Item 1. Business
General
United Surgical Partners International, Inc. (together with its subsidiaries, the “Company” or “USPI”, unless otherwise indicated or the context otherwise requires, the terms “we,” “us,” “our” and similar terms refer to USPI and its subsidiaries) owns and operates short-stay surgical facilities which are licensed as either ambulatory surgery centers, specialty hospitals or hospitals. We provide strategic solutions for physicians, physician networks, leading health systems and those paying for the cost of healthcare services, such as employers, insurance companies and government programs. Our strategy enables our partners and other aligned constituents to benefit from the high-quality, lower-cost settings in our facilities under financial structures that work for them. Our partner relationships often expand into new ventures and a stronger market presence which enhances our growth prospects and strategic position within a market. We focus primarily on providing high quality surgical facilities that meet the needs of patients, physicians and payors better than hospital-based and other outpatient surgical facilities. We believe that our facilities (1) enhance the quality of care and the healthcare experience of patients, (2) offer a strategic approach for physicians that provides significant administrative, clinical and economic benefits to physicians, (3) offer a strategic approach for our health system partners to expand capacity and access within the markets they serve, and (4) offer an efficient and low cost alternative for payors, employers and other financing organizations. We acquire and develop our facilities through the formation of strategic relationships with physicians and health system partners to better access and serve the communities in our markets. Our operating model is efficient and scalable, and we have adapted it to each of our markets. We believe that our acquisition and development strategy and operating model enable us to continue to grow by taking advantage of highly-fragmented markets, an increasing demand for short-stay surgery and a need by both our health system partners and physician partners to facilitate strategic networks to meet the needs of the evolving healthcare landscape. We are dedicated to providing high-quality, lower-cost solutions as various reform initiatives unfold in the communities we serve. We provide strategic solutions for physicians, health systems and those paying the cost of healthcare services such as employers, insurance companies and government programs.
We have developed our operating model to encourage physicians to affiliate with us and to use our facilities as an extension of their practices. We believe our physicians align with us in part to solidify their market position as networks form and narrow, to increase their productivity, to better control the outcomes of the facilities in which they practice and to ensure excellence in the experience of their patients and families. We operate our facilities, structure our strategic relationships and adopt staffing, scheduling and clinical systems and protocols with the goal of increasing physician productivity. We believe that our focus on physician satisfaction, combined with providing high quality healthcare in a friendly and convenient environment for patients, will continue to increase the number of procedures performed at our facilities each year.
Health systems partner with us to plan, develop and execute their diversification strategies and expand their ambulatory footprint. We align with our health system partners both clinically and economically to enhance their network, while providing more access, as the importance of moving business to shorter stay settings escalates.
As of December 31, 2014, we operated 219 short-stay surgical facilities in 27 states. Of the 219 facilities, 154 are jointly owned with major health system partners. Due in large part to our partnerships with physicians and health system partners, we do not consolidate the financial results of 156 of the 219 facilities in which we have ownership, meaning that while we record a share of their net profit within our operating income, we do not include their revenues and expenses in the consolidated revenue and expense line items of our consolidated financial statements. Until April 3, 2012, we also had ownership in seven facilities in the United Kingdom. On April 3, 2012, we distributed the stock of our U.K. subsidiary to our parent’s (USPI Group Holdings, Inc.) equity holders. Subsequent to April 3, 2012, we have had no further ownership in the U.K. operations.
Our consolidated revenues increased 4% from $616.2 million in 2013 to $640.8 million in 2014. In addition to our consolidated revenues, we also review an internal operating measure called systemwide revenue growth, which includes both consolidated and unconsolidated facilities. Our systemwide revenues grew 8% during 2014. While revenues of our unconsolidated facilities are not recorded as revenues by USPI, we believe the information is important in understanding USPI’s financial performance because these revenues are the basis for calculating our management services revenues and, together with the expenses of our unconsolidated facilities, are the basis for USPI’s equity in earnings of unconsolidated affiliates. In addition, we disclose growth rates and operating margins for the facilities that were operational in both the current and prior year periods, a group we refer to as same-store facilities.
Donald E. Steen formed USPI with the private equity firm Welsh, Carson, Anderson & Stowe in February 1998 and had publicly traded equity securities from June 2001 until April 2007. Pursuant to an Agreement and Plan of Merger (the merger) dated as of January 7, 2007, with an affiliate of Welsh, Carson, Anderson & Stowe X, L.P. (“Welsh Carson”), we became a wholly owned subsidiary of USPI Holdings, Inc. on April 19, 2007. USPI Holdings, Inc. is a wholly owned subsidiary of USPI Group Holdings, Inc., which is owned by an investor group that includes affiliates of Welsh Carson, members of our management and other investors. As a result of the merger, we no longer have publicly traded equity securities.
Available Information
We file annual, quarterly and current reports with the Securities and Exchange Commission (SEC). You may read and copy any document that we file at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549. You may also call the SEC at 1-800-SEC-0330 for information on the operation of the public reference room. Our SEC filings are also available to you free of charge at the SEC’s web site at http://www.sec.gov. We also maintain a web site at http://www.uspi.com that includes links to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. These reports are available on our website without charge as soon as reasonably practicable after such reports are filed with or furnished to the SEC. Information on our web site is not deemed incorporated by reference into this Form 10-K.
Industry Overview
Each year, the United States spends a substantial amount of funds on medical costs. According to reports from the Centers for Medicare and Medicaid Services (“CMS”), the United States spent $2.9 trillion on healthcare in 2013, and the percentage of gross domestic product devoted to healthcare has increased from 7.2% in 1970 to 17.4% in 2013.
We believe many physicians and patients prefer surgery centers and surgical hospitals over general acute care hospitals. We believe that this is due to the non-emergency nature of the procedures performed at our facilities, which allows physicians to schedule their time more efficiently and therefore increase the number of surgeries they can perform in a given amount of time. In addition, outpatient facilities usually provide physicians with greater scheduling flexibility, more consistent nurse staffing and faster turnaround time between cases. While surgery centers and surgical hospitals generally perform scheduled surgeries, large acute care hospitals generally provide a broad range of services, including high priority and emergency procedures. Medical emergencies often demand the unplanned use of operating rooms and result in the postponement or delay of scheduled surgeries, disrupting physicians’ practices and inconveniencing patients. Surgery centers and surgical hospitals are designed to improve physician work environments and improve physician efficiency. In addition, many physicians choose to perform surgery in facilities like ours because their patients prefer the comfort of a less institutional atmosphere and the convenience of simplified admissions and discharge procedures.
New surgical techniques and technology, as well as advances in anesthesia, have significantly expanded the types of surgical procedures that are being performed in surgery centers and have helped drive the growth in
outpatient surgery. Improved anesthesia has shortened recovery time by minimizing post-operative side effects such as nausea and drowsiness, thereby avoiding the need for overnight hospitalization in many cases. In addition, some states in the United States permit surgery centers to keep a patient for up to 23 hours. This allows more complex surgeries, previously only performed in an inpatient setting, to be performed in a surgery center.
In addition to these technological and other clinical advancements, a changing payor environment has contributed to the growth of outpatient surgery relative to all surgery performed. Government programs, private insurance companies, managed care organizations and self-insured employers have implemented cost containment measures to limit increases in healthcare expenditures, including procedure reimbursement. In addition, as self-funded employers are looking to curb annual increases in premiums, they continue to shift additional financial responsibility to patients through higher co-payments, higher deductibles and higher premium contributions. These cost containment measures have contributed to the significant shift in the delivery of healthcare services away from traditional inpatient hospitals to more cost-effective alternate sites, including surgery centers. We believe that surgery performed at a surgery center is generally less expensive than hospital-based outpatient surgery because of lower facility development costs, more efficient staffing and space utilization and a specialized operating environment focused on quality of care and cost containment.
Today, large healthcare systems generally offer both inpatient and outpatient surgery on site. In connection with the implementation of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Acts, the associated healthcare reform activities and the expected transition to more connected, value-based care management models, there is a rise in consolidation activities within the industry with certain payors expanding into the provider space along with an increase in hospital mergers and acquisitions. In addition, a number of healthcare systems have begun to expand their portfolios of facilities and services by entering into strategic relationships with specialty operators of surgery centers in order to expand capacity and access in the markets they serve. These strategic relationships enable healthcare systems to offer patients, physicians and payors the cost advantages, convenience and other benefits of outpatient surgery in a freestanding facility and, and in certain markets, establish networks needed to manage the full continuum of care for a defined population. Further, these relationships allow the healthcare systems to focus their attention and resources on their core business without the challenge of acquiring, developing and operating these facilities.
Our Business Strategy
Our goal is to steadily increase our revenues and cash flows. The key elements of our business strategy are to:
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attract, retain and pursue strategic relationships with top quality surgeons and other physicians;
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expand our presence in existing markets and assist with the development of integrated networks in certain markets;
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pursue strategic relationships with leading health system partners;
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expand selectively in new markets; and
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enhance operating efficiencies and the healthcare experience of patients.
Attract and retain top quality surgeons and other physicians
We have developed our operating model to encourage physicians to affiliate with us and to use our facilities as an extension of their practices. We believe we attract physicians because we design our facilities, structure our strategic partnerships and adopt marketing and sales, staffing, scheduling and clinical systems and protocols to increase physician productivity and promote their professional and financial success both at our facilities and in the physicians’ practices. We believe this focus on physicians, combined with providing safe, high quality healthcare in a friendly and convenient environment for patients, will continue to increase case volumes at our
facilities. In addition, we generally offer physicians the opportunity to purchase equity interests in the facilities they use as an extension of their practices and to actively participate in the management of their facilities, through service on the facilities’ governing boards, medical executive committees and partnership advisory boards. We believe the opportunity for physicians to own and actively participate in the management of our facilities attracts quality physicians and increases physicians’ commitment to facility operations, enhances quality of patient care, increases productivity, reduces costs and promotes enduring partnerships.
Expand our presence in existing markets
One of the key elements of our business strategy is to grow selectively in markets in which we already operate facilities. We believe that selective acquisitions and development of new facilities in existing markets allow us to leverage our existing knowledge of these markets and to improve operating efficiencies. In particular, our experience has been that newly developed facilities in markets where we already have a presence and a health system partner is one of the best uses of our capital. In addition, in certain markets, we believe that we can leverage the infrastructure in place to assist our strategic partners with the development of integrated networks needed to meet the needs of the evolving healthcare landscape.
Pursue strategic relationships with health system partners.
Through strategic relationships with us, health systems can benefit from our operating expertise, create a new cash flow opportunity with limited capital expenditures and develop the ambulatory components of a network needed for patient retention and care management across the continuum. We believe that these relationships also allow health systems to attract and retain physicians and secure alignment needed for new delivery system objectives, create new access points to support their missions or ministries, and improve their hospital operations by focusing on their core business. We also believe that strategic relationships with these healthcare systems help us to more quickly develop relationships with physicians, communities, payors, employers and other financing organizations. Generally, the healthcare systems with which we develop relationships have strong local market positions and excellent reputations that we use in branding our facilities. In addition, our relationships with health system partners enhance our acquisition and development efforts by (1) providing opportunities to acquire facilities the systems may own, (2) providing access to physicians already affiliated with the systems, (3) attracting additional physicians to affiliate with newly developed facilities, and (4) encouraging physicians who own facilities to consider a strategic relationship with us.
Expand selectively in new markets
We may continue to enter targeted markets by acquiring and developing surgical facilities. We expect we will often undertake these activities in conjunction with a local health system partner. We typically target the acquisition or development of multi-specialty centers that perform high volume, non-emergency, lower risk procedures requiring lower capital and operating costs than hospitals. In addition, we will also consider the acquisition of multi-facility companies.
In determining whether to enter a new market, we examine numerous criteria, including:
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the potential to achieve strong increases in revenues and cash flows;
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whether the physicians, healthcare systems and payors in the market are receptive to surgery centers and/or surgical hospitals;
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the demographics of the market;
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the number of surgical facilities in the market;
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the number and nature of outpatient surgical procedures performed in the market;
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the case mix of the facilities to be acquired or developed;
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whether the facility is or will be well-positioned to negotiate agreements with insurers and other payors; and
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licensing and other regulatory considerations.
Upon identifying a target facility, we conduct clinical, financial, legal and compliance, operational, technology and systems reviews of the facility and conduct interviews with the facility’s management, affiliated physicians and staff. Once we acquire or develop a facility, we focus on implementing our proprietary systems and protocols, USPI’s EDGE, to increase case volume and improve operating efficiencies.
Enhance operating efficiencies and the healthcare experience of patients
Once we acquire a new facility, we integrate it into our existing network by implementing a specific action plan to support the local management team, design growth strategies and incorporate the new facility into our group purchasing contracts. We also implement our systems and protocols to improve operating efficiencies and contain costs by optimizing materials management and billing and collection practices. Our most important operational tool is our management system “Every Day Giving Excellence,” which we refer to as USPI’s EDGE. This proprietary process management and measurement system allows us to track our clinical, service and financial performance, best practices and key indicators in each of our facilities. Our goal is to use USPI’s EDGE to ensure that we provide each of the patients using our facilities with high quality healthcare, offer physicians a superior work environment and eliminate inefficiencies. Using USPI’s EDGE, we track and monitor our performance in areas such as (1) providing surgeons the equipment, supplies and surgical support they need, (2) starting cases on time, (3) minimizing turnover time between cases, and (4) providing efficient case and personnel schedules. USPI’s EDGE compiles and organizes the specified information on a daily basis and is easily accessed over the Internet by our facilities on a secure basis. The information provided by USPI’s EDGE enables our medical staffs, employees, facility administrators and management to analyze trends over time and share processes and best practices among our facilities. USPI’s EDGE is now deployed in substantially all of our facilities. In addition to continuing to invest in USPI’s EDGE, we have also invested in decision support, market analysis and training tools that will allow us to better manage our facilities. We have installed an EHR system at all of our hospitals, and we are leveraging this experience to assess the need and timing of developing an electronic health record solution for our surgery centers.
Operations
We are an experienced and trusted partner in some of the nation’s most successful surgical networks. We provide strategic solutions for physicians, physician networks, leading health systems and those paying for the cost of healthcare services, such as employers, insurance companies and government programs.
Our operations consist primarily of our ownership and management of surgery centers. As of December 31, 2014, we had ownership interests in 203 surgery centers and 16 surgical hospitals. We also have numerous other potential projects in various stages of consideration, which may result in our adding additional facilities during 2015. Approximately 11,000 physicians have privileges to use our facilities. Our surgery centers are licensed outpatient surgery centers, and our surgical hospitals are licensed as hospitals. Each of our facilities is generally equipped and staffed for multiple surgical specialties and located in freestanding buildings or medical office buildings. Our average surgery center has approximately 12,000 square feet of space with three operating rooms, as well as ancillary areas for preparation, recovery, reception and administration. Our surgery center facilities range from a 2,000 square foot, one operating room facility to a 33,000 square foot, nine operating room facility. Our surgery centers are normally open weekdays from 7:00 a.m. to approximately 5:00 p.m. or until the last patient is discharged. We estimate that a surgery center with three operating rooms can accommodate up to 4,500 procedures per year. Our surgical hospitals have from six to 68 beds and average approximately 65,000 square feet of space with eight operating rooms, ranging in size from 30,000 to 177,000 square feet and having from five to seventeen operating rooms.
Our surgery center support staff typically consists of registered nurses, operating room technicians, an administrator who supervises the overall activities and strategies of the surgery center, and a small number of office staff. Each center also has appointed a medical director, who is responsible for supervising the quality of medical care provided at the center. Use of our surgery centers is generally limited to licensed physicians, podiatrists and oral surgeons who are also on the medical staff of a local accredited hospital. Each center maintains a peer review committee consisting of physicians who use our facilities and who review the professional credentials of physicians applying for surgical privileges. Our surgery centers generally have service agreements with anesthesiologists and certified registered nurse anesthetists (CRNAs) to provide anesthesiology services.
Substantially all of our surgical facilities are accredited by either The Joint Commission on Accreditation of Healthcare Organizations or by the Accreditation Association for Ambulatory Healthcare. From time to time, a few of our surgical facilities are in the process of applying for such accreditation. We believe that accreditation is the quality benchmark for managed care organizations. Many managed care organizations will not contract with a facility until it is accredited. We believe that our historical performance in the accreditation process reflects our commitment to providing high quality care in our surgical facilities.
Generally, our surgical facilities are limited partnerships, limited liability partnerships or limited liability companies in which ownership interests are also held by local physicians who are on the medical staff of the facilities. Our ownership interests in the facilities range from 5% to 95%, with our average ownership being approximately 34%. Our partnership and limited liability company agreements typically provide for the monthly or quarterly pro rata distribution of cash equal to net profits from operations, less amounts held in reserve for expenses and working capital. Our facilities derive their operating cash flow by collecting a fee from patients, insurance companies, or other payors in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. Our billing systems estimate revenue and generate contractual adjustments based on a fee schedule for approximately 90% of the total cases performed at our facilities. For the remaining cases, the contractual allowance is estimated based on the historical collection percentages of each facility by payor group. The historical collection percentage is updated quarterly for each facility. We estimate each patient’s financial obligation prior to the date of service. We request payment of that obligation at the time of service. Any amounts not collected at the time of service are subject to our normal collection and reserve policy. We also have a management agreement with each of the facilities under which we provide day-to-day management services for a management fee that is typically a percentage of the net revenues of the facility.
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. Our business could be adversely affected by the loss of our relationship with, or a reduction in use of our facilities by, a key physician or group of physicians. The physicians that affiliate with us and use our facilities are not our employees, except in a limited number of circumstances. However, we generally offer the physicians the opportunity to purchase equity interests in the facilities they use.
Strategic Relationships
A key element of our business strategy is to pursue strategic relationships with health system partners in selected markets. Of our 219 facilities, 154 are jointly-owned with health system partners. Our strategy involves developing these relationships in three primary ways. One way is by adding new facilities in existing markets with our existing health system partners. An example of this is our relationship with Baylor Scott & White Health, which is the new nonprofit healthcare system created from the affiliation agreement entered into by Baylor Health Care System and Scott & White Healthcare effective October 1, 2013. Our joint ventures with Baylor Scott & White Health own a network of 33 surgical facilities that serve the approximately six and one-half million people in the Dallas / Fort Worth area. Another example of a growing single-market relationship is our network of facilities in Houston, Texas with Memorial Hermann Healthcare System, with whom we opened our first facility in 2003 and with whom we now operate 21 facilities.
A second way we develop these relationships is through expansion into new markets, both with existing health system partners and with new partners. In 2014, we entered into a new health system partner relationship with Mercy Health in St. Louis, Missouri and Trinity Health in South Dakota. In 2013, we entered into a new health system partner relationship with Orlando Health in Orlando, Florida and St. Mary’s Good Samaritan in Illinois. During 2012, we entered into new health system partner relationships in Midland, Texas; Hackensack, New Jersey and also gained two new health system partners in Pennsylvania. A good long-term example of this strategy is our relationship with Ascension Health, with whom we initially owned a single facility in Nashville, Tennessee and now have a total of 22 facilities in four states. Similarly, with Dignity Health we began with one facility, which was in a suburb of Las Vegas, Nevada. This relationship has expanded to a total of 19 facilities, including eight in various California markets, nine in the Phoenix, Arizona market and two in the Las Vegas area.
A third way we develop our strategic relationships with health system partners is by adding them as co-owners of facilities that we have previously operated without them as partners. During 2013, we completed two transactions of this nature by expanding our joint ventures with Memorial Hermann and Baylor Scott & White Health. We completed a transaction of this nature in 2012 with a new health system partner in St. Louis, Missouri. We expect to add a health system partner in the future to some of the remaining 65 facilities that do not yet have such a partner.
Case Mix
The following table sets forth the percentage of internally reported revenues from our facilities for the year ended December 31, 2014 from each of the following specialties:
Payor Mix
The following table sets forth the percentage of the internally reported revenues from our facilities for the year ended December 31, 2014 from each of the following payors:
(1) The percentage of our revenue attributable to government payors is approximately 18% for Medicare and 2% for Medicaid.
The following table sets forth information relating to the health system partners with which we were affiliated as of December 31, 2014:
(a) Colorado, Florida, Georgia, Illinois, Kansas, Kentucky, Missouri, North Carolina, Tennessee, Texas, West Virginia, and Wisconsin.
(b) Alabama, Arkansas, Arizona, Connecticut, District of Columbia, Georgia, Florida, Idaho, Illinois, Indiana, Kansas, Kentucky, Louisiana, Maryland, Michigan, Missouri, New York, Pennsylvania, Tennessee, Texas, Washington, and Wisconsin.
(c) Florida, Kentucky, Maryland, New York, South Carolina, and Virginia
(d) Kentucky and Ohio
(e) Arkansas, Georgia, Louisiana, Missouri, New Mexico, and Texas.
(f) Arkansas, Kansas, Missouri and Oklahoma
(g) Alaska, California, Montana, Oregon, and Washington.
(h) Illinois, Missouri, Oklahoma and Wisconsin.
(i) Alabama, California, Connecticut, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Maryland, Massachusetts, Michigan, Nebraska, New Jersey, New York, Oregon, Ohio, and Pennsylvania.
Facilities
The following table sets forth information relating to the facilities that we operated as of December 31, 2014:
* Facilities jointly owned with health system partners.
(1) Indicates date of acquisition by OrthoLink Physician Corporation. We acquired OrthoLink in February 2001.
(2) Surgical hospitals, all of which are licensed and equipped for overnight stays.
(3) Operated through a consulting and administrative agreement.
(4) Indicates the date of our acquisition of Surgis.
(5) Indicates the date of our acquisition of HealthMark.
(6) Indicates the date of our acquisition of Titan.
(7) Indicates the date of our acquisition of AIGB Holdings, Inc. (True Results).
We lease the majority of the facilities where our various surgery centers and surgical hospitals conduct their operations. Our leases have initial terms ranging from five to twenty years and most of the leases contain options to extend the lease period, in some cases for up to ten additional years.
Our corporate headquarters is located in a suburb of Dallas, Texas. We currently lease approximately 100,000 square feet of space at 15305 Dallas Parkway, Addison, Texas. The lease expires in October 2020.
We also lease approximately 55,000 square feet of total additional space in Brentwood, Tennessee; Chicago, Illinois; Houston, Texas; St. Louis, Missouri; Tinton Falls, New Jersey; Denver, Colorado; and Pasadena, California for regional offices. These leases expire between December 2016 and December 2021.
Acquisitions and Development
We have projects under development which are in various stages of negotiation with both current and prospective joint venture partners, and will result in our operating additional facilities in 2015. While our history suggests that many of these projects will culminate with the opening or acquisition of a profitable surgical facility, we can provide no assurance that any of these projects will reach that stage or will be successful thereafter.
Marketing
Our sales and marketing efforts are directed primarily at physicians, who perform or are likely to perform surgical procedures in our facilities. We market our facilities to physicians by emphasizing (1) the high level of patient and physician satisfaction with our facilities, which is based on surveys we take concerning our facilities, (2) the quality and responsiveness of our services, (3) the practice efficiencies provided by our facilities, and (4) the benefits of our affiliation with our health system partners, if applicable. We also directly negotiate, together in some instances with our health system partners, 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. Maintaining access to physicians and patients through third-party payor contracting is essential for the economic viability of most of our facilities.
Competition
In all of our markets, our facilities compete with other providers, including major acute care hospitals and other surgery centers. Hospitals have various competitive advantages over us, including their established managed care contracts, community position, physician loyalty and geographical convenience for physicians’ inpatient and outpatient practices. However, we believe that, in comparison to hospitals with which we compete, our surgery centers and surgical hospitals compete favorably on the basis of cost, quality, efficiency and responsiveness to physician needs in a more comfortable environment for the patient.
We compete with other providers in each of our markets for patients, physicians and for contracts with insurers or managed care payors. Competition for managed care contracts with other providers is focused on the pricing, number of facilities in the market and affiliation with key physician groups in a particular market. We believe that our relationships with our health system partners enhance our ability to compete for managed care contracts. We also encounter competition with other companies for acquisition and development of facilities and in the United States for strategic relationships with local health systems and physicians.
There are several companies, both public and private, that acquire and develop freestanding multi-specialty surgery centers and surgical hospitals. Some of these competitors have greater resources than we do. The principal competitive factors that affect our ability and the ability of our competitors to acquire surgery centers and surgical hospitals are price, experience, reputation and access to capital. Further, many physician groups develop surgery centers without a corporate partner, and this presents a competitive threat to our company.
Employees
As of December 31, 2014, we employed approximately 10,600 people, 7,300 of whom are full-time employees and 3,300 of whom are part-time employees. The physicians that affiliate with us and use our facilities are not our employees, except in a limited number of circumstances. However, we generally offer the physicians the opportunity to purchase equity interests in the facilities they use.
Professional and General Liability Insurance
We maintain professional and general liability insurance through a wholly-owned captive insurance company. We make premium payments to the captive insurance company and accrue for claims costs based on actuarially predicted ultimate losses and the captive insurance company then pays administrative fees and the insurance claims. We also maintain business interruption, property damage and umbrella insurance with third-party providers. The governing documents of each of our surgical facilities require physicians who conduct surgical procedures at those facilities to maintain stated amounts of insurance. Our insurance policies are generally subject to annual renewals. We believe that we will be able to renew current policies or otherwise obtain comparable insurance coverage at reasonable rates. However, we have no control over the insurance markets and can provide no assurance that we will economically be able to maintain insurance similar to our current policies.
Government Regulation
General
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. Further, the regulatory environment in which we operate may change significantly in the future. While we believe we have structured our agreements and operations in material compliance with applicable law, there can be no assurance that we will be able to successfully address changes in the regulatory environment.
Every state imposes licensing and other requirements on healthcare facilities. In addition, many states require regulatory approval, including certificates of need, before establishing or expanding various types of healthcare facilities, including ambulatory surgery centers and surgical hospitals, offering services or making capital expenditures in excess of statutory thresholds for healthcare equipment, facilities or programs. In addition, the federal Medicare program imposes additional conditions for coverage and payment rules for services furnished to Medicare beneficiaries. We may become subject to additional regulations as we expand our existing operations and enter new markets.
In addition to extensive existing government healthcare regulation, there have been numerous initiatives on the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services. We believe that these healthcare reform initiatives will continue during the foreseeable future. If adopted, some aspects of 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.
We believe that our business operations materially comply with applicable law. However, we have not received a legal opinion from counsel or from any federal or state judicial or regulatory authority to this effect, and many aspects of our business operations have not been the subject of state or federal regulatory scrutiny or interpretation. Some of the laws applicable to us are subject to limited or evolving interpretations; therefore, a review of our operations by a court or law enforcement or regulatory authority might result in a determination that could have a material adverse effect on us. Furthermore, the laws applicable to us may be amended or interpreted in a manner that could have a material adverse effect on us. Our ability to conduct 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.
Healthcare Reform
The Acts were signed into law on March 23, 2010 and March 30, 2010, respectively. The Acts are intended to provide coverage and access to substantially all Americans, to increase the quality of care provided and to reduce the rate of growth in healthcare expenditures. The changes include, among other things, expanding Medicare’s use of value-based purchasing programs, tying facility payments to the satisfaction of certain quality criteria, bundling payments to hospitals and other providers, reducing Medicare and Medicaid payments, expanding Medicaid eligibility, requiring many health plans (including Medicare) to cover, without cost-sharing, certain preventative services, and expanding access to health insurance. The Acts also place limitations on the Stark Law exception 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 Acts prohibit hospitals from increasing the percentages of the total value of the ownership interests held in the hospital by physicians after March 23, 2010, as well as place restrictions on the ability of a hospital subject to the whole hospital exception to add operating rooms, procedure rooms and beds. The Acts provide for additional enforcement tools, cooperation between agencies, and funding for enforcement. The Acts mandate 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.
The Acts also make several significant changes to healthcare fraud and abuse laws, provide additional enforcement tools to the government, increase cooperation between agencies by establishing mechanisms for the sharing of information and enhance criminal and administrative penalties for non-compliance. For example, the Acts (i) provide $350 million in increased federal funding over the next 10 years to fight healthcare fraud, waste and abuse; (ii) expand the scope of the recovery audit contractor program to include Medicaid and Medicare Advantage plans; (iii) authorize the Department of Health and Human Services, in consultation with the Office of Inspector General, to suspend Medicare and Medicaid payments to a provider of services or a supplier “pending an investigation of a credible allegation of fraud;” (iv) provide Medicare contractors with additional flexibility to conduct random prepayment reviews; and (iv) strengthen the rules for returning overpayments made by governmental health programs, including expanding False Claims Act liability to extend to failures to timely repay identified overpayments.
As a result of the Acts, we expect enhanced scrutiny of healthcare providers’ compliance with state and federal regulations, infection control standards and other quality control measures. Effective January 15, 2009, CMS promulgated three national coverage determinations that prevent Medicare from paying for certain serious, preventable medical errors performed in any healthcare facility, such as surgery performed on the wrong patient. Several commercial payors also do not reimburse providers for certain preventable adverse events. The Acts also contain a number of provisions that are intended to improve the quality of care that is provided to Medicare and Medicaid beneficiaries. For example, beginning July 1, 2011, the Acts prohibited Medicaid programs from using federal funds to reimburse providers for the costs of care needed to treat hospital acquired conditions (“HACs”). Beginning in federal fiscal year (“FY”) 2015, the Acts mandate a 1% reduction in Medicare payments for hospitals that were in the highest quartile of national risk-adjusted HAC rates for the previous federal fiscal year (the “HAC Reduction Program”). In December 2014, CMS announced that 724 hospitals would be subject to the HAC Reduction Program for FY 2015. In addition, the Acts required CMS to examine whether the existing case-based HAC payment policy (as distinguished from the new rate-based HAC Reduction Program) should be expanded to cover ASCs and other facilities. In a December 2012 report to Congress, CMS concluded that extending the case-based HAC policy to ASCs was not feasible given the differing payment systems involved. Instead, CMS recommended exploration of other payment policies designed to reduce HACs at ASCs and other facilities. We could be subject to greater reduction in Medicare or Medicaid reimbursement in the future if such policies are ultimately adopted and applied to ASCs.
In addition, federal law authorizes CMS to require ambulatory surgery centers to submit data on certain quality measures or incur a penalty: namely, a two percentage point reduction to any annual increase in the ASC payment rate for that calendar year (“CY”). CMS first exercised this authority in November 2011, requiring
ASCs to report data initially on five specified quality measures beginning October 1, 2012, with penalties to be enforced beginning with the CY 2014 payment year. Under the most recent ASC payment and quality reporting rules promulgated by CMS in November 2014, the number of quality measures that must be reported has grown to 12. In addition, effective October 1, 2012, Medicare began offering incentive payments to hospitals for delivering high-quality care through a value-based purchasing program. The incentives will be funded through a one percent deduction in the base operating diagnosis-related group payments for hospitals’ discharges. The reductions will increase over subsequent years. Hospitals must meet or exceed a baseline score on a set of predetermined clinical and patient experience measures. With regard to ambulatory surgery centers, the Department of Health and Human Services submitted a report to Congress in April 2011 outlining the Department’s plan to implement a value-based purchasing program. While the report describes efforts to improve quality and payment efficiency in ambulatory surgery centers and examines the steps required to design and implement an ambulatory surgery center valued-based program, Congress has not yet authorized CMS to implement a valued-based program for ambulatory surgery centers.
Accountable Care Organizations
On October 31, 2011, CMS issued final regulations for Accountable Care Organizations (“ACOs”), which were created under the Acts and intended to allow providers, including hospitals, physicians and other designated professionals and suppliers, to coordinate care for Medicare beneficiaries through participation in a Medicare Shared Savings Program (the “Shared Savings Program” or “Program”). The Shared Savings Program is intended to produce savings as a result of improved quality and operational efficiency. ACOs that achieve certain savings benchmarks and quality performance standards will be eligible to share in a portion of the amounts saved under the Program, but will eventually have to share in financial losses as well. The 2011 regulations detailed certain key characteristics of an ACO and outlined other Program requirements, including those governing the scope and length of an ACO’s contract with CMS, the required governance of an ACO, the assignment of Medicare beneficiaries to an ACO, the payment models under which an ACO can share in cost savings, and the quality and other reporting requirements expected of an ACO. On December 1, 2014, CMS issued proposed rules that would implement several changes designed to encourage greater ACO participation in the Shared Savings Program. The proposed rule would extend the period in which ACOs can participate in the risk-free track of the Program without penalties; it also incentivizes continued participation by higher-performing ACOs through greater shared savings opportunities, and proposes certain operational streamlining initiatives. Patient and provider participation in ACOs and the Shared Savings Program is voluntary. We will continue to monitor developments with the implementation of the ACO regulations and their effect on our business in order to react accordingly.
Licensure and certificate-of-need regulations
Capital expenditures for the construction of new facilities, the addition of capacity or the acquisition of existing facilities may be reviewable by state regulators under statutory schemes that are sometimes referred to as certificate of need laws. States with certificate of need laws place limits on the construction and acquisition of healthcare facilities and the expansion of existing facilities and services. In these states, approvals are required for capital expenditures exceeding certain specified amounts and that involve certain facilities or services, including ambulatory surgery centers and surgical hospitals.
State certificate of need laws generally provide that, prior to the addition of new beds, the construction of new facilities or the introduction of new services, a designated state health planning agency must determine that a need exists for those beds, facilities or services. The certificate of need process is intended to promote comprehensive healthcare planning, assist in providing high quality healthcare at the lowest possible cost and avoid unnecessary duplication by ensuring that only those healthcare facilities that are needed will be built.
Typically, the provider of services submits an application to the appropriate agency with information concerning the area and population to be served, the anticipated demand for the facility or service to be provided, the amount of capital expenditure, the estimated annual operating costs, the relationship of the proposed facility or service to the overall state health plan and the cost per patient day for the type of care contemplated. The
issuance of a certificate of need is based upon a finding of need by the agency in accordance with criteria set forth in certificate of need laws and state and regional health facilities plans. If the proposed facility or service is found to be necessary and the applicant to be the appropriate provider, the agency will issue a certificate of need containing a maximum amount of expenditure and a specific time period for the holder of the certificate of need to implement the approved project.
Our healthcare facilities also are subject to state licensing requirements for medical providers. Our facilities have licenses to operate as ASCs in the states in which they operate. Our surgical facilities that are licensed as ASCs must meet all applicable requirements for ASCs. In addition, even though our surgical facilities that are licensed as hospitals primarily provide surgical services, they must meet all applicable requirements for hospital licensure. To assure continued compliance with these regulations, governmental and other authorities periodically inspect our surgical facilities. The failure to comply with these regulations could result in the suspension or revocation of a facility’s license. In addition, based on the specific operations of our surgical facilities, some of these facilities maintain a pharmacy license, a controlled substance registration, and a clinical laboratory certification waiver, as required by applicable law.
Our healthcare facilities are also subject to state and local licensing regulations ranging from the adequacy of medical care to compliance with building codes and environmental protection laws. To assure continued compliance with these regulations, governmental and other authorities periodically inspect our facilities. The failure to comply with these regulations could result in the suspension or revocation of a healthcare facility’s license.
Our healthcare facilities receive accreditation from the Joint Commission on Accreditation of Healthcare Organizations or the Accreditation Association for Ambulatory Health Care, Inc., nationwide commissions which establish standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of various types of healthcare facilities. Generally, our healthcare facilities must be in operation for at least six months before they are eligible for accreditation. As of December 31, 2014, substantially all of our eligible healthcare facilities had been accredited by either the Joint Commission on Accreditation of Healthcare Organizations or the Accreditation Association for Ambulatory Health Care, Inc. From time to time, a few of our surgical facilities are in the process of applying for such accreditation. Many managed care companies and third-party payors require our facilities to be accredited in order to be considered a participating provider under their health plans.
Medicare and Medicaid Participation in Short-Stay Surgical Facilities
Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are 65 or older or who are disabled. 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 determine coverage and payment rates for surgical services furnished in hospitals and in ASCs. All of the states in which we currently operate cover Medicaid surgical facility services provided in these settings; however, these states may not continue to cover short-stay surgical facility services and states into which we expand our operations may not cover or continue to cover short-stay surgical facility services.
A portion of our revenues are attributable to payments received from the Medicare and Medicaid programs. For the years ended December 31, 2014, 2013 and 2012, Medicare and Medicaid comprised 38%, 37%, and 35%, respectively, of our case volumes. These payments represented, however, a significantly lower percentage of our overall revenues due to the lower reimbursement provided by government payors in comparison to private payors. For example, Medicare and Medicaid contributed approximately 18% and 2% respectively of our 2014 patient service revenues despite the fact that governmental payors represented a total of 38% of our case volume during 2014.
In order to participate in the Medicare program, our facilities (known to Medicare as “providers”) must satisfy provider enrollment requirements as well as regulatory conditions of participation (“COPs”) for hospitals and conditions for coverage (“CFCs”) for ASCs. Each facility can meet its COPs or CFCs requirements through accreditation with The Joint Commission on Accreditation of Healthcare Organizations or other CMS-approved accreditation organizations, or through direct surveys by CMS. Substantially all of our short-stay surgical facilities in the United States are enrolled in Medicare and certified to participate in the Medicare program or, with respect to newly acquired or developed facilities, are awaiting enrollment and certification to participate in the Medicare program. We have established systems to ensure our facilities’ compliance with their enrollment obligations, including certain ongoing reporting obligations. In addition, we have implemented ongoing quality assurance activities to monitor and to ensure our facilities’ compliance with their COPs or CFCs. Any failure by a facility to maintain compliance with its enrollment obligations, COPs or CFCs could result in the loss of the facility’s Medicare billing privileges and provider agreement. The loss of Medicare billing privileges results in the termination of the facility’s enrollment in the Medicare program and may preclude the facility from re-enrolling in the Medicare program for up to three years. In addition, federal regulations require states to deny Medicaid program enrollment or to terminate Medicaid program enrollment for any facility that has been terminated from Medicare or any other state’s Medicaid program. Conversely, federal regulations permit CMS to revoke Medicare billing privileges when a state Medicaid agency terminates, revokes, or suspends a facility’s Medicaid enrollment or billing privileges.
CMS also requires hospitals to disclose physician ownership to patients. Congress now requires written disclosures of physician ownership interests to hospital patients, on the hospital’s website and in any advertising. Federal legislation also imposes 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. A hospital’s provider agreement may be terminated if it fails to make such disclosures. We believe all of our facilities meet their disclosure obligations.
Medicare’s payment for short-stay surgical procedures, whether performed in a hospital or an ASC, is based upon a prospectively determined fixed payment amount. For most covered surgical procedures, the payment rate is the product of the relative weight determined for the procedure and a conversion factor and then adjusted for variations in labor costs across geographic areas. The hospital outpatient prospective payment system conversion factor is generally higher than the conversion factor set for procedures in ASCs. As a result, Medicare payment rates for a procedure are typically lower in ASCs than in hospital surgical facilities. Congress requires Medicare to update the conversion factor used to determine payment rates under the hospital outpatient prospective payment system and the ASC payment methodology annually. Medicare’s annual update to the hospital outpatient prospective payment system is equal to the hospital inpatient market basket percentage increase; the ASC annual payment update is based on the Consumer Price Index. Medicare thus uses a lower inflationary factor for ASC payments than for hospital surgical facilities. There is no certainty that the annual update in a given year will equal or exceed the update in the previous year. In addition, starting in calendar year 2011 for ASCs and in calendar year 2012 for hospitals, the annual update applicable to our facilities has been reduced by a productivity adjustment. The amount of that reduction is based on the projected nationwide productivity gains over the preceding 10 years. To determine the projection, Medicare uses the Bureau of Labor Statistics 10-year moving average of changes in specified economy-wide productivity.
Medicare’s payments for physician services under the physician fee schedule are updated annually based in part on the sustainable growth rate (“SGR”) formula, which weighs factors such as healthcare costs and gross domestic product. Every year since 2003, Congress has overridden scheduled reductions to physician payment rates that would have otherwise taken effect under the SGR formula. In 2014, Congress and the President again acted to defer scheduled rate cuts: the Protecting Access to Medicare Act of 2014 (P.L. 113-93), signed into law on April 1, 2014, freezes the SGR conversion factor through March 31, 2015, thus avoiding a 24% reduction in physician payment rates at a cost of approximately $20 billion. In 2014, as in other recent years, the SGR “patch” was paid for through reductions in various Medicare and Medicaid payments to hospitals and other providers. Additional reductions in Medicare reimbursement could have a negative impact on various factors that affect the profitability of USPI, such as the number of overall procedures performed at the ASCs.
Our hospitals and ASCs are subject to other payment adjustments. Since calendar year 2008, Medicare has required hospitals to report specified hospital outpatient quality measures in order to avoid reductions in their annual payment updates. In November 2011, as stated above, CMS introduced a similar quality reporting program for ASCs. Like hospitals, ASCs that fail to report on the required measures in any year will face reductions in their Medicare payment rates in a subsequent year. In addition, Congress has authorized CMS to establish a value-based purchasing program for Medicare hospital services. CMS has implemented value-based purchasing for hospital inpatient services but has not yet done so for hospital outpatient services. Similarly, Congress has directed CMS to develop a plan to implement a value-based purchasing program for payments to ASCs, although Congress still must provide statutory authority to implement such a program for ASCs. Failure by any of our facilities to meet Medicare’s quality measures and any performance standards implemented under value-based purchasing regulations may adversely affect such facilities’ net revenues from the Medicare program.
The various state Medicaid programs also pay us a fixed payment for our services, which amount varies from state to state. There is no certainty that the amount of Medicaid or Medicare payments we have received in prior years will continue at current levels. Both the Medicaid and Medicare 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 short-stay surgical facilities. The ultimate impact of the changes in Medicare reimbursement will depend on a number of factors, including the procedure mix at our facilities and our ability to realize an increased procedure volume.
Workers’ Compensation
Certain of our facilities provide workers’ compensation services. In the past, workers’ compensation payors generally reimbursed surgical facilities a higher percentage of the facilities’ charges than other payors. However, in recent years, a number of states have implemented or are considering implementing workers’ compensation fee schedules with rates generally lower than what our facilities have historically been paid for the same services.
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 admissions 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 the U.S. Department of Health and Human Services that a provider which is in substantial noncompliance with the standards of the quality improvement organization be excluded from participation in the Medicare program.
Federal Anti-Kickback Statute and Medicare Fraud and Abuse Laws
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 herein as the anti-kickback statute, that prohibits offering, paying, soliciting or receiving, directly or indirectly, any form of remuneration in return for:
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referring an individual to a person for furnishing, or arranging for the furnishing of, any service or item payable under a federal healthcare program, including Medicare or Medicaid, or
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purchasing, leasing or 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, including Medicare or Medicaid.
A violation of the anti-kickback statute constitutes a felony. Potential sanctions include imprisonment of up to five years, criminal fines of up to $25,000, civil money penalties of up to $50,000 per act plus three times the remuneration offered or three times the amount claimed and exclusion from all federally funded healthcare programs. The applicability of these provisions to some forms of business transactions in the healthcare industry has not yet been subject to judicial or regulatory interpretation. Moreover, several federal courts have held that the anti-kickback statute can be violated if only one purpose (not necessarily the primary purpose) of the transaction is to induce or reward a referral of business, notwithstanding other legitimate purposes.
Pursuant to the anti-kickback statute, and in an effort to reduce potential fraud and abuse relating to federal healthcare programs, the federal government has announced a policy of a high level of scrutiny of joint ventures and other transactions among healthcare providers. The Office of the Inspector General of the Department of Health and Human Services (“OIG”) closely scrutinizes healthcare joint ventures involving physicians and other referral sources. The OIG published a fraud alert that outlined questionable features of “suspect” joint ventures in 1989 and a Special Advisory Bulletin related to contractual joint ventures in 2003, and the agency has continued to rely on fraud alerts in later pronouncements.
The anti-kickback statute contains provisions that insulate certain transactions from liability. In addition, pursuant to the provisions of the anti-kickback statute, the OIG has also published regulations that exempt additional practices from enforcement under the anti-kickback statute. These statutory exceptions and regulations, known as “safe harbors,” if fully complied with, assure participants in particular types of arrangements that the OIG will not treat their participation in that arrangement as a violation of the anti-kickback statute. The statutory exceptions and 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 an exception or a safe harbor may subject an arrangement to increased scrutiny. Therefore, if a transaction or relationship does not fit within an exception or safe harbor, the facts and circumstances as well as intent of the parties related to a specific transaction or relationship must be examined to determine whether or not any illegal conduct has occurred.
Our partnerships and limited liability companies that are providers of services under the Medicare and Medicaid programs, and their respective partners and members, are subject to the anti-kickback statute. A number of the relationships that we have established with physicians and other healthcare providers do not fit within any of the statutory exceptions or safe harbor regulations issued by the Office of the Inspector General. All of the 219 surgical facilities in which we hold an ownership interest are owned by partnerships or limited liability companies, and 217 include as partners or members physicians who perform surgical or other procedures at the facilities. Because physician investors in our surgical facilities are in a position to generate referrals to the facilities, the distribution of available cash to those investors could come under scrutiny under the anti-kickback statute.
On November 19, 1999, the OIG promulgated regulations setting forth certain safe harbors under the anti-kickback statute, including a safe harbor applicable to surgery centers. The surgery center 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 surgery center 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 ambulatory surgery centers (1) surgeon-owned surgery centers, (2) single-specialty surgery centers, (3) multi-specialty surgery centers, and (4) hospital/physician surgery centers.
For multi-specialty ambulatory surgery centers, for example, if all of the investors are (i) physicians who are in a position to refer patients directly to the entity and perform procedures on such referred patients, (ii) group practices composed exclusively of such physicians, or (iii) investors who are not employed by the entity or by any investor, are not in a position to provide items or services to the entity or any of its investors and are not in a position to make or influence referrals directly to the entity or any of its investors, the following standards must be met:
(1) the terms on which an investment interest is offered to an investor must not be related to the previous or expected volume of referrals, services furnished, or the amount of business otherwise generated from that investor to the entity;
(2) 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 that require an ambulatory surgery center or specialty hospital setting in accordance with Medicare reimbursement rules;
(3) at least one third of the Medicare-eligible outpatient surgery procedures performed by each physician investor for the previous fiscal year or previous twelve-month period must be performed at the ambulatory surgery center in which the investment is made;
(4) the entity or any investor (or other individual or entity acting on behalf of the entity or any investor) must not loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest;
(5) the amount of payment to an investor in return for the investment must be directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor;
(6) all ancillary services for federal healthcare program beneficiaries performed at the entity must be directly and integrally related to primary procedures performed at the entity, and none may be separately billed to Medicare or other federal healthcare programs; and
(7) the entity and any physician investors must treat patients receiving medical benefits or assistance under any federal healthcare program in a nondiscriminatory manner.
Similar standards apply to each of the remaining three categories of ambulatory surgery centers set forth in the regulations. In particular, each of the four categories includes the requirement that no ownership interests be held by a non-physician or non-hospital investor if that investor is (a) employed by the center or another investor, (b) in a position to provide items or services to the center or any of its other investors, or (c) in a position to make or influence referrals directly or indirectly to the center or any of its investors.
Because one of our subsidiaries is an investor in each partnership or limited liability company that owns one of our ambulatory surgery centers, and since this subsidiary provides management and other services to the surgery center, our arrangements with physician investors do not fit within the specific terms of the ambulatory surgery center safe harbor or any other safe harbor. We cannot assure you that the OIG would view our activities favorably even though we strive to achieve compliance with the remaining elements of the safe harbor.
In addition, although we typically contractually require that each physician-investor utilize the ASC as an extension of his or her practice, i.e. that such physician-investor meet the quantitative requirements of the surgery center safe harbor, because we do not control the medical practices of our physician investors or control where they perform surgical procedures, it is possible that the quantitative tests described above will not be met, or that other conditions of the surgery center safe harbor will not be met. Accordingly, while the surgery center safe harbor is helpful in establishing that a physician’s investment in a surgery center should be considered an extension of the physician’s practice and not as a prohibited financial relationship, we can give no assurances that these ownership interests will not be challenged under the anti-kickback statute. In an effort to monitor our compliance with the safe harbor’s extension of practice requirement, we have implemented an attestation
process, which tracks physicians’ annual extension of practice certification. While this process provides support for physician compliance with the safe harbor’s quantitative tests, we can give no assurance of such compliance. However, we believe that our arrangements involving physician ownership interests in our ambulatory surgery centers do not fall within the activities prohibited by the anti-kickback statute.
With regard to our hospitals, the OIG has not adopted any safe harbor regulations under the anti-kickback statute for physician investments in hospitals. All but one of our hospitals is held in partnership with physicians who are in a position to refer patients to the hospital. There can be no assurances that these relationships will not be found to violate the anti-kickback statute or that there will not be regulatory or legislative changes that prohibit physician ownership of hospitals.
While several federal court decisions have aggressively applied the restrictions of the anti-kickback statute, they provide little guidance regarding the application of the anti-kickback statute to our partnerships and limited liability companies. We believe that our operations do not violate the anti-kickback statute. However, a federal agency charged with enforcement of the anti-kickback statute might assert a contrary position. Further, new federal laws, or new interpretations of existing laws, might adversely affect relationships we have established with physicians or other healthcare providers or result in the imposition of penalties on us or some of our facilities. Even the assertion of a violation could have a material adverse effect upon us.
In addition, the Medicare Patient and Program Protection Act of 1987, as amended by the Health Insurance Portability and Accountability Act of 1996, (“HIPAA”), and the Balanced Budget Act of 1997, impose civil monetary penalties and exclusion from state and federal healthcare programs on providers who commit violations of the Medicare fraud and abuse laws. Pursuant to the enactment of HIPAA, as of June 1, 1997, the Secretary of the U.S. Department of Health and Human Services may, and in some cases must, exclude individuals and entities that the Secretary determines have “committed an act” in violation of the Medicare fraud and abuse laws or improperly filed claims in violation of the Medicare fraud and abuse laws from participating in any federal healthcare program, HIPAA also expanded the Secretary’s authority to exclude a person involved in fraudulent activity from participating in a program providing health benefits, whether directly or indirectly, in whole or in part, by the U.S. government. Additionally, under HIPAA, individuals who hold a direct or indirect ownership or controlling interest in an entity that is found to violate the Medicare fraud and abuse laws may also be excluded from Medicare and Medicaid and other federal and state healthcare programs if the individual knew or should have known, or acted with deliberate ignorance or reckless disregard of, the truth or falsity of the information of the activity leading to the conviction or exclusion of the entity, or where the individual is an officer or managing employee of such entity. This standard does not require that specific intent to defraud be proven by the OIG; however, the OIG will apply a series of factors enumerated in a guidance document issued in 2010 to determine whether exclusion is warranted. Under HIPAA it is also a crime to defraud any commercial healthcare benefit program.
On October 3, 2014, the OIG issued a proposed rule that would make amendments to the anti-kickback safe harbors and the civil monetary penalty (“CMP”) regulations. Among other changes, the proposed rule would create new safe harbors for certain waivers of cost-sharing obligations by pharmacies and government-owned emergency ambulance services, and would codify certain statutory exceptions to the definition of “remuneration” under the CMP law. The proposed changes do not materially impact the analysis above regarding our risk of liability under the anti-kickback stature or CMP law.
Federal Physician Self-Referral Law
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 such as an ownership interest or compensation arrangement with the entity that furnishes services to Medicare beneficiaries, unless an exception applies. 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.
The list of designated health services under the Stark Law does not include ambulatory surgery services as such. However, some of the ten types of designated health services are among the types of services furnished by our ambulatory surgery centers. The Department of Health and Human Services, acting through CMS, has promulgated regulations implementing the Stark Law. These regulations exclude health services provided by an ambulatory surgery center from the definition of “designated health services” if the services are included in the surgery center’s composite Medicare payment rate. Therefore, the Stark Law’s self-referral prohibition generally does not apply to health services provided by an ambulatory surgery center. However, if the ambulatory surgery center is separately billing Medicare for designated health services that are not covered under the ambulatory surgery center’s composite Medicare payment rate, or if either the ambulatory surgery center or an affiliated physician is performing (and billing Medicare) for procedures that involve designated health services that Medicare has not designated as an ambulatory surgery center 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. However, it is possible that CMS will further address the exception relating to services provided by an ambulatory surgery center in the future. Therefore, we cannot assure you that future regulatory changes will not result in our ambulatory surgery centers becoming subject to the Stark Law’s self-referral prohibition.
Sixteen of our facilities are hospitals rather than ambulatory surgery centers, and physicians invest directly in fifteen of our sixteen hospitals. We believe that the physician investments in our hospitals fall within the whole hospital exception and are therefore permitted under the Stark Law. The whole hospital exception applies to physician ownership of a hospital, provided such ownership is in the whole hospital and the physician is authorized to perform services at the hospital. Physician investments in our facilities licensed as hospitals meet this requirement. However, changes to the whole hospital exception have been the subject of recent regulatory action and legislation. Changes in the Acts include:
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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;
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a limitation on the maximum aggregate percentage of total physician ownership in the hospital to the aggregate percentage of physician ownership as of March 23, 2010;
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a prohibition on expanding the aggregate number of beds, operating rooms, and procedure rooms for which the hospital is licensed as of March 23, 2010, unless the hospital obtains an exception from the Secretary of the Department of Health and Human Services;
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a requirement that return on investment be proportionate to the investment by each investor;
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restrictions on preferential treatment of physician versus non-physician investors;
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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;
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a prohibition on the hospital or other investors from providing financing to physician investors;
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a requirement that any hospital that does not have 24/7 physician coverage inform patients of this fact and receive signed acknowledgement from the patients of the disclosure; and
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a prohibition on “grandfathered” status for any physician owned hospital that converted from an ambulatory surgery center to a hospital on or after March 23, 2010 (of which we have none).
We cannot predict whether other proposed amendments to the whole hospital exception will be included in any future legislation or if Congress will adopt any similar provisions that would prohibit or otherwise restrict physicians from holding ownership interests in hospitals. The Acts could have an adverse effect on our financial condition and results of operations. See “Risk Factors - Healthcare Reform has restricted our ability to operate our surgical hospitals.”
In addition to the physician ownership in our surgical facilities, we have other financial relationships with potential referral sources that potentially could be scrutinized under the fraud and abuse laws. We have entered into personal service agreements, such as medical director agreements, with physicians at our hospitals and ASCs. We believe that our agreements with referral sources satisfy the requirements of the applicable exceptions to the fraud and abuse laws and we have implemented formal compliance programs designed to safeguard against overbilling. However, we cannot assure you that the Office of the Inspector General would find our compliance programs to be adequate or that our agreements with referral sources would be found to comply with the fraud and abuse laws.
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. Claims filed with private insurers can also lead to criminal and civil penalties, including, but not limited to, penalties relating to violations of federal mail and wire fraud statutes. The government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances. For example, the government has taken the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant should have known the services were unnecessary, even if the government cannot demonstrate actual knowledge. The government has also taken the position that claiming payment for low-quality services is a violation of these statutes if the claimant should have known that the care was substandard.
Over the past several years, the government has accused an increasing number of healthcare providers of violating the federal False Claims Act. The False Claims Act prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the U.S. government for payment. 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. Because our facilities perform hundreds of similar procedures a year for which they are paid by Medicare, and there is a relatively long statute of limitations (of up to ten years), a billing error or cost reporting error could result in significant penalties under the False Claims Act. Additionally, anti-kickback statute or Stark Law claims can be “bootstrapped” to claims under the False Claims Act on the theory that, when a provider submits a claim to a federal healthcare program, the claim includes an explicit or implicit certification that the provider is in compliance with the Medicare Act, which would require compliance with other laws, including the anti-kickback statute and the Stark Law. As a result of this “bootstrap” theory, the U.S. government can collect additional civil penalties under the False Claims Act for claims that have been “tainted” by the anti-kickback or Stark Law violation. In addition, civil penalties may be imposed by the Office of the Inspector General of the U.S. Department of Health and Human Services and a provider can be found liable for violating the False Claims Act for the failure to report and return an overpayment within 60 days of identifying the overpayment or, in certain circumstances, by the date a corresponding cost report is due, whichever is later.
Under the “qui tam,” or whistleblower, provisions of the False Claims Act, private parties may bring actions on behalf of the federal government. Such private parties, often referred to as relators, are entitled to share in the amounts recovered by the government through trial or settlement. Both direct enforcement activity by the government and whistleblower lawsuits have increased significantly in recent years and have increased the risk that a healthcare company, like us, will have to defend a false claims action, pay fines or face exclusion from the Medicare and Medicaid programs as a result of an investigation resulting from a whistleblower complaint. Although we believe that our operations materially 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. Providers found liable for False Claims Act violations are subject to damages of up to three times the actual damage sustained by the government plus mandatory civil monetary penalties between $5,500 and $11,000 for each separate false claim. A determination that we have violated these laws could have a material adverse effect on us.
State Anti-Kickback and Physician Self-Referral Laws
Many states, including those in which we do or expect to 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. However, a number of these laws apply to all healthcare services in the state, regardless of the source of payment for the service. Based on court and administrative interpretations of the federal anti-kickback statute, we believe that the federal anti-kickback statute prohibits payments only if they are intended to induce referrals. However, the laws in most states regarding kickbacks have been subjected to more limited judicial and regulatory interpretation than federal law. Therefore, we can give you no assurances that our activities will be found to be in compliance with these laws. Noncompliance with these laws could subject us to penalties and sanctions and have a material adverse effect on us.
A number of states, including those in which we do or expect to do business, have enacted physician self-referral laws that are similar in purpose to the Stark Law but which impose different restrictions. Some states, for example, only prohibit referrals when the physician’s financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Some states do not prohibit referrals, but require that a patient be informed of the financial relationship before the referral is made. We believe that our operations are in material compliance with the physician self-referral laws of the states in which our facilities are located.
Health Information Security and Privacy Practices
We are subject to HIPAA and the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”), which was enacted as part of the American Recovery and Reinvestment Act of 2009 (“ARRA”). The regulations promulgated under HIPAA contain, among other measures, provisions that require many organizations, including us, to employ systems and procedures designed to protect the privacy and security of each patient’s individual healthcare information. Among the standards that the Department of Health and Human Services has adopted pursuant to HIPAA are standards for the following:
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electronic transactions and code sets;
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unique identifiers for providers, employers, health plans and individuals;
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security and electronic signatures;
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privacy; and
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enforcement.
In August 2000, the Department of Health and Human Services finalized the transaction standards, with which we are in material compliance. The transaction standards require us to use standard code sets established by the rule when transmitting health information in connection with some transactions, including health claims and health payment and remittance advices.
The Department of Health and Human Services has also published a rule establishing standards for the privacy of individually identifiable health information, with which we are in material compliance. These privacy standards apply to all health plans, all healthcare clearinghouses and many healthcare providers, including healthcare providers that transmit health information in an electronic form in connection with certain standard transactions. We are a covered entity under the final rule. The privacy standards protect individually identifiable health information held or disclosed by a covered entity in any form, whether communicated electronically, on paper or orally. These standards not only require our compliance with rules governing the use and disclosure of
protected health information, but they also require us to impose those rules, by contract, on any business associate to whom such information is disclosed, and, as of a final rule promulgated by the Department of Health and Human Services on January 25, 2013, by our business associates on any subcontractor to which such information is disclosed. Under the January 25, 2013, final rule, we were required to conform all of our contracts with business associates to certain established standards by September 23, 2014. The rule further requires certain revisions to our notices of privacy practices, redistribution of these policies to our patients, and for us to provide our patients with access to an electronic copy of their health records, upon request. A violation of the privacy standards could result in civil money penalties (which amounts are described below) and the federal rules also provide for criminal penalties of up to $50,000 and one year in prison for knowingly and improperly obtaining or disclosing protected health information, up to $100,000 and five years in prison for obtaining protected health information under false pretenses, and up to $250,000 and ten years in prison for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm.
Finally, the Department of Health and Human Services has also issued a rule establishing, in part, standards for the security of health information by health plans, healthcare clearinghouses and healthcare providers that maintain or transmit any health information in electronic form, regardless of format. We are an affected entity under the rule. These security standards require affected entities to establish and maintain reasonable and appropriate administrative, technical and physical safeguards to ensure integrity, confidentiality and the availability of the information. The security standards were designed to protect the health information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. Although the security standards do not reference or advocate a specific technology, and affected entities have the flexibility to choose their own technical solutions, the security standards required us to implement significant systems and protocols. We believe that we are in material compliance with these regulations.
Signed into law on February 17, 2009, the HITECH Act broadened the scope of the HIPAA privacy and security regulations. Among other things, the HITECH Act 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. Under the HITECH Act, the U.S. Department of Health and Human Services is required to conduct periodic compliance audits of covered entities and their business associates. Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties, and the HITECH Act has strengthened the enforcement provisions of HIPAA, which may result in increased enforcement activity. The HITECH Act increased the amount of civil penalties, with penalties now ranging up to $50,000 per violation for a maximum civil penalty of $1,500,000 in a calendar year for violations of the same requirement. Under the final rule promulgated by the Department of Health and Human Services on January 25, 2013, civil monetary penalties may not be imposed for violations where the covered entity did not know or, after exercising reasonable diligence, could not have known that the violation had occurred, if the covered entity corrects the violation within 30 days. In addition, the HITECH Act authorized 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.
In addition to HIPAA, many states have enacted their own security and privacy provisions concerning a patient’s health information. These state privacy provisions will control whenever they provide more stringent privacy protections than HIPAA. Therefore, a healthcare facility could be required to meet both federal and state privacy provisions if it is located in a state with strict privacy protections.
Adoption of Electronic Health Records
ARRA also includes provisions designed to increase the use of Electronic Health Records (“EHR”) by both physicians and hospitals. Beginning with 2011 and extending through 2016, eligible hospitals may receive reimbursement incentives based upon successfully demonstrating “meaningful use” of certified EHR technology.
Beginning in 2015, those hospitals that do not successfully demonstrate meaningful use of EHR technology are subject to reductions in reimbursements. On July 13, 2010, CMS released final meaningful use regulations and on August 23, 2012, CMS released final rules on the Stage 2 meaningful use criteria. On September 4, 2014, CMS issued a final rule that, among other changes, grants providers flexibility to comply with the meaningful use requirements in 2014, and delays the January 1, 2016 deadline for the implementation of Stage 3 meaningful use requirements for the first cohort of adopters to January 1, 2017. We have implemented EHR at our hospitals and, with the exception of one hospital, complied with the EHR meaningful use requirements to date. As a result, 15 of the 16 hospitals we operate received cash payments of approximately $3.4 million and $7.2 million in 2014 and 2013, respectively, and are eligible to receive additional amounts in 2015 and 2016 if we meet meaningful use requirements in effect for those years. Implementation of EHR may result in additional costs in the future to comply with any changes in the meaningful use criteria that may be established in the future by HHS. Some or all of any additional costs may not be offset by the reimbursement incentives we will receive.
Audits
Our facilities will be subject to federal audits to validate the accuracy of Medicare and Medicaid program submitted claims. If these audits identify overpayments, we could be required to pay a substantial rebate of prior years’ payments, including EHR incentives, subject to various administrative appeal rights. The federal government contracts with third-party recovery audit contractors (“RACs”) to identify overpayment and underpayments for services through post-payment reviews of Medicare providers and suppliers. The Acts expand the RAC program’s scope to include managed Medicare and to include Medicaid claims by requiring all states to establish programs to contract with RACs by December 31, 2010. In addition, the federal government employs Medicaid integrity contractors (“MICs”) to perform post-payment audits of Medicaid claims and identify overpayments. The Acts increase federal funding for the MIC program for federal fiscal year 2011 and later years. Similarly, Medicare zone program integrity contractors (“ZPICs”) target claims for potential fraud and abuse. Additionally, Medicare administrative contractors (“MACs”) must ensure they pay the right amount for covered and correctly coded services rendered to eligible beneficiaries by legitimate providers. However, potential liability from future federal or state audits could ultimately exceed established reserves, and any excess could potentially be substantial.
Corporate Practice of Medicine
Several states have laws and/or regulations that prohibit corporations and other entities from employing physicians and practicing medicine for a profit or that prohibit certain direct and indirect payments or fee-splitting arrangements between healthcare providers that are designed to induce or encourage the referral of patients to, or the recommendation of, particular providers for medical products and services. Possible sanctions for violation of these restrictions include loss of license and civil and criminal penalties. In addition, agreements between the corporation and the physician may be considered void and unenforceable. These statutes and/or regulations vary from state to state, are often vague and have seldom been interpreted by the courts or regulatory agencies. We do not expect these state corporate practice of medicine proscriptions to significantly affect our operations. Many states also have laws and regulations which prohibit payments for referral of patients and fee-splitting with physicians.
EMTALA
All of our hospitals in the United States are subject to the Emergency Medical Treatment and Active Labor Act (“EMTALA”). This federal law requires any hospital participating in the Medicare program to conduct an appropriate medical screening examination of every individual who presents to the hospital’s emergency room for treatment and, if the individual is suffering from an emergency medical condition, to either stabilize the condition or make an appropriate transfer of the individual to a facility able to handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of an individual’s ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer an individual or if the hospital delays appropriate treatment in order to first inquire about the individual’s
ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured individual, the individual’s family or a medical facility that suffers a financial loss as a direct result of a hospital’s violation of the law can bring a civil suit against the hospital. We believe our hospitals are in material compliance with EMTALA.
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 regulatory compliance including billing, reimbursement, cost reporting practices and contractual arrangements with referral sources.
Our regulatory compliance program is intended to maintain high standards of conduct applicable to the conduct of our business and that policies and procedures are implemented so that employees act in full compliance with all applicable laws, regulations and company policies. Under the regulatory compliance program, every employee receives legal compliance and ethics training upon hire and annually thereafter. 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 employees to report, without fear of retaliation, any suspected legal or ethical violations through our independent compliance hotline. In addition, we perform excluded parties background checks of employees upon hire, annually thereafter and as otherwise required by state law. 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.
Item 1A.
Item 1A. Risk Factors
You should carefully read the risks and uncertainties described below and the other information included in this report. Any of the following risks could materially and adversely affect our business, financial condition or results of operations. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially and adversely affect our business, financial condition or results of operations.
We depend on payments from third-party payors, including government healthcare programs. If these payments are reduced, our revenue will decrease.
We are dependent upon private and governmental third-party sources of payment for the services provided to patients in our surgery centers and surgical hospitals. The amount of payment a surgical facility receives for its services may be adversely affected by market and cost factors as well as other factors over which we have no control, including Medicare and Medicaid regulations and the cost containment and utilization decisions of third-party payors. Fixed fee schedules, capitation payment arrangements, exclusion from participation in or inability to reach agreement with managed care programs or other factors affecting payments for healthcare services over which we have no control could also cause a reduction in our revenues.
If we are unable to acquire and develop additional surgical facilities on favorable terms, are not successful in integrating operations of acquired surgical facilities, or are unable to manage growth, we may be unable to execute our acquisition and development strategy, which could limit our future growth.
Our strategy is to increase our revenues and earnings by continuing to acquire and develop additional surgical facilities, primarily in collaboration with our health system partners. Our efforts to execute our acquisition and development strategy may be affected by our ability to identify suitable candidates and negotiate and close acquisition and development transactions. We are currently evaluating potential acquisitions and development projects and expect to continue to evaluate acquisitions and development projects in the foreseeable future. The surgical facilities we develop typically incur losses in their early months of operation (more so in the case of surgical hospitals) and, until their case loads grow, they generally experience lower total revenues and operating margins than established surgical facilities, and we expect this trend to continue. Historically, most of our newly developed facilities have generated positive cash flow within the first 12 months of operations. We may not be successful in acquiring surgical facilities, developing surgical facilities or achieving satisfactory operating results at acquired or newly developed facilities. Further, the companies or assets we acquire in the future may not ultimately produce returns that justify our related investment. If we are not able to execute our acquisition and development strategy, our ability to increase revenues and earnings through future growth would be impaired.
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. Further, any delays or unexpected costs incurred in connection with integration could have a material adverse effect on our operations and earnings. 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.
We have acquired interests in or developed all of our surgical facilities since our inception. We expect to continue to expand our operations in the future. Our rapid growth has placed, and will continue to place, increased demands on our management, operational and financial information systems and other resources. Further expansion of our operations will require substantial financial resources and management attention. To accommodate our past and anticipated future growth, and to compete effectively, we will need to continue to improve our management, operational and financial information systems and to expand, train, manage and motivate our workforce. Our personnel, systems, procedures or controls may not be adequate to support our operations in the future. Further, focusing our financial resources and management attention on the expansion of
our operations may negatively impact our financial results. Any failure to improve our management, operational and financial information systems, or to expand, train, manage or motivate our workforce, could reduce or prevent our growth.
We depend on our partnerships with the physicians who use our facilities. Our ability to provide medical services at our facilities would be impaired and our revenues reduced if we are not able to maintain these partnerships.
Our business depends upon the efforts and success of the physicians who provide medical and surgical services at our facilities and the strength of our partnerships with these physicians. Our revenues would be reduced if we fail to actively manage, with our physicians, our facilities or if we lose a relationship with one or more key physicians or group of physicians or such physicians or groups reduce their use of our facilities. Any failure of these physicians to maintain the quality of medical care provided or to otherwise adhere to professional guidelines at our surgical facilities or any damage to the reputation of a key physician or group of physicians could also damage our reputation, subject us to liability and significantly reduce our revenues. In addition, although physicians who own interests in our facilities are generally subject to agreements restricting them from owning an interest in competitive facilities, we may not learn of, or be unsuccessful in preventing, our physician partners from acquiring interests in competitive facilities.
In addition, healthcare reform may contribute to increased physician employment with hospitals, which could weaken our relationships with these physicians. The creation of ACOs in the Acts may cause physicians to accept employment to become part of a network that includes an ACO. The Acts’ focus on investing in infrastructure to increase efficiencies may further contribute to shifting physicians’ practice patterns from private practice to employment with hospitals and ACOs. ACOs that achieve quality performance standards established by the Department of Health and Human Services will be eligible to share in a portion of the amounts saved by the Medicare program. Because an individual physician may view the costs associated with investing in technology and processes to increase efficiencies as too large to bear individually, the physician may turn to employment as a means to participate in the Medicare savings and the capital investments required by the Acts. Physicians who accept employment may be restricted from owning interests in or utilizing our facilities.
Changes in our payor or case mix could adversely affect our business.
In general, we receive higher reimbursement rates from commercial and workers’ compensation payors than Medicare, Medicaid and other government-funded programs. A material shift in our payor mix toward government-sponsored programs, which could occur for reasons beyond our control, could cause a reduction in our revenues. We also receive higher reimbursement for certain types of cases, such as orthopedic cases, compared to other procedures. A material shift in our case mix toward a higher percentage of lower revenue cases, which could occur for reasons beyond our control, could cause a reduction in our revenues.
If we fail to effectively and timely implement electronic health record systems, 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 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. Through December 31, 2014, we have incurred approximately $26.6 million of costs to develop and deploy our certified EHR technology and to meet meaningful use requirements as they are defined for 2014 and 2013, which resulted in our hospitals receiving $3.4 million and $7.2 million in incentive payments in 2014 and 2013, respectively. Our hospitals are eligible for decreasing incentive amounts in 2015 and 2016 provided we continue to meet meaningful use requirements. Because CMS can change those requirements, we may incur additional costs in the future to maintain our eligibility for incentive funding, and we will additionally incur ongoing expense to support and maintain our existing EHR software. The timing of expenditures will not correlate with the receipt of incentive payments and
the recognition of incentive income. If our eligible hospitals are unable to continue to meet the requirements for participation in the incentive payment program, we will not be eligible to receive incentive payments. 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 or a penalty on physicians for failing to perform enough procedures at facilities with EHR 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.
All providers and health plans subject to HIPAA, including our facilities, will be required to transition from the International Statistical Classification of Diseases (ICD)-9 to the ICD-10 coding system by October 1, 2015. (The previous scheduled implementation date of October 1, 2014, was delayed pursuant to the Protecting Access to Medicare Act of 2014 (P.L. 113-93), which was signed into law on April 1, 2014.) ICD-10 greatly expands the number and detail of billing codes used for claims. This transition requires a significant investment in technology and software and training of staff. In addition to these costs, it is possible that our facilities could experience disruption or delays in payment due to implementation issues or technical or coding errors by us or health plans and their business partners. Although it is unknown at this time, the transition to ICD-10 could result in decreased reimbursement if the ICD-10 codes reclassify conditions to payment groupings reimbursed at lower levels than assigned under the previous system.
Our revenues may be reduced by changes in payment methods or rates under the Medicare or Medicaid programs.
The Department of Health and Human Services and the states in which we perform surgical procedures for Medicaid patients may revise the Medicare and Medicaid payment methods or rates in the future. Any such changes could have a negative impact on the reimbursements we receive for our surgical services from the Medicare program and the state Medicaid programs. In addition, the Acts’ requirement that the Department of Health and Human Services develop a plan to implement a value-based purchasing program for ambulatory surgery centers may further impact Medicare reimbursement of ambulatory surgery centers or increase our operating costs in order to satisfy any future value-based standards that may be authorized and implemented. The Acts’ creation of a bundled payment initiative, under which organizations enter into payment arrangements that include financial and performance accountability for episodes of care, may impact our Medicare and other payors’ reimbursement as organizations develop, implement and accept this new reimbursement model. The ultimate impact of the changes in reimbursement will depend on a number of factors, including the procedure mix at our facilities, our ability to demonstrate our high quality of care, our potential participation with other organizations in new payment programs and our ability to realize an increased procedure volume.
Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our debt obligations.
We have a substantial amount of indebtedness. As of December 31, 2014, we had $1.5 billion of total indebtedness and a total indebtedness to total capitalization percentage ratio of 72%.
Our and our subsidiaries’ high degree of leverage could have important consequences to you. For example, it:
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requires us and certain of our subsidiaries to dedicate a substantial portion of cash flow from operations to payments on indebtedness, reducing the availability of cash flow to fund working capital, capital expenditures, development activity, acquisitions and other general corporate purposes;
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increases vulnerability to adverse general economic or industry conditions;
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limits flexibility in planning for, or reacting to, changes in our business or the industry in which we operate;
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makes us and our subsidiaries more vulnerable to increases in interest rates, as borrowings under our amended senior secured credit facilities are at variable rates;
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limits our and our subsidiaries’ ability to obtain additional financing in the future for working capital or other purposes, such as raising the funds necessary to repurchase our senior unsecured notes upon the occurrence of specified changes of control, or
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places us at a competitive disadvantage compared to our competitors that have less indebtedness.
Our significant indebtedness could limit our flexibility.
We are significantly leveraged and will continue to have significant indebtedness in the future. Our acquisition and development program requires substantial capital resources, estimated to range from $125.0 million to $150.0 million per year over the next three years, although the range could be exceeded if we identify attractive multi-facility acquisition opportunities. The operations of our existing surgical facilities also require ongoing capital expenditures. We believe that our cash on hand, cash flows from operations and available borrowings under our revolving credit facility will be sufficient to fund our acquisition and development activities in 2015, but if we identify favorable acquisition and development opportunities that require additional resources, we may be required to incur additional indebtedness in order to pursue these opportunities. However, we may be unable to obtain sufficient financing on terms satisfactory to us, or at all. In that event, our acquisition and development activities would have to be curtailed or eliminated and our financial results could be adversely affected.
Our debt agreements contain restrictions that limit our flexibility in operating our business.
The operating and financial restrictions and covenants in our debt instruments, including our senior secured credit facilities and the indenture governing our senior unsecured notes, may adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our interest. For example, our senior secured credit facility restricts, subject to certain exceptions, our and our subsidiaries’ ability to, among other things:
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incur, assume or permit to exist additional indebtedness or guarantees;
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incur liens and engage in sale leaseback transactions;
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make loans, investments and other advances;
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declare dividends, make payments or redeem or repurchase capital stock;
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engage in mergers, acquisitions and other business combinations;
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prepay, redeem or repurchase certain indebtedness including the notes;
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amend or otherwise alter terms of certain subordinated indebtedness including the notes;
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enter into agreements limiting subsidiary distributions;
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sell assets;
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engage in certain transactions with affiliates;
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alter the business that we conduct; and
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issue and sell capital stock of subsidiaries.
The indenture governing our senior notes includes similar restrictions. Our amended senior secured credit facility also requires us to comply with a financial covenant with respect to the revolving credit facility that becomes more restrictive over time. Our and our subsidiaries’ ability to comply with these covenants and ratios may be affected by events beyond our control. A breach of any covenant or required financial ratio could result in a default under the senior secured credit facilities. In the event of any default under the senior secured credit
facilities, the applicable lenders could elect to terminate borrowing commitments and declare all borrowings and accrued interest and fees to be due and payable, to require us to apply all available cash to repay these borrowings or to prevent us from making or permitting subsidiaries to make distributions or dividends, the proceeds of which are used by us to make debt service payments on our senior subordinated notes, any of which would be an event of default under the notes.
If we incur material liabilities as a result of acquiring surgical facilities, our operating results could be adversely affected.
Although we conduct extensive due diligence prior to the acquisition of surgical facilities and seek indemnification from prospective sellers covering unknown or contingent liabilities, we may acquire surgical facilities that have material liabilities for failure to comply with healthcare laws and regulations or other past activities. Although we maintain professional and general liability insurance, we do not currently maintain insurance specifically covering any unknown or contingent liabilities that may have occurred prior to the acquisition of surgical facilities. If we incur these liabilities and are not indemnified or insured for them, our operating results and financial condition could be adversely affected.
We depend on our relationships with health system partners. If we are not able to maintain our relationships with these health system partners, or enter into new relationships, we may be unable to implement our business strategies successfully.
Our business depends in part upon the efforts and success of our health system partners and the strength of our relationships with those health systems. Our business could be adversely affected by any damage to those health systems’ reputations or to our relationships with them. We may not be able to maintain our existing agreements on terms and conditions favorable to us or enter into relationships with additional health systems. Our relationships with health systems and the joint venture agreements that represent these relationships are structured to comply with current revenue rulings published by the Internal Revenue Service as well as case law relevant to joint ventures between for-profit and not-for-profit healthcare entities. Material changes in these authorities could adversely affect our relationships with health system partners. If we are unable to maintain our existing arrangements on terms favorable to us or enter into relationships with additional health system partners, we may be unable to implement our business strategies successfully.
If we and our health system partners are unable to successfully negotiate contracts and maintain satisfactory relationships and renew existing contracts on favorable terms with managed care organizations or other third-party payors, our revenues may decrease.
Our competitive position has been, and will continue to be, affected by initiatives undertaken during the past several years by major purchasers of healthcare services, including federal and state governments, insurance companies and employers, to revise payment methods and monitor healthcare expenditures in an effort to contain healthcare costs. As a result of these initiatives, managed care companies such as health maintenance and preferred provider organizations, which offer prepaid and discounted medical service packages, represent a growing segment of healthcare payors, the effect of which has been to reduce the growth of healthcare facility margins and revenue. We have undertaken initiatives to favorably position our facilities to respond to these changing payment methodologies and cost containment efforts, but the ultimate success of our initiatives is unknown at this time.
As an increasing percentage of patients become subject to healthcare coverage arrangements with managed care payors, we believe that our success will continue to depend upon our and our health system partners’ ability to negotiate favorable contracts and payment arrangements on behalf of our facilities with managed care organizations, employer groups and other private third-party payors. We have structured our ventures with health system partners in a manner we believe to be consistent with applicable regulatory requirements. If applicable regulatory requirements were interpreted to require changes to our existing arrangements, or if we are unable to enter into these arrangements on satisfactory terms in the future, we could be adversely affected. Many of these
payors already have existing provider structures in place and may not be able or willing to change their provider networks. We could also experience a material adverse effect to our operating results and financial condition as a result of the termination of existing third-party payor contracts. In addition, in recent years many payors and healthcare plans have increased plan participants’ co-payments, co-insurance and deductibles. Patient volumes could be negatively impacted if this trend continues.
Our surgical facilities face competition for patients from other healthcare providers.
The healthcare business is highly competitive, and competition among hospitals and other healthcare providers for patients has intensified in recent years. Generally, other facilities in the local communities served by our facilities provide services similar to those offered by our surgery centers and surgical hospitals. In addition, the number of freestanding surgical hospitals and surgery centers in the geographic areas in which we operate has increased significantly, and many of these facilities operate under different reimbursement models than we have traditionally seen. As a result, most of our surgery centers and surgical hospitals operate in a highly competitive environment. Some of the hospitals that compete with our facilities are owned by governmental agencies or not-for-profit corporations supported by endowments, charitable contributions and/or tax revenues and can finance capital expenditures and operations on a tax-exempt basis. Our surgery centers and surgical hospitals are facing increasing competition from unaffiliated physician-owned surgery centers and surgical hospitals for market share in high margin services and for quality physicians and personnel. If our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their facilities than our surgery centers and surgical hospitals, we may experience an overall decline in patient volume.
Financial pressures on patients may adversely impact our business.
Even as the U.S. economy shows signs of sustained, if modest, growth, many individuals throughout the country continue to experience difficult financial conditions. Burdened by economic constraints and higher patient deductibles, patients have delayed or canceled non-emergency surgical procedures in recent years. Although we have taken steps to minimize the impact of these conditions, it is difficult to predict the degree to which our business will continue to be impacted by such conditions or the course of the economy in the future.
The Supreme Court’s 2014 decision to hear the case of King v. Burwell-a Fourth Circuit decision upholding an IRS rule extending tax credits to individuals purchasing health insurance under the Acts through federally established exchanges-poses an additional element of uncertainty and risk. If the IRS rule is struck down, millions of individuals in the 36 states with federal exchanges would be ineligible for federal health insurance subsidies, and would likely lose insurance coverage entirely absent further action by Congress or the states. Apart from the political upheaval and resulting uncertainty regarding the future implementation of the Acts, such a result could adversely affect our business by exacerbating the financial pressures on patients in these states, leading them to further delay or cancel non-emergency surgical procedures.
Our surgical facilities may be negatively impacted by weather and other factors beyond our control.
The results of operations of our surgical facilities may be adversely impacted by adverse weather conditions, including hurricanes, or other factors beyond our control that cause disruption of patient scheduling, displacement of our patients, employees and physician partners and force certain of our surgical facilities to close temporarily. In certain markets, we have a large concentration of surgical facilities that could be simultaneously affected by adverse weather conditions or events.
Shortages or quality control issues with medical supplies could disrupt our operations and negatively impact our profitability.
We depend on our ability to obtain medical supplies from suppliers on a timely basis. If we are unable to obtain such necessary supplies for a period of time, we would be unable to perform certain surgeries. As a result, we could suffer operational disruptions, increased costs and reductions in profitability. Medical supplies may also
be subject to supplier quality control incidents. Significant quality control issues by producers or vendors have occurred in the past and may occur again in the future, for reasons beyond our control. Such issues could negatively impact our operations regardless of whether they were caused by us.
Efforts to regulate the construction, acquisition or expansion of healthcare facilities could prevent us from acquiring additional surgical facilities, renovating our existing facilities or expanding the breadth of services we offer.
Many states in the United States require prior approval for the construction, acquisition or expansion of healthcare facilities or expansion of the services they offer. When considering whether to approve such projects, these states take into account the need for additional or expanded healthcare facilities or services. In a number of states in which we operate, we are required to obtain certificates of need for capital expenditures exceeding a prescribed amount, changes in bed capacity or services offered and under various other circumstances. Other states in which we now or may in the future operate may adopt certificate of need legislation or regulatory provisions. Our costs of obtaining a certificate of need have ranged up to $500,000. Although we have not previously been denied a certificate of need, we may not be able to obtain the certificates of need or other required approvals for additional or expanded facilities or services in the future. In addition, at the time we acquire a facility, we may agree to replace or expand the acquired facility. If we are unable to obtain the required approvals, we may not be able to acquire additional surgery centers or surgical hospitals, expand the healthcare services provided at these facilities or replace or expand acquired facilities.
If any of our existing healthcare facilities lose their accreditation or any of our new facilities fail to receive accreditation, such facilities could become ineligible to receive reimbursement under Medicare or Medicaid.
The construction and operation of healthcare facilities are subject to extensive federal, state and local regulation relating to, among other things, the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting and compliance with building codes and environmental protection. Additionally, such facilities are subject to periodic inspection by government authorities to assure their continued compliance with these various standards.
All of our facilities are deemed certified, meaning that they are accredited, properly licensed under the relevant state laws and regulations and certified under the Medicare program or are in the process of applying for such accreditation, licensing or certification. The effect of maintaining certified facilities is to allow such facilities to participate in the Medicare and Medicaid programs. We believe that all of our healthcare facilities are in material compliance with applicable federal, state, local and other relevant regulations and standards. However, should any of our healthcare facilities lose their deemed certified status and thereby lose certification under the Medicare or Medicaid programs, such facilities would be unable to receive reimbursement from either of those programs and our business could be materially adversely affected.
Failure to comply with federal and state statutes and regulations relating to patient privacy and electronic data security could negatively impact our financial results.
There are currently numerous federal and state statutes and regulations that address patient privacy concerns and federal standards that address the maintenance of the security of electronically maintained or transmitted electronic health information and the format of transmission of such information in common healthcare financing information exchanges. These provisions are intended to enhance patient privacy and the effectiveness and efficiency of healthcare claims and payment transactions. In particular, the Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996 required us to implement new systems and to adopt business procedures for transmitting healthcare information and for protecting the privacy and security of individually identifiable information.
We believe that we are in material compliance with existing state and federal regulations relating to patient privacy, security and with respect to the format for electronic healthcare transactions. However, if we fail to comply with the federal privacy, security and transactions and code sets regulations, we could incur significant civil and criminal penalties. Failure to comply with state laws related to privacy could, in some cases, also result in civil fines and criminal penalties.
Our operations could be impaired by a failure of our information systems.
An information system failure that causes an interruption in service or availability of our information systems could adversely affect operations or delay the collection of revenues. We have implemented multiple layers of security measures through technology, processes, and our people; utilize current security technologies; and our defenses are monitored and routinely tested internally and by external parties. Despite these efforts, threats from malicious persons and groups, new vulnerabilities, and advanced new attacks against information technology systems create risk of cyber security incidents that could impact availability of systems. The occurrence of any of these events could result in interruptions, delays, the loss or corruption of data, cessations in the availability of systems or liability under privacy and security laws, all of which could have a material adverse effect on our financial position and results of operations and harm our business reputation.
If we fail to comply with applicable laws and regulations, we could suffer penalties 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 jurisdictions in which we operate. These laws and regulations require that our healthcare facilities meet various licensing, certification and other requirements, including those relating to:
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physician ownership of our facilities;
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the adequacy of medical care, equipment, personnel, operating policies and procedures;
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building codes;
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licensure, certification and accreditation;
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billing for services;
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handling of medication;
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maintenance and protection of records; and
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environmental protection.
We believe that we are in material compliance with applicable laws and regulations. However, if we fail or have failed to comply with applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in Medicare, Medicaid and other government sponsored healthcare programs. A number of initiatives have been proposed during the past several years to reform various aspects of the healthcare system in the United States. In the future, different interpretations or enforcement of existing or new laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. Current or future legislative initiatives or government regulation may have a material adverse effect on our operations or reduce the demand for our services.
In pursuing our growth strategy, we may expand our presence into new geographic markets. In entering a new geographic market, we will be required to comply with laws and regulations of jurisdictions that may differ from those applicable to our current operations. If we are unable to comply with these legal requirements in a cost-effective manner, we may be unable to enter new geographic markets.
If a federal or state agency asserts a different position or enacts new laws or regulations regarding illegal remuneration under the Medicare or Medicaid programs, we may be subject to civil and criminal penalties, experience a significant reduction in our revenues or be excluded from participation in the Medicare and Medicaid programs.
The federal anti-kickback statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for referrals for items or services payable by Medicare, Medicaid, or any other federally funded healthcare program. Additionally, the anti-kickback statute prohibits any form of remuneration in return for purchasing, leasing or ordering, or arranging for or recommending the purchasing, leasing or ordering of items or services payable by Medicare, Medicaid or any other federally funded healthcare program. The anti-kickback statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by existing case law or regulations. Moreover, several federal courts have held that the anti-kickback statute can be violated if only one purpose (not necessarily the primary purpose) of a transaction is to induce or reward a referral of business, notwithstanding other legitimate purposes. Violations of the anti-kickback statute may result in substantial civil or criminal penalties, including up to five years imprisonment and criminal fines of up to $25,000 and civil penalties of up to $50,000 for each violation, plus three times the remuneration involved or the amount claimed and exclusion from participation in all federally funded healthcare programs. An exclusion, if applied to our surgery centers or surgical hospitals, could result in significant reductions in our revenues, which could have a material adverse effect on our business.
In July 1991, the Department of Health and Human Services issued final regulations defining various “safe harbors.” Two of the safe harbors issued in 1991 apply to business arrangements similar to those used in connection with our surgery centers and surgical hospitals: the “investment interest” safe harbor and the “personal services and management contracts” safe harbor. However, the structure of the partnerships and limited liability companies operating our surgery centers and surgical hospitals, as well as our various business arrangements involving physician group practices, do not satisfy all of the requirements of either safe harbor.
On November 19, 1999, the Department of Health and Human Services promulgated final regulations creating additional safe harbor provisions, including a safe harbor that applies to physician ownership of or investment interests in surgery centers. The surgery center safe harbor protects four types of investment arrangements: (1) surgeon owned surgery centers; (2) single specialty surgery centers; (3) multi-specialty surgery centers; and (4) hospital/physician surgery centers. Each category has its own requirements with regard to what type of physician may be an investor in the surgery center. In addition to the physician investor, the categories permit an “unrelated” investor, who is a person or entity that is not in a position to provide items or services related to the surgery center or its investors. Our business arrangements with our surgical facilities typically consist of one of our subsidiaries being an investor in each partnership or limited liability company that owns the facility, in addition to providing management and other services to the facility. Therefore, our business arrangements with our surgery centers, surgical hospitals and physician groups do not qualify for “safe harbor” protection from government review or prosecution under the anti-kickback statute. When a transaction or relationship does not fit within a safe harbor, it does not mean that an anti-kickback violation has occurred; rather, it means that the facts and circumstances as well as the intent of the parties related to a specific transaction or relationship must be examined to determine whether or not any illegal conduct has occurred.
Although we believe that our business arrangements do not violate the anti-kickback statute, 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 the physician investors to become illegal or result in the imposition of penalties against us or our facilities. If any of our business arrangements with physician investors were deemed to violate the anti-kickback statute or similar laws, or if new federal or state laws were enacted rendering these arrangements illegal, our business could be adversely affected.
Also, most of the states in which we operate have adopted anti-kickback laws, many of which apply more broadly to all third-party payors, not just to federal or state healthcare programs. Many of the state laws do not have regulatory safe harbors comparable to the federal provisions and have only rarely been interpreted by the
courts or other governmental agencies. We believe that our business arrangements do not violate these state laws. Nonetheless, if our arrangements were found to violate any of these anti-kickback laws, we could be subject to significant civil and criminal penalties that could adversely affect our business.
If physician self-referral laws are interpreted differently or if other legislative restrictions are issued, we could incur significant sanctions and loss of reimbursement revenues.
The U.S. federal physician self-referral law, commonly referred to as the “Stark Law,” prohibits a physician from making a referral for a “designated health service” to an entity to furnish an item or service payable under Medicare 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 list of designated health services under the Stark Law does not include ambulatory surgery services as such. However, some of the designated health services are among the types of services furnished by our facilities.
The Department of Health and Human Services, acting through the CMS, has promulgated regulations implementing the Stark Law. These regulations exclude health services provided by an ambulatory surgery center 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 a surgery center. However, if the surgery center is separately billing Medicare for designated health services that are not covered under the surgery center’s composite Medicare payment rate, or if either the surgery center or an affiliated physician is performing (and billing Medicare) for procedures that involve designated health services that Medicare has not designated as an ambulatory surgery center 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.
In addition, we believe that physician ownership of surgery centers 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. 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. Exclusion of our surgery centers or surgical hospitals from these programs through future judicial or agency interpretation of existing laws or additional legislative restrictions on physician ownership or investments in healthcare entities could result in significant loss of reimbursement revenues.
We may be subject to actions for false and other improper claims.
Federal and state government agencies, as well as private payors, have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of the cost reporting and billing practices of healthcare organizations and their quality of care and financial relationships with referral sources. In addition, the Office of the Inspector General of the U.S. Department of Health and Human Services, and the U.S. Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse.
The U.S. 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 and other federal and state healthcare programs. Claims filed with private insurers can also lead to criminal and civil penalties, including, but not limited to, penalties relating to violations of federal mail and wire fraud statutes, as well as penalties under the anti-fraud provisions of the HIPAA. The U.S. government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances. For example, the government has taken the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant should have known the services were unnecessary, even if the government cannot demonstrate actual knowledge. The government has also taken the position that claiming payment for low-quality services is a violation of these statutes if the claimant should have known that the care was substandard. The Fraud Enforcement and Recovery Act of 2009 (“FERA”) further expanded the scope of the False Claims Act to create
liability for knowingly and improperly avoiding or decreasing an obligation to pay money to the federal government and FERA, along with statutory provisions found in the Acts, created federal False Claims Act liability for the knowing failure to report and return an overpayment within 60 days of the identification of the overpayment or, in certain cases, the date by which a corresponding cost report is due, whichever is later. 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 financial condition or results of operations.
Companies within the healthcare industry continue to be the subject of federal and state audits and investigations, which increases the risk that we may become subject to investigations in the future.
Both federal and state government agencies, as well as private payors, have heightened and coordinated audits and administrative, civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations. These investigations relate to a wide variety of topics, including the following:
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cost reporting and billing practices;
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quality of care;
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financial reporting;
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financial relationships with referral sources; and
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medical necessity of services provided.
In addition, the Office of the Inspector General of the Department of Health and Human Services and the Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. In its 2013 Work Plan, the office of the Inspector General stated its intention to review the safety and quality of care for Medicare beneficiaries having surgeries and procedures in ambulatory surgery centers and hospital outpatient departments. We have not received any related audit letters to date. Moreover, another trend impacting healthcare providers is the increased use of the federal False Claims Act, particularly by individuals who bring actions under that law. Such “qui tam” or “whistleblower” actions allow private individuals to bring actions on behalf of the government alleging that a healthcare provider has defrauded the federal government. If the government intervenes and prevails in the action, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil monetary penalties of between $5,500 and $11,000 for each false claim submitted to the government. As part of the resolution of a qui tam case, the party filing the initial complaint may share in a portion of any settlement or judgment. If the government does not intervene in the action, the qui tam plaintiff may pursue the action independently. Additionally, some states have adopted similar whistleblower and false claims provisions. Although companies in the healthcare industry have been, and may continue to be, subject to qui tam actions, we are unable to predict the impact of such actions on our business, financial position or results of operations.
If laws governing the corporate practice of medicine or fee-splitting change, we may be required to restructure some of our relationships which may result in significant costs to us and divert other resources.
The laws of various jurisdictions in which we operate or may operate in the future do not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business practices, such as fee-splitting with physicians (i.e., sharing a percentage of professional fees). The interpretation and enforcement of these laws vary significantly from state to state. We are not required to obtain a license to practice medicine in any jurisdiction in which we own or operate a surgery center or surgical hospital because our facilities are not engaged in the practice of medicine. The physicians who utilize our facilities are individually licensed to practice medicine. In most instances, the physicians and physician group practices performing medical services at our facilities do not have investment or business relationships with us other than through the physicians’ ownership interests in the partnerships or limited liability companies that own and operate our facilities and the service agreements we have with some of those physicians.
Through our OrthoLink subsidiary, we provide consulting and administrative services to a number of physicians and physician group practices affiliated with OrthoLink. Although we believe that our arrangements with these and other physicians and physician group practices comply with applicable laws, a government agency charged with enforcement of these laws, or a private party, might assert a contrary position. If our arrangements with these physicians and physician group practices were deemed to violate state corporate practice of medicine, fee-splitting or similar laws, or if new laws are enacted rendering our arrangements illegal, we may be required to restructure these arrangements, which may result in significant costs to us and divert other resources.
If regulations change, we may be obligated to purchase some or all of the ownership interests of the physicians affiliated with us.
Upon the occurrence of various fundamental regulatory changes, we could be obligated to purchase some or all of the ownership interests of the physicians affiliated with us in the partnerships or limited liability companies that own and operate our surgery centers and surgical hospitals. The regulatory changes that could create this obligation include changes that:
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make illegal the referral of Medicare or other patients to our surgical facilities by physicians affiliated with us;
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create the substantial likelihood that cash distributions from the limited partnerships or limited liability companies through which we operate our surgical facilities to physicians affiliated with us would be illegal; or
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make illegal the ownership by the physicians affiliated with us of interests in the partnerships or limited liability companies through which we own and operate our surgical facilities.
At this time, we are not aware of any regulatory amendments or proposed changes that would trigger this obligation. Typically, our partnership and limited liability company agreements allow us to use shares of our common stock as consideration for the purchase of a physician’s ownership interest. The use of shares of our common stock for that purpose would dilute the ownership interests of our common stockholders. In the event that we are required to purchase all of the physicians’ ownership interests and our common stock does not maintain a sufficient valuation, we could be required to use our cash resources for the acquisitions, the total cost of which we estimate to be up to approximately $610.9 million at December 31, 2014. The creation of these obligations and the possible termination of our affiliation with these physicians could have a material adverse effect on us.
Healthcare reform has restricted our ability to operate our surgical hospitals.
The Acts provide, among other things: (i) a prohibition on hospitals from having any physician ownership unless the hospital already had physician ownership and a Medicare provider agreement in effect on December 31, 2010; (ii) a limitation on the maximum percentage of total physician ownership in the hospital to the percentage of physician ownership as of March 23, 2010; (iii) a requirement for written disclosures of physician ownership interests, along with an annual report to the government detailing such ownership; and (iv) restrictions on the ability of a hospital subject to the whole hospital exception to add operating rooms, procedure rooms and beds.
Fifteen of our existing hospitals were grandfathered at the dates of enactment of the Acts, although they are largely prohibited from expanding their physical plants. Our sixteenth hospital does not have any physician ownership. If future legislation were to be enacted by Congress that prohibits physician referrals to hospitals in which the physicians own an interest, or that otherwise further limits physician ownership in existing facilities, our financial condition and results of operations could be materially adversely affected.
If we become subject to significant legal actions, we could be subject to substantial uninsured liabilities.
In recent years, physicians, surgery centers, hospitals and other healthcare providers have become subject to an increasing number of legal actions alleging malpractice or related legal theories. Many of these actions
involve large monetary claims and significant defense costs. In particular, since the majority of our hospitals maintain emergency departments, there is an increased risk of claims at these facilities because of the nature of the cases seen in the emergency departments. We do not employ any of the physicians who conduct surgical procedures at our facilities and the governing documents of each of our facilities require physicians who conduct surgical procedures at our facilities to maintain stated amounts of insurance. Additionally, to protect us from the cost of these claims, we maintain (through a captive insurance company) professional malpractice liability insurance and general liability insurance coverage in amounts and with deductibles that we believe to be appropriate for our operations. Although we have excess coverage beyond our captive, we are effectively self-insured up to the excess. If we become subject to claims, however, our insurance coverage may not cover all claims against us or continue to be available at adequate levels of insurance. If one or more successful claims against us were not covered by or exceeded the coverage of our insurance, we could be adversely affected.
If we are unable to effectively compete for physicians, strategic relationships, acquisitions and managed care contracts and implement and execute responses to competitive changes, our business could be adversely affected.
The healthcare business is highly competitive. We compete with other healthcare providers, primarily other surgery centers and hospitals, in recruiting physicians and contracting with managed care payors in each of our markets. There are major unaffiliated hospitals in each market in which we operate. These hospitals have established relationships with physicians and payors. In addition, other companies either are currently in the same or similar business of developing, acquiring and operating surgery centers and surgical hospitals or may decide to enter our business. Many of these other facilities compete with us for market share in high margin services and for quality physicians and personnel and operate under different reimbursement models than we have traditionally seen. We may also compete with some of these companies for entry into strategic relationships with health systems and healthcare professionals. If we are unable to identify and execute solutions to compete effectively with any of these entities, we may be unable to implement our business strategies successfully and our business could be adversely affected.
Because our senior management has been key to our growth and success, we may be adversely affected if we lose any member of our senior management.
We are highly dependent on our senior management, including William H. Wilcox, who is our chief executive officer and Brett P. Brodnax, who is our president and chief development officer. Although we have employment agreements with Mr. Wilcox and Mr. Brodnax and other senior managers, we do not maintain “key man” life insurance policies on any of our officers. Because our senior management has contributed greatly to our growth since inception, the loss of key management personnel or our inability to attract, retain and motivate sufficient numbers of qualified management or other personnel could have a material adverse effect on us.
The growth of patient receivables and a deterioration in the collectability of these accounts could adversely affect our results of operations.
The primary collection risks of our accounts receivable relate to patient receivables for which the primary insurance carrier has paid the amounts covered by the applicable agreement but patient responsibility amounts (deductibles and copayments) remain outstanding. The allowance for doubtful accounts relates primarily to amounts due directly from patients.
We provide for bad debts principally based upon the aging of accounts receivable and use specific identification to write-off amounts against our allowance for doubtful accounts, without differentiation between payor sources. Our allowance for doubtful accounts at December 31, 2014 and 2013, represented approximately 17% and 16% of our accounts receivable balance, respectively. Due to the difficulty in assessing future trends, we could be required to increase our provisions for doubtful accounts. A deterioration in the collectability of these accounts could adversely affect our collection of accounts receivable, cash flows and results of operations.
We may have a special legal responsibility to the holders of ownership interests in the entities through which we own surgical facilities, and that responsibility may prevent us from acting solely in our own best interests or the interests of our stockholders.
Our ownership interests in surgery centers and surgical hospitals generally are held through partnerships or limited liability companies. We typically maintain an interest in a partnership or limited liability company in which physicians or physician practice groups also hold interests. As general partner or manager 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 owners. We also have a duty to operate our business for the benefit of our stockholders. As a result, we may encounter conflicts between our responsibility to the other owners and our responsibility to our stockholders. For example, we have entered into management agreements to provide management services to our 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 are 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 affiliated physicians with respect to a particular business decision or regarding the interpretation of the provisions of the applicable partnership or limited liability company agreement. If we are unable to resolve a dispute on terms favorable or satisfactory to us, our business may be adversely affected.
We do not have exclusive control over the distribution of revenues from some of our operating entities and may be unable to cause all or a portion of the revenues of these entities to be distributed.
All of the surgical facilities in which we have ownership interests are partnerships or limited liability companies in which we own, directly or indirectly, ownership interests. Our partnership, and limited liability company agreements, which are typically with the physicians who perform procedures at our surgical facilities, usually provide for the monthly or quarterly pro-rata cash distribution of net profits from operations, less amounts to satisfy obligations such as the entities’ non-recourse debt and capitalized lease obligations, operating expenses and working capital. The creditors of each of these partnerships and limited liability companies are entitled to payment of the entities’ obligations to them, when due and payable, before ordinary cash distributions or distributions in the event of liquidation, reorganization or insolvency may be made. We generally control the entities that function as the general partner of the partnerships or the managing member of the limited liability companies through which we conduct operations. However, we do not have exclusive control in some instances over the amount of net revenues distributed from some of our operating entities. If we are unable to cause sufficient revenues to be distributed from one or more of these entities, our relationships with the physicians who have an interest in these entities may be damaged and we could be adversely affected. We may not be able to resolve favorably any dispute regarding revenue distribution or other matters with a healthcare system with which we share control of one of these entities. Further, the failure to resolve a dispute with these healthcare systems could cause the entity we jointly control to be dissolved.
Welsh Carson controls us and may have conflicts of interest with us or you in the future.
An investor group led by Welsh Carson owns substantially all of the outstanding equity securities of our Parent, USPI Group Holdings, Inc. Welsh Carson controls a majority of the voting power of such outstanding equity securities and therefore ultimately controls all of our affairs and policies, including the election of our board of directors, the approval of certain actions such as amending our charter, commencing bankruptcy proceedings and taking certain corporate actions (including, without limitation, incurring debt, issuing stock, selling assets and engaging in mergers and acquisitions), and appointing members of our management. The interests of Welsh Carson could conflict with your interests.
Additionally, Welsh Carson is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Welsh Carson may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as investment funds associated with or designated by Welsh Carson continue to indirectly own a significant amount of our capital stock, even if such amount is less than 50% of our outstanding common stock on a fully-diluted basis, Welsh Carson will continue to be able to strongly influence or effectively control our decisions.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The response to this item is included in Item 1.
Item 3.
Item 3. Legal Proceedings
From time to time, we may be named as a party to legal claims and proceedings in the ordinary course of business. We are not aware of any claims or proceedings against us or our subsidiaries that might have a material adverse impact on us.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
We are wholly-owned by USPI Holdings, Inc., which is wholly-owned by USPI Group Holdings, Inc., both of which are privately owned corporations. There is no public trading market for our equity securities or those of USPI Holdings, Inc. or USPI Group Holdings, Inc. As of February 23, 2015, there were 238 holders of USPI Group Holdings, Inc. common stock.
Payment of dividends is restricted under our amended senior secured credit facility and the indenture governing our senior notes, except for limited circumstances. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financing Activities - Dividend Payment.” Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operation, capital requirements, restrictions contained in current and future financing instruments and other factors that our board of directors deems relevant.
Item 6.
Item 6. Selected Financial Data
The selected consolidated statement of operations data set forth below for the years ended December 31, 2014, 2013, 2012, 2011 and 2010 and the consolidated balance sheet data at December 31, 2014, 2013, 2012, 2011, and 2010 are derived from our consolidated financial statements.
The historical results presented below (in thousands, except number of facilities) are not necessarily indicative of results to be expected for any future period. The comparability of the financial and other data included in the table is affected by our debt refinancing in April 2013 and 2012, the U.K. goodwill impairment in 2011 (now presented in discontinued operations), and various acquisitions completed during the years presented. In addition, the results of operations of subsidiaries sold by us, including the spin-off of our U.K. subsidiary in April 2012 have been reclassified to “discontinued operations” for all data presented in the table below except for the “consolidated balance sheet data.” For a more detailed explanation of this financial data, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this report.
(a) Not derived from audited financial statements; excludes our former U.K. facilities.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” and our consolidated financial statements and related notes included elsewhere in this report.
Overview
We are an experienced and trusted partner in some of the nation’s most successful surgical networks. We provide strategic solutions for physicians, physician networks, leading health systems and those paying for the cost of healthcare services, such as employers, insurance companies and government programs.
Our portfolio includes 219 short-stay surgical facilities in 27 states. In these facilities, which are licensed as either ambulatory surgery centers, specialty hospitals or hospitals, we serve almost 11,000 physicians and approximately one million patients each year. We maintain strategic joint venture relationships with approximately 4,000 physicians and over 50 prominent health systems. All but two of our facilities are co-owned with local physicians, and 154 are in strategic ventures with a health system. During 2014, we added ten facilities, consisting of three in Texas, two in New Jersey and one each in California, Georgia, Indiana, Missouri and South Dakota.
Our facilities generally specialize in non-emergency surgical cases. Due in part to advancements in medical technology, and additionally due to the lower cost structure and greater efficiency that are attainable in a specialized outpatient site, the volume and complexity of surgical cases performed in an outpatient setting has steadily increased over the past three decades. We believe continuing national focus on controlling the cost of healthcare will lead to further opportunities for high quality, low cost providers, such as USPI. Our strategy is to further enhance our value to our partners, employers, payors and patient populations in ways that build upon our historic experience and success, both in our existing facilities as well as additional acquired or developed facilities or other complementary businesses.
Our facilities’ primary income source is a fee from patients, insurance companies or other payors in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. After providing for the related expenses of the case, including the nursing staff, supplies and property costs, each facility distributes its profit to us and the other owners. In addition, we earn a monthly fee from each facility we operate in exchange for managing its operations. How these income streams affect our financial statements depends on whether we consolidate each respective facility entity. Because our ownership levels and rights vary from facility to facility, we do not consolidate 156 of the 219 facilities that we operate, instead accounting for our investments in them under the equity method. To help analyze our results of operations, we disclose an operating measure we refer to as systemwide revenue growth, which includes both consolidated and unconsolidated (i.e., equity method) facilities. While revenues of our unconsolidated facilities are not recorded as revenues by USPI, we believe the information is important in understanding our financial performance because these revenues are the basis for calculating our management services revenues and, together with the expenses of our unconsolidated facilities, are the basis for our equity in earnings of unconsolidated affiliates. In addition, we disclose growth rates and operating income margins (both consolidated and unconsolidated) for the facilities that were operational in both the current and prior year periods, a group we refer to as same-store facilities.
Critical Accounting Policies and Estimates
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 accounting principles generally accepted in the United States of America (GAAP). The preparation of consolidated financial statements under GAAP requires our management to make certain estimates and assumptions that impact the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. These estimates and assumptions also impact the reported amount of net earnings during any period. Estimates are based on information available as of the date
financial statements are prepared. Accordingly, actual results could differ from those estimates. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and that require management’s most subjective judgments. Our critical accounting policies and estimates include our policies and estimates regarding consolidation, revenue recognition and accounts receivable, income taxes, and goodwill and intangible assets.
Consolidation
We generally own less than 100% of each facility we operate. As discussed in “Results of Operations,” local physicians have invested in all but two of our facilities. A majority of our facilities also include a health system partner. We generally have a leadership role in these facilities through a significant voting and economic interest and a contract to manage each facility’s operations, but the degree of ultimate control we have varies from facility to facility. Accordingly, as of December 31, 2014, we consolidated the financial results of 63 of the facilities we operate and accounted for 156 under the equity method.
Our consolidated financial statements include our accounts, the accounts of our wholly owned subsidiaries, and other investees over which we have control or of which we are the primary beneficiary. Investments in companies that we do not control but over whose operations we have the ability to exercise significant influence (including some investees in which we have less than 20% ownership), are accounted for under the equity method. We also consider the relevant sections of the Financial Accounting Standards Board’s Accounting Standards Codification, Topic 810, Consolidation to determine if we are the primary beneficiary of (and therefore should consolidate) any entity whose operations we do not control with voting rights. See further discussion in Note 5 to our consolidated financial statements.
Accounting for an investment as consolidated versus equity method has no impact on our net income (loss) or total equity in any accounting period, but it does impact individual balances within the consolidated statement of operations and consolidated balance sheet. Under either consolidation or equity method accounting, our results of operations include our share, generally corresponding to our ownership percentage, of the underlying facility’s net income or loss.
Revenue Recognition and Accounts Receivable
We recognize revenue in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements, as updated, which has four criteria that must be met before revenue is recognized:
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Existence of persuasive evidence that an arrangement exists;
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Delivery has occurred or services have been rendered;
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The seller’s price to the buyer is fixed or determinable; and
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Collectibility is reasonably assured.
Our revenue recognition policies are consistent with these criteria. Approximately 90% of our facilities’ surgical cases are performed under contracted or government mandated fee schedules or discount arrangements. The patient service revenues recorded for these cases are recorded at the contractually defined amount at the time of billing. We estimate the remaining revenue based on historical collections, and adjustments to these estimates in subsequent periods have not had a material impact in any period presented. If the discount percentage used in estimating revenues for the cases not billed pursuant to fee schedules were changed by 1%, our 2014 after-tax net income would change by approximately $0.2 million. The collection cycle for patient services revenue is relatively short, typically ranging from 30 to 60 days depending upon payor and geographic norms, which allows us to evaluate our estimates frequently. Our revenues earned under management and other service contracts are typically based upon objective formulas driven by an entity’s financial performance and are generally earned and paid monthly.
In 2014, uninsured or self-pay revenues only accounted for approximately 3% of our consolidated revenues and approximately 5% of our accounts receivable balance was comprised of amounts owed from patients,
including the patient portion of amounts covered by insurance. Insurance revenues (including government payors) accounted for 97% of our 2014 consolidated revenues and approximately 95% of our accounts receivable balance was comprised of amounts owed from contracted payors. Our facilities primarily perform surgery that is scheduled in advance by physicians who have already seen the patient. As part of our internal control processes, we verify benefits, obtain insurance authorization, calculate patient financial responsibility and notify the patient of their responsibility, usually prior to surgery. The nature of our business is such that we do not have any significant receivables that are pending approval from third-party payors. We also focus our collection efforts on aged accounts receivable. However, due to complexities involved in insurance reimbursements and inherent limitations in verification procedures, our business will always have some level of bad debt expense. In both 2014 and 2013, our bad debt expense was approximately 2% of revenue. In addition, as of December 31, 2014 and 2013, our average days sales outstanding were 36 days and 34 days, respectively. The aging of our accounts receivable at December 31, 2014 was 57% less than 60 days old, 17% between 60 and 120 days and 26% over 120 days old. Our bad debt allowance at December 31, 2014 and 2013 represented approximately 17% and 16% of our accounts receivable balance, respectively.
Due to the nature of our business, management relies upon the aging of accounts receivable as its primary tool to estimate bad debt expense, but also considers the impact of any known material events in determining the allowance for doubtful accounts. We reserve for bad debt based principally upon the aging of accounts receivable, without differentiating by payor source. We write off uncollectible accounts against the allowance for doubtful accounts after exhausting collection efforts and adding subsequent recoveries. We believe our reserve policy allows us to accurately estimate our allowance for doubtful accounts and bad debt expense.
Income Taxes
Our income tax policy is to record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and the bases of those assets and liabilities as reported in our consolidated balance sheets. This estimation process requires that we evaluate the need to accrue deferred tax liabilities or for a valuation allowance against deferred tax assets, based on factors such as historical financial information, expected timing of future events, the probability of expected future taxable income and available tax planning opportunities. We carry a valuation allowance against deferred tax assets that have restrictions as to use and are not considered more likely than not to be realized. If our estimates related to the above items change significantly, we may need to alter the amount of the valuation allowance in the future through a favorable or unfavorable adjustment to net income.
Goodwill and Intangible Assets
Given the significance of our intangible assets as a percentage of our total assets, we also consider our accounting policy regarding goodwill and intangible assets to be a critical accounting policy. Consistent with GAAP, we do not amortize goodwill or indefinite-lived intangibles but rather test them for impairment annually or more often when circumstances change in a manner that indicates they may be impaired. Impairment tests occur at the reporting unit level for goodwill. Historically, our reporting units were defined as our operating segments (United States and United Kingdom). Due to the spin-off of our U.K. subsidiary in April 2012, we now operate in one segment and test goodwill within one reporting unit. Our intangible assets consist primarily of indefinite-lived contractual rights to manage individual surgical facilities. Intangible assets with definite lives primarily consist of rights to provide management and other contracted services to surgical facilities, hospitals, and physicians. These assets are amortized over their estimated useful lives, and the portfolios are tested for impairment when circumstances change in a manner that indicates their carrying values may not be recoverable.
We performed a qualitative assessment to determine whether it was more-likely-than-not that the fair value of our reporting unit was less than its carrying amount for years ended December 31, 2014. In performing this qualitative assessment, we assessed relevant events and circumstances including macroeconomic conditions, industry and market conditions, cost factors, overall financial performance and entity-specific events. For the
year ended December 31, 2014, we concluded it was more-likely-than-not that the fair value of our reporting unit exceeded its carrying value. Therefore, the two-step goodwill impairment test was not required and there was no impairment of goodwill.
In tests for impairment of indefinite-lived intangible assets, the fair value of the asset is compared to its carrying amount. If the carrying amount exceeds the fair value, an impairment loss is recognized. Fair values for indefinite-lived intangible assets are estimated based on market multiples and discounted cash flow models which have been derived based on our experience in acquiring surgical facilities, market participant assumptions and third-party valuations we have obtained with respect to such transactions.
Merger Transaction
We had publicly traded equity securities from June 2001 through April 2007. Pursuant to an Agreement and Plan of Merger (the merger) dated as of January 7, 2007, between an affiliate of Welsh, Carson, Anderson & Stowe X, L.P. (Welsh Carson), we became a wholly owned subsidiary of USPI Holdings, Inc. on April 19, 2007. USPI Holdings is a wholly owned subsidiary of USPI Group Holdings, Inc. (Parent), which is owned by an investor group that includes affiliates of Welsh Carson, members of our management and other investors.
Acquisitions, Equity Investments and Development Projects
We acquire interests in existing surgery facilities from third parties, and we invest in new facilities that we develop in partnership with health system partners and local physicians. Some of these transactions result in our controlling the acquired entity and meet the GAAP definition of a business combination. The financial results of acquired entities are included in our consolidated financial statements beginning on the acquisition’s effective date. During the year ended December 31, 2014, the Company obtained control of the following entities:
(1) Acquisition of a controlling interest in and right to manage a surgical facility in which we previously had no involvement. The facility is jointly owned with local physicians.
(2) We obtained control of this facility in which we already had ownership due to changes in the voting rights of the facility. Although no consideration was transferred, GAAP requires the transaction to be accounted for as a business combination. This facility is jointly owned with local physicians.
We also regularly engage in the purchase and sale of equity interests with respect to our investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in unconsolidated affiliates that need capital for acquisitions, new construction or other business growth opportunities. During the year ended December 31, 2014, these transactions resulted in a net cash outflow of approximately $146.9 million, which is summarized as follows:
(1) Acquisition of a noncontrolling interest in and the right to manage a surgical facility in which we previously had no involvement. The facility is jointly owned with local physicians.
(2) Acquisition of a noncontrolling interest in and the right to manage two surgical facilities in which we previously had no involvement. These facilities are jointly owned with a health system partner and local physicians.
(3) Acquisition of a noncontrolling interest in and the right to manage a surgical facility in which we previously had no involvement. The facility is jointly owned with a health system partner and local physicians.
(4) Represents the net payment related to various other purchases and sales of equity interests and contributions of cash to equity method investees.
Similar to our investments in unconsolidated affiliates, we regularly engage in the purchase and sale of equity interests in our consolidated subsidiaries that do not result in a change of control. These types of transactions are accounted for as equity transactions, as they are undertaken among us, our consolidated subsidiaries, and noncontrolling interests. During the year ended December 31, 2014, we purchased and sold equity interests in various consolidated subsidiaries in the amounts of $8.8 million and $6.2 million, respectively. The difference between our carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to our additional paid-in capital. These transactions resulted in a $12.0 million decrease to our additional paid-in capital during the year ended December 31, 2014.
During the year ended December 31, 2014, the Company received a return of capital in the amount of $22.0 million from one of its unconsolidated affiliates.
During the year ended December 31, 2013, we obtained control of the following entities:
(1) Acquisition of a controlling interest in and right to manage a surgical facility in which we previously had no involvement. The facility is jointly owned with a health system partner and local physicians.
(2) Acquisition of a controlling interest in a surgical facility in which we already had ownership and already managed. The facility is jointly owned with a health system partner and local physicians. We recorded a loss of approximately $0.8 million as a result of adjusting the carrying value of its existing ownership to fair value as required by GAAP. The loss is included in “Net losses on deconsolidations, disposals and impairments” in our accompanying consolidated statements of income.
We also regularly engage in the purchase and sale of equity interests with respect to our investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in unconsolidated affiliates that need capital for acquisitions, new construction or other business growth opportunities. During the year ended December 31, 2013, these transactions resulted in a net cash outflow of approximately $33.3 million, which is summarized as follows:
(1) Investment of additional funds in an existing joint venture with one of our health system partners.
(2) Acquisition of additional ownership in a surgical facility in which we already held ownership and already managed. The facility is jointly owned with local physicians.
(3) Acquisition of an investment in a partnership that is constructing a new building for one of our facilities.
(4) Represents the net payment related to various other purchases and sales of equity interests and contributions of cash to equity method investees.
Similar to our investments in unconsolidated affiliates, we regularly engage in the purchase and sale of equity interests in our consolidated subsidiaries that do not result in a change of control. These types of transactions are accounted for as equity transactions, as they are undertaken among us, our consolidated subsidiaries, and noncontrolling interests. During the year ended December 31, 2013, we purchased and sold equity interests in various consolidated subsidiaries in the amounts of $5.7 million and $4.1 million, respectively. The difference between our carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to our additional paid-in capital. These transactions resulted in a $3.9 million decrease to our additional paid-in capital during the year ended December 31, 2013.
During the year ended December 31, 2012, we obtained control of the following entities:
(1) As further discussed below, we acquired 100% of the equity interests of AIGB Holdings, Inc. (True Results). True Results has an equity investment in five surgery centers, all of which are located in markets in which we already operate. The purchase price noted above is net of approximately $5.8 million of cash acquired.
(2) We obtained control of this facility in which we already had ownership due to changes in the voting rights of the facility. Although no consideration was transferred, GAAP requires the transaction to be accounted for as a business combination and requires adjusting the carrying value of our existing ownership to its fair value. As a result, we recorded a loss totaling approximately $6.5 million for the year ended December 31, 2012, which is included in “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income.
(3) Acquisition of a controlling interest in and right to manage a surgical facility in which we previously had no involvement. This facility is jointly owned with local physicians and a health system partner.
(4) Acquisition of a controlling interest in a surgical facility in which we already had an equity method investment and the right to manage. This facility is jointly owned with local physicians. We recorded a gain of approximately $0.2 million as a result of adjusting the carrying value of our existing ownership to fair value as required by GAAP. The gain is included in “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income.
Effective November 8, 2012, we completed the acquisition of 100% of the equity interests in True Results, a privately-held, Dallas, Texas-based owner and operator of surgery centers specializing in weight loss services. We paid cash totaling approximately $65.4 million, which is net of $5.8 million of cash acquired, subject to certain purchase price adjustments set forth in the purchase agreement. We funded the purchase using cash on hand and by drawing on our revolving credit facility. We incurred approximately $0.7 million in acquisition costs, which are included in “general and administrative expenses” in the accompanying consolidated statements of income.
In January 2013, we contributed two of the surgery centers acquired in the True Results acquisition to a joint venture with one of our health system partners, a Baylor Scott & White Health affiliated entity (Baylor Scott & White). Baylor Scott & White, which is a related party, paid us approximately $9.0 million for ownership interests in the two surgery centers, which we believe approximates fair value as if it had been negotiated on an arms’ length basis. We continue to account for these facilities under the equity method.
We also regularly engage in the purchase and sale of equity interests with respect to our investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in surgical facilities under development. During the year ended December 31, 2012, these transactions resulted in a net cash outflow of approximately $54.5 million, which is summarized as follows:
(1) Acquisition of a noncontrolling interest in and right to manage a surgical facility in which we previously had no involvement. The facility is jointly owned with local physicians.
(2) Acquisition of a noncontrolling interest in and right to manage a surgical facility in which we previously had no involvement. The facility is jointly owned with a health system partner and local physicians.
(3) Acquisition of a noncontrolling interest in and right to manage two surgical facilities in Hackensack and Paramus, New Jersey, respectively, in which we previously had no involvement. The facilities are jointly owned with a health system partner and local physicians.
(4) Represents the net payment related to various other purchases and sales of equity interests and contributions of cash to equity method investees.
Similar to our investments in unconsolidated affiliates, we regularly engage in the purchase and sale of equity interests in our consolidated subsidiaries that do not result in a change of control. These types of
transactions are accounted for as equity transactions, as they are undertaken among us, our consolidated subsidiaries, and noncontrolling interests. During the year ended December 31, 2012, we purchased and sold equity interests in various consolidated subsidiaries in the amounts of $4.0 million and $8.8 million, respectively. The difference between our carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to our additional paid-in capital. These transactions resulted in a $17.1 million decrease to our additional paid-in capital during the year ended December 31, 2012.
Discontinued Operations, Deconsolidations and Other Dispositions
Before the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Update 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (ASU 2014-08) in 2014, we classified formerly consolidated subsidiaries in which it had no continuing involvement as discontinued operations. The gains or losses on these transactions were classified within discontinued operations in our consolidated statements of income. We also reclassified the historical results of these subsidiaries to remove the operations of these entities from our revenues and expenses, collapsing the net income or loss from these operations into a single line within discontinued operations. On April 3, 2012, we distributed the stock of our U.K. subsidiary to our Parent’s equity holders. Subsequent to April 3, 2012, we have no ownership in the U.K. operations. Because GAAP requires spin-off transactions to be accounted for at carrying value, there was no gain or loss recorded on the spin-off of the U.K. operations. Our U.K. operations are now classified as “discontinued operations” in our historical results of operations.
In 2014 and 2012, we completed sales of investments in two facilities operated through unconsolidated affiliates, including our equity ownership in these entities as well as the related rights to manage the facilities. These transactions do not qualify for discontinued operations presentation. We did not dispose of any facility we operated through an unconsolidated affiliate during 2013. Gains and losses on the disposals of these investments are classified within “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income. These transactions are summarized below:
From time to time, we surrender control of an entity but retain a noncontrolling interest (classified within “investments in unconsolidated affiliates”). These types of transactions result in a gain or loss, computed as the difference between (a) the sales proceeds and fair value of the retained investment and (b) our carrying value of the investment prior to the transaction. Gains or losses for such transactions are classified within “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income. Fair values are estimated based on market multiples and discounted cash flow models which have been derived from our experience in acquiring surgical facilities and third party valuations we have obtained with respect to such transactions. During the year ended December 31, 2014, we surrendered control of, but retained an equity method investment in, two entities as part of our strategy of partnering with health systems. These transactions are summarized below:
Sources of Revenue
Revenues primarily include the following:
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net patient service revenues of the facilities that we consolidate for financial reporting purposes, which are those in which we maintain effective control, generally indicated by an ownership interest of greater than 50% but also including variable interest entities of which we are the primary beneficiary;
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management and contract service revenues, consisting of the fees that we earn from managing the facilities that we do not consolidate for financial reporting purposes and the fees we earn from providing certain consulting and contracted services to other healthcare providers. Our consolidated revenues and expenses do not include the management fees we earn from operating the facilities that we consolidate for financial reporting purposes as those fees are charged to subsidiaries and thus are eliminated in consolidation.
The following table summarizes our revenues by type and as a percentage of total revenue for the periods presented:
Net patient service revenues consist of the revenue earned by the facilities we consolidate for financial reporting purposes. As a percent of our total revenues, these revenues did not change significantly compared to prior year periods. Revenues earned by our unconsolidated affiliates for similar services are not included in our revenues. The percentage of our facilities we account for under the equity method was approximately 70% at December 31, 2014, 2013, and 2012.
Our management and contract service revenues are earned from the following types of activities (in thousands):
As described above, we also earn management fees from consolidated facilities, but those fees are eliminated in consolidation and thus are not included in revenues on our consolidated statements of income.
Results of Operations
The following table summarizes certain consolidated statements of income items expressed as a percentage of revenues for the periods indicated:
Our business model of partnering with health system partners and physicians results in our accounting for 156 of our surgical facilities under the equity method rather than consolidating their results. The following table reflects the summarized results of the unconsolidated facilities that we account for under the equity method of accounting (amounts are expressed as a percentage of unconsolidated affiliates’ revenues, and represent 100% of the investees’ results on an aggregated basis):
Our share of the net income of unconsolidated affiliates is shown in our consolidated statements of income on a net basis as “equity in earnings of unconsolidated affiliates.”
Executive Summary
We are an experienced and trusted partner in some of the nation’s most successful surgical networks. We provide strategic solutions for physicians, physician networks, leading health systems and those paying for the cost of healthcare services, such as employers, insurance companies and government programs.
Our portfolio includes 219 short-stay surgical facilities in 27 states. In these facilities, which are licensed as either ambulatory surgery centers, specialty hospitals or hospitals, we serve approximately 11,000 physicians and one million patients each year. We maintain strategic joint venture relationships with approximately 4,000
physicians and over 50 prominent health systems. All but two of our facilities are co-owned with local physicians, and 154 of our facilities are in strategic joint ventures with a health system. Our strategy continues to include acquiring facilities, developing new facilities with health system partners, and improving the operating results of our existing facilities. During 2014, we added ten facilities, consisting of three in Texas, two in New Jersey and one each in California, Georgia, Indiana, Missouri and South Dakota.
Our facilities generally specialize in non-emergency surgical cases. Due in part to advancements in medical technology, and additionally due to the lower cost structure and greater efficiency that are attainable in a specialized outpatient site, the volume and complexity of surgical cases performed in an outpatient setting has steadily increased over the past three decades. We believe the continuing national focus on controlling the cost of healthcare will lead to further opportunities for high quality, low cost providers, such as us. Our strategy is to further enhance our value to our partners, employers, payors and patient populations in ways that build upon our historic experience and success, both in our existing facilities as well as additional acquired or developed facilities or other complementary businesses.
Our earnings from a facility, whether consolidated or equity method, are driven by the same factors: the facility’s underlying profits and revenues and our ownership percentage. Accordingly, to assess our overall operating results we often utilize systemwide and same-store measures, which include both consolidated and unconsolidated facilities. Our operating results for the year ended December 31, 2014, reflect 5% same-store facility revenue growth as compared to 2013, and our overall business also grew as a result of our operating more facilities in 2014. Our consolidated revenue growth in 2014 was 4% and our systemwide revenue growth was 8%. Our systemwide revenues include all facilities that we operate; our revenues only include consolidated facilities, which represent less than one-third of our facilities. Accounting for the majority of our facilities under the equity method is a direct result of deploying our primary business strategy of jointly owning our facilities with prominent local physicians and a health system partner. In carrying out this strategy during the period from January 1, 2013 to December 31, 2014, our number of equity method facilities increased from 149 to 156 while our consolidated facility count decreased from 64 to 63.
Operating income increased 2% and operating income margin decreased 70 basis points during 2014 as compared to 2013. In addition to our consolidated operating income margin, we also focus on same-store facility level operating income margins (which include both consolidated and equity method facilities) as important indicators of our business because the net earnings and cash flows we derive from our facilities are the same whether they are reflected in our individual revenue and expense line items (consolidated facilities) or on a net basis within our equity in earnings of unconsolidated affiliates (unconsolidated facilities). These margins were flat in 2014 as compared to 2013.
Our Business and Key Measures
We operate surgical facilities in partnership with local physicians and, in the majority of cases, a health system partner. We hold an ownership interest in each facility, operating each through a separate legal entity owned by us, the health systems and local physicians who utilize the facility. We operate each facility on a day-to-day basis through a management services contract. Our sources of earnings from each facility consist of:
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our share of each facility’s net income or loss, which is computed by multiplying the facility’s net income or loss times the percentage of each facility’s equity interests owned by us; and
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management services revenues, computed as a percentage of each facility’s net revenues (often net of bad debt expense).
Our role as an owner and day-to-day manager provides us with significant influence over the operations of each facility. In a majority of our facilities (currently 156 of our 219 facilities), this influence does not represent control of the facility, so we account for our investment in the facility under the equity method, i.e., as an unconsolidated affiliate. We control the other 63 facilities and account for these investments as consolidated subsidiaries.
Our net earnings from a facility are the same under either method, but the classification of those earnings differs. For consolidated subsidiaries, our consolidated statements of income reflect, within each revenue and expense line item, 100% of the revenues and expenses of each subsidiary, after the elimination of intercompany amounts. The net profit attributable to owners other than us is classified within “net income attributable to noncontrolling interests.”
For unconsolidated affiliates, our consolidated statements of income reflect our earnings in only two line items:
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equity in earnings of unconsolidated affiliates: our share of the net income or loss of each facility, which is based on the facilities’ net income or loss and the percentage of the facility’s outstanding equity interests owned by us; and
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management and administrative services revenues: income we earn in exchange for managing the day-to-day operations of each facility, usually quantified as a percentage of each facility’s net revenues less bad debt expense.
In summary, our operating income is driven by the performance of all facilities we operate and by our ownership interest in those facilities, but our individual revenue and expense line items only contain consolidated businesses, which represent less than one-third of our operations. This translates to trends in operating income that often do not correspond with changes in our individual revenue and expense line items. The divergence in these relationships is particularly significant when our strategy is heavily weighted to unconsolidated affiliates, as it has been in recent years during the ongoing deployment of our strategy to partner with health systems. Accordingly, we supplementally review several types of information in order to monitor and analyze our results of operations, including:
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The results of operations of our unconsolidated affiliates
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Our average ownership share in the facilities we operate; and
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Facility operating indicators irrespective of consolidation treatment, such as systemwide revenue growth, same-store revenue growth, and same-store operating margins.
Our Consolidated and Unconsolidated Results
The following table shows our results of operations and the results of operations of our unconsolidated affiliates.
The following table provides other information regarding our unconsolidated affiliates (in thousands):
(1) Our weighted average percentage ownership in our unconsolidated affiliates is calculated as our equity in earnings of unconsolidated affiliates divided by the total net income (loss) of unconsolidated affiliates for each respective period. This is a non-GAAP measure but management believes it provides further useful information about our involvement in unconsolidated affiliates.
(2) Our weighted average percentage ownership in our unconsolidated affiliates is calculated as the total debt of each unconsolidated affiliate, multiplied by the percentage ownership we held in the affiliate as of the end of each respective period, divided by the total debt of all of the unconsolidated affiliates as of the end of each respective period. This is a non-GAAP measure but management believes it provides further useful information about our involvement in unconsolidated affiliates.
One of our unconsolidated affiliates, Texas Health Ventures Group, L.L.C., is considered significant to our consolidated financial statements under regulations of the SEC. As a result, we have filed Texas Health Ventures Group, L.L.C.’s consolidated financial statements with this Form 10-K for the appropriate periods.
As shown above, our consolidated net patient service revenues for the year ended December 31, 2014 increased $16.1 million compared to the prior year, and the net patient service revenues of our unconsolidated affiliates increased $176.7 million. These variances are analyzed more extensively in the “Revenues” section. The increase in revenues of these unconsolidated affiliates, net of their expenses, led to the affiliates earning $85.5 million more in 2014 than in 2013, which resulted in a $21.1 million increase in our equity in earnings of unconsolidated affiliates. Our consolidated net patient service revenues for the year ended December 31, 2013 increased $66.1 million compared to the prior year, and the net patient service revenues of our unconsolidated affiliates increased $56.7 million.
Our Ownership Interests in the Facilities We Operate
Our earnings are primarily driven by our investments in the facilities we operate, so we focus on those businesses’ performance together with the percentage ownership interest we hold in them to help us understand our results of operations. Our average ownership interest in the surgical facilities we operate is as follows:
(1) Computed for unconsolidated facilities by dividing (a) our total equity in earnings of unconsolidated affiliates by (b) the aggregate net income of surgical facilities we account for under the equity method.
(2) Computed for consolidated facilities by dividing (a) the aggregate net income (loss) of surgical facilities we operate less our total minority interests in income (loss) of consolidated subsidiaries by (b) the aggregate net income of our consolidated surgical facilities.
(3) Computed in total by dividing our share of the facilities’ net income (loss), defined as the sum of (a) in footnotes (1) and (2), by the aggregate net income of our surgical facilities, defined as the sum of (b) in footnotes (1) and (2).
Our average ownership interest for each group of facilities is determined by many factors, including the ownership levels we negotiate in our acquisition and development activities, the relative performance of facilities in which we own percentages higher or lower than average, and other factors. As described earlier, our focus on partnering our facilities with health system partners in addition to physicians generally leads to our accounting for more facilities under the equity method (unconsolidated) as reflected in our number of unconsolidated facilities increasing by seven from January 1, 2013 to December 31, 2014, while our number of consolidated facilities decreased by one. We generally have a lower ownership percentage in an equity method facility as compared to a consolidated facility.
Revenues
Our consolidated net revenues increased approximately 4% during the year ended December 31, 2014, as compared to the year ended December 31, 2013. The table below quantifies several significant items impacting year over year growth.
As shown above, the increases in our consolidated revenues and the revenues of our unconsolidated affiliates resulted from both acquisitions, which added $15.3 million and $83.2 million to revenues for consolidated and unconsolidated affiliates, respectively and from same-store growth, which added $12.6 million to consolidated revenues and $92.6 million to unconsolidated affiliates. As described earlier, we supplementally focus on our systemwide results in order to understand the source of our growth in income. Our systemwide revenues, which include revenues of facilities we account for under the equity method as well as facilities we consolidate, grew by 8%, 6% and 12% during the years ended December 31, 2014, 2013 and 2012, respectively.
Facility Growth
For the year ended December 31, 2014, systemwide revenues increased due to same-store growth and acquisitions that were made in 2013 and 2014. Our same-store case volumes increased 1% as compared to 2013, and our net revenue per case increased 4%, which was driven by a shift to more complex cases during 2014. While cases increased 1% overall during 2014, they were flat during 2013. We believe a variety of factors may be adversely affecting our surgical volumes, including but not limited to the increased use of high-deductible health plans and other efforts to contain the growth of healthcare spending, and general economic conditions.
During 2013, while systemwide revenue growth was primarily driven by acquisitions, a portion of growth was driven by facilities that have been open for more than one year (same-store facilities). The same-store
growth was due to an increase in net revenue per case as our surgical volumes were flat during 2013 as compared to 2012. The increase was driven both by reimbursement increases from commercial payors and by favorable shifts in the complexity of cases performed, offset by a shift in payor mix to government.
The following table summarizes our same-store facility growth rates, as compared to the corresponding prior year period:
Joint Ventures with Health System Partners
The addition of new facilities continues to be slightly more heavily weighted to surgical facilities with a health system partner, both as we initiate joint venture agreements with new systems and as we add facilities to our existing arrangements. Facilities have been added to hospital joint ventures through construction of new facilities (de novos), acquisitions of facilities and through our contribution of our equity interests in existing facilities into a hospital joint venture structure, effectively creating three-way joint ventures by sharing our ownership in these facilities with a health system partner while leaving the existing physician ownership intact. We continue to explore affiliating more of our facilities with health system partners. Often these affiliations are initiated in markets where we already operate other facilities with a health system partner, but we also affiliate our facilities with new partners.
The following table summarizes the facilities we operated as of December 31, 2014, 2013, and 2012:
(1) At December 31, 2014, physicians own a portion of all but two of these facilities.
(2) During 2014, we sold two facilities in Pennsylvania and merged four Missouri locations into two locations. During 2013, we sold our ownership interests in a facility in Illinois and merged two Texas facilities into one location. During 2012, we sold our ownership interests in a facility in Nashville, Tennessee. We also merged two Texas facilities into one location and two of our California facilities into one location.
Facility Operating Margins
Same-store facility operating margins were flat for the year ended December 31, 2014 as compared to 2013. Our same-store facility operating margins declined 220 basis points during the first quarter of 2014 due to a decline in case volumes and an unfavorable shift in payor mix. Our case volumes and payor mix improved in later quarters, and we also experienced a shift to more complex cases. Overall, these factors together with cost control efforts led to our margins being flat compared to 2013 on a full year basis.
Continuing a trend we have experienced in recent years, the year-over-year change in the operating margins of facilities partnered with a health system partner was more favorable (or, in the case of 2013 and 2012, less unfavorable) than the change experienced by the facilities that do not have a health system partner. During 2014, our hospital-partnered facilities’ operating margins increased 70 basis points, as compared to a decrease of 280 basis points for the facilities that do not have health system partners. We believe this is due in part to our hospital-partnered facilities having more stable reimbursement rates and in some cases more stable referral patterns. The pattern of our acquisition and development activity can also affect this relationship over time.
Same-store facility operating margins decreased 160 basis points for the year ended December 31, 2013 as compared to 2012 due largely to a shift toward more government payors. The direct costs of performing these cases are not different for government than for private payors, but reimbursement is lower so our margins were adversely impacted. We also experienced a slight specialty mix shift from higher reimbursing musculoskeletal cases to lower reimbursing specialties. The impact of these two factors was particularly significant in our unconsolidated facilities, where a 3% increase in revenues did not translate to any increase in net earnings.
The following table summarizes our year-over-year increases (decreases) in same-store operating margins (see footnote 1 below):
(1) Operating margin is calculated as operating income divided by total net revenues. This table aggregates all of the same-store facilities we operate using 100% of their results. This does not represent the overall margin for our operations because we have a variety of ownership levels in the facilities we operate, and facilities open for less than a year are excluded from same-store calculations.
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
As discussed more fully in “Revenues,” our consolidated revenues increased by $24.6 million, or 4.0%, to $640.8 million for the year ended December 31, 2014 from $616.2 million for the year ended December 31, 2013. The increase in consolidated revenues was due to acquisitions ($15.3 million), consolidation of a facility ($7.3 million) and an increase from operations ($12.3 million), which was offset by deconsolidations of three facilities and the sale of one facility of approximately $10.3 million.
Equity in earnings of unconsolidated affiliates increased by $21.1 million, or 22.1%, to $116.6 million for the year ended December 31, 2014 from $95.5 million for the year ended December 31, 2013. The increase in equity in earnings was primarily driven by acquisitions of $10.9 million.
Operating expenses, excluding depreciation and amortization, increased by $40.9 million, or 9.7%, to $461.7 million for the year ended December 31, 2014 from $420.7 million for the year ended December 31, 2013. The increase primarily represents the expenses of facilities we acquired during late 2013 and 2014 and additionally resulted from increased investment in general and administrative expenses related to deploying our strategic initiatives. We also recorded an impairment charge of $5.7 million related to four of our management contracts in 2014.
Depreciation and amortization decreased $1.2 million, or 4.5% to $26.0 million for the year ended December 31, 2014 from $27.2 million for the year ended December 31, 2013. Depreciation and amortization, as a percentage of revenues, was 4.1% for the year ended December 31, 2014 and 4.4% for the year ended December 31, 2013.
Operating income increased $6.0 million, or 2.3%, to $269.8 million for the year ended December 31, 2014 from $263.8 million for the year ended December 31, 2013, and decreased as a percentage of revenues to 42.1% from 42.8%, respectively. The increase in operating income was driven by the increases in net revenues and equity in earnings of unconsolidated affiliates described above, which was mostly offset by the increases in operating expense also discussed earlier. For the year ended December 31, 2014, operating income was also favorably impacted by EHR incentive income of approximately $3.2 million.
Interest expense, net of interest income, decreased $6.1 million, or 6.1%, to $93.7 million for the year ended December 31, 2014 from $99.8 million for the year ended December 31, 2013. The decrease is primarily due to fees we paid in February and March 2013 related to the refinancing we completed in April 2013.
Provision for income taxes was $37.5 million for the year ended December 31, 2014 as compared $31.4 million for the year ended December 31, 2013. Our effective tax rate for the years ended December 31, 2014 and 2013 was approximately 38% and 39%, respectively.
Total loss from discontinued operations was $0.3 million for the year ended December 31, 2014, and relates to the final disposal of fixed assets related to a previously sold entity.
Net income attributable to noncontrolling interests decreased $1.7 million, or 2.2%, to $77.1 million for the year ended December 31, 2014 from $78.8 million for the year ended December 31, 2013. Net income attributable to noncontrolling interests includes $1.1 million related to EHR incentive income recorded by our three consolidated hospitals during 2014.
Net income increased $11.1 million, or 8.7%, to $138.1 million for the year ended December 31, 2014 as compared to $127.1 million for the year ended December 31, 2013. Net income attributable to USPI’s common stockholder increased $12.8 million, or 26.4%, to $61.0 million for the year ended December 31, 2014 as compared to $48.3 million for the year ended December 31, 2013.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
As discussed more fully in “Revenues,” our consolidated revenues increased by $76.0 million, or 14.1%, to $616.2 million for the year ended December 31, 2013 from $540.2 million for the year ended December 31, 2012. The majority of the increase, approximately $68.7 million, was due to acquisitions.
Equity in earnings of unconsolidated affiliates decreased by $0.9 million, or 0.9%, to $95.5 million for the year ended December 31, 2013 from $96.4 million for the year ended December 31, 2012. The decrease in equity in earnings was primarily driven by the favorable impact of our share of an investee’s gain on the sale of real estate ($2.4 million) in 2012, and our gaining control of three facilities that are now consolidated ($1.8 million). These decreases were partially offset by our $2.6 million share of EHR incentive income accrued by our equity method hospitals in 2013 and net increase related to the acquisition of equity method facilities in late 2012 and same-store facilities ($0.7 million).
Depreciation and amortization increased $3.2 million, or 13.7% to $27.2 million for the year ended December 31, 2013 from $24.0 million for the year ended December 31, 2012. Depreciation and amortization, as a percentage of revenues, was constant at 4.4% for both the years ended December 31, 2013 and December 31, 2012.
Operating income increased $18.6 million, or 7.6%, to $263.8 million for the year ended December 31, 2013 from $245.2 million for the year ended December 31, 2012, and decreased as a percentage of revenues to 42.8% from 45.4%, respectively. The increase in operating income was largely driven by acquisitions made in late 2012 as well as EHR incentive income recorded during 2013 of approximately $5.2 million. These increases offset the $1.7 million loss on the consolidation of a hospital and a $3.2 million impairment of a management contract. The decrease in operating income margin was driven by lower net revenue growth than we have historically experienced, and a payor mix shift to government versus commercial and a specialty mix shift.
Interest expense, net of interest income, increased $14.5 million, or 17.1%, to $99.8 million for the year ended December 31, 2013 from $85.3 million for the year ended December 31, 2012. The increase is due to higher overall debt balances at December 31, 2013 due to the refinancing we completed in April 2012 and additional borrowings in December 2012 and April 2013.
We incurred a loss on the early retirement of debt of $5.5 million during the year ended December 31, 2013, as a result of the repricing we completed in April 2013. The amount consists of finance and legal fees and the write-off of previously recorded debt issuance costs.
Provision for income taxes was $31.4 million for the year ended December 31, 2013 as compared $21.5 million for the year ended December 31, 2012. Our effective tax rates for the years ended December 31, 2013 and 2012 were approximately 39% and 44%, respectively.
Total income from discontinued operations was $3.1 million for the year ended December 31, 2012 On April 3, 2012, we spun-off our U.K. subsidiary to the equity holders of our Parent. As a result, the historical results of our U.K. operations are now classified as discontinued operations. The $3.1 million of income in 2012 is related to our U.K. operations before the spin-off.
Net income attributable to noncontrolling interests increased $6.1 million, or 8.4%, to $78.8 million for the year ended December 31, 2013 from $72.7 million for the year ended December 31, 2012. The increase was primarily driven by our gaining control of three facilities and acquiring an additional facility in 2013. Net income attributable to noncontrolling interests also includes $1.7 million related to EHR incentive income recorded by our three consolidated hospitals during 2013.
Net income increased $23.6 million to $127.1 million for the year ended December 31, 2013 as compared to $103.5 million for the year ended December 31, 2012. Net income (loss) attributable to USPI’s common stockholder increased $17.5 million to a net income of $48.3 million for the year ended December 31, 2012 as compared to $30.8 million for the year ended December 31, 2012. The increase was due to the $38.0 million loss on early retirement of debt in 2012 and the 2013 earnings of acquired businesses, both of which were partially offset by higher interest expense in 2013.
Liquidity and Capital Resources
At December 31, 2014, we had cash and cash equivalents totaling $36.6 million, as compared to $78.7 million at December 31, 2013.
Operating Activities
Our cash flows from operating activities were $211.6 million, $159.9 million, and $180.3 million in the years ended December 31, 2014, 2013, and 2012, respectively. Operating cash flows in 2014 increased $51.7 million, or 32.3%, as compared to 2013. The increase was primarily due to our increased earnings and the timing of distributions from our unconsolidated affiliates. Operating cash flows in 2013 decreased $20.4 million, or 11.3%, as compared to 2012. The decrease was primarily due to the timing of distributions from our facilities and increased interest expense due to higher debt balances after our April 2012 refinancing.
A significant element of our cash flows from operating activities is the collection of patient receivables and the timing of payments to our vendors and service providers. Collections efforts for patient receivables are conducted primarily by our personnel at each facility or in centralized service centers for some metropolitan
areas with multiple facilities. These collection efforts are facilitated by our patient accounting system, which prompts individual account follow-up through a series of phone calls and/or collection letters written 30 days after a procedure is billed and at 30 day intervals thereafter. Bad debt reserves are established in increasing percentages by aging category based on historical collection experience. Generally, the entire amount of all accounts remaining uncollected 180 days after the date of service are written off as bad debt and sent to an outside collection agency. Net amounts received from collection agencies are recorded as recoveries of bad debts. Our operating cash flows, including changes in accounts payable and other current liabilities, are impacted by the timing of payments to our vendors. We typically pay our vendors and service providers in accordance with invoice terms and conditions, and take advantage of invoice discounts when available. In 2014, 2013 and 2012, we did not make any significant changes to our payment timing to our vendors.
Our net working capital deficit was $124.5 million at December 31, 2014 as compared to a net working capital deficit of $102.4 million in the prior year. The overall negative working capital position at December 31, 2014 and 2013 is primarily the result of $159.6 million and $185.0 million due to affiliates associated with our cash management system being employed for our unconsolidated facilities. We hold our unconsolidated facilities’ cash until these amounts are distributed to our partners, typically on a monthly or quarterly basis. As discussed further below, we have sufficient availability under our new credit agreement, together with our expected future operating cash flows, to service our obligations.
Investing Activities
During the years ended December 31, 2014, 2013 and 2012, respectively, our net cash used for investing activities was $145.2 million, $64.7 million and $160.9 million, respectively. The majority of the cash used in our investing activities relates to our purchases of businesses, incremental investment in unconsolidated affiliates and purchases of property and equipment. The cash used in investing activities was funded primarily from cash on hand as well as draws upon the revolving feature of our amended senior secured credit facility.
Acquisitions and Sales
During the year ended December 31, 2014, we invested $150.8 million, net of cash acquired, for the purchase and sales of businesses and investments in unconsolidated affiliates. These 2014 transactions are described earlier in this Item 7 under the captions “Acquisitions, Equity Investments and Development Projects” and “Discontinued Operations and Other Dispositions.” These transactions are summarized below:
During the years ended December 31, 2013 and 2012, we invested $43.0 million and $141.2 million (all net of cash acquired), respectively, to make similar acquisitions. These transactions are summarized in this Item 7 under the caption “Acquisitions, Equity Investments and Development Projects.”
As part of our business strategy, we have made, and expect to continue to make, selective acquisitions in existing markets to leverage our existing knowledge of these markets and to improve operating efficiencies. Additionally, we may also make acquisitions in new markets. In making such acquisitions, we may use available cash on hand or draw upon our revolving credit facility as discussed below.
Property and Equipment/Facilities under Development
During the year ended December 31, 2014, we added $12.3 million in property and equipment, and an additional $7.1 million under capital lease arrangements. Approximately $4.1 million of the additions related to expansion and development projects, and the remaining $15.3 million primarily represents purchase of equipment at existing facilities. During the year ended December 31, 2013, we added $20.6 million in property and equipment, and an additional $1.8 million under capital lease arrangements. Approximately $11.1 million of the additions related to expansion and development projects, and the remaining $11.3 million primarily represents purchase of equipment at existing facilities. During 2012, we added $20.2 million in property and equipment, and an additional $10.5 million under capital lease arrangements. Approximately $17.5 million of the additions related to expansion and development projects, and the remaining $13.2 million primarily represents purchase of equipment at existing facilities.
Our growth strategy (through both acquisition and de novo projects) will continue to require substantial capital resources, which we estimate to range from $125.0 million to $150.0 million per year over the next three years. If we identify strategic opportunities that are larger than usual for us, then these amounts could increase.
Other than the specific transactions described above, our acquisition and development activities primarily include the development of new facilities, buyups of additional ownership in facilities we already operate, and acquisitions of additional facilities. In addition, the operations of our existing surgical facilities will require ongoing capital expenditures. The amount and timing of these purchases and related cash outflows in future periods is difficult to predict and is dependent on a number of factors including hiring of employees, the rate of change in technology/equipment used in our business and our business outlook. We expect to finance equipment primarily through internally generated funds and bank or manufacturer financing. We believe that our available capital is adequate to improve and equip our existing facilities.
The American Recovery and Reinvestment Act of 2009 (“ARRA”) includes provisions to encourage healthcare providers to establish an electronic health record system (“EHR”), including cash incentives for qualifying hospitals and healthcare professionals who meet the criteria during the eligibility period of 2011 through 2016. By September 30, 2013, we had deployed a qualifying EHR at all fourteen of our eligible hospitals. Through the year ended December 31, 2014, we have incurred approximately $26.6 million of total costs to develop and deploy this technology. Of this amount, $3.1 million, $7.4 million and $11.8 million were capitalized in 2014, 2013 and 2012, respectively, and the remaining $4.3 million are classified within operating expenses. Our eligible hospitals, most of which are unconsolidated affiliates, received and then paid us approximately $3.4 million and $7.2 million in federal incentive payments during 2014 and 2013, respectively, which is reflected within our consolidated statements of cash flows as a reduction of capital expenditures.
If we maintain required definitions of meaningful use of EHR in 2015 and 2016, we expect to qualify for additional cash incentives each year. Based upon 2013 and 2014 utilization patterns at our facilities, the total cash incentives we receive for the years 2013 through 2016 would recover substantially all of our investment to date in EHR. Because the Centers for Medicare and Medicaid Services expanded the definition of meaningful use for 2014 and may do so again for future periods, we expect to incur additional costs to maintain our eligibility for federal incentive payments.
Financing Activities
Cash flows used in financing activities were $108.5 million, $67.6 million and $43.0 million in the years ended December 31, 2014, 2013 and 2012, respectively. Historically, our cash flows from financing activities have been received through proceeds from long-term debt and offset by payments on our long-term debt. We also manage the cash of our unconsolidated affiliates. During 2014, our financing activities included net payments on long-term debt of $4.3 million. Cash distributions to noncontrolling interests (the other investors in the facilities we operate) are also a large component of our financing activities and were $75.7 million, $76.0 million and $77.8 million in the years ended December 31, 2014, 2013 and 2012, respectively. Cash held on behalf of our unconsolidated affiliates decreased $25.8 million during the year ended December 31, 2014, but increased during the years ended December 31, 2013 and 2012 by $29.0 million and $17.8 million, respectively.
We intend to fund our ongoing capital and working capital requirements through a combination of cash flows from operations and borrowings under our $125.0 million revolving credit facility, under which we had $108.4 million available at December 31, 2014. We believe that funds generated by operations and funds available under the revolving credit facility will be sufficient to meet working capital requirements over at least the next 12 months. However, in the future, we may have to incur additional debt or issue additional debt or equity securities from time to time. We may be unable to obtain sufficient financing on satisfactory terms or at all.
We and our subsidiaries, affiliates (subject to certain limitations imposed by existing indebtedness), or significant stockholders, in their sole discretion, may from time to time, purchase, redeem, exchange or retire any of our outstanding debt in privately negotiated or open market purchases, or otherwise. Such transactions will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
Debt
In April 2012, we amended our existing credit facility. The amended credit facility provided borrowings consisting of $144.4 million in non-extended term loans which was to mature in April 2014; $312.4 million in extended term loans maturing in April 2017; $375.0 million in a new term loan maturing in April 2019; and $125.0 million under a new revolving facility maturing in April 2017. The term loans require quarterly principal payments of 0.25% of the outstanding balance as of April 3, 2012 with the remaining balances due in 2017 for the extended term loan and in 2019 for the new term loan. No principal payments are required on the revolving credit facility until its maturity in 2017. In December 2012, we borrowed an additional $150.0 million in new term loans under the amended credit facility. This borrowing requires quarterly principal payments of 0.25% of the outstanding balance and also matures in April 2019. We pay 0.50% per annum on the daily-unused commitment of the new revolving credit facility. We also pay a quarterly participation fee of 2.13% per annum related to outstanding letters of credit.
In February 2013, we further amended our credit facility and committed to borrow $150.0 million, which was used to repay the non-extended term loan of $144.4 million and related fees and expenses. The transaction was completed on April 4, 2013. The new term loan matures in April 2019. The amendment also changed the interest rate charged on the term loans to LIBOR plus a margin of 3.50% to 3.75%.
At December 31, 2014, we had $977.6 million outstanding under the amended credit facility at a weighted average interest rate of approximately 4.6%. At December 31, 2014, we had $108.4 million available for borrowing under the revolving credit facility, representing the revolving facility’s $125.0 million capacity, net of the outstanding balance of $15.0 million and $1.6 million of outstanding letters of credit.
The amended credit facility is guaranteed by USPI Holdings, Inc. and its current and future directly and indirectly wholly-owned domestic subsidiaries, subject to certain exceptions, and borrowings under the credit facility are secured by a first priority security interest in all real and personal property of these subsidiaries, as well as a first priority pledge of our capital stock and the capital stock of each of our wholly owned domestic subsidiaries. Additionally, the credit facility contains various restrictive covenants, including financial covenants
that limit our ability and the ability of our subsidiaries to borrow money or guarantee other indebtedness, grant liens, make investments, sell assets, pay dividends, enter into sale-leaseback transactions or issue and sell capital stock. We believe we were in compliance with these covenants at December 31, 2014.
In April 2012, we issued $440.0 million of 9.0% senior unsecured notes due in April 2020. Interest on the notes is payable on April 1 and October 1 of each year, and commenced on October 1, 2012. At December 31, 2014, we had $440.0 million of the notes outstanding. The notes are unsecured senior obligations of our company; however, the notes are guaranteed by most of our current and future direct and indirect 100%-owned domestic subsidiaries. Additionally, the notes contain various restrictive covenants, including financial covenants that limit our ability and the ability of our subsidiaries to borrow money or guarantee other indebtedness, grant liens, make investments, sells assets, pay dividends, enter into sale-leaseback transactions or issue and sell capital stock. We believe we were in compliance with these covenants at December 31, 2014.
Contractual Cash Obligations
Our contractual cash obligations as of December 31, 2014 are summarized as follows:
(1) Scheduled principal payments.
(2) Represents interest due on long-term debt obligations. For variable rate debt, the interest is calculated using the December 31, 2014 rates applicable to each debt instrument.
(3) Includes principal and interest.
Debt at Operating Subsidiaries
Our operating subsidiaries, many of which have noncontrolling interest holders who share in the cash flow of these entities, have debt consisting primarily of capitalized lease obligations. This debt is generally non-recourse to USPI and is generally secured by the assets of those operating entities. The total amount of these obligations, which was $58.3 million at December 31, 2014, is included in our consolidated balance sheet because the borrower or obligated entity meets the requirements for consolidated financial reporting. Our average percentage ownership, weighted based on the individual subsidiary’s amount of debt and capitalized lease obligations, of these consolidated subsidiaries was approximately 45% at December 31, 2014. As further discussed below, our unconsolidated affiliates that we account for under the equity method have debt and capitalized lease obligations that are generally non-recourse to USPI and are not included in our consolidated financial statements.
We believe that existing funds, cash flows from operations, borrowings under our credit facilities, and borrowings under capital lease arrangements at newly developed or acquired facilities will provide sufficient liquidity for the next twelve months. We may require additional debt or equity financing for our future
acquisitions and development projects. There are no assurances that needed capital will be available on acceptable terms, if at all. If we are unable to obtain funds when needed or on acceptable terms, we will be required to curtail our acquisition and development program.
Purchases and Sales of Noncontrolling Interests
During 2014, 2013 and 2012, we purchased and sold a net of $2.5 million, $1.6 million and $4.8 million of noncontrolling interests. Transactions with noncontrolling interests in which we do not lose control of an entity are classified as financing activities. These transactions represent equity transactions because they are between us (or our subsidiaries) and noncontrolling interests
Dividend Payments
On April 3, 2012 and December 17, 2012, we paid cash dividends of approximately $314.5 million and $69.9 million, respectively, to our Parent’s equity holders.
Off-Balance Sheet Arrangements
As a result of our strategy of partnering with physicians and health systems, we do not own controlling interests in the majority of our facilities. We account for 156 of our 219 surgical facilities under the equity method. Similar to our consolidated facilities, our unconsolidated facilities have debts, including capitalized lease obligations, that are generally non-recourse to USPI. With respect to our unconsolidated facilities, these debts are not included in our consolidated financial statements. At December 31, 2014, the total debt on the balance sheets of our unconsolidated affiliates was approximately $356.2 million. Our average percentage ownership, weighted based on the individual affiliate’s amount of debt, of these unconsolidated affiliates was approximately 26% at December 31, 2014. USPI or one of our wholly-owned subsidiaries had collectively guaranteed $20.8 million of the $356.2 million in total debt of our unconsolidated affiliates as of December 31, 2014. In addition, our unconsolidated affiliates have obligations under operating leases, of which we or a wholly owned subsidiary had guaranteed $8.3 million as of December 31, 2014. Of the total $29.1 million of guarantees related to unconsolidated affiliates, approximately $2.8 million represents guarantees of obligations of two facilities which have been sold. We have full recourse to the buyers with respect to the $2.8 million related to the sold facilities. Some of the facilities we are currently developing will be accounted for under the equity method. As these facilities become operational, they will have debt and lease obligations.
As described above, our unconsolidated affiliates own operational surgical facilities or surgical facilities that are under development. These entities are structured as limited partnerships, limited liability partnerships, or limited liability companies. None of these affiliates provide financing, liquidity, or market or credit risk support for us. They also do not engage in hedging, 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.
Related Party Transactions
We have entered into agreements with certain majority and minority owned surgery centers to provide management services. As compensation for these services, the surgery centers are charged management fees which are either fixed in amount or represent a fixed percentage of each center’s net revenue less bad debt. The percentages range from 3% to 8%. Amounts recognized under these agreements, after elimination of amounts from consolidated surgery centers, totaled approximately $80.6 million, $71.1 million, and $67.6 million in 2014, 2013, and 2012, respectively, and are included in management and contract service revenues in our consolidated statements of income.
We regularly engage in purchases and sales of ownership interests in our facilities. We operate 33 surgical facilities in partnership with Baylor Scott & White and local physicians in the Dallas/Fort Worth area. Baylor Scott & White Health’s Chief Executive Officer is a member of our board of directors. The following table
summarizes transactions with Baylor Scott & White’s during 2013. We had no such transactions in 2014 or 2012. We believe that the sale price was approximately the same as if it had been negotiated on an arms’ length basis, and the price equaled the value assigned by an external appraiser who valued the business immediately prior to the sale.
(1) We contributed two surgery centers to a joint venture with Baylor Scott & White. We continue to account for these facilities under the equity method.
Included in general and administrative expenses are management fees payable to an affiliate of Welsh Carson, which holds a controlling interest in our company, in the amount of $2.0 million for the years ended December 31, 2014, 2013 and 2012. Such amounts accrue at an annual rate of $2.0 million. We pay $1.0 million in cash per year with the unpaid balance due and payable upon a change in control. At December 31, 2014, we had approximately $8.5 million accrued related to such management fee, of which $0.8 million is included in other current liabilities and $7.7 million is included in other long term liabilities in our consolidated balance sheet. At December 31, 2013, we had approximately $7.5 million accrued related to such management fee, of which $0.8 million is included in other current liabilities and $6.7 million is included in other long term liabilities in our consolidated balance sheet.
We have a revolving line of credit with European Surgical Partners Limited (ESP), a company owned in part by affiliates of Welsh Carson, members of USPI’s management and other investors of up to $3.0 million. The balance owed to us by ESP was $2.5 million and $0.9 million at December 31, 2014 and 2013, respectively, and is included in “Other Assets” in the accompanying consolidated balance sheets. The borrowing bears interest at 6.5% per annum and matures upon the earlier of the refinance or discharge of ESP under its current third-party credit facility, at which time all principal and interest is due. We believe that the terms of the revolving line of credit are approximately the same as if they had been negotiated on an arms’ length basis.
New Accounting Pronouncements
On May 28, 2014, the Financial Accounting Standards Board issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for our company on January 1, 2017. Early application is not permitted. The ASU permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that the ASU will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
On February 18, 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (ASU), which is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships and limited liability companies among others. The ASU reduces the number of consolidation models from four to two and places more emphasis on the risk of loss when determining a controlling financial interest, reduces the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity and can change consolidation conclusions for companies that make use of limited partnerships or variable interest entities. The new standard is effective on January 1, 2016, however early adoption is permitted. We are evaluating the effect that the ASU may have on our consolidated financial statements and disclosures.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in interest rates and other relevant market risks. Our primary market risk is a
change in interest rates associated with variable-rate borrowings. Historically, we have not held or issued derivative financial instruments other than the use of variable-to-fixed interest rate swaps for portions of our borrowings under credit facilities with commercial lenders as required by credit agreements. Currently, we have no interest rate swaps in effect. We do not use derivative instruments for speculative purposes.
Our financing arrangements with many commercial lenders are based on the spread over LIBOR or Prime. At December 31, 2014, $473.9 million of our outstanding debt was in fixed rate instruments and the remaining $977.6 million was in variable rate instruments. Accordingly, a hypothetical 100 basis point increase in market interest rates would result in additional annual expense of approximately $9.8 million.
Item 8.
Item 8. Financial Statements and Supplementary Data
For the financial statements and supplementary data required by this Item 8, see the Index to Consolidated Financial Statements included elsewhere in this Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Commission. Such information is accumulated and communicated to our management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this Annual Report on Form 10-K, we have carried out an evaluation, under the supervision and with the participation of management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the principal executive officer and principal financial officer concluded that, as of December 31, 2014, our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our reports filed with the Commission. There have been no significant changes in our internal controls which could significantly affect the internal controls subsequent to the date of their evaluation in connection with the preparation of this Annual Report on Form 10-K.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Our internal control over financial reporting includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets.
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and board of directors; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework-1992. Management’s assessment included an evaluation of the design and testing of the operational effectiveness of the Company’s internal control over financial reporting. USPI acquired several subsidiaries and equity method investments during 2014. Accordingly, management’s evaluation excluded the operations of the following subsidiaries and equity method investments acquired during 2014, with total assets of approximately $96.5 million and approximately $2.3 million of revenues included in the Company’s consolidated financial statements as of December 31, 2014:
•
USP Hazelwood, Inc.
•
USP Morris, Inc.
•
USP Siouxland, Inc.
•
USP Sacramento, Inc. (Investment in Hacienda Outpatient Surgery Center, LLC)
•
USP San Antonio, Inc. (Investment Alamo Heights Surgical Hospital Group, LP)
Based on this assessment, management did not identify any material weakness in the Company’s internal control, and management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2014.
KPMG LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this report, has issued an attestation report on management’s assessment of internal control over financial reporting, a copy of which is included with the Company’s consolidated financial statements in Item 15(a)(1).
Limitations on the Effectiveness of Controls
Our management, including the principal executive officer and the principal financial officer, recognizes that any set of controls and procedures, no matter how well-designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, with the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls. For these reasons, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation described above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
Directors and Executive Officers
Executive officers of USPI are appointed annually by the board of directors and serve until their successors are duly elected and qualified. Directors are elected by USPI’s stockholders and serve until their successors are duly elected and qualified. There are no arrangements or understandings between any officer or director and any other person pursuant to which any officer or director was, or is to be, selected as an officer, director, or nominee for officer or director. There are no family relationships among any of our executive officers or directors. The names, ages as of February 23 2015, and positions of the executive officers and directors of USPI are listed below along with their relevant business experience.
Paul B. Queally has served as a director of USPI since its inception in February 1998 and serves as the chairman of the compensation committee and a member of the executive committee. Mr. Queally is Co-President of Welsh, Carson, Anderson & Stowe, where he focuses primarily on investments in the healthcare industry and is a managing member of the general partner of Welsh, Carson, Anderson & Stowe IX, L.P. Prior to joining Welsh Carson in 1996, Mr. Queally was a general partner at the Sprout Group, the private equity group of the former Donaldson, Lufkin & Jenrette. He is a member of the boards of directors of AGA Medical Corporation, Aptuit, Inc. and several private companies. Mr. Queally’s service on the boards of multiple private and public companies and his extensive experience in corporate transactions, including mergers and acquisitions, leveraged buyouts and private equity financing, provide the board with an important perspective in making strategic decisions.
William H. Wilcox joined USPI as its president and a director in September 1998. Mr. Wilcox has served as USPI’s chief executive officer since April 2004 and is a member of the executive committee. Mr. Wilcox served as president and chief executive officer of United Dental Care, Inc. from 1996 until joining USPI. Mr. Wilcox served as president of the Surgery Group of HCA and president and chief executive officer of the Ambulatory Surgery Division of HCA from 1994 until 1996. Prior to that time, Mr. Wilcox also previously served as the chief operating officer and a director of Medical Care International, Inc. Mr. Wilcox, through his intimate knowledge of the operational, financial and strategic development of USPI and his experience in the healthcare industry, provides the board with a valuable perspective into the opportunities and challenges facing the Company.
Brett P. Brodnax serves as the president and chief development officer of USPI. Prior to joining USPI in December 1999, Mr. Brodnax was an assistant vice president of the Baylor Health Care System and worked for them from 1990 until 1999. Mr. Brodnax currently serves as a director of K2M, Inc. and also served as a director of AmeriPath, Inc. from January 2005 until May 2007.
Jason B. Cagle serves as the senior vice president and chief financial officer of USPI. Prior to joining USPI, Jason was an attorney with Vinson & Elkins, LLP, where he worked in the corporate section. Before his promotion to chief financial officer, Jason was USPI’s General Counsel from 2003 to 2012 and its Senior Vice President of Acquisitions from 2012 to 2013.
Philip A. Spencer joined USPI in July 2009. From November 2006 until joining USPI, Mr. Spencer served as President, Anatomic Pathology Services for AmeriPath, Inc. From November 2003 to November 2006, he served as Executive Vice President of Healthcare Sales and Marketing for LabOne, Inc. From December 2000 to November 2003, Mr. Spencer served as Vice President, Business Development for Laboratory Corporation of America.
Sandra R.A. Karrmann joined USPI as the senior vice president, chief human resources officer and support services officer in January 2013. Prior to joining USPI, Ms. Karrmann served in various leadership positions in human resources with Yum! Brands, Inc. from August 2007 until December 2012, including serving as the chief people officer of Yum! Restaurants International from March 2009 until January 2012 and chief people officer of Pizza Hut from August 2007 until March 2009. Prior to that time, Ms. Karrmann served as the executive vice president, chief human resources officer of Meritage Homes Corporation and held various leadership positions in human resources with Pepsico, Inc./Frito-Lay, Inc., Heller Financial, Inc. and Macy & Company, Inc.
Joel T. Allison has served on our board since March 2002. Mr. Allison has served as chief executive officer of Baylor Scott & White Health since Baylor Healthcare System (Baylor) and Scott & White entered into an affiliation and merger of governance of their healthcare systems effective October 1, 2013. Mr. Allison has also served as chief executive officer of Baylor since 2000, president of Baylor from 2000 until October 1, 2013, and senior executive vice president of Baylor from 1993 until 2000. Mr. Allison brings an important perspective to the board through his role in leading a major healthcare system and his familiarity with issues impacting physicians and the delivery of healthcare in the U.S.
Anthony F. Ecock joined our board in May 2013. Mr. Ecock is currently a general partner at Welsh, Carson, Anderson & Stowe, which he joined in 2007. He has over 25 years of experience in the healthcare field with eight years in senior management positions at leading healthcare technology companies. At WCAS, Mr. Ecock leads the Resources Group, a team responsible for helping its 30 portfolio companies identify and implement initiatives to increase growth, earnings and cash flow. Before joining WCAS, he served as Vice President and General Manager of GE Healthcare’s Enterprise Sales organization from 2003 to 2007. From 1999 to 2003, he served as Senior Vice President and Global General Manager of Hewlett Packard’s, then Agilent’s and finally Philips’ Patient Monitoring divisions. Mr. Ecock spent his early career at the consulting firm of Bain & Company, where he was a Partner in the healthcare and technology practices and Program Director for Consultant Training.
John C. Garrett, M.D. has served on our board since February 2001 and is a member of the audit and compliance committee. Dr. Garrett had been a director of OrthoLink Physicians Corporation, which was acquired by USPI in February 2001, since July 1997. Dr. Garrett founded Resurgens, P.C. in 1986, where he maintained a specialized orthopedics practice in arthroscopic and reconstructive knee surgery until his retirement in 2007. Dr. Garrett is a Fellow of the American Academy of Orthopedic Surgeons. The board benefits from Dr. Garrett’s knowledge of clinical and regulatory issues impacting our facilities and physician partners and his familiarity with USPI with which he has served as a director since 2001.
D. Scott Mackesy joined our board, executive committee and compensation committee in April 2007. Mr. Mackesy is a general partner of Welsh, Carson, Anderson & Stowe, where he focuses primarily on investments in the healthcare industry and is a managing member of the general partner of Welsh, Carson, Anderson & Stowe X, L.P. Prior to joining Welsh Carson, Mr. Mackesy was a research analyst at Morgan Stanley, where he was responsible for coverage of the healthcare services industry. He is a member of the board of directors of several private companies. Mr. Mackesy, through his lengthy and broad focus on the healthcare industry, offers the board greater insight into industry dynamics as well as investment and acquisition strategies.
James Ken Newman has served on our board since May 2005 and is a member of the audit and compliance committee. Mr. Newman served as president and chief executive officer of Horizon Health Corporation from May 2003 until its sale in June 2007 and as chairman of the board from February 1992 until June 2007. From July 1989 until September 1997, he served as president of Horizon Health and from July 1989 until October 1998, he also served as chief executive officer of Horizon Health. Mr. Newman is a member of the board of directors of Telecare Corporation and Springstone, Inc. Mr. Newman’s leadership and experience in the healthcare industry helps the board better assess the challenges and opportunities facing USPI.
Harold L. Paz, M.D., M.S., joined our board in February 2014. Dr. Paz has served as chief executive officer of Penn State Hershey Medical Center and Health System, senior vice president for health affairs for Penn State University and dean of its College of Medicine since April 2006. Prior to his appointment to Penn State, he served as dean of the Robert Wood Johnson Medical School and chief executive officer of Robert Wood Johnson University Medical Group in New Jersey for eleven years, where he was professor of medicine. Dr. Paz brings an important perspective to the board through his role in leading a major healthcare system and his familiarity with issues impacting physicians.
Raymond A. Ranelli joined our board in May 2007 and serves as the chairman of the audit and compliance committee. Mr. Ranelli retired from PricewaterhouseCoopers in 2003 where he was a partner for over 20 years. Mr. Ranelli held several positions at PricewaterhouseCoopers including Vice Chairman and Global Leader of the Financial Advisory Services practice. Mr. Ranelli is also a director of Syniverse Technologies, Inc., K2M, Inc. and several private companies. Mr. Ranelli possesses in-depth, practical knowledge of financial and accounting principles, having served in the financial services sector for over 20 years and serving on other boards and committees. This background, along with his past experience as a certified public accountant, is important to his role as chairman of the audit and compliance committee.
Audit Committee Financial Expert
Our board has determined that Raymond A. Ranelli, a director and chairman of the audit and compliance committee, is a financial expert and is independent as that term is used in the rules of the National Association of Securities Dealers’ listing standards (“NASDAQ Rules”).
Nominations for the Board of Directors
Our board of directors does not have a separately designated, standing nominating committee, a nominating committee charter, or a formal procedure for security holders to recommend nominees to the board of directors. USPI is not listed on a national securities exchange or in an automated inter-dealer quotation system of a national securities association, and we are not subject to either the listing standards of the New York Stock Exchange or the NASDAQ Rules.
Section 16(a) Beneficial Ownership Reporting Compliance
USPI does not have any class of equity securities registered under Section 12 of the Exchange Act. Consequently, Section 16(a) of the Exchange Act is not applicable.
Code of Ethics
We have adopted a Code of Conduct and a Financial Code of Ethics both applicable to our principal executive officer, principal financial officer, principal accounting officer or controller, or other persons performing similar functions. Copies of the Code of Conduct and the Financial Code of Ethics may be obtained, free of charge, by writing to the secretary of the Company at: United Surgical Partners International, Inc., 15305 Dallas Parkway, Suite 1600, Addison, Texas 75001.
Item 11.
Item 11. Executive Compensation
Overview
This compensation discussion and analysis describes the material elements of compensation awarded to named executive officers for our 2014 fiscal year. It should be read in conjunction with the Summary Compensation Table, related tables and the narrative disclosure. Unless otherwise specifically noted, the information contained in this section is stated as of December 31, 2014.
The compensation committee of our board of directors makes decisions regarding salaries, annual bonuses and equity incentive compensation for our named executive officers. Our named executive officers include our chief executive officer, our chief financial officer and our three most highly compensated executive officers other than our chief executive officer and chief financial officer. The compensation committee is also responsible for reviewing and approving corporate goals and objectives relevant to the compensation of our named executive officers, as well as evaluating their performance in light of those goals and objectives. Based on this evaluation, the compensation committee determines and approves the named executive officers’ compensation. The compensation committee solicits input from our chief executive officer regarding the performance of the company’s other named executive officers. Finally, the compensation committee also administers our equity incentive plan.
The chief executive officer reviews our compensation plan. Based on his analysis, the chief executive officer recommends a level of compensation to the compensation committee, other than for himself, which he views as appropriate to attract, retain and motivate executive talent. The compensation committee determines and approves the chief executive officer’s and other named executive officers’ compensation.
Our Compensation Philosophy and Objectives
We have sought to create an executive compensation program that balances short-term versus long-term payments and awards, cash payments versus equity awards and fixed versus contingent payments and awards in ways that we believe are most appropriate to motivate our executive officers. Our executive compensation program is designed to:
•
attract and retain superior executive talent in the healthcare industry;
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motivate and reward executives to achieve optimum short-term and long-term corporate operating results;
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align the interests of our executive officers and stockholders by motivating executive officers to increase stockholder value; and
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provide a compensation package that recognizes individual contributions as well as overall business results.
In determining each component of, and the overall, compensation of our named executive officers, the compensation committee does not exclusively use quantitative methods or formulas, but instead considers various factors, including the position of the named executive officer, the compensation of officers of comparable companies within the healthcare industry, the performance of the named executive officer with respect to specific objectives, increases in responsibilities, recommendations of the chief executive officer and other objective and subjective criteria as the compensation committee deems appropriate. The specific objectives for each named executive officer vary each year in accordance with the scope of the officer’s position, the potential inherent in that position for impacting the Company’s operating and financial results and the actual operating and financial contributions produced by the officer in previous years.
Compensation Components
Our compensation consists primarily of three elements: base salary, annual bonus and long-term equity incentives. We describe each element of compensation in more detail below.
Base Salary
Base salaries for our named executive officers are established based on the scope of their responsibilities and their prior relevant experience, taking into account competitive market compensation paid by other companies in our industry for similar positions and the overall market demand for such executives at the time of hire. A named executive officer’s base salary is also determined by reviewing the executive’s other compensation to ensure that the executive’s total compensation is in line with our overall compensation philosophy. Base salaries are reviewed annually and may be increased for merit reasons, based on the executive’s success in meeting or exceeding individual performance objectives. Additionally, we may adjust base salaries as warranted throughout the year for promotions or other changes in the scope or breadth of an executive’s role or responsibilities. Based on these factors base salaries for our named executive officers were set as follows effective August 1, 2014: $650,000 for Mr. Wilcox, $600,000 for Mr. Brodnax, $400,000 for Mr. Cagle, $390,000 for Ms. Karrmann and $390,000 for Mr. Spencer.
Annual Bonus
Our compensation program includes eligibility for an annual incentive cash bonus. The compensation committee assesses the level of the named executive officer’s achievement of meeting individual goals, as well as that officer’s contribution towards our long-term, Company-wide goals. The amount of the cash bonus depends primarily on the Company meeting budgeted EBITDA goals, with a target bonus for each named executive officer generally set as a percentage of base salary. Target bonuses for the named executive officers were set at the following percentages of base salary for 2014, 52% for Mr. Wilcox, 42% for Mr. Brodnax, 36% for Messrs. Spencer and Cagle and 33% for Ms. Karrmann. Based on the Company’s EBITDA performance compared to budget in 2014, the named executive officers received bonuses equal to the following percentages of their base salary for 2014: 47% for Mr. Wilcox (excluding discretionary contributions to the deferred compensation plan), 32% for Mr. Brodnax, 25% for Mr. Spencer, 38% for Mr. Cagle and 28% for Ms. Karrmann.
EBITDA is not a measure defined under GAAP. The Company believes EBITDA is an important measure for purposes of assessing performance. EBITDA, which is computed by adding operating income plus depreciation and amortization and losses on deconsolidations, disposals and impairments, is commonly used as an analytical indicator within the healthcare industry and also serves as a measure of leverage capacity and debt service ability. EBITDA should not be considered as measures of financial performance under GAAP and EBITDA targets and the Company’s achievement of such targets should not be understood as management’s prediction of future performance or guidance to investors.
Long-Term Equity Incentives
We believe that equity-based awards allow us to reward named executive officers for their sustained contributions to the Company. We also believe that equity awards reward continued employment by a named executive officer, with an associated benefit to us of employee continuity and retention. We believe that equity awards provide management with a strong link to long-term corporate performance and the creation of stockholder value. The compensation committee has the authority to grant shares of restricted stock and options to purchase shares of certain classes of common and preferred equity securities of our Parent. The compensation committee does not award equity awards according to a prescribed formula or target. Instead, the compensation committee takes into account the individual’s position, scope of responsibility, ability to affect profits and the individual’s historic and recent performance and the value of the awards in relation to other elements of the individual executive’s total compensation. Effective July 15, 2014, Mr. Cagle and Ms. Karrmann were granted
options to purchase 300,000 shares of the Company’s common stock and Mr. Spencer was granted options to purchase 200,000 shares of the Company’s common stock. These options vest ratably over four years and have an exercise price of $2.00 per share, equal to the compensation committee’s estimate of fair value on the date of grant. No other equity awards were granted to the Company’s named executive officers in 2014. For a further description of the Company’s equity-based plan, see “Restricted Stock and Option Plan” below.
Termination Based Compensation
For payments due to our named executive officers upon termination, and the acceleration of vesting of equity-based awards in the event of a change of control under our new equity plan, see “Restricted Stock and Option Plan” and “Employment Arrangements and Agreements” below.
Other Benefits and Perquisites
We provide health and welfare benefits to our named executive officers that are available to all of the Company’s employees. Included in these benefits is a 401(k) plan that we maintain because we wish to encourage our employees to save a percentage of their cash compensation, through voluntary deferrals, for their eventual retirement. We match fifty percent of the first six percent of cash compensation contributed by individual employees subject to IRS limitations.
We also make available to our named executive officers certain perquisites and other benefits that we believe are reasonable and consistent with the perquisites that would be available to them at companies with whom we compete for experienced senior management. The primary perquisite we currently provide to named executive officers as well as certain other select members of the management team is access to a Deferred Compensation Plan (“DCP”) through which the individuals can voluntarily defer up to 75% of their base salary and 100% of their bonus. We match fifty percent of the first ten percent of compensation voluntarily deferred under this plan. Additionally, in 2014 we contributed $200,000 to Mr. Wilcox’s DCP account.
Compensation Committee Report
The compensation committee of USPI has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the compensation committee has recommended to the board of directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.
The Compensation Committee
Paul B. Queally, Chairman
D. Scott Mackesy
Summary Compensation Table for 2014
The following table sets forth the total remuneration paid by us for each of the last three fiscal years to the named executive officers.
(1) We account for the cost of stock-based and option-based compensation awarded under the 2007 Equity Incentive Plan adopted by our Parent under which the cost of equity awards to employees is measured by the aggregate grant date fair value of the awards on their grant date calculated in accordance with the FASB’s Accounting Standards Codification Topic 718. No forfeitures occurred during 2012, 2013 or 2014. Assumptions used in calculation of these amounts are included in Note 13 to our consolidated audited financial statements for the fiscal year ended December 31, 2014, included in this Annual Report on Form 10-K.
(2) Ninety percent of the amount shown was paid in cash and ten percent was deferred at our named executive officer’s election pursuant to USPI’s Deferred Compensation Plan (the “DCP”).
(3) Includes cash dividends paid on stock awards held by each named executive officer and discretionary contributions to the named executive officers’ DCP, matching contributions to the named executive officers’ DCP and 401(k) accounts and cash incentives for participation in the Company’s wellness program as follows:
Grant of Plan-Based Awards
The following table shows the plan-based awards granted to the named executive officers during 2014.
Outstanding Equity Awards at Fiscal Year-End
The following table shows all outstanding equity awards held by our named executive officers as of December 31, 2014.
(1) Upon consummation of the merger, our named executive officers received new stock awards under the 2007 Equity Incentive Plan.
(2) Mr. Brodnax and Mr. Cagle received option awards under the 2007 Equity Incentive Plan in connection with promotions. In connection with the dividends declared on the Company’s stock in 2012, the exercise price on these options was reduced to $0.29 during 2012.
(3) Messrs. Cagle and Spencer and Ms. Karrmann received option awards under the 2007 Equity Incentive Plan in connection with a promotion to Chief Financial Officer for Mr. Cagle, assumption of additional responsibilities for Mr. Spencer and as an initial equity grant upon joining USPI for Ms. Karrmann.
(4) Messrs. Cagle and Spencer and Ms. Karrmann received option awards under the 2007 Equity Incentive Plan.
(5) Mr. Spencer received a stock award upon joining the Company.
(6) Because there is no active trading market for our common stock, we rely on members of the compensation committee and Welsh Carson to determine in good faith the fair value of our common stock. As of December 31, 2014, this value was determined to be $2.15 per share of common stock. Neither USPI, USPI Holdings, Inc. nor USPI Group Holdings, Inc. has any class of equity securities registered under Section 12 of the Exchange Act.
(7) The restrictions with respect to these shares will lapse on April 19, 2015; provided however, that such restrictions may lapse sooner if certain internal rate of return targets are met.
(8) The restrictions with respect to such shares will lapse upon a change of control or other exit event provided that Welsh Carson shall have disposed of all of its shares of our Parent acquired in connection with the merger and received its cost basis in such shares plus a return of at least 100%.
Option Exercises and Stock Values
The following table shows all stock options exercised during 2014 and the value realized upon exercise, and all stock awards vested during 2014 and the value realized upon vesting.
Restricted Stock and Option Plan
Our Parent adopted the 2007 Equity Incentive Plan which became effective contemporaneously with the consummation of the merger, which we sometimes refer to as the equity plan. The purposes of the equity plan are to attract and retain the best available personnel, provide additional incentives to our employees, directors and consultants and to promote the success of our business. A maximum of 31,816,215 shares of common stock may be delivered in satisfaction of awards made under the equity plan.
The compensation committee administers the equity plan (the “Administrator”). Participation in the plan is limited to those key employees and directors, as well as consultants and advisors, who in the Administrator’s opinion are in a position to make a significant contribution to the success of USPI and its affiliated corporations and who are selected by the Administrator to receive an award. The plan provides for awards of stock appreciation rights (“SARs”), stock options, restricted stock, unrestricted stock, stock units, including restricted stock units, and performance awards pursuant to the Administrator’s discretion and the provisions set forth in the plan. Eligibility for incentive stock options (“ISOs”) is limited to employees of USPI or of a “parent corporation” or “subsidiary corporation” of USPI as those terms are defined in Section 424 of the United States Internal Revenue Code of 1986, as amended. Each option granted pursuant to the plan will be treated as providing by its terms that it is to be a non-incentive stock option unless, as of the date of grant, it is expressly designated as an ISO.
The exercise price of each stock option and the share value above which appreciation is to be measured in the case of a SAR will be 100% of the fair value of the stock subject to the stock option or SAR, determined as of the date of grant, or such higher amount as the Administrator may determine in connection with the grant.
Neither ISOs nor, except as the Administrator otherwise expressly provides, other awards may be transferred other than by will or by the laws of descent and distribution. During a recipient’s lifetime an ISO and, except as the Administrator may provide, other non-transferable awards requiring exercise may be exercised only by the recipient. Awards permitted by the Administrator to be transferred may be transferred only to a permitted transferee.
No awards may be made after April 18, 2017, but previously granted awards may continue beyond that date in accordance with their terms. The Administrator may at any time amend the equity plan or any outstanding award for any purpose which may at the time be permitted by law, and may at any time terminate the equity plan as to any future grants of awards; provided, that except as otherwise expressly provided in the plan, the Administrator may not, without the participant’s consent, alter the terms of an award so as to affect adversely the participant’s right under the award, unless the Administrator expressly reserved the right to do so at the time of the award.
Upon termination of a named executive officer’s employment for any reason (including, without limitation, as a result of death, disability, incapacity, retirement, resignation, or dismissal with or without cause), then any vested shares as of the date of such termination shall remain vested shares, and no additional shares will become vested after the date of such termination, except if otherwise determined by the Administrator or within 180 days after the executive’s termination, USPI consummates a change of control, in which case, the provisions pertaining to a change of control will apply.
The restricted shares acquired under the equity plan shall vest in full upon a change of control if, as a result of such change of control, Welsh Carson shall have disposed of all of the investor shares and received its cost basis in its investor shares plus an investor return of at least 100%. In the event the shares do not vest on such change of control, such shares shall be forfeited upon the closing of such change of control.
Nonqualified Deferred Compensation
The following table shows certain information regarding the named executive officers’ DCP accounts as of December 31, 2014.
Deferred Compensation Plan
USPI has a deferred compensation plan that certain of its directors, executive officers and other employees participate in which allows such participants to defer a portion of their compensation to be paid upon certain specified events (including death, termination of employment, disability or some future date). Under the terms of the DCP, all amounts payable under the DCP would become immediately vested in connection with a change of control of USPI, and as a result, each participant would be entitled to be paid their full account balance upon consummation of such a transaction. Notwithstanding the foregoing, USPI amended the DCP to exclude the merger from the definition of a change of control for purposes of the DCP. As a result, the merger had no effect on the vesting of the account balance of any participant in the deferred compensation plan.
Our board of directors designates those persons who are eligible to participate in the DCP. Currently, each of Messrs. Wilcox, Brodnax, Spencer and Cagle, and Ms. Karrmann are eligible to participate in the DCP. The DCP enables participants to defer all or a portion of their bonus in a calendar year and up to 75% of their base salary, typically by making a deferral election in the calendar year prior to the year in which the bonus relates or the annual salary is otherwise payable.
Although participants are 100% vested in their deferrals of salary and bonus, USPI contributions to the DCP are subject to vesting schedules established by the compensation committee in its sole discretion (which may vary among different contributions). Notwithstanding such vesting schedules, participants will become 100% vested in their accounts under the DCP in the event of (i) retirement on or after the earlier to occur of (a) age 60 following the completion of five years of service with USPI or (b) age 65, (ii) a change in control or (iii) death.
Benefits are payable upon termination of employment. Participants may also elect, at the time they make an annual deferral, to receive a lump sum in-service distribution payable in a calendar year that is three or more years after the calendar year to which the deferral is related. A participant who elects an in-service distribution may defer the distribution for an additional five years from the original payment date so long as such election is
made at least 12 months prior to the original payment date. Participants may also make an in-service withdrawal from the DCP on account of an unforeseeable emergency (as defined in the DCP). Amounts under the DCP are distributed in a lump sum cash payment, except as provided below, unless the distribution is on account of retirement at normal retirement age under the DCP. A participant can elect, at the time of a deferral under the DCP, to receive his retirement benefit in either a lump sum or pursuant to annual installments over five, 10 or 15 years. Participants may change the form of payment of their retirement benefit from a lump sum to an annual installment payment, provided such election is submitted one year prior to the participant’s retirement.
A participant’s account will be credited with earnings and losses based on returns on deemed investment options selected by the participant from a group of deemed investments established by the deferred compensation plan committee.
USPI may make a discretionary contribution on behalf of any or all participants depending upon the financial strength of USPI. The amount of the contribution, if any, is determined in the sole discretion of the compensation committee. Currently, USPI matches fifty percent of any deferral by a named executive officer, subject to a total cap on the matching contribution of five percent of the officer’s compensation.
The DCP is administered by USPI’s compensation committee. The DCP is an “unfunded” arrangement for purposes of ERISA. Accordingly, the DCP consists of a mere promise by USPI to make payments in accordance with the terms of the DCP and participants and beneficiaries have the status of general unsecured creditors of USPI. A participant’s account and benefits payable under the DCP are not assignable. USPI may amend or terminate the DCP provided that no amendment adversely affects the rights of any participant with respect to amounts that have been credited to his account under the DCP prior to the date of such amendment. Upon termination of the DCP, a participant’s account will be paid out as though the participant experienced a termination of employment on the date of the DCP’s termination or, for participants who have attained normal retirement age, in the form of payment elected by the participant.
Employment Arrangements and Agreements
Set forth below is a description of our employment agreements and other compensation arrangements with our named executive officers.
We have employment agreements with William H. Wilcox as Chief Executive Officer, Brett P. Brodnax as President and Chief Development Officer, Jason B. Cagle as Senior Vice President and Chief Financial Officer, Philip A. Spencer as Executive Vice President, Business Development and Sandra R.A. Karrmann as Senior Vice President and Chief Human Resources and Support Services Officer
The initial term of our employment agreement with William H. Wilcox was for two years from April 18, 2007. Thereafter, Mr. Wilcox’s employment agreement automatically renews for additional two-year terms unless at least 30 days prior to the end of a two-year term, USPI or Mr. Wilcox gives notice that it or he does not wish to extend the agreement. Mr. Wilcox is paid a base salary of $650,000 per year, subject to increase from time to time with the possibility of a bonus, determined by the compensation committee in its sole discretion.
The initial term of our employment agreement with Brett P. Brodnax was for one year from April 18, 2007. Thereafter, Mr. Brodnax’s agreement automatically renews for additional one-year terms unless at least 30 days prior to the end of a one-year term, USPI or Mr. Brodnax gives notice that it or he does not wish to extend the agreement. Mr. Brodnax is paid a base salary of $600,000 per year, subject to increase from time to time with the possibility of a bonus, determined by the compensation committee in its sole discretion.
The initial term of our employment agreement with Jason B. Cagle is for one year from April 18, 2007. Thereafter, Mr. Cagle’s employment agreement automatically renews for additional one-year terms unless at 30 days prior to the end of a one-year term, USPI or Mr. Cagle gives notice that it or he does not wish to extend the agreement. Mr. Cagle is paid a base salary of $400,000 per year, subject to increase from time to time with the possibility of a bonus determined by the compensation committee in its sole discretion.
The initial term of our employment agreement with Philip A. Spencer was for three years from July 29, 2009. Thereafter, Mr. Spencer’s employment agreement automatically renews for additional one-year terms unless at 30 days prior to the end of a one-year term, USPI or Mr. Spencer gives notice that it or he does not wish to extend the agreement. Mr. Spencer is paid a base salary of $390,000 per year, subject to increase from time to time with the possibility of a bonus determined by the compensation committee in its sole discretion.
The initial term of our employment agreement with Sandra R.A. Karrmann was for one year from January 7, 2013. Thereafter, Ms. Karrmann’s employment agreement automatically renews for additional one-year terms unless at 30 days prior to the end of a one-year term, USPI or Ms. Karrmann gives notice that it or she does not wish to extend the agreement. Ms. Karrmann is paid a base salary of $390,000 per year, subject to increase from time to time with the possibility of a bonus determined by the compensation committee in its sole discretion; provided however, Ms. Karrmann’s bonus for 2014 is a minimum of $100,000.
Each of the employment agreements with our named executive officers also provides that if the executive is terminated for cause, or if he terminates his employment agreement without certain enumerated good reasons, we shall pay to him any accrued or unpaid base salary through the date of his termination. In addition, if we terminate the employment without cause or upon failure to renew his employment agreement, or if he terminates his employment for certain enumerated good reasons, we will (i) continue to pay him his base salary at the rate in effect on the date of his termination for 12 months; (ii) continue his health insurance benefits for 12 months following his date of termination (24 months for Mr. Wilcox) or the economic equivalent thereof if such continuation is not permissible under the terms of our health insurance plan; and (iii) pay him a good faith estimate of the bonus he would have received had he remained employed through the end of the fiscal year in which his termination occurred. Our obligations set forth in items (i) to (iii) above are conditioned on the executive signing a release of claims and the continued performance of his continuing obligations under his employment agreement.
In connection with the consummation of the merger and the adoption of our Parent’s equity plan, certain of our executive officers, including our named executive officers who were employed by USPI at the time of the merger, were awarded restricted shares of our Parent’s common stock under the equity plan pursuant to an agreement between each such named executive officer and our Parent. Pursuant to these restricted stock award agreements with our named executive officers, upon termination of such named executive officer’s employment for any reason (including, without limitation, as a result of death, disability, incapacity, retirement, resignation, or dismissal with or without cause), any vested shares as of the date of such termination shall remain vested shares and no additional shares will become vested after the date of such termination unless USPI consummates a change of control within 180 days after such named executive officer’s termination, in which case, such unvested shares shall become fully vested if such awards would have become fully vested had such named executive officer not been terminated on the date of such change of control as described below. Additionally, pursuant to such restricted stock award agreements with our named executive officers, all unvested restricted shares vest in full upon a change of control if, as a result of such change of control, Welsh Carson shall have disposed of all of its shares of our Parent acquired in connection with the merger and received its cost basis in such shares plus a return of at least 100%. In the event such restricted shares do not vest on such change of control, then such restricted shares shall be forfeited upon the closing of such change of control.
Potential Payments Upon Termination or Change of Control
The following table sets forth for each named executive officer potential post-employment payments and payments on a change in control and assumes that the triggering event took place on December 31, 2014.
(1) Amounts are based on the bonus amount paid with respect to 2014.
(2) Amounts will be paid at such time as annual bonuses are payable to other executive and officers of USPI in accordance with USPI’s normal payroll practices.
(3) Amounts consist of the cost to continue to pay such named executive officer’s health insurance benefits for the designated term or the economic equivalent thereof if such continuation is not permissible under the terms of the USPI’s health insurance plan.
(4) Pursuant to the restricted stock award agreements with our named executive officers, all unvested restricted shares of our Parent’s common stock will vest in full upon a change of control if, as a result of such change of control, Welsh Carson shall have disposed of all of its shares of our Parent acquired in connection with the merger and received its cost basis in such shares plus a return of at least 100%. A change of control is not defined to include an initial public offering of our stock. In the event such restricted shares do not vest on such change of control, then such restricted shares shall be forfeited upon the closing of such change of control transaction. The results in this column are the result of multiplying the total possible number of restricted shares of our Parent’s common stock that vest upon a change of control by $2.15 per share. Because there is no active trading market for our common stock, we rely on members of the compensation committee and Welsh Carson to determine in good faith the fair value of our common stock. As of December 31, 2014, this value was determined to be $2.15 per share of common stock. Neither USPI, USPI Holdings, Inc. nor USPI Group Holdings, Inc. has any class of equity securities registered under Section 12 of the Exchange Act.
(5) Pursuant to the 2007 Equity Incentive Plan, upon a change of control, unvested options of our named executive officers shall vest. The results in this column are the result of multiplying the number of unvested options by the difference of the fair value of our common stock on December 31, 2014 of $2.15 per share and the exercise price applicable to the named executive officer’s option award.
(6) Amounts to be paid over twenty-four months.
(7) Amounts to be paid over twelve months.
Director Compensation
The chairman and members of our board of directors who are also officers or employees of USPI, affiliates of Welsh Carson and Mr. Allison do not receive compensation for their services as directors. At Mr. Allison’s direction, his compensation for his service as a director are paid to his employer, Baylor Scott & White Health. At Mr. Paz’s direction, $26,250 of his compensation for his service as a director for 2014 were paid to his employer, Pennsylvania State University. The other directors (“non-employee directors”) receive cash compensation in the amount of $50,000 per year and are eligible to participate in our group insurance benefits. If a non-employee director elects to participate, the director will pay the full cost of such benefits. Non-employee directors also receive the following for all meetings attended: $2,500 per board meeting, $1,250 per telephonic meeting, $3,000 per audit committee meeting and $1,000 per other committee meeting. In addition, the audit committee chairman is paid a retainer of $20,000 per year.
The following table sets forth the compensation paid to our non-employee directors in 2014.
2014 Non-Employee Director Compensation Table
(1) We account for the cost of stock-based compensation awarded under the 2007 Equity Incentive Plan adopted by our Parent under which the cost of equity awards to employees is measured by the aggregate grant date fair value of the awards on their grant date calculated in accordance with the FASB’s Accounting Standards Codification Topic 718. No forfeitures occurred during 2014. On May 1, 2014 a grant of 45,000 restricted shares was made to each of Parent’s non-employee directors with the exception of Dr. Paz. On September 26, 2014, Dr. Paz received a grant of 125,000 restricted shares. The restricted shares were valued at $1.75 and $2.00 per share, respectively, equal to the fair value per share of common stock as determined by the compensation committee. The shares vest 25% per year over four years.
(2) Non-employee directors were issued a cash stipend of $19,700 in connection with the stock awards issued in May 2014.
Compensation Risk Assessment
At the request of the Compensation Committee, management conducted an assessment of the Company’s compensation plans to determine whether such plans encourage excessive or inappropriate risk taking by our employees. This assessment included a review of the risk characteristics of our business and the design of our compensation plans. Although a significant portion of our executive compensation program is performance-based, the Compensation Committee has focused on aligning the Company’s compensation plans with the long-term interests of the Company and its stockholders and avoiding rewards or incentive structures that could encourage unnecessary risks to the Company.
Management reported its findings from this assessment to the Compensation Committee. The Compensation Committee agreed that the Company’s compensation plans do not encourage excessive or inappropriate risk taking and are not reasonably likely to have a material, adverse effect on the Company.
Compensation Committee Interlocks and Insider Participation
The compensation committee of the board of directors consists of Messrs. Queally (Chairman) and Mackesy. None of such persons are officers or employees or former officers or employees of the Company. None of the executive officers of the Company served as a member of the compensation committee of any other company during 2014.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
USPI does not issue any of its equity securities in conjunction with an equity compensation plan. See Item 11, “Executive Compensation - Restricted Stock and Option Plan,” for a discussion of Parent’s equity compensation plan.
All of the issued and outstanding stock of USPI is owned by Holdings, which in turn is wholly-owned by Parent. The following table sets forth information as of February 23, 2014, with respect to the beneficial ownership of the capital stock of our Parent by (i) our chief executive officer and each of the other named executive officers, (ii) each of our directors, (iii) all of our directors and executive officers as a group and (iv) each holder of five percent (5%) or more of any class of our Parent’s outstanding capital stock.
Except as described in the agreements mentioned above or as otherwise indicated in a footnote, each of the beneficial owners listed has, to our knowledge, sole voting, dispositive and investment power with respect to the indicated shares of common stock beneficially owned by them.
* Less than one percent
(1) Unless otherwise indicated, the principal executive offices of each of the beneficial owners identified are located at 15305 Dallas Parkway, Suite 1600, Addison, Texas 75001.
(2) Represents (A) 54,671,610 common shares and 6,942,423 participating preferred shares held by Welsh Carson over which Welsh Carson has sole voting and investment power, (B) 200,200 common shares and 3,200 participating preferred shares held by WCAS Management Corporation, an affiliate of Welsh Carson, over which WCAS Management Corporation has sole voting and investment power, (C) an aggregate 1,462,785 common shares and 185,752 participating preferred over which individuals who are general partners of WCAS X Associates LLC, the sole general partner of Welsh Carson, and/or otherwise employed by an affiliate of Welsh, Carson, Anderson & Stowe have voting and investment power, and (D) an aggregate 80,288,761 common shares and 10,195,400 participating preferred shares held by other co-investors, over which Welsh Carson has sole voting power. WCAS X Associates LLC, the sole general partner of Welsh Carson and the individuals who serve as general partners of WCAS X Associates LLC, including D. Scott Mackesy, Paul B. Queally and Anthony F. Ecock, may be deemed to beneficially own the shares beneficially owned by Welsh Carson. Such persons disclaim beneficial ownership of such shares. The principal executive offices of Welsh, Carson, Anderson & Stowe are located at 320 Park Avenue, Suite 2500, New York, New York 10022.
(3) Such beneficial owner has granted to Welsh Carson sole voting power over its shares. The principal executive offices of such beneficial owner is 7667 Folsom Blvd., Suite 250, Sacramento, California 95826.
(4) Such beneficial owner has granted to Welsh Carson sole voting power over its shares. The principal executive offices of such beneficial owner is One Queen Street East, Suite 2600, Toronto, Ontario, M5C 2W5, Canada.
(5) Such beneficial owner has granted to Welsh Carson sole voting power over its shares. The principal executive offices of such beneficial owner is 255 Shoreline Drive, Suite 600, Redwood City, California 94065.
(6) Represents (A) 1,242,254 common shares and 157,746 participating preferred shares, (B) 4,196,536 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement entered into at the time of the consummation of the LBO, and (C) 275,000 common shares, 39,436 participating preferred shares and 100,000 common shares subject to restrictions on transfer owned by each of the Michelle Ann Steen Trust and the Marcus Anthony Steen Trust for which, in each case, Mr. Wilcox acts as trustee and has voting and investment power over such shares. Not included are 1,000,000 common shares owned by the 2012 WHW Descendants Trust over which Mr. Wilcox’s spouse is trustee.
(7) Represents (A) 212,958 common shares and 27,042 participating preferred shares, (B) 2,175,853 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement entered into at the time of the consummation of the LBO and (C) 750,000 options that are exercisable.
(8) Represents (A) 62,118 common shares and 7,888 participating preferred shares, (B) 175,000 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement entered into at the time of the consummation of the LBO and (C) 437,500 options that are exercisable.
(9) Represents (A) 13,310 common shares and 1,690 participating preferred shares, (B) 500,000 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement entered into at the time of initial employment with USPI and (C) 100,000 options that are exercisable.
(10) Represents 150,000 options that are exercisable.
(11) Does not include (A) 54,671,610 common shares or 6,942,423 participating preferred shares owned by Welsh Carson, or (B) 25,200 common shares or 3,200 participating preferred shares owned by WCAS Management Corporation. Messrs Queally, Mackesy and Ecock, as general partners of WCAS X Associates LLC, the sole general partner of Welsh Carson, and officers of WCAS Management Corporation, may be deemed to beneficially own the shares beneficially owned by Welsh Carson and WCAS Management Corporation. Each of Messrs Queally, Mackesy and Ecock disclaims beneficial ownership of such shares. The principal executive offices of Messrs Queally, Mackesy and Ecock are located at 320 Park Avenue, Suite 2500, New York, New York 10022.
(12) Represents (A) 133,095 common shares and 16,901 participating preferred shares and (B) 125,000 common shares which are subject to restrictions set forth in a restricted stock award agreement.
(13) Represents 125,000 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement.
(14) Represents (A) 177,463 common shares and 22,535 participating preferred shares and (B) 125,000 common shares which are subject to restrictions set forth in a restricted stock award agreement.
(15) Represents (A) 172,367 common shares and 21,888 participating preferred shares, (B) an aggregate 3,090 common shares and 393 preferred shares owned by certain trusts established for the benefit of Mr. Queally’s children for which, in each case, Mr. Queally acts as a trustee and has voting and investment power over such shares and (C) 80,000 common shares which are subject to restrictions on transfer set forth in a restricted stock awards agreement.
(16) Represents (A) 57,363 common shares and 7,885 participating preferred shares and 80,000 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement owned by the Lisa C. Ranelli Trust for which Mr. Ranelli acts as trustee and has voting and investment power over such shares, and (B) 45,000 common shares which are subject to restrictions on transfer set forth in a restricted stock award agreement.
(17) Does not include (A) 54,671,610 common shares or 6,942,423 participating preferred shares owned by Welsh Carson, or (B) 25,200 common shares or 3,200 participating preferred shares owned by WCAS Management Corporation. Includes an aggregate 9,897,592 common shares which are subject to restrictions on transfer set forth in restricted stock award agreements entered into at the time of the consummation of the LBO.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
This section describes certain relationships and transactions involving us and certain of our directors, executive officers, and other related parties. We believe that all the transactions described in herein are upon fair and reasonable terms no less favorable than could be obtained in comparable arm’s length transactions with unaffiliated third parties under the same or similar circumstances.
Arrangements with Our Investors
Welsh Carson, its co-investors and the rollover stockholders entered into agreements described below with our Parent. Welsh Carson’s co-investors includes individuals and entities invited by Welsh Carson to participate in our Parent’s financings such as affiliated investment funds, individuals employed by affiliates of Welsh Carson and limited partners of Welsh Carson.
Stockholders Agreement
The stockholders agreement contains certain restrictions on the transfer of equity securities of our Parent and provides certain stockholders with certain preemptive and information rights.
Management Agreement
In connection with the merger, USPI entered into a management agreement with WCAS Management Corporation, an affiliate of Welsh Carson, pursuant to which WCAS Management Corporation will provide management and financial advisory services to us. WCAS Management Corporation receives an annual management fee of $2.0 million, of which $1.0 million is payable in cash on an annual basis and the remainder accrues annually over time and will be paid upon a change in control, and annual reimbursement for out-of-pocket expenses incurred in connection with the provision of such services.
Revolving Line of Credit
The Company has a revolving line of credit with European Surgical Partners Limited (ESP) of up to $3.0 million, a company owned in part by Welsh Carson, its co-investors and the rollover stockholders. The balance owed to the Company by ESP was $2.5 million at December 31, 2014, and the borrowing bears interest at 6.50% per annum and matures upon the earlier of the refinance or discharge of ESP under its current third-party credit facility, at which time all principal and interest is due. The Company believes that the terms of the revolving line of credit are approximately the same as if they had been negotiated on an arms’ length basis.
Other Arrangements with Directors and Executive Officers
Restricted Stock and Option Plan
In connection with the merger, our Parent adopted a new restricted stock and option plan. Members of our management, including some of those who participated in the merger as rollover stockholders, received awards under this plan. See “Compensation Discussion and Analysis - Restricted Stock and Option Plan.”
Employment Agreements
Each of the named executive officers of USPI has employment agreements with us. See “Compensation Discussion and Analysis - Employment Arrangements and Agreements.”
Other Arrangements
We have entered into agreements with certain majority and minority owned surgery centers to provide management services. As compensation for these services, the surgery centers are charged management fees which are either fixed in amount or represent a fixed percentage of each center’s net revenue less bad debt. The percentages range from 3% to 8%. Amounts recognized under these agreements, after elimination of amounts from consolidated surgery centers, totaled approximately $80.6 million, $71.1 million, and $67.6 million in 2014, 2013, and 2012, respectively, and are included in management and contract service revenues in our consolidated statements of income.
We regularly engage in purchases and sales of ownership interests in our facilities. We operate 33 surgical facilities in partnership with a Baylor Scott & White Health affiliated entity (Baylor Scott & White) and local physicians in the Dallas/Fort Worth area. Baylor Scott & White Health’s Chief Executive Officer is a member of our board of directors. The following table summarizes transactions with Baylor Scott & White during 2013. We had no such transactions in 2014 and 2012. We believe that the sale price was approximately the same as if it had been negotiated on an arms’ length basis, and the price equaled the value assigned by an external appraiser who valued the business immediately prior to the sale.
(1) We contributed two surgery centers to a joint venture with Baylor Scott & White. We continue to account for these facilities under the equity method.
Additionally, we derived approximately 3% of our revenues and approximately 44% of our equity in earnings of unconsolidated affiliates in 2014 from our joint venture with Baylor Scott & White.
We do not have a written policy on related party transactions, however, the audit and compliance committee will review and approve all related party transactions required to be reported pursuant to item 404(a) of Regulation S-X.
Neither the Company, USPI Holdings, Inc. nor USPI Group Holdings, Inc. are listed on a national securities exchange or in an automated inter-dealer quotation system of a national securities association, and we are not subject to either the listing standards of the New York Stock Exchange or the NASDAQ Rules. For the purposes of the following determinations of director independence, we have chosen to use the NASDAQ Rules. Using such Rules, we have determined that each of the directors on our board of directors are independent for general board service, except Messrs. Wilcox, Mackesy, Queally, Ecock and Allison.
Our board of directors has a separately designated, standing audit and compliance committee comprised of the following members of the board: Messrs. Ranelli (Chairman), Garrett and Newman. Under the NASDAQ Rules, Messrs. Ranelli, Garrett and Newman would be considered independent for the purposes of audit and compliance committee service.
Our board of directors also has a separately designated, standing compensation committee comprised of the following members of the board: Messrs. Queally (Chairman) and Mackesy. Under the NASDAQ Rules, Messrs. Queally and Mackesy would not be considered independent for the purposes of compensation committee service.
ITEM 14.
ITEM 14. Principal Accounting Fees and Services
The following table shows the aggregate fees billed by KPMG LLP, our independent registered public accounting firm, during the years ended December 31, 2014 and 2013:
(1) Audit Fees. Includes fees billed for professional services rendered for the audit of our annual financial statements included in our Form 10-K, reviews of our quarterly financial statements included in Forms 10-Q, audits of subsidiaries, reviews of our other filings with the SEC, and other research work necessary to comply with generally accepted accounting standards for the years ended December 31, 2014 and 2013.
(2) Audit Related Fees. Includes fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees.” These services include other accounting and reporting consultations.
(3) Tax Fees. Includes fees billed for tax compliance, tax advice, and tax planning.
(4) All Other Fees. Includes fees billed for assistance with preparation of Medicare cost reports.
The charter of our audit and compliance committee provides that the committee must approve in advance all audit and non-audit services provided by KPMG LLP. The audit and compliance committee approved all of these services.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) (1) Financial Statements
The following consolidated financial statements are filed as part of this Form 10-K:
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholder
United Surgical Partners International, Inc.:
We have audited the accompanying consolidated balance sheets of United Surgical Partners International, Inc. (the Company) and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Surgical Partners International, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), United Surgical Partners International, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework-1992 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Dallas, Texas
February 25, 2015
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholder
United Surgical Partners International, Inc.:
We have audited United Surgical Partners International, Inc.’s (the Company) internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework-1992 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, United Surgical Partners International, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework-1992 issued by the COSO.
The Company acquired several subsidiaries and equity method investments during 2014, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, the following subsidiary’s and equity method investment’s internal control over financial reporting associated with total assets of $96.5 million and total revenues of $2.3 million included in the consolidated financial statements of United Surgical Partners International, Inc. and subsidiaries as of and for the year ended December 31, 2014. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of the following subsidiaries and equity method investments:
•
USP Hazelwood, Inc.
•
USP Morris, Inc.
•
USP Siouxland, Inc.
•
USP Sacramento, Inc. (Investment in Hacienda Outpatient Surgery Center, LLC)
•
USP San Antonio, Inc. (Investment Alamo Heights Surgical Hospital Group, LP)
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of United Surgical Partners International, Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated February 25, 2015 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Dallas, Texas
February 25, 2015
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2014 and 2013
See accompanying notes to consolidated financial statements
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
See accompanying notes to consolidated financial statements
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
See accompanying notes to consolidated financial statements
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
See accompanying notes to consolidated financial statements
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(1) Summary of Significant Accounting Policies and Practices
(a) Description of Business
United Surgical Partners International, Inc., a Delaware corporation, and subsidiaries (USPI or the Company) was formed in February 1998 for the primary purpose of ownership and management of ambulatory surgery centers, surgical hospitals and related businesses. At December 31, 2014, the Company, headquartered in Dallas, Texas, operated 219 short-stay surgical facilities in the United States. Of these 219 facilities, the Company consolidates the results of 63 and accounts for 156 under the equity method. The majority of the Company’s facilities are jointly owned with local physicians and a health system partner that has other healthcare businesses in the region. At December 31, 2014, the Company had agreements with health system partners providing for joint ownership of 154 of the Company’s 219 facilities and also providing a framework for the planning and construction of additional facilities in the future. All but two of the Company’s facilities include physician owners.
Prior to April 3, 2012, the Company operated seven facilities in the United Kingdom. On April 3, 2012, the Company distributed the stock of its U.K. subsidiary to the equity holders of its parent, USPI Group Holdings, Inc. (Parent). Subsequent to April 3, 2012, the Company has no further ownership in the U.K. operations. The Company’s former U.K. operations have now been classified as “discontinued operations” in its historical results of operations.
The Company is subject to changes in government legislation that could impact Medicare and Medicaid reimbursement levels and is also subject to increased levels of managed care penetration and changes in payor patterns that may impact the level and timing of payments for services rendered.
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The Company operates in one business segment, the ownership and operation of surgical facilities in the United States.
The Company had publicly traded equity securities from June 2001 through April 2007. Pursuant to an Agreement and Plan of Merger (the merger) dated as of January 7, 2007, between an affiliate of Welsh, Carson, Anderson & Stowe X, L.P. (Welsh Carson), the Company became a wholly owned subsidiary of USPI Holdings, Inc. on April 19, 2007. USPI Holdings is a wholly owned subsidiary of the Company’s Parent, which is owned by an investor group that includes affiliates of Welsh Carson, members of the Company’s management and other investors.
(b) Translation of Foreign Currencies
The financial statements of the Company’s former U.K. operations were measured in local currency and then translated into U.S. dollars. All assets and liabilities were translated using the current rate of exchange at the balance sheet date. Results of operations were translated using the average rates prevailing throughout the year. Translation gains or losses resulting from changes in exchange rates were accumulated in a separate component of stockholder’s equity.
(c) Principles of Consolidation
The consolidated financial statements include the financial statements of USPI and its 100%-owned and majority-owned subsidiaries. In addition, the Company consolidates the accounts of certain investees of which it does not own a majority ownership interest because the Company maintains effective control over the investees’ assets and operations. All significant intercompany balances and transactions have been eliminated in consolidation.
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
The Company also determines if it is the primary beneficiary of (and therefore should consolidate) any entity whose operations it does not control with voting rights (Note 5).
(d) Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(e) Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original or remaining maturities of three months or less to be cash equivalents. Cash and cash equivalents at times may exceed the FDIC limits. The Company believes no significant concentration of credit risk exists with respect to these cash investments.
The Company’s wholly-owned insurance subsidiary maintains certain balances in cash and cash equivalents that are used in connection with its retained professional and general liability risks and are not designated for general corporate purposes. At December 31, 2014 and 2013, these cash and cash equivalents balances were $5.5 million and $4.4 million, respectively.
(f) Available for Sale Securities
At both December 31, 2014 and 2013, the Company had $10.8 million of marketable securities, which are held by the Company’s wholly-owned insurance subsidiary. These investments are used in connection with its retained professional and general liability risks and are not designed for general corporate purposes. The marketable securities consist of U.S. Treasury and corporate debt, are classified as available for sale and are recorded at fair value on the consolidated balance sheet. Unrealized holding gains and losses, net of the related tax effect, on available for sale securities are excluded from earnings and are reported as a separate component of accumulated other comprehensive income until realized. Realized gains and losses from the sale of available for sale securities are determined on a specific-identification basis. Premiums and discounts on debt securities are amortized or accreted over the life of the related available for sale security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.
The fair value of these securities are classified within Level 2 of the valuation hierarchy, and are based on closing market prices of the investments when applicable, or alternatively, valuations utilizing market data and other observable inputs.
(g) Inventories of Supplies
Inventories of supplies are stated at cost, which approximates market, and are expensed as used.
(h) Property and Equipment
Property and equipment are stated at cost or, when acquired as part of a business combination, fair value at date of acquisition. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets. Upon retirement or disposal of assets, the asset and accumulated depreciation accounts are adjusted
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Notes to Consolidated Financial Statements - (Continued)
accordingly, and any gain or loss is reflected in earnings or loss of the respective period. Maintenance costs and repairs are expensed as incurred; significant renewals and betterments are capitalized. Assets held under capital leases are classified as property and equipment and amortized using the straight-line method over the shorter of the useful lives or lease terms, and the related obligations are recorded as debt. Amortization of assets under capital leases and of leasehold improvements is included in depreciation expense. The Company records operating lease expense on a straight-line basis unless another systematic and rational allocation is more representative of the time pattern in which the leased property is physically employed. The Company amortizes leasehold improvements, including amounts funded by landlord incentives or allowances, for which the related deferred rent is amortized as a reduction of lease expense, over the shorter of their economic lives or the lease term.
(i) Goodwill and Intangible Assets
Intangible assets consist of costs in excess of net assets acquired (goodwill), costs of acquired management and other contract service rights, and other intangibles, which consist primarily of debt issue costs. Most of the Company’s intangible assets have indefinite lives. Accordingly, these assets, along with goodwill, are not amortized but are instead tested for impairment annually, or more frequently if changing circumstances warrant. Goodwill is tested for impairment at the reporting unit level. Prior to spinning off its U.K. operations in April 2012, the Company had two reporting units, corresponding to the two countries in which it operated. The Company now operates in one segment and tests goodwill within one reporting unit. The Company amortizes intangible assets with definite useful lives over their respective useful lives to their estimated residual values and reviews them for impairment in the same manner as long-lived assets, discussed below.
(j) Impairment of Long-lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset, or related groups of assets, may not be fully recoverable from estimated future cash flows. In the event of impairment, measurement of the amount of impairment may be based on appraisal, market values of similar assets or estimates of future discounted cash flows using market participant assumptions with respect to the use and ultimate disposition of the asset.
(k) Fair Value Measurements
The fair value of a financial instrument is the amount at which the instrument could be exchanged in an orderly transaction between market participants to sell the asset or transfer the liability. The Company uses fair value measurements based on quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2) or unobservable inputs for assets or liabilities (Level 3), depending on the nature of the item being valued. The Company discloses on a yearly basis the valuation techniques and discloses any change in method of such within the body of each applicable footnote. The estimated fair values may not be representative of actual values that will be realized or settled in the future.
The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable approximate fair value because of the short maturity of these instruments.
(l) Derivative Instruments and Hedging Activities
The Company accounts for its derivative instruments at fair value and records the value on its consolidated balance sheet as an asset or liability. The Company does not engage in derivative instruments for speculative
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Notes to Consolidated Financial Statements - (Continued)
purposes. The Company’s derivatives (interest rate swaps) qualified for hedge accounting, and therefore gains or losses that resulted from changes in the values of the Company’s derivatives were reported in accumulated other comprehensive income (loss), a separate component of equity.
(m) Revenue Recognition
Revenues consist primarily of net patient service revenues, which are based on the facilities’ established billing rates less allowances and discounts, principally for patients covered under contractual programs with private insurance companies. The Company derives approximately 76% of its net patient service revenues from private insurance payors, approximately 20% from governmental payors and approximately 4% from self-pay and other payors. Amounts are recognized as services are provided.
With respect to management and contract service revenues, amounts are also recognized as services are provided. The Company is party to agreements with certain surgical facilities, hospitals and physician practices to provide management services. As compensation for these services each month, the Company charges the managed entities management fees which are either fixed in amount or represent a fixed percentage of each entity’s earnings, typically defined as net revenue less a provision for doubtful accounts or operating income. In many cases the Company also holds equity ownership in these entities (Note 11). Amounts charged to consolidated facilities eliminate in consolidation.
(n) Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is limited due to the large number of customers comprising the Company’s customer base and their breakdown among geographical locations in which the Company operates. The Company provides for bad debts principally based upon the aging of accounts receivable and uses specific identification to write off amounts against its allowance for doubtful accounts. The Company believes the allowance for doubtful accounts adequately provides for estimated losses as of December 31, 2014 and 2013. The Company has a risk of incurring losses if such allowances are not adequate.
(o) Investments and Equity in Earnings of Unconsolidated Affiliates
Investments in unconsolidated companies in which the Company exerts significant influence but does not control or otherwise consolidate are accounted for using the equity method. The Company’s ownership in these entities range from 5% to 72%. Certain investments in unconsolidated companies in which the Company owns a majority interest are not consolidated due to the substantive participating rights of the minority owners. These investments are included as investments in unconsolidated affiliates in the accompanying consolidated balance sheets.
The carrying amounts of these investments are greater than the Company’s equity in the underlying net assets of many of these companies due in part to goodwill, which is not subject to amortization. The Company monitors its investments for other-than-temporary impairment by considering factors such as current economic and market conditions and the operating performance of the companies and records reductions in carrying values when necessary.
Equity in earnings of unconsolidated affiliates consists of the Company’s share of the profits or losses generated from its noncontrolling equity investments in 156 surgical facilities. Because these operations are central to the Company’s business strategy, equity in earnings of unconsolidated affiliates is classified as a component of operating income in the accompanying consolidated statements of income. The Company has
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Notes to Consolidated Financial Statements - (Continued)
contracts to manage these facilities, which results in the Company having an active role in the operations of these facilities and devoting a significant portion of its corporate resources to the fulfillment of these management responsibilities.
(p) Income Taxes
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets may not be realized.
(q) Equity-Based Compensation
The Company accounts for equity-based compensation, such as stock options and other stock-based awards to employees and directors, at fair value. The fair value is measured at the date of grant and recognized as expense over the employee’s requisite service period. The Company also accounts for equity instruments issued to non-employees at fair value.
(r) Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties, and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.
(2) Discontinued Operations and Other Dispositions
Before the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Update 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (ASU 2014-08) in 2014, the Company classified formerly consolidated subsidiaries in which it had no continuing involvement as discontinued operations. The gains or losses on these transactions were classified within discontinued operations in the Company’s consolidated statements of income. The Company also reclassified the historical results of these subsidiaries to remove the operations of these entities from its revenues and expenses, collapsing the net income or loss from these operations into a single line within discontinued operations.
Prior to April 3, 2012, the Company operated seven facilities in the United Kingdom. On April 3, 2012, the Company distributed the stock of its U.K. subsidiary to the equity holders of Parent. Subsequent to April 3, 2012, the Company has no further ownership in the U.K. operations. The Company’s former U.K. operations have now been classified as “discontinued operations” in its historical results of operations. Because GAAP requires spin-off transactions to be accounted for at carrying value, there was no gain or loss recorded on the spin-off of the U.K. operations.
During the year ended December 31, 2014, the Company recorded a loss on the disposal of discontinued operations related to operations that were discontinued before the adoption of ASU 2014-08.
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Notes to Consolidated Financial Statements - (Continued)
The table below summarizes certain amounts related to the Company’s discontinued operations for the period presented (in thousands):
During 2014 and 2012, the Company completed sales of investments in two facilities operated through unconsolidated affiliates, including its equity ownership in these entities as well as the related rights to manage the facilities. The Company did not dispose of any facility it operated through an unconsolidated affiliate during 2013. Gains and losses on the disposals of these investments are classified within “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income. These transactions are summarized below:
The Company from time to time surrenders control of an entity but retains a noncontrolling interest (classified within “investments in unconsolidated affiliates”). These types of transactions result in a gain or loss, computed as the difference between (a) the sales proceeds and fair value of the retained investment and (b) the Company’s carrying value of the investment prior to the transaction. Gains or losses for such transactions are classified within “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income. Fair values for the retained noncontrolling interests are classified as Level 3 within the fair value hierarchy. The fair values are estimated based on market multiples and discounted cash flow models which have been derived from the Company’s experience in acquiring surgical facilities and third party valuations it has obtained with respect to such transactions.
During the year ended December 31, 2014, the Company surrendered control of, but retained an equity method investment in, two entities as summarized below:
(1) A controlling interest in a facility was sold to a health system partner as part of the Company’s strategy for partnering with this health system partner.
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Notes to Consolidated Financial Statements - (Continued)
(2) A controlling interest in a facility was sold to a health system partner as part of the Company’s strategy for partnering with this health system partner. Also in conjunction with this transaction, the Company obtained an equity method investment in a surgical hospital.
(3) Investments in Unconsolidated Affiliates and Business Combinations
The Company acquires interests in existing surgery centers from third parties and invests in new facilities that it develops in partnership with health system partners and local physicians. Some of these transactions result in the Company controlling the acquired entity and meet the GAAP definition of a business combination. The financial results of the acquired entities are included in the Company’s consolidated financial statements beginning on the acquisition’s effective closing date. During the year ended December 31, 2014, the Company obtained control of the following entities:
(1) Acquisition of a controlling interest in and right to manage a surgical facility in which the Company previously had no involvement. The facility is jointly owned with local physicians. The adjustments to arrive at pro forma operating results for these acquisitions are not material.
(2) The Company obtained control of this facility in which it already had ownership due to changes in the voting rights of the facility. This facility is jointly owned with local physicians.
Although no consideration was transferred, GAAP requires the transaction to be accounted for as a business combination and requires adjusting the carrying value of the Company’s existing ownership to its fair value. Based on the Company’s calculation of fair value, no gain or loss was recorded on the transaction. The fair value (Level 3 within the fair value hierarchy) was estimated based on market multiples and discounted cash flow models which have been derived from the Company’s experience in acquiring surgical facilities and third party valuations it has obtained. The following table presents the unaudited pro forma results as if the Company had acquired this facility on January 1 of each year. The pro forma results are not necessarily indicative of the results of operations that would have occurred if the acquisition had been completed on the dates indicated, nor is it indicative of the future operating results of the Company.
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Notes to Consolidated Financial Statements - (Continued)
The Company controls 63 of its entities and therefore consolidates their results. However, the Company accounts for a majority (156 of its 219 facilities at December 31, 2014) as investments in unconsolidated affiliates, i.e., under the equity method, as the Company’s level of influence is significant but does not reach the threshold of controlling the entity. The majority of these investments are partnerships or limited liability companies, which require the associated tax benefit or expense to be recorded by the partners or members. Summarized financial information for the Company’s equity method investees on a combined basis is as follows (amounts are in thousands, except number of facilities, and reflect 100% of the investees’ results on an aggregated basis and are unaudited):
The Company’s equity method investment in Texas Health Ventures Group, L.L.C., is considered significant to the Company’s 2014 consolidated financial statements under regulations of the United States Securities & Exchange Commission (SEC). As a result, the Company has filed Texas Health Ventures Group, L.L.C.’s consolidated financial statements with this Form 10-K for the required periods.
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Notes to Consolidated Financial Statements - (Continued)
The Company also regularly engages in the purchase and sale of equity interests with respect to its investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in unconsolidated affiliates that need capital for acquisitions, new construction or other business growth opportunities. During the year ended December 31, 2014, these transactions resulted in a net cash outflow of approximately $146.9 million, which is summarized as follows:
(1) Acquisition of a noncontrolling interest in and the right to manage a surgical facility in which the Company previously had no involvement. The facility is jointly owned with local physicians.
(2) Acquisition of a noncontrolling interest in and the right to manage two surgical facilities in which the Company previously had no involvement. These facilities are jointly owned with a health system partner and local physicians.
(3) Acquisition of a noncontrolling interest in and the right to manage a surgical facility in which the Company previously had no involvement. The facility is jointly owned with a health system partner and local physicians.
(4) Represents the net payment related to various other purchases and sales of equity interests and contributions of cash to equity method investees.
During the year ended December 31, 2014, the Company received a return of capital in the amount of $22.0 million from one of its unconsolidated affiliates.
(4) Noncontrolling Interests
The Company controls and therefore consolidates the results of 63 of its 219 facilities. Similar to its investments in unconsolidated affiliates, the Company regularly engages in the purchase and sale of equity interests with respect to its consolidated subsidiaries that do not result in a change of control. These transactions are accounted for as equity transactions, as they are undertaken among the Company, its consolidated subsidiaries, and noncontrolling interests, and their cash flow effect is classified within financing activities.
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Notes to Consolidated Financial Statements - (Continued)
During the year ended December 31, 2014, the Company purchased and sold equity interests in various consolidated subsidiaries in the amounts of $8.8 million and $6.2 million, respectively. The basis difference between the Company’s carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to additional paid-in capital. The impact of these transactions is summarized as follows (in thousands):
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Notes to Consolidated Financial Statements - (Continued)
Upon the occurrence of various fundamental regulatory changes, the Company could be obligated, under the terms of its investees’ partnership and operating agreements, to purchase some or all of the noncontrolling interests related to the Company’s consolidated subsidiaries. These repurchase requirements are limited to the portions of its facilities that are owned by physicians who perform surgery at the Company’s facilities and would be triggered by regulatory changes making the existing ownership illegal. While the Company is not aware of events that would make the occurrence of such a change probable, regulatory changes are outside the control of the Company. Accordingly, the noncontrolling interests subject to these repurchase provisions, and the income attributable to those interests, are not included as part of the Company’s equity and are carried as noncontrolling interests-redeemable on the Company’s consolidated balance sheets. The activity for the years ended December 31, 2014, 2013 and 2012 is summarized below (in thousands):
(5) Other Investments
The consolidated financial statements include the financial statements of USPI and subsidiaries the Company effectively controls, usually indicated by majority ownership. The Company also determines if it is the primary beneficiary of (and therefore should consolidate) any entity whose operations it does not control with voting rights.
The Company has ownership in an entity that operates and manages ten surgical facilities in the Houston, Texas area. Despite not holding a controlling voting interest, the Company is the primary beneficiary because the Company is able to make the decisions that are most significant to the operations of the entity and has provided all of the funding for the entity, which the entity has used to acquire surgical facilities. The Company is entitled to a majority of the entity’s earnings until the Company has received a specified return on the investment. The Company has no exposure for the entity’s losses beyond this investment. Accordingly, the Company did not provide any financial or other support to the entity that it was not previously contractually required to provide
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Notes to Consolidated Financial Statements - (Continued)
during the years ended December 31, 2014 or 2013. At December 31, 2014 and 2013, the total assets of this entity were $130.6 million and $123.6 million, and the total liabilities owed to third parties were $25.9 million and $24.8 million, respectively. Such amounts are included in the accompanying consolidated balance sheets.
(6) Other Receivables
Other receivables consist primarily of amounts receivable for services performed and funds advanced under management and administrative service agreements. As discussed in Note 11, many of the entities to which the Company provides management and administrative services are related parties, due to the Company being an investor in those facilities. At December 31, 2014 and 2013, the amounts receivable from related parties, which are included in other receivables on the Company’s consolidated balance sheet, totaled $7.9 million and $8.2 million, respectively.
(7) Property and Equipment
At December 31, 2014 and 2013, property and equipment consisted of the following (in thousands):
At December 31, 2014 and 2013, assets recorded under capital lease arrangements, included in property and equipment, consisted of the following (in thousands):
During 2012 and 2013, the Company developed and implemented an electronic healthcare record (EHR) software system for twelve hospitals the Company operates. During 2014, the Company developed additional functionality as a result of increased requirements of the federal program. The hospitals are eligible for federal incentive payments over a four year period which began in 2013, and that would result in the Company receiving the $13.7 million that is classified within property and equipment at December 31, 2014. Incentive amounts are accrued as income by the hospitals, which are partially-owned by the Company, at the end of each year once the hospitals have completed the required service period and patient service data required to estimate the incentive amount is known. The incentive payments are forwarded to the Company upon receipt by each hospital. During
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Notes to Consolidated Financial Statements - (Continued)
the years ended December 31, 2014 and 2013, the Company accrued $2.1 million and $3.5 million, respectively, of pretax income related to these incentives.
(8) Goodwill and Intangible Assets
Under GAAP, goodwill and intangible assets with indefinite useful lives are not amortized but instead are tested for impairment at least annually, with tests of goodwill occurring at the reporting unit level (defined as an operating segment or one level below an operating segment). Prior to spinning off its U.K. operations in April 2012, the Company had two reporting units, corresponding to the two countries in which it operated. The Company now operates in one business segment, the ownership and operation of surgical facilities in the U.S. Intangible assets with definite useful lives are amortized over their respective useful lives to their estimated residual values. The Company completed the required annual impairment tests during 2014, 2013 and 2012. No impairment losses were identified as a result of these goodwill impairment tests.
As a result of impairment testing performed on the Company’s indefinite-lived management contracts, the Company recorded impairment losses on four contracts in 2014, one contract in 2013 and one contract in 2012. These losses totaled approximately $5.7 million, $3.2 million and $1.7 million, respectively, and were primarily triggered by a reduction in the Company’s expected earnings under the contracts. Fair values for indefinite-lived intangible assets are estimated based on market multiples and discounted cash flow models which have been derived from the Company’s experience in acquiring surgical facilities, market participant assumptions and third-party valuations it has obtained with respect to such transactions. The inputs used in these models are Level 3 inputs, which under GAAP, are significant unobservable inputs. Inputs into these models include expected revenue growth, expected gross margins and discount factors. Such expense is recorded in “Net losses on deconsolidations, disposals and impairments” in the accompanying consolidated statements of income.
The following is a summary of changes in the carrying amount of goodwill for the years ended December 31, 2014 and 2013 (in thousands):
Goodwill additions resulted primarily from business combinations and additionally from purchases of additional interests in subsidiaries.
Intangible assets with definite useful lives are amortized over their respective estimated useful lives, ranging from approximately one to ten years, to their estimated residual values. The majority of the Company’s management contracts have indefinite useful lives. Most of these contracts have evergreen renewal provisions that do not contemplate a specific termination date. Some of the contracts have provisions which make it possible for the facility’s other owners to terminate them at certain dates and under certain circumstances. Based on the Company’s history with these contracts, the Company’s management considers the lives of these contracts to be indefinite and therefore does not amortize them unless facts and circumstances indicate otherwise.
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
The following is a summary of intangible assets at December 31, 2014 and 2013 (in thousands):
Amortization expense from continuing operations related to intangible assets with definite useful lives was $3.8 million and $3.2 million for the year ended December 31, 2014 and 2013, respectively. The amortization of debt issuance costs, which is included within interest expense, was $4.5 million and $4.3 million in for the year ended December 31, 2014 and 2013, respectively.
The following table provides estimated amortization expense, including amounts that will be classified within interest expense, related to intangible assets with definite useful lives for each of the years in the five-year period ending December 31, 2019 (in thousands):
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Notes to Consolidated Financial Statements - (Continued)
(9) Long-term Debt
At December 31, 2014 and 2013, long-term debt consisted of the following (in thousands):
(a) Amended senior secured credit facility
In April 2012, the Company amended its existing credit facility. The amended credit facility provided a new term loan and modified the terms of the Company’s existing term loan. The amended credit facility provided for borrowings consisting of $144.4 million in non-extended term loans which was to mature in April 2014; $312.4 million in extended term loans maturing in April 2017; $375.0 million in new term loans maturing in April 2019; and $125.0 million under a revolving facility maturing in April 2017. In December 2012, the Company borrowed an additional $150.0 million in a new term loan. The non-extended, extended and new term loans each require quarterly principal payments of 0.25% of the outstanding balance as of April 3, 2012 with the remaining balances due at maturity. No principal payments are required on the revolving credit facility until its maturity in 2017. In February 2013, the Company further amended its credit facility and committed to borrow $150.0 million, which was used to repay the non-extended term loan of $144.4 million and related fees and expenses. The transaction was completed in April 2013. The new $150.0 million term loan also matures in April 2019.
Interest rates on the amended credit facility are based on the LIBOR plus a margin of 3.5% to 3.75%. Additionally, the Company pays 0.50% per annum on the daily-unused commitment of the new revolving credit facility. The Company also pays a quarterly participation fee of 2.13% per annum related to outstanding letters of credit.
At December 31, 2014, the Company had $977.6 million outstanding under the amended credit facility at a weighted average interest rate of approximately 4.6%. At December 31, 2014, the Company had $108.4 million available for borrowing under the revolving credit facility, representing the facility’s $125.0 million capacity, net of the outstanding balance of $15.0 million and $1.6 million of outstanding letters of credit.
The amended credit facility is guaranteed by USPI Holdings, Inc. and most of its directly and indirectly 100%-owned domestic subsidiaries, subject to certain exceptions, and borrowings under the credit facility are secured by a first priority security interest in all real and personal property of these subsidiaries, as well as a first priority pledge of USPI’s capital stock, and the capital stock of each of USPI’s wholly owned domestic subsidiaries. Additionally, the credit facility contains various restrictive covenants, including financial covenants that limit the Company’s ability and the ability of the Company’s subsidiaries to borrow money or guarantee other indebtedness, grant liens, make investments, sell assets, pay dividends, enter into sale-leaseback transactions or issue and sell capital stock.
Fees paid for unused portions of the credit facility were approximately $0.5 million, $0.6 million and $0.5 million in the years ended December 31, 2014, 2013 and 2012, respectively. These amounts are included within interest expense in the Company’s consolidated statements of income.
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Notes to Consolidated Financial Statements - (Continued)
(b) Senior unsecured notes
The 9.0% senior unsecured notes, due in April 2020 (Notes) were issued in a private offering on April 3, 2012 and were subsequently registered as publicly traded securities through a Form S-4 declared effective by the SEC on September 5, 2012. The exchange offer was completed in October 2012. Interest on the Notes is payable on April 1 and October 1 of each year, and commenced on October 1, 2012. The Notes are unsecured senior obligations of the Company; however, the Notes are guaranteed by most of the Company’s directly and indirectly 100%-owned domestic subsidiaries. Additionally, the Notes contain various restrictive covenants, including financial covenants that limit the Company’s ability and the ability of its subsidiaries to borrow money or guarantee other indebtedness, grant liens, make investments, sells assets, pay dividends, enter into sale-leaseback transactions or issue and sell capital stock. At December 31, 2014, the Company had $440.0 million of Notes outstanding.
(c) Other Long-term Debt
The Company and its subsidiaries have notes payable to financial institutions and other parties of $33.9 million, which mature at various dates through 2023 and accrue interest at fixed and variable rates ranging from 2.8% to 8.3%. Capital lease obligations in the carrying amount of $24.4 million are secured by underlying real estate and equipment and have implicit interest rates ranging from 3.0% to 17.4% and mature at various dates through 2026.
At year-end, the aggregate maturities of long-term debt for each of the five years subsequent to December 31, 2014 were as follows (in thousands): 2015, $18,668; 2016, $18,489; 2017, $327,912; 2018, $13,237; 2019, $635,114 and thereafter, $462,451.
The fair value of the Company’s long-term debt is determined by either (i) estimation of the discounted future cash flows of the debt at rates currently quoted or offered to the Company for similar debt instruments of comparable maturities by its lenders, or (ii) quoted market prices at the reporting date for traded debt securities. At December 31, 2014, both the aggregate carrying amount and estimated fair value of long-term debt was approximately $1.5 billion. At December 31, 2013, both the aggregate carrying amount and estimated fair value of long-term debt was approximately $1.5 billion. The fair value of debt is classified within Level 2 of the valuation hierarchy.
As a result of the amendments to the Company’s credit facility and new borrowings described above, the Company recorded a loss on the early retirement of debt of $5.5 million and $37.5 million, during the years ended December 31, 2013 and 2012, respectively. The loss on the early retirement of debt represents finance and legal fees, the write off of debt issuance costs and the premium paid to retire its previously outstanding bonds in 2012.
(10) Leases
The Company leases various office equipment and office space under a number of operating lease agreements, which expire at various times through the year 2027. Such leases do not involve contingent rentals, nor do they contain significant renewal or escalation clauses. Office leases generally require the Company to pay all executory costs (such as property taxes, maintenance and insurance).
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Notes to Consolidated Financial Statements - (Continued)
Minimum future payments under noncancelable leases, with remaining terms in excess of one year as of December 31, 2014 are as follows (in thousands):
Total rent expense from continuing operations under operating leases was $19.6 million, $19.0 million and $15.8 million for the years ended December 31, 2014, 2013 and 2012, respectively.
(11) Related Party Transactions
The Company has entered into agreements with certain majority and minority owned surgery centers to provide management services. As compensation for these services, the surgery centers are charged management fees which are either fixed in amount or represent a fixed percentage of each center’s net revenue less bad debt. The percentages range from 3% to 8%. Amounts recognized under these agreements, after elimination of amounts from consolidated surgery centers, totaled approximately $80.6 million, $71.1 million and $67.6 million for the years ended December 31, 2014, 2013 and 2012, respectively. Such amounts are included in management and contract service revenues in the accompanying consolidated statements of income.
As discussed in Notes 2, 3 and 4, the Company regularly engages in purchases and sales of ownership interests in its facilities. The Company operates 33 surgical facilities in partnership with Baylor Scott & White and local physicians in the Dallas/Fort Worth area. Baylor Scott & White Health’s Chief Executive Officer is a member of the Company’s board of directors. The following table summarizes transactions with Baylor Scott & White during 2013. The Company did not sell any ownership interests in facilities to Baylor in 2014 or 2012. The Company believes that the sale prices were approximately the same as if they had been negotiated on an arms’ length basis, and the prices equaled the value assigned by an external appraiser who valued the businesses immediately prior to the sale.
(1) The Company contributed two surgery centers to a joint venture with Baylor Scott & White. The Company continues to account for these facilities under the equity method.
Included in general and administrative expenses are management fees payable to an affiliate of Welsh Carson, which holds a controlling interest in the Company, in the amount of $2.0 million for the years ended
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Notes to Consolidated Financial Statements - (Continued)
December 31, 2014, 2013 and 2012. Such amounts accrue at an annual rate of $2.0 million. The Company pays $1.0 million in cash per year with the unpaid balance due and payable upon a change in control. At December 31, 2014, the Company had approximately $8.5 million accrued related to such management fee, of which $0.8 million is included in other current liabilities and $7.7 million is included in other long term liabilities in the accompanying consolidated balance sheet. At December 31, 2013, the Company had approximately $7.5 million accrued related to such management fee, of which $0.8 million is included in other current liabilities and $6.7 million is included in other long term liabilities in the accompanying consolidated balance sheet.
The Company has a revolving line of credit with European Surgical Partners Limited (ESP), a company owned in part by affiliates of Welsh Carson, members of the Company’s management and other investors of up to $3.0 million. The balance owed to the Company by ESP was $2.5 million and $0.9 million at December 31, 2014 and 2013, respectively, and is included in “Other Assets” on the accompanying consolidated balance sheets. The borrowing bears interest at 6.5% per annum and matures upon the earlier of the refinance or discharge of ESP under its current third-party credit facility, at which time all principal and interest is due. The Company believes that the terms of the revolving line of credit are approximately the same as if they had been negotiated on an arms’ length basis.
(12) Income Taxes
Income tax expense attributable to income from continuing operations consists of (in thousands):
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Income tax expense differed from the amount computed by applying the U.S. federal income tax rate of 35% to pretax income from continuing operations as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2014 and 2013 are presented below (in thousands):
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. The Company carries a valuation allowance against certain of its deferred tax assets, which relates to deferred tax assets that have restrictions as to use and are not considered more likely than not to be realized. If the Company’s estimates related to the above items change significantly, the Company may need to alter the amount of its valuation allowance in the future through a favorable or unfavorable adjustment to net income.
At December 31, 2014, the Company had federal net operating loss carryforwards for U.S. federal income tax purposes of approximately $9.7 million. The Company’s ability to offset future taxable income with these
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
carryforwards would begin to be forfeited in 2020, if unused. The Company believes that it is more likely than not that it will be able to generate state taxable income in future periods to utilize its state net operating loss carryforwards.
The Company has analyzed its income tax filing positions in all of the federal and state jurisdictions where it is required to file income tax returns for all open tax years in these jurisdictions for uncertainty in tax positions. The Company continues to remain subject to examination by U.S. federal authorities for the years 2010 through 2014. The Company believes, based on the facts and technical merits associated with each of its income tax filing positions and deductions, that each of its income tax filing positions would be sustained on audit. Further, the Company has concluded that to the extent any adjustments to its income tax filing positions were not to be sustained upon an IRS or other audit, such adjustments would not have a material effect on the Company’s consolidated financial statements. As a result, no reserves for uncertain income tax positions have been recorded. The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income before taxes. The Company has not recorded any material amounts for interest or penalties related to audit or other activity.
(13) Equity and Equity-Based Compensation
On April 3, 2012 and December 17, 2012, the Company paid cash dividends of approximately $314.5 million and $69.9 million, respectively, to its Parent’s equity holders. Also, on April 3, 2012, the Company distributed the stock of its U.K. subsidiary to its Parent’s equity holders.
The Company accounts for equity-based compensation, such as stock options and other stock-based awards to employees and directors, at fair value. The fair value of the compensation is measured at the date of grant and recognized as expense over the recipient’s requisite service period.
The Company’s parent, USPI Group Holdings, Inc., has granted stock options and nonvested share awards to certain employees and members of the board of directors. These awards were granted pursuant to the 2007 Equity Incentive Plan (the Plan) which was adopted by Parent’s board of directors. The board of directors or a designated administrator has the sole authority to determine which individuals receive grants, the type of grant to be received, the vesting period and all other option terms. Stock options granted generally have a term not to exceed eight years. At December 31, 2014, a maximum of 31,816,215 shares of stock may be delivered under the Plan. As 10,827,750 shares have been delivered under the Plan, 20,988,465 remained available for delivery, with 19,485,585 awards having been granted at December 31, 2014.
Total equity-based compensation included in the consolidated statements of income, classified by line item, is as follows (in thousands):
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Total equity-based compensation, included in the consolidated statements of income, classified by type of award, is as follows (in thousands):
Total unrecognized compensation related to nonvested awards of stock options and nonvested shares was $14.0 million at December 31, 2014 of which $5.7 million is expected to be recognized over a weighted average period of approximately three years. The remaining $8.3 million relates to restricted share awards exchanged in conjunction with the merger and will be expensed only upon the occurrence of a change in control or other qualified exit event.
Stock Options
Parent generally grants stock options vesting 25% per year over four years and having an eight-year contractual life. The fair value of stock options is estimated using the Black-Scholes formula. The expected lives of options are determined using the “simplified method” which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches. The risk-free interest rates are equal to rates of U.S. Treasury notes with maturities approximating the expected life of the option. Volatility was calculated as a weighted average based on the historical volatility of the Company’s predecessor before the merger as well as industry peers. The assumptions are as follows:
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Stock option activity during the year ended December 31, 2014 was as follows:
During the years ended December 31, 2014 and 2013, the Company received immaterial cash proceeds from the exercise of stock options. During the year ended December 31, 2012, the majority of the options exercised were cashless and were exercised in conjunction with the April 2012 dividend payment. The total intrinsic value of options exercised during the year ended December 31, 2012 was $8.2 million.
Share Awards
On April 19, 2007, Parent granted nonvested share awards to certain company employees. The first tranche (50%) of the share awards vested 25% over four years, while the second tranche (50%) vests 100% in April 2015, but can vest earlier upon the occurrence of a qualified exit event and Company performance. An additional grant was made to Parent’s board of directors in August 2007, July 2011 and May 2014. The nonvested shares granted to the board of directors vests 25% each year over four years. The grant made to the board of directors in August 2007 is now fully vested. The value of such share awards is equal to the share price on the date of grant.
Additionally, in conjunction with the merger in April 2007, Parent cancelled 379,000 restricted share awards of the Company’s predecessor. These share awards were replaced with 2,212,957 nonvested shares of Parent. This cancellation and exchange was accounted for as a modification. The replacement awards vest only upon the occurrence of a change in control or other exit event as defined in the award agreement and Company performance. As a result of the modification, approximately $8.3 million of unamortized compensation cost related to the Predecessor awards will only be expensed upon the occurrence of a change in control or qualified exit event, and the completion of the derived service period. At December 31, 2014, 2,065,835 of these share awards remained outstanding and unvested.
The grants of nonvested share awards, excluding the awards exchanged concurrent with the merger, during the year ended December 31, 2014 are summarized as follows:
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
The weighted average grant-date fair value per share award was $1.98 and $1.59 for the years ended December 31, 2014 and 2013, respectively. No nonvested shares were granted during 2012. The total fair value of shares which vested during the years ended December 31, 2014, 2013 and 2012 was approximately $1.0 million, $0.1 million and $0.2 million, respectively.
Warrants
During 2009, Parent granted warrants to a health system partner that holds ownership in some of the Company’s facilities. The warrants are to purchase Parent’s common stock and were fully vested and non-forfeitable at the date of grant but contained exercise restrictions. The fair value of the warrants was determined using the Black Scholes formula. The assumptions included an expected life equal to the contractual life of approximately 8 1/2 years; a risk free interest rate of 2.7%; a dividend yield of 0.0%; and an estimated volatility of approximately 58%. In this grant, the health system partner received 333,330 warrants with an original exercise price of $3.00 per share, of which 55,555 were exercisable immediately; the exercise restrictions on additional tranches of 55,555 warrants lapsed each December 1 which began in 2009 and ended in 2013. At December 31, 2014, 333,330 warrants are exercisable.
During 2008, one of the Company’s health system partners, Baylor Scott & White Health, was granted 666,666 warrants to purchase Parent’s common stock with an original exercise price of $3.00 per share. The warrants were fully vested and nonforfeitable but contained exercise restrictions. The exercise restrictions on 111,111 warrants lapsed each December 31 which began in 2008 and ended in 2013. The warrants have a contractual life of ten years. The fair value of the warrants was determined using the Black Scholes formula. The assumptions included an expected life equal to the contractual life of the warrants; a risk free interest rate of 3.5%, a dividend yield of 0.0%; and an estimated volatility of approximately 59%. Baylor Scott & White Health’s Chief Executive Officer is a member of the Company’s Board of Directors (Note 11). At December 31, 2014, 666,666 warrants are exercisable.
During 2007, Parent granted a total of 2,333,328 warrants to purchase its common stock to four of the Company’s health system partners. The exercise price of the warrants was originally $3.00 per share. All of the warrants were fully vested and non-forfeitable but contained exercise restrictions. At December 31, 2014, all 2,333,328 warrants are exercisable. The warrants have a contractual life of eight to ten years. The fair value of the warrants was determined using the Black Scholes formula. The assumptions included an expected life equal to the contractual life of each warrant; a risk free interest rate of 3.6% to 4.6%; a dividend yield of 0.0%; and an estimated volatility of approximately 59%.
Because all of the warrants granted by Parent were fully vested, the expense associated with all of the warrants was recorded upon grant.
In conjunction with the dividends that were paid by the Company in 2012, the Company lowered the exercise price on the outstanding warrants by an amount equal to the per share dividend. As a result of this modification, the Company recorded an additional $0.2 million of other operating expense in 2012. At December 31, 2014, the exercise price is $1.39 per share.
(14) Commitments and Contingencies
(a) Financial Guarantees
As of December 31, 2014, the Company had issued guarantees of the indebtedness and other obligations of its investees to third parties, which could potentially require the Company to make maximum aggregate
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
payments totaling approximately $39.1 million. Of the total, $10.0 million relates to the obligations of consolidated subsidiaries, whose obligations are included in the Company’s consolidated balance sheet and related disclosures, and $26.3 million of the remaining $29.1 million relates to the obligations of unconsolidated affiliated companies, whose obligations are not included in the Company’s consolidated balance sheet and related disclosures. The remaining $2.8 million primarily represents guarantees of the obligations of two facilities which have been sold. The Company has full recourse to the buyers with respect to these amounts.
The Company has recorded long-term liabilities totaling approximately $0.6 million related to the guarantees the Company has issued to unconsolidated affiliates on or after January 1, 2003, and has not recorded any liabilities related to guarantees issued prior to that date. Generally, these arrangements (a) consist of guarantees of real estate and equipment financing, (b) are secured by the related property and equipment, (c) require payments by the Company, when the collateral is insufficient, in the event of a default by the investee primarily obligated under the financing, (d) expire as the underlying debt matures at various dates through 2030, and (e) provide no recourse for the Company to recover any amounts from third parties. The Company also has $1.6 million of letters of credit outstanding, as discussed in Note 9.
(b) Litigation
From time to time the Company is named as a party to legal claims and proceedings in the ordinary course of business. The Company’s management is not aware of any claims or proceedings that are expected to have a material adverse impact on the Company.
(c) Self Insurance and Professional Liability Claims
The Company is self-insured for certain losses related to health and workers’ compensation claims, although it obtains third-party insurance coverage to limit its exposure to these claims. The Company estimates its self-insured liabilities using a number of factors including historical claims experience, an estimate of incurred but not reported claims, demographic factors, severity factors and actuarial valuations. The Company believes that the accruals established at December 31, 2014, which were estimated based on actual employee health claim patterns, adequately provide for its exposure under this arrangement. The Company’s potential for losses related to professional and general liability is managed through a wholly-owned insurance captive.
(d) Employee Benefit Plans
The Company’s eligible employees may choose to participate in the United Surgical Partners International, Inc. 401(k) Plan under which the Company may elect to make contributions that match from zero to 100% of participants’ contributions. Charges to expense under this plan were $2.9 million, $2.6 million and $2.4 million for the years ended December 31, 2014, 2013, and 2012, respectively.
The Company’s Deferred Compensation Plan covers select members of management as determined by its Compensation Committee. Under the plan, eligible employees may contribute a portion of their salary and annual bonus on a pretax basis. The plan is a non-qualified plan; therefore, the associated liabilities are included in the Company’s consolidated balance sheets as of December 31, 2014 and 2013. In addition, the Company maintains an irrevocable grantor’s trust to hold assets that fund benefit obligations under the plan, including corporate-owned life insurance policies. The cash surrender value of such policies is included in the consolidated balance sheets in other noncurrent assets and totaled $17.3 million and $14.6 million at December 31, 2014 and 2013, respectively. The Company’s obligations related to the plan were $21.7 million and $20.0 million, at December 31, 2014 and 2013, respectively, of which $1.4 million and $0.8 million in 2014 and 2013,
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
respectively, are included in accrued salaries and benefits with the remaining amounts included in other long-term liabilities. Total expense under the plan for the years ended December 31, 2014, 2013 and 2012 was $0.5 million, $1.4 million and $1.2 million, respectively.
(e) Employment Agreements
The Company entered into an employment agreement dated April 19, 2007 with William H. Wilcox. The agreement with Mr. Wilcox, the Company’s Chief Executive Officer, provides for annual base compensation of $650,000 (as of December 31, 2014), subject to increases approved by the board of directors, and Mr. Wilcox is eligible for a performance bonus based on the sole discretion of the Company’s Board of Directors. The agreement renews automatically for two-year terms unless terminated by either party.
At December 31, 2014, the Company has employment agreements with 18 other senior managers which generally include one year terms and renew automatically for additional one year terms unless terminated by either party. The total annual base compensation under these agreements is $6.5 million as of December 31, 2014, subject to increases approved by the board of directors, and performance bonuses of up to a total of $5.8 million per year.
(15) Subsequent Events
The Company has entered into letters of intent with various entities regarding possible joint venture, development or other transactions. These possible joint ventures, developments or other transactions are in various stages of negotiation.
(16) Condensed Consolidating Financial Statements
The following information is presented as required by regulations of the SEC. None of this information is routinely prepared for use by management. The operating and investing activities of the separate legal entities included in the consolidated financial statements are fully interdependent and integrated. Accordingly, the operating results of the separate legal entities are not representative of what the operating results would be on a stand-alone basis. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other services.
The Notes were issued in a private offering on April 3, 2012 and were subsequently registered as publicly traded securities through a Form S-4 declared effective by the SEC on September 5, 2012. The exchange offer was completed in October 2012. The Notes are unsecured obligations of the Company; however, the Notes are guaranteed by most of its direct and indirect 100%-owned domestic subsidiaries. USPI, which issued the Notes, does not have independent assets or operations. USPI’s investees in which USPI owns less than 100% are not guarantors of the obligation. The financial positions and results of operations (below, in thousands) of the respective guarantors are based upon the guarantor relationship at the end of the period presented. Consolidation adjustments include purchase accounting entries for investments in which the Company’s ownership percentage in non-participating investees is not high enough to permit the application of pushdown accounting.
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Condensed Consolidating Balance Sheets:
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Condensed Consolidating Statements of Income:
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Condensed Consolidating Statements of Comprehensive Income:
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Condensed Consolidating Statements of Cash Flows:
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
(17) Selected Quarterly Financial Data (Unaudited)
Quarterly operating results are not necessarily representative of operations for a full year for various reasons, including case volumes, interest rates, acquisitions, changes in contracts, the timing of price changes, and financing activities. The Company has also completed acquisitions during 2013 and 2014, all of which significantly affect the comparability of net income from quarter to quarter. The Company recorded a $5.5 million loss on the early retirement of debt in the second quarter of 2013 due to the Company refinancing transactions in April 2013.
(18) New Accounting Pronouncements
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The ASU permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that the ASU will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
On February 18, 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (ASU), which is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships and limited liability companies among others. The ASU reduces the number of consolidation models from four to two and places more emphasis on the risk of loss when determining a controlling financial interest, reduces the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity and can change consolidation conclusions for companies that make use of limited partnerships or variable interest entities. The new standard is effective on January 1, 2016, however early adoption is permitted. The Company is evaluating the effect that the ASU may have on its consolidated financial statements and disclosures.
SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
Valuation allowance for deferred tax assets
(1) Accounts written off.
(2) Balances from entities that were acquired, deconsolidated or sold.
All other schedules are omitted because they are not applicable or not required or because the required information is included in the consolidated financial statements or notes thereto.
S-1
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Consolidated Financial Statements
Years Ended June 30, 2014 and 2013
(With Independent Auditors’ Report Thereon)
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2014 AND 2013
CONTENTS
Report of Independent Auditors
Audited Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
INDEPENDENT AUDITOR’S REPORT
To the Board of Managers
Texas Health Ventures Group, L.L.C.:
We have audited the accompanying consolidated financial statements of Texas Health Ventures Group, L.L.C. and subsidiaries (the “Company”), which comprise the consolidated balance sheets as of June 30, 2014 and 2013, and the related consolidated statements of income and changes in equity, and of cash flows for the years then ended.
Management’s Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Texas Health Ventures Group, L.L.C. and subsidiaries at June 30, 2014 and 2013, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
/s/ PricewaterhouseCoopers LLP
November 11, 2014
Dallas, Texas
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -
JUNE 30, 2014 AND 2013
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JUNE 30, 2014 AND 2013
(In thousands)
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE YEARS ENDED JUNE 30, 2014 AND 2013
(In thousands)
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2014 AND 2013
(In thousands)
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
YEARS ENDED JUNE 30, 2014 AND 2013
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Texas Health Ventures Group, L.L.C. and subsidiaries (THVG or the Company), a Texas limited liability company, was formed on January 21, 1997, for the primary purpose of developing, acquiring, and operating ambulatory surgery centers and related entities. THVG is ultimately a subsidiary of Baylor Health Care System (BHCS) through the combined ownership by Baylor University Medical Center and Baylor Health Services. USP North Texas, Inc. (USP), a Texas corporation and subsidiary of United Surgical Partners International, Inc. (USPI), owns 49.9% of THVG. THVG’s fiscal year ends June 30. THVG’s subsidiaries’ fiscal years end December 31; however, the financial information of these subsidiaries included in these consolidated financial statements is as of and for the twelve months ended June 30, 2014 and 2013.
Effective October 1, 2013, BHCS, a Texas nonprofit corporation, and Scott & White Healthcare (S&W), a Texas nonprofit corporation, consummated their affiliation pursuant to an Affiliation Agreement (the “Agreement”) dated June 19, 2013. BHCS and S&W formed BSW Health, a Texas nonprofit corporation now known as Baylor Scott & White Holdings (BSW Holdings), and BSW Health Service, a Texas nonprofit corporation now known as Baylor Scott & White Health (BSW Health).
While the receipt of Internal Revenue Service (IRS) tax-exempt and public charity determination letters for BSW Holdings and BSW Health was pending, BHCS and S&W formed two Texas limited liability companies, Baylor Scott & White Health LLC (BSW Holdings LLC) and Baylor Scott & White Health Service LLC (BSW Health LLC). On December 31, 2013, BSW Holdings and BSW Health each received a favorable determination letter from the IRS regarding their tax-exempt and public charity status. Effective March 1, 2014, BSW Holdings LLC was merged into BSW Holdings and BSW Health LLC was merged into BSW Health. BSW Holdings is now the sole member of BHCS and S&W and has control and substantial reserved powers over all BHCS and S&W material affiliates. BUMC and BHS are defined as material affiliates of BHCS in the Agreement. BSW Holdings and its affiliates are referred collectively herein as “Baylor”.
THVG owns equity interests in and operates ambulatory surgery centers, surgical hospitals, and related businesses in the Dallas/Fort Worth, Texas, metropolitan area. At June 30, 2014, THVG operated thirty-one facilities (the Facilities) under management contracts, thirty of which are consolidated for financial reporting purposes and one of which is accounted for under the equity method. In addition, THVG holds equity method investments in two partnerships that each own the real estate used by two of the Facilities.
THVG has been funded by capital contributions from its members and by cash distributions from the Facilities. The board of managers, which is controlled by Baylor, initiates requests for capital contributions. The Facilities’ operating agreements provide that cash flows available for distribution will be distributed at least quarterly to THVG and other owners of the Facilities.
THVG’s operating agreement provides that the board of managers determine, on at least a quarterly basis, if THVG should make a cash distribution based on a comparison of THVG’s excess cash on hand versus current and anticipated needs, including, without limitation, needs for operating expenses, debt service, acquisitions, and a reasonable contingency reserve. The terms of THVG’s operating agreement provide that any distributions, whether driven by operating cash flows or by other sources, such as the distribution of noncash assets or distributions in the event THVG liquidates, are to be shared according to each member’s overall ownership level in THVG.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Basis of Accounting
THVG maintains its books and records on the accrual basis of accounting, and the consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Management has determined that the consolidated entities all perform the same business activities and therefore should be considered as one reporting segment.
Principles of Consolidation
The consolidated financial statements include the financial statements of THVG and its wholly owned subsidiaries and other entities THVG controls. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management of THVG to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Cash Equivalents
THVG considers all highly liquid instruments with original maturities when purchased of three months or less to be cash equivalents. There were no cash equivalents at June 30, 2014 or 2013. Under the Company’s cash management system, checks issued but not presented to the bank may result in book cash overdraft balances for accounting purposes. The company reclassifies book overdrafts to accounts payable, which are reflected as an operating activity in its consolidated statements of cash flows. Book overdrafts included in accounts payable were $9.3 million as of June 30, 2014.
Patient Receivables
Patient receivables are stated at estimated net realizable value. Significant concentrations of patient receivables at June 30, 2014 and 2013 include:
Receivables from government-related programs (i.e. Medicare and Medicaid) represent the only concentrated groups of credit risk for THVG and management does not believe that there is any credit risk associated with these receivables. Commercial and managed care receivables consist of receivables from various payors involved in diverse activities and subject to differing economic conditions, and do not represent any concentrated credit risk to THVG. THVG maintains allowances for uncollectible accounts for estimated losses resulting from the payors’ inability to make payments on accounts. THVG assesses the reasonableness of the allowance account based on historic write-offs, the aging of accounts and other current conditions. Furthermore, management continually monitors and adjusts the allowances associated with its receivables. Accounts are written off when collection efforts have been exhausted.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Supplies
Supplies, consisting primarily of pharmaceuticals and supplies inventories, are stated at cost, which approximates market value, and are expensed as used.
Property and Equipment
Property and equipment are initially recorded at cost or, when acquired as part of a business combination, at fair value at the date of acquisition. Depreciation is calculated on the straight line method over the estimated useful lives of the assets. Upon retirement or disposal of assets, the asset and accumulated depreciation accounts are adjusted accordingly, and any gain or loss is reflected in earnings or loss of the respective period. Maintenance costs and repairs are expensed as incurred; significant renewals and betterments are capitalized.
Assets held under capital leases are classified as property and equipment and amortized using the straight line method over the shorter of the useful lives or the lease terms, and the related obligations are recorded as debt. Amortization of property and equipment held under capital leases and leasehold improvements is included in depreciation and amortization expense.
THVG records operating lease expense on a straight-line basis unless another systematic and rational allocation is more representative of the time pattern in which the leased property is physically employed. THVG amortizes leasehold improvements, including amounts funded by landlord incentives or allowances, for which the related deferred rent is amortized as a reduction of lease expense, over the shorter of their economic lives or the lease term.
Investments in Unconsolidated Affiliates
Investments in unconsolidated affiliates in which THVG exerts significant influence, but has less than a controlling ownership, are accounted for under the equity method. THVG exerts significant influence in the operations of its unconsolidated affiliates through representation on the governing bodies of the investees and additionally, with respect to the Facilities, through contracts to manage the operations of the investees.
Equity in earnings of unconsolidated affiliates consists of THVG’s share of the profits and losses generated from its noncontrolling equity investments. Because these operations are central to THVG’s business strategy, equity in earnings of unconsolidated affiliates is classified as a component of operating income in the accompanying consolidated statements of income. THVG has contracts to manage these facilities, which results in THVG having an active role in the operations of these facilities.
Intangible Assets and Goodwill
Intangible assets consist of costs in excess of net assets acquired (goodwill), costs associated with the purchase of management service contract rights, and other intangibles. Most of these assets have indefinite lives. Accordingly, these assets are not amortized but are instead tested for impairment annually, using the market and income approach, or more frequently if changing circumstances warrant.
To determine the fair value of our goodwill reporting units, we generally use a present value technique (discounted cash flow) corroborated by market multiples and/or data from third-party valuation specialists. The factor most sensitive to change with respect to our discounted cash flow analyses is the estimated future cash flows of each reporting unit which is, in turn, sensitive to our estimates of future revenue growth and margins for these businesses. If actual revenue growth and/or margins are lower than our expectations, the impairment test results could differ. We base our fair value estimates on assumptions we believe to be reasonable and consistent with market participant assumptions, but that are unpredictable and inherently uncertain.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
The provisions of the accounting standard for goodwill require that we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. An analysis of the goodwill balance was performed in March of 2014 and 2013 and no such impairments were identified.
THVG amortizes intangible assets with definite useful lives over their respective useful lives to the estimated residual values and reviews them for impairment in the same manner as long-lived assets, as discussed below.
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset, or related groups of assets, may not be fully recoverable from estimated future cash flows. In the event of impairment, measurement of the amount of impairment may be based on appraisal, fair values of similar assets or estimates of future undiscounted cash flows resulting from use and ultimate disposition of the asset. No such impairment was identified in 2014 or 2013.
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in an orderly transaction between market participants to sell the asset or transfer the liability. The Company uses fair value measurements based on quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2) or unobservable inputs (Level 3), depending on the nature of the item being valued. The Company does not have financial assets or liabilities measured at fair value on a recurring basis at June 30, 2014 and 2013. The carrying amounts of cash, funds due from United Surgical Partners, Inc., accounts receivable, and accounts payable approximate fair value because of the short maturity of these instruments.
The fair value of the Company’s long-term debt is determined by Level 2 inputs which are an estimation of the discounted future cash flows of the debt at rates currently quoted or offered to a comparable company for similar debt instruments of comparable maturities by its lenders. At June 30, 2014, the aggregate carrying amount and estimated fair value of long-term debt were $24,229,000 and $25,672,000, respectively. At June 30, 2013, the aggregate carrying amount and estimated fair value of long term debt were $32,367,000 and $33,939,000, respectively.
Revenue Recognition
THVG has agreements with third-party payors that provide for payments to THVG at amounts different from its established rates. Payment arrangements include prospectively-determined rates per discharge, reimbursed costs, discounted charges, and per diem payments. Net patient service revenue is reported at the estimated net realizable amount from patients, third-party payors, and others for services rendered, including estimated contractual adjustments under reimbursement agreements with third party payors. Contractual adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. These contractual adjustments are related to the Medicare and Medicaid programs, as well as managed care contracts.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Net patient service revenue from the Medicare and Medicaid programs accounted for approximately 14% and 13% of total net patient service revenue in 2014 and 2013, respectively.
Net patient service revenue from commercial and managed care contracts accounted for approximately 81% and 84% of net patient service revenue in 2014 and 2013, respectively.
Net patient service revenue from private payors accounted for approximately 5% and 3% of total net patient service revenue in 2014 and 2013, respectively.
For facilities licensed as hospitals, federal regulations require the submission of annual cost reports covering medical costs and expenses associated with services provided to program beneficiaries. Medicare and Medicaid cost report settlements are estimated in the period services are provided to beneficiaries.
Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is a reasonable possibility that recorded estimates with respect to the six THVG facilities licensed as hospitals may change as interpretations are clarified. These initial estimates are revised as needed until final cost reports are settled.
Income Taxes
No amounts for federal income taxes have been reflected in the accompanying consolidated financial statements because the federal tax effects of THVG’s activities accrue to the individual members.
The Texas franchise tax applies to all THVG entities and is reflected in the accompanying consolidated statements of income. Under the revised law, the tax is calculated on a margin base and is therefore reflected in THVG’s consolidated statements of income for the years ended June 30, 2014 and 2013 as income tax.
THVG follows the provisions of ASC 740, “Income Taxes”, which prescribes a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements.
As of June 30, 2014 and 2013, THVG had no gross unrecognized tax benefits. THVG files a partnership income tax return in the U.S. federal jurisdiction and a franchise tax return in the state of Texas. THVG is no longer subject to U.S. federal income tax examination for years prior to 2011 and no longer subject to state and local income tax examination for years prior to 2010. THVG has identified Texas as a “major” state taxing jurisdiction. THVG does not expect or anticipate a significant change over the next twelve months in the unrecognized tax benefits.
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties, and other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated.
Recently Issued Accounting Pronouncements
In May 2014, FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. THVG has not evaluated all of the provisions of ASU 2014-09, which are effective for fiscal years beginning after December 15, 2016.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
2. PROPERTY AND EQUIPMENT
At June 30, 2014 and 2013, property and equipment and related accumulated depreciation and amortization consisted of the following (in thousands):
At June 30, 2014 and 2013, assets recorded under capital lease arrangements included in property and equipment consisted of the following (in thousands):
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
3. INVESTMENTS IN SUBSIDIARIES AND UNCONSOLIDATED AFFILIATES
THVG’s investments in consolidated subsidiaries and unconsolidated affiliates consisted of the following:
1. List excludes holding companies, which are wholly-owned by the Company and hold the Company’s investments in the Facilities.
2. Partnership that has investment in North Central Surgical Center, Baylor Surgicare, and Mary Shields Hospital.
3. These entities are not surgical facilities and do not have ownership in any surgical facilities.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
On December 31, 2013, Fort Worth Surgicare Partners Ltd., which is consolidated by THVG, acquired 50.5% of Tarrant County Surgical Center, LLC (TCSC), and all of its assets and liabilities for $4.75 million, consisting of units in Fort Worth Surgicare Partners Ltd. valued at $3.1 million, $905 thousand of cash, and a note payable, with a due date one year from the closing of the center, to the physicians in the amount of $750 thousand.
On June 30, 2014, THVG acquired 51% of Texas Endoscopy Centers LLC (TX Endo), for $7.3 million. TX Endo consists of two locations, one in Plano, Texas and one in Allen, Texas.
There were no equity acquisitions during fiscal year 2013.
The following table summarizes the recorded values of the assets acquired and liabilities assumed at the dates of acquisition (in thousands):
The acquisitions were accounted for in accordance with ASC 805 and the acquisition method was applied. The results of these acquisitions are included in THVG’s consolidated financial statements from the date of acquisition. Total acquisition costs included in professional fees on THVG’s consolidated statement of income were $69,000 for 2014.
4. NONCONTROLLING INTERESTS
The Company controls and therefore consolidates the results of 30 of its 31 facilities at June 30, 2014. Similar to its investments in unconsolidated affiliates, the Company regularly engages in the purchase and sale of equity interests with respect to its consolidated subsidiaries that do not result in a change of control. These transactions are accounted for as equity transactions, as they are undertaken among the Company, its consolidated subsidiaries, and noncontrolling interests, and their cash flow effect is classified within financing activities.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
During the fiscal year ended June 30, 2014, the Company purchased and sold equity interests in various consolidated subsidiaries in the amounts of $1,855,000 and $2,141,000, respectively. During the fiscal year ended June 30, 2013, the Company purchased and sold $1,739,000 and $671,000, respectively. The basis difference between the Company’s carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to the Company’s equity. The impact of these transactions is summarized as follows (in thousands):
5. GOODWILL AND INTANGIBLE ASSETS
At June 30, 2014 and 2013, goodwill and intangible assets, net of accumulated amortization, consisted of the following (in thousands):
The following is a summary of changes in the carrying amount of goodwill for the years ended June 30, 2014 and 2013 (in thousands):
Goodwill additions resulting from business combinations are recorded and assigned to the parent and noncontrolling interests.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Intangible assets with definite useful lives are amortized over their respective estimated useful lives. The agreements underlying THVG’s management contract assets have no determinable termination date and, consequently, the related intangible assets have indefinite useful lives. The carrying amount of THVG’s management contract was approximately $1,150,000 at both June 30, 2014 and 2013. Goodwill and intangible assets with indefinite useful lives are not amortized but instead are tested for impairment at least annually. No impairment was identified in 2014 or 2013.
The $848,000 adjustment for North Central Carrell Clinic in 2013 relates to a final purchase price allocation adjustment to the fair value of property and equipment acquired.
6. LONG-TERM OBLIGATIONS
At June 30, 2014 and 2013, long-term obligations consisted of the following (in thousands):
The aggregate maturities of notes payable for each of the five years subsequent to June 30, 2014 and thereafter are as follows (in thousands):
The Facilities have notes payable to financial institutions which mature at various dates through 2031 and accrue interest at fixed and variable rates ranging from 3% to 7%. Each note is collateralized by certain assets of the respective Facility.
Capital lease obligations are collateralized by underlying real estate or equipment and have interest rates ranging from 1% to 13%.
7. LEASES
The Facilities lease various office equipment, medical equipment, and office space under a number of operating lease agreements, which expire at various times through the year 2030. Such leases do not involve contingent rentals, nor do they contain significant renewal or escalation clauses. Office leases generally require the Facilities to pay all executory costs (such as property taxes, maintenance and insurance).
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Minimum future payments under noncancelable leases with remaining terms in excess of one year as of June 30, 2014 are as follows (in thousands):
Total rent expense under operating leases was approximately $21,744,000 and $19,791,000 for the years ended June 30, 2014 and 2013, respectively, and is included in other operating expenses in the accompanying consolidated statements of income.
8. RELATED-PARTY TRANSACTIONS
THVG operates the Facilities under management and royalty contracts, and THVG in turn is managed by Baylor and USP, resulting in THVG incurring management and royalty fee expense payable to Baylor and USP in amounts equal to the management and royalty fee income THVG receives from the Facilities. THVG’s management and royalty fee income from the facilities it consolidates for financial reporting purposes eliminates in consolidation with the facilities’ expense and therefore is not included in THVG’s consolidated revenues. THVG’s management and royalty fee income from facilities which are not consolidated was $600,000 for both years ended June 30, 2014 and 2013, respectively, and is included in the consolidated revenues of THVG.
The management and royalty fee expense to Baylor and USP was approximately $27,900,000 and $28,276,000 for the years ended June 30, 2014 and 2013, respectively, and is reflected in operating expenses in THVG’s consolidated statements of income. Of the total, 64.3% and 34.0% represent management fees payable to USP and Baylor, respectively, and 1.7% represents royalty fees payable to Baylor.
Under the management and royalty agreements, the Facilities pay THVG an amount ranging from 4.5% to 7% of their net patient service revenue less provision for doubtful accounts annually, subject, in some cases, to an annual cap.
In addition, a subsidiary of USPI frequently pays bills on behalf of THVG and has custody of substantially all of THVG’s excess cash, paying THVG and the Facilities interest income on the net balance at prevailing market rates. Amounts held by USPI on behalf of THVG and the facilities totaled $68,856,000 and $56,749,000 at June 30, 2014 and 2013, respectively, net against accrued expenses that USPI paid on behalf of THVG of $7,486,000 and $7,426,000 at June 30, 2014 and 2013, respectively. These net amounts are shown in Funds due from United Surgical Partners, Inc. The interest income amounted to $93,590 and $93,350 for the years ended June 30, 2014 and 2013, respectively.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
9. COMMITMENTS AND CONTINGENCIES
Financial Guarantees
THVG guarantees portions of the indebtedness of its investees to third-parties, which could potentially require THVG to make maximum aggregate payments totaling approximately $6,870,000. Of the total, $5,238,000 relates to the obligations of four consolidated subsidiaries whose obligations are included in THVG’s consolidated balance sheet and related disclosures, $1,632,000 relates to obligations of two consolidated subsidiaries under operating leases whose obligations are not included in THVG’s consolidated balance sheet and related disclosures.
These arrangements (a) consist of guarantees of real estate and equipment financing, (b) are collateralized by all or a portion of the investees’ assets, (c) require payments by THVG in the event of a default by the investee primarily obligated under the financing, (d) expire as the underlying debt matures at various dates through 2020, or earlier if certain performance targets are met, and (e) provide no recourse for THVG to recover any amounts from third-parties. The fair value of the guarantee liability was not material to the consolidated financial statements and, therefore, no amounts were recorded at June 30, 2014 related to these guarantees. When THVG incurs guarantee obligations that are disproportionately greater than the guarantees provided by the investee’s other owners, THVG charges the investee a fair market value fee based on the value of the contingent liability THVG is assuming.
Litigation and Professional Liability Claims
In their normal course of business, the Facilities are subject to claims and lawsuits relating to patient treatment. THVG believes that its liability for damages resulting from such claims and lawsuits is adequately covered by insurance or is adequately provided for in its consolidated financial statements. USPI, on behalf of THVG and each of the Facilities, maintains professional liability insurance that provides coverage on a claims-made basis of $1,000,000 per incident and $11,000,000 in annual aggregate amount with retroactive provisions upon policy renewal. Certain of THVG’s insurance policies have deductibles and contingent premium arrangements. THVG believes that the expense recorded through June 30, 2014, which was estimated based on historical claims, adequately provides for its exposure under these arrangements. Additionally, from time to time, THVG may be named as a party to other legal claims and proceedings in the ordinary course of business. THVG is not aware of any such claims or proceedings that have more than a remote chance of having a material adverse impact on THVG.
10. SUBSEQUENT EVENTS
THVG regularly engages in exploratory discussions or enters into letters of intent with various entities regarding possible joint ventures, development, or other transactions. These possible joint ventures, developments of new facilities, or other transactions are in various stages of negotiation.
THVG has performed an evaluation of subsequent events through November 11, 2014, which is the date the consolidated financial statements were available to be issued.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Consolidated Financial Statements
Years Ended June 30, 2013 and 2012
(With Independent Auditors’ Report Thereon)
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2013 AND 2012
CONTENTS
INDEPENDENT AUDITOR’S REPORT
To the Board of Managers
Texas Health Ventures Group, L.L.C.:
We have audited the accompanying consolidated financial statements of Texas Health Ventures Group, L.L.C. and subsidiaries (the “Company”), which comprise the consolidated balance sheets as of June 30, 2013 and 2012, and the related consolidated statements of income and changes in equity, and of cash flows for the years then ended.
Management’s Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Texas Health Ventures Group, L.L.C. and subsidiaries at June 30, 2013 and 2012, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
/s/ PricewaterhouseCoopers LLP
November 8, 2013
Dallas, Texas
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -
JUNE 30, 2013 AND 2012
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
(In thousands)
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
(In thousands)
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
(In thousands)
See accompanying notes to consolidated financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
YEARS ENDED JUNE 30, 2013 AND 2012
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Texas Health Ventures Group, L.L.C. and subsidiaries (THVG or the Company), a Texas limited liability company, was formed on January 21, 1997, for the primary purpose of developing, acquiring, and operating ambulatory surgery centers and related entities. THVG is ultimately a subsidiary of Baylor Health Care System through the ownership by Baylor University Medical Center of 50.1% (referred to herein as Baylor). USP North Texas, Inc. (USP), a Texas corporation and subsidiary of United Surgical Partners International, Inc. (USPI), owns 49.9% of THVG. THVG’s fiscal year ends June 30. THVG’s subsidiaries’ fiscal years end December 31; however, the financial information of these subsidiaries included in these consolidated financial statements is as of and for the twelve months ended June 30, 2013 and 2012.
THVG owns equity interests in and operates ambulatory surgery centers, surgical hospitals, and related businesses in the Dallas/Fort Worth, Texas, metropolitan area. At June 30, 2013, THVG operated thirty facilities (the Facilities) under management contracts, twenty-nine of which are consolidated for financial reporting purposes and one of which is accounted for under the equity method. In addition, THVG holds equity method investments in two partnerships that each own the real estate used by two of the Facilities.
THVG has been funded by capital contributions from its members and by cash distributions from the Facilities. The board of managers, which is controlled by Baylor, initiates requests for capital contributions. The Facilities’ operating agreements provide that cash flows available for distribution will be distributed at least quarterly to THVG and other owners of the Facilities.
THVG’s operating agreement provides that the board of managers determine, on at least a quarterly basis, if THVG should make a cash distribution based on a comparison of THVG’s excess cash on hand versus current and anticipated needs, including, without limitation, needs for operating expenses, debt service, acquisitions, and a reasonable contingency reserve. The terms of THVG’s operating agreement provide that any distributions, whether driven by operating cash flows or by other sources, such as the distribution of noncash assets or distributions in the event THVG liquidates, are to be shared according to each member’s overall ownership level in THVG.
Basis of Accounting
THVG maintains its books and records on the accrual basis of accounting, and the consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Management has determined that the consolidated entities all perform the same business activities and therefore should be considered as one reporting segment.
Principles of Consolidation
The consolidated financial statements include the financial statements of THVG and its wholly owned subsidiaries and other entities THVG controls. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management of THVG to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Cash Equivalents
THVG considers all highly liquid instruments with original maturities when purchased of three months or less to be cash equivalents. There were no cash equivalents at June 30, 2013 or 2012. Under the Company’s cash management system, checks issued but not presented to the bank may result in book cash overdraft balances for accounting purposes. The company reclassifies book overdrafts to accounts payable, which are reflected as an operating activity in its consolidated statements of cash flows. Book overdrafts included in accounts payables were $10.9 million as of June 30, 2013.
Patient Receivables
Patient receivables are stated at estimated net realizable value. Significant concentrations of patient receivables at June 30, 2013 and 2012 include:
Receivables from government-related programs (i.e. Medicare and Medicaid) represent the only concentrated groups of credit risk for THVG and management does not believe that there is any credit risk associated with these receivables. Commercial and managed care receivables consist of receivables from various payors involved in diverse activities and subject to differing economic conditions, and do not represent any concentrated credit risk to THVG. THVG maintains allowances for uncollectible accounts for estimated losses resulting from the payors’ inability to make payments on accounts. THVG assesses the reasonableness of the allowance account based on historic write-offs, the aging of accounts and other current conditions. Furthermore, management continually monitors and adjusts the allowances associated with its receivables. Accounts are written off when collection efforts have been exhausted.
Supplies
Supplies, consisting primarily of pharmaceuticals and supplies inventories, are stated at cost, which approximates market value, and are expensed as used.
Property and Equipment
Property and equipment are initially recorded at cost or, when acquired as part of a business combination, at fair value at the date of acquisition. Depreciation is calculated on the straight line method over the estimated useful lives of the assets. Upon retirement or disposal of assets, the asset and accumulated depreciation accounts are adjusted accordingly, and any gain or loss is reflected in earnings or loss of the respective period. Maintenance costs and repairs are expensed as incurred; significant renewals and betterments are capitalized.
Assets held under capital leases are classified as property and equipment and amortized using the straight line method over the shorter of the useful lives or the lease terms, and the related obligations are recorded as debt. Amortization of property and equipment held under capital leases and leasehold improvements is included in depreciation and amortization expense.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
THVG records operating lease expense on a straight-line basis unless another systematic and rational allocation is more representative of the time pattern in which the leased property is physically employed. THVG amortizes leasehold improvements, including amounts funded by landlord incentives or allowances, for which the related deferred rent is amortized as a reduction of lease expense, over the shorter of their economic lives or the lease term.
Investments in Unconsolidated Affiliates
Investments in unconsolidated affiliates in which THVG exerts significant influence, but has less than a controlling ownership, are accounted for under the equity method. THVG exerts significant influence in the operations of its unconsolidated affiliates through representation on the governing bodies of the investees and additionally, with respect to the Facilities, through contracts to manage the operations of the investees.
Equity in earnings of unconsolidated affiliates consists of THVG’s share of the profits and losses generated from its noncontrolling equity investments. Because these operations are central to THVG’s business strategy, equity in earnings of unconsolidated affiliates is classified as a component of operating income in the accompanying consolidated statements of income. THVG has contracts to manage these facilities, which results in THVG having an active role in the operations of these facilities.
Intangible Assets and Goodwill
Intangible assets consist of costs in excess of net assets acquired (goodwill), costs associated with the purchase of management service contract rights, and other intangibles. Most of these assets have indefinite lives. Accordingly, these assets are not amortized but are instead tested for impairment annually, using the market and income approach, or more frequently if changing circumstances warrant.
To determine the fair value of our goodwill reporting units, we generally use a present value technique (discounted cash flow) corroborated by market multiples and/or data from third-party valuation specialists. The factor most sensitive to change with respect to our discounted cash flow analyses is the estimated future cash flows of each reporting unit which is, in turn, sensitive to our estimates of future revenue growth and margins for these businesses. If actual revenue growth and/or margins are lower than our expectations, the impairment test results could differ. We base our fair value estimates on assumptions we believe to be reasonable and consistent with market participant assumptions, but that are unpredictable and inherently uncertain.
The provisions of the accounting standard for goodwill require that we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. An analysis of the goodwill balance was performed in March of 2013 and no such impairment was identified in 2013 or 2012.
THVG amortizes intangible assets with definite useful lives over their respective useful lives to the estimated residual values and reviews them for impairment in the same manner as long-lived assets, as discussed below.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset, or related groups of assets, may not be fully recoverable from estimated future cash flows. In the event of impairment, measurement of the amount of impairment may be based on appraisal, fair values of similar assets or estimates of future undiscounted cash flows resulting from use and ultimate disposition of the asset. No such impairment was identified in 2013 or 2012.
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in an orderly transaction between market participants to sell the asset or transfer the liability. The Company uses fair value measurements based on quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2) or unobservable inputs (Level 3), depending on the nature of the item being valued. The Company does not have financial assets or liabilities measured at fair value on a recurring basis at June 30, 2013. The carrying amounts of cash, funds due from United Surgical Partners, Inc., accounts receivable, and accounts payable approximate fair value because of the short maturity of these instruments.
The fair value of the Company’s long-term debt is determined by Level 2 inputs which are an estimation of the discounted future cash flows of the debt at rates currently quoted or offered to a comparable company for similar debt instruments of comparable maturities by its lenders. At June 30, 2013, the aggregate carrying amount and estimated fair value of long-term debt were $32,367,000 and $33,939,000, respectively. At June 30, 2012, the aggregate carrying amount and estimated fair value of long term debt were $37,754,000 and $37,116,000, respectively.
Revenue Recognition
THVG has agreements with third-party payors that provide for payments to THVG at amounts different from its established rates. Payment arrangements include prospectively-determined rates per discharge, reimbursed costs, discounted charges, and per diem payments. Net patient service revenue is reported at the estimated net realizable amount from patients, third-party payors, and others for services rendered, including estimated contractual adjustments under reimbursement agreements with third party payors. Contractual adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. These contractual adjustments are related to the Medicare and Medicaid programs, as well as managed care contracts.
Net patient service revenue from the Medicare and Medicaid programs accounted for approximately 13% of total net patient service revenue in both 2013 and 2012.
Net patient service revenue from managed care contracts accounted for approximately 84% of net patient service revenue in 2013 and 2012.
Net patient service revenue from private payors accounted for approximately 3% of total net patient service revenue in both 2013 and 2012.
For facilities licensed as hospitals, federal regulations require the submission of annual cost reports covering medical costs and expenses associated with services provided to program beneficiaries. Medicare and Medicaid cost report settlements are estimated in the period services are provided to beneficiaries.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is a reasonable possibility that recorded estimates with respect to the six THVG facilities licensed as hospitals may change as interpretations are clarified. These initial estimates are revised as needed until final cost reports are settled.
Income Taxes
No amounts for federal income taxes have been reflected in the accompanying consolidated financial statements because the federal tax effects of THVG’s activities accrue to the individual members.
The Texas franchise tax applies to all THVG entities and is reflected in the accompanying consolidated statements of income. Under the revised law, the tax is calculated on a margin base and is therefore reflected in THVG’s consolidated statements of income for the years ended June 30, 2013 and 2012 as income tax.
THVG follows the provisions of ASC 740, “Income Taxes”, which prescribes a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements.
As of June 30, 2013 and 2012, THVG had no gross unrecognized tax benefits. THVG files a partnership income tax return in the U.S. federal jurisdiction and a franchise tax return in the state of Texas. THVG is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2007. THVG has identified Texas as a “major” state taxing jurisdiction. THVG does not expect or anticipate a significant change over the next twelve months in the unrecognized tax benefits.
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties, and other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated.
Recently Issued Accounting Pronouncements
In July 2011, The Financial Accounting Standards Board (FASB) issued ASU 2011-07, “Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities.” This ASU requires certain health care entities to change the presentation of their statement of operations by reclassifying the provision for bad debts associated with patient service revenue from an operating expense to a deduction from patient service revenue (net of contractual allowances and discounts). Additionally, those health care entities are required to provide enhanced disclosure about their policies for recognizing revenue and assessing bad debts. The amendments also require disclosures of patient service revenue (net of contractual allowances and discounts) as well as qualitative and quantitative information about changes in the allowance for doubtful accounts. For public entities, this ASU is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2011, with early adoption permitted. For nonpublic entities, the amendments are effective for the first annual period ending after December 15, 2012, and interim and annual periods thereafter, with early adoption permitted. The amendments to the presentation of the provision for bad debts related to patient service revenue in the statement of operations should be applied retrospectively to all prior periods presented. The disclosures required by the amendments in this Update should be provided for the period of adoption and subsequent reporting periods. THVG has concluded that this ASU will have no impact on its financial statements.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
In September 2011, the FASB issued ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” This ASU provides an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to the determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, an entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early application permitted in an entity’s financial statements that have not yet been issued. THVG plans to reevaluate, on a yearly basis, whether or not to elect to implement this option in testing for impairment to goodwill.
In February 2012, the FASB issued ASU 2012-02,“Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” This ASU provides an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to the determination that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If, after assessing the totality of events and circumstances, an entity determines that it is not more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying amount, then performing the two-step impairment test is unnecessary. This ASU is effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012 with early application permitted in an entity’s financial statements that have not yet been issued. THVG plans to reevaluate, on a yearly basis, whether or not to elect to implement this option in testing for impairment to indefinite-lived intangible assets.
2. PROPERTY AND EQUIPMENT
At June 30, 2013 and 2012, property and equipment and related accumulated depreciation and amortization consisted of the following (in thousands):
At June 30, 2013 and 2012, assets recorded under capital lease arrangements included in property and equipment consisted of the following (in thousands):
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
3. CAPITAL CONTRIBUTIONS BY MEMBERS
As discussed in Note 1, THVG receives part of its funding through cash and capital contributions from its members. During fiscal year 2012, THVG received noncash capital contributions consisting primarily of investments in partnerships that operate surgery centers in the Dallas/Fort Worth area. These noncash capital contributions, including THVG’s ownership in the investee, are as follows (in thousands):
USP previously had a controlling interest in Park Cities. On the effective date listed above, USP sold 25% interest in Park Cities to Baylor. Through the contributions of USP and Baylor, THVG obtained control of Park Cities, and accounted for the acquisition as a business combination in accordance with ASC 805. THVG recorded the contribution from Baylor at predecessor basis, as it was a common control transaction between a parent and subsidiary. In this transaction, Baylor’s predecessor basis is the same as fair value since the transfer happened at the same time as the business combination for Baylor. THVG recorded the contribution from USP at fair value, based on an appraisal, as USP is a noncontrolling interest holder.
Concurrent with the contribution, THVG began managing the operations of this facility. The result of this transaction is included in THVG’s consolidated results of operations from the date of contribution.
The assets acquired and liabilities assumed resulting from the above contribution is summarized as follows (in thousands):
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
4. INVESTMENTS IN SUBSIDIARIES AND UNCONSOLIDATED AFFILIATES
THVG’s investments in consolidated subsidiaries and unconsolidated affiliates consisted of the following:
(1) List excludes holding companies, which are wholly owned by the Company and hold the Company’s investments in the Facilities.
(2) Partnership that has investment in North Central Surgical Center, Baylor Surgicare, and Mary Shields Hospital.
(3) These entities are not surgical facilities and do not have ownership in any surgical facilities.
In September of 2011, North Central Surgical Center, L.L.P. (North Central), which is consolidated by THVG, acquired Carrell Clinic Imaging Center, and all of its assets and liabilities.
There were no equity acquisitions during fiscal year 2013.
THE REMAINDER OF THIS PAGE WAS INTENTIONALY LEFT BLANK
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
The following table summarizes the recorded values of the assets acquired and liabilities assumed at the dates of acquisition (in thousands):
The acquisition was accounted for in accordance with ASC 805 and the acquisition method was applied. THVG paid $3.6 million in cash and the acquisition was recorded at fair value, which resulted in goodwill for the parent.
The results of this acquisition are included in THVG’s consolidated statements of income from the date of acquisition. Total acquisition costs included in professional fees on THVG’s consolidated statement of income were $113,000 for 2012.
5. NONCONTROLLING INTERESTS
The Company controls and therefore consolidates the results of 29 of its 30 facilities at June 30, 2013. Similar to its investments in unconsolidated affiliates, the Company regularly engages in the purchase and sale of equity interests with respect to its consolidated subsidiaries that do not result in a change of control. These transactions are accounted for as equity transactions, as they are undertaken among the Company, its consolidated subsidiaries, and noncontrolling interests, and their cash flow effect is classified within financing activities.
During the fiscal year ended June 30, 2013, the Company purchased and sold equity interests in various consolidated subsidiaries in the amounts of $1,739,000 and $671,000, respectively. During the fiscal year ended June 30, 2012, the Company purchased and sold $2,044,000 and $1,403,000, respectively. The basis difference between the Company’s carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to the Company’s equity. The impact of these transactions is summarized as follows (in thousands):
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
As further described in Note 1, upon the occurrence of various fundamental regulatory changes, the Company could be obligated, under the terms of its investees’ partnership and operating agreements, to purchase some or all of the noncontrolling interests related to the Company’s consolidated subsidiaries. As a result, these noncontrolling interests are not included as part of the Company’s equity and are carried as noncontrolling interests-redeemable on the Company’s consolidated balance sheets. The activity in noncontrolling interests-redeemable for the years ended June 30, 2013 and 2012 is summarized below (in thousands):
6. GOODWILL AND INTANGIBLE ASSETS
At June 30, 2013 and 2012, goodwill and intangible assets, net of accumulated amortization, consisted of the following (in thousands):
The following is a summary of changes in the carrying amount of goodwill for the years ended June 30, 2013 and 2012 (in thousands):
Goodwill additions resulting from business combinations are recorded and assigned to the parent and noncontrolling interests.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Intangible assets with definite useful lives are amortized over their respective estimated useful lives. The agreements underlying THVG’s management contract assets have no determinable termination date and, consequently, the related intangible assets have indefinite useful lives. The carrying amount of THVG’s management contract was approximately $1,150,000 at both June 30, 2013 and 2012. Goodwill and intangible assets with indefinite useful lives are not amortized but instead are tested for impairment at least annually. No impairment was identified in 2013 or 2012.
THVG allows one year from the date of acquisition, to adjust the opening balance sheet of the acquired entity. The $848,000 adjustment for North Central Carrell Clinic is a balance sheet reclassification from goodwill to property and equipment with no income statement impact.
7. LONG-TERM OBLIGATIONS
At June 30, 2013 and 2012, long-term obligations consisted of the following (in thousands):
The aggregate maturities of notes payable for each of the five years subsequent to June 30, 2013 and thereafter are as follows (in thousands):
The Facilities have notes payable to financial institutions which mature at various dates through 2031 and accrue interest at fixed and variable rates ranging from 3% to 7%. Each note is collateralized by certain assets of the respective Facility.
Capital lease obligations are collateralized by underlying real estate or equipment and have interest rates ranging from 1% to 13%.
8. LEASES
The Facilities lease various office equipment, medical equipment, and office space under a number of operating lease agreements, which expire at various times through the year 2030. Such leases do not involve contingent rentals, nor do they contain significant renewal or escalation clauses. Office leases generally require the Facilities to pay all executory costs (such as property taxes, maintenance and insurance).
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Minimum future payments under noncancelable leases with remaining terms in excess of one year as of June 30, 2013 are as follows (in thousands):
Total rent expense under operating leases was approximately $19,791,000 and $19,085,000 for the years ended June 30, 2013 and 2012, respectively, and is included in other operating expenses in the accompanying consolidated statements of income.
9. RELATED-PARTY TRANSACTIONS
THVG operates the Facilities under management and royalty contracts, and THVG in turn is managed by Baylor and USP, resulting in THVG incurring management and royalty fee expense payable to Baylor and USP in amounts equal to the management and royalty fee income THVG receives from the Facilities. THVG’s management and royalty fee income from the facilities it consolidates for financial reporting purposes eliminates in consolidation with the facilities’ expense and therefore is not included in THVG’s consolidated revenues. THVG’s management and royalty fee income from facilities which are not consolidated was approximately $600,000 and $547,000 for the years ended June 30, 2013 and 2012, respectively, and is included in the consolidated revenues of THVG.
The management and royalty fee expense to Baylor and USP was approximately $28,276,000 and $27,333,000 for the years ended June 30, 2013 and 2012, respectively, and is reflected in operating expenses in THVG’s consolidated statements of income. Of the total, 64.3% and 34.0% represent management fees payable to USP and Baylor, respectively, and 1.7% represents royalty fees payable to Baylor.
Under the management and royalty agreements, the Facilities pay THVG an amount ranging from 4.5% to 7% of their net patient service revenue less provision for doubtful accounts annually, subject, in some cases, to an annual cap.
In addition, a subsidiary of USPI frequently pays bills on behalf of THVG and has custody of substantially all of THVG’s excess cash, paying THVG and the Facilities interest income on the net balance at prevailing market rates. Amounts held by USPI on behalf of THVG and the facilities totaled $49,323,000 and $46,854,000 at June 30, 2013 and 2012, respectively. The interest income amounted to $93,350 and $90,560 for the years ended June 30, 2013 and 2012, respectively.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
10. COMMITMENTS AND CONTINGENCIES
Financial Guarantees
THVG guarantees portions of the indebtedness of its investees to third-parties, which could potentially require THVG to make maximum aggregate payments totaling approximately $8,394,000. Of the total, $6,038,000 relates to the obligations of four consolidated subsidiaries whose obligations are included in THVG’s consolidated balance sheet and related disclosures, $1,674,000 relates to obligations of two consolidated subsidiaries under operating leases whose obligations are not included in THVG’s consolidated balance sheet and related disclosures and the remaining $682,000 relates to the obligations of an unconsolidated affiliated company whose obligations are not included in THVG’s consolidated balance sheet and related disclosures.
These arrangements (a) consist of guarantees of real estate and equipment financing, (b) are collateralized by all or a portion of the investees’ assets, (c) require payments by THVG in the event of a default by the investee primarily obligated under the financing, (d) expire as the underlying debt matures at various dates through 2020, or earlier if certain performance targets are met, and (e) provide no recourse for THVG to recover any amounts from third-parties. The fair value of the guarantee liability was not material to the consolidated financial statements and, therefore, no amounts were recorded at June 30, 2013 related to these guarantees. When THVG incurs guarantee obligations that are disproportionately greater than the guarantees provided by the investee’s other owners, THVG charges the investee a fair market value fee based on the value of the contingent liability THVG is assuming.
Litigation and Professional Liability Claims
In their normal course of business, the Facilities are subject to claims and lawsuits relating to patient treatment. THVG believes that its liability for damages resulting from such claims and lawsuits is adequately covered by insurance or is adequately provided for in its consolidated financial statements. USPI, on behalf of THVG and each of the Facilities, maintains professional liability insurance that provides coverage on a claims-made basis of $1,000,000 per incident and $11,000,000 in annual aggregate amount with retroactive provisions upon policy renewal. Certain of THVG’s insurance policies have deductibles and contingent premium arrangements. THVG believes that the expense recorded through June 30, 2013, which was estimated based on historical claims, adequately provides for its exposure under these arrangements. Additionally, from time to time, THVG may be named as a party to other legal claims and proceedings in the ordinary course of business. THVG is not aware of any such claims or proceedings that have more than a remote chance of having a material adverse impact on THVG.
11. SUBSEQUENT EVENTS
THVG regularly engages in exploratory discussions or enters into letters of intent with various entities regarding possible joint ventures, development, or other transactions. These possible joint ventures, developments of new facilities, or other transactions are in various stages of negotiation.
In September of 2012, Fort Worth Surgicare Partners, Ltd (“Hospital”) entered into a debt agreement on behalf of Park Place Investor Group, LP, for the purpose of purchasing land to build a new facility for the operations of the Hospital. The $8.1 million note was recorded within Accrued expenses and other on the balance sheet, with the intention to sell the note and land, at cost, to Park Place Investor Group, LP once the entity was legally formed. In August of 2013, the note and land was sold to Park Place Investor Group, LP at cost with no fair value impact to the Hospital. Park Place Investor Group, LP also reimbursed $1.9 million of expenses incurred by the Hospital during the purchase process.
TEXAS HEALTH VENTURES GROUP, L.L.C. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - (Continued)
Effective October 1, 2013, Baylor Health Care System (BHCS) and Scott & White Healthcare, a Texas nonprofit corporation (S&W), have consummated their affiliation (the “Affiliation”) pursuant to an Affiliation Agreement (the “Affiliation Agreement”) dated June 19, 2013. The Affiliation was accomplished through the creation of a new Texas limited liability company, Baylor Scott & White Health LLC (“Baylor Scott & White Health”). BHCS and S&W are equal members in Baylor Scott & White Health, which has control and substantial reserved powers over all BHCS and S&W material affiliates. THVG is defined as a material affiliate of BHCS in the Affiliation Agreement.
THVG has performed an evaluation of subsequent events through November 8, 2013, which is the date the consolidated financial statements were available to be issued.
(4) Exhibits:
IV-1
IV-2
(1) Previously filed.
(2) Filed herewith.
(3) Management contract or compensatory plan or arrangement in which a director or executive officer participates.
IV-3
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
By:
/s/ WILLIAM H. WILCOX
William H. Wilcox
Chief Executive Officer and Director
Date: February 25, 2014
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in capacities and on the dates indicated.
IV-4
* W. Bradley Bickham, by signing his name hereto, does hereby sign this Annual Report on Form 10-K on behalf of each of the above-named directors and officers of the Company on the date indicated below, pursuant to powers of attorney executed by each of such directors and officers and contemporaneously filed herewith with the Commission.
By:
/s/ W. Bradley Bickham
W. Bradley Bickham
Attorney-in-fact
Date: February 25, 2015
IV-5
INDEX TO EXHIBITS
IV-6
IV-7
(1) Previously filed.
(2) Filed herewith.
(3) Management contract or compensatory plan or arrangement in which a director or executive officer participates.
IV-8