Surgery Partners Inc (SGRY) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Surgery Partners, Inc. Third Quarter 2017 Earnings Call.

(Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Teresa Sparks. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us today for Surgery Partners Third Quarter 2017 Earnings Conference Call.

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 risk and other factors are set forth in the company's earnings release posted on the website and provided in our Annual Report on Form 10-K and our quarterly report on Form 10-Q; each is 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 and adjusted net income to 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 quarterly report on Form 10-Q.

With that, I'll turn the call over to Cliff Adlerz, our interim Chief Executive Officer of Surgery Partners.

Good morning, and thank you for joining the call. It has been a dynamic first few months in my role as interim CEO. Our first challenge was the natural disasters impacting several of our markets, and our main priority was ensuring the safety well-being of our colleagues in these areas. We are pleased to report that all of our employees are okay, our facilities suffered only minor damages and we appreciate the swift response by our entire team in addressing immediate needs.

As this is my first earnings call, I would like to frame up this morning's discussion around 3 primary topics. First, Teresa will provide a brief update on our third quarter and year-to-date results, which are in line with our pre-release on October 31. I will then provide an update on the status of our integration efforts related to NSH and how we are leveraging these efforts in creating focus and discipline around our core operations. And finally, I will outline some of the 2018 headwinds and tailwinds and the efforts we are undertaking to achieve growth and improved underlying financial performance.

At the onset, before stepping through each of these 3 topics, I want to clearly state I'm very excited about the opportunities ahead of Surgery Partners given the business is well aligned to take advantage of the long-term trend for an increasing number of surgical procedures moving to high-quality, more cost-efficient outpatient facilities. Moving forward, the organization is focused on several key initiatives including: setting appropriate growth objectives and providing the corresponding guidance to our investors; integrating NSH to achieve the scale benefits of a larger, more diversified organization; focusing our efforts on our core outpatient surgical facilities by driving performance improvements to achieve increased same-facility growth and enhanced margins; and evaluating and completing accretive acquisitions of short-stay surgical facilities. I will elaborate further on these items. But in short, these are the main areas of organizational focus and action.

With that backdrop, let me hand the call over to Teresa for an update on our financial results and near-term outlook.

Thanks, Cliff. As you saw last week, we preannounced select financial results in the quarter and updated guidance for 2017 in order to provide greater transparency regarding the state of the business, the innate challenges we faced during the quarter and their impact on our financial results.

For the quarter, total revenues increased 8.4% to $306.3 million from $282.7 million for the third quarter of 2016. Total revenues reflect the contribution of one month of revenues from the NSH business, partially offset by the impact of certain industry headwinds and hurricanes. On a normalized basis, total revenues increased 16.7% to $330 million. As a reminder, normalized revenue is adjusted for the impact from hurricanes as well as the onetime adjustments disclosed in our earnings prerelease.

Our same-facility revenues in the quarter on both a normalized and pro forma basis reflecting the NSH acquisition increased 2.9%, which is a result of a 3.3% increase in net revenue per case offset by a slight decrease in case volume.

On a sequential basis, we have seen a stabilization in the payer mix between commercial and government payers.

Our adjusted EBITDA margin on a normalized basis declined to 13.1% from 15.8% of revenue as compared to the third quarter of last year. This decline in margins was primarily driven by an increase in our medical supply and implant costs driven by higher acuity cases and an adverse payer mix shift within commercial. We have launched specific initiatives to address margins with a focus on procurement and medical supplies. Cliff will elaborate on these in a moment.

Normalized adjusted EBITDA for the third quarter of 2017, which excludes the impact of hurricanes and the charges identified in our earnings prerelease, was $43.1 million compared to $44.7 million third quarter 2016.

On a year-to-date basis, revenues increased 4.9% to $880.9 million, up from $839.4 million during the same period last year. On a normalized basis, year-to-date revenues increased to $904.5 million from $839.4 million during the same period of 2016.

Additionally, on a normalized basis and pro forma for the NSH acquisition, our same-facility revenues increased 5.7% with a 4.3% increase in net revenue per case and an increase in cases of 1.3%.

Now turning to the balance sheet. We ended the quarter with cash and cash equivalents of approximately $200 million and availability of approximately $75 million under our revolving credit facility.

Net operating cash flow including operating cash flow less distributions to noncontrolling interests and adjusting for merger-related expenses and tax receivable payments of $15.2 million, was $5.3 million.

The company has an appropriately flexible capital structure with no financial covenant on the term loan or our senior unsecured note.

Our balance sheet is well positioned with ample cash to fund both organic and inorganic growth initiatives.

Finally, for the full year 2017 including the partial year impact of the NSH acquisition, which is performing as anticipated, revenue is now expected in the range of $1.3 billion to $1.33 billion and adjusted EBITDA in the range of $178 million to $185 million, which is inclusive of the normalization for the impact of hurricanes and the reserve adjustment disclosed in our earnings prerelease. This outlook highlights our more conservative approach towards assessing the company's performance, the impact of certain nonrecurring items and expectations for the business for the remainder of 2017.

With that, let me hand the call back over to Cliff for his commentary on the integration efforts and our operational initiatives. Cliff?

Thanks, Teresa. Although the quarter and the near-term outlook on the business were impacted by certain industry headwinds and the hurricanes, we feel more confident than ever about our ability to create long-term profitable growth. Our current focus is on the seamless integration of NSH and the opportunity to leverage our core operating assets. We believe that the combined company operating on a larger scale will be effective in delivering a more diversified set of services focused on high-quality, cost-effective surgical procedures to a growing number of patients, payers and providers.

The integration is proceeding as expected. We are beginning to operate with scale and efficiencies of a larger organization. As a reminder, the combined company now has a portfolio of 124 surgical facilities, 60 physician practices and complementary ancillary services, and operates in 32 states with more than 5,000 affiliated physicians.

We continue to expect approximately $20 million in run rate synergies with the majority captured in 2018.

Despite the unique challenges in the quarter, our underlying core assets continue to deliver growth. As was previously stated, we exhibited strong same-facility revenue growth of 2.9% as compared to the third quarter of 2016 and 5.7% growth on a year-to-date basis. We believe the continued same-facility growth rates in the quarter and year-to-date demonstrates the underlying market demand for outpatient surgical procedures at our facilities.

We are even more convicted in our belief that the trend in surgical procedures towards high-quality, more cost-effective settings is a long-term growth driver for our business that was further strengthened as CMS is finalizing its proposal to add 3 procedures to the ASC-covered procedures list. These new proposed rules, coupled with our initiatives to expand recruitment and marketing, are expected to pay dividends to the business long term. This increases our target patient market, represents a significant opportunity for short-stay surgical facilities. We are well positioned to capitalize on the long-term positive trends in our industry, leveraging our balance sheet to support additional organic growth or tuck-in acquisitions.

We've also launched a number of initiatives to accelerate same-facility growth including, but not limited to, first, expanding our dedicated recruitment team and enhancing our marketing capabilities related to new service lines including total joints. This initiative will be supportive of our short-stay surgery assets, which comprise over 90% of our revenue and will be the primary focus of our strategy and growth moving forward.

Second, implementing procurement initiatives to improve margins by harnessing the purchasing power of the combined entities and utilizing best practices across the organization. We've already completed a deep dive assessment of the opportunities and believe such opportunities are better than we had initially anticipated when analyzing the NSH acquisition.

Third, leveraging enhanced analytical tools to enable us to fully understand, evaluate and act on the opportunities for margin improvements across all our locations and procedures. Importantly, we will take such action on a more dynamic and real-time basis.

These and other efforts are actively underway with dedicated internal teams and external resources implementing programs and taking specific actions. We believe these near-term initiatives will maximize our organic growth opportunities and position the company to enter 2018 with a stronger, more diversified business that will deliver improved, sustainable, long-term financial performance.

Moving to 2018 headwinds and tailwinds. We're optimistic regarding the opportunities for improved execution in 2018. While we're hopeful that the industry softness and hurricanes we encountered in 2017 do not repeat in 2018. In addition to the aforementioned initiatives, we have a number of significant tailwinds as we begin to enter the new year that are within our care and custody to execute including run rate synergies resulting from the integration of NSH and Surgery Partners. We remain confident in our ability to achieve approximately $20 million in synergies with significant action to be taken in 2018.

A strong balance sheet with approximately $200 million of cash at the parent, coupled with over $75 million in undrawn revolver, we are well positioned to invest both organically and inorganically for growth.

Related to the deployment of our healthy balance sheet, we continue to build our pipeline for accretive, tuck-in acquisitions under the leadership of our new Chief Development Officer, Ben Jacobs, formally of NSH.

We have the benefit strategically of being the nation's largest independent and focused short-stay surgery facility operator, positioning us as the premier partner for physicians who desire the outpatient setting.

Through a refocused and disciplined effort, our tuck-in M&A strategy will begin to add to our growth trajectory. This strategy will predominantly be focused on short-stay surgical facilities, particularly those with a musculoskeletal focus.

We currently do not see any significant unmanageable headwinds heading into 2018. We look forward to executing on our initiatives with a renewed focus on short-stay surgical procedures. We will provide more detailed guidance during our fourth quarter earnings call in February 2018.

I would now like to turn the call back over to the operator to begin the question-and-answer session.

(Operator Instructions) Our first question comes from Brian Tanquilut with Jefferies.

Cliff, welcome back, I guess, to Surgery Partners. First question for you. Obviously, you know a lot of these assets that are in the portfolio. So coming in from the outside and I know you stayed here in Nashville, so you've watched this asset over the last few years, where do you think things kind of fell through the cracks? Or what were the issues? And as I think about it, is this in your mind a basic blocking-and-tackling story at this point where you have a few things that you need to fix? Or is this more of a we need to pivot the strategy to a certain point to get the growth back in the business?

Yes. I know, thanks, Brian. It is good to be back. And as you know, I've got great familiarity with our senior management team and our operators. We've got a great team here, a great group of group presidents and even -- and then down to our RVP levels, so it's nice that I could come in and really kind of hit the ground running. I don't see it as a turnaround situation or a big pivot.

I believe the issue is really just focus, and -- over 90% of our assets are in the short-stay surgical facilities. So that really should be our focus going forward. And it's a business that we know extremely well, all the trends are positive in that business, cost-effective, low-cost setting, the inpatient/outpatient shift, high patient satisfaction, great patient outcomes. So we feel very good about that business long term. So I think it's really focusing in on our core business, on our core assets and starting to optimize, excuse me, those assets.

Got you. And then, Teresa, as I think about, the payer mix seems to be stabilizing and actually your revenue performance in the quarter ex hurricanes looked pretty good, right? So how should we think about, I know you're talking about procurement and all these things, but is this a margin reset given the types of patients that you're taking in right now or the types of cases? Or is there ample room to push margins higher even as we see these higher-acuity ortho cases coming in?

Yes, good question. So as we look at the business from a margin perspective, our trend towards higher-acuity cases has obviously had an impact on the business, although very well aligned with the trends, as Cliff just mentioned, that we're seeing in the broader industry in terms of shifts to -- from inpatient to outpatient supported by CMS and commercial payers.

So if we think about these cases being -- having a lower-margin profile, that really does focus the business, as that trend emerges and continues to accelerate, focuses our attention squarely upon our supplies and particularly our implant cost. And so with the opportunity bringing NSH together and focusing on procurement and med supplies, you look at those opportunities near term to long term and really from a near-term perspective, combining GPOs, leveraging pricing tiers, restructuring rebates, those are the things that you focus on near term to address the cost trends related to these higher-acuity cases and you really move through that continuum of initiatives from a supply standpoint based on near-term GPO, long-term physician preference items. So that's the really the way we think about it, think about tackling the business and improving margins.

We've also got to focus on analytics. We've, for some time, been building a data warehouse that we think is going to be very helpful in getting real-time information, and with some outside resources and our Bain partners, we are focusing on finishing up that effort, which will give us improved real-time information, will give us case costing, improved managed care contracting data and real-time trending data. So if we start mixing in the higher-acuity cases, then we've got the opportunity to evaluate those cases very quickly and determine what we need to do about our cost structure and/or make sure that we've got our revenue structure in line for those types of cases.

So I think those efforts, in addition to expanding our dedicated sales team, we've got a very strong sales group in the company and they have a very good infrastructure, they're using analytics to target physician recruitment, so it's really just a matter of expanding that group right now in cohort with our group presidents to make sure that we are developing our markets and supporting our surgery centers.

And then, the other effort is really tuck-in acquisitions in our same-store market. So we've got the ability to kind of I think rebuild that pipeline a little bit and letting our group presidents know that we have capital and we're ready to develop our markets. So if you're looking at one-off physician acquisitions or if you're looking at folding in another ASC into our portfolio in a market so that we can combine 2 ASCs or combine a smaller ASC into one of our markets, then we have the ability to do that, we have the development team to do that and we have the capital to do that, and that's often very effective growth for us because we know our market so well. So we think we've got some initiatives in place already started that will help us tremendously.

Our next question comes from Kevin Fischbeck with BoAML.

So I guess, throughout the year, companies -- you guys included -- saw weak first half volumes and the thought was volumes will be pushed to the back half of the year because of high deductibles, high copays. What is the Q4 assumption in your guidance around the rebound of volumes seasonally? Do they -- is it a normal seasonality? Or are you still forecasting an accelerated seasonality in Q4?

Yes. Thanks, Kevin. So as you mentioned, I mean, we really identified these trends really emerging in the second quarter and then continuing in the third and our projections lay out that those trends would persist into the fourth quarter, with some muted seasonality expected in the fourth quarter. So that, from just an overview perspective, is how we laid out our thoughts and projections related to the fourth quarter.

All right. So I guess, given that it sounds like you're taking this from a holistic year perspective, a more muted volume backdrop for the year this year. When you talked about headwinds and tailwinds, you indicated that there really weren't in your view any unmanageable headwinds for next year. I guess, when you think about the core growth of the business for next year, the industry, like just as your backdrop, I'm not even talking about you specifically, is there a reason to think that the industry growth absent the hurricanes will be better next year than it is this year? Or is the assumption that the pressures that you've seen this year are likely to persist into next year?

Yes, there are obviously tailwinds as we look into next year in just the continued acceptance of and push towards inpatient cases into the outpatient setting. Depending on the timing of the final rule for the ASCs from a CMS perspective, we know that that's out there. The timing is uncertain at this point, but definitely near term. But as we think about going into next year, we feel like we've established a base of business that has the opportunities to be enhanced going forward, certainly with the larger platform that has merged from NSH, for us specifically. So I think all those things and some of the things that Cliff mentioned as far as specific initiatives definitely point to a return to more normalized growth rates and normalized approach to 2018.

Okay. And then I guess -- I appreciate the fact that you get to refocusing on the core business, I think that makes some sense. But I guess, can you help us think about what then the right growth rate organically, I guess, plus acquisitions that you would think about? I think in the past, you talked about 3 to 6 from surgery centers or 1 or 2 from tuck-in deals, maybe 3 to 4 from ancillary and then 3 to 4 from deals. Like what does this new company that's refocused mostly on the surgery center business, how do we think about the long -- if not 2018 specifically, how do we think about the long-term growth rate and building blocks to get there?

Well, I think in the absence of pointing to specific data points for next year, I can give you some color around -- specifically you mentioned M&A spend. And as we refocus the company on our core surgical assets, which Cliff mentioned is over 90% of our revenue actually in the third quarter, we're right at a 96%, so that just gives you an indicator of the new kind of combined platform with NSH and the core and how that material is to the business. So as we look at M&A spend going into next year and the year following, I think you can expect a normalized approach to M&A. We had circled up, as we talked about the transaction, $100 million in spend roughly each year. I think that's a good target for us, largely focused -- primarily focused on our surgical facilities.

We'll continue to think about one-off physician practice transactions on a very muted, lower level in terms of our overall capital spend. So -- and just one other data point, as you think about how we thought about the business and throughout the year, we did have a couple of data points of, as we move throughout the year, if you just kind of peg from 3% same-facility growth to 7%, which is kind of the range as we move through the year and saw the trends emerging, we did land in that 3% for the quarter and on the high end of that 6% for the year. So as we think about the revenue and top line revenue being at those levels, then it's a matter of focus and initiatives related to converting, which is primarily focused on our med supplies, procurement specifically related to our implant costs, and those initiatives are well underway. So I think that's really how we would talk about 2018 and beyond in the absence of specific metrics that we're just not ready to outline today.

Okay. And then you mentioned the payer mix was stable from a Medicare to -- commercial perspective, but there was a negative mix shift within commercial, can you explain what happened there?

Yes, so I think -- a couple of points on the payer mix that we just wanted to highlight is, one, we did see the payer mix stabilize from sequentially as well as quarter-over-quarter in terms of just this mix between government and commercial. However, between -- within that commercial bucket, we're still seeing pressure -- we're seeing a mix. Number one, we're continuing to get our just standard rate increases from commercial payers, that's been consistent where the rate variability has emerged and some of the things we've been talking about, again, ties back to the shift to higher-acuity cases. I mean, these are new -- this is a new trend that is moving rapidly and so commercial payers are responding to those trends just like we are with our vendors on the cost side. And so just that rate variability that has existed on the commercial side, and for example, we've had some pockets where workers comp has had some pressure not prevailing throughout -- through the network, but we've had pockets within that commercial mix that -- where we've had some variability and some continued pressure within the commercial mix of business.

Okay. And then, I guess, lastly, you mentioned in the press release accounts receivable, if you could talk about what happened there?

Yes, so during the quarter we had certain known events that occurred, and I can give you some for examples. But as a result of these known events, we had new information that, as a result of that new information, we really had to take a look at some older accounts and we mentioned that dated back to really first quarter '16 and prior where -- primarily related to the ancillary services segment where there has been a very volatile rate environment, as we all know when we've kind of lived that together, but really dating back to that first quarter '16 and beyond -- or prior; and those certain known events that gave us new information, we had to evaluate probability of collection of those accounts during the quarter and determined that there was a low probability of collection and decided that we had to record this in the quarter because of those known events. I can give you a for...

Yes, an example would be great.

Yes. For example, we entered into a contract in the third quarter, again this is primarily in the ancillary services side, to go in network. So we were out of network with a particular payer, and again this is just one example. And so as we entered into that contract with that payer, the contract has to stand on its own merit and it has to be the right business decision at this point in time and going forward. But typically, what you'll see as part of those discussions is, hey, if there's anything out there that we've been disputing, that's been under negotiation, let's settle these old accounts, let's wipe the slate clean and move forward.

And again, it's sort of independent of that new contract, but also related because you want to make sure that, when you're entering into this contract, which stands on its own, has to have its own merit from a business standpoint, going forward that you do take the opportunity to settle everything that's outstanding that's been taking up management time and resources and wipe the slate clean in terms of going forward. So those payer settlements occurred as a result of entering into those in-network contracts.

And the reason why it's an old AR issue and not like an ongoing run rate EBITDA issue is that, at some point over the last year or so, your views about ultimate collection on run rate business changed and you were booking revenue at a more conservative rate over the last year, but you still had the old AR asset at a network rate?

Yes, that's exactly right. So that pivot was made really first quarter of '16 and -- but it did leave those accounts in dispute that were older at that point in time and then exactly, booking to those -- basically those agreed-upon contractor rates going forward.

Our next question comes from Tejus Ujjani with Goldman Sachs.

It's Tejus here. Just staying on the lab topic there. Are you expecting any impact from recent updates to the clinical lab fee schedule?

Tejus, yes, thanks for the question. As you know, the PAMA rules were finalized in November and so we will have an impact going forward. When you look at the overall scope of the business, any dollar of rate reduction is important to us and significant from the standpoint of we want to retain all reimbursement, but really immaterial in terms of the overall revenue of the company, which is expected that, that will be less than $1 million of impact next year.

Great, great. And just going back to the earlier question, I know you're not providing 2018 guidance, but as we exit 2017, what's your expected run rate of EBITDA normalized for any acquisitions that are closed as of year-end? Just trying to get a sense of the earnings base that we should think about.

Yes. So really, as we talked about at the beginning of the year as NSH emerged, we're -- we focused on that, we diverted our attention on the one-off M&A transactions as a result of the bigger NSH transaction. And so really that's the only thing that you would need to pro forma into the base for this year, is really just the NSH transaction.

No, but I guess, exiting the year accounting for whatever seasonality on these items, like assuming everything was normalized end of Q4, like what is the run rate EBITDA power of the business? Forget about future growth rate, just curious on what do you expect the run rate business to be?

Well, on a pro forma basis, we would be in the range of, call it, $240 million. I think it's difficult to take even the fourth quarter as sort of the low end of the range. You can take that and annualize that for the business, but it's always tricky even annualizing the fourth quarter, which while we're projecting to have the trends continued, it's always sort of difficult to annualize the fourth quarter. So I would think about the -- 2 things: one, the pro forma of the business as it stands today and the expected synergies for next year.

Okay. So kind of like a $240 million plus $20 million, is that...?

Well, I think the $20 million would be over a 2-year time frame. So you could say the $240 million plus $10 million is (inaudible) in very general terms how we would think about synergy capture into 2018.

Got it, that's helpful. And just to follow on, on the topic of EBITDA growth and how much you can expect from M&A. You've done the sizable NSH deal. I think it makes a lot of sense that your focused M&A kind of strategy going forward is more on the facilities side as opposed to physician practices. But within -- now pro forma for the organization, you still have a big chunk of your EBITDA, about 50%, is from the surgical hospitals and I understand that's mostly outpatient. But I guess, if you've got a larger base of EBITDA from these hospital facilities, but you're rolling up these smaller ASCs, I'm just trying to understand is there any concern about how much actual M&A contribution you'll have from the ASC side because you've got this larger base of hospital assets now?

No, I don't think so. I mean, we consider ourselves generally in the short-stay surgery market. So whether the M&A comes from ASCs or surgical hospitals, it's all an opportunity to develop our short-stay surgery facility. So we look at approximately $100 million spend and that will get us EBITDA from short-stay surgery, whether that's surgery centers or surgical hospitals. So we're indifferent as to which type of facility, but we think there's a great opportunity in both arenas to expand our footprint as well as the M&A tuck-in acquisitions that we're focused on. So I think there's a great ability to expand. And again, we're the only kind of independent multispecialty short-stay surgery company out there, so we think we have a great opportunity to develop the business.

And just to clarify -- I think that makes a lot of sense. I guess most people are familiar with the freestanding ASC space, roughly 5,500 centers around the U.S, highly fragmented, still a lot of opportunity there. But the surgical hospitals, especially physician owned, I think people are less familiar on what that landscape is and I don't think -- I think based on current law, you can't build more of them, et cetera. So I mean, how many of these -- if you can just give us a rough sense of what is that runway there, how many centers are kind of independent or still out there in the U.S. that could be potential M&A targets?

Yes, there's -- I think there's over 200-plus physician-owned surgical hospitals still out there and so that's a great opportunity for us. There's -- obviously the cap is on physician ownership of those facilities. But within that ownership, you could still acquire and move shares within that ownership so just having the ability to go into an underperforming asset and retool it and develop it. So there's still a lot of opportunity in the surgical hospital area as well as the ASC area. So we like both opportunities to continue to develop our company, and I think there's plenty of opportunity there for quite a long time.

The changes on the surgical hospital side, one thing that we've done very well and executed across the platform, particularly in a couple of our markets in particular, is to continue to expand the ancillary services in those markets. So whether that's acquiring urgent care facilities, wound care, medical oncology, physician practices within each of those hospitals without the benefit of expansion from a bed and OR standpoint, there's an enormous amount of opportunity and we've executed on that across the network, some markets very effectively and have had a lot of success in rolling out those ancillaries within an existing platform and within the existing market.

Great. Last question, I promise. How many on average operating rooms does a surgical hospital have versus your ASCs?

Well, they can -- it varies. I mean, you can -- and especially from a bed standpoint, we can have 12 beds up to 70 beds. So it's a wide range.

Yes, that could be 4 to 6 to 8 ORs just depending on the facility. So I would say a range of 4 to 6 is reasonable.

For the hospital, you're saying?

Right. But your point of -- they are 90% outpatient in nature, so I think (inaudible) you need to focus on.

Our next question comes from Bill Sutherland with Benchmark Company.

I'm curious on the procurement efforts you're going to be making. Are you all thinking there'll be quite a bit of impact early in '18? Or is that something that's going to take its course through the year? And any way to give us any sense of how much that could move the needle?

Yes, it's hard to give an estimate right now because that effort has just started. We are going out right now to renegotiate certain contracts, but -- so it'll be difficult to estimate that right now until we get some data back. But certainly, if you think about the spend of the combined companies and if you think about the opportunity with 2 different GPOs to compare pricing, determine net pricing after rebates, if we just take best price for what we're purchasing now, that'll be the first phase and we should get significant opportunity from that.

But given that the effort has just started, it's very difficult to predict that. It will flow throughout the year because after we get done with the first phase and phase 2, we'd be starting to look at physician preference items and other items that -- where we may be able to work with our physician partners and maybe change, for example, the implant that we're using to a lower-cost implant. So it will definitely roll out through the year. But first phase, getting pricing on items that we're currently purchasing, will have a great benefit. It's just too early to tell since we don't have any early returns on that. But we do have that effort underway right now.

Makes sense. And then as you all look at the quarter to date and this issue that has been -- that you and everyone else is seeing with utilization related to out-of-pocket costs, to what degree are you seeing the normal kind of seasonal uptick occur and -- aside from obviously areas where there's been some disruption still in October? Is it still widespread? Yes, sorry, go ahead, Teresa.

No, that's a good a point, is just what visibility we have into the fourth quarter today. And I think that visibility has been somewhat clouded primarily due to the residual impact of the hurricane rolling into the first part of the fourth quarter. Some of our facilities were closed for 3 days, but then we had a number of facilities that were closed to 3 weeks and so that gives you an indication of really the impacts on the community where we had that extended closed period and the community struggling to ramp up back to sort of status quo and a normal way of life. So I think as we thought about the fourth quarter and looking for those trends to emerge and that seasonality to return, it was somewhat clouded, that visibility, by the residual impacts of the hurricanes.

So if you look just at your unimpacted parts of the country, which, thankfully, is most of the country, do you feel like -- to what degree is there normalcy kind of in the seasonality compared to what we've seen here through the first 3 quarters?

Yes, there are -- as you would expect, with a vast -- operating in 32 states and multi-sites, there are pockets where the demand has returned in the fourth quarter, but there are other pockets of the country where we're not seeing that return. So I think, at this point, our projections are prudent in the fact that they are consistent with the broader industry trends and what we're hearing across the board, but obviously we remain encouraged that those trends would -- that seasonality would return. But I think we've been prudent in expecting the broader trends that we experienced in the second and third quarter to persist into the fourth.

Okay, so it's a mix. And then your same-store that's implied in your full year '17 guide is kind of what range?

Yes, so I think I have kind of pointed to the 3% in the third quarter and the 6.7% -- I'm sorry, 5.7% in the year-to-date. I think as we have projected our trends into the fourth, volume is expected to still basically be flat, again with the things we just kind of ticked through, but that's the expectation reflected in the guidance.

Okay, with some pricing?

Right.

Our next question comes from John Ransom with Raymond James.

Cliff, welcome back. Just to kind of drill down, a lot of good questions have been asked. When you talk about implant costs pressure, is that orthopedic and pain? Or is it one specialty more than the other?

It's both orthopedic and pain and we've done a good job of going out and recruiting and developing those cases, but we need to now focus on making sure that we manage the costs down on those cases and that we understand our revenue side. But it's both pain and total joint procedures.

Okay. Now when the company came public, and I know it was 3 years ago, there was a lot made of being able to buy these little doctor practices for 2x EBITDA, which seemed to us to be an incredible use of capital. Is that just no longer the case?

No, John. I think, we are still obviously very interested in tuck-ins and acquiring practices. But what we're saying is it'll be to support our surgery centers in our markets. So if you look at our operators and the tool kit they have, in their tool kit, they'll have employment, they'll have one-off physician acquisitions and tuck-ins as part of the tool kit as well as in-market mergers.

So what we're saying is we're not going to go out and acquire independent physician groups outside our markets. That's not what we're going to focus on. What we're going to definitely focus on within our markets supporting our core surgery assets, developing those one-off acquisitions, employment, just physician recruitment of independent physicians to our markets; those are all a tool kit for our operators to use. So we will continue to do those and -- where it supports our core surgery center assets.

Okay. So if you look at the company now with your acquisition, what is the top 3 procedure mix by revenue and where would you like to take that with your M&A strategy -- in your development strategy?

Right. We're still, as far as from a revenue standpoint, it's orthopedics. I mean, that continues to be, even when you think about the total joints and the higher implant cases that have inherent margin compression in those type cases as a result of the supplies required, we still have a very diverse multispecialty platform that leverages kind of the bread-and-butter cases, if you will, of pain and GI and ophthalmology that really as you -- you're covering your base, you're covering your fixed costs, you bring these incremental higher-acuity cases into the mix, which is the trend, and that enhances the overall if you just think about it on an individual facility basis. And so as we go out and look for M&A opportunities, that's always -- the orthopedic side of the business is always what interests us the most, but we are not taking our eye off the bread-and-butter GI, pain and ophthalmology, which has proven to be good steady-state business lines for us and we have the multispecialty environment to accommodate that.

And last question. I mean, so Cliff, you -- I don't know that you had much experience in the pain business; it was something new for me as well. What do you -- when you took a look at that coming onboard, what do you kind of think of that business as it stacks up to some of your other -- I mean, from what I have been -- what I have learned, I guess mix shift in that business is deadly. I mean, a Medicare patient with an expensive implant may be a money loser and a commercial patient may not be. But is that a business that you like? And is there a way to better manage the volatility of that margin?

No, I think there's still a good business there. I think it's just like our other lines of business, we've got to understand it. We've got to make sure we manage it correctly. And we've got an employed physician base that is developing our pain business, particularly down in Florida, and we think there's a lot of opportunity there to recruit physicians and develop that business.

But just like managing our implants on the orthopedic side, we've got to make sure that we focus and develop the business. But I think we can do quite well with the business if we focus on it and I think that is definitely an opportunity for us along with, as Teresa said, our other multispecialty opportunity. So we're good with the business. It's, again, just a matter of just kind of the fundamentals, staying focused, understanding it. But I think there's an opportunity there for sure.

Our next question comes from Seth Canetto with Stifel.

My question is just on your opening commentary. You guys mentioned that you completed a deep dive assessment. Are the opportunity -- and you said that the opportunities are better than initially anticipated for NSH. Can you just unpack that comment a little more? Is that opportunity going to be reflected in the margins? Or really, what did you find? Is that what led to the procurement optimization program?

Yes. I think, just the -- if you think about the combined size now of the company, the leverage to -- it gives you the opportunity to go out and renegotiate. It gives you leverage to go out and renegotiate, but also kind of best practices. So if you look at something like our implant cases, best practices from both companies starting to manage those implant cases better, getting best pricing and making sure you get the revenue side, I think that there's a great opportunity there in the -- just looking at net pricing for the items that we're currently buying from both companies, there's an immediate opportunity to go out and negotiate just across the system best pricing that one company or the other is already getting.

So when you see that kind of opportunity, then you feel like there's probably a good long-term opportunity also because we haven't even gotten to Phase 2 of how do we start developing our -- working with our physicians to get lower-cost implants, maybe change some of our purchasing behavior. So that's a second and third phase that we can get to. So seeing the immediate opportunity to get this best pricing and using an outside resource to get it, it makes you feel like there's a longer-term opportunity there and I think that's kind of what we're referring to in terms of the procurement opportunity here.

All right, great. And then you mentioned the $20 million in synergies with the majority realized in 2018. Given that immediate pricing opportunity, are there any synergies that you've captured in 3Q or you've assumed in your 4Q guidance?

Yes. So as you think about, just in general, the $20 million of synergies and you break that down to roughly 50% operational procurement supplies, other operational initiatives; and the remaining 50% corporate related and roughly half of that is related to duplicative headcount and other corporate initiatives as you would expect with the executive level team having duplicative headcount there. So to the extent that roughly 50% of the 50% is focused on corporate headcounts and so forth, that has been identified and executed. So there is some as we continue to operate the business and those synergies for a month in the third quarter and into the fourth quarter have been reflected to that pro rata effect.

Okay, great. And then just focusing on the $5 million impact from the hurricanes, I know you mentioned some facilities were closed for 3 days, some up to 3 weeks. Just given that you're in 32 states, it just seemed like $5 million was high relative to EBITDA in the quarter. I mean, is some of that because you're expecting slower volumes in the 4Q as well and that impact kind of trickles in the 4Q? Or how should we think about that?

Yes, we gave a range of projected outcome so -- and we pegged the midpoint to give a normalized look at the third quarter. But you have to keep in mind that we have roughly 27 ASCs and 2 hospitals that were impacted. NSH has a hospital in Corpus Christi and one in Savannah, Georgia that were impacted. And so -- as well as that just being the surgical facility base, our ancillaries are primarily focused in Florida. So where you have a closure of a surgical facility, you lose anesthesia, you lose revenue from the physician practice and the lab as well. So there's the ancillary effect of that in the quarter. And these communities, there were mandatory evacuations. And so physicians leave, clinical staff leave and it's just slow to ramp up back to normal.

Our next question comes from Frank Morgan with RBC.

I hopped on late, so I hope this hasn't already been asked, but I did hear a lot of the commentary around cost management in the procurement, but I just wanted to focus really a little bit on the organic base of assets that you have, really on the top line growth opportunity. And I'm just curious, any strategies that you have specifically within that base to really drive volume growth, specifically by just taking market share. I know there are new service loan opportunities. But just curious if you have any strategies there?

And then also just some color on the final rules coming out related to outpatient surgery, ambulatory surgery in terms of the rates and the rate differentials and the opportunity you see from knee replacements going forward. And just any color there would be great.

Yes, I'll talk little bit about the growth side. I think, as we referred to earlier, we've got a very solid and long-term recruitment function here in the company. They have continued to develop and refine their infrastructure, great use of analytics now. So our immediate effort in process is to add to that sales team. And I think that will help us start immediately developing our business in our markets. They have targeted specific areas and specific markets where they're going to add resource and start developing.

I think the other area is just kind of the in-market tuck-ins and acquisitions. We've always had a solid pipeline of those. And just opening up that opportunity to our group presidents is -- it will pay dividends for us. So whether that's acquiring a single specialty into a multispecialty center, combining 2 multispecialty centers, one of our surgical hospitals acquiring an ASC, I think there's a tremendous opportunity there for us and we're getting very focused on identifying those opportunities and then converting those opportunities. So we think that will pay dividends for us in the future.

And then, obviously, developing our new market opportunities. We're building a development team to go out and look at new market opportunities, so I think that's a -- will be a driver for us going forward. But particularly our core physician recruitment, product line development, going after the in-market tuck-in acquisitions, these all activities that will help our operators develop their markets.

And I think the last part of the question, from a CMS standpoint, we obviously view this as a -- very much as a positive, their interest in shifting in-patient cases from an orthopedic total joint standpoint into the appropriate site of service and view it kind of as a phased approach. And the rule announced in -- this month from inpatient only to outpatient really is a precursor to the final rule, which we anticipate, allowing ASCs to perform these types of procedures in that site of service, which, to your point, I think just as far as the pricing, just as a reminder, we're still at a 45% discount. So there is encouragement in the CMS rules, and again, we see this as a phased approach and a precursor to finally getting to the appropriate site of service.

Got you. Maybe one final and I'll hop. Just any color, any update on your practice acquisition down in South Georgia, the one that kind of brought you some problems a couple of quarters ago. Any updates there, any progress on that front?

Sure. Hopefully, you'll -- if you think about that line of business and with the new platform, larger platform, the practice in Jacksonville is isolated now. We've anniversaried in terms of a financial impact. We're continuing to execute on our plan. I think we really have had a few challenges there with physician leadership, in executing that plan, but are working through those challenges. I think the good news is such a -- it becomes such a smaller component of our overall business especially in light of the combined transaction -- or the combined company with NSH and so while we'll continue to focus on those operational plans, you'll hear us talk about it less and you'll see the impact financially -- from a financial perspective even less and going forward again as we've anniversaried kind of that impact from the decline we saw there in that practice.

Our next question comes from Kyle Smith with Jefferies.

Cliff, welcome back aboard here. First question for me is with the changes in ownership and leadership here, have there been any follow-on changes to the company's thoughts about the balance sheet and target leverage?

Yes. As we think about the balance sheet, as we both mentioned, the balance sheet is appropriately flexible for the company. We have approximately $200 million of cash on the balance sheet. We have no financial covenant. From a technical term, we do have a springing covenant at a 35% drawdown on the revolver. So it's -- in current phase, it's 9.5x. So again, we have no financial covenants. We have sufficient cash on the balance sheet and we're excited about the opportunities to deploy capital in a leverage-neutral manner in terms of continuing to grow the business and focusing on those M&A opportunities to expand and continue that growth.

And how about in terms of focusing on debt repayment. You've got relatively inexpensive longer-dated capital in there, but you've got a high coupon bond that's little bit shorter maturity. Is that something you're giving consideration to at this point? Or is that for further down the road?

Yes. I'd say we're newly settled into our capital structure since we just closed August 31, and we're always considering strategic alternatives in terms of the balance sheet. But at this point, we're newly settled in and we're enjoying having cash on the balance sheet and flexibility with our revolver. And so I feel like, at this point, we'll think about that, to use your terms, down the road.

Okay, great. And then a question, physician recruitment was, I think, the first initiative item that was listed. And over the past year, there have been a couple of challenges in physician leadership in a couple of areas here. I was just wondering what's the magnitude of the opportunity that you can unlock, whether it's retired docs, physician leadership challenges, underutilized facilities where recruiting in a solid physician can open up some value. How big is the magnitude there? And how quickly can you realize that?

Well, I think it's all part of the kind of same-store metric that Teresa was talking about earlier. All this adds in to same-store growth and it's something that you're going to constantly pay attention to, constantly develop. And so we had 3% revenue growth in the quarter same-store with basically flat volumes and our goal is to get that volume up. And so whether that turns into a 3% to 6% range that Teresa talked about, our goal is to get same-store up. So we think there's a significant opportunity. And again, this tool kit of either one-off physician acquisitions or recruitment, the tuck-in acquisitions, all those relate to same-store development. So we feel good that, with those activities, that we're going to have a positive impact on same-store volume.

Okay, great. And then just the last question for me is, with the possibility of CMS allowing total knee replacement in ASCs, can you box in the magnitude of the opportunity there? And is that something where it's like flipping a light switch? Or would that be a slower transition from hospitals into your facilities?

I mean, it's a transition obviously, but something that we are ahead of in terms of our preparation and preparing -- this as a very detailed example, but preparing manuals that our guides that we can give to our physician partners and they're very comprehensive on here's a patient education material that you can distribute and just really working through those type of steps to make sure that we're well ahead of this final decision at the shift.

(Operator Instructions) Our next question comes from [Rishi Parikh] with Barclays.

I apologize, I jumped on late on the call. But I just want to make sure, on the acquisitions that you say you're looking for, I think in the past you had stated that the best way to looking in terms of the EBITDA contribution is roughly 7x and a 60% contribution rate. Are we still working with that same -- those same metrics?

Correct. So the pricing ranges, we're still seeing 6x to 8x, and as we've talked about how you're arriving at the 7x, it's usually that you get the turn -- 1x benefit from the pricing multiple to effective. So yes, I would say that 7x is -- you're right on it.

And what are you allocating towards acquisitions for the remainder of '17? And what have you allocated for '18?

Well, as we've talked about returning to a normalized approach to M&A, in 2018 I think we would be in that -- we'd be circling $100 million in that range for kind of a normalized approach to M&A. With the NSH transaction in 2017, we entered into the year with a very active pipeline and just an enormous amount of opportunity and we continue to evaluate those opportunities, but obviously put those on hold while we completed the NSH transaction. Those opportunities are still out there and active and the timing on those is uncertain at this moment. Just, again, we made the decision to place those on hold, but I think you would see a normalized M&A spend around $100 million a year.

Okay. And then I believe you had stated that you might still be looking at acquiring more physician offices. But given the issue that happened with the Jacksonville facility, how are you, I guess, approaching some of these acquisitions? And how would you change the incentive plans for these doctors?

Well, I think what we're not going to do is acquire large independent groups outside of our markets. What we would like to continue to do is one-off physician acquisitions as a tool kit in our markets for our operating group to use. We think that there's continued opportunity there to either employ, acquire physicians, but we want that to be within our market supporting our core assets of short-stay surgery facilities. So we will continue that activity. What we don't want to do is acquire independent physician groups not in our core markets that's supporting our core assets of short-stay surgery facilities.

Okay. And then just going on a pro forma basis based on that to $240 million of EBITDA that you mentioned, what is the mix of EBITDA coming from the surgical hospitals?

We haven't given that breakout and primarily because that's not how we operate the business. These are short-stay surgical facilities. They -- approximately 90% of their procedures are outpatient. And so when you look at our operating groups, we have a mix of surgical hospitals and ambulatory surgery centers and that's how we focus on the business, that short-stay surgical facilities.

Okay. Well, then, if you could answer another. The procedures flowing through the surgical hospitals, the payer mix, is it mostly Medicare? Or is it commercial?

No, it's a similar mix. We'll -- combined with NSH, will be about 50% commercial. I mean, you have some facilities, whether ASC or surgical hospitals, that focus on ophthalmology, GI and have a higher mix of government. But in general, for the company as a whole, it's a 50% commercial business.

Okay. So I guess, that's what I was getting to. If you look at other surgical centers, their commercial mix is mostly, call it, 70%, 80% commercial and I just was trying to figure out why yours is roughly 50% and not as high as that -- your comps? Is it because of the ophthalmology, GI?

Yes, with having that multispecialty approach and having GI, ophthalmology, you'll have a mix of government, which is fairly consistent. If you look across the portfolio, it's pretty consistent, each facility, kind of that mix of corresponding GI, ophthalmology, government and commercial and so it appears pretty normalized to us with that multispecialty mix.

Yes. I think we would be very consistent with other multispecialty companies. There may be some single-specialty companies that maybe have a higher commercial. But if you're looking at the multispecialty business just through time, historically and currently, we're all pretty consistent.

Okay. And just last question, and I apologize if you already talked about it. But in terms of Jacksonville, any color -- update or color as to maybe how that facility is turning around? Did you see any pressure on EBITDA during the quarter? And if you could quantify what that impact was?

Yes. It's pretty well been -- it's stabilized, consistent with what we saw in the second quarter. I know I mentioned earlier that we have the operational plan for improvement. We've had a few challenges related to some leadership in that market, but again, my comment earlier is you'll hear less about this as it becomes a smaller component of our overall business. But that doesn't mean we're not continuing to focus on that operational plan and the overall improvement that we have laid out earlier in the year.

This concludes our question-and-answer session. I'd like to turn the conference back over to Cliff Adlerz for any closing remarks.

Thank you. In closing, although we experienced some challenges during the quarter, we remain enthusiastic about the future of Surgery Partners as we move toward 2018. As the industry continues to shift towards more efficient care, we're focused on successfully integrating the NSH acquisition. We believe that the combined company operating on a larger scale will be effective in delivering a more diversified set of services focused on maximizing our short-stay surgery assets. We're on the right side of the cost equation in a complex, evolving healthcare environment as evidenced by our continued same-facility growth rate and underlying trends in our business. As a result, the company is well positioned to continue to deliver high-quality, cost-effective solutions. We're moving forward with a stronger, more diversified platform to support our short-stay surgical procedure growth objectives and continue to work to deliver significant volume to patients, providers and payers. We really appreciate everybody's interest in the company. Thank you for your time this morning and participating in our call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.