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EX-32.1 - EXHIBIT 32.1 - R1 RCM INC.exhibit321-q22017.htm
EX-31.2 - EXHIBIT 31.2 - R1 RCM INC.exhibit312-q22017.htm
EX-32.2 - EXHIBIT 32.2 - R1 RCM INC.exhibit322-q22017.htm
EX-31.1 - EXHIBIT 31.1 - R1 RCM INC.exhibit311-q22017.htm
EX-10.1 - EXHIBIT 10.1 - R1 RCM INC.amendmentno1.htm



 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q

(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NUMBER: 001-34746
R1 RCM INC.
(Exact name of registrant as specified in its charter)
Delaware
02-0698101
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
401 North Michigan Avenue Suite 2700 Chicago, Illinois
60611
(Address of principal executive offices)
(Zip code)
(312) 324-7820
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
ý
Non-accelerated filer
o
Smaller reporting company
o
Emerging growth company
o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No R
As of July 31, 2017, the registrant had 104,889,834 shares of common stock, par value $0.01 per share, outstanding.
 






Table of Contents





R1 RCM Inc.
Consolidated Balance Sheets
(In millions, except per share data)


PART I — FINANCIAL INFORMATION
ITEM 1.
CONSOLIDATED FINANCIAL STATEMENTS

 
 
June 30,
 
December 31,
 
 
2017
 
2016
 
 
(unaudited)
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
132.4

 
$
181.2

Accounts receivable, net
 
7.2

 
4.0

Accounts receivable, net - related party
 
16.3

 
1.8

Prepaid income taxes
 
0.4

 
3.8

Prepaid expenses and other current assets
 
19.1

 
13.8

Total current assets
 
175.4

 
204.6

Property, equipment and software, net
 
50.6

 
32.8

Non-current deferred tax assets
 
104.3

 
169.9

Restricted cash equivalents
 
1.5

 
1.5

Other assets
 
10.0

 
6.3

Total assets
 
$
341.8

 
$
415.1

Liabilities
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
6.8

 
7.9

Current portion of customer liabilities
 
1.0

 
69.7

Current portion of customer liabilities - related party
 
10.9

 
14.2

Accrued compensation and benefits
 
24.5

 
24.8

Other accrued expenses
 
16.2

 
18.5

Total current liabilities
 
59.4

 
135.1

Non-current portion of customer liabilities
 
0.5

 
1.0

Non-current portion of customer liabilities - related party
 
8.3

 
110.0

Other non-current liabilities
 
12.6

 
9.7

Total liabilities
 
$
80.8

 
$
255.8

 
 
 
 
 
8.00% Series A convertible preferred stock: par value $0.01 per share, 370,000 authorized, 218,650 shares issued and outstanding as of June 30, 2017 (aggregate liquidation value of $223.0); 370,000 authorized, 210,160 shares issued and outstanding as of December 31, 2016 (aggregate liquidation value of $214.4)
 
180.3

 
171.6

Stockholders’ equity (deficit)
 
 
 
 
Common stock, $0.01 par value, 500,000,000 shares authorized, 116,626,791 shares issued and 104,889,834 shares outstanding at June 30, 2017; 116,425,524 shares issued and 106,659,542 shares outstanding at December 31, 2016
 
1.2

 
1.2

Additional paid-in capital
 
341.7

 
349.2

Accumulated deficit
 
(200.7
)
 
(304.7
)
Accumulated other comprehensive loss
 
(2.0
)
 
(2.8
)
Treasury stock, at cost, 11,736,957 shares as of June 30, 2017; 9,765,982 shares as of December 31, 2016
 
(59.5
)
 
(55.2
)
Total stockholders’ equity (deficit)
 
80.7

 
(12.3
)
Total liabilities and stockholders’ equity (deficit)
 
$
341.8

 
$
415.1


See accompanying notes to consolidated financial statements.

3


R1 RCM Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(In millions, except per share data)



 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(Unaudited)
 
(Unaudited)
Net services revenue ($87.7 million and $163.1 million for the three and six months ended June 30, 2017, respectively, and $0 and $343.4 million for the three and six months ended June 30, 2016 from related party, respectively)
 
$
99.4

 
$
8.7

 
$
186.3

 
$
360.9

Operating expenses:
 
 
 
 
 
 
 
 
Cost of services
 
96.4

 
45.1

 
177.3

 
90.2

Selling, general and administrative
 
12.2

 
24.6

 
26.5

 
42.2

Other
 
1.0

 
8.7

 
1.2

 
19.5

Total operating expenses
 
109.6

 
78.4

 
205.0

 
151.9

Income (loss) from operations
 
(10.2
)
 
(69.7
)
 
(18.7
)
 
209.0

Net interest income
 

 

 
0.1

 
0.1

Income (loss) before income tax provision
 
(10.2
)
 
(69.7
)
 
(18.6
)
 
209.1

Income tax provision (benefit)
 
(3.5
)
 
(28.9
)
 
(3.6
)
 
82.5

Net income (loss)
 
$
(6.7
)
 
$
(40.8
)
 
$
(15.0
)
 
$
126.6

Net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
$
(0.11
)
 
$
(0.45
)
 
$
(0.23
)
 
$
0.45

Diluted
 
$
(0.11
)
 
$
(0.45
)
 
$
(0.23
)
 
$
0.45

Weighted average shares used in calculating net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
102,467,078

 
99,414,066

 
101,918,797

 
98,851,934

Diluted
 
102,467,078

 
99,414,066

 
101,918,797

 
99,951,394

Consolidated statements of comprehensive income (loss)
 
 
 
 
 
 
Net income (loss)
 
(6.7
)
 
(40.8
)
 
(15.0
)
 
126.6

Other comprehensive loss:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 

 
(0.3
)
 
0.8

 
(0.2
)
Comprehensive income (loss)
 
$
(6.7
)
 
$
(41.1
)
 
$
(14.1
)
 
$
126.4

Reconciliation of net income (loss) to income (loss) available to common shareholders:
Basic:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(6.7
)
 
$
(40.8
)
 
$
(15.0
)
 
$
126.6

Less dividends on preferred shares
 
(4.4
)
 
(4.1
)
 
(8.7
)
 
(54.4
)
Less income allocated to preferred shareholders
 

 

 

 
(27.8
)
Net income (loss) available/allocated to common shareholders - basic
 
$
(11.1
)
 
$
(44.9
)
 
$
(23.7
)
 
$
44.4

Diluted:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(6.7
)
 
$
(40.8
)
 
$
(15.0
)
 
$
126.6

Less dividends on preferred shares
 
(4.4
)
 
(4.1
)
 
(8.7
)
 
(54.4
)
Less income allocated to preferred shareholders
 

 

 

 
(27.6
)
Net income (loss) available/allocated to common shareholders - diluted
 
$
(11.1
)
 
$
(44.9
)
 
$
(23.7
)
 
$
44.6

See accompanying notes to consolidated financial statements.

4


R1 RCM Inc.
Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited)
(In millions, except per share data)


 
 
 
Common Stock
 
Treasury Stock
 
Additional
Paid-In
Capital
 
Accumulated
Deficit
 
Accumulated
other
comprehensive
(loss)
 
Total
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
116,425,524

 
$
1.2

 
(9,765,982
)
 
$
(55.2
)
 
$
349.2

 
$
(304.7
)
 
$
(2.8
)
 
$
(12.3
)
Impact of adoption of Topic 606
 

 

 

 

 

 
113.4

 

 
113.4

Impact of adoption of ASU 2016-09
 

 

 

 

 
1.5

 
(0.9
)
 

 
0.6

Adjusted Balance at January 1, 2017
 
116,425,524

 
1.2

 
(9,765,982
)
 
(55.2
)
 
350.7

 
(192.2
)
 
(2.8
)
 
101.7

Share-based compensation expense
 

 

 

 

 
6.2

 

 

 
6.2

Issuance of common stock related to share-based compensation plans
 
155,535

 

 

 

 

 

 

 

Exercise of vested stock options
 
45,732

 

 

 

 

 

 

 

Dividends paid/accrued dividends
 

 

 

 

 
(8.7
)
 

 

 
(8.7
)
Acquisition of treasury stock related to equity award plans
 

 

 
(693,088
)
 

 

 

 

 

Treasury stock purchases
 

 

 
(1,277,887
)
 
(4.3
)
 

 

 

 
(4.3
)
Reclassification of excess share-based compensation
 

 

 

 

 
(6.5
)
 
6.5

 

 

Foreign currency translation adjustments
 

 

 

 

 

 

 
0.8

 
0.8

Net (loss) income
 

 

 

 

 

 
(15.0
)
 

 
(15.0
)
Balance at June 30, 2017
 
116,626,791

 
$
1.2

 
(11,736,957
)
 
$
(59.5
)
 
$
341.7

 
$
(200.7
)
 
$
(2.0
)
 
$
80.7

See accompanying notes to consolidated financial statements.

5


R1 RCM Inc.
Consolidated Statements of Cash Flows
(In millions)


 
 
Six Months Ended June 30,
 
 
2017
 
2016
 
 
(Unaudited)
Operating activities
 
 
 
 
Net income (loss)
 
$
(15.0
)
 
$
126.6

Adjustments to reconcile net income (loss) to net cash used in operations:
 
 
 
 
Depreciation and amortization
 
7.0

 
4.6

Share-based compensation
 
5.9

 
20.4

Loss on disposal
 
0.2

 

Provision (recovery) for doubtful receivables
 
0.1

 

Deferred income taxes
 
(4.1
)
 
82.4

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable and related party accounts receivable
 
(13.2
)
 
3.6

Prepaid income taxes
 
3.5

 
0.5

Prepaid expenses and other assets
 
(9.2
)
 
(3.4
)
Accounts payable
 
(2.3
)
 
(1.5
)
Accrued compensation and benefits
 
(0.4
)
 
7.2

Other liabilities
 
(0.4
)
 
5.1

Customer liabilities and customer liabilities - related party
 
5.0

 
(298.0
)
Net cash (used in) provided by operating activities
 
(22.9
)
 
(52.5
)
Investing activities
 
 
 
 
Purchases of property, equipment, and software
 
(23.2
)
 
(7.1
)
Proceeds from maturation of short-term investments
 

 
1.0

Net cash used in investing activities
 
(23.2
)
 
(6.1
)
Financing activities
 
 
 
 
Series A convertible preferred stock and warrant issuance, net of issuance costs
 

 
178.7

Exercise of vested stock options
 

 
0.1

Purchase of treasury stock
 
(1.2
)
 

Shares withheld for taxes
 
(1.9
)
 
(2.0
)
Net cash (used in) provided by financing activities
 
(3.1
)
 
176.8

Effect of exchange rate changes in cash
 
0.4

 

Net increase (decrease) in cash and cash equivalents
 
(48.8
)
 
118.2

Cash and cash equivalents, at beginning of period
 
181.2

 
103.5

Cash and cash equivalents, at end of period
 
$
132.4

 
$
221.7

Supplemental disclosures of cash flow information
 
 
 
 
Accrued dividends payable to Preferred Stockholders
 
$
4.3

 
$
4.0

Accrued liabilities related to purchases of property, equipment and software
 
$
1.0

 
$
1.0

Accounts payable related to purchases of property, equipment and software
 
$
1.7

 
$

Income taxes paid
 
$
(0.6
)
 
$
(0.4
)
Income taxes refunded
 
$
3.4

 
$
0.6


See accompanying notes to consolidated financial statements.

6



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements


1. Business Description and Basis of Presentation
Business Description
R1 RCM Inc. (the "Company") is a leading provider of revenue cycle management ("RCM") services and physician advisory services ("PAS") to healthcare providers. The Company helps healthcare providers generate sustainable improvements in their operating margins and cash flows while also enhancing patient, physician and staff satisfaction for its customers.The Company achieves these results for its customers by managing healthcare providers’ revenue cycle operations, which encompass processes including patient registration, insurance and benefit verification, medical treatment documentation and coding, bill preparation and collections from patients and payers. The Company does so by deploying a unique operating model that leverages its extensive healthcare site experience, innovative technology and process excellence.
 
The Company's primary service offering consists of end-to-end RCM, which encompasses patient registration, insurance and benefit verification, medical treatment documentation and coding, bill preparation and collections. The Company deploys its RCM services through a co-managed relationship or an operating partner relationship. Under a co-managed relationship, the Company leverages its customers’ existing RCM staff and processes, and supplements them with the Company's infused management, subject matter specialists, proprietary technology and other resources. Under an operating partner relationship, the Company provides comprehensive revenue cycle infrastructure to providers, including all revenue cycle personnel, technology, and process workflow. The Company also offers modular services, allowing customers to engage the Company for only specific components of its end-to-end RCM service offering. The Company's PAS offering complements the Company's RCM offering by strengthening customer’s compliance with certain third-party payer requirements and limiting denials of claims. For example, the Company's PAS offering helps customers determine whether to classify a hospital visit as an in-patient or an out-patient observation case for billing purposes.
On February 16, 2016, the Company entered into a long-term strategic partnership with Ascension Health Alliance, the parent of the Company's largest customer and the nation’s largest Catholic and non-profit health system, and TowerBrook Capital Partners ("TowerBrook"), an investment management firm (the "Transaction"). As part of the Transaction, the Company amended and restated its Master Professional Services Agreement ("A&R MPSA") with Ascension Health ("Ascension") effective February 16, 2016 with a term of ten years. Pursuant to the A&R MPSA and with certain limited exceptions, the Company will become the exclusive provider of RCM services and PAS with respect to acute care services provided by the hospitals affiliated with Ascension that execute supplement agreements with the Company.
Basis of Presentation
The accompanying unaudited consolidated financial statements reflect the Company's financial position as of June 30, 2017, the results of operations for the three and six months ended June 30, 2017 and 2016, and the cash flows of the Company for the six months ended June 30, 2017 and 2016. These financial statements include the accounts of R1 RCM Inc. and its wholly owned subsidiaries. All material intercompany amounts have been eliminated in consolidation. These financial statements have been prepared in accordance with United States generally accepted accounting principles ("GAAP") for interim financial reporting and as required by the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the interim financial information, have been included. Operating results for the three and six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2017.



7



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

When preparing financial statements in conformity with GAAP, the Company must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements. Actual results could differ from those estimates. For a more complete discussion of the Company’s significant accounting policies and other information, the unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 (the "2016 10-K"). As of January 1, 2017, the Company adopted Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09") and ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). See Note 6, Revenue Recognition, and Note 9, Share-Based Compensation, for discussion on the impact of the adoption of these standards on the Company's policies for revenue and stock compensation, respectively.
2. Recent Accounting Pronouncements

Recently Issued Accounting Standards and Disclosures

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"), which supersedes existing guidance on accounting for leases in Topic 840, Leases. ASU 2016-02 generally requires all leases to be recognized in the consolidated balance sheet. The provisions of ASU 2016-02 are effective for reporting periods beginning after December 15, 2018; early adoption is permitted. The provisions of ASU 2016-02
are to be applied using a modified retrospective approach. The Company is currently evaluating the impact of the adoption of this prospective guidance on its consolidated financials.

ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash ("ASU 2016-18"). ASU 2016-18 is intended to reduce diversity in practice in the classification and presentation of changes in restricted cash on the Consolidated Statement of Cash Flows. ASU 2016-18 requires that the Consolidated Statement of Cash Flows explain the change in total cash and equivalents and amounts generally described as restricted cash or restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts. ASU 2016-18 also requires a reconciliation between the total of cash and equivalents and restricted cash presented on the Consolidated Statement of Cash Flows and the cash and equivalents balance presented on the Consolidated Balance Sheet. The guidance is effective for interim and annual periods beginning after December 15, 2017, and early adoption is permitted. The guidance requires application using a retrospective transition method. The Company is currently evaluating the impact of the adoption of this prospective guidance on its consolidated financials.
3. Fair Value of Financial Instruments
The Company records its financial assets and liabilities at fair value. The accounting standard for fair value (i) defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date, (ii) establishes a framework for measuring fair value, (iii) establishes a hierarchy of fair value measurements based upon the ability to observe inputs used to value assets and liabilities, (iv) requires consideration of nonperformance risk and (v) expands disclosures about the methods used to measure fair value. The accounting standard establishes a three-level hierarchy of measurements based upon the reliability of observable and unobservable inputs used to arrive at fair value. Observable inputs are independent market data, while unobservable inputs reflect the Company’s assumptions about valuation. The three levels of the hierarchy are defined as follows:
Level 1: Observable inputs such as quoted prices in active markets for identical assets and liabilities;
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

8



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

Level 3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The carrying amounts of the Company’s financial instruments, which include financial assets such as cash and cash equivalents, restricted cash equivalents, accounts receivable, net, and certain other current assets, as well as financial liabilities such as accounts payable, accrued service costs, accrued compensation and benefits and certain other accrued expenses, approximate their fair values, due to the short-term nature of these instruments. The Company does not have any financial assets or liabilities that are required to be measured at fair value on a recurring basis.
4. Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable is comprised of unpaid balances pertaining to non-RCM services fees and net receivable balances for RCM customers after considering cost reimbursements owed to such customers, including related accrued balances.
The Company maintains an estimated allowance for doubtful accounts to reduce its accounts receivable to the amount that it believes will be collected. This allowance is based on the Company’s historical experience, its assessment of each customer’s ability to pay, the length of time a balance has been outstanding, input from key customer resources assigned to each customer, and the status of any ongoing operations with each applicable customer.    
Movements in the allowance for doubtful accounts are as follows (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Beginning balance
$
107

 
$
82

 
$
66

 
$
99

Provision (recoveries)
50

 
(10
)
 
91

 
(27
)
Write-offs
(6
)
 
(31
)
 
(6
)
 
(31
)
Ending balance
$
151

 
$
41

 
$
151

 
$
41


5. Property, Equipment and Software
Property, equipment and software consist of the following (in millions):
 
 
June 30, 2017
 
December 31, 2016
Computer and other equipment
 
$
28.8

 
$
23.3

Leasehold improvements
 
21.0

 
16.0

Software
 
40.5

 
28.1

Office furniture
 
6.6

 
4.9

Property, equipment and software, gross
 
96.9

 
72.3

Less accumulated depreciation and amortization
 
(46.3
)
 
(39.5
)
Property, equipment and software, net
 
$
50.6

 
$
32.8

The following table summarizes the allocation of depreciation and amortization expense between cost of services and selling, general and administrative expenses (in millions):

9



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Cost of services
 
$
3.5

 
$
2.2

 
$
6.4

 
$
4.3

Selling, general and administrative
 
0.3

 
0.1

 
0.6

 
0.3

Total depreciation and amortization
 
$
3.8

 
$
2.3

 
$
7.0

 
$
4.6

6. Revenue Recognition
The Company follows the guidance under Topic 606, Revenue from Contracts with Customers, (“Topic 606”). Revenue is measured based on consideration specified in a contract with a customer, and excludes any sales incentives and amounts collected on behalf of third parties. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a service to a customer, which is typically over the contact term. Estimates of variable consideration are included in revenue to the extent that it is probable that a significant reversal of cumulative revenue will not occur once the uncertainty is resolved.

Periods prior to January 1, 2017
    
Revenue is generally recognized when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) services have been rendered, (iii) the fee is fixed or determinable and (iv) collectability is reasonably assured.

Net service fees, as reported in the consolidated statement of operations and comprehensive income (loss), consist of: (a) RCM services fees and (b) professional service fees earned on a fixed fee, transactional fee or time and materials basis. The Company’s primary source of revenue is RCM services fees. RCM services fees are primarily contingent, but along with fixed fees are generally viewed as one deliverable. To the extent that certain RCM services fees are fixed and not subject to refund, adjustment or concession, such fees are generally recognized as revenue on a straight-line basis over the term of the contract.

On a limited basis, the Company enters into contracts with multiple accounting elements which may include a combination of fixed fee or transactional fee elements. The selling price of each element is determined by using management's best estimate of selling price. Revenues are recognized in accordance with the accounting policies for the separate elements.
    
RCM services fees that are contingent in nature are recognized as revenue once all the criteria for revenue recognition are met, which is generally at the end of a contract or other contractual agreement event. Revenue is recognized for RCM services fees upon the contract reaching the end of its stated term (such that the contractual relationship will not continue in its current form) to the extent that: (i) cash has been received for invoiced fees and (ii) there are no disputes at the conclusion of the term of the contract.

If fees or services are disputed by a customer at the end of a contract, a settlement agreement entered into with the customer triggers revenue recognition. An other "contractual agreement event" occurs when a renewal, amendment to an existing contract, or other settlement agreement is executed in which the parties reach agreement on prior fees. Revenue is recognized up to the amount covered by such agreements.

RCM services fees consist of the following contingent fees: (i) Net Operating Fees and (ii) Incentive Fees.

Net Operating Fees

The Company generates net operating fees to the extent the Company is able to assist customers in reducing the cost of revenue cycle operations. In limited cases, the Company earns a fixed fee instead of a fee based on the mechanics described below. The Company’s net operating fees consist of:


10



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

i) gross base fees invoiced to customers; less

ii) corresponding costs of customers’ revenue cycle operations which the Company pays pursuant to its RCM agreements, including salaries and benefits for the customers' RCM personnel, and related third-party vendor costs; less

iii) any cost savings the Company shares with customers.

Net operating fees are recorded as deferred customer billings until the Company recognizes revenue for a customer contract at the end of a contract or reaches an "other contractual agreement event". The amount of unpaid costs of customers’ revenue cycle operations and shared cost savings are reported as accrued service costs within customer liabilities in the consolidated balance sheets.

Incentive Fees

The Company generates revenue in the form of performance-based fees when the Company improves the customers’ financial or operational metrics. These performance metrics vary by customer contract. However, certain contracts contain a contract-to-date performance metric that is not resolved until the end of the term of the contract.

Periods commencing January 1, 2017

Nature of Goods and Services

The Company's primary source of revenue is its end-to-end RCM services fees. The Company also generates revenue through its modular RCM services, where customers will engage the Company for only specific components of its end-to-end RCM service offering on a fixed-fee or transactional basis, as well as its PAS offering.

Revenue Cycle Management

RCM services fees are primarily variable and performance related, and are generally viewed as the consideration earned in satisfaction of a single performance obligation. RCM services fees consist of net operating fees, incentive fees, and other fees.

Net Operating Fees

The Company’s net operating fees consist of:

i) gross base fees invoiced to customers; less
    
ii) corresponding costs of customers’ revenue cycle operations which the Company pays pursuant to its RCM agreements, including salaries and benefits for the customers' RCM personnel, and related third-party vendor costs.

The Company recognizes revenue related to net operating fees ratably as the performance obligation for the RCM services is satisfied. Base fees are typically billed in advance of the quarter and paid in three monthly payments as the entity performs and the customer simultaneously receives and consumes the benefits provided by the services provided. The costs of customers’ revenue cycle operations which the company pays pursuant to its RCM agreements are accrued based on the service period.

Incentive Fees

The Company recognizes revenue related to incentive fees ratably as the performance obligation for RCM services is satisfied, to the extent that it is probable that a significant reversal of cumulative revenue

11



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

will not occur once the uncertainty is resolved. Incentive fees are structured to reflect quarterly or annual, performance and are evaluated on a contract-by-contract basis. Incentive fees are typically billed and paid on a quarterly basis.

RCM Other

The Company recognizes revenue related to other RCM fees as RCM services are provided. These services typically consist of the Company's modular RCM services offering, which consists of an obligation to provide services for a specific component of its end-to-end RCM service offering. Fees are typically variable in nature with the entire amount being included in revenue in the month of service. The customer simultaneously receives and consumes the benefits provided by the services and the fees are typically billed on a monthly basis with payment terms of up to 30 days. To the extent that certain service fees are fixed and not subject to refund, adjustment or concession, these fees are generally recognized into revenue ratably as the performance obligation is satisfied.

Other Services

The Company recognizes revenue from PAS in the period in which the service is performed. The Company’s PAS arrangements typically consist of an obligation to provide specific services to customers on a when and if needed basis. These services are provided under a fixed price per unit arrangement. These contracts are evaluated on a contract-by-contract basis. Fees for the Company's PAS arrangements are typically billed on a monthly basis with 30 to 60 day payment terms.

Bundled Services

Modular RCM services may be sold separately or bundled in a contract and end-to-end RCM services are typically sold separately but may be bundled with PAS services. PAS services are commonly sold separately. The typical length of an end-to-end RCM contract is three to ten years (subject to the parties' respective termination rights) but varies from customer to customer. PAS and modular RCM agreements generally vary in length between one and three years.

For bundled arrangements, the Company accounts for individual services as a separate performance obligation if a service is separately identifiable from other items in the bundled arrangement and if a customer can benefit from it on its own or with other resources that are readily available to the customer. The transaction price is allocated between separate services in a bundle based on their relative standalone selling prices. The standalone selling prices are determined based on the prices at which the Company separately sells its RCM, PAS, or modular services. PAS services are provided at a customer’s election but do not represent material rights as the services are priced at standalone selling price throughout the life of the agreement. In certain situations, the Company allocates variable consideration to a distinct service, or services, within a contract. The Company allocates variable payments to one or more, but not all, of the distinct services in a contract when (i) the variable payment relates specifically to the Company’s efforts to transfer the distinct service and (ii) the variable payment is for an amount that depicts the amount of consideration to which the Company expects to be entitled in exchange for transferring the promised services to its customer.

Disaggregation of Revenue

In the following table, revenue is disaggregated by source of revenue (in millions):

12



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

 
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
RCM services: net operating fees
 
$
80.1

 
$
150.8

RCM services: incentive fees
 
7.1

 
12.7

RCM services: other
 
4.1

 
7.0

Other services fees
 
8.1

 
15.8

Total net service revenue
 
$
99.4

 
$
186.3

    

Contract Balances

The following table provides information about receivables, contracts assets, and contract liabilities from contracts with customers (in millions):
 
June 30, 2017
At adoption
Receivables, which are included in accounts receivable, net
23.5

30.5

Contract assets


Contract liabilities
10.6

20.9


The Company recognized revenue of $1.7 million for the three months ended June 30, 2017 related to changes in transaction price estimates during the quarter for certain revenue cycle management contracts.

The Company recognized revenue of $0.3 million during the three months ended June 30, 2017, which amount was included in contract liabilities at the beginning of the period.

A receivable is recognized in the period the Company provides services when the Company’s right to consideration is unconditional. Payment terms on invoiced amounts are typically 30-60 days.

Significant changes in the contract assets and the contract liabilities balances during the period are as follows (in millions):
 
 
June 30, 2017
 
 
Contract assets
 
Contract liabilities
Revenue recognized that was included in the contract liability balance at the beginning of the period
 
 
29.6
Increases due to cash received, excluding amounts recognized as revenue during the period
 
 
2.2
Transferred to receivables from contract assets recognized at the beginning of the period
 
 
Increases as a result of cumulative catch-up adjustment arising from changes in the estimate of the stage of completion, excluding amounts transferred to receivables during the period
 
 

Transaction Price Allocated to the Remaining Performance Obligation

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of the reporting period (in millions). The estimated revenue does not include amounts of variable consideration that are constrained.

13



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

 
RCM
 
Other
 
Net operating fees
Incentive fees
Other
 
Other Services fees
2017
$
6.8

$
0.3

$
2.3

 
$

2018
13.5


1.6

 

2019


1.6

 

2020


1.1

 

Thereafter


5.6

 

Total
$
20.3

$
0.3

$
12.2

 
$

    

The amounts presented in the table above primarily consist of fixed fees which are typically recognized ratably as the performance obligation is satisfied.

Estimates of revenue expected to be recognized in future periods also exclude unexercised customer options to purchase services within the Company's PAS contracts that do not represent material rights to the customer. Customer options that do not represent a material right are only accounted for in accordance with Topic 606 when the customer exercises its option to purchase additional goods or services.

The Company has elected certain of the optional exemptions from the disclosure requirement for remaining performance obligations for specific situations in which an entity need not estimate variable consideration to recognize revenue. Accordingly, the Company applies the practical expedient in paragraph 606-10-55-18 to its stand-alone PAS contracts and modular RCM services and does not disclose information about variable consideration from remaining performance obligations for which the Company recognizes revenue. PAS performance obligations are typically short in duration (often less than 1 day) with any uncertainty related to the associated variable consideration resolved as each increment of service (completion of a level of care review or an appeal) is completed which reflects the value the Customer receives from the Company’s fulfillment of the performance obligation. Modular RCM services performance obligations for variable consideration are of short duration with fees corresponding to the value the customer has realized, for example, patient accounts collected on behalf of the Customer or medical record lines transcribed.
The Company also applies the guidance in paragraph 606-10-50-14A(b) to variable consideration within its end-to-end RCM contracts and does not disclose information about remaining, wholly unsatisfied performance obligations for variable consideration that the Company is able to allocate to one or more, but not-all, of the performance obligations in its contracts in accordance with paragraph 606-10-32-40. The Company’s end-to-end RCM services performance obligations are satisfied over time and are substantially the same from period to period under either a co-managed or operating partner model. Fees are variable and consist of net operating fees and incentive fees with the uncertainty related to net operating fees and certain incentive fees being resolved quarterly with the uncertainty of other incentive fees being resolved annually. The information presented in the table above includes estimates for incentive fees where the uncertainty related to the final fee is resolved on longer than a quarterly basis and to the extent the Company does not believe the associated consideration is constrained.
Changes in Accounting Policies

Except for the changes below, the Company has consistently applied the accounting policies to all periods presented in these consolidated financial statements.

The Company adopted Topic 606 with a date of the initial application of January 1, 2017. As a result, the Company has changed its accounting policy for revenue recognition as detailed below.

The Company adopted Topic 606, effective January 1, 2017, using the modified retrospective method, applying Topic 606 to contracts that are not complete as of the date of initial application. Therefore, the comparative information

14



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

has not been adjusted and continues to be reported under Topic 605. The details of the significant changes and quantitative impact of the changes are set out below.
 
RCM services fees
    
RCM services fees that are variable in nature were recognized under Topic 605 as revenue once all the criteria for revenue recognition are met, which is generally at the end of a contract or other contractual agreement event. Revenue previously has been recognized for RCM service fees upon the contract reaching the end of its stated term (such that the contract relationship will not continue in its current form) to the extent that cash has been received for invoiced fees and there are no disputes at the conclusion of the term of the contract.

Under Topic 606, the Company recognizes service fees that are variable in nature over time as the service is provided to the customer to the extent that it is probable that a significant reversal of cumulative revenue will not occur once the uncertainty related to the estimated revenue is subsequently resolved. Net operating fees are typically recognized on a quarterly basis as the RCM services are rendered and measurement of the net operating fees earned during the distinct performance period is objectively determinable. Incentive fees are calculated quarterly based upon contractually defined agreed-upon performance metrics and are recognized as revenue to the extent that it is probable that a significant reversal of cumulative revenue will not occur once any uncertainty related to the estimated revenue is subsequently resolved.

Fixed fees are generally recognized over the term of the contract on a ratable basis as the performance obligation is satisfied.

Other service fees
    
The PAS contract between the Company and customer typically stipulates the price per unit the Company is entitled to for each unit of service performed. Certain contracts include minimum fees and volume discounts but the Company does not know the quantity or mix of service types the customer will request until the request is made. The length of time it takes the Company to perform each service can vary depending on the nature of the service or complexity of the specific situation or case. Revenue previously has been recognized for PAS service fees when the service is completed.

Under Topic 606, the Company recognizes revenue on a monthly basis when services are completed during the month consistent with recognition under Topic 605.

Deferred contract costs
    
Eligible, one-time, nonrecurring fulfillment costs associated with the initial phases of the Ascension A&R MPSA and with the transition of additional Ascension hospitals under separate contracts are deferred and subsequently amortized. These costs are amortized on a straight-line basis over the expected period of benefit. Under Topic 606, the Company will continue to amortize associated assets over the remaining life of the contract as services are provided.

Impacts on Financial Statements

The following tables summarize the impacts of adopting Topic 606 on the Company’s consolidated financial statements as of and for the three and six months ended June 30, 2017 (in millions, except per share data):


15



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

i.
Consolidated balance sheets

 
 
Impact of changes in accounting policies
 
 
As reported June 30, 2017
 
Adjustments
 
Balances without adoption of Topic 606
Assets
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
132.4

 
$

 
$
132.4

Accounts receivable, net
 
7.2

 
(0.3
)
 
6.9

Accounts receivable, net - related party
 
16.3

 
(6.7
)
 
9.6

Prepaid income taxes
 
0.4

 

 
0.4

Prepaid expenses and other current assets
 
19.1

 
(0.2
)
 
18.9

Total current assets
 
175.4

 
(7.2
)
 
168.2

Property, equipment and software, net
 
50.6

 

 
50.6

Non-current deferred tax assets
 
104.3

 
128.1

 
232.4

Restricted cash equivalents
 
1.5

 

 
1.5

Other assets
 
10.0

 
0.1

 
10.1

Total assets
 
$
341.8

 
$
121.0

 
$
462.8

Liabilities
 
 
 
 
 

Current liabilities:
 
 
 
 
 

Accounts payable
 
6.8

 
(1.2
)
 
5.6

Current portion of customer liabilities
 
1.0

 
67.5

 
68.5

Current portion of customer liabilities - related party
 
10.9

 
2.7

 
13.6

Accrued compensation and benefits
 
24.5

 

 
24.5

Other accrued expenses
 
16.2

 
(1.2
)
 
15.0

Total current liabilities
 
59.4

 
67.8

 
127.2

Non-current portion of customer liabilities
 
0.5

 
0.1

 
0.6

Non-current portion of customer liabilities - related party
 
8.3

 
256.3

 
264.6

Other non-current liabilities
 
12.6

 

 
12.6

Total liabilities
 
$
80.8

 
$
324.2

 
$
405.0

 
 
 
 
 
 

8.00% Series A convertible preferred stock
 
180.3

 

 
180.3

Stockholders’ equity (deficit)
 
 
 
 
 

Common stock
 
1.2

 

 
1.2

Additional paid-in capital
 
341.7

 

 
341.7

Accumulated deficit
 
(200.7
)
 
(203.2
)
 
(403.9
)
Accumulated other comprehensive loss
 
(2.0
)
 

 
(2.0
)
Treasury stock
 
(59.5
)
 

 
(59.5
)
Total stockholders’ equity (deficit)
 
80.7

 
(203.2
)
 
(122.5
)
Total liabilities and stockholders’ equity (deficit)
 
$
341.8

 
$
121.0

 
$
462.8




16



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

ii.
Consolidated statements of operations and comprehensive income (loss) -
 
 
Impact of changes in accounting policies
 
 
As reported three months ended June 30, 2017
 
Adjustments
 
Balances without adoption of Topic 606
 
As reported six months ended June 30, 2017
 
Adjustments
 
Balances without adoption of Topic 606
Net services revenue
 
$
99.4

 
$
(81.8
)
 
$
17.6

 
$
186.3

 
$
(154.1
)
 
$
32.2

Operating expenses:
 
 
 

 

 
 
 
 
 

Cost of services
 
96.4

 
(3.5
)
 
92.9

 
177.3

 
(6.5
)
 
170.8

Selling, general and administrative
 
12.2

 

 
12.2

 
26.5

 

 
26.5

Other
 
1.0

 

 
1.0

 
1.2

 

 
1.2

Total operating expenses
 
109.6

 
(3.5
)
 
106.1

 
205.0

 
(6.5
)
 
198.5

Income (loss) from operations
 
(10.2
)
 
(78.3
)
 
(88.5
)
 
(18.7
)
 
(147.6
)
 
(166.3
)
Net interest income
 

 

 

 
0.1

 

 
0.1

Income (loss) before income tax provision
 
(10.2
)
 
(78.3
)
 
(88.5
)
 
(18.6
)
 
(147.6
)
 
(166.2
)
Income tax provision (benefit)
 
(3.5
)
 
(30.7
)
 
(34.2
)
 
(3.6
)
 
(57.8
)
 
(61.4
)
Net income (loss)
 
$
(6.7
)
 
$
(47.6
)
 
$
(54.3
)
 
$
(15.0
)
 
$
(89.8
)
 
$
(104.8
)
Net income (loss) per common share:
 
 
 

 

 
 
 
 
 

Basic
 
$
(0.11
)
 
$
(0.46
)
 
$
(0.57
)
 
$
(0.23
)
 
$
(0.88
)
 
$
(1.11
)
Diluted
 
$
(0.11
)
 
$
(0.46
)
 
$
(0.57
)
 
$
(0.23
)
 
$
(0.88
)
 
$
(1.11
)
Weighted average shares used in calculating net income (loss) per common share:
 
 
 

 

 
 
 
 
 

Basic
 
102,467,078

 

 
102,467,078

 
101,918,797

 

 
101,918,797

Diluted
 
102,467,078

 

 
102,467,078

 
101,918,797

 

 
101,918,797

Consolidated statements of comprehensive income (loss)
 

 

 
 
 
 
 

Net income (loss)
 
$
(6.7
)
 
$
(47.6
)
 
$
(54.3
)
 
$
(15.0
)
 
$
(89.8
)
 
$
(104.8
)
Other comprehensive loss:
 
 
 

 

 
 
 
 
 

Foreign currency translation adjustments
 

 

 

 
0.8

 

 
0.8

Comprehensive income (loss)
 
$
(6.7
)
 
$
(47.6
)
 
$
(54.3
)
 
$
(14.1
)
 
$
(89.8
)
 
$
(103.9
)


17



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

iii.
Consolidated statements of cash flows -
 
 
Impact of changes in accounting policies
 
 
As reported June 30, 2017
 
Adjustments
 
Balances without adoption of Topic 606
Operating activities
 
 
 
 
 
 
Net income (loss)
 
$
(15.0
)
 
$
(89.8
)
 
$
(104.8
)
Adjustments to reconcile net income (loss) to net cash used in operations:
 
 
 
 
 

Depreciation and amortization
 
7.0

 

 
7.0

Share-based compensation
 
5.9

 

 
5.9

Loss on disposal
 
0.2

 

 
0.2

Provision (recovery) for doubtful receivables
 
0.1

 

 
0.1

Deferred income taxes
 
(4.1
)
 
(57.8
)
 
(61.9
)
Changes in operating assets and liabilities:
 
 
 
 
 

Accounts receivable and related party accounts receivable
 
(13.2
)
 
2.5

 
(10.7
)
Prepaid income taxes
 
3.5

 

 
3.5

Prepaid expenses and other assets
 
(9.2
)
 
0.1

 
(9.1
)
Accounts payable
 
(2.3
)
 
(1.2
)
 
(3.5
)
Accrued compensation and benefits
 
(0.4
)
 

 
(0.4
)
Other liabilities
 
(0.4
)
 
(1.2
)
 
(1.6
)
Customer liabilities and customer liabilities - related party
 
5.0

 
147.4

 
152.4

Net cash (used in) provided by operating activities
 
(22.9
)
 

 
(22.9
)
Investing activities
 
 
 
 
 

Purchases of property, equipment, and software
 
(23.2
)
 

 
(23.2
)
Proceeds from maturation of short-term investments
 

 

 

Net cash used in investing activities
 
(23.2
)
 

 
(23.2
)
Financing activities
 
 
 
 
 

Series A convertible preferred stock and warrant issuance, net of issuance costs
 

 

 

Exercise of vested stock options
 

 

 

Purchase of treasury stock
 
(1.2
)
 

 
(1.2
)
Shares withheld for taxes
 
(1.9
)
 

 
(1.9
)
Net cash (used in) provided by financing activities
 
(3.1
)
 

 
(3.1
)
Effect of exchange rate changes in cash
 
0.4

 

 
0.4

Net increase (decrease) in cash and cash equivalents
 
(48.8
)
 

 
(48.8
)
Cash and cash equivalents, at beginning of period
 
181.2

 

 
181.2

Cash and cash equivalents, at end of period
 
$
132.4

 
$

 
$
132.4

7. Customer Liabilities
Customer liabilities include (i) accrued service costs (amounts due and accrued for cost reimbursements),
(ii) deferred customer billings (net operating fees invoiced or accrued and incentive fees collected that have not met all revenue recognition criteria), (iii) refund liabilities (amounts potentially due as a refund to the Company's customers on incentive fees) (iv) customer deposits (consisting primarily of net operating fees under the Company’s RCM contracts that are paid prior to the service period and amounts due as a refund to the Company's customers on incentive fees) and (v) Deferred Revenue (contract liabilities) (fixed or variable fees amortized to revenue over the

18



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

service period). Deferred customer billings are classified as current based on the customer contract end dates or other termination events that fall within twelve months of the balance sheet dates. Accrued service cost, refund liabilities and contract liabilities are classified as current or non-current based on the anticipated period in which the liabilities are expected to be settled or the revenue is expected to be recognized.
Customer liabilities consist of the following (in millions):
 
June 30,
 
December 31,
 
2017
 
2016
Deferred customer billings, current
$
0.3

 
$
68.2

Accrued service costs, current (1)
9.9

 
14.8

Customer deposits, current (1)

 
0.9

Refund liabilities, current

 

Deferred revenue (contract liabilities), current (1)
1.7

 

Current portion of customer liabilities
$
11.9

 
$
83.9

Deferred customer billings, non-current (2)
$

 
$
110.0

Refund liabilities, non-current

 

Customer deposits, non-current

 

Deferred revenue (contract liabilities), non-current (2)
8.8

 
1.0

Non current portion of customer liabilities
$
8.8

 
$
111.0

Total customer liabilities
$
20.7

 
$
194.9


(1) Includes $9.8 million and $1.1 million in current accrued service costs and deferred revenue respectively, for a related party that are included in the current portion of customer liabilities - related party in the accompanying consolidated balance sheets at June 30, 2017. Includes $13.2 million and $1.0 million in current accrued service costs and customer deposits, respectively, for a related party that are included in the current portion of customer liabilities - related party in the accompanying consolidated balance sheets at December 31, 2016.
(2) Includes $8.3 million in deferred revenue for a related party that are included in the non-current portion of customer liabilities - related party in the accompanying consolidated balance sheet at June 30, 2017. Includes $110.0 million in deferred customer billings for a related party that are included in the non-current portion of customer liabilities - related party in the accompanying consolidated balance sheets at December 31, 2016.
8. Stockholders’ Equity (Deficit)
Preferred Stock and Warrant
The Company has 5,000,000 shares of authorized preferred stock, each with a par value of $0.01. The preferred stock may be issued from time to time in one or more series. The board of directors of the Company ("Board") is authorized to determine the rights, preferences, privileges and restrictions of the Company’s authorized but unissued shares of preferred stock. On February 16, 2016, at the close of the Transaction, the Company issued to TCP-ASC ACHI Series LLLP, a limited liability limited partnership jointly owned by Ascension Health Alliance and investment funds affiliated with TowerBrook (the "Investor"): (i) 200,000 shares of its 8.00% Series A Convertible Preferred Stock, par value $0.01 per share (the "Series A Preferred Stock" or "Preferred Stock"), for an aggregate price of $200 million and (ii) an exercisable warrant to acquire up to 60 million shares of its common stock with an exercise price of $3.50 per common share and a term of ten years. The Series A Preferred Stock is immediately convertible into shares of common stock. As of June 30, 2017 and December 31, 2016, the Company had 218,650 and 210,160 shares of preferred stock outstanding, respectively. See Note 12, 8% Series A Convertible Preferred Stock, for additional information.
Common Stock

19



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

Each outstanding share of the Company's common stock, par value $0.01 per share ("common stock"), is entitled to one vote per share on all matters submitted to a vote by shareholders. Subject to the rights of any preferred stock which may from time to time be outstanding, the holders of outstanding shares of common stock are entitled to receive dividends and, upon liquidation or dissolution, are entitled to receive pro rata all assets legally available for distribution to stockholders. No dividends were declared or paid on the common stock during 2017 or 2016.
Treasury Stock
On November 13, 2013, the Board authorized a repurchase of up to $50.0 million of the Company’s common stock in the open market or in privately negotiated transactions. The timing and amount of any shares repurchased will be determined by the Company based on its evaluation of market conditions and other factors. The repurchase program may be suspended or discontinued at any time at the sole discretion of the Board. Any repurchased shares will be available for use in connection with the Company’s stock plans and for other corporate purposes. The Company funds the repurchases from cash on hand. During the year ended December 31, 2016, the Company repurchased 158,557 shares of the Company stock for $0.4 million. During the three and six months ended June 30, 2017, 243,270 and 513,344 shares were repurchased for $0.6 million and $1.2 million, respectively. No shares have been retired. As of June 30, 2017 and December 31, 2016, the Company held in treasury 4,979,363 and 4,465,919 shares of repurchased stock, respectively.
    
In addition to the amounts above, $1.3 million was recorded as an increase to other accrued expenses and treasury stock as a result of the Company entering into agreements as of June 30, 2017 to repurchase 342,130 shares of Company stock held by certain former executive. Treasury stock also includes repurchases of Company stock related to employees’ tax withholding upon vesting of restricted shares as well as restricted shares that have been canceled or forfeited. See Note 9, Share-Based Compensation.
9. Share-Based Compensation
The share-based compensation expense relating to the Company’s stock options, restricted stock awards ("RSAs") and restricted stock units ("RSUs") for the three months ended June 30, 2017 and 2016 was $2.2 million and $13.6 million, respectively, with related tax benefits of approximately $0.8 million and $5.4 million, respectively. The share-based compensation expense relating to the Company’s stock options, RSAs and RSUs for the six months ended June 30, 2017 and 2016 was $5.8 million and $20.5 million, respectively, with related tax benefits of approximately $2.2 million and $8.1 million, respectively.

As of January 1, 2017, the Company adopted ASU 2016-09. The Company elected to change its accounting policy to account for forfeitures as they occur under the new standard. The change was applied on a modified retrospective basis with a cumulative effect adjustment recorded to increase accumulated deficit by $0.9 million, increase additional paid-in capital by $1.5 million and increase non-current deferred tax assets by $0.5 million as of January 1, 2017. Excess tax benefits and shortfalls for share-based payments are now included in operating activities rather than in financing activities. The changes have been applied prospectively in accordance with ASU 2016-09 and prior periods have not been adjusted.

Amendments related to accounting for excess tax benefits and shortfalls have been adopted prospectively, resulting in recognition of excess tax benefits and shortfalls in income tax expenses (benefit) rather than additional paid-in capital. For the three and six months ended June 30, 2017, the Company recognized $0.0 million and $0.9 million of income tax expense from shortfalls associated with vesting and exercises of equity awards.
Total share-based compensation costs that have been included in the Company’s consolidated statements of operations were as follows (in millions):

20



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Share-Based Compensation Expense Allocation Details:
 
 
 
 
 
 
 
 
Cost of services
 
$
1.0

 
$
1.5

 
$
2.1

 
$
3.5

Selling, general and administrative
 
1.1

 
10.3

 
3.6

 
15.2

Other
 
0.1

 
1.8

 
0.1

 
1.8

Total share-based compensation expense (1)
 
$
2.2

 
$
13.6

 
$
5.8

 
$
20.5

(1) Includes $0.1 million in share-based compensation expense paid in cash during the three and six months ended June 30, 2016 respectively. In addition to the share-based compensation expense recorded above, $0.0 million and $0.3 million of share-based compensation expense was capitalized to deferred contract costs for the three and six months ended June 30, 2017, respectively. See Note 16, Deferred Contract Costs, for further discussion.
The Company uses the Black-Scholes option pricing model to estimate the fair value of its service-based options as of its grant date. The Company uses the Monte Carlo simulations to estimate the fair value of its RSAs with vesting based on market-based performance conditions as of their respective grant dates. Expected life is based on the market condition to which the vesting is tied.
The following table sets forth the significant assumptions used in the Black-Scholes option pricing model and the Monte Carlo simulations and the calculation of share-based compensation expense for the six months ended June 30, 2017 and 2016:
 
 
Six Months Ended June 30,
 
 
2017
 
2016
Expected dividend yield
 

 

Risk-free interest rate
 
1.9% to 2.3%
 
1.4% to 1.9%
Expected volatility
 
45%
 
50%
Expected term (in years)
 
6.25 to 6.29
 
6.25
Forfeitures
 
—%
 
5.68% annually
The risk-free interest rate input is based on U.S. Treasury instruments, and expected volatility of the share price based upon review of the historical volatility levels of the Company’s common stock in conjunction with that of public companies that operate in similar industries or are similar in terms of stage of development or size and a projection of this information toward its future expected volatility. The Company used the simplified method to estimate the expected option life for 2017 and 2016 option grants. The simplified method was used due to the lack of sufficient historical data available to provide a reasonable basis upon which to estimate the expected term of each stock option.







21



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

Stock options
A summary of the options activity during the six months ended June 30, 2017 is shown below:
 
 
Shares
 
Weighted-
Average
Exercise
Price
Outstanding at December 31, 2016
 
20,418,607

 
$
6.26

Granted
 
3,298,550

 
3.31

Exercised
 
(45,732
)
 
2.36

Canceled/forfeited
 
(5,541,759
)
 
9.67

Outstanding at June 30, 2017
 
18,129,666

 
4.70

Outstanding, vested and exercisable at June 30, 2017
 
5,639,643

 
$
9.23

Outstanding, vested and exercisable at December 31, 2016
 
7,993,168

 
$
11.34

On May 12, 2017, the Company offered certain employees and directors an opportunity to elect to exchange certain stock options for new options covering a fewer number of shares of common stock. Under this offer, the Company accepted for exchange 4,279,463 options. All surrendered options were canceled and the Company issued 1,728,795 new stock options in exchange for such tendered options. The exchange ratios were established with the intent not to generate incremental share-based compensation expense and were established just prior to commencement of the offer. The incremental compensation associated with the fluctuations in the Company’s common stock price between the date the exchange ratios were established and the commencement of the offer was insignificant.
Restricted stock awards
A summary of the restricted stock activity during the six months ended June 30, 2017 is shown below:
 
 
Shares
 
Weighted-
Average Grant
Date Fair Value
Outstanding and unvested at December 31, 2016
 
5,862,712

 
$
3.01

Granted
 

 

Vested
 
(2,613,902
)
 
3.52

Forfeited
 
(693,088
)
 
1.18

Outstanding and unvested at June 30, 2017
 
2,555,722

 
$
3.40

RSA vesting is based on the passage of time. The amount of share-based compensation expense is based on the fair value of the Company's common stock on the respective grant dates and is recognized ratably over the vesting period.

The Company's RSA agreements allow employees to surrender to the Company shares of common stock upon vesting of their RSAs in lieu of their payment of the required personal employment-related taxes. During the six months ended June 30, 2017 and 2016, employees delivered to the Company 713,753 and 887,660 shares of stock, respectively, which the Company recorded at a cost of approximately $1.8 million and $2.0 million, respectively. Shares surrendered for payment of personal employment-related taxes are held in treasury.

22



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

Restricted stock units
A summary of the restricted stock activity during the three months ended June 30, 2017 is shown below:
 
 
Shares
 
Weighted-
Average Grant
Date Fair Value
Outstanding and unvested at December 31, 2016
 
1,346,774

 
$
2.35

Granted
 
172,046

 
2.66

Vested
 
(155,535
)
 
2.35

Forfeited
 
(173,250
)
 
2.35

Outstanding and unvested at June 30, 2017
 
1,190,035

 
$
2.39

The Company’s RSU agreements allow employees to receive shares of stock upon vesting of their RSUs.
The Company's RSU agreements allow employees to surrender to the Company shares of common stock upon vesting of their RSUs in lieu of their payment of the required personal employment-related taxes. During the six months ended June 30, 2017 and 2016, employees delivered to the Company 50,762 and no shares of stock, respectively, which the Company recorded at a cost of approximately $0.2 million and $0.0 million, respectively. Shares surrendered for payment of personal employment-related taxes are held in treasury.

10. Other

Other costs are comprised of reorganization-related and certain other costs. For the three months ended June 30, 2017 and 2016, the Company incurred $1.0 million and $8.7 million in other costs, respectively. For the six months ended June 30, 2017 and 2016, the Company incurred $1.2 million and $19.5 million in other costs, respectively.
Other costs consist of the following (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Severance and employee benefits
$
0.3

 
$
2.8

 
$
0.3

 
$
2.8

Facility charges

 

 

 
0.7

Non-cash share based compensation
0.1

 
1.8

 
0.1

 
1.8

Reorganization-related
0.4

 
4.6

 
0.4

 
5.3

Transaction fees (1)

 
3.2

 

 
13.3

Transitioned employees restructuring expense (2)
0.6

 
0.9

 
0.8

 
0.9

Other
0.6

 
4.1

 
0.8

 
14.2

Total other
$
1.0

 
$
8.7

 
$
1.2

 
$
19.5


(1) Costs related to retention payments and legal fees paid in connection with the closing of the Transaction (see Note 12).

23



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

(2) As part of the transition of Ascension personnel to the Company in conjunction with the A&R MPSA, the Company has agreed to reimburse Ascension for certain severance and retention costs related to certain Ascension employees who will not be transitioned to the Company.

Reorganization-related
    
During the second and fourth quarters of 2016, the Company initiated a restructuring plan consisting of reductions in its workforce in order to align the size and composition of its workforce to its current client base, better position itself for already committed future growth, and enable the Company to more efficiently serve contracted demand.

The Company's reorganization activity was as follows (in millions):

 
Severance and Employee Benefits
 
Facilities and Other Costs
 
Total
Reorganization liability at December 31, 2016
$
1.6

 
$
0.5

 
$
2.1

Restructuring charges
0.4

 

 
0.4

Cash payments
(1.5
)
 
(0.1
)
 
(1.6
)
        Non-cash charges
(0.1
)
 
$

 
(0.1
)
Reorganization liability at June 30, 2017
$
0.4

 
$
0.4

 
$
0.8

11. Income Taxes

Income tax provisions for interim periods are based on estimated annual income tax rates, adjusted to reflect the effects of any significant and infrequent or unusual items which are required to be discretely recognized within the current interim period.  The Company’s intention is to permanently reinvest its foreign earnings outside the United States.  As a result, the effective tax rates in the periods presented are largely based upon the projected annual pre-tax earnings by jurisdiction and the allocation of certain expenses in various taxing jurisdictions where the Company conducts its business. These taxing jurisdictions apply a broad range of statutory income tax rates.

The income tax benefit for the three and six months ended June 30, 2017 was lower than the amount derived by applying the federal statutory tax rate of 35% primarily due to discrete items recognized in the period. The income tax expense for the period ended June 30, 2016 was higher than the amount derived by applying the federal statutory tax rate of 35% primarily due to the impact of state taxes. The tax rate is also impacted by discrete items that may occur in any given period.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. U.S. federal income tax returns since 2011 are currently open for examination. State jurisdictions vary for open tax years. The statute of limitations for most states ranges from three to six years.

As of January 1, 2017, the Company adopted ASU 2016-09. The Company elected to change its accounting policy to account for forfeitures as they occur under the new standard. The change was applied on a modified retrospective basis with a cumulative effect adjustment recorded to increase non-current deferred tax assets by $0.5 million as of January 1, 2017. Excess tax benefits for share-based payments are now included in net cash used in operating activities rather than net cash used in financing activities. The changes have been applied prospectively in accordance with ASU 2016-09 and prior periods have not been adjusted.

Amendments related to accounting for excess tax benefits and shortfalls have been adopted prospectively, resulting in recognition of excess tax benefits and shortfalls as part of income tax expense rather than additional paid-in capital. For the three months ended June 30, 2017, the Company recognized $0.0 of income tax expense from shortfalls associated with vesting and exercises of equity awards.

24



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements


The Company wrote-off approximately $0.4 million and $3.0 million of deferred tax assets due to the expiration of shared-based awards and was recognized as discrete expense during the three months ended June 30, 2017 and as a reduction in additional paid-in capital for the three months ended June 30, 2016, respectively.

In the six month period ended June 30, 2017, the Company corrected the deferred tax asset balance associated with share-based compensation.  In 2015 and 2016 the Company incorrectly recorded excess share-based compensation of approximately $2.6 and $4.0 million.  This excess share-based compensation expense resulted in deferred tax assets of approximately $2.5 million being erroneously recorded in the consolidated balance sheet at December 31, 2016.    The Company has determined these amounts are immaterial to the quarterly and annual periods in 2015, 2016 and 2017.  In addition to correcting the deferred tax balance in the six month ended June 30, 2017 the reclassified approximately $6.6 million from additional paid-in-capital to accumulated deficit to correct for the excess share-based compensation expense recorded in 2015 and 2016. 

At December 31, 2016, the Company had deferred tax assets of $169.9 million, of which $71.0 million related to net operating loss carryforwards. In conjunction with the adoption of ASU 2016-09 and Topic 606, a cumulative effect adjustment was recorded to increase deferred tax assets by $0.5 million for ASU 2016-09 and decrease deferred tax assets by $70.3 million for Topic 606 as of January 1, 2017. The majority of the Company's carryforwards were generated in 2013, 2014 and 2015 when the Company incurred substantial expenses related to the restatement. The Company expects its business growth contracted for under the Ascension A&R MPSA will be profitable and allow the Company to utilize its NOL carryforwards and other deferred tax assets. Accordingly, the Company believes that it is more likely than not that the remaining deferred tax assets will be realized. Should the Company not operationally execute as expected, and the growth in the Ascension business not be as profitable as expected, such realizability assessment may change.
12. 8.00% Series A Convertible Preferred Stock
At the close of the Transaction on February 16, 2016 (as described in Note 1), the Company issued to the Investor: (i) 200,000 shares of Preferred Stock, for an aggregate price of $200 million, and (ii) a warrant with a term of ten years to acquire up to 60 million shares of common stock, par value $0.01 per share (“common stock”), at an exercise price of $3.50 per share, on the terms and subject to the conditions set forth in the Warrant Agreement (“Warrant”). The Preferred Stock is immediately convertible into shares of common stock.

During the twelve months ended December 31, 2016, the Company incurred direct and incremental expenses of $21.3 million (including $14.0 million in closing fees paid to the Investor) relating to financial advisory fees, closing costs, legal expenses and other offering-related expenses in connection with the Transaction. These direct and incremental expenses reduced the carrying amount of the Preferred Stock. In connection with the issuance of the Preferred Stock, a beneficial conversion feature of $48.3 million was recognized. Since the Preferred Stock is presently convertible into common stock, this amount was subsequently accreted to the carrying amount of the Preferred Stock, and treated as a deemed preferred stock dividend in the calculation of earnings per share.

Dividend Rights

The holders of the Preferred Stock are entitled to receive cumulative dividends January 1, April 1, July 1 and October 1 of each year (dividend payment dates), commencing on April 1, 2016, at a rate equal to 8% per annum (preferred dividend) multiplied by the liquidation preference per share, initially $1,000 per share adjusted for any unpaid cumulative preferred dividends. For the first seven years after issuance, the dividends on the Preferred Stock will be paid-in-kind. As of June 30, 2017, the Company had accrued dividends of $4.4 million associated with the Preferred Stock, which was paid in additional shares of Preferred Stock in July 2017.

Conversion Features


25



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements

Each share of the Preferred Stock may be converted to common stock on any date at the option of the holder into the per share amount (as defined in the Certificate of Designations of the 8.00% Series A Convertible Preferred Stock (the "Series A COD")). Fractional shares resulting from any conversion will be rounded to the nearest whole share.

Redemption Rights

Since the redemption of the Preferred Stock is contingently or optionally redeemable and therefore not certain to occur, the Preferred Stock is not required to be classified as a liability under ASC 480, Distinguishing Liabilities from Equity. As the Preferred Stock is redeemable at the option of the holders upon a fundamental change (as defined in the Series A COD) and is redeemable in certain circumstances upon the occurrence of an event that is not solely within the Company's control, the Company has classified the Preferred Stock in mezzanine equity on the Consolidated Balance Sheets. In the event the Company believes that redemption of the Preferred Stock is probable, the Company would be required to accrete changes in the carrying value to the redemption value over the period until the expected redemption date.

Voting Rights

Each holder of the Preferred Stock is entitled to vote with the common stock on an as-converted basis, and has full voting rights and powers equal to the voting rights and powers of the holders of common stock.

The following summarizes the Preferred Stock activity for the six months ended June 30, 2017:
 
 
Preferred Stock
 
 
Shares Issued and Outstanding
 
Carrying Value
Balance at December 31, 2016
 
210,160

 
$
171.6

Dividends paid/accrued dividends
 
8,490

 
8.7

Balance at June 30, 2017
 
218,650

 
$
180.3


13. Earnings (Loss) Per Share
Basic net income per share is computed by dividing net income, less any dividends, accretion or decretion, redemption or induced conversion on the Preferred Stock, by the weighted average number of common shares outstanding during the period. As the Preferred Stock participates in dividends alongside the Company’s common stock (per their participating dividends), the Preferred Stock would constitute participating securities under ASC 260-10 and are applied to earnings per share using the two-class method. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends.
Diluted net income per share is calculated using the more dilutive of the if-converted or the two-class method. For the three and six months ended June 30, 2017 and 2016, the two-class method was more dilutive and was computed by adjusting the denominator used in the basic net income per share computation by the weighted average number of common shares outstanding and potentially dilutive securities outstanding during the period plus, when their effect is dilutive, incremental shares consisting of shares subject to stock options, shares issuable upon vesting of RSAs, RSUs and Preferred Stock.




26



R1 RCM Inc.
Notes to Unaudited Consolidated Financial Statements





Basic and diluted net income (loss) per common share are calculated as follows (in millions, except share and per share data):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Basic EPS:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(6.7
)
 
$
(40.8
)
 
$
(15.0
)
 
$
126.6

Less dividends on preferred shares
 
(4.4
)
 
(4.1
)
 
(8.7
)
 
(54.4
)
Less income allocated to preferred shareholders
 

 

 

 
(27.8
)
Net income (loss) available/(allocated) to common shareholders - basic
 
$
(11.1
)
 
$
(44.9
)
 
$
(23.7
)
 
$
44.4

Diluted EPS:
 
 
 
 
 
 
 
 
Net income (loss)
 
(6.7
)
 
(40.8
)
 
(15.0
)
 
126.6

Less dividends on preferred shares
 
(4.4
)
 
(4.1
)
 
(8.7
)
 
(54.4
)
Less income allocated to preferred shareholders
 

 

 

 
(27.6
)
Net income (loss) available/(allocated) to common shareholders - diluted
 
$
(11.1
)
 
$
(44.9
)
 
$
(23.7
)
 
$
44.6

Basic weighted-average common shares
 
102,467,078

 
99,414,066