SGRY 10-K Fiscal year ended Dec. 31, 2019

x	Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2019

o	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

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•	the social and economic impact of the COVID-19 outbreak on our business;

•	the impact of future legislation and other health care regulatory reform actions, and the effect of that legislation and other regulatory actions on our business;

•	our ability to comply with current health care laws and regulations;

•	reductions in payments from government health care programs and private insurance payors, such as health maintenance organizations ("HMOs"), preferred provider organizations ("PPOs"), and other managed care organizations and employers;

•	our ability to contract with private insurance payors;

•	changes in our payor mix or surgical case mix;

•	failure to maintain or develop relationships with our physicians on beneficial or favorable terms, or at all;

•	the impact of payor controls designed to reduce the number of surgical procedures;

•	our efforts to integrate operations of acquired businesses and surgical facilities, attract new physician partners, or acquire additional surgical facilities;

•	shortages or quality control issues with surgery-related products, equipment and medical supplies;

•	competition for physicians, nurses, strategic relationships, acquisitions and managed care contracts;

•	our ability to attract and retain qualified health care professionals;

•	our ability to enforce non-compete restrictions against our physicians;

•	our ability to manage material liabilities whether known or unknown incurred as a result of acquiring surgical facilities;

•	economic and competitive conditions;

•	the outcome of legal and regulatory proceedings that have been or may be brought against us;

•	changes in the regulatory, economic and other conditions of the states where our surgical facilities are located;

•	payments we are required to make under the tax receivable agreement; and

•	our indebtedness.

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•	Deliver outstanding patient care and clinical outcomes;

•	Continue to execute and expand upon our physician engagement strategy in attractive markets;

•	Become the partner of choice for physicians seeking to become or stay independent;

•	Drive organic growth at existing facilities through targeted physician recruitment, service line expansion and implementing our efficient operating model;

•	Seek partnership opportunities with payors to make health care more affordable for their members;

•	Continue our disciplined acquisition strategy;

•	Offer new services to provide a more comprehensive continuum of care; and

•	Enhance operational efficiencies and productivity by delivering on integration.

•	Our surgical facility services segment consists of the operation of ASCs and surgical hospitals and includes our anesthesia services. Our surgical facilities primarily provide non-emergency surgical procedures across many specialties, including, among others, orthopedics and pain management, ophthalmology, gastroenterology ("GI") and general surgery.

•	Our ancillary services segment consists of a diagnostic laboratory and multi-specialty physician practices, including physician practices owned and operated pursuant to long-term management service agreements.

•	Our optical services segment consists of an optical products group purchasing organization. Until we divested certain businesses in October 2018, this segment also included an optical laboratory that manufactured eyewear.

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•

We offer physicians toxicology testing services through our wholly-owned diagnostic laboratory, based in Tampa, Florida. Advanced toxicology screening provides physicians with the ability to identify when a patient is taking too much of a prescribed substance, when a patient is non-compliant with a prescribed substance or when a patient is taking unprescribed or illicit substances. Our diagnostic laboratory supports the needs of our physicians across our existing specialties and new service lines.

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We employ two models in connection with our network of multi-specialty physician practices. For example, in the state of Florida, where the law does not preclude a business corporation from employing physicians, we own and operate Tampa Pain Relief Center, Inc., a wholly-owned business with several locations throughout Florida. In certain other states, we operate physician practices pursuant to long-term management service agreements with separate professional corporations that are wholly-owned by physicians.

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•	The ASC must be certified to participate in the Medicare program, and its operating and recovery room space must be dedicated exclusively to the center and not a part of a hospital (although such space may be leased from a hospital if such lease meets the requirements of the safe harbor for space rental).

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Each investor must be either (a) a physician who derived at least one-third of his or her medical practice income for the previous fiscal year or 12-month period from performing procedures on the list of Medicare-covered procedures for ASCs, (b) a hospital, or (c) a person or entity not in a position to make or influence referrals to the center, nor to provide items or services to the center, nor employed by the center or any investor.

•	Unless all physician-investors are members of a single specialty, each physician-investor must perform at least one-third of his or her procedures at the ASC each year. This requirement is in addition to the requirement that the physician-investor has derived at least one-third of his or her medical practice income for the past year from performing procedures.

•	Physician-investors must have fully informed their referred patients of the physician’s investment.

•	The terms on which an investment interest is offered to an investor are not related to the previous or expected volume of referrals, services furnished or the amount of business otherwise generated from that investor to the entity.

•	Neither the ASC nor any other investor nor any person acting on their behalf may loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest.

•	The amount of payment to an investor in return for the investment interest is directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor.

•	All physician-investors, any hospital-investor and the center agree to treat patients receiving benefits or assistance under a federal health care program in a non-discriminatory manner.

•	All ancillary services performed at the ASC for beneficiaries of federal health care programs must be directly and integrally related to primary procedures performed at the center and may not be billed separately.

•	No hospital-investor may include on its cost report or any claim for payment from a federal health care program any costs associated with the ASC.

•	The ASC may not use equipment owned by or services provided by a hospital-investor unless such equipment is leased in accordance with a lease that complies with the Anti-Kickback Statute equipment rental safe harbor and such services are provided in accordance with a contract that complies with the Anti-Kickback Statute personal services and management contract safe harbor.

•	No hospital-investor may be in a position to make or influence referrals directly or indirectly to any other investor or the center.

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•	a prohibition on hospitals from having any physician ownership unless the hospital already had physician ownership and a Medicare provider agreement in effect as of December 31, 2010;

•	a limitation on the percentage of total physician ownership or investment interests in the hospital or entity whose assets include the hospital to the percentage of physician ownership or investment as of March 23, 2010;

•	a prohibition from expanding the number of beds, operating rooms, and procedure rooms for which it is licensed after March 23, 2010, unless the hospital obtains an exception from the Secretary of the Department of Health & Human Services (the "Secretary");

•	a requirement that return on investment be proportionate to the investment by each investor;

•	restrictions on preferential treatment of physician versus non-physician investors;

•	a requirement for written disclosures of physician ownership interests to the hospital’s patients and on the hospital’s website and in any advertising, along with annual reports to the government detailing such interests;

•	a prohibition on the hospital or other investors from providing financing to physician investors;

•	a requirement that any hospital that does not have 24/7 physician coverage inform patients of this fact and receive signed acknowledgments from the patients of the disclosure; and

•	a prohibition on "grandfathered" status for any physician owned hospital that converted from an ASC to a hospital on or after March 23, 2010.

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•	making it more difficult for us to satisfy our obligations with respect to our indebtedness;

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

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

•	limiting our flexibility in reacting to competitive and other changes in our industry and economic conditions generally; and

•	limiting our ability to raise additional capital for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other general corporate purposes.

•	incur additional indebtedness and guarantee indebtedness;

•	pay dividends or make other distributions in respect of, or repurchase or redeem, capital stock;

•	prepay, redeem or repurchase certain debt;

•	make loans and investments;

•	sell or otherwise dispose of assets;

•	sell stock of our subsidiaries;

•	incur liens;

•	enter into transactions with affiliates;

•	enter into agreements restricting certain of our subsidiaries’ ability to pay dividends; and

•	consolidate, merge or sell all or substantially all of our assets.

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•	the collapse or insolvency of our insurance carriers;

•	further increases in premiums and deductibles;

•	increases in the number of liability claims against us or the cost of settling or trying cases related to those claims; or

•	an inability to obtain one or more types of insurance on acceptable terms, if at all.

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•	disputes between payors as to which party is responsible for payment;

•	failure of information systems and processes to submit and collect claims in a timely manner;

•	variation in coverage for similar services among various payors;

•	the difficulty of adherence to specific compliance requirements, diagnosis coding and other procedures mandated by various payors; and

•	failure to obtain proper physician credentialing and documentation in order to bill various payors.

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•	reducing the highest marginal U.S. federal corporate income tax rate from 35% to 21% for tax years beginning after December 31, 2017;

•	limiting the extent to which net operating losses can be utilized against taxable income that would apply to losses created after December 31, 2017;

•	changing rules related to the ability to apply net operating losses against later or earlier tax years that would apply to losses created after December 31, 2017;

•	creating a new limitation on deductible interest expense for tax years beginning after December 31, 2017;

•	eliminating the corporate alternative minimum tax ("AMT") and changing how existing AMT credits can be realized for tax years beginning after December 31, 2017; and

•	generally repealing the performance-based compensation exception to the Section 162(m) $1.0 million deduction limitation and revising the definition of a covered employee for tax years beginning after December 31, 2017.

•	changes in the valuation of our deferred tax assets and liabilities;

•	expected timing and amount of the release of any tax valuation allowances;

•	tax effects of equity-based compensation;

•	costs related to intercompany restructurings;

•	changes in tax laws, regulations or interpretations thereof; or

•	lower than anticipated future earnings in jurisdictions where we have lower statutory tax rates and higher than anticipated future earnings in jurisdictions where we have higher statutory tax rates.

•	ownership and control of our facilities;

•	operating policies and procedures;

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•	qualification, training and supervision of medical and support persons;

•	pricing of, billing for and coding of services and properly handling overpayments, debt collection practices and the submission of false statements or claims;

•	the necessity, appropriateness and 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;

•	screening, stabilization and transfer of individuals who have emergency medical conditions and provision of emergency services;

•	antitrust;

•	building codes;

•	workplace health and safety;

•	licensure, certification and accreditation;

•	fee-splitting and the corporate practice of medicine;

•	handling of medication;

•	confidentiality, data breach, identity theft and maintenance and protection of health-related and other personal information and medical records; and

•	environmental protection, health and safety.

•	the responses of individuals, businesses and other market participants to the evolving choices and obligations under the Affordable Care Act;

•	the states’ decisions whether to implement the Medicaid expansion provisions of the Affordable Care Act, and under what terms;

•	the effect of value-based purchasing and other quality programs established under the Affordable Care Act;

•	the scope and nature of changes to Medicare reimbursement methods and programs, including accountable care organizations, bundled payment programs and other coordinated care models;

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•	the financial sustainability of the Health Insurance Marketplace, which may be impacted by whether a sufficient number of payors participate;

•	our ability to participate in health insurance plans offered through the Health Insurance Marketplaces and the terms of our participation;

•	the net effect of reductions in federal health care program spending under the Affordable Care Act; and

•	the resolution of new and ongoing legislative and legal challenges to the Affordable Care Act.

•	make illegal the referral of Medicare or other patients to our surgical facilities and hospitals by physician investors;

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

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

•	require us to reduce the aggregate percentage of physician investor ownership in our hospitals.

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•	the requirement that a majority of the board of directors consist of independent directors;

•	the requirement that we have a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

•	the requirement that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.

•	variations in our operating performance and the performance of our competitors;

•	actual or anticipated fluctuations in our quarterly or annual operating results;

•	publication of research reports by securities analysts about us or our competitors or our industry;

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

•	our failure or the failure of our competitors to meet analysts’ projections or guidance that we or our competitors may give to the market;

•	strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;

•	the passage of legislation or other regulatory developments affecting us or our industry;

•	our limited public float;

•	speculation in the press or investment community;

•	changes in accounting principles;

•	terrorist acts, acts of war or periods of widespread civil unrest;

•	natural disasters and other calamities; and

•	changes in general market and economic conditions.

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(1)	Shares delivered to or withheld by us in connection with employee payroll tax withholding upon exercise or vesting of stock awards.

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(1)	Revenues in 2019 and 2018 reflect changes related to adoption of ASU 2014-09 as discussed in Note 1. "Organization and Summary of Accounting Policies."

(2)	Includes accrued dividends for the Series A Preferred Stock for the years ended December 31, 2019, 2018 and 2017. Includes a mark to redemption adjustment for the Series A Preferred Stock for the year ended December 31. 2017. There were no participating securities during 2016 and 2015.

(3)	The impact of potentially dilutive securities for the years ended December 31, 2019, 2018, and 2017 was not considered because the effect would be anti-dilutive in each of those periods.

(4)	See Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Certain non-GAAP Metrics" for a table showing the reconciliation of Adjusted EBITDA to income before income taxes.

(5)	Includes surgical facilities that we manage but in which we have no ownership interest.

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(1)	Other is comprised of anesthesia service agreements, auto liability, letters of protection and other payor types.

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(1)	For a reconciliation of Adjusted EBITDA to income before income taxes as reflected in the audited consolidated statements of operations see "Certain Non-GAAP Metrics" below.

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(1)

This amount includes transaction and integration costs of $19.0 million , $31.7 million and $13.1 million in 2019, 2018 and 2017, respectively, acquisition costs of $2.8 million , $2.2 million and $3.9 million in 2019, 2018 and 2017, respectively. This amount further includes start-up costs related to a de novo surgical hospital of $14.3 million in 2019, with no comparable costs in the 2018 and 2017 periods.

(2)	This amount includes a loss on litigation settlements of $0.2 million and $46.0 million in 2019 and 2018, respectively, and a gain on litigation of $12.5 million in 2017. This amount further includes other litigation costs of $4.4 million in 2019, with no comparable costs in the 2018 and 2017 periods.

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(3)	This amount represents adjustments to revenue in order to apply consistent policies to businesses acquired by Surgery Partners in prior periods.

(1)	Represents impact of acquisitions as if each acquisition had occurred on January 1, 2019. Further this includes revenue synergies from other business initiatives, de novo facilities and an adjustment for the effects of adopting the new lease accounting standard, as defined in the credit agreement governing the Senior Secured Credit Facilities.

(1)

Included in long-term debt obligations are principal and interest owed on our outstanding debt obligations. These amounts exclude our unamortized fair value adjustments related non-cash amortization for the Term Loan. These obligations are explained further in Note 5 to our consolidated financial statements included elsewhere in this Annual Report. We used the applicable annual interest rate as of December 31, 2019 of 4.96%, based on LIBOR plus the applicable margin, for our $1.4 billion outstanding Term Loan to estimate interest payments on this variable rate debt instrument.

(2)

This reflects our future operating lease payments. We enter into operating leases in the normal course of business. Substantially all of our operating lease agreements have fixed payment terms based on the passage of time. Some lease agreements provide us with the option to renew the lease. Our future operating lease obligations would change if we exercised these renewal options and if we entered into additional operating lease agreements. These obligations are explained further in Note 6 to our consolidated financial

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(3)	This reflects payments made pursuant to the terms of the TRA, as described further in "Critical Accounting Policies and Tax Receivable Agreement."

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(1)	The impact of potentially dilutive securities for all periods were not considered because the effect would be anti-dilutive in those periods.

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(1)	Includes post acquisition date adjustments in all periods, including reallocation in application of pushdown accounting in the 2017 successor period.

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•	Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.

•	Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These may include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

•	Level 3: Unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, depending on the nature of the item being valued.

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(1)	Other is comprised of anesthesia service agreements, auto liability, letters of protection and other payor types.

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(1)	Includes post acquisition date adjustments in all periods.

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(1)

In connection with the clinic acquisition in 2019, the Company acquired the remaining non-controlling interests in one of its existing consolidated surgical facilities. As such, $6.3 million of the cash consideration for the clinic acquisition was classified as a financing activity and presented in payments related to ownership transactions with non-controlling interest holders in the Consolidated Statements of Cash Flows.

(2)	The assets acquired in 2019 includes the fair value of a non-controlling investment held by the acquired clinic in one of the Company's consolidated surgical facilities of $8.8 million . This investment asset was subsequently eliminated in consolidation.

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(1)	Includes unamortized fair value discount of $4.6 million and $5.5 million as of December 31, 2019 and 2018 , respectively.

(2)	Includes unamortized fair value premium of $6.7 million as of December 31, 2018 . The premium was written-off upon redemption as discussed below.

(3)

In connection with the adoption of the Lease Accounting Standard, the Company's capital lease obligations that existed as of December 31, 2018 were derecognized and included as a component of the finance lease obligations included in the table shown above. See Note 6. "Leases" for further discussion on the adoption of the Lease Accounting Standard. The increase in finance lease obligations upon adoption of the Lease Accounting Standard is due to the inclusion of certain financing obligations that were previously recognized as a component of other current and long-term liabilities as discussed further in Note 13. "Other Assets and Liabilities." The increase also includes the addition of a new finance lease associated with a new de novo hospital, which began operations in the fourth quarter of 2019.

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(1)

Includes financing obligations payable to the lessors of certain land, buildings and improvements that arose due to the Company's continued involvement with the leased assets under the sale-leaseback guidance in effect prior to the adoption of the Lease Accounting Standard. As of December 31, 2018, the current portion of the financing obligations was $7.0 million and was included in other current liabilities in the consolidated balance sheets. The long-term portion of the finance obligations was $149.8 million and was included as other long-term liabilities in the consolidated balance sheets.

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(1)	There were no derivatives outstanding for the comparative periods in 2017.

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(1)	Includes dividends accrued during the Successor periods for the Series A Preferred Stock. The Series A Preferred Stock does not participate in undistributed losses. There were no participating securities during the Predecessor periods.

(2)	The impact of potentially dilutive securities for all periods were not considered because the effect would be anti-dilutive in each of those periods.

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▪	Risk-free interest rate .  The risk-free interest rate is used as a component of the fair value of stock options to take into account the time value of money. For the risk-free interest rate, the Company uses the implied yield on United States Treasury zero-coupon issues with a remaining term equal to the expected life, in years, of the options granted.

▪

Expected volatility .  Volatility, for the purpose of share-based compensation, is a measurement of the amount that a share price has fluctuated. Expected volatility involves reviewing historical volatility and determining what, if any, change the share price will have in the future. The Company used historical stock price information of certain peer group companies for a period of time equal to the expected option life period to determine estimated volatility.

▪	Expected life, in years .  A clear distinction is made between the expected life of an option and the contractual term of the option. The expected life of an option is considered the amount of time, in years, that an option is expected to be outstanding before it is exercised.  Whereas, the contractual term of the stock option is the term an option is valid before it expires.

▪	Expected dividend yield .  Since issuing dividends will affect the fair value of a stock option, GAAP requires companies to estimate future dividend yields or payments. The Company has not historically issued dividends and does not intend to issue dividends in the future. As a result, the Company does not apply a dividend yield component to its valuation.

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(1)

For the years ended December 31, 2019 and 2018 (Successor), this amount includes transaction and integration costs of $19.0 million and $31.7 million , respectively, and acquisition costs of $2.8 million and $2.2 million , respectively. This amount further includes start-up costs related to a de novo surgical hospital of $14.3 million for the year ended December 31, 2019 (Successor), with no comparable costs in the 2018 period (Successor). For the four months ended December 31, 2017 (Successor) and the eight months ended August 31, 2017 (Predecessor), this amount includes transaction and integration costs of $7.5 million and $5.6 million , respectively, and acquisition costs of $1.8 million and $2.1 million , respectively. There were no start-up costs related to the de novo surgical hospital in the 2017 periods.

(2)

For the years ended December 31, 2019 and 2018 (Successor), this amount includes a loss on litigation settlements of $0.2 million and $46.0 million , respectively. This amount further includes other litigation costs of $4.4 million for the year ended December 31, 2019 (Successor), with no comparable costs in the 2018 period (Successor). For the four months ended December 31, 2017 (Successor) and the eight months ended August 31, 2017 (Predecessor), this amount includes a gain on litigation settlements of $8.7 million and $3.8 million , respectively.

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(3)	This amount represents adjustments to revenue in connection with applying consistent policies across the combined company as a result of the integration of Surgery Partners and a previously acquired entity.

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