Surgery Partners, Inc. Q2 FY2022 Earnings Call

Greetings, and welcome to the Surgery Partners, Inc. Second Quarter 2022 Earnings Call. This conference is being recorded. I will now turn the conference over to CFO, Dave Doherty. Please go ahead, sir.

Good morning, and welcome to Surgery Partners second quarter 2022 earnings call. This is Dave Doherty, Chief Financial Officer. Joining me today are Wayne DeVeydt, Surgery Partners Executive Chairman; and Eric Evans, 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 file with the SEC. The company does not undertake any duty to update such forward-looking statements. Additionally, during today's call, we 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 on Form 10-Q, when filed. With that, I'll turn the call over to Wayne. Wayne?

Thank you, Dave. Good morning, and thank you all for joining us today. Before we begin the call, I would like to acknowledge and thank our colleagues and frontline caregivers for their relentless focus on providing the highest clinical care and quality to our patients and communities. You are at the core of our values as an organization, and on behalf of the Board of Directors and the Executive Management Team, thank you for everything you do. Turning to our second quarter results. We are pleased to report second quarter 2022 adjusted EBITDA of $86.1 million, a 13% increase compared to the prior year quarter and nearly 18% growth when excluding CARES Act grants. In the quarter, we performed just over 149,000 surgical cases, nearly 7% more than 2021, resulting in a 13% increase in net revenue. We are especially encouraged by these results as we have continued navigating the macroeconomic challenges, including the broader inflationary pressures and continuation of COVID-19 variants. As we have restated, we are not immune to such challenges, but our business model continues to demonstrate its durability and resiliency. We ended the quarter with strong momentum and are optimistic that we can continue to navigate these areas through the balance of the year. We closely monitor and manage inflationary risk, whether in labor or supply costs. Year to date, the team has successfully managed these costs in line with our expectations and to pre-pandemic levels relative to net revenue. As previously stated, we believe we have a competitive advantage. And consistent with our experience last quarter, our second quarter results again demonstrate and reinforce how our business model is uniquely positioned both now and for future growth. Dave will share more details regarding our financial results, but a few highlights. Same-facility revenues increased almost 7% compared to the prior year quarter with nearly 2% case growth and 5% higher net revenue per case. New physician recruiting efforts yielded 100 new recruits to our facilities in the second quarter, bringing our overall new recruits in the first half of the year to over 250, with recruits spanning all of our core high growth specialties. Previously, we've shared with you the increasing contribution our newly recruited physicians bring to our facilities. Our most recent 2022 cohorts are no exception to this trend, bringing more cases with a higher overall net revenue per case than our 2021 cohorts did in the same period last year. And finally, the transition of procedures out of traditional acute care inpatient settings continues to accelerate. Joint replacements in our ASCs were up 32% from last year, and our cardiac procedures have increased nearly 9%. Over the past 3 years, our total joint program had a compounded aggregate growth rate of approximately 90%, while our cardiac program rate of growth is over 27%. We will continue to focus on this significant shift in the site of care and our recruiting efforts, acquisition, and de novo investments. We believe our strong financial results reflect the numerous macro tailwinds associated with the benefit of performing procedures in a high-quality, lower-cost patient and physician-centric setting. With a total addressable market of over $150 billion, our company is well positioned to capture its fair share of that market. Moving to capital deployment. Our M&A team continues its disciplined approach to sourcing and executing on strategically important acquisitions at attractive multiples. Our team is currently managing a robust pipeline of potential targets. In the second quarter, we acquired minority ownership positions in 5 ASCs through our relationship with ValueHealth and acquired a majority interest in a vascular-focused ASC. Combined, we deployed approximately $90 million for these 6 ASCs. In addition, as we discussed on our last call, we acquired 4 in-process de novos from ValueHealth for approximately $14 million. Eric will speak further to the continued execution on acquisition opportunities related to our ValueHealth partnership we announced on our last quarter's call. Our balance sheet remains strong with limited exposure to interest rate changes and no material debt maturities until 2026. We believe our existing acquisition pipeline, coupled with a renewed focus on de novo development, further enhances our long-term trajectory. Based on our solid performance during the first half of the year and our outlook for the back half of the year, we are reaffirming our full-year guidance for 2022 adjusted EBITDA to a range of $375 million to $385 million and revenue in the range of $2.5 billion to $2.6 billion. With that, let me turn the call over to Eric. Eric?

Thank you, Wayne, and good morning. I will focus my comments on a couple of areas that will explain my optimism for the company and our guidance for the year. First, I will provide a few additional highlights from our second quarter results, including statistics about our key organic growth initiatives. Then I will share more details about the continued execution of our M&A strategy. We are very pleased with our second quarter results. The company continues its positive trajectory as it emerges from the pandemic, with surgical case growth across specialties at levels consistent with pre-pandemic levels. We continue to see stabilization of our case mix, which is another data point that we have resumed business as usual. While we continue to have impacts from COVID-19, after dealing with this pandemic for over 2 years, our facilities, physicians, and patients have learned how to navigate outbreaks with less disruption to normal life, and in most instances, cases get rescheduled within a few weeks rather than being canceled. To support this point, we performed over 149,000 surgical cases in the second quarter, which represents approximately 7% growth over the prior year quarter. On a same-facility basis, net revenue grew 6.9%. Our organic growth initiatives, coupled with acquisitions completed over this past year, have translated into strong top-line growth of over 13%. Adjusted EBITDA came in at $86.1 million, with a 14% margin when you exclude the impact of CARES Act grants, delivering 50 basis points of margin expansion compared to the prior year period, which was in line with our expectations for the quarter. As we mentioned on our last call, we closely monitor inflationary impacts to our labor and supply costs. Our enhanced reporting of labor and supply costs allows us to identify any new trends early and to react accordingly. While we have done well overall in mitigating the impacts of these pressures, we have seen elevated contract labor rates in certain markets, which can be explained by the enormous pressure the omicron variants have had on our healthcare system. With improved data analysis, we can evaluate if the use of such labor is the best option for a particular facility versus other options, helping avoid some cost pressures. Premium labor as a percentage of our total salaries, wages, and benefits in the second quarter of 2022 continues to be consistent with the same ratio in pre-pandemic periods. We attribute our high retention of key talent and recruiting speed to our favorable workplace environment, allowing us to obtain the high clinical quality and exceptional patient experience we are known for in the communities we serve. We are also working with our GPO and key suppliers to understand inflationary factors that impact our business. In the second quarter, supplies were approximately 28.2% of net revenue, 80 basis points lower than the second quarter of last year. Given the global environment and continued disruptions to the supply distribution chain, we acknowledge the potential for increased costs moving forward. At this point, we are not seeing unusually large price increases in commodities, implant costs, or deliveries, but we remain vigilant in managing this risk and have active initiatives underway to proactively mitigate it. Moving on to our organic growth levers. We continue to benefit from our relentless focus on physician recruitment and targeted facility-level and service line expansions. These efforts contribute to higher overall revenue per case rates as well as generate the highest contribution margin for our portfolio. Our physician recruiting team has been meeting the increased demand for new physicians for short-stay surgical facilities by targeting the highest quality positions. In the second quarter, we added 100 new physicians spanning our key specialties, bringing our first-half total to over 250 new surgeons using our facilities. As Wayne highlighted, each of our recruiting cohorts continues to drive strong year-over-year growth, and we are encouraged by the early strength of our current quarter recruiting class. As a point of reference, the average net revenue per physician in the 2022 cohort is already 55% more than the very strong 2021 cohort that we recruited last year. All of this has helped fuel our growth in MSK procedures, particularly total joint cases in our ASCs. We performed approximately 25,400 orthopedic procedures this quarter, 12% more than the prior year quarter. We do not see this growth slowing. And as we have discussed, we are preparing for the next wave in procedures that we expect to migrate to outpatient settings. With an increasing share of orthopedic and cardiac procedures moving into lower cost, high quality, short-stay surgical facilities, we are considering all options to capture our fair share, including the increased use of robotics, renovation of existing facilities, increasing our M&A pipeline, and developing de novo facilities. As Wayne mentioned, in the second quarter, we acquired ValueHealth minority equity stakes and management agreements in 5 ASCs. We also acquired interests in 4 ValueHealth de novos. We expect to help these facilities grow disproportionately over time, leveraging our differentiated and specialized operating system. These transactions represent the continuation of our partnership with ValueHealth as we maximize our combined strengths and capitalize on the rapid migration of high acuity cases to the high-quality, short-stay facilities we own and operate. As we have discussed previously, in-market development of de novo facilities is a core strategic growth pillar for the company. The capital investment required for these facilities is low when compared to traditional M&A, but the time it takes to syndicate and build out the centers often exceeds 18 months. In addition to the initial syndicated projects acquired from ValueHealth, there are multiple other de novos in development across our portfolio. To summarize, through the first half of the year, we have deployed over $125 million on existing facilities and have invested $14 million more on de novos, well on our way to completing our commitment to deploy at least $200 million in capital in 2022. Given the results we reported this morning, along with our outlook for the remainder of the year, our adjusted EBITDA guidance range of $375 million to $385 million is prudent. As you can see from our first half results, we are confident we can manage through these risks. Our teams are highly aligned, and we are executing on our initiatives across business development, recruiting, managed care, procurement, revenue cycle, and operations to achieve our goals. In summary, I am very proud of the team's accomplishments this quarter. Our company provides a cost-efficient, high-quality, and patient-centered environment in purpose-built, short-stay surgical facilities that provide meaningful value to all of our key stakeholders. I'm also excited about our continued partnership with ValueHealth and the strength of our de novo and M&A pipeline. With that said, I'll turn the call over to Dave who will provide additional color on our financial results as well as our outlook. Dave?

Thanks, Eric. I will first talk about our second quarter financial results and liquidity before providing additional perspective on our outlook for the remainder of the year. Starting with the top line, we performed over 149,000 surgical cases in the second quarter of 2022, 6.7% more than the same period last year with strength across specialties, especially in orthopedics where we grew by nearly 12.5% versus prior year. We believe our volumes are near normalized levels as we have effectively managed the continuing impact of the pandemic through enhanced visibility and proactive efforts to reschedule procedures canceled due to patient or physician illness. Largely attributed to this growth, we saw revenues rise 13.3% over last year to $615 million. This growth is a combination of the organic growth factors Eric described and contributions from our prior year acquisitions in consolidated facilities. As a reminder, many of our more recent acquisitions are in non-consolidating facilities that provide us the opportunity to enhance performance through operational excellence and to buy up over time, a highlight point as we are agnostic to the accounting treatment of the assets we acquire. Our focus is to acquire high growth, high-quality assets aligned with our targeted specialties at the most favorable multiple possible. On a same-facility basis, which we report on a days-adjusted basis, total revenue increased 6.9% in the second quarter with case growth at 1.9%. Net revenue per case was approximately 4.9% higher than the prior year period, driven by solid growth in our high acuity cases, such as orthopedics. Adjusted EBITDA was $86.1 million in the second quarter, which included approximately $100,000 of benefit from the recognition of grant income from recent CARES Act grants. As a reminder, adjusted EBITDA for the second quarter of 2021 included $2.9 million of grant income recognition. Adjusted EBITDA margin, excluding the impact of the CARES Act grant, was 14%, a 50 basis point expansion from the prior year. As I've mentioned before, we are diligently managing inflationary pressures affecting our labor and supply costs. Although we are not immune, these factors were not material to the results we are reporting this morning. Our salaries, wages, and benefit costs, as well as our medical supplies costs, were in line with prior year pre-pandemic levels and our expectations. Given the market dynamics, we will continue to carefully monitor these cost factors, proactively deploying cost mitigation tactics to help offset potential pressure. But it does continue to represent a risk to future results that we are incorporating into our guidance for 2022. Moving on to cash flow and liquidity. We ended the quarter with approximately $227 million of cash, which includes approximately $17 million of Medicare advanced payments recorded as deferred revenue on our balance sheet. Recoupment of these funds from future Medicare revenue will continue through the third quarter. We reported positive free cash flows in the second quarter with $42 million of cash flow from operations, $61 million of distributions to our partners and CapEx, and $22 million of repayments of Medicare advanced payments. Year-to-date through July, and excluding our de novo investments, we have deployed approximately $135 million on 10 ASC transactions at an average multiple of less than 7.5x on a trailing 12-month basis. These centers are primarily focused on MSK procedures and are well positioned to support and strengthen our same-store growth trends in future. Our acquisition pipeline also positions us well to achieve our targeted $200 million of annual capital deployment. The company's ratio of total net debt-to-EBITDA at the end of the second quarter, as calculated under the company's credit agreement, was 6.0x, consistent with our expectations. We expect this leverage to float in the upper 5x to lower 6x range in the near term as we continue to deploy capital for accretive assets. As of June 30, 2022, we had total liquidity of $430 million, representing consolidated cash of $227 million and $203 million of undrawn revolver capacity. This solid liquidity position supports both our local facility working capital, investments and capitalization, as well as our future M&A. On the debt front, we have approximately $2.4 billion in gross debt at the corporate level, of which $1.5 billion is floating. We previously executed interest rate swaps and caps that have significantly mitigated our exposure on 100% of this floating debt. At the end of the second quarter, we hit our interest rate caps. But the benefit of our interest rate swaps and caps means our exposure to incremental interest expense from fluctuations in the market is not material. In addition, we have no material debt maturities until 2026 and approximately 15% of our debt due by 2025. As a reminder, the company has an appropriately flexible capital structure with no financial covenants on the term loan or our senior notes. When combined with proceeds from ongoing portfolio management activities, our current liquidity position allows us to approach the capital markets opportunistically. To be clear, we are confident in our ability to fund current and future M&A opportunities. With the second quarter results we released this morning, we are optimistic about 2022 and are reaffirming our 2022 guidance for total revenue in the range of $2.5 billion to $2.6 billion. In addition, we are reaffirming our 2022 guidance range for adjusted EBITDA of $375 million to $385 million. We continue to believe this range is prudent, given the macroeconomic environment we are facing. We anticipate the seasonal pattern of our financial results will be relatively consistent with pre-pandemic levels, with the third quarter earnings and net revenue representing between 24% and 25% of our projected full year performance, along with our best estimate of the impact of known extended vacations in the third quarter. As we evaluate risks versus opportunities in 2022, we are confident in our annual outlook and continue to see strength and momentum across multiple product lines and geographies.

Operator, if you could open the line for questions, please.

The first question we have is from Kevin Fischbeck from Bank of America.

This is Nabil Gutierrez on for Kevin. So given this higher inflationary period, how are you thinking about commercial pricing? Can you talk about how long it will take for them to catch up to the inflation?

Appreciate the question. First thing I would highlight, just as a reminder for all of our shareholders is that about 1/3 of our contracts renew each year when you think about commercial contracting. And in some cases, they have inflationary builds already into them as we've been going through the normal renewal process. So if you think about it purely on a top line pricing, you generally are going to get about 1/3 each year that will run rate into that. That being said, we're clearly in a unique environment. And we have our managed care teams actively working with the payers to see if we can accelerate certain provisions and especially around inflationary provisions that are in there.

The next question is from Brian Tanquilut from Jefferies.

Congratulations on the quarter. For Wayne or Dave, considering the capital structure and your guidance on spending $200 million this year on acquisitions, many investors are focused on cash usage, cash generation, and the sustainability of that $200 million beyond 2022, especially in light of the current market's leverage profile. Could you share your thoughts on your ability to adjust your acquisition spending?

I'm going to have Dave in just a moment maybe just highlight again our current cash positions and kind of where we stand. Just talking about in general, though, kind of the cap structure, we generally target between 5x to 6x leverage. We have always said we'd probably be to the higher end of that simply because we can acquire assets at such attractive levels that would make sense to leverage point. That being said, we are generating positive operating cash flow now as an organization and expect to generate positive cash flow for the year. This is the last year that we have unique outflows, both around the taxes that we have as well as around the Medicare repayment. And so as we move into next year, we expect to be in the $100-plus million of operating cash flow that we will generate, and of course, that number will continue to grow. So then the real question becomes that if you're deploying $200 million a year, what levers do you have available? And I think one is, as Dave will highlight, not only the ample cash that we have available today on our balance sheet, but we're also going through a portfolio refresh that we do every so many years. As we started back in 2018 and 2019, we do that again. And one of the things we find is that we have many assets that are in markets that we believe while good markets, don't necessarily have the same growth trajectory our other specialties have or other assets have. And so we also have unique opportunities to refresh the portfolio and redeploy capital at a very high multiple that we would sell certain assets at and then redeploy at a very low multiple. So net-net, I would say, feel very good about our forward-looking approach. And it really starts with the idea that we'll generate north of $100 million of free cash flow as we go into next year. But with that, Dave, maybe highlight again our capital position and some of the things that we've been thinking about around cash outflows, in particular the interest environment we're in and why we're very confident with that.

Yes, there's not much to add. Good morning, Brian. In addition to the opportunities we have to raise more capital through our portfolio management activities, which I consider essential for us as a company, I believe we've effectively managed our risk from an interest rate perspective. As you know, we take a proactive approach to managing those risks. A couple of years ago, we hedged our variable rate debt, our term loan, which has served us well and protected us in the current rising interest rate environment. With nothing significant coming due until 2026, we don't have exposure regarding cash outlays, making us very comfortable. Now, it's about managing the conversion of earnings, and being in a strong earnings position gives us a high degree of confidence in that. Given the current state of our balance sheet and revolver support, I don't see any reason to change our long-term guidance.

I appreciate that. And then I guess, Dave, since I have you, my follow-up will just be on the G&A line. As I look at it, it was down about 11% sequentially. Is that the right baseline to be using for the rest of the year? Or just any thoughts on the G&A line that we need to be thinking about?

It's a good question. We consistently evaluate all the line items in our general and administrative expenses as part of our growth strategy, always looking for efficiencies. We're currently navigating a challenging environment with inflation, so our focus remains on these areas. While we won't provide specific guidance on the components of our balance sheet or income statement, it's important to note that we adjust for seasonality. Throughout the year, you'll see overall revenue increase as we manage more commercial patients. Overall, we will continue to concentrate on all the available levers.

Yes. And Brian, on G&A, if you think about that, that's something we look at constantly as we grow to gain efficiencies, right? Our expectation is that should fall over time as a percent of our total revenues and we continue to pay close attention to that.

The next question we have is from Jason Cassorla from Citi.

I just wanted to ask about the volume backdrop. And I guess within the second quarter and as we look forward to the next couple of months, are you seeing any elevated level of cancellations or procedures perhaps being pushed out because folks are perhaps reprioritizing their discretionary income, just given the high inflation backdrop? Or maybe just at a high level, how do you view the impact of this high inflation on procedure demand in your facilities would be helpful.

Thanks for the question. This is Eric. We are observing some cancellations and rescheduling due to a couple of factors. One is the presence of some COVID variants still circulating, and the second is summer vacations, which we have discussed previously. Those vacations often get rescheduled, and we track them closely. At this time, we have no evidence to suggest that people are making decisions regarding what we consider necessary procedures, even though we refer to them as elective. We haven't seen any changes in that regard. It’s important to note that we recognize we are in a different economic environment than before. However, given our highly skilled physicians and the necessity of these procedures, we do not anticipate a significant decline. We are monitoring the situation closely. In terms of vacations and the summer season, along with the COVID variant, there have been some cancellations. Typically, these are rescheduled within a few weeks, and we are continuing to monitor this closely. This is all I can share on the matter.

This is Wayne. I want to highlight that our model is quite unique. If we look at historical trends, particularly during the 2008-2009 Great Recession, we saw that high acuity and elective procedures actually increased significantly during that time. This was largely due to individuals who, upon losing their jobs, moved to COBRA and we covered many of their costs. They took the opportunity to undergo elective procedures that they had postponed. While it may seem unusual, our model appears to provide some distinct insulation if history is any guide for the future.

Got it. Okay. That's helpful. As a follow-up, looking back to mid-January, you provided guidance expecting at least $300 million of EBITDA for 2022. Today, you've maintained a midpoint of $380 million. You've completed approximately $135 million in transactions year-to-date, which suggests a high-single to low-double-digit EBITDA contribution for 2022 based on my calculations. In this context, do you see your business organically aligning with your expectations at this point? How would you assess the positives and negatives compared to where we started at the beginning of the year?

Yes. I would say organically, being at around 7% same-store is pretty strong in light of the environment. I think it's fair to say that we continue to see the impact of the variants. The reality is people are still getting COVID. People are still then canceling procedures. And then while those procedures get rescheduled, you do lose the days that they cancel. And you're not exactly backfilling the day that somebody calls in and says I tested positive for COVID. So I think it's fair to say that it's clearly having some headwind relative to our organic growth rate. But at the 7% same-store, we're very comfortable with that, especially in this environment. And if anything, we only see those trends improving, not getting worse as we move forward. And the last thing I would simply say is on the M&A front, as we think about the $200 million, we always recommend using kind of a midyear convention. Think about it that way. M&A can be lumpy, so sometimes it gets accelerated. Sometimes it gets delayed. But net-net, it's kind of where you land the plane. So overall, relative to our expectations for the year, we're feeling pretty good. We raised guidance in Q1. I think it's no secret that the inflationary pressures are continuing for the industry broadly, and I don't think it's any secret about the different variants. But we have a lot of confidence in that range. And we have a lot of reasons to believe not only that we'll finish strong this year, but we don't see anything deviating from our mid-teens growth going into next year.

The next question we have is from Lisa Gill from JP Morgan.

I just really want to go back to about commercial contracting. Wayne, I think you talked about 1/3 of renewals each year. Last quarter, you talked about a new relationship with Privia on the MSO side. So can you really talk about what you're seeing around contracting as we think about value-based care? Are the managed care companies and the commercial market starting to talk about contracting around value-based care? I would think that your company is really well positioned as we think about this shift in site of care to better outcomes, lower cost. So if you could just maybe more broadly talk about that, one, and then two, where you are with the Privia relationship.

Yes. Lisa, I’d like Eric to share his insights on the Privia relationship and provide additional thoughts on the managed care relationship. First, I want to highlight that we've been discussing value-based care within our industry for nearly 20 years. It’s amusing to see everyone talk about it while still trying to figure out its practical implementation. Ultimately, despite developing technology and processes, the key is translating care into a high-quality environment at a lower cost. This has often been lacking in the industry, with shifts in pricing often leading to compromised quality or patient experience. However, we believe we have the resources to not only improve quality but also significantly enhance the patient experience. We’re currently seeing meaningful discussions around value-based care, with payers fully supporting it. This makes it easier for us, as we can assure them that we can manage their volume effectively. If we can engage in these value-based care agreements, we also want to share in the potential benefits. I'll allow Eric to elaborate on our progress with the Privia relationship and our efforts in that area. But the central point remains that, as I mentioned in the last call, we represent the value in value-based care, and now it’s about connecting with the payers to demonstrate its tangible benefits.

Yes, Lisa. First of all, great question, and thank you for the question. A couple of things I'd point out. Starting with the commercial rate, there are a few things to keep in mind. So when we think about commercial contract negotiations, we think about a few levers. It's not just rate, right? We're never going to lead them on rate. We certainly want to get paid fairly. But we actually work very closely with the payers. There have been some big Blues across the country that have announced 50% professional fee bumps for the right site of care for independent ASCs, non-HOPD ASCs. And those are all to advantage. We work closely with payers to think about levers that not just get us additional revenue, but also get us additional volume. So I'd point that out. We clearly are talking about cost pressures, and we're clearly looking for above-market rates. So it's too early to say the amount of success we'll have in doing that. We want to make sure we're locking in some of that mitigation in case we see more pressure going forward than we have to date. And then as a reminder, a lot of contracts in our industry aren't set of Medicare. So we saw yesterday, we're still reacting to Medicare's slight improvement on what they offered. It's still not where the industry wanted it but better than the initial. And so all of that rolls through as well. So I would just say when we think about those commercial relationships, it's more than just the unit price. We certainly want to make sure we're getting paid as much as we can fairly in the market, but we also think very, very hard about how we get that moving care because going back to what Wayne said, we are value-based care in the fee-for-service world. Move to our site, dramatic reductions in cost. Going to your VBC question. So look, we partnered with Privia in Montana. We've talked to Privia as a company that is very aligned with what we're trying to do, which is to move patients to the right site of care. Their primary care docs are increasingly incentivized by value-based care contracts and/or some kind of capitated contract. Those types of groups, and there's more than just Privia, we're naturally aligned with. We're an independent provider. We're not tied to health systems. We don't bring a lot of conflicts. And so we see that continuing to happen. We continue to talk with Privia about a broader relationship. And obviously, we've talked a lot about our ValueHealth partnership, and their whole model is about talking with payers to create the incentives to allow cardiac, orthopedics, higher acuity procedures to move faster. We see it move quite fast. You guys saw our growth numbers for the quarter in orthopedics were 12%. So we feel pretty good about the speed of it. But if we can accelerate that, and I think there's reasons to be optimistic based on the fact that payers can see that they've got 5-figure discounts from what they're paying hospitals in many procedures, that's a place we're going to continue to lean in.

The next question we have is from Bill Sutherland from The Benchmark Company.

I am having trouble hearing the operator. I have a couple of updates on some data points you provided or need clarification on. I observed that the same-store revenue growth seemed to decline in terms of case numbers and revenue per case. Is this the mix you are considering moving forward compared to the first quarter?

So Bill, we've talked about the recovery kind of across specialties. As we start getting further away from the height of the pandemic, I think you will see more of a normal 2% to 3% case growth. We're really proud of our case growth in the environment. We think that it continues to be industry leading, and we still have opportunity there. But in total, Bill, I do think you're going to see some normalization. You saw huge case growth in certain quarters where it was really about the recovery of some of that lower acuity business, whether it's GI, ENT, et cetera. But yes, we're going to get back to some normalized rate. We've talked for a long time, 2% to 3% case rate in volume. That gets you the 4% to 6% range. We've outrun that for quite some time. We expect we probably will for a while because of rate and because of our ability to recruit physicians and move sub disproportionately. But that case rate feels about right.

I was also thinking about the productivity you're seeing from the newer cohorts. Can you provide some insights into where those productivity drivers are coming from in the cohorts you are onboarding?

I believe one important point to emphasize is how our Ambulatory Surgery Centers have naturally matured during the pandemic. We have become better at onboarding physicians more quickly, helping them secure the blocks of time they need, and increasing their comfort levels, especially as they see their peers being recruited. Looking back to 2018 when we began this journey, it took a long time for a physician to not only join our facility but also to gradually increase their case load from a few cases a month to eventually reaching full capacity. However, that maturation process has significantly shortened in recent years. This change is largely due to our track record of safely performing procedures, the communication among peers highlighting the value of joining us, and our improved scheduling capabilities. We've mastered the scheduling aspect in our facilities, allowing us to provide the necessary block time to new recruits right from the start, enabling them to contribute much sooner than before. Additionally, the ongoing impact of COVID variants continues to affect the acute care environment, leading to frustrations for many doctors as surgeries are postponed. This situation reinforces the stability we offer, presenting an opportunity for physicians to work effectively with us.

The next question we have is from Whit Mayo with SVB Securities.

Just a couple clarifications here. Wayne, I think you said earlier that you expect $100 million of cash flow next year. I just want to make sure that we're defining that. Are you saying the internal expectations for $100 million of free cash flow after cash NCI, after CapEx? Just how are you defining that $100 million?

Yes. No, just as you said, we expect $100-plus million even after CapEx and our core investments of free cash flow that can be deployed for M&A.

Okay. Pure discretionary free cash flow. Okay. Great. And Dave, what was the bank-defined EBITDA in the second quarter? I think you said leverage was 6x, but I may have misheard you.

No. You heard correctly. We are at 6.0x this quarter, which aligns with our guidance. Our calculation of credit agreement EBITDA, as mentioned in our press release, was just under $440 million, slightly higher than what we reported in the first quarter, mainly due to the acquisitions we completed.

Can you provide an update on some of the acquisitions in the last six months? I understand the organic numbers, and people should consider the sequential growth in light of the high numbers from last year. However, the M&A activity seems to be less than I expected. If you could update us on that and also on Idaho Falls, I would appreciate it.

Yes, we're quite satisfied with our progress in M&A. I want to emphasize that with the ValueHealth arrangement, we find it compelling as we can selectively invest in facilities where we can take over management. Initially, we hold a minority interest, but this gives us the flexibility to demonstrate the value we bring as SP and gradually increase our stake. This approach means that, in the short term, you may not see the usual revenue increase from M&A due to the lack of consolidation, but the EBITDA is present. The multiples are very attractive, even below our typical 7x multiples. It's important to note that these figures are on a trailing 12-month basis and not adjusted for synergies. We are optimistic about our pipeline, though we are being more selective given the significant opportunity with the ValueHealth assets, comparing those to external assets where we can gain immediate control. Generally, assets with immediate control come at a higher multiple. However, we have no concerns about our pace. Currently, we have an LOI for over $100 million in progress, and I am confident we can achieve our $200 million target this year. Our ability to adapt our strategy as we move into the final quarter and the new year will depend on the quality of the assets we are considering, but there are no delays from our side, and the activity is quite strong.

Yes. Regarding Idaho Falls, I want to emphasize that we still have strong confidence in that market. It's exceeding our expectations this year from the hospital perspective at the community hospital. We've continually observed improvements, particularly after the delayed opening during the pandemic. We've successfully added many of the programs we planned, including a Trauma Center and NICU capabilities. This market has been very promising for us for a long time, and it is currently performing exceptionally well, approaching the levels we've anticipated for our credit agreement EBITDA. Additionally, referring back to Wayne's earlier remarks, we've discussed ValueHealth, and to date, we have completed seven existing and seven de novo transactions in the partnership. We're very pleased with the growth opportunities we've found together.

The next question we have is from Ben Hendrix from RBC Capital.

I would like to discuss the ValueHealth acquisitions and their alignment with the overall acuity spectrum and specialty focus. Additionally, could you provide insights on the vascular ASC and its potential to improve your position in the growing cardio market?

Yes. Regarding ValueHealth, their facilities generally handle a higher acuity level in orthopedics compared to ours. This company has been primarily focused on orthopedics. Therefore, what we're acquiring aligns well with our targeted specialties, especially in orthopedics and total joints. A significant aspect of this transaction is our strong alignment on high-end specialties, which also fits with their model of creating incentives for all stakeholders to shift business from acute care hospitals through their bundled approach. This alignment has worked out very effectively. Now, concerning your second question...

Moving past ValueHealth, we recently acquired a vascular center and have additional cardiology opportunities in our pipeline. Cardiologists and vascular surgeons show significant interest in entering this field. However, progress has been somewhat slow due to several challenges, as many of these doctors lack experience in this area and are often employed across the country. The vascular center we've acquired excites us, as it offers cardiovascular synergies in that market and ample capacity for expansion. We anticipate more similar opportunities ahead. The nature of these procedures is such that, similar to orthopedics, they yield higher acuity and greater net revenue, which we expect will lead to increased EBITDA potential. We are confident that we will be able to achieve more in these facilities on average. Our focus will continue to align closely with orthopedic procedures. We are genuinely thrilled about that center and have several more in the pipeline that align with it.

The next question we have is from Tao Qiu from Stifel.

The Medicare proposed rate growth was 2.7% in July. We've seen that the finalized rule allowed other providers who were probably 1% better. How do you feel about that maybe high 3% ASC payment when the final rule came out? How does that compare to your outlook of cost growth in the next year?

So this is Wayne. One thing I would highlight is we never quite know where these rates will finally fall. So we always plan for more of the worst-case scenario. So any time we see the rates improve between the preliminary versus final, that is a positive from our perspective as we think about how we build our plans for next year. That said, we're still in a very unique inflationary environment, and we don't plan to take our foot off the pedal just because the rates have improved. Because we really, really do believe this has some sustainability to it in the near term, as we've seen some of our peers have to manage through. It's why we will continue to put a lot of aggressive behaviors on how we control those costs, both around implant costs as well as just our broad G&A and our labor costs. So we're pleased to see the rates improve. We're always pleased with that. But we always prepare for more of the preliminary level as being a more worst-case scenario.

Got you, Wayne. Second question is probably for Dave. The capital market has changed decidedly in the second quarter. And we saw that some of the leverage names were kind of on our favor. You mentioned earlier that you're still confident on your existing capital deployment plans. I remember that you raised some equity last year, maybe in the $30-ish level. How do you feel about your leverage today? And would you be more comfortable coming to the market at some point?

I want to highlight our strong balance sheet. I agree that the market appears unstable right now, which has been true for many, not just Surgery Partners. However, we don't need to enter the market at this time. We view the current market as an opportunity. Our strong cash position and robust support from our revolver give us confidence. As Wayne noted earlier, our ability to consistently turn earnings into cash enables us to navigate this situation effectively.

Got you. So the plan is to delever through growth.

Yes, or remain kind of in that 5x to 6x range, which we think we're comfortable with. If the disciplined approach to M&A that we have continues to deliver equity value compared to the price that we're paying, we will always look at those levers that are out there. So right now, we're not changing kind of our view of upper 5s, low 6s for that leverage rate.

The last question we have is from Sarah James from Barclays.

I wanted to go back to your earlier comments on the commitment to robotics purchases and how it fits into your strategy. Can you give us some comparison on how your robotics investment ROI compared to like M&A or other uses of...? When we look at your CapEx, how much of that is actually going towards robotics?

Thanks for your question, Sarah. I'll let Dave provide some specifics on how we manage these arrangements. I can mention that many of these are funded locally, and we don't invest heavily in capital expenditures for them. The return and payoff are quite strong. I would say the ROI from internal investments in same-store growth is better than any other options available to us. Therefore, when we identify those opportunities, they are our top priority for funding. It's important to note that when we utilize robotics, it's quite different from my experiences in acute care. In that setting, robotics often serve to maintain procedures as we transition from open surgeries. However, for us, it's an offensive strategy. We have a group of physicians who want to be in the ASC unit, and they might already be sending us cases, but they would increase that volume if we had the right technology. Consequently, we're leveraging this to enhance our operations, providing a significant net gain for our model. We are not shifting existing cases to higher-cost technology but rather opening up avenues for more advanced technology. We've made substantial progress in orthopedics and have our first center with a robotics program at the ASC level, which we expect to expand over time. Payers are becoming more receptive to the idea that we shouldn't conduct patient procedures in higher-cost environments simply due to the technology being used. We are collaborating with payers and others to address this challenge to ensure patients receive care at the most appropriate and cost-effective settings. This represents a continuous investment opportunity for us. Our primary focus has been on organic growth, and over the past few years, we've identified ways to expand within our existing facilities, which offers us the best returns. Dave, would you like to add anything about our approach?

Yes, I believe Eric's description aligns perfectly with our return on investment perspective. To support our recruiting efforts, we have continued to implement this strategy as needed. Last year, we introduced nine robots into our operations, and this year, we are adding four more. Our ROI analysis is supported by the improvements made by our recruiting team. We have strong confidence in our communication with recruited physicians, and we have good visibility into their backgrounds, which reinforces our confidence in the ROI. Additionally, advancements in robotics allow us to acquire these tools at a rapid pace and at a facility-level leasing cost, which makes us optimistic about this growth opportunity.

That's helpful. And let's go one level deeper. You mentioned the Da Vinci, but you also mentioned that there's other robotics that if you have them, surgeries could actually switch from inpatient acute to your centers. Can you give us an idea of what those are, of what the specific specialties are or robotics that are allowing you to recruit new surgeons and surgeries?

Sure. There are many systems available, and we utilize most of them. In the field of orthopedics, for example, we work with various vendors, depending on physician preferences and their training backgrounds. Physicians who have performed total joints primarily in hospitals are now feeling more at ease transitioning to the ASC setting when they have experience with robotic systems. The same applies to the Da Vinci system, which encompasses service lines such as gynecology, urology, and general surgery; these surgeons have received extensive training on Da Vinci and often use it as their main procedure method. We see a significant opportunity here in ensuring that outpatient surgeries can be performed in facilities offering better value to patients. While I mentioned three specialties, orthopedics and spine are additional areas where robotics play a role. We recognize a substantial opportunity because many outpatient procedures currently take place in inpatient settings due to technology constraints. We remain committed to empowering physicians to direct patients to the most suitable environments while maintaining high quality and excellent customer experiences. I would like to take this moment to express gratitude for the dedication of our 11,000 colleagues and 4,800 physicians nationwide. Surgery Partners is committed to providing the optimal environment for our physicians to deliver surgical care and ensure an exceptional patient experience. Each year, over 600,000 patients choose us during what is often a vulnerable time in their lives. I am honored to collaborate with these professionals as we strive to fulfill Surgery Partners' mission to improve patient quality of life through collaboration. Thank you all for participating in our call this morning, and I wish you a wonderful day.

Thank you. Ladies and gentlemen, that concludes today's conference. You may now disconnect your lines at this time. Thank you for your participation.