Surgery Partners, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results. This is an annual report, not a standalone quarterly filing. Amounts are in U.S. dollars; 2017 comparisons combine predecessor and successor periods following Bain Capital’s 2017 change of control and pushdown accounting, so comparability is limited.
Business context
Surgery Partners operated or managed 123 surgical facilities across 31 states at year-end: 108 ambulatory surgery centers and 15 surgical hospitals. It held majority interests in 84 and consolidated 106. About 521,000 procedures were performed during 2018. Surgical facility services generated 95% of revenue; ancillary services and optical services made up most of the remainder. The 2017 NSH acquisition materially expanded the business.
Financial results and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $1.771 billion | $1.341 billion |
| Operating income | $77.8 million | $158.2 million |
| Net income (loss), consolidated | $(95.6) million | $28.7 million |
| Net loss attributable to Surgery Partners, Inc. | $(205.7) million | $(53.0) million |
| Adjusted EBITDA (non-GAAP) | $234.8 million; 13.3% of revenue | $164.3 million; 12.3% of revenue |
| Cash from operating activities | $144.6 million | $120.9 million |
Revenue increased 32.1%, primarily because NSH was included for all of 2018 versus four months in 2017, along with other acquisitions. On a pro forma same-facility basis, cases declined 0.8% to 542,335, while revenue per case rose 5.8% to $3,408. Cost of revenues increased to 76.9% of revenue from 75.6%, reflecting acquisitions and higher supply costs associated with higher-acuity cases. The company reported no separate 2018 provision for doubtful accounts after adopting a revenue standard that reclassified estimated uncollectible amounts as reductions to revenue; the adoption did not materially affect net income.
Fourth-quarter revenue was $491.2 million. Consolidated net loss was $107.1 million; net loss attributable to Surgery Partners, Inc. was $147.7 million, or $3.25 per share. The fourth quarter included substantial year-end charges, including goodwill impairment and the litigation-related accrual described below.
Year-end cash was $184.3 million and working capital was $239.0 million. Total debt, including capital leases, was $2.326 billion; long-term debt excluding current maturities was $2.271 billion. The $75 million revolving facility had $71.2 million available after letters of credit. The company stated it believed liquidity was sufficient for the next 12–18 months. Operating cash flow increased year over year; investing activities used $128.9 million, including $39.8 million for property and equipment and approximately $106.8 million net cash for acquisitions.
Material changes and unusual items
- FY2018 operating income fell to $77.8 million from $158.2 million despite higher revenue. Interest expense rose to $147.0 million from $117.7 million.
- The company recorded $74.4 million of non-cash goodwill impairment: $60.7 million in ancillary services and $13.7 million in the Alliance reporting unit. The surgical facilities reporting unit’s fair value remained substantially above carrying value, according to management.
- A $46.0 million litigation-related charge was recorded for a federal investigation into the medical necessity of certain drug tests. The company had a non-binding agreement in principle with DOJ on financial settlement terms; the matter remained unresolved, and additional losses were reasonably possible but not estimable.
- Disposals and deconsolidations produced a net loss of $31.8 million, including a $20.1 million loss on the disposal of six facilities and the optical laboratory. The company also incurred $31.7 million of transaction and integration costs.
- Acquisitions included five facilities in new markets, two in existing markets (one merged into an existing facility), and multiple physician practices, for approximately $106.4 million total investment. The company disposed of four surgery centers, two surgical hospitals, and its optical laboratory.
- Goodwill was $3.383 billion at year-end, a significant portion of the company’s $4.676 billion in total assets; future impairments remain possible if assumptions or performance deteriorate.
Debt, outlook, risks and contingencies
Debt included approximately $1.453 billion principal on variable-rate term loans, $400 million of 8.875% notes due 2021, and $370 million of 6.75% notes due 2025. The term loan is generally due in 2024, but could accelerate to October 2020 if at least half of the 2021 notes are not repaid or refinanced by the specified deadline. The company drew a $180 million incremental term loan in October 2018 to fund acquisitions and general corporate purposes. Management said it would explore financing alternatives to improve the capital structure, including reducing debt, extending maturities, or relaxing covenants; it gave no quantified operating guidance.
Variable-rate debt exposes the company to higher interest costs. A hypothetical 100-basis-point LIBOR increase was estimated to add about $14.6 million in annual interest expense. Interest-rate swaps covered $900 million notional at year-end. Other significant obligations include $812.5 million of future operating lease payments and an estimated $64.6 million of remaining tax receivable agreement payments. The 2021 notes, term loan maturity condition, covenants, and substantial leverage are material refinancing and liquidity risks.
Key operating and regulatory risks include changes to Medicare, Medicaid and commercial reimbursement; payor and procedure mix; physician relationships and recruitment; integration and acquisition execution; labor and supply costs; and healthcare fraud, self-referral, privacy and licensing rules. The federal drug-testing investigation is particularly important: payments to Logan Laboratories had been suspended pending investigation, and a possible resolution could include an OIG corporate integrity agreement and related costs. Other litigation and audit outcomes are uncertain. Bain Capital controlled approximately 67% of common stock at year-end; the company also had redeemable Series A preferred stock accruing dividends at 10% annually. Management reported that prior-year material weaknesses in revenue/receivables and acquisition valuation controls were remediated by year-end 2018; the auditor gave unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Progress, final terms and sufficiency of the $46 million reserve for the federal drug-testing investigation, including the laboratory payment suspension and any compliance obligations.
- Near-term refinancing or repayment plans for the $400 million 2021 notes and the resulting potential October 2020 term-loan maturity trigger.
- Cash generation, leverage and covenant headroom, especially if operating performance or reimbursement weakens.
- Underlying same-facility procedure trends and revenue per case, separating organic performance from acquisitions and changes in case mix.
- Potential further goodwill impairment, particularly in ancillary and optical-related businesses, and assumptions supporting reported valuations.
- Whether the stated 12–18-month liquidity outlook remains valid after debt service, preferred dividends, lease obligations, TRA payments and planned acquisitions.