Surgery Partners, Inc. (NASDAQ:SGRY) Q4 2022 Earnings Call Transcript

Surgery Partners, Inc. (NASDAQ:SGRY) Q4 2022 Earnings Call Transcript March 1, 2023

Operator: Greetings, and welcome to the Surgery Partners, Inc. Fourth Quarter 2022 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. Please go ahead, sir.

Dave Doherty: Good morning, and welcome to Surgery Partners’ fourth quarter 2022 earnings call. I’m Dave Doherty, the company’s CFO. With me today is Eric Evans, CEO; and Wayne DeVeydt, our Executive Chairman. During this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning’s press release and the reports we file with the SEC. The company does not undertake any duty to update such forward-looking statements. Additionally, during today’s call, we will discuss certain 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 these measures can be found in this morning’s press release, which is posted on our website at surgerypartners.com and in our most recent annual report on Form 10-K when filed. With that, I’ll turn the call over to Wayne. Wayne?

Wayne DeVeydt: Thank you, Dave. Good morning and thank you all for joining us today. This morning, we are pleased to report full year 2022 adjusted EBITDA of $380.2 million, 12% higher than the prior year, and over 20% year-over-year growth when adjusting for the non-recurring benefit of grants. Including our non-consolidating joint ventures, we performed approximately 680,000 cases in 2022, nearly 12% more than 2021, with all specialties growing in line or in excess of our expectations, despite the early 2022 impact from the Omicron variant. This strong case growth, combined with improved rates and contributions from our recent acquisitions, resulted in net revenue of $2.54 billion, 14% higher than 2021. The algorithm for our long-term double-digit adjusted EBITDA growth story relies on top-line growth, organic margin expansion and targeted capital deployment, and each of these growth levers continue to contribute as expected in 2022.

The combination of our top-line growth and focus on controllable costs allowed us to report an adjusted EBITDA margin of 15%, representing an 80 basis point improvement over 2021 when adjusting for grants. Dave will go into these results in greater detail in a few minutes. Our fourth quarter results continue to affirm the power of our business model and the value proposition we provide to our stakeholders. Net revenues increased 16% from the prior year to $707 million with same facility revenues increasing nearly 11% compared to 2021. Physician recruiting efforts yielded over 150 new surgeons in the fourth quarter, bringing our overall new recruits in 2022 to almost 575. The 2022 recruiting class spans all of our core high-growth specialties and is bringing a higher volume of cases and generating more revenue than prior recruiting cohorts.

For example, the first year net revenue contribution from our 2022 cohort was 40% higher than the year one revenue contributions from last year’s cohort. Based on our experience as the recruiting cohorts mature, there is an earnings compounding effect for multiple years. As evidenced, the class recruited in 2021 delivered 143% more cases and 156% more revenue growth in 2022. We have high confidence that both 2021 and 2022 cohorts will continue to grow in 2023. Finally, we continue to benefit from the transition of procedures out of the traditional acute care in-patient setting, and we are not seeing those cases return to the hospital setting as we exit the pandemic. Joint replacements in our ASCs for the fourth quarter were up 100% from the prior year and almost 80% for the full year 2022 compared to 2021.

We will continue to focus on this significant shift in site of care in our recruiting efforts, acquisitions and de novo investments. Our management team, which has a tenacious focus on execution, coupled with the infrastructure we’ve built over the past five years, has positioned us to capture the significant shift of care moving to the outpatient setting within the $150 billion total addressable market. Rounding out our growth story, our M&A team continues its disciplined approach to sourcing and executing on strategically important acquisitions at attractive multiples, and finished 2022 deploying just shy of $250 million at a sub 8x multiple. And our M&A engine isn’t slowing down. Our team is currently managing a robust pipeline of potential targets in excess of $250 million.

With the incredible support of existing and new investors, in November we raised over $850 million in a primary offering of our equity. Dave will provide greater detail on the use of proceeds from the offering, but by repaying a significant portion of our long-term debt, we reduced our annual cash interest costs by north of $40 million. Combined with strong operational execution and cash flow conversion, we expect to generate over $140 million in free cash flow in 2023 and to exceed $200 million in annual free cash flow by 2025. In addition to our projected operating cash flow, we start 2023 with over $820 million in liquidity. This liquidity position gives us further conviction into the continued long-term growth of the company. On behalf of the Board, I’d like to emphasize that point.

We have high confidence in the long-term growth prospects of Surgery Partners. This management team continues to demonstrate their ability to successfully navigate the challenges of our current macroeconomic environment, as it executes on organic and inorganic growth strategies to provide significant year-over-year growth. Off the strength of our fourth quarter reported results and continued investments, we anticipate 2023 adjusted EBITDA to be greater than $425 million and with net revenue exceeding $2.75 billion. This outlook is inclusive of the anticipated headwinds and tailwinds that Dave will discuss in more detail. Let me conclude with an observation as to the journey the company has been on for the past five years. Despite a challenging macro backdrop, the company has experienced compound aggregate growth of 18% in adjusted EBITDA and improved margins by 270 basis points.

The cultural shift that started in 2018 has demonstrated the results we believe our company was capable of achieving. More importantly, our team is brimming with confidence and with the grit and determination to continue this strong double-digit growth over the next five years. Our leadership team and our physician partners are all aligned on the opportunity that this industry shift presents for our business and remain prepared and excited for the future. With that, let me turn the call over to Eric. Eric?

Eric Evans: Thanks, Wayne. And good morning, everyone. I will echo Wayne’s pleasure with our fourth quarter results as we continued our multiyear positive trajectory and execution that will extend into 2023 and beyond. Our continuously refined facility-level operating system supported by corporate growth leaders, empowers our physician partners to focus on delivering the best clinical care with the convenience and cost efficiency our patients expect, all while delivering strong financial results for all of our stakeholders. 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 155,000 surgical cases in the quarter, 7.3% more than last year.

On a same facility basis, net revenue grew by almost 11% in the fourth quarter. Our strong competitive position in the markets we serve, superior operational execution and broader macro tailwinds drove a healthy same-facility case growth of 4.3%, and our mix resulted in over 6% growth in revenue per case. Our organic growth initiatives, coupled with the acquisitions completed over this past year have translated into a very strong top line growth of nearly 16%. Dave will talk about this in more detail, but our adjusted EBITDA of $120.8 million for the quarter and $388.2 million for the year both represent new all-time highs for our company. Income recognized from CARES grants were not material in the fourth quarter or full year 2022 as they were in 2021.

When looking at results purely without grants, the company’s adjusted EBITDA grew by more than 20% in 2022. Our proactive, disciplined and data-driven approach has enabled us to closely monitor and react accordingly to inflationary impacts in labor and supply costs. On the labor front, in the fourth quarter, we experienced an overall reduction of premium labor as a percentage of salaries, wages and benefits in most of our markets with the overall utilization of premium labor abating, as is the contract labor rates that the market is demanding. As a reminder, premium labor represents approximately 3% of our total salaries, wages and benefits, and we continue to be an employer of choice in this fluid labor environment. Our favorable workplace environment allows us to recruit faster and is a key enabler to maintaining the high clinical quality and exceptional patient experience we are known for in the communities we serve.

When we do experience turnover in our facilities, we are able to fill the jobs posted in approximately 30 days on average. As it relates to supply costs, we continue to work with our group purchasing organization and key suppliers to mitigate inflationary risk factors that could impact our businesses. In the fourth quarter, supplies were approximately 27.1% of net revenue, 80 basis points better than the third quarter and 100 basis points lower than last year. At this point, we are not seeing any unusual large price increases in commodities, endpoint costs or deliveries, but we remain vigilant in managing this risk to have active initiatives underway to proactively address it. Moving on to our organic growth levers. We continue to benefit from our relentless focus on physician recruitment and targeted facility level and service line expansions.

As Wayne alluded to, these efforts contribute to higher overall revenue per case rates as well as generate the highest contribution margin for our portfolio. Our physician recruitment team has been meeting the increased demand for new physicians by targeting the highest quality physicians. As part of our value proposition to new recruits, we have demonstrated a unique ability to predictably consistently and cost-effectively staff our facilities with high-quality front office and clinical teams, and capabilities that often contrast with and separates us in the eyes of our physician partners from alternatives in our industry. In the fourth quarter, we added over 150 new physicians spanning our key specialties, bringing our 2022 total to nearly 575 new surgeons using our facilities.

Photo by Olga Guryanova on Unsplash

As Wayne highlighted, each of our recruiting cohorts continues to drive strong year-over-year growth, and we are encouraged by the strength of our current year recruiting class. As a point of reference, the average net revenue per physician in the 2022 cohort is already 53% more than the very strong 2021 cohort that we recruited last year. All of this has helped fuel our growth in MSK procedures, particularly total joint cases in our ASCs. We performed over 28,000 orthopedic procedures this quarter, almost 13% more than prior year. We do not see this growth slowing, nor are we seeing cases returning to the inpatient setting. And as we have discussed, we are preparing for the next wave of cardiac procedures that we expect to migrate to outpatient settings starting in earnest over the next 5 years.

With an increase in the share of orthopedic and cardiac procedures moving into lower cost, high-quality, short-stay surgical facilities, we are considering all options to capture our fair share, including sourcing and managing a robust M&A pipeline, as well as investments in robotic equipment, expanding existing facilities and leveraging our partnerships with value health and select health systems, as well as the ongoing development of de novo facilities. These investments often require minimal spend, are financed at the facility level and are only authorized when we determine that the ROI is strong in the near term. We look forward to updating you on the efforts to build upon hospital system partnerships as the year progresses. Our 2022 capital deployment of nearly $250 million for acquisitions exceeded our annual commitment of $200 million.

Since 2018, we have deployed $870 million on acquisitions with an average multiple of less than 8x earnings, expanding our footprints in California, Texas and New York. We have selectively optimized our portfolio to unlock capital for redeployment with high-growth, short-stay surgical assets. This approach to optimizing our portfolio will continue in 2023, but does introduce complications for us as we develop our projections for revenue growth, which is affected by both the timing of acquisitions and divestitures, as well as the number of facilities in which we purchased a consolidating interest versus a minority stake. Despite the timing-related projection challenges on revenue, the team continues to prioritize bottom line growth and adjusted EBITDA for both 2023 and our long-term future.

As Wayne mentioned, we continue to manage a robust pipeline of acquisition targets, and our approach to capital deployment will provide meaningful contributions to future earnings in 2023 and beyond. Our 2023 guidance that Wayne laid out and Dave will discuss in more detail shortly, prudently considers that we are still in a challenging macro environment and in a period of inflation that could pressure margins. As you can see from our results in 2022, we are confident we can effectively manage through these risks. Our teams are highly aligned, and we are executing on our initiatives across business development, recruiting, managed care, procurement, revenue cycle and operations to achieve our goals and continue to win in an increasing share of the rapidly shifting market.

In summary, I am proud of the team’s accomplishments this quarter and for the full year of 2022. 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 will turn the call over to Dave to provide additional color on our financial results as well as our 2023 outlook. Dave?

Dave Doherty: Thanks, Eric. I will first talk about our fourth quarter financial results and liquidity before providing detail on our outlook for 2023. Starting with the top line, we performed over 155,000 surgical cases in the fourth quarter, 7.3% more than the same period last year. These are only cases that are included in our consolidated revenue. But if I include cases performed at nonconsolidated facilities, we performed 182,000 cases. These cases spanned across all our specialties, with an increasing focus in orthopedics where we grew by 12.7% versus prior year. Largely attributed to this case growth, we saw revenues rise 15.9% over last year to $707 million. This growth is a combination of the organic growth factors Wayne and Eric described, and contributions from our current and prior year acquisitions in consolidated facilities.

As a reminder in 2022, many of our acquisitions were in non-consolidating facilities that provide us the opportunity to enhance performance through operational excellence and to buy up over time. So these acquisitions, we do not include their revenue in our consolidated net revenue. We will continue to be agnostic to the accounting treatment of the assets we acquired since our focus is to acquire high-growth, high-quality assets aligned with our targeted specialties at the most favorable multiple possible. On a same-facility basis, which we report on a day’s adjusted basis, total revenue increased 10.7% in the fourth quarter with case growth at 4.3%. Net revenue per case was 6.1% higher than last year, primarily driven by higher acuity procedures.

For the year, same-facility total revenue growth was 7.7%, with strong contributions from both volume and rate. Adjusted EBITDA was $120.8 million in the fourth quarter, giving us a margin of 17.1%. Adjusted EBITDA for the full year was $380.2 million with a 15% margin, in line with our expectations. Excluding the impact of income from CARES Act grants, margins expanded by 20 basis points in the fourth quarter and 80 basis points for the year. We continue to proactively manage inflationary pressures affecting our labor and supply costs. Although we are not immune, these factors were not material to the results we are reporting this morning. As Eric mentioned, our salaries, wages and benefit costs, as well as our medical supply costs, were both lower as a percentage of revenue compared to the fourth quarter of 2021, with 50 basis points of improvement in salaries, wages and benefits, and 100 basis points of improvement in supply costs.

Given the market dynamics, we will continue to carefully monitor these cost factors, proactively deploying cost mitigation tactics to help offset potential pressure. As you know, in late November we completed our primary equity offering that generated net cash proceeds of approximately $860 million. This transaction was immediately deleveraging, taking almost two turns off our ratio of total net debt to EBITDA. We utilized approximately $585 million of these proceeds to repay long-term debt and finalized the acquisition of Kansas Pine and Specialty Hospital, with the remaining proceeds included in our consolidated cash balance. These transactions resulted in a fourth quarter ratio of total net debt-to-EBITDA as calculated under the company’s credit agreement being 4.3x, a $40 million reduction to our annual cash interest cost, and the elimination of a springing maturity in our term loan that would have brought it due in 2025.

Further, to enhance our liquidity position in January, we worked with our banking syndicate, along with new members joining the syndicate to expand the borrowing capacity under our revolving credit facility, bringing the total capacity under that instrument to just over $550 million, which remains undrawn. We ended the quarter with $283 million of cash. As we enter 2023, our liquidity position is greater than $820 million, enhancing our confidence in our ability to navigate this current macroeconomic environment, and continue to fund accretive M&A. We reported negative free cash flows in the fourth quarter, which was due to the timing of spend on growth initiatives, a $20 million payment for the tax receivable agreement, $11 million for the payment of accrued interest in connection with the early retirement of portions of our long-term debt, and $9 million for deferred payroll tax payments.

For the year 2022, we generated negative free cash flow of $10 million, consistent with our expectations. With the exception of spend on growth initiatives, which we will isolate for you going forward, we do not expect these significant unusual outflows to impact our free cash flows in the future. We remain confident in our ability to deliver greater than $140 million in free cash flow in 2023, and lower net debt leverage as we progress to our target of mid 3x by the end of 2025. In 2022, excluding our de novo investments, we have deployed $246 million on 13 transactions at a sub 8 times multiple. These centers 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. Proceeds from any divestiture activity will be redeployed as incremental M&A, as we intend to sell certain assets at a relatively high multiple and then redeploy the capital at a relatively low multiple with stronger future growth prospects. While the timing of divestiture and related M&A activity can be challenging to predict, we believe our 2023 full year revenue outlook reflects our conservative view. On the debt front, we ended the year with less than $1.9 billion in gross debt at the corporate level. All of this debt is effectively fixed at 6.7% as a result of the favorable benefit of the interest rate swaps we entered into in prior years, leaving us with no exposure to incremental interest rate fluctuations.

In connection with the $150 million pay down of our term loan, in January we terminated the corresponding amount of our interest rate caps. We have no material debt maturing until 2026. With today’s interest rate environment, we are not exposed to significant rate risks, which is another factor, giving us confidence in our free cash flow growth. We are carrying the momentum of the strong finish to 2022 into 2023. And we are setting our initial guidance for 2023 adjusted EBITDA to greater than $425 million, representing 12% growth over 2022. On the top line, we expect 2023 revenue to be greater than $2.75 billion. We expect to deploy at least $200 million of capital on M&A, with additional spend depending on the timing of any portfolio management opportunities underway.

Our adjusted EBITDA and revenue guidance is informed by a balance of case growth and rate growth as a results of organic growth efforts from investments we’ve made in physician recruitment, revenue cycle, supply chain and managed care initiatives. The annualization of our 2022 acquisitions, in addition to projected 2023 acquisition activity and contributions from our in-process de novos, including the continued maturation of a community hospital we opened in Idaho during the pandemic. While we are optimistic about 2023 and these fundamentals that will be driving growth, we believe our initial adjusted EBITDA and revenue guide are prudent, given the macroeconomic environment and headwinds related to the elimination of government programs related to the pandemic, the end of sequestration, and the impact of further pressures from today’s economic environment.

We have been managing these headwinds for the past few years and remain confident our teams have the right line of sight to mitigate these risks, but feel it is appropriate at this time to remain prudently conservative in our guidance. 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 are projecting 2023 will have a seasonality pattern consistent with 2022, with first quarter adjusted EBITDA and revenue, representing an estimated 20% and 24%, respectively, of our full year guidance. We have stated for years now that we believe we have a powerful and unique business model that benefits from favorable organic trends, demographics and a fragmented marketplace that provides ample opportunity for consolidation.

Our 2022 results speak to the strength of our operations and our business model. And we believe that in 2023, we will 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. The first question comes from Jason Cassorla from Citigroup. Please proceed with your question, Jason.

Ben Rossi: Hey, good morning. Thanks for taking my question. You actually have Ben Rossi on here for Jason. So thinking about 2023 volumes, when looking at your guidance of $2.75 billion in revenue, how should we think about volume demand across your facilities in 2023? You previously suggested volume growth of about 2% to 3% on a normalized basis, but in the context of about 8% organic growth for 2022. Should we see some acceleration above that target for 2023? Are there some nuances that we should be mindful of, including a difficult comp?

Wayne DeVeydt: Hey, Ben, good morning, and thank you for the question. Let me start by saying we have always talked about the simplicity of the algorithm that we pursue, which is the 2% to 3% volume and 2% to 3% rate, which from a same-store basis, we’ve always concluded that would put us closer to the high end of that range, if not better. And as you know, in 2022, we exceeded that for the full year. And a big portion of that was the fact that our volume on a full year basis was closer to 3.9%. As we built our plans for the upcoming year, we will continue from an algorithm standpoint, remain conservative on our posture. But we do believe our outlook would support us being at the high end of that 2% to 3% in volume, if not better. Again, it’s early in the year. We’ll see how it progresses, but we are encouraged by what we’ve seen through January already.

Ben Rossi: Got it. Thank you. Just as a quick follow-up on demand for some of your value-based arrangements. Just turning to commercial contracting. Any color you can share on what you’re seeing in terms of demand for those value-based arrangements? And what are you seeing more from the managed care side or primary care practices?

Eric Evans: Yes. Appreciate the questions. This is Eric. I would say a couple of things. First of all, I always remind everyone we start to talk about value-based care that we are a value-based care player in the fee-for-service world. So just moving cases to our side of care tends to stay 40% to 60%. So before we start about anything else, I always why it might take risk when you can drive the savings that way? I would say that there’s continued interest. As you know, we have a partnership with Value Health. We have some facilities that are gaining traction in that area. It’s early innings, but I do believe there’s, again, continued interest. I do expect that over the next several years, you’re going to see more of our revenue flow through that.

That tends to be a good thing for us just because we are set to cost savings. It allows us and our physician partners to participate in the savings we create. So we were a natural catchers in it for whether that be payers that are interested in driving value-based care or whether that be, as you mentioned, large primary care groups or providers that are interested in that. We tend to be €“ because we are an independent pure-play kind of €“ sort of surgical provider, we tend to be the right hedges mid for that. So I would not say it’s overwhelming at the moment, but there’s a lot of interest and continues to be, I think, a slow steady migration.