Surgery Partners, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Unaudited. Surgery Partners operates surgical facilities and ancillary services; at quarter-end it owned or operated 128 facilities in 31 states.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $452.0 million | $432.4 million | $1,314.2 million | $1,280.3 million |
| Operating income | $59.0 million | $45.0 million | $164.1 million | $129.7 million |
| Net income | $10.9 million | $2.0 million | $22.5 million | $11.5 million |
| Net loss attributable to common stockholders | $(24.8) million | $(29.2) million | $(82.0) million | $(81.9) million |
| Adjusted EBITDA | $62.2 million | $59.0 million | $174.2 million | $161.4 million |
- Q3 revenue increased 4.5%; patient service revenue rose 5.1%. Same-facility revenue grew 9.7%, reflecting 2.8% case growth and 6.7% growth in revenue per case. The quarter marked the fifth consecutive quarter of same-facility case growth.
- Q3 cost of revenues increased to $353.1 million, or 78.1% of revenue, from $334.3 million, or 77.3%. For the nine-month period, cost of revenues was 77.6% of revenue versus 78.2% a year earlier.
- Interest expense rose 22.8% in Q3 to $45.7 million and 25.0% over nine months to $134.1 million, principally reflecting additional term-loan borrowing and the 2027 notes issuance.
- Operating cash flow for the first nine months was $104.1 million, compared with $99.1 million. Investing cash outflow was $61.8 million, including $50.2 million of property and equipment purchases; financing cash outflow was $115.3 million. Cash and cash equivalents fell to $111.3 million from $184.3 million at year-end 2018.
Debt and liquidity
- Total debt carrying value was $2.454 billion, including $51.3 million of current maturities; long-term debt was $2.403 billion. Cash was $111.3 million.
- The company had $115.2 million available under its $120 million revolving credit facility, after letters of credit. Management stated operating cash flow, available cash and revolver capacity should meet short-term liquidity needs.
- In April 2019, the company issued $430 million of 10.0% senior unsecured notes due 2027 and redeemed its 8.875% notes due 2021, recording an $11.7 million extinguishment loss. The term loan matures in 2024; $370 million of 6.75% notes mature in 2025.
- Operating and finance lease liabilities totaled $470.7 million following adoption of the new lease accounting standard. The company reported $317.2 million of operating lease liabilities and $153.5 million of finance lease liabilities.
Changes, outlook and risks
- Nine-month revenue increased 2.6%, while operating income rose to $164.1 million from $129.7 million. Adjusted EBITDA grew to $174.2 million from $161.4 million. The company’s net loss attributable to common stockholders was broadly unchanged year over year.
- Lower transaction and integration costs and a $7.0 million net gain on disposals supported nine-month results. The gain included $10.9 million from selling real property. Offsetting items included higher interest expense, higher depreciation and amortization, and the $11.7 million debt-extinguishment loss.
- The company provided no specific financial guidance in the supplied filing text. Management emphasized same-facility growth, selective acquisitions, new facility development, and operational and revenue-improvement initiatives.
- A federal investigation concerns the medical necessity of certain drug tests and billing to company-owned laboratories; CMS suspended payments to Logan Laboratories pending investigation. The company reported a non-binding agreement in principle with DOJ on settlement financial terms and had reserved $46.0 million in 2018. It said additional losses are reasonably possible but cannot be estimated.
- Other risks include healthcare reimbursement and regulatory changes, physician-referral and anti-kickback rules, integration and execution risks, and interest-rate exposure. A 100-basis-point rate change was estimated to affect annual net earnings and cash flow by about $2.5 million. Interest-rate swaps had a $1.2 billion notional amount; $14.2 million was expected to be reclassified as increased interest expense over the next 12 months.
- The company adopted lease accounting on January 1, 2019, recognizing lease assets and liabilities; adoption produced an $18.0 million cumulative adjustment to retained deficit. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Progress, final terms and potential additional exposure from the DOJ/CMS investigation and settlement discussions.
- Whether same-facility case and revenue-per-case growth can continue, and how rising supply costs affect margins.
- Debt-service capacity and refinancing exposure, particularly given the 10.0% notes and higher interest expense.
- Cash conversion after capital spending, distributions to non-controlling holders and acquisition-related investment.
- Lease obligations, preferred stock claims and accrued cumulative preferred dividends; the Series A preferred stock redemption value was $385.7 million at quarter-end.