Surgery Partners, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2018. Surgery Partners operated 124 surgical facilities in 32 states, including 106 ambulatory surgery centers and 18 surgical hospitals, and ancillary and optical businesses. Comparisons with 2017 require caution: the NSH acquisition and pushdown accounting resulted in predecessor and successor periods with different accounting bases. Management’s MD&A combines the 2017 periods for comparison.
Financial results and liquidity
| Metric | Q3 2018 | Nine months 2018 |
|---|---|---|
| Revenue | $443.9 million, up 44.9% year over year | $1.306 billion, up 48.3% |
| Operating income / margin | $45.0 million / 10.1%; compared with a $1.6 million operating loss / (0.5%) in Q3 2017 | $129.7 million / 9.9%; compared with $77.9 million / 8.8% in 2017 |
| Net income (loss) attributable to Surgery Partners | $(21.0) million, compared with $(13.6) million | $(58.0) million, compared with $(20.8) million |
| Adjusted EBITDA | $59.0 million, compared with $23.2 million | $161.5 million, compared with $100.4 million |
| Operating cash flow | Not separately provided for the quarter | $99.1 million, compared with $66.5 million |
Q3 cost of revenues was 75.3% of revenue, down from 80.5%; nine-month cost of revenues was 76.7%, versus 76.6%. Revenue growth was primarily attributed to the NSH acquisition. Same-facility cases increased 0.9% in Q3 but declined 1.5% for the nine-month period; revenue per case rose 10.5% and 6.2%, respectively.
At September 30, cash and cash equivalents were $79.1 million, down from $174.9 million at year-end 2017. Working capital was $167.7 million, versus $260.2 million. Nine-month investing and financing cash flows were $(66.6) million and $(128.2) million, respectively. Total debt, including capital leases, was $2.173 billion; $60.5 million was available under the revolver. Management said cash from operations, available cash and revolver capacity should cover short-term liquidity needs.
Changes, outlook, risks and unusual items
- Growth chiefly reflects the NSH acquisition, not solely organic performance. Same-facility case volume was mixed, while revenue per case increased.
- Q3 included a $12.6 million net loss on disposals and deconsolidations and $7.1 million of transaction and integration costs. Nine-month figures included a $15.9 million disposal/deconsolidation loss and $23.8 million of transaction and integration costs, including corporate integration severance and office lease costs.
- Interest expense was $37.2 million in Q3 and $107.4 million for nine months. At quarter-end, $962.8 million of debt principal was variable-rate; management estimated a 100-basis-point LIBOR increase would add about $2.4 million to quarterly interest expense.
- The company reported a $5.8 million Q3 income tax expense and $10.9 million for nine months. Tax accounting remained incomplete for certain Tax Act provisions, including interest deductibility and bonus depreciation; $69.8 million of disallowed interest expense was provisionally estimated, with an $11.4 million valuation allowance recorded against the associated deferred tax asset.
- After quarter-end, the company drew a $180 million incremental term loan on October 23, 2018, and on October 31 acquired three surgery centers for $50 million using loan proceeds. It also entered into additional interest-rate swaps.
- A federal False Claims Act investigation concerning the medical necessity of certain drug tests remained ongoing; CMS had suspended payments to the company’s Logan Laboratories pending further investigation. The company could not estimate the potential loss or outcome.
- Disclosure controls were deemed ineffective because of material weaknesses in documentation of controls over revenue, receivables and allowances, and business combinations. Management reported remediation work was underway, but not complete.
- Other risks include healthcare billing and referral regulation, payor reimbursement and audit exposure, and pending stockholder litigation relating to prior transactions. The filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much reported revenue and Adjusted EBITDA growth reflects NSH and other acquisitions versus same-facility performance; assess the limitations of the non-GAAP measure.
- Cash generation, working-capital decline, debt maturities and interest-rate exposure, including the subsequent $180 million borrowing and center acquisition.
- Progress toward remediating the material weaknesses and whether the controls become effective.
- Developments in the drug-testing investigation and CMS payment suspension, including any measurable financial or operational impact.
- Final Tax Act accounting and any changes to tax assets, valuation allowances or interest deductions.