Surgery Partners Inc (SGRY) 2016 Q2 法說會逐字稿

Greetings and welcome to the Surgery Partners, Inc. second-quarter 2016 earnings conference call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Mike Doyle, CEO. Thank you, sir. You may begin.

Thank you, operator. I would like to welcome everyone to Surgery Partners second-quarter 2016 earnings call. Joining me today is Teresa Sparks, our Executive Vice President and Chief Financial Officer.

I will turn it over to Teresa to review the Safe Harbor statements.

Thanks, Mike. Before we begin let me remind everyone that during this call Surgery Partners management may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about future expectations, anticipation, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risk, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements.

Such risks and other factors are set forth in the Company's earnings release posted on the website, provided in our final prospectus and subsequently filed Form 10-Q as filed with the Securities and Exchange Commission. The Company does not undertake any duty to update such forward-looking statements.

Additionally during today's call, the Company will discuss non-GAAP measures which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of adjusted EBITDA to net earnings calculated under GAAP can be found in our earnings release which is posted on our website at SurgeryPartners.com and in our most recent Form 10-Q.

With that, I will turn the call back over to Mike.

Thank you, Teresa. Our second quarter marked another strong period of growth for Surgery Partners and I would like to thank our physicians and employees for their hard work in delivering exceptional care to our patients on a daily basis. During the quarter, our revenue growth continued to accelerate as we generated a 24.4% increase compared with the same period last year. As a reminder, we reported a 19.2% increase in the first quarter.

These figures reflect expansion of our service lines, recruitment of new physicians in existing markets and the addition of new locations over the past year.

On a same facility basis, revenue increased 14.9% with strong case growth of 7.9%. Our same facility revenue continues to benefit from our differentiated operating model as we continue to add integrated and higher acuity services. We are at the forefront of this outpatient focus as our model meets the needs of patients, physicians and payers.

There has been a great deal of attention on orthopedic procedures in recent quarters with growing payer interest regarding outpatient joint surgeries. We now perform total joint procedures at 23 of our facilities. With our expanding range of services and physicians, we are well-positioned for and an environment of integrated services and improved measurements that better demonstrate both quality and value.

Supporting this effort, our dedicated recruiting team has played a key role in attracting physicians in specialties that perform higher acuity procedures as we have expanded these programs in key areas. Our experienced team has a deep understanding of core nation of physicians, staff, payers and vendors required to continue our success in this area.

Our integrated approach appeals to physicians and payers alike continuing to be a key driver in our growing network of healthcare facilities.

In the second quarter, we completed five transactions. As we previously announced, we closed an integrated physician practice in Jacksonville, Florida in April. Jacksonville is an attractive market for us and in addition to the physician practice, this transaction added a second Surgery Center, anesthesia and related ancillary services.

We also complemented our existing market in Idaho with an acquisition of a multispecialty physician practice and an additional urgent care facility. Also during the quarter, we entered into a strategic relationship with a health system and physicians in a new market in Texas with the acquisition of ambulatory surgery center and an anesthesia practice in Houston.

Finally, our acquisitions of independent physician practices remain an efficient use of our capital and during the quarter we completed an acquisition of an independent practice in Sarasota, Florida. Our ancillary group's performance will continue to improve as our acquired and de novo physician practices mature and benefit from our infrastructure.

As most of you know, CMS has proposed a 1.2% increase for the ASC and a 1.6% increase for our surgical hospitals in 2016. In addition, a CMS advisory panel has reconsidered the rate on definitive drug testing with the majority vote in support of an increase. The decision is now in the hands of the Secretary of Health and Human Services. This change could provide a 40%, 50% increase in Medicare reimbursement for the same services that received a significant cut in reimbursement this year.

Our network now consists of 103 surgical facilities across 29 states as well as providing anesthesia services to over 45 locations and operating 51 physician practices. We believe there is a significant opportunity to grow in existing and new markets and our pipeline remains robust.

I will now turn the call over to Teresa to review the financials for the quarter.

As Mike mentioned, we were pleased with the continued strong performance of our operations this quarter. Second quarter revenue increased 24.4% to $289.7 million with cases up 10.3%. Same facility revenue increased 14.9% and same facility cases increased 7.9%. By business segment, our surgical facilities revenue increased 21.8% and ancillary services increased 80%.

Ancillary services are now approximately 15% of revenue including anesthesia.

Adjusted EBITDA increased 19.6% to $46 million compared to $38.5 million in the second quarter 2015. Last quarter we discussed the CMS lab rate reduction which had an adjusted EBITDA margin impact of approximately 1% in this quarter as compared to the prior year. As expected, margins improved over the first quarter this year. Our adjusted EBITDA margin was 15.9% compared with 16.5% last year and 14.4% in the first quarter.

From a segment perspective, the adjusted EBITDA margin at our core surgical facilities increased 50 basis points compared to the prior year to 20.6% in 2016 from 20.1% in 2015. Our surgical facilities continue to benefit from our differentiated model. As it relates to our ancillary services segment, we continue to focus on the integration of our physician practices and capital investments in the infrastructure associated with this rapidly growing segment.

The adjusted EBITDA margin in this segment reflects the lab rate reduction along with the growth in our physician practices which operate at a lower margin.

We remain very active on the acquisition front. We closed on four end market transactions during the quarter including the integrated physician practice in Jacksonville, Florida, and an ASC in Houston, Texas representing a new market.

Through the first six months of 2016, we spent approximately $117 million including $16.6 million of contingent acquisition consideration of which approximately $109 million occurred in the second quarter. We continue to estimate that our acquisition spend for the full year will be in a range of $150 million to $160 million.

We ended the quarter with cash and equivalents of $51.6 million and availability of $146.9 million under our revolving credit facility.

Net operating cash flow including operating cash less distributions to noncontrolling interest was $33.9 million for the second quarter. Free cash flow for the second quarter was $27.6 million as normalized for merger transaction costs of $1.3 million and integration related capital of $900,000.

At the end of the second quarter, our ratio of total debt to EBITDA as calculated under the Company's credit agreement was 6 times. We expect to end the year with leverage below 6 times and are targeting a ratio of 4.5 times by the end of 2018. Overall, we are very pleased with our results for the quarter.

With that I would like to turn the call back to Mike to discuss our 2016 outlook.

Thank you, Teresa. It has been another solid quarter for the business and we continue to find compelling opportunities for growth. We have a strong network of physicians and facilities, our expansion pipeline remains full and we continue to attract new physicians through both recruitment and employment opportunities.

Before moving to the Q&A, I would like to reiterate our 2016 guidance. We expect adjusted EBITDA growth of 16% to 21% or a range of $184 million to $191 million. We expect revenue growth of 14% to 18% or a range of $1.1 billion to $1.14 billion.

Thank you for your interest and support. Let me turn the call back over to the operator to begin the question-and-answer session.

(Operator Instructions). Kevin Fischbeck, Bank of America Merrill Lynch.

Great, thanks. Was wondering if you could talk a little bit about the surgical margins in the quarter. You mentioned that margins were up due to the performance of your model. I was wondering if you could give a little more color on what was really driving the year-over-year improvement in margins there?

Yes, thanks, Kevin. So one of the drivers is just the overall improvement on a quarter-over-quarter basis but specifically we had talked in the first quarter about some pressure we had from the relocation of our hospital at Great Falls and some of the anesthesia-related expenses that occur in the first quarter by nature. And so we saw improvement in both of these areas as we expected. So when you look at that segment just on a sequential basis, we had about a 280 basis point improvement in our margins again really as those things improved in the second quarter.

So the model continues to drive an increase in surgical cases. As we focus on end market development and physician practices, those will continue to have a benefit related to our surgical cases in that segment as well as anesthesia which falls in that segment.

Okay. I guess on the ancillary side, did you say how much the margins were impacted by the lab cut in the quarter?

I don't think we mentioned it in the text but if you normalize for kind of the rate reduction overall for the Company, it was about 100 basis points related to our adjusted EBITDA margin.

To the consolidated EBITDA margin?

Right, that is correct.

And I guess the margin has got to bounce around the first couple of quarters in ancillary. What do you think the right kind of way to think about ancillary margins over the medium-term or longer-term are?

So I think by the end of the year we will be in the around the 20% range. Some of the transaction or transition costs we incurred in the second quarter will continue to improve as we move through the rest of the year. So I think we will probably be in probably the 18% to 20% range. And I will just take a second just to note that we did transition from an op income perspective in our segment reporting to adjusted EBITDA. We found precedent other companies presenting in that manner and thought it would be more transparent, more useful to the reader. And so I am speaking on that adjusted EBITDA basis.

Okay, great. Thanks.

Brian Tanquilut, Jefferies.

Good morning. Congratulations, guys. So Mike, same-store was very strong during the quarter and it hasn't been strong. As you look forward say over the next 12 to months, what is your outlook on organic growth and same-store, number one?

And then as I look at the guidance that you just reiterated, it seems like based on the revenue that you've delivered for the first half of the year just annualizing the Q2 number gets you above the guidance range. So how should we think about those moving parts if you don't mind just giving some color to that?

Maybe starting with the same store, again we have been able to continue the same process we have had and as we mentioned during the IPO roadshow as we went through our first few quarters, post-Symbion deal and integrating our teams the ability to accelerate and continue to get the momentum from both the combined recruitment team having a dedicated recruitment team focusing on bringing not only new physicians but new specialties and new types of procedures to our facilities has really been performing very well.

On top of that giving us that extra tool to be able to employ physicians is another way that has given us that capability. And again, most of the case growth is coming from the ability to bring in new physicians and new types of specialties, new types of procedures to our facility. But there is also some that is also being enhanced slightly by the ability to employ the physicians.

So from a same facility perspective we continue to see our target list, our pipeline from a recruitment perspective, the number of locations where we can continue to increase the acuity of procedures and also just the numbers of those higher acuity procedures. Again, we are in the early stages of that. We seem to have a lot of running room there. So that will continue and again focusing -- there will be some fluctuation between case and rate just depending on the type of specialties we are recruiting but again a strong pipeline and strong future on that piece of it.

On the other side of looking at the revenue side of guidance, we continue to have a -- it will depend on the mix of acquisitions as we continue to go forward. As you know the physician practices will have a lower margin so that revenue will convert to just by the nature of the business convert to less on the margin perspective. And we continue to have as we bring on these physician practices, our mature practices continue to perform very well whereas our new practices have that transition period where we are bringing them over, where we have overlapping providers. We are doing some integration work and transition work on these practices, combining physical plants, bringing them into new physical plants, adding marketing, adding ancillary services and converting ancillary services and there has been a little bit of a softer practice volume.

So that piece of it should get more clarity as the year continues but I think from a guidance perspective, we are comfortable on holding where we are although we are on a little bit of the high side from a revenue perspective, we will continue to see improvement in that ancillary division.

Got it. I will jump back into queue. Thanks, Mike.

Ralph Giacobbe, Citi.

Thanks, good morning. You mentioned the potential lab increase for next year of 40% to 50%. I guess is that determined already or help us with next steps to getting visibility on that.

And then just around the math of it, if it was an $11 million, $12 million hit this year is it basically getting you about half of it back next year? Is that how we should think about it?

Yes, you have answered the question to that. So we will get 40% to 50% of it back. There is still a little bit out there so what we are looking for is we have had the advisory panel has had a positive reception and really the approval is now at the Secretary of Health Human Services and the word is that is unlikely that that will be a significant change from what has been recommended. I think as we talked about on our earlier calls, the cuts were greater than expected, significantly greater than expected although it didn't change our strategy. And I think what they have done is they've taken a look at it and understood that this is an important piece of the continuum of care that needs to be provided in these types of services.

Looking at that 40% to 50% improvement from where we are today feels appropriate. Again, we think there continues to be room but we will be pleased to have about 40% to 50% of that back.

Okay, great. One more if I could. You mentioned also in the call a growing interest in ortho. You talked about sort of expanding that out to 23 of your facilities. I am assuming growing interest meaning from the payer side. I guess just help us in terms of maybe what payers are doing to potentially push that volume or help us understand the conversations you are having there to capture that category?

As I mentioned on last quarter's call, we have begun the strategic relationships with the payers more on a contracting basis and focusing on how can we bring things that are traditionally done in the hospital setting into the outpatient setting and obviously total joints that are associated with orthopedics are really a key focus for the payers currently.

We have a significant ability to coordinate care on an outpatient basis through our surgical facility, our anesthesia, our vendors and our physicians to coordinate that care and provide appropriate post-op care and follow-up with the physicians in their office. So they really see that as an opportunity to begin with their commercial patients and find ways to have us do those for the appropriate patients on an outpatient basis.

Again, early stages for that both from a physician perspective and a payer perspective but continue to get a lot of traction there. Our focus is really working with the physicians and ensuring that the clinical protocols are in place at our surgical facilities are not only being able to perform the procedure which we are very, very capable of and have the capabilities at many of our facilities to do that but it is the post-op care and ensuring that we have that coordinated not only with the physician and the patient but also the vendors.

So I think we will continue to seek focus and growth there and we have a very focused program on how do we systematically work through facility by facility and capture those opportunities both from a payer and physician perspective.

Okay, thank you.

Frank Morgan, RBC Capital Markets.

Good morning. I was hoping to get a little bit of color around the case growth throughout the months of the quarter and maybe if you could also parse out was any of that impacted by these newer higher acuity procedures that you are talking about? Is that far enough along to have an impact? That would be my first question.

From a growth perspective, it is very difficult to go to facility by facility in parse out specialty by specialty and then within that specialty the case mix of how much of it is higher acuity. I think what we have looked at from an overall basis is as we have a combination of strong case growth and strong revenue growth, those are usually associated with some upticks in the higher acuity cases. But difficult to parse that out as you have a portfolio of facilities with multiple specialties and then a pretty diverse case volume within those specialties.

The way we approach the growth and case growth specifically is really if we have capacity in a facility we would like to bring in the appropriate specialties and the appropriate physicians that can bring cases to that center. So we are somewhat indiscriminate on the types of cases we bring but understanding that the relationships that we have with orthopedic surgeons and people that do higher acuity cases have the ability to bring in and bring new relationships to those facilities.

In terms of just volumes across the months of the quarter and maybe if there is any geographical commentary about any color on how volume transfers from a geographic perspective? Thanks.

Yes, from a geographic perspective, it has been pretty consistent. As we look on a national basis state by state and even market by market, we see continued performance mostly in our multispecialty. As we look at our single specialty and smaller markets we see less growth there but it is usually a single practice group of physicians with AST and often times being single specialty limits your ability to recruit into those. Although we have seen many of those that we've been able convert to multispecialty or bring in new providers in a market. But for the most part we see pretty consistent growth in our multispecialty facilities.

And progression in most of the quarter and should we expect any softness going into the third-quarter seasonally? Thanks.

Typically as the quarter goes we will have a strong month, a softer month and one that kind of falls in the middle and that is pretty typical with each quarter. I think July is off to a little bit of a soft start but that is not unusual for the third quarter.

Okay, thanks.

Matthew Borsch, Goldman Sachs.

This is Tejus Ujjani on for Matt. Thanks for taking the question. Just to go back to the organic trends a little bit more on the pricing side, the same-store pricing was much stronger compared to first quarter. Can you give us a sense of how much of this was just from simply higher price cases versus actual cross-selling of anesthesia?

We saw in the first quarter and we talked about this, it was kind of unusual that our cases drove 11.6% of our 13.3% same facility revenue growth in the first quarter. Really think it was attributed to just a higher growth in the quarter related to lower acuity cases which you would see that with the pressure on co-pays and deductibles, all that kind of makes sense but we did speak to in the first quarter, we thought same facility revenue growth would normalized to be a more even split between cases and net revenue per case which we saw in the second quarter and is consistent with our historical results.

And so embedded in that net revenue per case is really where you see the pricing, the acuity and the ancillary services which are all reflected in that component of the same facility revenue growth and then also obviously cases to get the total revenue growth for the quarter.

So it kind of normalized as we thought it would to more of an even split and we are seeing pricing continue to be consistent. We are seeing our ancillary services continue to benefit in terms of our same facility growth and then obviously acuity is playing a role as well.

Great, thank you very much.

John Ransom, Raymond James.

Good morning. So I think initially your guidance said your 150 to 160 of acquisitions spend was around $30 million of acquired EBITDA. Is that still a good number?

Yes, that is still, we are still on track to achieve that. We have acquired roughly $18 million with the transactions completed to date and realized about $11 million to $12 million. So we are still on track as it relates to that acquired EBITDA embedded in our guidance. Based on timing, it's about 50% of that but yes, we are still on track. That is still a good number.

So that would imply the remaining spend would be at a pretty low multiple then like 2, 3 times?

Well, I think it is really as you look at this contingent consideration piece of the equation, that is about $17 million so if we set that aside, that is a cash for the next three years, it is a use of cash for the next three years, we would have a little bit more room with that 150 to 160.

Got you. What is the mix in that spend of practice acquisitions versus ASCs and what is your thought about timing for the -- is the remaining spend going to be mostly backend weighted toward the end of the fourth quarter or should there be some incremental contribution this year?

We are looking at some incremental contribution this year but obviously the timing is sensitive as you roll into the last half of the year. The spend so far has been more heavily weighted towards physician practices with the transaction in Jacksonville being a large platform transaction for us in that market. And then the ASC in Houston, was really our focus in terms of a standalone ASC in a new market. So that spend is pretty much just related to Houston but total spend more heavily weighted toward the physician practices.

For the balance of the year, is it going to be more ASC weighted?

The pipeline is extremely active and there's a lot of opportunities on both of those fronts and so it really will depend on just how quickly we can execute and bring one of them across the finish line. So it is a mix in our pipeline and so it is a pretty balanced pipeline.

Okay. I will jump back in queue. Thanks.

Brian Tanquilut, Jefferies.

Thanks for taking the follow-up. Teresa, just on bad debt it was below 2% of revenue and it has been that way for the last two quarters. Just wanted to ask you how we should be modeling that going forward?

We are very pleased with the bad debt results in the second quarter is 1.2%. I would like to think that that can continue but if I were to model I'm usually in that 2.5% range. That is usually a more normalized approach to bad debt expense, 2% to 3%. But we have had great success this year in terms of our overall bad debt and managing our AR. So for modeling purposes again, we are pleased with our results but I think that 2.5% is pretty consistent with our historical results.

Got it. Last follow-up for me so on the G&A side it was up sequentially even if you adjust for the contingent acquisition charge. How should we think about that run rating for the back half of this year?

So we had the two things you mentioned just to be clear, the contingent acquisition consideration is now amortized and that is a change this quarter and there is about $1.5 million included in corporate G&A as we noted on the face of the financials.

We also had a little bit of increase in non-cash stock compensation expense with equity changes this year and so that increased just a little bit. That rolls into corporate G&A. But I think it will be consistent. If you normalize for those things, we are at 4.5% of revenue and I would expect us to stay in that range.

Got it. Thanks, guys.

Bill Sutherland, Emerging Growth Equities.

Thanks, good morning. Where do things stand with the Symbion synergies year to date? I think you were targeting something around $10 million for the year.

I think from a synergy perspective, we are there on what we expected to get for the year. And as we break it into the cost synergies versus our revenue synergies we have continued to make progress from a revenue perspective. Ancillary services now about 15% of our total revenues which is where we expected to be by the end of the year of 2016. From a cost perspective, that piece of it has been done and continue to realize it in the run rate of the $15 million that we expected.

Great. If I could just sneak in a follow-up. On the Texas market, Mike, and your move into Houston, maybe you can just give us some color on what you think of the possibilities in that market for you? Thanks.

That continues to be an active market so this is our first step into this market and our feeling was in order to come into this market we wanted to make sure that we could have the ability to bring in multiple service lines and we were able to do that with this acquisition. So Houston appears to be a good market. It started very well for us.

Again, that market has -- and the ability to partner with a health system in that market is really something that brings along the capabilities for success. And as was seen in different markets in Texas, there is a different market by market, there is a different assessment and in this market, our thought process the best way to enter was with a health system partner.

Great, thanks again.

John Ransom, Raymond James Financial.

Going back to your acquisition, is that -- the requisite dumb question for the call -- so was this a hit to EBITDA that wasn't contemplated originally in guidance or was this contemplated or was this a change that happened? I just wasn't clear. Sorry.

You are going to have to ask that one more time, John.

So you talked about the acquisition amortization going through corporate G&A. Is that something that was different than what you thought about in guidance?

Yes.

I'm just not clear about the accounting, sorry.

So from a deal perspective basically it's a great deal for us in terms of business transaction where we have the physicians tied into the business over the next three years based on their employment and continued employment. So from a business perspective, it makes perfect sense. It gives us an enhanced protection related to that to our physicians.

It just happens to have poor accounting treatment so basically you are just amortizing part of the purchase price and you will amortize that over the next three years which matches the term of their employment. So a good business decision, bad accounting treatment but --.

So it not part of D&A then, it is an expense? I thought this would be through D&A.

No, it is a contingent acquisition consideration. We've got some comps that we looked at. TeamHealth is one of those and you can see it clearly on their income statement and so there are some other pretty notable comps that have the same issue. And so anyway again, a good business decision for us, just poor accounting treatment.

And then the other thing to go back to labor margin, I know you guys are looking for a couple hundred basis points improvement by the end of the year. As we think about 2017, is there further improvement expected? I think it is around 30% for the back half but should that continue to get better? Is that going to be kind of a level set based on your current mix of business?

I think really as our mix of business continues to shift towards anesthesia and physician practices we will see that and we will pretty much stay in that 30% range. As you look at the income statement, the kind of the offset is in supplies where those lines of business have higher salary related costs but very little supply. So that is kind of a mix you are seeing there in terms of the line items as a percent of revenue.

Okay, thank you.

Thanks.

At this time, I would like to turn the floor back over to Mr. Doyle for any additional or closing comments.

Thanks, operator. I appreciate everyone joining us today. Again, a good quarter. We are pleased with our results and we look forward to catching up with everybody following the third quarter and appreciate the support. Thanks.

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day.