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EX-32.2 - EXHIBIT 32.2 - Surgery Partners, Inc.q22016exhibit322.htm
EX-32.1 - EXHIBIT 32.1 - Surgery Partners, Inc.q22016exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - Surgery Partners, Inc.q22016exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - Surgery Partners, Inc.q22016exhibit311.htm


 
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 June 30, 2016
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.)

40 Burton Hills Boulevard, Suite 500
Nashville, Tennessee 37215
(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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer o
 
Accelerated filer o
Non-accelerated filer x
 
Smaller reporting company 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 August 9, 2016, there were 48,530,497 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 Disclosure About Market Risk
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 3.
Defaults Upon Senior Securities
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
Item 5.
Other Information
 
 
 
Item 6.
Exhibits





PART 1 - FINANCIAL INFORMATION
Item 1.  Financial Statements
SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, amounts in thousands, except shares and per share amounts)
 
 
June 30, 2016
 
December 31, 2015
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
51,599

 
$
57,933

Accounts receivable, less allowance for doubtful accounts of $25,162 and $18,322, respectively
 
202,743

 
177,757

Inventories
 
25,931

 
25,591

Prepaid expenses and other current assets
 
26,704

 
34,620

Acquisition escrow deposit
 
8,901

 
13,984

Indemnification receivable due from seller
 
1,072

 
1,072

Total current assets
 
316,950

 
310,957

Property and equipment, net
 
196,772

 
184,550

Intangible assets, net
 
51,487

 
53,568

Goodwill
 
1,510,851

 
1,407,927

Investments in and advances to affiliates
 
34,715

 
34,103

Restricted invested assets
 
315

 
316

Long-term deferred tax assets
 
88,919

 
94,105

Long-term acquisition escrow deposit
 
2,085

 
8,408

Other long-term assets
 
11,429

 
10,509

Total assets
 
$
2,213,523

 
$
2,104,443

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
43,874

 
$
45,341

Accrued payroll and benefits
 
28,855

 
26,307

Acquisition escrow liability
 
8,901

 
13,984

Other current liabilities
 
72,069

 
68,410

Current maturities of long-term debt
 
28,738

 
27,247

Total current liabilities
 
182,437

 
181,289

Long-term debt, less current maturities
 
1,325,778

 
1,228,112

Long-term tax receivable agreement liability
 
119,655

 
119,655

Long-term acquisition escrow liability
 
2,085

 
8,408

Other long-term liabilities
 
87,290

 
85,613

 
 
 
 
 
Non-controlling interests—redeemable
 
182,667

 
183,439

 
 
 
 
 
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, 48,493,366 shares issued and outstanding at June 30, 2016; 48,156,990 shares issued and outstanding at December 31, 2015
 
485

 
482

Additional paid-in capital
 
318,764

 
316,294

Retained deficit
 
(325,875
)
 
(320,804
)
Total Surgery Partners, Inc. stockholders' deficit
 
(6,626
)
 
(4,028
)
Non-controlling interests—non-redeemable
 
320,237

 
301,955

Total stockholders' equity
 
313,611

 
297,927

Total liabilities and stockholders' equity
 
$
2,213,523

 
$
2,104,443

See notes to unaudited condensed consolidated financial statements.


1



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, amounts in thousands, except shares and per share amounts)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Revenues
 
$
289,681

 
$
232,827

 
$
556,755

 
$
456,970

Operating expenses:
 
 
 
 
 
 
 
 
Salaries and benefits
 
93,791

 
62,182

 
180,677

 
122,333

Supplies
 
66,915

 
59,087

 
130,577

 
116,173

Professional and medical fees
 
20,304

 
16,171

 
39,957

 
30,911

Lease expense
 
13,074

 
11,096

 
25,508

 
22,056

Other operating expenses
 
14,768

 
13,022

 
28,836

 
25,858

Cost of revenues
 
208,852

 
161,558

 
405,555

 
317,331

General and administrative expenses (includes contingent acquisition compensation expense of $1,530 in 2016)
 
15,023

 
11,846

 
27,220

 
23,708

Depreciation and amortization
 
9,702

 
8,465

 
19,271

 
16,927

Provision for doubtful accounts
 
3,544

 
5,023

 
7,417

 
10,209

Income from equity investments
 
(1,082
)
 
(839
)
 
(1,840
)
 
(1,546
)
Loss (gain) on disposal or impairment of long-lived assets, net
 
1,331

 
(2,906
)
 
1,125

 
(2,683
)
Loss on debt refinancing
 

 

 
8,281

 

Merger transaction and integration costs
 
1,325

 
8,642

 
4,497

 
13,648

Electronic health records incentive income

(2
)

50

 
(95
)
 
50

Other expense (income)
 
40

 
(13
)
 
97

 
(26
)
Total operating expenses
 
238,733

 
191,826

 
471,528

 
377,618

Operating income
 
50,948

 
41,001

 
85,227

 
79,352

Interest expense, net
 
(26,235
)
 
(26,178
)
 
(48,388
)
 
(51,934
)
Income before income taxes
 
24,713

 
14,823

 
36,839

 
27,418

Income tax expense
 
2,420

 
2,344

 
4,190

 
4,451

Net income
 
22,293

 
12,479

 
32,649

 
22,967

Less: Net income attributable to non-controlling interests
 
(20,173
)
 
(17,905
)
 
(37,720
)

(35,155
)
Net income (loss) attributable to Surgery Partners, Inc.
 
$
2,120

 
$
(5,426
)
 
$
(5,071
)
 
$
(12,188
)
 
 
 
 
 
 
 
 
 
Net income (loss) per share attributable to common stockholders
 
 
 
 
 
 
Basic
 
$
0.04

 
$
(0.17
)
 
$
(0.11
)
 
$
(0.38
)
Diluted (1)
 
$
0.04

 
$
(0.17
)
 
$
(0.11
)
 
$
(0.38
)
Weighted average common shares outstanding(2)
 
 
 
 
 
 
 
 
Basic
 
48,019,652


32,054,089

 
48,018,228

 
32,054,089

Diluted (1)
 
48,129,041


32,054,089

 
48,018,228

 
32,054,089

(1) The impact of potentially dilutive securities for the six months ended June 30, 2016 and the three and six months ended June 30, 2015 was not considered because the effect would be anti-dilutive in each of those periods.
(2) Effect of the Reorganization, as defined in Note 1, has been retrospectively applied to the periods ended June 30, 2015.


See notes to unaudited condensed consolidated financial statements.



2



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, amounts in thousands)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Net income
 
$
22,293

 
$
12,479

 
$
32,649

 
$
22,967

Other comprehensive income
 

 

 



Comprehensive income
 
$
22,293

 
$
12,479

 
$
32,649

 
$
22,967

Less: Comprehensive income attributable to non-controlling interests
 
(20,173
)
 
(17,905
)
 
(37,720
)
 
(35,155
)
Comprehensive income (loss) attributable to Surgery Partners, Inc.
 
$
2,120

 
$
(5,426
)
 
$
(5,071
)
 
$
(12,188
)
See notes to unaudited condensed consolidated financial statements.




3



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited, amounts in thousands, except shares)
 
Common Stock
 
Additional
Paid-in Capital
 
Retained Deficit
 
Non-Controlling Interests—
Non-Redeemable
 
Total
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2015
48,156,990

 
$
482

 
$
316,294

 
$
(320,804
)
 
$
301,955

 
$
297,927

Net (loss) income

 

 

 
(5,071
)
 
28,533

 
23,462

Issuance of restricted stock, net of forfeitures
336,376

 
3

 
(3
)
 

 

 

Equity-based compensation

 

 
635

 

 

 
635

Acquisition and disposal of shares of non-controlling interests, net

 

 
1,838

 

 
13,389

 
15,227

Distributions to non-controlling interests—non-redeemable holders

 

 

 

 
(23,640
)
 
(23,640
)
Balance as of June 30, 2016
48,493,366

 
$
485

 
$
318,764

 
$
(325,875
)
 
$
320,237

 
$
313,611


See notes to unaudited condensed consolidated financial statements.



4



SURGERY PARTNERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
Net income
 
$
32,649

 
$
22,967

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
19,271

 
16,927

Amortization of debt issuance costs and discounts
 
3,348

 
3,302

Amortization of unfavorable lease liability
 
(216
)
 
(216
)
Equity-based compensation
 
635

 
853

Loss (gain) on disposal or impairment of long-lived assets, net
 
1,125

 
(2,683
)
Loss on debt refinancing
 
8,281

 

Deferred income taxes
 
3,890

 
3,630

Provision for doubtful accounts
 
7,417

 
10,209

Income from equity investments, net of distributions received
 
(611
)
 
634

Changes in operating assets and liabilities, net of acquisitions and divestitures:
 
 
 
 
Accounts receivable
 
(25,902
)
 
(20,227
)
Other operating assets and liabilities
 
24,150

 
(4,410
)
Net cash provided by operating activities
 
74,037

 
30,986

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment, net
 
(20,350
)
 
(11,546
)
Payments for acquisitions, net of cash acquired
 
(113,017
)
 
(12,063
)
Proceeds from divestitures
 

 
10,867

Net cash used in investing activities
 
(133,367
)
 
(12,742
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Principal payments on long-term debt
 
(424,348
)
 
(29,274
)
Borrowings of long-term debt
 
525,422

 
21,653

Payments of debt issuance costs
 
(12,555
)
 

Penalty on prepayment of debt
 
(4,900
)
 

Distributions to non-controlling interest holders
 
(32,362
)
 
(32,376
)
Receipts (payments) related to ownership transactions with consolidated affiliates
 
573

 
(5,036
)
Financing lease obligation
 
(390
)
 
(224
)
Other financing activities
 
1,556

 

Net cash provided by (used in) financing activities
 
52,996

 
(45,257
)
Net decrease in cash and cash equivalents
 
(6,334
)
 
(27,013
)
Cash and cash equivalents at beginning of period
 
57,933

 
74,920

Cash and cash equivalents at end of period
 
$
51,599

 
$
47,907

See notes to unaudited condensed consolidated financial statements.


5

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)


1. Organization
Surgery Partners, Inc., a Delaware corporation (together with its subsidiaries, the “Company”), was formed April 2, 2015, as a holding company for the purpose of facilitating an initial public offering (the “IPO”) of shares of common stock. Prior to September 30, 2015, the Company conducted business through Surgery Center Holdings, Inc. and its subsidiaries. Surgery Center Holdings, LLC was and is the sole indirect owner of the equity interests of Surgery Center Holdings, Inc. and has no other material assets. On October 1, 2015, the Company completed its IPO of 14,285,000 shares of common stock at an offering price of $19.00 per share.
On September 30, 2015, Surgery Partners, Inc. became the direct parent and sole member of Surgery Center Holdings, LLC (the "Reorganization"). In the Reorganization, all of the equity interests held by the pre-IPO owners of Surgery Center Holdings, LLC were contributed to Surgery Partners, Inc. in exchange for 33,871,990 shares of common stock of Surgery Partners, Inc. and certain rights to additional payments under a tax receivable agreement. After giving effect to the Reorganization, Surgery Partners, Inc. is a holding company, and its sole material asset is an equity interest in Surgery Center Holdings, LLC. The Company's condensed consolidated financial statements for periods prior to the Reorganization represent the historical operating results and financial position of Surgery Center Holdings, Inc. and certain of its subsidiaries.
As of June 30, 2016, the Company owned and operated a national network of surgical facilities and ancillary services in 29 states.  The surgical facilities, which include ASCs and surgical hospitals, primarily provide non-emergency surgical procedures across many specialties, including, among others, otolaryngology ("ENT"), gastroenterology ("GI"), general surgery, ophthalmology, orthopedics, cardiology and pain management. The Company's surgical hospitals provide services such as diagnostic imaging, laboratory, obstetrics, oncology, pharmacy, physical therapy and wound care. Ancillary services are comprised of a diagnostic laboratory, multi-specialty physician practices, urgent care facilities, anesthesia services, optical services and specialty pharmacy services.
As of June 30, 2016, the Company owned or operated a portfolio of 103 surgical facilities, comprised of 98 ASCs and five surgical hospitals. The Company owns these facilities in partnership with physicians and, in some cases, healthcare systems in the markets and communities it serves. The Company owned a majority interest in 72 of the surgical facilities and consolidated 92 of these facilities for financial reporting purposes. In addition, the Company owned or operated a network of 51 physician practices.
2. Significant Accounting Policies
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, as well as interests in partnerships and limited liability companies controlled by the Company through its ownership of a majority voting interest or other rights granted to the Company by contract to manage and control the affiliate's business. All significant intercompany balances and transactions are eliminated in consolidation.
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation of the Company's financial position and results of operations have been included. The Company’s fiscal year ends on December 31 and interim results are not necessarily indicative of results for a full year or any other interim period. The condensed consolidated balance sheet at December 31, 2015 has been derived from the audited financial statements as of that date. The information contained in these condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the fiscal year ended December 31, 2015. 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 accompanying notes. Actual results could differ from those estimates.
Non-Controlling Interests
The physician limited partners and physician minority members of the entities that the Company controls are responsible for the supervision and delivery of medical services. The governance rights of limited partners and minority members are restricted to those that protect their financial interests. Under certain partnership and operating agreements governing these partnerships and limited liability companies, the Company could be removed as the sole general partner or managing member for certain events such as material breach of the partnership or operating agreement, gross negligence or bankruptcy. These protective rights do not preclude consolidation of the respective partnerships and limited liability companies.
Ownership interests in consolidated subsidiaries held by parties other than the Company are identified and generally presented in the condensed consolidated financial statements within the equity section but separate from the Company's equity. However, in instances in which certain redemption features that are not solely within the control of the Company are present, classification of non-controlling interests outside of permanent equity is required. Consolidated net income attributable to the Company and to the non-controlling interests are identified and presented on the condensed consolidated statements of operations; changes in ownership interests in which the Company retains a controlling interest are accounted for as equity transactions. Certain transactions with non-controlling interests are classified within financing activities in the condensed consolidated statements of cash flows.
The condensed consolidated financial statements of the Company include all assets, liabilities, revenues and expenses of surgical facilities in which the Company has sufficient ownership and rights to allow the Company to consolidate the surgical facilities. Similar to its investments


6

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

in non-consolidated affiliates, the Company regularly engages in the purchase and sale of ownership interests with respect to its consolidated subsidiaries that do not result in a change of control.
Non-Controlling Interests — Redeemable. Each of the partnerships and limited liability companies through which the Company owns and operates its surgical facilities is governed by a partnership or operating agreement.  In certain circumstances, the partnership and operating agreements for the Company's surgical facilities provide that the facilities will purchase all of the physicians’ ownership if certain adverse regulatory events occur, such as it becoming illegal for the physicians 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 interests - redeemable are reported outside of stockholders' equity in the condensed consolidated balance sheets.
A summary of activity related to the non-controlling interests—redeemable follows (in thousands):
Balance at December 31, 2015
 
$
183,439

Net income attributable to non-controlling interests—redeemable
 
9,187

Acquisition and disposal of shares of non-controlling interests, net—redeemable
 
(1,237
)
Distributions to non-controlling interest —redeemable holders
 
(8,722
)
Balance at June 30, 2016
 
$
182,667

Variable Interest Entities
The condensed consolidated financial statements include the accounts of variable interest entities in which the Company is the primary beneficiary under the provisions of Accounting Standards Codification Topic ("ASC") 810, Consolidation. As of June 30, 2016 and December 31, 2015, the variable interest entities include five surgical facilities, three anesthesia practices and one physician practice. The Company has the power to direct the activities that most significantly impact the variable interest entity's economic performance. Additionally, the Company would absorb the majority of the expected losses of these entities should they occur. As of June 30, 2016 and December 31, 2015, the condensed consolidated balance sheets of the Company included total assets of $97.7 million and $104.2 million, respectively, and total liabilities of $13.1 million and $13.2 million, respectively, related to the Company's variable interest entities.
Equity Method Investments
The Company has non-consolidating investments in surgical facilities and management companies that own or manage surgical facilities. These investments are accounted for using the equity method of accounting. The total amount of these investments included in investments in and advances to affiliates in the condensed consolidated balance sheets was $34.7 million and $34.1 million as of June 30, 2016 and December 31, 2015, respectively.
Reclassifications
Certain reclassifications have been made to the comparative periods' financial statements to conform to the three and six months ended June 30, 2016 presentation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and footnotes. Examples include, but are not limited to, estimates of accounts receivable allowances, professional and general liabilities and the estimate of deferred tax assets or liabilities. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All adjustments are of a normal, recurring nature. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in an orderly transaction between market participants to sell the asset or transfer the liability. The Company uses fair value measurements based on quoted prices in active markets for identical assets or liabilities (Level 1), inputs other than quoted prices in active markets that are either directly or indirectly observable (Level 2), or unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions (Level 3), depending on the nature of the item being valued.
The carrying amounts reported in the condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, restricted invested assets and accounts payable approximate their fair values.


7

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

A summary of the carrying amounts and fair values of the Company's long-term debt follows (in thousands):
 
 
Carrying Amount
 
Fair Value
 
 
June 30,
2016
 
December 31,
2015
 
June 30,
2016
 
December 31,
2015
 
 
 
 
 
 
 
 
 
2014 First Lien Credit Agreement, net of debt issuance and discount
 
$
912,305

 
$
839,701

 
$
905,462

 
$
828,816

2014 Second Lien Credit Agreement, net of debt issuance and discount
 
$

 
$
237,532

 
$

 
$
225,382

Senior Unsecured Notes, net of debt issuance and discount
 
$
386,846

 
$

 
$
398,935

 
$

The fair values of the 2014 First Lien Credit Agreement, 2014 Second Lien Credit Agreement and Senior Unsecured Notes, as defined in Note 4 on Long-Term Debt, were based on a Level 2 computation using quoted prices for identical liabilities in inactive markets at June 30, 2016 and December 31, 2015, as applicable. The carrying amounts related to the Company's other long-term debt obligations approximate their fair values.
The Company maintains a supplemental executive retirement savings plan (the "SERP") for certain executive officers. The SERP is a non-qualified deferred compensation plan for eligible executive officers and other key employees of the Company that allows participants to defer portions of their compensation. The fair value of the SERP asset and liability was based on a quoted market price, or a Level 1 computation. As of both June 30, 2016 and December 31, 2015, the fair value of the assets in the SERP were $1.6 million and were included in other long-term assets in the condensed consolidated balance sheets. The Company had a liability related to the SERP of $1.6 million as of June 30, 2016 and December 31, 2015, which was included in other long-term liabilities in the condensed consolidated balance sheets.
Revenues
The Company recognizes revenues in the period in which the services are performed. Patient service revenues and receivables from third-party payors are recorded net of estimated contractual adjustments and allowances, which the Company estimates based on the historical trend of its cash collections and contractual write-offs, accounts receivable agings, established fee schedules, contracts with payors and procedure statistics.
A summary of revenues by service type as a percentage of total revenues follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Patient service revenues:
 
 
 
 
 
 
 
 
   Surgical facilities revenues
 
90.0
%
 
92.5
%
 
90.6
%
 
92.4
%
   Ancillary services revenues
 
7.7
%
 
5.4
%
 
7.2
%
 
5.5
%
 
 
97.7
%
 
97.9
%
 
97.8
%
 
97.9
%
Other service revenues:
 
 
 
 
 
 
 
 
   Optical services revenues
 
1.2
%
 
1.6
%
 
1.3
%
 
1.6
%
   Other
 
1.1
%
 
0.5
%
 
0.9
%
 
0.5
%
 
 
2.3
%
 
2.1
%
 
2.2
%
 
2.1
%
Total revenues
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Patient service revenues. 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 on the date of service, net of estimated contractual adjustments and discounts from third-party payors, including Medicare and Medicaid.  Changes in estimated contractual adjustments and discounts are recorded in the period of change. During the three and six months ended June 30, 2016, 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 $1.1 million and $2.0 million, respectively.


8

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

The following table sets forth patient service revenues by type of payor and as a percentage of total patient service revenues for the Company's consolidated surgical facilities (dollars in thousands):
 
 
Three Months Ended June 30,
 
 
2016
 
2015
 
 
Amount
 
%
 
Amount
 
%
Patient service revenues:
 
 
 
 
 
 
 
 
Private insurance
 
$
145,211

 
51.3
%
 
$
122,784

 
53.9
%
Government
 
113,971

 
40.2
%
 
89,032

 
39.1
%
Self-pay
 
4,766

 
1.7
%
 
4,001

 
1.8
%
Other
 
19,263

 
6.8
%
 
12,078

 
5.2
%
Total patient service revenues
 
$
283,211

 
100.0
%
 
$
227,895

 
100.0
%
Other service revenues:
 
 
 
 
 
 
 
 
Optical service revenues
 
$
3,395

 


 
$
3,751

 


Other revenues
 
3,075

 


 
1,181

 


Total net revenues
 
$
289,681

 
 
 
$
232,827

 
 
 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
 
Amount
 
%
 
Amount
 
%
Patient service revenues:
 
 
 
 
 
 
 
 
Private insurance
 
$
277,426

 
50.9
%
 
$
245,265

 
54.9
%
Government
 
219,774

 
40.3
%
 
168,465

 
37.7
%
Self-pay
 
8,479

 
1.6
%
 
9,105

 
2.0
%
Other
 
39,092

 
7.2
%
 
24,211

 
5.4
%
Total patient service revenues
 
$
544,771

 
100.0
%
 
$
447,046

 
100.0
%
Other service revenues:
 
 
 
 
 
 
 
 
Optical service revenues
 
$
7,019

 
 
 
$
7,491

 
 
Other revenues
 
4,965

 
 
 
2,433

 
 
Total net revenues
 
$
556,755

 
 
 
$
456,970

 
 
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 and sales from the Company's marketing products and services business. 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. Revenue is recognized as 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. Revenue is recognized when product is shipped, net of allowance for discounts. The Company's marketing products and services businesses recognize revenue when product is shipped or services are rendered.
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. 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 services are rendered.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.  The Company maintains its cash and cash equivalent balances at high credit quality financial institutions.
Accounts Receivable and Allowances for Contractual Adjustments and Doubtful Accounts
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


9

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

with these government agencies. Concentration of credit risk with respect to other payors is limited because of the large number of such payors. As of June 30, 2016 and December 31, 2015, the Company had third-party settlements of $5.6 million and $5.2 million, respectively, 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 significant. The Company's policy is to collect co-payments and deductibles prior to providing medical services. It is also the Company's policy to verify a patient’s insurance 72 hours prior to the patient’s procedure. Patient services of the Company are primarily non-emergency, which allows the surgical facilities to control the procedures for which third-party reimbursement is sought and obtained. The Company does not require collateral from self-pay patients.
The Company analyzes accounts receivable at each of its facilities to ensure the proper aged category and collection assessment. At a consolidated level, the Company's policy is to review accounts receivable aging, by facility, to determine the appropriate allowance for doubtful accounts. Patient account balances are reviewed for delinquency based on contractual terms. This review is supported by an analysis of the actual revenues, contractual adjustments and cash collections received. An account balance is written off only after the Company has pursued collection with legal or collection agency assistance or otherwise has deemed an account to be uncollectible.
The receivables related to the Company's optical products purchasing organization are recognized separately from patient accounts receivable, as discussed above, and are included in other current assets in the condensed consolidated balance sheets. Such receivables were $8.3 million and $8.4 million at June 30, 2016 and December 31, 2015, respectively.
Inventories
Inventories, which consist primarily of medical and drug supplies, are stated at the lower of cost or market value. Cost is determined using the first-in, first-out method.
Prepaid Expenses and Other Current Assets
A summary of prepaid expenses and other current assets follows (in thousands):
 
 
June 30, 2016
 
December 31,
2015
 
 
 
 
 
Prepaid expenses
 
$
7,656

 
$
7,409

Receivables - optical product purchasing organization
 
8,287

 
8,434

Acquisition escrow receivable
 

 
8,000

Other current assets
 
10,761

 
10,777

Total
 
$
26,704

 
$
34,620

Property and Equipment
Property and equipment are stated at cost or, if obtained through acquisition, at fair value determined on the date of acquisition. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets, generally three to five years for computers and software and five to seven years for furniture and equipment.  Leasehold improvements are depreciated on a straight-line basis over the shorter of the lease term or the estimated useful life of the assets. Routine maintenance and repairs are expensed as incurred, while expenditures that increase capacities or extend useful lives are capitalized.
A summary of property and equipment follows (in thousands):
 
 
June 30, 2016
 
December 31,
2015
 
 
 
 
 
Land
 
$
8,082

 
$
6,790

Buildings and improvements
 
108,808

 
104,971

Furniture and equipment
 
16,745

 
14,520

Computer and software
 
28,395

 
24,597

Medical equipment
 
110,910

 
96,291

Construction in progress
 
5,253

 
7,619

Property and equipment, at cost
 
278,193

 
254,788

Less: Accumulated depreciation
 
(81,421
)
 
(70,238
)
Property and equipment, net
 
$
196,772

 
$
184,550

The Company also leases certain facilities and equipment under capital leases. Assets held under capital leases are stated at the present value of minimum lease payments at the inception of the related lease. Such assets are depreciated on a straight-line basis over the lesser of


10

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

the lease term or the remaining useful life of the leased asset. The carrying values of assets under capital lease were $13.2 million and $12.3 million as of June 30, 2016 and December 31, 2015, respectively, net of accumulated depreciation of $11.0 million and $10.5 million, respectively.
Intangible Assets
The Company has indefinite-lived intangible assets related to the certificates of need held in jurisdictions where certain of its surgical facilities are located. The Company also has finite-lived intangible assets related to physician guarantee agreements, non-compete agreements, management agreements and customer relationships. Physician income guarantees are amortized into salaries and benefits costs in the condensed consolidated statements of operations over the commitment period of the contract, generally three to four years. Non-compete agreements and management rights agreements are amortized into depreciation and amortization expense in the condensed consolidated statements of operations over the service lives of the agreements, ranging from two to 20 years for non-compete agreements and 15 years for the management rights agreements. Customer relationships are amortized into depreciation and amortization expense in the condensed consolidated statements of operations over the estimated lives of the relationships, ranging from three to ten years.

A summary of the activity related to intangible assets for the six months ended June 30, 2016 follows (in thousands):
 
 
Physician Income Guarantees
 
Management Rights
 
Non-Compete Agreements
 
Certificates of Need
 
Customer Relationships
 
Other
 
Total Intangible Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
 
$
1,212

 
$
23,026

 
$
18,571

 
$
3,711

 
$
4,936

 
$
2,112

 
$
53,568

Additions
 
210

 

 
2,614

 

 

 

 
2,824

Recruitment expense
 
(225
)
 

 

 

 

 

 
(225
)
Amortization
 

 
(871
)
 
(2,965
)
 

 
(610
)
 
(234
)
 
(4,680
)
Balance at June 30, 2016
 
$
1,197

 
$
22,155

 
$
18,220

 
$
3,711

 
$
4,326

 
$
1,878

 
$
51,487

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 activity related to goodwill for the six months ended June 30, 2016 follows (in thousands):
Balance at December 31, 2015
 
$
1,407,927

Acquisitions
 
102,929

Divestitures
 

Purchase price adjustments
 
(5
)
Balance at June 30, 2016
 
$
1,510,851

Impairment of Long-Lived Assets, Goodwill and Intangible Assets
The Company evaluates the carrying value of long-lived assets when impairment indicators are present or when circumstances indicate that impairment may exist in accordance with ASC 350, Intangibles- Goodwill and Other. The Company performs an impairment test by preparing an expected undiscounted cash flow projection. If the projection indicates that the recorded amount of the long-lived asset is not expected to be recovered, the carrying value is reduced to estimated fair value.  The cash flow projection and fair value represents management’s best estimate, using appropriate and customary assumptions, projections and methodologies, at the date of evaluation. The Company tests its goodwill and intangible assets for impairment at least annually, or more frequently if certain indicators arise. 
Restricted Invested Assets
Restricted invested assets of $315,000 and $316,000 at June 30, 2016 and December 31, 2015, respectively, were related to a requirement under the operating lease agreement at the Company's Chesterfield, Missouri facility. In accordance with the provisions of the lease agreement, 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.


11

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

Other Long-Term Assets
A summary of other long-term assets follows (in thousands):
 
 
June 30, 2016
 
December 31,
2015
Notes receivable
 
$
188

 
$
212

Deposits
 
2,815

 
2,475

Assets of SERP
 
1,638

 
1,606

Debt issuance costs
 
1,699

 
2,005

Other
 
5,089

 
4,211

Total
 
$
11,429

 
$
10,509

Other Current Liabilities
A summary of other current liabilities follows (in thousands):
 
 
June 30, 2016
 
December 31,
2015
Interest payable
 
$
20,174

 
$
5,410

Current taxes payable
 
2,388

 
1,977

Insurance liabilities
 
6,281

 
5,476

Third-party settlements
 
5,603

 
5,222

Acquisition consideration payable
 

 
16,768

Amounts due to patients and payors
 
15,422

 
11,424

Other accrued expenses
 
22,201

 
22,133

Total
 
$
72,069

 
$
68,410

The acquisition consideration payable is related to the acquisition of Symbion Holdings Corporation ("Symbion") and was funded to an escrow account on May 3, 2016.
Other Long-Term Liabilities
A summary of other long-term liabilities follows (in thousands):
 
 
June 30, 2016
 
December 31,
2015
Facility lease obligations
 
$
53,347

 
$
53,927

Medical malpractice liability
 
6,339

 
6,339

Liability of SERP
 
1,638

 
1,608

Contingent consideration obligation
 
14,611

 
14,049

Unfavorable lease liability
 
1,834

 
1,996

Other long-term liabilities
 
9,521

 
7,694

Total
 
$
87,290

 
$
85,613

The Company has facility lease obligations in connection with the surgical hospital located in Idaho Falls, Idaho and with a radiation oncology building at this facility. The obligation is payable to the lessor of this facility for the land, building and improvements. The current portion of the lease obligation was $939,000 and $797,000 at June 30, 2016 and December 31, 2015, respectively, and was included in other current liabilities in the condensed consolidated balance sheets. The total of the facility lease obligations related to the surgical hospital and radiation oncology building in Idaho Falls, Idaho was $50.4 million and $50.8 million at June 30, 2016 and December 31, 2015, respectively.
In addition, the Company has a facility lease obligation with a surgical facility in Ocala, Florida. The obligation is payable to the lessor of this facility for the building. The current portion of the lease obligation was $175,000 and $169,000 at June 30, 2016 and December 31, 2015, respectively, and was included in other current liabilities in the condensed consolidated balance sheets. The total of the facility lease obligations related to the surgical facility in Ocala, Florida was $4.0 million and $4.1 million at June 30, 2016 and December 31, 2015, respectively.
Operating Leases
The Company leases office space and equipment for its surgical facilities, including surgical facilities under development. The lease agreements generally require the lessee, or the Company, to pay all maintenance, property taxes, utilities and insurance costs. The Company


12

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

accounts for operating lease obligations and sublease income on a straight-line basis.  Contingent obligations of the Company, as defined by each lease agreement, are recognized when specific contractual measures have been met, typically the result of an increase in the Consumer Price Index. Lease obligations paid in advance are recorded as prepaid rent and included in prepaid expenses and other current assets on the condensed consolidated balance sheets. The difference between actual lease payments and straight-line lease expense over the initial lease term, excluding optional renewal periods, is recorded as deferred rent and included in other current liabilities and other long-term liabilities on the condensed consolidated balance sheets.
Equity-Based Compensation
Transactions in which the Company receives employee and non-employee services in exchange for the Company’s equity instruments or liabilities that are based on the fair value of the Company’s equity securities or may be settled by the issuance of these securities are accounted for using a fair value method. Prior to the Reorganization, on the grant date, the Company employed a market approach to estimate the fair value of equity-based awards based on various considerations and assumptions, including implied earnings multiples and other metrics of relevant market participants, the Company’s operating results and forecasted cash flows and the Company’s capital structure. Such estimates required the input of highly subjective, complex assumptions. However, such assumptions are no longer required to determine fair value of shares of the Company’s common stock as its underlying shares began trading publicly during the fourth quarter of 2015. The Company applies the Black-Scholes-Merton method of valuation in determining share-based compensation expense for option awards. 
The Company’s policy is to recognize compensation expense using the straight line method over the relevant vesting period for units that vest based on time. Prior to the Reorganization, employees held membership units in Surgery Center Holdings, LLC, and the associated expense was referred to as unit-based compensation. In connection with the Reorganization, the Company’s board of directors and stockholders adopted the Surgery Partners, Inc. 2015 Omnibus Incentive Plan from which the Company’s future equity-based awards will be granted. Following the Reorganization, such expense is referred to as equity-based compensation.
Professional, General and Workers' Compensation Insurance
The Company maintains general liability and professional liability insurance in excess of self-insured retentions through third party commercial insurance carriers in amounts that management believes is sufficient for the Company's operations, although, potentially, some claims may exceed the scope of coverage in effect. The professional and general insurance coverage is on a claims-made basis. Workers' compensation insurance is on an occurrence basis.
The Company expenses the costs under the self-insured retention exposure for general and professional liability and workers compensation claims which relate to (i) claims made during the policy period, which are offset by insurance recoveries and (ii) an estimate of claims incurred but not yet reported that are expected to be reported after the policy period expires. Reserves and provisions are based upon actuarially determined estimates. The reserves are estimated using individual case-basis valuations and actuarial analysis. Reserves for professional, general and workers' compensation claim liabilities are determined with no regard for expected insurance recoveries and are presented gross on the condensed consolidated balance sheets. Total professional, general and workers' compensation claim liabilities as of June 30, 2016 and December 31, 2015 were $9.7 million and $9.5 million, respectively. The balance includes expected insurance recoveries of $6.5 million and $6.3 million as of June 30, 2016 and December 31, 2015, respectively.
Electronic Health Record Incentives
The American Recovery and Reinvestment Act of 2009 provides for Medicare and Medicaid incentive payments beginning in calendar year 2011 for eligible hospitals and professionals that implement and achieve meaningful use of certified Electronic Health Records ("EHR") technology. Several of the Company's surgical hospitals have implemented plans to comply with the EHR meaningful use requirements of the Health Information Technology for Economic and Clinical Health Act ("HITECH") in time to qualify for the maximum available incentive payments.
Compliance with the meaningful use requirements has and will continue to result in significant costs including business process changes, professional services focused on successfully designing and implementing the Company's EHR solutions, along with costs associated with the hardware and software components of the project. The Company currently estimates that total costs incurred to comply will be recovered through the total EHR incentive payments over the projected life cycle of this initiative. The Company incurs both capital expenditures and operating expenses in connection with the implementation of its various EHR initiatives. The amount and timing of these expenditures do not directly correlate with the timing of the Company's cash receipts or recognition of the EHR incentives as other income. The Company expects to receive incentive payments and recognize corresponding revenue upon the completion of the EHR meaningful use requirements. The Company recorded electronic health records incentives income of $2,000 and $95,000 during the three and six months ended June 30, 2016, respectively, and expense for returned payments of $50,000 during the three and six months ended June 30, 2015.
Income Taxes and Tax Receivable Agreement
The Company uses the asset and liability method to account for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If a net operating loss carryforward exists, the Company makes a determination as to whether that net operating loss carryforward will be utilized in the future. A valuation allowance is established for certain net operating loss carryforwards when their recoverability is deemed to be uncertain. The carrying value of the net


13

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

deferred tax assets assumes that the Company will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions. If these estimates and related assumptions change in the future, the Company may be required to adjust its deferred tax valuation allowances.
The Company, or one or more of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal or state income tax examinations for years prior to 2011.
As part of the Reorganization that was effective September 30, 2015, the Company entered into a Tax Receivable Agreement (“TRA”) under which generally the Company will be required to pay to its stockholders as of immediately prior to the IPO 85% of the cash savings, if any, in U.S. federal, state or local tax that the Company actually realizes (or is deemed to realize in certain circumstances) as a result of (i) certain tax attributes, including NOLs, capital losses, charitable deductions, alternative minimum tax credit carryforwards and federal and state tax credits of Surgery Partners, Inc. and its affiliates relating to taxable years ending on or before the date of the Reorganization (calculated by assuming the taxable year of the relevant entity closes on the date of the Reorganization) that are or become available to the Company and its wholly-owned subsidiaries as a result of the Reorganization, and (ii) tax benefits attributable to payments made under the TRA, together with interest accrued at a rate of LIBOR plus 300 basis points from the date the applicable tax return is due (without extension) until paid.
The amounts payable under the TRA will vary depending upon a number of factors, including the amount, character and timing of the taxable income of Surgery Partners, Inc. in the future. The Company estimates the total amounts payable to be approximately $119.9 million, if the tax benefits of related deferred tax assets are ultimately realized. The amounts payable were recognized during 2015 in conjunction with the release of the Company's valuation allowance recorded against the deferred tax assets.
The Company and its subsidiaries file a consolidated federal income tax return. The partnerships, limited liability companies, and certain non-consolidated physician practice corporations file separate income tax returns. The Company's allocable portion of each partnership's and limited liability company's income or loss is included in taxable income of the Company. The remaining income or loss of each partnership and limited liability company is allocated to the other owners.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers," which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. This ASU provides companies the option of applying a full or modified retrospective approach upon adoption. This ASU was originally set to be effective for fiscal years beginning after December 15, 2016, and early adoption was not permitted. In July 2015, the FASB deferred the effective date for the standard to be effective for fiscal years beginning after December 15, 2017. The FASB will now permit companies to early adopt within one year of the new effective date. The Company will adopt this ASU on January 1, 2018 and is currently evaluating its plan for adoption and the impact on the Company's revenue recognition policies, procedures and the resulting impact on the Company's condensed consolidated financial position, results of operations and cash flows.
In February 2015, the FASB issued ASU 2015-02 “Amendments to the Consolidation Analysis,” which amends the current consolidation guidance, including introducing a separate consolidation analysis specific to limited partnerships and other similar entities. Under this analysis, limited partnerships and other similar entities will be considered a variable-interest entity unless the limited partners hold substantive kick-out rights or participating rights. The provisions of ASU 2015-02 are effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company adopted this ASU on January 1, 2016. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial position, results of operations, cash flows and financial disclosures.
In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs," which simplifies the presentation of debt issuance costs by requiring debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted, and the new guidance should be applied retrospectively. The Company adopted this ASU on January 1, 2016 retrospectively for all periods presented. As a result of the adoption of this ASU, the Company reclassified approximately $2.2 million at December 31, 2015, respectively, from deferred loan costs to long-term debt. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial position, results of operations, cash flows and financial disclosures.
In August 2015, the FASB issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements which clarifies the Securities and Exchange Commission (“SEC”) staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements given the lack of guidance on this topic in ASU 2015-03. The SEC staff has announced that it would “not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement.” The Company adopted this ASU on January 1, 2016 retrospectively for all periods presented. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial position, results of operations, cash flows and financial disclosures.
In September 2015, the FASB issued ASU 2015-16, “Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments” which eliminates the requirement for an acquirer to retrospectively adjust its financial statements for changes to provisional amounts that are identified during the measurement-period following the consummation of a business combination. Instead, ASU 2015-16 requires these types of adjustments to be made during the reporting period in which they are identified and would require additional disclosure or separate presentation of the portion of the adjustment that would have been recorded in the previously reported periods as if the adjustment


14

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 is effective prospectively for fiscal years beginning after December 15, 2015, including interim periods within those years. The Company adopted this ASU on January 1, 2016. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial position, results of operations, cash flows and financial disclosures.
In February 2016, the FASB issued ASU 2016-02, “Leases,” which will require, among other items, lessees to recognize most leases as assets and liabilities on the balance sheet. Qualitative and quantitative disclosures will be enhanced to better understand the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact this new guidance may have on the condensed consolidated financial position, results of operations and cash flows.
In March 2016, the FASB issued ASU 2016-07, “Investments- Equity Method and Joint Ventures,” which allows investments that now meet equity method treatment that were previously accounted for under a different method to apply the equity method prospectively from the date the investment qualifies for equity method treatment. ASU 2016-07 is effective prospectively for fiscal years beginning after December 15, 2016, including interim periods within those years. Early adoption is permitted. The Company is currently evaluating the impact this new guidance may have on the condensed consolidated financial position, results of operations and cash flows.
In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplifies the accounting for share-based payments including the income tax consequences, classification of certain awards and treatment of forfeitures. ASU 2016-09 is effective prospectively for fiscal years beginning after December 15, 2016, including interim periods within those years. Early adoption is permitted. The Company early adopted this ASU during the first quarter of 2016. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial position, results of operation, cash flows and financial disclosures.
3. Acquisitions and Developments
The Company accounts for its business combinations in accordance with the fundamental requirements of the acquisition method of accounting and under the premise that an acquirer can be identified for each business combination. The acquirer is the entity that obtains control of one or more businesses in the business combination and the acquisition date is the date the acquirer achieves control. The assets acquired, liabilities assumed and any non-controlling interests in the acquired business at the acquisition date are recognized at their fair values as of that date, and the direct costs incurred in connection with the business combination are recorded and expensed separately from the business combination. Acquisitions in which the Company is able to exert significant influence but does not have control are accounted for using the equity method.
2016 Transactions
During the six months ended June 30, 2016, the Company acquired a controlling interest in one surgical facility and an anesthesia practice in a new market and a surgical facility in an existing market which was merged into an existing facility for $28.8 million. Also, the Company completed acquisitions in existing markets of an urgent care facility, four physician practices and an integrated physician practice which includes an ASC, a lab and a pharmacy for a combined purchase price of $88.3 million, net of $16.6 million of contingent acquisition consideration. The acquisitions were funded through cash from operations, proceeds from the First Lien Credit Agreement and revolver proceeds.

















15

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

The aggregate amounts preliminarily recognized as of the acquisition date for each major class of assets and liabilities assumed in the acquisitions closed during the six months ended June 30, 2016 are as follows:

Cash consideration
$
100,493

Fair value of non-controlling interests
15,455

Aggregate fair value of acquisitions
115,948

Net assets acquired:
 
Cash and cash equivalents
4,244

Accounts receivable
6,321

Other current assets
216

Property and equipment
3,698

Intangible assets
2,614

Long-term assets
56

Accounts payable
(1,197
)
Other current liabilities
(2,933
)
     Net assets acquired
13,019

Excess of fair value over identifiable net assets acquired
$
102,929

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.
In accordance with ASC 805, Business Combinations, contingent consideration with a continuing employment provision is recognized ratably over the defined performance period as compensation expense. As of June 30, 2016, the Company estimates it may have to pay $16.6 million in future contingent purchase compensation expense over the remaining performance periods. These payments will be made should the requirements for continuing employment agreed to in the respective acquisition agreements be met. The contingent acquisition compensation expense recognized for the three months ended June 30, 2016 was $1.5 million and is included as a component of general and administrative expense (and parenthetically disclosed) in the results of the Company's operations.
Estimated contingent acquisition compensation expense subsequent to June 30, 2016 is as follows (in thousands):
For the remainder of 2016
$
3,059

2017
5,463

2018
5,244

2019
1,311

Total
$
15,077



16

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

4. Long-Term Debt
A summary of long-term debt follows (in thousands):
 
 
June 30, 2016
 
December 31,
2015
 
 
 
 
 
2014 Revolver Loan
 
$


$
125,250

2014 First Lien Credit Agreement
 
936,750


861,300

2014 Second Lien Credit Agreement
 


246,500

Senior Unsecured Notes

400,000



Subordinated Notes
 
1,000


1,000

Notes payable and secured loans
 
42,230


40,615

Capital lease obligations
 
12,135


11,316

Less: unamortized debt issuance costs and discount
 
(37,599
)

(30,622
)
Total debt
 
1,354,516

 
1,255,359

Less: Current maturities
 
28,738

 
27,247

Total long-term debt
 
$
1,325,778

 
$
1,228,112

2014 Revolver Loan
The 2014 Revolver Loan (“Revolver”), entered into on November 3, 2014, is a revolving credit facility used for working capital, acquisitions and development activities and general corporate purposes and matures on November 3, 2019. On October 7, 2015, the Company entered into an amendment to the 2014 First Lien Credit Agreement to increase certain lenders’ commitments under the Revolver from $80.0 million to an aggregate principal amount at any time outstanding not to exceed $150.0 million.
The Company has the option of classifying borrowings under the Revolver as either Alternate Base Rate ("ABR") loans or Eurodollar ("ED") loans. The interest base rate on an ABR loan is equal to the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Effective Rate in effect on such day plus 0.50% and (c) the adjusted LIBO Rate for a Eurodollar Borrowing with a one-month interest period plus 1.00%. In addition to the base rate, the Company is required to pay a 3.25% margin for ABR loans. The interest base rate on an ED loan is equal to (x) the LIBO Rate for such Eurodollar borrowing in effect for such Interest Period divided by (y) One minus the Statutory Reserves (if any) for such Eurodollar Borrowing for such interest period. In addition to the base rate, the Company is required to pay a 4.25% margin for ED loans. The Company must also pay quarterly commitment fees of 0.50% per annum of the average daily unused amount of the Revolver. As of June 30, 2016, the Company availability on the Revolver was $146.9 million (including outstanding letters of credit of $3.1 million).
The 2014 First Lien Credit Agreement governs the Revolver and contains various covenants that include limitations on the Company's indebtedness, liens, acquisitions and investments. It additionally includes the requirement that, if triggered, the Company maintain a net leverage ratio within a specified range. As of June 30, 2016, the Company was in compliance with the covenants contained in the 2014 First Lien Credit Agreement.
2014 First Lien Credit Agreement
The 2014 First Lien Credit Agreement (“2014 First Lien”), entered into on November 3, 2014, is a senior secured obligation of Surgery Center Holdings, Inc. and is guaranteed on a senior secured basis by certain subsidiaries of the Company. The 2014 First Lien matures on November 3, 2020. On March 24, 2016, Surgery Center Holdings, Inc. and certain subsidiaries of the Company entered into an amendment to the 2014 First Lien to obtain an incremental term loan in an aggregate principal amount of $80.0 million, which increased the total term loan obligation under the 2014 First Lien to $950.0 million. The Company used the proceeds of the incremental term loan to fund certain proposed acquisitions and for other corporate purposes.
The Company has the option of classifying the 2014 First Lien as either an ABR loan or an ED loan. The interest base rate on an ABR loan is equal to the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Effective Rate in effect on such day plus 0.50%, and (c) the Adjusted LIBO Rate for a Eurodollar Borrowing with a one-month interest period plus 1.00%; provided that the base rate shall not be less than 2.00% per annum. In addition to the base rate, the Company is required to pay a 3.25% margin for ABR loans. The interest base rate on an ED loan is equal to (x) the LIBO Rate for such Eurodollar borrowing in effect for such Interest Period divided by (y) One minus the Statutory Reserves (if any) for such Eurodollar Borrowing for such interest period; provided that the rate shall not be less than 1.00% per annum. In addition to the base rate, the Company is required to pay a 4.25% margin for ED loans. In 2015, the Company classified the 2014 First Lien as an ED loan with an interest rate of 5.25% (1.00% base rate plus a 4.25% margin). Accrued interest is payable in arrears on a quarterly basis. Within five business days after the earlier of (i) 90 days after the end of each fiscal year or (ii) the date on which financial statements have been delivered, the Company is required to make mandatory prepayments in amounts calculated in accordance with the excess cash flow provisions of the 2014 First Lien Credit Agreement. There were no excess cash flow payments required as of June 30, 2016.


17

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

In connection with the incremental loan of $80.0 million in March 2016, the Company recorded an additional $1.6 million and $3.3 million as original issue discount and amounts paid to lender for debt related issuance costs, respectively.
The 2014 First Lien Credit Agreement governs the 2014 First Lien and contains various covenants that include limitations on the Company's indebtedness, liens, acquisitions and investments. As of June 30, 2016, the Company was in compliance with the covenants contained in the 2014 First Lien Credit Agreement. The 2014 First Lien is collateralized by substantially all of the assets of the Company.
2014 Second Lien Credit Agreement
The 2014 Second Lien Credit Agreement (“2014 Second Lien”), entered into on November 3, 2014, was prepaid in full on March 31, 2016 as described below. The 2014 Second Lien was a senior secured obligation of Surgery Center Holdings, Inc. and was guaranteed on a senior secured basis by the Company and certain of its subsidiaries. On March 31, 2016, the Company repaid the remaining principal of the 2014 Second Lien of $252.8 million with the proceeds of the issuance of the Senior Unsecured Notes, defined below, of which $1.3 million was accrued interest. In connection with the prepayment, the Company incurred a loss on the extinguishment of debt of $8.3 million which included the write-off of loan costs and the original issue discount and a prepayment penalty.
Senior Unsecured Notes
Effective March 31, 2016, one of the Company's subsidiaries, Surgery Center Holdings, Inc., issued $400.0 million in gross proceeds of senior unsecured notes due April 15, 2021 (the "Senior Unsecured Notes"). The Senior Unsecured Notes bear interest at the rate of 8.875% per year, payable semi-annually on April 15 and October 15 of each year. The Senior Unsecured Notes are a senior unsecured obligation of Surgery Center Holdings, Inc. and are guaranteed on a senior unsecured basis by each of Surgery Center Holdings, Inc.'s existing and future domestic wholly owned restricted subsidiaries that guarantees the Revolver and the 2014 First Lien.
The Company may redeem up to 35% of the aggregate principal amount of the Senior Unsecured Notes, at any time before April 15, 2018, with the net cash proceeds of certain equity offerings at a redemption price equal to 108.875% of the principal amount to be redeemed, plus accrued and unpaid interest to, but excluding, the date of redemption, provided that at least 50% of the aggregate principal amount of the Senior Unsecured Notes remain outstanding immediately after the occurrence of such redemption and such redemption occurs within 180 days of the date of the closing of any such qualified equity offering.
The Company may redeem the Senior Unsecured Notes, in whole or in part, at any time prior to April 15, 2018 at a price equal to 100.000% of the principal amount of the notes redeemed plus an applicable make-whole premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company may redeem the Senior Unsecured Notes, in whole or in part, at any time on or after April 15, 2018, plus accrued and unpaid interest, if any, to the date of redemption plus a redemption price equal to a percentage of the principal amount of the notes redeemed based on the following redemption schedule:
April 15, 2018 to April 14, 2019
106.656
%
April 15, 2019 to April 14, 2020
104.438
%
April 15, 2020 and thereafter
100.000
%
If one of the Company's subsidiaries, Surgery Center Holdings, Inc., experiences a change in control under certain circumstances, it must offer to purchase the notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest to, but excluding, the date of repurchase.
The Senior Unsecured Notes contain customary affirmative and negative covenants, which among other things, limit the Company’s ability to incur additional debt, pay dividends, create or assume liens, effect transactions with its affiliates, guarantee payment of certain debt securities, sell assets, merge, consolidate, enter into acquisitions and effect sale and leaseback transactions.
In connection with the offering of the Senior Unsecured Notes, the Company recorded debt issuance costs of $8.4 million.    
Subordinated Notes
Effective April 11, 2013, the Company amended and reduced the size of its subordinated debt facility ("Subordinated Notes") to $1.0 million from $53.8 million. The Subordinated Notes, owed to H.I.G. Surgery Centers, LLC, mature on August 4, 2017. Effective January 1, 2014, the Subordinated Notes bear interest of 17.00% per annum.
Notes Payable and Secured Loans
Certain of the Company’s subsidiaries have outstanding bank indebtedness, which is collateralized by the real estate and equipment owned by the surgical facilities to which the loans were made. The various bank indebtedness agreements contain covenants to maintain certain financial ratios and also restrict encumbrance of assets, creation of indebtedness, investing activities and payment of distributions. At June 30, 2016, the Company was in compliance with its covenants contained in the credit agreement. The Company and its subsidiaries had notes payable to financial institutions of $42.2 million and $40.6 million as of June 30, 2016 and December 31, 2015, respectively. The Company and its subsidiaries also provide a corporate guarantee of certain indebtedness of the Company’s subsidiaries.
Capital Lease Obligations
The Company is liable to various vendors for several equipment leases classified as capital leases.  The carrying value of the leased assets was $13.2 million and $12.3 million as of June 30, 2016 and December 31, 2015, respectively.


18

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

5. 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. The following is a reconciliation of the numerator and denominator of basic and diluted earnings per share for the three and six months ended June 30, 2016 and 2015 (in thousands except share and per share amounts):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Net income (loss) attributable to Surgery Partners, Inc.
 
$
2,120

 
$
(5,426
)
 
$
(5,071
)
 
$
(12,188
)
 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted average shares outstanding- basic (1)
 
48,019,652

 
32,054,089

 
48,018,228

 
32,054,089

Effect of dilutive securities (2)
 
109,389

 

 

 

Weighted average shares outstanding- diluted
 
48,129,041

 
32,054,089

 
48,018,228

 
32,054,089

 
 
 
 
 
 
 
 
 
Net income (loss) per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.04

 
$
(0.17
)
 
$
(0.11
)
 
$
(0.38
)
Diluted (2)
 
$
0.04

 
$
(0.17
)
 
$
(0.11
)
 
$
(0.38
)
 
 
 
 
 
 
 
 
 
Securities outstanding not included in the computation of diluted income (loss) per share as their effect is antidilutive:
 
 
 
 
 
 
 
 
Stock options
 

 

 

 

Restricted shares
 
109,389

 
1,817,901

 
100,560

 
1,799,035

(1) Effect of the Reorganization has been retrospectively applied to the three and six months ended June 30, 2015.
(2) The impact of potentially dilutive securities for the six months ended June 30, 2016 and the three and six months ended June 30, 2015 was not considered because the effect would be anti-dilutive in each of those periods.

6. Related Party Transactions
On December 24, 2009, the Company and Bayside Capital, Inc. (or "Bayside"), an affiliate of H.I.G. Capital, LLC (or "H.I.G."), entered into a Management and Investment Advisory Services Agreement ("Management Agreement") pursuant to which the Company received certain management, consulting and financial advisory services. Effective November 3, 2014, the Management Agreement was amended pursuant to the Symbion acquisition and the management fee was increased to $3.0 million annually. Fees related to the Management Agreement for the six months ended June 30, 2015 are recognized as general and administrative expense in the accompanying condensed consolidated statements of operations. Bayside was paid a transaction fee pursuant to the Management Agreement of $5.4 million in connection with the IPO and the Management Agreement was terminated upon the completion of the IPO.
7. Commitments and Contingencies
Lease and Debt Guarantees of Non-Consolidated Facilities
As of June 30, 2016 and December 31, 2015, the Company had guaranteed approximately $86,000 and $539,000, respectively, of operating lease payments for a non-consolidated surgical facility. These operating leases typically have 10-year terms, with optional renewal periods.
Professional, General and Workers' Compensation Liability Risks
The Company is subject to claims and legal actions in the ordinary course of business, including claims relating to patient treatment, employment practices and personal injuries. To cover these claims, the Company maintains general liability and professional liability insurance in excess of self-insured retentions through third party commercial insurance carriers in amounts that management believes is sufficient for the Company's operations, although, potentially, some claims may exceed the scope of coverage in effect. The professional and general insurance coverage is on a claims-made basis. Workers' compensation insurance is on an occurrence basis. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. The Company is not aware of any such proceedings that would have a material adverse effect on the Company's business, financial condition or results of operations.


19

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

Laws and Regulations
Laws and regulations governing the Company's business, including those relating to the Medicare and Medicaid programs, are complex and subject to interpretation. These laws and regulations govern every aspect of how the Company's surgical facilities conduct their operations, from licensing requirements to how and whether the Company's facilities may receive payments pursuant to the Medicare and Medicaid programs. Compliance with such laws and regulations can be subject to future government agency review and interpretation as well as legislative changes to such laws. Noncompliance with such laws and regulations may subject the Company to significant regulatory action including fines, penalties, and exclusion from the Medicare, Medicaid and other federal healthcare programs. From time to time, governmental regulatory agencies will conduct inquiries of the Company's practices, including, but not limited to, the Company's compliance with federal and state fraud and abuse laws, billing practices and relationships with physicians. It is the Company's current practice and future intent to cooperate fully with such inquiries. The Company is not aware of any such inquiry that would have a material adverse effect on the Company's business, results of operations or financial condition.
Acquired Facilities
The Company, through its wholly-owned subsidiaries or controlled partnerships and limited liability companies, has acquired and will continue to acquire surgical facilities with prior operating histories. Such facilities may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although the Company attempts to assure that no such liabilities exist, obtain indemnification from prospective sellers covering such matters and institute policies designed to conform centers to its standards following completion of acquisitions, there can be no assurance that the Company will not become liable for past activities that may later be asserted to be improper by private plaintiffs or government agencies. There can be no assurance that any such matter will be covered by indemnification or, if covered, that the liability sustained will not exceed contractual limits or the financial capacity of the indemnifying party.
The Company cannot predict whether federal or state statutory or regulatory provisions will be enacted that would prohibit or otherwise regulate relationships which the Company has established or may establish with other healthcare providers or have materially adverse effects on its business or revenues arising from such future actions. Management believes, however, that it will be able to adjust the Company's operations so as to be in compliance with any statutory or regulatory provision as may be applicable.
Potential Physician Investor Liability
A majority of the physician investors in the partnerships and limited liability companies which operate the Company's surgical facilities carry general and professional liability insurance on a claims-made basis. Each partnership or limited liability company may, however, be liable for damages to persons or property arising from occurrences at the surgical facilities. Although the various physician investors and other surgeons generally are required to obtain general and professional liability insurance with tail coverage that extends beyond the period of any claims-made policies, such individuals may not be able to obtain coverage in amounts sufficient to cover all potential liability. Since most insurance policies contain exclusions, the physician investors will not be insured against all possible occurrences. In the event of an uninsured or underinsured loss, the value of an investment in the partnership interests or limited liability company membership units and the amount of distributions could be adversely affected.
Contingent Consideration
Pursuant to a purchase agreement dated December 24, 2009 (“the Purchase Agreement”), the Company acquired controlling interests in 36 business entities in various Florida locations which operate freestanding ASCs and provided anesthesia and pain management services (“the 2009 Acquisition”). The Purchase Agreement provided for maximum potential contingent consideration of up to $10.0 million based on operating results subsequent to the acquisition for the period from January 1, 2010 to December 31, 2010. Pursuant to the Purchase Agreement, the contingent consideration is payable as principal under a Subordinated Promissory Note that bears interest at 8%, the form of which was delivered concurrent with the Purchase Agreement. The balance is still outstanding due to ongoing litigation as a result of the civil claim. The Company has made indemnification claims against the Seller exceeding the amount of the contingent consideration liability which the Company has a contractual right of offset against the contingent consideration. The fair value of the contingent consideration liability, including accrued interest, as of June 30, 2016 and December 31, 2015 was $14.6 million and $14.0 million, respectively.
In connection with an acquisition during the three months ended June 30, 2016, pursuant to the purchase agreement, the Company must pay consideration to the prior owners of the applicable facility should the requirements for continuing employment agreed to in the respective purchase agreements be met. As of June 30, 2016, the Company estimates it may have to pay $16.6 million in future contingent purchase compensation expense over the remaining performance periods. The contingent acquisition compensation expense recognized for the three months ended June 30, 2016 was $1.5 million and is included as a component of general and administrative expense (and parenthetically disclosed) in the results of the Company's operations.
Acquisition of Symbion
The Company completed the acquisition of Symbion effective November 3, 2014. At closing, the Company funded $16.2 million of the purchase price to an escrow account. During 2015, $2.1 million of the escrow account was distributed based on a working capital settlement reducing the total amount funded on the escrow account to $14.0 million as of December 31, 2015. On May 3, 2016, the Company paid $16.6 million to fully fund the required balance in the escrow account. The amounts funded were materially consistent with the amounts stated within the purchase agreement. Subsequent to this funding, the escrow balance was fully distributed to the prior owners of Symbion.


20

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

8. Segment Reporting
A public company is required to report annual and interim financial and descriptive information about its reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or "CODM," in deciding how to allocate resources and in assessing performance.
The Company operates in three major lines of business that are also the Company's reportable operating segments - the operation of surgical facilities, the operation of optical services and the operation of ancillary services, which includes physician practices, a diagnostic laboratory and a specialty pharmacy.
During the second quarter of 2016, the Company reassessed its segment reporting and realigned the disclosures to reflect the review and decision making made by the Chief Operating Decision Maker (“CODM”). The purpose of these changes was to replace operating income with adjusted EBITDA as the primary profit/loss metric reviewed by the CODM in making key business decisions and on allocation of resources. The Company has revised the segment disclosures below to replace operating income with adjusted EBITDA and has provided a reconciliation from adjusted EBITDA back to net income in the reported condensed consolidated financial information. These changes had no effect on the Company’s reportable segments, which are presented consistent with prior periods.
The following tables present financial information for each reportable segment (in thousands):
 
 
Three Months Ended June 30,

Six Months Ended June 30,
 
 
2016
 
2015

2016

2015
Revenues:
 
 
 
 




Surgical facility services
 
$
263,783

 
$
216,585


$
509,453


$
424,269

Ancillary services
 
22,503

 
12,492


40,283


25,211

Optical services
 
3,395

 
3,750


7,019


7,490

        Total revenues
 
$
289,681

 
$
232,827


$
556,755


$
456,970






21

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Segment Adjusted EBITDA:
 
 
 
 
 
 
 
Surgical facility services
$
54,311

 
$
43,486

 
$
99,971

 
$
85,306

Ancillary services
3,068

 
4,484

 
6,568

 
8,300

Optical services
849

 
1,173

 
1,728

 
2,191

        Total segment adjusted EBITDA (3)
$
58,228

 
$
49,143

 
$
108,267

 
$
95,797

 
 
 
 
 
 
 
 
General and administrative expenses
$
(15,023
)
 
$
(11,846
)
 
$
(27,220
)
 
$
(23,708
)
Non-cash stock compensation expense
502

 
427

 
635

 
853

Contingent acquisition compensation expense
1,530

 

 
1,530

 

Management fee (4)

 
750

 

 
1,500

Acquisition related costs
795

 

 
1,245

 

 
 
 
 
 
 
 
 
Total adjusted EBITDA (3)
$
46,032

 
$
38,474

 
$
84,457

 
$
74,442

 
 
 
 
 
 
 
 
Net income attributable to non-controlling interests
$
20,173

 
$
17,905

 
$
37,720

 
$
35,155

Depreciation and amortization
(9,702
)
 
(8,465
)
 
(19,271
)
 
(16,927
)
Interest and other expense, net
(26,235
)
 
(26,178
)
 
(48,388
)
 
(51,934
)
Income tax expense
(2,420
)
 
(2,344
)
 
(4,190
)
 
(4,451
)
Non-cash stock compensation expense
(502
)
 
(427
)
 
(635
)
 
(853
)
Contingent acquisition compensation expense
(1,530
)
 

 
(1,530
)
 

Management fee (4)

 
(750
)
 

 
(1,500
)
Merger transaction, integration and practice acquisition costs (5)
(2,192
)
 
(8,642
)
 
(6,108
)
 
(13,648
)
(Loss) gain on disposal or impairment of long-lived assets, net
(1,331
)
 
2,906

 
(1,125
)
 
2,683

Loss on debt refinancing

 

 
(8,281
)
 

Total net income
$
22,293

 
$
12,479

 
$
32,649

 
$
22,967

(3) The above table reconciles adjusted EBITDA by segment to net income as reflected in the unaudited condensed consolidated statements of operations.
When the Company uses the term “Adjusted EBITDA,” it is referring to net income minus (a) net income attributable to non-controlling interests plus (b) income tax expense, (c) interest and other expense, net, (d) depreciation and amortization, (e) management fee, (f) merger transaction, integration and practice acquisition costs, (g) non-cash stock compensation expense, (h) loss on debt refinancing, (i) contingent acquisition compensation expense and (j) (gain) loss on disposal of investments and long-lived assets. Non-controlling interests represent the interests of third parties, such as physicians, and in some cases, healthcare systems that own an interest in surgical facilities that the Company consolidates for financial reporting purposes. The Company's operating strategy is to apply a market-based approach in structuring its partnerships with individual market dynamics driving the structure. The Company believes that it is helpful to investors to present Adjusted EBITDA as defined above because it excludes the portion of net income attributable to these third-party interests and clarifies for investors the Company's portion of Adjusted EBITDA generated by its surgical facilities and other operations.
The Company uses Adjusted EBITDA as a measure of liquidity. It is included because the Company believes that it provides investors with additional information about its ability to incur and service debt and make capital expenditures.
Adjusted EBITDA is not a measurement of financial performance or liquidity under GAAP. It should not be considered in isolation or as a substitute for net income, operating income, cash flows from operating, investing or financing activities, or any other measure calculated in accordance with generally accepted accounting principles. The items excluded from Adjusted EBITDA are significant components in understanding and evaluating financial performance and liquidity. The Company's calculation of Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.
(4) Fee payable pursuant the Management and Investment Advisory Services Agreement between the Company and Bayside Capital, Inc., which was terminated in connection with our IPO.
(5) This amount includes merger transaction and integration costs of $1.3 million and $4.5 million for the three and six months ended June 30, 2016, respectively, and practice acquisition costs of $867,000 and $1.6 million for the three and six months ended June 30, 2016, respectively.



22

SURGERY PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2016
(Unaudited)

 
 
June 30, 2016
 
December 31, 2015
Assets:
 
 
 
 
Surgical facility services
 
$
1,849,326

 
$
1,762,396

Ancillary services
 
164,394

 
118,198

Optical services
 
24,902

 
25,537

           Total
 
$
2,038,622

 
$
1,906,131

 
 
 
 
 
General and administrative
 
$
174,901

 
$
198,312

Total assets
 
$
2,213,523

 
$
2,104,443

 
 
Six Months Ended June 30,
 
 
2016
 
2015
Supplemental Information:
 
 
 
 
Cash purchases of property and equipment, net:
 
 
 
 
    Surgical facility services
 
$
14,745

 
$
8,506

    Ancillary services
 
2,951

 
147

    Optical services
 
96

 
50

           Total
 
$
17,792

 
$
8,703

 
 
 
 
 
General and administrative
 
$
2,558

 
$
2,843

Total cash purchases of property and equipment, net
 
$
20,350

 
$
11,546



23

SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (UNAUDITED)
JUNE 30, 2016


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report and included in the Annual Report on Form 10-K for the year ended December 31, 2015. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those estimated or projected in any of these forward-looking statements. Unless otherwise indicated or the context otherwise requires, references herein to the “Company”, “Surgery Partners”, “we”, “us” and “our” refer to, (i) Surgery Center Holdings, LLC and its consolidated subsidiaries, including Surgery Center Holdings, Inc., immediately prior to the Reorganization and (ii) Surgery Partners, Inc. and its consolidated subsidiaries, including Surgery Center Holdings, LLC and Surgery Center Holdings, Inc., immediately following the Reorganization. Unless the context implies otherwise, the term “affiliates” means direct and indirect subsidiaries of Surgery Center Holdings, LLC and Surgery Partners, Inc., as applicable, 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, and the term “employees” refers to employees of affiliates of Surgery Partners.
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, including statements regarding our future financial position, business strategy, budgets, effective tax rate, projected costs and plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” and similar expressions are generally intended to identify forward-looking statements. These statements involve risks, uncertainties and other factors that may cause actual results to differ from the expectations expressed in the statements. Many of these factors are beyond our ability to control or predict.  These factors include, without limitation: (i) reductions in payments from government healthcare programs and managed care organizations; (ii) inability to contract with private third-party payors; (iii) failure to fully integrate the operations of Surgery Partners and legacy Symbion; (iv) changes in our payor mix or surgical case mix; (v) failure to maintain relationships with our physicians; (vi) payor controls designed to reduce the number of surgical procedures; (vii) inability to integrate operations of acquired surgical facilities, attract new physician partners, or acquire additional surgical facilities; (viii) shortages or quality control issues with surgery-related products, equipment and medical supplies; (ix) competition for physicians, nurses, strategic relationships, acquisitions and managed care contracts; (x) inability to enforce non-compete restrictions against our physicians; (xi) material liabilities incurred as a result of acquiring surgical facilities; (xii) litigation or medical malpractice claims; (xiii) changes in the regulatory, economic and other conditions of the states where our surgical facilities are located; (xiv) substantial payments we expect to be required to make under the tax receivable agreement; and (xv) other risks and uncertainties described in this report and set forth under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 11, 2016.
In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur, and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report.
These forward-looking statements speak only as of the date made. Other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Executive Overview
As of August 10, 2016, we owned and operated a national network of surgical facilities and physician practices in 29 states. Our surgical facilities, which include ASCs and surgical hospitals, primarily provide non-emergency surgical procedures across many specialties, including, among others, otolaryngology ("ENT"), gastroenterology ("GI"), general surgery, ophthalmology, orthopedics, cardiology and pain management. Our surgical hospitals provide services, such as diagnostic imaging, laboratory, obstetrics, oncology, pharmacy, physical therapy and wound care. Our portfolio of outpatient surgical facilities is complemented by our suite of ancillary services, which support our physicians in providing high quality and cost-efficient patient care. These ancillary services are comprised of a diagnostic laboratory, multi-specialty physician practices, urgent care facilities, anesthesia services, optical services and specialty pharmacy services. As a result, we believe we are well positioned to benefit from rising consumerism and payors’ and patients’ focus on the delivery of high quality care and superior clinical outcomes in the lowest cost and care setting.
As of August 10, 2016, we owned or operated, primarily in partnership with physicians, a portfolio of 103 surgical facilities comprised of 98 ASCs and five surgical hospitals across 29 states. We owned a majority interest in 72 of the surgical facilities and consolidated 92 of these facilities for financial reporting purposes. In addition to surgical facilities, we owned or operated a network of 53 physician practices as of August 10, 2016. For the six months ended June 30, 2016, approximately 209,000 surgical procedures were performed in our surgical facilities, generating approximately $509.5 million in revenue.
We continue to focus on improving our same-facility performance, selectively acquiring established facilities and developing new facilities. During the six months ended June 30, 2016, we completed one surgical facility and anesthesia practice transaction in a new market and two surgical facility transactions and an anesthesia practice transaction in an existing market, six in-market physician practice transactions, a pharmacy and a lab for an aggregate investment of $117.1 million, net of $16.6 million of contingent acquisition consideration, adding a total of twelve physicians to our physician network.


24

SURGERY PARTNERS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (UNAUDITED)
JUNE 30, 2016


Revenues
Our revenues consist of patient service revenues and other service revenues. Patient service revenues consist of revenue from our surgical facility services and ancillary services segments. Specifically, patient service revenues include fees for surgical or diagnostic procedures performed at surgical facilities that we consolidate for financial reporting purposes, as well as for patient visits to our physician practices, anesthesia services, pharmacy services and diagnostic screens ordered by our physicians. Other service revenues consist of product sales from our optical laboratories, as well as the discounts and handling charges billed to the members of our optical products purchasing organization. Other service revenues also include management and administrative service fees derived from our non-consolidated facilities that we account for under the equity method, management of surgical facilities and physician practices in which we do not own an interest and management services we provide to physician practices for which we are not required to provide capital or additional assets.
The following table summarizes our revenues by service type as a percentage of total revenues for the periods indicated:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Patient service revenues:
 
 
 
 
 
 
 
 
   Surgical facilities revenues
 
90.0
%
 
92.5
%
 
90.6
%
 
92.4
%
   Ancillary services revenues
 
7.7
%
 
5.4
%
 
7.2
%
 
5.5
%
 
 
97.7
%
 
97.9
%
 
97.8
%
 
97.9
%
Other service revenues:
 
 
 
 
 
 
 
 
   Optical services revenues
 
1.2
%
 
1.6
%
 
1.3
%
 
1.6
%
   Other
 
1.1
%
 
0.5
%
 
0.9
%
 
0.5
%
 
 
2.3
%
 
2.1
%
 
2.2
%
 
2.1
%
Total revenues
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Payor Mix
The following table sets forth by type of payor the percentage of our patient service revenues generated at the surgical facilities which we consolidate for financial reporting purposes in the periods indicated:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Private insurance payors
 
51.3
%
 
53.9
%
 
50.9
%
 
54.9