Surgery Partners, Inc. (NASDAQ:SGRY) Q1 2024 Earnings Call Transcript

Surgery Partners, Inc. (NASDAQ:SGRY) Q1 2024 Earnings Call Transcript May 7, 2024

Surgery Partners, Inc. beats earnings expectations. Reported EPS is $0.2628, expectations were $0.07. SGRY isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to Surgery Partners First Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to Dave Doherty, CFO. Thank you. You may begin.

Dave Doherty: Good morning. My name is Dave Doherty, CFO of Surgery Partners. I am joined today by Eric Evans, our CEO; and Wayne DeVeydt, our Executive Chairman. During this call, we will make forward-looking statements. There are risk factors that could cause future results to be materially different from these statements. These risk factors are described in this morning’s press release and the reports we filed with the SEC, each of which are available on our website, 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 as a substitute for results prepared in accordance with GAAP.

These measures are reconciled to the most applicable GAAP measure in this morning’s press release. With that, I will turn the call over to Wayne. Wayne?

Wayne DeVeydt: Thank you, Dave. Good morning, and thank you all for joining us today. My initial comments will briefly highlight our consolidated first quarter results and the strength we continue to see in our long-term growth algorithm as it relates to both our organic and capital deployment initiatives. I will then provide a brief update on our recent acquisition activity and refreshed outlook for the remainder of the year before I hand over the call to Eric and Dave. They will provide additional insights into our operating and financial performance for the quarter along with recent activities to further strengthen our balance sheet and support our long-term mid-teens growth goals. Turning to our first quarter results. We reported net revenue of approximately $717 million, representing growth of 7.7% over the prior year quarter.

On a same-facility basis, net revenues grew 10.2% as compared to the comparable period, representing a combination of both case and net revenue per case growth. Adjusted EBITDA was $97.5 million, representing 8.2% growth over the prior year quarter, with adjusted EBITDA margins improving in the quarter by 10 basis points to 13.6%. Finally, our efforts to pursue higher acuity procedures continue to produce strong results, with total joint replacements increasing by 54% over the first quarter of 2023. Eric will provide additional insights into our physician recruitment and total joint expansion programs along with our early success in targeting orthopedic surgeons specializing in total shoulder procedures, which were removed from the inpatient-only list starting January 1 of this year.

We continue to be extremely pleased with our same facility growth and the expected long-term sustainability of our organic top line and margin expansion growth goals. As previously stated, our short-stay surgical facilities have been purpose-built to capture the macro tailwinds of both an aging population and the increased movement of higher acuity procedures into a purpose-built outpatient setting. We believe our results reflect the strength and durability of our business model as we pursue this highly fragmented segment, which currently consists of over 6,000 ambulatory surgical facilities and an estimated $150 billion total addressable market, representing both current and expected surgical procedures to be performed in an outpatient setting in the coming years.

Moving to our capital deployment activities. We maintained our disciplined approach to sourcing and executing on strategically important acquisitions at attractive multiples. As a reminder, we previously completed a $60 million transaction in early January that we had initially targeted closing in the fourth quarter of 2023. Since that time, we’ve maintained a robust pipeline and anticipate closing an additional $200 million to $250 million in acquisitions in the second quarter of this year, with the low end of that range having closed on April 30. This level of deployment reflects both an annual targeted goal of at least $200 million, along with the redeployment of the remaining net proceeds from assets divested in 2023. Our business development team continues to source a robust pipeline of acquisition and de novo investment opportunities, and we believe the capital deployment aspects of our growth algorithm remain predictable and executable.

Before I turn the call over to Eric, let me provide a brief update on our outlook for the remainder of 2024. Based on our strong organic performance in the first quarter and the timing of our recently completed acquisitions, we are increasing full year net revenue and adjusted EBITDA outlook to at least $3.05 billion and $505 million, respectively. This refreshed outlook represents at least 11% and 15% growth in net revenue and adjusted EBITDA, respectively, as compared to the prior year and balances our optimism for the company’s growth with an appropriate amount of conservatism. We look forward to updating you on our progress as the year unfolds. With that, let me turn the call over to Eric to provide additional insights for the quarter. Eric?

Eric Evans: Thanks, Wayne, and good morning, everyone. The start of 2024 for Surgery Partners has been productive, and our results continue to demonstrate the outsized demand for purpose-built short-stay surgical facilities that offer a safe, high-quality and high-value experience for both patients and physicians. Importantly, for our investors and based on current and past performance, our growth remains consistent and predictable, in line or better than our internal expectations. As Wayne mentioned, all aspects of our mid-teens growth algorithm continue to deliver. Diving deeper into our results. Same-facility net revenue growth was 10.2% in the first quarter and represented both case and net revenue per case growth of 1.3% and 8.8%, respectively.

We continue to put increased focus on both physician recruitment activities and higher acuity procedures that would benefit from an enhanced patient and physician experience associated with our purpose-built short-stay surgical facilities. On the physician recruitment front, we added over 200 physician in the quarter, slightly higher than our historic run rate, and our 2024 recruitment class has a revenue per case that is 25% higher than the class of 2023. That is partially impacted by the growth of orthopedic surgeons that specialize in higher acuity total joints, including shoulder procedures, which represented approximately 1/3 of our first quarter recruitment class. Additionally, as we have previously stated, each of our recruiting cohorts continue to drive strong compounding year-over-year growth, with our 2023 class performing 134% more cases in the first quarter of 2024 as compared to their initial quarter in 2023.

Our recruitment activities have continued to fuel our growth, especially in musculoskeletal, with over 61,000 MSK-related procedures performed in the first quarter of 2024, representing 14% growth over the prior year quarter. More importantly, total joint cases in our ASCs continue to grow at a disproportionate rate, which saw a 54% increase in case volume as compared to the prior year quarter and a 90% compound annual growth rate since 2019. On a consolidated basis, our specialty case mix and volumes were in line with our expectations with over 153,000 consolidated surgical cases in the quarter with particular focus in our high acuity business lines. To put a finer point on this, while all our specialties have recovered from the pandemic with strong growth rates, in aggregate, our first quarter case volume has a compound annual growth rate since 2019 of just over 4%, with growth of over 6% in orthopedics.

Our unique partnership model and our approach to enabling our physician partners independence and strong community reputation allows us to naturally benefit from the continued site of care shift to our safe, high-quality and cost-effective facilities. We work every day to bring the benefits of a professional scale management company, while keeping the invaluable local feel and connection that differentiate our surgical facilities. This approach preserves the strong reputation of our partners have earned, allowing them to focus on their patients, knowing their preferences and input will remain an integral part of the facility that they have helped build. Together, our partners win, our payers win and most importantly, our patients get the best care possible for their surgical care needs.

When this happens, we deliver consistent high-quality results as we have done over the past five-plus years despite managing through a global pandemic and a challenging inflationary macro environment. Moving to operating margins. As Wayne mentioned, our operating margins improved in the quarter by 10 basis points to 13.6%. Our operating margin improvements reflect both our ongoing procurement and revenue cycle initiatives that continue to benefit from our increasing scale along with synergies achieved on our previously acquired facilities. We expect margins to improve throughout the remainder of the year, consistent with historical earning patterns. Finally, diving deeper into our capital deployment activities. As Wayne discussed, we continue to have a robust pipeline of opportunities and expect to deploy over $200 million in the second quarter of 2024.

We closed on the majority of our targeted acquisitions on April 30, representing five different transactions, including a large system acquisition that includes a specialty surgical hospital, ambulatory surgical center and related physician practices. We are excited about partnering with the physicians in this market, which is in a region we know quite well. These acquisitions, which will increase our multi-specialty capacity, are rapidly being integrated into our operations and are expected to yield further earnings from our operating system synergies in the first 12 to 18 months post-closing. On the de novo front, since 2019, we have opened 11 new ASC facilities and have 11 fully syndicated de novos under construction. Many of these projects are slated to open in 2024 and early 2025.

These facilities include consolidated and minority interest ownerships and are primarily multi-specialty with a concentration in orthopedics. In closing, I’m proud of our management team and our many talented physician partners and colleagues for effectively managing through inflationary, labor and supply pressures over the past few years, while delivering a superior patient experience with high clinical quality. With inflationary pressures largely abated, coupled with how well our teams are effectively executing on our initiatives across business development, recruiting, managed care, procurement, revenue cycle and operations, we are confident that we will achieve our updated 2024 goals. 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.

The desire and need to move more procedures to our care setting has never been greater, and our company is positioned to deliver industry-leading growth associated with these tailwinds. This, coupled with an existing and growing M&A pipeline and a talented, deep and experienced leadership team, provides further optimism for long-term sustainable mid-teens adjusted EBITDA growth. With that, I will now turn the call over to Dave to provide additional color on our financial results as well as our updated outlook for 2024. Dave?

Dave Doherty: Thanks, Eric. Starting with the top line. We performed 153,000 consolidated surgical cases and 178,000 total surgical cases in the first quarter. 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 7.7% over last year to $717.4 million, which is overcoming approximately $36 million of revenue headwinds associated with facilities divested in 2023. On a same-facility basis, total revenue increased 10.2% in the first quarter. Same-facility rate growth was 8.8%.

We have seen especially strong rate growth in the back half of 2023 and continuing into 2024, primarily driven by higher acuity procedures, specifically orthopedics and spine. We continue to forecast our same-facility net revenue growth to exceed our algorithm target of 4% to 6% in 2024. With full year same-facility revenue finishing in the high single-digit range, our forecast anticipates net revenue being more balanced between rate and volume on an annualized basis, with rates playing a smaller role and volume playing a larger role in the second half of the year. Adjusted EBITDA was $97.5 million for the first quarter, giving us a margin of 13.6%, in line with our expectations of continued margin expansion. Inflationary pressures related to labor and supply costs continue to abate as we return to a more normalized run rate that provides natural margin expansion as we grow volume.

We will remain vigilant in monitoring these factors across our portfolio and expect margins to continue to improve throughout the year with annualized margins improving by at least 50 basis points over full year 2023. We ended the quarter with $185 million in cash. When combined with the untapped revolver capacity, we had nearly $800 million in total liquidity. We reported operating cash flows of $40 million in the quarter, which was in line with our expectations. This amount differs somewhat from last year due to the timing of certain events. However, it is in line with our expectations of lower cash generation in the first quarter and supports our continued belief that we will achieve our previously discussed free cash flow goals in 2024.

The effective interest rate on our corporate debt is 6.3% fixed through the first quarter of 2025. The company was able to effectively redeem our senior unsecured debt at favorable terms and pricing, extending the maturity to 2032. We now have no debt maturities until 2030. We also recently entered into interest rate caps that will cap the variable component of our $1.4 billion term loan at 5% starting in the second quarter of 2025. Over the past six months, we have addressed all exposures we had related to financing and interest rate risk through the end of the decade. Accordingly, we have predictability in our interest costs and are not exposed to significant interest rate risks, which are key factors giving us confidence in our free cash flow growth.

In the event that the interest rate environment becomes more favorable in the future, we will have an opportunity to capitalize on such improvements. Our first quarter ratio of total net debt-to-EBITDA, as calculated under our credit agreement, was 3.5x. As a reminder, this ratio will be impacted in the short term based on the timing of acquisitions, but we remain committed to our long-term target of sub-3.5x. In the first quarter, we deployed just over $70 million in acquisitions, including $60 million associated with the previously discussed transaction closed earlier in January. We also completed additional acquisitions on April 30 of this year, which represented our targeted goal of $200 million in annual capital deployment. 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.

Carrying the momentum of our first quarter results, we remain optimistic and confident about the company’s growth and are raising our outlook for 2024 net revenue to at least $3.05 billion and adjusted EBITDA to at least $505 million, representing at least 11% and 15% growth, respectively, compared to 2023. This guidance implies continued year-over-year margin expansion consistent with our long-term guidance. This updated outlook represents greater than a 14% compound annual growth rate since 2019, emphasizing the resiliency of the business model and demonstrating the power of our long-term growth. Our business has a natural seasonal pattern, largely driven by the number of surgical days and 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 2023, with second quarter adjusted EBITDA to be approximately 23% and 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?

Operator: [Operator Instructions] Our first question is from Brian Tanquilut with Jefferies.

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Q&A Session

Brian Tanquilut: Congrats on a solid quarter and the acquisitions. I guess, my first question, maybe for Eric or Wayne, as we think about this bolus of deals coming in the second quarter, number one, is there something in the market or are there assets that are just coming up for sale because this is a big chunk of deals that you’re announcing. And then maybe second, I know Dave mentioned it’s MSK, but just anything you can share with us in terms of the margin profile for these assets or the seasonality factor for these assets as it compares to yours?

Wayne DeVeydt: Brian, let me start with the M&A and then I’ll actually have Eric talk a little bit about the MSK because I think as we look at the increases in total joints, coupled with the new activities around shoulders, I think you’ll get a better feel of why we’re having such a positive impact on same-store. Starting on the M&A front. Just a reminder for all those listening that our base algorithm assumes that we will achieve 4% to 6% growth through deploying somewhere between $150 million and $200 million a year for M&A. And we continue to target $200 million as our preferred goal for the year. As we mentioned in prior years, we always have this robust pipeline. But as you know, M&A can be fickle. So a lot of the timing of what you’re seeing in 2Q was really a function of a lot of the grassroots efforts that were done last year in building these relationships with a number of facilities and physician partners and really just came to a head in the second quarter of this year.

We were somewhat optimistic we might have gotten those done in the first quarter, but they pushed into April 30 of the second quarter. That being said, with those transactions closed on April 30, we’ve already accomplished our entire $200 million targeted goal for the year. I would remind you though that the algorithm assumed we would deploy $200 million and use generally a midyear convention, assuming a high single-digit multiple. So you’ll get an incremental value, though, due to the timing for the current year and then you get, of course, full run rate effect as we move into next year. Last thing I would say is we continue to have a robust pipeline, and I don’t anticipate that slowing down. It’s nothing new, though, Brian. We’re not necessarily seeing the pipeline growing because of any kind of macro situation.

It really is, though, importance of partnership. And I think many of these organizations are realizing the value we can bring. And word of mouth gets out there over time as we continue to do this, and these partners have an opportunity to get some liquidity for themselves, but also have an opportunity to remain owners in something that they built. With that, Eric, maybe highlight a little bit just on the higher acuity stuff and what we’re doing in that space.

Eric Evans: Yes. I guess it’s related to the M&A, I would just comment that these are MSK-heavy, our transactions. And so your question on margin seasonality, it’s going to match our portfolio overall though it leans MSK-heavy. I think to Wayne’s point, one of the things you saw this quarter, and we’re glad it’s MSK-heavy, there’s a lot of growth opportunity within that service line. So one of the changes this year was CMS for the total shoulders off of the inpatient-only list and put them on the ASC list. We’ve since that time in Q1 have performed over 500 total shoulders, really strong growth with the vast majority of that being in ASCs. Certainly, this new acquisition gives us the opportunity to grow that along with bringing our synergies to a really, really exciting market. So we couldn’t be more pleased with the transactions we just completed.

Brian Tanquilut: That’s awesome. And then maybe my second question for Dave. We’ve got a lot of questions about the Idaho payments last year and how that affects comps and growth rates this year. I know you gave sort of guidance on Q2 EBITDA. But maybe if you can just share some color on how we should be thinking about those comps from a growth rate perspective, given the lumpiness of those payments?

Eric Evans: Yes, Brian, thanks for the question. I’m going to jump in on this one. And I know there was some confusion coming out of the end of the year last year and want to make sure I clarify a few things. So I’d make three points. But one point that I think you should all hear is this is not a material issue for the company. As you think about, our total Medicaid business is 4% of our cases. The net revenue is roughly comparable to that 4%. So you have 4% of our cases, I want to hear you — make sure you hear it’s immaterial. And that 4% revenue, that includes all the different programs that go into it. So it’s not a big part of our business, I’ll start there and make sure everyone hears that. On the second point, these programs that are in multiple states, whether it’s upper payment limit or [HUF] payments or across different states, there’s different programs that wrap around Medicaid.

Those programs are sustainable and expanding, but will still be immaterial to our business for the foreseeable future. Just don’t see that as a big thing for us. Now what I would say the last point is the timing of reimbursement and state tax policy and the way payments come in, that is really hard to predict. So that’s kind of what you saw a little bit of last year. But the key message here is we don’t do a lot of Medicaid business, a small portion of our business. The vast majority of the payment for Medicaid is fee-for-service. There are some of these programs that help make Medicaid sustainable. And those programs, again, still insignificant in the grand scheme of things.

Operator: Our next question is from Whit Mayo with SVB Leerink.

Whit Mayo: Maybe just remind me guys, just on the revenue cycle initiatives now that you’re on, one, clearing house, just the anticipated impact this year. I think it’s expected to be a larger driver of growth. I think there’s been a big focus on this internally. Any color would be helpful.

Dave Doherty: Yes. Thank you for the question. Our rev cycle initiatives are definitely a component part of our growth. They have been now for several years as we enter into 2024. We’ve become a lot more mature in our rev cycle process, but we do expect continued contributions from there. Our first quarter results in this area are reflected somewhat in our revenue and in our cash flows that we reported from an operating perspective and gives us confidence that the value is going to continue to show through in our results for 2024.