Pediatrix Medical Group Inc (MD) 2008 Q3 法說會逐字稿

Welcome to the third quarter earnings conference call.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

I would like to turn the conference over to our host Mr.

Bob Kneeley.

Good morning, everyone.

Thanks for joining our third quarter earnings call.

Before I open the call up for comments from management I just wanted to read our forward-looking statements.

Certain statements and information during this 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 are based on assumptions and assessments made by Pediatrix management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors that they believe to be appropriate.

Any forward-looking statements made during this call are made as of today and Pediatrix undertakes no duty to undertake or revise any such statements whether as the result of new information, future events, or otherwise.

Important factors that could cause actual results, developments, and business decisions to differ materially from forward-looking statements are described in Pediatrix' most recent annual report on Form 10-K including the section entitled risk factors.

Before I turn can call over to Roger Medel and Karl Wagner, I would like to ask for your cooperation in giving as many people as possible the opportunity to participate during the Q&A station.

I'm requesting that you limit your questions to one question and a follow-up during the Q&A session.

We will allow for you to requeue with additional questions after that.

At this point I will turn the call over to Roger.

Good morning.

Thanks for joining our call today to discuss our 2008 third quarter results.

Our results this quarter are telling two stories.

One of a Company that is executing on a clearly defined growth strategy developing a new platform within the anesthesia services area and one of a Company that is bumping up against what appears to be cyclical issues within our core (inaudible) operations.

Our 15% revenue growth for the 2008 third quarter is largely the product of acquisition.

Acquired revenue includes contributions from our Fairfax and Atlanta Anesthesia practices, two of our current three groups in that specialty.

The third anesthesia group, Critical Health Systems of Raleigh, North Carolina was acquired on the last day of the quarter and you will see contributions from that practice impact our fourth quarter results.

Same unit revenue growth was 1.2% and was positive because of reimbursement increases from commercial payers and volume growth at our office space practices.

Our same unit revenue comparison continues to be pulled-down by lower neonatal intensive care unit patient volume which we've been experiencing since March of this year and a shift toward government payers that occurred during the third quarter which we announced last month.

During this call, both Karl Wagner and I will be focusing our comments on issues around managing our growth and working this apparent cyclical issue.

I want to emphasize that we continue to grow our business and we continue to invest in the resources necessary to support or business.

During the 2008 third quarter we bought two anesthesia practices.

At the start of the quarter Georgia Perioperative Consultants joined us.

They are the anesthesia group at Atlanta's Piedmont Hospital and Piedmont Fayette Hospital as well as at a few ambulatory surgery centers there.

At the end of the quarter, as I said, we acquired another large anesthesia group Critical Health Systems of Raleigh, North Carolina which has longstanding relationships with three hospital systems and several ambulatory surgery centers in that community.

These practices joined our Fairfax group which was acquired during the 2007 third quarter.

Within a little more than a year our American Anesthesiology group has added three well established anesthesia practices.

More than 450 clinical professionals working at tertiary care hospitals in three very attractive rapidly growing US Metropolitan areas.

We are seeing the clinical infrastructure investments in our (inaudible) business paying dividends as we talk with anesthesia practices which is helping us to establish a reputation for a physician centric national anesthesia group.

As excited as we are about our progress in anesthesia thus far, please allow me to remind you that this is also a very strong year for base business acquisitions.

With 10 base business acquisitions, four neonatal groups, three maternal fetal practices, and three pediatric cardiology practices, this year we have exceeded our guided estimates for 2008 base business acquisitions o 70 million to $75 million.

We continue to grow our base business and we continue to see opportunities to grow this business.

In each acquisition announcements there is a hint the reasons they are joining.

Reasons that we believe will allow us to attract additional groups for the foreseeable future.

Our largest neonatal acquisition of the year, a 25,000 patient day practice in Akron, Ohio that joined last month have worked on a number of neonatal collaborative studies.

As part of our group they are looking to expand the breadth of evidence based foods they are using to improve patient care.

This is also a practice that enjoys a great relationship with its principal hospital partner.

The physicians and the hospital are working together conducting outreach in an effort to expand their referral base in Northeast Ohio.

In Nashville we acquired a maternal fetal medicine practice that has a national, if not international reputation for clinical research.

As part of our national group they now have the ability to collaborate with other groups across the country.

The experiences that we can offer physicians joining our group are very different from what they are finding by remaining in private practice and that is is the ability for physicians to focus on patient care.

It is one of the many reasons why we are optimistic about our ability to continue to acquire practices.

We are also confident that our model has properly aligned the physicians interest.

I want to bring you back to one of the underlying tenets of our model which is our practice of using cash as our acquisition currency.

I think it is safe to say that given the market volatility of the past year, had we issued stocks to fund some of our acquisitions we would have physicians groups who would be unhappy.

Fortunately our physicians received a favorable liquid currency at closing and we successfully integrated those fruits into our national practice.

Finally, I want to talk with you about our management infrastructure.

Last month I spoke with you about our decision to change our name to Mednax and our ticker signal to MD starting next year.

That decision reflects the growth of our anesthesia services business and the optimistic view that we hold for that business and for our base business.

It is also part of us moving toward a holding Company structure.

Early in the third quarter of this year we promoted two of our executives to new leadership positions within what will become our pediatric division once the reorganization is complete.

Dr.

Frederick Miller now serves as President of our pediatric division which encompasses our neonatal, pediatric intensive care, maternal fetal, and pediatric cardiology physician services as well as our Hearing Screen program.

David Clark is Chief Operating Officer of the Pediatrix division.

Frederick is a Pediatrix veteran.

He joined us in 1991 and has served in various leadership positions, most recently as regional President for our Atlantic region.

Where he has done a tremendous job building that region since the year 2000.

David Clark has been with Pediatrix since 2001 when we acquired the Modella Healthcare where he served as Vice President of Development.

During the past seven years he has been a member of our regional operations team in Texas and most recently has served as Senior Vice President Operations of Pediatrix.

I am very pleased that we were able to fill these new positions from our existing management team.

People who understand our operations, our culture and our approach to the opportunities presented to us.

These executives have been part of our long-term success in managing our practices more efficiently.

We are confident that they will continue to make important contributions going forward.

With that let me turn the call over to Karl for a discussion of our financial results for the quarter.

Thanks, Roger.

I am going to spend the next few minutes going over our financial results for the three months and nine months ended September of 2008.

I will provide a quick overview of our results.

We are growing our business including the anesthesia services.

Our neonatal business is facing what we believe is a cyclical challenge and our margins are changing as an anticipated reaction to both our acquisition mix and base business challenges.

For the third quarter our revenue grew by 15% over the comparable prior year period to $267.2 million.

As Roger said, almost all of that growth is attributable to acquisitions completed during the past 12 months.

Same unit revenue growth was 1.2%.

Which can be broken down into net positive reimbursement growth even after the payor mix shift of 1.7% and net bottom decline of one-half of one percent.

On the reimbursement side, our ongoing improvements and reimbursements from third party commercial payers is being slightly offset by this shift to government payers.

There has been no change to our contracting strategy or results of the efforts.

We expect continued contributions in this area on ago forward bases.

The government mix shift is affecting revenue and margin.

To give you a sense of magnitude a 1 percentage point increase of government reimbursement results in approximately $10 million annualize reduction in revenue on average.

That average amount can vary by the markets in which the payer mix is occuring.

This is across our national met work.

For this quarter we saw a change of approximately 2 percentage points to our payer mix.

If you recall my comments on the October call our payer mix was unchanged in July.

The government payers as a percent of all payers increased significantly during the month of August.

During September our mix improved slightly from the August levels.

As we said in this mornings press release the impact of the mix shift was 2.2% reduction in ame unit revenue for the 2008 third quarter.

Assuming payer mix stays at current levels throughout the fourth quarter we expect the impact from the change to our mix will be a 3% reduction of same unit revenue.

On the volume side the 0.5% decline of overall volume consists of a3.4% reduction of our neonatal business which is toward the low end of our guided range of minus 1 to minus 4%.

Offset by roughly mid single digit volume growth from our office based practices.

Our maternal fetal medicine physicians are seeing higher demand principally from referring obstetricians and pediatric cardiologists are building their referral base among both obstetric and pediatric physicians.

We think this demand driver will continue.

I have given you a lot to absorb in the discussion of same unit revenue but this should help you understands the rest of the income statement discussion.

As I continue to discuss our income statement I will be comparing our 2008 results to no GAAP numbers fro 2007.

This non-GAAP presentation excludes costs associated with a stock option review and detailed reconciliation table is included in our press release which is available on our website at www.Pediatrix.com.

For the 2008 third quarter profit after practice expense was $96.2 million up 3% from the prior year period.

Profit after practice expense margins declined by 410 basis points to 36% for the 2008 third quarter from 40.1% for the prior year period.

Operating income declined by 2.4% to $62.2 million for the third quarter and $63.7 million for the 2007 third quarter.

General and administrative expenses were 11.5% of revenue down 25 basis points from the prior year.

Operating margins declined by 406 basis points year-over-year to $23.3 million for the 2008 third quarter.

As I said last quarter, our margins are shifting for several reasons.

We are seeing the issue of lower patient volume and the payer mix shift affecting our margins.

As we have said, we believe both these issues are results of current economic conditions.

At a fundamental level out acquisition mix has had and will continue to have the effect of reducing practice level margins.

This year our acquisitions are weighted heavily toward anesthesia and office based practices.

Both of which have lower margins than our neonatal business.

As the Raleigh acquisition rose into our fourth quarter results and beyond, this dynamic will continue.

When you look at volume growth and the practice related expenses required to support that volume there is a fundamental difference between our neonatal practices and other practices.

There is a step function to staffing levels.

We don't have to change schedules or add staff when the next premature baby is admitted there is a point at which volume requires additional clinical resources in order to provide appropriate clinical care.

More directly related to our P&L we typically see the revenue and then add the staff.

During the third quarter we have added neonatal physicians fulfilling commitments we had made earlier this year including the fellows who usually complete their training at the end of June and start working for us during the summer.

These staffing levels are required to support the practices based upon historical volume levels and will support growth that we anticipate in the future.

With our anesthesia and office based practices staffing growth and related costs precedes volume.

In anesthesia the operating room isn't open and procedures don't happen unless they provide the care.

In time, we do expect and we are seeing improvement in our anesthesia practices particularly from contracting improvement and better oversight in the collection function.

Continuing with our income statement discussion.

Our net interest expense was $639,000 for the third quarter as we have increased the use of the line of credit.

This compares with net investment income of $2 million in the 2007 third quarter.

Our provision for taxes is 39.25% which is consistent with our guidance.

Income from continuing operations was $37.4 million and we earned $0.81 per share based on a weighted average 46.2 million shares outstanding for the September 30, 2008 period.

This compares with income from continuing operations of $40 million for the 2007 third quarter and $0.79 per share based on a weighted average 50.3 million shares outstanding.

In the 2007 third quarter we had income from discontinued operations of $759,000 or $0.02 per share resulting in net income of $40.7 million or $0.81 per share.

That is a lengthy income statement discussion.

I hope it gives you a perspective on what we're seeing and how it is going through our statement.

To get back to a review of the quarter we ended the 2008 third quarter with modest cash balances of $12 million.

As we continue to use our cash and line of credit to fund acquisition.

Accounts receivable was $151.5 million at September 30.

AR has grown by 6% from September 30, 2007, which is lower than our revenue growth.

Resulting decline in day sales outstanding can be attributed to the on going revenue cycle management.

We ended the quarter with $171 million outstanding on a revolving credit facility and that include payments for two acquisitions completed on the last day of the quarter.

Cash flow from operations was $83.1 million up 32% from the 2007 third quarter.

The growth in operating cash flow can be largely attributed to improvements in the working capital account.

Specifically accounts receivable and the timing of tax payments.

We invested a quarterly record $188.7 million to complete five acquisitions during the quarter.

The bulk of these investments were in the Raleigh and Atlanta anesthesia practices.

The nine months results on a GAAP basis for the 2008 and 2007 our revenue grew by 15% to $770.5 million year-to-date.

Operating income of $176.6 million is up 13% in the first nine months of 2007, and income from continuing operations excludes the metabolic screening lab we sold earlier this year was $107.7 million up 8% from the prior year.

Earnings per share from continuing operations to the nine months of 2008 was $2.26 up 14% from $1.99 through nine months of 2007.

Our 2008 cash flow year to date from operations was $113.1 million up 14% when compared with the same period in 2007.

Finally, I want to discuss our outlook for the going forward period.

For the 2008 fourth quarter we are now expecting to earn between $0.77 and $0.81.

Reassumptions for the fourth quarter include same unit volume with no change or decline of up to 2% on a year-over-year bases.

Actually, our preliminary information on same unit volume for October shows patient days equal to October of last year.

This is the first month we haven't seen a negative year-over-year comparison since February.

Given the volatility we have seen over the last several months I think the conservative call is for a range of unchanged to minus 2% for the quarter.

On payor mix, remember that we saw government reimbursement as a percent of overall payor mix increase in August.

Our third quarter results won't include only two months with the higher government payer mix.

For the fourth quarter we assume the full quarter impact of the payer mix shift was about a $2.5 million reduction in anticipated revenue.

As of today we have information for about three-quarters of the month of October and it suggesting that our fourth quarter payer mix is starting out about the same level as September which means a higher percent of our revenue mix is coming from government payers on a year-over-year.

In looking at our business historically we typically see slightly less neonatal volume in the fourth quarter than in the third.

That is a function of the timing of births in the country including premature births.

Our office space and anesthesia practice volumes are driven largely by scheduled appointments and procedures.

The way the weekends and holidays fall there is one fewer business day in the 2008 fourth quarter than the third quarter and our assumption for that period includes one less day of revenue from these practices.

We are very much encouraged by our business development pipeline.

We can provide some guidance for 2009 acquisition contributions.

In our base business we now expect to invest 70 million to $75 million to acquire neonatal, maternal fetal and pediatric cardiology practices.

We expect the multiples paid for these practices based on pro forma contributions will remain within our historical ranges.

We also expect to complete two to three anesthesia practice acquisitions throughout 2009.

It is difficult for us to predict the timing of these acquisitions.

I expect that we will continue to provide you with specific accretion estimates when these transactions are announced.

At this point it will be difficult for us to make predictions about patient volume or payer mix for 2009.

We continue to see reimbursement growth as a result of contract improvement from third party commercial payers.

Those improvements could be offset in whole or in part by higher government payer mix.

We will have to wait to see how how the current economic conditions will affect our business going forward.

We hope to provide you with future information on our fourth quarter earnings call in February.

At this time let me turn the call back to Roger.

Before opening up the call for questions let me address the topic that is on top mind given that we are now on day one of the 2012 presidential campaign.

In recent weeks it has become fairly clear that healthcare initiatives moved lower down on the priority list either in terms of appetite for major reform or for ability to fund that reform.

I think that our new administration is going to be hard-pressed to advance sweeping reforms.

It is clear, however, that the legislative agenda for 2009 will include some form of physician fee schedule fix and will address the supplemental government insurance program for children in some ways.

As a reminder S-chip is a small piece of our business.

The best way to ensure that it remains a small piece of our business is through effective crowd out language.

Essentially we are proponents of S-chip as a safety net.

It should not compete against private sector healthcare plans.

The last time S-chip was addressed in late 2007 we were comfortable with the crowd out language that was in bills at that time.

We have taken a lot of time with our formal comments and at this point I I would like to open up the call for questions.

Operator?

(OPERATOR INSTRUCTIONS) Our first question comes from Dawn Brock with JPMorgan.

Please two ahead.

Good morning.

My first question has to do with commentary from the acute care hospitals over the last couple of quarters regarding a deemphasis on OB/GYN admissions and volume.

If they are not saying that their commercial admissions are dropping on their own but rather that they are deemphasizing the focus on that volume.

Is that a potential issue for you?

Is that something that you would see in your host hospitals or is that an incorrect connection to make because a hospital with that would naturally not deemphasize those services.

What do they mean by deemphasizing the services?

Afraid a mother shows up and she is ready to deliver she has to deliver.

What do they mean they're deemphasizing those services?

It's interesting.

I think you are thinking along the lines I am.

What are we going to have the cardiologist deliver the baby?

The commentary is more around going after higher service lines and in those markets where maybe a competitor has a strong OB service line where they are actually going to stop emphasizing those services.

They will continue to have small beds attributed to OB but they are going to essentially shift those beds over to other higher end services where possible.

We don't believe that we are losing market share to other hospitals in our communities.

We don't think that is what is going on.

We think we would know that if a group of obstetricians stopped delivering the patients at our hospital and moved their practice to a different hospital, we would know that.

We don't have any evidence that is what is going on so I mean I don't know what they mean by deemphasizing OB services.

Are they going to be marketing more services differently or something like that?

That could be going on, but I still think it is hard to say that when a mother comes into the hospital and she is ready to deliver.

I still think it is the obstetrician who brings patients to the hospital.

I don't think mothers decide where they are going to go deliver based upon ads in the newspaper.

The idea is the fact that it is a very, very low profit center for the hospital even though it is obviously, as we all know it is a place where you actually develop your relationships and develop stickiness within a community.

It seems as though they are stepping away from it.

I appreciate your answer there.

I guess the other question that I have.

My follow-up would be you talked about the cyclical challenge.

Could you talk or maybe just give us your thinking around whether or not you have focused in on whether or not you do think it is more economic, whether or not you do think it is more a reversion to the mean or whether or not you feel there is any additional clarity around that right now?

I think that our best guess is that the payer mix shift is related to the economy.

It is clear to see that as people lose jobs they lose their health insurance and so I think we can attributes the payer mix shift to that.

As far as the draft in births, it is still very difficult for us to make a, or to reach a conclusion as to what is going on.

That is because we still see significant variation on a month to month and quarter to quarter basis going on across the country.

While we see one month a particular state or particular region may be down in double digits, the following month they may be flat or up in single digits and the other way around.

For us it continues to be difficult to say exactly what is going on.

Our best guess at this point is that it is just a reversion back to the mean of 4 million babies that was the norm for the late 1990s and through the early 2000s.

Right now it is difficult for us to clearly understand what has caused the change in births, whether it is economic or reversion to the mean, but it is happening.

I do believe the payer mix is representative of an economic change that has occurred that we would expect when economic times change.

You will see that come back is our expectation.

Going back to your first question on hospitals deemphasizing their OB services.

I don't think we would expect to see that in units that have level three care.

Most of our patients are cared for in level two units.

We do have a mix of level two and three units.

It has been developed for the strengthening of the OB care.

The level three units I wouldn't expect to see a deemphasis in OB care because it has been developed for that strengthening of the OB care in the hospital.

The large levels are typically very profitable for a hospital.

I would expect that they would not want to lose that profitability in the hospital in deemphasizing the OB services.

Thank you very much, guys.

Next question is from Sudeep Singh with Deutsche Bank.

Good morning.

Thanks for taking the question.

I guess just to piggyback off of Dawn's question, I am just curious to hear your take and whether you guys get this type of information from your hospital clients.

I am curious to get a sense of your hospital clients and overall portfolio.

How many of them are really, with regard to the OB budgets how many are continuing to invest going into 09 and how many of them do you think would keep their budgets somewhat flat going into '09.

Well, typically, the hospitals invest in capital equipment and so that is more a function of specific needs, bass nets if they need if bassinettes need to be changed or ventilators or that kind of stuff.

I would not expect that in our medical directors which there is one in each unit participate in the budgeting process, with the hospital.

They will get together with the nursing director and start talking for the next year about what equipment they think might be needed in their neonatal ICU.

If there is like, I want a new ventilator because it does double back flips or whatever then that is more of a I would like to have kind of a presentation.

I don't think there are too many of those going on this year.

But I haven't heard from our medical directors that there are any specific I need or I must have pieces of equipment at the hospital that it is not buying.

I haven't heard any specific complaints from our medical directors about this budgeting cycle being different from any other one.

Okay.

I would agree with that but add to it.

There are several units that had discussions and plans to expand their neonatal unit.

We haven't heard any discussion from the hospital saying they don't plan to continue and go forward with those projects in the future.

We haven't heard these plans to pull back on the capital it had committed in the past.

I guess to follow-up to that.

As an outsider looking in to this business can I make a simple assumption and assume that in a given market if you have two hospitals and one is continuing to invest in the OB where as one is not or is keeping their budget somewhat flat or even cutting their budget as it relates to the OB, can we assume the one that continues to invest could actually win, hypothetically could win market share in terms of birth volume or is that too simple of an assumption to make?

I believe that would be a longer term situation where that could occur.

The OBs in a market typically place their offices close to the hospital that they would be delivering at.

Over the long-term if a hospital can recruit OB practices to relocate their offices closer to their campus that clearly would improve the deliveries at that hospital on a immediate change it would take time for that to occur.

The OB practice would need to make decisions on where they were going to deliver and how they would move it there and several of their patients for the near term would already be planning their delivery at the hospital that they are at.

I would also add to that that I think it depends on what they means by deemphasizing.

If they are cutting back nursing staff, yes, because obstetricians depend tremendously on the nursing staff.

Their mothers show up, they are in labor and they are waiting for the nurses to call the obstetrician who doesn't want to sit there for six hours and tell them that the mother is ready and the fetal monitoring strip is looking okay.

If it is a matter of the obstetricians are not going to have the nursing staff or the equipment that they need, I think the answer is yes.

That hospital loses market share.

Our next question comes from Bill Bonello with Wachovia.

Go ahead.

A question around the neonatal acquisitions.

I'm just curious if you can speak a little bit to how you get comfortable with how much to spend for additional acquisitions given the current mix and volume trends?

We are looking at our pipeline.

We are managing for the long-term.

We believe this is cyclical .

We are looking at, obviously current volumes and that does have an impact on what we pay for practices.

With the volume going down and the payer mix changing they're not just changing for us they are changing for everybody across the country.

It does have an impact on what we are paying for

Is it possible that if volume and mix returns to more normal for historical trends in a way you kind of purchase the practice at a discount?

That is what we are counting on.

That is great.

I'll get back in the queue.

Thank you.

Our next question comes from Gary Taylor with Citigroup.

Please go ahead.

Good morning.

A few quick ones.

First on the comment about the October patient days being flat year-over-year.

Is there any geographic color you can provide?

Particularly, Florida has been an area of concern, but anything else you can discuss on that?

As I said earlier we have not been able to make heads nor tails of what is going on geographically.

You will see one state or one region that is negative during a quarter or month and will be exactly the opposite the following quarter or the following month.

For us it is just continues to move up or down in a manner which does not allow us to reach any significant conclusion.

That doesn't apply to your large markets must have done better in October given how much of your business they are, I guess.

My second question is can you talk about how much of a lag, if any, in the job environment, employment environment there is in terms of how it impacts your business?

In other words, you get a pregnant mother, she has benefits because her husband has a job.

The husband loses his health benefits, loses his job two months before delivery, is that child at the NICU necessarily going to be Medicaid such that your peer mix shift is tracking in a realtime way what is happening in the job environment or is there some other mechanism whereby you may still have commercial benefits for that child?

Well, as you know, there is the COBRA effect which is that if somebody loses their job they still have the right for 18 months to continue to buy health insurance from their employer.

I think that that does play a significant roll, particularly with the pregnancy for two reasons.

One is that a pregnancy is sort of a planned.

It is not like you have an accident two months after you lose your job.

You know you are pregnant.

If you lose your job you might be more likely to apply for COBRA.

The second reason is that the majority of private obstetricians in fact that do not accept Medicaid.

If you lose your job during your six months of pregnancy and lose your health coverage, what it would mean at that point in time the mother would have to probably change obstetricians.

It is likely her current obstetrician does not take Medicaid.

For those two reasons we do think there is an impact from the ability to maintain your health insurance by electing to go with COBRA.

There could be some flag in this.

You think the COBRA obviously without a job and COBRA is expensive.

You think the incentive is there to pick up COBRA even without any core knowledge of a very expensive NICU stay for the pregnancy and the delivery itself?

Yes and particularly because I believe that most people when they lose their job they don't just automatically make the election to go into Medicaid.

I think the logical thing to do is to start looking for another job and try to get back on track as quickly as you can.

Yes, I think that is it.

Particularly if it is only going to be for a few months.

You don't have to take COBRA for the hole 18 months.

Just take it for the few months until the child is delivered.

It will also depend upon state eligibility rules.

They may not immediately be eligible for a Medicaid program.

In a lot of states in addition, in some employment situations they may be able to keep their benefits for the low end of a month or depending if it was a layoff that the employer may extend benefits for a period of time.

So that will impact that as well.

I agree with Roger, in order to have access to their obstetrician they are going to want to be sure that they have coverage for a period of time.

Some of these mothers it is not the first time they have a premature baby.

They already know that they can have a premature baby.

Some of them are being cared for by a paranatologist who is already telling them there is some likelihood their child will end up in the newborn--.

Those are good points.

I appreciate it.

It is fair to say that you can't tell if someone is on COBRA, right?

It just looks like commercial to you?

That's correct.

Thank you.

Next question comes from the line of Brooks O'Neil with Dougherty and Company.

Please go ahead.

Thank you for taking my call.

This is Deepak Chaulagai, I am filling in for Brooks O'Neil.

Karl, you made a comment in terms of the improvement you have seen in your anesthesia business.

What update can you provide on the continued investment you have made and the technology outside of acquisitions and how they are trending and what your outlook is for the business?

Our outlook for the business is strong.

I will talk about a few different areas.

When you talk about technology, one of the things we have been talking about is a billing system.

One of the nice things about the acquisition that we've completed in Raleigh is is the billing system they use is the one that we were heading down the path of using for the practice that we had already completed acquisitions of.

That will roll in nicely for our plan to move forward in bringing in house collections for the anesthesia practices that we have.

The infrastructure that came with the Raleigh practice also gives us a quicker step into bringing that in and the ability to more efficiently bring that into an environment that is used to doing the inhouse billing and collections for a anesthesia practice.

We look forward to starting that process.

That from an IT standpoint that is is our biggest first investment in our anesthesia practices.

In addition we are growing from using the infrastructure at Raleigh as well as the infrastructure here working on managed care contracting.

Predominantly it has been in Fairfax.

They are the ones we have had for a year.

We have seen nice growth which we've talked about in the past on the contract we've completed and we will continue to do some there.

We have done several contracts at this point in Fairfax and are happy with the way those have moved forward.

When we looking at the other practices we see opportunity by improving the billing and collections and managed care contracting functions, bringing Atlanta into the billing process that we talked about for Raleigh.

I think we do see opportunities and we do see the investment in the infrastructure and the investment we are making on the IT side for our billing system and paid dividends for the future.

To follow-up on that then.

You are talking about investment two to three acquisitions next year.

I am just curious if those are platform acquisitions or tuck-ins within your three existing practices you have now?

Any color on that would be helpful.

I would expect next year we will see a mix of that.

We may do one or two of them will be larger platform acquisitions and one or two would be tuck ins.

I think the tuck-in opportunity if they are out there, we may see the opportunities to do more of those smaller acquisitions.

We will look at that and gauge that as we go forward.

I do believe the opportunity in anesthesia with those tuck-ins continues to be very strong.

That is something now that we have done a few large platform type deals we will concentrate on those so that we can bring those in and bring improvements to them and work with them.

One of the other things we are excited about now that we have three large strong clinical practices it will be able to bring these practices together so they can share their thoughts and we can work together to develop the clinical structure for American Anesthesiology on ago forward basis.

They can help us think through how we integrate these practices amongst each other to improve the care provided and make sure the services they are looking for we are providing.

Thank you for your comment.

I will get back in the queue.

Next question comes from [Eric North] with RBC.

Please go ahead.

Karl, Eric, here for Kevin.

I am thinking about the payer mix shift.

Is it related to the rising unemployment or is it more a function of volume?

If so can you break down the two to three impact that you are seeing?

It is hard to tell if it is the employment or if it is the volume and what is really occurring on that.

What we are seeing is more of our patients are, as a percent are eligible and providing Medicaid as primary insurance.

That is what we are getting paid for.

Let me answer that, Eric.

There is a difference between this increase in volume and payer mix shift.

If we acquire a practice or a hospital somewhere that has a lot of Medicaid patients you will see our Medicaid percentage volume go up.

That is a reflection of a practice we bought that has a lot of Medicaid patients.

We will pay less for that practice because it will be a less profitable practice.

It is built in to what we are paying.

That is different from saying we see a shift where we have 53% Medicaid and 47% commercial and all of a sudden that changes to 55% Medicaid and 41% insurance.

That, what I think we're talking about here is the shift and not an increase in volumes cost by just acquiring practices that have a larger Medicaid make up.

The shift is the same unit shift.

When we talk about seeing a shift in our mix, it is not a result of acquisition, it is in the same unit analysis of our payer mix.

That's what we've seen.

As I said, in the third quarter we saw a 2 percentage point increase in our government reimbursed patients.

That was predominantly from August and September changes as July was the same as the prior year.

Extrapolating that into the fourth quarter we expect that will be on a full quarter impact 3 percentage points change in our payer mix on a whole quarter basis.

That is what we are seeing from a payer mix standpoint.

As Q3 compared to Q4 would that 1 percentage point change we expect about a $2.5 million quarter over quarter comparison reduction in our revenue because of that payer mix shift.

What we saw in October was it had stayed consistent with the September levels.

While we said September is slightly lower than August, it is slightly lower, it hasn't been a move shift anywhere back to where we were in July.

Our next question comes from the line of Gary Taylor with Citigroup.

One other question occurred to me.

Obviously your physician partners share, in practice profitability to a certain degree with the bonus structure.

Does the 3Q results and the 4Q guidance, does that fully reflect the lower bonus accrual for the profitability changes or is there still some of that that would still come through?

Is that fully normalized?

The results for the third quarter and expectations of the fourth quarter include any bonus impact that we expect to see as a result of these changes during the quarter.

There will be some bonus impact and that is reflected in what we expect to see.

That would be if you moved into '09 without any additional changes in mix, you would see your fourth quarter guidance would reflect the same sort of bonus payout you would see in '09 then, without any additional mix shift?

Yes, I believe that's correct.

Thanks.

Our next question comes from the line of Bill Bonello with Wachovia.

Thanks for taking the second question.

Can you just tell us, you might have said this, Karl, when you were talking about Q4 but I want to make sure I have it correct.

What a full quarter impact of payer mix shift is if it was negative 2.2 for part of the quarter what is it for a full quarter?

I think we said the impact was about 3%.

When you look at the numbers as we said a 1 percentage point change is about $10 million a year or $2.5 million a quarter.

We are expecting a 3 percentage point change in the fourth quarter based upon what we had seen in the latter part of the second quarter.

So the impact on the year over year basis is approximately $7.5 million from a same unit basis on a payer mix change.

Okay.

Wait.

If 1% is $10 million I get lost somewhere.

$10 million a year.

$2.5 million a quarter.

Sorry.

Can you just comment on how that flows through to pre-tax?

A -- I don't want to get specific, a significant portion but not all of it will be impacted at the bonus level.

Our 50% bonus plan, while in a significant number of our practices is not in all of them.

So it wouldn't flow through at 50% at the bonus level.

It would be something less than that.

Slightly less than that when we look at that number going down.

We haven't broken out historically what that piece is.

Just so I get that correctly, in other words more than 50% hits pretax?

That's correct.

Thank you.

We have another question from the line of Brooks O'Neal with Dougherty and Company.

This really is Brooks O'Neil this time.

I apologize, I got on late so if you have covered this in excruciating detail just let me know.

You are talking about a 1, 2, 3% mix shift change in the third and fourth quarters.

Can you help us with some historical perspective on the magnitude of mix shift you have seen?

It is my sense that in the recent past Medicaid has represented about 53% of your volume.

I am just curious over the years I know it swings around, everything swings in the business.

Are we talking about a pretty steady 53% or is there a pretty wide swing around that over time?

On a quarter to quarter basis we do see swings in those numbers as we've said in the past.

Typically in the first half of the year it is a little bit lower Medicaid mix in the second half of the year.

Can't tell you why that is, but historically it has been that way.

So we do see that swing in a quarter to quarter basis.

This is comparison to the same period in the prior year when we are looking at this change.

Part of the swing you've seen in the past would make it go up and down is because the number that's included in our annual filing is a total Company number and not necessarily a same unit number.

Over the last couple of years from the same unit standpoint our payer mix has stayed relatively constant.

We have not seen changes since what we saw in '04 flow through our '05 numbers.

I appreciate that and again, I am not trying to be a jerk here or probe unduly.

But obviously there is some suspicion that some of the change in mix is related to the economy.

I was hoping you might at least be able to look back to say 2000, 2001 whether there have been any material shifts in the mix on the same unit basis you are describing or even, God forbid, we look back to '90, '91?

I think going back to 1991, we won't have the data.

So I don't think that is something we could do.

Back to the 2000, 2001 timeframe we are talking about a much smaller population here at pediatrics than we have now that's looking at that impact.

You might have said this.

Again, I apologize.

Given the larger population you probably see a great variation across it but it may tend to smooth out.

Is that what you are saying?

Geographically there is a much broader array of regions and a much larger number of babies involved.

You are saying that today on the larger population maybe the swings are going to be less significant?

Is that right?

I think that is potentially true, although right now what we are seeing is the change in the payer mix is geographically widespread.

We are not seeing it isolated to one area.

One might suggest that whatever is driving that is affecting people and mix across the whole country, not at one particular area?

Yes, which is why we believe this is more economically based, unlike back in '04 where it was tracked to a couple of areas and as we looked at that it was directly related to changes in eligibility requirements in a couple of states.

It is very different from back in the '04 period when we saw a change.

All that makes sense.

Let me just ask one last question.

It is really for clarification.

Roger talked a lot about COBRA.

I understand that whole phenomenon.

What I don't necessarily understand is I have some sense that a mother might be covered by an insurance plan that would allow her, for example, access to an OB but perhaps, she might elect to enroll the baby if born prematurely in Medicaid, at the time of the birth.

Anything you can share with us with regard to how that might work?

I recognize there is probably variation state to state, would be very helpful.

Medicaid is the payer of last resort.

You can't go to Medicaid, -- you can't choose to go to Medicaid if you have insurance.

If you have COBRA and you have a child and the child is born, Medicaid is not an option for you.

So the only babies that might get enrolled in Medicaid at the time of birth would be babies born to mothers that are already in Medicaid?

Or babies who just don't have insurance period.

Okay.

Thank you very much.

(OPERATOR INSTRUCTIONS) We have a question from the line of Bill Bonello with Wachovia.

Just one last question tying together the volume and mix.

Is there any possibility that the two issues are related?

In other words given what you said about a big chunk of private OBs don't even take Medicaid, is it possible that as people lose their commercial insurance, mothers that would have had their babies at the hospitals where you practice are perhaps being admitted to some other maybe more community type hospital where you don't practice?

Again, we don't think that we are losing market share.

Our analysis is that, there are fewer births going on not only at our hospitals but also at other hospitals where we don't provide care.

It does not feel to us like we are losing market share.

Okay.

Thanks.

Just a quick follow-up on that.

In addition that would be understandable if we didn't have a fair amount of Medicaid patients coming to our hospitals already.

Based upon the mix of patients that we have in our hospitals they are and there are OBs, significant numbers that are admitting to that hospital because of the Medicaid mix that we do have.

Thank you.

There are no further questions in the queue.

Well, if there aren't any further questions then thank you for your attention this morning.

Ladies and gentlemen that does conclude your conference for today.

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