Greetings, and welcome to the Surgery Partners, Inc. Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dave Doherty. Doherty, you may begin.

Good morning, and welcome to Surgery Partners third quarter 2022 earnings call. I’m Dave Doherty, the company’s CFO. Joining me today is our Executive Chairman, Wayne DeVeydt; and our CEO, Eric Evans. During this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we file with the SEC. The company does not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these measures can be found in this morning’s press release posted on our website at surgerypartners.com and in our most recent quarterly report on Form 10-Q, when filed. With that, I'll turn the call over to Wayne. Wayne?

Thank you, Dave. Good morning, and thank you all for joining us today. This morning, we're pleased to report third quarter 2022 adjusted EBITDA of 96.2 million, a 26% increase as compared to the prior year quarter. Net revenue grew 11% to 621 million from a combination of case growth and an increase in net revenue per case from higher acuity procedures and rate improvements, as well as our continued execution on deploying capital for high value acquisitions. As we've experienced in prior quarters, we've managed the rate of supply cost inflation and premium labor cost pressures at levels consistent with our historical trend. The combination of our top line growth and focus on controllable cost allowed us to report an adjusted EBITDA margin of 15.5%, a 180 basis points above the prior year and 150 basis points above our second quarter margin. Each of these results is within the expectations we set internally and those that we guided to in our second quarter call. Dave will go into these results in greater detail in a few minutes. As you know, we operate in a sector of the healthcare landscape that has many immediate and long-term tailwinds. These tailwinds and the team's execution has allowed us to effectively manage the macro environment challenges that both are – and others in healthcare are experiencing. As we discussed in the past, this team has been monitoring many of these pressure points and reacted with structural controls, aligned incentives, and rapid responses. Today's reported results are continued evidence that this business model is durable and resilient and we have the management team engaged in the right areas to capitalize on core growth opportunities. Although the impact of COVID-19 is still being felt across our country, experience any material direct impact related to the…

Thank you, Wayne, and good morning, everyone. As Wayne mentioned, we are very pleased with the results of our third quarter [Technical Difficulty] continue our positive trajectory that started before the pandemic. We have learned much regarding the resiliency of our business model and the requisite tools in the toolbox needed to earn market share throughout the pandemic and current broader macro environment. Specifically, we have seen the strength of leveraging our data driven culture with strong partnerships that have been created with our physician partners. These partnerships, coupled with our data driven approach to decision making, truly enhance patient quality of life. From an operational perspective, year to date, our specialty case legalized with all core specialties growing. In fact, our overall cases have grown at a 4% CAGR over the past three years. As we noted last quarter, we experienced some extended vacations in the quarter, but those were in-line with our expectations. What we did not anticipate however was Hurricane Ian, which had a significant impact on our ASCs in the Florida region. Out of an abundance of caution for the safety of our teams and patients we significantly limited operating hours and canceled or rescheduled cases that were for last week of September. During that week, 19 ASCs and 15 practices that were located in Hurricane warning counties were impacted with canceled or rescheduled cases. Although many of our colleagues were impacted, we did not experience any loss of life or catastrophic injuries. We continue to reschedule cancel procedures and still have some facilities to repair. We expect to fully resume operations in the region in the fourth quarter. The hurricane is expected to result in the cancellation or rescheduling of over [Technical Difficulty] but the full impact is unknowable as many residents in the area…

Thanks, Eric. I will first talk about our third quarter financial results and liquidity before providing additional prospects on our outlook for the remainder of the year and broad perspectives on 2023. Starting with the top line, we performed almost 148,000 surgical cases in the third quarter of 2022, 5.6% more than the same period last year with strength across all our specialties, especially in orthopedics where we grew by 9.1% versus prior year. We believe our volumes are near normalized levels as we have effectively managed the continuing impact [Technical Difficulty] through enhanced visibility and proactive efforts to reschedule procedures canceled, due to patient or physician illness. This growth was in-line with the expectations that we shared with you last quarter, despite the impact Hurricane Ian had on many of our Florida centers. Largely attributed to this case growth, we saw revenues rise 11% over last year to 620.6 million. This growth is a combination of the organic growth factors [Technical Difficulty] and contributions from our prior year acquisitions in consolidated facilities. As a reminder, many of our more recent acquisitions are a non-consolidating facility that provide us the opportunity to enhance performance through operational excellence and to buy up over time. Because of this ownership structure, we do not include their revenue in our consolidated net revenue. I noted last quarter that when we evaluate M&A opportunities, agnostic to the accounting treatment of the assets we acquire, our focus is to acquire high growth, high quality assets aligned with our targeted specialties at the most favorable [multiple possible] [ph]. On a same facility basis, which we report on a days adjusted basis, total revenue increased 5.1% in the third quarter with case growth at 3.3%. Net revenue per case was approximately 1.8% higher than the prior year period.…

Thank you. [Operator Instructions] Our first question is from Brian Tanquilut of Jefferies. Please go ahead.

Hey, good morning guys and congrats on the quarter. I know it wasn't easy. So, I guess, Wayne, my first question for you, I mean, I appreciate all the color on your views on capital needs of the company and the access to capital right now, but as I think about your views longer-term on acquisition spend, a lot of investors are still wondering if you'll need to tap the equity markets or the debt markets at some point. Just want to hear your thoughts on that and how you're thinking about cash flow generation and capital deployment as we think about 2023 and beyond?

Hey, Brian, good morning and appreciate the question. Look, let me anchor on a few things for all of our listeners and shareholders. First and foremost, a big part of our long-term growth model is a combination of not just the organic initiatives and the de novos and the physician recruitment, but clearly is around capital deployment. And with over 4,000 independently owned ASCs out there, we like the opportunity of continuing to do this at an aggressive pace, especially if these highly attractive multiples. Our model has been baked on to get to the mid-teens growth that we target on us deploying at least 200 million a year. And I'd like to give anchor on that number because I think that's the important one to anchor on as you think about the long-term. As you heard Dave say in the prepared remarks, we have about $500 million of liquidity right now when you look at both kind of consolidated cash flow, as well as our undrawn revolver as of September 30. What you can't see in our current results is that our run rate cash flow is positive, free cash flow. We had the remaining payments to CMS this year for Medicare. We have the tax payments. I say all that to say that as we go into next year, I believe and are forecasting that we will do approximately $100 million of free cash that can be used towards M&A. And as you think about that, that says we have a gap roughly of [100] [ph] to get to your lease number, but we also have about 0.5 billion of opportunity there between our revolver, as well as our consolidated cash. So, I'd say that we have a path to whether this what we think is hopefully a storm that will start to subside in this upcoming year. And then we'll [Technical Difficulty] further evaluate then where we see the markets. We would love to refinance some of our debt, but I'm not sure that we view debt long-term as the right place to go and put more debt on this asset, quite the contrary. We've committed to taking our leverage down and we've been doing that and we will continue to do that. And we'll be opportunistic. If we think the right opportunity exists, that we can raise capital for our shareholders, while delevering will do that, but I would tell you that we feel very confident in our ability to deliver for the next several years on that commitment. that cash flow number will continue to grow because of the way it converts all of our substantial one-time payments related to either the CARES Act and those items that had to be refunded or related to the tax agreement we had subside after this year. And so, I think you'll really start to see the power of this engine and its ability to fund M&A from free cash flow.

I appreciate that. And I guess, Eric, just for you too, obviously CMS put out their final rule for ASC recently. And as we think about 2023, how should investors be thinking of a commercial rate trend and your interpretation of the benefit or impact to you guys from the CMS rule?

Good morning, Brian, and thanks for the question and the kind words to start the quarter. We're obviously very pleased with the quarter. CMS ruling obviously is better than initially came out, so we'll take that. Certainly, we feel good about the impact that that has on the ASCs. I think there's still some arguments that given inflation, we were hoping for a little bit more, but better than we expected. I would say this, we continue to believe with our [Technical Difficulty] with the commercial payers that because of our value position, we're able to find a really nice happy medium that allows us to grow revenues appropriately and we feel good about where those negotiations are with Medicare coming in near 4% clearly we have some room on revenue and on the commercial side, those negotiations are always a little bit of a dance between steerage and being the high value player and making sure we're [paid fairly] [ph]. A third of those come up each year, we feel well-positioned on that. Clearly, we are trying to make sure that we more than impact or more than offset inflationary pressures and that's the focus of the managed care team. And I feel really good about their ability to do that and certainly the Medicare increase helps offset that and was a net positive to where we started. I don't know, Dave, if you want to talk more about the specifics of [indiscernible]?

Yes. I think I agree with you, Eric. It was obviously very good to see the Medicare rate a little bit from what we saw in the proposed rule. We have three aspects of that rate that affect us. The ASC rate, I think, came up relatively favorable. The headline news on the hospital rates also was pretty positive. However, I would encourage folks to take a look at the impact of that 340B drug program change, which did have a dampening effect on that headline number that obviously, we're still working through. All of those things will [Technical Difficulty] how we look at next year and of course how much of that will flow through our commercial rate program, but generally positive versus where our expectations were in the middle of the year.

Our next question is from Kevin Fischbeck of Bank of America. Please go ahead.

Great. Thanks. I just want to dig into the margin side a little bit because I guess there are a couple of comments there that left me wondering exactly how you're thinking about the margins. If the guidance assumes a lower revenue number, but a higher margin than what you had previously, it sounded like generally speaking things came in-line with what you were thinking. So, you're just trying to bridge that change in the guidance on the margin side? Thanks.

Kevin, good morning. A couple of things I would anchor on regarding margins. First and foremost, our business model has a fair amount of variable costs associated with it and we [flattened down] [ph]. I think I would highlight the fact that one, we were very much aware of what we saw being kind of the atypical vacation in July and we started flexing from that perspective our G&A quickly. And it was no surprise that the hurricane was on its way. In fact, we took the initiative to cancel many of the procedures, shutdown our facilities, but then flex our G&A accordingly. That in and of itself, I think because of our ability to use data and drive those decision quickly, did an influence margin, but what it did do is took away the headwind that you would typically see when it is being impacted from those type of factors such as the hurricane. But outside of that, I would point to a few things. One is, our G&A initiatives we've been investing in years are really just continuing to ramp up. I actually think our underlying margins would be even better if it wasn't for the current environment that we are in. As we mentioned, we now have almost all of our facilities on a standard data warehouse. We now have our entire HR functions on one HRS system over 90% of all facilities are on a single HRS system. These [Technical Difficulty] we've been making over the last several years, but they've all been staged along the way. This is the first year that you're seeing, kind of the full force and power of all these investments coming together, and kind of the long-term benefits that come with that. The second thing I would highlight for you is to keep in mind that we are doing much more acquisitions through this ValueHealth partnership arrangement we have, whereby we acquire a minority interest we take over 100% of management, so we get a management fee and we have the ability over time to buy up. That is so relevant, is that one, because of the way the accounting rules were, when those acquisitions occur, you get zero revenue, zero revenue associated with it because you have the inability to consolidate, but you do get the impact of the EBITDA. And so, you'll start to see a miscorrelation at times between what's happening with EBITDA versus revenue, but nonetheless the quality of that earnings is quite strong and the cash flow continues to be quite strong. And obviously to the extent we buy up to become a majority owner, then that will flip, but we will start recording 100% of the revenue. So, that's the other factor that's been affecting us, especially in this year as we continue to move down these partnerships that we've been building. Dave, anything you want to add on the margin front?

Yes. Just because your question relates to our guide point from last year or from last quarter going into this quarter, and yes, you're right, the reported adjusted EBITDA number is a little bit better than what our guide was really at the top end of our range. And revenue was right in the middle, which again in this market I think was a remarkable outcome for the third quarter. I'm really pleased with how the team managed that, but mechanically, when you look at what gets reported in adjusted earnings, you do get the benefit of grant income that was received and recognized inside [indiscernible] about $300,000 and the impact of the hurricane that we took out of adjusted earnings is about $1.1 million. So, when you do the math behind those things, you'll probably find that our margin line may be a little bit better than our conservative guide point that we gave in the second quarter.

Okay. That's helpful. If I can then squeeze in two questions for my second question. You mentioned as some of your headwinds the elimination – potential elimination of the hospital [outwalls] [ph] program. Can you just talk a little bit about what that is? How meaningful that is for you? And then secondly, you mentioned the potential to sell some assets and redeploy them at better multiples. Any way to [Technical Difficulty] that opportunity? Thanks.

Yes. So, thanks for the question. On the [hospital outwalls] [ph] loss program, it's not material, but we do have a number of centers that took advantage of the ability to become [indiscernible]. It requires extra staffing. It allows us to do higher acuity procedures. We're actually quite hopeful actually with the success of that program that Medicare is going to look at those procedures and continue to think about moving them permanently into the ASC space. But clearly that program allows you to access HOPD Medicare rates for those specific facilities. It's not a huge number, but it certainly is something we've got to overcome and we'll overcome that in a couple of ways. One is, hopefully continuing to drive increased volume at those centers, which we've done. And the second is, using these as examples of the high quality work we can do on what had previously be considered two high acuity procedures to be done in ASCs, but actually were done quite safely. So, we were really excited about our ASCs that we’re able to step-up and provide higher level of care. Again, not a huge number of those [indiscernible] within our company, but it did make a difference for that period of time and it's something that we'll have to outgrow in other ways. As far as your second question, which was on our portfolio management work, that's going to be something ongoing that we're quite excited about just because we think that increased diligence in that area allows us to proactively make sure that our facilities are with the best natural owner. There are times where we see [Technical Difficulty] where our asset is highly valuable to someone else. We maybe don't have the same growth perspectives on that facility as we do on other opportunities. And we think that can be relatively meaningful. So, the idea here is we're in a particular market or a particular facility. We sell it at a higher multiple than we can put the cash back to work for. We've done some of that this year. We expect to do more of that going into next year. All of those things take time, but it certainly gives us more confidence in our ability to deploy that [Technical Difficulty] number because it gives us a real arbitrage opportunity. So, as far as sizing that, we haven't done that publicly, but it’s [meaningful] [ph].

Yes, I mean, maybe Kevin to give you a gauge though, I would say that as a member of the Board, Chair of the Board, we talk to management all the time about we'd like to look at the portfolio as just that, but we always look at kind of the bottom part of our portfolio and is it in the bottom because it has the ability to grow and we can influence and grow disproportionately or is it at the bottom because we've maximized its growth potential. Other individuals in the market that may like that asset and we have an opportunity then to get a unique arbitrage. And so, we're generally looking at something that has, if you look at all the assets combined that have EBITDA in the 5 million to 100 million range total. So, it's not a massive number if you think about what we would be doing, but if you're thinking about 5 million to 10 million and if you can get a multiple that's potentially double-digit, and you're able to acquire it say Sub-8, Sub-7, you can see how quickly the math works and why it's an easy arbitrage for us and it also affects the long-term growth rate. And so, we are constantly doing this every single year. We are always looking at the bottom group of assets that we want to understand better as to, is this the right time to liquidate and redeploy that capital or is it the right time to further invest? And we think that the team has done a real nice job of showing the power of that I think it's another reason we have a lot of confidence not just in the 100 million of free cash flow that we'll generate next year, but the idea that we have a lot of assets out there that we have a lot of very substantial interest in is, what I would say at what we see as attractive multiples if we can get them over the finish line.

Our next question is from Lisa Gill of JP Morgan. Please go ahead.

Thanks very much and thanks for the details this morning. I just want to go back to the headwinds tailwinds that Dave talked about. If I look at your current guidance and I look at consensus, it looks like consensus is about 15% call it mid-teens growth on 2023, is that the right way to think about it? Obviously, you talked about a fewer headwinds in totality versus tailwinds, but obviously that doesn't always align for how we think about that impact – how will that impact the numbers? So, that would just be my first question. Is the mid-teens growth on EBITDA the right way think about this business?

Yes. Hi, Lisa. Thanks for the question. First off, it is a little bit too early for us to be talking about how we kind of quantify that responding to kind of the consensus out there is a little bit difficult because we don't – obviously our math looks different in how we build up our process. I will say that Eric and I have gone through – we're going through our budget process right now. Eric and I have gone through how do we feel comfortable that we're a double-digit earner on a short-term, as well as on a long-term basis. And I'm looking at Wayne right now, and yes, he's definitely shaking his head that this is what the Board expects of us and our ability to, kind of get there. So, we will be providing that guidance, kind of how we think about our future calls, but at this point somewhat prudent for us to stay a little bit quiet into the specifics of how we get there. But double-digit is definitely our goal.

Okay, great. I appreciate that.

Yes, just speaking on behalf of the Board, I can assure you that we continue to challenge this management team to identify all opportunities and levers to hit our long-term mid-teens growth goal. As you know, I think we all can agree this has been an incredibly unique year from a macro environment, but then if you strip out CARES grants, our growth rate year-over-year is over 20%, and we're really proud of what we do with this company and how we push these guys and this entire team. So, I would say, as Dave said, the prepared remarks are quite intentional in saying we have high confidence that we will be double-digit. Now, we're just trying to figure out where we fall at relative to those mid-teen targets that we've been shooting for. And then how do we continue to build more catalyst between now and going into the next year that help give us high confidence that that will be achieved regardless of the environment that we're in [indiscernible].

And then Wayne, just a bigger picture question around value based care. I mean you and I've had conversations in the past as we think about one, your relationship with Privia; but two, the move in the market towards value based care. How do you think about that impact on one margins over time; and two, the actual shift in that direction? Will we see more of that in 2023?

So, it's a great question, and you and I joked about that's right that I think we've heard people talk about value based care for about two decades now and it does seem like it's finally getting its real moment and real momentum behind the number companies, including previous and others that have built the technology to really be able to track and monitor this. I do think it will get more momentum in 2023. I think I can assure you from our discussions with folks, as we've said before, and we don't say this flippantly, we really mean this and believe this. We are the value, in value based care. We are the key component to make the math analogy that folks have built actually work. The math that aligns with both the cost structure and the quality. And so, I think you will continue to see what I would call for the first time real proof points in VBC, like real proof points that individuals can share within their existing model and that we can share with payers that show that. And then ultimately, relative to margins, 100% is the answer to your question, which is, this will improve margins for us and this will allow us to start taking a bigger piece of [pie over time] [ph]. The key for us is just proving to the world that it actually works because I think people [indiscernible] and they want to see that it truly does work. But we have a lot of confidence in it and we're excited about the early relationship with Privia and how that's proceeding.

Our last question is from Ben Hendrix of RBC Capital. Please go ahead.

Hey, thanks guys. You noted vigilance around supply costs amid the inflationary environment. Can you remind us of how much of your supply falls under GPO arrangements and long-term supplies. We've heard from commentary from peers about supply contracts coming due in the coming months. Do you guys have any large renewals coming up that could present a material step-up given the inflationary pressure? Thanks.

Hey, Ben. Your question is a good one related to supply chain because our GPO is one of the areas that we believe is a good technical hedge for us or structural hedge for us against inflation. We have a great relationship with GPO. A majority of our supply spend is underneath that. And we have more room to grow inside that. It provides a huge amount of benefits for us in a number of ways. One, that GPO gives us a lot of data visibility. And with data you can make much more informed decisions and spread that across our portfolio. So, our operators and our clinicians can do their job much more effectively. And from a cost management side, that data gives us good strong visibility into where cost trends are. And the visibility that we have there is pretty tremendous. Our GPO is not up for renewal, but what you may be referring to and what others have, kind of talked about is underneath the GPO, they manage long-term contracts with key vendors. And so, they can see on a typical basis when those contracts come up for renewal. Now, the good news on that is, you get good visibility to them. It's a staggered impact, but the GPO is not limited to [Technical Difficulty] key vendors. It gives us the opportunity again to see which vendor is inside their portfolio, maybe a little bit better price than allows us to give that visibility again to our operators, so they can make more informed decisions inside there. So, the GPO has been just a great tool for us and it was one of the ways that we help to navigate our expectations for this year. It will definitely inform us as we think about 2023 and we provide that [Technical Difficulty].

Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to hand the call back to Eric Evans for closing comments. Please go ahead, sir.

Thank you and appreciate everyone joining us today. Before we let you go, I would like to recognize the significant efforts and the commitment to excellence of our 11,000 colleagues and nearly 5,000 physicians. Collectively, we take the responsibility for providing the absolute best environment for our physicians to provide exceptional clinical quality and a differentiated patient experience. We know that more than 600,000 patients each year place their trust in us and what are often their most vulnerable moments. I'm privileged to work alongside these professionals and colleagues as we work to more fully deliver on our mission to enhance patient quality of life through partnership. Thank you all for joining the call this morning and have a great day.

This concludes today's conference. Thank you for joining us. You may disconnect your lines.