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IPC The Hospitalist Co. (NASDAQ:IPCM)

Q3 2008 Earnings Call

November 11, 2008

Executives

Adam Singer – Chairman, Chief Executive Officer

Devra Shapiro – Chief Financial Officer

Jeffrey Taylor – Chief Operating Officer

Analysts

Arthur Henderson – Jefferies & Co.

Kristina Blaschek – William Blair

Sudeep Singh – Deutsche Bank

Brooks O'Neil – Dougherty & Co.

[Eugene – Civic]

Operator

Welcome to the IPC The Hospitalist third quarter 2008 earnings conference call. (Operator Instructions) I would now like to the call over to your host for today's call, Stephanie Carrington.

Stephanie Carrington

With us today from management are Adam Singer, M.D., Chairman and Chief Executive Officer, Jeff Taylor, President and Chief Operating Officer and Devra Shapiro, Chief Financial Officer.

I hope you have seen the press release announcing the earnings of the IPC The Hospitalist Company for the third quarter. If you have not received a copy, please call Ben Carmichael at 646-536-7023 and he will fax or email you a copy or a copy may be obtained from IPC's web site at www.hospitalist.com.

Certain statements and information in this conference call may be deemed forward-statements within the meaning of the Federal Private Securities and Litigation Reform Act of 1995. Forward looking statements in this press release may include but are not limited to those statement regarding projected operating results, revenues, earnings and IPC's growth opportunities and strategies.

Forward-looking statements are often characterized by terminology such as may, anticipate, will, expect, estimate, project, position, strategy and similar expressions. Although IPC believes that the expectations reflected in any of its forward-looking statements are reasonable based upon existing trends and information and IPC judgments as of today, actual results could differ materially from those projected or assumed based on a number of factors including those factors set forth in its annual report on Form 10-K under the heading risk factors and IPC's other filings with the SEC.

IPC's future financial conditions and results of operations as well as any forward-looking statements are subject to inherent known and unknown risks and uncertainties. IPC does not intend and undertakes no obligation to update any forward-looking statement to reflect future events or circumstances.

With that I will now turn the call over to Adam Singer, M.D., Chairman and Chief Executive Officer of IPC.

Adam Singer

Thank you everyone for joining us. We reported our third quarter 2008 results today after the close of market. I will start by reviewing our recent highlights. Devra will review the financials and then we will open up the call for questions.

We are very pleased to again report record top and bottom line results this quarter. For the third quarter of 2008 our Hospitalists reported over 690,000 patient encounters generating net revenue of approximately $63.2 million, up 32% from the same period of the prior year. This is driven largely by a 19% same market revenue growth.

We are very pleased with our ability to continue to grow top line revenue through both same market revenue growth and acquisitions while demonstrating significant operating leverage. We continue to reduce our G&A as a percentage of revenue with 150 basis point reduction year to date. We generated $3.2 million in net income, or $0.20 per fully diluted share.

So far this year we've entered two new markets through acquisitions in New England and Southeast Florida and closed five in market acquisitions in our existing markets in Texas, Florida and Arizona. Our strong balance sheet with $55 million in cash and untapped $30 million line of credit and positive cash flow will enable us to continue to execute on our acquisition strategy.

We continue to see a robust pipeline of deals which are in all stages of development from early discussions to due diligence and deal documentation.

We have executed on our 2008 hiring plan. We have increased every one of our recruiting staffs over the prior year including the number of physicians sourced, the number interviewed and the number hired. We currently have over 1,000 physicians working for IPC with a cadre of over 650 fully employed physicians and another 400 who work on an as needed or subcontracted basis.

We believe that we are well positioned to continue to grow the company both on a same market basis and by developing new markets. We, like everyone else, have seen the reports of reductions in hospital admissions. Since the close of the third quarter, our regional executives have begun to report that census is soft in many of the facilities.

In spite of the reported decreases in admissions, we continue to show some growth in patient encounters and have not seen a degradation in pay or mix. However, we have as yet not seen the normal seasonal uptick in activity that we have experienced in the past during this time of year.

But we continue to believe that activity will increase before year end. Based on the information we have on hand, and as we indicated in our press release, we believe that it is prudent to forecast that we will be near the low end of our previously announced full year 2008 range for both revenue and EPS.

We want to reiterate that we believe that we are well positioned to weather the economic downturn and the current softening in hospital census. We have motivated physicians in place to provide medical care to the patients who will inevitably require hospitalization. We have the cash on hand to continue acquisitions and increased interest from privately owned practices which will need the resources, financial stability and infrastructure we provide.

Given these facts, we continue to be confident in our ability to grow our company.

Devra Shapiro

Total patient encounters increased 27% to 692,000 compared to 544,000 in the same period last year. We recorded third quarter 2008 net revenue of $63.2 million, an increase of 32% from $47.8 million for the same period last year.

Of the $15.4 million revenue increase, $8.7 or 57% was attributable to same market area growth giving us a 19% revenue increase over the same quarter of the prior year. The increase in same market revenue was primarily the result of the addition of new hospitalists either hired or added from end market acquisition and higher physician productivity for existing hospitals.

Overall revenue per encounter increased 1.9% largely as a result of improvements in our billing and collections. Physician private salary, benefits and other expenses for the third quarter of 2008 were $45.8 million or 72.5% of net revenue compared to $35.4 million or 74% of net revenue for the same period of last year.

The decrease of physician cost as a percentage of revenue is primarily attributable to higher average productivity per physician.

General administrative expenses increased $2.1 million or 23% to $11.4 million for the third quarter of 2008 as compared to $9.3 million for the same period last year. However, as a percentage of revenue general and administrative expenses decreased to 18% of revenue in the third quarter of 2008 compared to 19.4% for the same period last year which demonstrates the continuing leverage of our cost structure on a larger revenue base even after factoring in the higher cost associated with being a publicly traded company.

Third quarter 2008 income from operations increased $2.6 million or 93% to $5.4 million as compared to $2.8 million for the same period the prior year. Our operating margin or earnings before interest and taxes as a percent of revenue increased to 8.5% for the third quarter of 2008 compared to 5.8% for the same period last year. The increase in operating margin was directly attributable to the reduction in physician costs and general administrative expenses percent of revenue, again demonstrating the operating leverage that we've built into our infrastructure as we grow top line revenue.

Third quarter 2008 net income was $3.2 million or $0.20 per diluted share compared to $7.3 million net loss for the third quarter of 2007. The 2007 numbers included a $9.7 million loss related to the accounting for the increase in fair value of our preferred stock warrant liabilities.

Our 2008 third quarter margin increased to 5% compared to a third quarter 2007 net income margin of 3% after excluding the accounting charge in 2007.

Turning to our balance sheet, we ended the third quarter 2008 with $55 million in cash. Combined with our available borrowings under the credit facility of $30 million and positive cash flow from operations, we have sufficient capital to continue to fund our growth and our acquisition strategy in these highly precarious economic times.

Our day sales outstanding have decreased to 60 as of September 30, 2008 compared to 69 as of December 31, 2007. This decrease reflects continued improvement in our billing processes and collection results.

Cash flow from operations year to date was a positive $17.6 million which is higher than net income plus depreciation and stock based compensation expense by approximately $6.5 million primarily reflecting decreases in pre-paid expenses. Pre-paid expenses decreased due to amortization of malpractice premiums, funding IPO costs paid in 2007 from the proceeds of our public stock offering in 2008 and application of $2 million of taxes overpaid in 2007 against our $6.5 million current period tax provision.

We believe that with our strong balance sheet and positive cash flow together with our very low debt balance, we are more than well positioned to continue to grow the company. With that, I will now turn the call back over to Adam.

Adam Singer

We would now like to open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Arthur Henderson – Jefferies & Co.

Arthur Henderson – Jefferies & Co.

Could you talk a little bit more about what you're seeing inside the hospitals, the weaknesses and the volumes? What transpired since the beginning of October that you could give us some more color on?

Jeffrey Taylor

If what we've been seeing in October as opposed to down turns, is we're just not seeing the uptick that we normally begin to see in Q4. It's obviously hospital to hospital. Some places are very soft. Some places are doing fine. But on average we're just not seeing quite the uptick that we normally have by the end of October. It happens at various times each year and it's obviously a little later this year.

Arthur Henderson – Jefferies & Co.

Is there any geographic trend or anything that might be playing into that?

Jeffrey Taylor

A little bit. We're speculating like everyone else is in terms of possible reasons for this. We're hearing from the hospital side of a decrease of elective admissions, maybe driven by the economy. Frankly most of our patients are not elective in nature anyway, and the majority of our business is Medicare so it really isn't as affected by that. These people are, we're normally taking care of acutely ill, and it's not optional.

It has been a little bit of a warm fall in some of our more northern markets so people aren't getting sick there yet and that may also have delayed the flight of the snowbirds into some of our southern markets that we see every winter. We're hearing anecdotally that people were not moving south this year until after the election. They wanted to stay home and vote. I have no idea whether that's valid or not but we hear it quite often.

We hear speculation that people are losing insurance and therefore may be delaying procedures. Again, we have not seen that as yet in our payer mix and the last possibility is, this is simply one of those years where illnesses are less acute.

Arthur Henderson – Jefferies & Co.

On the cash flow, during this quarter it looked like cash flow from operations was a little lighter than what we would expect and it may have been a timing issue as far as payables is concerned. Could you give us some color on that, what might have happened this quarter?

Devra Shapiro

If you look at what the cash flow is, it's all in the timing of working capital. It would be in that piece of it.

Arthur Henderson – Jefferies & Co.

Was there anything in payables that occurred this quarter that caused it? It looked like you were almost breakeven on a cash flow from operations basis.

Devra Shapiro

The balance from the accrued compensation due to the timing of the payroll.

Operator

Your next question comes from Kristina Blaschek – William Blair.

Kristina Blaschek – William Blair

Can you comment on revenue per encounter during the quarter? I know you had mentioned during your prepared remarks that gross could be attributed to improvements in billing and collections. Was there any specific mix shift that also drove this growth and what can we expect going forward?

Devra Shapiro

The answer to that is no, there's not been any payer mix during the quarter. As Adam said in his remarks, we've not really seen any change in degradation in our payer mix for this year. The other thing is, just recently CMS announced the physician payment schedule for '09, and that came out on October 30. We've just started taking a look at that.

On an overall basis for the codes that we use, if you weight them in the metrics that we use them, it looks like CMS is going to give us around a 4% increase in Medicare payments which for us is about half of that because half of our business is Medicare. That's before any regional adjustments are added. They've not yet published the regional adjustments, so we don't know what that's going to be by region, but I think we are looking at recap in Medicate next year.

Kristina Blasheck – William Blair

You said that was about 4%?

Devra Shapiro

As I said in my remarks, 1.9% increase for this particular quarter we believe was due to improvements in our revenue cycle processing.

Kristina Blaschek – William Blair

Can you talk a little bit more about recent acquisitions and more specific maybe the types of integration activities that have been made and how has that integration process been progressing?

Jeffrey Taylor

We've been doing a nice job with integrating our acquisitions with the number we've done over the last couple of years. This is becoming a core competency of ours. As you know, five of the acquisitions we've done were tuck ins in our existing markets so we have a leg up because we have existing experienced infrastructure on the ground. But all of those have gone well.

The New England acquisition that we did at the beginning of '08, that management team is settling in, maturing. We have learned a lot about their mid level extender model and are actually taking some of the lessons learned there to our other markets, but that region is performing well.

Our newer large acquisition and new market entry was the Hospitals of America. That transaction in Southeast Florida, we're only a few months into that transaction, but it has performed to our expectation. In fact, we've been pleasantly surprised by the engagement of the independent contractors within that model.

We are continuing to move in the areas of concentration to put full time employed doctors in some of the facilities and we've already commenced that with our first doctors who are employed by us on the ground there. This deal, as we said at the time, is going to take a little longer to fully integrate because of the independent contractor model. They're not fully on our technology day one like all of the other acquisitions. In fact, it will take several months before our technology has much impact on the Hospitals of America acquisition.

Thus far, we've had no unpleasant surprises in the integration activities on our acquisitions.

Operator

Your next question comes from Sudeep Singh – Deutsche Bank.

Sudeep Singh – Deutsche Bank

I'd be interested in getting your thoughts on overall in the current environment we're in especially with lower hospital volumes and the overall weakening economy, I'm curious to get your thoughts as to what you see in terms of a correlation between encounters and overall census and given that you were operating and managing your business during the last recession, if you could just maybe talk about historically what you saw back then and specifically with respect to volumes and any sort of mix shift.

Adam Singer

In any previous downturn it would be very hard for me to say that it had any negative impact. We continued to grow steadily through those downturns. This market is obviously somewhat different, although I will tell you that even though hospitals seem to be reporting lower census, we continue to grow the number of encounters that we're seeing.

Obviously if a hospital is empty or if there is a wide spread recession, loss of jobs, that's going to have some impact on us but I'll point to several factors that insulate us from what's going on in the economy.

First, half of our business in Medicare, insured by the government, payment is fixed. In fact the payments on our codes will most likely increase approximately 4% in '09. On that book of business, I don't believe elective admissions are really part of the equation.

As hospitalists, we're seeing very sick acute patients who don't really choose to be in the hospital, they have to be there. So I don't think that book of business is really going to be impacted.

On the commercial side of the business, these again are not elective admissions that we're seeing. It's really the minority of our cases that are coming from what otherwise would choose to be in the hospital. And indeed as of right now, we've not seen any degradation in the payer mix. So whatever impact is going on in the economy I don't believe had really impacted the number of insured patients out there yet.

I don't know what's ultimately going to happen, and to be honest with you the recent reports of hospital census dropping, I'm not sure if I can completely equate that to what's going on with the current economic downturn versus just we're a few weeks later this year in seeing the seasonal uptick in business which over the 20 years or so I've been practicing periodically happens.

I think we're well positioned for just about whatever happens, better positioned that it appears some other companies out there that are more directly related to the economic conditions out there.

Sudeep Singh – Deutsche Bank

From an operation perspective is there anything that you could do on the ground to either work with your referral sources to increase that base or to do something there to increase the overall market share that you have amongst Medicare patients in your markets?

Adam Singer

Not directly. I don't think there's ease to be done there, but I might guide to you a slightly different question or maybe answer. If the percentage of our patients or if patients increasingly have no insurance, we do somewhat control the percentage of those patients we see by the volume of business that we take through the emergency room on assigned call.

By modulating how many days of call we take for unassigned patients, we really can control the percentage of our business that is uncompensated care. So I guess in a relative fashion you could further that and increase Medicare on a percentage basis.

I would also point to two other facts about that ER. One is that in a lot of these situations we're contracted with hospitals and there is direct compensation for uncompensated care. About 55 of our revenues previously were coming from the hospital, as well as the fact that there really isn't any increase cost structure or cost related to seeing the increase number of indigent patients. Our physician costs are already somewhat fixed. So it's really only, are we at capacity that that becomes an issue.

So those are the different ways we would look at that.

Sudeep Singh – Deutsche Bank

There's certainly been a lot of discussion around a Medicare expansion and I know it's still a small portion of your business, but I was wondering how you thought about that and if you're willing to comment on what sort of any expansion would mean to your overall business.

Adam Singer

The amount of patients affected by a shift that I can see is non material. The pediatric population, our volume is extremely small. So I really don't see any impact. I understand that Mr. Obama's plan is one of the first things he's going to approach is the expansion program but I really don't think that will benefit nor hurt us when and if those changes come.

Operator

Your next question comes from Brooks O'Neil – Dougherty & Co.

Brooks O'Neil – Dougherty & Co.

I'm curious, would you estimate that you are currently servicing 100% of the available patients in the hospitals in which you work or is there an opportunity for you to continue to increase your penetration even though hospital census might be somewhat soft temporarily?

Adam Singer

If indeed hospital census is down as has been reported by the hospital companies and indeed you saw our encounters increase, it seems to me the logical conclusion is that we've gone deeper in the facilities we're in, and there's very few facilities amongst the 300 or so facilities that we practice in that we don't believe we could go deeper in.

We don't track linearly with hospital census. It can actually drop and we could actually continue to increase and indeed the data is supporting that. I will tell you though, obviously if hospital census is significantly impacted negatively, that's not a positive for us. And even though we will and have gone deeper in the facilities we're in, there is some lag when hospital census drops and changes to our marketing programs and where we get patients from can take affect.

But indeed you're seeing our encounters did not drop to the hospital census, we increased.

Brooks O'Neil – Dougherty & Co.

Are you seeing any reluctance on the part of referring physicians to turn their patients over to you in this environment?

Adam Singer

No.

Brooks O'Neil – Dougherty & Co.

Maybe you could comment a little more specifically about what the normal seasonal pattern in the fourth quarter. I'm guessing that it has something to do with flu and influenza and that kind of stuff, but obviously historically the presence of the flue has jumped around from month to month over time, so just any help you can give us in terms of what it is that drives a seasonal increase in your business in the fourth quarter.

Adam Singer

Typically it's exactly as you predicted. This is the time of year it gets cold, people come together indoors. They're not outdoors. The viral epidemics begin and then the epidemics are increasing. Respiratory disease, pneumonia, things like that, and it's hard to predict when it's going to happen, the second week of November or later in December, which is why I can't 100% tell you that drops in hospital census are flattened. Hospital census is really related to anything other than acuity of illness that's out there.

We have several other things that happened during October. We just had an election and does that impact the number of people moving from the northern states, their home states down to the south for the winter? We have some reports that there were delays in people making that move and that transition. It's also been very warm this fall although it's just recently getting colder up where you are in the north.

We'll start to see that migration and indeed, more of our practices are in the south than in the north. So exactly when you see these upticks over my 20 years of practice, it's really hard to predict, but it generally always happens.

Brooks O'Neil – Dougherty & Co.

You had a very nice increase in your operating margin this quarter. Have you or would you comment at all about whether you continue to see opportunities for operating leverage going forward and how high is high?

Devra Shapiro

I think we've always said in the past that we see that margin, the contribution margins being between 27% and 28% at the practice level. This quarter at 27.5% was kind of more of our historical percentage than the same quarter was last year. We believe that mid 27% to 28% is where it's going to be.

Operator

Your next question comes from Arthur Henderson – Jefferies & Co.

Arthur Henderson – Jefferies & Co.

In terms of your pipeline for acquisitions, I know that a lot of what you've done is some smaller tuck in things. I assume that the multiples that the bigger sellers are asking for may still be a bit too high. Can you talk a little bit about that?

Adam Singer

I'm not sure that we've really seen creep in the multiples at this point. We're very diligent about the process we undergo to do acquisitions. There are not that many of the larger enterprise like hospitals companies out there, only a handful. I don't really think multiples have been the reason that we haven't moved forward on a deal on that side yet.

I will tell you that our acquisition pipeline is very robust and all sizes of companies are on the table if you will, and it's as robust a pipeline as we've ever had.

I think the only change I will tell you and it's really not in cost, it's a positive, is the downturn in the economic times I think has brought a lot of the privately owned smaller groups to the table. They've seen their 401K's drop significantly. They feel the pinch of not being able to obtain

credit for their small practices, the inability therefore to hire physicians and to grow and build infrastructure in their own practices and I think that's accelerating somewhat our ability to do these smaller deals. And to be honest with you, these small deals in key markets as Jeff has mentioned is really becoming a core competency and we're becoming very tactile at doing them.

I think we're going to continue to aggressively pursue those and if a larger deal becomes available, we'll do that too.

Arthur Henderson – Jefferies & Co.

There are a couple of different business models approaching the hospitalist sector. You have one of them, there are others? As you continue to look around at acquisition opportunities, is there anything out there that you feel like you'd like to have as part of your portfolio of offerings in terms of the hospitalist business as it stands right now?

Adam Singer

I think right now, IPC has the three legs on the stool which is the private practice model, the hospital contracting model and the health plan centric model with the acquisition of HOA. I think it's really at this point about adding to each of those models if you will, rather than finding a fourth leg which I'm not sure is really out there right now.

Arthur Henderson – Jefferies & Co.

But are any of those legs that you have, any particular one standing out as doing better than the other? Is there anything you can comment on that?

Adam Singer

I think all three are doing well. Our core business model is building, practices within facilities and expanding to all the different referral channels within that facility. That model continues to be the core of our business. It is what continues to grow in a more even fashion if I'm giving it any extra credit.

I don't want to say we're emphasizing one more over the other, but clearly that's the bulk of our business and continues to be a major focus.

Operator

Your next question comes from [Eugene – Civic]

[Eugene – Civic]

Have you seen any change in the length of stay of the hospitals that you serve?

Adam Singer

Not really. We continue as part of our programs to be focused on measuring length of stay as well as readmission rates which are kind of the other side to be sure you're not increasing readmissions while decreasing length of stay, and we work in collaborative fashion with our facilities to join operating communities to provide that data and to be looking for ways with our partner facilities to improve length of stay.

We have not seen really, other than the continued down, or creep down length of stay that's been happening over the last decade. I don't think there's been a major shift one way or the other.

[Eugene – Civic]

Can you comment about any turnover in your hospitalist in the quarter or is there any trend there?

Adam Singer

There's no trend. We continue to run at the same retention rates or turn over rates that we have been historically reporting. The good news is that number is not picking up at all. Another potential benefit of the economic down turn we believe, although hard to know yet, might be a little bit more stability within those physicians that are choosing to leave and changing markets and the ease of some of these docs to be able to pick jobs in other markets which is usually what they do, when they leave.

We believe that might positively affect that turn over rate over time as people are kind of hunkering down and not making decisions that affect their careers quite as rapidly. The overall attrition rates are staying about flat.

[Eugene – Civic]

Are you seeing that affect for your nurse hospitals as well physicians?

Adam Singer

Yes, pretty much. I don't think the trends are any different for our extenders, the nurse practitioners and physician systems.

[Eugene – Civic]

Are they also kind of hunkering down given the economy?

Adam Singer

I don't want to overstretch what I actually know. People are worried out there and I think that a lot of them have seen what's going on with their friends and physicians and other companies and I think it will positively impact us. As I said, we've not seen yet a change in the percentage so I'm really guessing as to what might happen.

If you talk to them, and the word on the street and the water cooler, people are worried about these kinds of things.

Operator

There are no additional questions. I'd like to turn it back to management for closing remarks.

Adam Singer

Thank you everyone for joining us on our call today. I want to thank everyone for participating. Again, I want to reiterate we are well positioned to continue to executive on our growth strategy. We were happy to report a record third quarter and we look forward to speaking to you again next quarter.

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