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IPC The Hospitalist Company, Inc. (NASDAQ:IPCM)

Q2 2014 Results Earnings Conference Call

July 23, 2014, 05:00 PM ET

Executives

Evan Pondel - Head-Investor Relations, PondelWilkinson, Inc.

Adam Singer - Chairman and CEO

Jeff Taylor - President and COO

Rick Kline - CFO

Analysts

Ralph Giacobbe - Credit Suisse

Darren Lehrich - Deutsche Bank

Brian Tanquilut - Jefferies

Nick Hiller - William Blair

Gary Lieberman - Wells Fargo

Kevin Ellich - Piper Jaffray

Brian Zimmerman - Goldman Sachs

Frank Morgan - RBC Capital Markets

Gary Taylor - Citi

Dana Hambly - Stephens

Operator

Good day, ladies and gentlemen, and welcome to the IPC The Hospitalist Company Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded.

I would now like to turn the call over to Evan Pondel with PondelWilkinson. Please go ahead, sir.

Evan Pondel

Thank you, operator, and good afternoon, everyone. With us today from management are Dr. Adam Singer, Chairman and Chief Executive Officer; Jeff Taylor, President and Chief Operating Officer; and Rick Kline, Chief Financial Officer.

Before we begin today’s call, I would like to review the Safe Harbor statement. Certain statements and information in this conference call may be deemed to be forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995.

Forward-looking statements in this conference call may include, but are not limited to, those statements regarding estimated 2014 revenue and diluted earnings per share, projected operating results, revenues, earnings, and IPC’s growth opportunities and strategy.

Forward-looking statements are often characterized by terminology such as may, anticipate, will, expect, estimate, project, positioned, 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 in IPC’s judgments as of today, actual results could differ materially from those projected or assumed based upon a number of factors, including those factors set forth in its 2013 Annual Report on Form 10-K filed on February 26, 2014 under the heading “Risk Factors” and IPC’s other filings with the SEC.

IPC’s future financial condition 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 its forward-looking statements to reflect future events or circumstances.

Also, please note that all comparisons, unless otherwise specified, are to the second quarter of 2013. Also, all references to amounts as adjusted reflect the exclusion of the change in fair market value of contingent consideration for practice acquisitions.

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

Adam Singer

Okay. Thank you, Evan, and thank you, everyone, for joining our call. Earlier today, we reported our second quarter results. And I want to touch upon some of the highlights of what was a very solid quarter.

Patient encounters grew 14% to 1.7 million encounters. Revenues grew 18% to $172 million. Adjusted EBITDA increased 15% to $18.2 million, and adjusted diluted EPS grew 9% to $0.58. From a headcount perspective, as of quarter-end, we had 1,744 providers, which is an increase of 22% as compared with the same period last year.

For the six months of the year, we acquired eight practices but total acquired encounters slightly ahead of the same six-month period of the prior year. Since 2013 was a record year of acquisitions, it may be difficult to actually repeat that level of activity. Nevertheless, we still see a healthy pipeline of acquisition opportunities enough to capitalize on them through the remainder of 2014.

As we reported last month, the Federal Government has filed a civil complaint against the company in connection with a whistleblower lawsuit originally filed under seal in 2009. The lawsuit claims the company submitted false claims to the federal health care programs by overbilling for patient services.

While we cannot comment on the ongoing legal matter or predict the outcome, we believe our providers bill appropriately for the kinds of services provided. The focus and mission of IPC is not only to improve the clinical outcomes for our patients but to also improve the costs associated with care. Our continued investment in the post arena is a perfect example of how we can lower these overall costs by reducing hospital readmissions.

It has been from inception the goal of this company to maintain a culture of compliance while supporting clinical excellence by ensuring our providers are equipped with the tools and resources necessary to have a meaningful impact on patient results while reducing health care costs.

With that, I'll turn the call over to Jeff to review some of our operating highlights.

Jeff Taylor

Thanks, Adam. And thanks everyone for joining the call. We're pleased with the second quarter results with net revenue and adjusted diluted EPS up nicely compared to prior year. During the first quarter, we reported that our margins were impacted by the integration of acquisitions late last year.

Certain underperforming practices and the exiting of some contracted facilities. We continue to make progress integrating the acquired practices and addressing the underperforming practices, both of which contributed to our practice margins improving on a sequential basis by 70 basis points to 27%.

And despite the exiting of a number of contracted facilities in the first quarter, we still achieved same market revenue growth of 13.7% which outpaced our same market encounter growth of 9%. The difference between revenue growth and encounter growth is attributable to an increase in hospital stipends, medical directorship revenues, meaningful use incentives and a true up to previously estimated parity rates.

Adjusting for the exiting of certain contracted facilities in the first quarter, our same-market revenue and encounter growth would have been 17.8% and 12.7% respectably. For the second quarter of 2014, our post acute encounters have grown to approximately 30% of our business compared with 24% last year with a good portion of that growth coming from the park avenue acquisition in December.

We believe there are opportunities to continue to grow our post-acute encounters in many of our markets. In regard to our payer mix, we have seen a gradual improvement on a year-to-date basis. Historically our uninsured rate was slightly above 5% of total encounters and is now trending in the mid-4% range. Since the impact of new enrollment first began to appear in March of this year, we may see additional improvement in that percentage, remainder of 2014.

On the subject of growth, I want to talk about preliminary indications of our recruiting efforts. While we are still in the early stages of on-boarding our providers for 2014, we have noted improvements in operating efficiencies resulting from the additional investments in recruiting that have been implemented.

The refinements in how we source candidates and move them through the process to contract signing is helping to streamline our efforts and ensure a consistent process within the recruiting function. We have seen an increased flow of better screened candidates, which is resulting in offering positions to an increased percentage of those interviewed at the regions.

Through the first six months, we have hired over 20% more than at this stage last year. This allowed us to grow headcount sequentially in the second quarter. We expect a steeper than normal ramp in revenues in our fourth quarter this year driven by increased hiring. We expect to expand our percentage growth over the prior year in the second half of the year.

As is always the case, the market for providers remains very competitive, and competition can also affect our ability to retain providers. Overall, we remain encouraged by the early developments in recruiting and expect to hire another record level of providers during 2014.

I will now turn the call over to Rick to review the quarterly financial results. Rick?

Rick Kline

Thanks, Jeff. Please refer to the earnings release for a complete review of our operating results, since I’m only going to discuss a few other financial highlights that haven’t already been mentioned by Adam and Jeff.

With respect to overhead, our general and administrative expenses for the second quarter were 16.4% of revenues compared with 15.9%. The increase in cost is primarily related to our investments in our recruiting department and our development team, as we talked about in previous earnings calls. While the percentage is higher this quarter, it is important to note that the level of G&A spending is tracking within our own internal forecasts.

Our gross margin improved 10 basis points to 27% as a percentage of revenues, while our adjusted EBITDA margin decreased slightly to 10.6% as a percentage of revenues compared with 10.9%. The slight decrease in our adjusted EBITDA margin relates primarily to increased G&A costs I just mentioned.

As of quarter-end, we had $85 million outstanding from our $125 million line of credit, which is unchanged from the balance outstanding at the end of the first quarter. With regard to accounts receivable, our DSO, or day sales outstanding, at quarter-end was unchanged from year-end at 56 days but down sequentially by 2 days from the first quarter of this year.

As we talked about last quarter, the State of Texas has just recently begun to process the Medicaid parity payments, while substantially all other states have been processing the increased payments for several quarters now.

In regard to guidance, we are reaffirming our 2014 guidance as previously announced in February. For the full year 2014, we expect revenue to be in the range of $720 million to $732 million and adjusted earnings per diluted share to be in the range of $2.41 to $$2.51. Please refer to our earnings release for the assumptions related to the EPS guidance.

I will now turn the call back over to Adam. Adam?

Adam Singer

Okay. Thanks, Rick and Jeff. And in closing, I just want to reiterate that the second quarter was a very solid quarter for us. We expect to see further positive developments throughout the remainder of the year and beyond.

And, with that we’ll open up the call to any questions you might have.

Question-and-Answer-Session

(Operator Instructions) The first question comes from Ralph Giacobbe from Credit Suisse.

Ralph Giacobbe - Credit Suisse

Thanks. Hi, guys

Adam Singer

Hey, Ralph.

Ralph Giacobbe - Credit Suisse

I guess, first, can you help us break out the revenues between the hospital stipends, the medical directorship, meaningful use and parity true-up; can you just give some color in terms of what the revenue was for each of those?

Adam Singer

We're not breaking it out, but – the two largest amounts are clearly the hospital contracts and medical directorships. The other things that blow through are smaller pieces.

Ralph Giacobbe - Credit Suisse

And then just as it relates to the flow through, the stipends and the directorship, I believe, sort of, those are full pass through, is that right?

Rick Kline

That's not right, Ralph. The medical directorship, some of them are full pass through. Some of them we take a 10% on the new contracts, and hospital stipends, the largest basket are a mixed bag. Some of its 70/30, some of it is direct reimbursement for costs incurred. In general, we sort of have kind of mid teens margin on that basket of revenue.

Ralph Giacobbe - Credit Suisse

Okay. And then, just as it relates to meaningful use, is that sort of a new kind of component in terms of revenue flowing through, and the same thing with just trying to figure out the parity true up, what exactly – I guess what exactly is that? I think you were running at 1.5 million a quarter on party.

So I want to make sure that's still the run rate or are you expecting just more parity payments than you initially expected?

Adam Singer

I'll take those in turn. The EHR incentive payments are not new. I believe we've been getting those for about...

Jeff Taylor

Several quarters. several quarters, five or six quarters now, as we have been beginning to utilize the EHRs in the post-acute setting. Those all apply to the post-acute setting, as our providers in the acute settings are not eligible for meaningful use payments. So, no, it is not new.

In terms of parity, we have been booking parity, as you point out, as we've gone along. We're now into our second year of experience. We have states like Texas that are finally begun to pay, the last state to be, again, to pay.

We think we've been booking responsibly as we've gone, but now we have more experience with a secondary payments under parity when you have Medi-Medi claims etcetera. And so we feel like based on six quarters now of experience, we've been slightly conservative which is how we always like to be, and we've just brought that up to date now.

Rick Kline

De minimis amount.

Rick Kline

It's not – it's a small amount.

Ralph Giacobbe - Credit Suisse

So we should think $1.5 million a quarter or slightly above that is, kind of, still the run rate?

Rick Kline

Yeah, it's close enough.

Ralph Giacobbe - Credit Suisse

Okay. And then, just my last one, can you help with the revenue per encounter kind of excluding the pieces that we just talked about, can you give us what that number was? Is it zero, is it 100%, sort of, offset in terms of, kind of, the other revenue or what was the revenue per encounter excluding those other pieces?

Rick Kline

Excluding the other pieces it's essentially flat from the prior year, that’s in the $88 range.

Ralph Giacobbe - Credit Suisse

$88?

Rick Kline

For now.

Adam Singer

Is that right? Okay. Yeah.

Ralph Giacobbe - Credit Suisse

88? All right. Thank you very much.

Adam Singer

Thanks Ralph.

Operator

The next question comes from Darren Lehrich from Deutsche Bank.

Adam Singer

You out there Darren?

Darren Lehrich - Deutsche Bank

Yeah. Sorry, I had you on mute. Good afternoon, everybody. So just to follow on to that, so I just want to make sure I have the number right. You'd been tracking with subsidies and some of these other revenue items from stipends etcetera at about 8% of revenue, I guess, with what you just said, Jeff, that would probably put you closer to 9% of revenue. Is that right?

Jeff Taylor

It's closer to $8, Darren if you're looking just at the hospital stipends and the medical directorship of revenues, its right in the $8 range.

Darren Lehrich - Deutsche Bank

Okay. All right. That's helpful. And then, I guess my question here really is just on the post acute care side of the business, I wanted to just get a little bit of an update around your staffing levels specific to that area of your business, and if you could talk a little bit about, you know, some of the growth you saw here in the quarter in the post acute business, and then just maybe a comment, if you could, about any kind of traction you're seeing in the marketplace with regard to bigger, you know, more multiunit sniff providers for the services you can provide to them. Thanks.

Jeff Taylor

Okay. Darren, this is Jeff. I'll try to track all of the pieces of that question. Our post-acute has continued to grow faster than our acute because the opportunities are -- were pretty much wide open, but the big jump here, you know, year-to-year from 24 to 30 is largely the -- the effect of the large acquisition of park avenue at the end of last year, which is in this quarter and was not in the quarter at all last year.

Having said that, we are aggressively hiring as we're building out post-acute markets around all of our hospitals, and we're continuing to do that aggressively. It's a slightly different recruit, but you can also use a healthy mix of nurse practitioners and PAs, which also lessens the challenge a bit.

So we're gratified by what we've seen to date on recruiting both in the acute and the post-acute side as I mentioned in the prepared remarks. We're a bit north of 20% above the number of people we've been able to hire at this point last year, and we remain hopeful that we'll be farther ahead than that when we get to the end of the year.

Darren Lehrich - Deutsche Bank

Okay. And then just the other part of my question was just about, you know, how you're approaching some of these bigger nursing home operators and whether, you know, you see any traction in maybe getting, you know, bigger chunks of business with your post-acute group.

Jeff Taylor

Sorry, I did miss that piece, Darren. We are having discussions and have been for the last year or two with a lot of the major providers. You know there's just the density issue. We find open doors that they want our service, but unless they have real density in a particular market, it doesn't make sense for us to go to a brand new city where they have three skilled nursing facilities.

But in the markets where we already have presence and they have facilities, we have very fruitful discussions, and you know, discussions go on if they have a real, you know, cluster or concentration in the market of us entering the market just to service their needs. We did a market entry in Pittsburgh that way, pure post-acute just with one chain late last year.

Darren Lehrich - Deutsche Bank

Got it. And then -- thank you. And then just the last thing maybe for Rick, just noticed sequentially your CapEx moved up a little bit. Just want to understand what was behind that and you know with the right CapEx levels going forward ought to be? Thanks.

Jeff Taylor

Yeah. They’re separate – if you’re referring to stuff separate from acquisitions, Darren.

Darren Lehrich - Deutsche Bank

Yes. Yes, I am.

Adam Singer

We’re expanding some of our facilities because of our increased size of the company. And so we’ve – accordingly, we will have some costs with that as well as some technology refreshes. And with the HR implementations that we’re doing, you have to buy the equipment, etcetera. So it’s along those lines. I don’t think it’s going to drastically change, but it will continue in its form.

Darren Lehrich - Deutsche Bank

Okay. Thanks.

Operator

The next question comes from Brian Tanquilut from Jefferies.

Brian Tanquilut - Jefferies

Hey. Good afternoon, guys, and congratulations.

Adam Singer

Thanks, Brian.

Brian Tanquilut - Jefferies

First question for you guys, on the gross margin side, I know, Jeff, you talked about the sequential drivers for the increase in the gross margin. But how do you reconcile decreased in clinician productivity, as we measure it on encounter per Hospitalist basis and rise in gross margins?

Jeff Taylor

Well, Brian, this is Jeff. There are a number of factors in gross margins rising. Remember, the vast majority of our practices perform at full – perfect 28.5% margins. And in any quarter when we’re below that, which we always are, it’s a function of how many of our practices and to what magnitude are they experiencing challenges.

What you see in this quarter is a smaller percentage and smaller magnitude of practices having challenges. In our core practices that are performing optimally, as long as the providers are seeing more than nine or so encounters a day, they’re at full margin.

So if we staff up and add another provider, we’re ambivalent as a company as to whether we have six people seeing 72 or seven people seeing 74. The productivity is down slightly, but our profitability is up. So it’s a matter – I mean, our overall productivity margins the way we measure it moved very slightly.

Brian Tanquilut - Jefferies

Okay. And then, Jeff, as I look at the physician practice salary line, on a dollar basis, it’s down sequentially. What’s driving that? And the second part of the question is,, as I look at your staffing levels, it seems like the nurse practitioner category has gone up and the physician number has gone down. So is that the dynamic that we should be thinking about going forward?

Jeff Taylor

As the post-acute growth continues to outpace acute growth, you will see the percentage of nurse practitioners go up a bit. And their salary per unit is lower than the physician salary per unit. So that would explain that.

Brian Tanquilut - Jefferies

Got it. And then last one from me. In the release, it said you have had eight acquisitions. So we’ve seen five releases so far. So is that sort of the new way of thinking about it that some acquisitions are not going to be announced anymore? I’m just wondering.

Adam Singer

Some of the really small end market acquisitions that are really immaterial, we haven’t been doing a press release. And we try and wait until there is enough, and then we book them altogether. But the way the timing is we didn’t get that done before this call.

Brian Tanquilut - Jefferies

Okay.

Adam Singer

They were not of any size or anything that would be material.

Brian Tanquilut - Jefferies

Okay. Got it. Thanks, Adam.

Adam Singer

Yes.

Jeff Taylor

Thanks, Brian.

Operator

The next question comes from Ryan Daniels from William Blair.

Nick Hiller - William Blair

Hi. This is Nick in for Ryan. Thanks for taking my question. So is the hiring effectively complete at this point for the back half? Meaning we’re at late July now, so are you at a point where you know mostly who and when is going to be coming online in Q3 and Q4, or is there still a pretty healthy recruiting season left to drive this year's results?

Jeff Taylor

Yeah, Nick and this is Jeff. Your question's a good one. I mean, obviously we have a number of, you know, a very solid number of people hired. So we know who and when coming in Q3 and Q4, but we are still hiring, and we expect to add more names and hire more people who will start in the back half of the year. We have seen a bit of a shift toward more experienced people.

We have a much higher percentage of people we're hiring this year who are coming to us with prior work experience rather than right out of residency. And we believe, although we're continuing to investigate this to see if it's actually true, this will lead to a more, 12-month effect of our hiring as opposed to the huge concentration we've seen just at the end of Q3 and early Q4. But we have not finished, we've not stopped recruiting and we will continue to sign more people right up until the end of the year.

Adam Singer

Well, the other color is that as we continue to grow in the post-acute, the lag in the timing between when you start interviewing and when they can start is actually much shorter because you kind of drop off the piece of having to credential them in the hospital. So the recruiting season for that, is on the timing we might find someone today, they could actually still start whereas you're getting closer as your question implies, to where you might start interviewing them but they're never going to start this year because of the privileging issues. As I said that that’s a – that effect is less now because we're doing so much for the post-acute.

Nick Hiller - William Blair

Okay, great. Thanks. That's really helpful. And just a bookkeeping question. What was post-acute as a percentage of revenues, I think you said it was 30% of encounters?

Rick Kline

24%, 25%.

Jeff Taylor

26% of revenues.

Nick Hiller - William Blair

26% of revenues. Okay. And then just one more, so it's been a few quarters with Steward operations under your management. I know that was a big takeover from the hospital system, so can you talk a little bit more about how you've integrated that asset and what early feedback has been from Steward regarding the success of the operations that are under your control?

Jeff Taylor

Yes, we've now had three complete quarters and, you know, a stub of another. It's gone to our expectations, nothing goes perfectly and we didn't expect this to. We took over a practice that was, you know, short staffed at the time we took it over, so it's taken a while for us to chop away at that deficit and get the practices fully staffed.

We're gratified by the financial performance. It's tracked to our original forecast. We are happy with the clinical performance we have seen, but, you know, Steward is like every other hospital client we have, good is never good enough, and they always want us to be better and we always strive to be better. But I think on balance, both parties feel this has been a successful transaction.

Adam Singer

One thing I'll say about it that they do not have when we took it over, at this point we have at least one quality improvement project going on at every single one of those buildings, and are working in a collaborative fashion multidisciplinary teams at every single one of their buildings now on length of stay issues and cost per day issues. So we have now in place programs to improve performance of every single one of their buildings.

Nick Hiller - William Blair

Okay. Great. Thanks for taking my questions, and congrats on the quarter.

Adam Singer

Thank you.

Operator

The next question comes from Gary Lieberman from Wells Fargo.

Gary Lieberman - Wells Fargo

Good afternoon. Thanks for taking my question. I guess, just in terms of physician recruitment you said it was 20% ahead of where you were last year. Is that comparable to sort of the target of the 50% number which would get you to sort of the 600 physician adds for the year, and how do you feel about that?

Jeff Taylor

Gary, this is Jeff. That number refers to physicians that have on-boarded to date through the first – through the first half. As I mentioned in prepared remarks, we need to expand that number.

20% is not what we're shooting for in terms of an increase year-over-year. Where we stand now and what we see in the – in our recruiting pipeline, we still feel that our recruiting division is going to hit their – their assigned target for the year.

Now, remember there's another moving piece in all of this, and that is attrition. What we are focusing on is how many net adds can we get. Our attrition through the first half has clicked up a bit, and that was and is concerning. However, the contract exits we saw in Q1 were responsible for quite a bit of that, but even when we strip those out, it was still up a bit.

On an encouraging side it has started to ameliorate in June and July, and we've actually seen those numbers come down too point where they're below not on a percentage basis but on a finite basis where we've lost less doctors in June and July than we did in June and July of last year.

If that trend holds so that we have fairly what we would consider acceptable stable attrition we feel really good about where we are. But as we've said many times, if we, you know, really thump our recruiting targets and attrition stays manageable, we're going to do really well. Conversely if attrition ticks up and we're a bit short of our hiring goals, we'll be a bit short.

Gary Lieberman - Wells Fargo

Is there anything that leads you to believe that the attrition would tick up. I guess, looking back at first quarter was that a surprise or was that sort of stuff you thought might be coming along?

Jeff Taylor

There's nothing that we're looking at though it's unexpected to create some new expectation than we've ever had before.

Adam Singer

And we normally see lower attrition in the second half of the year and we're hopeful that we see that again this year.

Gary Lieberman - Wells Fargo

Okay. And then I think you said the same market revenue per encounter was – it was basically flat year-over-year?

Adam Singer

Yes.

Gary Lieberman - Wells Fargo

Okay. And so that's comparable with sort of the 80 basis point decrease that we saw in the first quarter?

Rick Kline

The revenue per encounter simply on fee for service collection you mean?

Gary Lieberman - Wells Fargo

Yes.

Rick Kline

Yes. Exclusive of the stipends et cetera, yeah, that's correct. It's comparable to that.

Gary Lieberman - Wells Fargo

Okay. So I guess my next question, you've talked a little bit about it, so of the 26.5 million revenue growth, I guess based on the numbers you gave, roughly 6.7 million of that came from, you know, stuff other than same store encounter growth, and that is – it's not quite double from the first quarter, but it's about – it's about $3 million more than the first quarter, and so I guess my question is where – one, where is the majority of that coming from? Is it the parity true-up or is it the EHR, which are the two, you know, the two things that you mentioned this quarter that you didn't mention last quarter?

Adam Singer

I'm a little confused on your question. Are you talking about our non-same store growth, where that growth came from, or are you talking about the gap between patient revenue per encounter and total revenue per encounter?

Gary Lieberman - Wells Fargo

I'm talking about the gap.

Rick Kline

Okay. All right. No, there are just, three or four pieces to that that we've gone through. The biggest piece is the hospital stipends. That's the biggest dollar piece. The fastest growing percentage piece is the medical directorships in post-acute.

I mean those have grown north of 40% year-over-year, so that piece, although smaller is far and away the most rapid grower in this basket, and you know, as we said, the true-up for parity is the smallest piece of all of this fraction.

Adam Singer

Anyone.

Gary Lieberman - Wells Fargo

Okay. So did the medical directorship grow relatively quickly sequentially as well to year-over-year?

Rick Kline

It's growing consistently.

Adam Singer

It grows sequentially as well as year-over-year, yes.

Rick Kline

It's growing right along with the growth in our post-acute. It's almost as fast as we enter new buildings we add new medical directorships.

Gary Lieberman - Wells Fargo

Okay. I guess I'm just looking at the gap. The gap is, you know, essentially twice the amount that the gap was in the first quarter on an absolute dollar basis. So if you're saying the medical directorship is growing sort of steadily, it – where that gap come from?

Rick Kline

We have to do all this math but yes, it has – it has definitely grown sequentially Q1 to Q2. Steward is still in there, but it would have been in both – both periods. The HR incentive we had in both quarters but it was a little bigger this quarter, and we had the Medicaid true-up for parity in this quarter, so when you add them all together, yeah, it's a bigger delta than we had last quarter.

Gary Lieberman - Wells Fargo

And what's the net impact on EBITDA margins just from that total amount without breaking it out piece by piece?

Adam Singer

I don't know. I don't know on the fly.

Rick Kline

I can't do that math in my head. Gary I'll get back to you on that.

Gary Lieberman - Wells Fargo

Okay. All right. Thanks a lot.

Operator

The next question comes from Kevin Ellich from Piper Jaffray.

Kevin Ellich - Piper Jaffray

Hey guys, nice quarter. Just wanted to start off with the same market encounter growth of 9%, this was a nice tick up since last quarter and probably the best we've seen over the last four quarters. Anything you can call out that drove that? I mean was utilization better, hospital admission trends I think are starting to look a little bit better as well. Anything that you can point to?

Rick Kline

Well, there's really nothing that we've seen that jumps out. I mean, our post-acute has grown. We did have, you know, the weather impacts and all those things, and a light flu season in Q1, so it made Q1 sort of an easy comp as we grew off.

We keep hearing that hospital volumes seem to be creeping up a bit, so, you know, there could have been a little impact there. We just look at how many encounters we have and we were glad that they were growing.

Kevin Ellich - Piper Jaffray

Got it. So, would you say the majority of that same market encounter growth is coming from post-acute?

Adam Singer

It's kind of all over. I don't know if it's the majority, but it's -- as a segment, it is growing faster than the acute.

Kevin Ellich - Piper Jaffray

Okay. That's fair. And then Adam, just kind of wondering, could you give us your updated thoughts on the industry and kind of the competitive landscape. We've seen some kind of non-traditional companies come into The Hospitalist market and just wondering what your thoughts are.

Adam Singer

We have seen -- we saw -- for some of us get into the space through an acquisition of Sound. I have to say in my head, I'm still scratching my head a little bit about where the synergies are for that particular transaction and how that really changes the competitive landscape.

My initial reaction is it really doesn't change anything. The landscape for hospital services continues to be very bullish. I mean the hospitals are -- have more attention to the kinds of issues that Hospitalist will work to help solve than ever before under their need to better perform under value-based purchasing. So, the drive for services of Hospitalist has never been any greater than it is now.

The other kind of competitive landscape changes the continued development of the ER companies and particularly, in vision promoting the bundle and I guess the sub text under that is joint ventures they're forming with hospitals to provide bundled services.

Quite frankly from a direct competitive view we're not really faced with bundle as being a competition for work and existing buildings that we're in, literally or almost no displacement that's occurred.

It certainly out there taking business or getting contracts under a bundle that may maybe in this wave of hospital outsourcing of hospital services, which I really believe depends on this one floor we would have done more if that product hadn't been developed, but quite frankly, I still see it as tailwind because in those programs, the Hospitalist piece of the bundle still loses money.

And therefore, I'm working very actively to talk to most of the ER companies or any of the ER companies I can get on the phone to build side by side practices to go after 75% of the business in those buildings that would not be under that contract and would not be in their interests to expand because they'll lose more money. So, I mean there's a lot of moving parts going on, but for the most part everything's still pretty bullish.

Kevin Ellich - Piper Jaffray

Got it. Now as for The Hospitalist piece of the bundle that's losing money, is that due to staffing, mismanaging it? I guess.

Adam Singer

No, no I don't think it's mismanagement at all. These programs typically at least as of now and most ones I've seen, these are takeovers of existing hospital-employed Hospitalists, and those programs are staffed in a way and run in a way that is very inefficient requiring 50%, 60% or even north of that in terms of hospital subsidy, but the bundle is all about economically, at least as we look at it, is give us your ER group. We'll do the Hospitalist for no subsidy because they're making enough money on the ER side to self-subsidize it.

And so by taking the loss leader of the Hospitalist, they could grow their ER contracts and then I'm assuming the hope of those that are doing a bundle is to better operate those practices at lesser of a loss, and to perform better clinically for their client facility. The program is still running at a loss though. And you're certainly not going to want to expand the size of that program and lose more money.

Kevin Ellich - Piper Jaffray

Yeah. That makes sense. Okay.

Adam Singer

Now, is it a function of staffing? The answer is yes. But I can tell you from experience here and from some quarters in the past you heard us talk about, it's not easy to take a shift model program and convert it to an efficient, you know, normal staff program that we run.

Kevin Ellich - Piper Jaffray

Okay.

Adam Singer

Very difficult process.

Kevin Ellich - Piper Jaffray

Got it. My last question going back to Jeff, your comments about the attrition that you saw tick up in the first half of the year, I guess what do you think caused it, when stripping out kind of the contracts and whatnot, what do you think led to the higher attrition, and I guess where did those physicians go? Did they go to specialize in something else or?

Rick Kline

Kevin, when you strip out the exited contracts, it was still up, but not up significantly once you stripped those out. And our reasons tend to be the same as they have been. We've maybe seen a little bit more work content schedule creep in, but still fellowship, family, geography those kinds of issues are still very large pieces of the attrition puzzle.

As I said, the encouraging piece is we've seen a significant amelioration of the turnover in June and July and we're hopeful that that continues.

Jeff Taylor

I'll try and give a little deeper color on that, we are faced in the death blow of these hospital employee shift model programs, one of the strategies hospitals take before they decide to outsource it is, let's just double down on what we're paying these docs to get our programs fully staffed.

And so you do see a subset of hospitals that are paying way above market for working half-time, and their idea is if we can get it fully staffed maybe we'll see the benefit of this increased subsidy by better performance. I think that's an ill advised strategy, but we do see that out in the marketplace and that’s creating some or did create, particularly earlier this year some increased competition for doctors both in new recruits and from our own existing work force that saw an opportunity to make more money and work less.

Kevin Ellich - Piper Jaffray

Okay. That sounds good. Thanks guys.

Adam Singer

Thanks, Kevin.

Operator

The next question comes from Brian Zimmerman from Goldman Sachs.

Brian Zimmerman - Goldman Sachs

Hi, thanks guys, and good afternoon. I appreciated all the comments you made on bundling and what you say makes a lot of sense, and you said you've seen little to no displacement. But would you be – would you say it's fair to say that you've lost a number of acquisitions from providers that are coming in and offering a bundled product and maybe you lose that acquisition opportunity?

Adam Singer

We've lost, no – if I understand an acquisition meaning buying a group.

Brian Zimmerman - Goldman Sachs

Yes.

Adam Singer

We've not lost any opportunities for acquisitions from based on anything related to a bundle, and quite frankly we really haven't been competing for acquisitions with anybody on anything.

Jeff Taylor

But more of we've seen more or envisioned actively acquiring Hospitalist groups, but what Adam did say, and we can say as we probably have missed some opportunities to get a new hospital contract or take over an outsourced program of being, you know, sort of given away by a hospital.

Undoubtedly we have lost opportunities there, it's not business we had before, but those opportunities went to people offering a bundle. It has had impact there.

Brian Zimmerman - Goldman Sachs

Okay. Thanks. That's helpful. And then, you know, in looking at your numbers and your performance for the first half of the year and your overall 2014 guidance, you are assuming a bit of a steeper back half, and you've alluded to some of that with your hiring. Is there anything else in your numbers that might drive up your back half performance to help you get to your guidance I guess? What's embedded in your assumptions to help get us to guidance in 2014?

Jeff Taylor

This is Jeff. When we came out with our guidance originally and we've probably had a little bit of a communication issue just pre-Q1, our numbers always assumed a steeper than normal ramp on encounters in Q4 driven by increased hiring and to the extent, you know, we still see demands, to the extent there's a little shortfall in hiring, which I'm not saying we expect. We expect to hit it.

You could also see an uptick then in productivity because the demand is there, but you don't have quite as many providers, but this is still largely a headcount game for us. We would not expect a steeper than normal ramp in Q4 based solely on productivity.

We're looking at it based on our expectation that we ended last year with a lot of “open slots” meaning we needed the doctors, and it was our intent and hope to narrow that gap this year by hiring more doctors, and we were on our way to doing that.

Adam Singer

I guess the other -- and you know the obvious other assumption that we've said many, many times that our same store acquisitions are embedded in our guidance and I guess another moving target there is we outpace our expectation on those same store acquisitions, you know, that could be another variable that could impact or if we missed our assumptions on those same-store acquisitions, that could be another variable in hitting that last two quarter ramp.

Brian Zimmerman - Goldman Sachs

Okay. That's helpful and then my last question is just one on G&A. You know, it picked up a bit in the quarter, we widely expected, how should we be thinking about G&A for the remainder of the year? Is it sort of a 16.4% of revenues a good run rate number, or should we expect to see sort of 10 to 20 basis points of improvement towards the end of the year?

Rick Kline

Hi. Brian, this is Rick. What we've got, if you look at our high and low range for the year, in other words with the revenue guidance we've given and everything else, it's a range of about 16.2% to 16.3%. So with that being said, I don't know if it's going to change that radically, but by the end of the year, we're within our range, we're somewhere in that 16.2% and 16.3% range.

Brian Zimmerman - Goldman Sachs

Which implies the second half is lower than the first half.

Rick Kline

Yeah, it'd be a little lower.

Brian Zimmerman - Goldman Sachs

Okay. That's helpful. Thanks guys.

Operator

The next question comes from Frank Morgan from RBC Capital Markets.

Frank Morgan - RBC Capital Markets

Most of mine have been answered. But I would like to hop over to the topic of the impact of the Affordable Care Act. You talked about a modest improvement in your self-pay encounters. It seemed like that was fairly consistent with what you said last quarter. But I'm just curious do you have any more color on where that conversion is coming, how much is going to Medicaid and at this point, can you really tell how much of it is coming on the public exchange side?

Jeff Taylor

Frank, this is Jeff. We really can’t see that yet. Obviously, we believe we like everybody else have seen more impact in Medicaid expansion states than not, but we can’t quite prove that yet.

We have a difficulty here because there are other factors that could drive our and have driven our self-pay rates down that have nothing to do with the Affordable Care Act or people getting insurance. It’s that the bulk of our growth in the last four years has not come through unassigned ER. We got a lot of that business early.

We’ve been growing the private referrals on top of that in the hospital, which are 100% insured. And in post acute, there is no self-pay. All of those people have some form of coverage. So if the Affordable Care Act didn’t exist, we would expect to see some lessening in our self-pay rate. But it does appear to be going faster than we would expect just from those organic factors, and we have to assume that’s for newly insured people.

Adam Singer

The only other color I would provide, good and bad in terms of understanding this question, is we start off with such a small percentage of our business being uninsured, it’s just not as big issue for us to say ER companies are stronger than the hospitals or some of the other healthcare provider groups.

Frank Morgan - RBC Capital Markets

Okay. And I guess I’ll go back to the recruiting one more time. Just simplistically, would you say you – at this point of the year that you’re at – I’ll make a number up – 80%, 70% of what you need to be at to hit your encounter growth for the year assuming – forget about making additional acquisitions, just based on what you’re doing today, could you give us some kind of range of where you are relative to what the target is? Thanks.

Adam Singer

I don’t think we’re going to give you a range. But the fact that we affirmed our guidance tells you we’re fairly confident we’re going to get there.

Frank Morgan - RBC Capital Markets

Okay. That’s fair. Thanks.

Operator

The next question comes from Gary Taylor from Citi.

Gary Taylor - Citi

Hey, guys. Good evening. I just wanted to go back to a comment or some figures. Jeff, I think, you gave – in your prepared commentary, I think, you were talking about in the context of just this modest true-up of the previous – previously estimated parity payments. And you gave some figures of 17.8 and 12.7, which, I think, were just revised year-over-year revenue growth excluding that true-up. And I just wanted to make sure that I got that correct.

Jeff Taylor

Yeah. I’m sorry, Gary. That was actually what our growth rates per same store would have been, had we not exited the facilities that we exited.

Gary Taylor - Citi

Okay.

Jeff Taylor

But the reality is we did exit those, and so the only ones that really matter are the ones that we actually reported.

Gary Taylor - Citi

Okay. And then the mid-4 – you followed that with a mid-4 comment. Was that…

Jeff Taylor

That relates to our self-pay percentage dropping from the 5-plus percent down into the…

Gary Taylor - Citi

Got it.

Jeff Taylor

… mid-4% range.

Gary Taylor - Citi

Which you had also told us on the 1Q. So it sounds like that payer mix self-pay was pretty stable sequentially.

Jeff Taylor

It’s strengthening a bit but not a lot.

Gary Taylor - Citi

Okay. Strengthening meaning improving?

Jeff Taylor

Meaning it’s – the self-pay is – the mix is improving.

Gary Taylor - Citi

Got it. And then on your – I wanted to go and just understand something on your same market fee-for-service revenue per account, which you said was roughly flat year-over-year at $88, excluding all the stipends, parities and all those other things.

Obviously that's a number that includes both acute and post-acute. But post-acute is growing, which would naturally pressure that number, so if it's flat, that means if we looked at acute only, it has to be up by some degree?

Jeff Taylor

Yes, that would be -- that would be the case.

Gary Taylor - Citi

And is there -- is there an estimate for what that is or if it is up, I presume it's primarily just commercial rate growth, probably not, probably not acute mix is that fair?

Jeff Taylor

There would be some rate expansion on the commercial side. Whatever our underlying Medicare rate is, and there are a number of moving pieces here. Length of stay also impacts that number. If our length of stay drops a bit, our revenue per encounter in the hospital goes up because we have a higher percentage of admit and discharge codes, so there are really a lot of levers that move around in that number.

Gary Taylor - Citi

Okay. So maybe would be most interesting for me, just, you know commercial rate, is there -- what's kind of the latest ballpark range for what you think you can generate in terms of commercial rate growth annually?

Jeff Taylor

It's a very small fraction of the rate in which our employee health costs go up each year.

Rick Kline

And we haven't been putting out the rates but generally it's about 110% of the Medicare rate.

Gary Taylor - Citi

Yeah. Okay, very funny. My one -- let's see. You covered that. So the last question, I was listening or doing my best to understand just your commentary around the guidance, and I guess if we kind of look naturally where 3Q EBITDA performance tends to be a little better than 2Q and then 4Q tends to jump, is that -- it sounds like that's still what you're expecting and then also perhaps that -- that 4Q could be larger than a typical jump? I thought I heard you say that, and then I thought I heard you not say that so I'm a little confused.

Adam Singer

That is what we were saying. Our guidance implies, you know, just a slightly, you know, the normal historical trend on Q3, and then the jump in Q4 being, you know, a few inches higher than the normal jump.

Gary Taylor - Citi

Okay. Thank you. That's all I had. Thanks.

Adam Singer

Thank you.

Operator

The next question comes from Dana Hambly from Stephens.

Dana Hambly - Stephens

Hi, good afternoon, thanks for getting me in. Jeff you talked about the sequential increase in the gross margin. I know we talked about a few things last quarter. I just want to be clear, that so you've exited all the contracts are all exited in the first quarter correct?

Jeff Taylor

Correct

Dana Hambly - Stephens

Okay. So no drag in the second quarter from those. And then so is the integration, I know that's ongoing but obviously there's a big one at the end of last year. Is that complete at this point or is there still improvement there?

Rick Kline

From a gross margin standpoint, I think that one is largely complete. It's performing very well. We may have or we expect to have a little more G&A leverage as we go into the second half of the year or with that large acquisition, but from a gross margin standpoint it's performing very nicely now.

Dana Hambly - Stephens

Okay. And then the same question on the handful of underperforming contracts you had in the first quarter, are those back to – I don't know if it's 28% but acceptable levels for you?

Rick Kline

The way to look at that Dana is we always have that basket of practices that are below our 28.5%, and what we – what you saw in Q2 was that basket being smaller than it was in Q1 and that was simply because of exceptional management, Dana.

Dana Hambly - Stephens

Yeah. Congratulations. And then I just wanted to – the – obviously the hiring is very much under your control. It sounds like attrition is very much not in your control. I know it's come down quite a bit over the years, but I mean, what can you – or maybe I'm wrong. Are there levers you can pull on attrition?

Rick Kline

Yeah. The attrition – some result of it is, just to leave or not is certainly not under our control, but there's certainly a lot of things we do to improve the experience, the clear platform for doctors here, and we do all of those things from creating a competitive compensation plan, providing better business development and administrative support, better compliance and risk, and our call center, transition management providing better recruiting which is probably number one in terms of creating better lifestyle for our docs.

It's literally everything that we do to make the practice better makes the practice life better for that doc and we're working on every one of those things to help ameliorate attrition. We also study it. We do exit interviews on every candidate, or every doctor or clinician that leaves, and we are very visibly looking at that data to make sure that the issues that are addressable are being addressed.

Dana Hambly - Stephens

Okay. No, that's helpful. You're just not paying them twice as much to work half as many hours.

Adam Singer

That is kind of one of the lines in the sand that we draw is that we're not going to create a non-economic business model that many others in this industry have done. There is some adjustment around comp that we can make in terms of base salaries. Although, they don't impact the financials because it just lowers the threshold for when they get their bonus, right, because they're paid 70/30 anyway.

And so there are some accommodations we work around the edges for where comp is the issue, but quite frankly I find compensation to be the least of the issues when people leave. And it's more likely the life – that life – work life balance and looking for different kinds of work schedules.

I think that as hospitals continue to outsource more and more programs, you're going to see less and less opportunities for doctors to take positions that are paying you full salary and working half-time, because people like Envision and other, who are profit minded people, are just not going to continue to pay like that.

Dana Hambly - Stephens

Okay. No, that's helpful. Last one from me, you had mentioned that you're seeing a shift in hiring to more experienced hires. Was one – do you have a rough percentage of, kind of, experienced hires relative to new residents and was this factored into your budget for the year? Is this taking you by a little bit of a surprise?

Jeff Taylor

Dana this is Jeff. It's actually up this year right now to 77% and 23%, 77% with experience. We have seen this trend. It began last year as a higher percentage of our hires last year were also experienced. It has moved more quickly than I would have guessed that. We're happy with the trend.

Adam Singer

And it's not a budget issue, though because we don't pay them really any different. Right.

Jeff Taylor

There may be less training and a slightly faster ramp for somebody that has experience. But I think it is maybe more attributable to the fact that people coming right out of school a higher percentage of them gravitate to the shift model. They want that lifestyle model as people get in the workspace for a while, many of them start to realize that that is not nearly as nice as it sounded and want to switch to a different model. I think that's probably more the driving factor.

Dana Hambly - Stephens

Okay. Very helpful. Thanks and nice quarter.

Adam Singer

Thank Dana.

Dana Hambly - Stephens

Thank you.

Operator

I show no further questions at this time. I would now like to turn the call back over to the presenters.

Adam Singer

Thank you everyone for listening on the call, and we look forward to hopefully providing the same kind of results next quarter. Thank you.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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Source: IPC The Hospitalist's (IPCM) CEO Adam Singer on Q2 2014 Results - Earnings Call Transcript

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