Charles W. Lynch - MEDNAX, Inc. Roger J. Medel, M.D. - MEDNAX, Inc. Vivian Lopez-Blanco - MEDNAX, Inc..

Kevin Mark Fischbeck - Bank of America Merrill Lynch Ryan S. Daniels - William Blair & Co. LLC Brian Gil Tanquilut - Jefferies LLC Tejus Ujjani - Goldman Sachs & Co. LLC Ralph Giacobbe - Citigroup Global Markets, Inc. Chad Vanacore - Stifel, Nicolaus & Co., Inc. Gary P. Taylor - JPMorgan Securities LLC John W. Ransom - Raymond James & Associates, Inc..

Ladies and gentlemen, good morning. Thank you for standing by and welcome to the MEDNAX 2017 Second Quarter Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. As a reminder, today's conference is being recorded.

I would now like to turn the conference over to our host, Mr. Charles Lynch. Please go ahead..

Thanks, Tom. Good morning, everyone. I'm going to read our forward-looking statements, and then I'll turn the call over to Roger and Vivian. Certain statements and information during this conference call may be deemed to be forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based on assumptions and assessments made by MEDNAX's management in light of their experience and assessment of historical trends, current conditions, expected future developments and other factors they believe to be appropriate.

Any forward-looking statements made during this call are made as of today and MEDNAX undertakes no duty to update or revise any such statements, whether as a result of new information, future events or otherwise.

Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are described in the company's most recent Annual Report on Form 10-K and its Quarterly Reports on Form 10-Q, including the sections entitled Risk Factors.

In today's remarks by management, we will be discussing non-GAAP financial metrics. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures can be found in this morning's earnings press release, our Quarterly Report on Form 10-Q or in the Investors section of our website located at mednax.com.

With that, I'd like to turn the call over to our CEO, Dr. Roger Medel..

Thank you, Charlie. Good morning and thanks for joining the call to discuss our results for the second quarter of 2017. And our results for the quarter were in line with the financial expectations we provided in May.

Our same-store trends reflected similar dynamics to what we saw in the first quarter in terms of both anesthesia payor mix and neonatology volumes, although on a sequential basis, there were some differences in what we observed in those specialties. In neonatology, we saw a decline in total births at the hospitals where we provide services.

Our core neonatal ICU volume comparison was somewhat better than in the first quarter based on a slightly higher rate of admissions and length of stay. But the decline in births also impacted our patient volumes for attended deliveries, newborn nursery care and hearing screens.

Based on the volatility that we have experienced over the past year in birth volumes, we will continue to watch these trends closely, and we've maintained a conservative approach to our expectations for the third quarter. In anesthesiology, payor mix remain challenging.

What we have continued to see is either slight growth or modest declines in our commercial volumes and faster growth in both Medicare and self-pay volumes. We've also continued to see growth in compensation expense for nurse anesthetists.

The trends we have seen in our anesthesia business led us to make some strategic decisions during the quarter related to acquisitions. I know we didn't complete any anesthesiology acquisition during the quarter, and that did impact our results. But that was on purpose. We had a couple of anesthesia deals that we were preparing to close.

But based on the trends we began seeing earlier this year, we opted to renegotiate them in order to account for those trends. This makes sense to us, but that's a difficult process and it slowed down our pace of acquisitions in the quarter.

Longer term, we remain committed to our growth in anesthesia, and I expect that we will complete additional practice acquisitions in this specialty. But those will be done in a deliberate fashion and with a heavy focus on valuations that we're willing to pay.

In the meantime, we generated strong free cash flow during the quarter, which we utilized to repay roughly $130 million in revolver borrowings. This leaves us with available capacity on our revolver of just under $840 million, which we can utilize towards our acquisition strategy as we move forward.

Related to that, in radiology, after completing our first hospital-based acquisition earlier this year, we have spent our first few months continuing to study the business, validating our theories for growth in this specialty and solidifying the opportunities for integration between hospital-based and teleradiology services.

We have learned a lot, in particular from our experience with Radiology Alliance in Tennessee.

And it makes me optimistic that our approach to this specialty, combining the technology and capabilities of vRad with the premier hospital-based radiology groups in the country, can provide true value to our physicians, our hospital partners, and most importantly, to our patients.

Based on our work, we have made the strategic decision to move forward and build a national group practice of radiologists. In terms of the timing of acquisitions, here too, we've been very deliberate.

But at this time, we have some large practices under signed letters of intent, and our goal is to complete these acquisitions before the end of the year. Our radiology strategy has been very well received by these groups, and I am excited about the opportunity to now build a national radiology practice.

Finally, turning to our expectations for the third quarter of this year, I'll be clear that the impact of what we've seen in both the same-unit revenue growth and compensation expense are significant, and we continue to account for our expectations that those trends will persist in the near future.

At the same time, we've taken the necessary steps to renegotiate the value we're willing to pay for anesthesia groups, as well as acting very deliberately to structure our radiology acquisitions appropriately. The pause that these steps have created in our acquisition activity will now impact our near-term outlook.

That being said, we like the businesses we're in, and I believe that we've taken the appropriate steps in what has proven to be a very challenging environment while also moving forward to develop broader opportunities for growth in the years to come. With that, I'll turn the call over to our CFO, Vivian Lopez-Blanco..

Thanks, Roger. Good morning and thanks for joining our call. I'll discuss some details of the quarter, as well as our outlook for the third quarter. For the second quarter, net revenue increased by 9% to $843 million, driven by contributions from acquisitions, slightly offset by a decrease in same-unit revenue.

Looking at our same-unit metrics, same-unit revenue decreased by 90 basis points, within the range that we provided as part of our financial guidance for the quarter. On the volume side, same-unit volumes declined by roughly 30 basis points.

Similar to the first quarter, we saw modest growth in our anesthesia services, but that growth was offset by declines in our neonatology and related pediatric service volumes. For the quarter, births at the hospitals where we provide NICU and related services declined by 1.8% on a same-unit basis.

Same-unit NICU days declined by a more modest 40 basis points with slight increases in the rate of admissions into the NICU and length of stay somewhat offsetting the declines in total births. However, we also saw declines in volumes for our other hospital-based services, including attended deliveries, newborn nursery and hearing screens.

On the pricing side, same-unit revenue declined by 60 basis points. The payor mix shift we saw in the quarter impacted our same-unit pricing negatively by 140 basis points, somewhat offset by the positive impact of modest increases in managed care pricing.

On a same-unit basis, anesthesia payor mix shifted 160 basis points to government payors year-over-year. The factors driving this anesthesia payor mix shift were similar to what we observed in the first quarter of the year, with growth in both Medicare and self-pay volumes versus a slight growth or modest declines in commercial volume.

Our mix shift was directionally the same across most of the states where we provide anesthesia services. So, it was not isolated to one state or region. In terms of the magnitude of the financial impact, there were some variances from state-to-state, but the impact was fairly dispersed across our broader footprint of anesthesia services.

EBITDA was $148 million for the quarter as compared to $168 million for the second quarter of 2016. EBITDA as a percentage of revenue was 17.5% for the second quarter as compared to 21.8% in the prior year period.

Also, similar to the factors we experienced in the first quarter this year, EBITDA margins were impacted by both the same-unit revenue results I discussed and by some cost items, as well as the impact from mix and volume of acquisitions completed since April of 2016.

For the 2017 second quarter, practice salary and benefits expense was $561 million or 66.6% of net revenue as compared to $485 million or 62.8% of revenue in Q2 of 2016. The increase in expense as a percentage of revenue was primarily related to acquisition growth and increases in same-unit comp expense.

Similar to Q1, the rate of increase in same-unit compensation expense was greater for non-physician clinicians, primarily nurse anesthetists. Also as a result of the same-unit revenue declines and compensation expense increases, the result of certain practices was below the internal bonus eligibility thresholds established for each practice.

Because of this, the impact of the lower practice results was not shared by the practice and was instead largely absorbed in our results. Now, I'll briefly discuss on some balance sheet and cash flow items. At the end of the second quarter, accounts receivable were $480 million, a decrease of approximately $15 million as compared to December 31.

Days sales outstanding were 52 at the end of the quarter, down 3 days as compared to December. For the second quarter, we generated cash flow from operations of $138 million. Our total net outstanding debt was $1.8 billion at June 30.

During the second quarter, we used our cash flow from operations to repay roughly $130 million in borrowings on our revolving credit facility. As a result, our available borrowings under our credit facility at the end of the quarter were approximately $840 million.

Turning on to our outlook for the third quarter, we do believe that it remains appropriate to anticipate that the factors impacting our results for the first half of 2017 will continue in the third quarter.

As a result, we have incorporated a similar expectation of same-unit result, as well as a continuation of practice salary and benefits cost inflation that we've experienced thus far this year.

Additionally, based on the uncertainty as to the particular timing of closing of acquisitions, we have incorporated very limited contribution from them in our expectations.

As we announced in this morning's press release, we expect that our earnings per share for the three months ending September 30, 2017 will be in a range of $0.66 to $0.71 and that our adjusted EPS will be in a range of $0.83 to $0.88.

The range for our third quarter outlook assumes anticipated same-unit revenue growth will be negative 2% to flat year-over-year. For the third quarter of 2017, we expect that our EBITDA will decline by 17.5% (sic) [17%] to 21% compared to the third quarter of 2016.

As compared to the 12% decline in EBITDA we've reported in the second quarter, this expectation includes the lapping of contributions of certain acquisitions that we completed during 2016. This outlook also assumes an effective tax rate for the third quarter of approximately 39%.

Our effective tax rate of 31.4% for the third quarter of 2016 included the favorable impact from the settlement of a tax matter. Excluding this favorable settlement, the effective income tax rate was 39%. With that, I'll now turn the call back over to Roger..

Thank you, Vivian. Operator, let's go ahead and open up the call for questions, please..

Thank you. Our first question today comes from the line of Kevin Fischbeck representing Bank of America. Please go ahead..

Great. Thanks. Just wanted to follow up on the commentary around payor mix. I guess last quarter, you kind of highlighted Texas and North Carolina as maybe being a little bit bigger of an issue than average. This quarter, it sounds a little bit more like it was broad-based.

Just wanted to hear any color you had there, and if there was anything in particular that you would point to as causing this, whether there was any issues around commercial contracting or at a network or anything that might have caused your payor mix to be unusually weak..

No. And so, Kevin, good morning. This is Vivian. So, yeah, it's a similar – honestly a similar trend from the first quarter.

We do have certain states that we talked about last quarter, again, that were ones that had, we believe, as you know, a larger decrease in enrollment on the exchanges that are impacting this more heavily than their percentage of revenue contribution. So, those remain to be North Carolina, Georgia, et cetera.

And so, the trend is pretty similar from the payor mix. There's fluctuations among states, which is why we made that comment. But when we look at a couple of those, they did have a larger contribution on mix decline than their percentage of revenue..

So, I guess to the extent that you think that exchanges are a headwind, this then should be a headwind probably next year as well. Would that be your expectation, because it sounds like the exchanges are still under a lot of uncertainty? I think last night, Trump tweeted that he wanted the reform to implode.

So, it feels like these are pressures that we should expect to last the next year or is there a reason to think that you'll see some sort of rebound there?.

It's hard to say, but I do think it's (15:31). But that's one of those things that is a thesis there. So, I do think that you'll lap, and so at some point, really it will stop. But again, that's our assumption based on the data we've looked at, talking to our government relations folks, et cetera.

So, I do think at some point, it'll get to a steady state..

Okay.

And as far as the labor side on anesthesia, how would you characterize that labor pressure in Q2 versus Q1? Is that similar? Is it getting worse? Is it getting better? How do you feel about the staffing and when we start to lap that issue?.

Yeah. So, based on conversations that we have with our operations people, I think it's – as I said last quarter, I think it's really about the same. I think that there's more pressure and more of the urban settings with the nurse anesthetists comp. And so, I think I wouldn't say it's any more difficult than it was in the first quarter.

I would say it's roughly about the same. And as we mentioned in the first quarter call, Kevin, we have seen this in the past, and at some point, it'll settle down. I can't pinpoint what quarter that will be, but I do think it will settle down. And we are seeing it in certain pockets, like I said, that are more of the urban settings..

Okay. All right, thank you..

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

Yeah. Thanks for taking the question. Just regarding some of the staffing and bonus programs, I'm curious if you continue to see the mix shift trends and some of the weakness in NICU volumes.

If there's any staffing model or compensation model changes you can do to help protect your margins versus kind of seeing this constant pressure?.

Hey, Ryan. Good morning. Yeah, that's a source of frustration for us, because we continue to see volumes fluctuate from hospital-to-hospital, from state-to-state, and there isn't any real trend that we can identify.

I'll tell you, for example, about six weeks ago, when I look at our national volume across the country, I get that report on a weekly basis. And about six weeks ago, that – and that volume last summer was in the 5,700 range and on a daily census basis. And about six weeks ago, the volume was down to 5,000. And two weeks later, it was up to 5,300.

And last week, it was into 5,500 range. And so, you're just seeing these fluctuations, which makes it very difficult to – if there was a unit that you saw, there are a bunch of obstetricians who left there and they're not delivering babies anymore in that hospital and that kind of stuff, those are easy decisions to make.

But to be able to project where the cuts are with these kinds of fluctuations makes it very difficult to do that..

Okay, that's helpful color. And then, as my follow-up, just any update you have on vRad? I don't think you mentioned that in your prepared comments. But anything about growth expectations, sales pipeline, reading and hired rads, any color you want to offer there? Thanks..

Yeah, thanks. vRad is on line with our expectations. The radiologists are at 500. They are growing the business. I don't have the specific numbers in front of me, but it is working according to plan.

And the exciting part for me has been the ability to integrate this one radiology practice that we acquired in Nashville at the beginning of the year with the vRad....

Operator, we have some background noise, if you could address that..

Mr. Daniels, I'll disconnect his line..

Okay..

Next, we'll go to the line of Brian Tanquilut with Jefferies. Please go ahead..

Hey, good morning..

Hey..

Roger, just first to start on the acquisition comment, so it sounds like there's something you're seeing in anesthesiology that has made you pull back.

If you don't mind just giving us some color, is it just the case of pure volume weakness or is it payor mix volume weakness, wages, competition and cross-selling, hitting some of these markets? We just want to hear how the thought process worked through that issue..

Yeah. We look at what's happening in anesthesia, and clearly, for us, the impact there is significant. We see people leaving exchanges and they end up as self-pay or Medicaid. That's not a problem that we have with neonatology. The issue with neonatology is just the volume – birth volume.

And I've always maintained that I expect that those will come back. I don't think that that's a permanent thing. So, looking at that and seeing what's happening with the payor mix situation there and the sudden and significant impact from that, we believe that as we look at these practices that we have to assume that that is going to continue.

And so, that affects the valuation for the practices. And as I said, we had a couple of good LOIs in place for some of these – a couple of anesthesia practices, and we just decided that we just weren't willing to pay a multiple that perhaps a year from now would be even higher than what we were paying today.

And so, that's the decision that we made and to go back and renegotiate those deals. That, of course, is not an easy thing to do. And one of those deals, I'll say, is still on the table. And so, as we move forward, that's what we expect to do, that we expect to take into account what we continue to think the results will be for anesthesia.

On the other hand, we see significant growth on the radiology side. We see the synergies that we have already created in the practice that we acquired in Tennessee between vRad and the radiology practice, the night coverage, the availability of additional subspecialists in radiology.

And frankly, the attraction that our vRad component creates for these practices is they see the value that vRad is able to bring for them. And so, I'll just tell you frankly, we have three significant LOIs in place with radiology practices. And like I said, I expect that we'll get those closed in the near future.

So, given that and given our confidence that we are able to grow these practices, and some changes that we have made to our structure for the acquisitions of these practices, makes me very bullish on the future of building our radiology national group practice. So, I don't know if I answered your question..

Yeah. No, I appreciate that. Thank you for that color. And then, Viv, my second question. As we think about your employment agreements with the physicians – and I know it's bonus. But historically, you've been very good at maintaining that variability of the comp, right, where the gross margin essentially holds fairly steady.

So, as volumes have come down and profitability has come down, what's the ability to flex further and try to adjust the comp structure in order to maintain a certain level of margin?.

Yeah. And so, I think Roger is trying to answer Ryan's question on that. So, we have a couple of levers that we can pull, right. So, we really would have to be – if we felt that it was going to be sustained or this is the new reimbursement levels, because like I said, on anesthesia, it's been really more on payor mix and not so much volume.

We still are seeing positive volumes there. We have to have some discussions on potential reallocation of staffing, workflow initiatives. As you guys know, we have a perioperative consulting company. We have to partner with a hospital.

Certainly, for new deals, we're looking at potentially a different compensation model that will have physicians at risk with some of the macro drivers of revenue. And so, we would be looking at all of the above on that. And so, it's just – time will tell as we kind of feel that this has been a reset on a more global reimbursement measure..

Got it. Thank you..

Next question comes from the line of Tejus Ujjani with Goldman Sachs. Just a moment, we're opening his line..

...joint procedures off of the inpatient-only list, essentially recommending that some can be performed in an outpatient setting. Have you looked at that in terms of potential impact to your anesthesia business? My understanding is a bulk of your practice settings are outpatient.

Any idea of the revenue opportunity there?.

Hey, Tejus. We missed the early part of your question, if you could repeat it. You were on mute..

Sure. Sorry about that. So, there was a CMS proposal, an RFI about – out about two weeks ago that discussed removing some joint procedures off of the inpatient-only list, essentially meaning that they can be done in an outpatient setting.

And just trying to understand like have you looked at that at all in terms of potential impact to your anesthesia business? I think most of your practice settings are outpatient.

So, any idea of any opportunity there?.

Well, what was the first part of what you said? I still didn't get the first part of what you said. I apologize, but....

I'm sorry.

Can you hear me better now?.

Yes..

Not sure what's happening with my phones here. But there was a CMS proposal, an RFI out about two weeks ago..

Okay..

And so, it discussed removing some procedures from the inpatient-only list. And I'm just trying to understand is that an opportunity for your anesthesia business..

For us, most of our businesses, both in in-hospital and outpatient as well, most of our surgery centers are related to the hospital surgery centers. And so, moving procedures from in-hospital to out-of-hospital probably is more of a neutral event than anything else..

Okay. And just a brief follow-up. There's been a lot of focus on bundled payments for surgeries, more now in the outpatient setting, as ASCs are discussing these arrangements with payors.

Just wondering like how anesthesia fits into that, like is it your view that anesthesia will always be like billed separately or is it possible that anesthesia could enter those discussions? And if so, what could be the earnings impact there?.

Yeah, not at all. We think that anesthesia is the perfect specialty to be bundled with surgery. And in fact, we have bundled contracts already in some of our – with some of our surgery friends in different states, North Carolina being one of them. And so, we think that there is a significant opportunity there for us to provide those services.

And the increased revenue opportunity so far has proven in a few instances – where we already have that in place, has proven to work according to plan..

Great. Thank you very much..

Our next question comes from the line of Ralph Giacobbe with Citi. Please go ahead..

Thanks. Good morning. Just want to understand the 3Q guide better and what seems to be an expectation of further worsening of trends with EBITDA down, the expected 17% to 21% versus what we've seen so far this year, and margin sequentially lower, which I don't think we typically see. So, just hoping you can flush it out for us..

Yeah. So, good morning, Ralph. So, yeah, it's really related to – I tried to give some indications of that on my prepared comments. It really has to do not so much with same-unit metrics, but more on the acquisitions side.

If you guys remember, last year, in the third quarter specifically, one large one that we had, which was Cardon, which was one that rolled into MedData.

So, that is impacting that percentage pretty widely, obviously, coupled with, as Roger talked about in his prepared comments, basically the deals that we haven't done in the second quarter, given some of the push-back on anesthesia deals and then just tightening the timing on the radiology. So, it really has more to do with that.

The same-unit metrics, as I said, are a continuation of what we saw in the first half of the year..

And I guess the question, then what is happening with those acquisitions? I would think they'd be sort of – you have an underlying baseline and you'd be able to sort of grow off of that baseline.

So, is there a drag now or am I not thinking about that right in terms what the incremental pressure would be from the M&A side?.

Yeah. I think, as you know, MEDNAX historically has been double-digits, so from a top-line perspective as well as the operating income perspective, a big chunk of our contribution does come from acquisitions. And so, that has slowed down, and so we will feel that in the third quarter..

Okay, all right.

And then, I guess can you maybe just talk about the timing of the decision to build-out the National Radiology Group, just given all the pressures, as opposed to maybe kind of slowing or stopping M&A and maybe spending more time on kind of the current asset base? Any consideration there?.

Well, we have spent the first half of this year studying our radiology opportunity. And like I said earlier, we believe that we have a pretty unique opportunity given, as you know, the vRad asset that we have and the ability to combine both the on-the-ground practices with the teleradiology practices.

And so, we think that we – given the interest that we have seen from radiology practices that we have visited with and our ability to reach agreement with them on an LOI basis for the acquisition of these large practices across the country, we believe that we're really well positioned to build our national group practice.

If we get to the end of the year and we haven't been able to execute on that strategy, I think we would consider other alternatives. But right now, our emphasis is on growth. We think that the only way out of the situation that we are in is to grow our way out of it. And so, our plan is to do just that. I like the business.

I like the idea of forming this national group practice. We have been successful at it in neonatology, we're successful at it in anesthesia, and I believe we'll be successful at it in radiology..

But I think, again, because we have a value proposition there that we think is unique with the combination of the teleradiology and the – with vRad, of course, as well as the expertise we bring to the table with on-the-ground practices.

And so, I do think in this macro environment of healthcare trying to be more efficient, I think that's what that brings to the table. So, I do think it's a little bit different there, Ralph..

Okay. And then, one more, if I could squeeze it in.

I guess at this point, is there any way to think about kind of 2018? Is the thought that 2017 is somewhat of a rebase year and you'll be able to sort of get back to growing EBITDA mid or high single-digits next year? How are you thinking about those trends today and just anything you could frame for us in terms of your thought process around 2018? Thanks..

That's exactly how we're thinking about it and that's exactly why we continue to position ourselves to grow when we see the opportunities for growth. I think the technology component of the radiology field is just starting to take place now with computer reads and making the whole radiology business more efficient.

And I think given vRad's position and their technology and their database, I think that we're in a pretty good position to take advantage of those opportunities, so yes..

Okay, thank you..

Our next question today comes from the line of Chad Vanacore with Stifel. Please go ahead..

Thank you. So, I'm going to follow-up some earlier analyst questions from Brian and Ralph. But first off, you mentioned renegotiating anesthesia deals.

So, what underwriting metrics change for you that necessitated the change you did, and maybe you could quantify and give a magnitude of your changes and assumptions of payor mix and synergies and how that changes multiples you're willing to pay?.

Yeah. I really don't want to get into all of that. We just – I'll just say that we renegotiated – trying to renegotiate those deals based on multiples and salary expectations, etc..

I think, Roger....

So, let me just put that in perspective. So, as you guys know, we always do a pro forma contribution model for each deal that we do. So, we have to embed in that some of the current trends that we're seeing.

So, that's why you look at it from a pricing perspective, and so it's you're running the numbers through based on what you're seeing the trends to be.

And so, you're looking not only at physician comp or CRNA comp versus the market versus that and having discussions back with their group on that, also there are more current payor mix trends, because remember, some of the stuff that we've seen is recent.

And so, we just want to make sure that we're not going to, from a fiduciary perspective, have a deal that the return on investment isn't going to play out the way we think from day one. So, there is a lot of thought through it..

So, if we had to list the issues here, is it really payor mix maybe reducing revenues or does it have more to do with cost reducing the synergies that you can garner?.

Clearly, it's a combination of both things, but payor mix is the big thing here. Nurse practitioner, nurse anesthetists salaries going up don't help, but we've seen this before. It seems to be about a seven-year cycle. We saw it seven years ago, and it does calm down after a year. And so, we are expecting that that should go away.

But if we're dealing with a group whose nurse practitioner salaries – nurse anesthetists salaries are not yet in line with what we're seeing across the country, then we have to assume that that is going to happen with them as well, and that impacts the model that we build.

And maybe when we talked to them six months ago about a purchase price, it was before we have seen those changes, and so that's another change to the model, which impacts the valuation of the practice..

So, have you seen other competitors, either private or public, pull back on the market as well?.

I don't know – I don't know what our competitors are doing..

All right, fair enough.

So, then on the National Radiology, can you lay out what your growth strategy is? And how should we expect you going out, and what kind of road map have you laid out? You've got three practices in the pipeline, what kind of size and then how do you foresee that ramping up in 2018?.

Yeah.

Well, we expect that the benefit that vRad brings – for example, what we have seen already in the one practice that we have is that, by vRad providing the night reads, it frees up the physicians who used to be – have the night call in order for the practice to go out to other opportunities in their community and without the practice having to invest in hiring new physicians.

And so, that's the kind of value that we think we're able to bring with vRad. In addition, they have a 24-hour back-up by all of the subspecialists for the reads. And the physicians who work at this practice also will have the opportunity to read for vRad at the same time, if they're so inclined.

So, it's just a combination of this hybrid kind of practice that has the best attributes of being on-the-ground, and at the same time, all of the technology benefits of being affiliated with vRad. And so, the practices will – we believe, will be more efficient, which will hopefully make them more profitable as a result of that.

We have three LOIs, and I don't want to project here anything other than what we have in place right now, but there are a number of other practices that we're speaking with, and we expect that we will get some more. And hopefully, 2018 will continue that trend. And as we are able to bring these – which is kind of what happened to us in neonatology.

This specialty is a little reminiscent of neonatology for me. As we brought in good practices that had good reputations and good names within the neonatology community, other practices decided that they should be talking with us, and we're interested.

And so, we would hope that given what we – the practices that we have been able to get LOIs with us, they join us, it sends a message to the radiology community, and that we'll have others interested in talking with us. And hopefully that will grow into 2018..

Roger, generally, what kind of size practices are you targeting in radiology?.

Well, we're trying to target the largest practices in the state. And so, I would say that the – and so, that depends, right? Some are 50, some are 100 and....

50 to 100 radiologists?.

Radiologists, yeah, yeah. But the idea is that if we bring the largest – the practice in Tennessee is the largest practice in the state in Nashville. And the idea is that by doing that, other smaller practices will be interested in joining as well. And that seems so far to be – in Tennessee, seems to be the case..

All right, thanks for taking the questions. I'll hop back in the queue..

And next, we'll go to Gary Taylor's line representing JPMorgan..

Hey, good morning..

Hey, Gary..

A couple of questions. I guess one is I wanted to go back to the discussion earlier about potentially making some changes to physician compensation structure. It sounds a little more doable than adjusting staff levels with the kind of volatility you're seeing on volumes.

Roger, could you just talk through a little bit how you approach the urgency of making changes to the comp structure and what are the trade-offs presumably that drives increased physician turnover, et cetera? So, I know you want to be careful with that.

But how are you evaluating kind of that responsibility to your physicians and employees and your fiduciary responsibilities to the shareholders?.

Yeah. And so, that is a balance, as you've already identified. We have to, on the one hand, make sure that we're offering a fair package on the one hand, and on the other hand, as you say, we have to be fiscally responsible. There is a third element to that, which is the hospital. And so, the hospital has a say.

If we come in and start changing a number of anesthesiologists or whatever in the hospital, then there's feedback and push-back from the surgeons, et cetera. So, it's a balancing act. I'll say that the obvious way to talk about that, to start those conversations is during the practice renegotiation stages, right.

So, we acquire a practice and they get five-year contracts, and now the five years are up and it's time to renegotiate those employment contracts. And that's kind of where we have been focusing, as these practices now come around and having those conversations. So, that's the most logical place where we are having those conversations right now..

Yeah. And then, one other question. Just looking back to our model, having covered the company for quite some time, I look at three periods where same-store revenue was essentially flat to slightly negative, second half of 2008, second half of 2010, second half of 2015.

And really there was only one quarter, fourth quarter of 2008, where we saw the margin pressure off of the weaker same-store revenue growth anywhere near as significant as it's been year-to-date. And I guess if my rough math is right, I think you're contemplating margins being down 500 basis points or more in the third quarter with the guidance.

And so, certainly, I understand that in the near term, even though this is not a fixed asset business, it certainly in the near term looks a lot like a fixed-cost business. But nevertheless, these levels of margin pressure just seem really outsized, given some comparable periods of revenue weakness.

And I've struggled to understand that and explain that to folks.

So, is the difference in your mind, from a historic perspective, that the wage pressure in combination with the revenue weakness is kind of the unique element this time around that creates that incremental margin pressure or could there be something else you'd suggest?.

So, Gary, hi. This is Vivian. So, back then in 2008, it was primarily pediatrics, as you know. So, we are seeing – there's one other component, which is what I tried to introduce in my comments on the flow-through of the bonus. Because certainly on anesthesia practices, that's impacting it a lot, given the payor mix. So I have to go back to 2008.

I can't tell you that I remember, but from the top of my head and what I would think how the business was back then, we probably had less of that. So, I do think that that's pretty significant certainly in the first, second and what we expect in the third quarter..

I didn't hear what you said. What did you – I'm sorry, I missed the first part of what you said. I couldn't understand it..

The flow-through of the bonus, Gary..

Oh, yeah..

Yeah, yeah..

Because there's more of a variable cost or variable comp structure in anesthesia.

Is that the point versus...?.

Well, it's because of the threshold that we established for a practice, right, saying, okay, this is your baseline, right, and that's based on certain assumptions on what we think the profitability is going to be. Now, given the significant impact of the payor mix shift, that puts them below the threshold..

Gary, the way that we do bonuses, as you know, is when we acquire a practice, we typically say this is the contribution that we expect from the practice, and anything above this, we'll share with you on a 50/50 basis.

And so, what happens is when the practices start to grow and they're in bonus, they get half of the – half of that bonus number is theirs. When times go south and there's a decrease in profitability, half of that is absorbed by the practice, because their bonus goes down.

When the practice is not in bonus and their bonus is zero and the profitability of the practice continues to drop, 100% of that is absorbed by the company. And so, I think that's what Vivian is talking about, the ability for the practice to absorb half of whatever the hit is as long as they're in bonus.

As it happens now, many practices are not in bonus, and so what you're seeing is 100% of the flow-through coming back to the company..

Yeah. I appreciate that, and I understand the arithmetic, I guess. The question is, it sounds like there is a lot more practices this time that are not in bonus status than maybe there was back in 2008, and maybe I'm just not understanding that dynamic..

No, I think that that's right, Gary..

Yeah..

I don't disagree with you one bit. I don't know the number off the top of my head, but for sure, yeah..

Okay, thank you..

Yeah..

And we'll go to Jason Ransom's (sic) [John Ransom's] line with Raymond James..

Jason's my better-looking brother. This is John Ransom..

All right, John..

I'm sorry, this is John Ransom. Just two questions. So, one on vRad, just doing the simple math, I think you bought about $50 million of EBITDA and then that EBITDA got cut in half. You lapped that comparison in 3Q.

Do you expect quarter-over-quarter EBITDA growth from vRad or is it still trending down?.

No, we do expect growth from vRad..

Okay. And then, just drilling down, I think Gary was on the right track. Is there a different way – and I should probably know this.

But is there a different way that you pay anesthesiologists and how you pay neonatologists or is it the same structure?.

Yeah. It's pretty much the same structure. There's a base salary and then a bonus, but it's pretty much the same, yeah..

Okay. And then, I guess my other question is just kind of a more philosophical one. I know this is big yacht that you can't move quickly, but has there been any debate internally? It seems to me the company is very, very leveraged to two things. One is millennials having babies, and number two is hospital inpatient surgeries.

And if we assume for the sake of argument that those are not going to be growth businesses over the next five years, is there a thought that maybe the company needs to be more leveraged to outpatient trends? Or is it you think – can you make a growth case for being kind of joined at the hip with hospital trends and births?.

Well, I think the whole healthcare industry is moving towards the outpatient world and our move there is more in conjunction with the hospitals where we provide services, as the hospitals move outside the hospital world into outpatient services.

These radiology practices that we are looking at all have or most of them have outpatient components, and we think that that's a good place for us to be at. So, I agree. I think as far as neonatology, one of our – you might remember me saying this years ago, one of our complaints about neonatology is you can't practice it outside the hospital.

Neonatal ICU babies have to be in the hospital. And one of the things that was attractive to us about anesthesia to begin with was the fact that that was a specialty that could be taken outside the hospital. We're doing, by the way, in anesthesia, it isn't just surgery centers.

We think a significant growth avenue for us are offices, physicians' offices, and that is an area that we are – office-based anesthesia is an area that we are paying a lot of attention to as far as growth, and what that means are people who would run their plastic surgery offices or even dentists' offices or other physicians that do surgical procedures, urologists, et cetera, in their offices that we see that as another avenue of growth for us..

Okay. And do you know, for example, in your anesthesia what percentage of the surgeries are inpatient versus outpatient? I think you'd said before, but I want to make sure I'm not making something up..

Yeah.

Charlie, do you have that number?.

I don't have it precisely. But I can get it for you, but it's – I think it's a big percentage that's in....

I think you said 90% at one time, but again I don't want to make a number up..

Yeah..

But it was a bigger number than I would have guessed. So, I think that's the issue. Medicare probably needs more inpatient care, but the commercial – you see the growth in the freestanding surgery centers that are based on the physician office codes compared to, say, even ATA surgery centers, which are more HOPD.

There's just more elasticity, I think, in these commercial patients, especially for elective procedures. So, that seems to be the piece that's kind of missing here, if I'm not crazy. But anyway, I'll stop there, I think.

But just to get this fact on the table, I think maybe not a lot of people know this, but is the spread between Medicare rates and commercial anesthesia, it's like five-to-one, is it not? It's sort of like dialysis like spreads. That's part of the problem that it's just a huge spread when you swap one patient for another..

Yeah. It's....

I think it's roughly around four..

I wouldn't say it's as big as five, but it's big..

Yeah, sort of around four..

Four-to-one, yeah. So, literally Medicare pays 25% of commercial rates, and that's the big issue here. Okay..

Thank you..

All right, it sounds like time to invest in a lobbying group. Okay. Thanks so much. All right, thanks. Bye..

And speakers, there are no further questions queued up at this time..

Okay. If there aren't any further questions, I'll thank everyone for participating this morning and I look forward to speaking with you next quarter. Thank you, operator..

Thank you. Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and using the AT&T Executive TeleConference. You may now disconnect..