Surgery Partners, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; filed May 10, 2017. Surgery Partners operated surgical facilities and related services across 29 states. At quarter-end it owned or operated 104 surgical facilities (99 ASCs and five surgical hospitals) and 56 physician practices. Approximately 109,000 procedures were performed during the quarter.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $286.2 million | $267.1 million; up 7.2% |
| Operating income / margin | $41.7 million / 14.6% | $34.3 million / 12.8% |
| Adjusted EBITDA | $40.1 million | $38.4 million |
| Net income | $14.4 million | $10.4 million |
| Net loss attributable to Surgery Partners | $2.8 million; loss per share $0.06 | $7.2 million; loss per share $0.15 |
| Net cash from operating activities | $34.9 million | $25.2 million |
| Cash and cash equivalents | $56.0 million at March 31 | $69.7 million at December 31, 2016 |
| Total debt | $1.425 billion | $1.442 billion at December 31, 2016 |
Patient service revenue rose 7.7%, largely reflecting integration of acquisitions completed after Q1 2016. Same-facility case growth was 2.1%; revenue per case increased 5.6%. Surgical facility services generated $258.1 million of revenue and $48.2 million of segment Adjusted EBITDA. Ancillary services revenue was $25.2 million; optical services revenue was $2.8 million.
Cost of revenue increased to 74.1% of revenue from 73.7%. Management attributed lower adjusted operating margin year over year (15.8% in Q1 2017 versus 17.0% in Q1 2016, excluding specified items) primarily to higher supply costs associated with higher-acuity procedures. Interest expense increased to $25.2 million from $22.2 million, reflecting the 2016 debt refinancing. Working capital was $153.6 million, down from $175.2 million at year-end. Cash used in investing was $6.6 million, including $6.4 million of property and equipment purchases; cash used in financing was $42.0 million, including debt repayments and distributions to non-controlling holders.
Debt, outlook, and material developments
- Debt included $929.6 million under the First Lien Credit Agreement, $400 million of 8.875% senior unsecured notes due 2021, and $69 million drawn on the revolver. Revolver availability was $77.9 million, including letters of credit. The company reported compliance with applicable debt covenants.
- Management said operating cash flow, cash on hand, and revolver availability should meet short-term needs (12 months or less) and longer-term needs (less than five years). It expected a full-year effective tax rate of 41%–42% measured against income after non-controlling interests; the Q1 rate on pretax income was 12.8%.
- On April 20, 2017, the company settled litigation concerning contingent consideration from a 2009 acquisition and expected to record a $3.9 million gain in Q2.
- On May 9, 2017, the company agreed to acquire NSH Holdco for approximately $760 million and entered into related preferred-stock and controlling-stockholder sale agreements. The disclosed transaction contemplated BCPE Seminole Holdings becoming the controlling stockholder; completion and financing details are not established by this filing.
- Healthcare exposure includes reimbursement changes, Medicare and Medicaid audits, physician referral and ownership rules, licensing, and other regulatory requirements. A Medicaid audit of an Idaho hospital resulted in an approximately $4.7 million alleged overpayment and penalty; the company appealed and was awaiting the result.
- Management disclosed a material weakness in internal control over financial reporting related to documentation of certain revenue, accounts receivable, and allowance controls. Remediation was underway but was not yet considered complete. Disclosure controls were assessed as effective.
- A 100-basis-point LIBOR increase was estimated to increase quarterly interest expense by approximately $2.3 million. The company had $915.4 million of variable-rate debt at quarter-end.
- The company noted the potential for healthcare-law violations, malpractice claims, and acquired-facility liabilities; it said it was not aware of legal proceedings expected to have a material adverse effect.
Key investor verification points
- Track acquisition-related revenue and costs, same-facility volumes, revenue per case, and supply expense to assess underlying growth and margin trends.
- Review cash conversion, debt reduction, revolver availability, interest-rate sensitivity, and the ability to service the substantial debt load.
- Confirm status, purchase financing, approvals, and final terms of the proposed NSH acquisition and related ownership transactions.
- Follow the Idaho Medicaid audit appeal and assess potential outcomes; check for developments in other audits and reimbursement matters.
- Monitor remediation and testing of the material weakness, particularly controls over revenue, receivables, and allowances.
- Evaluate the company’s non-GAAP Adjusted EBITDA alongside GAAP earnings and cash flows; its definition excludes significant costs and may not be comparable across companies.
- Verify the expected Q2 recognition and cash collection of the $3.9 million litigation settlement and consider the ongoing tax receivable agreement liability, estimated at approximately $123.4 million if related tax benefits are realized.