R1 RCM Inc
NASDAQ:RCM
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R1 RCM Inc
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Good morning. My name is Rob, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the R1 RCM Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
Thank you. Atif Rahim, Head of Investor Relations. You may begin your conference.
Good morning, everyone, and welcome to the call. Certain statements made during this call may be considered forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
In particular, any statements about our future growth, plans and performance, including statements about our strategic and cost saving initiatives, our liquidity position, our growth opportunities and our future financial performance are forward-looking statements.
These statements are often identified by the use of words such as anticipate, believe, estimate, expect, intend, design, may, plan, project, would and similar expressions or variations. Investors are cautioned not to place undue reliance on such forward-looking statements.
All forward-looking statements made on today’s call involve risks and uncertainties. While we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law.
Our actual results and outcomes may differ materially from those included in these forward-looking statements as a result of various factors, including, but not limited to, economic downturns and market conditions beyond our control, including periods of inflation, the quality of global financial markets, our ability to timely and successfully achieve the anticipated benefits and potential synergies of the Cloudmed acquisition and factors discussed under the heading Risk Factors in our most recent annual report on Form 10-K and in our quarterly reports on Form 10-Q.
We will also be referencing non-GAAP metrics on this call. For a reconciliation of non-GAAP amounts to their equivalent GAAP amounts, please refer to our press release.
Now I’d like to turn the call over to Lee.
Thank you, Atif. Good morning, everyone, and thank you for joining us. I am pleased to report strong second quarter results driven by our technology-focused operating model and our team of experts delivering on behalf of our customers.
Revenue totaled $560.7 million and adjusted EBITDA was $142.9 million, inclusive of an $11.6 million increase to reserves covering credit losses related to a physician customer. Adjusted EBITDA would have been well ahead of expectations, absent this reserve increase.
We are pleased with our first half performance and are refining our guidance to reflect our updated outlook for the remainder of the year. Jennifer will cover the financials shortly, but first, I’d like to discuss progress against our top three priorities.
First, operating trends across both the business and industry remain largely in line with our expectations and we continue to help our end-to-end customers navigate complex macro dynamics across the provider industry.
Second, the power of our technology platform, including automation, AI and large-scale data analytics continues to strengthen our provider partnership.
And third, commercial activity expansion reflects a strong sales model, including cross-sell opportunities and differentiated capabilities in a market where providers need us now more than ever.
Let me cover operational delivery for our customers. Our combination of people and technology allows us to proactively address evolving industry dynamics for our customers. Our global infrastructure reduces cost, while continuing to achieve high quality results. Purpose-built technology deployments drive deep insights and accelerated cash conversion, including predictive analytics, performance benchmarking and trend management.
Years of revenue cycle experience and access to data across more than 500 customers and $900 billion of NPR drives more predictability for our customers, allowing them to focus on what they do best, care for patients.
Industry metrics such as payer time lines and volumes were in line with our expectations for the second quarter. Our internal efforts and customer engagement resulted in reductions to both total AR and aged AR. As a reminder, customer-specific fluctuations are expected within these calculations and are dependent upon customer geography, care setting types and payer mix.
While payer dynamics in our own operating performance have improved throughout the first half of the year, providers continue to face pressures due to sustained financial backlogs and increased cost, as well as an evolving regulatory landscape. Our customers understand that our technology, expertise and unit economics continue to make us the preferred market partner.
Next, I would like to talk about our technology strategy, the progress we’ve made this year on our platform and data approach and applications of AI. First, let me start by reminding you of the problem we are solving for our customers and the technology journey we have been on for 10-plus years.
Revenue cycle is a highly complex process typically solved with manual effort at a high cost. The complexity is due to a large volume of claims compounded by limited digitization, lack of data standardization and siloed data across provider and payer systems.
Our technology investments have been and continue to be aimed at digitizing, standardizing and automating this process, which improves both the productivity of our team and the quality of our services. Our customers typically do not have the financial capacity to invest in technology at scale and often struggle with a manual process or use fragmented point solutions.
Our technology journey has been focused largely in three areas; intelligent automation, patient experience and scaled analytics. Our intelligent automation work, which began in 2018, has focused on automating repeatable processes and reducing the need for labor in areas such as claims adjustments, insurance verifications and payment posting.
Our patient experience solution, which we call Entri, unifies and digitizes the scheduling, patient registration and patient payment experience, which provides a combination of patient self-service and behind-the-scenes automation that makes patient’s lives easier and improves the efficiency of our team.
Our scaled analytics power solutions across our customer base by maximizing revenue opportunity identification, using our breadth of data, algorithms and expert rules across our over 500 customers.
Across all of these areas, we leverage machine learning, for example, to extract data from documents, to personalized patient payment plans and to find data anomalies that are new revenue opportunities.
Now for a few specific examples of technology deployed in our second quarter. The automation team released several net new use cases. One high value example is our enhanced prior authorization determination. This solution determines whether a prior auth is required by comparing the scheduled service against frequently changing payer policies to determine whether an authorization is required without human intervention.
In another example, we continue to leverage our data by expanding our work prioritization models across our modular offerings. By analyzing the over 500 million patient encounters we touch annually, our models can more accurately predict the likelihood of collectibility and time to collection, translating to more revenue for our customers faster. We expanded these models to our underpayments business, which have now automated and simplified the complex trade-offs our teams use to prioritize their work.
In summary, we made significant progress across our technology portfolio, including extending our business intelligence solutions to new clients, automating cash posting activities, reducing appeal generation time, consolidating legacy applications and improving stability and scale.
Our efforts today create a strong foundation for us to leverage AI across our technology platform. We believe large language models have the potential to significantly reduce, and in some areas, fully automate workloads by summarizing account histories and medical records, classifying documents, enabling patients to solve more complex problems via self-service and more.
Our data science and technology team has made great progress testing the applicability of these models on data from real-world use cases and we expect to have several end production by year-end.
We think of AI and large language models as a significant new toolkit that when combined with our data access and revenue cycle expertise will enable us to achieve another level of automation, patient satisfaction and service quality, which will further extend our competitive advantage.
Finally, I’d like to discuss the continued strength of our commercial engines. End market dynamics remain favorable due to continued financial and capital pressures faced by providers, large and aged AR backlogs, change in reimbursement and policy developments, as well as overall costs continue to drive a need for our solutions.
Despite these challenges, over 70% of providers continue to manage revenue cycle processes in-house, we believe these factors present us with sizable runway for long-term growth across the business.
In Q2, the pipeline expanded across both end-to-end and modular opportunities for both hospital and physician customers. We saw an increase in cross-sell activity as our teams leveraged our new commercial model.
We increased the number of meetings with CFOs and heads of revenue cycle, thanks to internal opportunities from Cloudmed, cross-sell of legacy R1 modular solutions into the Cloudmed base and introduction of end-to-end solutions to the Cloudmed base.
On the modular side, bookings in the first half were ahead of expectations, with a faster sales and deployment cycle relative to our end-to-end solutions, we’ve been able to capture market demand faster with momentum expected to continue into the second half of the year.
On the end-to-end side, several partnership opportunities continue to progress in our pipeline. Furthermore, there was an uptick in inbound activity throughout the first half of the year, thanks to the cross-sell efforts made by our commercial teams. As a result, we are making good progress towards our goal of signing $4 billion of NPR by year-end.
In closing, our teams remain dedicated to our 2023 priorities. We solve an important problem for our customers in a time when they need us the most. The market for our solutions is large and growing and we have highly differentiated offerings with technology and data to maximize results for our customers.
Now I’d like to turn the call over to Jennifer to review the financials.
Thank you, Lee, and good morning, everyone. We are pleased to report strong second quarter results with revenue of $560.7 million and adjusted EBITDA of $142.9 million. Adjusted EBITDA for the quarter grew 64% year-over-year and was well ahead of our expectations, excluding the $11.6 million reserve taken in the quarter for the physician customer that Lee referenced earlier. I’ll provide more detail on that shortly. But first, I’d like to provide some color on revenue.
Total revenue in the second quarter grew 43% year-over-year, driven by contributions from the Cloudmed acquisition completed in late Q2 of last year and revenue from new end-to-end customer wins in 2022. Normalizing for Cloudmed, revenue growth was 13% compared to the second quarter of 2022.
So let’s go through some additional details on our revenue growth. Net operating fees of $357.8 million grew approximately 12% or $39.5 million year-over-year from new business wins. On a sequential basis, net operating fees declined $3.2 million due to normal seasonality and cash collections.
We also moderated the pace of employee and vendor contract transitions at some of our newer customers. While the timing of these transitions impact net operating fee revenue, it has little or no impact on near-term adjusted EBITDA. This transition is also beneficial from an operational standpoint as it creates better stability and customer satisfaction during the onboarding process.
Incentive fees of $30.8 million in the second quarter were ahead of our expectations, driven by strong operational performance and the achievement of cumulative performance targets for some of our customers. We are very pleased with the progress our operational teams are making here, as these incentives are aligned directly to our operational metrics. Our commitment to execution drove the sequential improvement in revenue compared to last quarter.
Our modular and other revenue posted another strong quarter with revenue of $172.1 million. Revenue from Cloudmed solutions was up 20% year-over-year and remains on track to grow 20% full year.
Turning to expenses for the quarter. Non-GAAP cost of services in Q2 was $364.5 million, up $84 million year-over-year. The increase was primarily driven by Cloudmed and costs related to onboarding our new customers. On a sequential basis, non-GAAP cost of services remained relatively flat, thanks to cost discipline across our teams, benefits from automation and realization of cost synergies.
Non-GAAP SG&A expenses were $53.3 million in the second quarter, which includes the reserve previously mentioned. Excluding this reserve, non-GAAP SG&A expenses would have been essentially flat from the first quarter as we realized cost synergies in real estate and in corporate functions.
Let me provide some additional color on the charge taken this quarter related to one of our physician customers. In the third quarter of last year, we booked a reserve for this customer for approximately $10 million.
In mid-July of this year, the customer announced the decision to cease operations effective July 31st. As a result, we have increased the reserve for this customer by $11.6 million in the quarter and are now fully reserved for all amounts outstanding. We are also pursuing payment for the outstanding receivables balance.
Our adjusted EBITDA, as reported for the quarter was $142.9 million. Excluding the reserve, adjusted EBITDA would have been well ahead of expectations we communicated on our last earnings call, higher incentive fees, higher modular revenue and lower cost due to continuing operating discipline were the main drivers of this performance.
Lastly, we incurred $28.3 million in other expenses, primarily related to Cloudmed integration cost and technology transformation initiatives. We remain on track to achieve approximately $30 million in cost synergies in 2023 from these activities.
Now let me provide a few comments on the balance sheet. Cash and cash equivalents at the end of June were $123.1 million, compared to $104.2 million at the end of March. We generated $57.4 million in cash from operations in the quarter.
We also incurred $25 million for CapEx and used $12 million for debt pay down in the quarter. Net debt at the end of the quarter was $1.65 billion, down from $1.68 billion at the end of March, driven by the debt paydown I just mentioned and a higher cash balance.
As I’ve previously discussed, we expect net debt and leverage to continue to decline over the course of the year. Our liquidity remains strong with approximately $632 million of liquidity at the end of June, both from cash on our balance sheet and availability on our revolver.
So what does this mean for our financial outlook? We are updating our 2023 guidance to reflect our expectations for the remainder of the year. Let me start by saying that our operational performance has been strong, as demonstrated in our core financial results this quarter and year-to-date, even when considering the impact of the reserve taken for the physician customer. We are very pleased with our financial results and with the progress we are making against the priorities that we reviewed.
Starting with revenue. We now expect 2023 revenue to be in a range of $2.25 billion to $2.275 billion. Our updated guidance is driven by three factors. Number one, the wind down of the physician customer will impact revenue in the second half of the year by approximately $15 million.
Number two, the timing of new end-to-end business wins is expected to impact revenue in the second half by approximately $25 million. Our guidance assumes new business signed from this point forward in the year will not contribute revenue in 2023.
Number three, timing of employee and vendor transitions will impact our net operating fees as we pace the ramp of our recent customer wins. It’s important to note that this will not have a material impact on our adjusted EBITDA for the year as the costs will not transition to us until we execute the operational transition. Our current pace is aligned with our customer expectations. It creates stability in our operations and is the right balance in the near future as we continue to deploy new business.
One additional note on revenue guidance. Our prior guidance anticipated incentive fees would increase modestly across each quarter to achieve approximately $30 million by the fourth quarter. We achieved those results in the second quarter, which included a benefit from metrics calculated on a cumulative basis. Therefore, we expect incentive fees in the second half of 2023 to remain in line with comments provided on prior calls.
We now expect 2023 adjusted EBITDA of $600 million to $615 million. This update includes three drivers in our business. Number one, the $11.6 million reserve for the physician customer we previously discussed.
Number two, the second half EBITDA impact for the same customer as they wind down operations and we adjust our cost structure to reflect the change.
And number three, better operational execution year-to-date and changes we are making to our model to ensure long-term stabilization through scale. This has allowed our operations team to realize savings on some key initiatives in the first half of the year that were already embedded in our original guidance for the second half of 2023. For the third quarter, we expect adjusted EBITDA to be slightly ahead of current consensus estimates.
Overall, absent the impact from the physician customer, our adjusted EBITDA would have been above the high end of our prior guidance range, thanks to the efforts of our global teams that work to serve our customers every day. We are well positioned to deliver value to healthcare providers who are unable to do so on their own and we will continue to execute on our priorities to drive shareholder value.
In closing, our team is executing well on both operations and on our customer performance metrics. We are on track to deliver results for the second half, in line with our updated guidance and look forward to updating you on our progress on future calls.
Now I’ll turn the call over to the operator for Q&A.
[Operator Instructions] And your first question comes from the line of Glen Santangelo from Jefferies. Your line is open.
Oh! Yeah. Good morning. Thanks for taking my question. Lee and Jennifer, just a lot of people are asking questions, obviously, about this customer and everyone is trying to do these gymnastics to figure out how much the charge in this customer may be impacting the 2023 full year guidance. But it sounds like, Jennifer, I heard you correctly, you don’t anticipate taking any additional charges. And if we could maybe just look past 2023 for a second and look to 2024, based on reports and what we’ve seen about this company, this customer’s NPR, is it fair to say that maybe this customer represents a little bit more than 1% of your total NPR? And if we think about this customer having, let’s call it, average margins, is it fair to sort of size up this customer a little bit maybe more than 1% of rev and EBITDA, because what I’m really trying to figure out is the impact of this customer on 2024 and beyond really?
Good morning. Thanks, Glen. Yeah. So the way to think about this customer is, at this point, with the $11.6 million charge we took in the quarter, we are fully reserved for all of the AR that’s outstanding. So there’s no more exposure there from an AR perspective.
From a just normal operations perspective in the second half of the year, we -- as we noted, we expect the revenue impact to be about $15 million. So the customer on an annual basis about $30 million of revenue, low 30% margins here and so that’s the annual kind of impact. In the second half of the year, it’s $15 million on revenue.
The EBITDA impact is more in the second half, because we’re not -- we’re assuming we’re not going to be generating any revenue, but it will take us some time to right-size the cost structure. So there will be a bit of an outsized impact in the second half of the year, but will be normalized going into 2024.
Okay. That’s awesome. I really appreciate that detail. Hey, Lee. Maybe if I could just ask you a quick follow-up on the current operating environment. It sounds like you’re getting -- you’re starting to see a tailwind from this utilization uptick that we’ve seen across the industry. And in your presentation, you seem to suggest that you’re comfortable adding that $4 billion of NPR in the back half of the year. Could you maybe just frame the conversation you’re seeing or having with your customers right now and how confident you are in that $4 billion and may -- and just maybe what you’re seeing in the market more broadly?
Yeah. So, Glen, let me touch on a few things on the market first and then Jennifer, if you have any color commentary before I get into new business. On the utilization side, largely in line with our expectations. We have a mix of customers in different geographies, different care settings. There’s obviously a lot of factors that can drive variances to industry average.
We’re generally positive. We see some more stability. The thing you have to note is, you’d have to look at our specific -- our three largest, for example, look at the geographies, what their care settings are to kind of do the math. And so there’s some -- there’s always some variability within our customer base, but we feel good about it. So we’re seeing what you see across the market, which is some level of stabilization in volumes. Jennifer, anything to add there before I get to new business...
No. I think that’s in line.
Okay. On the new business side, a couple of things I’d say. First of all, the headline matter, I and the team are confident in signing at least $4 billion of NPR by year-end. Here’s what I’d say a couple of things. This one is there’s a little bit of a color commentary that I think it’s consistent with what I’ve said in the last couple of months, but I had a couple of points of emphasis.
First is, the market demand is strong, okay? So we have seen increased interest within mid-to-large systems and it’s a couple of factors. It’s very, very common themes. I personally spent most of my time on the road talking to prospective customers and current customers and the conversation is always very similar.
And it goes something like this. One is, especially in certain markets on the West Coast, continued labor challenges, challenged, particularly in hiring administrative staff and the cost structure of their workforce.
The second is, we could go on, on this one as well, there’s still pressure on payer time lines with residual AR. So depending on the market, that is always a theme within the boardrooms of these systems is, what’s happening in our market, and coincidentally, we can help them, because we -- with the Cloudmed data of access to 95 of the top 100 systems, we have access to data across every state, every payer, every care setting and so we can show them with what we call net revenue variance analysis exactly what’s happening in their markets and CEO, the current customers or prospective customers are just wowed by the analysis we can do given the data sets we have. But it typically shows there’s hotspots, if you will.
And the third thing we’ve heard is that, there’s -- the technology theme is always tricky, because if you’re a hospital system, there’s only so much you can invest organically in technology or with vendors you hire. And then oftentimes, if you do have the capacity to invest in vendors, it’s often fragmented point solutions.
So they look to us and say, where can you help us? And the conversation Jennifer and I and my team has is, look, we have a history of significant investment in technology, both to make our operators more efficient and to drive innovation in different areas, whether it is the front end on the patient side, the middle and coding or CDI prioritization or the back end on something that sounds been benign, but low balance AR is a big industry problem, we can apply automation to help solve that. So that’s the nature of the discussion with the headline that demand is very strong.
The second point I’d say is our pipeline. I have a lot of resources internally, a team that’s been around 20 years and seen patterns for the last 10 on quality of pipeline, including the -- my predecessor, who I still talk to a good bit. Our pipeline has a range of deals across different sizes and types for both the modular and end-to-end business and it is very strong.
I’m not don’t give metrics on size of the pipeline. I’ve run sales teams. I understand you can always do match gymnastics on side of the pipeline. What I would say is, it is as strong or stronger than we’ve ever seen.
And the last thing I’d make is, our message and value prop is resonating. The combination of our revenue integrity Cloudmed business, plus the legacy R1 business is resonating and so all signs are very positive towards signing the $4 billion by midyear.
Thanks very much for all those details. Much appreciated.
Thanks, Glen.
Your next question comes from the line of Sean Dodge from RBC Capital Markets. Your line is open.
Yeah. Thanks and congratulations on the great progress again this quarter. Lee, your comments around strong market demand and seeing an uptick in inbound interest in end-to-end. Where do you all stand now from a nominal deployment capacity? I think you entered the year with a structure that could support $9 billion, but I also think there are plans to continue scaling that. Have you guys continued to invest there to expand that to meet this demand?
Yeah. Jennifer, you want to take that?
Yeah. I can answer that one. Hey, Sean. The -- from a market capacity perspective to deploy new business, we are still in that between $8 billion and $9 billion range. We’re obviously monitoring it with the existing new business wins that we are continuing to deploy, as well as the pipeline, as Lee indicated, being strong and just monitoring the time line of when we think those deals are coming in.
It’s something that we’ll continue to monitor. We’ve kept it fairly stable since we made the investment mid last year and started to ramp some of those resources, but it’s something that we’ll continue to monitor to see if we need to continue to expand and make an additional investment there or if we’re comfortable at the level that it is.
Okay. And then just quickly on the payer reimbursement time lines. I think, Lee, you said continues to normalize. Are we back to kind of more normal levels now or are there still some improvements you can drive there? And then at what point can you start to release the extra resources you have to address that or those issues?
So on the time lines, we are -- we have seen some improvement. What I would say is it’s more stable. If you look at the days claims payable, which again is not perfect, but a proxy, some of the public payers are saying that they’re up slightly in quarter and some are down, but it’s somewhat mixed. So I would say, overall, fairly stable.
We saw an improvement in our AR, both AR and HR this quarter, modest improvement and I would say that there’s still work to do. There’s still opportunity for it to come down. We still aren’t back to, what I would say is, baseline is still elevated from historical levels.
Okay. Great. Thanks again.
And your next question comes from the line of Charles Rhyee from TD Cowen. Your line is open.
Yeah. Thanks for taking the questions. Jennifer, I wanted to follow up on Glen’s question about, when we think about 2024, and you mentioned, obviously, this year’s EBITDA numbers impacted, obviously, by the charge, but also sort of the ongoing contribution from APP that is no longer there and this normalizing the cost structure. Given sort of what you’ve given us here, it sounds like that APP contribution would have been something like $3 million to $5 million in EBITDA. The cost structure part, can you kind of frame sort of what kind of expense we’ll be running through or sort of the deleverage you’re getting on the cost structure until you normalize it. Is that more than the contribution perhaps? And I guess what I’m trying to get at is, if we were to then add these kind of items back, is that the right baseline number then to think about as we grow 2024?
So on an annual basis, it’s about $30 million of revenue with margins in the low 30%. So the EBITDA contribution is higher than that and that’s on an annual basis. But in the second half of the year, Charles, the way to think about the impact is obviously, the revenue is a half year impact on revenue. But on the cost side, it will take us through most of the third quarter to be able to right-size cost. So it will have an outsized impact, because we still have those costs in the business through the third quarter before we’re able to really normalize it. So it will create a distorted view in the second half of the year versus just ongoing margin.
Okay. Okay. I think everything is back into that. And then, Lee, you talked a lot about automation and particularly in the use of AI. Can you envision going forward, are you -- can you think of a vision in the future where you don’t even need people to look at a claim? And I know we have target margins of 35%. It’s currently, I think, when -- after the merger happened. But where can that margin opportunity go to, because if you think about a lot of the use cases you just talked about, I know you already automate a good percentage of the shared services functions, but where do you see sort of that upper limit? I mean is there a possibility down the road when you think about, you saw computer vision, natural language processing, where you don’t actually need a human touch to manage a claim?
So, Charles, I love the question. I appreciate it. We are thinking very aggressively about how to get to that vision of what you talk about. And what we think about is, a frictionless revenue cycle where, to your point, you don’t need a person to evaluate some element of a claim. So that’s absolutely part of our vision.
Let me give you a little detail on just how we think about the application of automation data -- large-scale data and analytics, which, as you know, we have a significant amount of clinical payment reimbursement data through our Cloudmed customer base and then the application of some of these new tools around genre.
A couple of things. Just the way we think about it, the framework we use is, we have -- three things we have to think about. The data has to be accessible, quality and accuracy is imperative and privacy has to be at the top of the list.
So let me just touch on the first one. We have just -- you know this, Charles, about $55 billion of NPR end-to-end, plus $900 million of NPR touched with our Cloudmed data. So we absolutely have access to data. But that data can’t be siloed across many systems, you need to think about a way to aggregate it, to access and standardize it and that’s exactly what we have done over the course of our journey on building a data platform, building automation tools and so on.
Quality and accuracy is imperative. This isn’t like other industries, consumer where you can apply technologies and trend in us, you have to be super accurate, especially if you’re dealing with something like coding, for example.
And then privacy is a core competency of ours, which is embedded in our systems and culture we day. So the point of all this is, we have -- we believe we have a right to win with our and given that we are embedded in our customer workflows and have access to data.
So the thing I’d say, Charles, just I can give you an example on each end, right? On the automation side, this is applying RPA automation to otherwise labor-intensive and repeatable processes. An example I would use is prior authorization requires multiple touch points, accessing payer portals, et cetera. We are absolutely automating all elements of that area of revenue cycle, which historically is a point of friction to your point, Charles. We’ll just need less people accessing the systems to do to accomplish that task.
On the analytics side, there’s -- we don’t talk about this enough, but -- and I use -- I have many examples, but we access an episode of care in any given state, for any given payer, in any given care setting and we see that thousands or tens of thousands of times across the country. And when we see a charge associated with a hip surgery, we know the variance of that charge. And we could either A, have a human auditing, okay, the charge is not a variance, somebody go and check it or we have a model a bot that says, hey, this is out of variance. Let me set this example to an auditor, right, that says, okay, it’s above or beyond that reimbursement level. So that’s an example of just needing less people, less touches and applying machine learning a model to that area.
The third example I’d say is on generative AI. So this is -- there’s lots of examples of ChatGPT is applied to SAs, what have you. The common theme in healthcare is 80% of data in healthcare is unstructured, okay? So think of the clinical notes in a medical record. The example we use a lot is, when a denial happens from a payer, there’s a write-up, and then from the provider, there has to be another write-up.
What if there is an automated appeal on that claim that it’s auto generated by a large language model that we have tested and verified because we see that claim thousands or tens of thousands of times or that denial. And so that’s an example of where you’d otherwise have a person writing it, probably using a template. Now you have a tool like generative AI that is essentially writing that without any person handling that work.
So all these are examples of just needing less people, and that leads to, on the customer side, way more efficiency, faster fast collection, more insight, more prediction of where there might be problems in the claims process. And then for us, Charles, to your point, that gives us confidence in our long range margin profile.
And then -- and do you think we can see exceeding that 35% over time, because it seems like particularly when you start adding large language models and being able to remove more people out of the workforce, we can start getting closer to maybe not total software margins, but getting further from where we are.
Yeah. Charles, I am aspirational on this, but that’s a little too far out. I see…
Okay.
I see good projection in the next I can -- I feel confident in the next couple of years.
Okay. Great. I appreciate all the comments. Thanks, guys.
Thanks, Charles.
Your next question comes from the line of Elizabeth Anderson from Evercore ISI. Your line is open.
Hi, guys. This is Sameer Patel on for Elizabeth Anderson. I was wondering, could you add a little bit more color on that $25 million timing impact from new wins, sort of give us color on what your previous expectations were versus what you’re expecting now? Thanks.
Thanks. Sure. The $25 million is based on the assumption of $4 billion in the back half of the year, the original guidance assumes one -- essentially one quarter of revenue that we would sign in the back half of the year, but we would start the transitions and actually generating revenue in the fourth quarter.
Based on where we sit at the beginning of August now, we’ve made the assumption that any deals that we signed between now and the end of the year based on a very cautious ramp and deployment process that we would not generate any revenue in year for it.
As Lee indicated, our pipeline is still very strong and we’re confident about our ability to close business, but at this point, just where we sit in the year, the ability to generate any revenue associated with it, we made the adjustment for that.
Got it. Super helpful. And then one last quick question. Just based on your guidance, it looks like your strategic initiatives cost range is a little bit lower for the year. Is there anything specifically driving that, is that lower integration costs or anything you’re sort of postponing into 2024? Just curious on what was driving that down a little bit?
It’s really our integration cost and our outlook on that. We’ve been very prudent in the spend there and as efficient as we can to realize the synergies. We’re still confident in the level of synergies that we’ll realize this year in that $30 million range, but it will cost us less to get there, which is certainly a good indication that we’ll spend less cash to do so.
Great. Super helpful. Thanks, guys.
And your next question comes from the line of Jailendra Singh from Truist Securities. Your line is open.
Thank you, and good morning, everyone. So I actually wanted to follow up on your comment that payer dynamics have improved recently. I know you gave some color. How much of the $6 million outperformance, $7 million performance in the quarter? Would you attribute to that or is it all around your own technology investment or process changes? I mean some of the excuse you guys have called out in the past around labor shortage, payer even higher dollar cost claims. Just wondering if you are seeing in terms of the improvement anywhere even if it’s marginal?
Thanks, Jailendra. On the payer time lines, look, when you see the data in the industry, it kind of indicates stable time lines, but our AR is improving modestly. So I would say that we’re doing a little bit better than what would be expected in the overall industry.
Now we’ve said on prior earnings calls that we have added labor to bring those balances down. And so we believe that our efforts on behalf of our customers are paying off to do that. That is driving in the quarter drove higher incentive fees. So that’s part of the EBITDA impact is the flow-through of those higher incentive fees.
We aren’t expecting that there’s going to be some huge improvement in the second half of the year. We still expect there’s going to be slow, steady improvement, not just even in the second half of this year but into 2024 as we come back to more historical norms on the AR and the payer -- overall payer time lines.
So it was really the incentive fees that drove the performance, because we would say our labor associated with that is slightly elevated, but to generate those incremental revenues, it’s certainly paid off.
You still expect -- so your guidance is $30 million incentive fees for both 3Q and 4Q, right, just to make sure that?
No. We -- the guidance on incentive fees has remained unchanged from our prior commentary. So we expect -- because in the quarter, we saw some cumulative impact where, for some of the cumulative metrics, we had a great quarter on those metrics and we were able to think about it catch up some of the incentive fees where they’re cumulative calculations. So for the third quarter, I would expect that it will go down slightly, but then back to the $30 million by the end of the year.
Okay. And then I have a question on American Physician Partners customer. Clearly, the situation seems very isolated. But just curious what are your views on customer health in general? And if this development impacts your willingness to work with physician groups in the future, our understanding is that you guys have another, of course, $750 million with other physician partner groups, any update that would be helpful?
Yeah. I mean, that’s -- Jailendra, what I’d say is, just strategically, this is a part of the market we need to continue to work with. We have a capability to apply technology, people, processes, global scale to that end of the market. So broadly, I’d say, this is absolutely a part of the market we are going to address and help customers in that space, both on the current base, as well as going after net new customers.
But there’s always something -- some learning here and we have to be thoughtful about what kind of customers we take on, right? And do our own diligence on the type of work, the markets they serve, the long-term viability of that customer. This is an isolated case though and we are sympathetic to a physician group that serves this part of the market and want to work with them. So I would say no change to our strategy, but every instance had some learning.
All right. Thanks, guys.
Thanks, Jailendra.
And your next question comes from the line of Craig Hettenbach from Morgan Stanley. Your line is open.
Thanks. A question on the positive commentary around cross-sell. Lee, can you just touch on what’s resonating and then any changes in go-to-market or sales under the leadership of Kyle?
Yeah. Sure. So just to remind you, Craig, the group, what the commercial strategy is and what we changed. So we still have our President, John Sparby, that handles a lot of the customer interactions. It’s a team effort. But as you noted, Kyle Hicok, who has 25-plus years of experience, similar pedigree to all the legacy R1 folks in the revenue cycle space is leading our commercial group.
The strategy is leverage the Cloudmed customer base to start to move -- make advance some discussions that would eventually lead to end-to-end opportunities. Now that is very purposeful. We’re very targeted because our end customer in that space is typically the head of revenue cycle.
Then on the other side and I’ll come back to this first piece. But on the other side, it’s -- there is a set of large R1 end-to-end end customers that would benefit from Cloudmed solutions. And that is -- nothing is easy, correct, but that has gone really well advancing those discussions, either within or outside of the current end-to-end contract with our largest customers.
So let me go back to the first point. The discussions are sophisticated in that our first priority with those customers is to advance cross-sell opportunities within Cloudmed. So the discussion that is happening a lot is, let’s say, we’re working with a large top 100 system and we’ve deployed our coding accuracy solution, what we call DRG validation and we see a major opportunity in optimizing their underpayments, they don’t use that service for us.
And we have access to all their data. We know the opportunity in that -- that -- in this example, in the underpayment space. It is a very straightforward discussion to cross-sell Cloudmed solutions within that customer and that’s why you’re seeing very strong growth and continued strong growth in Cloudmed.
The more sophisticated discussion is, how do we elevate a discussion from the head of revenue cycle to the buyer of an end-to-end opportunity, the CFO. And so the way that has worked and I have a couple of examples in my head of recent discussion is, we’re already doing a great job with the head of revenue cycle on some Cloudmed solution.
There is a discussion that really we are considering expanding our relationship, because we’re having those same three problems I highlighted earlier, which is labor challenges, pressure from payers and we’re having a hard time figuring out our own technology strategy, and that discussion with the head of revenue cycle elevates to the CFO. And those are discussions we’ve had and what you see in our pipeline is traction from that type of cross-sell opportunity.
Got it. Thanks for that. And then just a follow-up for Jennifer. You’re making really nice progress on the integration savings and are on track there. More broadly, can you just touch about anything you’re doing in the organization from an efficiency standpoint and maybe it’s leveraging some technology, but just how you’re thinking about kind of margins on the more intermediate term.
Sure. I mean specific to integration, like I said, we’re on track on the synergy realization front. At this point, most of our back-end G&A functions are integrated and so we’re realizing synergies there. Our facility closures and reductions in our facility footprint are done. So we will, in the back half of the year, be generating synergies from that. You saw some of the one-time or other costs in the quarter for some of the facility charges we took. So those are all on track. So we feel very good about the overall integration.
Specific to technology and margin improvement, I think, Lee gave a lot of examples on different extremes of where we’re deploying technology to drive efficiencies, whether it’s through just RPA and automating manual task or whether it’s through more generative AI and more -- what we term internally as more intelligent automation. We do expect that we’ll see margin improvement as we move forward in the -- over the long-term -- medium- to long-term from technology deployment.
It’s built into our model, into our long range models and its part of that margin maturity on new business as we deploy technology. So I would say that it’s factored into the near-term guidance of -- medium-term guidance of the 30% margins. But as Lee indicated earlier, we’re constantly looking at other opportunities to continue to deploy new technologies and drive further synergies and efficiencies in the business.
Got it. Thank you.
And your next question comes from the line of Michael Cherny from Bank of America. Your line is open.
Hi. Thanks for taking the question. This is Hanna Lee on for Mike Cherny. Could you talk a bit about the second half impact for the APP physician customer? How should we think about the full year headwind to EBITDA?
Yes. On the second half, we specifically called out the revenue impact of about $15 million in the second half of the year. On a normalized basis, it’s a low 30% margin customer. But the second half of the year will be a little bit bigger impact, because we won’t and are not expecting to generate any revenue in the third quarter, but it will take us some time to get the cost out. So think about from a Q3 versus Q4 impact, having a larger EBITDA impact in Q3.
Great. That’s helpful. Thank you.
And your next question comes from the line of Scott Schoenhaus from KeyBanc. Your line is open.
Hi, Lee and Jennifer. Thanks for all that color on the uptick in cross-sell activity on the Cloudmed base and modular bookings. You maintained your 20% growth for Cloudmed for the year. What’s driving the assumptions in the back half and does any of the $4 billion in new NPR expected to be signed this year. Is there any opportunity there for cross-sell or upsell in 4Q or will those opportunities really emerge in 2024? Thanks.
Yeah. So a couple of things, Scott. What’s driving the Cloudmed growth is, at the highest level there is, we saw a very large problem of revenue leakage, if you will, with a safety net approach to our customers. And we -- and that problem is large 1% to 3% of total NPR across hospital systems and physician groups is well over $100 billion problem.
And so it’s an easy discussion to have when we’re going to them and saying, we already work with you with one solution. We have the data. We see the opportunity and so our cross-sell approach is working.
We’re also going after what have historically been net new markets for us from the old Cloudmed business, going to physician customers and we’re also innovating with net new products, right, like several new products that we’re introducing to customers. So that at the highest level is what is driving continued growth in Cloudmed.
On the end-to-end side, these are -- the color I would add are these are sophisticated deals, and by the way, a larger one may or may not be more sophisticated, a couple of variables that I think about when I see a -- whether it’s a -- I’ll give you an example. I have a $4 billion to $5 billion NPR system we’re working with, three hospital system type prospective customer has one host system, let’s say, one EMR. That is a down in the middle. We do that all day, could onboard very quickly, but may have their own set of politics, right, local community boards, different processes, RFP or no RFP.
So there’s always nuance that versus a very large system and we have at least a couple of those in our pipeline, we would expect those to take time -- and I would expect to be -- have a very sophisticated conversation on phasing, just like we did with our last large win and say, at what rate do we want to take on this customer? How do we think about it? The simple framework is always front end in all that. We historically have done a lot in the back end with AR on reimbursement, just the classic billing space. We’ve historically now done a lot more in the middle on coding and more recently introduced technology on the front end and scheduling registration, coverage discovery and so on.
And so all of these are unique discussions. I personally on the one hand, very positive, I see blending our pipeline. I’m personally involved in all those discussions. On the other hand, I want to be very thoughtful about not pushing these naturally and getting them to the right place at the right time.
So the net of all this is, you never really know because you’re looking at a pipeline, I have confidence based on where I am and I say. But we and the team, but we personally and in many of these discussions, feel very good about closing that business this year. But it may turn out to be at some point end of the year, which is why we’re adjusting the revenue piece. Jennifer, anything…
That’s very helpful.
Yeah. Good. Thanks, Scott.
And your next question comes from the line of George Hill from Deutsche Bank. Your line is open.
Yeah. Hi. It’s Maxy [ph] on for George. Thanks for taking the question. I want to follow up on the earlier commentary on prior authorization. What are you seeing in the prior authorization process from the largest payers and are still making it harder for providers to get paid? Thanks.
No. It’s a great question. There’s a lot of nuances here and I don’t want to take us down a rabbit hole. But it’s still a friction point, right? It’s absolutely a friction point in the industry. There’s a few places where you’ll see a lot of attempts at innovation prior auth is one of them. We feel like we have a huge advantage, because we see the workflow. We’re used to working with payers.
But I would say, broadly, no major changes. But look, there’s still an element of -- I’d sit with lots of hospital system customers. We have them on our Boards. There is a discussion that is both data backed because we can look at days of AR, we can look at time lines by payer, that is what kind of pressure are we seeing from payers and what -- you have to remind folks is, these payers have software tools that use to optimize reimbursement. So it’s a constant battle, if you will, to make sure that providers are paid what they deserve. So no major changes. It’s especially on prior auth, but it remains a very, very significant point of friction in the system and one that we’re very specifically addressing.
Got it. That’s very helpful color. Just a quick follow-up. Are you seeing any impact from Medicare redetermination in terms of collection and time line? Thanks.
Yeah. No. It’s a great question. No major exposure and we anticipate minimal long-term impact just based on the time line of rollouts as well the states participating. Just in the interest of time, I’d just make one comment. The data we’re seeing is that, individuals remove will either reenroll with updated paperwork or we’ll move into the exchange process and the latter would increase revenue for providers under new commercial policies.
We’ve also seen a minor uptick in the open uninsured population, but we have a full team dedicated to finding coverage for these claims. So, broadly, we are watching this very closely, but no major impact to us.
Thank you.
And our final question comes from the line of Jack Wallace from Guggenheim Securities. Your line is open.
Yeah. Thanks for squeezing me in. Congrats on the quarter. Just wondering if we could get a quick update on Sutter. Can you remind us kind of when we expect the Phase 1 of that client to get to full base fee recognition and then as a follow-up to that, timing expectations for Phase 2? Thank you.
Yeah. George [ph], great question. Just a couple of points, Jennifer if you have anything to add. Onboarding of the first phase continues to go well. This is obviously a large flagship customer for us on the West Coast, as we didn’t talk about priorities, but priority number one, absolutely for us in 2023 was operational execution and that included both stabilizing the current customer base, as well as onboarding new customers. This was top of our list on onboarding.
So I’m proud to say that the team has done a very, very good job. All metrics have been positive on onboarding Sutter. I would also highlight, they have a new CEO, CFO. It’s a very strong new leadership team. I’ve been out west several times, met with them, educated them on our partnership to-date, and overall, they’ve been very supportive. So we continue to make progress on the latter phases of the deal and feel good about it. Jennifer, anything to add?
The only thing I would say on the future phases is it’s really more of a 2024 impact. So we would start to -- expect to start planning on the second phase the later part of this year and then we’ll provide more guidance, obviously, as we give updates on 2024, but we’re not expecting any impact in 2023 for the deployment of the second phase on revenue.
Got you. That’s helpful. Thanks so much and congrats on the another strong execution quarter.
Thanks, George.
And this ends our question-and-answer session. Mr. Lee Rivas, I turn the call back over to you for some final closing remarks.
Thank you, Rob, and thank you all for joining us today. Just a few closing comments to end the call. First, as you can tell, we’re very focused on strong operational execution into the second half of the year and feel very good about progress we made in the first half. The second point I hope you got from today is our pipeline is very active across both modular and end-to-end solutions. And then third, I’m glad some questions came to me around technology. This is a big focus area for us. We are investing heavily in the progress we made already in automation, AI, machine learning and deploying generative AI and large language models into our workflows. So we look forward to updating you on future calls and thank you again for your interest in R1.
This concludes today’s conference call. Thank you for your participation. You may now disconnect.