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Surgery Partners, Inc. (NASDAQ:SGRY)
Q2 2020 Earnings Call
Aug 5, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Surgery Partners, Inc. Second Quarter 2020 Earnings Call. [Operator Instructions]

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.

Tom Cowhey -- Executive Vice President and Chief Financial Officer

Good morning. And welcome to Surgery Partners second quarter 2020 earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today are Wayne DeVeydt, 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?

Wayne S. DeVeydt -- Executive Chairman of the Board

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 second quarter results. Over the past two 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 that is 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 -- an unprecedented crisis like COVID-19. More importantly with the growth engine we established, be able to survive and continue to drive given our differentiated strategy and assets.

As you can see from our second 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, 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-19 as 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 and 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 as 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 a lot more procedures to be done safely and on an outpatient basis and it should be up to physician 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 second quarter has remained resilient. Of particular note, given the disruption we've experienced musculoskeletal procedures were more than 700 basis 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 and 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 2019. 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 second quarter results in this very challenging environment, there is still much uncertainty. We are humbled that 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?

Eric Evans -- Chief Executive Officer

Thank you, Wayne. And good morning. Today, I'd like to review highlights of our most recent results, provide an update on our COVID-19 response and outline our plans to navigate this crisis throughout the second half of 2020. Tom will then close our prepared remarks with greater detail on second quarter financial results, before we take questions.

From March 14 when the surgeon general of CMS and some states starting 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 the 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-K on July 22, our same-store cases for volumes as a percentage of prior year totals increased from 19% to 93% from April to June. Today, we announced that our second quarter 2020 Adjusted EBITDA was $58.2 million inclusive of $27 million 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. That 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 and focus and frequency and most the only pre-screen 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 using quantity of PPE, Personal, Protective equipment. Our teams have been hard at work navigating the supply chain implications of COVID-19. While demand for critical items remain 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 vans 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 hot spot geographies, including Texas, Florida and California to understand emerging trends and to take mitigating actions. I have personally visited a number of the hot spot locations over the past two 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 healthcare 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 2020. As surgical volumes started to recover during the second quarter, we sought to manage our expenses, so the return would lack 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&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 stand-alone facilities across the country now more than ever see the value of being part of a larger organization. Given the COVID-19 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 had been the primary drivers of this shift pre-COVID, and we believe that patient and physician sentiments in our current environment will further propel this shift for 2020 and beyond. This has been our company's differentiation and now more than ever, due to COVID-19 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 million of gross proceeds via an add-on offering to our 2027 notes. With the proceeds from this most recent offering, we plan to focus on growth-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. Through this recruiting and technology infrastructure investments to further improve the effectiveness of our lead generation in 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&A pipeline of transactions heavily focused in orthopedics, cardiology and other key specialties across the country.

We believe this crisis is fundamentally changed the way patients and surgeons were thinking 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 2020. More importantly, if we are able to return to our pre-COVID run rate in the back half of 2020, 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 in 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 in 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 three 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 include -- 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 cover procedures list at ASCs as they look to further increase the availability of ASCs as an alternative site of care for Medicare beneficiaries and to allow for a more efficient use of healthcare resources and infrastructure in light of the current COVID-19 crisis. We look forward to continuing to serve our providers and communities by providing safe, convenient, high quality alternatives to this traditional hospital environment.

With that, I will turn the call over to Tom, who will provide additional color on our financial results. Tom?

Tom Cowhey -- Executive Vice President and Chief Financial Officer

Thanks, Eric. First, I'll spend a few minutes on our second quarter financial performance, before moving on to liquidity and some considerations as we move into the second half of 2020. Starting with the top line. Surgical cases declined to just under 83,000 in the quarter primarily caused by COVID-19 related restrictions. Adjusted revenues for the quarter were $383 million, 16% lower than the prior year period. Reported results included approximately $12 million of contribution from our new community hospital in Idaho Falls. On a same facility basis, total revenue declined approximately 18.6% in the second 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 second quarter 2020 adjusted EBITDA was $58.2 million just under a 5% decrease as compared to the comparable period in 2019. During the second quarter, we received approximately $48 million in CARES Act funds of which we recognized approximately $43 million as other income based on lost revenue since the COVID outbreak. After non-controlling interest the grants we recognized in the second quarter contributed approximately $27 million to our adjusted EBITDA. During the quarter we recorded $10.1 million of transaction, integration and acquisition costs. Of note, second quarter 2020 transaction, integration and acquisition costs included approximately $5 million 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 second quarter associated with COVID-19, the underlying momentum remains very positive.

Moving on to cash flow and liquidity. We ended the quarter with a strong cash position of $326 million, which includes approximately $120 million of Medicare advance 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 million after giving consideration to outstanding letters of credit. Of note, during the second quarter, Surgery Partners had operating cash flows of approximately $182 million. We raised approximately $120 million of incremental capital through an incremental term loan issuance in April. And subsequent to the quarter, raised an additional $115 million of incremental senior notes due 2027.

Finally, we deployed approximately $7 million 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-19. Normalizing for the impact of Medicare advance 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 senior notes. As mentioned in the first quarter 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 2020, 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 second quarter is a testament to one, the natural shift of higher acuity procedures to short-stay surgical facilities. Two, our targeted physician recruitment efforts and three, 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 in acuity mix in the second quarter.

We are encouraged by the pace of recovery during the second quarter 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 million to $260 million this year. This indicative range assumes that the volume levels in corresponding specialty mix, payor mix and net revenue per case metrics that we have seen in June persist an improved 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 on to 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?

Questions and Answers:

Operator

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Kevin Fischbeck with Bank of America. Please proceed with your question.

Kevin Fischbeck -- Bank of America Merrill Lynch -- Analyst

Just to make sure that I understand the last comment correctly.

Eric Evans -- Chief Executive Officer

Hey 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?

Operator

Yes, I can hear you. His line is breaking up. Mr. Fishbeck perhaps if you dial back in on a landline, we can take your question. I'm sorry. Your next question comes from the line of Brian Tanquilut with Jefferies. Please proceed with your question.

Brian Tanquilut -- Jefferies -- Analyst

Hey, good morning guys. Congrats. I guess my first question, Wayne, as I think about MSK obviously a big opportunity. 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?

Wayne S. DeVeydt -- Executive Chairman of the Board

Hey, Brian, good morning. Thanks for the question.

Brian Tanquilut -- Jefferies -- Analyst

I meant joint replacement surgery. Sorry about that.

Wayne S. DeVeydt -- Executive Chairman of the Board

So a couple of things that I would respond to regarding your questions. First 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 in 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 that to become more sticky.

Two is, clearly the advantage we have with our facilities is the flexibility in scheduling. And that is something that many inpatient organizations cannot offer the docs and so we don't generally find that stickiness is the concern. In fact, we think during this environment, COVID-19 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 with 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 three years. It 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.

Eric Evans -- Chief Executive Officer

Yes, Brian. So good morning. I 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 are going 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. Its 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 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.

Brian Tanquilut -- Jefferies -- Analyst

I appreciate it. I think as my follow up, Wayne, you're obviously sitting on a lot of cash on the balance sheet. Successful debt raise and I know you're very active in the M&A world, but how should we be thinking about the pace of deals, the makeup of deals, you looking at bigger transactions, given the amount of capital that you have in front of you or is it still the same kind of strategy you are rolling up relatively smaller one-off transactions?

Wayne S. DeVeydt -- Executive Chairman of the Board

Brian, thanks for the question. A couple of things I would highlight. First and foremost, the M&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 is 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 two or three years to start hitting that way. 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 on 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 is no need to bet the farm, things are going well. Our process works well. We're able to plug and play these things inefficiently, but we are looking at some slightly larger transactions maybe we've done over the last couple of years, but focused on a multi-specialty of cardiovascular in 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.

Brian Tanquilut -- Jefferies -- Analyst

Got it. All right.

Eric Evans -- Chief Executive Officer

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 rollout transactions and those continue to be very accretive and they continue to be available to us.

Brian Tanquilut -- Jefferies -- Analyst

All right. Got it. Thanks guys. Congrats again.

Wayne S. DeVeydt -- Executive Chairman of the Board

Thanks.

Operator

[Operator Instructions] Thank you. This concludes our question-and-answer session. I'll turn the floor back to Mr. Evans for any final comments.

Eric Evans -- Chief Executive Officer

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 you 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.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Tom Cowhey -- Executive Vice President and Chief Financial Officer

Wayne S. DeVeydt -- Executive Chairman of the Board

Eric Evans -- Chief Executive Officer

Kevin Fischbeck -- Bank of America Merrill Lynch -- Analyst

Brian Tanquilut -- Jefferies -- Analyst

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