Surgery Partners Inc

NASDAQ:SGRY

Earnings Call Transcript 2018-Q2

[Operator]

Greetings, and welcome to Surgery Partners Second Quarter 2018 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Tom Cowhey, Chief Financial Officer. Thank you, you may begin.

[Thomas Cowhey, EVP & CFO]

Good morning, and welcome to Surgery Partners Second 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 cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we filed 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 & Director]

Good morning. And thank you tom. And thank you all for joining us. To start this morning, I would like to review some highlights from the quarter, then provide an update regarding the progress we have made in refining our strategy and the actions we've taken to drive us towards our strategic goals. 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 second quarter 2018 revenues of $444.8 million and adjusted EBITDA of $55.4 million, each representing strong year-over-year growth, primarily as a result of the acquisition of National Surgical Healthcare in August of last year.

As we look deeper into the quarter, surgical case volume grew by 17.8% over the prior year period. Same-store revenue increased 3% from the prior year quarter. Sequentially, surgical case volume increased by 5.4%. Adjusted EBITDA margins improved by 120 basis points to 12.5% and our private payer mix improved by nearly 2%. And also note that our adjusted EBITDA margins includes the negative impact of our run rate investments.

These sequential trends are encouraging, providing us with positive momentum as we build sustainable platforms and position our company for future growth. We continue to make key investments across our business to drive operational efficiencies, and we see our strategic initiatives beginning to pay dividend and accelerate in the second half of the year.

Accordingly, we are maintaining our revenue and adjusted EBITDA guidance at greater than $1.75 billion and $240 million, respectively. Turning to our strategy and key initiatives. Having recently completed my first six months with Surgery Partners, I thought it would be appropriate to reflect on what I learned since my arrival and how those learnings have impacted our strategic thinking and tactics to drive meaningful shareholder value creation. Having visited with many of our surgical facility employees and affiliated physician partners, a few key themes have become abundantly clear. Specifically, our 10,000 plus associates that support our patients and physician partners each and every day are appropriately focused on what matters most: Clinical quality, patient satisfaction and physician engagement.

To provide some context, we believe in measuring everything we do. These measurements provide a frame of reference as we strive to achieve the best-in-class metrics we know we are capable of delivering. As we looked at our clinical quality metrics and specifically, how we benchmarked against the ASC quality cooperative outcome data for those who self-report, we have achieved best-in-class outcomes across our facilities.

Additionally, when we benchmark our average deficiencies per survey as reported by the Accreditation Association for Ambulatory Healthcare, we experienced over 40% fewer deficiencies when compared to all other ASCs combined. These are exceptional results that we are proud of, but we will continue to push to improve further. Clinical quality and safety is paramount in what we do each and every day but it is also important to ensure that our patients are satisfied with their experience and that our physician partners are engaged.

We're pleased to report that Surgery Partners has achieved best-in-class net promoter scores in both patient and physician satisfaction, achieving scores of 91 and 81, respectively. These scores place Surgery Partners in the upper echelon of NPS scores as compared to some of the best consumer brands in the world. When you combine our industry-leading clinical metrics with our best-in-class promoter scores, it further emphasizes the value proposition of short-stay surgical facilities and how our industry and Surgery Partners specifically play such an important role in transforming the health care landscape.

Regarding our strategy, we spent much of our energy around the work necessary to return to long-term, sustainable growth by leveraging what we already do well within our operations. Broadly speaking, the foundational elements of our strategy are anchored across 3 dimensions. First, we need to focus on what we do best, short-stay surgical facilities. This is our core competency and we are uniquely positioned, as clinicians continue to shift more procedures to the high-quality, low-cost settings that our surgical facilities provide. Furthermore, favorable industry trends such as an aging demographic, a shift to higher acuity procedures, recent CMS proposals to increase reimbursement and cover procedures at ASCs and payer alignment have positioned our industry for outsized future growth.

We believe we have the right people, processes and assets to capitalize on these favorable trends, as we strive to be the preferred national partner for operating short-stay surgical facilities across the United States. Our core strength and platform for growth in the short-stay setting are setted on specific practice areas, orthopedics, including total joint and spine procedures, ophthalmology, pain and GI. We're focused on these high-growth specialties when it comes to physician recruitment and capital deployment. Our early physician recruitment efforts are already paying dividends from our focused and data-driven approach.

While the number of docs recruited in the first half of 2018 versus 2017 are up slightly, their productivity in terms of case volume has more than doubled as compared to a year ago, and the average direct contribution margin per case has also increased slightly. We continue to add to our physician recruitment team and expect these figures to continue to improve as the year progresses. Additionally, we've rebuilt our M&A pipeline in a series of transactions focused on these high-growth specialties. Our goal is to deploy between $80 million and $100 million of capital per year related to M&A at prevailing industry multiples to help build out our platform. We have deployed nearly $50 million year-to-date at attractive multiples and are confident that we will meet our capital deployment goals this year.

Concurrent with our focus on building upon our core competencies, we are exploring strategic alternatives for those assets that are not aligned with our growth goals. To date, we've consolidated or closed 16 physician practices, closed or sold 2 ASCs and are in the process of evaluating the best path forward for our optical businesses. We're also in the process of consolidating many of our core physician practice groups including anesthesia under common surgical facility management. We're confident these moves will provide for greater focus and agility in decision-making. The second foundational element of our strategy relates to increasing our franchise value by unlocking the economies to come from having 125 surgical facilities across 32 states.

We have discussed in the past a series of initiatives, specifically procurement and revenue cycle management, both of which we continue to advance since the last quarter. Regarding procurement, our renegotiated group purchasing contract goes into effect in the third quarter of 2018, and we've made steady progress in getting improved pricing from our top 20 vendors as it relates to implant costs. You should expect to see value creation from these initiatives in the back half of 2018 with solid incremental benefits in 2019.

Moving to revenue cycle management. We are investing in our centralized billing office in Tampa. By the end of the year, nearly 100% of our facilities will be using a standardized clearinghouse for claim submissions. This platform investment will move us from 16 concurrent systems being used across the organization to a single source of truth. We're also investing in our post judication workflow process and should be on a single platform at our Tampa location by the end of the year. We are confident that there are opportunities to reduce leakage in the system and create demonstrable benefits for both our physician partners and shareholders.

The final foundational element of our strategy relates to core investments and creating a scalable platform that allows us to plug and play, as we acquire new facilities or expand existing facility relationships. As is common of the business built through a series of acquisitions, our IT platform is highly fragmented. While it is often economically efficient in the short term to maintain multiple platforms, as we look to build a scalable asset that drives greater long-term value, we are migrating 18 variant patient accounting systems towards 4 core integrated systems, picking best-in-class products for different elements of our business and tieing them together through a single data warehouse.

We expect to have the majority of this work completed by the first quarter of next year, with the remaining elements substantially addressed by the end of 2019. We are confident these investments will pay dividends and operational efficiency, enhance reaction time to emerging market dynamics and an efficient integration of acquired short-stay surgical facilities, which will reduce the risk profile of acquired assets while improving our effective multiples.

Before I turn the call over to Tom, I want to take a quick moment on a key action we took this past quarter, as we approached the anniversary of the acquisition of National Surgical Healthcare. As we alluded on our first quarter call, this past quarter, we completed our evaluation and implementation of our operating structure. Among other actions, we have realigned some of our businesses to simplify our reporting structure and span of control. We also finalized plans to close the NSH headquarters in Chicago.

While these types of decisions are always difficult due to the impact on people, we believe such actions will bring our leadership closer to our patients and physician partners and allow us to drive even more value for all stakeholders.

The benefits of these moves will begin to be recognized in the back half of 2018 with full run rate benefits beginning in 2019. As you can see, we have made substantial progress on our strategic initiatives and the team that will be accountable for execution is now in place. Simply put, we're moving from a collection of great assets but under managed to a scalable platform with clear strategic direction and purpose.

With that, I would like to turn the call over to Tom to provide further details on the quarter. Tom?

[Thomas Cowhey, EVP & CFO]

Thank you, Wayne. It's exciting to be part of the team here at Surgery Partners, and it's been a pleasure getting to know all of the talented individuals on our team and getting to interact with the investment community over the last few months. I hope to meet even more of you over the coming quarters, and I look forward to continuing to help you all understand the power of the assets we have assembled and the value we can create over the long-term.

Today, I'd like to spend a few minutes on second quarter and first half 2018 financial performance, starting with some of our key revenue drivers, then moving on to adjusted EBITDA, cash flows and our 2018 outlook. Our second quarter revenue of $444.8 million, reflects a 54% increase over the prior year quarter, primarily as a result of the acquisition of National Surgical Healthcare in the third quarter of 2017.

Development activities also impacted net revenues in the quarter, as some of our acquisitions came online and we trimmed the portfolio of ASC assets under management. Surgical cases also increased to nearly 132,000, which is an 18% increase as compared to the prior year quarter and a sequential increase of over 5%. On a same-store basis, total company revenue was up 3% from the prior year quarter, consisting of a 4.5% increase in net revenue per case, offset by a 1.4% decrease in case volume. Year-to-date, our same-store revenue was now up 1.3% driven by higher net revenue per case.

Note that 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 periods. With respect to same-store volumes, let me take a moment to address some of the dynamics that are impacting this metric. As I just noted, in the quarter, same-store case volumes declined. However, we did see sequential improvement over the first quarter of 2018.

As we work to improve our volume performance, we believe one of our key initiatives, physician recruitment will play an important role. We have made tremendous strides in this area, and we're very pleased with our new physician recruitment team and the progress they are making. We expect to make further progress in improving case volumes in the back half of 2018, as we see enhanced productivity out of these newly recruited physicians.

Also encouraging to us was that private payer mix increased nearly 2% over the first quarter of 2018, while specialty mix remained relatively consistent. This dynamic when combined with a focus we've had to consciously increase acuity mix in our centers helped to drive an increase in net revenue per case in the second quarter. A quick note on our ancillary services business. Revenue declined slightly in the second quarter as compared to the prior year quarter consistent with our previous statements that we were approaching an appropriate run rate for this business.

Turning to operating earnings. Our second quarter 2018 adjusted EBITDA was $55.4 million, a 49% increase over the comparable period in 2017. Again, primarily a result of the addition of NSH in current period results. Our adjusted EBITDA margin declined to 12.5% from 12.9% of revenue as compared to the second quarter of last year but increased by approximately 120 basis points sequentially. A major driver of the year-over-year margin decline is the run rate investments that we continue to make in our business to build the foundation for future growth.

While we continue to invest in building out our infrastructure to support long-term growth, we also continue to encourage substantial onetime investment costs. Specifically, we recorded nearly $12.5 million of transaction and integration costs in the quarter. The largest of these costs was a $4.5 million integration charge for the organizational realignment that Wayne discussed. However, we also continue to incur substantial onetime costs to execute on our integration and transformation efforts that we are confident will generate substantial value over the months and years to come.

As we approach the anniversary of the NSH acquisition, we expect these onetime merger and integration costs to subside but expect to continue to adjust for integration activities as well as ongoing acquisition costs as we execute on our development strategies.

Moving on to cash flow and liquidity. At the end of the second quarter, the company had cash balances of approximately $96 million and approximately $72 million of availability under our revolving credit facility. Of note, during the second quarter, Surgery Partners had net operating cash inflow, defined as operating cash flow less distribution and noncontrolling interests, of approximately $15 million. We deployed approximately $22 million for the acquisition of a majority interest in 3 ASPs and the majority ownership of an associated physician practice, we received approximately $10 million in proceeds from the divestiture activities, and we used approximately $12 million for payments on our long-term debt and our preferred stock.

The total ratio of net debt to EBITDA at the end of the second quarter of 2018, as calculated under the company's credit agreement, was just below 8x, primarily related to lower pro forma adjustments in the current period. The company has an appropriately flexible capital structure with no financial covenant on the term loan or our senior unsecured note. As we look forward to the third quarter of 2018 and the substantial pro forma adjustments that were made related to the hurricanes and reserves in the third quarter of 2017, we project that our ratio of total net debt to EBITDA will increase before declining back to current levels at year-end. Our total net debt-to-EBITDA ratio should naturally decline over the course of 2019 as our business continues to grow.

With respect for our 2018 outlook, we continue to have confidence in our ability to deliver greater than $1.75 billion in revenues and at least $240 million in adjusted EBITDA. This current projection assumes at least $137.5 million of adjusted EBITDA in the second half of the year or approximately 57% of our total, a result that we expect will be heavily weighted towards the fourth quarter when volumes and commercial payer mix tend to be highest.

Our same-store metrics showed signs of improvement this quarter. Our M&A pipeline and execution is in full swing and we continue to project that we will deploy between $80 million and $100 million of capital this year on acquisitions.

Finally, we project that we will begin to see the benefits of our savings and integration initiatives in the second half of this year. Looking out longer term, we plan to actively manage the business and leverage these near-term organic and inorganic strategic initiatives and investments to drive double-digit adjusted EBITDA growth in future years. I remain excited to be part of the team that will deliver these results and as I look into 2019 and beyond, I'm confident we can create value for our patients, providers, payers, and in doing so, create value for our shareholders.

With that, we are now ready to open the call for Q&A. [Operator Instructions]. Operator, the first question please?

[Operator]

[Operator Instructions]. Our first question is from Kevin Fischbeck with Bank of America Merrill Lynch.

[Joanna Gajuk, Bank of America Merrill Lynch]

This is Joanna Gajuk filling in for Kevin today. So in terms of the organic revenue, which improved nicely right, up 3%, but what kind of level of organic growth do you need to be able to maintain margins? Because obviously surgical margin is still down year-over-year?

[Wayne DeVeydt, CEO & Director]

This is Wayne. Let me start and I'll let Tom add to this. So let me first start by saying that the margin sequential is really what we've been focusing on, because you've got to consider where we, kind of, started the year at and the assets that we've been pruning along the way. That being said, we actually expect margin expansion as the year progresses and then we actually expect to see meaningful lift in the next year, as many of our investments we've made run their course both in terms of the returns we expect to see but also the investment dollars we're spending today go away, and so they don't repeat. So I think our margin sequential improvement, we're encouraged by, because we're still early in the game, six months with this new management team, but more important there, I think what you're going to see is probably out performance from a margin perspective, especially going into '19. Tom, anything you want to add to that?

[Thomas Cowhey, EVP & CFO]

No. I mean -- there is a substantial number of investment cost, so we're obviously below the line, and so we're not part of that EBITDA margin but there were substantial costs that we're seeing inside the -- our run rate SG&A for some of the personnel that we've hired and some of the staff that we've built that is clearly impacting the margin performance. Some of that will continue to repeat into next year. As you look at the revenue guidance, the -- note that we're giving you minimums so for both of our metrics. And on the revenue guidance in particular, I think we're tracking probably a little bit better than consensus clearly, and we've seen some strong momentum there primarily driven by rate and mix. And so the -- as you think about what we need to do for the back half of the year, I think we are going to see some of the initiatives that we have really been working on start to take hold. We have great volume that we're anticipating that's consistent with, kind of, the seasonal trends. And we think we've got a strong outlook for the remainder of the year. So I think we're probably less concerned about what the margin profile is and more concerned with the dollars of EBITDA growth. And how that translates into the back half of '18 and then really into 2019.

[Joanna Gajuk, Bank of America Merrill Lynch]

Okay. And if I might follow up on your comment about, you've talked -- or you've seen that the revenue, I guess, tracking slightly better, mostly on pricing and mix. So can you comment on the volumes that clearly improved but still negative? So when do you expect volumes to actually turn positive? I know that on the -- three months ago, on the call, you said that April volumes were returning to growth, so what happened after that? And, kind of, when should we expect volumes to turn positive?

[Thomas Cowhey, EVP & CFO]

So I said this I think on the call last quarter but there was an extra business day in April and so you got to be careful about looking at a too small a period. I would probably point you to just as you think about what we did in same store in the first quarter, the volumes were off almost 4% and that number has meaningfully improved year to date with this second quarter results. I think we've got positive momentum here, and so we're encouraged by what we saw in the second quarter.

[Wayne DeVeydt, CEO & Director]

Another thing I would highlight, because I think this is super important to recognize is that this is a long-term play here around volume, and as we're pruning the asset, we have negative impacts on volume in the short-term, but we believe you'll see over time that improves not only the margins that we have but absolute dollar EBITDA. In addition, our physician recruitment efforts as you know just started this year in terms of ramping up. And so again, as I mentioned, if you actually look at the number of new doctors recruited in the first half of this year, and you compare that with the number of new doctors recruited in the first half last year, the number of doctors recruited is only slightly up. But by being very focused on the right specialties and being very data-driven in the right geographies, the volume contribution has more than doubled and our margins are up on that. And of course, that's with just early results of our new efforts. We actually are adding 4 new recruiters both in the next couple of months. We've actually got offers out to 3 right now, so I think you're going to see these trends both continue to move in the right direction. The other item I'd point you to is through some of our pairing efforts and pruning efforts that we've done is you'll actually see that the EBITDA actually improved in our ancillary business for the first time. And so while it does hurt case volume, you'll actually see that we're taking out inefficiencies in the system that we see within our business while improving overall EBITDA.

[Operator]

Our next question is from Ralph Giacobbe with Citi.

[Ralph Giacobbe, Citigroup]

Just wanted to go to guidance a little bit more. Can you talk about the comforting confidence in that back half ramp? I know there is always seasonality more back half weighted but does seem a little bit more pronounced this year. Maybe you could talk about how much it relies on top line improvement particularly volume versus maybe more tangible or visible cost improvements? I know in your prepared remarks you talked about the GPO and potential saving there, should we sense that you can, kind of, quantify that. And then lastly, just maybe what your assumptions are for organic growth in the back half?

[Wayne DeVeydt, CEO & Director]

Yes, Ralph, thanks for the question. Let me highlight a few things that give us a lot of comfort. And I think you're asking the right question. We're not leveraging much of our top line investment for the back half at this year point, meaning we believe it's going to be there, we believe you're going to see it in case volumes as the year continues to progress and improve. We are going to continue to prune the asset in the back half of the year really to position ourselves for 1/1 of '19. So with that being said, to remain conservative in our outlook, we've chosen to place less reliance on that and more reliance on those items that have great line of sight of us, that we know are coming with confidence. As you highlighted, clearly, the GPO contract is one that we can see with great visibility. We know the contract's been signed.

We know what our new pricing is. We can see that with line of sight. We've made substantial strides with our top 20 vendors outside of the GPO. Again, another example where we know many of that really starts that ramp up in the back half of the year. It's also important to recognize that we did our broad restructuring, and we just finalized that recently, and there's clearly benefits that are associated with that, with the reduced headcount in the back half of the year because of our spans and layers work that we performed. So there's many things that give us confidence, and what you'll start to see as sustainable margin improvement through efficiencies by leveraging our national scale. Obviously, to the extent that a lot of our top line initiatives start to come to light sooner than we expect, then that will be juiced to the back half. But to be fair, we're seeing opportunities to accelerate our investments and we're leveraging some of that, and we did some of that in the second quarter because we think consolidating these platforms sooner rather than later actually provides even more value in '19 and beyond.

[Ralph Giacobbe, Citigroup]

That's helpful. And then you talked a lot about different initiatives and one of the more important one obviously being physician recruitment. Can you help a little bit on details on maybe how many you've onboarded? I think in the prepared, you said it's a little bit higher than it was a year ago. I'm just wondering, that's gross versus net? And are you still seeing attrition? And just maybe help us with the ramp on how we should think about how quickly things can ramp as you bring on new surgeons?

[Wayne DeVeydt, CEO & Director]

Yes, it's a great question, Ralph. Let me first start with -- we're first looking at our initiatives on a gross basis. The primary premise being let's not scramble the eggs and not understand whether our data-driven approach is working or not working. So starting on a gross basis, I think in the first quarter, we talked about having north of a 100 new physicians recruited at that point in time. We've more than doubled that already through the first six months, and I would say that's with the ramping up of our recruiters really just getting initiated and the data-driven approach really getting underway. We then did an analysis. We actually compared the absolute volume contribution, and what's quite interesting in the set, the volume from this physician group and the cohorts that we're representing, which are clearly the specialties we want -- when I say doubled, what I'm talking about moving from 200 cases to 400 cases, we're talking about moving from thousands of cases to thousands of cases on the doubling aspect, and then of course we're looking at the direct contribution margin, we're looking at it by minute, and we've actually improved on that as well.

So we're getting the right docs with the right productivity with the right mix. I view this a little bit like a snowball though so as those doctors become stickier, and as we recruit even more high-productivity doctors, and we increase the size of our recruitment team, they slowly stat filling the gap from those physicians that leave over time. So when we carve out physicians leaving over time, what -- somewhat of an interesting dynamic is we're not necessarily finding that the docs that leave were necessary driving such a huge volume. It's more that even some of the docs that're still here today, right, as we have an aging population in doctors and as the physician recruiting machine was not really ramped up over the last several years, we're feeling kind of a multiyear impact of just existing docs with lower productivity, as they get closer to retirement, which is a very good normal kind of aspect of human behavior. So from our perspective, what we're looking forward is kind of look at the gross activity, let's measure of it, let's see if we are stemming the negative activity in terms of outflow from not only exiting doctors but more importantly from existing physicians that are nearing retirement. So we can understand that impact. I anticipate the turnaround fully flips by next year. We projected internally that we think by start of next year, we will be fully recovering from anybody who was lower productivity within our range or has left, and we'll start getting net positive on top of that. So that's why I think '19 becomes really the growth year for us, while '18 is kind of a rebuild year and replenish year.

[Operator]

Our next question is from Chad Vanacore from Stifel.

[Chad Vanacore, Stifel, Nicolaus & Company]

So just thinking about dispositions through the year, you said you consolidated -- closed 16 practices and two ASCs, is that right?

[Wayne DeVeydt, CEO & Director]

That's correct.

[Chad Vanacore, Stifel, Nicolaus & Company]

All right. Could you give us the EBITDA contribution from that in the first half? And then, how much more in planned divestitures should we expect through the year?

[Wayne DeVeydt, CEO & Director]

Yes, it's a great question. So Chad, obviously, we're not going to carve out EBITDA by facility, but what I will tell you is if you look at the prepared remarks that Tom highlighted, he talked about net proceeds from dispositions in sales. You can see those proceeds around $10 million. Think about what average multiples are in this business, you can probably back into some EBITDA contribution from those. The one thing that I want to highlight though for you is when you think about physician practices, it's also about looking at the broader ecosystem. So in some cases, while we may have been a net positive contributor to let's say an ASC, when we actually looked at some of these practices, the G&A flow from running multiple facilities made no sense. And so it was better to consolidate and in that case, it didn't necessarily impact the ASC EBITDA, but it took G&A infrastructure out of our operations, which is why you're seeing for example ancillary actually improving where a lot of our physician practices reside. So I think the thing I'll highlight is that we've been able to cover those shortfalls for the year in terms of the pruning. We believe in our outlook, we're able to cover them. I think the next big one we're tackling right now is optical and if you look at the segment reporting, you can see optical generated about $1.5 million of EBITDA in the first half of the year, and you should assume that it's a fairly steady state business. So kind of gives you a flavor for even more EBITDA that we expect to have pruned as the year goes by.

[Chad Vanacore, Stifel, Nicolaus & Company]

All right. So you made a lot of changes in the organizational structure, you expect cost savings in that and other strategic initiatives like you've been purchasing. What is -- what's the gross savings we should expect in the back half of the year?

[Wayne DeVeydt, CEO & Director]

So when you say gross, just so I understand your question, I want to make sure, are you saying pre-NCI or do you want to know net of NCI? Because ultimately, what benefits our shareholders is the net of NCI.

[Chad Vanacore, Stifel, Nicolaus & Company]

Okay. Let's talk net.

[Wayne DeVeydt, CEO & Director]

Yes, so well, I won't give the specific details, because we need to be able to execute and show the value chain is all coming through, but what I would say is we believe it's more than enough to cover our future pruning in the back half of the year, and it's more than enough to cover our additional investments to further accelerate our platforms that we're doing. That being said, we expect all those investments to theoretically go away by the end of the year, and we'll get kind of the supercharge effect of both the EBITDA incremental value with that going into next year. So as an example, I mean I know you get this Chad, but when you do a restructuring mid-year and you're having a GPO contract mid-year, the actual value creation from that really ramps up in the subsequent year, because you get full run rate benefit into it. So we won't get full run rate benefit this year and again, it's a partial benefit but it's using things like optical we talked about, using other items I highlighted in terms of investments, you can easily see the numbers where they come into, and it's not the single millions but it's ramps up quite a bit.

[Chad Vanacore, Stifel, Nicolaus & Company]

Okay. Because we're in a situation now where the first half margins were pretty weak and costs were elevated. You got to get those costs down to get the margins improved in the second half of the year just to meet the guidance. So I just want to get an idea on how do you get there? How do you improve years' margins?

[Wayne DeVeydt, CEO & Director]

Yes. And again, Chad, I think the thing I would say is no apologies on the first half margin. We knew the asset was undermanaged, and we had a lot of work to do here, but I would say the investments we're making -- we could have had great margins in the second quarter if we chose not to make investments but that doesn't drive long-term growth. So I think from our perspective, proof will be in the pudding, we obviously have to show you that we're executing on our strategy going into Q3 and Q4. We believe by the end of Q3, we'll be in a strong enough position than to show you some execution patterns and to be able to give you some input on how we think our outlook will look for 2019 then.

[Thomas Cowhey, EVP & CFO]

Yes, Chad. I think number one, you got to remember that the margin profile is different pro forma than it was historically, right? The NSH acquisition brings with it some new answers on cost of sales and passthroughs that are going to change the margin profile. That doesn't mean that the EBITDA is bad or that the growth rate is different than what we talked about. But I think the margins returning to historical levels given the nature of the mix of the business is probably not something that's going to happen in the near term. The -- you're also seeing the cost associated with some of the investments that we're making without the benefits of the investments that we're making, and we've done our best to try to normalize for that for where we thought it was appropriate and pull those costs below the line, but as you look at our G&A relative to where it was last year, we've made substantial investments that we're bearing inside that margin profile. So we've got work to do in the back half of the year, but from where we sit right now, we feel like we've got a good level of visibility, and we feel good about what we told you for the back half.

[Chad Vanacore, Stifel, Nicolaus & Company]

All right. So you framed physician recruiting is going well. You increased your recruiting effort. You say these new physicians coming online are actually becoming more and more efficient, so why is it that organic volume growth was down? And are the exiting docs just exceeding that recruiting rate?

[Wayne DeVeydt, CEO & Director]

No. Chad, look, I think it's a function of history. I mean, let's recognize this is a new team that just started six months ago and many of the team members have only come on in the last three months, so you had a multiyear period of, what I would call, just physician attrition that has occurred. A lot of that wasn't necessarily seen because of the acquisitions that were being performed along the way, and you started to see that pretty much hit last year in the back of the year, and so you've just seen the full run rate effects of those as we start this year. So I'm actually quite encouraged at not only the results that we're getting already on our recruitment efforts, but I already think we're starting to stem the tide. One of the things we did is we're doing, kind of, a rolling 12-month average to see what our net recruitment efforts are producing, so we're kind of looking at our absolute 6 to 6 We're roughly looking at rolling 12 to make sure that are we starting to bend the curve on case volume and where we want that to be. And I think the answer is yes. We're seeing that curve start to bend and start to move in the right direction. But it takes time to call out of a multiyear hole that's been dug, and six months in, I think the team has done a really nice job, so I'm really confident as we move into '19, and I think we're going to be able to do a lot of investments this year that will be on as we thought because we're bending the curve.

[Wayne DeVeydt, CEO & Director]

Thanks, Chad. We've got to move on to the next caller.

[Operator]

Our next question is from Brian Tanquilut from Jefferies.

[Brian Tanquilut, Jefferies]

Wayne, just a quick question for you. So as I think about the progress you've made in driving the revenue per case up, and you've talked about how it's like -- you're benefiting from acuity and the commercial payer mix improving. How much runway do you have left? And how exactly are you driving those specific metrics?

[Wayne DeVeydt, CEO & Director]

Yes. Brian, first of all, the runway is substantial. If you were to ask me what inning do I think we're in of a 9-inning game, I'd say we're probably late in the first inning to be honest. As I have seen the value creation is very short window. And the reason I say that, I think it's important to recognize first and foremost that we had stem the tide, if you will, kind of triage the history of the lost physicians along the way, and the fact that we're just starting to see that happen is encouraging. The fact that we have to actually ramp up our recruiting efforts, get our in-market machines moving again, we're seeing those things happen now. I -- when I look at this, we did -- but we won't give long-term guidance, obviously, today, but we've done our 3-year modeling already, and we've looked at what we think this asset is completely capable of. And I don't -- I'd loved to say it's aspirational, but I don't think it's overly aspirational what we can think we can accomplish in terms of growing case volume and margin expansion. And so from our standpoint, I think we're still early innings, and I think in '19, if we can show the solid execution I expect this team will deliver in the back half of this year, I think you'll be encouraged as we are about how much we can grow in '19 and more importantly, we're making many investments today already that will drive value into '20 and '21. Our construction pipeline and our de novo pipeline is meaningful, not in the five millions or tens millions, we're in the hundreds of millions that we've got moving already on de novo opportunities. So I think we've already started the process of building a multiyear pipeline even outside of the shorter-term initiatives.

[Brian Tanquilut, Jefferies]

I guess my follow-up to this last one you just made, so as I think about -- you're talking about the 3-year plan, right? So as I think about the opportunity or the holy grail opportunity we're thinking about on the outpatient joint replacement, reimbursement kind of coming out of CMS, so how are you preparing for that? And how should we be thinking about the incremental investments that you have to make beyond 2018 to really harness that opportunity?

[Wayne DeVeydt, CEO & Director]

It's a great question. So look, I think first and foremost, so we're very excited about what CMS has proposed and obviously it's still a proposal, we'd like to see this get over the finish line, but we think these tea leaves continue to come to light each quarter around where CMS is moving over time. While we recognize that the Medicare environment is a lower pay environment than the commercial environment, we think as a company, part of our long-term strategy is if you, kind of, look at a core book today and you look just at much -- muscular skeletal and GI and ophthalmology, just look at those buckets by themselves, right, they represent about 85% of our book of business, and MSK being the largest of that book. And so we get very excited about this shift that we're seeing, so we think: One is, we're very positioned; two is, as we look then for physician recruitment, that's why we're being very intentional in focusing on MSK as one of those.

If you look at our recent acquisitions that we've done in the $50 million while we haven't called out all the pieces, I would tell you at one is an orthopedic group that we picked up in Nebraska, another one is a spine group that we picked up in Southern California, and I would tell you our pipeline that we have today is very much aligned around MSK. And so I think when we look at long-term strategy, we're making all the investments today to position ourselves to be the partner of choice whether we're recruiting a physician, whether we're acquiring a practice or whether we're working with partners about a JV in a market, because they're recognizing that this shift is happening. And if you don't have the assets in place today, it's -- you're behind the curve at catching this wave, and so I -- those are kind of the key things. The last thing I would highlight is in managed care. It's important to recognize that we have a huge opportunity not only within just our basic contracting but we're working with large national players now around side of service opportunities, where we're showing them the benefits of side of service, we're showing them our clinical data now. It's superior data and we're showing them our NPS scores now.

And so we now have the story to tell that I don't think people really appreciate, and I wanted to emphasize that point, Bryan, because it wasn't that the company ever had but assets. I mean the ASC assets are phenomenal assets. In fact, our 10000-plus employees that support the day in day out operations were producing phenomenal clinical and customer scores and physician engagement scores. We just needed to structurally get back to what's the strategy, what's our core, and what we're focusing. So I feel more even more encouraged today than I did before about the long-term pipeline we've built and in particular, around MSK.

[Operator]

Our next question is from Frank Morgan with RBC Capital Markets.

[Frank Morgan, RBC Capital Markets]

I wanted to go back to an earlier question. I don't know that we quite got the answer there. On the consolidation efforts of the practices and the ASC closures, did you by chance give a -- any kind of expectation on how much incremental activity in that area is really [indiscernible]?

[Thomas Cowhey, EVP & CFO]

No. We didn't. Look, Frank, there's a couple of things that you should think about. The -- if you look at the ancillary business in the press release and you'll get a little bit more data when Q comes out today. You'll see that the profit actually went up year-over-year in that business. And there is 2 primary things that are in that business. one is some of our practices and the second is our lab. And you can think about those as going in opposite directions but still driving a positive year-over-year result. And the practices improved primarily because of some of the actions that we've taken. Now on a net basis, we think that those are at least neutral to the company, but that definitely impacted a little bit of our volumes on the ASP side as we made some really tough decisions in particular markets. But we think that those were the right moves to make for the total company, and so we went forward and made them. So there is a lot that we're doing here to really trim the portfolio and try to drive growth in future years, and it's just a little bit noisy as you go through these in interim months

[Frank Morgan, RBC Capital Markets]

Then is it fair to say that more of that activity, more likely will be ancillaries going forward then in, say, the traditional ASC in practice area?

[Wayne DeVeydt, CEO & Director]

I think that's a fair statement. We have a few geographies, very limited now on the ASC side that we're still looking at whether or not they're really worth investing in and not necessarily aligned with what I would call our core growth assets, and so look, there is a viable market right now for ASCs. People are excited about them. If they're not part of what we think being part of the growth engine, we're open-minded to potentially spending off a few of those, but I would say, in general, most of you where you see the future pruning is going to generally be around the ancillary but to be clear, I -- we have done a fair amount of that, I think the last thing we've got to really focus on at this point on the ancillary is really around the lab and how we decide ultimately to integrate that within the core business either a little bit more or to take other initiatives there.

[Frank Morgan, RBC Capital Markets]

Got you. And then a follow-up here. Just in terms of that sequential margin improvement. If you sort of had to parse it out between the fact that you've still have these investments that you had to make in the quarter, the fact that you have these consolidating activity -- I guess I'm trying to figure out from this point forward, how much of the margin story are sort of cost-related restructuring and strategic things versus just flat out driving volumes? That's it.

[Wayne DeVeydt, CEO & Director]

Yes, probably, I don't know if this will answer your question. Probably, Frank, the easiest way to think about it is one of the things that we do is we try to analyze. There is a lot of moving parts on the revenue piece, we talked about the lab and us getting that paired off. We wanted it to get it, we talked about some asset we sold, et cetera, but when, kind of, pull it all out, if you just did the most basic assessment, and said look if the margins were flat with last year, what would that translate in G&A. Or if the margins were up versus last year, what would that translate to in G&A investment and you can go right through our G&A and see our COGS are up by an amount greater than that margin. And I can tell you it is a direct driver of our core investments. And then Tom and I have gone to the pieces to say what are those investments, and we've looked at them by division, by area, et cetera.

So I think again -- I'll use physician recruitment as a very simple example, but as you're ramping up a recruiting team, as you are buying the data that allows us to be very surgical, no pun intended, in the physicians we want to go after, that are how productivity in the right specialties, as you're doing this and cutting it in every market, you are front-end loaded on that. We already know now that will give us a return that will more than cover our cost in the back half of the year. And then we know, of course, it will ramp up from there, so when we start just bifurcating these pieces out, we could've shown margin improvement versus a year ago, but we really don't think that's the right answer for the long-term. And so our goal is to show you that we're going to keep kind of ratcheting it up a little bit as the year goes back. I think in the next quarterly call, when we talk more about 19 is I think when you'll get a lot more of the optimism we have, because at that point -- we want to see another three months. I mean I think six months in with team is still pretty immature, but we think we get another three months under our belt, some of these initiatives will be able to start showing you real proof points and evidence of that growth.

[Thomas Cowhey, EVP & CFO]

Frank, as you look at the volume sequentially, we're up 5.4% and make sure you look at what the days are there, because there's probably a little bit of benefit in Q2 versus Q1 given the holidays and the workdays, et cetera, but the net revenue per case is still up over a point just sequentially, right? And some of that is clearly just the payer mix. We've got more probably payer mix in the quarter, almost up nearly 2%, but as you start to look at that year-over-year, I think it really has to do with some of the initiatives that we've taken to drive the business towards some of those higher acuity areas that have higher net revenue per case. You're starting to see some of that come through in the numbers. It's coming through in some of the work that we're doing with our new physicians. We're trying to recruit in specific specialties. We've made a lot of investments to have better visibility as to who's out in the market and those that we're going after those that will be aligned with where we want to drive the company for future growth. And so I think there is definitely a lift that we have in the back half. The mix, as people burn through deductibles on the private payer side, will clearly be a benefit here, both from a volume side but also from rate side. But hopefully, a lot of the initiatives that we're taking to drive incremental volumes, to drive savings on our G&A, on whether that's bandage or implants, right? We're trying to take the actions to drive this core business to have it accelerate in the back half and then further into '19.

[Operator]

Our next question is from Bill Sutherland with The Benchmark Company.

[William Sutherland, The Benchmark Company]

Most of my have been asked. Thought I might get at this case volume question, same-store case volume one more time just from this perspective of having -- you the way you called out onetime factors that depressed it in the first quarter. Anything in the second quarter? Or if you, I don't know, sort of normalized the first quarter for the second quarter? How that would comp?

[Wayne DeVeydt, CEO & Director]

Well, I think the one thing I would highlight in Q2 this year is we did sell a relatively fully functional ASC that had good volume. But it was geographically literally across the river from where we had a multispecialty ASC, and we had a physician that was considering retirement, a physician partner and owner, and so we felt like this was an opportune time to liquidate and sell that asset. Our few acquisitions we did didn't happen until more back half of the second quarter. And so -- and I think one of the things is that you are -- we're losing a little bit of volume on a well-performing ASC, but nonetheless, one that didn't strategically make sense for both our geographic focus as well as our long-term growth focus, and so there is nuances like that, and I think that's the one thing that we're -- we recognize the desire for information, but we have a lot eggs we're scrambling and a lot of eggs we're unscrambling, and I think as we, kind of, move through the year those little nuances are going to happen. I think what we want to continue to encourage everybody is to look at the sequential improvements as the year goes, because if we can continue to show that path and show that it's happening while we're making investments, it will hopefully give you the comfort as we move into '19.

[William Sutherland, The Benchmark Company]

Okay. I guess Wayne, you alluded to how you're positioning to get negotiations going with the payers where you guys have single site, touched the discussions, when -- how long a game is that, kind of, be to, kind of, see the impact?

[Wayne DeVeydt, CEO & Director]

Yes. Really appreciate the question, Bill. It's interesting the one thing I said in the -- it was my first 6 weeks when I was with the company on the year-end call, I commented that this is the one place where you really have to play long ball, right? It just takes time and you have built those relationships and have to grow. I would say, considered in, what I'll call, three very basic buckets, one is just basic contracting and the most basic bucket, generally, your contracts renew once every three years, you kind of tackle it with that capacity. You've got to be data-driven that's how -- if you want to get better rates, you got to be data-driven, but that's not really what I would call super value creating for us. It's important for us. We think we can outperform based on where we've been historically, but it's really be moving to the next two areas, which is much more innovative, partnerships and working with the national carriers around the side of service and the fact that we are a lower cost environment and hopefully, physicians will be rewarded or at least excited about using that lower cost environment, but that's really something we need the payer to create the incentives and to our work with them, so we're working on innovative programs with the payers right now. I would say those discussions are very far along with multiple national carriers at this point. So those are not an early innings at all, there in later innings, and I would anticipate that between now and probably end of third quarter, we might be in a good spot to have a few of these inked if not early fourth quarter.

So that's encouraging. And then the last part though is really what I would call the very innovative kind of outside the box new partnering, and that's where we explore opportunities with payers to actually co-invest in some of these ASCs and the opportunities we see there, for they did not only participate in the value chain of ASCs but be actually incented to really take advantage of the quality metrics that we have in these facilities in a low-cost environment, actually move more of their membership to an in-network but high-volume concentration and I would tell you we have a couple of those discussions underway right now. I don't want to get over our skis on those, because large carriers can move sometimes slow in this process, but that being said, I'm hopeful we'll have at least one of those inked by the end of the year, which will be a real proof point as we move out with large carriers around the art of the possible. And why we think that's where this wave needs to go next in terms of vertical integration.

[Wayne DeVeydt, CEO & Director]

Before we conclude our call, I do want to take a moment to say thank you to over 10000-plus surgery partners associates for their contributions this quarter. And as we execute against our goal to become the preferred partner for operating short-stay surgical facilities across the U.S., it really is a daily efforts of each and every one of these employees that will get us there. We still have a lot of work ahead of us, and 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. I do look forward to providing updates to our shareholders on our progress and our return to sustainable long growth. Thank you for joining our call this morning and have a great day.

[Operator]

Thank you. This concludes today's conference. You may disconnect your lines at this time? And thank you for participation.