AMN Healthcare Services, Inc. (AMN) Q2 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the AMN Healthcare Second Quarter Earnings Call. [Operator Instructions] As a reminder, the conference is being recorded. And I'll now turn the meeting over to our host, Director of Investor Relations, Mr. Randy Reece. Please go ahead.

Thank you, Laurie. Good afternoon, everyone. Welcome to AMN Healthcare's Second Quarter 2018 Earnings Call. A replay of this webcast will be available until August 16 at amnhealthcare.investorroom.com following the conclusion of this call. Details for the audio replay of the conference call are in our earnings release issued this afternoon. Various remarks we make during this call about future expectations, projections, plans, events or circumstances constitute forward-looking statements. These statements reflect the company's current beliefs based upon information currently available to it. Our actual results may differ materially from those indicated by these forward-looking statements as a result of various factors, including those identified in our most recent Form 10-K and subsequent filings with the SEC. The company does not intend to update the guidance or any forward-looking statements provided today prior to its next earnings release. This call contains certain non-GAAP financial information. Information regarding and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in our earnings release and on the financial reports page of the company's website, which can be accessed at amnhealthcare.investorroom.com. On the call today are Susan Salka, Chief Executive Officer; Brian Scott, Chief Financial Officer; Ralph Henderson, President of Professional Services and Staffing; and Dan White, President of Workforce Solutions. I will now turn the call over to Susan.

Thank you, Randy. In the second quarter, AMN demonstrated our leadership position in healthcare workforce solutions with record high revenue. We continue to expand existing MSP clients and win new clients, which gives us good opportunity to build strategic relationships and market share in an environment where demand in some of our businesses is somewhat tepid. Our second quarter results were stronger-than-expected primarily due to staffing a large labor disruption event. Otherwise, most of our businesses performed in line with expectations. As we enter the third quarter, our growth track became a bit more challenging. We have seen lingering disruption in our locum tenens business and lower volume growth for travel nursing. Several labor statistics show that the health care sector has continued to grow jobs at a strong space, indicating that are clients are increasing their permanent hiring even though their attrition is still running high. They are also filling gaps by further increasing overtime and hours worked. The June BLS reports showed average hours worked at an all-time high in health care. Working permanent clinician's more overtime is typically not a sustainable staffing solution. However, it can have the effect of moderating demand for temporary staff. Macro drivers of our business remained positive and should support long-term growth opportunities for the company. We are also focused on expanding our strategic relationships, particularly with MSP clients, and this should enable growth and market share opportunities. Now let's turn to our current results and outlook. Second quarter revenue of $558 million grew 14% year-over-year and reflected a record high for revenue. Our guidance did not include strike-related revenue, which totaled $25 million in the quarter. Excluding this revenue, our second quarter performance was in line with our guidance range. Adjusted EBITDA was $70 million or 12.6% of revenue. Our nurse and allied segment posted revenue of $333 million, higher by 11% year-over-year or 2% excluding the labor disruption business. Revenue for our largest business, travel nurse staffing, grew 2% year-over-year. Volume was higher while the average bill rate was down due to a lower mix of premium rate assignments. Our ability to fill assignments quickly and with high-quality candidates is translating into excellent outcomes for our clients, and we're quite confident that the AMN team continues to lead the industry in service delivery. This credibility enables us to create even more strategic relationships and engage our clients with other services. With that said, we do have some headwinds that are inhibiting revenue growth. The travel nurse demand environment is muted with new order trends flat year-over-year. In this current environment, we are expecting Travel Nurse volume to grow approximately 2% year-over-year in the third quarter. This is being offset by fewer premium rate assignments, reducing the average bill rate. As we look to the third quarter, our average bill rate trends are relatively flat from month to month, indicating that the mix shift has likely stabilized. Growth in allied staffing was better-than-expected in the second quarter with revenue up 7% year-over-year. Volume drove the upside surprise, while pricing remained stable. Continued strength in placements, particularly with our MSP clients, gives us optimism that the allied business can sustain its growth. Our local staffing business, which is 5% of segment revenue, remained soft in the second quarter with revenue down double digits driven by volume. While local staffing is still an important solution, many acute care clients have shifted away from daily assignments. We are adjusting the service delivery model of this business and investing in digital capabilities to improve both performance and profitability. Looking ahead to the third quarter, nurse and allied segment revenue is expected to be flat to slightly down year-over-year with volume growth offset primarily by the premium rate mix shift along with declines in our local staffing division. In the locum tenens segment, second quarter revenue of $107 million was 1% lower year-over-year. Despite internal distractions, the division did make progress on profit margins compared with the first quarter. Overall, demand for locum tenens remains above prior year. Our lack of growth does not appear to be market-related but rather due to higher-than-planned disruption from operating process changes and technology upgrades. In May, we completed the migration of our entire locum tenens business to a new business model and technology platform. Once we are through the post-launch learning curve, we are very confident we will gain productivity and efficiencies. For the third quarter, locum tenens revenue is expected to be down about 6% year-over-year. Second quarter revenue in our Other Workforce Solutions segment was 118 million, which was 46% higher year-over-year including the benefit of acquisitions closed in April. The segment was up organically by 2%. Before I give more color on the businesses in this segment, I'd like to welcome Kelly Rakowski to the AMN leadership team. Kelly is joining us as our first President of Leadership and Search Solutions and will be responsible for the strategy and performance of our interim leadership in permanent placement businesses. Kelly has an outstanding background in health care consulting and transformation and is a perfect fit as AMN strives to create more collaborative workforce solutions for our clients. Now turning to a little more color on this segment. Physician permanent placement revenue was down 3% from prior year, slightly below expectations. This division continue to make progress on productivity, and we expect physician perm revenue to return to year-over-year growth in the third quarter. Our mid-revenue cycle division produced 38 million of revenue in the second quarter. Peak Health grew its top line by 11% year-over-year, its second consecutive quarter of double-digit growth. MedPartners, which we acquired in April, added 29 million in revenue with positive momentum as they head into the third quarter. Our VMS businesses saw revenue down year-over-year, reflecting the slower sales momentum we mentioned last quarter. In workforce optimization, Avantas had another solid quarter of growth. We continue to see a strong appetite for workforce solutions, which can help our clients optimize their scheduling and staffing decisions. Overall, third quarter revenue for the Other Workforce Solutions segment is expected to be up approximately 2% to 3% year-over-year on an organic basis and up about 50% including the recent acquisitions. Although recent market trends have moderated, we remain bullish about the long-term growth potential of AMN. We are excited about our MSP momentum with year-to-date wins and deals in contracting, positioning us for another strong year in MSP awards. These new deals will contribute revenue at the end of this year with a much greater contribution in 2019. We continue to invest in innovative tools and technologies to help transform our industry and deliver even greater value to our clients, and that will enable them to achieve their financial and patient care goals. We are also focused on building and refining the talented and highly motivated AMN team. They embody our commitment to exceed the expectations of clients, health care professionals, their patients and the communities we serve. In the spirit of strengthening our leadership team and our ability to drive innovation, we have recently welcomed Mark Hagan to the AMN family as our new Chief Information Officer. Mark has a successful track record designing and executing on major deployments of core business applications, leading digital transformation and launching new software products. He brings substantial and relevant experience to AMN, having previously led technology execution for a multibillion-dollar health care services company. And this week, we were very excited to announce that Daphne Jones was appointed to the AMN Board of Directors. Daphne is an accomplished executive with extensive experience in strategic, entrepreneurial and global use of digital technologies. Her leadership roles with Johnson & Johnson, Hospira and most recently, GE Healthcare, will be extremely valuable in the boardroom and while engaging with our management team. We are very honored to have Daphne joining the AMN board, and I know she will make valuable contributions. Our recent additions to leadership, along with changes we are making in technology and our business model, create a stronger foundation for future growth. These investments help us to evolve our strategy and build the business in a way that delivers greater value to our clients, health care professionals and shareholders. Now I will turn the call over to Brian for a financial update, after which Ralph and Dan will join us for the Q&A session.

Thanks, Susan, and good afternoon, everyone. The company's second quarter revenue of $558 million was well above the high end of our guidance range due to $25 million of revenue from a large labor disruption event that was not included in our guidance. Excluding this event, revenue was right in line. The quarter included $36 million of revenue from our recent acquisitions that occurred in early April. Gross margin for the quarter was 32.4%, down 50 basis points from last year, but higher by 30 basis points from last quarter. The year-over-year decline was driven by a lower gross margin in the Nurse and Allied and Other Workforce Solutions segments. The sequential improvement resulted from an improved locum tenens margin and a favorable segment mix change partly offset by lower nurse and allied gross margin. SG&A expenses in the quarter totaled $116 million or 20.7% of revenue compared with 19.7% last year and 20% last quarter. The increase in SG&A expenses and the expense margin was impacted by the added cost from the recently acquired companies and the recent change in the physician permanent placement model that prompted us to begin recording recruiter expenses in SG&A rather than cost of revenue. SG&A expenses as a percentage of revenue also increased year-over-year primarily from a larger favorable malpractice reserve adjustment in the prior year. Sequentially, the SG&A margin was unfavorable due mainly to the change in recording of physician perm recruiter expenses. Second quarter nurse and allied segment revenue was $333 million, an increase of 10.6% from the prior year and down 1.6% sequentially. Excluding the labor disruption staffing, volume was higher by 4% year-over-year. This was partly offset by 3% lower average bill rate. Nurse and allied gross margin of 26.3% was 150 basis points lower compared to the prior year and 170 basis points below the prior quarter. The year-over-year decline was in part from a below-average gross margin on the labor disruption event along with higher health insurance costs. The prior year also included some favorable sales adjustments. Sequentially, the seasonally lower second quarter margin was coupled with the lower-margin strike revenue and higher health insurance costs. Segment EBITDA margin was 13.2%, lower by 270 basis points from the prior year due in large part to the lower gross margin and the prior year favorable malpractice reserve adjustment. Second quarter locum tenens segment revenue of $107 million was slightly lower than the prior year and up 4% on a sequential basis. On a year-over-year basis, the average bill rate increased by 5%, and the number of days filled was lower than by 6%. Locum tenens gross margin of 29.8% was down 20 basis points from the prior year but improved by 110 basis points sequentially. Locum tenens EBITDA margin was 12.5%, up 110 basis points year-over-year. Second quarter Other Workforce Solutions segment revenue of $118 million was up 46% year-over-year and 45% sequentially driven mainly by the recent acquisitions that were included in the segment. Gross margin of 52.2% was lower by 350 basis points year-over-year and was 140 basis points lower sequentially. The year-over-year variance was the result of the acquisition of MedPartners, which has a lower gross margin than the segment average, along with a lower interim leadership gross margin and an unfavorable organic business mix shift in this segment. This was partially offset by the previously noted change in the recording of physician perm placement recruiter compensation to SG&A that was previously in cost of revenue. On a consolidated basis, second quarter adjusted EBITDA of $70 million was up 4% year-over-year and 5% sequentially. The adjusted EBITDA margin of 12.6% was 110 basis points below the prior year margin and lower by 10 basis points sequentially. We reported net income of $36 million and diluted earnings per share of $0.73 in the second quarter. Adjusted earnings per share was $0.83 compared with $0.67 in the prior year quarter. Our income tax rate in the quarter was 27% and is expected to be 28% for the remainder of the year. Cash flow from operations was $66 million for the quarter. In the first half of 2018, cash flow from operations totaled $126 million, up 80% year-over-year. This cash flow result reflects our strong level of profitability, favorable working capital and the benefit of the lower federal tax rate. Days sales outstanding at quarter end was 58 days, consistent with last quarter, and 4 days lower than the year-ago quarter. As of June 30, cash and equivalents totaled $23 million. Capital expenditures in the second quarter were $11 million. During the quarter, we repurchased 385,000 shares of stock for $21 million and repaid $40 million of debt. At quarter end, our total debt outstanding was $480 million, and our leverage ratio was 1.7 times to 1. Now let's turn to third quarter 2018 guidance. The company expects consolidated revenue of $522 million to $530 million. This represents top line growth of 6% to 7% year-over-year on a reported basis. On an organic basis, revenue is expected to be down about 1% due primarily to the disruption in the locum tenens business and the lower mix of premium rate assignments in travel nursing. No significant labor disruption revenue is included in the third quarter guidance. Gross margin is projected to be approximately 33%, and SG&A expenses as a percentage of revenue are expected to be approximately 21.5%. Adjusted EBITDA margin is expected to be approximately 12.5%. Other third quarter 2018 estimates include the following: interest expense of $5.8 million, depreciation expense of $4.5 million, amortization expense of $6.7 million, integration-related expenses of about $1 million and diluted share count of 48.8 million shares. And now we'd like to open up the call for questions.

[Operator Instructions] And our first question from Jeff Silber with BMO Capital Markets.

It's Henry Chien calling for Jeff. So I just want to kind of clarify or get your view on sort of what's driving some of these changes. It seems like -- so the -- I understand the wage -- the premium rate business has gone down. But just in terms of orders being flat, the change in volumes for travel, just in the context of it seems like [indiscernible] is doing fine and as you pointed out, health care labor is still quiet demand. I'm just wondering, what do you think is driving that kind of widespread shift there?

So first, on a consolidated basis, as we mentioned, some of the softer guidance that we gave going into the third quarter is related to continuing disruption in the locums business. And quite honestly, it's lingered on a bit longer than we would've expected and been a little greater than we would've expected. With that said, I feel quite confident that the team is turning the corner. We've seen some good results more recently, and Ralph can speak more to that. But that's part of the reason why third quarter guidance might be a bit below what some of the analysts have in their models. On the Travel Nurse business, our volume is still growing, and that's primarily coming from our MSP clients. Our greatest growth year-over-year in the third quarter is from our MSP-based business, which has been true for quite some time and is deliberate on our part as we continue to build stronger relationships and we have more ability to fill those jobs than we do with direct and third party. Direct and third party is where we've seen the year-over-year decline in TOA, or travelers on assignment, sorry about that. And so that's probably been where we felt more of the softness. The lack of growth in new orders, and as I mentioned in the script, we characterize new orders as being relatively flat, and the lack of growth in new orders is likely due to hospitals working their existing perm staff more overtime. We saw that show up in the BLS data that indicated more hours being worked, and you would assume that's more overtime hours being worked and we're certainly hearing that anecdotally from our clients. And that perm hiring, as that -- there's not a lot of good current data on perm hiring, meaning, in the last month or so. But even as we look at our own travelers, slightly greater number have gone perm as they've come off assignment. It's not a huge number, but it's enough to support the notion that hospitals are indeed hiring more perm staff even though their attrition remains very high. So I don't know if that helps answer your question?

No, no, that's really helpful.

And let me just add, Henry, we are actually very pleased with the stabilization that we've seen in the average bill rate. You brought up the premium rate assignment mix, and that was something we called out in the second quarter as being a greater sequential and year-over-year decline. And we saw it ticked down just a little bit more in the third quarter, which we had expected, but the good news is we also saw it stabilized through the quarter. And so we believe that we probably largely hit the stabilization point in that mix. We've also received many of our winter orders, which are placements we'll make in the fourth and the first quarter, and the rates on most of those look very strong as well. So gives us good confidence as we go into our typical uptick season in the fourth quarter.

Yes, that's helpful. And just as a follow-up on the locum side. I know that there is, if I remember correctly, that there is some changes in the, I think, your internal order or recruitment systems? Just curious how that's going and if that played any role at all.

Yes, it definitely played a role in our forecasted results and in the quarter. So during the quarter, we replaced both our front and our back office systems across the entire business, which about 500 people were touched in the deployment of new technology. And we also modified our operating model to what we think is a streamlined model which will allow us to recruit and fill jobs faster than we could in the past with the old systems. So we're retiring some very old systems at the same time. We go from three different front office systems, two different back office systems to one integrated system. So there's some big wins there. And so as Susan mentioned, disruption is a little more than we expected, but we're confident that it's going to ultimately support our better daily execution, and that we'll probably start to -- you can see our Q3 guidance reflects that disruption. But we think that we will start to see some improvement in the first quarter next year, maybe even late Q4.

And so I mean, just in terms of just the implementation, is that expected to be mostly complete by 3Q or 4Q?

So we actually completed the last phase of the implementation towards the end of the second quarter. And I guess we've been in production now for about five weeks, six weeks. And so, yes, we're still enhancing the product, kind of a period we call the warranty period where we're finding little things that would make it work better, we continue get that work done. But mostly right now we're kind of in the period of time where adoption is really important. So kind of change management. Our leaders have done an excellent job of making sure their team have good training on the new tools and are working our way to higher production levels.

Henry, this is Brian. So just to follow up on that. If you look at the guidance, we went through that implementation that you see over the last several months. Because of the lag and kind of booking activity, the actual placements of physicians when they go to work, the disruption we had more in the first half of the year, you actually see more of it flow through in the third and fourth quarter. And that's why you're seeing that reflected more in the lower revenue in the third quarter. So as we start to see our daily productivity improve as we move to this quarter, that's where Ralph is alluding to improvement kind of in the later part of this year and really even more so in the first part of 2019.

And we have a question from A.J. Rice with Crédit Suisse. Please go ahead.

Just maybe to follow up on the comments around locum tenens first. So is it your basic view that the softness you're seeing is largely a function of the new system and the disruption that's caused? Has there been any change to what you think the underlying tone of the locum tenens business is at this point? And do you feel like you have the right management team in there once you come out at the other end of this? Or are you still transitioning management there?

A.J., this is Ralph. I'll answer that. Maybe others might have something to add. I'll start with the management team. We have an excellent team there. Remember that Jeff Decker runs that business. He ran our allied business and led it to substantial increases in both revenue and profitability over time he ran that business. So we have a lot of confidence in him and the rest of his team. The market itself, the demand levels are slightly above prior year. The mix of the market, I would say, is not quite as favorable as we'd like, the hospitals business, which is a substantial portion of that segment is still kind of lagging what we saw the past couple of years in that business. So any strengthening in hospitals would help us accelerate that turnaround back to year-over-year growth, but there is plenty of demand there for us to grow the business.

Okay. And then just going back to the comments around travel nursing and relatively tepid demand environment. Is that -- I mean, I know last quarter we [Indiscernible] talking about the drop off in the premium rate, and it seemed like you might've characterized that as a relatively tepid demand environment. Are we -- is the description today a step down further from what we saw in the second -- first quarter? Or how would you characterize it? And yes, I guess -- and your competitor, obviously much smaller scale, said that they saw some concentration of weakness in the MSP -- a few big MSP accounts, but weren't exactly sure it was across the overall market. It sounds like you're describing a little broader tepid demand scenario, and I just want to make sure that, that is indeed what you're saying.

Well, first, I'll start with the comparison to the second quarter and I'd say, no, there's not been any sort of step change. We just are saying it hasn't grown necessarily. And kind of going back to the earlier questions and comments around, well, geez, if census is up and there are still shortages, why aren't we seeing more growth in demand? and we think that's because they're -- our clients are hiring more permanent staff and using more overtime. So demand is relatively stable. It doesn't move around a bit whether the new orders come from MSP clients or third -- what we would call third party or direct. But I'd say it's really more stable, and so we're sort of referring to that as tepid in that it's not growing. For us, the MSP business has actually been very strong. That's where we've seen the greatest growth in travelers on assignment. That's where we have our best fill rates. So I think that perhaps it's because we've built strong, strategic relationships and many of those relationships are very mature and maybe we just wouldn't see as much of that variation and we just have a different client base. We also have seen our ability to improve fill rates at clients. And as we are maturing more of these new MSPs that we've won over the last year or two, we still have opportunity to improve fill rates. Our first goal is to, of course, fill the job for the client, no matter who that candidate comes from. And we're at our really, I think, historical high fill rates for our clients in terms of overall filling of their gross spend under management. But our second objective then is to see where we have opportunities to fill their jobs. And because of, again, many of the MSPs that we've won over the last year or two that are still ramping, we are still below the averages and where we think we could get in terms of fill rate. So I don't know if, Dan, you want to add anything more regarding those MSP strategic relationships?

Yes, I think there's couple of things I would add for you, A.J. If you look at the top 20 MSPs that we have, 16 of those 20 have a higher net revenue year-over-year. Susan talked a little bit about our average fill rate. Across all of our MSPs, it's about 70%, and we think we have much more room to grow there. On the other hand, the MSPs that have been just entering into from go-lives or leaving implementation, we see in Q2 we had 11 go-live, six new clients, five expansions. We're expecting to see about $15 million in revenue in the second half of the year from them. We also expect in Q3 another nine to go live and are expecting to contribute some into the fourth quarter as well. But all of those are going to really continue to grow into 2019.

Okay. Just two clean-up questions. I think these have both come up last quarter. There was some discussion about a very large MSP contract that might be out for bid. Is there any update on that?

I don't -- yes, we've been asked about that. I don't think we provided that information as much as just talking about our very strong pipeline. And so you would assume that if there are large opportunities, that we certainly would want to be in the mix on those. So we -- as I think Dan alluded to, we certainly have some really nice wins year-to-date and even just since the second quarter, and those will be rolling out and even one I would characterize as rather large, close to $30 million, in gross spend under management. So just to kind of give you a sense of the sizes are kind of all over the board, and then I'm talking about ones that we've actually signed and we'll begin to work towards implementation. So hopefully, that helped.

Okay. And then the other one, maybe I'm wrong on this, too, but it seemed like there was some discussion about sort of an opportunity to potentially put in place more branch network -- branch operations but doing it almost a virtual or electronic manner that you were exploring. Any update on that?

Yes, this is Ralph. I'll start with that one. The -- we wouldn't expand the number of branches. We think that model is less efficient than a centralized model. What we've talked about over -- a little bit, I think, on the last call is shifting to more digitally deployed staffing model, per diem staffing. We talked about our local staffing business being down in the quarter as well, and part of that is just the inconvenience and the lengthy credential in time for short-term assignments that have made that service not as attractive as it used to be. So we think by creating that -- putting that in mobile devices and deploying talent mobile-y, we might make that a little more attractive. Certainly, it would cut our internal expenses to operate and increase our profitability and then -- and give, I think, some RNs who are working full-time job some moonlighting opportunities they might not have taken otherwise. Hopefully some growth there.

We have a question from Tobey Sommer with SunTrust.

I wanted to delve in the fill rates a little bit more. What kind of fill rate improvement potential do you have given kind of the tepid demand environment, the ability to grow or shield yourself from pockets of weakness, this kind of an important topic? And I don't know if you want to speak to a precise percentage points or say it's one or two points or five or 10 kind of order of magnitude, would be helpful.

Tobey, this is Ralph. I'll start with Travel Nurse, but there's upside in our locums business and our allied business as well. But I'm guessing the highest interest is Travel Nurse. Our fill rates there are very good. We do think there's still upside remaining. We're -- probably got 5 -- 5 percentage -- 5 points would be a decent improvement. Certainly, we've been higher than we are today. So that's probably a good upside. When we implement new MSP accounts, there's a little bit of a lag. And so we might start out at 25% to 35% as the internal fill and the rest is filled by our affiliate vendors. But as they mature and we start to see higher fill rates get up in -- and I think I've said this before, kind of in the high 70s, just 80s even internal fill. So we have -- we're certainly not at that level across all of our accounts.

Susan, you mentioned clients making greater efforts to hire more full-time staff. Is that sort of thing that you felt in your RPO business? Or is it really more a question of kind of [indiscernible] single hires that AMN has not participated in, in terms of helping the customers achieve those internal hires?

Yes, thanks for asking, Tobey. We haven't talked about RPO in a while, but they actually did have a nice uptick in the second quarter. Now we still want to characterize that business as relatively small and not yet material to our results. But they had a really nice improvement in their -- both their sales, but also most importantly, in their placements with clients. And so I don't know, Dan, if you want to give a little more color on that?

Sure. I'd be happy to. Tobey, that business was up over prior year 34% and 12% quarter-over-quarter. To really get to your point, that business signs 1- to 2-year agreements with exclusive volume-specific kinds of programs. And so I think you were kind of referring to onesie, twosie kind of thing. That is not what that team does. The good news is that there's a whole lot more interest in these kinds of programs than there have been before. And so -- and the team is renewing customers, expanding customers. They've signed a couple of new deals in the quarter, and so -- and those new deals are being worked now. So we're seeing the same kind of continued prosperity for that business going into Q3 as well. I would say the overall message about transitioning from really -- into really large outsourcing is still something that is not comfortable to a lot of leaders in health care, but I do see it being talked about a whole lot more.

And what -- can we delve into the reason as to why nurses at this stage of an economy with pretty good job growth, relatively fast GDP growth, what's luring them into full-time jobs at a time when I kind of would think the propensity to work full-time would be in decline? I'm guessing it's wages and compensation, but maybe you got some additional details there?

Tobey, it's -- I don't think it is wages as much as it is onetime enticements upfront. While certainly wages are rising and probably rising at a higher level than what they've done in prior years because of the large portion of the budget at a hospital that comes from nurse wages, they're not likely to increase that cost center, if you will, or that expense by more than typical wage inflation. So we're not hearing of anything unusual beyond sort of your typical 2%, 3%, 4%. If it is happening, it's probably one-off. What we are hearing are lucrative incentives upfront: onetime bonuses, maybe a $20,000 bonus to sign on; and many times, the requirement to stay isn't more than one or maybe two years. Other things like tuition reimbursement and other sorts of incentives are being thrown in. But again, they're usually upfront enticements. They're not particularly ongoing, sustainable costs, which would make a lot of sense since that would raise the overall wages for all of the nurses there. So I could see where even though the nurse has many more options to travel, to go perm, if they're being presented with a onetime opportunity to get a bonus like that, they might take it. And keep in mind, the number of premium rate assignments within travel has come down. They still exists. Looks like it stabilized. But the number of open assignments within the travel industry that have those higher pay rates or maybe bonuses attached has come down. So you might expect that some of the nurses who were traveling have decided to go perm and maybe even take some of those sign-on bonuses.

Could you elaborate a little bit more on the winter orders since premium rate has been a tough conversation, kind of an elevated one, in the first half of the year? [Technical Difficulty] shape up kind of exiting the year and early next year. Can you describe the contours of that? Like, what's typical seasonal and what your early glimpse into demand looks like relative to what you might normally expect?

Yes, thanks. That's a great question. Appreciate it. We just actually sat through a comparison of winter orders on a year-over-year basis to see how we were tracking against prior year, and we're seeing demand levels that are equal to prior year and there's still quite a bit of time for other clients to submit those to us. As it relates to the premium rate category, because those assignments do hit a peak period, they're over the holidays often and they do demand that premium bill rates of the initial sets of orders we received so far, they're at that same kind of premium bill rate levels they were in the prior year. So no, this shouldn't be a drag on our business. It actually could potentially still unfold to be more positive.

And this all gets to -- I know you don't necessarily guide out longer, but with the third quarter guide kind of down a little bit organically, trying to get a sense for how we might think about the model a little bit more kind of medium term?

It's Brian. Well, as Ralph said, as we look to the fourth quarter, we feel like we're seeing a normal behavior. So it isn't coming off of a little bit lower of a point that we'd normally see in Q3. But we would expect at this point, from the trends we're seeing, a normal kind of seasonal uptick from the winter assignments. And so that I think you can kind of build off of the third quarter guidance we've given, but applied pretty normal seasonality off of that for the fourth quarter. I think the unknown for us still is as the rate of when orders come in and as we look at some of the newer MSP awards that we see, how quickly we can get those implemented and how much impact they have in the fourth quarter. We're optimistic they'll have some, but not a huge amount, but that's a little bit of upside maybe beyond just our normal seasonality.

And our next question from Mark Marcon with R.W. Baird.

I'm wondering on bill rates, can you talk on the nurse travel side? What sort of bill rate trends you ended up seeing during this last quarter on a year-over-year basis? Like, how should we think about it or composition of percentage of premium orders relative to standard orders?

I'll start. Brian might add some detail to it. Overall, our bill rates end up being down on a year-over-year basis 3%, which is right where we projected it. And if you look at our guidance into Q3, it's about the same on a year-over-year basis, just a little bit of forward-look there. The -- all of the decrease is in the lowering of the premium bill rate percentage of orders on a year-over-year basis. So last year, there was just more utilization of it. I think demand levels were about the same, but the industry capacity hadn't kept up. So -- and we were trying to, remember, lever people out of full-time jobs at that time to get those orders filled. So the premium bill rates did run a little higher than they are right now.

What were they like -- go ahead, Brian.

No, you can just follow up the question, Mark, and then I'll give color.

I was just wondering what percentage of the orders this past quarter were filled at a premium level relative to, say, a year ago? Or how we should think about that?

Yes, I think we've talked after last call that the percentage of the Travel Nurse assignments was -- it's around 20% of the placements were at this kind of premium rate assignment. It -- from the second to the third quarter, we talked about that in our guidance, it's down maybe 200 basis points. So it does seem to stabilize. We expected that. We even talked in the last call that as we looked at the July bookings, that it was down just a little bit in Q2, kind of played out that way. Really the quarter has been pretty stable in terms of the percentage at our premium rate. So again, and the average bill rates in the segment Q2 to Q3 is pretty consistent with that 3% down. So I'd say overall from the second to the third quarter, no real large changes in rates and the types of assignments that we're taking. And again, the core business, the average rates we're seeing are holding up and we're still getting rate increases on certain clients as well.

And so the percentage of orders that are premium rate for this quarter is how much?

Yes, we're going to -- we're not going to keep giving that every time. So I'm going to -- if you're okay, we're going to kind of pass on answering that directly. But again, it's been pretty stable just in Q2 to Q3 is what we'd say.

Or what was it in Q2?

I don't think we gave the orders, quite honestly. We gave the travelers on assignment and the mix of our volume. Right now, for example, you would expect that the mix would be higher because we have our winter orders that we received in June and July, and those are at higher rates, premium rates, the winter rates. And so that's going to move around a little bit. And what Ralph said earlier is of the winter orders we've received, the majority have been at those premium rates. So we're feeling good about that.

And then it sounds like on the MSP side, you continue to fill more orders, obviously, with some of the MSPs that are ramping. The mature MSPs, what do you see in there in terms of order trends?

So this is Dan. That was the -- in terms of revenue, that was the comment I made a little bit earlier. So of the top 20, most of which are pretty mature, we're seeing higher revenue year-over-year, and I think the actual order count itself is about flat. Is that true for the most mature ones?

Yes.

And our actual fill rate, I think you were also asking what is our direct fill portion at maturity, and as Ralph said, we've got some room to grow. For the mature accounts, it's not changed measurably on a year-over-year basis. But we have opportunity to -- and that's because we can't fill every order. If we're going to fill 95% of a client's needs or more, we work with fantastic affiliate vendors that do a great job of also helping us get quality candidates placed quickly. So they're an important part of the success of our relationship with those clients. So we are not, nor we'll ever be, at 100% direct fill at our MSPs. But for the less mature MSPs that maybe have been implemented over the last year, we are below that maturity level. So we could be below 60%, 50% at some of them, and that's probably where we have more opportunity to increase our direct fill rates. So hopefully that's helpful, Mark.

And Mark, I had given some direction last time. On average, our MSPs ramped to about half their maturity after 6 months after the implementation is over. Typical implementation is about 90 days, and then they reach maturity about 18 months after that go-live. So you can see the ramp takes a decent amount of time for us to get to even the level of maturity you're talking about.

And then a couple of three quick questions. One, what was the impact on gross margins in nurse and allied of the labor disruption work? In other words, or another way of phrasing it would be, what would be the expected gross margin in Q3 without any labor disruption? That's one. Two, was there any malpractice reserve adjustment in this quarter? And if so, how much? And then the third one would be on locum tenens, and this -- when you would expect that the -- that your internal personnel would feel really acclimated and comfortable with the new systems and could really go back to their old productivity levels?

This is Brian. I'll take the first couple of questions there. The strike impact was about 60 basis points to the segment in terms of a drag. So if you had look at the second quarter results, kind of play that forward to Q3, you would say that the more normalize is about 27%, which that's about what we've been talking about the last couple of years as being in the range of the gross margin, we think, is appropriate for that segment. So that's what we've kind of built into our third quarter expectations. And then on the malpractice reserve adjustment, second quarter overall kind of spread across nurse, allied and locum, just about a $2 million favorable adjustment. And I mentioned that if you look at the year-over-year, prior year second quarter had an over $4 million adjustment, a lot of it in nurse and allied. So that's probably why you see the -- on comparative basis the gross margin and EBITDA margin down year-over-year, a combination of both of those factors. And then for the locum tenens, I'll pass that to Ralph.

Yes, the -- what we've seen on the learning curve from our prior releases is about 30 to 60 days that are disrupted by training and go-live activities, and then the adoption period ranges from 30 to 90 days by individual, almost. So we are anticipating that the locums business will start to see some improvements like that. Late in the fourth quarter would be great, but first quarter is to be expected.

That's when the revenue would start to be impacted. We would actually see productivity and booking improvement in the third quarter and the beginning of the fourth quarter.

And we go next to Tim McHugh with William Blair.

Just following up on that last question, just to be clear. Are you seeing signs in that activity yet for locums that, I guess, give you optimism? Or is it more based on kind of what you just -- the last answer, which was more, I guess, what you would normally expect given the change like this?

Yes, we're -- we had a couple of groups that went live early back in mid-March, and the production of those teams is back up above prior year already. So that's one sign our candidate flow has increased and our margins have improved as well as there are some pricing tools that are built in the model that weren't in our previous tool. So yes, there's lots of positive signs. We're just trying to predict when you can -- when 500 people cross the line. It's harder than looking at it on a small basis. But I appreciate the question because there's plenty of positives to point to that make us confident that while the disruption is a little bit more than we anticipated, that the other side of it is near.

And then just the comment on MSP go-live, I guess. You gave us some metrics. But how is that relative to, I guess, the normal pace of go-live here? Are you seeing an abnormal level -- or expecting an abnormal level of incremental revenue from MSPs? Or is this consistent with what basically we've been seeing the last couple of years?

So we did a pretty thorough analysis of the go-lives of all the deals that we have last year, and they're -- to a large extent, Tim, they're very normal. We had one customer that was an outlier, that was a large one, that required quite extensive integrations. And so they pushed their go-live back by about 5 months. All of those MSPs have gone live now as of May of this year. So all of that cadence that I was talking about now is beginning to flow through into sort of the back half of this year and 2019.

And we go to Jason Plagman with Jefferies and Company.

The first question, so was the strike revenue a drag on your EBITDA margin as well on the nurse and allied segment?

It was just a little below our consolidated EBITDA margin. So it had a lower gross margin, and a lot of that was actually driven by a large amount of pass-through expenses. We have costs like travel and hotels and things like that where you have either no or very little margin on that. And because of the size and the number of workers we brought in, that pulls down the gross margin, but you have a favorable SG&A margin on that. So end of the day, it had a nominal drag on the consolidated margin but obviously not material enough for us to note in our prepared remarks.

And then can you just comment on the long-term stability of the revenue and volumes you see from some of your MSP clients and just your ability to weather any pullback that you'd see if you sold several of their client's pullback in their order flows? How much of an impact -- your ability to push capture rate higher to offset that in a hypothetical scenario?

So Jason, I think it depends upon the clients and what our current fill rate is. Obviously, we already have a very high fill rate, and it's going to be more difficult for us to increase that percentage. And again, we always need our affiliate vendors there to help with those hard to fill and orders that need to be filled quickly as well. And then for the newer ones, we would have more opportunity to increase them. So it's hard to put a number on it because it obviously depends upon where that softness would occur and what kinds of positions. But we feel confident that we've got some room to absorb some of that depending upon where it would occur. I'm sorry I can't be more specific, but it really is dependent upon where the decline would happen.

No, understood. Completely hypothetical since you aren't seeing a pullback from those clients. And then I think we've discussed the focus on MSPs, but I don't think you've specified the level of MSP wins in Q2 and I think you've mentioned maybe one since the quarter closed. What was the amount there?

So first of all, I appreciate the question because our team had a really good quarter. It was nice solid performance. We had $46 million worth of new wins. 20% of that is locum specific, which is really terrific for that business and then the rest would be nurse and allied. It's a very nice geographic diversity, which is also really helpful for our sourcing and recruiting departments to get new clinicians because of the number of choices that are available. The other part about this is that the pipeline going into Q3 is also quite robust. As you mentioned, we've signed a couple already here in July. So I'm really confident that in Q3 we'll do more than what we would've done in Q2 that I already referenced, and we're well on pace to improve on last year's overall total which, again, was the most we had ever done. So we feel really good about where we're going with our MSP clients. The market is really adopting these tools to help them manage this spend in a much bigger way than we might have thought about two or three years ago. So I'm really bullish on that side of things.

We go to Mitra Ramgopal with Sidoti and Company. Please go ahead.

Two questions, I believe you mentioned the reason in terms of the softness in demand can be attributed to more OT and maybe more perm hiring. Just wondering if also you're seeing maybe some of that business shifting to the non-acute care setting in terms of affecting potential renewal rates also? And what you're seeing -- if you could comment also what you're seeing on that side in terms of some opportunities on the non-acute side?

Mitra, I can't say that we've seen a material shift in the sort of recent trends. I'm sure to some degree it happens. Of course, it's happening generally within health care. But when we look at our book of business and where we are placing people and generating revenue, it's continued to shift a little bit more towards non-acute, but it's not as if the last two quarters we've seen some sort of step change. When we look at our placements and revenue, we roughly estimate that about 80% comes from the acute care setting. The other 20% comes from non-acute, which would include clinics, home health, subacute, ambulatory surgery, rehab, schools, sort of all those categories [Indiscernible] no one of those categories dominates that 20%. So we'll continue to make sure that we have contracts and relationships with those types of organizations. And as they become larger themselves, it gives us opportunity to sign MSPs and larger contracts with them.

And then quickly in terms of maybe driving fill rates, et cetera. Is there any particular demand you're seeing in terms of some of the specialties you probably might be looking to enter into or expand upon?

We covered -- between the recent acquisitions, we covered the space pretty well. The demand trends that we're seeing, right, on the nursing side are from your traditional ICU, tele, med-surg. And on the physician side, we'd like to be strong at recruiting psych doctors. That's probably an opportunity for us. We're fairly large in that space, maybe the first or second largest, but there just aren't many of them. So it would be -- there's an opportunity of upside there. Some new specialties that we've had conversation with clients about like informatics physicians at health care; document improvement specialists, which we are now doing through our recent acquisition. So it seems like there's nothing that's really big out there, but we keep our eye on it. And what we have seen is a lot of low-skilled physicians start to get replaced. And so a little bit of a drag on our local business is physicians that were working in homes or sitting with patients and things like that are being replaced, video technology and a few things there. So we try to stay away from things we think would eventually go away, and -- but focus on those things that have higher profit potential and bigger markets.

And we'll go to Bill Sutherland with The Benchmark Company.

I'm down to one question, and that's in OWS, I'm just thinking a little bit more about what you said, I think, Susan, about the third quarter. I think you're having to think about 2% to 3% growth there. And can you speak to kind of how the components might shakeout to do that?

So as I mentioned, we're seeing nice growth in our Peak Health, if I'm looking at the organic business, that Peak Health is growing very nicely. It's been double digit and they're set up well for the second half of the year. RPO, we mentioned earlier, feeling better even though it's still very small. Physician perm, we expect to grow on a year-over-year basis although admittedly, sort of low single-digit growth. But we're turning the corner, so we felt that, that was notable. VMS is expected to be down year-over-year in the third quarter. It's a combination of some client attrition not being replaced with new clients and some slowdown in their gross spend under management and the filled jobs. So that's a little bit indicative of that tepid demand environment within health care staffing that we've mentioned. And then our leadership business -- interim leadership businesses are relatively flat, including -- I'm sorry, excluding the Leaders for Today acquisition, which, of course, is adding revenue. So hopefully that's helpful so you get a bit of the moving parts. And -- oh, I'm sorry, do not want to forget about Avantas because they are doing fantastic. They had nice growth in the second quarter and continuing to look at double-digit growth in the third quarter. Again, smaller business, but strategically very important to our clients and we're seeing continued growth and appetite for those kinds of workforce solutions.

Anything notable as you look at the interim business, what the fact -- what the factors might be and what the outlook might be?

Demand levels have been pretty flat in the business. Our fill rates have gone up, and we're seeing an increase in MSP -- inclusion in MSP agreements. So I would say you're kind of probably slightly up in the interim and leadership business and -- but nothing super -- not double-digits or anything. Just kind of just single -- probably low single-digit increase.

A few more perm conversions, which is always a compliment when they like our talent so much that they want to convert them into a permanent leadership role, and it just is reflective of how difficult it is for them to recruit permanent talent as well. And sometimes they bring in our talent so that they can sort of try them and see how it works. So we did see a slight uptick in the number of people that went permanent, and that's driven by the clients, again, very much wanting them to be an ongoing part of the team.

And I believe we have time for one last question. That will be from the line of Brooks O'Neil with Lake Street Capital.

I'm curious. I guess I have thought historically about positive -- very extraordinarily positive secular tailwinds on both the supply and the demand side of your business. Clearly, now a few quarters of softer trends and maybe different behavior on the part of the demand side of this equation. I'm curious, I just really would love to get your perspective on why your customers are trying to hire nurses and other staff permanently. Why are they paying big inducements today? And is this a change and something different from what you've seen historically? Or is this a pretty normal pattern you have seen will be at over time?

I would -- Brooks, I would say this is a fairly normal cycle that we see. Although, some of the inducements that they're using, like the high bonuses, you don't see those that often because they are very expensive and the facilities run the risk of upsetting their tenured core perm staff who've been there for a while. But nevertheless, because they have such high attrition and are having challenges in recruiting, they have -- you have to start stepping up and doing something different. And so I'd say that's -- the notion of we're going to start to hire more people and increase our internal recruitment efforts is not a new thing when you're going through a time like this. The tactics that they're using in throwing these higher bonuses and tuition reimbursement are more than what we've seen in the past. Whether they'll work or not remains to be seen and whether they're sustainable or not remains to be seen. I'm pretty sure the overtime and extra hours worked are not particularly sustainable. Most nurses complain about burnout and working too many hours. And so if they're being pushed or forced to pick up extra hours and shifts, that's likely to translate into even higher attrition, even though we're already at historical highs, and frustration by their nurses. So that trend is not a particularly new one, but I think they're probably trying to press that lever just a little bit harder in this environment.

And I'll turn it back to our speakers for closing remarks.

Wonderful. Well, we very much appreciate everybody joining us today, and we look forward to updating you on our next earnings call at the end of October.

Thank you. Ladies and gentlemen, this will conclude our teleconference for today. Thank you for using AT&T Executive TeleConference Service. You may now disconnect.