Surgery Partners, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; quarterly figures below are for Q4 2016. The company operates ambulatory surgery centers, surgical hospitals, physician practices and related ancillary and optical services. At year-end it owned or operated 104 surgical facilities in 29 states and 56 physician practices.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $1,145.4 million | $959.9 million |
| Operating income / margin | $196.5 million / 17.2% | $144.8 million / 15.1% |
| Net income | $85.1 million | $72.8 million |
| Net income attributable to Surgery Partners, Inc. | $9.5 million; $0.20 diluted EPS | $1.4 million; $0.04 diluted EPS |
| Adjusted EBITDA | $179.3 million; 15.7% of revenue | $158.1 million; 16.5% of revenue |
| Cash from operating activities | $125.2 million | $84.5 million |
| Cash and working capital at year-end | $69.7 million / $175.2 million | $57.9 million / $129.7 million |
| Total debt, net of issuance costs and discounts | $1,442.2 million | $1,255.4 million |
Q4 2016 revenue was $306.0 million, compared with $263.3 million in Q4 2015. Q4 net income was $38.1 million, of which $16.9 million was attributable to Surgery Partners; diluted EPS was $0.35 versus $0.35 in Q4 2015.
FY 2016 revenue grew 19.3%, principally reflecting acquisitions. Same-facility cases rose 6.6% and revenue per case increased 5.2%. Surgical facility services generated $1,042.1 million in revenue and $214.2 million in segment Adjusted EBITDA; ancillary services generated $90.8 million and $12.7 million, respectively. Consolidated net income includes $75.6 million attributable to non-controlling interests, substantially reducing earnings attributable to the company’s shareholders.
Operating cash flow improved, while investing cash outflow was $184.7 million, including $146.4 million for acquisitions and $39.1 million for capital expenditures. Financing cash inflow was $71.3 million. Accounts receivable rose to $220.6 million net of a $29.9 million doubtful-account allowance; days sales outstanding increased to 70 from 60.
Material changes and unusual items
- Revenue increased 19.3% year over year; acquisitions were the primary stated driver. Cost of revenues rose to 71.7% of revenue from 69.7%, and Adjusted EBITDA margin declined to 15.7% from 16.5%.
- The company issued $400 million of 8.875% senior unsecured notes in March 2016 and used proceeds to repay the remaining second-lien debt. It also increased first-lien term debt by $80 million and reduced first-lien interest margins in September. Revolver availability was $61.9 million at year-end; the company reported compliance with debt covenants.
- FY 2016 included a $14.1 million litigation-settlement gain, $11.9 million debt-refinancing loss, $8.7 million merger and integration costs, and $5.1 million contingent acquisition compensation expense.
- The company recorded $7.1 million income tax expense in 2016, versus a $149.0 million tax benefit in 2015, when a valuation-allowance release materially affected results. The tax receivable agreement liability was $122.4 million; estimated total payments are approximately $123.3 million if associated tax benefits are realized, with about $1.0 million expected in 2017.
Outlook, risks and contingencies
The filing provides no specific revenue, earnings or cash-flow guidance. Management stated it believed liquidity was sufficient for the next 12 to 18 months, while continuing to assess financing alternatives, including debt reduction, maturity extensions and covenant changes. The company’s growth strategy emphasizes same-facility improvement, acquisitions, new facility development and expansion of ancillary services.
- Leverage and financing: Debt service, variable-rate exposure, restrictive covenants and access to subsidiary cash could constrain liquidity and acquisitions. A 100-basis-point LIBOR increase was estimated to raise annual interest expense by approximately $1.8 million.
- Reimbursement and regulation: Government payors represented 39.9% of consolidated-facility patient service revenue in 2016. Medicare/Medicaid payment changes, payor contracting, healthcare reform and complex fraud-and-abuse rules may affect results.
- Audit contingency: A Medicaid audit of an Idaho surgical hospital asserted approximately $4.7 million in overpayments and penalties. The company appealed and was awaiting the result.
- Reporting controls: Management and Ernst & Young identified a material weakness involving documentation of controls over revenue, accounts receivable and related allowances. Management concluded internal control over financial reporting was ineffective at December 31, 2016; the auditor issued an adverse ICFR opinion. The financial-statement audit opinion was unqualified, and no prior-period restatement was reported. Remediation was planned.
- Concentration and other risks: The Idaho Falls hospital represented 20% of revenue; Florida facilities represented 13% and Texas facilities 10% in 2016. Physician utilization, staffing costs, patient collections, acquisition integration, malpractice exposure, cybersecurity and possible goodwill impairment are additional risks. Goodwill was $1.56 billion; the 2016 annual impairment test found no impairment.
Investor facts to verify
- Whether the material weakness in revenue and receivables controls is remediated and whether subsequent filings report any control changes or restatements.
- Trends in days sales outstanding, receivables allowances and operating cash conversion, given DSO increased to 70 days.
- Progress on debt reduction, refinancing, variable-rate exposure, covenant headroom and the company’s stated 12–18 month liquidity assessment.
- The outcome and financial impact of the approximately $4.7 million Idaho Medicaid audit appeal and related acquisition litigation.
- Whether acquired businesses deliver expected returns and whether margins recover amid higher cost of revenues and lower Adjusted EBITDA margin.
- Actual timing and amount of tax receivable agreement payments and any impact on cash available for investment or debt service.