Surgery Partners, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report and our 2021 Annual Report on Form 10-K. 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. Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements, which are based on our current expectations, estimates and assumptions about future events. All statements other than statements of current or historical fact contained in this report are forward-looking statements. These statements include, but are not limited to, statements regarding our future financial position, business strategy, budgets, effective tax rate, projected costs and plans and objectives of management for future operations. The words "projections," "believe," "continue," "drive," "estimate," "expect," "intend," "may," "plan," "will," "could," "would" and similar expressions are generally intended to identify forward-looking statements. These statements involve risks, uncertainties and other factors that may cause actual results to differ from the expectations expressed in the statements. Many of these factors are beyond our ability to control or predict. These factors include, without limitation, the effects of the ongoing COVID-19 pandemic in the United States and the regions in which we operate; the impact to the state and local economies of restrictive orders, vaccine and other mandates and the pandemic generally; our ability to respond nimbly to challenging economic conditions; the unpredictability of our case volume in the current environment; our ability to preserve or raise sufficient funds to continue operations throughout this period of uncertainty; the impact of our cost-cutting measures on our future performance; our ability to cause distributions from our subsidiaries; the responsiveness of our payors, including Medicaid and Medicare, to the challenging operating conditions, including their willingness and ability to continue paying in a timely manner and to advance payments in a timely manner, if at all; the impact of COVID-19 related stimulus programs, including the CARES Act, and uncertainty in how these programs may be administered, monitored and modified in the future; our ability to execute on our operational and strategic initiatives; the timing and impact of our portfolio optimization efforts; our ability to continue to improve same-facility volume and revenue growth on the timeline anticipated, if at all; our ability to successfully integrate acquisitions; the anticipated impact and timing of our ongoing efficiency efforts; the impact of adverse weather conditions and other events outside of our control; and the risks and uncertainties set forth under the heading "Risk Factors" in our 2021 Annual Report on Form 10-K and discussed from time to time in our reports filed with the SEC. Considering these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur, and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report. These forward-looking statements speak only as of the date made. Other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether because of new information, future events or otherwise. Executive Overview Total revenues for the first quarter of 2022 increased 16.4% to $596.2 million from $512.4 million for the first quarter of 2021. Days adjusted same-facility revenues for the first quarter of 2022 increased 8.2% from the same period last year, with a 1.7% increase in revenue per case and a 6.3% increase in same-facility cases. For the first quarter of 2022, the Company’s net income attributable to common stockholders and Adjusted EBITDA was $12.2 million and $77.1 million, respectively. For the first quarter of 2021, the Company’s net loss attributable to common stockholders and Adjusted EBITDA was $31.3 million and $72.9 million, respectively. A reconciliation of non-GAAP financial measures appears below under "Certain Non-GAAP Measures." We had cash and cash equivalents of $378.9 million and $203.0 million of borrowing capacity under our revolving credit facility at March 31, 2022. Operating cash inflows were $79.8 million in the first quarter of 2022, an increase of $29.6 million compared to the prior-year period. Net operating cash flows, including operating cash flows less distributions to non-controlling interests, were an inflow of $43.6 million and $18.9 million for the first quarter of 2022 and 2021, respectively. The increase in operating cash flows and net operating cash flows compared to the same period in 2021 is primarily due to proceeds received in the first quarter of 2022 from the settlement of a stockholder litigation matter. Impact of COVID-19 The COVID-19 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 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. We cannot provide any certainty regarding the length and severity of the impact of the COVID-19 pandemic, which is difficult to predict and is dependent on factors beyond our control. The Company is monitoring legislative actions at federal and state levels, including the impact of the CARES Act and other governmental assistance that might be available. 20 Table of Contents 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 our revenues by service type as a percentage of total revenues for the periods indicated: Three Months Ended March 31, 2022 2021 Patient service revenues: Surgical facilities revenues 95.7 % 95.5 % Ancillary services revenues 2.9 % 3.2 % Total patient service revenues 98.6 % 98.7 % Other service revenues 1.4 % 1.3 % Total revenues 100.0 % 100.0 % Payor Mix The following table sets forth by type of payor the percentage of our patient service revenues generated at the surgical facilities which we consolidate for financial reporting purposes in the periods indicated: Three Months Ended March 31, 2022 2021 Private insurance payors 51.1 % 48.7 % Government payors 42.4 % 44.8 % Self-pay payors 2.9 % 2.6 % Other payors (1) 3.6 % 3.9 % Total 100.0 % 100.0 % (1) Other is comprised of anesthesia service agreements, automobile 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 which we consolidate for financial reporting purposes for the periods indicated: Three Months Ended March 31, 2022 2021 Orthopedic and pain management 36.8 % 37.5 % Ophthalmology 24.6 % 25.4 % Gastrointestinal 22.7 % 21.4 % General surgery 3.0 % 3.0 % Other 12.9 % 12.7 % Total 100.0 % 100.0 % 21 Table of Contents Critical Accounting Policies A summary of significant accounting policies is disclosed in our 2021 Annual Report on Form 10-K under the caption “Critical Accounting Policies” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section. There have been no material changes in the nature of our critical accounting policies or the application of those policies since December 31, 2021. Results of Operations Three Months Ended March 31, 2022 Compared to Three Months Ended March 31, 2021 The following table summarizes certain results from the statements of operations for the three months ended March 31, 2022 and 2021 (dollars in millions): Three Months Ended March 31, 2022 2021 Revenues $ 596.2 $ 512.4 Operating expenses: Cost of revenues 471.4 408.9 General and administrative expenses 29.5 26.8 Depreciation and amortization 27.4 25.7 Transaction and integration costs 7.1 5.3 Grant funds (1.2) (15.1) Gain on disposals and deconsolidations, net (0.1) (0.9) Income from equity investments (3.1) (2.6) Litigation settlement (32.8) — Other income (2.4) — 495.8 448.1 Operating income 100.4 64.3 Interest expense, net (56.3) (53.3) Income before income taxes 44.1 11.0 Income tax expense (1.3) (0.2) Net income 42.8 10.8 Less: Net income attributable to non-controlling interests (30.6) (31.8) Net income (loss) attributable to Surgery Partners, Inc. $ 12.2 $ (21.0) Overview. During the three months ended March 31, 2022, our revenues increased 16.4% to $596.2 million compared to $512.4 million for the three months ended March 31, 2021. Net income attributable to Surgery Partners, Inc. was $12.2 million for the 2022 period, compared to a net loss of $21.0 million for the 2021 period. The increase in revenues was primarily attributable to increases in surgical case volumes and acquisitions completed since the prior-year period. Revenues. Revenues for the three months ended March 31, 2022 compared to the three months ended March 31, 2021 were as follows (dollars in millions): Three Months Ended March 31, 2022 2021 Patient service revenues $ 587.7 $ 505.7 Other service revenues 8.5 6.7 Total revenues $ 596.2 $ 512.4 Patient service revenues increased 16.2% to $587.7 million for the three months ended March 31, 2022 compared to $505.7 million for the three months ended March 31, 2021. The increase of 16.2% was driven by a 6.3% increase in days adjusted same-facility case volume, a 1.7% increase in same-facility revenue per case and acquisitions completed since the prior-year period. Cost of Revenues. Cost of revenues were $471.4 million for the three months ended March 31, 2022 compared to $408.9 million for the three months ended March 31, 2021. The increase was primarily driven by continued case count recovery and acquisitions completed 22 Table of Contents since the prior-year period. As a percentage of revenues, cost of revenues decreased to 79.1% for the 2022 period compared to 79.8% for the 2021 period. General and Administrative Expenses. General and administrative expenses were $29.5 million for the three months ended March 31, 2022 compared to $26.8 million for the three months ended March 31, 2021. As a percentage of revenues, general and administrative expenses decreased to 4.9% for the 2022 period compared to 5.2% for the 2021 period. Depreciation and Amortization. Depreciation and amortization was $27.4 million and $25.7 million for the three months ended March 31, 2022 and 2021, respectively. As a percentage of revenues, depreciation and amortization expenses decreased to 4.6% for the 2022 period compared to 5.0% for the 2021 period. Transaction and Integration Costs. We incurred $7.1 million of transaction and integration costs for the three months ended March 31, 2022 compared to $5.3 million for the three months ended March 31, 2021. The increase primarily relates to costs for ongoing development initiatives and the integration of acquisitions we completed in 2022 and 2021. Grant Funds. During the three months ended March 31, 2022, the Company received approximately $1 million of additional grants from HHS. Based on guidance from HHS and other authorities, the Company updated its estimate of the amount of grant funds received that qualified for recognition, resulting in the recognition of $1.2 million during the three months ended March 31, 2022. Grant funds recognized in the three months ended March 31, 2021 were $15.1 million. For further discussion, see Note 1. "Organization and Summary of Accounting Polices - COVID-19 Pandemic" to our condensed consolidated financial statements included elsewhere in this report. Litigation Settlement. Gain on litigation settlement was $32.8 million for the three months ended March 31, 2022, related to the resolution of the stockholder litigation matter, as discussed in Note 9. "Commitments and Contingencies" to our condensed consolidated financial statements included elsewhere in this report. There was no comparable activity for the 2021 period. Interest Expense, Net. Interest expense, net, increased to $56.3 million for the three months ended March 31, 2022 compared to $53.3 million for the three months ended March 31, 2021. As a percentage of revenues, interest expense, net decreased to 9.4% for the 2022 period compared to 10.4% for the 2021 period. Income Tax Expense. The income tax expense was $1.3 million and $0.2 million for the three months ended March 31, 2022 and 2021, respectively. The effective tax rate was 2.9% for the three months ended March 31, 2022 compared to 1.8% for the three months ended March 31, 2021. For the three months ended March 31, 2022, the effective tax rate differed from 21% primarily due to earnings attributable to non-controlling interests, an increase in the Company’s valuation allowance attributable to interest expense limitations, and discrete tax benefits of (a) $4.6 million related to the vesting of restricted stock awards, (b) $1.8 million attributable to non-recurring earnings’ impact on the Company’s valuation allowance, and (c) $1.0 million related to entity divestitures. For the three months ended March 31, 2021, the effective tax rate differed from 21% due to tax benefits of $2.2 million related to the vesting of restricted stock awards. Based upon the application of interim accounting guidance, the tax rate as a percentage of net income after income attributable to non-controlling interests will vary based upon the relative net income from period to period. Net Income Attributable to Non-Controlling Interests. Net income attributable to non-controlling interests was $30.6 million for the three months ended March 31, 2022 compared to $31.8 million for the three months ended March 31, 2021. As a percentage of revenues, net income attributable to non-controlling interests was 5.1% for the 2022 period and 6.2% for the 2021 period. Liquidity and Capital Resources Operating Activities The primary source of our operating cash flow is the collection of accounts receivable from federal and state agencies (under the Medicare and Medicaid programs), private insurance companies and individuals. During the three months ended March 31, 2022, our cash flow provided by operating activities was $79.8 million compared to $50.2 million in the three months ended March 31, 2021. The increase is primarily due to settlement proceeds related to the resolution of a stockholder litigation matter. Investing Activities Net cash used in investing activities during the three months ended March 31, 2022, was $47.1 million, which included $18.2 million related to purchases of property and equipment. We paid $31.1 million in cash for acquisitions (net of cash acquired), which included controlling interests in two surgical facilities, one of which was merged into an existing surgical facility. Additionally, we received cash proceeds of $11.5 million related to the sale of interests in a surgical facility, which was previously accounted for as an equity method investment. Net cash used in investing activities during the three months ended March 31, 2021, was $14.3 million, which included $14.5 million related to purchases of property and equipment. We paid $2.1 million in cash for acquisitions (net of cash acquired), which included controlling interests in two surgical facilities in existing markets that were merged into existing facilities. Additionally, we received cash proceeds of $2.3 million related to the disposal of certain long-lived assets. 23 Table of Contents Financing Activities Net cash used in financing activities during the three months ended March 31, 2022 was $43.7 million. During this period, we made distributions to non-controlling interest holders of $36.2 million and made payments related to ownership transactions with consolidated affiliates of $3.1 million. We repaid $17.0 million of our long-term debt and had borrowings on long-term debt of $11.9 million. Net cash provided by financing activities during the three months ended March 31, 2021 was $187.8 million. During this period, we received gross proceeds of $260.9 million from an equity offering which was partially offset by equity offering costs paid of $12.6 million. We made distributions to non-controlling interest holders of $31.3 million and received proceeds related to ownership transactions with consolidated affiliates of $1.0 million. We repaid $16.6 million of our long-term debt, which was offset by borrowings of $0.6 million. We also paid a cash dividend of $5.1 million related to the Series A preferred stock. Debt As of March 31, 2022, the carrying value of our total indebtedness was $3.093 billion, which includes unamortized fair value discount of $2.8 million and unamortized deferred financing costs and issuance discount of $15.8 million. Term Loan and Revolving Credit Facility As of March 31, 2022, we had term loan borrowings with a carrying value of $1.527 billion, consisting of outstanding aggregate principal of $1.530 billion and unamortized fair value discount of $2.8 million (the "Term Loan"). The Term Loan matures on August 31, 2026 (or, if at least $185 million of the Borrower’s 6.750% senior unsecured notes due 2025 shall have not either been repaid, repurchased or redeemed or refinanced with indebtedness having a maturity date not earlier than 91 days after August 31, 2026 by no later than April 1, 2025, then April 1, 2025) and amortizes in equal quarterly installments of 0.25% of the aggregate original principal amount. We have a revolving credit facility providing for revolving borrowings of up to $210.0 million ("the Revolver" and, together with the Term Loan, the "Senior Secured Credit Facilities"). The Revolver will mature on February 1, 2026. As of March 31, 2022, our availability on the Revolver was $203.0 million (including outstanding letters of credit of $7.0 million). 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 of 3.75% per annum (LIBOR with respect to the Term Loan shall be subject to a floor of 0.75%) 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 (the alternate base rate with respect to the Term Loan shall be subject to a floor of 1.75%)) plus a margin of 2.75% per annum. In addition, we are required to pay a commitment fee of 0.50% per annum in respect of unused commitments under the Revolver. Senior Unsecured Notes We have $545.0 million aggregate principal amount of senior unsecured notes due April 15, 2027, which bear interest at the rate of 10.000% per year, payable semi-annually on April 15 and October 15 of each year. We have $370.0 million aggregate principal amount of senior unsecured notes due July 1, 2025, which 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 $159.3 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 $507.7 million for which we are liable to various vendors for several property and equipment leases classified as finance leases. Material Cash Requirements In addition to the cash requirements related to our long-term debt, operating lease obligations and the tax receivable agreement, pursuant to the CARES Act, repayment of certain advanced payments and other deferrals received as part of relief during 2020 will continue during 2022. We received approximately $120 million of accelerated payments during the year ended December 31, 2020. Through March 31, 2022, approximately $78 million has been repaid including approximately $18 million during the three months ended March 31, 2022. In addition to the continued repayment of the advanced payments received under the CARES Act, we anticipate additional cash outflows during 2022 for the repayment of the remaining payroll taxes deferred in 2020 pursuant to the CARES Act. See Note 1. "Organization and Summary of Accounting Policies" for a further discussion of the accelerated payments and payroll tax deferral. 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. 24 Table of Contents 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 re-opened and allowed for non-emergent procedures, broad economic factors resulting from the ongoing COVID-19 pandemic could negatively affect our payor mix, increase the relative proportion of lower margin services we provide and reduce patient volumes, as well as diminish our ability to collect outstanding receivables. 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 flows from operations, available cash, available capacity on our Revolver, funds we have received under the CARES Act, funds we may receive in the future and continued access to capital markets, 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 and Adjusted EBITDA excluding grant funds are not measurements 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 these non-GAAP metrics are significant components in understanding and evaluating our financial performance. We believe such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. Our calculation of Adjusted EBITDA and Adjusted EBITDA excluding grant funds may not be comparable to similarly titled measures reported by other companies. We use Adjusted EBITDA and Adjusted EBITDA excluding grant funds as measures of financial performance. Adjusted EBITDA and Adjusted EBITDA excluding grant funds are key measures used by our management to assess operating performance, make business decisions and allocate resources. The following table reconciles Adjusted EBITDA and Adjusted EBITDA excluding grant funds to income before income taxes, the most directly comparable GAAP financial measure (in millions and unaudited): Three Months Ended March 31, 2022 2021 Condensed Consolidated Statements of Operations Data: Income before income taxes $ 44.1 $ 11.0 Plus (minus): Net income attributable to non-controlling interests (30.6) (31.8) Depreciation and amortization 27.4 25.7 Interest expense, net 56.3 53.3 Equity-based compensation expense 3.7 5.2 Transaction, integration and acquisition costs (1) 7.1 9.4 Gain on disposals and deconsolidations, net (0.1) (0.9) (Gain) loss on litigation settlement and other litigation costs (2) (30.8) 1.0 Adjusted EBITDA $ 77.1 $ 72.9 Less: Impact of grant funds (3) (1.0) (10.7) Adjusted EBITDA excluding grant funds $ 76.1 $ 62.2 (1) This amount includes transaction and integration costs of $7.1 million and $5.3 million for the three months ended March 31, 2022 and 2021, respectively. This amount further includes start-up costs related to a de novo surgical hospital of $4.1 million for the three months ended March 31, 2021. (2) This amount includes other litigation costs of $2.0 million and $1.0 million for the three months ended March 31, 2022 and 2021, respectively. This amount also includes a litigation settlement gain of $32.8 million for the three months ended March 31, 2022, with no comparable activity in the 2021 period. (3) 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 25 Table of Contents 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 our management and calculated in conformance with the definition of “Consolidated EBITDA” used in the credit agreements governing our credit facilities. The following table reconciles Credit Agreement EBITDA to cash flows from operating activities, the most directly comparable GAAP financial measure (in millions and unaudited): Twelve Months Ended March 31, 2022 Cash flows from operating activities $ 116.7 Plus (minus): Non-cash interest expense, net (26.5) Non-cash lease expense (37.9) Deferred income taxes (10.0) Equity in earnings of unconsolidated affiliates, net of distributions received 0.5 Changes in operating assets and liabilities, net of acquisitions and divestitures 188.4 Income tax expense 11.6 Net income attributable to non-controlling interests (140.4) Interest expense, net 224.0 Transaction, integration and acquisition costs 43.8 Litigation settlement and other litigation costs (26.2) Hurricane-related impacts (1) (0.2) Acquisitions and synergies (2) 71.8 Credit Agreement EBITDA $ 415.6 (1) Reflects the impact of insurance proceeds received net of operating losses incurred in the six months ended December 31, 2021, at a surgical facility that was closed following Hurricane Ida. (2) Represents impact of acquisitions as if each acquisition had occurred on April 1, 2021. Further this includes revenue and cost synergies from other business initiatives and de novo facilities and an adjustment for the effects of adopting the new lease accounting standard, as defined in the credit agreement governing the Senior Secured Credit Facilities.