Surgery Partners, Inc.

Greetings and welcome to the Surgery Partners Q4 and full year 2025 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Dave Doherty, CFO. Please go ahead.

Good morning, and welcome to Surgery Partners' Q4 and full-year 2025 earnings call. I am joined today by Eric Evans, our CEO. During this call, we will make forward-looking statements. There are risk factors that could cause future results to be materially different from these statements, as described in yesterday's press release and the reports we filed with the SEC, each of which are available on our corporate website. The company does not undertake any duty to update these forward-looking statements. In addition, we reference certain financial measures that are non-GAAP, which we believe can be useful in evaluating our performance. These measures are reconciled to the most applicable GAAP measure in yesterday's press release. With that, I will turn the call over to Eric. Eric?

Thank you, Dave. Good morning, and thank you all for joining us today. My initial comments will briefly highlight our consolidated fourth quarter and full year 2025 results. I will then provide additional color on the drivers of performance this quarter and and our initial outlook for 2026. First, let me provide highlights from our fourth quarter and full-year results. We reported full-year net revenue at the low end of expectations at $3.3 billion, up 6.2% year-over-year, with same facility revenue growth of 4.9%. Full-year adjusted EBITDA was $526 million, up 3.5% year-over-year, but significantly below our expectations. Our adjusted EBITDA margin was 15.9%, reflecting 40 basis points of margin compression. These results tell a tale of two halves where momentum in the first half of the year gave way to significant headwinds in the second half, culminating in fourth quarter performance that fell short of our revised expectations. Before getting into the details, I want to level set the scope of the challenges we experienced in the second half of the year. In our Q3 call, we lowered our guidance based on delayed net capital deployment as well as slower case growth and pair mix trends we experienced in Q3 and early Q4. While those trends continued in Q4, the impacts were isolated to our surgical hospitals, and our earnings shortfall was concentrated in just three surgical hospital markets. These markets had a combination of softer-than-expected case growth, pair mix shifts, and anesthesia dynamics that created outsized pressure. The balance of our portfolio performed in line with expectations, and these issues were not systemic across the enterprise. I will address these headwinds in more detail shortly. However, I first want to emphasize that we are confident that our long-term structural growth opportunity remains intact, driven by a combination of organic, de novo, and acquired growth. We remain committed to our growth algorithm and are focused on improving free cash flow, reducing leverage, and creating long-term shareholder value through our portfolio optimization strategy. I will now turn to the drivers of Q4 performance in more detail. Starting with organic growth, in the facilities we consolidate, we performed nearly 670,000 surgical cases in 2025 compared to 656,000 cases in 2024. We ended the quarter with 1.3% same-facility case growth, reflecting marginally softer than expected volume growth. Despite this short-term weakness, we remain committed to our organic growth strategy, centered on expanding surgical case volumes while strategically shifting towards higher acuity procedures in orthopedic specialties, including total joint replacements. We performed over 42,000 orthopedic cases in the fourth quarter, supported by strong growth in total joints, with these cases growing 15% in the fourth quarter and 19% on a year-to-date basis compared to the same periods last year. We are reaffirming and continuing to execute on expanding our facility's capabilities to deliver high-acuity procedures. Our investments in robotics and physician recruitment remain core to our strategy of capturing greater high-acuity demand. Within our portfolio, we have 74 surgical robots in service, including the addition of six in 2025, that enable our physician partners to safely perform increasingly complex procedures. Physician recruitment, a critical component of our organic growth initiatives, remains on track with almost 700 physicians recruited in 2025. That said, a portion of our payer mix pressure in the second half of 2025 was attributable to physician transitions. Several experienced physicians who historically contributed to higher commercial payer mix and volumes retired or departed during the period. At the same time, many of our newly recruited physicians served a higher proportion of Medicare patients than previous cohorts and did not ramp as quickly as anticipated. This physician transition dynamic contributed to our payer mix pressure, as commercial payers represented a declining percentage of total revenue year over year. Notably, this phenomenon was not seen across the full enterprise. It was largely seen in our surgical hospital markets and was more concentrated in a handful of our larger facilities. We anticipate improvement in both volume and payer mix as these newer physicians mature within our platform, but we will need to lower operating expenses in the short term to protect margins. As I mentioned earlier, fourth quarter margins saw compression year over year and came in below our revised outlook from the third quarter. At a high level, the margin pressure we experienced in the fourth quarter was driven by two primary factors, concentrated in three surgical hospital markets. First, we saw slower-than-expected case growth and sharper-than-anticipated shift in payer mix in those facilities, driven by both position transitions as well as near-term addressable market-specific dynamics. Second, in those same markets, our cost structure, including labor expenses as well as the cost of anesthesia coverage, did not adjust quickly enough to that changing payer mix, creating an incremental near-term margin pressure. While we've been managing anesthesia dynamics across our ASC portfolio for several years, the incremental pressure we saw in 2025 was largely in our surgical hospitals with a higher Medicare mix rather than broad-based across our ambulatory footprint. Given these impacts, we acknowledge that our performance does not reflect the potential of our business or the strength of our model, and we recognize that there is work to be done in terms of execution. Importantly, the dynamics we experienced in the second half are identifiable, measurable, and addressable. We now have clear visibility into the drivers of our recent performance, and those learnings are embedded in our 2026 planning assumptions. Reflecting on performance and the need for improvement, we have also invested in new leadership at those facilities, and our recently named Chief Operating Officer, Justin Oppenheimer, is dedicating substantial time to support their success. I'll speak about the 2026 outlook shortly and our plan to move forward, but first let me finish my review of the quarter with a brief discussion on capital deployment. In 2025, we deployed $182 million of capital towards acquisitions, modestly below our annual target of $200 million plus proceeds from divestitures and admittedly back-end weighted. We continue to believe this is the right annual deployment level given how fragmented our industry remains and the breadth of opportunities available to us. Importantly, the acquisitions we completed during the year were made at attractive valuations and represent meaningful additions to our portfolio that we expect will support future growth. The pace of deployment reflected our disciplined approach to capital allocation, and we remain encouraged by the strength of our near- and mid-term pipeline. M&A remains a critical component of our growth strategy, and we remain focused on executing transactions that align with our strategic objectives and generate long-term value at favorable multiples. Investing in the development of de novo facilities represents a relatively new and expanding component of our long-term growth, enabling us to establish ASCs in strategically selected high-growth markets that they focus on higher acuity specialties. In the fourth quarter, we opened four de novos, which makes a total of eight openings throughout 2025. As a reminder, the typical development timeline for de novo facilities entails 12 to 18 months to build, with an additional year required to reach break-even performance. Now, I'd like to take a moment to share a progress update on our portfolio optimization process. As a reminder, we are executing a comprehensive portfolio optimization strategy designed to accelerate balance sheet improvement without sacrificing growth. The portfolio optimization process reflects a proactive, long-term approach to unlock value and drive sustained success, rather than a reactive response to near-term market pressures. Our focus remains on selectively partnering our divesting facilities that will help us best meet the goals of our strategy. We continue to advance our portfolio optimization efforts, which are focused on a small number of our larger surgical hospitals that fall outside of our core short-stay surgical strategy. These efforts, some of which are in active negotiations, are intended to be incremental and disciplined, and any actions we ultimately take will be guided by value creation rather than timing. We believe these actions will be accretive to shareholder value and demonstrate financial benefit to the company through reduced leverage and increased cash conversion as a percentage of adjusted EBITDA. We are encouraged by the steady advancement of our portfolio optimization efforts, and our team is confident we will reach a resolution on a key part of this effort within the first half of the year. The recent Baylor Scott and White joint venture involving our surgical hospital in Bryan, Texas, is a good example of the strategic alignment we are seeking through our portfolio optimization efforts. This transaction allows us to partner with a leading health system that is well positioned to support long-term growth and physician alignment in the market. As a result of the transaction, we will no longer consolidate the facility, which will reduce reported revenue. However, on a run rate basis, we expect the earnings contribution to improve despite our lower ownership. reflecting a more efficient capital structure and improved alignment with our strategic objectives. Importantly, this transaction was driven by long-term value creation rather than near-term financial impact, and it reinforces our focus on simplifying the portfolio and concentrating on assets that best fit our short-stay searchable strategy. We look forward to sharing any further material updates from the ongoing portfolio review process when appropriate. We also plan to provide a comprehensive update on our longer-term portfolio composition at the upcoming Investor Day, the timing of which will be aligned with a validating milestone in our portfolio optimization process. As we assess our operating landscape and plan for the year ahead, we are taking a measured and conservative approach to the 2026 preliminary guidance reflective of earnings growth rate resets for parts of the business. Our initial guidance for net revenue is $3.35 billion to $3.45 billion, representing single-digit year-over-year growth and underscoring our continued conviction in the company's organic growth opportunities. We are providing initial guidance of at least $530 million of adjusted EBITDA, contributing to growth of at least 0.7%, which incorporates the anticipated near-term impact from many of the key headwinds we have discussed this morning. We have quantified the impact of anticipated headwinds and the core organic growth underlying our initial guidance, in the supplemental slide that we provided with our earnings materials. Let me now take you through the slide to help you understand how we arrived at this initial guidance. Starting with our 2025 adjusted EBITDA of $526 million. We anticipate $9 million in full-year contributions from last year's net acquisitions and divestitures. Additionally, as we enter a new fiscal year, we estimate a $15 million impact related to funding our annual cash incentive at Target. Recall that in the third quarter, we reported lower incentive-based compensation to account for our year-to-date performance. This impact effectively represents a return to baseline G&A expenses, assuming achievement of our targets this year. We have included state-specific reimbursement and new or increased hospital provider taxes in three markets that will pressure earnings in 2026 by an estimated $8 million. We do not expect any benefit from the additional provider taxes given our immaterial Medicaid mix. Although the Supreme Court recently weighed in on existing tariffs, we have estimated year-over-year pressure of $4 million of potential tariff exposure embedded in our supply costs. Our guidance allows for a degree of continued pressure on payer mix, but we are also taking actions to help alleviate this short-term pressure and to support future commercial growth. Regarding the three market-specific pressures that I discussed earlier, we are confident that we have plans in place to address and resolve them, and they are appropriately reflected in our 2026 outlook, though we will continue to monitor the landscape diligently. We believe that our approach is based on measured assumptions. Importantly, we remain optimistic in the structural tailwinds underpinning long-term ASC market growth, and we believe we remain well-positioned to continue to drive that shift to higher acuity procedures to capture long-term momentum in the market. We are also confident in our ability to drive improvements across the business as our new position cohorts mature, our cost containment programs continue to support long-term margin expansion, and our portfolio optimization progresses. Lastly, we remain committed to pursuing disciplined and strategic M&A in 2026. Unlike past years and recognizing the fickle nature of M&A timing, we are not explicitly including the impact of M&A in our initial guidance for 2026. We continue to be excited by our strong pipeline of opportunities that align with our short-stay surgical ethos, representing additional levers to drive growth and shareholder value creation. As the year unfolds and we gain additional clarity on market dynamics and the active portfolio optimization efforts underway, we will update our full-year outlook. Before concluding, I would like to share a couple of board-related actions that took place last week. At that meeting, we authorized the company to repurchase up to $200 million of the company's common stock. This authorization conveys the board's confidence in the company's future and our opportunity to deliver significant shareholder value as we execute on our strategy. It also positions the company to optimize capital allocation, recognizing our portfolio optimization progress, and that our stock price offers an increasingly attractive relative return at current prices. Of note, Bain Capital has informed us that they won't be a seller in this share buyback program. In addition, last week the board appointed Lloyd Dean as our newest director. Lloyd is a well-known and highly respected healthcare executive who most recently served as CEO of Common Spirit Health, one of the largest healthcare systems in the country. His deep healthcare services experience and expertise, combined with his dedication to improving health and expanding access across healthcare for all, make him an outstanding addition. He will also be an invaluable resource as we grow our health system partnerships. I'm excited to work with Lloyd and will undoubtedly benefit from his insights and counsel. With that, I will now turn the call over to Dave to provide additional color on our financial results as well as the 2026 outlook.