Surgery Partners, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report and our 2023 Annual Report on Form 10-K. Unless the context otherwise indicates, the terms "Surgery Partners," "we," "us," "our" or the "Company," as used herein, refer to Surgery Partners, Inc. and its subsidiaries, and the term "affiliates" means direct and indirect subsidiaries of Surgery Partners, Inc. and partnerships and joint ventures in which such subsidiaries are partners. The terms "facilities" or "hospitals" refer to entities owned and operated by affiliates of Surgery Partners, Inc. and the term "employees" refers to employees of affiliates of Surgery Partners, Inc. Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements, which are based on our current expectations, estimates and assumptions about future events. All statements other than statements of current or historical fact contained in this report are forward-looking statements. These statements include, but are not limited to, statements regarding our future financial position, business strategy, budgets, effective tax rate, projected costs and plans and objectives of management for future operations. The words "projections," "believe," "continue," "drive," "estimate," "expect," "intend," "may," "plan," "will," "could," "would" and similar expressions are generally intended to identify forward-looking statements. By their nature, forward-looking statements involve risks, uncertainties and other factors that may cause actual results to differ from the expectations expressed in the statements. Many of these factors are beyond our ability to control or predict. These factors include, without limitation, reductions in payments from government health care programs and private insurance payors, such as health maintenance organizations, preferred provider organizations, and other managed care organizations and employers; our ability to contract with private insurance payors; changes in our payor mix or surgical case mix; failure to maintain or develop relationships with physicians on beneficial or favorable terms, or at all; the impact of payor controls designed to reduce the number of surgical procedures; our efforts to integrate operations of acquired businesses and surgical facilities, attract new physician partners, or acquire additional surgical facilities; supply chain issues, including shortages or quality control issues with surgery-related products, equipment and medical supplies; competition for physicians, nurses, strategic relationships, acquisitions and managed care contracts; our ability to attract and retain qualified health care professionals; our ability to enforce non-compete restrictions against our physicians; our ability to manage material liabilities whether known or unknown incurred as a result of acquiring surgical facilities; the impact of future legislation and other health care regulatory reform actions, and the effect of that legislation and other regulatory actions on our business; our ability to comply with current health care laws and regulations; the outcome of legal and regulatory proceedings that have been or may be brought against us; the impact of cybersecurity attacks or intrusions; changes in the regulatory, economic and other conditions of the states where our surgical facilities are located; our indebtedness; the social and economic impact of a pandemic, epidemic or outbreak of a contagious disease, such as COVID-19, on our business.; and the risks and uncertainties set forth under the heading "Risk Factors" in our 2023 Annual Report on Form 10-K and discussed from time to time in our reports filed with the SEC. Considering these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur, and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report. These forward-looking statements speak only as of the date made. Other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether because of new information, future events or otherwise. Executive Overview As of March 31, 2024, we owned or operated, primarily in partnership with physicians, a portfolio of 165 surgical facilities comprised of 147 ASCs and 18 surgical hospitals across 33 states. We owned a majority interest in 92 of the surgical facilities and consolidated 124 of these facilities for financial reporting purposes. Total revenues for the first quarter of 2024 increased 7.7% to $717.4 million from $666.2 million for the first quarter of 2023. The increase in revenues was attributable to same-facility revenue growth and the net impact from acquisitions and divestitures completed during the last twelve months ended March 31, 2024. Days adjusted same-facility revenues for the first quarter of 2024 increased 10.2% from the first quarter of 2023, with an 8.8% increase in revenue per case and a 1.3% increase in same-facility cases. Additionally, for the first quarter of 2024, Adjusted EBITDA increased 8.2% to $97.5 million compared to $90.1 million for the same period in 2023. The increase in Adjusted EBITDA was primarily attributable to revenue growth, continued cost management initiatives and acquisitions completed since the prior year period. For the first quarter of 2024, net loss attributable to common stockholders was $12.4 million compared to $24.9 million for the same period in 2023. A reconciliation of non-GAAP financial measures appears below under the heading "Certain Non-GAAP Measures." We continue to focus on improving our same-facility performance, selectively acquiring established facilities, developing new facilities and other portfolio management initiatives. During the first quarter of 2024 we completed the following: • We acquired a controlling interest in two surgical facilities and several physician practices for aggregate cash consideration of $66.0 million, net of cash acquired, and non-cash consideration of $1.1 million. As of March 31, 2024, $11.4 million of the cash consideration was deferred and included as a component of current liabilities in the condensed consolidated balance sheets. 18 Table of Contents • We sold a portion of our interests in a surgical facility for net cash proceeds of $1.5 million. As a result of the transaction, we no longer control the previously controlled surgical facility but retain a non-controlling interest, resulting in the deconsolidation of the previously consolidated entity. We had cash and cash equivalents of $185.2 million and $607.3 million of borrowing capacity under our Revolver as of March 31, 2024. Revenues Our revenues consist of patient service revenues and other service revenues. Patient service revenues consist of revenue from our Surgical Facility Services and Ancillary Services segments. Specifically, patient service revenues include fees for surgical or diagnostic procedures performed at surgical facilities that we consolidate for financial reporting purposes, as well as for patient visits to our physician practices, anesthesia services, pharmacy services and diagnostic screens ordered by our physicians. Other service revenues include management and administrative service fees derived from our non-consolidated facilities that we account for under the equity method, management of surgical facilities and physician practices in which we do not own an interest, management services we provide to physician practices for which we are not required to provide capital or additional assets and other non-patient services. The following table summarizes revenues by service type as a percentage of total revenues: Three Months Ended March 31, 2024 2023 Patient service revenues: Surgical Facility Services 94.9 % 96.0 % Ancillary Services 3.4 % 2.5 % Total patient service revenues 98.3 % 98.5 % Other service revenues 1.7 % 1.5 % Total revenues 100.0 % 100.0 % Payor Mix The following table sets forth by type of payor the percentage of our patient service revenues generated at the surgical facilities that we consolidate for financial reporting purposes: Three Months Ended March 31, 2024 2023 Private insurance payors 51.2 % 51.1 % Government payors 43.0 % 43.8 % Self-pay payors 2.8 % 2.4 % Other payors (1) 3.0 % 2.7 % Total 100.0 % 100.0 % (1) Other is comprised of automobile liability, letters of protection and other payor types. 19 Table of Contents Surgical Case Mix We primarily operate multi-specialty surgical facilities where physicians perform a variety of procedures in various specialties. We believe this diversification helps to protect us from adverse pricing and utilization trends in any individual procedure type and results in greater consistency in our case volume. The following table sets forth the percentage of cases in each specialty performed at the surgical facilities that we consolidate for financial reporting purposes for the periods indicated: Three Months Ended March 31, 2024 2023 Orthopedics and pain management 40.0 % 35.7 % Ophthalmology 23.5 % 24.1 % Gastrointestinal 22.1 % 23.5 % General surgery 2.3 % 3.0 % Other 12.1 % 13.7 % Total 100.0 % 100.0 % Critical Accounting Policies A summary of significant accounting policies is disclosed in our 2023 Annual Report on Form 10-K under the caption “Critical Accounting Policies” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section. There have been no material changes in the nature of our critical accounting policies or the application of those policies since December 31, 2023. Results of Operations Comparison of Operating Results for the Three Months Ended March 31,2024 to the Three Months Ended March 31, 2023 The following tables summarize certain results from the statements of operations for the periods indicated (in millions): Three Months Ended March 31, 2024 2023 Revenues $ 717.4 $ 666.2 Operating expenses: Cost of revenues 562.1 532.2 General and administrative expenses 33.2 32.0 Depreciation and amortization 33.7 33.7 Transaction and integration costs 17.4 12.5 Net loss on disposals, consolidations and deconsolidations 1.5 10.5 Equity in earnings of unconsolidated affiliates (2.7) (3.3) Litigation settlements (1.8) 3.0 Other income (2.0) (0.8) 641.4 619.8 Operating income 76.0 46.4 Interest expense, net (47.3) (46.8) Income (loss) before income taxes 28.7 (0.4) Income tax (expense) benefit (4.4) 1.6 Net income 24.3 1.2 Less: Net income attributable to non-controlling interests (36.7) (26.1) Net loss attributable to Surgery Partners, Inc. $ (12.4) $ (24.9) 20 Table of Contents Revenues. The following table sets forth patient service revenues (in millions): Three Months Ended March 31, 2024 2023 Patient service revenues $ 705.3 $ 656.4 Other service revenues 12.1 9.8 Total revenues $ 717.4 $ 666.2 Patient service revenues increased 7.4% to $705.3 million for the three months ended March 31, 2024 compared to $656.4 million for the three months ended March 31, 2023. The increase was primarily driven by a 10.2% increase in days adjusted same-facility revenues and the net impact from acquisitions and divestitures completed during the last twelve months ended March 31, 2024. The increase in days adjusted same-facility revenues was attributable to a 1.3% increase in same-facility case volumes and a 8.8% increase in same-facility revenue per case. Cost of Revenues. Cost of revenues was $562.1 million for the three months ended March 31, 2024 compared to $532.2 million for the three months ended March 31, 2023. The increase was primarily driven by increased performance of high acuity procedures and acquisitions completed during the last twelve months ended March 31, 2024. As a percentage of revenues, cost of revenues was 78.4% and 79.9% for the three months ended March 31, 2024 and 2023, respectively. General and Administrative Expenses. General and administrative expenses were $33.2 million and $32.0 million for the three months ended March 31, 2024 and 2023, respectively. As a percentage of revenues, general and administrative expenses were 4.6% in the first quarter of 2024 compared to 4.8% in the first quarter of 2023. Depreciation and Amortization. Depreciation and amortization expenses were $33.7 million for each of the three months ended March 31, 2024 and 2023. As a percentage of revenues, depreciation and amortization expenses were 4.7% and 5.1% for the three months ended March 31, 2024 and 2023, respectively Transaction and Integration Costs. We incurred $17.4 million of transaction and integration costs for the three months ended March 31, 2024 compared to $12.5 million for the three months ended March 31, 2023. The costs for both periods primarily related to ongoing development initiatives and the integration of acquisitions. Net Loss on Disposals, Consolidations and Deconsolidations. The net loss on disposals, consolidations and deconsolidations for the three months ended March 31, 2024 and 2023 includes activity discussed in Note 2. "Acquisitions, Disposals and Deconsolidations" of the accompanying notes to the condensed consolidated financial statements. The remaining net loss in both periods was primarily attributable to sales and disposals of other assets. Interest Expense, Net. Interest expense, net was $47.3 million for the three months ended March 31, 2024 compared to $46.8 million for the three months ended March 31, 2023. As a percentage of revenues, interest expense, net was 6.6% and 7.0% for the three months ended March 31, 2024 and 2023, respectively. Income Tax (Expense) Benefit . Income tax expense was $4.4 million for the three months ended March 31, 2024 as compared to income tax benefit of $1.6 million for the three months ended March 31, 2023. The effective tax rate was 15.3% and 400.0% for the three months ended March 31, 2024 and 2023, respectively. See Note 1. "Organization and Summary of Accounting Policies" under the heading Income Taxes for additional information related to the Company's effective tax rates for the three months ended March 31, 2024 and March 31, 2023, including why these rates differed from the U.S. federal statutory rate of 21%. Net Income Attributable to Non-Controlling Interests. As a percentage of revenues, net income attributable to non-controlling interests was 5.1% and 3.9% for the three months ended March 31, 2024 and 2023, respectively. Liquidity and Capital Resources Cash and cash equivalents were $185.2 million at March 31, 2024 compared to $195.9 million at December 31, 2023. The primary source of our operating cash flows is the collection of accounts receivable from private insurance companies, federal and state agencies (under the Medicare and Medicaid programs) and individuals. Our cash flows provided by operating activities was $40.7 million for the three months ended March 31, 2024 compared to $74.5 million for the three months ended March 31, 2023. The $33.8 million decrease was primarily driven by the timing of routine transactions involving working capital and accrued payroll and benefits. Net cash used in investing activities for the three months ended March 31, 2024 was $83.1 million compared to $70.7 million for the three months ended March 31, 2023. The $12.4 million increase was primarily driven by an aggregate net increase of $6.3 million in payments for acquisitions (net of cash acquired) and purchases of equity method investments and a $6.5 million decrease in proceeds from sales of facilities. 21 Table of Contents Net cash provided by financing activities for the three months ended March 31, 2024 was $31.7 million compared to net cash used of $41.2 million for the three months ended March 31, 2023. The increase of $72.3 million was primarily driven by net borrowings on the Revolver due to the timing of acquisitions completed during the first quarter of 2024. Debt On April 10, 2024, we completed the issuance and sale of $800.0 million in aggregate principal amount of 2032 Notes. The 2032 Notes bear interest at an annual rate of 7.250% per year, payable semi-annually on April 15 and October 15 of each year, beginning on October 15, 2024. Proceeds from sale of the 2032 Notes were used (i) to redeem all of the outstanding 2025 Notes and 2027 Notes, (ii) to pay accrued interest on the Existing Notes through, but not including, April 25, 2024, (iii) to pay related fees and expenses in connection with the offering of the 2032 Notes and redemption of the Existing Notes and (iv) for general corporate purposes, including to fund future acquisitions. Capital Resources Net working capital was approximately $372.5 million at March 31, 2024 compared to $372.0 million at December 31, 2023. In addition to cash flows from operations and available cash, other sources of capital include amounts available on our Revolver as well as anticipated continued access to the capital markets. Material Cash Requirements There have been no material changes outside of the ordinary course of business to our upcoming cash obligations during the three months ended March 31, 2024 from those disclosed under “Material Cash Requirements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2023 Annual Report on Form 10-K. Summary Broad economic factors, including recent increases in interest rates, inflation and supply chain risks and market volatility, could negatively affect our payor mix, increase the relative proportion of lower margin services we provide and reduce patient volumes, as well as diminish our ability to collect outstanding receivables. Any increase in the amount or deterioration in the collectability of patient accounts receivable will adversely affect our cash flows and results of operations, requiring an increased level of working capital. If general economic conditions, including recent increases in interest rates, inflation risk and market volatility, continue to deteriorate or remain uncertain for an extended period of time, our ability to access capital could be harmed, which could negatively affect our liquidity and ability to repay our outstanding debt. Based on our current level of operations, we believe cash flows from operations, available cash, available capacity on our Revolver and continued anticipated access to capital markets, will be adequate to meet our short-term (i.e., 12 months) and long-term (beyond 12 months) liquidity needs. Certain Non-GAAP Measures Adjusted EBITDA is not a measurement of financial performance under GAAP and should not be considered in isolation or as a substitute for net income, operating income or any other measure calculated in accordance with GAAP. The items excluded from this non-GAAP metric are significant components in understanding and evaluating our financial performance. We believe such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. Our calculation of Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies. We use Adjusted EBITDA as a measure of financial performance. Adjusted EBITDA is a key measure used by our management to assess operating performance, make business decisions and allocate resources. 22 Table of Contents The following table reconciles Adjusted EBITDA to income (loss) before income taxes, the most directly comparable GAAP financial measure (in millions and unaudited): Three Months Ended March 31, 2024 2023 Condensed Consolidated Statements of Operations Data: Income (loss) before income taxes $ 28.7 $ (0.4) Plus (minus): Net income attributable to non-controlling interests (36.7) (26.1) Depreciation and amortization 33.7 33.7 Interest expense, net 47.3 46.8 Equity-based compensation expense 4.9 4.2 Transaction, integration and acquisition costs (1) 18.9 12.8 Net loss on disposals, consolidations and deconsolidations 1.5 10.5 Litigation settlements and regulatory change impact (2) (1.2) 8.0 Undesignated derivative activity — 0.6 Other 0.4 — Adjusted EBITDA $ 97.5 $ 90.1 (1) This amount includes transaction and integration costs of $17.4 million and $12.5 million for the three months ended March 31, 2024 and 2023, respectively. This amount further includes start-up costs related to de novo surgical facilities of $1.5 million and $0.3 million for the three months ended March 31, 2024 and 2023, respectively. (2) This amount includes a litigation settlements gain of $1.8 million and a loss of $3.0 million for the three months ended March 31, 2024 and 2023, respectively. This amount also includes other litigation costs of $0.6 million and $0.6 million for the three months ended March 31, 2024 and 2023, respectively. Additionally, the three months ended March 31, 2023, includes $4.4 million related to the impact of recent changes in Florida law regarding the use of letters of protection. We use Credit Agreement EBITDA as a measure of liquidity and to determine our compliance under certain covenants pursuant to our New Credit Facilities. Credit Agreement EBITDA is determined on a trailing twelve-month basis. We have included it because we believe that it provides investors with additional information about our ability to incur and service debt and make capital expenditures. Credit Agreement EBITDA is not a measurement of liquidity under GAAP and should not be considered in isolation or as a substitute for any other measure calculated in accordance with GAAP. The items excluded from Credit Agreement EBITDA are significant components in understanding and evaluating our liquidity. Our calculation of Credit Agreement EBITDA may not be comparable to similarly titled measures reported by other companies. When we use the term "Credit Agreement EBITDA," we are referring to Adjusted EBITDA, as defined above, further adjusted for acquisitions and synergies. These adjustments do not relate to our historical financial performance and instead relate to estimates compiled by management and calculated in conformance with the definition of "Consolidated EBITDA" used in the credit agreements governing our credit facilities. 23 Table of Contents The following table reconciles Credit Agreement EBITDA to cash flows from operating activities, the most directly comparable GAAP financial measure (in millions and unaudited): Twelve Months Ended March 31, 2024 Cash flows from operating activities $ 260.0 Plus (minus): Non-cash interest expense, net (20.0) Non-cash lease expense (35.2) Deferred income taxes (2.6) Equity in earnings of unconsolidated affiliates, net of distributions received 1.0 Changes in operating assets and liabilities, net of acquisitions and divestitures 112.6 Income tax expense 5.7 Net income attributable to non-controlling interests (157.8) Interest expense, net 193.5 Transaction, integration and acquisition costs 71.0 Litigation settlements and other litigation costs 8.3 Other (1) 9.0 Acquisitions and synergies (2) 68.1 Credit Agreement EBITDA $ 513.6 (1) This amount includes estimates for the impact of a cyber event and losses from divested business that occurred in 2023. (2) Represents impact of acquisitions as if each acquisition had occurred on April 1, 2023. Further this includes revenue and cost synergies from other business initiatives and de novo facilities and an adjustment for the effects of adopting the new lease accounting standard, as defined in the credit agreement governing the New Credit Facilities.