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Edited Transcript of CCRN earnings conference call or presentation 1-Nov-18 9:00pm GMT

Q3 2018 Cross Country Healthcare Inc Earnings Call

Boca Raton Nov 2, 2018 (Thomson StreetEvents) -- Edited Transcript of Cross Country Healthcare Inc earnings conference call or presentation Thursday, November 1, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher R. Pizzi

Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer

* William J. Burns

Cross Country Healthcare, Inc. - Executive VP & COO

* William J. Grubbs

Cross Country Healthcare, Inc. - CEO, President & Director

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Conference Call Participants

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* Albert J. William Rice

Crédit Suisse AG, Research Division - Research Analyst

* Frank James Takkinen

Lake Street Capital Markets, LLC, Research Division - Analyst

* Jacob K. Johnson

Stephens Inc., Research Division - Research Associate

* Jason Michael Plagman

Jefferies LLC, Research Division - Equity Associate

* Tobey O'Brien Sommer

SunTrust Robinson Humphrey, Inc., Research Division - MD

* William Sutherland

The Benchmark Company, LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good evening, ladies and gentlemen, and welcome to the Cross Country Healthcare Earnings Conference Call for the Third Quarter of 2018. This call is being simultaneously webcast live. A replay of this call will also be available until November 15, 2018, and can be accessed either on the company's website or by dialing (800) 944-9725 for domestic participants, and (402) 220-3524 for international callers and by entering the passcode 2018.

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

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [2]

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Thank you, and good afternoon, everyone. Joining me today is our Chief Executive Officer, Bill Grubbs; and our Chief Operating Officer, Bill Burns. This call will include a discussion of our financial results for the third quarter of 2018 as disclosed in our press release, as well as a discussion of our financial outlook for the fourth 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.crosscountryhealthcare.com.

Before we begin, 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 2017 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, which would only affect our year-to-date results duo to the acquisition of Advantage RN in July 2017.

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

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [3]

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Thank you, Chris. Thank you, everyone, for joining us today. This is the first time I've had a chance to address everyone since the announcement of my retirement. First, let me thank all of you that reached out to me. I appreciate it. Secondly, I wanted to let you know that the process of identifying my replacement is on track and that the board of directors has been working diligently with our outside search firm.

Our financial performance for the third quarter was as expected and within the guidance ranges we had provided, despite a further reduction in premium rate business and some higher-than-anticipated healthcare costs. Without those items, both our revenue and adjusted EBITDA would have been towards the higher end of our guidance ranges.

Due to the seasonality in our Nurse and Allied Staffing segment, our fourth quarter performance has normally shown a slight decrease in revenue from the third quarter. Although we are hoping to buck that trend this year, our guidance for the fourth quarter is in line with what we provided for the third quarter. And although we do expect additional cost savings in the fourth quarter, we're also making investments in producer headcount that is offsetting those savings.

Let me explain what is driving the investments. In August, we stated that we had started to see an increase in travel nurse orders through July, after a pullback in the second quarter. The growth in orders escalated further in August, September, and October. At the end of October, our order count is at the highest level for all of 2018 and up over 50% from the end of June. The travel nurse orders are at the highest level since March of 2017. And the good news is that we're seeing an increase in orders pretty much across the board from some of the MSP customers that had pulled back previously, from established MSP customers, from MSPs that are continuing to ramp, and from newly-won MSPs that are coming online, and from the general marketplace. We are very encouraged by these trends and want to make sure that we're staffed to take advantage of them going forward, as most of the increase in orders will have an impact on 2019.

Although we have not yet offset the decline in billable headcount that we experiences in the fourth quarter last year, we have solid opportunities to grow from our current base of revenue, things that I just talked about, the new MSPs that are just getting implemented now, and Bill Burns will give an update on that, ramping up the previously won MSPs, increasing the capture rate at our existing MSPs, and of course the general increase in orders across the board that I just mentioned.

Bill Burns and the team have put initiatives in place which we believe will ensure we execute well in all of those areas. And even though they are not reflected yet in our numbers, we are very encouraged with the progress of these initiatives and recent performance from our teams, in particular our travel nursing team. But a lot of these efforts are for starts in early 2019, so we may not see the fruits of these labors until then.

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

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [4]

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Thanks, Bill, and good afternoon, everyone. I'm going to spend just a few minutes talking about the third quarter performance, and then I'm going to touch on the fourth quarter outlook and how we're positioning the company for success.

Total revenue was down about 12% year-over-year and 2% sequentially. The year-over-year declines were largely due to the headwinds from Nurse and Allied coming into the year and through the first half of the year, and to a lesser extent, continued softness from our physician business. Nurse and Allied, our largest segment, reported revenue of $176 million, which was down sequentially about 2% due to the seasonal impact from the summer break for our school business. Excluding the impact from the summer break, revenue for Nurse and Allied was up 1% sequentially.

In addition to this sequential improvement we saw in Nurse and Allied, there are many positive indicators that the business is continuing to move in the right direction. Revenue from travel nurse was flat sequentially, though the headcount out on billing for travel nurse slowly recovered throughout the quarter and was up about 4% compared to the start of the quarter. Revenue from branch operations was up about 1% sequentially, as they continued to gain momentum. And finally, travel allied was up 9% sequentially, which has continued to see strong demand.

On a year-over-year basis, we had two businesses show double-digit revenue growth. Travel allied was up 24%, and education healthcare grew by 30%, and we expect those trends to continue as we move into 2019.

Physician Staffing revenue was down nearly 15% year-over-year and flat sequentially. Unfortunately, the turnaround for Physician Staffing has taken longer than we would have liked or expected. Although the financial results have not shown the desired improvement, we continue to take appropriate actions to refine our market strategy and see some positive trends within that business, which we believe will help us return the segment to positive revenue growth. Though still a fairly small part of the total physician staffing mix, advanced practitioners continues to outperform, with year-over-year revenue growth of 15%, and we expect that trend to continue as well.

Turning to our executive and physician search business, which is reported in Other Human Capital Management segment, we experienced 3% growth over the prior year, which was due to a higher level of active executive searches. We expect this business will continue to reflect the positive trends, given the demand environment.

Looking ahead, we believe market conditions remain favorable for us, and demand seems to be heating back up. As Bill noted, both total orders and MSP orders for travel positions have risen steadily through the third quarter and into the start of the fourth quarter. Given the normal lead time from when we receive these orders to when it translates into revenue, we expect this will have a bigger impact as we enter 2019.

From an MSP perspective, we've won 10 new MSP programs this year with expected incremental annual spend under management of approximately $70 million. Between the spend from programs yet to go live and programs still ramping, we believe there is approximately $80 million to $85 million of opportunity. Sequentially, spend under management remained largely unchanged at an annualized level of between $400 million and $450 million.

While we would certainly expect top line revenue growth from the anticipated increases in spend under management, we're also proactively working to improve our capture rate for the revenue that we recognize from the total spend under management. The capture rate of our MSPs was just above 60%, up nearly 300 basis points year-over-year and a slight improvement sequentially. A significant part of the increase in year-over-year capture is due to the impact from Advantage RN, which has steadily increased its fill at our MSPs by more than 100 FTEs since its acquisition in July of 2017.

In addition, we continue to refine candidate attraction campaigns aimed at geographies and modalities where we believe opportunity exists to capture a larger share of the spend, and we are investing in more dedicated resources to source new candidates for these programs. Though not reflected in the numbers yet, we are seeing positive indications that the capture rate continues to move upward, based on forward-looking metrics like net weeks booked, which should be a source of growth in 2019.

Finally, our guidance for the fourth quarter reflects revenue and profitability consistent with the third quarter. While our education staffing business is expected to see sequential growth due to the start of a new school year, physician staffing is expected to decline, due in part to normal seasonality. Excluding education, the rest of Nurse and Allied is expected to be flat sequentially on continued softness from premium rates, as well as the impact from holidays, partly offset by the continued recovery in the billable headcount.

As a reminder, premium rate orders began to decline as a percentage of total orders starting in 2017 and has continued throughout 2018. Though we could see this trend reverse on the rising demand, it will likely remain a headwind as we move into the first half of 2019. As I mentioned previously, however, demand, especially in travel nurse, seems to be picking back up, with increasing orders which should support our ability to grow. Given these favorable underlying trends and demand, we're making incremental investments in direct revenue producers to better position the company for a solid start to 2019.

Coupled with the opportunity for revenue growth from higher spend under management, the potential to further improve our capture rate, and the positive momentum in education staffing, travel allied, and advanced practices, we believe the company will return to consolidated organic growth for 2019.

Now let me turn the call over to Chris Pizzi, who will review the results for the third quarter in more detail and provide more detail on the fourth quarter guidance.

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [5]

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Thanks, Bill. Revenue was slightly above the midpoint of our guidance range for the quarter, and our gross profit margin, adjusted EBITDA and adjusted EPS were all within our quarterly guidance ranges. For the quarter, total revenue was $200.7 million, down 12% from the prior year and down 2% from the prior quarter. The year-over-year decrease was due to volume declines primarily in travel nurse, and to a lesser extent, in branch operations, coupled with volume declines in our physician staffing business. The sequential decrease was primarily due to the seasonal nature of our education healthcare staffing business, which is impacted by the summer break. Our quarterly revenue was also impacted by further declines in our premium rate business, which contributed to both the year-over-year and sequential declines.

Gross profit margin for the quarter was 25.7%, down 80 basis points from the prior year and down 50 basis points sequentially. The year-over-year margin decline was due to lower bill pay spread, primarily in travel nurse, coupled with an increase in employee benefit costs. The sequential margin decline was primarily due to higher healthcare costs.

SG&A for the quarter was $44.1 million, down 7% from the prior year and down 3% sequentially. Both improvements were driven by our cost savings and efficiency initiatives. We remain focused on improving our profitability by identifying and eliminating inefficiencies within our businesses and corporate functions. In connection with these initiatives, we incurred a restructuring charge of $1.4 million during the quarter. This charge was primarily related to severance costs, in addition to exit costs incurred consolidating our office locations.

Adjusted EBITDA for the quarter was $8.1 million, or 4% of revenue, as compared with 6% of revenue in the prior year and 4.3% of revenue in the prior quarter. The 200 basis point year-over-year margin decline was driven by lower volumes, primarily in travel nurse. The 30 basis point sequential margin decline was mainly due to seasonal trends in our education healthcare staffing business.

Depreciation and amortization expense was $2.9 million for the quarter, essentially flat with both the prior year and prior quarter. Interest expense was $1.5 million for the quarter, a year-over-year increase of $300,000 and a sequential increase of less than $100,000. The year-over-year increase was due to a higher base rate on our floating-rate term loan, coupled with a slightly higher rate on our fixed interest rate swap. During the quarter, we repaid $6.3 million on our term loan, including a $5 million optional prepayment.

Income tax expense for the quarter was $1.4 million, driven higher by a mixed issue of permanent tax differences and lower profitability. During the quarter, the ratio of income taxes on our on our nondeductible expenses to our expected annual profitability increased, driving up our effective tax rate. As a result, we expect our 2018 annual effective tax rate to remain higher than anticipated, due to our low level of profitability. We still have considerable NOLs remaining that we expect to utilize over the next couple of years. As a result, we believe the amount of annual cash taxes paid will range between $1 million and $1.5 million during this timeframe.

For the quarter, the net loss attributable to common shareholders was $400,000, or a loss of $0.01 per share, as compared with net income of $6.7 million, or $0.19 per diluted share in the prior year and $1.5 million, or $0.04 per diluted share in the prior quarter. Adjusted EPS for the quarter was $0.02, compared with $0.23 in the prior year and $0.05 in the prior quarter. Both the year-over-year and sequential declines were primarily driven by lower profitability and a higher tax rate.

Next, let me review the quarterly results for our 3 business segments. Revenue for our Nurse and Allied segment was $176.3 million, down 12% from the prior year and down 2% sequentially. The year-over-year decrease was primarily due to volume declines in travel nurse and branch operations. Our travel allied and education healthcare staffing service lines continued to perform very well this quarter, reporting strong year-over-year double-digit growth. The sequential decrease was mainly due to the seasonal nature of our education healthcare staffing business.

Revenue per FTE per day for the quarter was $276, down 2% from the prior year and flat sequentially. We averaged 6,953 field FTEs for the quarter, representing a 10% decrease from the prior year and a 3% decrease from the prior quarter.

Segment contribution income for the quarter was $16.5 million, representing a 9.4% contribution margin, down 90 basis points from the prior year and flat sequentially. The year-over-year margin decline was primarily due to lower travel nurse volumes, and to a lesser extent, lower travel nurse bill rates.

Turning next to our Physician Staffing segment, revenue was $21.2 million, down 15% from the prior year and down 1% sequentially. The year-over-year decrease was primarily due to a lower number of days filled in physician specialties, which was partly offset by growth in advanced practice.

Revenue per day filled of $1,582 was down 1% from the prior year and up 2% sequentially, predominantly due to a shift in mix.

Segment contribution income for the quarter was $1.3 million representing a 6.2% contribution margin, up 80 basis points from the prior year and down 30 basis points sequentially. The year-over-year margin improvement was driven by higher gross profit margins coupled with lower SG&A expenses from our cost savings initiatives. The sequential margin decline was due to slightly lower gross profit margins.

Lastly, revenue for our Other Human Capital Management Services segment was $3.2 million representing a year-over-year increase of 3% and a sequential decrease of 18%. The year-over-year increase was mainly due to growth in executive search, partly offset by a decline in physician search, while the sequential decrease was primarily due to a decline in physician search.

Segment contribution income was $100,000 as compared to break even in the prior year and $300,000 in the prior quarter. The year-over-year improvement was driven by revenue growth coupled with lower SG&A expenses, while the sequential decline was primarily due to lower physician search revenue.

Turning to the balance sheet, we ended the quarter with $28.1 million of cash and $91.3 million of term loan outstanding at par. As of September 30, we did not have any amounts drawn on our $115 million revolving credit facility. As I mentioned earlier, we made a $5 million optional prepayment on our term loan during the quarter. In addition, earlier this week we amended our credit agreement. The combination of the amendment and prepayment provides us with the additional borrowing availability and flexibility as we move forward.

For the quarter, our operating cash flows were $3.8 million, up from $3.2 million in the prior year and down from $4.7 million in the prior quarter. On a year-to-date basis, our operating cash flows were $21.8 million, as compared to $28.7 million in the prior year. Our DSO was 61 days, as compared to 57 days in both the prior year and prior quarter, driven by slower collections from several large customers. Based on senior-level discussions held with these customers, we expect these amounts to be fully collectible. We are also encouraged by our average weekly collections in October, as we've seen an uptick during the first four weeks of the quarter as compared to our third-quarter average. We believe our DSO should be below 60 days, and we will continue to work diligently in the fourth quarter to reduce it.

Our capital expenditures were $1.1 for the quarter and were in line with our expectations. We repurchased 33,000 shares for an aggregate price of $300,000 during the quarter, which brings our year-to-date repurchases to 432,000 shares for an aggregate price of $5 million. We still have 510,000 shares remaining under our existing share repurchase program, and any future buybacks are subject to limitations within our credit agreement. We will continue to review our capital allocation strategy, which includes targeted organic growth investments, strategic acquisitions, debt repayments, and opportunistic share repurchases.

This brings me to our fourth quarter guidance. As discussed earlier, the further decline in premium rate business we experienced in the third quarter will impact our fourth quarter revenue guidance. In addition, in order to capitalize on recent demand trends, we will be investing in revenue producers during the fourth quarter, and we now expect to begin seeing the benefit from that demand in the first quarter of 2019. Our guidance also assumes higher health care costs will continue into the fourth quarter, based on recent trends as well as normal seasonal trends.

Our fourth quarter guidance reflects the following ranges: Revenue of $195 million to $205 million; gross profit margin of 25.0% to 25.5%; adjusted EBITDA of $8 million to $9 million, and adjusted EPS of $0.01 to $0.03. In addition, our guidance assumes the following estimates: $2.9 million of depreciation and amortization expense, $1.5 million of interest expense, $1.4 million of stock compensation expense, and a diluted share count of 36 million shares.

Finally, during the third quarter we entered into an agreement for the development of a new front-end system, which will support our legacy travel nurse operations. We anticipate the cost of this project to range between $10 million and $12 million and the timeframe to be 18 months to 24 months. The noncapitalizable costs related to this project will be expensed and incurred and excluded from our definition of adjusted EBITDA until the project is complete, which is expected to be in the second quarter of 2020.

Now let me turn the call back over to Bill Grubbs to wrap up our prepared remarks.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [6]

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Thanks, Chris. Before we close the call, I'd like to make a comment on our 8% adjusted EBITDA target. This is a goal I set a couple of years ago, and I've been pushing hard to achieve that run rate by the fourth quarter of 2019. While we still believe this is the right target for the company given our current mix of business, I want to provide my successor the opportunity to reassess the timeline, given his or her priorities. In the meantime, we are continuing to take the steps necessary to improve our profitability as outlined earlier on the call.

So this includes our prepared remarks, and at this point, I would like to open up the lines for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of A.J. Rice from Credit Suisse.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [2]

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Bill, I know you may be on some future calls, but we wish you well in retirement there. I'm just trying to put in perspective this notion that you've seen a 50% increase in orders over the last three months since the end of the second quarter. I mean, it seems like there's other data points to say there's just a little bit of a strengthening heading into the year-end, but a 50% increase seems like a lot. Is there anything company-specific that would sort of account for that, that we should take into account before we think that the market overall is seeing that kind of pickup, or do you think the underlying market--I guess last year, hurricanes would have impacted, potentially, the order book, but you're talking about a sequential quarterly increase. So any perspective you could provide there would be helpful.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [3]

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Yes, we went through the same thought process, and so we tried to analyze it, you know, every which way, up and down and sideways, and that's why in the prepared statements, I wanted to make sure I stressed that this looks like it's across the board. Some of the customers that pulled back have started to increase their orders again. Existing MSPs that we've had for a long time have started to increase their orders again. The ones that we won last year that are still ramping continue to ramp. In fact, some of the new ones that we won, Bill Burns went back and he did the analysis, and we think they're going to be bigger than what we thought when we initially won the deal. And then, our general customers that aren't under an MSP also increased orders. It looks across the board to us at this point. And remember -- well, first of all, this is off of a low base in Q2. That's why the 50% sounds like so much. I think the better data point is it's the highest number since March of 2017, so we're back to towards the end of the really busy periods in the market. So I do think it's here to stay; I do think it's sustainable. We said in August we didn't think it was sustainable for our customers to pull back the way they were, and we've seen it before and that we thought it would bounce back, and that seems to be the case. Bill, you want to add any color to that?

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [4]

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Yes, I'd just echo that. I think we looked at this between total orders and orders coming from MSPs. We don't provide those two data points, but they're both up in a very consistent fashion, so it's very encouraging.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [5]

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Okay, and you had mentioned as you think about 2019, obviously you're not guiding for 2019 or anything, but is there any way to think about what you think the underlying--when we get back to more of a normal environment, is it right to think about the Nurse and Allied being sort of a normalized growth rate, putting aside any comments about recession or economic strength, but just normalized sort of mid-single digits? Is that, in your mind, what the underlying growth would support in the industry?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [6]

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Yes, I think you should forget the fact of the headwinds that we had in the fourth quarter and whether we're ever going to build it back up again, because those kind of step changes are hard to (inaudible). Just assume that our new basis is this low $200 million per quarter. Yes, we think we can grow low single digits off of the current base of business we have--sorry, mid-single digits off of the current base of business we have today.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [7]

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Okay, just maybe one or two quick more. The press release and I think in the prepared remarks, you said that the premium rate business was still declining. I see in Nurse and Allied the average rate of $276. That's stable versus second quarter, so is it really sort of declining year-to-year but flat sequentially? Are we sort of at a base level here, where there's really not much more premium to lose in your mind?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [8]

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So I'll give you a little bit of color, and then I'll turn it over to Chris. He may have a little bit more. You have to remember, the $276 number, there's a mix of business and specialty areas and geographies and things that move that number around, so they're not a direct correlation necessarily to the premium rate side of it. But if you remember, a couple quarters ago I said I wasn't going to talk about the premium rate business anymore because it was about $1 million per quarter that was declining. We didn't think that was enough to talk about. Well, it more than doubled this quarter to between $2.5 million and $3 million on a year-over-year--that's a year-over-year basis, Chris?

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [9]

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Yes.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [10]

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On a year-over-year basis. Is that sequential?

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [11]

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That was sequential.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [12]

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That was sequentially. So it was a big enough number that it surprised us. We expected about $1 million or a little over $1 million that we had normally been seeing, and it ended up being more than twice that, so that's why we wanted to make sure we talked about it. It is getting down to a level where it seems to be more normalized. I think we'll have a little bit of that headwind, which is in our guidance, in Q4. I don't think we'll be surprised in Q4, and then we believe it should normalize somewhat as we get into the first half of 2019. We don't give the exact number out, but we're getting to a point where it's going to have to stop at some point.

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Operator [13]

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And our next question comes from the line of Jason Plagman from Jefferies.

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Jason Michael Plagman, Jefferies LLC, Research Division - Equity Associate [14]

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So just wanted to dig in a little bit more on the demand trend. So in your discussions with your clients, I mean, have they given you any color on what's kind of caused the inflection over the last three or four months? Is it, you know, strong census, or what's going on at the hospitals?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [15]

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It's a variety of things. I'll let Bill give a little bit as well. I'll start it out with the stories are kind of--vary by customer and they're a bit contradictory. We go into a quarterly business review, and the first thing they say is we need to cut costs. We have pricing--not pricing pressures. We have reimbursement pressures and cost pressures that we need to address. But in the meantime, we're busy and we need a whole lot more nurses. So it's kind of a weird conversation to have. But similar to what we said last quarter is that the things that they were doing when they had pulled back just weren't sustainable. They were either doing without and increasing their nurse-to-patient ratio--the patient-to-nurse ratio--or they were asking their permanent nurses to work overtime and fill in the gap, and neither one of those was going to be sustainable. So some of this is just getting back to more normal business, where they had hoped to try to do it with less, and they found out that they can't because they're getting poor quality scores and they're getting dissatisfaction from the patients. So Bill, you've been out with a couple of customers.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [16]

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I think that's right. I think what we saw earlier in the year were clients were certainly clamping down hard for cost purposes. And, you know, we obviously have a better line of sight on the MSP portion of the business; that's where we have the direct relationship and we can understand what's happening, and so there's a variety of reasons why it's ticked back up. Part of it is this rebound, this artificial pullback that we saw where they were holding off on costs. And the demand has always been there, they just were holding off on it, so that's a piece of it. And on the MSP side, we also are continuing to ramp on the programs that we've won recently. So we have--we went live on another program in the third quarter. We have seven left yet to be implemented of all of our wins that we've historically done. So we've got more opportunity to see orders grow there, but I think the thing that's particularly encouraging is that the order flow coming from the non-MSP relationships where we don't have that direct relationship is up consistent with that. So it's not just on the back of wins that we've had; this seems to be something in the marketplace where demand is rebounding.

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Jason Michael Plagman, Jefferies LLC, Research Division - Equity Associate [17]

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That's helpful. And then, in the Locum segment, are you seeing demand growth there as well? And then, just what actions, you know, are you taking to try and improve the profitability there by returning to growth or, you know, cutting costs, if necessary, to improve the profitability in that segment?

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [18]

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I'll answer that, Jason. This is Bill Burns. So when we look at the physician side, it seems that demand is still there. It may not be seeing the same kind of trend that we've seen on the Nurse and Allied side, but demand seems strong. We've had a couple of new MSP wins where they've included locum tenens, so there seems to be adequate demand on that side. I think a little bit of what we saw on physicians coming into the back half of 2018, what's in the Q3 actuals and the fourth quarter, is a little bit of attrition that was maybe not what we would have liked to see. So we had been taking out some cost actions earlier in the year. There's a little bit of [regretted] attrition sometimes when that happens, and so our headcount there on the direct revenue producer side, we're reinvesting and continuing to build that back up, but you lose a little bit of ground there when that happens.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [19]

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Yes, it went down to a level that was probably lower than we needed it to be, and so they're building that back up again. So a little bit of the fourth quarter is a reflection of that.

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Operator [20]

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And our next question comes from the line of Brooks O'Neil from Lake Street.

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Frank James Takkinen, Lake Street Capital Markets, LLC, Research Division - Analyst [21]

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This is Frank Takkinen for Brooks O'Neil. Thanks for taking my question. I know you guys aren't given any fiscal year 2019 guidance out yet, but I was kind of curious on how you kind of expect all this order growth to ramp into 2019. My assumption is if you are thinking you are going to return to organic growth, that it's going to most likely be skewed more towards the second half of the year, but any additional insight in that area would be greatly appreciated.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [22]

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I'll start again, and I'll turn it over to one of these two guys if they want to add some color. We normally have a sequential decline from Q4 to Q1. We're hoping that some of this increased demand and some of the production we're seeing in the last few weeks, that they're really replacements in early 2019 that we can offset some of that normal decline. So if we do, then that means we'll start to see some improvement, even in the first half. So I don't think I'd push it all out to the back half, but I'll turn it over to Chris or Bill.

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Unidentified Company Representative, [23]

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I'll just add a little more color on the operations side of things. So Bill's right; the demand is going to likely line up to a 2019 impact, just as the orders are coming in with the start dates. We're obviously putting investments in on the recruiter and the account managers so that we have the resources to capture as much of it as possible. But I would just reiterate what we talked about earlier, which is the premiums rates that continued to decline throughout--it started--we first called it out in probably Q2 of 2017, and I think has continued this sequential decline through the third quarter. So we have a little bit of that to lap as we get into the first quarter for year-over-year comparisons and the second quarter, and it obviously diminishes throughout the year. So it will be interesting to see, but I think the demand being where it is and coming into the year so strong could get us back to a...

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [24]

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That's a good point, because the headwinds from premium rates will start to go away in the first half of the year and start to normalize. You know, we're talking about $2.5 million to $3 million sequentially this quarter. That's a headwind of almost 1.5% on our revenue, and if that starts to go away with this increase in orders, I think we could start bucking the trends going in the other direction.

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Unidentified Company Representative, [25]

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And just one more point. Our school business usually gets a second bite at the apple to see that schoolyear sequential trend. So they've started off this year strong in the third quarter, as we saw, and for what we're guiding into the fourth quarter is that they'll continue to see their double-digit growth. They get another chance, usually as the second half of the school year starts, so we could see some sequential increase from Q4 to Q1 from our school business that could bode well for 2019.

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Frank James Takkinen, Lake Street Capital Markets, LLC, Research Division - Analyst [26]

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Okay, great, that helps a lot. And then my second question, and last question, just kind of has to do with how you guys are feeling about Florida, with you guys losing I think you mentioned 550 billable headcount in Q4 2017. I'm just kind of curious if you are starting to see some of that come back now.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [27]

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Yes, as I said a little bit earlier, you know, you don't see step changes in our business very often, and losing 550 people in one quarter is kind of a step change. You can't just step-change your production and build it all back again. So we have--Bill talked about the headcount out on billing from the end of the second quarter to the end of the third quarter in travel nurses up about 4%. So we are building back some of it, but I think the way to look at it is that we're not going to go back and find those 550 people and start doing $20 million more business per quarter that we lost when that happened. I think the way to look at it is this is our new base, this $200 million to $205 million of revenue, and can we start to grow off of that and get leverage, along with our cost savings, along with some of our higher-margin businesses growing a little bit faster, what can we get to based on that? And that's kind of how we're looking at 2019.

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Operator [28]

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Our next participant is Bill Sutherland Benchmark Company.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [29]

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When you look, Bill, at your--whichever Bill--when you look at the plans in terms of cost take-outs, kind of bring us up to date with what's been done, what will be incremental. And then, of that incremental, what will be I guess the net incremental if you're netting against investments that you are planning?

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [30]

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You want me to start?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [31]

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You go ahead, Chris. (inaudible).

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [32]

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So we've identified about $11 million of annualized savings, and we expect to realize about $5 million of that this year and $5 million next year, incremental. And then, we had talked about the replacement of our legacy travel nurse business. We're going to see about $1 million come out in probably the--you know, coming out starting in 2020 when that goes live. So for next year, about $5 million incremental, but as we had talked about, we are putting investments in revenue producers back into the business starting this quarter, and we'll continue into next year. It will probably be a few million dollars, I would say.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [33]

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Annualized?

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [34]

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Annualized?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [35]

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Yes. So the fourth quarter is the one where it kind of all washes out. Between the investments in new producers and the increase in the health care costs that we talked about, and obviously a little bit lower revenue than what was in most of your models out there is what's driving the kind of flat profitability. Because we would have expected profitability to go up from Q3 to Q4, just on the back of cost savings. But between the increase in health care costs and the new investments, that's kind of a wash in Q4, but that should change, because we don't expect the healthcare costs to carry on. In fact, nobody's asked the question on the healthcare, but it really is -- you have the right wording for it. I'll let you...

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [36]

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Yes, it's just a handful, probably single-digit number of claims -- specific claims, high-dollar claims that spiked up in the second half or late in the third quarter.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [37]

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Yes, this isn't an ongoing increase in healthcare costs moving forward; this is specific to claims, so we don't expect that to carry on into next year. The cost savings should start to kick in next year. We shouldn't get the repeat of the increased health cost, a little bit offset by the investments in (inaudible). So we will see some of that into next year, about probably up to $5 million. Is that what you said?

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [38]

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Yes, $5 million.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [39]

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Bill, the investment is in business development?

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [40]

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It's in--we call them direct revenue producers. These are folks that really are actively involved in the sourcing, placement, scheduling, onboarding of candidates, and so bringing them all the way through the cycle to putting them out on assignment and working through the retention and renewal. So these are folks that are really close to the fulfillment and delivery.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [41]

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Okay. And education, remind us kind of what the size is of that now. And you're saying it's just trending along at a low double-digit rate, and that's all just weighing new contracts, I guess both public and charter?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [42]

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Yes, it's a combination of public and charter. When we bought the business at the end of October of 2015, the school-based business was about $20 million, and it's grown organically to about $40 million, just through the double-digit growth every year. So we're--and by the way, it's good gross margin, and it's a very good bottom line margin as well. So we'd like to continue to grow that at double digits and maybe supplement that with an acquisition if we can, but we're very bullish on that (inaudible). They're doing a great job. It's still mostly California-based -- well, not completely, but mostly.

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Unidentified Company Representative, [43]

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Yes, about 90% of it.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [44]

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So on the capital allocation question, kind of how are you thinking about that as you go into next year?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [45]

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Yes, so I think it's still the three areas of -- well, maybe four, so I guess investments in headcount for the increase in demand that we're seeing. I guess that's not really a capital expenditure, but certainly that's where some of our cash flow will go. We're certainly looking at more share buybacks, and probably we'll do some more pay-down of debt. Those are the three areas that we've traditionally looked at. But we're not ruling out acquisitions. We're not out--especially since we're in transition with the CEO, we're not out knocking on doors, and we certainly wouldn't do anything transformational while we're in a CEO search. But we're not shying away from things that make sense strategically for us that come to us through the market, and so we will continue to look at those and see if there's something that makes sense. Schools would be the most logical one for us, maybe some other value-added services that we've been trying to add into our workforce solutions. But we're still looking at them and we're not ruling those out.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [46]

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Okay, and then I'll finish up with just revisiting this premium rate. Now, so it's obviously a smaller issue for you than a competitor. So you're saying it only applies to--did you say it applies to just $2 million or $3 million of your revenue?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [47]

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Yes, so the reduction in the percent of our total hours that was premium last quarter to this quarter resulted in a $2.5 million to $3 million headwind on revenue.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [48]

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Oh, that's different than what I was thinking. So you're not talking pricing.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [49]

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No, no. It shows up in pricing, but it's a real--it's a revenue issue.

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William Sutherland, The Benchmark Company, LLC, Research Division - Equity Analyst [50]

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Okay. So when you just look at pricing, and I guess we should just talk overall pricing, would you call it starting to stabilize quarter-over-quarter when you look at your Q4 book versus Q3?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [51]

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Yes, so -- and Chris, correct me if I get it wrong. So year-over-year, our Nurse and Allied pricing bill rates were down about 2.5% -- 2.4%, but sequentially, they were up just slightly, $0.04 per hour. So yes, sequentially, they seemed pretty flat. Both bill rates and pay rates sequentially were flat, so that gives me a good comfort level that we're not seeing a fall off of the cliff. Year-over-year it's different, but a lot of that year-over-year does have to do with these premium rates and things that we've talked about earlier.

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Operator [52]

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Our next question comes from the line of Tobey Sommer from SunTrust.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [53]

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I apologize. I joined the call a little bit late. How would you apportion the headwinds to your top line between sort of market forces and internal execution, just in broad strokes, if you were to allocate, like, percentages?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [54]

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Yes, so I don't -- the only internal execution from a revenue perspective, to me, is our physician staffing.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [55]

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That's right.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [56]

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Bill was looking at me like, are you going to answer this the right way? And we're executing very well on all of our other sectors -- education, search, travel allied, travel nurse. Travel nurse just looks bad because of the headwinds from the fourth quarter of last year, but our execution is very good. We've had some very good production weeks based on this increase in orders as we've gotten to the end of Q3 and into Q4. Now this all starts for next year, but I'm very pleased with our overall production. But, Bill, I mean, you're...

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [57]

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Yes, you said it spot on. That's exactly right. I think internally, when we look at the rest of the businesses, they are performing incredibly well week-over-week, including our branch business that's continued to gain momentum. We didn't really talk about that much, but their weekly production and revenue that we see is continuing to move in the right direction as well. We think that that's a huge opportunity for us, and we're going to continue to invest there as well.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [58]

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What's the trend this year in your direct fill rates in the MSP business, and just in the context of the revenue decline, I'm wondering how your fill rates compare.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [59]

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Yes, remember, the revenue decline is almost all from the fourth quarter of last year, hurricane headwinds, but I'll let Bill answer it.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [60]

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Yes. So Tobey, it's a great question. I mean, the capture rates continue to improve. In our prepared remarks, we called out that we're up about 300 basis points year-over-year on a capture basis. But it's relatively -- yes, it's slightly up sequentially, so we're making progress there, and I think the sequential piece is the bigger point to talk to because year-over-year, the spend profile is different. We had that pullback in the second quarter from the larger MSP customers, so capture sometimes can look a little bit different based on the pool of spend you have out there. But sequentially we're making progress, and on a forward-looking basis, we obviously track metrics even before it becomes revenue, and we're looking at that, and it's continuing to move in the right direction, so I'm encouraged. As the spend under management grows, and if we keep moving the capture in the right direction, it's going to...

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [61]

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And we expect both of those to grow. We expect both the revenue under management to grow and our capture rate to continue to inch upward.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [62]

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That's right.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [63]

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Okay, if you were to kind of give me your top three green shoots representing signs of potential improvement in revenue growth, what would those top two or three items be?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [64]

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Bill?

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [65]

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Well, I'll give you mine.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [66]

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I know we have the same ones.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [67]

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We're probably going to say the same things. I would say the top three opportunities for revenue growth right now, besides the growth engine--so we have several parts of our business growing in very nice, high single- or double-digit territory, so we would think that would continue--travel, allied, education, advanced practices. But if I think about the larger picture, it's going to be the backdrop of demand, the orders recovery that we talked about. It's going to be the wins of the MSPs and the ramping of the spend and the opportunity on the capture rate. Those are how we think of the big opportunities for revenue growth.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [68]

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Yes, if you average the last three years of wins for us, and you know, we could almost forget the number of wins because it's really about the dollars, we're averaging about $80 million of new MSP wins each year. And so, you know, that's a $40 million to $50 million revenue opportunity at the current capture rates, but we hope that goes up as well. So I think Bill's right; we have three or four of our smaller businesses, but high margin businesses, growing at double digits, but it really is going to come down to new MSPs and increase the capture rate and branch.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [69]

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Yes, and branch.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [70]

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Branch is -- and branch.

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [71]

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Yes, well branch also services the MSPs.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [72]

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And that dovetails and leads me right to my next question. Are you happy with the current branch infrastructure in footprints, or does anything about the change in the business year-over-year -- granted, because of the hurricanes -- cause you to reconsider and think about trimming that branch network to boost profitability more quickly?

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William J. Burns, Cross Country Healthcare, Inc. - Executive VP & COO [73]

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I would say no, we're not looking at trimming down the branch portfolio. But, you know, we regularly and routinely go through a portfolio analysis to look at where the branches are. We'll open branches; we'll close branches as needed, if the market isn't supporting it. But in general, we're continuing to think that's a great opportunity for us. And you mentioned Florida, I mean, that's -- the hurricane. Really, that's not a branch issue; that was more of where our travel headquarters is. But no, we think branches will continue to be an opportunity for us. As we look at new MSP businesses, I can tell you, one of the accounts we were just out talking to liked the fact that we had a local presence. I think that they had another hospital in their system that we said, look, if the business is there, we would look at having a branch there, too. So it's the kind of thing where I think if it's going to service our clients and we think the opportunity is in the right marketplace, we'll keep going after it.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [74]

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I think there's two things there. One is this shift in treating patients out of the acute care environment into these ambulatory and outpatient facilities, we need to be in the local markets to service those. So, you know, we're happy that we're there, and we're seeing the improvement there, and an improvement in our mix of business as well, so that's one. And I have been to several customer presentations where we won our MSP because we were the only competitor bidding that had local presence already, and knew the local marketplace, had local candidates, and it's made a difference to us. So Bill's right; we're happy they're growing, and we think strategically, they're needed anyway.

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [75]

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And just one point, Tobey, on your comment about profitability. They're not less profitable. I mean, they cover their infrastructure and their costs. We have branches of all sizes; we have very small branches to very large branches. But in general, they run the same level of contribution income as we see in our travel nurse business, so it's a good business for us.

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Tobey O'Brien Sommer, SunTrust Robinson Humphrey, Inc., Research Division - MD [76]

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Okay, from a strategic standpoint, Bill Grubbs, I guess, but doesn't have to be, from a capital deployment standpoint, should we expect you to kind of hold--stand pat in light of your announced transition out of the business, at least for the next, you know, handful of months?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [77]

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I don't think so. I mean, look, you know, it's probably only going to be a few months before somebody else is here. But if there's some small tuck-in or there's something that makes sense, we'll move forward with that. Like I said, I don't think we'd go do anything big, because that should just wait for somebody new. But there are some things that are just kind of no-brainers. So, you know, if it's out there, we'll explore it and participate like we should. We don't want to miss an opportunity just because we're transitioning. We don't have any gaps here, and we have good resources, and I have a strong team underneath me that, you know, it's not completely dependent on me or me transitioning to a new CEO. So look, we're not going to go out there and make something happen, but something could happen, even in the transition period.

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Operator [78]

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And our last question comes from the line of Jacob Johnson from Stephens.

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Jacob K. Johnson, Stephens Inc., Research Division - Research Associate [79]

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Just a couple from me really quickly. First, sounds like the health care costs are perhaps a nonrecurring expense. Any chance we can get a magnitude of what those were in the quarter?

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Unidentified Company Representative, [80]

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Yes, sequentially, they were up about $700,000 and about $600,000 higher than we had guided.

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Jacob K. Johnson, Stephens Inc., Research Division - Research Associate [81]

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And that's contemplated to be at a similar level in the fourth quarter, but no change sequentially?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [82]

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No, a little bit higher.

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Unidentified Company Representative, [83]

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No, they are -- yes, they will be a little bit higher sequentially, just because we're seeing that these--the claim levels will continue into the fourth quarter, as well as just normal seasonal trends. Fourth quarter is typically the highest quarter.

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Jacob K. Johnson, Stephens Inc., Research Division - Research Associate [84]

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Okay, got it. And then, Chris, on the new finance system for the travel nursing business, is this back office only, or will it impact your sales effort? And then, is this going to be a gradual rollout, or are there any dates we need to be aware of?

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [85]

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So it's actually not a financial system. It's not a back office system; it's a front-end recruitment system for our travel nurse business. And it won't affect the business at all until we start to roll it out, which probably won't be until the first quarter of...

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Christopher R. Pizzi, Cross Country Healthcare, Inc. - Senior VP, CFO & Principal Accounting Officer [86]

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Second quarter of 2020.

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William J. Grubbs, Cross Country Healthcare, Inc. - CEO, President & Director [87]

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Yes. Well, we'll roll out some of it. We'll phase some of it in and do some testing a little bit earlier. But we're still a year away from starting to do anything with rolling it out. So it's going to be in development for at least a year, and we have a very good change management organization. There may be some modules that can be implemented earlier for maybe credentialing and a few other things so that we don't have to go big bang. But we're still a long way from that.

Okay, well thank you, everyone. We appreciate you joining us, and we will talk to you again in I think early March for the fourth quarter and full-year results. Thank you.

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Operator [88]

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A replay of today's conference will be available through November 15, 2018. You may access the replay by dialing 1 (800) 944-9725 or 1 (402) 220-3524. Please use the passcode 2018. Thank you for joining. You may now disconnect.