gary Rubin, senior director of finance. Please proceed, sir.

Thank you. Good morning and thank you for joining us. With me on the call today are Mary Tolan, Accretive'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 2011 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 annual report on Form 10-K for the year ended December 31st, 2010 filed on March 12th, 2011, 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 10th, 2011 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, 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 reconciliation to the appropriate GAAP measures.

After the conclusion of Mary 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.

Thanks, Gary, and good morning, everyone. Today I want to begin with an update on our accomplishments in the quarter. We're very excited about our growth in PCARR, which grew by 41% year-over-year. This is the most important metric by which we gauge our momentum in business and future growth. As you know that PCARR is our projected contracted annual run rate, and this essentially tells us with no future business what the next 12 months will be with just the contracts that we have.

In addition, we've posted 21% growth in revenue, a 68% increase in adjusted EBITDA and a 78% increase in adjusted earnings per share over the same period last year. Since our last earnings call we've signed new revenue cycle management contracts that increased PCARR by $119 million, further cementing our leadership position in revenue cycle management.

We continue to execute well in our quality and total cost of care engagement with Fairview Health Services, which I will share more about in a minute, and experienced record growth in our physician advisory services business.

We entered the second half of the year with a strong book of business. Our projected contracted annual run rate of revenue, or PCARR, is currently in the range of $883 million to $901 million. In addition, we have $120 million to $140 million of additional potential PCARR in the final contracting stage of our sales process and pipeline, which consists of new customers that have moved into this phase of our pipeline since our last earnings call.

While we continue to experience great success in bringing on new customers, we're mindful that our business model can produce results that are lumpy from quarter to quarter. Revenue in any given quarter is largely a function of where new contracts are signed during that quarter, given the large base fees in our revenue model. Some contracts signings came in later than we had originally planned during the quarter, but this is only a timing issue and we're very pleased with our success rate in actually signing these new customers and remain positive about our full year revenue guidance.

Looking at RCM, we signed a five-year exclusive revenue cycle management agreement with the Beaumont Health System, a very prestigious and highly regarded healthcare provider in the greater metropolitan Detroit market. The Beaumont board requested a competitive review, but it turned out that no other company came close to our capabilities in value creation position with a very diligent process in the Beaumont management team's effort.

With Beaumont we now have a 65% market penetration for acute care revenue in the Detroit metro market. This gives us an indication of our market potential because this has been achieved in only five and a half years of operating presence in that market. We've achieved a 65% market penetration, and we think this is a bellwether of what the model can do as we continue to mature and grow in other markets.

So, as we scale our RCM business, we're delighted to see this level of interest in our shared service offerings as well. During the quarter we increased the volume to our transcription shared service center, as well as our patient financial services center in Chicago. The market demand for RCM services remains strong as hospitals are faced with increasing regulatory challenges and financial pressures on both the revenue and the cost side of the equation.

We think that this trend in recent events point to continued need. As an example, the recently passed debt ceiling bill is expected to reduce the amount paid to commercial Medicare payers, but we believe will likely pass this increasing burden on to healthcare providers. We see these types or pressures on provider revenues continuing. This creates a tremendous incentive for hospitals and physicians to seek innovative solutions so they can extract as much value from their processes as possible.

So, based on the feedback we're receiving in the marketplace, we believe our competitive position is stronger than ever. Healthcare leaders are the ones that are our customers. They're typically the smartest and the most highly regarded management teams in the markets that they work in. And they're the ones that are adopting our services. The results that we are delivering for our customers creates an environment where others then see that our solutions can work for them, and we begin to grow with that kind of word of mouth reputation.

Our quality and total cost of care program with Fairview Health Services is progressing ahead of plan. As judged by the key metrics that we use to analyze the business such as lower inpatient admissions and reduced readmissions for the targeted high risk patients we have enrolled in our care coordination program. We are seeing positive developments where revenues for Fairview are up in total, and yet the costs or charges for our attributed population are down and down more than our expectations for this point in time.

We're currently managing the patient populations of three commercial payers representing approximately $1.3 billion in annual total cost of care. We anticipate that other commercial payers at Fairview will come on by the end of 2011, and this will expand the scope of our engagement from $1.3 billion to at least $2 billion.

Our goal is to take out 25% of total annual cost of care by the third year of our engagement and significantly increase the quality of patient care. This would be a $250 million economic value for every $1 billion in total cost of care that we are attacking. We believe that our quality and total cost of care offering is a game changer in several respects. And I want to take some time today to give you a better understanding of how this service offering works.

As you know, we've invested substantially in this business and believe we're looking at $100 billion domestic market. But unlike RCM, there are no borders to quality and total cost of care. The world wants quality healthcare at lower costs, and we are starting to evaluate how to deploy this solution internationally.

In our quality and total cost of care offering we're providing the first and only complete infrastructure offering that enables providers to take accountability for the health and cost of their patient populations. We had to invent this infrastructure from the ground up. And I want you to better understand the game changing aspects of what we've accomplished.

First, there were no existing market forces in the form of incentives and information. So we undertook a series of systematic studies to assess actual medical results and relative cost efficiency.

Second, we had to develop a funding mechanism and that meant getting the payers on board first. We did this by demonstrating a real reduction in per member per month cost compared to prevailing market costs by proving our solution could generation substantial cost savings in the risk adjusted patient population of Fairview Health and help increase the quality of care delivered to patients.

This is a real inflection point for payers and was accomplished through the application of our superior technology and analytics. Early on we recognized that primary physicians, primary care physicians are the quarterbacks in the entire process and that they were being overworked and underpaid. By providing the analytics and best practice outcomes through our technology and processes, they can concentrate on the sickest and most costly of the patient population.

Furthermore, they are supported by staff and caretakers that Accretive provides, and this gives them more bandwidth to focus on preventive medicine, which is another critical factor in lowering costs. Primary care physicians participating in our program can practice the kind of medicine they were trained to do, and at the same time have the opportunity to potentially double their earnings power through their share of the cost of savings.

Fairview Health saw the immense potential and partnered with us on this exciting journey that we believe will ultimately change the face of healthcare. Fairview will continue to be a leading innovator in healthcare and will be at the vanguard of hospitals that benefit from retaining and attracting top caliber of doctors and from gaining high marks in patient satisfaction. With our quality and total cost of care all parties have a true incentive to succeed together.

We continue to see strong interest in our quality and total cost care offering from existing RCM customers, as well as new potential customers. We're in active discussions with some of the most prestigious healthcare institutions in the country and are being very deliberate in selecting our next customer given the early stages of this market and our commitment to outstanding execution. We expect to have one or two more customers on board by the end of this year.

Our physician advisory services offering is winning new business at a robust pace. This service assists hospitals in maximizing their compliant revenue associated with emergency room visits and dealing with similar patient classification issues. This relatively untapped market is estimated to be around $1 billion domestically, and we're only one of two firms with scale that is addressing this problem and this opportunity.

Both businesses of ours -- both of these new businesses, quality and physician advisory services, are delivering solid performance and we look forward to building upon them in future quarters. Accretive is a built-for-purpose company we're committed to making certain that our rapid growth is well supported by investments in our people, processes and technology.

To that end, we recently added some key people who are senior management team in the areas of sales and operations. Andrew Appel joins us as senior vice president of revenue operations. Prior to joining Accretive he was the chief operating officer at Aon Corporation, where he developed and implemented a highly successful growth plan for the Company, unleashing significant shareholder value over the last five years.

Joe Bellini was recently named our chief revenue officer and will head our business development activities. Most recently Joe was EVP and Chief Sales Officer for TeleTech, a large business processing outsourcing organization with over 40,000 employees. Prior to that he held key positions and drove growth at Oracle, GE and EDS and brings a wealth of experience in sales, business development and new business creation.

Looking ahead, we will continue to build our team by relentless pursuit of best talent. We're proud of our accomplishments and remain committed to growing the business and delivering outstanding value to our clients. We're well positioned for the future and excited about the opportunities ahead.

Now let me turn this call over to our CFO, John Staton to review our second quarter financials.

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

Let me review the highlights from the second quarter 2011. PCARR, operating margin, adjusted EBITDA and adjusted earnings per share all exceeded our expectations in the quarter. Total net services grew 21% to $183.6 million from $151.9 million in the second quarter of 2010.

Net fee based revenues were $149.1 million for the second quarter, an increase of $20.9 million over the second quarter of 2010. Incentive payments, which are our share of the benefits we generate for our clients, were $25.9 million for the second quarter, an increase of $5.8 million over the second quarter of 2010.

Other services revenue was $8.6 million for the second quarter of 2011, an increase of $5 million over the second quarter of 2010. We had great success in signing new customers since our last earnings call and have increased our PCARR by 41% from a year ago. As we previously explained, our business model can be lumpy from quarter to quarter due to the timing of contract signings. Our operating margin for second quarter increased by 39% to $47.1 million, or 25.6% of net services revenue.

Our operating margin expanded by 330 basis points year-over-year, largely driven by expansion of our share of added revenue that is the share of our client benefits and cost efficiencies of our maturing contract portfolio. Shared services adoption is contributing to our increased cost efficiency. We remain committed to further improving leverage of our business.

Our infuse management and technology expense was $21.2 million, or 11.6% of net services revenue for the second quarter of 2011 as compared to $16.1 million, or 10.6% of net services revenue for the prior year's second quarter. The primary driver of the increase is expenses associated with our quality and total cost of care offering. While infuse management and technology expenses for our revenue cycle management business actually decreased as a percentage of net revenue year-over-year, thus demonstrating ongoing leverage in our RCM operating model.

Selling, general and administrative costs were $12.6 million for the second quarter of 2011, an increase of $2.3 million from the prior year's quarter. As we've built out our business development team, the increase included incremental sales and marketing expense of $1.1 million net of stock-based compensation expense. It also included incremental $1.1 -- I'm sorry, an incremental $1 million of depreciation, amortization and stock option 123R expense.

We believe adjusted EBITDA, a non-GAAP measure, is the most instructive metric for measuring our progress toward increasing the profitability of our company. For the second quarter 2011 adjusted EBITDA was $27 million -- I'm sorry, was $20.7 million, an increase of $8.4 million, or 68% over the second quarter of 2010. Our adjusted EBITDA margin increased by 320 basis points to 11.3% in the second quarter 2011 from 8.1% in the second quarter of 2010.

Net income for the second quarter of 2011 was $8.6 million as compared to $3.9 million for the second quarter of 2010. Non-GAAP adjusted net income was $11.8 million in the second quarter of 2011 as compared to $6.1 million in the second quarter of 2010. Non-GAAP adjusted net income from diluted common share was $0.12 for the second quarter of 2011 as compared to $0.07 in the prior year's quarter.

Now, turning to our balance sheet, our balance sheet remains strong, with $150 million in cash and equivalents and no debt. This represents an increase of $31 million over the first quarter 2011 and $30 million over the same period last year. Cash from operations was $16.8 million for the second quarter of 2011 as compared to $7.8 million in the second quarter of 2010.

During the quarter we invested $4.8 million in capital expenditures, primarily for proprietary technology enhancements and leasehold improvements. As we have mentioned before, our strong balance sheet provides us with ample resources to fund our growth initiatives and has been a key criteria in winning new business.

Before I open up the call to your questions, I want to reaffirm our full year 2011 guidance. Based on our new contract awards to date, the status of our current contract negotiations and our strong pipeline, we are affirming our previously issued guidance. We expect PCARR at December 31st, 2011 to exceed $900 million. For the full fiscal year, we are expecting net services revenues of $835 million to $850 million, and non-GAAP adjusted EBITDA of $80 million to $86 million.

The midpoint of our guidance range implies a year-over-year adjusted EBITDA growth rate of 84%. As we previously explained, our adjusted EBITDA guidance is backend loaded, with approximately two-thirds of adjusted full year EBITDA projected in the second half of 2011, reflecting the seasonality of our incentive payments and the investments and expected revenues in our quality and total cost of care business.

And finally, we continue to expect our non-GAAP adjusted net income for diluted comment share to be in the range of $0.42 to $0.45 a share.

Thanks, John. And before we open it up for questions, let me just summarize quickly. We were pleased with the performance of the business and remain on track to achieve our objectives for fiscal year 2011. We're seeing a great deal of demand and, frankly, growing demand in the marketplace for all of our offerings. And we believe that our investments in R&D are throwing off significant innovation that will be fueling future growth and profits.

So, let's take some questions. Operator?

Thank you. (Operator Instructions). And our first question comes from the line of Atif Rahim with JPMorgan.

Hi. Thanks for taking the question and, Mary, I appreciate all the additional color and cost quality. Any contribution, I guess just sticking to cost quality aspect, any contribution from Fairview this quarter? And when you say you're progressing ahead of plan, any metrics you could share with us on that front?

In terms of what has been run through our financials, we have not recognized any revenue yet, so our financials are at the most conservative position. And in terms of the actual metrics, what we are looking at are the total charges for the attributed population. And that is sort of an all-in look at expenses.

We are looking at admissions per thousand of capita and we are looking at readmission rates. And we're looking at all of those versus expected, and the expected model does include adjustments for acuity and seasonality. So we think that our metrics are very robust. They're the kind of metrics that would be used, for instance, in the Medicare Advantage program that has been honed over many years. And, again, we're very, very encouraged by the results that we're seeing.

Okay. And when you look at your pipeline and talk about the one to two more cost quality deals that you expect to sign, is that included in the pipeline right now or is that something that you're looking to do going forward.

They are included in the pipeline, but not in our final stages to begin contracting at this point in time.

Okay. Okay, got it. And then, John, did I hear you right saying your RCM infused management and technology expenses were down year-over-year? How are you managing to do that given the rapid increase in PCARR year-over-year?

Oh, I'm sorry. As a percent of revenue, our RCM infuse management and technology is declining --

Okay.

-- 7.6% last year. It did show an increase, but that increase as a percentage was more than tied to our quality and total cost of care. As you recall, Atif, the expenses for our quality and total cost of care business last year set in the SG&A line has now moved -- at least the operating expenses have now moved into the infused management technology line.

Okay. Oaky, and could you share with us what those expenses are running like on a quarterly basis?

We haven't disclosed those, but they are running probably a little north of $3 million.

Got it. Okay. Thanks a lot.

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

Yes, thanks. Good morning. Hey, Mary, I just wanted to follow up on some comments you made regarding the debt ceiling debate. Clearly there's some concern in the marketplace about the potential cuts on some of the entitlement programs.

And so I was just kind of curious, could you give us a little bit more detail about your conversations are going with the C-level executives at these hospitals these days. Do you believe that maybe all the confusion around future policy could potentially elongate the sales cycles or you think it's actually maybe going to contract the sales cycle as these guys feel the need that they need to something sooner rather than later?

Glen, it's a great question. I think we really are getting to a point that is different from the experience that healthcare executives have had over the last decade. Where now the number and just preponderance of signals about future financial stress are really breaking through and convincing people that outside the box sort of options need to be considered. So we see it in our case really getting a lot of management teams sort of out of a posture of steady as she goes and into one of we've got to get out in front of this whole sort of wave of financial stress that otherwise is coming at us.

So, I've had very significant conversations with CFOs who are actually at the lead and who have some of the best bond ratings in the industry and if you think of them as lead (inaudible) sort of management teams, they're very clearly saying this is different, this is different than it's ever been before, and we think actually the conditions for change and progress are better than ever before because there's really a financial burning platform.

So we're noticing that if you have a way of throwing off cash flow quickly, which is what we do, and it's not like bet the farm on a big sort of scary investment and a new technology with questionable outcomes, then I think this actually helps shrink the sales cycle, or at least creates more demand of people looking seriously at it without elongating the sale cycle.

And, okay, thanks for that. And, John, if I could just kind of follow up by I think you guys said that last quarter you had $200 million to $240 million of potential PCARR that was kind of in the later stages of contracting. You took -- you cleared $119 million out of that this quarter, which now you're basically suggesting you got $120 million to $140 million left. So, it looks like you added a little bit to that late stage contracting cycle, if my math is correct.

And kind of given your current PCARR just a shade under -- using the midpoint, a shade under $900 million at this point, don't you feel like that guidance that you gave probably should be conservative, right, assuming that you're able to execute on all this late stage contracting stuff by the end of the year?

That is correct. And we do believe and very confident that we're going to exceed our $900 million in PCARR, the low end of the range certainly by the end of the year. And as we progress through the remaining part of the year we'll give you updates to that number in future quarters.

And just one more follow-up on Fairview. It sounds like you didn't recognize any revenues conservatively, but what about on the expense side? Mary, you sort of suggested that you're having to implement some of your own caretakers and operations people into that. So are you incurring any meaningful expenses on a quarterly basis that are worth calling out?

Yes, absolutely, Glen. We are incurring expenses. We are a little bit more than $3 million in this most current quarter. And we continue to ramp and we'll ramp through the rest of the year. But we're -- the key thing here is we're matching against our priorities, getting measured results, and then expanding the operations. So we're going to be very much investing as we go, looking to drive returns here. And again, we still are very confident this business will break even or better for all of 2011.

Okay. And then my last question, and then I'll hope off, was the physician advisory business clearly did better than kind of what we were modeling. If you could just give us a little bit of color maybe what drove that and then the margin profile of that business. Then I'll jump off.

Yes, I think the margin profile, let me address that question first, is we expect that to get into the 30% plus range as we go forward. We're obviously in kind of an astronomic growth period right now, and as we should be given the market opportunities that exist there.

I think the driver of the growth here, as we think about it, is really just client references and market opportunity. So we believe we're really the only scalable real alternative to another player in the marketplace. And as our hospital clients are getting more concerned about compliance, and being very compliant in their classification of patients for reimbursement, I think that's creating an enhanced market opportunity that we're able to capitalize on.

And when we do get the opportunity to go head-to-head, we're winning more than our fair share, more than 50% of those head-to-head battles with the primary competitor in the marketplace.

Okay, thank you.

And our next question comes from the line of Ryan Daniels with William Blair. Please proceed.

Yes, good morning, everyone, and thanks for taking the questions. Let me continue with the physician advisory services. I'm curious if you could just give us a little bit of a profile of the client base there. I don't think you've talked about that in the past, but maybe how many clients you're currently with. And I'd be curious what percent of those are current RCM clients versus other parties that you don't have an RCM relationship with.

Great question. We are working with market leaders across the board on the physician advisory business and with a number of logos that we don't have yet in our RCM business. So we actually anticipate that this is a bit of a Trojan horse growth strategy even for RCM, as we sort of land the band flag and get execution quality and get results for our clients.

And then we have a chance to open up those dialogs with those CEOs and CFOs further and we are seeing that. So we have very good adoption rate within our existing customer base, even to the extent of where a customer might have been using the other competitor in the market and then switched over to us.

And then we're also getting a lot of customers that are not our CM customers, and we have built out that sales team very aggressively so that we could really, as I say, almost sort of carpet bomb the market in terms of awareness and management discussions and really grow that offering as maybe a Trojan horse into a lot of other parts of the market.

Okay, that's helpful. Do you actually have a client count you're willing to share with us, or is that not something you want to disclose at this point?

I don't actually have one at my fingertips. Do you have a client count, John?

I do not have a client count currently. But we could -- I don't think there's any reason why we couldn't offer that in the future.

Okay. Yes, just as it grows, I'm trying to get a better handle on that. And then maybe if we could go back to the quality and total cost of care. And appreciate all your details and responses to the questions already.. I think you mentioned on the last call you may actually have some data you could share with us on kind of what trends you're actually seeing in regards to readmits and admissions and cost trends. Do you have any data that's been approved by Fairview to share yet that you can disclose?

Well, Fairview has complete support for all of our data. So we don't have any issues there. What we are -- if you're familiar with the way the insurance industry likes to take a look at things, they look at a period where care is delivered, then they look at our run-out period because there are times when all of the claims have not come in subsequently. So that means that if you look at any period that we would have right now that is already included the run-out period, it was just Q1, so the first quarter of effort.

What we look at is something that is much more contemporaneous, which is to take a look at what the total charges are that are just landing in any period of time, regardless of when the episodes of care took place. So, on those leading indicators, we are seeing significant reductions in readmission rates, like 30%. We're seeing significant reductions in original admissions for our most acute patients. And we are seeing total charges that are running in the range of 8% lower than expected.

Having said that, we do have to caution that until we get the run-out period that the way that we ultimately will recognize value in the contracts with the payer is yet to be corroborated. So that's the only hesitation. We think our metrics are really very good and we fully expect them to be corroborated. But we're going through this the first time and we only have two quarters of actual operating results.

Got you. No, that's exactly what I was looking for, and that's helpful. Maybe two more quick ones on that, and I'll hop off.

Are you seeing more competition emerge? Obviously this is a great alternative for healthcare delivery in the US to lower costs and improve quality. I think some of the more traditional disease management companies have talked about moving into the provider market. So I'm curious what the competitive front has looked like there and if you see that kind of changing on a real-time basis.

We don't see a real competitive offering here. I mean I think the big ah-hah that we have had that seems to really be ringing through is that when you partner with providers themselves directly, I mean all the disease management effort, to a certain extent, went around the docs and was not a capability with and for the docs to support patient care and delivery.

And so what we're doing is with and for the docs, supporting them in their efforts to really treat their population. And I think that's a game changer, as we mentioned. We don't see any other competition out there and even in the conversations that we're having with others in our pipeline. And we're talking to the kinds of people that anyone who had an offering or an innovation would want to talk to first because they are bellwethers in the market and they indicate to us that we're the only ones bringing these ideas to them.

Okay. Thank you for that. And last question just on the revenue, I think you mentioned there was no revenue from the Fairview program. I was under the assumption that you were actually getting some small base fees and that the bulk would still be incentive fees. But are the base fees at risk such that you haven't been able to recognize any of those either?

They're not at risk, but we're actually working through some of the delegated costs from the payers. And so that process is one that we think will be trued up by the end of the year, but it's not been completed.

Okay. That makes sense. Thanks a lot, guys.

And our next question comes from the line of Jamie Stockton with Morgan Keegan. Please proceed.

Yes, good morning. Thanks for taking my questions. I guess the first one, John, real quick, the number of hospitals you ended the quarter with. Do you have that?

Yes. Number of hospitals was 74 that we finished the quarter with.

Okay, thank you. And then, Mary, I guess bigger picture --

By the way -- I think we're on the same page here, but that hospital count is only for RCM offering. It's not for our physician advisor services offering.

That's correct. It's RCM only.

Okay. And then, Mary, I guess bigger picture. when you think about the two different primary offerings, RCM and quality and total cost of care, as far as technology is concerned, where do you feel like that is a bigger differentiator for Accretive?

I think it's a very key differentiator in both, but the technology has a different characteristic. In RCM, the algorithms that identify risk are game changing. But then it's really all the day to day grind it out operating processes that really monitor where the crumbs are being left on the floor that allow the sort of consistent execution of the last 4%.

On the quality and total cost of care side, it's much more into algorithms and predicting which portion of the population has had some progression in their underlying health state that is putting them in position to be one of the patients that could spiral in the next 12 months.

It's very, very important if you try to take a physician who already has a very taxing workload and say somehow we want you to squeeze out more time and energy on certain patients, the first thing you have to be able to do is predict which patients we could focus on that would really make a difference. So those models are true secret sauce and they have been built over a number of years that our president of this division [Tim Barry] had in executing a similar model with the Medicare Advantage business.

The next thing is then you do move into those operationally intense technologies that say even once we know who those patients are, now do we make sure that we're going to do everything we're supposed to do. So that's where we let physicians have technology to support their care plan. Everything else that's being done in healthcare technology today is about an episode of care. So everything that people like Epic and Cerner and so forth do is they're inside an episode of care.

This is a whole different thing. This is now saying longitudinally for a patient that we think needs intensive care, what -- or focused care, what are the things we want to do during the course of this year to keep them well so we don't even incur an episode of care called an acute care admission. And so by saying here's what we want to happen, we want it to happen monthly, we want this blood work to happen quarterly, we want this to happen, that then gets documented and is put into the technology.

And for the first time in American medicine outside of a clinical trial we then monitor the adherence to the doctor's good plans and ideas, to say is this all happening. And we know that a lot of these patients have trouble with compliance. So we also don't have laissez-faire medicine, we have follow-up medicine where we basically now begin to notice so and so didn't have their blood work, we can call out to Mrs. Jones, we can say what can we do? Is there a transportation issue? Maybe there's a social work visit that is needed.

But it's really, then, executing. Executing on things that are knowable today in medicine, but supporting, again, physicians who are highly taxed in terms of their time and workload and being able to get those good ideas all the way through implementation. So technology's very important. It's insufficient in both cases. You require the whole operating capability and all that follow-up and rigor and measurement. But it's that whole loop that winds up being important in both.

Okay. I appreciate the color. I guess just one other follow-up question for John. The other services line I'm guessing that the bump that you guys got there was the physician advisory business during the quarter. But if there's -- is there anything that was not as recurring in that line? It seemed like it increased pretty significantly sequentially.

Yes, the bulk of the increase, the vast majority of the increase was tied to our physician advisory services business. There's a few other ancillary services we provide outside of our typical arrangements, but the vast majority of the revenue and the growth is our physician advisory services business.

Okay, and so that level of business should be either sustainable or should ramp from here basically?

Correct. At a longer term, one year to two year contracts.

Thank you very much.

And our next question comes from the line of Bret Jones with Oppenheimer. Please proceed.

Thanks for taking the question. Gentlemen, I'm having a little trouble trying to get reconciled to your revenue guidance. And evidently I'm not the only one having trouble modeling revenues. But I'm just wondering if you can help me out with how you get there.

If I look at the PCARR that you currently have, and it would imply a little over $220 million on a quarterly basis, and it would like your PCARR would have to enter Q4 at well over $1 billion. Am I thinking of that right or is there something else that may not be showing up in PCARR that will -- that you would expect to recognize, whether it's Fairview or something else?

I think there's a couple of things and factors to consider as we look at the back half revenues and you think about modeling it. First is obviously our quality revenue is backend loaded. It's been sitting in our PCARR for a while. But again, it is backend loaded, as we've described on prior calls for Q3 and Q4. So we do expect that to ramp in those two quarters.

Secondly, as you know, our incentive payments are seasonal. So obviously we have -- (inaudible) experienced this year the lighter first quarter, yet the fourth quarter will be much stronger and that will add to revenue. If you haven't factored that in, that will certainly be an increase that sits there.

Thirdly, as you look at our business, our PAS business does take usually two months to get fully ramped in terms of revenue while it sits in our PCARR and that business we expect to continue to grow very nicely quarter to quarter sequentially through the main part of the year.

Those things should come together to get us to our revenue guidance in addition to our confidence of the $120 million to $140 million that we currently have in the final stages of our pipeline, what we call the end contracting phase.

All right, thank you. And then in terms of physician advisory, you called out that you had $40 million in PCARR. Can you give us a sense for how that's grown year over year?

It is -- let me give you the range. It is over tripled year over year. Maybe -- I got to look at the numbers. It could possibly be quadrupled at this point.

All right, that's helpful. On the accounts receivable, it remains stubbornly high. And I was wondering, you called it out last quarter to get $24 million paid on April 1. Did you have any kind of similar cash flow come through since the end of the quarter, or is there something else going on in that line?

Two things that are affecting that line. One, there's just kind of the sequential growth in our business, particularly our share of added revenue that grew by about $9 million from Q1 to Q2, which adds to AR that we're not able to collect just on that timing.

Our PAS business just its growth has added another $4 million, and we've had a drop. So we've had about a $15 million actually what I would call adjusted sequential decline in the open AR, actually normalized for the growth in the business.

And then secondly, we do see, which we've had every second quarter, is it is the end of the fiscal year for one of our major clients, namely Ascension, so we do tend to collect some of their cash shortly after their fiscal year end, which has happened here during the month of July.

Okay, thank you. And then just one last question. In terms of the gross margin, obviously you -- it spiked up considerably and even adjusting for the bump-up in incentive fees, unless the physician advisory profitability changed dramatically, it didn't sound like it did when you answered the earlier question, it looks like your base fees would have had to add about a 250 basis point quarter over quarter improvement. And I'm wondering is that all driven by your shared services benefit that you receive or is there something else going on?

Shared services is definitely contributing to that in a significant way. But it's also just where contracts are maturing. As we see more and more mature contracts in our portfolio, we're able to leverage technology to a greater extent and even drive more efficiencies both within shared services model and non-shared services clients.

Okay. Can you give us the update on the shared services percentage?

The shared services percentage, we continue to add to the business and we have continued to add additional clients in the quarter and we have a strong pipeline to continue to add. It has gone down to 34% of the business, mostly because we had a number of significant new signings that clicked over to the year. We expect to be -- I'm sorry, a year in the denominator. Even though we've grown the numerator, we do expect that to grow back up towards 39% towards the end of the year.

Great. Thank you very much.

And our next question comes from the line of Eric Coldwell with R.W. Baird. Please proceed.

Thanks. A lot of mine have been hit, but I am curious on shared services if you could give us the impact on revenue, if you've calculated that.

I have not calculated that specifically. But the incremental cost takeout that we take in incremental incentives would likely have an impact on the base fee that would be negative, which is actually correct. I have not calculated that, but my guess is it's probably about a 1% impact in the quarter.

Okay. You mentioned that you have 74 revenue cycle customers now. I believe that's an increase of seven quarter over quarter. Curious whether that includes the three Beaumont hospitals and, if so, where did the -- what was the mix of the other four net hospital wins? So, was it add-ons to existing accounts or new mix? If you could give us some detail on that.

Those were all new client wins.

Three of them were Beaumont.

Three were Beaumont and the other four were new client wins.

And then you've also in the past given us number of contracts under management. Curious if we could get that update. John Staton: Sure. In our revenue cycle business it was 27 clients at the end of the first quarter. It's grown to 30 clients at the end of the second quarter.

Okay. And final question, just curious whether your PCARR guidance for yearend, which I agree with the previous question seems like it could prove to be a conservative number. Does that include the potential for contract losses upon renewals that are due this year? So we should be thinking about, yes, you'll win your business, but you might have contracts coming off, or are you modeling full retention of your client base at this point?

You're modeling a high retention rate amongst that based on our experience. But, yes, we have factored in a factor for potential nonrenewal into our PCARR numbers.

That's great. Thanks very much for the answers.

And our next question comes from the line of [Mr. Paul Maury] with Global Equity. Please proceed.

Most of my questions have been answered, but if we look at SG&A came down in the quarter even though revenues were up, can you talk about how sustainable that is and what it might look like the rest of the year?

We would continue to see leverage in our SG&A line as we continue to go forward. Obviously growing slightly less than revenues year-over-year. And you should certainly expect that as we go through the third and fourth quarter quality revenue will ramp. And certainly we have this seasonal aspect of incremental gain share that will happen in the fourth quarter with basically no real change to the SG&A trajectory at that point.

Okay, thanks.

And our next question comes from the line of Doug Simpson with Morgan Stanley. Please proceed.

Hey, everyone. This is actually [Collin Weiner] in for Doug. To the extent that you can, could you sort of comment briefly on your pipeline beyond the 130, kind of in the later stages? It looks like Beaumont certainly took a big piece of that when you looked at Q1 levels. But also as we move forward how you kind of view that evolving between revenue cycle, cost quality and physician advisory.

We have a really strong pipeline up above the level of what we call final stages of contracting, stronger than it's ever been. It was sort of tied to my earlier comment about how we see demand sort of increasing across all of our fronts. We think to a certain extent there's sort of synergistic value. Again, the [pads] offering creating sort of a Trojan horse and in a way getting more brand awareness out there and creating more opportunities to have RCM conversations.

But we're also seeing that the quality and total cost of care dialog that we're having is so strategic that it's really captivating sort of C-level attention. And then the RCM right now is just the fastest path to the most material cash flow improvement that a hospital can be looking at.

So, the pipeline is better than ever. We have some things that are expansions within existing clients also in there that are looking very promising at this stage. And we feel very good about the kind of growth trajectory that we've always talked about to the business.

Okay, great. That's helpful.

(Operator Instructions). And our next question comes from the line of Deepak Chaulagai with Dougherty & Company. Please proceed.

Good morning. Thank you for taking my questions. Do you have the portion of PCARR that's quality and total cost of care for this quarter?

We have not shared that or disclosed that. We're sensitive to our relationship with being just one client in Fairview at this point in time. Once we get to multiple clients, we'll be willing to start sharing both the quality component in PCARR and revenue.

Good. And, Mary, could you comment on -- you made a comment earlier that you're looking about expanding your total cost of care outside the US as well. We know that other physician and management companies have tried to do that, some with limited success, some not so much. Obviously they were focused on the -- mostly on the payer side. What gives you confidence that you can extrapolate what you've done here outside the US?

Well, you hit a very key difference. The disease management companies were focused on payers and they're usually outside the US -- healthcare is actually provisioned by the government. However, if you strip away all of that, what all regimes who are paying for healthcare want anywhere in the world is higher quality at lower cost. I think the big difference here is not having a capability that you have to pay for upfront and may or may not get results and frankly disease management didn't deliver.

I mean if you say in aggregate we've been at disease management for well over a decade and yet healthcare costs have been going up at 2.5 times inflation, the impact did not stem the growth in costs. When we, on the other hand, are turning around and saying we can reduce costs by 25%, not reduce the rate of growth by 25%, no small print like that, but reduce the total costs back, so for every $1 billion take $250 million out, that is a very, very different sort of impact. And that's the kind of thing that people who are having to pay for healthcare are hoping for in terms of innovation.

And if we can show that this is something that docs embrace and want and that it's really about giving what has actually been a pretty low tech environment and a major upgrade of technology and process in a way that we would execute in other industries to support the physicians' efforts, that's a game changer. And we're just now -- we're basically fielding a lot of inquiries from outside the United States and therefore see that there's a massive potential and that there's no way to -- no reason to think about this as just a domestic opportunity.

The other part of this, frankly, is we see that other parts of the world are doing things in healthcare more effectively than the United States. And so as we did our own research and benchmarking, we were starting to learn from other parts of the world and incorporate that in our model. And we want to continue that sort of two-way learning. We think there's going to be a lot of things that we can import that are happening in other parts of the world to help the way we help our physicians in terms of best practice knowledge.

And do you think you can leverage your infrastructure here or would you have to build out something wherever you go in that particular geography or country?

Well, I think, obviously, medicine is a very personal thing that needs to be delivered. And when you're assisting physicians you've got to be present. But all the technology assets and, frankly, the accumulated knowledge and methodologies and metrics and so forth can be leveraged so that expansion into a new geography doesn't have a lot of overhead expansion costs. The only thing is really cracking the code on how you sell to a new buyer. But absent that sort of different sales process, which we recognize, then everything else about delivery is as scalable as another domestic win would be.

Thank you for the color.

Ladies and gentlemen, with no further questions in the queue, this concludes today's question and answer session. I would now like to turn the call over to Mary Tolan for closing remarks.

Thank you. John and I would like to thank everyone for participating in our call today and for your continued interest in our company. We're excited about the great growth opportunities we see ahead, and we look forward to keeping you updated on our progress in these quarterly updates. Thanks, and have a great day.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a good day.