Surgery Partners, Inc. (SGRY) March 2026 Conference Transcript

Welcome back to the Barclays Global Healthcare Conference. My name is Andrew Mock. I'm the Facilities and Managed Care Analyst here at Barclays. And pleased to welcome on stage Surgery Partners CEO, Eric Evans. Eric, welcome. Eric, you framed 2025 as a tale of two halves with solid momentum in the first half, giving way to headwinds in the second half. So to start, can you talk about what changed over the course of the year, both at the macro level and at the facility level, and it would be helpful to highlight some of the actions you're taking to tighten execution as you move into 2026.

Sure, and I guess before I get started, since my CFO is not with me up here on the stage today, I'll just remind everyone that I'll be making forward-looking statements in our risk factors and gap reconciliations are in our 10K. So yeah, no, I think that is the way I framed the year. You know, we had a really solid start to the year. Second half of the year fell short of expectations, really a couple things happened. As you guys may recall in our Q3 call, we had started to see in the third quarter going into the fourth quarter, softer volumes than we expected. I think if you looked at our volumes overall, they compared pretty well to peers, but they were below our expectations and some paramix pressure. As you guys know, in our business, fourth quarter is an all-important quarter where you typically see a pretty big flip in paramix, particularly in our surgical hospitals. And we had noted that that really wasn't happening at the pace we had seen historically so we noted that in the third quarter we adjusted for that if you'll recall we adjusted for two things one is timing of m&a which we'll talk about later we're changing our approach on guidance there the second was this kind of softer volume a little bit a little bit weaker pair mix and then what changed in the back half of the year mostly that was correct so if I think about big picture let's talk about we were a little softer on our mix a little softer on volume and really that had a lot to do with our position transitions this year. You guys know we recruit on average somewhere around 700 new docs a year into our facilities. In any given month, that represents something around 10% of our business. And we can look at every cohort and we track very closely what that pair mix looks like. And last year, the new docs we brought in definitely skewed higher government. Some of that's transition timing, right? We got to try to marry that up as well, as good as we can. And some of that was just the mix of doctors this year that retired and departed. And so that put pressure we weren't really expecting in the big picture. That particularly affected the national group. The national group is our surgical hospitals. Our surgical hospitals tend to be in marketplaces where we're actually recruiting in new to market docs. And you can imagine those kind of transitions take a bit longer. And so big picture, we had that pressure that also then affected our expenses when it came to anesthesia coverage. And so we'll talk about that a little bit later. Beyond that, so that's big picture beyond that um so fourth quarter we did hit our consensus revenue uh but we did not get there on the bottom line and we there's really three markets that accounted for that um if you look back over the six years i've been with the company we've had just an amazingly consistent payer mix so we haven't seen these shifts and if you're anything like me the first time i started seeing these mixed shifts the first question i had the data must be wrong right because things just don't move this quickly so i will admit that can raise some skepticism but we spent a lot of time kind of looking about what happened to us. And there were really three markets that explained the entire miss on the bottom line. And I'll just spend a second kind of walking through those three different stories. In one market, we really had a change in competitor dynamics. So we had a marketplace where we compete with two large integrated nonprofit systems. When I say integrated employment models, closed systems that had been moving away and pushing out and canceling MA contracts, where the lone independent kind of surgical facility, along with an independent primary care base. And we didn't react fast enough to the fact that we were the MA access point and that we were not doing a good enough job of saving capacity for commercial patients. And when you think about that, it may sound simple, but keep in mind, our physician partners are not employed by us. And the primary care base is not employed by us. And so some of this stuff is coordination that we're going to have to tighten up when you look at Paramix. Again, it's in the six years I've been here, we haven't had that dynamic change. So that was one market that we, you know, I would say that's not going to be an overnight thing. We did not expect that to bounce back overnight, but we are going to go work on that. That's a marketplace where we've consistently earned and taken commercial market share. We've got the best value product. We've got great physicians. And so I have every expectation we'll recover that over time. The second market is an anomaly that I still struggle with. We had a market where we grew our high acuity procedures by 18%. If you would have told me in this market, we're the leading market share provider of orthopedics and a relatively good-sized MSA. If you had told me we grew high acuity procedures by 18%, I'd say we had a fantastic quarter. Unfortunately, in that particular marketplace, all of that growth was Medicare. And that's the only market, and I'll point out, we don't have a lot of exchange patients. Exchange patients tend to access the healthcare system through the ER, and we are primarily an elective business, and so we don't tend to get a lot of exchange patients. In this particular market, we did have exchange pressure with the Affordable Care Act subsidies going away for the exchange patients. And so within our commercial base, we also had pressure. So I had a market that grew 18% on high acuity patients that actually had less net revenue with 18% more cases. I'll come back to that. You can imagine our physicians had a lot of questions around working that hard and not seeing that come through their dividends. The good news about our business is we are perfectly connected. And then the third market was a rule market where it really was about physician transitions. We had some retirement timing around new recruits that didn't match up particularly well. We also had some docs that were out for personal reasons. And the fact that I'm up here talking about a handful of docs is probably surprising. But in a rule market that's that big can have a big impact. And those physicians are already back.

So there's a mix of reasons in there.

Those three markets really drove the entire difference on the earnings line. We feel like we've ring-fenced it. The question that I talked to you about is what are we going to do about it? First and foremost, those specialists we sit with every day, and they look at the fourth quarter and say, my margins were compressed. I'm going to get my lower dividends. We have a real opportunity to talk to them about a bunch of things. So number one is taking out cost. So we are already, we've been actively taking out costs, getting more efficient. These surgical hospitals, if any of you have been to them, these are the facilities you would want to go to get care. It's where you'd send your grandparents. These are kind of our physicians built their Taj Mahal, I would say, in many ways. These are really high patient experience facilities, often the top 5% in the country, great outcomes. And, you know, when things are going really well, physicians, they tend to want to have a little extra staffing. They don't want to be pushed on their physician preference items. And, you know, if you're growing and you've got great margins and you can have a great case, you'd probably get a little more leeway. Those doctors that have felt the pressure, we've got their attention that the pair mix has changed. we have to do some things on cost, we have to change our approach on anesthesia. So if you think about anesthesia coverage, you know, we have obviously a payment difference between commercial and Medicare that's pretty large. Anesthesia, it's three to four times, right? And so for anesthesia, you know, we had subsidies in place that were higher because of that mix. The doctors are now more aware of that. I would just say on the anesthesia point, often physicians don't want to move away from an MDA model. They don't want to move away from the coverage they're used to on flip rooms unless they have to, unless there's a compelling reason. And we now have a compelling reason. So we've taken action on cost. In those markets, we've made some leadership changes. Clearly, these are dynamics we need to make sure we react to quickly. So I'm excited about also our new chief operating officer that we've added to the company, Justin Oppenheimer, who's very, very focused on these dynamics. And then thirdly, we are very focused on working with our physician partners on having access in those offices to commercial patients, making sure we're really, really focused, not just at our level, because I do think ultimately, while we don't control those offices, our positions do care deeply about competing for those patients, and we're very, very focused on that. So, you know, we leave that 2025 headed to 2026, you know, in a position where we feel like we've put together, you know, a great plan, a conservative plan for this year that we're excited about for 2026.

Great. Eric, one point I wanted to clarify was that, you know, total of case volumes came in below expectations. There were some payer mix issues in the quarter that you just noted, yet you still exceeded the high end of revenue guidance. You know, how does that happen? How should we reconcile those events?

Yeah, no, it's very frustrating. I mean, I'm going to go back to we had really, really strong acuity growth. So we pointed out in the quarter versus a very tough comp from the prior year, we grew total joints by 15%. So we created tremendous value for the health care system. Unfortunately, we didn't capture enough of that because of the mix of patients, right? So it certainly was an acuity story. I'm proud of the team and our focus on orthopedics, particularly on high acuity cases, both total joint and spine. So it was an acuity case where you're getting to the top line, but because of the mix of patients, your bottom line was impacted both by the fact that you're getting lower reimbursement and also by the need to subsidize anesthesiology.

Understood. While some of the issues you described earlier seem transitory in nature, you know, things like the ACA exchange crowding out, physician time off, others may take time to address, you know, things like competitive dynamics, physician turnover. So from a guidance standpoint, can you help us understand what's already expected to rebound and what would represent, you know, potential upside?

Yeah, so I'll start with we did not assume it's just going to bounce back, right? So our guidance takes into account the current trend. You know, there are some things that will come back immediately, physicians that were gone that we know are back already for personal reasons. Certainly the one-time HIX pressure with the subsidies going away, we don't expect that to happen again. But other things like the dynamics around MA and commercial access, those will take time in coordination with our independent physician base. So from a guidance standpoint, we did not expect and did not guide to a number that would bounce back to where we were. We accepted kind of where we landed, allowed for a little bit of room on the trend to continue, but we have offset that with obviously cost actions. You know, I look back, I want to remind everyone. Our surgical hospitals are very highly managed care mix facilities. So if you compare it to a traditional acute care hospital, you know, we're running 50% managed care. It's a very, these are great pair mixed places. So I want to make sure despite the pressures we've had, these are facilities we're really excited about and they're great, great parts of our organization. And so when we think about our ability to go compete for commercial lives, we're higher value. We have outstanding patient service. We've got independent physicians who are highly motivated to provide great care for patients. So we think we're well positioned to maintain and build that back, but we did not assume that we're going to get back there overnight, and we did let some of that bleed through into 2026.

Sticking with guidance, you've taken a more conservative approach to 2026 guidance by excluding unannounced M&A, even as your capital deployment targets of at least $200 million remain unchanged. Can you walk us through the thinking behind that shift and how you're balancing conservatism and guidance with confidence in capital deployment.

For sure. I think back, I'm going into year seven, it's hard to believe. I think back when I joined this company, we, I think, rightfully have included M&A in our guidance because it's a big part of our story, right? We're in a very fragmented industry. There's over 12,000 ASCs, half of which are Medicare licensed, half of which are not. There's not that many players of scale. We think we're well positioned to be a consolidator. We feel good about that. it's a big part of our story and I think for many years it worked quite well for us over the last several years I mean as you guys know timing on M&A can be quite fickle we had one year where we were way above our target and that ended up with extra costs associated with integrating all those which which created issues for us we had another year we finished below that and we missed guidance because we didn't just just because of M&A timing and then of course this year I mean we ended up the year close to our 200 million dollar target but it was very back-end loaded and I think just Just from the purpose of Dave and I both want to be a meat and meat company. We have historically been that. We don't want to find ourselves again where we were sitting for the Q4 situation this year. We thought it was prudent just to say, you know what, our target hasn't changed. We still want to do 200 million plus of M&A, but we want that to be additive and not something that is built into guidance in quite the same way. We did a lot of research on growth companies in the marketplace, and we think this is certainly the most prudent approach going forward. understood.

Last Friday, the BLS released a weak jobs report with negative February headline numbers and downward revisions to prior months. Commercial mix is a meaningful part of your business, which leads to strong reimbursement, but also introduces economic sensitivity. So can you speak to the changes in employment trends and consumer confidence on commercial mix or utilization? And how are you positioning the business in the event of a broader slowdown in employment?

Yeah, I mean, I think we're all reading the same jobs reports, right? In our local markets, we haven't seen a tremendous change in employment, but I've been in the business long enough. I think for those of you who are here the last time we had potential economic uncertainty and the rapid increase outside of COVID, the financial crisis, it actually led to an increase in procedures. Patients who, you know, if you recall, they were worried about getting it done while they still had care before they got, you know, before COBRA ran out. And so you actually saw a spike the last time you had this. I don't know that that'd be the case today. You've obviously you've got the exchanges, you've got more safety nets. But historically, that has not been a huge headwind for us. Clearly, you know, I think that one of the benefits of our business model is we don't have the downside exposure that traditional acute care does to a payer-mixed change, meaning we're not going to see uninsured, we're not going to see Medicaid's a very small part of our business. So, payer-mixed deterioration is not going to be an issue. We're not really exposed to that. From the commercial side, even in a world where there might be less covered lives, I'm going to go back to my point we feel like we're really well positioned being a value player right if you think about across our portfolio 40 to 60 percent cheaper uh when you think about our procedures really great service really great quality so in an economic position where people are really concerned about paying for it where the health care system needs savings we think we're well positioned there um and uh you know look again it's hard to predict what exactly happens because sometimes it's counterintuitive uh the only other thing i'd mention is the procedures we do think about, you know, 50% of our business is MSK, knees, hips, cataracts, GI procedures. Most of those things, you might be able to put off a, you know, a bad knee or cataract for a while, but they're not, elective is probably not the right term over the long term. So there's pretty, you know, pretty strong demand and there's a timeframe around those. So we don't see that as a huge headwind for us. And if it does happen, we think because of our value position, we're extremely well-positioned.

Great. Let's move on to some of your portfolio optimization efforts. Surgical hospitals have always been an important and strategic part of your business, right? So can you help us understand the current exposure to surgical hospitals within the portfolio and the rationale for exploring divestitures now?

Of course. So let me start by saying I love surgical hospitals. There's only 240 or so of them in the U.S. There won't be any more that are physician-owned. These are JV physician hospitals, pre-moratorium. What's amazing about these assets is they allow us to have physician partnership across the acuity spectrum. So almost all of our surgical hospitals have ASCs, an ASC network we've built around them, because we can't expand these hospitals, right? They're a unique asset. They're a set moment in time, and the idea with our physician partners is let's keep their higher acuity patients in a facility they own and can have control of the quality, have control of the experience, and then let's decant ourselves and build ASCs to pull that lower acuity stuff out. So we love the model. Surgical hospitals in general have pair mix that's very similar to ASCs. The traditional surgical hospital, just so you guys can picture it, 10 ORs, 15 beds, right? May or may not have an ER. A lot of them don't. A few do. Even if they have an ER, not a very busy ER, right? So pair mix and procedural mix that looks a lot like an ASC. So we really, really like them. Now, with that said, going to portfolio optimization, one of the points of feedback we've had over the last several years is we do have a few markets that go beyond just short-stay surgical, right? So these are markets where there are still attractive markets, but we've expanded beyond that core ethos. And we hear from our investors, gosh, we really love the short-stay surgery space. We would like you to be even more pure play, right? That's one thing we've heard. The second thing we've heard is we'd like you to de-lever faster. We'd like you to drive free cash flow faster. And so what led to the portfolio optimization work is we think there's an opportunity to do all of those things, right? So we have a handful of facilities, let's call it less than five, that are meaningful in size, that are material, that tend to have higher debt loads, right? These are bigger facilities, like our ASCs. They're not as easy to move or just expand. You're going to be in that facility for a while. They tend to have finance leases that goes on the books as debt. They tend to have a lower free cash flow conversion, a little higher cash needs than our typical short-stay surgical business. So the whole goal here is making moves that lower our leverage, increase our free cash flow conversion, increase our growth profile going forward. And as we said on the call, we're in advanced discussions in one of those markets that's meaningful. And we would hope to kind of our goal would be to address all of those opportunities within the year so do you think it's meaningful for investors and again we we understand that there's a real need for us to de-lever faster and drive free cash flow in the business and we think this is an opportunity to do that right and the board also authorized a repurchase program which gives you some optionality for capital allocation could you see the company buying back shares in advance of a hospital transaction or is the thinking that the authorization will give you flexibility soon after receiving those proceeds? Yeah, it's a great question. There's certainly nothing that keeps us from buying shares in advance. I would say you should read a couple things into the board's decision, to our decision to approve a shareholder buyback of a reasonable size, a couple hundred million dollars. One is that's a pretty good sign that we think we're going to have funds coming in from portfolio optimization, right? Because the idea, we know we have to do lever. There's no plans to lever up to buy back shares. So that should be a sign, I think, of the confidence we have in our portfolio optimization work. I think secondly, we're really disciplined around how we think about capital allocation, right? The cheaper, I mean, our share, obviously everybody believes this, but we believe our shares are certainly undervalued with where they sit today. And as we look at that cost of shares, we compare that to our other options, right? Deleveraging, M&A, we have a very attractive M&A profile, typically can buy at eight times or less, take a turn off within 12 months. So from a capital allocation standpoint, we want to make sure we have all those levers at our disposal, and we will be opportunistic, right? If it's the right use of capital that's most accretive for our shareholders to create shareholder value, we'll go after it.

Great. Maybe moving on to some of the policy items. Site-neutral payment has been an ongoing conversation in Washington. If hospital outpatient reimbursement were to move closer to ASC rates for similar procedures, how do you ensure that ASCs continue to differentiate and retain their value proposition?

Yeah, so first of all, let me just say from site neutrality in general, it's like it's basically the whole thesis of our company, right? Which is we believe care should be delivered in the right place at the right time at the right cost. So, again, our sites of care, even our surgical hospitals, we typically don't have health system partners in those. And we're, you know, 30 percent cheaper than traditional acute care. So we are deep believers in site of care and site neutrality as far as being part of the answer. with that said i i think that even if you had site neutrality on the medicare side there's so much cross subsidy that happens with the commercial side it's hard to imagine it's hard to imagine a world where you could move those payments fast enough to actually cause a real true difference so number one i think it's unlikely you get that kind of overall payer pressure on an asc with ascs being 40 to 60 percent cheaper already I don't think there's I don't think that's going to be a cost competitive fight the other thing I would say and people people who are close to the ASCs in our surgical hospitals would know this but if you survey physicians like why are they invested in our ASCs why do they come to our places yes yes there's a financial impact but that's not number one on their list number one is convenient block time that's not disrupted right do they have control of their day and look having rent having run big surgical hospitals my life it's almost impossible when you have busy ER and you're running, you're trying to be all things to all people, it's almost impossible to be as efficient as we can be in our surgical facilities, right? So they're time machines for physicians. Physicians don't have a lot of time. They want to get six procedures done in the morning and they want to go to their office and not have to cancel it. That doesn't happen very well in the acute care setting. So outside of the issue around price, these are time machines that are great for their lifestyle. They also like to have a voice. You know, I've run hospitals that have a couple thousand docs on the medical staff. For me to say that any individual doc actually has a say is not really truthful right in our surgical facilities we're trying to do a few things do them exceptionally well and our docs really do have a voice those two things matter a lot we allow physicians to stay independent by giving them another source of income that's certainly part of it so there's there's the price difference which is meaningful and i i don't think actually that bridge can be i don't think that can be bridged uh given the cross subsidy requirements of the acute care space. But even further, it's really just about physician's efficiency and time.

Right. Another disruptive policy item ongoing is the expiration of enhanced ACA subsidies. I know the ACA is a relatively small part of your overall mix, which is why I found it somewhat surprising that an isolated incident inside one of your surgical hospitals could contribute towards the fourth quarter miss. So maybe help us understand what's going on there. Is the mix of ACA procedures just different from a typical commercial patient, or are the reimbursement differentials that significant?

Yeah, so it's kind of a combination of all those things. I think, again, most of our business is not through an ER. We don't have ERs at over half our cervical hospitals. Obviously, our ASCs are completely elective. And so that flow of referrals tends to be a different flow than HIX or exchange patients. A lot of those patients do access the healthcare system through an ER in a more emergent way. That's one of the reasons. And then, honestly, our facilities and physicians have never really had that connection, so we haven't had a ton of that business. It was really a state-driven thing. You know, in the market, we were talking about pretty big MSA. We're 40% of the market. And I think as these patients realized they were up against the deadline, there were so many of them, that it did impact what came into the offices. And interestingly enough, when you think about exchange patients, they often come in under some kind of commercial plan. And so I don't think that our offices, our independent physician offices, were always sophisticated enough to realize that this commercial patient is not a commercial patient is not a commercial patient. In our world, when you think about exchange patients, they pay very, very close to Medicare versus commercial. And so I do think that was, and again, it's one market. Big picture, just like Medicaid is less than 4% of our business, HIX is a very small percent of our business. but in that particular market was meaningful in the fourth quarter.

And maybe circling back to one of the cost items we talked about earlier, you've highlighted a linkage between labor and anesthesia costs and shifts in government payer mix. Can you walk us through that relationship in more detail and explain how changes to payer mix translate to higher anesthesia costs?

I gave a little detailed answer on this earlier, but just a reminder, anesthesiologists have not had an increase from Medicare pay increase for a long long time. They've had a lot of challenges obviously on reimbursement with the No Surprises Act and look depending on who you talk to there's no there's no tear shed for anesthesiologists based on their payment but it's been a real challenge on having enough capacity both for MD anesthesiologists and CRNAs. Going back to my earlier comment the way when I ran big hospitals the way I'd bring my anesthesia subsidy down was to allow them to get the coverage of ASCs in surgical hospitals. So, you know, we have a preferred side of care. Even with that, there's such a challenge on capacity that in order to ensure we have coverage, we often do have to enter into agreements that say there's going to be some kind of minimum collections to cover their expenses. For the most part, what's, well, let me back up a couple of interesting points on anesthesiology. You guys may all know this. I find it fascinating. Anesthesiologists do really well in lower acuity ASC. So think about GI only centers, ophthalmology. Those are fantastic places for anesthesiologists. They love them because of what they're paid, because of the mix of patients, because of their efficiency. Unfortunately, it's not quite as good on orthopedics, which is where our focus is, right? So you have a mismatch of our economics and their economics that sometimes flows through. And then when you get into the pay rate differences, they're probably one of the most exposed specialties on just how different. I think their Medicare rate is something like $22 a unit. And it's, you know, easily three to five times higher on commercial. And so that difference creates, you know, you can imagine if you're in a 70% Medicare facility versus a 30% Medicare facility, I mean, your revenue is dramatically swinging. And so they have choices on where to go. We often have to enter into agreements that give them some kind of collections guarantee. And when we see swings, it not only does it hurt our revenue and increase kind of our cost statistics as a percent of revenue but it requires then that we subsidize anesthesia coverage in a way that sometimes is counterintuitive right understood well with that we're out of time so eric thank you so much for joining today please enjoy the rest of the conference