Greetings, welcome to Surgery Partners' fourth quarter 2018 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tom Cowhey, Chief Financial Officer. Thank you. You may begin.
Good morning, welcome to Surgery Partners' fourth quarter and year-end 2018 earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today is Wayne DeVeydt, Surgery Partners' Chief Executive Officer. As a reminder, during this call, including during the Q&A portion of the call following our prepared remarks, 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 under the heading Risk Factors in our most recent annual report on Form 10-K, and in the other 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.
One such non-GAAP measure we are introducing for this quarter is adjusted revenue, as Surgery Partners recently implemented Accounting Standard 606. This standard essentially combines the previous expense provision for doubtful accounts into our net revenue presentation. Net revenues are thereby reduced with a corresponding offset through the elimination of bad debt expense, with no net impact to our adjusted EBITDA or bottom-line financial results. Adjusted revenue preserves the previous presentation for comparability purposes. The presentation of this and all 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 annual report when filed. With that, I'll turn the call over to Wayne. Wayne?
Good morning. Thank you, Tom, thank you all for joining us today. We have a lot to cover this morning. First, I'd like to review some highlights from our fourth quarter results. I will then provide an overview of the strategic initiatives that we implemented in 2018 to drive sustainable double-digit long-term adjusted EBITDA growth beginning in 2019. Finally, I'll turn the call over to Tom to provide further details on the financials and our 2019 outlook. Starting with the quarter, this morning we reported fourth quarter 2018 adjusted revenues of $500,000,000 and adjusted EBITDA of $73.3 million, primarily as a result of our strategic initiatives that continue to show solid progress in the fourth quarter of 2018. As we look deeper into the quarter, adjusted EBITDA grew by 14.7% over the fourth quarter of 2017.
This represents the first quarter where National Surgical Healthcare results were fully reflected in the prior year period. Same-store revenue increased by 7.4% from the prior year quarter. adjusted EBITDA margins improved by 100 basis points versus the prior year quarter, with adjusted EBITDA margins reaching 14.9%, and this improved margin profile occurred with government payer mix that increased by nearly 2% when compared with our prior year quarter. These trends, including our second consecutive quarter of same-store case volume improvement, when combined with improving margins, continue to be encouraging, providing us with the expected momentum as we build sustainable platforms and position our company for future growth. Turning to our long-term strategy, over the past year, we've been focused on reinforcing and building upon what we do best, operating high-quality, short-stay surgical facilities.
Throughout 2018, we've taken a data-driven approach in analyzing strategic opportunities and challenges across our portfolio and divesting or closing those assets that are not aligned with our growth goals. We also made substantial investments in platform consolidation, which eliminates execution distractions, provides data analytics that enable agility in decision-making, and effectively leverage our platforms for G&A efficiencies. Finally, we invested in our business with a priority placed on organic volume and revenue growth, along with margin expansion and capital deployment focused on high-growth assets. Some key accomplishments in 2018. We pruned our asset base of non-strategic, lower-growth assets, representing a total of over $100 million in annualized revenue. We recharged our organic growth engine, resulting in same-store facility revenue growth in Q3 and Q4 of 11.4% and 7.4%, respectively.
This is a result of both improved rates and case volume, with Q4 representing our largest same-store case volume as compared to the previous six quarters. We leveraged our scale, resulting in improved results for our physician partners and margin expansion for our shareholders. This includes sustainable run-rate supply chain savings, along with a 10%+ reduction in corporate headcount, net of our reinvestments in the business. We invested in our infrastructure, which includes, but is not limited to, 79% of our surgical facilities and clinical practices migrated to our in-house patient accounting platforms. 95% of our surgical facilities and clinical practices migrated to a common claims clearing house, and 84% of surgical facilities integrated into a centralized data warehouse. We also rebuilt our M&A pipeline with over $100 million in capital deployed in 2018 at a sub seven effective multiple.
Finally, we took these actions while maintaining a strong focus on clinical quality. As an example, in February of this year, CMS updated its overall hospital quality star ratings recognizing 293 or less than 10% of hospitals with five-star ratings. We are pleased to report that four of our surgical hospitals received a five-star rating in the most recent period. Further confirmation of our commitment to clinical excellence. While we are proud of these many accomplishments, we also realize that sustainable long-term growth requires a maniacal focus on execution and a proactive approach to eliminating headwinds that could impede our growth goals. While there were several headwinds impacting our growth in 2018, one headwind of particular importance to our company relates to our ability to resolve matters that are the subject of the civil investigated demand letter we received from the federal government in October 2017.
As previously disclosed in our SEC filings, the investigated demand letter was for documents and information dating back to January 1, 2010, relating to medical necessity of certain drug tests conducted by the company's physicians and submitted to laboratories owned and operated by the company. We are currently in discussions with the government about resolving potential claims relating to these matters. Based on those discussions, which are still ongoing, we recorded a charge of $46 million in the fourth quarter related to these matters. We currently expect this charge to be sufficient to cover a potential settlement with the government related to these matters and certain related legal expenses. It is important that we put this matter behind us so we can ensure our focus is in providing exceptional clinical care to our patients and services to our physician partners and associates.
This investigation relates to a chapter of our past that we are looking forward to closing shortly with federal investigators as we continue to improve on our culture of innovation, compliance, and accountability. Of course, 2018 was just the start of building our new culture. This is an exciting time for our company, and I feel privileged to be part of this great management team at this transformational period. I'm especially encouraged with our early track record of execution, which we believe will be further complemented with the addition of Eric Evans as our Chief Operating Officer, effective April 1st. Eric brings over 15 years of industry experience to our company and will play a key role in continuing to implement our growth strategy and deliver value to our stakeholders.
Before I turn the call over to Tom, I would like to close with some important initiatives that we began in 2018 that are expected to begin to create meaningful long-term shareholder value beginning in 2020 and beyond. As you are all aware, de novo investments are a highly accretive way of growing organically, but generally have a long digestive period from initial investment to initial returns on investment. In 2018, we began this journey with two of the largest de novo investments in our company's history. The first of these two investments is the Idaho Falls Community Hospital. This state-of-the-art 88-bed facility will include emergency room and ICU services and will complement the broader healthcare ecosystem that we have built in the greater Idaho Falls community and surrounding territories.
The second of these investments is The Villages Ambulatory Surgery Center, which is located in the nation's premier active adult retirement community, just northwest of Orlando, Florida. In partnership with The Villages Health, the largest multi-specialty practice group in the Tri-County area, Surgery Partners will be the exclusive owner and operator of The Villages Multi-Specialty ASC, serving its over 120,000 residents and growing and supporting The Villages Health more than 40,000 active patients. Both of these investments are expected to open no later than the first quarter of 2020, and to be significant contributors to our long-term organic growth. Let me hand the call back over to Tom for an introduction and overview on our fourth quarter financial results and initial 2019 outlook. Tom?
Thank you, Wayne. Today, I'll spend a few minutes on our fourth quarter and year-end 2018 financial performance, starting with some of our key revenue drivers, then moving on to adjusted EBITDA, cash flows, and our 2019 outlook. Starting with the top line, we ended the year with strong revenue growth, achieving approximately $500 million of fourth quarter adjusted revenues, up 8.5% as compared to the prior year quarter. Our full year adjusted revenues rose to just over $1.8 billion, representing year-over-year growth of nearly 35%, primarily related to the August 2017 acquisition of National Surgical Healthcare. Surgical cases also increased to approximately 137,000 cases in the quarter, and we ended the year just below 521,000 cases, representing year-over-year growth of 11.2%. On a same-store basis, total company revenue was up 7.4% from the prior year quarter.
For the full year, our same-store revenue was up 5%, driven by higher net revenue per case, partially offset by a small decline in volumes. As we reflect on our quarterly trends in cases and revenues, we are quite pleased with the progress we have made regarding our strategic initiatives around physician recruitment. In 2018, we recruited over 500 new physicians that began using our surgical facilities to provide services to their patients.
The impact of these new physicians is particularly evident when comparing our first half volumes to our second half, as same-store volumes improved from a net decline of 2.7% in the first half of 2018 as compared to second half performance of 1 percentage point of volume growth, nearly a 4 percentage point swing. Turning to operating earnings, our fourth quarter 2018 adjusted EBITDA was $73.3 million, a 14.7% increase over the comparable period in 2017, bringing our full year result to $234.8 million, consistent with the high end of our previous guidance range. Our fourth quarter adjusted EBITDA margin improved to 14.9% from 13.9% as compared to the prior year period, and on a full year basis, our adjusted EBITDA margin also increased by a point to 13.3%.
During the quarter, we recorded approximately $8.4 million of transaction integration and acquisition costs, including over $3 million of costs associated with recent headcount actions and additional one-time costs to implement some of our 2019 cost savings initiatives as we continue to integrate legacy NSH processes under one corporate umbrella. Over the last several quarters, we have been transparent with investors as we focused management time and effort on our core short-stay surgical facility business and also shifted focus away from our ancillary and optical segments. We explored strategic alternatives for our optical segment and completed the sale of two of those component businesses in 2018. We also closed or consolidated 16 physician practices and brought much of our lab business in-network.
Consistent with this strategic shift and our current outlook for these businesses, in the fourth quarter of 2018, we took a $74.4 million non-cash goodwill write-off in our ancillary and optical segments. Further, as Wayne discussed, we also recorded a charge of $46 million relating to pending matters with the federal government. We are pleased that we continue to make progress to eliminate distractions at our ancillary and optical businesses so we can continue to focus management time and effort on the core elements of our growth strategy. Moving on to cash flow and liquidity. At the end of the fourth quarter, the company had cash balances of approximately $184 million and approximately $71 million of availability under our revolving credit facility. Of note, during the fourth quarter, Surgery Partners had net operating cash inflow, defined as operating cash flows less distributions to non-controlling interests of $16.6 million.
We deployed approximately $52 million for the acquisition of a majority interest in three ASCs, and we used approximately $62 million for payments on our long-term debt. Based on the current status of our discussions with the federal government, we project that we will pay any potential settlement out of currently available resources. The ratio of total net debt to EBITDA at the end of 2018, calculated under the company's credit agreement, declined sequentially to approximately 7.7 x, primarily as a result of higher trailing 12-month credit agreement EBITDA and the positive impact of October acquisitions net of divestiture activity. The company has an appropriately flexible capital structure with no financial covenant on the term loan or our senior unsecured note.
We continue to project that the company's total net debt to EBITDA ratio should naturally decline over time as our business continues to grow, but may fluctuate on a quarterly basis based on timing of cash flows. I'd now like to turn to our 2019 outlook. In considering our outlook, it is first important for investors to understand some of the headwinds and tailwinds that are facing our business in 2019. The primary headwind that we considered was that the company undertook substantial portfolio optimization efforts in 2018. All told, we project that entities that are not part of our current portfolio would have achieved over $100 million of 2018 adjusted revenue, and as a group, they contributed positively to our 2018 adjusted EBITDA. Those revenues and profits will not recur in 2019.
Some of the tailwinds that we consider for next year include improving same-store volume and revenue growth dynamics in the second half of 2018 that we expect to persist and accelerate into 2019, the annualization of our 2018 acquisitions, including three ASCs that we acquired in late October, the expected impact of our efficiency efforts, including insurance consolidations and completed headcount actions, and the expected benefit of our ongoing procurement and revenue cycle efforts. As we consider these headwinds and tailwinds, we believe that our year-end 2018 adjusted EBITDA represents a reasonable baseline off which we can grow at a double-digit rate in 2019. We also project that we will grow net revenues by low single-digit rates in 2019, despite divesting nearly $100 million of annualized revenue from our 2018 reported results. When normalized for these divested revenues, our 2019 growth is projected to be high single-digits.
As a matter of prudence, we do not include the impact of unidentified M&A in our forward outlook, as we want our teams focused on deals that meet our long-term strategic objectives, not a short-term earnings goal. As Wayne indicated, we do not anticipate that our de novo facilities in Idaho Falls and at The Villages will open until the first quarter of 2020. In the event that these facilities open in 2019, we plan to exclude their operating results from our adjusted EBITDA presentation. One final thought on our 2019 outlook. While we do not provide quarterly guidance, the impact of our portfolio optimization efforts will be more prominent in the first quarter of 2019, resulting in mid-single digit year-over-year adjusted EBITDA growth rates.
We project that this impact will subside as we progress throughout the year, resulting in accelerating year-over-year growth rate by the fourth quarter. Our new management team spent the last year executing on a new strategy. It's exciting to be able to see the beginning of those efforts in our fourth quarter results and our 2019 outlook. Same-store volumes are growing again, cost efficiencies are manifesting themselves in our results, our M&A efforts are paying dividends, and we are planting new flags with our de novo activity, a combination that we project will enable 2019 to be the first year of multiple years of double-digit adjusted EBITDA growth. With that, we'll open the call for Q&A. Operator?
Thank you. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Please ask one question and one follow-up question, then re-queue for additional questions. Our first question is from Brian Tanquilut with Jefferies. Please proceed with your question.
Hey, guys. It's Jason Plagman on for Brian this morning. First question, embedded in your 2019 outlook, can you just comment on what you're thinking as far as same-store revenue growth? Should we expect similar performance to the second half and then some acceleration in the second half of 2019? Or, just how you're thinking about the trajectory of organic growth in 2019.
Hey, Jason. Good morning. Yeah, if you think about, as we talked about, what we see as the parameters for organic growth, normally you would target 2%-3% in rate and then 2%-3% in volume. Obviously, we're very encouraged at what we saw from a volume perspective, especially the trends in the back half of 2018. I would actually anticipate our volumes probably to be more to the upper end on that 2%-3% over time. On the rate side, if you remember, if you look at our book of business, a substantial part of our book is still Medicare related, obviously the ability to be at the 2%-3% within that range, probably closer to the higher end over time. Again, as we renew commercial contracts, it takes about three years to get fully through the cycle.
I wouldn't necessarily take what you saw in third and fourth quarter because there was some low-hanging fruit for us to go after very aggressively. I think long-term sustainable rates you should think about for 2019 and beyond is in that 2%-3% rate, 2%-3% volume, so 4%-6% range.
Jason, it's Tom. Couple of things I just might add. Mix matters, as you look at our mix in 2018, some of the places where we fell a little bit short relative to our expectations were in some of those lower rate but more frequent cases, so high volume, low dollar cases. As some of that volume comes back, you might see a little bit of a negative impact on the rate line there, that would be incorporated in and consistent with our volume guidance that we talked about. The second thing I would point out is that as you look at the business, you look at the way that we've historically reported same store, we actually include the ancillary revenues in the numerator of that, whereas they have an adverse impact because there's not really surgical case volume associated with them.
As we go into 2019, we're evaluating whether or not we actually might pull those out and strip this down so it's more of a surgical same-store metric for investors.
Okay. That's helpful. Just any update on the physician recruiting side. Are you still adding headcounts and investing there, or are you comfortable with the level of recruiting heads that you have right now?
It's a great question. I would say right now we actually like the run rate of our current headcount that we have. We're not looking to add at this point in time. As you know, you always get to a point of diminishing returns. We're not sure we're at that point yet, but this will be an important year for us. The trends in the back half of the year were quite substantial with the number of new physicians we recruited. We'd like to see if those trends continue in the first quarter or if they start to level off. I'd say at this point, I think we're going to go into this year with full run rate impact now of what we think the right headcount level is.
As you know, we ramped up that recruiting team throughout the year last year. We'll get a little bit of a headwind from the G&A load for them for this year. Clearly, we're getting more than an offset of tailwind from the volume that's coming from the physicians that are being recruited. For now, we're going to watch and see the first quarter. If those trends show there's continued momentum, we may hire more.
Thanks, guys.
Our next question is from Chad Vanacore with Stifel. Please proceed with your question.
All right, thanks. In 2018, you did roughly $100 million acquisitions. Should we expect that to be about the same level in 2019?
Hey, Chad, good morning, and appreciate the question. We're going to still target in the $80 million-$100 million annually over time is what we plan to deploy. I would say that we're finding that assets that are available in the market in some cases are becoming a little more richer. I don't think we're a surprise anymore to people, we're going to be very selective on those transactions. I would say over time, that that's our targeted range is the $80 million-$100 million, and we're going to continue to move down that path this year. We've got pipeline already. We've got some LOIs signed. We'll see if we get them over the finish line, that's where we're at.
You mentioned that in seeing assets a little bit richer, I think in your prepared comments, you said that you were seeing assets or did acquisitions at sub-7x EBITDA. Is that right? How does that compare with historical?
Chad, that's a great question. Yes. The items that we transacted on last year, we finished at a sub-7 x, which we find highly attractive. We felt very good about the assets that we got, and we feel very good about the markets in which we targeted. What I'm referring to, where we're starting to see some of the valuations creep up with, is on what I'll call pure play specialties in MSK. I think we were a little bit of a secret last year and people weren't paying attention, and we got into some of these markets, and we're finding that those valuations are moving up more into the 8x and 9x range. Not that we don't still find that attractive, especially relative to our current multiple, but we still think there's a lot of ASCs.
There's over 5,000 ASCs out there, and many of those are in the attractive specialties we like. We'll just be selective. We find that generally we get better multiples on non-brokered deals than brokered deals, and we like the idea of not just sitting in a tree and waiting for the opportunities to come, but to actually get out and hunt for those opportunities. We've got a nice pipeline of both in-market as well as broker opportunities in front of us. We're going to continue to be selective like we were last year. Just as a reminder, last year we targeted $80 million-$ 100 million, but it really wasn't until October 31st that we got half of that done because we just weren't liking where some of the multiples were falling out. I think we'll continue to target that. I don't see that changing.
We'll be very selective.
All right. On the flip side of the acquisitions, you've got dispositions. You said you disposed of about $100 million in revenues in 2018. Can you give us an idea what you did in the fourth quarter? I think you had a couple surgical hospitals that you were going to deal with. What's left to be done in 2019?
I'll let Tom talk about the two surgical hospitals because those actually were disposed of on the last day of the year and actually represent the vast majority of that $100 million. I'll let Tom give you some statistics there. I would tell you relative to going into 2019 and pruning activity, the good news, Chad, is that we've really done what I would call the heavy lift in 2018, those items that weren't core to our long-term strategic growth goals. In 2019, I'll never say that we're done with pruning, but now our shift moves more into the are we better off owning the asset or not? Can we grow it at a rate faster than what we could grow other assets if we redeployed the capital differently? I would say we're moving into what a mature pruning organization should look like.
I do think there could be some in 2019. I would tell you, I don't have anything specifically targeted right now, I will tell you, we are looking at our entire portfolio around optimization strategies, very different than what we did in 2018. Tom, do you want to comment a little bit about the revenue and in particular those two facilities?
Yeah, absolutely. As you look at, we did have two surgical hospitals that we either closed or sold essentially on the last day of the year. That was a pretty large effort. We're really proud of what the teams were able to accomplish there and how they were able to accomplish it. Those two facilities in and of themselves were nearly $70 million worth of calendar year revenue, and were positive contributors to the enterprise. They were below our target margin range. The remainder, we've talked about the physician practices that we closed. We've talked about the ASCs that we either closed or sold. All of those things contributed to the remainder. As we look at that, we wanted to highlight for investors, particularly as you look at our revenue guidance, it's more robust than it looks.
We wanted to make sure that we quantified that for investors so that they could understand that while we think this is the right thing for the enterprise, that it makes some of the metrics look a little funny.
All right. Just one more question on the changes and closures. How is it going to affect your rent going forward?
Pardon me? How is it going to affect the what?
The rent, your leased assets.
Are you talking about the lease accounting standard that we will implement in the first quarter?
No, I'm just talking about your quarterly lease payments.
I don't think it should have any impact on that. You're talking about the change in accounting standard? I just want to make sure I understand your question.
Yeah. You pay rental expense every quarter, every month. You've sold and closed a few hospitals, how does that affect your rent going forward?
Oh. There's no impact. We actually don't own those facilities, and those have been shut down. There is no impact to us on future rental commitments. Where we do have a rental commitment in the future was on our Chicago facility that was NSH's historical headquarters. As you know, we closed and consolidated that facility last year. We recently signed a sublet arrangement. That arrangement goes through 2023, and we were able to get the vast majority of the cash flow on the subletting arrangement back into our pockets prospectively. No real impacts on any of the facilities we closed at [12/31/2018]. The only one that has a net negative arbitrage for us in the short term is the Chicago facility, and that's a short-term cash flow arbitrage.
All right. Thanks for taking the question.
Thanks, Chad.
Our next question is from Ralph Giacobbe with Citigroup. Please proceed with your question.
Thanks. Good morning. Just hoping you could talk a little bit more about the payer mix dynamics in the quarter. I think you talked about a 200 basis point deterioration, and I guess a little bit surprising just given seasonality and sort of the whole argument around high deductible health plans that would seemingly impact more on the commercial side. Any commentary there and maybe what the outlook is there for 2019? Thanks.
Hey, Ralph, thanks for the question. Good morning. It's an interesting trend that we don't necessarily predict is going to slow. As we've talked about, as deductibles continue to rise for consumers through commercial payers, we think this is a dynamic that will continue to push over time and actually put more heavy weight. While fourth quarter, we saw our largest commercial mix throughout the year, it wasn't as large as what we've seen historically, by two points.
I'm not so sure this is something that's going away. I think this is the new trend, I still think commercial will be much heavier for us in Q4, like it's been historically. I think you'll continue to see the Medicare mix grow. The other thing I would highlight is we are being intentional in our behaviors. We like the opportunity to service customers and physicians, regardless of them having commercial or Medicare backgrounds. We still believe, similar to when I was at Anthem, that you have to learn to participate in the federal government programs. These are programs, over time, if done well, can become quite profitable to your organization.
We've also got a very intentional shift to not only continue to go aggressively after the commercial members, but we're equally interested in filling our facilities, and bringing this additional volume, and quite candidly, our clinical quality and services to those customers. I don't think you'll see that shift necessarily change, and our efforts are equally targeted.
Ralph, it's Tom. While the dynamics in the quarter were a little bit odd, I think Wayne points to the right one, which is incremental volume above your expectations, no matter where it comes from, is always a good thing. That's part of what I think you see in the quarter, just higher volumes are always good or better, if you have unused capacity. As you look at the quarterly dynamics, we are a little bit down year-over-year on the commercial side and a little bit up on the government side. As you look at the year-to-date dynamics, commercial is actually still up close to a point based on the numbers that I have. It's just really what happened inside the fourth quarter that is a little bit unusual.
Okay. All right. That's helpful. Just my follow-up, I just want to clarify the adjusted EBITDA growth guidance of low double digits. Is that off the reported for 2018? Is that normalized for divestiture? Maybe just given all the moving parts, can you just give us what the 2018 EBITDA baseline that you're using that ties to that low double-digit growth guidance? Thanks.
It's our printed results, Ralph.
Okay.
I think that as we think about it, the $100 million of annualized revenue has had a positive impact, which is worth probably a couple points in and of itself. As you think about where you want to be inside that range, I'd make sure that you give that some consideration. We're using our current baseline of 2018 reported results of [$234.8 million].
Okay. That's helpful. Lastly, I know you said you pruned the $100 million of revenue. You said EBITDA was positive. Are you not breaking out what the actual contribution was of EBITDA for those divested or store closed?
That's correct, Ralph. It's really our preference not to break it out. You can probably imagine, we continue to have ongoing dialogue regarding other assets we're at least evaluating, and we don't want to actually negotiate against ourselves on anything in a public call. What we will say is these items did contribute positively, net positive. Some actually were net negative, but many assets, when you add them all together, were a net positive contributor to our EBITDA.
They were below the average margin and certainly below our target. Okay, thank you very much.
Our next question is from Ana Gupte with SVB Leerink. Please proceed with your question.
Good morning. On the 2% - 3% volume growth that you're projecting same store going forward, just following up on Ralph's question, I guess, beyond the mix from commit, can you firstly tell us what is Medicare versus commercial in your expectations? Then also, how much of it is coming because you have now rehauled your surgical workforce and that's giving you some company specific tailwinds in the near term relative to more broadly from a secular standpoint. What should we think about for growth rates in this whole ASC space, and will there be any point where there is an inflection because of bundling or other reimbursement models that you might be exploring? Both you and Tom come from the payer space.
Ana, as you look at the mix, how that ultimately plays out is that we expect that we'll see higher government mix early in the year because of deductible shift, then we'll see more robust commercial mix as we get later into the year. We're not giving specific guidance on what it is that we assumed on that. We're still looking at, as Wayne said, we think that 2019 is a good year for the model as we've outlined it, 2 %-3% of volume growth and 2 %-3% of rate. Ultimately, how that mix develops over the course of the year will be important, in particular to the rate category. I would say that there's two dynamics in there.
It's the payer mix dynamic. It's also just the category specific or the specialty mix dynamic as well, where we are anticipating that we will see a little bit higher mix this year of some of those.
Higher volume, lower net revenue per case items that really underperformed in 2018 relative to our expectations. I don't know whether, [Wayne], you want to talk specifically about some of the bundling efforts?
Yeah. [Ana] , I really appreciate the question on the bundling, and in particular, the idea that we can now strategically start to really focus on what we do best, which is short stay surgical facilities. By eliminating many of these other distractions, I'll share some early data points that I find really encouraging for the company and what the team's been doing so far. If you were to look at the number of total joints that we did in 2017, we averaged about 15 total joints a quarter. Not very inspiring, smaller number.
In 2018, we rolled out a new program mid-year using bundling as an opportunity to save the payers a fair amount of money and move many of these procedures from a more costlier setting to a less cost setting in our case. To give you a statistic, our average total joints we did in 2018 went from 15 total joints a quarter in 2017 to over 60 total joints a quarter in 2018. We didn't roll that program out till mid-year, so to really put it in perspective, we did over 100 total joints in the fourth quarter alone of this past year in terms of total joints. Now, I wouldn't run rate fourth quarter because keep in mind, that's when many deductibles are met and many individuals were going in from a commercial side as well.
I think it gives you an indication of these initiatives take time to build, and they're like a small snowball that gets going down a hill, and it really starts to create momentum. As you can imagine, for us to average 60 total joints , that means we're really back and loaded on how many total joints we did in the back half of the year with over 100 + total joints in the fourth quarter. We like that this momentum can really continue. We piloted this program in four markets in 2018, and we are now rolling it out to four additional markets in 2019. If we continue to like how this goes, we'll continue to expand.
Right now, as you know, you've got to have the equipment to roll these out, you've got to have the space to roll these out, and you've got to have the block time to do this. We wanted to make sure we could do it well and do it right, but we're really encouraged at what we can do with bundling at this point and look forward to seeing how this impacts not only 2019 but 2020 and beyond.
That's helpful. Just on the bundling, that's really encouraging. To what degree are the payers concerned more about the, how much is it the reimbursement angle relative to safety concerns, perhaps? Because in an inpatient hospital bundle, there's like a natural post-acute provider, and it's not a direct discharge back to home, if you will. Then how does that correlate with any new de novos and these new models that are coming out with care suites and some short-term stays? Is that helping NPS scores for either you or other players?
Yeah. First of all, what I would say is to date, we've kept our bundles to a very finite level, same day. For us, basically, we're covering facility fee, prop fee, anesthesia, et cetera. As you know, the clinical quality scores and ASCs, and obviously SP in particular, are quite strong. We really have not had the similar impacts that maybe larger facilities have had in terms of readmittance or post-infection rates. That being said, I will say that the payers are encouraged by what they're seeing with what we're doing. We've had some approach us about would we be willing to take on a more extended bundle, maybe a 90-day bundle. At this point, we are entertaining those discussions. As you know, we like being who we are, which is short stay surgical facilities. That's what we do well.
We recognize that there's good partners out there for us, we're evaluating potential partners that we may consider a pilot program for an extended bundle, going to something more like 90 days, and allowing us to participate in a number of avenues, including the fact that we like the clinical quality out of our facilities. We already know today whether or not somebody has to come back to have a new joint replacement done or a new hip. We already know that. We have very little readmittance to what we do today to begin with. In some ways, if we do this program, we'll bet on ourselves for quality. Right now, we haven't picked the right partner or selected the partner that we think can help us manage this properly yet.
Okay. Helpful color. Thanks, Wayne. Thanks, Tom.
Thanks, Ana.
Thanks, Ana.
Our next question is from Frank Morgan with RBC Capital Markets. Please proceed.
Good morning. Wayne, a question for you. Now that you're in place, you've got your strategy implemented, your portfolio, you're starting to get that shaped up the way you want to look. Just curious your thoughts about the long-term margin potential for your portfolio. We look at some of the other providers and obviously much, much higher margins, EBITDA margins. I'm just curious, could you give us a little color around where you think the long-term potential is? What are you looking to see those margins get to over the next two or three years, given the strategy you put in place?
With regard to the portfolio today, when you look at margins, is it real chunky between, is there a weighting or a distribution where you have a lot that are low margins, or do you have some unusually high margin ones that influence the overall portfolio average for EBITDA? That's my question. Thanks.
Hey, Frank, good morning. It's a lot of questions weaved in there, but let me maybe just take a quick step back and start with the last part of your question, which is clearly our mix of business produces different margins depending on the type of procedures. As you know, certain businesses like GI are very high margin businesses, large volume, good cash flow businesses. They don't necessarily move the needle meaningfully from a growth perspective, but we like them. As you know, one of the things that we did in 2018 as we developed our strategy was to say, margins absolutely matter, but we're an organization that actually wants to grow at absolute dollars in EBITDA. We're an organization that would like to have more free cash flow to deploy in a very fragmented market. So margins are not the primary factor.
That being said, I would expect continued margin expansion over where we finished 2018, I think we'll move in the points over time. We are going after Medicare, though. As you know, that does impact margins, quote unquote, "negatively," but it contributes positive EBITDA, we're a very fixed cost leverage type organization relative to our facilities and their locations. I would say that a lot of the margin expansion it's not going to skyrocket in the next year or two necessarily because it's a hybrid strategy of how do we grab more market share, both commercial and Medicare, while we shift over time into these MSK, very high margin businesses that we really like, as well as very high dollar per minute contribution margin as well, in terms of facilities. Probably a long way of saying your answer, yes, margins will be moving up.
I wouldn't say that we've laid out specifically as much of a target margin, as much as we've laid out target initiatives of what we want to capture in terms of market share and what we want to capture in terms of G&A leverage.
Frank, just mathematically, if you're only growing revenues off of your current base by mid-single digits and you're growing adjusted EBITDA by double digits, you're going to see margin expansion next year. That's a down payment as we try to become more efficient over time. There's essentially embedded margin expansion in the initial guide that we gave today.
Got you. One follow-up and I'll hop. In terms of just the de novo developments, I'm just curious, one of those was a hospital. Beyond that one, any other likely chances of future hospitals, or is that sort of a one-off situation? Thanks.
Yeah. At this moment in time, we are targeting more the ASCs. It was very one-off. As you know, hospitals are very sizable investments. If you're familiar with the Idaho Falls community and the surrounding territories, we have an exceptional product in the market. We know that the demand chain is quite substantial there, and for services, we know that we could offer much more. In working in concert with payers, we know they're definitely looking for an improved quality at an improved cost. We have a surgical hospital facility over there, but we think we can actually create an even bigger ecosystem with this. I would say outside of Idaho Falls, no, we're not targeting de novo hospitals. We are targeting expansion in some of our surgical hospitals. We're adding ORs, et cetera, but not what I would call full-blown from scratch build-out.
We are doing a number of smaller de novo ASCs that we did not talk about, again, generally focused around the procedures that we like, MSK being a priority.
Okay. Thank you very much.
Thanks, Frank.
Our next question is from Kevin Fischbeck with Bank of America Merrill Lynch. Please proceed.
Good morning. This is Joanna Gajuk filling in for Kevin today. Thanks for taking the question. Just clarification question, follow-up question on the guidance, just to make sure, the comment was that you do not include the deals that you do not have visibility into. Are there deals included in the guidance? I guess you do talk about assuming that you're going to spend $80 million-$100 million per year on acquisitions. Just want to clarify how much of M&A is included in the guidance for 2019.
Appreciate the question. Just to clarify again, where we finished 2018 as a starting point, we'll grow double digit above that. When we say we do not include unidentified M&A, it means any new M&A that we plan to basically close and consummate in 2019. For example, those transactions we got done in October of 2018, clearly the run rate of those are included. Any new transactions we're doing from the $80 million-$100 million is what we see as more the substantive upside. In essence, we've signed on to agreements and deals in 2018 that will run rate into 2019, but this would be an incremental $80 million- $100 million that we would deploy that we have not contemplated in our guidance.
Great. That's very helpful. Also, there were some comments made in terms of some of the new cost-cutting initiatives. Is there any additional color that you can provide for 2019 plans?
Some of the items that we undertook in 2018 will support some of the 2019 growth. They'll be a little bit more back-end weighted, and that's why we think Q4 will be strong year-over-year lift for us. Just to give you some examples of things we did in 2018 that we plan to replicate in 2019. One was we took our first round of procurement. As we mentioned, as we looked at sourcing and suppliers, we focused on the top 20 contracts out of the gate. We focused on the new GPO contract. I would say that we essentially went after low-hanging fruit. We really hadn't done strategic sourcing yet. This was just about obtaining the best pricing that was available in the market for a company of our size and scale.
In 2019, our goal is to start the much more in-depth strategic sourcing with that creating hopefully value in 2020 and beyond. A second example is that we rolled out an enterprise employee benefit plan. We were a very fragmented organization with many different health plans across our organization, we went through a new open enrollment in the fourth quarter of 2018 for new benefits starting in 01/01/2019. We expect to see the benefits of that to our associates because we've implemented a number of wellness programs for them. Ultimately, as you know, over time, these wellness programs end up benefiting you when you're self-insured.
We expect to see those benefits actually start to really ramp up at the end of 2019 as people work through their health benefits and work through their deductibles. Then finally, I would just simply state that 2018 was about, we spent so much energy, in some ways I would say we were so distracted by all the things we had to do to get this asset to where we want it to be at, that really, we haven't really got into what I would say the efficiencies of leveraging our scale as much as we could. Again, 2018 was really about low-hanging fruit. 2019's about strategic leverage, and where we can really take advantage of more fixed cost structure and bring more value creation in.
We'll be providing updates throughout the year, similar to what we did in 2018, around what are we doing, when do we think value creation will start, and then how does that translate to the future. Probably by our second quarter, we'll provide even more insights on that.
Just to follow up on that, so how much would you say of the margin improvement came from the actions you took in 2019 on the cost-cutting? Because the margins did improve, especially Q4, nicely, and even for the year. Is there a way you think about how much of that improvement was due to these actions that you undertook?
Well, in the most basic sense, if you think about it, since we exclude unidentified M&A, all the margin improvement is a combination of our G&A activities and our rates that we're getting on volume. It's all organic. It's somewhat fungible because as you know, the more volume I can drive on a fixed cost basis, did the revenue drive the margin improvement or did the reduction in cost drive the margin improvement? Because they're fungible, it's hard for me to parse those two out. I do think it's fair to say that we were targeting for Fit for Growth going into this year, the 3%-5% improvement in G&A efficiency. If you think about that just from a lens, you can back into what that would've done for margins.
Great. Thank you so much.
Our next question is from Whit Mayo at UBS. Please proceed with your question.
Hey, thanks. I might just ask that last question a different way. Is there any way to put just dollar numbers around the strategic initiatives from procurement GPO just as we think about 2019? I get the fungible comment on margins, but just in terms of dollars, that would be maybe helpful.
Whit, if you go back to our quarterly calls in 2018, I'm trying to do this from memory, but I think if you go early in the year, we thought we would be able to target run rate around $15 million from procurement savings. Remember, those did not all inure to us. Many of those are shared with our physician partners. On average, we generally own around 55%-60% of our facilities. So if you wanted to back into a number, you can get a feel for about how much of that is ours. As you know, the GPO contract, for example, and some of the procurement items really didn't start. We didn't get the new contract until third quarter. Many of those contract efforts didn't happen. You're really getting some of that ramp up.
You're not getting the full lift in 2020 because you got a little bit in 2019, but you can see the ramp up if you wanted to back into those numbers, just using that math of giving you a gauge of how much of that just happened from GPO and procurement.
Okay. No, that's helpful. Tom, if my math is accurate, I think you're getting maybe $55 million of add backs to the bank agreement for EBITDA to get to 7.7x. I'm just trying to maybe reconcile what that number means for growth expectations in 2019, then maybe is there any way that we can forecast what the add backs could be? I know that that's really a moving target based off of a lot of these initiatives and acquisitions when they crystallize in your mind.
Yeah, Whit, I think that's a fair question. As you look at our credit agreement for certain types of initiatives, we actually get to incorporate 24 months worth of value associated with those. As we think about our procurement initiatives and we think about our revenue cycle initiatives, those are the places where we have gone out 24 months. You're looking at two years worth of potential upside associated with the dollars that we have invested today and the initiatives that we have in place. You have acquisitions in that number, on the day that we do those acquisitions, we put the full next 12 months into our roll forward less for the October acquisitions, for example, you would see a 10-month impact in the pro forma number at the end of the year.
We would also subtract out of that the value of the divestitures that we have executed. You would also see inside those numbers some of the efficiencies that we are expecting over the course of the next 12 months, particularly from some of our headcount and other consolidation actions, some of the corporate synergies that we've talked about would accrue in 2019. Those are probably the majority of the adjustments that you would see inside that credit agreement EBITDA.
Maybe the most simplistic way to look at it, if that $55 million, if that's the right number, if that captures future growth that you expect to obtain in the next 24 months, that should be at least an expectation for what we could see in two years, at least based off of what you've identified today. Is that the best way to look at the $55 million?
Yeah. It's less about growth. It starts with the LTM calc for the EBITDA, and then it adds essentially the value of initiatives. Where you can think of it as I've made the investment, but the investment hasn't borne fruit. What's the value of the investment over the course of the next 12 or 24 months? It isn't really, "Hey, I think I can grow my organic." Although there is a very small item in there associated with some of the run rate of our physician investments because our physician recruiting investments, again, we're bearing that G&A, but we haven't seen the full run rate of that.
Got it.
Otherwise, it's not contemplating organic growth in there. It's contemplating specific items that we've invested in, and the benefits that we expect to receive.
Okay, maybe two quick ones, if I can. I'm just wondering if you guys looking across the enterprise are doing anything differently with your anesthesia strategy. Just wondering if there's anything new, how you're using CRNAs or groups, anything that's different in GI or other specialties at this point?
Yeah, appreciate the question. The short answer is, not yet. The primary reason has been that our focus has been so much on pruning our assets this year and getting to the core ecosystem, that our anesthesia assets were performing well and have continued to perform well. They've been a lower priority. That being said, I will tell you, it's a focus of ours in 2019. It's one of the areas that we actually recently met with as a team with our board about some of the opportunities we want to evaluate deeper within our anesthesia business. At this point, we have not gone deep yet, and that's part of our focus for the upcoming year.
Any way to maybe to elaborate more on what those initiatives would be? I think some other ASC groups have insourced a lot of the anesthesia, so I'm just kind of wondering what you're thinking about.
Well, as you know, for those assets that we own, we actually currently insource. In one case, we actually do outside business as well. What we like about the anesthesia business is not only the ability to control the schedules and work with our doctors, and our patients love it, but we also like the idea of the flexibility it gives us when we receive bundle payments, for example, on total joints. What we're trying to evaluate strategically is, are there ways to leverage this even further and grow there?
As you know, there are organizations that do nothing but consolidate this space and specialize in this space, it's an integral part of what we do, we're trying to evaluate other ways for us to actually have a similar growth strategy that could be developed within it while not losing focus on our core, which is short stay surgical facilities.
Yep. I'm good. Thanks, guys.
Thanks, Whit.
Our next question is from Bill Sutherland with The Benchmark Company. Please go ahead.
Hey, thanks, and good morning. Real quick, back to Whit's question about leverage. Since we can't really calc it very effectively ourselves, where should we think about the 7.7 x directionally going forward?
Bill, we actually talked specifically about this in the prepared remarks. The plan that we have, and I don't think that this is new or something that we haven't talked, is really to grow into the leverage. It's part of the reason as you think about some of the M&A commentary that we made earlier, we're focusing on or our preference would be to have an average multiple of execution that's below our leverage ratio, because it helps. We look at those transactions as both an opportunity to grow, but also an opportunity to delever. The timing between quarters, that number on leverage may fluctuate, but our goal is to drive it down over time as we grow the EBITDA of the business.
Okay, there's no plans on the debt structure this year. I know you did some rate swaps and so forth to fix more of it last year.
We're always evaluating the debt structure. We have some nearer term maturities. We're looking at those. As we think about the value creation from the deployment of capital, it's something that we constantly consider. We're looking to deploy that capital in ways that would be accretive to the leverage ratio overall.
Understood. Last one, Wayne. You've talked in the past about going a step further with the payers than just risk sharing, bundling, and actually some strategic co-investment discussions. I'm wondering if there's any update on that direction. Thanks.
Yeah, Bill, thanks for the question. The short answer is, we have a couple of lines in the water right now that have got good momentum. We've got NDAs signed. We are looking at actually doing co-ownership with a named payer that people would recognize, and the concept being that we're looking at both de novos with them. In fact, we're recruiting physicians right now regarding the de novo, and we are looking at potentially even jointly acquiring a facility together at this point. I would say it's no longer early stages, these again have long digestive periods. Yeah, we've got a couple lines in that we're feeling encouraged about at this point. We're hopefully going to be able to show the payer community the value we can continue to bring.
We're excited about what we did on the bundle front, and we see that getting momentum. I think we're trying to show them the opportunities of having even more influence if they partner with us. More to come. Hopefully throughout 2019, we'll be able to announce a couple.
Great. Thanks again.
Thank you.
I would like to.
Before we.
Go ahead. Closing comments from Wayne.
Before we conclude our call, I want to take a moment to say thank you to our 10,000+ associates for their contributions. This has been a heavy lift year for the team. I know I feel privileged to be able to participate in this journey of improving healthcare and making it more affordable for Americans. As we execute against our goal to become the preferred partner for operating short-stay surgical facilities across the U.S., it is the daily efforts of each and every one of our employees that will get us there. Thank you for joining our call this morning. Have a great day.
Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a wonderful day.