Surgery Partners, Inc. (NASDAQ:SGRY) Q1 2023 Earnings Call Transcript

Surgery Partners, Inc. (NASDAQ:SGRY) Q1 2023 Earnings Call Transcript May 1, 2023

Operator: Greetings, and welcome to the Surgery Partners First Quarter 2023 Earnings Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dave Doherty, Chief Financial Officer. Thank you, Dave. You may begin.

Dave Doherty: Good afternoon. My name is Dave Doherty, CFO of Surgery Partners and I am here with our CEO, Eric Evans and our executive Chairman, Wayne DeVeydt. We appreciate you joining us to discuss our financial results for the first quarter of 2023. Today, we’ll make forward-looking statements. There are risk factors that may impact those statements and could cause actual future results to be materially different from them. These risk factors are described in this afternoon’s press release and the reports we file with the SEC, which are available on our website at surgerypartners.com. The company does not undertake any duty to update these forward-looking statements. In addition, we will reference certain financial measures that are considered non-GAAP, which we believe can be useful in evaluating our performance.

The presentation of this information should not be considered in isolation or is a substitute for results prepared in accordance with GAAP. These measures are reconciled to the most applicable GAAP measure in this afternoon’s press release. With that, I’ll turn the call over to Wayne. Wayne?

Wayne DeVeydt: Thank you, Dave. Good afternoon and thank you all for joining us today. I’m pleased to report Surgery Partners first quarter adjusted EBITDA of $90.1 million, 17% higher than last year’s first quarter, which generated an adjusted EBITDA margin that grew 60 basis points to 13.5%. Including our non-consolidated facilities, we performed approximately 176,000 surgical cases in the first quarter, 12% more than 2022, with contributions from all our core specialties, consistent with our expectations. This strong case growth combined with increased acuity and contributions from recent acquisitions generated net revenue of $666 million. Consistent with our prior quarters, our first quarter results demonstrate top line growth, organic margin expansion, and contributions from recent acquisitions, which are the cornerstone of our long-term growth algorithm.

Dave will share more details regarding our financial results, but let me highlight a few. Net revenue of $666 million represents nearly 12% growth from the prior year with same facility revenue growth of 10.3%. This organic growth rate was a combination of case growth of 5.3% and net revenue growth of 4.8 per case. As we pointed out in prior quarters, the case mix of our business has been stable since early 2022, with all specialties growing at rates consistent with our expectation, Physician recruiting efforts yielded nearly 150 new surgeons in the first quarter, representing all of our core high growth specialties. As we start the year, we continue to be encouraged by the quality of physicians that choose our high quality surgical facilities.

We anticipate recruiting approximately 500 new physicians to 600 new physicians annually. Our prior year recruiting cohorts continue to demonstrate strong year-over-year growth, with first quarter recruits from our 2022 cohort, generating 78% more revenue in the current year quarter as compared to the same period last year. Finally, joint replacements in our ASCs increased 84% since the first quarter of 2022, as we continue to focus on the significant shift in site of care in our recruiting efforts acquisitions and de novo Investments. Our M&A team continues its discipline approach to sourcing and executing on strategically aligned acquisitions at attractive multiples, and we finished the first quarter deploying $60 million at a sub eight times multiple.

Our M&A pipeline is robust and our balance sheet remains strong, giving us continued confidence in our ability to meet or exceed the annual goal of deploying at least $200 million through acquisitions. As Dave will discuss in a few minutes, we also unlocked additional capital for redeployment by executing on components of our asset portfolio refresh. We’ll be redeploying this capital in higher growth short stay surgical facilities. Together with the board, I’m optimistic and have high confidence in both the near-term and the long-term growth prospects of Surgery Partners. As I mentioned earlier, all growth levers that support our long-term growth algorithm are working as expected with top line growth, margin expansion and prudent capital deployment.

While our execution over many quarters has been strong and consistent amid a volatile environment, for the first time in years, the broader healthcare services operating backdrop feels more constructive for providers, including decelerating labor inflation, more consistent volumes across the ecosystem and a more constructive rate environment. Off this, the strength of our first quarter and our continued investments, we are raising our 2023 adjusted EBITDA to be greater than $430 million. This outlook is inclusive of the anticipated headwinds and tailwinds that Dave will discuss in more detail. With that, let me turn the call over to Eric. Eric?

Eric Evans: Thanks, Wayne, and good afternoon, everyone. The start of 2023 for Surgery Partners has been productive as the company again delivered on its commitment for double-digit growth and continued to position the company for long-term growth by completing five acquisitions and four divestitures and by signing two strategic partnerships with Marquee Health Systems. Combined, these actions position us well to not only deliver on our updated outlook for 2023, but also on our long-term double-digit adjusted EBITDA growth trajectory. Dave will discuss the details of our financial results and the drivers of our increased guidance, and I will dive deeper into our operations and the portfolio changes we are making this year. From an operational perspective, our specialty case mix is right where we want it to be, and volume was in line with our expectations with over 151,000 consolidated surgical cases in the quarter, 6.1% more than last year.

Let me reiterate what we shared throughout 2022. The effect of the pandemic on our results is completely in the rear view mirror. Since 2019, each of our specialties and subspecialties have experienced growth consistent with or exceeding our long-term growth. To put a finer point on this, since early 2022, all our specialties recovered from the pandemic with strong growth rates throughout the year. In aggregate, our quarter one case volume inclusive of 2023 has a four year CAGR of 4.9%. In the quarter, our same facility growth exceeded 5% when compared to the first quarter of 2022, continuing our consistently strong growth trajectory. As Wayne mentioned, this case growth included contributions from higher acuity cases, which helped our same facility net revenue per case increase almost 5% and combined to provide a double-digit same facility revenue increase in the quarter.

We expect to continue to see both volumes and rate growth in excess of our long-term guidance ranges throughout 2023. Labor and supply costs remain well under control, allowing our adjusted EBITDA up $90.1 million to generate 13.5% adjusted EBITDA margin, 60 basis points of expansion compared to last year. Physician recruiting, which targets the highest quality physicians, added approximately 150 physicians in the quarter. As Wayne highlighted, each of our recruiting cohorts continues to drive strong year-over-year growth and we are encouraged by the early strength of the 2023 recruiting class. All of this has continued to fuel our growth in MSK procedures, particularly total joint cases in our ASCs. We performed over 26,000 orthopedic procedures this quarter, and the volume of total joint surgeries that shifted into our ASCs increased by 84%, and as we have discussed, we are preparing for the next wave in cardiac procedures that we expect to migrate to outpatient settings, starting in earnest over the next three to five years.

Photo by Luis Melendez on Unsplash

We do not expect the shift of these orthopedic and cardiac procedures to slow down and we continue to position our portfolio to take advantage of this high growth opportunity. In the first quarter, we deployed $60 million acquiring two new ASCs and increasing our ownership position in three other facilities, including two from a prior year minority interest acquisitions from Value Health. These acquisitions, which increased our multi-specialty capacity have an average purchase price multiple of less than eight times trailing 12 month earnings. We are rapidly integrating these acquisitions into our operations and expect to yield further earnings from our operating system synergies in the first 12 months to 18 months post acquisition. On the de novo front, since 2019, we have opened four new ASC facilities and have 10 fully syndicated de novos under construction.

Many of these projects are slated to open in late 2023 or early 2024. These facilities include consolidated and minority interest ownerships and our multi-specialty with a concentration in orthopedics. In addition, as we mentioned in prior calls, we consistently evaluate our portfolio of approximately 150 short stay surgical facilities to ensure we are the best owner of the assets and they meet our high expectations for both growth and margin performance. Although each of our facilities generate revenue and earnings, in certain cases, the monetization and redeployment of the proceeds of our portfolio management efforts will be net accretive to the company’s earnings. Year to date, we have divested our interest in four facilities, and expect to divest of another four to six facilities by mid-year.

The aggregate proceeds from these divestitures will be redeployed at a lower multiple and will be accretive to future earnings. Our pipeline of new acquisition opportunities remained strong and supportive of our commitment to deploy at least $200 million plus the incremental proceeds from divestitures this year. Finally, I’m pleased to announce new strategic partnerships with two prominent health systems, Intermountain Health and Ohio Health. While decades of growth remain in our core business of two-way JVs with surgeons, Surgery Partners has emerged as a partner of choice for hospital systems revisiting their outpatient strategy. We are winning in this area because we are differentiated in our ability to consistently drive same site growth through data enabled position recruiting.

We bring a rigorous and disciplined approach to facility management, including on labor and supply costs, and more recently, our proven de novo capabilities at scale. Our deep operational excellence stands out. Accordingly, Intermountain and Ohio Health, our like-minded health systems that are joining with us on a long-term growth strategy, supporting the country’s migration of procedures into the highest value settings. Through these partnerships, we will combine Surgery Partners’ industry leading management expertise with the strong market reputation Intermountain Health has earned throughout the Mountain region, spanning Nevada to Montana, and equally strong reputation Ohio Health has earned in Ohio to create regional ASC networks. Specifically in partnership with Intermountain, we will provide management services for 19 current and future ASCs in the Utah and Idaho markets.

We will also partner with Intermountain to co-develop additional ASCs throughout their regional footprint in the years to come. Surgery Partners is now also the partner of choice with Ohio Health as it accelerates its plans to create a statewide ASC network in Ohio. In this partnership, we will provide management services to ASCs that we jointly acquire or develop in the coming years. These partnerships with like-minded health systems partners represent significant opportunities to serve these growing communities and to expand our scale. Although they will provide minimal earnings in 2023, we expect rapid and material contributions to our growth story over the next several years. We look forward to sharing more details about these developing ASC networks throughout the year.

In summary, I am very proud of the team’s accomplishments this quarter. Not only have we continued to excel within our core operations as evidenced by our consistent financial results, we are executing on our commitment to position the company’s footprint for long-term growth and success. More than ever, our company provides a cost efficient, high quality and patient-centered environment in purpose-built short stay surgical facilities that provide meaningful value to all of our key stakeholders. With that said, I’m going to turn the call over now to Dave to provide additional color on our financial results as well as our 2023 outlook. Dave?

Dave Doherty: Thanks, Eric. My initial remarks will focus on our first quarter financial results before providing additional perspective on our outlook for the remainder of the year. Starting with the top line, we performed 151,000 surgical cases in the first quarter, which is 6.1% more than the prior year, first quarter. These are only cases that are included in our consolidated revenue. If I include cases performed at non-consolidated facilities, we performed 176,000 cases. These cases spanned across all our specialties, with an increasing focus on higher acuity procedures, which is reflected in our double-digit same facility revenue growth this quarter. The combined case growth in higher acuity specialties, specific managed care actions and the continued impact of acquisitions supported revenue growth of 11.7% over last year to $666 million.

I will reiterate that an increasing share of recent acquisitions include minority interest investments. For these acquisitions, revenue is not included in our consolidated financials. We will continue to be agnostic to the accounting treatment of the assets we acquire. Our focus remains to acquire high growth, high quality assets aligned with our targeted specialties at the most favorable multiple possible. This may affect how some of our stakeholders model revenue expectations. So it is worth reiterating this point for you. From a financial planning perspective, we focus primarily on growing our adjusted EBITDA and managing the core operations to grow market share. On a same facility basis, total revenue increased 10.3% in the first quarter, with case growth at 5.3%.

Net revenue per case was 4.8% higher than last year, primarily driven by higher acuity procedures. As we reported throughout 2022, our prior year results were largely unaffected by the pandemic and the inflationary pressures that affected prior years. Hence, the first quarter of 2022 is a stable comparable period for this year. Adjusted EBITDA was $90.1 million for the first quarter, giving us a margin of 13.5%, a 60 basis point improvement over last year, and in line with our expectations of continued margin expansion. Inflationary pressures related to labor and supply costs have almost completely moderated in the first quarter, but we will remain vigilant in monitoring these factors across our portfolio. The costs of salaries, wages and benefits, as well as our medical supply costs were consistent with prior periods as a percentage of revenue.

As we noted in the past, we expect to produce at least $140 million of free cash flow in 2023. We defined free cash flow as the operating cash flow we report in the statement of cash flow, which is net of our cash interest expense, less the distributions paid to our partners and capital expenditures at our facility. In the first quarter, we generated free cash flow in excess of $20 million, which is in line with our expectations. There were no unusual items that affected this metric. We remain confident in the ability to meet our target of at least $140 million in 2023. We ended the quarter with $246 million in cash and an untapped revolver of $553 million. When combined with the free cash flow we are generating, we believe our current and future liquidity positions us well in this macroeconomic environment, while giving us flexibility to maintain our long-term acquisition posture of deploying at least $200 million per year for M&A.

As a reminder, our corporate debt is less than $1.9 billion. As a part of our consistent proactive approach in managing our balance sheet, including future interest rate exposure and long-term liquidity, prior to the current macro environment, we entered into a number of interest rate swaps and fully hedged the interest cost of this debt, which averages at a fixed rate of 6.7%. Accordingly, we are not exposed to significant rate risks, which is another factor giving us confidence in our free cash flow growth. Our first quarter ratio of total net debt to EBITDA as calculated under our credit agreement was 4.3 times. With the earnings growth, we expect we are confidence this ratio will decline over the year. In the first quarter, we deployed $60 million on five transactions at a sub eight times multiple.

The facilities we invested in are primarily focused on MSK procedures and are well positioned to support and strengthen our same facility growth trends in future years. Additionally, as mentioned in prior calls, we continually refresh our asset portfolio to align with long term market growth trends. Year-to-date, we have divested four lower performing facilities and expect to conclude another four to six by the middle of the year. Proceeds from these divestitures will be redeployed as incremental M&A at comparatively lower multiples with stronger future growth prospects. Combined, these divestitures will create a revenue headwind of over $100 million to 2023, prior to any redeployment of proceeds received. That being said, based on the strength of our first quarter results and our refreshed outlook for the remainder of the year, we expect to more than cover this divestiture headwind and are reaffirming our full year revenue guide of greater than $2.75 billion.

From an adjusted EBITDA perspective, we expect to more than overcome this headwind due to the strength of our top line revenue growth and continued margin improvement throughout the year. While the timing of divestiture and related M&A activity is a challenge to predict, we believe our 2023 full year outlook reflects a conservative view. Carrying the momentum of our first quarter results, we remain optimistic and confident about the company’s growth and are raising our outlook for 2023 adjusted EBITDA to greater than $430 million, representing at least 13% growth compared to 2022. Our financial guidance is informed by the continuation of strong organic case and rate growth, the annualization of prior acquisitions and the timing of future M&A and divestiture activity, contributions from our in process de novos, including the continued maturation of the community hospital we opened in Idaho during the pandemic.

Regarding the exciting new health system partnerships that Eric mentioned, we expect marginal benefit to our results this year, with more significant growth in adjusted EBITDA in 2024 and 2025. Given the nature of these partnerships, most of these earnings will be earned through management fees and minority interest earnings. As a reminder, our business has a natural seasonal pattern, largely driven by annual deductibles resetting for commercial payers that tend to skew our results lower in the first quarter and higher in the fourth relatively speaking. We continue to anticipate the seasonal pattern of our results will be consistent with 2022, with second quarter adjusted EBITDA to be approximately 23% in revenue to be approximately 24% of our full year guidance.

Our first quarter results speak to the strength of our operations and our business model, and we believe that the balance of the year should continue to capitalize on that momentum. With that, I’d like to turn the call back over to the operator for questions. Operator?

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. Our first question is from Jason Cassorla with Citi. Please press proceed with your question.

Jason Cassorla: Great. Thanks for taking my questions. Just on the volume front, certainly a solid number in the corner of 5.3, but I was hoping you could give us a flavor of how payer mix trended and then just given a macro backdrop, if any portion of that volume was perhaps pulled forward ahead of potential coverage changes later this year, or if you think, underlying the demand was just more broad based in that sense.

Eric Evans: Hey, Jason, thanks for the question and good afternoon. I would say from our perspective, we don’t believe anything was pulled forward. That’s not — this is the core run rate that we had anticipated. I think we’re feeling fairly optimistic for the full year, continue to believe that we’ll see similar patterns as this year progresses, and I think as we said in our prepared remarks, we are fully expecting to exceed our typical algorithm in terms of growth.

Wayne DeVeydt: Yeah, and I guess I’d say today is across all specialties, certainly you saw the acuity growth was strong. We talked a little bit about our joint growth being 84% year-over-year. Continue to see that acuity come through. From a mixed perspective, very consistent with what we expected. So, I would just say like fully meeting expectations as far as the overall growth and we liked how evenly spread it was across all of our service lines with specifically strong growth, the higher acuity procedures, which clearly showed up in our same store, net revenue per case.

Jason Cassorla: Got it. Okay, thanks. Helpful. And then just maybe the follow up, I wanted to ask about labor costs in the quarter. You talked about inflationary impact was generally moderated in 1Q, but if we isolate as WV to per case basis, it looks like it was up about 6.5% year-over-year. That’s been growing in that mid to high single digit range for the past few quarters. Maybe just helped bifurcate the impact between, underlying wage growth trend for ’23 and the impact that the shift towards higher acuity procedures has on the intensity of labor per case. That would prop that set up too. Thanks.

Eric Evans: Yeah, I’ll dive in there. So Jason, that’s a great question. We continue to see very moderate impact of premium labor. As we’ve talked about kind of throughout the pandemic, it’s been a low percentage of our total labor. Certainly at points in the pandemic, we saw some excessive rates in that in some markets, but in general, didn’t have a huge impact in prior years. We continue, we think to manage that cost quite well. From a per case perspective, I think you do point out something which is good to point out in higher revenue cases, obviously more higher acuity cases. There certainly is some length of stay difference in cases and it can be a different labor mix, but in total, we feel good about where labor came in. It still remains well controlled and we think it’s actually, if anything, it’s moderating and continuing to look better as the year moves forward.

Operator: Thank you. Our next question is from Kevin Fischbeck with Bank of America. Please proceed with your question.

Nabil Gutierrez: This is Nabil Gutierrez on for Kevin. Thanks for taking the question. Can you talk about how volumes trended throughout the quarter? Was the growth consistent each month?

Eric Evans: I would say relative to our expectations, yes, we obviously build our January, February and March, different each year. We look at a number of days. But if you look at a year-over-year basis, the number of days for us was consistent for 2022 versus Q1 of 2023. So no surprises from that. We saw a pretty consistent volume each month. So we have nothing weird to report.

Nabil Gutierrez: And then my follow-up is, what type of procedures grew the fastest?