Surgery Partners, Inc. (SGRY) CEO Wayne DeVeydt on Q2 2019 Results - Earnings Call Transcript

Aug. 09, 2019 9:03 AM ETSurgery Partners, Inc. (SGRY)
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Surgery Partners, Inc. (NASDAQ:SGRY) Q2 2019 Earnings Conference Call August 7, 2019 8:30 AM ET

Company Participants

Tom Cowhey - CFO

Wayne DeVeydt - CEO

Conference Call Participants

Kevin Fischbeck - Bank of America Merrill Lynch

Chad Vanacore - Stifel Nicolaus

Whit Mayo - UBS

Frank Morgan - RBC Capital Markets

Bill Sutherland - The Benchmark Company

Brian Tanquilut - Jefferies

Tom Cowhey

Welcome to Surgery Partners second quarter earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today is Wayne DeVeydt, our Chief Executive Officer and Eric Evans, our Chief Operating Officer.

As a reminder, during this call, we will make forward-looking statements. Risk factors that could impact those statements and cause actual 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 and on our most recent interim report on Form 10-Q when filed.

With that, I'll turn the call over to Wayne. Wayne?

Wayne DeVeydt

Good morning. Thank you, Tom. Thank you all for joining us today. Let me first apologize for the technical difficulties that we had right at the beginning, but we look forward to this morning's call with you.

For our call this morning, I would like to review some highlights from our second quarter results. I'll then provide an update on several of our strategic initiatives supporting our organic growth and margin expansion as we drive sustainable double-digit adjusted EBITDA growth. Finally, I'll turn the call over to Tom to provide further details on the quarter.

Starting with the quarter, I'm pleased to report second quarter 2019 adjusted revenues of $452.8 million and adjusted EBITDA of $61.2 million, reflecting continued traction from our strategic initiatives. As we look deeper into the quarter, adjusted EBITDA grew by 10.5% over the second quarter of 2018, consistent with our previous guidance and our targeted full year growth. Same facility revenue increased by 7.9% from the prior year quarter, driven by strong net revenue per case and volume growth.

And while we're excited by the significant growth over the prior year, we'd also like to highlight that this represents our fourth consecutive quarter of same facility revenue and case volume growth, which we believe is a testament to our efforts.

Finally, adjusted EBITDA margins were 13.5%, 100-basis point improvement versus the prior year quarter, which is especially encouraging when considering our government payer mix increased by approximately 200 basis points as compared to the same period in the last year. We are encouraged by our results for the quarter, which as we cross the halfway mark in 2019 affirms our confidence in our ability to grow adjusted EBITDA at a double-digit rate in 2019 and beyond.

Turning to our strategic initiatives supporting organic growth and margin expansion, this morning, I'd like to focus on three topics of interest to investors. First, I'd like to highlight the strength of our physician recruitment efforts, which will not only help us grow our topline organically but are also helping us outperform the broader ambulatory sector.

Second, I would like to comment on our capacity to continue to accelerate this topline growth through the expansion of our existing facility footprint and continued appetite for innovative in-market partnerships. Finally, I'd like to provide an update on the near-term and longer-term tailwinds we see for our industry, resulting from the proposed 2020 Medicare fee schedule that was recently published.

Starting with topline organic growth through physician recruitment, as you may recall, we rebuilt our physician recruitment team last year and made additional investments to empower them with proprietary data and tracking systems, improving our ability to identify and partner with high-quality and high-value physicians. As a result, we continue to outpace new physician additions year to date in 2019 over the accelerated pace at which we were adding physicians in 2018.

As we seek to measure the value of our physician recruiting efforts during the 2019 calendar year, we are tracking three specific cohorts of doctors, those that were recruited in 2017 prior to the implementation of our data-driven approach versus those that were recruited in 2018 and the first six months of 2019 and how each of those cohorts contribute to our 2019 growth.

Some data points to anchor on as we think about the composition of our first half 2019 growth -- our 2018 cohort has already contributed 20% greater case volume in 2019 as compared to the class of 2017 cohort. More importantly, our 2018 cohort of doctors have already produced more cases, have higher net revenue per case and contribution margins in the first half of 2019 than they did in all of 2018.

Early data points are telling us that the class of 2019 is already delivering strong growth, which is on pace to accelerate throughout the year as they become more familiar with our facilities and supporting medical staff. These results dive us increased confidence that our efforts in physician recruiting will have a compounding impact on volume and revenue growth that should allow us to outperform the broader industry for years to come. As you can see in our reported results, our physician recruitment efforts coupled with our targeted net revenue per case improvement initiatives have enabled us to exceed our previously discussed long-term organic growth targets.

Now, I'd like to discuss how we further leverage our existing footprint. Our ability to leverage our infrastructure and investments with our geographic footprint should provide for accelerated organic growth and margin expansion over time. These initiatives range from expansion of existing facilities in terms of number of operating and procedural rooms, the relocation of existing facilities to establish a more attractive physician recruiting space, while enhancing the patient experience, and our ability to enter into attractive, innovation partnerships with existing provider systems.

While we have a number of inflight expansion activities within our existing facilities, I would like to highlight one specific innovative partnership that we recently completed, which leverages our current relationship and infrastructure in the Southern California market. In the second, quarter, we acquired a minority stake in management rights in four ASCs in Southern California in concert with UCLA and the Southern California Orthopedic Institute, herein referred to as SCOI, a transaction that we agreed to in late 2018.

As you know, UCLA is one of the most prestigious academic medical centers in the country and SCOI is the largest orthopedic practice in the state of California, with nearly 40 practicing physicians. We successfully leveraged our existing ASC relationship with UCLA to establish a three-way joint venture that would drive accelerated organic growth for all parties and cement our position as the facility management company of choice for this prestigious academic institute.

At a time when many of our competitors are conflicted Surgery Partners' partnership with UCLA and SCOI is further validation of our increasingly unique value proposition. Furthermore, this expansion of our Southern California footprint fits perfectly with our long-term growth strategy and we could not be more pleased to welcome these new centers into the growing Surgery Partners family.

Finally, last Monday, CMS introduced the proposed calendar 2020 fee schedule updates for Medicare's hospital outpatient prospective payments system and ambulatory surgery centers. The proposed rates appear attractive, with increases from musculoskeletal procedures at approximately 2%, ophthalmology at approximately 3%, and gastrointestinal codes at approximately 1%. Based on our case mix, we estimate that we will net at least a 2% increase if finalized, a solid increase that we believe recognizes the quality and value that we provide in the marketplace.

Importantly, CMS also proposed adding multiple high-acuity procedures, including total knee replacement procedures to the ASC covered procedure list. We remain confident that we can provide a high-quality result on these procedures and our facilities as we do them routinely for our commercial and other patients. As an example, in the second quarter of 2019, we conduced nearly 300 total joint procedures in our ASCs alone, which was more than double the amount we did in the second quarter of 2018.

CMS also proposed moving total hip replacements from the inpatient only list in their recent proposal, a step they took with total knees for the 2018 payment year. Hip and knee replacements are the most common inpatient surgery for Medicare beneficiaries, with more than 400,000 procedures in 2014 costing more than $7 billion for the hospitalizations alone. We look forward to seeing the development of the final fee schedule for 2020 and remain optimistic that our ability to access this exciting new market opportunity remains just around the corner.

Before I turn the call over to Tom, I wanted to take a moment to discuss the ongoing public debate over how best to overall the US healthcare system to continue to provide access to quality care while addressing the issue of affordability. This is a topic that continues to receive much focus and why variations in opinion as to how best to proceed legislatively. More importantly, it raises a number of questions for investors as to how Surgery Partners is positioned for the variation of outcomes.

Let me start by saying that we are an in-network business model that focuses on planned procedures. We partner with over 4,000 physicians that share our goal of offering high quality at affordable prices, a goal shared with the payer community. Our business model is uniquely built to address these challenges, which is why we support any legislation that continues to expand access to quality care at lower cost. We believe we are in line with regulators, payers, and patients, and our distinctive business model should prove to be quite resilient in the wide spectrum outcomes that may evolve in the US healthcare debate.

With that, let me turn the call back over to Tom for an overview of our second quarter financial results and 2019 outlook. Tom?

Tom Cowhey

Thank you, Wayne. Today, I'll spent a few minutes on our second quarter 2019 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 topline.

We ended the second quarter with approximately $452.8 million in adjusted revenue, up approximately 2% as compared to the prior year quarter, a result in positions as well to achieve our full year revenue guidance of low single-digit growth or high single-digit growth excluding divested revenues from the 2018 baseline.

Surgical cases were just over 133,000 in the quarter, up 1.2% from the prior year period, despite the loss of cases from closed or divested facilities. On a same-facility basis, total company surgical revenues were up 7.9% from the prior year quarter, driven primarily by net revenue per case, but also by higher same store volumes.

Turning to operating earnings, our second quarter 2019 adjusted EBITDA was $61.2 million, a 10.5% increase over the comparable period in 2018. This strong result is consistent with our existed quarterly cadence and positions us well to achieve full year double-digit adjusted EBITDA growth. Our second quarter adjusted EBITDA margin also improved to 13.5%, a 100-basis point increase as compared to the prior year period, primarily driven by higher gross margins and our cost containment efforts.

During the quarter, we recorded approximately $8 million of transaction integration and acquisition costs, bringing our year to date total to $11.5 million, a greater than 50% decline from our first half 2018 costs and consistent with our guidance that integrated-related costs would subside. Of note, the second quarter 2019 transaction integration and acquisition costs included approximately $0.6 million of costs associated with our de novo hospital in Idaho Falls. We continue to expect to record these costs outside of adjusted EBITDA for at least the remainder of 2019.

While net revenues of our ancillary and optical segments were up slightly on a combined basis versus the prior year period, combined adjusted EBTIDA from these two segments was relatively stable versus the prior year quarter and consistent with previous comments about our outlook for these businesses.

Moving on to cash flow and liquidity -- at the end of the second quarter, the company had cash balances of approximately $117 million and our revolving credit facility remains undrawn, with nearly $116 million worth of availability. Of note, during the second quarter, surgery partners had net operating cash flows defined as operating cash flow list distributions to non-controlling interests of $0.4 million.

We deployed approximately $20.8 million primarily related to the acquisition of a minority stake in four ASCs in Southern California. We used approximately $9.9 million for payments on our long-term debt and as previously discussed, in April of 2019, we issued a new $430 million senior unsecured note, the proceeds of which were used to retire our existing 2021 notes.

The ratio of total net debt to EBITDA at the second quarter of 2019, as calculated under the company's credit agreement was up slightly at approximately 7.8 times, primarily as a result of higher debt from the April refinancing transaction, partially offset by higher trailing 12-month adjusted EBTIDA.

The company has an appropriately capped flexible capital strategy, with no financial covenant on the term loan or our senior unsecured notes. 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.

Moving on to our 2019 outlook, we were excited by our progress this quarter on a variety of fronts and remain committed to double-digit adjusted EBITDA growth this year. While we do not provide quarterly guidance, we will remind investors that we are projecting that roughly one-third of our full year adjusted EBITDA will occur in the fourth quarter, consistent with historical seasonality and the projected timing of some of our strategic initiatives.

In summary, we believe the first half of 2019 demonstrates the power of our model, our strategic initiatives, and our potential. We are pleased to see continued same facility growth in both volumes and rate, with strong margin improvement as our initiatives take hold. We continue to invest, to expand existing facilities, and enter new markets that will support organic growth while the introduction of Medicare total joints to our ASCs appears to be on the horizon. Untapped opportunities in rate, procurement and revenue cycle optimization give us conviction in our 2019 outlook with additional benefits that will drive growth in 2020 and beyond.

With that, we will open the call for Q&A. Operator?

Question-and-Answer Session


Thank you. We will now be conducting a question and answer session. [Operator Instructions] Thank you. Your first question comes from Kevin Fishbeck, Bank of America Merrill Lynch. Go ahead, please.

Kevin Fischbeck

Great. Thanks. First, appreciate the comments on seasonality heading into Q4. When we think about one-third of the earnings coming in, the Q4 number, how much of that is just kind of normal seasonality in volumes and commercial mix heading into Q4 versus some of the cost items and initiatives that you have in place?

Tom Cowhey

Hey, Kevin. It's Tom. Thanks for the question. As you think about the fourth, quarter, I'd encourage you to take a look at last year because it's the first year where we've got a full year of both business inside the four walls and inside the calendar year. So, we're using that as -- we think that's a reasonable proxy. As you look at that, it's probably 31%, 32% of the adjusted EBITDA that was sitting inside that fourth quarter. As you think about that fourth quarter in particular, we also were burying some losses from some of our divested facilities.

So, as we think about the seasonality plus the ramp associated with some of our initiatives, in particular our health benefit initiatives, where we believe that we have better visibility into what our costs are for the full year based on the claims lag in the fourth quarter and therefore have thought about where that benefit will come through will be weighted toward the fourth quarter. We think that a third of the earnings plus or minus is a good proxy and a good way to think about the seasonality for the remainder of the year.

Kevin Fischbeck

That's helpful. Then I guess when we think about the growth in the quarter, it sounds like you're doing a lot on the physician recruiting side, but you're still talking about 2% volume growth in the quarter, which I think is on the low end of what you might think of 2% to 3% long-term. Why are we at the low end of that long-term volume number if physician recruiting is coming in? It sounds like you're really optimistic about this. Should we expect it to be at 3% at some point in the next year or two?

Wayne DeVeydt

Yeah. Kevin, this is Wayne. I really appreciate the question. The thing to keep in mind is that there's a compounding effect that kind of snowballs over time. So, if you were to look at last year, take first quarter of last year and case volume down roughly 4%. What you'll see, of course, then is it went to roughly down 2% to then basically flat to then up 1%. Then of course, we're migrating up.

So, here we are now at the 2% threshold. I would anticipate that that would continue to ramp up relative to our targeted 2% to 3% and we'll be at the higher end. I would say we're still working through what I would call the recruitment history here and things that we had a lot of doctors that were disengaging, which is why there was negative same store growth when we joined versus now actually moving the volume at the right trajectory.

The second thing I would highlight is the very interesting fact we shared with our board just last week was if you look at the compounding effect of how this ramps up, as I mentioned, we know already that the 18 cohort of doctors have all exceeded what they did in all of '18 and just the first six months of this year and the trajectory would imply that it will more than double where they were at last year. That same phenomenon we expect with the '19 cohorts.

Then we actually think you get an additive year even after that. We think you get kind of a three-year period. There's a multi-year period that we feel before we get to what I would call run rate organic growth that should not be above average. So, we think we're still two to three years out just on that. I think we'll see that continue to ramp up over time.

The other thing I would highlight, just keep in mind on case volume, we have changed our focus from a year ago, where the focus was broadly around recruiting doctors without necessarily a focus on those specialties that drive the highest DCM per minute for us. So, our specialty focus is much heavier on MSK, which will be fewer procedures but much higher dollar contribution margin per minute. While we're still recruiting other procedures, such as GI and ophthalmology, which generate a lot of case volume, they don't necessarily generate a lot of revenue.

So, again, I highlight that for you as well. Our growth is into areas that have smaller case volume but higher DCM per minute. Just as a point of reference, our MSK procedures in the first six months of this year were 2,200 more than we did all of last year in the first six months. It gives you a feeling on same store, what we're trying to drive toward. That does not include the impacts of the Southern California Orthopedic Institute that we just spoke to as that transaction we finalized late in the quarter.

Kevin Fischbeck

When you say that the 2018 is doing 20% more than the 2017 was, how much of that is because of the number of docs versus the amount of volume that each doc is doing?

Wayne DeVeydt

It's more of the volume per doctor. If you actually look at the number of doctors, we're not talking about huge variations year-over-year. If you were to look at first six months of '17, for example, versus the first six months of recruited doctors in '18, that variation is only around 20 doctors. The difference is the doctors we focus on, the procedures we focus on and what we believe they'll drive.

The other thing to keep in mind is that a doctor is a doctor. Two years ago, if that doctor did one procedure, it was counted as a recruited doctor in 2017. While that's factually accurate to us, that may be a new doctor but if they're not doing volume and they're not doing a number of procedures, it doesn't really move the needle for our company. So, I would say it's the volume of doctors.

The other data point I would give you is that we are averaging almost $500 more per procedure on our newly recruited doctors that came into '18 and '19 than we did a year before. So, another data point that shows that we're creating that shift to more MSK as well as spine and these higher acuity procedures.

Kevin Fischbeck

Last question -- most of the commentary has been focused on the number of doctors recruited. Can you tell me about retention and what you're seeing there?

Wayne DeVeydt

That's actually a really good question. One of the things we did change with our recruiters, though, because at the end of the day, filling the bathtub up with water only to have a leak at the bottom of the tub doesn't really accomplish our goals. So, as part of the recruitment role, they actually have a job of maintaining a partnership not only with those doctors, but the existing physicians within the facility that support us. So, we've actually seen our retention improve as well.

I would still say, though, that we're in the earning innings on the retention effort. Originally, the goal was really to refine where our strategy was, refocus on who we recruited and how we recruited and start building more of a relationship that really stands the test of time versus the one-off recruitment of a procedure into the facility. So, again, another reason why I think over time, Kevin, you'll see us really pushing closer to that higher end on the case volume as we continue to ramp that up.

Kevin Fischbeck

Good. Thanks.


Thank you. Your next question comes from Chad Vanacore, Stifel. Go ahead, please.

Chad Vanacore

Thanks a lot. Good morning. Just thinking about the total knee opportunity, what would you have to change in terms of the structure of recruiting to take full advantage of the opportunity? Maybe you could quantify what you think the total long-term opportunity there is.

Wayne DeVeydt

Yeah. Chad, that's a very good question. Interestingly enough, because we've been building our model for where this opportunity is coming, a couple things that structurally, if you really want to be successful, first and foremost, still being in network is an important aspect of our business model, while a big chunk of the Medicare opportunity is Medicare direct, an even bigger chunk we know is with managed care companies. Our model is already built to be in network.

The second thing is I would say, structurally, our facilities are already very well-positioned to take on this new opportunity. We have a number of OR expansions that we are doing on existing facilities this year to basically bring in the next wave of opportunity. In the case of our St. Charles in Chicago, which is just the suburbs outside of the Chicago area, we have a brand new facility that will be opening in the third quarter this year. We're moving to more procedural rooms and more ORs. We have been building for this opportunity to come.

Then finally, what I would tell you is we have been putting our recruiters in this space already. While I won't provide the physician's name, it's just one of many examples where I know today, one of our leaders is actually meeting with a physician that does over 1,200 total knees a year in the Medicare population, so, just an insane number. The idea is nurturing these relationships throughout '18, continue to build on them in '19 so that when we get to 2020, we're in a position that if these rules were to stay as proposed, we really can start catching as many of these procedures as quickly as possible.

I would say no major structural shifts. They're all under way as we operate our business, recognizing that if the proposal doesn't hold, the opportunity doesn't go away, though. It just may have been deferred. We're going to continue to ramp up as if it's going into play next year.

Chad Vanacore

One of the things I noticed on the balance sheet income statement, interest expense jumped up pretty significantly from 1Q to 2Q. That's $4.4 million on what looks to be only about $13 million change in incremental debt. Anything unusual there? Absent any changes, should we expect around $46 million expense per quarter?

Tom Cowhey

Chad, this is Tom. Thanks for the question. Interest expense is going to go up, just because we replace $400 million worth of eight and seven-eighths paper with $430 million worth of 10% paper. I think what you're seeing there in capturing might be a little bit of noise relative to just the transactions themselves and how the accounting on that works.

As I think about what the payments will be on an annualized basis, I think we're looking at about $175 million worth of principal and interest payments annually because we do have to amortize about 1% of the term loan per year. That's probably a reasonable proxy for about where you should be modeling and thinking about the full year interest expense or cash used for interest in principal payments.

Chad Vanacore

All right. Then just on interest expense -- any opportunity now that interest rates have fairly significantly in a short period of time, or by the end of the year, maybe take advantage of any kind refinancing. Would that make any sense?

Tom Cowhey

I'm not sure about refinancing. We did take the opportunity of the inverted yield curve to swap out another $300 million at LIBOR rates that are sub-two. We'll see how that ultimately works over time. But for us, this has always been about trying to stabilize the capital structure, stabilize the interest expense so that we have a set bogey that we can climb over as we grow the EBITDA of the business.

Chad Vanacore

Then just one more -- you had talked about expanding facilities in markets and then you gave us the UCLA example. Is there any other market that we should consider that would be attractive to you or think about either geographically or specialty wise?

Wayne DeVeydt

Yeah. So, Chad, a couple things I would highlight -- let me start with the geographic footprint. Obviously, when you think about not only the tailwinds of what we anticipate with the Medicare transition over time of total knees and then hopefully total hips and other high-acuity procedures. It's hard not to focus on some of the more populous states with aging populations. That's a combination of both Florida, where we have a very large footprint, as well as Southern California.

Of course, when you look at the Sunbelt in general, it just kind of slaps you in the face as a market that you continue to expand in. So, we continue to have ongoing meetings, including meetings with payers and provers in the broader Sunbelt around partnership opportunities for both de novos as well as opportunities to potentially do JVs.

I think that's probably becoming an even more attractive opportunity for us of ways to accelerate our expansion is through these JV models, recognizing that many individuals really don't know how to run and operate these entities or how to recruit into these facilities. And yet, they recognize that the shift is moving to the outpatient setting over time. I would say that we're focusing a lot on JV opportunities to accelerate those investments into those new markets.


Thank you. Your next call comes from Whit Mayo, UBS. Go ahead, please.

Whit Mayo

Hey, maybe just to stick on the UCLA partnership for a second, I think it's a pretty interesting transaction, maybe any color on how long you've been in conversation with them? I'm really curious on the economics of the transaction. Is this an accretive trade for you this year? Do you get their contracted rates? Any color would be helpful.

Wayne DeVeydt

Yeah. Whit, this is one of many of what I'll call long digestive journeys. This is one that we kicked off with our board last year explaining where we thought this could go and where we could take this thing. It's important to recognize that we actually had existing partnerships in one center with UCLA already that we thought we really could leverage.

We thought we had executed well in that partnership. We had driven a lot of value, not only for us but for them. In approaching them, the idea was we would bring this independence for the SCOI physicians, but we would also bring the trust that UCLA had in us, along with UCLA's rates though in that market.

So, in essence, these will be accretive. They'll be accretive out of the gate for us on day one, very attractive multiples for us. More importantly, what we showed UCLA and the SCOI partners was what we thought we could do with this three-way combination over time, similar to what we did on the other partnership that we had with UCLA.

I would tell you that it's our goal to continue to look at these three-way JVs in a more unique and innovative way. We did a similar transaction recently which we didn't call out with Vanderbilt here in Tennessee, where we expanded an existing relationship and partnered with them to open another facility about another 30 miles south of Downtown Nashville, if you will.

So, we are continuing these kinds of academic relationships with what we'll call those that get it about moving costs into an outpatient setting and a high-quality setting. Those are really easy examples, I would say, of what we have in the pipeline. Those are just two examples of ones we've closed. I will tell you we have many in the pipeline and we're really optimistic about getting more of these done either later this year or early next year based on the current pipeline.

The only other comment I'd make is I would say our existing footprint in the existing markets really warrants a market by market assessment of whether a JV is a good thing with a large health system. Our preference, to be clear, is always to partner and remain independent with the payers. We believe that if the payers believe in taking cost out of the system, if they truly believe in driving long-term value, we are an excellent choice for that.

As you know, we are a discount to what the broader market is in terms of what is being charged in an inpatient setting and we really know that we can really create physician excitement around moving their procedures to the ASC. That being said, we also recognize that there's real value creation for our shareholders in the right JV partnerships with health systems. So, we have many other partnerships in existing markets as well outside of academic that we are pursuing as well.

Whit Mayo

That's helpful. My second question -- I just wanted to focus on cash flow for a second. It's down year-over-year but it does have the higher borrowing costs. Do you have, Tom, the cash interest payments this year on a three-month and six-month basis? Are there any other factors negatively impacting the six-month numbers? That would be helpful. Then maybe just any guidance on cash flow for this year.

Tom Cowhey

I mean, it's $1.45 billion worth of term loan that we pay 1% on, right? So, $175 million minus that, you're looking at $150 million of cash interest on an annual basis, plus or minus is kind of the new run rate you should be thinking about with the fixes we've done on the swaps and the new 10% debt. $149 million, $150 million is the numbers I've got in front of me on annual cash interest.

Whit Mayo

Okay. Thinking about the cadence of cash flow over the balance of the year, are there any other factors that are depressing cash other than the obvious and then looking at the second half, any help on modeling that number?

Tom Cowhey

We don't provide specific guidance on that. As you think about the third quarter, we are anticipating that we will reach final settlement with the department, which will come with a cash use. We believe that will happen in the third quarter and certainly by the end of this year. That will be a use of cash as you think about the short-term flows.

The first half, other than some of the specific transactional-related stuff, some of the specific builds that we've been doing, you've got to think about Idaho Falls, there's clearly a little bit of cash drain there. That would accelerate the new community hospital as you get into the back half. Those are the main things that I would keep a watch out on.

Whit Mayo

Last one for me real quick -- senior secured ratio? Thanks.

Tom Cowhey

I'll have to get back to you on that.

Whit Mayo

It's fine. Thanks, guys.


Thank you. Your next question comes from Frank Morgan, RBC Capital Markets. Go ahead, please.

Frank Morgan

A lot of discussion around the volume opportunity. I'm just curious on that really strong pricing you saw in the quarter, the same store pricing, could you parse that out a little bit more color between shifts in payer mix versus acuity? That would be my first question. The second question would just be on your goal of pursuing this 10% EBITDA growth. What type of same store topline growth do you have to have to achieve that? What is your long-term target margin? Thanks.

Wayne DeVeydt

Hey, Frank. Thanks for the question. Let me start with the same store topline growth -- as we said before, generally speaking, in a broader industry, at a minimum, you should average the average of average, right? You ought to be able to get 2% to 3% volume and you ought to be able to get 2% to 3% in rate. So, if you want to be at the upper echelon, you would be in that 4% to 6% range with a push closer to the 6%. That's been our long-term guidance. That's our long-term targeted range.

That being said, we fully believe that this asset has the ability to outperform that for not only the near-term, but really for the longer term as we look out to the foreseeable future around both our ability to recruit physicians, but also our ability to get a better value property and pricing for what we do.

So, to your other question, as you think about it, we have shown, as we look at our data, that our new cases that are coming in this year, on an acuity basis, it's a big driver, that we're recruiting the right acuities in the right space that were generating about $500 more per case and of course, that then translates to more margin for us as well as we're improving margins concurrently.

Acuity is a big driver because we're focused on the right procedures, not necessarily the procedures that drive the highest case volume, but the ones that drive the highest ECM per minute. We can see that in our underlying data. So, pretty meaningful improvement on specialty mix.

Then the last question was around margins -- look, as we did our modeling and as we shared with our board, we are still, I would say, meaningfully far away from what we believe we can accomplish over the next three to five years. The 100-basis point improvement that you see year over year is really a reflection of scratching the surface.

If you just consider our ability to continue to replicate what we're doing and you consider our ability to continue to leverage our size and scale, which the benefit of scale is the ability to leverage the G&A efficiently over that base as you grow into it, we think realistically that we can grow margins in the 50 basis point a year range over the next three to five years and with a pretty high degree of confidence in that based on our own modeling.

So, margins clearly get up to that higher-end range of industry averages between now and 2024. Tom, anything you'd like to add?

Tom Cowhey

Yeah. As you think about what we've talked about in the past, we kind of said if you can do the four to six, if you can do two to three on volume and two to three on rate, we think we can get to double digits just by looking at some of the places where we have rate opportunity, some of the places we have procurement opportunity and some of the places where we have RCM opportunity.

As we've tried to model that out, I think 50 basis points a year, as Wayne said, in terms of margin expansion based on where some of those things will hit and some will leverage, that's our longer-term goal. In many ways, it could be a floor. We'll have to see. Some years could be a little bit more, some years could be a little bit less. That's kind of a reasonable benchmark for what we're striving toward over the next few years to drive that margin back up to where we think it should be.

Frank Morgan

Okay. Thank you.


Thank you. Your next question comes from Bill Sutherland, The Benchmark Company. Go ahead, please.

Bill Sutherland

Thanks. Good morning. My operational and financial questions have all been asked. But I was curious, Wayne, on the CMS rule, you mentioned three cardiac codes approved for ASCs. Does that have any impact for you guys?

Wayne DeVeydt

It actually does. We have a very large surgical facility in Lubbock, Texas. What I will simply say is that it would be very positive for us in terms of the ability to move further procedures in. I would also add that we are currently working with a number of potential partners in that market right now on both the payer and the health system side around opportunities. I think many people are recognizing that this shift is coming. That particular facility specializes in cardiologist-related specialties.

So, we really feel like that's the next wave of high acuity procedures that will continue to move down. So, early innings for us, but the nice thing is we have a nice facility to learn in and grow in and see how this evolves and we're looking at that to be the next round of MSK, if you will, of how we start expanding our OR rooms for that next wave as that starts to evolve.

Bill Sutherland

And what did you see about the update on hips, Wayne?

Wayne DeVeydt

For hips, they've been removed from the inpatient only list in the proposal, which is the same step they took with TKA a couple years ago. It's essentially if they continue through with it, it would be probably a data gathering phase for them to understand whether or not they believe that those procedures could be moved further down the chain into ASCs over time. It's kind of a preliminary step but it's exactly the same step that they took two years ago for the '18 payment year with knees.

Bill Sutherland

Got it. Sounds like baby steps. Thanks, guys.


Thank you. Your last question comes from Brian Tanquilut, Jefferies. Go ahead, please.

Brian Tanquilut

Hey, good morning, guys. Wayne, I just wanted to ask for an update on the initiative that you put through to drive commercial reimbursement higher, especially in markets where you are below market. Where does that stand right now?

Wayne DeVeydt

Brian, thanks for the question. I would say that in my opinion, we are in early innings, but the opportunity is far greater than I had anticipated when we started this process over a year ago. What do I mean by that? As we look at markets where we thought we were underpaid, we are putting forward a multi-prong strategy, where we start first with the payers. Our goal is we would like to remain independent. We think there's massive value creation for us and for them. We have got a number of markets where we are having direct dialogue with the CEOs of large payers around what it would require for us to remain independent and not JV with a large health system. We're going to continue to pursue that.

Concurrent with that, I would tell you, Brian, we are talking with health systems. We don't mind being a discount play in the market. We know we offer high quality product with exceptional patient satisfaction and that's the value prop of us is that if you can offer those two at a more affordable price, you win the long-term, but we don't need to be deep discount. We need to get paid for the value we bring.

So, our goal is to continue to show payers market by market what we think that value creation is. Maybe in a future meeting, especially we're considering an IR day early next year, we'll put a little more size around what this might look like. What I would tell you is the opportunity to outperform that higher end of that 4% to 6% long-term same store growth target, I think the number of levers we have to pull, not only for the immediate term but the next several years, are so meaningful that we should consistently be at that high end for same store, if not outperforming it.

But when I say early innings, remember, the 125 locations and you've got to tackle them one location at a time. In essence, that's what we're doing one at a time as we move down that path.

Brian Tanquilut

That makes sense. Just a quick follow-up, Tom, I don't know if I missed this, but is there any callout for the elevated CapEx during the quarter?

Tom Cowhey

No, shouldn't be. There's obviously a lot of activity that's happening as we think about some of our expansions. You think about Idaho Falls Community Hospital. You think about the relocation and the new facilities that Wayne talked about, but I don't that -- as you think about the ordinary way capex has actually been pretty well-managed this year and very consistent with our historical norms.

Brian Tanquilut

Got it. Thanks, guys.

Wayne DeVeydt

Thanks, everyone for your questions and for participating on this morning's call. Before we conclude our call, I do want to take a moment to say thank you to our 10,000+ associates and our 4,000+ physicians for their contributions. 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 short-stay surgical facilities across the United States, it is really the daily efforts of each and every one of these surgery partners, employees, and physicians that will get us there.

Thanks again for joining our call this morning and have a great day.

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