Surgery Partners, Inc.

Good morning and welcome to the Surgery Partners second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dave Dougherty, CFO, please go ahead.

Good morning. My name is Dave Doherty, CFO of Surgery Partners, and I'm here with our CEO, Eric Evans, and our Executive Chairman, Wayne Devite. Thank you for joining us for our second quarter 2023 earnings announcement. During our call, we will make forward-looking statements. There are risk factors that could cause future results to be materially different from these statements. These risk factors are described in this morning's press release and the reports we file with the SEC, each of which are available on our website at surgerypartners.com. The company does not undertake any duty to update these forward-looking statements. In addition, we will reference certain financial measures that are considered non-GAAP, which we believe can be useful in evaluating our performance. The presentation of this information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. These measures are reconciled to the most applicable gap measure in this morning's press release. With that, I'll turn the call over to Wayne. Wayne?

Thank you, Dave. Good morning, and thank you all for joining us today. We are pleased to report another quarter of strong top-line revenue of $667.6 million and adjusted EBITDA of $100.2 million, both of which exceeded our expectations, inclusive of the cyber headwind that occurred in the quarter. Before we dive into our financial results, I want to remind everyone that in late May, a few of our facilities in Idaho were impacted by a cyber event. Out of an abundance of caution, we immediately enacted a well-rehearsed business continuity plan designed to help protect our patients, key stakeholders, and the integrity of our IT environment. This deliberate process was completed within the month of June, and all activities in these facilities have returned to normal. Throughout the event, we continued to safely care for patients, albeit with capacity constraints associated with downtime protocols. The team's proactive reaction mitigated the impact, which we estimate to have reduced revenue by approximately $8 million. While we anticipate insurance recoveries, our financial highlights related to consolidated revenue, margins, and same facility metrics are inclusive of this $8 million revenue headwind. Despite the impact of the cyber headwind, both our revenue and adjusted EBITDA exceeded our expectations for the quarter. Some highlights. Net revenue was $667.6 million, nearly 8.5% more than the prior year, with same facility revenue growth of 8.3%. We estimate same facility revenue growth would have grown approximately 10% normalizing for the impact of the event I just described. Adjusted EBITDA was $100.2 million. representing 16.4% growth year over year. Adjusted EBITDA margins improved 100 basis points over the prior year and 150 basis points sequentially to 15%. For our consolidated and unconsolidated facilities, we performed over 155,000 and 23,000 surgical cases, respectively, representing case growth of 5% over the prior year. Our surgical case growth continues to show resilience in both the pandemic and macroinflationary environment, Since 2019, our same facility cases have posted a 3.2% growth per year. Finally, we deployed approximately 60 million acquiring ownership interests in new and existing facilities, opened one new de novo, and announced a new three-way partnership with Methodist Health System. And our pipeline for each of these development areas remains robust. Eric will provide more detail in his remarks. We continue to be pleased with our balanced approach to growth, with all pillars of our long-term growth algorithm either exceeding or meeting our expectations. Based on the strength of our second quarter results and our continued positive outlook related to our numerous investments in the business, we are raising our full-year adjusted EBITDA guidance to greater than $435 million and are maintaining our revenue outlook of at least $2.75 billion. This refreshed outlook is inclusive of the impact related to the cyber event. Dave will discuss our guidance in more detail later in the call. With that, let me turn the call over to Eric to highlight some of our operational initiatives and recent investment activities. Eric?

Thanks, Wayne, and good morning, everyone. Consistent and predictable growth has defined our performance over the past five years, and these trends continue with our second quarter results. From an operational perspective, our specialty case mix is right where we expected it to be, and volume was in line with our expectations, with over 155,000 consolidated surgical cases in the quarter, despite the disruption in our Idaho Falls facilities. Our non-consolidated facilities, which are an increasing part of our portfolio, slightly exceeded our expectations with over 23,000 cases. Since 2019, each of our specialties and subspecialties have experienced growth consistent with or exceeding our long-term growth expectations. To put a finer point on this, since early 2022, all of our specialties recovered from the pandemic with strong growth rates throughout the year. In the quarter, our same facility growth was 2.3% when compared to the second quarter of 2022, and net revenue growth per case was 5.8%. Adjusting for the disruption in Idaho Falls, our same facility case volume was approximately 3% and same facility revenue was approximately 10%. Of note, we did not have any unusual factors affecting last year or this year's case volume or mix other than the previously discussed cyber event. We expect to continue to see both volume and rate growth in excess of our long-term guidance algorithm through 2023 due to the strength of our physician recruiting and case mix. On the recruiting front, Our various initiatives continue to drive strong year-over-year growth, fueling growth in MSK procedures, particularly total joint cases in our ASCs. We performed approximately 26,000 orthopedic procedures this quarter, and the volume of total joint surgeries that shifted into our ASCs increased by 73%. We do not expect the shift of these orthopedic and eventually cardiac procedures to slow down, and we will continue to position our portfolio to take advantage of this high-growth opportunity. Finally, labor and supply costs remains well under control, resulting in a 15% adjusted EBITDA margin in the quarter, which is 100 basis points of expansion compared to the prior year. Moving to capital deployment, in the second quarter, we deployed $60 million acquiring minority ownership interests in three facilities as we entered our third new strategic health system partnership this year to develop and manage new ASCs in the North Texas market and increasing our ownership position in two other facilities. These acquisitions, which increase our multi-specialty capacity, have an average purchase price multiple of less than eight times trailing 12-month earnings. This brings our year-to-date acquisition spend to $119 million. We are rapidly integrating these acquisitions into our operations and expect to yield further earnings from our operating system synergies in the first 12 to 18 months post-acquisition. We remain committed to our annual capital deployment goal of at least $200 million, plus the proceeds of any divestiture activity. Given the strength of our pipeline, we are confident we will meet or exceed this target. On the de novo front, since 2019, we have opened seven new ASC facilities and expect to have at least 15 additional de novos come online in the next 18 months. Many of these projects are slated to open in late 2023 or early 2024. These facilities include both consolidated majority-owned partnerships as well as minority interest unconsolidated partnerships. They include a mixture of two-way partnerships under development between us and physician partners and three-way partnerships with our new health system partners. We expect the pipeline to grow significantly over the next two years. Dave will shed more light on how we think about the financial performance of these unconsolidated facilities in his remarks, but needless to say, our growth in this area increases confidence in our long-term mid-teens growth expectations. Year-to-date, we have divested our interest in five facilities and expect to divest two to four additional facilities in the next six to 12 months. We fully anticipate that the aggregate proceeds from these divestitures will be redeployed at a lower multiple and will be accretive to future earnings. Finally, we announced this morning the third strategic partnership with the health system, Methodist Health System in Dallas, Texas. As I mentioned earlier, in conjunction with this partnership, we acquired minority interest in three of Methodist's existing surgical facilities. which we will also now manage. Similar to the partnerships with Intermountain Health and Ohio Health we announced last quarter, we will work with Methodist to acquire and or develop new ASCs in the fast-growing DFW Metroplex, capitalizing on the strong reputation and relationships that Methodist has earned in North Texas. We are working diligently with the development teams of all three of our new health system partners to identify and diligence new partnership opportunities. These facilities have the potential to deliver robust growth However, future earnings from acquisitions involving a minority interest will be reflected in equity earnings of unconsolidated affiliates rather than consolidated revenue and expenses. While decades of growth remain in our core business of two-way JVs with surgeons, Surgery Partners has emerged as a partner of choice for hospital systems revisiting their outpatient strategy. We are winning in this area because we are differentiated in our ability to consistently drive same-store facility growth through data-enabled physician recruiting, a rigorous and disciplined approach to facility management, including labor and supply costs, and more recently, our proven de novo capabilities at scale. Our deep operational excellence stands out. As our results demonstrate, our company has been built to capture the significant shift in side of care that the U.S. is experiencing, and together with our partners, we remain well positioned to deliver on our commitment of long-term mid-teens growth. With that said, I will turn the call over to Dave to provide additional color on our financial results as well as our 2023 outlook. Dave?

Thanks, Eric. My initial remarks will focus on our second quarter financial results before providing additional perspective on how we evaluate the performance of our full portfolio of consolidated and unconsolidated partnerships and the outlook for the remainder of the year. Starting with the top line, we performed over 155,000 surgical cases in the second quarter, which was 4.1% more than the prior year second quarter. These are only cases that are included in our consolidated revenue. If I include cases performed at non-consolidated facilities, we performed over 178,000 cases, representing 5% year-over-year growth. These cases spanned across all our specialties with an increasing focus on higher acuity procedures, which is reflected in our double-digit same-facility growth this quarter. The combined case growth in higher acuity specialties, specific managed care actions, and the continued impact of acquisitions supported revenue growth of 8.5% over the prior year. This growth was accomplished despite an $8 million impact associated with the cyber event and approximately $22 million of headwinds associated with divested facilities. As Eric highlighted, an increasing share of recent acquisitions include minority interest investments, which has been difficult for some of our stakeholders to model correctly, as the revenue of these investments is not included in our consolidated financial results. We benefit from growth in equity earnings, but it is difficult for many to assess the revenue associated with these earnings and the impact of our execution model. To add clarity, the second quarter revenue of the minority interest partnerships that is not reflected in consolidated revenue was $91 million, which was 32% higher than last year. Given the prior year acquisitions in such investments and our continued development and acquisitions of minority interest stakes, we expect growth in this revenue to accelerate over the next 12 to 18 months, which will correspond to an increase in equity earnings and affiliates in our results. We will continue to be agnostic to the accounting treatment of the assets we acquire. Our focus remains to acquire high-growth, high-quality assets aligned with our targeted specialties at highly accretive multiples. On a same facility basis, total revenue increased 8.3% in the second quarter, with case growth at 2.3%. Net revenue per case was 5.8% higher than last year, primarily driven by higher acuity procedures. If we adjust these statistics for the estimated impact of the cyber headwind, total revenue would have increased approximately 10%. We believe our second quarters of both 2022 and 2023 were stable periods with no unusual events such as backlogs, spikes in certain procedures, or other factors that would affect our year-over-year comparisons. Adjusted EBITDA was $100.2 million for the second quarter, giving us a margin of 15%, a 100 basis point improvement over last year, and in line with our expectations of continued margin expansion. Inflationary pressures related to labor and supply costs have moderated this year, and we have not seen a resurgence in COVID or other wide-scale illnesses, but we will remain vigilant in monitoring these factors across our portfolio. The cost of salaries, wages, and benefits, as well as our medical supplies costs as a percentage of revenue, were lower than the prior periods. As we noted in the past, we expect to produce at least $140 million of free cash flow in 2023. In the second quarter, we generated free cash flow of approximately $8 million, which was impacted by the delayed billing and collections related to the cyber event that Wayne mentioned. We do expect those billings to be caught up in the second half of the year. There were no other unusual items that affected this metric, and we remain confident in the ability to meet our target of at least $140 million in 2023. We ended the quarter with $177.4 million in consolidated cash and an untapped revolver of $546 million. When combined with the free cash flow we are generating, We believe our current and future liquidity positions us well in this macroeconomic environment while giving us flexibility to maintain our long-term acquisition posture of deploying at least $200 million per year for M&A. As a reminder, our corporate debt is less than $1.9 billion with an average fixed interest rate of 6.8%. Our second quarter ratio of total net debt to EBITDA as calculated under our credit agreement was 4.2 times. With the earnings growth we expect, we are confident this ratio will decline over the year. As we disclosed last quarter, we periodically divest of some of our facilities as part of our ongoing portfolio management efforts. Much like acquisition activity, the timing of these divestitures is difficult to predict. The timing of the divestitures completed a year today created a revenue headwind of over $100 million for 2023, prior to any redeployment of proceeds received. As noted, we also experienced the non-recurring revenue hit in the second quarter related to the cyber incident that is not projected to fully recover. That being said, based on the strength of our second quarter results and our refreshed outlook for the remainder of the year, we are reaffirming our full-year revenue guide of greater than $2.75 billion. While the timing of divestiture and acquisition activity is a challenge to predict, We believe our 2023 full year outlook reflects a conservative view. Carrying the momentum of our second quarter results, we remain optimistic and confident about the company's growth and are raising our outlook for 2023 adjusted EBITDA to greater than $435 million, representing at least 14% growth compared to 2022. As a reminder, our business has a natural seasonal pattern, largely driven by annual deductibles resetting for commercial payers that tend to skew our results lower in the second quarter and higher in the fourth, relatively speaking. We continue to anticipate the seasonal pattern of our results will be consistent with 2022, with third quarter adjusted EBITDA to be approximately 24% and revenue to be approximately 24.5% of our full year guidance. Our second quarter results speak to the strength of our operations, and our business model, and we believe that the balance of the year should continue to capitalize on that momentum. With that, I'd like to turn the call back over to the operator for questions. Operator?

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star and 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from the line of Jason Casorla with Citigroup. Please go ahead.

Great. Good morning. Thanks for taking my questions. Just to first start on a quick numbers question, you have that $6.5 million add-back to just an EBITDA account for the cybersecurity and divestitures. I guess what's the split between cyber and divestitures in that number? And I guess I'm a little confused on how divestitures are accounted for in your guidance, just given commentary, you know, for the $100 million revenue headwind, and there's been no implied add-back on divestitures from the first quarter. Just any help there around the treatment of that would be great to start. Thanks.

Yeah, thanks, Jason. I appreciate the question. It's Dave here. So, taking that in order, I would say a majority of that $6.5 million is the estimated impact of the cyber event that we had up in Idaho. And just as a reminder, as Wayne mentioned, that's predominantly all self-contained within the second quarter, more specifically in the month of June. So, Kind of one time in nature and something that we do expect in future periods to recover a large majority of, if not all of it, through our cyber insurance coverage that kind of sits out there. But accounting requires us to wait until that becomes recognized. So we put that out of adjusted earnings just to create some consistency. And, you know, the balance related to divested facilities is really the spillover of any earnings that happen post-divestiture. So there's a little bit of that that occurred inside the second quarter. It's not something that we expect to continue to occur.

Yeah, Jason, just to make sure we're clear, our top line includes all divestitures in it, as we've always said. Our bottom line does as well, but as Dave highlighted, we actually did add some small gain post those closing that we do not include in our run rate, and we actually bifurcate that out and put that below the line.

Got it. Okay, helpful there. And maybe just to follow up, Dave, to your commentary on the cash flow, the $30 million you've done year-to-date, obviously seasonality to consider for the typically strong fourth quarter, but can you just again walk us through the cash flow dynamics for the rest of the year and the trajectory of getting to that $140 million million of free cash flow just because it implies such a strong ramp. Just if any more color come and take a look, that would be helpful. Thanks.

Yeah, absolutely. And again, thanks for that question. This is the first year that the company has turned into a free cash flow positive company. We're very proud of that and still sitting behind our guide of $140 million. As we talked about in the first quarter, we did expect that to ramp consistently over the course of the year, partially due to contributions from prior acquisitions and from normal seasonality, and the absence of any unusual events, any unusual predictable events, I guess I could say, that we've had in years past, and the benefit of our retirement of nearly $800 nearly $600 million of debt at the end of the year last year, which generates $40 million of additional cash flow on lower interest rate payments. You know, the unfortunate reality is we did experience that cyber event. And again, as Wayne mentioned, we took steps on a proactive basis to kind of protect the organization, to protect patients, et cetera. And one of the side effects of that is a delay in billing and processing of as you can imagine, trying to be as protective as necessary in order to do so. We believe that created a headwind for us of approximately $20 million of cash coming into the organization. That's just timing in our view. That is, again, if we're back and fully up and running at the end of June, we expect all of those billings and the receipt of those billings to catch up for us inside the third and maybe a little bit into the fourth quarter. So our steady, slow ramp-up will benefit by a little bit of that timing issue between the second and the third quarter. And, again, we remain very confident in our ability to hit $140 million of free cash flow this year and the trajectory that gives us over the next few years to continue to kind of grow into a plus $200 million position in a couple years.

That's great. Thank you. Thank you.

Our next question comes from the line of Kevin Fishbeck with Bank of America. Please go ahead.

Kevin, your line is unmuted from our end.

If you can unmute from your end as well.

Sorry. Let's see. So it sounds like you guys are doing a lot more of the joint ventures. I was wondering, you talked about buying assets at less than eight times. You kind of talked about synergies and bringing those pro forma evaluations down over time. Is there a difference that we should be thinking about when something's within a JV versus something that is not within a JV? Is there more opportunity on those assets?

Hey, Kevin, good morning. This is Wayne. The way I would look at it means generally when you're buying a minority interest, the multiple is slightly more attractive than when you're buying a majority interest. That being said, In our case, we also then take over management. So unlike typical minority interest situations where you have more of a passive role, we take a very active role in that we will only do those investments if we are also then taking over management of the facilities. And so the real value create for us on the synergies is twofold. One is that we will get the synergies that we bring to the entity that we have a minority interest and will participate in those based on not only our ownership, but we will also get a management fee for those facilities. But in addition, the scale and volume of those minority interest investments will then get allayed across our broader book. So as you think about procurement or other items and how it really influences our ability to get synergies with even more scale. And as you know, the three partners that we are now start are quite substantial in scale and have a unique footprint. So as you think about synergies, it should allow us across our broader footprint albeit through the minority investment, to really have a positive influence on those synergies as well over time and then future acquisitions as well.

Okay, and just to make sure that I understand the adjustment that you're making for the cyber event to the same store revenue number, my assumption was that was really a volume delta. If we just took kind of your pro forma and your reported, the delta would be in the volume category. Is that right? I wasn't sure, though, if your slowdown in AR meant that some of it was going to show up in revenue per case.

Yeah, Kevin. So the math behind that would suggest it's both case and a little bit of rate as well. If you just kind of think about the nature of that facility up in Idaho, it is a surgical hospital as well as an acute care hospital. So you're going to get some higher acuity procedures. And so on balance, bringing those back into the fold is going to have an incremental benefit, especially the momentum that we were carrying going into the month of June in that facility. So a little bit of both that you see in that number. But as you can see from the adjustment that we've provided or the estimate that we've provided, it is a pretty big case impact that would push that 2.3 closer to 3. Okay. All right. Perfect.

Thank you.

Thank you. Our next question comes from the line of Gabby Taylor with Carbon. Please go ahead.

Hey, good morning. Thanks for taking the question. I wanted to go to the unconsolidated, you know, centers for a moment. I know in your commentary, you talk about wanting to make investments where you generate the highest return, and obviously that has, you know, impact on how the streets, you know, modeling consolidated revenue, et cetera. The non-consolidated revenue is up 30%. Talk to us a little bit about why the equity income is, you know, relatively flat in the quarter year over year and year to date. I'm sure that's because some of the facilities are newly ramping, but is there any way to sort of give us some insight into those 33 unconsolidated centers, you know, like how many are, profitable, how many are older than two years old, or some sort of metric that would give us a sense of what we should be looking for that equity income line to do in the back half or into 2024. Yeah.

Yeah. So you're absolutely right. The revenue impact that we're starting to see is from the ramp up that's occurring in those JPs. And as a reminder, Gary, last year, about a quarter of our acquisition spend related to minority interest owners or minority interest states, and many of those were in the de novo state or in the early kind of ramp-up state. A lot of those we opened up in the beginning last year, and as you noted in the second quarter here, we opened up two more, and those will continue to kind of add value to us. And you'll see that as those things ramp up over a, you know, from start to finish, a zero to 24-month kind of ramp up, sometimes a little bit accelerated with our health system partners. So you'll start to see those turn into an equity earnings perspective relative to the earnings growth that we see in there. And I believe over the future, as we kind of look at this, because you're absolutely right, the modeling of that growth on revenue, we feel good about it because as Wayne was kind of alluding to, we look at the full P&L kind of associated with these facilities, and we look for the growth in those JVs to be as strong as the rest of our consolidated book of business for the reasons that Wayne mentioned, the scale of operations and the provision of management services that we do. inside here. So you're going to see revenue kind of continue to grow at a pretty decent clip. We expect that 30% growth that we saw inside the second quarter year over year to accelerate as we go through the balance of the year. And that will turn into earnings growth as we go forward. I do believe we made this pretty clear when we were talking about last year's results. And as as we talked about first quarter acquisitions that involve minority interest stakes, that there was going to be a bit of a ramp up that we see inside there, in particular with the health system partners as those start. And we will see kind of marginal benefit inside 2023 with a bigger ramp growing into 2024.

Yeah, Gary, I think you hone in, though, on an important point. That's what I want to remind folks. We do not buy for Cade Alp. uh, the startup of our DeNovos. Uh, those are included in our adjusted EBITDA, meaning that when you initially open these things, they are not profitable. They ramp up fairly quickly over time then to a run rate profitability within 12 months. And then of course you start to get the real incremental lift thereafter. So maybe one of the things we can do prospectively, since we have so many new DeNovos coming on and provide a little more, uh, uh, clarity around, uh, how those are ramping. But, uh, we are actually very, very, um, very confident in our outlook and, uh, and in our long-term double-digit mid-teens growth rate.

Yeah. Just one other thing, Gary, that I should mention. We can talk about this a little bit more offline, but kind of the nuances of the accounting for equity method investments as opposed to our adjusted EBITDA would be somewhat burdened by the adjustments to EBITDA. So, you know, depreciation, amortization, interest costs all factor into equity earnings. So, It has an odd effect of depressing that number a little bit. So, you know, kind of a goofy way the accounting kind of throws that number.

Not an EBITDA construct, but I get it. My last question would be on the cyber tax. So by July 1, everything, both operationally and revenue cycle, back to normal, right? Is that correct? And obviously reflecting the guidance you just gave us in terms of the breakdown, but is the third quarter at all weighed upon by that event or it was back to normal by July 1st?

Hey, Gary, good morning. Thanks for that question. Yeah, I wanted to start by saying how proud I am of the team and the work we did to really kind of isolate that event and keep it within the month of June. Yes, by July 1, we were fully back up and functional. Now, I'll say on the revenue cycle side, there's some catch-up there. As Dave mentioned, we expect to get most of that shortfall in cash, which we estimate to be $20 billion in Q3, maybe going a little into Q4. But the reality of it is the market reacted really quickly, no reputational issues, and we're able to get fully back functional by July 1st. The team put in an incredible amount of work, both locally and corporate, and we're really We learned a lot from those events. We think it was well handled, but this is the world we live in today, right? And we have to make sure we're increasingly prepared, and we feel like we are, and just really proud of the team's efforts there to make sure that this is a one-time kind of blip. And moving forward, we feel that market is actually going to continue its usual strong performance.

Thank you.

Thank you. Our next question is from the line of Brian Tanquillette with Jefferies. Please go ahead.

Hey, good morning, guys. I guess my first question, as I think about the growth algorithm, I hear you reiterating that mid-teen EBITDA growth outlook. Maybe if we can just walk through, you know, looking at roughly 3% same sort of volume here, is this the right way to think about organic growth? And then maybe how do you bridge us to that mid-teens number, like on a go-forward basis?

Hey, Brian, good morning. Yeah, I would say nothing's deviated from the historical algorithm. Just to remind you that 2% to 3% in volume and 2% to 3% in rate, we continue to expect to be at the high end of the volume range, meaning three or north of that. And because of our acuity mix and targeting the higher dollar contribution procedures, we expect to be well north of the two to three on the revenue side. So we continue to believe we will be upper single digit, same store over time. If you then migrate to the $200 million of capital deployment a year, if you assume an eight times multiple and using a mid-year convention, that translates to another four to five percent growth that you would add to that upper single digit. And then if you look at the margin expansion, continuing on the trends it is, the margin is a combination of two factors, one being the synergies we then get on the acquisitions, which of course, as you know, we don't model when we buy them. We know what they are, but we don't We don't include them in our pro forma adjustments. So we look at those as things we've got to go get. And then, of course, it's the synergies across the broader book that we get with our scale. And we said that that over time contributes 3% to 5% to EBITDA. So if you just do kind of the basics of the math, you end up on the low end around 12%. You end up on the high end around 17%. And over the previous five years, we've done 18% CAGR. And we continue to expect to be within that range. And again, we would say more mid-teens. It feels very doable, especially with our de novos and three-way JVs.

I appreciate that, Wayne. Maybe I want to follow up to the comment earlier from Dave on the de novo ramp. So as we think about this and the comment from Wayne about synergies being realized from previous acquisitions, so as I think about 2024, Should we be thinking about that growth algorithm holding as well, given that, you know, obviously you're adding 15 dinobos over the next 18 months?

Yeah, I would see that. But your modeling might actually show it up coming through in different scenarios, right? It'll come through in that margin expansion column that Wayne was just referring to, where you'll see that. Obviously, we'll try to show you kind of that overall impact of where it comes from. But because of the accounting nuance of those non-consolidated JVs. You're not going to see that on the revenue side. So you might have historically thought about that 2% to 3% algorithm kind of showing through as all top line, but in reality, because of these minority interest investments, some of that's just going to come through equity earnings of affiliates.

Brian, I would also remind all of our shareholders that we strongly believe in performance at the board of directors level, and all of our senior management is tied to three-year category growth rates that are in the teens and mid-teens to achieve optimal performance and compensation. So we are not deviating from those plans, and that will continue to be our basis. So I see no reason we will deviate from our mid-teens growth going into next year.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star and 1. Our next question comes from the line of Whit Mill with Lee Ring Partners. Please go ahead.

Hey, thanks. We've made it... deep into the call of any talk about anesthesia. Can you guys maybe just talk about some of the changes in anesthesia coverage, any pain points with the physician groups you're working with, any increased subsidies, disruption, just so many documented challenges in the market. Just be curious on your perspective.

Hey, Wade. Good morning. Thanks for the question. Yeah, we did make it a long way without talking about anesthesia, but it's always a A good topic right now to cover. Clearly, look, there's pressure in the markets, in multiple markets across the country. We have very – it's a small minority of facilities that require any type of subsidy. But we have a lot of discussions around how do we manage our – facilities more efficiently to work with anesthesia to try to maximize that. We talk a lot about strategy around staffing. And what you can imagine with our national footprint, too, you know, one of our jobs as the manager is to make sure that we're using our national scale and size to work with the right anesthesia providers to minimize or eliminate the need for subsidies. I mean, we're blessed in our space compared to, you know, some traditional acute care, I You know, in general, it's a space that anesthesia does a little bit better historically. ASCs and surgical hospitals were what the acute systems would try to use to get rid of subsidies in the hospital level. Obviously, pressures have made that harder. We so far have had pretty good success in working through that. We are in the middle of thinking through larger strategies across the country to leverage our size and scale. But it's a real pressure. It's one that, you know, we take into account as we think about our guidance and one that we think we can manage quite well and so far have.

When you say size and scale, I just want to make sure that I'm thinking of this right. Is it thinking about how you contract differently at a national level, a regional level, or is there a different strategy that you're sort of exploring internally?

Yeah, no, that's right. I think you think about it as looking at a portfolio, right? So obviously with anesthesia in the AST world in general, they still do quite well in our world, but there are pressure points that sometimes don't match up with our economics the way anesthesia billing and reimbursement works. And so the idea here is how do we put a portfolio together that works for an anesthesia provider but also eliminates or mitigates our risk and pressure? And that's a combination of using our national scale but also making sure that we're working with them in a very team-based way to drive efficiencies.

Okay. Last question just around the accelerating de novo activity. It really stands out. Can you Maybe spend a minute, Eric, talking about some of the organizational changes that you've made to develop that muscle and maybe support the growth. This is just a little bit different than the model a few years ago. I just want to hear some around the investments and the people that support visibility around sustaining that.

Yeah, that's a great question. We have, over the past four years, been on a journey of building out great teams to help us with our M&A platform. You know, the traditional M&A agents have been working quite well, as you know, for a long time. We feel good about how well we integrate those assets, how quickly we can bring them on. The de novo muscle is a relatively new one for the company. I mean, I would point out, you know, we had a new hospital in Idaho Falls. We've done some rebuilds and investments, but clearly not the scale we've been at. So we brought in a lot of talent, people with that deep experience in the de novo world. We've built out a very dedicated team to help with that. You know, it's driven, and what's nice about our DeNovo platform is it's a mixture of, you know, independent DeNovos we go out and get together, and also the health system partnerships bringing new DeNovos. I'd also point out when we, I think I've asked this before, one of the things we like about the DeNovo world is that it does position us with payers in a way that we're not talking about trend, we're talking about value creation. And, you know, these DeNovos allow us to kind of reset those conversations and We get fair rates from the get-go there and really feel good about how much growth that's going to drive in the future. So we built out a team there. We certainly see it as just another leg to our stool, but it is a bit different.

One other item on the de novo is just one of the things we like to do is de-risk these investments for our investors. And so before we started de novo, we fully syndicate these. So in this case, we've already recruited the doctors. We've entered into syndication with the doctors. We know the volume that they will bring over. And so it's one of the really encouraging things. So when you hear about where we are at in the de novo kind of pipeline of things, know that when we start talking about a de novo, it is because we are at the syndicated level now and breaking ground level. It is not like the start of let's build something and they will come. It's quite the opposite. It's that we've already had them come, we know the volume, and now we're breaking ground. And then we just overlay our chassis of recruiting new free agents to the facility that are not syndicated owners. and overlaying our procurement and rev cycle.

Yeah, and the vast majority of these are orthopedic or there's a cardiology one as well. So these are all really, really structured around the growth in the right areas that we've been focused on. So super excited about it. It is a new leg to the stool. We feel very well prepared to execute. Okay. Thanks, guys.

Thank you. Our next question comes from Lisa Gill with J.P. Morgan. Please go ahead.

Hi. Thanks very much. Good morning. I just want to go back to your comments around there was no backlog or spike in procedures and just really try to square that away as to how to think about utilization going forward. I think you also commented that this real shift in site of care, joint procedures up 73%. So is that what this is, is that we're really finally seeing this absolute shift in site of care would be my first question as to how to think about the volume going forward. And then secondly, Wayne, I think you made the comment when you were talking about the different components of growth, when we really think about the rate. And so as I think about the difference between mix and contracting with managed care going forward, how do I think about those two variables on a go-forward basis when we think about growth?

Hey, Lisa, thanks for the question. Let me unpack this a little bit. Let me start first and foremost with your last question is, As we think about rate, just pure rate, ignoring acuity, we generally think about rate with a 2% to 3% lens. And we generally view that as our book being, say, 50-50 Medicare versus commercial. And so if you think about it in the simplest sense of just the math of it, we generally assume closer to 1% for Medicare is what we assume. Obviously, we continue to do better than that with CMS, and the new proposal would imply much better than that. And then we generally assume something in the, you know, 4% to 5% on commercial. And so as you kind of take the average of averages, you end up in that 2% to 3% blended rate. So some of the outperformance, as you know, is really we're just getting better rates from Medicare and on the commercial front. And then the delta really becomes the acuity mix. So if you think about the most simplistic aspects of the algorithm, you know, I would anchor on the 2% to 3% being purely just the rate of Medicare and commercial. Second thing I would say is to your question about site of care and the shift. Yeah, one of the reasons we highlighted our compound growth rate since 2019 is to show that it's just been a slow and steady for us. Like it's never been kind of a backlog or a spike or anything like that. Clearly, after the initial year in COVID in 2020, when volumes went negative for most, you saw that initially happen in early 2021. But the reality is, we don't really think there's been a spike. In fact, things have trended exactly as we would have expected. We did slightly better on the minority interest in the quarter than we expected on the volume. And And candidly, we were at expectations with the cyber event. So I had the cyber event, you know, not impacted us. We would have been slightly above expectations, but clearly not at a level of what I would call related to any kind of macro occurrence out there. And then I think, Dave, anything you want to add or Eric, anything you want to add?

Yeah, and you mentioned it, Wortho. I mean, we think there are still quite a ways to go there of moving that to the right side of care. Clearly, you're still seeing that in total joints, but I don't think that's a backlog. That's a movement of where those cases are being done. We continue to, you know, go earn those cases in the market. And again, I'll reiterate what Wayne said, which is, you know, we have stayed open and had consistent growth since 19 year over year. We expect that to continue. So from our perspective in our book of physicians, we believe we've kept up quite well. Now, even with that, we've had strong case growth this year, and that's just based on the natural organic run rate. We do expect that to continue. We expect to continue to add new physicians and continue to move more procedures to the best side of care when it comes to value. And so that's been pretty consistent. The ortho growth is fantastic. Obviously, it won't stay at 70% forever, but there's a lot of opportunity for us to continue to move cases, and that's even before we get to the next round of cardiology. I don't know, Dave, anything you want to add?

Yeah, no, I mean, reiterate that consistency of, you know, shift in the total joint procedures. And I think we said earlier the north of 70% year-over-year growth, you know, relatively consistent with what we saw in the first quarter. That trend has not stopped. It has not really slowed down. It's still a very upward trajectory. And so nothing unusual that we noted inside the second quarter.

Great. Thanks for the comments.

Thank you. Ladies and gentlemen, that was the last question. I would now hand the conference over to Eric Evans, CEO, for closing comments.

Thank you. And thank you everyone for joining us this morning. As we conclude, I'd like to reiterate just how proud I am of our results so far in 2023 and the work of our 12,000 colleagues and nearly 5,000 physicians. Their work and contributions allow us to deliver consistent and predictable results that will support a sustained growth for all of our stakeholders and to continue to serve our communities with the highest clinical care in a lower cost setting with convenience and professionalism that our facilities are known to provide. We are humbled with the privilege to serve over 600,000 patients annually in what are often their most vulnerable moments. Every day, I'm reminded that all of our talented members and partners are delivering on our mission to enhance patient quality of life through partnerships Thanks so much for joining our call today, and have a great rest of the day.

Thank you. The Conference of Surgery Partners has now concluded. Thank you for your participation. You may now disconnect your lines.