Item 7. Management’s Discussion and Analysis
Item 7. 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 our audited consolidated financial statements and related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. For additional information regarding certain of the risks and uncertainties that affect our business and the industry in which we operate, please see Item 1A. "Risk Factors" and Item 9A. "Controls and Procedures" found elsewhere in this report. Unless the context otherwise indicates, the terms "Surgery Partners," "we," "us," "our" or the "Company," as used herein, refer to Surgery Partners, Inc. and its subsidiaries. Unless the context implies otherwise, the term "affiliates" means direct and indirect subsidiaries of Surgery Partners, Inc., and partnerships and joint ventures in which such subsidiaries are partners. The terms "facilities" or "hospitals" refer to entities owned and operated by affiliates of Surgery Partners, Inc. and the term "employees" refers to employees of affiliates of Surgery Partners, Inc.
Executive Overview
As of December 31, 2020, we owned or operated, primarily in partnership with physicians, a portfolio of 127 surgical facilities comprised of 110 ASCs and 17 surgical hospitals across 30 states. We owned a majority interest in 84 of the surgical facilities and consolidated 107 of these facilities for financial reporting purposes.
Total revenues for 2020 increased 1.6% to $1.9 billion from $1.8 billion in 2019. Same-facility revenues for 2020 decreased 1.1% from 2019, with a 14.1% increase in revenue per case and a 13.3% decrease in same-facility cases. The decrease in same-facility cases is attributable to the impacts of the COVID-19 pandemic that the Company began experiencing in mid-March, and extending into the fourth quarter. Same-facility revenue per case growth was driven by a favorable surgical case mix as we experienced a faster recovery of higher acuity cases as states began to re-open and allow for non-emergent procedures. For 2020, the net loss attributable to common stockholders was $155.6 million compared to $110.5 million for 2019. Additionally, for 2020, Adjusted EBITDA decreased 0.8% to $256.6 million compared to $258.6 million for 2019. A reconciliation of non-GAAP financial measures appears below under "Certain Non-GAAP Measures."
We continue to focus on improving our same-facility performance, selectively acquiring established facilities and developing new facilities. During the year ended December 31, 2020, we acquired a controlling interest in three surgical facilities, including a surgical hospital, a controlling interest in five surgical facilities in existing markets, that were merged into existing facilities and a physician practice for total aggregate consideration of $120.1 million, including cash consideration of $104.6 million, net of cash acquired, non-cash consideration of $8.7 million and contingent consideration of $0.7 million. The non-cash consideration consisted of non-controlling interests in the Company's existing surgical facilities. The cash consideration was funded through cash from operations, proceeds from our recent divestitures and other available resources.
During 2020, we sold our interests in three surgery centers, one of which was previously accounted for as an equity method investment, sold certain assets related to our anesthesia business, certain imaging assets and our optical products purchasing organization for combined net cash proceeds of $59.0 million. Additionally, we closed our diagnostic laboratory in 2020.
We had cash and cash equivalents of $317.9 million and $112.5 million of borrowing capacity under our revolving credit facility at December 31, 2020. Operating cash flows were $246.9 million in 2020, an increase of $117.4 million compared to the prior year, primarily attributable to Medicare accelerated payments and other funds received under the CARES Act as well as actions taken to significantly reduce operating expenses and defer non-essential capital expenditures at the height of the crisis. Net operating cash inflows, including operating cash flows less distributions to non-controlling interests, were $137.3 million for 2020.
Impact of COVID-19
The COVID-19 global pandemic has significantly affected our facilities, employees, patients, communities, business operations and financial performance, as well as the U.S. economy and financial markets. The COVID-19 pandemic materially impacted our financial performance for the year ending December 31, 2020. The length and severity of the pandemic continues to be difficult to predict and is dependent on factors beyond our control.
We continue to take or support measures to try to slow the spread and minimize the impact of the virus. Beginning mid-March, the COVID-19 pandemic began to negatively affect our net revenue and business operations. Due in part to local, state and federal guidelines as well as recommendations from major medical societies regarding social distancing and self-quarantines in response to the COVID-19 pandemic, we cancelled or postponed a substantial percentage of the elective procedures scheduled at our facilities and reduced operating hours at a significant number of our facilities. As a result, surgical case volumes across most of our surgical facilities were significantly impacted in the second quarter of 2020. The impact of the COVID-19 pandemic on our surgical facilities varies based on the market in which the facility operates, the type of surgical facility and the procedures typically performed. Although we cannot provide any certainty regarding the length and severity of the impact of the COVID-19 pandemic, surgical case volumes improved in the second half of 2020 as states began to re-open and allow for non-emergent procedures.
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Our operating structure naturally enables some flexibility in the cost structure according to the volume of surgical procedures performed, including much of its cost of revenues. In addition to the natural variability of these costs, the Company and its partners in the surgical facilities have undertaken additional steps to preserve financial flexibility. Beginning in mid-March, and into the second and third quarters, we took actions that included significantly reducing cash operating expenses and deferring non-essential expenditures at the height of the crisis. These measures were gradually reduced as surgical case volumes improved. On April 22, 2020, we entered into a second incremental term loan amendment providing for an incremental borrowing of $120.0 million, and on July 30, 2020, we issued an additional $115.0 million aggregate principal amount of 10.000% senior unsecured notes due 2027. See Note 5. "Long-Term Debt" to our consolidated financial statements included elsewhere in this report for a further discussion of the second incremental term loan amendment and the senior unsecured notes. Additionally, as a result of the CARES Act and other governmental assistance programs, during the year ended December 31, 2020, the Company received approximately $59 million in direct grant funding and approximately $120 million in accelerated Medicare payments, each of which is described in more detail in Note 1. “Organization and Summary of Accounting Polices - COVID-19 Pandemic” to our consolidated financial statements included elsewhere in this report.
Even after taking into account our actions intended to increase financial flexibility (including actions that management estimates have lowered cash operating expenses), the volume reductions resulted in materially higher losses and material decreases in Adjusted EBITDA during 2020, and may potentially continue to do so for subsequent quarters. We cannot predict if or when utilization may return to pre-pandemic levels.
The Company is continuing to monitor legislative actions at federal and state levels, including the impact of the CARES Act and other governmental assistance that might be available.
Furthermore, please see "Capital Resources" and "Summary" under the heading "Liquidity and Capital Resources" below for more information about the impact of the COVID-19 pandemic on the Company.
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 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 revenues by service type as a percentage of total revenues:
Year Ended December 31,
2020 2019 2018
Patient service revenues:
Surgical facilities revenues 95.3 % 94.1 % 93.6 %
Ancillary services revenues 3.4 % 4.3 % 4.5 %
98.7 % 98.4 % 98.1 %
Other service revenues:
Optical services revenues 0.2 % 0.2 % 0.5 %
Other 1.1 % 1.4 % 1.4 %
1.3 % 1.6 % 1.9 %
Total revenues 100.0 % 100.0 % 100.0 %
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Payor Mix
The following table sets forth by type of payor the percentage of our patient service revenues generated at the surgical facilities that we consolidate for financial reporting purposes:
Year Ended December 31,
2020 2019 2018
Private insurance payors 53.9 % 53.8 % 54.6 %
Government payors 38.6 % 38.9 % 37.6 %
Self-pay payors 3.2 % 2.6 % 2.9 %
Other payors (1)
4.3 % 4.7 % 4.9 %
Total 100.0 % 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. We believe this diversification helps to protect us from adverse pricing and utilization trends in any individual procedure type and results in greater consistency in our case volume.
The following table sets forth the percentage of cases in each specialty performed at the surgical facilities that we consolidate for financial reporting purposes:
Year Ended December 31,
2020 2019 2018
Orthopedics and pain management 39.3 % 38.3 % 37.8 %
Ophthalmology 25.3 % 24.8 % 25.3 %
Gastrointestinal 19.4 % 20.9 % 21.4 %
General surgery 3.1 % 3.2 % 3.0 %
Other 12.9 % 12.8 % 12.5 %
Total 100.0 % 100.0 % 100.0 %
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Segment Information
Our business is comprised of three segments: (1) Surgical Facility Services, (2) Ancillary Services and (3) Optical Services. On December 31, 2020, we sold the remaining assets of the Optical Services segment. For more information about the components of each segment, please see Part I, Item 1. Business--Operations included elsewhere in this Annual Report. "All other" primarily consists of the Company's corporate general and administrative functions.
The following tables present financial information for each reportable segment (in millions):
Year Ended December 31,
2020 2019 2018
Revenues:
Surgical Facility Services $ 1,793.4 $ 1,748.2 $ 1,682.4
Ancillary Services 63.6 79.4 79.6
Optical Services 3.1 3.8 9.5
Total revenues $ 1,860.1 $ 1,831.4 $ 1,771.5
Adjusted EBITDA:
Surgical Facility Services $ 339.3 $ 328.9 $ 309.5
Ancillary Services (3.4) 2.6 3.0
Optical Services 1.4 1.4 2.5
All other (80.7) (74.3) (80.2)
Total Adjusted EBITDA (1)
$ 256.6 $ 258.6 $ 234.8
Supplemental Information:
Cash purchases of property and equipment, net:
Surgical Facility Services $ 38.7 $ 65.9 $ 34.2
Ancillary Services 0.4 1.1 0.4
All other 3.8 6.6 5.2
Total cash purchases of property and equipment, net $ 42.9 $ 73.6 $ 39.8
(1) For a reconciliation of Adjusted EBITDA to income before income taxes as reflected in the audited consolidated statements of operations see "Certain Non-GAAP Measures" below.
December 31,
2020 2019
Assets:
Surgical Facility Services $ 4,962.4 $ 4,580.4
Ancillary Services 35.0 69.6
Optical Services — 17.7
All other 415.8 351.2
Total assets $ 5,413.2 $ 5,018.9
Critical Accounting Policies
In preparing our consolidated financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP"), we must use estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures and the reported amounts of revenue and expenses. In general, our estimates are based on historical experience and various other assumptions we believe are reasonable under the circumstances. We evaluate our estimates on an ongoing basis and make changes to the estimates and related disclosures as experience develops or new information becomes known. Actual results could differ from those estimates.
We consider our critical accounting policies to be those that involve significant judgments and uncertainties, and may potentially result in materially different results under different assumptions and conditions.
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Revenue Recognition
Our patient service revenues are derived primarily from surgical procedures performed at our ASCs and surgical hospitals, patient visits to physician practices, anesthesia services provided to patients, pharmacy services and diagnostic screens ordered by our physicians. The fees for such services are billed either to the patient or a third-party payor, including Medicare and Medicaid. We recognize patient service revenues, net of contractual allowances, which we estimate based on existing contracts or the historical trend of our cash collections and contractual write-offs.
Prior to its sale on December 31, 2020, our optical products purchasing organization negotiated volume buying discounts with optical product manufacturers. The buying discounts and any handling charges billed to the members of the purchasing organization represented the revenues recognized for financial reporting purposes. Revenue is recognized as orders are shipped to members.
Other service revenues consist of management and administrative service fees derived from non-consolidated surgical facilities that we account for under the equity method, management of surgical facilities in which we do not own an interest and management services we provide to physician networks for which we are not required to provide capital or additional assets. The fees we derive from these management arrangements are based on a predetermined percentage of the revenues of each surgical facility and physician network. We recognize other service revenues in the period in which services are rendered.
Accounts Receivable
Our patient service revenues and other receivables from third-party payors are recorded net of estimated implicit price concessions which are estimated based on the historical trend of our surgical hospitals’ cash collections and contractual write-offs, and for our surgical facilities in general, established fee schedules, relationships with payors and procedure statistics. While changes in estimated reimbursement from third-party payors remain a possibility, we expect that any such changes would be minimal and, therefore, would not have a material effect on our financial condition or results of operations.
Our collection policies and procedures are based on the type of payor, size of claim and estimated collection percentage for each patient account. The operating systems used to manage our patient accounts provide for an aging schedule in 30-day increments, by payor, physician and patient. We analyze accounts receivable at each of our surgical facilities to ensure the proper collection and aged category. The operating systems generate reports that assist in the collection efforts by prioritizing patient accounts. Collection efforts include direct contact with insurance carriers or patients, written correspondence and the use of legal or collection agency assistance, as required. Our days sales outstanding was 69 days for the year ended December 31, 2020 and 64 days for the year ended December 31, 2019.
We recognize that final reimbursement of outstanding accounts receivable is subject to final approval by each third-party payor. However, because we have contracts with our third-party payors and we verify the insurance coverage of the patient before services are rendered, the amounts that are pending approval from third-party payors are minimal. Amounts are classified outside of self-pay if we have an agreement with the third-party payor or we have verified a patient’s coverage prior to services rendered. It is our policy to collect co-payments and deductibles prior to providing services, where possible. It is also our policy to verify a patient’s insurance 72 hours prior to the patient’s procedure. Because our services are primarily non-emergency, our surgical facilities have the ability to control these procedures.
Income Taxes
We use the asset and liability method to account for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If a NOL and/or interest limitation ("163(j)") carryforward exists, we make a determination as to whether that NOL and/or 163(j) carryforward will be utilized in the future. A valuation allowance will be established for certain NOL and 163(j) carryforwards and other deferred tax assets where their recoverability is deemed to be uncertain. The carrying value of the net deferred tax assets is based upon estimates and assumptions related to our ability to generate sufficient future taxable income in certain tax jurisdictions. If these estimates and related assumptions change in the future, we will be required to adjust our deferred tax valuation allowances.
As of December 31, 2020, we had unused federal NOL carryforwards of approximately $615.7 million. Such losses expire in various amounts at varying times beginning in 2026. Unless they expire, these NOL carryforwards may be used to offset future taxable income and thereby reduce our income taxes otherwise payable.
We recorded a valuation allowance against our deferred tax assets at December 31, 2020 and 2019 totaling $91.1 million and $77.9 million, respectively. The valuation allowance has been established for certain deferred tax assets for which we believe it is more likely than not that the tax benefits will not be realized, which are primarily Section 163(j) interest carryforwards, certain state net operating losses and capital loss carryforwards. If our expectations for future operating results on a consolidated basis or at the state jurisdiction level vary from actual results due to changes in health care regulations, general economic conditions, or other factors, we may need to adjust the valuation allowance, for all or a portion of our deferred tax assets. Our income tax expense in future periods will be reduced or increased to the extent of offsetting decreases or increases, respectively, in our valuation allowance in the period when the change in circumstances occurs. These changes could have a significant impact on our future earnings.
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Section 382 of the Internal Revenue Code of 1986 ("Section 382"), as amended (the "Code") imposes an annual limit on the ability of a corporation that undergoes an "ownership change" to use its NOLs to reduce its tax liability. An "ownership change" is generally defined as any change in ownership of more than 50.0% of a corporation’s "stock" by its "5-percent shareholders" (as defined in Section 382) over a rolling three-year period based upon each of those shareholder’s lowest percentage of stock owned during such period. As a result of the Symbion acquisition in 2014, approximately $179 million in NOL carryforwards are subject to an annual Section 382 base limitation of $4.9 million, and, as a result of the NovaMed acquisition in 2011, approximately $17 million in NOL carryforwards are subject to an annual Section 382 base limitation of $4.9 million. As a result of the acquisition of NSH, approximately $20.5 million in NOL carryforwards are subject to an annual Section 382 base limitation of $2.8 million. The Private Sale resulted in an ownership change as defined in Section 382. As a result, approximately $485.9 million in NOL carryforwards are subject to an annual Section 382 base limitation of $14.2 million. At this time, we do not believe this limitation, when combined with amounts allowable due to net unrecognized built in gains, will affect our ability to use any NOLs before they expire. However, no such assurances can be provided. If our ability to utilize our NOLs to offset taxable income generated in the future is subject to this limitation, it could have an adverse effect on our business, prospects, results of operations and financial condition.
Impairment of Goodwill
Goodwill represents the excess of the fair value of the consideration conveyed in the acquisition over the fair value of net assets acquired. Goodwill is reviewed for impairment at the reporting unit level, which is defined as one level below an operating segment, on an annual basis or sooner if the indicators of impairment arise. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance of each reporting unit. During 2020, the Company had identified three reporting units, which include the following: 1) Surgical Facilities, 2) Ancillary Services, and 3) Alliance, which is a component of the Optical Services operating segment.
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. A detailed evaluation of potential impairment indicators was performed, which specifically considered the volatility observed in the prices of the Company’s outstanding debt securities and common stock, as well as the decline in surgical case volumes following the emergence of the COVID-19 pandemic, all of which improved in the second half of 2020 as states began to re-open and allow for non-emergent procedures.
On the basis of available evidence as of August 31, 2020, we identified indicators of impairment related to the Ancillary Services and Alliance reporting units, including the impacts of the COVID-19 pandemic and the closure of our diagnostic laboratory. No indicators of impairment were identified for the Surgical Facilities reporting unit. Based on the impairment indicators noted, we performed an impairment analysis for the Ancillary Services and Alliance reporting units as of August 31, 2020. As of the August 31, 2020 valuation, the carrying value for both the Ancillary Services and Alliance reporting units exceeded the fair value, resulting in non-cash impairment charges of $28.6 million and $4.9 million, respectively.
As of October 1, 2020, prior to its annual impairment testing, the Company's three reporting units with allocated goodwill were as follows: 1) Surgical Facilities - $3.3 billion, 2) Ancillary Services - no remaining goodwill after the August 31 impairment discussed above, and 3) Alliance - $4.2 million. As of the October 1, 2020 valuation, the fair value for the Surgical Facilities reporting unit was substantially in excess of its carrying value, and there were no additional indicators of impairment related to the other reporting units.
Subsequent to the date of our annual impairment test, the Company considered its operating results for the fourth quarter of 2020, macroeconomic, industry and market conditions, and other market indicators including its market capitalization. Based on its evaluation of all such factors, the Company concluded that an event had not occurred or circumstances had not changed that would more likely than not reduce the fair value of its reporting units below their carrying values. On December 31, 2020, the Company disposed of the Alliance reporting unit with the sale of its optical products purchasing organization.
During the year ended December 31, 2019, as a result of its impairment testing, the Company recorded non-cash impairment charges of $2.5 million related to the Alliance reporting unit. During the year ended December 31, 2018, as a result of its impairment testing, the Company recorded non-cash impairment charges of $60.7 million and $13.7 million related to the Ancillary Services and Alliance reporting units, respectively.
See Note 4. "Goodwill and Intangible Assets" to the consolidated financial statements elsewhere in this Annual Report for additional disclosure related to goodwill.
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Results of Operations
The following tables summarize certain results from the statements of operations for the periods indicated (dollars in millions):
Year Ended December 31,
2020 2019 2018
Revenues $ 1,860.1 $ 1,831.4 $ 1,771.5
Operating expenses:
Cost of revenues 1,480.3 1,407.6 1,361.4
General and administrative expenses 97.1 88.6 93.6
Depreciation and amortization 94.8 76.5 67.4
Income from equity investments (10.8) (10.2) (8.9)
Loss (gain) on disposals and deconsolidations, net 5.7 (4.4) 31.8
Transaction and integration costs 23.2 19.0 31.7
Impairment charges 33.5 7.9 74.4
Grant funds (46.2) — —
Loss on debt extinguishment — 11.7 —
Litigation settlement 1.2 0.2 46.0
Other income (1.7) (1.4) (3.7)
Total operating expenses 1,677.1 1,595.5 1,693.7
Operating income 183.0 235.9 77.8
Tax receivable agreement expense — (2.4) —
Interest expense, net (201.8) (178.9) (147.0)
(Loss) income before income taxes (18.8) 54.6 (69.2)
Income tax (benefit) expense (20.1) 9.5 26.4
Net income (loss) 1.3 45.1 (95.6)
Less: Net income attributable to non-controlling interests (117.4) (119.9) (110.1)
Net loss attributable to Surgery Partners, Inc. $ (116.1) $ (74.8) $ (205.7)
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
Overview. During 2020, our revenues increased 1.6% to $1.9 billion from $1.8 billion in 2019. We incurred net loss attributable to Surgery Partners, Inc. in 2020 of $116.1 million, compared to net loss of $74.8 million in 2019, primarily attributable to the impairment charges taken during 2020 and the continued impact of the COVID-19 pandemic on surgical case volumes.
Revenues. Revenues for 2020 and 2019 were as follows (dollars in millions):
Year Ended December 31,
2020 2019
Patient service revenues $ 1,836.1 $ 1,803.1
Optical service revenues 3.0 3.8
Other service revenues 21.0 24.5
Total revenues $ 1,860.1 $ 1,831.4
Patient service revenues increased 1.8% to $1.84 billion in 2020 compared to $1.80 billion in 2019. The increase in patient service revenues was primarily attributable to a de novo hospital completed in 2019 and acquisitions completed in 2020 and 2019. Same-facility revenues for 2020 decreased 1.1% from 2019, with a 14.1% increase in same-facility revenue per case, and a 13.3% decrease in the same-facility case volume primarily due to the impacts of the COVID-19 pandemic. Same-facility revenue per case growth was driven by a favorable surgical case mix as higher acuity cases were some of the first to recover when elective procedures returned in the second quarter of 2020.
Cost of Revenues. Cost of revenues were $1.5 billion in 2020 compared to $1.4 billion in 2019. The increase in costs was primarily attributable to a de novo hospital completed in 2019, acquisitions completed in 2020 and 2019 and an increase in supply costs associated with higher acuity surgical case volumes. As a percentage of revenues, cost of revenues was 79.6% and 76.9% for 2020 and 2019, respectively. The increase as a percentage of revenues is primarily the result of the decreased revenues in 2020 driven by the decline in surgical case volume that began in mid-March due to the COVID-19 pandemic.
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General and Administrative Expenses. General and administrative expenses were $97.1 million and $88.6 million in 2020 and 2019, respectively. As a percentage of revenues, general and administrative expenses were 5.2% in 2020 compared to 4.8% in 2019. The increase as a percentage of revenues is primarily the result of the decreased revenues driven by the decline in surgical case volume that began in mid-March due to the COVID-19 pandemic.
Depreciation and Amortization. Depreciation and amortization was $94.8 million and $76.5 million in 2020 and 2019, respectively. The increase is primarily due to increased capital investments and integration of a de novo hospital completed in 2019 as well as acquisitions completed in 2020 and 2019. As a percentage of revenues, depreciation and amortization expenses were 5.1% in 2020 and 4.2% in 2019.
Income from Equity Investments. Income from equity investments was $10.8 million and $10.2 million in 2020 and 2019, respectively. As a percentage of revenues, income from equity investments was 0.6% for both 2020 and 2019.
Loss (gain) on Disposals and Deconsolidations, Net. The net loss on disposals and deconsolidations was $5.7 million in 2020, including a $2.5 million net gain on the sale of three surgical facilities, certain assets related to its anesthesia business, certain imaging assets, its optical products purchasing organization and the closure of a diagnostic laboratory and $8.2 million primarily related to disposals of other long-lived assets. The net gain on disposals and deconsolidations was $4.4 million in 2019, including a $10.9 million gain on the sale of previously owned real property associated with one of our non-consolidated surgical facility equity method investments, offset by a loss of $6.5 million of disposals of other long-lived assets.
Transaction and Integration Costs. We incurred $23.2 million of transaction and integration costs in 2020 compared to $19.0 million in 2019. The increase primarily relates to costs for ongoing development initiatives, divestitures completed in 2020 and the integration of acquisitions we completed in 2020 and 2019.
Impairment Charges. In 2020 we recorded non-cash impairment charges of $28.6 million and $4.9 million for goodwill assigned to the Ancillary Services and Alliance reporting units, respectively. See Note 4. "Goodwill and Intangibles" to our consolidated financial statements included elsewhere in this report for further discussion. In 2019 we recorded non-cash impairment charges of $2.5 million for goodwill assigned to the Alliance reporting unit and $5.4 million related to a management rights agreement intangible asset. The impairment of the management rights agreement is related to our 2019 acquisition of a clinic that we previously managed. As a result of the transaction, we determined the management rights agreement related to the acquired clinic no longer provided a future benefit.
Grant Funds. We recognized $46.2 million in grant funds in 2020. The funds were received based on relief available to eligible health care providers under the provisions of the CARES Act, which is described in further detail above in the section titled "Impact of COVID-19” and in Note 1. “Organization and Summary of Accounting Polices - COVID-19 Pandemic” to our consolidated financial statements included elsewhere in this report. There were no grant funds received in 2019.
Loss on Debt Extinguishment. In 2019, we incurred a debt extinguishment loss of $11.7 million in connection with issuance of the 2027 Unsecured Notes, effective April 11, 2019. The loss includes the redemption premium paid to redeem the 2021 Unsecured Notes partially offset by the write-off of the unamortized fair value premium as of the redemption date.
Litigation Settlement. We incurred a loss in the amount of $1.2 million and $0.2 million in 2020 and 2019, respectively, related to the potential resolution of the government investigation discussed in Note 14. "Commitments and Contingencies" to our consolidated financial statements included elsewhere in this report.
Interest Expense, Net. Interest expense, net, was $201.8 million in 2020 compared to $178.9 million in 2019. The increase primarily relates to the issuance of the 2027 Unsecured Notes effective April 11, 2019, the 2020 Incremental Term Loans, which were fully drawn on April 22, 2020, the issuance of additional 2027 Unsecured Notes in the amount of $115.0 million effective July 30, 2020 as well as interest on the Revolver during the period it was fully drawn. As a percentage of revenues, interest expense, net was 10.8% in 2020 compared to 9.8% in 2019.
Income Tax (Benefit) Expense . The income tax benefit was $20.1 million and income tax expense was $9.5 million in 2020 and 2019, respectively. The effective tax rate was 106.9% for 2020 compared to 17.4% in 2019. New reconciling items in the 2020 effective tax rate include (i) the release of federal and state valuation allowances on the Company’s Internal Revenue Code Section 163(j) interest carryforwards as a result of the increase in deductible interest expense allowed under the CARES Act; (ii) the release of federal and state valuation allowances on the Company’s deferred tax assets related to debt financing costs as a result of the finalization of the Internal Revenue Code Section 163(j) interest regulations, for which the deductions of such debt financing costs that are incurred in years 2021 and forward are not considered interest expense for income tax purposes; and (iii) the Settlement Agreement, as discussed in Note 14. "Commitments and Contingencies" to our consolidated financial statements included elsewhere in this Annual Report, which provided that a portion of the final settlement amount was "restitution" for income tax purposes.
Net Income Attributable to Non-Controlling Interests. Net income attributable to non-controlling interests was $117.4 million and $119.9 million in 2020 and 2019, respectively. As a percentage of revenues, net income attributable to non-controlling interests was 6.3% in the 2020 period and 6.5% for the 2019 period.
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Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
Our discussion regarding the comparison of the year ended December 31, 2019 compared to the year ended December 31, 2018 was previously disclosed beginning on page 46 in our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed on March 13, 2020, under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Year Ended December 31, 2019 Compared to Year Ended December 31, 2018 " and is hereby incorporated herein by reference.
Liquidity and Capital Resources
Operating Activities
The primary source of our operating cash flow is the collection of accounts receivable from federal and state agencies (under the Medicare and Medicaid programs), private insurance companies and individuals. Cash flow provided by operating activities was $246.9 million and $129.5 million in 2020 and 2019, respectively. The increase in operating cash flow in 2020 is primarily attributable to Medicare accelerated payments and other funds received under the CARES Act, discussed further below under the heading "Capital Resources," as well as actions taken to significantly reduce operating expenses and defer non-essential capital expenditures at the height of the crisis.
Investing Activities
Net cash used in investing activities in 2020 was $88.4 million, which included $42.9 million related to purchases of property and equipment. We paid $104.6 million, in cash for acquisitions (net of cash acquired), which included a controlling interest in three surgical facilities, including a surgical hospital, a controlling interest in five surgical facilities in existing markets, that were merged into existing facilities and a physician practice. Additionally, we received cash proceeds of $58.5 million related to the sale of interests in three surgery centers, certain assets related to our anesthesia business, certain imaging assets and an optical products purchasing organization
Net cash used in investing activities in 2019 was $85.2 million, which included $73.6 million related to purchases of property and equipment. We paid $13.8 million, in cash for acquisitions (net of cash acquired), which primarily included a surgical facility, a clinic that was merged into an existing facility and a physician practice. Further, we paid $15.2 million in cash for a non-controlling interest in four surgical facilities accounted for as equity method investments and we received cash proceeds of $17.6 million related to the sale of previously owned real property associated with one of our non-consolidated equity method investments.
Financing Activities
Net cash provided by financing activities in 2020 was $66.7 million. During the year, we made distributions to non-controlling interest holders of $109.6 million and payments related to ownership transactions with consolidated affiliates of $27.4 million. Further, we made repayments on our long-term debt of $216.3 million, which was offset by borrowings of $429.4 million. In connection with the 2020 Incremental Term Loans, which were fully drawn on April 22, 2020, and the issuance of additional 2027 Unsecured Notes in the amount of $115.0 million effective July 30, 2020, we paid debt issuance costs of $8.5 million.
Net cash used in financing activities in 2019 was $135.9 million. During this period, we made distributions to non-controlling interest holders of $121.2 million and payments related to ownership transactions with consolidated affiliates of $3.2 million. Further, we made repayments on our long-term debt of $490.8 million, which was offset by borrowings of $506.9 million. In connection with the issuance of the 2027 Unsecured Notes and redemption of the then existing 2021 Unsecured Notes, we paid debt issuance costs of $8.9 million and paid a redemption premium of $17.8 million.
Discussion of the operating, investing and financing activities for the year ended December 31, 2018 was previously disclosed beginning on page 47 in our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed on March 13, 2020, under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and is hereby incorporated herein by reference.
Long-Term Debt
As of December 31, 2020, the carrying value of our total indebtedness, including finance leases, was $2.857 billion, which includes unamortized fair value discount of $3.7 million and unamortized deferred financing costs of $16.3 million.
Term Loan and Revolving Credit Facility
As of December 31, 2020, we had term loan borrowings with a carrying value of $1.539 billion, consisting of outstanding aggregate principal of $1.543 billion and unamortized fair value discount of $3.7 million (the "Term Loan"). The Term Loan matures on August 31, 2024 The Term Loan amortizes in equal quarterly installments of 0.25% of the aggregate original principal amount of the Term Loan.
We have a revolving credit facility providing for revolving borrowings of up to $120.0 million (the "Revolver" and, together with the Term Loan, the "Senior Secured Credit Facilities"). The Revolver will mature on August 31, 2022. As of December 31, 2020, our availability on the Revolver was $112.5 million (including outstanding letters of credit of $7.5 million).
On January 27, 2021, the Company entered into an amendment to the Senior Secured Credit Facilities, which amended and
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supplemented the credit agreement to provide for an extension of the maturity date of the Revolver to February 1, 2026 and an increase in the outstanding commitments under the Revolver in an amount equal to $50.0 million. The maturity extension and the additional commitments became operative on February 1, 2021. See Note 11. "Subsequent Events" to our consolidated financial statements included elsewhere in this Annual Report for a further discussion of the amendment.
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, we may request one or more additional incremental term loan facilities or one or more increases in the commitments on the Revolver.
The 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 our first lien net leverage ratio or (y) an alternate base rate (which will be the highest of (i) the prime rate, (ii) 0.5% per annum above the federal funds effective rate and (iii) one-month LIBOR plus 1.00% per annum (solely with respect to the Term Loan, the alternate base rate shall not be less than 2.00% per annum)) plus a margin ranging from 2.00% to 2.25% per annum. In addition, we are required to pay a commitment fee of 0.50% per annum in respect of unused commitments on the Revolver.
On April 22, 2020, we entered into a second incremental term loan amendment, which amended and supplemented the existing credit agreement, to provide for an incremental borrowing of $120.0 million. The incremental amounts were fully drawn on April 22, 2020, and are included in the term loan borrowings discussed above. The incremental term loans bear interest at a rate per annum equal to (x) LIBOR plus a margin of 8.00% per annum 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, (iii) one-month LIBOR plus 1.00% per annum and (iv) 2.00% per annum) plus a margin of 7.00% per annum.
On April 16, 2020, we entered into a third amendment to our credit agreement, which amended and supplemented financial covenants applicable to the Revolver under the credit agreement. Pursuant to the third amendment, the Company's requirement to comply with a maximum consolidated total net leverage ratio was waived for the remainder of 2020. Additionally, for the first three quarters of 2021, the third amendment provides for an alternative calculation for the maximum consolidated total net leverage ratio where the trailing four quarter basis may be negatively impacted by the impacts of the COVID-19 pandemic. The third amendment became effective concurrently with the funding of the incremental term loans on April 22, 2020, discussed above.
Senior Unsecured Notes
We have $545.0 million aggregate principal amount of senior unsecured notes due April 15, 2027 (the "2027 Unsecured Notes"). The 2027 Unsecured Notes bear interest at the rate of 10.000% per year, payable semi-annually on April 15 and October 15 of each year. See Note 5. "Long-Term Debt" to our consolidated financial statements included elsewhere in this report for a further discussion of the senior unsecured notes.
On July 30, 2020, we completed the issuance and sale of $115.0 million in aggregate principal amount of senior unsecured notes due 2027 at 100.75% of the principal amount. The notes were issued as part of the same series as the existing 2027 Unsecured Notes originally issued in April 2019, and have the same terms.
We have $370.0 million aggregate principal amount of senior unsecured notes due July 1, 2025 outstanding (the "2025 Unsecured Notes"). The 2025 Unsecured Notes bear interest at the rate of 6.750% per year, payable semi-annually on January 1 and July 1 of each year.
Other Debt
We and certain of our subsidiaries have other debt consisting of outstanding bank indebtedness of $137.5 million, which is collateralized by the real estate and equipment owned by the surgical facilities to which the loans were made, and right-of-use finance lease obligations of $281.2 million for which we are liable to various vendors for several property and equipment leases classified as finance leases.
Capital Resources
In addition to cash flows from operations, available cash and capacity on our Revolver, other sources of capital include funds we have received under the CARES Act as well as continued access to the capital markets.
As noted in Note 1. "Organization and Summary of Accounting Policies" to our consolidated financial statements included elsewhere in this report, as of December 31, 2020, we received relief via the CARES Act, including approximately $59 million in direct grant payments and approximately $120 million of accelerated payments pursuant to the Medicare Accelerated and Advance Payment Program. The direct grant payments are not required to be repaid, subject to certain terms and conditions, while payments received under the Medicare Accelerated and Advance Payment Program are required to be repaid. As of December 31, 2020, approximately $95 million of accelerated payments are reflected as a component of Medicare accelerated payments and deferred governmental grants in the consolidated balance sheets while the remaining payments are included within other long-term liabilities. Based on the repayment terms, we expect recoupment of these funds to begin in 2021 under the repayment framework more specifically described in Note 1. "Organization and Summary of Accounting Policies."
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Additionally, the CARES Act permitted the deferral of payment of the social security payroll tax between March 27, 2020 and December 31, 2020, with half of the deferred amount due December 2021 and the other half due December 2022. As of December 31, 2020, we have deferred approximately $16.9 million.
We believe that deferral of the social security payroll tax match, which we began doing in April 2020, along with the funds received under the CARES Act as noted above, have positively impacted our cash flows from operations during 2020.
Summary
The COVID-19 pandemic has resulted in, and may continue to result in, significant disruptions of financial and capital markets, which could reduce our ability to access capital and negatively affect our liquidity in the future. Additionally, while we have received grants and accelerated payments under the CARES Act and other government assistance programs and may receive additional amounts in the future, there is no assurance regarding the extent to which anticipated negative impacts arising from the COVID-19 pandemic will be offset by amounts and benefits received under the CARES Act or future legislation.
Although we have seen continued improvement in surgical case volumes as states begin to re-open and allow for non-emergent procedures, broad economic factors resulting from the current COVID-19 pandemic, including increased unemployment rates and reduced consumer spending, could negatively affect our payor mix, increase the relative proportion of lower margin services we provide and reduce patient volumes, as well as diminish our ability to collect outstanding receivables. Business closings and layoffs in the areas in which we operate may lead to increases in the uninsured and underinsured populations and adversely affect demand for our services, as well as the ability of payors to pay for services as rendered. Any increase in the amount or deterioration in the collectability of patient accounts receivable will adversely affect our cash flows and results of operations, requiring an increased level of working capital. If general economic conditions continue to deteriorate or remain uncertain for an extended period of time, our liquidity and ability to repay our outstanding debt may be harmed.
Based on our current level of operations, we believe cash flow from operations, available cash, available capacity on our Revolver, the incremental term loan borrowings and issuance of new notes discussed above, funds we have received under the CARES Act, funds we may receive in the future and continued access to capital markets, together with the cost cutting steps taken in response to the impact of the COVID-19 pandemic, as discussed in Item 1A. "Risk Factors" elsewhere in this report, will be adequate to meet our short-term (i.e., 12 months) and long-term (beyond 12 months) liquidity needs.
Certain Non-GAAP Measures
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 GAAP. The items excluded from this non-GAAP metric are significant components in understanding and evaluating our financial performance. We believe such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. Our calculation of Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.
When we use the term "Adjusted EBITDA," we are referring to (loss) income before income taxes, adjusted for net income attributable to non-controlling interests, depreciation and amortization, net interest expense, equity-based compensation expense, transaction, integration and acquisition costs, impairment charges, net loss (gain) on disposals and deconsolidations, litigation settlements and other litigation costs, reserve adjustments, contingent acquisition compensation expense, gain on escrow release, loss on debt extinguishment and tax receivable agreement expense. When we use “Adjusted EBITDA excluding grant funds,” we are referring to Adjusted EBITDA less the impact of grant funds. We use Adjusted EBITDA and Adjusted EBITDA excluding grant funds as measures of financial performance. Adjusted EBITDA and Adjusted EBITDA excluding grant funds are key measures used by our management to assess operating performance, make business decisions and allocate resources.
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The following table reconciles Adjusted EBITDA and Adjusted EBITDA excluding grant funds to (loss) income before income taxes, the most directly comparable GAAP financial measure (in millions and unaudited):
Year Ended December 31,
2020 2019 2018
Consolidated Statements of Operations Data:
(Loss) income before income taxes $ (18.8) $ 54.6 $ (69.2)
Plus (minus):
Net income attributable to non-controlling interests (117.4) (119.9) (110.1)
Depreciation and amortization 94.8 76.5 67.4
Interest expense, net 201.8 178.9 147.0
Equity-based compensation expense 13.2 10.2 9.3
Transaction, integration and acquisition costs (1)
38.2 36.1 34.0
Impairment charges 33.5 7.9 74.4
Loss (gain) on disposals and deconsolidations, net 5.7 (4.4) 31.8
Litigation settlement and other litigation costs (2)
6.4 4.6 46.0
Reserve adjustments (3)
— — 2.7
Contingent acquisition compensation expense — — 1.5
Gain on escrow release (4)
(0.8) — —
Loss on debt extinguishment — 11.7 —
Tax receivable agreement expense — 2.4 —
Adjusted EBITDA $ 256.6 $ 258.6 $ 234.8
Less: Impact of grant funds (5)
(31.1) — —
Adjusted EBITDA excluding grant funds $ 225.5 $ 258.6 $ 234.8
(1) For the year ended December 31, 2020, this amount includes transaction and integration costs of $23.2 million, of which $6.6 million were acquisition related costs, and includes start-up costs related to a de novo surgical hospital of $15.0 million. For the year ended December 31, 2019, this amount includes transaction and integration costs of $19.0 million, and further includes other acquisition costs and start-up costs related to a de novo surgical hospital of $17.1 million. For the year ended December 31, 2018, this amount includes transaction and integration costs of $31.7 million, and further includes other acquisition costs of $2.3 million.
(2) This amount includes litigation settlement costs of $1.2 million, $0.2 million and $46.0 million for the years ended December 31, 2020, 2019 and 2018, respectively. This amount also includes other litigation costs of $5.2 million and $4.4 million for the years ended December 31, 2020 and 2019, respectively, with no comparable costs in 2018.
(3) This amount represents adjustments to revenue in order to apply consistent policies to businesses acquired by Surgery Partners in prior periods.
(4) Included in other income in the consolidated statement of operations for the year ended December 31, 2020, with no comparable gain in 2019 and 2018.
(5) Represents the impact of grant funds recognized, net of amounts attributable to non-controlling interests.
We use Credit Agreement EBITDA as a measure of liquidity and to determine our compliance under certain covenants pursuant to our credit facilities. Credit Agreement EBITDA is determined on a trailing twelve-month basis. We have included it because we believe that it provides investors with additional information about our ability to incur and service debt and make capital expenditures. Credit Agreement EBITDA is not a measurement of liquidity under GAAP, and should not be considered in isolation or as a substitute for any other measure calculated in accordance with GAAP. The items excluded from Credit Agreement EBITDA are significant components in understanding and evaluating our liquidity. Our calculation of Credit Agreement EBITDA may not be comparable to similarly titled measures reported by other companies.
When we use the term "Credit Agreement EBITDA," we are referring to Adjusted EBITDA, as defined above, further adjusted for acquisitions and synergies. These adjustments do not relate to our historical financial performance and instead relate to estimates compiled by management and calculated in conformance with the definition of "Consolidated EBITDA" used in the credit agreements governing our credit facilities.
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The following table reconciles Credit Agreement EBITDA to cash flows from operating activities, the most directly comparable GAAP financial measure (in millions and unaudited):
Year Ended December 31, 2020
Cash flows from operating activities $ 246.9
Plus (minus):
Non-cash interest income, net (4.5)
Non-cash lease expense (39.4)
Deferred income taxes 21.9
Income from equity investments, net of distributions received (0.5)
Changes in operating assets and liabilities, net of acquisitions and divestitures 59.3
Medicare accelerated payments and deferred governmental grants (135.2)
Income tax benefit (20.1)
Net income attributable to non-controlling interests (117.4)
Interest expense, net 201.8
Transaction, integration and acquisition costs 38.2
Litigation settlement and other litigation costs 6.4
Gain on escrow release (0.8)
Acquisitions and synergies (1)
86.7
Credit Agreement EBITDA $ 343.3
(1) Represents impact of acquisitions as if each acquisition had occurred on January 1, 2020. Further this includes revenue synergies from other business initiatives, de novo facilities and an adjustment for the effects of adopting the new lease accounting standard, as defined in the credit agreement governing the Senior Secured Credit Facilities.
Contractual Obligations and Commercial Commitments
The following table summarizes our contractual obligations by period as of December 31, 2020 (in millions):
Payments Due by Period
Total Less than 1 year 1-3 years 4-5 years More than 5 years
Long-term debt obligations, including interest (1)
$ 3,760.8 $ 233.2 $ 439.9 $ 2,041.9 $ 1,045.8
Operating lease obligations, including interest (2)
526.4 70.7 128.2 108.4 219.1
Tax receivable agreement (3)
43.2 21.2 21.5 0.5 —
Total contractual obligations $ 4,330.4 $ 325.1 $ 589.6 $ 2,150.8 $ 1,264.9
(1) Included in long-term debt obligations are principal and interest owed on our outstanding debt obligations. These amounts exclude our unamortized fair value adjustments related non-cash amortization for the Term Loan. These obligations are explained further in Note 5. "Long-Term Debt" to our consolidated financial statements included elsewhere in this Annual Report. We used the applicable annual interest rate as of December 31, 2020 of 4.25%, based on LIBOR plus the applicable margin, for our $1.4 billion outstanding Term Loan to estimate interest payments on this variable rate debt instrument.
(2) This reflects our future operating lease payments. We enter into operating leases in the normal course of business. Substantially all of our operating lease agreements have fixed payment terms based on the passage of time. Some lease agreements provide us with the option to renew the lease. Our future operating lease obligations would change if we exercised these renewal options and if we entered into additional operating lease agreements. These obligations are explained further in Note 6. "Leases" to our consolidated financial statements included elsewhere in this Annual Report. Operating lease obligations do not include common area maintenance, insurance or tax payments for which we are also obligated to pay.
(3) This reflects payments made pursuant to the terms of the TRA, as described further in "Critical Accounting Policies and Tax Receivable Agreement."
Inflation
Inflation and changing prices have not significantly affected our operating results or the markets in which we operate.
Recent Accounting Pronouncements
Please refer to Note 1. "Organization and Summary of Accounting Policies - Recent Accounting Pronouncements" to our consolidated financial statements included elsewhere in this Annual Report for a discussion of the impact of the adoption of recently issued accounting standards and accounting standards not yet adopted.
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