SURGERY PARTNERS, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report and our 2019 Annual Report on Form 10-K. Unless the context otherwise indicates, the terms "Surgery Partners ," "we," "us," "our" or the "Company," as used herein, refer toSurgery Partners, Inc. and its subsidiaries. Unless the context implies otherwise, the term "affiliates" means direct and indirect subsidiaries ofSurgery Partners, Inc. , and partnerships and joint ventures in which such subsidiaries are partners. The terms "facilities" or "hospitals" refer to entities owned and operated by affiliates ofSurgery Partners, Inc. and the term "employees" refers to employees of affiliates ofSurgery Partners, Inc. Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements, which are based on our current expectations, estimates and assumptions about future events. All statements other than statements of current or historical fact contained in this report are forward-looking statements. These statements include, but are not limited to, statements regarding our future financial position, business strategy, budgets, effective tax rate, projected costs and plans and objectives of management for future operations. The words "projections," "believe," "continue," "drive," "estimate," "expect," "intend," "may," "plan," "will," "could," "would" and similar expressions are generally intended to identify forward-looking statements. These statements involve risks, uncertainties and other factors that may cause actual results to differ from the expectations expressed in the statements. Many of these factors are beyond our ability to control or predict. These factors include, without limitation, the duration and severity of the COVID-19 outbreak inthe United States and the regions in which we operate, the impact to the state and local economies of prolonged shelter in place orders and the pandemic generally, our ability to respond nimbly to challenging economic conditions, the unpredictability of our case volume both in the current environment and if and when restrictions are eased, our ability to preserve or raise sufficient funds to continue operations throughout this period of uncertainty, including through our in-process asset sales, which may not occur during this period of uncertainty, if at all, the impact of our cost-cutting measures on our future performance, our ability to defer payments, including certain lease payments, our ability to cause distributions from our subsidiaries, the responsiveness of our payors, including Medicaid and Medicare, to the challenging operating conditions, including their willingness and ability to continue paying in a timely manner and to advance payments in a timely manner, if at all; our ability to execute on our operational and strategic initiatives; the timing and impact of our portfolio optimization efforts; our ability to continue to improve same-facility volume and revenue growth on the timeline anticipated, if at all; our ability to successfully integrate acquisitions; the anticipated impact and timing of our ongoing efficiency efforts, including insurance consolidations and completed headcount actions, as well as our ongoing procurement and revenue cycle efforts; the impact of adverse weather conditions and other events outside of our control; and the risks and uncertainties set forth under the heading "Risk Factors" in this report, our 2019 Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the three months endedMarch 31, 2020 , and discussed from time to time in our reports filed with theSEC . Considering these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur, and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report. These forward-looking statements speak only as of the date made. Other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether because of new information, future events or otherwise. Executive Overview Total revenues for the second quarter of 2020 decreased 15.9% to$374.7 million from$445.4 million for the second quarter of 2019. Same-facility revenues for the second quarter of 2020 decreased 18.6% from the same period last year, with a 32.4% increase in revenue per case offset by a 38.6% decrease in same-facility cases (there were the same number of business days in both periods). The overall decrease in revenues is attributable to the impacts of COVID-19 that the Company began experiencing in mid-March, which is described in further detail below in the section titled "Impact of COVID-19." Same-facility revenue per case growth was driven by a favorable surgical case mix as lower acuity cases were some of the first to decline as the COVID-19 crisis developed. For the second quarter of 2020, the Company's net loss attributable to common stockholders and Adjusted EBITDA was$42.2 million and$58.2 million , respectively, compared to$28.6 million and$61.2 million for the same period last year. A reconciliation of non-GAAP financial measures appears below under "Certain Non-GAAP Metrics." The increase in net loss attributable to common stockholders and the decrease in Adjusted EBITDA are attributable to the decline in surgical cases due to the impacts of COVID-19 as discussed further below. We had cash and cash equivalents of$326.3 million and$113.2 million of borrowing capacity under our revolving credit facility atJune 30, 2020 . Net operating cash inflows, including operating cash flows less distributions to non-controlling interests, were$154.2 million for the second quarter of 2020. Impact of COVID-19 The COVID-19 global pandemic is significantly affecting our facilities, employees, patients, communities, business operations and financial performance, as well asthe United States economy and financial markets. OnMarch 18, 2020 , we reported that we had withdrawn our previously announced full-year 2020 outlook and onApril 15, 2020 , we filed a Current Report on Form 8-K providing additional disclosure about the impact of the pandemic on our operations. The COVID-19 crisis is still rapidly evolving and much of its impact 20
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remains unknown and difficult to predict; however, it materially impacted our financial performance for the second quarter of 2020, and potentially could negatively impact our financial performance for the year endingDecember 31, 2020 or longer. We are taking or supporting measures to try to slow the spread and minimize the impact of the virus. Many of these measures are adversely impacting our business and likely will have an adverse impact on our financial results that we currently are not able to quantify. For example, due in part to local, state and federal guidelines as well as recommendations from major medical societies, social distancing and self-quarantines in response to the COVID-19 pandemic, we cancelled or postponed a substantial percentage of the elective procedures scheduled at our facilities and reduced operating hours at a significant number of our facilities. As a result, our facilities experienced lower surgical case volume, which was more significant at the beginning of the second quarter and has improved gradually as states re-open and allow for non-emergent procedures. The impact on our surgical facilities varies based on the market in which the facility operates, the type of surgical facility and the procedures that are typically performed. It is difficult to predict the duration of this lower surgical case volume and, while restrictions are starting to be eased, we cannot predict the timing of the potential recapture of cancelled or postponed procedures, if any. The Company's operating structure naturally enables some flexibility in the cost structure according to the volume of surgical procedures performed, including much of its cost of revenues. In addition to the natural variability of these costs, the Company and its partners in the surgical facilities have undertaken additional steps to preserve financial flexibility. Beginning in mid-March, and into the second quarter, the Company took actions that included significantly reducing cash operating expenses and deferring non-essential expenditures at the height of the crisis. These measures were gradually reduced throughout the second quarter as surgical case volumes improved. Even after taking into account our actions intended to increase financial flexibility (including actions that management estimates have lowered cash operating expenses), the volume reductions we are experiencing have resulted in materially higher losses and material decreases in Adjusted EBITDA during the second quarter of 2020 and may potentially continue to do so for subsequent quarters. We cannot predict if or when utilization may return to pre-pandemic levels. OnMarch 18, 2020 , we drew down our available capacity under the Revolver, as a precautionary measure in order to increase liquidity and preserve financial flexibility in light of uncertainty resulting from the COVID-19 pandemic. During the second quarter, we fully repaid the outstanding balance. OnApril 22, 2020 , we entered into a second incremental term loan amendment, which amended and supplemented the existing credit agreement, to provide for an incremental borrowing of$120.0 million . The incremental amounts were fully drawn onApril 22, 2020 . See Note 3. "Long-Term Debt" to our condensed consolidated financial statements included elsewhere in this report for a further discussion of the second incremental term loan amendment. Also, onJuly 30, 2020 , we issued an additional$115.0 million aggregate principal amount of 10.000% senior unsecured notes due 2027 at 100.75% of the principal amount. The notes were issued as part of the same series as the 2027 Unsecured Notes originally issued inApril 2019 . See Note 11. "Subsequent Events" to our condensed consolidated financial statements included elsewhere in this report for a further discussion of the senior unsecured notes. Additionally, as a result of the CARES Act and other governmental assistance programs, during the six months endedJune 30, 2020 , the Company received approximately$48 million in direct grant funding and approximately$120 million in accelerated Medicare payments, each of which is described in more detail in Note 1. "Organization and Summary of Accounting Polices - COVID-19 Pandemic" to our condensed consolidated financial statements included elsewhere in this report. The Company is continuing to monitor legislative actions at federal and state levels including the impact of the CARES Act and other governmental assistance that might be available. Furthermore, please see "Capital Resources" and "Summary" under the heading "Liquidity and Capital Resources" below for more information about the impact of the COVID-19 pandemic on the Company. Regulatory Developments in Response to COVID-19 Numerous recent legislative and regulatory actions have been taken in an attempt to provide businesses, including health care providers, with relief from the negative impacts of the COVID-19 pandemic. The legislative and regulatory responses to the COVID-19 pandemic generally impact many of the statutes, regulations and policies summarized or discussed throughout this report and in our 2019 Annual Report on Form 10-K. CARES Act OnMarch 27, 2020 , the CARES Act was signed into law. The CARES Act is intended to provide over$2 trillion in stimulus benefits for theU.S. economy in order to offset the negative economic impact of the COVID-19 public health emergency. Among other things, the CARES Act includes support for small businesses, expands unemployment benefits, and provides$500 billion for loans, loan guarantees, and other investments for or inU.S. businesses. The CARES Act contains a number of provisions that are intended to assist health care providers as they combat the effects of the COVID-19 public health emergency. The healthcare-specific provisions include: •the temporary suspension of Medicare sequestration fromMay 1, 2020 , toDecember 31, 2020 ; •an appropriation of$100 billion to thePublic Health and Social Services Emergency Fund for a new program to reimburse, through grants or other mechanisms, eligible health care providers and other approved entities for COVID-19-related expenses or lost revenues; 21
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•the expansion of CMS' Accelerated and Advance Payment Program; and •waivers or temporary suspension of certain regulatory requirements. Paycheck Protection Program and Health Care Enhancement Act OnJune 5, 2020 , the Paycheck Protection Program Flexibility Act of 2020 (the "New PPP Act") was signed into law. Among other things, the New PPP Act allocates$75 billion to Medicare and Medicaid participating hospitals and other health care providers to help offset COVID-19 related losses and expenses. The$75 billion allocated under the New PPP Act is in addition to the$100 billion allocated to health care providers for the same purposes in the CARES Act. The New PPP Act funds were disbursed to providers under terms and conditions that are similar to the CARES Act funds. Waivers or Temporary Suspension of Certain Regulatory Requirements In addition to the financial and other relief that has been provided by the federal government through the CARES Act and other legislation that has been passed byCongress , CMS and many state governments have also issued a number of waivers and temporary suspensions of health care facility licensure, certification, and reimbursement requirements in order to provide hospitals, ambulatory surgery centers, physicians, and other health care providers with increased flexibility to meet the challenges presented by the COVID-19 public health emergency. For example, CMS has temporarily waived the enforcement of certain requirements of the Medicare conditions of participation and implemented a "hospitals without walls" program that would enable hospitals to treat patients in temporary locations and enable ASCs to temporarily enroll in Medicare as hospitals. CMS has also temporarily waived many provisions of the Stark law, including those provisions of the Stark law that prohibit our hospitals with physician ownership from expanding capacity. Many states have also suspended the enforcement of certain regulatory requirements to ensure that health care providers have sufficient capacity to treat COVID-19 patients. These regulatory changes are temporary, with most slated to expire at the end of the declared COVID-19 public health emergency. Revenues Our revenues consist of patient service revenues and other service revenues. Patient service revenues consist of revenue from our surgical facility services and ancillary services segments. Specifically, patient service revenues include fees for surgical or diagnostic procedures performed at surgical facilities that we consolidate for financial reporting purposes, as well as for patient visits to our physician practices, anesthesia services, pharmacy services and diagnostic screens ordered by our physicians. Other service revenues include management and administrative service fees derived from our non-consolidated facilities that we account for under the equity method, management of surgical facilities and physician practices in which we do not own an interest and management services we provide to physician practices for which we are not required to provide capital or additional assets. The following table summarizes our revenues by service type as a percentage of total revenues for the periods indicated: Six Months Ended June Three Months Ended June 30, 30, 2020 2019 2020 2019 Patient service revenues: Surgical facilities revenues 95.0 % 94.1 % 94.8 % 94.0 % Ancillary services revenues 3.5 % 4.6 % 3.7 % 4.7 % 98.5 % 98.7 % 98.5 % 98.7 % Other service revenues: Optical services revenues 0.1 % 0.2 % 0.2 % 0.2 % Other 1.4 % 1.1 % 1.3 % 1.1 % 1.5 % 1.3 % 1.5 % 1.3 % Total revenues 100.0 % 100.0 % 100.0 % 100.0 % 22
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Payor Mix
The following table sets forth by type of payor the percentage of our patient
service revenues generated at the surgical facilities which we consolidate for
financial reporting purposes in the periods indicated:
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
Private insurance payors 54.0 % 52.4 % 52.9 % 52.4 %
Government payors 38.1 % 40.5 % 39.4 % 40.3 %
Self-pay payors 3.0 % 2.2 % 3.0 % 2.4 %
Other payors (1) 4.9 % 4.9 % 4.7 % 4.9 %
Total 100.0 % 100.0 % 100.0 % 100.0 %
(1)Other is comprised of anesthesia service agreements, automobile liability,
letters of protection and other payor types.
Surgical Case Mix
We primarily operate multi-specialty surgical facilities where physicians
perform a variety of procedures in various specialties. We believe this
diversification helps to protect us from adverse pricing and utilization trends
in any individual procedure type and results in greater consistency in our case
volume.
The following table sets forth the percentage of cases in each specialty
performed at the surgical facilities which we consolidate for financial
reporting purposes for the periods indicated:
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
Orthopedic and pain management 44.0 % 36.9 % 40.9 % 37.2 %
Ophthalmology 23.1 % 24.8 % 24.7 % 24.2 %
Gastrointestinal 15.8 % 21.2 % 18.2 % 21.2 %
General surgery 3.5 % 2.9 % 3.3 % 3.0 %
Other 13.6 % 14.2 % 12.9 % 14.4 %
Total 100.0 % 100.0 % 100.0 % 100.0 %
Critical Accounting Policies
A summary of significant accounting policies is disclosed in our 2019 Annual
Report on Form 10-K under the caption "Critical Accounting Policies" in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations section. There have been no material changes in the nature of our
critical accounting policies or the application of those policies since December
31, 2019 .
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Results of Operations Three Months EndedJune 30, 2020 Compared to Three Months EndedJune 30, 2019 The following table summarizes certain results from the statements of operations for the three months endedJune 30, 2020 and 2019 (dollars in millions): Three Months Ended June 30, 2020 2019 Revenues$ 374.7 $ 445.4 Operating expenses: Cost of revenues 319.3 340.4 General and administrative expenses 25.3 23.3 Depreciation and amortization 23.4 19.1 Income from equity investments (2.5) (2.2) Loss (gain) on disposals and deconsolidations, net 2.9 (8.2) Transaction and integration costs 4.9 6.2 Grant funds (43.1) - Loss on debt extinguishment - 11.7 Other income (0.2) (0.4) Total operating expenses 330.0 389.9 Operating income 44.7 55.5 Interest expense, net (49.2) (46.4) (Loss) income before income taxes (4.5) 9.1 Income tax (benefit) expense (0.6) 1.0 Net (loss) income (3.9) 8.1 Less: Net income attributable to non-controlling interests (28.6) (27.9) Net loss attributable to Surgery Partners, Inc. $
(32.5)
Overview. During the three months endedJune 30, 2020 , our revenues decreased 15.9% to$374.7 million compared to$445.4 million for the three months endedJune 30, 2019 . We incurred a net loss attributable toSurgery Partners, Inc. of$32.5 million for the 2020 period, compared to$19.8 million for the 2019 period, primarily attributable to the decline in surgical case volume that began in mid-March due to the COVID-19 pandemic. Revenues. Revenues for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 were as follows (dollars in millions): Three Months Ended June 30, 2020 2019 Patient service revenues$ 369.1 $ 439.5 Optical service revenues 0.5 1.0 Other service revenues 5.1 4.9 Total revenues$ 374.7 $ 445.4 Patient service revenues decreased 16.0% to$369.1 million for the three months endedJune 30, 2020 compared to$439.5 million for the three months endedJune 30, 2019 . The decrease of 16.0% was driven by a 38.6% decrease in same-facility case volume primarily due to the impacts of COVID-19 that began in mid-March, partially offset by a 32.4% increase in revenue per case. Same-facility revenue per case growth was driven by a favorable surgical case mix as lower acuity cases were some of the first to decline as the COVID-19 crisis developed. Cost of Revenues. Cost of revenues were$319.3 million for the three months endedJune 30, 2020 compared to$340.4 million for the three months endedJune 30, 2019 . The decrease in costs were primarily attributable to the impacts of the COVID-19 pandemic. As a percentage of revenues, cost of revenues increased to 85.2% for the 2020 period compared to 76.4% for the 2019 period. General and Administrative Expenses. General and administrative expenses were$25.3 million for the three months endedJune 30, 2020 compared to$23.3 million for the three months endedJune 30, 2019 . As a percentage of revenues, general and administrative 24
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expenses increased to 6.8% for the 2020 period compared to 5.2% for the 2019 period. The increase as a percentage of revenues is primarily the result of the decline in revenues driven by the decline in surgical case volume that began in mid-March due to the COVID-19 pandemic. Depreciation and Amortization. Depreciation and amortization was$23.4 million and$19.1 million for the three months endedJune 30, 2020 and 2019, respectively. As a percentage of revenues, depreciation and amortization expenses was 6.2% for the 2020 period compared to 4.3% for the 2019 period. The increase is primarily due to increased capital investments and integration of acquisitions and a de novo hospital completed in 2019. Loss (Gain) on Disposals and Deconsolidations, Net. The net loss on disposals and deconsolidations was$2.9 million for the 2020 period, related to disposals of other long-lived assets. The net gain on disposals and deconsolidations was$8.2 million for the 2019 period, including a$10.9 million gain on the sale of previously owned real property associated with one of our non-consolidated surgical facility equity method investments, offset by a loss of$2.7 million on disposals of other long-lived assets. Transaction and Integration Costs. We incurred$4.9 million of transaction and integration costs for the three months endedJune 30, 2020 compared to$6.2 million for the three months endedJune 30, 2019 . Grant Funds. Grant funds were$43.1 million for the three months endedJune 30, 2020 . The funds were received based on relief available to eligible health care providers under the provisions of the CARES Act, which is described in further detail above in the section titled "Impact of COVID-19" and in Note 1. "Organization and Summary of Accounting Polices - COVID-19 Pandemic" to our condensed consolidated financial statements included elsewhere in this report. There were no grant funds received for the 2019 period. Loss on Debt Extinguishment. We incurred a debt extinguishment loss of$11.7 million in connection with issuance of the 2027 Unsecured Notes during the three months endedJune 30, 2019 . There was no similar loss during the three months endedJune 30, 2020 . The loss includes the redemption premium paid to redeem the 2021 Unsecured Notes partially offset by the write-off of the unamortized fair value premium as of the redemption date. Interest Expense, Net. Interest expense, net, increased to$49.2 million for the three months endedJune 30, 2020 compared to$46.4 million for the three months endedJune 30, 2019 . The increase primarily relates to the 2020 Incremental Term Loans, which were fully drawn onApril 22, 2020 as well as interest on the Revolver during the period it was fully drawn. As a percentage of revenues, interest expense, net was 13.1% for the 2020 period compared to 10.4% for the 2019 period. Income Tax (Benefit) Expense. The income tax benefit was$0.6 million for the three months endedJune 30, 2020 compared to expense of$1.0 million for the 2019 period. The effective tax rate was 13.3% for the three months endedJune 30, 2020 compared to 11.0% for the three months endedJune 30, 2019 . Based upon the application of interim accounting guidance, the tax rate as a percentage of net income after income attributable to non-controlling interests will vary based upon the relative net income from period to period. Net Income Attributable to Non-Controlling Interests. Net income attributable to non-controlling interests was$28.6 million for the three months endedJune 30, 2020 compared to$27.9 million for the three months endedJune 30, 2019 . As a percentage of revenues, net income attributable to non-controlling interests was 7.6% in the 2020 period and 6.3% for the 2019 period. 25
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Six Months Ended
Six Months Ended June 30,
2020 2019
Revenues $ 815.7 $ 862.2
Operating expenses:
Cost of revenues 685.5 666.5
General and administrative expenses 48.1 45.0
Depreciation and amortization 45.2 37.9
Income from equity investments (4.5) (4.2)
Loss (gain) on disposals and deconsolidations, net 6.4 (7.6)
Transaction and integration costs 10.4 8.2
Grant funds (43.1) -
Litigation settlement 1.2 -
Loss on debt extinguishment - 11.7
Other income (1.7) (0.4)
Total operating expenses 747.5 757.1
Operating income 68.2 105.1
Tax receivable agreement expense - (2.4)
Interest expense, net (96.3) (88.4)
(Loss) income before income taxes (28.1) 14.3
Income tax (benefit) expense (15.8) 2.7
Net (loss) income (12.3) 11.6
Less: Net income attributable to non-controlling interests (47.7) (51.5)
Net loss attributable to Surgery Partners, Inc. $
(60.0)
Overview. During the six months endedJune 30, 2020 , our revenues decreased 5.4% to$815.7 million compared to$862.2 million for the six months endedJune 30, 2019 . We incurred a net loss attributable toSurgery Partners, Inc. of$60.0 million for the 2020 period, compared to$39.9 million for the 2019 period, primarily attributable to the decline in surgical case volume that began in mid-March due to the COVID-19 pandemic. Revenues. Revenues for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 were as follows (dollars in millions): Six Months Ended June 30, 2020 2019 Patient service revenues$ 803.7 $ 850.3 Optical service revenues 1.3 2.1 Other service revenues 10.7 9.8 Total revenues$ 815.7 $ 862.2 Patient service revenues decreased 5.5% to$803.7 million for the six months endedJune 30, 2020 compared to$850.3 million for the six months endedJune 30, 2019 . The decrease of 5.5% was driven by a 23.7% decrease in same-facility case volume primarily due to the impacts of COVID-19 that began in mid-March, partially offset by a 32.4% increase in revenue per case. Same-facility revenue per case growth was driven by a favorable surgical case mix as lower acuity cases were some of the first to decline as the COVID-19 crisis developed. Cost of Revenues. Cost of revenues were$685.5 million for the six months endedJune 30, 2020 compared to$666.5 million for the six months endedJune 30, 2019 . The increase in costs were primarily attributable to our 2020 and 2019 acquisitions and an increase in supply costs associated with higher acuity surgical case volumes. As a percentage of revenues, cost of revenues increased to 84.0% for the 2020 period compared to 77.3% for the 2019 period. 26
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General and Administrative Expenses. General and administrative expenses were$48.1 million for the six months endedJune 30, 2020 compared to$45.0 million for the six months endedJune 30, 2019 . As a percentage of revenues, general and administrative expenses was 5.9% for the 2020 period compared to 5.2% for the 2019 period. Depreciation and Amortization. Depreciation and amortization was$45.2 million and$37.9 million for the six months endedJune 30, 2020 and 2019, respectively. As a percentage of revenues, depreciation and amortization expenses was 5.5% for the 2020 period compared to 4.4% for the 2019 period. The increase is primarily due to increased capital investments and integration of acquisitions and a de novo hospital completed in 2019. Loss (Gain) on Disposals and Deconsolidations, Net. The net loss on disposals and deconsolidations was$6.4 million for the 2020 period, including a net loss of$3.1 million on the sale of interests in surgical facilities and$3.3 million related to disposals of other long-lived assets. The net gain on disposals and deconsolidations was$7.6 million for the 2019 period, related to disposals of other long-lived assets. Transaction and Integration Costs. We incurred$10.4 million of transaction and integration costs for the six months endedJune 30, 2020 compared to$8.2 million for the six months endedJune 30, 2019 . The increase primarily relates to costs for ongoing development initiatives, divestitures completed in 2020 and the integration of acquisitions we completed in 2020 and 2019. Grant Funds. Grant funds were$43.1 million for the six months endedJune 30, 2020 . The funds were received based on relief available to eligible health care providers under the provisions of the CARES Act, which is described in further detail above in the section titled "Impact of COVID-19" and in Note 1. "Organization and Summary of Accounting Polices - COVID-19 Pandemic" to our condensed consolidated financial statements included elsewhere in this report. There were no grant funds received for the 2019 period. Litigation settlement. Litigation settlement costs were$1.2 million for the six months endedJune 30, 2020 , related to the resolution of the government investigation, as discussed in Note 9. "Commitments and Contingencies" to our condensed consolidated financial statements included elsewhere in this report. There were no litigation costs for the 2019 period. Loss on Debt Extinguishment. We incurred a debt extinguishment loss of$11.7 million in connection with issuance of the 2027 Unsecured Notes during the six months endedJune 30, 2019 . There was no debt extinguishment loss during the three months endedJune 30, 2020 . The loss includes the redemption premium paid to redeem the 2021 Unsecured Notes partially offset by the write-off of the unamortized fair value premium as of the redemption date. Interest Expense, Net. Interest expense, net, increased to$96.3 million for the six months endedJune 30, 2020 , compared to$88.4 million for the six months endedJune 30, 2019 . The increase primarily relates to the issuance of$430.0 million in senior unsecured notes effectiveApril 11, 2019 . As a percentage of revenues, interest expense, net was 11.8% for the 2020 period compared to 10.3% for the 2019 period. Income Tax (Benefit) Expense. The income tax benefit was$15.8 million and expense was$2.7 million for the six months endedJune 30, 2020 and 2019, respectively. The effective tax rate was 56.2% for the six months endedJune 30, 2020 compared to 18.9% for the six months endedJune 30, 2019 . The higher effective tax rate for the 2020 period was primarily due to discrete tax benefits of approximately$11.9 million attributable to (a) the release of federal and state valuation allowances on the Company's IRC Section 163(j) interest carryforwards as a result of the increase in deductible interest expense allowed under the CARES Act; and (b) the Settlement Agreement, as discussed in Note 9. "Commitments and Contingencies" to our condensed consolidated financial statements included elsewhere in this report, which provided that a portion of the final settlement amount was "restitution" for income tax purposes. Based upon the application of interim accounting guidance, the tax rate as a percentage of net income after income attributable to non-controlling interests will vary based upon the relative net income from period to period. Net Income Attributable to Non-Controlling Interests. Net income attributable to non-controlling interests was$47.7 million for the six months endedJune 30, 2020 compared to$51.5 million for the six months endedJune 30, 2019 . As a percentage of revenues, net income attributable to non-controlling interests was 5.8% in the 2020 period and 6.0% for the 2019 period. Liquidity and Capital Resources Operating Activities The primary source of our operating cash flow is the collection of accounts receivable from federal and state agencies (under the Medicare and Medicaid programs), private insurance companies and individuals. During the six months endedJune 30, 2020 , our cash flow provided by operating activities was$211.1 million compared to$47.2 million in the six months endedJune 30, 2019 primarily attributable to stimulus funds received under the CARES Act as well as actions taken to significantly reduce cash operating expenses and defer non-essential expenditures at the height of the crisis. Investing Activities Net cash used in investing activities during the six months endedJune 30, 2020 , was$22.5 million , which included$19.9 million related to purchases of property and equipment. We paid$12.4 million in cash for acquisitions (net of cash acquired), which included a surgical facility in a new market and three surgical facilities in existing markets that were merged into existing facilities. Additionally, we received cash proceeds of$9.4 million related to the sale of our interests in two surgery centers, one of which was previously accounted for as an equity method investment. 27
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Net cash used in investing activities during the six months endedJune 30, 2019 was$42.9 million , which included$31.8 million related to purchases of property and equipment. We paid$13.2 million in cash for acquisitions (net of cash acquired), which primarily included a surgical facility and physician practice. Further, we paid$15.2 million in cash for a non-controlling interest in four surgical facilities accounted for as equity method investments and we received cash proceeds of$17.6 million related to the sale of previously owned real property associated with one of our non-consolidated equity method investments Financing Activities Net cash provided by financing activities during the six months endedJune 30, 2020 was$45.0 million . During this period, we made distributions to non-controlling interest holders of$51.7 million and payments related to ownership transactions with consolidated affiliates of$1.9 million . Additionally, we made repayments on our long-term debt of$182.8 million , which was offset by borrowings of$288.2 million . Net cash used in financing activities during the six months endedJune 30, 2019 was$71.2 million . During this period, we made distributions to non-controlling interest holders of$60.9 million and received cash related to ownership transactions with consolidated affiliates of$1.2 million . Further, we made repayments on our long-term debt of$422.8 million , which was offset by borrowings of$438.9 million . In connection with the issuance of the 2027 Unsecured Notes and redemption of the existing 2021 Unsecured Notes, we paid debt issuance costs of$8.8 million and paid a redemption premium of$17.8 million . Debt As ofJune 30, 2020 , the carrying value of our total indebtedness was$2.686 billion , which includes unamortized fair value discount of$4.1 million and unamortized deferred financing costs of$16.6 million . Term Loan and Revolving Credit Facility As ofJune 30, 2020 , we had term loan borrowings with a carrying value of$1.547 billion , consisting of outstanding aggregate principal of$1.551 billion and unamortized fair value discount of$4.1 million (the "Term Loan"). The Term Loan matures onAugust 31, 2024 . The Term Loan amortizes in equal quarterly installments of 0.25% of the aggregate original principal amount of the Term Loan. We have a Revolver providing for revolving borrowings of up to$120.0 million . The Revolver will mature onAugust 31, 2022 . As ofJune 30, 2020 , our availability on the Revolver was$113.2 million (including outstanding letters of credit of$6.8 million ). The Revolver may be utilized for working capital, capital expenditures and general corporate purposes. Subject to certain conditions and requirements set forth in the credit agreement, we may request one or more additional incremental term loan facilities or one or more increases in the commitments on the Revolver. The Revolver and the Term Loan, together the "Senior Secured Credit Facilities" bear interest at a rate per annum equal to (x) LIBOR plus a margin ranging from 3.00% to 3.25% per annum, depending on our first lien net leverage ratio or (y) an alternate base rate (which will be the highest of (i) the prime rate, (ii) 0.5% per annum above the federal funds effective rate and (iii) one-month LIBOR plus 1.00% per annum (solely with respect to the Term Loan, the alternate base rate shall not be less than 2.00% per annum)) plus a margin ranging from 2.00% to 2.25% per annum. In addition, we are required to pay a commitment fee of 0.50% per annum in respect of unused commitments on the Revolver. OnApril 22, 2020 , we entered into a second incremental term loan amendment, which amended and supplemented the existing credit agreement, to provide for an incremental borrowing of$120.0 million . The incremental amounts were fully drawn onApril 22, 2020 , and are included in the term loan borrowings discussed above. OnApril 16, 2020 , we entered into a third amendment to our credit agreement, which amended and supplemented financial covenants applicable to the Revolver under the credit agreement. Pursuant to the third amendment, the Company's requirement to comply with a maximum consolidated total net leverage ratio will be waived for the remainder of 2020. Additionally, for the first three quarters of 2021, the third amendment provides for an alternative calculation for the maximum consolidated total net leverage ratio where the trailing four quarter basis may be negatively impacted by the impacts of COVID-19. The third amendment became effective concurrently with the funding of the incremental term loans onApril 22, 2020 , discussed above. Senior Unsecured Notes We have$430.0 million aggregate principal amount of senior unsecured notes dueApril 15, 2027 (the "2027 Unsecured Notes"). The 2027 Unsecured Notes bear interest at the rate of 10.000% per year, payable semi-annually onApril 15 andOctober 15 of each year. OnJuly 30, 2020 , we issued an additional$115.0 million aggregate principal amount of 10.000% senior unsecured notes due 2027 at 100.75% of the principal amount. The notes were issued as part of the same series as the 2027 Unsecured Notes originally issued inApril 2019 . See Note 11. "Subsequent Events" to our condensed consolidated financial statements included elsewhere in this report for a further discussion of the senior unsecured notes. We have$370.0 million aggregate principal amount of senior unsecured notes dueJuly 1, 2025 outstanding (the "2025 Unsecured Notes"). The 2025 Unsecured Notes bear interest at the rate of 6.750% per year, payable semi-annually onJanuary 1 andJuly 1 of each year. 28
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Other Debt We and certain of our subsidiaries have other debt consisting of outstanding bank indebtedness of$111.6 million , which is collateralized by the real estate and equipment owned by the surgical facilities to which the loans were made, and right-of-use finance lease obligations of$244.1 million for which we are liable to various vendors for several property and equipment leases classified as finance leases. Capital Resources In addition to cash flows from operations, available cash and capacity on our Revolver, other sources of capital include funds we have received under the CARES Act as well as continued access to the capital markets. As previously noted in Note 1. "Organization and Summary of Accounting Policies" to our condensed consolidated financial statements included elsewhere in this report, as ofJune 30, 2020 , we received relief via the CARES Act, including approximately$48 million in direct grant payments and approximately$120 million of accelerated payments pursuant to the Medicare Accelerated and Advance Payment Program. The direct grant payments are not required to be repaid, subject to certain terms and conditions, while payments received under the Medicare Accelerated and Advance Payment Program are required to be repaid. Additionally, the CARES Act permits the deferral of payment of the social security payroll tax match for the remainder of 2020, with half of the deferred amount dueDecember 2021 and the other half dueDecember 2022 . As ofJune 30, 2020 , the Company has deferred approximately$4.3 million , included as a component of accrued payroll and benefits in the condensed consolidated balance sheets as ofJune 30, 2020 . We believe that deferral of the social security payroll tax match, which we began doing inApril 2020 , along with the funds received under the CARES Act as noted above, have positively impacted our cash flows from operations during 2020. Summary The COVID-19 pandemic has resulted in, and may continue to result in, significant disruptions of financial and capital markets, which could reduce our ability to access capital and negatively affect our liquidity in the future. Additionally, while we have received grants and accelerated payments under the CARES Act and other government assistance programs and may receive additional amounts in the future, there is no assurance regarding the extent to which anticipated negative impacts arising from the COVID-19 pandemic will be offset by amounts and benefits received under the CARES Act or future legislation. Although we have seen continued improvement in surgical case volumes as states begin to re-open and allow for non-emergent procedures, broad economic factors resulting from the current COVID-19 pandemic, including increasing unemployment rates and reduced consumer spending, could negatively affect our payor mix, increase the relative proportion of lower margin services we provide and reduce patient volumes, as well as diminish our ability to collect outstanding receivables. Business closings and layoffs in the areas in which we operate may lead to increases in the uninsured and underinsured populations and adversely affect demand for our services, as well as the ability of payors to pay for services as rendered. Any increase in the amount or deterioration in the collectability of patient accounts receivable will adversely affect our cash flows and results of operations, requiring an increased level of working capital. If general economic conditions continue to deteriorate or remain uncertain for an extended period of time, our liquidity and ability to repay our outstanding debt may be harmed. Based on our current level of operations, we believe cash flow from operations, available cash, available capacity on our Revolver, the incremental term loan borrowings and recent issuance of new notes discussed above, funds we have received under the CARES Act, funds we may receive in the future and continued access to capital markets, together with the cost cutting steps taken in response to the impact of COVID-19, as discussed in Item 1A. "Risk Factors" elsewhere in this report, will be adequate to meet our short-term (i.e., 12 months) liquidity needs. Certain Non-GAAP Metrics Adjusted EBITDA is not a measurement of financial performance under GAAP and should not be considered in isolation or as a substitute for net income, operating income or any other measure calculated in accordance with GAAP. The items excluded from this non-GAAP metric are significant components in understanding and evaluating our financial performance. We believe such adjustments are appropriate, as the magnitude and frequency of such items can vary significantly and are not related to the assessment of normal operating performance. Our calculation of Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies. When we use the term "Adjusted EBITDA," we are referring to income before income taxes, adjusted for net income attributable to non-controlling interests, depreciation and amortization, interest expense, net, equity-based compensation expense, transaction, integration and acquisition costs, net loss on disposals and deconsolidations, litigation settlement and other litigation costs, gain on escrow release, loss on debt extinguishment and tax receivable agreement expense. We use Adjusted EBITDA as a measure of financial performance. Adjusted EBITDA is a key measure used by our management to assess operating performance, make business decisions and allocate resources. 29
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The following table reconciles Adjusted EBITDA to (loss) income before income
taxes, the most directly comparable GAAP financial measure (in millions and
unaudited):
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
Condensed Consolidated Statements of Operations
Data:
(Loss) income before income taxes $ (4.5) $ 9.1 $ (28.1) $ 14.3
Plus (minus):
Net income attributable to non-controlling
interests (28.6) (27.9) (47.7) (51.5)
Depreciation and amortization 23.4 19.1 45.2 37.9
Interest expense, net 49.2 46.4 96.3 88.4
Equity-based compensation expense 3.4 3.0 6.9 4.9
Transaction, integration and acquisition costs (1) 10.1 8.0 22.7 11.5
Loss (gain) on disposals and deconsolidations, net 2.9 (8.2) 6.4 (7.6)
Litigation settlement and other litigation costs
(2) 2.3 - 3.8 -
Gain on escrow release (3) - - (0.8) -
Loss on debt extinguishment - 11.7 - 11.7
Tax receivable agreement expense - - - 2.4
Adjusted EBITDA $ 58.2 $ 61.2 $ 104.7 $ 112.0
(1)For the three months ended June 30, 2020 and 2019, this amount includes
transaction and integration costs of $4.9 million and $6.2 million ,
respectively, and acquisition and start-up costs related to a de novo surgical
hospital of $5.2 million and $1.8 million , respectively. For the six months
ended June 30, 2020 and 2019, this amount includes transaction and integration
costs of $10.4 million and $8.2 million , respectively, and acquisition and
start-up costs related to a de novo surgical hospital of $12.3 million and $3.3
million , respectively.
(2)For the three months ended June 30, 2020 , this amount includes other
litigation costs of $2.3 million , with no comparable costs in the same 2019
period. For the six months ended June 30, 2020 , this amount includes litigation
settlements of $1.2 million and other litigation costs of $2.6 million , with no
comparable costs in the same 2019 period.
(3)Included in other income in the condensed consolidated statement of
operations for the six months ended June 30, 2020 , with no comparable gain in
the same 2019 period.
We use Credit Agreement EBITDA as a measure of liquidity and to determine our
compliance under certain covenants pursuant to our credit facilities. Credit
Agreement EBITDA is determined on a trailing twelve-month basis. We have
included it because we believe that it provides investors with additional
information about our ability to incur and service debt and make capital
expenditures. Credit Agreement EBITDA is not a measurement of liquidity under
GAAP and should not be considered in isolation or as a substitute for any other
measure calculated in accordance with GAAP. The items excluded from Credit
Agreement EBITDA are significant components in understanding and evaluating our
liquidity. Our calculation of Credit Agreement EBITDA may not be comparable to
similarly titled measures reported by other companies.
When we use the term "Credit Agreement EBITDA," we are referring to Adjusted
EBITDA, as defined above, further adjusted for acquisitions and synergies. These
adjustments do not relate to our historical financial performance and instead
relate to estimates compiled by our management and calculated in conformance
with the definition of "Consolidated EBITDA" used in the credit agreements
governing our credit facilities.
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