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Edited Transcript of RCM.OQ earnings conference call or presentation 4-Aug-20 12:00pm GMT

Q2 2020 R1 RCM Inc Earnings Call

CHICAGO Sep 24, 2020 (Thomson StreetEvents) -- Edited Transcript of R1 RCM Inc earnings conference call or presentation Tuesday, August 4, 2020 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Atif A. Rahim

R1 RCM Inc. - SVP of IR & Business Development

* Joseph Gerard Flanagan

R1 RCM Inc. - President, CEO & Director

* Rachel Wilson

R1 RCM Inc. - Executive VP, CFO & Treasurer

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Conference Call Participants

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* Charles Rhyee

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* David Michael Larsen

Verity Research LLC - Founder & CEO

* Donald Houghton Hooker

KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst

* Eugene Mark Mannheimer

Colliers Securities LLC, Research Division - Senior Research Analyst of Healthcare

* Matthew Dale Gillmor

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Sean Wilfred Dodge

RBC Capital Markets, Research Division - Analyst

* Stephanie July Davis

SVB Leerink LLC, Research Division - MD & Senior Research Analyst

* Steven Paul Halper

Cantor Fitzgerald & Co., Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the R1 RCM, Q2 2020 Earnings Conference Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Atif Rahim, Head of Investor Relations. Thank you. Please go ahead, sir.

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Atif A. Rahim, R1 RCM Inc. - SVP of IR & Business Development [2]

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Good morning, everyone, and welcome to the call. Certain statements made during this call may be considered forward-looking statements made 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, designed, 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 could differ materially from those included in these forward-looking statements as a result of various factors, including, but not limited to, the potential impacts of the COVID-19 pandemic and other factors discussed under the heading Risk Factors in our annual report on our latest Form 10-K and in our quarterly report on our Form 10-Q for the quarter ended June 30, 2020.

Now I'd like to turn the call over to Joe.

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [3]

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Thank you, Atif. Good morning, everyone, and thank you for joining us. The second quarter presented continued unprecedented challenges from the COVID-19 pandemic. Despite this difficult backdrop, our team came together in a remarkable manner to support our customers and ensure that patients have access to care in a safe and expeditious manner. I'm very proud of our over 20,000 employees for their dedication, positive attitude and customer focus in the current environment. The commitment and engagement we've seen from the team is a key driver of our success.

We've provided uninterrupted service to our customers and helped them navigate challenges brought about by the pandemic, which has translated into strong positive feedback and strengthened relationships with our customers. We had a strong second quarter, with revenue up $314.7 million, driven by continued strong deployment execution and organic growth at our large end-to-end customers. Adjusted EBITDA of $65.3 million was up $24.7 million year-over-year, driven by broad-based operational execution with a particular focus on cash conversion for our customers and driving operating efficiency.

Overall, the company has performed well during this challenging environment. In addition to these strong results and navigating the COVID backdrop, we completed the acquisitions of SCI Solutions and Cerner's RevWorks business and announced the divestiture of the EMS business. These accomplishments are a testament to the significant effort by the entire R1 team.

Today, I want to focus our discussion on 3 key topics: first, review trends we are seeing related to COVID-19 and how we are managing through the current environment; second, provide an update on ongoing commercial activity; and third, highlight how our technology investments, particularly our digitization effort are building on and further differentiating our already strong operating model.

Starting with COVID 19, the health and safety of our workforce remains our top priority. The early actions we took starting in late February, including transition to a work-from-home environment, restricting travel, securing personal protective equipment and other precautionary measures for our frontline employees, have helped ensure a safe working environment and enabled us to continue to serve our customers without any disruption.

We also continue to support our customers as their operating partner to help them navigate the challenges they face. Let me recap some of the actions we have taken to date to support our customers. First, at the onset of the crisis, we raised the performance targets for our operations team with respect to the conversion of billings to cash, helping our customers generate cash to pay for supplies and expenses.

In March, we launched and deployed a new mobile registration solution, enabling contactless patient check-in. We've helped our customers navigate complex compliance and regulatory changes, addressing provisions of the CARES Act and various CMS, HHS and state-specific updates. We've ramped up Telehealth resources for our customers. And finally, and potentially most importantly, we are helping our customers with their restart processes for elective procedures.

SCI's platform is proving to be very effective in enabling our customers to navigate and quickly respond to different scheduling scenarios. This scheduling functionality proved especially important as we started to see volumes recover in the second quarter. Relative to March and April lows, volumes started recovering in late April and have posted successive monthly improvement through July.

Each geography and care setting has recovered at its own pace, but the recovery overall has been faster than we expected 3 months ago. Patient acuity has also been higher. Considering these trends and the visibility inherent in our business model, I am pleased to say we are in a position to reintroduce 2020 guidance.

We now expect revenue of $1.22 billion to $1.25 billion, and adjusted EBITDA of $230 million to $240 million. Importantly, this updated guidance includes the planned EMS divestiture, which represents approximately a $5 million headwind to adjusted EBITDA; and no EBITDA contribution from the Cerner RevWorks business is assumed in 2020.

Looking out to 2021, utilization trends continue to remain highly dynamic, which makes it challenging for us to reasonably forecast cash collections beyond a couple of quarters. At the same time, we see favorability to our previous 2021 adjusted EBITDA guidance, if patient volumes return to normal by the fall of this year. I'd like to note that we have executed on the corporate cost savings initiative we mentioned on the Q1 call. We remain vigilant and ready to adapt to changes in the operating environment in a way that balances the long-term opportunity we see in the market with near-term dynamics. We see this long-term opportunity accelerated by the current situation, which I'll discuss in more detail in my comments about the commercial activity we are seeing.

To round out the COVID-19 discussion, let me update you on our deployment activities. Starting with our most recent customer, Penn State Health, we initiated onboarding activities in May and are proceeding on schedule. Both Penn State Health and R1 teams have collaborated extremely well to move forward with onboarding in a virtual model.

Over the coming months, we will focus on maintaining this strong momentum and expect onboarding to conclude in the first quarter of 2021. Onboarding at RUSH continues to progress on schedule, also under a virtual model. Evolving COVID-19 restrictions in Illinois, may impact the pace at which some operational initiatives are implemented. But we are optimistic that we can complete the onboarding of RUSH by the end of 2020.

For the $700 million NPR physician contract we signed in the third quarter of 2019, we are currently 75% through our deployment plans, and we remain on track to complete onboarding in the fourth quarter. Lastly, deployment activities at Quorum Health are complete, and the team on the ground will now focus on optimizing performance.

Turning now to commercial activity, the emerging themes from prospective customers we discussed on the last earnings call have continued to play through, which gives us conviction in the view that the pandemic has the potential to accelerate the providers' inclination to enter into end-to-end agreements.

Some of the themes we continue to hear include: there is a higher desire to variablize the cost structure; they are questioning the need to leverage their own balance sheet for revenue cycle infrastructure and technology investments; the inefficiency associated with multiple third-party vendors is coming to light; and the business continuity and infrastructure resiliency we've been able to demonstrate through this crisis, is viewed favorably. They are seeking partners who are economically aligned and finally, a holistic solution to drive patient engagement and coverage for uninsured patients is increasingly important.

We are encouraged to see discussions intensify along these lines. Our pipeline for end-to-end as well as modular deals has grown over the past quarter, driven by an increase in RFP activity, which we view as an incremental positive indicator. We've also seen an increase in activity from health systems with $5 billion plus in NPR, in addition to ongoing activity in the $1 billion to $5 billion NPR segment of the market.

Given this activity, we have a high degree of visibility to meeting or exceeding our goal of $3 billion of new end-to-end NPR in 2020.

Yesterday, we completed the acquisition of RevWorks from Cerner. We're excited to serve the RevWorks customer base with our industry-leading services and to deliver superior operating performance on their behalf. We're equally excited about the strategic partnership we've created, whereby we will offer our revenue cycle capabilities and expertise to Cerner's current customers and new prospects.

This collaboration, augmented by direct, seamless purpose-built integration between our technology-enabled services platform and Cerner's software, stands to reduce any technical friction for our clients and accelerate our onboarding timeline for new end-to-end customers and deliver value to them faster. While we have been limited in our collaboration prior to close, this week we are launching a methodical deal and marketing playbook, designed to broadly and thoughtfully communicate the enhanced value proposition that R1 and Cerner now offer to prospects across the country.

Over the past 12 months, under Vijay Kotte's leadership, our physician solutions team has worked to ensure we have a highly differentiated value proposition for physician customers. As a direct result of this, our physician offering is gaining strong traction. 2 notable recent wins include Pinnacle Dermatology and Integrated Care Physicians. This segment of the market remains highly attractive for us.

In addition to faster growth relative to the acute segment, the vendor landscape is highly fragmented, competitors in the space generally have limited scale leverage, which presents a great opportunity for us to deliver meaningful value to large physician groups.

Now I'd like to update you on our technology, in particular our digitization effort. 6 quarters into the formal launch of our digital transformation office, we have a high degree of conviction that revenue cycle operations can be fundamentally transformed through the use of technology. Three levers, in particular, have a high degree of applicability to our business.

The first is digitization of the patient and physician interface within the revenue cycle encompassed in our Patient Experience Platform or PX; second, automation of manual tasks using Robotic Process Automation, or RPA technology; and third, using Machine Learning and predictive modeling to improve complex revenue cycle processes such as denials.

I'd like to provide additional context on these 3 levers.

Starting with the digitization of the patient and physician interface, we're seeing strong market demand for our PX platform. With the acquisition of SCI, we now have comprehensive digital patient interface capabilities across the front office, inclusive of scheduling, contactless patient intake and financial clearance. A strong proof point of the increased market demand and our differentiated value proposition is the number of new customer signings we've had over the past few months. A few notable signings include Boston Children's, St. Jude Children's, Nuvance Health, Houston Methodist, and another $5 billion NPR health system who we plan to announce after go live.

The traction we're seeing in the market gives us increased conviction in the strategic importance of digitizing and integrating the scheduling and registration processes, and fully enabling these processes via digital front door strategy. As such, we intend to further invest in advancing our capabilities and increasing market awareness of this offering. Given our domain expertise and significant experience managing patient intake, we are confident we can deliver meaningful value to healthcare providers via our PX platform.

In addition to the patient interface, we're also digitizing the contact points across the network of referring and rendering providers. This includes automation of historically burdensome processes like authorization and clinical appropriateness of care. By creating these efficient automated interfaces between healthcare demand and supply, over time, we intend to enable a uniquely high-performing digital marketplace for care coordination.

Next, I'd like to provide some context on the investments we've made in automation. The original portfolio of routines we discussed over the course of 2019 is fully deployed into production and is already generating meaningful dividends. Even in the current COVID-19 environment, we are on track to exceed our expected results.

At a summary level, we estimate that over the last 12 months, our employees have executed over 400 million tasks manually in the current workflow system. We believe about 1/4 of these manual transactions are strong candidates to be fully automated through the use of RPA and Machine Learning technologies. The original 13 routines I just referenced, cover approximately $15 million of this $100 million opportunity.

Our teams currently have an additional 10 routines in various stages of development and an ongoing process to ensure that we have a robust pipeline of new use cases, scope expansions and tangential expansions.

Lastly, we expect Machine Learning to present another significant opportunity to reduce inefficiency and improve productivity. We have started to leverage our vast repository of structured data to improve operational performance through the use of Machine Learning technology.

We currently have 4 proof-of-concepts, which we have launched, and we are very encouraged by the early results. Our deep operational expertise has proved critical to both iteratively improving model performance and integrating these models with existing operational processes to realize value. Similar to automation, we have initially focused on the foundational elements of the program, which are needed to quickly innovate and operate at scale. These initial proofs-of-concepts are validating our hypothesis of the broad applicability of this technology, and we are therefore increasing the intensity of our efforts in this area.

We believe the disciplined application of this technology will fundamentally transform the revenue cycle, driving improved satisfaction, improved revenue yield and significant reduction in the cost of revenue cycle operations.

In addition to our efforts in digitization, we also continue to advance our capabilities in the value-based arena. Yesterday, we announced the launch of an innovation lab in conjunction with Rush University System for Health. RUSH is one of the leading institutions with advanced capabilities and care quality tools. We intend to combine these tools with R1's scale to deliver new, innovative solutions to health care providers nationally. We're incredibly pleased to partner with RUSH and look forward to commercializing our solutions.

In closing, I'm pleased with how our team has managed to continue to deliver on our commitments through the current environment. This crisis has caused significant disruption, but it has also promoted innovation and better collaboration internally in R1 as well as with our customer partners. We remain very bullish on our long-term prospects and our ability to deliver significant value to healthcare providers and the company's stakeholders. Underpinning our bullish perspective at a very high level are the following key attributes. First, we operate in a large underpenetrated target market; second, technology is fragmented and far from optimized, resulting in subpar results for providers; and third, we have a highly differentiated and aligned value proposition to address the market's needs, fueled by our investments in technology and our global scale. These attributes provide us with a long runway for growth, which we fully intend to capitalize on.

Now I'd like to turn it over to Rachel Wilson, our new Chief Financial Officer. We are thrilled to have her join our team, and she brings a wealth of experience to the role. It's been a pleasure to work with Rachel over the last couple of months, and we look forward to her contributions to R1.

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Rachel Wilson, R1 RCM Inc. - Executive VP, CFO & Treasurer [4]

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Thank you for your kind words, Joe. I'm honored to be here today as part of the R1 team. I've been very pleased with my early learnings at the company. There's a strong metrics-driven culture, a high degree of accountability and a passionate team with deep industry expertise. I view these as incredible assets coming into the role. First off, I'd like to thank Rick and the entire finance team for a detailed and thorough onboarding process despite the challenges in the current environment.

We have a tremendous market opportunity ahead of us. The need for the healthcare industry to reduce the cost of revenue cycle operations and to further enhance the use of technology for automations and AI is clear, and even more apparent in this environment. Between market opportunity and team strength, I'm excited to be able to join Joe and the entire R1 team to drive our continued growth.

Before I discuss second quarter results, I'd like to remind everyone that we'll be referring to non-GAAP metrics on the call. For a reconciliation of the non-GAAP amounts mentioned to their equivalent GAAP amounts, please refer to our press release.

Revenue for the second quarter was $314.7 million, up $19.7 million or 6.7% year-over-year, driven by new customer wins and organic growth at existing customers. This was slightly ahead of our previously communicated expectation on the Q1 call. The majority of Q2 net operating fees were based on customer cash collections in the December 2019 to February 2020 time frame prior to COVID.

As you'll note, there's some volatility in our incentive fees in the current environment. In the second quarter, incentive fees declined to $1.3 million, driven by the sharp decline in customers of trailing 90-day average daily revenue due to COVID. This is a key component of the calculations that our performance fees are tied to. Conversely, following the recent recovery in volumes, incentive fee declines are expected to reverse in the second half of the year.

The non-GAAP cost of services in Q2 was $229.8 million, down $2.7 million year-over-year and $7.8 million sequentially due to actions we took to reduce our cost structure starting in late February, along with lower employee health care claims and CARES Act relief.

Corporate cost structure initiatives helped drive down non-GAAP SG&A expenses $2.3 million year-over-year and $1.7 million sequentially to $19.6 million. Adjusted EBITDA for the second quarter was $65.3 million compared to $61.6 million last quarter and $40.6 million a year ago. The sequential improvement was primarily driven by cost-containment initiatives and lower employee expenses, which drove a combined decline from Q1 of $9.5 million in non-GAAP cost of services and non-GAAP SG&A expenses. This helped more than offset the $5.8 million decline in revenue from Q1 reflecting COVID.

Lastly, we incurred $18 million in other costs in Q2 compared to $8.7 million last quarter, with the increase primarily driven by expenses related to M&A activities, facility exit charges and COVID-related costs pertaining to appreciation bonuses for our frontline employees and pandemic response mobilization efforts.

Turning to the balance sheet, cash and cash equivalents at the end of June were $123 million, up from $106 million at the end of March, driven by positive cash flow from operations of $44.7 million, offset by $17.8 million in CapEx and debt paydown of $11.4 million, which included payoff preconsolidation of $5 million in notes acquired as part of the SCI acquisition.

Net debt at the end of June, inclusive of restricted cash was $443.4 million, up from $275.8 million at the end of March. The increase was driven by incremental debt to finance the SCI acquisition, offset in part by positive cash flow from operations. After the pending EMS divestiture is complete, we expect to pay down the $70 million outstanding on our revolver to reduce ongoing interest expense, while maintaining flexibility for future acquisitions.

Our current cash position, availability on the revolver and expected proceeds from the EMS divestiture equate to over $285 million of cash that could be used for debt paydown, to invest in the business or for acquisitions. We thus believe we have sufficient liquidity to withstand a wide range of scenarios stemming from the COVID crisis.

Turning to our financial outlook, with the recovery in patient volumes to date, we are pleased to be in a position to reintroduce 2020 guidance, as Joe indicated. Again, we expect revenues of $1.22 billion to $1.25 billion and adjusted EBITDA of $230 million to $240 million. To provide some color on the quarterly progression, we expect Q3 revenue to be in the $290 million to $300 million range, with total non-GAAP expenses up modestly from Q2 levels.

We continue to manage the business prudently to ensure that we are positioned to deliver top-tier services to our customers as volumes rebound, and have sufficient capacity to onboard new customers given our commercial momentum. We started selectively hiring for strategic and critical roles and expect our cost structure to ramp up as we exit the year, albeit at a slower pace than the expected ramp in revenue. We also expect R1's health care benefit costs to increase as our employee base begins to access healthcare again.

These factors, along with the just-completed acquisition of RevWorks and the pending divestiture of the EMS business, representing a $5 million drag to 2020 EBITDA are all included in our guidance. Given the pace of our investments and recovery in patient volumes to date, we are comfortable with current Q3 consistent EBITDA estimates in the low to mid-$40 million range.

In closing, I'm proud of how the team has continued to perform through a challenging environment. We've taken balanced actions to reduce corporate costs, while increasing client-facing investments, positioning us for continued growth, while delivering sustained value for our customers and our shareholders.

I'm proud to be joining a veteran team in a time when revenue cycle management optimization is more needed than ever. Now I'll turn the call over to the operator for Q&A. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And your first question here comes from the line of Charles Rhyee with Cowen.

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Charles Rhyee, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [2]

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Congrats on the quarter. Maybe first, Joe, can you talk about the trends in APR you're seeing in your customer base -- you're seeing in your customer base in July? How is that relative to pre-COVID levels? And have you seen any sort of downward trends in business in hotspot areas such as like Texas, Arizona and Florida, and then maybe how much exposure does R1 have to these geographies?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [3]

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Thanks, Charles. Yes, just a little bit of color on kind of the different markets and how the recovery is progressing. As we noted in the comments, at a summary level the recovery is progressing faster than our original base case projections forecasted. As we look at geographically, we've seen the fastest recovery -- Florida, Alabama, Texas markets. Now Texas markets, given the recent resurgence or flare up, if you will, are not degrading, but they're stable and not improving. So we're holding water, so to speak, in some of those markets. And obviously, you can appreciate this is fluid, week-to-week based on the -- not only regional dynamics, but almost on the ground our county dynamics, if you will, in the various markets we serve.

On the other side of the equation, slower recovery markets -- Illinois, Wisconsin, Michigan, they're lagging a bit. But when you roll all that up, what I would say is, we're generally encouraged against what we had forecasted with the recovery along those lines. So that's, in essence, what we're seeing.

Then the other thing I would see -- and the other thing I would say is, while that's the leading indicator on revenue, which is a leading indicator for future cash collections, we do continue to be encouraged with the execution broadly on conversion of revenue to cash across the system. So I think there's really -- and that's something that we've commented on in prior calls, and that continues to be the situation that we see within our operating teams.

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Charles Rhyee, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [4]

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And just a follow-up on that. Does that -- when you're talking about your ability to improve the conversion into cash, how much of that would you say is contributing right now to the topline maybe compared to last year? Is it 5% more, 10% more than you normally would have?

And then lastly, sorry, you had noticed seeing some favorability to kind of getting back to the previous 2021 guidance when volumes return. Can you give us a sense on what sort of the puts and takes are for us actually to get there? I'll stop there.

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [5]

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Yes, no problem. It's hard for me to say, Charles; I'm just trying to think through it. It's hard for me to pin an exact number just because the environment has changed so much on a year-over-year basis. But I would say, even if we normalize for COVID, quarter-over-quarter we are generally encouraged with what we would characterize as our balance sheet performance -- the ability of our teams to convert AR into cash work through the payer adjudication processes and then post-payer adjudication, work through the patient collection processes.

So the absolute year-over-year variance of that, again, is a little bit hard for me because the environment has changed so much. But in summary, we're seeing strong progression there. And that is contributing to our quote-unquote base fee revenue, and we're seeing that flow through in our results. The -- Charles, can you give me the second question, I just...

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Charles Rhyee, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [6]

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Yes. Just -- you had noted earlier, you see there's a potential here kind of getting back to previous 2021 guidance? Just -- yes, just trying to get a sense of what the puts and takes to get there are?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [7]

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Yes. No, so in our commentary, assuming we see a return to normal as we exit this year, we would see, from our standpoint, favorability to the prior guidance. What's underpinning that, one is core execution. As I mentioned to you, the teams are executing well. The second is we're seeing good flow-through on automation. I commented along those lines on the call. And we don't see a shortage of future use cases from the original 12 use cases that we deployed. So we expect to continue to see that flow through.

As I highlighted on our Q1 call, and I commented here, we have executed our corporate savings program. So those actions are done, and that will contribute on a full-year basis going into next year. And then the final thing I would say, Charles, is a number of the responses we've had to the COVID volume backdrop, a number of those will stick. So a new normal on how we think about the need for travel. Obviously, as you can imagine, there's footprint rationalization opportunities. So a number of those things are sticky in nature and won't have to be necessarily fully reversed as we hopefully work back to a non-COVID environment.

So I would say those are kind of the handful of factors that contribute to our view along those lines on 2021.

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Charles Rhyee, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [8]

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Congrats, guys.

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Operator [9]

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Your next question comes from the line of Matthew Gillmor with Baird.

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Matthew Dale Gillmor, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [10]

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I wanted to ask about some of the pipeline commentary. I think you said there's an increase to RFP volumes and then also an increased level from both kind of the sweet spot of $1 billion to $5 billion, but also $5 billion plus. Would you say that's, that increase you're seeing is attributable to just the reaction from COVID and the need to get more efficient or does this also reflect some of the capabilities that are unique to the company?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [11]

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Well, I think, let me bifurcate the -- as we've talked about, Matt, in prior calls, the $1 billion to $5 billion market is where we've generally seen the most activity and the highest bias or the highest conviction to change the way they run their revenue cycle process internally. And I would say we continue to see that playing through. The activity is still strong there, and we continue to like that segment of the market.

I do think the nature of our value prop absolutely contributes to the activity, but also the success we've had in some of those pursuits up till now.

More recently, we've started to see stronger activity in the $5 billion plus segment of the market. Obviously, the number of those pursuits is lower, just given the number of providers that sit in that size range is much lower than any other segment of the market.

I do think the catalyst of the activity is definitely related to COVID. I think the COVID event, my sense is clearly has catalyzed an internal discussion and then the willingness in that segment to start to explore operating partnerships such as us. And then I think the fact that we're seeing those opportunities is a testament to our value prop. So I don't want to attribute it all to our value prop. I think it's kind of a combination of factors. The strength of our value prop, the demonstrated the experience of our teams to serve more complicated health systems and in our current contracted customer base, we have some of the most sophisticated and diverse footprints of customers in the industry.

And so I think those factors accrue to our benefit, and that's viewed favorably. But I think equally important, I think COVID is catalyzing an internal discussion, independent necessarily of us on a stand-alone basis. And so we're just encouraged and we think it creates a nice opportunity for us or window, if you will, to compete into.

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Matthew Dale Gillmor, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [12]

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And then if I could follow-up on asking about deployment capacity, I think in the past you talked about having sort of $6 billion of capacity that you could deploy with clients. How are you feeling about that sort of capacity level as you're looking at the current pipeline? And are you in a position where you may need to invest into that and increase it?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [13]

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Yes, so we nominally think of our deployment capacity that we run at right around $3 billion to $4 billion nominally. Now we've demonstrated an ability to flex that up into the $5 billion to $6 billion range when we've needed to. We did that in the 2018 time period as an example, most recently, when we had a number of Ascension deployments, and we also launched the Intermountain deployment. That year was a good example of our ability to flex our capacity.

What I would say in the current environment, Matt, is -- and this was, as we said, some of the balancing act that we wanted to work our way through as we thought it was prudent to pull guidance last quarter, and we're now in a position to reinstate guidance, part of that was just making sure, we have the appropriate actions to respond to the volume -- short-term volume backdrop, but equally important, to make sure we were adding capacity based on where we see growth. So going into the second half of the year, we're recruiting capacity; that's in our plans. And so we would be looking to nominally increase that $3 billion to $4 billion as we progress through Q3 and Q4 and head into Q1, just based on our current forecast.

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Operator [14]

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Your next question comes from the line of Donald Hooker of KeyBanc.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [15]

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Great. So I guess I just wanted to kind of review your guidance here. I guess, just from my perspective, I thought you might see a little bit more of a dip in Q3 with respect to revenues and a little bit more of an increase in Q4. It looks like it's somewhat flat. I know you have some deployments in Q4, and it sounds like you have some traction in new product areas. So I would have -- can you maybe walk through kind of the timing of quarterly revenues between Q3 and Q4, what's assumed, what's not -- is, maybe embedded in that, is Q4, where are we in Q4 with respect to sort of a baseline revenue for you guys?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [16]

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Yes, and let me take the first part of this question, Don, and then I'll refer to Rachel if we've got any additional commentary. But if you think about the shape of Q3 and Q4 and the progression of that, I think it's correct. As Rachel commented, Q3 will essentially be in our -- in the majority of our end-to-end operating partner contracts, we'll be working off our 4-month lag.

So that will be the cash collections off of kind of the toughest part of the COVID environment. So we would expect to kind of see a progression along those lines. And the recovery that we referenced, starting in late April, that's progressed and the reference of that recovery being favorable to our prior base case estimates, that's what we're collecting cash on kind of as we speak. And that will really drive our -- directionally drive our Q4 dynamics. So I think your commentary on a shape basis is generally accurate.

And then there's a portion of our business that is more real time -- our Penn's business, our physician business and then some of our modular businesses. And so those are a smaller portion of revenue, but those are more real-time indexed to current volumes. And so you see a more normal phasing in those areas.

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Rachel Wilson, R1 RCM Inc. - Executive VP, CFO & Treasurer [17]

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And Joe, he takes the words right out of my mouth here because I was actually going to add the point that we've got a high degree of visibility into the net operating piece from our largest customers actually through November, right? So that is the piece where we have that visibility, but we also, see, we think physician and modular Penn's, incentive fees, and some of that really depends on Q3 customer performance.

So because of that mix, and our indication that costs are expected to ramp up slightly as volumes recover, we've embedded all that into our guidance. And so that does help explain that shape with a little bit more detail.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [18]

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Okay. Okay. And maybe, I guess, I thought I heard, or maybe Joe, was it you commenting that you did not include any revenue from Cerner in your guidance? I think that's about $20 million of run rate per quarter, but you're not including that. Why are you not including that? Is there a reason?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [19]

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No. No. The comment was more on the EBITDA guidance. So again, on the EBITDA guidance of $230 million to $240 million, we've assumed that the Cerner revenue comes in and doesn't contribute on that revenue coming in, and that is included in our revenue guidance, but doesn't contribute EBITDA in 2020. That's the assumption, that we've got in that guidance range. And then the other comment was related to the EMS divestiture, we've assumed we incur a $5 million headwind associated with our projections on that divestiture. And that's included in the $230 million to $240 million guidance range.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [20]

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Okay, that's helpful. And then real last quick one for me, and I'll let others jump in. In terms of your relationship with Cerner, so interesting to, I think, everyone. When you look at your pipeline, what's the mix between Cerner and Epic and maybe just the dynamic there between those two client bases? How does that sort of -- is there anything for us to think about there, with regards to the Cerner versus Epic competition?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [21]

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Yes. What I would say, it's interesting. The first thing I would say at a high level, we are 100% committed to the agnostic nature of our technology. And what I mean by that is we have a demonstrated capability in our contracted book of business to integrate our technology into Cerner, into Epic, but also into a whole host of other EMS systems that currently exist in the provider end markets. And I would say, we received high ratings in our ability to navigate that complexity as part of our deployment process.

If I think about our current pipeline, our current active pipeline, the majority of that is non-Cerner, right? I'm just mentally running through that. But directionally, the majority of that is non-Cerner. That changes with the opportunity set any given point in time. So I don't want to convey that that's a predictable trend. It's really 100% dependent on the provider organizations that we're pursuing at any given point in time and what does their host system orient from. And as I commented on the call, we're excited with the close of that deal to start a more structured process commercially with Cerner to really identify the net new potential Cerner customers that together, we can kind of provide a very compelling value prop.

And we're excited to serve Cerner and their customers and to be a great skills partner for them in our area of expertise, which is revenue cycle management.

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Operator [22]

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Your next question comes from the line of David Larsen with Verity Research.

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David Michael Larsen, Verity Research LLC - Founder & CEO [23]

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Sorry about that, was on mute. Congrats on a good quarter. Can you talk a bit about Penn State, RUSH and Quorum -- how those deployments are progressing? And in particular, how do you expect those margins to progress through 2020 and 2021?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [24]

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Yes. Thanks, Dave. So those deployments are progressing well. The large physician customer and Quorum, we're at in the tail end. So we're coming to the tail end of those deployment activities. And as you look at RUSH and Penn State, more recent contract signings, we're in the heart of deployment. It's interesting. I would applaud the teams on our side, but equally important, the provider teams in the ability to embrace the virtual tools and to continue to progress those deployments.

So as an example, one of the things I was concerned with at the start of the pandemic was, would we really have an ability to do a detailed assessment of the current environment and really lay out a surgical plan to drive performance as part of that operating partnership? That's a key component of our deployment activity. And we have a very robust methodology, and we have a dedicated team that does those assessments for us and for the clients. And I'm happy to report, they've completely flipped that to a virtual environment, they're able to do the interview processes that they normally do with the client. They're able to audit operating routines virtually. And then they're able to look at technology configurations.

And so by and large, we've continued to maintain the progression of that. Now it's not the same as being face-to-face; don't get me wrong. I don't want to come across as, it's not without its own set of complexities, but I think given the environment, and it's a true testament I think to the structured process and the value prop, that this is still being made a priority in the backdrop of the current pandemic. So again, RUSH and Penn State, there's no red flags on those deployments in terms of delays and whatnot. And then on the large physician groups, and Quorum, those are progressing towards finishing deployment and then just fully running optimization.

Looking forward, we would expect those in line with our prior comments, we would expect those customer contracts to be right in line with the models we provided for the co-managed and operating partnership end-to-end agreements. And so we don't see any changes to that perspective.

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David Michael Larsen, Verity Research LLC - Founder & CEO [25]

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Great. That's very helpful. And then just one more. How is your relationship with Ascension? I mean, I'm assuming it's excellent, but can you just remind me how long that contract goes through? And are there any -- is there any growth potential there within Ascension? If they're such an important customer, just any sort of details that you could provide would be very helpful.

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [26]

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Yes. The -- sorry about that, Dave -- the relationship with Ascension is very, very strong. I mean, obviously, we have a huge responsibility to serve them just given the amount of the revenue cycle -- of their revenue cycle that we run on their behalf as a partner. So I would say it's very strong; we collaborate with them across all levels of the organization, both within the finance team, but as well within the operating teams. So that's some color along that relationship. That contract generally runs to February of 2026. So there's still a fair amount of time on that contract.

And then relative to growth potential inside of Ascension, I mean, we do -- we have a majority share just with the progression of how that contract has evolved since we've made the initial launch in 2016. We then added the physician revenue cycle management. There are some areas that we're working with them on different functionalities. And that's an always ongoing dynamic and discussion. But we're delighted with the relationship, and we're proud to be a partner of theirs.

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David Michael Larsen, Verity Research LLC - Founder & CEO [27]

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Great, congrats on a good quarter.

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Operator [28]

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Our next question comes from the line of Stephanie Davis with SVB Leerink.

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Stephanie July Davis, SVB Leerink LLC, Research Division - MD & Senior Research Analyst [29]

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Congratulations on the quarter guys, and Rachel, welcome to the team.

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Rachel Wilson, R1 RCM Inc. - Executive VP, CFO & Treasurer [30]

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Thank you, Stephanie.

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Stephanie July Davis, SVB Leerink LLC, Research Division - MD & Senior Research Analyst [31]

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Joe, you've talked about significant digitization efforts over the past 2 years -- has been a big differentiator of R1 RCM versus some of your web-cycle peers. With that in mind, how are you thinking of leveraging any of these investments now that you do own RevWorks? And with a follow-up for that, what levels of efficiencies are you expecting to gain? How should we think about RevWorks margins? And where could it kind of go over time, once they take advantage of these investments you've made?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [32]

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Yes. No, that's -- thanks, Stephanie. So we -- without a doubt, we intend to deploy our core technology suite and also the automation routines that we've got in production right now, systematically across the RevWorks book of business. So when you think about the levers that we want to pull, if you will, as it relates to that operational integration, a big component is definitely the application of our technology to their transactional processes.

We think, one, we can drive real efficiency, but equally important, we think we can give the RevWorks teams some of the tools that will allow them to get scale efficiency and also see the process systematically via our workflow platforms and then our automation routines that are in production today, but also those that we have use cases that are being developed and ultimately will be deployed into production. We see applicability there as well.

The other dynamic is just the operating methods that we use to run our central operations onshore and offshore. So that's another lever that we'll be working with the leadership team that's recently joined our team from RevWorks to drive that standardization, et cetera.

And so all in all, we would expect the margins we've generated on that business to be right in line with our target margins in the 20% to 25% contributed EBITDA range. And so we do see a meaningful opportunity, again, using technology and then using kind of scale and standardization of operations to unlock the earnings potential of that book of business. And then the team is very focused on kind of leveraging -- serving those customers exceedingly well and, off of that performance, earn the right to talk about broader relationships.

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Stephanie July Davis, SVB Leerink LLC, Research Division - MD & Senior Research Analyst [33]

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And what sort of timeline should we think for extracting these efficiencies, just given, I think that offshore can take a little bit more time?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [34]

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Yes. No. I mean, the one thing, Stephanie, I would say, the way we think about this is kind of in line with our typical deployments. So we think about -- and that's really -- and those typical deployments, we're looking to get our technology deployed within the first 6 months. We have a full future state footprint identified as it relates to kind of the optimal location and the optimal standard for which work is performed against.

And so as much as we can, I've started those plans based on the R1 team's understanding from diligence. We've gotten a head start on that. And so I would hope that we start to see some contribution as we progress through 2021. We won't have a full year in 2021, but given we closed right on time, based on our internal projections, that gives us a nice runway in Q3 and Q4 of this year, to really get those major integration activities done. And our goal will be to get as much in place over the course of this year and into early 2021, so we can maximize benefit accordingly.

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Stephanie July Davis, SVB Leerink LLC, Research Division - MD & Senior Research Analyst [35]

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That's super helpful. And one quick follow-up. Cerner is still -- they're still announcing some rev cycle wins. So how much control do you have over the terms for the deals that are currently in their pipeline, like Banner?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [36]

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I'm sorry, Stephanie, I missed your question.

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Stephanie July Davis, SVB Leerink LLC, Research Division - MD & Senior Research Analyst [37]

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I just said that, given Cerner are still announcing revenue cycle wins, how much control do you have over the terms for those deals, just given there are longer-term sort of contracts, so it's probably in their pipeline for a while?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [38]

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I don't think -- we don't have a significant amount of control, nor did we ever assume we would, on the wins Cerner is announcing. We're primarily focused on serving Cerner in whatever capacity they need us to serve them, as it relates to being a very strong skills partner for them.

Now as it relates to opportunities that we jointly look at that fit into the criteria that lend themselves to a more comprehensive partnership, including the R1 offering, that's what we'll be working kind of that net new, if you will, opportunity set. That's what -- upon the close, we're now mobilizing our teams against.

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Operator [39]

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Your next question comes from the line of Sean Dodge with RBC Capital Markets.

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Sean Wilfred Dodge, RBC Capital Markets, Research Division - Analyst [40]

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Maybe on the -- Joe, your comments around the faster conversion of billings to cash for clients. How much were you able to compress those timelines, is it days or weeks? And then can you give us just a quick education on how you do that? Is that just as simple as throwing more people at it? And what I'm trying to understand is how sustainable is this? Can you keep these timelines compressed or short? Or should we expect the return to more of a normal cadence as volumes and environments normalize?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [41]

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Yes. It's hard for me, Sean, to kind of -- again, it's hard for me to compress the -- to kind of characterize the percent compression on this call, just given the sensitivity of some of the dynamics related to our customers, and we'd like to respect that. The levers that we use, ultimately -- the levers we use is ultimately the fact of our global scale and the fact that we have significant flexibility to flex up and down and redistribute resources globally. And then that capacity, if you will, combined with the fact that we're able to systematically change, in essence, the follow-up timing, for lack of better words, in our core workflow applications. And by changing the timing with which the system is driving work to be done, that combination, the combination of changing the system expectations which drives the work. That's really the dynamic that we're working to.

And then we have a number of ways we deconstruct the conversion of revenue to cash and basically, going through all of those, what's billed and in the adjudication process, what's discharged and not final billed, the cycle times of each of those queues, we're able to systematically update the targets that our teams have for those and then our performance management teams as well as, like I said, the capacity models all get updated accordingly.

So that's kind of the operating mechanisms that underpin that headline comment, that we're pushing as hard as we can to convert the available billings to cash sooner.

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Sean Wilfred Dodge, RBC Capital Markets, Research Division - Analyst [42]

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Okay. And then maybe going back to your comments around the commercial activity among the larger health systems, those with over $5 billion of NPR, what you're seeing there -- are those more along the lines of competitive displacements? Or are these largely health systems that are looking at outsourcing for the first time or at least outsourcing at scale or en masse?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [43]

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Yes. They're largely looking at outsourcing at scale for the first time. So they're really not competitive displacements. When you think about the RFP scopes that we're responding to, they're generally -- we're generally looking at a comparator to the in-house operations in a different way that that health system runs their revenue cycle, very similar to the process we went through with Ascension and Intermountain in 2016 and 2018, and Quorum more recently. On the subprocess level, there's always displacements at the subprocess level, but it's not really an apples-to-apples displacement. It's a new model being looked at in comparison to the way the historical revenue cycle is run.

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Sean Wilfred Dodge, RBC Capital Markets, Research Division - Analyst [44]

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Great; congratulations on the quarter.

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Operator [45]

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Your next question comes from the line of Steven Halper with Cantor Fitzgerald.

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Steven Paul Halper, Cantor Fitzgerald & Co., Research Division - Analyst [46]

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On the PX customer win, you talked about a $5 billion NPR health system. Is that a current R1 customer? Or is that outside of the base? And can you talk about the cross-sell efforts for SCI?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [47]

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Outside of the base, Steve, so not a current R1 customer; and that particular customer, a heavy -- one interesting dynamic, a heavy driver. It was a competitive process, and a heavy driver for us getting the award was the SCI capability, the core recognition that at the end of the day, to enable the most comprehensive digital self-service scheduling in all the care settings. We've talked about this before, but scheduling, not only in the primary care initial visit setting, but also in the follow-on more complex care things. The ability to schedule across that base digitally was a significant contributor to us winning that pursuit.

And I would say, as we said, the cross-sell opportunity into SCI customers is starting. And we've got a number of pursuits that we're working on to broaden that relationship-based on the R1 comprehensive capabilities. And we've had very good feedback from the SCI customers on our acquisition and the way we've approached that. So we're generally over time, encouraged that, that installed base can be a mechanism or channel for growth for us. And then as you think about the PX platform more broadly, all the customers I referenced are net new customers. So we're really excited about the competitiveness of this solution and the opportunity for us to compete on an area that is a critical, critical capability providers are seeking right now. The ability to digitize their patient and physician interfaces.

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Steven Paul Halper, Cantor Fitzgerald & Co., Research Division - Analyst [48]

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Yes. And just one follow-up and the retention on SCI so far?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [49]

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Higher than we planned on our kind of diligence analysis.

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Operator [50]

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Your last question comes from the line of Gene Mannheimer with Colliers Securities.

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Eugene Mark Mannheimer, Colliers Securities LLC, Research Division - Senior Research Analyst of Healthcare [51]

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Welcome, Rachel. 2-part question. With the acquisition now of RevWorks and SCI and then the divestiture of EMS, what is the profile of your revenue today, relative to variability. In other words, the amount that's variable based on health care utilization. And then the second part would be just with the RUSH collaboration, some of the tools you're seeking to commercialize there, what would the business model look like? Would those be subscription-based or license, how would you sell those?

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Joseph Gerard Flanagan, R1 RCM Inc. - President, CEO & Director [52]

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Yes. So as we think about the RevWorks coming in, the EMS business going out, generally, it's probably net-net. And I mean, it's generally going to be flat. You've got -- both of those businesses have some degree of variability to provider revenues. The EMS business, obviously, is a completely different type of provider. I would say in the Cerner business, it's got a broader mix of contracts. So it's not a 100% like our core operating partnership contracts where those are very clear. The base fee is variable and you have an incentive count mechanism.

In the broad basket of customer contracts that sit in the RevWorks business. You've got some of those that are fixed-price contracts. You've got some of those that are 100% variable. You've got some of those that are hybrid. So when you think about it along those lines, that business coming in probably has less variability to our core operating partnerships. But it's not going to -- when you roll all that up, I would say there's no real change to kind of the profile of our revenue post those two transactions.

And then related to RUSH. One thing I'll note is, I commented Vijay Kotte, who joined us now about a little bit less than a year ago, but almost a year ago, and he joined us most recently as the Chief Value Officer of DaVita Medical Group. And the reason I mentioned that and one of the things that's really important in Vijay's background complementing our current leadership team is just a deep, deep expertise to understand how quality and value-based payments, infrastructure, revenue cycle infrastructure needs to evolve to ensure we're competitively supporting those revenue streams, as they increase as a percent of the overall revenue mix over time.

So Vijay has been working hand-in-hand with the leadership team at RUSH. And as we noted, RUSH is one of the nationally recognized leading institution as it relates to quality of care. And as part of their mission to be best-in-class as it relates to quality of care, they have built a number of advanced algorithms that they've used inside their system to improve that rating and improve their care delivery mechanisms.

And so what Vijay has been working on is the role we can play in our ability to understand how to productize those algorithms, how to scale those algorithms and how to commercialize them as part of our overall engagement process. And I think that offering will take different flavors. But I would reference our progression on PX as a very similar way to think about that. And what I mean by that is it's an additional capability just strengthens our value prop in our end-to-end agreements and is part of our overall suite. But equally important, it stands on its own, and we would expect over time, not overnight, but over time, with the investments we'll make there that, that will be a commercially viable stand-alone kind of suite.

And the final thing I'll say is, one of our strategic priorities is on the heels of all the hard work Vijay has done to prepare our physician business to aggressively compete. The next phase that we'll start to think about is how do we methodically and in a very disciplined way, build the infrastructure within the revenue cycle management domain to manage that alternative payment model.

We view it as just a different mix of revenue that we're managing. And I'm super excited. Vijay has been doing a lot of work on that. And so I'm excited to be in a position to start to shift our energy there. And I think it'll be received very well by our customers in the provider market. Okay, operator. Yes, I think with that, we'll close the call, just given the time. And as we close, first, thank you, Casey, for all your help on the call. And everybody for joining the call today.

As I close, I also like to thank our team for their continued focus on delivering strong performance. We look forward to operating and executing on the opportunity ahead and updating you accordingly on future calls. So many thanks again for joining. And operator, thank you, and we can close the call.

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Operator [53]

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Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.