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 Brian Gil Tanquilut - Jefferies LLC A.J. Rice - Credit Suisse Securities (USA) LLC Chad Christopher Vanacore - Stifel, Nicolaus & Co., Inc. Ralph Giacobbe - Citigroup Global Markets, Inc. Ana Gupte - Leerink Partners LLC.

Welcome to the MEDNAX 2018 Second Quarter Earnings Conference Call. As a reminder, this conference is being recorded. I would like to now turn the conference over to our host Charles Lynch. Please go ahead..

Thank you and good morning, everyone. I'm going to quickly read our forward-looking statements and then 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 press release or quarterly report on Form 10-K 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 second quarter of 2018.

Today, we announced a number of definitive steps that mark the acceleration of our corporate initiatives, shareholder friendly planned uses of our capital, and the building blocks for our strategic operational and financial direction over the coming 18 months and beyond.

Our operating results for the second quarter marked the sixth quarter in a row of meeting or exceeding our forecast. They also reflect the positive impact of the corporate, operational and growth initiatives which we began discussing back in 2017.

I want to discuss the announcements we've made this morning and put our results for the second quarter and for the first half of 2018 as a whole in the context of the broaden financial and operational improvement targets that we announced in our press release this morning.

But first, I think it's an appropriate time to reintroduce so to speak who we really are at MEDNAX. With all of the noise surrounding our industry and our company in the recent past, I think some of that may have been lost. Next year will mark our 40th anniversary as a company.

Over those four decades, we have been an organization of clinicians with a mission to take great care of our patients. Today, we do that in many more ways than we did when we started, but our mission has never changed.

What has changed over the years is the capabilities that we have built to follow that mission and in my view what we have built is strong, sustainable and yet still not fully realizing the potentials in front of us. That's what I'd like to talk about today with you related to our three primary clinical service lines.

First, our broader organization providing women and children's care includes 17 now different service lines covered subspecialty care for the maternal, fetal, neonatal and pediatric population.

Ours is the largest medical group of its kind in the United States and probably the world, spanning 39 states and Puerto Rico and encompassing more than 2,000 physicians and more than 1,000 advanced practitioners. Through this organization, we provide care for roughly a quarter of all babies born in the United States.

What we have built is irreplaceable and we believe that there is still a lot of room for us to move further. The services we provide in women's and children's care generates almost half of our company's revenue and well over half of our EBITDA. And we believe that our addressable market remains significantly larger than our current revenue base.

We believe there are continued opportunities to expand our hospital relationships to add new services and innovative care for our patients across the continuum from conception through childhood. I think it's important to note that our women and children's service line has grown against a backdrop of relatively flat births nationwide.

Our ability to expand the services provided by our existing practices to win new business and start-up opportunities and complement this activity with acquisitions enable us not to rely solely on a resumption of growth in birth for growth in our company.

Our women and children's organization has also been an innovator in patient care beginning with the establishment of our own electronic health records for neonatology, groundbreaking clinical research and education that have demonstrated significant improvements in outcomes, and meaningful contributions to advocacy related to important societal issues such as opioid use and addiction and its impact on newborns.

This organization also demonstrates the value of a true national medical group and I want to give you an example of what that means to our clinicians, our patients and our hospital partners.

In the early 2000s, we initiated what we call the 100,000 Babies Campaign, a network to utilize our data and our collective clinical expertise to develop innovations in the care of the neonates focusing on key aspects of that care and developing protocols that could be benchmarked, measured and improved.

When we ultimately published the paper with our findings, this effort actually included more than 400,000 babies and demonstrated significant improvements in mortality, reductions in length of stay and in complications.

We are extremely proud of these accomplishments, which could not have been achieved without the scale, investments and collaboration we were able to utilize only as a group of our size. But the real benefit is local.

Based at least in parts of their engagement in this campaign, one of our neonatology practices in Tennessee has now gone seven years without a central line infection.

This zero tolerance in now our benchmark and beyond the obvious benefit to our patients, this level of performance tremendously benefits our hospital partners through improved outcomes and lower costs of care.

Lower cost not through reducing compensation to providers but through providing better care by reducing complications, mortality and length of stay. Moving on to our anesthesiology organization, it is one of the largest in the country and comprises more than a third of our total topline.

This organization spans more than 45 practices across 15 states with over 3,400 clinicians including roughly 1,400 physicians and more than 2,000 nurse anesthetists. We cover roughly 2 million cases annually for our more than 155 hospital partners in addition to more than 160 ambulatory surgery centers.

This is a highly innovative clinical organization with a number of excellent value-add programs developed by our own physicians that improve patient safety and care and benefit our patients and our hospital partners alike. These include enhanced recovery after surgery, patient safety, perioperative surgical homes and clinical simulations.

Our national anesthesiology group is also supported by our own investments in resources and tools that aid our practitioners in demonstrating value to our hospital partners and to our payers.

A number of years ago, we were certified by the centers for Medicare and Medicaid services as our own clinical data registry for quality reporting and performance tracking, which avoids any need now for our practices to contract with a third-party to submit quality data under the macro legislation.

Based on the high quality of services our clinicians provide, we can now anticipate that they will receive bonus payments in 2019 under that legislation. Our practices are also supported by our own clinical consulting organization, Surgical Directions.

This is a unique company that applies a proprietary approach for measuring and improving operating room utilization as well as clinical staffing with demonstrated improvements in hospital and clinician productivity. Today, they are engaged with many of our practices to help optimize their delivery models.

Our anesthesiology organization also remains quite profitable despite the headwinds that we have faced over the recent past. These headwinds aren't unique to us.

The specialty as a whole will need to address the migration of a part of the patient population towards Medicare and the challenges in staffing anesthesiology services for a growing caseload, while maintaining and improving safety and outcomes.

What is unique to us though is our ability as a national medical group to execute on our plans and focus towards sustaining and then improving the profitability of this organization; again, not by reducing compensation to our clinicians, but rather by providing tools, expertise and support to allow their focus to be on clinical care and not on administrative functions by ensuring adequate payments for their services and by improving our own services to our practices.

Through the past year, our execution of these plans has enabled us to generate new revenue to help offset the top line impact of payor mix shifts, as well as to recapture dollars through our operating infrastructure beyond the G&A savings that we've talked about for the past several quarters.

We've given additional details today on these plans and our targeted improvement, and I will discuss them in just a bit. Lastly, our radiology organization is now a more than $400 million revenue operation comprising more than 700 physicians who interpret more than 11 million studies annually.

Today, this organization includes four of the largest and most well-established physician groups in the country, as well as what we believe is an unmatched technological capability via vRad.

We believe we hold the real and significant competitive advantage through the collaboration between vRad and their practices which we are starting to demonstrate through new business wins and the addition of complementary groups. Through the first half of 2018, our revenue from our radiology organization almost doubled.

This includes the contributions from the groups that we acquired in 2017 and the tuck-in acquisitions that we have completed so far this year. It also includes attractive same-unit growth, which reflects growth at both vRad and Radiology Alliance, our Tennessee practice, which rolled into our same-unit pool this quarter for the first time.

We remain committed to our radiology strategy, which entails collaborative efforts between vRad and their practices to identify expansion opportunity, as well as pipeline opportunities for M&A.

We believe our investments in this specialty give us a very attractive opportunity to build a leading radiology organization that can innovate, collaborate and continue to grow.

As part of our strategy and similar to what we have in place for our other service lines, we created an advisory council that includes MEDNAX leadership, our radiology leadership and the medical directors of each of our practices, and we meet regularly to develop plans for the organizations from both a clinical and a growth perspective.

Clearly, there is a significant amount of opportunity for us given our size as compared to our addressable market in the radiology industry. This council is charged with ensuring that our growth is targeted and sustainable and that it includes a continued integration across vRad and the on-site practices. So that is who we are today.

We are a national medical group of more than 7,000 clinicians, supported by a robust infrastructure, which enables them to collaborate, innovate and focus on taking greater care of our patients.

As I mentioned earlier, the challenges we have faced in our business are not unique to us and I would add that we don't have the luxury of simply expecting that they will go away.

To the extent that such external factors as birth trends or payor mix are not under our control, we need to approach everything that is under our control and to optimize it as best as possible.

At the same time, we need to ensure that the steps that we take enhance our ability to function as a true national medical group whose scale and clinical collaboration benefit our patient, providers and our partners at the local level.

To that end, last year, we undertook an extensive review of our organization from which we implemented the initiatives which we announced in the fall of 2017.

In their first phase, these initiatives were focused on reestablishing visibility in our results and working to offset the headwinds in our business, whether those were from payor mix trends in anesthesiology, elevated clinical wage inflation or flat birth trends.

At that time, we targeted a $25 million improvement in our G&A expense in 2018 with a longer term goal of a 10% improvement or roughly $40 million based on our run rate G&A cost at the time.

We remain focused on that goal, and through the first half of this year, we've realized roughly $12 million of improvements keeping us on track to meet our target for the full year.

On the operations side, we also developed specific plans for physician groups that include a wide range of initiatives that can impact revenue growth, cost effectiveness and provider satisfaction, and which are meant to engage people across our organization including our clinical and operating leadership, Surgical Directions, and our managed care and government affairs team.

The first stage of these initiatives, which we've been undertaking over the past several quarters, was very focused on the implementation of a robust management system for planning, execution and measurement that so far has been very effective in focusing our efforts and ensuring accountability.

As I reported last quarter, it also entailed the development of an operating plan for every single one of our practices which is being benchmarked and measured regularly through this formal centralized system. Again, the early stages of these efforts were targeted to offset industry headwinds, and to-date they have been effective in doing just that.

Through the first half of this year, we can quantify that our operation initiatives have recaptured $13 million, including $7 million as part of the second quarter results that we reported this morning.

These improvements came in the form of revenue via managed care negotiations and stipend renegotiations and practice expenses related to scheduling and staffing efficiency, as well as premium pay management and in cost management and scalability across our nationwide support structure.

Finally, over the past year, we have had positive results in the form of new business that we won through system relationships and RFP processes. I have discussed some of these successes over the past few quarters and they were another contributor to our results for this quarter.

In order to enhance our abilities to generate this kind of growth, though, over the past few quarters, we have undertaken a full reengineering of our growth capabilities with a formal centralized oversight of both M&A and organic initiatives as well as an expansion of our sales and marketing infrastructure.

This infrastructure spans all of our service lines in order to effectively target our addressable market from both a specialty standpoint and from a broader system relationship standpoint. All told, the combination of these efforts contributed meaningfully to our results for the quarter.

While we continue to experience headwinds in some of our end markets including somewhat unfavorable payor mix at our anesthesiology practices and relatively flat birth trends at the hospitals where we provide neonatology services, the operating initiatives which we implemented during 2017 were effective in offsetting these headwinds.

Our same-unit revenue growth was over 3%, which includes contributions from organic initiatives and practices across our service lines as well as pricing contributions from our initiatives around payor and hospital negotiations and government advocacy.

Our EBITDA growth accelerated from under 1% in the first quarter to 6% in the second quarter, also reflecting improvement in our G&A expense and a positive impact from our practice level operating plans.

And our EBITDA profitability was comparable to the year ago period with the exception of the additional expense which we incurred this quarter related to the change in timing for our equity grants program.

Based on the activity currently in place and underway, we announced this morning that for 2018 we expect to realize $35 million in improvement to our operational initiatives in addition to the $25 million G&A target we are on track to achieve.

We also announced that we're expanding and accelerating our initiatives to a target of $120 million in annual improvements with the goal of achieving this target over the coming eight months or through the end of 2019 – 18 months.

This represents a full realization of our targeted $40 million in G&A improvement as well as $80 million in annualized improvements through our operational plans.

I think it makes the most sense to view the activities we have undertaken over the past year as a first phase in which we focus on tactical improvement and created the operations management system for centralized oversight, benchmarking and accountability for our initiatives at the G&A and operations level for our growth efforts.

The improvements we've generated so far and which we have in place for this year represent the results of this first phase, which has been largely operations focused.

The next phase builds on this progress and becomes even more transformative focusing on our own service delivery model to our practices and on the practices' own clinical delivery models. It also targets additional growth initiatives and investments in technology capabilities at both the practice and corporate levels.

We believe these targets should represent helpful building blocks for what we intend to achieve financially over the coming 18 months.

As we begin to look beyond the second half of 2018 and into next year, we do believe that the execution of our plan can continue to contribute to our same-unit growth with an outlook that stack growth will remain in the low- to mid-single digits.

We also believe that based on the cost benefits of our plans, we can move beyond the stabilization of our EBITDA profitability that we have focused on achieving this year and toward a modest improvement in our EBITDA profitability in 2019 against that backdrop of same-unit revenue growth.

I anticipate that this outlook will raise some questions about how we appropriately baseline our 2018 operating results, which will be somewhat distorted through the second half based on the matter regarding Southeast Anesthesiology Consultants. So I want to comment briefly on that matter.

While we are disappointed that our hospital partner in Charlotte opted to move to a different anesthesia provider, a small number of the physicians in Southeast were not affected by this decision, while those who were affected will remain employed through the remainder of 2018 under the terms of their contract.

We are assisting these physicians in every way we can including relocation opportunities in other parts of our national medical group. I want to personally thank the physicians in Southeast for their dedication to providing truly great patient care over almost four decades for that stronger community and until the very last day.

From a financial standpoint, the ongoing employment of these physicians through year-end 2018 will be part of our normal salary and benefit expense, and we will provide as much clarity as possible in order for you to be able to bridge from our reported results to the underlying performance of our ongoing business.

We will provide this both from a retrospective view for the first half of this year and from a prospected view through the second half. That will help to create what we view as the most appropriate baseline off of which to formulate your outlook for 2019.

Related to that, I want to emphasize that all that I've discussed so far is based on our existing operations and is not reliant on capital deployment for acquisitions.

As you can see in our activity so far this year, we have been very deliberate in our use of capital for acquisitions and those we have completed have been smaller in size and very targeted and strategic.

We have completed tuck-in transactions as part of our radiology growth strategy and to add service lines in markets where we have existing practices across women's and children's care. Meanwhile, we do expect to complete additional acquisitions in 2018.

We can't predict how the market will change in 2019 or if acquisition pricing will become more attractive, but I can say that our review of opportunities will continue to be focused and delivers and more likely than not at a slower pace than we have undertaken in recent years and funded by our internal free cash flow.

With that as a backdrop, this morning, we announced that our board of directors authorized the repurchase of up to $500 million of our stock.

We believe that now is a good time to be making this investment based not only on our current valuation but also in our confidence in our national medical group model and the strategic path forward that I have presented to you this morning. The plans in place don't just have the goal of improving our profitability.

That's certainly a very important goal, but overriding that is our vision to continue to transform our organization toward the optimal environment for clinicians to provide great care for their patients.

I truly believe that we have identified the steps we need to take and I also believe that those steps will benefit you, our shareholders, as much as they benefit our clinicians and their patients.

Before turning the call over to our Chief Financial Officer, Vivian Lopez-Blanco, I want to make time to address our other announcements of Vivian's plan to retire. Vivian joined MEDNAX over a decade ago and became our CFO in 2009.

Since then, she has made a significant role in our growth as an organization expanding our actions to the markets and building excellent relations with our lenders and financial partners. I also consider her a close colleague and friend.

Vivian will be remaining with the company through the time that we conduct a search for her successor as well as during the transition period following that search. So while she is still in her role, I want to take the opportunity today to thank Vivian for her contributions over the years and for those that she'll continue to make in the near future.

With that, I'll turn the call over to Vivian..

Thanks, Roger, for your comments. And as you reminded folks in your prepared remarks today, MEDNAX is an organization committed to improving the quality of care and taking great care of the patients every day in every way. I am proud to be a part of that and will be here to ensure a smooth transition of my successor.

With that, let's get to our review of the second quarter. Our consolidated revenue growth of 8.7% reflected acquisition-related growth of 5.5% and same-unit growth of 3.2%. Within the same-unit revenue growth, volumes contributed 1.9% while pricing contributed 1.3%. On the volume side, we saw growth across all of our service lines.

In radiology, our first acquired on the ground practice, Radiology Alliance in Tennessee, rolled into our same-unit pool, and same-unit volume growth between the practice and vRad was very strong.

Beyond that, the greatest contributors to our volume growth were anesthesiology, our other neonatology related services, primarily newborn nursery care and maternal fetal medicine. Within neonatology, NICU days increased by 0.1%.

Similar to the first quarter, our volume trends also reflected contributions from organic growth initiatives which included both expansion of services and contract wins at our existing practices. Most of this activity was within neonatology and other pediatric services, maternal fetal medicine and anesthesia.

Pricing growth was largely driven by modest improvements in managed care contracting and increases in administrative fees received from our hospital partners. These help to offset a modest headwind from payor mix, which was unfavorable in anesthesiology and slightly favorable in neonatology and other pediatric services.

Net-net, payor mix trends reduced pricing growth by about 70 basis points, slightly favorable to what we saw in the first quarter.

On the cost side, practice salary and benefits expense was $621 million or 67.8% of revenue as compared to $561 million or 66.6% of revenue last year reflecting growth in clinical compensation from a combination of compensation increases, premium pay, agency labor and staffing initiatives at our existing practice as well as acquisition-related growth and staffing additions related to organic growth initiatives.

In the second quarter, G&A expense was 11.8% of revenue compared to 12.2% in the second quarter of 2017. We realized roughly $6 million of improvement in G&A in the second quarter as part of our corporate initiatives.

And with the $12 million of improvement through the first half of 2018, we remain on track towards our target of a $25 million reduction in 2018.

For the second quarter, I'll also remind you that our G&A expense did include an additional $3.2 million, primarily resulting from a change in the timing of our annual equity grant from June to March in order to align the timing of our year-end compensation-related activities.

This additional cost impacted our G&A expense for the quarter by roughly 30 basis points as a percent of revenue. EBITDA for the quarter was $158 million, compared to $149 million in the second quarter of 2017. Our EBITDA margin was 17.2%, versus 17.6% last year.

Again, the change in the timing of our annual equity grant impacted our EBITDA margin negatively by roughly 30 basis points in this year's second quarter. Below the EBITDA line, I want to point out that our effective tax rate for the quarter was 27.5%, slightly higher than the 27% we had included in our guidance.

Turning to our cash flow, we generated $135 million in operating cash flow in the second quarter. Of this, we used $75 million to pay down borrowings on our revolver and roughly $50 million to exercise our ordinary course annual share repurchase authorization that is meant to offset the dilutive impact of our equity programs.

Finally, turning to our balance sheet, we ended the quarter with total borrowings of $1.9 billion, consisting mostly of our revolver borrowings and senior notes. At quarter end, we had additional borrowing capacity under our revolving credit facility of roughly $850 million.

As we announced in this morning, our board of directors has authorized us to buy back up to $500 million of our common stock in addition to the existing program to compensate for equity plan dilution. We intend to begin exercising this authorization in the near term. Lastly, turning on to our outlook for the third quarter of 2018.

As we announced in our press release, we expect that our earnings per share for the quarter will be in a range of $0.72 to $0.77 and that our adjusted EPS will be in a range of $0.94 to $0.99. The range for our third quarter outlook assumes anticipated same-unit revenue growth will be between 2% and 4% year-over-year.

For the third quarter, we expect that our EBITDA growth will be within a range of 3% lower to 8% lower compared to EBITDA for the third quarter of 2017 of $152 million. There are a number of items that I'd like to mention related to our forecast for the third quarter.

First, given the non-renewal of Southeast contract effective July 1, we are no longer generating revenue related to that contract for content. Our EBITDA under the contract for the first six months of 2018 was $11 million and we would have anticipated a similar amount of contribution during the second half of the year.

Also related to Southeast, as Roger mentioned, we are providing continued employment to the physicians affected by the non-renewal through the end of 2018. And the expense related to this employment will be accounted for as normal salary and benefits expense in our income statement for the third and the fourth quarter of this year.

Since this expense is temporary, I want to point out that our expected results for the third quarter include approximately $10 million in expected salary and benefits expense related to the affected physicians impacted by this matter, or $0.08 per share in EPS.

Our expected results for the third quarter also reflect no ongoing EBITDA contribution from this contract, which to-date this year has been roughly $5 million to $6 million per quarter or roughly $0.04 to $0.05 per share in EPS.

As a result of these items, then our guidance for the third quarter reflects a total impact to our expected results related to Southeast of $15 million to $16 million or roughly $0.12 to $0.13 per share.

Second, related to our forecast of EBITDA growth, included within the expected general and administrative expense for the third quarter is approximately $6 million of expected improvement in G&A expense. Third, included in our forecast of EBITDA growth for the coming quarter is $10 million in positive impact from our operational plans.

This reflects a combination of incremental revenue and improvement in operating expenses. Lastly, our outlook also assumes an effective tax rate for the third quarter of 2018 of approximately 27.5%, compared to 39% in the third quarter of 2017. We currently expect that our effective tax rate for the full year will be in a range of 27% to 28%.

Finally, while we're not providing formal guidance for the fourth quarter of 2018, I want to comment that on a preliminary basis, we anticipate that our EBITDA results will be similar to our forecast for the third quarter, including the expected impact from those results related to Southeast. With that, I'll turn the call back over to Roger..

Thank you, Vivian. Operator, we can go ahead and open up the call for questions, please..

We have a question from the line of Kevin Fischbeck with Bank of America. Please go ahead..

Great. A few clarification questions. So, I guess, Vivian, just kind of picking up where you left off there.

So when you think about Q3, you're kind of saying you lose $5.5 million of EBITDA run rate, you got $10 million of extra expenses related to those doctors, so let's call it a $16 million drag, but you're also saying you're getting $6 million of G&A savings and $10 million of operational improvement, so that largely offsets that contract.

Is that the way to think about Q3?.

Well, sure. That was the only two things happening, right? But as Roger spoke about a lot and we've spoken through the first half of this year, we still have some of the headwinds that we are dealing with in the normal business related to the macro trends out on payor mix and other things.

So we are taking the appropriate steps to really offset those impacts with some of these initiatives, both on the G&A side as well as on the operational side. But those are certainly not going to be totally accretive, given that you have some of the other headwinds..

Okay. So I think it's the minus 3%, minus 8% EBITDA growth in Q3. That's kind of more what the fundamental structures are causing.

These other things are kind of offsetting is the way to think about it?.

No, no. That includes, like I said, $0.12 to $0.13 related to the impact of Southeast, one of which, as I said $5 million to $6 million or roughly $0.04 to $0.05, is related to the lack of the contribution from SAC.

And then the other one is the one-time cost of winding down related to the physicians' compensation that we'll be paying in the third and the fourth quarter. And so, that's another $10 million or roughly, like I said, $0.12 to $0.13 that impacted our estimate for the third quarter..

Okay. But I was just kind of also saying that these cost savings would be non-operational, or at least non-normal type benefits or tailwinds.

The fact that you have two things add to the equation is saying that they offset, then that would be the way to think about the quarter?.

Well, no. But you still have – if I would have taken those out, we would have a positive EBITDA growth similar to what you've seen by candidly in the second quarter..

Okay. So is it....

Yeah. You had offset to the operational initiatives that we had and the G&A initiatives. So you wouldn't have had positive EBITDA growth similar to the second quarter..

Okay.

And so then with Q4, I think you're saying that that $10 million of salary expense and then kind of the $5.5 million of EBITDA losses is also the way to think about that drag in Q4 related to that business?.

Yes. Yes..

Okay. So you're going to have, call it, $33 million of headwinds related to that in the second half. So when we think about that related to 2019, you had $11 million of positive in the first half, $33 million of negative.

You have kind of a $22 million drag in 2018 and that's basically what the drag will be in 2019 as well? So although there is a first half, second half dynamic, the drag from that contract in 2018 is going to be pretty similar to the drag in 2019. So these cost savings you're putting through will start to fill up more fully next year.

Is that the way to think about it?.

Absolutely. Yes. Right, because you have to – and you use the math right, Kevin, which is you have to back out the one-time cost for the physicians that we're paying through the end of the year, which obviously goes away for 2019. Yes.

So we do expect to get back to growth given that we would have had – we excluded these items certainly in the third and the fourth quarter, but again in 2019, the operational initiatives and the lack of some of these one-time items for SAC, we're definitely expecting to have positive margin and positive growth..

Okay. So if I understand the cost savings correctly, 2018, $35 million of operational improvement and $25 million of G&A in 2018 which gets you to $60 million and there's another $60 million incremental in 2019, gets you to the $120 million.

Is that the right way to think about it?.

Yeah. I mean some of these are on a run rate basis, so, yes, that's absolutely right..

Okay. And then, I guess, last question. So you mentioned that – I think you said in 2019, it sounds like you're kind of expecting still in that kind of 2% to 4% organic growth revenue and you expect to get some EBITDA margin improvement in 2019. Now you're doing that, I guess, with this incremental $60 million of cost savings.

If you didn't have this cost savings in place, would you still be able to get margin improvement on that kind of organic growth or do you need to kind of (00:40:17) what the cost structure each year to deliver that?.

Yeah. No, we need to look at our cost structure to deliver that. As I said to you guys before, in order for us to expand margin on a same-unit basis, you have to get way north of 3%. I used to say 3% years ago, and now it's close – it's not quite 4%, but it's certainly way north of 3%.

And so we would definitely have to be looking at that to get margin expansion..

All right. Great. Thank you..

Next question will come from the line of Brian Tanquilut with Jefferies. Please go ahead..

Hey. Good morning. Vivian, Roger as well, just a follow-up to that.

So as I think about all the cost cuts that you've laid out, I get the G&A side, but as I think about the other expense lines in your P&L, I mean it's basically salaries and benefits, right? So how do you find that much? I mean what exactly does MEDNAX need to do to realize these cost savings target?.

Yeah. Well, a lot of it is staffing. A lot of it is working on the anesthesia side, working with the hospital to make sure that their operating rooms are utilized efficiently. The operating room is the most expensive part of the hospital and also the most profitable.

And often to have an operating room open without a patient in it happens and it becomes very expensive for us to have an anesthesiologist who is sitting there waiting for the next patient to come, which never comes.

And so we have – our Surgical Directions team has put together some proprietary algorithms that we can go to the hospital and talk about. Heat maps that show what times, and this is all based on historical utilization of their operating rooms and we can identify what times different rooms should be open, et cetera.

And often we can save the salaries of two or three anesthesiologists in a large hospital and maybe add one nurse anesthetist instead. So, that's one area, is the staffing area which can be very important. There are other things like renegotiating hospital contracts.

There are things like asking for stipends or going with a different load or different mix of caregivers, et cetera. So it's a combination of all those things.

But we have been very effective and believe that given our Surgical Directions team and the leadership that they – the information that they have provided us, we think we still have some additional room for efficiencies..

Hey, Roger, just to follow up on that – sorry, go ahead, Vivian..

The other thing, Brian, to look at is that there are revenue opportunities given what Roger said in the prepared comments related to a realignment of some of organic growth initiatives and so we're pretty pleased with that..

Yeah, and then Roger, just it was very clear in your prepared remarks that you were communicating that we're not pulling back on physician comp, right? So it's a staffing strategy, but does this require you basically or does this hinge the hospitals agreeing to the moves or strategies that you want to roll out?.

Well, I mean it is a partnership. But what we're demonstrating to the hospital is a way for them to save money and to be more efficient in their provisional services. We're not asking them to cut back on any services.

We're saying that sometimes a hospital will say, there is an open operating room that we want to leave open for an orthopedic surgeon who has promised on Thursdays to bring those 12 patients and now it's 10 o'clock in the morning, he's done one patient and he has no more patients to bring to the hospital today.

And meanwhile, the OR is open and its staff and you got circulating nurses and you got surgical techs and all these people running around and the equipment anyway. So it's not about cutting services. It's about just providing them more efficiently and that actually has worked very well for us..

And just two clarification questions really quick ones.

Number one, Viv, when you talk about EBITDA margin expansion, does that include or exclude Southwest (sic) [Southeast] physician costs?.

No, that will exclude that..

Okay, got it. And then last one, Roger. You talked about pulling back on M&A. Does that include radiology as well or are we still saying, we're pulling back on anesthesiology for now given valuations or has that expanded into radiology? Thanks..

No, I wouldn't say that, and I would not say we're never going to do another anesthesia acquisition either, okay? I don't want to send that message. The multiples in anesthesia have gotten to a point where it's just not workable.

And so where we can find lower multiple deals that make sense for us and there won't be obviously a whole bunch of those, but there are groups that we're speaking with, there are smaller groups who are more appreciative of some of the other benefits that we bring and so we're talking with them. On the radiology side, we're finding the same thing.

There's been a couple of private equity firms that have jumped into that specialty and we are finding that with the larger groups that the multiples have gotten out of hand and we're not going to play that game.

Having said that, we have a pipeline where the multiples – there's benefits to vRad and some other benefits to be had from the practices that we have already acquired and those play a role in attracting practices.

And I will also tell you that I expect to close a neonatal deal – a nice neonatal deal before the end of the year, so we can continue to grow to go down that path. We'll have that as well. So we're not shying away from anything. We're just saying we're being more cautious and more strategic about what acquisitions we look to complete..

Awesome. Thank you..

Our next question will come from the line of A.J. Rice with Credit Suisse. Please go ahead..

Hi, everybody. Thanks for the question. First of all, I think this is probably a straightforward one, but I feel like we all at least ask it.

So the way the Southeast has played out, has that had any impact in other markets either with your existing customer base or your new contract efforts? And also I'd ask the same with your physicians both with your existing contracted physicians and with your ability to recruit physicians?.

We have not seen or heard from any other hospital that has anything to say about that. We have very carefully listened and tried to keep track of what's going on. And so the answer is we haven't. There are some – this is under litigation, so I don't want to talk about it very much.

There are some things about this specific hospital that make it, I would say, pretty unique. So at this point in time, that is not anything that we're seeing. On our physician groups, there's talk – a physicians' talk and one said something to the other and there are groups and whatever, but it's the same answer.

We've had lots of conversations with our doctors and we explain what's going on. Some positive things that happened here, I know that we're focused on the financial hit to the company and that's a big deal, I get it.

But it's also true that we have stood by the side of our physicians that our physicians have felt like they have a group that has – and a partner that has stood by their side. We paid them until the very last day of their contract and we're giving them their six-month severance that they were entitled to according to that contract.

We fought – it was an ugly fight. We fought with them. We brought their points. We believe that the hospital has, which is of course again not something I can talk about too much, but we believe the hospital has wronged us and has wronged the group.

And so we think that there are some positive things that have come out of this, not financially, but we're demonstrating to our physician partners another reason why they want to partner with MEDNAX because when it came time to stand by their side and this is as you can tell a big expense that we have decided to put in place for our physicians, we did exactly that.

And so we have also gotten a number of calls and comments from our physician partners across the country saying basically, wow, way to go..

Yeah. It's good. Okay. We've had the benefit of the cross-selling initiative in the women's and children's area in facilities where you managed the NICU. It seemed like that got started talking about that in the fourth quarter of last year, which happened also to be the time when we saw a re-acceleration in your same-store growth.

How big a factor has that been in contributing to the pickup in same-store growth that we've seen?.

Yeah, it's an important one. And as I said earlier, we're in 17 different subspecialty of the pediatric and maternal world. And what we find is that a lot of our hospital partners are asking us – we've won a number of RFPs particularly in this world.

And we believe that there is still a significant amount of growth to be had there, not only in neonatology, but one of the internal growth things that we put together is well baby care. And we're probably only caring for about half of the well babies that are born in our hospitals. We'd like to see if we can double that.

And so, yes, that plays a significant role..

And just my last thing. When you were giving your prepared remarks, Roger, you talked about sustaining sort of the low to mid-single digit same-store growth.

So I guess we had, had in our mind you're going to anniversary this pickup in growth in the fourth quarter, but it sounds like with what you see today you have confidence that it'll continue at least through the intermediate term..

We do. We do..

Okay. All right. Thanks a lot..

Yeah..

Our next question will come from Chad Vanacore with Stifel. Please go ahead..

Thanks so much. So just to put a pin in the cost-saving initiatives. On the operating expenses, it looks like you're expanding your 2019 operating expense savings by about $45 million, but $40 million is due to fewer physician contracting.

Is that correct?.

No. No. That wouldn't be correct..

All right.

Then, Vivian, then maybe you could parse out what kind of operating synergies you expect there?.

Yeah. And so, it's all of the above on the operating plans what Roger just talked about. It's really staffing initiatives, it's stipend renewals, it's revenue opportunities, it's reduction of premium pay; it's all of that, Chad..

Okay.

How should we think about what's a good run rate for OpEx as a percentage of revenue going forward given those initiatives?.

Well, I mean again I am hesitant about talking about that percentage because there's a lot of moving parts there. What we can say is that and I'm going to try to give you guys some guidelines there to bring your models is that without the impact of Southeast, we're definitely expecting margin to be increasing.

And so, we're expecting the margin increase and we're expecting the growth similar to what we saw in the second quarter. And as you saw, that EBITDA growth was roughly 6%. And so, that's what we can say to that. These initiatives were intended to kind of offset some of the headwinds that we're seeing in the macro environment.

But again, given the momentum that we see on the top line, we do expect the margins to expand..

Okay. Do you want to maybe frame the margin expansion? I mean in 2016 you were running above 20% EBITDA margin, 2017 with the change in business mix and maybe a bit of slowdown, you were running a little under 18%. Now, we're a little under 17%.

How should we think about margins given the new business mix?.

Yeah. I mean I don't want to quantify that at the moment. Because like I said, I can't predict the headwinds related to payor mix and some of the burst and all of that, but I do think that you'll see some margin expansion..

Okay. And then just share repurchase, you get $500 million authorized. You said you expect to exercise some near term.

Any change, you want to quantify that a little bit more?.

Yeah, yeah, thanks for that question. Yes. So we do expect in the near term to probably execute on about half of that, so roughly about $250 million..

Okay. Excellent. And then just one more quick question. Your range of tax rate being up by about 100 basis points from the prior estimate.

Why is that?.

Yeah. I think we had a shortfall in the equity exercises given that that now based on the accounting rules runs through the P&L there given just the drop in the stock price. So as you know, we typically have the big vesting there in June..

All right. Thanks for taking the questions..

Next question will come from the line of Ralph Giacobbe with Citi. Please go ahead..

Thanks. Good morning. Just want to come back again on sort of the cost side. I would think the visibility on the G&A, the $40 million pretty locked in.

I guess my question is, the $80 million, when you say sort of operational improvement and you've sort of alluded to the fact of kind of going back and asking for subsidies and revenue opportunities that you see.

I guess it just seems like we don't necessarily know that those are locked in or are they? Can you give us a sense of that $80 million, how much do you have to sort of workflow versus how much do you have visibility on today?.

So, Ralph, this is Vivian. So we have specific plans for each one of these practices and so we do have visibility into it. And it is real because we're really – we're executing on it now.

And so, if you look at the run rate for the year as we talked about the year-to-date $13 million and what we said on the third quarter that we're expecting another $10 million, I mean these things are happening and there's a specific management system to it. And so, they're not all related to stipend negotiations.

A lot of it is related to efficient staffing models as Roger mentioned and reduction in premium pay, et cetera. So we do have a good line of sight into that. I don't know, Roger, if you want to add anything to that..

No, I agree. I mean, look, I think that we obviously wouldn't be sitting here giving you a number if we weren't comfortable that that was a number that was reasonable. Obviously, we are going to try to beat that number, but we get on our weekly reports and we've got our team focused on this.

It's what we've been talking about doing for the last three quarters. We put a plan in place for every practice. There are people responsible to make this happen. And we feel that it is definitely an achievable number..

Okay, all right, fair enough. And then just want to go back to the commentary, you talked about the fourth quarter and I think you said same impact in the fourth quarter as in the third quarter.

Just wondering does that mean fourth quarter you'd expect to be down 3% to 8% off of the 4Q base, is that the context of those comments?.

Yeah, so that's the dollar number that we gave you. So just again to give you guys some guardrails to help you with what you're going to estimate there. But I don't want to get into the percentages because it might not be similar, right, it's just a different base, but the dollars are similar which is what we try to give you a guidance on.

And so the impact of Southeast we expected to be similar in the fourth quarter..

Okay, all right, got it. That's helpful.

And then just as we think about next year and again I know you don't want to guide next year, but it sounds like from what you're saying in terms of sort of stability certainly on the same-store top line and some improvement from the cost side and from margin expansion, I mean is there any reason for us not to think that you'd be able to do sort of at least the mid-single-digit EBITDA growth off whatever the base is this year?.

Yeah, that's exactly right. Yeah, that's a reasonable expectation..

Okay. All right. That's it for me. Thank you..

Thanks..

Our last question will come from the line of Ana Gupte with Leerink Partners. Please go ahead..

Hey. Thanks for fitting me in. Yeah, the question – the first one I had was about your anesthesia payor mix pressures and so the hospitals have been reporting better pricing growth which they attribute to service line improvements, improved acuity and inpatient.

Some of them like ATA even (00:59:37) talking about commercial mix optimization in inpatient and then the health plan side we're seeing more of a push toward ASC.

Is that likely – is that playing out at all as you see procedures and demand for your services and might that become eventually a tailwind for you at some point?.

Yean. Well, we reported what we saw. We hear some of those same comments and we also heard births were up, some people were talking about that. We just report what we have and what we see. We're hopeful that that will come true for us as well and we welcome that.

But right now what you have is a very accurate picture of what our financials were for the second quarter..

Okay.

And then on the efficiencies that you're talking about, the $40 million, can you tell us a little more about the breakdown between what you're doing at overhead versus at the practice level? And as you go beyond 2018 into 2019, what the runway for that is? Is this kind of capped at $40 million? Do you think that's conservative? And what the specifics on what exactly you're doing there?.

Yeah, Ana, hi, this is Vivian. So we kind of did try to give you some bases of how much is roughly in G&A. And so we had said in G&A we were expecting $25 million this year in 2018.

And on a longer term basis, 18 months or so, we were expecting it to have a 10% reduction or so which gets you to based on the base (01:01:22) that we were talking about when we did that that was based off roughly around $40 million or so. So, that would be the G&A component of that.

And then as we've said for the operational plan saving initiatives, we're expecting $35 million of that to be 2018 expectation and then we're getting to $80 million in 2019, so that's related to the operational plan..

I just got a sense though that there was lot more runway, I mean am I missing something? When we talked last, Vivian, is this kind of the most achievable that you have a detailed plan already outlined, but there's more to go here..

Well, sure. I mean we've said $120 million, so I'm considering that pretty respectable here for the total now.

Is that going to be the end of it? No, I think we're absolutely on the right track regarding continuing to look at the operations as Roger said and identifying ways to operate more efficiently in some of these pressured reimbursement environments with combination of staffing models and anesthesia with nurse anesthetists and physicians and reduction of premium pays, I think that will continue.

But I think we're pretty comfortable with this number and we think it's doable..

Okay. Well, that's it for me. Thank you..

There are no other questions in queue..

Okay. Well, if there are no other questions, let me thank everyone for participating this morning, and we will look forward to speaking with you next quarter. Thank you, operator..

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