UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D. C.  20549





FORM 10-Q





x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended June 30, 2011


OR


 ̈  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT





For the transition period from


__________to __________





Commission File No.     000-52458





FIRST SURGICAL PARTNERS INC.


(Exact name of registrant as specified in its charter)





Delaware

51-0383940(State or other jurisdiction of

(I.R.S. Employer Identificationincorporation or organization)

Number)





411 First Street


Bellaire, TX  77401


(Address of principal executive offices)





713-665-1111


(Issuer's telephone number)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                 Yes  x     No   ̈





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes  x  No   ̈





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





Large accelerated filer   ̈
Accelerated filer                      ̈Non-accelerated filer     ̈
Smaller reporting company  x





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





As of August 15, 2011, the Issuer had 40,650,006 shares of its common stock outstanding.








FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


INDEX TO QUARTERLY REPORT


ON FORM 10-Q





Part  I – Financial InformationItem 1.  Financial StatementsConsolidated Balance Sheets (Unaudited) as of June 30, 2011 and December 31, 2010

3Consolidated Statements of Income (Unaudited) for the three and six month periods ended June 30, 2011 and June 30, 2010

4Consolidated Statements of Cash Flows (Unaudited) for the six month periods ended June 30, 2011 and June 30, 2010

5Notes to Consolidated Financial Statements (Unaudited)

6Item 2.

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

17Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

25Item 4.

Controls and Procedures

25Part II - Other InformationItem 1.

Legal Proceedings

26Item 1A.

Risk Factors

26Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

26Item 3.

Defaults Upon Senior Securities

27Item 4.

(Removed and Reserved)

27Item 5.

Other Information

27Item 6.

Exhibits

27Signatures

29




2




PART I




Item 1.       Financial Statements


FIRST SURGICAL PARTNERS INC.


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


CONSOLIDATED BALANCE SHEETS


(Unaudited)




As ofJune 30, 2011


December 31, 2010AssetsCurrent AssetsCash and Cash Equivalents

$
662,618


$
266,708Accounts Receivable, net


26,673,248



22,874,493Inventory


1,155,892



1,413,275Prepaid Expenses and Other Current Assets


401,272



298,104Total Current Assets


28,893,030



24,852,579Property and Equipment, net


14,552,333



14,946,782Other Assets, net


55,456



64,379Total Assets

$
43,500,819


$
39,863,740Liabilities and Shareholders' EquityCurrent LiabilitiesAccounts Payable

$
8,085,782


$
9,634,602Accrued Expenses


1,887,787



1,380,223Lines of Credit


3,962,299



1,521,250Current Taxes


2,091,253



1,194,128Current Portion of Long-Term Debt and Capital Lease Obligations


1,217,456



1,238,277Total Current Liabilities


17,244,577



14,968,480Long-Term LiabilitiesLong-Term Debt and Capital Lease Obligations, Net of Current Portion


13,631,280



13,699,670Deferred Taxes


3,283,622



3,282,622Other Long-Term Liabilities


143,629



74,130Total Long-Term Liabilities


17,058,531



17,056,422Commitments and ContingenciesShareholders' EquityPreferred Stock, $0.0001 par value, 50,000,000 shares authorized, zero issued and outstanding, respectively


-



-Common Stock, $0.0001 par value, 200,000,000 shares authorized, 40,650,006 and 40,000,006 shares issued and outstanding, respectively


4,065



4,000Additional Paid-In Capital


11,429,455



11,716,594Accumulated Deficit


(2,235,809
)


(3,881,756
)Total Shareholders' Equity


9,197,711



7,838,838Total Liabilities and Shareholders' Equity

$
43,500,819


$
39,863,740




The accompanying notes are an integral part of these unaudited consolidated financial statements.


3




FIRST SURGICAL PARTNERS INC.


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


CONSOLIDATED STATEMENTS OF INCOME


(Unaudited)




For the Three Months Ended


For the Six Months EndedJune 30,


June 30,2011


2010


2011


2010Net Revenue

$
12,149,557


$
12,708,932


$
24,773,454


$
24,989,250Operating ExpensesSalaries and Benefits


3,365,197



2,803,477



6,898,257



5,329,100Medical Supplies


2,374,480



2,463,659



5,135,649



4,230,302Bariatric Program Sponsorship


1,200,000



1,200,000



2,400,000



2,400,000Management Fees


454,416



452,798



920,068



959,764Rent


447,862



441,242



1,009,813



898,774Depreciation and Amortization


543,837



455,784



1,072,806



694,251Other Operating Expenses


2,429,615



1,376,943



4,158,201



2,843,548Total Operating Expenses


10,815,409



9,193,905



21,594,795



17,355,739Other Income and ExpensesInterest Income


247



359



488



709Interest Expense


(316,974
)


(214,055
)


(613,075
)


(439,677
)Total Other Income and Expenses


(316,727
)


(213,696
)


(612,587
)


(438,968
)Income Before Income Taxes


1,017,421



3,301,331



2,566,072



7,194,543Income Taxes


378,098



-



920,125



-Net Income

$
639,323


$
3,301,331


$
1,645,947


$
7,194,543Basic and Diluted Income per Common Share

$
0.02


$
0.08


$
0.04


$
0.18Weighted average number of common shares outstanding - basic and fully diluted


40,522,533



39,964,346



40,273,762



39,964,346Dividends declared per common share

$
0.0250


$
-


$
0.0375


$
-




The accompanying notes are an integral part of these unaudited consolidated financial statements.


4




FIRST SURGICAL PARTNERS INC.


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




For the Six Months EndedJune 30,2011


2010CASH FLOWS FROM OPERATING ACTIVITIES:Net Income

$
1,645,947


$
7,194,543Adjustments to Reconcile Net Income to Net CashProvided by Operating Activities:Depreciation and Amortization


1,072,806



694,251Stock Compensation


468,914



-Common Shares Issued for Services


750,262



-Changes in Operating Assets and Liabilities:Accounts Receivable


(3,798,756
)


(2,406,133
)Inventory


257,383



(63,833
)Other Current Assets


(141,228
)


553,288Accounts Payable and Accrued Expenses


(993,434
)


(323,238
)Other Long Term Liabilities


69,499



(8,020
)Current and Deferred Taxes Payable


898,125



-Net Cash Provided by Operating Activities


229,519



5,640,858CASH FLOWS FROM INVESTING ACTIVITIES:Capital Expenditures


(669,435
)


(625,508
)Net Cash Used in Investing Activities


(669,435
)


(625,508
)CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings on Line of Credit


2,546,049



271,449Repayments on Line of Credit


(105,000
)


(60,000
)Proceeds from Issuance of Long-Term Debt


629,234



153,958Repayment of Long-Term Debt and Capital Lease Obligations


(728,208
)


(883,830
)Dividends Paid


(1,506,250
)


-Partner Contributions


-



30,000Partner Distributions


-



(4,502,625
)Net Cash Provided by (Used in) Financing Activities


835,826



(4,991,047
)NET INCREASE IN CASH AND CASH EQUIVALENTS


395,910



24,302CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD


266,708



261,594CASH AND CASH EQUIVALENTS AT END OF PERIOD

$
662,618


$
285,896SUPPLEMENTAL CASH FLOW INFORMATION:Cash Paid for Interest

$
591,366


$
401,904Cash Paid for Taxes

$
472,000


$
231,558




The accompanying notes are an integral part of these unaudited consolidated financial statements.


5


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




1.
INTERIM FINANCIAL INFORMATION




Business and Organization




First Surgical Partners Inc., including its subsidiaries, is an owner and operator of two ambulatory surgery centers (“ASC”), First Street Surgical Center, L.P., and First Surgical Woodlands, L.P., and a general acute care hospital, First Street Hospital, L.P., all located in the greater Houston, Texas metro area.  Procedures performed include non life-threatening surgeries, such as bariatrics, reconstructive and cosmetic plastics, orthopedics, pain management, neurosurgery and podiatry, which are often completed on an outpatient or short stay basis.




Effective December 1, 2010, Piper Acquisition III, Inc. (“Piper”) acquired all of the limited and general partnership interests of First Street Surgical Center, L.P., First Surgical Woodlands, L.P., and First Street Hospital, L.P. (“Partnerships”), all of which were under common control, in exchange for the issuance of 36,000,002 shares of Piper’s common stock.  The exchange of shares between Piper and the Partnerships was accounted for as a reverse acquisition under the purchase method of accounting.  Accordingly, the merger was been recorded as a recapitalization of Piper, with the consolidated financials of the Partnerships being treated as the continuing entity.  Effective December 3, 2010, the Company changed its name to First Surgical Texas, Inc.  The historical financial statements presented are those of the Partnerships.  The financial statements of the legal acquirer, Piper, were not significant; therefore, no pro forma financial information is submitted.




On November 4, 2010, the Company entered into a Contribution Agreement with the shareholders of First Surgical Texas, Inc., each of which are accredited investors (“First Surgical Texas Shareholders”) pursuant to which the First Surgical Texas Shareholders agreed to contribute 100% of the outstanding securities of First Surgical Texas in exchange for 39,964,346 shares of our common stock (the “First Surgical Texas Contribution”).  The First Surgical Texas Contribution closed on December 31, 2010.




Considering that, following the contribution, the First Surgical Texas Shareholders controlled the majority of our outstanding common stock and we effectively succeeded our otherwise minimal operations to those that are theirs, First Surgical Texas was considered the accounting acquirer in this reverse-merger transaction.  A reverse-merger transaction is considered, and accounted for as, a capital transaction in substance; it is equivalent to the issuance of First Surgical Texas securities for our net monetary assets, which were deminimus, accompanied by a recapitalization.  Accordingly, we have not recognized any goodwill or other intangible assets in connection with this transaction.  First Surgical Texas is the surviving and continuing entity and the historical financials following the reverse merger transaction are those of First Surgical Texas.




Effective February 18, 2011, the Company changed its name to “First Surgical Partners Inc.”




Basis of Presentation




The Company has prepared the accompanying unaudited consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) instructions to Form 10-Q and Item 310(b) of regulation S-K.  These financial statements should be read together with the financial statements and notes in the Company’s 2010 Form 10-K filed with the SEC on April 15, 2011, as amended on Form 10-K/A on June 21, 2011 and on August 1, 2011.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  The accompanying financial statements reflect all adjustments and disclosures, which, in the Company’s opinion, are necessary for fair presentation.  All such adjustments are of a normal recurring nature.  The results of operations for the interim periods are not necessarily indicative of the results of the entire year.  Certain reclassifications have been made to the prior year’s financial statements to conform to the current period’s presentation.


6


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES




Use of Estimates and Assumptions




Future events and their effects cannot be predicted with certainty; accordingly the preparation of financial statements in conformity with GAAP 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.  The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired , as additional information is obtained, and as our operating environment changes.  Significant estimates and assumptions are used for, but not limited to: (1) allowance for contractual revenue adjustments; (2) depreciable lives of assets; (3) economic lives and fair values of leased assets; (4) uncertain tax positions; and (5) contingency and litigation reserves.  The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources.  The Company evaluates its estimates and assumptions on a regular basis and may employ outside experts to assist in our evaluation, as considered necessary.  Actual results may differ from these estimates and assumptions used in preparation of its financial statements and changes in these estimates are recorded when known.




Revenue Recognition




Revenues consist primarily of net patient service revenues that are recorded based upon established billing rates less allowances for contractual adjustments.  Revenues are recorded during the period the healthcare services are provided, based upon the estimated amounts due from the patients and third-party payors, including federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, and employers.  Estimates of contractual allowances under third-party payor arrangements are based upon the payment terms specified in the related contractual agreements.  Third-party payor contractual payment terms are generally based upon predetermined rates per diagnosis, per diem rates, or discounted fee-for-service rates.  During all periods reported herein, there is no material change expected in the estimate of prior period allowances for contractual and other adjustments recorded during the current period. Further, we do not foresee any possible change in our estimate of unsettled amounts from third party payors as of the latest balance sheet date that could have a material effect on our financial position, results of operations or cash flows.




Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation, and are routinely modified for provider reimbursement.  All healthcare providers participating in the Medicare and Medicaid programs are required to meet certain financial reporting requirements. Federal regulations require submission of annual cost reports covering medical costs and expenses associated with the services provided by each hospital to program beneficiaries.  Annual cost reports required under the Medicare and Medicaid programs are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to the Company under these reimbursement programs.  These audits often require several years to reach the final determination of amounts earned under the programs.  As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term.




We provide care to patients who are financially unable to pay for the healthcare services they receive, and because we do not pursue collection of amounts determined to qualify as charity care, such amounts are not recorded as revenues.




Cash and Cash Equivalents




The Company considers all highly liquid short-term investments with an original maturity of three months or less at time of purchase to be cash equivalents.  These investments are carried at cost, which approximates fair value.  Cash and cash equivalent balances may, at certain times, exceed federally insured limits.




Accounts Receivable




The Company reports accounts receivable at estimated net realizable amounts from services rendered from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, workers’ compensation programs, employers, and patients.




Inventory




Inventory is comprised primarily of various medical supplies and is valued at the lower of cost or market with cost determined on first-in, first-out basis.


7


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




Property and Equipment




Property and equipment are recorded at cost.  Expenditures for maintenance and repairs are charged to expense as incurred.  Additions and betterments that extend the life of the asset are capitalized.  Assets under capital lease obligations are reported at the lower of fair value or the present value of the aggregate future minimum lease payments at the beginning of the lease term.  In the case of sale, retirement, or disposal, the asset cost and related accumulated depreciation balances are removed from the respective accounts, and the resulting net amount, less any proceeds, is included as income from operations in the consolidated statements of operations.  Depreciation is provided over the estimated useful lives of the assets.  The depreciable lives and depreciation methods used for each class of asset are as follows:


UsefulClass

Life

Depreciation MethodFurniture and Equipment

5-7 years

200% double decliningSoftware

3 years

Straight-lineLeasehold Improvements

5-30 years

Straight-line





Advertising




The Company expenses advertising costs as incurred.  Advertising expense was $102,721 and $76,819 for the three months ended June 30, 2011 and 2010, respectively, and $176,618 and $159,986 for the six months ended June 30, 2011 and 2010, respectively, and is included in the caption Other Operating Expenses.




Income Taxes




We provide for income taxes using the asset and liability method.This approach recognizes the amount of federal, state, and local taxes payable or refundable for the current year, as well as deferred tax assets and liabilities for the future tax consequence of events recognized in the consolidated financial statements and income tax returns.  Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates.  A valuation allowance is required when it is more likely than not that some portion of the deferred tax assets will not be realized.  Realization is dependent on generating sufficient future taxable income.  We evaluate our tax positions and establish assets and liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes.  We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly.  The Company and its corporate subsidiaries file a consolidated federal income tax return.  Some subsidiaries consolidated for financial reporting purposes are not part of the consolidated group for federal income tax purposes and file separate federal income tax returns.  State income tax returns are filed on a separate, combined, or consolidated basis in accordance with relevant state laws and regulations.  Partnerships, limited liability partnerships, limited liability companies, and other pass-through entities that we consolidate or account for using the equity method of accounting file separate federal and state income tax returns.  We include the allocable portion of each pass-through entity’s income or loss in our federal income tax return.  We allocate the remaining income or loss of each pass-through entity to the other partners or members who are responsible for their portion of the taxes.




For the six months ended June 30, 2011, the Company’s effective income tax rate of 37.2% of pretax income differed from the federal statutory rate of 35.0% due primarily to taxes provided for the taxable state jurisdiction in which the Company operates.   The Company’s income tax provision for the six months ended June 30, 2011, is comprised primarily of amount due on its current period earnings as the Company had no material changes in the timing of its deferred tax liabilities.




Prior to the Company’s acquisition by Piper, on December 1, 2010, all of the net income from the Company’s subsidiaries, First Street Surgical Center, L.P., First Surgical Woodlands, L.P., and First Street Hospital, L.P. passed through to the then-limited partners of each of the Company’s subsidiaries and the Company, therefore, had no corporate tax obligation to record.  Had the acquisition by Piper occurred on January 1, 2010, the Company would have incurred the following pro-forma income tax expense for the three and six months ended June 30, 2010:


8


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




Pro Forma for the


Pro Forma for theThree Months Ended


Six Months EndedJune 30, 2010


June 30, 2010Current Taxes

$
1,155,466


$
2,518,090Deferred Taxes


-



-Total

$
1,155,466


$
2,518,090




Fair Value of Financial Instruments




The Company’s financial instruments are cash, accounts receivable, accounts payable, capital lease obligations, and debt.  The recorded values of cash, accounts receivable, and accounts payable approximate their fair values based on their short-term nature.




The recorded values of capital lease obligations and long-term debt approximate their fair values, as their effective interest rates approximates market rates.




Impairment of Long-Lived Assets




We assess the recoverability of long-lived assets, whenever events or changes in circumstances indicate we may not be able to recover the asset’s carrying amount.  We measure the recoverability of long-lived assets by a comparison of the carrying amount of the asset to the expected net future cash flows to be generated by that asset.  We present an impairment charge as a separate line item within income from continuing operations in our consolidated statements of operations, unless the impairment is associated with a discontinued operation.  In that case, we include the impairment charge, on a net-of-tax basis, within the results of discontinued operations.  The Company did not recognize an impairment of long-lived assets during either of the three or six months ended June 30, 2011 or 2010.




Financing Costs




We amortize financing costs using the effective interest method over the life of the related debt.  The related expense is included in interest expense in our consolidated statements of operations.




Commitments and Contingencies




Accruals for loss contingencies arising from claims, assessments, litigation, environmental and other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated.  These accruals are adjusted as additional information becomes available or circumstances change.




Earnings per Common Share




The calculation of earnings per common share is based on the weighted-average number of our common shares outstanding during the applicable period.  The calculation for diluted earnings per common share recognizes the effect of all potential dilutive securities that were outstanding during the respective periods, unless their impact would be antidilutive.  The Company had no dilutive securities as of June 30, 2011 or 2010.




Prior to the Company’s acquisition by Piper, on December 1, 2010, all of the net income from the Company’s subsidiaries, First Street Surgical Center, L.P., First Surgical Woodlands, L.P., and First Street Hospital, L.P. passed through to the then-limited partners of each of the Company’s subsidiaries and the Company, therefore, had no corporate tax obligation to record.  Had the acquisition by Piper occurred on January 1, 2010, the Company’s pro-forma earnings per share would have been $0.05 and $0.12 for the three and six months ended June 30, 2010, respectively.


9


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




3.
PROPERTY AND EQUIPMENT




Property and equipment consisted of the following as of June 30, 2011 and December 31, 2010:




As ofJune 30,


December 31,2011


2010Leasehold Improvements

$
14,178,553


$
14,113,849Medical Equipment


10,565,581



10,167,306Furniture, Fixtures and Office Equipment


1,320,894



1,114,43926,065,028



25,395,594Accumulated Depreciation


(11,512,695
)


(10,448,812
)Property and Equipment, net

$
14,552,333


$
14,946,782


As of June 30, 2011 and December 31, 2010, the Company had $2,081,267 of equipment cost under capital lease, with accumulated amortization of $1,994,787 and $1,926,001, respectively, resulting in net assets under capital leases of $86,480 and $155,266, respectively.  All of the Company’s assets under capital lease consisted of medical equipment.




4.
LINES OF CREDIT




First Street Hospital, L.P. entered into a Letter Loan Agreement (“FSH Letter Loan Agreement”) with a financial institution on January 8, 2008.  The FSH Letter Loan Agreement, as amended, provides for a $1,500,000 line of credit loan and a term loan (“FSH Loans”).  The FSH Letter Loan Agreement provides for FSH Loans to be secured by real property owned by First Street Holdings, L.P., a related party to the Company, as well as accounts, inventory, fixtures, equipment and general intangibles; that the loans will be guaranteed personally by certain former partners of First Street Hospital, L.P., who are current shareholders of the Company; and require First Street Hospital, L.P. to maintain a debt service coverage ratio of 1.25 to 1.0.  The line of credit loan calls for monthly interest only payments which shall from day to day be equal to the lesser of (a) a fluctuating rate per annum (the ‘Contract Rate’) which is equal to the Index Rate which represents the rate of interest then most recently established by J.P. Morgan Chase Bank (or its successors) as its prime rate or (b) the Maximum Rate (the maximum lawful nonusurious rate of interest which under applicable law payee is permitted to charge).  The effective rate of interest at June 30, 2011 was 5.75%.  The line of credit loan originally matured on January 8, 2009, but has been extended to January 8, 2012.  The outstanding balance at June 30, 2011 and December 31, 2010, was $1,331,250 and $581,250, respectively.  Unused credit at June 30, 2011 was $168,750.  The Company recognized total interest expense of $19,349 and $8,476 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $32,017 and $17,207 during the six months ended June 30, 2011 and 2010, respectively, on this line of credit.




First Street Surgical Center, L.P. entered into a Letter Loan Agreement (“FSSC Letter Loan Agreement”) with a financial institution on January 8, 2008.  The FSSC Letter Loan Agreement provides for a $750,000 line of credit loan and a term loan (“FSSC Loans”).  The FSSC Letter Loan Agreement provides for FSSC Loans to be secured by real property owned by First Street Holdings, L.P., a related party to the Company, as well as accounts, inventory, fixtures, equipment and general intangibles; that the loans will be guaranteed personally by certain former partners of First Street Surgical Center, L.P., who are current shareholders of the Company; and require First Street Surgical Center, L.P. to maintain a debt service coverage ratio of 1.25 to 1.0.  The line of credit loan calls for monthly interest only payments which shall from day to day be equal to the lesser of (a) a fluctuating rate per annum (the ‘Contract Rate’) which is equal to the Index Rate which represents the rate of interest then most recently established by J.P. Morgan Chase Bank (or its successors) as its prime rate or (b) the Maximum Rate (the maximum lawful nonusurious rate of interest which under applicable law payee is permitted to charge).  The effective rate of interest at June 30, 2011 was 5.75%.  The line of credit loan originally matured on January 8, 2009, but has been extended to January 8, 2012.  The outstanding balance at June 30, 2011 and December 31, 2010 was $745,000 and $730,000, respectively.  Unused credit at June 30, 2011 was $5,000.  The Company recognized total interest expense of $10,856 and $10,242 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $21,350 and $19,640 during the six months ended June 30, 2011 and 2010, respectively, on this line of credit.


10


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




On September 18, 2009, First Surgical Woodlands, L.P. entered into a $250,000 revolving draw secured promissory note with a financial institution.  The note bears interest at 5.75% per annum.  The note originally matured on September 18, 2010, but has been extended to September 18, 2011.  The note is secured by all the equipment of First Surgical Woodlands, L.P.  The outstanding balance at June 30, 2011 and December 31, 2010, was $206,049 and $210,000, respectively.  Unused credit at June 30, 2011 was $43,951.  The Company recognized total interest expense of $3,355 and $735 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $6,073 and $735 during the six months ended June 30, 2011 and 2010, respectively, on this line of credit.




On March 31, 2011, First Surgical Texas entered into a $2,000,000 revolving draw unsecured promissory note with a financial institution.  The line of credit loan calls for monthly interest only payments calculated based upon the financial institution’s Prime Rate.  The effective rate of interest at June 30, 2011 was 5.0%.  The note matures on March 29, 2012.    The outstanding balance at June 30, 2011 was $1,700,000.  Unused credit at June 30, 2011 was $300,000.  The Company recognized total interest expense of $11,544 during the three months ended June 30, 2011.




5.
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS




The Company’s long-term debt and capital leases at June 30, 2011, and December 31, 2010, consisted of the following:




As ofJune 30,


December 31,2011


2010First Street Hospital, L.P.2008 FSH Note Payable

$
6,700,969


$
6,879,9652010 Construction Loan


4,410,158



4,439,1502010 Equipment Loan


1,863,062



1,483,828Capital Lease Obligations


128,191



286,699First Street Surgical Center, L.P.Long-term Line of Credit from Shareholder


331,127



321,3652008 FSSC Note Payable


1,415,229



1,453,032First Surgical Woodlands, L.P.2009 FSW Note Payable


-



73,90914,848,736



14,937,948Less: Current Portion


(1,217,456
)


(1,238,277
)Long-Term Portion

$
13,631,280


$
13,699,670




Long-Term Debt




In connection with the FSH Letter Loan Agreement, First Street Hospital, L.P. issued a secured promissory note in the original amount of $7,822,256 on January 8, 2008, to a financial institution (the “2008 FSH Note Payable”).  The 2008 FSH Note Payable bears interest at 7.70% per annum and matures on January 8, 2013.  The note calls for monthly interest and principal payments of $73,747, with a balloon payment due on January 8, 2013, of $6,162,583.  As of June 30, 2011, and December 31, 2010, the Company owed $6,700,969 and $6,879,965, respectively on the 2008 FSH Note Payable.  The Company recognized total interest expense of $131,599 and $138,268 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $263,485 and $276,601 during the six months ended June 30, 2011 and 2010, respectively, on this note.




On May 4, 2010, First Street Hospital, L.P. entered into an unsecured $250,000 promissory note with a financial institution.  The note bore interest at 6.50% per annum and matured on February 4, 2011.  During 2010, the Company borrowed approximately $110,815 under the note and repaid it in full during 2010 with proceeds from the 2010 Equipment Loan.


11


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


On May 4, 2010, First Street Hospital, L.P. entered into a secured construction loan agreement (the “2010 Construction Loan”) with a financial institution.  The loan agreement provides for advances equal to 80% of the “as completed” appraised value of the 2010 expansion of the Company’s First Street Hospital facility.  Total advances under the loan agreement were $4,439,150, of which $4,410,158 was outstanding at June 30, 2011.  The loan agreement provides for the 2010 Construction Loan to be secured by real property owned by First Street Hospital, L.P., as well as accounts, inventory, fixtures, equipment and general intangibles.  The loan was also guaranteed personally by certain former partners of First Street Hospital, L.P., who are current shareholders of the Company.  The note bears interest at 6.50% per annum and matures on May 4, 2013.  The Company recognized total interest expense of $72,867 and $306 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $143,804 and $306 during the six months ended June 30, 2011 and 2010, respectively, on this note.




On March 28, 2011, First Street Hospital, L.P. entered into a $200,000 and a $50,000 30-day loan with the Company’s Chairman and with the Company’s President and Chief Executive Officer, respectively.  The loans matured on April 27, 2011, and if paid at maturity bore no interest.  If the loans were not repaid at maturity, interest was to accrue at 6.0% per annum.  Both loans were repaid on April 27, 2011.




In connection with the issuance of the 2010 Construction Loan facility, on November 30, 2010, First Street Hospital, L.P. entered into a secured promissory note (the “2010 Equipment Loan”) providing for a total principal amount of $1,863,062 with a financial institution.  The 2010 Equipment Loan is also secured by real property owned by First Street Hospital, L.P., as well as accounts, inventory, fixtures, equipment and general intangibles.  The 2010 Equipment Loan was also guaranteed personally by certain former partners of First Street Hospital, L.P., who are current shareholders of the Company.  The note bears interest at 6.50% per annum and matures on November 30, 2013.  As of June 30, 2011, and December 31, 2010, the Company owed $1,863,062 and $1,483,828, respectively on the 2010 Equipment Loan.  The Company recognized total interest expense of $30,948 and $59,784 during the three and six months ended June 30, 2011, respectively, on this note.




On June 1, 2006, First Street Surgical Center, L.P. entered into a $700,000 long-term line of credit with the Company’s Chairman.  The line of credit bears interest at 6.0% per annum, matures on May 31, 2014 and is unsecured.  As of June 30, 2011 and December 31, 2010, the Company owed $331,127 and $321,365, respectively on the line of credit.  The Company recognized total interest expense of $4,918 and $4,632 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $9,762 and $9,195 during the six months ended June 30, 2011 and 2010, respectively, on this note.




In connection with the FSSC Letter Loan Agreement, First Street Surgical Center, L.P. issued a secured promissory note in the original amount of $1,652,030 on January 8, 2008, to a financial institution.  The note bears interest at 7.70% per annum and matures on January 8, 2013.  The note calls for monthly interest and principal payments of $15,502.88, with a balloon payment due on January 8, 2013, of $1,301,513.  As of June 30, 2011, and December 31, 2010, the Company owed 1,415,229 and$1,453,032, respectively on the note.  The Company recognized total interest expense of $28,220 and $29,635 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $56,197 and $58,966 during the six months ended June 30, 2011 and 2010, respectively, on this note.




On September 18, 2009, First Surgical Woodlands, L.P. issued a $1,300,000 secured promissory note to a financial institution.  The note bore interest at 5.95% per annum and matured on January 18, 2011.  The Company repaid the outstanding balance of the note at maturity.  The note was secured by all the equipment of First Surgical Woodlands, L.P.  As of December 31, 2010, the Company owed $73,909 on the note The Company recognized total interest expense of $415 on this note during 2011 and recognized $11,169 and $25,720 during the three and six months ended June 30, 2010, respectively, in interest on this note.




Capital Lease Obligations




We engage in a significant number of leasing transactions including medical equipment, computer equipment and other equipment utilized in operations.  Leases meeting certain accounting criteria have been recorded as an asset and liability at the lower of fair value or the net present value of the aggregate future minimum lease payments at the inception of the lease.  Interest rates used in computing the net present value of the lease payments generally ranged from 7.74% to 9.78% based on our incremental borrowing rate at the inception of the lease.  Our leasing transactions include arrangements for equipment with major equipment finance companies and manufacturers who retain ownership in the equipment during the term of the lease.


12


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




The Company was in compliance with all debt covenants as of June 30, 2011.




6.
STOCKHOLDER’S EQUITY




Holders of common stock are entitled to one vote per share, and to receive dividends and, upon liquidation or dissolution, are entitled to receive all assets available for distribution to stockholders. The holders have no preemptive or other subscription rights and there are no redemption or sinking fund provisions with respect to such shares. Common stock is subordinate to the preferred stock, if and when issued, with respect to dividend rights and rights upon liquidation, winding up and dissolution of the Company.




During the six months ended June 30, 2010, the Company made distributions to its limited partner unitholders, while the Company’s subsidiaries were owned by those limited partner unitholders prior to their acquisition by Piper totaling $4,502,625.  The Company has treated these distributions as deemed dividends for financial reporting purposes.




On February 23, 2011, the Company declared a special dividend on its Common Stock of $0.0125 per share.  The record date for this distribution was March 7, 2011, and the payment date was March 8, 2011.  The total dividend payable on March 8, 2011 was $500,000.  As the Company had no accumulated earnings at the date of declaration, this dividend was treated as a liquidating dividend and recorded as a reduction of additional paid-in capital rather than accumulated deficit.




On April 7, 2011, the Company declared a quarterly dividend on its Common Stock of $0.025 per share.  The record date for this distribution was April 25, 2011 and the dividend was paid on April 26, 2011.  The total dividend paid was $1,006,250. As the Company had no accumulated earnings at the date of declaration, this dividend was treated as a liquidating dividend and recorded as a reduction of additional paid-in capital rather than accumulated deficit.




On March 23, 2011, the Company issued 250,000 shares of common stock to the Company’s Vice President, Finance for services rendered.  These shares were valued at $468,914, based on the Company’s estimate of the fair market value of its Common Shares on that date.




On April 29, 2011, the Company entered into an Agreement with First Surgical Partners LLC, RJR Consulting Group, LLC (“RJR”) and RC Capital Group, LLC pursuant to which the parties agreed to settle all disputes with respect to an agreement between the Company and RJR for RJR to provide capital markets consulting and investor relations services to the Company.  In consideration of the Agreement, the Company issued 400,000 shares of the Company’s Common Stock to RJR.  These shares were valued at $750,262, based on the Company’s estimate of the fair market value of its Common Shares on that date.




7.
RELATED PARTY TRANSACTIONS




On March 28, 2011, First Street Hospital, L.P. entered into a $200,000 and a $50,000 30-day loan with the Company’s Chairman and with the Company’s President and Chief Executive Officer, respectively.  The loans matured on April 27, 2011, and if paid at maturity bore no interest.  If the loans were not repaid at maturity, interest was to accrue at 6.0% per annum.  Both loans were repaid on April 27, 2011.




During the six months ended June 30, 2011 and 2010, both First Street Hospital, L.P. and First Surgical Woodlands, L.P. held management agreements with First Surgical Partners, LLC (the former General Partner of the Company’s limited partnerships and the owners of which are shareholders of the Company) where the Company retained the services of First Surgical Partners, LLC to assist the Company in managing and conducting day-to-day business and services.  The First Surgical Woodlands, L.P. agreement was executed on February 1, 2005, with a term of five years and shall automatically renew for one additional two year period unless otherwise terminated.  The First Street Hospital, L.P. agreement was executed on July 25, 2006, with a term of ten years and shall automatically renew for one additional two year period unless otherwise terminated.  Each agreement calls for the payment by the partnerships to First Surgical Partners, LLC a monthly fee equal to 5% of the net monthly collected revenues from the partnership’s cash collections.  For the three months ended June 30, 2011 and 2010, the partnerships paid a total of $454,416 and $452,798, respectively, and for the six months ended June 30, 2011 and 2010, the partnerships paid a total of $920,068 and $959,764, respectively, in management fees to First Surgical Partners, LLC.


13


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




On June 1, 2006, First Street Surgical Center, L.P. entered into a $700,000 long-term line of credit with the Company’s Chairman.  The line of credit bears interest at 6.0% per annum, matures on May 31, 2014 and is unsecured.  As of June 30, 2011 and December 31, 2010, the Company owed $331,127 and $321,365, respectively on the line of credit.  The Company recognized total interest expense of $4,918 and $4,632 during the three months ended June 30, 2011 and 2010, respectively, and total interest expense of $9,762 and $9,195 during the six months ended June 30, 2011 and 2010, respectively, on this note.




On April 1, 2003, First Street Surgical Center, LP entered into a building lease with the Company’s Chairman.  The building lease was for an initial term of 10 years from the commencement date followed by an option to extend the initial ten year term by two consecutive five year terms.  The lease agreement called for minimum monthly lease payments of $23,000 per month, subject to escalation to reflect increases in the consumer price index. During each of the three and six months ended June 30, 2011 and 2010, First Street Surgical Center, LP paid $80,160  and $160,320, respectively, in lease payments on this lease.




On September 17, 2006, First Street Hospital, LP entered into a building lease with the Company’s Chairman.  The building lease was for an initial term of 10 years from the commencement date followed by an option to extend the initial ten year term by two consecutive ten year terms. This original lease agreement calls for minimum monthly lease payments of $39,400 per month, subject to escalation to reflect increases in the consumer price index.  During 2010, the hospital expanded its square footage by 23,000, adding 14 beds and two operating rooms.  The expansion was opened for surgical procedures on December 15, 2010.  As of June 30, 2011, a lease document or an amendment to the original lease had not been finalized or signed.  A market rent study is being performed by an independent real estate firm, whom we engaged July 7, 2011, to assist us in determining a fair rental value for the expansion.  The expansion project was funded 100% by First Street Hospital for $5,502,660, of which $4,436,150 was financed under long-term notes.  For each of the three and six months ended June 30, 2011 and 2010, First Street Hospital, LP paid $127,629 and $255,258, respectively, in lease payments on this lease.




8.
COMMITMENTS AND CONTINGENCIES




Regulations, Risks and Uncertainties




As a healthcare provider, we are required to comply with extensive and complex laws and regulations at the federal, state and local government levels.  These laws and regulations relate to, among other things:




·
Licensure, certification and accreditation,




·
Coding and billing for services,




·
Relationships with physicians and other referral sources, including physician self-referral and anti-kickback laws,




·
Quality of medical care,




·
Use and maintenance of medical supplies and equipment,




·
Maintenance and security of medical records,




·
Acquisition and dispensing of pharmaceuticals and controlled substances, and




·
Disposal of medical and hazardous waste.




In the future, changes in these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our investment structure, hospitals, equipment, personnel, services, capital expenditure programs, operating procedures, and contractual arrangements.


14


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




If we fail to comply with applicable laws or regulations, we could be subject to liabilities, including (1) criminal penalties, (2) civil penalties, including monetary penalties and the loss of our licenses to operate one or more of our facilities, and (3) exclusion or suspension of one or more of our facilities from participation in the Medicare, Medicaid, and other federal and state healthcare programs.  Substantial damages and other remedies assessed against us could have a material adverse affect on our business, financial position, results of operations, and cash flows.




Bariatric Program Sponsorship Agreement




The Company entered into a Bariatric Program Sponsorship Agreement on March 22, 2006, but effective May 1, 2006, with Vital Weight Control, Inc., d/b/a NeWeigh (‘Vital’).  Per the agreement, the Company desires to sponsor, in part, a gastroplasty program involving surgical intervention for morbid obesity.  Under the sponsorship, the Company makes available its facility for surgeries on prospective patients that are participants in the bariatric program as well as for surgeries on other prospective patients that meet criteria for eligibility for bariatric surgery.  At all times during the term of the agreement the Company shall either furnish, at its expense, or reimburse Vital amounts Vital expends for operation of the program, including office space, facilities, equipment, utilities, furniture, fixtures, office supplies, postage, courier services, and other outside services as may be reasonably required to operate the program.  The original term of the agreement commenced on May 1, 2006, for a period of 36 months.  As compensation for the services rendered by Vital, the Company was obligated to pay a program sponsorship fee of $200,000 per month.




On February 13, 2008, the Company amended the existing contract with Vital to operate a second facility in The Woodlands.  The amendment further extended the term of the contract for a period of one year, thus the new termination date of the agreement became May 1, 2010.  The payment of $200,000 per month continued on the existing facility as well as an additional $200,000 per month for the new facility.




On January 13, 2009, Vital terminated the agreement as a result of a breach of contract and demanded payment of $6,200,000.  On February 9, 2009, the Company and Vital entered a Reinstatement of Contract Agreement reinstating the contract and providing a payment to Vital of $400,000 representing payments due for January 15, 2009 and February 1, 2009.  Further, the Reinstatement provided that Vital, and not the Company, may terminate the agreement going forward.  Further, the Company and Vital entered into a Grant of Exclusivity Agreement providing Vital with the exclusive right to negotiate and tender contracts for the operation and management of emergency services.




On December 10, 2009, the Company extended and renewed the agreement for an additional two years.  Program payments for both facilities are now set to expire April 30, 2012.




The Company made payments totaling $1.2 million and $2.4 million during each of the three and six months ended June 30, 2011 and 2010, respectively.




Litigation




From time to time, the Company may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business.  However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.  Except as set forth below, the Company is not currently aware of any legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse affect on its business, financial condition or operating results.


15


FIRST SURGICAL PARTNERS INC. AND SUBSIDIARIES


(FORMERLY, ARKSON NUTRACEUTICALS, INC.)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





On January 7, 2011, Aetna Health Inc. and Aetna Life Insurance Company filed a petition in the District Court of Harris County, Texas (Case Number 201101291) against First Street Hospital, L.P. (“FSH”) and St. Michael’s Emergency Center LLC (“SMEC”) primarily claiming fraud/fraudulent non-disclosure and negligent misrepresentation and seeking damages, expenses and attorneys’ fees in connection with the billing practices associated with the affiliation agreement between FSH and SMEC whereby FSH’s off-campus emergency departments are improperly submitting facility fee claims under FSH’s tax identification number.  Aetna is claiming that FSH and SMEC are not properly or sufficiently integrated and affiliated and, as a result, such facility fee claims are fraudulent when submitted under FSH’s tax identification number.  On February 14, 2011, FSH filed its original answer denying all allegations.  Further, on March 2, 2011, FSH filed a Motion to Dismiss arguing that only federal courts have jurisdiction over ERISA matters.  In response to the Motion to Dismiss, on April 7, 2011, Aetna Life Insurance Company segregated its claims and filed an additional lawsuit with the United States District of Texas Houston Division (Case Number 4:11-cv-01341) against FSH and SMEC primarily claiming fraud/fraudulent non-disclosure and negligent misrepresentation and seeking damages, expenses and attorneys’ fees in connection with the billing practices associated with the affiliation agreement between FSH and SMEC.  On April 29, 2011, FSH filed a Motion to Dismiss the United States District of Texas Houston Division seeking to dismiss all claims based on state law as such claims are preempted by Federal law and seeking to dismiss all claims based on fraud and negligent misrepresentation as the claimant had not specifically plead facts supporting fraudulent knowledge and intent.  In April 2011, Aetna Health Inc. and Aetna Life Insurance Company filed a First Amended Petition in the District Court of Harris County, Texas.  Discovery in these matters is ongoing.  An estimate of the amount or range of loss or possible loss cannot be made at this time.  Although the lawsuits as currently pled are not clear regarding damages, the Original Petition filed by Aetna Health Inc. and Aetna Life Insurance Company in District Court of Harris County, Texas alleged total damages of $16.0 million in wrongfully submitted insurance claims, excluding punitive damages and attorney fees.  FSH has denied all claims and intends to continue to vigorously defend these claims.




9.
SUBSEQUENT EVENTS




On July 29, 2011, the Company declared a quarterly dividend on its Common Stock of $0.0275 per share.  The record date for this distribution was August 11, 2011 and the dividend was paid on August 12, 2011.  The total dividend paid was $1,117,875.


16





Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations




This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that relate to possible future events, our future performance, and our future operations. In some cases, you can identify these forward-looking statements by the use of words such as “may,” “will,” “should,” “anticipates,” “believes,” “expects,” “plans,” “future,” “intends,” “could,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other similar expressions. These statements are only our predictions.  Our actual results could and likely will differ materially from these forward-looking statements for many reasons, including the risks described in our Annual Report on Form 10-K for the year ended December 31, 2010, and our quarterly reports on Form 10-Q.  We cannot guarantee future results, levels of activities, performance, or achievements. We undertake no duty to update any of the forward-looking statements after the date of this document to conform them to actual results or to changes in our expectations.




Overview




We, along with our subsidiaries, own and operate two ambulatory surgery centers (“ASC”), First Street Surgical Center, L.P. (“FSSC”), and First Surgical Woodlands, L.P. (“FSW”), and a general acute care hospital, First Street Hospital, L.P. (“FSH”), all located in the greater Houston, Texas metropolitan area.  Procedures performed include non life-threatening surgeries, such as bariatrics, reconstructive and cosmetic plastics, orthopedics, pain management, neurosurgery and podiatry, which are often completed on an outpatient or short stay basis.




Executive Summary




We operate two ambulatory surgery centers and a general acute hospital that provide treatment on both an inpatient and outpatient basis.  We are a Texas-based organization with plans to expand to other areas of the country that make economic sense.  Our ASC and hospital based procedures vary, ranging from orthopedics, bariatrics, spine, general surgery, pain management, podiatry, and otolaryngology (ENT).  Our team of highly skilled physicians, nurses, radiology techs, scrub techs, physical therapists, dietitians, utilize the latest in equipment and technology to give our patients successful outcomes.  All patient care is provided by the previously mentioned experts, and all care is directed by a physician order.  We have an internal case manager that monitors each hospital patient’s progress; each patient's progress is documented with a progress note, achievement of goals, functional outcomes and a thorough discussion of a discharge plan.  This interdisciplinary approach leads to a higher, more personal level of care with excellent clinical outcomes.




We have over 30 affiliated physicians, which are shareholders of the company, who provide medical care and surgical services to our patients.  In addition, there are an additional 60 non-affiliated physicians that use our locations for surgical procedures, many with great frequency.  With the total count of surgeons exceeding ninety, as of June 30, 2011, 33.7% are shareholders or affiliated surgeons and 66.3% are non-owners or non-affiliates.  We believe surgeons choose to perform surgeries at First Surgical because of (1) the input and control they have over the facilities’ operations, (2) the quality of the facilities, (3) the well trained staff, (4) the reputations of the other surgeons using the facilities, and (5) the well respected, financially disciplined management team.  Since our formation in 2002, we have partnered with the best surgeons in their specialties covering the greater Houston area.  Since inception, these physicians (affiliated and non-affiliated) have performed over 41,200 procedures and the number of procedures performed each year continues to grow.




The affiliated surgeons consider our facilities as their main place to perform surgeries and as a result represented about 62.2% of our revenue for the six months ended June 30, 2011.  Non-affiliated surgeons represented about 37.8% of the revenue for the six months ended June 30, 2011.  We expect the mix of unaffiliated and affiliated surgeons and the percentage of revenue generated by each of these groups to continue in the near future.  All surgeons bill for their professional component separately and none of that revenue is reported by First Surgical.  The main source of revenue for First Surgical is the facility fee component which is billed and collected under each facility upon completion of surgery.  We plan on expanding the revenue generated by non-affiliated surgeons by introducing new technical innovations in spine, bariatrics, orthopedics and reconstructive surgery, which we believe will attract non-affiliated surgeons.  We are also currently evaluating the adoption of a physician stock purchase plan, which will allow physicians to purchase equity in our company.  We have engaged various experts to advise on the legality of such plan in light of the Stark and Anti-kickback regulations.  As a result, until such analysis is finalized, we are uncertain if we will be able to adopt such plan in the near future or ever.  In addition, the startup and development of surgical centers and the acquisition of hospitals in competitive markets we believe will allow for our company’s growth and expansion of business through the addition of non-affiliated and affiliated surgeons.  The risks associated with this aspect include surgeons’ practices not growing or even slowing down, competition for surgeons to join other facilities in the market, our inability to acquire existing facilities for business reasons, our inability to start or acquire new facilities as a result of various government regulations and the lack of interest in the new and innovative technology, which all may have a negative impact on our operations including the facility fees generated by both the affiliated and non-affiliated surgeons.  Further, if we are unable to adopt a physician stock purchase plan, we will be unable to expand our pool of affiliated surgeons.  As affiliated surgeons have historically generated a significant portion of our revenue, any future revenue growth will be limited if we do not implement such plan.




17




During 2009, given increased demand for services requiring overnight stays, we determined that we needed to expand our general acute care hospital.  Construction of the expansion commenced in March 2010, and the project was completed and passed inspection with the Texas Department of State Health Services during November 2010.  Surgical cases were scheduled and performed on December 15, 2010.  The expansion increased the hospital from 17,000 to 40,000 square feet.  Bed capacity increased to nineteen, from five, and the operating rooms doubled from two to four.




Key Challenges




The following represent the challenges facing our company going forward:




·
Declining reimbursements - Third party payors are reimbursing less and less for our services.  We will continue to negotiate for favorable managed care contracts, as well as looking at alternative methods of reimbursements, such as direct contracting with self-insured employers and/or unions.




·
Highly regulated industry - Over the last several years, changes in regulations regarding hospitals, specifically physician-owned hospitals, have created additional challenges from an operation perspective.  Many of these changes have resulted in limitations, including moratoriums on physician-owned start-up hospitals.  We have analyzed the aspects of Medicare reimbursements, and the changes in Medicare reimbursements may have a slightly harmful effect on our revenues. Although the moratorium on physician-owned start-up hospitals may prevent us from developing start up hospitals, which could have a negative impact on our growth strategy, we will be able to acquire existing hospitals as well as develop surgical centers.




·
Healthcare Reform - President Obama has identified healthcare reform as a priority.  The future of healthcare reform to our book of business is concerning, yet out business model of looking at existing facilities to acquire is still advantageous.  We will continue to look at hospitals that would benefit from our leadership and model going forward.




·
Accountable Care Organizations - Known as ACO's, this model of bundling payments to the facility, physician, and all other healthcare providers is concerning.  Major healthcare reform bills being contemplated now by Congress include, at the very least, consideration of this model.  At this time, it is difficult, if not impossible to determinate how the adoption of ACO’s may impact our operations, if at all.   If adopted, the ACO model may require our company to engage additional accounting and billing personnel to coordinate payments, which, in turn, could have a negative impact on our net income.




Business Outlook




Outpatient surgical procedures, which incorporate both hospital and surgical cases, continue to increase.  Due to technology, patients are going home quicker, and the availability for certain procedures just five years ago necessitating a two night stay in a hospital are now done the same day.  We believe we differentiate ourselves from competitors by offering surgeons and physicians that are best of class, superior outcomes, and competitive management efficiencies.  We believe we will deliver shareholder value by focusing on the key items discussed.




P ayor Mix




We bill payors for professional services provided by our affiliated and non-affiliated physicians to our patients based upon rates for specific services provided.  Our billed charges are substantially the same for all parties regardless of the party responsible for paying the bill for our services.  We determine our net patient service revenue based upon the difference between our gross fees for services and our estimated ultimate collections from payors.  Net patient service revenue differs from gross fees due to (i) managed care payments at contracted rates, (ii) government-sponsored healthcare program reimbursements at government-established rates, (iii) various reimbursement plans and negotiated reimbursements from other third-parties, and (iv) discounted and uncollectible accounts of private-pay patients.




18


Our payor mix is composed of contracted managed care, government, principally Medicare, other third-parties and private-pay patients.




The following is a summary of our payor mix, expressed as a percentage of net patient service revenue, exclusive of administrative fees, for the periods indicated:




For the Three Months Ended


For the Six Months EndedJune 30,


June 30,2011


2010


2011


2010Medicare


4.77
%


6.20
%


5.99
%


6.72
%Worker's Compensation


4.76
%


2.12
%


4.63
%


2.25
%Commercial Carriers


78.33
%


82.06
%


75.76
%


81.70
%Other (self pays, hardships, etc.)


12.14
%


9.62
%


13.62
%


9.33
%





Application of Critical Accounting Policies and Estimates




The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reporting of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities.  Note 2 to our unaudited Consolidated Financial Statements as of  and for the three months ended June 30, 2011, provides a summary of our significant accounting policies, which are all in accordance with generally accepted accounting principles in the United States.  Certain of our accounting policies are critical to understanding our Consolidated Financial Statements because their application requires management to make assumptions about future results and depends to a large extent on management’s judgment, because past results have fluctuated and are expected to continue to do so in the future.  We believe that the application of the accounting policies described in the following paragraphs is highly dependent on critical estimates and assumptions that are inherently uncertain and highly susceptible to change.  For all of these policies, we caution that future events rarely develop exactly as estimated, and the best estimates routinely require adjustment.  On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below.




Use of Estimates and Assumptions




Future events and their effects cannot be predicted with certainty; accordingly the preparation of financial statements in conformity with GAAP 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.  The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired , as additional information is obtained, and as our operating environment changes.  Significant estimates and assumptions are used for, but not limited to: (1) allowance for contractual revenue adjustments; (2) depreciable lives of assets; (3) economic lives and fair values of leased assets; (4) uncertain tax positions; and (5) contingency and litigation reserves.  The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources.  The Company evaluates its estimates and assumptions on a regular basis and may employ outside experts to assist in our evaluation, as considered necessary.  Actual results may differ from these estimates and assumptions used in preparation of its financial statements and changes in these estimates are recorded when known.




Revenue Recognition




Revenues consist primarily of net patient service revenues that are recorded based upon established billing rates less allowances for contractual adjustments.  Revenues are recorded during the period the healthcare services are provided, based upon the estimated amounts due from the patients and third-party payors, including federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, and employers.  Estimates of contractual allowances under third-party payor arrangements are based upon the payment terms specified in the related contractual agreements.  Third-party payor contractual payment terms are generally based upon predetermined rates per diagnosis, per diem rates, or discounted fee-for-service rates.  The Company does not expect material changes in the estimate of prior period allowances for contractual and other adjustments. Further, we do not foresee changes in our estimate of unsettled amounts from third party payors as of the latest balance sheet date that could have a material effect on our financial position, results of operations or cash flows.




19




Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation, and are routinely modified for provider reimbursement.  All healthcare providers participating in the Medicare and Medicaid programs are required to meet certain financial reporting requirements. Federal regulations require submission of annual cost reports covering medical costs and expenses associated with the services provided by each hospital to program beneficiaries.  Annual cost reports required under the Medicare and Medicaid programs are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to the Company under these reimbursement programs.  These audits often require several years to reach the final determination of amounts earned under the programs.  As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term.




We provide care to patients who are financially unable to pay for the healthcare services they receive, and because we do not pursue collection of amounts determined to qualify as charity care, such amounts are not recorded as revenues.




Income Taxes




We provide for income taxes using the asset and liability method.  This approach recognizes the amount of federal, state, and local taxes payable or refundable for the current year, as well as deferred tax assets and liabilities for the future tax consequence of events recognized in the consolidated financial statements and income tax returns.  Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates.  A valuation allowance is required when it is more likely than not that some portion of the deferred tax assets will not be realized.  Realization is dependent on generating sufficient future taxable income.  We evaluate our tax positions and establish assets and liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes.  We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly.  The Company and its corporate subsidiaries file a consolidated federal income tax return.  Some subsidiaries consolidated for financial reporting purposes are not part of the consolidated group for federal income tax purposes and file separate federal income tax returns.  State income tax returns are filed on a separate, combined, or consolidated basis in accordance with relevant state laws and regulations.  Partnerships, limited liability partnerships, limited liability companies, and other pass-through entities that we consolidate or account for using the equity method of accounting file separate federal and state income tax returns.  We include the allocable portion of each pass-through entity’s income or loss in our federal income tax return.  We allocate the remaining income or loss of each pass-through entity to the other partners or members who are responsible for their portion of the taxes.




Other Matters




Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of our Consolidated Financial Statements.  All of our significant accounting policies are further described in Note 2 to our unaudited Consolidated Financial Statements as of and for the three months ended June 30, 2011, in this Form 10-Q.  The policies described in Note 2 often require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance and are frequently reexamined by accounting standards setters and regulators.




20




Results of Operations




The following table sets forth, for the periods indicated, certain information related to our operations expressed as a percentage of our net patient service revenue:




For the Three Months Ended


For the Six Months EndedJune 30,


June 30,2011


2010


2011


2010Net Revenue


100.0
%


100.0
%


100.0
%


100.0
%Operating ExpensesSalaries and Benefits


27.7
%


22.1
%


27.8
%


21.3
%Medical Supplies


19.5
%


19.4
%


20.7
%


16.9
%Bariatric Program Sponsorship


9.9
%


9.4
%


9.7
%


9.6
%Management Fees


3.7
%


3.6
%


3.7
%


3.8
%Rent


3.7
%


3.5
%


4.1
%


3.6
%Depreciation and Amortization


4.5
%


3.6
%


4.3
%


2.8
%Other Operating Expenses


20.0
%


10.8
%


16.8
%


11.4
%Total Operating Expenses


89.0
%


72.3
%


105.1
%


70.3
%Other Income and ExpensesInterest Expense, net


(2.6
)%


(1.7
)%


(2.5
)%


(1.8
)%Total Other Income and Expenses


(2.6
)%


(1.7
)%


(2.5
)%


(1.8
)%Income Before Income Taxes


8.4
%


26.0
%


10.4
%


28.8
%Income Taxes


3.1
%


0.0
%


3.7
%


0.0
%Net Income


5.3
%


26.0
%


6.6
%


28.8
%





Three Months Ended June 30, 2011, as Compared to Three Months Ended June 30, 2010




Our net revenue decreased $559,375 or 4.4%, to $12,149,557 for the three months ended June 30, 2011, as compared to $12,708,932 for the comparable period in the prior year.  Although our total cases increased to 1,659 for the three months ended June 30, 2011, as compared to 1,616 for the three months ended June 30, 2010; and specifically our hospital cases increased by 112 from 469 cases during the three months ended June 30, 2010, to 581 for the three months ended June 30, 2011, the nature of our mix of specialty procedures performed between the two periods (e.g. podiatry, orthopedic, general surgery) caused the overall decline in revenue.  For example, during the three months ended June 30, 2011, podiatry cases increased 114.2%, to 105 from 49 during the three months ended June 30, 2010.  Podiatry cases have a lower net revenue per case then orthopedic and/ or neurosurgical cases.




Salaries and benefits increased $561,720 or 20.0%, to $3,365,197 for the three months ended June 30, 2011, as compared to $2,803,477 for 2010.  The increase was primarily attributable to: (i) the aforementioned higher case volume under the hospital; (ii) the need for new hospital clinical and administrative staffing to assist in accommodating the hospital expansion of two additional operating rooms and 14 additional beds; (iii) the need to hire additional support staff for the accounting department, and (iv) increased premium expense for the Company’s employee health insurance.




Medical supplies decreased $89,179, or 3.6%, to $2,374,480 for the three months ended June 30, 2011, as compared to $2,463,659 for 2010.  This slight decrease was attributable to ordering efficiency and monitoring of on-hand supplies.




Our Bariatric Program Sponsorship fees were unchanged between the two periods, at $1,200,000 per quarter.




During the three months ended June 30, 2011 and 2010, both First Street Hospital, L.P. and First Surgical Woodlands, L.P. held management agreements with First Surgical Partners, LLC (the former General Partner of the Company’s limited partnerships and the owners of which are shareholders of the Company) where we retained the services of First Surgical Partners, LLC to assist us in managing and conducting day-to-day business and services.  Each agreement calls for the payment by the partnerships to First Surgical Partners, LLC a monthly fee equal to 5% of the net monthly collected revenues from the partnership’s cash collections.  These fees were comparable between the two quarters.




21




Depreciation and amortization expense increased $88,053, or 19.3%, to $543,837 for the three months ended June 30, 2011, as compared to $455,784 for 2010.  This increase was attributable primarily to the hospital expansion leasehold improvements and equipment, furniture and fixtures needed to complete the expansion and open it for its intended use.  Those fixed assets were placed in service December 2010.




Our other operating expenses increased by $1,052,672, or 76.4%, to $2,429,615 for the three months ended June 30, 2011, as compared to $1,376,943 for 2010.  This increase was primarily attributable to a $750,262 charge associated with 400,000 shares of our Common Stock issued to settle all disputes we had with a provider of capital markets consulting and investor relations services.  The remainder of the increase was attributable to legal and professional fees associated with our public company filings.




We recorded net interest expense of $316,727 for the three months ended June 30, 2011, as compared to $213,696 for 2010, or an increase of 48.2%. The total increase of $102,918 in interest cost, or 48.1% was primarily a result of additional debt incurred in our hospital expansion.




Prior to the Company’s acquisition by Piper, on December 1, 2010, all of the net income from the Company’s subsidiaries, First Street Surgical Center, L.P., First Surgical Woodlands, L.P., and First Street Hospital, L.P. passed through to the then-limited partners of each of the Company’s subsidiaries and the Company, therefore, had no corporate tax obligation to record.  Had the acquisition by Piper occurred on January 1, 2009, the Company would have incurred the following pro-forma income tax expense:




Pro Forma for theThree Months EndedJune 30, 2010Current Taxes

$
1,155,466Deferred Taxes


-Total

$
1,155,466




Six Months Ended June 30, 2011, as Compared to Six Months Ended June 30, 2010




Our net revenue decreased $215,796 or 0.9%, to $24,773,454 for the six months ended June 30, 2011, as compared to $24,989,250 for the comparable period in the prior year.  As noted above with respect to the three month period ended June 30, 2011, although total cases increased to 3,137 for the six months ended June 30, 2011, as compared to 3,043 for the six months ended June 30, 2010; and specifically our hospital cases increased by 190 from 876 cases for the six months ended June 30, 2010, to 1,066 for the six months ended June 30, 2011, the nature of our mix of specialty procedures performed between the two periods (e.g. podiatry, orthopedic, general surgery) caused the overall decline in revenue.




Salaries and benefits increased $1,569,157 or 29.4%, to $6,898,257 for the six months ended June 30, 2011, as compared to $5,329,100 for 2010.  During the six months ended June 30, 2011, we issued 250,000 shares of our Common Stock to our Vice President, Finance for services rendered.  These shares were valued at $468,914, based on the Company’s estimate of the fair market value of its Common Shares on that date, and included as a component of our 2011 salaries and benefit expense.  The balance of the increase was primarily attributable to: (i) the aforementioned higher case volume under the hospital; (ii) the need for new hospital clinical and administrative staffing to assist in accommodating the hospital expansion of two additional operating rooms and 14 additional beds; (iii) the need to hire additional support staff for the accounting department, and (iv) increased premium expense for the Company’s employee health insurance.




Medical supplies increased $905,347, or 21.4%, to $5,135,649 for the six months ended June 30, 2011, as compared to $4,230,302 for 2010.  This increase was attributable to the increased volume resulting from the expansion.




Our Bariatric Program Sponsorship fees were unchanged at $2,400,000 for each period.




During the six months ended June 30, 2011 and 2010, both First Street Hospital, L.P. and First Surgical Woodlands, L.P. held management agreements with First Surgical Partners, LLC (the former General Partner of the Company’s limited partnerships and the owners of which are shareholders of the Company) where we retained the services of First Surgical Partners, LLC to assist us in managing and conducting day-to-day business and services.  Each agreement calls for the payment by the partnerships to First Surgical Partners, LLC a monthly fee equal to 5% of the net monthly collected revenues from the partnership’s cash collections.  These fees decreased $39,696, or 4.1%, to $920,068 for the six months ended June 30, 2011, as compared to $959,764  for 2010, as a direct result in corresponding decreases in cash collections in these two entities.  The management agreements are currently in effect and we will continue to pay such fees under the agreed upon terms set forth therein.




22




Our rent increased $111,039, or 12.4%, to $1,009,813 for the six months ended June 30, 2011, as compared to $898,774 for 2010.  This increase was primarily attributable to operating medical equipment rentals that were necessary to meet the demand for equipment supporting the overall increased case volume.




Depreciation and amortization expense increased $378,555, or 54.5%, to $1,072,806 for the six months ended June 30, 2011, as compared to $694,251 for 2010.  This increase was attributable primarily to the hospital expansion leasehold improvements and equipment, furniture and fixtures needed to complete the expansion and open it for its intended use.  Those fixed assets were placed in service December 2010.




Our other operating expenses increased by $1,314,653, or 46.2%, to $4,158,201 for the six months ended June 30, 2011, as compared to $2,843,548 for 2010.  This increase was primarily attributable to a $750,262 charge associated with 400,000 shares of our Common Stock issued to settle all disputes we had with a provider of capital markets consulting and investor relations services.  The remainder of the increase was attributable to legal and professional fees associated with our public company filings.




We recorded net interest expense of $612,587 for the six months ended June 30, 2011, as compared to $438,968 for 2010, or an increase of 39.6%. The total increase of $173,398 in interest cost, or 39.4 % was a result of additional debt incurred in our hospital expansion.




Prior to the Company’s acquisition by Piper, on December 1, 2010, all of the net income from the Company’s subsidiaries, First Street Surgical Center, L.P., First Surgical Woodlands, L.P., and First Street Hospital, L.P. passed through to the then-limited partners of each of the Company’s subsidiaries and the Company, therefore, had no corporate tax obligation to record.  Had the acquisition by Piper occurred on January 1, 2009, the Company would have incurred the following pro-forma income tax expense:




Pro Forma for the


Pro Forma for theThree Months Ended


Six Months EndedJune 30, 2010


June 30, 2010Current Taxes

$
1,155,466


$
2,518,090Deferred Taxes


-



-Total

$
1,155,466


$
2,518,090




We anticipate that our effective tax rate will be approximately 35% for 2011.




Liquidity and Capital Resources




Our primary sources of liquidity are cash on hand, cash flows from operations, and borrowings under our credit lines and long-term debt.




As of June 30, 2011, we had $662,618 of cash and cash equivalents on hand as compared to $266,708 at December 31, 2010.  Additionally, we had net working capital of $11,648,452 at June 30, 2011, an increase of $1,764,353 from our net working capital balance of $9,884,099 at December 31, 2010.




We were provided $229,519 of cash in operating activities for the six months ended June 30, 2011, as compared to cash provided by operating activities of $5,640,858 for the six months ended June 30, 2010.  This decrease was primarily attributable to our decrease in net income between the periods.




We used $669,435 and $625,508 of cash for investing activities during the six months ended June 30, 2011 and 2010, respectively.  These expenditures were primarily related to leasehold improvements and equipment purchases associated with our hospital expansion project.




23





During the six months ended June 30, 2011, we were provided $835,826 in cash from financing activities as advances under our lines of credit and long term debt were partially offset by partial repayments on those borrowing as well as our special and first quarter 2011 dividend.  During the six months ended June, 2010, we used $4,991,047.  Of this amount, $4,502,625 related to former limited partner distributions during the period.  The balance related to net repayments on our outstanding debt obligations.




As of June 30, 2011, we had $517,701 available to us under our various credit lines.  We monitor the financial strength of our depositories, creditors, insurance carriers, and other counterparties using publicly available information, as well as qualitative inputs.  Based on our current borrowing capacity and compliance with the financial covenants under our credit agreements, we do not believe there is significant risk in our ability to make draws under our various credit lines, if needed.  However, no such assurances can be provided.




As of June 30, 2011, we have scheduled principal payments of $1,217,456 during the next twelve months, related to long-term debt and capital lease obligations (see Note 5, Long-term Debt and Capital Lease Obligations , in the accompanying unaudited consolidated financial statements as of and for the six months ended June 30, 2011).  We do not face near-term refinancing risk.  Our credit agreements governing the vast majority of our secured borrowings contain financial covenants that include a leverage ratio.  As of June 30, 2011, we were in compliance with the covenants under our various credit agreements.  If we anticipated a potential covenant violation, we would seek relief from our lenders, which would have some cost to us, and such relief might not be on terms favorable to those in our existing credit agreements.  Under such circumstances, there is also the potential our lenders would not grant relief to us which, among other things, would depend on the state of the credit markets at that time.




Contractual Obligations




Long Term Debt




At June 30, 2011, our long-term debt consisted of the following:




·
First Street Hospital, L.P. issued a secured promissory note in the original amount of $7,822,256 on January 8, 2008, to a financial institution (the “2008 FSH Note Payable”).  The 2008 FSH Note Payable bears interest at 7.70% per annum and matures on January 8, 2013.  The note calls for monthly interest and principal payments of $73,747, with a balloon payment due on January 8, 2013, of $6,162,583.  As of June 30, 2011, the Company owed $6,700,969 on the 2008 FSH Note Payable.




·
On May 4, 2010, First Street Hospital, L.P. entered into a secured construction loan agreement (the “2010 Construction Loan”) with a financial institution.  Total advances under the loan agreement were $4,439,150, of which $4,410,158 remained outstanding at June 30, 2011.  The note calls for monthly interest and principal payments ranging from approximately $24,507 to $38,907, with a balloon payment due on May 4, 2013, of $4,099,241.  The note bears interest at 6.50% per annum.




·
In connection with the issuance of the 2010 Construction Loan facility, on November 30, 2010, First Street Hospital, L.P. entered into a secured promissory note (the “2010 Equipment Loan”) providing for a total principal amount of $1,863,062 with a financial institution.  As of June 30, 2011, the Company had $1,863,062 outstanding on the 2010 Equipment Loan. The note calls for monthly interest and principal payments ranging from approximately $9,419 to $27,753, with a balloon payment due on November 30, 2013, of $1,442,988.  The note bears interest at 6.50% per annum.




·
First Street Surgical Center, L.P. issued a secured promissory note in the original amount of $1,652,030 on January 8, 2008, to a financial institution.  The note bears interest at 7.70% per annum and matures on January 8, 2013.  The note calls for monthly interest and principal payments of $15,502.88, with a balloon payment due on January 8, 2013, of $1,301,513.  As of June 30, 2011, the Company owed $1,415,229 on the note.




24




Bariatric Program Sponsorship Agreement




We entered into a Bariatric Program Sponsorship Agreement on March 22, 2006, but effective May 1, 2006, with Vital Weight Control, Inc., d/b/a NeWeigh (‘Vital’).  Per the agreement, we are sponsoring, in part, a gastroplasty program involving surgical intervention for morbid obesity.  Under the sponsorship, we make available our facility for surgeries on prospective patients that are participants in the bariatric program as well as for surgeries on other prospective patients that meet criteria for eligibility for bariatric surgery.  Vital is responsible for managing the bariatric program including coordinating the use of our facilities, nutritionists, other medical professionals, insurance professionals and other clinicians.  Vital is also responsible for marketing, advertising and promoting the bariatric program.  We are responsible for providing hospital services and making all required payments under the agreement.




In addition to the above, at all times during the term of the agreement, we shall either furnish, at our expense, or reimburse Vital amounts Vital expends for operation of the program, including office space, facilities, equipment, utilities, furniture, fixtures, office supplies, postage, courier services, and other outside services as may be reasonably required to operate the program.  The original term of the agreement commenced on May 1, 2006, for a period of 36 months.  As compensation for the services rendered by Vital, the Company was obligated to pay a program sponsorship fee of $200,000 per month.




On February 13, 2008, we amended the existing contract with Vital to operate a second facility in The Woodlands.  The amendment further extended the term of the contract for a period of one year, thus the new termination date of the agreement became May 1, 2010.  The payment of $200,000 per month continued on the existing facility as well as an additional $200,000 per month for the new facility.




On January 13, 2009, Vital terminated our agreement as a result of a breach of contract and demanded payment of $6,200,000.  On February 9, 2009, we entered a Reinstatement of Contract Agreement reinstating the contract and providing a payment to Vital of $400,000 representing payments due for January 15, 2009 and February 1, 2009.  Further, the Reinstatement provided that Vital, and not the Company, may terminate the agreement going forward.  Further, we entered into a Grant of Exclusivity Agreement providing Vital with the exclusive right to negotiate and tender contracts for the operation and management of emergency services.




On December 10, 2009, we extended and renewed the agreement for an additional two years.  Program payments for both facilities are now set to expire April 30, 2012.




Management Fees




Both First Street Hospital, L.P. and First Surgical Woodlands, L.P. hold management agreements with First Surgical Partners, LLC (the former General Partner of the Company’s limited partnerships and the owners of which are shareholders of the Company) where we retained the services of First Surgical Partners, LLC to assist us in managing and conducting day-to-day business and services.  Each agreement calls for the payment by the partnerships to First Surgical Partners, LLC a monthly fee equal to 5% of the net monthly collected revenues from the partnership’s cash collections.  For the three and six months ended June 30, 2011, these fees totaled $454,416 and $920,068, respectively.  The management agreements are currently in effect and we will continue to pay such fees under the agreed upon terms set forth therein.  The First Surgical Woodlands LP agreement was executed on February 1, 2005 with a term of five years and automatically renews for one additional two year period unless otherwise terminated in writing by either party.  The First Street Hospital LP agreement was executed on July 25, 2006 with a term of ten years and automatically renews for an additional two year period unless otherwise terminated unless otherwise terminated in writing by either party.




Off-Balance Sheet Arrangements




At June 30, 2011, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.




Item 3.     Quantitative and Qualitative Disclosures About Market Risk




As a “smaller reporting company”, we are not required to provide the information required by this Item.




Item4.Controls and Procedures.




Management’s Report on Disclosure Controls and Procedures




We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer (our Principal Executive Officer) and our Vice President, Finance (our Principal Financial and Accounting Officer) to allow for timely decisions regarding required disclosure.




25




As of June 30, 2011, the end of our quarter covered by this report, we carried out an evaluation, under the supervision and with the participation of our President and Chief Executive Officer (our Principal Executive Officer) and our Vice President, Finance (our Principal Financial and Accounting Officer) of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our President and Chief Executive Officer (our Principal Executive Officer) and our Vice President, Finance (our Principal Financial and Accounting Officer) concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.




Changes in Internal Control over Financial Reporting




There have been no changes in our internal controls over financial reporting that occurred during our quarter ended June 30, 2011, that have materially or are reasonably likely to materially affect, our internal controls over financial reporting.




Part II – OTHER INFORMATION




Item 1.     Legal Proceedings




From time to time, the Company may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business.  However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.  Except as set forth below, the Company is not currently aware of any legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse affect on its business, financial condition or operating results.





On January 7, 2011, Aetna Health Inc. and Aetna Life Insurance Company filed a petition in the District Court of Harris County, Texas (Case Number 201101291) against First Street Hospital, L.P. (“FSH”) and St. Michael’s Emergency Center LLC (“SMEC”) primarily claiming fraud/fraudulent non-disclosure and negligent misrepresentation and seeking damages, expenses and attorneys’ fees in connection with the billing practices associated with the affiliation agreement between FSH and SMEC whereby FSH’s off-campus emergency departments are improperly submitting facility fee claims under FSH’s tax identification number.  Aetna is claiming that FSH and SMEC are not properly or sufficiently integrated and affiliated and, as a result, such facility fee claims are fraudulent when submitted under FSH’s tax identification number.  On February 14, 2011, FSH filed its original answer denying all allegations.  Further, on March 2, 2011, FSH filed a Motion to Dismiss arguing that only federal courts have jurisdiction over ERISA matters.  In response to the Motion to Dismiss, on April 7, 2011, Aetna Life Insurance Company segregated its claims and filed an additional lawsuit with the United States District of Texas Houston Division (Case Number 4:11-cv-01341) against FSH and SMEC primarily claiming fraud/fraudulent non-disclosure and negligent misrepresentation and seeking damages, expenses and attorneys’ fees in connection with the billing practices associated with the affiliation agreement between FSH and SMEC.  On April 29, 2011, FSH filed a Motion to Dismiss the United States District of Texas Houston Division seeking to dismiss all claims based on state law as such claims are preempted by Federal law and seeking to dismiss all claims based on fraud and negligent misrepresentation as the claimant had not specifically plead facts supporting fraudulent knowledge and intent.  In April 2011, Aetna Health Inc. and Aetna Life Insurance Company filed a First Amended Petition in the District Court of Harris County, Texas.  Discovery in these matters is ongoing.  An estimate of the amount or range of loss or possible loss cannot be made at this time.  Although the lawsuits as currently pled are not clear regarding damages, the Original Petition filed by Aetna Health Inc. and Aetna Life Insurance Company in District Court of Harris County, Texas alleged total damages of $16.0 million in wrongfully submitted insurance claims, excluding punitive damages and attorney fees.  FSH has denied all claims and intends to continue to vigorously defend these claims.




Item 1A.  Risk Factors




Please refer to the risk factors as previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.




Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds




On April 29, 2011, the Company entered into an Agreement with First Surgical Partners LLC, RJR Consulting Group, LLC (“RJR”) and RC Capital Group, LLC pursuant to which the parties agreed to settle all disputes with respect to an agreement between the Company and RJR for RJR to provide capital markets consulting and investor relations services to the Company.  In consideration of the Agreement, the Company issued 400,000 shares of the Company’s Common Stock to RJR.




26




The issuance of the above securities are exempt from the registration requirements under Rule 4(2) of the Securities Act of 1933, as amended, and/or Rule 506 as promulgated under Regulation D.    Each of the shareholders is an accredited investor as defined in Rule 501 of Regulation D promulgated under the Securities Act.




Item 3.    Defaults Upon Senior Securities




None




Item 4.     (Removed and Reserved)




Item 5.     Other Information




None




Item 6.     Exhibits




3.1

Certificate of Incorporation of First Surgical Partners, Inc (f/k/a Arkson Nutraceuticals Corp.), as amended (4)3.2

Corporate Bylaws of First Surgical Partners, Inc (f/k/a Arkson Nutraceuticals Corp.) (3)4.1

Letter Loan Agreement by and between First Street Hospital, L.P. and the Bank of River Oaks dated January 8, 2008 (4)4.2

Secured Promissory Note issued by First Street Hospital, L.P. to the Bank of River Oaks dated January 8, 2008 (4)4.3

Unsecured Promissory Note issued by First Street Hospital, L.P. to the Bank of River Oaks dated May 4, 2010 (4)4.4

Secured Construction Loan Agreement by and between First Street Hospital, L.P. and the Bank of River Oaks dated May 4, 2010 (4)4.5

Long Term Line of Credit issued by First Street Surgical Center, L.P. to Bank of River Oaks dated January 8, 2008 (4)4.6

Intentionally left blank4.7

Secured Promissory Note issued by First Surgical Woodlands, L.P.  to the Bank of River Oaks dated September 18, 2009 (4)4.8

Long-term Line of Credit between First Street Surgical Center, L.P. and Jacob Varon dated November 4, 2009 (4)4.9

Secured Promissory Note issued by First Street Hospital, L.P. to Bank of River Oaks dated November 30, 2010 (4)4.10

Fourth Amendment to Letter Loan Agreement by and between First Street Hospital, L.P. and the Bank of River Oaks dated January 8, 2008, dated effective January 8, 2011 (4)4.11

Modification, Renewal and Extension Agreement to the Secured Promissory Note issued by First Street Hospital, L.P. to the Bank of River Oaks dated January 8, 2008, dated effective January 8, 2011 (4)4.12

Fourth Amendment to Long Term Line of Credit issued by First Street Surgical Center LP to Bank of River Oaks dated January 8, 2008, dated effective January 8, 2011 (4)4.13

First Amendment to Secured Promissory Note issued by First Surgical Woodlands, L.P.  to the Bank of River Oaks dated September 18, 2009, dated effective September 18, 2010 (4)10.1

Contribution Agreement by and between Arkson Nutraceuticals Corp. and Piper Acquisition III, Inc., dated November 4, 2010.  (4)10.2

Amendment to the Contribution Agreement by and between Arkson Nutraceuticals Corp. and Piper Acquisition III, Inc., dated November 23, 2010. (1)10.3

Form of Non-Competition, Non-Disclosure and Non-Solicitation Agreement by and between First Surgical Texas, Inc. (f/k/a Piper Acquisition III, Inc., a wholly owned subsidiary of the Company), and former limited partners or members of First Street Hospital, L.P., First Surgical Woodlands, L.P., First Street Surgical Center, L.P. and First Surgical Partners, L.L.C.(2)10.4

Form of Lock-Up Agreement by and between First Surgical Texas, Inc. (f/k/a Piper Acquisition III, Inc., a wholly owned subsidiary of the Company), and former limited partners or members of First Street Hospital, L.P., First Surgical Woodlands, L.P., First Street Surgical Center, L.P. and First Surgical Partners, L.L.C. (2)10.5

Form of Voting Agreement by and between First Surgical Texas, Inc. (f/k/a Piper Acquisition III, Inc., a wholly owned subsidiary of the Company), and former limited partners or members of First Street Hospital, L.P., First Surgical Woodlands, L.P., First Street Surgical Center, L.P. and First Surgical Partners, L.L.C. (2)





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10.6

Agreement entered by and between the Company and David Roff dated December 31, 2010(2)10.7

Lease Agreement for First Street Surgical Center, L.P. dated April 1, 2003 (4)10.8

Lease Agreement for First Street Hospital, L.P. dated September 17, 2006 (5)10.9

Bariatric Program Sponsorship Agreement by and between the Company and Vital Weight Control, Inc. d/b/a NeWeigh dated May 1, 2006 (4)10.10

Amendment to the Bariatric Program Sponsorship Agreement by and between the Company and Vital Weight Control, Inc. d/b/a NeWeigh dated February 13, 2008 (4)10.11

Amendment to the Bariatric Program Sponsorship Agreement by and between the Company and Vital Weight Control, Inc. d/b/a NeWeigh dated December 10, 2009 (4)10.12

Management Agreement by and between First Surgical Partners LLC and First Street Hospital LP (4)10.13

Management Agreement by and between First Surgical Partners LLC and First Surgical Woodlands L P (4)10.14

Termination Letter from Vital Weight Control Inc. to First Street Hospital LP dated January 30, 2009 (4)10.15

Reinstatement of Contract Agreement dated February 6, 2009 between Vital Weight Control Inc. and First Street Hospital LP (5)10.16*

Letter Agreement between Jacob Varon and First Surgical Partners Inc. dated June 1, 201121.1

List of Subsidiaries (4)31.1*

CEO Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 193431.2*

CFO Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 193432.1*

CEO and CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Act of 2002




*Filed herewith


(1)
Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on November 26, 2010


(2)
Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on January 6, 2011


(3)
Incorporated by reference to the Form 10 Registration Statement filed with the Securities and Exchange Commission on February 9, 2007


(4)
Incorporated by reference to the Form 10-K Annual Report filed with the Securities and Exchange Commission on April 15, 2011


(5)
Incorporated by reference to the Form 8-K/A Current Report filed with the Securities and Exchange Commission on August 1, 2011




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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.




FIRST SURGICAL PARTNERS INC.Date: August 15, 2011
/s/ Anthony F. RotondoName:
Anthony F. RotondoTitle:
President and Chief Executive Officer and Director(Principal Executive Officer)/s/ Don KnightName:
Don KnightTitle:
Vice President, Finance(Principal Financial Officer)




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