Surgery Partners, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended June 30, 2018. Surgery Partners operates surgical facilities and ancillary and optical services. At quarter-end, it owned or operated 124 facilities in 32 states: 106 ambulatory surgery centers and 18 surgical hospitals.
Comparisons with 2017 require caution: Bain’s change of control on August 31, 2017 led the company to apply pushdown accounting, so 2018 “Successor” and 2017 “Predecessor” financial statements have different accounting bases. Revenue growth also reflects the 2017 NSH acquisition.
Financial performance and liquidity
| Metric | Q2 2018 | Six months 2018 |
|---|---|---|
| Revenue | $444.8 million, up 54.2% year over year | $862.1 million, up 50.1% |
| Operating income / margin | $43.6 million / 9.8% | $84.7 million / 9.8% |
| Net income (consolidated) | $4.3 million | $9.4 million |
| Net loss attributable to Surgery Partners | $19.5 million | $37.0 million |
| Net loss per common share | $0.57 | $1.10 |
| Adjusted EBITDA (non-GAAP) | $55.4 million | $102.5 million |
For the six months, operating cash flow was $69.6 million, investing cash outflow was $54.8 million, and financing cash outflow was $93.7 million. Cash and cash equivalents were $96.1 million at June 30, down from $174.9 million at year-end 2017. Working capital was $176.0 million.
Total debt carrying value, including capital leases, was $2.176 billion; current maturities were $53.7 million. The company had $71.9 million available under its $75 million revolving facility, including the effect of outstanding letters of credit. Its debt included $1.274 billion in term loans, $408.0 million in 2021 notes bearing 8.875% interest, and $370.0 million in 2025 notes bearing 6.750% interest. A 100-basis-point increase in LIBOR was estimated to raise quarterly interest expense by about $3.3 million.
Material changes versus the prior period
- NSH contributed $146.4 million of Q2 revenue and $286.2 million for the six-month period; management identified the acquisition as the primary driver of reported revenue growth.
- Same-facility cases declined 1.4% in Q2 and 2.7% for six months, while revenue per case increased 4.5% and 4.1%, respectively.
- Cost of revenues rose to 76.5% of revenue in Q2 and 77.4% for six months, from 75.1% and 74.6%. Management cited higher supply costs associated with a higher-acuity case mix.
- Operating margin fell from 13.1% to 9.8% in Q2 and from 13.8% to 9.8% for six months. Higher transaction and integration costs, disposals, and other items affected results; management’s adjusted Q2 and six-month margins excluding specified items were 12.8% and 12.0%.
- Six-month interest expense increased 38.3% to $70.2 million, though as a share of revenue it declined to 8.1% from 8.8%.
Outlook, risks, contingencies, and unusual items
- Management said operating cash flow, available cash, and revolver capacity should be adequate for short-term liquidity needs. The filing provides no specific revenue or earnings guidance.
- A federal False Claims Act investigation is ongoing regarding the medical necessity of certain drug tests. CMS also suspended payments to the company’s Logan Laboratories pending further investigation. The company could not estimate the scope, duration, outcome, or potential loss.
- Disclosure controls were deemed ineffective because of material weaknesses in documentation of controls over revenue, accounts receivable and related allowances, and business combinations. Management reported remediation progress but said the weaknesses were not yet fully remediated.
- The Tax Act’s interest-deduction limitation and bonus depreciation accounting remained under evaluation. The company reported an estimated $46.3 million of disallowed interest expense and a $6.9 million valuation allowance on the related deferred tax asset.
- Other notable items included $16.7 million of six-month transaction and integration costs, including $4.5 million of estimated severance, and a $3.2 million net loss on disposals and deconsolidations. A stockholder lawsuit concerning the 2017 transactions remained pending; a motion to dismiss was scheduled for hearing in September 2018.
- Healthcare reimbursement, fraud-and-abuse, licensing, and other regulatory requirements pose ongoing risks. Management stated it was not aware of proceedings reasonably likely to have a material adverse effect, apart from the matters discussed in the filing.
Most important facts for investors to verify
- How much of revenue and Adjusted EBITDA growth reflects NSH acquisition effects versus underlying same-facility performance, particularly given declining case volumes.
- Whether cost pressures and lower reported operating margins persist, and how much reported profitability depends on non-GAAP adjustments.
- Debt service capacity, variable-rate exposure, cash use, and the availability of revolver capacity.
- Developments and financial exposure related to the drug-testing investigation and Logan Laboratories payment suspension.
- Progress in remediating material weaknesses and completing Tax Act accounting estimates.