Surgery Partners, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The company operates surgical facilities and related services; at quarter-end it owned or operated 103 facilities across 29 states and 51 physician practices. Results include significant non-controlling interests, so consolidated earnings differ from earnings attributable to Surgery Partners, Inc.
Financial performance and liquidity
| Metric | Q2 2016 | Six months 2016 |
|---|---|---|
| Revenue | $289.7 million, up 24.4% year over year | $556.8 million, up 21.8% |
| Operating income / margin | $50.9 million / 17.6% | $85.2 million / 15.3% |
| Net income, consolidated | $22.3 million | $32.6 million |
| Net income (loss) attributable to Surgery Partners, Inc. | $2.1 million | $(5.1) million |
| Adjusted EBITDA, non-GAAP | $46.0 million, versus $38.5 million | $84.5 million, versus $74.4 million |
| Net interest expense | $26.2 million | $48.4 million, versus $51.9 million |
Growth was driven primarily by acquisitions. Same-facility cases grew 7.9% in Q2 and 9.8% in the first half; revenue per case rose 6.4% and 4.1%, respectively. Q2 operating margin was flat year over year, while first-half margin declined from 17.4% to 15.3%. Management cited CMS laboratory rate reductions as a key pressure; cost of revenues rose to 72.8% of first-half revenue from 69.4%.
Cash from operations was $74.0 million for the first half, compared with $31.0 million a year earlier. Investing used $133.4 million, including $113.0 million for acquisitions and $20.4 million for property and equipment. Cash declined to $51.6 million from $57.9 million at year-end. Working capital was $134.5 million.
Total debt was $1.355 billion at June 30, compared with $1.255 billion at December 31, 2015. The company had $146.9 million available under its revolving facility, including letters of credit. Current maturities were $28.7 million. First-lien debt was $936.8 million and senior unsecured notes were $400 million. The company reported compliance with debt covenants.
Material changes and unusual items
- In March 2016, the company issued $400 million of senior unsecured notes due 2021 at 8.875% and used proceeds in part to repay the second-lien facility and revolving borrowings. Repayment of the second lien generated an $8.3 million refinancing loss, including a prepayment penalty and write-off of debt costs and discount.
- First-half acquisitions and related transactions totaled approximately $117.1 million, net of $16.6 million of contingent acquisition consideration. Acquisitions added $102.9 million to goodwill. Revenue growth and higher operating costs reflect acquisition activity.
- Q2 included $1.5 million of contingent acquisition compensation expense and a $1.3 million loss on disposal of long-lived assets. Merger and integration costs were $1.3 million in Q2 and $4.5 million in the first half.
- Accounts receivable, net, increased to $202.7 million from $177.8 million at year-end; the doubtful-account allowance increased to $25.2 million from $18.3 million. Days sales outstanding were 65, compared with 60 at year-end.
Outlook, risks and contingencies
Management said operating cash flow, available cash and revolver availability should cover short-term and longer-term liquidity needs. It gave no specific revenue or earnings guidance. Management expected a 41%–42% tax rate as a percentage of income after non-controlling interests, while noting that the rate may vary by period. A 100-basis-point increase in LIBOR was estimated to add approximately $1.1 million to quarterly interest expense.
Key disclosed risks include reimbursement changes and CMS payment cuts, payor mix and utilization, acquisition integration, physician relationships, healthcare regulation and compliance, and liabilities associated with acquired facilities. The company disclosed a Medicaid audit of an Idaho surgical hospital resulting in an approximately $4.7 million overpayment and penalty assessment; the company appealed and was awaiting the result. Management stated it knew of no legal proceeding expected to have a material adverse effect. The company also estimated approximately $119.9 million of potential Tax Receivable Agreement payments if related tax benefits are realized.
Important facts for investors to verify
- Whether acquisition-led growth translates into sustainable same-facility revenue and margin performance, particularly given CMS laboratory rate reductions.
- Debt-service capacity and refinancing exposure, including the 8.875% notes, variable-rate debt and the $1.1 million quarterly sensitivity to a 100-basis-point LIBOR increase.
- Cash conversion, receivables aging and the increase in the doubtful-account allowance and days sales outstanding.
- Outcome and potential financial impact of the Idaho Medicaid audit appeal, and any other billing or regulatory matters.
- Timing and actual cash cost of the Tax Receivable Agreement and contingent acquisition compensation.
- Adjusted EBITDA is a company-defined non-GAAP measure; assess its reconciliation and exclusions alongside GAAP earnings and operating cash flow.