Earnings Call: Q2 2020

Aug 5, 2020

Greetings, and welcome to the Surgery Partners, Inc. 2nd Quarter 2020 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 Cowhey, Chief Financial Officer for Surgery Partners. Thank you. You may begin. Good morning, and welcome to Surgery Partners' Q2 2020 earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today are Wayne DeVyte, Surgery Partners' Executive Chairman and Eric Evans, 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? Thank you, Tom. Good morning and thank you all for joining us today. Before we begin our call this morning, I would like to acknowledge and recognize our 10,000 plus associates and physician partners that continue to support the healthcare system and the needs of their patients. These are clearly unprecedented times and we are proud to be affiliated with these heroes who have embodied our mission of enhancing patient quality of life through partnership during this public health crisis. On behalf of Surgery Partners Board of Directors and Management, thank you for your service and the sacrifices that you and your families are making each and every day. Turning to our Q2 results. Over the past 2 plus years, we built our company for growth and applied a data driven approach to decision making. We forged our strategy based on key data points, including but not limited to specialties expected to grow at a disproportionate rate versus industry averages, contribution margin per minute based on specialty type, and anticipated tailwinds such as the transition of many Medicare related procedures from a higher cost inpatient setting to a lower cost high quality outpatient setting. We also use data to support our physician recruiting efforts and to hold ourselves accountable for execution. Our strategy was built to support sustainable long term double digit growth. However, a data driven approach can only answer so many questions, including how a business model and team may perform during an unanticipated and unprecedented crisis like COVID-nineteen. More importantly, with the growth engine we established to be able to survive and continue to thrive given our differentiated strategy and assets. As you can see from our 2nd quarter results, despite the unique environment impacting both our country and company, our business model has proven to be quite resilient. We took decisive actions early, many of which required shared sacrifice across our organization and supported our colleagues and physician partners in a manner that would enable us to reopen quickly and address the needs of the communities we serve. And while the disruption of COVID-nineteen has pressured our business model in the near term, it has also reinforced the value of the key pillars that support our long term growth model. As an example, through June of this year, despite the severe disruption we experienced in late March April, revenue from physicians recruited this year through June are up approximately 37% compared to the same period in 2019. Further, we are completing an increasing number of high acuity procedures in our centers and programs like CMS's Hospitals Without Walls highlight that ambulatory surgical settings are an appropriate care setting for many high acuity procedures. Just yesterday, CMS noted that significant developments in the practice of medicine have allowed more procedures to be done safely and on an outpatient basis and it should be up to physicians to determine when inpatient care is required. We believe that recent experience and the underlying acceleration of trends just described emphasize the importance of care delivery migrating to lower cost, high quality, purpose built settings like our short stay surgical centers and that patient and physician preferences seem to be increasingly aligned with this accelerating trend. While Eric will go into greater detail regarding the results of the actions we undertook, I wanted to share a few data points that highlight the strength of our short stay surgical platform. Our musculoskeletal service line, which represents nearly 44% of the procedures we performed at our facilities in the 2nd quarter has remained resilient. Of particular note, given the disruption we've experienced, musculoskeletal procedures were more than 700 points of mix ahead of the prior year period. And the number of orthopedic cases in the month of June of 2020 increased by 18% versus the prior year period. The mix shift to higher acuity orthopedic procedures also favors our strategic focus on higher margin and higher dollar value per minute of operating room procedures. In May June, our average adjusted revenue per case increased by 21% compared to the prior year, which helped to partially offset lower volumes in these periods. And finally, the transition of procedures out of traditional acute care inpatient settings accelerated during the quarter. In June, we performed 2.6 times as many joint replacements in our ambulatory surgery centers as we did during June of 20 19. For the year, even with the disruption of COVID, joint replacements in our ambulatory surgery centers have increased by 70%. Let me conclude by saying that while we are pleased with our 2nd quarter results in this very challenging environment, there is still much uncertainty. We are humbled at the opportunity to support the health of our communities during these unique times and look forward to being able to continue to demonstrate the important value that Surgery Partners brings to our country's healthcare system. With that, let me turn the call over to Eric. Eric? Thank you, Wayne, and good morning. Today, I'd like to review highlights of our most recent results, provide an update on our COVID-nineteen response and outline our plans to navigate this crisis throughout the second half of twenty twenty. Tom will then close our prepared remarks with greater detail on Q2 financial results before we take questions. From March 14, when the Surgeon General, CMS and some states started to recommend suspension of elective surgeries to help preserve critical resources, we saw a wide variety of impacts to our facilities, with both regional differences as well as differences based on specialties. In general, our short stay surgical hospitals proved more resilient in the initial downturn than our ASCs and higher acuity cases were slightly less impacted than lower acuity cases such as GI procedures. Encouragingly, each month from April through June experienced larger increases in volume than we had projected. And these trends appear to be continuing through July and our current August scheduling. For the quarter, the temporary suspension of elective procedures depressed overall volume, but we remain cautiously optimistic as we look into second half of the year based on our most recent results and the outstanding efforts of all of our team members. As disclosed in our 8 ks on July 22nd, our same store cases volumes as a percentage of prior year totals increased from 19% to 93% from April to June. Today, we announced that our Q2 2020 adjusted EBITDA was $58,200,000 inclusive of $27,000,000 in CARES Act grants. Tom will go into more detail on the financials, but we are quite pleased to be able to demonstrate such strong performance in these difficult times. Such solid financial results would not have been possible without the efforts of lawmakers, local officials, and most importantly, of our team members and physicians who mobilized quickly to adapt the new protocols and procedures required based on national and local regulations and continue to provide critical services in a challenging environment. We are confident that our frontline colleagues, doctors and particularly our nurses and medical staff aided by our corporate teams can keep us squarely on this path to recovery. Some key priorities from which we continue to remain focused include the following ensuring that our facilities are safe places to conduct procedures. As mentioned, we are strictly following CDC guidelines to ensure compliance. Our facilities follow stringent cleaning policies, which have been further enhanced in focus and frequency, and most see only prescreen patients by appointment, which helps reduce our overall risk profile, making our facilities highly attractive options for patients and physicians in this environment. We also have to remain focused on ensuring appropriate use and quantity of PPE, personal protective equipment. Our teams have been hard at work navigating the supply chain implications of COVID-nineteen. While demand for critical items remains high, we believe we have sufficient inventory to continue to perform surgeries as needed. Finally, we are closely monitoring situational changes and evolving regulation across the country to ensure our compliance. As most of you are aware, there has been an uptick in the number of COVID cases throughout the country, resulting in certain county specific elective procedure restrictions. To date, the elective bans issued have been generally not applicable to our facilities. However, we are monitoring both macro and micro factors on a real time basis, with a particular focus on certain hotspot geographies, including Texas, Florida and California to understand emerging trends and to take mitigating actions. I have personally visited a number of the hotspot locations over the past 2 weeks, meeting with our colleagues and physician partners, and I continue to be encouraged by their commitment to our mission of enhancing patient quality of life through partnership, their resilience and their optimism about our value propositions growth prospects moving forward. Based on the strict protocols we have implemented and because our facilities generally do not treat COVID patients, we continue to believe we are uniquely positioned to be a safe haven for elective surgeries, and we are committed to serving the health care needs of our communities as this crisis continues to unfold. Let me take a moment now to address our ongoing actions as we prepare for the back half of twenty twenty. As surgical volumes started to recover during the Q2, we sought to manage our expenses so the return would lag revenue. Many of our expenses that were once not considered to be variable have proven otherwise and management will continue to remain vigilant in our cost control efforts moving forward. This prudence is reflected in our results. And even in the month of June, when volumes started to recover, our G and A plus our salary and benefit expense as a percent of revenues was nearly 800 basis points lower than the prior period year. We also use this time as an opportunity to look for new ways to enhance our long term productivity, which would further support our long term goals of double digit adjusted EBITDA growth. We continue to pursue consolidation and outsourcing opportunities to gain efficiencies and also provide enhanced services to our facilities and physician partners. The unique challenges that we have faced during this quarter have also provided new growth opportunities. Many standalone facilities across the country now more than ever see the value of being part of a larger organization. Given the COVID-nineteen backdrop, we expect the shift of surgeries to short stay surgical facilities to accelerate even more quickly than our previous expectations. Technological improvements, cost savings and patient safety have been the primary drivers of this shift pre COVID, and we believe that patient and physician sentiment in our current environment will further propel this shift for 2020 beyond. This has been our company's differentiation and now more than ever due to COVID-nineteen this value proposition is resonating with key stakeholders in the healthcare environment, patients, physicians and payers. To help capitalize on this trend, on July 22, we raised an additional $115,000,000 of gross related activities, including the following: service line expansions, where our teams are working to capitalize on the accelerated transition of orthopedic and spine cases in the short stay surgical facility setting as well as broader cardiology and robotic migration trends. This recruiting and technology infrastructure investments to further improve the effectiveness of our lead generation and ROI, as well as to make improvements in our data and analytics that will enhance our managed care and revenue cycle efforts. And importantly, to help fund a robust M and A pipeline of transactions heavily focused in orthopedics, cardiology and other key specialties across the country. We believe that this crisis has fundamentally changed the way patients and surgeons will think about the role that purpose built short stay surgical facilities will play in healthcare delivery. We continue to see strong surgical volume trends through July and remain as confident as ever in our long term organic growth model and believe that scaled independent operators such as surgery partners will be uniquely positioned to grow in this new marketplace. Given the level of uncertainty that remains relative to the COVID impact in the back half of the year, we will not be providing formal guidance today. That said, barring a significant change in recent trends, we currently project that we can deliver adjusted EBITDA consistent with our original guidance for the back half of twenty twenty. More importantly, if we are able to return to our pre COVID run rate in the back half of twenty twenty, we believe that will position us well to maintain a double digit adjusted EBITDA growth trajectory into 2021 and beyond. Finally, I want to take a moment to talk about the proposed 2021 Medicare Hospital Outpatient and Ambulatory Surgical Center payment update that was released yesterday. While our teams continue to evaluate the specific impact to surgery partners based on the proposed increases and our specific business mix, we were encouraged by the proposed 2.6% aggregate increase contained in the release. CMS is also proposing the elimination of the inpatient only list over the course of 3 calendar years beginning in 2021 with the removal of approximately 300 musculoskeletal related services. Procedures our facilities are particularly well suited to capture. Further, the addition of 11 new procedures to the ASC covered procedures list including total hip replacements, speaks to the value and quality that our short stay surgical facilities can provide to the system. Finally, CMS is also soliciting comments on procedural alternatives to enhance the covered procedures list at ASCs, as they look to further increase the availability of ASCs as an alternative side of care for Medicare beneficiaries and to allow for a more efficient use of healthcare resources and infrastructure in light of the current COVID-nineteen crisis. We look forward to continuing to serve our providers and communities by providing safe, convenient, high quality alternatives to the traditional hospital environment. With that, I will turn the call over to Tom, who will provide additional color on our financial results. Tom? Thanks, Eric. First, I'll spend a few minutes on our Q2 financial performance before moving on to liquidity and some considerations as we move into the second half of twenty twenty. Starting with the top line, surgical cases declined to just under 83,000 in the quarter, primarily caused by COVID-nineteen related restrictions. Adjusted revenues for the quarter were $383,000,000 16% lower than the prior year period. Reported results included approximately $12,000,000 of contribution from our new community hospital in Idaho Falls. On a same facility basis, total revenue declined approximately 18.6% in the 2nd quarter. Looking at the components of this decline, our case volume was 39% lower than the prior year period, offset by higher net revenue per case that increased by over 32% driven by acuity mix and pricing. Turning to operating earnings, our Q2 2020 adjusted EBITDA was $58,200,000 just under a 5% decrease as compared to the comparable period in 2019. During the Q2, we received approximately $48,000,000 in CARES Act funds, of which we recognized approximately $43,000,000 as other income based on lost revenue since the COVID outbreak. After non controlling interest, the grants we recognized in the 2nd quarter contributed approximately $27,000,000 to our adjusted EBITDA. During the quarter, we recorded $10,100,000 of transaction integration and acquisition costs. Of note, Q2 2020 transaction integration and acquisition costs included approximately $5,000,000 of EBITDA losses associated with our de novo hospital in Idaho Falls. As I've noted before, we expect to report results from this facility separately throughout 2020. And although this new hospital experienced lower volume in the Q2 associated with COVID-nineteen, the underlying momentum remains very positive. Moving on to cash flow and liquidity. We ended the quarter with a strong cash position of $326,000,000 which includes approximately $120,000,000 of Medicare advanced payments. We've held these advanced payments as deferred revenue in our financial statements. As a reminder, these advanced payments will reduce reimbursement from Medicare services that are provided starting in August. Our liquidity position is further enhanced by our undrawn revolver, which has a capacity of approximately 113,000,000 dollars after giving consideration to outstanding letters of credit. Of note, during the 2nd quarter, Surgery Partners had operating cash flows $182,000,000 We raised approximately $120,000,000 of incremental capital through an incremental term loan issuance in April and subsequent to the quarter raised an additional $115,000,000 of incremental senior notes due 2027. Finally, we deployed approximately $7,000,000 in the quarter, primarily related to the expansion of an existing facility in the state of Georgia and the acquisition of an ASC adjacent to one of our facilities in Texas. The company's ratio of total net debt to EBITDA at the end of the second quarter as calculated under the company's credit agreement was down slightly at approximately 7 times, primarily as a result of higher cash balances, partially offset by lower trailing 12 month adjusted EBITDA in the current quarter due to COVID-nineteen. Normalizing for the impact of Medicare Advanced Payment Funds, the ratio of total net debt to EBITDA would have been 7.35 times. The company has an appropriately flexible capital structure with no financial covenants on the term loan or our senior notes. As mentioned in the Q1 call, the company's lenders under its revolving credit facility waived our leverage covenant for the remainder of 2020 and provided substantial flexibility for the calculation in 2021. Looking forward to the back half of twenty twenty, although surgical volumes were depressed in the second quarter, we saw some of our strategic initiatives start to bear fruit. Our emphasis on investing in the procedures that produce the highest dollar contribution per minute has manifested itself in our results. The significant increase in revenue per case during the Q2 is a testament to 1, the natural shift of higher acuity procedures to short stay surgical facilities 2, our targeted physician recruitment efforts and 3, our strategic rate negotiations in multiple markets across the country. While the evolution of this pandemic and to what extent the economy will improve is unknown, we have not yet seen a material shift in payer mix due to higher unemployment levels. Rather, we have seen a slight improvement in commercial rates and acuity mix in the Q2. We are encouraged by the pace of recovery during the Q2 and remain confident in our long term growth model. As we look out to the remainder of the year, if the current recovery persists, we project that we could generate adjusted EBITDA in the range of $250,000,000 to $260,000,000 this year. This indicative range assumes that the volume levels and corresponding specialty mix, payer mix and net revenue per case metrics that we have seen in June persist and improve over the remainder of the year. That we do not see broad based elective procedure restrictions or stay at home orders issued in our key geographies and that we can continue to make progress on our initiatives in the midst of this crisis. As Eric mentioned in his comments, if we can realize this outlook for 2020, we believe this will position us well to get back onto the double digit adjusted EBITDA growth trajectory that we entered 2020 projecting we could achieve. With that, I'd like to turn the call back over to the operator for questions. Operator? Thank you. Just to make sure that I understand my last comment correctly. Kevin, you're not coming through well. I don't know if you're on a mobile line. Could you maybe try to ask the question again? I'm sorry, Kevin, but unfortunately we can't hear you. Operator, can you still hear us? Yes, I can hear you. His line is breaking up. Mr. Fishback, I'm sorry. Your next question comes from the line of Brian Ankleit with Jefferies. Please proceed with your question. Good morning, guys. Congrats. I guess my first question, Wayne, as I think about MSK, obviously a big opportunity. But just what do you think from an acceleration perspective in terms of shifting volumes from hospital settings to yours, what are the things that you still need to do to get this going? And then how do you make this sticky so that even post COVID, it doesn't move back into the hospitals? Hey, Brian, good morning. Thanks for the question. Yes, thanks. And I meant joint replacement surgery, sorry, my bad. So a couple of things that I would respond to regarding your questions. 1st and foremost, what's been interesting, as you know, isn't just the shift that we've been pursuing in terms of recruiting physicians and what we've been getting is kind of regular momentum. As we've mentioned historically, there's really several factors we have to go after to get these things not only to move, but then to become sticky. One is you've got to actively recruit docs into your facilities and you've got to show them that not only you have the quality to support that, but you even have the technology. And as you heard Eric in the prepared remarks comment that we are doubling down on our investments in robotics. We know that will actually help us not only recruit even more physicians into the facilities, but the level of technology that we can bring, which would be similar to what they could get in an inpatient setting, will enable App to become more sticky. 2 is, clearly the advantage we have with our facilities is the flexibility in scheduling and that is something that many inpatient organizations cannot offer to docs. And so we don't generally find that stickiness is the concern. In fact, we think during this environment, COVID-nineteen is actually giving us an opportunity to showcase our facilities to even more doctors in MSK and show them that we can not only accommodate their needs, but we can be highly flexible with their schedules. And so similar to what you heard from Eric and my comments, we actually believe that not only will these procedures come over, but they will actually become sticky. And we are actually seeing that as we looked at May, June, July and even early scheduling now for August that those are in fact trends we are seeing. And then the last thing I would simply say is this. The more that CMS continues to move procedures off the inpatient only list and the over 300 MSK procedures that as of yesterday now are being recommended to transition over the next 3 years, is just another example and another sign of what we think will encourage doctors to move these procedures over. And candidly, patients prefer it. So, all in all, Brian, I would just say we've got really all tailwinds going in our favor right now. I don't know, Eric, anything else you want to add? You've been on boots on the ground out visiting with our docs that we've been recruiting and others. Yes. Brian, so good morning. Appreciate the question. I do think that one of the really interesting things for us is as more and more procedures are moved into our setting or able to be done in our setting, it's easier for physicians to think about moving their practice making an investment, right? They don't have to split business. And so every time we add one of these procedures, it makes their life easier. They get to come to a place where they have a consistent schedule. They know that it's going to move on time. They're going to be able to get back to their office and now they can bring more and more cases. So it's not just that they will now bring the Medicare hip, it's that they can bring their whole lineup on a Wednesday. And so we see that as an incremental positive. Clearly, one of the other things that we have to continue to do, which we've been quite successful at over the last couple of years, is make more and more of our centers capable of doing total joints and spine cases. And so we continue to add every year the number of centers where we've invested in the space, the technology, the adequate capacity to allow those procedures to be added. And so that's one of those things that we're excited about. And then the last thing, and Wayne mentioned this, I mean, there are certain places where we have either existing partners or physicians that say, if it weren't for a robot or a piece of technology, we would do it in the ASC space and we're solving those problems actively. So we do feel like all of this net net continues to add to this natural transition that we only see accelerating. I appreciate that. And I guess my follow-up, Wayne, you're obviously sitting on a lot of cash from the balance sheet, successful debt raise. I know you're very active in the M and A world, but how should we be thinking about the pace of deals, the makeup of deals? Are you looking at bigger transactions given the amount of capital that you have in front of you? Or is this still the same kind of strategy where you're rolling up relatively smaller one transactions? Brian, thanks for the question. A couple of things I would highlight. 1st and foremost, the M and A pipeline is as robust as we've ever seen it. I think that is both a function of the value creation that SP is able to show to potential partners, the independence of our value creation. And candidly, COVID has really put a spotlight on those stand alone facilities that are struggling in this environment and they can see what we can do to actually help them during this time. And so when you think about that, I would tell you that a couple of things to hone in on. One is, we are very focused on those facilities that are heavy MSK and cardiovascular. We think cardiovascular is the next wave and we don't want to wait 2 or 3 years to start hitting that wave. In fact, we've got a number of facilities now that are doing that. We think MSK has got a good 5 to 10 year run-in it still. And it's just starting the growth trajectory, but we actually want to start the next run as well. I would tell you that our pipeline has several transactions under LOI currently that we could close between now and the end of the year subject to our due diligence and final procedures. And in terms of size and scale, I think they take on kind of all shapes and forms. We will not do a bet the farm transaction. There's no need to bet the farm. Things are going well. Our process works well. We're able to plug and play these things in efficiently. But we are looking at some slightly larger transactions than maybe we've done over the last couple of years, but focused on a multi specialty of cardiovascular and MSK. But again, not much bigger than what you've seen historically, but things that will really drive value creation to where we see the growth trajectory going. Just one quick addition. Clearly, the pipeline has been fantastic. We remain focused on those end market and de novo opportunities. They are extremely attractive. So we kind of have both going for us now. But I would just reiterate, we certainly love the end market de novo and roll up transactions and those continue to be very accretive and they continue to be available to us. All right. Got it. Thanks guys. Congrats again. Thanks. Thank you. Thank you. This concludes our question and answer session. I'll turn the floor back to Mr. Evans for any final comments. Thank you. And we realize this is a busy morning of calls, and so there may be a fewer questions than normal. I just want to wrap up and conclude by saying thank you on behalf of Tom, Wayne and myself to all of our colleagues across the country who have been contributing during this very difficult period and who are absolutely committed to delivering on our mission of improving patient quality of life through partnership. We're humbled by the efforts of our physicians, our nurses and other first responders across the nation as we all deal with this pandemic and certainly just want to say thanks for all they do. With that, thank you for joining the call today and we hope that you all remain safe and healthy. Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank