Surgery Partners Inc

NASDAQ:SGRY

Earnings Call Transcript 2019-Q1

[Operator]

Greetings and welcome to Surgery Partners, Incorporated First Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded.

I will now turn the conference to your host today, Mr. Tom Cowhey, CFO of Surgery Partners. Please proceed.

[Tom Cowhey, CFO]

Good morning and welcome to Surgery Partners' first quarter earnings call. This is Tom Cowhey, Chief Financial Officer. Joining me today is Wayne DeVeydt, our Chief Executive Officer, and we are also excited to have Eric Evans, our new Chief Operating Officer, join us for our Q&A session.

As a reminder, during this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we file with the SEC. The company does not undertake any duty to update such forward-looking statements.

Additionally, during today's call, the company will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these measures can be found in our earnings release, which is posted on our website at SurgeryPartners.com and in our most recent quarterly report when filed.

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

[Wayne DeVeydt, CEO]

Good morning. Thank you, Tom, and thank you all for joining us today.

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

Starting with the quarter, I'm pleased to report first quarter 2019 adjusted revenues of $416.8 million and adjusted EBITDA of $50.7 million, reflecting continued traction from our strategic initiatives.

As we look deeper into the quarter, adjusted EBITDA grew by 7.6% over the first quarter of 2018, moderately better than our previously guided mid-single-digit growth. Same-facility revenue increased by 5% from the prior year quarter, driven by strong net revenue per case and volume growth.

As a reminder, we had one fewer work day in 2019 in the first quarter as compared to 2018. Adjusting for this work day, same facility revenue increased by 6.7%. Finally, adjusted EBITDA margins were 12.2%, a 70 basis point improvement versus the prior year quarter, which is especially encouraging when considering our government payer mix increased by approximately 140 basis points as compared to the prior year quarter.

The first quarter of 2019 represents out third consecutive quarter of same-facility revenue and case volume growth, encouraging indicators that our strategic initiatives supporting organic growth and margin expansion are taking hold and providing us with solid momentum as we build sustainable platforms and position the company for future growth.

We remain confident in our ability to grow adjusted EBITDA at a double-digit rate in 2019 and beyond, turning to our strategic initiatives supporting organic growth and margin expansion.

As the leading independent operator of high quality short-stay surgical facilities in the U.S., Surgery Partners is uniquely positioned to capitalize on favorable industry trends as clinicians continue to shift more procedures to the high quality low-cost settings that our surgical facilities provide. Further, our strategic initiatives accelerate these growth trends while also expanding margins.

To provide some specific examples as to how our initiatives accelerate these favorable growth trends, in the first quarter of 2019, new physicians recruited and utilizing our facilities are up over 20% from the prior year period, and our physician retention remains strong. Key to the success of our position recruitment program is that our short-stay surgical facilities have consistently delivered best in-class clinical quality and exceptional patient experience.

I'd like to take a moment to thank our clinical team, and in particular, to recognize our outstanding physician partners who have clearly built a culture of clinical and service excellence throughout the company. This foundation of superior clinical quality, patient experience, and a growing number of recruited physicians has a compounded effect that enables accelerated growth.

The power of this compounding effect is most evident when comparing the first quarter of 2018 same-facility case volume decline of approximately 4% with the first quarter 2019 growth of approximately 1%, nearly a 500 basis point improvement and with one less day in the current year quarter.

Another example is our data-driven approach of targeting specialties that drive the largest dollar contribution margin per minute, with particular focus on musculoskeletal procedures. This focus not only leads to adjusted EBITDA growth over time but also efficiently leverages our fixed-cost infrastructure, resulting in improved margins.

There are a number of encouraging indicators from this data-driven approach in comparing first quarter 2018 ASC volumes for spinal and orthopedic implant cases with our 2019 results. Spinal implant case volume grew by over 30% versus the prior year period, and orthopedic implant surgical case volumes continue to grow faster than our company average.

More specifically, the number of total joints performed in our facilities continues to accelerate. In the first quarter of 2019, we nearly doubled the number of total joints performed in our facilities as compared to the same period a year ago. This growth is a function of our partnership efforts with both health plan partners and physicians, which are mutually aligned in providing the best clinical outcome in the most cost efficient setting for the patient.

As we have noted in the past, we undertook significant efforts to optimize our portfolio in 2018, with a heavy impact on first quarter case volume and revenue. However, as you can see, our physician recruitment and retention efforts coupled with our targeted specialty growth approach enables us to cover the headwinds of these pruning activities while growing earnings and expanding margins. We continue to expand these programs across our operational footprint and anticipate continued same-facility growth in the 4-6% range throughout the year.

Before I turn the call over to Tom, I wanted to take a moment to discuss the ongoing public debate over how best to overhaul the U.S. healthcare system to continue to provide improved access to quality care while addressing the issue of affordability. This is a topic that continues to receive much focus and wide variation in opinions as to how to best proceed legislatively.

Our business model is uniquely built to address these challenges, which is why we support legislation that expands access to quality care at lower costs. We believe we are aligned with regulators, payers, and patients, and our distinctive business model should prove to be resilient in the wide spectrum of outcomes that may evolve in the U.S. healthcare debate.

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

[Tom Cowhey, CFO]

Thank you, Wayne.

Today I'll spend a few minutes on our first quarter 2019 financial performance, starting with some of our key revenue drivers, then moving onto adjusted EBITDA, cash flows, and our 2019 outlook.

Starting with the top line, we ended the first quarter with approximately $417 million in revenue, up just over 1% as compared to the prior year quarter, a result that positions us well to achieve our full-year revenue guidance of low single-digit growth or high single-digit growth, excluding divested revenues from the 2018 baseline.

Additionally, in the fourth quarter of 2018, we adopted ASC 606, which impacts our revenue presentation. Implementation of that standard lowered first quarter net revenues by approximately $8 million, an adjustment that may not have been fully reflected in analyst estimates.

Surgical cases were just shy of 124,000 in the quarter, a slight decline from the prior year period, primarily a result of cases from closed or divested facilities. On a same-facility basis, total company surgical revenues were up 5% from the prior year quarter, driven primarily by net revenue per case but also by higher same-facility volumes. It is worth noting that when adjusted for business days that we operated in the first quarter of 2019 as compared to the prior year quarter, same-facility surgical revenues were up nearly 7%.

Turning to operating earnings, our first quarter 2019 adjusted EBITDA was $50.7 million, a 7.6% increase over the comparable period in 2018 and moderately better than our previously guided mid-single-digit growth. Our first quarter adjusted EBITDA margin improved to 12.2%, a 70 basis point increase as compared to the prior year period, primarily driven by higher gross margins and our cost containment efforts.

During the quarter, we recorded approximately $3.4 million of transaction integration and acquisition costs, including approximately $1 million of cost associated with our de novo hospital in Idaho Falls. While revenues in our ancillary and optical segments were down slightly on a combined basis versus the prior year period, combined adjusted EBITDA from those two segments was relatively stable versus the prior year quarter and consistent with previous comments about our outlook for these businesses.

Moving on to cash flow and liquidity, at the end of the first quarter, the company had cash balances of approximately $142.5 million and was undrawn on our revolving credit facility. Of note, during the first quarter, surgery partners had net operating cash outflows defined as operating cash flow less distributions to non-controlling interests of approximately $13 million.

We deployed approximately $8 million primarily for the acquisition of a practice asset associated with an existing Surgery Partners ASC, and we used approximately $13 million for payments on our long-term debt.

The ratio of total net debt to EBITDA at the end of the first quarter of 2019 as calculated under the company's credit agreement was stable sequentially at approximately 7.7 times, primarily as a result of higher trailing 12-month credit agreement EBITDA, the positive impact of acquisitions net of divestiture activity, offset by higher net debt.

The company has an appropriately flexible capital structure with no financial covenant on the term loan or our senior unsecured note. We continue to project that the company's total net debt to EBITDA ratio should naturally decline over time as our business continues to grow but may fluctuate on a quarterly basis based on timing of cash flows.

Additionally, in April of 2019, the company issued a new $430 million senior unsecured note due 2027 at a rate of 10%. The proceeds from this note were primarily used to retire our existing 2021 notes. Concurrent with this transaction, we also increased the availability under our revolving credit agreement by $45 million, bringing total capacity under our revolving credit facility to $120 million. With this transaction, the company's next maturity date for its debt is in late 2024, enhancing our flexibility to execute on our strategic initiatives and grow into our capital structure.

Moving onto our 2019 outlook, we're excited by our progress this quarter on a variety of fronts and remain committed to double-digit adjusted EBITDA growth this year. While we do not provide quarterly guidance, we remind investors that we project an accelerating year-over-year growth rate throughout the year based on the projected timing of some of our strategic initiatives.

Last year, we spent a majority of our time focused on optimizing our portfolio, streamlining our infrastructure, and investing to drive future growth. With the first quarter of 2019 behind us, we are quite pleased to begin to see the fruits of those efforts as we drive our growth agenda for the benefit of our customers, physician partners, employees, and stakeholders.

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

[Operator]

[Operator Instructions] Our first question comes from Ralph Giacobbe with Citigroup. Please proceed with your question.

[Ralph Giacobbe, Citigroup]

Just wanted to go to physician recruiting and sort of your efforts there. Maybe talk a little bit more about that, turnover at this point, and then your commentary I think in your prepared around the 20% new docs. Maybe you can give us a sense of the net number or net percentage and then how that ramps as you think about 2019?

[Wayne DeVeydt, CEO]

Ralph, good morning. Appreciate the questions. So, a couple things I would highlight on the physician recruitment. Keep in mind that typically as you start to recruit physicians, there's a fairly long digestive period, and so part of the reason, obviously, for the large increase in Q1 of this year versus a year ago is we initiated those efforts a year ago at this time. So, really, you could argue in some ways a lower comp, but at the same time, a very encouraging comp in terms of growth we've had.

And typically what happens is when we get a new physician recruited to use our facility, you really have almost a six-month digestive period before you really determine do they get the full run rate for you.

So, a lot of times, what they'll do is they'll come in and do one or two procedures, evaluate the facility, do they actually like the facility, is it accomplishing what they wanted to accomplish. They'll look at your turnaround time and your scheduling capacity, and they'll determine if they really enjoy the nurses in the ORs that support them in that process.

And so, what I would say is while really encouraging, now the next step is to see how that actually translates. Of course, we can see that our efforts from last year have translated into real EBITDA growth in same-store case volume in Q1, especially when they've adjusted, and so we think this is just another good indicator of what you could expect for the future.

Relative to turnover, we don't generally lose physicians at this point beyond what I would say is normal and customary, which is those that go into retirement, those that relocate or move, and in this new world that we're in, those that are ultimately potentially getting employed by a local hospital system.

But I would say our retention levels, while harder to track because you really don't know when somebody's going to move or relocate, as we've done kind of a statistical trendline, what we've seen is slight improvement over time, which means that our efforts, if anything, are kind of holding onto the workforce that we've had before versus losing them.

[Ralph Giacobbe, Citigroup]

And then, Wayne, also wanted to ask sort of a broader question. You've been CEO now for I think almost 18 months. There's been a lot that you've done around repositioning, but I guess I wanted to get your broader thoughts around, 1.) The competitive dynamic of the markets that you're seeing, and then 2.) If your thoughts have changed or evolved around interest or preferences in a two-way versus three-way JV, whether you think that does or doesn't influence managed care decisions around partnerships or agreements with them. Thanks.

[Wayne DeVeydt, CEO]

So, yes, this was my fifth quarter with the company, so in the next couple months, I'll finally be at that 18-month mark. It's been an interesting learning evolution for me, clearly a lot that I had to learn about this business model and really about the competitive environment on the provider's side.

That being said, I would say that there has been an evolution in my thinking while the majority of our business, roughly 96%, is generally two-way JVs. I would tell you that I am really open-minded.

In fact, the team and I, and with Eric Evans joining us, are really looking at how we can really expand that 4% of three-way JVs at a much more accelerated pace in the back half of this year and going into next year. I think there's an opportunity for us to accelerate some value creation for our shareholders through those JVs, and I think some of these in-market transactions, we've got good market share and good leverage. We might be able to accelerate some of our rate efforts over time through those initiatives.

That being said, I want to be clear that we are only really looking to partner with those parties that are truly interested in taking costs out of the system. It's not our goal to play the rate game. It's our goal to be the preferred provider of choice with the best quality at the most affordable price. But we are finding more and more of the providers, and larger systems are interested in having those discussions now, recognizing that our business model, if anything, cannibalizing over time their model, and so there's opportunities to partner together. We're exploring those. So, I think you'll start to see that hopefully evolve as the year progresses, and it's a big part of why Eric has joined us.

[Operator]

Our next question comes from Ana Gupte with SVB Leerink. Please proceed with your question.

[Scott Mafale, SVB Leerink]

This is Scott Mafale on for Ana. Thanks for taking the question. So, same-facility revenue per case is strong again in the quarter. Could you just break down what is driving that? I know last year, you talked about the contract renegotiations. Is that the major factor, or what are the other driving factors there?

[Wayne DeVeydt, CEO]

It's many items, and so one is we're clearly focused on recruiting the right specialties into our facilities. So, the fact that our same-facilities have actually grown volume, so that obviously contributes, but then on top of that, we're much more focused on MSK, which is of course going to drive a higher same-facility revenue, and our pro-revenue cases are up as well.

The other thing I would say though is clearly we're renegotiating rates with managed care, but the one thing I would remind everybody of is as we said a year ago that that is a very long digestive period. On average, your contracts renew once every three years, and clearly last year, many of us were new to the team, and so we were really just in kind of the balls of moving forward our initiative on the rate increases there.

So, I think that that's something that's going to take another year-and-a-half before we start seeing full value creation of what a three-year recycle looks like of renegotiations. But candidly, it's just basic blocking and tackling. It's getting the right rate increases for the value we create, it's recruiting new physicians and doing more procedures in your facilities than you did a year ago, and it's focused on the right procedures, and that being heavy in MSK.

[Tom Cowhey, CFO]

I think we've said this before, Scott, that we did a lot of analysis probably about 18 months ago, maybe a little longer, to really take a look at what are the things that drive the highest contribution margin per minute of our scarcest resource, which is the operating room. And as you look at that, a lot of our implant cases are those things. So, I could do five GI procedures in the same time that it takes to do certain complex procedures, but at the end of the day, I make more per minute of that scarce resource when I do those implant cases.

And so, that's where we've focused our recruiting, that's where we focused some of our acquisition and capital deployment efforts, and so we think over time, you're focused on the right metric, which is focus on what is the total same store look like, and we think that that metric, as we've said in the past, over time should be in the 4-6% range, and we're quite pleased that for the third consecutive quarter, we were well within that. And actually, this quarter, depending upon how you look at it, it's slightly above that range.

[Scott Mafale, SVB Leerink]

And then I guess could you give an update on the Idaho Falls and Villages de novos? Are they still set to open I think it was no later than 1Q20? And then I guess more broadly, how do you weigh opening a de novo versus M&A activity in terms of the initial cost and that kind of margin ramp over time? Thanks.

[Wayne DeVeydt, CEO]

So, as of today, I would say both facilities are still on track to open no later than Q1 of next year, so we're very encouraged by that. The weather has not really been a big impact to us. A little bit concerned with all the storms you saw throughout the U.S., but really, the two locations, Idaho Falls and Florida didn't really get impacted. So, so far, so good.

The short answer on de novos versus M&A is that if we had unlimited resources, we would do de novos all day long. They're very low cost of capital investment in the big scheme of things with a very high IRR. There's more of a ramp-up to the EBITDA, and so initially, when you open up one of these facilities, you lose a little money out of the gate, and then you get to break even over a short period of time, and then of course you get the long run-rate of organic growth that then moves from there once you get fully staffed, and you get all the physicians that you want to recruit in, and you get the facilities syndicated.

But it's not that we're not still open to the M&A pipeline. As you know, we continue to target $80-100 million for capital deployment, but I would really just anchor everybody on our first priority is double-digit organic growth, and for that, our idea is that if we focus on that first and make that our priority, then the de novos just become one tool in the toolbox of how we get there.

And so, you'll continue to see us be aggressive on the de novos over the next year and as we move into 2020 with a multiyear plan because we really think that helps support that true sustainable double-digit organic growth, and then M&A becomes a nice optionality play of another 3-5% growth that we can get through deployment of capital.

But we're going to be very strategic on M&A, and we're going to be very focused on the right specialties in the right new markets to view these as kind of new flags and new markets for us when we talk about that $80-100 million.

[Operator]

Our next question comes from Chad Vanacore with Stifel. Please proceed with your question.

[Chad Vanacore, Stifel]

So, just thinking about same-store organic revenue growth, you've got a target of 4-6%. Can you expect rate to carry the bulk of that growth? And then on the flip side, what leverage can you pull from here to drive volume?

[Wayne DeVeydt, CEO]

Chad, I don't know that rate will be the primary driver. It will probably be more heavily weighted out of the early years, but ultimately, we've always said to get to that 4-6%, you want to get around 2-3% through case line and around 2-3% for rate on average. As you know, a big part of our book today is government business as well, and obviously, you're a rate taker when it comes to that book, so you have to have a disproportionate influence on commercial, meaning you're getting rates much north of that 2-3% to get to a weighted average.

But that being said, we really think that it'll be fungible in that 2-3%. As you can tell, the case volume was about just under 1% in the quarter, but that was with one fewer day, so if you day-adjust it, we're in that 2-3% range on case volume, and then of course the delta being on revenue.

The thing I would say that I'm most encouraged about with Eric's joining us though is he brings a lot of insights of what they've seen on the provider side around the rate environment and in many markets where we obviously operate. And so, this is further giving us more intelligence about what we think the market bears and what we think we should be able to do as we negotiate our rates going forward.

So, you'll probably see, if we do our job well, probably more of an outsize of it being just your better rate negotiations in the nearer term, and then over time, hopefully, it becomes more of a balanced growth rate and case volume.

[Tom Cowhey, CFO]

Chad, it's Tom. I'm going to say one thing a little bit differently than what Wayne did, which is I don't know that I would be upset if the rate component is driving more of the same-store, particularly if it's about mix because if it's about mix that I'm substituting out some of those higher margin but lower revenue and lower dollar contribution cases for those higher profit implant cases, then that's a good thing for the business and a good thing for shareholders. But I don't think we're quite at that stage yet.

[Eric Evans, COO]

And Chad, this is Eric Evans. One other thing I'd say on the same-store organic revenue growth piece is that as you know, more acuity continues to move into the ASC setting, and as that happens, it's going to naturally give us opportunities in places that just weren't available in the past. So, we continue to see that obviously in musculoskeletal and expect to see that in other places over the coming years.

[Chad Vanacore, Stifel]

Thanks again. So, just thinking again about physician recruitment and retention, is there any possibility you could share net physician adds this year with us?

[Wayne DeVeydt, CEO]

Chad, while we won't share the net physician adds, I wanted to explain why. It's not due to a lack of wanting to give the details as much as it is that the nuances of how we have to track and monitor this. One of the things we realized was that historically, a company was counting a physician simply by getting them signed up and then doing a single procedure, which could be as simple as doing an injection in an ASC.

And at the same time, when a physician was leaving, we were realizing that they were being treated the same way, even though that physician theoretically could have been a whale and have done many procedures that were the right procedures.

And so, we have been redefining internally and working work each of our facilities to make sure we code for this in a way that we can really understand that when we count a physician now as a new physician, we generally want to see that they've done at least five cases and $20,000 in revenue. For us, that's kind of a metric that we say they're really not a new doc from our perspective until they've really at least ramped up to that level.

And conversely, we're not spending our energy on how we actually measure then the retention level around the same kind of metric, which is let's not overly get excited if somebody leaves us, if the person that left us was only doing one injection a month or something of that sort. So, we are now reworking the data.

So, what we've been doing though is trending broadly the position data while we rework the data on the retention side, and the broader trends are showing slight improvement over what we've been a year ago, but at the same time, I don't know if that really impacts my case volume. The data would imply that it hasn't because obviously we've grown case volume in the quarter.

[Chad Vanacore, Stifel]

Just one more for me then. Cost savings initiatives, what did you get done in the quarter, and do you have more cost savings weighted to the back half of the year and that's where you're expecting some of your margin pop?

[Wayne DeVeydt, CEO]

That's a great question, Chad. So, we did get a lot of our initiatives executed not only in this quarter, but in a lot of cases, last quarter. And so, an example of one, but it applies to many where we have the value creation more heavily weighted toward the back half of the year would be the benefit design changes we did for our organization.

As we mentioned previously, we had north of 20-plus different health plans that we were self-insured through, and we consolidated those. There were meaningful savings there, and what we've done is we've weighted those savings toward the back half of the year under the premise that we want to ensure that the enrollment occurred the way we did, which it has. We can track how many moved into high-deductible plans.

The value creation that comes from that high-deductible plan is usually very back-end weighted, and so we've built our budget with that concept in mind and tried to maintain what I would say is a level of conservatism in our IBNR for our own self-funded until we can see that actually come to life by the end of the year.

So, that's an example of one, but I would tell you many of our initiatives around G&A have actually already occurred. But as we think it's a prudent thing to do, we'd like to see how they evolved throughout the year, and if they look like they're coming through, then we'll start to allow that to flow through in the fourth quarter.

[Chad Vanacore, Stifel]

Anything too we should think about on the supplies expense there?

[Tom Cowhey, CFO]

Supply expense initiatives, if you look at the gross margins, the gross margins are actually improved in the quarter of a quarter at least - but the initiatives that we've had has been we implemented the new GPO contract in the third quarter, so you're starting to see the benefit of that both in the fourth quarter but also in the first quarter. We have been attacking our top 20 vendors.

I know that Eric is keen to think about what else we could do across some of our larger categories of spend in some of our operations based on his experience and taking a look at where there might be opportunity, and Eric, I don't know if there's anything you want to comment on there?

[Eric Evans, COO]

Sure. I mean, Tom mentioned the GPO side of it. That's a relationship we have to grow, and as we grow our implant business, it becomes obviously more important that we do that to allow for margin expansion. And then beyond that, even just in everything from how we distribute our medical supplies and pharmaceuticals, we have opportunities where we still have a relatively fragmented supply chain. So, there's a bunch of stuff we're looking at there that I think gives us opportunity going forward to continue our momentum on margin expansion.

[Operator]

Our next question comes from Brian Tanquilut with Jefferies. Please proceed with your question.

[Brian Tanquilut, Jefferies]

Congrats on the quarter. I guess first question is on the revenue per case performance in Q1. So, how should we be thinking about the breakdown of the drivers there between pure pricing, payer mix acuity?

[Wayne DeVeydt, CEO]

Well, let me start with the fact that our government payer mix was up 140 basis points. So, as you know, generally speaking, we get a substantial discount on Medicare, almost 45% than what you generally see on commercial rates in general. And so, you can think about as you back into just a headwind that that can create a margin expansion. That being said, we have obviously our G&A initiatives that are supporting margin expansion along the way. Clearly, the focus on MSK we are seeing come through, we're extremely pleased with the fact that the case volume came in strong, but we're more pleased with the fact that the mix came in the right way.

And so, one of the things that we track, although we won't publicly disclose, is we do track by specialty our margins, and we track whether or not our initiatives in the right buckets are affecting the right components. And generally speaking, pretty much across the board, we are seeing margin improvement. But as you know, it's the MSK that's a big part of our driver of what's really driving our margin improvement coupled with our G&A initiatives.

[Tom Cowhey, CFO]

And Brian, in the prepared remarks, Wayne gave you a couple of stats. The growth that we've seen year-over-year in our spinal implant cases in our ASCs where we have our best data is impressive. Orthopedics, in terms of implant cases, continues to grow much faster than the company average.

And as we look at the total joint program that we initiated, they really do feel like they're taking off. We're doing them in a number of facilities now on the ASC side in addition to our surgical hospital side that have been doing them for quite some time. And so, as we look at where the mix is coming in the quarter, it certainly has helped. I think that there continues to be opportunity for us to improve rate, and we're just scratching the surface on that.

[Brian Tanquilut, Jefferies]

Just a - sorry, go ahead.

[Wayne DeVeydt, CEO]

I was just going to say too, Brian, one thing I think sometimes that we don't spend much time on because we've obviously been focused on getting the company repositioned in the last year, but we're going to start talking more about this as the year evolves is the more that we do of these type of procedures, then the better opportunity we have to become a Center of Excellence. And a Center of Excellence is a very meaningful accreditation for us relative to payers.

I know from my experience on the payer side, I know Tom does as well, that if you can show that you can push volume through your facilities with exceptional quality outcomes - because to get that accreditation, you have to show not only the volume, but you have to show the outcomes and support it - it really leverages itself over time not only for recruiting new physicians, but it also leverages itself over time to actually get better rates with providers.

Now, again, very long, long, long runway here, a lot to do here, but we just got our second facility, we found out last night, has now gotten Center of Excellence accreditation. And so, now we've gotten two now that now we've got the ability to start actually marketing something and starting to share with the world that we're doing the right things, we're moving in the right direction, and we've got a third facility that we're hopeful will get there between now and early first quarter of next year.

And so, we've got a lot of data to support it. So, that would be another thing I would highlight is that it's not just about recruiting the right doctors, it's not just about getting the right procedures, it's actually being best in class because that's what over time becomes kind of the strategic game changer.

[Brian Tanquilut, Jefferies]

And Wayne, just to follow up on that, that's actually a good segue into my next question which is as we think about total joints and that opportunity opening up next year on the fee-for-service Medicare side potentially and then what you're seeing in M&A, does that all fall into the strategy of or the pick-up that we should be expecting in terms of the growth in total joints and further expansion of your MSK business beginning next year?

[Wayne DeVeydt, CEO]

Yes.

[Brian Tanquilut, Jefferies]

I'm sorry, beginning of 2022 or whenever that is.

[Wayne DeVeydt, CEO]

The short answer is yes, and this is why we said again and again too that we shouldn't shy away from Medicare business because of the impact it has on margins. What we really should do is embrace it and really accelerate our growth because the per dollar contribution is quite meaningful, and then find other ways to expand margins then through our rates and through our G&A initiatives and to basically cover the margin headwind, but nonetheless, capture that EBITDA growth that comes from this Medicare expansion. So, short answer to your question is yes, the way you're thinking about it is the way we're thinking about it.

[Tom Cowhey, CFO]

And Brian, as we're positioned right now by some of the data that we've been gathering, nearly a third of our facilities are performing total joints on the commercial side at this point.

[Brian Tanquilut, Jefferies]

And then last question for me, as I think about the M&A pipeline, how are you thinking about the split between surgical facilities and physician practices? I mean, do you still have any appetite for practice deals that are associated with your facilities?

[Wayne DeVeydt, CEO]

So, the short answer is our appetite is limited on practices, but we won't completely ignore them if they're part of a broader ecosystem and they play a good strategic play for us both defensively and offensively, and I think that's kind of the key thing I would highlight. So, we're currently evaluating a physician practice in a market that is a large supporter and feeder system within our surgical ASC group and whether or not that that makes sense for us defensively to potentially enter into a partnership with them that also then ties them into some syndication with our facility.

So, that would be an example where we would look at it with that type of lens. But generally speaking, our bias is not to acquire physician practices. Our bias is to be a surgical facility. That's what we do. But again, we'll think about the more, in what I'll call kind of an ecosystem support function.

[Tom Cowhey, CFO]

Brian, I think a great example, last year, we executed a very small physician practice acquisition, and the way that the licensure in that particular state worked is unless the physician was a member of that particular practice, they couldn't access the ASC, and so the key to being able to leverage all the good work that our team was doing on physician recruiting to increase volumes in the facility was to acquire that practice, and so we did.

So, that's I think a great example where there's a specific linkage to a particular ASC, and this is an effort to enhance or dive volume that otherwise not be captured. We think that's pretty firmly in our wheelhouse.

[Operator]

Our last question comes from Kevin Fischbeck with Bank of America Merrill Lynch. Please proceed with your question.

[Kevin Fischbeck, Bank of America Merrill Lynch]

So, couple questions here. I don't know if it's our job to kind of read your press releases like they're the Fed statements, but you guys said that Q1 came in slightly better than the Q1 guidance was, and then the language actually for your annual EBITDA was double-digits last quarter. It was low double-digits. I don't know if there's any implicit, slightly better view to this year, or whether I'm reading too much into that.

[Wayne DeVeydt, CEO]

Kevin, first of all, I really appreciate the Fed Reserve comment because Tom and I both smiled. We both smiled at the comment. It's clear to say that first quarter was better than what we had expected. We still expected a little bit of slower ramp-up.

That being said, I'm constantly reminded, and I've been through too many cycles, that this is a 12-round boxing match, and we're through three months of the year, so three rounds are down, and we're feeling pretty good right now, but we've still got nine more to go. And so, from my perspective, we wanted the investors to understand, look, we're really encouraged by this.

This is the right momentum. It's heck of a lot better than having a bad round along the way, but we have a lot of initiatives that we put forward last year that have to continue to create fruit throughout the remainder of this year, and there was both G&A initiatives as well as growth initiatives that were put forward last year that are really weighted to Q3 and then heavy in Q4. And so, more to come, but again, encouraged out of the gate.

[Kevin Fischbeck, Bank of America Merrill Lynch]

You may have just answered my next question, which was just the pacing of this. Would you say that there is a ramp into Q2 and a ramp into Q3, and then you're saying Q4 is probably the biggest thing on the -

[Wayne DeVeydt, CEO]

So, while we don't give quarterly guidance, at least the way we've modeled it, we definitely would expect a ramp in Q2, and then a very substantial ramp in Q4. Right now, in Q3, we want to see how Q2 evolves because you could see based on some of the timing of initiatives we did, and some pruning we did, and some other items, there could be what I'll call a smaller roller coaster going into Q3 where it takes a little dip relative to Q2, and then ramps back up in Q4. But again, we want to see how Q2 evolves and our initiatives come through. But right now you should expect a ramp into Q2. It would still be a growth rate into Q3, but maybe not at the same rate as Q2, and then an outperformance rate in Q4.

[Kevin Fischbeck, Bank of America Merrill Lynch]

And then I just want to reconcile the payer mix versus case mix discussion because obviously, case mix is a big driver to the rate per case, and you're talking about payer mix being a headwind, but I was wondering if those two things are somehow more closely related? Is MSK and ortho more government related so you can't really have one without the other, and that net is still a positive, or is there real government mix shift going on a case-by-case vertical?

[Wayne DeVeydt, CEO]

That's a really good question. I think part of it is that you can't view them as mutually exclusive. You do have to couple them, which of course, to your point, Kevin, is very encouraging because you say, well, this is good. You're bringing the volume in, but you're still creating kind of the EBITDA margin growth that you would want to get.

But I also want to highlight that a lot of our initiatives last year that we expanded were around total joint programs. It was really focused on negotiating commercial contracts for bundle payments, and so a lot of our growth is in our commercial contracts.

That being said, those doctors now are also doing more of their Medicare at our facilities as well. So, the initial play was, hey, can we get more procedures done in our facilities with the idea that we'll leverage the commercial contracts with the bundling? But what's happening is it's parlaying into obviously more Medicare being brought in with it as well. But to your point, you really can't be decouple them now. It's really part of a one-and-the-same. And so, hopefully, as long as the trends continue, we won't be so concerned about mix shift as much as we'll be concerned about the specialty mix.

[Kevin Fischbeck, Bank of America Merrill Lynch]

Great. Thank you.

[Wayne DeVeydt, CEO]

Great. Thanks, Kevin. And thank all of you for really participating this morning. I can't say enough about how encouraged we are at these trends, and let's continue hopefully as a team that we'll come back and show you that the next three rounds ended up being hopefully just as good.

Before we conclude our call though, I do want to just take a moment to say thank you to our 10,000-plus associates and our 4,000-plus physicians for their contributions. I know I feel privileged to be able to participate in this journey of improving healthcare and making it more affordable for Americans. As we execute against our goal to become the preferred partner for operating short-stay surgical facilities across the United States, it's really the daily efforts of each and every Surgery Partners' employee and physician that gets us there. Thanks again for joining our call this morning and have a great day.

[Operator]

Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time. And thank you for your participation.