Surgery Partners, Inc. (SGRY) Earnings Call Transcript & Summary

Good morning. We'll continue now with our next presentation. We have Surgery Partners. Today with us, we have Eric Evans, the CEO, along with Tom Cowhey, Chief Financial Officer. Good morning, gentlemen.

Good morning.

Good morning, Frank.

Well, we'll just hop right in here. Looking back at your earnings call from the first quarter, certainly seem to suggest a very robust M&A backlog, seem to be around $125 million of signed LOIs at that time, well on track for your targeted $200 million. So I'm just curious, can you give us an update on that color, maybe characterize the kind of deals you're seeing and the kind of markets you're seeing those in?

Sure, Frank, we'd be happy to. Obviously, we're pleased with where we are with our pipeline. We mentioned in the end of the quarter the $125 million number. That number is now over $140 million. And we're really pleased with what's in the pipeline, too. I think most of what's under LOI for us are the traditional tuck-in ASCs. We love those. They are opportunities for us to create a lot of value for physician partners and certainly, utilize our platform to drive synergies. Beyond that, we have a lot in discussions, well over $100 million, maybe even over $150 million in discussions that range from small platforms to individual ASCs to surgical hospitals. And so it's a robust platform. We're excited about where it's going. We feel quite good about meeting or exceeding our $200 million M&A target for 2021.

Got you. And I'm sorry, but the mix of the $140 million now, you say that is more in the traditional onesie-twosie ASCs?

That's correct. Yes. No, so most of what we have under LOI -- almost all of what we have under LOI is the traditional, either single specialty or multi-specialty ASCs, that we tuck into our existing platform.

Got you. Is there any geographic focus? I mean, when you think about going out and -- with your development team and looking at opportunities, I mean how do you really attack the market? What do you really try to go for? Is it purely just an economic decision? Or is there an existing geography or any other kind of considerations that come into play with your M&A strategy?

Yes. So I'd answer it a couple of ways. I mean, certainly, we always like to gain more scale in a given market, just because we can get better synergies around our operational team, how we support a team, our ability to kind of meet a broad consumer set of needs. We think that's important. So if you think about big markets, we're always open to those or a market we're in, where we can add in-market opportunities. That would probably be the #1 on our list. Beyond that, Frank, it's a little different. In my old acute care traditional world, geography was destiny. Because you had -- you relied on your ERs, a lot of what happened locally was kind of driven by that. When you think about our business, it's really about partnering with the right physicians, high-quality physicians. Physicians and what their payer mix is. It's elective business. And so we're probably less geographically constrained because of the way our model works. It's something attractive. But we certainly favor those markets where we have experience, we know the market well, we can bring synergies, and also, we certainly look at the demographics. Like, would that be in growing communities. Certainly, the aging population across the country is actually a good thing for us in most of our specialties. And so in general, we have a pretty broad array, but if we had to prioritize, we'd start with our key markets. And I don't know, Tom, if you would add anything to that.

Yes. The one thing that I would add is that as you think about the geographies that we're focused on, obviously, as you think about where we stand for the types of procedures that we're doing, that tends to be aging demographics. And so that tends to be more Sun Belt than it tends to be other areas. And so that's definitely a lens that we look at. The other lens that we really spend a lot of time on is just the physician marketplace, how much of it is independent is kind of a -- is a big determinant for us. We're not looking to kind of plant new flags in places where you've got high concentrations of employee docs. It just isn't as suitable to our model as so many other geographies where we can do better. I think we can succeed in any geography, but there are some that are -- where we've got more tailwinds at our back.

Got you.

And the one thing I'd add on the employee positions, that's health system employed. Obviously, some of the value-based care employment arrangements and some of the payer employment arrangements -- it's actually they love our facility. So it is very specific, though, as Tom said, kind of looking at the physician space for sure.

Got you. All that subject of physicians, why are these physician groups more inclined to sell today versus in the past? I mean, obviously, you're having a lot of success if you got $140 million pipeline. So what do they really see that's changed in the world of ASCs? A lot of changes in health care overall. But within the ASC, there being a business person and an owner in this enterprise, what do you see are the biggest changes that are making them more likely to sell?

Sure, Frank, it's a great question. We've always had a pretty good pipeline, but it's obviously more robust than it's ever been. And I would point to a couple of things. They've just gone through a pandemic, right? They've had to experience more indifferent needs of government advocacy and all the complexity around managing through grants and managing staff through the ups and downs. And I think just that -- just experiencing that, many of the supply chain shortages, right, the kind of things that a bigger system brings stability and expertise on, I think that is top of mind, because having gone through that, they realized the value of that. I would also say that a lot of these facilities are looking to grow acuity. And so if you think about -- they may have historically done orthopedics, but they haven't done total joints. And so they're looking for a platform that has a lot of experience and expertise in growing acuity and helping them grow. We're really proud of the fact that we kind of lead the industry basically at same-store growth. And so they look at that, too, as the ability to come in, help them recruit and grow their facilities, both within their current specialties and expanding specialties. So there's a multitude of reasons. We actually think we have a lot of great physician partners that are just looking for the type of platform we bring, which is both independent, but also brings a lot of expertise and scale.

Sure. And we...

Let me add to that. And this is a little bit of a snide remark, but I think the last time that a lot of these independent docs thought that it was great to be the owner and operator of their own ASC was the first time that they had to fill out a PPP loan. I do think that COVID has definitely demonstrated to a portion of the marketplace -- not the entire marketplace, but a portion of the marketplace, the value of being associated with a larger partner who can offer the infrastructure to help them to navigate through a crisis like the one that we've last seen. And so I think that all the things that Eric talked about are the things that help us convince somebody that we're the right partner. But I think some of that conversation starts with the fact that having gone through this crisis, I do think that there are a number of independent docs that are reevaluating whether or not they want to be part of a larger organization and whether or not they want to have a strong partner at their side.

Got you. Eric, you said a lot of these groups want to increase their acuity. The expertise that you can bring or the resources you can bring, I mean I suppose part of it is capital, right? Maybe there are things you have to do those centers to do those procedures. But is there anything that you all can do from a clinical perspective? Do you have the capabilities to add support services as they do these new types of procedures? And if not, I mean how do you feel about turning over a surgery center to people who are doing procedures they haven't done before in that setting? Is there any concerns there?

Yes. So we absolutely do. We have a really robust policies procedures approach to expanding into higher acuity procedures. We've done it in multiple centers. As we've talked about, a lot within orthopedics over the last couple of years. We add 5 to 10 of our centers that have never done joints onto that program every year. And so we've done it a lot. We know the pitfalls. We know the things you got to think about in anesthesia. We know the protocols. We know how you have to prepare patients, how you have to select patients. And so that expertise, you can imagine for a local group that hasn't taken the leap yet into the outpatient world. That experience, we bring the clinical expertise, even other physicians in our platform that can bring a lot of just peace of mind and advice for physician groups, it's extremely valuable. And so no, I wouldn't -- clearly, we want to make sure when we -- whenever we add higher acuity, we go through every single protocol and safety checklist to make sure we continue to drive the outstanding results we have historically. And that would be the same for orthopedics, as it is cardiology, as it is spine or even as it is in our surgical hospitals as we start doing higher acuity, joints and shoulders and all those things, we bring a ton of experience for that. And as these facilities look at where the future is and how they become more meaningful in their markets and more meaningful to payer relationships, a lot of that has to do with adding the higher acuity procedure. So yes, it's a big reason we see for some of the multi-specialty centers. They want to grow in those areas, and they want to do it quickly. They just don't necessarily always have the expertise or background.

Right. There are a lot of people want to buy ASCs, right? I mean you've got major health systems, you've got HCA, you got Tenet. There are a lot of other private chains out there. What is it that you think really differentiates you from the other buyers of ASC assets, other than you and Tom are nice guys, but what are you really bringing -- what can you bring in and say, this is why Surgery Partners is different, this is why you should go with us?

Yes. I think it's a great question. When you look across our peer group, I would say the biggest differentiator that stands out is that we're independent, right? When we come to a market, we typically don't -- we have very few health system relationships. So we typically don't have a, "Hey, you have to partner with us and X." We're not owned by a health plan, which can sometimes bring its own conflicts, right? So we're independent. All we do is short-stay surgery as well. That's the second thing, I would say. We're quite nimble with that. We can be quite flexible in how we work with physicians to make that work, especially if it involves a physician practice. Some of our peers are more or less likely to want to do those kind of transactions. And so our ability to be nimble to meet the physicians where they're at and also to be independent, not really bringing conflicts that may or may not have history with a particular group, that's a big deal. And so we're probably the only player at scale across the country that brings that. I would also say, look, we've got a long track record of really successful 2-way partnerships. We've got a track record of kind of outsized same-store growth. And so we look at those combinations, and it makes for a pretty compelling story, and we are successful more often than not on the access and targets we go after.

Got you. You commented it back in the earnings call that the March -- you had a strong recovery month in March after the COVID surge in January. And of course, you had some severe weather in February, but it sounded like April started on a strong note, but hoping to get any additional color you might have on trends in, say, either volume or mix?

Sure. So April is certainly continuing this -- the trend we saw in March. And I would say early May is also encouraging. So we were actually seeing -- kind of from a guidance standpoint, we're seeing what we expected when we built a 2021 plan that was not impacted by COVID, right? So feel good about that. We continue to see a lot of movement in total joints. I know we mentioned 122% growth in our ASCs year-over-year in Q1. That was, obviously, coming off a year we grew by 100%. We see continued strength there, driven partially by robotics. But yes, no, the strength is continuing from April -- or from March into April, and early May also looks optimistic. I don't know, Tom, is there anything else you might add to that?

No, no. I think you summed it up well. I mean we've seen great momentum this -- so far this year. I think it was a funny start, when you think about January and February with all those storms. March came roaring back. April, the volumes were quite strong. And so we're encouraged.

Sure. Anything in that mix that you saw? We've had sort of conflicting signals over the type of acuity that -- as the volumes have recovered, the change in acuity. Is there any way you would characterize when you did see that recovery in March and April, was it more in higher acuity services or was it return of low acuity services?

Yes, so I guess -- go ahead, Tom.

So the thing I was going to say is you look at the first quarter numbers, right? And so part of what we're starting to do now is we're really starting to compare back to the first quarter of 2019 to get a more normalized view of the baseline. We've seen kind of mid-single-digit growth in orthopedics and ophthalmology off of that 2019 baseline. We're not quite back to kind of getting 2 years of growth over that 2-year period. We're definitely above where we were in 2019 on GI. But we still think that there's a lot to come back there. And where we're really kind of low relative to 2019 is on the pain injections, which I think makes a lot of sense as you think about what's being deferred right now and a lot of that tends to be office-based. But we're probably 90%, 91% of the 2019 baseline still in the first quarter of 2019.

Got you. I don't know if you want to comment at all about the Medicare mix because that was the other part of the...

Yes. No, I think it's been a higher Medicare to start the year, and I would point to a couple of things that have kind of driven that growth. I mean one is -- and this is probably a natural thing to think about it, is the people that were most likely to put off procedures during the pandemic are older folks with higher risk. So we're seeing a little bit of that strength of return in Q1 as people got vaccinated, decided to move forward procedures. And obviously, some of that's just seasonality. So -- but that's certainly been part of the story that we've seen early in the year. We're a very seasonal business. We have no reason to believe we won't have the same kind of commercial bounce back the rest of the year, but that has been part of the story. I think to go along with what Tom said, back to that mid-single-digit growth in orthopedics and spine, the good news there is a lot of that growth is on the higher acuity side, too. So that's been a story that's been continuing for us for quite some time.

Got you. We've talked a lot about some of the new procedures that are out there, the musculoskeletal procedures and the growth story there. So will you talk about this expansion in MSK in a little bit more detail, maybe some of the economics of some of the more common procedures there, where do you see the best opportunities within MSK and from really in the short run, and in the long run?

Sure. So we came out working to build towards our orthopedic programs for quite some time, seeing this shift coming, right? I would say that Tom and I have talked about this a lot. There was a study done where we were trying to figure out where should we spend our time in our ORs, which are obviously our biggest capital assets, and the dollars per minute in orthopedic, particularly implant cases, and that would be total joints and spine procedures is clearly where we have the highest dollar contribution margin per minute, not necessarily the highest margin. And so it continues to be a very, very attractive business for us. And we're in the early innings, right? So we talked about one of the nice things that we're seeing is that as Medicare moved hips in last year and has moved knees in, we're seeing that Medicare growth, that's also driving commercial growth. Because if you think about it just from a very simple point of view from a physician, the fact that they don't have to split their day or they don't have to try to decide where to go based on the fact they have 2 different payers, so they have commercial and Medicare patients. They can bring it all to us now. That's been really helpful. I think the other thing that's really starting to change is historically we have not been as focused on robotics and kind of the cost conundrum of trying to figure out how to bring the technologies into the ASC space was a little more challenging. We figured those out, and we've actually got a lot of physicians who -- the only reason they were splitting or not bringing their higher acuity business was in fact with a piece of technology, which we are solving. So we're in the early innings. I think we're predicting that by 2025, up to half the joints will be done in ASCs. I think that number could grow as technology improves as we get more comfortable with care protocols for aftercare and just super excited about that continued growth. I mean I don't -- do I think it will be 100% forever? No, obviously not. But it's going to be substantial growth for the foreseeable future. Tom, you may want to dive in a little bit there, too.

No, actually, you covered all the points I would have.

I would say -- maybe Tom can answer this one. So when you said you figured it out on robotics, what did you figure out? What was the problem of getting robotics? And what was the answer?

Part of the problem for us was just under -- you can't -- it's very different when you have a physician that says that they will bring their cases, than trying to decide if you build it, will they come, right? And I would say that what has also changed is that as we've looked at some of the manufacturers of these robots, they have done a tremendous amount to help us with the financing. And so it's become more of a razor-razor blade kind of situation. Where if you're buying the razor blades or the implants in this case, they'll give you the razor or the robot, not quite for free, but in a way where we can make the economics work, particularly when we know or have known quantities on physicians that are committing to bring cases. We can make that economic bridge work pretty easily. And so that's why we put, what, probably about a dozen of these in over the course of the last 6 to 8 months. I actually just signed off on 2 more about 10 days ago. So we're continuing to expand our footprint here. We have about 20 ASCs that have robots in them right now. That's not accounting the surgical hospitals. And I think there's probably another half a dozen that we'll look to do over the course of the next 6 to 8 to maybe even as many as 12 months. Where it makes economical sense and where we can drive the volume because we have good partner physicians, we're going to make the investment.

Yes. And Frank, I would add to that. The one place we're still working on is da Vinci. That's a lot of service lines in urology and outpatient OB/GYN. I do think as we go into higher acuity procedures, the thing I would point out is these procedures matter a lot more to payers because they're a lot bigger dollar and they move the needle. And so I do think there's a growing awareness that we need to work together with payers and vendors to solve the technology problem because the site of care savings for patients in the system is so large. So I think there's a growing kind of just desire to figure out, like, we shouldn't let a piece of technology be what keeps patients from having access to the best value care.

Got you. Is there any difference -- as you think of -- you've got total joints that are kind of coming in now. Are there any procedures that are further down the road, either in MSK or in cardio or other areas, where you see a similar, if not even -- I won't say similar -- a better economic opportunity as those become available? And if so, what are they?

Yes . So obviously, I mean I can point to a couple of things. I would say total joints, obviously, is such a large opportunity that it rises to the top. If you think about within the spine world, we're getting better and better at higher acuity spine and partnering with home health and aftercare providers to really make sure that that's done well. So that's an area where I see a lot of growth, it's a smaller in, right, but certainly, attractive business for us. And then I'd be remiss if I didn't mention cardiology. Cardiology is one that right now, we're -- we do it in a lot of our hospitals. We have actually heart hospitals that do the full big gamut of cardiac procedures. But we're starting to see cardiac rhythm management interest in our ASCs, which is kind of the pacemakers, the basic cardiology. Over time, there's 2 things that I think are going to drive that kind of slower for the foreseeable future, but it depends on the market. So cardiology is one of the most heavily employed specialties. So in many markets, even cardiologists who are now really interested in getting in the outpatient world and investing, there's going to be some time for them to work through conflicts and make that happen. The second part of it is, cardiology is a little different in that it's not behind the red line in a traditional hospital, meaning you don't need the same kind of support services that an ASC has, and it's a little bigger room. So you almost have to start with -- in our perspective, you start with bringing cardiologists on to start with some of the simpler stuff. Over time, as we build and expand ASCs, we're going to look long and hard about whether we should be putting cath labs in and building out. But that will take time. I will tell you, it's a huge opportunity, right? So I think it's comparable to orthopedics. It's just going to take a bit longer. We're going to make incremental progress. And certainly, in our hospitals, we're going to continue to push forward there. But those will be the 2 I would point to as the most readily obvious.

Got you. I don't want Tom to feel left out here. So I'm going to ask a balance sheet question here. Looking at your leverage, you've obviously refinanced a lot of debt. You've done equity, but still a fairly levered balance sheet. What do you see really the longer-term optimal capital structure that can support the growth that you have in mind?

So there's a couple of things that you need to realize. If we can deploy capital in the high -- into the high single digits, and the company continues to trade where it does, just the value that we can continue to create for our equity shareholders by maintaining a healthy debt balance is something that can't be overlooked. And I think as you look at some of -- probably the best public comp, one of the last pure play you had was SCA, right? And SCA had been very similar to us in that they had had a sponsor and then they went public. But they were in that kind of 5% to 6% target range on an EBITDA basis. I think that's kind of where we think equilibrium is. I think over time, with the growth that we continue to expect, could we go below that? Yes. But then I think the question reasonably comes on the other side, couldn't you add more debt? Couldn't you deploy that accretively to drive additional equity value? And so I think the balance probably winds up somewhere around 5%, but the kind of the other side of that is that I know that there's a lot of equity investors where 5% is too high, and we want to make sure that we're doing the right things to, a, create the right equity value, but b, ensure that we have the right demand for our shares. We're just above 6% right now. When you normalize with the Medicare Advantage payments, we're in kind of the mid-6% range, 6.4%. We've got some growing to do into our adjustments, a lot of which will happen over the course of the next 24 months. So I'd expect it to stay in that range. And then I think as we continue to grow, you're going to start to see a decline and potentially pretty rapidly.

Got you. One last question here, well, more of a high level thought. Bain has been a great -- certainly a great partner for you. And I know we've recently had the conversion of the preferred issue that they had owned, and now their stake is over 50%. So as I think about this. They're, I guess, now over 4 years into this investment. How do you think about their long-term ownership here? And obviously, the float is impacted by such a significant ownership. But what are your thoughts there? When you talk to Bain, do you have any sense of kind of what their investment horizon is?

So let me start by saying, we were obviously very happy to have the option to convert the preferred stock. That wasn't Bain's choice. Obviously, it was something that management had the chance to do once our stock price remained above $40 for 20 out of 30 days so we took advantage of that to reduce dilution going forward. As far as Bain, you're right, they've been an outstanding partner. They've been very supportive. They bring a lot of expertise. Clearly, they're a long term holder. And when I say long-term, they've got a long-term mindset. They want to build great businesses. We certainly haven't had specific discussions around time frame. But what I will say is this, they love our thesis. They love our space. They are excited about the momentum and opportunities in front of us. And so as far as I -- any conversations I've had, they've been amazingly supportive. I feel really good about the continued opportunities we have. I don't know, Tom, if you would add to that based on your interactions.

No, no. I mean the fourth anniversary is this August. They own -- they control about 59% to 60% of the vote. The preferred voted as if it was converted into common, right? So this is something that the company did right? Bain would have been happy to continue to pick and get their dividends. But because of the share price performance, we were able to convert that into common. That happened actually yesterday. The 8-K went out this morning. So we're really excited about that. But their common ownership is now consistent with their voting ownership. It's not really a sea change relative to their position. It's just that we have converted it all into one instrument. I think it's more mechanical than anything else. But I do think that it's a great milestone for us as we think about the equity story to not have that looming preferred.

Got you. Would love to keep talking. I have a lot more questions, but we're at the end of our time, unfortunately. So Eric and Tom, thank you so much for being with us today. And we'll be moving on to our next presentation. Thank you very much.

Our pleasure. Frank, thank you.

Thanks.

All right. Bye-bye.