Surgery Partners, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Surgery Partners operates surgical facilities and ancillary services; at quarter-end it owned or operated 128 facilities in 31 states, including 113 ambulatory surgery centers and 15 surgical hospitals.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $445.4m | $436.6m | $862.2m | $847.9m |
| Operating income | $55.5m | $43.5m | $105.1m | $84.7m |
| Net income | $8.1m | $4.3m | $11.6m | $9.4m |
| Net loss attributable to Surgery Partners | $(19.8)m | $(19.5)m | $(39.9)m | $(37.0)m |
| Net loss attributable to common stockholders | $(28.6)m | $(27.4)m | $(57.2)m | $(52.7)m |
| Adjusted EBITDA | $61.2m | $55.4m | $112.0m | $102.5m |
| Net interest expense | $46.4m | $35.9m | $88.4m | $70.2m |
Q2 revenue increased 2.0%; same-facility revenue grew 7.9%, reflecting 5.9% higher revenue per case and 2.0% case growth. For the first half, revenue increased 1.7%; same-facility revenue grew 7.3% on a days-adjusted basis. Management said adoption of the revenue-recognition standard reduced reported revenue by $7.4m in Q2 2019 and $8.2m in Q2 2018.
Q2 cost of revenue was 76.4% of revenue versus 77.9% a year earlier; first-half cost of revenue was 77.3% versus 78.7%. Lower cost ratios and reduced general and administrative costs supported operating-income and Adjusted EBITDA growth. Adjusted EBITDA is a non-GAAP measure and should not be viewed as a substitute for GAAP results.
Cash flow, debt and liquidity
- Cash and cash equivalents were $117.4m at June 30, 2019, down from $184.3m at year-end 2018. First-half operating cash flow was $47.2m, versus $69.6m; management attributed the decline primarily to timing of payroll and trade-payable payments.
- First-half investing cash outflow was $42.9m, including $31.8m of capital spending. Financing cash outflow was $71.2m, including $60.9m of distributions to non-controlling holders. Cash, cash equivalents and restricted cash decreased $66.9m during the half.
- Total debt carrying value was $2.455bn, compared with $2.327bn at December 31, 2018. Current maturities were $57.3m. The company reported $115.9m available under its revolving facility, after $4.1m of letters of credit. Management believed cash, operating cash flow and revolver availability would cover short-term liquidity needs.
- In April, the company issued $430m of 10.0% senior unsecured notes due 2027 and redeemed all $406.7m of 2021 notes, recording an $11.7m extinguishment loss. Interest expense rose 29.2% in Q2 and 25.9% for the first half, primarily reflecting additional borrowings.
- Interest-rate swaps had a $1.2bn notional amount. Management estimated a 100-basis-point rate change would affect annual net earnings and cash flow by approximately $2.5m.
Material changes, outlook and risks
- Management highlighted ongoing priorities to improve same-facility performance, selectively acquire established facilities, develop new facilities, and pursue efficiency, procurement and revenue-cycle initiatives. No specific full-year financial guidance was provided in the filing.
- First-half acquisitions included a surgical facility and physician practice for $13.2m net cash, and a $14.0m investment in non-controlling interests in four facilities. A real-property disposal generated a $10.9m pretax gain; the company reported a $7.6m net gain on disposals and deconsolidations for the half.
- Adoption of the lease standard added $285.0m of operating lease assets and $289.9m of operating lease liabilities at June 30. This accounting change affects balance-sheet comparability with prior periods.
- A federal False Claims Act investigation concerns the medical necessity of certain drug tests. CMS had suspended payments to the company’s Logan Laboratories pending investigation. The company reported a non-binding agreement in principle with DOJ on settlement financial terms and said the $46.0m reserve recorded in 2018 was believed sufficient, but additional losses are reasonably possible and cannot be estimated; settlement timing and terms remain uncertain.
- Other disclosed exposures include healthcare regulatory compliance, professional and general liability claims, acquired-facility liabilities, and ongoing derivative stockholder litigation. Management reported no material change in the risk factors from its 2018 Form 10-K. Disclosure controls were concluded to be effective.
Key facts for investors to verify
- Whether same-facility growth and cost-ratio improvements persist, and how much reported growth reflects volume, pricing or portfolio changes.
- Debt and interest burden, including the 10.0% notes, variable-rate exposure, and the effect of refinancing on future cash flows.
- Cash conversion, distributions to non-controlling holders, capital expenditure needs and actual revolver availability.
- Resolution and final cost of the federal investigation, the adequacy of the $46.0m reserve, and the status of Logan Laboratories’ suspended payments.
- Lease obligations and the distinction between accounting changes and changes in underlying financing commitments.
- Adjusted EBITDA reconciliation and the extent to which gains, transaction costs and other exclusions affect the non-GAAP measure.