Surgery Partners, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2018. Surgery Partners operated 125 surgical facilities across 32 states (107 ambulatory surgery centers and 18 surgical hospitals), alongside physician practices and ancillary services. It consolidated 108 facilities and performed approximately 125,000 procedures during the quarter.
Comparability is limited: the August 2017 change of control and NSH acquisition led to pushdown accounting, so Q1 2018 “Successor” results and Q1 2017 “Predecessor” results use different accounting bases. The 2018 period also includes NSH for a full quarter; reported year-over-year growth is not a like-for-like comparison.
Financial results and key metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $417.4 million | $286.2 million |
| Operating income / margin | $41.2 million / 9.9% | $41.7 million / 14.6% |
| Consolidated net income | $5.1 million | $14.4 million |
| Net loss attributable to Surgery Partners | $17.5 million | $2.8 million |
| Net loss attributable to common stockholders / diluted loss per share | $25.3 million / $0.53 | $2.8 million / $0.06 |
| Adjusted EBITDA (non-GAAP) | $47.1 million | $40.1 million |
| Cash provided by operating activities | $30.1 million | $34.9 million |
Revenue rose 45.8%, primarily from NSH, which contributed $139.8 million of patient service revenue. Excluding NSH, patient service revenue fell $10.7 million, or 3.8%, partly due to weaker ancillary services and revenue-policy adjustments. Same-facility cases declined 4.1%, while revenue per case increased 3.8% to $3,318.
Cost of revenues increased to 78.4% of revenue from 74.1%; management cited higher supply costs associated with a higher-acuity case mix. Operating margin declined; excluding merger/integration costs and contingent acquisition compensation, management reported an adjusted operating margin of 11.2% versus 15.8% a year earlier. Net interest expense increased to $34.3 million from $25.2 million, reflecting the 2025 notes and refinancing. Adjusted EBITDA is a company-defined non-GAAP measure and includes adjustments; it should not be treated as a substitute for GAAP earnings or cash flow.
At March 31, cash and cash equivalents were $112.8 million, down from $174.9 million at year-end. Working capital was $204.8 million, versus $260.2 million at December 31. Operating cash flow was $30.1 million; investing cash use was $36.4 million, including $25.6 million for acquisitions and $10.0 million for capital expenditures; financing cash use was $55.7 million, including debt repayments, distributions to non-controlling holders and preferred dividends.
Total debt was $2.177 billion, including $2.122 billion of long-term debt; the revolving facility was undrawn, with $71.9 million available after letters of credit. The company reported covenant compliance. Management said cash, operating cash flow and revolver availability should meet short-term liquidity needs. The term loan bears variable interest; the filing estimates a 100-basis-point LIBOR increase would add about $3.3 million to quarterly interest expense.
Material changes, outlook, and risks
- Q1 acquisitions included two surgical facilities and a physician practice for approximately $25.6 million. On May 1, 2018, the company acquired a physician practice with five locations and three ASCs for $21.3 million.
- Series A preferred stock carries a 10% compounding dividend. Q1 preferred dividends accrued were $7.8 million; $3.9 million was paid in cash. Preferred claims affect amounts attributable to common stockholders.
- No quantified earnings or revenue guidance was provided. Management emphasized same-facility improvement, selective acquisitions and development, and stated its expectation that available liquidity would cover near-term needs.
- A federal False Claims Act civil investigative demand seeks information dating to 2010 concerning medical necessity of certain drug tests submitted to company-owned laboratories. The company said it had responded and would cooperate. A stockholder suit related to the 2017 transactions seeks damages; defendants moved to dismiss.
- Healthcare reimbursement, Medicare/Medicaid audits, licensing and physician-referral regulations are significant risks. The filing also discusses an estimated $24.9 million of Q1 interest expense disallowed under the new tax limitation and a $2.9 million tax-effected valuation allowance.
- Management reported disclosure controls were not effective because of material weaknesses in documentation of controls over revenue, receivables and related allowances, and business combinations. Remediation was underway but not complete.
Important facts for investors to verify
- How much reported growth reflects NSH and other acquisitions versus sustainable same-facility volume and pricing; particularly the decline in same-facility cases.
- Whether margins and operating cash flow improve as integration costs, supply pressures and higher interest expense affect results.
- Debt refinancing and maturity exposure, variable-rate interest sensitivity, revolver availability and continued covenant compliance.
- Developments in the drug-testing investigation, transaction-related litigation, and any resulting financial or operational exposure.
- Progress in remediating the disclosed control weaknesses and the effect of tax-law changes, preferred dividends and the tax receivable agreement on cash available to common stockholders.