Surgery Partners Inc (SGRY) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Surgery Partners Fourth Quarter and Full Year 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Kretschmer, Interim CFO. Thank you. You may begin.

Good morning, and welcome to Surgery Partners Fourth Quarter 2017 Earnings Call. This is David Kretschmer, Chief Strategy and Transformation Officer and Interim CFO. Joining me today is Wayne DeVeydt, our Chief Executive Officer.

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 risks, 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 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 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 quarterly report on Form 10-Q.

With that, I'll turn the call over to Wayne.

Good morning, and thank you for joining the call. I'm excited to be here this morning and to have joined Surgery Partners at this unique time for both our company and industry.

While we have much to discuss today, I would first like to share a bit regarding my decision to join Surgery Partners and the value-creation potential I saw in making this decision. I will then shift the discussion to some of the key fundamental strategic opportunities that we have for growth and margin improvement over the next few years and some specific initiatives we are undertaking to position us to capitalize on these opportunities. And finally, I would like to provide some insights into our 2018 outlook and key proof points that we will be tracking throughout the year to validate our strategy, initiatives and resulting execution.

Let me start by highlighting my reasons for joining Surgery Partners. As many of you are aware, we live in a health care industry that continues to have many interrelated but fragmented moving parts. As a result, health care costs in the United States continue to rise at levels that are challenging the consumers' ability to afford the high-quality health care every consumer expects, and candidly, deserves.

Having worked in the health care system for over 2 decades, I've had an opportunity to experience firsthand many of the initiatives put forth to drive cost out of the system while improving the patient experience. While there were many success stories around these initiatives, several fell short due to misalignment in priorities and incentives.

This is where Surgery Partners became such a compelling opportunity for me. Specifically, Surgery Partners understands the priority is the consumer, our patients. We can never lose sight of this basic tenet, making quality along with patient safety and satisfaction at the core of what we do each and every day.

Second, our business model aligns with and empowers physicians to provide them with the resources they need to be doctors first. The alignment of the consumer and the physician is paramount to any successful business model in health care.

But the remaining ingredient is the alignment with payers, including both state and federal government, which control the flow of health care dollars and are motivated to remove inappropriate and unnecessary costs from the health care system in order to not only protect the integrity of the system, but also to improve on the sustainability of the system.

The ability to bring experience on the payer side of the cost equation, coupled with the unique business model of Surgery Partners, is what drove me to accept the opportunity to lead this great company. Simply put, we are on the right side of cost equation and fully aligned with the goals and objectives of consumers, physicians and payers.

This alignment is even further strengthened when you consider the overarching macro trends that create tailwinds for our business. These include an aging population, which aligns well with our focus in orthopedics, including total joint and spine procedures, ophthalmology, pain and GI; advances in technology around patient safety and improved outcomes; and the resulting influence in shifting surgical procedures to the high-quality, low-cost ASC setting, which is evident from CMS' continuing discussion of adding total knee and hip arthroplasty to the ASC payable list. As you know, these procedures are already being performed safely and effectively on non-Medicare patients in ASCs.

Third, there's alignment with consumer and government advocate groups to improve patient safety while reducing cost. Our high-quality, low-cost positioning creates compelling value for payers while aligning with doctors and prioritizing safety and the provision of quality care to patients.

And finally, as the last independent ASC with national scale having been built over a 20-year period, we are a strategic and scarce asset in a consolidating market.

Moving to strategic opportunities for long-term sustainable growth in our core business, outpatient surgical facilities. While we are fortunate to have the right assets in the right space, we have several opportunities to improve both our strategy and our execution. These fall into 3 primary areas: payer alignment, physician recruitment and retention, and leveraging national scale.

Starting with payer alignment. As I stated previously, we are fortunate to have a business model that already focuses on our patients while empowering physicians. But aligning with payers, which are focused on improving patient safety while removing excess cost from the health care system is critical. We are beginning to identify opportunities where we believe we can have a substantial impact that not only benefits the payers but aligns with our growth objectives.

To be clear, this is not a simple game of checkers. It is important for us to have a thoughtful approach to those payers with whom we choose to partner and to identify locations and models which support both organic and inorganic growth. While these partnerships take time, we're playing long ball here, and this is an area where I plan to dedicate a substantial portion of my time focusing on value-creation into 2019 and beyond.

For the more immediate term, we are increasing our efforts around physician recruitment and retention. Increasing the number of physicians that perform procedures in our facilities is an important part of our organic growth engine.

To address this opportunity, we've implemented a number of initiatives, including, but not limited to, doubling the recruitment team and realigning structure, which will provide broader coverage of our ASCs and additional boots on the ground, establishing key relationships with those doctors with whom we want to partner. And two, implementing new analytical tools in training to enable best practice sharing across the organization and prioritizing the pipeline of over 170,000 potential physician partners.

We expect these efforts to begin to take hold throughout the year and drive a positive EBITDA contribution to 2018, and an incremental increase heading into 2019 as we begin to recognize the full run rate benefit.

Finally, we will begin to leverage the benefits of national scale, which was bolstered as a result of the successful NSH acquisition. As we progress through the integration of NSH, we've identified several opportunities for the combined organization that will add immediate value to the back half of 2018 while creating run rate lift into 2019 and beyond.

A few examples. On the procurement front, we are now negotiating as a significant national account rather than contracting locally. While this requires short-term investments in establishing a new purchasing system to improve data analytics, along with appropriate staffing, the value to the organization is meaningful and sustainable.

Additionally, it should improve synergies for future acquisitions with a more immediate impact as we implement newly contracted rates on acquired facilities. We've identified approximately $15 million in gross opportunities that we are targeting, with more than 1/2 of this accruing to EBITDA and benefiting Surgery Partners' shareholders.

While these benefits will be negotiated and realized throughout the year, they should provide further EBITDA lift heading into 2019 as we begin to recognize the full run rate benefits.

Another example of leveraging national scale relates to our revenue cycle management initiatives. Currently, operational diversity and revenue cycle management has resulted in over 100 different vendor relationships, tools, applications and outsourcing, all which increase cost and complexity.

Implementing standard operating policies and procedures and simplifying our revenue cycle management activities to mitigate collection risks should result in 2019 run rate and margin improvement. This will require meaningful investment in 2018, but will further enhance our ability to improve our run rate earnings and cash flow while enabling synergistic value to be recognized from future acquisitions sooner.

These savings from enhanced scale are among the components of the synergy figures we previously discussed to be achieved over the next 18 to 24 months. It is important to recognize that many of these savings also benefit our physician partners, which enhances the value proposition of Surgery Partners.

Providing meaningful proof points and case studies to our physician partners that demonstrate our ability to drive value should only enhance our opportunities to implement longer-term strategic sourcing and enhance our value proposition as we recruit physicians and acquire facilities.

We recognize that, much like consumers, doctors have a choice. With our focus on patient satisfaction and alignment with payers, backed by our expectation of demonstrating real value creation, our goal is simple, to become the partner of choice for a physician.

These are just a few examples of how we can and should leverage our national scale. As we continue to build out our management team, I expect that we'll identify further opportunities for improvement.

Turning to our 2018 outlook. We recognize that performance over the past several years has been inconsistent. I've had an opportunity to understand many of the issues that created volatility, but I want to better understand some of the dynamics that contributed to the deviation in expected performance.

It is incumbent upon us to ensure that we have the processes, infrastructure, people, incentives and culture in place to drive consistent performance over a multiyear period.

In establishing our 2018 outlook, we've made some changes compared to prior years. Specifically, we are excluding mergers and acquisitions from our 2018 outlook. We are in a dynamic competitive environment and we want the team focused on the right deals. That being said, we plan to deploy between $80 million and $100 million of capital per year related to mergers and acquisitions at prevailing industry multiples. As we complete transactions, we will reflect them in our future outlook.

We are including certain known and planned divestitures. We are evaluating our entire portfolio and plan to divest assets that are not core to our long-term strategy. Our intention is to redeploy proceeds into future acquisitions that align with our targeted high-growth portfolio markets. We have a number of negotiations underway and have modeled planned EBITDA divestitures for 2018. We are focused on obtaining maximum value for any divested assets and this number could fluctuate throughout the year.

Finally, we've increased our G&A spend to reflect key resources that will drive long-term growth and profitability for our stakeholders. In many respects, 2018 will be an investment year to ensure that we have the right people and processes in place to drive our business in the medium and long term. Along these lines, we've added some key leadership pieces to our team in procurement, revenue cycle management and physician recruitment.

We've also bolstered the ranks of our senior leadership team that will help drive growth across our business going forward. Dave Kretschmer, who you will hear from next, and as you can tell is fighting a cold, was appointed Chief Strategy and Transformation Officer as well as Interim CFO. David brings over 20 years of payer experience and will be a driving force and overseeing several of our key strategic initiatives, including payer alignment and physician recruitment and retention.

Angela Justice was recently announced as our Chief Human Resource Officer. This newly created position highlights the importance of talent development in driving the company's long-term growth objectives. And finally, as you know, we are actively engaged in a search for a new CFO. We anticipate filling this position in the near term.

Based on these changes, we expect full year 2018 revenue to be greater than $1.75 billion and full year adjusted EBITDA to be greater than $240 million. This outlook highlights our more conservative approach towards assessing the company's performance as we make the necessary investments to drive long-term sustainable growth.

And while we do not provide quarterly guidance, I would note that we anticipate earnings to be disproportionately back half-weighted, reflecting the continued seasonality of the business and the timing of benefits from implementation of various initiatives.

With that, let me hand the call back over to David for an introduction overview of our full year and fourth quarter financial results. David?

Thank you, Wayne, and thanks to everybody for bearing with me and my raspy voice this morning. I'd like to start off by echoing Wayne's comments about the excitement of being here at Surgery Partners. It is nice to be able to bring our payer experience and perspective to help drive affordability by ensuring care delivery is performed in the highest-quality status and most cost-efficient setting.

With that, I'll turn to our 2017 financial performance. Our fourth quarter revenue of $460.3 million reflects a $154.3 million or 50.4% increase over our Q4 2016 revenue of $306 million. Our Q4 same-facility revenues on a pro forma basis, reflecting the NSH acquisition, increased 1.6%, which is a result of a 2.1% increase in net revenue per case, offset by a slight decrease in case volume.

Our fiscal year 2017 revenue, approximately $1.34 billion, increased $195.8 million or 17.1% over our 2016 revenue of approximately $1.145 billion. Our fiscal year 2017 normalized revenue of approximately $1.365 billion was $219.4 million or 19.2% increase over our 2016 revenue. Please note that normalized is adjusted for the hurricane impact our facility experienced in 2017 and the nonrecurring adjustment to revenue, both of which were discussed during our Q3 earnings call.

Additionally, on a normalized basis and pro forma for the NSH acquisition, our same-facility revenues for the full year 2017 increased 4.7%, with a 3.8% increase in net revenue per case and an increase in cases of approximately 0.9%.

Turning to operating earnings. Our fourth quarter 2017 adjusted EBITDA was $63.9 million, a $13.8 million increase over Q4 2016 adjusted EBITDA of $50.1 million. Our full year 2017 adjusted EBITDA was $164.3 million, a $15 million decrease over 2016 adjusted EBITDA of $179.3 million. Our normalized 2017 adjusted EBITDA of $184.2 million was a $4.9 million or 2.7% increase over 2016.

Our adjusted EBITDA margin declined to 13.9% from 16.4% of revenue as compared to the fourth quarter of last year. The decline in margin was primarily driven by an increase in medical supply cost and implant cost, driven by higher acuity cases. This is a mathematical result of the pass-through nature of many of the supplies and implants in which we earn an appropriate dollar margin given the higher revenue. Nevertheless, we have launched specific initiatives to address margins with a focus on procurement and medical supplies.

Results for the fourth quarter 2017 include net noncash charges of $38.7 million related to the estimated impact of the Tax Cuts and Jobs Act under deferred tax assets and liabilities. This estimate may be further refined as information becomes available.

During the fourth quarter and through the close of business yesterday, the company used $4 million to acquire 337,000 shares or approximately 0.7% of its outstanding common stock at an average price of $11.83 per share. We ended the year with cash and cash equivalents of approximately $175 million and approximately $72 million of availability under our revolving credit facility.

The ratio of total debt-to-EBITDA at the end of the fourth quarter of 2017 as calculated under the company's credit agreement was 7.2x. The company has an appropriately flexible capital structure, with no financial covenant under term loan or a senior unsecured note. Our balance sheet is well positioned with ample cash to fund growth initiatives.

With that, operator, please open the call for Q&A.

(Operator Instructions) Our first question is coming from the line of Bill Sutherland with The Benchmark Company.

I wondered if you could give us a little more color on your same-facility case trend in the fourth quarter. It didn't -- there was some thought about the seasonality being more pronounced this year. And I did notice the peer -- some peers moving up into low single-digit case growth in the fourth quarter, so any color there would be helpful.

Sure. I look forward to actually meeting you in person. But let me first just highlight that clearly, we've seen some of our competitor data just as you've seen as well. And I would say their trends obviously were stronger than what we saw in the fourth quarter.

I think some of this is really around what we'll be talking about as we look towards the future about getting our efforts refocused around our core business, which is the surgical centers. While we had some growth in those -- in our same-store facilities, and if you pro forma with NSH over the same period last year, we're actually encouraged by what we saw, I would say, in light of what had probably been a distraction year for the company.

So that being said, one of the efforts that we put forward is the additional physician recruitment initiative. I think it's one of the reasons you saw our same-store not grow at the level that we would have anticipated. We've more than doubled the boots on the ground and we've more than doubled the coverage that we will now have over our facility.

So I think this will be a slow ramp-up as we go through '18 and then you'll start to see the value of that in the back half of '18 and then we'll get full run rate into '19. But it's a fair observation.

And just one other one. In '18, can you give us some sense of investment spend involved with what you've laid out? And I realize it's really not mostly about CapEx, but maybe a CapEx -- a feel for that directionally?

Sure, sure. While I obviously won't give specific details on every G&A item that we're spending on, I will give you some directional items where we're spending in areas that, I would say, are more CapEx-related versus those that will be more run rate-related.

On the CapEx side, one of the areas that we are spending money is around the (inaudible) reporting system. In essence, we want to have the ability to look at every facility at the most minute level, including not only the procedures by physician but the average time taken per procedure. So we can truly understand the direct contribution margin that we are getting at each of our facilities where we have opportunities to recruit more physicians into support time. And more importantly, take a much more rifle approach to our M&A as we move forward and ways we can improve those areas that we want to not only acquire but actually leverage our scale in.

From a broader G&A perspective, we're going to add just more resources. I think the resources that we should have around procurement did not exist. And so we are in the process and have made an offer to achieve procurement officer. We'll be staffing up in that area, as you heard in the call, the $15 million plus that we're targeting. And again, that's a first cut at our largest providers. So the reality is we think there's many more opportunities if we have the resources there.

I would also say around the physician recruitment and our retention efforts, the fact that we more than doubled our workforce there becomes a run rate cost, but we know the value will be there as we improve in our case count. So those are a couple of areas where I would say that we're spending absolute dollars.

And then finally, we're spending the dollars at the most senior management team level. We're trying to bring in some (technical difficulty) that have worked in this industry for a long time, either on the payer side of the shop or on the surgical center side that really know the nuances of how to drive value. And so what I would say is those will clearly have a value return associated with them. And then ultimately, as we migrate through the year, I do anticipate that we'll find more synergy as we start to fully integrate the very asset that we own.

Our next question is coming from the line of Brian Tanquilut with Jefferies.

Wayne, just to hit on guidance, I appreciate the conservatism and the sort of shift in strategy there. But just to kind of bridge us to what The Street was expecting and basically the previous guidance strategy of including M&A. How much do you think did you have to pull out of the EBITDA for that specific aspect of not including M&A contributions?

Hey, Brian, first of all, good to hear your voice again, and I appreciate the question. Let me first state that at least our philosophical belief was we did not want to try to predict M&A. I think the idea of assuming that we could predict with some level of certainty a date-specific close date, along with date-specific revenue and EBITDA, we thought wasn't prudent.

And also, we want the team focused on the right deals and we didn't want to create a guidance or budget that reflected that. That being said, we have provided the team with goals for the year of what we expect around M&A. We do expect to deploy $80 million to $100 million, obviously, as I said, at prevailing market rates.

I hope you understand that for competitive reasons, I don't want to discuss what those prevailing multiples are. But what I would say is, we clearly get a nice multiple arbitrage versus our current trading multiple and then the synergies we drive from each of these.

That being said, I think historically, you've been able to model somewhere in the $10 million to $15 million of what I'll call run rate EBITDA from M&A over time. That takes on a variety of fashions and looks depending on timing of when these deals would get done. But that gives you a little bit of a feel of what you could probably anticipate.

I appreciate that. And then, Wayne, as we think about, you're obviously coming in from the outside of the ASC industry or even provider land. As you think about the shifting payer mix in the health care provider space where you're seeing more Medicare, and obviously, there's pricing disparities there between commercial and Medicare. How are you thinking about -- what you can flex beyond procurement?

Kind of like longer term, how do you adapt and maintain a certain margin when, essentially, the effective rate is going to come down because of demographics and just that natural shift?

Yes. Brian, I really appreciate this question. It's an interesting dynamic issue that we had to deal with on the payer side as we saw the population aging in. And as you know from my previous experience at Anthem, at one point in time, we had less than 10% of our revenue in government business. And obviously, the focus was on purely the commercial front.

But we know -- the tea leaves are the tea leaves and the demographics are the demographics. And as we started to see those shifts occur, we realized that at least there that we had to choose how to self-cannibalize our own business and then reposition ourselves.

The nice thing here is we don't have to self-cannibalize. It's a whole new piece of pie available to us as we start to accept more of the Medicare business and as we begin to see CMS shift procedures into an outpatient surgery environment and a surgical center environment.

So from my perspective, I'm okay with margin declination on a percentage basis when I can grab a bigger piece of the pie on an absolute-dollar, margin-direct contribution method. So I actually want us to be more open-minded to the fact that there is more pie here to be had. It's a piece that is not going to cannibalize our existing business but rather will be an incremental growth story for us and provide more cash flow as we move forward.

That being said, on the commercial front, it's important we start recognizing the national assets we have and the value that we really bring to payers and hopefully can begin to get better rates as we move forward showing the payers the value we can bring to them. So I would say just dynamically though, we actually view this as a net positive for us over time with the shifts in the government, albeit it will put pressure on the contribution margin percentage.

The next question is coming from the line of Kevin Fischbeck with Bank of America Merrill Lynch.

This is (inaudible) on for Kevin Fischbeck. I just wanted to kind of talk a little bit more about the guidance. Can you kind of give us some color on whatever underlying assumption that you guys have as far as the industry growth pricing going into 2018?

Sure, sure. I think the first thing I want to highlight though is that the eggs are fairly scrambled at this point with the NSH acquisition and many of the investments that we're doing. I think it's fair to say that as you look at same-store surgical centers, you ought to be assuming 2% to 3% growth on volume and 2% to 3% growth on price, right. If you're just looking kind of core same store, those are reasonable assumptions.

That being said, we're not there yet. And I think it's clear from looking at last year's that we've got some room to improve. And so one of the things we've done is to start that process by ramping up the workforce that we have around physician recruitment and our retention efforts. I would also say that as we're looking to the outlook, we're going to staff up more on the front end around these procurement initiatives, it will start giving us more DCM.

So we should not be able to not only eventually move into those levels of growth. But I would argue, over time, we ought to outperform those levels as we begin to get the synergistic value of our national scale, both on revenue cycle management and on procurement.

So I would say, view '18 as a reset year. I don't think we're that far off consensus when you consider that we are excluding M&A and we've included some divestitures. For purposes of divestitures, these are assets that are noncore to our strategic growth model, and they're assets that we have line of sight on that we would expect to close in the next 30 to 60 days. So not a huge number, but it is shaving off some of our EBITDA growth as well for this year.

And on the divestitures, is there any thought around divesting like the ancillary business or anything of that nature?

Really appreciate this question. Well, I think it's fair to say that the ancillary business has struggled for this organization over the last several years since those acquisitions were done, and has meaningfully struggled in 2018 that is clear from the segment reporting.

That being said, I feel like we're at bottom at this point based on what we've seen. It looks like we have an opportunity to stabilize and potentially then move this in a positive direction. We are going to evaluate all of our assets though. To the extent that ancillary is core in a market, and as you know, in Florida, it plays a critical part of our ecosystem. We may be more open-minded to how that continues to be part of our business.

To the extent that it's not part of an ecosystem, we'll evaluate it on whether or not it becomes part of our ongoing growth strategy. And that gets back to our M&A where we're going to take more of a rifle approach to decide where we want to play at.

And just one quick one, one last one. It looks like the NSH, there -- seems like average rate per acuity is higher at NHS versus the legacy surgery? Is that the case? And if so, what's driving that?

Yes, I think that's fair. Remember, these are surgical hospitals, so in general, you have higher acuity cases that occur in these. And as a result, you get an overall higher revenue per case, so.

And I would say, obviously, we're bullish on our surgical hospitals. That was part of the reason for the acquisition of NSH. The key for us now is to bring the same national scale benefits to that part of our family as we're going to bring to the broader SP family and then evaluate opportunities, too, where our surgical centers can partner in the right capacity where we have overlap with our surgical hospitals.

The next question is coming from the line of Frank Morgan with RBC Capital Markets.

I guess on that same line about divestitures, any thoughts, I mean, you mentioned, sounds like possibly some ancillary move -- activity or maybe exiting some markets there. But any thoughts on other service lines that you might be looking to divest and maybe in the physician practice area?

And if not, how much of your -- that $80 million to $100 million of growth capital deployment? How would you mix that out between, if you are staying in the practice business, how much of that growth and how much of those capital will be allocated between, say, ASCs or surgical hospitals versus practices?

Hey, Frank, thank you. Let me take a stab at that. There's a few questions there and I want to make sure I hit them each individually. Let me first start with ancillary from the standpoint that ancillary in and by itself is not its own business. While it's currently being run as its own segment, it does create a feeder system in many ways to some of our surgical facilities.

So first and foremost, as we evaluate ancillary, we're going to take a much more holistic view of what pieces and components drive a net value to our organization. If the net value doesn't persist, we're going to make a very quick decision on whether we'll be able to fix it or if it's worth fixing; if not, we'll divest.

That being said, when we talked about the $80 million to $100 million in capital deployment for M&A, we were not anticipating capital that would be available from divestitures. So money becomes fungible at that point, and that would give us more capital that we would be able to deploy.

But as I mentioned, we did not assume a really meaningful divestiture for the current year as we continue to decide what assets make the most sense. Having been in this seat for 7 weeks, I obviously have line of sight on things that started under Cliff in the interim role. I'm highly supportive of those divestiture items that Cliff was doing and we're going to get those over the finish line. So I went ahead and modeled those out, but we'll do more as the year progresses.

And then finally, the last thing I would just say is, you can obviously look at the segments that exist today. But at the end of the day, the surgical facilities will be our primary focus. It's what we do well. It's where we want our focus to be and it's where our M&A dollars will be spent. And everything outside of those is on the table for consideration about whether or not it should be part of our core business.

Okay. And I guess just one final question on leverage. I know there's -- obviously, you've got flexibility with covenants. But what's your thought kind of now being in the seat and having been a CFO, how do you feel about your long-term objective with regard to the capital structure and the optimal leverage?

Thanks, Frank. Yes, it's a little different coming from a free operating cash flow company of $4 billion a year to where we're at today. That being said, look, I've had the benefit of understanding how leverage can work and work well for you. And what I would say is, we have a very solid asset here. And the surgical centers, despite the distractions of ancillary the last several years, have actually performed relatively well with those distractions.

And so as I look at our ability to grow into our EBITDA over the next 2 to 3 years, I think we'll get natural deleverage fairly quickly just through EBITDA growth. And then we get to leverage levels that I would say I think we're all very comfortable with.

That being said, I feel like relative to the size of leverage, we've got a decent debt structure, very covenant light, which I think gives us ample flexibility. And I think some of these divestitures will provide even more capital for deployment for us.

So big picture, I'm not concerned. If I was, I wouldn't have joined the company. But I understand the expectation of all of our stakeholders to drive that leverage down, to drive that down over the next couple of years through earnings growth.

(Operator Instructions) Our next question is coming from the line of Chad Vanacore with Stifel.

So just want to stay with that leverage for a question, the prior management had stated that they wanted to get leverage down to 5x by the end of 2019. Given your $80 million to $100 million of acquisition assumption this year and that your leverage is at 7.2x, should that still be a target? Or we're probably thinking that you're not going to have a concerted effort to delever in the next year or 2, but it will happen more naturally?

Hey, Chad. This is Dave. No, I think that's a very good observation. We ended the year around 7.2x. And our expectation is by the end of '18, we should be in the mid-6s. So shooting for '19 maybe targeting more low-6s. But as Wayne said, this will be a natural deleveraging through our EBITDA growth not through paying down any of the debt.

Got it. And then just going back to your organic growth assumptions. You're looking at 2% to 3%. Was that longer term? Or that's just what's in your 2018 guidance? If that's not in your 2018 guidance, what is?

Yes. We've got the 2% to 3% for a number of our surgical facilities loaded at that level. I think they'll be more at that level. What we're not getting right now though is what I would call the value creation of outperforming that. We should not be at 2% to 3% volume and 2% to 3% pricing at this stage. That's what we have loaded in our plan. But clearly, we have assets that should be able to outperform that.

And so as the year progresses, our hope is that our execution will start to show. As that starts to show, you will hopefully see both revenue, operating earnings and margins continue to improve. And that's why we wanted to start at the guidance level we started at, so you'll have at least visibility around whether our efforts are taking hold. But you should see those improve hopefully as we execute throughout the year.

All right. So it sounds like a little bit slower start to the year and a little bit more stabilization in the back half, is that right?

Yes. Yes, look, I think, as I said, it's a reset year for the company to get focused on the assets that matter. But I think as the year progresses, you should see improvement in all metrics.

All right. And just a little bit more on the investment in the platform. So how much extra CapEx should we plan? And then what levels of returns are you expecting on that CapEx? Can you quantify that?

Well, on the CapEx front, I wouldn't quantify incrementally. That was one of many examples I gave. And what I'd tell you it's challenging for me to put a return on having good data. What I can tell you is it's invaluable. The reality is the ability to know exactly where to rifle in and to do it real-time is how you have to run a business, especially a business that's diversified on a national scale and platform like this one is.

That being said, I think as the year goes, many of these investments you'll see organic improvement. And it'll be measurable and it'll be meaningful. And we'll spike that out on each quarterly call and we'll go from there. But ultimately, the proof is going to be in the pudding our ability to execute. But not having data it's almost impossible to execute the way you need to execute. And now we have that data.

We are now rolling that out over our NSH assets though. So, you know, we still have about another 2 months of infrastructure investment to get that same kind of granularity and rifle approach to our surgical hospitals. But once we get that, I think we're going to be in a really good position to show the value creation.

All right. And do you want to take a shot at how we should be thinking about free cash flow in 2018?

I think free cash flow is going to be in the $80 million-plus range. And as we get M&A done, we should migrate between there and we start showing improvements in our business between $80 million and $100 million. And again, that's exclusive of what we have available for M&A. Clearly, we could do more if we needed to.

But look at Q4 of 2017, it gives you kind of a pretty decent view of both NSH and us combined. There's not really noise in the quarter like you saw throughout the year. You'll see that cash flow, net of distributions for our noncontrolling interest, as well as any costs associated with our debt, et cetera, we're netting close to $27 million.

And so just doing basic math and extrapolation, you can figure out that $80 million to $100 million is not an unreasonable target. Although I think it'll ramp up again as our earnings are more back half-loaded.

We have time for one more question, which is coming from the line of Ralph Giacobbe with Citigroup.

Hoping you can just delve a little bit more into strategy. There's a lot of different models out there, sort of both 2-way and 3-way JVs, including hospitals. If there is a preference and will you consider both?

And then just around strategy, just a little bit more about sort of expanding surgical mix. You haven't really sort of talked a lot about that. I know that was sort of a imperative, and then obviously, the NSH deal would sort of suggest that as well. But just opportunities there, help us sort of understand the goals and the acceleration around that as well.

Yes. Ralph, first of all, great to hear your voice again and look forward to catching up more. First of all, we're obviously very open to both 2-way and 3-way transactions. I want to make sure that we don't leave any misimpression about our desires to want to partner with payers, but that in no way means that we have lack of a desire to partner with providers and hospitals accordingly.

I think the important part though is where we have really good alignment is around taking cost out of the system. So to the extent that we have opportunities to align with hospital systems and other providers that have those same mutual goals as ours, then we'll do those partnerships. And those are out there and we are having discussions in that arena. So I don't envision that changing.

But I also think it's important to recognize that the first dollars are still being controlled by the large commercial payers and they're still being controlled by states and federal governments. And I think it's an important part of our strategy that needs to shift in terms of bringing in that into the fold.

In terms of expanding our surgical centers, obviously, NSH was a big part of that. I think a big thing to recognize too is our focus is going to be on those areas that support both the aging population demographic shifts as well as those that are generally high-dollar procedures, albeit because of high acuity might be a lower percentage margin, they're a higher dollar contribution margin to what we're trying to accomplish.

So you'll find much more of a focus around the ortho and total joint, spine, pain, GI. Things like GI and ophthalmology, I'll just remind folks that while those aren't our core in terms of our high-dollar focus, they're very much our bread and butter in that they generate nice cash flow and they provide the cash flow that allows us to continue to do some of the M&As as we pursue these higher-dollar, higher-contribution margin businesses. So hopefully, that answered your question, Ralph.

Yes, that was helpful. And then just a follow-up, hoping you can -- there's been a lot of focus on top line. Certainly understand that. But what about margins? They've bounced around a bit as we've seen sort of weakness in the business.

I'm hoping you can give us a set or sense of where you see sort of normalized margins kind of once you get to maybe a more mature state or once you execute on what you think you can get to from a top line perspective?

Yes, Ralph, I really appreciate this question because I think it's really at the crux of what we're trying to manage as a company now. The reality is the margins of this business were distorted in many ways by the original M&A that was done around ancillary. And then as you know, those assets have struggled the last couple of years.

And so what got lost in the shuffle was what businesses were actually driving the right direct contribution margin, both percentage and dollar. And it's only over really the last 2 quarters, so since Bain got involved and started making investments with Cliff here, and as we continue to make those investments in these platforms and systems, we're only now getting that direct visibility into every procedure by minute around what actually is contributing to our margin.

So 7 weeks into the job, I can tell you I'm going to focus on exactly your question. I just don't have that data yet to draw a conclusion on what I think a more normalized, sustainable margin is. But it is something that I would expect to have as we progress throughout the year and begin to get that information and that reporting, and I'll be able to provide that to you later in the year.

We have reached the end of our question-and-answer session. So I would like to turn the floor back over to management for any additional concluding comments.

Thank you. And again, I just want to thank everybody for being on the call. Before we conclude, I do want to thank our over 7,000 associates and our 5,000 affiliated physicians for their dedication and efforts in making Surgery Partners the company we are today.

I also want to take a moment to express my personal gratitude to Cliff Adlerz for his leadership and stability that brought the company from last quarter to where we are today and in his interim role as CEO. And many of you should know that Cliff has been a mentor to me in this process and I continue to expect him to be a big part of this company as we move forward in both his capacity on the Board of Directors, but really in his knowledge and experience on the surgical front.

His steady hand and commitment to Surgery Partners and its patients, payers, providers and employees is invaluable. And I do look forward to continuing to draw on his strategic insights. Thank you for joining our call this morning and have a great day.

Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation and you may disconnect your lines at this time.