10-K 1 d656152d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-K

 

 

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2013

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)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Each Class

 

Name of Exchange on Which Registered

Common Stock, par value $0.01 per share   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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   ¨
Non-accelerated filer   x      Smaller reporting company   ¨

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

The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) computed by reference to the price at which the common stock was last sold on March 20, 2014 was $455,520,019. The registrant has provided this information as of March 20, 2014 because its common stock was not publicly traded as of the last business day of its most recently completed second fiscal quarter.

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

 

Class of Common Stock

 

Outstanding at March 20, 2014

Common stock, par value $0.01 per share   38,261,138 shares

 

 

 


Table of Contents

SURGICAL CARE AFFILIATES, INC.

FORM 10-K

INDEX

 

General        2   
Forward — Looking Statements      2   

PART I.

    

Item 1.

  Business      3   

Item 1A.

  Risk Factors      38   

Item 1B.

  Unresolved Staff Comments      70   

Item 2.

  Properties      70   

Item 3.

  Legal Proceedings      70   

Item 4.

  Mine Safety Disclosure      71   

PART II.

    

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      72   

Item 6.

  Selected Financial Data      73   

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      75   

Item 8.

  Financial Statements and Supplementary Data      105   

Item 9.

  Changes in and Disagreements with Accounting and Financial Disclosures      157   

Item 9A.

  Controls and Procedures      157   

Item 9B.

  Other Information      157   

PART III.

    

Item 10.

  Directors, Executive Officers and Corporate Governance      158   

Item 11.

  Executive Compensation      166   

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      176   

Item 13.

  Certain Relationships and Related Transactions and Director Independence      179   

Item 14.

  Principal Accounting Fees and Services      183   

Part IV.

    

Item 15.

  Exhibits and Financial Statement Schedules      185   

Signatures

       210   

 

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GENERAL

Unless the context otherwise indicates or requires, references in this Annual Report on Form 10-K to “Surgical Care Affiliates,” the “Company,” “we,” “us” and “our” refer to ASC Acquisition LLC and its consolidated affiliates prior to our conversion from a Delaware limited liability company to a Delaware corporation on October 30, 2013 and to Surgical Care Affiliates, Inc. and its consolidated subsidiaries after our conversion from a Delaware limited liability company to a Delaware corporation on October 30, 2013. In addition, unless the context otherwise indicates or requires, the term “SCA” refers to Surgical Care Affiliates, LLC, our direct operating subsidiary.

Pursuant to the conversion, every 10.25 outstanding membership units of ASC Acquisition LLC were converted into one share of common stock of Surgical Care Affiliates, Inc., and options to purchase membership units of ASC Acquisition LLC were converted into options to purchase shares of common stock of Surgical Care Affiliates, Inc. at a ratio of 10.25 membership units of ASC Acquisition LLC underlying such options to each one share of common stock of Surgical Care Affiliates, Inc. underlying such converted options. In connection with the conversion, the exercise prices of such converted options were adjusted accordingly. In addition, every 10.25 outstanding restricted equity units of ASC Acquisition LLC were converted into one restricted stock unit (“RSU”) of Surgical Care Affiliates, Inc. All information included in this Annual Report on Form 10-K is presented giving effect to the conversion.

On October 29, 2013, the Company’s Registration Statement on Form S-1 (File No. 333-190998) and the Company’s Registration Statement on Form 8-A each became effective, and the Company became subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 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 Annual Report on Form 10-K 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 “Part I, Item 1A. Risk Factors”.

 

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Part I

 

Item 1. BUSINESS

Overview

We are a leading national provider of solutions to physicians, health systems and payors to optimize surgical care. We operate one of the largest networks of outpatient surgery facilities in the United States, which as of December 31, 2013, was comprised of 171 ambulatory surgery centers (“ASCs”), five surgical hospitals and one sleep center with 11 locations. Our business model is focused on building strategic relationships with leading health systems, physician groups and payors to acquire and develop facilities in an aligned economic model that enables better access to lower cost, high-quality care. As of December 31, 2013, we owned and operated facilities in partnership with 43 leading health systems and approximately 2,000 physician partners. We believe that our partnership strategy and comprehensive suite of solutions will enable continued growth by capitalizing on increasing demand for high quality, cost-effective settings of care, the increasing need for scaled partners in healthcare, the transition to a coordinated care delivery model and the trend of physician and health system consolidation.

The healthcare industry is in the midst of a transition characterized by increasing focus on cost containment and clinical outcomes, driven by recent regulatory efforts and new payment and delivery models, such as Accountable Care Organizations (“ACOs”). In this environment, improving clinical quality and reducing the cost of surgical delivery, which represents one of the largest components of medical spending in the United States, will be of greater focus. We believe we are a critical part of the solution because we provide a lower-cost delivery alternative that (1) we believe enhances the quality of care and patient experience, (2) provides a strategic approach for physicians that improves productivity and economic alignment, (3) enables our health system partners to expand access within their markets while addressing the pressures resulting from changing payment models and (4) offers an efficient and lower-cost alternative for payors, employers and other health plan sponsors.

Our scale of operations allows us to provide our affiliated physicians and health system partners with a comprehensive suite of services that support clinical quality, operational efficiency and enhanced financial performance. In addition to a growing network of lower-cost, high quality ASCs, we offer tools and systems in the areas of clinical benchmarking, clinical best practices, operating efficiency, care coordination and supply chain management. Our partnership model aligns the interests of our partners in achieving strong clinical and operational outcomes.

Following the purchase of our company in 2007 by TPG Global, LLC (together with its affiliates, “TPG”), MTS-SCA Acquisition LLC (“MTS”) and certain of our current and former directors, our senior leadership team has transformed our strategic approach from operating a scaled network of facilities to providing a comprehensive suite of solutions to multiple constituents along the surgical care continuum. We have experienced significant growth in our provider partnerships and enhanced our focus on clinical outcomes and patient experience, resulting in strong and consistent performance in our key financial and operating metrics. We believe our comprehensive solution set has established SCA facilities as a site of choice to patients, physicians, health systems and payors, as reflected in (1) our patient and physician Net Promoter Scores, which are measures of loyalty based on asking patients or physicians whether they would recommend our facilities to a friend or family member or colleague, as applicable, (2) growth in physician partners to approximately 2,000 as of December 31, 2013, with approximately 7,500 physicians performing procedures in our affiliated facilities in 2013 and (3) growth in health system partnerships from 18 to 43 from December 31, 2007 to December 31, 2013.

Our commitment to patient care, our outstanding teammates, our health system partnerships and our investments in systems and processes to drive results, coupled with strong industry trends, have enabled us to build a track record of growth. Our consolidated total net operating revenues increased from $744.9 million in 2011 to $802.0 million in 2013, representing a 3.8% compounded annual growth rate (“CAGR”). Given the significant increase in the number of our nonconsolidated facilities, driven by the success of our health system

 

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and physician partnership growth strategy, we also review an internal supplemental operating measure that does not comply with generally accepted accounting principles (“GAAP”) called systemwide net operating revenues growth, which includes both consolidated and nonconsolidated facilities (without adjustment based on our percentage of ownership). Our systemwide net operating revenues grew by 15.2%, 16.4% and 17.0% during the years-ended December 31, 2013, 2012 and 2011, respectively. Our net losses increased from $9.7 million in 2011 to $51.3 million in 2013, our Adjusted EBITDA-NCI increased from $116.7 million in 2011 to $142.9 million in 2013, representing a 10.7% CAGR and our Adjusted Net Income increased from $28.1 million in 2011 to $49.3 million in 2013, representing a 32.5% CAGR. Adjusted EBITDA-NCI and Adjusted Net Income are non-GAAP financial measures and should not be considered substitutes for and are not comparable to our GAAP net income. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Adjusted EBITDA-NCI and Adjusted Net Income Reconcilements” for an explanation of Adjusted EBITDA-NCI and Adjusted net income and a reconciliation to the most directly comparable GAAP financial measures.

The revenues and expenses of affiliated facilities in which we do not have a controlling interest but do have an equity interest are not directly included in our consolidated GAAP results, rather 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, and we refer to such facilities as our “nonconsolidated facilities.”

We present Adjusted EBITDA-NCI because we believe it is useful for investors to analyze our operating performance on the same basis as that used by our management. Our management believes Adjusted EBITDA-NCI can be useful to facilitate comparisons of operating performance between periods because it excludes the effect of depreciation and amortization, which represents a non-cash charge to earnings, income tax, interest expense and other expenses or income not related to the normal, recurring operations of our business. In addition, Adjusted EBITDA-NCI is considered a non-GAAP financial measure and should not be considered a substitute for and is not comparable with net income or net operating income as determined in accordance with GAAP.

Strategic Partnerships with Leading Health Systems

In 2008, recognizing the trend towards branded integrated delivery systems in healthcare, we began to selectively partner with leading health systems in specific markets. From December 31, 2007 to December 31, 2013, we have grown the number of our health system partners from 18 to 43. Our health system partners include many of the leaders in healthcare delivery, such as Indiana University Health, Inc. (“IUH”), MemorialCare, Sutter Health and Texas Health Resources (“THR”), among others. We believe we are a partner of choice to leading health systems because of our comprehensive suite of surgical solutions, expertise in clinical operations and efficiency programs and developmental expertise. Partnering with leading health systems allows us to enter new markets in a capital-efficient way that provides us with immediate relevance to our partners, physicians and payors, translating into greater stability and growth opportunity. Our material health system partners are IUH, MemorialCare, Sutter Health and THR.

When we partner with a health system in a three-way joint venture, we typically hold a noncontrolling ownership interest in a holding company that owns a majority or controlling ownership interest in the facility, while the health system partner holds the controlling interest in the holding company.

We typically have co-development arrangements with our health system partners to jointly develop a network of outpatient surgical facilities. These co-development arrangements are an important source of differentiation and growth for our business. For example, through our relationship with Sutter Health, as of December 31, 2013, we have acquired and developed 17 facilities since 2007. Our success with high quality health system partners has also led them in some cases to have us manage the surgical departments of their hospital sites through our recently introduced hospital management solutions.

In addition to expanding the number of co-developed facilities within our existing partnerships, we continue to establish new partnerships with market-leading providers. During the twelve-months ended December 31,

 

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2013, we added relationships with 15 new health system partners for an initial 27 affiliated facilities. Our co-development arrangements are often informal, but in some cases, we enter into formal co-development agreements with our health system partners. In these agreements, we agree to collaborate on the identification of opportunities for the acquisition or development of new facilities within a defined geographic area. The co-development agreements generally have a duration of one or two years, with the option to renew upon mutual agreement. Some of the co-development agreements contain termination provisions that allow either party to terminate the agreement upon 60 to 120 days’ notice or for cause and others are silent as to termination. For example, our co-development agreement with IUH provides that the Company and IUH will collaborate in good faith to identify, solicit and cultivate potential opportunities for the acquisition of facilities in Indiana. The co-development agreement with IUH provides that it will continue for so long as the partnership between the Company and IUH continues.

Our Affiliated Facilities

Our network of facilities includes:

 

    ASCs. Like hospitals, ASCs serve as locations where physicians on each individual facility’s medical staff perform surgeries on their patients. Our ASCs provide the facilities, equipment, supplies and clinical support staff necessary to provide non-emergency surgical services to patients not requiring hospitalization. Surgeries in ASCs are typically reimbursed at significantly lower rates than in a hospital setting, and ASCs generally operate with greater efficiency and lower costs. For the year-ended December 31, 2013, our ASCs represented 87.7% of our net operating revenues.

 

    Surgical hospitals. Our surgical hospitals allow physicians to perform a broader range of surgical procedures, including more complex surgeries, and allow patients to stay in the hospital for up to three days. For the year-ended December 31, 2013, our surgical hospitals represented 10.3% of our net operating revenues.

 

    Hospital surgery departments. We also contract with hospitals to manage in-hospital surgery departments, which can focus exclusively on supporting physicians in the performance of surgeries on patients who do not require hospitalization (on an outpatient basis) or provide a full array of surgeries, including emergency surgeries, as well as surgeries on hospital inpatients and patients who will be admitted post-procedure. We believe managing hospital surgery departments strengthens our relationships with our hospital partners, as we are engaged across the continuum of surgical care. For the year-ended December 31, 2013, such hospital surgery departments represented 0.1% of our net operating revenues.

Physicians at our facilities provide surgical services in a wide variety of specialties, including orthopedics, ophthalmology, gastroenterology, pain management, otolaryngology (ear, nose and throat, or “ENT”), urology, spine and gynecology, as well as other general surgery procedures. As of December 31, 2013, we consolidated the operations of 87 of our 177 affiliated facilities, had 60 nonconsolidated affiliated facilities and held no ownership in 30 affiliated facilities that contract with us to provide management services only. We provide management services to all but two of our 177 facilities.

Our Industry

Medical costs account for a substantial percentage of spending in America. The United States spent $2.7 trillion on healthcare in 2011, according to Centers for Medicare and Medicaid Services (“CMS”), and the percentage of gross domestic product devoted to healthcare has increased from 7.2% in 1970 to 17.9% in 2011. Surgical delivery is one of the largest components of medical costs in the United States, currently representing approximately 30% of medical spending for individuals with commercial insurance, according to our estimates.

 

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Against this backdrop, we believe that we are well positioned to benefit from trends currently affecting the markets in which we compete, including:

Continued Migration of Procedures out of Hospitals

According to the American Hospital Association, from 1991 to 2011, outpatient surgeries increased from 52.3% of total surgery volumes to 64.2%. In addition, a significant share of outpatient surgeries shifted from hospitals to free-standing facilities over a similar period. Advancements in medical technology, such as lasers, arthroscopy, fiber optics and enhanced endoscopic techniques, have reduced the trauma of surgery and the amount of recovery time required by patients following certain surgical procedures. Improvements in anesthesia have also shortened the recovery time for many patients by minimizing post-operative side effects such as nausea and drowsiness, thereby avoiding, in some cases, overnight hospitalization. These medical advancements have significantly increased the number of procedures that can be performed in a surgery center and have fueled the migration of surgical procedures out of hospitals and into outpatient settings. We expect that continued advancements in healthcare delivery and regulatory reform will further this trend.

Growing Focus on Containment of Healthcare Costs

Because of an increased focus on controlling the growth of healthcare expenditures in our economy, constituents across the healthcare continuum, including government payors, private insurance companies and self-insured employers, are implementing meaningful cost containment measures. These initiatives have contributed to the shift in the delivery of healthcare services away from traditional inpatient hospitals to more cost-effective settings, such as ASCs. For example, based on 2014 Medicare fee schedules, a procedure in an ASC costs, on average, 55% of what the same procedure costs when performed in a hospital surgery department, according to the Ambulatory Surgery Center Association. The cost differential creates savings for the government, Medicare plans, commercial payors and patients when a procedure is performed at an ASC instead of a hospital-based surgery department. We expect this cost effectiveness will continue to fuel the migration of procedures into the ASC setting.

In addition, as self-insured employers look to reduce their overall healthcare costs, they are shifting increased financial responsibility to patients through higher co-pays and deductibles. These changes to health plan design, coupled with increased pricing transparency, have encouraged patients to seek out more cost-effective options for their healthcare delivery. Because of their cost advantage and high patient satisfaction, ASCs stand to benefit from this increase in consumerism.

Opportunities Created by Healthcare Legislation

We anticipate that recent healthcare legislation will create greater opportunities for cost-effective providers of healthcare. The Patient Protection and Affordable Care Act (“PPACA”) and other related healthcare reform activities are expected to promote the transition from traditional fee-for-service payment models to more “at risk” or “capitated” models in which providers receive a flat fee per member per month from payors, regardless of the cost of care. These changes will be reflected through the creation of ACOs or other payment model reforms. This shift will create financial incentives for “at-risk” providers to direct patient procedures into the most cost-effective settings, such as ASCs. We believe health systems, which are expected to remain the center of the delivery network in many markets, are resolving to shift many types of surgical cases out of their hospital surgery departments into the lower-cost ASC setting. Given that, according to management estimates, surgical spending currently represents approximately 30% of all medical spending for individuals with commercial insurance, the shift to “at risk” payment models is likely to create greater interest from health systems in expanding their delivery networks to include lower-cost surgical facilities.

Dynamics Impacting Health Systems

Many hospitals and health systems anticipate strategic and financial challenges stemming from healthcare reform and growing efforts to contain healthcare costs. In response, many health systems are focused on

 

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strategies to reduce operating costs, build market share, align with physicians, create additional service lines, expand their geographic footprint and prepare for new payment models, including ACOs, which are networks of doctors, hospitals and other healthcare providers who share responsibility for providing coordinated care to patients with the goal of reducing overall spending. As a result, a growing number of health systems are entering into strategic partnerships with select provider organizations that can provide focused expertise, scaled operating systems, best practices, speed of execution and financial capital.

These same trends have led many health systems to focus on increasing the efficiency and reducing the operating costs of their hospital surgery departments, which can be significant contributors to the profitability of an acute care hospital. We believe that efforts by hospital surgery departments to increase efficiency and reduce costs will continue to create demand for perioperative consulting and management services.

Increased Pressure on Physicians and Physician Groups

Physicians in many markets are increasingly interested in affiliating with leading health systems, especially in the context of an operating partner that can help ensure the continued efficiency of their practices. Uncertainty regarding reimbursement along with increased financial and administrative burdens resulting from healthcare legislation have contributed to the trend toward health system partnerships. As a result, physicians in many markets are pursuing partnerships with surgical providers and health systems in order to gain greater stability, access to scaled clinical and operating systems and a pathway to participating in new payment models. This is creating opportunities for providers with expertise and a track record of structuring partnerships with health systems and physicians in a way that creates value for all constituents.

Continued Provider Consolidation Driven by Changing Environment

We believe that consolidation among healthcare providers will continue due to cost pressures, a changing regulatory environment and the requirements imposed by new payment and delivery models. Our industry remains highly fragmented relative to other healthcare sectors, with the three largest companies in our industry operating an aggregate of only 12% of approximately 5,300 Medicare-certified ASCs in the United States as of December 31, 2013. We expect consolidation to continue, as larger operators like us bring to bear the benefits of systems, processes and larger-scale relationships.

Our Competitive Strengths

We believe that our commitment to outstanding patient care, our strategy and our market position align us to benefit from trends in the U.S. healthcare market. An environment that demands better access to high-quality care, improved patient experience, health system and physician partnership and continuous clinical and administrative improvement and efficiency aligns very well with our competitive strengths:

Multi-Pronged Growth Strategy Based on Aligned Economic Model and Diverse Business Mix

Our business model is focused on building strategic relationships with leading health systems, physician groups and payors to acquire, develop and operate facilities in an aligned economic model. The alignment of strategic and financial interests through shared ownership is an integral component of our ability to achieve strong results — clinically, operationally and financially. We believe our business model, which is aligned with secular industry trends demanding high quality, cost-effective settings of care, the need for more scaled partners in healthcare and the transition to a coordinated care delivery model, enables the following multiple growth avenues and positions us for long-term sustainable growth:

 

   

Strong same-site growth. We believe that several factors will contribute to continued same-site growth: (1) a significant majority of our facilities are multi-specialty (149 of our 177 affiliated facilities), (2) a payor mix weighted toward non-governmental payors (60% of our consolidated net patient revenues and 77% of net patient revenues at our nonconsolidated facilities for the year-ended December 31,

 

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2013 came from commercial payors), (3) our partnerships with leading health systems, (4) our strong physician satisfaction and (5) the continued focus of our regional facility leadership on physician recruitment, leveraging our tools and systems.

 

    In-market expansion and co-development with existing leading health system partnerships. We have partnered with many leading health systems in the country, and we are generally in the early stages of developing those health system partnerships. These partnerships create an opportunity for continued growth through expanding our footprint of facilities in the markets of our health system partners.

 

    New health system partnerships. Many factors are driving health systems to increasingly seek out partners, including the need for focused expertise and scaled operating systems and the need for human and financial capital. These dynamics will contribute to our ability to add new health system partnerships to our existing portfolio.

 

    Additional services across our broad suite of solutions. We provide a broad suite of solutions to meet the specific needs of our health system and physician partners in the communities they serve. These solutions include, among others, development of market growth strategies, multiple physician alignment models (including joint ventures and clinical co-management agreements), perioperative consulting and management services to assist health systems in increasing the efficiency of their own hospital surgery departments, supply chain management, data analytics and benchmarking and analytics to support the transition to new payment models. These additional services enhance patient care and strengthen our partnerships with health systems, physicians and payors while providing additional economic benefits to us.

 

    Opportunistic acquisitions. Our partnership model with leading health systems enables us to be a strategic acquirer in multiple geographic markets within the fragmented ASC industry. From June 30, 2010 to December 31, 2013, we acquired or entered into management agreements with 33 facilities in our existing markets and 34 facilities in new markets. Also during this same time period, we placed two de novo facilities into operation in our existing markets.

Strategic Partnerships with Leading Health Systems

We have positioned ourselves for the continued shift toward large scale, integrated delivery systems by selectively partnering with health systems that hold market-leading positions in their primary service areas. From December 31, 2007 to December 31, 2013, we have grown the number of our health system partners from 18 to 43, including many of the leaders in healthcare delivery, such as IUH, Sutter Health, THR and MemorialCare, among others. We believe we are a partner of choice to leading health systems because of our comprehensive suite of surgical solutions, expertise in clinical operations and efficiency programs and development expertise. Partnering with leading health systems allows us to enter new markets in a capital-efficient way that provides us with immediate relevance to our patients, physicians and payors, translating into greater stability and growth opportunity. Historically, our partnerships have delivered above-market same-site revenue growth, as well as growth from the co-development of additional facilities alongside our health system partners.

Leading National Brand and Scaled Franchise

We believe a healthcare environment characterized by cost pressure, regulatory change, increased consumerism and consolidation favors large scale competitors with strong reputations. We are one of the largest multi-specialty operators of ASCs in the United States, operating in 34 states, with 171 ASCs, five surgical hospitals and one sleep center with 11 locations. We operate a large surgical services purchasing platform that provides us substantial purchasing advantages as our dedicated supply chain team works with our facilities, health system partners and affiliated physicians across the country. Through our partnerships with locally branded health systems, we have established strong brand recognition among physicians in many communities, and we believe our national presence and leading reputation provide us with a greater opportunity to establish strategic relationships with local health systems and physicians. Our facilities have also developed a strong reputation among patients in our communities as a result of our principal focus on patient care and clinical

 

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quality. We provide each patient with a survey regarding their experience at our facility which is generally provided in person after their procedure has been performed or through the mail. According to our patient surveys conducted during 2013, we have a Net Promoter Score of approximately positive 97. This Net Promoter Score is a measure of loyalty ranging from negative 100 to positive 100 based on asking patients whether they would recommend our facilities to a friend or family member. The overall response rate for these surveys has been, on average, approximately 63% in 2013, which represented an average of approximately 32,000 responses received per month in 2013.

Proprietary and Expanding Suite of Technology-Enabled Solutions

New payment models and increasing pressure on health systems and physicians to contain costs are forcing providers to make new investments in areas such as information systems and data analytics in an effort to become more efficient and meet the demands for improved clinical outcomes. We have developed a comprehensive set of proprietary technology tools that enable health systems, physicians and payors to optimize patient experience, clinical outcomes, physician productivity and operating performance. Our proprietary technology tool set includes:

 

    SCA Quality Index. We measure patient satisfaction, clinical outcomes and licensure and accreditation inspection readiness for each affiliated facility and combine those measures into our SCA Quality Index to track quality metrics and increasingly to support the transition to new payment models.

 

    Operating system. Our operating system provides detailed benchmarking of key operational measures (including on-time starts, turn-times, staffing ratios and supply expense metrics) that allows management to identify, monitor and adjust areas such as case mix, staffing and operating costs to improve overall performance.

 

    Proprietary case-costing system (which we call the “Every Case Optimized System” or “ECOSystem™”). Our ECOSystem™ provides detailed labor cost, supply cost and contribution margin data by procedure code, physician, facility and payor to monitor key expenses and margins, allowing us to benchmark best practices by case type.

 

    Supply chain management system. Our supply chain management system provides detailed analysis on supply cost management to improve purchasing efficiency and costs.

Our data-driven insight and ability to measure performance metrics such as clinical outcomes and patient satisfaction as well as optimize performance through our ECOSystem™ have been integral in achieving clinical and operational excellence to date and position us for success in the payment models of the future, such as ACOs, bundled payments and capitated models.

Strategic Partner to Physicians

The evolving healthcare landscape, including regulatory changes, increasing administrative burden, payor consolidation, shifting competitive landscape and transition to new payment models, is increasing pressure on physicians. We offer physicians an attractive solution to help them operate successfully in this environment as we design our facilities, structure our strategic relationships and adopt staffing, scheduling and clinical systems and protocols with the aim of increasing physicians’ productivity and promoting their professional and financial success. Our approximately 2,000 physician partners (as of December 31, 2013), many of whom are leading practitioners in their respective fields and geographies, value the efficiency and convenience that our facilities provide. Our technology solutions allow our physicians to optimize clinical, operational and financial results. Our success in forming productive relationships with physicians is reflected in both the growth in the number of our physician partners and our Net Promoter Score of positive 90, according to our physician surveys conducted during November and December of 2013, which had a response rate of approximately 87% (which response rate is calculated on a weighted basis based on the number of cases performed by a physician at our facilities). This Net Promoter Score is a measure of loyalty ranging from negative 100 to positive 100 based on asking each of the physicians who utilize our facilities whether they would recommend performing cases at our facilities to a

 

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physician colleague. We monitor physician satisfaction on a facility-by-facility basis, survey all of our physicians who utilize our facilities at least on an annual basis and use physician feedback to drive continuous improvement on a local and national basis.

Proven Management Team

Our senior leadership team of Andrew Hayek, President and Chief Executive Officer, Peter Clemens, Executive Vice President and Chief Financial Officer, Michael A. Rucker, Executive Vice President and Chief Operating Officer, Joseph T. Clark, Executive Vice President and Chief Development Officer, and Richard L. Sharff, Jr., Executive Vice President, General Counsel and Corporate Secretary, averages approximately 20 years of experience in the healthcare industry and has transformed our strategic approach to provide solutions to physicians, health systems and payors to optimize surgical care. Under this management team, we have experienced significant growth in our provider partnerships and enhanced our focus on clinical outcomes and patient experience, resulting in strong and consistent performance in our key financial and operating metrics and positioning us well for long-term growth.

Our Business Strategy

We seek to provide outstanding patient care and clinical quality, and we seek to create measurable clinical, operational and financial advantages for our partners by leveraging our tools and processes, knowledge and experience and talented leaders in each market. The key components of our strategy include:

 

    Delivering outstanding patient care and clinical outcomes;

 

    Driving strong and consistent same-site performance;

 

    Capitalizing on existing health system partnerships poised for growth;

 

    Developing new health system partnerships;

 

    Leveraging our core competencies to expand into new service lines;

 

    Establishing partnerships that take advantage of new payment models; and

 

    Consolidating a fragmented industry.

Delivering Outstanding Patient Care and Clinical Outcomes

We are committed to outstanding patient care and clinical quality. Our culture and operating systems reinforce this focus and commitment. We measure patient satisfaction, clinical outcomes and licensure and accreditation inspection readiness for each affiliated facility and combine those measures into our SCA Quality Index, which we monitor closely to identify areas for improvement and track progress. We also develop and implement clinical toolkits, clinical training and best practice sharing across our network to drive ongoing improvement in clinical outcomes. Our Regional Quality Councils (“RQCs”) enable identification and sharing of best practices across our affiliated facilities. Each RQC is composed of at least one representative, such as a Regional Quality Coordinator or a Center Quality Coordinator, from each facility in the applicable region. Each RQC meets on at least a quarterly basis to share and compare clinical and operational experiences and to develop best practices, which are shared with governing boards at each facility. We have also developed focused training resources that are available to our physicians, nurses and surgical technicians at our affiliated facilities, including through a proprietary, learning computer portal called the Clinical Excellence Universe (or “CEU”). Our training programs include new teammate trainings, telephone and web conferences focusing on key clinical issues, continuing education programs, leadership development programs and initiatives aimed at enhancing our culture of patient safety.

Driving Strong and Consistent Same-Site Performance

Achieving strong performance on a same-site basis is important for us to drive organic revenue growth as well as support consistent operating performance for SCA and our partners. We believe that our partnership

 

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model aligns incentives such that we and our partners can achieve improved long-term performance. We also believe that our ability to affiliate with physicians as an extension of their practices is an important driver to sustained same-site performance. Our clinical protocols and proprietary technology tools are designed to improve physician productivity and increase the number of procedures performed in our facilities while improving both physician and patient satisfaction. In addition, our ability to attract physicians through recruitment initiatives provides an additional opportunity for us to drive same-site growth. This alignment with partner hospitals and physicians has contributed to annual same site systemwide net operating revenues growth of 8.8% in 2013, 5.8% in 2012 and 5.5% in 2011. We have shown an ability to improve facility-level profitability by gaining physician alignment around more efficient supply utilization, reducing clinical variation, more effectively contracting with payors and lowering administrative costs.

Capitalizing on Existing Health System Partnerships Poised for Growth

We believe that development of our existing health system relationships is an important part of our continued growth. While our facility count has grown significantly from 131 to 177 affiliated facilities from December 31, 2007 to December 31, 2013, our growth in health system partners has been even stronger, more than doubling from 18 to 43 over the same time period. We believe this recent growth in health system partnerships creates significant opportunities. Our aligned model incentivizes our partners to work closely with us to identify strategically important and financially accretive growth opportunities in the markets we serve. Our experience has shown that demonstrated results in achieving exceptional patient care and strong physician partnerships have encouraged our partners to expand their relationships with us. For example, through our relationship with Sutter Health, as of December 31, 2013, we have acquired and developed 17 facilities since 2007. Our success with high quality health system partners has also led such partners, in some cases, to have us manage the surgical departments of their hospital sites through our recently introduced perioperative management solutions. Given that many of our health system partnerships have been developed recently, including relationships with 15 new health system partners in the twelve-months ended December 31, 2013 alone, we believe we are in the early stages of a significant opportunity to expand the scope of these relationships in the near-term, similar to our experience to date.

Developing New Health System Partnerships

We are focused on developing new health system partnerships, and we expect this to continue as we position ourselves as a partner of choice to physician groups, health systems and payors. While we have demonstrated a track record of success among a group of leading health systems, we believe that our current footprint represents only a small percentage of potential health system partnerships and that we have substantial long-term opportunities to add new relationships. In addition, industry dynamics, such as a challenging reimbursement environment and an increased emphasis on achieving cost savings with improved clinical outcomes, are encouraging health systems with which we do not already have relationships to seek partners. We believe that our expertise developing tools that ensure improved outcomes, drive cost savings and support efficiencies in the clinical setting will further strengthen our value proposition as a partner of choice for new health system relationships.

Leveraging Our Core Competencies to Expand into New Service Lines

We intend to leverage significant expertise related to the provision of surgical solutions in the form of expansion into new lines of service. Our relationships and operating systems provide a strong platform from which we can deliver a broader range of solutions designed to achieve excellent clinical outcomes while improving efficiency and generating significant savings in the healthcare system. As an example, we launched our perioperative consulting services to health system partners to optimize physician engagement, operating and cost efficiency, margin enhancement, market share growth and the development of new service lines. As of December 31, 2013, we provided such services to 14 facilities, and we have a dedicated team of professionals focused on expanding this business, as we believe it represents a significant area of potential growth. In addition to providing a high growth and diversified revenue stream, our perioperative consulting business also serves as a sales channel for potential health system partnerships. By demonstrating our value proposition and operational

 

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expertise with the effective management of their surgical operations, we believe we are better positioned for partnering with the health system’s current and prospective ASCs.

In addition to perioperative consulting, we also offer additional services relating to the delivery of surgical care, including management services (where we manage a surgical facility in which we do not have an ownership interest), clinical co-management consulting services (for hospital surgery departments interested in having certain of their non-employee physicians participate in management) and supply chain management and data analytics, to better serve patients’ needs and strengthen our partnerships with our health system and physician partners as well as with payors.

Establishing Partnerships that Take Advantage of New Payment Models

We expect the evolving reimbursement landscape in healthcare to create opportunities to partner with physicians and payors in new payment models. We believe payment models such as “at risk” and “capitated” models, in which the providers receive a flat fee per member per month from payors regardless of the cost of care, drive surgical care to more cost-efficient settings, such as ASCs. We plan to continue working creatively with our various partners and potential partners to structure arrangements that provide solutions to the challenges created by the variety of new payment models.

For example, one of our partners is a large, integrated multi-specialty physician group and one of the original five ACOs piloted under a Dartmouth College/Brookings Institute-supported initiative in ACO healthcare delivery focused on improving care quality and bending the cost curve. As of December 31, 2013, we had four joint venture surgical facilities with this physician group, which takes capitated risk, and we have been able to improve the cost of surgical delivery for its patient base by shifting surgical case volume to our facilities.

As the various risk-based payment models evolve and grow in frequency, physicians and health systems that launch “at risk” payment models will need robust analytics and capabilities to improve the efficiency of surgical delivery. We plan to leverage our experience, data systems and physician engagement models to help health systems, physicians, employers and payors implement and successfully manage new payment models.

Consolidating a Fragmented Industry

Greater operating scale allows us to invest in better clinical, operational and financial systems and deliver outstanding results for our patients and partners. Therefore, we are focused on continuing to add new affiliated facilities where we see opportunities to grow volumes by recruiting new physicians and improve profitability by leveraging our scale, technology and operating efficiencies while delivering outstanding patient care. We expect our acquisition activity to continue as we continue to position ourselves as a partner of choice to health systems and physician groups. Given that we operate in a relatively fragmented segment of the healthcare industry, with the three largest companies operating an aggregate of only 12% of the approximately 5,300 Medicare-certified ASCs in the United States as of December 31, 2013, we believe there are and will continue to be robust opportunities to invest and partner in new facilities. We believe our scale, operational expertise and value-added services and solutions differentiate us and provide us with the ability to selectively acquire attractive assets in attractive markets where we can create value, both in the near term as well as over the longer term. We plan to continue to leverage our proven strategy for target identification, thorough diligence, transaction execution and integration which we have systematically implemented in acquisitions of 13 consolidated and 32 nonconsolidated facilities from January 1, 2010 to December 31, 2013.

Operations

General

Our operations consist primarily of our ownership and management of surgery centers. Our affiliated facilities provide the space, equipment and medical support staff necessary for physicians to perform non-emergency surgical procedures. Our typical ASC is a freestanding facility with fully-equipped operating and procedure rooms and ancillary areas for reception, preparation, recovery and administration. Our surgical

 

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hospitals provide medical services similar to those provided by our ASCs and can also accommodate more complicated procedures requiring patients to stay overnight. The typical staff of an affiliated facility includes an administrator, registered nurses and operating room technicians, as well as personnel in a business office performing tasks such as billing and collecting. In addition, at each affiliated facility, a physician who serves as the medical director is responsible for medical direction and certain administrative services at the facility, including ensuring that clinical activities are performed in accordance with the facility’s policies and procedures and serving as a liaison between the facility’s administration and its medical staff. Our affiliated facilities generally have service agreements with anesthesiologists and certified registered nurse anesthetists (“CRNAs”) to provide anesthesiology services. Generally, those anesthesiologists and CRNAs are independent contractors of the affiliated facilities and are responsible for their own clinical and billing activities; in a few cases, those individuals are employed by the affiliated facility. Otherwise, the physicians that utilize our facilities are not employees of our facilities. We typically assist each of our affiliated facilities with marketing, payor contracting, purchasing and other strategic and operational services, including the preparation of financial statements.

Each affiliated facility is licensed in accordance with local and state requirements. All but three of our affiliated facilities are also certified as Medicare providers. The affiliated facilities are available for use only by licensed physicians and other qualified healthcare providers. To ensure consistent quality of care, each affiliated facility has a medical executive committee comprised of local physicians that reviews the qualifications of each physician who applies to practice at the affiliated facility. In addition, as of December 31, 2013, 165 of our 171 ASCs and all five of our surgical hospitals were accredited by either The Joint Commission or the Accreditation Association for Ambulatory Health Care (“AAAHC”), the two major national organizations that establish standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of various types of healthcare facilities. Five of our six remaining ASCs that were not accredited as of December 31, 2013 are actively pursuing accreditation. We believe that accreditation is the quality benchmark used by commercial payors for inclusion of a facility in their network. Some payors may not include a facility in their network unless the facility is accredited.

Billing and Payment

Our affiliated facilities derive their net patient revenues by collecting fees from patients, insurance companies, government programs and other third-party payors in exchange for providing the facility and related services for surgical procedures. The surgeons and, in most cases, anesthesiologists and CRNAs at our affiliated facilities bill their patients or relevant other payors directly for their professional services; therefore, such services are not included in our billing for a procedure.

Each affiliated facility uses a patient accounting system to manage scheduling, billing and collection, accounts receivable management and other essential operational functions. We have implemented systems to centralize financial data from most affiliated facilities into our corporate data systems. These systems support our access to information on a timely basis and enhance our ability to provide each affiliated facility with financial statements and other financial data services.

Revenues at our affiliated facilities consist primarily of net patient service revenues that are recorded based upon established billing rates less allowances for contractual adjustments. Revenues are recorded during the period in which the healthcare services are provided, based upon the estimated amounts due from patients and third-party payors, including commercial health plans, commercial insurance companies, employers, workers’ compensation plans and federal and state agencies (under the Medicare and Medicaid programs). We utilize the payment history specific to each affiliated facility by payor to record estimated contractual allowances, and we employ other analytical tools to ensure the appropriateness of these estimates. Third-party payor contractual payment terms are generally based upon predetermined rates per procedure or discounted fee-for-service rates.

It is our general practice, where possible, to verify a patient’s insurance and collect estimated co-payments prior to rendering services. Claims are submitted electronically if the payor accepts electronic claims. We require claims submitted to third-party payors to be paid within timeframes that are generally consistent with industry standard practices, which vary based upon payor type.

 

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In general, we or our health system partners negotiate contracts directly with non-governmental third-party payors and employers. The rates paid by governmental third-party payors are set by such payor and are not subject to negotiations. We market our affiliated facilities directly to non-governmental third-party payors and employers in order to communicate the cost advantages of surgery centers versus hospitals. Payor marketing activities are conducted by reimbursement teammates and facility administrators, with important assistance from our physician partners. We emphasize the high-quality healthcare, cost advantages and convenience of our affiliated facilities.

Patients are generally not responsible for the difference between our established charges and amounts reimbursed for such services under Medicare, Medicaid and negotiated third-party payor contracts, but they are responsible for any exclusions, deductibles, co-payments or coinsurance features of their coverage.

Clinical and Operating Systems

We have developed a number of tools to track and compare results from our affiliated facilities and across our network. We believe these systems are an important strength and provide us data to improve results, training and efficiency across our affiliated facilities.

Our clinical systems allow detailed benchmarking of clinical outcomes endorsed by the National Quality Forum, patient satisfaction and accreditation inspection readiness. We have extensive tools to prepare for regulatory surveys. We strongly encourage all of our ASCs and surgical hospitals to seek and to maintain accreditation by an independent agency, either The Joint Commission or the AAAHC. All of our facilities that have sought such accreditation have successfully completed the survey process and have received a three-year term of accreditation, which is only provided after the accrediting organization has concluded that the facility is in substantial compliance with the relevant organizational standards. Our clinical education system, the CEU, provides tailored education programs to our approximately 2,900 clinicians, as of December 31, 2013, across the country.

Our operating systems provide detailed benchmarking of key operational measures (including on-time starts, turn-times, staffing ratios and supply expense metrics). Management uses these tools to measure operating results against target thresholds and to identify, monitor and adjust areas such as case mix, staffing, operating costs, teammate expenses and accounts receivable management.

Our case-costing system, the ECOSystem™, provides detailed labor cost, supply cost and contribution margin data by procedure code, physician, facility and payor. This ECOSystem™ data allows us to work with our physicians to benchmark their performance on a detailed level and show them precise steps they can take to optimize clinical, operational and financial results. We also have a dedicated supply chain team that works with our facilities and affiliated physicians across the country to aggregate the approximately $220 million spent on surgical supplies in 2013 and to use that purchasing power to negotiate more favorable company-wide contracts with vendors.

Our detailed data also allows us to work in partnership with payors to optimize the cost of surgery for their covered members. Surgery is one of the largest components of medical costs, typically representing approximately 30% of total medical spending for individuals with commercial insurance, according to our estimates. Because of this, we are increasingly focused on working with commercial payors, Medicare Advantage plans and capitated physician groups to help them reduce the total medical spend (or rate of medical spend growth) for their population while maintaining or improving the quality of care.

Facility Level Ownership Structure

Almost all of our affiliated facilities are owned in partnership with local physicians. As of December 31, 2013, we had approximately 2,000 aggregate physician partners. The amount of physician ownership in our

 

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facilities ranges widely based on local market conditions. Physician ownership of our consolidated facilities typically ranges from 10% to 50%. When we partner with a health system in a three-way joint venture, we typically hold a non-controlling ownership interest in a holding company that owns a majority or controlling ownership interest in the facility, and the health system partner holds the controlling interest in the holding company.

Our facilities are organized as limited partnerships (“LPs”) or general partnerships, limited liability companies (“LLCs”) or limited liability partnerships (“LLPs”). In ventures that do not include a health system partner, we typically serve as the general partner (or its equivalent) of the entity, as well as the day-to-day manager of the facility owned by the entity. In our three-way joint ventures that include a health system partner, we typically serve as a noncontrolling member of an LLC that is co-owned with the health system, and that LLC serves as the general partner (or its equivalent) of the facility. In such three-way ventures, we typically enter into a management agreement to handle most of the day-to-day management functions for the facilities owned by the LLC, and the health system negotiates fee schedules with payors and provides other miscellaneous services.

Our affiliated facilities typically pay a monthly management fee to us and, where we have an ownership interest, a monthly or quarterly pro rata distribution of cash in excess of current obligations, less amounts held in reserve for working capital and certain other anticipated expenditures. The partnership and LLC agreements typically provide for, among other things, limited voting rights for our limited partners and limited rights to transfer ownership interests. We have developed a “model” agreement that includes provisions to restrict a physician partner from owning an interest in a competing surgery center or surgical hospital during the period in which the physician owns an interest in our facility and for a period of two years after they no longer own an interest in our facility. Similarly, our model agreement for ASCs requires our physician partners to certify that they are using the applicable facility in a way that is consistent with the regulatory guidance on what constitutes use of the facility as an “extension of their office practice.” In multi-specialty ASCs, this means, among other things, that at least one-third of their eligible cases are performed at our facility. These provisions give us (or our health system partner) the right to repurchase equity from physician partners who do not meet this threshold. Our agreements also typically give us the right, but do not require us, to repurchase equity interests from physician partners who retire or trigger certain other repurchase provisions in the agreements. However, some of our agreements do not include some or any of these model provisions.

Certain of our operating agreements have termination dates by which the agreement expires by its terms. In these situations, if we wish to continue the business, we would attempt to negotiate an amendment to the agreement and, if necessary, to renegotiate material terms of the agreement to prevent such termination. None of our current operating agreements terminate in 2014. See “Risk Factors — Risks Related to Our Business — Certain of our partnership and operating agreements contain termination dates that will require us to amend and possibly renegotiate such agreements.”

In addition, certain of our agreements contain provisions that give our partners or other members rights that include, but are not limited to, rights to purchase our interest, rights to require us to purchase the interests of our partners or other members or rights requiring the consent of our partners and other members prior to our transferring our ownership interest in a facility or prior to a change in control of us or certain of our subsidiaries.

Almost all of our partnership and operating agreements contain restrictions on actions that we can take, even though we may be the general partner or the managing member, including rights of our partners and other members to approve the sale of substantially all of the assets of the entity, to dissolve the partnership or LLC, and to amend the partnership or operating agreement. Many of our agreements also restrict our ability in certain instances to compete with our existing facilities or with our partners. Where we hold only a limited partner or a non-managing member interest, the general partner or managing member may take certain actions without our consent, although we typically have certain protective rights to approve major decisions, such as the sale of substantially all of the assets of the entity, the dissolution of the partnership or LLC, and the amendment of the partnership or operating agreement. See “Risk Factors — Risks Related to Our Business — Certain of our partnership and operating agreements contain provisions giving rights to our partners and other members that may be adverse to our interests.”

 

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Further, some of our partnership and LLC agreements provide that the partnership, LLC, general partner or managing member, as applicable, will purchase all of the physicians’ ownership interests at fair market value if certain regulatory events occur, including, for example, if it becomes illegal for the physicians to own an interest in a facility, refer patients to a facility or receive cash distributions from a facility. See “Risk Factors — Risks Related to Healthcare Regulation — If laws or regulations governing physician ownership of our facilities change, we may be obligated to purchase some or all of the ownership interests of our physician partners or renegotiate some of our partnership and operating agreements with our physician partners and management agreements with our surgical facilities.” From time to time, we may extend loans to the partnerships or LLCs on commercially reasonable and fair market value terms in order to fund capital expenditures, leasehold improvements or other cash requirements. See “Risk Factors — Risks Related to Our Business — We make significant loans to the partnerships and LLCs that own and operate certain of our facilities.”

Resyndications

We periodically provide physicians who use our facilities the opportunity to purchase ownership interests (or increase their ownership interests) in those facilities, which we call “resyndication.” We believe that periodic resyndication of ownership interests helps our facilities maintain a core group of physicians who actively use the facility as an extension of their office practice and are incentivized to ensure that the facilities make the necessary investments and follow the necessary practices to provide high-quality and cost-efficient patient care services.

In addition to selling our equity interest, a key component of our resyndication strategy is repurchasing equity interests from existing physician partners and re-selling that equity to non-partner physicians or to other existing physician partners. Where feasible, we seek to redistribute equity from existing to new physician partners before selling our own equity or new equity in our facilities. However, we will continue to sell portions of our existing ownership where we believe it is in our overall best interest.

Case and Payor Mix

We seek to maintain diversity of case mix in our portfolio to insulate us from potential negative effects that could stem from emphasizing one particular case type. The following chart breaks down our consolidated net patient revenues by specialty and by type of payor for the year-ended December 31, 2013.

 

Case Mix

   

Payor Mix

 
     Year-Ended
December 31,
2013
         Year-Ended
December 31,
2013
 

Orthopedic

     30 %   Commercial health insurance payors      60 %

Ophthalmology

     17      Medicare      20   

Gastroenterology

     13      Workers’ compensation      11   

Pain

     8      Patients and other third-party payors      6   

ENT

     8      Medicaid      3   

General Surgery

     24        
  

 

 

      

 

 

 

Total

     100 %   Total      100 %
  

 

 

      

 

 

 

Seasonality

In recent years, our facilities have experienced a disproportionate allocation of payor mix throughout the year. Our facilities typically see a relatively higher percentage of patients with governmental payors in the first half of the year and a relatively higher percentage of patients with commercial payors in the second half of the year. We believe this trend is a result of the continuing sharing of the cost of care with patients by employers and insurers through increased annual deductibles, which are not typically met until later in the year.

 

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Facilities

The following table sets forth information relating to our facilities and corporate offices as of December 31, 2013:

 

Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

Alabama

         

*Birmingham Outpatient Surgery Center, Ltd.

  Birmingham, AL     6/29/2007      8   1   34.4%

*Florence Surgery Center, L.P.

  Florence, AL     6/29/2007      4   —     50.0%

*Gadsden Surgery Center, Ltd.

  Gadsden, AL     6/29/2007      4   2   57.5%

*Mobile-SC, LTD.

  Mobile, AL     6/29/2007      4   3   33.0%

Surgery Center of Cullman, LLC

  Cullman, AL     6/29/2007      4   3   33.3%

Surgicare of Mobile, Ltd.

  Mobile, AL     6/29/2007      5   3   30.0%

*Tuscaloosa Surgical Center, L.P.

  Tuscaloosa, AL     6/29/2007      5   7   30.0%

Alaska

         

*Alaska Surgery Center, Limited Partnership

  Anchorage, AK     6/29/2007      8   1   38.1%

California

         

Los Angeles Facilities

         

*Antelope Valley Surgery Center, L.P.

  Lancaster, CA     6/29/2007      4   2   80.6%

*Arcadia Outpatient Surgery Center, L.P.

  Arcadia, CA     6/29/2007      4   —     48.7%

Channel Islands Surgicenter, L.P.

  Oxnard, CA     6/29/2007      3   2   25.4%

Digestive Disease Center, L.P.

  Laguna Hills, CA     12/31/2012      —     3   25.0%

*Glenwood Surgical Center, L.P.

  Riverside, CA     6/29/2007      3   3   50.0%

*Golden Triangle Surgicenter, L.P.

  Murrieta, CA     6/29/2007      3   1   67.5%

Greater Long Beach Endoscopy Center

  Long Beach, CA     6/29/2007      3   3   20.0%

Hoag Outpatient Centers, LLC

  Newport Beach, CA     6/1/2013      —     3   5.0%

*Inland Surgery Center, L.P.

  Redlands, CA     6/29/2007      4   1   44.5%

Kerlan-Jobe Surgery Center, LLC

  Los Angeles, CA     6/29/2007      4   —     Managed-only

MemorialCare Surgical Center at Orange Coast, LLC

  Fountain Valley, CA     4/1/2013      3   —     Managed-only

MemorialCare Surgical Center at Saddleback, LLC (Saddleback)

  Laguna Hills, CA     12/27/2012      4   6   25.9%

MemorialCare Surgical Center at Saddleback, LLC (Laguna Hills)

  Laguna Hills, CA     12/27/2012      4   1   25.9%

*Newport Beach Endoscopy Center, LLC

  Newport Beach, CA     6/29/2007      2   2   39.5%

*Santa Monica Surgical Partners, L.L.C.

  Santa Monica, CA     11/1/2012      5   —     28.5%

*Surgicare of La Veta, Ltd., a California Limited Partnership

  Orange, CA     6/29/2007      5   1   20.0%

*Thousand Oaks Endoscopy Center, LLC

  Thousand Oaks, CA     6/29/2007      —     2   51.0%

*Upland Outpatient Surgical Center, L.P.

  Upland, CA     6/29/2007      2   1   92.8%

Sacramento Facilities

         

Fort Sutter Surgery Center, a California Limited Partnership (K. Street)

  Sacramento, CA     6/29/2007      3   3   29.0%

Fort Sutter Surgery Center, a California Limited Partnership (Scripps Drive)

  Sacramento, CA     6/29/2007      4   1   29.0%

Sacramento Surgery Center Associates, L.P.

  Sacramento, CA     1/1/2011      2   2   25.3%

South Placer Surgery Center, L.P.

  Roseville, CA     5/1/2012      2   1   25.0%

Sutter Alhambra Surgery Center, L.P.

  Sacramento, CA     6/29/2007      3   —     25.0%

 

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Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

San Diego Facilities

         

*Grossmont Surgery Center, L.P.

  La Mesa, CA     6/29/2007      3   2   21.6%

*Pomerado Outpatient Surgical Center, L.P.

  San Diego, CA     6/29/2007      4   1   60.8%

*San Diego Endoscopy Center

  San Diego, CA     6/29/2007      —     3   45.0%

UCSD Ambulatory Surgery Center, LLC

  San Diego, CA     11/30/2007      3   —     20.0%

San Francisco Facilities

         

East Bay Endoscopy Center, L.P.

  Emeryville, CA     7/1/2011      —     2   25.0%

Golden Gate Endoscopy Center, LLC

  San Francisco, CA     7/1/2011      —     3   25.0%

Marin Health Ventures, LLC

  Greenbrae, CA     8/1/2008      2   1   25.0%

Mountain View Endoscopy Center, LLC

  Mountain View, CA     7/1/2011      —     1   20.0%

Peninsula Eye Surgery Center, LLC

  Mountain View, CA     12/1/2012      2   —     25.0%

Presidio Surgery Center, LLC

  San Francisco, CA     6/29/2007      5   1   Managed-only

San Francisco Endoscopy Center LLC

  San Francisco, CA     7/1/2011      —     3   8.0%

Santa Rosa Surgery Center, L.P.

  Santa Rosa, CA     6/29/2007      4   1   25.6%

Sutter Street Endoscopy Center, LLC

  San Francisco, CA     7/1/2011      —     1   25.0%

Walnut Creek Endoscopy Center LLC

  Walnut Creek, CA     7/1/2011      —     2   25.0%

Other California Facilities

         

Auburn Surgical Center, L.P.

  Auburn, CA     6/29/2007      2   1   49.5%

*Bakersfield Physicians Plaza Surgical Center, L.P.

  Bakersfield, CA     6/29/2007      5   —     79.0%

Mirage Endoscopy Center, LP

  Rancho Mirage, CA     6/1/2013      —     1   Managed-only

North Coast Surgery Center, Ltd., a California Limited Partnership

  Oceanside, CA     6/29/2007      4   —     27.3%

Redding Surgery Center, LLC

  Redding, CA     10/1/2013      2   —     25.0%

San Luis Obispo Surgery Center, a California Limited Partnership

  San Luis Obispo, CA     6/29/2007      3   —     45.9%

Santa Barbara Endoscopy Center, LLC

  Santa Barbara, CA     7/1/2011      —     1   25.0%

*Santa Cruz Endoscopy Center, LLC

  Santa Cruz, CA     7/1/2011      —     1   40.0%

Colorado

         

Colorado Springs Health Partners Ambulatory Surgery Center

  Colorado Springs, CO     6/29/2007      5   —     Managed-only

Pueblo Ambulatory Surgery Center Limited Partnership

  Pubelo, CO     6/29/2007      5   —     12.3%

Surgery Center of Fort Collins, LLC

  Fort Collins, CO     6/29/2007      4   —     25.0%

Surgical Center at Premier, LLC

  Colorado Springs, CO     6/29/2007      5   2   38.0%

Connecticut

         

*Connecticut Surgery Center, Limited Partnership

  Hartford, CT     8/22/2007      2   1   65.0%

*Danbury Surgical Center, L.P.

  Danbury, CT     8/22/2007      4   2   46.5%

*Hartford Surgery Center, LLC

  Hartford, CT     8/22/2007      2   —     91.0%

Norwalk Surgery Center, LLC

  Norwalk, CT     6/1/2013      2   2   4.8%

*Surgery Center of Fairfield County, LLC

  Trumbull, CT     8/22/2007      4   2   38.0%

 

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Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

Florida

         

*Boca Raton Outpatient Surgery & Laser Center, LTD.

  Boca Raton, FL     6/29/2007      6   2   30.0%

*Citrus Regional Surgery Center, L.P.

  Lecanto, FL     6/29/2007      5   1   56.0%

*E Street Endoscopy, LLC

  Clearwater, FL     8/2/2010      1   2   51.0%

*Emerald Coast Surgery Center, L.P.

  Fort Walton Beach, FL     6/29/2007      5   3   35.0%

*Indian River Surgery Center, Ltd.

  Vero Beach, FL     6/29/2007      4   2   87.0%

*Melbourne Surgery Center, LLC

  Melbourne, FL     6/29/2007      4   1   69.3%

*Orlando Center for Outpatient Surgery, L.P.

  Orlando, FL     6/29/2007      4   1   55.3%

*Sarasota Endoscopy Center, L.P.

  Sarasota, FL     6/29/2007      1   2   82.1%

*The Brevard Specialty Surgery Center, LLC

  Melbourne, FL     10/1/2013      3   4   69.3%

*Winter Park Surgery Center, L.P.

  Winter Park, FL     6/29/2007      4   2   18.1%

Georgia

         

Atlanta Facilities

         

Atlanta Advanced Surgery Center, LLC

  Atlanta, GA     7/1/2012      5   2   Managed-only

*Perimeter Center for Outpatient Surgery, L.P.

  Atlanta, GA     6/29/2007      4   2   53.0%

Other Georgia Facilities

         

*Gainesville Surgery Center, L.P.

  Gainesville, GA     6/29/2007      4   3   42.6%

Gwinnett Advanced Surgery Center, LLC

  Snellville, GA     7/1/2012      3   1   Managed-only

Hawaii

         

*Aloha Surgical Center, L.P.

  Kahului, HI     6/29/2007      4   —     94.8%

Castle Ambulatory Surgery Center, LLC

  Kailua, HI     6/1/2013      2   2   10.0%

Honolulu Surgery Center, L.P.

  Honolulu, HI     6/29/2007      5   2   48.4%

Iowa

         

Mississippi Medical Plaza, L.C. (Endoscopy)

  Davenport, IA     6/1/2013      7   —     Managed-only

Mississippi Medical Plaza, L.C.

  Davenport, IA     6/1/2013      —     4   Managed-only

*Surgery Centers of Des Moines, Ltd., an Iowa Limited Partnership

  Des Moines, IA     6/29/2007      4   1   67.8%

*Surgery Centers of Des Moines, Ltd., an Iowa Limited Partnership (West)

  West Des Moines, IA     6/29/2007      10   —     67.8%

Tri-State Surgery Center, L.L.C.

  Dubuque, IA     6/1/2013      3   2   Managed-only

Idaho

         

*Treasure Valley Hospital Limited Partnership

  Boise, ID     6/29/2007      4   —     40.4%

Treasure Valley Surgery Center — Nampa, LP

  Nampa, ID     6/28/2012      5   —     25.2%

Illinois

         

Chicago Facilities

         

*Hawthorn Place Outpatient Surgery Center, L.P.

  Libertyville, IL     2/1/2008      3   1   38.0%

*Loyola Ambulatory Surgery Center at Oakbrook, L.P.

  Oakbrook Terrace, IL     2/1/2008      3   —     45.0%

*Northwest Surgicare, Ltd., an Illinois Limited Partnership

  Arlington Heights, IL     2/1/2008      5   1   57.0%

 

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Table of Contents

Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

Other Illinois Facilities

         

*Belleville Surgical Center, Ltd., an Illinois Limited Partnership

  Belleville, IL     2/1/2008      4   —     98.3%

*Joliet Surgery Center Limited Partnership

  Joliet, IL     11/1/2009      4   1   52.4%

Indiana

         

Indianapolis Facilities

         

Beltway Surgery Centers, L.L.C. — Glen Lehman Endoscopy Suite

  Indianapolis, IN     2/15/2012      —     8   24.5%

Beltway Surgery Centers, L.L.C. (BSC-GI)

  Indianapolis, IN     7/1/2011      4   4   24.5%

Beltway Surgery Centers, L.L.C. (BSC-MS)

  Indianapolis, IN     7/1/2011      8   1   24.8%

Beltway Surgery Centers, L.L.C. — Indiana Hand to Shoulder Beltway Surgery Center

  Indianapolis, IN     12/31/2012      3   1   24.8%

Eagle Highlands Surgery Center, LLC

  Indianapolis, IN     7/1/2011      7   —     24.7%

Eagle Highlands Surgery Center, LLC — Meridian South Surgery Center

  Indianapolis, IN     7/24/2013      4   —     24.7%

Indiana Endoscopy Centers, LLC (Avon)

  Avon, IN     7/1/2011      —     4   25.0%

Indiana Endoscopy Centers, LLC (Downtown)

  Indianapolis , IN     7/1/2011      —     4   25.0%

Indiana Endoscopy Centers, LLC (Fishers)

  Fishers, IN     7/1/2011      —     3   25.0%

Indiana University Health Saxony Surgery Center LLC

  Fishers, IN     3/5/2012      4   1   Managed-only

ROC Surgery LLC

  Indianapolis, IN     7/1/2011      6   —     28.5%

Senate Street Surgery Center, LLC

  Indianapolis, IN     7/1/2011      8   2   25.4%

Other Indiana Facility

         

Ball Outpatient Surgery Center, LLC

  Muncie, IN     7/1/2011      5   2   27.6%

Kansas

         

KU Medwest Ambulatory Surgery Center, L.L.C.

  Shawnee, KS     6/1/2013      3   1   Managed-only

Lawrence Surgery Center, L.L.C.

  Lawrence, KS     6/1/2013      4   —     Managed-only

Kentucky

         

Lexington Surgery Center, Ltd.

  Lexington, KY     6/29/2007      6   6   35.0%

Louisville S.C., Ltd.

  Louisville, KY     6/29/2007      4   1   29.9%

Owensboro Ambulatory Surgical Facility, Ltd.

  Owensboro, KY     6/29/2007      6   2   30.7%

Premier Surgery Center of Louisville, L.P.

  Louisville, KY     6/29/2007      4   4   25.0%

*Somerset Surgery Center, Limited Partnership

  Somerset, KY     6/29/2007      2   1   72.0%

Louisiana

         

*B.R.A.S.S. Partnership in Commendam

  Baton Rouge, LA     6/29/2007      4   1   56.4%

 

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Table of Contents

Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

Maryland

         

*Montgomery Surgery Center Limited Partnership

  Rockville, MD     6/29/2007      4   2   68.0%

Suburban Outpatient Surgery Center, LLC

  Bethesda, MD     7/1/2011      4   1   Managed-only

*The Surgery Center of Easton, L.P.

  Easton, MD     6/29/2007      1   1   67.0%

Minnesota

         

HealthEast Surgery Center-Maplewood, LLC

  Maplewood, MN     6/1/2013      4   —     10.0%

*St. Cloud Outpatient Surgery, Ltd., a Minnesota Limited Partnership

  St. Cloud, MN     6/29/2007      11   —     20.2%

*Surgicare of Minneapolis, Ltd., a Minnesota Limited Partnership

  Edina, MN     6/29/2007      3   —     59.5%

Missouri

         

South County Surgical Center, LLC

  St. Louis, MO     5/1/2009      2   2   27.6%

Mississippi

         

*Mississippi Surgical Center Limited Partnership

  Jackson, MS     7/1/2010      6   6   51.0%

*Surgicare of Jackson, Ltd., a Mississippi Limited Partnership

  Jackson, MS     6/29/2007      5   1   40.0%

Montana

         

*Northern Rockies Surgery Center, L.P.

  Billings, MT     6/29/2007      4   —     59.3%

Nebraska

         

Bergan Mercy Surgery Center, LLC

  Omaha, NE     6/1/2013      3   2   4.6%

Lakeside Ambulatory Surgical Center, LLC

  Omaha, NE     6/1/2013      4   1   Managed-only

Nebraska Spine Hospital, LLC

  Omaha, NE     6/1/2013      6   1   5.0%

New Jersey

         

Ambulatory Surgery Center at Virtua Washington Township LLC

  Sewell, NJ     6/1/2013      2   —     Managed-only

*East Brunswick Surgery Center, LLC

  East Brunswick, NJ     12/31/2013      4   1   51.0%

Memorial Ambulatory Surgery Center, LLC

  Mt. Holly, NJ     6/1/2013      4   1   Managed-only

South Jersey Musculoskeletal Institute LLC

  Sewell, NJ     6/1/2013      3   2   Managed-only

Summit Surgical Center LLC

  Voorhees, NJ     6/1/2013      7   3   Managed-only

*Surgical Center of South Jersey, Limited Partnership

  Mount Laurel, NJ     6/29/2007      4   2   88.2%

Vantage Surgical Center Associates, LLC.

  Medford, NJ     6/1/2013      3   1   Managed-only

Nevada

         

*The Surgical Center at Tenaya, L.P.

  Las Vegas, NV     6/29/2007      4   1   20.0%

 

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Table of Contents

Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

North Carolina

         

*Blue Ridge Day Surgery Center, L.P.

  Raleigh, NC     6/29/2007      6   1   45.5%

*Charlotte Surgery Center, Limited Partnership

  Charlotte, NC     6/29/2007      7   —     42.0%

*Fayetteville Ambulatory Surgery Center, L.P.

  Fayetteville, NC     6/29/2007      11   3   46.2%

Greensboro Specialty Surgery Center, LLC

  Greensboro, NC     6/29/2007      3   2   24.5%

*Surgical Center of Greensboro, LLC

  Greensboro, NC     6/29/2007      13   —     50.0%

*The Eye Surgery Center of the Carolinas, L.P.

  Southern Pines, NC     6/29/2007      3   1   50.0%

Ohio

         

Endoscopy Center West, LLC

  Cincinnati, OH     6/29/2007      —     2   20.0%

Middletown Surgery Center, LLC

  Franklin, OH     6/1/2013      2   2   Managed-only

OhioHealth Sleep Services, LLC

  Multiple Locations, OH     6/1/2013      N/A   N/A   Managed-only(4)

Polaris Surgery Center, LLC

  Westerville, OH     6/1/2013      4   1   Managed-only

Samaritan North Surgery Center, Ltd.

  Dayton, OH     6/1/2013      4   2   Managed-only

The Hand Center, LLC

  Columbus, OH     6/1/2013      2   —     Managed-only

Upper Arlington Surgery Center, Ltd.

  Columbus, OH     6/1/2013      6   1   Managed-only

Whitehall Surgery Center, Ltd.

  Columbus, OH     6/1/2013      4   2   Managed-only

Oklahoma

         

*Surgical Hospital of Oklahoma, L.L.C.

  Oklahoma City, OK     9/1/2009      7   —     60.0%

*Three Rivers Surgical Care, L.P.

  Muskogee, OK     6/29/2007      2   3   40.5%

Oregon

         

*McKenzie Surgery Center, L.P.

  Eugene, OR     6/29/2007      4   2   92.0%

*Salem Surgery Center, Ltd., an Oregon Limited Partnership

  Salem, OR     6/29/2007      5   —     71.0%

Pennsylvania

         

*Grandview Surgery Center, LTD.

  Camp Hill, PA     6/29/2007      4   2   20.0%

Lackawanna Physicians Ambulatory Surgery Center, LLC

  Dickson City, PA     12/31/2012      3   2   34.7%

*Mt. Pleasant Surgery Center, L.P.

  Mt. Pleasant, PA     6/29/2007      4   —     93.4%

*Paoli Surgery Center, L.P.

  Paoli, PA     6/29/2007      4   1   38.6%

Rhode Island

         

*Blackstone Valley Surgicare Acquisition, L.P.

  Johnston, RI     6/29/2007      5   2   93.0%

Rhode Island Hospital Surgery Center at Wayland Square

  Providence, RI     6/29/2007      3   1   Managed-only

South Carolina

         

*Charleston Surgery Center Limited Partnership

  North Charleston, SC     6/29/2007      4   2   58.4%

Tennessee

         

Memphis Surgery Center, LTD., L.P.

  Memphis, TN     6/29/2007      4   1   37.5%

*SCA Nashville Surgery Center, L.L.C.

  Nashville, TN     6/29/2007      5   1   60.0%

*Surgery Center of Clarksville, L.P.

  Clarksville, TN     6/29/2007      4   2   75.6%

 

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Facility

 

Location

  Date of
Acquisition
or
Affiliation(1)
    Capacity(2)
ORs
  Capacity(2)
PRs
  Our Beneficial
Ownership
Percentage(3)

Texas

         

Dallas / Fort Worth Facilities

         

*Cleburne Surgical Center, LLC

  Cleburne, TX     12/1/2013      2   1   25.0%(5)

*Denton Surgery Center, LLC

  Denton, TX     10/1/2012      3   2   35.0%(5)

Fort Worth Endoscopy Center (Southwest)

  Fort Worth, TX     8/17/2007      3   1   Managed-only

Fort Worth Endoscopy Center

  Fort Worth, TX     8/17/2007      2   1   Managed-only

*Greenville Surgery Center, LLC

  Dallas, TX     6/29/2007      4   1   39.4%(5)

*Surgical Caregivers of Fort Worth, LLC

  Fort Worth, TX     6/29/2007      7   2   25.0%(5)

*Texas Health Craig Ranch Surgery Center, LLC

  McKinney, TX     4/8/2013      5   1   32.3%(5)

*Texas Health Flower Mound Orthopedic Surgery Center, LLC

  Flower Mound, TX     9/25/2013      4   —     25.0%(5)

Other Texas Facilities

         

*Austin Center For Outpatient Surgery, L.P.

  Austin, TX     6/29/2007      5   2   58.0%

*Corpus Christi Endoscopy Center, L.L.P.

  Corpus Christi, TX     7/1/2011      2   3   19.5%

*Pasteur Plaza Surgery Center, L.P.

  San Antonio, TX     6/29/2007      3   1   66.6%

*SCA Houston Hospital for Specialized Surgery, L.P.

  Houston, TX     6/29/2007      6   2   50.0%

*Waco Surgical Center, Ltd.

  Waco, TX     6/29/2007      4   2   100.0%

Utah

         

*Salt Lake Surgical Center, L.P.

  Salt Lake City, UT     6/29/2007      7   —     91.3%

Wisconsin

         

Wausau Surgery Center, L.P.

  Wausau, WI     6/29/2007      4   1   26.0%

*Wauwatosa Surgery Center, Limited Partnership

  Wauwatosa, WI     6/29/2007      4   —     51.0%

Corporate Offices

 

Location

                 

Corporate Headquarters

  Deerfield, IL        

Operations Center

  Birmingham, AL        

 

* Indicates a consolidated facility. All other facilities are nonconsolidated, unless otherwise indicated that the facility is managed-only.
(1) Facilities noted as acquired on June 29, 2007, August 17, 2007, August 22, 2007, February 1, 2008 and November 1, 2009 were all acquired as part of the purchase of our company in 2007 by TPG and certain co-investors. The facilities that are listed as acquired after June 2007 were carved out of the initial acquisition closing, and were acquired upon completion of certain post-closing matters.
(2) Includes operating rooms (“ORs”) and procedure rooms (“PRs”) for ASCs and surgical hospitals.
(3) Many of our facilities are held through one or more intermediate holding companies. These intermediate holding companies are typically structured to be owned jointly with our partners, resulting in partial ownership of the intermediate holding company by us. The intermediate holding company itself typically only owns a portion of the facility, with the remaining portion owned by others, including our physician partners. Our beneficial ownership percentage presented in the table above represents our percentage of ownership in the facility as calculated by multiplying our percentage of ownership in the intermediate holding company by the intermediate holding company’s percentage of ownership in the facility.
(4) Represents one facility with eleven locations.

 

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(5) We do not currently hold an equity ownership interest in this facility, rather we hold a promissory note that is convertible into equity. The percentage represents what our beneficial ownership percentage will be upon conversion of the promissory note. Because this promissory note provides us with the power to direct the activities that most significantly impact the economic performance of this entity, we consolidate this facility into our financial results, as it meets the requirements to be a variable interest entity (“VIE”). See Note 3 “Summary of Significant Accounting Policies — Variable Interest Entities” of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further discussion.

We lease the majority of the facilities where our surgery centers and surgical hospitals conduct their operations from third parties. The terms of these leases generally range in length from three years up to ten years, and many of our leases contain options to extend the lease period, in some cases for up to an additional 15 years. In many cases, these leases are currently in the extension period. Various facility leases include provisions for rent escalation to recognize increased operating costs or require us to pay certain maintenance and utility costs. Certain leases contain annual escalation clauses based on changes in the Consumer Price Index, while others have fixed escalation terms. In addition, in the normal course of operations, several of our leases will be set to expire during any calendar year, and as of December 31, 2013, leases for 55 of our facilities are set to expire during the next three years. We do not expect difficulties in locating comparable facilities should we choose not to, or be otherwise unable to, extend one or more of our existing leases. Our leases do not typically provide for early termination rights in the absence of a tenant default.

Our corporate headquarters is located in Deerfield, Illinois at 520 Lake Cook Road, Suite 250, where we currently lease approximately 7,526 square feet of space. This lease expires in March 2017. In addition, certain of our corporate operational functions are located in Birmingham, Alabama at 3000 Riverchase Galleria, Suite 500, where we currently lease approximately 40,390 square feet of space. This lease expires in March 2015.

Acquisitions and Strategic Relationships

We pursue our growth strategy in the ASC and surgical hospital markets by making selective acquisitions of existing surgical facilities and groups of facilities. We actively seek opportunities where there are identifiable profit growth opportunities based on location, market dynamics and case mix, and where we can partner with committed physicians who are motivated to improve their facilities.

Our growth strategy includes entering into strategic relationships with hospitals and health systems. We believe that our core competencies in developing and operating outpatient surgery facilities are of value to major health systems attempting to retain their share of the outpatient surgery market. We also believe we offer hospitals and health systems an attractive alternative for expansion in ways that conserve capital, create investment vehicles for existing medical staff and provide a low-risk entry into new markets.

Marketing

Our sales and marketing efforts are directed primarily at physicians, who are principally responsible for referring patients to our facilities. We market our facilities to physicians by emphasizing (1) the high level of patient satisfaction with our surgery centers, which is based on patient surveys that we administer concerning our affiliated facilities, (2) the quality and responsiveness of our services and (3) the practice efficiencies provided by our facilities. In those U.S. markets in which we have partnered with a healthcare system, we coordinate the marketing effort with the healthcare system and generally benefit from this strategy. We and our health system partners also directly negotiate agreements with third-party payors, which generally focus on the pricing, number of facilities in the market and affiliation with physician groups in a particular market.

Competition

In each of our markets we face competition from other providers of ambulatory surgical care in developing ASC and surgical hospital joint ventures, acquiring existing facilities, attracting patients and negotiating commercial payor contract pricing. We believe we are the third largest ASC operator in the United States, based

 

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on the number of ASCs and surgical hospitals operated. United Surgical Partners, Inc., AmSurg Corp., HCA Healthcare Corporation, Symbion, Inc. and Surgery Partners are the largest national ASC operators. However, due to industry fragmentation, we commonly compete for business with hospitals partnering with physicians or with local physician groups who develop independent ASCs without a corporate partner, including those who use consultants to perform management services for a fee without an ongoing equity interest. We believe we compete effectively because of our size, quality of our management services, experience and reputation for providing quality care.

We often compete with other healthcare providers that provide outpatient procedures. In particular, we compete with the outpatient departments of acute care hospitals, which often perform the same procedures as we do in our freestanding facilities. We believe that, in comparison to acute care hospitals, our surgery centers and surgical hospitals compete favorably on the basis of cost, quality, efficiency and responsiveness to physician needs in a more comfortable and convenient environment for the patient. To a lesser, but growing, extent, we also face competition from physicians performing less complex outpatient procedures, such as pain management and certain gastrointestinal procedures, in their own offices.

Teammates

As of December 31, 2013, we employed approximately 5,000 full-time equivalent teammates, working in all of our affiliated facilities. While each facility varies depending on its size, case volume and case types, we employ an average of approximately 30 full-time equivalent teammates at our ASCs, and an average of approximately 71 full-time equivalent teammates at our surgical hospitals. While we provide “full-time equivalent” information, a number of our teammates work on flexible schedules rather than full-time, which increases our staffing efficiency. As a result, these teammates also do not participate in our benefits structure, which we believe reduces the relative cost of our benefits plans to us.

With the exception of one anesthesiologist, we do not employ the physicians who affiliate with us and use our affiliated facilities. However, we generally offer certain physicians the opportunity to purchase equity interests in the facilities they use. None of our teammates is represented by a collective bargaining agreement.

Regulatory Compliance Program

It is our policy to conduct our business with integrity and in compliance with the law. We have in place and continue to enhance a company-wide compliance program that focuses on all areas of regulatory compliance, including billing, reimbursement, cost reporting practices and contractual arrangements with referral sources.

This regulatory compliance program is intended to help ensure that high standards of conduct are maintained in the operation of our business and that policies and procedures are implemented so that teammates act in full compliance with all applicable laws, regulations and company policies. Under the regulatory compliance program, every teammate and certain contractors involved in patient care and coding and billing receive initial and periodic legal compliance and ethics training. In addition, we regularly monitor our ongoing compliance efforts and develop and implement policies and procedures designed to foster compliance with the law. The program also includes a mechanism for teammates to report, without fear of retaliation, any suspected legal or ethical violations to their supervisors, designated compliance officers in our facilities, our compliance hotline or directly to our compliance officer. We believe our compliance program is consistent with standard industry practices. However, we cannot provide any assurances that our compliance program will detect all violations of law or protect against qui tam suits or government enforcement actions.

Government Regulation

The healthcare industry is subject to extensive regulation by federal, state and local governments. Government regulation affects our business by controlling growth, requiring licensing or certification of facilities, regulating how facilities are used and controlling payment for services provided. Our ability to conduct

 

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our business and to operate profitably will depend in part upon obtaining and maintaining all necessary licenses, certificates of need and other approvals, and complying with applicable healthcare laws and regulations. See “Risk Factors — Risks Related To Healthcare Regulation.”

Licensure, Accreditation and Certificate of Need Regulations

Our facilities are also subject to state and local licensing requirements ranging from the quality of care to compliance with building codes and environmental protection laws. Governmental and other authorities periodically inspect our facilities to assure continued compliance with these regulations. Failure to comply with these regulations could result in the suspension or revocation of a facility’s license or other penalties.

In addition, as of December 31, 2013, 165 of our 171 ASCs and all five of our surgical hospitals were accredited by either The Joint Commission or the AAAHC, the two major national organizations that establish standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of various types of healthcare facilities. Five of our six remaining ASCs that were not accredited as of December 31, 2013 plan to apply for accreditation in the near future. These accredited facilities are subject to periodic surveys by the accrediting body to ensure that they are in compliance with the applicable standards. Generally, our healthcare facilities must be in operation for at least six months before they are eligible for accreditation. Many commercial payors require our facilities to be accredited in order to be a participating provider under their health plans.

Capital expenditures for the construction of new facilities, the addition of capacity or the acquisition, relocation, change of ownership or change of control of existing facilities may be reviewable by state regulators under certificate of need (“CON”) laws. A CON is a permit issued by a state health planning authority evidencing the authority’s opinion that a proposed facility or expansion is consistent with the need for the services to be offered by the facility. States with CON laws often place limits on the number of facilities or operating rooms in a region, or restrict providers’ ability to build, relocate, expand or change the ownership control of healthcare facilities and services. In some states, approvals are required for capital expenditures exceeding certain specified amounts or involving certain facilities or services, including ASCs and surgical hospitals. As of December 31, 2013, we operated in 16 states with CON laws, and in two such states our facilities were exempt from the CON laws.

Medicare and Medicaid Programs

Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are age sixty-five years or older or who are disabled. Medicare prospectively determines fixed payment amounts for procedures performed at ASCs and updates these amounts annually. These amounts are adjusted for regional wage variations. For the years-ended December 31, 2013, 2012 and 2011, approximately 20%, 21% and 20%, respectively, of our net patient revenues were attributable to Medicare payments.

To participate in the Medicare program and receive Medicare payments, our facilities must comply with regulations promulgated by CMS. Among other things, these regulations, known as “conditions for coverage” for ASCs and “conditions of participation” for hospitals, set forth requirements relating to the facility’s equipment, personnel, policies, standards of medical care and compliance with state and local laws and regulations. All of our ASCs and surgical hospitals are certified in the Medicare program and are subject to on-site, unannounced surveys by state survey agencies working on behalf of CMS. The frequency of on-site ASC surveys by state survey agencies has increased in recent years. Failure to comply with Medicare’s conditions for coverage and conditions of participation may result in loss of payment or other governmental sanctions, including termination of participation in the Medicare program. We have established ongoing quality assurance activities to monitor our facilities’ compliance with these conditions.

Medicaid is a health insurance program jointly funded by state and federal governments that provides medical assistance to qualifying low-income persons. Each state Medicaid program has the option to provide payment for

 

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ASC services. All of the states in which we currently operate provide Medicaid coverage for some ASC services; however, these states may elect to discontinue covering services, and states into which we expand our operations may not cover or continue to cover surgery center services. Medicaid programs pay us a fixed payment for our services, and the amounts paid vary state to state. For the years-ended December 31, 2013, 2012 and 2011, approximately 3%, 3% and 4%, respectively, of our net patient revenues were attributable to Medicaid payments.

Health Reform Initiatives

There have been numerous legislative and regulatory initiatives on the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services. Most notably, the PPACA, as amended by the Health Care and Education Affordability Reconciliation Act of 2010 (collectively, the “Health Reform Law”), was enacted in March 2010 and represents significant change for the healthcare industry.

The Health Reform Law includes provisions designed to change how healthcare services are covered, delivered and reimbursed through, among other things, expanded coverage of uninsured individuals, reduced growth in Medicare program spending and the establishment of programs where reimbursement is tied to quality. The Health Reform Law also reforms certain aspects of health insurance, expands existing efforts to tie Medicare and Medicaid payments to performance and quality and contains provisions intended to strengthen fraud and abuse enforcement. The Health Reform Law includes a number of reforms that will directly affect our facilities, including, without limitation, the reforms summarized below.

Based on the Congressional Budget Office’s February 2014 projection, the Health Reform Law will expand health insurance coverage to approximately 25 million individuals currently lacking coverage by 2024. The primary public program through which the Health Reform Law will expand coverage of uninsured individuals is Medicaid. The most significant changes will expand the categories of individuals eligible for Medicaid coverage and permit individuals with relatively higher incomes to qualify. The Health Reform Law requires all state Medicaid programs to provide, and the Federal government to subsidize, Medicaid coverage to virtually all adults under 65 years old with incomes at or under 133% of the federal poverty level. The Health Reform Law also requires states to apply a “5% income disregard” to the Medicaid eligibility standard such that Medicaid eligibility will effectively be extended to those with incomes up to 138% of the federal poverty level. However, while the United States Supreme Court (the “Supreme Court”) upheld the constitutionality of key provisions of the Health Reform Law in June 2012, the Court declared unconstitutional provisions that would have allowed the U.S. Department of Health and Human Services (“HHS”) to penalize states that do not implement the Medicaid expansion provisions of the law with the loss of existing federal Medicaid funding. As a result, some states have chosen not to implement the Medicaid expansion, and fewer individuals will be covered by a state Medicaid program than would have been covered had the Supreme Court upheld the Health Reform Law in its entirety.

In the private sector, the Health Reform Law will expand health insurance coverage through a range of requirements applicable to health insurers, employers and individuals. For example, as of January 1, 2014, health insurers are prohibited from imposing annual coverage limits, dropping coverage, excluding individuals on the basis of pre-existing conditions or denying coverage for any individual who is willing to pay the premiums for such coverage. In addition, certain larger employers that do not offer health insurance benefits to their employees will be required to make “shared responsibility payments” if an employee obtains government-subsidized coverage through the Health Insurance Marketplace. The Health Reform Law also requires individuals to maintain health insurance for a minimum defined set of benefits or pay a tax penalty, subject to certain exceptions. Individuals must have obtained health insurance coverage by March 31, 2014, in order to avoid tax penalties. To facilitate the purchase of health insurance, the Health Reform Law provides for the establishment of the Health Insurance Marketplace, a system of state and federal health insurance exchanges through which qualified health insurance coverage may be obtained.

Aside from the expansion of health insurance coverage, the Health Reform Law provides for reductions in Medicare, Medicaid and other federal healthcare program spending. The Health Reform Law includes a

 

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provision requiring CMS to apply a negative productivity adjustment to the indexes used to update Medicare payment rates on an annual basis. The productivity adjustment is equal to the 10-year moving average of changes in the annual economy-wide private nonfarm business multi-factor productivity measure, as reported by the Bureau of Labor Statistics each year. Hospital and ASC services were subject to this productivity adjustment starting in calendar year 2011. The practical impact of the productivity adjustment for hospital and ASC services is to reduce the amount of annual rate increases from Medicare, potentially to an amount below zero (that is, the index-based increase may be outweighed by the productivity adjustment and as a result reimbursement rates would decline). In addition to the productivity adjustment, for our surgical hospitals, the Health Reform Law requires a downward adjustment for each of the following federal fiscal years as follows: 0.3% in 2014; 0.2% in 2015 and 2016; and 0.75% in 2017, 2018 and 2019.

Additionally, pursuant to the Health Reform Law, HHS submitted a report to Congress in 2011 outlining HHS’s plan to implement a value-based purchasing program for ASCs. While the report describes efforts to improve quality and payment efficiency in ASCs and examines the steps required to design and implement an ASC value-based purchasing program, Congress has not yet authorized CMS to implement such a program. However, CMS has implemented a value-based purchasing program for inpatient hospital services, pursuant to which hospitals that meet or exceed specified quality performance standards will receive greater reimbursement than they would have otherwise and hospitals that do not meet the standards will receive reduced payments. The Health Reform Law also provides for other quality-based payment adjustments for inpatient hospital services, including reductions for “excess readmissions” to hospitals for certain conditions designated by CMS and reductions for hospitals with high rates of conditions acquired by patients while admitted as hospital inpatients.

The Health Reform Law established a new Independent Payment Advisory Board, which, if a Medicare per capita target growth rate is exceeded, will develop and submit proposals for a Medicare spending reduction to the President and Congress beginning in 2014 for implementation in 2015. This Board would have the authority to reduce Medicare payments to certain providers, including ASCs. In addition, the Board is precluded from submitting proposals that reduce Medicare payments prior to December 31, 2019 for providers scheduled to receive a reduction in their payment updates as a result of the Medicare productivity adjustment, which currently includes our facilities.

The Health Reform Law also makes several significant changes to healthcare fraud and abuse laws, provides additional enforcement tools to the government, increases cooperation between agencies by establishing mechanisms for the sharing of information and enhances criminal and administrative penalties for non-compliance. Among other things, the Health Reform Law provides for increased federal funding for healthcare fraud and abuse enforcement activities, expands the scope of the Recovery Audit Contractor (“RAC”) program and expands liability under the False Claims Act (the “FCA”) for failure to timely repay identified overpayments made by governmental healthcare programs.

The extent to which expanded coverage and associated reimbursement may or may not offset other impacts of the Health Reform Law on our results is not clear at this time. We believe healthcare reform initiatives will continue to develop during the foreseeable future. If adopted, some aspects of previously proposed reforms, such as further reductions in Medicare or Medicaid payments, or additional prohibitions on physicians’ financial relationships with facilities to which they refer patients, could adversely affect us in a material way.

Federal Anti-Kickback Statute

State and federal laws regulate relationships among providers of healthcare services, including employment or service contracts and investment relationships. These restrictions include a federal criminal law, referred to as the Anti-Kickback Statute, which prohibits knowingly and willfully offering, paying, soliciting or receiving any form of remuneration in return for:

 

    referring patients for services or items payable under a federal healthcare program, including Medicare or Medicaid, or

 

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    purchasing, leasing, ordering, or arranging for or recommending purchasing, leasing or ordering, any good, facility, service or item for which payment may be made in whole or in part by a federal healthcare program.

Violations of the Anti-Kickback Statute may be punished by a criminal fine of up to $25,000 for each violation or imprisonment, civil money penalties of up to $50,000 per violation and damages of up to three times the total amount of the remuneration and/or exclusion from participation in federal healthcare programs, including Medicare and Medicaid. The Health Reform Law provides that submission of a claim for services or items generated in violation of the Anti-Kickback Statute constitutes a false or fraudulent claim and may be subject to additional penalties under the FCA.

The Anti-Kickback Statute is broad in scope and the applicability of its provisions to many business transactions in the healthcare industry has not yet been subject to judicial or regulatory interpretation. The method by which investors are selected and bought out, the pricing of the issuance and redemption of partnership or LLC units to or from referring physicians and all of our other financial dealings with physicians are subject to regulation by the Anti-Kickback Statute. Courts have found a violation of the Anti-Kickback Statute if just one purpose of the remuneration is to generate referrals, even if there are other lawful purposes. Furthermore, the Health Reform Law provides that knowledge of the law or intent to violate the law is not required to establish a violation of the Anti-Kickback Statute.

The Federal government pays particular attention to joint ventures and other transactions among healthcare providers, particularly joint ventures involving physicians and other referral sources. In 1989, the Office of Inspector General (“OIG”), published a fraud alert that outlined questionable features of “suspect” joint ventures, and the OIG has continued to refer to those fraud alerts in later pronouncements. The OIG has also published regulations containing numerous “safe harbors” that exempt some practices from enforcement under the Anti-Kickback Statute. These safe harbor regulations, if fully complied with, assure participants in particular types of arrangements that the OIG will not treat their participation as a violation of the Anti-Kickback Statute. The safe harbor regulations do not expand the scope of activities that the Anti-Kickback Statute prohibits, nor do they provide that failure to satisfy the terms of a safe harbor constitutes a violation of the Anti-Kickback Statute. The OIG has, however, indicated that failure to satisfy the terms of a safe harbor may subject an arrangement to increased scrutiny.

The OIG has promulgated a safe harbor applicable to ASCs. The ASC safe harbor generally protects ownership or investment interests in a center by physicians who are in a position to refer patients directly to the center and perform procedures at the center on referred patients, if certain conditions are met. More specifically, the ASC safe harbor protects any payment that is a return on an ownership or investment interest to an investor if certain standards are met in one of four categories of ASCs: (1) surgeon-owned surgery centers; (2) single-specialty surgery centers; (3) multi-specialty surgery centers; and (4) hospital/physician surgery centers.

Surgeon-owned surgery centers are those in which all of the physician investors are either general surgeons or surgeons engaged in the same surgical specialty. Single-specialty surgery centers are those in which all of the physician investors — who do not need to be surgeons but who must perform procedures — are engaged in the same medical practice specialty. A gastroenterologist is an example of a physician who is not a surgeon but who performs procedures; an ASC owned exclusively by gastroenterologists and which accepts only gastroenterology procedures is an example of a single-specialty surgery center. Multi-specialty surgery centers may include a mix of physicians (surgeons and non-surgeons) in different specialties. Hospital/physician surgery centers must include at least one hospital investor.

Although the ASC safe harbor sets forth four separate categories, many of the same standards apply to each category. For example, in each case, no ownership interests may be held by a non-physician or non-hospital investor if that investor is (1) employed by the center or another investor, (2) in a position to provide items or services to the center or any of its other investors, or (3) in a position to make or influence referrals directly or indirectly to the center or any of its investors. In addition, in the case of surgeon-owned, single-specialty, and

 

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multi-specialty surgery centers, at least one-third of each physician investor’s medical practice income from all sources for the previous fiscal year or twelve-month period must be derived from performing outpatient procedures on the list of Medicare covered procedures for ASCs. For multi-specialty surgery centers, the safe harbor also requires that at least one-third of the Medicare-eligible outpatient surgery procedures performed by each physician investor for the previous fiscal year or twelve-month period must be performed at the surgery center in which the investment is made. For hospital/physician surgery centers, the safe harbor includes standards prohibiting the hospital investor and the center from sharing space and equipment except in certain instances, prohibiting the hospital investor from including costs associated with the center on the hospital’s cost report, and prohibiting the hospital from being in a position to make or influence referrals to the center or to any other investor in the center.

Entities that own facilities which provide services under the Medicare and Medicaid programs, and their respective physician partners and members, are subject to the Anti-Kickback Statute. In cases where one of our subsidiaries is an investor in the partnership or LLC that owns the facility, and we or our subsidiary provides management and other services to the facility, our arrangements with physician investors do not meet all of the specific terms of the ASC safe harbor or any other safe harbor. See “Risk Factors — Risks Related to Healthcare Regulation — Our surgical facilities do not satisfy the requirements for any of the safe harbors under the Anti-Kickback Statute. If we fail to comply with the Anti-Kickback Statute, we could be subject to criminal and civil penalties, loss of licenses and exclusion from governmental programs, which may result in a substantial loss of revenues.”

However, we believe that our operations do not violate the Anti-Kickback Statute. Moreover, we strive to ensure that our management services, lease agreements and other agreements with facilities are consistent with our standards for documented fair market value for services and space provided to or received from the facilities or the physician partners at the facilities.

Federal Physician Self-Referral Law

Section 1877 of the Social Security Act, the federal physician self-referral law commonly referred to as the Stark Law, prohibits any physician from referring patients to any entity for the furnishing of certain “designated health services” otherwise payable by Medicare or Medicaid, if the physician or an immediate family member has a financial relationship with the entity, unless an exception applies. The Stark Law also prohibits entities that provide designated health services otherwise payable by Medicare or Medicaid from billing the Medicare and Medicaid programs for any items or services that result from a prohibited referral and requires the entities to refund amounts received for items or services provided pursuant to the prohibited referral. As defined by the Stark Law, the term “financial relationship” includes both ownership (or investment) interests and compensation arrangements. Unlike safe harbors under the Anti-Kickback Statute with which compliance is voluntary, a financial relationship must comply with every requirement of a Stark Law exception in order to not violate the Stark Law. Persons who violate the Stark Law are subject to potential civil money penalties of up to $15,000 for each bill or claim submitted in violation of the Stark Law and up to $100,000 for each “circumvention scheme” they are found to have entered into, and potential exclusion from the Medicare and Medicaid programs. In addition, the Stark Law requires the denial (or refund, as the case may be) of any Medicare and Medicaid payments received for designated health services that result from a prohibited referral.

CMS has promulgated regulations to implement the Stark Law. Under these regulations, services provided by an ASC that would otherwise constitute “designated health services” are excluded from the definition of that term if the services are reimbursed by Medicare as part of the ASC’s composite payment rate. All services provided by our ASCs that would otherwise constitute designated health services are reimbursed by Medicare as part of the composite payment rate and are thus excepted from the Stark Law, with the exception of implants. The Stark Law provides for a special exception for implants, such as intraocular lenses and artificial joints, furnished in ASCs as long as certain regulatory requirements are met. These requirements provide that the implant must be implanted by the referring physician or a member of his or her group practice, that the implant be implanted during a surgical procedure reimbursed as an ASC procedure by Medicare, that the arrangement for

 

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the furnishing of the implant not violate the Anti-Kickback Statute and that the billing for the implant be conducted legally. We believe the operations of our ASCs comply with these requirements and, consequently, that the Stark Law generally does not apply to services provided by our ASCs. See “Risk Factors — Risks Related to Healthcare Regulation — If we fail to comply with physician self-referral laws as they are currently interpreted or may be interpreted in the future, or if other legislative restrictions are issued, we could incur substantial monetary penalties and a significant loss of revenues.”

As of December 31, 2013, five of our facilities were surgical hospitals. The Stark Law includes an exception that permits physicians to refer Medicare and Medicaid patients to hospitals in which they have an ownership interest if certain requirements are met. The Health Reform Law dramatically curtailed this exception and prohibits physician ownership in hospitals that did not have a Medicare provider agreement by December 31, 2010. This prohibition does not apply to our five surgical hospitals, each of which had a Medicare provider agreement prior to December 31, 2010 and are therefore able to continue operating with their existing ownership structure in compliance with the applicable exception. However, the law prohibits “grandfathered” hospitals from increasing the percentage of physician ownership, and the law limits to a certain extent their ability to grow because it prohibits such hospitals from increasing the aggregate number of inpatient beds, operating rooms and procedure rooms. In addition, the new law required all our surgical hospitals with physician owners to adopt certain measures addressing potential conflicts of interest, ensuring that physician investments are bona fide and relating to patient safety. We believe our facilities are in compliance with such requirements, but even the assertion of a violation of the Stark Law could have a material adverse effect upon us.

False and Other Improper Claims

The Federal government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for payment from the Medicare or Medicaid programs. False claims filed with private insurers can also lead to criminal and civil penalties. While the criminal statutes are generally reserved for instances of fraudulent intent, the government applies criminal, civil and administrative penalty statutes to a range of circumstances, including coding errors, billing for services not provided, billing for services that are not medically necessary, improperly classifying the level of care provided, submitting false cost reports and submitting claims resulting from arrangements prohibited by the Stark Law or the Anti-Kickback Statute. Over the past decade or more, the government has accused an increasing number of healthcare providers of violating the FCA, which prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the United States. The statute defines “knowingly” to include not only actual knowledge of a claim’s falsity, but also reckless disregard for or intentional ignorance of the truth or falsity of a claim. Violations of the FCA can result in awards of treble damages and significant per claim penalties.

Also, under the “qui tam” provisions of the FCA, private parties (“relators” or “whistleblowers”) may bring actions against providers on behalf of the Federal government. Such private parties are entitled to share in any amounts recovered by the government through trial or settlement. Qui tam cases are sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the Federal government and the presiding court.

Both direct enforcement activity by the government and whistleblower lawsuits under the FCA have increased significantly in recent years and have increased the risk of healthcare companies like us having to defend a false claims action, repay claims paid by the government, pay fines or be excluded from the Medicare and Medicaid programs. In addition, under the Health Reform Law, if we receive an overpayment, we must report and refund the overpayments before the later of 60 days after the overpayment was identified or the date any corresponding cost report is due, if applicable. Any overpayment that is retained after this deadline is considered an obligation subject to an action under the FCA.

Although we believe that our operations materially comply with federal and state laws, they may nevertheless be the subject of a whistleblower lawsuit, or may otherwise be challenged or scrutinized by governmental authorities. See “Risk Factors — Risks Related to Healthcare Regulation — Companies within the

 

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healthcare industry continue to be the subject of federal and state audits and investigations, and we may be subject to such audits and investigations, including actions for false and other improper claims.”

State Anti-Kickback, Physician Self-Referral and False Claims Laws

Many states, including those in which we do business, have laws that prohibit payment of kickbacks or other remuneration in return for the referral of patients. Some of these laws apply only to services reimbursable under state Medicaid programs. In most states, these laws have not been subjected to significant judicial and regulatory interpretation. Noncompliance with these laws could subject us to penalties and sanctions and have a material adverse effect on us. However, we believe that our operations are in material compliance with the physician self-referral laws of the states in which our facilities are located.

A number of states, including some of those in which we do business, have their own laws prohibiting the submission of false claims. These laws may be modeled on the FCA and contain qui tam provisions. Some state false claims acts can involve broader liability in terms of the costs that losing defendants must pay or the types of claims that are subject to the act.

Healthcare Industry Investigations and Audits

Federal and state government agencies have increased their civil and criminal enforcement efforts in the healthcare industry. For example, the Health Reform Law includes additional federal funding of $350 million to fight healthcare fraud, waste and abuse. Investigations by government agencies have addressed a wide variety of issues, including billing practices and financial arrangements with referral sources. In addition, the OIG and the U.S. Department of Justice (“DOJ”) have, from time to time, established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. An investigation of our facilities could result in significant costs, liabilities and penalties, as well as adverse publicity.

In addition, government agencies and their agents may conduct audits of the operations of our facilities. Under the RAC program, CMS contracts with RACs on a contingency basis to conduct post-payment reviews to detect and correct improper Medicare payments. The Health Reform Law expanded the scope of the RAC program to include Medicaid claims by requiring all states to enter into contracts with RACs to audit payments to Medicaid providers. In addition to RACs, other contractors, such as Medicare Administrative Contractors and Medicaid Integrity Contractors (“MICs”), perform payment audits to identify and correct improper payments.

Health Information Privacy and Security Practices

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) contains provisions that require covered entities, including most healthcare providers, to employ systems and procedures designed to protect individually identifiable health information, known as “protected health information.” Pursuant to HIPAA, HHS has promulgated privacy and security regulations that extensively regulate the use and disclosure of protected health information and require covered entities to implement administrative, physical and technical safeguards to protect the security of such information. The American Recovery and Reinvestment Act of 2009, as amended (“ARRA”), contains provisions that broaden the scope of the HIPAA privacy and security regulations and strengthen HIPAA’s enforcement provisions. As covered entities under HIPAA, both we and our facilities are required to comply with rules governing the use and disclosure of protected health information and to impose those rules, by contract, on any business associate to which such information is disclosed. In other relationships, such as when we provide management or consulting services to another covered entity, we are subject to the rules applicable under HIPAA and ARRA to business associates. Pursuant to a rule issued to implement ARRA, business associates and their subcontractors are subject to direct liability under the HIPAA privacy and security regulations. In addition, a covered entity may be subject to penalties as a result of its business associate violating the HIPAA privacy and regulations if the business associate is found to be an agent of the covered entity.

 

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As required by ARRA, covered entities must report breaches of unsecured protected health information to affected individuals without unreasonable delay and in no case later than 60 days after the discovery of the breach by the covered entity or its agents. Notification must also be made to HHS and, in certain situations involving large breaches, to the media. HHS is required to publish on its website a list of all covered entities that report a breach involving more than 500 individuals. Pursuant to a rule issued to implement ARRA, HHS has created a presumption that all non-permitted uses or disclosures of unsecured protected health information are breaches unless the covered entity or business associate establishes that there is a low probability the information has been compromised. Various state laws and regulations may also require us to notify affected individuals in the event of a data breach involving individually identifiable information.

Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties. ARRA increased the amount of civil penalties for HIPAA violations, with penalties now ranging up to $50,000 per violation and a maximum civil penalty of $1.5 million in a calendar year for violations of the same requirement. In addition, ARRA authorizes state attorneys general to bring civil actions seeking either injunction or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents.

States may impose more protective privacy and security laws, and both state and federal laws are subject to modification or enhancement of privacy and security protection at any time. Our facilities will continue to remain subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These statutes vary and could impose additional requirements on us and more severe penalties for breaches of privacy.

HIPAA Transactions and Code Sets Standards

HIPAA and its implementing regulations establish electronic data transmission standards that all healthcare providers must use for certain electronic healthcare transactions, such as submitting claims for payment for medical services. The Health Reform Law requires the adoption of standards for additional electronic transactions and provides for the creation of operating rules to promote uniformity in the implementation of each standardized electronic transaction. Under HIPAA, HHS has also published a final rule requiring the use or updated standard code sets for certain diagnoses and procedures known as ICD-10 code sets. Use of the ICD-10 code sets is required beginning October 1, 2014. It is possible that our facilities could experience disruptions or delays in payment due to the implementation of new electronic data transmission standards and the transition to ICD-10 code sets.

Federal Emergency Medical Treatment and Active Labor Act

The Federal Emergency Medical Treatment and Active Labor Act (“EMTALA”) applies to our five surgical hospitals. EMTALA requires hospitals participating in the Medicare program, including those without emergency rooms, to evaluate individuals who present with emergencies, provide initial stabilizing treatment and refer or transfer patients where appropriate. Possible liability for a violation of EMTALA includes a civil action by the patient as well as civil monetary penalties and exclusion from participation in the Medicare program.

Antitrust Laws

The Federal government and most states have enacted antitrust laws that prohibit certain types of conduct deemed to be anti-competitive. These laws prohibit price fixing, concerted refusal to deal, market monopolization, price discrimination, tying arrangements, acquisitions of competitors and other practices that have, or may have, an adverse effect on competition. Violations of federal or state antitrust laws can result in various sanctions, including criminal and civil penalties. Antitrust enforcement in the healthcare industry is currently a priority of the Federal Trade Commission (the “FTC”).

Some of our operating activities are subject to regulation by the antitrust laws. For example, the exchange of pricing information in connection with the creation of a joint venture or an acquisition, the formation of joint

 

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ventures with large health systems and the negotiation of our commercial payor contracts by our health system partners are all regulated by the antitrust laws. We undertake to conduct all of our business operations in compliance with these laws. The DOJ and the FTC, the two agencies charged with enforcing the federal antitrust laws, have promulgated a series of “Statements of Antitrust Enforcement Policy in Health Care.” These statements provide a series of “safety zones.” A “safety zone” describes conduct that the FTC and the DOJ will not challenge under the antitrust laws, absent extraordinary circumstances. Our activities do not necessarily fall within any of these safety zones. Nevertheless, we believe that our operations are in compliance with the antitrust laws, but courts or regulatory authorities may reach a contrary conclusion, and such a conclusion could adversely affect our operations.

Utilization Review

Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients meet professionally recognized standards and are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admission of Medicare and Medicaid patients must be reviewed by quality improvement organizations, which review the appropriateness of Medicare and Medicaid patient admissions and discharges, the quality of care provided, the validity of diagnosis related group classifications and the appropriateness of cases of extraordinary length of stay or cost. Quality improvement organizations may deny payment for services provided or assess fines and also have the authority to recommend to HHS that a provider which is in substantial noncompliance with the standards of the quality improvement organization be excluded from participation in the Medicare program.

Reimbursement

Medicare — Ambulatory Surgical Centers

Medicare establishes reimbursement methodologies for various types of healthcare facilities and services. These methodologies have historically been subject to periodic revisions that can have a substantial impact on existing healthcare providers. In accordance with authorization from Congress, CMS makes annual upward or downward adjustments to Medicare payment rates in most areas. These adjustments can result in decreases in actual dollars per procedure or a freeze in reimbursement despite increases in costs.

CMS reimburses providers for outpatient surgery performed in an ASC a prospectively determined rate for covered procedures. The standard payment rate for ASC-covered surgical procedures is calculated as the product of an ASC “conversion factor” and the ASC “relative payment weight” for each separately payable procedure or service. Subject to certain exclusions, covered surgical procedures in an ASC are surgical procedures that are separately paid under the Hospital Outpatient Prospective Payment System (“OPPS”) that would not be expected to pose a significant risk to safety when performed in an ASC, and that would not be expected to require overnight stay. Payment for ancillary items and services are packaged into ASC payment for a covered surgical procedure. The lists of, and payment rates for, covered surgical procedures and ancillary services in ASCs are updated in conjunction with the annual proposed and final rulemaking process to update the OPPS and ASC payment system. The Medicare and Medicaid programs are 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 surgery centers. Further, the Health Reform Law introduced new limitations on the increase in the index by which ASC rates are annually adjusted. See “— Government Regulation — Health Reform Initiatives.” For calendar year 2014, Medicare payments for ASC services are to be increased by 1.2% as compared to the prior year, reflecting a 1.7% increase based on the consumer price index and a negative 0.5% productivity adjustment.

CMS has implemented a quality data reporting program for ASCs, known as the ASC Quality Reporting Program. Beginning in October 2012, CMS required ASCs to report on five quality measures. Each year CMS has added to the reporting requirement, with two additional quality measures effective January 2013, and three

 

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additional quality measures effective January 2014. We have implemented procedures at our ASCs to comply with these requirements. Failure to report quality data according to CMS requirements may result in a reduction of the Medicare payment rates in subsequent years.

Medicare — Surgical Hospitals

As of December 31, 2013, five of our facilities are licensed as hospitals and receive reimbursement from Medicare for inpatient services under Medicare’s Inpatient Prospective Payment System, under which a hospital receives a fixed amount as reimbursement for inpatient hospital services based on each patient’s final assigned Medicare severity diagnosis-related group (“MS-DRG”). Our surgical hospitals generally focus on performing outpatient procedures and perform a relatively low number of Medicare inpatient cases.

Each federal fiscal year (which begins October 1), MS-DRG rates are updated and their weights are recalibrated. The index to update the MS-DRGs known as the “market basket” gives consideration to the inflation experienced by hospitals as well as entities outside the healthcare industry in purchasing goods and services. For several years, however, the percentage increases to the prospective payment rates have been generally lower than the percentage increases in the costs of goods and services for hospitals. Further, the Health Reform Law introduced new limitations on the increase in the market basket. See “— Government Regulation — Health Reform Initiatives.”

Our surgical hospitals are subject to a separate Medicare payment system for outpatient services. Most outpatient services provided by surgical hospitals are classified into groups called Ambulatory Payment Classifications (“APCs”) that are reimbursed by Medicare under the OPPS. A Medicare payment rate has been established for each APC. Depending on the services provided, a hospital may be paid for more than one APC for a patient visit. For calendar year 2014, CMS has issued a final rule that increases the rate for payments made under OPPS by 1.7%, reflecting a 2.5% increase based on the final inpatient hospital market basket percentage for federal fiscal year 2014, a negative 0.5% productivity adjustment and a negative 0.3% adjustment required by the Health Reform Law.

CMS has implemented a quality data reporting program for hospital outpatient care, known as the Hospital Outpatient Quality Data Reporting Program. CMS has adopted a similar quality data reporting program for hospital inpatient services, known as the Hospital Inpatient Quality Reporting Program. Hospitals that fail to report inpatient or outpatient data required for the quality measures selected by CMS in the form and manner required by CMS may incur a 2% reduction in the annual payment update factor. Therefore, if we fail to provide quality data in the manner and form required by CMS, our surgical hospitals could be subject to a reduction of the Medicare payment update by 2%. Any reduction would apply only to the payment year involved and would not be taken into account in computing the applicable payment update factor for a subsequent payment year.

Pursuant to the Health Reform Law, CMS has implemented a value-based purchasing program for inpatient hospital services, pursuant to which hospitals that meet or exceed specified quality performance standards will receive greater reimbursement than they would have otherwise and hospitals that do not meet the standards will receive reduced payments. The incentives provided through the program are funded by a reduction in payments for inpatient hospital services as follows: 1.25% for 2014; 1.5% for 2015; 1.75% for 2016; and 2% for 2017 and subsequent years. For each federal fiscal year, the total amount collected from these reductions will be pooled and used to fund payments to reward hospitals that meet specified quality performance standards.

Medicaid

Medicaid programs are jointly funded by Federal and state governments. As the Medicaid program is administered by the individual states under the oversight of CMS in accordance with certain regulatory and statutory guidelines, there are substantial differences in reimbursement methodologies and coverage policies from state to state. Many states have experienced shortfalls in their Medicaid budgets and are implementing

 

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significant cuts in Medicaid reimbursement rates. Additionally, certain states control Medicaid expenditures through restricting or eliminating coverage of certain services. Payments from Medicaid constituted approximately 3% of our net patient revenues for the year-ended December 31, 2013.

Cost Reports

Because of our participation in the Medicare and Medicaid programs, we are required to meet certain financial reporting requirements. Federal and some state regulations require the submission by us and our five surgical hospitals of annual cost reports stating the revenues, costs and expenses associated with the services provided to Medicare beneficiaries and Medicaid recipients at those hospitals.

These annual cost reports are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to us under these reimbursement programs. It generally takes years to settle audits of these cost reports. These audits are used for determining if any under- or over-payments were made by payors under these programs, setting payment levels for future years and detecting fraud. Providers are required to make certain certifications with these cost report submissions, including that they are in compliance with law. Such certifications, if incorrect and submitted knowingly or recklessly, may result in FCA liability. While currently ASCs are not subject to federal cost reporting requirements, it is possible that such requirements, which could be costly for us, will be implemented by CMS in the future.

Third-Party Payors

In addition to paying professional fees directly to the physicians performing medical services, most third-party payors also pay a facility fee to ASCs for the use of surgical facilities and reimburse surgical hospitals for the charges associated with the facilities and services that are provided by the hospitals to the third-party payors’ beneficiaries. We receive a majority of our reimbursement from third-party payors pursuant to written contracts between payors and our facilities. These contracts generally require our surgical hospitals and ASCs to offer discounts from their established charges and prohibit us from billing the patient for any amount other than a specified co-payment or deductible.

In some cases, our facilities do not have written contracts prior to providing services, commonly known as “out-of-network” services. Third-party payors have traditionally paid our out-of-network facilities a percentage of their charges. There has been a growing trend in recent years, however, for third-party payors to implement out-of-network fee schedules, which are more comparable to our contracted rates. In addition, some states where we operate have laws which restrict “out-of-network” billing, and a few payors have filed lawsuits claiming fraud and other wrongdoing on the part of ASCs that have engaged in certain out-of-network billing practices. We believe that where our facilities are out-of-network, our practices are appropriate, but we cannot guarantee that a payor will not successfully challenge those practices, which could lead to lower revenues at the facility involved.

Workers’ Compensation

Our facilities provide services to injured workers and receive payment from workers’ compensation payors pursuant to the various state workers’ compensation statutes. Historically, workers’ compensation payors have typically paid surgical facilities a higher percentage of the surgical facilities’ charges than other third-party payors. However, workers’ compensation payment amounts are subject to legislative, regulatory and other payment changes over which we have no control. In recent years, a number of states have implemented workers’ compensation fee schedules with rates generally lower than what our facilities have historically been paid for the same services. This trend has been exacerbated in some states by budget deficits and a perceived need to reduce expenditures. A reduction in workers’ compensation payment amounts could have a material adverse effect on the revenues of our facilities which perform a significant number of workers compensation cases.

 

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Operational Risks and Insurance

We maintain liability insurance in amounts that we believe are appropriate for our operations. Currently, we maintain professional and general liability insurance coverage for us and our facilities on a claims-made basis of $1.0 million per occurrence and $3.0 million in annual aggregate coverage per surgical facility. We also maintain umbrella liability insurance in the aggregate amount of $10.0 million and excess liability insurance in the aggregate amount of $15.0 million. We also currently maintain property damage insurance with aggregate coverage of $500.0 million and other types of insurance coverage we believe to be consistent with industry practice. Coverage under certain of these policies is contingent upon the policy being in effect when a claim is made regardless of when the events that caused the claim occurred. The cost and availability of such coverage has varied widely in recent years.

In most states, we maintain private market coverage for our workers’ compensation risk. The policy limits equal the minimum statutory requirements. In certain states, we procure comparable coverage through various state funds. In the state of Texas, we have elected not to participate in the workers’ compensation system and have procured separate coverage, subject to nominal deductibles.

While we believe that our insurance policies are adequate in amount and coverage for our current and anticipated operations based on both management judgment and external benchmarks, we cannot ensure that the insurance coverage will be sufficient to cover all future claims or will continue to be available in adequate amounts or at a reasonable cost.

Environmental Matters

We are subject to various federal, state and local laws and regulations relating to the protection of the environment and human health and safety, including those governing the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. Our operations include the use, generation and disposal of hazardous materials. We also regularly acquire ownership or operational interests in new facilities and properties, some of which may have had a history of commercial or other operations. We may, in the future, incur liability under environmental statutes and regulations with respect to contamination of sites we own or operate (including contamination caused by prior owners or operators of such sites, abutters or other persons) and the off-site disposal of hazardous substances. We believe that we have been and are in substantial compliance with the terms of all applicable environmental laws and regulations and that we have no liabilities or obligations under environmental requirements that we would expect to have a material adverse effect on our business, results of operations or financial condition.

Available Information

The Company maintains a web site at http://www.scasurgery.com. The Company makes available on its web site, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, as soon as it is reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (the “SEC”). These reports are also available on the SEC’s website, http://www.sec.gov. You may read and copy any reports that we file with the SEC at its Public Reference Room, located at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The Company is not including the information contained on or available through its web site as a part of, or incorporating such information into, this Annual Report on Form 10-K.

 

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Item 1A. RISK FACTORS

The following factors affect our business and the industry in which we operate. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also have an adverse effect on us. If any of the matters discussed in the following risk factors were to occur, our business, prospects, results of operations or financial condition could be materially adversely affected.

Risks Related to our Business

We depend on payments from third-party payors, including government healthcare programs, commercial payors and workers’ compensation programs. If these payments are reduced or eliminated, or do not increase as our costs increase, our revenues and profitability could decrease.

We depend upon governmental, commercial and workers’ compensation third-party sources of payment for the services provided to patients in our surgical facilities. The amount that our surgical facilities receive in payment for their services may be adversely affected by factors we do not control, including Medicare, Medicaid and state regulation changes, cost containment decisions and changes in reimbursement schedules of payors, legislative changes, refinements to the Medicare ASC payment system and refinements by CMS to Medicare’s reimbursement policies. Similarly, third-party payors may be successful in negotiating reduced reimbursement schedules with our facilities. Any reduction or elimination of these payments or an increase in the payments at a rate that is less than the increase in our costs could have a material adverse effect on our business, prospects, results of operations and financial condition.

If we or our health system partners are unable to negotiate and enter into favorable contracts or maintain satisfactory relationships and renew existing contracts on favorable terms with non-governmental third-party payors, our revenues and profitability may decrease.

Payments from non-governmental third-party payors represented approximately 60% of our consolidated net patient revenues and 77% of our nonconsolidated net patient revenues for the year-ended December 31, 2013. We receive most of these payments from third-party payors that have contracts with our facilities. These payors use a variety of methods for reimbursement depending on the insurance arrangement involved. These arrangements include preferred provider organizations, health maintenance organizations, as well as prepaid and discounted medical service packages, capitated (fixed fee) contracts, Medicare Advantage Plans and contracts with Independent Physician Associations. If we or our health system partners fail to enter into favorable contracts or to maintain satisfactory relationships and renew existing contracts on favorable terms with these payors, our revenues and profitability may decrease. Other healthcare providers may impact our ability to negotiate increases and other favorable terms in our reimbursement arrangements with non-governmental third-party payors. For example, some of our competitors may negotiate exclusivity provisions with non-governmental third-party payors or otherwise restrict the ability of non-governmental third-party payors to contract with us or our health system partners. Moreover, these third-party payors are increasingly implementing cost containment measures, such as fixed fee schedules and reductions to reimbursement schedules, which may reduce our revenues and profitability now or in the future. Further, the trend toward consolidation among non-governmental third-party payors tends to increase their bargaining power over fee structures. As various provisions of the Health Reform Law are implemented, including the establishment of health insurance exchanges, non-governmental third-party payors increasingly may demand reduced fees. In addition, there is a growing trend for third-party payors and employer-sponsored healthcare plans to take steps to shift the primary cost of care to the plan participant by increasing co-payments, co-insurance and deductibles, and these actions could discourage such patients from seeking treatment at our surgical facilities. Because some commercial third-party payors rely on all or portions of Medicare payment systems to determine payment rates, changes to government healthcare programs that reduce payments under these programs may negatively impact payments from commercial third-party payors. Patient volumes could decrease if we or our health system partners are unable to enter into acceptable contracts with such third-party payors, which could lead to a material adverse effect on our business, prospects, results of operations and financial condition.

 

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For the year-ended December 31, 2013, approximately 3.0% of our net patient revenues was derived from providing “out-of-network” services, where payments to us come from third-party payors with which our surgical facilities do not have contracts. In such cases, we generally charge patients a co-payment and submit claims to the payor, which typically have been paid at higher than comparable contracted rates. However, there is a trend for third-party payors to adopt out-of-network fee schedules that are more comparable to our contracted rates or to discourage their enrollees from seeking treatment at out-of-network surgical facilities. In such situations, we may be forced to choose between not providing services to out-of-network patients and accepting a payor contract with relatively low payment rates. In certain situations, we have seen an increase in case volume upon transitioning to in-network billing, although we may experience an overall decrease in revenues. We can provide no assurance that we will see a sufficient increase in volume of cases to compensate for the decrease in per case revenues where we transition to in-network billing, or that when we decline to sign a payor contract we will see a sufficient increase in payment rates to compensate for the decrease in volume of cases resulting from being out-of-network.

Significant changes in our payor mix or case mix resulting from fluctuations in the types of cases performed at our facilities could have a material adverse effect on our business, prospects, results of operations and financial condition.

Our results may change from period to period due to fluctuations in payor mix or case mix or other factors relating to the type of cases performed by physicians at our facilities. Payor mix refers to the relative share of total cases provided to patients with, respectively, no insurance, commercial insurance, Medicare coverage, Medicaid coverage and workers’ compensation insurance. Since, generally speaking, we receive relatively higher payment rates from commercial and workers’ compensation insurers than Medicare and Medicaid, a significant shift in our payor mix toward a higher percentage of Medicare and Medicaid cases, which could occur for reasons beyond our control, could result in a material adverse effect on our business, prospects, results of operations and financial condition. Case mix refers to the relative share of total cases performed by specialty, such as orthopedics, gastroenterology, pain management and otolaryngology. Generally speaking, we derive relatively higher revenues from certain types of cases. For example, orthopedic cases are generally higher revenue cases than pain management procedures, and if an orthopedic case that would have been performed at our facilities was replaced by a pain management case that was performed at our facilities, we would expect the revenue earned from that pain management case to be lower than the revenue that would have been earned for the orthopedic case. Therefore, a significant shift in our case mix toward a higher percentage of lower revenue cases, which could occur for reasons beyond our control, could result in a material adverse effect on our business, prospects, results of operations and financial condition.

As we operate in multiple markets, each with a different competitive landscape, shifts within our payor mix or case mix may not be uniform across all of our affiliated facilities. Rather, these shifts may be concentrated within certain markets due to local competitive factors. Therefore, the results of our individual affiliated facilities, including facilities that are material to our results, may be volatile, which could result in a material adverse effect on our business, prospects, results of operations and financial condition.

Payments we receive from workers’ compensation programs are subject to reduction as states implement reduced fee schedules and deal with increased budgeting and economic challenges.

Payments from workers’ compensation payors represented approximately 11% of our net patient revenues for the year-ended December 31, 2013. Several states have recently considered or implemented workers’ compensation provider fee schedules. In some cases, the fee schedule rates contain lower rates than the rates our surgical facilities have historically been paid for the same services. Additionally, budgeting and economic challenges have caused some states to reduce the payments made to us under workers’ compensation programs. In 2012, California enacted legislation that reduced the reimbursement rate for patients receiving care through its workers’ compensation program by 33% beginning on January 1, 2013. In addition, North Carolina has enacted legislation to reduce its workers’ compensation reimbursement rates by 15%, beginning on April 1, 2013. Finally, Indiana has passed legislation that will reduce workers’ compensation reimbursement rates by 53%,

 

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which is scheduled to go into effect on July 1, 2014. If the trend of states adopting lower workers’ compensation fee schedules continues, or the budgeting and economic challenges faced by states continue, resulting in reductions to reimbursement rates, such occurrences could have a material adverse effect on our business, prospects, results of operations and financial condition.

Our relationships with health systems, including not-for-profit health systems, are important to our growth strategy. If we are not able to maintain good relationships with these health systems, or enter into new relationships, we may be unable to implement our growth strategy successfully, which could adversely affect our profitability.

Our business depends in part upon the success of our health system partners and the strength of our relationships with those healthcare systems. Our business could be adversely affected by any damage to those health systems’ reputation or to our relationships with them, or as a result of an irreconcilable dispute with a health system partner. At December 31, 2013, we held ownership interests in 62 facilities in partnership with 30 different health systems. Our health system relationships include local health systems, regional health systems and national health systems. We enter into co-development agreements or have informal co-development arrangements with health systems in which we agree to jointly develop a network of surgical facilities in a defined geographic area. We expect our acquisition activity to continue with the primary focus on the creation of partnerships with health systems. If we are unable to develop and maintain good relationships with such health systems, maintain our existing agreements on terms and conditions favorable to us or enter into relationships with additional health systems on favorable terms, or at all, we may be unable to implement our growth strategies successfully, and such a failure could adversely affect our profitability. In addition, we are increasingly entering into joint ventures that we do not control because we do not have a majority stake in the joint venture or otherwise do not possess sufficient contractual rights to control the entity. Our failure to control such joint ventures may impair our ability to achieve the desired operating results from such joint ventures.

Material changes in revenue rulings published by the Internal Revenue Service (the “IRS”), case law or the interpretation of such rulings and case law could adversely affect our relationships with our not-for-profit health system partners and have a material adverse effect on our business, prospects, results of operations and financial condition.

Our relationships with tax-exempt, not-for-profit health systems and the joint venture agreements that represent these relationships are structured to minimize the possibility of adverse tax consequences to the non-profit systems, such as the imposition of the unrelated business income tax or the loss of tax exemption. These relationships are generally structured with the assistance of counsel to the non-profit systems, who rely on revenue rulings published by the IRS as well as case law relevant to joint ventures between for-profit and not-for-profit healthcare entities. Material changes in these rulings and case law, or the interpretation of such rulings and case law by the IRS, could adversely affect our relationships with our not-for-profit health system partners. Further, our compliance with the rules applicable to tax-exempt entities could have an adverse impact on the margins of facilities we own in partnership with our not-for-profit health system partners. Such rules, revenue rulings, case law and interpretations may preclude us from being able to enter into joint venture agreements or new relationships with not-for-profit health systems, which could have a material adverse effect on our business, prospects, results of operations and financial condition.

We depend on physician utilization of our facilities, which could decrease if we fail to maintain good relationships with physicians or due to other factors outside of our control.

Our business depends upon the efforts and success of the physicians who provide medical services at our facilities, and the strength of our relationships with these physicians. These physicians are not employees of our facilities and are generally not contractually required to use our facilities. We typically do not have contracts with physicians who use our facilities, other than partnership and operating agreements with physicians who own interests in our facilities, provider agreements with physicians who provide anesthesiology services in our surgical facilities and independent contractor agreements with physicians who provide certain limited services to

 

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the facilities, such as medical director services. Physicians who use our surgical facilities usually also use other surgery centers or hospitals. Due to technological advances, physicians may also choose to perform procedures that might otherwise be performed at our surgical facilities in their own offices, such as pain management procedures, endoscopies and cataract removals. Although many physicians who own an interest in our facilities are subject to agreements restricting them from having an ownership interest in competing facilities, these agreements do not restrict physicians from performing procedures at other facilities. Also, these agreements restricting ownership of competing facilities can be difficult to enforce, and we may be unsuccessful in preventing physicians who own an interest in our facilities from acquiring an interest in a competing facility.

We also depend on the quality of care provided by the physicians who provide medical services at our facilities. While those physicians are independent contractors and not employed by us or our facilities and maintain their own liability insurance coverage, the failure of particular groups of physicians who utilize our facilities to provide quality medical care or to otherwise adhere to professional guidelines at our surgical facilities, or any damage to the reputation of a particular group of physicians with whom we are affiliated, could also damage our reputation, subject us to liability and significantly reduce our revenues.

Healthcare reform and other factors are leading more physicians to accept employment by hospitals. The creation of ACOs may cause physicians to accept employment to become part of a network that includes an ACO. In addition, Medicare’s push for healthcare providers to invest in technology infrastructure to increase efficiencies may cause more physicians to move from private practice to employment with hospitals and ACOs because an individual physician or small group of physicians may view the costs associated with investing in technology as too large to bear individually. Physicians who accept employment with ACOs, hospitals or other organizations may be less likely to own, or may be contractually restricted from owning, interests in our facilities or, in some cases, restricted from using our facilities.

We have had and are likely to continue to have disputes with physicians who use our facilities or own interests in our facilities. Furthermore, we may in the future have disputes with key groups of physicians and such disputes, if they were to occur, could have a material adverse effect on our business, prospects, results of operations and financial condition. In addition, key groups of physicians may elect to leave a facility for a variety of reasons unrelated to us, including, for example, to be employed by a hospital or health system that competes with our facility. Our revenues and profitability could be reduced if we lose our relationship with key groups of physicians, or if key groups of physicians cease or reduce their use of our facilities, and we are unable to replace those groups of physicians with others who will use our facilities. The financial success of our facilities is in part dependent upon the volume of procedures performed by the physicians who use our facilities, which is affected by the economy, healthcare reform, increases in patient co-payments and deductibles and other factors outside our or their control. In addition, the physicians who use our surgical facilities may choose not to accept patients who pay for services through certain third-party payors, which could reduce our revenues. Any reduction in our revenues due to a decrease in the use by physicians of our surgical facilities could have a material adverse effect on our business, prospects, results of operations and financial condition.

Physician treatment methodologies and governmental or commercial health insurance controls designed to reduce the number of surgical procedures may reduce our revenues and profitability.

Controls imposed by Medicare, managed Medicare, Medicaid, managed Medicaid, employer-sponsored healthcare plans and commercial health insurance payors designed to reduce surgical volumes, in some instances referred to as “utilization review,” could adversely affect our facilities. Although we are unable to predict the effect these changes will have on our operations, significant limits on the scope of services reimbursed and on reimbursement rates and fees may reduce our revenues and profitability. Additionally, trends in physician treatment protocols and commercial health insurance plan design, such as plans that shift increased costs and accountability for care to patients, could reduce our surgical volumes in favor of lower intensity and lower cost treatment methodologies, each of which could, in turn, have a material adverse effect on our business, prospects, results of operations and financial condition.

 

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Our growth strategy depends in part on our ability to attract new physician investors, and to acquire and develop additional surgical facilities, on favorable terms. If we are unable to achieve either of these goals, our future growth could be limited.

We believe that an important component of our financial performance and growth is our ability to provide physicians who use our facilities with the opportunity to purchase ownership interests in our facilities. We may not be successful in attracting new physician investment in our surgical facilities, and that failure could result in a reduction in the quality, efficiency and profitability of our facilities. Based on competitive factors and market conditions, physicians may be able to negotiate relatively higher levels of equity ownership in our facilities, consequently limiting or reducing our share of the profits from these facilities. In addition, physician ownership in our facilities is subject to certain regulatory restrictions, see “— Risks Related to Healthcare Regulation — Our surgical facilities do not satisfy the requirements for any of the safe harbors under the Anti-Kickback Statute. If we fail to comply with the Anti-Kickback Statute, we could be subject to criminal and civil penalties, loss of licenses and exclusion from governmental programs, which may result in a substantial loss of revenues” and “—Risks Related to Healthcare Regulation — If we fail to comply with physician self-referral laws as they are currently interpreted or may be interpreted in the future, or if other legislative restrictions are issued, we could incur substantial monetary penalties and a significant loss of revenues.”

In addition, our growth strategy includes the acquisition of existing surgical facilities and the development of new surgical facilities jointly with local physicians and, in some cases, healthcare systems and other strategic partners. From January 2010 to December 31, 2013, we acquired 13 consolidated facilities and 32 noncontrolling interests in facilities accounted for as equity method investments. If we are unable to successfully execute on this strategy in the future, our future growth could be limited. We may be unable to identify suitable acquisition and development opportunities, or to complete acquisitions and new projects in a timely manner and on favorable terms. Our acquisition and development activities require substantial capital resources, and we may need to obtain additional capital or financing, from time to time, to fund these activities. As a result, we may take actions that could have a material adverse effect on our business, prospects, results of operations and financial condition, including incurring substantial debt with certain restrictive terms. Further, sufficient capital or financing may not be available to us on satisfactory terms, if at all. In addition, our ability to acquire and develop additional surgical facilities may be limited by state certificate of need programs and other regulatory restrictions on expansion. We also face significant competition from local, regional and national health systems and other owners of surgical facilities in pursuing attractive acquisition candidates.

Shortages of surgery-related products, equipment and medical supplies and quality control issues with such products, equipment and medical supplies could disrupt our operations and adversely affect our case volume, case mix and profitability.

Our operations depend significantly upon our ability to obtain sufficient surgery-related products, drugs, equipment and medical supplies from suppliers on a timely basis. If we are unable to obtain such necessary products, or if we fail to properly manage existing inventory levels, we would be unable to perform certain surgeries, which could adversely affect our case volume or result in a negative shift in our case mix. In addition, as a result of shortages, we could suffer, among other things, operational disruptions, disruptions in cash flows, increased costs and reductions in profitability. At times, supply shortages have occurred in our industry, and such shortages may recur from time to time.

Medical supplies and services can also be subject to supplier product quality control incidents and recalls. In addition to contributing to materials shortages, product quality can affect patient care and safety. Material quality control incidents have occurred in the past and may occur again in the future, for reasons beyond our control, and such incidents can negatively impact our case volume, product costs and our reputation. In addition, we may have to incur costs to resolve quality control incidents related to medical supplies and services regardless of whether they were caused by us. Our inability to obtain the necessary amount and quality of surgery-related products, equipment and medical supplies due to a quality control incident or recall could have a material adverse effect on our business, prospects, results of operations and financial condition.

 

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Competition for staffing, shortages of qualified personnel or other factors could increase our labor costs and adversely affect our results of operations and cash flows.

Our operations are dependent on the efforts, abilities and experience of our management and clinical personnel, particularly nurses. We compete with other healthcare providers in recruiting and retaining qualified management and support personnel responsible for the daily operations of each of our facilities. In some markets, the lack of availability of clinical personnel, such as nurses, has become a significant operating issue facing all healthcare providers. This shortage may require us to continue to enhance wages and benefits to recruit and retain qualified personnel or to contract for more expensive temporary personnel. For the year-ended December 31, 2013, our salary and benefit expenses represented 34.6% of our net operating revenues. We also depend on the available labor pool of semi-skilled and unskilled workers in each of the markets in which we operate.

If our labor costs increase, we may not be able to raise rates to offset these increased costs. Because a significant percentage of our revenues consist of fixed, prospective payments, our ability to pass along increased labor costs is limited. In particular, if labor costs rise at an annual rate greater than our net annual Consumer Price Index basket update from Medicare, our results of operations and cash flows will likely be adversely affected. Any union activity at our facilities that may occur in the future could contribute to increased labor costs. Certain proposed changes in federal labor laws and the National Labor Relations Board’s modification of its election procedures could increase the likelihood of employee unionization attempts. Although none of our teammates are currently represented by a collective bargaining agreement, to the extent a significant portion of our employee base unionizes, it is possible our labor costs could increase materially. Our failure to recruit and retain qualified management and medical personnel, or to control our labor costs, could have a material adverse effect on our business, prospects, results of operations and financial condition.

We face intense competition for patients, physicians, strategic relationships and commercial payor contracts.

The healthcare business is highly competitive, and each of the individual geographic areas in which we operate has a different competitive landscape. In each of our markets we compete with other healthcare providers for patients and in contracting with commercial payors. In addition, because the number of physicians available to utilize and invest in our facilities is finite, we face intense competition from other surgery centers, hospitals, health systems and other healthcare providers in recruiting physicians to utilize and invest in our facilities. We are in competition with other surgery centers, hospitals and healthcare systems in the communities we serve to attract patients and provide them with the care they need. There are hospitals and health systems that compete with us in each market in which we operate, and many of them have more established relationships with physicians and payors than we do. To the extent that a majority of physicians within an individual community or market decide to partner with a competing surgery center, hospital or health system and not with us, our affiliated facility in such community may become unprofitable and the value of this asset may decrease, even drastically. In addition, other companies are currently in the same or similar business of developing, acquiring and operating surgical facilities, or may decide to enter this business. We also compete with some of these companies for entry into strategic relationships with health systems and physicians. Moreover, many physicians develop surgical facilities without a corporate partner, using consultants who perform services that we often perform for a fee and who do not take an equity interest in the ongoing operations of the facility. As a result of the differing competitive factors within the markets in which we operate, the individual results of our facilities may be volatile. If we are unable to compete effectively with any of these entities or groups, or to attract a sufficient number of physicians to utilize or invest in our facilities, we may be unable to implement our business strategies successfully, which could have a material adverse effect on our business, prospects, results of operations and financial condition.

We often are subject to malpractice and related legal claims, and we could be required to pay significant damages in connection with those claims, which may not be covered by insurance.

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claims and significant defense costs. In some cases, it may be difficult to control the level of risk in this area. For example, it is possible that our facilities could inadvertently purchase tainted products from ostensibly reputable suppliers. Other providers are facing substantial litigation costs, and could face substantial damages, in connection with medical malpractice and products liability claims associated with the purchase of tainted epidural steroids, the administration of which by ASCs and other types of providers resulted in the recent nationwide meningitis outbreak. We maintain liability insurance in amounts that we believe are appropriate for our operations, including professional and general liability insurance that provides coverage on a claims-made basis of $1.0 million per occurrence and $3.0 million in annual aggregate coverage per surgical facility. We also maintain umbrella liability insurance in the aggregate amount of $10.0 million and excess liability insurance in the aggregate amount of $15.0 million. See “Business — Operational Risks and Insurance” for additional information regarding our insurance coverage. However, this insurance coverage may not cover all claims against us, and insurance coverage may not continue to be available at a cost satisfactory to us to allow for the maintenance of adequate levels of insurance. If one or more successful claims against us were not covered by or exceeded the coverage of our insurance, it could have a material adverse effect on our business, prospects, results of operations and financial condition.

Our case volume and case mix may be adversely affected due to current and future economic conditions.

The U.S. economy continues to experience difficult conditions. Our case volume and case mix may be adversely affected by patients’ inability to pay for procedures in our facilities. Higher numbers of unemployed individuals generally translate into more individuals without healthcare insurance to help pay for procedures, thereby increasing the potential for persons to elect not to have procedures performed. However, a majority of the procedures performed in our surgical facilities are not considered truly elective in nature. Therefore, even procedures normally thought to be non-elective may be delayed or may not be performed if the patient cannot afford the procedure due to a lack of insurance or money to pay their portion of our facility’s fee.

In addition, the difficult conditions of the U.S. economy have adversely affected and could continue to adversely affect the budgets of individual states and the Federal government, which has resulted in and could continue to result in attempts to reduce payments made to us by Federal and state government healthcare programs, including Medicare, military services, Medicaid and workers’ compensation programs, a reduction in the scope of services covered by those programs and an increase in taxes and assessments on our activities. In the past, the Federal government has entered a shutdown that suspended services deemed non-essential as a result of a failure by Congress to enact regular appropriations. A prolonged shutdown in the future could cause significant regulatory delays, including delays in our ability to obtain Medicare billing numbers or achieve Medicare certification for new facilities. Furthermore, if the Federal government debt incurrence ceiling expires and is not raised by Congress, the Federal government could default on its debts. A prolonged shutdown or a failure to raise the debt ceiling would negatively affect the U.S. economy and could have a material adverse effect on the healthcare industry, our business, results of operations or financial condition.

Many of our facilities are concentrated in certain states, which makes us particularly sensitive to regulatory, economic and other conditions in those states.

Our revenues are particularly sensitive to regulatory, economic and other conditions in certain states where we have a greater concentration of facilities. For the year-ended December 31, 2013, our facilities located in North Carolina, California and Texas represented approximately 14%, 14% and 12%, respectively, of our net patient revenues. Additionally, facilities located in each of Alabama, Alaska, Connecticut, Florida and Idaho represented in excess of 5% of our net patient revenues for the year-ended December 31, 2013. Of our 60 nonconsolidated facilities accounted for as equity method investments, as of December 31, 2013, 26 of these facilities were located in California and 12 of these facilities were located in Indiana. If there were an adverse regulatory, economic or other development in any of the states in which we have a higher concentration of facilities, our case volumes could decline in these states or there could be other unanticipated adverse impacts on our business in those states, which could have a material adverse effect on our business, prospects, results of operations and financial condition.

 

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We have a history of net losses and may not achieve or sustain profitability in the future.

We have historically incurred periods of net losses, including net losses of approximately $51.3 million in 2013, $20.0 million in 2012 and $9.7 million in 2011. We cannot assure you that our revenues will grow or that we will achieve or maintain profitability in the future. Even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis in the future. Our ability to achieve profitability will be affected by the other risks and uncertainties described in this section and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” If we are not able to achieve, sustain or increase profitability, our business will be adversely affected and our stock price may decline.

Certain of our partnership and operating agreements contain termination dates that will require us to amend and possibly renegotiate such agreements.

Certain of our LP agreements, general partnership agreements and LLC operating agreements have termination dates by which the agreement expires by its terms. In some cases, termination dates are required under the applicable state law governing the form of entity. In these situations we would attempt to negotiate an amendment to the agreement to prevent such termination if we wish to continue the business. Any such amendment could also require us to renegotiate material terms of the agreements with our physician and health system partners. There is no guarantee that we will be able to renegotiate these agreements on terms that are favorable or satisfactory to us or at all. If we are unable to amend or renew our agreements on terms that are satisfactory to us or at all, this could have a material adverse effect on our business, prospects, results of operations and financial condition. None of our operating agreements have termination dates in 2014.

Certain of our partnership and operating agreements contain provisions giving rights to our partners and other members that may be adverse to our interests.

Certain of the agreements governing the LPs, general partnerships and LLCs through which we own and operate our facilities contain provisions that give our partners or other members rights that may, in certain circumstances, be adverse to our interests. These rights include, but are not limited to, rights to purchase our interest in the partnership or LLC, rights to require us to purchase the interests of our partners or other members, or rights requiring the consent of our partners and other members prior to our transferring our ownership interest in a facility or prior to a change in control of us or certain of our subsidiaries. With respect to these purchase rights, the agreements generally include a specified formula or methodology to determine the applicable purchase price, which may or may not reflect fair market value.

In one case, two agreements governing seven facilities that we co-own with Sutter Health give Sutter Health the absolute right to purchase our proportionate interest in the facilities, including our ongoing profits from managing the facilities, after the passage of a certain amount of time. The first of these rights will arise in 2017. The purchase price of our interest will be the fair market value as determined by an independent appraisal. One of these agreements further provides that if Sutter Health forgoes the right to acquire our interest upon the initial trigger date, such right will renew and we must offer Sutter Health the same opportunity every three years. The other agreement gives Sutter Health an ongoing right to purchase our proportionate interest in one facility after the expiration of seven years following the commencement of operations of the center. There are an additional two agreements governing four facilities co-owned with Sutter Health under which Sutter Health has the right to purchase up to 10% of our ownership interest in one facility and up to 10% of our ownership interest in our joint venture entity that owns one facility, also at fair market value. Although the stated purchase price for these acquisitions is fair market value, the purchase of our interests by our partner will prevent us from continuing to recognize ongoing profits from owning and managing these facilities, which could have a material adverse effect on our business, prospects, results of operations and financial condition.

In addition to the purchase and consent rights described above, almost all of our partnership and operating agreements contain restrictions on actions that we can take, even though we may be the general partner or the managing member. Examples of these restrictions include the rights of our partners and other members to approve the sale of substantially all of the assets of the partnership or LLC, to dissolve the partnership or LLC, to

 

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appoint a new or additional general partner or managing member and to amend the partnership or operating agreements. Many of our agreements also restrict our ability in certain instances to compete with our existing facilities or with our partners. Where we hold only a limited partner or a non-managing member interest, the general partner or managing member may take certain actions without our consent, although we typically have certain protective rights to approve major decisions such as the sale of substantially all of the assets of the entity, dissolution of the partnership or LLC and the amendment of the partnership or operating agreement. These management and governance rights held by our partners and other members limit and restrict our ability to make unilateral decisions about the management and operation of the facilities without the approval of our partners and other members.

We may have a special legal responsibility to the holders of ownership interests in the entities through which we own our facilities, which may conflict with, and prevent us from acting solely in, our own best interests.

We generally hold our ownership interests in facilities through limited or general partnerships, LLCs or LLPs in which we maintain an ownership interest along with physicians and, in some cases, health systems. As general partner and manager of most of these entities, we may have a special responsibility, known as a fiduciary duty, to manage these entities in the best interests of the other interest holders. We may encounter conflicts between our responsibility to the other interest holders and our own best interests. For example, we have entered into management agreements to provide management services to our surgical facilities in exchange for a fee. Disputes may arise as to the nature of the services to be provided or the amount of the fee to be paid. In these cases, we may be obligated to exercise reasonable, good faith judgment to resolve the disputes and may not be free to act solely in our own best interests. Disputes may also arise between us and our physician investors with respect to a particular business decision or regarding the interpretation of the provisions of the applicable partnership agreement or operating agreement. We seek to avoid these disputes but have not implemented any measures to resolve these conflicts if they arise. If we are unable to resolve a dispute on terms favorable or satisfactory to us, it could have a material adverse effect on our business, prospects, results of operations and financial condition.

We may have difficulty operating and integrating newly acquired or developed facilities.

If we acquire or develop additional facilities, we may experience difficulty in retaining or integrating their operations, key physicians, systems and personnel. In some acquisitions, we may have to renegotiate, or risk losing, one or more of the facility’s commercial payor contracts. We may also be unable to immediately collect the accounts receivable of an acquired facility while we align the payors’ payment systems and accounts with our own systems. Certain transactions can require licensure changes which, in turn, result in disruptions in payment for services. Moreover, the integration of acquired facilities may result in the diversion of our management’s time from our existing operations.

If we are not successful in integrating newly acquired surgical facilities, we may not realize the potential benefits of such acquisitions. Likewise, if we are not able to integrate acquired facilities’ operations and personnel with ours in a timely and efficient manner, then the potential benefits of the transaction may not be realized. In particular, if we experience the loss of key personnel or if the effort devoted to the integration of acquired facilities diverts significant management or other resources from other operational activities, our operations could be impaired.

In addition, we may acquire facilities with unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations. Although we maintain professional and general liability insurance that provides coverage on a claims-made basis of $1.0 million per occurrence and $3.0 million in annual aggregate coverage per surgical facility, we do not maintain insurance specifically covering all unknown or contingent liabilities that may have occurred prior to the acquisition of facilities. See “Business — Operational Risks and Insurance” for additional information regarding our insurance coverage. In some cases, our right to indemnification for these liabilities from the seller may be subject to negotiated limits or limits on our ability to enforce indemnification rights.

 

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In developing new facilities, we may be unable to attract physicians to use our facilities or to enter into favorable contracts with commercial payors. In addition, newly developed facilities typically incur net losses during the initial periods of operation and, unless and until their case loads grow, they generally experience lower total revenues and operating margins than established facilities. Integrating a new facility can be expensive and time consuming and could disrupt our ongoing business and distract our management and other key teammates.

Growth of patient receivables or deterioration in the ability to collect on these accounts, due to changes in economic conditions or otherwise, could have a material adverse effect on our business, prospects, results of operations and financial condition.

The primary collection risks with respect to our patient receivables relate to patient accounts for which the primary third-party payor has paid the amounts covered by the applicable agreement, but patient responsibility amounts (deductibles and co-payments) remain outstanding. Our provision for doubtful accounts relates primarily to amounts due directly from patients.

We provide for bad debts principally based upon the type of payor and the age of the receivables. Our allowance for doubtful accounts at December 31, 2013 and 2012 represented approximately 13.0% and 7.2% of our accounts receivable balance, respectively.

Due to the difficulty in assessing future trends, including the effects of changes in economic conditions, we could be required to increase our provision for doubtful accounts. An increase in the amount of patient receivables or a deterioration in the collectability of these accounts could have a material adverse effect on our business, prospects, results of operations and financial condition.

Because our senior management has been key to our growth and success, we may be adversely affected if we lose the services of our senior management.

Our success depends to a significant extent upon the efforts and abilities of our senior management team and key financial and operating teammates. Although we have employment agreements with senior management, we do not maintain “key man” life insurance policies for any of our senior management. Competition for senior management generally, and within the healthcare industry specifically, is intense, and we may not be able to recruit and retain the personnel we need if we were to lose an existing member of senior management. Many of our senior management and other financial and operating key teammates were recruited by us specifically due to their industry experience or specific expertise. The loss of senior management or other key teammates, without adequate replacements, or our inability to attract, retain and motivate sufficient numbers of qualified senior management or other key teammates, could have a material adverse effect on our business, prospects, results of operations and financial condition.

We rely on our controlling stockholder.

We have in recent years depended on our relationship with TPG, our controlling stockholder, to help guide our business plan and we continue to rely on TPG’s significant expertise in financial matters. This expertise has been available to us through the representatives TPG has on the Company’s board of directors. Representatives of TPG have the ability to appoint, and have appointed, a majority of the seats on our board of directors. In the future, TPG may elect to reduce its ownership in our company or reduce its involvement on our board of directors, which could reduce or eliminate the benefits we have historically achieved through our relationship with it. See “— Risks Related to Our Common Stock — TPG has significant influence over us, including control over decisions that require the approval of stockholders, which could limit your ability to influence the outcome of key transactions, including a change of control, and which may result in conflicts with us or you in the future.”

 

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We have a substantial amount of indebtedness, which may adversely affect our available cash flow and our ability to operate our business, remain in compliance with debt covenants and make payments on our indebtedness.

We have a substantial amount of indebtedness. As of December 31, 2013, we had approximately $645.7 million of indebtedness (excluding capital leases), which includes $602.5 million under our Senior Secured Credit Facilities (as defined herein). We also have $132.3 million of unused commitments under our Class B Revolving Credit Facility. At December 31, 2013, we had approximately $1.7 million in letters of credit outstanding.

Our substantial level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of our indebtedness. Our substantial indebtedness, combined with our other financial obligations and contractual commitments, could have important consequences. For example, it could:

 

    make it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations under any of our debt instruments, including restrictive covenants, could result in an event of default under such instruments;

 

    make us more vulnerable to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation;

 

    require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes;

 

    limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

    place us at a competitive disadvantage compared to our competitors that are less highly leveraged and therefore able to take advantage of opportunities that our indebtedness prevents us from exploiting; and

 

    limit our ability to borrow additional amounts for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other purposes.

Any of the above listed factors could have a material adverse effect on our business, prospects, results of operations and financial condition. Furthermore, our interest expense could increase if interest rates increase because a portion of our debt under our Senior Secured Credit Facilities bears interest at floating rates, which could adversely affect our cash flows. If we do not have sufficient earnings to service our debt, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or sell securities, none of which we can guarantee we will be able to do.

In addition, our Senior Secured Credit Facilities contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. A breach of any of these restrictive covenants, if not cured or waived, could result in an event of default that could trigger acceleration of our indebtedness and may result in the acceleration of or default under any other debt to which a cross-acceleration or cross-default provision applies, which could have a material adverse effect on our business and financial condition. Utilization of the Class B Revolving Credit Facility is subject to compliance with a total leverage ratio test. In addition, our Senior Secured Credit Facilities require prepayment of the outstanding indebtedness thereunder if we have certain excess cash flow, as described therein. Finally, our Senior Secured Credit Facilities require the repayment in full of all amounts outstanding thereunder upon a change of control, as defined therein.

Despite our current indebtedness levels, we and our subsidiaries may still be able to incur substantially more debt, which could further exacerbate the risks associated with our substantial leverage.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future, including secured indebtedness. Although the Amended Credit Agreement (as defined herein) governing our Senior

 

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Secured Credit Facilities contains restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of significant qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. If new debt is added to our or our subsidiaries’ current debt levels, the related risks that we face would be increased.

To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control, and any failure to meet our debt service obligations could have a material adverse effect on our business, prospects, results of operations and financial condition.

Our ability to pay interest on and principal of our debt obligations principally depends upon our operating performance. As a result, prevailing economic conditions and financial, business and other factors, many of which are beyond our control, will affect our ability to make these payments.

In addition, we conduct our operations through our subsidiaries. Accordingly, repayment of our indebtedness is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us by dividend, debt repayment or otherwise. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each of our subsidiaries is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. In particular, the constituent documents governing many of our non-wholly owned subsidiaries limit, under certain circumstances, our ability to access the cash generated by those subsidiaries in a timely manner.

If we do not generate sufficient cash flow from operations to satisfy our debt service obligations, we may have to undertake alternative financing plans, such as refinancing or restructuring our indebtedness, selling assets, reducing or delaying capital investments or capital expenditures or seeking to raise additional capital. Our ability to restructure or refinance our debt, if at all, will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of existing or future debt instruments may restrict us from adopting some of these alternatives. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to refinance our obligations at all or on commercially reasonable terms, could affect our ability to satisfy our debt obligations and have a material adverse effect on our business, prospects, results of operations and financial condition.

The terms of our Senior Secured Credit Facilities may restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions.

Our Senior Secured Credit Facilities contain, and any future indebtedness of ours would likely contain, a number of restrictive covenants that impose significant operating restrictions, including restrictions on our ability to engage in acts that may be in our best long-term interests.

The Amended Credit Agreement governing our Senior Secured Credit Facilities includes covenants restricting, among other things, our ability to:

 

    incur liens;

 

    incur or assume additional debt or guarantees or issue or sell certain types of preferred stock;

 

    pay dividends or make redemptions and repurchases with respect to capital stock;

 

    prepay, or make redemptions and repurchases of, subordinated debt;

 

    make loans or investments; and

 

    engage in mergers, acquisitions, asset sales, sale/leaseback transactions and transactions with affiliates.

 

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The operating restrictions and covenants in these debt agreements and any future financing agreements may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. Our ability to comply with these covenants may be affected by events beyond our control, and any material deviations from our forecasts could require us to seek waivers or amendments of covenants, alternative sources of financing or reductions in expenditures. In addition, the outstanding indebtedness under our Senior Secured Credit Facilities is, subject to certain exceptions, secured by security interests in substantially all of our, SCA’s and the other Guarantors’ (as defined herein) assets. A breach of any of the restrictive covenants in the Amended Credit Agreement governing the Senior Secured Credit Facilities would result in a default, and our lenders may elect to declare all outstanding borrowings, together with accrued interest and other fees, to be immediately due and payable, or enforce and foreclose on their security interest and liquidate some or all of such pledged assets. The lenders under our Senior Secured Credit Facilities also have the right in these circumstances to terminate any commitments they have to provide further borrowings.

We are exposed to market risk related to interest rate changes.

We are exposed to market risk related to changes in interest rates as a result of the floating interest rates applicable to the outstanding debt under our Senior Secured Credit Facilities, including our $214.4 million Class B Term Loan due December 30, 2017 and our $388.1 million Class C Term Loan due June 30, 2018. The interest rate on the Class B Term Loan and the Class C Term Loan at December 31, 2013 was 4.25%. The weighted average interest rate for the outstanding debt under our Senior Secured Credit Facilities as of December 31, 2013 was 4.26%. Borrowings under each portion of the Senior Secured Credit Facilities bear interest at a base rate or at LIBOR, as elected by us, plus an applicable margin. The base rate is determined by reference to the higher of (i) the prime rate of JPMorgan Chase Bank, N.A. and (ii) the federal funds effective rate plus 0.50%. The LIBOR rate is determined by reference to the interest rate for dollar deposits in the London interbank market for the interest period relevant to such borrowings. There is no cap on the maximum interest rate for the Senior Secured Credit Facilities. As of December 31, 2013, we held forward starting interest rate swaps hedging interest rate risk on $240.0 million of our variable rate debt to manage our exposure to these fluctuations. These forward starting interest rate swaps, which are swaps that are entered into at a specified trade date but do not begin to accrue interest until a future start date, extend the interest rate swaps that we terminated in 2012 and 2013. These swaps are “receive floating/pay fixed” instruments, meaning we receive floating rate payments, which fluctuate based on 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. See Item 7A — “Quantitative and Qualitative Disclosures About Market Risk.”

We make significant loans to the partnerships and LLCs that own and operate certain of our facilities.

For certain of our surgical facilities, indebtedness at the partnership or LLC level is funded through intercompany loans that we provide. Through many of these loans, which totaled approximately $27.6 million to 27 surgical facilities as of December 31, 2013, we have a security interest in the partnership’s or LLC’s assets. However, our business, prospects, financial condition and results of operations could be materially adversely affected if our surgical facilities are unable to repay these intercompany loans.

We are liable for certain debts and other obligations of the partnerships and limited liability companies that own and operate certain of our facilities.

In certain of the general partnerships, LPs, LLPs or LLCs in which one of our affiliates is the general partner or managing member, our affiliate is liable for some or all of the debts and other obligations of the entity. Our partners or co-members are often required to guarantee their pro rata share of any indebtedness or lease agreements to which the entity is a party in proportion to their ownership interest in the entity. As of December 31, 2013, we guaranteed a total of $37.6 million of debt, consisting of $35.1 million at consolidated facilities and $2.5 million in the aggregate at nonconsolidated and managed-only facilities. For more information regarding guarantees made to nonconsolidated or managed-only facilities, see “Management’s Discussion and

 

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Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Off-Balance Sheet Transactions.” There can be no assurance that a third-party lender or lessor would seek performance of the guarantees rather than seek repayment from us of any obligation of the general partnership, LP, LLP or LLC if there is a default, or that the physician partners or co-members would have sufficient assets to satisfy their guarantee obligations.

We may recognize impairments on long-lived assets, including goodwill and other intangible assets, or recognize impairments on our equity method investments.

Our balance sheet at December 31, 2013 contained intangible assets, including goodwill, of $806.0 million. Future acquisitions that result in the recognition of additional long-lived and intangible assets would cause an increase in these types of assets. On an ongoing basis, we evaluate whether facts and circumstances indicate any potential impairment to the carrying value of these assets could exist. Estimates of the future cash flows associated with the assets are critical to the impairment assessments. Changes in estimates based on changed economic conditions or business strategies could result in material impairment charges and therefore have a material adverse impact on our business, prospects, results of operations and financial condition.

We recognize an impairment charge when the decline in the estimated fair value of our equity method investments in our nonconsolidated facilities below their book value are judged to be other-than-temporary. Significant judgment is used to identify events or circumstances that would likely have a significant adverse effect on the future prospects of an equity method investment. We consider various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, forecasted recovery and the financial condition and near-term prospects of the facility. Our current evaluation of other-than-temporary impairments reflects our intent to maintain our equity method investments for a reasonable period of time sufficient for a forecasted recovery of fair value. However, our intent to hold certain of these investments may change in future periods as a result of facts and circumstances impacting the operations of the facility. If our intent changes and we do not expect the equity method investment to fully be recoverable, we will write down the investment to its fair value in the period that our intent changes.

If we are unable to manage and secure our information systems effectively, our operations could be disrupted.

Our operations depend significantly on effective information systems, which require continual maintenance, upgrading and enhancement to meet our operational needs. Any system failure that causes an interruption in service or availability of our systems could adversely affect operations or delay the collection of revenues. Moreover, our growth and acquisition strategy will require frequent transitions and integration of various information systems. If we are unable to properly integrate other information systems or expand our current information systems, we could suffer, among other things, operational disruptions, disruptions in cash flows and increases in administrative expenses.

Information security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of perpetrators of cyber-attacks. A failure in or breach of our operational or information security systems as a result of cyber-attacks or information security breaches could disrupt our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs or lead to fines and financial losses. As a result, cyber security and the continued development and enhancement of the controls and processes designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. Although we believe that we have appropriate information security procedures and other safeguards in place, as cyber threats continue to evolve, we may be required to expend additional resources to continue to enhance our information security measures or to investigate and remediate any information security vulnerabilities.

We may not be able to fully realize the value of our net operating loss carryforwards.

As of December 31, 2013, we had unused federal net operating loss carryforwards (“NOLs”) of approximately $263.7 million. Such losses expire in various amounts at varying times beginning in 2027. Unless

 

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they expire, these NOLs may be used to offset future taxable income and thereby reduce our income taxes otherwise payable. While we believe we will be able to use a substantial portion of these tax benefits before they expire, no such assurances can be provided. For further discussion of our NOLs see Note 13, Income Taxes, to the accompanying consolidated financial statements.

As of December 31, 2013, we maintained a full valuation allowance of $166.1 million against our deferred tax assets. On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. While we have concluded that a full valuation allowance continued to be appropriate as of December 31, 2013, we are continually monitoring actual and forecasted earnings. 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.

If reversal of the valuation allowance does occur, we will need to continue to monitor results. If our expectations for future operating results on a consolidated basis or at the state jurisdiction level vary from actual results due to changes in healthcare regulations, general economic conditions, or other factors, we may need to adjust the valuation allowance, for all or a portion of our deferred tax assets. Our income tax expense in future periods will be reduced or increased to the extent of offsetting decreases or increases, respectively, in our valuation allowance in the period when the change in circumstances occurs. These changes could have a significant impact on our future earnings.

Section 382 (“Section 382”) of the Internal Revenue Code of 1986, as amended (the “Code”) imposes an annual limit on the ability of a corporation that undergoes an “ownership change” to use its NOLs to reduce its tax liability. An “ownership change” is generally defined as any change in ownership of more than 50% of a corporation’s “stock” by its “5-percent shareholders” (as defined in Section 382) over a rolling three-year period based upon each of those shareholder’s lowest percentage of stock owned during such period. It is possible that future transactions, not all of which would be within our control (including a possible sale by TPG or MTS of some or all of their respective shares of our common stock), could cause us to undergo an ownership change as defined in Section 382. In that event, we would not be able to use our pre-ownership-change NOLs in excess of the limitation imposed by Section 382. At this time, we do not believe these limitations will affect our ability to use any NOLs before they expire, but we cannot assure you that will be the case. If our ability to utilize our NOLs to offset taxable income generated in the future is subject to this limitation, it could have an adverse effect on our business, prospects, results of operations and financial condition.

Our facilities may be adversely impacted by weather and other factors beyond our control.

The financial results of our facilities may be adversely impacted by adverse weather conditions, such as tornadoes, earthquakes and hurricanes, or other factors beyond our control, such as wildfires. These weather conditions or other factors could disrupt patient scheduling, displace our patients, teammates and physician partners and force certain of our facilities to close temporarily or for an extended period of time. In certain markets, including Southern and Northern California, we have a large concentration of surgery centers that may be simultaneously affected by adverse weather conditions, earthquakes, wildfires or other events beyond our control.

Risks Related to Healthcare Regulation

We are currently unable to predict the impact of the Health Reform Law, which represents a significant change to the healthcare industry.

The Health Reform Law will change how healthcare services are covered, delivered and reimbursed through, among other things, expanded coverage of uninsured individuals, reduced growth in Medicare program spending and the establishment of programs where reimbursement is tied to quality. The Health Reform Law also reforms certain aspects of health insurance, expands existing efforts to tie Medicare and Medicaid payments to performance and quality and contains provisions intended to strengthen fraud and abuse enforcement. Due to the

 

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complexity of the Health Reform Law, the many factors involved in its implementation and ongoing court challenges on certain issues, it is difficult to predict the full impact of the Health Reform Law on the healthcare industry.

The Health Reform Law was signed into law in March 2010; however, many of its measures do not take effect until 2014 or later and other measures have been delayed. For example, the date by which individuals must have obtained qualified health insurance coverage in order to avoid tax penalties has been delayed until March 31, 2014. In addition, the Health Reform Law’s employer mandate, pursuant to which certain larger employers that do not offer health insurance benefits to their employees will be required to make “shared responsibility payments” if an employee obtains government-subsidized coverage through the Health Insurance Marketplace, will be delayed until January 1, 2015, for employers with 100 or more employees, and until January 1, 2016, for employers with 50 to 99 employees.

Further, it is unclear how many states will decline to implement the Medicaid expansion provisions of the Health Reform Law. In June 2012, the Supreme Court upheld the constitutionality of the individual mandate provisions of the Health Reform Law, but struck down provisions that would have allowed HHS to penalize states that do not implement the Medicaid expansion provisions of the law with the loss of existing Medicaid funding. As a result, some states may choose not to implement the Medicaid expansion, and fewer individuals will be covered by a state Medicaid program than would have been covered had the Supreme Court upheld the Health Reform Law in its entirety.

In addition, the potential impact of the Health Insurance Marketplace, the system of state and federal health insurance exchanges through which qualified health insurance coverage may be obtained, is uncertain. The purpose of the Health Insurance Marketplace is to provide consumers, including individuals that do not currently have health insurance, with a convenient and transparent marketplace through which individual health insurance products may be purchased. The Health Insurance Marketplace became operational on October 1, 2013, with insurance coverage purchased through the Marketplace taking effect as early as January 1, 2014. It is possible that rates payable to providers under health insurance policies purchased by an individual through the Health Insurance Marketplace will be lower than rates payable under policies purchased by an employer for a group. It is also possible that some employers will opt to cease providing group coverage and make “shared responsibility payments,” leaving their employees to purchase individual policies through the Marketplace. The impact of the Health Insurance Marketplace on the market for individual policies, and the rates payable to providers under health insurance products offered through the Marketplace, is uncertain.

The Health Reform Law makes several significant changes to healthcare fraud and abuse laws, provides additional enforcement tools for the Federal government, increases cooperation between federal agencies by establishing mechanisms for the sharing of information and enhances criminal and administrative penalties for non-compliance. For example, the Health Reform Law: (i) provides $350 million in increased federal funding to fight healthcare fraud, waste and abuse; (ii) expands the scope of the Recovery Audit Contractor program to include both the Medicaid and Medicare Advantage plans; (iii) authorizes HHS, in consultation with the OIG, to suspend Medicare and Medicaid payments to a provider of services or a supplier “pending an investigation of a credible allegation of fraud;” (iv) provides Medicare contractors with additional flexibility to conduct random prepayment reviews; and (v) strengthens the rules for returning overpayments made by governmental health programs, including expanding liability under the FCA to extend to failures to timely repay identified overpayments. The Health Reform Law also places limitations on an exception to the Stark Law that allows physicians to invest in hospitals if the physicians’ investments are in the entire hospital and not just a department of the hospital (the “whole hospital exception”). Among other things, the Health Reform Law prohibits hospitals from increasing the percentages of the total value of the ownership interests held in the hospital by physicians after March 23, 2010, and places restrictions on the ability of a hospital subject to the whole hospital exception to add operating rooms, procedure rooms and beds.

As a result of the Health Reform Law, we expect enhanced scrutiny of healthcare providers’ compliance with state and federal regulations, increased enforcement of infection control standards and implementation of

 

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other quality control measures. In addition, the Health Reform Law includes certain value-based purchasing initiatives, and we expect such initiatives, including programs that condition reimbursement on patient outcome measures, to become more common among governmental and commercial payors. Pursuant to the Health Reform Law, HHS has submitted a report to Congress outlining HHS’s plan to implement a value-based purchasing program for ASCs that would tie Medicare payments to quality and efficient measures. In addition, CMS has promulgated three national coverage determinations that prevent Medicare from paying for certain serious, preventable medical errors that occur in a healthcare facility. Several commercial payors also do not reimburse providers for certain preventable adverse events. CMS has also established an ASC Quality Reporting Program. Failure to report quality data according to CMS requirements may result in a reduction of the Medicare payment rates in subsequent years. An increased emphasis by government and accreditation agencies on the accuracy of quality reporting, quality performance and more rigorous performance standards and oversight could result in a reduction of the payments and fees that we receive from Medicare.

In addition, the Health Reform Law mandates reductions in reimbursement, such as adjustments to the hospital inpatient and outpatient prospective payment system market basket updates and productivity adjustments to Medicare’s annual inflation updates, which became effective in 2010 and 2012. Further, additional cuts to Medicare and Medicaid payments may occur depending on government response to economic conditions.

Because of the many fluid and dynamic variables involved, we are currently unable to predict the net effect of the Health Reform Law and other associated changes within the healthcare industry on us or our operations. Further, it is unclear how efforts to repeal or revise the Health Reform Law will be resolved or what the impact, if any, would be of any resulting changes to the law. However, depending on how the Health Reform Law is ultimately interpreted, amended and implemented, it could have a material adverse effect on our business, prospects, results of operations and financial condition.

If we fail to comply with or otherwise incur liabilities under the numerous federal and state laws and regulations relating to the operation of our facilities, we could incur significant penalties or other costs or be required to make significant changes to our operations.

We are subject to many laws and regulations at the federal, state and local government levels in the markets in which we operate. These laws and regulations require that our facilities meet various licensing, certification and other requirements, including, but not limited to, those relating to:

 

    ownership and control of our facilities;

 

    qualification of medical and support persons;

 

    pricing of, billing for and coding of services and properly handling overpayments;

 

    the adequacy of medical care, equipment, personnel, operating policies and procedures;

 

    maintenance and preservation of medical records;

 

    financial arrangements between referral sources and our facilities;

 

    the protection of privacy, including patient and credit card information;

 

    provision of emergency services;

 

    antitrust;

 

    state licensing standards; and

 

    environmental protection, health and safety.

If we fail or have failed to comply with applicable laws and regulations, we could be subject to administrative, civil or criminal penalties, cease and desist orders, forfeiture of amounts owed and recoupment of amounts paid to us by governmental or commercial payors, loss of licenses necessary to operate and disqualification from Medicare, Medicaid and other government-sponsored healthcare programs.

 

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We do not control compliance programs at certain of our nonconsolidated facilities; however, if there are failures in compliance or regulatory violations at those facilities, such failures or violations could have a material adverse effect on our business, prospects, results of operations and financial condition.

In pursuing our growth strategy, we may seek to expand our presence into states in which we do not currently operate. In new geographic areas, we may encounter laws and regulations that differ from those applicable to our current operations. If we are unwilling or unable to comply with these legal requirements in a cost-effective manner, we will not be able to expand into new states.

In addition, some of the governmental and regulatory bodies that regulate us are considering or may in the future consider enhanced or new regulatory requirements. These authorities may also seek to exercise their supervisory or enforcement authority in new or more robust ways. All of these possibilities, if they occurred, could detrimentally affect the way we conduct our business and manage our capital, either of which, in turn, could have a material adverse effect on our business, prospects, results of operations and financial condition.

If laws or regulations governing physician ownership of our facilities change, we may be obligated to purchase some or all of the ownership interests of our physician partners or renegotiate some of our partnership and operating agreements with our physician partners and management agreements with our surgical facilities.

Regulatory changes or changes in the interpretation of existing laws or regulations may obligate us to purchase all of the ownership interests of the physician investors in partnerships or LLCs that own and operate our facilities. Such changes would include those that:

 

    make illegal the referral of patients to our facilities by physician investors;

 

    create a substantial likelihood that cash distributions to physician investors from the partnerships or LLCs through which we operate our facilities would be illegal; or

 

    make illegal the ownership by the physician investors of interests in the partnerships or LLCs through which we own and operate our facilities.

In addition, some of our partnership and operating agreements with our physician partners and management agreements with our facilities require us to renegotiate such agreements upon the occurrence of various fundamental regulatory changes or changes in the interpretation of existing regulations and provide for termination of such agreements if such renegotiations are not successful.

We cannot control whether or when any of these regulatory events might occur. In the event we are required to purchase all of the physicians’ ownership interests in our facilities, our existing capital resources would not be sufficient for us to meet this obligation. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.” These obligations and the possible termination of our partnership, operating and management agreements would have a material adverse effect on our business, prospects, results of operations and financial condition.

The Medicare and Medicaid programs, which together provide a material portion of our net patient revenues, are particularly susceptible to legislative and regulatory changes that could adversely affect our revenues and profitability.

The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, spending freezes, federal and state funding reductions and administrative rulings and interpretations concerning, without limitation, patient eligibility requirements, funding levels and the method of calculating payments or reimbursements. Any of these factors could adversely affect the level and timing of payments to our surgical facilities. For the year-ended December 31, 2013, payments from Medicare and Medicaid represented approximately 20% and 3% of our net patient revenues, respectively.

 

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In recent years, legislative and regulatory changes have resulted in limitations on and, in some cases, reductions in levels of payments to healthcare providers for certain services under the Medicare program. The Budget Control Act of 2011 (the “BCA”) requires automatic spending reductions of $1.2 trillion for federal fiscal years 2013 through 2021, minus any deficit reductions enacted by Congress and debt service costs. The percentage reduction for Medicare may not be more than 2% for a fiscal year, with a uniform percentage reduction across all Medicare programs. The BCA-mandated spending reductions went into effect on March 1, 2013. We are unable to predict how these spending reductions will be structured, what other deficit reduction initiatives may be proposed by Congress or whether Congress will attempt to suspend or restructure the automatic budget cuts. These reductions will be in addition to reductions mandated by the Health Reform Law, which provides for material reductions in the growth of Medicare program spending.

Many states must operate with balanced budgets, and the Medicaid program is often the largest budget expenditure for many states. The current economic environment has increased the budgetary pressures on many states, and these budgetary pressures have resulted, and likely will continue to result, in decreased spending or decreased spending growth for Medicaid programs in many states. Some states that provide Medicaid supplemental payments are reviewing these programs or have filed waiver requests with CMS to replace these programs, which could result in Medicaid supplemental payments being reduced or eliminated.

We are unable to predict the effect of future government healthcare funding policy changes on our operations. If the rates paid by governmental payors are reduced or if the scope of services covered by governmental payors is limited there could be, in either case, a material adverse effect on our business, prospects, results of operations and financial condition.

Our surgical facilities do not satisfy the requirements for any of the safe harbors under the Anti-Kickback Statute. If we fail to comply with the Anti-Kickback Statute, we could be subject to criminal and civil penalties, loss of licenses and exclusion from governmental programs, which may result in a substantial loss of revenues.

The Anti-Kickback Statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for referring, ordering, leasing, purchasing or arranging for or recommending the ordering, purchasing or leasing of items or services payable by Medicare, Medicaid or any other federally funded healthcare program. The Anti-Kickback Statute is broad in scope, and many of its provisions have not been uniformly or definitively interpreted by existing case law or regulations. Courts have found a violation of the Anti-Kickback Statute if just one purpose of the remuneration is to generate referrals, even if there are other lawful purposes. Violations of the Anti-Kickback Statute may result in substantial civil or criminal penalties, plus three times the remuneration involved or the amount claimed and exclusion from participation in the Medicare and Medicaid programs. Our exclusion from participation in such programs would have a material adverse effect on our business, prospects, results of operations and financial condition. In addition, many of the states in which we operate have also adopted laws, similar to the Anti-Kickback Statute, that prohibit payments to physicians in exchange for referrals, some of which apply regardless of the source of payment for care. These statutes typically impose criminal and civil penalties, including the loss of a license to do business in the state.

In July 1991, HHS issued final regulations defining various “safe harbors” under the Anti-Kickback Statute. Business arrangements that meet the requirements of the safe harbors are deemed to be in compliance with the Anti-Kickback Statute. Business arrangements that do not meet the safe harbor requirements do not necessarily violate the Anti-Kickback Statute, but may be subject to scrutiny by the Federal government to determine compliance. Two of the original safe harbors issued in 1991 apply to business arrangements similar to those used in connection with our surgical facilities. However, the structure of the entities operating our facilities generally does not satisfy all of the requirements of either such safe harbor.

In November 1999, HHS issued final regulations creating additional safe harbor provisions, including a safe harbor that applies to physician ownership of, or investment interests in, ASCs. However, our ASC arrangements do not comply with all of the requirements of the ASC safe harbor and, therefore, are not immune from government review or prosecution.

 

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Further, we employ dedicated marketing personnel whose job functions include the recruitment of physicians to practice surgery at our centers. These teammates are paid a base salary plus a productivity bonus. We believe our employment arrangements with these teammates are consistent with a safe harbor provision designed to protect payments made to employees. However, a government agency or private party may assert a contrary position.

Although we believe that our business arrangements do not violate the Anti-Kickback Statute or similar state laws, a government agency or a private party may assert a contrary position. Additionally, new federal or state laws may be enacted that would cause our relationships with our physician partners to become illegal or result in the imposition of penalties against us or our facilities. If any of our business arrangements with physician partners were alleged or deemed to violate the Anti-Kickback Statute or similar laws, or if new federal or state laws were enacted rendering these arrangements illegal, it could have a material adverse effect on our business, prospects, results of operations and financial condition.

If we fail to comply with physician self-referral laws as they are currently interpreted or may be interpreted in the future, or if other legislative restrictions are issued, we could incur substantial monetary penalties and a significant loss of revenues.

The Stark Law prohibits a physician from making a referral to an entity for the furnishing of certain “designated health services” otherwise payable under Medicare or Medicaid if the physician or a member of the physician’s immediate family has a financial relationship with the entity, such as an ownership interest or compensation arrangement, unless an exception applies. The Stark Law also prohibits entities that provide designated health services otherwise payable by Medicare or Medicaid from billing the Medicare and Medicaid programs for any items or services that result from a prohibited referral and requires the entities to refund amounts received for items or services provided pursuant to the prohibited referral. HHS, acting through CMS, has promulgated regulations implementing the Stark Law. These regulations exclude health services provided by an ASC from the definition of “designated health services” if the services are included in the facility’s composite Medicare payment rate. Therefore, the Stark Law’s self-referral prohibition generally does not apply to health services provided by an ASC. However, if the ASC is separately billing Medicare for designated health services that are not covered under the ASC’s composite Medicare payment rate, or if either the ASC or an affiliated physician is performing (and billing Medicare) for procedures that involve designated health services that Medicare has not designated as an ASC service, the Stark Law’s self-referral prohibition would apply and such services could implicate the Stark Law. We believe that our operations do not violate the Stark Law, as currently interpreted. All services provided by our ASCs that would otherwise constitute designated health services are reimbursed by Medicare as part of the composite payment rate and are thus subject to an exception from the Stark Law, with the exception of implants. The Stark Law provides for a special exception for implants, such as intraocular lenses and artificial joints, furnished in ASCs as long as certain regulatory requirements are met. These requirements provide that the implant must be implanted by the referring physician or a member of his or her group practice, that the implant be implanted during a surgical procedure reimbursed as an ASC procedure by Medicare, that the arrangement for the furnishing of the implant not violate the Anti-Kickback Statute and that the billing for the implant be conducted legally. In addition, we believe that physician ownership of ASCs is not prohibited by similar self-referral statutes enacted at the state level. However, the Stark Law and similar state statutes are subject to different interpretations with respect to many important provisions. Moreover, the Stark Law applies to our five surgical hospitals. Violations of these self-referral laws may result in substantial civil or criminal penalties, including large civil monetary penalties and exclusion from participation in the Medicare and Medicaid programs. If physician self-referral laws are interpreted differently or if other legislative restrictions are issued, we could incur significant sanctions and loss of revenues, or we could have to change our arrangements and operations in a way that could have a material adverse effect on our business, prospects, results of operations and financial condition.

 

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Federal law restricts the ability of our surgical hospitals to expand surgical capacity.

The Stark Law includes an exception that permits physicians to refer Medicare and Medicaid patients to hospitals in which they have an ownership interest if certain requirements are met. However, the Health Reform Law dramatically curtailed this exception and prohibits physician ownership in hospitals that did not have a Medicare provider agreement by December 31, 2010. This prohibition does not apply to our five surgical hospitals, each of which had a Medicare provider agreement in place prior to December 31, 2010 and are therefore able to continue operating with their existing ownership structure. However, the Health Reform Law prohibits “grandfathered” hospitals from increasing their percentage of physician ownership, and it limits to a certain extent their ability to grow, because it prohibits such hospitals from increasing the aggregate number of inpatient beds, operating rooms and procedure rooms.

Companies within the healthcare industry continue to be the subject of federal and state audits and investigations, and we may be subject to such audits and investigations, including actions for false and other improper claims.

Federal and state government agencies, as well as commercial payors, have increased their auditing and administrative, civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations. These audits and investigations relate to a wide variety of topics, including the following: cost reporting and billing practices; quality of care; financial reporting; financial relationships with referral sources; medical necessity of services provided; and classification of the level of care provided, including proper classification of inpatient admissions, observation services and outpatient care. In addition, the OIG and the DOJ have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse.

The Federal government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for payment from the Medicare or Medicaid programs. Claims filed with private insurers can also lead to criminal and civil penalties. While the criminal statutes are generally reserved for instances of fraudulent intent, the Federal government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances, including claiming payment for unnecessary services if the claimant merely should have known the services were unnecessary and claiming payment for low-quality services if the claimant should have known that the care was substandard. In addition, a violation of the Stark Law or the Anti-Kickback Statute can result in liability under the FCA.

Over the past several years, the Federal government has accused an increasing number of healthcare providers of violating the FCA, which prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the Federal government. The statute defines “knowingly” to include not only actual knowledge of a claim’s falsity, but also reckless disregard for or intentional ignorance of the truth or falsity of a claim. Violators of the FCA are subject to severe financial penalties, including treble damages and per claim penalties in excess of $10,000. Because our facilities perform hundreds or thousands of similar procedures each year for which they are paid by Medicare, and since the statute of limitations for such claims extends for six years under normal circumstances (and possibly as long as ten years in the event of failure to discover material facts), a repetitive billing error or cost reporting error could result in significant, material repayments and civil or criminal penalties.

Under the “qui tam,” or whistleblower, provisions of the FCA, private parties may bring actions on behalf of the Federal government. These private parties, often referred to as relators, are entitled to share in any amounts recovered by the government through trial or settlement. These qui tam cases are sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the Federal government and the presiding court. It is possible that qui tam lawsuits have been filed against us and that we are unaware of such filings. Both direct enforcement activity by the government and whistleblower lawsuits under the FCA have increased significantly in recent years; thus, the risk that we will have to defend a false claims action, pay significant fines or be excluded from the Medicare and Medicaid programs has increased. In addition,

 

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under the Health Reform Law, if we receive an overpayment, we must report and refund the overpayment before the later of sixty days after the overpayment was identified or the date any corresponding cost report is due, if applicable. Any overpayment that is retained after this deadline is considered an obligation subject to an action under the FCA. Although we believe that our operations comply with both federal and state laws, they may nevertheless be the subject of a whistleblower lawsuit or may otherwise be challenged or scrutinized by governmental authorities. A determination that we have violated these laws could have a material adverse effect on our business, prospects, results of operations and financial condition.

We are also subject to various state laws and regulations, as well as contractual provisions with commercial payors that prohibit us from submitting inaccurate, incorrect or misleading claims. We believe that our surgical facilities are in material compliance with all such laws, regulations and contractual provisions regarding the submission of claims. We cannot be sure, however, that none of our surgical facilities’ claims will ever be challenged. If we were found to be in violation of a state’s laws or regulations, or of a commercial payor contract, we could be forced to discontinue the violative practice and be subject to recoupment actions, fines and criminal penalties, which could have a material adverse effect on our business, prospects, results of operations and financial condition.

All payors are increasingly conducting post-payment audits. For example, CMS has implemented the RAC program, involving Medicare claims audits nationwide. Under the program, CMS contracts with RACs on a contingency fee basis to conduct post-payment reviews to detect and correct improper payments in the fee-for-service Medicare program. The Health Reform Law expanded the RAC program’s scope to include managed Medicare plans and to include Medicaid claims. In addition, CMS employs MICs to perform post-payment audits of Medicaid claims and identify overpayments. The Health Reform Law increases federal funding for the MIC program. In addition to RACs and MICs, the state Medicaid agencies and other contractors have increased their review activities. We are regularly subject to these external audits and we also perform internal audits and monitoring. Depending on the nature of the conduct found in such audits and whether the underlying conduct could be considered systemic, the resolution of these audits could have a material adverse effect on our business, prospects, results of operations and financial condition.

Failure to comply with Medicare’s conditions for coverage and conditions of participation may result in loss of program payment or other governmental sanctions.

To participate in and receive payment from the Medicare program, our facilities must comply with regulations promulgated by CMS. These regulations, known as “conditions for coverage” for ASCs and “conditions of participation” for hospitals, set forth specific requirements with respect to the facility’s physical plant, equipment, personnel and standards of medical care. All of our surgery centers and surgical hospitals are certified to participate in the Medicare program. As such, these facilities are subject to on-site, unannounced surveys by state survey agencies working on behalf of CMS. Under the ASC survey process, the surveyors are becoming more familiar with expanded interpretive guidance and the updated ASC conditions for coverage, which may lead to an increased number of deficiency citations requiring remedy with appropriate action plans. Failure to comply with Medicare’s conditions for coverage and conditions of participation may result in loss of payment or other governmental sanctions, including termination from participation in the Medicare program. We have established ongoing quality assurance activities to monitor our facilities’ compliance with these conditions and respond to surveys, but we cannot be sure that our facilities are or will always remain in full compliance with the requirements.

We are subject to federal privacy regulations enacted under HIPAA, and ensuring continued compliance with HIPAA could require us to expend significant resources and capital, impair our profitability and limit our ability to grow our business.

HIPAA mandates the adoption of privacy, security and integrity standards related to patient information and standardizes the method for identifying providers, employers, health plans and patients. Numerous federal regulations have been adopted under HIPAA. We have taken actions to comply with the HIPAA privacy

 

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regulations and believe that we are in substantial compliance with those regulations. These actions include the establishment of policies and procedures, teammate training, identifying “business associates” with whom we need to enter into HIPAA-compliant contractual arrangements and various other measures. Ongoing implementation and oversight of these measures involves significant time, effort and expense.

Other federal regulations adopted under HIPAA require our surgical facilities to conduct certain standardized healthcare transactions, including billing and other claim transactions. We have undertaken significant efforts involving substantial time and expense to ensure that our surgical facilities and hospitals submit HIPAA-compliant transactions. We anticipate that continual time and expense will be required to submit HIPAA-compliant transactions and to ensure that any newly acquired facilities can submit HIPAA-compliant transactions.

In addition, compliance with the HIPAA security regulations requires ASCs, hospitals and other covered entities to implement reasonable technical, physical and administrative security measures to safeguard protected healthcare information maintained, used and disclosed in electronic form. We have taken actions in an effort to be in compliance with these regulations and believe that we are in substantial compliance with the HIPAA security regulations. A cyber-attack that bypasses our information security systems causing an information security breach, loss of protected health information or other data subject to privacy laws or a material disruption of our operational systems could result in a material adverse impact on our business, along with fines. Ongoing implementation and oversight of these security measures involves significant time, effort and expense. For additional information regarding the risks related to management and security of our information systems, see “Risks Related to Our Business — If we are unable to manage and secure our information systems effectively, our operations could be disrupted.”

ARRA broadened the scope of the HIPAA privacy and security regulations. Among other things, ARRA extends the application of certain provisions of the security and privacy regulations to business associates (entities that handle identifiable health information on behalf of covered entities) and subjects business associates to civil and criminal penalties for violation of the regulations. ARRA and its implementing regulations also require covered entities to report breaches of unsecured protected health information to affected individuals without unreasonable delay and in no case later than 60 days after the discovery of the breach by the covered entity or its agents. Notification must also be made to HHS and, in certain situations involving large breaches, to the media. Pursuant to a rule issued to implement ARRA, HHS has created a presumption that all non-permitted uses or disclosures of unsecured protected health information are breaches unless the covered entity or business associate establishes that there is a low probability the information has been compromised. Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties, and ARRA strengthened HIPAA’s enforcement provisions. ARRA increased the amount of civil penalties, with penalties now ranging up to $50,000 per violation and a maximum civil penalty of $1.5 million in a calendar year for violations of the same requirement. In addition, ARRA authorized state attorneys general to bring civil actions seeking either an injunction or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents.

In addition, states may impose more protective privacy laws, and both state and federal laws are subject to modification or enhancement of privacy protection at any time. Our facilities will continue to remain subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These statutes vary and could impose additional requirements on us and more severe penalties for disclosures of confidential health information. If we fail to comply with HIPAA or similar state laws, we could incur substantial monetary penalties.

If we fail to effectively and timely implement electronic health record systems and transition to the ICD-10 coding system, our operations could be adversely affected.

As required by ARRA, the Secretary of HHS has developed and implemented an incentive payment program for eligible hospitals and healthcare professionals that adopt and meaningfully use certified electronic

 

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health record (“EHR”) technology. We have incurred and will continue to incur both capital costs and operating expenses in order to implement certified EHR technology and meet meaningful use requirements. We have incurred $3.5 million of operating expenses to implement our certified EHR technology and to meet meaningful use requirements. These expenses are ongoing and are projected to continue over all stages of implementation of meaningful use. The timing of expenses will not correlate with the receipt of the incentive payments and the recognition of incentive income. If our eligible hospitals are unable to meet the requirements for participation in the incentive payment program, we will not be eligible to receive incentive payments that could offset some of the costs of implementing EHR systems. In addition, although the ARRA incentive payment program does not apply to surgery centers, we have not yet determined an EHR solution for our surgery center facilities. A requirement that surgery centers adopt and meaningfully use EHR technology could cause us to incur significant additional capital costs and operating expenses. As physicians become more integrated with EHR in their practices, we could incur additional capital costs and operating expenses in connection with implementing new technologies at our surgery centers.

Health plans and providers, including our facilities, are required to transition to the new ICD-10 coding system, which greatly expands the number and detail of billing codes used for third-party claims. Use of the ICD-10 system is required beginning October 1, 2014. This transition requires significant investment in coding technology and software, and training of staff involved in the coding and billing process. In addition to these upfront costs of transitioning to ICD-10, our facilities could experience significant disruption or delays in payment due to technical or coding errors or other implementation issues involving either our systems, or the systems and implementation efforts of health plans and their business partners. Further, the extent to which the transition to the more detailed ICD-10 coding system could result in decreased reimbursement, because the use of ICD-10 codes results in conditions being reclassified to payment groupings with lower levels of reimbursement than assigned under the previous system, is unknown at this time.

Efforts to regulate the construction, relocation, acquisition, change of ownership, change of control or expansion of healthcare facilities could prevent us from acquiring additional facilities, renovating our existing facilities or expanding the breadth of services we offer.

Some states require us to apply for and receive prior approval, typically in the form of a CON, for the construction, relocation, acquisition, change of ownership or change of control of healthcare facilities or expansion of the number of operating or procedure rooms or services our facilities offer. In granting approval, these states consider the need for additional or expanded healthcare facilities or for additional or expanded services. Additionally, third parties, including our competitors, have the right to, and often do, object to our applications for a CON. In many of the states in which we currently operate, CONs must be obtained for capital expenditures exceeding a prescribed amount, changes in capacity or services offered and various other matters, including change of control or change of ownership. Other states in which we now or may in the future operate may adopt similar legislation. Our costs of obtaining a CON could be significant, and we cannot ensure that we will be able to obtain the CON or other required approvals for the addition, expansion or change of control or change of ownership of facilities or services in the future. If we are unable to obtain required approvals, we may not be able to acquire additional facilities, expand healthcare services we provide at our existing facilities or replace, expand or relocate our facilities.

If antitrust enforcement authorities conclude that our market share in any particular market is too concentrated, that our or our health system partners’ commercial payor contract negotiating practices are illegal, or that we otherwise violate antitrust laws, we could be subject to enforcement actions that could have a material adverse effect on our business, prospects, results of operations and financial condition.

The Federal government and most states have enacted antitrust laws that prohibit certain types of conduct deemed to be anti-competitive. These laws prohibit price fixing, concerted refusal to deal, market monopolization, price discrimination, tying arrangements, acquisitions of competitors and other practices that have, or may have, an adverse effect on competition. Violations of federal or state antitrust laws can result in various sanctions, including criminal and civil penalties. Antitrust enforcement in the healthcare industry is

 

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currently a priority of the FTC. We believe we are in compliance with federal and state antitrust laws, but courts or regulatory authorities may reach a determination in the future that could have a material adverse effect on our business, prospects, results of operations and financial condition.

The healthcare laws and regulations to which we are subject are constantly evolving and may change significantly in the future.

The laws and regulations applicable to our business and to the healthcare industry generally to which we are subject are constantly in a state of flux. While we believe that we have structured our agreements and operations in material compliance with applicable healthcare laws and regulations, there can be no assurance that we will be able to successfully address changes in the current regulatory environment. We believe that our business operations materially comply with applicable healthcare laws and regulations. However, some of the healthcare laws and regulations applicable to us are subject to limited or evolving interpretations, and a review of our business or operations by a court, law enforcement or a regulatory authority might result in a determination that could have a material adverse effect on us. Furthermore, the healthcare laws and regulations applicable to us may be amended or interpreted in a manner that could have a material adverse effect on our business, prospects, results of operations and financial condition.

Risks Related to Our Common Stock

We are a “controlled company” within the meaning of the NASDAQ Stock Market (“NASDAQ”) listing rules and, as a result, qualify for, and rely on, exemptions from certain corporate governance requirements. You do not have the same protections afforded to stockholders of companies that are subject to such requirements.

TPG currently controls a majority of the voting power of our outstanding common stock. As a result, we are a “controlled company” within the meaning of NASDAQ listing rules. Under these standards, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements, including the requirements:

 

    that a majority of the board of directors consists of independent directors;

 

    that we have a nominating and corporate governance committee that is composed entirely of independent directors; and

 

    that we have a compensation committee that is composed entirely of independent directors.

We are currently utilizing certain of these exemptions. Although we currently have a majority of independent directors on our board of directors, our Nominating and Corporate Governance Committee and Compensation Committee do not consist entirely of independent directors. Accordingly, you do not have the same protections afforded to stockholders of companies that are subject to all of the NASDAQ corporate governance requirements.

In addition, on June 20, 2012, the SEC passed final rules implementing provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) pertaining to compensation committee independence and the role and disclosure of compensation consultants and other advisers to the compensation committee. The SEC’s rules directed each of the national securities exchanges to develop listing standards requiring, among other things, that:

 

    compensation committees be composed of fully independent directors, as determined pursuant to new independence requirements;

 

    compensation committees be explicitly charged with hiring and overseeing compensation consultants, legal counsel and other committee advisors; and

 

    compensation committees be required to consider, when engaging compensation consultants, legal counsel or other advisors, certain independence factors, including factors that examine the relationship between the consultant or advisor’s employer and us.

 

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On January 11 and December 11, 2013, the SEC approved the proposed listing standards of the national securities exchanges, including NASDAQ, related to, among other items, compensation committee advisors and compensation committee independence. As a “controlled company,” we are not subject to these compensation committee independence requirements, but we are subject to the other requirements.

If in the future we no longer qualify as a “controlled company” within the meaning of NASDAQ listing rules, we will no longer qualify for exemptions from certain corporate governance requirements.

We are listed on the NASDAQ Global Select Market and are therefore subject to NASDAQ’s listing rules. If in the future, as a result of additional issuances of common stock or otherwise, TPG no longer holds more than 50% of our outstanding common stock, we will no longer be a “controlled company” within the meaning of NASDAQ’s listing rules. Pursuant to the requirements of NASDAQ’s listing rules, within one year after a loss in status as a controlled company, our Compensation Committee and Nominating and Corporate Governance Committee must be composed entirely of “independent directors” (as defined by NASDAQ’s listing rules). During the phase-in period granted by NASDAQ’s listing rules, our stockholders will not have the same protections afforded to stockholders of companies that are subject to all of NASDAQ’s listing rules. If, within one year of a loss of controlled company status, we do not have additional independent directors on our Compensation Committee and Nominating and Corporate Governance Committee, we will not be in compliance with NASDAQ’s listing rules and may be subject to enforcement actions by NASDAQ.

TPG has significant influence over us, including control over decisions that require the approval of stockholders, which could limit your ability to influence the outcome of key transactions, including a change of control, and which may result in conflicts with us or you in the future.

We are controlled by TPG, and they currently own approximately 62.6% of our common stock. Pursuant to the Stockholders’ Agreement, dated November 4, 2013, among the Company, TPG and its affiliates, TPG currently has the right to designate a majority of the seats on our board of directors, and as a result Mr. Sisitsky, a TPG Partner, Mr. Rhodes, a TPG Principal, and Mr. Geiser and Dr. Mansukani, each of whom provide consulting services to TPG, have been appointed to our board of directors. As a result, TPG can exercise control over our affairs and policies, including the approval of certain actions such as amending our Certificate of Incorporation, commencing bankruptcy proceedings and taking certain actions (including, without limitation, incurring debt, issuing stock, selling assets and engaging in mergers and acquisitions), appointing members of our management and any transaction that requires stockholder approval regardless of whether others believe that such change or transaction is in our best interests. The interests of TPG may not be consistent with your interests as a stockholder. So long as TPG continues to hold a majority of our outstanding common stock, TPG will have the ability to control the vote in any election of directors, amend our Certificate of Incorporation or By-Laws or take other actions requiring the vote of our stockholders. Even if the amount owned by TPG is less than 50%, TPG will continue to be able to strongly influence or effectively control our decisions. So long as TPG collectively owns at least 50% of the shares of our common stock held by them at the closing of our initial public offering, they will be able to designate for nomination a majority of the seats on our board of directors. This control may also have the effect of deterring hostile takeovers, delaying or preventing changes of control or changes in management, or limiting the ability of our other stockholders to approve transactions that they may deem to be in the best interests of our company. In addition, although we have opted out of the provisions of Section 203 of the General Corporation Law of the State of Delaware (the “DGCL”), which regulates corporate takeovers, our Certificate of Incorporation contains similar provisions related to business combinations with interested stockholders and provides that TPG and any of its direct or indirect transferees and any group as to which such persons are a party do not constitute interested stockholders for purposes of this provision.

Additionally, TPG is in the business of making investments in companies and may currently hold, and may from time to time in the future acquire, controlling interests in businesses engaged in industries that complement or compete, directly or indirectly, with certain portions of our business. Further, if TPG pursues other acquisitions in our industry, those acquisitions may not be available to us. These rights of TPG are set forth in

 

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our Certificate of Incorporation. So long as the TPG Funds (as defined in Part III, Item 10 herein) continue to indirectly own a significant amount of our equity, TPG will continue to be able to strongly influence or effectively control our decisions.

We are an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company,” under the JOBS Act, and we are permitted to, and currently intend to, take advantage of certain exemptions from certain disclosure requirements. We are an “emerging growth company” until the earliest of: (i) the last day of the fiscal year during which we had total annual gross revenues of $1.0 billion or more, (ii) the last day of the fiscal year following the fifth anniversary of the completion of our initial public offering, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt or (iv) the date on which we are deemed a “large accelerated filer” as defined under the federal securities laws. We will be deemed a large accelerated filer in the fourth quarter of 2014 if our public float as of June 30, 2014 is $700 million or greater. Our public float as of March 20, 2014 was approximately $456 million.

For so long as we remain an “emerging growth company”, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on certain executive compensation matters, such as “say on pay” and “say on frequency.” As a result, our stockholders may not have access to certain information that they may deem important. Although we currently intend to rely on the exemptions provided in the JOBS Act, the exact implications of the JOBS Act for us are still subject to interpretations and guidance by the SEC and other regulatory agencies.

In addition, Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised financial accounting standards. An emerging growth company can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have determined to opt out of such extended transition period and, as a result, we will comply with new or revised financial accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised financial accounting standards is irrevocable.

We cannot predict if investors will find our common stock less attractive as a result of our taking advantage of these exemptions. If some investors find our common stock less attractive as a result of our choices, there may be a less active trading market for our common stock, and our stock price may be more volatile.

Some provisions of Delaware law and our governing documents could discourage a takeover that stockholders may consider favorable.

In addition to TPG’s ownership of a controlling percentage of our common stock, Delaware law and provisions contained in our Certificate of Incorporation and By-Laws could have the effect of delaying, deferring or preventing a change of control of us. A change of control could be proposed in the form of a tender offer or takeover proposal that might result in a premium over the market price for our common stock. In addition, these provisions could make it more difficult to bring about a change in the composition of our board of directors, which could result in entrenchment of current management. For example, our Certificate of Incorporation and By-Laws:

 

    establish a classified board of directors so that not all members of our board of directors are elected at one time;

 

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    require that the number of directors be determined, and any vacancy or new board seat be filled, only by the board of directors;

 

    do not permit stockholders to act by written consent once TPG ceases to beneficially own more than 50% of our outstanding shares entitled to vote generally in the election of directors;

 

    do not permit stockholders to call a special meeting, provided, however, at any time when TPG beneficially owns at least 50% of our outstanding shares entitled to vote generally in the election of directors, special meetings of our stockholders shall also be called by the board of directors or the chairman of the board of directors at the request of TPG;

 

    require a 66 2/3% vote of all outstanding shares entitled to vote generally in the election of directors in order to amend certain provisions in the Certificate of Incorporation and By-Laws;

 

    provide that our directors may be removed only for cause by the affirmative vote of at least 66 2/3% of our outstanding shares entitled to vote generally in the election of directors;

 

    establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings;

 

    authorize the issuance of undesignated preferred stock, or “blank check” preferred stock, by our board of directors without stockholder approval; and

 

    contain provisions similar to that of Section 203 of the DGCL related to business combinations with interested stockholders and provide that TPG and any of its direct or indirect transferees and any group as to which such persons are a party, do not constitute interested stockholders for purposes of this provision.

Many of our employment agreements, plans and equity arrangements with our executive officers also contain change of control provisions. Under the terms of these arrangements, the executive officers are entitled to receive (i) certain payments or benefits upon a termination without cause or for good reason and (ii) accelerated vesting of option awards if the executive is terminated without cause or for good cause within the two-year period following a change in control.

These and other provisions of our organizational documents and Delaware law may have the effect of delaying, deferring or preventing changes of control or changes in management, even if such transactions or changes would have significant benefits for our stockholders. As a result, these provisions could limit the price some investors might be willing to pay in the future for shares of our common stock.

    Prior to our initial public offering, there was no prior public market for our common stock and an active, liquid trading market for our common stock may not develop or be sustained.

Prior to our initial public offering, there was no public market for our common stock. Although our common stock is listed on the NASDAQ Global Select Market, we do not know whether third parties will find our common stock to be attractive or whether firms will be interested in continuing to make a market in our common stock. If an active and liquid trading market does not develop or is not sustained, you may have difficulty selling any of our common stock that you have purchased at an attractive price, or at all. The market price of our common stock may decline below its initial offering price, and you may not be able to sell your shares of our common stock at or above the price you paid for them, or at all, and may suffer a loss on your investment.

You may incur further dilution in the net tangible book value of the shares you have purchased.

We have a large number of outstanding stock options to purchase common stock with exercise prices that are below the initial public offering price of our common stock. In addition, HealthSouth Corporation (“HealthSouth”) holds an unvested option to purchase equity securities constituting 5% of the equity securities issued and outstanding as of the closing of our acquisition in 2007 on a fully diluted basis, which becomes exercisable upon certain customary liquidity events, including a public offering of shares of our common stock

 

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that results in 30% or more of our common stock being listed or traded on a national securities exchange. Additionally, as of March 20, 2014, there were 215,770 shares issuable upon settlement of restricted stock units. To the extent that these stock options are exercised, the option held by HealthSouth to purchase common shares becomes vested and is exercised or restricted stock units are settled in shares of our common stock, you may experience further dilution in the net tangible book value of the shares of common stock you have purchased.

The market price of our common stock may fluctuate significantly, and you could lose all or part of your investment as a result.

There is no guarantee that our common stock will appreciate in value or maintain the price at which our stockholders have purchased their shares. The trading price of our common stock may be volatile and subject to wide price fluctuations in response to various factors, many of which are beyond our control, including the following:

 

    quarterly variations in our results of operations;

 

    results of operations that vary from the expectations of securities analysts and investors;

 

    results of operations that vary from those of our competitors;

 

    changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors;

 

    strategic actions by us or our competitors;

 

    announcements by us, our competitors or our vendors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;

 

    changes in business or regulatory conditions;

 

    investor perceptions or the investment opportunity associated with our common stock relative to other investment alternatives;

 

    the public’s response to press releases or other public announcements by us or third parties, including our filings with the SEC;

 

    guidance, if any, that we provide to the public, any changes in this guidance or our failure to meet this guidance;

 

    changes in accounting principles;

 

    announcements by third parties or governmental entities of significant claims or proceedings against us;

 

    new laws and governmental regulations applicable to the healthcare industry, including the Health Reform Law;

 

    a default under the agreements governing our indebtedness;

 

    future sales of our common stock by us, directors, executives and significant stockholders;

 

    changes in domestic and international economic and political conditions and regionally in our markets; and

 

    other events or factors, including those resulting from natural disasters, war, acts of terrorism or responses to these events.

Furthermore, the stock market has recently experienced extreme volatility that, in some cases, has been unrelated or disproportionate to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance. As a result, our common stock may trade at a price significantly below the price at which any stockholder purchased his or her shares.

 

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In the past, following periods of market volatility, stockholders have instituted securities class action litigation. If we were to become involved in securities litigation, it could have a substantial cost and divert resources and the attention of executive management from our business regardless of the outcome of such litigation.

Future offerings of debt or preferred equity securities, which would rank senior to our common stock, may adversely affect the market price of our common stock.

If, in the future, we decide to issue debt or preferred equity securities that may rank senior to our common stock, it is likely that such securities will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.

Fluctuations in our future operating results may negatively affect the market price of our common stock.

Our operating results have fluctuated in the past and can be expected to fluctuate from time to time in the future. Some of the factors that may cause these fluctuations include but are not limited to:

 

    the timing, volume and pricing of procedures at our facilities;

 

    the impact to the marketplace of competitive products and pricing;

 

    surgery-related supplies, implants and equipment availability and cost;

 

    changes in or announcements regarding potential changes to Medicare reimbursement rates; and

 

    shifts in our ownership percentage in our facilities.

If our operating results are below the expectations of securities analysts or investors, the market price of our common stock may fall abruptly and significantly.

If we or our existing investors sell additional shares of our common stock, the market price of our common stock could decline.

The market price of our common stock could decline as a result of sales of a large number of shares of common stock in the market, or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

At the completion of our initial public offering, we had 38.1 million shares of common stock outstanding. Of these outstanding shares of common stock, all of the shares of common stock sold in the initial public offering are freely tradable in the public market. We believe 26.9 million shares are restricted securities as defined in Rule 144 under the Securities Act (“Rule 144”) and may be sold by the holders into the public market from time to time in accordance with and subject to limitation on sales under Rule 144.

We, our directors, our executive officers, TPG and the selling stockholders agreed not to sell or transfer any common stock or securities convertible into, exchangeable for, exercisable for, or repayable with common stock, for 180 days beginning on October 29, 2013 without first obtaining the written consent of J.P. Morgan Securities LLC and Citigroup Global Markets Inc.

 

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In connection with our initial public offering, we entered into a registration rights agreement with TPG and certain members of our management and our board of directors, which provides the signatories thereto the right, under certain circumstances, to require us to register their shares of common stock under the Securities Act for sale into the public markets.

Currently, we have approximately 2.0 million shares issuable upon the exercise of outstanding vested stock options under our equity incentive plans, approximately 1.1 million shares subject to outstanding unvested stock options under our equity incentive plans, and approximately 2.3 million shares reserved for future grant under our equity incentive plans. Shares acquired upon the exercise of vested options under our equity incentive plans may be sold by holders into the public market from time to time, in accordance with and subject to limitation on sales by affiliates under Rule 144. Sales of a substantial number of shares of our common stock following the vesting of outstanding stock options could cause the market price of our shares of common stock to decline.

Because we do not currently intend to pay cash dividends on our common stock for the foreseeable future, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.

We currently intend to retain future earnings, if any, for future operation, expansion and debt repayment and do not intend to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions, restrictions imposed by applicable law or the SEC and other factors that our board of directors may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our Senior Secured Credit Facilities. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it.

We are a holding company with nominal net worth and no operations of our own, and we will depend on dividends and distributions from our subsidiaries to pay any dividends.

Surgical Care Affiliates, Inc. is a holding company with nominal net worth. We do not have any assets or conduct any business operations other than our investments in our subsidiaries. Our business operations are conducted primarily out of our direct operating subsidiary, SCA. As a result, our ability to pay dividends, if any, will be dependent upon cash dividends and distributions or other transfers from our subsidiaries, including from SCA. Payments to us by our subsidiaries will be contingent upon their respective earnings and subject to any limitations on the ability of such entities to make payments or other distributions to us. See “— Risks Related to our Business — The terms of our Senior Secured Credit Facilities may restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions” for additional information regarding the limitations currently imposed by our Senior Secured Credit Facilities. In addition, our subsidiaries, including our direct operating subsidiary, SCA, are separate and distinct legal entities and have no obligation to make any funds available to us.

If we are unable to implement and maintain effective internal control over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the trading price of our common stock may be negatively affected.

Pursuant to Section 404 of the Sarbanes-Oxley Act and related rules and regulations, and beginning with our Annual Report on Form 10-K for the year ending December 31, 2014, our management will be required to report on the effectiveness of our internal control over financial reporting. However, until such time as we cease to be an “emerging growth company” as more fully described in “Risks Related to Our Common Stock — We are an ‘emerging growth company’ under the JOBS Act, and we cannot be certain if the reduced disclosure

 

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requirements applicable to emerging growth companies will make our common stock less attractive to investors,” our independent registered public accounting firm is not required to formally attest to the effectiveness of our internal control over financial reporting in compliance with Section 404(b) of the Sarbanes-Oxley Act.

The rules governing the standards that must be met for management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. We are in the process of designing, implementing, and testing the internal control over financial reporting required to comply with this obligation, which process is time consuming, costly, and complicated. As we only recently became a public company following the completion of our initial public offering on November 4, 2013, we have limited accounting personnel and other resources with which to address our internal controls and procedures. If we identify material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner or assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting when required, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected. As a result, we could become subject to investigations by the NASDAQ Global Select Market, the SEC, or other regulatory authorities, which could require additional financial and management resources. Any such action could have a material adverse effect on our business, prospects, results of operations and financial condition.

The requirements of being a public company are expensive and time-consuming and may strain our resources and distract our management, which could make it difficult to manage our business, particularly after we are no longer an “emerging growth company” under the JOBS Act.

Since the completion of our initial public offering of common stock, we have been required to comply with various regulatory and reporting requirements, including those required by the SEC. Complying with these reporting and other regulatory requirements is time-consuming and has resulted, and will continue to result, in increased costs to us and could have a material adverse effect on our business, results of operations and financial condition.

As a public company, we are subject to the reporting requirements of the Exchange Act, and requirements of the Sarbanes-Oxley Act and the Dodd-Frank Act. These requirements may place a strain on our systems and resources. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and internal control over financial reporting. To maintain and improve the effectiveness of our disclosure controls and procedures, we will need to commit significant resources, hire additional staff and provide additional management oversight. The Dodd-Frank Act introduced multiple executive compensation and corporate governance reforms, some of which are not yet in effect, but which will demand additional attention of management. We have implemented, and will continue to implement, additional procedures and processes for the purpose of addressing the standards and requirements applicable to public companies. Sustaining our growth also will require us to commit additional management, operational and financial resources to identify new professionals to join our firm and to maintain appropriate operational and financial systems to adequately support expansion. These activities may divert management’s attention from other business concerns, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

As an “emerging growth company” under the JOBS Act, we are permitted to, and intend to, take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements.

When these exemptions cease to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with them. We will remain an “emerging growth company” for

 

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up to five years, although we may cease to be an emerging growth company earlier under certain circumstances. See “Risks Related to our Common Stock — We are an ‘emerging growth company’ under the JOBS Act, and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors” for additional information on when we may cease to be an emerging growth company. We cannot yet predict or estimate the amount of additional costs that we may incur as a result of being a public company or the timing of such costs.

If securities or industry analysts do not publish, cease publishing or publish inaccurate or unfavorable research or reports about us, our business, or our market, or if they adversely change their recommendations regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock is influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If industry or securities analysts do not establish and maintain adequate research coverage, or if any of the analysts who may cover us downgrade our common stock or publish inaccurate or unfavorable research about our business or provide relatively more favorable recommendations about our competitors, our stock price could decline. If any analyst who may cover us ceases coverage of us or fails to regularly publish reports on us, we could lose visibility in the financial markets and demand for our common stock could decrease, which in turn could cause our stock price or trading volume to decline.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

Our corporate headquarters is located in Deerfield, Illinois at 520 Lake Cook Road, Suite 250, where we currently lease approximately 7,526 square feet of space. This lease expires in March 2017. In addition, certain of our corporate operational functions are located in Birmingham, Alabama at 3000 Riverchase Galleria, Suite 500, where we currently lease approximately 40,390 square feet of space. This lease expires in March 2015. The Company believes these spaces are sufficient and adequate for our needs at this time.

 

Item 3. Legal Proceedings

On May 5, 2006, Dr. Hansel DeBartolo filed a lawsuit captioned DeBartolo, et al. v. HealthSouth Corporation et al, in the United States District Court for the Northern District of Illinois, Eastern Division, against Joliet Surgery Center Limited Partnership (the “Partnership”), the general partner of that Partnership, Surgicare of Joliet, Inc., and its then-parent, HealthSouth, for a declaratory judgment and an injunction relating to the forced repurchase of his partnership interest (the “Federal Court Action”). We agreed to take responsibility from HealthSouth (our parent until SCA was purchased by ASC Acquisition LLC) regarding this matter. Dr. DeBartolo claimed that the partnership agreement’s requirement that an investor in a surgical center perform one-third of his surgical procedures at the center violates the federal Anti-Kickback Statute and its underlying federal policy, and he sought an order prohibiting the repurchase of his partnership interest. After the trial court dismissed the case by holding that no private cause of action exists under the Anti-Kickback Statute, Dr. DeBartolo appealed to the Seventh Circuit Court of Appeals, which directed the trial court to dismiss the case because the Federal courts did not have jurisdiction over the subject matter involved. On February 8, 2010, Dr. DeBartolo filed a lawsuit in the Twelfth Judicial Circuit Court, Will County, Illinois making the same claim and seeking the same relief as he sought in the Federal Court Action. On February 5, 2014, the Circuit Court entered an Order granting summary judgment in favor of the Defendants. On March 4, 2014, Plaintiff filed a Notice of Appeal in the Appellate Court of Illinois Third District seeking reversal of the Circuit Court’s Order.

 

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From time to time, we are involved in routine litigation that arises in the ordinary course of business. Other than the matter described above, we are not currently involved in any litigation that we believe could reasonably be expected to have a material adverse effect on our business, financial condition or results of operations.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market for Surgical Care Affiliates Common Stock

Our common stock trades under the symbol “SCAI” on the NASDAQ Global Select Market. The initial public offering of our common stock occurred on October 30, 2013. The following table sets forth the high and low sales prices per share for the common stock from the date of the initial public offering through December 31, 2013, as reported on the NASDAQ Global Select Market:

 

     October 30 -
December 31
 

2013:

  

High

   $ 35.80   

Low

   $ 25.50   

As of March 20, 2014, there were 42 stockholders of record, which excludes stockholders whose shares were held in nominee or street name by brokers. The actual number of common stockholders is greater than the number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities. The last reported sales price of Surgical Care Affiliates’ common stock as reported on the NASDAQ Global Select Market on March 20, 2014 was $32.32.

Dividends

Since our initial public offering we have not declared or paid a cash dividend on our common stock. We intend to retain our earnings to finance the growth and development of our business and do not expect to declare or pay any cash dividends in the foreseeable future. The declaration of dividends is within the discretion of our Board of Directors. Additionally, our ability to pay dividends in the future, if any, will be dependent upon cash dividends and distributions or other transfers from our subsidiaries.

Use of Proceeds from Our Initial Public Offering

On November 4, 2013, the Company completed an initial public offering of its common stock in which it issued and sold 7,857,143 shares of common stock and the selling shareholders offered and sold 3,387,301 shares of common stock, including 1,466,666 shares of common stock from certain of the selling stockholders pursuant to the exercise in full of the underwriters’ option to purchase additional shares of common stock. The shares sold in the offering were registered under the Securities Act pursuant to the Company’s Registration Statement on Form S-1 (Registration No. 333-190998), which was declared effective by the SEC on October 29, 2013. The proceeds to us, net of total expenses, were approximately $171.8 million. The Company did not receive any proceeds from shares sold by the selling shareholders.

We used the net proceeds received in the initial public offering to redeem in December 2013 all $150.0 million in aggregate principal amount of the Senior Subordinated Notes (as defined herein) at a redemption price of 103.333% of principal amount thereof, plus accrued and unpaid interest thereon. The remainder of the net proceeds was used for other general corporate purposes. This use of proceeds is consistent with the planned use of proceeds from our initial public offering as described in our final Prospectus filed with the SEC on October 30, 2013 pursuant to Rule 424(b).

 

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Item 6. Selected Financial Data

 

    YEAR-ENDED DECEMBER 31,  
          2013                 2012                 2011                 2010                 2009        
   

(in millions, except facilities and

per unit data in actual amounts)

 

Net operating revenues:

         

Net patient revenues

  $ 746.6      $ 714.6      $ 692.9      $ 697.3      $ 678.7   

Management fee revenues

    40.5        17.8        11.3        6.7        4.0   

Other revenues

    14.9        12.4        10.0        6.3        3.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net operating revenues

    802.0        744.9        714.2        710.3        686.5   

Equity in net income of nonconsolidated affiliates

    23.4        16.8        22.2        15.3        10.5   

Operating expenses:

         

Salaries and benefits

    277.7        241.8        221.8        216.6        218.4   

Supplies

    175.2        170.1        160.6        172.6        161.6   

Other operating expenses

    131.8        118.5        114.6        112.9        113.0   

Depreciation and amortization

    42.9        41.6        40.4        37.4        36.6   

Occupancy costs

    27.0        26.8        26.6        27.8        28.0   

Provision for doubtful accounts

    15.0        13.2        14.6        13.9        14.4   

Impairment of intangible and long-lived assets

    —          1.1        —          —          0.1   

Loss (gain) on disposal of assets

    0.1        (0.3     (0.8     0.4        (0.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    669.8        612.7        577.9        581.5        572.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    155.6        148.9        158.5        144.1        125.0   

Interest expense

    60.4        58.8        56.0        52.6        53.6   

Loss from extinguishment of debt

    10.3        —          —          —          —     

Interest income

    (0.2     (0.3     (0.4     (1.6     (1.3

Loss on sale of investments

    12.3        7.1        (3.9     (2.1     0.6  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income tax expense

    72.7        83.3        106.8        95.2        72.1   

Provision for income tax expense

    12.6        8.9        20.3        14.5        12.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations (1)

    60.1        74.4        86.5        80.7        59.5   

(Loss) income from discontinued operations, net of income tax expense

    (7.4     (2.1     (3.0     (11.1     (2.4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    52.7        72.3        83.5        69.6        57.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net income attributable to noncontrolling interests

    (104.0     (92.3     (93.2     (84.5     (82.6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to Surgical Care Affiliates

  $ (51.3   $ (20.0   $ (9.7   $ (14.9   $ (25.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share attributable to Surgical Care Affiliates:

         

Continuing operations attributable to Surgical Care Affiliates

  $ (1.39   $ (.59   $ (.23   $ (.14   $ (.82

Discontinued operations attributable to Surgical Care Affiliates

  $ (.23   $ (.07   $ (.10   $ (.39   $ (.09
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to Surgical Care Affiliates

  $ (1.62   $ (.66   $ (.33   $ (.53   $ (.91
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted weighted average shares outstanding (in thousands) (2)

    31,688        30,340        29,347        28,144        28,129   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Distribution paid per share on September 16, 2013

  $ 2.47           
 

 

 

         

Facilities (at period end):

         

Consolidated facilities

    87        87        94        95        105   

Equity method facilities

    60        52        44        23        19   

Managed-only facilities

    30        8        4        5        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total facilities

    177        147        142        123        125   

 

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     December 31,  
     2013      2012      2011      2010      2009  
     (in millions)  

Balance Sheet Data (at period end):

              

Cash and cash equivalents

   $ 85.8       $ 118.7       $ 71.3       $ 33.6       $ 35.6   

Total current assets

     234.9         267.4         215.0         172.0         161.7   

Total assets (3)

     1,422.4         1,412.1         1,356.5         1,189.8         1,178.0   

Current portion of long-term debt

     23.2         15.2         16.2         7.5         6.7   

Long-term debt, net of current portion

     649.7         774.5         769.1         673.4         671.4   

Total current liabilities

     197.6         175.2         148.9         133.6         121.9   

Total liabilities (3)

     984.5         1,070.4         1,030.6         897.5         869.0   

Noncontrolling interests — redeemable

     21.9         21.7         20.2         20.6         25.9   

Total Surgical Care Affiliates’ equity

     205.7         147.5         170.3         144.5         165.0   

Noncontrolling interests — non-redeemable

     210.3         172.5         135.4         127.2         118.1   

Total equity

     416.0         320.0         305.7         271.7         283.1   

 

(1) Loss from continuing operations attributable to Surgical Care Affiliates, which is income from continuing operations less net income attributable to noncontrolling interests, was $43.9 million, $17.9 million, $6.7 million, $3.8 million and $23.1 for years-ended December 31, 2013, 2012, 2011, 2010 and 2009, respectively.
(2) Calculated based on number of shares of common stock and vested RSUs that would have been outstanding as of December 31, 2012, 2011, 2010 and 2009, assuming our conversion from a Delaware limited liability company to a Delaware corporation.
(3) Our consolidated assets as of December 31, 2013 and December 31, 2012 include total assets of a VIE of $49.5 million and $28.2 million, respectively, which can only be used to settle the obligations of the VIE. Our consolidated total liabilities as of December 31, 2013 and December 31, 2012 include total liabilities of the VIE of $12.2 million and $1.4 million, respectively, for which the creditors of the VIE have no recourse to us, with the exception of $4.0 million of debt guaranteed by us at December 31, 2013.

 

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Item 7. 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)

This report contains certain forward-looking statements (all statements other than statements with respect to historical fact) within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Investors are cautioned that all forward-looking statements involve known and unknown risks and uncertainties including, without limitation, those described in Item 1A. Risk Factors, some of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. Actual results could differ materially and adversely from those contemplated by any forward-looking statement. In light of the significant risks and uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements in this discussion to reflect events and circumstances occurring after the date hereof or to reflect unanticipated events. Forward-looking statements and our liquidity, financial condition and results of operations may be affected by the risks set forth in Item 1A. Risk Factors or by other unknown risks and uncertainties.

OVERVIEW

We are a leading provider of surgical solutions to health systems and payors, providing high quality, cost-effective surgical care. For a substantial portion of the periods covered by our financial statements in this Annual Report on Form 10-K, we were a Delaware limited liability company that was formed with a focus on developing and operating a network of multi-specialty ASCs and surgical hospitals in the United States. However, on October 30, 2013, we converted from a Delaware limited liability company, previously named ASC Acquisition LLC, to a Delaware corporation. As of December 31, 2013, we operated in 34 states and had an interest in and/or operated 171 freestanding ASCs, five surgical hospitals and one sleep center with 11 locations. Of these 177 facilities, we consolidated the operations of 87 affiliated facilities, had 60 nonconsolidated affiliated facilities and held no ownership in 30 affiliated facilities that contract with us to provide management services only. In addition, at December 31, 2013, we provided perioperative consulting services to 14 facilities, which are not included in the facility count.

With the exception of the managed-only facilities, the entities that own our facilities are structured as general partnerships, LPs, LLPs or LLCs in which either one of our subsidiaries or a joint venture 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, 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 and health systems and making selective acquisitions of existing surgical facilities and groups of facilities.

We took several steps during 2013 to optimize our portfolio by:

 

    acquiring a controlling interest in four ASCs, which we consolidate;

 

    acquiring a noncontrolling interest in six ASCs and one surgical hospital that we hold as equity method investments;

 

    entering into agreements to manage 19 ASCs and one sleep center with 11 locations;

 

    placing two de novo facilities into operation, one that we consolidate and one that we hold as an equity method investment;

 

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    closing two non-strategic consolidated ASCs;

 

    selling our interest in two consolidated ASCs and one nonconsolidated ASC;

 

    terminating a management agreement with an ASC; and

 

    increasing the number of relationships with not-for-profit health systems.

Our consolidated net patient revenues increased $32.0 million, or 4.5%, for the year-ended December 31, 2013 compared to the prior year. Factors which increased consolidated net patient revenues included improved rates paid under payor contracts, fee schedule increases and changes in case mix. Consolidated net patient revenues per case increased 6.1% as compared to the prior period.

We do not consolidate 60 of the facilities affiliated with us because we do not hold a controlling equity interest in the partnerships 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 recorded in our consolidated financial statements, we believe systemwide net operating revenues growth and systemwide net patient revenue per case growth are important to understand 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” on page 84.

During the year-ended December 31, 2013, systemwide net operating revenues grew by 15.2% as compared to the prior year. Systemwide net patient revenues per case grew by 9.2% compared to the prior year. These increases are due to acquisitions of noncontrolling interests in ASCs since the prior period, coupled with improved rates paid under payor contracts, fee schedule increases and changes in case mix.

At December 31, 2013, we held ownership interests in consolidated and nonconsolidated facilities in partnership with 30 different health systems and managed facilities with an additional 13 health systems. Our health system relationships include local health systems, regional health systems 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 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.

 

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As of December 31, 2013, we consolidated six facilities into our financial results where we do not currently hold an equity ownership interest in the facility. All six facilities are majority-owned and controlled by a common parent company (the “future JV”). We hold a promissory note from the future JV that is convertible into equity of the future JV at our option upon the occurrence of the renegotiation of certain contractual arrangements. The promissory note has a fixed interest rate of 4% plus a variable component that is dependent on the earnings of the future JV. We are also party to management services agreements with the facilities controlled by the future JV. As a result of the financial interest in the earnings of the future JV held by us via the promissory note and the powers granted to us in the promissory note and the management services agreements, we have determined, under the Accounting Standards Codification Section 810, that the future JV is a VIE for which we are the primary beneficiary and as a result we consolidate these facilities into our financial results.

For our nonconsolidated affiliates, our 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.

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 revenue 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 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 a deconsolidation transaction, the affiliated facility’s results were reported as part of our consolidated net operating revenues and the associated expense line items.

 

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    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, 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 2013 to optimize our facility portfolio by acquiring, deconsolidating, placing de novo facilities into operation and closing or selling certain facilities. On June 1, 2013, we completed the acquisition of Health Inventures, LLC (“HI”) for a purchase price of $18.5 million. In the transaction, we acquired HI’s ownership interests in four ASCs and one surgical hospital and management agreements with 19 facilities that together are affiliated with 11 different health systems.

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

 

    During the
Year-
Ended
December 31,
2013
    During the
Year-
Ended
December 31,
2012
    During the
Year-
Ended
December 31,
2011
 

Facilities at Beginning of Period

     

Consolidated Facilities:

    87        94        95   

Equity Method Facilities:

    52        44        23   

Managed-only Facilities:

    8        4        5   

Total Facilities:

    147        142        123   

Strategic Activities Undertaken

     

Acquisitions

     

Consolidated Facilities acquired:

    4        2       3  

Noncontrolling interests acquired in facilities accounted for as equity method investments:

    7        7        17   

Management agreements entered into (Managed-only):

    20        4        3   

De novos

     

Consolidated de novo facilities placed into operations:

    1        —         —    

De novo facilities accounted for as equity method investments placed into operations:

    1        —         —    

Consolidations / Deconsolidations

     

Conversion transactions or contributions to joint ventures or other partnerships completed such that the facility is accounted for as a consolidated affiliate:

    1       4        —     

Conversion transactions or contributions to joint ventures or other partnerships completed such that the facility is accounted for as an equity method investment:

    2        3        4   

Changed to Managed-Only Facility

     

Change to providing management services only:

    3        —          —     

 

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    During the
Year-
Ended
December 31,
2013
    During the
Year-
Ended
December 31,
2012
    During the
Year-
Ended
December 31,
2011
 

Closures and Sales

     

Consolidated Facilities sold:

    —         3        —     

Noncontrolling interests in facilities accounted for as equity method investments sold:

    —         1       —    

Consolidated Facilities closed:

    2        3        —     

Equity Method Facilities closed:

    —         —         —    

Management agreements exited from (Managed-only):

    1        —         4  

Facilities at End of Period

     

Consolidated Facilities:

    87        87        94   

Equity Method Facilities:

    60        52        44   

Managed-only Facilities:

    30        8        4   
 

 

 

   

 

 

   

 

 

 

Total Facilities:

    177        147        142   

Average Ownership Interest

     

Consolidated Facilities:

    51.6     54.8     58.1

Equity Method Facilities:

    25.0     27.7     29.4

Revenues

Our consolidated net operating revenues for the years-ended December 31, 2013, 2012 and 2011 were $802.0 million, $744.9 million and $714.2 million, respectively.

Given the significant 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 revenue growth and same site systemwide net patient revenues per case growth.

 

    

YEAR-ENDED

DECEMBER 31,

 
     2013     2012     2011  

Systemwide net operating revenues growth (1)

     15.2     16.5     17.0

Systemwide net patient revenues per case growth (2)

     9.2     7.5     9.4

Same site systemwide net operating revenues growth (1)(3)

     8.8     5.8     5.5

Same site systemwide net patient revenues per case growth (2)(3)

     6.0     4.1     6.6

 

(1) The revenues and expenses of equity method facilities are not directly included in our consolidated GAAP results, rather 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 revenue growth, but not patient or other revenues from managed-only facilities (in which we hold no ownership interest).
(2)

The revenues and expenses of equity method facilities are not directly included in our consolidated GAAP results; rather, 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

 

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  our consolidated facilities and our equity method facilities (without adjustment based on our percentage of ownership). We do not include facilities at which we hold no ownership interest and provide only management services in systemwide net patient revenues per case growth or same site systemwide net patient revenues per case growth.
(3) Same site refers to facilities that were operational in both the current and prior periods.

Year-Ended December 31, 2013 Compared to Year-Ended December 31, 2012

Our consolidated net operating revenues increased by $57.1 million, or 7.7%, for the year-ended December 31, 2013 to $802.0 million from $744.9 million for the year-ended December 31, 2012. Consolidated net patient revenues per case increased by 6.1% to $1,710 per case during the year-ended December 31, 2013 from $1,612 per case during the year-ended December 31, 2012.

For the year-ended December 31, 2013, systemwide net operating revenues grew by 15.2% compared to the year-ended December 31, 2012. In addition, for the year-ended December 31, 2013, systemwide net patient revenues per case grew by 9.2% compared to the prior period.

The table below quantifies several significant items impacting our period-over-period net operating revenues growth and net operating revenues growth of our nonconsolidated affiliates.

 

     Year-Ended
December 31, 2013
 
     Surgical Care Affiliates
as Reported Under GAAP
    Nonconsolidated
Affiliates
 
     (in millions)  

Total net operating revenues, year-ended December 31, 2012 (1)(2)

   $ 744.9      $ 477.5   

Add: revenue from acquired facilities

     31.4        79.1   

revenue from consolidations

     5.2        (5.2

Less: revenue of disposed facilities

     —         (30.7

revenue from deconsolidated facilities

     (26.9     26.9   
  

 

 

   

 

 

 

Adjusted base year total net operating revenues

     754.6        547.6   

Increase from operations

     42.8        56.7   

Non-facility based revenue

     4.6        1.5   
  

 

 

   

 

 

 

Total net operating revenues, year-ended December 31, 2013:

   $ 802.0      $ 605.8   
  

 

 

   

 

 

 

 

(1) $1.6 million in revenues have been reclassified from prior periods 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 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.

Year-Ended December 31, 2012 Compared to Year-Ended December 31, 2011

Our consolidated net operating revenues increased by $30.7 million, or 4.3%, for the year-ended December 31, 2012 to $744.9 million from $714.2 million for the year-ended December 31, 2011. Consolidated net patient revenues per case increased by 1.5% to $1,612 per case during 2012 from $1,589 per case during the prior period.

For the year-ended December 31, 2012, systemwide net operating revenues grew by 16.5% compared to the year-ended December 31, 2011. In addition, for the year-ended December 31, 2012, systemwide net patient revenues per case grew by 7.5% compared to the year-ended December 31, 2011.

 

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The table below quantifies several significant items impacting our period-over-period net operating revenues growth and net operating revenues growth of our nonconsolidated affiliates.

 

     Year-Ended
December 31, 2012
 
     Surgical Care Affiliates
as Reported Under GAAP
    Nonconsolidated
Affiliates
 
     (in millions)  

Total net operating revenues, year-ended December 31, 2011 (1)(2)

   $ 714.2      $ 334.8   

Add: revenue from acquired facilities

     4.5        106.6   

revenue from consolidations

     12.6        (12.6

Less: revenue of disposed facilities

     —         —     

revenue from deconsolidated facilities

     (22.1     22.1   
  

 

 

   

 

 

 

Adjusted base year total net operating revenues

     709.2        450.9   

Increase from operations

     26.7        25.9   

Non-facility based revenue

     9.0        0.7   
  

 

 

   

 

 

 

Total net operating revenues, year-ended December 31, 2012:

   $ 744.9      $ 477.5   
  

 

 

   

 

 

 

 

(1) $1.5 million in revenues have been reclassified from prior periods 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 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 vast majority of our net operating revenues consist 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, 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.

 

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

Consolidated Facilities

 

    

YEAR-ENDED

DECEMBER 31,

 
     2013     2012     2011  

Managed care and other discount plans

     60     61     62

Medicare

     20        21        20   

Workers’ compensation

     11        10        10   

Patients and other third-party payors

     6        5        4   

Medicaid

     3        3        4   
  

 

 

   

 

 

   

 

 

 

Total

     100     100     100
  

 

 

   

 

 

   

 

 

 

Nonconsolidated Facilities

 

    

YEAR-ENDED

DECEMBER 31,

 
     2013     2012     2011  

Managed care and other discount plans

     77     73     69

Medicare

     15        14        15   

Workers’ compensation

     4        8        10   

Patients and other third-party payors

     2        2        3   

Medicaid

     2        3        3   
  

 

 

   

 

 

   

 

 

 

Total

     100     100     100
  

 

 

   

 

 

   

 

 

 

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

Medicare accounts for 20%, 21% and 20% of our net patient revenues for the years-ended December 31, 2013, 2012 and 2011, 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 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.

For the year-ended December 31, 2013, our facilities located in North Carolina, California and Texas collectively represented approximately 14%, 14% and 12%, respectively, of our net patient revenues. Additionally, our facilities located in each of Alabama, Alaska, Connecticut, Florida and Idaho represented in excess of 5% of our net patient revenues for the year-ended December 31, 2013.

Of our 60 nonconsolidated facilities accounted for as equity method investments, as of December 31, 2013, 26 of these facilities were located in California and 12 of these facilities were located in Indiana.

 

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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 34.6%, 32.5% and 31.1% of our net operating revenues for the years-ended December 31, 2013, 2012 and 2011, respectively.

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 21.8%, 22.8% and 22.5% of our net operating revenues for the years-ended December 31, 2013, 2012 and 2011, respectively, making it important for our facilities to appropriately manage these costs. Supplies expense is typically closely related not only to case volume but also to 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, utility and maintenance expense. 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 include 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, aging of accounts receivable, payor mix or trends in Federal or state governmental healthcare coverage.

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 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, limited partnerships, limited liability partnerships or limited liability companies, 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 Attributable to Surgical Care Affiliates

Net loss 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

 

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only through our wholly owned 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 sale 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.

Summary Results of Operations

Year-Ended December 31, 2013 Compared to Year-Ended December 31, 2012 and December 31, 2011

Our Consolidated Results and Results of Nonconsolidated Affiliates

The following tables show our results of operations and the results of operations of our nonconsolidated affiliates for the years-ended December 31, 2013, 2012 and 2011.

 

    YEAR-ENDED DECEMBER 31,  
    2013     2012     2011  
    As
Reported
Under GAAP
    Non-
consolidated
Affiliates (1)
    As
Reported
Under GAAP
    Non-
consolidated
Affiliates (1)
    As
Reported
Under GAAP
    Non-
consolidated
Affiliates (1)
 
    (in millions, except cases and facilities in actual amounts)  

Net operating revenues:

     

Net patient revenues

  $ 746.6      $ 600.6      $ 714.6      $ 474.4      $ 692.9      $ 332.6   

Management fee revenues

    40.5        —          17.8        —          11.3        —     

Other revenues

    14.9        5.2        12.4        3.2        10.0        2.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net operating revenues

    802.0        605.8        744.9        477.5        714.2        334.8   

Equity in net income of nonconsolidated affiliates (2)

    23.4        —          16.8        —          22.2        —     

Operating expense:

           

Salaries and benefits

    277.7        128.9        241.8        108.8        221.8        80.5   

Supplies

    175.2        99.6        170.1        78.8        160.6        57.9   

Other operating expenses

    131.8        89.3        118.5        68.8        114.6        49.1   

Depreciation and amortization

    42.9        17.3        41.6        14.0        40.4        11.4   

Occupancy costs

    27.0        22.7        26.8        20.8        26.6        14.4   

Provision for doubtful accounts

    15.0        10.4        13.2        6.3        14.6        6.5   

Impairment of intangible and long-lived assets

    —          —          1.1        —          —          —     

Loss (gain) on disposal of assets

    0.1        0.3        (0.3 )     0.1        (0.8 )     (0.1 )
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    669.8        368.5        612.7        297.6        577.9        219.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    155.6        237.3        148.9        179.9        158.5        115.2   

Interest expense

    60.4        1.7        58.8        1.6        56.0        1.5   

Loss from extinguishment debt

    10.3        —          —          —          —          —     

Interest income (3)

    (0.2 )     (0.1 )     (0.3 )     (0.1 )     (0.4 )     (0.1 )

Loss (gain) on sale of investments

    12.3        —          7.1        —          (3.9 )     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income tax expense

    72.7        235.6        83.3        178.4        106.8        113.8   

Provision for income tax expense (4)

    12.6        0.1        8.9        0.1        20.3        0.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    60.1        235.5        74.4        178.4        86.5        113.8   

Loss from discontinued operations, net of income tax expense

    (7.4 )     —          (2.1 )     —          (3.0 )     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    52.7      $ 235.5        72.3      $ 178.4        83.5      $ 113.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    YEAR-ENDED DECEMBER 31,  
    2013     2012     2011  
    As
Reported
Under GAAP
    Non-
consolidated
Affiliates (1)
    As
Reported
Under GAAP
    Non-
consolidated
Affiliates (1)
    As
Reported
Under GAAP
    Non-
consolidated
Affiliates (1)
 
    (in millions, except cases and facilities in actual amounts)  

Less: Net income attributable to noncontrolling interests

    (104.0 )       (92.3 )       (93.2 )  
 

 

 

     

 

 

     

 

 

   

Net loss attributable to Surgical Care Affiliates

  $ (51.3 )     $ (20.0 )     $ (9.7 )  
 

 

 

     

 

 

     

 

 

   

Equity in net income of nonconsolidated affiliates (2)

    $ 23.4        $ 16.8        $ 22.2   
   

 

 

     

 

 

     

 

 

 

Other Data (5)

           

Cases — consolidated facilities (6)

    436,560          443,361          436,207     

Cases — equity facilities (7)

    258,942          226,860          184,860     

Consolidated facilities

    87          87          94     

Equity method facilities

    60          52          44     

Managed-only facilities

    30          8          4     

Total facilities

    177          147          142     

 

(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 revenue, 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 years-ended December 31, 2013, 2012 and 2011 we recorded amortization expense of $25.9 million, $20.3 million and $10.1 million, respectively, for definite-lived intangible assets attributable to equity method investments within Equity in net income of nonconsolidated affiliates. For the years-ended December 31, 2013 and 2012 we recorded other than temporary impairment charges of $6.1 million and $9.2 million, respectively, within the line item Equity in net income of nonconsolidated affiliates. There was no such impairment charge for the year-ended December 31, 2011.
(3) Interest income of nonconsolidated affiliates was $0.060 million, $0.090 million and $0.067 million for the years-ended December 31, 2013, 2012 and 2011, respectively.
(4) Provision for income tax expense for nonconsolidated affiliates was $0.071 million, $0.060 million and $0.060 million for the years-ended December 31, 2013, 2012 and 2011, respectively.
(5) Case data is presented for the years-ended December 31, 2013, 2012 and 2011, as applicable. Facilities data is presented as of December 31, 2013, 2012 and 2011, 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.

Year-Ended December 31, 2013 Compared to Year-Ended December 31, 2012

Net Operating Revenues

Our consolidated net operating revenues increased $57.1 million, or 7.7%, for the year-ended December 31, 2013 to $802.0 million from $744.9 million for the year-ended December 31, 2012. The main factors that contributed to this increase were increased rates paid under certain payor contracts, revenues earned from a

 

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facility for which a consolidation transaction was completed during the second quarter of 2012, revenues earned from facilities acquired since December 31, 2012 and increases in acuity case mix. Consolidated net patient revenues per case grew by 6.1% to $1,710 per case for the year-ended December 31, 2013 from $1,612 per case during the prior period reflecting higher acuity case mix. During this same period, the number of cases at our consolidated facilities decreased to 436,560 cases during the year-ended December 31, 2013 from 443,361 cases during the year-ended December 31, 2012 and our number of consolidated facilities were 87 facilities as of December 31, 2013 and 2012.

For the year-ended December 31, 2013, systemwide net operating revenues grew by 15.2% compared to the year-ended December 31, 2012. The growth in systemwide net operating revenues is largely due to the acquisition of noncontrolling interests in seven facilities accounted for as equity method investments and four consolidated affiliates since the prior period and increased rates earned under certain payor contracts. The increase is also attributable to two de novo facilities, one of which is an equity method investment and the other one is a consolidated affiliate, which were placed into operations since December 31, 2012. These factors are partially offset by the sale of our interest in a nonconsolidated facility completed in 2012. In addition, for the year-ended December 31, 2013, systemwide net patient revenues per case grew by 9.2% compared to the year-ended December 31, 2012, which is due to similar factors as described above.

Equity in Net Income of Nonconsolidated Affiliates

Equity in net income of nonconsolidated affiliates increased $6.6 million, or 39.3%, to $23.4 million during the year-ended December 31, 2013 from $16.8 million during the year-ended December 31, 2012. This increase was primarily due to the acquisition of several noncontrolling interests in facilities since December 31, 2012 and the deconsolidation of two facilities completed during 2013 (i.e., the facilities became equity method facilities rather than consolidated facilities). After deconsolidation, the results of operations of the facilities were reported net in Equity in net income of nonconsolidated affiliates, whereas prior to deconsolidation, those results were reported within the consolidated revenue and expense line items. The increase was partially offset by $6.1 million of impairments related to five equity method facilities during 2013 and by the conversion of a facility that was previously accounted for as an equity method facility to a consolidated facility during the second quarter of 2012. After the date of conversion, the results of this facility were reported within our consolidated revenue and expense line items, whereas prior to the conversion, the results of operations at this facility were reported net in the line item Equity in net income of nonconsolidated affiliates. The $6.1 million of impairment recorded to our investments in nonconsolidated affiliates was due to a decline in the expected future cash flows of five nonconsolidated affiliates that we determined to be other than temporary. This impairment is included in Equity in net income of nonconsolidated affiliates. This decline in the expected future cash flows was caused by events specific to each impacted facility, as further described below. The impairments included:

 

    a $1.5 million impairment on our investment in Wausau Surgery Center, L.P. related to an offer received to purchase our interest in the facility;

 

    a $2.3 million impairment on our investment in Premier Surgery Center of Louisville, L.P. related to insufficient forecasted growth at the facility;

 

    a $0.9 million impairment on our investment in Kerlan-Jobe Surgery Center, LLC related to a buy-out agreement for the facility;

 

    a $0.8 million impairment on our investment in Surgery Center of Fort Collins, LLC related to insufficient forecasted growth at the facility; and

 

    a $0.6 million impairment on our investment in Surgery Center of Lexington, LLC related to insufficient forecasted growth at the facility.

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.

 

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During the year-ended December 31, 2013, we recorded $25.9 million of amortization expense for definite-lived intangible assets attributable to equity method investments. This expense was included in the line item Equity in net income of nonconsolidated affiliates in our consolidated financial statements. We recorded $20.3 million of amortization expense during the year-ended December 31, 2012.

Salaries and Benefits

Salaries and benefits expense increased $35.9 million, or 14.8%, to $277.7 million for the year-ended December 31, 2013 from $241.8 million for the year-ended December 31, 2012. The increase in salary and benefits expense is primarily due to the addition of new teammates in connection with acquisitions as well as the payment of a cash bonus to eligible holders of vested options and restricted equity units (the “2013 Special Cash Bonus Payment”) of approximately $2.46 per vested option or restricted equity unit, as applicable, recorded during the third quarter of 2013, resulting in a total bonus payment of $4.6 million. Salaries and benefits also increased as a result of the addition of the expenses associated with existing teammates as a result of the consolidation of previously nonconsolidated affiliates.

Supplies

Supplies expense increased $5.1 million, or 3.0%, to $175.2 million for the year-ended December 31, 2013 from $170.1 million for the year-ended December 31, 2012. This increase in supplies expense is primarily attributable to changes in our case mix, in particular an increase in the number of orthopedic and ophthalmology cases performed at our facilities, which tend to require higher cost supplies and implants. Supplies expense per case increased by 4.6% during the year-ended December 31, 2013, as compared to the prior year, which is attributable to changes in our case mix as well as inflationary increases to supply costs.

Other Operating Expenses

Other operating expenses increased $13.3 million, or 11.2%, to $131.8 million for the year-ended December 31, 2013 from $118.5 million for the year-ended December 31, 2012. This increase is primarily attributable to the incurrence of certain additional overhead costs resulting from our organizational growth, partially offset by our efforts to manage and decrease existing overhead operating expenses.

Depreciation and Amortization

Depreciation and amortization expense increased $1.3 million, or 3.1%, to $42.9 million for the year-ended December 31, 2013 from $41.6 million for the year-ended December 31, 2012, primarily due to the addition of new capitalized assets during the year, partially offset by the conversion of two consolidated facilities to equity method investments.

Occupancy Costs

Occupancy costs remained relatively steady at $27.0 million during the year-ended December 31, 2013 as compared to $26.8 million during the year-ended December 31, 2012.

Provision for Doubtful Accounts

The provision for doubtful accounts increased $1.8 million, or 13.6%, to $15.0 million for the year-ended December 31, 2013 from $13.2 million during the year-ended December 31, 2012, however it remains consistent as a percentage of net patient revenues at approximately 2.0%.

Interest Expense

Interest expense increased $1.6 million, or 2.7%, to $60.4 million for the year-ended December 31, 2013 as compared to $58.8 million during the year-ended December 31, 2012 due to the de-designation of interest rate

 

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swaps as cash flow hedges partially offset by interest savings from the refinancing of certain of our debt instruments in 2013, including the redemption of all of our outstanding senior notes and senior subordinated notes.

Loss (Gain) on Sale of Investments

We recognized a loss on sale of investments of $12.3 million for the year-ended December 31, 2013 and a loss on sale of investments of $7.1 million during the year-ended December 31, 2012. The loss during the year-ended December 31, 2013 was recorded in connection with the sale of two consolidated affiliates, a deconsolidation transaction and the consolidation of a previously nonconsolidated affiliate. The loss in 2012 was related to the divestiture of our interest in a nonconsolidated affiliate and the deconsolidation of a previously consolidated affiliate, which was partially offset by a gain from the consolidation of a previously nonconsolidated affiliate.

Provision for Income Tax Expense

For the year-ended December 31, 2013, income tax expense was $12.6 million, representing an effective tax rate of 17.4%, compared to an expense of $8.9 million, representing an effective tax rate of 10.6% for the year-ended December 31, 2012. The $12.6 million in expense for the year-ended December 31, 2013 includes $11.7 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, $0.2 million of current federal income tax attributable to noncontrolling interests, and $0.7 million of state income taxes accrued by subsidiaries with separate state tax filing requirements, including $0.4 million attributable to noncontrolling interests. The $8.9 million in expense for the year-ended December 31, 2012 included $8.4 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, and $0.5 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 December 31, 2013. 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. As of December 31, 2013, our valuation allowance was $166.1 million. See “Risk Factors — Risks Related to Our Business — We may not be able to fully realize the value of our net operating loss carryforwards.”

Net income attributable to noncontrolling interests

Net income attributable to noncontrolling interests increased $11.7 million, or 12.7%, to $104.0 million for the year-ended December 31, 2013 from $92.3 million for the year-ended December 31, 2012. 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. This increase was partially offset by the deconsolidation of two facilities in 2013.

 

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Net loss attributable to Surgical Care Affiliates

Net loss attributable to Surgical Care Affiliates increased $31.3 million to $51.3 million for the years-ended December 31, 2013 from $20.0 million for the year-ended December 31, 2012. While our facilities’ revenue and operating income increased during the year-ended December 31, 2013, the increase in revenues and operating income was more than offset by increases in net income attributable to noncontrolling interests, loss from extinguishment of debt and increases in salaries and benefits.

Year-Ended December 31, 2012 Compared to Year-Ended December 31, 2011

Net Operating Revenues

Our consolidated net operating revenues increased by $30.7 million, or 4.3%, for the year-ended December 31, 2012 to $744.9 million from $714.2 million for the year-ended December 31, 2011. The main factors that contributed to this increase were revenues earned from a facility for which a consolidation transaction was completed during the second quarter of 2012, increased rates earned under certain payor contracts and a change in case mix. These factors were partially offset by the conversion of one facility from a consolidated facility to an equity method facility during 2012 and the conversion of one facility to an equity method facility during 2011. Consolidated net patient revenues per case increased by 1.5% to $1,612 per case for the year-ended December 31, 2012 from $1,588 per case during the prior period. During this same period, the number of cases at our consolidated facilities increased to 443,361 cases during the year-ended December 31, 2012 from 436,207 cases during the year-ended December 31, 2011, while our number of consolidated facilities decreased to 87 facilities as of December 31, 2012 from 94 facilities as of December 31, 2011. Our consolidated management fee revenues increased $6.5 million, or 57.5%, for the year-ended December 31, 2012 to $17.8 million from $11.3 million in the year-ended December 31, 2011. The increase in consolidated management fee revenues results primarily from the inclusion of a full year of management fee revenue from a nonconsolidated investment that was made in July 2011, whereas in 2011 only a half year of such revenues were included in our results, and an increase in our number of managed equity method facilities as compared to the prior year.

For the year-ended December 31, 2012, systemwide net operating revenues grew by 16.5% compared to the year-ended December 31, 2011. The growth in systemwide net patient revenues is due largely to the inclusion of a full year of revenue earned from acquisitions made in 2011 and from the acquisition of two consolidated facilities and noncontrolling interests in seven facilities accounted for as equity investments since the prior period, increased rates earned under certain payor contracts and changes in case mix. In addition, for the year-ended December 31, 2012, systemwide net patient revenues per case grew by 7.4% compared to the year-ended December 31, 2011, which is due to similar factors as described above.

Equity in Net Income of Nonconsolidated Affiliates

Equity in net income of nonconsolidated affiliates decreased by $5.4 million, or 24.3%, to $16.8 million for the year-ended December 31, 2012 from $22.2 million for the year-ended December 31, 2011. This decrease was primarily due to impairment charges totaling $9.2 million recorded during 2012 on our investments in nonconsolidated affiliates due to a decline in the expected future cash flows of five nonconsolidated affiliates that we determined to be other than temporary. This decline in the expected future cash flows was caused by events specific to each impacted facility, as further described below. We do not believe that the impairments at these facilities are indicative of any overall market trends or uncertainties in our business. The impairments included:

 

    a $1.1 million impairment on our investment in Pueblo Ambulatory Surgery Center LLC related to declining volumes and earnings at the facility;

 

    a $3.3 million impairment on our investment in Premier Surgery Center of Louisville, L.P. related to insufficient forecasted growth at the facility;

 

    a $1.7 million impairment on our investment in Endoscopy Center West, LLC related to a buy-out offer received for our interest in the facility;

 

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    a $0.4 million impairment on our investment in Kerlan-Jobe Surgery Center, LLC related to a buy-out agreement for the facility; and

 

    a $2.7 million impairment on our investment in Surgical Center at Premier, LLC related to an estimated valuation obtained for the facility in connection with consideration of a new health system partner.

The fair value of our investments in nonconsolidated affiliates is determined using discounted cash flows or earnings, estimates or sales proceeds. No such impairment charges were recorded during the year-ended December 31, 2011.

Also contributing to the decrease in equity in net income of nonconsolidated affiliates was the conversion of a facility that was previously accounted for as an equity method investment to a consolidated facility during the second quarter of 2012. After the date of conversion, the results of such facility were reported in the our consolidated revenue and expense line items, whereas prior to the conversion, the results of operations at this facility were reported on a net basis in the line item Equity in net income of nonconsolidated affiliates.

These factors were partially offset by having a full year of equity income from certain large nonconsolidated affiliates acquired in 2011 and the acquisition of seven equity method facilities during 2012. Also, during the first quarter of 2012, we deconsolidated one previously consolidated facility to an equity method facility. After the deconsolidation, the results of operations for the affected facility are reported on a net basis in the line item Equity in net income of nonconsolidated affiliates, whereas prior to deconsolidation, the facility’s results were reported in our consolidated net operating revenues and the associated expense line items.

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

During the year-ended December 31, 2012, we recorded $20.3 million of amortization expense for definite-lived intangible assets attributable to equity method investments. This expense was included in the line item Equity in net income of nonconsolidated affiliates in our consolidated financial statements. We recorded $10.1 million of amortization expense during the year-ended December 31, 2011.

Salaries and Benefits

Salaries and benefits expense increased $20.0 million, or 9.0%, to $241.8 million for the year-ended December 31, 2012 from $221.8 million for the year-ended December 31, 2011. The increase in salary and benefits expense is primarily a result of our adding teammates to support our new health system relationships and in connection with acquisitions of new facilities. In addition, this increase is also in part driven by an increase in total facility labor costs resulting largely from increased case volumes.

Supplies

Supplies expense increased $9.5 million, or 5.9%, to $170.1 million for the year-ended December 31, 2012 from $160.6 million for the year-ended December 31, 2011. The increase in supplies expense is primarily attributable to pharmaceutical shortages, a shift in case mix and inflation, which was partially offset by the positive impact of our various supply chain initiatives, designed to improve our purchasing power and negotiate more favorable pricing from key vendors. Supplies expense per case increased by 4.1% during the year-ended December 31, 2012, as compared to the prior year, which was also primarily due to similar factors.

Other Operating Expenses

Other operating expenses increased $3.9 million, or 3.4%, to $118.5 million for the year-ended December 31, 2012 from $114.6 million for the year-ended December 31, 2011. This increase is primarily

 

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attributable to the incurrence of certain additional overhead costs resulting from our organizational growth, partially offset by our efforts to manage and decrease existing overhead operating expenses and the release of certain litigation and general and professional liability reserves.

Depreciation and Amortization

Depreciation and amortization expense increased $1.2 million, or 3.0%, to $41.6 million for the year-ended December 31, 2012 from $40.4 million for the year-ended December 31, 2011, primarily due to the addition of new capitalized assets during the year, partially offset by the conversion of one consolidated facility to an equity method investment.

Occupancy Costs

Occupancy costs remained relatively steady at $26.8 million during the year-ended December, 31, 2012 as compared to $26.6 million during the year-ended December, 31, 2011.

Provision for Doubtful Accounts

The provision for doubtful accounts decreased $1.4 million, or 9.6%, to $13.2 million for the year-ended December 31, 2012, from $14.6 million for the year-ended December 31, 2011, primarily as a result of improved collection of accounts receivables.

Impairment of Intangible and Long-Lived Assets

During 2012 and 2011, we examined our long-lived assets for impairment due to facility closings and facilities experiencing cash flows insufficient to recover the net book value of our long-lived assets. Based upon such review, we recorded $1.1 million of impairment charges during the year-ended December 31, 2012. No material impairment charges were recorded during the year-ended December 31, 2011.

Loss (Gain) on Sale of Investments

We recorded a loss on sale of investments of $7.1 million during 2012, compared to a gain of $3.9 million for 2011. The loss in 2012 was related to the divestiture of our interest in a nonconsolidated affiliate and the deconsolidation of a previously consolidated affiliate, which was partially offset by a gain from the consolidation of a previously nonconsolidated affiliate. The gain in 2011 was primarily related to deconsolidation transactions.

Provision for Income Tax Expense

For the year-ended December 31, 2012, income tax expense was $8.9 million, representing an effective tax rate of 10.6%, compared to an expense of $20.3 million, representing an effective tax rate of 19.0%, for the year-ended December 31, 2011. The $8.9 million in expense for the year-ended December 31, 2012 includes $8.4 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, and $0.5 million of state income taxes accrued by subsidiaries with separate state tax filing requirements, including $0.2 million attributable to noncontrolling interests. The $20.3 million in expense for the year-ended December 31, 2011 included $19.9 million attributable to the tax amortization of goodwill, an indefinite-lived intangible, and $0.4 million of state income taxes accrued by subsidiaries with separate state tax filing requirements, including $0.2 million attributable to noncontrolling interests. See “Risk Factors — Risks Related to Our Business — We may not be able to fully realize the value of our net operating loss carryforwards.”

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.

 

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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 considers all positive and negative evidence available, and concluded that a full valuation allowance was appropriate as of December 31, 2012. As of December 31, 2012, our valuation allowance was $151.8 million. See “Risk Factors — Risks Related to Our Business — We may not be able to fully realize the value of our net operating loss carryforwards.”

Net income attributable to noncontrolling interests

Net income attributable to noncontrolling interests decreased $0.9 million, or 1.0%, to $92.3 million for the year-ended December 31, 2012 from $93.2 million for the year-ended December 31, 2011. The increase in our consolidated net operating revenues, as described above, was more than offset by an increase in operating expenses. Most of our consolidated facilities include noncontrolling owners. A decrease in the earnings of these facilities resulted in a decrease in net income attributable to noncontrolling interests.

Net loss attributable to Surgical Care Affiliates

Net loss attributable to Surgical Care Affiliates increased $10.3 million, or 106.2%, to $20.0 million for the year-ended December 31, 2012 from $9.7 million for the year-ended December 31, 2011. While our facilities’ revenue increased, lower equity in net income of nonconsolidated affiliates, higher operating expenses and higher loss on sale of investments drove the increase in net loss attributable to Surgical Care Affiliates.

Adjusted EBITDA-NCI and Adjusted Net Income Reconcilements

The following table represents the reconciliation of net income to Adjusted EBITDA-NCI and of net loss attributable to Surgical Care Affiliates to Adjusted Net Income for the periods indicated below:

 

     2013     2012     2011  

Adjusted EBITDA-NCI:

                  

Net income

   $ 52.7      $ 72.3      $ 83.5   

Plus (minus):

      

Interest expense, net

     60.2        58.5        55.6   

Provision for income tax expense

     12.6        8.9        20.3   

Depreciation and amortization

     42.9        41.6        40.4   

Loss from discontinued operations, net

     7.4        2.1        3.0   

Equity method amortization expense (a)

     25.9        20.3        10.1   

Loss (gain) on sale of investments

     12.3        7.1        (3.9 )

Loss on extinguishment of debt

     10.3        —          —     

Asset impairments

     6.1        10.2        —     

Loss (gain) on disposal of assets

     0.1        (0.3 )     (0.8 )

IPO related expense (b)

     9.1        —          —     

Stock compensation expense (c)

     7.3        1.7        1.7   
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

     246.9        222.4        209.9   

(Minus):

      

Net income attributable to noncontrolling interests

     (104.0 )     (92.3 )     (93.2 )
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA-NCI

   $ 142.9      $ 130.1      $ 116.7   
  

 

 

   

 

 

   

 

 

 

 

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     2013     2012     2011  

Adjusted Net Income:

                  

Net loss attributable to Surgical Care Affiliates

   $ (51.3 )   $ (20.0 )   $ (9.7 )

Plus (minus)

      

Change in deferred income tax

     15.4        7.4        22.2   

Loss on extinguishment of debt

     10.3        —          —     

Asset impairments

     6.1        10.2        —     

Amortization expense

     6.7        4.9        5.5   

Loss from discontinued operations, net

     7.4        2.1        3.0   

Loss (gain) on sale of investments

     12.3        7.1        (3.9 )

Loss (gain) on disposal of assets

     0.1        (0.3 )     (0.8 )

Equity method amortization expense (a)

     25.9        20.3        10.1   

IPO related expense (b)

     9.1        —          —     

Stock compensation expense (c)

     7.3        1.7        1.7   
  

 

 

   

 

 

   

 

 

 

Adjusted Net Income

   $ 49.3      $ 33.4      $ 28.1   

 

(a) For the years-ended December 31, 2013, December 31, 2012 and December 31, 2011, we recorded $25.9 million, $20.3 million and $10.1 million, respectively, of amortization expense for definite-lived intangible assets attributable to equity method investments. These expenses are included in Equity in net income of nonconsolidated affiliates in our consolidated financial statements.
(b) IPO related expense includes an $8.0 million fee paid to TPG Capital pursuant to the Management Services Agreement (as defined herein) at the closing of our initial public offering in November 2013. After the fee was paid, the Management Services Agreement was terminated. See “Certain Relationships and Related Party Transactions — Management Services Agreement” for additional information regarding the Management Services Agreement.
(c) Represents stock-based compensation expense comprised of $2.7 million non-cash expense and $4.6 million in a non-recurring cash bonus paid on vested awards in the fourth quarter of 2013.

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:

 

    

YEAR-ENDED

DECEMBER 31,

 
     2013     2012     2011  

Net operating revenues

   $ 4.1      $ 16.6      $ 24.4   

Costs and expenses

     (5.4     (17.9     (26.6

(Loss) gain on sale of investments or closures

     (2.5     (1.8     1.6   
  

 

 

   

 

 

   

 

 

 

(Loss) income from discontinued operations

     (3.8     (3.1     (0.6

Income tax (expense) benefit

     (3.6     1.0        (2.4
  

 

 

   

 

 

   

 

 

 

Net loss from discontinued operations

   $ (7.4   $ (2.1   $ (3.0
  

 

 

   

 

 

   

 

 

 

Both the decline in net operating revenues and the decline in costs and expenses in each period were due to the timing of the sale or closure of the facilities identified as discontinued operations. Tax expense for each year is attributable to the amortization and write-offs of tax goodwill. Thus, to the extent the sale or closure of a facility triggers a write-off of goodwill, tax expense is impacted accordingly. Given that the number of facilities sold or closed varies from year to year, tax expense will vary based on the number of discontinued facilities, and the amount of tax goodwill associated with those facilities. The net loss from our discontinued operations is included in the line item Loss from discontinued operations, net of income tax expense in our consolidated financial statements.

 

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Liquidity and Capital Resources

Our primary cash requirements are paying our operating expenses, servicing our existing debt, capital expenditures on our existing properties, financing acquisitions of ASCs and surgical hospitals (including as both consolidated and nonconsolidated affiliates), the purchase of equity interests in nonconsolidated affiliates and distributions to noncontrolling interests. These continuing liquidity requirements have been and will continue to be significant, primarily due to financing costs relating to our indebtedness. 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 years-ended December 31, 2013, 2012 and 2011:

 

    

YEAR-ENDED

DECEMBER 31,

 
     2013     2012     2011  

Net cash provided by operating activities

   $ 165.6      $ 171.2      $ 162.2   

Net cash used in investing activities

     (76.8     (21.8     (157.9

Net cash (used in) provided by financing activities

     (121.7     (102.1     33.3   
  

 

 

   

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

   $ (32.9   $ 47.3      $ 37.7   
  

 

 

   

 

 

   

 

 

 

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.

 

    

YEAR-ENDED

DECEMBER 31,

 
     2013     2012     2011  

Net Income

   $ 52.7      $ 72.3      $ 83.5   

Depreciation and amortization

     42.9        41.6        40.4   

Distributions from nonconsolidated affiliates

     50.5        38.7        27.1   

Equity in income of nonconsolidated affiliates

     (23.4     (16.8     (22.2

Provision for doubtful accounts

     15.0        13.2        14.6   

Loss on de-designation and change in fair value of swap

     8.3        —          —     

Loss on extinguishment of debt

     10.3        —          —     

Payment of deferred interest

     (14.8     —          —     

Debt call premium paid

     (5.0     —          —     

Other operating cash flows, net

     29.1        22.2        18.8   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

   $ 165.6      $ 171.2      $ 162.2   
  

 

 

   

 

 

   

 

 

 

During the year-ended December 31, 2013, we generated $165.6 million of cash flows provided by operating activities, as compared to $171.2 million during the year-ended December 31, 2012. Cash flows from operating activities decreased $5.6 million, or 3.3%, from the prior period, primarily due to the payment of $14.8 million of interest that had been deferred as a payment-in-kind for the Senior PIK-election Notes (as defined herein), as discussed in the “Debt” section below, and a debt call premium of $5.0 million, partially offset by an increase in distributions from nonconsolidated affiliates of $11.8 million.

During the year-ended December 31, 2012, we generated $171.2 million of cash flows provided by operating activities, as compared to $162.2 million during the year-ended December 31, 2011. Cash flows provided by operating activities increased $9.0 million, or 5.5%, from the prior period, primarily due to an $11.6 million increase in distributions from nonconsolidated affiliates, partially offset by a $5.8 million decrease in net income, excluding equity in income of nonconsolidated affiliates.

 

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Cash Flows Used in Investing Activities

During the year-ended December 31, 2013, our net cash used in investing activities was $76.8 million, consisting primarily of $54.5 million for business acquisitions, net of cash acquired, $36.8 million of capital expenditures and $2.9 million of net settlements on interest rate swaps, partially offset by $5.9 million of proceeds from the disposal of assets, $4.6 million of proceeds from the sale of equity interests of nonconsolidated affiliates, $2.6 million of return of capital related to equity method investments and $2.1 million of proceeds from the sale of equity interests of consolidated affiliates in deconsolidation transactions.

During the year-ended December 31, 2012, our net cash used in investing activities was $21.8 million, consisting primarily of $28.4 million used in capital expenditures, $6.1 million used in net settlements on interest rate swaps and $14.5 million used in purchases of equity interests in nonconsolidated affiliates, partially offset by $4.3 million of proceeds received from the sale of equity interests of consolidated affiliates in deconsolidation transactions, $10.2 million of proceeds from the sale of businesses and $15.0 million of proceeds from the sale of equity interests of nonconsolidated affiliates.

During the year-ended December 31, 2011, our net cash used in investing activities was $157.9 million, consisting primarily of $131.4 million used for business acquisitions and purchase of equity interests in nonconsolidated affiliates, including $123.1 million used in the acquisition of 49% of the membership interests of IUH Surgery, $8.5 million used in net settlements on interest rate swaps and $32.9 million used in capital expenditures, partially offset by $9.0 million from the net change in restricted cash, $3.2 million in proceeds from the sale of equity interests of consolidated affiliates in deconsolidation transactions and $2.9 million in proceeds from the disposal of assets.

Cash Flows Used in Financing Activities

Net cash used in financing activities for the year-ended December 31, 2013 was $121.7 million, consisting primarily of $527.6 million for principal payments on long-term debt, $103.0 million of distributions to noncontrolling interests, which primarily related to existing facilities, $74.9 million of distributions to unit holders, and $5.7 million of payments of debt acquisition costs, partially offset by $417.7 million long-term debt borrowings and $171.9 million in proceeds from our initial public offering.

Net cash used in financing activities for the year-ended December 31, 2012 was $102.1 million, consisting primarily of $94.2 million in distributions to noncontrolling interests of consolidated affiliates, $8.9 million of repayments of long-term debt and $6.2 million of principal payments under capital lease obligations, partially offset by $7.6 million of proceeds from the sale of equity interests of consolidated affiliates.

Net cash provided by financing activities for the year-ended December 31, 2011 was $33.3 million, driven primarily by the funding of a $100.7 million senior secured incremental term loan facility, as well as $25.2 million of member equity contributions and $15.2 million of proceeds from the sale of equity interests of consolidated affiliates, partially offset by $84.7 million of distributions to noncontrolling interests, $6.4 million of repayments of long-term debt, $4.7 million of principal payments under capital lease obligations, $6.3 million of decreases in checks issued in excess of bank balance and $6.2 million of repurchases of equity interests of consolidated affiliates.

Cash and cash equivalents were $85.8 million at December 31, 2013 as compared to $118.7 million at December 31, 2012. 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. Our overall working capital position at December 31, 2013 was $37.3 million, as compared to $92.3 million at December 31, 2012, a decrease of $55.0 million, or 59.6%. This decrease is primarily driven by a decrease in cash due to the net cash flows from investing and financing activities referenced above and an increase in amounts payable to nonconsolidated affiliates.

 

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

Debt

Our primary sources of funding have been the issuance 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 Class B Revolving Credit Facility.

The Credit Facility

Our senior secured credit facilities consist of a $132.3 million Class B Revolving Credit Facility, which will mature on June 30, 2016 (the “Class B Revolving Credit Facility”); a $214.4 million Class B Term Loan, which will mature on December 30, 2017 (the “Class B Term Loan”); and a $388.1 million Class C Term Loan, which will mature on June 30, 2018 (the “Class C Term Loan” and, together with the Class B Revolving Credit Facility and the Class B Term Loan, the “Senior Secured Credit Facilities”).

We used the proceeds from our Class C Term Loan to repay in full our $118.7 million Class A Term Loan and $98.3 million Class A incremental Term Loan and to redeem our $164.8 million of Senior PIK-election Notes. On June 29, 2013, our $21.5 million Class A Revolving Credit Facility was terminated after we decided not to renew the revolving credit facility because we believe we have sufficient available borrowing capacity for our operations under our Class B Revolving Credit Facility.

The table below indicates the current maturity date for each of our credit facilities.

 

Facility

   Maturity Date

Class B Revolving Credit Facility

   June 30, 2016

Class B Term Loan

   December 30, 2017

Class C Term Loan

   June 30, 2018

As further shown in the table above, we believe that we do not currently face a substantial refinancing risk. However, upon the occurrence of certain events, such as a change of control or a violation of certain covenants in our Senior Secured Credit Facilities, we could be required to repay or refinance our indebtedness. See “Risk Factors — Risks Related to Our Business — We have a substantial amount of indebtedness, which may adversely affect our available cash flow and our ability to operate our business, remain in compliance with debt covenants and make payments on our indebtedness.”

As of December 31, 2013, we had no outstanding balance under the Class B Revolving Credit Facility. At December 31, 2013, we had approximately $1.7 million in letters of credit outstanding under this facility. Utilization of the Class B Revolving Credit Facility is subject to compliance with a total leverage ratio test. No utilization of the Class B Revolving Credit Facility may be outstanding (other than issuances of up to an aggregate of $5.0 million of letters of credit) at the end of any fiscal quarter in which the total leverage ratio, which is the ratio of consolidated total debt to consolidated EBITDA (each as defined in our credit agreement (the “Amended Credit Agreement”)), as of the last day of such fiscal quarter, is greater than the specified ratio level.

 

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Borrowings under each portion of the Senior Secured Credit Facilities bear interest at a base rate or at LIBOR, as elected by us, plus an applicable margin. The base rate is determined by reference to the higher of (i) the prime rate of JPMorgan Chase Bank, N.A. and (ii) the federal funds effective rate plus 0.50% (the “base rate”). The LIBOR rate is determined by reference to the interest rate for dollar deposits in the London interbank market. The table below outlines the applicable margin for each credit facility.

 

   

Applicable Margin (per annum)

Facility

 

Base Rate Borrowings

 

LIBOR Borrowings

Class B Revolving Credit Facility

  2.50%   3.50%

Class B Term Loan

  3.00%   4.00%

Class C Term Loan

 

2.00% or 2.25% (with a base rate floor of 2.00%), depending upon

the total leverage ratio

  3.00% or 3.25% (with a LIBOR floor of 1.00%), depending upon the total leverage ratio

At December 31, 2013, the interest rate on the Class B Term Loan was 4.25%. At December 31, 2013, the interest rate on our Class C Term Loan was 4.25%. We must repay each of the Class B Term Loan and the Class C Term Loan in quarterly installments equal to 0.25% of the original principal amount of the respective loan. The remaining amount of each of the Class B Term Loan and the Class C Term Loan is due in full at maturity. We are also required to pay a commitment fee to the lenders under our Class B Revolving Credit Facility in respect of the unutilized commitments thereunder of either 0.375% or 0.50%, depending on the senior secured leverage ratio (as defined in the Amended Credit Agreement).

The Senior Secured Credit Facilities contain certain customary representations and warranties, affirmative covenants, events of default and various restrictive covenants, which are subject to certain significant exceptions. As of December 31, 2013, we believe we and SCA were in compliance with these covenants.

Senior Subordinated Notes

On June 29, 2007, SCA and Surgical Holdings, Inc. (the “Co-Issuer”) issued $150.00 million in aggregate principal amount of 10% senior subordinated notes due July 15, 2017 (the “Senior Subordinated Notes”). On December 4, 2013, SCA and the Co-Issuer redeemed the Senior Subordinated Notes at a premium of 3.333%. The satisfaction, discharge and redemption of the Senior Subordinated Notes was funded with proceeds from our initial public offering. In conjunction with the redemption, we recognized a loss on extinguishment of $6.5 million.

Senior PIK-election Notes

On June 29, 2007, SCA and the Co-Issuer issued $150.0 million in aggregate principal amount of 8.875% / 9.625% Senior PIK-election Notes due July 15, 2015 (the “Senior PIK-election Notes”). On June 14, 2013, SCA and the Co-Issuer issued a notice of redemption for all of the outstanding Senior PIK-election Notes (which totaled $164.8 million as of June 14, 2013) and deposited sufficient funds with the trustee for the Senior PIK-election Notes to satisfy and discharge all of our and the Co-Issuer’s obligations with respect to the Senior PIK-election Notes and the related indenture. The Senior PIK-election Notes were redeemed in full on July 15, 2013. This satisfaction, discharge and redemption of the Senior PIK-election Notes was funded with borrowings from the Class C Term Loan. In conjunction with the redemption, we recognized a loss on extinguishment of $3.8 million.

 

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Contractual Obligations

The table below sets forth our future maturities of debt, interest on debt, capitalized lease obligations, operating lease obligations and other contractual obligations as of December 31, 2013:

 

     Payments due by period  
     Total      Less than
1 year
     1-3
years
     3-5
years
     More than 5
years
 
     (in millions)  

Debt obligations (1)

   $ 646.5       $ 15.7       $ 27.3       $ 593.9       $ 9.6   

Interest on debt obligations (2)

     118.0         28.1         54.5         34.7         0.7   

Capitalized lease obligations (3)

     31.1         8.5         10.3         4.8         7.5   

Operating lease obligations (4)

     103.1         24.3         35.4         17.8         25.6   

Other contractual obligations (5)

     5.5         2.9         2.2         0.4         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 904.2       $ 79.5       $ 129.7       $ 651.6       $ 43.4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) As of December 31, 2013 and for purposes of this table, our indebtedness included (i) $214.4 million of Class B Term Loans, (ii) $388.1 million of Class C Term Loans, (iii) $132.3 million of Class B Revolving Credit Facility capacity and (iv) $44.0 million of notes payable to banks and others.
(2) Represents (i) interest expense on the debt obligations based on an assumed interest rate of the current 3-month LIBOR rate as of December 31, 2013 plus 175 basis points with respect to the Class B Term Loan and Class B Revolving Credit Facility, an interest rate of 3.25% with a LIBOR floor of 1.00%, (ii) quarterly commitment fees on unused borrowing capacity under the Class B Revolving Credit Facility and (iii) various fixed and variable rates on notes payable to banks and others.
(3) Capitalized lease obligations include real estate, medical equipment, computer equipment and other equipment utilized in operations (interest and principal).
(4) Operating lease obligations include land, buildings and equipment.
(5) Other contractual obligations are attributable to maintenance and service contracts.

Because their future cash outflows are uncertain, the following liabilities are excluded from the table above: deferred income taxes, professional liability reserves, workers’ compensation reserves, redeemable noncontrolling interests and our estimated liability for unsettled litigation. Deferred rent is also excluded from the table above.

Repurchases of Equity from Physician Partners

We are obligated under the agreements governing certain of our partnerships and LLCs to repurchase all of the physicians’ ownership interests upon the occurrence of certain regulatory events, including if it becomes illegal for physicians to own an interest in one of our facilities, refer patients to one of our facilities or receive cash distributions from a facility. The purchase price that we would be required to pay for these ownership interests is typically based on either a multiple of the applicable facility’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), or the fair market value of the ownership interests as determined by a third-party appraisal. In the event we are required to purchase all of the physicians’ ownership interests in all of our facilities, our existing capital resources would not be sufficient for us to meet this obligation. See “Risk Factors — Risks Related to Healthcare Regulation — If laws or regulations governing physician ownership of our facilities change, we may be obligated to purchase some or all of the ownership interests of our physician partners or renegotiate some of our partnership and operating agreements with our physician partners and management agreements with our surgical facilities.”

Capital Expenditures

Currently, we project our capital expenditures for fiscal year 2014 to be approximately $48 million, which we expect to finance primarily through internally generated funds and bank or manufacturer financing. Capital

 

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expenditures totaled $36.8 million and $28.4 million for the years-ended December 31, 2013 and 2012. The capital expenditures made during 2013 consisted primarily of fixture improvements made at our leased 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 inception of the lease. Interest rates used in computing the net present value of the lease payments generally range from 2.3% to 12.2% based on our incremental borrowing rate at the inception of the lease.

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 December 31, 2013, we accounted for 60 of our 177 facilities under the equity method. Similar to 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 December 31, 2013, the total debt on the balance sheets of our nonconsolidated affiliates was approximately $40.9 million. Our average percentage of ownership of these nonconsolidated affiliates, weighted based on the particular affiliate’s amount of debt and our ownership of such affiliate, was approximately 22% at December 31, 2013. We or one of our wholly owned subsidiaries collectively guaranteed $2.5 million of the $40.9 million in total debt of our nonconsolidated affiliates as of December 31, 2013. Our guarantees related to operating leases of nonconsolidated affiliates were $4.0 million at December 31, 2013.

As described above, our nonconsolidated affiliates are structured as LPs, general partnerships, 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

 

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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.

Principles of Consolidation

Our consolidated financial statements include the accounts of us, our 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 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 consolidated financial statements for our consolidated affiliates. For our equity method affiliates, assets and liabilities are reported on a net basis in the line item Investment in and advances to nonconsolidated affiliates on the consolidated balance sheets, and revenues and expenses are reported on a net basis in the line item Equity in net income of nonconsolidated affiliates on the consolidated statements of operations.

Variable Interest Entities

Under Accounting Standards Codification Section 810, Consolidations, we include the assets, liabilities and activities of a VIE in our financial statements if we are the primary beneficiary of such VIE and the entity has one or more of the following characteristics: (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) as a group the holders of the equity investment at risk lack (i) the ability to make decisions about an entity’s activities through voting or similar rights, (ii) the obligation to absorb the expected losses of the entity or (iii) the right to receive the expected residual returns of the entity, or (c) the equity investors have voting rights that are not proportional to their economic interests and substantially all of the entity’s activities either involve, or are conducted on behalf of, an investor that has disproportionately few voting rights. The primary beneficiary of a VIE is generally the entity that will receive a majority of the VIE’s expected losses or receive a majority of a VIE’s expected residual returns and has the power to direct the activities that most significantly impact the VIE’s economic performance.

Determining the primary beneficiary of a VIE requires substantial judgment, including determining what activities most significantly impact the economic performance of the VIE and which entity or entities have control over those activities.

Revenue Recognition

Our revenues consist primarily of net patient revenues that are recorded based upon established billing rates less allowances for contractual adjustments. Revenues are recorded during the period the services are provided,

 

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based upon the estimated amounts due from patients and third-party payors, including federal and state payors (primarily the Medicare and Medicaid programs), commercial health insurance companies, workers’ compensation programs and employers. These estimates are complex and require significant judgement. Estimates of contractual allowances under third-party payor arrangements are based upon the payment terms specified in the related contractual agreements and payment history. Third-party payor contractual payment terms are generally based upon predetermined rates per procedure or discounted fee-for-service rates.

During the year-ended December 31, 2013, approximately 60% of our net patient revenues related to patients with commercial insurance coverage. Healthcare service providers are under increasing pressure to accept reduced reimbursement for services on these contracts. Continued reductions could have a material adverse impact on our financial position, results of operations and cash flows.

During the year-ended December 31, 2013, approximately 23% of our net patient revenues related to patients participating in the Medicare and Medicaid programs. Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation and are routinely modified for provider reimbursement. We are unable to predict if or when we may be subject to a suspension of payments by the Medicare and/or Medicaid programs, the possible length of the suspension period or the potential cash flow impact of a payment suspension. Any such suspension would adversely impact our financial position, results of operations and cash flows.

During the year-ended December 31, 2013, uninsured or self-pay revenues accounted for less than 6% of our net patient revenues.

Our facilities primarily perform surgery that is scheduled in advance by physicians who have already seen the patient. We verify benefits, obtain insurance authorization, calculate patient financial responsibility and notify the patient of their responsibility, usually prior to surgery.

Accounts Receivable

We report accounts receivable at estimated net realizable amounts from services rendered from federal and state payors (primarily the Medicare and Medicaid programs), commercial health insurance companies, workers’ compensation programs, employers and patients. Our accounts receivable are geographically dispersed, but a significant portion of our accounts receivable are concentrated by type of payor.

Accounts receivable from government payors are significant to our operations, comprising 18% of net patient service accounts receivable at December 31, 2013. We do not believe there are significant credit risks associated with these government payors.

Accounts receivable related to workers’ compensation are significant to our operations, comprising 14% of net patient service accounts receivable at December 31, 2013. We do not believe there are significant credit risks associated with workers’ compensation payors and related receivables.

Accounts receivable from commercial health insurance payors were 63% of our net patient service accounts receivable at December 31, 2013. Because the category of commercial health insurance payors is composed of numerous individual payors which are geographically dispersed, our management does not believe there are any significant concentrations of revenues from any individual payor that would subject us to significant credit risks in the collection of our accounts receivable.

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. Due to the complexity of insurance reimbursements and

 

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inherent limitations of insurance verification procedures, we expect we will continue to have write-offs of bad debt and provision for doubtful accounts. In 2013 our “Provision for doubtful accounts” was approximately 2% of net operating revenue. We reserve for doubtful accounts based principally upon the payor class and age of the receivable. We also write off accounts on an individual basis based on that information. We believe our policy allows us to accurately estimate our “Provision for doubtful accounts.

Noncontrolling Interest in Consolidated Affiliates

Our consolidated financial statements include all assets, liabilities, revenues and expenses of less-than-100%-owned affiliates that we control. Accordingly, we have recorded a noncontrolling interest in the earnings and equity of such affiliates. We record adjustments to noncontrolling interest for the allocable portion of income or loss to which the noncontrolling interest holders are entitled based upon the portion of the subsidiaries they own. Distributions to holders of noncontrolling interests reduce the respective noncontrolling interest holders’ balance.

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 RSUs to key teammates, directors, service providers, consultants and affiliates.

Under the Plans, our key teammates, directors, service providers, consultants and affiliates are provided with what we believe to be appropriate incentives to encourage them to continue employment with us or providing service to us or any of our affiliates and to improve our growth and profitability.

Option awards are generally granted with an exercise price equal to at least the fair market value of the underlying share at the date of grant. Vesting in the option awards varies based upon time, attainment of certain performance conditions, or upon the occurrence of a Liquidity Event (as defined in the applicable Plan) in which the TPG Funds and/or any of its affiliates achieves a minimum cash return on its original investment. All existing RSU awards vest over time.

Income Taxes

We provide for income taxes using the asset and liability method. This approach recognizes the amount of federal, state and local taxes payable or refundable for the current year, as well as deferred tax assets and liabilities for the future tax consequence of events recognized in the consolidated financial statements and income tax returns. Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates.

A valuation allowance is required when it is more-likely-than-not that some portion of the deferred tax assets will not be realized. Realization is dependent on generating sufficient future taxable income.

We file a consolidated federal income tax return. State income tax returns are filed on a separate, combined or consolidated basis in accordance with relevant state laws and regulations. LPs, LLPs, LLCs and other pass-through entities that we consolidate or account for using the equity method of accounting file separate federal and state income tax returns. We include the allocable portion of each pass-through entity’s income or loss in our federal income tax return. We allocate the remaining income or loss of each pass-through entity to the other partners or members who are responsible for their portion of the taxes.

 

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Goodwill

We test goodwill for impairment using a fair value approach at least annually, absent some triggering event that would require an interim impairment assessment. Absent any impairment indicators, we perform our goodwill impairment testing as of October 1st of each year.

We recognize an impairment charge for any amount by which the carrying amount of goodwill exceeds its implied fair value. We present a goodwill impairment charge as a separate line item within income from continuing operations in the consolidated statements of operations, unless the goodwill impairment is associated with a discontinued operation. In that case, we include the goodwill impairment charge, on a net-of-tax basis, within the results of discontinued operations.

When we dispose of a facility, the relative fair value of goodwill is allocated to the gain or loss on disposition.

The results of the first step of the annual impairment test performed as of October 1, 2013 indicated that the fair values of all operating segments substantially exceeded their carrying values.

Impairment of Long-Lived Assets and Other Intangible Assets

We assess the recoverability of long-lived assets (excluding goodwill) and identifiable acquired intangible assets with definite useful lives whenever events or changes in circumstances indicate we may not be able to recover the asset’s carrying amount. We measure the recoverability of assets to be held and used by a comparison of the carrying amount of the asset to the expected net future cash flows to be generated by that asset, or, for identifiable intangibles with definite useful lives, by determining whether the amortization of the intangible asset balance over its remaining life can be recovered through undiscounted future cash flows. The amount of impairment of identifiable intangible assets with definite useful lives, if any, to be recognized is measured based on projected discounted future cash flows. We measure the amount of impairment of other long-lived assets (excluding goodwill) as the amount by which the carrying value of the asset exceeds the fair market value of the asset, which is generally determined based on projected discounted future cash flows or appraised values. We present an impairment charge as a separate line item within income from continuing operations in our consolidated statements of operations, unless the impairment is associated with a discontinued operation. In that case, we include the impairment charge, on a net-of-tax basis, within the results of discontinued operations. We classify long-lived assets to be disposed of other than by sale as held and used until they are disposed. We report long-lived assets to be disposed of by sale as held for sale and recognize those assets in the balance sheet at the lower of carrying amount or fair value less cost to sell, and cease depreciation.

Recent Revisions to Authoritative Accounting Guidance

Reclassification of Other Comprehensive Income

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This update requires companies to include reclassification adjustments for items that are reclassified from other comprehensive income to net income in a single note or on the face of the financial statements. The amendment was effective for annual and interim reporting periods beginning after December 15, 2012. The adoption of this standard did not have a material impact on our consolidated financial statements.

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

 

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JOBS Act

The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. However, we are choosing to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Our principal market risk is our exposure to variable interest rates. As of December 31, 2013, we had $645.7 million of indebtedness (excluding capital leases), of which $635.1 million is at variable interest rates and $10.6 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 neither use financial instruments for trading or other speculative purposes, nor use leveraged financial instruments.

At December 31, 2013, we held interest rate swaps hedging interest rate risk on $240.0 million of our variable rate debt through three forward starting interest rate swaps with an aggregate notional amount of $240.0 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 interest rate swaps with an aggregate notional amount of $100.0 million were effective on September 30, 2012 and the remaining forward starting interest rate swap with a notional amount of $140.0 million was effective on September 30, 2013. A forward interest rate starting swap with a notional amount of $50.0 million will terminate 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 December 31, 2013, our annual interest expense would increase by approximately $3.6 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 December 31, 2013. 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.

 

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Auditors

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Surgical Care Affiliates, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income (loss), changes in equity and cash flows present fairly, in all material respects, the financial position of Surgical Care Affiliates, Inc. and its subsidiaries at December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Birmingham, Alabama

March 24, 2014

 

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SURGICAL CARE AFFILIATES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

    DECEMBER 31,
2013
    DECEMBER 31,
2012
 
Assets    

Current assets

   

Cash and cash equivalents

  $ 85,816      $ 118,725   

Restricted cash

    25,031        27,630   

Accounts receivable, net of allowance for doubtful accounts (2013 — $11,918; 2012 — $5,928)

    91,783        82,192   

Receivable from nonconsolidated affiliates

    12,331        22,883   

Prepaids and other current assets

    19,609        14,402   

Current assets related to discontinued operations

</