Surgery Partners, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited results. The company operates surgical facilities and ancillary services; at period-end it owned or operated 104 surgical facilities across 29 states and 53 physician practices.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $282.7 million | $239.6 million | $839.4 million | $696.6 million |
| Operating income | $42.8 million | $44.3 million | $128.1 million | $123.6 million |
| Net income | $14.3 million | $13.8 million | $47.0 million | $36.8 million |
| Net loss attributable to Surgery Partners | $(2.3) million | $(3.1) million | $(7.4) million | $(15.3) million |
| Adjusted EBITDA | $44.7 million | $39.9 million | $129.2 million | $114.3 million |
- Margins: Q3 operating margin fell to 15.2% from 18.5%; excluding specified refinancing, acquisition, integration, and asset-disposal items, management reported 17.8% versus 19.5%. Nine-month operating margin was 15.3% versus 17.7%. CMS laboratory rate reductions were cited as a principal pressure.
- Cash flow: Nine-month operating cash flow was $92.9 million, compared with $60.3 million. Investing cash outflow was $154.4 million, including $126.0 million for acquisitions and $28.4 million for property and equipment. Financing cash inflow was $58.8 million. Cash declined $2.7 million to $55.2 million.
- Debt and liquidity: Total debt was $1.387 billion, versus $1.255 billion at December 31, 2015. Working capital was $150.1 million. Revolver availability was $114.9 million, including letters of credit. The company reported compliance with debt covenants and believed cash, operating cash flow, and revolver availability would meet near- and longer-term needs.
- Other indicators: Accounts receivable, net, was $206.0 million; the allowance for doubtful accounts rose to $28.2 million from $18.3 million at year-end. Days sales outstanding was 67, compared with 60 at year-end.
Changes and business developments
- Revenue grew 18.0% in Q3 and 20.5% over nine months, primarily reflecting integration of 2015 and 2016 acquisitions. Same-facility cases grew 4.3% in Q3 and 7.8% over nine months; revenue per case rose 5.8% and 4.6%, respectively.
- Nine-month surgical facility revenue increased to $766.2 million from $643.9 million; ancillary revenue rose to $63.0 million from $41.6 million. Optical revenue declined to $10.2 million from $11.1 million.
- The company invested approximately $130.3 million, net of contingent acquisition consideration, in facility and practice acquisitions and related businesses. Goodwill increased by $123.8 million from acquisitions.
- In March, the company issued $400 million of 8.875% senior unsecured notes due 2021 and repaid its remaining second-lien debt. It also borrowed an additional $80 million under the first-lien facility. A September amendment reduced first-lien interest margins and resulted in a $3.6 million refinancing loss.
Outlook, commentary, and risks
- No full-year revenue or earnings guidance is provided. Management expected its effective tax rate to remain relatively consistent for the year, and estimated a 41%–42% rate measured against income after non-controlling interests, subject to interim-period variability.
- Management cited a finalized 1.9% net increase in ASC Medicare payment rates for 2017 and did not anticipate a material effect from that update.
- A Medicaid audit of one surgical hospital resulted in an asserted overpayment and penalty totaling approximately $4.7 million. The company appealed and was awaiting the outcome.
- The company estimated approximately $123.6 million of potential Tax Receivable Agreement payments if related tax benefits are realized. It recorded $3.7 million of TRA expense in the first nine months.
- Other key exposures include reimbursement and payor changes, healthcare regulation and fraud-and-abuse compliance, physician relationships, acquisition integration and legacy liabilities, malpractice claims, and interest-rate risk. Two hospitals without emergency rooms maintain patient-transfer protocols that the filing says may be interpreted as inconsistent with CMS policy.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to the risk factors in its 2015 Form 10-K.
Investor verification priorities
- Assess whether revenue and case growth persist without acquisition contributions, and monitor the decline in operating margins and the impact of CMS laboratory rate reductions.
- Review receivable aging, the higher doubtful-account allowance, and whether DSO returns toward prior levels.
- Verify debt-service capacity, refinancing terms, floating-rate exposure, and continued covenant compliance; a 100-basis-point LIBOR increase was estimated to raise quarterly interest expense by about $1.3 million.
- Track the appeal and potential cash impact of the $4.7 million Medicaid audit assessment.
- Monitor acquisition integration, contingent compensation obligations, and whether anticipated returns support the increased goodwill and debt.
- Evaluate realizability of tax assets and the timing and amount of potential TRA payments.