Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________________
Form 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
or
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number:  001-37576
Surgery Partners, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
47-3620923
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

310 Seven Springs Way, Suite 500
Brentwood, Tennessee 37027
(Address of principal executive offices and zip code)
(615) 234-5900
(Registrant’s telephone number, including area code) 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No  x
As of May 9, 2018, there were 48,912,753 shares of the registrant’s common stock outstanding.
 




SURGERY PARTNERS, INC.
FORM 10-Q
TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
Item 1.
 
 
 
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
 
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
 
Item 2.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
 
 
 
 
 
 
Item 1.
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits





PART 1 - FINANCIAL INFORMATION
Item 1.  Financial Statements
SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, amounts in thousands, except shares and per share amounts)
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
112,816

 
$
174,914

Accounts receivable, less allowance for doubtful accounts of $2,122 and $2,026, respectively
 
275,338

 
288,023

Inventories
 
48,101

 
44,951

Prepaid expenses and other current assets
 
54,324

 
55,337

Total current assets
 
490,579

 
563,225

Property and equipment, net
 
400,385

 
398,536

Intangible assets, net
 
62,412

 
58,908

Goodwill
 
3,382,801

 
3,346,838

Investments in and advances to affiliates
 
75,194

 
74,282

Restricted invested assets
 
315

 
315

Long-term deferred tax assets
 
130,819

 
132,319

Other long-term assets
 
52,379

 
48,350

Total assets
 
$
4,594,884

 
$
4,622,773

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
80,960

 
$
84,710

Accrued payroll and benefits
 
36,836

 
49,625

Other current liabilities
 
113,570

 
109,944

Current maturities of long-term debt
 
54,386

 
58,726

Total current liabilities
 
285,752

 
303,005

Long-term debt, less current maturities
 
2,122,447

 
2,130,556

Other long-term liabilities
 
233,524

 
222,480

 
 
 
 
 
Non-controlling interests—redeemable
 
313,643

 
299,316

Redeemable preferred stock - Series A, 310,000 shares authorized, issued and outstanding at both March 31, 2018 and December 31, 2017; redemption value of $334,692 and $330,806, respectively
 
334,692

 
330,806

 
 
 
 
 
Stockholders' equity:
 
 
 
 
Preferred stock, $0.01 par value, 20,000,000 shares authorized, no shares issued or outstanding
 

 

Common stock, $0.01 par value, 300,000,000 shares authorized, 48,898,004 shares issued and outstanding at March 31, 2018; 48,687,136 shares issued and outstanding at December 31, 2017
 
489

 
487

Additional paid-in capital
 
689,012

 
695,560

Retained deficit
 
(58,837
)
 
(41,316
)
Total Surgery Partners, Inc. stockholders' equity
 
630,664

 
654,731

Non-controlling interests—non-redeemable
 
674,162

 
681,879

Total stockholders' equity
 
1,304,826

 
1,336,610

Total liabilities and stockholders' equity
 
$
4,594,884

 
$
4,622,773

See notes to unaudited condensed consolidated financial statements.


1



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, amounts in thousands, except shares and per share amounts)
 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
 
 
 
 
 
 
 
Revenues
 
$
417,369

 
 
 
$
286,183

Operating expenses:
 
 
 
 
 
 
Salaries and benefits
 
129,735

 
 
 
89,887

Supplies
 
114,430

 
 
 
71,160

Professional and medical fees
 
35,679

 
 
 
21,125

Lease expense
 
21,361

 
 
 
13,626

Other operating expenses
 
26,107

 
 
 
16,150

Cost of revenues
 
327,312

 
 
 
211,948

General and administrative expenses (1)
 
24,152

 
 
 
15,541

Depreciation and amortization
 
15,749

 
 
 
11,108

Provision for doubtful accounts
 
6,037

 
 
 
5,675

Income from equity investments
 
(1,862
)
 
 
 
(1,200
)
Loss on disposal or impairment of long-lived assets, net
 
47

 
 
 
1,196

Merger transaction and integration costs
 
5,033

 
 
 
337

Other income
 
(262
)
 
 
 
(143
)
Total operating expenses
 
376,206

 
 
 
244,462

Operating income
 
41,163

 
 
 
41,721

Interest expense, net
 
(34,276
)
 
 
 
(25,182
)
Income before income taxes
 
6,887

 
 
 
16,539

Income tax expense
 
1,762

 
 
 
2,117

Net income
 
5,125

 
 
 
14,422

Less: Net income attributable to non-controlling interests
 
(22,646
)
 
 
 
(17,176
)
Net loss attributable to Surgery Partners, Inc.
 
(17,521
)
 
 
 
(2,754
)
Less: Amounts attributable to participating securities (2)
 
(7,772
)
 
 
 

Net loss attributable to common stockholders
 
$
(25,293
)
 
 
 
$
(2,754
)
 
 
 
 
 
 
 
Net loss per share attributable to common stockholders
 
 
 
 
 
 
Basic
 
$
(0.53
)
 
 
 
$
(0.06
)
Diluted (3)
 
$
(0.53
)
 
 
 
$
(0.06
)
Weighted average common shares outstanding
 
 
 
 
 
 
Basic
 
48,006,870

 
 
 
48,019,652

Diluted (3)
 
48,006,870

 
 
 
48,019,652


(1) Includes contingent acquisition compensation expense of $0.5 million and $2.0 million for the three months ended March 31, 2018 (Successor) and 2017 (Predecessor), respectively.
(2) Includes accrued dividends and undistributed earnings allocated to participating securities for the Series A Preferred Stock. There were no participating securities during the Predecessor period. See Note 6. "Earnings Per Share" for further discussion.
(3) The impact of potentially dilutive securities for all periods presented was not considered because the effect would be anti-dilutive in those periods.

See notes to unaudited condensed consolidated financial statements.



2



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, amounts in thousands)
 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
 
 
 
 
 
 
 
Net income
 
$
5,125

 
 
 
$
14,422

Other comprehensive income
 

 
 
 

Comprehensive income
 
5,125

 
 
 
14,422

Less: Comprehensive income attributable to non-controlling interests
 
(22,646
)
 
 
 
(17,176
)
Comprehensive loss attributable to Surgery Partners, Inc.
 
$
(17,521
)
 
 
 
$
(2,754
)
See notes to unaudited condensed consolidated financial statements.




3



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited, amounts in thousands, except shares)
 
Common Stock
 
Additional
Paid-in Capital
 
Retained Deficit
 
Non-Controlling Interests—
Non-Redeemable
 
Total
 
Shares
 
Amount
 
Successor
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
48,687,136

 
$
487

 
$
695,560

 
$
(41,316
)
 
$
681,879

 
$
1,336,610

Net (loss) income

 

 

 
(17,521
)
 
15,908

 
(1,613
)
Equity-based compensation

 

 
1,997

 

 

 
1,997

Preferred dividends

 

 
(7,772
)
 

 

 
(7,772
)
Issuance of restricted and unrestricted shares
439,773

 
4

 
(4
)
 

 

 

Cancellation of restricted shares
(72,087
)
 

 
(749
)
 

 

 
(749
)
Repurchase of shares
(156,818
)
 
(2
)
 
(1,980
)
 

 

 
(1,982
)
Acquisition and disposal of shares of non-controlling interests, net

 

 
1,960

 

 
(1,175
)
 
785

Distributions to non-controlling interests—non-redeemable holders

 

 

 

 
(22,450
)
 
(22,450
)
Balance at March 31, 2018
48,898,004

 
$
489

 
$
689,012

 
$
(58,837
)
 
$
674,162

 
$
1,304,826


See notes to unaudited condensed consolidated financial statements.



4



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
 
 
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
 
 
Net income
 
$
5,125

 
 
 
$
14,422

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation and amortization
 
15,749

 
 
 
11,108

Other non-cash amortization
 
(127
)
 
 
 
1,765

Equity-based compensation
 
1,997

 
 
 
634

Loss on disposal or impairment of long-lived assets, net
 
47

 
 
 
1,196

Deferred income taxes
 
1,352

 
 
 
1,806

Provision for doubtful accounts
 
6,037

 
 
 
5,675

Income from equity investments, net of distributions received
 
322

 
 
 
(139
)
Changes in operating assets and liabilities, net of acquisitions and divestitures:
 
 
 
 
 
 
Accounts receivable
 
8,083

 
 
 
(3,433
)
Other operating assets and liabilities
 
(8,529
)
 
 
 
1,836

Net cash provided by operating activities
 
30,056

 
 
 
34,870

 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
Purchases of property and equipment, net
 
(9,983
)
 
 
 
(6,350
)
Payments for acquisitions, net of cash acquired
 
(25,589
)
 
 
 
(275
)
Other investing activities
 
(842
)
 
 
 

Net cash used in investing activities
 
(36,414
)
 
 
 
(6,625
)
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
Principal payments on long-term debt
 
(16,252
)
 
 
 
(45,527
)
Borrowings of long-term debt
 
374

 
 
 
23,592

Payments of preferred dividends
 
(3,924
)
 
 
 

Distributions to non-controlling interest holders
 
(30,919
)
 
 
 
(19,262
)
(Payments) receipts related to ownership transactions with non-controlling interest holders
 
(782
)
 
 
 
154

Repurchase of shares
 
(1,982
)
 
 
 

Financing lease obligations
 
(1,506
)
 
 
 
(286
)
Other financing activities
 
(749
)
 
 
 
(649
)
Net cash used in financing activities
 
(55,740
)
 
 
 
(41,978
)
Net decrease in cash, cash equivalents and restricted cash
 
(62,098
)
 
 
 
(13,733
)
Cash, cash equivalents and restricted cash at beginning of period
 
175,229

 
 
 
70,014

Cash, cash equivalents and restricted cash at end of period
 
$
113,131

 
 
 
$
56,281

 
 
 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
 
 
Non-cash purchases of property and equipment under capital leases and financing activities
 
$
4,028

 
 
 
$
2,320

See notes to unaudited condensed consolidated financial statements.


5

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. Organization
Surgery Partners, Inc., a Delaware corporation (together with its subsidiaries, the “Company”), was formed on April 2, 2015, as a holding company for the purpose of facilitating an initial public offering (the “IPO”) of shares of common stock. Prior to September 30, 2015, the Company conducted business through Surgery Center Holdings, Inc. and its subsidiaries. Surgery Center Holdings, LLC was and is the sole indirect owner of the equity interests of Surgery Center Holdings, Inc. and has no other material assets.
On September 30, 2015, Surgery Partners, Inc. became the direct parent and sole member of Surgery Center Holdings, LLC (the "Reorganization"). In the Reorganization, all of the equity interests held by the pre-IPO owners of Surgery Center Holdings, LLC were contributed to Surgery Partners, Inc. in exchange for 33,871,990 shares of common stock of Surgery Partners, Inc. and certain rights to additional payments under a tax receivable agreement. After giving effect to the Reorganization, Surgery Partners, Inc. is a holding company, and its sole material asset is an equity interest in Surgery Center Holdings, LLC. On October 1, 2015, the Company completed its IPO of 14,285,000 shares of common stock at an offering price of $19.00 per share.
On August 31, 2017, (i) the Company completed the sale and issuance of 310,000 shares of the Company's preferred stock, designated as 10.00% Series A Convertible Perpetual Participating Preferred Stock (the “Series A Preferred Stock”) to BCPE Seminole Holdings LP (“Bain”), a fund advised by an affiliate of Bain Capital Private Equity, at a purchase price of $1,000 per share in cash (the “Preferred Private Placement”), and (ii) Bain completed its purchase of 26,455,651 shares (the “Purchased Shares”) of the Company's common stock from H.I.G. Surgery Centers, LLC (“H.I.G.”) at a purchase price of $19.00 per share in cash (the “Private Sale”). As of August 31, 2017, the Purchased Shares represented approximately 54.2% of the Company’s outstanding common stock. As a result of the Preferred Private Placement and the Private Sale, Bain became the controlling stockholder of the Company, holding Series A Preferred Stock and common stock 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. The Preferred Private Placement and the Private Sale are referred to collectively in this Quarterly report on Form 10-Q as the “Transactions.”
In connection with the change of control effected by the Preferred Private Placement and the Private Sale, the Company elected to apply “pushdown” accounting by applying the guidance in Accounting Standards Codification Topic ("ASC") 805, Business Combinations, including the recognition of the Company’s assets and liabilities at fair value as of August 31, 2017, and similarly recognizing goodwill calculated based on the terms of the transaction and the fair value of the new basis of net assets of the Company. Accordingly, the condensed consolidated financial statements of the Company for periods before and after August 31, 2017 reflect different bases of accounting, and the financial positions and results of operations of those periods are not comparable. Throughout the Company's condensed consolidated financial statements and the accompanying notes herein, periods prior to the change of control are identified as "Predecessor" and periods after the change of control are identified as "Successor."
As of March 31, 2018 (Successor), the Company owned and operated a national network of surgical facilities and ancillary services in 32 states. The surgical facilities, which include ambulatory surgery centers ("ASCs") and surgical hospitals, primarily provide non-emergency surgical procedures across many specialties, including, among others, gastroenterology ("GI"), general surgery, ophthalmology, orthopedics and pain management. The Company's surgical hospitals provide services such as diagnostic imaging, laboratory, obstetrics, oncology, pharmacy, physical therapy and wound care. Ancillary services are comprised of a diagnostic laboratory, multi-specialty physician practices, urgent care facilities, anesthesia services and optical services.
As of March 31, 2018 (Successor), the Company owned or operated a portfolio of 125 surgical facilities, comprised of 107 ASCs and 18 surgical hospitals. The Company owns these facilities in partnership with physicians and, in some cases, healthcare systems in the markets and communities it serves. The Company owned a majority interest in 85 of the surgical facilities and consolidated 108 of these facilities for financial reporting purposes.
2. Significant Accounting Policies
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, as well as interests in partnerships and limited liability companies controlled by the Company through its ownership of a majority voting interest or other rights granted to the Company by contract to manage and control the affiliate's business. All significant intercompany balances and transactions are eliminated in consolidation.
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation of the Company's financial position and results of operations have been included. The Company’s fiscal year ends on December 31 and interim results are not necessarily indicative of results for a full year or any other interim period. The condensed consolidated balance sheet at December 31, 2017 (Successor) has been derived from the audited financial statements as of that date. The information contained in these condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the fiscal year ended December 31, 2017 (Successor). The preparation of financial statements in


6

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Non-Controlling Interests
The physician limited partners and physician minority members of the entities that the Company controls are responsible for the supervision and delivery of medical services. The governance rights of limited partners and minority members are restricted to those that protect their financial interests. Under certain partnership and operating agreements governing these partnerships and limited liability companies, the Company could be removed as the sole general partner or managing member for certain events such as material breach of the partnership or operating agreement, gross negligence or bankruptcy. These protective rights do not preclude consolidation of the respective partnerships and limited liability companies.
Ownership interests in consolidated subsidiaries held by parties other than the Company are identified and generally presented in the condensed consolidated financial statements within the equity section but separate from the Company's equity. However, in instances in which certain redemption features that are not solely within the control of the Company are present, classification of non-controlling interests outside of permanent equity is required. Consolidated net income attributable to the Company and to the non-controlling interests are identified and presented on the condensed consolidated statements of operations; changes in ownership interests in which the Company retains a controlling interest are accounted for as equity transactions assuming the Company continues to consolidate related entities. Certain transactions with non-controlling interests are classified within financing activities in the condensed consolidated statements of cash flows.
The condensed consolidated financial statements of the Company include all assets, liabilities, revenues and expenses of surgical facilities in which the Company has sufficient ownership and rights to allow the Company to consolidate the surgical facilities. Similar to its investments in non-consolidated affiliates, the Company regularly engages in the purchase and sale of ownership interests with respect to its consolidated subsidiaries that do not result in a change of control.
Non-Controlling Interests — Redeemable. Each partnership and limited liability company through which the Company owns and operates its surgical facilities is governed by a partnership or operating agreement, respectively. In certain circumstances, the applicable partnership or operating agreements for the Company's surgical facilities provide that the facilities will purchase all of the physician limited partners’ or physician minority members’, as applicable, ownership if certain adverse regulatory events occur, such as it becoming illegal for the physician(s) to own an interest in a surgical facility, refer patients to a surgical facility or receive cash distributions from a surgical facility. The non-controlling interestsredeemable are reported outside of stockholders' equity in the condensed consolidated balance sheets.
A summary of activity related to the non-controlling interests—redeemable follows (in thousands):
Successor
 
 
Balance at December 31, 2017
 
$
299,316

Net income attributable to non-controlling interests—redeemable
 
6,738

Acquisition and disposal of shares of non-controlling interests, net—redeemable
 
16,058

Distributions to non-controlling interest—redeemable holders
 
(8,469
)
Balance at March 31, 2018
 
$
313,643

Variable Interest Entities
The condensed consolidated financial statements include the accounts of variable interest entities in which the Company is the primary beneficiary under the provisions of ASC 810, Consolidation. As of both March 31, 2018 (Successor) and December 31, 2017 (Successor), the variable interest entities include five surgical facilities, three anesthesia practices and three physician practices. The Company has the power to direct the activities that most significantly impact a variable interest entity's economic performance. Additionally, the Company would absorb the majority of the expected losses from any of these entities should such expected losses occur.
The total assets (excluding goodwill and intangible assets, net) of the consolidated VIEs included in the accompanying condensed consolidated balance sheets as of March 31, 2018 (Successor) and December 31, 2017 (Successor), were $14.1 million and $13.1 million, respectively, and the total liabilities of the consolidated VIEs were $5.8 million and $5.8 million, respectively.
Equity Method Investments
The Company has non-consolidating investments in surgical facilities and management companies that own or manage surgical facilities. These investments are accounted for using the equity method of accounting. The total amount of these investments included in investments in and advances to affiliates in the condensed consolidated balance sheets was $75.2 million and $74.3 million as of March 31, 2018 (Successor) and December 31, 2017 (Successor), respectively.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and footnotes. Examples include, but are not limited to, estimates of accounts receivable allowances, professional and general liabilities and the estimate of deferred tax assets or liabilities. In the opinion of


7

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

management, all adjustments considered necessary for a fair presentation have been included. All adjustments are of a normal, recurring nature. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the comparative periods' financial statements to conform to the current year presentation.
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in an orderly transaction between market participants to sell the asset or transfer the liability. The Company uses fair value measurements based on quoted prices in active markets for identical assets or liabilities (Level 1), inputs other than quoted prices in active markets that are either directly or indirectly observable (Level 2), or unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions (Level 3), depending on the nature of the item being valued.
The carrying amounts reported in the condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, restricted invested assets and accounts payable approximate their fair values.
A summary of the carrying amounts and fair values of the Company's long-term debt follows (in thousands):
 
 
Successor
 
 
Carrying Amount
 
Fair Value
 
 
March 31,
2018
 
December 31, 2017
 
March 31,
2018
 
December 31, 2017
2017 Senior Secured Credit Facilities:
 
 
 
 
 
 
 
 
Revolver
 
$

 
$

 
$

 
$

Term Loan
 
$
1,277,482

 
$
1,280,532

 
$
1,275,566

 
$
1,267,189

Senior Unsecured Notes due 2021
 
$
408,633

 
$
409,235

 
$
422,424

 
$
422,535

Senior Unsecured Notes due 2025
 
$
370,000

 
$
370,000

 
$
356,125

 
$
346,413

The fair values of the Term Loan, 2021 Unsecured Notes and the 2025 Unsecured Notes (in each case, as defined in Note 4. Long-Term Debt) were based on a Level 2 inputs using quoted prices for identical liabilities in inactive markets at March 31, 2018 (Successor) and December 31, 2017 (Successor), as applicable. The carrying amounts related to the Company's other long-term debt obligations, including the Revolver (as defined in Note 4. Long-Term Debt), approximate their fair values.
The Company maintains a supplemental executive retirement savings plan (the "SERP") for certain executive officers. The SERP is a non-qualified deferred compensation plan for eligible executive officers and other key employees of the Company that allows participants to defer portions of their compensation. The fair value of the SERP asset and liability was based on a quoted market price, or a Level 1 computation. As of both March 31, 2018 (Successor) and December 31, 2017 (Successor), the fair value of both the assets and liabilities in the SERP were $1.9 million and were included in other long-term assets and other long-term liabilities in the condensed consolidated balance sheets.
Revenues
In May 2014, the Financial Accounting Standards Board ("FASB") issued a new standard related to revenue recognition. The Company adopted the new standard effective January 1, 2018, using the modified retrospective method. The adoption of the new standard did not have an impact on our recognition of net revenues for any periods prior to adoption. The majority of the “Provision for doubtful accounts” will continue to be recognized as an operating expense rather than as a direct reduction to revenues, given the Company’s practice of assessing a patient’s ability to pay prior to or on the date of providing healthcare services. After initial recognition, the Company’s accounts receivables are subject to impairment assessments periodically based on changes in credit risks using historical trends of cash collections, write-offs, accounts receivable agings and other factors.
The Company's revenues generally relate to contracts with patients in which the performance obligations are to provide healthcare services. The Company recognizes revenues in the period in which our obligations to provide health care services are satisfied and reports the amount that reflects the consideration the Company expects to be entitled to. The Company's performance obligations are generally satisfied over a period of less than one day. The contractual relationships with patients, in most cases, also involve a third-party payer (Medicare, Medicaid, managed care health plans, employers and commercial insurance companies, including plans offered through the health insurance exchanges) and the transaction prices for the services provided are dependent upon the terms provided by (Medicare and Medicaid) or negotiated with (managed care health plans, employers and commercial insurance companies) the third-party payers. The payment arrangements with third-party payers for the services provided to the related patients typically specify payments at amounts less than the Company's standard charges. Medicare generally pays for services at prospectively determined rates based on clinical, diagnostic and other factors. Services provided to patients having Medicaid coverage are generally paid at prospectively determined rates per discharge, per identified service or per covered member. Agreements with commercial insurance carriers, managed care and preferred provider organizations generally provide for payments based upon predetermined rates per diagnosis, per diem rates or discounted fee-for-service rates. The Company continually reviews the


8

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

contractual estimation process to consider and incorporate updates to laws and regulations and the frequent changes in managed care contractual terms resulting from contract renegotiations and renewals.
A summary of revenues by service type as a percentage of total revenues follows:
 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
Patient service revenues:
 
 
 
 
 
 
   Surgical facilities revenues
 
93.5
%
 
 
 
89.6
%
   Ancillary services revenues
 
4.9
%
 
 
 
8.8
%
 
 
98.4
%
 
 
 
98.4
%
Other service revenues:
 
 
 
 
 
 
   Optical services revenues
 
0.7
%
 
 
 
1.0
%
   Other revenues
 
0.9
%
 
 
 
0.6
%
 
 
1.6
%
 
 
 
1.6
%
Total revenues
 
100.0
%
 
 
 
100.0
%
Patient service revenues. This includes revenue related to charging facility fees in exchange for providing patient care. The fee charged for healthcare procedures performed in surgical facilities varies depending on the type of service provided, but usually includes all charges for usage of an operating room, a recovery room, special equipment, medical supplies, nursing staff and medications. The fee does not normally include professional fees charged by the patient’s surgeon, anesthesiologist or other attending physician, which are billed directly by such physicians to the patient or third-party payor. However, in several surgical facilities, the Company charges for anesthesia services. Ancillary service revenues include fees for patient visits to the Company's physician practices, pharmacy services and diagnostic tests ordered by physicians.
Patient service revenues are recognized as performance obligations are satisfied. Performance obligations are based on the nature of services provided. Typically, the Company recognizes revenue at a point in time in which services are rendered and the Company has no obligation to provide further patient services. As the Company primarily performs outpatient procedures, performance obligations are generally satisfied same day and revenue is recognized on the date of service.
The Company determines the transaction price based on gross charges for services provided, net of estimated contractual adjustments, discounts from third-party payors, including Medicare and Medicaid. The Company estimates its contractual adjustments and discounts based on contractual agreements, its discount policies and historical experience. Changes in estimated contractual adjustments and discounts are recorded in the period of change. There were no adjustments as a result of changes in estimates to third-party settlements related to prior years during the three months ended March 31, 2018 (Successor). During the three months ended March 31, 2017 (Predecessor), the Company recognized an increase to patient service revenues as a result of changes in estimates to third-party settlements related to prior years of approximately $0.4 million.


9

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table sets forth patient service revenues by type of payor and as a percentage of total patient service revenues for the Company's consolidated surgical facilities (dollars in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
 
 
Amount
 
%
 
 
 
Amount
 
%
Patient service revenues:
 
 
 
 
 
 
 
 
 
 
Private insurance
 
$
219,636

 
53.5
%
 
 
 
$
139,003

 
49.4
%
Government
 
159,347

 
38.8
%
 
 
 
116,878

 
41.5
%
Self-pay
 
12,970

 
3.1
%
 
 
 
6,071

 
2.2
%
Other (1)
 
18,793

 
4.6
%
 
 
 
19,694

 
6.9
%
Total patient service revenues
 
410,746

 
100.0
%
 
 
 
281,646

 
100.0
%
Other service revenues:
 
 
 
 
 
 
 
 
 
 
Optical services revenues
 
2,960

 
 
 
 
 
2,821

 
 
Other revenues
 
3,663

 
 
 
 
 
1,716

 
 
Total revenues
 
$
417,369

 
 
 
 
 
$
286,183

 
 
(1)
Other is comprised of anesthesia service agreements, auto liability, letters of protection and other payor types.
Other service revenues. Optical service revenues consist of product sales from the Company's optical laboratories as well as handling charges billed to the members of the Company's optical products purchasing organization. The Company's optical products purchasing organization negotiates volume buying discounts with optical products manufacturers. The buying discounts and any handling charges billed to the members of the buying group represent the revenue recognized for financial reporting purposes. The Company satisfies the performance obligation and recognizes revenue when the orders are shipped to members. The Company bases its estimates for sales returns and discounts on historical experience and has not experienced significant fluctuations between estimated and actual return activity and discounts given. The Company's optical laboratories manufacture and distribute corrective lenses and eyeglasses to ophthalmologists and optometrists. The Company satisfies the performance obligation and recognize revenue when the product is shipped, net of allowance for discounts.
Other revenues include management and administrative service fees derived from the non-consolidated facilities that the Company accounts for under the equity method, management of surgical facilities in which it does not own an interest, and management services provided to physician practices for which the Company is not required to provide capital or additional assets. These agreements typically require the Company to provide recurring management services over a multi-year period which are billed and collected on a monthly basis. The fees derived from these management arrangements are based on a predetermined percentage of the revenues of each facility or practice and are recognized in the period in which management services are rendered and billed.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.  The Company maintains its cash and cash equivalent balances at high credit quality financial institutions.
In accordance with the provisions of the operating lease agreement at the Company's Chesterfield, Missouri facility, the Company has a deposit with the landlord that shall be held as security for performance under the Company's covenants and obligations within the agreement through January 2024. The Company presents the restricted amount separate from cash and cash equivalents under the caption "restricted invested assets" in the condensed consolidated balance sheets.
The following table reconciles cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets to the totals shown within the condensed consolidated statement of cash flows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
Cash and cash equivalents
 
$
112,816

 
$
174,914

Restricted invested assets
 
315

 
315

Total cash, cash equivalents and restricted cash in the statement of cash flows
 
$
113,131

 
$
175,229



10

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Accounts Receivable and Allowances for Contractual Adjustments and Doubtful Accounts
With the Company's adoption of ASC 2014-09 on January 1, 2018, for those accounts in which the Company has an unconditional right to payment, subject only to the passage of time, the right is recorded as a receivable. Accounts receivable are recorded net of contractual adjustments and allowances for doubtful accounts to reflect accounts receivable at net realizable value. Accounts receivable consists of receivables from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, employers and patients. Management recognizes that revenues and receivables from government agencies are significant to the Company's operations, but it does not believe that there is significant credit risk associated with these government agencies. Concentration of credit risk with respect to other payors is limited because of the large number of such payors. The Company had a net third-party Medicaid settlements liability of $4.3 million and $1.0 million as of March 31, 2018 (Successor) and December 31, 2017 (Successor), respectively, included in other current liabilities in the condensed consolidated balance sheets.
The Company recognizes that final reimbursement of accounts receivable is subject to final approval by each third-party payor. However, because the Company has contracts with its third-party payors and also verifies insurance coverage of the patient before medical services are rendered, the amounts that are pending approval from third-party payors are not considered significant. The Company's policy is to collect co-payments and deductibles prior to providing medical services. It is also the Company's policy to verify a patient’s insurance 72 hours prior to the patient’s procedure. Patient services of the Company are primarily non-emergency, which allows the surgical facilities to control the procedures for which third-party reimbursement is sought and obtained. The Company does not require collateral from self-pay patients.
The Company analyzes accounts receivable at each of its facilities to ensure the proper aged category and collection assessment. At a consolidated level, the Company's policy is to review accounts receivable aging, by facility, to determine the appropriate allowance for doubtful accounts. Patient account balances are reviewed for delinquency based on contractual terms. This review is supported by an analysis of the actual revenues, contractual adjustments and cash collections received. An account balance is written off only after the Company has pursued collection with legal or collection agency assistance or otherwise has deemed an account to be uncollectible.
The receivables related to the Company's optical products purchasing organization are recognized separately from patient accounts receivable, as discussed above, and are included in other current assets in the condensed consolidated balance sheets. Such receivables were $10.3 million and $7.6 million at March 31, 2018 (Successor) and December 31, 2017 (Successor), respectively.
Inventories
Inventories, which consist primarily of medical and drug supplies, are stated at the lower of cost or market value. Cost is determined using the first-in, first-out method.
Prepaid Expenses and Other Current Assets
A summary of prepaid expenses and other current assets follows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
Prepaid expenses
 
$
15,810

 
$
16,835

Receivables - optical product purchasing organization
 
10,259

 
7,563

Insurance recoveries
 
2,828

 
2,828

Other
 
25,427

 
28,111

Total
 
$
54,324

 
$
55,337

Property and Equipment
Property and equipment are stated at cost or, if obtained through acquisition, at fair value determined on the date of acquisition. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets, generally 20 to 40 years for buildings and building improvements, three to five years for computers and software and five to seven years for furniture and equipment. Leasehold improvements are depreciated on a straight-line basis over the shorter of the lease term or the estimated useful life of the assets. Routine maintenance and repairs are expensed as incurred, while expenditures that increase capacities or extend useful lives are capitalized.


11

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

A summary of property and equipment follows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
Land
 
$
19,546

 
$
19,561

Buildings and improvements
 
193,942

 
188,571

Furniture and equipment
 
23,681

 
20,813

Computer and software
 
30,904

 
28,578

Medical equipment
 
137,956

 
138,112

Construction in progress
 
25,860

 
22,581

Property and equipment, at cost
 
431,889

 
418,216

Less: Accumulated depreciation
 
(31,504
)
 
(19,680
)
Property and equipment, net
 
$
400,385

 
$
398,536

The Company also leases certain facilities and equipment under capital leases. Assets held under capital leases are stated at the present value of minimum lease payments at the inception of the related lease. Such assets are depreciated on a straight-line basis over the lesser of the lease term or the remaining useful life of the leased asset. The carrying values of assets under capital lease were $19.1 million and $16.2 million as of March 31, 2018 (Successor) and December 31, 2017 (Successor), respectively, net of accumulated depreciation of $7.4 million and $5.8 million, respectively.
Intangible Assets
The Company has indefinite-lived intangible assets related to the certificates of need held in jurisdictions where certain of its surgical facilities are located. The Company also has finite-lived intangible assets related to physician guarantee agreements, non-compete agreements, management agreements and customer relationships. Physician income guarantees are amortized into salaries and benefits costs in the condensed consolidated statements of operations over the commitment period of the contract, generally three to four years. Non-compete agreements and management rights agreements are amortized into depreciation and amortization expense in the condensed consolidated statements of operations over the service lives of the agreements, typically ranging from two to five years for non-compete agreements and fifteen years for the management rights agreements. Customer relationships are amortized into depreciation and amortization expense in the condensed consolidated statements of operations over the estimated lives of the relationships, ranging from three to ten years.
A summary of the components of intangible assets follows (in thousands):
 
 
Successor
 
 
March 31, 2018
 
December 31, 2017
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
 
 
 
 
 
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Management rights agreements
 
$
42,600

 
$
(1,998
)
 
$
40,602

 
$
42,600

 
$
(1,058
)
 
$
41,542

Non-compete agreements
 
4,381

 
(1,102
)
 
3,279

 
4,874

 
(715
)
 
4,159

Physician income guarantees
 
878

 
(323
)
 
555

 
878

 
(227
)
 
651

Total finite-lived intangible assets
 
47,859

 
(3,423
)
 
44,436

 
48,352

 
(2,000
)
 
46,352

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Management rights agreements
 
11,000

 

 
11,000

 
5,900

 

 
5,900

Certificates of need
 
5,863

 

 
5,863

 
5,548

 

 
5,548

Medicare licenses
 
1,113

 

 
1,113

 
1,108

 

 
1,108

Total intangible assets
 
$
65,835

 
$
(3,423
)
 
$
62,412

 
$
60,908

 
$
(2,000
)
 
$
58,908



12

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Goodwill
Goodwill represents the fair value of the consideration provided in an acquisition over the fair value of net assets acquired and is not amortized. Additions to goodwill include amounts resulting from new business combinations and incremental ownership purchases in the Company's subsidiaries. A summary of the Company's acquisitions for the three months ended March 31, 2018 is included in Note 3. Acquisitions and Developments.
A summary of activity related to goodwill for the three months ended March 31, 2018 (Successor) follows (in thousands):
Successor
 
 
Balance at December 31, 2017
 
$
3,346,838

Acquisitions, including post acquisition adjustments
 
35,963

Balance at March 31, 2018
 
$
3,382,801

Impairment of Long-Lived Assets, Goodwill and Intangible Assets
The Company evaluates the carrying value of long-lived assets when impairment indicators are present or when circumstances indicate that impairment may exist. The Company performs 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. No impairment losses on long-lived assets were recognized during the three months ended March 31, 2018 (Successor) and three months ended March 31, 2017 (Predecessor).
The Company tests its goodwill and indefinite-lived intangible assets for impairment at least annually, as of October 1, or more frequently if certain indicators arise. The Company tests for goodwill impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment. The Company has determined that it has five reporting units, which include the following: 1) Surgical Facilities 2) Ancillary Services, 3) Midwest Labs, 4) The Alliance and 5) Family Vision Care. The Company compares the carrying value of the net assets of the reporting unit to the estimated fair value of the reporting unit. If the carrying value exceeds the estimated fair value, an impairment indicator exists and an estimate of the possible impairment loss is calculated. The fair value of the reporting units are estimated using a discounted cash flows approach and are corroborated using a market-based approach. The fair value calculation includes multiple assumptions and estimates, including the projected cash flows and discount rates applied. The Company performed its most recent annual impairment test as of October 1, 2017 (Successor) and did not incur an impairment loss.
Other Long-Term Assets
A summary of other long-term assets follows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
Acquisition escrow deposit
 
$
20,471

 
$
19,600

Insurance recoveries
 
11,518

 
10,018

Other
 
20,390

 
18,732

Total
 
$
52,379

 
$
48,350



13

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Other Current Liabilities
A summary of other current liabilities follows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
Interest payable
 
$
22,895

 
$
20,537

Amounts due to patients and payors
 
20,283

 
18,096

Insurance liabilities
 
9,843

 
9,873

Facility lease obligations
 
6,426

 
6,256

Current taxes payable
 
5,678

 
4,912

Accrued expenses and other
 
48,445

 
50,270

Total
 
$
113,570

 
$
109,944

Other Long-Term Liabilities
A summary of other long-term liabilities follows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
Facility lease obligations
 
$
119,239

 
$
121,627

Tax receivable agreement liability
 
44,930

 
43,791

Acquisition escrow liability
 
20,471

 
19,600

Medical malpractice liability
 
17,950

 
16,450

Other
 
30,934

 
21,012

Total
 
$
233,524

 
$
222,480

At four of the Company's surgical facilities, the Company has facility lease obligations payable to the lessor of each facility. Payments are allocated to principal adjustments of the lease obligations and interest expense. The current and long-term balances of the lease obligations are included in the other current liabilities and other long-term liabilities tables above.
Operating Leases
The Company leases office space and equipment for its surgical facilities, including surgical facilities under development. The lease agreements generally require the lessee, or the Company, to pay all maintenance, property taxes, utilities and insurance costs. The Company accounts for operating lease obligations and sublease income on a straight-line basis. Contingent obligations of the Company, as defined by each lease agreement, are recognized when specific contractual measures have been met, typically the result of an increase in the Consumer Price Index. Lease obligations paid in advance are recorded as prepaid rent and included in prepaid expenses and other current assets on the condensed consolidated balance sheets. The difference between actual lease payments and straight-line lease expense over the initial lease term, excluding optional renewal periods, is recorded as deferred rent and included in other current liabilities and other long-term liabilities on the condensed consolidated balance sheets.
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. In September 2015, the Company adopted the Surgery Partners, Inc. 2015 Omnibus Incentive Plan ("2015 Omnibus Incentive Plan") from which all equity-based awards will be granted. Under this plan, the Company can grant stock options, SARs, restricted stock, unrestricted stock, stock units, performance awards, cash awards and other awards convertible into or otherwise based on shares of its common stock.
The Company applies the Black-Scholes-Merton method of valuation in determining share-based compensation expense for option awards. Application of this method includes assumptions such as expected stock price volatility, risk-free interest rate, expected dividends, and expected term. The fair values of time-based restricted stock units are based on the closing price of the Company’s common stock on the trading date immediately prior to the grant date. The fair values of performance-based restricted stock units are determined based on a combination, where applicable, of the closing price of the Company's common stock on the trading date immediately prior to the grant date


14

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

for units subject to performance conditions, or at its Monte-Carlo simulation value for units subject to market conditions. For these restricted stock units, the number of shares payable at the end of the vesting periods is based on the Company’s actual performance and/or market conditions results as compared to the targets.
The Company's policy is to recognize compensation expense using the straight line method over the relevant vesting period for units that vest based on time. The Company recognizes compensation expense for the portion of performance-based restricted stock units subject to market conditions even if the condition is never satisfied. However, if the performance conditions are not met for the portion of the performance-based restricted stock units subject to such performance conditions, no compensation expense will be recognized, and any previously recognized compensation expense will be reversed. Forfeitures are recognized as incurred. 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.
Professional, General and Workers' Compensation Insurance
The Company maintains general liability and professional liability insurance in excess of self-insured retentions through third party commercial insurance carriers in amounts that management believes is sufficient for the Company's operations, although, potentially, some claims may 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.
The Company expenses the costs under the self-insured retention exposure for general and professional liability and workers compensation claims which relate to (i) claims made during the policy period, which are offset by insurance recoveries and (ii) an estimate of claims incurred but not yet reported that are expected to be reported after the policy period expires. Reserves and provisions are based upon actuarially determined estimates. The reserves are estimated using individual case-basis valuations and actuarial analysis. Reserves for professional, general and workers' compensation claim liabilities are determined with no regard for expected insurance recoveries and are presented gross on the condensed consolidated balance sheets. Total professional, general and workers' compensation claim liabilities as of March 31, 2018 (Successor) and December 31, 2017 (Successor) are $22.4 million and $21.0 million, respectively. The balance includes expected insurance recoveries of $14.3 million and $12.8 million as of March 31, 2018 (Successor) and December 31, 2017 (Successor), respectively.
Income Taxes
The Company uses 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If a net operating loss ("NOL") or Section 163(j) interest (“163(j)”) carryforward exists, the Company makes a determination as to whether the NOL or 163(j) carryforward will be utilized in the future. A valuation allowance is established for certain carryforwards when their recoverability is deemed to be uncertain. The carrying value of the net deferred tax assets assumes that the Company will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions. If these estimates and related assumptions change in the future, the Company may be required to adjust its deferred tax valuation allowances.
The Company and certain of its subsidiaries file a consolidated federal income tax return. The partnerships, limited liability companies, and certain non-consolidated physician practice corporations also file separate income tax returns. The Company's allocable portion of each partnership's and limited liability company's income or loss is included in taxable income of the Company. The remaining income or loss of each partnership and limited liability company is allocated to the other owners.
The Company, or one or more of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal income tax examinations for years prior to 2014 or state income tax examinations for years prior to 2013.
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. The Company adopted this ASU on January 1, 2018 using the modified retrospective approach. The adoption of this standard did not have a significant impact on our recognition of net revenues for any period. Adoption of the standard resulted in the Company revising its related disclosures.
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. The Company believes the primary effect of adopting the new standard will be to record right-of-use assets and obligations for current operating leases.
In November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows – Restricted Cash," which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or


15

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

restricted cash equivalents. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those years. The Company adopted this ASU on January 1, 2018 and retrospectively applied the guidance to all periods presented in the condensed consolidated statement of cash flows. The retrospective application to prior periods had no impact on the Company's cash flows from operating, investing and financing activities as previously disclosed. The adoption of this ASU resulted in the modification of the Company's presentation of the reconciliation of beginning-of-period and end-of-period total amounts shown on the condensed consolidated statement of cash flows to include restricted cash as discussed under the heading "Cash and Cash Equivalents" above.
3. Acquisitions and Developments
The Company accounts for its business combinations in accordance with the fundamental requirements of the acquisition method of accounting and under the premise that an acquirer can be identified for each business combination. The acquirer is the entity that obtains control of one or more businesses in the business combination and the acquisition date is the date the acquirer achieves control. The assets acquired, liabilities assumed and any non-controlling interests in the acquired business at the acquisition date are recognized at their fair values as of that date, and the direct costs incurred in connection with the business combination are recorded and expensed separately from the business combination. Any goodwill recognized is determined as the excess of the fair value of the consideration conveyed plus the fair value of any non-controlling interests in the acquisition over the fair value of the net assets acquired. Acquisitions in which the Company is able to exert significant influence but does not have control are accounted for using the equity method.
Acquired assets and assumed liabilities typically include, but are not limited to, fixed assets, intangible assets and professional liabilities. The valuations are based on appraisal reports, discounted cash flow analyses, actuarial analyses or other appropriate valuation techniques to determine the fair value of the assets acquired or liabilities assumed. Fair value attributable to non-controlling interests is based on a Level 3 computation using significant inputs that are not observable in the market. Key inputs used to determine the fair value include financial multiples used in the purchase of non-controlling interests, primarily from acquisitions of surgical facilities. Such multiples, based on earnings, are used as a benchmark for the discount to be applied for the lack of control or marketability. Fair value attributable to the property and equipment acquired is based on Level 3 computations using key inputs such as cost trend data and comparable asset sales. Fair value attributable to the intangible assets acquired is based on Level 3 computations using key inputs such as the Company's internally-prepared financial projections. Fair values assigned to acquired working capital are based on carrying amounts reported by the acquiree at the date of acquisition, which approximate their fair values. The preliminary estimated fair value assigned to goodwill is primarily attributable to the acquisitions favorable reputations in their markets, their market positions and their ability to deliver quality care with high patient satisfaction consistent with the Company's business model.
2018 Transactions
During the three months ended March 31, 2018 (Successor), the Company acquired a controlling interest in one surgical facility in a new market and a surgical facility in an existing market, which was merged into an existing facility, and a physician practice for a combined cash purchase price of $25.6 million, net of cash acquired. The acquisitions were funded through cash from operations. The total consideration related to these 2018 acquisitions was allocated to the assets acquired and liabilities assumed based upon their respective acquisition date fair values. The acquisitions were funded through cash from operations. The aggregate amounts preliminarily recognized for each major class of assets and liabilities assumed are as follows (in thousands):
Cash consideration
 
$
25,545

Fair value of non-controlling interests
 
17,287

Aggregate fair value of acquisitions
 
42,832

 
 
 
Current Assets
 
3,487

Property and equipment
 
1,905

Goodwill
 
38,539

Other long-term assets
 
1,155

Current liabilities
 
(1,254
)
Long-term liabilities
 
(1,000
)
Aggregate fair value allocated
 
$
42,832

The results of operations of the acquisitions are included in the Company’s results of operations beginning on the dates of acquisitions, and were not considered significant for the three months ended March 31, 2018. The fair values assigned to certain assets and liabilities assumed by the Company have been estimated on a preliminary basis and are subject to change as new facts and circumstances emerge that were present at the date of acquisition. All goodwill acquired in connection with the 2018 transactions was allocated to the Company's surgical facility services operating segment.


16

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

During the three months ended March 31, 2018, no significant changes were made to the purchase price allocation of assets and liabilities, existing at the date of acquisition, related to individual acquisitions completed in 2017, excluding the acquisition of NSH as discussed below.
Acquisition of NSH
On August 31, 2017 (Predecessor), the Company completed its acquisition of NSH Holdco, Inc. (“NSH”) for total cash consideration of $711.7 million, net of cash acquired, including $19.6 million funded to an escrow account. The total consideration related to the acquisition of NSH was allocated to the assets acquired and liabilities assumed based upon their respective acquisition date fair values. The aggregate amounts preliminarily recognized for each major class of assets and liabilities, including post acquisition date adjustments, are as follows (in thousands):
Cash consideration
 
$
762,850

Fair value of non-controlling interests
 
325,965

Aggregate fair value of acquisition
 
1,088,815

Net assets acquired:
 
 
Cash and cash equivalents
 
51,159

Accounts receivable
 
71,875

Inventories
 
14,986

Prepaid expenses and other current assets
 
18,367

Property and equipment
 
174,499

Intangible assets
 
27,881

Goodwill
 
869,090

Investments in and advances to affiliates
 
29,737

Long-term deferred tax assets
 
18,971

Other long-term assets
 
26,988

Accounts payable
 
(29,652
)
Accrued payroll and benefits
 
(28,755
)
Other current liabilities
 
(23,339
)
Current maturities of long-term debt
 
(16,416
)
Long-term debt, less current maturities
 
(42,770
)
Other long-term liabilities
 
(73,806
)
     Total fair value of net assets acquired
 
$
1,088,815

During the three months ended March 31, 2018 (Successor), information existing at the acquisition date became known to the Company as part of its evaluation of the assets and liabilities existing at the date of acquisition, resulting in a net decrease to goodwill of $1.2 million and corresponding changes to certain classes of assets and liabilities from the preliminary allocation recorded at August 31, 2017 (Predecessor), that are reflected in the table above. The Company is still in the process of evaluating all major classes of assets acquired and liabilities assumed. As such, the fair values assigned are subject to change as new facts and circumstances emerge that were present at the date of acquisition.
Change of Control - Pushdown Accounting
As previously discussed in Note 1. Organization, on August 31, 2017, in connection with the change of control, the Company elected to apply “pushdown” accounting by applying the guidance in Accounting Standards Codification Topic ("ASC") 805, Business Combinations. In accordance with ASC 805, all identifiable assets and liabilities of the Company were measured at and adjusted to fair value as of August 31, 2017, and similarly goodwill was recognized based on the terms of the transaction and the fair value of the new basis of the net assets of the Company.


17

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The aggregate amounts preliminarily recognized in connection with the application of pushdown accounting for each major class of assets and liabilities as of August 31, 2017 are as follows (in thousands):
Equity attributable to Surgery Partners, Inc.
$
720,606

Redeemable preferred stock
310,000

Fair value of non-controlling interests
957,027

Aggregate fair value
1,987,633

Net assets:
 
Cash and cash equivalents
214,206

Accounts receivable
253,147

Inventories
44,310

Prepaid expenses and other current assets
61,438

Property and equipment
380,085

Intangible assets
63,978

Goodwill
3,297,389

Investments in and advances to affiliates
75,113

Restricted invested assets
315

Long-term deferred tax asset
204,831

Other long-term assets
50,666

Accounts payable
(64,921
)
Accrued payroll and benefits
(54,437
)
Other current liabilities
(97,019
)
Current maturities of long-term debt
(49,942
)
Long-term debt, less current maturities
(2,142,375
)
Long-term tax receivable agreement liability
(78,498
)
Other long-term liabilities
(170,653
)
Total fair value of net assets
$
1,987,633

During the three months ended March 31, 2018 (Successor), information existing at the acquisition date became known to the Company as part of its evaluation of the assets and liabilities existing at August 31, 2017, resulting in a net decrease to goodwill of $2.5 million and corresponding changes to certain classes of assets and liabilities from the preliminary allocation recorded, that are reflected in the table above. The Company is still in the process of evaluating all major classes of assets and liabilities. As such, the fair values assigned are subject to change as new facts and circumstances emerge that were present at August 31, 2017.


18

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

4. Long-Term Debt
A summary of long-term debt follows (in thousands):
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
 
 
 
 
 
2017 Senior Secured Credit Facilities:
 
 
 
 
Revolver
 
$

 
$

Term Loan (1)
 
1,277,482

 
1,280,532

Senior Unsecured Notes due 2021 (2)

408,633

 
409,235

Senior Unsecured Notes due 2025
 
370,000

 
370,000

Notes payable and secured loans
 
94,253

 
101,921

Capital lease obligations
 
26,465

 
27,594

Total debt
 
2,176,833

 
2,189,282

Less: Current maturities
 
54,386

 
58,726

Total long-term debt
 
$
2,122,447

 
$
2,130,556

(1) Includes unamortized fair value discount of $6.1 million as of March 31, 2018 and $6.2 million as of December 31, 2017. See further discussion below.
(2) Includes unamortized fair value premium of $8.6 million as of March 31, 2018 and $9.2 million as of December 31, 2017. See further discussion below.
2017 Senior Secured Credit Facilities
On August 31, 2017 (Predecessor), SP Holdco I, Inc. and Surgery Center Holdings, Inc., each a wholly-owned subsidiary of the Company, entered into a credit agreement (the “Credit Agreement”) providing for a $1.290 billion senior secured term loan (the “Term Loan”) 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 (Predecessor) and the proceeds thereof were used to finance the consideration paid in the NSH acquisition, to repay amounts outstanding under the Company’s then-existing 2014 First Lien Credit Agreement and 2014 Revolver Loan, amounts outstanding under the existing senior secured credit facilities of NSH, and to pay fees and expenses in connection with the foregoing and related transactions. The Revolver may be utilized for working capital, capital expenditures and general corporate purposes. Subject to certain conditions and requirements set forth in the Credit Agreement, the Company may request one or more additional incremental term loan facilities or one or more increases in the commitments under the Revolver. As of March 31, 2018 (Successor), the Company's 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).
The 2017 Senior Secured Credit Facilities 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 the Company's 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 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, the Company is 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. 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, 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 March 31, 2018 (Successor).
With respect to the Revolver, the Company is required to comply with a maximum consolidated total net leverage ratio of 9.50:1.00, which covenant is 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 the ability of the Company and its restricted subsidiaries, to, among other things, sell assets, alter its 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


19

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

covenants and events of default. As of March 31, 2018 (Successor), the Company was in compliance with the covenants contained in the Credit Agreement.
The 2017 Senior Secured Credit Facilities are guaranteed, on a joint and several basis, by SP Holdco I, Inc. and each 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 all 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, the Company recorded debt issuance costs and discount of $18.8 million and $9.4 million, respectively, in the Predecessor period, which were eliminated with the application of pushdown accounting.
In connection with the application of pushdown accounting, the Company remeasured and recorded the Term Loan at fair value using a measurement date of August 31, 2017. The fair value was based on a Level 2 input using quoted prices for identical liabilities in inactive markets. As a result, the Company recorded a fair value discount of $6.5 million as of the measurement date, which is reported in the consolidated balance sheets as a direct deduction from the face amount the Term Loan. The Company amortizes the fair value discount to interest expense over the life of the Term Loan.
Senior Unsecured Notes due 2021
Effective March 31, 2016 (Predecessor), 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).
The Company 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.
The Company 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. The Company 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
%
If 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.
In connection with the offering 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.
In connection with the application of pushdown accounting, the Company remeasured and recorded the 2021 Unsecured Notes at fair value using a measurement date of August 31, 2017. The fair value was based on a Level 2 input using quoted prices for identical liabilities in inactive markets. As a result, the Company recorded a fair value premium of $10.0 million as of the measurement date, which is reported in the consolidated balance sheets as a direct addition to the face amount the notes. The Company amortizes the fair value premium to interest expense over the life of the 2021 Unsecured Notes.
Senior Unsecured Notes due 2025
On 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"). In connection with the closing of the NSH acquisition, Surgery Center Holdings Inc. assumed the obligations of SP Finco, LLC. 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 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.


20

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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.
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. At March 31, 2018 (Successor), the Company was in compliance with its covenants contained in the credit agreements. The Company and its subsidiaries had notes payable to financial institutions of $94.3 million and $101.9 million as of March 31, 2018 (Successor) and December 31, 2017 (Successor), 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 property and equipment leases classified as capital leases. The carrying value of the leased assets was $19.1 million and $16.2 million as of March 31, 2018 (Successor) and December 31, 2017 (Successor), respectively.
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 acquisition.
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 20 out of 30 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


21

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 follows (in thousands):
Successor
 
 
Balance at December 31, 2017
 
$
330,806

Dividends accrued
 
7,772

Cash dividends declared
 
(3,886
)
Balance at March 31, 2018
 
$
334,692

Cash dividends declared but unpaid at both March 31, 2018 (Successor) and December 31, 2017 (Successor) was $3.9 million, and were included in other current liabilities in the consolidated balance sheet. The aggregate and per share amounts of unpaid cumulative preferred dividends as of March 31, 2017 (Successor) were $13.0 million and $41.97, respectively.
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, the Company began computing 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.


22

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

A reconciliation of the numerator and denominator of basic and diluted earnings per share follows (in thousands except share and per share amounts):
 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
Net loss attributable to Surgery Partners, Inc.
 
$
(17,521
)
 
 
 
$
(2,754
)
Less: amounts allocated to participating securities (1)
 
7,772

 
 
 

Net loss attributable to common stockholders
 
$
(25,293
)
 
 
 
$
(2,754
)
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
Weighted average shares outstanding- basic
 
48,006,870

 
 
 
48,019,652

Effect of dilutive securities (2)
 

 
 
 

Weighted average shares outstanding- diluted
 
48,006,870

 
 
 
48,019,652

 
 
 
 
 
 
 
Loss per share:
 
 
 
 
 
 
Basic
 
$
(0.53
)
 
 
 
$
(0.06
)
Diluted (2)
 
$
(0.53
)
 
 
 
$
(0.06
)
 
 
 
 
 
 
 
Dilutive securities outstanding not included in the computation of (loss) earnings per share as their effect is antidilutive:
 
 
 
 
 
 
Stock options
 
123,410

 
 
 
851

Restricted shares
 
58,244

 
 
 
132,485

Convertible preferred stock
 

 
 
 
N/A

(1) 
Includes dividends accrued during the three months ended March 31, 2018 (Successor) for the Series A Preferred Stock. The Series A Preferred Stock does not participate in undistributed losses. There were no participating securities during the Predecessor period.
(2) 
The impact of potentially dilutive securities for both periods presented was not considered because the effect would be anti-dilutive in each period.
Share Repurchase Transactions
On December 15, 2017 (Successor), the Board of Directors authorized a share repurchase program of up to $50.0 million of the Company's issued and outstanding common stock from time to time. The timing and size of repurchases will be determined based on market conditions and other factors. The authorization does not obligate the repurchase any shares and the Company may repurchase shares of common stock at any time without prior notice. The share repurchases will be made in accordance with applicable securities laws in open market or privately negotiated transactions. The authorization does not have a specified expiration date, and the share repurchase program may be suspended, recommenced or discontinued at any time or from time to time without prior notice.
During the first quarter of 2018 (Successor), through the date of this report, the Company repurchased 156,818 shares of its common stock stock at an average price of $12.64 per share through market purchases. At March 31, 2018 (Successor), the Company had $46.0 million of repurchase authorization available under the December 2017 authorization.
7. 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, the Company maintains general liability and professional liability insurance in excess of self-insured retentions through third party commercial insurance carriers in amounts that management believes is sufficient for the Company's operations, although, potentially, some claims may 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 would have a material adverse effect on the Company's business, financial position, results of operations or liquidity.


23

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 action including fines, penalties, and exclusion from the Medicare, Medicaid and other federal healthcare 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 is the Company's current practice and future intent to cooperate fully with such inquiries. The Company is not aware of any such inquiry that would have a material adverse effect on the Company's business, financial position, results of operations or liquidity. In addition, on October 23, 2017, the Company 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 the Company’s physicians and submitted to laboratories owned and operated by the Company. The Company has responded to the CID and will continue to cooperate with the U.S. Attorney’s Office in connection with the FCA investigation.
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 healthcare laws and regulations, such as billing and reimbursement, 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 healthcare 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.
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.
Tax Receivable Agreement
On May 9, 2017, the Company entered 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 amendment became effective on August 31, 2017. Pursuant to the amendment to the TRA, 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 six 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 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 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 effective 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 that the total remaining amounts payable under the TRA was approximately $65.1 million as of both March 31, 2018 (Successor) and December 31, 2017 (Successor). As a result of 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


24

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

rate. The carrying value of the liability under the TRA, reflecting the discount, was $45.5 million as of March 31, 2018 (Successor) and $44.3 million as of December 31, 2017 (Successor).
Contingent Consideration
As disclosed in the footnotes to the condensed consolidated statements of operations, the Company recognized contingent acquisition compensation expense of $0.5 million and $2.0 million for three months ended March 31, 2018 (Successor) and 2017 (Predecessor), respectively.
In connection with certain acquisitions during 2016, pursuant to the applicable purchase agreements, the Company was required to pay consideration to the prior owners of the applicable facilities should the requirements for continuing employment agreed to in the purchase agreements be met. In accordance with ASC 805, Business Combinations, contingent consideration with a continuing employment provision is recognized ratably over the defined performance period as compensation expense. The Company estimates total contingent acquisition compensation expense of for the year ended December 31, 2018 will be $1.5 million.
8. Segment Reporting
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 operates in three 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. "All other" primarily consists of the Company's corporate general and administrative functions. Prior to the third quarter of 2017, the all other component was disaggregated and presented below the reportable operating segments in the Adjusted EBITDA reconciliation table. The Company has conformed the prior periods to align to the current year presentation. These changes had no effect on the Company’s reportable operating segments, which are presented consistent with prior periods.
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):
 
 
Three Months Ended March 31,

 
2018
 
 
 
2017

 
Successor
 
 
 
Predecessor
Revenues:
 
 
 
 
 
 
Surgical facility services
 
$
394,066

 
 
 
$
258,149

Ancillary services
 
20,344

 
 
 
25,212

Optical services
 
2,959

 
 
 
2,822

Total revenues
 
$
417,369

 
 
 
$
286,183



25

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
Adjusted EBITDA:
 
 
 
 
 
 
Surgical facility services
 
$
66,467

 
 
 
$
48,241

Ancillary services
 
1,054

 
 
 
3,782

Optical services
 
825

 
 
 
776

All other
 
(21,269
)
 
 
 
(12,692
)
Total Adjusted EBITDA (1)
 
47,077

 
 
 
40,107

 
 
 
 
 
 
 
Net income attributable to non-controlling interests
 
22,646

 
 
 
17,176

Depreciation and amortization
 
(15,749
)
 
 
 
(11,108
)
Interest expense, net
 
(34,276
)
 
 
 
(25,182
)
Non-cash stock compensation expense
 
(1,997
)
 
 
 
(634
)
Contingent acquisition compensation expense
 
(503
)
 
 
 
(2,033
)
Merger transaction, integration and practice acquisition costs (2)
 
(5,485
)
 
 
 
(591
)
Reserve adjustments (3)
 
(4,779
)
 
 
 

Loss on disposal or impairment of long-lived assets, net
 
(47
)
 
 
 
(1,196
)
Income before income taxes
 
$
6,887

 
 
 
$
16,539

(1) 
The above table reconciles Adjusted EBITDA to income before income taxes as reflected in the unaudited condensed consolidated statements of operations. When the Company uses the term “Adjusted EBITDA,” it is referring to income before income taxes adjusted for (a) net income attributable to non-controlling interests, (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 (g) reserve adjustments and (h) loss on disposal or impairment of long-lived assets, net. 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 $5.0 million and $0.3 million for the three months ended March 31, 2018 (Successor) and 2017 (Predecessor), respectively, and practice acquisition costs of $0.5 million and $0.3 million for the three months ended March 31, 2018 (Successor) and 2017 (Predecessor), respectively.
(3) 
This amount represents adjustments to revenue in connection with applying consistent policies across the combined company as a result of the integration of Surgery Partners and NSH.
 
 
Successor
 
 
March 31,
2018
 
December 31,
2017
Assets:
 
 
 
 
Surgical facility services
 
$
4,086,822

 
$
4,072,521

Ancillary services
 
104,970

 
104,274

Optical services
 
50,984

 
48,309

All other
 
352,108

 
397,669

Total assets
 
$
4,594,884

 
$
4,622,773



26

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
Three Months Ended March 31,
 
 
2018
 
 
 
2017
 
 
Successor
 
 
 
Predecessor
Cash purchases of property and equipment, net:
 
 
 
 
 
 
Surgical facility services
 
$
7,937

 
 
 
$
4,417

Ancillary services
 
185

 
 
 
1,511

Optical services
 
18

 
 
 
18

All other
 
1,843

 
 
 
404

Total cash purchases of property and equipment, net
 
$
9,983

 
 
 
$
6,350



27

Table of Contents
SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9. Subsequent Events
On May 1, 2018, the Company purchased an integrated physician practice, including five practice locations and three ASCs, in an existing market for a purchase price of $21.3 million. The Company funded the purchase price with cash flow from operations. As of the date of this filing, the Company has not completed its preliminary estimation of the fair values assigned to the assets acquired and liabilities assumed.


28

Table of Contents
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


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 Annual Report on Form 10-K for the year ended December 31, 2017. 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.
Unless otherwise indicated or the context otherwise requires, references 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 Center Holdings, Inc., (ii) immediately following the Reorganization but immediately prior to the consummation of the NSH Merger, 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.
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 acquistion, including the projected synergies thereof, the performance of our business and other non-historical statements. The words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” 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, the risks and uncertainties described in this report, and set forth under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 16, 2018 and discussed from time to time in our reports filed with the SEC.
In light of 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 result of new information, future events or otherwise.
Executive Overview
As of March 31, 2018, we owned and operated a national network of surgical facilities, physician practices and a suite of ancillary services in 32 states. Our surgical facilities, which include ASCs and surgical hospitals, primarily provide non-emergency surgical procedures across many specialties, including, among others, gastroenterology ("GI"), general surgery, ophthalmology, orthopedics and pain management. Our surgical hospitals provide services, such as diagnostic imaging, laboratory, obstetrics, oncology, pharmacy, physical therapy and wound care. Our portfolio of outpatient surgical facilities is complemented by our suite of ancillary services, which support our physicians in providing high quality and cost-efficient patient care. 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 outcomes in the lowest cost and care setting.
As of March 31, 2018, we owned or operated, primarily in partnership with physicians, a portfolio of 125 surgical facilities comprised of 107 ASCs and 18 surgical hospitals across 32 states. We owned a majority interest in 85 of the surgical facilities and consolidated 108 of these facilities for financial reporting purposes. During the three months ended March 31, 2018, approximately 125,000 surgical procedures were performed in our surgical facilities, generating approximately $394.1 million in revenue.
On August 31, 2017, (i) we completed the sale and issuance of 310,000 shares of our 10.00% Series A Convertible Perpetual Participating Preferred Stock (the “Series A Preferred Stock”) to BCPE Seminole Holdings LP (“Bain”), a fund advised by an affiliate of Bain Capital Private Equity, at a purchase price of $1,000 per share in cash (the “Preferred Private Placement”), and (ii) Bain completed its purchase of 26,455,651 shares (the “Purchased Shares”) of our common stock from H.I.G. Surgery Centers, LLC (“H.I.G.”) at a purchase price of $19.00 per share in cash (the “Private Sale”). As a result of the Preferred Private Placement and the Private Sale, Bain became our controlling stockholder, holding Series A Preferred Stock and Common Stock 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. The Preferred Private Placement and the Private Sale are referred to collectively in this Quarterly report on Form 10-Q as the “Transactions.”
The following discussion and analysis of our financial condition and results of operations covers periods both prior to and subsequent to the Transactions (as defined above). Accordingly, the discussion and analysis of historical periods do not reflect the significant impact the


29

Table of Contents
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


Transactions had. As discussed in the notes to the condensed consolidated financial statements included in this report, in connection with the change of control effected by the Private Sale, we elected to apply “pushdown” accounting. You should read the following discussion together with our historical financial statements and related notes included elsewhere herein.
We continue to focus on improving our same-facility performance, selectively acquiring established facilities and developing new facilities. During the three months ended March 31, 2018, we completed acquisitions of one surgical facility in a new market, a surgical facility in an existing market, which was merged into an existing facility, and a physician practice for an aggregate investment of $25.5 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 March 31,
 
 
2018
 
2017
Patient service revenues:
 
 
 
 
Surgical facilities revenues
 
93.5
%
 
89.6
%
Ancillary services revenues
 
4.9
%
 
8.8
%
 
 
98.4
%
 
98.4
%
Other service revenues:
 
 
 
 
Optical services revenues
 
0.7
%
 
1.0
%
Other
 
0.9
%
 
0.6
%
 
 
1.6
%
 
1.6
%
Total revenues
 
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 March 31,
 
 
2018
 
2017
 
 
 
 
 
Private insurance payors
 
53.5
%
 
49.4
%
Government payors
 
38.8
%
 
41.5
%
Self-pay payors
 
3.1
%
 
2.2
%
Other payors (1)
 
4.6
%
 
6.9
%
Total
 
100.0
%
 
100.0
%
(1) Other is comprised of anesthesia service agreements, auto 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. 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.


30

Table of Contents
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


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 March 31,
 
 
2018
 
2017
 
 
 
 
 
Gastrointestinal
 
21.1
%
 
23.0
%
General surgery
 
3.1
%
 
2.3
%
Ophthalmology
 
25.8
%
 
28.4
%
Orthopedic and pain management
 
37.6
%
 
33.8
%
Other
 
12.4
%
 
12.5
%
Total
 
100.0
%
 
100.0
%
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 the three months ended March 31, 2017.

 
Three Months Ended March 31,

 
2018
 
2017

 
 
 
 
Cases
 
$
135,904

 
$
141,758

Case growth
 
(4.1
)%
 
N/A

Revenue per case
 
$
3,318

 
$
3,196

Revenue per case growth
 
3.8
 %
 
N/A

Number of facilities
 
115

 
N/A

Segment Information
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 financial information by reporting segment is prepared on an internal management reporting basis that the CODM 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.
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 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.
"All other" primarily consists of the Company's corporate general and administrative functions. Prior to the third quarter of 2017, the all other component was disaggregated and presented below the reportable operating segments in the Adjusted EBITDA table. The Company has


31

Table of Contents
SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


conformed the prior periods to align to the current year presentation. These changes had no effect on the Company’s reportable operating segments, which are presented consistent with prior periods.
The following tables present financial information for each reportable segment (in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Revenues:
 
 
 
 
Surgical facility services
 
$
394,066

 
$
258,149

Ancillary services
 
20,344

 
25,212

Optical services
 
2,959

 
2,822

Total revenues
 
$
417,369

 
$
286,183