Q3 2019 Earnings Call
Greetings and welcome to the surgery partners third quarter 2019 earnings Conference call.
At this time, all participants are in listen only mode.
Your next question answer session will follow the formal presentation.
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As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Tom Kelly Chief Financial Officer. Thank you Sir you may begin.
Good morning, and welcome to surgery partners third quarter 2019 earnings call. This is Tom Kelly Chief Financial Officer, joining me today, as Wayne device or Chief Executive Officer, and Eric Evans, Our Chief operating officer.
As a reminder, during this call we will make forward looking statements risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this mornings press release and a reports we filed with the FCC.
The company does not undertake any duty to update such forward looking statements.
Additionally, during today's call the company will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance.
Presentation of this additional information should not be considered in isolation worth substitute for results prepared in accordance with gap.
A reconciliation of these measures can be found on our earnings release, which is posted on our web site at surgery partners Dot Com and our most recent interim report on Form 10-Q , one filed with that I'll turn the call over to wane Wayne.
Good morning, Thank you Tom and thank you all for joining US today [laughter] for call. This morning, I'll review some highlights from our third quarter results and then provide an update on several of our strategic initiatives that support organic growth and margin expansion I briefly discuss how those initiatives impact our sustainable double digit adjusted EBITDA growth goals fine.
Ali I'll turn the call over to Tom to provide further details on the quarter.
Starting with the quarter.
I'm pleased to report third quarter 2019, adjusted revenues of 458.3 million and adjusted EBITDA of 62.2 million.
As we look deeper into the quarter.
Adjusted EBITDA grew by 5.4% over the third quarter of 2018, consistent with our previous guidance and our target a double digit full year growth.
Days adjusted same facility revenue increased by 7.9% from the prior year quarter, driven by strong net revenue per case in volume growth.
We're pleased with the significant growth over the prior year, representing our fifth consecutive quarter same facility revenue in case volume growth, which we believe is a testament to our efforts.
Finally, adjusted EBITDA margins were 13.6% and improvement of 30 basis points over the prior year quarter.
As Tom will discuss later adjusting for the impact of closed her divested facilities revenue growth would've been over 9% and EBITDA growth would've been approximately 13% over the prior quarter.
Our strong third quarter performance does not incorporate any add back or adjustment for the impact of hurricane Dorian in early September , which we estimate reduced our reported results by over 3 million in revenue and approximately 1.2 to 1.5 million an adjusted EBITDA.
While our facilities fared well in the storm to ensure the safety of our employees and patients 14 of our facilities along the south Eastern coast close for anywhere from one to four days representing over 750 previously scheduled surgical cases, many of which for higher acuity.
It is our hope that we can recapture some of the smallest volume by the end of the calendar year.
As we prepare for the fourth quarter, we continue to be pleased with our year to date progress on a variety of fronts.
Same facility revenues continue to exceed the high end of our targeted long term range of 4% to 6%.
These results are driven by both our physician recruiting efforts as well as solid improvements in our commercial rates.
More importantly, as we discussed our previous call Theres, a compounding impact on our business as new surgeons continue to ramp up in our facilities. We are concurrently improving our commercial rates a compounding that we expect to meaningfully impact our fourth quarter 2019 and longer term results.
A few data points to anchor on.
Year to date basis same facility revenues were up 7.6% and improvement of 300 basis points over the comparable period in 2018.
During this period the contribution margin for positions recruited since the beginning of 2018 are already more than doubled their contribution from all of 2018, and we expect to see further strengthen the fourth quarter consistent with typical industry trends for our sector.
Our 2019 physician recruitment cohort is also driving strong results to date, we've recruited an equivalent number of doctors at this point last year and those doctors are performing cases at a 25% higher direct contribution margin per case versus last year.
And finally, our data driven focus to brought our targeted specialties, including our total joints programs has yielded meaningful improvements in higher acuity cases.
Year to date, we've done approximately 800 total joints in our ambulatory surgery centers, which is double our total at this point last year.
As you can see by our results we continue to be pleased with our team's efforts and making our surgical facilities a destination of choice for both physicians and patients.
We are equally pleased with the positive momentum, we continue to make with payers and sharing with Dundee experienced their members can enjoy at a much more affordable and efficient facility.
A testament to our efforts relates to our recently completed all cycle rate negotiations and a few pilot markets, where we achieved double digit commercial increases that commenced early in the fourth quarter of 2019.
These negotiations were successful due to that a demonstrable value proposition, we provide state regional and National Health plans.
Our health plan partners increasingly understand in value the benefits that a vibrant independents short stay surgical facility, operator can provide to them and their members.
Look forward to continuing and are already actively engaged in this dialogue with other payers across the country.
As we start to look to next year. We're confident we can continue to build on the strong foundation, we constructed over the last seven quarters. Our model remains the same.
We believe that our base business can grow at 2% to 3% on volume and two or 3% on rate, yielding 4% to 6% same facility revenue growth with a bias towards the higher end of the range.
Our results to date, our proved that if we focused on bringing the right doctors doing the right procedures in our target specialties and focused on getting appropriate payment for the value we bring to the system. We can achieve at least this level of growth.
On top of this baseline for growth we've been focused on three additional areas to expand margins that we expect will contribute an additional 3% to 5% of growth in support of our double digit adjusted EBITDA growth goals.
These areas include procurement.
Revenue cycle and DNA leverage.
We continue to plant seeds in each of these areas and we're confident they will bear further fruit in 2020 and beyond.
We have built new leadership teams in these functions over the past 18 months that continue to scale. These initiatives and we see brought opportunities.
And procurement as we continue to optimize our GPO contract. We're also making progress in negotiating purchase discounts on implants, and other supplies as well as being more creative and how we purchased to take advantage of rebate opportunities.
Revenue cycle or centralized operations are starting to exceed our collection targets and we are using new data from consolidation of electronic claims submissions to begin to optimize denials management across wide portions of our business.
And as many of you know from your previous experience with several members of this management team. We have a maniacal focus on DNA management, we've just recently implemented a new tools and policies to further monitor and manage our costs.
These distinct initiatives on top of our base grows give us confidence in our double digit trajectory.
Finally, as we look beyond the tactical.
Our Idaho Falls community Hospital is slated to open stores just days from now this multiyear investment and a new acute care hospital will complement our existing surgical hospital and expand our capabilities in this very important market for our company.
We are excited to be able to better serve this community, but the brand new facility and we expect this to be a material contributor to our adjusted EBITDA in years to come.
More broadly or Idaho falls effort demonstrates our willingness to make strategic investments across our portfolio to achieve long term sustainable accelerated growth.
We are building surgery partners everyday to be position consistently and predictably achieve near term medium term and long term growth goals.
Before I turn the call over to Tom I'd like to spend a moment on Fridays announcement from CMS regarding the calendar year 2020, Medicare hospital outpatient prospective payment system and ambulatory surgical center payments system final rule.
We were pleased with the announcement across a variety of fronts as we felt CMS demonstrated their commitment to FCC.
With respect to overall rates CMS is finalized an aggregate rate increase in 2020 of 2.6%, which is 50 basis points higher than the 2019 aggregate rate increase.
Well the specific rate cells will impact individually as season different ways. We're pleased by CMS is continuing commitment to the industry.
Another exciting development for 2020 is the total knees and six additional coronary intervention procedures were added to the Medicare AOCI covered procedures list for the first time opening a vast new markets for our facilities.
And finally total hip replacements, six spinal surgical procedures and certain anesthesia services were removed from the Medicare inpatient only lists making these procedures eligible to be paid by Medicare and the hospital outpatient setting. In addition to the hospital inpatient setting in 2020 as with total knees, which was first removed from the inpatient only live.
In 2018, we believe this move could signal additional near term and long term opportunities for our facilities to better serve the Medicare population.
The continued favorable actions undertaken by CMS to benefit FCS demonstrates what we know to be true.
Our industry in general and surgery partners in particular, it's on the Rightside, the quality and cost effective healthcare delivery.
Regulation continues to reflect this.
With that let me hand, the call back over to Tom for an overview of our third quarter financial results in 2019 outlook Tom.
Thank you Wayne today I'll spend a few minutes on our third quarter 2019 financial performance starting with some of our key revenue drivers then moving onto adjusted EBITDA cash flows and our 2019 outlook starting with the topline surgical cases were just shy of 130000 in the quarter up 2.1% from the.
Prior year period, despite the loss of cases from closed or divested facilities that contributed nearly 3300 cases in the prior year quarter and the impact of Hurricane Dorian, which we estimate impacted us by just over 750 cases in the current year quarter.
We ended the third quarter with approximately 458.3 million, an adjusted revenue up 3.2% as compared to the prior year quarter. Despite overcoming 25 million of revenue in the prior year quarter from closed or divested facilities and over 3 million of estimated loss revenue from hurricane Dorian in the current pure.
Good.
On a same facility basis days adjusted total company surgical revenues were up 7.9% from the prior year quarter, driven primarily by net revenue per case, but also by higher same facility volumes.
Turning to operating earnings our third quarter 2019, adjusted EBITDA was 62.2 million a 5.4% increase over the comparable period in 2018.
Of note closer divested facilities contributed just under 4 million of adjusted EBITDA in the prior year quarter, and we estimate that the marginal adjusted EBITDA impact from Hurricane Dorian occurred period is between 1.2 and $1.5 million. Our third quarter results is consistent with our expected quarterly cadence.
Despite the hurricane impact and continues to position us well to achieve full year double digit adjusted EBITDA growth.
During the quarter, we recorded approximately 5.3 million of transaction integration and acquisition costs, bringing our year to date totaled to 16.8 million less than half of our year to date 2018 costs and consistent with our guidance that integration related costs would subside of note third quarter 2009.
Teen transaction integration and acquisition costs included approximately 1.4 million of costs associated with our de Novo Hospital in Idaho Falls, we expect to continue to record these costs outside of adjusted EBITDA for the remainder of 2019 and throughout 2020.
While net revenues on our ancillary and optical segments were down slightly on a combined basis versus the prior year period combined adjusted EBITDA from these two segments was relatively stable versus the prior year quarter and consistent with our previous comments about our outlook for these businesses.
Moving onto cash flow and liquidity an important part of our strategy is to optimize our cash flow to be able to deploy available capital and generate returns for our shareholders. We continue to evaluate our portfolio to assure ensure that we are the best owner for our assets as we scour the landscape organic.
I think investment opportunities to drive future growth.
I'm, particularly pleased with the efforts of our Treasury and development teams, whose efforts have once again been highlight this quarter.
At the end of the third quarter. The company had cash balances of approximately $111 million and a revolving credit facility remains undrawn with approximately 115 million of availability.
Of note during the third quarter surgery partners had net operating cash inflows defined as operating cash flow less distributions to noncontrolling interest of $28.3 million. We deployed approximately 8 million in cash that is accounted for in various sections of the cash flow statement related to a buy up.
In related investment in an existing facility in Montana.
And we used approximately 13.3 million for payments on our long term debt.
The ratio of total net debt to EBITDA at the end of the third quarter of 2019 as calculated under the company's credit agreement decreased to approximately 7.6 times as a result of higher trailing 12 month adjusted EBITDA in greater visibility into the value of some of our managed care initiatives.
As we've noted before the company has an appropriately flexible capital structure with no financial covenant on the term loan or our senior unsecured notes.
We continue to project at the company's total net debt to EBITDA ratio should naturally decline overtime as our business continues to grow but may fluctuate on a quarterly basis based on timing of cash flows.
With respect to our capital structure and leverage calculation, we expected financing leases will increase by approximately $105 million in the fourth quarter as we take possession of our new facility in Idaho Falls and we projected our new community Hospital will also incur nearly 30 million of new local debt to finance equipment needs concern.
System with the terms of our credit agreement, we expect to begin to incorporate the long term EBITDA contribution from this facility in our credit agreement EBITDA in the fourth quarter, which we believe could be between 20 and 30 million annually. When run rate has achieved over the next few years.
Given the magnitude of this adjustment we wanted to start to socialize the deleveraging impact of this adjustment with investors now.
Before we move on I'd like to take a moment to discuss the investment we made this quarter in our surgical hospital in Montana, including purchasing the remaining interest in associated assay and the local click.
This non traditional opportunity first identified by our local teams allows us to fully deploy some of the strategic resources. We have built in revenue cycle and managed care unlocking a myriad of revenue and cost synergies over time.
This unique investment in an existing market will better position surgery partners to grow in this geography and better serve a local community and we are truly excited by the long term potential of this market.
Moving onto our 2019 outlook, we're excited by our progress this quarter on a variety of fronts and remain committed to double digit adjusted EBITDA growth this year and our full year revenue guidance of low single digit growth or high single digit growth, excluding divested revenues from the 2018 baseline.
As we look forward to the fourth quarter, which is seasonally our largest earnings quarter, we would ask investors to keep in mind the following trends.
Higher deductibles have continued to push commercial procedures to later points in the year.
To date, our government business mix is approximately 140 basis points higher than the same period last year.
We continue to expect commercial business mix to improve in the fourth quarter, which should drive higher net revenue and profit per case.
The value of some of our strategic initiatives, including the savings from our health plan consolidation are backend weighted.
The two surgical hospitals, we closed late in 2018 or negative contributors to adjusted EBITDA in the fourth quarter of 2018, those losses will not recur this year.
And we have newly we negotiated rates that are currently effect in several key markets.
While the seasonal nature of our business always introduces late year risk. We believe we are well positioned to achieve our full year guidance.
In summary, we believe our year to date 2019 results continue to demonstrate our ability to achieve our targets. We are pleased to see strong same facility revenue growth. We continued margin expansion as are our initiatives take hold we continue to invest to expand existing facilities and enter new markets that will soon.
Organic growth as we finalize preparations for new Medicare procedures in our facilities starting in 2020.
With that we will open the call for queuing.
Operator.
Thank you we will now be conducting a question and answer session. If you would like to ask your question. Please press star one on your telephone keypad, a confirmation Hill will indicate your line is in the question Q.
Please press star too if you would like to remove your question from the Q.
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One moment, please when we pull for questions.
Thank you. Our first question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch. Please proceed with your question.
Great. Thanks.
I guess I heard the comp I guess I Wasnt sure exactly what.
But the context, where you said that you guys are reiterating your 46%.
Same store revenue growth expectation, maybe could if theres a bias to the high end of that was that just really for 20.
19 or were you, saying that for next couple of years and thank you can be towards the higher end of that range.
Hey, Kevin Good morning short answer is not just for the current year, but we think really for the next several years that we should be at the high into that range I think as we continue to go deeper and see the volume kind of compounding effect of our recruiting efforts coupled with the fact that I think our opportunities on rates are probably much more meaningful than the typical 2% to 3% on rate that you should.
Good so I would say the bias is towards the high end of that range.
And when do you think about that.
That rate dynamic part of it.
How much of that is on the tennis commercial re contracting versus some of the acuity mix shift as you kind of talked about.
As well.
Yes, so I would see first and foremost to the juice.
Substantial part of it is just getting the rates that were entitled to in the markets. We still have several markets that are well below what our appropriate level, but we would say even being at the average of average rates.
Since we've been able to bring on the full time managed care team and as I mentioned in his prepared remarks, we've had several programs. We've done all cycle increases that had been.
In the double digit range and so.
I think we're getting more and more momentum there that being said mix does play a factor in that but I would say mix would be the factors that could put us above that high into that range above 6%, but I would say just purely on the typical rate negotiation of 2% to 3% that you should get on rate, we should be able to exceed or at least be at the high end to that and then let mix be the delta.
Yes.
Hey, Kevin It's Tom Good morning.
The compounding effect as well the especially as you think about how our physician partners are able to share in the economics of the facility through their ownership as we achieve more attractive rates of it actually incents them to bring more procedures to our facilities.
Yes, I guess, maybe just to build on that.
This ramp that you've been able to during the last couple of years as far as recruiting and then their ramp up as they.
Come onboard I mean, how much more do we have to go before you kind of anniversary all that and get to the point, where it's now kind of steady state versus the scanner big ramp.
Over the year. This next year or is that you're going to kind of normalize answer.
You're welcome sustainable growth trajectory, Hi, I'll, let me first start by saying as we have to our own internal five year projections in share them with our board. There's no reason to believe that we should not be able to achieve the higher into that range for both the near end the longer term.
And so I don't think that we're going to hit an inflection point for at least two to three years out at best if not longer simply because I think the opportunity is meaningful and I would add to that with the ships were seeing.
Kms, the new procedures that will come their procedures, it's going to open up a whole new Avenue for us to leverage our fixed cost that we have there today so.
If I look at pure ignore even the transition and the new opportunity that's afforded to us with that with CMS rules that were finalized on Friday, I would say, Kevin I think we've got three to five years of positive runway at the high into that range or better.
Okay, great. Thanks.
Our next question comes from the line of Ralph Jacoby with Citigroup. Please proceed with your question.
Thanks, Good morning.
Just wanted to understand the improvement commercial rates beginning kind of in the fourth quarter can you give us any sense at all of what percentage of the commercial book will see the boost and I certainly understand the value you guys bring but just help us on the promise of the payers kind of giving you the off cycle bumps.
Where are you kind of in that process and then I guess for those that don't give you those off cycle increases how long to kind of get through the book to get to that higher baseline.
Yes, So let me let me first start with just strategically why would a payer give us an off cycle increase I think thats. The most logical question and one of the things that I would tell you Ralph is as we've been meeting with the payers, we've gone to them with them understanding that it is our preference and it is our playbook to be the value play in a market.
To have the quality that we offered our facilities coupled with the value play and so what we do know share within the data that shows where we think the value play should be at.
Versus what we are being compensated at and what alternatives are available to us in the market. If the payer chooses not to want to participate in that value play and so said differently. It's always our preference as we've said to first partner with appear on the right market structure, but if thats not available to us we know there's many providers out there and health systems that would like to partner with us.
So as well.
And we've continued to try to partner with those that look at being a value play in the market, but under any scenario our rates go up I will tell you pretty much across the board as we look at our bookings were going through these negotiations we can either partner with a health system and have meaningful rate increases or we can partner with the payer and have meaningful rate increases and as I said it is our cut as our.
Our goal it is our mission to be the value play in a market and so we're not necessarily looking for what drives the greatest EBITDA, we're looking for what accomplishes a longer sustainable business model goal that being said.
If a player in this case, a payer would not want to participate than we are going to partner with a health system to get the rates. We believe we're entitled to in a market.
The other thing I would tell you is while we won't size up necessarily for you up what percentage is of commercial this that what I will tell you is it was up nine of our facilities.
Reasonable contributors to our EBITDA in Q4.
All getting a double digit increase across the board. This initiative just to you know started though early in the year. These would things we thought would happen when they would happen. So we're very pleased with that.
We have inflationary kickers over the next several years that are meaningful.
And so I feel like this was the starting point of starting to leverage our value prop and leverage the idea of providers being in the market.
The thing, though as I'm going to let Eric just comment on since he's been here. They really brings as you know a lot of surgical facility in surgical hospital experience and one of the things that he's been doing in the managed care sector is really looking at just even basic things available to US for example, under the charge master and whether or not we've been taking advantage of those opportunities that are afforded us in our fund.
Realty, So Eric maybe comment on some of your warfare as well and how that will start benefiting us in Q4, as well and beyond sure. Good morning, Ralph and did just to build on wine spies. One thing I would also say just on the payer side is we do take a very much a collaborative approach. So as we think about any rate increase the reality of it is most of the time, that's going to be in a situation that makes our facilities more.
Attractive and actually draws patients potentially from higher cost settings rights to the goal here is in total another reason a payer would do something off cycle with us is the opportunity to make us more sustainable in the market to actually dropped procedures over to what our higher value settings, even with a rate increase and so we we look for win wins, there clearly Dwayne point from a facility.
But as we've as we've grown the company.
We have not been as.
Probably as this one is we could be around just thinking about annual annual rate increases how we should think about managing our book.
Based on where we sit in a given market and so we've got some opportunities there as well that we're looking at to be more consistent and to make sure that we are appropriately.
Adjusting our charges to reflect market realities in wind, where we said, but all of that said I think what what's great is even in these conversations where we are having discussions with payers that maybe are a bit out of cycle. The reality of it is for these payers, we present enough value creation that they want to make investments in us right. They want to make investments Ross as an alternative in some markets.
And they want to make an investment to that because of our quality and service and so we feel good about where part of the solution and we want to make sure that while we offer a discount we don't offer a deep discount that is on warranted.
Okay. That's that's very helpful.
I wanted to sort of switch topics, but somewhat related you guys noted the CMS announcement of knee replacement and certain cardiac procedures moving to ask sees.
Is there any way to sort of need to frame the opportunity or give us some odd guardrails around what you think the opportunities are and then we certainly had payors, namely United and anthem sort of puts changes to to benefit design around side as service and prior auth can you give us a sense of either maybe.
What your overlap with those payers are in your markets and and how meaningful or not of a driver do you see it specifically for 2020. Thanks.
Rob appreciate the question, let me start by saying I think both are very meaningful trends for our industry and our business model specifically.
Look I think let me start with the payers that this is well overdue.
I think enough quality data has been supported now that shows that the quality is actually in many cases equal or better than what you get an acute care hospital settings, and and I would also add that nobody will debate or dispute that there is generally a 45% lower cost structure for it.
And and so I would say that the payers in the moves there, making and I would tell you there's meaningful overlap in our markets with those two pairs you mentioned as well as other payers that are better considering similar.
Processes on top of that relative to.
Skating, where the books going we didn't spend much time this past year highlighting the idea that.
That we were fairly bullish this would have been but we knew that you never quite know if this gets delayed another year. So in terms of sizing it.
I want to get ahead of our board, but we actually board meetings. This weaken as part what we're going to be sharing with our board is little bit of our of our thoughts on this space, but what I would tell you is we've spent the last year expanding multiple locations ours for exactly this opportunity and as you know or expansions are fairly inexpensive to do if you're simply adding on a room to existing facility I would also tell you on our fuzzy.
Vision recruiting efforts, we've spent a fair amount of time this past year, starting to build deeper relationships with those physicians in markets that we believe our facilities are not only capable of bringing on this new windfall thats coming our way, but more importantly, with the quality positions, we want to deal with and while I won't give specific names I mean, we have physicians that are doing.
Anywhere from 500 to a thousand.
Total joint procedures, a year, which gives you an idea of but mostly in Medicare and generally in and high retirement communities, but areas that we are actually well positioned and so we're going to continue to have those relationships and we're looking syndicating so more to come but what I would tell you is I just few these additional tools and the toolbox that should give us confidence in our long term double digit growth.
Okay very helpful. Thank you.
Ralph I'm going to pile on even though I know, you're probably just dropped off the the only other thing that I just want to highlight for you is this is part of the reason that we've been trying to demonstrate for you. The number of procedures that we're already doing of this type.
In our assay right. So we're doing these types of procedures today for our commercial clients and we have the capabilities and are actually doing this in about a third of our FCS today and have capability to do it more than that but we think we're really well positioned.
For this this opportunity over the short term and over the longer term.
Okay. Thank you.
Our next question comes from the line of Chad Vanacore with Stifel. Please proceed with your question.
Hey, good morning way to Tom.
Feature.
I would like to continue at Ralph's question on the opportunity in the east and maybe even hips. So.
If you can't quantify initial impact in 2020, where do you think you can get to in five years or if you you'd rather how much of that business do you think migrates from inpatient to outpatient.
So.
Difficult question to answer not because we don't want to answer because I think hopefully some of these projections are going be sharing with our board I will tell you. It is our intention to share. These early next year with you on a on a five year outlook and we'll give more detail, but let me give some maybe some anecdotal things that hopefully will be somewhat helpful. In answering it for 2020, it's a little more challenging.
Simply because we've been working with a number of physicians that we would like to start having moved procedures into our facilities, but ultimately they could until this role went into effect. So what I would tell you as we've got a lot of physicians lined up we have a lot of individuals that we're willing to commit but the reality was until Friday, we will now though for certain.
Paul how strong that commitment is and whether you actually get those individuals to syndicate and move forward with us so until I can really see how that enrollment comes along.
What the see where that's at the other thing to keep in mind is it. Some patients are of course, you know never really candidates I mean, they have to remain in an inpatient setting and so one of the things we have to look at too as we as we've been targeting certain surgeons and physicians as we're trying to target those that we believe have at least more of a bias to what they could do in an outpatient setting so again a lot of moving parts.
But I think 2020 is a slower ramp up to be honest just because we're now late in the year, allowing stocks. We've been recruiting now now it's going to be full push to go back out and say look the rules are there can we get you to start scheduling time, if you just take physician recruiting in general in general.
And I don't think these patterns would be any different with our Medicare doctors.
Last year, we added almost 500 this year, we think we're at about five on a new surgeons as the year progressed as but when you look at those numbers generally the pattern as those physicians will do one or two procedures for the first two or three months in your facility simply to see can you deliver on your promise right and then if you do they start to do three to five the next month and fortify and then eventually you're getting.
On the do 25 procedures, a month, but I want you to know that ramp up time is it takes really a full digestive year from from soup to nuts. So I think it will be slow out of the gate in 2020, but ramp up by the end of 2020 and I think 2021 is when you really start to see more run rate sustainable movement at that but remember we're going after new physician.
Base that a lot of Medusa purely Medicare that we're trying to get moved into this population so more to come but.
In general just very bullish that this just to me I just view it as another example of why we should have competence and double digit growth I wouldnt necessarily start adding to it because as you know there's many levers you pull at different times, but.
But we think opportunities very meaningful.
Alright, so I'm going to ask even more granular question on the general topic, which is presumably most hip knee replacements or Medicare covered.
Have you thought about how that impacts government pay mix.
Yes. So this is Erik I mean, and certainly yes. There is the fair amount of those that are Medicare covered and clearly we are very very focused on looking at implant costs and making sure that we appropriately prepare for what that reimbursement looks like as it will put pressure on margins.
The good news is that acuity growth when you think about just the revenue opportunity for us it's pretty meaningful Nancy setting. So we've got a lot of efforts underway. We do feel confident we can make that a accretive business, but it's going to take some work and clearly.
We have to earn some commercial mix with that and so the idea here is that a lot of the surgeons.
That's fair fair mix and our job is to earn all that business and make it all makes sense in total and we believe through our efforts, particularly as we gain volume and as we really go deep on how we deal physician preference items in the type of deals that we get with our our vendors for implants, we see it as as a tremendous opportunity, but youre right with something you got to prepare for him.
The very very precise on how you manage your costs.
A reminder, wall lower margin business has a very strong.
Return on invested capital and so from our perspective. This is still very good business very positive EBITDA cash flow growth will put some pressure on margins, but I would tell even with that we still expect margin expansion over the next five years and consistently every year.
Alright, and then I just want to get too on the rate renegotiations fourth quarter did I hear that right you got double digit rates competitors to your target of 2% to 3% and then yes, why such a large rate increase.
So first answer is yes, but that you did hear correctly.
Two is look it really came down to the value play in a market I think as Eric said. The date has always been readily available and I think as a management team hopefully we'll continue to prove to to you in our investors that were very data driven in all of our decision, making and so as we went out with the data we simply met with the payers to show them, where we know the market was was Barry.
Relative to rates for procedures being done in outpatient setting and we have health system data that we can get we can get other other assay I mean this data is available and as you go out and pull this data even if its sanitize you can understand where you stand in the pecking order and so part of it has been simply us going out saying we've been in underpaid facility for many years, we believe.
We had meaningful value, we showed them our ability to create steer edge over time through through our programs at our quality programs and and we basically show them. The alternative which is if we can't get paid meaningful rates to maintain and grow as sustainable business model in certain markets. Then we will partner with health systems that will also give us though sustainable rate. So I think the key is we.
Health systems that see all the trends happening there procedures are moving into an outpatient setting at many of them or not prepared for this and we have payers who would prefer to see those costs go to were were added value play then move to a health system cost structure and so we just happen to be uniquely positioned in the REIT space at the right time to have two.
Very.
Leverageable points, and we're going to continue to use those in every market where it.
One thing I'd just add onto that when you think about managed care side, we were taking a more of a state regional and national approach and one of the problems when you're just simply individual facility negotiations that we've missed is kind of telling the broader sorted value. We can create in a given market in one state region that is a different approach for us and I do think that as as payers realize our.
Scale in certain markets in our ability to actually meaningfully helped them more than just one location, but across the geography that also changes the story it changes the kind of the the the place we're negotiating on right not just about a local unit cost, but about how in the course of a read pallet over a broader geography can we help drive costs down in the system and help them.
Create value and I think thats thats positioning us well.
Going forward.
All right I must sneak in one more question so by maintaining double digit growth outlook for F. 119 is implied steep ramp up what would be typical seasonal strength in fourq.
How much of that ramp do you expect to be driven by revenue increase in how much is that for margin improvement.
So I appreciate the question just some high level things to keep in mind.
Just as we benefited from some of those divested assets in Q3, and the sense that that EBITDA last year and of course, that's not the here. This year those assets were very lumpy in their seasonality and so some of our divestiture is actually lost money in Q4. So let me just start by saying that Theres several million dollars pickup simply by not having losses recur in Q4, which probably gives you a little more of a.
Since the seasonality patterns are not as far off is what historically you've seen if you just adjust for that I would tell you that it's probably heavier on the revenue side pretty meaningful lift that we have coming both through the rate negotiations plus the ramp up of doctors that we've seen from not only 18, but all those higher to 19 in those patterns.
Starkly as I mentioned earlier, the seasonality of how a doctor gets engage with your facilities usually gets pretty meaningful in Q4 Q4, typically heavy commercial and many physicians are generally somewhat intentional and how they scheduled procedures around Q4, and so I would say is heavier weighted towards that being said, we have value benefits coming through we expect from our benefit design.
And changes we made in our health plans and more DNA leverage and the RCM benefits continue to look up positive each day. So I think you'll see both margin improvement, but I think you'll see strong topline.
All right Thats it for me thanks.
Thanks, Chad.
Our next question comes from the line of Brian with Jefferies. Please proceed with your question.
Hey, good morning, guys.
Well I guess my first question just to follow up on that last question.
As I think about Q4 is there anything qualitatively at least you could share with us in terms of what you're seeing it through maybe with volume of shifting from Q3 because of Dorian or.
How should we feel comfortable comfortable are confident with the revenue ramp that you're expecting just like you you alluded too.
Yes, so Brian let me start by saying that to.
Again, I think due to the onetime items that were there last year, coupled with many of our initiatives that were fourth quarter loaded for the benefits.
That we expected.
Obviously, we have insights that you're trying to get comfortable with that being said.
When the when Hurricane Dorian happens as you know it's a day that you lose you just wanted to recover those days back to schedule procedures, but the hope is that you'll get some of those rescheduled into the fourth quarter and what I would say is October seems to be at least indicating that that has happened now we're not done closing our books, we have a view on case volume.
But I would say all those facilities that were affected appeared to be performing well in October .
And generally very strong versus our original expectations. We built our budget. So I think as of today, we feel pretty good on the volume.
I think the biggest thing is really comes on the mix and does the mix shift by can commercial we've historically seen occur, especially because we know we have pretty meaningful rate lift across the board in our commercial book in the core in the quarter. So.
I think it's going to be a more to come but I would say our commitment to double digit growth is still there and we have many levers that we could pull if we felt there was any pressure in the quarter.
I appreciate that comment Wayne as they think about it just shifting gears to the whole.
Total knee replacement opportunity and obviously one of the key debate is what is the right reimbursement right. I mean, this is kind of a new area for a lot of the payers as well. So you mentioned, 45% deeper than hospitals is what you are you guys are averaging at as in the industry is that the starting point of the conversation as we think about that you can.
Nomics of total knee replacements.
So the first of all if you look at what they propose I think it's $8000 shipment north of 8000, just north of $8000, let that proposed.
We've looked at a number of our facilities and believe we can earn a.
Reasonable return on that.
Keep in mind I think this is what typically happens with all government business everybody cries fallen says they can't make money in this environment as we've heard for years on Medicaid and Medicare in that somehow the industry becomes innovative and figures it out and so I would just simply tell you that in a lot of ways. We actually welcome. This stake in the ground at these rates, where we'd like to be paid more of course.
We would but I would tell you our business model was built to be efficient like this and because of our fixed cost leverage structure. We think will be just fine the core issues going to be how do we continue to manage our our contracts around our implant costs than what we're doing there and thats, where Eric and the procurement team of a pretty substantial effort that gives us confidence that we can do well.
In that environment, and if we think we're not able to at a particular market. Our particular facility remember we lose nothing from this is only upside to us so I feel like where the right spot at the right time than we've got a lot of Optionality on how we want to play Eric anything you want to at the other thing I would add there Brian is that I think what's what's interesting. So Medicare obviously is typically one of the lower.
As when we talk to commercial payers, what we really spend our time focusing on is the gap between what they pay today and what they get paid our facilities in the value creation is pretty large.
So it's interesting as payers as payers are starting to look at this they're realizing that hey, there probably making investment on the side to pay a better rate that that helps cover make sure. We cover the implant helps attract docs to the outpatient setting making those investments is still a huge win for them and so we expect yes, while there is some pressure on the Medicare side I think.
It's kind of play out over time, whether the rate they have a sustainable and it actually moves in us business is what they really want to do is take advantage of that huge gap right. So whether they they go to 8600, eventually 10 Grand where that number is their savings is large and so they're trying to find that spot I will tell you on the payer side, they see that large opportunity as well and it's our job to make sure we get.
Fairly and capture some of the value that we can create so we see it is a huge when I would agree with weighing that just having a stake in the ground and saying you know what outpatient probably a place a lot of these proceeds should be certainly changes the dialogue.
Brian .
One thing on to that you know as you think about the rates here. We believed that we can make money, but this has got to be in and non core right and that's the very simple way I'm thinking about it. This is got to be a positive to volume in bringing procedures in and filling space that we might not otherwise utilized.
For where were making more marginal dollars versus lower contribution procedures right and Thats I think part of the reason why we're still also cautious about 2020 in the ramp is that we want to make sure that we're actively managing this to achieve that and result.
No. It makes a lot and my last question I think about Idaho Falls you you mentioned that in your prepared remarks, how should I think about the ramp or the drag from that in 2020 on.
EBITDA.
So the EBITDA drag in 2020 is going to be excluded from adjusted EBITDA as a startup cost and as we've done every quarter. This year, we've highlighted what that is going to be for investors.
It could be 10 plus million dollars next year and I think that it will be in that same ZIP code as we hit a lot of as the facility opens and we look at what 2019 will be from a EBITDA drag with a lot of that obviously occurring this in the fourth quarter.
Any on the ISO throw in there, having having opened up a number of new hospitals, you I've never seen a hospital in year. One go positive. It's always a it's going to be a drag profile, but I will tell you that the turnaround here, we expect thats market, given our context and given our strong position in the market already our strong value position, even with this new hospital, it's right for a new hospital weeks.
To be a relatively quick ramp, but obviously every hospital has a period of time. It goes through that has to build so.
And Brian we want to see what the what their trajectory looks like we want to see how quickly. It gets less facility gets licensed and work with the the team out there who has done a yeoman's effort in getting into this stage, but theres a lot of variables in play right now and I'm being cautiously.
Cautious in what I tell you right now because we want them, we want to see what this looks like when it opens and how quickly it looks like it's going to ramp before we give any real projections or baseline for what this could look like next year.
Hi, thank guys.
Our next question comes from the line of Frank Morgan with RBC. Please proceed with your question.
Good morning, I'll stick with Idaho Falls for just a second would you remind me I think that facilities going to be leased but.
Did in terms of is that correct and then number two.
With regard to your leverage calculations in your covenants does the startup losses on those facilities I'm, assuming it does get excluded from covenant calculations.
And then the second question you mentioned, the Montana opportunity I, just love a little more color. There in terms of what you see as the EBITDA opportunity the capital deployed that required in that market and just any more color in detail on how much you think that could contribute in 2020. Thanks.
Yes, let me start with Idaho, and then I can answer Montana or or Wayne can but the.
Idaho, Yes medical properties Trust was kind enough to construct the building in the new parking garage for us.
And so when we take possession of that facility, we will have a lease payment that will essentially be accounted for as interest.
For the vast majority of that payment, but it will show up in the depth schedule as a financing lease and our current estimate on that as that it will be about $105 million plus or minus we obviously need to finalize the calculations once we take possession.
And then don't forget we do we do have a very attractive facility that we have put in place.
In Idaho for the equipment to help.
For that facility and so that'll be just shy of $30 million as well and we expect that.
In the fourth quarter that that facility will be pretty close to fully drawn as we outfit the new facility.
The the losses, our current interpretation of the credit agreement is exactly how you put it the losses are eligible to be excluded.
And big but the cost we're taking the debt in we're trying to.
Retry its matching principal essentially you are tapping the debt under balance sheets, you're trying to give a sense as to what the contribution from that is.
And we'll as we finalize those projections will give you a better sense as to what that is when we report the fourth quarter, but we've given you at least some benchmarks as to the type of opportunity that we're expecting over the course of the next few years and it will be deleveraging dip.
But broke integrate panels you guys just to just a little bit of background. There of this is a market where we have a lot of experience already so we were already.
Majority owner in the hospital system, we were an owner in the AMC and then there was also the clinic in the market and if you have a little bit history here, It's 100 year plus physician clinics. So it's a very well established market.
There was some opportunities, though we thought that we could really deploy especially with what we saw a lot of the growth going in the market and similar to what we did in Idaho Falls. We saw this is probably unique opportunity to start building a broader ecosystem in so step one for us was really to.
Get more ownership in the hospitals that we could syndicate to more doctors that we would like to syndicate also we took over full ownership then of the AMC, which allows us to get the NHL PD rates since it is on campus and so there's some what I would call low hanging synergies that will be able to start driving value now you will start to see some of that value next year.
EBITDA growth, but the real meaningful value will be in 2021, we can kind of the full year run rate of the ramp up.
That will do because obviously preparing the facility for each of PD requires different AC equipment different there is just different things we have to do that being said the capital improvements that we had to do in the capital deployed to we've already done this year and so I think it's really just and we've already committed and and so I don't think you'll see much more cap cash flow outlay going into next year's just rather.
Executing on our plans and where we're going future cash flow outlay would be if we do something somewhat Idaho falls, but I think our first but is let's go get the low hanging fruit in the synergies that are available to us.
We've got some good rates in that market. We've got some really strong physicians that are that we'd like to syndicate and.
We think this will be a good ramp up a good story starting both next year, a plus we'll start to get the full value of owning more of the hospital for the pieces that we retain that we don't syndicate.
Okay. Thank you.
Our final question comes from the line of Whit Mayo with you. We ask please proceed with your question.
Hey, Thanks, I'll just stick with one question I wanted to go back to the.
Three strategic initiatives that Wayne discuss procurement revenue cycle DNA I think these are areas that have been called out for some time I'm. Just wondering specifically maybe what's changed are you finding new cost opportunities are there opportunities within the opportunities I just want to make sure that I'm processing. These these three initiatives appropriately.
Yes, So let me let me first start with all three of the initiatives and the easiest analogy I can give you as a nine inning baseball game and I would say we're in the third inning right of opportunity I mean, we're far from what this company is capable of doing.
The first year, just as a reminder, last year when when this new management team joined support and recognize that despite the 125 plus facilities. There was no centralized procurement function. So just moving to a centralized procurement function, establishing a GPO getting new contracted rates all low hanging fruit, but things you would expect of accompany of our site.
Yes, and scale rolling that out across the facilities took time to so thats whats happened now we're moving to just a very simplification of evolution, which is okay. Now how do we get we hadn't even move to kind of preferred implants are preferred pricing. We were just simply getting better pricing due to the lack of leveraging scale and so I would just say that on the procurement front we have nothing.
Out of 20, new initiatives that are constantly in front of us that are kind of the next round of low hanging fruit, we're going after on the RCM front as a reminder.
We had so many divergent systems that were submitting claims in so many different ways with the ability to actually go out and and actually put in true RCM management best practices was completely hindered by the lack of consolidation of platforms.
Last year through the end of last year and then early this year, we now have over 95% of our facilities. All on a single claims processing platform consistently processing through the claims clearing house and warehouse and then with that data now we can actually take actions audit and so again I would tell you very low hanging fruit that we've been going after last year was the and.
And your this year was the execution year, but even on the execution interest arts opening our eyes to more more opportunities and then finally LNG M&A front. If you can imagine where we read on the maturity curve on procurement in RCM. It was the same same thing last year was we had no centralized benefit plan I mean, we had 24 different health plans for a company that was self insured right. Obviously, we made that too.
Transition last year in those value creation comes through this year now we can get more creative and benefit design. So theres always like this evolution that were end, but I would say words were still very early innings I'd say two years and we're in the one of the third any known we still got another six settings to goal of opportunity just in those three arenas.
Okay. That's helpful.
Thanks for the question really thanks for Everybodys time today I know this has been an interesting journey the last to 18 months.
Almost 20 months styles, we kind of been laying out to where we were going to take the company I know as a management team. We're very excited about the progress than where we're at.
Even more excited about hosting an IR day, which will publish more information regarding next year, we plan to give us a five year outlook and really share with you a lot of exciting things we've been doing and building. This platform assets before we conclude our call, though I do want to take a moment to thank our 10000, plus associates and our 4000 plus physicians for their contributions I feel.
Privileged to be able to participate in this journey of improving healthcare make you more affordable for Americans as we execute against our goal to become the preferred partner for operating short stay surgical facilities across the US. It is really the daily efforts of each and every surgery partners employee and physician that gets us there.
Thanks for joining our call this morning and have a great day.
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation and have a wonderful day.