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U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-KSB/A AMENDMENT NO. 1 TO
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 SURGICARE, INC. (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
 DELAWARE
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
    58-1597246(I.R.S. EMPLOYER IDENTIFICATION NO.)12727 KIMBERLEY LANE, SUITE 200 HOUSTON, TX
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
    77024(ZIP CODE)
 ISSUERS TELEPHONE NUMBER: (713) 973-6675 SECURITIES REGISTERED UNDER SECTION 12(b) OF THE ACT: NAME OF EACH EXCHANGE ONTITLE OF EACH CLASS
    
    WHICH REGISTEREDCOMMON STOCK, $.005 PAR
VALUE
    
    THE AMERICAN STOCK EXCHANGE
 Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained, and no disclosure will be contained in this form, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. o SurgiCares revenues for fiscal year ended December 31, 2003: $8,064,523. As of March 31, 2004, 28,408,685 shares of the registrants common stock were
outstanding. The aggregate market value of the shares of common stock of the
registrant held by non-affiliates on March 31, 2004 was approximately
$9,386,036 based upon a per share price of $0.38, the closing price per share
for the companys common stock on the American Stock Exchange on that day.




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SURGICARE, INC. FORM 10-KSB/A TABLE OF CONTENTS PART IItem 1. Description of BusinessItem 2. Description of PropertyItem 3. Legal ProceedingsItem 4. Submission or matters to a Vote of Security HoldersPART IIItem 5. Market for Common Equity and Related Stockholder Matters.Item 6. Managements Discussion and Analysis or Plan of OperationItem 7. Financial StatementsItem 8. Changes in and Disagreements with AccountantsItem 8A. Controls and ProceduresPART IIIItem 9. Directors and Executive Officers of the RegistrantItem 10. Executive CompensationItem 11. Security Ownership of Certain Beneficial Owners and ManagementItem 12. Certain Relationships and Related TransactionsItem 13. Exhibits and Reports on Form 8-KItem 14. Principal Accounting Fees and ServicesSignatures




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PART I ITEM 1. DESCRIPTION OF BUSINESS THE COMPANY SurgiCare, Inc. (SurgiCare, Company, we, us, or our) was
incorporated in Delaware on February 24, 1984 as Technical Coatings
Incorporated. On September 10, 1984, its name was changed to Technical
Coatings, Inc. (TCI). Immediately prior to July 1999, TCI was an inactive
company. On July 11, 1999, TCI changed its name to SurgiCare Inc., and at that
time changed its business strategy to developing, acquiring and operating
freestanding ambulatory surgery centers (ASC). On July 21, 1999, SurgiCare
acquired all of the issued and outstanding shares of common stock of Bellaire
SurgiCare, Inc., a Texas corporation (Bellaire), in exchange for the issuance
of 9.86 million shares of common stock, par value $.005 per share (Common
Stock) and 1.35 million shares of Series A Redeemable Preferred Stock, par
value $.001 per share (Series A Preferred), of SurgiCare to the holders of
Bellaires common stock. For accounting purposes, this reverse acquisition was
effective July 1, 1999. As of December 31, 2003, the company owned a majority interest in three
surgery centers and a minority interest as general partner in one additional
center. Three of SurgiCares centers are located in Texas and one is located
in Ohio. In limited circumstances, SurgiCare, or its subsidiaries may also
furnish anesthesia services in support of the activities of the surgery
centers. Our ASCs perform various types of procedures including: orthopedic
surgery, colonoscopy, ophthalmic laser surgery, pain injections and various
pediatric surgeries. The most common procedures performed in our ASCs include
knee arthroscopy, lumbar nerve block and sacral injection, colonoscopy,
hammertoe correction, sinus endoscopic biopsy, cataract removal, breast biopsy,
Mitchell procedures and cystourethroscopy. With a view to SurgiCare consolidating the operations of some or all of
these surgery centers, SurgiCare anticipates that it will need to adjust its
ownership interest in such centers to establish an ownership interest of
approximately 35% in each surgery center in keeping with our strategy of
maximizing our investor pool. SurgiCare anticipates that allowing physicians
who perform cases at a surgery center to own a majority interest of each
surgery center will generate more revenues and be more profitable. SurgiCare
believes that physician owned centers are typically more profitable because
physicians who own an ambulatory surgery center are the centers most
significant source of patients and benefactors. Generally, it is the operating
physician, not the patient, who chooses the facilities where surgical
procedures are to be performed. By allowing physicians to own approximately
sixty-five percent of the interest in the surgery centers, there is more
opportunity for more physicians to own an interest in the surgery center. When
physicians have an ownership interest in surgery centers, they have an
incentive to make the surgery centers as profitable as possible. Therefore,
despite SurgiCares lower ownership percentage, it believes net earnings will
improve due to the restructuring. We have begun the process of restructuring the ownership of the surgery
center partnership that owns and operates the Bellaire ASC to allow for the
sale of investment interests to additional operating physicians practicing in
that area of Houston, Texas. The Bellaire partnership prepared a private
placement memorandum for the private offering of partnership interests to Texas
resident physicians, which it released on April 15, 2004. Sixty-five percent
(65%) of the total ownership interest in the Bellaire partnership is being
offered for sale. This offering is a purely intrastate transaction and is
exempt from federal securities laws. If it is determined that federal
securities laws apply, SurgiCare believes the offering is exempt pursuant to
Section 4(2) of the Securities Act and Rule 506 of Regulation D. Our principal executive offices are located at 12727 Kimberley Lane, Suite
200, Houston, TX 77024, and our telephone number is 713-973-6675. PROPOSED RESTRUCTURING TRANSACTIONS We have negotiated a series of transactions that will restructure
SurgiCare and result in a change of control. In this report, these proposed
transactions are collectively called the Restructuring. The transactions
include the acquisition of three new businesses and issuance of new equity
securities for cash and contribution of outstanding debt. We also intend to complete a reverse
stock split and change our name to Orion HealthCorp, Inc.
(Orion). Our board of
directors has 3




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approved all of these actions and a special meeting of stockholders in
lieu of an annual meeting will be held to approve them. The highlights of the
financial transactions include:  
    
    Effecting a one-for-ten reverse stock split and re-designating
our outstanding common stock as Class A common stock.
    
    Issuing a new class of common stock Class B common stock to
Brantley Partners IV, L.P., a private investor (Brantley IV) or its
assignees. Brantley IV will purchase the Class B common stock for $10
million in cash plus cash in the amount of the accrued but unpaid
interest immediately prior to the closing of the transactions owed to
a subsidiary of Brantley IV by SurgiCare and Integrated Physician
Solutions, Inc. (IPS) on amounts advanced prior to October 24, 2003
(the Base Bridge Interest Amount), which as of July 19, 2004 was
$86,252. A portion of Brantley IVs cash investment will be used to
pay off the indebtedness owed by SurgiCare and IPS to the subsidiary
of Brantley IV. Based on the interest accrued on such indebtedness
through July 19, 2004, it is estimated that the net cash proceeds to
SurgiCare will be approximately $5,751,233. The shares to be received
by Brantley IV or its assignees will constitute approximately 59.0% of
SurgiCares outstanding equity after the transactions on an
as-converted basis. Brantley IV will also receive the option to
purchase shares of Class A stock for cash in an amount up to an
aggregate of $3 million after the closing of the transactions.
    
    Acquiring IPS, a holding company whose two business units provide
business management services dedicated to the practice of pediatrics
and integrated business and clinical software applications for
physicians, in a merger in which we will issue Class A common stock to
the IPS stockholders and certain IPS creditors. After the
transactions, former IPS stockholders and creditors will own
approximately 18.1% of our outstanding equity on an as-converted
basis.
    
    Acquiring Medical Billing Services, Inc. (MBS), and Dennis Cain
Physician Solutions, Ltd. (DCPS), two providers of physician
management, billing, consulting and collection services in an
acquisition in which we will pay between $2.9 million and $3.5 million
cash and issue promissory notes in the aggregate principal amount of
$500,000 and Class C common stock to the current equity holders of MBS
and DCPS. The amount of consideration received depends upon the fair
market value of our common stock at the time of the closing of the
transactions, and the consideration is also subject to retroactive
increase or decrease, including the issuance of additional shares of
Class A common stock. We will also issue shares of Class A common
stock as directed by the DCPS and MBS equity holders, and may be
required to make additional payments in certain circumstances.
Immediately after the transactions, the equity holders of these two
companies and their designees will own Class A common stock and Class
C common stock which may amount to as much as approximately 7.7% of
our outstanding equity on an as-converted basis. These transactions are contingent upon refinancing SurgiCares, IPSs and
MBSs debt. The transactions and the refinancing will provide SurgiCare with
increased revenues and earnings, an improved balance sheet and the opportunity
to grow the business. Please review our proxy statement for our special
meeting of stockholders in lieu of an annual meeting, filed with the SEC for
the full details of the proposed restructuring. Prior to the proposed amendments to its certificate of incorporation ,
SurgiCare is authorized to issue up to 50,000,000 shares of common stock, par
value $.005 per share, and 20,000,000 shares of preferred stock, par value
$.001 per share. OUR SURGICAL CENTERS Bellaire SurgiCare, Inc. Bellaire owns and operates an ASC located in Houston, Texas. The ASC has
been in operation for 14 years, first as The Institute for Eye Surgery, and
since March of 1995, as Bellaire SurgiCare, Inc. This center provides the
venue for a wide range of high volume, lower-risk surgical procedures within a
multi-specialty environment. Surgeons specializing in podiatry, orthopedics,
pain management, gynecology, as well as reconstructive and general surgery
utilize this facility. The surgeons performing surgery at Bellaire generally
charge their patients for the professional services they provide, while
Bellaire only charges the patients for the facility fee. While Bellaire is
currently a wholly-owned subsidiary of SurgiCare, we have begun the process of
restructuring the ownership of the surgery center owned and operated by
Bellaire to allow for the sale of investment interests to operating physicians
in 4




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such surgery center. In 2003, there were 1,803 patients treated at Bellaire by
approximately 30 doctors, 14 of which have an ownership interest in the
Company. SurgiCare Memorial Village, L.P. SurgiCare, through its wholly owned subsidiary Town & Country SurgiCare,
Inc., owns a 60% general partnership interest in SurgiCare Memorial Village,
L.P. (Memorial Village). This center provides the venue for a wide range of
high volume, lower-risk surgical procedures within a multi-specialty
environment. Surgeons specializing in podiatry, orthopedics, pain management,
gynecology, reconstructive, as well as general surgery utilize this facility.
The surgeons performing surgery at Memorial Village generally charge their
patients for the professional services they provide, while Memorial Village
only charges the patients for the facility fee. In 2003, there were 2,226
patients treated at Memorial Village by approximately 60 doctors, 25 of which
have an ownership interest in Memorial Village. San Jacinto Surgery Center, L.P. SurgiCare through its wholly owned subsidiary Baytown SurgiCare, Inc. owns
a 10% general partnership interest in San Jacinto Surgery Center, L.P. (San
Jacinto). This center provides the venue for a wide range of high volume,
lower-risk surgical procedures within a multi-specialty environment. Surgeons
specializing in podiatry, orthopedics, pain management, gynecology, plastics,
as well as general surgery, utilize this facility. The surgeons performing
surgery at San Jacinto generally charge their patients for the professional
services they provide, while San Jacinto only charges the patients for the
facility fee. In 2003, there were 4,214 patients treated at San Jacinto by
approximately 43 doctors, 19 of which have an ownership interest in San
Jacinto. Tuscarawas Ambulatory Surgery Center, LLC SurgiCare owns a 51% interest in Tuscarawas Ambulatory Surgery Center, LLC
(Tuscarawas) located in Dover, Ohio. This center provides the venue for a wide
range of high volume, lower-risk surgical procedures within a multi-specialty
environment. Surgeons specializing in orthopedics, ear, nose and throat and
general surgery utilize this facility. The surgeons performing surgery at the
center generally charge their patients for the professional services they
provide, while Tuscarawas only charges the patients for the facility fee. In
2003, there were 2,762 patients treated at Tuscarawas by approximately 25
doctors, 12 of which have an ownership interest in Tuscarawas. INDUSTRY OVERVIEW ASCs are licensed outpatient surgery centers, generally equipped and
staffed for a wide variety of surgical procedures. These procedures are
generally lower-risk and considered appropriate for the freestanding ambulatory
setting. In recent years, government programs, private insurance companies,
managed care organizations and self-insured employers have implemented various
cost-containment measures to limit the growth of healthcare expenditures. These
cost-containment measures, together with technological advances, have resulted
in a significant shift in the delivery of healthcare services away from
traditional inpatient hospitals to more cost-effective alternative sites,
including ASCs. This shift is illustrated by an outpatient market study,
performed by Verispan, L.L.C. shows an 81% increase in surgeries provided
outside traditional hospitals, over a 7 year period from 1996 to 2003. SurgiCare believes that the following factors have contributed to the growth of ASCs: Cost-effective Alternative. ASCs are not usually saddled with the high
cost and overhead of the ancillary services such as administration, laboratory,
radiology, or dietary, that are generally found in the hospital settings.
Therefore, surgery is generally less expensive than hospital inpatient surgery.
In addition, SurgiCare believes that surgery performed at a freestanding ASC is
also less expensive than hospital-based ambulatory surgery for a number of
reasons, including:  
    
    Lower facility development costs;
    
    More efficient use of staffing and space utilization; and
    
    Specialized operating environment focused on cost containment. 5




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SurgiCare believes that interest in ASCs has grown as managed care
organizations have continued to seek a cost-effective alternative to inpatient
services. Physician and Patient Preference. Operating physicians, who have
determined that their patients are in need of a surgical procedure, generally
choose in which facility the surgery will be performed. In most cases, patients
will have their surgery performed at the facility that their doctor determines
is most appropriate. Freestanding ASCs subject neither doctors nor their patients to the large
institutional environment found at both acute care inpatient hospitals, and
outpatient surgery centers located within a hospital. SurgiCare believes that because of the ease of admission and discharge,
many physicians prefer ASCs. SurgiCare believes that such centers enhance
physicians productivity by providing them with greater scheduling flexibility,
more consistent nurse staffing and faster turnaround time between cases. This
allows the physician to perform more surgeries in a defined period. In contrast, hospitals generally serve a broader group of physicians,
including those involved with emergency procedures, resulting in postponed or
delayed surgeries. Additionally, many physicians choose to perform surgery in
an ASC because their patients prefer the simplified admissions and discharge
procedures and the less institutional atmosphere. New Technology. The increased use of minimally invasive surgery, enhanced
endoscopic techniques and fiber optics, have reduced the trauma and recovery
time associated with many surgical procedures. Improved anesthesia has
shortened recovery time by minimizing postoperative side effects such as nausea
and drowsiness, thereby avoiding, in some cases, overnight hospitalization.
These new technologies and advances in anesthesia, which have been increasingly
accepted by physicians, have significantly expanded the types of surgical
procedures that are being performed in ASCs. BUSINESS PHILOSOPHY SurgiCare believes that physician owned and operated ASCs are typically
profitable. This profitability results primarily from the fact that physicians
who own and operate an ASC are the centers most significant source of patients
and benefactors. Generally, it is the operating physician, not the patient, who
chooses the facilities where surgical procedures are to be done. Because this
decision is made at the physician level, it is in fact the physicians bringing
patients to the outpatient surgical facility. SurgiCare believes that ASCs receive their patient referrals almost
exclusively from the operating physicians. Therefore, it becomes an extremely
important role of a centers management to insure that the operating physicians
have everything they need, and that they are pleased with the results that they
are able to obtain at the center. If management and the operating physicians
are substantially the same, it becomes much easier to insure that physician
needs are meet, and that their experiences at the centers are pleasant. Furthermore, SurgiCare believes that physicians become more cost conscious
when they own and manage the ASCs in which they practice. This increased cost
consciousness can have a significant positive effect on the overall
profitability of the center without detrimentally affecting the patients. SurgiCare believes that the profitability of freestanding ASCs tends to
make them attractive to acquirers. Nevertheless, following the acquisition of a
physician owned center, evidence suggests that the typical centers
profitability will significantly decrease. SurgiCare believes that this typical
decline in profitability can be explained, in part, because in many of such
acquisitions, the operating physicians lose control of the center. After a
typical acquisition of an ASC, the control of the center is typically vested in
non-physician management. The factors motivating the physician users to insure
the centers profitability are therefore typically removed. SurgiCares management structure consists of physicians and healthcare
professionals. SurgiCares management has substantial experience in the
operation and management of ASCs. SurgiCare also expects that it will issue its
own shares, or other equity interests to the physicians who own and operate
other centers in which SurgiCare may acquire an interest. SurgiCare believes
that it will thereby be able to substantially align the interests 6




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of SurgiCares management and shareholders with those of the physician owners
of centers in which SurgiCare may acquire an interest. SurgiCare also presently
intends to permit each surgery center to be substantially managed by its own
board, which is anticipated to consist of a majority of physicians associated
with the center and one or more representatives of SurgiCare. Based upon this
approach, SurgiCare expects that it will benefit from the substantial unity of
goals and motivations of its own management and shareholders with those of
physicians who have previously owned and operated a freestanding center
acquired, in whole or in part, by SurgiCare. SurgiCare believes that if the goals and motivations for each center are
substantially aligned, then SurgiCare can achieve profitability for every
center in which it acquires an interest. However, there are numerous factors
that affect the profitability of ASCs, including regulatory and liability
matters. Therefore, there can be no assurance that the profitability of any
center or SurgiCare as a whole will be maintained. SurgiCare intends to apply its philosophy in the acquisition, development
and operation of physician owned/managed freestanding ASCs. STRATEGY SurgiCares market strategy is to accelerate penetration of key markets
and expand into new markets by:  
    
    Attracting and retaining top quality, highly productive surgeons
and other physicians. Recognizing the importance of physician
satisfaction, SurgiCare operates its facilities and has designed its
operating model to encourage physicians to choose our facilities.
SurgiCare has identified and seeks to accommodate the key factors in a
physicians decision making process, which SurgiCare believes includes
quality of care, patient comfort, streamlined administrative processes,
efficient operation and overall opportunity for increased physician
productivity.
    
    Enhance physician productivity. SurgiCare intends to enhance
physician productivity and promote increased same-center volumes,
revenues and profitability by increasing physician involvement, and
creating operating efficiencies, including improved scheduling, group
purchasing programs and clinical efficiencies.
    
    Growth through selective domestic acquisitions and development of
surgical facilities. SurgiCare typically targets the acquisition or
development of surgery centers that provide high volume, non-emergency,
lower risk procedures in several medical specialties. Our focus is on
under-performing centers where acquisition prices are modest and the
leverage returns for operational performance improvements is high.
SurgiCares development staff first identifies existing centers that
are potential acquisition candidates. The candidates are then evaluated
against SurgiCares project criteria which may be expected to include
several factors such as number of procedures currently being performed
by the center, competition from and the fees being charged by other
surgical providers, relative competitive market position of the surgery
centers under consideration, ability to contract with payers in the
market and state certificate of need (CON) requirements for
development of a new center. SurgiCare is in the process of
identifying ASCs as potential acquisition targets and has, in some
cases, conducted preliminary discussions with representatives of
centers, although there are no signed letters of intent or any verbal
offers to acquire such surgery centers. SurgiCare expects that the
acquisition of other surgery centers will take the form of mergers,
stock-for-stock exchanges or stock-for-assets exchanges and that in
most instances, the target company will wish to structure the business
combination to be within the definition of a tax-free reorganization
under Section 368 of the Internal Revenue Code of 1986, as amended.
SurgiCare may, however, use other acquisition structuring techniques
including purchases of assets or stock for cash or cash and stock, or
through formation of one or more limited partnerships or limited
liability companies. SurgiCare will typically acquire a minority
interest in a particular center.
    
    Enhance operating efficiencies. We use systems and protocols to
enhance operating efficiencies at both existing and newly acquired or
developed facilities. These systems and protocols include: patient
scheduling and pre-certification process, block scheduling by
physicians, dedicating multiple operating rooms to each physician to
speed turn-around time, and not offering emergency room services
which 7




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ensures ease in scheduling and availability. We believe that this
focus on efficient operations increases our own profitability and
encourages physicians to use our facilities by increasing their
productivity. In addition, efficient operations are critical to our
lower cost model and our competitive advantage in attracting and
negotiating with payers.
    
    Creation of operationally efficient clusters of ASCs. We seek to
build a core management team in each geographical market, which will
gain increased marketing and operational efficiencies as we add new
centers to the market. Spreading the overhead burdens across more
operating units not only reduces the total overhead per center but
also allows us to attract increasingly more competent operating
managers.
    
    Diversification into complimentary healthcare businesses.
SurgiCare expects to diversify into related healthcare markets and
are targeting imaging centers and practice management companies.
SurgiCare is looking to develop and/or acquire imaging centers that
are in conjunction with our surgery centers. This will strategically
position us to service medical outpatient needs and enhance the
practices of the healthcare providers who utilize our services.
SurgiCare is planning to expand into practice management, which is a
core discipline that SurgiCare will need to continue to grow and be
profitable. Servicing surgery centers with practice management
functions can be a source of potential acquisitions. ACQUISITION AND DEVELOPMENT OF SURGERY CENTERS SurgiCares development staff works to identify existing centers that are
potential acquisition candidates and identify physician practices that are
potential partners for new center development in the medical specialties that
SurgiCare has targeted for development. The candidates are then evaluated against SurgiCares project criteria
which may be expected to include several factors such as number of procedures
currently being performed by the practice, competition from and the fees being
charged by other surgical providers, relative competitive market position of
the physician practice under consideration, ability to contract with payers in
the market and state CON requirements for development of a new center. In presenting the advantages to physicians of developing a new
freestanding ASC in partnership with SurgiCare, we anticipate that our
development staff will emphasize the following factors, among others: 1.
    
    SurgiCares model of minority interest, allowing the physicians or
limited partners to own a majority of the center.2.
    
    Simplified administrative procedures.3.
    
    The ability to schedule consecutive cases without preemption by inpatient
or emergency procedures.4.
    
    Rapid turnaround time between cases.5.
    
    The high technical competency of the centers clinical staff that
performs only a limited number of specialized procedures, and
state-of-the-art surgical equipment.
 SurgiCare expects that it will provide the following developmental
services: financial feasibility pro forma analysis; assistance in state CON
approval process; site selection; assistance in space analysis and schematic
floor plan design; analysis of local, state, and federal building codes;
negotiation of equipment financing with lenders; equipment budgeting,
specification, bidding, and purchasing; construction financing; architectural
oversight; contractor bidding; construction management; assistance with
licensing; assistance with Medicare certification and third party managed care
contracts. SurgiCare, under previous management, developed Bellaire surgery center.
SurgiCare, under current management developed Physicians Endoscopy Center, L.P.
(Physicians Endoscopy). SurgiCare sold its interest in Physicians Endoscopy
in June 2003 and SurgiCare acquired Memorial Village, San Jacinto and
Tuscarawas as already established and operating surgery centers. SurgiCares
current management has experience in developing 8




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surgery centers and was responsible for developing five new centers and
managing two centers prior to working for SurgiCare. In addition, SurgiCare is opening the Tuscarawas MRI center to expand our
operations in Dover, Ohio. Sixty percent of the funding is being provided by a
third party lease finance company called Maxus Leasing Group (Maxus). The
Maxus financing is a typical equipment lease financed over five years. The
remaining portion of the funding was loaned to SurgiCare by a wholly-owned
subsidiary of Brantley IV. Brantley IC and SurgiCare are negotiating regarding
the terms of warrants to be issued by SurgiCare in connection with this loan. Going forward, SurgiCare anticipates that its ownership interests in most
of its ASCs will be approximately 35%. However, from time to time, SurgiCare
may identify centers where it is advantageous to acquire a majority interest.
Regardless of the percentage of each center that SurgiCare acquires, the
physicians who had owned and operated a center acquired by SurgiCare, or who
have newly developed a center in partnership with SurgiCare, generally will
become shareholders in SurgiCare. The local physicians will continue to oversee
their operations through an executive committee that interacts with SurgiCare
on a regular basis to provide feedback and set policy. SURGERY CENTER LOCATIONS The following table sets forth information related to SurgiCares surgical
centers in operation as of December 31, 2003: Acquisition
    
    SurgiCareName
    
    Location
    
    Date
    
    OwnershipBellaire SurgiCare
    
    Houston, Texas
    
    July 1999
    
    
    100
    %SurgiCare Memorial Village
    
    Houston, Texas
    
    Oct. 2000
    
    
    60
    %San Jacinto Surgery Center
    
    Baytown, Texas
    
    Oct. 2000
    
    
    10
    %Tuscarawas Ambulatory
Surgery Center
    
    Dover, Ohio
    
    June 2002
    
    
    51
    %
 AAAHC ACCREDITATION Two of SurgiCares surgery centers are accredited by the Accreditation
Association for Ambulatory Health Care Inc. (AAAHC). SurgiCares Bellaire
and Memorial Village facilities are not yet accredited. SurgiCare will seek
accreditation for the Bellaire facility upon completion of the facilitys
renovation. In the future, SurgiCares Memorial Village facility will re-apply
for accreditation. Although not required, SurgiCare believes that obtaining an
AAAHC accreditation is useful in competing for, and contracting with, certain
managed care organizations. SurgiCare, where practical, will strive to obtain
AAAHC accreditation. REVENUES SurgiCares principal source of revenues is a surgical facility fee
charged to patients for surgical procedures performed in its surgery centers.
SurgiCare depends upon third-party programs, including governmental and private
health insurance programs to pay these fees on behalf of their patients.
Patients are responsible for the co-payments and deductibles when applicable.
The fees vary depending on the procedure, but usually include all charges for
operating room usage, special equipment usage, supplies, recovery room usage,
nursing staff and medications. Facility fees do not include the charges of the
patients surgeon, anesthesiologist or other attending physicians, which are
billed directly to third-party payers by such physicians. In addition to the
facility fee revenues, SurgiCare also earns management fees from its operating
facilities and development fees from centers that it develops. ASCs, such as those in which SurgiCare owns or intends to acquire an
interest depend upon third-party reimbursement programs, including governmental
and private insurance programs, to pay for services rendered to patients.
SurgiCare derived approximately 21% of its gross revenues from governmental
healthcare programs, including Medicare and Medicaid, in 2003. The Medicare
program currently pays ASCs and physicians in accordance with fee schedules,
which are prospectively determined. 9




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The Department of Health and Human Services (DHHS) currently bases its
reimbursement system to ASCs on a 1986 cost survey. The Medicare Prescription
Drug, Improvement and Modernization Act of 2003 (MMA) requires that the
current ASC reimbursement methodology based on cost surveys be replaced with a
new ASC payment system that will be effective prior to 2008. This new system
will be based on recommendations made by the General Accounting Office after
studying the relative costs of procedures furnished in ASCs to those furnished
in hospital outpatient departments. The new payment methodology could
adversely impact surgery center reimbursement and therefore our financial
condition, results of operations and business prospects. The MMA also reduces
Medicare payments to ASCs by 1% starting April 1, 2004 and freezes the payment
rates from October 1, 2004 through December 31, 2009. In addition to payment from governmental programs, ASCs derive a
significant portion of their net revenues from private healthcare reimbursement
plans. These plans include both standard indemnity insurance programs as well
as managed care structures such as preferred provider organizations ( PPOs),
health maintenance organizations (HMOs) and other similar structures. The strengthening of managed care systems nationally has resulted in
substantial competition among providers of services, including providers of
surgery center services. This competition includes companies with greater
financial resources and market penetration than SurgiCare. In some cases,
national managed care systems require that a provider, in order to participate
in a specific plan, be able to cover an expanded geographical area. SurgiCare believes that all payers, both governmental and private, will
continue their efforts over the next several years to reduce healthcare costs
and that their efforts will generally result in a less stable market for
healthcare services. While no assurances can be given concerning the ultimate
success of SurgiCares efforts to contract with healthcare payers, SurgiCare
believes that its position as a low-cost alternative for certain surgical
procedures should enable its current centers, and additional centers which it
may acquire, to compete effectively in the evolving healthcare marketplace. COMPETITION There are several companies, many in niche markets, that acquire existing
freestanding ASCs. Many of these competitors have greater resources than
SurgiCare. The principal competitive factors that affect the ability of
SurgiCare and its competitors to acquire surgery centers are price, experience,
reputation, and access to capital. SurgiCares most significant competitors include: Symbion, Inc., Amsurg
Corporation, Surgis, Inc., Foundation Surgery Affiliates, Inc., HealthSouth
Corporation, United Surgical Partners International, Inc., Dynacq Healthcare,
Inc., NovaMed Eyecare, Inc., TLC Vision Corporation, LCA Vision, Inc., Hospital
Partners of America, Inc. and National Surgical Care, Inc. MANAGED CARE CONTRACTS SurgiCares participation in managed care contracts, often referred to as
HMOs and PPOs, in most cases simply makes it more convenient and cost effective
for a potential patient to allow their doctor to choose a SurgiCare facility.
Participation in most managed care contracts is helpful, but not material to
SurgiCares business. SurgiCare believes that its current centers can provide
lower-cost, high quality surgery in a more comfortable environment for the
patient in comparison to hospitals and to hospital-based surgery centers with
which SurgiCare competes for managed care contracts. SurgiCare intends that any
additional center, which it may acquire, will be 10




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similarly situated. In competing for managed care contracts, it is important
that SurgiCare be able to show insurance companies that it provides quality
healthcare at affordable, competitive prices. GOVERNMENT REGULATION The healthcare industry is subject to extensive regulation by a number of
governmental entities at the federal, state and local levels. Regulatory
activities affect the business activities of SurgiCare by controlling its
growth, requiring licensure and certification for its facilities, regulating
the use of SurgiCares properties, and controlling reimbursement to SurgiCare
for the services provided at those facilities. Certificates of Need and State Licensing.CON regulations control the
development of ASCs in certain states. CON statutes generally provide that
prior to the expansion of existing centers, the construction of new centers,
the acquisition of major items of equipment or the introduction of certain new
services, approval must be obtained from the designated state health-planning
agency based on a determination that a need exists for those facilities or
services. SurgiCare expects that its development of ASCs will generally focus
on states that do not require CONs. However, acquisitions of existing surgery
centers, even in states that require CONs for new centers, generally do not
require CON regulatory approval. There are currently 23 states that do not
require CONs for ASCs. The large population states that require CON regulatory
approval are New York, Michigan and Illinois. State licensing of ASCs is generally a prerequisite to the operation of
each center and to participation in federally funded programs, such as Medicare
and Medicaid. Once a center becomes licensed and operational, it must continue
to comply with federal, state and local licensing and certification
requirements in addition to local building and life safety codes. In addition,
each center is also subject to federal, state and local laws dealing with
issues such as occupational safety, employment, medical leave, insurance
regulations, civil rights and discrimination, and medical waste and other
environmental issues. Insurance Laws. Laws in all states regulate the business of insurance and
the operation of HMOs. Many states also regulate the establishment and
operation of networks of healthcare providers. SurgiCare believes that its
operations are in compliance with these laws in the states in which it
currently does business. The National Association of Insurance Commissioners
(the NAIC) recently endorsed a policy proposing the state regulation of risk
assumption by healthcare providers. The policy proposes prohibiting providers
from entering capitated payment contracts (which are contracts that compensate
the provider based on the number of members in the plan rather than based on
the services the provider performs) or other risk sharing contracts, except
through HMOs or insurance companies. Several states have adopted regulations
implementing the NAIC policy in some form. In states where such regulations
have been adopted, healthcare providers will be precluded from entering into
capitated contracts directly with employers and benefit plans other than HMOs
and insurance companies. SurgiCare and its affiliated groups currently do not and currently do not
intend to enter into contracts with managed care organizations, such as HMOs,
whereby SurgiCare and its affiliated groups would assume risk in connection
with providing healthcare services under capitated payment arrangements,
although certain of the subsidiaries of SurgiCare that will exist after the
transactions currently do so, and may continue to do so in the future. If
SurgiCare or its affiliated entities are considered to be in the business of
insurance as a result of entering into such arrangements, they could become
subject to a variety of regulatory and licensing requirements applicable to
insurance companies or HMOs, which could have a material adverse effect upon
SurgiCares ability to enter into such contracts. SurgiCare has not made a
determination regarding whether it will be deemed to be in the insurance
business after the transactions close. With respect to managed care contracts that do not involve capitated
payments or some other form of financial risk sharing, federal and state
antitrust laws restrict the ability of healthcare provider networks such as
SurgiCares specialty physician networks to negotiate payments on a collective
basis. Reimbursement.SurgiCare depends upon third-party programs, including
governmental and private health insurance programs to reimburse its ASCs for
services rendered to patients in its centers. In order to receive Medicare
reimbursement, each ASC must meet the applicable conditions of participation
set forth by DHHS relating to the type of facility, its equipment, personnel
and standard of medical care, as well as compliance with state and local laws
and regulations, all of which are subject to change from time to time. ASCs
undergo periodic on-site 11




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Medicare certification surveys. SurgiCares existing centers are certified as
Medicare providers. SurgiCare believes that its current centers will
participate in Medicare and other government programs. However, SurgiCares
current centers may or may not continue to qualify for participation in
Medicare and other government programs. Additionally, the centers that
SurgiCare acquires in the future may not qualify for participation in Medicare
or other government programs. Medicare-Medicaid Illegal Remuneration Provisions. The anti-kickback
statute makes unlawful knowingly and willfully soliciting, receiving, offering
or paying any remuneration (including any kickback, bribe, or rebate) directly
or indirectly to induce or in return for referring an individual to a person
for the furnishing or arranging for the furnishing of any item or service for
which payment may be made in whole or in part under Medicare or Medicaid.
Violation is a felony punishable by a fine of up to $25,000 or imprisonment for
up to five years, or both. The Medicare and Medicaid Patient Program Protection
Act of 1987 (the 1987 Act) provides administrative penalties for healthcare
practices which encourage over utilization or illegal remuneration when the
costs of services are reimbursed under the Medicare program. Loss of Medicare
certification and severe financial penalties are included among the 1987 Acts
sanctions. The 1987 Act, which adds to the criminal penalties under preexisting
law, also directs the Inspector General of the DHHS to investigate practices
which may constitute over utilization, including investments by healthcare
providers in medical diagnostic facilities and to promulgate regulations
establishing exemptions or safe harbors for investments by medical service
providers in legitimate business ventures that will be deemed not to violate
the law even though those providers may also refer patients to such a venture.
Regulations identifying safe harbors were published in final form in July 1991
(the Regulations). If an operating physician has a financial interest in a facility through a
partnership interest or as a stockholder, the operating physician has the
potential to benefit from the profitability of the facility. Where a physician
is in a position to direct referrals or business to an entity or facility in
which such physician has an ownership interest, and, therefore will benefit
from the financial profitability of such entity or facility, there is risk
under federal and state law, including the Medicare-Medicaid Illegal
Remuneration Provisions. If the facility where a surgeon performs surgery is
considered an extension of the surgeons practice, this may reduce the risk of
a violation of the anti-kickback statutes of the Medicare-Medicaid Illegal
Remuneration Provisions. The Regulations set forth two specific exemptions or safe harbors
related to investment interests: the first concerning investment interests in
large publicly traded companies ($50 million in net tangible assets) and the
second for investments in smaller entities. The corporate structure of
SurgiCare and its centers meet all of the criteria of either existing
investment interests safe harbor as announced in the Regulations. While several federal court decisions have aggressively applied the
restrictions of the anti-kickback statute, they provide little guidance as to
the application of the anti-kickback statute to SurgiCare or its subsidiaries.
There is safe harbor protection under the anti-kickback statute for
physician-owned ASCs that are structured to meet certain tests set out in the
regulations. SurgiCares surgery centers may not currently satisfy all
components of the tests for the safe harbor applicable to the ASCs.
Nonetheless, SurgiCare believes that it is in compliance with the current
requirements of the anti-kickback statute. Notwithstanding SurgiCares belief that the relationship of physician
partners to SurgiCares surgery center should not constitute illegal
remuneration under the anti-kickback statute, no assurances can be given that a
federal or state agency charged with enforcement of the anti-kickback statute
or similar state laws might not assert a contrary position or that new federal
or state laws might not be enacted that would cause the physician partners
ownership interest in SurgiCare to become illegal, or result in the imposition
of penalties on SurgiCare or certain of its facilities. Even the assertion of a
violation could have a material adverse effect upon SurgiCare. Prohibition on Physician Ownership of Healthcare Facilities.The Stark
II provisions of the Omnibus Budget Reconciliation Act of 1993 amend the
federal Medicare statute to prohibit a referral by a physician for designated
health services to an entity in which the physician has an investment interest
or other financial relationship, subject to certain exceptions. A referral
under Stark II that does not fall within an exception is strictly prohibited.
This prohibition took effect on January 1, 1995. Sanctions for violating Stark
II can include civil monetary penalties and exclusion from Medicare and
Medicaid. 12




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Ambulatory surgery is not identified as a designated health service and
Stark II regulations state that items and services provided in any ASC and
reimbursed under the composite payment rate are not designated health services.
Because all items and services provided at SurgiCares surgery centers are
billed to Medicare under a composite payment rate, as discussed below,
SurgiCare believes that it is not subject to the physician self-referral
restrictions set forth in Stark II. However, in the event that SurgiCare in
the future offers services that are not ASC services covered by a composite
payment rate and are designated health services under Stark II, SurgiCare
would be subject to the Stark II physician self-referral prohibition with
respect to those services. Medicare pays ASCs a composite rate, or fixed facility payment, as payment
in full for all items and services furnished to a patient in connection with a
surgical procedure. For example, the Medicare ASC facility fee includes
payment for all lab work that might be furnished in connection with a surgical
procedure. As such, the physician who furnishes a surgical procedure in an ASC
in which he or she has an ownership interest has no incentive to unnecessarily
order lab services. The Centers for Medicare and Medicaid Services
(CMS)
cited this as the primary basis for expressly protecting ASC services, and
items and services that otherwise would constitute designated health services
when furnished in the ASC setting. Most payers pay using a composite payment rate based on the various
procedure groups used by ASCs. Some payers will pay separately for supplies
and implants. The compensation paid by each payer for the facility fees varies
by insurance carrier. Most pay at a percentage of Medicare or a fixed amount
per procedure group. If a facility has a mix of patients whose payers pay
better rates than average, the margins of that center are typically higher. If
a facility has a mix of patients whose payers pay less than the average rates,
the margins of that center are typically lower. The margins achieved at each
center are primarily a function of volume, payer, mix and operating efficiency,
in that order. However, unfavorable future Stark II regulations or subsequent adverse
court interpretations concerning the Stark II law or regulations or similar
provisions found in similar state statutes could prohibit reimbursement for
treatment provided by the physicians affiliated with SurgiCare or its current
or future centers to their patients. The negative effect of such unfavorable
future Stark II regulations or court rulings may be that investor physicians
would not admit their patients to SurgiCare ASCs because of the prohibition on
reimbursement for services. This would have a chilling effect on the revenues
of SurgiCare and would make its continuing viability questionable. However,
due to the positive financial benefits ASCs offer over hospitals, as discussed
in Industry Overview in this section, SurgiCare believes it is unlikely that
the legislature or court will take such unfavorable actions because of the
overwhelming financial benefits enjoyed by Medicare by allowing procedures to
be performed at ASCs. Neither SurgiCare nor its subsidiaries are engaged in the corporate
practice of medicine. SurgiCare does not employ any physicians to practice
medicine on its behalf. SurgiCare and its subsidiaries merely provide the venue
for its physicians to perform surgical procedures. SurgiCare submits claims and
bills to patients for the facility fee only, and in no way are involved with
the billing or submission of claims for any professional medical fees. Administrative Simplification and Privacy Requirements.There are
currently numerous legislative and regulatory initiatives at the state and
federal levels addressing patient privacy concerns. In particular, on December
28, 2000, DHHS released final health privacy regulations implementing portions
of the Administrative Simplification Provisions of the Health Insurance
Portability and Accountability Act of 1996 (HIPAA), and in August 2002
published revisions to the final rules. These final health privacy regulations
generally require compliance by April 14, 2003 and extensively regulate the use
and disclosure of individually identifiable health-related information. In
addition, HIPAA requires DHHS to adopt standards to protect the security of
health-related information. DHHS released final security regulations on
February 20, 2003. The security regulations will generally become mandatory on
April 20, 2005. These security regulations will require healthcare providers to
implement administrative, physical and technical practices to protect the
security of individually identifiable health-related information that is
electronically maintained or transmitted. Further, as required by HIPAA, DHHS
has adopted final regulations establishing electronic data transmission
standards that all healthcare providers must use when submitting or receiving
certain healthcare transactions electronically. Compliance with these
regulations became mandatory on October 16, 2002. However, entities that filed
for an extension before October 16, 2002 have until October 16, 2003 to comply
with the regulations. SurgiCare filed extensions for its centers before October
16, 2002, and we believe that we were in compliance with the standards by
October 16, 2003. We believe that the cost of 13




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compliance with these regulations will not have a material adverse effect
on our business, financial position or results of operations. If we fail to
comply with these regulations, we could suffer civil penalties up to $25,000
per calendar year for each provision violated and criminal penalties with fines
of up to $250,000 per violation. In addition, our facilities will continue to
remain subject to any state laws that are more restrictive than the privacy
regulations issued under HIPAA. These statutes vary by state and could impose
additional penalties. SurgiCare cannot predict whether other regulatory or statutory provisions
will be enacted by federal or state authorities which would prohibit or
otherwise regulate relationships which SurgiCare has established or may
establish with other healthcare providers or the possibility of material
adverse effects on its business or revenues arising from such future actions.
SurgiCare believes, however, that it will be able to adjust its operations to
be in compliance with any regulatory or statutory provision, as may be
applicable. SurgiCare is subject to state and federal laws that govern the submission
of claims for reimbursement. These laws generally prohibit an individual or
entity from knowingly and willfully presenting a claim (or causing a claim to
be presented) for payment from Medicare, Medicaid or other third party payers
that is false or fraudulent. The standard for knowing and willful often
includes conduct that amounts to a reckless disregard for whether accurate
information is presented by claims processors. Penalties under these statutes include substantial civil and criminal
fines, exclusion from the Medicare program, and imprisonment. One of the most
prominent of these laws is the federal False Claims Act, which may be enforced
by the federal government directly, or by a qui tamplaintiff (a private person
suing on the governments behalf under a statute that assigns a certain part of
the penalty award to the government). Under the False Claims Act, both the
government and the private plaintiff, if successful, are permitted to recover
substantial monetary penalties, as well as an amount equal to three times
actual damages. In recent cases, some qui tamplaintiffs have taken the
position that violations of the anti-kickback statute and Stark II should also
be prosecuted as violations of the federal False Claims Act. Even though
SurgiCare believes that it has procedures in place to ensure the accurate
completion of claims forms and requests for payment, the laws and regulations
defining the proper parameters of proper Medicare or Medicaid billing are
frequently unclear and have not been subjected to extensive judicial or agency
interpretation. Billing errors can occur despite SurgiCares best efforts to
prevent or correct them, and no assurances can be given that the government
will regard such errors as inadvertent and not in violation of the False Claims
Act or related statutes. SurgiCare does not believe it has materially failed to comply with the any
of the regulations described above during the past two years. EMPLOYEES As of December 31, 2003, SurgiCare and its subsidiaries employed
approximately 96 persons, 67 of whom were full-time employees and 29 of whom
were part-time employees. Of the above, eight were employed at SurgiCares
corporate office in Houston, Texas and the remaining employees were employed by
SurgiCares surgery centers. These employees work in the following positions:
corporate management (8); business office (14); administrators (4); nurses
(47); and technicians (23). SurgiCare believes its relationship with its
employees to be good. SurgiCare does not have any employment or labor
contracts, except for its Chief Executive Officer (see Note 18 to the
accompanying financial statements). Additionally, SurgiCare does not currently
plan on having any such contracts with any operating physician on staff at any
of its facilities. At this time, SurgiCare believes that all of its nurses and
other employees have at-will employment relationships with the SurgiCare. PHYSICIAN STOCKHOLDERS SurgiCare has never entered into any arrangement, nor does it plan on
entering into any arrangement with any physicians that operate at any of its
facilities, to assure their continued use of its facilities. However, many of
the surgeons operating in SurgiCare facilities own SurgiCare common stock.
Depending on SurgiCares profitability, the potential exists for all
stockholders, both physician and non-physician, to benefit financially. Surgeons specializing in podiatry, orthopedics, pain management,
gynecology, ophthalmology, reconstructive, as well as general surgery, utilize
SurgiCares facilities. SurgiCare is not dependent on the revenue 14




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generated by patients brought by any single operating physician. At certain
facilities, SurgiCare derives a large portion of its revenue from procedures
performed within specific specialties. Currently, podiatry and pain management
are the dominant specialties at Bellaire. Since Bellaire has over twenty
podiatrist and three pain management physicians bringing patients to the
surgery center, none are considered to be a major customer. ITEM 2. DESCRIPTION OF PROPERTY In 2003, SurgiCares principal office was located at 12727 Kimberley Lane,
Suite 200, Houston, Texas, 77024. This property is approximately 3,900 square
feet, located on the 2nd floor of the Kimberley Medical Office Building above
our Memorial Village surgery center. The property was leased from an
unaffiliated third party. Annual rental of $55,272.96 was payable monthly in
the amount of $4,606.08. The Kimberley Medical Office Building Lease
terminates at the end of July 2004, at which time SurgiCare will move its
principal business office to 10700 Richmond, Suite 300, Houston, Texas 77042.
The Richmond property is approximately 21,118 square feet, located on the third
floor of the building. This property is leased from an unaffiliated third
party for an initial term that expires in September 2011. Annual rental of
$295,652.04 is payable monthly in the amount of $24,637.67 for months 1 through
38, and annual rental in the amount of $316,770 is payable in the amount of
$26,397.50 for months 39 through 86. Additionally, a rental credit for the
Kimberley Lane lease in the amount of $1,345,373.33 shall be applied to the
rent in equal monthly increments of $4,976.79 for 27 consecutive months
commencing upon the first month of the lease. SurgiCare maintains commercial
general liability insurance, all risk property insurance, and other insurance
on its property in an amount deemed adequate by SurgiCare. SurgiCare has also
entered into a sublease agreement with MBS for 12,403 square feet of the
Richmond property. The sublease will terminate upon the sooner of (i) the
consummation of the merger contemplated by the Restructuring, or (ii) such time
as SurgiCare, for any reason, is no longer the lawful lessee of the premises.
MBS is currently paying SurgiCare a monthly rent equal to MBSs pro rata share
of the rent for the 21,118 square foot property. The four surgery centers in
operation at July 8, 2004, lease space ranging from 10,000 to 14,000 square
feet with remaining lease terms ranging from month-to-month to 8 1/2 years. In June 2002, SurgiCare acquired five properties from American
International Industries, Inc., (AII) Texas Real Estate Enterprises, Inc. and MidCity
Houston Properties, Inc. in exchange for 1.2 million shares of Series AA
Redeemable Preferred Stock. The land holdings are undeveloped properties. The
properties include 735.66 acre tract of vacant land located on the east side of
a shell paved road leading to the Anahuac National Wildlife Refuse,
approximately two miles South of FM 1985, in Chambers County, Texas; a 22.38
acre tract of land located on the east side of US 59 at the Old
Humble/Atascocita Road exit, and an adjacent 14.25 acre tract of land on the
west side of Homestead Road in Houston, Harris County, Texas; a 22,248 square
foot tract of land located on the northeast corner of Almeda Road and Riverside
Drive, in Houston, Harris County, Texas; four tracts of land totaling 26.856
acres located on the southeast, northwest, and northeast corners of Airport
Boulevard and Sims Bayou and east side of 4th Street south of Airport Boulevard
in Houston, Harris County, Texas; and a 12.216 net acre tract of land located
on the southwest corner of Airport Boulevard and Sims Bayou, Houston, Harris
County, Texas. SurgiCare currently has contracts to sell two of these
properties  the tract adjacent to the Anahuac National Wildlife Refuge and the
tract on Almeda Road. Pursuant to a December 11, 2002 agreement, American
International Industries, Inc. guaranteed a resale price on the land of $4
million and agreed to make up any shortfall. On June 23, 2004, SurgiCare entered into an
agreement with AII, which is the sole owner of all outstanding
Series AA preferred stock, pursuant to which SurgiCare will
issue 8,750,000 shares of its common stock (prior to giving
effect to the Reverse Stock Split) to AII in exchange for the
conversion of all 900,000 shares of Series AA
preferred stock. The conversion of the Series AA preferred
stock to common stock will take place upon the later to occur of
the approval for listing of the shares of common stock on the
AMEX or the fulfillment by AII of its obligations under the
agreement to acquire the aforementioned properties and to assume
or eliminate SurgiCares obligations with respect thereto,
and to pay SurgiCare $250,000. Upon compliance by AII with these
obligations, SurgiCare will transfer the properties to AII, and
AII will have no further obligations regarding the resale
guarantee of the properties in the December 11, 2002
agreement. If the conversion does not occur by July 30,
2004, SurgiCare is required by the certificate of designations
of the Series AA preferred stock filed pursuant to the
agreement to either convert or redeem 300,000 shares of
Series AA preferred stock on each of July 30, 2004,
June 4, 2005, and June 4, 2006. Each share of
Series AA preferred stock would be convertible into the
number of shares of common stock determined by the following
formula: $5.00 divided by the greater of (a) the average of
the closing price of the common stock on the twenty trading days
immediately preceding the conversion date or (b) $0.41. The
redemption price of each share of Series AA preferred stock
would be $5.00. The real property purchase agreement relating to
the Properties between AII and SurgiCare states that AII will
indemnify SurgiCare for expenses involved in the settlement of
the termination of the contracts for the sale of the tract
adjacent to the Anahuac National Wildlife Refuge and the tract
on Almeda Road. ITEM 3. LEGAL PROCEEDINGS In March 2003, SurgiCare Memorial Village, L.P. and Town & Country
SurgiCare, Inc. were named as defendants in a suit entitled MarCap Corporation
vs. Health First Surgery Center-Memorial, Ltd.; HFMC, L.C.; SurgiCare Memorial
Village, L.P.; and Town & Country SurgiCare, Inc. MarCap has sued for default
under a promissory note and refusing to remit payment on a promissory note in
the amount of $215,329.36. SurgiCare has paid $53,832.34 of this balance and
settlement has been reached whereby SurgiCare will pay MarCap $150,000 over the
next year with interest at 10%, with an underlying settlement of approximately
$200,000 in the event of a breach in the payment plan. A balance of $48,890.84
remains on this settlement as of July 19, 2004. 15




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On July 7, 2003, SurgiCare, Inc. was named as a party in the arbitration
entitled Brewer & Pritchard, P.C. vs. SurgiCare, Inc. before the American
Arbitration Association. Brewer & Pritchard have claimed breach of contract and
demanded payment of $131,294.88 in billed and unbilled legal fees plus third
party expenses, interest at the highest legal rate, costs, legal fees and
damages from breach of contract. This case was settled in November 2003 and
SurgiCare issued shares of common stock valued at $117,500 as compensation for
past legal fees. On February 10, 2003, SurgiCare, Inc. was named as a defendant in a suit
entitled S.E. Altman v. SurgiCare. S.E. Altman has sued for breach of contract,
alleging that SurgiCare did not pay monies owed under a Finders Fee Contract.
Plaintiff asserts damages in the amount of $217,000, plus interest and
attorneys fees. International Diversified Corporation, Limited has indemnified
SurgiCare with respect to any fees owed to Altman under the Finders Fee
Contract. The case has been dismissed in favor of arbitration. In March
2004, the parties executed a Settlement Agreement and Release of Claims to
resolve the dispute in which SurgiCare agreed to issue Mr. Altman 540,000
shares of common stock to be registered with the Securities and Exchange
Commission on Form S-8. On April 14, 2003, SurgiCare, Inc. was named as a defendant in a suit
entitled A.I. International Corporate Holdings, Ltd. v. SurgiCare, Inc. in the
U.S. District Court for the Southern District of New York. Subsequently,
SurgiCare filed suit against A.I. International Corporate Holdings, Ltd. and
First National Bank, S.A.L. of Lebanon in the 215th Judicial District Court of
Harris County, Texas. The New York case involves allegations that SurgiCare
defaulted on its loan agreement. The plaintiffs in the New York case are suing
SurgiCare for $834,252 representing the loan amount and interest, plus
$219,000, representing damages for No-filing Charges and Non-Effective
Charges under the contract. SurgiCares lawsuit in Texas asserted that the
loan agreement is usurious. The parties signed an agreement to settle this
matter, which will close after the consummation of the Transactions. Pursuant
to this settlement, SurgiCare will pay Plaintiffs $220,000 in cash
and issue 2,100,000 shares of SurgiCare common stock (210,000 shares
after giving effect to the reverse stock split contemplated in
connection with the merger and equity transactions set forth above),
to be paid and issued after the closing of such
transactions. On November 24, 2003, SurgiCare, Inc. was named as a defendant in a suit
entitled Vincent A. Giammalva, Trustee v. SurgiCare, Inc., Keith G. LeBlanc,
and Phillip C. Scott; in the 344th Judicial District Court of Chambers County,
Texas. This case involves allegations that SurgiCare defaulted on a contract to
sell a parcel of real estate to plaintiff. Plaintiff also claims that LeBlanc
and Scott committed fraud. SurgiCare states that it could not sell the parcel
of land because of a lien on the property. The plaintiff seeks specific
performance, forcing SurgiCare to sell the property, as well as actual damages.
SurgiCare is negotiating with the plaintiff in an effort to settle this matter.
AII has agreed to indemnify SurgiCare, Inc., Keith LeBlanc and Phillip Scott
for all claims asserted in this litigation by agreement dated June 23, 2004. In addition, we are involved in various other legal proceedings and claims
arising in the ordinary course of business. Our management believes that the
disposition of these additional matters, individually or in the aggregate, is
not expected to have a materially adverse effect on our financial condition.
However, depending on the amount and timing of such disposition, an unfavorable
resolution of some or all of these matters could materially affect our future
results of operations or cash flows in a particular period. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION 16




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In April 2000, the company began trading on the OTC Bulletin Board. In
July 2001, SurgiCare qualified for listing on the American Stock Exchange
(AMEX) and began trading on this exchange at that time under the symbol SRG.
The following table sets forth the high and low sales prices relating to
SurgiCares common stock for the last two fiscal years: FISCAL 2004 HIGH
    
    LOWQuarter ended March 31, 2004
    
    $
    0.67
    
    
    $
    0.35Quarter ended June 30, 2004
    
    $
    0.52
    
    
    $
    0.31
 FISCAL 2003 HIGH
    
    LOWQuarter ended March 31, 2003
    
    $
    0.50
    
    
    $
    0.27Quarter ended June 30, 2003
    
    $
    0.45
    
    
    $
    0.23Quarter ended September 30, 2003
    
    $
    0.54
    
    
    $
    0.22Quarter ended December 31, 2003
    
    $
    0.72
    
    
    $
    0.36
 FISCAL 2002 HIGH
    
    LOWQuarter ended March 31, 2002
    
    $
    2.50
    
    
    $
    1.90Quarter ended June 30, 2002
    
    $
    3.70
    
    
    $
    1.76Quarter ended September 30, 2002
    
    $
    2.68
    
    
    $
    0.30Quarter ended December 31, 2002
    
    $
    0.93
    
    
    $
    0.22
 HOLDERS SurgiCare believes that as of March 31, 2004, there were approximately 402
holders of record of the Companys Common Stock and one holder of the Companys
Series AA Preferred Stock. DIVIDENDS SurgiCare has not paid dividends on shares of its common stock within the
last two years, and does not expect to declare or pay any cash dividends on its
common shares in the foreseeable future. OPTION PLAN DATA In October 2001, SurgiCare established our 2001 Stock Option Plan, which
authorized 1.4 million shares of our common stock to be made available through
an incentive program for employees. The 2001 Stock Option Plan was approved by
the stockholders. The options were granted at an exercise price equal to the
fair market value of the common stock at the date of grant. The options had a
ten year term. There were 81,955 options granted under the 2001 Stock Option
Plan in 2002. There were none granted under the 2001 Stock Option Plan in
2003. As of December 31, 2003, there were 62,706 options outstanding. The number of warrants outstanding as of the beginning of 2003 to
employees was 7,265,899. The number of warrants outstanding as of the end of
2003 to employees or former employees was 6,855,899 with exercise prices
ranging from $0.32 to $2.00, with a weighted average exercise price of $0.407
per share. There were no changes in the exercise price of outstanding warrants
through cancellation and re-issuance or otherwise, except price changes
resulting from the normal operation of anti-dilution provisions of the
warrants. 17




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RECENT SALES OF UNREGISTERED SECURITIES Set forth below is certain information concerning issuances of securities
by SurgiCare during the quarter ended December 31, 2003. On October 24, 2003, the Company issued 228,310 shares of common stock to
Charles Cohen, a former officer and director, in settlement of claims by Cohen
for compensation for services while he was employed by the Company. The stock
was issued to Mr. Cohen, an accredited investor, for services rendered in
reliance on the exemption provided by Section 4(2) of the Securities Act. On November 10, 2003, the Company issued 682,035 shares of common stock to
Long Nguyen, M.D., David Roberts, Gerald McIntosh, Hank Moore, and SMT
Marketing, LLC, each of whom are accredited investors for services rendered by
each of them under separate agreements with the Company. The stock was issued
in reliance on the exemption provided by Section 4(2) of the Securities Act. On December 9, 2003, the Company issued 41,833 shares of common stock to
U.S. Billing & Contracting, LLC, an accredited investor, for services rendered,
in reliance on to the exemption provided by Section 4(2) of the Securities Act. No underwriters were involved in any of the foregoing sales or issuance of
securities. Such sales or issuance were made in reliance upon an exemption
from the registration provisions of the Securities Act set forth in Section
4(2) thereof relative to sales by an issuer not involving any public offering,
or the rules and regulations there under. Each recipient either received
adequate information about SurgiCare or had access, through employment or other
relationships, to such information, and SurgiCare determined that each
recipient had such knowledge and experience in financial and business matters
that they were able to evaluate the merits and risks of an investment in
SurgiCare. All of the foregoing securities are deemed restricted securities
for the purposes of the Securities Act. ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Forward-Looking Statements The information contained herein contains certain forward looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are intended to be covered by the safe harbors created thereby.
Investors are cautioned that all forward looking statements involve risks and
uncertainty, including, without limitation, our ability to continue our
expansion strategy, changes in federal or state healthcare laws and regulations
or third party payer practices, our historical and current compliance with
existing or future healthcare laws and regulations and third party payer
requirements, changes in costs of supplies, labor and employee benefits, as
well as general market conditions, competition and pricing. Although we
believe that the assumptions underlying the forward looking statements
contained herein are reasonable, any of the assumptions could be inaccurate,
and therefore, there can be no assurance that the forward looking statements
included in this Form 10-KSB/A will prove to be accurate. In view of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by management or any other person that our objectives and plans
will be achieved. We undertake no obligation to update or revise
forward-looking statements to reflect changed assumptions, the occurrence of
unanticipated events or changes to future operating results over time. Critical Accounting Policies In December 2001, the SEC requested that reporting companies discuss their
most critical accounting policies in managements discussion and analysis of
financial condition and results of operations. The SEC indicated that a
critical accounting policy is one that is important to the portrayal of a
companys financial condition and operating results and requires managements
most difficult, subjective or complex judgments, often as a result of the need
to make estimates about the effect of matters that are inherently uncertain. 18




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We have identified the policies below as critical to our business
operations and the understanding of our results of operations. The impact and
any associated risks related to these policies on our business operations is
discussed throughout Managements Discussion and Analysis of Financial
Condition and Results of Operations where such policies affect our reported and
expected financial results. For a detailed discussion on the application of
this and other accounting policies, see Notes 1 and 2 to the accompanying
Consolidated Financial Statements. Our preparation of this Annual Report on
Form 10-KSB requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities as of the date of our financial statements. Therefore, actual
results may differ from those estimates. Revenue Recognition- Revenue is recognized on the date the procedures are
performed, and accounts receivable are recorded at that time. Revenues are
reported at the estimated realizable amounts from patients and third-party
payers. If such third-party payers were to change their reimbursement
policies, the effect on revenue could be significant. Earnings are charged
with a provision for contractual adjustments and doubtful accounts based on
such factors as historical trends of billing and cash collections, established
fee schedules, accounts receivable agings and contractual relationships with
third-party payers. Contractual allowances are estimated primarily using each
surgery centers collection experience. Contractual rates and fee schedules
are also helpful in this process. On a rolling average basis, the Company
tracks collections as a percentage of related billed charges. This percentage,
which is adjusted on a quarterly basis, has proved to be the best indicator of
expected realizable amounts from patients and third-party payers. Contractual
adjustments and accounts deemed uncollectible are applied against the allowance
account. The Company is not aware of any material claims, disputes or
unsettled matters with third-party payers. Investment in Limited Partnerships- The investments in limited
partnerships are accounted for by the equity method. Under the equity method,
the investment is initially recorded at cost and is subsequently increased to
reflect the Companys share of the income of the investee and reduced to
reflect the share of the losses of the investee or distributions from the
investee. These general partnership interests were accounted for as investment in
limited partnerships due to the interpretation of FAS 94/ARB 51 and the
interpretations of such by Issue 96-16 and SOP 78-9. Under those
interpretations, SurgiCare could not consolidate its interest in those
facilities in which it held a minority general interest partnership interest
due to management restrictions, shared operating decision-making, capital
expenditure and debt approval by limited partners and the general form versus
substance analysis. Therefore, SurgiCare recorded them as investments in
limited partnerships. Goodwill- Goodwill represents the excess of cost over the fair value of
net assets of companies acquired in business combinations accounted for using
the purchase method. Goodwill acquired in business combinations prior to June
30, 2001 had been amortized using the straight-line method over an estimated
useful life of 20 years. In July 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No.
141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. SFAS No. 142
requires that goodwill no longer be amortized but instead be reviewed
periodically for possible impairment. The Company has adopted SFAS No. 142
effective January 1, 2002 and is no longer amortizing goodwill. Upon adoption of SFAS 142, as well as December 31, 2003 and 2002, the
Company performed an impairment test of its goodwill and determined that no
impairment of the recorded goodwill existed. Under SFAS No. 142, goodwill is
tested annually and more frequently if an event occurs which indicates the
goodwill may be impaired. 19




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Overview SurgiCares principal business strategies are to (a) increase physician
utilization of existing facilities, (b) increase both the revenue and profits
from current cases and procedures being performed in existing
facilities, (c)
achieve growth and expand revenues by pursuing strategic acquisitions of
existing, and the development of new, physician owned ambulatory surgical
centers, and (d) expand into related healthcare facilities, including imaging
and practice management. Surgical supply costs are the single largest cost component of any
ambulatory surgical center. Therefore, SurgiCares goal is to minimize the
cost of surgical supplies. Through participation in national buying groups,
SurgiCare has been able to negotiate discounts on most of the commonly used
surgical supplies. SurgiCare has also implemented a Just in Time approach to
inventory. This allows the center to minimize the amount of supplies that it
is required to keep in inventory. SurgiCare is in the process of identifying ambulatory surgical centers,
imaging centers and practice management companies as potential acquisition
targets and has, in some cases, conducted preliminary discussions with
representatives of these organizations. Although there are no commitments,
understandings, or agreements with any other potential acquisition targets,
talks are ongoing for the acquisition of additional entities. All of such
discussions have been tentative in nature and there can be no assurance that we
will acquire any center with whom discussions have been conducted. FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth for the periods indicated the percentages
of revenues represented by income statement items. 2003
    
    2002Revenues, net
    
    
    100.00
    %
    
    
    100.00
    %Expenses:Direct Cost of Services
    
    
    56.16
    %
    
    
    46.55
    %General & Administrative Expenses
    
    
    75.64
    %
    
    
    106.54
    %Other Operating Expenses
    
    
    8.97
    %
    
    
    31.60
    %Total Operating Expenses
    
    
    140.77
    %
    
    
    184.69
    %Operating Loss
    
    
    -40.77
    %
    
    
    -84.69
    %Other Loss
    
    
    -21.03
    %
    
    
    -12.62
    %Minority Interest in Losses of Limited Partnerships
    
    
    
    
    
    
    6.77
    %Loss Before Federal Income Tax Expense
    
    
    -61.80
    %
    
    
    -90.54
    %Federal Income Tax Benefit:Current
    
    
    -2.15
    %
    
    
    -1.94
    %Deferred
    
    
    
    
    
    
    -11.99
    %Net Loss
    
    
    -59.65
    %
    
    
    -76.60
    %
 RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2003 (2003) vs. YEAR ENDED DECEMBER 31, 2002 (2002) Net Revenue. On a consolidated basis, case volume decreased 7.9% to 6,791
in 2003 compared to 7,374 cases in 2002. Revenue declined $3,487,916, or 30.2%
to $8,064,523 in 2003 from $11,552,439 in 2002. On a per-case basis, revenue
decreased to $1,188 in 2003 from $1,567 in 2002. In both comparable years, the
average contractual allowance was approximately 68%. Of the decrease,
approximately $900,000 is attributable to the decrease in case volume. The
remaining decrease is due to the shift in types of cases performed, where the
company experienced decreases in cases with higher reimbursement, including
pain management, podiatry and urology, and increases in ophthalmology cases,
with lower reimbursement. 20




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##### 



Following a change in management of the Company in September 2002, the
Company determined that it needed to revise the assumptions used in estimating
contractual allowances resulting in a more conservative method of estimating
contractual allowances based on a rolling average ratio of actual cash
collections to related billed charges. The adoption of this policy resulted in
insurance contractual allowances being increased by approximately $2.17
million, or approximately 6% of gross billings. This increase in allowances
did not represent a material change in the revenues and collections of the
Company. The increase in contractual allowances was a result of a change in
internal controls as disclosed in Item 14 of our Annual Report on Form 10-KSB
for the year ended December 31, 2002. The Companys management determined that
it was in the best interest of the Company to use a conservative method of
estimating such contractual allowances. The method uses a rolling average
based upon the trend of actual cash collected compared to related billings. The previous method used to calculate the allowances was based upon
evaluating the historical contractual allowances by payer classification. An
historical trend analysis based on the weighted average contractual allowance
was then performed to test for reasonableness. Using the previous method which
relied more on historical contractual allowance trends, prior management
believed that increases in accounts receivable in 2001 and 2002 had been the
result of poor collections procedures. When changes in collections procedures
failed to sufficiently improve cash collections, prior management recorded
increases in doubtful accounts in 2002, as described under the caption General
and Administrative Expenses below. Current management changed its procedure to estimate contractual
allowances in 2002 and to base contractual allowances on actual cash
collections against gross billings for services. This change shifted emphasis
away from reliance on historical allowances and emphasized recent collection
history. This did not represent a correction of error but an improvement on
the estimation of the contractual allowances. The Company has made changes to
its internal controls in this area by measuring the actual collections against
the gross billings on a rolling average on a quarterly basis, which accounts
for changes in payer and services mix that directly affect the contractual
allowance. Direct Cost of Revenues.Direct Cost of Revenues decreased $849,554, or
15.8% to $4,528,644 in 2003 from $5,378,198 in 2002. Surgical costs decreased
$1,085,148, or 40.0% to $1,629,661 in 2003 from $2,714,809 in 2002. As a
percentage of revenue, surgical costs decreased to 20.2% of revenue in 2003
from 23.5% in 2002. The decrease primarily corresponds to the 30.2% decrease
in revenue and case volume as discussed above. Additionally, based on the age
of some of the inventory items, new management determined in the third quarter
of 2002 that it was appropriate to adjust the value of inventory. As a result,
surgical costs for 2002 reflect an adjustment of $300,000 to allow for
potential obsolescence of inventory. Direct clinical salaries and benefits
increased $226,104 or 13.3% to $1,928,822 in 2003 from $1,702,718 in 2002
primarily due to the full year impact of the Tuscarawas acquisition, which
occurred in June 2002. As a whole, Direct Cost of Revenues per case decreased
8.6% to $666 in 2003 compared to $729 in 2002, resulting from the factors
discussed above. General and Administrative Expenses. General and administrative costs
decreased $6,207,882, or 50.4% to $6,100,192 in 2003 from $12,308,073 in 2002.
The decrease is primarily due to charges of $5.4 million to bad debt expense
taken in 2002 related to a change in the Companys policies regarding doubtful
accounts. Additionally, professional fees decreased by $1.1 million in 2003
compared to 2002, where the Company incurred substantial professional fees in
2002 related to raising equity, medical oversight and legal issues. These
expense decreases were partially offset by an increase of approximately
$445,000 in expenses related to Tuscarawas (of which $233,000 included an
increase in rent), which was acquired in June 2002. In early 2002, the Companys existing management implemented a
centralization of the collection functions of its centers and an outsourcing of
the collection of certain aged receivables. Because the new collection
functions were largely unsuccessful in reducing aged receivables, the Company
recorded significant expenses for doubtful accounts beginning in the second
quarter of 2002, which totaled $5.75 million for doubtful accounts for the year
ended December 31, 2002. In September 2002, the Companys new management revised its assumptions in
estimating doubtful accounts. Prior estimates of doubtful accounts were based
on trend analysis of the Companys historic experience 21




---



##### 



by payer category and made an exception for the aged receivables based on
the expectation of increased collection through revised collection procedures.
The new policy heavily discounted the receivables over 60 days. Management
considers this change in estimates to be a more conservative valuation of net
accounts receivable. Other Operating Expenses. Loss on sale of assets. In August 2003, the Company sold a promissory
note with a face amount of $223,177 to International Diversified Corporation
(IDC) for $160,000, incurring a loss of $63,177. The Company also agreed to
release IDC from its $400,000 obligation to the Company, which had been
included in other receivables. In addition to the cash consideration,
SurgiCare was released from any and all obligations regarding the raising of
additional funds for working capital and was released of all liabilities
regarding the lawsuit filed by IDC claiming breach of contract requesting the
return of $1 million or 2,439,024 shares under a previous agreement with IDC
and American International Industries, Inc. A total loss of $463,177 was
recorded as a loss on sale of assets. As part of the sale agreement, the
Company was released of any liability of the center and removed as a guarantor
on the centers bank note payable. Other than IDCs ownership of certain
shares of the Companys common stock, IDC has no relationship with the Company. Loss (gain) on sale of partnership interests. In June 2003, the Company
sold its 10% interest in Physicians Endoscopy Center, Ltd for $425,000 and
recognized a gain on the sale of $319,086. As part of the sale agreement, the
Company was released of any liability of the center and removed as a guarantor
on the centers bank note payable. In 2002, the Company sold its 20% interest
in Bayside Surgical Partners, LP for a loss of $169,934. Loss on terminated acquisition. In 2002, the Company incurred a loss of
$1,977,382 associated with its termination of the Aspen Healthcare acquisition. Impairment on investment in land. In 2002, under the Companys previous
management, the Company acquired five tracts of land. Managements purpose for
acquiring the land was for the future development of additional surgery centers
for the Company. Management obtained an appraisal from Associated National
Appraisal Services, Inc. in January 2002, to determine the fair market value of
the transaction to purchase the land. The land was acquired from Texas Real
Estate Enterprises, Inc. and MidCity Houston Properties, Inc. The Company has
no relationship with either of these entities, other than the purchase of this
land. The Company entered into a resale guarantee agreement with American
International Industries, Inc., as a part of the agreement of December 11,
2002, described below. The guarantee provides the Company with a land resale
guarantee if, by June 1, 2006, the Company is unable to sell any or all of the
tracts of land for net sales proceeds of less than $4,000,000. If the net
sales proceeds are less than $4,000,000, American International Industries,
Inc. agrees to compensate the Company in an amount equal to the difference
between $4,000,000 and the net sales proceeds received by the Company from the
sale of any of the land prior to June 1, 2006. The Company believes that net
sales proceeds, as used in the guarantee agreement, means gross sales proceeds
minus any direct sales costs. American International Industries, Inc. shall
have the option to make such payment in the form of shares of the Companys
common stock valued at $0.41 per share or cash. In the event that American
International Industries, Inc. does not own any of the Companys common stock
on that date, it agrees to pay such difference in cash. Other than this
guarantee and its ownership of certain shares of the Companys common and
Series AA Preferred stock, American International Industries, Inc. has no
relationship with the Company. The land was re-appraised in November 2002, in connection with a
refinancing and at the request of a lender. The Companys new management
determined that the development of surgery centers on these locations was not
in the best interest of the Company. The new management determined that the
Company would be better served by selling the land and using the proceeds to
help fund the operations of the Company. The Company incurred an impairment of its investment in land of $1,500,000
during the third quarter of 2002 to reflect the investments estimated
valuation at that time. In September 2003, the Company recorded additional
impairment on its investment in land amounting to $579,385. Such impairment
was based on the information gathered during the marketing of the land
holdings. This information indicated that SurgiCare would not receive in
excess of the land resale guarantee from AII, and thus the value was written down to the resale guarantee amount of $4
million. 22




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##### 



Total Operating Expenses. Total operating expenses decreased $9,983,255,
or 46.8% to $11,352,481in 2003 from $21,335,736 in 2002. As a percent of net
revenue, such expenses decreased to 140.8% in 2003 from 184.7% in 2002. Such
expense fluctuations, expressed both in dollars and as a percentage of revenue,
are related to the factors discussed above. Other Income (Loss).Total Other Expense increased $237,384, or 16.3% to
$1,695,667 in 2003 from $1,458,283 in 2002 primarily due to the following: In 2003, the Companys equity in earnings (losses) from limited
partnerships was $194,444 compared to $(103,874) in 2002. In 2003, the limited
partnerships (in which the Company had a 10% equity interest) were profitable,
in contrast to 2002 when losses were incurred, resulting primarily from the
centers adoption of the Companys policies and procedures surrounding
contractual allowances, provision for doubtful accounts and inventory
valuation. Additionally, the Company recorded a loss of approximately $40,000
for its 10% interest in Physicians Endoscopy Center, which was a start up
center and began operations in December 2002. Interest expense increased $563,255, or 41.4% to $1,922,315 in 2003 from
$1,359,060 in 2002 due to additional borrowings to complete an acquisition, to
attempt to acquire Aspen Healthcare, and to finance the Companys working
capital needs during 2003. Minority Interest in Earnings (Losses) of Partnerships. In 2003, no
credit for minority interest in losses of partnerships was recorded because
cumulative losses exceeded the limited partners minority interest in equity
capital of the partnerships. In 2002, $782,386 was recorded due to significant
losses incurred by the partnerships (whose financial results are consolidated
with the Companys), resulting primarily from the partnerships adoption of the
Companys policies and procedures surrounding contractual allowances, provision
for doubtful accounts and inventory valuation. Federal Income Tax. In 2003, the Company recorded a tax benefit of
$173,407, or 3.5% of its pre-tax loss of $4,983,624. In 2002, the Company
recorded a tax benefit of $1,609,576, or 15.4% of its pre-tax loss of
$10,459,194. In both years, the percentage is less than the normally expected
rate due to valuation allowances against the Companys deferred tax assets. Net Loss. Due to the factors discussed above, the Companys net loss in
2003 decreased to a loss of $4,810,217 compared to a net loss of $8,849,618 in
2002. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities was $1,743,143 in 2003 compared to
$462,422 in 2002. The primary reason for usage of cash is due to continued
operating losses in both years. Net cash provided by investing activities was $492,038 in 2003 compared to
net cash used in investing activities of $1,667,443 in 2002. In 2003, the
Company sold its ownership interest in Physicians Endoscopy Center for $425,000
cash and sold a note receivable for $160,000. In 2002, the increased use of
cash was primarily for the investment in Tuscarawas Ambulatory Surgery Center
($426,859) and Aspen Healthcare ($1.1 million). Net cash provided by financing activities decreased to $1,130,331 in 2003
from $2,315,918 in 2002. In 2003, cash raised through the sale of common
stock, the exercise of warrants and additional loans was predominantly used to
pay down debt and for working capital purposes. In 2002, the Company used
portions of the cash raised through debt and issuance of common stock to fund
acquisitions and other capital expenditures. As of December 31, 2003, the Company had cash and cash equivalents of
$141,553 and negative working capital of $10,498,027. SurgiCare has a total of
$6,928,542 in long-term debt and an additional $1,331,475 in 23




---



##### 



revolving lines of credit currently
in default. SurgiCare has defaulted
on certain provisions of its Loan and Security Agreement with its senior
lender, DVI Business Credit Corporation and DVI Financial Services, Inc.
(DVI). On August 25,2003, DVI filed for protection under Chapter 11 of the
U.S. Bankruptcy laws. IPS and SurgiCare completed
negotiations with DVI which resulted in a decrease of their combined debt of
approximately $10.1 million to a combined payout of approximately
$6.5 million including a buy-out of the
revolving lines of credit. As part of that agreement, the companies have
executed a new loan agreement with U.S. Bank
Portfolio Services (USBPS), as servicer for payees, for payment of the revolving line of credit and
renegotiated the term loan amounts. The sum due to
DVI at the closing of the aforementioned merger and equity transactions is $2,000,000. As a part of that transaction, the companies have signed a term sheet for a
new revolving line of credit, which will be used to pay off the DVI revolving line of credit. The Company has financed its working capital needs primarily though the
issuance of equity, secured and/or convertible debt. See CHANGE OF CONTROLS
under Item 14  Controls & Procedures. As of December 31, 2003, the Company
does not have any credit facilities available with financial institutions or
other third parties to provide for working capital shortages. Although the
Company believes it will generate cash flow from operations in the future, due
to its debt load, it is not able to fund its current operations solely from its
cash flow. On March 6, 2003, the Company received a $1.2 million investment from
existing physician shareholders, local physicians, and select individuals. The
investment was made via a private placement, under which 3,418,544 shares of
the companys common stock were issued. The shares are restricted under Rule
144. In addition, the investors received a warrant for every two shares of
common stock purchased. The warrants are exercisable for one year and are
priced at $0.35. The proceeds of the financing are being used for working
capital purposes. In November 2003, SurgiCare completed a $470,000 financing for working
capital through the issuance of one-year convertible unsecured promissory notes
bearing interest at 10% per annum. The notes are convertible into shares of
Company common, at any time, at the option of the note holder. The conversion
price for the notes will be equal to (a) $.35 per share, if the note is
converted on or prior to January 31, 2004, or (b) if the note is converted
after January 31, 2004, the lower of (i) $0.25 or (ii) seventy-five percent
(75%) of the average closing price for the 20 trading days immediately prior to
the conversion date. Based on the relative fair value of the beneficial
conversion feature of the notes, a charge of $123,566 was recorded to interest
expense. The note holders also received a five-year warrant to purchase shares
of Company common stock. The number of shares of common stock that may be
purchased upon the exercise of the warrant will be equal to 25% of the number
of shares of common stock into which the note is convertible. The warrant may
be exercised at an exercise price of $0.35 per share, and may be exercised on a
cashless basis at the option of the holder. Based on the relative fair value
of the warrants, a discount of $76,834 was recorded and is being amortized to
interest expense over the one-year term of the notes. The promissory notes
will mature on October 31, 2004. The Company believes that additional sales of debt and/or equity
securities will be required to continue operations. The Company has arranged
the Restructuring which, if consummated, will involve an equity investment and
recapitalization of the Company. See Item 1 Description of Business 
Proposed Restructuring Transactions, page 3. The Company believes that, after
the equity financing, it will have sufficient cash to fund operations for
approximately twelve months following the Restructuring. Prior to the closing
of such contemplated transactions, any additional sales of debt and/or equity
by the Company will be subject to the prior approval of the counterparties to
the applicable transaction documents. The Company can provide no assurance that
it will be successful in any future financing effort to obtain the necessary
working capital to support its operations, or fund acquisitions for its
anticipated growth. In the event that any future financing efforts are not
successful, the Company will be forced to liquidate assets and/or curtail
operations. 24




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##### 



ITEM 7. FINANCIAL STATEMENTS TABLE OF CONTENTS Page NumberIndependent Auditors Reports
    
    
    27Consolidated Balance Sheets
    
    
    29Consolidated Statements of Operations
    
    
    31Consolidated Statements of Shareholders Equity
    
    
    33Consolidated Statements of Cash Flows
    
    
    34Notes to Consolidated Financial Statements
    
    
    36
 25




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##### 



Independent Auditors Report The Board of Directors
SurgiCare, Inc.
Houston, Texas We have audited the accompanying Consolidated Balance Sheet of SurgiCare, Inc.
and Subsidiaries as of December 31, 2003 and the related Consolidated
Statements of Operations, Shareholders Equity, and Cash Flows for the year
then ended. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. We conducted our audit 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 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 audit provides a
reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
SurgiCare, Inc. and Subsidiaries as of December 31, 2003 and the consolidated
results of their operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States
of America. The accompanying consolidated financial statements have been prepared assuming
that SurgiCare, Inc. and Subsidiaries will continue as a going concern. As
described more fully in Note 2, the Company has incurred operating losses, cash
deficits from operations and is in default of certain loan agreements. These
conditions raise substantial doubt about the Companys ability to continue as a
going concern. Managements plan in regards to these matters is also described
in Note 2. The consolidated financial statements do not reflect any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty. Mann, Frankfort, Stein & Lipp CPAs, LLP
Houston, Texas
March 18, 2004 26




---



##### 



Independent Auditors Report The Board of Directors
SurgiCare, Inc.
Houston, Texas We have audited the accompanying Consolidated Balance Sheet of SurgiCare, Inc.
and Subsidiaries as of December 31, 2002 and the related Consolidated
Statements of Operations, Shareholders Equity, and Cash Flows for the year
then ended. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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 audit provides a
reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
SurgiCare, Inc. and Subsidiaries as of December 31, 2002 and the consolidated
results of their operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States
of America. The accompanying consolidated financial statements have been prepared assuming
that SurgiCare, Inc. and Subsidiaries will continue as a going concern. As
described more fully in Note 2, the Company has incurred operating losses, cash
deficits from operations and is in default of certain loan agreements. These
conditions raise substantial doubt about the Companys ability to continue as a
going concern. Managements plan in regards to these matters is also described
in Note 2. The consolidated financial statements do not reflect any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty. WEINSTEIN SPIRA & COMPANY, P.C.
Houston, Texas
March 19, 2003 27




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##### 



SURGICARE, INC.
CONSOLIDATED BALANCE SHEETS December 31,2003
    
    2002ASSETSCurrent AssetsCash and cash equivalents
    
    $
    141,553
    
    
    $
    262,327Accounts Receivable:Trade (less allowance for contractual
adjustments and doubtful accounts of
$3,768,846 and $6,496,000 at December 31,
2003 and 2002, respectively)
    
    
    1,309,682
    
    
    
    1,324,944Other
    
    
    59,909
    
    
    
    398,834Note receivable
    
    
    
    
    
    
    223,178Income tax receivable
    
    
    159,846Inventory
    
    
    338,470
    
    
    
    397,772Prepaid expenses
    
    
    133,293
    
    
    
    69,380Other current assets
    
    
    23,027
    
    
    
    76,313Total Current Assets
    
    
    2,165,780
    
    
    
    2,752,748Property and EquipmentOffice furniture and equipment
    
    
    399,912
    
    
    
    378,901Medical and surgical equipment
    
    
    3,748,559
    
    
    
    3,576,721Leasehold improvements
    
    
    946,890
    
    
    
    941,440Computer equipment and software
    
    
    382,263
    
    
    
    377,495Transportation equipment
    
    
    19,015
    
    
    
    19,0155,496,639
    
    
    
    5,293,572Less: Accumulated depreciation and amortization
    
    
    3,237,657
    
    
    
    2,468,6622,258,982
    
    
    
    2,824,910Goodwill
    
    
    8,105,735
    
    
    
    8,045,735Real Estate
    
    
    4,000,000
    
    
    
    4,579,385Investment in Limited Partnerships
    
    
    381,434
    
    
    
    306,654Advances to Limited Partners
    
    
    440,423
    
    
    
    403,748Loan Fees(net of amortization of $198,249 and
$108,321 in 2003 and 2002, respectively)
    
    
    103,788
    
    
    
    193,716$
    17,456,142
    
    
    $
    19,106,896
 28




---



##### 



SURGICARE, INC.
CONSOLIDATED BALANCE SHEETS (continued) December 31,2003
    
    2002LIABILITIESCurrent LiabilitiesAccounts payable
    
    $
    2,864,199
    
    
    
    2,362,378Accrued expenses
    
    
    1,274,340
    
    
    
    472,645Lines of credit
    
    
    1,331,475
    
    
    
    1,665,657Current maturities of long-term debt
    
    
    6,928,542
    
    
    
    6,295,389Current portion of capital leases
    
    
    265,251
    
    
    
    313,725Payable to a related party
    
    
    
    
    
    
    116,909Total Current Liabilities
    
    
    12,663,807
    
    
    
    11,226,703Long-Term Capital Lease Obligations
    
    
    103,341Long-Term Debt
    
    
    
    
    
    
    454,328Minority Interest in Partnerships12,767,148
    
    
    
    11,681,031SHAREHOLDERS EQUITYPreferred Stock,Series A, par value
$.001, 1,650,000 authorized; 1,137,700
and 1,225,100 issued and outstanding
at December 31, 2003 and 2002;
respectively; redemption and
liquidation value $5,688,500 and
$6,125,500, respectively
    
    
    1,138
    
    
    
    1,225Preferred Stock,Series AA, par value
$.001, 1,200,000 authorized; 900,000
issued and outstanding at December 31,
2003 and 2002
    
    
    900
    
    
    
    900Common Stock,par value $.005,
50,000,000 shares authorized;
27,082,843 issued and 26,991,443
outstanding at December 31, 2003;
21,327,131 issued and 21,252,131
outstanding at December 31, 2002
    
    
    135,414
    
    
    
    106,635Additional Paid-In Capital
    
    
    17,116,523
    
    
    
    15,065,801Retained Earnings (Deficit)
    
    
    (12,518,413
    )
    
    
    (7,708,196
    )Less: Treasury Stock  at cost, 91,400
and 75,000 shares at December 31, 2003
and 2002, respectively
    
    
    (38,318
    )
    
    
    (32,250
    )Less: Shareholder receivables
    
    
    (8,250
    )
    
    
    (8,250
    )4,688,994
    
    
    
    7,425,865$
    17,456,142
    
    
    $
    19,106,896
 See notes to consolidated financial statements. 29




---



##### 



SURGICARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS For the Year EndedDecember 31,2003
    
    2002Revenues:Surgical, net
    
    $
    7,772,955
    
    
    $
    11,164,043Management fees
    
    
    291,568
    
    
    
    388,3968,064,523
    
    
    
    11,552,439Direct Cost of Revenues:Surgical costs
    
    
    1,629,661
    
    
    
    2,714,809Clinical salaries and benefits
    
    
    1,928,822
    
    
    
    1,702,718Other
    
    
    970,161
    
    
    
    960,6714,528,644
    
    
    
    5,378,198General and Administrative Expenses:Salaries and benefits
    
    
    1,576,831
    
    
    
    1,604,562Management and affiliation fees
    
    
    110,829
    
    
    
    130,979Rent
    
    
    931,425
    
    
    
    741,124Depreciation
    
    
    768,996
    
    
    
    671,880Amortization
    
    
    89,928
    
    
    
    73,851Professional fees
    
    
    1,097,264
    
    
    
    2,223,374Provision for doubtful accounts
    
    
    289,823
    
    
    
    5,753,734Other
    
    
    1,235,096
    
    
    
    1,108,5696,100,192
    
    
    
    12,308,073Other Operating Expenses:Loss on sale of assets
    
    
    463,346
    
    
    
    2,149Loss (gain) on sale of partnership interests
    
    
    (319,086
    )
    
    
    169,934Loss on terminated acquisition
    
    
    
    
    
    
    1,977,382Impairment on investment in land
    
    
    579,385
    
    
    
    1,500,000723,645
    
    
    
    3,649,465Total Operating Expenses
    
    
    11,352,481
    
    
    
    21,335,736Operating Loss
    
    
    (3,287,958
    )
    
    
    (9,783,297
    )Other Income (Expense)Miscellaneous income
    
    
    32,205
    
    
    
    4,651Equity in earnings (loss) of limited partnerships
    
    
    194,444
    
    
    
    (103,874
    )Interest expense
    
    
    (1,922,315
    )
    
    
    (1,359,060
    )(1,695,667
    )
    
    
    (1,458,283
    )
 See notes to consolidated financial statements. 30




---



##### 



SURGICARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued) For the Year EndedDecember 31,2003
    
    2002Loss Before Minority Interest and Federal
Income Tax Benefit
    
    
    (4,983,624
    )
    
    
    (11,241,580
    )Minority Interest in Loss of Partnerships
    
    
    
    
    
    
    782,386Loss Before Federal Income Tax Benefit
    
    
    (4,983,624
    )
    
    
    (10,459,194
    )Federal Income Tax BenefitCurrent
    
    
    (173,407
    )
    
    
    (224,576
    )Deferred
    
    
    
    
    
    
    (1,385,000
    )(173,407
    )
    
    
    (1,609,576
    )Net Loss
    
    $
    (4,810,217
    )
    
    $
    (8,849,618
    )Net Loss Per Share  Basic
    
    $
    (.19
    )
    
    $
    (.56
    )Net Loss Per Share  Diluted
    
    $
    (.19
    )
    
    $
    (.56
    )Weighted Average Common Shares OutstandingBasic
    
    
    24,754,050
    
    
    
    15,831,748Diluted
    
    
    24,754,050
    
    
    
    15,831,748
 31




---



##### 



SURGICARE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
For the Years Ended December 31, 2003 and 2002 $.001
    
    $.001
    
    $.005Series A
    
    Series AA
    
    Par ValuePreferred
    
    Preferred
    
    Common
    
    Additional
    
    
    
    
    
    RetainedStock
    
    Stock
    
    Stock
    
    Paid-In
    
    Treasury
    
    Earnings
    
    Shareholder
    
    TotalShares
    
    Amount
    
    Shares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Stock
    
    (Deficit)
    
    Receivables
    
    EquityBalance  January 1, 2002
    
    
    1,316,100
    
    
    $
    1,316
    
    
    
    
    
    
    
    
    
    
    
    14,089,320
    
    
    $
    70,446
    
    
    $
    4,991,301
    
    
    
    
    
    
    $
    1,141,422
    
    
    $
    (8,250
    )
    
    $
    6,196,235Issuance of preferred stock for land
    
    
    
    
    
    
    
    
    
    
    1,200,000
    
    
    $
    1,200
    
    
    
    
    
    
    
    
    
    
    
    5,998,800
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,000,000Sale of common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,039,024
    
    
    
    15,195
    
    
    
    1,955,805
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,971,000Conversion of preferred stock
    
    
    (91,000
    )
    
    
    (91
    )
    
    
    (300,000
    )
    
    
    (300
    )
    
    
    3,749,537
    
    
    
    18,748
    
    
    
    (18,357
    )Exercise of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125,000
    
    
    
    625
    
    
    
    11,875
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,500Issuances of stock for consulting
services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136,250
    
    
    
    681
    
    
    
    220,360
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    221,041Issuances of stock and warrants for
acquisitions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    188,000
    
    
    
    940
    
    
    
    770,313
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    771,253Issuances of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    923,114
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    923,114Beneficial conversion feature of
debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    212,590
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    212,590Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (32,250
    )
    
    
    
    
    
    
    
    
    
    
    (32,250
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,849,618
    )
    
    
    
    
    
    
    (8,849,618
    )Balance  December 31, 2002
    
    
    1,225,100
    
    
    $
    1,225
    
    
    
    900,000
    
    
    $
    900
    
    
    
    21,327,131
    
    
    $
    106,635
    
    
    $
    15,065,801
    
    
    $
    (32,250
    )
    
    $
    (7,708,196
    )
    
    $
    (8,250
    )
    
    $
    7,425,865Sale of common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,418,544
    
    
    
    17,093
    
    
    
    885,992
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    903,085Warrants issued in connection with
sale of common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    236,811
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    236,811Warrants issued in connection with
debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    76,834
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    76,834Beneficial conversion feature of
debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    123,566
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    123,566Exercise of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,384,990
    
    
    
    6,925
    
    
    
    299,723
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    306,648Issuances of stock for consulting
services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    952,178
    
    
    
    4,761
    
    
    
    427,796
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    432,557Redemption of preferred stock
    
    
    (87,400
    )
    
    
    (87
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (87
    )188,000
    
    
    
    940
    
    
    
    770,313
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    771,253Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,068
    )
    
    
    
    
    
    
    
    
    
    
    (6,068
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,810,217
    )
    
    
    
    
    
    
    (4,810,217
    )Balance  December 31, 2003
    
    
    1,137,700
    
    
    $
    1,138
    
    
    
    900,000
    
    
    $
    900
    
    
    
    27,082,843
    
    
    $
    135,414
    
    
    $
    17,116,523
    
    
    $
    (38,318
    )
    
    $
    (12,518,413
    )
    
    $
    (8,250
    )
    
    $
    4,688,994
 See notes to consolidated financial statements.




---



##### 



SURGICARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS For the Year EndedDecember 31,2003
    
    2002Cash Flows From Operating ActivitiesNet loss
    
    $
    (4,810,217
    )
    
    $
    (8,849,618
    )Adjustments to reconcile net loss to net cash provided by (used
in) operating activities:Equity in (earnings) loss of limited partnerships
    
    
    (194,444
    )
    
    
    103,874Minority interest in loss of partnerships
    
    
    
    
    
    
    (782,386
    )Depreciation and amortization
    
    
    858,924
    
    
    
    745,731Amortization of debt discount
    
    
    95,134Interest expense recognized on beneficial conversion features
on notes payable
    
    
    123,566Provision for doubtful accounts
    
    
    289,823
    
    
    
    5,753,734Deferred federal income tax (benefit)
    
    
    
    
    
    
    (1,385,000
    )Loss (gain) on sale of interest in limited partnerships
    
    
    (319,086
    )
    
    
    169,934Loss on sale of assets
    
    
    463,346
    
    
    
    2,118Loss on terminated acquisition
    
    
    
    
    
    
    1,977,382Impairment on investment in land
    
    
    579,385
    
    
    
    1,500,000Other
    
    
    (256
    )Change in:Accounts receivable
    
    
    (335,636
    )
    
    
    (1,166,934
    )Income tax receivable
    
    
    (159,846
    )Inventory
    
    
    59,302
    
    
    
    230,804Prepaid expenses
    
    
    (63,913
    )
    
    
    113,350Other current assets
    
    
    16,612
    
    
    
    (163,170
    )Loan fees
    
    
    
    
    
    
    (139,537
    )Accounts payable
    
    
    852,468
    
    
    
    1,555,074Federal income tax payable
    
    
    
    
    
    
    (224,576
    )Accrued expenses
    
    
    801,695
    
    
    
    96,767Net Cash Used in Operating Activities
    
    
    (1,743,143
    )
    
    
    (462,422
    )Cash Flows From Investing ActivitiesPurchase of Tuscarawas
    
    
    
    
    
    
    (426,859
    )Capital expenditures
    
    
    (46,712
    )
    
    
    (226,203
    )Distributions from partnerships
    
    
    13,750
    
    
    
    81,000Investment in limited partnerships
    
    
    
    
    
    
    (14,865
    )Sale of note receivable
    
    
    160,000Proceeds from sale of interest in limited partnership
    
    
    425,000Buyout of limited partners
    
    
    (60,000
    )Proceeds from sale of assets
    
    
    
    
    
    
    19,484Investment in terminated acquisition
    
    
    
    
    
    
    (1,100,000
    )Net Cash Provided by (Used in) Investing Activities
    
    
    492,038
    
    
    
    (1,667,443
    )Cash Flows From Financing ActivitiesBorrowings on lines of credit
    
    
    3,789,996
    
    
    
    8,569,165Payments on lines of credit
    
    
    (4,124,178
    )
    
    
    (9,044,054
    )Proceeds from debt
    
    
    883,166
    
    
    
    3,867,689Payments on debt
    
    
    (751,975
    )
    
    
    (2,527,036
    )Principal payments on capital lease
    
    
    (101,489
    )
    
    
    (113,991
    )
 33




---



##### 



SURGICARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) For the Year EndedDecember 31,2003
    
    2002Cash Flows From Financing Activities (continued)Distributions to limited partners
    
    
    
    
    
    
    (536,946
    )Issuance of warrants with debt
    
    
    76,834
    
    
    
    149,841Purchase of treasury stock
    
    
    (6,068
    )
    
    
    (32,250
    )Exercise of warrants
    
    
    294,148
    
    
    
    12,500Proceeds from issuance of common stock with warrants
    
    
    1,069,897
    
    
    
    1,971,000Net Cash Provided by Financing Activities
    
    
    1,130,331
    
    
    
    2,315,918Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    (120,774
    )
    
    
    186,053Cash and Cash Equivalents  Beginning of Period
    
    
    262,327
    
    
    
    76,274Cash and Cash Equivalents  End of Period
    
    $
    141,553
    
    
    $
    262,327Supplemental Disclosures of Cash Flow InformationCash paid during the year for:Interest
    
    $
    784,503
    
    
    $
    1,205,353Supplemental Schedule of Non-Cash Investing andFinancing ActivitiesPurchase of land with preferred stock
    
    
    
    
    
    $
    6,000,000Issuance of shares for investment
    
    
    
    
    
    $
    74,750Issuance of shares and warrants in payment of debt
    
    $
    47,500Issuance of shares in payment of accounts payable
    
    $
    467,556
    
    
    $
    404,314Beneficial conversion feature of convertible notes
    
    $
    123,566
    
    
    $
    212,590Equipment acquired with capital lease obligation
    
    $
    156,356
    
    
    $
    67,032
 34




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##### 



SURGICARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002 Note 1  Organization and Accounting Policies SurgiCare, Inc. and Subsidiaries (the Company) maintains their accounts on the
accrual method of accounting in accordance with accounting principles generally
accepted in the United States of America. Accounting principles followed by
the Company and the methods of applying those principles, which materially
affect the determination of financial position, results of operations and cash
flows are summarized below: Description of Business Bellaire SurgiCare, Inc. (Bellaire) was formed in January 1995 as a Texas
corporation to operate an ambulatory surgery center (ASC) in Houston, Texas.
Effective July 1, 1999, Bellaire acquired SurgiCare, Inc. (formerly Technical
Coatings, Inc.) in a reverse acquisition. Bellaire SurgiCare, Inc. is now a
wholly-owned subsidiary of SurgiCare, Inc. In September 2000, Town & Country SurgiCare, Inc. (Town & Country) was formed
as a Texas corporation and a wholly-owned subsidiary of SurgiCare, Inc. Town &
Country is a 60% general partner in SurgiCare Memorial Village, L.P., which
operates an ASC in Houston, Texas. During 2002, Town & Country acquired a 10%
general partner interest in Physicians Endoscopy Center, Ltd., L.L.P.
(Physicians Endoscopy), which operates an ASC in Houston, Texas. During
2003, Town & Country sold its interest in Physicians Endoscopy. See Note 3. In October 2000, Baytown SurgiCare, Inc. (Baytown) was formed as a Texas
corporation and a wholly-owned subsidiary of SurgiCare, Inc. Baytown is a 10%
general partner of San Jacinto Surgery Center, Ltd (San Jacinto), which
operates an ASC in Baytown, Texas. In May 2001, Southeast SurgiCare, Inc. was formed as a Texas corporation and a
wholly-owned subsidiary of SurgiCare, Inc. Southeast SurgiCare, Inc. is a 20%
general partner of Bayside Surgical Partners, L.P. (Bayside), which operates an
ASC in Pasadena, Texas. During 2002, Southeast SurgiCare, Inc. sold their 20%
interest in Bayside. See Note 3. On May 31, 2002, SurgiCare, Inc. acquired a 51% ownership in Tuscarawas
Ambulatory Surgery Center, LLC (Tuscarawas), an Ohio limited liability company,
which operates an ASC in Dover, Ohio. See Note 3. Principles of Consolidation These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, Bellaire SurgiCare, Inc., Southeast SurgiCare,
Inc., Town & Country SurgiCare, Inc., Baytown SurgiCare, Inc. and Tuscarawas
Ambulatory Surgery Center, LLC (51% owned). All material intercompany balances
and transactions have been eliminated in consolidation. Cash and Cash Equivalents The Company considers all short-term investments with an original maturity of
three months or less to be cash equivalents. Revenue Recognition Surgical revenue is recognized on the date the procedures are performed, and
accounts receivable are recorded at that time. Such revenues are reported at
the estimated realizable amounts from patients 35




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##### 



and third-party payers. If such
third-party payers were to change their reimbursement policies, the effect on
revenue could be significant. Earnings are charged with a provision for
contractual adjustments and doubtful accounts based on such factors as
historical trends of billing and cash collections, established fee
schedules, accounts receivable agings and contractual relationships with
third-party payers. Contractual allowances are estimated primarily using each
surgery centers collection experience. Contractual rates and fee schedules
are also helpful in this process. On a rolling average basis, the Company
tracks collections as a percentage of related billed charges. This percentage,
which is adjusted on a quarterly basis, has proved to be the best indicator of
expected realizable amounts from patients and third-party payers. Contractual
adjustments and accounts deemed uncollectible are applied against the allowance
account. The Company is not aware of any material claims, disputes or
unsettled matters with third-party payers. Net surgical revenue is comprised of the following components: 2003
    
    2002Gross surgical revenue
    
    $
    25,108,526
    
    
    $
    35,759,108Contractual adjustments
    
    
    (17,335,571
    )
    
    
    (24,595,065
    )Net surgical revenue
    
    $
    7,772,955
    
    
    $
    11,164,043
 Management fees are based on a percentage of customers collected revenues and
are recognized during the period which services were performed. Inventory Inventory consists of medical and pharmaceutical supplies, which are stated at
the lower of cost or market. Cost is determined under the first-in, first-out
method. Property and Equipment Property and equipment are presented at cost. Depreciation and amortization
are computed at rates considered sufficient to amortize the cost of the assets,
using the straight-line method over their estimated useful lives as follows: Office furniture and equipment
    
    7 yearsMedical and surgical equipment
    
    5 yearsLeasehold improvements
    
    Remaining life of leaseComputer equipment and software
    
    5 yearsTransportation equipment
    
    5 years
 Investment in Limited Partnerships The investments in limited partnerships are accounted for by the equity method.
Under the equity method, the investment is initially recorded at cost and is
subsequently increased to reflect the Companys share of the income of the
investee and reduced to reflect the share of the losses of the investee or
distributions from the investee. These general partnership interests were accounted for as investment in limited
partnerships due to the interpretation of FAS 94/ARB 51 and the interpretations
of such by Issue 96-16 and SOP 78-9. Under those interpretations, SurgiCare
could not consolidate its interest in those facilities in which it held a
minority general interest partnership interest due to management restrictions,
shared operating decision- making, capital expenditure and debt approval by
limited partners and the general form versus substance analysis. Therefore,
SurgiCare recorded them as investments in limited partnerships. 36




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##### 



As of December 31, 2003 and 2002, the Company has a 10% general partnership
interest in San Jacinto Surgery Center, Ltd., a Texas limited partnership. As
of December 31, 2003, the difference in the carrying amount of the investment
and the underlying equity in net assets of San Jacinto was approximately
$237,000. This amount is considered goodwill and is not being amortized. As
of December 31, 2003, there is no impairment to this goodwill. As of December
31, 2003, San Jacinto had a $1,000,000 draw note payable to a bank with an
outstanding balance of $457,054, which is guaranteed by the Company. The note
bears interest at the prime rate plus 1% (4% as of December 31, 2003) and is
secured by the accounts receivable of San Jacinto. As of December 31, 2002, the Company had a 10% general partnership interest in
Physicians Endoscopy Center, Ltd., L.L.P., a Texas limited partnership. As
described in Note 3, the Company sold its 10% interest during 2003. Segments of an Enterprise and Related Information The Company has adopted Statement of Financial Accounting Standards No. 131
(SFAS 131), Disclosures about Segments of an Enterprise and Related
Information. SFAS 131 changes the way public companies report information
about segments of their business in their annual financial statements and
requires them to report selected segment information in their quarterly reports
issued to shareholders. It also requires entity-wide disclosures about the
products and services an entity provides, the material countries in which it
holds assets and reports revenues and its major customers. As substantially
all of the Companys revenues, loss from operations and identifiable assets are
from the ambulatory surgical segment, the Company has not made segment
disclosures in the accompanying consolidated financial statements. Goodwill Goodwill represents the excess of cost over the fair value of net assets of
companies acquired in business combinations accounted for using the purchase
method. Goodwill acquired in business combinations prior to June 30, 2001 had
been amortized using the straight-line method over an estimated useful life of
20 years. In July 2001, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS
No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. SFAS No. 142 requires
that goodwill no longer be amortized but instead be reviewed periodically for
possible impairment. The Company has adopted SFAS No. 142 effective January 1,
2002 and is no longer amortizing goodwill. Under SFAS No. 142, goodwill is required to be tested annually and more
frequently if an event occurs which indicates the goodwill may be impaired.
Upon adoption of SFAS 142, as well as December 31, 2003 and 2002, the Company
performed an impairment test of its goodwill and determined that no impairment
of the recorded goodwill existed. Real Estate Real estate is presented at the lower of cost or current market value based on
a current appraisal. Loan Fees Fees paid in connection with obtaining debt financing are being amortized over
the terms of the loans. Income Taxes Provisions for income taxes are based on taxes payable or refundable for the
current year and deferred taxes on temporary differences between the tax bases
of assets and liabilities and their reported 37




---



##### 



amounts in the financial
statements. Deferred tax assets and liabilities are included in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled as prescribed in SFAS No. 109, Accounting for Income Taxes.As changes
in tax laws or rates are enacted, deferred tax assets and liabilities are
adjusted through the current periods provision for income taxes. A valuation
allowance is provided for deferred tax assets if it is more likely than not
that such asset will not be realizable. Stock-Based Compensation SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. In December 2002, the FASB issued SFAS No.
148, Accounting for Stock-Based Compensation-Transition and Disclosure-
an amendment of FASB Statement No. 123, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. The statement also amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
compensation and the effect of the method used on reported results. The Company has chosen to continue to account for stock-based compensation
issued to employees using the intrinsic value method prescribed in Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Companys stock at the date of the grant over the amount an employee must
pay to acquire the stock. The Company grants options at or above the market
price of its common stock at the date of each grant. The fair value of options is calculated using the Black-Scholes option-pricing
model. Had the Company adopted the fair value method of accounting for stock
based compensation, compensation expense would have been higher, and net loss
and net loss attributable to common shareholders would have increased for the
periods presented. No change in cash flows would occur. The effects of applying
SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. 2003
    
    2002Net loss  as reported
    
    $
    (4,810,217
    )
    
    $
    (8,849,618
    )Deduct: Total stock-based employee
compensation (expense determined under the
fair value based method for all awards),
net of tax effect
    
    
    (210,900
    )
    
    
    (742,034
    )Net loss  pro forma
    
    $
    (5,021,117
    )
    
    $
    (9,591,652
    )Net Loss per share:Basic  as reported
    
    $
    (.19
    )
    
    $
    (.56
    )Basic  pro forma
    
    $
    (.20
    )
    
    $
    (.61
    )Diluted  as reported
    
    $
    (.19
    )
    
    $
    (.56
    )Diluted  pro forma
    
    $
    (.20
    )
    
    $
    (.61
    )
 No options were granted to employees during 2003. The weighted average fair
value of options granted as employee compensation during 2002 was $0.18. The
fair values were determined using the Black-Scholes option pricing model with
the following weighted average assumptions, and a forfeiture rate that is
assumed to be negligible. 2002Risk-free interest rate
    
    
    3.00
    %Expected life
    
    3.14 years
 38




---



##### 



2002Expected dividends
    
    NoneExpected volatility
    
    
    57
    %
 New Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities,and subsequently revised the Interpretation in
December 2003 (FIN 46R). This Interpretation of Accounting Research Bulletin
No. 51, Consolidated Financial Statements,addresses consolidation by business
enterprises of variable interest entities, which have certain characteristics.
As revised, FIN 46R is now generally effective for financial statements for
interim or annual periods ending on or after March 15, 2004. We have not
identified any variable interest entities. In the event a variable interest
entity is identified, we do not expect the requirements of FIN 46R to have a
material impact on our consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity.SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. An
issuer is required to classify a financial instrument that is within the scope
of this statement as a liability (or an asset in some circumstances). SFAS No.
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. We adopted the standard on July 1, 2003,
and the adoption did not have a material impact on our consolidated financial
statements. Advertising The Companys policy is to expense advertising costs as incurred, which
amounted to $80,366 and $248,386 for the years ended December 31, 2003 and
2002, respectively. Reclassifications Certain reclassifications have been made in the 2002 financial statements to
conform to the reporting format in 2003. Such reclassifications had no effect
on previously reported earnings. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates. Note 2  Going Concern The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States
of America, which contemplate continuation of the Company as a going concern.
However, the Company has incurred substantial operating losses during 2003. In
addition, the Company has used substantial amounts of working capital in their
operations and is in default of certain loan agreements. These conditions
raise substantial doubt about the Companys ability to continue as a going
concern. The Company has financed its growth primarily through the issuance of equity,
secured and/or convertible debt. As of December 31, 2003, the Company does not
have any credit facilities available with financial institutions or other third
parties to provide for working capital shortages. Although the 39




---



##### 



Company
believes it will generate cash flow from operations in the future, due to its
debt load, it is not able to fund its current operations solely from its cash
flow. As such, additional sales of debt and/or equity securities will be
required to continue operations. The Company believes that additional sales of debt and/or equity securities
will be required to continue operations. See Note 19  Subsequent Events for a
description of a series of transactions recently announced by the Company that,
if consummated, will involve an equity investment and recapitalization of the
Company. Prior to the closing of such contemplated transactions, any
additional sales of debt and/or equity by the Company will be subject to the
prior approval of the counterparties to the applicable transaction documents.
The Company can provide no assurance that it will be successful in any future
financing effort to obtain the necessary working capital to support its
operations, or fund acquisitions for its anticipated growth. In the event that
any future financing efforts are not successful, the Company will be forced to
liquidate assets and/or curtail operations. Note 3  Acquisitions / Dispositions On May 31, 2002, the Company acquired a 51% interest in Tuscarawas for an
aggregate of $725,000 in cash and warrants to purchase 200,000 shares of the
Companys common stock at an exercise price of $0.01 per share expiring May 31,
2007. The warrants were valued at $590,000. The Company has also entered into
a Management Agreement with Tuscarawas to act as exclusive manager of the
center in exchange for 5% of the centers net monthly collected revenue. In June 2003, the Company sold its 10% interest in Physicians Endoscopy
Center, Ltd for $425,000 and recognized a gain on the sale of $319,086. As
part of the sale agreement, the Company was released of any liability of the
center and removed as a guarantor on the centers bank note payable. In 2002, under the Companys previous management, the Company acquired five
tracts of land. Managements for acquiring the land was for the future
development of additional surgery centers for the Company. Management obtained
an appraisal from Associated National Appraisal Services, Inc. in January 2002,
to determine the fair market value of the transaction to purchase the land.
The land was acquired from Texas Real Estate Enterprises, Inc. and Midcity
Houston Properties, Inc. The Company has no relationship with either of these
entities, other than the purchase of this land. The Company entered into a resale guarantee agreement with American
International Industries, Inc., as a part of the agreement of December 11,
2002, (See Note 14  Preferred Stock). The guarantee provides the Company with
a land resale guarantee if, by June 1, 2006, the Company is unable to sell any
or all of the tracts of land for net sales proceeds of less than $4,000,000.
If the proceeds are less than $4,000,000, American International Industries,
Inc. agrees to compensate the Company in an amount equal to the difference
between $4,000,000 and the net sales proceeds received by the Company from the
sale of any of the land prior to June 1, 2006. The Company believes that the
language of the guarantee means that American International Industries, Inc.,
will pay the difference between $4,000,000 and the price received, net of
direct sales costs. American International Industries, Inc. shall have the
option to make such payment in the form of shares of the Companys common stock
valued at $0.41 per share or cash. In the event that American International
Industries, Inc. does not own any of the Companys common stock on that date,
it agrees to pay such difference in cash. Other than this guarantee and its
ownership of certain shares of the Companys common and Series AA Preferred
stock, American International Industries, Inc. has no relationship with the
Company. The land was re-appraised in November 2002 in connection with a refinancing and
at the request of a lender. The Companys new management determined that the
development of surgery centers on these locations was not in the best interest
of the Company. The new management determined that the Company would be better
served by selling the land and using the proceeds to help fund the operations
of the Company. 40




---



##### 



The Company incurred an impairment of its investment in land of $1,500,000
during the third quarter of 2002 to reflect the investments estimated
valuation at that time. In September 2003, the Company recorded additional
impairment on its investment in land amounting to $579,385. The Company is
continuing to market the tracts of land for sale and is protected by a
guarantee by American International Industries, Inc. of a $4 million resale
price and does not believe it will generate sales prices greater than the
guarantee in the next year or two. We valued the land at $4 million because of
the existence of the guarantee by AIII of $4 million on our sales price. Note 4  Certain Transactions In August 2003, the Company sold a promissory note with a face amount of
$223,177 to International Diversified Corporation (IDC) for $160,000, incurring
a loss of $63,177. The Company also agreed to release IDC from its $400,000
obligation to the Company, which had been included in other receivables. In
addition to the cash consideration, SurgiCare was released from any and all
obligations regarding the raising of additional funds for working capital and
was released of all liabilities regarding the lawsuit filed by IDC claiming
breach of contract requesting the return of $1 million or 2,439,024 shares
under a previous
agreement with IDC and American International Industries, Inc. A total loss of
$463,177 was recorded as a loss on sale of assets. Note 5  Intangible Assets Subject to Amortization Intangible assets subject to amortization consist of loan fees, net of
accumulated amortization of $198,249 and $108,321 at December 31, 2003 and
2002, respectively. The loan fees are amortized on a straight-line basis over
the loan terms. Amortization expense recorded for the years ended December 31,
2003 and 2002 was $89,928 and $73,851, respectively. Estimated future
amortization expense is as follows: Year Ending December 31,2004
    
    $
    38,4432005
    
    
    38,4432006
    
    
    18,7462007
    
    
    8,156$
    103,788
 Note 6  Earnings Per Share Basic earnings per share are calculated on the basis of the weighted average
number of shares outstanding. Diluted earnings per share, in addition to the
weighted average determined for basic loss per share, include common stock
equivalents, which would arise from the exercise of stock options and warrants
using the treasury stock method, and assumes the conversion of the Companys
preferred stock for the period outstanding, since their issuance. For the Year EndedDecember 31,2003
    
    2002Basic Loss Per Share:Net Loss
    
    $
    (4,810,217
    )
    
    $
    (8,849,618
    )Weighted average shares outstanding
    
    
    24,754,050
    
    
    
    15,831,748Dilutive stock options and warrants
    
    
    (A
    )
    
    
    (A
    )Conversion of preferred shares
    
    
    (B
    )
    
    
    (B
    )Conversion of debt
    
    
    (C
    )
    
    
    (C
    )
 41




---



##### 



For the Year EndedDecember 31,2003
    
    2002Weighted average common shares
outstanding for diluted net loss
per share
    
    
    24,754,050
    
    
    
    15,831,748Net loss per share  Basic
    
    $
    (.19
    )
    
    $
    (.56
    )Net loss per share  Diluted
    
    $
    (.19
    )
    
    $
    (.56
    )
 The following potentially dilutive securities are not included in the 2003 and
2002 calculation of common shares outstanding for diluted net earnings per
share, because their effect would be anti-dilutive due to the net loss for the
year:  (A)
    
    9,654,297 and 8,897,020 options and warrants outstanding at December
31, 2003 and 2002,respectively.(B)
    
    900,000 shares of Series AA Preferred stock are convertible into
$4,500,000 of common shares.
1,137,700 shares of Series A Preferred stock are convertible into
1,137,700 common shares.(C)
    
    $1,000,000 of debentures are convertible into common stock at a price
equal to $1.50 per share. $470,000 of notes are convertible into common
stock at a price equal to $0.35 per share until January 31, 2004. If the
notes are converted after January 31, 2004, the conversion price will be
equal to the lower of $0.25 or 75% of the average closing price for the 20
trading days immediately prior to the conversion date. Note 7  Lines-of-Credit Lines-of-credit as of December 31 are as follows: 2003
    
    2002$2,500,000 revolving
lines-of-credit with a
financial institution, secured
by accounts receivable, bearing
interest at prime (4.00% at
December 31, 2003) plus 2%,
interest payable monthly,
matured March 31, 2003
    
    $
    1,284,577
    
    
    $
    1,665,657$150,000 revolving
line-of-credit with a financial
institution, secured by
accounts receivable, bearing
interest at prime (4.00% at
December 31, 2003) plus 2%,
interest payable monthly, due
upon demand
    
    
    43,711
    
    
    
    Total
    
    $
    1,331,475
    
    
    $
    1,665,657
 Note 8  Long-Term Debt Long-term debt as of December 31, 2003 and 2002, is as follows: 2003
    
    2002Note payable to a financial institution, secured by all assets
of the Company, due in monthly installments of $81,068 including
interest at 10.75%, due April 2006
    
    $
    2,682,536
    
    
    $
    2,845,407
 42




---



##### 



2003
    
    2002Note payable to a financial institution, secured by all assets
of the Company and 400,000 shares of SurgiCare, Inc. common
stock pledged by certain shareholders, $375,000 due February
2002, remaining principal refinanced, due in monthly
installments of $11,060 including interest at 12%, due January
2006
    
    
    332,995
    
    
    
    355,730Notes payable to a financial institution, secured by inventory
and equipment, due in monthly installments of $12,222 including
interest at 11.5%, due November 2002
    
    
    122,368
    
    
    
    175,122Notes payable to an private equity organization, unsecured,
interest at 8.00%, payable on demand
    
    
    490,000
    
    
    
    $470,000 convertible notes payable, bearing interest at 10%,
maturing October 2004, net of discount for warrants (see below)
    
    
    407,136
    
    
    
    Note payable to a financial institution, secured by an
automobile, due in monthly installments of $550 including
interest at 7.99%, due November, 2004
    
    
    6,318
    
    
    
    12,147Note payable to a bank, secured by land, due in monthly
installments of $29,740 including interest at the prime rate
(4.00% at December 31, 2003) plus 1.5%, due December, 2007
    
    
    1,240,651
    
    
    
    1,500,000Note payable to a shareholder, unsecured, interest at the prime
rate (4.00% at December 31, 2003) plus 2% due March 2003
    
    
    2,500
    
    
    
    50,000Note payable to a unrelated entity, unsecured, due in monthly
payments of $4,303 including interest of 6%, due October, 2003
    
    
    50,000
    
    
    
    50,000Note payable to a financial institution, secured by accounts
receivable, inventory and equipment, due in monthly installments
of $3,297 including interest of 15.9%, due December, 2003
    
    
    24,649
    
    
    
    32,966$1,000,000 convertible debentures, bearing interest at 25%,
maturing June, 2003
    
    
    1,000,000
    
    
    
    918,836Note payable to a financial institution, secured by equipment,
furniture and fixtures, due in monthly installments of $25,955
including interest of 10%, due July, 2005
    
    
    562,445
    
    
    
    706,463Note payable to a bank, due on demand or in monthly installments
of $6,944 plus interest at the prime rate (4.00% at December 31,
2003) plus 1%, due December, 2003
    
    
    6,944
    
    
    
    83,3346,928,542
    
    
    
    6,749,717Less: Current maturities
    
    
    6,928,542
    
    
    
    6,295,389$
    
    
    
    $
    454,328
 Loan agreements relating to the majority of the Companys credit lines, notes
payable and capital leases contain requirements for maintenance of defined
minimum financial ratios. The Company is not in compliance with all such
provisions as of December 31, 2003. Further, the Company is delinquent in
payments on the majority of its outstanding debt. All notes and capital
leases in default have been shown as current in these financial statements.
On August 25, 2003 the Companys senior lender, DVI Business Credit Corp.
(DVI) announced that it is seeking protection under Chapter 11 of the United
States Bankruptcy laws. 43




---



##### 



In July 2004, SurgiCare and Integrated
Physician Solutions, Inc. (see Note 19
  Subsequent Events) completed negotiations to settle the companies combined
debt with DVI and U.S. Bank Corp., which totals $10.1 million. The settlement
calls for $6.5 million in payments to be made as follows: $2,000,000 payment
at the closing of the Transactions; $500,000 on the date 12 months after the
closing; $250,000 on the date 18 months after the closing; $2,500 per month
for the first 24 months after closing; $45,628 per month in years starting in
the 25th month and continuing through the 72nd month after closing; and a
$1,500,000 balloon payment at the completion of 72 months after closing. The Company has financed its growth primarily though the issuance of equity,
secured and/or convertible debt. As of December 31, 2003, the Company does not
have any credit facilities available with financial institutions or other
third parties to provide for working capital shortages. Although the Company
believes it will generate cash flow from operations in future quarters, due to
its debt load, it is not able to fund its current operations solely from its
cash flow. In November 2003, SurgiCare completed a $470,000 financing for working capital
through the issuance of one-year convertible unsecured promissory notes
bearing interest at 10% per annum. The notes are convertible into shares of
Company common, at any time, at the option of the note holder. The conversion
price for the notes will be equal to (a) $.35 per share, if the note is
converted on or prior to January 31, 2004, or (b) if the note is converted
after January 31, 2004, the lower of (i) $0.25 or (ii) seventy-five percent
(75%) of the average closing price for the 20 trading days immediately prior
to the conversion date. Based on the relative fair value of the beneficial
conversion feature of the notes, a charge of $123,566 was recorded to interest
expense. The note holders also received a five-year warrant to purchase
shares of Company common stock. The number of shares of common stock that may
be purchased upon the exercise of the warrant will be equal to 25% of the
number of shares of common stock into which the note is convertible. The
warrant may be exercised at an exercise price of $0.35 per share, and may be
exercised on a cashless basis at the option of the holder. Based on the
relative fair value of
the warrants, a discount of $76,834 was recorded and is being amortized to
interest expense over the one-year term of the notes. The promissory notes
will mature on October 31, 2004. The Company believes that additional sales of debt and/or equity securities
will be required to continue operations. See Note 19  Subsequent Events for
a description of a series of transactions recently announced by the Company
that, if consummated, will involve an equity investment and recapitalization
of the Company. Prior to the closing of such contemplated transactions, any
additional sales of debt and/or equity by the Company will be subject to the
prior approval of the counterparties to the applicable transaction documents.
The Company can provide no assurance that it will be successful in any future
financing effort to obtain the necessary working capital to support its
operations, or fund acquisitions for its anticipated growth. In the event that
any future financing efforts are not successful, the Company will be forced to
liquidate assets and/or curtail operations. Note 9  Long-Term Capital Leases The Company leases certain equipment from third parties. The leases expire
through 2008. As of December 31, 2003, certain leases were in default and
have been classified as current in these financial statements. The following is a schedule of future minimum lease payments under the
capital leases, together with the present value of the net minimum lease
payments as of December 31, 2003: For the Year EndingDecember 31,2004
    
    $
    302,826
 44




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##### 



For the Year EndingDecember 31,2005
    
    
    36,8442006
    
    
    18,4222007
    
    
    18,4222008
    
    
    12,281Total
    
    
    425,638Less: Amount representing interest
    
    
    (57,046
    )Present value of minimum lease payments
    
    
    368,592Less: Current obligations
    
    
    265,251Long-term obligations under capital lease
    
    $
    103,341
 Property and equipment includes the following amounts for leases that have
been capitalized: Office furniture and equipment
    
    $
    65,994Medical and surgical equipment
    
    
    409,276Computer equipment and
software
    
    
    162,904638,174Less: accumulated
depreciation
    
    
    269,214$
    368,960
 Depreciation for property and equipment under capital leases is included
in depreciation expense. Note 10  Operating Leases The Company leases its treatment facilities and corporate office space under
operating leases that expire in various years through 2008. The leases
provide for annual operating expense increases. The Company also leases
medical equipment under an operating lease, which expires in 2006. Base
rental payments under these lease agreements are as follows: For the Year Ending December 31,2004
    
    $
    718,0302005
    
    
    701,4822006
    
    
    507,8692007
    
    
    400,5052008
    
    
    267,003$
    2,594,889
 Note 11  Management Fees The Company has contracted with affiliated outpatient surgical centers to
manage the operation of the treatment facilities. Under the contracts, the
Company receives fees ranging from 2.5% to 5% of 45




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##### 



revenues collected by the
facilities under contract. The Company recorded the following fees during 2003
and 2002: 2003
    
    2002SurgiCare Memorial Village, L.P.
    
    $
    57,223
    
    
    $
    102,630San Jacinto Surgery Center, Ltd.
    
    
    103,772
    
    
    
    219,918Bayside Surgical Partners, L.P.
    
    
    
    
    
    
    37,500Physicians Endoscopy Center, L.P.
    
    
    76,967
    
    
    
    28,348Tuscarawas Ambulatory Surgery Center
    
    
    53,606
    
    
    
    $
    291,568
    
    
    $
    388,396
 The contract with Bayside was terminated in 2002 with the sale of the
investment in Bayside. The contract with Physicians Endoscopy was terminated
in June 2003 with the sale of the Companys investment in Physicians Endoscopy. Note 12  Related Party Transactions As of December 31, 2003 and 2002, the Company had a non-interest-bearing
receivable from a shareholder of $8,250 for the purchase of stock. As of December 31, 2003, the Company had a receivable from San Jacinto of
$13,364. As of December 31, 2002, the Company had a payable to San Jacinto of
$126,086. As of December 31, 2002, the Company had a receivable from Physicians
Endoscopy of $9,177. Bellaire leases space for its offices in a medical office building owned by a
partnership in which Dr. Mineo, director and shareholder, has a 25% interest.
The lease expired in 2003 and is now month-to-month. During 2003 and 2002,
Bellaire paid approximately $179,000 and $195,000 as rent to the partnership. A group of doctors who own 35% of Tuscarawas also have an ownership interest in
Oxford Capital Enterprises Two, which owns the medical building where the
center is located. The lease expires in 2008. During 2003 and 2002,
Tuscarawas paid approximately $401,000 and $234,000 as rent to Oxford Capital
Enterprises Two. The Company entered into a resale guarantee agreement with American
International Industries, Inc., which also owns shares of the Companys common
and Series AA Preferred stock. See Note 3  Acquisitions / Dispositions and
Note 14  Preferred Stock for further discussion. Note 13  Income Taxes A reconciliation of the statutory federal income tax rate to the effective tax
rate for the years ended December 31, 2003 and 2002 is as follows: 2003
    
    2002Federal income tax benefit at statutory rate
    
    $
    (1,635,474
    )
    
    
    (3,474,002
    )Increase in valuation allowance
    
    
    1,629,000
    
    
    
    2,679,000Change in estimates
    
    
    (166,933
    )
    
    
    (814,574
    )$
    (173,407
    )
    
    $
    (1,609,576
    )
 46




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##### 



Components of deferred taxes as of December 31, 2003 and 2002 were as follows: Deferred tax liabilities:Accrual to cash conversion
    
    $
    
    
    
    $
    (595,000
    )Goodwill
    
    
    (150,000
    )
    
    
    Total deferred tax liabilities
    
    
    (150,000
    )
    
    
    (595,000
    )Deferred tax assets:Accrual to cash conversion
    
    
    93,000
    
    
    
    Net operating loss
    
    
    4,365,000
    
    
    
    3,274,000Total deferred tax assets
    
    
    4,458,000
    
    
    
    3,274,000Net deferred tax asset
    
    
    4,308,000
    
    
    
    2,679,000(4,308,000
    )
    
    
    (2,679,000
    )Total Net deferred tax asset
    
    $
    
    
    
    $
    
 At December 31, 2003, the Company has a net operating loss carryforward of
approximately $12.8 million, which will begin to expire in 2021. The increase
in valuation allowance for 2003 and 2002 was $1,629,000 and $2,679,000,
respectively. The change in estimates for 2003 of $166,933 relates to an
income tax refund from an amended 2001 tax return. The change in estimates for
2002 of $814,574 relates to non-deductible tax adjustments and permanent
differences related to partnership accounting for the 2001 tax estimate. Note 14  Preferred Stock The Series A preferred stock is convertible at a rate of one share of preferred
stock into one share of $.005 par value common stock. The Company can redeem
the stock at $5 per share. The stock also has a liquidation preference of $5
per share. Holders of Series A preferred stock are entitled to one vote for
each share of Series A preferred stock held. The Series A preferred stock was
converted on January 29, 2004. See Note 19  Subsequent Events. In 2002, the Company issued 1,200,000 shares of Series AA Preferred Stock to
fund the acquisition of land (see Note 3). Under the original terms, 25% of
the preferred shares were convertible each year into common stock on a
one-to-one basis beginning June 1, 2003. If the common stock was trading at
less than $5 per share, the difference between the redemption value ($5) and
the market value was to be paid in cash or in Class B shares. The number of
Class B shares issued would be the amount of cash due divided by the average
stock price over the previous five trading days. Class B shares required
redemption at $5 per share plus 16% interest, payable quarterly on the first
anniversary of their issuance. The Company also had the option to redeem the
preferred stock for $5 per share at any time. In an agreement dated December 11, 2002, the terms of the Series AA Preferred
Stock were modified as follows: 300,000 shares converted immediately to
3,658,537 shares of common stock. On June 1, 2004, June 1, 2005 and June 1,
2006, 300,000 shares convert to a number of common shares equivalent to
$1,500,000 divided by the average closing price over the previous 20 trading
days. The Company has the option to redeem the Series AA Preferred shares on
the above dates for $5 per share. Holders of Series AA Preferred Stock are
entitled to one vote for each share of Series AA Preferred Stock held at all
shareholders meetings for all purposes. 47




---



##### 



The Company negotiated a modification to the original terms of the Series AA
Preferred Stock for several reasons, including: a) Management determined that
it was unlikely that the Companys common share price would be greater than $5
within the next few years and the Company would not have the cash to redeem the
shares, thus requiring the Company to issue Class B shares, which carried the
same redemption plus a 16% interest rate; b) It was in the best interest of the
Company to obtain the land resale guarantee, obtain the refinancing of the land
debt and to obtain an additional equity investment of $1 million at the time the
terms were renegotiated; c) It allowed the Company to redeem the Series AA
Preferred Stock with common shares regardless of the price of the common shares
and maintain a floor of $0.41 per share for conversion. The Company has authorized 20 million shares of total Preferred stock,
including those authorized for Series A, Series AA and any future series of
Preferred stock. The accompanying balance sheets reflect the shares allocated
to such series. Note 15  Warrants and Options Transactions with Other Than Employees The Company accounts for equity instruments issued to non-employees based on
the fair value of the equity instruments issued. During 2003, the Company issued warrants as follows: ExerciseNumber of Shares
    
    Price
    
    Expiration
    
    In connection with526,531
    
    $
    .35
    
    
    January 31,2008
    
    Consulting80,000
    
    
    .45
    
    
    January 31, 2008
    
    Private Placement1,629,272
    
    
    .35
    
    
    February 29,2004
    
    Private Placement335,713
    
    
    .35
    
    
    September 30, 2008
    
    Debt2,571,516
 During 2002, the Company issued warrants as follows: ExerciseNumber of Shares
    
    Price
    
    Expiration
    
    In connection with235,849
    
    $
    2.12
    
    
    July 15, 2005
    
    Debt200,000
    
    
    .01
    
    
    June 1, 2007
    
    Acquisition50,000
    
    
    1.00
    
    
    March 1, 2005
    
    Consulting336,786
    
    
    .32
    
    
    September 15, 2007
    
    Acquisition526,531
    
    
    .35
    
    
    November 12, 2007
    
    Consulting1,349,166
 Information with respect to warrants for December 31, 2003 and 2002, is as
follows: 2003
    
    2002Price Per
    
    
    
    
    
    Price PerWarrants
    
    Share
    
    Warrants
    
    ShareOutstanding on January 1,
    
    
    1,549,166
    
    
    $
    .32 - 3.00
    
    
    
    325,000
    
    
    $
    .10 - 3.00Issued
    
    
    2,571,516
    
    
    
    .35 - .45
    
    
    
    1,349,166
    
    
    
    .01 - 2.95
 48




---



##### 



2003
    
    2002Price Per
    
    
    
    
    
    Price PerWarrants
    
    Share
    
    Warrants
    
    ShareExercised
    
    
    (1,384,990
    )
    
    
    .01 - .25
    
    
    
    (125,000
    )
    
    
    .10Outstanding on December 31
    
    
    2,735,692
    
    
    $
    .01 - 3.00
    
    
    
    1,549,166
    
    
    $
    .32 - 3.00Weighted average exercise price
    
    $
    .70
    
    
    
    
    
    
    $
    .93Weighted average fair value of
warrants granted during the
year
    
    $
    .12
    
    
    
    
    
    
    $
    .85Weighted average remaining
life of warrants at December 31
    
    1.51 years
    
    
    
    
    
    4.26 years
 The fair value of the warrants at date of issuance was estimated using the
Black-Scholes Model with the following weighted average assumptions: 2002
    
    2001Risk-free interest rate
    
    
    3.00
    %
    
    
    3.01
    %Expected life
    
    1.9 years
    
    2.7 yearsExpected dividends
    
    None
    
    NoneExpected volatility
    
    
    55
    %
    
    
    74
    %
 Transactions with Employees The Company accounts for its employee stock options under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees, for which no
compensation expense is recognized for employee stock options if there is no
intrinsic value at the date of grant. In October 2001, the Company established a stock option plan which authorized
1,400,000 shares of common stock to be made available through an incentive
program for employees. The options are granted at an exercise price equal to
the fair market value of the common stock at the date of grant. The options
have a ten-year term. No options were granted under this plan in 2003. There
were 81,955 granted under this plan in 2002. During 2002, the Company granted options to an employee to purchase 175,000
shares of common stock with an exercise price of $2.00 and a term of 5 years.
The options are fully vested. During 2002, the Company also granted options to executives to purchase
6,489,232 shares of common stock with an exercise price of $.32 and a term of
10 years. One fourth of these options vested immediately upon grant, with the
remainder vesting over 3 years. On October 5, 2001, the Company granted options to purchase 860,000 shares of
common stock to employees. The options vest over various periods, have an
exercise price of $1.90 and a term of 10 years. Information with respect to employee stock options for December 31, 2003 and
2002, is as follows: 2003
    
    2002Price Per
    
    
    
    
    
    Price PerOptions
    
    Share
    
    Options
    
    ShareOutstanding on January 1
    
    
    7,347,854
    
    
    $
    1.90
    
    
    
    860,000
    
    
    $
    1.90Granted
    
    
    
    
    
    
    .32 - 2.05
    
    
    
    6,746,187
    
    
    
    .32 - 2.05
 49




---



##### 



2003
    
    2002Price Per
    
    
    
    
    
    Price PerOptions
    
    Share
    
    Options
    
    ShareForfeited
    
    
    (429,249
    )
    
    
    1.90
    
    
    
    (258,333
    )
    
    
    1.90Outstanding on December 31
    
    
    6,918,605
    
    
    $
    .32 - 2.05
    
    
    
    7,347,854
    
    
    $
    .32 - 2.05Exercisable on December 31
    
    
    3,788,279
    
    
    $
    .32 - 2.05
    
    
    
    2,657,853
    
    
    $
    .32 - 2.05Weighted average fair value of
options granted during the
year
    
    $
    .00
    
    
    
    
    
    
    $
    .18Weighted average exercise priceOutstanding
    
    $
    .42
    
    
    
    
    
    
    $
    .51Exercisable
    
    $
    .50
    
    
    
    
    
    
    $
    .84Weighted
average remaining life of options at December 31Outstanding
    
    8.69 years
    
    
    
    
    
    9.64 yearsExercisable
    
    8.55 years
    
    
    
    
    
    9.23 years
 Note 16  401(k) Plan The Company has an employee benefit plan under Section 401(k) of the Internal
Revenue Code for all eligible employees. Participants are permitted to defer
compensation up to a maximum of 15% of their income. On a discretionary basis,
the Company may match 25% of the employees deferrals up to 4% of their income.
The Company contributions vest 20% after two years of service and 20% each
year thereafter, being fully vested after six years of service. During 2003,
the Company did not make a matching contribution to the plan. In 2002, the
Company contributed approximately $7,000 to the Plan. Note 17  Litigation In March 2003, SurgiCare Memorial Village, L.P. and Town & Country SurgiCare,
Inc. were named as defendants in a suit entitled MarCap Corporation vs. Health
First Surgery Center-Memorial, Ltd.; HFMC, L.C.; SurgiCare Memorial Village,
L.P.; and Town & Country SurgiCare, Inc. MarCap has sued for default under a
promissory note and refusing to remit payment on a promissory note in the
amount of $215,329.36. SurgiCare has paid $53,832.34 of this balance and
settlement has been reached whereby SurgiCare will pay MarCap $150,000 over the
next year with interest at 10%, with an underlying settlement of approximately
$200,000 in the event of a breach in the payment plan. A balance of $48,890.84
remains on this settlement as of July 19, 2004. On July 7, 2003, SurgiCare, Inc. was named as a party in the arbitration
entitled Brewer & Pritchard, P.C. vs. SurgiCare, Inc. before the American
Arbitration Association. Brewer & Pritchard have claimed breach of contract and
demanded payment of $131,294.88 in billed and unbilled legal fees plus third
party expenses, interest at the highest legal rate, costs, legal fees and
damages from breach of contract. This case was settled in November 2003 and
SurgiCare issued shares of common stock valued at $117,500 as compensation for
past legal fees. On February 10, 2003, SurgiCare, Inc. was named as a defendant in a suit
entitled S.E. Altman v. SurgiCare. S.E. Altman has sued for breach of contract,
alleging that SurgiCare did not pay monies owed under a Finders Fee Contract.
Plaintiff asserts damages in the amount of $217,000, plus interest and
attorneys fees. International Diversified Corporation, Limited has indemnified
SurgiCare with respect to any
fees owed to Altman under the Finders Fee Contract. The case has been dismissed
in favor of arbitration. In March 2004, the parties executed a Settlement
Agreement and Release of 50




---



##### 



Claims to resolve the dispute in which SurgiCare
issued Mr. Altman 540,000 shares of common stock, which was registered with the
Securities and Exchange Commission on Form S-8. On April 14, 2003, SurgiCare, Inc. was named as a defendant in a suit
entitled A.I. International Corporate Holdings, Ltd. v. SurgiCare, Inc. in the
U.S. District Court for the Southern District of New York. Subsequently,
SurgiCare filed suit against A.I. International Corporate Holdings, Ltd. and
First National Bank, S.A.L. of Lebanon in the 215th Judicial District Court of
Harris County, Texas. The New York case involves allegations that SurgiCare
defaulted on its loan agreement. The plaintiffs in the New York case are suing
SurgiCare for $834,252 representing the loan amount and interest, plus
$219,000, representing damages for No-filing Charges and Non-Effective
Charges under the contract. SurgiCares lawsuit in Texas asserted that the
loan agreement is usurious. The parties signed an agreement to settle this
matter, which will close after the consummation of the Transactions. Pursuant
to this settlement, SurgiCare will pay Plaintiffs $220,000 in cash
and issue 2,100,000 shares of SurgiCare common stock (210,000 shares
after giving effect to the reverse stock split contemplated in
connection with the merger and equity transactions set forth above),
to be paid and issued after the closing of such
transactions. On November 24, 2003, SurgiCare, Inc. was named as a defendant in a suit
entitled Vincent A. Giammalva, Trustee v. SurgiCare, Inc., Keith G. LeBlanc,
and Phillip C. Scott; in the 344th Judicial District Court of Chambers County,
Texas. This case involves allegations that SurgiCare defaulted on a contract to
sell a parcel of real estate to plaintiff. Plaintiff also claims that LeBlanc
and Scott committed fraud. SurgiCare states that it could not sell the parcel
of land because of a lien on the property. The plaintiff seeks specific
performance, forcing SurgiCare to sell the property, as well as actual damages.
SurgiCare is negotiating with the plaintiff in an effort to settle this matter.
AII has agreed to indemnify SurgiCare, Inc., Keith LeBlanc and Phillip Scott
for all claims asserted in this litigation by agreement dated June 23, 2004. In addition, we are involved in various other legal proceedings and claims
arising in the ordinary course of business. Our management believes that the
disposition of these additional matters, individually or in the aggregate, is
not expected to have a materially adverse effect on our financial condition.
However, depending on the amount and timing of such disposition, an unfavorable
resolution of some or all of these matters could materially affect our future
results of operations or cash flows in a particular period. Note 18  Commitments On November 10, 2002, the Company entered into employment agreements with its
executives. The term of the agreements is three years. These agreements
provide for annual salaries and incentive bonuses of up to 30% of the
employees base compensation. The criteria for earning the bonus is
established by the Board of Directors at the beginning of each 12-month period.
In addition, the agreements provide for payments of two times annual base
salary if the executives are terminated without cause. All options would also
vest at that time. As if December 31, 2003, the Companys aggregate base
salary commitment under the employment agreements through their respective
terms is $1,588,000. Note 19  Subsequent Events On January 29, 2004, the Company converted all of its Series A Redeemable
Preferred Stock with the rights and preferences set forth in the Certificate of
Designation, Powers, Preferences, and Rights filed with the Secretary of State
of Delaware on September 12, 2001 (the Preferred Stock) to common stock of
the Company. This conversion was approved by the majority vote of the Preferred
Stock shareholders in a written consent effective as of October 20, 2003, which
granted the Company the right to convert the Preferred Stock and in which the
shareholders disclaimed any past or possible future rights regarding the
Preferred Stock, including but not limited to the liquidation preference upon
the liquidation, dissolution or winding upon of the Company, pursuant to the
aforementioned Certificate of Designation. 51




---



##### 



We have negotiated a series of transactions that will restructure SurgiCare and
result in a change of control. The transactions include the acquisition of
three new businesses and issuance of new equity securities for cash
and contribution of outstanding debt. We also intend to complete a reverse stock split and change our
name to Orion. Our board of directors has approved all of these actions and
a special meeting of stockholders in lieu of an annual meeting will be held to
approve them. The highlights of the financial transactions include:  
    
    Effecting a one-for-ten reverse stock split and re-designating our
outstanding common stock as Class A common stock.
    
    Issuing a new class of common stock Class B common stock to
Brantley Partners IV, L.P., a private investor (Brantley IV) or its
assignees. Brantley IV will purchase the Class B common stock for $10
million in cash plus cash in the amount of the accrued but unpaid
interest immediately prior to the closing of the transactions owed to a
subsidiary of Brantley IV by SurgiCare and Integrated Physician
Solutions, Inc. (IPS) on amounts advanced prior to October 24, 2003
(the Base Bridge Interest Amount), which as of July 19, 2004 was
$86,252. A portion of Brantley IVs cash investment will be used to
pay off the indebtedness owed by SurgiCare and IPS to the subsidiary
of Brantley IV. Based on the interest accrued on such indebtedness
through July 19, 2004, it is estimated that the net cash proceeds to
SurgiCare will be approximately $5,751,233. The shares to be received
by Brantley IV or its assignees will constitute approximately 59.0%
of SurgiCares outstanding equity after the transactions on an
as-converted basis. Brantley IV will also receive the option to
purchase shares of Class A stock for cash in an amount up to an
aggregate of $3 million after the closing of the transactions.
    
    Acquiring IPS, a holding company whose two business units provide
business management services dedicated to the practice of pediatrics
and integrated business and clinical software applications for
physicians, in a merger in which we will issue Class A common stock to
the IPS stockholders and certain IPS creditors. After the
transactions, former IPS stockholders and creditors will own
approximately 18.1% of our outstanding equity on an as-converted basis.
    
    Acquiring Medical Billing Services, Inc. (MBS), and Dennis Cain
Physician Solutions, Ltd. (DCPS), two providers of physician
management, billing, consulting and collection services in an
acquisition in which we will pay between $2.9 million and $3.5 million
cash and issue promissory notes in the aggregate principal amount of
$500,000 and Class C common stock to the current equity holders of MBS
and DCPS. The amount of consideration received depends upon the fair
market value of our common stock at the time of the closing of the
transactions, and the consideration is also subject to retroactive
increase or decrease, including the issuance of additional shares of
Class A common stock. We will also issue shares of Class A common
stock as directed by the DCPS and MBS equity holders, and may be
required to make additional payments in certain circumstances.
Immediately after the transactions, the equity holders of these two
companies and their designees will own Class A common stock and Class C
common stock which may amount to as much as approximately 7.7% of our
outstanding equity on an as-converted basis. These transactions are contingent upon refinancing SurgiCares, IPSs and MBSs
debt. The transactions and the refinancing will provide SurgiCare with
increased revenues and earnings, an improved balance sheet and the opportunity
to grow the business. Please review our proxy statement for our special
meeting of stockholders in lieu of an annual meeting, filed with the SEC for
the full details of the proposed restructuring. 52




---



##### 



ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On July 28, 2003, we dismissed Weinstein Spira & Company, P.C. (WSC) as
our independent auditors and retained Mann Frankfort Stein & Lipp CPAs, LLP
(MSFL) as our new independent auditors. The decision to change auditors was
approved by our board of directors. WSC reported on our financial statements for each of the fiscal years
ended December 31, 2002 and 2001. WSC did not include in any report on our
financial statements, an adverse opinion or a disclaimer of opinion, or a
qualification or modification as to uncertainty, audit scope or accounting
principles. During our two most recent fiscal years ended December 31, 2002, and the
subsequent interim period through July 28, 2003, there were no disagreements
between us and WSC on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to WSCs satisfaction, would have caused WSC to
make reference to the subject matter of the disagreement in connection with its
reports on our financial statements. WSCs report on our financial statements
for the year ended December 31, 2002, was modified by the inclusion of an
explanatory paragraph addressing our ability to continue as a going concern. ITEM 8A. CONTROLS AND PROCEDURES We maintain a set of disclosure controls and procedures that are designed
to ensure that information required to be disclosed by us in the reports filed
by us under the Securities and Exchange Act of 1934, as amended (Exchange
Act), is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms. As of the end of the period covered by
this report, we evaluated, under the supervision and with the participation of
our management, including our President and Chief Executive Officer and our
Secretary and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on
that evaluation, our President and Chief Executive Officer and our Secretary
and Chief Financial Officer concluded that our disclosure controls and
procedures are effective. During the most recent fiscal quarter, there have been no changes in our
internal controls over financial reporting that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting. CHANGES IN INTERNAL CONTROLS During 2002, under prior management, SurgiCare issued restricted common
stock in some circumstances in which restrictive transfer legends were
improperly omitted from stock certificates. SurgiCares current management has
conferred with counsel about these past issuances, and has instituted
procedures to ensure that future issuances of unregistered shares of securities
include appropriate legends and safeguards against transfer. SurgiCare has
issued instructions to its transfer agent warning against permitting transfers
of shares or removal of restrictive legends without assurance that such actions
are permissible under federal securities laws. SurgiCare also plans, after
completion of the Restructuring, to switch to a new transfer agent, which has
better protections in place for maintaining internal control over issuance and
transfer of securities. Disclosure controls are controls and other procedures that are designed to
ensure that information required to be disclosed by us in reports that we file
or submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SECs rules
and forms. Our disclosure controls and procedures are designed to insure that
the information required to be filed is accumulated and communicated to our
management in a manner designed to enable them to make timely decisions
regarding required disclosure. Our management, including our CEO and CFO, does not expect that our
disclosure controls or internal controls over financial reporting will prevent
all error or fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, but not absolute, assurance that the
objectives of a control system are met. Any control system contains
limitations imposed by resources and relevant cost considerations. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues have teen addressed. These
inherent limitations include the realities that judgments can be faulty and
that breakdowns can occur because of simple error or mistake. In addition,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of a control. Our
control system design is 53




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also based on assumptions about the likelihood of future events, and we
cannot be sure that we have considered all possible future circumstances and
events. PART III ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Listed below is certain information about our directors and executive
officers for 2003. Directors are elected by shareholders at each annual
shareholders meeting and serve until their successors are elected and
qualified. Officers serve at the discretion of the board of directors. Name
    
    Age
    
    Positions HeldKeith G. LeBlanc
    
    
    46
    
    
    President and Chief Executive OfficerBruce Miller
    
    
    55
    
    
    DirectorMichael A. Mineo
    
    
    60
    
    
    DirectorSherman Nagler
    
    
    48
    
    
    DirectorJeffrey Penso
    
    
    49
    
    
    Director and Vice PresidentPhillip C. Scott
    
    
    42
    
    
    Former Chief Financial Officer
 A summary of the business experience of each director and executive
officer for the past five years follows: Keith G. LeBlanc was appointed Chief Executive Officer on September 10,
2002. Mr. LeBlanc previously served as CEO for Gulf Coast Surgery and Endoscopy
in Biloxi, Mississippi. Mr. LeBlanc has extensive healthcare management
experience, serving as a hospital CEO for 10 years and as the CEO and founder
of The Quest Group, a physician equity MSO joint venture. The Quest Group
managed physician practices statewide in Louisiana. Mr. LeBlanc is a registered
respiratory therapist and holds a MHS from LSU Medical School. Dr. Bruce Miller, D.P.M., was elected as director of SurgiCare, Inc., on
July 26, 2000. Dr. Miller has been in private practice for 25 years. He
received his undergraduate degree in 1969 at Temple University and then
attended the Pennsylvania College of Podiatric Medicine. He has been a
Diplomat of the American Board of Podiatric Surgery since 1986. Dr. Michael Mineo D.P.M. was elected as Director of SurgiCare, Inc. on
July 10, 1999. Dr. Mineo has served as Vice-President of Bellaire SurgiCare,
Inc. since March of 1995. He has been in private practice for 29 years. He
received his undergraduate degree in 1964 from Geneva College, Beaver Falls,
PA, and then attended the Ohio College of Podiatric Medicine. He has been a
Diplomat of the American Board of Podiatric Surgery since 1979, and a Fellow of
the American College of Foot Surgeons since 1980. Dr. Sherman Nagler D.P.M. was elected as Director of SurgiCare, Inc. on
July 10, 1999. He has been in private practice for 16 years. He received his
undergraduate degree in 1977 at State University of New York at Plattsburgh,
and then attended the New York College of Podiatric Medicine. He has been a
Diplomat of the American Board of Podiatric Surgery since 1985. Dr. Jeffery Penso D.P.M. was elected as Director of SurgiCare, Inc. on
July 10, 1999. Dr. Penso has served as Vice-President of SurgiCare, Inc. since
July 1999 and Vice-President of Bellaire SurgiCare, Inc. since July 1998. He
has been in private practice for 16 years. He received his undergraduate degree
in 1983 at University of Akron, and then attended the Ohio College of Podiatric
Medicine. He has been a Diplomat of the American Board of Podiatric Surgery
since 1988. Phillip C. Scott was appointed Chief Financial Officer on September 18,
2002. Mr. Scott previously served as the Vice President of Development for
HealthCare Partners, a $300 million physician management services organization.
Mr. Scott was also a co-founder, Vice President and CFO for The Camden Group, a
national healthcare consulting firm. Mr. Scott is a Chartered Financial Analyst
and was awarded an MBA from the University of San Diego. On June 25, 2004, Mr.
Scott terminated his employment with SurgiCare. 54




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Board of Directors Meetings and Committees The current board of directors is comprised of four independent directors.
The board of directors has determined that they are independent according to
the listing standards of the AMEX. The board of directors held seven meetings
and acted pursuant to written consent on one occasion during the fiscal year
ended December 31, 2003. The board of directors currently has two standing
committees, the Audit Committee and the Compensation Committee. During fiscal
year 2003, each incumbent director attended at least seventy-five percent of
the aggregate of (1) the total number of meetings of the board of directors and
(2) the total number of meetings held by all committees of the board of
directors on which he served. The AMEX has adopted minimum requirements for director independence and
nominating and compensation committee membership. These requirements do not
apply to companies whose ownership is controlled by a single owner or group.
After the Transactions, SurgiCare will be considered a controlled company under
the AMEX rules and will not be required to comply with certain of the AMEX
rules on director independence and nominating and compensation committee
membership. The Audit Committee held one meeting for the fiscal year ended December
31, 2003. Dr. Miller was and is the sole member of the Audit Committee. The
board of directors has determined that Dr. Miller is independent as such term
is defined in the listing standards of the AMEX. However, the board of
directors has determined that Dr. Miller is not an audit committee financial
expert as such term is defined in the applicable regulations of the SEC. The
board of directors has not been able to locate new directors who meet the audit
committee financial expert standards. Upon closing of the Transactions, the
Audit Committee will be composed of three or more independent directors,
provided that for any period during which Orion is a small business issuer
that files reports under the Securities Exchange Commission Regulation S-B, the
Audit Committee will be composed of two or more independent directors. After
the transactions, it is expected that at least one of the directors on the
committee will be an audit committee financial expert or will be financially
sophisticated as such term is used in the AMEX Company Guide. In connection
with the Transactions, the board of directors will adopt a new written charter
for the Audit Committee. The Compensation Committee did not meet during the fiscal year ended
December 31, 2003. Dr. Nagler, Dr. Mineo and Dr. Penso, each of whom is
independent, are the members of the Compensation Committee. The Compensation
Committee provides recommendations to, and may act on behalf of, the board of
directors regarding compensation matters, and administers SurgiCares stock
option and compensation plans. Upon closing of the Transactions, Orion
will be a controlled company for purposes of the AMEX Company
Guide, because Brantley IV and its affiliates will hold over 50% of the voting
power of Orion. As a controlled company, Orion will not be required by the AMEX
to have a compensation committee of independent directors or to have the
majority of the independent directors on the board perform the functions of the
compensation committee. However, Orions board of directors may elect to
maintain a compensation committee nonetheless. SurgiCare does not have a nominating committee. The board of directors,
all of whom are considered independent according to the listing standards of
the AMEX, perform the nominating function. Upon the closing of the
Transactions, Orion will be a controlled company and will not be required by
the AMEX to maintain a nominating committee or to have the majority of the
independent directors on the board perform the functions of a nominating
committee, but it may choose to do so. Compliance with Section 16(a) of the Exchange Act Section 16(a) of the Securities Exchange Act of 1934 and SEC regulations
require that our directors, officers, and greater than 10 percent stockholders
file reports of ownership and changes in ownership with the SEC and AMEX and
furnish us with copies of all such reports they file. Based on the reports we
have received, we believe that the following reports were not filed on a timely
basis during 2001, 2002 or 2003:  
    
    On November 10, 2002, Keith LeBlanc, our chief executive
officer, received warrants to purchase a total of 3,244,616 shares of
our common stock under the terms of the employment agreement pursuant
to which he became the chief executive officer, which was effective
as of that date. The warrants have an exercise price of $0.32 per
share, become exercisable in monthly increments over three years, and
expire ten years from the date of grant. A Form 3 to report these
holdings was required but not filed. On January 31, 2003, Mr.
LeBlanc also purchased 80,000 shares of restricted common stock and
40,000 warrants to purchase common stock at an exercise price of
$0.45 per share, for a total purchase price for 55




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the stock and warrants of $36,000, as part of a private placement of
our securities. A Form 4 to report this acquisition was required but
not filed. Both of these acquisitions were reported in a Form 5 filed
with the SEC on February 9, 2004.
    
    On November 10, 2002, Phil Scott, our former chief financial
officer, received warrants to purchase a total of 3,244,616 shares of
our common stock under the terms of the employment agreement pursuant
to which he became the chief financial officer, which was effective
as of that date. The warrants have an exercise price of $0.32 per
share, become exercisable in monthly increments over three years, and
expire ten years from the date of grant. A Form 3 to report these
holdings was required but not filed. On January 31, 2003, Mr. Scott
also purchased 80,000 shares of restricted common stock and 40,000
warrants to purchase common stock at an exercise price of $0.45 per
share, for a total purchase price for the stock and warrants of
$36,000, as part of a private placement of our securities. A Form 4
to report this acquisition was required but not filed. Both of these
acquisitions were reported in a Form 5 filed with the SEC on February
9, 2004.
    
    No officers or directors filed Form 5 Annual Statements of
Change in Beneficial Ownership of Securities nor written
representations that no such reports were necessary for the years
ended December 31, 2001 or 2002.
    
    The reports of security holdings of certain beneficial owners
and management that are contained in our Form 10-KSB reports for the
years ended December 31, 2001 and 2002 also indicate that, since our
last stockholders meeting was held, the reported holdings of common
stock and derivative securities by some directors and former
directors, including current directors Sherman Nagler, Michael Mineo,
Jeffrey Penso and Bruce Miller have changed, but we have not received
copies of reports under Section 16 of the Securities Exchange Act
that give dates or details of the ownership changes by these
directors and former directors. Code of Ethics The
board of directors is reviewing a draft of the Corporate Code of Business Conduct
and Ethics for the Company (the Code), and plans to
finalize revisions to the Code as soon as practicable.
Upon approval by the Board of Directors, the Company will post the
Code on its website at www.surgicareinc.com. ITEM 10. EXECUTIVE COMPENSATION Executive Compensation Table The following table lists the compensation paid during each of SurgiCares
last three fiscal years to each of the highest paid executive officers of
SurgiCare, Inc., receiving compensation of at least $100,000, including Keith
G. LeBlanc, the Chief Executive Officer (our Covered Executives). Long-TermCompensation(3)Annual Compensation
    
    AwardsSecuritiesOther Annual
    
    UnderlyingCompensation
    
    Options/SARsName and Principal Position
    
    Year
    
    Salary ($)
    
    ($)
    
    (#)Keith G.
LeBlanc, President and CEO
    
    
    2003
    
    
    
    188,942
    
    
    
    28,828
    (2)2002
    
    
    
    56,654
    (1)
    
    
    3,072
    (4)
    
    
    3,244,6162001
    
    
    
    
    
    
    
    
    
    
    
    Phillip C. Scott, former CFO
    
    
    2003
    
    
    
    186,154
    
    
    
    11,120
    (5)
    
    
    2002
    
    
    
    56,654
    (1)
    
    
    2,017
    (5)
    
    
    3,244,6162001
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    Includes $30,000 (each) paid to Mr. LeBlanc and Mr. Scott as consultants
prior to employment with SurgiCare.(2)
    
    Includes $11,120 for living expenses, $11,372 for moving expenses and
$6,336 for auto allowance. 56




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(3)
    
    SurgiCare pays premiums for group life term insurance offered to all
employees as part of total benefit package through Administaff. Specific
costs are not individually specified.(4)
    
    Includes $2,017 for living expenses and $1,055 for auto allowance.(5)
    
    Consists of living expenses. Options, Warrants, and Stock Appreciation Rights No grants of stock options or stock appreciation rights were made to our
Covered Executives during the fiscal year ended December 31, 2003. The following table sets forth information concerning option exercises
during the fiscal year ended December 31, 2003, and option holdings as of
December 31, 2003, with respect to our Covered Executives. No stock
appreciation rights were outstanding at the end of the fiscal year. No shares
were acquired on exercise of options by our Covered Executives during 2003. Aggregated Option Exercises in 2003 and Fiscal Year End Values Shares
    
    
    
    
    
    Number of Securities
    
    Value of SecuritiesAcquired
    
    
    
    Underlying Unexercised
    
    Underlying UnexercisedonExercise
    
    ValueRealized
    
    Options at FYE (#)
    
    Options at FYE ($)Name
    
    (#)
    
    ($)
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    UnexercisableKeith G. LeBlanc
    
    
    0
    
    
    
    0
    
    
    
    1,729,902
    
    
    
    1,554,714
    
    
    
    101,394
    
    
    
    93,283Phillip C. Scott
    
    
    0
    
    
    
    0
    
    
    
    1,729,902
    
    
    
    1,554,714
    
    
    
    101,394
    
    
    
    93,283
 The securities listed in this table are warrants. The values of the
unexercised warrants above are based on the difference between the exercise
price of the warrant and the fair market value of SurgiCare common stock at the
end of the fiscal year ended December 31, 2003, which was $0.38 per share. Equity Compensation Plan Information The following table gives information about SurgiCare common stock that
may be issued upon the exercise of options, warrants and rights under all of
SurgiCares existing equity compensation plans as of July 19, 2004. (c)Number ofsecuritiesremaining available(a)
    
    
    
    
    
    for future issuanceNumber of securities
    
    (b)
    
    under equityto be issued upon
    
    Weighted-average
    
    compensation plansexercise of
    
    exercise price of
    
    (excludingoutstanding
    
    outstanding
    
    securitiesoptions, warrants and
    
    options, warrants
    
    reflected in columnPlan Category
    
    rights
    
    and rights
    
    (a))Equity compensation plans
approved by security holders
    
    
    52,090
    
    
    
    2.050
    
    
    
    1,347,910Equity compensation plans not
approved by security holders
    
    
    5,706,761
    
    
    
    .425
    
    
    
    0Total
    
    
    5,758,851
    
    
    
    .444
    
    
    
    1,347,910
 Employment Agreements Effective November 10, 2002, SurgiCare entered into an employment
agreement with its Chief Executive Officer, Keith G. LeBlanc. The term of the
agreement is three years. The agreement has a base salary of $198,000 for the
first year and $298,000 for the following years. Pursuant to the employment
agreement, Mr. LeBlanc has also received warrants to purchase 3,244,616 shares
of SurgiCare common stock with an exercise price of $0.32 per share that vest
over the three year term of the employment agreement and has purchased other
warrants and common stock of SurgiCare. The agreement provides for payments of
two times annual base salary if the Mr. LeBlanc is terminated 57




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##### 



without cause. All warrants would also vest at that time. SurgiCare will
enter into a new employment agreement with Mr. LeBlanc to replace this
agreement, as part of the Restructuring. Effective November 10, 2002, SurgiCare entered into an employment
agreement with Phillip C. Scott for the position of Chief Financial Officer.
Mr. Scott terminated his employment with SurgiCare on June 25, 2004. The
agreement had a base salary of $198,000 for the first year and $298,00 for the
subsequent two years of the contract term. Pursuant to the employment
agreement, Mr. Scott received warrants to purchase 2,095,478 shares of
SurgiCare common stock with an exercise price of $0.32 per share and has
purchased other warrants and common stock of SurgiCare. Although Mr. Scott has
not taken any formal legal action, the letter SurgiCare received from Mr. Scott
on June 25, 2004, alleges claims for two years severance pay (which would total
$596,000), unpaid base salary in the amount of $62,000, full vesting of all
1,149,138 remaining unvested warrants granted pursuant to the employment
agreement, certain bonuses, expense reimbursement and warrant re-pricing. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth, as of July 19, 2004, information with
respect to shares beneficially owned by: (a) each person who is known by us to
be the beneficial owner of more than 5% of the outstanding shares of SurgiCare
common stock or Series AA preferred stock, (b) each of our directors and
executive officers named in the Summary Compensation Table above, and (c) all
current directors and executive officers as a group. As of July 8, 2004, there
were 28,408,685 shares of SurgiCare common stock outstanding (prior to giving
effect to the Reverse Stock Split). Beneficial ownership has been determined in accordance with Rule 13d-3
under the Exchange Act. Under this rule, certain shares may be deemed
beneficially owned by more than one person (if, for example, persons share the
power to vote or the power to dispose of the shares). In addition, shares are
deemed beneficially owned by a person if the person has the right to acquire
shares (for example, upon conversion of our Series AA preferred stock or the
exercise of an option or warrant) within sixty days of the date as of which the
information is provided. In computing the percentage ownership of any person,
the amount of shares is deemed to include the amount of shares beneficially
owned by such person by reason of such acquisition rights. As a result, the
percentage of outstanding shares of any person as shown in the following table
does not necessarily reflect the persons actual voting power at any particular
date. To our knowledge, except as indicated in the footnotes to this table and
pursuant to applicable community property laws, the persons named in the table
have sole voting and investment power with respect to all shares of SurgiCare
common stock shown as beneficially owned by them. Shares Owned BeneficiallyCommon Stock
    
    Series AA Preferred StockPercentName and Address of Beneficial Owner
    
    Number (1)
    
    Percent (1)
    
    Number (1)
    
    (1)Keith G. LeBlanc, 12727 Kimberley
Lane, Suite 200, Houston, TX 77024
    
    
    11,168,266
    (2)(5)
    
    
    27.89
    
    
    
    900,000
    (6)
    
    
    100Roger Huntington, 12727 Kimberley Lane,
Suite 200, Houston, TX 77024
    
    
    
    
    
    
    Jeffrey J. Penso, 11006 Westheimer,
Houston, TX 77042
    
    
    944,036
    
    
    
    3.26International Diversified Corporation,
601 Hanson Road, Kemah, TX 77565
    
    
    10,459,024
    (3)(4)(5)
    
    
    27.74
    
    
    
    900,000
    (3)(6)
    
    
    100Michael A. Mineo, 6699 Chimney
Rock, Houston, TX 77081
    
    
    959,409
    
    
    
    3.31Sherman Nagler, 1200 Binz, Houston,
TX 77004
    
    
    807,610
    
    
    
    2.79Bruce Miller, 13737 S.W. Freeway,
Sugar Land, TX 77478
    
    
    851,536
    
    
    
    2.94
 58




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Shares Owned BeneficiallyCommon Stock
    
    Series AA Preferred StockPercentName and Address of Beneficial Owner
    
    Number (1)
    
    Percent (1)
    
    Number (1)
    
    (1)Phillip C. Scott (Former Chief Financial
Officer), 7920 Corta Panka, Carlsbad, CA
92009
    
    
    2,215,478
    (7)
    
    
    7.13All directors and executive officers as a
group (6 persons)
    
    
    14,730,857
    
    
    
    36.79
    
    
    
    900,000
    (6)
    
    
    100
   (1)
    
    Share numbers and percentages are calculated on the basis of the number
of outstanding shares of common stock of such class plus, for each person
or group, any shares such person or group has the right to acquire on or
prior to September 17, 2004.(2)
    
    Includes 2,338,266 shares issuable upon the exercise of warrants which
are exercisable on or prior to September 17, 2004.(3)
    
    Elkana Faiwuszewicz has all the investment and voting control of the
shares held by International Diversified Corporation (IDC).(4)
    
    Includes 8,750,000 shares of common stock to which AII, which is majority
owned by IDC, is entitled to receive upon conversion of the Series AA
preferred stock pursuant to the terms of its agreement with SurgiCare
described below under Certain Relationships and Related Transactions -
Summary of Transactions with Daniel Dror, AII, and IDC, etc.If the
conversion does not occur by July 30, 2004, SurgiCare is required by the
certificate of designations of the Series AA preferred stock filed
pursuant to the agreement to either redeem or convert 300,000 shares of
Series AA preferred stock on each of July 30, 2004, June 4, 2005 and June
4, 2006. Each share of Series AA preferred stock would be convertible
into the number of shares of common stock determined by the following
formula: $5.00 divided by the greater of (a) the average of the closing
price of the common stock on the twenty trading days immediately preceding
the conversion date or (b) $0.41. The redemption price of each share of
Series AA preferred stock would be $5.00.(5)
    
    Includes 8,750,000 shares of common stock for which Keith G. LeBlanc, in
his capacity as the Chief Executive Officer of SurgiCare, holds an
irrevocable proxy pursuant to the agreement between SurgiCare and AII
referenced in note 4. The proxy expires with respect to any such shares
of common stock upon the earlier of (a) the sale thereof by AII in an open
market transaction to an unaffiliated third party, (b) 60 days after the
record date for the special meeting, or (c) December 31, 2004.(6)
    
    Includes 2,215,478 shares issuable upon the exercise of warrants which
are exercisable on or prior to September 17, 2004. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS As of December 31, 2002, the Company revised the contractual relationship
with its founding physicians, all of whom are beneficial owners of 5% or more
of the Companys preferred stock, whereby the physicians would be retained as
an advisory committee to oversee the activities of the physician staffed
medical executive committees of each of SurgiCares surgery centers. In
addition to the services previously covered under the agreement, the advisory
committee would also assist management in revising existing and new operating
agreements, management agreements, establishing medical bylaws, and reviewing
policies and procedures. The Company has reduced the compensation to be paid
to the physician group for its services to $30,000 per month and shortened the
term of the contract from five years to six months. The contract has now
expired. Bellaire leases space on a month-to-month basis for its offices in a
medical office building owned by a partnership in which Dr. Michael Mineo, a
director and shareholder, has a 25% interest. In 2003, Bellaire paid
approximately $195,000 as rent to the partnership. In 2002, Bellaire paid
approximately $195,000 as rent to the partnership. In February 2003, Dr. Mineo purchased 100,000 shares of SurgiCare common
stock in a private placement for a purchase price of $35,000. In March 2003, directors and shareholders Dr. Penso and Dr. Miller each
purchased 34,284 shares of SurgiCare common stock in a private placement for a
purchase price of $11,999.40 each. 59




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##### 



Summary of Transactions with Daniel Dror, AII, and IDC, Etc. Daniel Dror is the CEO of American International Industries, Inc. (AII).
Elkana Faiwuszewicz is the CEO and owner of International Diversified
Corporation, Ltd. (IDC), majority owner of AII and brother of Daniel Dror.
IDC is the majority owner of AII. Texas Real Estate Enterprises, Inc., a Texas corporation, and MidCity
Houston Properties, Inc., a Texas corporation, were wholly-owned subsidiaries
of AII. In June 2002, SurgiCare acquired five properties from AII, Texas Real
Estate Enterprises, Inc., and MidCity Houston Properties, Inc., in exchange for
1.2 million shares of SurgiCare AA preferred stock. The land holdings are
undeveloped properties. On December 11, 2002, SurgiCare issued 3,658,537 shares of common stock to
AII upon the conversion of shares of our Series AA preferred stock pursuant to
the exemption provided by Regulation D and Section 4(2) of the Securities Act.
Also o December 11, 2002, SurgiCare issued 2,439,024 shares of common stock to
IDC for the aggregate consideration of $1 million pursuant to the exemption
provided by Regulation D and Section 4(2) of the Securities Act. In addition,
AII indemnified SurgiCare for any and all broker fees due to Sig Altman an
Altman Associates due from the transaction above. In addition, AII guaranteed
a resale price on the land of $4 million and agreed to make up any shortfall.
The terms of the preferred AA Series were also modified. Finally, IDC agreed
to reimburse SurgiCare $400,000 by January 15, 2003. SurgiCare declared a breach of the December 2002 agreement and withheld
1,709,024 shares of SurgiCare common stock from IDC. IDC filed suit against
SurgiCare for breach of contract related to the withholding of those shares.
On August 26, 2003, SurgiCare agreed to release stock certificate #1214 to IDC
in the amount of 1,709,024 shares of common stock of SurgiCare. In addition,
IDC was released from its obligation to reimburse SurgiCare $400,000 by January
15, 2003, under Section 6.2 of the December 2002 agreement. In addition,
SurgiCare, was released from any and all obligations regarding its obligation
to raise additional funds for working capital and to refinance debt obligations
under Section 7.1 of the December 2002 agreement. IDC agreed to acquire
without recourse a promissory note held by SurgiCare in the face amount of
$223,177.78 dated September 20, 2002, for $160,000. The makers of the note are
Cirrus Ancillary Services  Arkansas, L.P., Donald C. Wilson, and Roger S.
Clary, collectively Cirrus. On June 23, 2004, SurgiCare entered into an agreement with AII, which is
the sole owner of all outstanding Series AA preferred stock, pursuant to which
SurgiCare will issue 8,750,000 share of its common stock to AII in exchange for
the conversion of all 900,000 shares of Series AA preferred stock. The
conversion of the Series AA preferred stock to common stock will take place
upon the later to occur of the approval for listing of the shares of common
stock on the AMEX or the fulfillment by AII of its obligations under the
agreement to acquire the Properties and to assume or eliminate SurgiCares
obligations with respect thereto, and to pay SurgiCare $250,000. Upon
compliance by AII with these obligations, SurgiCare will transfer the
Properties to AII, and AII will have no further obligations regarding the
resale guarantee of the Properties in the December 11, 2002 agreement. If the
conversion does not occur by July 30, 2004, SurgiCare is required by the
certificate of designations of the Series AA preferred stock filed pursuant to
the agreement to either convert or redeem 300,000 shares of Series AA preferred
stock on each of July 30, 2004, June 4, 2005 and June 4, 2006. Each share of
Series AA preferred stock would be convertible into the number of shares of
common stock determined by the following formula: $5.00 divided by the greater
of (a) the average of the closing price of the common stock on the twenty
trading days immediately preceding the conversion date or (b) $0.41. The
redemption price of each share of Series AA preferred stock would be $5.00.
The real property purchase agreement relating to the Properties between AII and
SurgiCare states that AII will indemnify SurgiCare for expenses involved in the
settlement of the termination of the contracts for the sale of the tract
adjacent to the Anahuac National Wildlife Refuge and the tract on Almeda Road. At the time of the original acquisition of these properties, AII and its
affiliates and associates were unrelated third parties with respect to
SurgiCare and SurgiCare believes that the acquisition and subsequent
negotiations and transactions described above were entered after arms-length
negotiations on terms as favorable as could have been obtained from other,
unrelated third parties. 60




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Summary of Transactions with Brantley IV Paul H. Cascio and Michael J. Finn, each of whom is a nominee to become
director at the closing of the Restructuring, are general partners of the
general partner of Brantley IV and limited partners of Brantley IV. Brantley
IV is one of the shareholders of the companies to be acquired in the
Restructuring and is making an additional cash investment and forgiving certain
debt in connection with the Restructuring. Brantley IV has, through a
wholly-owned entity, bridge loans outstanding to SurgiCare in the principal
amount of $1,815,411 as of July 19, 2004, which will be pad by Orion with a
portion of the cash contributed by Brantley IV. Upon completion of the
Restructuring , Brantley IV and its affiliates will hold a majority of the
fully-diluted Orion shares. At the time the loan was made, Mr. Cascio, Mr.
Finn and Brantley IV were unrelated third parties with respect to SurgiCare,
and the loan was made after arms length negotiations on terms the company
believes were as favorable as could be obtained from unrelated third parties. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No.
    
    DescriptionExhibit 3.1
    
    Amended and Restated Certificate of Incorporation of
SurgiCare, Inc. (Incorporated by reference to Exhibit 3.1 of
the Companys Registration Statement on Form 10-KSB/A filed
on January 28, 2000)Exhibit 3.2
    
    Articles of Incorporation of Bellaire SurgiCare, Inc.
(Incorporated by reference to Exhibit 3.2 of the Companys
Registration Statement on Form 10-KSB/A filed on January 28,
2000)Exhibit 3.3
    
    By-Laws of Technical Coatings Incorporated (now SurgiCare,
Inc.) (Incorporated by reference to Exhibit 3.3 of the
Companys Registration Statement on Form 10-KSB/A filed on
January 28, 2000)Exhibit 4.1
    
    Certificate of Designation, Powers, Preferences and Rights
of Series A Redeemable (Incorporated by reference to Exhibit
4.1 of the Companys Registration Statement on Form 10-KSB/A
filed on January 28, 2000)Exhibit 4.2
    
    Amended Certificate of Designation, Powers, Preferences and
Rights of Series AA Preferred Stock, par value $.001 per
share (Incorporated by reference to Exhibit 10.3 of the
Companys Form 8-K filed on January 29, 2003)Exhibit 4.3
    
    Form of SurgiCare, Inc. Common Stock Certificate
(Incorporated by reference to Exhibit 4.3 of the Companys
Form 10-KSB for the year ended December 31, 2002 filed April
14, 2003)Exhibit 10.1
    
    Agreement between SurgiCare, Inc. and American International
Industries, Inc., Texas Real Estate Enterprises, Inc., and
MidCity Houston Properties, Inc. dated December 11, 2002
(Incorporated by reference to Exhibit 10.2 of the Companys
Form 8-K filed on January 29, 2003)Exhibit 10.2
    
    Employment Agreement with Keith G. LeBlanc dated November
10, 2002 (Incorporated by reference to Exhibit 10.2 of the
Companys Form 10-KSB for the year ended December 31, 2002
filed on April 14, 2003)Exhibit 10.3
    
    Employment Agreement with Phillip C. Scott dated November
10, 2002 (Incorporated by reference to Exhibit 10.2 of the
Companys Form 10-KSB for the year ended December 31, 2002
filed on April 14, 2003)Exhibit 16.1
    
    Letter to the Securities and Exchange Commission from
Weinstein Spira & Company, P.C., dated July 31, 2003,
regarding Item 4 to the Registrants Form 8-K filed August
1, 2003 (Incorporated by reference to Exhibit 16.1 of the
Companys Form 8-K/A filed on August 4, 2003)Exhibit 21
    
    List of Subsidiaries of SurgiCare, Inc. (Incorporated by
reference to Exhibit 21 of the Companys Form 10-KSB filed
on April 14, 2004)Exhibit 31.1
    
    Rule 13a-14(a)/15d-14(a) CertificationExhibit 31.2
    
    Rule 13a-14(a)/15d-14(a) CertificationExhibit 32.1
    
    Section 1350 CertificationExhibit 32.2
    
    Section 1350 Certification
 61




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(b) Reports on Form 8-K For the quarter ended December 31, 2003, the following reports on Form 8-K
were filed:  Dated November 18, 2003 to announce that the SurgiCare had entered
into agreements relating to business combinations with three other
companies, an equity investment and a recapitalization that will
result in a new healthcare company named Orion.Dated November 24, 2003 to report issuance of a press release
summarizing SurgiCares third quarter 2003 financial results. After December 31, 2003, the following reports on Form 8-K were filed:  Dated January 29, 2004 to report SurgiCares conversion of all of
its Series A Redeemable Preferred Stock.Dated February 17, 2004 to announce that SurgiCare has executed a
definitive agreement to acquire Dennis Cain Physician Solutions, Ltd
and Medical Billing Services, Inc. In addition, SurgiCare
announced that it has filed preliminary proxy materials with the
Security and Exchange Commission relating to a meeting of
stockholders to be held to approve various matters relating to the
aforementioned acquisitions as well as the previously announced
recapitalization, equity investment and acquisition of Integrated
Physician Solutions, Inc.Dated May 10, 2004, to report issuance of a press release announcing
the filing of SurgiCares amended preliminary proxy statement with
the Securities and Exchange Commission.Dated May 14, 2004, to report issuance of a press release
summarizing SurgiCares first quarter 2004 financial results. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Audit Fees The aggregate fees billed by Mann Frankfort Stein & Lipp CPAs, LLP
(MFSL) for professional services rendered for the review of financial
statements included in SurgiCares quarterly reports on Form 10-QSB for the
fiscal year 2003 were $5,365. During fiscal years 2002 and 2003 the aggregate
fees billed by Weinstein Spira & Company, P.C. (WSC) totaled $73,776 and
$72,434. Tax Fees The aggregate fees billed by MFSL during fiscal year 2003 for tax-related
services totaled $6,728. The aggregate fees billed by WSC during fiscal years
2002 and 2003 for tax related services totaled $18,167 and $25,900,
respectively. All Other Fees During fiscal years 2002 and 2003, all other fees billed by WSC totaled
$374 and $1,500, which primarily consisted of finance charges and Form S-8
consents. 62




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SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. SurgiCare, Inc.July 23, 2004
    By:
    /s/
Keith G. LeBlancKeith G. LeBlanc,President & Chief Executive Officer By:
    /s/ Roger S. HuntingtonRoger S. Huntington,Chief Financial Officer 63




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Exhibit Index Exhibit No.
    
    DescriptionExhibit 3.1
    
    Amended and Restated Certificate of Incorporation of
SurgiCare, Inc. (Incorporated by reference to Exhibit 3.1 of
the Companys Registration Statement on Form 10-KSB/A filed
on January 28, 2000)Exhibit 3.2
    
    Articles of Incorporation of Bellaire SurgiCare, Inc.
(Incorporated by reference to Exhibit 3.2 of the Companys
Registration Statement on Form 10-KSB/A filed on January 28,
2000)Exhibit 3.3
    
    By-Laws of Technical Coatings Incorporated (now SurgiCare,
Inc.) (Incorporated by reference to Exhibit 3.3 of the
Companys Registration Statement on Form 10-KSB/A filed on
January 28, 2000)Exhibit 4.1
    
    Certificate of Designation, Powers, Preferences and Rights
of Series A Redeemable (Incorporated by reference to Exhibit
4.1 of the Companys Registration Statement on Form 10-KSB/A
filed on January 28, 2000)Exhibit 4.2
    
    Amended Certificate of Designation, Powers, Preferences and
Rights of Series AA Preferred Stock, par value $.001 per
share (Incorporated by reference to Exhibit 10.3 of the
Companys Form 8-K filed on January 29, 2003)Exhibit 4.3
    
    Form of SurgiCare, Inc. Common Stock Certificate
(Incorporated by reference to Exhibit 4.3 of the Companys
Form 10-KSB for the year ended December 31, 2002 filed April
14, 2003)Exhibit 10.1
    
    Agreement between SurgiCare, Inc. and American International
Industries, Inc., Texas Real Estate Enterprises, Inc., and
MidCity Houston Properties, Inc. dated December 11, 2002
(Incorporated by reference to Exhibit 10.2 of the Companys
Form 8-K filed on January 29, 2003)Exhibit 10.2
    
    Employment Agreement with Keith G. LeBlanc dated November
10, 2002 (Incorporated by reference to Exhibit 10.2 of the
Companys Form 10-KSB for the year ended December 31, 2002
filed on April 14, 2003)Exhibit 10.3
    
    Employment Agreement with Phillip C. Scott dated November
10, 2002 (Incorporated by reference to Exhibit 10.2 of the
Companys Form 10-KSB for the year ended December 31, 2002
filed on April 14, 2003)Exhibit 16.1
    
    Letter to the Securities and Exchange Commission from
Weinstein Spira & Company, P.C., dated July 31, 2003,
regarding Item 4 to the Registrants Form 8-K filed August
1, 2003 (Incorporated by reference to Exhibit 16.1 of the
Companys Form 8-K/A filed on August 4, 2003)Exhibit 21
    
    List of Subsidiaries of SurgiCare, Inc. (Incorporated by
reference to Exhibit 21 of the Companys Form 10-KSB filed
on April 14, 2004)Exhibit 31.1
    
    Rule 13a-14(a)/15d-14(a) CertificationExhibit 31.2
    
    Rule 13a-14(a)/15d-14(a) CertificationExhibit 32.1
    
    Section 1350 CertificationExhibit 32.2
    
    Section 1350 Certification
 64