Greetings, and welcome to the Surgery Partners, Inc. 1st Quarter 2018 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. Tom Cowley, Chief Financial Officer. Please go ahead.
Good morning, and welcome to Surgery Partners' Q1 2018 earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today is Wayne DeBite, Surgery Partners' Chief Executive Officer. As a reminder, during this call, we will make forward looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we file with the SEC.
The company does not undertake any duty to update such forward looking statements. Additionally, during today's call, the company will discuss certain non GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these measures can be found in our earnings release, which is posted on our website at surgerypartners.com and in our most recent quarterly report when filed. With that, I'll turn the call over to Wayne.
Wayne? Good morning. Thank you, Tom, and thank you all for joining us today. I'm pleased to update you on the progress we have made at Surgery Partners as we continue to position the company for the significant growth opportunities we see ahead. Before I begin, let me start by reiterating my excitement to be joining Surgery Partners at this unique time in its history.
I continue to be impressed with our surgical footprint and our ability to have a positive influence on the healthcare ecosystem and overall cost to consumers. Having visited several of our facilities in the Q1, I've been able to see firsthand the efforts of our associates and physician partners to put our patients first by making quality and patient safety the core of what we do each and every day. I've also been able to observe and reinforce my original thesis around the strength of the surgical facility assets we own and operate and the power of our independence as we look to align with payers, including both state and federal governments to remove inappropriate and unnecessary costs from the healthcare system. It is incumbent on us to help protect the integrity of the healthcare system, while improving on the sustainability of the system. As I've said before, we are on the right side of the cost equation and fully aligned with the goals and objectives of consumers, physicians and payers.
I'm going to start with some highlights from the quarter and review the progress we've made in aligning our strategy and structure in my first 100 days as CEO. I'll then provide an update on the medium and longer term value creation opportunities we discussed last quarter. And finally, I'll turn the call over to Tom to discuss the financial results in greater detail. Starting with the quarter. This morning, we reported Q1 2018 revenues of $417,400,000 and adjusted EBITDA of 47,100,000 dollars Operating results in the quarter were characterized by strong year over year revenue and surgical case growth as well as continuing investments in our infrastructure as we position our company for 2019 beyond.
We're excited about the early progress we've achieved across our strategic initiatives and remain confident that they will have a positive impact on the business in both 2018 and beyond. However, at this early stage in the year, we are maintaining our current revenue and adjusted EBITDA guidance of greater than $1,750,000,000 $240,000,000 respectively. Since we spoke 2 months ago on our Q4 earnings call, I've spent much of my time engaging with our leadership team across the enterprise to better understand the challenges and opportunities for surgery partners as we execute on our growth strategy. In addition, we began an assessment of our assets and opportunities with an eye towards improved performance. I would like to share some perspectives from these assessments and changes we've begun to implement to our organizational design.
First, our senior management composition changed during the quarter with several new members joining the team. Specifically, Tom Cowhey joined as Chief Financial Officer, David Kretzmer joined as Head of Strategy and Transformation, and Doctor. Angela Justice is now leading our enterprise human resource functions. While this is Tom's first earnings call as part of our team, Tom joins us after over a decade at Aetna, where he was the CFO for Aetna's largest operating unit, including all of Aetna's domestic health plan business, and he previously held roles leading Investor Relations, Corporate Development, Treasury and Integration. I'm excited to leverage his financial expertise, discipline and broad experience to help drive out our next phase of growth.
We also made excellent progress this quarter in filling out our leadership teams in procurement and revenue cycle management, critical areas as we execute on our integration and growth plans. These strong additions to our leadership team are a critical step in enhancing the culture of execution and excellence that should be expected of a company with the national reach of surgery partners. Further advancing our human capital and organizational efforts, we recently consolidated our enterprise functions under these key leaders to advance agility and efficiency in our shared service operations in support of our P and L leaders. As a team, we are now beginning the process of evaluating the next level of our operational structure for further efficiencies and realignment, a process we expect to complete early in Q3. Along with our governance, executive and operational realignment, we're also moving to deeply instill a purpose driven culture based on transparency, execution and accountability.
Our culture will embed the expected behaviors where an associate can act to support our patients, physician partners and other constituents with consistency and discipline as we begin to capture the value of our surgical facility platform. With our enterprise shared service executive leadership team in place, we are now reviewing our operational structure and next tier of leadership to ensure we best align those teams to support our strategic and financial goals. In addition to rebuilding our team and realigning our structure, we've also begun to shift our strategic positioning for 2019 and beyond. We recently engaged in a data driven strategic assessment of the opportunities and challenges across our portfolio of businesses. As stated previously, this assessment has only reinforced my view that Surgery Partners has the key assets to win in the market, while also highlighting our need to improve performance in a number of areas.
I would like to take a moment to discuss some of the larger strategic questions that we are addressing within our portfolio of businesses. 1st, we strive to be the preferred national partner for operating short stay surgical facilities across the United States. Operating short stay surgical facilities is the core competency for Surgery Partners and we believe we have the right people, processes and assets to continue to be a leader in this dynamic and growing sector. We are uniquely positioned in the industry as payers and providers continue to shift more procedures to the high quality, low cost setting that our surgical facilities provide, specifically in orthopedics, including total joint and spine procedures, ophthalmology, pain and GI. These practice areas represent core strengths upon which we will grow and we've begun the process of pruning those assets that are not aligned with our long term growth strategy.
We recently completed some smaller scale divestitures based on geographical relevance and are now engaged in a process to determine the best next steps for certain non surgical businesses. While such pruning may pressure our short term adjusted EBITDA goals, we believe these actions will allow us to redeploy capital and refocus management on long term value creation. As an example, we discussed the importance of being focused on the right deals and our goal to deploy between $80,000,000 $100,000,000 of capital per year related to mergers and acquisitions at prevailing industry multiples. We've rebuilt the pipeline of opportunities and late in the Q1, we closed a transaction in Omaha, Nebraska of an ASC focused on the orthopedic, spine, podiatry and pain specialties. In addition, we have several signed letters of intent in our pipeline with assets that are aligned with our long term growth goals, increasing our confidence that we can achieve our stated capital deployment goals this year.
Moving to organic growth and margin expansion, we discussed on our previous call the need to increase our efforts around physician recruitment and retention, revenue cycle management and procurement. I would like to provide you with a brief update on each of these initiatives and some of our early results. Regarding physician recruitment, we've begun the process of doubling the physician recruitment team and are already beginning to see some early benefits from our efforts. Specifically, we've already organically added over 100 new physicians that will begin using our surgical facilities in 2018. More importantly, we are using data to identify physicians in both specialties and geographies where we want to focus our growth.
While the process to rebuild our physician recruitment pipeline will take time to mature and demonstrate financial impact, we are encouraged by our early results. Turning to revenue cycle management. We previously discussed the need to leverage our national scale and expanded footprint resulting from the NSH acquisition and began to consolidate the over 100 different vendor relationships, tools, applications and outsourcing, all which have led to increased cost and complexity. It is important for our long term success to be able to make data driven decisions and result the limited transparency that exists today related to revenue cycle management. To this end, we are initially focusing our efforts on our shared services center in Tampa, Florida, which currently performs revenue cycle management for approximately 25% of our ASCs and 80% of our practice locations.
By the end of 2Q, we will have begun the process of rolling out a new front end tool to reduce errors at patient registration, including improving patient eligibility and pre authorization rates, which should lead to fewer payer denials. This tool will also improve the estimated patient portion of the final charges, allowing us to more proactively collect at the point of service, which reduces both future collection costs and collection risk. Finally, we're moving to a single claims clearinghouse, which will give us consistent insights into payer claims performance and denials, allowing us to improve our front end processes to preempt reimbursement leakage. We've already seen improvement in many of our operating statistics at our Tampa facility, which we believe can serve as a longer term model for all our future revenue cycle management efforts. We anticipate incremental cost savings and operating synergies during 2018 with more material benefits being realized in 2019 as we implement these efforts across additional facilities.
On the procurement front, as previously highlighted, we hired a full time procurement officer and have begun the process of investing in a purchasing system to improve data analytics. We previously identified approximately $15,000,000 in gross opportunities with more than half accruing to adjusted EBITDA and benefiting Surgery Partners' shareholders. To date, we've initiated discussions with our top 20 suppliers along with consolidating our $200 plus 1,000,000 spend into a new group purchasing organization contract that will take effect in the Q3 of this year. On our top 20 non GPO contracts, we've already renegotiated approximately 15% of the contracts and expect to continue to make positive progress with the remaining vendors as the year progresses. Based on these early results, our confidence in achieving our $15,000,000 gross procurement savings goal is high.
As a reminder, while these benefits are being negotiated and partially realized throughout the year, the majority of these benefits will be realized in 2019. Lastly, our team believes that aligning with payers is critical and will support and drive objectives. Our shared emphasis on patient safety and cost efficiency provides a great platform for future partnerships with the payer community. We are taking a thoughtful approach and have begun to look for opportunities with those payers with whom we choose to partner and to identify locations and models which support both organic and inorganic growth. Based on early discussions, it is clear to me that the short stay surgical facility space is a key and rapidly emerging part of the healthcare ecosystem.
Because we are on the right side of the cost equation, we are fully in line with the goals and objectives of the payer community. As you can see, we have a lot to do over the remainder of the year. The actions we need to take are not unique or difficult. They simply require focus and execution. However, coming out of my initial 100 day assessment, extremely encouraged and confident that we have the right assets and the right opportunities in place to achieve our outlined objectives and drive growth and value for all stakeholders going forward.
With that, let me hand the call back over to Tom for an introduction and overview of our Q1 financial results. Tom? Thank you, Wayne, and good morning, everyone. I'd like to start off by echoing Wayne's comments about my excitement of being here at Surgery Partners. As the largest independent operator of short stay surgical facilities, I think that Surgery Partners has a unique opportunity to improve the efficiency and quality of the healthcare system and create value for all of our constituents.
I'm optimistic that our strategic initiatives will unlock the long term value in Surgery Partners' assets, and I'm excited to be part of the team that will deliver those results. With that, I'll turn to our Q1 2018 financial performance, starting with some of our key revenue drivers, then moving on to adjusted EBITDA, cash flows and finishing with our 2018 outlook. Our first quarter revenue of $417,400,000 reflects a 46% increase over the prior year quarter, primarily as a result of the acquisition of National Surgical Hospital in the Q3 of 2017. Surgical cases also increased to approximately 125,000, nearly a 15% increase as compared to the prior year quarter. On a same store basis, the company revenue total company revenue was down slightly, a result of a 3.8% increase in net revenue per case, offset by a 4.1% decrease in case volume.
Note that consistent with past practice, our same store calculations are inclusive of revenues associated with our ancillary services business, which experienced declining revenue as compared to the prior year period and influenced our same store revenue growth metrics. Let me take a moment to address some of the dynamics that are impacting our surgical case volume. In the quarter, we saw some softness in case volume, primarily related to high volume lower revenue procedures. As an example, we had 11 of our facilities closed for a total of 19 days this past quarter as a result of severe weather in the Northeast with additional volume softness on the reopening of those facilities. We estimate this weather related impact reduced case volume by over 900 procedures in the quarter, with minimal impact to net revenues due to the nature of the cases involved.
Further, while flu related delays and cancellations are hard to quantify, we also believe this dynamic impacted volumes inside the quarter. We also experienced lower surgical case volume from commercial payers in the Q1, a typical dynamic at the beginning of the year as higher deductible plans encourage consumers to perform discretionary procedures in latter parts of the calendar year. Our early read on April would suggest that same store surgical volumes have started to recover back into the low to mid single digit percentage growth range. Additionally, as Wayne previously discussed, we are in the process of improving our organic physician recruitment, which we expect will have a greater impact later in the year. Turning to our ancillary services business, revenue declined approximately $5,000,000 in the Q1 as compared to the prior year period, partially driven by dynamics in our lab business.
Throughout the back half of twenty seventeen and this is the early part of 2018, we have been migrating our out of network lab services into commercial networks, a process that is substantially complete. While this puts short term pressure on revenue and operating earnings, we believe it is aligned with our longer term strategy of being on the right side of the cost equation and partnering with payers in driving costs out of the healthcare system. Turning to operating earnings. Our Q1 2018 adjusted EBITDA was $47,100,000 a 17.4% increase over the comparable period in 2017, again primarily a result of the addition of business of approximately $2,500,000 partially driven by the lab pressures I previously discussed. Our adjusted EBITDA margin declined to 11.3% from 14% of revenue as compared to the Q1 of last year.
Consistent with our discussion last quarter, the decline in margins was primarily driven by an increase in our medical supply and implant costs, driven by higher acuity cases, but was also impacted by the year over year decline in our ancillary services margins. As Wayne highlighted, we are also making substantial investments in our infrastructure, including human capital. These investments put short term pressure on operating earnings and margins, but we'll begin to pay dividends in the back half of the year and into 2019 beyond. We continue to have confidence in our ability to recognize the synergistic benefits of the NSH acquisition and are focused on obtaining long term sustainable benefits as highlighted in our revenue cycle management and procurement work. Finally, we undertook an effort this quarter to evaluate our contractual adjustments and other balances to continue to apply consistent policies across our combined businesses.
As a result, we strengthened reserve balances at March 31, a portion of which was recorded in pre acquisition periods and the remainder of which approximately $4,800,000 was recorded this quarter. As detailed in our reconciliation, we have excluded these adjustments from our adjusted EBITDA presentation. Moving on to cash flow and liquidity. At the end of the Q1, the company had cash balances of approximately $113,000,000 and approximately $72,000,000 of availability under our revolving credit facility. Of note, during the Q1, Surgery Partners deployed approximately $1,000,000 for the acquisition of a surgical facility in Omaha and other end market investments, used approximately $20,000,000 for payments on our long term debt and our preferred stock and purchased approximately 157,000 shares of our outstanding common stock at an average price of $12.64 for an aggregate amount of approximately $2,000,000 The ratio of total debt to EBITDA at the end of the Q1 of 2018 as calculated under the company's credit agreement was 7.7 times, primarily related to the same store and ancillary services business performance in the current quarter as compared to the prior year quarter.
The company has an appropriately flexible capital structure with no financial covenant on the term loan or our senior unsecured note. Our balance sheet is well positioned to continue to fund our strategic initiatives and our total debt to EBITDA ratio should naturally decline over time as our business grows. With respect to our 2018 outlook, we have increasing confidence in our ability to deliver greater than $1,750,000,000 in revenues and at least $240,000,000 in adjusted EBITDA, particularly as we begin to execute on our M and A strategy and begin to see the benefits of our savings and integration initiatives. I'm excited to be part of the team that will deliver these results and as I look into 2019 and beyond, I'm confident we can create value for our patients, providers, payers and in doing so, create value for our shareholders. With that, operator, please open the call for Q and A.
Thank you. At this time, we will be conducting a question and answer Our first question comes from the line of Brian Tanquilut with Jefferies. Please
Wayne, thanks for all the color that you gave us on the reviews that you're doing and the feedback you're getting from the ground. But just wanted to see what the feedback so far has been through the change in management and just the change in ownership essentially from the physician angle considering that obviously these are your partners and they own 49% of the centers. So what is the feedback and what are you seeing in terms of the physician performance and morale since you've come in?
Hey, Brian. First of all, good morning and thanks for the question. And the thoughtful part of it about just how the physicians are feeling in this process, It's look, it's feeling very encouraging is what I would say at this stage. I've had an opportunity to visit several of our facilities and interact directly with some of our largest physician groups that are out there. I have several more scheduled in the Q2.
I think in the early stages, it's fair to say that many were curious kind of what does this really mean for us, what is the value you are trying to drive for the organization and how do we want to partner as we're thinking about expansions. I'm personally encouraged in the fact that, one, those discussions have all gone very well. As you would expect, we value our physician partners, so they provided feedback on how we can be a better partner to them, and so we're taking that feedback to heart. And ultimately, it's really led to us actually having some pretty productive discussions on some de novo opportunities with several of them in many markets right now. So I'd say early read is quite encouraging, but we're getting the right feedback we need, which is how can we be a better company for you as your partner.
Got you. And then Wayne, during the quarter, we saw some of the Blues plans and I think Humana as well announce early pilot programs and outpatient joint replacements. So how are you preparing for that? How are you marketing around it? And are you seeing or participating in any of those early programs that we've seen these health plans announce?
Yes, Brian, that's a great question. Short answer is yes. We are participating. We're still in dialogue with different partners right now as to which ones make the most sense. Our partnership discussions range from what I would call strategic discussions in the sense that there is a limited competitors at the hospital side and we have a chance to somewhat disintermediate along the way to those that are much more strategic about wanting to have a longer term partnership in terms of starting a dialogue around how we might partner on a more national basis.
So, I do anticipate that we'll ink a few of those probably in the next 90 days or so, smaller in nature. These things are generally programs out of the gate and then you show that you can drive the value you believe you can drive. We think we are fairly easy value prop to prove. So, don't think that's our concern. I think the biggest thing is just getting those opportunities to show people that we can bring that value.
So, it's a little bit of a slug out of the gate, especially when you bring a team in, because I think people want to make sure who you're going to be long term, where you're taking the company, and so we're having those discussions. But I feel pretty good about the progress and where we'll be by the end of the year.
Last question for me, you guys touched on revenue per case and the discussions on managed care. I mean, how are you thinking about the trend in that specific metric? And how are these discussions going? And also, what percentage of the year or what portion of the revenue per case year over year decline would you attribute just to mix both case and payer versus true rate deceleration? Thanks.
Sure. So Brian, there's a couple of different questions in there and I want to make sure I answer this thoughtfully and if we don't obviously let's make sure we can get you the answer. But me start with just kind of the revenue case metric and I'll ask Tom to feel free to join in here. One of the things I want to caution everybody on is to recognize that we're pruning our asset along the way and there's some assets that we think long term, while maybe solid, don't really have growth trajectory to them, do a lot of cases that are low dollar cases, and yet we may be shifting to what we think are much more higher dollar cases, core reinvestments in our business, orthopedics, spine, etcetera. And of course, we ultimately think those will be high revenue per case.
And so you have this kind of interesting dynamic though that will be happening that will have both positive shifts on it as we make these moves, but also negative shifts as we make these moves. And as you move to these higher implant cases, it's also important to recognize that concurrent with moving to this type of environment, we're also the process of negotiating lower implant costs, right? So, the value chain and the benefits of all those don't happen as we're moving forward, they happen kind of concurrently and you'll see that value occur over time. So, let me just start with saying, I would caution everyone on any particular metric, but nonetheless, you should focus and ask us those questions just as you're doing today. Relative to the payers, the one thing I would tell you that I find highly encouraging is we've done a deep dive of our top 20 locations, we've looked at the top 100 CPT codes and then we've tried to benchmark ourselves against what we think the average AFC is getting in the market.
And while I won't share the specifics of that, what I would tell you is the opportunity for revenue improvement is very meaningful for our organization, especially for the value we drive. Now that cuts both ways. In one way, it's helpful because we can sit with payers and show them why we're the better choice and why we are also probably the most efficiently run ASC out there. The flip side of that is, need to get paid for the value we bring as well. And so, we need to make sure that when we have these discussions, we negotiate from both sides.
But I would say some of the revenue lift you saw in the quarter, I think is very indicative when you look at overall revenue increase per case of something you should continue to see in the future. Just a reminder though that many of these contracts renew generally over a 2 or 3 year period. And so, as much as we want to go get all the lift today, that actually happens over a multiyear period as you're renegotiating. But now we've empowered our operators for the first time with the data to really understand how we stack up in our markets on the top 100 CPT codes, so we can have a much more thoughtful negotiation with payers. Sounds good.
Thanks, guys.
Our next question comes from the line of Ralph Giacobbe with Citigroup. Please proceed with your question.
Thanks. Good morning. You talked about lower volume in the lower acuity services. So I was hoping you can come back and sort of talk about growth maybe you're seeing in higher acuity service lines. Where are you seeing the increase?
And again, if you could break that out by service line, that would be helpful.
As you think Ralph, it's Tom. Good morning. And as you think about the case mix inside the quarter, we gave you a little bit of data in the prepared remarks on some of what we saw inside the Northeast. And as you look at that data, we didn't give you the exact revenue per case, but it's significantly below the average. And as you look across kind of the different categories where we were projecting that we would see growth, one of the places that we actually saw a little bit of softness as well was also in the pain category.
And those tend to be injections, those tend to be very quick, low dollar revenue, but good margin business. And then as you look at the mix kind of year over year and admittedly this is a little bit tainted by the NSH volumes coming in because the mix changes a lot on that basis. We are seeing good increases in kind of our ortho business, which is consistent with some of the focus that we've had as a company to spine in particular to drive those cases into our facilities by recruiting the right physicians. And ultimately, we think that that's a better dollar margin play for the enterprise. But as we make that shift, there's a little bit of breakage there.
Yes, Ralph. One thing I would add to that, just to Tom's comment, look, as we look at the underpinning, we're actually encouraged of what we're seeing on the ortho and spine front. A little mix shift in the Q1, which is not uncommon though as deductibles get reset at the beginning of the year. So, you see a little more of the kind of government Medicare coming in, a little less of the commercial and then we expect that to ramp up as the year goes through. But in general, we're seeing it in the right places, in the right spots.
And I think probably the best evident point I can point to is you can see our revenue was pretty decent in the quarter. We have pretty strong revenue and that's even with us actually divesting of a number of assets in the quarter and pruning back. Divested of 1 ASC and 7 practices in the quarter that weren't core to what we're doing. And so, we were obviously still accomplishing pretty strong revenue. And so from that perspective, we felt pretty good about it.
And the last thing I would highlight is, as you heard in the prepared remarks, the lab, because it gets integrated into some of these statistics and revenues numbers you've seen historically, it really distorts how we're actually performing on the revenue front with the surgical facilities. And so again, back to our core, I think we're doing the right things, we're repositioning the book the right way, we're covering the divestitures that we're doing along the way, and the goal would be towards the back half of the year, you'll start to really see that improvement. And then more importantly, we understand that there's an expectation for meaningful EBITDA growth starting in 2019 and beyond and that's really what we're building towards.
Okay. Can you give us the payer mix for the quarter versus sort of
a year ago on as much
as we can on sort of a comparable basis just to get an understanding of sort of the weakness on the commercial side?
Well, that's a follow-up with you offline on that. It's not data that's readily available given some of the transition issues associated with NSH. I think your best look at this point is to try to take a look at some of the mix that you saw in the Q4 versus last year versus the Q1, because you do have total company that obviously is going to very much show the shift that Wayne is talking about, kind of that lower commercial mix as a total company. As we look at some of the subsets of data, we definitely can see some of the dynamics that we're talking about, but it's our visibility on the total company at this stage with our integration is a little bit limited. I want to highlight one thing Tom said.
You can clearly look to Q4 and you'll see the declination in commercial and the heavier weight to government, but Q4 is a bad proxy in the sense that that's very common. Deductibles get reset and you should see that declination just as you should see in Q4 the higher commercial setting. I also want to clarify what Tom said from the standpoint that when we talk about lack of visibility,
it's not lack of visibility
in what we have today and what we do today, it's that we're trying to do a comp for you as best as we can against an asset we didn't own a year ago at this time and of which we're trying to pull as much data to make sure that we get it at the right granularity. So, it's not a lack of confidence in what we're telling you because we know it's directionally right and we have enough data. It's the fact that as we are doing these integrations and migrating these systems and platforms, we want to make sure that when we tell you something, we tell you exactly what we know and I think that's the point Tom wanted to make is it's not completely apples to apples, we believe quarter over quarter when we look at a year ago, but we know directionally, we can definitely see that it's not that big of a reset over what we would have typically seen in Q1 of a year ago, but a meaningful reset versus Q4, which was expected.
Okay. All right. That's helpful. One more if I could squeeze in. Margins in aggregate, but also within surgical facilities, were under pressure both year over year, but also sequentially.
So I guess I'm still trying to understand sort of the sequential. You had the good revenue in totality. Is the way to think about it, the higher sort of the mix of the procedure, the lower the margin profile of that? Or help us sort of reconcile even the sequential when you had NSHN and the fall off 1Q over 4Q? Thanks.
The first thing I would say, Ralph, is think about it in the most basic sense and use an example of 1 person and use the example of $100 in kind of revenue, right? And if you're not doing larger implant cases, which is what we're migrating towards, which is orthopedics and spine, etcetera. As you think about those, you have a gross up in revenue for an implant case and let's just say that the gross up is $50 right, because that's what, let's say, the implant cost, but your cost of goods sold went up by $50 And so just the basic math of saying, well, now my revenue is $150 but my cost of goods sold, let's say, went from 0 up to 50. You can see the math of it would create a margin declination, just the math of it does, even though your actual EBITDA is actually improving and your cash flow contribution margin per minute is actually improving. So one dynamic is this continued shift to what we're migrating to, we'll continue to put this short term pressure on it.
Now, the expectation and what Tom is pushing the team on is to say, yes, but now we've got to go get our top 20 vendor contracts renegotiated because that's how we start getting our margin expansion back because now we start cutting into the COGS of each of those implants and as we get those COGS down, we get margin expansion on those higher cost procedures.
Okay. All right. Thank you.
Our next question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch. Please proceed with your question.
Good morning. This is actually Joanna Gajuk in for Kevin today. Thanks for taking the question. So actually, first, I just want to follow-up on the comment you were making about your confidence in the outlook. So did I hear it right?
Did you imply that I guess the acquisitions are going to help you reach your $240,000,000 or EBITDA in excess of $240,000,000 So I guess are you talking about the deals that you already closed in Q1 or also you're including additional future acquisitions?
I would say the following. There is a lot of things that are moving inside the overall portfolio right now and we've talked about the acquisition that we completed inside the Q1. Wayne has talked about some of the activity that we have undergone and some of the strategic activity. We've actually pruned some assets inside the quarter as well. And so there are puts and takes.
I would focus you on the fact that we have a floor out there for both revenue and for EBITDA and we've said we're going to exceed that and we continue to believe that we will exceed that. But given how early it is in the year, we'd like to print a little bit more in terms of time before we and see a little bit more in the business, especially given that the Q1 was a little bit soft on the volume side, although we have seen some recovery in April as we talked about in the prepared remarks. So that when we give you an update to our outlook that we have a high level of confidence in it, that isn't influenced by potentially a one off quarter. And as we said in the last quarter, we expect M and A to be additive to any guidance we provide. So to the extent that we exceed $240,000,000 in EBITDA or our revenue metrics, you would expect to see some of that come from M and A front.
But as a reminder, we actually feel like now that we've done this database strategic assessment, we think we can move even a little faster on pruning some assets along the way that don't make a lot of sense for what we're taking us long term and the growth we're trying to do. And because we've got a pretty robust pipeline right now, we think we can redeploy it fairly fast, but it doesn't exactly happen 1 for 1, right? As you get rid of 1, you probably got at least another 90 days of getting the other one kind of signed and inked and moving it through the process. So there's a few things, but as Tom said, kind of the eggs get scrambled as you are running through a pruning process, but an ad net process, but our confidence level in greater than 240 and the revenue numbers is high at this point and we believe we will continue to achieve those, but we are not baking in any letters of intent that we have at this point or anything of that sort. As those get done, those will become additive to earnings.
That's helpful. I understand that. And then I guess also on the comment you made on the volumes and how Q1 was soft. So do you have sort of a view in terms of how the organic volumes were kind of play out this year?
Well, we don't give guidance specifically on case volume, nor do I intend to do that today. But I think that we did specifically give you a sense that as we looked at the month of April that we had seen on a same store basis, year over year April and looking at or pitting too much credence in one data point based on 1 month is always a tricky game. But we did see lowtomidsingledigitgrowth on a same store basis in surgical cases in the month of April. And so, we are encouraged by that because it does lend credence to the theory that there were some pressure points in the Q1, which we specifically talked about some of the mix issues, some of the weather issues, some of the flu issues, plus the increasing ever increasing impact of deductibles, which push some of these elective higher dollar revenue commercial procedures into the latter part of the year that we could see some of that come back. But as we said in answer to your first question, we'd like see a little bit more evidence before we talk about that or declare victory.
Great. That's helpful. And the last one, a quick question. You talked about you're recruiting 100 physicians so far this year. So how does it compare to last year to the similar period of time or maybe also overall for the full year last year?
Yes, I really appreciate the question. If you were to look at last year, we had a net declination in physicians within our organization. I want to I know the number. I don't want to give you the number. What I will say is we have a meaningful headwind coming into the year because of that net declination that we have to kind of backfill if you will.
The example I use is filling a bathtub, right? If the bathtub is filled up with all these physicians using your facilities and you get this kind of slow leakage that happens over a multiyear period, eventually the tub is halfway full. And so, first goal is, if you want to get that kind of utilization machine moving again and getting those case machine moving again, you got to fill that tub back up. Super encouraged by what I've seen with what the team has done in the 1st 90 days of the year, adding over 100 new positions and more importantly in the right areas that we want to be in, the right specialties. But more importantly, what you're going to see early in the year is you're just starting to fill it back up.
And so when you're comparing even a quarter ago, a year ago versus a quarter ago this year, you're still dealing with a net headwind of fewer physicians using your facilities than you had. By the end of this year, I would fully expect to see the opposite dynamic, which is we have a lot more physicians using our facilities by Q4 than we actually had in Q4 of last year. And so, I think, again, it's an important proof point for not only us, but for you that we can show you that we're kind of filling this bathtub back up, if you will, of individuals using our facilities. And so, early trends are really encouraging. We really saw the most significant declinations actually start beginning of last year.
We saw some net declinations the year before, but not super meaningful, but last year is when they really started and kind of went throughout the year.
Great. That's all for me. Thank you so much.
Our next question comes from the line of Chad Vanacore with Stifel. Please proceed with your question.
Thanks a lot. So I'm looking at the same store volumes, which were fairly weak down 4.1% in the quarter. How much of that volume loss was due to controllable factors? And then what's the best lever you have to influence those volumes going forward?
Hey, Chad, good morning. Well, look, I think when you look at the items we highlighted, I think there's 2 things that were not necessarily controllable. Clearly, the weather and the impact of that, which was around 900 cases and we can point to physical facilities being closed, so it's pretty straightforward. I think the other thing that we saw, which was pretty meaningful declination in there, was a change in policy over the last year from payers around what we'll call some of the pain and specifically the shots. 2 things that we saw happen there.
1 is, historically, when you were getting an approval for shots, you would be able to send out an authorization pre auth and they would ping you same day while the patient is in the office and they would pre approve 3 shots, so basically 1 per month for the quarter. What we've seen is an actual dynamic change where now they are taking up to 7 days to pre auth, which means that patient leaves the office and you actually lose the opportunity for that patient to come back. And 2 is, what we're seeing is they're only authorizing now one shot. And so, it's a simple dynamic, but that will have a substantial impact on volume, but not a substantial impact on revenue or EBITDA. And I want to emphasize that point, because those are the two dynamics we saw that were a little more out of our care and custody.
That being said, look, at the end of the day, it's our job to figure out how to deal with this evolving environment, right? And it's our job to figure out how to get this machine moving again and a big part of that is you got to get docs in your facilities. It's really that simple. And so, the
physician recruitment is a big part, but that takes a ramp up. We ramped up the staff in Q1. You
can
procedures a month, right? You're then getting them used to your facilities, getting them used to the scheduling and then of course that ramps up as the year goes. So that's one thing we're doing to drive it. 2 is, we're working on a number of de novos, right? I mean, the reality is the organic growth machine has to come through some de novos and the ability to expand not only where you reside today, but where you want to reside tomorrow.
And we've got the de novo machine running again and those are running. But as you know, those have more of an 18 month window associated with them. So, every activity we're doing today is about how we drive growth into tomorrow and tomorrow being more like late 2018, 2019, 2020. But yes, I mean, I would be the first that would say to you, Chad, we shouldn't be in this position in the Q1, but it's a function of not having the right resources focused on the right areas over the year, specifically on acquisition recruitment.
All right. And just thinking about case growth, Q1 typically seasonally weak. And so and you pointed out that April seemed to get better. How should we consider the, I guess, the sequential movement of case volume from 1Q to 2Q?
Are you asking us to give you an estimate of what we believe case volume will be in the Q2?
Or however comfortable you feel in guiding toward that level?
Yes, I mean, I have one point on the line at this point for the Q2. It's an encouraging data point relative to the Q1, but we'd like to see a little bit more of the Q2 before we talk about what that might mean for the full year.
Fair enough. So what really was the issue in the quarter, expenses were elevated across the board. So how do you get those down? Because it seems like most of the improvement that you're expecting on the expense side is really weighted toward the back half of the year and most of that targeted toward full realization in 2019?
Yes, I couldn't agree more, Chad. I don't know that I would say that I'm concerned about expenses, quite the contrary. I know where they're being spent. I know exactly where we're investing. I've got line of sight on what the payback will be for our shareholders, but it's back end weighted and it run rates.
So, it's real cash flow value. You can't run an organization of this size and scale and not invest in basic functions like procurement. I mean that requires headcount and revenue cycle management that requires headcount. And so, we're adding headcount in areas and we're making investments in core infrastructure that will drive long term sustainable value. I mean, personally, I view this year as a reset year, as a year of heavy investments and then we should be coming out to you, which we plan to with a 3 year strategy about what we think our 3 year CAGR will be.
But my confidence in our initiatives and the investments are high at this point. I can see early wins and I can see sustainable wins, And so, I don't think you're going to see the investments pair back in those areas. And what you will see as we progress through the back half of the year is as we start shutting down more facilities and more locations and becoming more efficient as an organization. That will continue to happen, but we didn't want to do that at the expense at the same time that we're in the middle of investing. So, first was get ramped up on the staffing in the right place, then ramp down on the staffing in the wrong place.
And so, those are all back end loaded.
How should we think about that comment on shutting down facilities in the back half of the year? What kind of size are we talking about?
Well, it depends. We've done a strategic assessment of all of our non surgical facilities. We continue that process now. Some of these could be much more sizable and if they are, we'll call them out. Obviously, we're not going to sell an asset or disperse an asset unless we get what we believe is fair market value for it.
2 is, in obtaining fair market value, we think based on the existing pipeline, the ability to redeploy the capital quickly is there, now quickly meaning generally within 90 days to basically replenish that EBITDA, but we can have a short window of 90 days to 100 days where we take an EBITDA headwind in the short term. But again, I am not concerned about that because I think it's kind of like pruning a rose bush, doesn't look too pretty when you start, but I'll tell you what, by next year, it looks pretty darn good and that's what we're focused on.
All right. So along those lines, as you had mentioned a disposition in the quarter, what kind of revenue and EBITDA impact should we expect from that sale? I'm sorry, could you repeat
the question? What revenue and EBITDA we're not going to break out any of the specifics on some of the smaller assets that we've pruned or any of the acquisitions that we've done to date at this point. We will be updating our guidance again at the next quarter for now. We've said that we have increasing confidence in our ability to achieve or exceed I'm sorry, to exceed the guidance points that we've put out for the full year. And we're happy to continue to talk to you as the year progresses on what some of those puts and takes are and as we update that guidance point.
Thanks for your question this morning.
Our next question comes from the line of Mr. Frank Morgan with RBC Capital Markets. Please proceed with your question.
Good morning. I'm just curious on the physicians that you've recruited, I think you mentioned the importance of the mix of those physicians. Can you give us a little more color, more detail on that mix of physicians that you've added? And then historically, what is sort of the timeframe over which you see the contribution from new additions like that to really start to move the needle? That would be my first question.
Let me start by saying that one of the efforts we went through is we went through an analysis of not only our facilities and where we had capacity, but we also did a direct contribution by minute analysis, so we could get a real feel for as we're recruiting physicians into facilities that have the ability to do multiple procedures, what procedures do we believe drive the highest direct contribution margin on a permanent basis so that we're being efficient in who we recruit and why. It's probably not with much of a surprise that those align very much with what we've been talking about broadly, which is orthopedics, spine, etcetera. So, a lot of our physician recruitment is in those areas. It's not exclusively to those areas, though, because as you know, certain facilities may not have the wherewithal, meaning the equipment to do those type of procedures. So, if we have capacity in a facility that could be ophthalmology or GI, we'll still recruit into those because it's as much about filling the facilities as it is targeting.
But we're being much more targeted though in how we fill facilities based on what their capabilities, capacities are. Second thing I would say is, you have kind of a window where it takes roughly 90 days to 100 days to build relationships with docs. Ultimately, you get them convinced that they should use your facility. Then it takes probably another 90 days, another quarter or so before you start getting to more ramped up run rate. So, if you think about it with that lens, every dock you basically get in probably doesn't hit more full run rate until about 6 months afterwards.
And so you're kind of always on a 6 month delay in the process. So you can get a feel for the docks we have today through the end of Q1, probably start really using our facilities much more frequently and much more comfortably, probably more by Q3. And then of course, what we're recruiting in Q2 moves to Q4. But as you can see, as you move into next year, you start really getting the full lift because you get the lift from all those you get this year, plus those you get in the back half and then you continue to recruit going into next year. So, it's another reason we have a lot of optimism on what we can do with case volume beginning in late this year early into 2019.
Got you. And second question is really on cost and on margins. I think you referenced the loss of EBITDA, but I was actually concerned that maybe some of these are not concerned, but hopeful that some of these divestitures might be EBITDA negative and that would actually be a quicker pop for you. So when you make that comment about the drag or the loss of that EBITDA on things that are divested temporarily, when you look, I mean most of what you sold in the quarter, it looks like or in this batch is 7 practices and 1 ASC. Is there a much of a discernible difference in the profitability characteristics of the ASC versus those physician practices?
Would the practices be more likely to be very, very low EBITDA and the ASC be higher EBITDA?
I think as you think about the activity that we've done to date, most of it is small, right? But it is indicative of the fact that we are taking a much broader look at a portfolio and a portfolio nature has got winners and it's got laggards. And for those that are laggards, we're trying to understand what's the reason, can we turn it around, over what time period and ask the question, are we the best owner of that asset? And that's what we're doing across the portfolio to try to decide whether or not we're the best asset owner for all of these particular facilities. And there are some that the removal of them from our outlook may be EBITDA positive.
That absolutely is a possibility, but as we look at the things that we've done to date and executed in the Q1 relative to the things that we're currently evaluating, I'd say the impact is small. But as you as I step back just a little bit to your question about margins overall, there is and you can see some of this data from either the press release or you'll see it in the segment data when we file the Q. Was there pressure in margins core surgical business? Absolutely, we've talked about some of the drivers of that, whether that's a combination of volume and some of the mix that we've seen. But I wouldn't lose sight of the fact that margins are down fairly dramatically on a year over year basis on our ancillary business.
We've talked about one of the drivers there, which is our lab business and some of that's a very conscious effort to drive a more sustainable business model as we look to partner with payers. The other piece as you just look at the overall margins is some of the investments that we've made that are going to be front end loaded relative to the strategic transformation work that we're executing on. Frank, one thing to tag along with what Tom said is, I think your question around are some of these items that either we're losing a little bit of money or breakeven. Yes, Q1 was easy. That's a low hanging fruit and that's what we went after.
There was clearly physician practices that made no sense, weren't contributing to the net value chain of the company and we made those changes. In some of the ASCs as we look forward, you'll see de minimis ASC divestitures, albeit we will do some because geographically they don't make sense. We don't think there's a growth proposition there for the future. And we think we can deploy those potentially at reasonable multiples that we can redeploy at a reasonable multiple, meaning we can net flush those out with at least a neutrality to them and maybe a positive. But we have some non surgical assets that do generate some EBITDA and those are assets that we're looking at with a lens that says they're a little bit of distraction from what we are trying to do, because they are not core to what we do, they don't get the focus that they should get.
And even if we gave them the focus, we are not sure it's worth the dollars of where we deploy them in other areas for growth. So I think that will be the next round that we'll be focusing on as the year progresses is some of those assets. All that being said, we said in our original guidance that we generally have contemplated some degree of divestitures in our original guidance outlook and we have not included the M and As and so we are still confident in our guidance outlook even with the things we are contemplating at this point.
Okay. Thank you very much.
Thanks, Frank.
Our final question comes from the line of Bill Sutherland with The Benchmark Company. Please proceed with your question.
Thanks. Hey, good morning, Tom and Wayne. And thanks for squeezing me in. Just a couple here.
Where have you built out the recruiting bench completely at this point, Wayne?
No, Bill. Appreciate it. No, it's not completely built out yet. We still have a few more hires that we want to do. And then more importantly, as we start the M and A pipeline, which is again, as I said, robustly growing again, we'll want to contemplate whether we add even more there to the extent that we have facility capacity or as we start to actually get our de novos up and running.
So, I don't think this is ever one that completely finishes our end. But we are not far off from where I want to be at in terms of optimal staffing right now. But we are still a few staff away from where we want to be to be optimal on where we want to be at. And the other thing is these staff have a ramp up in training because we've got to get them trained before they can get on the field and tell the surgery partner story to then begin bringing the docs. So, what we've done is for the existing recruits, we've been very focused on prioritizing the right geographies and services we want to provide.
And where we're not having boots on the ground yet, I would say they're less long term growth they're long term growth drivers, but they're much smaller than where we're focusing our
today. And with the physicians that
are coming in, are they they are not coming in as employees, are they? They are just utilizing centers?
That's correct. These are just utilizing centers. So they have no ownership interest in the organization. Generally, these are ones that we think make a lot of sense to recruit. If we think there is a possibility to syndicate, we will, because if there is docs that we think are really the right docs we really think through the right procedures at the right quality and obviously are well known in the communities, we'd like to have those docs.
And in those cases, we'll lock them in with some liquidity or equity in the company, if you will.
And you had, I think, mentioned on the kind of in the mid-6s. Based on what you've got on the table at this point, are you still spending, etcetera? Are you is that still kind of a number we should think about?
As I look at the hey, Bill, it's Tom. As I look at the leverage ratios and I think about our guidance and we saw a lot of pressure on the multiple or the EBITDA debt to EBITDA multiple inside the quarter. We had a relatively good Q1 in our pro formas. We swapped that out for a weaker one. And as I look at the numbers, I would say, I'm not sure that at the end of the year that we're going to see 6, but I would say that that partially depends on exactly where it is or how much we grow, but 6 seems like a far way off.
I'm not exactly concerned about the current leverage ratio, given the covenant package that we have, the amount of financial flexibility that we have and that's exactly why we have that financial flexibility, because we want to do the right things to grow this business over the longer term. We are making investments today that will have a longer tail on them. And when we see the benefit of those, I think and we grow the business, I think we will naturally delever. But I think that probably seeing 6 by the end of the year feels optimistic.
Okay. That's fair enough. I'll just hit you with some more questions just want to highlight.
One is, I really appreciate the questions from each and every just want to highlight. One is, I really appreciate the questions from each and every one of you this morning. These are the right questions you should focus on. And to be honest, it's exactly what we're focused on each and every day. I'm actually super encouraged about where we're taking the company right now.
What we've accomplished in really 1 quarter has been quite Herculaneum, quite proud of what the team has done in such a short period of time. I'm even more excited as we really start to get back to the basics and really start to execute and show you the positive developments and ultimately when we guide for next year, hopefully be able to show you what we've been talking about. But with that, I want to take a moment just to say thank you to our 10,000 plus Surgery Partners associates for their contributions this quarter. As we execute against our goal to become the preferred partner for operating short stay surgical facilities across the United States. It's the efforts of each and every one of these employees that gets us there.
While we still have much work ahead of us, I'm very proud of what this team has accomplished in a very short period of time. We've begun the process of creating a culture of discipline, focus and accountability as we refine our portfolio and advance our strategy. And I look forward to providing you all updates to our shareholders and the progress and our return to sustainable long term growth. Thank you for joining the call this morning and have a great day.