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Greetings, and welcome to the Surgery Partners Inc. First Quarter 2018 Earnings Conference Call. At this time, all participants will be in a listen only mode. A question and answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. Tom Cowhey, Chief Financial Officer. Please go ahead.
Good morning, and welcome to Surgery Partners' first quarter 2018 earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today is Wayne DeVeydt, Surgery Partners' Chief Executive Officer. As a reminder, during this call, we will make forward-looking statements. Risk factors that may impact those statements and could actual future results to differ materially from currently projected results are described in this morning’s press release and the reports we file with the SEC. The company does not undertake any duty to update such forward-looking statements.
Additionally, during today's call, the company will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP.
A reconciliation of these measures can be found in our earnings release, which is posted on our website at surgerypartners.com and in our most recent quarterly report when filed.
With that, I'll turn the call over to Wayne. Wayne?
Good morning. Thank you, Tom, and thank you all for joining us today. I’m pleased to update you on the progress we have made at Surgery Partners as we continue to position the company for the significant growth opportunities we see ahead. Before I begin, let me start by reiterating my excitement to be joining Surgery Partners at this unique time in its history. I continue to be impressed with our surgical foot print and our ability to have a positive influence on the healthcare eco system and overall cost to consumers.
Having visited several of our facilities in the first quarter, I have been able to see first hand the efforts of our associates and physician partners to put our patients first by making quality and patient safety the core of what we do each and every day. I’ve also been able to observe and reinforce my original thesis around the strength of the surgical facility assets we own and operate and the power of our independence as we look to align with payors, including both state and federal governments to remove inappropriate and unnecessary cost from the healthcare system.
It is incumbent on us to help protect the integrity of the healthcare system, while improving on the sustainability of the system. As I said before, we are on the right side of the cost equation and fully align with the goals and objectives of consumers, physicians and payors.
I’m going to start with some highlights from the quarter and review the progress we have made in aligning our strategy and structure in my first 100 days as CEO. I’ll then provide an update on the medium and longer-term value creation opportunities we discussed last quarter. And finally, I’ll turn the call over to Tom to discuss the financial results in greater detail. Starting with the quarter, this morning we reported first quarter 2018 revenues of $417.4 million and adjusted EBITDA of $47.1 million.
Operating results in the quarter were characterized by strong year-over-year revenue and surgical case growth, as well as continuing investments in our infrastructure as we position our company for 2019 and beyond. We’re excited about the early progress we have achieved across our strategic initiatives and remain confident that they will have a positive impact on the business in both 2018 and beyond.
However, at this early stage in the year, we are maintaining our current revenue and adjusted EBITDA guidance of greater than $1.75 billion and $240 million, respectively. Since we spoke two months ago on our fourth quarter earnings call, I have spent much of time engaging with our leadership team across the enterprise to better understand the challenges and opportunities for Surgery Partners as we execute our growth strategy.
In addition, we began an assessment of our assets and opportunities with an eye towards improved performance. I would like to share some perspectives from these assessments and changes we’ve begun to implement to our organizational design.
First, our senior management composition changed during the quarter with several new members joining the team. Specifically, Tom Cowhey joined as Chief Financial Officer; David Kretschmer joined as Head of Strategy and Transformation; and Dr. Angela Justice is now leading our Enterprise Human Resource functions.
While this is Tom’s first earnings call as part of our team, Tom joins us after over a decade at Aetna, where he was the CFO for Aetna’s largest operating unit, including all of Aetna’s domestic health plan business. And he previously held roles leading Investor Relations, Corporate Development, Treasury and Integration. I’m excited to leverage this financial expertise, discipline, and broad experience help drive out our next phase of growth.
We also made excellent progress this quarter in filling out our leadership teams in procurement and revenue cycle management, critical areas as we execute on our integration and growth plans. These strong additions to our leadership team, our critical step in enhancing the culture of execution and excellence that should be expected of a company with a national reach of surgery partners.
Further advancing our human capital and organizational efforts, we recently consolidated our enterprise functions under these key leaders to advance agility and efficiency in our shared service operations in support of our P&L leaders. As a team, we are now beginning the process of evaluating the next level of our operational structure for further efficiencies and realignment, a process we expect to complete early in the third quarter.
Along with our governance, executive, and operational realignment we are also moving to deeply instill a purpose driven culture based on transparency, execution, and accountability. Our culture will embed the expected behaviors wherein associates can act to support our patients, physician partners, and other constituents with consistency and discipline as we begin to capture the value of our surgical facility platform.
With our enterprise shared service executive leadership team in place, we are now reviewing our operational structure and next chair of leadership to ensure we best align those teams to support our strategic and financial goals. In addition to rebuilding our team and realigning our structure, we’ve also begun to shift our strategic positioning for 2019 and beyond. We recently engaged in a data driven strategic assessment of the opportunities and challenges across our portfolio of businesses.
As stated previously, this assessment has only reinforced my view that Surgery Partners has the key assets to win in the market, while also highlighting our need to improve performance in a number of areas. I would like to take a moment to discuss some of the larger strategic raises questions that we are addressing within our portfolio of businesses.
First, we strive to be the preferred national partner for operating short stay surgical facilities across the United States. Operating short stage surgical facilities is the core competency for Surgery Partners and we believe we have the right people, processes, and assets to continue to be a leader in this dynamic and growing sector.
We are uniquely positioned in the industry as payors and providers continue to ship, more procedures to the high-quality, low cost setting that our surgical post facilities provide, specifically in orthopedics, including total joint and spine procedures, ophthalmology, pain, and GI. These practice areas represent core strengths upon which we will grow and we’ve begun the process of pruning those assets that are not aligned with our long-term growth strategy.
We recently completed some smaller scale divestitures based on geographical relevance and are now engaged in a process to determine the best next steps for certain non-surgical businesses. While such pruning may pressure our short-term adjusted EBITDA goals, we believe these actions will allow us to redeploy capital and refocus management on long-term value creation.
As an example, we discuss the importance of being focused on the right deals and our goal to deploy between $80 million and $100 million of capital per year related to mergers and acquisitions at prevailing industry multiples. We’ve rebuilt the pipeline of opportunities and late in the first quarter we closed the transaction in Omaha, Nebraska of an ASC focus on the orthopedic spine, podiatry, and pain specialties.
In addition, we have several signed letters of intent in our pipeline with assets that are aligned with our long-term growth goals increasing our confidence so we can achieve our stated capital deployment goals this year.
Moving to organic growth and margin expansion, we discussed on our previous call the need to increase our efforts around physician recruitment and retention, revenue cycle management, and procurement. I would like to provide you with a brief update on each of these initiatives in some of our early results.
Regarding physician recruitment, we have begun the process of doubling the physician recruitment team and are already beginning to see some early benefits from our efforts. Specifically, we’ve already organically added over 100 new physicians that will begin using our surgical facilities in 2018.
More importantly, we are using data to identify physicians in both specialties and geographies where we want to focus our growth. While the process to rebuild our physician recruitment pipeline will take time to mature and demonstrate financial impact, we are encouraged by our early results.
Turning to revenue cycle management, we previously discussed the need to the leverage our national scale and expanded footprint, resulting from the NSH acquisition and begin to consolidate the over 100 different vendor relationships, tools, applications, and outsourcing all which have led to an increased cost and complexity. It is important for our long-term success to be able to make data driven decisions and result the limited transparency that exist today related to revenue cycle management.
To this end, we are initially focusing our efforts on our shared services center in Tampa, Florida, which currently performs revenue cycle management for approximately 25% of our ASC’s and 80% of our practice locations. By the end of 2Q, we will have begun the process of rolling out a new front-end tool to reduce errors at patient registration, including improving patient eligibility and pre-authorization rates, which should lead to fewer payer denials. This tool will also improve the estimated patient portion of the final charges allowing us to more proactively collect at the point of service, which reduces both future collection cost and collection risk.
Finally, we’re moving to a single claims clearinghouse, which will give us consistent insights into payor claims performance and denials, allowing us to improve our front-end processes to pre-emp reimbursement leakage. We’ve already seen improvement in many for operating statistics at our Tampa facility, which we believe can serve as a longer-term model for all our future revenue cycle management efforts.
We anticipate incremental cost savings and operating synergies during 2018 with more material benefits being realized in 2019 as we implement these efforts across additional facilities. On the procurement front, as previously highlighted, we hired a full-time procurement officer and have begun the process of investing in the purchasing system to improve data analytics. We previously identified approximately 15 million in gross opportunities with more than half accruing to adjusted EBITDA and benefiting Surgery Partners shareholders.
To date, we’ve initiated discussions with our Top 20 suppliers, along with consolidating our 200 plus million spend into a new group purchasing organization contract that will take effect in the third quarter of this year. On our Top 20 non-GPO contracts, we’ve already re-negotiated approximately 15% of the contracts and expect to continue to make positive progress with the remaining vendors as the year progresses. Based on these early results, our confidence in achieving our $15 million gross procurement savings goal is high.
As a reminder, while these benefits are being negotiated and partially realized throughout the year, the majority of these benefits would be realized in 2019. Lastly, our team believes that aligning with payors is critical and will support and drive our growth objectives. Our shared emphasis on patient safety and cost efficiency provides a great platform for future partnerships with the payor community.
We are taking a thoughtful approach and have begun to look for opportunities with those payors with whom we choose to partner and to identify locations and models, which support both organic and inorganic growth. Based on early discussions it is clear to me that is short stay surgical facilities space is a key and rapidly emerging part of the healthcare ecosystem. Because we are on the right side of the cost equation, we are fully in-line with the goals and objectives of the payor community.
As you can see, we have a lot to do over the remainder of the year. The actions we need to take are not unique or difficult, they simply require focus and execution. However, coming out of my initial 100 assessment, I’m extremely encouraged and confident that we have the right assets and the right opportunities in place to achieve our outlined objectives and drive growth and value for all stakeholders going forward.
With that, let me hand the call back over to Tom for introduction and overview of our first quarter financial results. Tom?
Thank you, Wayne, and good morning everyone. I’d like to start off by echoing Wayne's comments about my excitement of being here at Surgery Partners. As the largest independent operator of short stay surgical facilities, I think that Surgery Partners has a unique opportunity to improve the efficiency and quality of the healthcare system and create value for all of our constituents. I’m optimistic that our strategic initiatives will unlock the long-term value and surgery partners assets and I’m excited to be part of the team that will deliver those results.
With that, I’ll turn to our first quarter 2018 financial performance, starting with some of our key revenue drivers, then moving on to adjusted EBITDA cash flows, and finishing with our 2018 outlook. Our first quarter revenue of $417.4 million, reflects the 46% increase over the prior year quarter, primarily as a result of the acquisition of National Surgical Hospital in the third quarter of 2017.
Surgical cases also increased to approximately 125,000, nearly 15% increase, as compared to the prior year quarter. On a same-store basis, total company revenue was down slightly, a result of the 3.8% increase in net revenue per case offset by a 4.1% decrease in case volume. Note, the consistent with past practice, our same store calculations are inclusive of revenues associated with our ancillary services business, which experienced declining revenue as compared to the prior year period and influenced our same store revenue growth metrics.
Let me take a moment to address some of the dynamics that are impacting our surgical case volume. In the quarter, we saw some softness in case volume, primarily related to high volume lower revenue procedures. As an example, we had 11 of our facilities closed for total of 19 days this past quarter, as a result of severe weather in the north-east with additional volume softness on the reopening of those facilities.
We estimate this weather-related impact reduced case volume by over 900 procedures in the quarter with minimal impact in net revenues due to the nature of the cases involved. Further, while flu-related delays and cancellations are hard to quantify, we also believe, this dynamic impacted volumes inside the quarter. We also experience lower surgical case volume from commercial payors in the first quarter, a typical dynamic at the beginning of the year as higher deductible plans encourage consumers to perform discretionary procedures in latter parts of the calendar year.
Our early read on April would suggest that same-store surgical volumes have started to recover back into the low-to-mid single-digit percentage growth range. Additionally, as Wayne previously discussed, we are in the process of improving our organic physician recruitment, which we expect will have a greater impact later in the year.
Turning to our ancillary services business, revenue declined approximately $5 million in the first quarter, as compared to the prior year period, partially driven by dynamics in our lab business. Throughout the back half of 2017, and into the early part of 2018, we have been migrating our out of network lab services into commercial networks, a process that is substantially complete.
While this puts short-term pressure on revenue and operating earnings, we believe it is aligned with our longer-term strategy of being on the right side of the cost equation and partnering with payors and driving cost out of healthcare system.
Turning to operating earnings, our first quarter 2018 adjusted EBITDA was $47.1 million, a 17.4% increase over the comparable period in 2017, again primarily a result of the addition of NSH in current period results. Our adjusted EBITDA includes a year-over-year headwind from our ancillary services business of approximately $2.5 million, partially driven by the lab pressures I previously discussed.
Our adjusted EBITDA margin declined to 11.3% from 14% of revenue, as compared to the first quarter of last year. Consistent with our discussion last quarter, the decline in margins was primarily driven by an increase in our medical supply and implant costs driven by higher acuity cases but was also impacted by the year-over-year decline at our ancillary services margins.
As Wayne highlighted, we’re also making substantial investments in our infrastructure, including human capital. These investments put short-term pressure on operating earnings and margins but will begin to pay dividends in the back half of the year and into 2019 and beyond. We continue to have confidence in our ability to recognize the synergistic benefits of the NSH acquisition, and our focus on obtaining long-term sustainable benefits as highlighted in our revenue cycle management and procurement work.
Finally, we undertook an effort this quarter to evaluate our contractual adjustments and other balances to continue to apply consistent policies across our combined businesses. As a result, we strengthen reserve balances at March 31, a portion of which was recorded in pre-acquisition periods and the remainder of which approximately $4.8 million was recorded this quarter. As detailed in our reconciliation, we have excluded these adjustments from our adjusted EBITDA presentation.
Moving on to cash flow and liquidity, at the end of the first quarter, the company had cash balances of approximately $113 million and approximately $72 million of availability under our revolving credit facility. Of note, during the first quarter, Surgery Partners deployed approximately $26 million for the acquisition of a surgical facility in Omaha, and other in market investments, used approximately $20 million for payments on our long-term debt and our preferred stock, and purchased approximately 157,000 shares of our outstanding common stock at an average price of $12.64 for an aggregate amount of approximately 2 million.
The ratio of total debt-to-EBITDA, at the end of the first quarter of 2018 as calculated into the company's credit agreement was 7.7 times, primarily related to the same-store and ancillary services business performance in the current quarter as compared to the prior year quarter.
The company has an appropriately flexible capital structure with no financial covenant on the term loan or senior unsecured notes. Our balance sheet is well positioned to continue to fund our strategic initiatives and our total debt-to-EBITDA ratio should naturally decline over time as our business grows.
With respect to our 2018 outlook, we have increasing confidence in our ability to deliver greater than $1.75 billion in revenues and at least $240 million in adjusted EBITDA, particularly as we begin to execute on our M&A strategy and begin to see the benefits of our savings and integration initiatives. I’m excited to be part of the team that delivered these results and as I look into 2019 and beyond, I'm confident we can create value for our patients, providers, payors, and in doing so create value for our shareholders.
With that operator, please open the call for Q&A.
Thank you. [Operator Instructions] Our first question comes from the line of Brian Tanquilut with Jefferies. Please proceed with your question.
Hi, good morning guys. Wayne, thanks for all the color that you gave us on the reviews that you're doing and the feedback you’re getting from the ground, but just wanted to see what the feedback so far has been to the change in management, and just the change in ownership essentially from the physician angle, considering that obviously these are your partners and they own 49% of the centers. So, what is the feedback and what do you see in terms of the physician performance and more since you’ve come-in?
Brian, first of all good morning, and thanks for the question, and the thoughtful part of it about just how the physicians are feeling in this process. It’s been very encouraging, is what I would say at this stage. I’ve had an opportunity to visit several of our facilities and interact directly with some of our largest physician groups that are out there, I have several more scheduled in the second quarter. I think in the early stages it is fair to say that many were curious, kind of what this really mean for us? What is the value you are trying to drive for the organization, and how do we want to partner as we’re thinking about expansions?
I’m personally encouraged in the fact that one, those discussions have all gone very well. As you would expect, we value our physician partners so they provided feedback on how we can be a better partner to them, and so we’re taking that feedback to heart, and ultimately, it’s really led to us actually having some pretty productive discussions on some de novo opportunities with several there in the many markets right now. So, I would say the early read is quite encouraging, but we're getting the right feedback we need, which is, how can we be a better company for you as your partner?
Got you. And then Wayne during the quarter we saw, some of the blues plans, and I think you might have well announced early pilot programs on outpatient joint replacements, so how are you preparing for that, how are you marketing around it and are you seeing or participating in any of those early programs that we’ve seen these helplines announce?
Yes, Brian, it is a great question. Short answer is, yes. We are participating, we’re still in dialogue with different partners right now, as to which ones make the most sense, our partnership discussions range from what I would call strategic discussions in the sense that there is limited competitors at the hospital side and we have a chance to somewhat disintermediate along the way to those that are much more strategic about wanting to have a longer term partnership in terms of starting a dialogue around how we might partner on a more national basis.
So, I do anticipate that we will ink a few of those, probably in the next 90 days or so. Smaller in nature, these things are generally pilot programs out of the gate, and then you show that you can drive the value you believe you can drive. We think we’re fairly easy value prop to prove, so I don't think that’s our concern, I think the biggest thing is just giving those opportunities to show people that we can bring that value. So, it is a little bit of a slog out of the gate, especially when you bring a new team in because I think people want to make sure who you are going to be long-term, where you are taking the company, and so we are having those discussions, but I feel pretty good about the progress and where we will be by the end of the year.
Last question for me, you guys touched on revenue per case and the discussions on managed care, I mean how are you thinking about the trend in that specific metric and how are these discussions going and also what percentage of the – or portion of the revenue per case year-over-year decline would you attribute just to mix both case and payer versus true rate deceleration? Thanks.
Sure. So, Brian there is a couple of different questions in there and I want to make sure I answer this thoughtfully and if we don’t, obviously, let’s make sure we can get to the answer, but let me start with just kind of the revenue case metric and I will ask Tom to feel free to join here. One of the things I want to caution everybody on is to recognize that we are pruning our asset along the way and there are some assets that we think long-term, while may be solid don't really have growth trajectory to them, do a lot of cases that are low dollar cases, and yet we may be shifting to what we think are much more higher dollar cases, core reinvestments in our business, in orthopedics, spine, et cetera.
And of course, we ultimately think those will be a higher revenue per case and so you have this kind of interesting dynamic though that will be happening that will have both positive shifts on it as we make these moves, but also negative shifts as we make these moves. And as you move to these higher implant cases, it’s also important to recognize that concurrent with moving to this type of environment, we’re also in the process of negotiating lower implant cost, right. So, the value chain and the benefits of all those don't happen as we’re moving forward. They happen kind of currently, and you will see that value occur over time. So, let me just start with saying, I would caution everyone or any particular metric, but nonetheless you should focus and ask us those questions just as you are doing today.
Relative to the payors, the one thing I would tell you that I find tightly encouraging is, we have done a deep dive of our top 20 locations, we’ve looked at the top 100 CPC codes, and we’ve tried to benchmark ourselves against what we think the average ASC is getting in the market. And while I won't share the specifics of that, what I would tell you is, the opportunity for revenue improvement is very meaningful for our organization, especially for the value we try.
Now, that cuts both ways. In one way, it is helpful because we can sit with payors and show them why we are the better choice, and why we are also probably the most efficiently run ASC out there. The flip side of that is, we need to get paid for the value we bring as well, and so we need to make sure that when we have these discussions we negotiate from both sides, but I would say some of the revenue lift you saw in the quarter, I think is very indicative when you look at overall revenue increase per case of something you should continue to see in the future.
Just a reminder though that many of these contracts renew generally over a two or three-year period, and so as much as we want to go get all of lift today that actually happens over a multiyear period as you’re renegotiating, but now we’ve empowered our operators for the first time with the data to really understand how we stack up in our markets on the top 100 CPC codes. So, we're going to have a much more thoughtful negotiation with payors.
Sounds good. Thanks guys.
Our next question comes from the line of Ralph Giacobbe with Citigroup. Please proceed with your question.
Thanks. Good morning. You talked about lower volume in the lower equity services, so I was hoping you could come back and sort of talk about growth maybe you are seeing in higher equity service lines, where are you seeing the increase, and again if you could break that out by service line that would be helpful.
Ralph, it’s Tom. Good morning. As you think about the case mix inside the quarter, we gave you a little bit of data in the prepared remarks on some of what we saw inside the north-east. And as you look at that data you, we did not give you the exact revenue per case, but it is significantly below the average. And as you look across kind of the different categories where we were projecting that we would see growth, you know one of the places that we actually saw a little bit of softness as well was also in the pain category, and those tend to be injections, those tend to be very quick low dollar revenue, but good margin business.
And then as you look at the mix kind of year-over-year and admittedly this is a little bit tainted by the NSH volumes coming in because the mix changes a lot on that basis, you know, we are seeing good increases in kind of our ortho business, which is consistent with some of the focus that we’ve had as a company to drive spine in particular, to drive those cases into our facilities by recruiting the right physicians, and ultimately we think that that is a better dollar margin play for the enterprise, but as we make that shift there is a little bit of breakage there.
Ralph, one thing I would add to that, just to Tom's comment, you know look as we, as we look at the [indiscernible] we’re actually encouraged what we’re seeing on the ortho and spine front. A little mix-shift in the first quarter, which is not uncommon though as deductibles get reset at the beginning of the year as you see a little more of the kind of government Medicare coming in a little less of the commercial then we expect that to ramp up as the year goes through. But in general, we’re seeing it in the right places in the right spots, and I think probably the best evident point I can point to is, you could see how revenue was actually pretty decent in the quarter. We have pretty strong revenue, and that thing was – actually divesting of a number of assets in the quarter and pruning back we divested one ASC and 7 practices in the quarter that weren’t quarter what we are doing.
And so, we obviously are still accomplishing pretty strong revenue, and so from that perspective we felt pretty good about it and then the last thing I would highlight is, as you heard in the prepared remarks, you know the lab because it gets integrated into some of these statistics and revenue numbers you have seen historically, it really distorts how we’re actually performing on the revenue front with the surgical facilities and so again, back to our core, I think we’re doing the right things. We're repositioning the book the right way, we're covering the divestitures that we’re doing along the way, and the goal would be towards the back half of the year that you will start to really see that improvement and then more importantly, we understand that if there is an expectation for meaningful EBITDA growth starting in 2019 and beyond and that’s really what we're building towards.
Okay. Can you give us the payor mix for the quarter versus sort of a year ago on as much of kind of a sort of comparable basis just to get an understanding of sort of the weakness on the commercial side?
We would like to follow up with you offline on that, as it is not data that is readily available given some of the system transition issues associated with NSH, you know, I think your best look at this point is to try to take a look at some of the mix that you saw in the fourth quarter versus the first quarter because you do have total company. That obviously is going to very much show the shift that Wayne is talking about, kind of that lower commercial mix as a total company. As we look at some of the subsets of data, we definitely can see some of the dynamics that we’re talking about, but it’s – our visibility of the total company at this stage with our integration is a little bit limited.
I want to emphasize one thing Tom said, you can clearly look to Q4 and you will see the declination in commercial and the heavier wait to government, but Q4 is a bad proxy in the sense that that is very common. Deductibles get reset, and you should see that declination just as you should see in Q4 the higher commercial setting. I also want to clarify what Tom said from the standpoint that when we talk about lack of visibility, it’s not like a visibility of what we have today, and what we do today, it’s that we’re trying to do a comp for you as best as we can against an asset we didn’t own a year ago at this time, and of which we’re trying to pull in as much data to make sure that we get at the right granularity.
So, it’s not a lack of confidence in what we’re telling you because we know it’s directionally right and we have enough data. It’s the fact that as we’re doing these integrations and migrating the systems and platforms we want to make sure that when we tell you something, we tell you exactly what we know, and I think that’s the point Tom wanted to make, because it is not completely apples-to-apples. We believe quarter-over-quarter when we look at a year ago, but we know directionally we can definitely see that it’s not that big of a reset what we would have typically seen in Q1 a year ago, but a meaningful reset versus Q4, which was expected.
Okay. All right. That’s helpful. One more if I could squeeze it in. Margins in aggregate, but also within surgical facilities we’re under pressure both year-over-year, but also sequentially. So, I guess I’m still trying to understand sort of the sequential, you had the good revenue in totality into way to think about it, the higher sort of the mix of the procedure, the lower the margin profile of that or help us sort of reconcile even the sequential when you had NSH in and the fall of 1Q over 4Q? Thanks.
The first thing I would say Ralph is, think about it in the most basic sense and use an example of one person, and use the example of $100 in kind of revenue right and if you're not doing larger implant cases, which is what we’re migrating towards orthopedics and spine et cetera, as you think about those you have a gross up in revenue for an implant case and let’s just say that the gross up is $50 right because that’s what lets the implant cost, but your cost of goods sold went up by $50 and so just the basic math of saying, well now my revenue is 150, but my cost of goods sold let's say went from 0 to 50, you can see the math of it will create a margin declination, just the math of it does.
Even though your actual EBITDA is actually improving and your cash flow contribution margin per minute [ph] is actually improving. So, one dynamic is, this continued shift to what we’re migrating to, we’re continuing to put the short-term pressure on it now. The expectation and what Tom’s pushing the team on is to say, yes, but now we’ve got to go get our top 20 vendor contracts renegotiated because that’s how we start getting our margin expansion back because now we start cutting into the COGS of each of those implants and as we get those COGS down we get margin expansion on those higher cost procedures.
Okay, alright, thank you.
Our next question comes from the line of Kevin Fischbeck with Bank of America/Merrill Lynch. Please proceed with your question.
Good morning. This is actually Joanna Gajuk in filling for Kevin today. Thanks for taking the question. So actually, first I just want to follow-up on the comment you were making about your confidence in the outlook, did I hear right that you implied, I guess the acquisitions going to help you reach your 240, you know EBITDA in excess of 240 million, so I guess are you talking about the deals that you already closed in Q1 or also you are including additional future acquisition?
I would say the following. There is a lot of things that are moving inside the overall portfolio right now, and we’ve talked about the acquisition that we completed inside the first quarter. Wayne has talked about some of the activity that we have undergone and some of the strategic activity, we've actually pruned some assets inside the quarter as well, and so there were puts and takes.
I would focus you on the fact that we have a floor out there for both revenue and for EBITDA and we have said, we were going to exceed that and we will continue to believe that we will exceed that, but given how early it is in the year, we would like to print a little bit more in terms of time before we can see a little bit more in the business especially given that the first quarter was a little bit soft on the volume side, although we have seen some recovery in April as we talked about in the prepared remarks. So, when we give you an update to our outlook that we have a high level of confidence in net that isn't influenced by potentially a one-off quarter.
And as we have said in the last quarter, we expect M&A to be additive to any guidance we provide. So to the extent that we exceed 240 in EBITDA or revenue metrics, you know you would expect to see is some of that come from M&A front, but as a reminder we actually feel like now that we have done this database strategic assessment, we think we can move even a little faster on pruning some assets along the way that don't make a lot of sense for what where taking us long-term in the growth we're trying to do and because we’ve got a pretty robust pipeline right now, we think we can to redeploy it fairly fast, but it doesn’t exactly happen one for one, right as you get rid of one, you probably got at least another 90 days of getting the other one kind of signed and aimed to moving it through the process. So, there is a few things, but as Tom said, kind of the age gets trampled as you are running through a pruning process, but [indiscernible] process, but our confidence level in the greater than 240 and the revenue numbers is highly at this point and we believe we will continue to achieve those, but we are not baking in any letters of intent that we have at this point or anything of that sort as those get done. Those will become additive to earnings.
That’s helpful. I understand it. And then I guess also on the comment you made on the volumes and how Q1 was soft, so do you have sort of a view in terms of how the organic volumes will kind of play out this year?
We don’t give guidance specifically on case volume nor do I intend to do that today, but I think that we did specifically give you a sense that as we looked at the month of April that we had seen on same-store basis year-over-year April and looking at - we're bidding too much credence in one data point based on one month is always a tricky game, but we did see a low-to-mid single-digit growth on a same-store basis in surgical cases in the month of April and so, we’re encouraged by that because it does lend credence to the theory that there were some pressure points in the first quarter, which we specifically talked about some of the mix issues some of the weather issues, some of the flu issues, plus the increasing, ever increasing impact of deductibles, which pushed some of these elective higher dollar revenue commercial procedures into the latter part of the year that we could see some of that come back, but as we said, in answer to your first question we would like to see a little bit more evidence before we talk about that or declare victory.
Great, it’s helpful. And the last one, quick question, are you talking about the recruiting 10 physicians so far this year, so how does it compare to last years to the similar period of time, or maybe also overall for the full year last year?
Yes, I really appreciate the question. If you were to look at last year, we had a net declination in physicians within our organization. I’m going to – I know the number, I don't want to give you the number, what I would say is, we have a meaningful headwind coming into the year because of the net declination that we have to kind of back fill if you will, the example I use is like filling the bath tub, right. If the bathtub is with filled up with all these physicians using your facility and you get this kind of slow leakage that happens over a multiyear period, eventually the tub is halfway full, and so first call is, if you want to get that kind of utilization machine moving again and getting those case machine moving again, you got to fill that tub backup, super encouraged with what I have seen with what the teams have done in the first 90 days of the year, adding over 100 new physicians, and more importantly in the right areas that we want to be in, the right specialties, and – but more importantly what you’re going to see an early in the year is you're just starting to fill it back up, and so when you’re comparing even a quarter ago, a year ago versus a quarter ago this year, you are still dealing with a net headwind of fewer physicians using your facilities then you have.
By the end of this year, I would fully expect to see the opposite dynamic, which is we have a lot more physicians using our facilities by Q4 than we actually had in Q4 of last year. And so, I think again it is an important proof point for not only us, but for you that we can show you that we are kind of filling this bathtub back up if you will of individuals using our facilities and so early trends are really encouraging. We really saw the more significant declinations actually start beginning of last year. You know, we saw some net declination a year before, but not super meaningful, but last year is when they really started and kind of went throughout the year.
Great. That’s all from me. Thank you so much.
Our next question comes from the line of Chad Vanacore with Stifel. Please proceed with your question.
Thanks a lot. So, I’m looking at the same store volumes, which were fairly weak down 4.1% in the quarter, how much of that volume loss was due to controllable factors and then what’s the best lever you have influenced those volumes going forward?
Hi Chad, good morning. When you look at the items we highlighted, I think there is two things that were not necessarily controllable. Clearly the weather and the impact of that which was around 900 cases that we can point to physical facilities being closed, so it is pretty straightforward. I think the other thing that we saw, which was pretty meaningful declination in there was the change in policy over the last year from payors around what will cause some of the pain and specifically the shots, two things that we saw happen there, one is historically when you were getting an approval for shots, you would be able to send out an authorization pre-op and they would ping you same day, while the patient is in the office and they would pre-approve three shots.
So, basically one per month for the quarter. What we’ve seen is an actual dynamic change where now they are taking up to 7 days to pre-op, which means that patient leaves the office and you actually lose the opportunity for the patient to come back. And two is, what we're seeing is we’re only authorizing now one shot. And so, it is a simple dynamic, but that will have a substantial impact on volume, but not a substantial impact on revenue or EBITDA.
And I want to emphasize that point because those are the two dynamics we saw that were a little more out of our care and custody. That being said, look, at the end of the day it’s our job to figure out how to deal with this evolving environment, right, and it’s our job to figure out how to get this machine moving again, and a big part of that is you got to get docs in your facilities, it’s really that simple.
So, the physician recruitment is a big part, but that takes a ramp up. We ramped up the staff in Q1, you can already see we have recruited over 100 new physicians by the end of Q1, but even those docs don't walk in on day one and do 10 procedures a month, right. You're then getting them used to your facilities, getting them used to the scheduling and then of course that ramps up as the year goes. So that’s one thing that we are doing to drive it.
Two is, we're working on a number of the de novo’s, right. I mean the reality is, the organic growth machine has to come through some de novo’s and need only to expand not only where you reside today, but where you want to reside tomorrow, and we have got the de novo machine running again, and those are running. But as you know, those have more of a 18-month window associated with them.
So, every activity we’re doing today is about how we drive growth into tomorrow and tomorrow being more like the late 2018, 2019, 2020, but I would be the first that would say to you Chad, we shouldn't be in this position in the first quarter, but it is a function of not having the right resources focused on the right areas over the last year specifically in our physician recruitment.
All right, and just thinking about case growth here, first quarter, typically seasonally weak and so – and you pointed out that April seem to get better, how should we consider the, I guess the sequential movement of case volume from 1Q to 2Q?
Are you asking us to give you an estimate of what we believe case volume will be in the second quarter?
Or however comfortable you feel in guiding towards that level?
I mean, I have one point on the line at this point for the second quarter, you know it is an encouraging data point relative to the first quarter, but we would like to see a little bit more of the second quarter before we talk about, you know what that might mean for the full-year.
All right, fair enough. So, what really was the issue in the quarter, expenses were elevated across the board, so how do you get those down because it seems like most of the improvement that you are expecting on the expense side is really weighted towards the back half of the year and most of that’s targeted towards full realization in 2019?
Yes, I couldn't agree more Chad. I don't know that I would say that I am concerned about expenses quite the contrary. I know where they are being spent, I know exactly where we are investing. I’ve got line of sight on what the payback will be for our shareholders, but it’s back-end weighted in run rates, so it is real cash flow value. You can’t run an organization of this size and scale, but not invest in basic functions like procurement, I mean that requires headcount and revenue cycle management that requires headcount, and so we’re adding headcount in areas and we're making investments in core infrastructure that will drive long-term sustainable value.
I mean personally, I view this year as a reset year as the year of heavy investments and then we should be coming out to you, which we plan to with a three-year strategy about what we think our three-year CAGR will be, but my confidence in our initiatives and the investments are high at this point. I can see early wins and I can see sustainable wins, and so I don't think you guys see the investments pay back in those areas.
Now what you will see, as we progress through the back half of the year is as we start shutting down more facilities in more locations and becoming more efficient as an organization. That will continue to happen, but we did not want to do that as the expense at the same time that we’re in the middle of investing. So, first was, get ramped up on the staffing in the right place, then ramped out on the staffing in the wrong place. So, those are all back-end loaded.
So, how should we think about that comment on shutting down facilities in back half of the year and what kind of size are we talking about?
Well, it depends. We’ve done a strategic assessment of all of our non-surgical facilities. We continue that process now. Some of these could be much more sizeable and if they are we will call them out. Obviously, we're not going to sell an asset or dispose an asset unless we gave what we believe is fair market value for it. Two is and obtaining fair market value we think based on the existing pipeline, the ability to redeploy the capital quickly is there.
Now quickly meaning generally within 90 days to basically replenish that EBITDA, but we can have a short window of 90 days to 100 days, where we have taken EBITDA headwind in the short-term, but again I’m not concerned about that because I think it’s kind of like pruning a rosebush. Doesn't look too pretty when you start, but I’ll tell you what, by next year it looks pretty damn good and that’s what we're focused on.
All right. So, along those lines you had mentioned the disposition in the quarter, what kind of revenue and EBITDA impact shall we expect in that sale?
I'm sorry, could you repeat the question, what revenue – we're not going to break any of the specifics on some of the smaller assets that we’ve pruned or any of the acquisitions that we’ve done to date at this point. You know, we will be updating our guidance again at the next quarter. For now, you know we have said that we have increasing confidence in our ability to achieve or exceed – to exceed the guidance points that we put out for the full-year and we are happy to continue to talk to you as the year progresses on what some of those puts and takes are as we update that guidance point. Thanks for your question this morning.
[Operator Instructions] Our next question comes from the line of Mr. Frank Morgan with RBC Capital Markets. Please proceed with your question.
Good morning. I'm just curious on the physicians that you’ve recruited, I think you mentioned the importance of the mix of those physicians, can you give us a little more color, little more detail on that mix of physicians that you’ve added, and then historically what is sort of the timeframe over which you see the contribution from the new additions like that to really start to move the needle? That would be my first question.
Frank, good morning. And thank you for the question. Let me start by saying that one of the efforts we went through is we went through an analysis of not only our facilities and where we had capacity, but we also did a direct contribution by minute analysis so we can get a real feel for, as we’re recruiting physicians into facilities that have the ability to do multiple procedures, what procedures do we believe drive the highest direct contribution margin on a permanent basis so that we’re being efficient in who we recruit and why? It is probably not with much of a surprise that those align very much with who we have been talking about broadly, which is orthopedics, spine, et cetera.
So, a lot of our physician recruitment is in those areas. It’s not exclusively to those areas because you know certain facilities may not have the wherewithal meaning the equipment to do those type of procedures. So, if we have capacity in a facility that could be ophthalmology or GI, we will still recruit into those because it is as much about filling the facilities as it is targeting, but we will be much more targeted though on how we felt facilities based on what their capabilities, capacities are. Second thing I would say is, you have kind of a window where it takes roughly 90 days to 100 days to build relationships with the docs, ultimately you get them convinced that they should use your facility and then it takes probably another 90 days, another quarter, so before you start giving some more ramped up run rate.
So, if we think about with that lens, in every doc you basically get in, probably doesn't hit more full run rate until about six months afterwards. And so, you're kind of always on a six-month delay in the process. So you can get a feel for the docs we have today through the end of Q1, probably start really using our facilities much more frequently and much more comfortably probably more by Q3, and then of course where we recruit in Q2 moves to Q4, but as you can see as you move into next year, you start really getting the full lift, because get the lift from all those you get this year, plus those you get in the back half and then you continue to recruit going into next year. So, it’s another reason we have a lot of optimism on what we could do with case volume beginning in late this year and early into 2019.
Got you. And second question is really on cost and on margins, I think you referenced the loss of EBITDA, but I was actually concerned and maybe some of these or not concerned about, but hopeful that some of these divestitures might be EBITDA negative and if that would actually be a quicker thought for you, so, when you make that comment about the drag or the loss of that EBITDA on things that are divested temporarily, when you look, I mean most of what you sold in the quarter looks like they are in this batch, just seven practices and one ASC, is there a bunch of a discernible difference in the profitability characteristics of the ASC versus those physician practices, would the practices be more likely to be very, very low EBITDA and the ASC be higher EBITDA?
I think as you think about the activity that we have done to date, you know most of it is small. All right, but it is indicative of the fact that we are taking a much broader look at a portfolio. And a portfolio by nature has got winners and it has got laggards. And for those that are laggards we’re trying to understand what’s the reason? Can we turn it around? Over what time period and ask the question are we the best owner of that asset. And that’s what we’re doing across the portfolio to try to decide whether or not we’re the best asset owner for all of these particular facilities and there are some that, the removal of them from our outlook may be EBITDA positive.
That absolutely is a possibility, but you know as we look at the things that we have done to date and executed in the first quarter relative to the things that we’re currently evaluating, I’d say the impact is small, but as a step back just a little bit to your question about margins overall, there is – and you can see some of this data from either the press release or you will see it in the segment data when we filed the Q, was there pressure in margins in the core surgical business? Absolutely.
We’ve talked about some of the drivers of that, whether that’s a combination of volume and some of the mix that we’ve seen. But I wouldn't lose sight of the fact that margins are down fairly dramatically on a year-over-year basis on our ancillary business. We’ve talked about one of the drivers there, which is our lab business and some of that’s a very conscious effort to drive a more sustainable business model as we look to partner with payors. The other piece as you just look at the overall margins is some of the investments that we’ve made that are going to be front-end loaded relative to the benefits of some of the strategic transformation work that we’re executing on.
Frank, one thing to tag along with what Tom said is, I think your question around, are some of these items that either we’re losing a little bit of money or breakeven? Yes, the first quarter was easy. That’s the low hanging fruit and that’s what we went after. There was clearly physician practices that made no sense, while contributing to net value chain of the company and we made those changes, and some of the ASC’s as we look forward you will see de minimis ASC divestitures, albeit we will do some because geographically they don't make sense.
We don't think there is a growth proposition there for the future, and we think we can deploy those potentially at reasonable multiples that we can redeploy at a reasonable multiple, meaning we can net flush those out with at least neutrality to may be a positive, but we have some non-surgical assets that do generate some of EBITDA, and those are assets that we’re looking at with aligns that says there is little bit of a distraction from what we are trying to do because they are not core to what we do, they don't get the focus that they showed.
And even if we gave them the focus we're not sure it’s worth the dollars of where we can deploy them in other areas for growth. So, I think that will be the next round that we will be focusing on as the year progresses if some of the assets. All that being said, we said in our original guidance that we generally have contemplated some degree of divestitures in our original guidance outlook and we have not included the M&A’s a and so we're still confident in our guidance outlook even with the things we’re contemplating at this point.
Okay. Thank you very much.
Thanks Frank.
Our final question comes from the line of Bill Sutherland with The Benchmark Company. Please proceed with your questions.
Thanks. Hi, good morning Tom and Wayne. And thanks for squeezing me in. Just a couple here. Had you built out the recruiting bench completely at this point Wayne?
No. Bill, appreciate it. No, it is not completely built out. Yes, we still have a few more hires that we want to do. And then more importantly, as we start the M&A pipeline, which is again as I said robustly growing again, we want to contemplate whether we had even more there to the extent that we have facility capacity or as we start to actually get our de novo’s up and running. So, I don’t think this is ever one that completely finishes or end, but we are not far off from where I want to be at in terms of optimal staffing right now, but we’re still a few staff away from where we want to be optimal or where we want to be at, and the other thing is, the staff have a ramp up in training because we got to get them trained before they can get out in the field and tell the Surgery Partners story to then begin bringing the doc.
So, what we’ve done is, for the existing recruits, we’ve been very focused on prioritizing the right geographies and services we want to provide and where we're not having boots on the ground yet, I would say there are less long-term growth there – they are long-term growth drivers, but they are much smaller than where we are focusing our efforts today.
And with the physicians that are coming in, they are not coming in as employees, are they? They are just utilizing centers.
That’s correct. These are just utilizing centers. So, they have no ownership interest in the organization. Generally, these are ones that we think make a lot of sense to recruit. If we think there is a possibility to syndicate we will because if there is docs we think are, really the right docs that we really think do the right procedures at the right quality, and obviously are well known in the communities. We would like to have those docs, and in those cases, we will come in with some liquidity or equity in the company if you will.
And, you had I think mentioned on the first call Wayne, sort of a level to expect on leverage by year-end, kind of in the mid-sixes, based on what you get on the table at this point are you still spending et cetera, is that still kind of a number we should think about?
As I look at – Bill, it is Tom. As I look at the leverage ratios, and I think about our guidance and we saw a lot of pressure on the multiple or the EBITDA or debt-to-EBITDA multiple inside the quarter, you know we had a relatively good first quarter in our performance. We swapped that out for a week or one, and as I look at the – at the numbers, I would say, I’m not sure that at the end of the year that we're going to see six, but I would say that partially depends on exactly where it is that – or how much we grow, but six seems like a faraway off.
I’m not exactly concerned about the current leverage ratio, given the covenant package that we have and the amount of financial flexibility that we have, and that’s exactly why we have the financial flexibility because we want to do the right things to grow this business over the longer-term. We’re making investments today that will have a longer tail on them, and when we see the benefit of those, I think, and we grow the business I think we will naturally de-lever, but I think that probably seeing six by the end of the year feels optimistic.
Okay. Fair enough. However, I will just hit you with some more questions off-line. Thanks. Appreciate it.
Thank you very much Bill.
Thanks Bill. Before I conclude, a couple of things I just want to highlight. One is, I really appreciate the questions from each and every one of you this morning. These are the right questions you should focus on and to be honest it’s exactly where we're focused on each and every day, I’m actually super encouraged about where we're taking the company right now, what we’ve accomplished in really one quarter has been quite [indiscernible]. I’m quite proud of what the team’s done in such a short period of time.
I’m even more excited as we really start to get back to the basics and really start to execute and show you the positive developments. And ultimately when we guide for next year, hopefully be able to show you what we’ve been talking about, but with that, I want to take a moment just to say thank you to our 10,000 plus Surgery Partners associates for their contributions this quarter. As we are executing it is our goal to become preferred partner for operating short stay surgical facilities across United States.
It’s the efforts of each and every one of these employees that gets us there. While we still have much work ahead of us. I'm very proud of what this team has accomplished in a very short period of time. We’ve begun the process of creating a culture of discipline, focus, and accountability as we refine our portfolio and advance our strategy, and I look forward to providing you all updates to our shareholders and the progress and our return to sustainable long-term growth. Thank you for joining the call this morning and have a great day.
This concludes today's conference. You may disconnect all your lines at this time. Thank you for your participation.