Surgery Partners, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. The company operates surgical facilities and related physician and ancillary services; at quarter-end it owned or operated 101 surgical facilities in 29 states and 48 physician practices. Its financial statements consolidate facilities it controls, including income attributable to physician and other non-controlling owners.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 / prior balance |
|---|---|---|
| Revenue | $267.1 million | $224.1 million; up 19.2% |
| Operating income / margin | $34.3 million / 12.8% | $38.4 million / 17.1% |
| Net income | $10.4 million consolidated; $7.2 million net loss attributable to Surgery Partners, Inc. ($0.15 per share) | $10.5 million consolidated; $6.8 million attributable loss ($0.21 per share) |
| Net interest expense | $22.2 million | $25.8 million |
| Operating cash flow | $25.2 million | $9.5 million |
| Cash and working capital | $135.0 million cash; $211.1 million working capital | $57.9 million cash; $129.7 million working capital |
| Total debt, as reported | $1.356 billion | $1.255 billion |
Capital expenditures were $11.8 million and investing cash outflow was $18.9 million. Financing cash inflow was $70.7 million, bringing cash up $77.1 million during the quarter. The company reported $146.8 million of revolver availability, including outstanding letters of credit, and stated that operating cash flow, cash on hand and revolver capacity should meet short- and longer-term liquidity needs.
Revenue growth primarily reflected integration of 2015 acquisitions. Surgical facility revenue was $245.7 million; ancillary services revenue was $17.8 million. Management reported approximately 101,000 procedures in the quarter. Same-facility case growth was 11.6%, while revenue per case increased 1.5%. Government payors rose to 40.5% of consolidated-facility patient service revenue from 36.2%; private insurance declined to 50.5% from 55.9%.
Changes, financing and unusual items
- Reported operating margin fell to 12.8% from 17.1%. Excluding debt-extinguishment and merger/integration costs and asset-disposal gains or losses, management reported margins of 17.0% versus 19.4%.
- Management attributed the underlying margin decline principally to CMS laboratory rate reductions, which it said accounted for about 1.4 percentage points, and first-quarter fixed costs from expanding anesthesia services. It cited expected revenue enhancements and cost savings as ancillary services are integrated, but gave no quantified forecast.
- The quarter included an $8.3 million loss on debt refinancing and $3.2 million of merger transaction and integration costs. Adjusted EBITDA, a non-GAAP measure, was $38.4 million versus $36.0 million; management cautioned it is not a substitute for GAAP results or cash flows.
- On March 31, the company issued $400 million of 8.875% senior unsecured notes due 2021, repaid the remaining $252.8 million principal of its second-lien debt, and prepaid $126.5 million on its revolver. It also added an $80 million first-lien term loan for proposed acquisitions and corporate purposes. First-lien and revolver covenants were reported in compliance.
- Q1 acquisition activity included one surgical facility and two physician-practice transactions for approximately $7.7 million aggregate investment. After quarter-end, the company reported a $57.4 million Jacksonville-area acquisition plus $16.6 million in contingent future payments, a $3.6 million Sarasota practice acquisition, and a $16.6 million Symbion escrow funding and distribution.
Outlook, risks and contingencies
- Management expected its effective tax rate, measured against income after non-controlling interests, to be 41%–42% for the year, while noting quarter-to-quarter variation. The company estimated approximately $119.9 million of potential Tax Receivable Agreement payments if related tax benefits are realized; it generally owes pre-IPO holders 85% of qualifying tax savings.
- Key stated risks include Medicare and Medicaid reimbursement or regulatory changes, payor contracting and mix, physician relationships, acquisition integration, healthcare fraud-and-abuse and self-referral rules, malpractice and litigation, and the ability to realize tax attributes. Management reported no material changes to the prior annual report’s risk factors.
- A Medicaid Integrity Contractor audit of an Idaho surgical hospital alleged approximately $4.7 million in overpayments and penalties; the company appealed and was awaiting the result. Management said it was not aware of legal proceedings expected to have a material adverse effect. The company also disclosed ongoing exposure to claims and potential liabilities at acquired facilities.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It disclosed a $940,000 increase in patient service revenue from revisions to prior-year third-party settlement estimates.
Important facts for investors to verify
- Whether acquisition-led revenue and same-facility procedure growth can be sustained while operating margins recover from reimbursement pressure and anesthesia-related costs.
- The company’s actual debt and interest burden after the refinancing, including the 8.875% notes, first-lien borrowings, variable-rate exposure and available revolver capacity.
- The result and potential financial impact of the Idaho Medicaid audit appeal, and whether further audits or healthcare compliance matters arise.
- Whether the expected acquisition synergies and ancillary-service savings materialize, and how subsequent acquisitions affect cash flow, debt and reported results.
- The realizability of deferred tax assets and the timing and amount of Tax Receivable Agreement payments.