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 Tejus Ujjani - Goldman Sachs & Co. LLC Ryan S. Daniels - William Blair & Co. LLC Gary P. Taylor - JPMorgan Securities LLC Ralph Giacobbe - Citigroup Global Markets, Inc. John W. Ransom - Raymond James & Associates, Inc.

Brian Gil Tanquilut - Jefferies LLC Chad Christopher Vanacore - Stifel, Nicolaus & Co., Inc. Matt Borsch - BMO Capital Markets (United States) Dana Hambly - Stephens, Inc..

Ladies and gentlemen, thank you for standing by, and welcome to the MEDNAX 2017 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. As a reminder, your conference is being recorded.

I would now like to turn the conference over to our host, Mr. Charles Lynch, Vice President of Strategy and Investor Relations. Please go ahead..

Thank you, operator. I'm going to read our forward-looking statements and 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 statement, 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 section 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'll turn the call over to our CEO, Roger Medel..

Thank you, Charlie. Good morning and thanks for joining the call to discuss our results for the third quarter of 2017.

We've got quite a bit to discuss today, but I want to start with the recognition of our associates who have been affected by not only the hurricanes in Texas, Florida, Georgia and Puerto Rico but also the terrible events in Las Vegas and the wildfires in California.

These have been devastating incidents for those who were personally impacted and we will continue to support them as part of the MEDNAX family.

This particularly includes associates at Cardon Outreach near Houston, some of whom lost their homes during Hurricane Harvey and our employees in Puerto Rico for whom recovery will be a long and difficult process. I would also like to personally thank our MEDNAX clinicians, who went to great lengths to assist patients during and after these events.

In Texas, our clinicians at Bayshore Medical Center, which stayed open during and after Hurricane Harvey, our clinicians remained in the hospital for days caring for patients. Our practice at Cook Children's Medical Center in Fort Worth received newborns, who had to be evacuated for Corpus Christi.

Our physicians at Sunrise Hospital & Medical Center in Las Vegas were part of the tremendous medical support provided to victims of that horrible event, and our neonatologists at Sutter Santa Rosa Regional Hospital in California cared for newborns throughout the fires there, for one physician even when his own home was destroyed.

These were challenging events for everyone involved and I am particularly proud of the dedication of our clinicians to take great care of our patients every day and in every way. Now turning to our third quarter. Results for the quarter were at the high end of the financial expectations we provided in July.

The revenue headwinds we experienced during the first half related to anesthesia payor mix and neonatology volumes were less challenging this quarter. In neonatology, births at the hospitals where we provide services declined to a lesser extent than during the first half. And our neonatal ICU volumes increased slightly.

In our anesthesia, our payor mix was unfavorable compared to last year but also to a more moderate degree than during the first half. And the financial impact to our revenues was, thus, less meaningful.

We also made significant progress in the development of our radiology strategy, acquiring two large practices during the quarter and an additional group in October.

Thus far, in 2017, four highly respected practices totaling almost 300 physicians have joined MEDNAX, which makes me very excited that we truly are creating a differentiated radiology practice as part of our national medical group.

What I wanted to spend time on today is the work that we have done during this summer and early fall to address the external challenges facing, not just MEDNAX but healthcare providers in general. MEDNAX has talked for a long time about the changes happening in healthcare.

We're seeing the impact of those changes today whether it's in our payor mix or more generally in utilization trends and we need to accelerate the ways we adapt and transform our company. So, during the third quarter, we developed a number of strategic initiatives that we have either already put into action or will implement.

I'll make a few high level observations about our plans. First, we started with the premise that while it's extremely difficult to predict births, hospital volumes or payor mix, we have to manage with the expectation that our revenue will continue to face some level of persistent headwinds in the future.

Second, the plans we've developed focus on both the clinical and operational aspects of our business. Third, the timeframes for these plans range from short-term to long-term, but our initiatives go well beyond a simple cost reduction plan and have a transformational goal for our organization.

Lastly, we've communicated our plans across the entire organization, and we have also designated senior leaders who have direct ownership of each initiative supported by all the relevant functional areas. Our first group of initiatives are focused at the corporate level, and they have the common goals of best-in-class cost and service excellence.

I will be clear here. Yes, costs are a meaningful component of our plans, but this is not a simplistic cost reduction response to our operating results this year.

Instead, it's a broad set of initiatives to identify areas where we could use our resources more efficiently and redeploy those resources to the areas that can directly impact our long-term success.

So we have reviewed all of our corporate and practice support functions and identified ways in which we can improve the processes, enhance our use of IT and other technology solutions and utilize our scale more effectively in all areas of our operations.

The timeframes for these initiatives vary, but I can report that we have a longer-term goal of reducing our G&A expense by 10%. And that as part of that goal, we expect to realize a dollar cost reduction of $25 million in 2018. Our second set of initiatives focuses at the practice level.

In the short-term, these plans include a more formal process for executing and measuring the action plans that we developed for practices facing internal or external challenges.

Our plans also involve reimbursement, including advocacy at the state level, for more appropriate Medicaid payments for our services as well as renegotiation of hospital stipends where appropriate, to better reflect the costs of our services at those facilities. These steps are also ongoing and we have made modest amount of headway already in 2017.

Over the longer-term, our practice level initiatives will take on a more transformative (08:36) they include engaging our clinical leadership, our chief medical officers, and divisional medical officers as well as our consulting organization, Surgical Directions to support the practices in reviewing staffing models, accelerating the development of value-based programs and fostering greater collaboration across practices (08:58).

In terms of the impact of our practice level initiatives, while some of these target near-term improvements, many others are longer-term in nature. So we think it's premature to establish financial targets for these initiatives. But as we move forward, we will provide more definition of our progress.

Our third set of initiatives focus on our investments in growth. In addition to the radiology practice acquisitions that we have completed this year, I'll point out that we have also added six new physician groups across the clinical services we provide in women and children's care.

Acquisitions like these are very attractive to us since they typically complement the service lines we already have in place in those markets and strengthen our hospital relationships as well.

While we have certainly slowed our acquisition pace in anesthesia this year, we, nonetheless, will continue to be interested in growing our presence in this specialty. The approach that we're taking is to be deliberate and methodical and focused on opportunities to grow in markets where we already have a presence.

Of course, our development of the radiology service line is a significant component of our growth initiatives, and I'm very happy that we have been able to attract some of the largest and highly respected radiology groups in the country to MEDNAX.

Alongside this progress, we've also built an advisory structure for this specialty, which includes individuals at MEDNAX, vRad and the practices who have joined us so far this year.

I don't want to go into too many details about our strategy for radiology, but I do want to give a guideline for our expectations of M&A deployment through the remainder of this year and 2018.

We intend to be very deliberate and very focused in our growth and to pursue selected acquisitions of what we call cornerstone practices and support ways that we can grow organically and with tuck-in acquisitions beyond those larger groups that joined MEDNAX.

To that end, I don't envision us accelerating our acquisition deployment much beyond the pace we've gone at this year. Lastly, as we review our growth opportunities across the company, we also considered the fact that they can come in many ways.

So, in addition to acquisitions, we have very sales-driven organizations in vRad and MedData as well as opportunities for growth within our existing MEDNAX clinical service lines.

So we have created a sales-focused leadership structure to help ensure that what we're pursuing can be complementary to our existing services and enhance our hospital relationships. The initiatives that I've gone through today have a common long-term goal.

We want to be a truly differentiated provider of health solutions for our patients and for our partners. MEDNAX has followed the same philosophy for decades, take great care of our patients.

With all that is changing in the healthcare markets today, the steps that we're taking will ensure that we adapt to those changes and stay true to that philosophy. And as a public company, these initiatives are meant to improve our ability to optimize our earnings power regardless of the ups and downs in the areas that we cannot control.

With that, I want to turn the call over to our CFO, Vivian Lopez-Blanco..

Thanks, Roger. Good morning and thanks for joining our call. Hopefully, you've all had a chance to review the operating results we reported this morning. First, I know that this fall's hurricane season is an important topic this quarter. For MEDNAX, the financial impact was fairly minor.

We estimate that our revenues were impacted negatively by roughly $2 million related to either disruption in office days or canceled procedures equating to roughly $0.01 in EPS. Our consolidated revenue growth of 5% included 70 basis points of same-unit growth with acquisitions making up the rest.

In terms of growth from acquisitions, a little over half of this growth related to radiology acquisitions, and about a third related to anesthesia, and the remainder related to neonatology and other pediatric services acquisitions.

Our same-unit revenue growth of 70 basis points was better than what we had forecasted with pricing growth of 90 basis points, partially offset by a 20-basis point decline in volumes.

On the pricing side, the drivers of same-unit growth were modest improvement in managed care contracting and increase in administrative fees received from our hospital partners. As Roger mentioned, payor mix in anesthesia continued to be a headwind, but to a lesser degree than what we experienced during the first half of this year.

For the quarter, mix shift reduced same-unit revenue by 60 basis points. In anesthesia, payor mix shifted by 50 basis points unfavorably, which reflects similar factors to what we saw during the first half of the year in terms of growth in Medicare volumes and modest declines in commercial volumes.

On the volume side, same-unit growth was a negative 20 basis points with volume growth in radiology and neonatology offset by volume declines in anesthesia. We did have one less office day and just under one less anesthesia day in the quarter versus 2016, which unfavorably impacted same-unit volumes by 60 basis points.

The modest disruptions we experienced from the hurricanes also had an unfavorable impact of roughly 20 basis points. Within neonatology, our NICU days increased by 30 basis points. Same-unit births declined by 40 basis points, less than the 1.8% decline we recorded in the second quarter of this year.

On the cost side, practice salary and benefits expense was $586 million or 67.5% of revenue as compared to $522 million or 63% of revenue last year.

There were similar dynamics behind this growth to what we saw during the first half of 2017 with growth in clinicians' compensation being higher than in the past years and a lesser amount of bonus flow-through due to practices being below threshold established for eligibility. Our G&A expense was 11.7% of revenue.

This percentage is somewhat lower than what we reported for the first half of 2017 but modestly higher than the same period last year. As Roger mentioned, the initiatives we have developed are expected to impact our G&A expense with targeted improvements of $25 million that we expect to realize in 2018 and a longer-term goal of a 10% reduction.

Lastly, EBITDA for the quarter was $152 million compared to $181 million in the third quarter of 2016. This equates to a 16.3% decline or slightly better than the range that we provided in our forecast.

EBITDA margin was 17.4% versus 21.9% last year and this decline primarily reflects the impact of same-unit cost trends compared to our same-unit revenue growth. Turning now to our balance sheet. As we announced in this morning's press release, we completed a refinancing of our credit facility, expanding it from $1.9 billion to $2 billion.

This amount is composed entirely of an unsecured revolving credit facility compared to our prior facility that contained a $1.7 billion revolver and a $200 million term loan. Our new facility can be further increased to $2.4 billion on an unsecured basis subject to the satisfaction of certain conditions.

As of the end of September, we had $1.8 billion of total debt outstanding, including $920 million of borrowings under our credit facility. Separately, our days sales outstanding at September 30 was 55 with an increase from the previous quarter primarily related to acquisitions we completed during the third quarter.

Finally, we generated $200 million of operating cash flow during the third quarter, a slight increase over the prior year. We used this cash flow primarily to fund the majority of our acquisition outlays during the quarter. Turning to our outlook for the fourth quarter.

As we announced in this morning's press release, we expect that our earnings per share for the quarter will be in a range of $0.64 to $0.69 and that our adjusted earnings per share will be in a range of $0.80 to $0.85. The range for our fourth quarter outlook assumes the anticipated same-unit revenue growth will be flat to 2% year-over-year.

For the fourth quarter, we expect that our EBITDA will decrease by 10% to 15% compared to the fourth quarter of 2016. This outlook also assumes an effective tax rate for the fourth quarter of 2017 of approximately 39%. Finally, while we're not providing guidance for 2018, I do want to provide a few building blocks for how to think about modeling.

First, in developing our corporate initiatives, we are starting with the premise that some of the headwinds that we faced this year to same-unit revenue growth will persist.

This isn't meant to be a market forecast but rather an acknowledgment that it's difficult to predict the multiple factors that can impact volumes and payor mix, particularly when those factors have been as volatile as they've been this year. The initiatives we've developed and are implementing are meant to address these potential headwinds.

Second, in terms of our capital deployment for acquisitions, we do intend to be focused and deliberate in our growth strategy, targeting selected cornerstone practice acquisitions and tuck-in opportunities.

So, to this point, we aren't anticipating an acceleration of our M&A deployment in 2018 compared to the activity we've completed thus far this year. And third, I want to reinforce the seasonal dynamics of our operating results.

Between the fourth quarter and the first quarter of the following year, we have typically experienced a decline in our EBITDA, reflecting the additional expenses we typically incur early in the year related to payroll taxes and other items.

To be more specific, over the past decade, this decline in EBITDA has ranged between 9% and 22% with an average of roughly 15%. For those same reasons, our first quarter calendar also has historically been our weakest seasonal period.

Over the last decade, our first quarter EBITDA has made up less than a quarter of the full year EBITDA, ranging from 17% to 22% and averaging between 20% and 21%. We anticipate providing the first quarter guidance in the ordinary course of the full year operating results. I hope these observations will be helpful for modeling purposes.

With that, now I'll turn the call back over to Roger..

Thank you, Vivian. And with that, operator, let's open up the call to questions..

Our first question is from Kevin Fischbeck from Bank of America Merrill Lynch. Please go ahead..

Great. Thanks. I wanted to ask a little bit about – sounds like you guys are reacting and assuming that industry pressures continue into next year. But Q3 was a little bit better, I guess, than the trends in the first half of the year.

Are you seeing anything that makes you think that this is going to continue? Or how do you think about the relative improvement in Q3 versus 1H?.

No, we're not seeing anything that makes us think that things are getting worse. We're just being cautious about how we present the information. We're not seeing anything that makes us the – feeling like there's worse headwinds ahead..

But I guess, is there a view that it is actually starting to get better? Or do you think a continuation of these trends is kind of the way to forecast it?.

Well, I don't know, but we are hopeful that our volumes, particularly on the neonatology side, are getting slightly better. We did see a slight improvement here in this quarter, and we're hopeful that that trend will continue. So we're just cautiously, I guess, optimistic about where volumes are headed..

Okay. I think last quarter, you kind of described that headwinds as kind of maybe half NICU volumes and then half on the anesthesia side with the anesthesia problem being payor mix and then maybe nursing anesthetists costs.

When you think about that Q4 year-over-year decline, is that a similar way to think about it? Or has that changed at all as far as where the pressure is coming from?.

Well, we think that the nurse anesthetists problem is alleviating somewhat. So we don't have quite the same impact into our fourth quarter numbers for the nurse anesthetists. The payor mix shift got a little better in the third quarter, where hopefully – we're hoping it gets a little better in the fourth quarter and the same is true for volumes.

So what I can tell you is that the nurse anesthetists issue has gotten better in the third and going into the fourth quarter..

Okay.

And then can you give a little more color on the administrative fees? Is the number you highlighted kind of in this quarter, is that the start of what you've been talking about as trying to go back to the hospital to improve those going forward? Or is that a separate issue? And what exactly is the rationale from the hospital to make those payments?.

So, yes, Kevin, this is Vivian. So, yes, we talked about those in prior quarters, and really, we've made progress in that. I mean, that's part of our initiatives. And really, part of it is just talking to them about really the coverage and what we need to be able to make ends meet with that.

And so, given that, there's also expansion of services that we've also provided that really has been a part of our organic growth initiatives as well. And so, yes, some of those things are being seen as they flow-through the P&L..

Also on the Medicaid side, I'll say that we have a very active government relations program that has some pretty good relationships with most of the Medicaid programs in the states where we practice.

And I can tell you that this year, we've so far generated about an $8 million increase in different states across the country in reimbursements for our neonatal services for Medicaid. We didn't see the whole impact of that this year, but we'll see it next year for our Medicaid in three or four of the states where we practice.

And we intend to continue to push those buttons in the other states for 2018..

Okay. That's very helpful. And I guess, maybe just going back to the hospital, kind of, I guess, is it right to call it a subsidy in some cases? I mean, obviously, you'd be spending services, you get paid for it.

But when you talk about how much it cost to actually staff the hospital, I guess, my impression was that subsidies weren't generally as prevalent in NICU as they were in some of the other services.

Is that the case? And to the extent that you do end up with subsidies, does that increase the risk of contract turnover at all?.

There's no doubt that hospitals aren't eager to pay you a subsidy, okay. It's not like you're walking in and they're writing you a check. But you make the case about what's happened with payor mix or what's happened with volumes and you have a conversation with your clients.

And they understand that if they want to continue to have the level of services that they have, then it makes it difficult for us to remain there. I don't think it puts our contracts at risk. And in fact, we probably have a couple million dollars or so in additional subsidies that we have generated within the second half of this year.

So, again, it's just a matter of having business-like conversations with your hospitals administrators..

All right. Great. That's helpful. Thank you..

Thank you. Our next question is from Tejus Ujjani from Goldman Sachs. Please go ahead..

Hi. Thanks for taking the question.

Can you share color on like how we think about normalized EBITDA margins for neonatology versus anesthesia versus radiology, just kind of directionally?.

Yeah, so good morning. So, obviously, we've said for a long time neonatology volumes exceed anesthesia and radiology..

Margins..

Yeah, margins, yeah. So radiology right now, it's a little soon to tell, but we do see them being north of anesthesia. And again, anesthesia were the ones that were the lower margins of the specialties that we had.

And again, this is just in the normal course because obviously we've seen some volatility with that this year given the payor mix impact to anesthesia and then the volume impact to neonatology, which has gotten much, much better in the third quarter. But generally, from a trending perspective, that's really how it plays out..

Okay. And then just thinking of going back to neonatology being higher like, if we look at your EBITDA margins before you really started expanding to anesthesia, I mean, it's pretty close to like the 20-ish percent.

I mean, is that the kind of level of margins we're talking about for neonate? And then just secondly, to the last question around subsidies and things like, I guess, how do you make that, to the extent that is the right kind of range of margin that you're thinking about, how do you make that argument to the hospitals that are paying you subsidies, that that's still the right level of margin to be paying given this is a tough volume environment and hospitals are under pressure as well? Any color you can share there would be helpful..

We wouldn't go to a hospital where we have a 20% margin..

Right..

In that contract (28:25) asking – we're talking about going to the hospitals where there is no margin or the margin is very small. We're obviously not going to go – so we're not showing them financials across the company. We're showing them the financials that impact the local services..

Okay. And then just – sorry, last question, just in terms of modeling.

How should we think of top line versus EBITDA growth kind of over the longer-term?.

Yeah, and so that again, I've shared with you guys in the past that we used to say you needed to have same-unit growth be north of 3% to maintain the margins. And again, that this year has been more volatile and so it's slightly higher.

And so that's why you have seen some of the margin degradation that you've seen because of the lack of top line growth. And then this year, given some of the cost pressures on the non-clinician side and then the lack of bonus flow-through has really created that to be somewhat higher. So that's really what I can say about that..

Great. Thanks very much..

Thank you. And our next question is from Ryan Daniels from William Blair. Please go ahead..

Yeah, thanks for taking the question. Roger, you talked about your lobbying efforts to the states to increase your neonatal rates. I think there's even a larger payor mix impact on the anesthesia side, given the kind of well-known underpayment for physicians in anesthesia for Medicare.

I'm curious if you thought about stepping up a federal lobbying effort there? Or if that's just too difficult to do? Just any thoughts on that as we continue to have this long-term mix shift given the aging population..

Yeah, no, we have that as well. We have that in place and they are two senior lobbyists that have been in Washington for a long time. As you may know, Donna Shalala, the old HHS Secretary – ex HHS Secretary, not old -.

Former..

– is part of our board. And she has recommended to us a number of times, she's very instrumental in getting us conversations and getting us meetings with the different people. So that's a definite advantage that we have on our Board of Directors. So, yes, we're focused on that as well..

Okay. Great. And then just a follow-up on vRad and radiology, I know you said you don't want to dive into your strategy there a whole lot. But obviously, there was some noise there earlier in the year that appears to have gotten back on track.

So just hoping to get an update there about what you're seeing from a supply demand balance, what you're seeing from new business pipeline, how growth in teleradiology in particular, now that the site base (31:18) is going, just maybe a state of the union, if you will, on radiology. And I'll hop off..

Thanks for the question. vRad is growing. We are very excited to own that company. We think the technology solution that they offer is a significant opportunity for us. We have seen, for example, our theoretical strategy that putting these practices on the ground together with a teleradiology component leads to more business.

I can tell you that that's already happened with one of the practices that we acquired during the second quarter, already working together with vRad. They were able to get a small contract in a hospital where the local practice provides daytime coverage, and vRad provides the after hours coverage.

There's about three others of those that are being pursued at this point in time. So we think that this strategy, the theory that we originally had for it, is in fact, in practice, turning out to be correct. Our practices, our hospital-based practices that we've acquired are very excited about this opportunity.

They see a lot of growth potential for them, particularly the very large practice that we acquired in Houston. That practice already had expanded into Arizona, and they see an opportunity again to grow reasonably quickly with the vRad opportunity. The manpower situation that we had there last year did not occur at all this summer.

You might remember, last summer, they had increased demand for their services that we were not able to meet because we did not have enough radiologists to service their demand. That did not happen. All of the – our turnaround times and everything else worked well. So we're very happy with the vRad acquisition.

We think that the combination of on-the-ground practices with teleradiology presents a very viable solution to healthcare because we're able to provide a hospital now with 24-hour coverage of all the radiology subspecialties, pediatric radiology and neuroradiology, et cetera, without the hospital or the local group having to employ all of those subspecialists and have them be on call 24 hours a day..

Okay. Great. Thank you for that update..

Thank you. Our next call is from Gary Taylor from JPMorgan. Please go ahead..

Hi, good morning..

Hi, Gary..

A couple of questions.

I guess, the first one, Roger, when you started talking about some transformational stuff that could be longer-term in nature, I guess I'm thinking about just the physician staffing model itself where you have long-term multi-year compensation guarantees versus what we've seen hospitals evolve to over the last decade or so in their clinical labor, non-physician labor, but certainly, clinical labor where they have really some very real-time flex staffing models, intraday responding to census levels on the floors, et cetera.

They've created some of their own internal floating pools, et cetera.

I mean, when we think longer-term transformationally, is there an opportunity to move the physician staffing business in the direction of kind of this flex staffing models that the hospitals have because really the issue is revenue and volumes modestly weaker and then there's this tremendous amount of negative operating leverage because, in the near-term, your physician comp is very fixed.

So is there a way to kind of lead down that direction that makes sense to you?.

Yeah, there's two issues there. One is, we're obviously doing that with our radiology component as we're utilizing the teleradiology piece to cover night times and additional shifts, et cetera, et cetera, vacations, et cetera.

But beyond that, I will tell you that we have come up with a different compensation model that we would like to eventually rollout across our business. And every single one of our radiology practices is in this new model. I don't really want to get into it, but I can tell you that it is not a guaranteed salary model.

It is a model which is dependent upon how well the group does and has been well accepted by them. And in fact, we believe that it incentivizes the physicians to go out and grow their practice in a way that, as their practice grows, their income is going to grow along as well. We have started now.

And so as practices that we have acquired, they typically – when we acquire a practice, they typically will get a five-, six-, or seven-year contract, employment contract. Those contracts – we started in anesthesia, for example, in 2007. So a number of those contracts are now coming up for renewal.

As those contracts due, we are offering our – we are planning and have in one occasion offered that new compensation plan to the practices as it is time to renew their employment contracts.

And so the longer-term plan, and that's what we were talking about for longer-term is to convert the practices into this different and new compensation plan, and we have a number of those renewals that are coming up in 2018 and 2019. So, yes, I think we have an opportunity here to revamp that.

The neonatology contracts, they're more in the bonus plan that we talked about. As we see what volume does over the next year or so, there is the opportunity to convert those practices that come up for renewal into that same model as well..

That sounds pretty optimistic. That's good. I guess, whatever competitive risk maybe you might have thought about facing there seems to be more limited in an environment where Envision is now facing really similar issues and themes seem to be (38:37) facing those issues for the whole industry itself, maybe needing to move in that direction.

It seems like that would limit some of the possible turnover risk from attempting to change that. One other question.

I know it's not a new question, and I just wanted to get maybe an updated thought what – when we look at anesthesia volume and some of the weakness there and the headwinds there, I mean, we've heard over and over for a few years about volumes kind of shifting away from not just inpatient to outpatient, but also outpatient into ambulatory settings.

Can you just remind us your latest thinking on, how do you feel your anesthesia practice is structurally positioned for those two things, inpatient moving to outpatient and outpatient moving to ambulatory?.

Yeah, well, I mean, we think that that phenomena is happening. We have – our practices have – a significant percentage of our practices are already in those ambulatory settings. I want to say more than 30% or 40% of our revenue, of our anesthesia revenue is already coming from that area.

Most of them are – our physicians have a contract in a hospital, then the hospital has some outpatient facilities, and that's what where most of that is happening. But I don't know, Vivian, exactly, but it's more than 30% or 40% of our revenue..

Yes..

In anesthesia already coming from....

Yeah, it's surgery centers that are related to the hospitals. So we have some of that where we don't have as much as where there's stand-alone ASCs. But the ones that are related to the hospitals, yes, that's primarily hospitals have moved to that as well, Gary. And so, yes, the number is roughly in that range..

Gary, just getting back to that other prior question about trying to renegotiate employment contracts. I'll just remind you that we always felt that it's difficult for hospitals to change providers.

The idea that somebody would come in and offer for less amount of money or something to change their anesthesiologists, wasn't something that we felt we were very concerned with and that has turned out to be the case. I mean, we haven't lost a single contract to anyone coming in and offering to do it less expensively than we're doing it..

Your view has been very consistent on that. Okay. Thank you very much..

Yeah..

Thanks..

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

Thanks. Good morning.

Roger, did you say G&A, you can cut by about 10%? I think that'd give you about $40 million of savings, and you thought you can get $25 million of that in 2018, is that right?.

Yes, similar (41:45)..

Yes..

Okay. And so when I look at your margins kind of this quarter in that 17.5% range and even last quarter kind of in that range, 4Q, it looks like it implies about 100 basis points lower with seasonality.

Looks like we're going to kind of exit the year in that 17% range, maybe a little bit lower, is that the right kind of baseline to think about at this point?.

Yes..

Yes, that's right..

Yes, that's right..

Okay. So, if that's sort of flat, and I just assume sort of the $25 million on the G&A, I'm already looking at something like 70 basis points of EBITDA margin improvement.

Just sort of in a vacuum, obviously understanding there's a lot of sort of puts and takes to that, but I'm assuming there's nothing wrong with sort of that simple math?.

Well, if you look at it from a simple math perspective, yes. I knew you guys were going to go to that right away, but there is offsets to that because obviously that's from the base of this year.

There will be growth in G&A just from a regular perspective on a same-unit basis, salary increases, et cetera, and then you'll have the acquisitions we bring in that will also have some G&A. But if you were to look at that just stand-alone and nothing else changed, then I would agree with that math..

Okay. All right. Fair enough.

And then just going back to the administrative fees or the subsidies, could you just give a sense, I don't have a big feel of exactly what percentage of revenue they make up today?.

So it's not a material number. It's between 6% and 8%..

I'm sorry, 6% and 8% of total revenue?.

That's right..

Of total revenue..

Yes, of total revenue..

Okay. All right. Okay. That's helpful.

And then some of your peers have been sort of shifting out-of-network to in-network, and I think out-of-network is a small piece of your book, but maybe if you can remind us what that makes up of total revenue at this point? And I guess, more importantly, just trying to get an understanding of how negotiations are going with payors whether you're seeing pressure on rate even within sort of you're in-network book that's maybe a little bit different than what you've faced in the past?.

Yes, so you....

I mean, we don't have any out-of-network issues. Our strategy has never been to be out-of-network. It's a very small percentage, out-of-network, and that's typically just part of the negotiation when you're negotiating a contract with a payor or something.

But our strategy, when you're out-of-network, it doesn't help the patients, it doesn't help the hospital, and it certainly doesn't help the doctors, and so we've always had a theory that we wanted to be in-network, and I don't know what the number is, but at any point in time....

Less than 5% net, yes..

Yeah, maybe a couple of percentage points..

Gross in total (44:42)..

I mean as far as negotiating with payors, listen, that's your bread and butter, right. Every day for the last 20 years, you have to go into the payors and negotiate with them. And so I wouldn't say, it's just part of the blocking and tackling that we do. It's why we have managed care negotiating teams set up in different regions across the country.

And it's – I don't know that it's getting any harder. It isn't any easier I'll tell you that much. But I think it's just part of the everyday blocking and tackling that we have to do..

Okay. Fair enough. Thank you..

Yeah..

And the next question is from the line of John Ransom from Raymond James. Please go ahead..

Hey, good morning.

Going back to that managed care question, what would you say your book is contracted at next year in terms of pricing kind of same apples-to-apples? And how much of your book is contracted versus how much needs to be contracted?.

So, typically, we say that roughly about a third of our contracts come up for renewals a year..

Typically, three-year contracts with escalators built into them and so – I mean in general terms, I don't know exactly, but you can say a third..

Yeah, no, that hasn't changed, John, from what we kind of talked about in the past. It's usually about a third of the book that comes up for renewal because they are like typically three-year contracts that have some escalators in them..

And those escalators kind of mid single-digit, is that the right way to think about it?.

Yeah..

Yeah..

And then my other question is just in a broad sense, I mean, we hear about problems with exchanges in Florida and Texas rolling over.

After peaking in 2016, what's your general geographic exposure to those two markets?.

So I don't think we have – we don't really have much yet of that in those two markets..

Did you say about Florida and Georgia?.

No, Florida and Texas.

What's your kind of revenue, your revenue roughly in those two states?.

(47:00).

I mean, if you talk about anesthesia in specific, it's very little exposure....

On the exchange..

...for Florida and Texas, obviously, for neonatology, it's very large, but I don't think that's what you're talking about, right?.

Yeah. Okay. No, that's all. That's it. Thank you..

Yeah..

The next question comes from Brian Tanquilut from Jefferies. Please go ahead..

Hey, good morning. Roger, just going back to Gary's question earlier on the negotiation with the physicians on the contract. So I appreciate the example that you gave.

But as we think about that, who has the leverage in that situation and how do you convince the docs to adapt to a new compensation structure? And then the follow-up to that is, is that what gets you to the long-term margins for the specialty that Vivian laid out earlier?.

Well, I think what gets you to it is the conversation that the most likely way for them to increase their compensation is through growth. And so here's an opportunity to go out and pick up some growth and have it impact your compensation immediately.

And so I think that – if you think about historically how we have compensated our practices, it's when we acquire the practice, we expect this much contribution from the practice. Anything above that, you get 50-50 of. But the problem is that, when you drop below whatever that threshold is, you're not getting a bonus.

And if you're $1 million below what that threshold is, you're just not looking to work any harder because you know you're not in bonus and you're not going to get a bonus.

Changing that to let's go out and have some small local practices join you or provide additional services in your existing hospitals and you get a significant amount of that immediately changes the conversation. And so that's how we think we make some progress there..

I appreciate that. And then you mentioned that – as we think about M&A for 2018, should be more or less look – it shouldn't look more or less like 2017.

Now, as we think about radiology, and we hear about initiatives from the payors to move radiology volumes out of the hospital, how are you thinking about the strategy and capital deployment there? I mean, we thought anesthesiology was a hot space. And then pressures have started hitting the hospitals and procedures are coming down.

So, as we look out three to five years with these payor initiatives in radiology, what is your perspective of that?.

Well, we cover the – some of the groups that we have acquired do cover a number of those facilities. They are hospital owned, and so they're just part of the hospital.

Our strategy, and we are speaking with hospitals, is to – as they grow outside the hospital to provide that coverage for them, the fact that vRad provides that service on a per use basis and is able to provide the 24-hour coverage of all the sub-specialists, gives us a competitive advantage.

And so we think that that is exactly part of the strategy that we're excited about with vRad because we're able to provide coverage immediately. It's only on a per use basis. So you pay per study and you have access 24 hours a day to all of the radiology sub-specialists.

There will be some need to have some local radiologists present, particularly the interventional radiologist side. And we're able to provide that with our on-the-ground practices. So we do agree with you that it's headed in that direction, but we think we're pretty well positioned for that change..

Got it. And then last question for you, Viv.

As we think about the Q4 guide, if you don't mind just sharing with us your views or assumptions on the mix of rate versus volume in the same-store guidance?.

Yeah, so we think rate will continue somewhat favorable like we saw this quarter. And hopefully, volume will tick up slightly because we did have some things in the third quarter that we're not expecting in the fourth related to the hurricane and some of the days. So, basically – so that's the outlook..

I'm good. All right. Thanks, guys..

Okay..

Thank you. Our next question is from Chad Vanacore from Stifel. Please go ahead..

Hey, good morning, all..

Good morning..

Okay. So just given the long-term initiatives to reduce expenses, sounds like most of that's on the G&A.

Is that right or is there some direct cost improvements that you're expecting there too?.

So we did say that for the shorter-term, the G&A is the piece that we can grab hold of right away. But as Roger mentioned, we have longer-term initiatives, certainly, on the clinical modeling side that I think will certainly impact us on a longer-term basis.

But like we talked about throughout this call, those are ones that are a little bit longer to execute. So the initiatives on the G&A, albeit not easy to do, but those are ones we could get a hold of on a shorter-term basis. They're not all related to cost reductions per se.

They're related to really operating more efficiently, some use of technology and things like that, that we feel can impact the productivity in certain ones of our functional areas as well..

All right.

So just given the initiatives, can you give an example, one or two, you mentioned IT investments maybe leveraging economies of scale?.

You're saying on the G&A side?.

Just on the cost initiative side overall, and there's a few things you did mention..

Yes, so on the cost initiative, it's really using technology to automate some processes that are now manual. And so I think we'll get more productivity from that..

Is that more on the billings and collections side? Is that taking care of patient quality metrics? How does that flow into the system?.

Some of it will billing and collection. Some of it will be just in our other areas, even in accounting with some of the stuff that we do manually. So billing and collection is the one you generally go to because we're always working in that area on automating stuff.

But it's the pervasive use of technology throughout the organization even on some of the stuff that we do on the – even on the data side..

All right. Then just thinking about your radiology practice, you're integrating new physician-based practices with vRad.

Is the main goal to have that same model that you pointed to, the practice does the day shift and vRad does the night shift? And has that helped with recruiting new radiology practices?.

Yeah, of course. In general terms, I'll say that's right, but there's vacation coverage. There's coverage for sick days.

There's the opportunity to provide the hospital with again, that 24-hour coverage by – there are probably about, I don't know, I'll say 8, 9 or 10 radiology sub-specialists, whether it's pediatric or cardiac or breast imaging or body imaging or musculoskeletal or neuro radiologists, there's a number of – and you can imagine if a hospital wants to have all of these specialists available to read the x-rays 24 hours a day, the kind of subsidies they'd have to pay for that kind of service.

And so vRad offers our local practices, our local hospitals that same service without having to make that expenditure. So it's a combination of all those things where getting new contracts makes it a lot easier for the local group because they have the backup of the vRad radiologists..

All right. So, Roger, just one more, you mentioned labor pressures in anesthesia seem to be moderating.

So what's changed, because there had been a pretty good drag early in the year?.

Well, the change is we renegotiated the contract and there's less pressure in different parts of the country. So where we saw that pressure, which typically reflects a small number of practices, some practices trying to steal the nurse practitioner or the nurse anesthetist from the other practice.

But where there is a large material number of practices and where there are a number of schools that are putting nurse anesthetists out, et cetera, the pressure is less significant. And so that's what we're seeing is just less pressure because those other practices have quieted down..

All right. Thanks for taking the questions..

Yeah..

Thank you. Our next question is from Matt Borsch from BMO Capital Markets. Please go ahead..

Yes, thanks for squeezing me in here at the end. I wanted to just ask about how the volume growth assumption you're sort of looking at this environment and saying we don't know what's going to happen next, but it's probably best for us to assume that this is the new normal, if I got that right.

I guess, the question I'm asking is, what does that then influence in terms of decisions you're making and maybe some of that is the cost reduction.

Conversely, if volumes pick up, are there things that you would wish you had done coming into this year that you will need to scramble to accomplish?.

Well, we're assuming yes, is that this is the new normal and that we do – I personally, my own personal opinion is that births will improve because of the demographics, et cetera.

It's just me reading the tea leaves, but there's some statistical information that makes me feel that people who put off having babies a while back are now at a point where they have to make that decision. And so I personally expect that we'll see some improvement in births over the next year or two.

But in general terms, our units, because of the fluctuation in neonatal care, our units remain pretty much staffed to the level where they can have a full unit without us not being able to take care of those patients.

We also, by having two or three units within the same community, we also have the opportunity to switch physicians and coverage around from hospital A to hospital B, et cetera. So that makes it a little bit easier.

I don't think – I think that if volumes come back, and we're wrong, we get volumes back, I don't think we're going to be very unhappy about it. I think we'll deal with that problem in whatever way we have to..

Yeah, I got it, got it. Okay. Just one last one, which is I think in the past you talked about HCA representing as many as half of your engagements. And my question is, they had – births were down 2.5%. NICU was flat.

How do we square that with the growth that you reported?.

Yeah, it's the other way around. HCA doesn't represent half of our units. We cover about half of HCA's..

Thank you..

But smaller number..

Okay..

And then the other point that I always make is that when you hear a number, a number of births like that across the country or across a large system, they're talking about births in their bigger hospitals, in their smaller hospitals, in their community hospitals.

Births in NICU hospitals tend to fluctuate less than the overall number that you hear because the high risk births tend to go there anyway. And so even though births may be down 1% or 2% across the country, they might only be down 20 basis points or something within these larger hospitals that have neonatal intensive care units..

Fantastic. Okay. Thank you..

Thank you. Our next question is from Dana Hambly from Stephens. Please go ahead..

Yeah, good morning. Thanks for getting me in. Just a couple of questions. On the external growth for next year, Vivian, I just want to make sure I understand it because I think the contribution to the growth in the first couple of quarters was low double-digits and then it was more like 4% this quarter.

Is it a blend of those numbers? Or is it more like a mid single-digit number next year we should target?.

Well, I haven't given guidance for 2018 yet, but....

Well, you did you make comments about kind of thinking about contribution for next year..

Well, yeah, I made comments because I wanted folks to kind of start looking at the trajectory of the guidance. That is the consensus that's out there for the first quarter to remind people of how our operating results vary. But, yes, I mean – so I think normally, trending is I think that you're not off.

I mean, this quarter, as I mentioned last quarter when we talked about the guidance, was going to be significantly impacted on the top line because we did make a conscious move to not do anesthesia....

Right. Okay..

...acquisitions in the same rate. So that was what impacted this. So, as you can see, just even from the guidance in the fourth quarter, it goes back to a more average number in the 8% to 10% range..

Okay. Okay. That's helpful. I got it.

And then, just lastly, could you – because I'm not as familiar with the model, could you just update me on kind of structurally how radiology is different from anesthesiology in terms of payor mix or differences between commercial and Medicare reimbursement? I'm just – as that becomes a bigger piece of the pie, I'm wondering why we want to go down the same path that we're going down anesthesiology right now..

Yeah, so right now, we don't really have that much experience with it. But it does vary from practice to practice. So I don't believe it's going to be like anesthesia. But I think it's going to be more regional than anything else on each practice how that changes..

Well, in general terms, I would say just to add to that, the local hospital-based practices follow whatever the payor mix for that hospital is going to be. And probably half of it might be Medicare, a small percentage Medicaid, and the remainder in general terms, and the remainder would be managed care. Now the vRad practice is very different.

A good percentage of vRad is – their compensation comes from groups that are not our groups but other groups that are – that have a hospital contract, which contracts with vRad to do their night-time reads, their weekend reads, et cetera. And so that's just a direct payment from the group.

Another percentage of that business comes from the hospitals, which contracts with vRad to provide those same kinds of services. And then the third payment methodology for vRad is direct contracting with the payors. So it's a different – it's a little bit of a different payor mix there..

Okay. Thank you very much..

Yeah..

And at this time, there are no further questions in queue. Please continue..

Okay. Well, if there aren't any further questions, let me thank everyone for participating this quarter, and I look forward to speaking with you again next quarter. Thank you, operator..

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