Cross Country Healthcare Inc (CCRN) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cross Country Healthcare Earnings conference call for the fourth quarter and full year of 2017. This call is being simultaneously webcast live. A replay of this call will also be available until March 15 of 2018, and can be accessed either on the company's website or by dialing (866) 357-1431 for domestic calls and (203) 369-0118 for international calls and by entering the passcode 2018.

I will now turn the call over to Chris Pizzi, Cross Country Healthcare's Chief Financial Officer. Please go ahead.

Thank you, and good morning, everyone. With me this morning is our Chief Executive Officer, Bill Grubbs, and our Chief Operating Officer, Bill Burns. This call will include a discussion of fourth quarter and full year results for 2017 as disclosed in our press release and will also include a discussion of our financial outlook for the first quarter of 2018. After our prepared remarks, we will open the lines for questions. A copy of our press release is available on our website at www.crosscountyhealthcare.com.

Before we begin though, we need to remind you that certain statements made on this call may constitute forward-looking statements. As noted in our press release, forward-looking statements can vary materially from actual results and are subject to known and unknown risks, uncertainties and other factors, including those contained in the company's 2016 annual report on Form 10-K and quarterly reports on Form 10-Q as well as in other filings with the SEC. I would encourage all of you to review the risk factors listed in these documents. The company undertakes no obligation to update any of its forward-looking statements. Also, comments made during this teleconference reference non-GAAP financial measures such as adjusted EBITDA or adjusted earnings per share. Such non-GAAP financial measures are provided as additional information and should not be considered substitutes for, or superior to, financial measures calculated in accordance with U.S. GAAP. More information related to these non-GAAP financial measures is contained in our press release.

Lastly, in order to facilitate a better understanding of underlying trends, we may refer to pro forma information on this call, giving effect to acquisitions and divestitures as though the transactions had occurred at the start of the periods impacted. As a reminder, we completed the Advantage RN acquisition effective July 1, 2017 and the results of its operations have been included in our reported result for the third and fourth quarters.

With that, I will now turn the call over to our Chief Executive Officer, Bill Grubbs.

Thank you, Chris. Thank you, everyone, for joining us this morning. This was a disappointing quarter for us, as we experienced weaker than expected results due in part to a mix of what we believe are short term pressures on our business, particularly with respect to our Nurse and Allied segment. While we expect some of these pressures to affect results in the first quarter of '18, we also believe that they are ultimately short term in nature. That the overall trends for the business are strong as their performance will improve as the company moves further into the fiscal year. As we will go into later on the call, we are also taking concrete steps as an organization to improve our operations and bring greater focus, accountability and consistency to our performance.

So, turning to the quarter, our Nurse and Allied business was down year-over-year and sequentially. We believe, there were 3 trends that negatively affected our business in the quarter that I want to provide some context around. First, Hurricane Irma had a larger than anticipated drag on our business in Q4. We had initially projected the effect of Hurricane Irma to be about $4 million in revenues based on the number of days our offices were closed in Boca Raton, which is where our Nurse and Allied travel nursing business is headquartered, during and immediately following the storm.

What became apparent later in the quarter, however, was the addition effect that the disruption caused by school closings, prolonged fuel shortages, Internet outages, power outages, et cetera had on candidate recruitment and productivity, which resulted in a decline in placements in the quarter. Overall, we believe this disruption resulted in an additional loss of approximately $2 million in revenues for the quarter, bringing the total Hurricane Irma impact to $6 million. Because our placements typically last for 13 weeks, we expect that the lower Q4 placement levels will result in a lower base for Q1.

The second trend that, we believe, came to a head in the fourth quarter was lower renewal rates. We did not lose any customers in a fourth quarter, but a select number of large MSP customers pulled back their contingent labor spend to adjust to market dynamics, which resulted in a reduction in our renewal rates. While our capture rate at our MSPs increased in the fourth quarter, it was not enough to offset the reduced renewals. So far in the first quarter, however, renewals have rebounded back to more normalized levels and the number of travel nurses out on billing has grown from the yearend each week as we've gone through the quarter and our capture rate is up and we have -- we believe, we have the ability to grow that even more.

Finally, the third trend that negatively affected the performance up in Nurse and Allied business in the fourth quarter was the decline in our premium rate business. Now, we've talked about this before. But during this quarter, revenue from premium rates declined sequentially by approximately $2 million. We've seen reduction in our premium rates for several quarters. And from what we are seeing, this unfavorable trend appears to be an industry wide issue as demand for premium placements in a higher margin specialties continues to normalize from the elevated levels we experienced in 2015 and 2016. We anticipate this decline will level off in the second half of 2018.

Turning to our other segments. After starting to see a pass through recovery for Physician Staffing in Q2 and Q3, we had lower than expected results in the fourth quarter. Revenue decline was predominantly due to mix, but volumes actually held up fairly decently. We do believe the demand for locum tenens services remained strong and we have a strong competitive position with respect to our premium accounts and we are continuing to improve our operational efficiency. We expect the business to grow at low single digit percentage in 2018. We also expect to see a much improved contribution level moving forward.

The story is similar for our Other Human Capital Management segment. This is our search business, which had a difficult 2017, primarily due to disruption from personnel changes. We believe, that we are now beginning to see positive trends in the market and in our own performance and we expect this business to grow year-over-year in 2018. So far it appears we're off to a strong start. This business is also expected to improve its contribution levels.

While we faced a number of challenges in the fourth quarter, Cross Country also realized some key successes that are worth noting. First, our operating cash flow was very strong at $17 million for the quarter, bringing the full year number to $46 million, an increase of 51% over the prior year. Also, our orders are up in Q -- our orders in Q4 were up from Q3 and our orders are up again in Q1.

Our school healthcare staffing business continues to perform well with revenue growing at double digits and a strong contribution level. In particular, our DirectEd business serving charter schools is growing at over 30% year-over-year and we expect that to continue. We're very bullish on our school business.

Lastly, in the fourth quarter, we believe we have corrected the issues we had with Advantage RN. Part of the reason for making this acquisition was to get more support for our MSPs. We did not see that in the third quarter because of technology and process integration issues. I'm happy to say that we have that back on track and the amount of revenue that Advantage RN is experiencing -- that Advantage RN is experiencing at our MSPs was up over 30% from third quarter to the fourth quarter. We believe, we can continue to improve on this throughout 2018 to support a higher capture rate at our MSPs.

Overall, we believe the market remained strong with favorable tailwinds to support better performance in 2018. Over the last 4 years, the company has experienced tremendous growth and we believe the key challenge for us moving forward is how we can more efficiently and effectively convert these favorable trends of demand into greater placements and renewals. While we believe that a number of the headwinds we faced in the fourth quarter will dissipate as we move through the year, we also recognize that we've reached a stage in our development where we need to place more emphasis on sharper execution and greater efficiency to capitalize on this opportunity. So what are we doing to meet that challenge? First and foremost, we believe the management changes announced in January are critical to our long term strategy. It is the right thing to do for where we are in our growth and development. As we've gotten bigger and more diverse, the need for a more streamlined, agile and accountable management structure has become more apparent.

So let's start with the Chief Operating Officer role. We expect having a dedicated executive in this role who will streamline our operations, make us more agile in responding to market developments and will provide with greater capacity to focus on strategies, differentiations, acquisitions, Investor Relations and other public company activities. I was a Chief Operating Officer for more than 10 years before coming to Cross Country, so I know what a positive impact a role like this can have on a company's performance. I'm excited that we had such a strong internal candidate in Bill Burns for the role and I want to congratulate him on his promotion.

We also separated our Travel Nurse and Allied business from our branch operations. Again, the main reason for this was to drive additional focus on operational excellence. The travel business has a different operating model for the branch operations. As both businesses grew, we came to the view that a President level executive, independently focused on each model was a best way to improve results. Travel nursing is our largest business and the largest segment in the market.

We believe, this business will benefit significantly from having its own management team driving growth and improving the bottom line. In addition, we continue to see a shift from treating patients in the acute care setting to ambulatory and outpatient facilities, which are serviced from our branches. Our branch operations have performed very well over the past few years, propelling us to be the largest provider of per diem nursing and driving additional local allied business. We not only believe we can continue to build on this success, but that this is a competitive differentiator for us.

Again, I was very pleased that we had a strong enough management team to fill both of these President roles internally. Congratulations to Buffy White, the new President of our Travel Nurse and Allied business and Marisa Zaharoff, President of our Branch Operations. I want to also mention that as a result of Bill Burns becoming our new Chief Operating Officer; Chris Pizzi, formerly our Corporate Controller, has been named our new Chief Financial Officer. Again, we are thrilled that we were able to fill the role from our deep internal bench and I would like to congratulate Chris on his promotion.

These organizational changes are part of our commitment to achieve an adjusted EBITDA margin of 8%. We recognized that we are behind our original schedule of meeting this goal and this will be an area of focus for Bill Burns -- Chief Operating Officer; Chris Pizzi as Chief Financial Officer and the rest of the management team. We had hoped to get more leverage from growth over the last few years to achieve this milestone, but growth is not getting us there fast enough. Having said that, we are focused on taking the reins at accelerating our progress to decisive action. In just a moment, Bill Burns will provide more details on how we are positioning ourselves to achieve this milestone.

To conclude, while we are not satisfied with last quarter's results, we believe there is significant opportunity ahead of us an organization and a clear pathway to getting there. I am confident in our team and the changes we have already made and believe we will build momentum as we move through the year.

With that let me turn the call over to Bill Burns, who will view our operational focus in more detail.

Thanks Bill, and good morning, everyone. As Bill mentioned, the fourth quarter did not turn out as we'd expected. However, we do remain very optimistic about our future. We continue to be in a relatively strong market with favorable conditions and as I will explain in a few moments, we're taking the necessary actions to get our business to where we want it to be. We've said previously that 8% is the right adjusted EBITDA margin for us to target in the near term and that is still the case. 8% is not the end game, of course, but rather a milestone for us and our path to 8% is dependent on several things. Let me give you a little more insight on some of the specific things we need to do.

First, we have to return the company to market growth, which creates improved operating leverage. Though our organic growth has slowed in parts of the business, we believe we have sufficient demand across all parts of our business and our challenges have been predominately on the supply side. I'll get a bit deeper into that and the things we're doing to address it in a moment.

Generally, we can put about a third of our organic incremental gross profit or about 15% of incremental revenue to the adjusted EBITDA line, which assumes normal investments in SG&A to continue to grow the business. However, normal operating leverage alone will not be enough for us to achieve the 8% goal in the near term.

The other part of the formula involves rightsizing our cost structure. There are really 3 areas of focus. This is -- the first is really on improving the profitability of our Physician Staffing and search businesses. Both of these businesses have a cost structure that is capable of supporting a much larger book of business. Returning these businesses to a contribution income of just 10%, which is still below our optimal level of profitability, is expected to produce an approximately $5 million in additional profit for the business at their current size.

Clearly, it would be our preference that we grow into these costs by continuing and accelerating the positive underlying trends we've seen. However, we recognize that this has been a process that's taken longer than we anticipated, and we are looking into ways to align and optimize the cost structure for these businesses that gives them best chance for both growth and improved profitability.

The other big area for improvement has to do with operating efficiencies in both our field operations and corporate functions. For a variety of reasons, we've not fully realized the opportunity from standardizing, automating, centralizing various functions and processes. For example, from an operations perspective, our staffing businesses have some degree of overlap in activities like candidate vetting, onboarding, credentialing. Yet they continue to operate fairly decentralized with disparate processes and tools. We're actively working on plans to drive necessary improvements that will result in better productivity, scalability and ultimately profitability in 2018. Costs are generally easy to get at since there is often a direct line of sight, so let me return to the things we need to do to drive top line growth.

I mentioned earlier that at this point in time, for us it's all about supply. We need to continue to refine our candidate attraction efforts to the most efficient and cost effective means of attracting talent. We're actively looking at all of the touch points in the candidate lifecycle to make sure that we are as competitive and easy to work with as possible. In this market, speed of engagement is critical to success and we want to make certain that every candidate is presented with the best opportunities as quickly as possible.

Another area of focus that we expect to drive organic growth is candidate retention or improved renewal rates, as Bill mentioned. We had seen a decline in the renewal rate in 2017, particularly our Travel Nurse and Allied businesses driven by a pullback in spend predominantly by several of our large clients as they continue to wrestle with their costs. While our renewal rates have already started to improve in early 2018 and are more in line with historic experience, we believe there is room for further improvement. Higher retention, obviously means more of our new candidates will be incremental and so we are actively working on initiatives to continue the improvements we have already started to see this year.

Before I turn the call of the Chris Pizzi, though, I'd like to just share a slightly more personal note. I've been with Cross Country Healthcare now for 4 years and as a Chief Financial Officer I have gained insights into the business and developed an appreciation for how we can operate more effectively as a company. Looking across our portfolio of businesses, we have tremendous opportunity for working more collaboratively for cross selling, for improving and streamlining many of our core processes.

All my career is predominantly been spent in finance, I've worked in many different industries with some incredibly successful companies. Those experiences have prepared me well for the task at hand in my new role. While our focus remains on delivering significant value to our clients, through our staffing solutions, we recognize clearly that we need to execute well across all fronts. Seeing the opportunities we have for improvement and being in a role where I can focus specifically on that with the majority of my time, is precisely why I'm so excited about taking on this new role. I look forward to sharing more insights with you and our -- on our plans and updating you on our progress as we move throughout 2018.

Now, let me turn the call over to Chris Pizzi who will review the fourth quarter and full year results.

Thanks Bill. For the full year total revenue was $865 million, up 4% from the prior year primarily driven by the acquisition of Advantage RN. Our gross profit margin for the year was 26.4%, down 20 basis points from the prior year. Adjusted EBITDA was $43.4 million or 5% of revenue as compared with $44.7 million or 5.4% of revenue in the prior year. Our net income attributable to common shareholders was $37.5 million or $1.01 per diluted share compared to $8 million or $0.15 per diluted share in the prior year. Adjusted EPS was $0.61 compared with $0.69 in the prior year.

Revenue and adjusted EBITDA for the quarter were below guidance, primarily in our Nurse and Allied staffing business due to fewer overall placements and lower renewal rates. We also experienced a higher than expected reduction in premium rates, as well as the impact from the disruption of Hurricane Irma. Despite these events, we increased our gross profit margin over the prior year and in the quarter within guidance. From an operating leverage standpoint, the company has taken certain steps to improve its leverage through cost containment measures. As a result, we incurred restructuring costs of $300,000 during the quarter.

Turning to the quarter, total revenue was $219.7 million dollars, down 1% from the prior year and down 4% sequentially. The year-over-year decrease was primarily due to premium rate declines in our travel nurse business, fewer overall placements and lower renewal rates on existing nurses and the non-recurring project business in the prior year, which were offset by the Advantage RN acquisition. The sequential decrease was mainly due to lower volumes in our legacy Nurse and Allied and Physician Staffing businesses. Gross profit margin for the quarter was 26.5% up 60 basis points from the prior year and flat sequentially. The year-over-year increase was primarily driven by improved margins in our legacy Nurse and Allied business related to higher workers compensation and health insurance costs incurred in the prior year.

Moving down the income statement, SG&A for the quarter was $46.3 million, flat to prior year, despite adding $3.3 million in the quarter for Advantage RN. SG&A was down 2% sequentially due to the cost containment measures taken during the third and fourth quarters. Adjusted EBITDA was $12.3 million or 5.6% of revenue as compared with $12 million or 5.4% of revenue in the prior year. Below adjusted EBITDA, we incurred a non-cash impairment charge of $14.4 million related to our Physician Staffing segment as revenue declined 5% and contribution income declined 36% for the full year, driven by revenue shortfalls, coupled with investments made in revenue producing employees.

Depreciation and amortization expense was $2.8 million, up $600,000 from the prior year and flat sequentially. The year-over-year increase was due to the impact of the Advantage RN acquisition. Interest expense was $1.2 million, down $200,000 from the prior year and flat sequentially. The year-over-year improvement was due to the higher interest rate on our convertible notes which were repaid in March 2017.

Income taxes for the quarter resulted in a benefit of $35.8 million driven by the release of our valuation allowance on our net deferred tax assets, partly offset by the impact of the 2017 Tax Cuts and Jobs Act. The release of the valuation allowance was driven by our consistent and sustained pretax income for 12 consecutive quarters and our projections of pretax income, which are expected to exceed future tax deductions. Due the release of the valuation allowance, we believe our ongoing effective tax rate will be more normalized and that our remaining NOLs should offset the majority of cash taxes paid until 2019.

Net income attributable to common shareholders was $28 million or $0.77 per diluted share as compared with a net loss of $7.9 million or a loss of $0.24 per diluted share in the prior year. The current included the net favorable noncash income tax adjustments of $34.5 million, partly offset by $14.4 million noncash impairment charge. The prior year included of $14.2 million noncash loss on the derivative in the convertible notes which were repaid in March 2017. Adjusted EPS was $0.17 compared with $0.20 in the prior year and $0.23 in the prior quarter.

Next, let me review the quarterly results for our 3 business segments. Revenue for our Nurse and Allied segment was $193.7 million, flat to the prior year and down 3% sequentially. While the segment was flat on a year-over-year basis, the lower volumes we experienced in our legacy Nurse and Allied business were offset by the Advantage RN acquisition. The sequential decrease was mainly due to lower volumes in our Nurse and Allied business offset by growth in our education, healthcare, staffing business. Revenue per FTE per day was $280, down 5% from the prior year and 1% sequentially. We averaged 7,521 field FTEs for the quarter, up 5% from the prior year and down 2% sequentially. Segment contribution for the quarter was $19.2 million, representing a 9.9% contribution margin, up 60 basis points from the prior year and down 40 basis points sequentially.

Turning next to our Physician Staffing segment, revenue was $22.6 million, down 9% from the prior year and 9% sequentially. Both the year-over-year and sequential declines were mainly due to a shift in mix of specialties within our Physicians Staffing business and an overall shift in mix in the business, driven by growth in our advanced practice business, which generally has a lower daily bill rate. Revenue per day filled of $1,489 was down 7% from the prior year, largely due to the mix impacts mentioned earlier. Segment contribution income for the quarter was $1 million, representing 4.7% contribution margin, down 440 basis points from the prior year and down 70 points sequentially. These declines were largely due to investments made in revenue producing employees which led to lower operating leverage in the business.

Finally, revenue for our Other Human Capital Management Services segment was $3.4 million, representing a decrease of 8% from the prior year and an increase of 8% sequentially. The year-over-year decline was primarily due to fewer executive search placements, partly offset by growth in physician search placements, while the sequential increase was due to a higher number of placements and retained searches during the quarter. Segment contribution loss was $200,000 as compared to a loss of $300,000 in the prior year and breakeven in the prior quarter.

Turning to the balance sheet, we ended the quarter with $25.5 million of cash and $100 million of debt outstanding at par. As of December 31st, we did not have any amounts drawn on our $115 million revolving credit facility. During the quarter, we generated $16.8 million of operating cash, which increased the full year to $45.5 million, an increase of 51% over the prior year. Our DSO, net of subcontractor payables, was 58 days, representing a 3 day increase from the prior year. Generally, we believe that our DSO should average in the mid-50s with the exception of timing for collections at certain period ends. For the quarter, our capital expenditures were $1.1 million and in line with our expectation.

Finally, this brings me to our first quarter 2018 guidance. We expect consolidated revenue to be between $205 million and $210 million, reflecting a range of negative 1% to positive 1% year-over-year growth. Gross profit margins are expected to be between 25.5% and 26%, reflecting the sequential impact of the annual payroll tax reset of between 70 and 80 basis points. For adjusted EBITDA, we expect to generate between $6 million and $7 million, reflecting the sequential decline in gross profit on lower revenue. Finally, adjusted EPS is expected to be between $0.01 and $0.03 for the quarter. Our guidance assumes the following estimates. $2.9 million of depreciation and amortization expense. $1.3 million of interest expense, $1 million of stock compensation expense, $300,000 of tax expense and a diluted share count of 36.3 million shares.

Before we open up the lines for question, I would like to turn the call back over to Bill Grubbs.

Okay. Thanks Chris. To wrap up, although we had headwinds in the fourth quarter, some of which will carry on into Q1, I am encouraged about the underlying trends driving our business. Demand in the market remains strong and we are seeing an increase in orders across all of our businesses. Our organizational changes should give us renewed focus on execution and operational improvements.

Advantage RN is on track and making strides to support our goal of a higher capture rate at our MSPs. We still have approximately $75 million of business to ramp at MSPs we won last year and our pipeline for new MSPs remains strong. And although, we saw a lower renewal rate on our nurses in Q4, we have seen an improvement back to more normalized levels in Q1 and we'll continue to work diligently to build on that and to drive shareholder value.

So this concludes our prepared remarks and at this point, I'd like to open up the lines for questions. Operator.

(Operator Instructions) And our first question comes from Brooks O'Neil from Lake Street Capital Markets.

Yes, no problem.

Bill, you mentioned in the press release and I think in your prepared remarks that you're going to take steps to reduce costs further and then you also commented about a new travel system in your largest business. When do you think those initiatives will be completed and when do you expect to see benefits from them in your operating results?

Let me start with the second one first. So replacing the legacy system in our travel nursing business won't be complete probably until towards the end of 2019. And I will let Bill Burns tell you about the cost savings. This is his baby.

Yes. So Brooks, as you heard us say, there's really 3 areas of focus here. One is on the rightsizing the cost structure in our 2 businesses that have struggled, which is Physician Staffing and search, and so we'll be looking at that over the next several months to understand what's it going to take to either get the -- accelerate the growth or to right size that cost structure. We have already begun having those conversations. The other parts of the cost action...

...most of that $5 million in this year.

Yes. I mean it won't be we all realized this year, but we should have a substantial chunk of it recognized by the fourth quarter, that's our goal anyway. And then, if you look at the rest of what we're talking about, there's really 2 pieces I mentioned. One is on the operations and one of on the corporate side. As we look at -- I'll just kind of give you the background -- back of the envelope here. But as we look at our corporate expenses, generally speaking, we think that there's opportunity there of probably somewhere in the mid-single millions of dollars of savings just as we continue to streamline our organization and centralize our functions et cetera. We've recently completed an effort to get on to one ERP systems for our backs office, so we think should drive some of the savings we expect on the corporate side. The real challenge is going to be on the operational side. I mentioned some of the things that we have in common across all of our businesses. When you look at things like credentialing and onboarding, that's certainly an area of focus for us. When you look at things like candidate sourcing and how we go about getting that -- I mentioned it's not only a key to organic growth, but it's also a way in which we want to continue to find the most cost effective and efficient means. They don't all have the same conversion rate, so we don't publicly give the conversion rates. But that's something we're definitely targeting as we go through the mix of our activities on candidate attraction. So there's operational efficiencies that are driven off of those type of activities.

And then the second portion of operational activities is somewhat tied to the system implementation through our travel nurse business that Bill mentioned. That project will take a bit more time to get through, but that also should yield additional savings. Maintaining an old 30 year old home grown [greenfield] system is more costly in both the people we have to have on board as well as the efficiency and the ramp time and productivity of our recruiters and revenue producers. So we will expect to see more improvements on the operations side as those systems or tools go live.

Okay. And then I'm curious -- I guess, I have to confess that Q1 guidance surprised me a little bit. I understand the impacts in Q4. Can you talk just a little bit about seasonality? And how that might be affecting your outlook for Q1? And then sort of -- I know you're not giving guidance for all of 2018. But just maybe speak to us a little bit about your expectations for what I assume is fairly significant improvements Q2 and beyond.

Yes, so let me start with the second one. We do believe we will grow organically in 2018 and we do believe we will have an improved adjusted EBITDA margin for the year, partly from the revenue growth and partly from the cost savings that Bill talked about. But we debated about giving full year guidance, we decided not to do that. And yes, it looks like we're starting weak in 2018. But that's all due to the fact of these disruptions in Q4. Once you set the base in Q4 to a lower number and our travel is own assignment, from Q3 to Q4 we're down over 200. And once that base is reset, you just don't rebound in one quarter. I feel very good that our operations are strong. That this was not an execution issue in Q4. We're seeing our capture rate go up with our MSPs. We're seeing our conversion rates hold fairly well. We're seeing our renewal rates back to normalized levels in Q1. You just don't rebound that quickly when you reset the base in Q4. So the softer Q1 is not about execution, not about underlying market trends, not about anything else other than the base got reset in Q4 and we just have to build back up from that base. So I feel good about where we are, even though the numbers aren't showing that. Okay. Thanks.

And our next question comes from Tobey Sommer from SunTrust.

Could you describe your current fill rate, and fill rate trends in recent quarters? Is it possible delineate between the total company and the MSP business?

Okay. Well, -- so at MSPs, we call it a capture rate. I think that's what you're referring to from a fill rate. And I'll give you the relative. We said it was in the mid-50s before the fourth quarter. It's gone up a couple of hundred basis points, so it's more towards the high-50s now. It has not passed the 60% mark. We expect to go above 60% in 2018 from a capture rate perspective. So the portion of our MSPs that we're filling ourselves is going up, as I said, a couple hundred basis points sequentially and we expect that to continue going forward. The problem is some of those MSPs pulled back somewhat in Q4, which is why our renewal rates were lower and that increased capture rate was not enough to offset the lower renewal rate or the pullback from key customers. One of these other guys here will tell you what the percentage of our total revenue is from our MSPs. Today, because of the pullback it did go down a little bit, I believe, in the third quarter. It went from 29% to 27% -- 28%, basically. Well, that was Q4 last year to Q4 of this year, it went from 29% to 28% and we look at sequentially...

Sequentially, it's about flat, 27.8% to 27.7%.

So sequentially it's flat about 27%. And if I missed part of your question, Tobey, just remind me please.

No, I'm just trying to understand the dynamic here between MSP and the rest of the book of business. Maybe I can ask you another question. Does the -- is the company in a good position to continue to pursue new MSP business? Or maybe there's a need to put in place an increased ability to kind of substantially increase placements first? And the reason I ask it that way is, I'm trying to understand how you can balance making new commitments to guaranteeing placements for MSP customers without an already established pattern of organic growth?

Right, that's a good question. And we've had that question before in various formats. I don't think it needs to be an either/or answer. I do believe that we can do both. And we've actually done very well at our new MSPs. So I don't think that's holding us back. I mean, yes, Bill -- Bill Burns mentioned that candidate attraction is a big focus for us and we believe we can get better at attracting candidates and retaining candidates, and I think that will help us not only ramp up new MSPs, but also to increase our capture rates. So I don't think it needs to be one or the other. We don't need to stop doing one for the other. Our pipeline is strong for MSPs. We have a good value proposition. Our customers are very happy with the service we're delivering to them. We're meeting all our service level agreements. We don't have any issues with our MSP relationships. As I mentioned, we didn't lose any customers in Q4. So it's not like we're not performing at them. It's these underlying disruptions that are affecting the numbers, not the fact that we're -- we have MSPs and we're winning new ones. Bill you want to add anything to that? No?

No. I guess, I would just say -- Tobey, I would say, yes, we want to continue to expand the spend under management. We think as we've talked about, that that gives us an opportunity as we go forward to continue to increase the capture rate, as we get other operational things moving in the right direction, and we leverage the full business to get the supply growing faster. But as Bill mentioned, we're not having any service issues with the large accounts. We're able to leverage our network of other subcontractor to continue to meet the full SLAs. And as we get -- as I said, we get our recruiting back on track and our renewal rates growing in the right direction, we'll continue to raise our capture rate and grow within to cut spend.

So without the Irma disruption and resetting our base to a lower number of people out on billing, if we continue to increase our capture rate by 200 basis points a quarter, that's a huge difference for us and we believe we can continue to do that. And so to put Bill's comments about candidate attraction and those efforts, it's not like we're not doing it. We're not doing enough to grow the business, forget all the disruptions, we just think we can get better at it and that we can get back to at or above market growth. So it's not about we're not doing a good job of it, it's just about improving it.

Right. And we believe that there is always an opportunity no matter how good you get at this to continue to improve. So we're rechallenging and looking at everything that we do to make sure that we're as Bill mentioned, as agile or as fast as we can be with engaging with healthcare professionals.

And actually that's probably the best point that's not in our prepared remarks is -- to me, our biggest challenge isn't the market and isn't these things that I think will be short term in nature regarding the disruptions to our business. It's the fact that we have not been agile enough or nimble enough to adjust to either changing customer needs or changing market needs. And this is why we've put this new structure in place. But with Bill Burns focusing 100% on day-to-day operations and separating our travel nurse from our branch operations, we believe, that will make us more nimble and able to make decisions faster and adjust our business to changing marketplace.

Could you give us a new color -- or additional color, excuse me, about the investment in new system, that migration cost savings, and other goals that you hope to achieve as well as the expected timing?

Sure. So the expected timing is going to be fully ramped up between the third -- between the second and fourth quarters of this year and then the first 3 quarters of next year. And we anticipate in 2018 about $5 million to $6 million of spend and again, $5 million to $6 million of spend in 2019 with about 20% of that being operating expense. And I think the overall targeted savings is about a few million...

Well, yes, we haven't sized it. It's specific to the system implementation.

Okay. But there will be millions of dollars of savings from implementation of this system that will be the final step that gets us over the 8% adjusted EBITDA. So we do need this to be completed to get to that 8%. But it's about a $10 million to $12 million total project with about 80% of it capitalized over a 2-year period.

I know you don't guide for the year, but should we think about 2018 as a flattish EBITDA year or with the investments in just below starting place in the first quarter, is it more like a slightly down here potentially?

No, I don't expect it to be flat and I certainly don't expect it to be down. I do believe we will get growth in Q2, Q3 and Q4. Bill Burns will get better profitability out of our Physician Staffing and our search business. We have some cost savings initiatives on top of that. So we already have some cost savings that we put in, in the fourth quarter here that we'll carry through into subsequent quarters in '18. So, no, I expect we'll have a decent increase in adjusted EBITDA dollars and percentage in 2018.

What's your appetite Bill for -- at least near term for acquisition?

It would be very targeted. Although, we got off to a slow start with Advantage RN in Q3. That's back on track now, so I feel very good that that's starting to make a difference and help us to increase our capture rate. But my biggest target would be on the school business. Our school business is growing at -- we said, over 30% year-over-year. It has a great bottom line. We have some great talent in that business that we think has room to grow and expand. So I think right now that would be my #1 area to look at. Would I be opportunistic if something else came across the table that looked good and that made sense? Yes, but from a strategic standpoint probably schools at this point and then the rest of my focus would be on getting -- making sure that we do see the improvement in revenue and bottom line for 2018.

And our next question comes from Jason Plagman from Jefferies.

So I just wanted to drill down a little bit further on market demand. So are you seeing any difference in order flows between your MSP clients and in the non-MSP business?

A little bit. As we mentioned in the fourth quarter, we had a few of our larger MSPs pulled back a little bit. But generally our MSP orders are going up. In fact, they're up quite a bit year-over-year and they've been going up sequentially almost every quarter up until the -- well, actually our orders are still pretty strong in Q4 even though we saw the pullback in several customers. So we see -- I don't have the exact stat, but my guess is that, the increase that we've seen from Q3 to Q4 and Q4 and Q1 is probably half general market and half new MSPs that we've won.

But you are seeing growth in the non-MSP order flows as well?

We are.

And then just wanted to -- as far as your outlook for -- your performance in Q4 and outlook for Q1. Was there any difference in performance between the travel nurse and the branch operations that you would call out or what are the dynamics in each of those 2 sub-segments?

In Q1? Yes. So I -- this is Bill Burns. I would say that the impact in Q1 for the guidance that we've delivered is predominately due to the softness we experienced coming out of the fourth quarter in our travel nurse business, and that's what's really impacting most of the first quarter. We actually have reasonable growth coming still from our education business. We have kind of continued soft performance in our physician business and we're actually expecting pretty decent performance out of our search business. So...

And travel allied as well.

And travel allied as well. So it's really been about travel nurse and how they exited the year coming into this year. As Bill mentioned, those orders take time to -- once you exited that new run rate, it takes time to build back up the core.

Look, if you're down a couple of hundred nurses in Q4 then you're carrying off into Q1 -- obviously, that lower rate, plus a high percentage of those 200 extra nurses would have renewed going into next year as well. So we kind of have a double whammy that you just have to build back up from and we have seen a build. Since the first quarter -- since the first month -- week of this quarter up till to the end of February, we have seen constant growth in our billable headcount of travel nursing. It's just harder to makeup that -- the shortfalls from the disruption in Q4.

And did you see -- is the -- the branch operations is that declining just less so or flatter or is that growing just -- where -- how is that been performing during this period?

It's been growing very well. We don't give specific guidance on the subsectors in the go-forward basis. But our branch operations up until the fourth quarter, I know, had been growing at high single digit numbers and if we remove the project business...

Yes, that's the only challenge right now is its --

It had a lot of the projects business.

It had a lot of the project business.

But if you take the project business out of it, it's growing high single-digit number.

That's right.

Gross margin guidance for Q1, are you seeing any pressure there? Or is that more just seasonal mix for the Q1 guidance for gross margin? How are you feeling about that for 2018?

Yes, the decline that we're anticipating in the first quarter is really mainly due to the payroll tax reset, which we're expecting to be between 70 and 80 basis points.

But, we're not seeing particular pricing pressure on customers negotiating lower rates or that we're having to pay nurses higher wages that are negatively affecting our gross margin. We're certainly not seeing that. The overall rates are being affected by a lower percentage of our overall hours being in premium rates, and I'll give you a little bit of color on that. So premium rate -- the percentage of our total hours that were premium rates year-over-year is down 500 basis points and sequentially from Q3 to Q4 it's down a 140 basis points. That's -- that We thought it had been at a point where we are starting level off and that's obviously not the case. So we think we may have another quarter or 2 of some leveling off of premium rates and then it should normalize by the second half of the year.

And our next question comes from Jeff Silber from BMO Capital Markets.

Henry Chien calling for Jeff.

[Good Morning], Henry.

Just had a question -- just wanted to clarify that I am understand correctly that -- so I understand that the impact from the Hurricane, but -- on the lower renewal rates and the decline in premium rate business that you talked about earlier. Can you kind of elaborate a little bit on what's going on there in terms of why clients are having lower renewal rates and why you're just not seeing as much demand for premium rate or higher margins staffing?

Yes. So renewal rates, in particular, were really specific to the pullback of a few customers. So whatever the number was, we had a few customers that decided that they needed to cut back on their contingent labor spending before the end of the year. So the healthcare professionals that they normally would have extended didn't get extended in the fourth quarter and so our overall renewal rate went down. Like it went down sequentially by 630 basis points, which is a big decline. And when I first saw that I said, well, that's a terrible trend. But it's now back at 6 -- we've grown back that 630 basis points to a more normalized level in Q1. So it looks like it's very specific to a selected number of customers that just did not want to renew their contracts in Q4 because they had sticker shock on how much money they were spending on contingent labor. It looks back to normalized rates now. To answer that my whole 5 years here it has been at almost exact same percentage for every quarter I've been here up until this fourth quarter, so we do think it's very specific to those specific customers. Premium rates, it's -- we went back and looked at before the market really got busy in '15 and '16 and we looked to try to see what percentage of our total billable hours were at premium rates in 2014, what was it in 2015, what was it in 2016. And in the heyday of '15 and '16, when everybody was fighting over healthcare professionals, certain clients were willing to pay the higher or pay higher to be able to get the healthcare professionals. Now the market has more leveled off to a more normalized demand level and as such they don't need to pay as much premium rates as they used to. So we've seen it slowly come down about 200 basis points a quarter through each of the quarters of 2017. But it's now getting to a point where we believe it will be normalized after the next quarter or 2, to a level that will probably be a normal percentage of our billable hours in premium rate. So it's just the resetting of the market based on that demand leveling off from the heyday of '15 and '16.

And I understand that you are not giving any full year guidance and it's probably difficult to try to predict that. But what -- I am just curious in trying to get a sense of what would be a kind of normalized growth level, whether that -- if you look at the change in your orders for this quarter or any kind of metric that you look at on what growth could look like later in the year for Nurse and Allied?

Yes, so given an even playing field without the disruptions, we think a 4% or 5% year-over-year growth is where we should be getting to. So we get things back on to a more normalized level after Q1. We think we can get back to close to mid-single digit growth.

And our next question comes from AJ Rice from Credit Suisse.

Hi, AJ.

You didn't mention it, the flu, but obviously it has got a lot of press and I guess I could see that it could have had some impact on your branch or per diem business. Was there any flu impact or do you see any in the first quarter?

We do actually. The branches did benefit from the flu. Actually our travel allied with a lot of respiratory therapy was actually -- is part of the reason why our travel allied is growing in Q1. So we did see it, but it certainly wasn't enough to offset the disruptions that are carrying on into Q1 from Q4. But we did see a positive impact from the flu season and we are still seeing it now. Even that -- we track it certainly every week and it's starting to come off of its peak, but it's still a pretty strong flu season. So even though that is helping to offset the disruption from Q4, it's not enough to overcome it.

And when I hear you talking about some of the challenges in the Nurse and Allied, it sounds like you are couching those. It's mostly company specific. You are saying the underlying tone of the market is still pretty good. On locums, would you say that that's -- that sounds like that's more market, am I hearing you right on that or how would you describe what you see sort of seeing? I know it's not nearly as important a segment, but it's 10% or so. What are you seeing there?

Yes. So I told Bill Burns I was going to [home] through this. But I'm going to -- I'll start off. I will let him add to that. I actually -- it's -- sometimes it the perfect storm where everything kind hits at once. I'm not that worried that we had a shift in the mix of business, that's -- I don't know if that's market or just where our particular customers -- our MS -- sorry, our Physician Staffing is supporting, I think, 4, maybe 5 of our MSPs now and that maybe driving the change in mix. We had growth in several of our specialties, primary care. We hit growth in psychiatry, radiology. But some of those we adjust just at lower biller rates than some of the other areas. So the volume itself was off about 2% and the pricing was off about 7%, and I am getting confirmation from these 2 guys. So the 2% volume was really in line with Q2 and Q3 if the mix hadn't changed so much. So, Sorry, Bill I wasn't...

it's okay.

... anything you want to add color to that?

No, I think that was perfect. I think the advanced practice demand we're seeing is certainly a market condition. Our execution on the physician side is not because there's softness in the marketplace, it's more around our ability to execute on that side. So we're still recovering and getting the team up to speed. I think that we're doing all the right things. I believe we have the right metrics, the right visibility. It's really now just about execution. So...

So, as Bill mentioned, they have an infrastructure that probably supports $115 million, $120 million business. So if we don't see the -- both the volume and the rates -- or the revenue coming back, Bill will make sure that we right size the cost base.

And then, I know you've commented a lot about MSP. But I just wonder, are you seeing the competitive landscape around MSPs shift for any reason? Is that part of a dynamic? Is it becoming more difficult or not? Any thoughts on what the competitive environment looks like?

Yes, I mean, we do have some smaller players that have come up through the heyday of the big growth years in our industry that are starting to dip their toe in the water of providing MSPs and we see them a little bit more than we used to. It hasn't seemed to affect our win rate percentage and it certainly hasn't affected any lost customers. I think our number for this year was we won 23 new programs and I think we lost 2, so we netted positive 21. Chris is going to double check my numbers. So that -- I mean, if I keep winning 20 and losing 2 a year, I'm pretty good with that. I don't think it's causing any additional press on us at this point.

And it is my last question, I know you reaffirmed your target margin of 8%, any update on thinking about when you might see that?

Yes, I think we need the final push to get over that line is with that technology change in travel nursing and since that's not going to be done till the third or fourth quarter of 2019, we would look to get to a run rate of 8% by the end of '18 -- sorry, by the end of '19. So I think that's what will push us over the edge -- is that final element.

And our last question comes Mitra Ramgopal from Sidoti & Company.

Are you there Mitra? Okay.

I just wanted to follow up on the MSPs. I know you've averaged about 20 plus in the past 2 years and you've made significant investments to support that. I was wondering where you stand as it relates to implementation of the existing ones and how comfortable are you that you can continue to win -- I don't know, 20 for example, over the next few years without having to make significant investments to support that.

I don't think we need to make significant investments. I think we have a decent amount of resources to achieve what we need to. I'm not sure I'd predict another 20-year win this year. We won a couple already so far, one that was a pretty decent size. We are being a little bit more selective on some of them to make sure that they fit the profile that makes sense for us from a cultural standpoint as well as from a geography standpoint as well as a rate standpoint. But no, we have a good pipeline. We expect to continue to win our fair share this year. We're more focused on the dollar amount that we are on the number of wins. And so we may win less than 20 this year, but I think the target is to try to win another $100 million or so of revenue.

And let me just -- this is Bill Burns. We have a handful that are not yet live that were either recent wins. For the ones that are -- that we did win throughout '17, I think it's the exact number, but there's probably a dozen or so that are still continuing their ramp. We estimate or size the additional spend on the management that will be derived from that is about $75 million.

Yes, that's right. That's a good point, so that's still in progress ramping up for this year.

Okay. I think we've reached our maximum. Again thank you everyone for joining us today. We look forward to updating you on our first quarter results in early May.

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