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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

OR

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission file number: 001-36154

 

SURGICAL CARE AFFILIATES, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

20-8740447

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

520 Lake Cook Road, Suite 250

Deerfield, IL

 

60015

(Address of principal executive offices)

 

(Zip Code)

(847) 236-0921

(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  ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

¨

  

Accelerated filer

 

x

 

 

 

 

Non-accelerated filer

 

¨

  

Smaller reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class of Common Stock

  

Outstanding at July 31, 2015

Common stock, $0.01 par value

  

39,479,212 shares

 

 

 


SURGICAL CARE AFFILIATES, INC.

FORM 10-Q

INDEX

 

PART I.

  

FINANCIAL INFORMATION

 

 

Item 1.

  

Financial Statements (Unaudited):

1

 

  

 

Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014

1

 

  

 

Condensed Consolidated Statements of Operations for the Three- and Six-Months Ended June 30, 2015 and 2014

2

 

  

 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three- and Six-Months Ended June 30, 2015 and 2014

4

 

  

 

Condensed Consolidated Statements of Changes in Equity for the Six-Months Ended June 30, 2015 and 2014

5

 

  

 

Condensed Consolidated Statements of Cash Flows for the Six-Months Ended June 30, 2015 and 2014

6

 

  

 

Notes to Condensed Consolidated Financial Statements

8

 

Item 2.

  

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

31

 

Item 3.

  

 

Quantitative and Qualitative Disclosures About Market Risk

51

 

Item 4.

  

 

Controls and Procedures

52

 

PART II.

  

 

OTHER INFORMATION

 

Item 1.

  

 

Legal Proceedings

53

Item 1A.

  

 

Risk Factors

53

Item 2.

  

 

Unregistered Sales of Equity Securities and Use of Proceeds

53

Item 3.

  

 

Defaults Upon Senior Securities

53

Item 4.

  

 

Mine Safety Disclosure

53

Item 5.

  

 

Other Information

53

Item 6.

  

 

Exhibits

54

 

 

 

 


 

GENERAL

Unless the context otherwise indicates or requires, references in this Quarterly Report on Form 10-Q to “Surgical Care Affiliates,” the “Company,” “we,” “us” and “our” refer to Surgical Care Affiliates, Inc. and its consolidated affiliates. In addition, unless the context otherwise indicates or requires, the term “SCA” refers to Surgical Care Affiliates, LLC, our direct operating subsidiary.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements that reflect our current views with respect to, among other things, future events and financial performance, which involve substantial risks and uncertainties. Certain statements made in this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include any statement that, without limitation, may predict, forecast, indicate or imply future results, performance or achievements instead of historical or current facts and may contain words like “anticipates,” “approximately,” “believes,” “budget,” “can,” “could,” “continues,” “contemplates,” “estimates,” “expects,” “forecast,” “intends,” “may,” “might,” “objective,” “outlook,” “predicts,” “probably,” “plans,” “potential,” “project,” “seeks,” “shall,” “should,” “target,” “will,” or the negative of these terms and other words, phrases, or expressions with similar meaning.

Any forward-looking statements contained in this Quarterly Report on Form 10-Q are based upon our historical performance and on our current plans, estimates and expectations in light of information currently available to us. The inclusion of forward-looking information should not be regarded as a representation by us that the future plans, estimates or expectations will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions relating to our operations, financial results, financial condition, business, prospects, growth strategy and liquidity. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from those projected in the forward-looking statements, and the Company cannot give assurances that such statements will prove to be correct. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information or otherwise. Given these uncertainties, the reader should not place undue reliance on forward-looking statements as a prediction of actual results. Factors that could cause actual results to differ materially from those projected or estimated by us include those that are discussed in our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2015 under Part II, “Item 1A. Risk Factors” and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 under Part I, “Item 1A. Risk Factors.”

 

 

 

ii


 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amount)

(Unaudited)  

 

JUNE 30,

 

 

DECEMBER 31,

 

 

2015

 

 

2014

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

$

77,838

 

 

$

8,731

 

Restricted cash

 

24,883

 

 

 

24,073

 

Accounts receivable, net of allowance for doubtful accounts (2015 - $14,094; 2014 - $10,448)

 

102,189

 

 

 

100,529

 

Receivable from nonconsolidated affiliates

 

35,287

 

 

 

72,030

 

Prepaids and other current assets

 

32,651

 

 

 

30,170

 

Current assets related to discontinued operations

 

7

 

 

 

1,959

 

Current assets held for sale

 

1,201

 

 

 

 

Total current assets

 

274,056

 

 

 

237,492

 

Property and equipment, net of accumulated depreciation

 

221,971

 

 

 

209,642

 

Goodwill

 

979,129

 

 

 

902,391

 

Intangible assets, net of accumulated amortization

 

95,159

 

 

 

84,262

 

Deferred debt issue costs

 

7,932

 

 

 

5,383

 

Investment in and advances to nonconsolidated affiliates

 

207,255

 

 

 

194,610

 

Other long-term assets

 

5,088

 

 

 

4,311

 

Assets related to discontinued operations

 

480

 

 

 

9,344

 

Assets held for sale

 

7,520

 

 

 

 

Total assets (a)

$

1,798,590

 

 

$

1,647,435

 

Liabilities and Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Current portion of long-term debt

$

26,848

 

 

$

24,690

 

Accounts payable

 

29,237

 

 

 

31,717

 

Accrued payroll

 

25,346

 

 

 

29,199

 

Accrued interest

 

4,637

 

 

 

234

 

Accrued distributions

 

32,170

 

 

 

29,134

 

Payable to nonconsolidated affiliates

 

66,680

 

 

 

104,519

 

Deferred income tax liability

 

908

 

 

 

855

 

Other current liabilities

 

29,576

 

 

 

26,747

 

Current liabilities related to discontinued operations

 

2,015

 

 

 

2,280

 

Current liabilities held for sale

 

1,198

 

 

 

 

Total current liabilities

 

218,615

 

 

 

249,375

 

Long-term debt, net of current portion

 

774,875

 

 

 

665,119

 

Deferred income tax liability

 

138,306

 

 

 

130,165

 

Other long-term liabilities

 

21,391

 

 

 

19,683

 

Liabilities related to discontinued operations

 

426

 

 

 

683

 

Liabilities held for sale

 

2,526

 

 

 

 

Total liabilities (a)

 

1,156,139

 

 

 

1,065,025

 

Commitments and contingent liabilities (Note 14)

 

 

 

 

 

 

 

Noncontrolling interests – redeemable (Note 8)

 

16,965

 

 

 

15,444

 

Equity

 

 

 

 

 

 

 

Surgical Care Affiliates’ equity

 

 

 

 

 

 

 

Common stock, $0.01 par value, 180,000 shares authorized, 39,458 and 38,648 shares

   outstanding, respectively

 

395

 

 

 

386

 

Additional paid-in capital

 

440,478

 

 

 

419,088

 

Accumulated deficit

 

(180,741

)

 

 

(176,135

)

Total Surgical Care Affiliates’ equity

 

260,132

 

 

 

243,339

 

Noncontrolling interests – non-redeemable (Note 8)

 

365,354

 

 

 

323,627

 

Total equity

 

625,486

 

 

 

566,966

 

Total liabilities and equity

$

1,798,590

 

 

$

1,647,435

 

(a)

Our consolidated assets as of June 30, 2015 and December 31, 2014 include total assets of our variable interest entities (“VIEs”) of $148.5 million and $117.5 million, respectively, which can only be used to settle the obligations of the VIEs. Our consolidated total liabilities as of June 30, 2015 and December 31, 2014 include total liabilities of the VIEs of $34.3 million and $23.8 million, respectively, for which the creditors of the VIEs have no recourse to us, with the exception of $4.5 million and $3.4 million of debt guaranteed by us at June 30, 2015 and December 31, 2014, respectively. See further description in Note 4, Variable Interest Entities.

See accompanying notes to the unaudited condensed consolidated financial statements.

 

1


 

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

 

THREE-MONTHS ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Net operating revenues:

 

 

 

 

 

 

 

Net patient revenues

$

233,860

 

 

$

191,324

 

Management fee revenues

 

14,391

 

 

 

15,327

 

Other revenues

 

5,435

 

 

 

2,069

 

Total net operating revenues

 

253,686

 

 

 

208,720

 

Equity in net income of nonconsolidated affiliates

 

11,631

 

 

 

7,934

 

Operating expenses:

 

 

 

 

 

 

 

Salaries and benefits

 

84,932

 

 

 

72,747

 

Supplies

 

51,841

 

 

 

43,363

 

Other operating expenses

 

38,121

 

 

 

30,210

 

Depreciation and amortization

 

15,897

 

 

 

12,770

 

Occupancy costs

 

9,190

 

 

 

7,262

 

Provision for doubtful accounts

 

4,455

 

 

 

3,370

 

Gain on disposal of assets

 

(35

)

 

 

(14

)

Total operating expenses

 

204,401

 

 

 

169,708

 

Operating income

 

60,916

 

 

 

46,946

 

Interest expense

 

10,710

 

 

 

8,436

 

HealthSouth option expense

 

1,873

 

 

 

 

Debt modification expense

 

154

 

 

 

 

Interest income

 

(42

)

 

 

(49

)

Loss (gain) on sale of investments

 

272

 

 

 

(4

)

Income from continuing operations before income tax expense

 

47,949

 

 

 

38,563

 

Provision for income tax expense

 

4,267

 

 

 

1,392

 

Income from continuing operations

 

43,682

 

 

 

37,171

 

Loss from discontinued operations, net of income tax expense

 

(172

)

 

 

(2,690

)

Net income

 

43,510

 

 

 

34,481

 

Less: Net income attributable to noncontrolling interests

 

(38,950

)

 

 

(28,452

)

Net income attributable to Surgical Care Affiliates

$

4,560

 

 

$

6,029

 

Basic net income (loss) per share attributable to Surgical Care Affiliates:

 

 

 

 

 

 

 

Continuing operations attributable to Surgical Care Affiliates

$

.12

 

 

$

.23

 

Discontinued operations attributable to Surgical Care Affiliates

$

.00

 

 

$

(.07

)

Net income per share attributable to Surgical Care Affiliates

$

.12

 

 

$

.16

 

Basic weighted average shares outstanding

 

39,383

 

 

 

38,380

 

Diluted net income (loss) per share attributable to Surgical Care Affiliates:

 

 

 

 

 

 

 

Continuing operations attributable to Surgical Care Affiliates

$

.11

 

 

$

.22

 

Discontinued operations attributable to Surgical Care Affiliates

$

.00

 

 

$

(.07

)

Net income per share attributable to Surgical Care Affiliates

$

.11

 

 

$

.15

 

Diluted weighted average shares outstanding

 

40,797

 

 

 

39,865

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

 

 

 

 

 

2


 

 

 

 

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Net operating revenues:

 

 

 

 

 

 

 

Net patient revenues

$

450,495

 

 

$

366,121

 

Management fee revenues

 

28,513

 

 

 

28,412

 

Other revenues

 

8,769

 

 

 

6,839

 

Total net operating revenues

 

487,777

 

 

 

401,372

 

Equity in net income of nonconsolidated affiliates

 

23,702

 

 

 

13,633

 

Operating expenses:

 

 

 

 

 

 

 

Salaries and benefits

 

168,325

 

 

 

141,924

 

Supplies

 

101,262

 

 

 

84,548

 

Other operating expenses

 

74,815

 

 

 

59,396

 

Depreciation and amortization

 

31,123

 

 

 

24,371

 

Occupancy costs

 

17,410

 

 

 

14,107

 

Provision for doubtful accounts

 

8,679

 

 

 

6,314

 

Impairment of intangible and long-lived assets

 

 

 

 

515

 

Loss (gain) on disposal of assets

 

197

 

 

 

(51

)

Total operating expenses

 

401,811

 

 

 

331,124

 

Operating income

 

109,668

 

 

 

83,881

 

Interest expense

 

19,538

 

 

 

16,352

 

HealthSouth option expense

 

11,702

 

 

 

 

Debt modification expense

 

5,032

 

 

 

 

Loss on extinguishment of debt

 

544

 

 

 

 

Interest income

 

(71

)

 

 

(97

)

(Gain) loss on sale of investments

 

(1,594

)

 

 

4,307

 

Income from continuing operations before income tax expense

 

74,517

 

 

 

63,319

 

Provision for income tax expense

 

8,080

 

 

 

3,074

 

Income from continuing operations

 

66,437

 

 

 

60,245

 

Loss from discontinued operations, net of income tax expense

 

(1,642

)

 

 

(2,593

)

Net income

 

64,795

 

 

 

57,652

 

Less: Net income attributable to noncontrolling interests

 

(69,401

)

 

 

(51,389

)

Net (loss) income attributable to Surgical Care Affiliates

$

(4,606

)

 

$

6,263

 

Basic net (loss) income per share attributable to Surgical Care Affiliates:

 

 

 

 

 

 

 

Continuing operations attributable to Surgical Care Affiliates

$

(.08

)

 

$

.23

 

Discontinued operations attributable to Surgical Care Affiliates

$

(.04

)

 

$

(.07

)

Net (loss) income per share attributable to Surgical Care Affiliates

$

(.12

)

 

$

.16

 

Basic weighted average shares outstanding

 

39,073

 

 

 

38,349

 

Diluted net (loss) income per share attributable to Surgical Care Affiliates:

 

 

 

 

 

 

 

Continuing operations attributable to Surgical Care Affiliates

$

(.08

)

 

$

.22

 

Discontinued operations attributable to Surgical Care Affiliates

$

(.04

)

 

$

(.06

)

Net (loss) income per share attributable to Surgical Care Affiliates

$

(.12

)

 

$

.16

 

Diluted weighted average shares outstanding

 

39,073

 

 

 

39,921

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

3


 

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

THREE-MONTHS ENDED

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net income and comprehensive income

$

43,510

 

 

$

34,481

 

 

$

64,795

 

 

$

57,652

 

Net income and comprehensive income attributable to noncontrolling interests

 

(38,950

)

 

 

(28,452

)

 

 

(69,401

)

 

 

(51,389

)

Net income (loss) and comprehensive income (loss) attributable to Surgical Care Affiliates

$

4,560

 

 

$

6,029

 

 

$

(4,606

)

 

$

6,263

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

 

4


 

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surgical Care

 

 

Noncontrolling

 

 

 

 

 

 

Common Stock

 

 

Additional

 

 

Accumulated

 

 

Affiliates

 

 

Interests-

 

 

Total

 

 

Shares

 

 

Amount

 

 

Paid-in Capital

 

 

Deficit

 

 

Equity

 

 

Non-redeemable

 

 

Equity

 

Balance at December 31, 2013

 

38,166

 

 

$

382

 

 

$

413,419

 

 

$

(208,115

)

 

$

205,686

 

 

$

210,285

 

 

$

415,971

 

Net income

 

 

 

 

 

 

 

 

 

 

6,263

 

 

 

6,263

 

 

 

41,817

 

 

 

48,080

 

Stock options exercised

 

289

 

 

 

3

 

 

 

1,184

 

 

 

 

 

 

1,187

 

 

 

 

 

 

1,187

 

Stock compensation

 

 

 

 

 

 

 

1,600

 

 

 

 

 

 

1,600

 

 

 

 

 

 

1,600

 

Net change in equity related to purchase of ownership interests

 

 

 

 

 

 

 

(1,166

)

 

 

 

 

 

(1,166

)

 

 

23,401

 

 

 

22,235

 

Contributions from noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

16,892

 

 

 

16,892

 

Change in distribution accrual

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3,931

)

 

 

(3,931

)

Distributions to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(37,553

)

 

 

(37,553

)

Balance at June 30, 2014

 

38,455

 

 

$

385

 

 

$

415,037

 

 

$

(201,852

)

 

$

213,570

 

 

$

250,911

 

 

$

464,481

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surgical Care

 

 

Noncontrolling

 

 

 

 

 

 

Common Stock

 

 

Additional

 

 

Accumulated

 

 

Affiliates

 

 

Interests-

 

 

Total

 

 

Shares

 

 

Amount

 

 

Paid-in Capital

 

 

Deficit

 

 

Equity

 

 

Non-redeemable

 

 

Equity

 

Balance at December 31, 2014

 

38,648

 

 

$

386

 

 

$

419,088

 

 

$

(176,135

)

 

$

243,339

 

 

$

323,627

 

 

$

566,966

 

Net (loss) income

 

 

 

 

 

 

 

 

 

 

(4,606

)

 

 

(4,606

)

 

 

58,198

 

 

 

53,592

 

Issuance of stock pursuant to teammate equity plans

 

484

 

 

 

6

 

 

 

5,626

 

 

 

 

 

 

5,632

 

 

 

 

 

 

5,632

 

HealthSouth stock option

 

326

 

 

 

3

 

 

 

11,699

 

 

 

 

 

 

11,702

 

 

 

 

 

 

11,702

 

Stock compensation

 

 

 

 

 

 

 

3,761

 

 

 

 

 

 

3,761

 

 

 

 

 

 

3,761

 

Net change in equity related to purchase of ownership interests

 

 

 

 

 

 

 

304

 

 

 

 

 

 

304

 

 

 

43,982

 

 

 

44,286

 

Contributions from noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,208

 

 

 

5,208

 

Change in distribution accrual

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,294

)

 

 

(4,294

)

Distributions to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(61,367

)

 

 

(61,367

)

Balance at June 30, 2015

 

39,458

 

 

$

395

 

 

$

440,478

 

 

$

(180,741

)

 

$

260,132

 

 

$

365,354

 

 

$

625,486

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

5


 

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net income

$

64,795

 

 

$

57,652

 

Loss from discontinued operations

 

1,642

 

 

 

2,593

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

 

 

Provision for doubtful accounts

 

8,679

 

 

 

6,314

 

Depreciation and amortization

 

31,123

 

 

 

24,371

 

Amortization of deferred issuance costs

 

720

 

 

 

1,589

 

Impairment of intangible and long-lived assets

 

 

 

 

515

 

Realized (gain) loss on sale of investments

 

(1,594

)

 

 

4,307

 

Loss (gain) on disposal of assets

 

197

 

 

 

(51

)

Equity in net income of nonconsolidated affiliates

 

(23,702

)

 

 

(13,633

)

Distributions from nonconsolidated affiliates

 

27,507

 

 

 

27,026

 

Deferred income tax

 

7,495

 

 

 

3,139

 

Stock compensation

 

3,761

 

 

 

1,600

 

Change in fair value of interest rate swap

 

287

 

 

 

458

 

Loss on extinguishment of debt

 

544

 

 

 

 

HealthSouth option expense

 

11,702

 

 

 

 

(Increase) decrease in assets, net of business combinations

 

 

 

 

 

 

 

Accounts receivable

 

(5,743

)

 

 

(803

)

Other assets

 

30,098

 

 

 

(21,022

)

(Decrease) increase in liabilities, net of business combinations

 

 

 

 

 

 

 

Accounts payable

 

(3,635

)

 

 

(2,191

)

Accrued payroll

 

(4,590

)

 

 

(7,730

)

Accrued interest

 

4,403

 

 

 

(288

)

Other liabilities

 

(34,020

)

 

 

4,706

 

Other, net

 

(534

)

 

 

(75

)

Net cash used in operating activities of discontinued operations

 

(2,389

)

 

 

(1,809

)

Net cash provided by operating activities

 

116,746

 

 

 

86,668

 

Cash flows from investing activities

 

 

 

 

 

 

 

Capital expenditures

 

(19,023

)

 

 

(18,172

)

Proceeds from disposal of assets

 

256

 

 

 

153

 

Proceeds from sale of business

 

 

 

 

2,744

 

Proceeds from sale of equity interests of nonconsolidated affiliates

 

20,138

 

 

 

888

 

Proceeds from sale of equity interests of consolidated affiliates in deconsolidation transactions

 

 

 

 

2,375

 

Decrease in cash related to conversion of consolidated affiliates to equity interests

 

 

 

 

(30

)

(Increase) decrease in restricted cash

 

(310

)

 

 

5,254

 

Net settlements on interest rate swap

 

(727

)

 

 

(784

)

Business acquisitions, net of cash acquired (2015 - $1,188; 2014 - $144)

 

(54,731

)

 

 

(34,992

)

Purchase of equity interests in nonconsolidated affiliates

 

(30,272

)

 

 

(3,999

)

Net cash provided by investing activities of discontinued operations

 

11,000

 

 

 

 

Other

 

(3,017

)

 

 

(3,136

)

Net cash used in investing activities

$

(76,686

)

 

$

(49,699

)

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

6


 

 

 

 

 

 

 

SURGICAL CARE AFFILIATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(In thousands)

(Unaudited)

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Cash flows from financing activities

 

 

 

 

 

 

 

Borrowings under line of credit arrangements and long-term debt, net of issuance costs

$

703,648

 

 

$

14,544

 

Payment of debt acquisition costs

 

(3,238

)

 

 

 

Principal payments on line of credit arrangements and long-term debt

 

(604,063

)

 

 

(7,750

)

Principal payments under capital lease obligations

 

(5,097

)

 

 

(4,271

)

Distributions to noncontrolling interests of consolidated affiliates

 

(73,695

)

 

 

(49,486

)

Contributions from noncontrolling interests of consolidated affiliates

 

5,208

 

 

 

11,668

 

Proceeds from sale of equity interests of consolidated affiliates

 

4,399

 

 

 

2,321

 

Repurchase of equity interests of consolidated affiliates

 

(3,499

)

 

 

(1,946

)

Proceeds from teammate equity plans

 

8,195

 

 

 

1,187

 

Other

 

(2,795

)

 

 

 

Net cash provided by (used in) financing activities

 

29,063

 

 

 

(33,733

)

Change in cash and cash equivalents

 

69,123

 

 

 

3,236

 

Cash and cash equivalents at beginning of period

 

8,731

 

 

 

85,829

 

Cash and cash equivalents of discontinued operations at beginning of period

 

37

 

 

 

1

 

Less: Cash and cash equivalents of discontinued operations at end of period

 

(53

)

 

 

(107

)

Cash and cash equivalents at end of period

$

77,838

 

 

$

88,959

 

Supplemental schedule of noncash investing and financing activities

 

 

 

 

 

 

 

Property and equipment acquired through capital leases and installment purchases

$

9,291

 

 

$

7,788

 

Goodwill attributable to sale of surgery centers

 

 

 

 

752

 

Net investment in consolidated affiliates that became equity method facilities

 

 

 

 

970

 

Noncontrolling interest associated with conversion of consolidated affiliates to equity method affiliates

 

 

 

 

3,180

 

Accrued capital expenditures at end of period

 

3,476

 

 

 

901

 

Contributions from noncontrolling interests of consolidated affiliates

 

 

 

 

5,224

 

Equity interest purchase in nonconsolidated affiliates via withheld distributions

 

5,259

 

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

 

7


 

SURGICAL CARE AFFILIATES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Amounts in tables are in thousands of U.S. dollars unless otherwise indicated)

 

NOTE 1 — DESCRIPTION OF BUSINESS

Nature of Operations and Ownership of the Company

Surgical Care Affiliates, Inc. (“Surgical Care Affiliates” or the “Company”), a Delaware corporation, was formed primarily to own and operate a network of multi-specialty ambulatory surgery centers (“ASCs”) and surgical hospitals in the United States of America. We do this through our direct operating subsidiary, Surgical Care Affiliates, LLC (“SCA”). As of June 30, 2015, the Company operated in 34 states and had an interest in and/or operated 187 freestanding ASCs, five surgical hospitals and one sleep center with 11 locations, with a concentration of facilities in California, Florida, Indiana, Texas and New Jersey. Our ASCs and surgical hospitals primarily provide the facilities, equipment and medical support staff necessary for physicians to perform non-emergency surgical and other procedures in various specialties, including orthopedics, ophthalmology, gastroenterology, pain management, otolaryngology (ear, nose and throat, or “ENT”), urology and gynecology, as well as other general surgery procedures. At our ASCs, physicians perform same-day surgical procedures. At our surgical hospitals, physicians perform a broader range of surgical procedures, and patients may stay in the hospital for several days.

During the six-months ended June 30, 2015, our portfolio of facilities changed as follows:

·

we acquired a controlling interest in eleven ASCs that we consolidate (three of these facilities were previously equity method investments, see Note 2 regarding the Kentucky JVs);

·

we acquired a noncontrolling interest in six ASCs that we hold as equity method investments (three of these facilities were previously managed-only facilities); and

·

we closed three consolidated ASCs, sold a consolidated surgical hospital and sold a noncontrolling interest in one ASC and now account for it as a managed-only facility (this facility was previously an equity method investment).

Business Structure

We operate our facilities through strategic relationships with approximately 2,600 physician partners and, in many cases, with healthcare systems that have strong local market positions and that we believe have strong reputations for clinical excellence. The facilities in which we hold an ownership interest are owned by general partnerships, limited partnerships (“LP”), limited liability partnerships (“LLP”) or limited liability companies (“LLC”) in which a subsidiary of the Company typically serves as the general partner, limited partner, managing member or member. We account for our 193 facilities as follows:

 

 

AS OF

 

 

JUNE 30, 2015

 

Consolidated facilities(1)

 

102

 

Equity method facilities

 

67

 

Managed-only facilities

 

24

 

Total facilities

 

193

 

(1)

As of June 30, 2015, we consolidated 15 facilities as a Variable Interest Entity (“VIE”) (see Note 4).

In addition, at June 30, 2015 and December 31, 2014, we provided perioperative consulting services to 9 and 13 facilities, respectively, which are not included in the above facility count.

Basis of Presentation

The Company maintains its books and records on the accrual basis of accounting, and the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), the instructions for Form 10-Q, and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (the “SEC”). Such financial statements include the assets, liabilities, revenues and expenses of all wholly-owned subsidiaries, subsidiaries over which we exercise control and, when applicable, affiliates in which we have a controlling financial interest. These interim financial statements do not include all of the disclosures required by GAAP for complete financial statements. In the opinion of management, the accompanying unaudited financial statements of the Company reflect all adjustments

8


 

(consisting only of normal, recurring items) necessary for a fair statement of the results for the interim period presented. Operating results for the three- and six-month periods ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. The accompanying unaudited condensed consolidated financial statements and related notes should be read in conjunction with the Company’s audited December 31, 2014 consolidated financial statements included in our 2014 Annual Report on Form 10-K.

 

 

NOTE 2 — TRANSACTIONS

Acquisitions   

During the six-months ended June 30, 2015, we acquired a controlling interest in eleven ASCs for total consideration of $57.9 million. Three of the eleven ASCs were previously equity method investments, and five of the eleven ASCs were acquired through our VIE groups (see Note 4) for which we are the primary beneficiary.  These acquisitions are described in further detail below.

We accounted for these transactions under the acquisition method of accounting and reported the results of operations from the date of acquisition. The assets acquired, liabilities assumed and any noncontrolling interest 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. The fair value of identifiable intangible assets was based on valuations using the cost and income approaches. The cost approach is based on amounts that would be required to replace the asset (i.e., replacement cost). The income approach is based on management’s estimates of future operating results and cash flows discounted using a weighted-average cost of capital that reflects market participant assumptions. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired was recorded as goodwill. Factors contributing to the recognition of goodwill include the centers’ favorable reputations in their markets, their market positions, their ability to deliver quality care with high patient satisfaction consistent with the Company’s business model and synergistic benefits that are expected to be realized as a result of the acquisitions. The total amount of goodwill acquired as a result of the 2015 transactions was $75.5 million, approximately $50.8 million of which is expected to be tax deductible.

 

Prior to January 1, 2015, we owned a noncontrolling interest and our health system partner owned a controlling interest in three separate joint venture entities (mentioned above) that in the aggregate controlled three ASCs located in the Lexington and Louisville, Kentucky markets (collectively referred to as the “Kentucky JVs”).  Pursuant to a delegation agreement effective as of January 1, 2015, our health system partner in the Kentucky JVs delegated certain rights to SCA that enabled us to consolidate the Kentucky JVs.  As a result of SCA receiving these rights, we now consolidate the three Kentucky JVs and the three underlying ASCs under the VIE model; these entities were previously accounted for as equity method investments.  See Note 4 for more information on VIEs.  No cash consideration was paid in exchange for these rights.  The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

 

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

287

 

Accounts receivable

 

1,609

 

Other current assets

 

667

 

Total current assets

 

2,563

 

Property and equipment

 

4,020

 

Goodwill

 

5,389

 

Intangible assets

 

1,803

 

Total assets

$

13,775

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

2,119

 

Total current liabilities

 

2,119

 

Other long-term liabilities

 

4,684

 

Total liabilities

$

6,803

 

 

In February 2015, an indirect wholly-owned subsidiary of SCA purchased a 67.0% controlling interest in Surgery Center of Wilson, LLC, which owns and operates an ASC in Wilson, North Carolina, for $3.8 million.  In addition, SCA purchased the right to manage the facility for $0.2 million.  This ASC is a consolidated facility.  The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

9


 

 

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

62

 

Accounts receivable

 

240

 

Other current assets

 

12

 

Total current assets

 

314

 

Property and equipment

 

2,231

 

Goodwill

 

2,472

 

Intangible assets

 

1,326

 

Total assets

$

6,343

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

493

 

Total current liabilities

 

493

 

Other long-term liabilities

 

75

 

Total liabilities

$

568

 

In February 2015, the Michigan JV, defined and further described in Note 3, purchased a 51.0% controlling interest in Clinton Partners, LLC, which owns and operates an ASC in Clinton Township, Michigan, for total consideration of $4.1 million.  In addition, SCA purchased the management agreement rights of the facility for $0.7 million.  This ASC is a consolidated facility.  The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

 

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

130

 

Accounts receivable

 

553

 

Other current assets

 

54

 

Total current assets

 

737

 

Property and equipment

 

4,742

 

Goodwill

 

1,717

 

Intangible assets

 

1,814

 

Total assets

$

9,010

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

735

 

Total current liabilities

 

735

 

Other long-term liabilities

 

2,151

 

Total liabilities

$

2,886

 

 

10


 

In March 2015, the Future Texas JV, as defined and further described in Note 3, purchased a 61.0% controlling interest in NovaMed Surgery Center of Dallas, LP (the “Partnership”), which owns and operates an ASC in Dallas, Texas, for $6.8 million.  Simultaneously with the closing of the transaction, the Partnership converted to a Texas limited liability company, Texas Health Surgery Center Preston Plaza, LLC.  In addition, SCA purchased the management rights of the facility for $1.2 million.  This ASC is a consolidated facility. The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

 

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

421

 

Accounts receivable

 

457

 

Other current assets

 

68

 

Total current assets

 

946

 

Property and equipment

 

1,592

 

Goodwill

 

6,129

 

Intangible assets

 

4,813

 

Total assets

$

13,480

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

631

 

Total current liabilities

 

631

 

Other long-term liabilities

 

159

 

Total liabilities

$

790

 

 

In April 2015, an indirect wholly-owned subsidiary of the Company purchased a 60.0% controlling interest in Specialists in Urology Surgery Center, LLC, which owns and operates three ASCs located in Naples, Bonita Springs and Fort Myers, Florida, for $11.5 million.  These ASCs are consolidated facilities.  The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

 

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

2

 

Accounts receivable

 

860

 

Other current assets

 

267

 

Total current assets

 

1,129

 

Property and equipment

 

6,880

 

Goodwill

 

16,730

 

Intangible assets

 

2,190

 

Total assets

$

26,929

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

2,402

 

Total current liabilities

 

2,402

 

Other long-term liabilities

 

5,188

 

Total liabilities

$

7,590

 

 

In May 2015, an indirect wholly-owned subsidiary of the Company purchased a 55.0% controlling interest in Parkway Surgery Center, LLC, which owns and operates an ASC in Hagerstown, Maryland, for $7.7 million.  In addition, SCA purchased the management agreement rights of the facility for $0.4 million.  This ASC is a consolidated facility.  The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

 

11


 

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

276

 

Accounts receivable

 

466

 

Other current assets

 

42

 

Total current assets

 

784

 

Property and equipment

 

732

 

Goodwill

 

12,128

 

Intangible assets

 

1,960

 

Total assets

$

15,604

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

462

 

Total current liabilities

 

462

 

Other long-term liabilities

 

742

 

Total liabilities

$

1,204

 

 

In May 2015, an indirect wholly-owned subsidiary of the Company purchased a 55.0% controlling interest in Franklin Surgical Center, LLC, which owns and operates an ASC in Basking Ridge, New Jersey, for $21.5 million.  This ASC is a consolidated facility. The amounts recognized as of the acquisition date for each major class of assets and liabilities assumed are as follows:

 

  

Assets

 

 

 

Current assets

 

 

 

Cash and cash equivalents

$

10

 

Accounts receivable

 

1,582

 

Other current assets

 

64

 

Total current assets

 

1,656

 

Property and equipment

 

3,047

 

Goodwill

 

30,973

 

Intangible assets

 

3,825

 

Total assets

$

39,501

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

367

 

Total current liabilities

 

367

 

Other long-term liabilities

 

42

 

Total liabilities

$

409

 

 

Intangible assets acquired in 2015 in connection with the above consolidated acquisitions include:

 

 

 

Estimated Fair Value on Acquisition Date

 

 

Estimated Useful Life

Certificates of need

 

$

2,510

 

 

15.0*

Licenses

 

$

2,839

 

 

15.0*

Management agreements

 

$

6,182

 

 

15.0*

Noncompete agreements

 

$

6,200

 

 

  4.8*

Total

 

$

17,731

 

 

11.4*

*Reflects the weighted average estimated useful life of acquired intangible assets that are subject to amortization.

12


 

The purchase price allocations above are preliminary.  Additionally, all purchase price allocations related to business combinations completed in the third and fourth quarters of 2014 are preliminary. When we obtain all relevant information, our provisional purchase price allocation may be retrospectively adjusted to reflect new information about the facts and circumstances that existed as of the respective acquisition dates which would have affected the measurement of the amounts recognized as of those dates. The preliminary amounts of these purchase price allocations relate primarily to working capital balances.

In March 2015, Multi-Specialty Surgery Center, LLC (“Multi-Specialty”), which owns and operates an ASC in Indianapolis, Indiana, contributed substantially all of its assets to Beltway Surgery Centers, L.L.C. (“Beltway”), in exchange for $15.9 million in cash and 13.75 units, or 3.8% of the total membership interest, of Beltway valued at $6.1 million.  Beltway is a nonconsolidated SCA entity and a joint venture among a subsidiary of SCA, physicians and a health system which owns and operates multiple ASCs in Indiana.  As a result of the transaction, the Multi-Specialty location became an additional location of Beltway and is an equity method investment for us.

In April 2015, a joint venture entity owned by an indirect wholly-owned subsidiary of the Company and a health system purchased a 55.0% controlling interest in Mississippi Medical Plaza, L.C., which owns and operates two ASCs in Davenport, Iowa, for $35.3 million.  These ASCs are equity method investments.  

Also in April 2015, a joint venture entity owned by an indirect wholly-owned subsidiary of the Company and a health system purchased a 55.0% controlling interest in Seashore Surgical Institute, L.L.C., which owns and operates an ASC in Brick, New Jersey, for $7.3 million.  This ASC is an equity method investment.

Additionally, in April 2014, a wholly-owned subsidiary of SCA (the “SCA Subsidiary”) loaned a wholly-owned subsidiary of a health system partner (the “Counterparty”) $3.0 million in exchange for a promissory note that was convertible at the Counterparty’s option into a 49% noncontrolling ownership interest in the Counterparty.  Also on April 1, 2014, the Counterparty used the proceeds of the loan and other funds to purchase 100% of the ownership interests in an ASC located in Costa Mesa, California (the “Costa Mesa ASC”) for $5.2 million.  Effective April 1, 2015 and pursuant to the loan conversion agreement between the SCA Subsidiary and the Counterparty, the convertible promissory note was converted by the Counterparty, and as result of the conversion, the SCA Subsidiary owns a 49% noncontrolling ownership interest in the Counterparty and an indirect noncontrolling ownership interest in the Costa Mesa ASC. We account for this noncontrolling ownership interest as an equity method investment.

In June 2015, a joint venture entity owned by an indirect wholly-owned subsidiary of the Company and a health system purchased a 55.0% controlling interest in Surgicare of Central Jersey, LLC, which owns and operates an ASC in Watchung, New Jersey, for $15.0 million.  This ASC is an equity method investment.

 

During the six-months ended June 30, 2014, the Company acquired a controlling interest in five ASCs, two of which were previously managed-only facilities, for total consideration of $36.5 million and a noncontrolling interest in one ASC, which was previously a managed-only facility, for total consideration of $2.5 million.

Deconsolidation

During the six-month period ended June 30, 2014, we completed one deconsolidation transaction. In this transaction, we sold a controlling equity interest in an ASC and transferred certain control rights to a partner in the entity. We retained a noncontrolling interest in this affiliate. We received cash proceeds of approximately $2.4 million and recorded a pre-tax loss of approximately $3.4 million, which was primarily related to the revaluation of our remaining investment in this affiliate to fair value. The loss on this transaction is recorded in (Gain) loss on sale of investments in the accompanying condensed consolidated statements of operations.

There were no deconsolidation transactions during the six-month period ended June 30, 2015.

Fair values for retained noncontrolling interests are primarily estimated based on third-party valuations we have obtained in connection with such transactions and/or the amount of proceeds received for the controlling equity interest sold.

13


 

 

Closures and Sales

 

During the six-months ended June 30, 2015, we closed three consolidated ASCs.  There were no material gains or losses recorded related to these closures.

 

During the six-months ended June 30, 2014, we closed two consolidated facilities and absorbed their operations into existing SCA consolidated facilities.  We impaired $0.5 million of property and equipment and intangible assets related to these two closed facilities.

 

During the six-months ended June 30, 2015, we sold our entire ownership interest in an ASC that we held as an equity method investment for $7.6 million.  We continue to provide management services to the facility.  We also sold our entire interest in a consolidated surgical hospital for $0.3 million and the real estate owned by the surgical hospital for $10.8  million.  A pre-tax gain of approximately $2.1 million related to this transaction was recorded in the Loss from discontinued operations, net of income tax in the accompanying condensed consolidated statements of operations.  The surgical hospital and the real estate of the surgical hospital were placed into discontinued operations in 2014.

 

During the six-months ended June 30, 2014, we sold all of our ownership interest in two ASCs. We recorded a pre-tax gain of approximately $0.2 million as a result of the sales. The gain on these transactions is recorded in (Gain) loss on sale of investments in the accompanying condensed consolidated statements of operations. We also wrote off approximately $0.8 million of goodwill related to one of these sales.

Unaudited Pro Forma Financial Information

Summarized below are our consolidated results of operations for the six-months ended June 30, 2015 and 2014, on an unaudited pro forma basis as if the consolidated acquisitions closed in the three-months ended June 30, 2015 had occurred at the beginning of the earliest period presented. The pro forma information is based on the Company’s consolidated results of operations for the three- and six-months ended June 30, 2015 and 2014 and on other available information. These pro forma amounts include historical financial statement amounts with the following adjustments: we converted the sellers’ historical financial statements to GAAP, as necessary, applied the Company’s accounting policies and adjusted for depreciation and amortization expense assuming the fair value adjustments to intangible assets had been applied beginning January 1, 2014. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transactions occurred on the basis assumed above, nor are they indicative of results of the future operations of the combined enterprises.

 

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net operating revenues

$

254,634

 

 

$

223,032

 

 

$

490,223

 

 

$

430,189

 

Income from continuing operations

 

43,459

 

 

 

39,298

 

 

 

66,221

 

 

 

65,211

 

Consolidated acquisitions closed during the three- and six-months ended June 30, 2015 contributed Net operating revenues of $14.6 million and $21.3 million for the three- and six-months ended June 30, 2015, respectively, and Income from continuing operations of $2.3 million for each of the three- and six-months ended June 30, 2015.

Nonconsolidated acquisitions closed during the three- and six-months ended June 30, 2015 contributed $0.8 million and $0.9 million to Equity in net income of nonconsolidated affiliates for the three- and six-months ended June 30, 2015, respectively.

 

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company, its subsidiaries and VIEs for which we are the primary beneficiary. All significant intercompany transactions and accounts have been eliminated.

We evaluate partially owned subsidiaries and joint ventures held in partnership form using authoritative guidance, which includes a framework for evaluating whether a general partner(s) or managing member(s) controls an affiliate and therefore should consolidate it. The framework includes the presumption that general partner or managing member control would be overcome only when the limited partners or members have certain rights. Such rights include the right to dissolve or liquidate the LP, LLP or LLC or otherwise remove the general partner or managing member “without cause,” or the right to effectively participate in significant

14


 

decisions made in the ordinary course of business of the LP, LLP or LLC. To the extent that any noncontrolling investor has rights that inhibit our ability to control the affiliate, including substantive veto rights, we do not consolidate the affiliate.

We use the equity method to account for our investments in affiliates with respect to which we do not have control rights but have the ability to exercise significant influence over operating and financial policies. Assets, liabilities, revenues and expenses are reported in the respective detailed line items on the condensed consolidated financial statements for our consolidated affiliates. For our equity method affiliates, assets and liabilities are reported on a net basis in Investment in and advances to nonconsolidated affiliates in the condensed consolidated balance sheets, and revenues and expenses are reported on a net basis in Equity in net income of nonconsolidated affiliates in the condensed consolidated statements of operations. This difference in accounting treatment of equity method affiliates impacts certain financial ratios of the Company.

Variable Interest Entities

In order to determine if we are the primary beneficiary of a VIE for financial reporting purposes, we consider whether we have the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE and whether we have the obligation to absorb losses or the right to receive returns that would be significant to the VIE. We consolidate a VIE when we are the primary beneficiary of the VIE. At June 30, 2015 and as further described below, we had three VIE groups: the Future Texas JV, the Kentucky JVs and the Michigan JV.

The Company holds a promissory note with an entity (the “Future Texas JV”) that owns controlling interests in 11 ASCs and is wholly-owned by a health system partner. The promissory note, which eliminates upon consolidation, has a fixed interest rate plus a variable component dependent on the earnings of the Future Texas JV. The promissory note contains a conversion feature that allows us to convert the promissory note into a 49% equity interest in the Future Texas JV at our option upon the occurrence of the renegotiation of certain contractual arrangements. We are also party to management services agreements with the facilities controlled by the Future Texas JV. As a result of the financial interest in the earnings of the Future Texas JV held by us via the promissory note and the powers granted us in the promissory note and the management services agreements, we have determined that the Future Texas JV is a VIE for which we are the primary beneficiary. Accordingly, we consolidate the Future Texas JV and the underlying ASCs.

 

In January 2015, we entered into an agreement with a health system partner whereby the health system partner delegated certain rights to SCA that enable us to consolidate under the VIE model three jointly owned joint venture entities (the “Kentucky JVs”), which own controlling interests in three ASCs in the Lexington and Louisville, Kentucky markets.  As a result of SCA receiving these rights, we consolidate the three Kentucky JVs and the three underlying ASCs; these entities were previously accounted for as equity method investments.

 

In February 2015, we and a health system partner, through a joint venture entity (the “Michigan JV”), acquired a controlling interest in an ASC located in Clinton Township, Michigan.  In conjunction with the acquisition, our health system partner delegated certain rights to SCA that enable us to consolidate the Michigan JV under the VIE model.  Accordingly, we consolidate the Michigan JV and the underlying ASC.

Investment in and Advances to Nonconsolidated Affiliates

Investments in entities we do not control, but for which we have the ability to exercise significant influence over the operating and financial policies, are accounted for under the equity method. Equity method investments are recorded at original cost and adjusted periodically to recognize our proportionate share of the entity’s net income or losses after the date of investment, additional contributions made and distributions received, amortization of definite-lived intangible assets attributable to equity method investments and impairment losses resulting from adjustments to the carrying value of the investment. We record equity method losses in excess of the carrying amount of an investment when we guarantee obligations or we are otherwise committed to provide further financial support to the affiliate.

During the first quarter of 2015, we received an aggregate amount of $12.9 million of cash proceeds related to the planned sale of a portion of an equity method investment that was initially acquired on December 31, 2014. These transactions had an immaterial impact on (Gain) loss on sale of investments in our condensed consolidated statement of operations. The proceeds from these transactions are included in Proceeds from sale of equity interests of nonconsolidated affiliates in our condensed consolidated statement of cash flows.

Secondary Offering and HealthSouth Option

In March 2015, certain existing stockholders of SCA (the "Selling Stockholders"), including certain affiliates of TPG Global, LLC and certain directors and officers of SCA, sold 8,050,000 shares of our common stock in an underwritten public offering at a price of $33.25 per share. SCA did not sell any shares of common stock in the offering and did not receive any proceeds from the sale of the shares of common stock by the Selling Stockholders. The secondary offering closed on April 1, 2015.

15


 

 

In connection with the acquisition of our Company in 2007 by TPG, we granted HealthSouth Corporation (“HealthSouth”) an option (the “HealthSouth Option”) to purchase 5% of our outstanding equity as of the closing of the 2007 acquisition.  The HealthSouth Option became exercisable upon certain customary liquidity events, including a public offering of shares of our common stock that resulted in 30% or more of our common stock being listed or traded on a national securities exchange. Once vested, the HealthSouth Option became exercisable on a net exercise basis.  The HealthSouth Option vested on April 1, 2015 upon the closing of the aforementioned secondary offering.

 

The value of the HealthSouth Option as of March 31, 2015 was $9.8 million. This amount was included as an expense in HealthSouth option expense on our condensed consolidated statement of operations for the three-months ended March 31, 2015 and was included in Other current liabilities on the condensed consolidated balance sheets. On April 9, 2015, HealthSouth exercised the HealthSouth Option and we issued 326,242 new shares of common stock at a value of $11.7 million. Accordingly, an additional $1.9 million of expense was recorded in the second quarter of 2015.  This amount was included as an expense in HealthSouth option expense on our condensed consolidated statement of operations for the three-months ended June 30, 2015.  $11.7 million of expense was included in the condensed consolidated statement of operations for the six-months ended June 30, 2015.

Reclassifications

Certain amounts in the condensed consolidated financial statements for prior periods have been reclassified to conform to the current period presentation. Such reclassifications primarily relate to facilities we closed or sold, which qualify for reporting as discontinued operations.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Earnings Per Share (“EPS”)

We report two earnings per share numbers, basic and diluted. These are computed by dividing net earnings by the weighted-average common shares outstanding (basic EPS) or weighted-average common shares outstanding assuming dilution (diluted EPS), as set forth below:

 

 

 

THREE-MONTHS

 

 

SIX-MONTHS

 

 

 

ENDED

 

 

ENDED

 

 

 

JUNE 30,

 

 

JUNE 30,

 

In thousands

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Weighted average shares outstanding

 

 

39,383

 

 

 

38,380

 

 

 

39,073

 

 

 

38,349

 

Dilutive effect of equity-based compensation plans and arrangements

 

 

1,414

 

 

 

1,485

 

 

 

 

 

 

1,572

 

Weighted average shares outstanding, assuming dilution

 

 

40,797

 

 

 

39,865

 

 

 

39,073

 

 

 

39,921

 

 

All dilutive share equivalents are reflected in our earnings per share calculations. Antidilutive share equivalents are not included in our EPS calculations. In periods of loss, shares that otherwise would have been included in our diluted weighted-average common shares outstanding computation are excluded. 1,457,000 dilutive share equivalents were excluded for the six-months ended June 30, 2015.

Reportable Segments

We have six operating segments, which aggregate into one reportable segment. Our six operating segments are generally organized geographically. For reporting purposes, we have aggregated our operating segments into one reportable segment because the nature of the services are similar and the businesses exhibit similar economic characteristics, processes, types and classes of customers, methods of service delivery and distribution and regulatory environments.

16


 

Net operating loss carryforwards (“NOLs”)

At June 30, 2015, we had federal net operating loss carryforwards of approximately $247.9 million. Such losses expire in various amounts at varying times beginning in 2027. These NOLs are subject to a valuation allowance. Due to the secondary offering described above, we are analyzing the impact of the limitations imposed by Internal Revenue Code Section 382.  At this time, we do not believe the limitations imposed by Internal Revenue Code Section 382 will restrict our ability to use any Federal NOLs before they expire; however, we cannot be certain that will be the case.

Recent Revisions to Authoritative Guidance

In April 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03, Simplifying the Presentation of Debt Issuance Costs.  This standard modifies existing guidance regarding the presentation of debt issuance costs in the financial statements.  ASU 2015-03 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2015.  Early adoption is permitted for financial statements that have not already been issued. Additionally, the provisions should be applied on a retrospective basis as a change in accounting principle. We do not believe this ASU will have a material impact on our consolidated financial position, results of operations and cash flows; however, the presentation of deferred costs related to debt issuances will change.  

In February 2015, the FASB issued Accounting Standards Update (“ASU”) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This standard modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2015 and requires either a retrospective or a modified retrospective approach to adoption. Early adoption is permitted.  We are currently evaluating the potential impact of this standard on our consolidated financial position, results of operations and cash flows.

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU changes the criteria for determining which disposals (both consolidated investments and equity method investments) can be presented as discontinued operations and modifies related disclosure requirements. Under the new criteria, a discontinued operation is defined as a disposal of a component or group of components, which may include equity method investments, that is disposed of or is classified as held for sale and “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The ASU became effective for the Company on January 1, 2015. This ASU did not have a material effect on our consolidated financial position, results of operations or cash flows; however, the presentation of discontinued operations will be impacted.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The ASU becomes effective for the Company at the beginning of its 2017 fiscal year; early adoption is not permitted. We are currently assessing the impact that this ASU will have on our consolidated financial position, results of operation and cash flows.

We do not believe any other recently issued, but not yet effective, revisions to authoritative guidance will have a material effect on our condensed consolidated financial position, results of operations or cash flows.

 

 

NOTE 4 — VARIABLE INTEREST ENTITIES

 

Under the applicable authoritative guidance, a VIE is a legal entity that possesses any of the following characteristics: an insufficient amount of equity at risk to finance its activities, equity owners who do not have the power to direct the significant activities of the entity (or have voting rights that are disproportionate to their ownership interest) or equity owners who do not have the obligation to absorb expected losses or the right to receive the expected residual returns of the entity. Companies are required to consolidate a VIE if they are its primary beneficiary, which is the enterprise that has the power to direct the activities that most significantly affect the entity’s economic performance.

 

17


 

At June 30, 2015 and December 31, 2014, we consolidated three VIE groups and one VIE group, respectively, for which we were the primary beneficiary. As of June 30, 2015, we consolidated a total of 15 facilities among the three VIE groups, the details of which are as follows:

 

 

# of Consolidated Facilities

 

 

# of Consolidated Facilities

 

VIE Group

 

as of June 30, 2015

 

 

as of December 31,  2014

 

Future Texas JV

 

 

11

 

 

 

10

 

Kentucky JVs

 

 

3

 

 

 

 

Michigan JV

 

 

1

 

 

 

 

 

The carrying amounts and classifications of the assets and liabilities of the VIE groups, which are included in our June 30, 2015 and December 31, 2014 condensed consolidated balance sheets, were as follows:

 

 

JUNE 30,

 

 

DECEMBER 31,

 

 

2015

 

 

2014

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Accounts receivable, net

$

13,370

 

 

$

12,396

 

Other current assets

 

4,948

 

 

 

2,236

 

   Total current assets

 

18,318

 

 

 

14,632

 

Property and equipment, net

 

29,845

 

 

 

20,829

 

Goodwill

 

82,629

 

 

 

69,330

 

Intangible assets

 

17,757

 

 

 

12,663

 

  Total assets

$

148,549

 

 

$

117,454

 

Liabilities

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable and other current liabilities

$

15,141

 

 

$

11,402

 

   Total current liabilities

 

15,141

 

 

 

11,402

 

Other long-term liabilities

 

19,151

 

 

 

12,403

 

  Total liabilities

$

34,292

 

 

$

23,805

 

 

The assets of the consolidated VIE groups can only be used to settle the obligations of the VIE groups. The creditors of the VIE groups have no recourse to us, with the exception of $4.5 million and $3.4 million of debt guaranteed by us at June 30, 2015 and December 31, 2014, respectively.

 

 

NOTE 5 — GOODWILL

Goodwill represents the unallocated excess of purchase price over the fair value of identifiable assets and liabilities acquired in business combinations. Goodwill also includes the unallocated excess of purchase price plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair value of identifiable assets and liabilities acquired in the business combination. The following table shows changes in the carrying amount of goodwill for the six-months ended June 30, 2015:

 

Balance at December 31, 2014

$

902,391

 

Acquisitions (see Note 2)

 

75,538

 

Other

 

1,200

 

Balance at June 30, 2015

$

979,129

 

 

18


 

NOTE 6 — RESULTS OF OPERATIONS OF NONCONSOLIDATED AFFILIATES

The following summarizes the combined results of operations of our equity method affiliates:

 

 

THREE-MONTHS ENDED

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net operating revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net patient revenues

$

180,616

 

 

$

158,416

 

 

$

340,077

 

 

$

305,039

 

Other revenues

 

1,558

 

 

 

1,704

 

 

 

3,268

 

 

 

2,834

 

Total net operating revenues

 

182,174

 

 

 

160,120

 

 

 

343,345

 

 

 

307,873

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

39,452

 

 

 

34,165

 

 

 

75,679

 

 

 

66,851

 

Supplies

 

32,566

 

 

 

25,931

 

 

 

61,278

 

 

 

51,490

 

Other operating expenses

 

39,521

 

 

 

32,455

 

 

 

75,382

 

 

 

65,469

 

Depreciation and amortization

 

7,066

 

 

 

5,106

 

 

 

12,985

 

 

 

10,111

 

Total operating expenses

 

118,605

 

 

 

97,657

 

 

 

225,324

 

 

 

193,921

 

Operating income

 

63,569

 

 

 

62,463

 

 

 

118,021

 

 

 

113,952

 

Interest expense, net of interest income

 

578

 

 

 

466

 

 

 

877

 

 

 

849

 

Income from continuing operations before income tax expense

$

62,991

 

 

$

61,997

 

 

$

117,144

 

 

$

113,103

 

Net income

$

62,978

 

 

$

61,970

 

 

$

117,125

 

 

$

113,063

 

During the three- and six-months ended June 30, 2015, we recorded $0.2 million and $0.4 million, respectively, of amortization expense for definite-lived intangible assets attributable to equity method investments. During the three- and six-months ended June 30, 2014, we recorded $5.8 million and $11.6 million, respectively, of amortization expense for definite-lived intangible assets attributable to equity method investments. This expense is included in Equity in net income of nonconsolidated affiliates in our condensed consolidated statements of operations.

Also during the three- and six-months ended June 30, 2015, an impairment charge of $2.7 million was recorded due to advances previously extended to a nonconsolidated affiliate that were deemed not recoverable.  This impairment is included in Equity in net income of nonconsolidated affiliates in the accompanying condensed consolidated statement of operations.

 

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NOTE 7 — LONG-TERM DEBT

Our long-term debt outstanding consisted of the following:

 

 

AS OF

 

 

JUNE 30,

 

 

DECEMBER 31,

 

 

2015

 

 

2014

 

New Credit Facilities debt payable:

 

 

 

 

 

 

 

Advances under $250 million New Revolving Credit

   Facility (excluding letters of credit issued thereunder)

$

 

 

$

 

New Term Loan due 2022

 

448,875

 

 

 

 

Discount of New Term Loan due 2022

 

(1,482

)

 

 

 

Old Credit Facilities debt payable:

 

 

 

 

 

 

 

Advances under $132.3 million Class B Revolving Credit

   Facility (excluding letters of credit issued thereunder)

 

 

 

 

 

Class B Term Loan due 2017

 

 

 

 

212,224

 

Class C Term Loan due 2018

 

 

 

 

384,150

 

Discount of Class C Term Loan

 

 

 

 

(452

)

6.00% Senior Notes due 2023

 

250,000

 

 

 

 

Discount of Senior Notes due 2023

 

(4,238

)

 

 

 

Notes payable to banks and others

 

75,803

 

 

 

64,634

 

Capital lease obligations

 

32,765

 

 

 

29,253

 

 

 

801,723

 

 

 

689,809

 

Less: Current portion

 

(26,848

)

 

 

(24,690

)

Long-term debt, net of current portion

$

774,875

 

 

$

665,119

 

First Quarter 2015 Refinancing Transactions

On March 17, 2015, we issued senior unsecured notes due in 2023 in the aggregate principal amount of $250 million (the “Senior Notes”) under an Indenture dated March 17, 2015 among the Company, The Bank of New York Mellon Trust Company, N.A., as trustee, and certain wholly-owned subsidiaries of the Company (the “Guarantors”) that are guaranteeing the Senior Notes  (the “Indenture”).  Also on March 17, 2015, we entered into a $700 million credit agreement with JP Morgan Chase Bank, N.A., as administrative agent and collateral agent, and the other lenders party thereto (the “New Credit Agreement”). The New Credit Agreement provides for a seven-year, $450 million term loan credit facility (the “New Term Loan Facility”) and a five-year, $250 million revolving credit facility (the “New Revolving Credit Facility” and together with the New Term Loan Facility, collectively, the “New Credit Facilities”).  This issuance of the Senior Notes and the entry into the New Credit Facilities are collectively referred to as the “Refinancing Transactions.”

We received $245.6 million in net proceeds from the sale of the Senior Notes after deducting the Initial Purchasers’ (as defined below) discount. We used all of those net proceeds, together with approximately $381 million of the $450 million borrowed under the New Term Loan Facility, to repay all of the outstanding indebtedness (including accrued interest and fees) under the Company’s previous credit facilities (the “Old Credit Facilities”). We used a portion of the remaining approximately $69 million of net proceeds from the Refinancing Transactions to pay the transaction costs associated with the Refinancing Transactions, with the remainder to be used for general corporate purposes.  In connection with the settlement of existing debt upon entering into our New Credit Facilities, we incurred debt modification expense of $5.0 million.

          Senior Notes

On March 17, 2015, we issued the Senior Notes under the Indenture.  The Senior Notes were sold to Goldman, Sachs & Co. and certain other initial purchasers (the “Initial Purchasers”) in a private placement in reliance on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Senior Notes were expected to be resold by the Initial Purchasers to qualified institutional buyers pursuant to Rule 144A and/or Regulation S under the Securities Act.

The Senior Notes are general unsecured obligations of the Company and are guaranteed by the Guarantors and any subsequently acquired wholly-owned subsidiaries that guarantee certain of the Company’s indebtedness, subject to certain exceptions. The Senior Notes are pari passu in right of payment with all of the existing and future senior debt of the Company, including the Company’s indebtedness under the New Credit Facilities, and senior to all existing and future subordinated debt of the Company.

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Interest on the Senior Notes accrues at the rate of 6.00% per annum and is payable semi-annually in arrears on April 1 and October 1, beginning on October 1, 2015. The Senior Notes mature on April 1, 2023.

The Indenture contains certain covenants that, with certain exceptions and qualifications, limit the ability of the Company and the restricted subsidiaries to, among other things, incur or guarantee additional indebtedness and issue certain types of preferred stock; pay dividends on capital stock or redeem, repurchase or retire capital stock or subordinated indebtedness; create liens on assets; make investments; sell assets; engage in transactions with affiliates; create restrictions on the ability of the restricted subsidiaries to pay dividends; and consolidate, merge or transfer substantially all of the Company’s assets.  The Indenture also provides for certain events of default which, if any of them were to occur, would permit or require the principal and accrued interest, if any, on the Senior Notes to become or be declared due and payable (subject, in some cases, to specified grace periods).  We believe that we were in compliance with the covenants contained in the Indenture as of June 30, 2015.

          New Credit Facilities

On March 17, 2015, we entered into the New Credit Agreement, which, subject to the terms and conditions set forth therein, provides for the New Term Loan Facility and the New Revolving Credit Facility. The New Credit Agreement includes an accordion feature that, subject to the satisfaction of certain conditions, will allow us to add one or more incremental term loan facilities to the New Term Loan Facility and/or increase the revolving commitments under the New Revolving Credit Facility, in each case based on leverage ratios and minimum dollar amounts, as more particularly set forth in the New Credit Agreement.  The interest rate on the New Term Loan was 4.25% at June 30, 2015.

The New Credit Facilities replaced our Credit Agreement, dated as of June 29, 2007 (as amended and restated and further amended, the “2007 Credit Agreement”), among the Company, SCA, JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, and the other lenders party thereto.

Quarterly principal payments on the loans under the New Term Loan Facility are payable in equal installments in an amount equal to 0.25% of the aggregate initial principal amount of the loans made under the New Term Loan Facility. The loans made under the New Term Loan Facility mature and all amounts then outstanding thereunder are payable on March 17, 2022.

The New Revolving Credit Facility matures, the commitments thereunder terminate, and all amounts then outstanding thereunder are payable on March 17, 2020.

Borrowings under the New Credit Agreement bear interest, at our election, either at (1) a base rate determined by reference to the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the United States federal funds rate plus 0.50% and (c) a LIBOR rate plus 1.00% (provided that, with respect to the New Term Loan Facility, in no event will the base rate be deemed to be less than 2.00%) (the “Base Rate”) or (2) an adjusted LIBOR rate (provided that, with respect to the New Term Loan Facility, in no event will the adjusted LIBOR rate be deemed to be less than 1.00%) (the “LIBOR Rate”), plus in either case an applicable margin. The applicable margin for borrowings under the New Term Loan Facility is 2.25% for Base Rate loans and 3.25% for LIBOR Rate loans. The applicable margin for any borrowings under the New Revolving Credit Facility depends on the Company’s senior secured leverage ratio and varies from 0.75% to 1.25% for Base Rate loans and from 1.75% to 2.25% for LIBOR Rate loans.  Interest payments, along with the installment payments of principal, are payable at the end of each quarter.  The following table outlines the applicable margin for each portion of the New Credit Facilities:

 

 

Applicable Margin (per annum)

Facility

 

Base Rate Borrowings

 

LIBOR Rate Borrowings

New Revolving Credit Facility

 

0.75% to 1.25%, depending upon the senior secured leverage ratio

 

1.75% to 2.25%, depending upon the senior secured leverage ratio

New Term Loan due 2022

 

2.25% (with a Base Rate floor of 2.00%)

 

3.25% (with a LIBOR Rate floor of 1.00%)

There was no outstanding balance under the New Revolving Credit Facility or the revolving credit facility of the Old Credit Facilities as of June 30, 2015 or December 31, 2014, respectively, other than $4.2 million and $2.9 million, respectively, of letters of credit. As of June 30, 2015, the New Revolving Credit Facility had a capacity of $250.0 million.

Any utilization of the New Revolving Credit Facility in excess of $15.0 million will be subject to compliance with a total leverage ratio test. At June 30, 2015, we had approximately $4.2 million in letters of credit outstanding that utilize capacity under the New Revolving Credit Facility. We pay a commitment fee of either 0.375% or 0.500% per annum, depending on our senior secured leverage ratio, on the unused portion of the New Revolving Credit Facility.

21


 

The New Credit Facilities are guaranteed by the Company and certain of SCA’s direct wholly-owned domestic subsidiaries (the “Credit Agreement Guarantors”), subject to certain exceptions, and borrowings under the New Credit Facilities are secured by a first priority security interest in substantially all equity interests of SCA and of each wholly-owned domestic subsidiary directly held by SCA or a Credit Agreement Guarantor.  The New Credit Agreement contains a provision that could require prepayment of a portion of our indebtedness if SCA has excess cash flow, as defined by the New Credit Agreement. Additionally, the New Credit Agreement contains various restrictive covenants that, subject to certain exceptions, prohibit us from prepaying certain subordinated indebtedness. The New Credit Agreement also generally restricts SCA’s and SCA’s restricted subsidiaries’ ability to, among other things, incur indebtedness or liens, make investments or declare or pay dividends. We believe that the Company and SCA were in compliance with these covenants as of June 30, 2015.

Interest Rate Swaps

We use an interest rate risk management strategy that incorporates the use of derivative financial instruments to limit our exposure to interest rate risk. The swaps are “receive floating/pay fixed” instruments that define a fixed rate of interest on the economically hedged debt that the Company will pay, meaning we receive floating rate payments, which fluctuate based on LIBOR, from the counterparty and pay at a fixed rate to the counterparty, the result of which is to convert the interest rate of a portion of our floating rate debt into fixed rate debt, or to limit the variability of interest related payments caused by changes in LIBOR. At June 30, 2015, interest rate swaps of $190.0 million remained outstanding.  The remaining aggregate notional amount of $190.0 million in interest rate swaps will terminate on September 30, 2016.

All derivative instruments are recognized on the balance sheet on a gross basis at fair value. The fair value of the interest rate swaps is recorded in the Company’s condensed consolidated balance sheets, either in Other current liabilities and Other long-term liabilities or Prepaids and other current assets and Other long-term assets, depending on the changes in the fair value of the swap and the payments or receipts expected within the next 12 months, with an offsetting adjustment reported as Interest expense in the condensed consolidated statements of operations. At each of June 30, 2015 and December 31, 2014, $1.4 million was included in Other current liabilities in the condensed consolidated balance sheets based on the fair value of the derivative instruments and the amounts expected to be settled within the next 12 months. At June 30, 2015 and December 31, 2014, $0.4 million and $0.8 million, respectively, were included in Other long-term liabilities in the condensed consolidated balance sheets based on the fair value of the derivative instruments. Although all our derivative instruments are subject to master netting arrangements, no amounts have been netted against the gross liabilities previously detailed and no collateral has been posted with counterparties. During the six-months ended June 30, 2015, the liability related to the swaps decreased by $0.4 million due to $0.7 million of swap settlements and a $0.3 million increase in the change in fair value. During the six-months ended June 30, 2015, the Company recorded losses of approximately $0.3 million within Interest expense due to changes in fair value of derivative instruments.

The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge related to foreign currency exposure. We previously designated our interest rate swaps as a cash flow hedge; however, the interest rate swaps were de-designated as hedges in the second quarter of 2013.

Credit risk occurs when a counterparty to a derivative instrument fails to perform according to the terms of the agreement. Derivative instruments expose the Company to credit risk and could result in material changes from period to period. The Company minimizes its credit risk by entering into transactions with highly rated counterparties. In addition, at least quarterly, the Company evaluates its exposure to counterparties who have experienced or may likely experience significant threats to their ability to perform according to the terms of the derivative agreements to which we are a party. We have completed this review of the financial strength of the counterparties to our interest rate swaps using publicly available information, as well as qualitative inputs, as of June 30, 2015. Based on this review, we do not believe there is a significant counterparty credit risk associated with these derivative instruments. However, no assurances can be provided regarding our potential exposure to counterparty credit risk in the future.

 

22


 

NOTE 8 — NONCONTROLLING INTERESTS

The following table shows the breakout of net income (loss) attributable to Surgical Care Affiliates between continuing operations and discontinued operations:

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net income (loss) from continuing operations, net of tax, attributable to Surgical Care Affiliates

$

4,732

 

 

$

8,719

 

 

$

(2,964

)

 

$

8,856

 

Net loss from discontinued operations, net of tax,

   attributable to Surgical Care Affiliates

 

(172

)

 

 

(2,690

)

 

 

(1,642

)

 

 

(2,593

)

Net income (loss), net of tax, attributable to

   Surgical Care Affiliates

$

4,560

 

 

$

6,029

 

 

$

(4,606

)

 

$

6,263

 

 

The following table shows the effects of changes to Surgical Care Affiliates’ ownership interest in its subsidiaries on Surgical Care Affiliates’ equity:

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net income (loss) attributable to Surgical Care Affiliates

$

4,560

 

 

$

6,029

 

 

$

(4,606

)

 

$

6,263

 

Increase (decrease) in equity due to sales to

   noncontrolling interests

 

178

 

 

 

(352

)

 

 

(46

)

 

 

59

 

Increase (decrease) in equity due to purchases from

   noncontrolling interests

 

151

 

 

 

(85

)

 

 

350

 

 

 

(1,225

)

Change from net income (loss) attributable to Surgical Care Affiliates and transfers to/from noncontrolling interests

$

4,889

 

 

$

5,592

 

 

$

(4,302

)

 

$

5,097

 

 

$5.2 million of Contributions from noncontrolling interests in the condensed consolidated statement of changes in equity were recorded in the first quarter of 2015 and relate to funding from our partners for their pro rata portion of cash transferred for business combinations.

Certain of the Company’s noncontrolling interests have industry specific redemption features whereby the Company could be obligated, under the terms of certain of its operating subsidiaries’ partnership and operating agreements, to purchase some or all of the noncontrolling interests of the consolidated subsidiaries. As a result, these noncontrolling interests are not included as part of the Company’s equity and are presented as Noncontrolling interests-redeemable on the Company’s condensed consolidated balance sheets.

The activity relating to the Company’s noncontrolling interests-redeemable is summarized below:

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Balance at beginning of period

$

15,444

 

 

$

21,902

 

Net income attributable to noncontrolling interests

 

11,203

 

 

 

9,572

 

Net change related to purchase of ownership interests

 

1,387

 

 

 

(961

)

Change in distribution accrual

 

1,259

 

 

 

586

 

Distributions to noncontrolling interests

 

(12,328

)

 

 

(11,933

)

Balance at end of period

$

16,965

 

 

$

19,166

 

 

23


 

NOTE 9 — FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company follows the provisions of the authoritative guidance for fair value measurements, which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP.

The fair value of an asset or liability 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. As a basis for considering assumptions, the authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

·

Level 1 – Observable inputs such as quoted prices in active markets;

·

Level 2 – Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

·

Level 3 – Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Assets and liabilities measured at fair value are based on one or more of three valuation techniques, as follows:

·

Market approach – Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities;

·

Cost approach – Amount that would be required to replace the service capacity of an asset (i.e., replacement cost); and

·

Income approach – Techniques to convert future amounts to a single present amount based on market expectations (including present value techniques, option-pricing models and lattice models).

Disclosures for Recurring Measurements

Interest Rate Swaps

On a recurring basis, we measure our interest rate swaps at fair value. The fair value of our interest rate swaps is a Level 2 measurement derived from models based upon well recognized financial principles and reasonable estimates about relevant future market conditions and calculations of the present value of future cash flows, discounted using market rates of interest. Further, included in the fair value is approximately $0.1 million related to non-performance risk associated with the interest rate swaps at each of June 30, 2015 and December 31, 2014.

The fair values of our liabilities that are measured on a recurring basis are as follows (in millions):

 

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

Fair Value Measurements Using

 

 

Assets/Liabilities

 

 

Valuation

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

at Fair Value

 

 

Technique1

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other current liabilities

$

 

 

$

1.4

 

 

$

 

 

$

1.4

 

 

I

Other long-term liabilities

 

 

 

 

0.4

 

 

 

 

 

 

0.4

 

 

I

Total liabilities

$

 

 

$

1.8

 

 

$

 

 

$

1.8

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

Fair Value Measurements Using

 

 

Assets/Liabilities

 

 

Valuation

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

at Fair Value

 

 

Technique1

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other current liabilities

$

 

 

$

1.4

 

 

$

 

 

$

1.4

 

 

I

Other long-term liabilities

 

 

 

 

0.8

 

 

 

 

 

 

0.8

 

 

I

Total liabilities

$

 

 

$

2.2

 

 

$

 

 

$

2.2

 

 

 

1 

As discussed above, the authoritative guidance identifies three valuation techniques: market approach (M), cost approach (C), and income approach (I).

Disclosures for Nonrecurring Measurements

Where applicable, on a nonrecurring basis, we measure property and equipment, goodwill, other intangible assets, investments in nonconsolidated affiliates and assets and liabilities of discontinued operations at fair value. The fair values of our property and

24


 

equipment and other intangible assets are determined using discounted cash flows and significant unobservable inputs. The fair value of our investments in nonconsolidated affiliates is determined using discounted cash flows or earnings, or market multiples derived from a set of comparables. The fair value of our assets and liabilities of discontinued operations is determined using discounted cash flows and significant unobservable inputs unless there is an offer to purchase such assets and liabilities, which would be the basis for determining fair value. The fair value of our goodwill is determined using discounted cash flows, and, when available and as appropriate, we use comparative market multiples to corroborate discounted cash flow results. Goodwill is tested for impairment as of October 1 of each year, absent any interim impairment indicators.

We recorded an impairment charge of $0.7 million during the three- and six-months ended June 30, 2014 for intangible and long-lived assets. The impairment is recorded in Loss from discontinued operations, net of income tax expense on the Company’s condensed consolidated statements of operations.  A declining trend of earnings from operations at a facility and increased local competition resulted in the impairment charge recorded in 2014, as management determined its intent to sell or close the impacted facility. The fair value of the impaired long-lived assets was determined based on the assets’ estimated fair value using expected proceeds from the sale of the facility.

Assets related to discontinued operations measured at fair value on a nonrecurring basis are as follows (in millions of U.S. dollars):

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

 

 

 

 

 

 

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

Net

 

 

Quoted Prices in

 

 

Other

 

 

Significant

 

 

 

 

 

 

 

Carrying

 

 

Active Markets for

 

 

Observable

 

 

Unobservable

 

 

 

 

 

 

 

Value

 

 

Identical Assets

 

 

Inputs

 

 

Inputs

 

 

 

 

 

June 30, 2014

 

as of:

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

 

Total Losses

 

Assets related to discontinued operations

 

$

 

 

 

 

 

 

 

 

$

 

 

$

0.7

 

The inputs used by the Company in estimating the value of Level 3 Assets related to discontinued operations include the expected proceeds from the sale of the facility. Assumptions used by the Company due to the lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s results of operations. The following table includes information regarding significant unobservable inputs used in the estimation of Level 3 fair value measurement.

 

 

Level 3 Assets

 

 

 

 

 

 

 

 

 

 

 

Level 3 Property and

 

as of

 

 

Significant Unobservable

 

Range of

 

 

Weighted

 

equipment

 

June 30, 2014

 

 

Input

 

Inputs

 

 

Average

 

Income Approach

 

$

 

 

Expected proceeds from sale

 

$

 

 

$

 

No impairment charges for intangible and long-lived assets were recorded during the three- and six- months ended June 30, 2015.

The following table presents the carrying amounts and estimated fair values of our financial instruments that are classified as long-term liabilities in our condensed consolidated balance sheets. The carrying value approximates fair value for financial instruments that are classified as current in our condensed consolidated balance sheets. The carrying amounts of a portion of our long-term debt approximate fair value due to various characteristics, including short-term maturities, call features and rates that are reflective of current market rates. For our long-term debt without such characteristics, we determined the fair market value by using quoted market prices, when available, or discounted cash flows to calculate their fair values. The fair values utilize inputs other than quoted prices in active markets, although the inputs are observable either directly or indirectly; accordingly, the fair values are in Level 2 of the fair value hierarchy.

 

25


 

 

As of June 30, 2015

 

 

As of December 31, 2014

 

 

Carrying

 

 

Estimated

 

 

Carrying

 

 

Estimated

 

 

Amount

 

 

Fair Value

 

 

Amount

 

 

Fair Value

 

Interest rate swap agreements (includes short-term

   component)

$

1,751

 

 

$

1,751

 

 

$

2,192

 

 

$

2,192

 

Long-term debt:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New Credit Facilities debt payable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Advances under $250 million New Revolving Credit

   Facility (excluding letters of credit issued thereunder)

$

 

 

$

 

 

$

 

 

$

 

New Term Loan due 2022

 

448,875

 

 

 

446,070

 

 

 

 

 

 

 

Old Credit Facilities debt payable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Advances under $132.3 million Class B Revolving

       Credit Facility

 

 

 

 

 

 

 

 

 

 

 

     Class B Term Loan due 2017

 

 

 

 

 

 

 

212,224

 

 

 

206,786

 

     Class C Term Loan due 2018

 

 

 

 

 

 

 

384,150

 

 

 

371,905

 

6.00% Senior Notes due 2023

 

250,000

 

 

 

250,625

 

 

 

 

 

 

 

Notes payable to banks and others

 

75,803

 

 

 

75,803

 

 

 

64,634

 

 

 

64,634

 

Financial commitments

$

 

 

$

 

 

$

 

 

$

 

 

NOTE 10 — EQUITY-BASED COMPENSATION

We have one active equity-based compensation plan, the 2013 Omnibus Long-Term Incentive Plan, and two legacy equity-based compensation plans, the Management Equity Incentive Plan and the Directors and Consultants Equity Incentive Plan, under which we are no longer issuing new awards (together, the “Plans”). The Plans provide or have provided for the granting of options to purchase our stock, as well as restricted stock units (“RSUs”), to key teammates, directors, service providers, consultants and affiliates.

Option awards are granted with an exercise price equal to at least the fair market value of the underlying shares at the date of grant. Option awards and RSUs vest based upon the passage of time.

At June 30, 2015, 4,489,420 stock-based awards had been issued under the Plans (excluding forfeitures) and 958,096 stock-based awards were available for future equity grants.

During the first six months of 2015, we issued to certain members of our management team 289,629 RSU awards with an average fair value of $36.01 per RSU award and 340,912 time-based stock options with an average exercise price of $35.87, and an average fair value of $14.43 per option. The fair value of these RSU awards and options was determined using the policies described in Note 3, Summary of Significant Accounting Policies, and Note 11, Equity-Based Compensation, to the consolidated financial statements of our 2014 Annual Report on Form 10-K.

 

NOTE 11 — INCOME TAXES

The provision for income tax expense for the three-months ended June 30, 2015 includes the following: (1) current income tax expense of $0.3 million attributable to state income taxes of subsidiaries which have separate state tax filing requirements and (2) deferred income tax expense of $4.0 million attributable to the tax amortization of goodwill that is not amortized for book purposes, as well as write-offs of book and tax goodwill due to syndications of partnership interests.

The provision for income tax expense for the three-months ended June 30, 2014 includes the following: (1) current income tax expense of $0.2 million attributable to state income taxes of subsidiaries which have separate state tax filing requirements and (2) deferred income tax expense of $1.2 million attributable to the tax amortization of goodwill that is not amortized for book purposes, as well as write-offs of book and tax goodwill due to syndications of partnership interests.

The provision for income tax expense for the six-months ended June 30, 2015 includes the following: (1) current income tax expense of $0.6 million attributable to state income taxes of subsidiaries which have separate state tax filing requirements and (2) deferred income tax expense of $7.5 million attributable to the tax amortization of goodwill that is not amortized for book purposes, as well as write-offs of book and tax goodwill due to syndications of partnership interests.

The provision for income tax expense for the six-months ended June 30, 2014 includes the following: (1) current income tax expense of $0.3 million attributable to state income taxes of subsidiaries which have separate state tax filing requirements and

26


 

(2) deferred income tax expense of $2.8 million attributable to the tax amortization of goodwill that is not amortized for book purposes, as well as write-offs of book and tax goodwill due to syndications of partnership interests.

We reduce our deferred income tax assets by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or a portion of a deferred tax asset will not be realized. We currently have a full valuation allowance against our net deferred tax assets, other than the deferred tax liability resulting from the amortization of goodwill, which is considered an indefinite-lived intangible. On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our most recent operating performance, the scheduled reversal of temporary differences and our forecast of taxable income in future periods are important considerations in our assessment. Management has considered all positive and negative evidence available at this time and has concluded that a full valuation allowance continues to be appropriate as of June 30, 2015. We continue to closely monitor actual and forecasted earnings and, if there is a change in management’s assessment of the amount of deferred income tax assets that is realizable, adjustments to the valuation allowance will be made in future periods.

 

NOTE 12 — DISCONTINUED OPERATIONS AND ASSETS AND LIABILITIES HELD FOR SALE

We have closed or sold certain facilities that qualify for reporting as discontinued operations. The assets and liabilities associated with these facilities are reflected in the accompanying condensed consolidated balance sheets as of June 30, 2015 and December 31, 2014 as Current assets related to discontinued operations, Assets related to discontinued operations, Current liabilities related to discontinued operations and Liabilities related to discontinued operations. Additionally, the accompanying condensed consolidated statements of operations and cash flows reflect the loss, net of income tax expense, and the net cash (used in) provided by operating, investing and financing activities, respectively, associated with these facilities as discontinued operations.

The operating results of discontinued operations were as follows:  

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net operating revenues

$

906

 

 

$

4,399

 

 

$

4,022

 

 

$

8,173

 

Costs and expenses

 

(2,506

)

 

 

(5,886

)

 

 

(6,943

)

 

 

(9,643

)

Gain on sale of investments or closures

 

2,104

 

 

 

13

 

 

 

2,034

 

 

 

1

 

Impairments

 

 

 

 

(700

)

 

 

 

 

 

(700

)

Income (loss) from discontinued operations

 

504

 

 

 

(2,174

)

 

 

(887

)

 

 

(2,169

)

Income tax expense

 

(676

)

 

 

(516

)

 

 

(755

)

 

 

(424

)

Net loss from discontinued operations

$

(172

)

 

$

(2,690

)

 

$

(1,642

)

 

$

(2,593

)

The assets and liabilities related to discontinued operations consisted of the following:

 

 

JUNE 30,

 

 

DECEMBER 31,

 

 

2015

 

 

2014

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Accounts receivable, net

$

 

 

$

1,788

 

Other current assets

 

7

 

 

 

171

 

  Total current assets

 

7

 

 

 

1,959

 

Property and equipment, net

 

422

 

 

 

9,153

 

Other long term assets

 

58

 

 

 

191

 

Total assets

$

487

 

 

$

11,303

 

Liabilities

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable and other current liabilities

$

2,015

 

 

$

2,280

 

  Total current liabilities

 

2,015

 

 

 

2,280

 

Other long-term liabilities

 

426

 

 

 

683

 

Total liabilities

$

2,441

 

 

$

2,963

 

 

We have three facilities that qualify for reporting as held for sale that do not also qualify for reporting as discontinued operations. Management has committed to selling these facilities, and an active program to locate a buyer is underway. We expect that the sale of these facilities will be completed within twelve months. The assets and liabilities associated with these facilities are

27


 

reflected in the accompanying condensed consolidated balance sheets as of June 30, 2015 as Current assets held for sale, Assets held for sale, Current liabilities held for sale and Liabilities held for sale.  There were no assets or liabilities held for sale that were not also discontinued operations as of December 31, 2014.

 

Assets and liabilities held for sale consisted of the following:

 

 

JUNE 30,

 

 

2015

 

Assets

 

 

 

Current assets

 

 

 

Accounts receivable, net and other current assets

$

1,201

 

  Total current assets

 

1,201

 

Property and equipment, net

 

7,278

 

Other long term assets

 

242

 

Total assets

$

8,721

 

Liabilities

 

 

 

Current liabilities

 

 

 

Accounts payable and other current liabilities

$

1,198

 

  Total current liabilities

 

1,198

 

Other long-term liabilities

 

2,526

 

Total liabilities

$

3,724

 

 

 

 

 

 

 

 

 

 

 

28


 

NOTE 13 — RELATED PARTY TRANSACTIONS

TPG Capital BD, LLC, an affiliate of TPG, served as an arranger in connection with the New Credit Agreement and was paid an arrangement fee in the amount of aproximately $0.2 million during the three-months ended March 31, 2015. TPG Capital BD, LLC also served as an initial purchaser in connection with the offering of the Senior Notes, which resulted in an aggregate gross spread to TPG Capital BD, LLC of approximately $0.2 million.  In addition, TPG Capital BD, LLC participated in the underwriting of the shares of our common stock that were offered and sold by the Selling Stockholders in March 2015 on the same terms as other underwriters in the offering, which resulted in an aggregate underwriting discount to TPG Capital BD, LLC of approximately $0.4 million.

Certain directors of the Company have received equity-based compensation under the 2013 Omnibus Long-Term Incentive Plan and the Directors and Consultants Equity Incentive Plan as part of their compensation for service on our Board of Directors and for consulting services provided to the Company. Total expense recognized by the Company related to these options was immaterial for the three- and six-month periods ended June 30, 2015 and 2014.

 

NOTE 14 — COMMITMENTS AND CONTINGENT LIABILITIES

Legal Proceedings

The Company provides services in a highly regulated industry and is subject to various legal actions, regulatory and other governmental and internal audits and investigations from time to time. As a result, we expect that various lawsuits, claims and legal and regulatory proceedings may be instituted or asserted against us, including, without limitation, employment-related claims and medical negligence claims. Additionally, governmental agencies often possess a great deal of discretion to assess a wide range of monetary penalties and fines. We record accruals for contingencies to the extent that we conclude it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The outcome of any current or future litigation or governmental or internal investigations cannot be accurately predicted, nor can we predict any resulting penalties, fines or other sanctions that may be imposed at the discretion of federal or state regulatory authorities. Nevertheless, it is reasonably possible that any such penalties, fines or other sanctions could be substantial, and the outcome of these matters may have a material adverse effect on our results of operations, financial position and cash flows and may affect our reputation.

Risk Insurance

Risk insurance for the Company and most of our facilities is provided through SCA’s risk insurance program. We insure our professional liability, general liability, property and workers’ compensation risks through commercial insurance plans placed with unrelated carriers.

Provisions for these risks are based upon market driven premiums and actuarially determined estimates for incurred but not reported exposure under claims-made policies. Provisions for losses within the policy deductibles represent the estimated ultimate net cost of all reported and unreported losses incurred through the consolidated balance sheet dates. Those estimates are subject to the effects of trends in loss severity and frequency. While we believe the provisions for losses are adequate, we cannot be sure the ultimate costs will not exceed our estimates.

Leases

We lease certain land, buildings and equipment under non-cancelable operating leases expiring at various dates through 2031. We also lease certain buildings and equipment under capital leases expiring at various dates through 2028. Operating leases generally have 3 to 22 year terms with one or more renewal options and with terms to be negotiated at the time of renewal.

 

NOTE 15 — SUBSEQUENT EVENTS

Effective July 31, 2015, Sarasota Endoscopy Center, L.P., which owned and operated an ASC in Sarasota, Florida, ceased operations.

Effective July 31, 2015, the members of Surgical Center at Premier, LLC, an SCA nonconsolidated ASC located in Colorado Springs, Colorado (the “Premier ASC”), entered into a series of transactions such that Audubon Ambulatory Surgery Center, LLC, the owners and operators of two non-SCA ASCs located in Colorado Springs, Colorado (the “Audubon ASCs”), own 100% of the Premier ASC entity.  As a result of the transactions, the members of the Premier and Audubon ASCs, one of which is a joint venture entity owned by SCA and a health system partner, jointly own the facilities through the Audubon ASC entity.  Cash consideration was not paid by any of the parties for the acquisition of the Audubon ASCs, and all three ASCs are equity method investments for SCA.

29


 

Effective August 1, 2015, an indirect wholly-owned subsidiary of SCA, SCA Nashville Surgery Center, LLC, which owned and operated an ASC in Nashville, Tennessee, sold substantially all of its assets for $4.5 million.

Effective August 1, 2015, an indirect wholly-owned subsidiary of SCA sold its entire 75.6% partnership interest in Surgery Center of Clarksville, LP, which owned and operated an ASC located in Clarksville, Tennessee, for $2.4 million.

 

 

 

 

 

 

 

 

 

 

 

 

 

30


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Amounts in tables are in millions of U.S. dollars unless otherwise indicated)

The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, as well as our consolidated audited financial statements and related notes included in our 2014 Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those contained in forward-looking statements as a result of many factors, including those discussed in our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2015 under Part II, “Item 1A. Risk Factors” and in the section of the 2014 Annual Report on Form 10-K entitled Part I, “Item 1A. Risk Factors.”

OVERVIEW

We are a leading provider of surgical solutions to physicians, health systems and payors, providing high quality, cost-effective surgical care. We were formed in 2007 with a focus on developing and operating a network of multi-specialty ASCs and surgical hospitals in the United States. As of June 30, 2015, we operated in 34 states and had an interest in and/or operated 187 freestanding ASCs, five surgical hospitals and one sleep center with 11 locations. Of these 193 facilities, we consolidated the operations of 102 affiliated facilities, had 67 nonconsolidated affiliated facilities and held no ownership in 24 affiliated facilities that contract with us to provide management services only. In addition, at June 30, 2015, we provided perioperative consulting services to 9 facilities, which are not included in our facility count.

The entities that own our facilities are structured as general partnerships, LPs, LLPs or LLCs, and where we have an ownership interest in the facility, either one of our subsidiaries or a joint venture in which we have an ownership interest is an owner and serves as the general partner, limited partner, managing member or member. Our partners or co-members in these entities are generally licensed physicians and hospitals or health systems.

EXECUTIVE SUMMARY

Our growth strategy continues to include growing the profits at our existing facilities, entering into strategic relationships with hospitals, health systems and medical groups and making selective acquisitions of existing surgical facilities and groups of facilities.

We took several steps during the first six months of 2015 to optimize our portfolio by:

·

acquiring a controlling interest in eleven ASCs that we consolidate (three of these facilities were previously equity method investments and did not increase our facility count, see Note 2 to the condensed consolidated financial statements included herein regarding the Kentucky JVs);

·

acquiring a noncontrolling interest in six ASCs that we hold as an equity method investments (three of these facilities were previously managed-only facilities); and

·

closing three consolidated ASCs, selling a consolidated surgical hospital and selling a noncontrolling interest in one ASC that we now account for as a managed-only facility (this facility was previously an equity method investment and did not decrease our facility count).

Our consolidated net operating revenues increased $45.0 million, or 21.6%, for the three-months ended June 30, 2015 compared to the three-months ended June 30, 2014. The main factors that contributed to this increase were revenues earned from acquisitions (including the consolidation of three previously nonconsolidated facilities), increased rates paid under certain payor contracts and higher acuity case mix. Consolidated net patient revenues per case grew by 6.3% to $1,844 per case for the three-months ended June 30, 2015 from $1,735 per case during the prior year period, reflecting acquisitions of facilities with higher rates per case than the average rates at our consolidated facilities, increased rates paid under certain payor contracts and higher acuity case mix. The number of cases at our consolidated facilities increased to 126,826 cases during the three-months ended June 30, 2015 from 110,252 cases during the three-months ended June 30, 2014, largely due to acquisitions since June 30, 2014. Our number of consolidated facilities increased to 102 facilities as of June 30, 2015 from 88 facilities as of June 30, 2014.

We do not consolidate 67 of the facilities affiliated with us because we do not hold a controlling equity interest in the entities that own those facilities. To assist management in analyzing our results of operations, including at our nonconsolidated facilities, we prepare and disclose a “systemwide” case volume statistic and certain supplemental “systemwide” growth measures, each of which treats our equity method facilities as if they were consolidated. While the revenues earned at our equity method facilities are not

31


 

recorded in our consolidated financial statements, we believe that systemwide net operating revenues growth and systemwide net patient revenues per case growth are important to understanding our financial performance because they are used by management to help interpret the sources of our growth and provide management with a growth metric incorporating the revenues earned by all of our affiliated facilities, regardless of the accounting treatment. “Systemwide” is a non-GAAP measure which includes the results of both our consolidated and nonconsolidated facilities (without adjustment based on our percentage of ownership). For more information, please see “Our Consolidated Results and Results of Nonconsolidated Affiliates” under “Summary Results of Operations” below.

During the three-months ended June 30, 2015, systemwide net operating revenues grew by 18.2% compared to the prior year period. Systemwide net patient revenues per case grew by 3.3% compared to the prior year period. These increases were due to acquisitions and increased rates paid under certain payor contracts.

Our consolidated net operating revenues increased $86.4 million, or 21.5%, for the six-months ended June 30, 2015 compared to the six-months ended June 30, 2014. The main factors that contributed to this increase were revenues earned from acquisitions (including the consolidation of three previously nonconsolidated facilities), increased rates paid under certain payor contracts and higher acuity case mix. Consolidated net patient revenues per case grew by 7.5% to $1,880 per case for the six-months ended June 30, 2015 from $1,749 per case during the prior year period, reflecting acquisitions with higher rates per case than the average of our consolidated facilities, as well as higher acuity case mix. The number of cases at our consolidated facilities increased to 239,608 cases during the six-months ended June 30, 2015 from 209,357 cases during the six-months ended June 30, 2014, due to acquisitions since June 30, 2014. Our number of consolidated facilities increased to 102 facilities as of June 30, 2015 from 88 facilities as of June 30, 2014.

During the six-months ended June 30, 2015, systemwide net operating revenues grew by 17.2% as compared to the prior year period. Systemwide net patient revenues per case grew by 4.7% compared to the prior year period. These increases are due to acquisitions and  increased rates paid under certain payor contracts.

At June 30, 2015, we had 106 facilities in partnership with 45 health systems.   We held ownership interests in facilities in partnership with 35 health systems.  We managed 22 facilities in partnership with another nine health systems. Additionally, there is one health system relationship where we consolidate 11 facilities in which we do not currently hold an equity ownership interest (see Note 3 to the condensed consolidated financial statements included herein regarding Future Texas JV). Our health system relationships include local, regional and national health systems. We typically have co-development arrangements with our health system partners to jointly develop a network of outpatient surgery centers in a defined geographic area. These co-development arrangements are an important source of differentiation and potential growth of our business. We expect our co-development and acquisition activity to continue, with a major focus on creating partnerships with not-for-profit health systems as we continue to position ourselves as a partner of choice to physician groups and health systems.

Our Consolidated Subsidiaries and Nonconsolidated Affiliates

At facilities where we serve as an owner and day-to-day manager, we have significant influence over the operations of such facilities. When we have control of the facility, we account for our investment in the facility as a consolidated subsidiary. When this influence does not represent control of the facility, but we have the ability to exercise significant influence over operating and financial policies, we account for our investment in the facility under the equity method, and treat the facility as a nonconsolidated affiliate. Our net earnings from a facility are the same under either method, but the classification of those earnings in our condensed consolidated statements of operations differs.

For our consolidated subsidiaries, our financial statements reflect 100% of the revenues and expenses for these subsidiaries, after elimination of intercompany transactions and accounts. The net income attributable to owners of our consolidated subsidiaries, other than us, is classified within the line item Net income attributable to noncontrolling interests.

For our nonconsolidated affiliates, our condensed consolidated statements of operations reflect our earnings from such facilities in two line items:

·

Equity in net income of nonconsolidated affiliates, which represents our combined share of the net income of each equity method facility that is based on such equity method facility’s net income and the percentage of such equity method facility’s outstanding equity interests owned by us; and

·

Management fee revenues, which represents our combined income from management fees that we earn from managing the day-to-day operations of the facilities that we do not consolidate for financial reporting purposes.

32


 

Our equity in net income of nonconsolidated affiliates is primarily a function of the performance of our nonconsolidated affiliates and our percentage of ownership interest in those affiliates. However, our net patient revenues and associated expense line items only contain the results from our consolidated facilities. As a result of this incongruity in our reported results, management uses a variety of supplemental information to analyze our results of operations, including:

·

the results of operations of our consolidated subsidiaries and nonconsolidated affiliates;

·

our ownership share in the facilities we operate; and

·

facility operating indicators, such as systemwide net operating revenues growth, systemwide net patient revenues per case growth, same site systemwide net operating revenues growth and same site systemwide net patient revenues per case growth.

While revenues of our nonconsolidated affiliates are not recorded in our net operating revenues, we believe this information is important in understanding our financial performance because these revenues are typically the basis for calculating the line item Management fee revenues and, together with the expenses of our nonconsolidated affiliates, are the basis for deriving the line item Equity in net income of nonconsolidated affiliates. As we execute on our strategy of partnering with health systems, we expect the number of our facilities that we account for as equity method facilities will increase relative to our total number of facilities.

 

key measures

Facilities

Changes in our ownership of individual facilities and related changes in how we account for such facilities drive changes in our consolidated results from period to period in several ways, including:

·

Deconsolidations. As a result of a deconsolidation transaction, an affiliated facility that was previously consolidated becomes a nonconsolidated facility. Any income we earn, based upon our ownership percentage in the facility, is reported on a net basis in the line item Equity in net income of nonconsolidated affiliates, whereas prior to the deconsolidation transaction, the affiliated facility’s results were reported as part of our consolidated net operating revenues and the associated expense line items.

·

Consolidations. As a result of a consolidation transaction, an affiliated facility that was previously nonconsolidated and accounted for on an equity method basis becomes a consolidated facility. After consolidation, revenues and expenses of the affiliated facility are included as part of our consolidated results.

·

De novos. Where strategically appropriate, we invest, typically with a health system partner and physicians, in de novo facilities, which are newly developed ASCs. A de novo facility may be consolidated or nonconsolidated, depending on the circumstances.

·

Shifts in Ownership Percentage. Our net income is driven in part by our ownership percentage in a facility since a portion of the net income earned by the facility is attributable to any noncontrolling owners in the facility, even if we consolidate such facility. As a result of our partnerships with physicians, our percentage of ownership in a facility may shift over time, which may result in an increase or a decrease in the net income we earn from such facility.

We took several steps during the six-months ended June 30, 2015 to optimize our facility portfolio by acquiring, selling and closing certain consolidated and nonconsolidated facilities.

33


 

The following table presents a breakdown of the changes in the number of consolidated, nonconsolidated and managed-only facilities during the periods presented.

 

 

During the

 

 

During the

 

 

Six-Months

 

 

Six-Months

 

 

Ended

 

 

Ended

 

 

June 30,

 

 

June 30,

 

 

2015

 

 

2014

 

Facilities at Beginning of Period

 

 

 

 

 

 

 

Consolidated facilities:

 

95

 

 

 

87

 

Equity method facilities:

 

65

 

 

 

60

 

Managed-only facilities:

 

26

 

 

 

30

 

Total Facilities:

 

186

 

 

 

177

 

Strategic Activities Undertaken

 

 

 

 

 

 

 

Acquisitions

 

 

 

 

 

 

 

Consolidated facilities acquired:

 

8

 

 

 

3

 

Noncontrolling interests acquired in facilities accounted for

   as equity method investments:

 

3

 

 

 

 

Management agreements entered into:

 

 

 

 

2

 

De novos

 

 

 

 

 

 

 

Consolidated de novo facilities placed into operations:

 

 

 

 

 

De novo facilities accounted for as equity method

   investments placed into operations:

 

 

 

 

 

Consolidations / Deconsolidations / Other

 

 

 

 

 

 

 

Conversion transactions or contributions to joint ventures or

    other partnerships completed such that the facility is

    accounted for as a consolidated affiliate:

 

3

 

 

 

2

 

Conversion transactions or contributions to joint ventures or

    other partnerships completed such that the facility is

    accounted for as equity method investment:

 

3

 

 

 

2

 

Transactions completed such that consolidated or equity method facilities are accounted for as a managed-only facility:

 

1

 

 

 

 

Closures and Sales

 

 

 

 

 

 

 

Consolidated facilities sold:

 

1

 

 

 

1

 

Noncontrolling interests in facilities accounted for as equity

    method investments sold:

 

 

 

 

1

 

Consolidated facilities closed:

 

3

 

 

 

2

 

Equity method facilities closed:

 

 

 

 

 

Management agreements exited from:

 

 

 

 

 

Facilities at End of Period

 

 

 

 

 

 

 

Consolidated facilities:

 

102

 

 

 

88

 

Equity method facilities:

 

67

 

 

 

61

 

Managed-only facilities:

 

24

 

 

 

29

 

Total Facilities:

 

193

 

 

 

178

 

Average Ownership Interest

 

 

 

 

 

 

 

Consolidated facilities:

 

48.6

%

 

 

51.0

%

Equity method facilities:

 

25.5

%

 

 

25.0

%

Perioperative Contracts(1)

 

 

 

 

 

 

 

Number of contracts at beginning of period:

 

13

 

 

 

14

 

Number of contracts at end of period:

 

9

 

 

 

14

 

(1)

Perioperative service arrangements involve agreements between SCA and a hospital under which SCA manages the hospital’s outpatient surgery department or departments to improve physician alignment, optimize operational effectiveness and attain key outcomes in quality, growth and financial metrics.

34


 

Revenues

Our consolidated net operating revenues for the three-months ended June 30, 2015 and 2014 were $253.7 million and $208.7 million, respectively. Our consolidated net operating revenues for the six-months ended June 30, 2015 and 2014 were $487.8 million and $401.4 million, respectively.

Given the increase in the number of our nonconsolidated facilities, driven by the success of our health system and physician partnership growth strategy, we review nonconsolidated facility revenues and also manage our facilities utilizing certain supplemental systemwide growth metrics.

The following table summarizes our systemwide net operating revenues growth, systemwide net patient revenues per case growth, same site systemwide net operating revenues growth and same site systemwide net patient revenues per case growth.

 

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS  ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

 

(growth rates in actual amounts)

 

Systemwide net operating revenues growth (1)

 

18.2

%

 

 

10.2

%

 

 

17.2

%

 

 

9.7

%

Systemwide net patient revenues per case growth (1)

 

3.3

%

 

 

4.7

%

 

 

4.7

%

 

 

5.1

%

Same site systemwide net operating revenues growth (1)(2)

 

8.4

%

 

 

2.0

%

 

 

8.1

%

 

 

0.3

%

Same site systemwide net patient revenues per case growth (1)(2)

 

3.7

%

 

 

1.8

%

 

 

5.1

%

 

 

0.9

%

 

 

(1)

The revenues and expenses of equity method facilities are not directly included in our consolidated GAAP results. Only the net income earned from such facilities is reported on a net basis in the line item Equity in net income of nonconsolidated affiliates. Because of this, management supplementally focuses on non-GAAP systemwide results, which measure results from all our facilities, including revenues from our consolidated facilities and our equity method facilities (without adjustment based on our percentage of ownership). We include management fee revenues from managed-only facilities in systemwide net operating revenues growth and same site net operating revenues growth, but not patient or other revenues from managed-only facilities (in which we hold no ownership interest). We do not include managed-only facilities in systemwide net patient revenues per case growth or same site systemwide net patient revenues per case growth.

(2)

Same site refers to facilities that were operational in both the current and prior three- and six-month periods, as applicable.

Three-Months Ended June 30, 2015 Compared to Three-Months Ended June 30, 2014

Our consolidated net operating revenues increased by $45.0 million, or 21.6%, for the three-months ended June 30, 2015 to $253.7 million from $208.7 million for the three-months ended June 30, 2014. Consolidated net patient revenues per case increased by 6.3% to $1,844 per case during the three-months ended June 30, 2015 from $1,735 per case during the three-months ended June 30, 2014.

For the three-months ended June 30, 2015, systemwide net operating revenues grew by 18.2% compared to the three-months ended June 30, 2014. In addition, for the three-months ended June 30, 2015, systemwide net patient revenues per case grew by 3.3% compared to the three-months ended June 30, 2014.

The following table quantifies several significant items impacting our consolidated net operating revenues growth and net operating revenues growth of our nonconsolidated affiliates on a period-over-period basis:

 

 

Surgical Care Affiliates

 

 

Nonconsolidated

 

 

as Reported Under GAAP

 

 

Affiliates

 

 

(in millions)

 

Total net operating revenues, three-months ended

    June 30, 2014(1)(2)

$

208.7

 

 

$

160.1

 

Add: revenue from acquired facilities

 

26.8

 

 

 

15.2

 

    revenue from consolidations

 

4.6

 

 

 

(4.6

)

Less: revenue of disposed facilities

 

(4.0

)

 

 

(1.6

)

Adjusted base year net operating revenues

 

236.1

 

 

 

169.1

 

Increase from operations

 

17.6

 

 

 

13.1

 

Total net operating revenues, three-months ended

    June 30, 2015

$

253.7

 

 

$

182.2

 

 

35


 

 

(1)

$3.7 million in revenues have been removed from the prior period presented related to facilities accounted for as discontinued operations.

(2)

Additions to revenue represent revenue from the acquisition or consolidation of facilities during the 12 months after the date of acquisition or consolidation, as applicable. Deductions from revenue represent revenue from the disposition or deconsolidation of facilities that were owned or consolidated in a prior period but are not owned or consolidated at the end of the current period.

Six-Months Ended June 30, 2015 Compared to Six-Months Ended June 30, 2014

Our consolidated net operating revenues increased by $86.4 million, or 21.5%, for the six-months ended June 30, 2015 to $487.8 million from $401.4 million for the six-months ended June 30, 2014. Consolidated net patient revenues per case increased by 7.5% to $1,880 per case during the six-months ended June 30, 2015 from $1,749 per case during the six-months ended June 30, 2014.

For the six-months ended June 30, 2015, systemwide net operating revenues grew by 17.2% compared to the six-months ended June 30, 2014. In addition, for the six-months ended June 30, 2015, systemwide net patient revenues per case grew by 4.7% compared to the six-months ended June 30, 2014.

The following table quantifies several significant items impacting our consolidated net operating revenues growth and net operating revenues growth of our nonconsolidated affiliates on a period-over-period basis:

 

 

Surgical Care Affiliates

 

 

Nonconsolidated

 

 

as Reported Under GAAP

 

 

Affiliates

 

 

(in millions)

 

Total net operating revenues, six-months ended

   June 30, 2014(1)(2)

$

401.4

 

 

$

307.9

 

Add: revenue from acquired facilities

 

49.8

 

 

 

25.9

 

    revenue from consolidations

 

8.9

 

 

 

(8.9

)

Less: revenue of disposed facilities

 

(7.1

)

 

 

(3.3

)

Adjusted base year net operating revenues

 

453.0

 

 

 

321.6

 

Increase from operations

 

34.8

 

 

 

21.7

 

Total net operating revenues, six-months ended

    June 30, 2015:

$

487.8

 

 

$

343.3

 

 

 

(1)

$6.5 million in revenues have been removed from the prior period presented related to facilities accounted for as discontinued operations.

(2)     Additions to revenue represent revenue from the acquisition or consolidation of facilities during the 12 months after the date of  acquisition or consolidation, as applicable. Deductions from revenue represent revenue from the disposition or deconsolidation of facilities that were owned or consolidated in a prior period but are not owned or consolidated at the end of the current period.

Summary of Key Line Items

Net Operating Revenues

The majority of our net operating revenues consists of net patient revenues from the facilities we consolidate for financial reporting purposes. Net patient revenues are derived from fees we collect from insurance companies, Medicare, Medicaid, state workers’ compensation programs, patients and other payors in exchange for providing the facility and related services and supplies a physician requires to perform a surgical procedure. Our Net operating revenues also includes the line item Management fee revenues, which includes fees we earn from managing the facilities that we do not consolidate for financial reporting purposes. The line item Other revenues is composed of other ancillary services and fees received for anesthesia services. The physicians who perform procedures at our facilities bill and collect from their patients and other payors directly for their professional services, and their revenues from such professional services are not included in our net operating revenues.

 

Net Patient Revenues

Net patient revenues are recorded during the period in which the healthcare services are provided, based upon the estimated amounts due from insurance companies, patients and other government and third-party payors, including federal and state agencies (under the Medicare and Medicaid programs), state workers’ compensation programs and employers.

The following table presents a breakdown by payor source of the percentage of net patient revenues for the periods presented:

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Consolidated Facilities

 

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS  ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Managed care and other discount plans

 

64

%

 

 

61

%

 

 

63

%

 

 

61

%

Medicare

 

20

 

 

 

21

 

 

 

19

 

 

 

21

 

Workers’ compensation

 

9

 

 

 

11

 

 

 

10

 

 

 

11

 

Patients and other third party payors

 

4

 

 

 

4

 

 

 

5

 

 

 

4

 

Medicaid

 

3

 

 

 

3

 

 

 

3

 

 

 

3

 

Total

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

Nonconsolidated Facilities

 

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS  ENDED

 

 

JUNE 30,

 

 

JUNE 30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Managed care and other discount plans

 

69

%

 

 

71

%

 

 

70

%

 

 

70

%

Medicare

 

18

 

 

 

16

 

 

 

18

 

 

 

17

 

Workers’ compensation

 

5

 

 

 

6

 

 

 

5

 

 

 

6

 

Patients and other third party payors

 

6

 

 

 

5

 

 

 

5

 

 

 

5

 

Medicaid

 

2

 

 

 

2

 

 

 

2

 

 

 

2

 

Total

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

The majority of our net patient revenues are related to patients with commercial health insurance coverage. Reimbursement rates have been relatively stable, on an average basis, across our portfolio.

Medicare accounted for 20% and 21% of our net patient revenues for the three-months ended June 30, 2015 and 2014, respectively, and 19% and 21% of our net patient revenues for the six-months ended June 30, 2015 and 2014, respectively. The Medicare program is subject to statutory and regulatory changes, possible retroactive and prospective rate adjustments, administrative rulings, freezes and funding reductions, all of which may adversely affect the level of payments to our facilities. Significant spending reductions mandated by the Budget Control Act of 2011 (the “BCA”) impacting the Medicare program went into effect on March 1, 2013. Under the BCA, the percentage reduction for Medicare may not be more than 2% for a fiscal year, with a uniform percentage reduction across all providers. The impact from these spending reductions has not been material to our results. In October 2014, the Centers for Medicare and Medicaid Services finalized the payment update of 1.4% for ASCs for federal fiscal year 2015, consisting of 1.9% inflation minus a 0.5% productivity factor.  This payment update has not materially affected our results.

For the six-months ended June 30, 2015, the net patient revenues from our consolidated facilities located in each of Texas, California and North Carolina represented approximately 16%, 13% and 11%, respectively, of our total net patient revenues. Additionally, the net patient revenues from our consolidated facilities located in each of Alabama, Alaska, Florida and Idaho represented more than 5% of our total net patient revenues for the six-months ended June 30, 2015. As of June 30, 2015, 29 of our 67 nonconsolidated facilities accounted for as equity method investments were located in California, and 14 of these 67 facilities were located in Indiana.

Management Fee Revenues

Management fee revenues consist of management fees that we receive from managing the day-to-day operations of the facilities that we do not consolidate for financial reporting purposes.

Operating Expenses

Salaries and Benefits

Salaries and benefits represent the most significant cost to us and include all amounts paid to full- and part-time teammates, including all related costs of benefits provided to such teammates. Salaries and benefits expense represented 33.5% and 34.9% of our net operating revenues for the three-months ended June 30, 2015 and 2014, respectively, and 34.5% and 35.4% of our net operating revenues for the six-months ended June 30, 2015 and 2014, respectively.

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Supplies

Supplies expense includes all costs associated with medical supplies used while providing patient care at our consolidated facilities. Our supply costs primarily include sterile disposables, pharmaceuticals, implants and other similar items. Supplies expense represented 20.4% and 20.8% of our net operating revenues for the three-months ended June 30, 2015 and 2014, respectively, and 20.8% and 21.1% of our net operating revenues for the six-months ended June 30, 2015 and 2014, respectively.  Supplies expense is typically closely related to case volume, the timing of purchases and case mix, as an increase in the acuity of cases and the use of implants in those cases tends to drive supplies expense higher.

Other Operating Expenses

Other operating expenses consists primarily of expenses related to insurance premiums, contract services, legal fees, repairs and maintenance, professional and licensure dues, office supplies and miscellaneous expenses. Other operating expenses do not generally correlate with changes in net patient revenues.

Occupancy Costs

Occupancy costs include facility rent and utility and maintenance expenses. Occupancy costs do not generally correlate with changes in net patient revenues.

         Provision for Doubtful Accounts

We write off uncollectible accounts against the allowance for doubtful accounts after exhausting collection efforts and adding subsequent recoveries. Net accounts receivable includes only those amounts we estimate we will collect. We perform an analysis of our historical cash collection patterns and consider the impact of any known material events in determining the allowance for doubtful accounts. In performing our analysis, we consider the impact of any adverse changes in general economic conditions, business office operations, payor mix or trends in federal or state governmental healthcare coverage.

HealthSouth Option Expense

HealthSouth Corporation (“HealthSouth”) held an option (the “HealthSouth Option”) to purchase equity securities constituting 5% of the equity securities issued and outstanding as of the closing of our acquisition by TPG in 2007 on a fully diluted basis.  The HealthSouth Option became exercisable upon certain customary liquidity events, including a public offering of shares of our common stock that results in 30% or more of our common stock being listed or traded on a national securities exchange. Once vested, the HealthSouth Option was exercisable on a net exercise basis.

The HealthSouth Option’s value as of March 31, 2015 was $9.8 million, and that entire amount was expensed in the first quarter of 2015. There was no expense in the first quarter of 2014 related to the HealthSouth Option. On April 9, 2015, HealthSouth exercised the option at a value of $11.7 million. Accordingly, we recorded an additional $1.9 million of expense in the second quarter of 2015.

Debt Modification Expense

In conjunction with the refinancing of our corporate debt in the first quarter of 2015, we recognized $5.0 million of debt modification expense. There was no similar expense in 2014.

Loss on Extinguishment of Debt

In conjunction with the refinancing of our corporate debt in the first quarter of 2015, we recognized a $0.5 million loss on extinguishment of debt. There was no similar loss in 2014.

Provision for Income Tax Expense

Because we have a full valuation allowance booked against our net deferred tax assets, our tax expense is generated primarily from amortization of tax goodwill and write-offs of book and tax goodwill resulting from the syndication of partnership interests. Our tax expense therefore bears no relationship to pre-tax income, and our effective tax rate will fluctuate from period to period, depending upon the amount of tax expense from amortization and write-offs of goodwill. Since substantially all of our facilities are organized as general partnerships, LPs, LLPs or LLCs, which are not taxed at the entity level for federal income tax purposes and are only taxed at the entity level in five states for state income tax purposes, substantially all of our tax expense is attributable to Surgical Care Affiliates.

Net (Loss) Income Attributable to Surgical Care Affiliates

Net (loss) income attributable to Surgical Care Affiliates is derived by subtracting net income attributable to noncontrolling interests from net income. Net income includes certain revenues and expenses that are incurred only through our wholly-owned

38


 

subsidiaries, and therefore, do not impact net income attributable to noncontrolling interests. These revenues and expenses include management fee revenues, interest expense related to Surgical Care Affiliates’ debt, losses or gains on sales of investments and provision for income taxes. In periods where net income is negatively affected by these non-shared revenues and expenses, the deduction of net income attributable to noncontrolling interests from net income can result in a net loss attributable to Surgical Care Affiliates in periods where net income is positive.

 

39


 

Summary Results of Operations

Three-Months Ended June 30, 2015 Compared to Three-Months Ended June 30, 2014

Our Consolidated Results and Results of Nonconsolidated Affiliates

The following table shows our results of operations and the results of operations of our nonconsolidated affiliates for the three-months ended June 30, 2015 and 2014:

 

 

THREE-MONTHS ENDED JUNE 30,

 

 

2015

 

 

2014

 

 

As

 

 

 

 

 

 

As

 

 

 

 

 

 

Reported

 

 

Nonconsolidated

 

 

Reported

 

 

Nonconsolidated

 

 

Under GAAP

 

 

Affiliates(1)

 

 

Under GAAP

 

 

Affiliates(1)

 

 

(in millions, except cases and facilities in actual amounts)

 

Net operating revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net patient revenues

$

233.9

 

 

$

180.6

 

 

$

191.3

 

 

$

158.4

 

Management fee revenues

 

14.4

 

 

 

 

 

15.3

 

 

 

Other revenues

 

5.4

 

 

 

1.6

 

 

 

2.1

 

 

 

1.7

 

Total net operating revenues

 

253.7

 

 

 

182.2

 

 

 

208.7

 

 

 

160.1

 

Equity in net income of nonconsolidated affiliates(2)

 

11.6

 

 

 

 

 

7.9

 

 

 

Operating expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

84.9

 

 

 

39.5

 

 

 

72.7

 

 

 

34.2

 

Supplies

 

51.8

 

 

 

32.6

 

 

 

43.4

 

 

 

25.9

 

Other operating expenses

 

38.1

 

 

 

28.1

 

 

 

30.2

 

 

 

23.1

 

Depreciation and amortization

 

15.9

 

 

 

7.1

 

 

 

12.8

 

 

 

5.1

 

Occupancy costs

 

9.2

 

 

 

7.7

 

 

 

7.3

 

 

 

6.2

 

Provision for doubtful accounts

 

4.5

 

 

 

3.4

 

 

 

3.4

 

 

 

2.9

 

(Gain) loss on disposal of assets

 

(0.0

)

 

 

0.2

 

 

 

(0.0

)

 

 

0.2

 

Total operating expenses

 

204.4

 

 

 

118.6

 

 

 

169.7

 

 

 

97.7

 

Operating income

 

60.9

 

 

 

63.6

 

 

 

46.9

 

 

 

62.5

 

Interest expense

 

10.7

 

 

 

0.6

 

 

 

8.4

 

 

 

0.5

 

HealthSouth option expense

 

1.9

 

 

 

 

 

 

 

Debt modification expense

 

0.2

 

 

 

 

 

 

 

Interest income(3)

 

(0.0

)

 

 

(0.0

)

 

 

(0.0

)

 

 

(0.0

)

Loss (gain) on sale of investments(4)

 

0.3

 

 

 

 

 

(0.0

)

 

 

 

Income from continuing operations before income tax expense

 

47.9

 

 

 

63.0

 

 

 

38.6

 

 

 

62.0

 

Provision for income tax expense(5)

 

4.3

 

 

 

0.0

 

 

 

1.4

 

 

 

0.0

 

Income from continuing operations

 

43.7

 

 

 

63.0

 

 

 

37.2

 

 

 

62.0

 

Loss from discontinued operations, net of income tax expense

 

(0.2

)

 

 

 

 

(2.7

)

 

 

 

Net income

 

43.5

 

 

$

63.0

 

 

 

34.5

 

 

$

62.0

 

Less: Net income attributable to noncontrolling interests

 

(39.0

)

 

 

 

 

 

 

(28.5

)

 

 

 

 

Net income attributable to Surgical Care Affiliates

$

4.6

 

 

 

 

 

 

$

6.0

 

 

 

 

 

Equity in net income of nonconsolidated affiliates

 

 

 

 

$

11.6

 

 

 

 

 

 

$

7.9

 

Other Data(6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cases—consolidated facilities(7)

 

126,826

 

 

 

 

 

 

 

110,252

 

 

 

 

 

Cases—equity method facilities(8)

 

75,959

 

 

 

 

 

 

 

66,493

 

 

 

 

 

Consolidated facilities(9)

 

102

 

 

 

 

 

 

 

88

 

 

 

 

 

Equity method facilities

 

67

 

 

 

 

 

 

 

61

 

 

 

 

 

Managed-only facilities

 

24

 

 

 

 

 

 

 

29

 

 

 

 

 

Total facilities

 

193

 

 

 

 

 

 

 

178

 

 

 

 

 

40


 

(1)

The figures in this column, except within the line item Equity in net income of nonconsolidated affiliates, are non-GAAP presentations, but management believes they provide further useful information about our equity method investments. The revenues, expense and operating income line items included in this column represent the results of our facilities that we account for as an equity method investment on a combined basis, without taking into account our percentage of ownership interest. The line item Equity in net income of nonconsolidated affiliates represents the total net income earned by us from our facilities accounted for as an equity method investment, which is computed as our percentage of ownership interest in the facility (which differs among facilities) multiplied by the net income earned by such facility, adjusted for basis differences such as amortization and other than temporary impairment charges, as described below.

(2)

For the three-months ended June 30, 2015 and 2014, we recorded amortization expense of $0.2 million and $5.8 million, respectively, for definite-lived intangible assets attributable to equity method investments within Equity in net income of nonconsolidated affiliates.

(3)

Interest income as reported under GAAP was $0.042 million and $0.049 million for the three-months ended June 30, 3015 and 2014, respectively. Interest income of nonconsolidated affiliates was $0.016 million and $0.014 million for the three-months ended June 30, 2015 and 2014, respectively.

(4)

Loss (gain) on sale of investments as reported under GAAP was $0.004 million for the three-months ended June 30, 2014.

(5)

Provision for income tax expense for nonconsolidated affiliates was $0.013 million and $0.027 million for the three-months ended June 30, 2015 and 2014, respectively.

(6)

Case data is presented for the three-months ended June 30, 2015 and 2014, as applicable. Facilities data is presented as of June 30, 2015 and 2014, as applicable.

(7)

Represents cases performed at consolidated facilities. The number of cases performed at our facilities is a key metric utilized by us to regularly evaluate performance.

(8)

Represents cases performed at equity method facilities. The number of cases performed at our facilities is a key metric utilized by us to regularly evaluate performance.

(9)

As of June 30, 2015 we consolidated 15 of these facilities as VIEs.

Net Operating Revenues

Our consolidated net operating revenues increased $45.0 million, or 21.6%, for the three-months ended June 30, 2015 compared to the three-months ended June 30, 2014. The main factors that contributed to this increase were revenues earned from acquisitions (including the consolidation of three previously nonconsolidated facilities), increased rates paid under certain payor contracts and higher acuity case mix. Consolidated net patient revenues per case grew by 6.3% to $1,844 per case for the three-months ended June 30, 2015 from $1,735 per case during the prior year period, reflecting acquisitions of facilities with higher rates per case than the average rates at our consolidated facilities, increased rates paid under certain payor contracts and higher acuity case mix. The number of cases at our consolidated facilities increased to 126,826 cases during the three-months ended June 30, 2015 from 110,252 cases during the three-months ended June 30, 2014, largely due to acquisitions since June 30, 2014. Our number of consolidated facilities increased to 102 facilities as of June 30, 2015 from 88 facilities as of June 30, 2014.

For the three-months ended June 30, 2015, systemwide net operating revenues grew by 18.2% compared to the three-months ended June 30, 2014. The growth in systemwide net operating revenues was largely due to the acquisition of 18 consolidated facilities, excluding three of which that were previously accounted for as equity method investments (see Note 3 to the condensed consolidated financial statements included herein regarding Kentucky JVs).  The acquisition of noncontrolling interests in twelve facilities accounted for as equity method investments since the prior period and increased rates earned under certain payor contracts also contributed to this growth in systemwide net operating revenues. In addition, for the three-months ended June 30, 2015, systemwide net patient revenues per case grew by 3.3% compared to the three-months ended June 30, 2014, due to the acquisitions described above as well as increased rates paid under certain payor contracts.

Equity in Net Income of Nonconsolidated Affiliates

Equity in net income of nonconsolidated affiliates increased $3.7 million, or 46.8%, to $11.6 million during the three-months ended June 30, 2015 from $7.9 million during the three-months ended June 30, 2014. Equity in net income of nonconsolidated affiliates increased due to a decrease in amortization expense for definite-lived intangible assets attributable to equity method investments from the prior year period and the acquisition of several noncontrolling interests in facilities since June 30, 2014. This increase was primarily offset by an impairment recorded during the second quarter of 2015 due to advances previously extended to a nonconsolidated affiliate that were deemed not recoverable, as well as the consolidation of three facilities that were previously accounted for as equity method investments in the second quarter of 2014.

Additionally, changes in our ownership amounts in equity method facilities and changes in the profitability of those equity method facilities also impacted Equity in net income of nonconsolidated affiliates.

41


 

Salaries and Benefits

Salaries and benefits expense increased $12.2 million, or 16.8%, to $84.9 million for the three-months ended June 30, 2015 from $72.7 million for the three-months ended June 30, 2014 due to the addition of teammates of newly acquired consolidated facilities (including the conversion of three previously nonconsolidated facilities to consolidated) and corporate investments related primarily to operations and development.

Supplies

Supplies expense increased $8.4 million, or 19.4%, to $51.8 million for the three-months ended June 30, 2015 from $43.4 million for the three-months ended June 30, 2014. Supplies expense per case increased by 3.9% during the three-months ended June 30, 2015, as compared to the prior year period, primarily due to inflation and changes in case mix.

Other Operating Expenses

Other operating expenses increased $7.9 million, or 26.2%, to $38.1 million for the three-months ended June 30, 2015 from $30.2 million for the three-months ended June 30, 2014. This increase was primarily attributable to the incurrence of additional costs resulting from our organizational growth through acquisitions.

Depreciation and Amortization

Depreciation and amortization expense increased $3.1 million, or 24.2%, to $15.9 million for the three-months ended June 30, 2015 from $12.8 million for the three-months ended June 30, 2014, primarily due to consolidated acquisitions and the addition of new capitalized assets since June 30, 2014.

Occupancy Costs

Occupancy costs increased $1.9 million, or 26.0%, to $9.2 million for the three-months ended June 30, 2015 from $7.3 million for the three-months ended June 30, 2014, primarily due to acquisitions after the prior year period and organizational growth.

Provision for Doubtful Accounts

The provision for doubtful accounts increased to $4.5 million for the three-months ended June 30, 2015 as compared to $3.4 million during the three-months ended June 30, 2014. However, it remained consistent as a percentage of net patient revenues, at approximately 2.0%, for each of the three-months ended June 30, 2015 and 2014.

Interest Expense

Interest expense increased $2.3 million, or 27.4%, to $10.7 million for the three-months ended June 30, 2015 from $8.4 million for the three-months ended June 30, 2014, primarily due to the refinancing of our indebtedness during the first quarter of 2015.

HealthSouth Option Expense

HealthSouth held an option to purchase equity securities constituting 5% of the equity securities issued and outstanding as of the closing of our acquisition by TPG in 2007 on a fully diluted basis.  The option became exercisable upon certain customary liquidity events, including a public offering of shares of our common stock that results in 30% or more of our common stock being listed or traded on a national securities exchange. Once vested, the option was exercisable on a net exercise basis.

The option’s value as of March 31, 2015 was $9.8 million, and that entire amount was expensed in the first quarter of 2015. There was no expense in the first quarter of 2014 related to the HealthSouth option. On April 9, 2015, HealthSouth exercised the option at a value of $11.7 million. Accordingly, an additional $1.9 million of expense was recorded in the second quarter of 2015. There was no similar expense in the second quarter of 2014.

Gain (Loss) on Sale of Investments

We recognized losses on sale of investments of $0.3 million for the three-months ended June 30, 2015 and immaterial gains on sale of investments for the three-months ended June 30, 2014.

42


 

Provision for Income Tax Expense

For the three-months ended June 30, 2015, income tax expense was $4.3 million, representing an effective tax rate of 8.9%, compared to an expense of $1.4 million, representing an effective tax rate of 3.6%, for the three-months ended June 30, 2014. The $4.3 million in expense for the three-months ended June 30, 2015 includes $4.0 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, as well as write-offs of book and tax goodwill, and $0.3 million of state income taxes accrued by subsidiaries with separate state tax filing requirements, including $0.2 million attributable to noncontrolling interests. The $1.4 million in expense for the three-months ended June 30, 2014 includes $1.2 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, as well as write-offs of book and tax goodwill, and $0.2 million of state income taxes accrued by subsidiaries with separate state tax filing requirements, including $0.1 million attributable to noncontrolling interests.

Because we have a full valuation allowance booked against our net deferred tax assets, our tax expense is generated primarily from amortization of tax goodwill and write-offs of tax goodwill resulting from the syndication of partnership interests. Our tax expense therefore bears no relationship to pre-tax income, and our effective tax rate will fluctuate from period to period, depending upon the amount of tax expense from amortization and write-offs of goodwill.

On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our most recent operating performance, the scheduled reversal of temporary differences and our forecast of taxable income in future periods are important considerations in our assessment. Management has considered all positive and negative evidence available at this time and has concluded that a full valuation allowance continues to be appropriate as of June 30, 2015. We continue to closely monitor actual and forecasted earnings and, if there is a change in management’s assessment of the amount of deferred income tax assets that is realizable, adjustments to the valuation allowance will be made in future periods.

Net income attributable to noncontrolling interests

Net income attributable to noncontrolling interests increased $10.5 million, or 36.8%, to $39.0 million for the three-months ended June 30, 2015 from $28.5 million for the three-months ended June 30, 2014. The increase in our consolidated net operating revenues, as described above, drove an increase in consolidated facilities’ net income. Most of our consolidated facilities include noncontrolling owners. An increase in the earnings of these facilities resulted in an increase in net income attributable to noncontrolling interests.

Net (loss) income attributable to Surgical Care Affiliates

Net income attributable to Surgical Care Affiliates decreased $1.4 million to $4.6 million of net income for the three-months ended June 30, 2015 from net income of $6.0 million for the three-months ended June 30, 2014.  While our facilities’ revenue and operating income increased during the three-months ended June 30, 2015, the increase in revenues and operating income was offset by increases in net income attributable to noncontrolling interests, interest expense and HealthSouth option expense.

43


 

Six-Months Ended June 30, 2015 Compared to Six-Months Ended June 30, 2014

Our Consolidated Results and Results of Nonconsolidated Affiliates

The following table shows our results of operations and the results of operations of our nonconsolidated affiliates for the six-months ended June 30, 2015 and 2014:

 

 

SIX-MONTHS ENDED JUNE 30,

 

 

2015

 

 

2014

 

 

As

 

 

 

 

 

 

As

 

 

 

 

 

 

Reported

 

 

Nonconsolidated

 

 

Reported

 

 

Nonconsolidated

 

 

Under GAAP

 

 

Affiliates(1)

 

 

Under GAAP

 

 

Affiliates(1)

 

 

(in millions, except cases and facilities in actual amounts)

 

Net operating revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net patient revenues

$

450.5

 

 

$

340.1

 

 

$

366.1

 

 

$

305.0

 

Management fee revenues

 

28.5

 

 

 

 

 

28.4

 

 

 

Other revenues

 

8.8

 

 

 

3.3

 

 

 

6.8

 

 

 

2.8

 

Total net operating revenues

 

487.8

 

 

 

343.3

 

 

 

401.4

 

 

 

307.9

 

Equity in net income of nonconsolidated affiliates(2)

 

23.7

 

 

 

 

 

13.6

 

 

 

Operating expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

168.3

 

 

 

75.7

 

 

 

141.9

 

 

 

66.9

 

Supplies

 

101.3

 

 

 

61.3

 

 

 

84.5

 

 

 

51.5

 

Other operating expenses

 

74.8

 

 

 

53.5

 

 

 

59.4

 

 

 

46.8

 

Depreciation and amortization

 

31.1

 

 

 

13.0

 

 

 

24.4

 

 

 

10.1

 

Occupancy costs

 

17.4

 

 

 

14.9

 

 

 

14.1

 

 

 

12.5

 

Provision for doubtful accounts

 

8.7

 

 

 

6.9

 

 

 

6.3

 

 

 

5.9

 

Impairment of intangible and long-lived assets

 

 

 

 

 

 

 

0.5

 

 

 

 

Loss (gain) on disposal of assets

 

0.2

 

 

 

0.0

 

 

 

(0.1

)

 

 

0.2

 

Total operating expenses

 

401.8

 

 

 

225.3

 

 

 

331.1

 

 

 

193.9

 

Operating income

 

109.7

 

 

 

118.0

 

 

 

83.9

 

 

 

114.0

 

Interest expense

 

19.5

 

 

 

0.9

 

 

 

16.4

 

 

 

0.9

 

HealthSouth option expense

 

11.7

 

 

 

 

 

 

 

 

 

Debt modification expense

 

5.0

 

 

 

 

 

 

 

 

Loss on extinguishment of debt

 

0.5

 

 

 

 

 

 

 

 

Interest income(3)

 

(0.1

)

 

 

(0.0

)

 

 

(0.1

)

 

 

(0.0

)

(Gain) loss on sale of investments

 

(1.6

)

 

 

 

 

 

4.3

 

 

 

 

Income from continuing operations before income tax expense

 

74.5

 

 

 

117.1

 

 

 

63.3

 

 

 

113.1

 

Provision for income tax expense(4)

 

8.1

 

 

 

0.0

 

 

 

3.1

 

 

 

0.0

 

Income from continuing operations

 

66.4

 

 

 

117.1

 

 

 

60.2

 

 

 

113.1

 

Loss from discontinued operations, net of income tax expense

 

(1.6

)

 

 

 

 

 

(2.6

)

 

 

 

Net income

 

64.8

 

 

$

117.1

 

 

 

57.7

 

 

$

113.1

 

Less: Net income attributable to noncontrolling interests

 

(69.4

)

 

 

 

 

 

 

(51.4

)

 

 

 

 

Net (loss) income attributable to Surgical Care Affiliates

$

(4.6

)

 

 

 

 

 

$

6.3

 

 

 

 

 

Equity in net income of nonconsolidated affiliates

 

 

 

 

$

23.7

 

 

 

 

 

 

$

13.6

 

Other Data(5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cases—consolidated facilities(6)

 

239,608

 

 

 

 

 

 

 

209,357

 

 

 

 

 

Cases—equity method facilities(7)

 

141,297

 

 

 

 

 

 

 

129,279

 

 

 

 

 

Consolidated facilities(8)

 

102

 

 

 

 

 

 

 

88

 

 

 

 

 

Equity method facilities

 

67

 

 

 

 

 

 

 

61

 

 

 

 

 

Managed-only facilities

 

24

 

 

 

 

 

 

 

29

 

 

 

 

 

Total facilities

 

193

 

 

 

 

 

 

 

178

 

 

 

 

 

44


 

(1)

The figures in this column, except within the line item Equity in net income of nonconsolidated affiliates, are non-GAAP presentations, but management believes they provide further useful information about our equity method investments. The revenues, expense and operating income line items included in this column represent the results of our facilities that we account for as an equity method investment on a combined basis, without taking into account our percentage of ownership interest. The line item Equity in net income of nonconsolidated affiliates represents the total net income earned by us from our facilities accounted for as an equity method investment, which is computed as our percentage of ownership interest in the facility (which differs among facilities) multiplied by the net income earned by such facility, adjusted for basis differences such as amortization and other than temporary impairment charges, as described below.

(2)

For the six-months ended June 30, 2015 and 2014, we recorded amortization expense of $0.4 million and $11.6 million, respectively, for definite-lived intangible assets attributable to equity method investments within Equity in net income of nonconsolidated affiliates.

(3)

Interest income of nonconsolidated affiliates was $0.034 million and $0.026 million for the six-months ended June 30, 2015 and 2014, respectively.

(4)

Provision for income tax expense for nonconsolidated affiliates was $0.019 million and $0.040 million for the six-months ended June 30, 2015 and 2014, respectively.

(5)

Case data is presented for the six-months ended June 30, 2015 and 2014, as applicable. Facilities data is presented as of June 30, 2015 and 2014, as applicable.

(6)

Represents cases performed at consolidated facilities. The number of cases performed at our facilities is a key metric utilized by us to regularly evaluate performance.

(7)

Represents cases performed at equity method facilities. The number of cases performed at our facilities is a key metric utilized by us to regularly evaluate performance.

(8)

As of June 30, 2015 we consolidated 15 of these facilities as VIEs.

Net Operating Revenues

Our consolidated net operating revenues increased $86.4 million, or 21.5%, for the six-months ended June 30, 2015 compared to the six-months ended June 30, 2014. The main factors that contributed to this increase were revenues earned from acquisitions (including the consolidation of three previously nonconsolidated facilities), increased rates paid under certain payor contracts and higher acuity case mix. Consolidated net patient revenues per case grew by 7.5% to $1,880 per case for the six-months ended June 30, 2015 from $1,749 per case during the prior year period, reflecting acquisitions with higher rates per case than the average of our consolidated facilities as well as higher acuity case mix. The number of cases at our consolidated facilities increased to 239,608 cases during the six-months ended June 30, 2015 from 209,357 cases during the six-months ended June 30, 2014, due to acquisitions since June 30, 2014. Our number of consolidated facilities increased to 102 facilities as of June 30, 2015 from 88 facilities as of June 30, 2014.

For the six-months ended June 30, 2015, systemwide net operating revenues grew by 17.2% compared to the six-months ended June 30, 2014. The growth in systemwide net operating revenues was largely due to the acquisition of 18 consolidated facilities, excluding three of which that were previously accounted for as equity method investments (see Note 3 to the condensed consolidated financial statements included herein regarding Kentucky JVs).  The acquisition of noncontrolling interests in twelve facilities accounted for as equity method investments since the prior period and increased rates earned under certain payor contracts also contributed to this growth in systemwide net operating revenues. In addition, for the six-months ended June 30, 2015, systemwide net patient revenues per case grew by 4.7% compared to the six-months ended June 30, 2014, due to the acquisitions described above as well as increased rates paid under certain payor contracts.

Equity in Net Income of Nonconsolidated Affiliates

Equity in net income of nonconsolidated affiliates increased $10.1 million, or 74.3%, to $23.7 million during the six-months ended June 30, 2015 from $13.6 million during the six-months ended June 30, 2014. Equity in net income of nonconsolidated affiliates increased due to a decrease in amortization expense for definite-lived intangible assets attributable to equity method investments from the prior year period and the acquisition of several noncontrolling interests in facilities since June 30, 2014. This increase was primarily offset by an impairment recorded during the second quarter of 2015 due to advances previously extended to a nonconsolidated affiliate that were deemed not recoverable, and the consolidation of three facilities that were previously accounted for as equity method investments in the first half of 2014.

 

Additionally, changes in our ownership amounts in equity method facilities and changes in the profitability of those equity method facilities also impacted Equity in net income of nonconsolidated affiliates.

45


 

Salaries and Benefits

Salaries and benefits expense increased $26.4 million, or 18.6%, to $168.3 million for the six-months ended June 30, 2015 from $141.9 million for the six-months ended June 30, 2014 due to the addition of teammates of newly acquired consolidated facilities and corporate investments primarily related to operations and development.

Supplies

Supplies expense increased $16.8 million, or 19.9%, to $101.3 million for the six-months ended June 30, 2015 from $84.5 million for the six-months ended June 30, 2014.  Supplies expense per case increased by 4.6% during the six-months ended June 30, 2015, as compared to the prior year period, primarily due to inflation and changes in case mix.

Other Operating Expenses

Other operating expenses increased $15.4 million, or 25.9%, to $74.8 million for the six-months ended June 30, 2015 from $59.4 million for the six-months ended June 30, 2014. This increase is primarily attributable to the incurrence of additional costs resulting from our organizational growth through acquisitions.

Depreciation and Amortization

Depreciation and amortization expense increased $6.7 million, or 27.5%, to $31.1 million for the six-months ended June 30, 2015 from $24.4 million for the six-months ended June 30, 2014, primarily due to acquisitions and the addition of new capitalized assets since June 30, 2014.

Occupancy Costs

Occupancy costs increased $3.3 million, or 23.4%, to $17.4 million for the six-months ended June 30, 2015 from $14.1 million for the six-months ended June 30, 2014, primarily due to acquisitions after the prior period and organizational growth.

Provision for Doubtful Accounts

The provision for doubtful accounts increased $2.4 million, or 38.1%, to $8.7 million for the six-months ended June 30, 2015 from $6.3 million during the six-months ended June 30, 2014.  However, it remained consistent as a percentage of net patient revenues at approximately 2.0% for the six-months ended June 30, 2015 and 2014.

Interest Expense

Interest expense increased $3.1 million, or 18.9%, to $19.5 million for the six-months ended June 30, 2015 from $16.4 million for the six-months ended June 30, 2014, primarily due to the refinancing of our indebtedness during the first quarter of 2015.

HealthSouth Option Expense

HealthSouth held an option to purchase equity securities constituting 5% of the equity securities issued and outstanding as of the closing of our acquisition by TPG in 2007 on a fully diluted basis.  The option became exercisable upon certain customary liquidity events, including a public offering of shares of our common stock that results in 30% or more of our common stock being listed or traded on a national securities exchange. Once vested, the option was exercisable on a net exercise basis.

On April 9, 2015, HealthSouth exercised the option at a value of $11.7 million. Accordingly, $11.7 million of expense was recorded in the first half of 2015. There was no similar expense in the first half of 2014.

Debt Modification Expense

In conjunction with the refinancing of our corporate debt in the first quarter of 2015, we recognized $5.0 million of debt modification expense. There was no similar expense in the first six months of 2014.  

(Gain) Loss on Sale of Investments

We recognized gains on sale of investments of $1.6 million and losses on sale of investments of $4.3 million for the six-months ended June 30, 2015 and 2014, respectively. The gains recognized during the six-months ended June 30, 2015 were primarily due to the sale of the right to manage a facility held as an equity method investment. The losses for the six-months ended June 30, 2014 were primarily due to deconsolidation transactions.

 

Provision for Income Tax Expense

For the six-months ended June 30, 2015, income tax expense was $8.1 million, representing an effective tax rate of 10.8%, compared to an expense of $3.1 million, representing an effective tax rate of 4.9%, for the six-months ended June 30, 2014. The $8.1 million in expense for the six-months ended June 30, 2015 includes $7.5 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, as well as write-offs of book and tax goodwill, and $0.6 million of state income taxes accrued by

46


 

subsidiaries with separate state tax filing requirements, including $0.5 million attributable to noncontrolling interests. The $3.1 million in expense for the six-months ended June 30, 2014 includes $2.8 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, as well as write-offs of book and tax goodwill, and $0.3 million of state income taxes accrued by subsidiaries with separate state tax filing requirements, including $0.2 million attributable to noncontrolling interests.

Because we have a full valuation allowance booked against our net deferred tax assets, our tax expense is generated primarily from amortization of tax goodwill and write-offs of tax goodwill resulting from the syndication of partnership interests. Our tax expense therefore bears no relationship to pre-tax income, and our effective tax rate will fluctuate from period to period, depending upon the amount of tax expense from amortization and write-offs of goodwill.

On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our most recent operating performance, the scheduled reversal of temporary differences and our forecast of taxable income in future periods are important considerations in our assessment. Management has considered all positive and negative evidence available at this time and has concluded that a full valuation allowance continues to be appropriate as of June 30, 2015. We continue to closely monitor actual and forecasted earnings and, if there is a change in management’s assessment of the amount of deferred income tax assets that is realizable, adjustments to the valuation allowance will be made in future periods.

Net income attributable to noncontrolling interests

Net income attributable to noncontrolling interests increased $18.0 million, or 35.0%, to $69.4 million for the six-months ended June 30, 2015 from $51.4 million for the six-months ended June 30, 2014. The increase in our consolidated net operating revenues, as described above, drove an increase in consolidated facilities’ net income. Most of our consolidated facilities include noncontrolling owners. An increase in the earnings of these facilities resulted in an increase in net income attributable to noncontrolling interests.

Net (loss) income attributable to Surgical Care Affiliates

Net loss attributable to Surgical Care Affiliates increased $10.9 million to $4.6 million of net loss for the six-months ended June 30, 2015 from $6.3 million of net income for the six-months ended June 30, 2014. While our facilities’ revenue and operating income increased during the six-months ended June 30, 2015, the increase in revenues and operating income was offset by increases in net income attributable to noncontrolling interests, HealthSouth option expense and debt modification expense.

Results of Discontinued Operations

We have closed or sold certain facilities that qualify for reporting as discontinued operations. The operating results of discontinued operations were as follows:

 

 

THREE-MONTHS  ENDED

 

 

SIX-MONTHS  ENDED

 

 

JUNE 30,

 

 

JUNE  30,

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Net operating revenues

$

0.9

 

 

$

4.4

 

 

$

4.0

 

 

$

8.2

 

Costs and expenses

 

(2.5

)

 

 

(5.9

)

 

 

(6.9

)

 

 

(9.6

)

Gain on sale of investments or closures

 

2.1

 

 

 

0.0

 

 

 

2.0

 

 

 

0.0

 

Impairments

 

 

 

 

(0.7

)

 

 

 

 

 

(0.7

)

Income (loss) from discontinued operations

 

0.5

 

 

 

(2.2

)

 

 

(0.9

)

 

 

(2.2

)

Income tax expense

 

(0.7

)

 

 

(0.5

)

 

 

(0.8

)

 

 

(0.4

)

Net loss from discontinued operations

$

(0.2

)

 

$

(2.7

)

 

$

(1.6

)

 

$

(2.6

)

Both the decline in net operating revenues and the decrease in costs and expenses from the prior year periods were due to the deterioration of the operating results of one facility identified as a discontinued operation. The net loss from our discontinued operations is included in the line item Loss from discontinued operations, net of income tax expense in the condensed consolidated financial statements.

 

 

47


 

Liquidity and Capital Resources

Our primary cash requirements are paying our operating expenses, making distributions to noncontrolling interests, financing acquisitions of interests in ASCs and surgical hospitals, servicing our existing debt and making capital expenditures on our existing properties. These continuing liquidity requirements have been and will continue to be significant. The following chart shows the cash flows provided by or used in operating, investing and financing activities of continuing and discontinued operations (in the aggregate) for the six-months ended June 30, 2015 and 2014:

 

 

SIX-MONTHS

 

 

ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Net cash provided by operating activities

$

116.7

 

 

$

86.7

 

Net cash used in investing activities

 

(76.7

)

 

 

(49.7

)

Net cash provided by (used in) financing activities

 

29.1

 

 

 

(33.7

)

Increase in cash and cash equivalents

$

69.1

 

 

$

3.2

 

Cash Flows Provided by Operating Activities

Cash flows provided by operating activities is primarily derived from net income before deducting non-cash charges for depreciation and amortization.

 

 

SIX-MONTHS

 

 

ENDED

 

 

JUNE 30,

 

 

2015

 

 

2014

 

Net income

$

64.8

 

 

$

57.7

 

Depreciation and amortization

 

31.1

 

 

 

24.4

 

Distributions from nonconsolidated affiliates

 

27.5

 

 

 

27.0

 

Provision for doubtful accounts

 

8.7

 

 

 

6.3

 

Equity in income of nonconsolidated affiliates

 

(23.7

)

 

 

(13.6

)

Other operating cash flows, net

 

8.4

 

 

 

(15.1

)

Net cash provided by operating activities

$

116.7

 

 

$

86.7

 

During the six-months ended June 30, 2015, we generated $116.7 million of cash flows provided by operating activities compared to $86.7 million during the six-months ended June 30, 2014. Cash flows from operating activities increased $30.0 million, or 34.6%, from the prior year period, primarily due to a $23.5 million increase in other operating cash flows consisting largely of changes in working capital.

Cash Flows Used in Investing Activities

During the six-months ended June 30, 2015, our net cash used in investing activities was $76.7 million, consisting primarily of $54.7 million for business acquisitions, net of cash acquired, $30.3 million of purchases of equity interests in nonconsolidated affiliates and $19.0 million of capital expenditures, partially offset by $20.1 million of proceeds from the sale of equity interests of nonconsolidated affiliates and $11.0 million of net cash provided by investing activities of discontinued operations. Cash flows used in investing activities increased $27.0 million, or 54.3%, from the prior year period, primarily due to an increase in cash outflows for business acquisitions and purchases of equity interests in nonconsolidated affiliates, partially offset by an increase in cash inflows from proceeds from sale of equity interests of nonconsolidated affiliates and cash provided by discontinued operations.

Cash Flows Provided by (Used in) Financing Activities

Net cash provided by financing activities for the six-months ended June 30, 2015 was $29.1 million, consisting primarily of $703.6 million in long-term debt borrowings and $5.2 million of contributions from noncontrolling interests of consolidated affiliates, partially offset by $604.1 million for principal payments on long-term debt and $73.7 million of distributions to noncontrolling interests, which primarily related to existing facilities.

Net cash provided by financing activities increased $62.8 million, or 186.4%, from the prior year period, primarily due to higher net long-term debt borrowings in conjunction with our refinancing transactions completed in March 2015.

48


 

Cash and cash equivalents were $77.8 million at June 30, 2015 as compared to $8.7 million at December 31, 2014. Cash and cash equivalents consist of cash on hand, demand deposits with financial institutions (reduced by the amount of outstanding checks and drafts where the right of offset exists for such bank accounts) and short-term, highly liquid investments. We consider all highly liquid investments with original maturities of 90 days or less, such as certificates of deposit, money market funds and commercial paper, to be cash equivalents. The overall working capital position at June 30, 2015 was $55.4 million compared to a deficit of $11.9 million at December 31, 2014, an increase of $67.3 million, or 565.5%. This increase was primarily driven by an increase in Cash and cash equivalents.

Based on our current level of operations, we believe cash flow from operations and available cash, together with available borrowings under the New Revolving Credit Facility, will be adequate to meet our short-term (12 months or less) and longer-term (less than five years) liquidity needs.

Debt

Our primary sources of funding have been the incurrence of debt and cash flows from operations. In the future, our primary sources of liquidity are expected to be cash flows from operations and additional funds available under the New Revolving Credit Facility.

First Quarter 2015 Refinancing Transactions

On March 17, 2015, the Company issued $250 million aggregate principal amount of its 6.00% senior unsecured notes due 2023 (the “Senior Notes”) under an Indenture dated March 17, 2015 (the “Indenture”).  Also, on March 17, 2015, we entered into a $700 million credit agreement (the “New Credit Agreement”). The New Credit Agreement provides for a seven-year, $450 million term loan credit facility (the “New Term Loan Facility”) and a five-year, $250 million revolving credit facility (the “New Revolving Credit Facility” and together with the New Term Loan Facility, collectively, the “New Credit Facilities”).

We received $245.6 million in net proceeds from the sale of the Senior Notes after deducting the initial purchasers’ discount. We used the net proceeds from the sale of the Senior Notes, together with approximately $381 million of the aggregate of $450.0 million in principal amount of borrowings under the Company’s New Term Loan Facility (together with the issuance of the Senior Notes, the “Refinancing Transactions”), to repay all of the outstanding indebtedness (including accrued interest and fees) under the Company’s then existing credit facilities. The remaining approximately $69 million of net proceeds from the Refinancing Transactions was used to pay the transaction costs associated with the Refinancing Transactions and for general corporate purposes.  In connection with the settlement of existing debt upon entering into our New Credit Agreement, we incurred debt modification costs of $5.0 million.

          Senior Notes

On March 17, 2015, we issued the Senior Notes under the Indenture.  The Senior Notes are general unsecured obligations of the Company and are guaranteed by certain wholly-owned subsidiaries of the Company and any subsequently acquired wholly-owned subsidiaries that guarantee certain of the Company’s indebtedness, subject to certain exceptions. The Senior Notes are pari passu in right of payment with all of the existing and future senior debt of the Company, including the Company’s indebtedness under the New Credit Facilities, and senior to all existing and future subordinated debt of the Company.

Interest on the Senior Notes accrues at the rate of 6.00% per annum and is payable semi-annually in arrears on April 1 and October 1, beginning on October 1, 2015. The Senior Notes mature on April 1, 2023.

The Indenture contains certain customary affirmative covenants, events of default and various restrictive covenants, which are subject to certain significant exceptions. As of June 30, 2015, we believe that we were in compliance with these covenants.

          New Credit Facilities

On March 17, 2015, we entered into the $700 million New Credit Agreement with JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, and the other lenders party thereto. The New Credit Agreement, subject to the terms and conditions set forth therein, provides for a seven-year, $450 million New Term Loan Facility and a five-year, $250 million New Revolving Credit Facility. The New Credit Agreement also includes an accordion feature that, subject to the satisfaction of certain conditions, will allow us to add one or more incremental term loan facilities to the New Term Loan Facility and/or increase the revolving commitments under the New Revolving Credit Facility, in each case based on leverage ratios and minimum dollar amounts, as more particularly set forth in the New Credit Agreement.  The interest rate on the New Term Loan was 4.25% at June 30, 2015.

49


 

The New Credit Facilities replaced our Credit Agreement, dated as of June 29, 2007 (as amended and restated and further amended, the “2007 Credit Agreement”), among the Company, SCA, JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, and the other lenders party thereto.

Quarterly principal payments on the loans under the New Term Loan Facility are payable in equal installments in an amount equal to 0.25% of the aggregate initial principal amount of the loans made under the New Term Loan Facility. The loans made under the New Term Loan Facility mature and all amounts then outstanding thereunder are payable on March 17, 2022.

The following table indicates the current maturity date of the New Credit Facilities:

 

Facility

 

Maturity Date

New Revolving Credit Facility

 

March 17, 2020

New Term Loan due 2022

 

March 17, 2022

Borrowings under the New Credit Agreement bear interest, at the Company’s election, either at (1) a base rate determined by reference to the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the United States federal funds rate plus 0.50% and (c) a LIBOR rate plus 1.00% (provided that, with respect to the New Term Loan Facility, in no event will the base rate be deemed to be less than 2.00%) (the “Base Rate”) or (2) an adjusted LIBOR rate (provided that, with respect to the New Term Loan Facility, in no event will the adjusted LIBOR rate be deemed to be less than 1.00%) (the “LIBOR Rate”), plus in either case an applicable margin. The applicable margin for borrowings under the New Term Loan Facility is 2.25% for Base Rate loans and 3.25% for LIBOR Rate loans. The applicable margin for any borrowings under the New Revolving Credit Facility depends on the Company’s senior secured leverage ratio and varies from 0.75% to 1.25% for Base Rate loans and from 1.75% to 2.25% for LIBOR Rate loans.  Interest payments, along with the installment payments of principal, are made at the end of each quarter.  The following table outlines the applicable margin for each portion of the New Credit Facilities:

 

 

 

Applicable Margin (per annum)

Facility

 

Base Rate Borrowings

 

LIBOR Borrowings

New Revolving Credit Facility

 

0.75% to 1.25%, depending upon the senior secured leverage ratio

 

1.75% to 2.25%, depending upon the senior secured leverage ratio

New Term Loan due 2022

 

2.25% (with a Base Rate floor of 2.00%)

 

3.25% (with a LIBOR Rate floor  of 1.00%)

Any utilization of the New Revolving Credit Facility in excess of $15.0 million will be subject to compliance with a total leverage ratio test.

The New Credit Agreement contains certain customary representations and warranties, affirmative covenants, events of default and various restrictive covenants, which are subject to certain significant exceptions. As of June 30, 2015, we believe that we and SCA were in compliance with these covenants.

Contractual Obligations

The Company updated the contractual obligations table under the caption “Contractual Obligations” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 as of March 31, 2015 in our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2015 to reflect the new projected principal and interest payments for the remainder of 2015 and beyond. There have been no material changes to the information set forth in the table between March 31, 2015 and June 30, 2015.

Capital Expenditures

Capital expenditures totaled $19.0 million and $18.2 million for the six-months ended June 30, 2015 and 2014, respectively. The capital expenditures made during the six-months ended June 30, 2015 consisted primarily of fixture improvements at our leased facilities, remodeling and expansion of existing facilities and our purchase of medical and other equipment. These capital expenditures were financed primarily through internally generated funds and bank or manufacturer financing. We believe that our capital expenditure program is adequate to improve and equip our existing facilities.

Capital Leases

We engage in a significant number of leasing transactions, including real estate, medical equipment, computer equipment and other equipment utilized in operations. Certain leases that meet the lease capitalization criteria in accordance with authoritative guidance for leases have been recorded as an asset and liability at the net present value of the minimum lease payments at the

50


 

inception of the lease. Interest rates used in computing the net present value of the lease payments generally range from 2.2% to 12.2% based on the rate implied by the lease at the inception of the lease or the lessee’s incremental borrowing rate, if lower.

Inflation

For the past three years, inflation has not significantly affected our operating results or the geographic areas in which we operate.

 

 

Off-Balance Sheet Transactions

As a result of our strategy of partnering with physicians and health systems, we do not own controlling interests in many of our facilities. At June 30, 2015, we accounted for 67 of our 193 affiliated facilities under the equity method. Like our consolidated facilities, our nonconsolidated facilities have debts, including capitalized lease obligations, that are generally non-recourse to us. With respect to our equity method facilities, these debts are not included in our consolidated financial statements. At June 30, 2015, the total debt on the balance sheets of our nonconsolidated affiliates was approximately $53.1 million. Our average percentage of ownership of these nonconsolidated affiliates, weighted based on the individual affiliate’s amount of debt and our ownership of such affiliate, was approximately 23% at June 30, 2015. We or one of our wholly-owned subsidiaries collectively guaranteed $2.9 million of the $53.1 million in total debt of our nonconsolidated affiliates as of June 30, 2015. Additionally, our guarantees related to operating leases of nonconsolidated affiliates were $9.6 million at June 30, 2015.

As described above, our nonconsolidated affiliates are structured as general partnerships, LPs, LLPs or LLCs. None of these affiliates provide financing, liquidity, or market or credit risk support for us. They also do not engage in hedging or research and development services with us. Moreover, we do not believe that they expose us to any of their liabilities that are not otherwise reflected in our consolidated financial statements and related disclosures. Except as noted above with respect to guarantees, we are not obligated to fund losses or otherwise provide additional funding to these affiliates other than as we determine to be economically required in order to successfully implement our development plans.

Critical Accounting Policies

General

Our discussion and analysis of our financial condition, results of operations and liquidity and capital resources are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of consolidated financial statements under GAAP requires our management to make certain estimates and assumptions that impact the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. These estimates and assumptions also impact the reported amount of net earnings during any period. Estimates are based on information available as of the date financial statements are prepared. Accordingly, actual results could differ from those estimates. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and that require management’s most subjective judgments. Our critical accounting policies and estimates include our policies and estimates regarding consolidation, variable interest entities, revenue recognition, accounts receivable, noncontrolling interests in consolidated affiliates, equity-based compensation, valuation of our common stock, income taxes, goodwill and impairment of long-lived assets and other intangible assets. There were no material changes to our critical accounting policies during the six-months ended June 30, 2015.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our principal market risk is our exposure to variable interest rates. As of June 30, 2015, we had $768.9 million of indebtedness (excluding capital leases), of which $485.4 million is at variable interest rates and $283.5 million is at fixed interest rates. In seeking to reduce the risks and costs associated with such activities, we manage exposure to changes in interest rates primarily through the use of derivatives. We do not use financial instruments for trading or other speculative purposes, nor do we use leveraged financial instruments.

At June 30, 2015, we held interest rate swaps hedging interest rate risk on $190.0 million of our variable rate debt through two forward starting interest rate swaps with an aggregate notional amount of $190.0 million, which we entered into during 2011. These forward starting interest rate swaps, which are swaps that are entered into at a specified trade date but do not begin until a future start date, extend the interest rate swaps that we terminated in 2012 and on September 30, 2013. These swaps are “receive floating/pay fixed” instruments, meaning we receive floating rate payments, which fluctuate based upon LIBOR, from the counterparty and provide payments to the counterparty at a fixed rate, the result of which is to convert the interest rate of a portion of our floating rate debt into fixed rate debt in order to limit the variability of interest-related payments caused by changes in LIBOR. Forward starting

51


 

interest rate swaps with an aggregate notional amount of $100.0 million became effective on September 30, 2012, and the remaining forward starting interest rate swap with a notional amount of $140.0 million became effective on September 30, 2013. A forward interest rate starting swap with a notional amount of $50.0 million terminated on September 30, 2014. The remaining aggregate notional amount of $190.0 million in forward starting interest rate swaps will terminate on September 30, 2016. Assuming a 100 basis point increase in LIBOR on our un-hedged debt at June 30, 2015, our annual interest expense would increase by approximately $2.6 million.

Counterparties to the interest rate swaps discussed above expose us to credit risks to the extent of their potential non-performance. The credit ratings of the counterparties, which consist of investment banks, are monitored at least quarterly. We have completed a review of the financial strength of the counterparties using publicly available information, as well as qualitative inputs, as of June 30, 2015. Based on this review, we do not believe there is a significant counterparty credit risk associated with these interest rate swaps. However, we cannot assure you that these actions will protect us against or limit our exposure to all counterparty or market risks.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We have carried out an evaluation under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2015, the Company’s disclosure controls and procedures are effective in ensuring that material information relating to the Company required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods and is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

Changes in Internal Control Over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the Company’s quarter ended June 30, 2015, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

52


 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we are party to various legal proceedings that have arisen in the normal course of conducting business. See Note 14, Commitments and Contingent Liabilities, to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q for information regarding legal proceedings, which is incorporated herein by reference in response to this item.

 

 

Item 1A. Risk Factors

In addition to the other information contained in this Quarterly Report on Form 10-Q, the risks and uncertainties that we believe could materially affect our business, financial condition or future results and are most important for you to consider are discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014 and in Part II, “Item 1A. Risk Factors” in Quarterly Report on Form 10-Q for the quarter ended March 31, 2015. Additional risks and uncertainties which are not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also materially and adversely affect any of our business, financial position or future results.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

 

Item 3. Defaults Upon Senior Securities

None.

 

 

Item 4. Mine Safety Disclosure

Not applicable.

 

 

Item 5. Other Information

 

None.

 

 

 

53


 

Item 6. Exhibits

 

Exhibit

Number

  

Exhibit Description

 

3.1

  

 

Certificate of Incorporation of Surgical Care Affiliates, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on November 4, 2013)

 

3.2

  

 

By-Laws of Surgical Care Affiliates, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed with the SEC on November 4, 2013)

10.1

 

 

Employment Agreement, dated as of April 14, 2015 and effective as of May 19, 2015, by and among Surgical Care Affiliates, Inc., Surgical Care Affiliates LLC and Tom De Weerdt (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 17, 2015)

10.2

 

 

Consulting Agreement, dated as of April 15, 2015 and effective as of July 1, 2015, by and among Surgical Care Affiliates, Inc., Surgical Care Affiliates LLC and Peter J. Clemens IV (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on April 17, 2015)

 

31.1

  

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934

 

31.2

  

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934

 

32.1

  

 

Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350

 

32.2

  

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

 

101.INS

  

 

XBRL Instance Document

 

101.SCH

  

 

XBRL Taxonomy Extension Schema Document

 

101.CAL

  

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

101.DEF

  

 

XBRL Taxonomy Extension Definition Linkbase Document

 

101.LAB

  

 

XBRL Taxonomy Extension Label Linkbase Document

 

101.PRE

  

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

54


 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

SURGICAL CARE AFFILIATES, INC.

 

Date: August 4, 2015

 

/s/ Andrew P. Hayek

 

 

Andrew P. Hayek

President and Chief Executive Officer

 

Date: August 4, 2015

 

/s/ Tom De Weerdt

 

 

Tom De Weerdt

Executive Vice President and Chief Financial Officer

 

 

 

55


 

EXHIBIT INDEX

 

Exhibit

Number

  

Exhibit Description

 

3.1

  

 

Certificate of Incorporation of Surgical Care Affiliates, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on November 4, 2013)

 

3.2

  

 

By-Laws of Surgical Care Affiliates, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed with the SEC on November 4, 2013)

 

10.1

 

 

Employment Agreement, dated as of April 14, 2015 and effective as of May 19, 2015, by and among Surgical Care Affiliates, Inc., Surgical Care Affiliates LLC and Tom De Weerdt (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 17, 2015)

 

10.2

 

 

Consulting Agreement, dated as of April 15, 2015 and effective as of July 1, 2015, by and among Surgical Care Affiliates, Inc., Surgical Care Affiliates LLC and Peter J. Clemens IV (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on April 17, 2015)

 

31.1

  

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934

 

31.2

  

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934

 

32.1

  

Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350

 

32.2

  

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

 

101.INS

  

XBRL Instance Document

 

101.SCH

  

XBRL Taxonomy Extension Schema Document

 

101.CAL

  

XBRL Taxonomy Extension Calculation Linkbase Document

 

101.DEF

  

XBRL Taxonomy Extension Definition Linkbase Document

 

101.LAB

  

XBRL Taxonomy Extension Label Linkbase Document

 

101.PRE

  

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

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