|
| | |
April 15, 2018 to April 14, 2019 | 106.656 | % |
April 15, 2019 to April 14, 2020 | 104.438 | % |
April 15, 2020 and thereafter | 100.000 | % |
16If Surgery Center Holdings, Inc., experiences a change in control under certain circumstances, it must offer to purchase the notes at a purchase price equal to 101.000% of the principal amount, plus accrued and unpaid interest to, but excluding, the date of repurchase. The change of control as discussed in Note 1. "Organization", did not trigger repurchase.
The 2021 Unsecured Notes contain customary affirmative and negative covenants, which among other things, limit the Company’s ability to incur additional debt, pay dividends, create or assume liens, effect transactions with its affiliates, guarantee payment of certain debt securities, sell assets, merge, consolidate, enter into acquisitions and effect sale and leaseback transactions.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(Unaudited)
In connection with the offering(1)Includes amortization of the 2021 Unsecured Notes, the Company recorded debt issuance costs of $8.4 million in the Predecessor period, which were eliminated with the application of pushdown accounting.
Senior Unsecured Notes due 2025
Effective June 30, 2017 (Predecessor), SP Finco, LLC, a wholly owned subsidiary of Surgery Center Holdings, Inc., issued $370.0 million in gross proceeds of senior unsecured notes due July 1, 2025 (the "2025 Unsecured Notes"), which gross proceeds were deposited in an escrow account (the “Escrow Account”) established at Wilmington Trust, National Association (in such capacity, the “Escrow Agent”) in the name of the trustee under the indenture governing the 2025 Unsecured Notes (the “2025 Unsecured Notes Indenture”) on behalf of the holders of the 2025 Unsecured Notes. The 2025 Unsecured Notes bear interest at the rate of 6.750% per year, payable semi-annually on January 1accumulated OCI related to de-designated and July 1 of each year, commencing on January 1, 2018.
In connection with the closing of the NSH Merger and the release of the proceeds from the Escrow Account, both of which occurred on August 31, 2017 (Predecessor), SP Finco, LLC merged with and into Surgery Center Holdings, Inc., with Surgery Center Holdings, Inc. surviving such merger and assuming, by operation of law, the rights and obligations of SP Finco, LLC under the 2025 Unsecured Notes and the indenture governing such notes. As of such time, the 2025 Unsecured Notes became guaranteed on a senior unsecured basis by each of Surgery Center Holdings, Inc.’s domestic wholly owned restricted subsidiaries that guarantees Surgery Center Holdings, Inc.’s senior secured credit facilities (subject to certain exceptions).
The Company may redeem up to 40% of the aggregate principal amount of the 2025 Unsecured Notes at any time prior to July 1, 2020, with the net cash proceeds of certain equity issuances at a redemption price equal to 106.750% of the principal amount to be redeemed, plus accrued and unpaid interest to, but excluding, the date of redemption, provided that at least 50% of the aggregate principal amount of the 2025 Unsecured Notes remain outstanding immediately after the occurrence of such redemption and such redemption occurs within 180 days of the date of the closing of the applicable equity offering.
The Company may redeem the 2025 Unsecured Notes, in whole or in part, at any time prior to July 1, 2020, at a price equal to 100.000% of the principal amount to be redeemed plus the applicable premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company may redeem the 2025 Unsecured Notes, in whole or in part, at any time on or after July 1, 2020, at the redemption prices set forth below (expressed as a percentage of the principal amount to be redeemed), plus accrued and unpaid interest, if any, to, but excluding, the date of redemption:
|
| | |
July 1, 2020 to June 30, 2021 | 103.375 | % |
July 1, 2021 to June 30, 2022 | 101.688 | % |
July 1, 2022 and thereafter | 100.000 | % |
If Surgery Center Holdings, Inc. experiences a change in control under certain circumstances, it must offer to purchase the 2025 Unsecured Notes at a purchase price equal to 101.000% of the principal amount, plus accrued and unpaid interest to, but excluding, the date of repurchase.
The 2025 Unsecured Notes contain customary affirmative and negative covenants, which, among other things, limit the Company’s ability to incur additional debt, pay dividends, create or assume liens, effect transactions with its affiliates, guarantee payment of certain debt securities, sell assets, merge, consolidate, enter into acquisitions and effect sale and leaseback transactions.
In connection with the offering of the 2025 Unsecured Notes, the Company recorded debt issuance costs of $17.3 million in the Predecessor period, which were eliminated with the application of pushdown accounting.
Subordinated Notes
On August 3, 2017 the Company redeemed in whole a subordinated debt facility of $1.0 million with a maturity date of August 4, 2017 and anterminated interest rate swaps of 17.00% per annum, at a price equal 100% of$5.4 million for the $1.0 million principal amount redeemed, plus accrued and unpaid interest.
Notes Payable and Secured Loans
Certain of the Company’s subsidiaries have outstanding bank indebtedness, which is collateralized by the real estate and equipment owned by the surgical facilities to which the loans were made. The various bank indebtedness agreements contain covenants to maintain certain financial ratios and also restrict encumbrance of assets, creation of indebtedness, investing activities and payment of distributions. Atthree months ended September 30, 2017 (Successor), the Company was in compliance with its covenants contained in the credit agreements. The Company2022 and its subsidiaries had notes payable2021. Includes amortization of accumulated OCI related to financial institutionsde-designated and terminated interest rate swaps of $113.5$16.0 million and $42.5$8.6 million as offor the nine months ended September 30, 2017 (Successor)2022 and December 31, 2016 (Predecessor),2021, respectively. The Company and its subsidiaries also provide a corporate guarantee of certain indebtedness of the Company’s subsidiaries.
Capital Lease Obligations
The Company is liable to various vendors for several equipment leases classified as capital leases. The carrying value of the leased assets was $19.2 million and $15.4 million as of September 30, 2017 (Successor) and December 31, 2016 (Predecessor), respectively.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(Unaudited)
5. Redeemable Preferred Stock
On August 31, 2017, the Company issued 310,000 shares of Series A Preferred Stock to Bain at a purchase price of $1,000 per share for an aggregate purchase price of $310.0 million. The net proceeds from the Preferred Private Placement (as defined in Note 1. "Organization") were used to finance a portion of the NSH Merger.
The accrued value of the Series A Preferred Stock is convertible into shares of Common Stock at a price per share of Common Stock equal to $19.00, subject to certain adjustments as provided in the Certificate of Designations, Preferences, Rights and Limitations of the 10.00% Series A Convertible Perpetual Participating Preferred Stock of Surgery Partners, Inc. (the “Series A Certificate of Designation”), at any time at the option of the holder. In addition, the Company may require the conversion of all, but not less than all, of the Series A Preferred Stock pursuant to the terms and conditions of the Series A Certificate of Designation, after the second anniversary of the date of issuance, if the volume weighted average closing price of the Common Stock for any twenty out of thirty consecutive trading days prior to such date, equals or exceeds $42.00 per share.
The Company cannot redeem the Series A Preferred Stock prior to the fifth anniversary of its issuance and thereafter, may redeem all, but not less than all, of the Series A Preferred Stock for cash pursuant to and subject to the terms and conditions of the Series A Certificate of Designation. The holders of Series A Preferred Stock may cause the Company to redeem the Series A Preferred Stock upon the occurrence of certain change of control transactions of the Company or the Common Stock ceasing to be listed or quoted on a trading market. The Company adjusts the carrying amount of the Series A Preferred Stock to equal the redemption value at the end of each reporting period as if it were also the redemption date. Changes in the redemption value are recognized immediately as they occur.
The Series A Preferred Stock ranks senior to the Common Stock and any other capital stock of the Company with respect to dividends, redemption and any other rights upon the liquidation, dissolution or winding up of the Company, and the holders thereof are entitled to vote with the holders of Common Stock, together as a single class, on all matters submitted to a vote of the Company’s stockholders. In addition to participating in any dividends that may be declared with respect to the Common Stock on an as-converted basis, each share of Series A Preferred Stock accrues dividends daily at a dividend rate of 10.00%, compounding quarterly, and in any given quarter, subject to certain conditions, the Board of Directors of the Company may declare a cash dividend in an amount up to 50% of the amount of the dividend that has accrued and accumulated during such quarter through the end of such quarter, and the amount of any quarterly dividend paid in cash shall not compound on the applicable date and shall not be included in the accrued value of the Series A Preferred Stock. In the event of the Company’s liquidation, dissolution or winding-up (whether voluntary of involuntary), holders of Series A Preferred Stock will be entitled to receive out of the assets of the Company available for distribution to shareholders, after satisfaction of any liabilities and obligations to creditors of the Company, with respect to each Series A Preferred Share, an amount equal to the greater of (i) $1,000.00 per share, plus dividends compounded to date, plus dividends accrued but not yet compounded and (ii) the amount that a holder of one share of Common Stock would receive, assuming the Series A Preferred Stock had converted into shares of Common Stock.
In connection with the issuance of Series A Preferred Stock in the Preferred Private Placement, the Company incurred issuance costs of $18.3 million in the Predecessor period, which were eliminated with the application of pushdown accounting.
A summary of activity related to the redeemable preferred stock for the period from September 1, 2017 to September 30, 2017 (Successor) follows (in thousands):
|
| | | | |
| Successor | | |
| Balance at September 1, 2017 | | $ | 310,000 |
|
| Dividends accrued | | 2,633 |
|
| Cash dividends declared | | (1,316 | ) |
| Mark to redemption adjustment | | 15,566 |
|
| Balance at September 30, 2017 | | $ | 326,882 |
|
6. Earnings Per Share
Basic and diluted earnings per share are calculated in accordance with ASC 260, Earnings Per Share, based on the weighted-average number of shares outstanding in each period and dilutive stock options, unvested shares and warrants, to the extent such securities exist and have a dilutive effect on earnings per share. Beginning in the Successor period, in connection with the issuance of the Series A Preferred Stock, theThe Company began computingcomputes basic and diluted earnings per share using the two-class method. The two-class method of computing earnings per share is an earnings allocation method that determines earnings per share for common shares and participating securities according to their participation rights in dividends and undistributed earnings. Refer to Note 5. "Redeemable Preferred Stock", for further disclosure of the terms and conditions, including the participation rights, of the Series A Preferred Stock.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(Unaudited)
A reconciliation of the numerator and denominator of basic and diluted earnings per share for the period from January 1, 2017 to August 31, 2017 (Predecessor) and the period from September 1, 2017 to September 30, 2017 (Successor) follows (in thousands(dollars in millions, except share and per share amounts)amounts; shares in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Numerator: | | | | | | | |
| Net loss attributable to Surgery Partners, Inc. | $ | (25.0) | | | $ | (22.9) | | | $ | (31.2) | | | $ | (70.8) | |
Less: amounts allocated to participating securities (1) | — | | | — | | | — | | | (10.3) | |
| Net loss attributable to common stockholders | $ | (25.0) | | | $ | (22.9) | | | $ | (31.2) | | | $ | (81.1) | |
| | | | | | | |
| Denominator: | | | | | | | |
| Weighted average shares outstanding- basic | 88,907 | | | 80,726 | | | 88,604 | | | 68,350 | |
Weighted average shares outstanding- diluted (2) | 88,907 | | | 80,726 | | | 88,604 | | | 68,350 | |
| | | | | | | |
| Loss per share: | | | | | | | |
| Basic | $ | (0.28) | | | $ | (0.28) | | | $ | (0.35) | | | $ | (1.19) | |
Diluted (2) | $ | (0.28) | | | $ | (0.28) | | | $ | (0.35) | | | $ | (1.19) | |
| | | | | | | |
| Dilutive securities outstanding not included in the computation of loss per share as their effect is antidilutive: | | | | | | | |
| Stock options | 1,323 | | | 1,974 | | | 1,527 | | | 1,927 | |
| Restricted shares | 604 | | | 1,461 | | | 669 | | | 1,444 | |
|
| | | | | | | | | | | | | | | | | | | | | | |
| | | Successor | | | | Predecessor | | Predecessor |
| | | September 1 to September 30, | | | | July 1 to August 31, | | Three Months Ended September 30, | | January 1 to August 31, | | Nine Months Ended September 30, |
| | | 2017 | | | | 2017 | | 2016 | | 2017 | | 2016 |
| | | | | | | | | | | | | |
| Numerator: | | | | | | | | | | | | |
| Net loss attributable to Surgery Partners, Inc. | | $ | (9,140 | ) | | | | $ | (4,444 | ) | | $ | (2,338 | ) | | $ | (11,669 | ) | | $ | (7,409 | ) |
Less: amounts allocated to participating securities (1) | | 2,633 |
| | | | — |
| | — |
| | — |
| | — |
|
| Less: mark to redemption adjustment | | 15,566 |
| | | | — |
| | — |
| | — |
| | — |
|
| Net loss attributable to common stockholders | | $ | (27,339 | ) | | | | $ | (4,444 | ) | | $ | (2,338 | ) | | $ | (11,669 | ) | | $ | (7,409 | ) |
| | | | | | | | | | | | | |
| Denominator: | | | | | | | | | | | | |
| Weighted average shares outstanding- basic | | 48,314,746 |
| | | | 48,146,611 |
| | 48,019,652 |
| | 48,121,404 |
| | 48,018,706 |
|
Effect of dilutive securities (2) | | — |
| | | | — |
| | — |
| | — |
| | — |
|
| Weighted average shares outstanding- diluted | | 48,314,746 |
| | | | 48,146,611 |
| | 48,019,652 |
| | 48,121,404 |
| | 48,018,706 |
|
| | | | | | | | | | | | | |
| Loss per share: | | | | | | | | | | | | |
| Basic | | $ | (0.57 | ) | | | | $ | (0.09 | ) | | $ | (0.05 | ) | | $ | (0.24 | ) | | $ | (0.15 | ) |
Diluted (2) | | $ | (0.57 | ) | | | | $ | (0.09 | ) | | $ | (0.05 | ) | | $ | (0.24 | ) | | $ | (0.15 | ) |
| | | | | | | | | | | | | |
| Dilutive securities outstanding not included in the computation of (loss) earnings per share as their effect is antidilutive: | | | | | | | | | | | | |
| Stock options | | — |
| | | | — |
| | 586 |
| | — |
| | 345 |
|
| Restricted shares | | 112,529 |
| | | | 34,506 |
| | 369,545 |
| | 105,944 |
| | 337,915 |
|
| Convertible preferred stock | | — |
| | | | N/A |
| | N/A |
| | N/A |
| | N/A |
|
(1)Amounts allocated to participating securities includesIncludes dividends accrued during the Successor period for the Series A Preferred Stock.Stock for the nine months ended September 30, 2021. The Series A Preferred Stock doesdid not participate in undistributed losses.losses and was converted to common stock during the second quarter of 2021. There were no participating securities duringfor the Predecessor periods.three and nine months ended September 30, 2022 and the three months ended Septemberer 30, 2021.
(2)The impact of potentially dilutive securities for all periods presented was not considered because the effect would be anti-dilutive in each period.anti-dilutive.
7. Other Current Liabilities
A summary of other current liabilities is as follows (in millions):
| | | | | | | | | | | | | | |
| | September 30,
2022 | | December 31,
2021 |
| | | | |
| Deferred consideration payable | | $ | 61.0 | | | $ | — | |
| Right-of-use operating lease liabilities | | 36.8 | | | 40.1 | |
| Interest payable | | 38.3 | | | 29.2 | |
| Amounts due to patients and payors | | 34.1 | | | 26.0 | |
| Cost report liabilities | | 20.3 | | | 26.4 | |
| Tax receivable agreement liability | | 20.2 | | | 19.7 | |
| Accrued expenses and other | | 81.1 | | | 68.6 | |
| Total | | $ | 291.8 | | | $ | 210.0 | |
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. Commitments and Contingencies
Professional, General and Workers' Compensation Liability Risks
The Company is subject to claims and legal actions in the ordinary course of business, including claims relating to patient treatment, employment practices and personal injuries. To cover these claims, theThe Company maintains professional, general liability and professionalworkers' compensation liability insurance in excess of self-insured retentions through third party commercial insurance carriers in amounts thatcarriers. Although management believes the coverage is sufficient for the Company's operations, although, potentially, some claims may potentially exceed the scope of coverage in effect. The professional and general insurance coverage is on a claims-made basis. Workers' compensation insurance is on an occurrence basis. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. The Company is not aware of any such proceedings that wouldare reasonably possible to have a material adverse effect on the Company's business, financial position, results of operations or liquidity.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBERSeptember 30, 2017
(Unaudited)
2022 and December 31, 2021 were $16.7 million and $19.8 million, respectively. Expected insurance recoveries of $8.7 million as of both September 30, 2022 and December 31, 2021 are included as a component of other current assets and other long-term assets in the condensed consolidated balance sheets.
Laws and Regulations
Laws and regulations governing the Company's business, including those relating to the Medicare and Medicaid programs, are complex and subject to interpretation. These laws and regulations govern every aspect of how the Company's surgical facilities conduct their operations, from licensing requirements to how and whether the Company's facilities may receive payments pursuant to the Medicare and Medicaid programs. Compliance with such laws and regulations can be subject to future government agency review and interpretation as well as legislative changes to such laws. Noncompliance with such laws and regulations may subject the Company to significant regulatory actionsanctions including fines, penalties, and exclusion from the Medicare, Medicaid and other federal healthcarehealth care programs. From time to time, governmental regulatory agencies will conduct inquiries of the Company's practices, including, but not limited to, the Company's compliance with federal and state fraud and abuse laws, billing practices and relationships with physicians. It
Stockholder Litigation
On December 4, 2017, a purported Company stockholder filed an action in the Delaware Court of Chancery (the "Delaware Action"). That action is captioned Witmer v. H.I.G. Capital, L.L.C., et al., C.A. No. 2017-0862. The plaintiff in the Company'sDelaware Action asserted claims against (i) certain current practice and future intentformer members of the Company’s Board of Directors (together, the "Directors"); (ii) H.I.G. Capital, LLC and certain of its affiliates (collectively, "H.I.G."); and (iii) Bain Capital Private Equity, L.P. and certain of its affiliates (collectively, "Bain Capital" and, together with the Directors and H.I.G., the "Defendants"). The parties to cooperate fullythe Delaware Action negotiated a final stipulation of settlement (the “Settlement Stipulation”), which governs the terms of the settlement of the Delaware Action, and which they filed with such inquiries.the Court of Chancery on November 22, 2021. On February 11, 2022, the Court of Chancery approved the settlement of the Delaware Action as memorialized in the Settlement Stipulation. That decision became final and non-appealable on March 14, 2022. The Companycase is not aware of any such inquiry that would have a material adverse effect onnow closed. Pursuant to the Company's business, financial position, results of operations or liquidity. In addition, on October 23, 2017,settlement, the Company received a civil investigative demand (“CID”) from$32.8 million in March 2022, which was included in litigation settlement in the federal government undercondensed consolidated statements of operations for the False Claims Act (“FCA”) for documents and information dating back to January 1, 2010 relating to the medical necessity of certain drug tests conducted by the Company’s physicians and submitted to laboratories owned and operated by the Company. The Company intends to respond to the CID and cooperate with the U.S. Attorney’s Office in connection with the FCA investigation.nine months ended September 30, 2022.
Acquired Facilities
The Company, through its wholly-owned subsidiaries or controlled partnerships and limited liability companies, has acquired and will continue to acquire surgical facilities with prior operating histories. Such facilities may have unknown or contingent liabilities, including liabilities for failure to comply with healthcarehealth care laws and regulations, such as billing and reimbursement laws and regulations, the Stark Law, the Anti-Kickback Statute, the FCA, and similar fraud and abuse and similar anti-referral laws. Although the Company attempts to assure that no such liabilities exist, obtain indemnification from prospective sellers covering such matters and institute policies designed to conform centers to its standards following completion of acquisitions, there can be no assurance that the Company will not become liable for past activities that may later be asserted to be improper by private plaintiffs or government agencies. There can be no assurance that any such matter will be covered by indemnification or, if covered, that the liability sustained will not exceed contractual limits or the financial capacity of the indemnifying party.
The Company cannot predict whether federal or state statutory or regulatory provisions will be enacted that would prohibit or otherwise regulate relationships which the Company has established or may establish with other healthcarehealth care providers or have materially adverse effects on its business or revenues arising from such future actions. Management believes, however, that it will be able to adjust the Company's operations so as to be in compliance with any statutory or regulatory provision as may be applicable.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Potential Physician Investor Liability
A majority of the physician investors in the partnerships and limited liability companies which operate the Company's surgical facilities carry general and professional liability insurance on a claims-made basis. Each partnership or limited liability company may, however, be liable for damages to persons or property arising from occurrences at the surgical facilities. Although the various physician investors and other surgeons generally are required to obtain general and professional liability insurance with tail coverage that extends beyond the period of any claims-made policies, such individuals may not be able to obtain coverage in amounts sufficient to cover all potential liability. Since most insurance policies contain exclusions, the physician investors will not be insured against all possible occurrences. In the event of an uninsured or underinsured loss, the value of an investment in the partnership interests or limited liability company membership units and the amount of distributions could be adversely affected.
Contingent ConsiderationTax Receivable Agreement
Pursuant to a purchase agreement dated December 24, 2009 (“the Purchase Agreement”),On May 9, 2017, the Company acquired controlling interests in 36 business entities in various Florida locationsentered into an agreement to amend that certain Income Tax Receivable Agreement, dated September 30, 2015 (as amended, the "TRA"), by and between the Company, and the other parties referred to therein, which operate freestanding ASCs and provided anesthesia and pain management services (“the 2009 Acquisition”). The Purchase Agreement provided for maximum potential contingent consideration of up to $10.0 million basedamendment became effective on operating results subsequent to the acquisition for the period from January 1, 2010 to DecemberAugust 31, 2010.2017. Pursuant to the Purchase Agreement,amendment to the contingent considerationTRA, the Company agreed to make payments to H.I.G., the Company's former controlling shareholder, in its capacity as the stockholders representative pursuant to a fixed payment schedule. The amounts payable under the TRA are calculated as the product of (i) an annual base amount and (ii) the maximum corporate federal income tax rate for the applicable year plus three percent. The amounts payable under the TRA are related to the Company’s projected realized tax savings over the next five years and are not dependent on the Company’s actual tax savings over such period. The calculation of amounts payable pursuant to the TRA is thus dependent on the maximum corporate federal income tax rate. To the extent that the Company is unable to make payments under the TRA, such payments will be deferred and will accrue interest at a rate of the LIBOR plus 500 basis points until paid. If the terms of credit agreements and other debt documents cause the Company to be unable to make payments under the TRA and such terms are not materially more restrictive than those existing as of September 30, 2015, such payments will be deferred and will accrue interest at a rate of LIBOR plus 300 basis points until paid.
Assuming the Company's tax rate is 24%, calculated as the maximum corporate federal tax rate plus three percent, throughout the remaining term of the TRA, the Company estimates the total remaining amounts payable under the TRA was approximately $22.0 million as principal under a Subordinated Promissory Note, the form of which was delivered concurrent with the Purchase Agreement. The balance remains outstanding due to ongoing litigation asboth September 30, 2022 and December 31, 2021. As a result of a civil claim.the amendment to the TRA, the Company was required to value the liability under the TRA by discounting the fixed payment schedule using the Company’s incremental borrowing rate. The Company has made indemnification claims against the seller exceeding the amountcarrying value of the contingent consideration liability whichunder the Company has a contractual right of offset against. Based on a court order in December 2016,TRA, reflecting the Company removed the contingent consideration liability on its consolidated balance sheets at December 31, 2016 (Predecessor). On April 20, 2017, a settlementdiscount, was reached between the two parties resulting in the Company receiving $3.9$21.3 million of which $2.7and $19.7 million was paid from the escrow funds set up at the time of purchase and $1.2 million was paid by the seller. During the second quarter (Predecessor) the Company recorded a gain on litigation settlement of $3.8 million for the settlement amount, net of legal costs.
In connection with an acquisition during the three months ended June 30, 2016, pursuant to the applicable purchase agreement, the Company must pay consideration to the prior owners of the applicable facility should the requirements for continuing employment agreed to in the purchase agreement be met. Asas of September 30, 2017 (Successor),2022 and December 31, 2021, respectively. The current portion of the Company estimates it may have to pay $15.7liability was $20.2 million in future contingent acquisition compensation expense over the remaining performance periods. The contingent acquisition compensation expenseand $19.7 million as of September 30, 2022 and December 31, 2021, respectively, and is recognizedincluded as a component of general and administrative expenseother current liabilities in the condensed consolidated statementsbalance sheets. The long-term portion is included as a component of operations and was $1.2 million and $5.1 million forother long-term liabilities in the two and eight months ended August 31, 2017 (Predecessor), respectively and $605,000 for the one month ended
condensed consolidated balance sheets.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(Unaudited)
September 30, 2017 (Successor). For the prior year, contingent acquisition compensation expense was $1.5 million and $3.1 million for the three and nine months ended September 30 2016, respectively.
8.9. Segment Reporting
A public company is required to report annual and interim financial and descriptive information about its reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or "CODM," in deciding how to allocate resources and in assessing performance.
The Company currently operates in threetwo major lines of business that are also the Company's reportable operating segments - the operation of surgical facilities the operation of optical services and the operation of ancillary services, which includesservices. The Surgical Facility Services segment consists of the operation of ASCs, surgical hospitals and anesthesia services. The Ancillary Services segment consists of multi-specialty physician practices, a diagnostic laboratory and a specialty pharmacy.practices. The "All other" line item primarily consists of the Company's corporate general and administrative functions.
Adjusted EBITDA is the primary profit/loss metric reviewed by the CODM in making key business decisions and on allocation of resources. The segment disclosures below provide a reconciliation from Adjusted EBITDA to income before income taxes, its most directly comparable GAAP financial measure, in the reported condensed consolidated financial information.
The following tables present financial information for each reportable segment (in thousands)millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Revenues: | | | | | | | | |
| Surgical Facility Services | | $ | 603.9 | | | $ | 542.1 | | | $ | 1,780.6 | | | $ | 1,563.7 | |
| Ancillary Services | | 16.7 | | | 17.1 | | | 51.6 | | | 51.2 | |
| Total | | $ | 620.6 | | | $ | 559.2 | | | $ | 1,832.2 | | | $ | 1,614.9 | |
| | | | | | | | |
| Adjusted EBITDA: | | | | | | | | |
| Surgical Facility Services | | $ | 110.2 | | | $ | 96.9 | | | $ | 319.9 | | | $ | 287.5 | |
| Ancillary Services | | (1.5) | | | — | | | (2.2) | | | (1.0) | |
| All other | | (12.5) | | | (20.5) | | | (58.3) | | | (61.3) | |
| Total | | $ | 96.2 | | | $ | 76.4 | | | $ | 259.4 | | | $ | 225.2 | |
| | | | | | | | |
| Reconciliation of Adjusted EBITDA: | | | | | | | | |
| Income before income taxes | | $ | 13.4 | | | $ | 9.4 | | | $ | 77.1 | | | $ | 26.5 | |
| | | | | | | | |
| Net income attributable to non-controlling interests | | (30.6) | | | (31.1) | | | (94.9) | | | (98.6) | |
| Depreciation and amortization | | 29.8 | | | 25.2 | | | 85.2 | | | 76.1 | |
| Interest expense, net | | 60.7 | | | 54.2 | | | 173.9 | | | 160.9 | |
| Equity-based compensation expense | | 5.0 | | | 4.1 | | | 13.0 | | | 13.4 | |
Transaction, integration and acquisition costs (1) | | 13.1 | | | 10.2 | | | 28.4 | | | 31.0 | |
| Loss on disposals and deconsolidations, net | | 2.2 | | | 1.9 | | | 3.2 | | | 2.0 | |
Loss (gain) on litigation settlement and other litigation costs (2) | | 1.5 | | | 2.5 | | | (27.6) | | | 4.3 | |
| (Gain) loss on debt extinguishment | | — | | | (0.5) | | | — | | | 9.1 | |
Hurricane-related impacts (3) | | 1.1 | | | 0.5 | | | 1.1 | | | 0.5 | |
| Adjusted EBITDA | | $ | 96.2 | | | $ | 76.4 | | | $ | 259.4 | | | $ | 225.2 | |
|
| | | | | | | | | | | | | | | | | | | | | | |
| | | Successor | | | | Predecessor | | Predecessor |
| | September 1 to September 30, | | | | July 1 to August 31, | | Three Months Ended September 30, | | January 1 to August 31, | | Nine Months Ended September 30, |
| | 2017 | | | | 2017 | | 2016 | | 2017 | | 2016 |
| Revenues: | | | | | | | | |
|
|
|
|
| Surgical facility services | | $ | 125,595 |
| | | | $ | 167,765 |
| | $ | 256,795 |
|
| $ | 688,725 |
|
| $ | 766,248 |
|
| Ancillary services | | 5,775 |
| | | | 4,409 |
| | 22,684 |
|
| 52,261 |
|
| 62,967 |
|
| Optical services | | 888 |
| | | | 1,905 |
| | 3,203 |
|
| 7,629 |
|
| 10,222 |
|
| Total revenues | | $ | 132,258 |
| | | | $ | 174,079 |
| | $ | 282,682 |
|
| $ | 748,615 |
|
| $ | 839,437 |
|
This amount includes transaction and integration costs of $27.8 million and $24.7 million for the nine months ended September 30, 2022 and 2021, respectively. This amount further includes start-up costs related to de novo surgical facilities of $0.6 million and $6.3 million for the nine months ended September 30, 2022 and 2021, respectively.
(2)This amount includes other litigation costs of $1.5 million and $2.5 million for the three months ended September 30, 2022 and 2021, respectively.
This amount includes other litigation costs of $5.2 million and $4.3 million for the nine months ended September 30, 2022 and 2021, respectively. This amount also includes gain on litigation settlement of $32.8 million for the nine months ended September 30, 2022.
(3) Reflects losses incurred, net of insurance proceeds received at certain surgical facilities that were closed following Hurricane Ida in September 2021 and Hurricane Ian in September 2022.
| | | | | | | | | | | | | | |
| | September 30,
2022 | | December 31,
2021 |
| Assets: | | | | |
| Surgical Facility Services | | $ | 5,915.0 | | | $ | 5,552.8 | |
| Ancillary Services | | 42.4 | | | 47.5 | |
| All other | | 579.1 | | | 517.3 | |
| Total assets | | $ | 6,536.5 | | | $ | 6,117.6 | |
|
| | | | | | | | | | | | | | | | | | | | | | |
| | | Successor | | | | Predecessor | | Predecessor |
| | | September 1 to September 30, | | | | July 1 to August 31, | | Three Months Ended September 30, | | January 1 to August 31, | | Nine Months Ended September 30, |
| | | 2017 | | | | 2017 | | 2016 | | 2017 | | 2016 |
| Adjusted EBITDA: | | | | | | | | | | | | |
| Surgical facility services | | $ | 20,947 |
| | | | $ | 27,726 |
| | $ | 53,347 |
| | $ | 125,912 |
| | $ | 153,318 |
|
| Ancillary services | | (1,265 | ) | | | | (10,737 | ) | | 2,573 |
| | (6,526 | ) | | 9,141 |
|
| Optical services | | 193 |
| | | | 555 |
| | 1,276 |
| | 2,214 |
| | 3,004 |
|
| All other | | (5,033 | ) | | | | (9,142 | ) | | (12,448 | ) | | (36,036 | ) | | (36,258 | ) |
Total Adjusted EBITDA (1) | | 14,842 |
| | | | 8,402 |
| | 44,748 |
| | 85,564 |
| | 129,205 |
|
| | | | | | | | | | | | | |
| Net income attributable to non-controlling interests | | 6,492 |
| | | | 8,813 |
| | 16,672 |
| | 42,087 |
| | 54,392 |
|
| Depreciation and amortization | | (3,330 | ) | | | | (7,599 | ) | | (9,713 | ) | | (30,124 | ) | | (28,984 | ) |
| Interest expense, net | | (15,883 | ) | | | | (18,147 | ) | | (26,475 | ) | | (68,929 | ) | | (74,863 | ) |
| Non-cash stock compensation expense | | (1,683 | ) | | | | (1,628 | ) | | (691 | ) | | (3,697 | ) | | (1,326 | ) |
| Contingent acquisition compensation expense | | (605 | ) | | | | (1,210 | ) | | (1,530 | ) | | (5,057 | ) | | (3,060 | ) |
Merger transaction, integration and practice acquisition costs (2) | | (3,457 | ) | | | | (2,949 | ) | | (2,471 | ) | | (7,677 | ) | | (8,579 | ) |
| Gain on litigation settlement | | — |
| | | | — |
| | — |
| | 3,794 |
| | — |
|
| Gain on acquisition escrow release | | — |
| | | | 1,000 |
| | — |
| | 1,000 |
| | — |
|
| Loss on disposal or impairment of long-lived assets, net | | (333 | ) | | | | (114 | ) | | (572 | ) | | (1,715 | ) | | (1,697 | ) |
| Gain on amendment to tax receivable agreement | | 1,098 |
| | | | 15,294 |
| | — |
| | 15,294 |
| | — |
|
| Tax receivable agreement expense | | — |
| | | | — |
| | (3,733 | ) | | — |
| | (3,733 | ) |
| Loss on debt refinancing | | — |
| | | | (18,211 | ) | | (3,595 | ) | | (18,211 | ) | | (11,876 | ) |
| (Loss) income before income taxes | | $ | (2,859 | ) | | | | $ | (16,349 | ) | | $ | 12,640 |
| | $ | 12,329 |
| | $ | 49,479 |
|
(1) The above table reconciles Adjusted EBITDA to income before income taxes as reflected in the unaudited condensed consolidated statements of operations.
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(Unaudited)
When the Company uses the term “Adjusted EBITDA,” it is referring to income before income taxes minus (a) net income attributable to non-controlling interests plus (b) depreciation and amortization, (c) interest expense, net, (d) non-cash stock compensation expense, (e) contingent acquisition compensation expense, (f) merger transaction, integration and practice acquisition costs, minus (g) gain on litigation settlement, (h) gain on acquisition escrow release, plus (i) loss on disposal or impairment of long-lived assets, net, minus (j) gain on amendment to tax receivable agreement, plus (k) tax receivable agreement expense and (l) loss on debt refinancing. The Company uses Adjusted EBITDA as a measure of financial performance. Adjusted EBITDA is a key measure used by the Company’s management to assess operating performance, make business decisions and allocate resources. Non-controlling interests represent the interests of third parties, such as physicians, and in some cases, healthcare systems that own an interest in surgical facilities that the Company consolidates for financial reporting purposes. The Company believes that it is helpful to investors to present Adjusted EBITDA as defined above because it excludes the portion of net income attributable to these third-party interests and clarifies for investors the Company's portion of Adjusted EBITDA generated by its surgical facilities and other operations.
Adjusted EBITDA is not a measurement of financial performance under GAAP, and should not be considered in isolation or as a substitute for net income, operating income or any other measure calculated in accordance with generally accepted accounting principles. The items excluded from Adjusted EBITDA are significant components in understanding and evaluating the Company's financial performance. The Company believes such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. The Company's calculation of Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.
(2) This amount includes merger transaction and integration costs of $3.0 million for the one month ended September 30, 2017 (Successor), $2.3 million and $5.6 million for the two and eight months ended August 31, 2017 (Predecessor), respectively, and $1.9 million and $6.4 million for the three and nine months ended September 30, 2016, respectively.
This amount includes practice acquisition costs of $474,000 for the one month ended September 30, 2017 (Successor), $606,000 and $2.1 million for the two and eight months ended August 31, 2017 (Predecessor), respectively, and $607,000 and $2.2 million for the three and nine months ended September 30, 2016, respectively. | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2022 | | 2021 |
| Cash purchases of property and equipment: | | | | |
| Surgical Facility Services | | $ | 52.8 | | | $ | 42.0 | |
| Ancillary Services | | 0.4 | | | 0.4 | |
| All other | | 4.7 | | | 1.1 | |
| Total cash purchases of property and equipment | | $ | 57.9 | | | $ | 43.5 | |
|
| | | | | | | | | | |
| | | Successor | | | | Predecessor |
| | | September 30,
2017 | | | | December 31,
2016 |
| Assets: | | | | | | |
| Surgical facility services | | $ | 3,969,584 |
| | | | $ | 1,914,842 |
|
| Ancillary services | | 183,288 |
| | | | 184,002 |
|
| Optical services | | 43,451 |
| | | | 22,478 |
|
| Total | | 4,196,323 |
| | | | 2,121,322 |
|
| | | | | | | |
| All other | | 405,531 |
| | | | 183,636 |
|
| Total assets | | $ | 4,601,854 |
| | | | $ | 2,304,958 |
|
|
| | | | | | | | | | | | | | |
| | | Successor | | | | Predecessor |
| | | September 1 to September 30, | | | | January 1 to August 31, | | Nine Months Ended September 30, |
| | | 2017 | | | | 2017 | | 2016 |
| Supplemental Information: | | | | | | | | |
| Cash purchases of property and equipment, net: | | | | | | | | |
| Surgical facility services | | $ | 1,613 |
| | | | $ | 14,582 |
| | $ | 21,151 |
|
| Ancillary services | | 2 |
| | | | 1,875 |
| | 3,450 |
|
| Optical services | | 23 |
| | | | 73 |
| | 323 |
|
| Total | | $ | 1,638 |
| | | | $ | 16,530 |
| | $ | 24,924 |
|
| | | | | | | | | |
| All other | | 202 |
| | | | 2,243 |
| | 3,453 |
|
| Total cash purchases of property and equipment, net | | $ | 1,840 |
| | | | $ | 18,773 |
| | $ | 28,377 |
|
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report and included in our 2021 Annual Report on Form 10-K for the year ended December 31, 2016. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those estimated or projected in any of these forward-looking statements.
10-K. Unless otherwise indicated or the context otherwise requires, referencesindicates, the terms "Surgery Partners," "we," "us," "our" or the "Company," as used herein, to the “Company”, “Surgery Partners”, “we”, “us” and “our” refer: (i) immediately prior to the Reorganization, to Surgery Center Holdings, LLC and its consolidated subsidiaries, including Surgery
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Center Holdings, Inc., (ii) immediately following the Reorganization but immediately prior to the consummation of the NSH Merger,refer to Surgery Partners, Inc. and its consolidated subsidiaries, including Surgery Center Holdings, LLC and Surgery Center Holdings, Inc., and, (iii) immediately following the consummation of the NSH Merger, to Surgery Partners, Inc. and its consolidated subsidiaries, including Surgery Center Holdings, LLC, Surgery Center Holdings, Inc. and NSH.
subsidiaries. Unless the context implies otherwise, the term “affiliates” means direct and indirect subsidiaries of Surgery Partners, Inc., and partnerships and joint ventures in which such subsidiaries are partners. The terms “facilities” or “hospitals” refer to entities owned and operated by affiliates of Surgery Partners, Inc. and the term “employees” refers to employees of affiliates of Surgery Partners, Inc.
Cautionary Note Regarding Forward-Looking Statements
This report contains forward-looking statements, which are based on our current expectations, estimates and assumptions about future events. All statements other than statements of current or historical fact contained in this report are forward-looking statements. These statements include, but are not limited to, statements regarding our future financial position, business strategy, budgets, effective tax rate, projected costs and plans and objectives of management for future operations, as well as our expectations regarding the benefits of the NSH Merger, including the projected synergies thereof, the performance of our business and other non-historical statements.operations. The words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,”"projections," "believe," "continue," "drive," "estimate," "expect," "intend," "may," "plan," "will," "could," "would" and similar expressions are generally intended to identify forward-looking statements. These statements involve risks, uncertainties and other factors that may cause actual results to differ from the expectations expressed in the statements. Many of these factors are beyond our ability to control or predict. These factors include, without limitation:(i) reductions in payments from government healthcare programs and managed care organizations; (ii) inability to contract with private third-party payors; (iii) changes in our payor mix or surgical case mix; (iv) failure to maintain relationships with our physicians; (v) payor controls designed to reducelimitation, the numbereffects of surgical procedures; (vi) inability to integrate operations of acquired surgical facilities, attract new physician partners, or acquire additional surgical facilities; (vii) shortages or quality control issues with surgery-related products, equipment and medical supplies; (viii) competition for physicians, nurses, strategic relationships, acquisitions and managed care contracts; (ix) inability to enforce non-compete restrictions against our physicians; (x) material liabilities incurred as a result of acquiring surgical facilities; (xi) litigation or medical malpractice claims; (xii) changesthe ongoing COVID-19 pandemic in the regulatory, economicUnited States and the regions in which we operate; the impact to the state and local economies of restrictive orders, vaccine and other mandates and the pandemic generally; our ability to respond nimbly to challenging economic conditions, including recent inflationary pressures; the unpredictability of our case volume in the states wherecurrent environment; our surgical facilities are located; (xiii) substantialability to preserve or raise sufficient funds to continue operations throughout this period of uncertainty; the impact of our cost-cutting measures on our future performance; our ability to cause distributions from our subsidiaries; the responsiveness of our payors, including Medicaid and Medicare, to the challenging operating conditions, including their willingness and ability to continue paying in a timely manner and to advance payments we expectin a timely manner, if at all; the impact of COVID-19 related stimulus programs, including the CARES Act, and uncertainty in how these programs may be administered, monitored and modified in the future; our ability to be requiredexecute on our operational and strategic initiatives; the timing and impact of our portfolio optimization efforts; our ability to make undercontinue to improve same-facility volume and revenue growth on the TRA;timeline anticipated, if at all; our ability to successfully integrate acquisitions; the anticipated impact and (xiv)timing of our ongoing efficiency efforts; the impact of adverse weather conditions and other events outside of our control; and the risks and uncertainties described in this report, and set forth under the heading “Risk Factors”"Risk Factors" in our Quarterly2021 Annual Report on Form 10-Q for the period ended June 30, 2017, filed with the Securities and Exchange Commission on August 9, 201710-K and discussed from time to time in our reports filed with the SEC.
In light ofConsidering these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur, and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report.
These forward-looking statements speak only as of the date made. Other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a resultbecause of new information, future events or otherwise.
Executive Overview
AsTotal revenues for the third quarter of November 9, 2017, we owned and operated2022 increased 11.0% to $620.6 million from $559.2 million for the third quarter of 2021. Same-facility revenues for the third quarter of 2022 increased 5.1% from the same period last year, with a national network of surgical facilities, physician practices1.8% increase in revenue per case and a suite3.3% increase in same-facility cases. For the third quarter of ancillary services in 32 states. Our surgical facilities, which include ASCs2022, the Company’s net loss attributable to common stockholders and surgical hospitals, primarily provide non-emergency surgical procedures across many specialties, including, among others, gastroenterology ("GI"), general surgery, ophthalmology, orthopedicsAdjusted EBITDA was $25.0 million and pain management. Our surgical hospitals provide services, such as diagnostic imaging, laboratory, obstetrics, oncology, pharmacy, physical therapy$96.2 million, respectively. For the third quarter of 2021, the Company’s net loss attributable to common stockholders and wound care. Our portfolioAdjusted EBITDA was $22.9 million and $76.4 million, respectively. A reconciliation of outpatient surgical facilities is complemented bynon-GAAP financial measures appears below under "Certain Non-GAAP Measures."
We had cash and cash equivalents of $154.8 million and $342.0 million of borrowing capacity under our suite of ancillary services, which support our physicians in providing high quality and cost-efficient patient care. These ancillary services are comprised of a diagnostic laboratory, multi-specialty physician practices, urgent care facilities, anesthesia services, optical services and specialty pharmacy services. As a result, we believe we are well positioned to benefit from rising consumerism and payors’ and patients’ focus on the delivery of high quality care and superior clinical outcomesrevolving credit facility at September 30, 2022. Operating cash inflows were $29.7 million in the lowest costthird quarter of 2022, an increase of $14.8 million compared to the prior year period. Net operating cash flows, including operating cash flows less distributions to non-controlling interests, were an outflow of $5.6 million for the third quarter of 2022, compared to an outflow of $19.2 million for the third quarter of 2021.
COVID-19 Pandemic
The public health and care setting.
As of November 9, 2017, we owned or operated, primarily in partnership with physicians, a portfolio of 124 surgical facilities comprised of 104 ASCs and twenty surgical hospitals across 32 states. We owned a majority interest in 85economic effects of the surgicalCOVID-19 pandemic have significantly affected our facilities, employees, patients, communities, business operations and consolidated 109financial performance, as well as the U.S. economy and financial markets. The impact of these facilities for financial reporting purposes. In addition to surgical facilities, we owned or operated a network of 60 physician practices as of November 9, 2017. For the nine months ended September 30, 2017, approximately 332,000 surgical procedures were performed inCOVID-19 pandemic on our surgical facilities generating approximately $814.3 millionvaries based on the market in revenue.
On August 31, 2017, we completedwhich the acquisitionfacility operates, the type of NSH Holdco, Inc. (“NSH”). Pursuant tosurgical facility and the termsprocedures typically performed. We cannot provide any certainty regarding the length and severity of the Agreement and Plan of Merger, dated as of May 9, 2017, by and among us, SP Merger Sub, Inc., a wholly owned subsidiaryimpact of the Company, NSH,COVID-19 pandemic, which is difficult to predict and IPC / NSH, L.P. (solely in its capacity as sellers’ representative), as amended by thatis dependent on factors beyond our control.
Taking into account the pandemic and other factors, the United States economy has recently experienced general inflationary pressures, significant disruptions to global supply networks, and an extremely competitive labor market. We have incurred, and may continue to incur, certain Letter Amendment, dated as of July 7, 2017 (as amended,increased expenses arising from the “NSH Merger Agreement”), SP Merger Sub, Inc. merged withpandemic and into NSH with NSH continuing as the surviving corporation and a wholly owned subsidiary of the Company (the “NSH Merger”). Also on August 31, 2017, (i) we completed the sale and issuance of 310,000 shares of the Company's preferred stock, par value $0.01 per share, designated as 10.00% Series A Convertible Perpetual Participating Preferred Stock (the “Series A Preferred Stock”) to BCPE Seminole Holdings LP (“Bain”), an affiliate of Bain Capital Private Equity, at a purchase price of $1,000 per share in cash (the “Preferred Private Placement”) pursuant to the Securities Purchase Agreement, dated as of May 9, 2017, by and between the Company and Bain (the “Preferred Stock Purchase Agreement”), and (ii) Bain completed its purchase of 26,455,651 shares (the “Purchased Shares”) of the Company's common stock, par value $0.01 per share, (the “Common Stock”) from H.I.G. Surgery Centers,
these economic conditions, including additional labor, supply
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
chain, capital and other expenditures. While we have implemented cost containment and other measures to try to counteract these developments, we may be unable to fully offset these increases in our costs and otherwise effectively respond to supply disruptions.
LLC (“H.I.G.”),The Company is monitoring legislative actions at a purchase price of $19.00 per share in cash (the “Private Sale”) pursuant tofederal and state levels, including the Stock Purchase Agreement, dated as of May 9, 2017, by and among the Company, Bain, H.I.G., and H.I.G. Bayside Debt & LBO Fund II L.P. (for the purposes stated therein)(the “Common Stock Purchase Agreement” and together with the NSH Merger Agreement, the Preferred Stock Purchase Agreement and the other agreements and documents executed in connection therewith, the “Transaction Agreements”). As a resultimpact of the Preferred Private PlacementCARES Act and the Private Sale, Bain became our controlling stockholder, holding Series A Preferred Stock and Common Stockother governmental assistance that collectively represent approximately 65.7% of the voting power of all classes of capital stock of the Company as of August 31, 2017, and H.I.G. and its affiliated investment funds no longer own any capital stock of the Company.might be available.
As noted in the notes to the consolidated financial statements included previously in this report, in connection with the change of control effected by the Private Sale, we elected to apply “pushdown” accounting. For the purposes of management's discussion and analysis of financial condition and results of operations we have combined the Predecessor and Successor periods (each as defined in Note 1. "Organization" of our condensed consolidated financial statements), where applicable, as presented within the condensed consolidated financial statements and the accompanying notes.
We continue to focus on improving our same-facility performance, selectively acquiring established facilities and developing new facilities. During the nine months ended September 30, 2017, we completed acquisitions of four physician practices in existing markets and the assets of an endoscopy practice, for an aggregate investment of $15.4 million.
Revenues
Our revenues consist of patient service revenues and other service revenues. Patient service revenues consist of revenue from our surgical facility services and ancillary services segments. Specifically, patient service revenues include fees for surgical or diagnostic procedures performed at surgical facilities that we consolidate for financial reporting purposes, as well as for patient visits to our physician practices, anesthesia services, pharmacy services and diagnostic screens ordered by our physicians. Other service revenues consist of product sales from our optical laboratories, as well as the discounts and handling charges billed to the members of our optical products purchasing organization. Other service revenues also include management and administrative service fees derived from our non-consolidated facilities that we account for under the equity method, management of surgical facilities and physician practices in which we do not own an interest and management services we provide to physician practices for which we are not required to provide capital or additional assets.
The following table summarizes our revenues by service type as a percentage of total revenues for the periods indicated:
|
| | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| Patient service revenues: | | | | | | | | |
| Surgical facilities revenues | | 95.5 | % | | 90.4 | % | | 91.4 | % | | 90.6 | % |
| Ancillary services revenues | | 2.7 | % | | 8.0 | % | | 7.0 | % | | 7.5 | % |
| | | 98.2 | % | | 98.4 | % | | 98.4 | % | | 98.1 | % |
| Other service revenues: | | | | | | | | |
| Optical services revenues | | 1.1 | % | | 1.1 | % | | 1.0 | % | | 1.2 | % |
| Other | | 0.7 | % | | 0.5 | % | | 0.6 | % | | 0.7 | % |
| | | 1.8 | % | | 1.6 | % | | 1.6 | % | | 1.9 | % |
| Total revenues | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
During the third quarter of 2017, we experienced lower than expected revenue and incurred certain expenses related to Hurricanes Harvey and Irma, primarily driven by electrical outages at, and temporary closures of, certain of our facilities in affected areas. While all affected facilities are currently open and our operations have returned to normal, we anticipate residual impact from the hurricanes in the fourth quarter 2017. We expect the total impact from the hurricanes during the second half of 2017 to be approximately a $7.0 million to $9.0 million decrease in expected revenue.
Additionally, in the third quarter of 2017, we incurred a non-recurring adjustment to revenue of $15.6 million that was attributable to an increase in reserves for certain accounts receivables. This increase in reserves resulted from certain known events and actions during the third quarter of 2017 related to select payors primarily in our ancillary services segment. Upon consideration of such additional information, related receivables were determined to have a low likelihood of collection. The majority of this adjustment relates to receivables with balances from the first quarter of 2016 and prior. We believe we have accounted for all necessary reserve adjustments at this time.
On a normalized basis, net revenues for the three and nine months ended September 30, 2017 were $329.9 million and $904.4 million.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
The following table reconciles normalized revenues to revenues, the most directly comparable GAAP financial measure: |
| | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| Condensed Consolidated Statements of Operations Data: | | | | | | | | |
| Revenues | | $ | 306,337 |
| | $ | 282,682 |
| | $ | 880,873 |
| | $ | 839,437 |
|
| Hurricane estimated impact | | 8,000 |
| | — |
| | 8,000 |
| | — |
|
| Reserve adjustment | | 15,572 |
| | — |
| | 15,572 |
| | — |
|
| Normalized Revenues | | $ | 329,909 |
| | $ | 282,682 |
| | $ | 904,445 |
| | $ | 839,437 |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Patient service revenues: | | | | | | | |
| Surgical facilities revenues | 95.6 | % | | 95.6 | % | | 95.7 | % | | 95.5 | % |
| Ancillary services revenues | 2.7 | % | | 3.0 | % | | 2.8 | % | | 3.1 | % |
| Total patient service revenues | 98.3 | % | | 98.6 | % | | 98.5 | % | | 98.6 | % |
| Other service revenues | 1.7 | % | | 1.4 | % | | 1.5 | % | | 1.4 | % |
| Total revenues | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
Payor Mix
The following table sets forth by type of payor the percentage of our patient service revenues generated at the surgical facilities which we consolidate for financial reporting purposes in the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | |
| Private insurance payors | 49.5 | % | | 49.2 | % | | 50.4 | % | | 49.6 | % |
| Government payors | 44.2 | % | | 45.0 | % | | 43.0 | % | | 44.0 | % |
| Self-pay payors | 2.6 | % | | 2.9 | % | | 2.7 | % | | 2.9 | % |
Other payors (1) | 3.7 | % | | 2.9 | % | | 3.9 | % | | 3.5 | % |
| Total | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
|
| | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| | | | | | | | | |
| Private insurance payors | | 50.8 | % | | 50.6 | % | | 50.0 | % | | 50.9 | % |
| Government payors | | 39.9 | % | | 40.2 | % | | 41.0 | % | | 40.2 | % |
| Self-pay payors | | 2.7 | % | | 1.9 | % | | 2.3 | % | | 1.7 | % |
Other payors (1) | | 6.6 | % | | 7.3 | % | | 6.7 | % | | 7.2 | % |
| Total | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
(1)Other is comprised of anesthesia service agreements, autoautomobile liability, letters of protection and other payor types.
Surgical Case Mix
We primarily operate multi-specialty surgical facilities where physicians perform a variety of procedures in various specialties, including GI, general surgery, ophthalmology, orthopedics and pain management, among others.specialties. We believe this diversification helps to protect us from adverse pricing and utilization trends in any individual procedure type and results in greater consistency in our case volume.
The following table sets forth the percentage of cases in each specialty performed at the surgical facilities which we consolidate for financial reporting purposes for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | |
| Orthopedic and pain management | 35.7 | % | | 34.8 | % | | 36.0 | % | | 35.8 | % |
| Ophthalmology | 24.4 | % | | 27.1 | % | | 24.5 | % | | 26.5 | % |
| Gastrointestinal | 23.4 | % | | 22.6 | % | | 23.1 | % | | 22.1 | % |
| General surgery | 3.0 | % | | 3.0 | % | | 3.0 | % | | 3.0 | % |
| Other | 13.5 | % | | 12.5 | % | | 13.4 | % | | 12.6 | % |
| Total | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
|
| | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| | | | | | | | | |
| Gastrointestinal | | 22.8 | % | | 22.3 | % | | 23.2 | % | | 21.9 | % |
| General surgery | | 2.8 | % | | 2.4 | % | | 2.5 | % | | 2.4 | % |
| Ophthalmology | | 28.8 | % | | 29.8 | % | | 28.5 | % | | 29.8 | % |
| Orthopedic and pain management | | 33.9 | % | | 31.6 | % | | 33.5 | % | | 31.6 | % |
| Other | | 11.7 | % | | 13.9 | % | | 12.3 | % | | 14.3 | % |
| Total | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Case Growth
Same-facility Information
Same-facility revenues include revenues from our consolidated and non-consolidated surgical facilities (excluding facilities acquired in new markets or divested during the current and prior period) along with the revenues from our ancillary services comprised of a diagnostic laboratory, multi-specialty physician practices, urgent care facilities, anesthesia services, optical services and specialty pharmacy services that complement our surgical facilities in our existing markets. The below table reflects the pro forma effect of the NSH acquisition for a full period in both the three and nine months ended September 30, 2017 and 2016.
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, |
| Nine Months Ended September 30, |
| | 2017 | | 2016 |
| 2017 |
| 2016 |
| | | | |
|
|
|
|
|
|
Cases (2) | | $ | 138,798 |
| | $ | 139,247 |
|
| $ | 410,331 |
|
| $ | 405,051 |
|
| Case growth | | (0.3 | )% | | N/A |
|
| 1.3 | % |
| N/A |
|
Revenue per case (2) | | $ | 3,245 |
| | $ | 3,143 |
|
| $ | 3,263 |
|
| $ | 3,128 |
|
| Revenue per case growth | | 3.3 | % | | N/A |
|
| 4.3 | % |
| N/A |
|
| Number of facilities | | 112 |
| | N/A |
|
| 110 |
|
| N/A |
|
(2) The table above includes normalization impact of the hurricanes and the non-recurring adjustment to revenue on the same-facility information of $23.6 million in revenues and 2,828 cases for both the three and nine months ended September 30, 2017.
Segment Information
A public company is required to report annual and interim financial and descriptive information about its reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or “CODM,” in deciding how to allocate resources and in assessing performance. Aggregation of similar operating segments into a single reportable operating segment is permitted if the businesses have similar economic characteristics and meet the criteria established by GAAP.
Our business is comprised of the following three reportable segments:
Surgical Facility Services Segment: Our surgical facility services segment consists of the operation of ASCs and surgical hospitals, and includes our anesthesia services. Our surgical facilities primarily provide non-emergency surgical procedures across many specialties, including, among others, GI, general surgery, ophthalmology, orthopedics and pain management.
Ancillary Services Segment: Our ancillary services segment consists of a diagnostic laboratory, a specialty pharmacy and multi-specialty physician practices. These physician practices include our owned and operated physician practices pursuant to long-term management service agreements.
Optical Services Segment: Our optical services segment consists of an optical laboratory and an optical products group purchasing organization. Our optical laboratory manufactures eyewear, while our optical products purchasing organization negotiates volume buying discounts with optical product manufacturers.
Our financial information by reportable segment is prepared on an internal management reporting basis that the chief operating decision maker uses to allocate resources and assess the performance of the operating segments. Our operating segments have been defined based on the separate financial information that is regularly produced and reviewed by our CODM, which is our Chief Executive Officer.
Adjusted EBITDA is the primary profit/loss metric reviewed by the CODM in making key business decisions and on allocation of resources. We have provided a reconciliation from Adjusted EBITDA back to income before income taxes in the reported condensed consolidated financial information.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
The following tables present financial information for each reportable segment (in thousands):
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| Revenues: | | | | | | | | |
| Surgical facility services | | $ | 293,360 |
| | $ | 256,795 |
| | $ | 814,320 |
| | $ | 766,248 |
|
| Ancillary services | | 10,184 |
| | 22,684 |
| | 58,036 |
| | 62,967 |
|
| Optical services | | 2,793 |
| | 3,203 |
| | 8,517 |
| | 10,222 |
|
| Total revenues | | $ | 306,337 |
| | $ | 282,682 |
| | $ | 880,873 |
| | $ | 839,437 |
|
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| Adjusted EBITDA: | | | | | | | | |
| Surgical facility services | | $ | 48,673 |
| | $ | 53,347 |
| | $ | 146,859 |
| | $ | 153,318 |
|
| Ancillary services | | (12,002 | ) | | 2,573 |
| | (7,791 | ) | | 9,141 |
|
| Optical services | | 748 |
| | 1,276 |
| | 2,407 |
| | 3,004 |
|
| All other | | (14,175 | ) | | (12,448 | ) | | (41,069 | ) | | (36,258 | ) |
Total adjusted EBITDA (1) | | 23,244 |
| | 44,748 |
| | 100,406 |
| | 129,205 |
|
| | | | | | | | | |
| Net income attributable to non-controlling interests | | 15,305 |
| | 16,672 |
| | 48,579 |
| | 54,392 |
|
| Depreciation and amortization | | (10,929 | ) | | (9,713 | ) | | (33,454 | ) | | (28,984 | ) |
| Interest expense, net | | (34,030 | ) | | (26,475 | ) | | (84,812 | ) | | (74,863 | ) |
| Non-cash stock compensation expense | | (3,311 | ) | | (691 | ) | | (5,380 | ) | | (1,326 | ) |
| Contingent acquisition compensation expense | | (1,815 | ) | | (1,530 | ) | | (5,662 | ) | | (3,060 | ) |
Merger transaction, integration and practice acquisition costs (2) | | (6,406 | ) | | (2,471 | ) | | (11,134 | ) | | (8,579 | ) |
| Gain on litigation settlement | | — |
| | — |
| | 3,794 |
| | — |
|
| Gain on acquisition escrow release | | 1,000 |
| | — |
| | 1,000 |
| | — |
|
| Loss on disposal or impairment of long-lived assets, net | | (447 | ) | | (572 | ) | | (2,048 | ) | | (1,697 | ) |
| Gain on amendment to tax receivable agreement | | 16,392 |
| | — |
| | 16,392 |
| | — |
|
| Tax receivable agreement expense | | — |
| | (3,733 | ) | | — |
| | (3,733 | ) |
| Loss on debt refinancing | | (18,211 | ) | | (3,595 | ) | | (18,211 | ) | | (11,876 | ) |
| (Loss) income before income taxes | | $ | (19,208 | ) | | $ | 12,640 |
| | $ | 9,470 |
| | $ | 49,479 |
|
(1) The above table reconciles Adjusted EBITDA to income before income taxes as reflected in the unaudited condensed consolidated statements of operations.
When we use the term “Adjusted EBITDA,” it is referring to income before income taxes minus (a) net income attributable to non-controlling interests plus (b) depreciation and amortization, (c) interest expense, net, (d) non-cash stock compensation expense, (e) contingent acquisition compensation expense, (f) merger transaction, integration and practice acquisition costs, minus (g) gain on litigation settlement, (h) gain on acquisition escrow release, plus (i) loss on disposal or impairment of long-lived assets, net, minus (j) gain on amendment to tax receivable agreement, plus (k) tax receivable agreement expense and (l) loss on debt refinancing. We use Adjusted EBITDA as a measure of financial performance. Adjusted EBITDA is a key measure used by management to assess operating performance, make business decisions and allocate resources. Non-controlling interests represent the interests of third parties, such as physicians, and in some cases, healthcare systems that own an interest in surgical facilities that we consolidate for financial reporting purposes. We believe that it is helpful to investors to present Adjusted EBITDA as defined above because it excludes the portion of net income attributable to these third-party interests and clarifies for investors our portion of Adjusted EBITDA generated by its surgical facilities and other operations.
Adjusted EBITDA is not a measurement of financial performance under GAAP, and should not be considered in isolation or as a substitute for net income, operating income or any other measure calculated in accordance with generally accepted accounting principles. The items excluded from Adjusted EBITDA are significant components in understanding and evaluating our financial performance. We believe such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. Our calculation of Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.
(2) This amount includes merger transaction and integration costs of $5.3 million and $1.9 million for the three months ended September 30, 2017 and 2016, respectively, and practice acquisition costs of $1.1 million and $607,000 for the three months ended September 30, 2017 and 2016, respectively.
This amount includes merger transaction and integration costs of $8.6 million and $6.4 million for the nine months ended September 30, 2017 and 2016, respectively, and practice acquisition costs of $2.6 million and $2.2 million for the nine months ended September 30, 2017 and 2016, respectively.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
|
| | | | | | |
| | | September 30,
2017 | | December 31,
2016 |
| Assets: | | | | |
| Surgical facility services | | 3,969,584 |
| | 1,914,842 |
|
| Ancillary services | | 183,288 |
| | 184,002 |
|
| Optical services | | 43,451 |
| | 22,478 |
|
| Total | | 4,196,323 |
| | 2,121,322 |
|
| | | | | |
| All other | | 405,531 |
| | 183,636 |
|
| Total assets | | 4,601,854 |
| | 2,304,958 |
|
|
| | | | | | | | |
| | | Nine Months Ended September 30, |
| | | 2017 | | 2016 |
| Supplemental Information: | | | | |
| Cash purchases of property and equipment, net: | | | | |
| Surgical facility services | | $ | 16,196 |
| | $ | 21,151 |
|
| Ancillary services | | 1,877 |
| | 3,450 |
|
| Optical services | | 96 |
| | 323 |
|
| Total | | $ | 18,169 |
| | $ | 24,924 |
|
| | | | | |
| All other | | $ | 2,444 |
| | $ | 3,453 |
|
| Total cash purchases of property and equipment, net | | $ | 20,613 |
| | $ | 28,377 |
|
Critical Accounting Policies
OurA summary of significant accounting policies is disclosed in our 2021 Annual Report on Form 10-K under the caption “Critical Accounting Policies” in the Management’s Discussion and practices are describedAnalysis of Financial Condition and Results of Operations section. There have been no material changes in Note 2the nature of our condensed consolidated financial statements included previously in this report. In preparing our condensed consolidated financial statements in conformity with Generally Accepted Accounting Principles ("GAAP"), our management must make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Certain accounting estimates are particularly sensitive because of their complexity and the possibility that future events affecting them may differ materially from our current judgments and estimates. Our actual results could differ from those estimates. We believe that the following critical accounting policies are important to the portrayal of our financial condition and results of operations and require our management’s subjective or complex judgment because of the sensitivity of the methods, assumptions and estimates used. This listing of critical accounting policies is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with no need for management’s judgment regarding accounting policy.
Consolidation and Control
Our condensed consolidated financial statements include the accounts of our Company, wholly-owned or controlled subsidiaries and variable interest entities in which we are the primary beneficiary. Our controlled subsidiaries consist of wholly-owned subsidiaries and other subsidiaries that we control through our ownership of a majority voting interest or other rights granted to us by contract to function as the sole general partner or managing member of the surgical facility. The rights of limited partners or minority members at our controlled subsidiaries are generally limited to those that protect their ownership interests, including the right to approve the issuance of new ownership interests, and those that protect their financial interests, including the right to approve the acquisition or divestiture of significant assets or the incurrence of debt that either physician limited partners or minority members are required to guarantee on a pro-rata basis based upon their respective ownership, or that exceeds 20.0% of the fair market value of the related surgical facility’s assets. All significant intercompany balances and transactions, including management fees from consolidated surgical facilities, are eliminated in consolidation.
As of September 30, 2017 we held less than a majority economic interest in five surgical facilities, three anesthesia practices and three physician practices over which we exercise controlling influence. Controlling influence includes financial interests, duties, rights and responsibilities for the day-to-day management of the entity. We also consider the relevant sections of the Accounting Standard Codification ("ASC") 810, Consolidation, to determine if we have the power to direct the activities and are the primary beneficiary of (and therefore should consolidate) any entity whose operations we do not control with voting rights. As we were the primary beneficiary, we consolidated the above 11 entities at September 30, 2017.
Revenue Recognition
Our patient service revenues are derived from surgical procedures performed at our ASCs, patient visits to physician practices, anesthesia services provided to patients, pharmacy services and diagnostic screens ordered by our physicians. The fees for such services are billed either
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
to the patient or a third-party payor, including Medicare and Medicaid. We recognize patient service revenues, net of contractual allowances, which we estimate based on the historical trend of our cash collections and contractual write-offs.
Our optical products purchasing organization negotiates volume buying discounts with optical product manufacturers. The buying discounts and any handling charges billed to the members of the purchasing organization represent the revenues recognized for financial reporting purposes. Revenue is recognized as orders are shipped to members. Product sale revenues from our optical laboratories and marketing products and services businesses, net of an allowance for returns and discounts, is recognized when the product is shipped or service is provided to the customer. We base our estimates for sales returns and discounts on historical experience and have not experienced significant fluctuations between estimated and actual return activity and discounts given.
Other service revenues consist of management and administrative service fees derived from non-consolidated surgical facilities that we account for under the equity method, management of surgical facilities in which we do not own an interest and management services we provide to physician networks for which we are not required to provide capital or additional assets. The fees we derive from these management arrangements are based on a predetermined percentage of the revenues of each surgical facility and physician network. We recognize other service revenues in the period in which services are rendered.
Allowance for Contractual Adjustments and Doubtful Accounts
Our patient service revenues and other receivables from third-party payors are recorded net of estimated contractual adjustments and allowances from third-party payors, which we estimate based on the historical trend of our surgical facilities’ cash collections and contractual write-offs, accounts receivable agings, established fee schedules, relationships with payors and procedure statistics. While changes in estimated reimbursement from third-party payors remain a possibility, we expect that any such changes would be minimal and, therefore, would not have a material effect on our financial condition or results of operations.
We estimate our allowances for doubtful accounts using similar information and analysis. While we believe that our allowances for contractual adjustments and doubtful accounts are adequate, if the actual write-offs are significantly different from our estimates, it could have a material adverse effect on our financial condition and results of operations. Because in most cases we have the ability to verify a patient’s insurance coverage before services are rendered, and because we have entered into contracts with third-party payors which account for a majority of our total revenues, the out-of-period contractual adjustments have been minimal. Our net accounts receivable reflected allowances for doubtful accounts of $2.0 million and $29.9 million at September 30, 2017 and December 31, 2016, respectively. The decrease is due to the application of pushdown accounting.
Our collectionthose policies and procedures are based on the type of payor, size of claim and estimated collection percentage for each patient account. The operating systems used to manage our patient accounts provide for an aging schedule in 30-day increments, by payor, physician and patient. We analyze accounts receivable at each of our surgical facilities to ensure the proper collection and aged category. The operating systems generate reports that assist in the collection efforts by prioritizing patient accounts. Collection efforts include direct contact with insurance carriers or patients, written correspondence and the use of legal or collection agency assistance, as required. Our days sales outstanding were 63 days for the nine months ended September 30, 2017 and 70 days for the year endedsince December 31, 2016.2021.
At a consolidated level, we review the standard aging schedule, by facility, to determine the appropriate provision for doubtful accounts by monitoring changes in our consolidated accounts receivable by aged schedule, days sales outstanding and bad debt expense as a percentage of revenues. At a consolidated level, we do not review a consolidated aging by payor. Regional and local employees review each surgical facility’s aged accounts receivable by payor schedule. These employees have a closer relationship with the payors and have a more thorough understanding of the collection process for that particular surgical facility. Furthermore, this review is supported by an analysis of the actual revenues, contractual adjustments and cash collections received. If our internal collection efforts are unsuccessful, we further review patient accounts with balances of $25 or more. We then classify the accounts based on any external collection efforts we deem appropriate. An account is written-off only after we have pursued collection with legal or collection agency assistance or otherwise deemed an account to be uncollectible. Typically, accounts will be outstanding a minimum of 120 days before being written-off.
We recognize that final reimbursement of outstanding accounts receivable is subject to final approval by each third-party payor. However, because we have contracts with our third-party payors and we verify the insurance coverage of the patient before services are rendered, the amounts that are pending approval from third-party payors are minimal. Amounts are classified outside of self-pay if we have an agreement with the third-party payor or we have verified a patient’s coverage prior to services rendered. It is our policy to collect co-payments and deductibles prior to providing services. It is also our policy to verify a patient’s insurance 72 hours prior to the patient’s procedure. Because our services are primarily non-emergency, our surgical facilities have the ability to control these procedures. Our patient service revenues from self-pay payors as a percentage of total revenues were approximately 2.1% and 1.6% for the nine months ended September 30, 2017 and 2016, respectively.
Income Taxes and Tax Receivable Agreement
We use the asset and liability method to account for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If a net operating loss ("NOL") carryforward exists, we make a determination as to whether that NOL carryforward will be utilized in the future. A valuation allowance will be established for certain NOL carryforwards and other deferred tax assets where their recoverability is deemed to be uncertain. The carrying value of the net deferred tax assets is based upon estimates and assumptions related to our ability to generate sufficient future taxable income in certain
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
tax jurisdictions. If these estimates and related assumptions change in the future, we will be required to adjust our deferred tax valuation allowances.
As of September 30, 2017, we maintained a valuation allowance against certain state NOLs and capital losses for which we believe it is more likely than not that they will not be realized. On a quarterly basis, we continue to monitor results. If our expectations for future operating results on a consolidated basis or at the state jurisdiction level vary from actual results due to changes in healthcare regulations, general economic conditions, or other factors, we may need to adjust the valuation allowance, for all or a portion of our deferred tax assets. Our income tax expense in future periods will be reduced or increased to the extent of offsetting decreases or increases, respectively, in our valuation allowance in the period when the change in circumstances occurs. These changes could have a significant impact on our future earnings.
For the nine months ended September 30, 2017, we recorded income tax expense at a rate of approximately (193.2)% of income before income taxes. As a percentage of net income after income attributable to non-controlling interests, we expect the tax rate for the year to be between 41% and 42%. Based upon the application of interim accounting guidance, however, the tax rate as a percentage of net income after income attributable to non-controlling interests will vary based upon the relative net income from period to period.
Section 382 (“Section 382”) of the Internal Revenue Code of 1986, as amended (the “Code”) imposes an annual limit on the ability of a corporation that undergoes an “ownership change” to use its NOLs to reduce its tax liability. An “ownership change” is generally defined as any change in ownership of more than 50.0% of a corporation’s “stock” by its “5-percent shareholders” (as defined in Section 382) over a rolling three-year period based upon each of those shareholder’s lowest percentage of stock owned during such period. As a result of the Symbion acquisition, approximately $179 million in NOL carryforwards are subject to an annual Section 382 base limitation of $4.9 million, and, as a result of the NovaMed acquisition, approximately $17 million in NOL carryforwards are subject to an annual Section 382 base limitation of $4.9 million. As a result of the NSH acquisition, approximately $20.5 million in NOL carryforwards are subject to an annual Section 382 base limitation of $2.8 million. The sale of H.I.G.’s shares to Bain in connection with the Private Sale resulted in an ownership change as defined in Section 382. As a result, approximately $449.7 million in NOL carryforwards are subject to an annual Section 382 base limitation of $14.2 million. At this time, we do not believe this limitation, when combined with amounts allowable due to net unrecognized built in gains, will affect our ability to use any NOLs before they expire. However, no such assurances can be provided. If our ability to utilize our NOLs to offset taxable income generated in the future is subject to this limitation, it could have an adverse effect on our business, prospects, results of operations and financial condition.
On May 9, 2017, we entered into an agreement with H.I.G. (in its capacity as the stockholders representative) to amend that certain Income Tax Receivable Agreement, dated September 30, 2015 (as amended, the “TRA”), by and between the Company, H.I.G. (in its capacity as the stockholders representative) and the other parties referred to therein, which amendment became effective on August 31, 2017. The TRA was initially entered into in connection with the Reorganization undertaken to facilitate our initial public offering. Pursuant to the amendment to the TRA, we agreed to make payments to H.I.G. in its capacity as the stockholders representative pursuant to a fixed payment schedule. The amounts payable under the TRA are calculated as the product of (i) an annual base amount and (ii) the maximum corporate federal income tax rate for the applicable year plus three percent. The amounts payable under the TRA are related to our projected realized tax savings over the next five years and are not dependent on our actual tax savings. Amounts payable pursuant to the TRA will be adjusted downward in the event that the maximum corporate federal income tax rate is reduced. To the extent that we are unable to make payments under the TRA and such inability is a result of the terms of credit agreements and other debt documents that are materially more restrictive than those existing as of September 30, 2015, such payments will be deferred and will accrue interest at a rate of LIBOR plus 500 basis points until paid. If the terms of such credit agreements and other debt documents cause us to be unable to make payments under the TRA and such terms are not materially more restrictive than those existing as of September 30, 2015, such payments will be deferred and will accrue interest at a rate of LIBOR plus 300 basis points until paid.
As a result of the amendment to the TRA, we were required to value the liability under the TRA by discounting the fixed payment schedule using our incremental borrowing rate. During the three and nine months ended September 30, 2017, we recognized a reduction in the carrying value of the TRA liability of $43.9 million, with $15.3 million of the reduction recorded to a gain on amendment of TRA and $28.6 million recorded as a reduction to the goodwill recorded in connection with the application of pushdown accounting related to the change of control (discussed in Note 1. "Organization" of our condensed consolidated financial statements included previously in this report).
Assuming our effective tax rate is 38% throughout the term of the TRA, we estimate that the total amounts payable under the TRA will be approximately $120.5 million. Prior to the effectiveness of the amendment to the TRA, the amounts payable under the TRA varied depending upon a number of factors, including the amount, character and timing of our taxable income. We estimated the total amounts payable would be approximately $123.4 million, if the tax benefits of related deferred tax assets were ultimately realized. The amounts payable were recognized during 2015 in conjunction with the release of our valuation allowance recorded against the deferred tax assets.
On September 8, 2017, in connection with the resignation of our former Chief Executive Officer, Michael Doyle, Mr. Doyle entered into a TRA Waiver and Assignment Agreement (the “CEO TRA Assignment Agreement”) with the Company, pursuant to which we accepted the assignment of 50% of Mr. Doyle’s (and his affiliates’) interest in future payments to which such parties were entitled pursuant to the TRA, in exchange for an upfront payment of approximately $5.1 million, in the aggregate, as set forth in the CEO TRA Assignment Agreement. On September 15, 2017 (Successor), certain of our employees entered into TRA Waiver and Assignment Agreements with the Company (collectively, the “Employee TRA Assignment Agreements” and together with the CEO TRA Assignment Agreement, the “TRA Assignment Agreements”), pursuant to which we made upfront payments of approximately $4.8 million in the aggregate, in exchange for the assignment of 100% of each such employee’s interest in future payments to which such employee was entitled pursuant to the TRA. During the period from September 1, 2017 to September 30, 2017, we recognized an aggregate gain of $1.1 million as a result of the TRA Assignment Agreements.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Long-Lived Assets, Goodwill and Intangible Assets
We evaluate the carrying value of long-lived assets when impairment indicators are present or when circumstances indicate that impairment may exist in accordance with ASC 350, Intangibles- Goodwill and Other. We perform an impairment test by preparing an expected undiscounted cash flow projection. If the projection indicates that the recorded amount of the long-lived asset is not expected to be recovered, the carrying value is reduced to estimated fair value. The cash flow projection and fair value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies, at the date of evaluation. We test our goodwill and intangible assets for impairment at least annually, or more frequently if certain indicators arise.
Off-Balance Sheet Arrangements
From time to time, we guarantee our pro-rata share of the third-party debts and other obligations of many of the non-consolidated partnerships and limited liability companies in which we own an interest. In most instances of these guarantees, the physicians and/or physician groups have also guaranteed their pro-rata share of the indebtedness to secure the financing. At September 30, 2017, we did not guarantee any debt of our non-consolidated surgical facilities.
Equity-Based Compensation
Transactions in which the Company receives employee and non-employee services in exchange for the Company’s equity instruments or liabilities that are based on the fair value of the Company’s equity securities or may be settled by the issuance of these securities are accounted for using a fair value method. The fair value of future stock options awarded will be based on the quoted market price of our common stock upon grant, as well as assumptions including expected stock price volatility, risk-free interest rate, expected dividends, and expected term.
Our policy is to recognize compensation expense using the straight line method over the relevant vesting period for units that vest based on time. Our equity-based compensation expense can vary in the future depending on many factors, including levels of forfeitures and whether performance targets are met and whether a liquidity event occurs. In connection with the Reorganization, our board of directors and stockholders adopted the Surgery Partners, Inc. 2015 Omnibus Incentive Plan from which our future equity-based awards will be granted.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Results of Operations
Three Months Ended September 30, 2022 Compared to Three Months Ended September 30, 2021
The following tables summarizetable summarizes certain results from the statements of operations for the three and nine months ended September 30, 20172022 and 2016. The tables also show the percentage relationship to revenues for the periods indicated2021 (dollars in thousands)millions):
| | | | | | | | | | | | | | |
| | Three Months Ended September 30, |
| | 2022 | | 2021 |
| | | | |
| Revenues | | $ | 620.6 | | | $ | 559.2 | |
| Operating expenses: | | | | |
| Cost of revenues | | 489.4 | | | 436.7 | |
| General and administrative expenses | | 17.9 | | | 25.5 | |
| Depreciation and amortization | | 29.8 | | | 25.2 | |
| Transaction and integration costs | | 12.5 | | | 10.2 | |
| Grant funds | | (0.5) | | | — | |
| Loss on disposals and deconsolidations, net | | 2.2 | | | 1.9 | |
| Equity in earnings of unconsolidated affiliates | | (2.4) | | | (2.9) | |
| Gain on debt extinguishment | | — | | | (0.5) | |
| Other income, net | | (2.4) | | | (0.5) | |
| | 546.5 | | | 495.6 | |
| Operating income | | 74.1 | | | 63.6 | |
| Interest expense, net | | (60.7) | | | (54.2) | |
| Income before income taxes | | 13.4 | | | 9.4 | |
| Income tax expense | | (7.8) | | | (1.2) | |
| Net income | | 5.6 | | | 8.2 | |
| Less: Net income attributable to non-controlling interests | | (30.6) | | | (31.1) | |
| Net loss attributable to Surgery Partners, Inc. | | $ | (25.0) | | | $ | (22.9) | |
|
| | | | | | | | | | | | | | |
| | | Three Months Ended September 30, |
| | | 2017 | | 2016 |
| | | Amount | | % of Revenues | | Amount | | % of Revenues |
| | | | | | | | | |
| Revenues | | $ | 306,337 |
| | 100.0 | % | | $ | 282,682 |
| | 100.0 | % |
| Operating expenses: | | | | | | | | |
| Cost of revenues | | 246,696 |
| | 80.5 | % | | 201,394 |
| | 71.2 | % |
General and administrative expenses (1) | | 20,378 |
| | 6.7 | % | | 14,985 |
| | 5.3 | % |
| Depreciation and amortization | | 10,929 |
| | 3.6 | % | | 9,713 |
| | 3.4 | % |
| Provision for doubtful accounts | | 8,524 |
| | 2.8 | % | | 8,514 |
| | 3.0 | % |
| Income from equity investments | | (1,608 | ) | | (0.5 | )% | | (1,167 | ) | | (0.4 | )% |
| Loss on disposal or impairment of long-lived assets, net | | 447 |
| | 0.1 | % | | 572 |
| | 0.2 | % |
| Merger transaction and integration costs | | 5,326 |
| | 1.7 | % | | 1,864 |
| | 0.7 | % |
| Loss on debt refinancing | | 18,211 |
| | 5.9 | % | | 3,595 |
| | 1.3 | % |
| Gain on acquisition escrow release | | (1,000 | ) | | (0.3 | )% | | — |
| | — | % |
| Electronic health records incentive income | | 4 |
| | — | % | | 364 |
| | 0.1 | % |
| Total operating expenses | | 307,907 |
| | 100.5 | % | | 239,834 |
| | 84.8 | % |
| Operating (loss) income | | (1,570 | ) | | (0.5 | )% | | 42,848 |
| | 15.2 | % |
| Gain on amendment to tax receivable agreement | | 16,392 |
| | 5.4 | % | | — |
| | — | % |
| Tax receivable agreement expense | | — |
| | — | % | | (3,733 | ) | | (1.3 | )% |
| Interest expense, net | | (34,030 | ) | | (11.1 | )% | | (26,475 | ) | | (9.4 | )% |
| (Loss) income before income taxes | | (19,208 | ) | | (6.3 | )% | | 12,640 |
| | 4.5 | % |
| Income tax benefit | | (20,929 | ) | | (6.8 | )% | | (1,694 | ) | | (0.6 | )% |
| Net income | | 1,721 |
| | 0.6 | % | | 14,334 |
| | 5.1 | % |
| Less: Net income attributable to non-controlling interests | | (15,305 | ) | | (5.0 | )% | | (16,672 | ) | | (5.9 | )% |
| Net loss attributable to Surgery Partners, Inc. | | $ | (13,584 | ) | | (4.4 | )% | | $ | (2,338 | ) | | (0.8 | )% |
(1) Includes contingent acquisition compensation expense of $1.8Overview. During the three months ended September 30, 2022, our revenues increased 11.0% to $620.6 million and $1.5compared to $559.2 million for the three months ended September 30, 2017 and 2016, respectively.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
|
| | | | | | | | | | | | | | |
| | | Nine Months Ended September 30, |
| | | 2017 | | 2016 |
| | | Amount | | % of Revenues | | Amount | | % of Revenues |
| | | | | | | | | |
| Revenues | | $ | 880,873 |
| | 100.0 | % | | $ | 839,437 |
| | 100.0 | % |
| Operating expenses: | | | | | | | | |
| Cost of revenues | | 675,096 |
| | 76.6 | % | | 606,949 |
| | 72.3 | % |
General and administrative expenses (1) | | 54,574 |
| | 6.2 | % | | 42,205 |
| | 5.0 | % |
| Depreciation and amortization | | 33,454 |
| | 3.8 | % | | 28,984 |
| | 3.5 | % |
| Provision for doubtful accounts | | 19,987 |
| | 2.3 | % | | 15,931 |
| | 1.9 | % |
| Income from equity investments | | (3,860 | ) | | (0.4 | )% | | (3,007 | ) | | (0.4 | )% |
| Loss on disposal or impairment of long-lived assets, net | | 2,048 |
| | 0.2 | % | | 1,697 |
| | 0.2 | % |
| Merger transaction and integration costs | | 8,567 |
| | 1.0 | % | | 6,361 |
| | 0.8 | % |
| Loss on debt refinancing | | 18,211 |
| | 2.1 | % | | 11,876 |
| | 1.4 | % |
| Gain on litigation settlement | | (3,794 | ) | | (0.4 | )% | | — |
| | — | % |
| Gain on acquisition escrow release | | (1,000 | ) | | (0.1 | )% | | — |
| | — | % |
| Electronic health records incentive (income) expense | | (298 | ) | | — | % | | 269 |
| | — | % |
| Other (income) expense | | (2 | ) | | — | % | | 97 |
| | — | % |
| Total operating expenses | | 802,983 |
| | 91.2 | % | | 711,362 |
| | 84.7 | % |
| Operating income | | 77,890 |
| | 8.8 | % | | 128,075 |
| | 15.3 | % |
| Gain on amendment to tax receivable agreement | | 16,392 |
| | 1.9 | % | | — |
| | — | % |
| Tax receivable agreement expense | | — |
| | — | % | | (3,733 | ) | | (0.4 | )% |
| Interest expense, net | | (84,812 | ) | | (9.6 | )% | | (74,863 | ) | | (8.9 | )% |
| Income before income taxes | | 9,470 |
| | 1.1 | % | | 49,479 |
| | 5.9 | % |
| Income tax (benefit) expense | | (18,300 | ) | | (2.1 | )% | | 2,496 |
| | 0.3 | % |
| Net income | | 27,770 |
| | 3.2 | % | | 46,983 |
| | 5.6 | % |
| Less: Net income attributable to non-controlling interests | | (48,579 | ) | | (5.5 | )% | | (54,392 | ) | | (6.5 | )% |
| Net loss attributable to Surgery Partners, Inc. | | $ | (20,809 | ) | | (2.4 | )% | | $ | (7,409 | ) | | (0.9 | )% |
(1) Includes contingent acquisition compensation expense of $5.7 million and $3.1 million for the nine months ended September 30, 2017 and 2016, respectively.
Three Months Ended September 30,2017 Compared to Three Months Ended September 30, 2016
Overview. During the three months ended September 30, 2017, our revenues were $306.3 million compared to $282.7 million for the three months ended September 30, 2016. Revenue growth for the period was primarily attributable to the acquisition of NSH (closed on August 31, 2017) which added 22 surgical facilities to our portfolio. We incurred a net2021. Net loss attributable to Surgery Partners, Inc. of $13.6was $25.0 million for the 20172022 period, compared to $2.3a net loss of $22.9 million for the 20162021 period. During the 2017 period we experienced lower than expected revenue and incurred certain expenses relatedThe increase in revenues was primarily attributable to Hurricanes Harvey and Irma, primarily driven by electrical outages at, and temporary closures of, certain of our facilities in affected areas resulting in an estimated loss of approximately 2,828 cases. We estimate the total impact from the hurricanes during the second half of 2017 to be a decrease of approximately $7.0 million to $9.0 million in expected revenue, with a majority of the impact being recognized in the third quarter. Additionally, in the 2017 period, subsequent to the Preferred Private Placement, we, as part of a review of operations undertaken to create a solid foundation to support our long-term growth objectives, incurred a non-recurring expense of $15.6 million associated with an increase in reserves for certain accounts receivables. This increasesurgical case volumes, favorable shift in reserves resulted from certain known eventssurgical case mix and actions duringacquisitions completed since the third quarter of 2017 related to select payors primarily in our ancillary services segment. Upon consideration of such additional information, related receivables were determined to have a low likelihood of collection. The majority of this adjustment related to receivables with balances from the first quarter of 2016 and prior. We believe we have accounted for all necessary reserve adjustments at this time. Excluding these items from the 2017 period, we achieved revenue growth of 16.7%.
prior year period.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Revenues. Revenues for the three months ended September 30, 20172022 compared to the three months ended September 30, 20162021 were as follows (dollars in thousands)millions):
| | | | | Three Months Ended September 30, | | | | | | Three Months Ended September 30, |
| | | 2017 | | 2016 | | Dollar Variance | | Percent Variance | | 2022 | | 2021 |
| | | | | | | | | | | | | |
| Patient service revenues | | $ | 300,763 |
| | $ | 278,195 |
| | $ | 22,568 |
| | 8.1 | % | Patient service revenues | | $ | 610.1 | | | $ | 551.4 | |
| Optical service revenues | | 2,794 |
| | 3,203 |
| | (409 | ) | | (12.8 | )% | |
| Other service revenues | | 2,780 |
| | 1,284 |
| | 1,496 |
| | 116.5 | % | Other service revenues | | 10.5 | | | 7.8 | |
| Total revenues | | $ | 306,337 |
| | $ | 282,682 |
| | $ | 23,655 |
| | 8.4 | % | Total revenues | | $ | 620.6 | | | $ | 559.2 | |
Patient service revenues increased 8.1%10.6% to $300.8$610.1 million for the three months ended September 30, 20172022 period compared to $278.2$551.4 million for the three months ended September 30, 2016. The2021 period, primarily driven by a 1.8% increase in patient service revenues was primarily attributable tosame-facility revenue per case, a 3.3% increase in same-facility case volumes and acquisitions completed since the acquisition of NSH.prior year period.
Cost of Revenues. Cost of revenues increased to $246.7$489.4 million for the three months ended September 30, 20172022 period compared to $201.4$436.7 million for the three months ended September 30, 2016. The increase was2021 period, primarily attributable to the integration ofdriven by acquisitions completed after September 30, 2016 (includingsince the acquisition of NSH) and an increase in higher acuity case mix.prior year period. As a percentage of revenues, cost of revenues were 80.5%78.9% for the 20172022 period and 71.2%compared to 78.1% for the 20162021 period.
General and Administrative Expenses. General and administrative expenses were $20.4$17.9 million for the three months ended September 30, 20172022 period compared to $15.0$25.5 million for the three months ended September 30, 2016. The increase was primarily due to an increase in stock compensation expense, costs incurred related to the planned relocation of the corporate office in Nashville, TN and the integration of NSH during the2021 period. As a percentage of revenues, general and administrative expenses were 6.7%decreased to 2.9% for the 20172022 period compared to 5.3%4.6% for the 20162021 period. The decrease is primarily driven by ongoing cost management initiatives.
Depreciation and Amortization. Depreciation and amortization increased to $10.9 million for the three months ended September 30, 2017 compared to $9.7 million for the three months ended September 30, 2016. As a percentage of revenues, depreciation and amortization expenses were 3.6%4.8% for the 20172022 period and 3.4%compared to 4.5% for the 20162021 period. The increase was attributable to the addition
Transaction and Integration Costs. We incurred $12.5 million of 22 surgical facilities in connection with the acquisition of NSH.
Provisiontransaction and integration costs for Doubtful Accounts. The provision for doubtful accounts was $8.5 million for each of the three months ended September 30, 2017 and September 30, 2016. As a percentage of revenues, the provision for doubtful accounts was 2.8% for the 2017 period and 3.0% for the 2016 period. The increase was attributable2022 compared to the addition of 22 surgical facilities in connection with the acquisition of NSH.
Income from Equity Investments. The income from equity investments was $1.6$10.2 million for the three months ended September 30, 20172021. The costs for both periods primarily relate to ongoing development initiatives and the integration of acquisitions.
Grant Funds. Based on guidance from the U.S. Department of Health and Human Services ("HHS") and other authorities, the Company updated its estimate of the amount of grant funds received that qualified for recognition, resulting in the recognition of $0.5 million during the three months ended September 30, 2022. For further discussion, see Note 1 to our condensed consolidated financial statements included elsewhere in this report.
Interest Expense, Net. As a percentage of revenues, interest expense, net increased to 9.8% for the 2022 period compared to 9.7% for the 2021 period.
Income Tax Expense. The income tax expense was $7.8 million for the three months ended September 30, 2022 compared to an expense of $1.2 million for the three months ended September 30, 2016.2021. The increaseeffective tax rate was attributable to the addition of 4 minority owned surgical facilities (equity method investments) in connection with the acquisition of NSH.
Loss on Disposal or Impairment of Long-Lived Assets, Net. The net loss on disposal of long-lived assets was $447,00058.2% for the three months ended September 30, 20172022 compared to $572,00012.8% for the three months ended September 30, 2016.
Merger Transaction and Integration Costs. We incurred $5.3 million of merger transaction and integration costs related to the integration of our acquisitions for2021. For the three months ended September 30, 2017 compared2022, the effective tax rate differed from 21% primarily due to $1.9 million foran increase in the Company’s valuation allowance attributable to interest expense limitations. For the three months ended September 30, 2016. The increase is2021, the effective tax rate differed from 21% primarily related to the costs incurred in connection with the acquisition of NSH.
Loss on Debt Refinancing. The loss on debt refinancing was $18.2 million for the three months ended September 30, 2017 compared to $3.6 million for the three months ended September 30, 2016. The increase was due to the prepayment in wholereversal of the outstanding principal of the 2014 Revolver Loan and the 2014 First Lien Credit Agreement, with the proceeds from the 2017 Senior Secured Credit Facilities.
Operating (Loss) Income. Our operating income margin for the three months ended September 30, 2017 was (0.5)% compared to 15.2% during the three months ended September 30, 2016. During the three months ended September 30, 2017, we recorded a loss on debt refinancing of $18.2 million, merger transaction and integration costs related to acquisitions of $5.3 million, contingent acquisition compensation expense of $1.8 million and a loss on disposal of long-lived assets of $447,000. Further, the 2017 period included the impact of hurricanes Irma and Harvey and the impact associated with an increase in reserves for certain accounts receivables, the combination of these items resulted in a one time reduction to operating income of $23.2 million. Excluding the impact of these items, our operating income margin was 15.5% for the three months ended September 30, 2017.
During the three months ended September 30, 2016, we recorded $1.9 million of merger transaction and integration costs related to acquisitions, loss on debt refinancing of $3.6 million, contingent acquisition compensation expense of $1.5 million and a loss on disposal of long-lived assets of $0.6 million. Excluding the impact of these items, our operating income margin was 17.8% for the three months ended September 30, 2016.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
The decline was primarily related to an unfavorable payor mix shift on our higher acuity cases resulting in higher supply costs with lower reimbursement rates.
Tax Receivable Agreement Gain. During the three months ended September 30, 2017, we recognized a tax receivable agreement gain of $16.4 million. We recognized this gain as a result of the amendment of the TRA and the TRA Assignment Agreements.
Tax Receivable Agreement Expense. We incurred tax receivable agreement expense of $3.7 million for the three months ended September 30, 2016. The 2016 expense was recorded to update the initial estimated liability for the filed tax returns and final 2015 tax losses that are included in the amounts payable under the TRA.
Interest Expense, Net. Interest expense, net, was $34.0 million for the three months ended September 30, 2017 compared to $26.5 million for the three months ended September 30, 2016. As a percentage of revenues, interest expense, net was 11.1% for the 2017 period compared to 9.4% for the 2016 period. The increase relates to our refinancing of our Senior Secured Credit Agreement and the issuance of our 2025 Senior Unsecured Notes, further discussed in Note 4. "Long-Term Debt" of our condensed consolidated financial statements included previously in this report.
Income Tax Benefit. The income tax benefit was $20.9 million for the three months ended September 30, 2017 compared to $1.7 million for the three months ended September 30, 2016. The effective tax rate was 109.0% for the three months ended September 30, 2017 compared to (13.4)% for the three months ended September 30, 2016. As a percentage of net income after incomeCompany's earnings attributable to non-controlling interests, we expect the tax rate for the year to be between 41% and 42%.minority interest. Based upon the application of interim accounting guidance, however, the tax rate as a percentage of net income after income attributable to non-controlling interests will vary based upon the relative net income from period to period.
Net Income Attributable to Non-Controlling Interests. Net income attributable to non-controlling interests was $15.3 million for the three months ended September 30, 2017 compared to $16.7 million for the three months ended September 30, 2016. As a percentage of revenues, net income attributable to non-controlling interests was 5.0% in4.9% for the 20172022 period and 5.9%5.6% for the 20162021 period.
Nine Months Ended September 30,2017 2022 Compared to Nine Months Ended September 30, 20162021
The following table summarizes certain results from the statements of operations for the nine months ended September 30, 2022 and 2021 (dollars in millions):
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2022 | | 2021 |
| | | | |
| Revenues | | $ | 1,832.2 | | | $ | 1,614.9 | |
| Operating expenses: | | | | |
| Cost of revenues | | 1,441.6 | | | 1,270.6 | |
| General and administrative expenses | | 73.5 | | | 76.8 | |
| Depreciation and amortization | | 85.2 | | | 76.1 | |
| Transaction and integration costs | | 27.8 | | | 24.7 | |
| Grant funds | | (1.8) | | | (20.0) | |
| Loss on disposals and deconsolidations, net | | 3.2 | | | 2.0 | |
| Equity in earnings of unconsolidated affiliates | | (8.1) | | | (8.5) | |
| Litigation settlement | | (32.8) | | | — | |
| Loss on debt extinguishment | | — | | | 9.1 | |
| Other income, net | | (7.4) | | | (3.3) | |
| | 1,581.2 | | | 1,427.5 | |
| Operating income | | 251.0 | | | 187.4 | |
| Interest expense, net | | (173.9) | | | (160.9) | |
| Income before income taxes | | 77.1 | | | 26.5 | |
| Income tax (expense) benefit | | (13.4) | | | 1.3 | |
| Net income | | 63.7 | | | 27.8 | |
| Less: Net income attributable to non-controlling interests | | (94.9) | | | (98.6) | |
| Net loss attributable to Surgery Partners, Inc. | | $ | (31.2) | | | $ | (70.8) | |
Overview. During the nine months ended September 30, 2017,2022, our revenues were $880.9increased 13.5% to $1,832.2 million compared to $839.4$1,614.9 million for the nine months ended September 30, 2016. Revenue growth for the period is primarily attributable to the acquisition of NSH (closed on August 31, 2017) which added 22 surgical facilities to our portfolio. We incurred a net2021. Net loss attributable to Surgery Partners, Inc. for the 2017 period of $20.8 million, compared to $7.4was $31.2 million for the 20162022 period, compared to a net loss of $70.8 million for the 2021 period. During the 2017 period we experienced lower than expected revenue and incurred certain expenses related to Hurricanes Harvey and Irma, primarily driven by electrical outages at, and temporary closures of, certain of our facilities in affected areas resulting in an estimated loss of approximately 2,828 cases. We estimate the total impact from the hurricanes during the second half of 2017 to be a decrease of approximately $7.0 million to $9.0 million in expected revenue, with a majority of the impact being recognized in the third quarter. Additionally, in the 2017 period, subsequent to the Preferred Private Placement, we, as part of a review of operations undertaken to create a solid foundation to support our long-term growth objectives, incurred a non-recurring expense of $15.6 million associated with anThe increase in reserves for certain accounts receivables. This increaserevenues was primarily attributable to increases in reserves resulted from certain known eventssurgical case volumes, a favorable shift in surgical case mix and actions duringacquisitions completed since the third quarter of 2017 related to select payors primarily in our ancillary services segment. Upon consideration of such additional information, related receivables were determined to have a low likelihood of collection. The majority of this adjustment related to receivables with balances from the first quarter of 2016 and prior. We believe we have accounted for all necessary reserve adjustments at this time. Excluding these items from the 2017 period, we achieved revenue growth of 7.7%.prior-year period.
Revenues. Revenues for the nine months ended September 30, 20172022 compared to the nine months ended September 30, 20162021 were as follows (dollars in thousands)millions):
| | | | | Nine Months Ended September 30, | | | | | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | Dollar Variance | | Percent Variance | | 2022 | | 2021 |
| | | | | | | | | | | | | |
| Patient service revenues | | $ | 866,244 |
| | $ | 822,966 |
| | $ | 43,278 |
| | 5.3 | % | Patient service revenues | | $ | 1,805.1 | | | $ | 1,593.0 | |
| Optical service revenues | | 8,518 |
| | 10,222 |
| | (1,704 | ) | | (16.7 | )% | |
| Other service revenues | | 6,111 |
| | 6,249 |
| | (138 | ) | | (2.2 | )% | Other service revenues | | 27.1 | | | 21.9 | |
| Total revenues | | $ | 880,873 |
| | $ | 839,437 |
| | $ | 41,436 |
| | 4.9 | % | Total revenues | | $ | 1,832.2 | | | $ | 1,614.9 | |
Patient service revenues increased 5.3%13.3% to $866.2$1,805.1 million for the nine months ended September 30, 20172022 period compared to $823.0$1,593.0 million for the nine months ended September 30, 2016. The2021 period, primarily driven by a 3.8% increase in patient service revenues was primarily attributable todays adjusted same-facility case volume, a 2.7% increase in same-facility revenue per case and acquisitions completed since the acquisition of NSH.prior year period.
Cost of Revenues. Cost of revenues were $675.1$1,441.6 million for the nine months ended September 30, 20172022 period compared to $606.9$1,270.6 million for the nine months ended September 30, 2016. The increase was2021 period, primarily attributable to the integration ofdriven by acquisitions completed after September
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
30, 2016 (including NSH) and an increase in higher acuity case mix.since the prior year period. As a percentage of revenues, cost of revenues were 76.6%78.7% for both the 2017 period2022 and 72.3% for the 2016 period.2021 periods.
General and Administrative Expenses. General and administrative expenses were $54.6 million for the nine months ended September 30, 2017 compared to $42.2 million for the nine months ended September 30, 2016. The increase was primarily due to an increase in stock compensation expense, costs incurred related to the planned relocation of the corporate office in Nashville, TN and the integration of NSH during the period. As a percentage of revenues, general and administrative expenses were 6.2%decreased to 4.0% for the 20172022 period compared to 5.0%4.8% for the 20162021 period.
Depreciation and Amortization. Depreciation and amortization increased to $33.5 million for the nine months ended September 30, 2017 compared to $29.0 million for the nine months ended September 30, 2016. As a percentage of revenues, depreciation and amortization expenses were 3.8%4.7% for both the 2017 period2022 and 3.5% for the 2016 period. The increase was attributable to the addition2021 periods.
Provision for Doubtful Accounts. The provision for doubtful accounts increased to $20.0 million for the nine months ended September 30, 2017 compared to $15.9 million for the nine months ended September 30, 2016. As a percentage of revenues, the provision for doubtful accounts was 2.3% for the 2017 period and 1.9% for the 2016 period. The increase was attributable to the addition of 22 surgical facilities in connection with the acquisition of NSH.
Income from Equity Investments. The income from equity investments was $3.9 million for the nine months ended September 30, 2017 compared to $3.0 million for the nine months ended September 30, 2016. The increase was attributable to the addition of 4 minority owned surgical facilities (equity method investments) in connection with the acquisition of NSH.
Loss on Disposal or Impairment of Long-Lived Assets, Net. The net loss on disposal of long-lived assets was $2.0 million for the nine months ended September 30, 2017 compared to $1.7 million for the nine months ended September 30, 2016.
Merger Transaction and Integration Costs. We incurred $8.6$27.8 million of merger transaction and integration costs for the nine months ended September 30, 20172022 compared to $6.4$24.7 million for the nine months ended September 30, 2016.2021. The increase primarily relates to costs for ongoing development initiatives and the integration of acquisitions we completed in 2022 and 2021.
Grant Funds. Based on guidance from HHS and other authorities, the Company updated its estimate of the amount of grant funds received that qualified for recognition, resulting in the recognition of $1.8 million during the nine months ended September 30, 2022. Grant funds recognized in the nine months ended September 30, 2021 were $20.0 million. For further discussion, see Note 1 to our condensed consolidated financial statements included elsewhere in this report.
Litigation Settlement. Gain on litigation settlement was primarily related to the costs incurred in connection with the acquisition of NSH.
Loss on Debt Refinancing. We incurred a loss on debt refinancing of $18.2$32.8 million for the nine months ended September 30, 2017 compared2022, related to $11.9the resolution of the stockholder litigation matter, as discussed in Note 8. "Commitments and Contingencies" to our condensed consolidated financial statements included elsewhere in this report. There was no comparable activity for the 2021 period.
Loss on Debt Extinguishment. We incurred a loss on debt extinguishment of $9.1 million for the three months ended September 30, 2016. The increase was due2021 period related to prepayment in fullan amendment to our credit agreement, which refinanced all of the outstanding principal of the 2014 Revolver Loan and the 2014 First Lien Credit Agreement, with the proceeds from the 2017 Senior Secured Credit Facilitiesthen existing term loans during the nine months ended September 30, 2017.2021. There was no comparable loss during the 2022 period.
Operating Income. Our operating income marginInterest Expense, Net. As a percentage of revenues, interest expense, net decreased to 9.5% for the nine months ended September 30, 2017 was 8.8%2022 period compared to 15.3% during the nine months ended September 30, 2016. During the nine months ended September 30, 2017, we recorded a loss on debt refinancing of $18.2 million, merger transaction and integration costs related to acquisitions of $8.6 million, contingent acquisition compensation expense of $5.7 million and a loss on disposal of long-lived assets of $2.0 million. Further, the 2017 period included the impact of hurricanes Irma and Harvey and the impact associated with an increase in reserves for certain accounts receivables, the combination of these items resulted in a one time reduction to operating income of $23.2 million. Excluding the impact of these items, our operating income margin was 15.4%10.0% for the nine months ended September 30, 2017.2021 period.
During the nine months ended September 30, 2016, we recorded a loss on debt refinancing of $11.9 million, $6.4 million of merger transaction and integration costs related to acquisitions, contingent acquisition compensationIncome Tax (Expense) Benefit. The income tax expense of $3.1 million and a loss on disposal of long-lived assets of $1.7 million. Excluding the impact of these items, our operating income margin was 18% for the nine months ended September 30, 2016.
The decline primarily relates to an unfavorable payor mix shift on our higher acuity cases resulting in higher supply costs with lower reimbursement rates.
Interest Expense, Net. Interest expense, net, was $84.8$13.4 million for the nine months ended September 30, 20172022 compared to $74.9a benefit of $1.3 million for the nine months ended September 30, 2016. As a percentage of revenues, interest expense, net2021. The effective tax rate was 9.6% for the 2017 period compared to 8.9% for the 2016 period.
Tax Receivable Agreement Gain. During the nine months ended September 30, 2017, we recognized a tax receivable agreement gain of $16.4 million. We recognized this gain as a result of the amendment of the TRA and the TRA Assignment Agreements.
Tax Receivable Agreement Expense. We incurred tax receivable agreement expense of $3.7 million17.4% for the nine months ended September 30, 2016. The 2016 expense was recorded to update the initial estimated liability for the filed tax returns and final 2015 tax losses that are included in the amounts payable under the TRA.
Income Tax (Benefit) Expense. The income tax benefit was $18.3 million for the nine months ended September 30, 20172022 compared to expense of $2.5 million for the nine months ended September 30, 2016. The effective tax rate was (193.2)(4.9)% for the nine months ended September 30, 2017 compared to 5.0% for2021. For the nine months ended September 30, 2016. As a percentage of net income after income2022, the effective tax rate differed from 21% primarily due to earnings attributable to non-controlling interests, we expectan increase in the Company’s valuation allowance attributable to interest expense limitations, and discrete tax benefits of (a) $4.6 million related to the vesting of restricted stock awards, (b) $1.8 million attributable to non-recurring earnings’ impact on the Company’s valuation allowance, and (c) $1.0 million related to entity divestitures. For the nine months ended September 30, 2021, the effective tax rate fordiffered from 21% primarily due to tax benefits of (a) $4.4 million related to the yearvesting of restricted stock awards and (b) $3.0 million related to be between 41% and 42%.entity divestitures. Based upon the application of interim accounting
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
guidance, however, the tax rate as a percentage of net income after income attributable to non-controlling interests will vary based upon the relative net income from period to period.
Net Income Attributable to Non-Controlling Interests. Net income attributable to non-controlling interests decreased to $48.6 million for the nine months ended September 30, 2017 compared to $54.4 million for the nine months ended September 30, 2016. As a percentage of revenues, net income attributable to non-controlling interests was 5.5%5.2% for the 20172022 period and 6.5%6.1% for the 20162021 period.
Liquidity and Capital Resources
Operating Activities
The primary source of our operating cash flow is the collection of accounts receivable from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercialprivate insurance companies and individuals. During the nine months ended September 30, 2017,2022, our cash flow provided by operating activities was $66.5$151.6 million compared to $92.9$67.4 million in the nine months ended September 30, 2016.2021. The decrease period over periodincrease is primarily relateddue to interest paymentsan increase in net income, the receipt of $17.8stockholder litigation proceeds of $32.8 million on our 2021 Unsecured Notes and $10.0 million of tax receivable payments that were not incurred in the prior2022 period and a DOJ settlement payment of $32.2 million made during the 2021 period. At September 30, 2017, we had working capital of $298.6 million compared to $175.2 million at December 31, 2016.
Investing Activities
Net cash used in investing activities during the nine months ended September 30, 20172022, was $747.6$235.7 million which included $20.6compared to $141.7 million related to purchases of property and equipment. We acquired NSH for a purchase price of $711.4 million, net of cash acquired. Additionally, we purchased four physician practices and the assets of an endoscopy practice for an aggregate purchase price of $15.4 million.
Net cash used in investing activities during the nine months ended September 30, 2016 was $154.4 million, which included $28.42021. The increase in cash used is primarily due to an increase of $14.4 million related to purchases of property and equipment, including $4.9an increase of $95.1 million for purchases of equity method investments, a decrease of $2.5 million in cash proceeds from divestitures and an increase in other investing activities of $11.9 million. The increases in cash used in investing activities were partially offset by an increase of $11.5 million related to the relocationsale of our hospital in Great Falls, Montana. Additionally, we paid $126.0equity method investments and a decrease of $18.4 million in cash for acquisitions (net of cash acquired), of which $96.4 million, excluding $16.6 million of contingent acquisition consideration, related to the purchase of three surgical facilities, one of which was merged with an existing facility, six physician practices, a lab and a pharmacy. The remaining amount included an additional payment of $16.6 million to fund the final escrow payment related to the acquisition of Symbion Holding Corporation.
Financing Activities.
Net cash used in financing activities during the nine months ended September 30, 20172022 was $811.1 million. During this period, we made distributions$151.0 million compared to non-controlling interest holders of $56.8 million and paid cash related to ownership transactions with consolidated affiliates of $1.5 million. Further, we made repayments on our long-term debt of $1.2 billion offset by borrowings of $1.8 billion. Our repayments and borrowings include a $132.5 million draw down and subsequent repayment of $217.5 million on our Revolver during the period. In addition, we paid debt issuance costs of $58.6 million and received proceeds on the issuance of preferred stock of $291.7 million, net of issuance costs.
Net cash provided by financing activities during the nine months ended September 30, 2016 was $58.8 million. During this period, we made distributions to non-controlling interest holders of $49.4 million and received cash related to ownership transactions with consolidated affiliates of $1.1 million. Further, we made repayments on our long-term debt of $454.0 million offset by borrowings of $580.9 million. Our repayments and borrowings include a $91.5 million draw down and subsequent repayment of $184.8 million on our Revolver during the period. In addition, we paid debt issuance costs and the original issue discount of $14.3 million and a prepayment penalty on the payoff of the 2014 Second Lien of $4.9 million.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Long-Term Debt
A summary of long-term debt follows (in thousands):
|
| | | | | | | | |
| | | September 30,
2017 | | December 31,
2016 |
| | | | | |
| 2014 Revolver Loan | | $ | — |
| | $ | 85,000 |
|
| 2014 First Lien Credit Agreement | | — |
| | 932,000 |
|
| 2017 Senior Secured Credit Facilities: | | | | |
| Revolver | | — |
| | — |
|
| Term Loan | | 1,283,626 |
| | — |
|
| Senior Unsecured Notes due 2021 | | 409,821 |
| | 400,000 |
|
| Senior Unsecured Notes due 2025 | | 370,000 |
| | — |
|
| Subordinated Notes | | — |
| | 1,000 |
|
| Notes payable and secured loans | | 113,547 |
| | 42,521 |
|
| Capital lease obligations | | 16,340 |
| | 13,996 |
|
| Less: unamortized debt issuance costs and discount | | — |
| | (32,274 | ) |
| Total debt | | 2,193,334 |
| | 1,442,243 |
|
| Less: Current maturities | | 48,472 |
| | 27,822 |
|
| Total long-term debt | | $ | 2,144,862 |
| | $ | 1,414,421 |
|
2014 Revolver Loan & 2014 First Lien Credit Agreement
On August 31, 2017, we prepaid in full the outstanding principal of the 2014 Revolver Loan, a revolving credit facility entered into on November 3, 2014, and the 2014 First Lien Credit Agreement, a senior secured obligation of Surgery Center Holdings, Inc. entered into on November 3, 2014, with the proceeds from the 2017 Senior Secured Credit Facilities. The total prepayment amount was $1.030 billion, which included $1.027 billion of outstanding principal and $3.0 million of accrued and unpaid interest, other fees and expenses. In connection with the prepayment, we recorded a loss on debt refinancing of $18.2 million, for each of the three and nine months ending September 30, 2016. The loss includes the partial write-off of unamortized debt issuance costs and discount related to the 2014 Revolver Loan and 2014 First Lien Credit Agreement and a portion of costs incurred with the 2017 Senior Secured Credit Facilities.
2014 Second Lien Credit Agreement
On March 31, 2016, we prepaid in full the outstanding principal of the 2014 Second Lien Credit Agreement, plus accrued and unpaid interest, with the proceeds of the issuance of the 2021 Unsecured Notes, defined below. In connection with the prepayment, we recorded a loss on debt refinancing of $8.3$86.5 million for the nine months ended September 30, 2016.
2017 Senior Secured Credit Facilities
On August 31, 2017, SP Holdco I, Inc.2021. The decrease is primarily due to $248.2 million of proceeds received from an equity offering, net of related costs in the 2021 period, with no comparable activity in the 2022 period, an increase of $13.0 million for distributions to non-controlling interest holders and Surgery Center Holdings, Inc., eachan increase of $6.3 million of net payments related to ownership transactions with consolidated affiliates. The increases in cash used in financing activities were partially offset by a wholly-owned subsidiarydecrease of the Company, entered into$5.1 million in repayments of long-term debt, net of borrowings, a credit agreement (the “Credit Agreement”), providing for a $1.290 billion senior secured term loan (the “Term Loan”)decrease of $11.7 million related to payments of deferred financing costs and a $75.0 million revolving credit facility (the “Revolver” and, together with the Term Loan, the “2017 Senior Secured Credit Facilities”).
The Term Loan was fully drawn on August 31, 2017 and the proceeds thereof were used to finance the consideration paid in the NSH Merger, to repay amounts outstanding under our then-existing 2014 First Lien Credit Agreement and 2014 Revolver Loan and amounts outstanding under the existing senior secured credit facilities of NSH and to pay fees and expenses in connection with the foregoing and transactionsprepayment premium related to the Transaction Agreements. The Revolver may be utilizedmodification of the term loan in the 2021 period, a decrease of $5.1 million for preferred dividends and a decrease in other financing activities of $8.1 million.
Capital Resources
Net working capital was approximately $114.0 million at September 30, 2022 compared to $409.3 million at December 31, 2021. The decrease is due to a decrease in cash, primarily as a result of payments for acquisitions, an increase in other current liabilities and an increase in current maturities of long-term debt, offset by a decrease in deferred Medicare accelerated payments.
In addition to cash flows from operations and available cash, other sources of capital expendituresinclude amounts available on our Revolver as well as anticipated continued access to the capital markets.
Material Cash Requirements
In addition to the cash requirements related to our long-term debt, operating lease obligations and general corporate purposes. Subjectthe tax receivable agreement, pursuant to the CARES Act, repayment of certain conditionsadvanced payments and requirements set forthother deferrals received as part of relief during 2020 will continue during 2022. Further, at September 30, 2022, we had $100.4 million of deferred consideration payable and assumed debt due in October 2022 pursuant to a purchase agreement for a surgical hospital acquired in September 2022.
We received approximately $120 million of accelerated payments during the year ended December 31, 2020. Through September 30, 2022, approximately $117 million has been repaid including approximately $13 million and $56 million during the three and nine months ended September 30, 2022, respectively. In addition to the continued repayment of the advanced payments received under the CARES Act, we anticipate additional cash outflows during 2022 for the repayment of the remaining payroll taxes deferred in 2020 pursuant to the CARES Act.
There have been no material changes outside of the ordinary course of business to our upcoming cash obligations during the nine months ended September 30, 2022 from those disclosed under “Material Cash Requirements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2021 Annual Report on Form 10-K.
Summary
Broad economic factors resulting from the ongoing COVID-19 pandemic could negatively affect our payor mix, increase the relative proportion of lower margin services we provide and reduce patient volumes, as well as diminish our ability to collect outstanding receivables. Additionally, while we have received grants and accelerated payments under the CARES Act and other government assistance programs and may receive additional amounts in the Credit Agreement,future, there is no assurance regarding the extent to which anticipated negative impacts arising from the COVID-19 pandemic will be offset by amounts and benefits received under the CARES Act or future legislation. Business closings and layoffs in the areas in which we operate may request one or more additional incremental term loan facilities or one or morelead to increases in the commitments under the Revolver. As of September 30, 2017,uninsured and underinsured populations and adversely affect demand for our availability on the Revolver was $71.9 million (including outstanding letters of credit of $3.1 million).
The Term Loan will mature on August 31, 2024 (or, if at least 50.0% of the 2021 Unsecured Notes (as defined below) shall have not either been repaid or refinanced with permitted indebtedness having a maturity date not earlier than six months after the maturity date of the Term Loan by no later than October 15, 2020, then October 15, 2020). The Revolver will mature on August 31, 2022 (or, if at least 50.0% of the 2021 Notes have not either been repaid or refinanced with permitted indebtedness having a maturity date not earlier than six months after the maturity date of the Term Loan by no later than October 15, 2020, then October 15, 2020).
Interest on the 2017 Senior Secured Credit Facilities shall bear interest at a rate per annum equal to (x) LIBOR plus a margin ranging from 3.00% to 3.25% per annum, depending on our first lien net leverage ratio or (y) an alternate base rate (which will be the highest of (i) the prime rate, (ii) 0.5% per annum above the federal funds effective rate and (iii) one-month LIBOR plus 1.00% per annum (solely with
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
respect to the Term Loan, the alternate base rate shall not be less than 2.00% per annum)) plus a margin ranging from 2.00% to 2.25% per annum. In addition, we are required to pay a commitment fee of 0.50% per annum in respect of unused commitments under the Revolver.
The Term Loan amortizes in equal quarterly installments of 0.25% of the aggregate original principal amount of the Term Loan (such amortization payments will commence on or around the last business day of the fiscal quarter ending December 31, 2017). The Term Loan is subject to mandatory prepayments based on excess cash flow for the applicable fiscal year that will depend on the first lien net leverage ratio as of the last day of the applicable fiscal year,services, as well as upon the occurrence of certain other events, as described in the Credit Agreement. There were no excess cash flow payments required as of September 30, 2017.
With respect to the Revolver, we are required to comply with a maximum consolidated total net leverage ratio of 9.50:1.00, which covenant will be tested quarterly on a trailing four quarter basis only if, as of the last day of the applicable fiscal quarter the Revolver is drawn in an aggregate amount greater than 35% of the total commitments under the Revolver. Such financial maintenance covenant is subject to an equity cure. The Credit Agreement includes customary negative covenants restricting or limiting our ability and the ability of our restricted subsidiaries,payors to among other things, sell assets, alter our business, engage in mergers, acquisitions and other business combinations, declare dividends or redeem or repurchase equity interests, incur additional indebtedness or guarantees, make loans and investments, incur liens, enter into transactions with affiliates, prepay certain junior debt, and modify or waive certain material agreements and organizational documents, in each case, subject to customary and other agreed upon exceptions. The Credit Agreement also contains customary affirmative covenants and events of default. As of September 30, 2017, we were in compliance with the covenants containedpay for services as rendered. Any increase in the Credit Agreement.
The 2017 Senior Secured Credit Facilities are guaranteed, on a jointamount or deterioration in the collectability of patient accounts receivable will adversely affect our cash flows and several basis, by SP Holdco I, Inc. and eachresults of Surgery Center Holdings, Inc.'s current and future wholly-owned domestic restricted subsidiaries (subject to certain exceptions) (the “Subsidiary Guarantors”) and are secured by a first priority security interest in substantially alloperations, requiring an increased level of Surgery Center Holdings, Inc.'s, SP Holdco I, Inc.'s and the Subsidiary Guarantors’ assets (subject to certain exceptions).
In connection with the Term Loan and Revolver, we incurred debt issuance costs and discount of $18.8 million and $9.4 million, respectively, which were eliminated with the application of pushdown accounting.
Senior Unsecured Notes due 2021
Effective March 31, 2016, Surgery Center Holdings, Inc., issued $400.0 million in gross proceeds of senior unsecured notes due April 15, 2021 (the "2021 Unsecured Notes"). The 2021 Unsecured Notes bear interest at the rate of 8.875% per year, payable semi-annually on April 15 and October 15 of each year. The 2021 Unsecured Notes are a senior unsecured obligation of Surgery Center Holdings, Inc. and are guaranteed on a senior unsecured basis by each of Surgery Center Holdings, Inc.'s existing and future domestic wholly owned restricted subsidiaries that guarantees the 2017 Senior Secured Credit Facilities (subject to certain exceptions).
We may redeem up to 35% of the aggregate principal amount of the 2021 Unsecured Notes, at any time before April 15, 2018, with the net cash proceeds of certain equity offerings at a redemption price equal to 108.875% of the principal amount to be redeemed, plus accrued and unpaid interest to, but excluding, the date of redemption, provided that at least 50% of the aggregate principal amount of the 2021 Unsecured Notes remain outstanding immediately after the occurrence of such redemption and such redemption occurs within 180 days of the date of the closing of any such qualified equity offering.
We may redeem the 2021 Unsecured Notes, in whole or in part, at any time prior to April 15, 2018 at a price equal to 100.000% of the principal amount to be redeemed plus an applicable make-whole premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. We may redeem the 2021 Unsecured Notes, in whole or in part, at any time on or after April 15, 2018, at the redemption prices set forth below (expressed as a percentage of the principal amount to be redeemed), plus accrued and unpaid interest, if any, to the date of redemption:
|
| | |
April 15, 2018 to April 14, 2019 | 106.656 | % |
April 15, 2019 to April 14, 2020 | 104.438 | % |
April 15, 2020 and thereafter | 100.000 | % |
working capital.If Surgery Center Holdings, Inc., experiences a changegeneral economic conditions, including recent increases in control under certain circumstances, we must offerinterest rates, inflation risk and market volatility continue to purchase the 2021 Unsecured Notes at a purchase price equal to 101.000%deteriorate or remain uncertain for an extended period of the principal amount, plus accrued and unpaid interest to, but excluding, the date of repurchase. The change of control as discussed in Note 1. "Organization", did not trigger repurchase.
The 2021 Unsecured Notes contain customary affirmative and negative covenants, which among other things, limittime, our ability to incur additional debt, pay dividends, create or assume liens, effect transactions with its affiliates, guarantee payment of certain debt securities, sell assets, merge, consolidate, enter into acquisitionsaccess capital could be harmed, which could negatively affect our liquidity and effect sale and leaseback transactions.
In connection with the offering of the 2021 Unsecured Notes, we incurred debt issuance costs of $8.4 million, which were eliminated with the application of pushdown accounting.
Senior Unsecured Notes due 2025
Effective June 30, 2017, SP Finco, LLC, a wholly owned subsidiary of Surgery Center Holdings, Inc., issued $370.0 million in gross proceeds of senior unsecured notes due July 1, 2025 (the "2025 Unsecured Notes"), which gross proceeds were deposited in an escrow account (the “Escrow Account”) established at Wilmington Trust, National Association (in such capacity, the “Escrow Agent”) in the name of the
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
trustee under the indenture governing the 2025 Unsecured Notes (the “2025 Unsecured Notes Indenture”) on behalf of the holders of the 2025 Unsecured Notes. The 2025 Unsecured Notes bear interest at the rate of 6.750% per year, payable semi-annually on January 1 and July 1 of each year, commencing on January 1, 2018.
In connection with the closing of the NSH Merger and the release of the proceeds from the Escrow Account, both of which occurred on August 31, 2017, SP Finco, LLC merged with and into Surgery Center Holdings, Inc., with Surgery Center Holdings, Inc. surviving such merger and assuming, by operation of law, the rights and obligations of SP Finco, LLC under the 2025 Unsecured Notes and the indenture governing such notes. As of such time, the 2025 Unsecured Notes became guaranteed on a senior unsecured basis by each of Surgery Center Holdings, Inc.’s domestic wholly owned restricted subsidiaries that guarantees Surgery Center Holdings, Inc.’s senior secured credit facilities (subject to certain exceptions).
We may redeem up to 40% of the aggregate principal amount of the 2025 Unsecured Notes at any time prior to July 1, 2020, with the net cash proceeds of certain equity issuances at a redemption price equal to 106.750% of the principal amount to be redeemed, plus accrued and unpaid interest to, but excluding, the date of redemption, provided that at least 50% of the aggregate principal amount of the 2025 Unsecured Notes remain outstanding immediately after the occurrence of such redemption and such redemption occurs within 180 days of the date of the closing of the applicable equity offering.
We may redeem the 2025 Unsecured Notes, in whole or in part, at any time prior to July 1, 2020, at a price equal to 100.000% of the principal amount to be redeemed plus the applicable premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. We may redeem the 2025 Unsecured Notes, in whole or in part, at any time on or after July 1, 2020, at the redemption prices set forth below (expressed as a percentage of the principal amount to be redeemed), plus accrued and unpaid interest, if any, to, but excluding, the date of redemption:
|
| | |
July 1, 2020 to June 30, 2021 | 103.375 | % |
July 1, 2021 to June 30, 2022 | 101.688 | % |
July 1, 2022 and thereafter | 100.000 | % |
If Surgery Center Holdings, Inc., experiences a change in control under certain circumstances, we must offer to purchase the 2025 Unsecured Notes at a purchase price equal to 101.000% of the principal amount, plus accrued and unpaid interest to, but excluding, the date of repurchase.
The 2025 Unsecured Notes contain customary affirmative and negative covenants, which, among other things, limit our ability to incur additional debt, pay dividends, create or assume liens, effect transactions withrepay our affiliates, guarantee payment of certain debt securities, sell assets, merge, consolidate, enter into acquisitions and effect sale and leaseback transactions.
In connection with the offering of the 2025 Unsecured Notes, we incurred debt issuance costs of $17.3 million, which were eliminated with the application of pushdown accounting.
Subordinated Notes
On August 3, 2017, we redeemed in whole a subordinated debt facility of $1.0 million with a maturity date of August 4, 2017 and an interest rate of 17.00% per annum, at a price equal 100% of the $1.0 million principal amount redeemed, plus accrued and unpaid interest.
Notes Payable and Secured Loans
Certain of our subsidiaries have outstanding bank indebtedness, which is collateralized by the real estate and equipment owned by the surgical facilities to which the loans were made. The various bank indebtedness agreements contain covenants to maintain certain financial ratios and also restrict encumbrance of assets, creation of indebtedness, investing activities and payment of distributions. At September 30, 2017, we were in compliance with the covenants contained in the credit agreement. We and our subsidiaries had notes payable to financial institutions of $113.5 million and $42.5 million as of September 30, 2017 and December 31, 2016, respectively. We and our subsidiaries also provide a corporate guarantee of certain indebtedness of our subsidiaries.
Capital Lease Obligations
We are liable to various vendors for several equipment leases. The carrying value of the leased assets was $19.2 million and $15.4 million as of September 30, 2017 and December 31, 2016, respectively.
Summarydebt.
Based on our current level of operations, we believe cash flowflows from operations, and available cash, together with available borrowings under thecapacity on our Revolver and continued anticipated access to capital markets, will be adequate to meet our short-term (12 months or less)(i.e., 12 months) and longer-term (less than five years)long-term (beyond 12 months) liquidity needs.
EBITDA, Certain Non-GAAP Measures
Adjusted EBITDA and Credit Agreement EBITDA
When we use the term “EBITDA,” we are referring to income before income taxes minus (a) net income attributable to non-controlling interests plus (c) interest expense, net, and (d) depreciation and amortization. Non-controlling interests represent the interests of third parties, such as physicians, and in some cases, healthcare systems that own an interest in surgical facilities that we consolidate for financial reporting purposes. Our operating strategy is to apply a market-based approach in structuring our partnerships with individual market dynamics driving
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
the structure. We believe that it is helpful to investors to present EBITDA as defined above because it excludes the portion of net income attributable to these third-party interests and clarifies for investors our portion of EBITDA generated by our surgical facilities and other operations.
When we use the term "Adjusted EBITDA", we are referring to EBITDA, as defined above, adjusted for (a) merger transaction, integration and practice acquisition costs, (b) non-cash stock compensation expense, (c) loss on debt refinancing, (d) contingent acquisition compensation expense, (e) gain on litigation settlement, (f) loss on disposal or impairment of long-lived assets, net, (g) gain on amendment to tax receivable agreement, (h) tax receivable agreement expense and (i) gain on acquisition escrow release. We use Adjusted EBITDA as a measure of financial performance. Adjusted EBITDA is a key measure used by our management to assess operating performance, make business decisions and allocate resources.
EBITDA and Adjusted EBITDA excluding grant funds are not measurements of financial performance under GAAP. TheyGAAP and should not be considered in isolation or as a substitute for net income, operating income or any other measure calculated in accordance with generally accepted accounting principles.GAAP. The items excluded from Adjusted EBITDAthese non-GAAP metrics are significant components in understanding and evaluating our financial performance. We believe such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. Our calculation of Adjusted EBITDA and Adjusted EBITDA excluding grant funds may not be comparable to similarly titled measures reported by other companies. We use Adjusted EBITDA and Adjusted EBITDA excluding grant funds as measures of financial performance. Adjusted EBITDA and Adjusted EBITDA excluding grant funds are key measures used by our management to assess operating performance, make business decisions and allocate resources.
The following table reconciles Adjusted EBITDA and Adjusted EBITDA excluding grant funds to income before income taxes, the most directly comparable GAAP financial measure (in millions and unaudited):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Condensed Consolidated Statements of Operations Data: | | | | | | | |
| Income before income taxes | $ | 13.4 | | | $ | 9.4 | | | $ | 77.1 | | | $ | 26.5 | |
| Plus (minus): | | | | | | | |
| Net income attributable to non-controlling interests | (30.6) | | | (31.1) | | | (94.9) | | | (98.6) | |
| Depreciation and amortization | 29.8 | | | 25.2 | | | 85.2 | | | 76.1 | |
| Interest expense, net | 60.7 | | | 54.2 | | | 173.9 | | | 160.9 | |
| Equity-based compensation expense | 5.0 | | | 4.1 | | | 13.0 | | | 13.4 | |
Transaction, integration and acquisition costs (1) | 13.1 | | | 10.2 | | | 28.4 | | | 31.0 | |
| Loss on disposals and deconsolidations, net | 2.2 | | | 1.9 | | | 3.2 | | | 2.0 | |
Loss (gain) on litigation settlement and other litigation costs (2) | 1.5 | | | 2.5 | | | (27.6) | | | 4.3 | |
| (Gain) loss on debt extinguishment | — | | | (0.5) | | | — | | | 9.1 | |
Hurricane-related impacts (3) | 1.1 | | | 0.5 | | | 1.1 | | | 0.5 | |
| Adjusted EBITDA | $ | 96.2 | | | $ | 76.4 | | | $ | 259.4 | | | $ | 225.2 | |
Less: Impact of grant funds (4) | (0.3) | | | — | | | (1.4) | | | (13.7) | |
| Adjusted EBITDA excluding grant funds | $ | 95.9 | | | $ | 76.4 | | | $ | 258.0 | | | $ | 211.5 | |
(1)This amount includes transaction and integration costs of $12.5 million and $10.2 million for the three months ended September 30, 2022 and 2021, respectively. This amount further includes start-up costs related to de novo surgical facilities of $0.6 million for the three months ended September 30, 2022.
This amount includes transaction and integration costs of $27.8 million and $24.7 million for the nine months ended September 30, 2022 and 2021, respectively. This amount further includes start-up costs related to de novo surgical facilities of $0.6 million and $6.3 million for the nine months ended September 30, 2022 and 2021, respectively.
(2)This amount includes other litigation costs of $1.5 million and $2.5 million for the three months ended September 30, 2022 and 2021, respectively.
This amount includes other litigation costs of $5.2 million and $4.3 million for the nine months ended September 30, 2022 and 2021, respectively. This amount also includes gain on litigation settlement of $32.8 million for the nine months ended September 30, 2022.
(3)Reflects losses incurred, net of insurance proceeds received at certain surgical facilities that were closed following Hurricane Ida in September 2021 and Hurricane Ian in September 2022.
(4)Represents the impact of grant funds recognized, net of amounts attributable to non-controlling interests.
We use Credit Agreement EBITDA as a measure of liquidity and to determine our compliance under certain covenants pursuant to our credit facilities. Credit Agreement EBITDA is determined on a trailing twelve-month basis. We have included it because we believe that it provides investors with additional information about our ability to incur and service debt and make capital expenditures. Credit Agreement EBITDA is not a measurement of liquidity under GAAP and should not be considered in isolation or as a substitute for any other measure calculated in accordance with GAAP. The items excluded from Credit Agreement EBITDA are significant components in understanding and evaluating our liquidity. Our calculation of Credit Agreement EBITDA may not be comparable to similarly titled measures reported by other companies.
When we use the term “Credit Agreement EBITDA,” we are referring to Adjusted EBITDA, as defined above, further adjusted for (a) acquisitions (b) non-cash expenses and (c) de novo start-up losses.synergies. These adjustments do not relate to our historical financial performance and instead relate to estimates compiled by our management and calculated in conformance with the definition of “Consolidated EBITDA” used in the credit agreements governing our credit facilities. We use Credit Agreement EBITDA as a measure of liquidity and to determine our compliance under certain covenants pursuant to our credit facilities. We have included it because we believe that it provides investors with additional information about our ability to incur and service debt and make capital expenditures.
Credit Agreement EBITDA is not a measurement of liquidity under GAAP, and should not be considered in isolation or as a substitute for any other measure calculated in accordance with generally accepted accounting principles. The items excluded from Credit Agreement EBITDA are significant components in understanding and evaluating our liquidity. Our calculation of Credit Agreement EBITDA may not be comparable to similarly titled measures reported by other companies.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
The following table reconciles EBITDA , Adjusted EBITDA and Normalized Adjusted EBITDA to income before income taxes, the most directly comparable GAAP financial measure (in thousands and unaudited):
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | | 2017 | | 2016 | | 2017 | | 2016 |
| Condensed Consolidated Statements of Operations Data: | | | | | | | | |
| (Loss) income before income taxes | | $ | (19,208 | ) | | $ | 12,640 |
| | $ | 9,470 |
| | $ | 49,479 |
|
| (Minus): | | | | | | | | |
| Net income attributable to non-controlling interests | | 15,305 |
| | 16,672 |
| | 48,579 |
| | 54,392 |
|
| Plus: | | | | | | | | |
| Interest expense, net | | 34,030 |
| | 26,475 |
| | 84,812 |
| | 74,863 |
|
| Depreciation and amortization | | 10,929 |
| | 9,713 |
| | 33,454 |
| | 28,984 |
|
| EBITDA | | 10,446 |
| | 32,156 |
| | 79,157 |
| | 98,934 |
|
| Plus: | | | | | | | | |
| Non-cash stock compensation expense | | 3,311 |
| | 691 |
| | 5,380 |
| | 1,326 |
|
| Contingent acquisition compensation expense | | 1,815 |
| | 1,530 |
| | 5,662 |
| | 3,060 |
|
| Merger transaction, integration and practice acquisition costs | | 6,406 |
| | 2,471 |
| | 11,134 |
| | 8,579 |
|
| Gain on litigation settlement | | — |
| | — |
| | (3,794 | ) | | — |
|
| Gain on acquisition escrow release | | (1,000 | ) | | — |
| | (1,000 | ) | | — |
|
| Loss on disposal or impairment of long-lived assets, net | | 447 |
| | 572 |
| | 2,048 |
| | 1,697 |
|
| Gain on amendment to tax receivable agreement | | (16,392 | ) | | — |
| | (16,392 | ) | | — |
|
| Tax receivable agreement expense | | — |
| | 3,733 |
| | — |
| | 3,733 |
|
| Loss on debt refinancing | | 18,211 |
| | 3,595 |
| | 18,211 |
| | 11,876 |
|
| Adjusted EBITDA | | $ | 23,244 |
| | $ | 44,748 |
| | $ | 100,406 |
| | $ | 129,205 |
|
| Hurricane estimated impact | | 5,000 |
| | | | 5,000 |
| | |
| Reserve adjustment | | 14,868 |
| | | | 14,868 |
| | |
| Normalized Adjusted EBITDA | | $ | 43,112 |
| | $ | 44,748 |
| | $ | 120,274 |
| | $ | 129,205 |
|
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
The following table reconciles Credit Agreement EBITDA to cash flows from operating activities, the most directly comparable GAAP financial measure (in thousandsmillions and unaudited):
| | | | | | | | |
| | Twelve Months Ended September 30, 2022 |
| | |
| Cash flows from operating activities | | $ | 171.3 | |
| Plus (minus): | | |
| Non-cash interest expense, net | | (29.0) | |
| Non-cash lease expense | | (35.6) | |
| Deferred income taxes | | (23.6) | |
| Equity in earnings of unconsolidated affiliates, net of distributions received | | 0.5 | |
| Changes in operating assets and liabilities, net of acquisitions and divestitures | | 151.3 | |
| Income tax expense | | 25.2 | |
| Net income attributable to non-controlling interests | | (137.9) | |
| Interest expense, net | | 234.0 | |
| Transaction, integration and acquisition costs | | 43.5 | |
| Litigation settlement and other litigation costs | | (26.3) | |
Hurricane-related impacts (1) | | 0.4 | |
Acquisitions and synergies (2) | | 91.2 | |
| Credit Agreement EBITDA | | $ | 465.0 | |
|
| | | | |
| | | Twelve Months Ended September 30, 2017 |
| | | |
| Cash flows from operating activities | | $ | 98,872 |
|
| Adjustments to reconcile cash flows from operating activities to income before income taxes: | | |
| Depreciation and amortization | | (44,021 | ) |
| Amortization of debt issuance costs and discounts | | (6,892 | ) |
| Amortization of unfavorable lease liability | | 352 |
|
| Equity-based compensation | | (6,075 | ) |
| Loss on disposal or impairment of long-lived assets, net | | (2,706 | ) |
| Loss on debt refinancing | | (18,211 | ) |
| Gain on amendment to tax receivable agreement | | 16,392 |
|
| Gain on legal settlement | | 14,101 |
|
| Deferred income taxes | | 14,189 |
|
| Interest on contingent consideration obligation | | (1,124 | ) |
| Provision for doubtful accounts | | (28,268 | ) |
| Income from equity investments, net of distributions received | | 422 |
|
| Changes in operating assets and liabilities, net of acquisitions and divestitures | | 28,839 |
|
| Income tax expense | | (13,701 | ) |
| Income before income taxes | | 52,169 |
|
| (Minus): | | |
| Net income attributable to non-controlling interests | | 69,817 |
|
| Plus: | | |
| Interest expense, net | | 110,520 |
|
| Depreciation and amortization | | 44,021 |
|
| EBITDA | | 136,893 |
|
| Plus: | | |
| Merger transaction, integration and practice acquisition costs | | 14,170 |
|
| Gain on amendment to tax receivable agreement | | (16,392 | ) |
| Non-cash stock compensation expense | | 6,191 |
|
| Loss on debt refinancing | | 18,211 |
|
| Contingent acquisition compensation expense | | 7,694 |
|
| Gain on litigation settlement | | (17,895 | ) |
| Gain on acquisition escrow release | | (1,000 | ) |
| Loss on disposal of investments and long-lived assets, net | | 2,706 |
|
| Adjusted EBITDA | | 150,578 |
|
| Plus: | | |
Acquisitions (1) | | 119,583 |
|
| Hurricane estimated impact | | 5,000 |
|
| Reserve impact | | 14,868 |
|
| Non-cash expenses | | 1,596 |
|
De novo start-up losses (2) | | 136 |
|
| Credit Agreement EBITDA | | $ | 291,761 |
|
(1)(2)Represents impact of acquired anesthesia entities, physician practices and surgical facilitiesacquisitions as if each acquisition had occurred on October 1, 2016 including cost savings from reductions in corporate overhead, supply chain rationalization, enhanced physician engagement, improved payor contracting and revenue synergies associated with the NSH acquisition.2021. Further this includes revenue and cost synergies from other business initiatives and de novo facilities and an adjustment for the effects of adopting the new lease accounting standard, as defined in the Credit Agreement.
(2) Relates to the losses associated with de novo in-market physician practices opened during the last twelve months.
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
Inflation
Inflation and changing prices have not significantly affected our operating results or the markets in which we operate.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers," along with subsequent amendments, updates and an extension of the effective date (collectively the “New Revenue Standard”), which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. This five-step process will require significant management judgment in addition to changing the way many companies recognize revenue in their financial statements. Additionally, and among other provisions, the New Revenue Standard requires expanded quantitative and qualitative disclosures, including disclosure about the nature, amount, timing and uncertainty of revenue. The provisions of the New Revenue Standard are effective for annual periods beginning after December 15, 2017, including interim periods within those years by applying either the full retrospective method or the modified retrospective approach upon adoption. We will adopt this ASU on January 1, 2018. We currently plan to adopt using the modified retrospective method, including providing all requisite disclosures under such method.
In preparation for the adoption of the New Revenue Standard, we continue to evaluate and refine our estimates of the anticipated impacts the New Revenue Standard will have on our revenue recognition policies, procedures, financial position, results of operations, cash flows, financial disclosures and control framework. Specifically, we continue to evaluate our accounting policies and internal controls under the New Revenue Standard, as well as analyzing all of the potential effects of the New Revenue Standard, particularly with respect to non-patient service revenue sources. Upon further evaluation, we anticipate that the majority of our provision for doubtful accounts will continue to be recognized as an operating expense rather than as a direct reduction to revenues, given our practice of assessing a patient’s ability to pay prior to or on the date of providing healthcare services.
In February 2016, the FASB issued ASU 2016-02, “Leases,” which will require, among other items, lessees to recognize most leases as assets and liabilities on the balance sheet. Qualitative and quantitative disclosures will be enhanced to better understand the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. We believe the primary effect of adopting the new standard will be to record right-of-use assets and obligations for current operating leases.
In March 2016, the FASB issued ASU 2016-07, “Investments- Equity Method and Joint Ventures,” which allows investments that now meet equity method treatment and were previously accounted for under a different method to apply the equity method prospectively from the date the investment qualifies for equity method treatment. ASU 2016-07 is effective prospectively for fiscal years beginning after December 15, 2016, including interim periods within those years. Early adoption is permitted. We adopted this ASU on January 1, 2017. The adoption of this ASU did not have a material impact on our consolidated financial position, results of operations, cash flows and financial disclosures.
In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which clarifies the classification of certain cash receipts and cash payments on the statement of cash flows. ASU 2016-15 is effective retrospectively for fiscal years beginning after December 15, 2017, including interim periods within those years. Early adoption is permitted. We are currently evaluating the impact this new guidance may have on the consolidated cash flows.
In October 2016, the FASB issued ASU 2016-17, “Interests Held through Related Parties That Are under Common Control,” which modifies existing guidance with respect to how a decision maker that holds an indirect interest in a VIE through a common control party determines whether it is the primary beneficiary of the VIE as part of the analysis of whether the VIE would need to be consolidated. Under the ASU, a decision maker would need to consider only its proportionate indirect interest in the VIE held through a common control party. Previous guidance had required the decision maker to treat the common control party’s interest in the VIE as if the decision maker held the interest itself. As a result of the ASU, in certain cases, previous consolidation conclusions may change. ASU 2016-17 is effective prospectively for fiscal years beginning after December 15, 2016, including interim periods within those years. We adopted this ASU on January 1, 2017. The adoption of this ASU did not have a material impact on our consolidated financial position, results of operations, cash flows and financial disclosures.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows: Restricted Cash,” which will require the reconciliation of restricted cash in the statement of cash flows. ASU 2016-18 is effective retrospectively for fiscal years beginning after December 15, 2017, including interim periods within those years. Early adoption is permitted. The adoption of this ASU will not have a material impact on our consolidated cash flows.
In January 2017, the FASB issued ASU 2017-01, “Business Combinations – Clarifying the Definition of a Business,” which narrows the definition of a business when evaluating whether transactions should be accounted for as asset acquisitions or business combinations. ASU 2017-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those years. Early adoption is permitted. The adoption of this ASU will not have a material impact on our condensed consolidated financial position, results of operations and cash flows.
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based on the current Step 1). ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, including interim periods
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
within those years. Early adoption is permitted for annual and interim periods after January 1, 2017. We early adopted this ASU on January 1, 2017. The adoption of ASU 2017-04 only impacts our financial statements in situations where an impairment of a reporting unit’s assets is determined.
Sources of Revenue and Recent Regulatory Developments
General
The healthcare industry is highly regulated, and we cannot provide any assurance that the regulatory environment in which we operate will not significantly change in the future or that we will be able to successfully address any such changes.
Every state imposes licensing requirements on individual physicians and healthcare facilities. In addition, federal and state laws regulate HMOs and other managed care organizations. Many states require regulatory approval, including licensure and accreditation, and in some cases, certificates of need, before establishing certain types of healthcare facilities, including surgical hospitals and ASCs, offering certain services, including the services we offer, or making expenditures in excess of certain amounts for healthcare equipment, facilities or programs. Our ability to operate profitably will depend in part upon our surgical facilities obtaining and maintaining all necessary licenses, accreditation, certificates of need and other approvals and operating in compliance with applicable healthcare regulations. Failure to do so could have a material adverse effect on our business.
Our surgical facilities are subject to federal, state and local laws dealing with issues such as occupational safety, employment, medical leave, insurance regulations, civil rights, discrimination, building codes and medical waste and other environmental issues. Federal, state and local governments are expanding the regulatory requirements on businesses like ours. The imposition of these regulatory requirements may have the effect of increasing operating costs and reducing the profitability of our operations.
We believe that hospital, outpatient surgery, physician, laboratory and other diagnostic and healthcare services will continue to be subject to intense regulation at the federal and state levels. We are unable to predict what additional government regulations, if any, affecting our business may be enacted in the future or how existing or future laws and regulations might be interpreted. If we, or any of our surgical facilities, fail to comply with applicable laws, it might have a material adverse effect on our business.
Certificates of Need and Licensure
Capital expenditures for the construction of new healthcare facilities, the addition of beds or new healthcare services or the acquisition of existing healthcare facilities may be reviewable by state regulators under statutory schemes that are sometimes referred to as certificate of need laws. States with certificate of need laws place limits on the construction and acquisition of healthcare facilities and the expansion of existing facilities and services. In these states, approvals, generally known as certificates of need, are required for capital expenditures exceeding certain preset monetary thresholds for the development, acquisition and/or expansion of certain facilities or services, including surgical facilities. We have a concentration of surgical facilities in certificate of need states as we believe the regulations present a competitive advantage to existing operators.
Our healthcare facilities also are subject to state licensing requirements for medical providers. Our ASCs have licenses to operate in the states in which they operate and must meet all applicable requirements for ASCs. In addition, even though our surgical facilities that are licensed as hospitals primarily provide surgical services, they must meet all applicable requirements for general hospital licensure. To assure continued compliance with these regulations, governmental and other authorities periodically inspect our surgical facilities. The failure to comply with these regulations could result in the suspension or revocation of a facility’s license. In addition, based on the specific operations of our surgical facilities, some of these facilities maintain a pharmacy license, a controlled substance registration, a clinical laboratory certification waiver, and environmental protection permits for biohazards and/or radioactive materials, as required by applicable law.
Healthcare Reform
The Affordable Care Act has been subject to a number of challenges to its constitutionality. On June 28, 2012, the United States Supreme Court upheld challenges to the constitutionality of the “individual mandate” provision, which generally requires all individuals to purchase healthcare insurance or pay a penalty, but struck down as unconstitutional the provision that would have allowed the federal government to revoke all federal Medicaid funding to any state that did not expand its Medicaid program. As a result, many states have refused to extend Medicaid eligibility to more individuals as envisioned by the law.
On June 25, 2015, the United States Supreme Court upheld the legality of premium subsidies made available by the federal government to individuals residing in the 36 states that have federally-run health insurance exchanges. The subsidies are provided to low-income individuals to assist with the cost of purchasing health insurance through federally-run health insurance exchanges. Other legal challenges to the Affordable Care Act are pending.
Additionally, at least one court has ruled that the President lacks authority to continue to make certain payments to insurers to offset the cost of reductions in out-of-pocket expenses (deductibles and coinsurance) that insurers are required to provide to certain enrollees whose incomes are below certain specified levels. Although that decision has been stayed, the Trump administration has announced that the federal government will not continue to make such payments absent explicit Congressional authority. It is uncertain whether Congress will enact legislation granting such authority, and it is therefore uncertain whether these payments will be reinstated in the future.
Initiatives to repeal the Affordable Care Act, in whole or in part, to delay elements of implementation or funding, and to offer amendments or supplements to modify its provisions have been persistent and have increased as a result of the 2016 election. The ultimate outcomes of
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
legislative attempts to repeal or amend the Affordable Care Act and legal challenges to the Affordable Care Act are unknown. As of September 30, 2017, there have been numerous pieces of legislation introduced in Congress for the repeal and replacement of the Affordable Care Act. Much of the introduced legislation calls for substantial reduction in federal spending over the next ten years primarily related to the termination of federal funding for the expanded eligibility for Medicaid coverage. Such legislation may have significant impact on the reimbursement for healthcare services generally, and may cause more individuals to become uninsured, rendering them unable to afford healthcare services offered by the Company. Accordingly, there can be no assurance that the adoption of any future federal or state healthcare reform legislation will not have a negative financial impact on the Company.
Moreover, other legislative changes have also been proposed and adopted since the Affordable Care Act was enacted. On August 2, 2011, the Budget Control Act of 2011, among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering the legislation’s automatic reduction to several government programs. This included aggregate reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013 and, due to subsequent legislative amendments, will remain in effect through 2025 unless additional Congressional action is taken. On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years. These and other similar new laws may result in additional reductions in Medicare and other health care funding, which could have a material adverse effect on our financial operations.
Medicare and Medicaid Private Contractor Audits
The Centers for Medicare and Medicaid Services (“CMS") has implemented a number of programs that use private contractors that contract with CMS to identify overpayments and underpayments and other potential sources of billing fraud. These contractors, known as Recovery Audit Contractors (“RACs”) and Zone Program Integrity Contractors (“ZPICs”) conduct both post-payment and pre-payment review of claims submitted by Medicare providers. In addition, CMS employs Medicaid Integrity Contractors (“MICs”) to perform post-payment audits of Medicaid claims and identify overpayments. Our facilities and providers continue to receive letters from auditors such as RACs and ZPICs requesting repayment of alleged overpayments for services and incur expenses associated with responding to and appealing these determinations, as well as the costs of repaying any overpayments. Moreover, in recent years, the increase in Medicare payment appeals has created a backlog such that resolving appeals often takes multiple years.
For instance, we received the results of a MIC audit that resulted in an overpayment obligation. HMS Federal Solutions, a MIC, completed the audit of one of our surgical hospitals for the period July 1, 2009 through May 31, 2012 and determined an overpayment obligation in the amount of approximately $4.6 million based on its extrapolation of a statistical sampling of claims, as well as a civil monetary penalty in the amount of $162,000, for a total amount owed to Idaho’s Department of Health and Welfare, Medicaid Program Integrity Unit of approximately $4.7 million for failure to comply with Medicaid rules by billing for (i) non-covered services, (ii) services provided by non-eligible providers, (iii) services not provided and (iv) unauthorized services. We appealed the audit, which was settled during the quarter ending June 30, 2017 for $1.3 million.
Although all other repayments requested to date as a result of RAC, MIC and ZPIC audits have not been material to our Company, we are unable to quantify the aggregate financial impact of these audits on our facilities given the pending appeals and uncertainty about the extent of future audits.
Quality Improvement
The Medicare program presently requires hospitals and ASCs to report performance data on a variety of quality metrics. Facilities that fail to report are penalized with reduced Medicare payments. Additionally, payments to hospitals are adjusted based on the hospital’s performance on these quality measures. A substantial portion of hospital payment is at risk depending on its individual performance relative to benchmarks and other hospitals’ performance. There is a substantial risk that our Medicare payments could be reduced if our hospitals fail to perform adequately on these measures. Additionally, there is a risk that Medicare payments could be reduced if our facilities-hospitals and ASCs-fail to adequate report data as required by CMS. ASC payments are not yet adjusted based on performance against quality measures, but there is a substantial risk that Congress may soon link ASC Medicare payments to actual performance, in addition to reporting.
If the public performance data becomes a primary factor in determining where patients choose to receive care, and if competing hospitals and ASCs have better results than our facilities on those measures, we would expect that our patient volumes could decline.
Medicare and Medicaid Participation
The majority of our revenue is expected to continue to be received from third-party payors, including federal and state programs, such as Medicare and Medicaid, and commercial payors. To participate in the Medicare program and receive Medicare payment, our surgical facilities must comply with regulations promulgated by the Department of Health and Human Services (“HHS”). Among other things, these regulations, known as “conditions for coverage” or “conditions of participation,” impose numerous requirements on our facilities, their equipment, their personnel and their standards of medical care, as well as compliance with all applicable state and local laws and regulations. On April 26, 2007, CMS issued a policy memorandum that reaffirmed its prior interpretation of its conditions of participation that all hospitals (other than critical access hospitals) participating in the Medicare program are required to provide basic emergency care interventions regardless of whether or not the hospital maintains an emergency department. Our five facilities licensed as hospitals are required to meet this requirement to maintain their participating provider status in the Medicare program. As of September 30, 2017, two of our hospitals, which do not have an emergency room, maintain a protocol for the transfer of patients requiring emergency treatment, which protocol may be interpreted as
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
inconsistent with the 2007 CMS policy memorandum. Our surgical facilities must also satisfy the conditions of participation to be eligible to participate in the various state Medicaid programs. The requirements for certification under Medicare and Medicaid are subject to change and, in order to remain qualified for these programs, we may have to make changes from time to time in our facilities, equipment, personnel or services. Although we intend to continue to participate in these reimbursement programs, we cannot assure you that our surgical facilities will continue to qualify for participation.
The Affordable Care Act and its implementing regulations require a hospital to provide written disclosure of physician ownership interests to the hospital’s patients and on the hospital’s website and in any advertising, along with annual reports to the government detailing such interests. Additionally, hospitals that do not have 24/7 physician coverage are required to inform patients of this fact and receive signed acknowledgment from the patients of the disclosure. A hospital’s providercredit agreement may be terminated if it fails to provide the required notices. In 2010, CMS issued a “self-referral disclosure protocol” for hospitals and other providers that wish to self-disclose potential violations of the Stark Law to CMS and to attempt to resolve those potential violations and any related overpayment liabilities at levels below the maximum penalties and amounts set forth in the statute. The disclosure requirements set forth in the Affordable Care Act and the self-referral disclosure protocol reflect a move towards increasing government scrutiny of the financial relationships between hospitals and referring physicians and increasing disclosure of potential violations of the Stark Law to the government by hospitals and other healthcare providers. We intend for all of our facilities to meet their disclosure obligations.
Survey and Accreditation
Hospitals and healthcare facilities are subject to periodic inspection by federal, state and local authorities to determine their compliance with applicable regulations and requirements necessary for licensing, certification and accreditation. All of our hospitals and surgical facilities currently are licensed under appropriate state laws and are qualified to participate in the Medicare and Medicaid programs. Renewal and continuation of certain of these licenses, certifications and accreditations are based on inspections or other reviews generally conducted in the normal course of business of health facilities. Loss of, or limitations imposed on, licenses or accreditations could reduce a facility’s utilization or revenue, or its ability to operate all or a portion of its facilities.
Utilization Review
Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients meet professionally recognized standards and are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admissions of Medicare and Medicaid patients must be reviewed by quality improvement organizations, which review the appropriateness of Medicare and Medicaid patient admissions and discharges, the quality of care provided, the validity of MS-DRG classifications and the appropriateness of cases of extraordinary length of stay or cost. Quality improvement organizations may deny payment for services provided or assess fines and also have the authority to recommend to HHS that a provider which is in substantial noncompliance with the standards of the quality improvement organization be excluded from participation in the Medicare program. Utilization review is also a requirement of most non-governmental managed care organizations.
Federal Anti-Kickback Statute and Medicare Fraud and Abuse Laws
The Social Security Act includes provisions addressing false statements, illegal remuneration and other instances of fraud and abuse in federal health care programs. These provisions include the statute commonly known as the federal Anti-Kickback statute (the “Anti-Kickback Statute”). The Anti-Kickback Statute prohibits providers and others from, among other things, soliciting, receiving, offering or paying, directly or indirectly, any remuneration in return for either making a referral for, or ordering or arranging for, or recommending the order of, any item or service covered by a federal healthcare program, including, but not limited to, the Medicare and Medicaid programs. Violations of the Anti-Kickback Statute are criminal offenses punishable by imprisonment and fines of up to $25,000 for each violation. Civil violations are punishable by fines of up to $50,000 for each violation, as well as damages of up to three times the total amount of remuneration received from the government for healthcare claims.
Because physician-investors in our surgical facilities are in a position to generate referrals to the facilities, the distribution of available cash to those investors could come under scrutiny under the Anti-Kickback Statute. Some courts have held that the Anti-Kickback Statute is violated if one purpose (as opposed to a primary or the sole purpose) of a payment to a provider is to induce referrals. Further, Section 6402(f)(2) of the Affordable Care Act amends the Anti-Kickback Statute by adding a provision to clarify that a person need not have actual knowledge of such section or specific intent to commit a violation of the Anti-Kickback Statute. Because none of these cases involved a joint venture such as those owning and operating our surgical facilities, it is not clear how a court would apply these holdings to our activities. It is clear, however, that a physician’s investment income from a surgical facility may not vary with the number of his or her referrals to the surgical facility, and we believe that we comply with this prohibition.
Under regulations issued by the Office of the Inspector General of the U.S. Department of Health and Human Services (the “OIG"), certain categories of activities are deemed not to violate the Anti-Kickback Statute (commonly referred to as the safe harbors). According to the preamble to these safe harbor regulations, the failure of a particular business arrangement to comply with the regulations does not determine whether the arrangement violates the Anti-Kickback Statute. The safe harbor regulations do not make conduct illegal, but instead outline standards that, if complied with, protect conduct that might otherwise be deemed in violation of the Anti-Kickback Statute. Failure to meet a safe harbor does not indicate that the arrangement violates the Anti-Kickback Statute, although it may be subject to additional scrutiny.
We believe the ownership and operations of our surgery centers and hospitals do not fit wholly within any of the safe harbors, but we attempt to structure our ASCs to fit as closely as possible within the safe harbor designed to protect distributions to physician-investors in ASCs who directly refer patients to the ASC and personally perform the procedures at the center as an extension of their practice (the “ASC
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Safe Harbor”). The ASC Safe Harbor protects four categories of investors, including ASCs owned by (1) general surgeons, (2) single-specialty physicians, (3) multi-specialty physicians and (4) hospital/physician joint ventures, provided that certain requirements are satisfied. These requirements include the following:
The ASC must be an ASC certified to participate in the Medicare program, and its operating and recovery room space must be dedicated exclusively to the ASC and not a part of a hospital (although such space may be leased from a hospital if such lease meets the requirements of the safe harbor for space rental).
Each investor must be either (a) a physician who derived at least one-third of his or her medical practice income for the previous fiscal year or 12-month period from performing procedures on the list of Medicare-covered procedures for ASCs, (b) a hospital, or (c) a person or entity not in a position to make or influence referrals to the center, nor to provide items or services to the ASC, nor employed by the ASC or any investor.
Unless all physician-investors are members of a single specialty, each physician-investor must perform at least one-third of his or her procedures at the ASC each year. This requirement is in addition to the requirement that the physician-investor has derived at least one-third of his or her medical practice income for the past year from performing procedures.
Physician-investors must have fully informed their referred patients of the physician’s investment.
The terms on which an investment interest is offered to an investor are not related to the previous or expected volume of referrals, services furnished or the amount of business otherwise generated from that investor to the entity.
Neither the ASC nor any other investor nor any person acting on their behalf may loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest.
The amount of payment to an investor in return for the investment interest is directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor.
All physician-investors, any hospital-investor and the center agree to treat patients receiving benefits or assistance under a federal healthcare program in a non-discriminatory manner.
All ancillary services performed at the ASC for beneficiaries of federal healthcare programs must be directly and integrally related to primary procedures performed at the ASC and may not be billed separately.
No hospital-investor may include on its cost report or any claim for payment from a federal healthcare program any costs associated with the ASC.
The ASC may not use equipment owned by or services provided by a hospital-investor unless such equipment is leased in accordance with a lease that complies with the Anti-Kickback Statute equipment rental safe harbor and such services are provided in accordance with a contract that complies with the Anti-Kickback Statute personal services and management contract safe harbor.
No hospital-investor may be in a position to make or influence referrals directly or indirectly to any other investor or the ASC.
We believe that the ownership and operations of our surgical centers will not satisfy this ASC Safe Harbor for investment interests in ASCs because, among other things, we or one of our subsidiaries will generally be an investor in and provide management services to each ASC. We cannot assure you that the OIG would view our activities favorably even though we strive to achieve compliance with the remaining elements of this safe harbor.
In addition, although we expect each physician-investor to utilize the ASC as an extension of his or her practice and ask each physician-investor to certify this practice, we cannot assure you that all physician-investors will derive at least one-third of their medical practice income from performing Medicare-covered ASC procedures, perform one-third of their procedures at the ASC or inform their referred patients of their investment interests. Interests in our ASC joint ventures are purchased at what we believe to be fair market value. Investors who purchase at a later time generally pay more for a given percentage interest than founding investors. The result is that while all investors are paid distributions in accordance with their ownership interests, for ASCs where there are later purchases, we cannot meet the safe harbor requirement that return on investment is directly proportional to the amount of capital investment. The OIG has on several occasions reviewed investments relating to ASCs, and in Advisory Opinion No. 07-05, raised concerns that (a) purchases of interests from physicians might yield gains on investment rather than capital infusion to the ASCs, (b) such purchases could be meant to reward or influence the selling physicians’ referrals to the ASC or the hospital, and (c) such returns might not be directly proportional to the amount of capital invested. Nonetheless, we believe our fair market value purchase requirements and distribution policies comply with the Anti-Kickback Statute.
In OIG Advisory Opinion No. 09-09 (July 29, 2009), the OIG concluded that an arrangement involving an ASC joint venture between a hospital and physicians involving the combination of their two ASCs into a single, larger ASC presented minimal risk of fraud or abuse, despite the fact that it did not fit within any applicable Anti-Kickback safe harbors. Additionally, the OIG stated that fair market value should be determined based only on the tangible assets of each ASC since the physician investors are referral sources for the ASC. The OIG stated that a cash flow-based valuation of the business contributed by the physician investors potentially would include the value of the physician investors’ referrals over the time that their ASC was in existence prior to the merger with the hospital’s ASC. The OIG went on to note that a valuation involving intangible assets would not necessarily result in a violation of the Anti-Kickback Statute, but would require a review of all the facts and circumstances. It is not clear whether the OIG is concerned about using a cash flow-based valuation in most healthcare transactions involving referral sources, or just transactions, similar to this one, where the parties’ contributions would be valued differently for contributing
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the same assets if only one party’s contribution is valued as a going concern based on cash flow. Also, the OIG appears to be focused on historical cash flow rather than a projected, discounted cash flow, which is a commonly used valuation methodology. What is clear is that for the first time, the OIG addressed valuation methodologies, which could lead to increased scrutiny of all transactions involving physicians.
Our hospital investments do not fit wholly within the safe harbor for investments in small entities because more than 40.0% of the investment interests are held by investors who are either in a position to refer to the hospital or who provide services to the hospital and more than 40.0% of the hospital’s gross revenue last year were derived from referrals generated by investors. However, we believe we comply with the remaining elements of the safe harbor.
In addition to the physician ownership in our surgical facilities, other financial relationships of ours with potential referral sources could potentially be scrutinized under the Anti-Kickback Statute. We have entered into management agreements to manage the majority of our surgical facilities. Most of these agreements call for our subsidiary to be paid a percentage-based management fee. Although there is a safe harbor for personal services and management contracts (the “Personal Services and Management Safe Harbor”), the Personal Services and Management Safe Harbor requires, among other things, that the amount of the aggregate compensation paid to the manager over the term of the agreement be set in advance. Because our management fees are generally based on a percentage of revenue, our management agreements do not typically meet this requirement. We do, however, believe that our management arrangements satisfy the other requirements of the Personal Services and Management Safe Harbor for personal services and management contracts. The OIG has taken the position in several advisory opinions that percentage-based management agreements are not protected by a safe harbor, and consequently, may violate the Anti-Kickback Statute. We have implemented formal compliance programs designed to safeguard against overbilling and believe that our management agreements comply with the requirements of the Anti-Kickback Statute. However, we cannot assure you that the OIG would find our compliance programs to be adequate or that our management agreements would be found to comply with the Anti-Kickback Statute.
Certain of our ASCs have entered into arrangements for professional services, including arrangements for anesthesia services. In a Special Advisory Bulletin issued in April 2003, the OIG focused on “questionable” contractual arrangements where a health care provider in one line of business (the “Owner”) expands into a related health care business by contracting with an existing provider of a related item or service (the “Manager/Supplier”) to provide the new item or service to the Owner’s existing patient population, including federal health care program patients (so called “suspect Contractual Joint Ventures”). The Manager/Supplier not only manages the new line of business, but may also supply it with inventory, employees, space, billing, and other services. In other words, the Owner contracts out substantially the entire operation of the related line of business to the Manager/Supplier-otherwise a potential competitor-receiving in return the profits of the business as remuneration for its referrals. Through an Advisory Opinion, the OIG extended this suspect contractual joint venture analysis to arrangements between anesthesiologists and physician owners of ASCs. In Advisory Opinion 12-06, the OIG concluded that certain proposed arrangements between anesthesia groups and physician-owned ASCs could result in prohibited remuneration under the federal Anti-Kickback Statute. We believe our arrangements for anesthesia services are distinguishable from those described in Advisory Opinion 12-06 (May 25, 2012) and are in compliance with the requirements of the federal Anti-Kickback Statute. However, we cannot assure you that regulatory authorities would agree with that position.
We also may guarantee a surgical facility’s third-party debt financing and certain lease obligations as part of our obligations under a management agreement. Physician investors are generally not required to enter into similar guarantees. The OIG might take the position that the failure of the physician investors to enter into similar guarantees represents a special benefit to the physician investors given to induce patient referrals and that such failure constitutes a violation of the Anti-Kickback Statute. We believe that the management fees (and in some cases guarantee fees) are adequate compensation to us for the credit risk associated with the guarantees and that the failure of the physician investors to enter into similar guarantees does not create a material risk of violating the Anti-Kickback Statute. However, the OIG has not issued any guidance in this regard.
The OIG is authorized to issue advisory opinions regarding the interpretation and applicability of the Anti-Kickback Statute, including whether an activity constitutes grounds for the imposition of civil or criminal sanctions. We have not, however, sought such an opinion regarding any of our arrangements. If it were determined that our activities, or those of our surgical facilities or hospitals, violate the Anti-Kickback Statute, we, our subsidiaries, our officers, our directors and each surgical facility and hospital investor could be subject, individually, to substantial monetary liability, prison sentences and/or exclusion from participation in any healthcare program funded in whole or in part by the U.S. government, including Medicare, Medicaid, TRICARE or state healthcare programs.
Evolving interpretations of current, or the adoption of new, federal or state laws or regulations could affect many of our arrangements. Law enforcement authorities, including the OIG, the courts and Congress, are increasing their scrutiny of arrangements between healthcare providers and potential referral sources to ensure that the arrangements are not designed as a mechanism to exchange remuneration for patient care referrals or opportunities. Investigators have also demonstrated a willingness to look behind the formalities of a business transaction to determine the underlying purposes of payments between healthcare providers and potential referral sources.
Federal Physician Self-Referral Law
Congress has enacted the federal physician self-referral law, or Stark Law, that prohibits certain self-referrals for healthcare services. As currently enacted, the Stark Law prohibits a practitioner, including a physician, dentist or podiatrist, from referring patients to an entity with which the practitioner or a member of his or her immediate family has a “financial relationship” for the provision of certain “designated health services” that are paid for in whole or in part by Medicare or Medicaid unless an exception applies. The term “financial relationship” is broadly defined and includes most types of ownership and compensation relationships. The Stark Law also prohibits the entity from seeking payment from Medicare or Medicaid for services that are rendered through a prohibited referral. If an entity is paid for services provided through a prohibited referral, it may be required to refund the payments. Violations of the Stark Law may also result in the imposition of damages equal
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to three times the amount improperly claimed and civil monetary penalties of up to $15,000 per prohibited claim and $100,000 per prohibited circumvention scheme and exclusion from participation in the Medicare and Medicaid programs. For the purposes of the Stark Law, the term “designated health services” is defined to include:
clinical laboratory services;
physical therapy services;
occupational therapy services;
radiology services, including magnetic resonance imaging, computerized axial tomography scan and ultrasound services;
radiation therapy services and supplies;
durable medical equipment and supplies;
parenteral and enteral nutrients, equipment and supplies;
prosthetics, orthotics and prosthetic devices and supplies;
home health services;
outpatient prescription drugs; and
inpatient and outpatient hospital services.
The list of designated health services does not, however, include surgical services that are provided in an ASC. Furthermore, in final Stark Law regulations published by HHS on January 4, 2001, the term “designated health services” was specifically defined to not include services that are reimbursed by Medicare as part of a composite rate, such as services that are provided in an ASC. However, if designated health services are provided by an ASC and separately billed, referrals to the ASC by a physician-investor would be prohibited by the Stark Law. Because our facilities that are licensed as ASCs do not have independent laboratories and do not provide designated health services apart from surgical services, we do not believe referrals to these facilities by physician-investors are prohibited. If legislation or regulations are implemented that prohibit physicians from referring patients to surgical facilities in which the physician has a beneficial interest, our business and financial results would be materially adversely affected.
Five of our facilities are licensed as hospitals as of September 30, 2017. The Stark Law currently includes the Whole Hospital Exception, which applies to physician ownership of a hospital, provided such ownership is in the whole hospital and the physician is authorized to perform services at the hospital. We believe that physician investments in our facilities licensed as hospitals meet this requirement. However, changes to the Whole Hospital Exception have been the subject of recent regulatory action and legislation. Changes in the Affordable Care Act include:
a prohibition on hospitals from having any physician ownership unless the hospital already had physician ownership and a Medicare provider agreement in effect as of December 31, 2010;
a limitation on the percentage of total physician ownership or investment interests in the hospital or entity whose assets include the hospital to the percentage of physician ownership or investment as of March 23, 2010;
a prohibition from expanding the number of beds, operating rooms, and procedure rooms for which it is licensed after March 23, 2010, unless the hospital obtains an exception from the Secretary;
a requirement that return on investment be proportionate to the investment by each investor;
restrictions on preferential treatment of physician versus non-physician investors;
a requirement for written disclosures of physician ownership interests to the hospital’s patients and on the hospital’s website and in any advertising, along with annual reports to the government detailing such interests;
a prohibition on the hospital or other investors from providing financing to physician investors;
a requirement that any hospital that does not have 24/7 physician coverage inform patients of this fact and receive signed acknowledgments from the patients of the disclosure; and
a prohibition on “grandfathered” status for any physician owned hospital that converted from an ASC to a hospital on or after March 23, 2010.
The Affordable Care Act also requires that each hospital with physician ownership submit an annual report of ownership and/or investment interest. Our hospitals have submitted their first reports. CMS has delayed the collection of the second report and publication of the first annual report. We cannot predict whether other proposed amendments to the Whole Hospital Exception will be included in any future legislation, including a repeal of the Affordable Care Act, or if Congress will adopt any similar provisions that would prohibit or otherwise restrict physicians from holding ownership interests in hospitals. Any such changes could have an adverse effect on our financial condition and results of operations.
In addition to the physician ownership in our surgical facilities, we have other financial relationships with potential referral sources that potentially could be scrutinized under the Stark Law. We have entered into personal service agreements, such as medical director agreements, with physicians at our hospitals. We believe that our agreements with referral sources satisfy the requirements of the personal service arrangements exception to the Stark Law and have implemented formal compliance programs designed to ensure continued compliance.
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However, we cannot assure you that the OIG or CMS would find our compliance programs to be adequate or that our agreements with referral sources would be found to comply with the Stark Law.
False and Other Improper Claims
The U.S. government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for payment from the Medicare or Medicaid programs or other federal and state healthcare programs. Claims filed with private insurers can also lead to criminal and civil penalties, including, but not limited to, penalties relating to violations of federal mail and wire fraud statutes, as well as penalties under the anti-fraud provisions of HIPAA. While the criminal statutes are generally reserved for instances of fraudulent intent, the U.S. government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances. For example, the U.S. government has taken the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant merely should have known the services were unnecessary, even if the government cannot demonstrate actual knowledge. The U.S. government has also taken the position that claiming payment for low-quality services is a violation of these statutes if the claimant should have known that the care being provided was substandard.
Over the past several years, the U.S. government has investigated an increasing number of healthcare providers for potential violations of the federal False Claims Act. The federal False Claims Act prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the U.S. government. The statute defines “knowingly” to include not only actual knowledge of a claim’s falsity, but also reckless disregard for or intentional ignorance of the truth or falsity of a claim. The Fraud Enforcement and Recovery Act of 2009 further expanded the scope of the False Claims Act by, among other things, creating liability for knowingly and improperly avoiding or decreasing an obligation to pay money to the federal government. The Affordable Care Act also created federal False Claims Act liability for the knowing failure to report and return an overpayment within 60 days of the identification of the overpayment or the date by which a corresponding cost report is due, whichever is later. This requirement has led to an increasing use of the self-disclosure protocols that have been implemented by CMS, the OIG and other governmental agencies by the healthcare industry. The Affordable Care Act also provided that claims submitted in connection with patient referrals that result from violations of the Anti-Kickback Statute constitute false claims for the purposes of the federal False Claims Act, and some courts have held that a violation of the Stark Law can result in False Claims Act liability as well. Because our surgical facilities perform hundreds of similar procedures a year for which they are paid by Medicare and other government health care programs, and there is a relatively long statute of limitations, a billing error or cost reporting error could result in significant civil or criminal penalties.
Under the qui tam, or whistleblower, provisions of the False Claims Act, private parties may bring actions on behalf of the U.S. government. These private parties, often referred to as relators, are entitled to share in any amounts recovered by the government through trial or settlement. Both whistleblower lawsuits and direct enforcement activity by the government have increased significantly in recent years and have increased the risk that a healthcare company, like us, will have to defend a false claims action, pay fines or be excluded from the Medicare and Medicaid programs and other federal and state healthcare programs as a result of an investigation resulting from a whistleblower case. Although we believe that our operations materially comply with both federal and state laws, they may nevertheless be the subject of a whistleblower lawsuit or may otherwise be challenged or scrutinized by governmental authorities. Providers found liable for False Claims Act violations are subject to damages of up to three times the actual damage sustained by the government plus mandatory civil monetary penalties between $5,500 and $11,000 for each separate false claim. A determination that we have violated these laws could have a material adverse effect on us.
Other Fraud and Abuse Laws
The Medicare Patient and Program Protection Act of 1987, as amended by the Health Insurance Portability and Accountability Act of 1996, (“HIPAA”), and the Balanced Budget Act of 1997, impose civil monetary penalties and exclusion from state and federal healthcare programs on providers who commit violations of fraud and abuse laws. HIPAA authorizes the Secretary of the Department of Health & Human Services (“Secretary”), and in some cases requires the Secretary, to exclude individuals and entities that the Secretary determines have “committed an act” in violation of applicable fraud and abuse laws or improperly filed claims in violation of such laws from participating in any federal healthcare program. HIPAA also expanded the Secretary’s authority to exclude a person involved in fraudulent activity from participating in a program providing health benefits, whether directly or indirectly, in whole or in part, by the U.S. government. Additionally, under HIPAA, individuals who hold a direct or indirect ownership or controlling interest in an entity that is found to violate these laws may also be excluded from Medicare and Medicaid and other federal and state healthcare programs if the individual knew or should have known, or acted with deliberate ignorance or reckless disregard of, the truth or falsity of the information of the activity leading to the conviction or exclusion of the entity, or where the individual is an officer or managing employee of such entity. This standard does not require that specific intent to defraud be proven by OIG. Under HIPAA it is also a crime to defraud any commercial healthcare benefit program.
Federal and State Privacy and Security Requirements
We are subject to HIPAA, including The HITECH Act, which was enacted as part of The American Recovery and Reinvestment Act of 2009. The HITECH Act strengthened the requirements and significantly increased the penalties for violations of the HIPAA privacy and security regulations. On January 25, 2013, HHS issued the HIPAA Omnibus Rule, which became effective on March 26, 2013. Prior to the HIPAA Omnibus Rule, the HITECH Act required us to notify patients of any unauthorized access, acquisition, or disclosure of their unsecured protected health information that poses significant risk of financial, reputational or other harm to a patient. The HIPAA Omnibus Rule eliminated this harm threshold standard and instead we are now required to notify patients of any unauthorized access, acquisition, or disclosure of their unsecured protected health information in all situations except those in which we can demonstrate that there is a low probability that the protected health information has been compromised. We now have the burden of demonstrating through a risk assessment that a breach of
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protected health information has not occurred. This new more objective standard may lead to an increased number of occurrences that require breach notifications. In addition, the HIPAA Omnibus Rule also modified the following aspects of the HIPAA privacy and security regulations:
makes our facilities’ business associates directly liable for compliance with certain of HIPAA’s requirements;
makes our facilities liable for violations by their business associates if HHS determines an agency relationship exists between the facility and the business associate under federal agency law;
adds limitations on the use and disclosure of health information for marketing and fund-raising purposes, and prohibits the sale of protected health information without individual authorization;
expands our patients’ rights to receive electronic copies of their health information and to restrict disclosures to a health plan concerning treatment for which our patient has paid out of pocket in full;
requires modifications to, and redistribution of, our facilities’ notice of privacy practices;
requires modifications to existing agreements with business associates;
adopts the additional HITECH Act provisions not previously adopted addressing enforcement of noncompliance with HIPAA due to willful neglect;
incorporates the increased and tiered civil money penalty structure provided by the HITECH Act; and
revises the HIPAA privacy rule to increase privacy protections for genetic information as required by the Genetic Information Nondiscrimination Act of 2008.
The HIPAA privacy standards apply to individually identifiable information held or disclosed by a covered entity in any form, whether communicated electronically, on paper or orally. These standards impose extensive administrative requirements on us. These standards require our compliance with rules governing the use and disclosure of this health information. They create rights for patients in their health information, such as the right to amend their health information, and they require us to impose these rules, by contract, on any business associate to whom we disclose such information in order to perform functions on our behalf.Senior Secured Credit Facilities.
The HIPAA security standards require us to establish and maintain reasonable and appropriate administrative, technical and physical safeguards to ensure the integrity, confidentiality and the availability of electronic protected health and related financial information. Although the security standards do not reference or advocate a specific technology, and covered healthcare providers, plans and clearinghouses have the flexibility to choose their own technical solutions, the security standards have required us to implement significant new systems, business procedures and training programs.
Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties. The HITECH Act strengthened the requirements of the HIPAA privacy and security regulations and significantly increased the penalties for violations by introducing a tiered penalty system, with penalties of up to $50,000 per violation with a maximum civil penalty of $1.5 million in a calendar year for violations of the same requirement. However, a single breach incident can result in violations of multiple requirements, resulting in possible penalties well in excess of $1.5 million. Under the HITECH Act, HHS is required to conduct periodic compliance audits of covered entities and their business associates. The HITECH Act and the HIPAA Omnibus Rule also extend the application of certain provisions of the security and privacy regulations to business associates and subjects business associates to civil and criminal penalties for violation of the regulations.
The HITECH Act authorizes State Attorneys General to bring civil actions seeking either an injunction or damages in response to violations of HIPAA privacy and security regulations or the new data breach law that affects the privacy of their state residents. We expect vigorous enforcement of the HITECH Act’s requirements by HHS and State Attorneys General. Additionally, HHS conducted a pilot audit program that concluded December 2012 in the first phase of HHS’ implementation of the HITECH Act’s requirements of periodic audits of covered entities and business associates to ensure their compliance with the HIPAA privacy and security regulations. HHS has allocated increased funding towards HIPAA enforcement activity and such enforcement activity has seen a marked increase over recent years. We cannot predict whether our surgical facilities will be able to comply with the final rules and the financial impact to our surgical facilities in implementing the requirements under the final rules when they take effect, or whether our hospitals will be selected for an audit, or the results of such an audit.
Our facilities also remain subject to any state laws that relate to privacy or the reporting of data breaches that are more restrictive than the regulations issued under HIPAA and the requirements of the HITECH Act. For example, various state laws and regulations may require us to notify affected individuals in the event of a data breach involving certain personal information, such as social security numbers, dates of birth and credit card information.
Adoption of Electronic Health Records
The HITECH Act includes provisions designed to increase the use of EHR by both physicians and hospitals. Beginning in 2011 and extending through 2016, eligible hospitals may receive incentive payments based upon successfully demonstrating meaningful use of its certified EHR technology. Beginning in 2015, those hospitals that do not successfully demonstrate meaningful use of EHR technology are subject to reduced payments from Medicare. EHR meaningful use objectives and measures that hospitals and physicians must meet in order to qualify for incentive payments will be implemented in three stages. Stage 1 has been in effect since 2011 and Stage 2 took effect for hospitals beginning in fiscal year 2014. On October 16, 2015, CMS published a final rule that consolidated Stage 1 and Stage 2 into a “Modified Stage 2” effective as of 2015 and set out requirements for Stage 3, which is set to take full effect in 2018. In connection with the acquisition of
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Symbion, we acquired six surgical facilities that are licensed as hospitals, five of which we own as of September 30, 2017. These hospitals began the implementation of EHR initiatives in 2012. We strive to comply with the EHR meaningful use requirements of the HITECH Act so as to qualify for incentive payments. Continued implementation of EHR and compliance with the HITECH Act will result in significant costs. We recorded income of $3,000 and $305,000 which was recognized during the three and nine months ended September 30, 2017, respectively. We incurred negligible costs for hardware, software and implementation expenses during the same three month period. We do not currently know the extent of additional costs that will be associated with implementation of additional systems or the amount of future incentives that we will receive.
HIPAA Administrative Simplification Requirements
The HIPAA transaction regulations were issued to encourage electronic commerce in the healthcare industry. These regulations include standards that healthcare providers must follow when electronically transmitting certain healthcare transactions, such as healthcare claims.
Emergency Medical Treatment and Active Labor Act
Our hospitals are subject to the Emergency Medical Treatment and Active Labor Act (“EMTALA”). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital’s emergency department for treatment and, if the patient is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the patient to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions or transfer exists regardless of a patient’s ability to pay for treatment. Off-campus facilities such as surgery centers that lack emergency departments or otherwise do not treat emergency medical conditions generally are not subject to EMTALA. They must, however, have policies in place that explain how the location should proceed in an emergency situation, such as transferring the patient to the closest hospital with an emergency department. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient’s ability to pay, including civil monetary penalties and exclusion from participation in the government health care programs. In addition, an injured patient, the patient’s family or a medical facility that suffers a financial loss as a direct result of another hospital’s violation of the law can bring a civil suit against that other hospital. CMS has actively enforced EMTALA and has indicated that it will continue to do so in the future. Although we believe that our hospitals comply with EMTALA, we cannot predict whether CMS will implement new requirements in the future and, if so, whether our hospitals will comply with any new requirements.
State Regulation
Many of the states in which our surgical facilities operate have adopted statutes and/or regulations that prohibit the payment of kickbacks or any type of remuneration in exchange for patient referrals and that prohibit healthcare providers from, in certain circumstances, referring a patient to a healthcare facility in which the provider has an ownership or investment interest. While these statutes generally mirror the federal Anti-Kickback Statute and Stark Law, they vary widely in their scope and application. Some are specifically limited to healthcare services that are paid for in whole or in part by the Medicaid program; others apply to all healthcare services regardless of payor; and others apply only to state-defined designated services, which may differ from the designated health services under the Stark Law. In addition, many states have adopted statutes that mirror the False Claims Act and that prohibit the filing of a false or fraudulent claim with a state governmental agency. We intend to comply with all applicable state healthcare laws, rules and regulations. However, these laws, rules and regulations have typically been the subject of limited judicial and regulatory interpretation. As a result, we cannot assure you that our surgical facilities will not be investigated or scrutinized by the governmental authorities empowered to do so or, if challenged, that their activities would be found to be lawful. A determination of non-compliance with the applicable state healthcare laws, rules, and regulations could subject our surgical facilities to civil and criminal penalties and could have a material adverse effect on our operations.
We are also subject to various state insurance statutes and regulations that prohibit us from submitting inaccurate, incorrect or misleading claims. Many state insurance laws and regulations are broadly worded and could be implicated, for example, if our surgical facilities were to adjust an out-of-network co-payment or other patient responsibility amounts without fully disclosing the adjustment on the claim submitted to the payor. While some of our surgical facilities adjust the out-of-network costs of patient co-payment and deductible amounts to reflect in-network co-payment costs when providing services to patients whose health insurance is covered by a payor with which the surgical facilities are not contracted, our policy is to fully disclose adjustments in the claims submitted to the payors. We believe that our surgical facilities are in compliance with all applicable state insurance laws and regulations regarding the submission of claims. We cannot assure you, however, that none of our surgical facilities’ insurance claims will ever be challenged. If we were found to be in violation of a state’s insurance laws or regulations, we could be forced to discontinue the violative practice, which could have an adverse effect on our financial position and results of operations, and we could be subject to fines and criminal penalties.
Fee Splitting; Corporate Practice of Medicine
The laws of many states prohibit physicians from splitting fees with non-physicians (i.e., sharing in a percentage of professional fees), prohibit non-physician entities (such as us) from practicing medicine and exercising control over or employing physicians and prohibit referrals to facilities in which physicians have a financial interest. The existence, interpretation and enforcement of these laws vary significantly from state to state. In light of these restrictions, in certain states we facilitate the provision of physician services by maintaining long-term management services agreements through our subsidiaries with affiliated professional contractors, which employ or contract with physicians and other healthcare professionals to provide physician professional services. Under these arrangements, our subsidiaries perform only non-medical administrative services, do not represent that they offer medical services and do not exercise influence or control over the practice of medicine by the physicians employed by the affiliated professional contractors. Although we believe that the fees we receive from affiliated professional
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 30, 2017
contractors have been structured in a manner that is compliant with applicable fee-splitting laws, it is possible that a government regulator could interpret such fee arrangements to be in violation of certain fee-splitting laws. Future interpretations of, or changes in, these laws might require structural and organizational modifications of our existing relationships, and we cannot assure you that we would be able to appropriately modify such relationships. In addition, statutes in some states could restrict our expansion into those states.
Clinical Laboratory Regulation
Our clinical laboratories are subject to federal oversight under the Clinical Laboratory Improvement Amendments of 1988 (“CLIA”) which extends federal oversight to virtually all clinical laboratories by requiring that they be certified by the federal government or by a federally-approved accreditation agency. CLIA requires that all clinical laboratories meet quality assurance, quality control and personnel standards. Laboratories also must undergo proficiency testing and are subject to inspections. Standards for testing under CLIA are based on the complexity of the tests performed by the laboratory, with tests classified as “high complexity,” “moderate complexity,” or “waived.” Laboratories performing high complexity testing are required to meet more stringent requirements than moderate complexity laboratories. Laboratories performing only waived tests, which are tests determined by the Food and Drug Administration to have a low potential for error and requiring little oversight, may apply for a certificate of waiver exempting them from most of the requirements of CLIA. Our operations also subject to state and local laboratory regulation. CLIA provides that a state may adopt laboratory regulations different from or more stringent than those under federal law, and a number of states have implemented their own laboratory regulatory requirements. State laws may require that laboratory personnel meet certain qualifications, specify certain quality controls, or require maintenance of certain records. We believe that we are in material compliance with all applicable laboratory requirements, but no assurances can be given that our laboratories will pass all future licensure or certification inspections.
Regulatory Compliance Program
It is our policy to conduct our business with integrity and in compliance with the law. We have in place and continue to enhance a company-wide compliance program that focuses on all areas of regulatory compliance including billing, reimbursement, cost reporting practices and contractual arrangements with referral sources.
This regulatory compliance program is intended to help ensure that high standards of conduct are maintained in the operation of our business and that policies and procedures are implemented so that employees act in full compliance with all applicable laws, regulations and company policies. Under the regulatory compliance program, every employee and certain contractors involved in patient care, and coding and billing, receive initial and periodic legal compliance and ethics training. In addition, we regularly monitor our ongoing compliance efforts and develop and implement policies and procedures designed to foster compliance with the law. The program also includes a mechanism for employees to report, without fear of retaliation, any suspected legal or ethical violations to their supervisors, designated compliance officers in our facilities, our compliance hotline or directly to our corporate compliance office. We believe our compliance program is consistent with standard industry practices. However, we cannot provide any assurances that our compliance program will detect all violations of law or protect against qui tam suits or government enforcement actions.
Item 3. Quantitative and Qualitative Disclosures aboutAbout Market Risk
We are subject to market risk primarily from exposure to changes in interest rates based on our financing, investing and cash management activities. We utilize a balanced mix of maturities along with both fixed rate and variable rate debt to manage our exposures to changes in interest rates,rates. Additionally, we periodically enter into interest rate swap and docap agreements to manage our exposure to interest rate fluctuations. Our interest rate swap and cap agreements involve the exchange of fixed and variable rate interest payments between two parties, based on common notional principal amounts and maturity dates. The notional amounts of the interest rate swap and cap agreements represent balances used to calculate the exchange of cash flows and are not holdour assets or issue any derivativeliabilities. Our credit risk related to these agreements is considered low because the interest rate swap and cap agreements are with creditworthy financial instruments for this purpose. institutions. The interest payments under these agreements are settled on a net basis. These derivatives have been recognized in the financial statements at their respective fair values. Changes in the fair value of these derivatives, which are designated as cash flow hedges, are included in other comprehensive income.
Our variable rate debt instruments are primarily indexed to the prime rate or LIBOR. InterestWithout derivatives, interest rate changes would result in gains or losses in the market value of our fixed rate debt portfolio due to differences in market interest rates and the rates at the inception of the debt agreements. AtBased on our indebtedness and the effectiveness of our interest rate swap and cap agreements at September 30, 2017, we had outstanding principal amount of debt of $1.30 billion in variable rate instruments. Assuming a hypothetical 100 basis points increase in LIBOR on our debt as of September 30, 2017, our quarterly interest expense would increase by approximately $3.2 million. Although there can be no assurances that interest rates will not change significantly,2022, we do not expect changes in interest rates to have a material effect on our net earnings or cash flows in 2017 based on our indebtedness at September 30, 2017.2022.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officerchief executive officer and the Chief Financial Officer,chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”))amended) as of the end of the period covered by this report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.September 30, 2022. Based on and as of the time of suchthat evaluation, our management, including the Chief Executive Officerchief executive officer and Chief Financial Officer,chief financial officer concluded that our disclosure controls and procedures were not effective as a result of the material weakness identified by management as initially disclosed under “Item 9A-Controls and Procedures”effective.
Changes in Internal Control Over Financial Reporting
There were no changes in our Annual Report on Form 10-K for the year ended December 31, 2016.
Such material weakness pertains to lack of documentation evidencing certain controls involving revenue, accounts receivable and related allowances. Notwithstanding the identified material weakness, as of the date of this filing, management, including the Chief Executive Officer and Chief Financial Officer, believes that the unaudited consolidatedinternal control over financial statements contained in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows for the fiscal years presented in conformity with GAAP. Management is actively engaged in the implementation of a remediation plan to address the lack of documentation issue. The plan includes the implementation of enhanced documentation policies and procedures, along with the allocation of resources dedicated to training and monitoring these policies and procedures.
As a result of these efforts, as of the date of this filing management believes we have made progress toward remediating the underlying causes of the material weakness. Although we believe our remediation efforts will be effective in remediating the material weakness, there can be no assurance as to when the remediation plan will be fully implemented, or that the plan, as currently designed, will adequately remediate the material weakness. The material weakness will not be considered fully addressed until the enhanced policies and procedures over documentation evidencing certain controls involving revenue, accounts receivable and related allowances have been in operation for a sufficient period of time for our management to conclude that the material weakness has been fully remediated. We will continue to work on implementing and testing the enhanced documentation policies and procedures in order to make this final determination.
Other than our progress in our remediation efforts outlined above, there have been no changesreporting during the quarter ended September 30, 20172022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness
Our management, including the Chief Executive Officer and the Chief Financial Officer, recognizes that any set of controls and procedures, no matter how well-designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, with the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls. For these reasons, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
WeStockholder Litigation. Please refer to the disclosure in Note 8. "Commitments and Contingencies - Stockholder Litigation" to our condensed consolidated financial statements included elsewhere in this report, which is incorporated into this item by reference.
Other Litigation. In addition, we are, from time to time, subject to claims and suits, arising in the ordinary courseor threats of claims or suits, relating to our business, including claims for damages for personal injuries, breach of management contracts and employment related claims. In certain of these actions, plaintiffs request payment for damages, including punitive damages, thatwhich may not be covered by insurance. In the opinion of management, we are not currently a party to any such proceedings that wouldinsurance or may otherwise have a material adverse effect on our business financial condition or results of operations. In addition, on October 23, 2017, we received a civil investigative demand (“CID”) from the federal government under the False Claims Act (“FCA”) for documents and information dating back to January 1, 2010 relating to the medical necessity of certain drug tests conducted by our physicians and submitted to laboratories owned and operated by us. We intend to respond to the CID and cooperate with the U.S. Attorney’s Office in connection with the FCA investigation.
Item 1A. Risk Factors
There have been no material changes with respect to the risk factors discussed in the Quarterlyour 2021 Annual Report on Form 10-Q for the period ended June 30, 2017.10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
As previously reported in our Current Report on Form 8-K filed September 1, 2017, we issued 310,000The Company did not repurchase any shares of Series A Preferred Stockcommon stock during the nine months ended September 30, 2022. At September 30, 2022, the Company continued to Bain at a purchase pricehave authority to repurchase up to $46.0 million of $1,000.00 pershares of common stock under its Board-authorized share for an aggregate purchase price of $310,000,000.00 on August 31, 2017. The net proceeds from the Preferred Private Placement were used to finance a portion of the NSH Merger. The issuance of the Series A Preferred Stock to Bain was made in reliance on an exemption from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) and Rule 506 promulgated thereunder. The issuance of Common Stock that may be issued upon the conversion of the Series A Preferred Stock will be issued in reliance upon an exemption from the registration requirements of the Securities Act pursuant to Section 4(a)(2) promulgated thereunder.repurchase program.
For further discussion of the Preferred Private Placement and the Series A Preferred Stock, see Note 1. “Organization” and Note 5, “Redeemable Preferred Stock” of our condensed consolidated financial statements included previously in this report and the disclosures set forth in Item 3.02 and Item 3.03 of our Current Report on Form 8-K filed September 1, 2017, which are incorporated by reference herein.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
As previously reported in our Current Report on Form 8-K filed November 3, 2017, the Amended and Restated Certificate of Incorporation of the Company (as amended, the “Third Amended and Restated Charter”), which reallocates certain rights with respect to the determination of the size and composition of the Board, became effective upon its filing with the Secretary of State of the State of Delaware on October 30, 2017.None.
Item 6. Exhibits
| | | | | | | | |
| No. | | Description |
| | |
No.10.1 | | Description |
| | |
2.1 | | Eighth Amendment to the Credit Agreement, and Plan of Merger by and among Surgery Partners, Inc., SP Merger Sub, Inc., NSH Holdco, Inc. and IPC / NSH, L.P., dated as of May 9, 2017 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed May 11, 2017).* |
2.2 | | Letter Amendment to Merger Agreement, by and among Surgery Partners, Inc., SP Merger Sub, Inc., NSH Holdco, Inc. and IPC / NSH, L.P., dated as of July 7, 2017 (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed July 11, 2017).* |
3.1 | | Amended and Restated Certificate of Incorporation of Surgery Partners, Inc., dated August 31, 2017 (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed September 1, 2017). |
3.2 | | Amended and Restated Bylaws of Surgery Partners, Inc., dated August 31, 2017 (incorporated herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed September 1, 2017). |
3.3 | | Certificate of Designations, Preferences, Rights and Limitations of the 10.00% Series A Convertible Perpetual Participating Preferred Stock of Surgery Partners, Inc., dated August 31, 2017 (incorporated herein by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K filed September 1, 2017). |
3.4 | | Amended and Restated Certificate of Incorporation of Surgery Partners, Inc., dated October 30, 2017 (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed November 3, 2017). |
4.1 | | First Supplemental Indenture, by and among Surgery Center Holdings, Inc., Wilmington Trust, National Association, as Trustee, and certain other parties thereto, dated August 31, 2017 (incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed September 1, 2017). |
4.2 | | Fourth Supplemental Indenture, by and among Surgery Center Holdings, Inc., Wilmington Trust, National Association, as Trustee, and certain other parties thereto, dated August 31, 2017 (incorporated herein by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed September 1, 2017). |
10.1 | | Amended and Restated Registration Rights Agreement by and among Surgery Partners, Inc., certain stockholders of Surgery Partners, Inc. and certain other parties thereto, dated August 31, 2017 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed September 1, 2017). |
10.2 | | Credit Agreement,18, 2022, by and among SP Holdco I, Inc., Surgery Center Holdings, Inc., the other Guarantors party thereto, Jefferies Finance LLC and the other guarantors and lenders party thereto, dated August 31, 2017 (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed September 1, 2017).* |
10.3 | | Employment Agreement, by and between Surgery Partners, Inc. and Cliff Adlerz, dated September 7, 2017 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed September 8, 2017). |
10.4 | | Termination and Release Agreement, by and among Surgery Partners, Inc., Surgery Partners, LLC and Michael T. Doyle, dated September 7, 2017 (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed September 8, 2017). |
10.5 | | Consulting Services Agreement, by and between Surgery Partners, Inc. and Michael T. Doyle, dated September 7, 2017 (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed September 8, 2017). |
10.6 | | TRA Waiver and Assignment Agreement, by and among Surgery Partners, Inc., Michael T. Doyle, the Makayla Doyle 2012 Irrevocable Trust under agreement dated July 20, 2012, the Michael Doyle 2012 Irrevocable Trust under agreement dated July 20, 2012 and the Mason Doyle 2012 Irrevocable Trust under agreement dated July 20, 2012, dated September 8, 2017 (incorporated herein by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed September 8, 2017). |
10.7 | | Form of Leveraged Performance Unit Award Agreement (incorporated herein by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed September 8, 2017). |
31.1 | | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101.INS | | XBRL Instance Document |
101.SCH | | XBRL Taxonomy Extension Schema Document |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Documentthereto.
|
101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document |
|
| 31.1 | | |
101.LAB | | XBRL Taxonomy Extension Label Linkbase Document |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document |
* Schedules and/or Exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish a supplemental copy of any omitted schedule to the SEC upon request.
EXHIBIT INDEX
|
| | |
No. | | Description |
| | |
2.1 | | |
2.2 | | Letter Amendment to Merger Agreement, by and among Surgery Partners, Inc., SP Merger Sub, Inc., NSH Holdco, Inc. and IPC / NSH, L.P., dated as of July 7, 2017 (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed July 11, 2017).* |
3.1 | | |
3.2 | | |
3.3 | | |
3.4 | | |
4.1 | | |
4.2 | | |
10.1 | | |
10.2 | | |
10.3 | | |
10.4 | | |
10.5 | | |
10.6 | | TRA Waiver and Assignment Agreement, by and among Surgery Partners, Inc., Michael T. Doyle, the Makayla Doyle 2012 Irrevocable Trust under agreement dated July 20, 2012, the Michael Doyle 2012 Irrevocable Trust under agreement dated July 20, 2012 and the Mason Doyle 2012 Irrevocable Trust under agreement dated July 20, 2012, dated September 8, 2017 (incorporated herein by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed September 8, 2017). |
10.7 | | |
31.1 | | |
| 31.2 | | |
| 32.1 | | |
32.2101.INS | | instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document. |
101.INS101.SCH | | XBRL Instance Document |
101.SCH | | Inline XBRL Taxonomy Extension Schema Document |
| 101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase Document |
| 101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document |
|
| 101.LAB | | |
101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase Document |
| 101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase Document |
| 104 | | The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2022, formatted in Inline XBRL (included in Exhibit 101). |
* Schedules and/or Exhibits have been omitted pursuant to Item 601(b)(2)32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrantregistrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | | |
| SURGERY PARTNERS, INC. |
| |
SURGERY PARTNERS, INC. |
| |
| By: | /s/ Teresa F. SparksDavid T. Doherty Teresa F. SparksDavid T. Doherty
Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |
Date: November 9, 2017
8, 2022