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 September 30, 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
 
 
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 November 8, 2018, there were 48,891,520 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



Table of Contents

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
 
 
September 30,
2018
 
December 31,
2017
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
79,123

 
$
174,914

Accounts receivable, less allowance for doubtful accounts of $3,416 and $2,026, respectively
 
286,260

 
288,023

Inventories
 
44,360

 
44,951

Prepaid expenses and other current assets
 
53,575

 
55,337

Total current assets
 
463,318

 
563,225

Property and equipment, net of accumulated depreciation of $49,534 and $19,680, respectively
 
420,013

 
398,536

Intangible assets, net
 
55,607

 
58,908

Goodwill
 
3,372,606

 
3,346,838

Investments in and advances to affiliates
 
80,785

 
74,282

Long-term deferred tax assets
 
126,660

 
132,319

Other long-term assets
 
39,675

 
48,665

Total assets
 
$
4,558,664

 
$
4,622,773

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
76,979

 
$
84,710

Accrued payroll and benefits
 
41,563

 
49,625

Other current liabilities
 
122,938

 
109,944

Current maturities of long-term debt
 
54,106

 
58,726

Total current liabilities
 
295,586

 
303,005

Long-term debt, less current maturities
 
2,118,567

 
2,130,556

Other long-term liabilities
 
247,311

 
222,480

 
 
 
 
 
Non-controlling interests—redeemable
 
317,541

 
299,316

Redeemable preferred stock - Series A, 310,000 shares authorized, issued and outstanding at both September 30, 2018 and December 31, 2017; redemption value of $350,893 and $330,806, respectively
 
350,893

 
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, 48,891,520 shares issued and outstanding at September 30, 2018; 48,687,136 shares issued and outstanding at December 31, 2017
 
489

 
487

Additional paid-in capital
 
671,252

 
695,560

Accumulated other comprehensive loss
 
(1,389
)
 

Retained deficit
 
(99,280
)
 
(41,316
)
Total Surgery Partners, Inc. stockholders' equity
 
571,072

 
654,731

Non-controlling interests—non-redeemable
 
657,694

 
681,879

Total stockholders' equity
 
1,228,766

 
1,336,610

Total liabilities and stockholders' equity
 
$
4,558,664

 
$
4,622,773

See notes to unaudited condensed consolidated financial statements.


1

Table of Contents

SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, amounts in thousands, except shares and per share amounts)
 
 
Successor
 
 
 
Predecessor
 
Successor
 
 
 
Predecessor
 
 
Three Months Ended September 30,
 
September 1 to September 30,
 
 
 
July 1 to August 31,
 
Nine Months Ended September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
2018
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
443,932

 
$
132,258

 
 
 
$
174,079

 
$
1,306,076

 
 
 
$
748,615

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries and benefits
 
131,441

 
41,784

 
 
 
61,240

 
395,196

 
 
 
241,149

Supplies
 
120,123

 
35,028

 
 
 
48,078

 
355,701

 
 
 
193,322

Professional and medical fees
 
34,902

 
11,254

 
 
 
14,229

 
107,294

 
 
 
57,931

Lease expense
 
21,629

 
6,858

 
 
 
9,203

 
64,910

 
 
 
36,503

Other operating expenses
 
26,194

 
8,000

 
 
 
11,022

 
78,590

 
 
 
43,267

Cost of revenues
 
334,289

 
102,924

 
 
 
143,772

 
1,001,691

 
 
 
572,172

General and administrative expenses
 
19,478

 
7,777

 
 
 
12,601

 
69,729

 
 
 
46,797

Depreciation and amortization
 
16,945

 
3,330

 
 
 
7,599

 
49,379

 
 
 
30,124

Provision for doubtful accounts
 
11,555

 
3,690

 
 
 
4,834

 
25,788

 
 
 
16,297

Income from equity investments
 
(1,861
)
 
(712
)
 
 
 
(896
)
 
(6,283
)
 
 
 
(3,148
)
Loss on disposals and deconsolidations, net
 
12,631

 
333

 
 
 
114

 
15,875

 
 
 
1,715

Transaction and integration costs
 
7,099

 
2,983

 
 
 
2,343

 
23,771

 
 
 
5,584

Loss on debt refinancing
 

 

 
 
 
18,211

 

 
 
 
18,211

Gain on litigation settlement
 

 

 
 
 

 

 
 
 
(3,794
)
Gain on acquisition escrow release
 

 

 
 
 
(1,000
)
 

 
 
 
(1,000
)
Other (income) expense
 
(1,207
)
 
7

 
 
 
(3
)
 
(3,601
)
 
 
 
(307
)
Total operating expenses
 
398,929

 
120,332

 
 
 
187,575

 
1,176,349

 
 
 
682,651

Operating income (loss)
 
45,003

 
11,926

 
 
 
(13,496
)
 
129,727

 
 
 
65,964

Gain on amendment to tax receivable agreement
 

 
1,098

 
 
 
15,294

 

 
 
 
15,294

Interest expense, net
 
(37,159
)
 
(15,883
)
 
 
 
(18,147
)
 
(107,368
)
 
 
 
(68,929
)
Income (loss) before income taxes
 
7,844

 
(2,859
)
 
 
 
(16,349
)
 
22,359

 
 
 
12,329

Income tax expense (benefit)
 
5,825

 
(211
)
 
 
 
(20,718
)
 
10,905

 
 
 
(18,089
)
Net income (loss)
 
2,019

 
(2,648
)
 
 
 
4,369

 
11,454

 
 
 
30,418

Less: Net income attributable to non-controlling interests
 
(23,000
)
 
(6,492
)
 
 
 
(8,813
)
 
(69,418
)
 
 
 
(42,087
)
Net loss attributable to Surgery Partners, Inc.
 
(20,981
)
 
(9,140
)
 
 
 
(4,444
)
 
(57,964
)
 
 
 
(11,669
)
Less: Amounts attributable to participating securities
 
(8,245
)
 
(18,199
)
 
 
 

 
(23,973
)
 
 
 

Net loss attributable to common stockholders
 
$
(29,226
)
 
$
(27,339
)
 
 
 
$
(4,444
)
 
$
(81,937
)
 
 
 
$
(11,669
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss per share attributable to common stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
(0.61
)
 
$
(0.57
)
 
 
 
$
(0.09
)
 
$
(1.71
)
 
 
 
$
(0.24
)
Diluted (1)
 
$
(0.61
)
 
$
(0.57
)
 
 
 
$
(0.09
)
 
$
(1.71
)
 
 
 
$
(0.24
)
Weighted average common shares outstanding
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
48,037,634

 
48,314,746

 
 
 
48,146,611

 
48,020,369

 
 
 
48,121,404

Diluted (1)
 
48,037,634

 
48,314,746

 
 
 
48,146,611

 
48,020,369

 
 
 
48,121,404

(1) 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

Table of Contents

SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, amounts in thousands)
 
 
Successor
 
 
 
Predecessor
 
Successor
 
 
 
Predecessor
 
 
Three Months Ended September 30,
 
September 1 to September 30,
 
 
 
July 1 to August 31,
 
Nine Months Ended September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
2018
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
2,019

 
$
(2,648
)
 
 
 
$
4,369

 
$
11,454

 
 
 
$
30,418

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative activity
 
(1,389
)
 

 
 
 

 
(1,389
)
 
 
 

Comprehensive income (loss)
 
$
630

 
$
(2,648
)
 
 
 
$
4,369

 
$
10,065

 
 
 
$
30,418

Less: Comprehensive loss attributable to non-controlling interests
 
(23,000
)
 
(6,492
)
 
 
 
(8,813
)
 
(69,418
)
 
 
 
(42,087
)
Comprehensive loss attributable to Surgery Partners, Inc.
 
$
(22,370
)
 
$
(9,140
)
 
 
 
$
(4,444
)
 
$
(59,353
)
 
 
 
$
(11,669
)
See notes to unaudited condensed consolidated financial statements.



3

Table of Contents

SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited, amounts in thousands, except shares)
 
 
 
 
 
 
 
Accumulated Other Comprehensive Loss
 
 
 
 
 
 
 
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

 

 

 

 
(57,964
)
 
48,890

 
(9,074
)
Equity-based compensation

 

 
6,303

 

 

 

 
6,303

Preferred dividends

 

 
(23,973
)
 

 

 

 
(23,973
)
Other comprehensive loss

 

 

 
(1,389
)
 

 

 
(1,389
)
Issuance of restricted and unrestricted shares
512,948

 
5

 
(5
)
 

 

 

 

Cancellation of restricted shares
(151,746
)
 
(1
)
 
(1,126
)
 

 

 

 
(1,127
)
Repurchase of shares
(156,818
)
 
(2
)
 
(1,980
)
 

 

 

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

 

 
(3,527
)
 

 

 
(15,566
)
 
(19,093
)
Distributions to non-controlling interests—non-redeemable holders

 

 

 

 

 
(57,509
)
 
(57,509
)
Balance at September 30, 2018
48,891,520

 
$
489

 
$
671,252

 
$
(1,389
)
 
$
(99,280
)
 
$
657,694

 
$
1,228,766

(1)
Includes post acquisition date adjustments.

See notes to unaudited condensed consolidated financial statements.



4

Table of Contents

SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
 
 
Successor
 
 
 
Predecessor
 
 
Nine Months Ended September 30,
 
September 1 to September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
 
 
 
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
11,454

 
$
(2,648
)
 
 
 
$
30,418

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
 
Depreciation and amortization
 
49,379

 
3,330

 
 
 
30,124

Non-cash interest (income) expense, net
 
(1,041
)
 
(130
)
 
 
 
4,874

Equity-based compensation
 
6,303

 
1,683

 
 
 
3,697

Loss on disposals and deconsolidations, net
 
15,875

 
333

 
 
 
1,715

Loss on debt refinancing
 

 

 
 
 
18,211

Gain on amendment to tax receivable agreement
 

 
(1,098
)
 
 
 
(15,294
)
Deferred income taxes
 
9,464

 
(465
)
 
 
 
(18,703
)
Provision for doubtful accounts
 
25,788

 
3,690

 
 
 
16,297

Income from equity investments, net of distributions received
 
(186
)
 
(203
)
 
 
 
489

Changes in operating assets and liabilities, net of acquisitions and divestitures:
 
 
 
 
 
 
 
 
Accounts receivable
 
(23,665
)
 
(2,795
)
 
 
 
8,837

Other operating assets and liabilities
 
5,683

 
(2,919
)
 
 
 
(12,947
)
Net cash provided by (used in) operating activities
 
99,054

 
(1,222
)
 
 
 
67,718

 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Purchases of property and equipment
 
(26,618
)
 
(1,840
)
 
 
 
(18,773
)
Payments for acquisitions, net of cash acquired
 
(55,213
)
 
(1,163
)
 
 
 
(725,853
)
Proceeds from divestitures
 
18,031

 

 
 
 
70

Other investing activities
 
(2,811
)
 

 
 
 

Net cash used in investing activities
 
(66,611
)
 
(3,003
)
 
 
 
(744,556
)
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Principal payments on long-term debt
 
(94,880
)
 
(3,609
)
 
 
 
(1,164,237
)
Borrowings of long-term debt
 
62,759

 

 
 
 
1,805,966

Payments of debt issuance costs
 

 
(4
)
 
 
 
(58,591
)
Proceeds from preferred stock issuance
 

 

 
 
 
310,000

Payments of stock issuance costs
 

 

 
 
 
(18,347
)
Payments of preferred dividends
 
(7,810
)
 

 
 
 

Distributions to non-controlling interest holders
 
(80,091
)
 
(6,444
)
 
 
 
(50,343
)
Payments related to ownership transactions with non-controlling interest holders
 
(483
)
 
30

 
 
 
(1,518
)
Repurchase of shares
 
(1,982
)
 

 
 
 

Principal payments on financing lease obligations
 
(4,622
)
 
(253
)
 
 
 
(796
)
Other financing activities
 
(1,125
)
 

 
 
 
(789
)
Net cash (used in) provided by financing activities
 
(128,234
)
 
(10,280
)
 
 
 
821,345

Net (decrease) increase in cash, cash equivalents and restricted cash
 
(95,791
)
 
(14,505
)
 
 
 
144,507

Cash, cash equivalents and restricted cash at beginning of period
 
175,229

 
214,521

 
 
 
70,014

Cash, cash equivalents and restricted cash at end of period
 
$
79,438

 
$
200,016

 
 
 
$
214,521

See notes to unaudited condensed consolidated financial statements.


5

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


1. Organization, Basis of Presentation and Significant Accounting Policies
Organization
Surgery Partners, Inc., a Delaware corporation, acting through its subsidiaries, owns and operates a national network of surgical facilities and ancillary services. 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 surgical hospitals also 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. Unless context otherwise indicates, Surgery Partners, Inc. and its subsidiaries are referred to herein as the "Company."
As of September 30, 2018, the Company owned or operated a portfolio of 124 surgical facilities, comprised of 106 ASCs and 18 surgical hospitals in 32 states. The Company owns a majority of 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 84 of the surgical facilities and consolidated 105 of these facilities for financial reporting purposes.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. 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 information contained in these condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
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.
In connection with the change of control effective August 31, 2017, the Company elected to apply “pushdown” accounting by applying the guidance in Accounting Standards Codification Topic ("ASC") 805, Business Combinations. 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." See Note 2. Acquisitions and Developments for further discussion of the change of control.
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. Actual results could differ from those estimates.
Variable Interest Entities
The condensed consolidated financial statements include the accounts of variable interest entities ("VIEs") in which the Company is the primary beneficiary under the provisions of ASC 810, Consolidation. The Company has the power to direct the activities that most significantly impact a VIEs economic performance, and the Company would absorb the majority of the expected losses from any of these entities should such expected losses occur. As of September 30, 2018 (Successor), the consolidated VIEs include four surgical facilities, three anesthesia practices and four physician practices. During the nine months ended September 30, 2018 (Successor), the Company divested of one surgical facility and acquired a physician practice, which were classified as VIEs. As of December 31, 2017 (Successor), the consolidated VIEs included five surgical facilities, three anesthesia practices and three physician practices.
The total assets (excluding goodwill and intangible assets, net) of the consolidated VIEs included in the accompanying condensed consolidated balance sheets as of September 30, 2018 (Successor) and December 31, 2017 (Successor), were $6.5 million and $13.1 million, respectively, and the total liabilities of the consolidated VIEs were $3.4 million and $5.8 million, respectively.
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


6

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

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
 
 
September 30,
2018
 
December 31, 2017
 
September 30,
2018
 
December 31, 2017
2017 Senior Secured Credit Facilities:
 
 
 
 
 
 
 
 
Revolver
 
$
11,000

 
$

 
$
11,000

 
$

Term Loan
 
$
1,271,397

 
$
1,280,532

 
$
1,272,986

 
$
1,267,189

Senior Unsecured Notes due 2021
 
$
407,372

 
$
409,235

 
$
423,667

 
$
422,535

Senior Unsecured Notes due 2025
 
$
370,000

 
$
370,000

 
$
355,200

 
$
346,413

The fair values of the Term Loan, Senior Unsecured Notes due 2021 and the Senior Unsecured Notes due 2025 were based on a Level 2 inputs using quoted prices for identical liabilities in inactive markets at September 30, 2018 (Successor) and December 31, 2017 (Successor). The carrying amounts related to the Company's other long-term debt obligations, including the Revolver, approximate their fair values.
During the nine months ended September 30, 2018 (Successor), the Company entered into certain derivative financial instruments. A summary of the fair values of the Company's derivative financial instruments follows (in thousands):
 
 
Successor
 
 
Fair Value
 
 
September 30,
2018
 
December 31, 2017
Derivative liabilities
 
 
 
 
Interest rate swap agreement
 
$
1,389

 
$

The fair value of the derivative financial instruments was based on a quoted market price, or a Level 2 computation. As of September 30, 2018 (Successor), the fair value of the derivative liabilities was included in other long-term liabilities in the condensed consolidated balance sheets. As of December 31, 2017 (Successor), the Company had no derivative financial instruments.
The Company maintains a supplemental executive retirement savings plan (the "SERP") for certain executives. 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 September 30, 2018 (Successor) and December 31, 2017 (Successor), the fair value of both the assets and liabilities in the SERP were $1.6 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 Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers. 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.


7

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

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 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:
 
 
Successor
 
 
 
Predecessor
 
Successor
 
 
 
Predecessor
 
 
Three Months Ended September 30,
 
September 1 to September 30,
 
 
 
July 1 to August 31,
 
Nine Months Ended September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
2018
 
 
 
2017
Patient service revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Surgical facilities revenues
 
93.2
%
 
94.0
%
 
 
 
95.5
%
 
93.2
%
 
 
 
91.4
%
   Ancillary services revenues
 
4.7
%
 
4.2
%
 
 
 
2.7
%
 
4.8
%
 
 
 
7.0
%
 
 
97.9
%
 
98.2
%
 
 
 
98.2
%
 
98.0
%
 
 
 
98.4
%
Other service revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Optical services revenues
 
0.6
%
 
0.7
%
 
 
 
1.1
%
 
0.6
%
 
 
 
1.0
%
   Other revenues
 
1.5
%
 
1.1
%
 
 
 
0.7
%
 
1.4
%
 
 
 
0.6
%
 
 
2.1
%
 
1.8
%
 
 
 
1.8
%
 
2.0
%
 
 
 
1.6
%
Total revenues
 
100.0
%
 
100.0
%
 
 
 
100.0
%
 
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. During the three and nine months ended September 30, 2018 (Successor), the Company recognized an increase in patient service revenues as a result of changes in estimates to third-party settlements related to prior years of approximately $1.4 million for both periods. There were no adjustments as a result of changes in estimates to third-party settlements related to prior years for the one month ended September 30, 2017 (Successor). During the two and eight months ended August 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 $0.6 million and $1.1 million, respectively.


8

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):
 
 
Successor
 
 
 
Predecessor
 
 
Three Months Ended September 30,
 
September 1 to September 30,
 
 
 
July 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
 
Amount
 
%
 
Amount
 
%
 
 
 
Amount
 
%
Patient service revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Private insurance
 
$
230,718

 
53.1
%
 
$
72,930

 
56.2
%
 
 
 
$
80,166

 
46.9
%
Government
 
166,880

 
38.4
%
 
46,162

 
35.5
%
 
 
 
73,734

 
43.1
%
Self-pay
 
12,742

 
2.9
%
 
3,861

 
3.0
%
 
 
 
4,119

 
2.4
%
Other (1)
 
24,345

 
5.6
%
 
6,883

 
5.3
%
 
 
 
12,909

 
7.6
%
Total patient service revenues
 
434,685

 
100.0
%
 
129,836

 
100.0
%
 
 
 
170,928

 
100.0
%
Other service revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Optical services revenues
 
2,699

 
 
 
888

 
 
 
 
 
1,905

 
 
Other revenues
 
6,548

 
 
 
1,534

 
 
 
 
 
1,246

 
 
Total revenues
 
$
443,932

 
 
 
$
132,258

 
 
 
 
 
$
174,079

 
 
 
 
Successor
 
 
 
Predecessor
 
 
Nine Months Ended September 30,
 
September 1 to September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
 
Amount
 
%
 
Amount
 
%
 
 
 
Amount
 
%
Patient service revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Private insurance
 
$
682,479

 
53.3
%
 
$
72,930

 
56.2
%
 
 
 
$
360,092

 
48.9
%
Government
 
493,362

 
38.6
%
 
46,162

 
35.5
%
 
 
 
308,993

 
42.0
%
Self-pay
 
39,050

 
3.1
%
 
3,861

 
3.0
%
 
 
 
15,949

 
2.2
%
Other (1)
 
64,075

 
5.0
%
 
6,883

 
5.3
%
 
 
 
51,374

 
6.9
%
Total patient service revenues
 
1,278,966

 
100.0
%
 
129,836

 
100.0
%
 
 
 
736,408

 
100.0
%
Other service revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Optical services revenues
 
8,437

 
 
 
888

 
 
 
 
 
7,629

 
 
Other revenues
 
18,673

 
 
 
1,534

 
 
 
 
 
4,578

 
 
Total revenues
 
$
1,306,076

 
 
 
$
132,258

 
 
 
 
 
$
748,615

 
 
(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.


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

Cash, Cash Equivalents and Restricted Cash
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
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
Cash and cash equivalents
 
$
79,123

 
$
174,914

Restricted invested assets included in other long-term assets
 
315

 
315

Total cash, cash equivalents and restricted cash in the statement of cash flows
 
$
79,438

 
$
175,229

Restricted invested assets included in other long-term assets on the condensed consolidated balance sheet represents restricted cash held 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.
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 $7.7 million and $1.0 million as of September 30, 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 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 $9.3 million and $7.6 million at September 30, 2018 (Successor) and December 31, 2017 (Successor), respectively.
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 nine months ended September 30, 2018 is included in Note 2. Acquisitions and Developments.
A summary of activity related to goodwill for the nine months ended September 30, 2018 (Successor) follows (in thousands):
Successor
 
 
Balance at December 31, 2017
 
$
3,346,838

Acquisitions, including post acquisition adjustments
 
57,710

Divestitures and deconsolidations
 
(31,942
)
Balance at September 30, 2018
 
$
3,372,606



10

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
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
Interest payable
 
$
28,322

 
$
20,537

Amounts due to patients and payors
 
22,400

 
18,096

Accrued expenses and other
 
72,216

 
71,311

Total
 
$
122,938

 
$
109,944

Other Long-Term Liabilities
A summary of other long-term liabilities follows (in thousands):
 
 
Successor
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
Facility lease obligations
 
$
138,116

 
$
121,627

Other
 
109,195

 
100,853

Total
 
$
247,311

 
$
222,480

At four of the Company's surgical facilities, the Company has financing obligations payable to the lessors of certain land, buildings and improvements. Payments are allocated to principal adjustments of the financing obligations and interest expense. The current portions of the financing obligations were $6.8 million and $6.3 million at September 30, 2018 (Successor) and December 31, 2017 (Successor), respectively, and were included in other current liabilities in the condensed consolidated balance sheets. The long-term portions of the financing obligations are included as facility lease obligations in the table above.
In 2017, one of the Company's surgical facilities entered into a development agreement to construct a new hospital. Due to certain provisions of the agreement, the surgical facility is deemed the owner during construction, and as such, the Company records the ongoing costs as incurred as a deferred financing obligation. As of September 30, 2018 (Successor), the Company has recorded a total of $36.7 million of costs for this project, of which $23.1 million was recorded during the nine months ended September 30, 2018 (Successor). These project costs are included as non-cash additions to property and equipment, net in the condensed consolidated balance sheet and as a component of facility lease obligations.
Derivative Instruments and Hedging Activities
In accordance with ASC 815, Derivatives and Hedging (“ASC 815”), the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
In accordance with the FASB’s fair value measurement guidance in ASU 2011-04, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
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.


11

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

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
 
20,528

Acquisition and disposal of shares of non-controlling interests, net—redeemable (1)
 
20,279

Distributions to non-controlling interest—redeemable holders
 
(22,582
)
Balance at September 30, 2018
 
$
317,541

(1)
Includes post acquisition date adjustments.
Recent Accounting Pronouncements
In May 2014, the FASB issued 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 requires 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 the 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 guidance is required to be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements. In preparation of adopting the new standard, the Company has engaged outside consultants to assist in the identification of the Company's population of leases, implementing a new software for lease accounting and assisting in evaluating new accounting policy elections. The Company will adopt this ASU on January 1, 2019 and believes the primary effect of adopting the new standard will be to record right-of-use assets and obligations for current operating leases with material increases in reported property and equipment and liabilities. The Company is still evaluating the effect of adoption on financial disclosures, policies, procedures and control framework.
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 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.
2. 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


12

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

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.
Acquisitions
During the nine months ended September 30, 2018 (Successor), the Company acquired a controlling interest in two surgical facilities in new markets, 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 $32.9 million, net of cash acquired. The Company also acquired a controlling interest in an integrated physician practice, including multiple practice and surgical facility locations, in an existing market for a purchase price of $21.1 million, net of cash acquired. The purchase price for the 2018 acquisitions was funded through cash from operations. The total consideration related to these acquisitions 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 acquired and liabilities assumed for acquisitions completed in the nine months ended September 30, 2018 (Successor), including post acquisition date adjustments, are as follows (in thousands):
Cash consideration
 
$
54,308

Fair value of non-controlling interests
 
28,776

Aggregate acquisition date fair value
 
$
83,084

Net assets acquired:
 
 
Current Assets
 
$
4,708

Property and equipment
 
2,301

Goodwill
 
75,947

Other long-term assets
 
3,460

Current liabilities
 
(2,332
)
Long-term liabilities
 
(1,000
)
Aggregate acquisition date fair value
 
$
83,084

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. The goodwill acquired in connection with the 2018 acquisitions was allocated to the Company's reportable segments as follows: $68.6 million to surgical facility services and $7.4 million to ancillary services. Approximately $49.9 million of goodwill recorded for the 2018 acquisitions is deductible for tax purposes. 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 nine months ended September 30, 2018 (Successor).
During the one month ended September 30, 2017 (Successor), the Company completed acquisitions in existing markets of one physician practice and the assets of an endoscopy practice for a combined purchase price of $1.2 million. During the eight months ended August 31, 2017 (Predecessor), the Company completed acquisitions (excluding the NSH Holdco, Inc. acquisition) in existing markets of three physician practices for a combined cash purchase price of $14.2 million. During the nine months ended September 30, 2018 (Successor), 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.
2018 Disposals and Deconsolidation
During the nine months ended September 30, 2018 (Successor), the Company sold its interests in three surgery centers and its optical laboratory for net cash proceeds of $17.6 million, and recognized a net pretax loss of $9.5 million included in loss on disposals and deconsolidations, net in the condensed consolidated statement of operations for the three and nine months ended September 30, 2018 (Successor). This non-cash loss was primarily a result of the write-off of the net assets of the facility (net of proceeds received) and was primarily driven by the write-off of the associated goodwill.
During the nine months ended September 30, 2018 (Successor), the Company sold a portion of its interest in one surgery center for net cash proceeds of $0.5 million. As a result of this transaction, the Company lost control of the previously controlled entity but retains a noncontrolling interest, resulting in the deconsolidation of the previously consolidated entity. The remaining noncontrolling interest was accounted for as an equity method investment, and initially measured and recorded at fair value as of the date of the transaction.
The fair value measurement utilizes Level 3 inputs, which include unobservable data, to measure the fair value of the retained noncontrolling interest. The fair value determination was based on a combination of multiple valuation methods, which included discounted cash flow and market value approach, which incorporates estimates of future earnings and market valuation multiples for certain guideline companies. The fair value of the investment of $2.0 million was recorded as a component of investments in and advances to affiliates in the accompanying condensed consolidated balance sheets.


13

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

Further, the transaction resulted in a pretax gain on deconsolidation of $1.1 million, which is included in loss on disposals and deconsolidations, net, in the accompanying condensed consolidated statement of operations for the three and nine months ended September 30, 2018 (Successor). The gain was determined based on the difference between the fair value of the Company's retained interest in the entity and the carrying value of both the tangible and intangible assets of the entity immediately prior to the transaction less cash proceeds received.
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. During the nine months ended September 30, 2018 (Successor), information existing at the acquisition date became known to the Company as part of its continuing evaluation of the assets and liabilities existing at the date of acquisition, resulting in a net increase to goodwill of $1.1 million. The corresponding changes to certain classes of assets and liabilities from the preliminary allocation recorded at August 31, 2017 (Predecessor), are reflected in the table below, which has been finalized as of September 30, 2018 (Successor). The increase to goodwill during the period includes a working capital settlement payment resulting in additional cash consideration of $1.2 million.
The acquisition date fair value for each major class of assets acquired and liabilities assumed, including post acquisition date adjustments, are as follows (in thousands):
Cash consideration
 
$
764,007

Fair value of non-controlling interests
 
325,965

Acquisition date fair value
 
$
1,089,972

Net assets acquired:
 
 
Cash and cash equivalents
 
$
51,159

Accounts receivable
 
71,639

Inventories
 
14,986

Prepaid expenses and other current assets
 
18,367

Property and equipment
 
174,100

Intangible assets
 
27,881

Goodwill
 
871,373

Investments in and advances to affiliates
 
29,737

Long-term deferred tax assets
 
20,212

Other long-term assets
 
26,988

Accounts payable
 
(29,652
)
Accrued payroll and benefits
 
(30,853
)
Other current liabilities
 
(23,937
)
Current maturities of long-term debt
 
(16,416
)
Long-term debt, less current maturities
 
(42,770
)
Other long-term liabilities
 
(72,842
)
Acquisition date fair value
 
$
1,089,972

Change of Control - Pushdown Accounting
On August 31, 2017, BCPE Seminole Holdings LP (“Bain”), a fund advised by an affiliate of Bain Capital Private Equity, completed its purchase of 26,455,651 shares of the Company's common stock at a purchase price of $19.00 per share in cash (the “Private Sale”). As a result of the Private Sale and the Preferred Private Placement (defined in Note 4. Redeemable Preferred Stock), Bain became the controlling stockholder of the Company, holding preferred 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. In connection with this change of control, the Company elected to apply “pushdown” accounting by applying the guidance in 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.
During the nine months ended September 30, 2018 (Successor), information existing at the transaction 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 $18.2 million and corresponding changes to certain classes of assets and liabilities from the preliminary allocation recorded, that are reflected in the table below, which has been finalized as of September 30, 2018 (Successor).


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

The transaction date fair value recognized in connection with the application of pushdown accounting for each major class of assets and liabilities as of August 31, 2017, including post transaction date adjustments, are as follows (in thousands):
Equity attributable to Surgery Partners, Inc.
$
721,764

Redeemable preferred stock
310,000

Fair value of non-controlling interests
939,083

Transaction date fair value
$
1,970,847

Net assets:
 
Cash and cash equivalents
214,206

Accounts receivable
252,911

Inventories
44,310

Prepaid expenses and other current assets
61,438

Property and equipment
379,685

Intangible assets
63,978

Goodwill
3,281,728

Investments in and advances to affiliates
75,113

Restricted invested assets
315

Long-term deferred tax asset
206,073

Other long-term assets
50,666

Accounts payable
(64,921
)
Accrued payroll and benefits
(56,535
)
Other current liabilities
(97,617
)
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
(169,688
)
Transaction date fair value
$
1,970,847

The post transaction date adjustments for pushdown accounting during the period includes a net increase of $3.9 million to the preliminary amounts assigned to intangible assets. The remaining adjustments to goodwill are attributable to a $17.9 million decrease to the preliminary fair value assigned to non-controlling interests, a $1.1 million increase related to the Acquisition of NSH (discussed above), and a $2.5 million increase to other long-term liabilities.


15

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

3. Long-Term Debt
A summary of long-term debt follows (in thousands):
 
 
Successor
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
2017 Senior Secured Credit Facilities:
 
 
 
 
Revolver
 
$
11,000

 
$

Term Loan (1)
 
1,271,397

 
1,280,532

Senior Unsecured Notes due 2021 (2)

407,372

 
409,235

Senior Unsecured Notes due 2025
 
370,000

 
370,000

Notes payable and secured loans
 
88,068

 
101,921

Capital lease obligations
 
24,836

 
27,594

Total debt
 
2,172,673

 
2,189,282

Less: Current maturities
 
54,106

 
58,726

Total long-term debt
 
$
2,118,567

 
$
2,130,556

(1)
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 as of the measurement date, which is reported in the consolidated balance sheets as a direct rededuction from the face amount the Term Loan and amortized to interest expense over the life of the Term Loan. The unamortized fair value discount as of September 30, 2018 (Successor) and December 31, 2017 (Successor) was $5.7 million and $6.2 million, respectively.
(2)
In connection with the application of pushdown accounting, the Company remeasured and recorded the Senior Unsecured Notes due 2021 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 as of the measurement date, which is reported in the consolidated balance sheets as a direct addition to the face amount the notes and amortized to interest expense over the life of the Senior Unsecured Notes due 2021. The unamortized fair value premium as of September 30, 2018 (Successor) and December 31, 2017 (Successor) was $7.4 million and $9.2 million, respectively.
4. Redeemable Preferred Stock
On August 31, 2017 (Predecessor), 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 "Preferred Private Placement"). The net proceeds from the issuance were used to finance a portion of the NSH acquisition.
A summary of activity related to the redeemable preferred stock follows (in thousands):
Successor
 
 
Balance at December 31, 2017
 
$
330,806

Dividends accrued
 
23,973

Cash dividends declared
 
(3,886
)
Balance at September 30, 2018
 
$
350,893

There were no unpaid cash dividends declared at September 30, 2018 (Successor). The cash dividends declared but unpaid at December 31, 2017 (Successor) was $3.9 million, and were included in other current liabilities in the condensed consolidated balance sheet. The aggregate and per share amounts of unpaid cumulative preferred dividends as of September 30, 2018 (Successor) were $25.3 million and $81.70, respectively.
5. Derivatives and Hedging Activities
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. During 2018, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings, as documented at hedge inception in accordance with the Company’s accounting policy election. The earnings


16

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

recognition of excluded components is presented in interest expense. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. Over the next 12 months, the Company estimates that an additional $1.1 million will be reclassified as a reduction to interest expense.
As of September 30, 2018 (Successor), the Company had one interest rate swap with a current notional amount of $330.0 million and a termination date of November 30, 2023. The Company had no derivative instruments as of December 31, 2017 (Successor).
The Company classifies its derivative financial instruments of $1.4 million as a long-term liability on the Balance Sheet as of September 30, 2018 (Successor). The Company had no derivative financial instruments as of December 31, 2017 (Successor).
The table below presents the effect of fair value and cash flow hedge accounting on the Company's consolidated balance sheets.
 
 
Successor
 
 
 
Predecessor
 
Successor
 
 
 
Predecessor
 
 
Three Months Ended September 30,
 
September 1 to September 30,
 
 
 
July 1 to August 31,
 
Nine Months Ended September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
2018
 
 
 
2017
Derivatives in Cash Flow Hedging Relationships
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses related to effective portion of derivatives recognized in accumulated OCI, gross of tax effect
 
$
(1,389
)
 
$

 
 
 
$

 
$
(1,389
)
 
 
 
$

Loss related to effective portion of derivatives reclassified from accumulated OCI to interest expense, gross of tax effect
 

 

 
 
 

 

 
 
 

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.


17

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):
 
 
Successor
 
 
 
Predecessor
 
Successor
 
 
 
Predecessor
 
 
Three Months Ended September 30,
 
September 1 to September 30,
 
 
 
July 1 to August 31,
 
Nine Months Ended September 30,
 
 
 
January 1 to August 31,
 
 
2018
 
2017
 
 
 
2017
 
2018
 
 
 
2017
Numerator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss attributable to Surgery Partners, Inc.
 
$
(20,981
)
 
$
(9,140
)
 
 
 
$
(4,444
)
 
$
(57,964
)
 
 
 
$
(11,669
)
Less: amounts allocated to participating securities (1)
 
8,245

 
2,633

 
 
 

 
23,973

 
 
 

Less: mark to redemption adjustment
 

 
15,566

 
 
 

 

 
 
 

Net loss attributable to common stockholders
 
$
(29,226
)
 
$
(27,339
)
 
 
 
$
(4,444
)
 
$
(81,937
)
 
 
 
$
(11,669
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding- basic
 
48,037,634

 
48,314,746

 
 
 
48,146,611

 
48,020,369

 
 
 
48,121,404

Effect of dilutive securities (2)
 

 

 
 
 

 

 
 
 

Weighted average shares outstanding- diluted
 
48,037,634

 
48,314,746

 
 
 
48,146,611

 
48,020,369

 
 
 
48,121,404

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
(0.61
)
 
$
(0.57
)
 
 
 
$
(0.09
)
 
$
(1.71
)
 
 
 
$
(0.24
)
Diluted (2)
 
$
(0.61
)
 
$
(0.57
)
 
 
 
$
(0.09
)
 
$
(1.71
)
 
 
 
$
(0.24
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dilutive securities outstanding not included in the computation of (loss) earnings per share as their effect is antidilutive:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock options
 
144,795

 

 
 
 

 
153,884

 
 
 

Restricted shares
 
134,054