##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
   Form 10-K (Mark One) þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the
transition period from ______ to _____ Commission file number: 000-50574  Symbion, Inc.  Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
    
    62-1625480
(I.R.S. Employer
Identification No.)40 Burton Hills Boulevard, Suite 500
Nashville, Tennessee
(Address Of Principal Executive Offices)
    
    37215
(Zip Code)
 (615) 234-5900
 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value
(Title of Class)
    
    Preferred Stock Purchase Rights
(Title of Class)
 Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [   ]  No
[X] Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [   ]  No [X] There was no established public trading market for the registrants common
stock as of the last business day of the registrants most recently completed
second fiscal quarter. As of March 15, 2004, 20,669,241 shares of the registrants common stock
were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement for our annual meeting of
stockholders to be held on May 11, 2004 are incorporated by reference into Part
III of this report.




---

TABLE OF CONTENTS



|                                                  |                                                                                                                      |  |  |  |  |  |  | 
|------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                           
|                                                  | Item 1. Business                                                                                                    
|                                                  | Item 2. Properties                                                                                                  
|                                                  | Item 3. Legal Proceedings                                                                                           
|                                                  | Item 4. Submission of Matters to a Vote of Security Holders                                                         
|PART II                                          
|                                                  | Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|                                                  | Item 6. Selected Financial Data                                                                                     
|                                                  | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations                       
|                                                  | Item 7A. Quantitative and Qualitative Disclosures about Market Risk                                                 
|                                                  | Item 8. Financial Statements and Supplementary Data                                                                 
|                                                  | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                        
|                                                  | Item 9A. Controls and Procedures                                                                                    
|PART III                                         
|                                                  | Item 10. Directors and Executive Officers of the Registrant                                                         
|                                                  | Item 11. Executive Compensation                                                                                     
|                                                  | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters             
|                                                  | Item 13. Certain Relationships and Related Transactions                                                             
|                                                  | Item 14. Principal Accountant Fees and Services                                                                     
|PART IV                                          
|                                                  | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                                            
|REPORT OF INDEPENDENT AUDITORS                   
|CONSOLIDATED BALANCE SHEETS                      
|CONSOLIDATED STATEMENTS OF OPERATIONS            
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY  
|CONSOLIDATED STATEMENTS OF CASH FLOWS            
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|SIGNATURES                                       
|EXHIBIT INDEX                                    
|EX-3.3 CERTIFICATE OF RETIREMENT OF STOCK        
|EX-10.19 FIRST AMENDMENT TO LEASE AGREEMENT      
|EX-23.1 CONSENT OF ERNST & YOUNG LLP             
|EX-23.2 CONSENT OF CASUALTY ACTUARIAL CONSULTANTS
|EX-31.1 SECTION 302 CERTIFICATION OF THE CEO     
|EX-31.2 SECTION 302 CERTIFICATION OF THE CFO     
|EX-32.1 SECTION 906 CERTIFICATION OF THE CEO     
|EX-32.2 SECTION 906 CERTIFICATION OF THE CFO     



---



##### Table of Contents



Cautionary Note Regarding Forward-Looking Statements This Annual Report on Form 10-K contains some forward-looking statements,
which are based on our current expectations, estimates and assumptions about
future events. All statements other than statements of current or historical
fact contained in this report, including statements regarding our future
financial position, business strategy, budgets, projected costs and plans and
objectives of management for future operations, are forward-looking statements.
The words anticipate, believe, continue, estimate, expect, intend,
may, plan, will, and similar expressions are generally intended to
identify forward-looking statements. In particular, these include, among other
things, statements relating to:  
    
    our ability to attract and retain quality physicians;
    
    our ability to acquire and develop additional facilities on
favorable terms and to integrate their business operations;
    
    our ability to enter into strategic alliances with health care
systems and other health care providers that are leaders in their
markets;
    
    our ability to negotiate favorable contracts on behalf of our
facilities with managed care organizations or other third-party payors;
and
    
    our ability to enhance operating efficiencies. These forward-looking statements involve various risks and uncertainties,
some of which are beyond our control. Any or all of our forward-looking
statements in this report may turn out to be wrong. We have based these
forward-looking statements largely on our current expectations and projections
about future events and financial trends that we believe may affect our
financial condition, results of operations, business strategy and financial
needs. They can be affected by inaccurate assumptions we might make or by known
or unknown risks, uncertainties and assumptions, including the risks,
uncertainties and assumptions described in Managements Discussion and
Analysis of Financial Condition and Results of Operations  Risk Factors. In light of these risks, uncertainties and assumptions, the
forward-looking events and circumstances discussed in this report may not occur
and actual results could differ materially from those anticipated or implied in
the forward-looking statements. When you consider these forward-looking
statements, you should keep in mind these risk factors and other cautionary
statements in this report. Our forward-looking statements speak only as of the date made. Other than
as required by law, we undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. 
 PART I 
 Item 1.Business Overview We own and operate a network of surgery centers in 19 states. Our surgery
centers provide non-emergency surgical procedures across many specialties. We
offer services designed to meet the health care needs of the communities in
which we operate and seek to develop strong relationships with physicians and
other health care providers in these markets. We also believe that one of our
competitive advantages is the experience of our senior management team, with
four of our executive officers having an average of over 25 years of experience
in the health care industry, including senior management positions at public
and private health care companies. The remaining six members of our senior
management team have an average of over 20 years of experience in the health
care industry. As of March 15, 2004, we owned and operated 36 surgery centers
and managed eight additional surgery centers. Our surgery centers include three
facilities that are licensed as hospitals, two of which we own and one of which
we 1




---



##### Table of Contents



manage. In addition to our surgery centers, we also operate a diagnostic
center and manage three physician networks, including two physician networks in
markets in which we operate surgery centers. Surgery Center Industry Outpatient surgery has experienced tremendous growth since 1970, when the
first surgery center opened in the United States, according to Verispan,
L.L.C., an independent health care market research and information firm.
Surgery centers are facilities where physicians can perform surgical procedures
that generally do not require the patient to stay overnight. According to
Verispan, about 3,644 outpatient surgery centers were operating in the United
States as of February 2003, an increase of more than 50% since 1996. Based on
data compiled by Verispan, the number of outpatient surgery cases performed
annually in U.S. outpatient surgery centers increased from an estimated 4.3
million in 1996 to an estimated 7.8 million in 2003, representing a compound
annual growth rate of about 9%. We believe that the following factors have contributed to the growth in
surgery centers and outpatient surgical procedures:  
    
    Physician and Patient Preference for Surgery Centers.Physicians
often prefer to operate in surgery centers, as compared to acute care
hospitals, because of the efficiency and convenience that surgery
centers afford. Procedures performed at surgery centers are typically
non-emergency, so physicians can schedule their time more efficiently
and increase the number of procedures that they can perform in a given
period. Surgery centers also provide physicians with greater scheduling
flexibility, more consistent nurse staffing and faster turnaround time
between cases, as compared to acute care hospitals. In addition, we
believe patients prefer the comfort of a less institutional setting and
the more convenient process for scheduling and registration available in
surgery centers, as compared to acute care hospitals.
    
    Lower Cost Alternative.Based upon our managements experience in
the health care industry, we believe that surgeries performed in surgery
centers are generally less expensive than those performed in acute care
hospitals because of lower facility development costs, the focus on
non-emergency procedures and more efficient staffing and work flow
processes. We believe that cost-conscious payors are attracted to the
lower costs afforded by surgery centers, as compared to acute care
hospitals.
    
    Advanced Technology and Improved Anesthesia.Advancements in medical
technology such as lasers, arthroscopy, fiber optics and enhanced
endoscopic techniques have reduced the trauma of surgery and the amount
of recovery time required by patients following a surgical procedure.
Improvements in anesthesia also have shortened the recovery time for
many patients and have reduced post-operative side effects such as pain,
nausea and drowsiness. These medical advancements have enabled more
patients to undergo surgery without an overnight stay and reduced the
need for hospitalization following surgery. With an estimated 3,644 outpatient surgery centers operating in the United
States as of February 2003, we believe significant opportunities exist for
consolidation in this industry. The four largest national operators of
outpatient surgery centers by number of centers represented an aggregate of
less than 15% of the total number of outpatient surgery centers in the United
States as of February 2003, according to Verispan. We believe that the surgery
center industry will continue to consolidate because of the increasing
complexity of the regulatory and managerial aspects of health care delivery,
the growing influence of managed care, the rising cost of technology and the
need for capital. We believe there are many surgery centers that are seeking to
affiliate with experienced operators of facilities with access to capital,
management expertise and other resources. Our Strategy We intend to expand our network of surgery centers in attractive markets
throughout the United States by acquiring established centers and developing
new centers while enhancing the performance of our existing centers. We also
seek to provide patients with high-quality surgical services across many
specialties. When attractive opportunities arise, we may acquire or develop
other types of facilities, including diagnostic centers. The key components of
our strategy are to: 2




---



##### Table of Contents




    
    Identify, recruit and retain leading surgeons and other physicians
for our surgery centers.We believe that establishing and maintaining
strong relationships with surgeons and other physicians is a key factor
to our success in acquiring, developing and operating surgery centers.
We identify and partner with surgeons and other physicians that we
believe have established reputations for clinical excellence in their
communities. We believe that we have had success in recruiting and
retaining physicians because of the ownership structure of our surgery
centers and our staffing, scheduling and clinical systems that are
designed to increase physician productivity, promote physicians
professional success and enhance the quality of patient care. We also
believe that forming relationships with medical centers or health care
systems can enhance our ability to recruit physicians. We currently have
strategic relationships with six health care systems.  
    
    Capitalize on our experienced management team to pursue multiple
growth opportunities in the surgery center market.We believe that the
experience and capabilities of our senior management team provides a
strategic advantage in improving the operations of our surgery centers,
attracting physicians and identifying new development and acquisition
opportunities. Four of our executive officers have an average of over 25
years of experience in the health care industry, including senior
management positions at public and private health care companies. The
remaining six members of our senior management team have an average of
over 20 years of experience in the health care industry. Our
managements broad industry experience has allowed them to establish
strong relationships with participants throughout the health care
industry. These relationships are helpful in forming leads for
acquisitions, and in making decisions about expanding into new markets
and services. The experience and capabilities of our management team
also enable us to pursue multiple growth strategies in the surgery
center market, including acquisitions of established surgery centers, de
novo developments in attractive markets, strategic relationships with
prominent hospitals and other health care providers and turnaround
opportunities in connection with underperforming facilities. We have
successfully executed each of these growth strategies, and intend to
pursue each of them in the future.  
    
    Pursue a disciplined strategy of acquiring and developing surgery
centers.Since January 1999, we have acquired 28 surgery centers and
developed 11 surgery centers, including three surgery centers that we
subsequently divested. We anticipate acquiring about two to three
centers and developing three to four centers annually during the next
three to five years. We seek to acquire and develop both single and
multi-specialty surgery centers that meet our criteria, including
prominence and quality of physician partners, specialty mix,
opportunities for growth, level of competition in the local market,
level of managed care penetration and our ability to access managed care
organizations. Our acquisition and development team conducts extensive
due diligence and applies a financial model that targets a threshold
return on invested capital over a period of five years. Once we acquire
a surgery center, our team establishes a strategic plan to improve the
centers operating systems, physician recruitment and facilities, and
capitalize on the centers competitive strengths. We have historically
targeted majority ownership in our facilities and currently hold
majority ownership interests in over 70% of the surgery centers in which
we own an interest. We believe majority ownership allows us to make and
execute managerial decisions at our facilities that provide greater
opportunity for growth and higher returns. We also believe that by
starting with majority ownership of a center, we can benefit by
capturing a greater share of the value we create in managing and
improving the center. We intend to continue to target majority ownership
in our facilities. However, when attractive opportunities arise, we may
acquire minority interests in surgery centers.  
    
    Increase revenues and profitability of existing surgery centers
through operational focus.We seek to increase revenues, profitability
and return on our invested capital at all of our centers by focusing on
operations. We have a dedicated team that is responsible for
implementing best practices, cost controls and overall efficiencies at
each of our surgery centers. Our centers benefit from our network of
facilities by sharing best practices and participating in group
purchasing agreements designed to reduce the cost of supplies and
equipment. We intend to continue to recruit additional physicians and
expand the range of services offered at our surgery centers to increase
the number and types of surgeries performed in our centers. We are
committed to enhancing programs and services for our physicians and
patients by providing advanced technology, quality care, cost-effective
service and convenience. 3




---



##### Table of Contents



Operations Surgery Center Operations As of March 15, 2004, we owned and operated 36 surgery centers and managed
eight surgery centers. Three of our facilities are licensed as hospitals, two
of which we own and one of which we manage. Our typical surgery center is a
freestanding facility with about 14,000 square feet of space and four fully
equipped operating rooms, two treatment rooms and ancillary areas for
preparation, recovery, reception and administration. Our surgery centers
provide non-emergency surgical procedures among many specialties, including
orthopedic, obstetrics/gynecology, general surgery, ear, nose and throat, pain
management, gastrointestinal, plastic surgery and ophthalmology. Our surgery
centers that are licensed as hospitals may also provide additional services
such as diagnostic imaging, pharmacy, laboratory and obstetrical services and
can accommodate overnight stays. In certain markets where we believe it is
appropriate, we operate surgery centers that focus on a single specialty. Our surgery centers are generally located in proximity to physicians
offices. Each facility typically employs a staff of about 30, depending on its
size, the number of cases and the type of services provided. Our staff at each
center generally includes a center administrator, a business manager, a medical
director, registered nurses, operating room technicians and clerical workers.
At each of our surgery centers, we have arrangements with anesthesiologists to
provide anesthesiology services. We also provide each of our surgery centers
with a full range of financial, marketing and operating services. For example,
our regional managed care directors assist the local management team at each of
our centers in developing relationships with managed care providers and
negotiating managed care contracts. All of our surgery centers are Medicare certified. To ensure that a high
level of care is provided, we implement quality assurance procedures at each of
our surgery centers. Each of our surgery centers is available for use only by
licensed physicians who have met professional credentialing requirements
established by the centers medical advisory committee. In addition, each
centers medical director supervises and is responsible for the quality of
medical care provided at the center. Surgery Center Ownership Structure We own and operate our surgery centers through limited partnerships or
limited liability companies. Local physicians or physician groups also own an
interest in most of our surgery centers. In some cases, a hospital may own an
interest in our surgery center. One of our wholly-owned subsidiaries typically
serves as the general partner or majority member of our surgery centers. We
generally own a majority interest in our surgery centers, or otherwise have
sufficient control over the centers to be able to consolidate the financial
results of operations of the centers with ours. In some instances, we will
acquire an ownership interest in a surgery center with the prior owners
retaining an ownership interest, and, in some cases, we offer new ownership
interests to other physicians or hospital partners. We own a majority interest
in 26 of the 36 surgery centers in which we own an interest. We typically
guarantee all of the debts of these limited partnerships and limited liability
companies, even though we do not own all of the ownership interests in the
surgery centers. We also have a management arrangement with each of the surgery
centers, under which we provide day-to-day management services for a management
fee, which is typically based on a percentage of the revenues of the center. Each of the limited partnerships and limited liability companies through
which we own and operate our surgery centers are governed by a partnership or
operating agreement. These partnership and operating agreements typically
provide, among other things, for voting rights and limited transfer of
ownership interests. The partnership and operating agreements also provide for
the distribution of available cash to the owners, in some cases on a quarterly
basis. In addition, the agreements typically restrict the physician owners from
owning an interest in a competing surgery center during the period in which the
physician owns an interest in our center and for one year after that period.
The partnership and operating agreements for our centers typically provide that
the centers will purchase all of the physicians ownership interests if certain
adverse regulatory events occur, such as it becoming illegal for the physicians
to own an interest in a surgery center, refer patients to a center or receive
cash distributions from a surgery center. The purchase price that we would be
required to pay for these ownership interests is based on pre-determined
formulas, typically either a multiple of the centers EBITDA (defined as
operating income (loss) plus depreciation and amortization) or the fair market
value of the ownership interests as determined by a third-party 4




---



##### Table of Contents



appraisal. Some of these agreements require us to make a good faith effort
to restructure our relationships with the physician investors in a manner that
preserves the economic terms of the relationship prior to purchasing these
interests. See Managements Discussion and Analysis of Financial Condition and
Results of Operations  Risk Factors and  Government Regulation. In certain
circumstances, we have the right to purchase a physicians ownership interests,
including upon a physicians breach of the noncompetition provisions of a
partnership or operating agreement. In some cases, we have the right to require
the physician owners to purchase our ownership interest in the event our
management agreement with a center is terminated. In one center, the physician
owners have the right to purchase our ownership interest upon a change in our
control and, in another center, a hospital investor has the right to require us
to repurchase its interest in the center. We currently manage six surgery centers without owning an interest in them
through a strategic alliance with a hospital system located in the Memphis,
Tennessee area. We also manage a surgery center licensed as a hospital located
in Kansas City, Kansas in which we have no ownership interest. In addition, we
own an interest in a limited liability company which assisted in the
development of a surgery center in Lynbrook, New York and which provides
administrative services to the surgery center. Surgery Centers The following table sets forth information regarding each of our surgery
centers as of March 15, 2004: Number of
    
    
    
    
    
    SymbionOperating
    
    Number of
    
    PercentageFacility
    
    City
    
    Rooms
    
    Treatment Rooms
    
    OwnershipColoradoDry Creek Surgery Center
    
    Denver
    
    
    4
    
    
    
    2
    
    
    
    51
    %(1)FloridaDeland Surgery Center
    
    Deland
    
    
    3
    
    
    
    2
    
    
    
    79
    %(1)West Bay Surgery Center
    
    Largo
    
    
    4
    
    
    
    3
    
    
    
    51
    %(1)Jacksonville Beach Surgery Center
    
    Jacksonville
    
    
    3
    
    
    
    2
    
    
    
    86
    %(1)Lee Island Coast Surgery Center
    
    Fort Myers
    
    
    5
    
    
    
    3
    
    
    
    51
    %(1)Orlando Surgery Center
    
    Orlando
    
    
    5
    
    
    1 minor procedure room
    
    
    56
    %(1)Tampa Bay Regional Surgery Center
    
    Largo
    
    
    1
    
    
    
    2
    
    
    
    51
    %(1)The Surgery Center of Ocala
    
    Ocala
    
    
    4
    
    
    
    2
    
    
    
    51
    %(1)GeorgiaPremier Surgery Center
    
    Brunswick
    
    
    3
    
    
    
    1
    
    
    
    51
    %(1)The Surgery Center
    
    Columbus
    
    
    4
    
    
    
    2
    
    
    
    74
    %(1)IndianaVincennes Surgery Center
    
    Vincennes
    
    
    2
    
    
    
    
    
    
    
    51
    %(1)KansasHeartland Specialty Surgical Hospital(2)
    
    Kansas City
    
    
    7
    
    
    
    3

    
    
    
    (3)19 hospital roomsKentuckyDuPont Surgery Center
    
    Louisville
    
    
    5
    
    
    
    
    
    
    
    61
    %(1)LouisianaGreater New Orleans Surgery Center
    
    Metairie
    
    
    2
    
    
    
    
    
    
    
    30
    %(1)Physicians Surgical Specialty Hospital(2)
    
    Houma
    
    
    4
    
    
    
    4
    
    
    
    56
    %(1)10 hospital roomsMassachusettsWorcester Surgery Center
    
    Worcester
    
    
    4
    
    
    1 minor procedure room
    
    
    77
    %(1)Worcester ENT
    
    Worcester
    
    
    1
    
    
    
    
    
    
    
    51
    %(1)MissouriCentral Missouri Medical Park Surgical
Center
    
    Jefferson City
    
    
    4
    
    
    
    2
    
    
    
    58
    %(1)MississippiPhysicians Outpatient Center
    
    Oxford
    
    
    4
    
    
    
    2
    
    
    
    
    (3)New YorkSouth Shore Ambulatory Surgery Center
    
    Lynbrook
    
    
    3
    
    
    
    1
    
    
    
    
    (4)
 5




---



##### Table of Contents



Number of
    
    
    
    
    
    SymbionOperating
    
    Number of
    
    PercentageFacility
    
    City
    
    Rooms
    
    Treatment Rooms
    
    OwnershipNorth CarolinaOrthopaedic Surgery Center of Asheville
    
    Asheville
    
    
    3
    
    
    
    
    
    
    
    63
    %(1)Wilmington SurgCare
    
    Wilmington
    
    
    6
    
    
    4 minor procedure rooms
    
    
    100
    %(1)OhioPhysicians Ambulatory Surgery Center
    
    Circleville
    
    
    2
    
    
    
    4
    
    
    
    76
    %(1)OklahomaLakeside Womens Hospital(2)
    
    Oklahoma City
    
    
    3
    
    
    16 hospital rooms
    
    
    42
    %Surgery Center of Edmond
    
    Edmond
    
    
    4
    
    
    
    
    
    
    
    40
    %(1)PennsylvaniaVillage SurgiCenter
    
    Erie
    
    
    5
    
    
    
    1
    
    
    
    82
    %(1)Rhode IslandBayside Endoscopy Center
    
    Providence
    
    
    
    
    
    
    6
    
    
    
    75
    %(1)TennesseeBaptist Germantown Surgery Center
    
    Memphis
    
    
    6
    
    
    
    1
    
    
    
    
    (3)3 overnight roomsMaury Regional Surgery Center
    
    Columbia
    
    
    2
    
    
    
    1
    
    
    
    35
    %Cool Springs Surgery Center
    
    Franklin
    
    
    4
    
    
    
    1
    
    
    
    44
    %1 overnight roomEast Memphis Surgery Center
    
    Memphis
    
    
    6
    
    
    
    1
    
    
    
    
    (3)4 overnight roomsMidtown Surgery Center
    
    Memphis
    
    
    6
    
    
    
    
    
    
    
    
    (3)Union City Center
    
    Union City
    
    
    2
    
    
    
    1
    
    
    
    
    (3)UroCenter
    
    Memphis
    
    
    3
    
    
    
    1
    
    
    
    
    (3)University Ambulatory Surgical Center
    
    Knoxville
    
    
    4
    
    
    
    1
    
    
    
    25
    %2 overnight roomsTexasCentral Park Surgery Center
    
    Austin
    
    
    5
    
    
    
    1
    
    
    
    61
    %(1)Clear Fork Surgery Center
    
    Fort Worth
    
    
    3
    
    
    
    1
    
    
    
    38
    %(1)East Houston Surgery Center
    
    Houston
    
    
    4
    
    
    
    2
    
    
    
    62
    %(1)Northeast Baptist Surgery Center
    
    San Antonio
    
    
    4
    
    
    
    3
    
    
    
    52
    %(1)NorthStar Surgical Center
    
    Lubbock
    
    
    5
    
    
    
    4
    
    
    
    44
    %(1)2 overnight roomsPhysicians SurgiCenter of Houston
    
    Houston
    
    
    5
    
    
    
    2
    
    
    
    38
    %(1)3 overnight roomsSurgery Center of Duncanville
    
    Duncanville
    
    
    4
    
    
    
    
    
    
    
    41
    %(1)Texarkana Surgery Center
    
    Texarkana
    
    
    4
    
    
    
    3
    
    
    
    66
    %(1)WashingtonBellingham Surgery Center
    
    Bellingham
    
    
    4
    
    
    
    
    
    
    
    100
    %(1)
   (1)
    
    We consolidate these surgery centers for financial reporting purposes.(2)
    
    This facility is licensed as a hospital.(3)
    
    We manage these facilities, but do not have an ownership interest in
them.(4)
    
    We hold a 57% ownership interest in the limited liability company which
provides administrative services to this surgery center. Due to regulatory
restrictions in the State of New York, we cannot directly own an interest
in the facility. 6




---



##### Table of Contents



Case Mix The following table sets forth the percentage of cases in each specialty
performed in 2003 at surgery centers in which we owned an interest as of
December 31, 2003: Year EndedDecember 31, 2003SpecialtyEar, nose and throat
    
    
    8
    %Gastrointestinal
    
    
    16General surgery
    
    
    6Obstetrics/gynecology
    
    
    4Ophthalmology
    
    
    14Orthopedic
    
    
    20Pain management
    
    
    17Plastic surgery
    
    
    4Other
    
    
    11Total
    
    
    100
    %
 Payor Mix The following table sets forth by type of payor the percentage of our
patient service revenues generated in 2003 for surgery centers in which we
owned an interest as of December 31, 2003: Year EndedDecember 31, 2003PayorPrivate Insurance
    
    
    76
    %Government
    
    
    19Self-pay
    
    
    3Other
    
    
    2Total
    
    
    100
    %
 Strategic Relationships When attractive opportunities arise, we may develop, acquire or operate
surgery centers through strategic alliances with health care systems and other
health care providers. We believe that forming a relationship with a medical
center can enhance our ability to recruit physicians and access managed care
contracts for our facilities in that market. We currently have strategic
relationships with:  
    
    Vanderbilt Health Services, Inc., with which we own and operate a surgery center in Franklin, Tennessee;
    
    Vanguard Health Systems, Inc., with which we own and operate a surgery center in San Antonio, Texas;
    
    Baptist Memorial Health Services, Inc., for which we manage six
surgery centers in Memphis, Tennessee and surrounding areas;
    
    University Health System, Inc., with which we own and operate a surgery center in Knoxville, Tennessee;
    
    Harris Methodist Ft. Worth, with which we own and operate a surgery center in Fort Worth, Texas; and
    
    Memorial Hermann Hospital, with which we own and operate a surgery center in Houston, Texas. The strategic relationships through which we own and operate surgery
centers are governed by partnership and operating agreements that are generally
comparable to the partnership and operating agreements of the other surgery
centers in which we own an interest. The primary difference between the
structure of these strategic relationships and the other surgery centers in
which we own an interest is that, in the strategic relationships, a health care
system holds an ownership interest in the surgery center, in addition to
physician investors. For a general description of the 7




---



##### Table of Contents



terms of our partnership and operating agreements, see  Operations 
Surgery Center Ownership Structure. In each of these strategic relationships,
we have also entered into a management agreement under which we provide
day-to-day management services for a management fee based on a percentage of
the revenues of the surgery center. The terms of those management agreements
are comparable to the terms of our management agreements with other surgery
centers in which we own an interest. We manage six surgery centers owned by Baptist Memorial Health Services,
Inc. under management agreements with Baptist Memorial, in exchange for a
management fee based on a percentage of the revenues of these surgery centers.
The management agreements terminate on various dates from
June 2004 to March
2006 and may be terminated earlier by either party for material breach after
notice and an opportunity to cure. We have also entered into a development
agreement with Baptist Memorial under which we are to provide development
support for new surgery centers that may be developed by Baptist Memorial in
exchange for a development fee negotiated for each developed center. Acquisition and Development of Surgery Centers We intend to expand our presence in the surgery center market by making
strategic acquisitions of existing surgery centers and by developing new
surgery centers in cooperation with local physician partners and, when
appropriate, with hospitals and other strategic partners. Acquisition Program.We employ a dedicated acquisition team with
experience in health care services. Our team seeks to acquire surgery centers
that meet our criteria, including prominence and quality of physician partners,
specialty mix, opportunities for growth, level of competition in the local
market, level of managed care penetration and our ability to access managed
care organizations. Our team utilizes their extensive industry contacts, as
well as referrals from current physician partners and other sources, to
identify, contact and develop potential acquisition candidates. We believe there are numerous acquisition opportunities that would pass
our general screening criteria. We carefully evaluate each of our acquisition
opportunities through an extensive due diligence process to determine which
facilities have the greatest potential for growth and profitability
improvements under our operating structure. In many cases, the acquisition team
identifies specific opportunities to enhance a centers productivity
post-acquisition. For example, we may renovate or construct additional
operating or treatment rooms in existing facilities to meet anticipated demand
for procedures based on analysis of local market characteristics. Our team may
also identify opportunities to recruit additional physicians to increase the
acquired facilitys revenues and profitability. Once we decide to proceed with
an acquisition proposal, we use a pricing strategy that targets a threshold
return on invested capital over a period of five years. We have acquired 28
surgery centers since January 1999 and anticipate acquiring about two to three
centers annually during the next three to five years. Development Program.We develop surgery centers in markets in which we
anticipate substantial interest by physicians and payors. We have experience in
developing both single and multi-specialty surgery centers. When we develop a
new surgery center, we generally provide all of the services necessary to
complete the project. We offer in-house capabilities for structuring
partnerships and financing facilities and work with architects and construction
firms in the design and development of facilities. Before and during the
development phase of a new center, we analyze the competitive environment in
the local market, review market data to identify appropriate services to
provide, prepare and analyze financial forecasts, evaluate regulatory and
licensing issues and assist in designing the center and identifying appropriate
equipment to purchase or lease. After the surgery center is developed, we
generally provide startup operational support, including information systems,
equipment procurement and financing. We have developed 11 surgery centers since
January 1999 and anticipate developing about three to four centers annually
during the next three to five years. Development and construction of a surgery center generally takes us from
12 to 18 months, depending on whether we are building the facility or improving
available space. Estimated construction costs generally total from $1.0 million
to $2.0 million for improving existing space. Equipment and other furnishing
costs generally range from $900,000 to $2.5 million. In addition, working
capital of approximately $1.0 million to $1.5 million is generally required to
sustain operations for the initial six to 12 months of operations. We
historically finance these costs through capital contributions from investors
in the center, borrowings under our facility loan agreements and 8




---



##### Table of Contents



long-term facility lease agreements. We expect to finance these costs in
the future with borrowings under our senior credit facility in addition to
capital contributions from investors in the centers. See Managements
Discussion and Analysis of Financial Condition and Results of Operations. Other Services Although our business is primarily focused on owning and operating surgery
centers, we also provide other services that complement our core surgery center
business. Diagnostic Centers We operate Dry Creek Imaging Center, a diagnostic imaging center that is
adjacent to our surgery center in the Denver, Colorado market. We own a 90%
interest in the diagnostic imaging center through a joint venture with
Touchstone Medical Imaging, LLC. Dry Creek Imaging Center currently provides
MRI, CT, ultrasound and mammography procedures. Touchstone and Dry Creek
Imaging Center have entered into a management agreement, under which Touchstone
provides daily management and administrative services to the diagnostic center
in exchange for a percentage of the diagnostic centers net revenues. The
initial term of the management agreement expires in 2006, and may be renewed
for additional renewal terms of one year each. We believe the services provided
by this diagnostic center complement and support the services provided by our
surgery center in this market. On December 22, 2003, we entered into a joint venture with Touchstone to
develop a diagnostic imaging center in Erie, Pennsylvania adjacent to our
surgery center in this market. We own a 51% interest in the joint venture
formed to develop, own and operate the center. We anticipate that the
diagnostic imaging center will begin operations in the third quarter of 2004.
The joint venture has entered into a management agreement with Touchstone,
under which Touchstone will provide daily management and administrative
services to the diagnostic center in exchange for a percentage of the
diagnostic centers net revenues. The initial term of the management agreement
expires on December 19, 2008 and may be renewed for additional renewal terms of
one year each. After December 19, 2005, either party to the management
agreement has the right to terminate the management agreement. In the event
that we terminate the management agreement without cause, Touchstone has the
right to require us to repurchase its ownership interest in the joint venture.
We believe the services provided by this diagnostic center will complement and
support the services provided by our surgery center in this market. We may
explore the possibility of selectively purchasing and developing additional
diagnostic centers in the markets in which we operate surgery centers. Physician Networks We currently manage physician networks in Memphis, Tennessee, Johnson
City, Tennessee and Louisville, Kentucky. Each of these physician networks has
entered into a long-term agreement with us, which provides, among other things,
that we will provide billing, financial services and other business management
services in exchange for a management fee. One of the physician networks is an
independent practice association, or IPA, of health care providers located in
the greater Louisville, Kentucky area. We believe this network is complementary
to our local surgery center by providing the center with greater access to
managed care contracts. Information Systems and Controls Each of our surgery centers uses a standard financial reporting system
that provides information to our corporate office to track financial
performance on a timely basis. In addition, each of our facilities uses an
operating system to manage its business by providing critical support in areas
such as scheduling, billing and collection, accounts receivable management,
purchasing and other essential operational functions. We have implemented a
standardized system to support all of our facilities and to enable us to access
more easily information about our centers on a timely basis. The new
information system has been installed in all of our surgery centers, except for
those facilities we acquired in our acquisition of Physicians Surgical Care,
Inc. in April 2002. The Physicians Surgical Care facilities operate on a
different standardized system provided by the same vendor that provides our
information system. We are currently working with this vendor to integrate the
two systems at a later date. 9




---



##### Table of Contents



We calculate net revenues through a combination of manual and
system-generated processes. Our operating systems include insurance modules
that allow us to establish profiles of insurance plans and their respective
payment rates. The systems then match the charges with the insurance plan rates
and compute a contractual adjustment estimate for each patient account. We then
manually review the reasonableness of the systems contractual adjustment
estimate using the insurance profiles. This estimate is adjusted, if needed,
when the insurance payment is received and posted to the account. Net revenue
is computed and reported by the systems as a result of this activity. It is our policy to collect co-payments and deductibles prior to providing
services. It is also our policy to verify a patients insurance 72 hours prior
to the patients procedure. Because our services are non-emergency, our
facilities have the ability to control these processes. We do not track
exceptions to these policies, but we believe that they occur infrequently and
involve insignificant amounts. When they do occur, we require patients whose
insurance coverage is not verified to assume full responsibility for the fees
prior to services being rendered and we seek prompt payment of co-payments and
deductibles and verification of insurance following the procedure. We manually input each patients account record and the associated billing
codes. Our operating systems then calculate the amount of fees for that patient
and the amount of the contractual adjustments. Claims are submitted
electronically if the payor accepts electronic claims. We use clearinghouses
for electronic claims, which then forward the claims to the respective payors.
Payments are manually input to the respective patient accounts. We have developed proprietary measurement tools to track key operating
statistics at each of our surgery centers by integrating data from our local
operating systems and our standardized financial system. Management uses these
tools to measure operating results against target thresholds and to identify,
monitor and adjust areas such as specialty mix, staffing, operating costs,
employee expenses and accounts receivable management. Our corporate and
facility-level management team is compensated in part using performance-based
incentives focused on revenue growth and improvement in operating income. Marketing Our sales and marketing efforts are directed primarily at physicians, who
are responsible for referring patients to our facilities. Marketing activities
directed at physicians and other health care providers are coordinated locally
by the individual facility and are supplemented by dedicated corporate
personnel. These activities generally emphasize the benefits offered by our
surgery centers compared to other facilities in the market, such as the
proximity of our facilities to physicians offices, the ability to schedule
consecutive cases without preemption by inpatient or emergency procedures, the
efficient turnaround time between cases, our advanced surgical equipment and
our simplified administrative procedures. Although the facility administrator
is the primary point of contact, physicians who utilize our surgery centers are
important sources of recommendations to other physicians regarding the benefits
of using our facilities. Each facility administrator develops a target list of
physicians and we continually review these marketing lists and the facility
administrators progress in contacting and successfully attracting additional
local physicians. We also market our surgery centers directly to payors, including HMOs,
PPOs and other managed care organizations, employers and other payors. Payor
marketing activities conducted by our corporate office management and facility
administrators emphasize the high quality of care, cost advantages and
convenience of our facilities, and are focused on making each facility an
approved provider under local managed care plans. Competition In each market in which we operate a surgery center, we compete with
hospitals and operators of other surgery centers to attract physicians and
patients. We believe that the competitive factors that affect our centers
ability to compete for physicians are convenience of location of the surgery
center, access to capital and participation in managed care programs. We
believe that our centers attract patients based upon our quality of care, the
specialties and reputations of the physicians who operate in our centers,
participation in managed care programs, ease of access and convenient
scheduling and registration procedures. 10




---



##### Table of Contents



In developing or acquiring existing surgery centers, we compete with other
public and private surgery center and hospital companies. Several large
national companies own and/or manage surgery centers and surgical hospitals,
including HEALTHSOUTH Corporation, HCA Inc., Universal Health Services, Inc.,
AmSurg Corp. and United Surgical Partners International, Inc. In general, these
companies have greater resources and access to capital than we do. In addition,
local hospitals, physician groups and other providers may compete with us in
the ownership and operation of surgery centers. Employees At December 31, 2003, we had about 2,000 employees, of which about 1,300
were full-time employees. None of our employees are represented by a collective
bargaining agreement. We believe that we have a good relationship with our
employees. Environmental We are subject to various federal, state and local laws and regulations
relating to the protection of the environment and human health and safety,
including those governing the management and disposal of hazardous substances
and wastes, the cleanup of contaminated sites and the maintenance of a safe
workplace. Our operations include the use, generation and disposal of hazardous
materials. We may, in the future, incur liability under environmental statutes
and regulations with respect to contamination of sites we own or operate
(including contamination caused by prior owners or operators of such sites,
abutters or other persons) and the off-site disposal of hazardous substances.
We believe that we have been and are in substantial compliance with the terms
of all applicable environmental laws and regulations and that we have no
liabilities under environmental requirements that we would expect to have a
material adverse effect on our business, results of operations or financial
condition. Insurance We maintain liability insurance in amounts that we believe are appropriate
for our operations. Currently, we maintain professional and general liability
insurance that provides coverage on a claims made basis of $1.0 million per
occurrence and $3.0 million in annual aggregate coverage per facility. We also
maintain business interruption insurance and property damage insurance, as well
as an additional umbrella liability insurance policy in the aggregate amount of
$10.0 million. Coverage under certain of these policies is contingent upon the
policy being in effect when a claim is made regardless of when the events which
caused the claim occurred. The cost and availability of such coverage has
varied widely in recent years. While we believe that our insurance policies are
adequate in amount and coverage for our anticipated operation, we cannot assure
you that the insurance coverage is sufficient to cover all future claims or
will continue to be available in adequate amounts or at a reasonable cost. Government Regulation General The health care industry is highly regulated, and we cannot assure you
that the regulatory environment in which we operate will not change
significantly in the future or that we will be able to successfully address
changes in the regulatory environment. In addition to extensive, existing
government health care regulation, there continues to be numerous initiatives
on the federal and state levels affecting the payment for and availability of
health care services. We believe that these health care initiatives will
continue during the foreseeable future. Some of the reform initiatives proposed
in the past, such as further reductions in Medicare and Medicaid payments and
additional prohibitions on physician ownership of facilities to which they
refer patients, could, if adopted, adversely affect us and our business. Every state imposes licensing requirements on individual physicians and
health care facilities. In addition, federal and state laws regulate HMOs and
other managed care organizations. Many states require regulatory approval,
including certificates of need, before establishing certain types of health
care facilities, including surgery centers, offering certain services,
including services we offer, or making expenditures in excess of statutory
thresholds for health care equipment, facilities or programs. We believe that
outpatient surgery and diagnostic services will continue to be subject to
intense regulation at the federal and state levels. 11




---



##### Table of Contents



Our ability to operate profitably will depend in part upon all of our
facilities obtaining and maintaining all necessary licenses, certificates of
need and other approvals and operating in compliance with applicable health
care regulations. If we fail to obtain any necessary licenses or certifications
or fail to maintain our existing licenses and certifications it could have a
material adverse effect on our business. The laws of many states prohibit physicians from splitting fees with
non-physicians, prohibit non-physician entities (such as us) from practicing
medicine and prohibit referrals to facilities in which physicians have a
financial interest. We believe our activities do not violate these state laws;
however, we cannot assure you that future interpretations of, or changes in,
these laws might require structural and organizational modifications of our
existing relationships with facilities and physician networks, and we cannot
assure you that we would be able to appropriately modify such relationships. In
addition, statutes in some states could restrict our expansion into those
states. Our facilities are subject to federal, state and local laws dealing with
issues such as occupational safety, employment, medical leave, insurance
regulations, civil rights, discrimination, building codes, and medical waste
and other environmental issues. Federal, state and local governments are
expanding the regulatory requirements on businesses. The imposition of these
regulatory requirements may have the effect of increasing operating costs and
reducing the profitability of our operations. We are unable to predict what additional government regulations, if any,
affecting our business may be enacted in the future or how existing or future
laws and regulations might be interpreted. If we or any of our facilities fail
to comply with applicable laws, it might have a material adverse effect on our
business. Licensure and Certificates of Need Capital expenditures for the construction of new facilities, the addition
of beds or the acquisition of existing facilities may be reviewable by state
regulators under statutory schemes that are sometimes referred to as
certificate of need laws. States with certificate of need laws place limits on
the construction and acquisition of health care facilities and the expansion of
existing facilities and services. In these states, approvals are required for
capital expenditures exceeding amounts that involve certain facilities or
services, including surgery centers. State certificate of need laws generally provide that, prior to the
addition of new beds, the construction of new facilities or the introduction of
new services, a designated state health planning agency must determine that a
need exists for those beds, facilities or services. The certificate of need
process is intended to promote comprehensive health care planning, assist in
providing high quality health care at the lowest possible cost and avoid
unnecessary duplication by ensuring that only those health care facilities that
are needed will be built. Typically, the provider of services submits an application to the
appropriate agency with information concerning the area and population to be
served, the anticipated demand for the facility or service to be provided, the
amount of capital expenditure, the estimated annual operating costs, the
relationship of the proposed facility or service to the overall state health
plan and the cost per patient day for the type of care contemplated. The
issuance of a certificate of need is based upon a finding of need by the agency
in accordance with criteria set forth in certificate of need laws and state and
regional health facilities plans. If the proposed facility or service is found
to be necessary and the applicant to be the appropriate provider, the agency
will issue a certificate of need containing a maximum amount of expenditure and
a specific time period for the holder of the certificate of need to implement
the approved project. Our health care facilities are also subject to state licensing
requirements for medical providers. Our surgery centers have licenses to
operate as ambulatory surgery centers in the states in which they operate,
except for one facility in Kansas, one facility in Louisiana and one facility
in Oklahoma that are licensed as hospitals. Even though these facilities
licensed as hospitals provide surgical services, they must meet all applicable
requirements for general hospital licensure. Our surgery centers that are
licensed as ambulatory surgery centers must meet all applicable requirements
for ambulatory surgery centers. To assure continued compliance with these
regulations, governmental and other authorities periodically inspect our
facilities. The failure to comply with these regulations could result in the
suspension or revocation of a facilitys license. 12




---



##### Table of Contents



Medicare and Medicaid Participation The majority of our revenues are expected to continue to be received
through third-party reimbursement programs, including state and federal
programs, such as Medicare and Medicaid, and private health insurance programs.
Medicare is a federally funded and administered health insurance program,
primarily for individuals entitled to social security benefits who are 65 or
older or who are disabled. Medicaid is a health insurance program jointly
funded by state and federal governments that provides medical assistance to
qualifying low income persons. Each state Medicaid program covers in-patient
hospital services and has the option to provide payment for surgery center
services. The Medicaid programs of all of the states in which we currently
operate cover surgery center services; however, these states may not continue
to cover surgery center services and states into which we expand our operations
may not cover or continue to cover surgery center services. To participate in the Medicare program and receive Medicare payment, our
facilities must comply with regulations promulgated by the Department of Health
and Human Services. Among other things, these regulations, known as conditions
of participation, relate to the type of facility, its equipment, its personnel
and its standards of medical care, as well as compliance with state and local
laws and regulations. Our facilities must also satisfy the conditions of
participation in order to be eligible to participate in the Medicaid program.
The requirements for certification under Medicare and Medicaid are subject to
change and, in order to remain qualified for these programs, we may have to
make changes from time to time in our facilities, equipment, personnel or
services. Although we intend to continue to participate in these reimbursement
programs, we cannot assure you that our facilities will continue to qualify for
participation. Three of our facilities, including one managed facility, are licensed as
hospitals. The Medicare program pays hospitals on a prospective payment system
for acute inpatient services. Under this prospective payment system, a hospital
receives a fixed amount for inpatient hospital services based on each patients
final diagnosis. These payments do not consider a specific hospitals costs,
but are national rates adjusted for area wage differentials and case-mix index.
For several years, the percentage increases to the prospective payment rates
have been generally lower than the percentage increases in the costs of goods
and services by hospitals. Most outpatient services provided by hospitals are
reimbursed by Medicare under the outpatient prospective payment system. The
Balanced Budget Act of 1997 mandated the implementation of the prospective
payment system for Medicare outpatient services. This outpatient prospective
payment system is based on a system of Ambulatory Payment Categories. Each
Ambulatory Payment Category represents a bundle of outpatient services, and
each Ambulatory Payment Category has been assigned a fully prospective
reimbursement rate. Payments under the Medicare program to ambulatory surgery centers are made
under a system whereby the Secretary of Health and Human Services determines
payment amounts prospectively for various categories of medical services
performed in ambulatory surgery centers, subject to an inflation adjustment.
The various state Medicaid programs also pay us a fixed payment for our
services, which amount varies from state to state. About 18.4% of our patient
service revenues during 2003 were attributable to Medicare and Medicaid
payments. The Medicare Prescription Drug, Improvement, and Modernization Act of
2003, commonly referred to as the Medicare Modernization Act, limits increases
in Medicare reimbursement rates for ambulatory surgery centers. Under the
Medicare Modernization Act, the 2% increase in Medicare reimbursement rates for
ambulatory surgery centers that became effective on October 1, 2003 will be
limited beginning April 1, 2004 to an amount equal to the increase in the
Consumer Price Index for all urban consumers as estimated by the Secretary of
the Department of Health and Human Services for the 12-month period ended March
31, 2003, minus 3.0 percentage points. The Medicare Modernization Act also
provides that there will be no increase in these rates during the years 2005
through 2009. The Medicare Modernization Act also directs the General
Accounting Office to conduct a study comparing the cost of procedures in
surgery centers to the cost of procedures performed in hospital outpatient
departments. The General Accounting Office is directed to submit the results of
its study to the Centers for Medicare and Medicaid Services, or CMS, by no
later than January 1, 2005. CMS is directed to develop a new ambulatory surgery
center payment system based upon the Medicare hospital outpatient department
payment system so that it is effective on or after January 1, 2006 and no later
than January 1, 2008. The Medicare Modernization Act provides that, in the year
that the new payment system is implemented, it must be designed to result in
the same aggregate amount of expenditures for surgical services provided at
ambulatory surgery centers as would be made if the new system were 13




---



##### Table of Contents



not adopted. The rate changes mandated by the Medicare Modernization Act
could have an adverse effect on the revenues of our centers, but we cannot
predict at this time the full effect of the payment rate revisions. A rule proposed by CMS would make substantial changes to the rate-setting
methodology, payment rates, payment policies and the list of covered surgical
procedures for ambulatory surgery centers. Among the proposed changes is a
shift from eight payment groups to 105 ambulatory payment classifications. A
federal statute allows the payment methodology to be phased in for ambulatory
surgery centers over four years beginning as early as January 1, 2002. To date,
CMS has not implemented this payment methodology, and in light of the payment
study mandated by the Medicare Modernization Act, it is uncertain whether this
proposed surgery center payment methodology will be implemented. If implemented
in its proposed form, the change in payment methodology could reduce our
Medicare revenues, depending on the volume and type of procedures performed at
a particular facility. The proposed rule does not apply to our facilities
licensed as hospitals. The Medicare Payment Advisory Commission, or MedPAC, and the Office of the
Inspector General of the Department of Health and Human Services, or OIG, have
both recently recommended changes to the Medicare payment methodology for
ambulatory surgery centers. MedPAC is a congressional advisory board charged
with advising Congress on Medicare payment issues, while the OIG is a
governmental agency responsible for investigating and monitoring Medicare,
Medicaid and other Department of Health and Human Services programs. Generally,
MedPAC and the OIG have recommended that reimbursement levels for ambulatory
surgery center procedures be reduced. These are recommendations only and it is
uncertain if Congress will act on either or both recommendations. If these
recommendations become effective, our revenue and profitability could be
adversely affected. While most of our existing surgery center surgical
procedures are generally reimbursed at levels lower than hospital outpatient
departments, some of our existing surgical procedures are reimbursed at higher
levels. These recommended changes do not apply to our facilities licensed as
hospitals. We cannot predict what further legislation may be enacted or what
regulations or guidelines may be established concerning third party
reimbursement by state, federal or private programs. Reductions or changes in
these programs could have a material adverse affect on our business. Antitrust Laws Federal and state antitrust laws prohibit price fixing among competitors.
Independent physicians who are not economically integrated through a group
practice or some other method of sharing substantial financial risk may be
considered competitors under antitrust laws and subject to prohibitions on
price fixing. Price fixing is considered a per se violation of federal
antitrust laws. The Federal Trade Commission and the Department of Justice have
the authority to bring civil and criminal enforcement actions against persons
and entities who violate federal antitrust laws. Moreover, competitors and
customers who are injured by activities that violate federal antitrust laws may
bring civil actions against the alleged violator. In some cases, treble damages
are available to an injured competitor or customer. Networks of physicians, such as the IPA that we manage, involve price
discussions among competitors, which create antitrust concerns. In recognition
of the beneficial nature of these entities in a changing health care
environment, the FTC and the Department of Justice have issued several joint
policy statements regarding enforcement in the health care industry that set
forth antitrust safety zones in which a network may safely operate. The IPA that we manage may not fit within a safety zone. However, the
policy statements issued by the Department of Justice and the FTC provide that
the failure of an IPA to meet all of the requirements of a safety zone will not
render the activities of the IPA per se illegal. The government will examine
IPA arrangements on a case by case or rule of reason basis to determine if
the IPA can demonstrate that its members are economically or clinically
integrated and that the pro-competitive aspects of the IPA outweigh the
anti-competitive aspects. If there are sufficient pro-competitive aspects to
the IPA, it should not be held to be illegal. The FTC and the Department of
Justice will provide advisory opinions regarding the compliance of physician
network arrangements with the antitrust statutes; however, we have not sought
such an opinion. 14




---



##### Table of Contents



Medicare Fraud and Abuse and Anti-Referral Laws The Social Security Act includes provisions addressing false statements,
illegal remuneration and other fraud. These provisions are commonly referred to
as the Medicare Fraud and Abuse Laws, and include the statute commonly referred
to as the federal anti-kickback statute. The federal anti-kickback statute
prohibits providers and others from, among other things, soliciting, receiving,
offering or paying, directly or indirectly, any remuneration in return for
either making a referral for a service or item covered by a federal health care
program or ordering or arranging for or recommending the order of any covered
service or item. Violations of the federal anti-kickback statute are punishable
by a fine of up to $50,000 or imprisonment for each violation, as well as
damages up to three times the total amount of remuneration. In addition, the Medicare Patient and Program Protection Act of 1987, as
amended by the Health Insurance Portability and Accountability Act of 1996,
commonly referred to as HIPAA, and the Balanced Budget Act of 1997, imposes
civil monetary penalties for a violation of the Medicare Fraud and Abuse Laws,
as well as exclusion from federal health care programs. Pursuant to the
enactment of HIPAA, as of June 1, 1997, the Secretary of Health and Human
Services may, and in some cases must, exclude individuals and entities from
participating in any government health care program that the Secretary
determines have committed an act in violation of the Medicare Fraud and Abuse
Laws or have improperly filed claims in violation of the Medicare Fraud and
Abuse Laws. HIPAA also expanded the Secretarys authority to exclude a person
involved in fraudulent activity from participation in a program providing
health benefits, whether directly or indirectly, which is funded directly, in
whole or in part, by the U.S. government. Because physician-investors in our surgery centers are in a position to
generate referrals to the centers, the distribution of available cash to those
investors could come under scrutiny under the federal anti-kickback statute.
The U.S. Court of Appeals for the Third Circuit has held that the federal
anti-kickback statute is violated if one purpose (as opposed to a primary or
sole purpose) of a payment to a provider is to induce referrals. Other federal
circuit courts have followed this decision. None of these cases involved a
joint venture such as those owning and operating our surgery centers and it is
not clear how a court would apply these holdings to our activities. It is
clear, however, that a physicians investment income from a surgery center may
not vary with the number of his or her referrals to the surgery center, and we
comply with this prohibition. In a case involving a physician-owned joint venture, the U.S. Court of
Appeals for the Ninth Circuit held that the federal anti-kickback statute is
violated when a person or entity (1) knows that the statute prohibits offering
or paying remuneration to induce referrals and (2) engages in prohibited
conduct with the specific intent to violate the law. In that case, the joint
venture was determined to have violated the law because its agent solicited
prospective limited partners by implying that eligibility to purchase shares in
the limited partnership was dependent on an agreement to refer business to it,
told prospective limited partners that the number of shares they would be
permitted to purchase would depend on the volume of business they referred, and
stated that partners who did not refer business would be pressured to leave the
partnership. The joint venture was vicariously liable for the actions of its
agents, notwithstanding that the agents actions were contrary to the
principals stated policy. Further, under HIPAA, individuals who hold a direct or indirect ownership
or controlling interest in an entity that is found to violate the Medicare
Fraud and Abuse Laws may also be excluded from the Medicare and Medicaid
programs if the individual knew or should have known of the activity leading to
the conviction or exclusion of the entity, or where the individual is an
officer or managing employee of the entity. Under HIPAA, the term should know
means that a person acts in deliberate ignorance or reckless disregard of the
truth or falsity of the information. This standard does not require that
specific intent to defraud be proven by the OIG. Under regulations issued by the OIG, certain categories of activities are
deemed not to violate the federal anti-kickback statute. According to the
preamble to these safe harbor regulations, the failure of a particular business
arrangement to comply with the regulations does not determine whether the
arrangement violates the federal anti-kickback statute. The safe harbors do not
make conduct illegal, but instead outline standards that, if complied with,
protect conduct that might otherwise be deemed in violation of the federal
anti-kickback statute. One earlier safe harbor protects profit distributions to investors in
small entity joint ventures, such as limited partnerships, if certain
conditions are met. However, we believe that our ownership and operation of our
facilities, 15




---



##### Table of Contents



will not satisfy this safe harbor for small entity joint ventures, because
this safe harbor requires that no more than 40% of the value of each class of
investment interests be held by investors in a position to make or influence
referrals or to generate business for the entity, and we anticipate that our
facilities will not meet this requirement. The OIG published an expanded listing of safe harbors under the federal
anti-kickback statute on November 19, 1999. The new, expanded provisions
include a safe harbor designed to protect distributions to physician investors
in ambulatory surgery centers who refer patients directly to the center and
personally perform the procedures as an extension of their practice. The safe
harbor for surgery center ownership protects four categories of investors,
including facilities owned by general surgeons, single-specialty physicians,
multi-specialty physicians and hospital/physician ventures, provided that
certain requirements are satisfied. The requirements include the following: 1. The center must be an ambulatory surgery center certified to
participate in the Medicare program and its operating and recovery room space
must be dedicated exclusively to the surgery center and not a part of a
hospital (although such space may be leased from a hospital if such lease
meets the requirements of the safe harbor for space rental). 2. Each investor must be either (a) a physician who derived at least
one-third of his or her medical practice income for the previous fiscal year
or 12-month period from performing procedures on the list of Medicare-covered
procedures for ambulatory surgery centers, (b) a hospital, or (c) a person or
entity not in a position to make or influence referrals to the center, nor to
provide items or services to the center, nor employed by the center or any
investor. 3. Unless all physician-investors are members of a single specialty,
each physician-investor must perform at least one-third of his or her
procedures at the center each year. (This requirement is in addition to the
requirement that the physician-investor has derived at least one-third of his
or her medical practice income for the past year from performing procedures.) 4. Physician-investors must have fully informed their referred patients
of the physicians investment interest. 5. The terms on which an investment interest is offered to an investor
are not related to the previous or expected volume of referrals, services
furnished or the amount of business otherwise generated from that investor to
the entity. 6. Neither the center nor any other investor may loan funds to or
guarantee a loan for an investor if the investor uses any part of such loan
to obtain the investment interest. 7. The amount of payment to an investor in return for the investment
interest is directly proportional to the amount of the capital investment
(including the fair market value of any pre-operational services rendered) of
that investor. 8. All physician-investors, any hospital-investor and the center agree
to treat patients receiving medical benefits or assistance under the Medicare
or Medicaid programs. 9. All ancillary services performed at the center for beneficiaries of
federal health care programs must be directly and integrally related to
primary procedures performed at the center, and may not be billed separately. 10. No hospital-investor may include on its cost report or any claim for
payment from a federal health care program any costs associated with the
center. 11. The center may not use equipment owned by or services provided by a
hospital-investor unless such equipment is leased in accordance with a lease
that complies with the equipment rental safe harbor and such services are
provided in accordance with a contract that complies with the personal
services and management contracts safe harbor. 16




---



##### Table of Contents



12. No hospital-investor may be in a position to make or influence
referrals directly or indirectly to any other investor or the center. We believe that the ownership and operations of our surgery centers will
not fully satisfy this safe harbor for investment interests in ambulatory
surgery centers because, among other reasons, we or one of our subsidiaries
generally will be an investor in each surgery center and provide management
services to the surgery center. We cannot assure you that the OIG would view
our activities favorably even though they are intended to achieve compliance
with the remaining elements of this safe harbor. In addition, although we
expect each physician-investor to utilize the surgery center as an extension of
his practice, we cannot assure you that all physician-investors will perform
one-third of their procedures at the surgery center or inform their referred
patients of their investment interests. We own an interest in one surgery center in which a physician group that
includes primary care physicians who do not use the center also owns an
interest. In OIG Advisory Opinion 03-5 (February 6, 2003), the OIG declined to
grant a favorable opinion to a proposed ambulatory surgery center structure
that would be jointly owned by a hospital and a multi-specialty group practice
composed of a substantial number of primary care physicians who would not
personally use the center. According to the opinion, the fact that interests in
the center would be indirectly owned by physicians who would not personally
practice at the center precluded the OIG from determining that the proposed
arrangement poses a minimal risk of fraud and abuse. The OIG concluded that the
proposed structure could potentially generate prohibited remuneration under the
federal anti-kickback statute. We believe that the ownership of our center
complies with the federal anti-kickback statute because the physician group
that owns an interest in our center is structured to fit within the definition
of a unified group practice under the federal law prohibiting physician
self-referrals, commonly known as the Stark law, and the income distributions
of the group practice comply with the Stark laws acceptable methods of income
distribution. No physician in the group practice receives an income
distribution that is based directly on his referrals to the center. We believe
that the groups ownership of the center is no different than its ownership of
other ancillary services common in physician practices. Nevertheless, there can
be no assurance that the proposed arrangement will not be determined to be in
violation of the law. We have entered into management agreements to manage many of our surgery
centers, as well as three physician networks. Most of these agreements call for
our subsidiary to be paid a percentage-based management fee. Although there is
a safe harbor for personal services and management contracts, this safe harbor
requires, among other things, that the aggregate compensation paid to the
manager over the term of the agreement be set in advance. Because our
management fee may be based on a percentage of revenues, it does not meet this
requirement. However, we believe that our management arrangements satisfy the
other requirements of the safe harbor for personal services and management
contracts and that they comply with the federal anti-kickback statute. The OIG
has taken the position that percentage-based management agreements are not
protected by a safe harbor, and consequently, may violate the federal
anti-kickback statute. On April 15, 1998, the OIG issued Advisory Opinion 98-4
which reiterates this proposition. This opinion focused on areas the OIG
considers problematic in a physician practice management context, including
financial incentives to increase patient referrals, no safeguards against
overutilization and incentives to increase the risk of abusive billing. The
opinion reiterated that proof of intent to violate the federal anti-kickback
statute is the central focus of the OIG. We have implemented formal compliance
programs designed to safeguard against overbilling and otherwise assure
compliance with the federal anti-kickback statute and other laws, but we cannot
assure you that the OIG would find our compliance programs to be adequate. In some cases, we guarantee a surgery centers debt financing and lease
obligations as part of our obligations under a management agreement.
Physician-investors are generally not required to enter into similar
guarantees. The OIG might take the position that the failure of the physician
investors to enter into similar guarantees represents a special benefit to the
physician investors given to induce referrals and that such failure would
result in a violation of the federal anti-kickback statute. We believe that the
management fees (and in some cases guarantee fees) are adequate compensation to
us for the credit risk associated with the guarantee and that the failure of
the physician investors to enter into similar guarantees does not create a
material risk of violating the federal anti-kickback statute. However, the OIG
has not issued any guidance in this regard. The OIG is authorized to issue advisory opinions regarding the
interpretation and applicability of the federal anti-kickback statute,
including whether an activity constitutes grounds for the imposition of civil
or criminal 17




---



##### Table of Contents



sanctions. We have not, however, sought such an opinion regarding any of
our arrangements. If it were determined that our activities, or those of our
facilities, violate the federal anti-kickback statute, we, our subsidiaries,
our officers, our directors and each surgery center investor could be subject,
individually, to substantial monetary liability, prison sentences and/or
exclusion from participation in any health care program funded in whole or in
part by the U.S. government, including Medicare, CHAMPUS or state health care
programs. Federal Anti-Referral Laws Physician self-referral laws have been enacted by the U.S. Congress and
many states prohibiting certain self-referrals for health care services. The
federal prohibition prohibits a practitioner, including a physician, dentist or
podiatrist, from referring patients for certain designated health services
provided by an entity with which the practitioner or a member of his immediate
family has a financial relationship if those services are paid in whole or in
part by Medicare or Medicaid unless an exception exists. The term financial
relationship is broadly defined and includes most types of ownership and
compensation relationships. The Stark law also prohibits the entity from
seeking payment from Medicare or Medicaid for services rendered through a
prohibited referral. If an entity is paid for services rendered through a
prohibited referral, it may be required to refund the payments. Violations of
the Stark law may also result in damages of three times the amount claimed,
civil penalties of up to $15,000 per prohibited claim and $100,000 per
prohibited scheme and exclusion from participating in Medicare and Medicaid.
Designated health services include:  
    
    clinical laboratory services;
    
    physical therapy services;
    
    occupational therapy services;
    
    radiology services, including magnetic resonance imaging,
computerized axial tomography scan and ultrasound services;
    
    radiation therapy services and supplies;
    
    durable medical equipment and supplies;
    
    parenteral and enteral nutrients, equipment and supplies;
    
    prosthetics, orthotics and prosthetic devices and supplies;
    
    home health services;
    
    outpatient prescription drugs; and
    
    inpatient and outpatient hospital services. The list of designated health services includes imaging services and other
diagnostic services provided by our diagnostic center. However, the Stark law
is implicated only if the referring physician or a member of his immediate
family has a financial relationship with the provider of designated health
services. There is no physician ownership (or physician family member
ownership) in our diagnostic center. Any compensation relationships between our
diagnostic centers and physicians are set forth in writing, provide for a fair
market value compensation and are otherwise structured to fit within applicable
exceptions to the Stark law. The list of designated health services does not include surgical services
provided in an ambulatory surgery center. Furthermore, in final Stark law
regulations published by the Department of Health and Human Services on January
4, 2001, the term designated health services was defined as not including
services that are reimbursed by Medicare as part of a composite rate, such as
services provided in an ambulatory surgery center. 18




---



##### Table of Contents



However, if designated health services are provided by an ambulatory
surgery center and separately billed, referrals to the surgery center by a
physician investor would be prohibited by the Stark law. Because our facilities
that are licensed as ambulatory surgery centers do not have independent
laboratories and do not provide designated health services apart from surgical
services, we do not believe referrals to these facilities by physician
investors are prohibited. If legislation or regulations are implemented that prohibit physicians
from referring patients to surgery centers in which the physician has a
beneficial interest, our business and financial results would be adversely
affected. Additionally, the physician networks we manage must comply with the
in-office ancillary services exception of the Stark law. We believe that
these physician networks operate in compliance with the language of statutory
exceptions to the Stark law, including the exceptions for services provided by
physicians within a group practice or in-office ancillary services. Three of our facilities, including one managed facility, are licensed as
hospitals. The Stark law includes an exception relating to physician ownership
of a hospital, provided that the physicians ownership interest is in the whole
hospital and the physician is authorized to perform services at the hospital.
Physician investment in our facilities licensed as hospitals meet this
requirement. However, the Medicare Modernization Act amended the Stark law to
provide that an exception in the Stark law relating to physician ownership in
hospitals does not apply to specialty hospitals for a period of 18 months
following November 18, 2003. Specialty hospitals are defined in the Medicare
Modernization Act as hospitals that are primarily or exclusively engaged in the
care and treatment of (1) patients with a cardiac condition, (2) patients with
an orthopedic condition, (3) patients receiving a surgical procedure or (4) any
other specialized category of services that the Secretary of the Department of
Health and Human Services designates as inconsistent with the purpose of the
hospital ownership exception. The 18-month moratorium does not apply to
specialty hospitals that were in existence or under development on November 18,
2003, as long as: (a) the total number of physician investors in the hospital
does not increase from the number of physician investors on November 18, 2003;
(b) the hospital does not change the type of specialty services that it
provides from the types that it provided on November 18, 2003; and (c) the
hospital does not increase its number of beds by more than 5% or five beds,
whichever is greater. The Medicare Modernization Act also directs the
Department of Health and Human Services and MedPAC to conduct studies of
specialty hospitals by February 2005, and to prepare reports to Congress
recommending any needed legislative or administrative changes in the Stark
laws exception for physician ownership in hospitals. Two of our facilities licensed as hospitals, including the managed
facility, currently fit within the Medicare Modernization Acts definition of
specialty hospital. Our other facility licensed as a hospital, in which we
own a 42% interest, primarily provides obstetrical and other womens health
services and could be designated in the future by the Secretary of the
Department of Health and Human Services as a specialty hospital. However, none
of our facilities are subject to the specialty hospital moratorium because they
were in existence on November 18, 2003. Consequently, the current physician
investors in these facilities can refer to the hospitals and fit within the
Stark laws whole hospital exception. The Medicare Modernization Act, however,
will prevent us from increasing the number of physician investors in these
facilities, significantly increasing the number of licensed beds or changing
the types of specialty services that we provide. These legal constraints on the
operation of these facilities could have an adverse financial effect. In
addition, there is no guarantee that the MedPAC and Department of Health and
Human Services specialty hospital reports to Congress will be favorable, or
that future legislation will not be enacted that would prevent us from
operating specialty hospitals with physician investors. If future legislation
were to be enacted that prohibits all physician referrals to specialty
hospitals in which the physicians own an interest, even if those facilities
already exist, our specialty hospitals could be materially adversely affected. False and Other Improper Claims The U.S. government is authorized to impose criminal, civil and
administrative penalties on any person or entity that files a false claim for
payment from the Medicare or Medicaid programs. Claims filed with private
insurers can also lead to criminal and civil penalties, including, but not
limited to, penalties relating to violations of federal mail and wire fraud
statutes. While the criminal statutes are generally reserved for instances of
fraudulent intent, the U.S. government is applying its criminal, civil and
administrative penalty statutes in an ever-expanding range of circumstances.
For example, the government has taken the position that a pattern of claiming
reimbursement for 19




---



##### Table of Contents



unnecessary services violates these statutes if the claimant merely should
have known the services were unnecessary, even if the government cannot
demonstrate actual knowledge. The government has also taken the position that
claiming payment for low-quality services is a violation of these statutes if
the claimant should have known that the care was substandard. In addition, some
courts have held that a violation of the Stark law can result in liability
under the federal False Claims Act. Over the past several years, the U.S. government has accused an increasing
number of health care providers of violating the federal False Claims Act. The
False Claims Act prohibits a person from knowingly presenting, or causing to be
presented, a false or fraudulent claim to the U.S. government. The statute
defines knowingly to include not only actual knowledge of a claims falsity,
but also reckless disregard for or intentional ignorance of the truth or
falsity of a claim. Because our facilities perform hundreds of similar
procedures a year for which they are paid by Medicare, and there is a
relatively long statute of limitations, a billing error or cost reporting error
could result in significant civil or criminal penalties. Under the qui tam, or whistleblower, provisions of the False Claims Act,
private parties may bring actions on behalf of the U.S. government. These
private parties, often referred to as relators, are entitled to share in any
amounts recovered by the government through trial or settlement. Both direct
enforcement activity by the government and whistleblower lawsuits have
increased significantly in recent years and have increased the risk that a
health care company, like us, will have to defend a false claims action, pay
fines or be excluded from the Medicare and Medicaid programs as a result of an
investigation resulting from a whistleblower case. Although we believe that our
operations materially comply with both federal and state laws, they may
nevertheless be the subject of a whistleblower lawsuit, or may otherwise be
challenged or scrutinized by governmental authorities. A determination that we
have violated these laws could have a material adverse effect on us. We are also subject to various state insurance statutes and regulations
that prohibit us from submitting inaccurate, incorrect or misleading claims. We
believe that our surgery centers are in compliance with all state insurance
laws and regulations regarding the submission of claims. We cannot assure you,
however, that none of our centers insurance claims will ever be challenged. If
we were found to be in violation of a states insurance laws or regulations, we
could be forced to discontinue the violative practice, which could have an
adverse effect on our business and operating results, and we could be subject
to fines and criminal penalties. Health Information Practices There are currently numerous laws at the state and federal levels
addressing patient privacy concerns. Federal regulations issued pursuant to HIPAA contain,
among other measures, provisions that require many organizations, including us,
to implement very significant and potentially expensive new computer systems,
employee training programs and business procedures. The federal regulations are
intended to encourage electronic commerce in the healthcare industry. On August 17, 2000, the Department of Health and Human Services finalized
regulations requiring us to use standard data formats and code sets established
by the rule when electronically transmitting information in connection with
several transactions, including health claims and equivalent encounter
information, health care payment and remittance advice and health claim status.
On February 20, 2003, the Department of Health and Human Services issued final
modifications to these regulations. We have implemented or upgraded computer
systems, as appropriate, at our facilities and at our corporate headquarters to
comply with the new transaction and code set regulations and have tested these
systems with several of our payors. If we or our payors are unable to exchange
information in connection with the specified transactions because of an
inability to comply fully with the regulations, we are required to exchange the
information using paper. If we are forced to submit paper claims to payors, it
will significantly increase our costs associated with billing and could delay
payment of claims. Although compliance with the transaction and code set
regulations was required on October 16, 2003, CMS announced on September 23,
2003 that it would implement a contingency plan to accept noncompliant
electronic transactions after the October 16, 2003 deadline. On February 27,
2004, CMS announced a modification to its claims payment policies that will
significantly increase the payment waiting period for electronic claims that
are submitted in a non-HIPAA compliant format. Effective July 1, 2004, only
claims that are submitted electronically in a HIPAA compliant format will be
eligible for payment 14 days after the claim is received. All other claims
will not be eligible for payment until 27 days after the claim is received. 20




---



##### Table of Contents



HIPAA requires the Department of Health and Human Services to issue
regulations establishing standard unique health identifiers for individuals,
employers, health plans and health care providers to be used in connection with
standard electronic transactions. On May 31, 2002, the Department of Health and Human Services issued a
final rule that calls for using the Employer Identification Number (the
taxpayer identifying number for employers that is assigned by the Internal
Revenue Service) as the standard unique health identifier for employers. Most
health care organizations, including us, must comply with this final rule by
July 30, 2004. Health plans, health care clearinghouses and providers would use
this identifier, among other uses, in connection with the standard electronic
transactions standards. On January 23, 2004, the Department of Health and Human Services published
a final rule that adopted the National Provider Identifier, or NPI, as the
standard unique health identifier for health care providers. When the NPI is
implemented, health care providers, including our facilities, must use only the
NPI to identify themselves in connection with electronic transactions. Legacy
numbers, such as Medicaid numbers, CHAMPUS numbers and Blue Cross-Blue Shield
numbers, will not be permitted. Health care providers will no longer have to
keep track of multiple numbers to identify themselves in the standard
electronic transactions with one or more health plans. The NPI will be a
10-digit all numeric number that will be assigned to eligible health care
providers, including our facilities, by the National Provider System, or NPS,
an independent government contractor. Under the final rule, all health care
providers may begin applying for NPIs on May 23, 2005 with the NPS. All health
care providers, including our facilities, must obtain and start using NPIs in
connection with the standard electronic transactions no later than May 23,
2007. The Department of Health and Human Services has not yet issued proposed
rules that establish the standard for unique health identifiers for health
plans or individuals. Once these regulations are issued in final form, we
expect to have about two years to become fully compliant. On February 20, 2003, the Department of Health and Human Services
finalized a rule that establishes, in part, standards to protect the
confidentiality, availability and integrity of health information by health
plans, health care clearinghouses and health care providers that receive,
store, maintain or transmit health and related financial information in
electronic form, regardless of format. These security standards require us to
establish and maintain reasonable and appropriate administrative, technical and
physical safeguards to ensure the integrity, confidentiality and the
availability of electronic health and related financial information. The
security standards were designed to protect electronic information against
reasonably anticipated threats or hazards to the security or integrity of the
information and to protect the information against unauthorized use or
disclosure. Although the security standards do not reference or advocate a
specific technology, and covered health care providers, plans and
clearinghouses have the flexibility to choose their own technical solutions, we
expect that the security standards will require us to implement significant new
systems, business procedures and training programs. We must comply with these
security regulations by April 21, 2005. On December 28, 2000, the Department of Health and Human Services
published a final rule establishing standards for the privacy of individually
identifiable health information. The final rule establishing the privacy
standards became effective on April 14, 2001, with compliance required by April
14, 2003. On August 14, 2002, the Department of Health and Human Services
published final revisions to the privacy rule. The final revisions did not
alter the compliance date of April 14, 2003 for the majority of the
requirements in the privacy regulations. These privacy standards apply to all
health plans, all health care clearinghouses and health care providers that
transmit health information in an electronic form in connection with the
standard transactions. We are a covered entity under the final rule. The
privacy standards apply to individually identifiable information held or
disclosed by a covered entity in any form, whether communicated electronically,
on paper or orally. These standards impose extensive new administrative
requirements on us. They require our compliance with rules governing the use
and disclosure of this health information. They create new rights for patients
in their health information, such as the right to amend their health
information, and they require us to impose these rules, by contract, on any
business associate to whom we disclose such information in order to perform
functions on our behalf. In addition, our facilities will continue to remain
subject to any state laws that are more restrictive than the privacy
regulations issued under HIPAA. These state laws vary by state and could impose
additional penalties. 21




---



##### Table of Contents



A violation of these regulations could result in civil money penalties of
$100 per incident, up to a maximum of $25,000 per person per year per standard.
HIPAA also provides for criminal penalties of up to $50,000 and one year in
prison for knowingly and improperly obtaining or disclosing protected health
information, up to $100,000 and five years in prison for obtaining protected
health information under false pretenses, and up to $250,000 and ten years in
prison for obtaining or disclosing protected health information with the intent
to sell, transfer or use such information for commercial advantage, personal
gain or malicious harm. Since there is no history of enforcement efforts by the
federal government at this time, it is not possible to ascertain the likelihood
of enforcement efforts in connection with the HIPAA regulations or the
potential for fines and penalties which may result from the violation of the
regulations. We expect that compliance with these standards will require significant
commitment and action by us. We have appointed members of our management team
to direct our compliance with these standards. Implementation will require us
to engage in extensive preparation and make significant expenditures. At this
time we have appointed a privacy officer, prepared privacy policies, trained
our workforce on these policies and entered into business associate agreements
with the appropriate vendors. Because some of the regulations are proposed
regulations, we cannot predict the total financial impact of the regulations on
our operations. Health Care Regulations Affecting Our New York Operations Laws in the State of New York require that corporations have natural
persons as stockholders in order to be approved by the New York Department of
Health as a licensed health care facility. Accordingly, we are not able to own
interests in a limited partnership or limited liability company that owns an
interest in a health care facility located in New York. Laws in the State of
New York also prohibit the delegation of certain management functions by a
licensed health care facility. The law does permit a licensed facility to lease
premises and obtain various services from non-licensed entities; however, it is
not clear what types of delegation constitute a violation. Although we believe
that our operations and relationships in New York are in compliance with these
laws, if New York regulatory authorities or a third party asserts a contrary
position, we may be unable to continue or expand our operations in New York. We
own an interest in a limited liability company which provides administrative
services to a surgery center located in New York. Available Information Our website is www.symbion.com. We make available free of charge on this
website under Investor Relations  SEC Filings our periodic and other reports
and amendments to those reports filed with or furnished to the Securities and
Exchange Commission (SEC) as soon as reasonably practicable after we
electronically file or furnish such materials. 
 Item 2.Properties Our corporate headquarters are located in Nashville, Tennessee in 39,852
square feet of leased office space, under a ten-year lease that commenced on
November 1, 2002. Effective April 1, 2004, we will lease an additional 3,920
square feet, of which we will sublease 1,827 square feet to a third party. We
also lease 8,553 square feet of space in an office building located in Houston,
Texas, substantially all of which we sublease to a third party. The lease of
the office space in Houston, Texas expires on April 30, 2004. Typically, our surgery centers are located on real estate leased by the
limited partnership or limited liability company that owns the centers. These
leases generally have initial terms of ten years, but range from two to 15
years. Most of the leases contain options to extend the lease period for up to
ten additional years. The surgery centers are generally responsible for
property taxes, property and casualty insurance and routine maintenance
expenses. Three of our surgery centers are located on real estate owned by the
limited partnership or limited liability company that owns the surgery center.
We generally guarantee the lease obligations of the limited partnerships and
limited liability companies that own our surgery centers. 22




---



##### Table of Contents



Additional information about our surgery centers and our other properties
can be found in Item 1 of this report under the caption, Business 
Operations. 
 Item 3.Legal Proceedings We are involved, from time to time, in litigation arising in the ordinary
course of business. We believe that the matters in which we are currently
involved will be resolved without a material adverse effect on our financial
position or results of operations. 
 Item 4.Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the stockholders during the fourth
quarter ended December 31, 2003. 23




---



##### Table of Contents



PART II 
 Item 5.Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market for Common Stock.Until February 6, 2004, there was no established
public trading market for our common stock. On February 6, 2004, our common
stock commenced trading on the Nasdaq National Market under the symbol SMBI.
The following table sets forth for the period indicated the high and low bid
price per share of our common stock as reported on the Nasdaq National Market. 2004
    
    High
    
    LowFebruary 6, 2004 to March 15, 2004
    
    $
    20.66
    
    
    $
    17.39
 On March 15, 2004, the last reported sales price for our common stock on
the Nasdaq National Market was $17.55 per share. At March 15, 2004, there were
approximately 301 stockholders of record. Dividends.We have never declared or paid dividends on our common stock.
We intend to retain future earnings to finance the growth and development of
our business and, accordingly, do not currently intend to declare or pay any
dividends on our common stock. Our board of directors will evaluate our future
earnings, results of operations, financial condition and capital requirements
in determining whether to declare or pay cash dividends. Delaware law prohibits
us from paying any dividends unless we have capital surplus or net profits
available for this purpose. In addition, our credit facility imposes
restrictions on our ability to pay dividends. See Managements Discussion and
Analysis of Financial Condition and Results of Operations  Liquidity and
Capital Resources. Recent Sales of Unregistered Securities.In 2003, we issued the following
securities, as adjusted to reflect a 1-for-4.4303 reverse stock split effective
February 6, 2004, that were not registered under the Securities Act of 1933, as
amended. Each of the transactions described below was conducted in reliance
upon the exemptions from registration provided in Sections 3(b) and 4(2) of the
Securities Act and Regulation D and the other rules and regulations promulgated
thereunder. Each of these issuances was made without the use of an underwriter, and
the certificates and other documentation evidencing the securities issued in
connection with these transactions bear a restrictive legend permitting
transfer of the securities only upon registration under the Securities Act or
pursuant to an exemption from registration.  
    
    On May 7, 2003, we granted options to purchase an aggregate of
25,393 shares of our common stock under one of our stock option plans
to employees at an exercise price of $13.87 per share.
    
    On July 21, 2003, we issued 14 3/4% Senior Subordinated Notes due
2008 in the aggregate principal amount of $15,106,000 to DLJ Investment
Partners II, L.P. and its affiliates.
    
    On August 1, 2003, we issued 13,686 shares of our common stock to a
former employee for an aggregate of $17,199 upon exercise of stock
options.
    
    On August 1, 2003, we issued 70,940 shares of our common stock to a
former employee for an aggregate of $38,442 upon exercise of stock
options.
    
    On November 4, 2003, we issued 4,740 shares of our common stock to
a former employee for an aggregate of $39,484 upon exercise of stock
options.
    
    On November 17, 2003, we issued warrants to purchase 14,101 shares
of our common stock to 23 individuals and two entities which each held
an ownership interest in certain of the surgery centers we acquired
from MediSphere Health Partners, Inc. in connection with such
acquisition. The exercise price of these warrants is $13.87 per share. 24




---



##### Table of Contents




    
    On November 26, 2003, we issued 14 3/4% Senior Subordinated Notes
due 2008 in the aggregate principal amount of $14,000,000 to DLJ
Investment Partners II, L.P. and its affiliates and to affiliates of
Jack Tyrrell, Frederick L. Bryant, Donald W. Burton and David M. Wilds,
each of whom is a member of our board of directors.
    
    On December 11, 2003, we granted options to purchase an aggregate
of 450,928 shares of our common stock to employees at an exercise price
of $15.00 per share. Use of Proceeds from Registered Securities.On February 11, 2004, we
completed an underwritten initial public offering of 8,280,000 shares of our
common stock pursuant to a Registration Statement on Form S-1 (Registration No.
333-110555), which became effective on February 5, 2004. The shares included
1,080,000 shares of common stock sold following exercise in full by the
underwriters of an option to purchase the additional shares, which we granted
to the underwriters to cover over-allotments. The offering has been completed
and all shares were sold at an initial public offering price per share of
$15.00. The aggregate price of the offering amount registered was
$124,200,000. Credit Suisse First Boston acted as lead manager for the
offering, and the co-managers were Banc of America Securities LLC, Merrill
Lynch & Co., Jefferies & Company, Inc. and Raymond James. Our net proceeds, after deducting underwriting fees of $8.7 million, were
about $115.5 million. We estimate the offering costs to be about $3.2 million.
None of the payments for offering costs were made to any of our directors,
officers or affiliates or to any persons owning 10% or more of any class of our
equity securities. We have used all of the net proceeds of the offering to:  
    
    pay about $31.8 million to holders of shares of our Series A and
Series B convertible preferred stock in connection with the conversion
of those shares upon completion of the offering;
    
    repay about $29.1 million of indebtedness under our outstanding
senior subordinated notes and pay about $727,500 of redemption premiums
and $688,000 of accrued interest to the holders of the notes;
    
    pay about $108,000 of accrued interest on our subordinated convertible debentures on conversion; and
    
    repay about $49.9 million of indebtedness under our senior credit facility. About $31.6 million of the proceeds of the offering were paid to J.H.
Whitney III, L.P., J.H. Whitney IV, L.P. and Whitney Strategic Partners III,
L.P., who collectively owned more than 10% of our outstanding common stock
prior to the offering, upon conversion of the shares of Series A and Series B
preferred stock owned by such investors upon completion of the offering.
Affiliates of four of our directors received an aggregate of about $3.9 million
upon repayment of the senior subordinated notes held by such investors. 25




---



##### Table of Contents



Item 6.Selected Financial Data The following selected consolidated financial and other data should be
read in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations and our audited consolidated financial
statements and the related notes included elsewhere in this report. The
selected consolidated statement of operations data set forth below for each of
the three years ended December 31, 2003, and the selected consolidated balance
sheet data set forth below at December 31, 2002 and 2003, are derived from our
audited consolidated financial statements that are included elsewhere in this
report. The selected consolidated statement of operations data set forth below
for the years ended December 31, 1999 and 2000, and the selected consolidated
balance sheet data set forth below at December 31, 1999, 2000 and 2001, are
derived from our audited consolidated financial statements that are not
included in this report. The historical results presented below are not necessarily indicative of
the results to be expected for any future period. Year Ended December 31,1999(1)
    
    2000
    
    2001
    
    2002
    
    2003(dollars in thousands, except per share amounts)Consolidated Statement Of
Operations Data:Revenues
    
    $
    58,120
    
    
    $
    126,942
    
    
    $
    104,704
    
    
    $
    144,688
    
    
    $
    176,269Cost of revenues
    
    
    48,781
    
    
    
    101,793
    
    
    
    75,783
    
    
    
    93,692
    
    
    
    117,305General and administrative expense
    
    
    8,097
    
    
    
    11,454
    
    
    
    12,407
    
    
    
    14,328
    
    
    
    15,874Depreciation and amortization
    
    
    3,351
    
    
    
    7,503
    
    
    
    7,743
    
    
    
    7,836
    
    
    
    9,295Provision for doubtful accounts
    
    
    482
    
    
    
    1,717
    
    
    
    1,055
    
    
    
    4,843
    
    
    
    2,748Loss (income) on equity investments
    
    
    55
    
    
    
    466
    
    
    
    192
    
    
    
    (541
    )
    
    
    (402
    )Impairment and loss on disposal of long-lived assets
    
    
    
    
    
    
    6,043
    
    
    
    385
    
    
    
    492
    
    
    
    437Gain on sale of long-lived assets
    
    
    
    
    
    
    
    
    
    
    (2,346
    )
    
    
    (457
    )
    
    
    (571
    )Total operating expenses
    
    
    60,766
    
    
    
    128,976
    
    
    
    95,219
    
    
    
    120,193
    
    
    
    144,686Operating income (loss)
    
    
    (2,646
    )
    
    
    (2,034
    )
    
    
    9,485
    
    
    
    24,495
    
    
    
    31,583Minority interests in (income) loss of consolidated subsidiaries
    
    
    647
    
    
    
    526
    
    
    
    (1,909
    )
    
    
    (7,353
    )
    
    
    (10,447
    )Interest expense, net
    
    
    (1,189
    )
    
    
    (3,234
    )
    
    
    (2,600
    )
    
    
    (4,625
    )
    
    
    (5,782
    )Income (loss) before income taxes
    
    
    (3,188
    )
    
    
    (4,742
    )
    
    
    4,976
    
    
    
    12,517
    
    
    
    15,354Provision (benefit) for income taxes
    
    
    72
    
    
    
    135
    
    
    
    287
    
    
    
    215
    
    
    
    (2,170
    )Net income (loss)
    
    $
    (3,260
    )
    
    $
    (4,877
    )
    
    $
    4,689
    
    
    $
    12,302
    
    
    $
    17,524Net income (loss) per share:Basic
    
    $
    (0.63
    )
    
    $
    (0.49
    )
    
    $
    0.47
    
    
    $
    1.19
    
    
    $
    1.66Diluted
    
    $
    (0.63
    )
    
    $
    (0.49
    )
    
    $
    0.45
    
    
    $
    1.01
    
    
    $
    1.38Shares used to compute net income (loss) per share:Basic
    
    
    5,187,473
    
    
    
    9,912,349
    
    
    
    9,908,447
    
    
    
    10,349,568
    
    
    
    10,536,745Diluted
    
    
    5,187,473
    
    
    
    9,912,349
    
    
    
    10,341,085
    
    
    
    12,144,140
    
    
    
    12,658,620Cash Flow Data:Net cash provided by (used in) operating activities
    
    $
    (4,305
    )
    
    $
    6,834
    
    
    $
    8,438
    
    
    $
    21,770
    
    
    $
    27,181Net cash used in investing activities
    
    
    (24,347
    )
    
    
    (18,359
    )
    
    
    (5,821
    )
    
    
    (21,592
    )
    
    
    (73,348
    )Net cash provided by (used in) financing activities
    
    
    39,116
    
    
    
    11,654
    
    
    
    (3,423
    )
    
    
    5,235
    
    
    
    43,177Other Data:EBITDA(2)
    
    $
    705
    
    
    $
    5,469
    
    
    $
    17,228
    
    
    $
    32,331
    
    
    $
    40,878EBITDA as a % of revenues
    
    
    1.2
    %
    
    
    4.3
    %
    
    
    16.5
    %
    
    
    22.3
    %
    
    
    23.2
    %EBITDA less minority interests(2)
    
    $
    1,352
    
    
    $
    5,995
    
    
    $
    15,319
    
    
    $
    24,978
    
    
    $
    30,431BITDA less minority interests as a % of revenues
    
    
    2.3
    %
    
    
    4.7
    %
    
    
    14.6
    %
    
    
    17.3
    %
    
    
    17.3
    %Number of surgery centers operated as of the end of period(3)
    
    
    16
    
    
    
    20
    
    
    
    24
    
    
    
    34
    
    
    
    44
 As of December 31,1999(1)
    
    2000
    
    2001
    
    2002
    
    2003(in thousands)Consolidated Balance Sheet Data:Working capital
    
    $
    26,293
    
    
    $
    35,347
    
    
    $
    21,706
    
    
    $
    24,839
    
    
    $
    25,979Total assets
    
    
    97,421
    
    
    
    103,759
    
    
    
    100,799
    
    
    
    188,888
    
    
    
    252,784Total long-term debt, less current maturities
    
    
    34,694
    
    
    
    47,986
    
    
    
    39,983
    
    
    
    60,909
    
    
    
    104,108Total stockholders equity
    
    
    41,734
    
    
    
    37,127
    
    
    
    41,610
    
    
    
    86,677
    
    
    
    104,015
   (1)
    
    On June 25, 1999, we acquired Ambulatory Resource Centres, Inc. in a
merger that was accounted for as a reverse acquisition under the purchase
method of accounting. For financial accounting purposes, Ambulatory
Resource Centres was considered to be the acquiring company in the merger
and its historical financial 26




---



##### Table of Contents



statements replaced ours. Accordingly, for the period prior to June 25,
1999, our consolidated financial statements reflect only the results of
Ambulatory Resource Centres.(2)
    
    When we use the term EBITDA, we are referring to operating income
(loss) plus depreciation and amortization. EBITDA less minority
interests represents our portion of EBITDA, after subtracting the
interests of third parties, such as physicians, hospitals and other health
care providers, that own interests in surgery centers that we consolidate
for financial reporting purposes. We consolidate for financial reporting
purposes the financial results of 32 of the 36 surgery centers in which we
own an interest. Our operating strategy involves sharing ownership of our
surgery centers with physicians, physician groups and hospitals. These
third parties own an interest in all but two of the centers in which we
own an interest. We believe that it is preferable to present EBITDA less
minority interests because it excludes the portion of EBITDA attributable
to these third-party interests and clarifies for investors our companys
portion of EBITDA generated by our surgery centers and other operations.We use EBITDA and EBITDA less minority interests as measures of liquidity. We
have included them because we believe that they provide investors with
additional information about our ability to incur and service debt and make
capital expenditures. We also use EBITDA, with some variation in the
calculation, to determine our compliance with some of the covenants under our
senior credit facility, as well as to determine the interest rate and
commitment fee payable under the senior credit facility.EBITDA and EBITDA less minority interests are not measurements of financial
performance or liquidity under generally accepted accounting principles. They
should not be considered in isolation or as a substitute for net income
(loss), operating income (loss), cash flows from operating, investing or
financing activities, or any other measure calculated in accordance with
generally accepted accounting principles. The items excluded from EBITDA and
EBITDA less minority interests are significant components in understanding
and evaluating financial performance and liquidity. Our calculation of EBITDA
and EBITDA less minority interests may not be comparable to similarly titled
measures reported by other companies.The following table reconciles EBITDA and EBITDA less minority interests to
net cash (used in) provided by operating activities: Year Ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003(in thousands)(unaudited)EBITDA
    
    $
    705
    
    
    $
    5,469
    
    
    $
    17,228
    
    
    $
    32,331
    
    
    $
    40,878Minority interests in (income) loss of consolidated subsidiaries
    
    
    647
    
    
    
    526
    
    
    
    (1,909
    )
    
    
    (7,353
    )
    
    
    (10,447
    )EBITDA less minority interests
    
    
    1,352
    
    
    
    5,995
    
    
    
    15,319
    
    
    
    24,978
    
    
    
    30,431Depreciation and amortization
    
    
    (3,351
    )
    
    
    (7,503
    )
    
    
    (7,743
    )
    
    
    (7,836
    )
    
    
    (9,295
    )Interest expense, net
    
    
    (1,189
    )
    
    
    (3,234
    )
    
    
    (2,600
    )
    
    
    (4,625
    )
    
    
    (5,782
    )Income taxes
    
    
    (72
    )
    
    
    (135
    )
    
    
    (287
    )
    
    
    (215
    )
    
    
    2,170Net income (loss)
    
    
    (3,260
    )
    
    
    (4,877
    )
    
    
    4,689
    
    
    
    12,302
    
    
    
    17,524Depreciation and amortization
    
    
    3,351
    
    
    
    7,503
    
    
    
    7,743
    
    
    
    7,836
    
    
    
    9,295Impairment and loss on disposal of long-lived assets
    
    
    
    
    
    
    6,043
    
    
    
    385
    
    
    
    492
    
    
    
    437Gain on sale of long-lived assets
    
    
    
    
    
    
    
    
    
    
    (2,346
    )
    
    
    (457
    )
    
    
    (571
    )Minority interests in (income) loss of consolidated subsidiaries
    
    
    (647
    )
    
    
    (526
    )
    
    
    1,909
    
    
    
    7,353
    
    
    
    10,447Noncash compensation expense
    
    
    565
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Distributions to minority partners
    
    
    (348
    )
    
    
    (511
    )
    
    
    (2,186
    )
    
    
    (6,177
    )
    
    
    (10,690
    )Loss (income) on equity investments
    
    
    55
    
    
    
    466
    
    
    
    192
    
    
    
    (541
    )
    
    
    (402
    )Provision for bad debts
    
    
    482
    
    
    
    1,717
    
    
    
    1,055
    
    
    
    4,843
    
    
    
    2,748Changes in operating assets and liabilities, net of effects of
acquisitions and dispositions:Accounts receivable
    
    
    (2,867
    )
    
    
    (2,887
    )
    
    
    (1,052
    )
    
    
    (5,694
    )
    
    
    (3,537
    )Other current assets
    
    
    21
    
    
    
    (568
    )
    
    
    (2,424
    )
    
    
    (3,080
    )
    
    
    (642
    )Other current liabilities
    
    
    (1,657
    )
    
    
    474
    
    
    
    473
    
    
    
    4,893
    
    
    
    2,572Net cash (used in) provided by operating activities
    
    $
    (4,305
    )
    
    $
    6,834
    
    
    $
    8,438
    
    
    $
    21,770
    
    
    $
    27,181
  (3)
    
    Includes surgery centers that we manage but in which we do not have an
ownership interest. 27




---



##### Table of Contents



Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with Selected Financial
Data and our audited consolidated financial statements and related notes
included elsewhere in this report. This discussion contains forward-looking
statements that involve risks and uncertainties. For additional information
regarding some of the risks and uncertainties that affect our business and the
industry in which we operate, please read  Risk Factors. Our actual results
may differ materially from those estimated or projected in any of these
forward-looking statements. Executive Overview We own and operate a network of surgery centers in 19 states. As of March
15, 2004, we owned and operated 36 surgery centers and managed eight additional
surgery centers. We own a majority interest in 26 of the 36 surgery centers,
and consolidate 32 of these centers for financial reporting purposes. Our
surgery centers include three facilities that are licensed as hospitals, two of
which we own and one of which we manage. In addition to our surgery centers, we
also operate a diagnostic center and manage three physician networks, including
two physician networks in markets in which we operate surgery centers. On September 16, 2002, we reincorporated in Delaware. We were originally
incorporated in Tennessee in January 1996 under the name UniPhy Healthcare,
Inc. and focused on the development and management of physician networks. On
June 25, 1999, we acquired Ambulatory Resource Centres, Inc., an owner and
operator of surgery centers, and changed our name to Symbion, Inc. Our
acquisition of Ambulatory Resource Centres was accounted for as a reverse
acquisition under the purchase method of accounting and, for financial
reporting purposes, Ambulatory Resources Centres was considered to be the
acquiring company and its historical financial statements replaced ours.
Accordingly, for periods prior to June 25, 1999, our consolidated financial
statements reflect only the results of Ambulatory Resource Centres. Since our acquisition of Ambulatory Resource Centres, we have focused on
developing, acquiring and managing surgery centers, and have grown our
operations from 14 to 44 surgery centers. During that period, we terminated all
but three of our management agreements with physician networks and transferred
our assets and liabilities relating to those terminated agreements to the
physician networks in exchange for cash and our previously issued securities.
We also modified our agreements with two of the remaining physician networks to
require us to provide only management services. As a result of these actions,
we now focus our business on developing, acquiring and managing surgery centers
and it may be difficult to compare our historical operating results from period
to period. We anticipate acquiring about two to three centers and developing three to
four centers annually during the next three to five years. A typical surgery
center costs us between $2.0 million and $7.0 million to develop and equip,
excluding costs of real estate. This cost varies depending on the range of
specialties that will be provided at the facility and the number of operating
and treatment rooms. We typically fund about 70% of the development costs of a
new surgery center with borrowings under our senior credit facility, and the
remainder with equity contributed by us and the other owners of the center. Our
ownership interests in surgery centers that we have developed range from 25% to
82%, although we anticipate that we will own primarily majority interests in
future developments. The remaining owners are typically local physicians,
physician groups or hospitals. We expect that our acquisition and development
program will require substantial capital resources, which we estimate to range
from $30.0 million to $50.0 million per year over the next three years. In
addition, the operations of our existing facilities will require ongoing
capital expenditures. We expect that our capital needs will be financed through
a combination of cash flow from operations, bank debt and the issuance of debt
and equity securities. We generate revenue and cash through patient service revenues, physician
service revenues and other service revenues. Patient service revenues are
revenues for surgical or diagnostic procedures performed in each of the surgery
centers that we consolidate for financial reporting purposes. The fee charged
for a procedure varies depending on the procedure, but usually includes all
charges for usage of an operating room, a recovery room, special equipment,
supplies, nursing staff and medications. The fee does not include professional
fees charged by the patients surgeon, anesthesiologist or other attending
physician, which are billed directly by such physicians to the patient or
third-party payor. Patient service revenues are recognized on the date of
service, net of estimated contractual adjustments and discounts for third-party
payors, including Medicare and Medicaid. Changes in 28




---



##### Table of Contents



estimated contractual adjustments and discounts are recorded in the period
of change. Physician service revenues are revenues from physician networks
consisting of reimbursed expenses, plus participation in the excess of revenue
over expenses of the physician networks, as provided for in our service
agreements with our physician networks. Reimbursed expenses include the costs
of personnel, supplies and other expenses incurred to provide the management
services to the physician networks. We recognize physician service revenues in
the period in which reimbursable expenses are incurred and in the period in
which we have the right to receive a percentage of the amount by which a
physician networks revenues exceed its expenses. Physician service revenues
are based on net billings with any changes in estimated contractual adjustments
reflected in service revenues in the subsequent period. Other service revenues
consists of management and administrative service fees derived from the
non-consolidated facilities that we account for under the equity method,
management of surgery centers in which we do not own an interest and management
services we provide to physician networks for which we are not required to
provide capital or additional assets. The following table summarizes our revenues by service type as a
percentage of revenues for the periods indicated: Year Ended December 31,2001
    
    2002
    
    2003Patient service revenues
    
    
    60
    %
    
    
    90
    %
    
    
    90
    %Physician service revenues
    
    
    29
    
    
    
    2
    
    
    
    2Other service revenues
    
    
    11
    
    
    
    8
    
    
    
    8Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 The shift in revenues from physician service revenues to patient service
revenues is the result of our focus on our surgery center operations and the
termination and modification of our management agreements with physician
networks in which we recorded physician service revenues. We intend to continue
our focus on surgery center operations and revenues. Other service revenues as
a percentage of total revenues has decreased from 11% in 2001 to 8% in 2003
primarily as a result of modifications to two of our management agreements with
physician networks. Recent Developments On February 11, 2004, we completed an initial public offering of 8,280,000
shares of common stock at a price of $15.00 per share, which included 1,080,000
shares sold following exercise in full by the underwriters of an option to
purchase the additional shares, that we granted to the underwriters to cover
over-allotments. We received net proceeds of $115.5 million in the offering,
after deducting underwriting discounts and commissions. We used the net
proceeds to repay indebtedness and to pay holders of our Series A and Series B
convertible preferred stock in connection with the conversion of those shares
to common stock upon the completion of the offering. See Market for
Registrants Common Equity, Related Stockholders Matters and Issuer Purchases
of Equity Securities  Use of Proceeds from Registered Securities. Acquisitions, Developments and Divestitures Acquisitions and Developments During 2003, we acquired five centers, including one licensed as a
hospital, opened five newly-developed surgery centers and assumed a management
agreement for one additional surgery center licensed as a hospital. We entered
into management agreements with each of these surgery centers and have a
majority ownership interest in four of these centers. Our investment related to
these centers was about $52.6 million, including about $50.7 million funded
with debt, and the assumption of about $873,200 in long-term debt. In addition,
we issued warrants to purchase 14,101 shares of our common stock. In addition, during 2003, we acquired an additional 39% ownership interest
in Dry Creek Imaging Center, a diagnostic imaging center that is adjacent to
our surgery center in the Denver, Colorado market, for about $1.5 million in
cash. We now own 90% of the center. We also acquired an additional 16.4%
ownership interest in Village SurgiCenter in Erie, Pennsylvania, for about $1.0
million in cash. We now own about 82% of the center. 29




---



##### Table of Contents



In April 2002, we acquired Physicians Surgical Care, Inc., which had
ownership interests in and managed seven surgery centers, including one
licensed as a hospital. A subsidiary of Physicians Surgical Care assisted in
the development of an additional surgery center to which we began providing
administrative services when it opened in October 2002. In connection with the
acquisition, we issued an aggregate of 624,919 shares of our common stock,
4,341,726 shares of our Series A convertible preferred stock and 2,604,590
shares of our Series B convertible preferred stock. In addition, we agreed to
issue up to an additional 494,297 shares of our common stock to the former
stockholders of Physicians Surgical Care based on the 2003 financial results of
one of the Physicians Surgical Care surgery centers. In March 2004, we calculated the number of shares to be issued to the former
stockholders of Physicians Surgical Care and submitted the calculation to the
stockholder agent for approval. In addition to Physicians Surgical Care, we acquired ownership interests
in three additional surgery centers and opened two newly-developed surgery
centers during 2002. We entered into management agreements with each of these
surgery centers and have majority ownership interests in four of the centers.
Our total investment related to these centers was about $24.6 million,
including about $16.8 million funded with debt. During 2001, we acquired ownership interests in three surgery centers and
opened one additional newly-developed surgery center and one diagnostic imaging
center. We entered into management agreements with each of these surgery
centers and have majority ownership interests in all of these centers. Our
total investment related to these centers was about $21.9 million, consisting
of about $15.8 million in cash, of which about $8.3 million was funded with
debt related to the acquisitions, $5.7 million of debt incurred by the
newly-developed surgery center and 28,623 shares of our common stock. All of our acquisitions were accounted for under the purchase method of
accounting and, accordingly, the results of operations of these acquired
surgery centers are reflected on a consolidated or equity basis in our
consolidated financial statements from the respective dates of their
acquisitions. Divestitures Effective August 8, 2003, we sold a 33% interest in Physicians SurgiCenter
of Houston in Houston, Texas to Memorial Hermann Hospital for about $825,000 in
cash. We now own an approximately 38% interest in the center. Memorial Hermann
Hospital has the right to require us to repurchase its interest at any time,
for an appraised fair market value. We have reflected this repurchase
obligation as a liability in our consolidated balance sheet at December 31,
2003. We are negotiating with the hospital to amend this right so that it will
not be triggered unless, among other reasons, the center relocates, closes,
ceases business or loses its license to provide outpatient surgical services,
we materially breach the partnership agreement and fail to cure the breach or
the partnership incurs more than an agreed upon amount of indebtedness. We
cannot assure you that we will be able to obtain this amendment. Effective May 20, 2003, the surgery center we managed in Knoxville,
Tennessee closed following the opening of the new surgery center in this market
we developed with the same organization, University Health System, Inc. We have
a 25% ownership interest in the new surgery center. Effective September 6, 2002, we sold all of our ownership interest in a
surgery center and terminated our management agreement with the surgery center.
In consideration for our ownership interest and termination of the management
agreement, we received about $1.4 million in cash in October 2002. In addition,
we were released from a guaranty of about $4.6 million of debt incurred by the
center. We recorded a charge in 2002 of about $380,000 in connection with this
transaction. Effective May 31, 2002, we sold all of our ownership interest in a surgery
center and terminated our management agreement with the surgery center. In
consideration for our ownership interest, we were released from a guaranty of
the facility lease for the surgery center and the purchaser assumed about $1.1
million of liabilities. We recorded a net loss in 2002 of about $8,000 in
connection with this transaction. Since January 1, 2001, we terminated our management agreements with three
physician networks and transferred our assets and liabilities relating to those
terminated agreements to these physician networks. Prior to termination of 30




---



##### Table of Contents



these management agreements, we recognized management fees earned and
expenses reimbursed under these management agreements as physician service
revenues. We also modified our management agreements with two physician
networks to require us to provide only management services, which are reflected
as other service revenues, and we transferred certain related accounts
receivable, prepaid expenses and liabilities to these physician networks. In
exchange for these terminations, modifications and asset transfers, we received
an aggregate of about $22.6 million in cash, 227,381 shares of our common
stock, a promissory note in the principal amount of $400,000 and the
cancellation of a convertible subordinated debenture in the principal amount of
$2.7 million that we had previously issued to one of these physician networks.
In addition, the physician networks assumed about $1.8 million in liabilities.
In 2001, we recorded gains on the sale of long-lived assets of $2.3 million in
connection with the termination and modification of these management
agreements. In January 2002, we terminated the last of these management
agreements. The loss of $255,000 on termination of this management agreement
was recorded in 2001 and is included in the impairment and loss on disposal of
long-lived assets of $385,000 in 2001. Critical Accounting Policies Our accounting policies are described in Note 2 of our consolidated
financial statements included elsewhere in this report. In preparing our
consolidated financial statements in conformity with accounting principles
generally accepted in the United States, our management must make estimates and
assumptions that affect the reported amounts of assets and liabilities and
related disclosures at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Certain
accounting estimates are particularly sensitive because of their complexity and
the possibility that future events affecting them may differ materially from
our current judgments and estimates. We believe that the following critical
accounting policies are important to the portrayal of our financial condition
and results of operations, and require our managements subjective or complex
judgment because of the sensitivity of the methods, assumptions and estimates
used. This listing of critical accounting policies is not intended to be a
comprehensive list of all of our accounting policies. In many cases, the
accounting treatment of a particular transaction is specifically dictated by
generally accepted accounting principles, with no need for managements
judgment regarding accounting policy. Our actual results could differ from
those estimates. Consolidation and Control Our consolidated financial statements include our accounts and those of
our wholly-owned subsidiaries, as well as our interests in facilities that we
control through our ownership of a majority voting interest or other rights
granted to us by contract as the sole general partner or manager to manage and
control the business. The rights of the limited partners or minority members in
these surgery centers are generally limited to those that protect their
ownership interests, including the right to approve of the issuance of new
ownership interests, and those that protect their financial interests,
including the right to approve the acquisition or divestiture of significant
assets or the incurrence of debt that physician limited partners or members are
required to guarantee on a pro rata basis based upon their respective ownership
interests or that exceeds 20% of the fair market value of the centers assets.
All significant intercompany balances and transactions, including management
fees from consolidated centers, are eliminated in consolidation. We also hold non-controlling interests in some surgery centers over which
we exercise significant influence. Significant influence includes financial
interests ranging from 25% to 42% and duties, rights and responsibilities for
the day-to-day management of the surgery center. These non-controlling
interests are accounted for under the equity method. In addition, at December 31, 2003, as a result of Interpretation No. 46,
Consolidation of Variable Interest Entities (VIEs), an Interpretation of
Accounting Research Bulletin No. 51 (FIN 46), we consolidated for financial
reporting purposes a surgery center in which we do not own an interest. Under
FIN 46, the surgery center is considered a VIE and we are the primary
beneficiary. Therefore, under FIN 46 we are required to consolidate this
surgery center for financial reporting purposes. We currently do not expect
the consolidation of this surgery center to have a material impact on our
results of operations. At the time of adoption of FIN 46, we increased current
assets by approximately $934,000, decreased long-term assets by approximately
$871,000 and increased current liabilities by approximately $63,000. The
adoption of FIN 46 had no effect on our results of operations. 31




---



##### Table of Contents



Revenue Recognition Our revenues are comprised of patient service revenues, physician service
revenues and other service revenues. Our patient service revenues relate to
fees charged for surgical or diagnostic procedures performed at facilities that
we consolidate for financial reporting purposes. These fees are billed either
to the patient or a third-party payor. Our fees vary depending on the
procedure, but usually include all charges for usage of an operating room, a
recovery room, equipment, supplies, nursing staff and medications. Our fees do
not include professional fees charged by the patients surgeon,
anesthesiologist or other attending physician, which are billed directly by the
physicians to the patient or third-party payor. We recognize patient service
revenues when the related procedures are performed. Our physician service revenues relate to fees we derive from managing
physician networks for which we also have a contractual obligation to provide
capital and additional assets. Currently we have such an obligation to only one
group of six physicians included in one of the three physician networks we
manage. We expect our physician service revenues to decline as a percentage of
our total revenues as we continue to focus on our surgery center business.
Physician service revenues consist of reimbursed expenses and a percentage of
the amount by which each physician networks revenues exceed its expenses, as
defined by our management agreement with each physician network. We recognize
physician service revenues in the period in which reimbursable expenses are
incurred and the period in which we have rights to a percentage of the amount
by which a physician networks revenues exceed its expenses. Our other service revenues are comprised of management and administrative
service fees we derive from non-consolidated facilities that we account for
under the equity method, management of surgery centers in which we do not own
an interest and management services we provide to physician networks for which
we are not required to provide capital or additional assets. The fees we derive
from these management arrangements are based on a pre-determined percentage of
the revenues of each surgery center and physician network. We recognize other
service revenues in the period in which services are rendered. Allowance for Contractual Adjustments and Doubtful Accounts Our patient service revenues are recorded net of estimated contractual
allowances from third-party payors, which we estimate based on the historical
trend of our surgery centers cash collections and contractual write-offs,
accounts receivable agings, established fee schedules, relationships with
payors and procedure statistics. We estimate our allowances for bad debts using
similar information and analysis. While we believe that our allowances for
contractual adjustments and bad debts are adequate, if the actual write-offs
are significantly different from our estimates, our results of operations may,
in turn, be significantly impacted. Our net accounts receivable reflected
allowances for doubtful accounts of $12.5 million and $11.6 million at December
31, 2003 and 2002, respectively. We derive all of our physician service revenues from physician networks
with which we have service agreements. Physician service revenues from
physician networks consist of reimbursed expenses, plus participation in the
excess of revenue over expenses of the physician networks as provided for in
the service agreements. Reimbursed expenses include the costs of our personnel,
supplies and other expenses incurred to provide the management services to the
physician networks. We recognize physician service revenues in the period in
which reimbursable expenses are incurred and in the period in which we have
rights to a percentage of the amount by which a physician networks revenues
exceed its expenses. Physician service revenues are based on net billings of
the physician network with any changes in estimated contractual adjustments and
bad debts reflected in physician service revenues in the subsequent period. Our
physician service revenues would be impacted by changes in estimated
contractual adjustments and bad debts recorded by the physician networks. The following table summarizes our days sales outstanding as of the dates
indicated: As of December 31,2001
    
    2002
    
    2003Days sales outstanding
    
    
    46
    
    
    
    44
    
    
    
    45
 Our target for days sales outstanding related to patient service revenues
ranges from 40 days to 47 days. Our days sales outstanding for the dates
presented in the table above are within the target range. 32




---



##### Table of Contents



Our collection policies and procedures are based on the type of payor,
size of claim and estimated collection percentage for each patient account. The
operating systems used to manage our patient accounts provide for an aging
schedule in 30-day increments, by payor, physician and patient. The operating
systems generate reports that assist in the collection efforts by prioritizing
patient accounts. Collection efforts include direct contact with insurance
carriers or patients, written correspondence and the use of legal or collection
agency assistance, as required. We review the standard aging schedule, by facility, to determine the
appropriate provision for doubtful accounts. This review is supported by an
analysis of the actual net revenues, contractual adjustments and cash
collections received. If our internal collection efforts are unsuccessful, we
manually review patient accounts with balances of $25 or more. We then classify
the accounts based on any external collection efforts we deem appropriate. An
account is written-off only after we have pursued collection with legal or
collection agency assistance or otherwise deemed an account to be
uncollectible. Typically, accounts will be outstanding a minimum of 120 days
before being written-off. Income Taxes We use the asset and liability method to account for income taxes. Under
this method, deferred income tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. If a net
operating loss carryforward exist, we make a determination on whether that net
operating loss carryforward will be utilized in the future. A valuation
allowance will be established for certain net operating loss carry forwards
where their recoverability is deemed to be uncertain. The carrying value of the
net deferred tax assets assumes that we will be able to generate sufficient
future taxable income in certain tax jurisdictions, based on estimates and
assumptions. If these estimates and related assumptions change in the future,
we will be required to adjust our deferred tax valuation allowances. During
2003, we recognized additional deferred tax assets of approximately $3.1
million. Long-lived Assets, Goodwill and Intangible Assets When events, circumstances and operating results indicate that the
carrying values of certain long-lived assets and the related identifiable
intangible assets might be impaired, we assess whether the carrying value of
the assets will be recovered through undiscounted future cash flows expected to
be generated from the use of the assets and their eventual disposition. If the
assessment indicates that the recorded cost will not be recoverable, that cost
will be reduced to estimated fair value. Estimated fair value will be
determined based on a discounted future cash flow analysis. Using this
methodology, in 2001, we recorded an impairment charge of $130,000 related to
three of our surgery centers. During 2003, we recorded an impairment charge of
$275,000 related to software that we purchased but no longer intend to use. We
believe that there has been no other impairment. Goodwill represents the excess of purchase price over fair value of net
tangible assets acquired. Effective January 1, 2002, the amortization of all
goodwill was discontinued upon the adoption of Statement of Financial
Accounting Standards, or SFAS, No. 142, Goodwill and Other Intangible Assets.
SFAS No. 142 no longer permits the amortization of goodwill and other
indefinite lived intangible assets over a set period, rather these assets must
be tested for impairment at least annually using a fair value method.
Impairment is measured at the reporting unit level using a discounted cash
flows model to determine the fair value of the reporting units. We will perform
a goodwill impairment test whenever events or changes in facts or circumstances
indicate that impairment may exist, or at least annually during the fourth
quarter each year. 33




---



##### Table of Contents



Results of Operations The following table summarizes certain statements of operations items for
each of the three years ended December 31, 2001, 2002 and 2003. The table also
shows the percentage relationship to total revenues for the periods indicated: Year Ended December 31,2001
    
    2002
    
    2003% of
    
    
    
    
    
    % of
    
    
    
    
    
    % ofAmount
    
    Revenues
    
    Amount
    
    Revenues
    
    Amount
    
    Revenues(dollars in thousands)Revenues
    
    $
    104,704
    
    
    
    100.0
    %
    
    $
    144,688
    
    
    
    100.0
    %
    
    $
    176,269
    
    
    
    100.0
    %Cost of revenues
    
    
    75,783
    
    
    
    72.4
    
    
    
    93,692
    
    
    
    64.8
    
    
    
    117,305
    
    
    
    66.5General and administrative expense
    
    
    12,407
    
    
    
    11.8
    
    
    
    14,328
    
    
    
    9.9
    
    
    
    15,874
    
    
    
    9.0Depreciation and amortization
    
    
    7,743
    
    
    
    7.4
    
    
    
    7,836
    
    
    
    5.4
    
    
    
    9,295
    
    
    
    5.3Provision for doubtful accounts
    
    
    1,055
    
    
    
    1.0
    
    
    
    4,843
    
    
    
    3.3
    
    
    
    2,748
    
    
    
    1.6Loss (income) on equity investments
    
    
    192
    
    
    
    0.2
    
    
    
    (541
    )
    
    
    (0.3
    )
    
    
    (402
    )
    
    
    (0.2
    )Impairment and loss on disposal of
long-lived assets
    
    
    385
    
    
    
    0.3
    
    
    
    492
    
    
    
    0.3
    
    
    
    437
    
    
    
    0.2Gain on sale of long-lived assets
    
    
    (2,346
    )
    
    
    (2.2
    )
    
    
    (457
    )
    
    
    (0.3
    )
    
    
    (571
    )
    
    
    (0.3
    )Total operating expenses
    
    
    95,219
    
    
    
    90.9
    %
    
    
    120,193
    
    
    
    83.1
    %
    
    
    144,686
    
    
    
    82.1
    %Operating income
    
    
    9,485
    
    
    
    9.1
    
    
    
    24,495
    
    
    
    16.9
    
    
    
    31,583
    
    
    
    17.9Minority interests in income loss
of consolidated subsidiaries
    
    
    (1,909
    )
    
    
    (1.8
    )
    
    
    (7,353
    )
    
    
    (5.1
    )
    
    
    (10,447
    )
    
    
    (5.9
    )Interest expense, net
    
    
    (2,600
    )
    
    
    (2.5
    )
    
    
    (4,625
    )
    
    
    (3.1
    )
    
    
    (5,782
    )
    
    
    (3.3
    )Income before income taxes
    
    
    4,976
    
    
    
    4.8
    
    
    
    12,517
    
    
    
    8.7
    
    
    
    15,354
    
    
    
    8.7Provision (benefit) for income taxes
    
    
    287
    
    
    
    0.3
    
    
    
    215
    
    
    
    0.2
    
    
    
    (2,170
    )
    
    
    (1.2
    )Net income
    
    $
    4,689
    
    
    
    4.5
    %
    
    $
    12,302
    
    
    
    8.5
    %
    
    $
    17,524
    
    
    
    9.9
    %
 Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 In 2003, our revenues increased 21.8% to $176.3 million from $144.7
million for 2002. Net income increased 42.3% to $17.5 million from $12.3
million for 2002. Our financial results in 2003 were driven by the addition of
ten new centers and organic growth at existing centers. Results for 2003
included a benefit for income taxes of approximately $2.2 million, which
primarily related to the recognition of deferred tax assets of approximately
$3.1 million. The 2003 results also included the impact of higher interest
expense and prepayment penalties incurred in connection with the refinancing of
outstanding indebtedness, which was completed in the third quarter of 2003. We
paid off the higher cost indebtedness with the proceeds from our initial public
offering completed in February 2004. Revenues. Revenues increased 21.8% from $144.7 million for 2002 to $176.3
million for 2003. This increase was primarily the result of a $21.4 million
increase in patient service revenues from surgery centers acquired or developed
since January 1, 2002 and a $10.2 million increase in patient service revenues
from facilities that we owned throughout 2002 and 2003 (which we refer to as
same store facilities). The increase in same store revenues was primarily the
result of a 4.9% increase in the number of cases during 2003. Cost of Revenues. Cost of revenues increased 25.2% from $93.7 million for
2002 to $117.3 million for 2003. The increase was primarily the result of a
$17.0 million increase in cost of revenues from surgery centers acquired or
developed since January 1, 2002. The increase in cost of revenues was also the
result of a $6.6 million increase in cost of revenues from same store
facilities. The increase in same store cost of revenues was primarily the
result of the increase in the number of cases performed during 2003 as compared
with 2002 and a $1.0 million increase in our general and professional liability
expense during 2003. The general and professional liability expense includes
reserves for an estimate of losses limited to deductibles and self-insured
retention related to claims incurred and reported in the policy period and an
estimate for unlimited losses related to claims incurred but not yet reported
during the policy period. The accrual for general and professional liability
expense was increased during the third quarter based on managements analysis
of an independent actuarial study performed in the third quarter of 2003 by
Casualty Actuarial Consultants, Inc. The $17.0 million increase in costs of
revenues was primarily related to 34




---



##### Table of Contents



increases in salaries and wages of $6.2 million, supplies expense of $4.9
million, professional and medical fees of $1.4 million, rent and lease expense
of $1.3 million and other cost of revenues of $3.2 million. As a percentage of
revenues, cost of revenues increased from 64.8% for 2002 to 66.5% for 2003,
primarily as a result of surgery centers acquired or developed during
2003 and the increase in general and professional liability
expense. General and Administrative Expenses. General and administrative expenses
increased 11.2% from $14.3 million for 2002 to $15.9 million for 2003. The
increase in general and administrative expense was primarily related to the
overall growth in the number of surgery centers. As a percentage of revenues,
general and administrative expense decreased from 9.9% for 2002 to 9.0% for
2003. This decrease was primarily the result of improved economies of scale. Depreciation and Amortization. Depreciation and amortization expense
increased 19.2% from $7.8 million for 2002 to $9.3 million for 2003. The
increase in depreciation and amortization expense was primarily related to
surgery centers acquired or developed since January 1, 2002. As a percentage of
revenues, depreciation and amortization expense decreased from 5.4% for 2002 to
5.3% for 2003. Provision for Doubtful Accounts. Provision for doubtful accounts
decreased $2.1 million from $4.8 million for 2002 to $2.7 million for 2003.
This decrease can be attributed to improved cash collections primarily in the
earlier months of 2003, related to the conversion of surgery centers we
acquired in 2002 to our cash collections processes and improved collections of
older accounts receivable from our same store facilities. As a percentage of
revenues, the provision for doubtful accounts decreased from 3.3% for 2002 to
1.6% for 2003. Operating Income. Operating income increased 28.9% from $24.5 million for
2002 to $31.6 million for 2003. This increase was the result of an increase of
$4.4 million from surgery centers acquired or developed since January 1, 2002
and a $4.2 million increase from same store facilities, which was partially
offset by an increase in general and administrative expenses during 2003. As a
percentage of revenues, operating income increased from 16.9% for 2002 to 17.9%
for 2003. Minority Interests in Income of Consolidated Subsidiaries. Minority
interests in income of consolidated subsidiaries increased 40.5% from $7.4
million for 2002 to $10.4 million for 2003, as a result of a $1.9 million
increase in minority interests for surgery centers acquired or developed since
January 1, 2002 and a $1.2 million increase in minority interests for same
store facilities. Interest Expense, Net of Interest Income. Interest expense, net of
interest income, increased 25.0% from $4.6 million for 2002 to $5.8 million for
2003. The increase in interest expense was primarily the result of higher
interest expense and prepayment penalties incurred in connection with the
refinancing of outstanding indebtedness. Provision (Benefit) for Income Taxes. The provision (benefit) for income
taxes decreased from a $215,000 provision for 2002 to a $2.2 million benefit
for 2003. The 2003 results included the recognition of deferred tax
assets of
approximately $3.1 million. Net Income. Net income increased 42.4% from $12.3 million for 2002 to
$17.5 million for 2003, primarily as a result of surgery centers acquired or
developed since January 1, 2002, an increase in cases performed in 2003
compared to 2002, improved economies of scale and the $3.1 million deferred tax
assets recorded during 2003. As a percentage of revenues, net income increased
from 8.5% for 2002 to 9.9% for 2003. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 In 2002, our revenues increased 38.2% to $144.7 million from $104.7
million for 2001. Net income for 2002 increased to $12.3 million from $4.7
million for 2001. Results for 2002 reflect increased revenues from surgery
centers that we acquired or developed since January 1, 2001 and the continued
shift in revenues as a result of our focus on our surgery center operations and
the termination or modification of our management agreements with physician
networks. Revenues. Revenues increased 38.2% from $104.7 million for 2001 to $144.7
million for 2002. This increase was primarily the result of a $65.2 million
increase in patient service revenues from surgery centers acquired or 35




---



##### Table of Contents



developed since January 1, 2001 and an increase of $4.8 million from
facilities that we owned throughout 2001 and 2002 (which we refer to as same
store facilities). This increase was partially offset by a decrease in
physician service revenues of $30.0 million, which resulted from termination
and modification of management agreements with physician networks for which we
recorded physician service revenues. Cost of Revenues. Cost of revenues increased 23.6% from $75.8 million for
2001 to $93.7 million for 2002. The increase was primarily the result of a
$43.3 million increase for surgery centers acquired or developed since January
1, 2001. This increase was partially offset by a decrease of $25.6 million
resulting from termination and modification of management agreements with
physician networks. The $43.3 million increase in costs of revenues was
primarily related to increases in salaries and wages of $15.3 million, supplies
expense of $12.7 million, professional and medical fees of $3.6 million, rent
and lease expense of $4.1 million and other cost of revenues of $7.6 million.
The $25.6 million decrease in cost of revenues was primarily related to
decreases in salaries and wages of $14.2 million, supplies expense of $3.3
million, professional and medical fees of $2.2 million, rent and lease expense
of $3.0 million and other cost of revenues of $2.9 million. As a percentage of
revenues, cost of revenues decreased from 72.4% for 2002 to 64.8% for 2002,
primarily as a result of surgery centers representing a higher percentage of
our total operations and generating higher operating margins than our
management or physician networks, as well as improved operating efficiencies at
same store facilities. General and Administrative Expenses. General and administrative expenses
increased 15.3% from $12.4 million for 2001 to $14.3 million for 2002. This
increase was primarily related to the overall growth in the number of surgery
centers. As a percentage of revenues, general and administrative expense
decreased from 11.8% for 2001 to 9.9% for 2002. This decrease was primarily the
result of improved economies of scale. Depreciation and Amortization. Depreciation and amortization expense
increased by 1.2% from $7.7 million for 2001 to $7.8 million for 2002. This
increase was primarily the result of a $3.2 million increase in depreciation
and amortization expense related to surgery centers acquired or developed since
January 1, 2001, which was partially offset by a $1.8 million decrease in
depreciation and amortization expense resulting from termination and
modification of management agreements with physician networks. In addition, on
January 1, 2002 we adopted SFAS 142, Goodwill and Other Intangible Assets,
which required goodwill and indefinite-lived intangible assets to no longer be
amortized, but instead to be tested at least annually for impairment, resulting
in a decrease of depreciation and amortization expense of $1.3 million. As a
percentage of revenues, depreciation and amortization expense decreased from
7.4% for 2001 to 5.4% for 2002. Provision for Doubtful Accounts. Provision for doubtful accounts
increased $3.7 million from $1.1 million for 2001 to $4.8 million for 2002. We
increased our allowance for doubtful accounts in 2002 because of uncertainties
about the collectibility of some of the accounts receivable of surgery centers
owned by Physicians Surgical Care, which we acquired in April 2002, and the
other surgery centers we acquired in 2002. These uncertainties relate to the
process of converting these surgery centers to our policies and procedures
related to collections during the second, third and fourth quarters of 2002.
This resulted in an increase in the provision for doubtful accounts. The
completion of this conversion process resulted in a decrease in the provision
for doubtful accounts during the first and second quarters of 2003. As a
percentage of revenues, the provision for doubtful accounts increased from 1.0%
for 2001 to 3.3% for 2002. Gain on Sale of Long-Lived Assets. Gain on sale of long-lived assets
decreased from $2.3 million in 2001 to $457,000 in 2002. This decrease was due
to a gain of approximately $2.3 million recorded in 2001 related to the
termination of a management agreement with a physician network. Operating Income. Operating income increased from $9.5 million for 2001
to $24.5 million for 2002. This increase was primarily the result of a $15.6
million increase in operating income from surgery centers acquired or developed
since January 1, 2001 and an increase of $5.9 million from same store
facilities, which was partially offset by a $1.9 million increase in general
and administrative expenses and a $2.6 million decrease in operating income
resulting from termination and modification of management agreements. The
increase was also partially offset by a $2.0 million decrease in gain on sale
of long-lived assets, net of impairment and loss on sale of long-lived assets.
As a percentage of revenues, operating income increased from 9.1% for 2001 to
16.9% for 2002. 36




---



##### Table of Contents



Minority Interests in Income of Consolidated Subsidiaries. Minority
interests in income of consolidated subsidiaries increased from $1.9 million
for 2001 to $7.4 million for 2002. This increase was primarily the result of an
increase in the number of facilities in which we hold less than 100% of the
ownership interests and consolidate for financial reporting purposes. Interest Expense, Net of Interest Income. Interest expense, net of
interest income, increased 76.9% from $2.6 million for 2001 to $4.6 million for
2002 as a result of an increase in long-term debt, primarily related to surgery
centers acquired or developed since January 1, 2001. Provision for Income Taxes. Provision for income taxes decreased 25.1%
from $287,000 for 2001 to $215,000 for 2002, primarily related to a decrease in
state income taxes assessed by certain states in which our surgery centers
operate and a decrease in pre-tax income. Net operating loss carryforwards
totaled $23.2 million and $17.2 million, respectively, at December 31, 2001 and
2002. We experienced cumulative losses for income tax purposes for the three
years ended December 31, 2001 and 2002. Given our lack of history of income for
income tax purposes and significant net operating losses, we established a
valuation allowance for the entire amount of the net deferred tax assets at
those dates because of the uncertainty of the ultimate realization of the net
deferred tax assets. Net Income. Net income increased from $4.7 million for 2001 to $12.3
million for 2002. As a percentage of revenues, net income increased from 4.5%
for 2001 to 8.5% for 2002, primarily related to an $8.1 million increase from
surgery centers acquired or developed since January 1, 2001, a $6.3 million
increase from same store facilities, which was partially offset by a decrease
in net income of $2.9 million resulting from the termination and modification
of management agreements with physician networks, a $2.0 million gain on the
sale of long-lived assets recorded in 2001, along with an increase in general
and administrative expenses of $1.9 million. 37




---



##### Table of Contents



Quarterly Results of Operations The following tables present a summary of our unaudited quarterly
consolidated results of operations for each of the four quarters in 2002 and
2003. The unaudited financial statements include all adjustments, consisting of
normal recurring adjustments, necessary for a fair statement of such
information when read in conjunction with our audited consolidated financial
statements and related notes. Our quarterly operating results have varied in
the past, may continue to do so and are not necessarily indicative of results
for any future period. 2003First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter(dollars in thousands)(unaudited)Consolidated Statement of Operations Data:Revenues
    
    $
    41,455
    
    
    $
    44,053
    
    
    $
    43,289
    
    
    $
    47,472Operating expenses:Salaries and benefits
    
    
    10,902
    
    
    
    11,326
    
    
    
    11,740
    
    
    
    12,307Supplies
    
    
    7,619
    
    
    
    8,590
    
    
    
    8,937
    
    
    
    9,953Professional and medical fees
    
    
    2,125
    
    
    
    2,362
    
    
    
    2,553
    
    
    
    2,849Rent and lease expense
    
    
    2,661
    
    
    
    2,665
    
    
    
    2,686
    
    
    
    2,879Other operating expenses
    
    
    3,283
    
    
    
    3,519
    
    
    
    4,434
    
    
    
    3,915Cost of revenues
    
    
    26,590
    
    
    
    28,462
    
    
    
    30,350
    
    
    
    31,903General and administrative expenses
    
    
    3,911
    
    
    
    4,178
    
    
    
    3,718
    
    
    
    4,067Depreciation and amortization
    
    
    2,239
    
    
    
    2,273
    
    
    
    2,342
    
    
    
    2,441Provision for doubtful accounts
    
    
    400
    
    
    
    670
    
    
    
    756
    
    
    
    922Income on equity investments
    
    
    (103
    )
    
    
    (55
    )
    
    
    (18
    )
    
    
    (226
    )Impairment and loss on disposal of long-lived assets
    
    
    
    
    
    
    
    
    
    
    162
    
    
    
    275Gain on sale of long-lived assets
    
    
    
    
    
    
    
    
    
    
    (162
    )
    
    
    (409
    )Total operating expenses
    
    
    33,037
    
    
    
    35,528
    
    
    
    37,148
    
    
    
    38,973Operating income
    
    
    8,418
    
    
    
    8,525
    
    
    
    6,141
    
    
    
    8,499Minority interests in income of consolidated subsidiaries
    
    
    (2,894
    )
    
    
    (3,036
    )
    
    
    (1,819
    )
    
    
    (2,698
    )Interest expense, net
    
    
    (959
    )
    
    
    (1,138
    )
    
    
    (1,961
    )
    
    
    (1,724
    )Income before income taxes
    
    
    4,565
    
    
    
    4,351
    
    
    
    2,361
    
    
    
    4,077Provision (benefit) for income taxes
    
    
    184
    
    
    
    320
    
    
    
    455
    
    
    
    (3,129
    )Net income
    
    $
    4,381
    
    
    $
    4,031
    
    
    $
    1,906
    
    
    $
    7,206Other Data:Number of surgery centers operated as of the end of period(1)
    
    
    34
    
    
    
    35
    
    
    
    37
    
    
    
    44
 38




---



##### Table of Contents



2002First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter(dollars in thousands)(unaudited)Consolidated Statement of Operations Data:Revenues
    
    $
    25,293
    
    
    $
    39,357
    
    
    $
    38,126
    
    
    $
    41,912Operating expenses:Salaries and benefits
    
    
    6,716
    
    
    
    9,921
    
    
    
    9,949
    
    
    
    10,955Supplies
    
    
    5,100
    
    
    
    7,765
    
    
    
    7,474
    
    
    
    7,999Professional and medical fees
    
    
    1,116
    
    
    
    2,050
    
    
    
    2,044
    
    
    
    2,146Rent and lease expense
    
    
    1,665
    
    
    
    2,525
    
    
    
    2,502
    
    
    
    2,454Other operating expenses
    
    
    2,280
    
    
    
    2,977
    
    
    
    3,235
    
    
    
    2,819Cost of revenues
    
    
    16,877
    
    
    
    25,238
    
    
    
    25,204
    
    
    
    26,373General and administrative expenses
    
    
    3,016
    
    
    
    3,848
    
    
    
    3,562
    
    
    
    3,902Depreciation and amortization
    
    
    1,558
    
    
    
    2,140
    
    
    
    1,957
    
    
    
    2,181Provision for doubtful accounts
    
    
    679
    
    
    
    1,060
    
    
    
    1,334
    
    
    
    1,770Loss (income) on equity investments
    
    
    (72
    )
    
    
    (303
    )
    
    
    (180
    )
    
    
    14Impairment and loss on disposal of long-lived assets
    
    
    
    
    
    
    112
    
    
    
    380
    
    
    
    Gain on sale of long-lived assets
    
    
    (351
    )
    
    
    (106
    )
    
    
    
    
    
    
    Total operating expenses
    
    
    21,707
    
    
    
    31,989
    
    
    
    32,257
    
    
    
    34,240Operating income
    
    
    3,586
    
    
    
    7,368
    
    
    
    5,869
    
    
    
    7,672Minority interests in income of consolidated subsidiaries
    
    
    (985
    )
    
    
    (2,352
    )
    
    
    (1,528
    )
    
    
    (2,488
    )Interest expense, net
    
    
    (724
    )
    
    
    (1,254
    )
    
    
    (1,563
    )
    
    
    (1,084
    )Income before income taxes
    
    
    1,877
    
    
    
    3,762
    
    
    
    2,778
    
    
    
    4,100Provision for income taxes
    
    
    54
    
    
    
    54
    
    
    
    54
    
    
    
    53Net income
    
    $
    1,823
    
    
    $
    3,708
    
    
    $
    2,724
    
    
    $
    4,047Other Data:Number of surgery centers operated as of the end of period(1)
    
    
    27
    
    
    
    33
    
    
    
    32
    
    
    
    34
   (1)
    
    Includes surgery centers that we manage but in which we do not have an
ownership interest. During the fourth quarter of 2003, we acquired five additional centers.
The fourth quarter 2003 results included a benefit for income taxes of $3.1
million, which primarily related to the recognition of deferred tax
assets of
approximately $3.1 million. The fourth quarter of 2003 was also
impacted by higher interest expense incurred
in connection with the refinancing of outstanding indebtedness. Liquidity and Capital Resources On February 11, 2004, we received net proceeds of $115.5 million, after
deducting underwriting discounts and commissions, from our initial public
offering of 8,280,000 shares of common stock, which included 1,080,000 shares
attributable to the underwriters exercise of their over-allotment option. We
used the net proceeds to repay indebtedness and to pay holders of Series A and
Series B convertible preferred stock in connection with the conversion of those
shares to common stock upon the completion of the offering. After repaying
indebtedness with the net proceeds from the initial public offering, we had
total debt outstanding of about $22.0 million and approximately $100.0 million
of available credit under our senior credit facility. During 2003, we generated operating cash flow of $27.2 million. Net cash
used in investing activities during 2003 was $73.3 million, including $62.8
million of payments related to capital expenditures, which consisted of
facilities acquired and developed and the acquisition of additional ownership interests in
existing centers. Our net cash provided by financing activities during 2003 was
$43.2 million, primarily related to $100.4 million of proceeds from borrowings
under our senior credit facility and debt issuances for facilities acquired or
developed. The proceeds for long-term debt were partially offset by $62.1
million of principal payments on long-term debt. During 2002, we generated operating cash flow of $21.8 million. Net cash
used in investing activities during 2002 was $21.6 million, including $24.4
million of payments related to capital expenditures and facilities acquired 39




---



##### Table of Contents



or developed. Our net cash provided by financing activities during 2002
was $5.2 million, primarily related to $11.4 million of proceeds from debt
issuances for facilities acquired or developed during this period, which was
partially offset by $8.2 million of repayment of debt. During 2003, we acquired five surgery centers, including one licensed as a
hospital, opened five newly-developed surgery centers and assumed a management
agreement for one additional surgery center licensed as a hospital. We entered
into management agreements with each of these surgery centers and have a
majority ownership interest in four of these centers. Our investment related to
these centers was about $52.6 million, including about $50.7 million funded
with debt, and the assumption of about $873,200 in long-term debt. In addition,
we issued warrants to purchase 14,101 shares of our common stock.
Approximately $570,000 of the long-term
debt we assumed is secured by a first priority lien in the real estate
owned by the surgery center. The cash portion of the purchase price for the
acquired centers was funded with borrowings under our senior credit facility
and the issuance of senior subordinated notes. We have used capital during the past three years primarily to acquire and
develop surgery centers. Our cash is used primarily to acquire centers, develop
centers and pay operating expenses. We anticipate acquiring about two to three
centers and developing three to four centers annually during the next three to
five years. We expect that our acquisition and development program will require
substantial capital resources, which we estimate to range from $30.0 million to
$50.0 million per year over the next three years. In addition, the operations
of our existing facilities will require ongoing capital expenditures. A typical
surgery center costs us between $2.0 million and $7.0 million to develop and
equip, excluding costs of real estate. This cost varies depending on the range
of specialties that will be provided at the facility and the number of
operating and treatment rooms. We typically fund about 70% of the development
costs of a new surgery center with borrowings under our senior credit facility,
and the remainder with equity contributed by us and the other owners of the
center. Our ownership interests in surgery centers that we have developed range
from 25% to 82%, although we anticipate that we will own primarily majority
interests in future developments. We expect that our capital needs will be
financed through a combination of cash flow from operations, bank debt and the
issuance of debt and equity securities. In July 2003, we established a senior credit facility under which we can
borrow up to $110.0 million from a group of lenders for acquisitions,
developments of new centers and working capital. At the date of closing of the
senior credit facility, we borrowed $31.1 million to refinance outstanding
indebtedness. At December 31, 2003, we had outstanding indebtedness under our
senior credit facility of about $63.6 million. We repaid about
$49.9 million
of outstanding indebtedness under the senior credit facility using a portion of
the net proceeds from our initial public offering. At our option, loans under
the senior credit facility bear interest at Bank of Americas base rate or the
Eurodollar rate in effect on the applicable borrowing date, plus an applicable
margin. The applicable margin will vary depending upon the ratio of our
consolidated funded indebtedness to EBITDA. As of December 31, 2003, the
interest rate for this debt ranged from 3.62% to 5.25% per year based on the
borrowing date. The senior credit facility contains various financial and
non-financial covenants and restrictions. We believe that we are in compliance
with these covenants and restrictions. The obligations under the senior credit
facility and the related documents are secured by a first priority lien upon
substantially all of our and our subsidiary guarantors real and personal
property, a pledge of all the capital stock or other ownership interests in
each of our wholly-owned subsidiaries, and a pledge of our ownership interests
in all but one of our majority-owned subsidiaries. Our obligations under the
senior credit facility are guaranteed by all of our wholly-owned subsidiaries. In July 2003, we entered into a purchase agreement through which DLJ
Investment Partners II, L.P. and its affiliates agreed to purchase our 14 3/4%
Senior Subordinated Notes due 2008 in the aggregate principal amount of up to
$40.0 million. As of December 31, 2003, we had issued notes in the aggregate
principal amount of about $29.1 million. The $29.1 million in proceeds from
the issuance of our these notes were used for acquisitions and to refinance
outstanding indebtedness. We used a portion of the net proceeds of our initial
public offering to repay all indebtedness under the outstanding notes,
including about $727,500 of redemption premiums and about $688,000 of accrued
interest. A commitment fee of 0.5% of the outstanding commitment is payable
semi-annually, so long as the commitment is outstanding. The notes are our
unsecured obligations and contain various financial and non-financial covenants
and restrictions. We believe that we are in compliance with these covenants and
restrictions. The commitment of the purchasers of the notes to purchase up to
an additional $10.9 million of notes in the future remains outstanding and we
may issue additional notes at any time before July 18, 2005. 40




---



##### Table of Contents



In connection with our acquisition of Physicians Surgical Care, we issued
subordinated convertible debentures to various persons in exchange for their
ownership interests in certain of Physician Surgical Cares surgery centers. At
December 31, 2003, the aggregate principal amount of outstanding debentures was
about $3.1 million. The debentures bear interest at 4.0% per year and are
unsecured obligations. These debentures automatically converted into shares of
our common stock at $13.87 per share upon completion of the initial public
offering. As of December 31, 2003, we had outstanding indebtedness to Southwest Bank
of Texas in an aggregate amount of about $780,000 in connection with the
financing of a surgery center located in Houma, Louisiana. This debt bears
interest at variable rates equal to 1.0% above the lenders prime rate, with a
maturity date of March 31, 2004. As of December 31, 2003, the interest rate for
this debt was 5.0% per year. This loan is secured by a first priority lien on
the personal property of the surgery center. As of December 31, 2003, we had outstanding indebtedness to Synergy Bank
in an aggregate amount of about $3.4 million in connection with the financing
of a surgery center located in Houma, Louisiana. This debt, which consists of
two loans, bears interest at 6.7% per year and matures on May 1, 2008 and
January 1, 2008. These loans are secured by a first priority lien in the real
estate and certain personal property owned by the surgery center. As of December 31, 2003, we had outstanding indebtedness to DVI Financial
Services in an aggregate amount of about $5.4 million in connection with
financing of surgery centers that we developed. This debt, which consists of
two loans, bears interest at fixed rates that differ for each loan and range
from 8.9% to 11.1% per year, with maturity dates ranging from 2007 to 2009.
Generally, these loans are secured by a first priority lien on the personal
property of the respective surgery center that borrowed the funds. Upon completion of our initial public offering on February 11, 2004, all
of the outstanding shares of our Series A convertible preferred stock and
Series B convertible preferred stock, which were issued in connection with our
acquisition of Physicians Surgical Care, automatically converted into shares of
our common stock and the right to receive cash payments in the aggregate amount
of about $31.8 million. A portion of the net proceeds from the initial public
offering were used to fund these cash payments. We believe that existing funds, cash flows from operations, borrowings
under our senior credit facility and amounts received upon our issuance of
additional senior subordinated notes will provide sufficient liquidity for the
next 12 to 18 months. We will need to incur additional debt or issue additional
equity or debt securities in the future to fund our acquisitions and
development projects. We cannot assure you that capital will be available on
acceptable terms, if at all. If we are unable to obtain funds when needed or on
acceptable terms, we will be required to curtail our acquisition and
development program. Our ability to meet our funding needs could be adversely
affected if we suffer adverse results from our operations, or if we violate the
covenants and restrictions to which we are subject under our senior credit
facility and senior subordinated notes. Contractual Obligations and Commercial Commitments The following table summarizes our contractual obligations by period as of
December 31, 2003 on a historical basis: Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    After 5Contractual Obligation
    
    Total
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    Years(in thousands)Long-term debt (including interest expense)(1)
    
    $
    128,842
    
    
    $
    11,255
    
    
    $
    80,668
    
    
    $
    36,798
    
    
    $
    121Capital lease obligations
    
    
    966
    
    
    
    548
    
    
    
    392
    
    
    
    26
    
    
    
    Operating leases
    
    
    97,053
    
    
    
    10,306
    
    
    
    18,353
    
    
    
    17,698
    
    
    
    50,696Other long-term obligations (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    226,861
    
    
    $
    22,109
    
    
    $
    99,413
    
    
    $
    54,522
    
    
    $
    50,817
   (1)
    
    Subsequent to December 31, 2003, we used a portion of the net proceeds
from our initial public offering to repay indebtedness. Our long-term
debt is about $22.0 million after giving effect to our use of the $115.5
million net proceeds from the offering. Our long-term debt will increase
in the future, primarily as a result of 41




---



##### Table of Contents



acquisitions and developments. Our long-term debt, after repaying certain
indebtedness with proceeds from our initial public offering, consists
primarily of debt under our senior credit facility, which currently bears
interest at 3.6%, and our indebtedness to DVI Financial Services, which bears
interest ranging from 8.9% to 11.1%(2)
    
    We agreed to issue up to an additional 494,297 shares of our common stock
to the former stockholders of Physicians Surgical Care based on the 2003
financial results of one of the Physicians Surgical Care surgery centers.
In March 2004, we calculated the number of shares to be
issued to the former stockholders of Physicians Surgical Care and
submitted the calculation to the stockholder agent for approval. The following table summarizes our other commercial commitments related to
unconsolidated entities by period as of December 31, 2003 on a historical
basis: Amount of Commitment Expiration Per PeriodTotalOther Commercial Commitments
    
    Amounts
    
    Less than
    
    1-3
    
    4-5
    
    After 5Related to Unconsolidated Entities
    
    Committed
    
    1 Year
    
    Years
    
    Years
    
    Years(in thousands)Long-term debt guarantees(1)
    
    $
    600
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    600Operating lease guarantees
    
    
    1,534
    
    
    
    248
    
    
    
    519
    
    
    
    551
    
    
    
    216Total
    
    $
    2,134
    
    
    $
    248
    
    
    $
    519
    
    
    $
    551
    
    
    $
    816
   (1)
    
    We have guaranteed $600,000 of long-term debt incurred by an
unconsolidated surgery center in which we have a 44% ownership interest.
The proceeds from this debt were used to construct and equip the center.
This debt is payable in monthly installments of principal and interest
over a period of seven years, and matures on various dates during 2006 and
2007. The debt is secured by substantially all of the assets of the
surgery center. Inflation Inflation and changing prices have not significantly affected our
operating results or the markets in which we operate. Recently Issued Accounting Pronouncements In June 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 addresses financial accounting and reporting for
costs associated with exit or disposal activities and supercedes Emerging
Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under EITF No. 94-3, a liability for an exit
cost as generally defined in EITF No. 94-3 was recognized at the date of an
entitys commitment to an exit plan. The provisions of SFAS No. 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. We adopted SFAS No. 146 effective July
1, 2002, and it did not have a material effect on our consolidated financial
position or results of operations. In November 2002, the FASB issued FIN No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an Interpretation of FASB statements No. 5, 57 and 107
and Rescission of FASB Interpretation No. 34. The interpretation requires that
upon issuance of a guarantee, the entity must recognize a liability for the
fair value of the obligations it assumes under that obligation. This
interpretation is intended to improve the comparability of financial reporting
by requiring identical accounting for guarantees issued with separately
identified consideration and guarantees issued without separately identified
consideration. This initial recognition and measurement provision of FIN 45 is
applicable to guarantees issued or modified after December 31, 2002. The
adoption of FIN 45 did not have a material effect on our consolidated financial
position or results of operations. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure, which amends SFAS No. 123.
SFAS No. 148 provides alternative methods of transition for a voluntary change
to the fair value-based method of accounting for stock-based employee
compensation and amends the 42




---



##### Table of Contents



disclosure requirements of SFAS No. 123 to require more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. SFAS No. 148 is effective for financial statements issued for
fiscal years ending after December 15, 2002, and interim disclosure provisions
are effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. We have elected to account for
stock-based compensation plans under the intrinsic value-based method of
accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to
Employees,that does not utilize the fair value method. However, we have
adopted the disclosure requirements of SFAS No. 123, and we have adopted the
additional disclosure requirements as specified in SFAS No. 148 in this report
as disclosed in Note 2 and Note 8 to the consolidated financial statements
included elsewhere in this report. In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities (VIEs), an Interpretation of Accounting Research Bulletin
No. 51. FIN 46 requires certain VIEs to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new VIEs created or acquired after January 31, 2003. For VIEs created or
acquired prior to February 1, 2003, the provisions of FIN 46 for public
companies must be applied for the first interim or annual period beginning
after March 15, 2004, with early adoption allowed. We adopted FIN 46 on
December 31, 2003. We have not entered into or acquired any VIEs subsequent to
January 31, 2003. We have determined that we are the primary beneficiary of a
VIE created on July 31, 2002. We entered into a development agreement with a
group of physicians to develop a surgery center in which we have no ownership
interest. The surgery center opened on October 16, 2002. Under the development
agreement, a limited liability company in which we own a majority of the
ownership interests manages the surgery center, leases certain fixed assets to
the surgery center and provides working capital needs to the surgery center. In
addition, the investors in the surgery center have insufficient equity at risk.
At the time of adoption of FIN 46, we increased current assets by approximately
$934,000, decreased long-term assets by approximately $871,000 and increased
current liabilities by approximately $63,000. Our adoption of FIN 46 had no
effect on our results of operations and we do not currently expect FIN 46 to
have a material effect on our future results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
This statement generally requires liability classification for two broad
classes of financial instruments. Under SFAS No. 150, instruments that
represent, or are indexed to, an obligation to buy back the issuers shares,
regardless whether the instrument is settled on a net-cash or gross physical
basis are required to be classified as liabilities. Obligations that can be
settled in shares, but either derive their value predominately from some other
underlying, have a fixed value, or have a value to the counterparty that moves
in the opposite direction as the issuers shares, are also required to be
classified as liabilities under this statement. SFAS No. 150 must be applied
immediately to instruments entered into or modified after May 31, 2003 and to
all other instruments that exist as of the beginning of the first interim
financial reporting period beginning after June 15, 2003. On November 5, 2003,
the FASB agreed to defer indefinitely the effective date of the statement for
certain types of noncontrolling interests that are classified as equity in the
financial statements of subsidiaries, but are classified as liabilities in the
financial statements of related parent companies. As a result of the deferral,
companies should continue to account for these interests as minority interests.
We do not expect this statement to have a material impact on our consolidated financial position or results of operations. In November 2003, the FASB issued EITF No. 03-8, Accounting for
Claims-Made Insurance and Retroactive Insurance Contracts by the Insured
Entity. Under EITF No. 03-8, we are required to follow SFAS Interpretation
No. 39, Offsetting of Amounts Related to Certain Contracts. Under
Interpretation No. 39, offsetting of liabilities for claims made and incurred
but not reported against receivables for expected recoveries from insurers is
not appropriate unless the conditions specified in Interpretation No. 39 are
met. EITF No. 03-8 did not have a material impact on our consolidated
financial position or results of operations. 43




---



##### Table of Contents



Risk Factors The following are some of the risks and uncertainties that could cause our
actual financial condition, results of operations, business and prospects to
differ materially from those contemplated by the forward-looking statements
contained in this report or our other filings with the SEC. These risks and
uncertainties are also factors that you should consider before investing in our
common stock. If any of the following risks actually occurred, our business,
financial condition and operating results could suffer, and the trading price
of our common stock could decline. Risks Related to Our Business and Industry We depend on payments from third-party payors, including government health care
programs and managed care organizations. If these payments are reduced or
eliminated, our revenues and profitability could be adversely affected. We are dependent upon private and governmental third-party sources of
payment for the services provided to patients in our surgery centers and other
facilities and the physician networks we manage. The amount that our centers,
facilities and networks receive in payment for their services may be adversely
affected by market and cost factors as well as other factors over which we have
no control, including Medicare, Medicaid and state regulations and the cost
containment and utilization decisions and reduced reimbursement schedules of
third-party payors. For the year ended December 31, 2003, payments from
government payors represented about 19.0% of our patient service revenues from
surgery centers that we consolidate for financial reporting purposes. Medicares system of paying for covered procedures performed in a surgery
center or its rates for surgery center procedures may change in the near
future. The Medicare Prescription Drug, Improvement, and Modernization Act of
2003, commonly referred to as the Medicare Modernization Act, limits increases
in Medicare reimbursement rates for ambulatory surgery centers. Under the
Medicare Modernization Act, the 2% increase in Medicare reimbursement rates for
ambulatory surgery centers that became effective October 1, 2003 will be
limited beginning April 1, 2004 to an amount equal to the increase in the
Consumer Price Index for all urban consumers as estimated by the Secretary of
the Department of Health and Human Services for the 12-month period ended March
31, 2003, minus 3.0 percentage points. The Medicare Modernization Act also
provides that there will be no increase in these rates during the years 2005
through 2009. The Medicare Modernization Act also directs the General
Accounting Office to conduct a study comparing the cost of procedures in
surgery centers to the cost of procedures performed in hospital outpatient
departments. The General Accounting Office is directed to submit the results of
its study to the Centers for Medicare and Medicaid Services, or CMS, by no
later than January 1, 2005. CMS is directed to develop a new ambulatory surgery
center payment system based upon the Medicare hospital outpatient department
payment system so that it is effective on or after January 1, 2006 and no later
than January 1, 2008. The Medicare Modernization Act provides that, in the year
that the new payment system is implemented, it must be designed to result in
the same aggregate amount of expenditures for surgical services provided at
ambulatory surgery centers as would be made if the new system were not adopted.
The rate changes mandated by the Medicare Modernization Act could have an
adverse effect on the revenues of our centers, but we cannot predict at this
time the full effect of the payment rate revisions. Previously, the Department of Health and Human Services proposed a rule
which would increase the number of surgical procedure payment groups from eight
to 105 and the number of surgical procedures covered by the Medicare program to
about 2,500. All of the procedures paid at a particular rate would constitute a
payment group. Each of the procedures would be paid at one of the 105
prospectively determined payment rates. To date, CMS has not implemented the
proposed surgery center methodology, and in light of the payment study mandated
by the Medicare Modernization Act, it is uncertain whether this proposed
surgery center payment methodology will be implemented. If implemented in its
proposed form, the change in payment methodology could reduce our Medicare
revenues, depending on the volume and type of procedures performed at a
particular facility. States in which we perform Medicaid procedures could also
change their payment methodology in the future, and these changes may reduce
the payments we receive for our services from state Medicaid programs. In
addition, the Medicare Payment Advisory Commission, or MedPAC, and the Office
of the Inspector General of the Department of Health and Human Services, or
OIG, have both recently recommended changes to the Medicare payment methodology
for surgery centers. MedPAC is a congressional advisory board charged with
advising Congress on Medicare payment issues, while the OIG is a governmental
agency responsible for investigating and monitoring Medicare, Medicaid 44




---



##### Table of Contents



and other Department of Health and Human Services programs. Generally,
MedPAC and the OIG have recommended that reimbursement levels for surgery
center procedures be reduced. These are recommendations only and it is
uncertain if Congress will act on either or both recommendations. If these
recommendations become effective, our revenues and profitability could be
adversely affected. While most of our existing surgery center surgical
procedures are generally reimbursed at levels lower than hospital outpatient
departments, some of our existing surgical procedures are reimbursed at higher
levels. These proposed changes do not apply to our facilities licensed as
hospitals. If we are unable to negotiate contracts or maintain satisfactory relationships
with private third-party payors, our revenues and operating income will
decrease. Payments from private third-party payors represented about 76.4% of our
patient service revenues in 2003. Managed care companies such as health
maintenance organizations, or HMOs, and preferred provider organizations, or
PPOs, which offer prepaid and discounted medical service packages, represent a
growing segment of private third-party payors. If we fail to enter into
contracts and maintain satisfactory relationships with managed care
organizations, our revenues may decrease. Cost containment measures, such as
fixed fee schedules, capitation payment arrangements, reductions in
reimbursement schedules by third party payors and closed provider networks,
could also cause a reduction of our revenues in the future and cause our profit
margins to decline. Our growth strategy depends in part on our ability to acquire and develop
additional surgery centers on favorable terms. If we are unable to do so, our
future growth could be limited and our operating results could be adversely
affected. Our strategy is to increase our revenues and earnings by continuing to
focus on existing facilities and continuing to acquire and develop additional
surgery centers. Since January 1999, we have acquired or developed 39 surgery
centers, including three centers that we no longer own. We may be unable to
identify suitable acquisition and development opportunities and to negotiate
and complete acquisitions and new projects on favorable terms. In addition, our
acquisition and development program requires substantial capital resources, and
we may need to obtain additional capital or financing, from time to time, to
fund these activities. As a result, we may take actions that could have a
detrimental effect on our results of operations or the price of our common
stock, including incurring substantial debt or issuing equity securities or
convertible debt securities that would dilute our existing stockholders
ownership percentage. Sufficient capital or financing may not be available to
us on satisfactory terms, if at all. We may encounter numerous business risks in acquiring and developing additional
surgery centers, and may have difficulty operating and integrating those
surgery centers. If we acquire or develop additional surgery centers, we may be unable to
successfully operate the centers and we may experience difficulty in
integrating their operations and personnel. For example, in some acquisitions,
we have experienced delays in implementing standard operating procedures and
systems and improving existing managed care agreements and the mix of
specialties offered at the centers. Following the acquisition of a surgery
center, key physicians may cease to use the facility or we may be unable to
retain key management personnel. In some acquisitions, we may have to
renegotiate, or risk losing, one or more of the surgery centers managed care
contracts if the contracts are between the third-party payor and the seller of
the center rather than the center itself. In addition, if we acquire the assets
of a center rather than ownership interests in the entity that owns the center,
we may be unable to assume the centers existing managed care contracts. We may
also be unable to collect the accounts receivable of an acquired center. In
addition, we may acquire surgery centers with unknown or contingent
liabilities, including liabilities for failure to comply with health care laws
and regulations. In some cases, our right to indemnification for these
liabilities may be subject to negotiated limits. We may also experience
negative effects on our reported results of operations because of
acquisition-related charges and potential impairment of goodwill and other
intangibles. In developing new surgery centers, we may be unable to attract
physicians to use our facilities or contract with third-party payors. We may
also experience losses and lower gross revenues and operating margins during
the initial periods of operating our newly-developed centers. Integrating a new
surgery center could be expensive and time consuming, and could disrupt our
ongoing business and distract our management and other key personnel. If we are
unable to timely and efficiently integrate an acquired or newly-developed
center, our business could suffer. 45




---



##### Table of Contents



Efforts to regulate the construction, acquisition or expansion of health care
facilities could prevent us from acquiring additional surgery centers or other
facilities, renovating our existing facilities or expanding the breadth of
services we offer. Some states require prior approval for the construction, acquisition or
expansion of health care facilities or expansion of the services the facilities
offer. In giving approval, these states consider the need for additional or
expanded health care facilities or services. In 11 states in which we currently
operate, certificates of need must be obtained for capital expenditures
exceeding a prescribed amount, changes in capacity or services offered and
various other matters. Other states in which we now or may in the future
operate may adopt similar legislation. Our costs of obtaining a certificate of
need could be significant and we cannot assure you that we will be able to
obtain the certificates of need or other required approvals for additional or
expanded facilities or services in the future. In addition, at the time we
acquire a facility, we may agree to replace or expand the acquired facility. If
we are unable to obtain required approvals, we may not be able to acquire
additional surgery centers or other facilities, expand health care services we
provide at these facilities or replace or expand acquired facilities. If we fail to maintain good relationships with the physicians who use our
facilities, our revenues and profitability could be adversely affected. Our business depends upon the efforts and success of the physicians who
provide medical services at our facilities and the strength of our
relationships with these physicians. These physicians are not employees of our
facilities and are not contractually required to use our facilities. We
generally do not enter into contracts with physicians who use our facilities,
other than partnership and operating agreements with physicians who own
interests in our surgery centers, provider agreements with anesthesiology
groups that provide anesthesiology services in our surgery centers, medical
director agreements and pain clinic agreements. Physicians who use our
facilities also use other facilities or hospitals. In addition, the physicians
who use our facilities may choose not to accept patients who pay for services
through certain third-party payors, which could reduce our revenues. In six of
the surgery centers in which we own an interest, a single physician performed
over 25% of the total number of cases performed at the center during 2003.
From time to time, we may have disputes with physicians who use our facilities
and/or own interests in our centers or our company. Our revenues and
profitability could be significantly reduced if we lost our relationship with
one or more key physicians or groups of physicians or if a key physician or
group ceased or reduced his or its use of our facilities. In addition, any
damage to the reputation of a key physician or group of physicians or the
failure of these physicians to provide quality medical care or adhere to
professional guidelines at our facilities could damage our reputation, subject
us to liability and significantly reduce our revenues. We also manage three
physician networks that accounted for about 6.3% of our revenues during the
year ended December 31, 2003. The termination of any of our contracts to
manage our physician networks would have an adverse effect on our revenues. We have a limited history of operations. We have experienced net losses in
recent periods and we may experience net losses in the future. We were founded in 1996, but we have focused on owning and operating
surgery centers only since our acquisition of Ambulatory Resource Centres in
June 1999. In addition, we acquired Physicians Surgical Care in April 2002 and
four centers from MediSphere Health Partners, Inc. in November 2003. We have
limited experience in operating the facilities we acquired in these
transactions. As a result, we have a limited history of operations upon which
you can evaluate us or our prospects. Forecasts of our future revenues,
expenses and operating results may not be as accurate as they would be if we
had a longer history of operations. We experienced net losses of about $3.3
million in 1999 and $4.9 million in 2000, and we may experience net losses in
the future. In addition, our newly-developed surgery centers typically incur
net losses during the first six months of operation and, unless and until their
case loads grow, they generally experience lower total revenues and operating
margins than established surgery centers. 46




---



##### Table of Contents



We may be required to spend substantial amounts to comply with new legislative
and regulatory initiatives relating to privacy and security of patient health
information and standards for electronic transactions. In addition, we may
experience delays in payment of claims and increased costs if we fail to comply
with these laws, as well as be subject to substantial fines. There are currently numerous legislative and regulatory initiatives at the
federal and state levels addressing patient privacy and security concerns. In
particular, federal regulations issued under the Health Insurance Portability
and Accountability Act of 1996, or HIPAA, contain provisions that have
required, and in the future may require us to implement costly new computer
systems and to adopt business procedures designed to protect the privacy and
security of each of our patients individually identifiable health and related
financial information. Compliance with the privacy regulations was required on
April 14, 2003 for most health care organizations, including us. The privacy
regulations are expected to have a financial impact on the health care industry
because they impose extensive new administrative requirements, restrictions on
the use and disclosure of individually identifiable patient health and related
financial information, provide patients with new rights with respect to their
health information and require us to enter into contracts extending many of the
privacy regulation requirements to third parties who perform functions on our
behalf involving health information. On February 20, 2003, the Department of
Health and Human Services issued final security regulations. Compliance with
these security regulations is required by April 21, 2005 for most health care
organizations, including us. These security regulations require us to implement
administrative, physical and technical safeguards to protect the integrity,
confidentiality and availability of electronically received, maintained or
transmitted patient individually identifiable health and related financial
information. We cannot predict the total financial or other impact of these
regulations on our business. Compliance with these regulations requires
substantial expenditures, which could negatively impact our financial results.
In addition, our management has spent, and may spend in the future, substantial
time and effort on compliance measures. On August 17, 2000, the Department of Health and Human Services issued
regulations requiring most health care organizations, including us, to use
standard data formats and code sets by October 16, 2003 when electronically
transmitting information in connection with several types of transactions,
including health claims, health care payment and remittance advice and health
claim status transactions. On February 27, 2004, CMS announced a modification
to its claims payment policies that will significantly increase the payment
waiting period for electronic claims that are submitted in a non-HIPAA
compliant format. Effective July 1, 2004, only claims that are submitted
electronically in a HIPAA compliant format will be eligible for payment 14 days
after the claim is received. All other claims will not be eligible for payment
until 27 days after the claim is received. Violations of the privacy, security and transaction regulations could
subject us to civil penalties of up to $25,000 per calendar year for each
provision contained in the privacy, security and transaction regulations that
is violated and criminal penalties of up to $250,000 per violation for certain
other violations. Since there is no history of enforcement efforts by the
federal government at this time, it is not possible to ascertain the likelihood
of enforcement efforts in connection with these regulations or the potential
for fines and penalties which may result from the violation of the regulations. If we fail to comply with laws and regulations relating to the operation of our
facilities, we could suffer penalties or be required to make significant
changes to our operations. We are subject to many laws and regulations at the federal, state and
local government levels in which we operate. These laws and regulations require
that our facilities meet various licensing, certification and other
requirements, including those relating to:  
    
    qualification of medical and support persons;
    
    pricing of services by health care providers;
    
    the adequacy of medical care, equipment, personnel, operating policies and procedures;
    
    maintenance and protection of records; and
    
    environmental protection, health and safety. 47




---



##### Table of Contents



If we fail or have failed to comply with applicable laws and regulations,
we could suffer civil or criminal penalties, including becoming the subject of
cease and desist orders, the loss of our licenses to operate and our ability to
participate in Medicare, Medicaid and other government sponsored health care
programs. In pursuing our growth strategy, we may seek to expand our presence into
new geographic markets. In new geographic markets, we may encounter laws and
regulations that differ from those applicable to our current operations. If we
are unable to comply with these legal requirements in a cost-effective manner,
we may be unable to expand geographically. Our facilities do not satisfy all of the requirements for any of the safe
harbors under the federal anti-kickback statute. If we fail to comply with the
federal anti-kickback statute, we could be subject to criminal and civil
penalties, loss of licenses and exclusion from the Medicare and Medicaid
programs, which may result in a substantial loss of revenues. A provision of the Social Security Act, commonly referred to as the
federal anti-kickback statute, prohibits the offer, payment, solicitation or
receipt of any form of remuneration in return for referring, ordering, leasing,
purchasing or arranging for or recommending the ordering, purchasing or leasing
of items or services payable by Medicare, Medicaid, or any other federally
funded health care program. The federal anti-kickback statute is very broad in
scope and many of its provisions have not been uniformly or definitively
interpreted by existing case law or regulations. Violations of the federal
anti-kickback statute may result in substantial civil or criminal penalties,
including criminal fines of up to $25,000 and civil penalties of up to $50,000
for each violation, plus three times the remuneration involved or the amount
claimed and exclusion from participation in the Medicare and Medicaid programs.
The exclusion, if applied to our facilities, could result in significant
reductions in our revenues and could have a material adverse effect on our
business. In addition, many of the states in which we operate have also adopted
laws, similar to the federal anti-kickback statute, that prohibit payments to
physicians in exchange for referrals, some of which apply regardless of the
source of payment for care. These statutes typically impose criminal and civil
penalties as well as loss of licenses. No state or federal regulatory actions
have been taken against our facilities under anti-kickback or self-referral
statutes during the time we have owned or managed the facilities. Management is
not aware of any such actions prior to our acquisition or management of these
facilities. In July 1991, the Department of Health and Human Services issued final
regulations defining various safe harbors. Business arrangements that meet
the requirements of the safe harbors are deemed to be in compliance with the
federal anti-kickback statute. Business arrangements that do not meet the safe
harbor requirements do not necessarily violate the federal anti-kickback
statute, but may be subject to scrutiny by the federal government to determine
compliance. Two of the safe harbors issued in 1991 apply to business
arrangements similar to those used in connection with our surgery centers: the
investment interest safe harbor and the personal services and management
contracts safe harbor. However, the structure of the limited partnerships and
limited liability companies operating our facilities, as well as our business
arrangements involving physician networks, do not satisfy all of the
requirements of either safe harbor. On November 19, 1999, the Department of Health and Human Services issued
final regulations creating additional safe harbor provisions, including a safe
harbor that applies to physician ownership of, or investment interests in,
surgery centers. These regulations do not apply to our facilities licensed as
hospitals. The surgery center safe harbor protects four types of investment
arrangements. Each category has its own requirements with regard to what type
of physician may be an investor in the surgery center. In addition to the
physician investor, the categories permit an unrelated investor, who is a
person or entity that is not in a position to provide items or services related
to the surgery center or its investors. Our business arrangements with our
surgery centers typically consist of one or more of our subsidiaries being an
investor in each limited partnership or limited liability company that owns the
surgery center, in addition to providing management and other services to the
surgery center. As a result of these and other aspects of our business
arrangements, including those relating to the composition of physician groups
that own an interest in our facilities, these arrangements do not comply with
all the requirements of the surgery center safe harbor and, therefore, are not
immune from government review or prosecution. 48




---



##### Table of Contents



If a federal or state agency asserts a different position or enacts new laws or
regulations regarding illegal remuneration under the Medicare, Medicaid or
other governmental programs, we may be subject to civil and criminal penalties,
experience a significant reduction in our revenues or be excluded from
participation in the Medicare, Medicaid or other governmental programs. Any change in interpretations or enforcement of existing or new laws and
regulations could subject our current practices to allegations of impropriety
or illegality, or could require us to make changes in our facilities,
equipment, personnel, services, pricing, capital expenditure programs and
operating expenses, which could have a material adverse effect on our
operations or reduce the demand for or profitability of our services. Additionally, new federal or state laws may be enacted that would cause
our relationships with physician investors to become illegal or result in the
imposition of penalties against us or our facilities. If any of our business
arrangements with physician investors were deemed to violate the federal
anti-kickback statute or similar laws, or if new federal or state laws were
enacted rendering these arrangements illegal, our business could be adversely
affected. If we fail to comply with physician self-referral laws as they are currently
interpreted or may be interpreted in the future, or if other legislative
restrictions are issued, we could incur a significant loss of reimbursement
revenues. The federal physician self-referral law, commonly referred to as the Stark
law, prohibits a physician from making a Medicare or Medicaid reimbursed
referral for a designated health service to an entity if the physician or a
member of the physicians immediate family has a financial relationship with
the entity. Designated health services include a number of services,
including clinical laboratory services, radiology and certain other imaging
services and inpatient and outpatient hospital services. Under the current
Stark law and related regulations, services provided at a surgery center are
not covered by Stark, even if those services include imaging, laboratory
services or other Stark designated health services, provided that the surgery
center does not bill for these services separately. However, services provided
at our facilities licensed as hospitals are covered by Stark. The Stark law and similar state statutes are subject to different
interpretations with respect to many important provisions. Violations of these
self-referral laws may result in substantial civil or criminal penalties,
including large civil monetary penalties and exclusion from participation in
the Medicare and Medicaid programs. Exclusion of our surgery centers from these
programs through future judicial or agency interpretation of existing laws or
additional legislative restrictions on physician ownership or investments in
health care entities could result in a significant loss of reimbursement
revenues. The recently adopted Medicare Prescription Drug, Improvement, and Modernization
Act of 2003 could restrict our ability to operate our facilities licensed as
hospitals and could adversely impact our reimbursement revenues. The Medicare Modernization Act was signed into law on December 8, 2003.
Among other things, the Medicare Modernization Act amended the Stark law to
provide that an exception in the Stark law relating to physician ownership in
hospitals does not apply to specialty hospitals for a period of 18 months
following November 18, 2003. Specialty hospitals are defined in the Medicare
Modernization Act as hospitals that are primarily or exclusively engaged in the
care and treatment of (1) patients with a cardiac condition, (2) patients with
an orthopedic condition, (3) patients receiving a surgical procedure or (4) any
other specialized category of services that the Secretary of the Department of
Health and Human Services designates as inconsistent with the purpose of the
hospital ownership exception. The 18-month moratorium does not apply to
specialty hospitals that were in existence or under development on November 18,
2003, as long as: (a) the total number of physician investors in the hospital
does not increase from the number of physician investors on November 18, 2003;
(b) the hospital does not change the type of specialty services that it
provides from the types that it provided on November 18, 2003; and (c) the
hospital does not increase its number of beds by more than 5% or five beds,
whichever is greater. The Medicare Modernization Act also directs the
Department of Health and Human Services and MedPAC to conduct studies of
specialty hospitals by February 2005, and to prepare reports to Congress
recommending any needed legislative or administrative changes in the Stark
laws exception for physician ownership in hospitals. 49




---



##### Table of Contents



Three of our facilities, including one managed facility, are licensed as
hospitals. We may acquire additional facilities licensed as hospitals in the
future. Two of our facilities licensed as hospitals, including the managed
facility, currently fit within the Medicare Modernization Acts definition of
specialty hospital. Our other facility licensed as a hospital, in which we
own a 42% interest, primarily provides obstetrical and other womens health
services and could be designated in the future by the Secretary of the
Department of Health and Human Services as a specialty hospital. We are not
able to increase the number of physician investors, significantly increase the
number of licensed beds or change the type of specialty services that we
provide in any of our specialty hospitals. These legal constraints on the
operation of these facilities could have an adverse financial effect on these
facilities. Moreover, the studies and recommendations by MedPAC and the
Department of Health and Human Services may not be favorable to specialty
hospitals. If future legislation is enacted that prohibits all physician
referrals to specialty hospitals in which the physicians own an interest, even
if those facilities already exist, our specialty hospitals could be materially
adversely affected. The Medicare Modernization Act also limits increases in Medicare
reimbursement rates for ambulatory surgery centers. Under the Medicare
Modernization Act, the 2% increase in Medicare reimbursement rates for
ambulatory surgery centers that became effective on October 1, 2003 will be
limited beginning April 1, 2004 to an amount equal to the increase in the
Consumer Price Index for all urban consumers as estimated by the Secretary of
the Department of Health and Human Services for the 12-month period ended March
31, 2003, minus 3.0 percentage points. The Medicare Modernization Act also
provides that there will be no increase in these rates during the years 2005
through 2009. The Medicare Modernization Act also directs the General
Accounting Office to conduct a study comparing the cost of procedures in
surgery centers to the cost of procedures performed in hospital outpatient
departments. The General Accounting Office is directed to submit the results of
its study to CMS by no later than January 1, 2005. CMS is directed to develop a
new ambulatory surgery center payment system based upon the Medicare hospital
outpatient department payment system so that it is effective on or after
January 1, 2006 and no later than January 1, 2008. The Medicare Modernization
Act provides that, in the year that the new payment system is implemented, it
must be designed to result in the same aggregate amount of expenditures for
surgical services provided at ambulatory surgery centers as would be made if
the new system were not adopted. The rate changes mandated by the Medicare
Modernization Act could have an adverse effect on the revenues of our centers,
but we cannot predict at this time the full effect of the payment rate
revisions. We may be subject to actions for false and other improper claims. Federal and state government agencies, as well as private payors, have
heightened and coordinated civil and criminal enforcement efforts as part of
numerous ongoing investigations of the cost reporting and billing practices of
health care organizations and their quality of care and financial relationships
with referral sources. In addition, the OIG and the U.S. Department of Justice
have, from time to time, undertaken national enforcement initiatives that focus
on specific billing practices or other suspected areas of abuse. The U.S. government is authorized to impose criminal, civil and
administrative penalties on any person or entity that files a false claim for
payment from the Medicare or Medicaid programs. Claims filed with private
insurers can also lead to criminal and civil penalties, including, but not
limited to, penalties relating to violations of federal mail and wire fraud
statutes. While the criminal statutes are generally reserved for instances of
fraudulent intent, the U.S. government is applying its criminal, civil and
administrative penalty statutes in an ever-expanding range of circumstances.
For example, the government has taken the position that a pattern of claiming
reimbursement for unnecessary services violates these statutes if the claimant
merely should have known the services were unnecessary, even if the government
cannot demonstrate actual knowledge. The government has also taken the position
that claiming payment for low-quality services is a violation of these statutes
if the claimant should have known that the care was substandard. In addition,
some courts have held that a violation of the Stark law can result in liability
under the federal False Claims Act. Over the past several years, the U.S. government has accused an increasing
number of health care providers of violating the federal False Claims Act. The
False Claims Act prohibits a person from knowingly presenting, or causing to be
presented, a false or fraudulent claim to the U.S. government. The statute
defines knowingly to include not only actual knowledge of a claims falsity,
but also reckless disregard for or intentional ignorance of the truth or
falsity of a claim. Because our facilities perform hundreds of similar
procedures a year for which they are 50




---



##### Table of Contents



paid by Medicare, and there is a relatively long statute of limitations, a
billing error or cost reporting error could result in significant civil or
criminal penalties. Under the qui tam, or whistleblower, provisions of the False Claims Act,
private parties may bring actions on behalf of the U.S. government. These
private parties, often referred to as relators, are entitled to share in any
amounts recovered by the government through trial or settlement. Both direct
enforcement activity by the government and whistleblower lawsuits have
increased significantly in recent years and have increased the risk that a
health care company, like us, will have to defend a false claims action, pay
fines or be excluded from the Medicare and Medicaid programs as a result of an
investigation resulting from a whistleblower case. Although we believe that our
operations comply with both federal and state laws, they may nevertheless be
the subject of a whistleblower lawsuit, or may otherwise be challenged or
scrutinized by governmental authorities. A determination that we have violated
these laws could have a material adverse effect on us. We are also subject to various state insurance statutes and regulations
that prohibit us from submitting inaccurate, incorrect or misleading claims. We
believe that our surgery centers are in material compliance with all state
insurance laws and regulations regarding the submission of claims. We cannot
assure you, however, that none of our centers insurance claims will ever be
challenged. If we were found to be in violation of a states insurance laws or
regulations, we could be forced to discontinue the violative practice, which
could have an adverse effect on our business and operating results, and we
could be subject to fines and criminal penalties. If laws governing the corporate practice of medicine change, we may be required
to restructure some of our relationships, which may result in a significant
loss of revenues and divert other resources. The laws of various states in which we operate or may operate in the
future do not permit business corporations to practice medicine, to exercise
control over or employ physicians who practice medicine or to engage in various
business practices, such as fee-splitting with physicians. The interpretation
and enforcement of these laws vary significantly from state to state. We
provide management services to three physician networks. If our arrangements
with these networks were deemed to violate state corporate practice of
medicine, fee-splitting or similar laws, or if new laws are enacted rendering
our arrangements illegal, we may be required to restructure these arrangements,
which may result in a significant loss of revenues and divert other resources. We are liable for debts and other obligations of the limited partnerships and
limited liability companies that own and operate some of our surgery centers. We own and operate our surgery centers through 20 limited partnerships and
16 limited liability companies. Local physicians, physician groups and health
care systems also own an interest in all but two of these limited partnerships
and limited liability companies. In the limited partnerships in which we are
the general partner, we are liable for 100% of the debts and other obligations
of the limited partnership, even if we do not own all of the partnership
interests. We also guarantee the debts and other obligations of many of the
limited partnerships and limited liability companies in which we own an
interest. Our senior credit facility allows us to borrow up to $110.0 million,
including funds that we can lend to the limited partnerships and limited
liability companies in which we own an interest. The physicians and physician
groups that own an interest in these limited partnerships and limited liability
companies do not guarantee a pro rata amount of this debt or the other
obligations of these limited partnerships and limited liability companies. If our operations in New York are found not to be in compliance with New York
law, we may be unable to continue or expand our operations in New York. We own an interest in a limited liability company which provides
administrative services to a surgery center located in New York. New York law
requires that, in order to be approved by the New York Department of Health as
licensed health care facilities, corporations must have natural persons as
stockholders. Accordingly, we are not able to own interests in a partnership or
limited liability company that owns an interest in a New York health care
facility. New York law also prohibits the delegation of certain management
functions by a licensed health care facility. The law does permit a licensed
facility to obtain various services from non-licensed entities; however, it is
not clear what types of delegation constitute a violation. Although we believe
that our operations and relationships 51




---



##### Table of Contents



in New York are in compliance with these laws, if New York regulatory
authorities or a third party asserts a contrary position we may be unable to
continue or expand our operations in New York. If regulations change, we may be obligated to purchase some or all of the
ownership interests of our physician partners or renegotiate some of our
partnership agreements with our physician partners and management agreements
with surgery centers. Upon the occurrence of various fundamental regulatory changes or changes
in the interpretation of existing regulations, we may be obligated to purchase
all of the ownership interests of the physician investors in most of the
limited partnerships or limited liability companies that own and operate our
surgery centers. The purchase price that we would be required to pay for these
ownership interests is typically based on either a multiple of the centers
EBITDA or the fair market value of the ownership interests as determined by a
third-party appraisal. The physician investors in some of our surgery centers
can require us to purchase their interests in exchange for cash or shares of
our common stock if these regulatory changes occur. In addition, some of our
partnership agreements with our physician partners and management agreements
with surgery centers require us to attempt to renegotiate the agreements upon
the occurrence of various fundamental regulatory changes or changes in the
interpretation of existing regulations and provide for termination of the
agreements if renegotiations are not successful. Regulatory changes that could create purchase or renegotiation obligations
include changes that:  
    
    make illegal the referral of Medicare or other patients to our
surgery centers by physician investors;
    
    create a substantial likelihood that cash distributions to physician
investors from the limited partnerships or limited liability companies
through which we operate our surgery centers would be illegal; or
    
    make illegal the ownership by the physician investors of interests in
the limited partnerships or limited liability companies through which we
own and operate our surgery centers. We do not control whether or when any of these regulatory events might
occur. In the event we are required to purchase all of the physicians
ownership interests, our existing capital resources would not be sufficient for
us to meet this obligation. These obligations and the possible termination of
our partnership and management agreements would have a material adverse effect
on us. If we become subject to malpractice and related legal claims, we could be
required to pay significant damages, which may not be covered by insurance. In recent years, physicians, hospitals and other health care providers
have become subject to an increasing number of legal actions alleging
malpractice, product liability or related legal theories. Many of these actions
involve large monetary claims and significant defense costs. We maintain
liability insurance in amounts that we believe are appropriate for our
operations. Currently, we maintain professional and general liability insurance
that provides coverage on a claims made basis of $1.0 million per occurrence
and $3.0 million in annual aggregate coverage per facility. We also maintain
business interruption insurance and property damage insurance, as well as an
additional umbrella liability insurance policy in the aggregate amount of $10.0
million. However, this insurance coverage may not cover all claims against us.
Insurance coverage may not continue to be available at a cost allowing us to
maintain adequate levels of insurance. If one or more successful claims against
us were not covered by or exceeded the coverage of our insurance, our financial
condition could be adversely affected. We have the ability to incur significant indebtedness. As of March 15, 2004, we had outstanding debt of about $22.0 million that
we incurred to finance our acquisitions and developments and for other general
corporate purposes. Our senior credit facility allows us to borrow up to
$110.0 million, and we may issue additional 14 3⁄4% senior subordinated notes
in an aggregate principal amount of up to $10.9 million. 52




---



##### Table of Contents



We face intense competition for physicians, strategic relationships,
acquisitions and managed care contracts, which may result in a decline in our
revenues, profitability and market share. The health care business is highly competitive. We compete with other
health care providers, primarily hospitals and other surgery centers in
recruiting physicians to utilize our facilities and in contracting with managed
care payors in each of our markets. There are unaffiliated hospitals in each
market in which we operate. These hospitals have established relationships with
physicians and payors. In addition, other companies either are currently in the
same or similar business of developing, acquiring and operating surgery centers
and other facilities or may decide to enter our business. Many of these
companies have greater resources than we do, including financial, marketing,
staff and capital resources. We may also compete with some of these companies
for entry into strategic relationships with health care systems and health care
professionals. In addition, many physician groups develop surgery centers
without a corporate partner, utilizing consultants who perform their services
for a fee and do not take an equity interest in the ongoing operations of the
center. If we are unable to compete effectively with any of these entities, we
may be unable to implement our business strategies successfully and our
business could be adversely affected. A large number of our surgery centers are located in Texas and Florida, which
makes us particularly sensitive to regulatory, economic and other conditions in
those states. In addition, three of our surgery centers account for a
significant portion of our revenues. Our revenues are particularly sensitive to regulatory, economic and other
conditions in the states of Texas and Florida. As of March 15, 2004, we
operated eight surgery centers in Texas and seven surgery centers in Florida.
The surgery centers in Texas, excluding a center that we acquired from
MediSphere Health Partners in November 2003, represented about 16.0% of our
revenues during 2003 and the surgery centers in Florida represented about 10.9%
of our revenues during 2003. In addition, Wilmington SurgCare in Wilmington,
North Carolina, Physicians Surgical Specialty Hospital in Houma, Louisiana and
NorthStar Surgical Center in Lubbock, Texas generated about 7.5%, 8.3% and
7.5%, respectively, of our revenues during 2003. If these facilities are
adversely affected by regulatory, economic and other conditions, or if these
facilities do not perform effectively, our operating results will be adversely
affected. We depend on our senior management and we may be adversely affected if we lose
any member of our senior management. We are highly dependent on our senior management, including Richard E.
Francis, Jr., our chairman of the board and chief executive officer, and
Clifford G. Adlerz, our president and chief operating officer. We have entered
into employment agreements with Messrs. Francis and Adlerz and William V. B.
Webb, our chief development officer. The initial term of each of these
agreements is three years, which is automatically extended so that the term is
three years until terminated. We may terminate each employment agreement for
cause. In addition, either party may terminate the employment agreement at any
time by giving prior written notice to the other party. We do not maintain key
man life insurance policies on any of our officers. Because our senior
management has contributed greatly to our growth since inception, the loss of
key management personnel or our inability to attract, retain and motivate
sufficient numbers of qualified management personnel could have a material
adverse effect on us. If we are unable to integrate and manage our information systems effectively,
our operations could be disrupted. Our operations depend significantly on effective information systems. Our
information systems and applications require continual maintenance, upgrading
and enhancement to meet our operational needs. Moreover, our acquisition
activity requires frequent transitions from, and the integration of, various
information systems. If we experience difficulties with the transition from
information systems or are unable to maintain properly or expand our
information systems, we could suffer, among other things, operational
disruptions and increases in administrative expenses. 53




---



##### Table of Contents



Risks Related to Our Corporate Structure We may have a special legal responsibility to the holders of ownership
interests in the entities through which we own our surgery centers, which may
conflict with the interests of our stockholders and prevent us from acting
solely in our own best interests or the interests of our stockholders. Our ownership interests in surgery centers generally are held through
limited partnerships or limited liability companies in which we maintain an
ownership interest along with physicians or physician practice groups. As
general partner or manager of these entities, we may have a special
responsibility, known as a fiduciary duty, to manage these entities in the best
interests of the other interest holders. We also have a duty to operate our
business for the benefit of our stockholders. As a result, we may encounter
conflicts between our responsibility to the other interest holders and our
responsibility to our stockholders. For example, we have entered into
management agreements to provide management services to our surgery centers in
exchange for a fee. Disputes may arise as to the nature of the services to be
provided or the amount of the fee to be paid. In these cases, we are obligated
to exercise reasonable, good faith judgment to resolve the disputes and may not
be free to act solely in our own best interests or the interests of our
stockholders. Disputes may also arise between us and our physician investors
with respect to a particular business decision or regarding the interpretation
of the provisions of the applicable limited partnership agreement or operating
agreement. We seek to avoid these disputes but have not implemented any
measures to resolve these conflicts if they arise. If we are unable to resolve
a dispute on terms favorable or satisfactory to us, our business may be
adversely affected. We are a holding company with no operations of our own. We are a holding company and our ability to service our debt and pay
dividends, if any, is dependent upon the earnings from the business conducted
by our subsidiaries. The distributions of those earnings or advances or other
distributions of funds by these subsidiaries to us, all of which are contingent
upon the subsidiaries earnings and are subject to various business
considerations. In addition, distributions by subsidiaries could be subject to
statutory restrictions, including state laws requiring that the subsidiary be
solvent, or contractual restrictions. We do not have exclusive control over the distribution of cash from our
operating entities and may be unable to cause all or a portion of the cash of
these entities to be distributed. All of the surgery centers in which we have ownership interests are held
through limited partnerships or limited liability companies. We typically own,
directly or indirectly, the general partnership or majority member interests in
these entities. The limited partnership and operating agreements for these
entities provide for distribution of available cash, in some cases on a
quarterly basis. If we are unable to cause sufficient revenues to be
distributed from one or more of these entities, our relationships with the
physicians who also own an interest in these entities may be damaged and we
could be adversely affected. We may not be able to resolve favorably any
dispute regarding revenue distribution or other matters with a health care
system with which we share control of the distributions made by these entities.
Further, the failure to resolve a dispute with these health care systems could
cause an entity in which we own an interest to be dissolved. Our stockholder rights plan, provisions of our certificate of incorporation and
bylaws and Delaware law could prevent or discourage a change in our management
or a takeover you may consider favorable. We have adopted a stockholder rights plan. The rights plan may discourage,
delay or prevent a merger or acquisition that you may consider favorable. The
rights plan may also entrench our management by making it more difficult for a
potential acquirer to replace or remove our management or board of directors. In addition, some of the provisions of our certificate of incorporation
and bylaws may discourage, delay or prevent a merger or acquisition that you
may consider favorable or the removal of our current management. These
provisions:  
    
    authorize the issuance of blank check preferred stock;
    
    provide for a classified board of directors with staggered, three-year terms; 54




---



##### Table of Contents




    
    prohibit cumulative voting in the election of directors;
    
    prohibit our stockholders from acting by written consent without the approval of our board of directors;
    
    limit the persons who may call special meetings of stockholders; and
    
    establish advance notice requirements for nominations for election to
the board of directors or for proposing matters to be approved at
meetings of stockholders. Our certificate of incorporation and bylaws also prohibit the amendment of
many of the provisions in the certificate of incorporation and bylaws by our
stockholders unless the amendment is approved by the holders of at least 67% of
our shares of common stock. In addition, Delaware law may discourage, delay or
prevent a change in our control by prohibiting us from engaging in a business
combination with an interested stockholder for a period of three years after
the person becomes an interested stockholder. Because our management and their affiliates together own a large percentage of
our common stock, they will be able to exert significant influence over all
matters submitted to our stockholders for approval, regardless of the
preferences of our other stockholders. As of March 15, 2004, our officers, directors and their affiliates
together beneficially owned about 34.5% of our outstanding common stock.
Accordingly, these stockholders are able to exert significant influence over:  
    
    the election of our board of directors;
    
    our management and policies; and
    
    the outcome of any corporate transaction or other matter submitted to
our stockholders for approval, including mergers, consolidations and the
sale of all or substantially all of our assets. Whitney & Co., LLC and its affiliated funds have the right to designate
one nominee for our board of directors until February 11, 2006 if certain
conditions are met. Our officers, directors and their affiliates are also able
to exert significant influence over a change in our control or an amendment to
our certificate of incorporation or bylaws. In addition, we granted
registration rights to these stockholders covering all shares of our stock they
own. Their interests may conflict with the interests of other holders of common
stock and they may take actions affecting us with which you disagree. Risks Related to Our Common Stock Because we have not paid dividends and do not anticipate paying dividends on
our common stock in the foreseeable future, you should not expect to receive
dividends on shares of our common stock. We currently anticipate that we will retain all future earnings, if any,
to finance the growth and development of our business and do not anticipate
paying cash dividends on our common stock in the foreseeable future. Any
payment of cash dividends will depend upon our financial condition, capital
requirements, earnings and other factors deemed relevant by our board of
directors. Further, under the terms of our senior credit facility, we are
restricted from paying cash dividends and making other distributions to our
stockholders. Our stock price is likely to be highly volatile. Before February 6, 2004, there was no public market for our common stock.
The stock market has, from time to time, experienced extreme price and volume
fluctuations. Many factors may cause the market price for our common stock to
decline, perhaps substantially, including:  
    
    our failure or delay in meeting our development and acquisition
plans; 55




---



##### Table of Contents




    
    our revenues and operating results failing to meet the expectations
of securities analysts or investors in any quarter;
    
    changes in laws and regulations governing health care and the surgery center industry;
    
    proposed or enacted changes in reimbursement by governmental and other third-party payors;
    
    changes in securities analysts financial estimates or recommendations;
    
    investor perception of our industry or our prospects; and
    
    general economic trends and market conditions, including factors unrelated to our operating performance. In the past, other companies in the health care industry have experienced
volatility in the market price of their stock and have been the subject of
securities class action litigation. We may be involved in securities class
action litigation in the future which could divert our managements attention
and resources and could have a material adverse effect on our business,
operations and financial condition. Future sales of our common stock, or the perception in the public markets that
these sales may occur, could depress our stock price. Sales of substantial amounts of our common stock in the public market, or
the perception in the public markets that these sales may occur, could cause
the market price of our common stock to decline. As of March 15, 2004, we had
about 20,669,241 shares of our common stock outstanding. Of these shares, the
8,280,000 shares sold in our initial public offering are freely tradable,
unless purchased by our affiliates. The holders of about 10,839,328 shares of
our common stock are subject to lock-up agreements that prohibit the sale of
these shares in the public market until August 3, 2004. After such date, or if
Credit Suisse First Boston consents in its sole discretion to an earlier sale,
these holders will in general be entitled to sell those shares in the public
market, subject to the requirements of Rule 144 under the Securities Act of
1933. In addition to the adverse effect a price decline could have on holders
of our common stock, such a decline would likely impede our ability to raise
capital through the issuance of additional shares of our common stock or other
equity securities. The holders of about 10,959,064 shares of our common stock have rights,
subject to some conditions, to include their shares in registration statements
that we may file on our behalf or on behalf of other stockholders. By
exercising their registration rights and selling a large number of shares,
these holders could cause the price of our common stock to decline.
Furthermore, if we file a registration statement to offer additional shares of
our common stock and have to include shares held by those holders, it could
impair our ability to raise needed capital by depressing the price at which we
could sell our common stock. In addition, we have registered the shares of our
common stock to be issued under our stock option plans and employee stock
purchase plan. 
 Item 7A.Quantitative and Qualitative Disclosures about Market Risk We are exposed to market risk related to changes in prevailing interest
rates. Historically, we have not held or issued derivative financial
instruments, including interest rate swaps. Our outstanding debt to commercial
lenders is generally based on a predetermined percentage above LIBOR or the
lenders prime rate. At December 31, 2003, $64.4 million of our total long-term
debt was subject to variable rates of interest, while the remaining $41.2
million of our total long-term debt was subject to fixed rates of interest. A
hypothetical 100 basis point increase in market interest rates would result in
additional annual interest expense of $644,000. The fair value of our long-term
debt, based on a discounted cash flow analysis, approximates its carrying value
as of December 31, 2003. 
 Item 8.Financial Statements and Supplementary Data Information with respect to this Item is contained in our consolidated
financial statements beginning with the Index on Page F-1 of this report. 56




---



##### Table of Contents



Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 
 Item 9A.Controls and Procedures  (a)
    
    Evaluation of Disclosure Controls and Procedures.We carried out an
evaluation, under the supervision and with the participation of
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of our disclosure controls and procedures
as of the end of the period covered by this report pursuant to Exchange
Act Rule 13a-15. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective in ensuring that information
required to be disclosed by us (including our consolidated subsidiaries)
in reports that we file or submit under the Securities Exchange Act of
1934, as amended, is recorded, processed, summarized and reported in a
timely basis.(b)
    
    Changes in Internal Control Over Financial Reporting.There has been
no change in our internal control over financial reporting that occurred
during the fourth quarter of 2003 that has materially affected, or is
reasonably likely to materially affect, our internal control over
financial reporting. 57




---



##### Table of Contents



PART III 
 Item 10.Directors and Executive Officers of the Registrant Directors and Executive Officers The following table provides information about our directors and executive
officers: Name
    
    Age
    
    PositionRichard E. Francis, Jr.
    
    
    50
    
    
    Chairman of the Board, Chief Executive Officer and DirectorClifford G. Adlerz
    
    
    50
    
    
    President, Chief Operating Officer and DirectorWilliam V.B. Webb
    
    
    51
    
    
    Chief Development Officer and DirectorKenneth C. Mitchell
    
    
    54
    
    
    Chief Financial Officer and Senior Vice President of FinanceR. Dale Kennedy
    
    
    54
    
    
    Senior Vice President of Management Services and SecretaryFrederick L. Bryant
    
    
    49
    
    
    DirectorDonald W. Burton
    
    
    60
    
    
    DirectorEve M. Kurtin
    
    
    50
    
    
    DirectorJack Tyrrell
    
    
    57
    
    
    DirectorDavid M. Wilds
    
    
    63
    
    
    Director
 Richard E. Francis, Jr.has served as the Chairman of the Board since May
2002 and as Chief Executive Officer since 1996. Mr. Francis also served as
President of Symbion from 1996 to May 2002. Mr. Francis served from 1992 to
1995 as Senior Vice President, Development of HealthTrust, Inc. From 1990 to
1992, Mr. Francis served as Regional Vice President, Southern Region for
HealthTrust, where he oversaw operations of 11 hospitals in five states. Clifford G. Adlerzhas served as Symbions President since May 2002 and as
the Chief Operating Officer and a director since 1996. Mr. Adlerz also served
as Secretary from 1996 to May 2002. Mr. Adlerz served as Regional Vice
President, Midsouth Region for HealthTrust, Inc. from 1992 until its merger
with HCA in May 1995, at which time he became Division Vice President of HCA
and served in that position until September 1995. Mr. Adlerz served as Chief
Executive Officer of South Bay Hospital in Sun City, Florida from 1987 to 1992. William V. B. Webbhas served as the Chief Development Officer and a
director of Symbion since June 1999. Mr. Webb served as President and Chief
Executive Officer and a director of Ambulatory Resource Centres, Inc. from 1997
until Symbions acquisition of Ambulatory Resource Centres in June 1999. Mr.
Webb served as Vice President and Senior Vice President of Acquisitions and
Development for OrNda HealthCorp from 1991 to 1997. From 1990 to 1991, Mr. Webb
was Vice President of Development for Heritage Surgical Corp. Kenneth C. Mitchellhas served as Chief Financial Officer of Symbion since
May 2002 and as Senior Vice President of Finance since December 2002. Mr.
Mitchell served as Symbions Vice President of Finance from 1996 to December
2002. Mr. Mitchell served as Chief Financial Officer of American HealthMark,
Inc. from 1989 to 1995 and as Vice President  Controller for HCA Management
Company from 1988 to 1989. Prior to that time, Mr. Mitchell served as
Assistant Vice President-Development and Regional Controller for HCA Management
Company. R. Dale Kennedyhas served as Secretary of Symbion since May 2002 and
Senior Vice President of Management Services since December 2002. Mr. Kennedy
served as Symbions Vice President of Management Services from 1996 to December
2002. Mr. Kennedy served as Chief Operations Officer for IPN Network, LLC, a
company that managed the business office functions of healthcare entities, from
1991 until 1995. Prior to that time, Mr. Kennedy serviced in regional
financial roles for HealthTrust and HCA. Frederick L. Bryanthas served as a director of Symbion since 1999. Mr.
Bryant served as a General Partner of ABS Capital Partners, L.P., a private
equity firm, from 1993 to 2003, when he retired. Prior to 1993, Mr. Bryant
served as head of the mergers and acquisitions department and as a founder of
the Alex. Brown & Sons Incorporated private equity investment program. Donald W. Burtonhas served as a director of Symbion since 1999. Mr.
Burton has served as managing general partner of South Atlantic Venture Fund I,
II and III, Limited Partnerships and Chairman of South Atlantic Capital, Inc.
and South Atlantic Private Equity Fund, IV, Limited Partnership. Mr. Burton has
also managed The Burton Partnership, which invests in public and private
companies, since 1979. Mr. Burton serves on the boards of directors of ITC
Financial Services, LLC, ITC DeltaCom, Inc., KNOLOGY, Inc. and 26 Merrill
Lynch-sponsored mutual funds. Eve M. Kurtinhas served as a director of Symbion since 1996. Ms. Kurtin
has served as a Managing Partner of Pacific Venture Group, L.P. since its
inception in 1997. Prior to joining Pacific Venture Group, Ms. Kurtin served
as Chief Executive Officer of Physician Venture Management, a joint venture of
UniHealth America and HCA Inc. (formerly Columbia/HCA Healthcare Corporation),
from 1994 to 1996. Ms. Kurtin was President and Chief Executive Officer of
Kurtin Communications, serving as a consultant in areas of managed care for
major pharmaceutical companies and major providers, including UniHealth, from
1991 to 1994. Jack Tyrrellhas served as a director of Symbion since 1999. Mr. Tyrrell
has been a founder of five venture capital funds since 1985 and currently
serves as managing partner of Richland Ventures I, L.P., Richland Ventures II,
L.P. and Richland Ventures III, L.P. He is currently a director of seven
privately held companies. David M. Wildshas served as a director of Symbion since 1999. Mr. Wilds
has served as a managing director of First Avenue Partners, L.P., a venture
capital firm, since 1998. From 1995 until 1998, he was a principal at Nelson
Capital Corp. From 1991 to 1995, Mr. Wilds was Chairman of the Board of
Cumberland Health Systems, Inc. Mr. Wilds serves on the board of directors of
Dollar General Corporation, Internet Pictures Corp. and iPayment, Inc. Additional information about our directors and executive officers is
incorporated by reference to the information contained under the captions
Election of Directors and Corporate Governance included in our proxy
statement relating to our annual meeting of stockholders to be held on May 11,
2004. Code of Business Conduct
and Ethics We have adopted a Code of Business Conduct and Ethics. This code of
ethics is posted on our website located at www.symbion.comunder the heading
Corporate Governance-Code of Business Conduct and Ethics. Compliance with Section 16(a) of the Exchange Act Information with respect to compliance with Section 16(a) of the
Securities Exchange Act of 1934 is incorporated by reference to the information
contained under the caption Security Ownership of Certain Beneficial Owners
and Management  Section 16(a) Beneficial Ownership Reporting Compliance
included in our proxy statement relating to our annual meeting of stockholders
to be held on May 11, 2004. 
 Item 11.Executive Compensation This information is incorporated by reference to the information contained
under the captions Corporate Governance Compensation of Directors,
Executive Compensation, Compensation Committee Report on Executive
Compensation and Comparative Performance Graph included in our proxy
statement relating to our annual meeting of stockholders to be held on May 11,
2004. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information about the security ownership of certain beneficial owners and
management is incorporated by reference to the information contained under the
caption Security Ownership of Certain Beneficial Owners and Management
included in our proxy statement relating to our annual meeting of stockholders
to be held on May 11, 2004. Equity Compensation Plan Information The following table provides aggregate information as of December 31, 2003
with respect to shares of our common stock that may be issued under our
existing equity compensation plans, including the Symbion Stock Incentive Plan
(the Incentive Plan), the Symbion Non-Employee Directors Stock Option Plan
(the Non-Employee Directors Plan), the Symbion Employee Stock Purchase Plan
(the Purchase Plan), the Ambulatory Resource Centres, Inc. Nonqualified
Initial Option Plan (the ARC Initial Plan) and the Amended and Restated
Ambulatory Resource Centres, Inc. 1997 Stock Option Plan (the ARC 1997 Plan). 58




---



##### Table of Contents



Number of securitiesNumber of
    
    
    
    
    
    remaining availablesecurities to
    
    
    
    
    
    for futurebe issued upon
    
    
    
    
    
    issuance under equityexercise
    
    Weighted-average
    
    compensation plansof outstanding
    
    exercise price of
    
    (excludingoptions,
    
    outstanding options,
    
    securities reflectedPlan Category
    
    warrants and rights
    
    warrants and rights
    
    in column (a))(a)
    
    
    
    (b)
    
    
    
    (c)Equity compensation
plans approved by
security holders
    
    
    1,718,475
    (1)
    
    $
    11.87
    
    
    
    765,903
    (2)Equity compensation
plans not approved
by security holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    1,718,475
    
    
    
    
    
    
    
    765,903
   (1) Includes the following:  
    
    1,441,077 shares of common stock to be issued upon exercise of
outstanding stock options granted under the Incentive Plan;
    
    72,225 shares of common stock to be issued upon exercise of
outstanding stock options granted under the Non-Employee Directors
Plan;
    
    86,996 shares of common stock to be issued upon exercise of
outstanding stock options granted under the ARC Initial Plan; and
    
    118,177 shares of common stock to be issued upon exercise of
outstanding stock options granted under the ARC 1997 Plan. (2) Includes the following:  
    
    357,763 shares of common stock available for issuance under the Incentive Plan;
    
    35,705 shares of common stock available for issuance under the Non-Employee Directors Plan; and
    
    372,435 shares of common stock available for issuance under the Purchase Plan. 
 Item 13.Certain Relationships and Related Transactions This information is incorporated by reference to the information contained
under the caption Executive Compensation  Certain Transactions included in
our proxy statement relating to our annual meeting of stockholders to be held
on May 11, 2004. 
 Item 14.Principal Accountant Fees and Services This information is incorporated by reference to the information contained
under the caption Ratification of Appointment of Auditors included in our proxy
statement relating to our annual meeting of stockholders to be held on May 11,
2004. 59




---



##### Table of Contents



PART IV 
 Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Index to Consolidated Financial Statements, Financial Statement
Schedules and Exhibits (1) Consolidated Financial Statements The consolidated financial statements required to be included in Part
II, Item 8, are indexed on Page F-1 and submitted as a separate section of
this report. (2) Consolidated Financial Statement Schedules All schedules are omitted because they are not applicable or not
required, or because the required information is included in the consolidated
financial statements or notes in this report. (3) Exhibits No.
    
    
    
    Description2.1
    
    
    
    Agreement and Plan of Merger, dated as of March 7, 2002, among Symbion, Inc., Symbion
Acquisition Sub, Inc. and Physicians Surgical Care, Inc. (a)3.1
    
    
    
    Certificate of Incorporation (b)3.2
    
    
    
    Certificate of Amendment to Certificate of Incorporation (c)3.3
    
    
    
    Certificate of Retirement of Stock3.4
    
    
    
    Certificate of Designation of Rights and Preferences of Series A Convertible Preferred
Stock and Series B Convertible Preferred Stock (b)3.5
    
    
    
    Certificate of Designation of Series A Junior Participating Preferred Stock (c)3.6
    
    
    
    Bylaws (b)4.1
    
    
    
    Form of Common Stock Certificate (b)4.2
    
    
    
    Amended and Restated Investors Rights Agreement, dated as of June 25, 1999, among Symbion,
Inc. and the security holders named therein (a)4.3
    
    
    
    Amendment No. 1 to Amended and Restated Investors Rights Agreement, dated as of August 11,
1999, among Symbion, Inc. and the security holders named therein (a)4.4
    
    
    
    Amendment No. 2 to Amended and Restated Investors Rights Agreement, dated as of April 1,
2002, among Symbion, Inc. and the security holders named therein (a)4.5
    
    
    
    Form of Warrant for the purchase of shares of Symbion, Inc. common stock (a)4.6
    
    
    
    Rights Agreement, dated as of February 6, 2004, between Symbion, Inc. and SunTrust Bank (d)4.7
    
    
    
    Director Nomination Agreement, dated as of April 1, 2002, among Symbion, Inc., J. H.
Whitney III, L.P., J. H. Whitney IV, L.P. and Whitney Strategic Partners III, L.P. (a)
 60




---



##### Table of Contents



No.
    
    
    
    Description10.1
    
    
    
    Amended and Restated Executive Employment Agreement, dated May 16, 2002, between Symbion,
Inc. and Richard E. Francis, Jr. (a) (e)10.2
    
    
    
    Amended and Restated Executive Employment Agreement, dated May 16, 2002, between Symbion,
Inc. and Clifford G. Adlerz (a) (e)10.3
    
    
    
    Amended and Restated Executive Employment Agreement, dated May 16, 2002, between Symbion,
Inc. and William V. B. Webb (a) (e)10.4
    
    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and
Richard E. Francis, Jr. (a) (e)10.5
    
    
    
    Employee Stock Purchase Agreement, dated as of December 30, 1996, between Symbion, Inc. and
Richard E. Francis, Jr. (a) (e)10.6
    
    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and
Clifford G. Adlerz (a) (e)10.7
    
    
    
    Employee Stock Purchase Agreement, dated as of December 30, 1996, between Symbion, Inc. and
Clifford G. Adlerz (a) (e)10.8
    
    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and
Kenneth C. Mitchell (a) (e)10.9
    
    
    
    Employee Stock Purchase Agreement, dated as of December 30, 1996, between Symbion, Inc. and
R. Dale Kennedy (a) (e)10.10
    
    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and R.
Dale Kennedy (a) (e)10.11
    
    
    
    Employee Stock Purchase Agreement, dated as of June 1, 1999, between Symbion, Inc. and R.
Dale Kennedy (a) (e)10.12
    
    
    
    Securities Purchase Agreement, dated as of July 18, 2003, among Symbion, Inc. and DLJ
Investment Partners II, L.P. and its affiliates (b)10.13
    
    
    
    Form of 14 3⁄4% Senior Subordinated Note due 2008 (b)10.14
    
    
    
    Credit Agreement, dated as of July 18, 2003, among Symbion, Inc., various lenders party
thereto, Bank of America, N.A., as Administrative Agent and as Issuing Bank, Credit Suisse
First Boston as Syndication Agent, Key Corporate Capital, Inc. as Documentation Agent, and
Banc of America Securities, LLC, as sole Lead Arranger and Sole Book Manager (b)10.15
    
    
    
    First Amendment to Credit Agreement, dated January 30, 2004, among Symbion, Inc., various
lenders party thereto and Bank of America, N.A., as Administrative Agent and as Issuing
Bank (b)10.16
    
    
    
    Limited Guaranty and Suretyship Agreement, dated as of July 24, 2001, by PSC Development
Company, L.L.C. to and for the benefit of DVI Financial Services Inc. (a)10.17
    
    
    
    Limited Guaranty and Suretyship Agreement, dated as of July 24, 2001 by PSC of New York,
L.L.C. to and for the benefit of DVI Financial Services Inc. (a)10.18
    
    
    
    Lease Agreement, dated June 26, 2001, between Burton Hills IV Partners and Symbion, Inc. (a)
 61




---



##### Table of Contents



No.
    
    
    
    Description10.19
    
    
    
    First Amendment to Lease Agreement, dated February 9, 2004, between Burton Hills IV
Partners and Symbion, Inc.10.20
    
    
    
    Lease Agreement, dated June 6, 1997, between Physicians Surgical Care, Inc. and San Felipe
Plaza, Ltd. (a)10.21
    
    
    
    Escrow Agreement, dated as of March 7, 2002, among Symbion, Inc., Physicians Surgical Care,
Inc., J. H. Whitney Equity Partners III, L.L.C., Bank of America, N.A. and the stockholders
named therein (a)10.22
    
    
    
    Amended and Restated Ambulatory Resource Centres, Inc. 1997 Stock Option Plan (a) (e)10.23
    
    
    
    Ambulatory Resource Centres, Inc. Nonqualified Initial Option Plan (a) (e)10.24
    
    
    
    Symbion Stock Incentive Plan (a) (e)10.25
    
    
    
    Symbion Non-Employee Directors Stock Option Plan (a) (e)10.26
    
    
    
    Symbion Employee Stock Purchase Plan (a) (e)10.27
    
    
    
    First Amendment to Symbion Employee Stock Purchase Plan (a) (e)10.28
    
    
    
    Executive Change in Control Severance Plan, dated December 11, 1997 (a) (e)21.1
    
    
    
    Subsidiaries of Registrant (b)23.1
    
    
    
    Consent of Ernst & Young LLP23.2
    
    
    
    Consent of Casualty Actuarial Consultants, Inc.31.1
    
    
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 200231.2
    
    
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 200232.1
    
    
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   (a)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form S-1 (Registration No. 333-89554).(b)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form S-1 (Registration No. 333-110555).(c)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form S-8 (Registration No. 333-113272).(d)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form 8-A filed with the Securities and Exchange
Commission on February 6, 2004 (Registration No. 000-50574).(e)
    
    Compensation plan or arrangement. (b) Reports on Form 8-K None. 62




---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReport of Independent Auditors
    
    
    F-2Consolidated Balance Sheets as of December 31, 2002 and 2003
    
    
    F-3Consolidated Statements of Operations for the years ended December 31, 2001, 2002 and 2003
    
    
    F-4Consolidated Statements of Stockholders Equity for the years ended December 31, 2001, 2002 and 2003
    
    
    F-5Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2002 and 2003
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-8
 F-1




---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders
Symbion, Inc. We have audited the accompanying consolidated balance sheets of Symbion,
Inc. as of December 31, 2002 and 2003, and the related consolidated statements
of operations, stockholders equity and cash flows for each of the three years
in the period ended December 31, 2003. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Symbion, Inc.
at December 31, 2002 and 2003, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
2003, in conformity with accounting principles generally accepted in the United
States. As discussed in Note 2 to the consolidated financial statements, in 2001
the Company changed its method of accounting for business combinations, and in
2002 the Company changed its method of accounting for goodwill and other
intangible assets. /s/ Ernst & Young LLP Nashville, Tennessee
February 25, 2004 F-2




---



##### Table of Contents



SYMBION, INC. 
 CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share amounts)
 December 31,2002
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    20,648
    
    
    $
    17,658Restricted cash
    
    
    1,000
    
    
    
    Accounts receivable, less allowance for
doubtful accounts $11,632 and $12,532,
respectively
    
    
    18,732
    
    
    
    21,991Inventories
    
    
    4,350
    
    
    
    5,371Prepaid expenses and other current assets
    
    
    5,163
    
    
    
    4,062Total current assets
    
    
    49,893
    
    
    
    49,082Property and equipment:Land
    
    
    1,420
    
    
    
    1,276Buildings and improvements
    
    
    23,372
    
    
    
    32,845Furniture and equipment
    
    
    38,537
    
    
    
    48,854Computers and software
    
    
    5,595
    
    
    
    6,64568,924
    
    
    
    89,620Less accumulated depreciation
    
    
    (17,855
    )
    
    
    (26,906
    )Property and equipment, net
    
    
    51,069
    
    
    
    62,714Goodwill
    
    
    77,942
    
    
    
    116,654Other intangible assets, net
    
    
    1,093
    
    
    
    1,022Investments in and advances to affiliates
    
    
    5,490
    
    
    
    13,778Other assets
    
    
    3,401
    
    
    
    9,534Total assets
    
    $
    188,888
    
    
    $
    252,784LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,996
    
    
    $
    3,800Accrued payroll and benefits
    
    
    4,741
    
    
    
    6,533Other accrued expenses
    
    
    7,699
    
    
    
    9,139Current maturities of long-term debt
    
    
    8,618
    
    
    
    3,631Total current liabilities
    
    
    25,054
    
    
    
    23,103Long-term debt, less current maturities
    
    
    57,738
    
    
    
    101,037Other liabilities
    
    
    1,154
    
    
    
    4,609Convertible debentures
    
    
    3,171
    
    
    
    3,071Minority interests
    
    
    15,094
    
    
    
    16,949Stockholders equity:Preferred stock, $0.01 par value;
16,946,316 shares authorized at December
31, 2002 and December 31, 2003:Series A convertible preferred stock,
4,341,726 shares designated, issued
and outstanding at December 31, 2002
and December 31, 2003
    
    
    13,590
    
    
    
    13,590Series B convertible preferred stock,
2,604,590 shares designated, issued
and outstanding at December 31, 2002
and at December 31, 2003
    
    
    8,152
    
    
    
    8,152Common stock, 225,000,000 shares, $0.01
par value, authorized at December 31,
2002 and at December 31, 2003;
10,570,565 shares issued and outstanding
at December 31, 2002, 10,612,687 shares
issued and outstanding at December 31,
2003
    
    
    106
    
    
    
    106Additional paid-in-capital
    
    
    62,008
    
    
    
    61,746Stockholder notes receivable
    
    
    (381
    )
    
    
    (305
    )Retained earnings
    
    
    3,202
    
    
    
    20,726Total stockholders equity
    
    
    86,677
    
    
    
    104,015Total liabilities and stockholders equity
    
    $
    188,888
    
    
    $
    252,784
 See accompanying notes. F-3




---



##### Table of Contents



SYMBION, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)
 Year Ended December 31,2001
    
    2002
    
    2003Revenues
    
    $
    104,704
    
    
    $
    144,688
    
    
    $
    176,269Operating expenses:Salaries and benefits
    
    
    34,131
    
    
    
    37,541
    
    
    
    46,275Supplies
    
    
    18,161
    
    
    
    28,338
    
    
    
    35,099Professional and medical fees
    
    
    5,559
    
    
    
    7,356
    
    
    
    9,889Rent and lease expense
    
    
    8,162
    
    
    
    9,146
    
    
    
    10,891Other operating expenses
    
    
    9,770
    
    
    
    11,311
    
    
    
    15,151Cost of revenues
    
    
    75,783
    
    
    
    93,692
    
    
    
    117,305General and administrative expense
    
    
    12,407
    
    
    
    14,328
    
    
    
    15,874Depreciation and amortization
    
    
    7,743
    
    
    
    7,836
    
    
    
    9,295Provision for doubtful accounts
    
    
    1,055
    
    
    
    4,843
    
    
    
    2,748Loss (income) on equity investments
    
    
    192
    
    
    
    (541
    )
    
    
    (402
    )Impairment and loss on disposal of long-lived assets
    
    
    385
    
    
    
    492
    
    
    
    437Gain on sale of long-lived assets
    
    
    (2,346
    )
    
    
    (457
    )
    
    
    (571
    )Total operating expenses
    
    
    95,219
    
    
    
    120,193
    
    
    
    144,686Operating income
    
    
    9,485
    
    
    
    24,495
    
    
    
    31,583Minority interests in income of consolidated
subsidiaries
    
    
    (1,909
    )
    
    
    (7,353
    )
    
    
    (10,447
    )Interest expense, net
    
    
    (2,600
    )
    
    
    (4,625
    )
    
    
    (5,782
    )Income before income taxes
    
    
    4,976
    
    
    
    12,517
    
    
    
    15,354Provision (benefit) for income taxes
    
    
    287
    
    
    
    215
    
    
    
    (2,170
    )Net income
    
    $
    4,689
    
    
    $
    12,302
    
    
    $
    17,524Net income per share:Basic:
    
    $
    0.47
    
    
    $
    1.19
    
    
    $
    1.66Diluted:
    
    $
    0.45
    
    
    $
    1.01
    
    
    $
    1.38Weighted average number of common shares
outstanding and common equivalent shares:Basic:
    
    
    9,908,447
    
    
    
    10,349,568
    
    
    
    10,536,745Diluted:
    
    
    10,341,085
    
    
    
    12,144,140
    
    
    
    12,658,620
 See accompanying notes. F-4




---



##### Table of Contents



SYMBION, INC. 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (dollars in thousands, except per share amounts)
 Symbion, Inc.
    
    Symbion, Inc.Series A Convertible
    
    Series B Convertible
    
    Symbion, Inc.Preferred Stock
    
    Preferred Stock
    
    Common StockShares
    
    Amount
    
    Shares
    
    Amount
    
    Shares
    
    AmountBalance at January 1, 2001
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    9,933,960
    
    
    $
    51,320Issuance of common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53,719
    
    
    
    484Stock received from disposition of physician networks
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (229,538
    )
    
    
    (1,894
    )Expiration of redemption feature of redeemable
common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    153,695
    
    
    
    1,197Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2001
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,911,836
    
    
    
    51,107Issuance of common stock in acquisition of
Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    624,919
    
    
    
    8,672Issuance of Series A convertible preferred stock in
acquisition of Physicians Surgical Care, Inc
    
    
    4,341,726
    
    
    
    13,590
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of Series B convertible preferred stock in
acquisition of Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    2,604,590
    
    
    
    8,152
    
    
    
    
    
    
    
    Issuance of warrants and stock options in acquisition of
Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,274Issuance of common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,810
    
    
    
    61Designation of common stock as $0.01 par value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (62,008
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2002
    
    
    4,341,726
    
    
    
    13,590
    
    
    
    2,604,590
    
    
    
    8,152
    
    
    
    10,570,565
    
    
    
    106Issuance of warrants and common stock, net of repurchases, and other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    42,122
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2003
    
    
    4,341,726
    
    
    $
    13,590
    
    
    
    2,604,590
    
    
    $
    8,152
    
    
    
    10,612,687
    
    
    $
    106
   [Continued from above table, first column(s) repeated] Additional
    
    Stockholder
    
    Retained
    
    TotalPaid-In
    
    Notes
    
    Earnings
    
    StockholdersCapital
    
    Receivable
    
    (Deficit)
    
    EquityBalance at January 1, 2001
    
    $
    
    
    
    $
    (404
    )
    
    $
    (13,789
    )
    
    $
    37,127Issuance of common stock
    
    
    
    
    
    
    7
    
    
    
    
    
    
    
    491Stock received from disposition of physician networks
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,894
    )Expiration of redemption feature of redeemable
common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,197Net income
    
    
    
    
    
    
    
    
    
    
    4,689
    
    
    
    4,689Balance at December 31, 2001
    
    
    
    
    
    
    (397
    )
    
    
    (9,100
    )
    
    
    41,610Issuance of common stock in acquisition of
Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,672Issuance of Series A convertible preferred stock in
acquisition of Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,590Issuance of Series B convertible preferred stock in
acquisition of Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,152Issuance of warrants and stock options in acquisition of
Physicians Surgical Care, Inc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,274Issuance of common stock
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    77Designation of common stock as $0.01 par value
    
    
    62,008
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    12,302
    
    
    
    12,302Balance at December 31, 2002
    
    
    62,008
    
    
    
    (381
    )
    
    
    3,202
    
    
    
    86,677Issuance of
warrants and common stock, net of repurchases, and other
    
    
    (262
    )
    
    
    76
    
    
    
    
    
    
    
    (186
    )Net income
    
    
    
    
    
    
    
    
    
    
    17,524
    
    
    
    17,524Balance at December 31, 2003
    
    $
    61,746
    
    
    $
    (305
    )
    
    $
    20,726
    
    
    $
    104,015
 See accompanying notes. F-5




---



##### Table of Contents



SYMBION, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
 Year Ended December 31,2001
    
    2002
    
    2003Cash flows from operating activities:Net income
    
    $
    4,689
    
    
    $
    12,302
    
    
    $
    17,524Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    7,743
    
    
    
    7,836
    
    
    
    9,295Impairment and loss on disposal of long-lived assets
    
    
    385
    
    
    
    492
    
    
    
    437Gain on sale of long-lived assets
    
    
    (2,346
    )
    
    
    (457
    )
    
    
    (571
    )Minority interests
    
    
    1,909
    
    
    
    7,353
    
    
    
    10,447Distributions to minority partners
    
    
    (2,186
    )
    
    
    (6,177
    )
    
    
    (10,690
    )Loss (income) on equity investments
    
    
    192
    
    
    
    (541
    )
    
    
    (402
    )Provision for bad debts
    
    
    1,055
    
    
    
    4,843
    
    
    
    2,748Changes in operating assets and liabilities, net of
effects of acquisitions and dispositions:Accounts receivable
    
    
    (1,052
    )
    
    
    (5,694
    )
    
    
    (3,537
    )Other assets
    
    
    (2,424
    )
    
    
    (3,080
    )
    
    
    (642
    )Other liabilities
    
    
    473
    
    
    
    4,893
    
    
    
    2,572Net cash provided by operating activities
    
    
    8,438
    
    
    
    21,770
    
    
    
    27,181Cash flows from investing activities:Payments for acquisitions, net of cash acquired
    
    
    (11,029
    )
    
    
    (13,916
    )
    
    
    (48,940
    )Purchases of property and equipment, net
    
    
    (11,668
    )
    
    
    (10,461
    )
    
    
    (13,826
    )Proceeds from sale of clinic operations
    
    
    17,473
    
    
    
    4,585
    
    
    
    Change in other assets
    
    
    (597
    )
    
    
    (1,800
    )
    
    
    (10,582
    )Net cash used in investing activities
    
    
    (5,821
    )
    
    
    (21,592
    )
    
    
    (73,348
    )Cash flows from financing activities:Principal payments on long-term debt
    
    
    (19,819
    )
    
    
    (8,157
    )
    
    
    (62,106
    )Proceeds from debt issuances
    
    
    16,221
    
    
    
    11,350
    
    
    
    100,419Proceeds from capital contributions by minority partners
    
    
    133
    
    
    
    981
    
    
    
    3,348Change in other long-term liabilities
    
    
    (76
    )
    
    
    977
    
    
    
    1,516Net proceeds from issuance of common stock
    
    
    118
    
    
    
    84
    
    
    
    Net cash provided by (used in) financing activities
    
    
    (3,423
    )
    
    
    5,235
    
    
    
    43,177Net increase (decrease) in cash and cash equivalents
    
    
    (806
    )
    
    
    5,413
    
    
    
    (2,990
    )Cash and cash equivalents at beginning of period
    
    
    16,041
    
    
    
    15,235
    
    
    
    20,648Cash and cash equivalents at end of period
    
    $
    15,235
    
    
    $
    20,648
    
    
    $
    17,658Supplemental cash flow information:Cash paid for interest
    
    $
    3,468
    
    
    $
    4,974
    
    
    $
    5,442
 See accompanying notes. F-6




---



##### Table of Contents



Non-cash financing activities: During 2003, employees surrendered common stock valued at $349 in exchange
for the Company withholding estimated income taxes on stock option exercises on
their behalf. During 2001, shares of common stock and related stockholder notes
receivable valued at $12 were forfeited as a result of employee terminations. During 2001, the Company issued 6,783 shares of common stock valued at $35
as contingent consideration for previous years acquisitions. F-7




---



##### Table of Contents



SYMBION, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003
(dollars in thousands, except per share amounts)
 1. Organization Symbion, Inc. (the Company), through its wholly-owned subsidiaries, owns
interests in limited partnerships and limited liability companies which own and
operate surgery centers in joint-ownership with physicians and physician
groups, hospitals and hospital networks. In addition, the Company operates a
diagnostic center and provides development and management services on a
contract basis to non-affiliated surgery centers and manages physician
networks. As of December 31, 2003, the Company operated and managed 44 surgery
centers and managed three physician networks. 2. Significant Accounting Policies and Practices Principles of Consolidation The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, as well as its interest in limited
partnerships and limited liability companies controlled by the Company through
ownership of a majority voting interest or other rights granted to the Company
by contract as the sole general partner to manage and control the ordinary
course of the affiliates business. The consolidated financial statements also
include the accounts of a variable interest entity in which the Company is the
primary beneficiary. The limited partner or minority member responsibilities
are to supervise the delivery of medical services with their rights being
restricted to those that protect their financial interests. Under certain of
the partnership and operating agreements governing these limited partnerships
and limited liability companies, the Company could be removed as the sole
general partner or managing member for certain events such as material breach,
gross negligence or bankruptcy. These protective rights do not preclude
consolidation of the respective limited partnerships and limited liability
companies. All significant intercompany balances and transactions are
eliminated in consolidation. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The Company
maintains its cash and cash equivalent balances at high credit quality
financial institutions. The Company had $1,000 of restricted cash equivalents related to long-term
obligations as of December 31, 2002. See Note 7 for further discussion. Accounts Receivable Accounts receivable consist of receivables from federal and state agencies
(under the Medicare and Medicaid programs), managed care health plans,
commercial insurance companies, employers and patients. The Company recognizes
that revenues and receivables from government agencies are significant to its
operations, but it does not believe that there are significant credit risks
associated with these government agencies. Concentration of credit risk with
respect to other payors is limited because of the large number of such payors.
Accounts receivable are recorded net of allowances for doubtful accounts to
reflect accounts receivable at net realizable value. Accounts receivable at
December 31 were as follows: 2002
    
    2003Surgery centers
    
    $
    17,682
    
    
    $
    20,922Physician networks
    
    
    1,050
    
    
    
    1,069$
    18,732
    
    
    $
    21,991
 F-8




---



##### Table of Contents



The following table sets forth by type of payor the percentage of the
Companys accounts receivable for consolidated surgery centers as of December
31, 2003: Payor
    
    As of December 31, 2003Private insurance
    
    
    63.2
    %Medicare and Medicaid
    
    
    14.9Other government
    
    
    0.3Self-pay
    
    
    19.1Other
    
    
    2.5Total
    
    
    100.0
    %
 Collection periods vary by payor class. During the year ended December 31,
2003, the collection period for private insurance payors generally ranged from
44 to 50 days, the collection period for government payors generally ranged
from 22 to 35 days and the collection period for self-pay generally ranged from
75 to 80 days. Self-pay accounts receivable represented 19.1% of the Companys accounts
receivable as of December 31, 2003. The allowance for doubtful accounts related
to self-pay was equal to 73.6% of the accounts receivable from self-pay as of
December 31, 2003. The remaining balance of the allowance for doubtful accounts
as of December 31, 2003 relates to aged accounts due from other payors. Allowance for Doubtful Accounts Changes in the allowance for doubtful accounts and the amounts charged to
revenues, costs and expenses were as follows: Allowance
    
    Charged toBalance at
    
    Revenues,
    
    Charged to
    
    
    
    
    
    AllowanceBeginning of
    
    Costs and
    
    Other
    
    
    
    
    
    Balance atPeriod
    
    Expenses
    
    Accounts(1)
    
    Write-offs
    
    End of PeriodYear ended December 31:2001
    
    $
    3,944
    
    
    $
    1,055
    
    
    $
    748
    
    
    $
    969
    
    
    $
    4,7782002
    
    
    4,778
    
    
    
    4,843
    
    
    
    3,570
    
    
    
    1,559
    
    
    
    11,6322003
    
    
    11,632
    
    
    
    2,748
    
    
    
    1,362
    
    
    
    3,210
    
    
    
    12,532
   (1)
    
    Relates to allowances for doubtful accounts recorded under the purchase
method of accounting for acquired entities. Inventories Inventories, which consists of medical and drug supplies, are stated at
the lower of cost or market value. Cost is determined using the first-in,
first-out method. Property and Equipment Property and equipment are stated at cost or, if obtained through
acquisition, at fair value determined on the date of acquisition, and
depreciated on a straight-line basis over the useful lives of the assets,
generally three to five years for computers and software and five to seven
years for furniture and equipment. Leasehold improvements are depreciated on a
straight-line basis over the shorter of the lease term or the estimated useful
life of the assets. Routine maintenance and repairs are charged to expenses as
incurred, while expenditures that increase capacities or extend useful lives
are capitalized. Depreciation expense, including the amortization of assets under capital
leases, was $6,172, $7,765 and $9,224 for the years ended December 31, 2001,
2002 and 2003, respectively. F-9




---



##### Table of Contents



Goodwill Goodwill represents the excess of purchase price over fair value of net
tangible assets acquired. Through December 31, 2001, goodwill was amortized on
a straight-line basis over the expected periods to be benefited, generally
twenty years. In June 2001, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations,and SFAS No. 142, Goodwill and Other Intangible Assets.SFAS No.
141 requires that the purchase method of accounting be used for business
combinations initiated after June 30, 2001 and prohibits the use of the
pooling-of-interests method of accounting for those business combinations.
Under SFAS No. 141, goodwill of $9,800 relating to acquisitions after June 30,
2001 was not amortized in 2001. In addition, effective January 1, 2002, the
amortization of all goodwill was discontinued upon the adoption of SFAS No.
142. SFAS No. 142 no longer permits the amortization of goodwill and other
indefinite lived intangible assets over a set period, rather these assets must
be tested for impairment at least annually using a fair value method. During
2002, the Company performed a transitional goodwill impairment test noting no
impairment. Impairment is measured at the reporting unit level using a
discounted cash flows model to determine the fair value of the reporting units.
The Company will perform a goodwill impairment test whenever events or changes
in facts or circumstances indicate that impairment may exist, or at least
annually during the fourth quarter each year. Goodwill resulting from
acquisitions in 2001, 2002 and 2003 is deductible for tax purposes over a
15-year period. For the year ended December 31, 2001, the Company identified and recorded
impairment charges to goodwill of $130 related to three surgery centers. For
the year ended December 31, 2002, there was no impairment. For the year ended
December 31, 2003, the Company recorded impairment charges of $275 related to
software that the Company purchased but no longer intends to use. Service Agreement Rights Service agreement rights represent the exclusive right to operate the
physician network during the 20-year term of the agreement. The service
agreement right is amortized over 20 years. Long-Lived Assets The Company accounts for assets of a long term nature (long-lived
assets) in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets,which requires that companies consider whether
events or changes in facts and circumstances, both internally and externally,
may indicate that an impairment of long-lived assets held for use are present.
The Company adopted SFAS No. 144 effective January 1, 2002. Under SFAS No. 144,
impairment is measured at the reporting unit level based on discounted future
cash flows from the reporting unit including the long-lived assets. The cash
flow estimates and discount rates incorporate managements best estimates,
using appropriate and customary assumptions and projections at the date of
evaluation. Through December 31, 2001, long-lived assets were accounted for in
accordance with SFAS No. 121, Accounting for the Impairment of Long-lived
Assets and Long-lived Assets to be Disposed-of. In accordance with SFAS No.
121, the Company reviewed internal and external factors to determine whether
events or changes in facts or circumstances were present and indicative of an
impairment of long-lived assets. Under SFAS No. 121, the review included
estimates of future cash flows related to such long-lived assets. See Note 4
for a discussion of impairments and loss on disposal of assets during the year
ended December 31 2001. Minority Interests The consolidated financial statements include all assets, liabilities,
revenues and expenses of controlled surgery centers. Accordingly, the Company
has recorded minority interests in the earnings (losses) of such surgery
centers. Investments in and Advances to Affiliates Investments in and advances to affiliates at December 31, 2002 and 2003
include approximately $4,500 and $6,768, respectively, of advances to, net
investments in and a note receivable from a surgery center that the Company
manages which are secured by substantially all of the assets of the related
surgery center. At December F-10




---



##### Table of Contents



31, 2003, the Company had $4,654 of investments in and advances to
affiliates related to a 42% interest in a surgery center acquired during the
third quarter of 2003. In addition, the Company holds non-controlling
interests in certain surgery centers where it exercises significant influence.
The Company accounts for such investments under the equity method. Other Assets Other assets at December 31, 2002 and 2003 included approximately $671 and
$3,003, respectively, related to deferred financing costs. Deferred financing
costs consist of prepaid interest, loan fees and other costs of financing that
are amortized over the term of the related financing agreements. In addition,
approximately $3,108 is included in other assets at December 31, 2003 related
to the Companys deferred tax assets discussed in Note 10. Other assets at December 31, 2002 and 2003 also included approximately
$1,900 and $2,724, respectively, of costs associated with the Companys initial
public offering. These costs were reclassified to equity upon the completion of
the initial public offering discussed in Note 14. Revenues Revenues consist of the following for the years ended December 31: 2001
    
    2002
    
    2003Patient service revenues
    
    $
    62,807
    
    
    $
    130,942
    
    
    $
    158,120Physician service revenues
    
    
    30,611
    
    
    
    2,563
    
    
    
    3,797Other service revenues
    
    
    11,286
    
    
    
    11,183
    
    
    
    14,352Total revenues
    
    $
    104,704
    
    
    $
    144,688
    
    
    $
    176,269
 Patient Service Revenues Patient service revenues are recorded at the time health care services are
provided at estimated amounts due from patients and third-party payors. A fee
is charged for surgical procedures performed in each of the Companys surgery
centers. The fee varies depending on the procedure, but usually includes all
charges for usage of an operating room, a recovery room, special equipment,
supplies, nursing staff and medications. The fee does not include professional
fees charged by the patients surgeon, anesthesiologist or other attending
physician, which are billed directly by such physicians to the patient or
third-party payor. The Medicare program and most other payors pay surgery
centers in accordance with a fee schedule that is prospectively determined.
Accordingly, there is no retroactive cost report settlement process. Revenues
from surgery centers are recognized on the date of service, net of estimated
contractual adjustments and discounts from third-party payors, including
Medicare and Medicaid. Changes in estimated contractual adjustments and
discounts are recorded in the period of change. The following table sets forth by type of payor the percentage of our
patient service revenues generated in 2001, 2002 and 2003 for surgery centers
in which we owned an interest as of December 31: Payor
    
    2001
    
    2002
    
    2003Private insurance
    
    
    74.5
    %
    
    
    76.0
    %
    
    
    76.4
    %Medicare and Medicaid
    
    
    19.5
    
    
    
    18.2
    
    
    
    18.4Other government
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.6Self-pay
    
    
    4.1
    
    
    
    2.7
    
    
    
    2.8Other
    
    
    1.6
    
    
    
    2.8
    
    
    
    1.8Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 Physician Service Revenues The Company derives all of its physician service revenues from physician
networks with which it has service agreements. Physician service revenues from
physician networks consist of reimbursed expenses, plus participation in the
excess of revenue over expenses of the physician networks, as provided for in
the service agreements. Reimbursed expenses include the costs of personnel,
supplies and other expenses incurred to provide the management services to the
physician networks. The Company recognizes physician service revenues in the
period F-11




---



##### Table of Contents



in which reimbursable expenses are incurred and in the period in which the
Company has the right to receive a percentage of the amount by which a
physician networks revenues exceed its expenses. Physician service revenues
are based on net billings with any changes in estimated contractual adjustments
and bad debts reflected in service revenues in the subsequent period. The
Companys physician service revenues would be impacted by changes in estimated
contractual adjustments and bad debts recorded by the physician networks. As
required by the service agreements, the Company purchases patient accounts
receivable on a monthly basis from the physician networks at estimated net
realizable value (i.e., net of estimated contractual adjustments and bad debts)
to provide liquidity to the physician networks and collects amounts from the
responsible payor as described under Accounts Receivable in Note 2. As of
December 31, 2003, the Company had such an obligation to only one group of
three physicians included in one of the three physician networks the Company
manages (see Note 4). Such activity is reflected as cash flows from operating
activities in the accompanying consolidated statements of cash flows. Accounts
receivable are a function of clinic revenues generated by the physician
networks, rather than physician service revenues of the Company. Physician service revenues consist of the following amounts for the years
ended December 31: 2001
    
    2002
    
    2003Professional services revenues
    
    $
    79,325
    
    
    $
    7,047
    
    
    $
    10,029Contractual adjustments and bad debt expense
    
    
    (32,342
    )
    
    
    (2,900
    )
    
    
    (4,235
    )Clinic revenue
    
    
    46,983
    
    
    
    4,147
    
    
    
    5,794Medical group retainage
    
    
    (16,372
    )
    
    
    (1,584
    )
    
    
    (1,997
    )Physician service revenues
    
    $
    30,611
    
    
    $
    2,563
    
    
    $
    3,797
 No management agreements accounted for more than 10% of the Companys
revenues for the years ended December 31, 2002 and 2003. One management
agreement in Fredericksburg, Virginia accounted for 17.4% of the Companys
revenues for the year ended December 31, 2001. Stock-Based Compensation SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but
does not require, companies to record compensation cost for stock-based
employee compensation plans at fair value. The Company has elected to record
stock options in accordance with Accounting Principles Board (APB) Opinion
No. 25 Accounting for Stock Issued to Employees and related interpretations
thereof and, accordingly, recognizes no compensation expense for options
granted when the exercise price equals, or is greater than, the market price of
the underlying stock on the date of grant (the intrinsic value method). Had the Company used the Black-Scholes estimates to determine compensation
expense for options granted, net income and net income per share attributable
to common stockholders would have been reduced to the following pro forma
amounts: Year Ended December 31,2001
    
    2002
    
    2003Net income as reported
    
    $
    4,689
    
    
    $
    12,302
    
    
    $
    17,524Pro forma compensation expense for stock option grants
    
    
    (590
    )
    
    
    (1,460
    )
    
    
    (2,122
    )Pro forma net income
    
    $
    4,099
    
    
    $
    10,842
    
    
    $
    15,402Basic earnings per share:As reported
    
    $
    0.47
    
    
    $
    1.19
    
    
    $
    1.66Pro forma
    
    
    0.41
    
    
    
    1.05
    
    
    
    1.46Diluted earnings per share:As reported
    
    $
    0.45
    
    
    $
    1.01
    
    
    $
    1.38Pro forma
    
    
    0.40
    
    
    
    0.89
    
    
    
    1.22
 The effect of applying SFAS No. 123 for providing pro forma disclosure is
not likely to be representative of the effect on reported net income for future
years. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input F-12




---



##### Table of Contents



of highly subjective assumptions including the expected stock price
volatility. Because the Companys employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in managements opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options. Income Taxes Income taxes are computed based on the liability method of accounting
whereby deferred tax assets and liabilities are determined based upon
differences between the financial reporting and tax basis of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
consolidated financial statements and notes. Actual results could differ from
those estimates. Fair Value of Financial Instruments The following methods and assumptions were used by the Company in
estimating its fair value disclosures for the following financial instruments: For cash, accounts receivable and accounts payable, the carrying amounts
reported in the accompanying consolidated balance sheets approximate fair value
because of their short-term nature. For long-term debt and capitalized leases,
the carrying amounts reported in the accompanying consolidated balance sheets
approximate fair value based upon the borrowing rates available to the
Company. Reclassifications Certain reclassifications have been made to the prior year financial
statements to conform to the 2003 presentation. The reclassifications had no
impact on the Companys financial position or results of operations. Recently Adopted Accounting Standards In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring)(Issue
94-3). SFAS No. 146 requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. Under
EITF No. 94-3, a liability for an exit cost as generally defined in EITF No.
94-3 was recognized at the date of an entitys commitment to an exit plan. The
provisions of SFAS No. 146 are effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged. The
Company adopted SFAS No. 146 effective July 1, 2002, and it did not have a
material effect on the Companys consolidated financial position or results of
operations. In November 2002, the FASB issued Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No.
5, 57 and 107 and Rescission of FASB Interpretation No. 34(FIN 45). The
interpretation requires that upon issuance of a guarantee, the entity must
recognize a liability for the fair value of the obligation it assumes under
that obligation. This interpretation is intended to improve the comparability
of financial reporting by requiring identical accounting for guarantees issued
with separately identified consideration and guarantees issued without
separately identified consideration. The initial recognition and measurement
provisions of FIN 45 were applicable to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have a material effect on the
Companys consolidated financial position or results of operations. F-13




---



##### Table of Contents



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure,which amends SFAS No. 123. SFAS No. 148
provides alternative methods of transition for a voluntary change to the fair
value-based method of accounting for stock-based employee compensation and
amends the disclosure requirements of SFAS No. 123 to require more prominent
and more frequent disclosures in financial statements about the effects of
stock-based compensation. SFAS No. 148 is effective for financial statements
issued for fiscal years ending after December 15, 2002, and interim disclosure
provisions are effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002. The Company has elected
to account for stock-based compensation plans under the intrinsic value-based
method of accounting prescribed by APB Opinion No. 25, Accounting for Stock
Issued to Employees,that does not utilize the fair value method. However, the
Company has adopted the disclosure requirements of SFAS No. 123, and the
Company has adopted the additional disclosure requirements as specified in SFAS
No. 148 in this report as disclosed in Note 2 and Note 8. In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
No. 51. FIN 46 requires certain variable interest entities (VIEs) to be
consolidated by the primary beneficiary of the entity if the equity investors
in the entity do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other
parties. FIN 46 is effective for all new VIEs created or acquired after January
31, 2003. For VIEs created or acquired prior to February 1, 2003, the
provisions of FIN 46 for public companies must be applied for the first interim
or annual period beginning after March 15, 2004, with early adoption allowed.
The Company adopted FIN 46 on December 31, 2003. The Company has not entered
into or acquired any VIEs subsequent to January 31, 2003. The Company has
determined that it is the primary beneficiary of a VIE created on July 31,
2002. The Company entered into a development agreement with a group of
physicians to develop a surgery center in which it has no ownership interest.
The surgery center opened on October 16, 2002. Under the development agreement,
a limited liability company in which the Company owns a majority of the
ownership interests manages the surgery center, leases certain fixed assets to
the surgery center and provides working capital needs to the surgery center. In
addition, the investors in the surgery center have insufficient equity at risk.
At the time of adoption of FIN 46, the Company increased current assets by
approximately $934,000, decreased long-term assets by approximately $871,000
and increased current liabilities by approximately $63,000. The adoption of
FIN 46 had no effect on the Companys results of operations. In November 2003, the FASB issued EITF No. 03-8, Accounting for
Claims-Made Insurance and Retroactive Insurance Contracts by the Insured
Entity. EITF No. 03-8 requires the Company to follow SFAS Interpretation No.
39, Offsetting of Amounts Related to Certain Contracts. Under Interpretation
No. 39, offsetting of liabilities for claims made and incurred but not reported
claims against receivables for expected recoveries from insurers is not
appropriate unless the conditions specified in Interpretation No. 39 are met.
EITF No. 03-8 did not have a material impact on the Companys consolidated
financial position or results of operations. Recently Issued Accounting Standard In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
statement generally requires liability classification for two broad classes of
financial instruments. Under SFAS No. 150, instruments that represent, or are
indexed to, an obligation to buy back the issuers shares, regardless whether
the instrument is settled on a net-cash or gross physical basis are required to
be classified as liabilities. Obligations that can be settled in shares, but
either derive their value predominately from some other underlying, have a
fixed value, or have a value to the counterparty that moves in the opposite
direction as the issuers shares, are also required to be classified as
liabilities under this statement. SFAS No. 150 must be applied immediately to
instruments entered into or modified after May 31, 2003 and to all other
instruments that exist as of the beginning of the first interim financial
reporting period beginning after June 15, 2003. On November 5, 2003 the FASB
agreed to defer indefinitely the effective date of the statement for certain
types of noncontrolling interests that are classified as equity in the
financial statements of subsidiaries, but are classified as liabilities in the
financial statements of related parent companies. As a result of the deferral,
companies should continue to account for these interests as minority interests.
The Company does not expect SFAS No. 150 to have a material impact on its
consolidated financial position or results of operations. F-14




---



##### Table of Contents



3. Acquisitions The Company, through wholly-owned subsidiaries and in separate
transactions, acquired a majority interest in three surgery centers during
2001. During 2002, the Company acquired Physicians Surgical Care, Inc. In
addition to its acquisition of Physicians Surgical Care, Inc, the Company
purchased an additional three surgery centers during 2002 in separate
transactions. During 2003, the Company acquired five surgery centers. The
following table summarizes the allocation of the aggregate purchase price of
these acquisitions for the years ended December 31: 2001
    
    2002
    
    2003Fair value of assets acquired
    
    $
    14,404
    
    
    $
    81,628
    
    
    $
    49,925Liabilities assumed
    
    
    (3,114
    )
    
    
    (35,287
    )
    
    
    (4,284
    )Common stock, preferred stock and warrants issued
    
    
    (350
    )
    
    
    (32,688
    )
    
    
    (49
    )Net cash used for acquisitions
    
    $
    10,940
    
    
    $
    13,653
    
    
    $
    45,592
 The cash for the acquisitions was funded primarily through bank loans with
the remainder funded from the operations of the Company. These acquisitions were accounted for under the purchase method of
accounting and, accordingly, the results of operations of the acquired
businesses are included in the accompanying consolidated financial statements
from their respective dates of acquisitions. These acquisitions placed the
Company in new markets or expanded the Companys presence in current markets. The Company paid $89 and $263 in additional consideration related to
previous years acquisitions in 2001 and 2002, respectively, which are
reflected as additions to goodwill in the accompanying consolidated balance
sheets. Included in the acquisitions discussed above were the following
individually significant transactions: 2001 Significant Activity On July 31, 2001, the Company acquired a 51% interest in Physicians
Surgery Center, LLC, an outpatient surgery center located in Fort Myers,
Florida. This is the Companys first facility in Fort Myers. The interest in
the surgery center was acquired for consideration of $10,222 in cash and 28,623
shares of the Companys common stock, valued at $350. The acquisition resulted
in the following purchase allocation: Assets acquired:Cash
    
    $
    220Accounts receivable, less allowances
    
    
    1,050Inventories
    
    
    104Property and equipment, net
    
    
    690Goodwill
    
    
    9,654Other assets
    
    
    1311,731Liabilities assumed:Accounts payable and other accrued expenses
    
    
    278Minority interest
    
    
    8811,159Net assets acquired
    
    $
    10,572
 2002 Significant Activity On March 7, 2002, the Company entered into an agreement and plan of merger
with Physicians Surgical Care, Inc. (PSC), pursuant to which a subsidiary of
the Company was to merge with and into PSC in a stock-for-stock merger. The
merger was approved by the respective shareholders of the Company and PSC on
March 28, 2002 and was effective April 1, 2002. In the merger, the outstanding
shares of PSCs capital stock converted into shares of the Companys capital
stock, and all options, warrants or other rights to acquire shares of PSCs
capital stock converted into comparable rights to acquire shares of the
Companys capital stock, with the number of shares and rights representing, in
the aggregate, 19.1% of the Companys capital stock on a fully diluted basis,
subject to certain F-15




---



##### Table of Contents



adjustments specified in the merger agreement. Under the terms of the
merger agreement with PSC, the Company issued 624,919 shares of its common
stock, 4,341,726 shares of its Series A convertible preferred stock, 2,604,590
shares of its Series B convertible preferred stock, options to purchase 64,078
shares of its common stock and warrants to purchase 28,998 shares of its common
stock to PSC stockholders. The fair market value, as determined by the
Companys board of directors with the assistance of financial advisors, of the
shares of common stock issued in connection with the merger was $13.87 per
share. The fair market value, as determined by the Companys board of directors
with the assistance of financial advisors, of the shares of Series A
convertible preferred stock and Series B convertible preferred stock issued in
connection with the merger was $13.87 per share. The exercise price of the
options and warrants issued in connection with the merger range from $0.09 to
$26.76 per share (with fair values ranging from $1.51 to $13.78 per share)
based on the conversion ratio applied to the PSC options and warrants. In
conjunction with the merger, the Company acquired additional ownership
interests and certain physician owners terminated their rights to acquire
additional interests in certain PSC surgery centers. The Company issued
warrants to purchase 251,166 shares of common stock, paid $2,122 in cash,
issued convertible debentures in the aggregate principal amount of $3,171 and
issued promissory notes in the aggregate principal amount of $595 as
consideration. The exercise price of the warrants issued in connection with
these transactions range from $11.08 to $13.87 per shares (with fair values
ranging from $4.87 to $7.09 per share). All options and warrants issued were recorded as purchase price at their
fair value, which was calculated using the Black-Scholes option-pricing model. The purchase price, comprised of common and preferred stock, stock options
and warrants issued ($32,688), cash, notes payable and convertible debentures
issued ($5,888) and acquisition costs incurred ($3,681), allocated to the
acquired assets and liabilities assumed at April 1, 2002 is as follows: Working capital
    
    $
    7,983Property and equipment
    
    
    14,601Goodwill
    
    
    34,647Other long-term assets
    
    
    5,724Long-term debt
    
    
    (15,323
    )Minority interests
    
    
    (5,375
    )Total purchase price
    
    $
    42,257
 In addition, the Company agreed to issue up to an additional 494,297
shares of its common stock, which would be recorded as an addition to goodwill,
to the former stockholders of PSC based on the 2003 financial results of one of
the acquired PSC surgery centers. Subsequent to December 31, 2003, the Company
calculated the number of shares to be issued to the former stockholders of PSC
and submitted the calculation to the stockholder agent for approval. The Series
A convertible preferred stock and Series B convertible preferred stock have
certain conversion rights upon certain events. One of these events is an
initial public offering by the Company. In the event these rights are
exercisable, the Company will be required to make an additional cash payment of
$31,831. This amount will be reflected as additional purchase price and
recorded as an addition to goodwill. As discussed in Note 14, on February 11,
2004, the Company used proceeds from the initial public offering to make the
cash payment of $31,831. See Note 8 for additional information related to the
Series A convertible preferred stock and Series B convertible preferred stock. The Company also made individually insignificant acquisitions of majority
interests in three surgery centers for approximately $12,017 in cash. The fair
value of tangible net assets acquired was approximately $626 with approximately
$11,391 recorded as goodwill. F-16




---



##### Table of Contents



Pro Forma Results The following represents the unaudited pro forma results of consolidated
operations as if the 2001 and 2002 significant acquisitions discussed above had
occurred at the beginning of the immediately preceding period, after giving
effect to certain pro forma adjustments, for the years ended December 31: 2001
    
    2002Revenues
    
    $
    132,925
    
    
    $
    156,991Income before income taxes
    
    
    556
    
    
    
    12,301Earnings per share:Basic
    
    $
    0.06
    
    
    $
    1.19Diluted
    
    
    0.05
    
    
    
    1.01
 2003 Significant Activity On November 17, 2003, the Company acquired three surgery centers from
MediSphere Health Partners, Inc. One of these facilities is licensed as a
hospital. The Company paid approximately $7,938 in cash, issued $49 in
warrants and incurred $422 in acquisition costs in connection with the
acquisition of these centers. The purchase price is also subject to additional
settlements related to working capital and indemnification holdbacks that will
be finalized during 2004. The additional consideration will be reflected as
additional goodwill. On December 1, 2003, in separate transactions, the
Company purchased two additional surgery centers for $37,402 in cash. The
Company incurred $227 in acquisition costs related to these centers. The
purchase price of each transaction is subject to additional settlements related
to working capital that will be finalized during 2004. The purchase price
allocated to the acquired assets and liabilities assumed on the purchase dates
is as follows: Working capital
    
    $
    3,253Property and equipment
    
    
    4,050Goodwill
    
    
    37,563Other long-term assets
    
    
    4,544Long-term debt
    
    
    (1,748
    )Minority interests
    
    
    (1,624
    )Total purchase price
    
    $
    46,038
 In 2003, the Company also made individually insignificant acquisitions of
additional ownership interests in certain of its consolidated surgery centers
in exchange for $3,348 in cash, which resulted in additions to goodwill of
$1,594 and additions to investments in and advances to affiliates of $750. The
pro forma effect of the Companys 2003 acquisitions on
its results of operations for the periods prior to the respective
acquisition dates was not significant. 4. Dispositions During the first and second quarters of 2001, the Company terminated its
management agreements with two of its physician networks (Terminated Physician
Networks) and transferred its related assets and liabilities to the networks.
In addition, the Company amended its management agreements with two additional
physician networks (Restructured Physician Networks) to delete provisions
that required the Company to provide the networks with capital and additional
assets, in addition to management services, and transferred certain related
accounts receivable, prepaid expenses and liabilities to the networks. The
Company also agreed to transfer to the Restructured Physician Networks its
existing equipment and other assets relating to the networks for no additional
consideration, on an annual basis beginning in January 2006, for one of the
networks, and September 2007, for the other network, as the assets become fully
depreciated. For 2001, the Terminated Physician Networks had generated the following
results prior to their disposition: Revenues
    
    $
    8,786Operating expenses
    
    
    (7,426
    )Depreciation and amortization
    
    
    (410
    )Interest expense
    
    
    (5
    )Income before income taxes
    
    $
    945
 F-17




---



##### Table of Contents



In conjunction with the Restructured Physician Networks and one of the
Terminated Physician Networks, the Company received consideration approximating
the net carrying value of the assets disposed of and recorded as held for sale
at December 31, 2000. In conjunction with the disposition of the other
Terminated Physician Network, the Company received consideration of $2,346 in
excess of the carrying amount of the related net assets. The gain on
termination is included in gain on sale of long-lived assets in the
accompanying Consolidated Statements of Operations for the year ended December
31, 2001. In the fourth quarter of 2001, the Company initiated a plan to terminate
its management agreement with another physician network and to transfer its
related assets and liabilities to the network. The Company recorded an
impairment and loss on disposal charge for these assets of $255. The net assets
held were sold in January 2002. The results of operations for the year ended December 31, 2001, derived
from net assets held for sale at December 31, 2001, were as follows: 2001Revenues
    
    $
    18,246Net income
    
    
    1,439
 During 2003, the Company sold ownership interests in certain consolidated
surgery centers for $1,659 in cash. The Company recorded an impairment and loss
on disposal of long-lived assets of $162 and a gain on sale of long-lived
assets of $571 in connection with these transactions. In connection with one
sale, the buyer received the right to require the Company to repurchase the
buyers interest in the center, and the Company recorded a long-term liability
of $825 related to this redeemable feature. 5. Goodwill and Intangible Assets In accordance with SFAS No. 142, the Company discontinued the amortization
of goodwill effective January 1, 2002. A reconciliation of previously reported
net income to the pro forma amounts adjusted for the exclusion of goodwill
amortization net of the related income tax effect follows: Year Ended December 31,2001
    
    2002
    
    2003Reported net income
    
    $
    4,689
    
    
    $
    12,302
    
    
    $
    17,524Add: goodwill amortization
    
    
    1,271
    
    
    
    
    
    
    
    Pro forma adjusted net income
    
    $
    5,960
    
    
    $
    12,302
    
    
    $
    17,524Reported basic earnings per share
    
    $
    0.47
    
    
    $
    1.19
    
    
    $
    1.66Add: goodwill amortization
    
    
    0.13
    
    
    
    
    
    
    
    Pro forma adjusted basic earnings per share
    
    $
    0.60
    
    
    $
    1.19
    
    
    $
    1.66Reported diluted earnings per share
    
    $
    0.45
    
    
    $
    1.01
    
    
    $
    1.38Add: goodwill amortization
    
    
    0.13
    
    
    
    
    
    
    
    Pro forma adjusted diluted earnings per share
    
    $
    0.58
    
    
    $
    1.01
    
    
    $
    1.38
 Changes in the carrying amount of goodwill are as follows: Balance at December 31, 2001
    
    $
    31,641Purchase price allocations
    
    
    46,301Balance at December 31, 2002
    
    
    77,942Purchase price allocations
    
    
    39,157Finalized purchase price allocations
    
    
    (445
    )Balance at December 31, 2003
    
    $
    116,654
 F-18




---



##### Table of Contents



Information regarding the Companys other intangible assets is as
follows: Gross Carrying
    
    AccumulatedAmount
    
    AmortizationAmortized intangible assets:As of December 31, 2002Service agreement rights
    
    $
    1,370
    
    
    $
    (277
    )As of December 31, 2003Service agreement rights
    
    
    1,370
    
    
    
    (348
    )
 Amortization expense for the year ended December 31, 2003 was $71.
Estimated amortization expense for each of the succeeding five fiscal years is
$71. 6. Leases The Company leases office space and equipment for its surgery centers,
including surgery centers under development. The lease agreements generally
require the lessee to pay all maintenance, property taxes, utilities, and
insurance costs. The future minimum lease payments under non-cancelable operating leases at
December 31, 2003 are as follows: 2004
    
    $
    10,3062005
    
    
    9,2322006
    
    
    9,1212007
    
    
    8,8392008
    
    
    8,859Thereafter
    
    
    50,696Total minimum lease payments
    
    $
    97,053
 Total rent and lease expense was $8,738, $9,906 and $12,089 for the years
ended December 31, 2001, 2002 and 2003, respectively. The Company incurred
rental expense of $1,377, $3,007 and $3,143 under operating leases with
physician investors and an entity that is an affiliate of one of the Companys
directors for the years ended December 31, 2001, 2002 and 2003, respectively. 7. Long-Term Debt and Convertible Debentures The Companys long-term debt is summarized as follows: December 31,2002
    
    2003Senior credit facility
    
    $
    
    
    
    $
    63,600Notes payable to banks
    
    
    41,335
    
    
    
    4,800Secured term loans
    
    
    17,369
    
    
    
    6,241Senior subordinated notes payable
    
    
    
    
    
    
    29,106Capital lease obligations
    
    
    6,542
    
    
    
    921Other
    
    
    1,110
    
    
    
    66,356
    
    
    
    104,668Less current maturities
    
    
    (8,618
    )
    
    
    (3,631
    )$
    57,738
    
    
    $
    101,037
 Senior Credit Facility In July 2003, the Company entered into a senior secured credit facility
(Senior Credit Facility) with a syndicate of financial institutions led by
Bank of America, N.A. The Company is the borrower under the Senior Credit
Facility and all of its active and existing wholly-owned subsidiaries are
guarantors. Under the terms of the Senior Credit Facility, entities that become
wholly-owned subsidiaries must also guarantee the debt. At the date of closing
of the Senior Credit Facility, the Company borrowed $31.1 million to refinance
existing debt. F-19




---



##### Table of Contents



The Senior Credit Facility provides senior secured financing of up to
$110.0 million, through a revolving credit line. Provided that the Company is
not in default under the Senior Credit Facility, it is entitled, at any time
prior to January 18, 2005, to request an increase in commitments of up to $20.0
million more, subject to the consent of the administrative agent, lenders
having at least 51% of the commitments under the Senior Credit Facility and all
lenders providing such commitment increase. Up to $2.0 million of the Senior
Credit Facility is available for the issuance of standby letters of credit, and
up to $5.0 million of the Senior Credit Facility is available for swing line
loans. The swing line loans are made available by Bank of America as the swing
line lender on a same-day basis in minimum purchase amounts of $100,000. The
Company is required to repay each swing line loan in full upon the demand of
the swing line lender. The Senior Credit Facility terminates and is due and
payable on July 18, 2006. At December 31, 2003, the Company had $63,600 of
outstanding debt under the Senior Credit Facility. At our option, loans under
the Senior Credit Facility bear interest at Bank of Americas base rate or the
Eurodollar rate in effect on the applicable borrowing date, plus an applicable
Eurodollar rate margin. Both the applicable base rate margin and applicable
Eurodollar rate margin will vary depending upon the ratio of our consolidated
funded indebtedness to EBITDA. At December 31, 2003, the interest rate on the
Senior Credit Facility ranged from 3.62% to 5.25%. As discussed in Note 14, the
Company used proceeds from the initial public offering to pay off the Senior
Credit Facility. Notes Payable to Banks The Company has notes outstanding with Bank of America and U.S. Bank, used
to acquire or develop certain surgery centers, maturing in 2004 and carrying
interest at LIBOR plus 2.5% and LIBOR plus 3.5% per year, respectively. Each
loan and security agreement (collectively, the Loan Agreements) is
collateralized by a security interest in the accounts receivable and equipment
of the borrower or the Companys ownership interest in the related surgery
center. The Loan Agreements contain various financial covenants applicable to
specific surgery centers and the Company, as the guarantor, which include a
fixed charge coverage ratio, minimum stockholders equity and cash balances and
a maximum funded indebtedness to adjusted EBITDA ratio (all as defined in the
Loan Agreements). At December 31, 2002, the Company was in compliance with all
such covenants. The outstanding principal balance under the Loan Agreements
was $35,562 at December 31, 2002. The Company has an outstanding loan agreement with Southwest Bank of
Texas, used to finance the acquisition and development of a certain surgery
center. This note (the SWBT Note) bears interest at variable rates equal to
1.0% above the lenders prime rate. As of December 31, 2003, the interest rate
for this note was 5.0% per year. This note matures in March 2004 and is
collateralized by substantially all of the related surgery centers assets.
The SWBT Note contains restrictive covenants requiring the surgery center and
the Company, as guarantor, to maintain certain financial ratios and also
restricts encumbrance of assets, creation of indebtedness, disposition of
assets, investing activities and payment of distributions. At December 31,
2003, the surgery centers and the Company were in compliance with all such
covenants, as amended. The outstanding principal balance under the SWBT Note
was $1,790 and $780 at December 31, 2002 and 2003, respectively. The Company has a mortgage note payable outstanding with Synergy Bank (the
Mortgage Note). The Mortgage Note is collateralized by the related surgery
centers real estate. The Company refinanced the Mortgage Note during 2003. As
a result of the refinancing, the Mortgage Note matures in 2008 and bears an
interest rate of 6.7% per year. The Mortgage Note had an outstanding principal
balance of $2,816 and $2,564 at December 31, 2002 and 2003, respectively. The
Mortgage Note contains various covenants to maintain certain financial ratios
and also restricts encumbrance of assets, creation of indebtedness, investing
activities and payment of distributions. At December 31, 2003, the surgery
center and the Company were in compliance with all such covenants. The Company had additional outstanding principal balances on notes payable
to other banks of $1,167 and $1,456 at December 31, 2002 and 2003,
respectively. These promissory notes have interest rates ranging from 6.5% to
8.0% per year and maturity dates ranging from 2004 through 2010. Secured Term Loans The Company has outstanding loan and security agreements with DVI
Financial Services, Inc. (the DVI Loans). The proceeds of the DVI Loans were
used to finance tenant improvements, medical, surgical and office equipment,
and working capital. The DVI Loans bear interest ranging from 8.5% to 11.5% per
year, with maturity F-20




---



##### Table of Contents



dates ranging from 2006 to 2009, and had an outstanding principal balance
of $16,070 and $5,416 at December 31, 2002 and 2003, respectively. At
December 31, 2002, one of the DVI loans was collateralized by a $1,000
certificate of deposit, which was classified as restricted cash on the December
31, 2002 accompanying balance sheet. The Company had additional principal balances on secured term loans of
$1,299 and $825 at December 31, 2002 and 2003, respectively. Senior Subordinated Notes Payable In July 2003, the Company entered into an agreement through which DLJ
Investment Partners II, L.P. and its affiliates agreed to purchase the
Companys 143⁄4% Senior Subordinated Notes due 2008 in the aggregate
principal amount of up to $40.0 million. During 2003, the Company issued notes
in the aggregate principal amount of about $29.1 million, and may issue
additional notes at any time before July 18, 2005 as long as we are permitted
under the agreement. On August 15, 2003, the initial purchasers of the notes
sold a portion of the notes and a portion of the outstanding commitment to
affiliates of the Company. The notes are the Companys unsecured obligations. The Companys active
and existing wholly-owned subsidiaries guarantee the notes. Entities that
become the Companys wholly-owned subsidiaries must also guarantee the notes. A
commitment fee of 0.5% of the outstanding, undrawn commitment is payable
semi-annually, so long as the commitment is outstanding. The Company may redeem
the notes, in whole or in part, at any time at specified redemption prices. As
discussed in Note 14, the Company used a portion of the proceeds from the
initial public offering to redeem the notes. The redemption price will be
102.5% of the principal amount outstanding. Capital Lease Obligations The Company is liable to various vendors for equipment leases, with
interest rates from 7% to 12% per year, payable in installments through 2004.
The carrying value of property and equipment under capital leases at December
31, 2001 and 2003 was $4,696 and $1,274, respectively. Other Long-Term Debt Information Scheduled maturities of obligations as of December 31, 2002 are as
follows: Long-term
    
    Capital LeaseDebt
    
    Obligations
    
    Total2004
    
    $
    3,103
    
    
    $
    548
    
    
    $
    3,6512005
    
    
    2,207
    
    
    
    318
    
    
    
    2,5252006
    
    
    65,955
    
    
    
    74
    
    
    
    66,0292007
    
    
    1,553
    
    
    
    26
    
    
    
    1,5792008
    
    
    30,815
    
    
    
    
    
    
    
    30,815Thereafter
    
    
    114
    
    
    
    
    
    
    
    114103,747
    
    
    
    966
    
    
    
    104,713Less current maturities
    
    
    (3,103
    )
    
    
    (528
    )
    
    
    (3,631
    )Amounts representing interest
    
    
    
    
    
    
    (45
    )
    
    
    (45
    )$
    100,644
    
    
    $
    393
    
    
    $
    101,037
 Convertible Debentures In connection with the acquisition of PSC, the Company issued subordinated
convertible debentures totaling $3,171 to various persons in exchange for
additional ownership interests in certain of PSCs surgery centers. The
debentures carry interest at 4.0% per year, mature on April 1, 2005 and
automatically converted at $13.87 per share upon the Companys completion of
the initial public offering discussed in Note 14. F-21




---



##### Table of Contents



8. Stockholders Equity Capital In March 2002, the Board of Directors approved the Amended and Restated
Charter of Symbion, Inc., increasing authorized capital stock to 225,000,000
shares of common stock, no par value, and 16,946,322 shares of preferred stock,
$0.01 par value, of which 4,341,726 shares are designated as Series A
convertible preferred stock, 2,604,590 shares are designated as Series B
convertible preferred stock and approximately 10,000,000 shares are
undesignated. Prior to approval of the Amended and Restated Charter, the authorized
capital stock of the Company consisted of 60,000,000 shares of common stock, no
par value, and 7,042,738 shares of preferred stock, no par value, of which
2,571,429 shares were designated as Series A preferred stock and 1,866,667
shares were designated as Series B preferred stock. In September 2002, the Company reincorporated in the State of Delaware by
merging into a wholly-owned subsidiary named Symbion, Inc. that was
incorporated in Delaware (Symbion-Delaware). In connection
with the
reincorporation, each outstanding share of the Companys common stock, no par
value per share, was converted into the right to receive a share of common
stock, $0.01 par value per share, of Symbion-Delaware, each outstanding
share of the Companys Series A and Series B convertible preferred stock, $0.01
par value per share, was converted into the right to receive a share of Series
A and Series B convertible preferred stock, $0.01 par value per share,
respectively, of Symbion-Delaware, and the Company reduced its
authorized preferred stock to 16,946,316 shares. The holders of common stock are entitled to one vote per share on all
matters on which stockholders are entitled to vote and do not have cumulative
voting rights. The holders of common stock have no preemptive, conversion,
redemption or sinking fund rights. The holders of the Series A convertible preferred stock and Series B
convertible preferred stock issued by the Company in the PSC merger (a) have
the same voting rights as holders of the Companys common stock on the same
basis as if the preferred stock had been converted to common stock; (b) may
convert each of their shares of convertible preferred stock at any time into
one share of common stock and each of their shares of convertible preferred
stock would automatically convert into a share of the Companys common stock
and the right to receive a cash payment upon either (i) an initial public
offering or (ii) consolidation or merger of the Company resulting in
stockholders of the Company receiving cash or capital stock registered under
the Securities Act of 1933, as amended; (c) have the same liquidation rights as
the holders of the Companys common stock on the same basis as if the preferred
stock had been converted to common stock; and (d) have the same dividend rights
as holders of the Companys common stock on the same basis as if the preferred
stock had been converted to common stock. The Series A convertible preferred stock and Series B convertible
preferred stock automatically convert into shares of common stock upon the
completion of an initial public offering. When converted, each share of Series
A convertible preferred stock and Series B convertible preferred stock will
entitle the holder to receive 0.2257 of a share of common stock and a cash
payment of $4.20 for the Series A holders and $5.22 for the Series B holders,
for a total cash payment of $31,831 (See Note 3). The
Company has outstanding warrants to purchase 490,799 shares of common
stock of the Company at exercise prices ranging from $0.53 to $26.71 per share.
As of December 31, 2003, the warrants remained issued and outstanding and are
currently exercisable. The warrants expire beginning January 2004 through May
2009. Stock Options Under the Companys three stock option plans, the maximum number of shares
of common stock reserved for the grant of options is 2,484,378. The maximum
number of shares is calculated as the lesser of (i) 6,348,328 or 12.5% of
common stock outstanding on a fully diluted basis for the employee plan, and
(ii) the lesser of 380,899 or 0.75% of common stock outstanding on a fully
diluted basis for the non-employee directors plan. All options have been
granted at exercise prices that equaled the fair value of the stock on the date
of grant and vest over a four year period. The exercise periods range from ten
to fifteen years. F-22




---



##### Table of Contents



The estimated weighted average fair values of the options at the date of
grant using the Black-Scholes option-pricing model as promulgated by SFAS No.
123 in 2001, 2002 and 2003 were $9.61, $9.61 and $9.48 per share, respectively. In applying
the Black-Scholes model, the Company assumed the following: Year Ended December 31,2001
    
    2002
    
    2003Risk-free interest rate
    
    
    4.8
    %
    
    
    4.1
    %
    
    
    4.1
    %Expected volatility
    
    
    70
    %
    
    
    70
    %
    
    
    70
    %Expected life, in years
    
    
    7
    
    
    
    7
    
    
    
    7Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Expected forfeiture rate
    
    
    3
    %
    
    
    3
    %
    
    
    3
    %
 For purposes of pro forma disclosure, the estimated fair value of the
options is amortized to expense over the options vesting period. The following is a summary of option transactions: WeightedAverage ExerciseNumber of Shares
    
    PriceDecember 31, 2000
    
    
    731,731
    
    
    $
    5.45Exercised
    
    
    (28,561
    )
    
    
    6.16Expired
    
    
    (43,159
    )
    
    
    8.28December 31, 2001
    
    
    660,011
    
    
    $
    5.49Granted
    
    
    821,250
    
    
    
    12.89Exercised
    
    
    (35,807
    )
    
    
    5.94Expired
    
    
    (11,071
    )
    
    
    12.80December 31, 2002
    
    
    1,434,383
    
    
    $
    10.06Granted
    
    
    476,322
    
    
    
    14.96Exercised
    
    
    (84,627
    )
    
    
    0.66Expired
    
    
    (107,603
    )
    
    
    10.35December 31, 2003
    
    
    1,718,475
    
    
    $
    11.87
 At December 31, 2003, options to purchase 393,468 shares
of common stock were available for grant. At December 31, 2001, 2002 and 2003, options to purchase 495,641 shares,
582,911 shares and 761,978 shares of common stock, respectively, were
exercisable. The following table summarizes information regarding the options
outstanding at December 31, 2003: Options Outstanding
    
    Options ExercisableWeighted-Outstanding
    
    Average
    
    Weighted-
    
    Exercisable
    
    Weighted-as of
    
    Remaining
    
    Average
    
    as of
    
    AverageRange of
    
    December 31,
    
    Contractual
    
    Exercise
    
    December 31,
    
    ExerciseExercise Prices
    
    2003
    
    Life
    
    Price
    
    2003
    
    Price$  0.00
 $  2.53
    
    
    139,657
    
    
    
    3.5
    
    
    $
    0.54
    
    
    
    139,657
    
    
    $
    0.54$  5.05
 $  7.58
    
    
    2,952
    
    
    
    4.1
    
    
    $
    5.42
    
    
    
    2,952
    
    
    $
    5.42$  7.58
 $10.10
    
    
    337,115
    
    
    
    6.2
    
    
    $
    8.23
    
    
    
    337,115
    
    
    $
    8.23$10.10  $12.63
    
    
    49,568
    
    
    
    0.9
    
    
    $
    10.69
    
    
    
    49,568
    
    
    $
    10.69$12.63  $15.15
    
    
    1,189,183
    
    
    
    9.0
    
    
    $
    14.30
    
    
    
    232,686
    
    
    $
    13.871,718,475
    
    
    
    8.3
    
    
    $
    11.87
    
    
    
    761,978
    
    
    $
    8.69
 F-23




---



##### Table of Contents



9. Earnings Per Share Basic and diluted income per share are based on the weighted
average number of common shares outstanding and the dilutive impact of
outstanding options and warrants to purchase shares. Year Ended December 31,2001
    
    2002
    
    2003Numerator for basic and diluted income per share:Net income
    
    $
    4,689
    
    
    $
    12,302
    
    
    $
    17,524Denominator:Denominator for basic income per share
weighted-average shares outstanding
    
    
    9,908,447
    
    
    
    10,349,568
    
    
    
    10,536,745Effect of dilutive securities:Employee stock options
    
    
    302,927
    
    
    
    392,959
    
    
    
    301,903Warrants
    
    
    129,711
    
    
    
    178,776
    
    
    
    189,527Preferred stock
    
    
    
    
    
    
    1,175,935
    
    
    
    1,567,910Common stock held in escrow
    
    
    
    
    
    
    46,902
    
    
    
    62,535Denominator for diluted income per share 
adjusted weighted-average shares outstanding
    
    
    10,341,085
    
    
    
    12,144,140
    
    
    
    12,658,620Basic net income per share
    
    $
    0.47
    
    
    $
    1.19
    
    
    $
    1.66Diluted net income per share
    
    $
    0.45
    
    
    $
    1.01
    
    
    $
    1.38
 The effects of 450,928 employee stock options for 2003 and 11,071, 19,643
and 19,568 warrants for 2001, 2002 and 2003, respectively, were not included in
the computation of diluted earnings per share because their effects would have
been anti-dilutive. 10. Income Taxes The Company and its subsidiaries file a consolidated federal income tax
return. The limited partnerships and limited liability companies file separate
income tax returns. The Companys allocable portion of each partnerships and
limited liability companys income or loss is included in the taxable income of
the Company. The remaining income or loss of each partnership and limited
liability company is allocated to the limited partners. Income tax expense is comprised of the following for the years ended
December 31: 2001
    
    2002
    
    2003Current:Federal
    
    $
    
    
    
    $
    
    
    
    $
    272State
    
    
    287
    
    
    
    215
    
    
    
    666Deferred
    
    
    
    
    
    
    
    
    
    
    (3,108
    )Income tax expense (benefit)
    
    $
    287
    
    
    $
    215
    
    
    $
    (2,170
    )
 The effective income tax rate differed from the federal statutory
rate as follows for the years ended December 31: 2001
    
    2002
    
    2003Tax at U.S. statutory rates
    
    $
    1,692
    
    
    $
    4,222
    
    
    $
    5,374State income taxes, net of federal tax benefit
    
    
    287
    
    
    
    142
    
    
    
    249Change in valuation allowance
    
    
    (2,054
    )
    
    
    (4,183
    )
    
    
    (8,207
    )Other
    
    
    362
    
    
    
    34
    
    
    
    414$
    287
    
    
    $
    215
    
    
    $
    (2,170
    )
 F-24




---



##### Table of Contents



The components of temporary differences and the approximate tax effects
that give rise to the Companys net deferred tax asset are as follows at
December 31: 2002
    
    2003Deferred tax assets:Amortization
    
    $
    5,247
    
    
    $
    6,417Accrued vacation
    
    
    237
    
    
    
    350Net operating loss carryforward
    
    
    6,590
    
    
    
    3,745Deferred project costs
    
    
    209
    
    
    
    89Other deferred liabilities
    
    
    374
    
    
    
    374Other
    
    
    762
    
    
    
    2,337Total gross deferred tax assets
    
    
    13,419
    
    
    
    13,312Less: Valuation allowance
    
    
    (9,691
    )
    
    
    (1,484
    )Total deferred tax assets
    
    
    3,728
    
    
    
    11,828Deferred tax liabilities:Depreciation on property and equipment
    
    
    (3,728
    )
    
    
    (6,116
    )Basis differences of partnerships and joint ventures
    
    
    
    
    
    
    (2,373
    )Other
liabilities
    
    
    
    
    
    
    (231
    )Net deferred tax asset (liability)
    
    $
    
    
    
    $
    3,108
 The Company has federal net operating losses of $6,948 and state net
operating losses of $31,596 at December 31, 2003. These losses expire from
December 31, 2011 through 2022. Management has evaluated the need for a
valuation allowance for deferred tax assets and believes that certain deferred
tax assets will more likely than not be realized through the future reversal of
existing taxable temporary differences and future earnings of the Company. In
the fourth quarter of 2003, the Company recorded deferred tax assets of
$3,108, resulting in a corresponding decrease to the valuation
allowance and to deferred income tax expense.
During 2003, the valuation allowance decreased by $8,207, including the $3,108
decrease discussed above, as a result of changes in the deferred tax items. 11. Employee Benefit Plans Symbion, Inc. 401(k) Plan The Symbion, Inc. 401(k) Plan (the Symbion Plan) is a defined
contribution plan whereby employees who have completed six months of service in
which they have worked a minimum of 1,000 hours and are age 21 or older are
eligible to participate. The Symbion Plan allows eligible employees to make
contributions of varying percentages of their annual compensation, up to the
maximum allowed amounts by the Internal Revenue Service. Eligible employees may
or may not receive a match of their contributions. The match varies by surgery
center and is determined prior to the start of each plan year. Generally
employer contributions vest 20% after two years of service and continue vesting
at 20% per year until fully vested. The Companys matching expense for 2001,
2002 and 2003 was $815, $521 and $513, respectively. Employee Stock Purchase Plan Effective March 2002, the Company adopted an Employee Stock Purchase Plan
(Stock Purchase Plan) to provide substantially all employees an opportunity
to purchase shares of its common stock in amounts not to exceed 10% of eligible
compensation, 5,642 shares of common stock or $25 of common stock each calendar
year. Annually, the participants September 30 account balance is used to
purchase shares of stock at the lesser of 85% of the fair market value of
shares at the beginning of the plan year or September 30. A total of 372,435
shares are available for purchase under the plan. The Stock Purchase Plan is
effective upon the Companys completion of an initial public offering as
discussed in Note 14. 12. Commitments and Contingencies Debt and Lease Guaranty on Unconsolidated Entities The Company has guaranteed $600 of long-term debt incurred by an
unconsolidated surgery center in which the Company has a 44% ownership
interest. The proceeds from this debt were used to construct and equip the
surgery F-25




---



##### Table of Contents



center. This debt is payable in monthly installments of principal and
interest over a period of seven years, and matures on dates ranging from 2006
to 2007. The debt is secured by substantially all of the assets of the surgery
center. The Company has also guaranteed $1,534 of operating lease payments of this
surgery center in which it owns a 44% interest. The lease is related to the
facility and is for a term through 2009. Professional, General and Workers Compensation Liability Risks The Company is subject to claims and legal actions in the ordinary course
of business, including claims relating to patient treatment, employment
practices and personal injuries. To cover these types of claims, the Company
maintains general liability and professional liability insurance in excess of
self-insured retentions through a commercial insurance carrier in amounts that
the Company believes to be sufficient for its operations, although,
potentially, some claims may exceed the scope of coverage in effect. This
insurance coverage is on a claims-made basis. Plaintiffs in these matters may
request punitive or other damages that may not be covered by insurance. In the
opinion of management, the ultimate resolution of such proceedings will not
have a material adverse effect on the Companys business, financial condition
or results of operations. The Company expenses the costs under the self-insured
retention exposure for general and professional liability claims which relate
to (i) deductibles on claims made during the policy period, and (ii) an
estimate of claims incurred but not yet reported that are expected to be
reported after the policy period expires. These expenses are based on
various assumptions. A change in one or more of these assumptions
could materially change the Companys consolidated financial
position or results of operations. As of December 31, 2002 and 2003, the
Companys professional and general liability accrual for the estimate of
self-insured retentions was $1,579 and $3,209, respectively, of which $510 is
included in other accrued expenses in the accompanying consolidated balance
sheets as of December 31, 2002 and $1,069 and $3,209 is included in other
liabilities in the accompanying consolidated balance sheets as of December 31,
2002 and 2003, respectively. Current Operations Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. Compliance with such laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory action including fines, penalties, and exclusion
from the Medicare, Medicaid and other federal health care programs. From time
to time, governmental regulatory agencies will conduct inquiries of the
Companys practices. It is the Companys current practice and future intent to
cooperate fully with such inquiries. The Company is not aware of any such
inquiry that would have a material adverse effect on the Companys consolidated
financial position or results of operations. Acquired Centers The Company, through its wholly-owned subsidiaries or controlled
partnerships and limited liability companies, has acquired and will continue to
acquire surgical and diagnostic centers with prior operating histories. Such
centers may have unknown or contingent liabilities, including liabilities for
failure to comply with healthcare laws and regulations, such as billing and
reimbursement, fraud and abuse and similar anti-referral laws. Although the
Company attempts to assure itself that no such liabilities exist and obtains
indemnification from prospective sellers covering such matters and institutes
policies designed to conform centers to its standards following completion of
acquisitions, there can be no assurance that the Company will not become liable
for past activities that may later be asserted to be improper by private
plaintiffs or government agencies. There can be no assurance that any such
matter will be covered by indemnification or, if covered, that the liability
sustained will not exceed contractual limits or the financial capacity of the
indemnifying party. The Company cannot predict whether federal or state statutory or
regulatory provisions will be enacted that would prohibit or otherwise regulate
relationships which the Company has established or may establish with other
health care providers or have materially adverse effects on its business or
revenues arising from such future actions. The Company believes, however, that
it will be able to adjust its operations so as to be in compliance with any
regulatory or statutory provision as may be applicable. F-26




---



##### Table of Contents



Potential Physician Investor Liability Each physician investor in the partnerships and limited liability
companies which operate surgery centers carries general and professional
liability insurance on a claims-made basis. Each investee may, however, be
liable for damages to persons or property arising from occurrences at the
surgery centers. Although the various physician investors and other surgeons
are required to obtain general and professional liability insurance with tail
coverage, such individual may not be able to obtain coverage in amounts
sufficient to cover all potential liability. Since most insurance policies
contain exclusions, the physician investor will not be insured against all
possible occurrences. In the event of an uninsured or underinsured loss, the
value of an investment in the partnership interests or limited liability
company membership units and the amount of distributions could be adversely
affected. 13. Selected Quarterly Financial Data (Unaudited) The following is selected quarterly financial data for each of the four
quarters in 2002 and 2003. Quarterly results are not necessarily
representative of operations for a full year. 2003First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter(unaudited)Revenues
    
    $
    41,455
    
    
    $
    44,053
    
    
    $
    43,289
    
    
    $
    47,472Cost of Revenues
    
    
    26,590
    
    
    
    28,462
    
    
    
    30,350
    
    
    
    31,903Net Income
    
    
    4,381
    
    
    
    4,031
    
    
    
    1,906
    
    
    
    7,206Net income per share:Basic
    
    
    0.42
    
    
    
    0.38
    
    
    
    0.18
    
    
    
    0.68Diluted
    
    
    0.34
    
    
    
    0.32
    
    
    
    0.15
    
    
    
    0.57
 2002First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter(unaudited)Revenues
    
    $
    25,293
    
    
    $
    39,357
    
    
    $
    38,126
    
    
    $
    41,912Cost of Revenues
    
    
    16,877
    
    
    
    25,238
    
    
    
    25,204
    
    
    
    26,373Net Income
    
    
    1,823
    
    
    
    3,708
    
    
    
    2,724
    
    
    
    4,047Net income per share:Basic
    
    
    0.18
    
    
    
    0.35
    
    
    
    0.26
    
    
    
    0.39Diluted
    
    
    0.17
    
    
    
    0.29
    
    
    
    0.21
    
    
    
    0.32
 The fourth quarter 2003 results included a benefit for income taxes
of $3,129, which primarily related to the recognition of deferred tax
assets of approximately $3,108. The fourth quarter of 2003 was also
impacted by higher interest expense
incurred in connection with the refinancing of outstanding indebtedness. 14. 2004 Subsequent Event On February 5, 2004, the Companys Board of Directors approved a
1-for-4.4303 reverse stock split of the Companys common stock in connection
with its initial public offering. All information related to common stock,
options to purchase common stock, warrants to purchase common stock and
earnings per share data presented in the accompanying consolidated financial
statements have been restated to reflect the effect of the reverse stock split
of the Companys common stock. On February 11, 2004, Symbion completed an initial public offering of
8,280,000 shares of its common stock at a price of $15.00 per share, including
1,080,000 shares sold following exercise in full by the underwriters of an
option granted to them by the Company to purchase the additional shares to
cover over-allotments. The Company received net proceeds of $115.5 million in
the offering, after deducting underwriting discounts and commissions. The
Company has used the net proceeds to repay indebtedness and to pay holders of
the Companys Series A and Series B convertible preferred stock in connection
with the conversion of those shares to common stock upon the completion of the
offering. F-27




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Nashville, State of Tennessee, on March 26, 2004. SYMBION, INC.By:
    
    /s/ Richard E. Francis, Jr.Richard E. Francis, Jr.Chairman and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the date indicated. Signature
    
    Title
    
    Date/s/ Richard E. Francis, Jr.
Richard E. Francis, Jr.
    
    Chairman of the Board, Chief Executive Officer,
Director (principal executive officer)
    
    March 26, 2004/s/ Kenneth C. Mitchell
Kenneth C. Mitchell
    
    Chief Financial Officer, Senior Vice
President of Finance
(principal financial and accounting officer)
    
    March 26, 2004/s/ Clifford G. Adlerz
Clifford G. Adlerz
    
    President, Chief Operating Officer,
Director
    
    March 26, 2004/s/ William V. B. Webb
William V. B. Webb
    
    Chief Development Officer,
Director
    
    March 26, 2004/s/ Frederick L. Bryant
Frederick L. Bryant
    
    Director
    
    March 26, 2004Donald W. Burton
    
    Director/s/ Eve M. Kurtin
Eve M. Kurtin
    
    Director
    
    March 26, 2004/s/Charles N. Martin, Jr.
Charles N. Martin, Jr.
    
    Director
    
    March 26, 2004/s/ Jack Tyrrell
Jack Tyrrell
    
    Director
    
    March 26, 2004/s/ David M. Wilds
David M. Wilds
    
    Director
    
    March 26, 2004




---



##### Table of Contents



EXHIBIT INDEX No.
    
    
    Description2.1
    
    
    
    Agreement and Plan of Merger, dated as of March 7, 2002, among Symbion, Inc., Symbion
Acquisition Sub, Inc. and Physicians Surgical Care, Inc. (a)3.1
    
    
    
    Certificate of Incorporation (b)3.2
    
    
    
    Certificate of Amendment to Certificate of Incorporation (c)3.3
    
    
    
    Certificate of Retirement of Stock3.4
    
    
    
    Certificate of Designation of Rights and Preferences of Series A Convertible Preferred
Stock and Series B Convertible Preferred Stock (b)3.5
    
    
    
    Certificate of Designation of Series A Junior Participating Preferred Stock (c)3.6
    
    
    
    Bylaws (b)4.1
    
    
    
    Form of Common Stock Certificate (b)4.2
    
    
    
    Amended and Restated Investors Rights Agreement, dated as of June 25, 1999, among Symbion,
Inc. and the security holders named therein (a)4.3
    
    
    
    Amendment No. 1 to Amended and Restated Investors Rights Agreement, dated as of August 11,
1999, among Symbion, Inc. and the security holders named therein (a)4.4
    
    
    
    Amendment No. 2 to Amended and Restated Investors Rights Agreement, dated as of April 1,
2002, among Symbion, Inc. and the security holders named therein (a)4.5
    
    
    
    Form of Warrant for the purchase of shares of Symbion, Inc. common stock (a)4.6
    
    
    
    Rights Agreement, dated as of February 6, 2004, between Symbion, Inc. and SunTrust Bank (d)4.7
    
    
    
    Director Nomination Agreement, dated as of April 1, 2002, among Symbion, Inc., J. H.
Whitney III, L.P., J. H. Whitney IV, L.P. and Whitney Strategic Partners III, L.P. (a)10.1
    
    
    
    Amended and Restated Executive Employment Agreement, dated May 16, 2002, between Symbion,
Inc. and Richard E. Francis, Jr. (a) (e)10.2
    
    
    
    Amended and Restated Executive Employment Agreement, dated May 16, 2002, between Symbion,
Inc. and Clifford G. Adlerz (a) (e)10.3
    
    
    
    Amended and Restated Executive Employment Agreement, dated May 16, 2002, between Symbion,
Inc. and William V. B. Webb (a) (e)10.4
    
    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and
Richard E. Francis, Jr. (a) (e)10.5
    
    
    
    Employee Stock Purchase Agreement, dated as of December 30, 1996, between Symbion, Inc. and
Richard E. Francis, Jr. (a) (e)10.6
    
    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and
Clifford G. Adlerz (a) (e)




---



##### Table of Contents



No.
    
    
    Description10.7

    
    
    Employee Stock Purchase Agreement, dated as of December 30, 1996, between Symbion, Inc. and
Clifford G. Adlerz (a) (e)10.8

    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and
Kenneth C. Mitchell (a) (e)10.9

    
    
    Employee Stock Purchase Agreement, dated as of December 30, 1996, between Symbion, Inc. and
R. Dale Kennedy (a) (e)10.10

    
    
    Employee Stock Purchase Agreement, dated as of March 13, 1996, between Symbion, Inc. and R.
Dale Kennedy (a) (e)10.11

    
    
    Employee Stock Purchase Agreement, dated as of June 1, 1999, between Symbion, Inc. and R.
Dale Kennedy (a) (e)10.12

    
    
    Securities Purchase Agreement, dated as of July 18, 2003, among Symbion, Inc. and DLJ
Investment Partners II, L.P. and its affiliates (b)10.13

    
    
    Form of 14 3⁄4% Senior Subordinated Note due 2008 (b)10.14

    
    
    Credit Agreement, dated as of July 18, 2003, among Symbion, Inc., various lenders party
thereto, Bank of America, N.A., as Administrative Agent and as Issuing Bank, Credit Suisse
First Boston as Syndication Agent, Key Corporate Capital, Inc. as Documentation Agent, and
Banc of America Securities, LLC, as sole Lead Arranger and Sole Book Manager (b)10.15

    
    
    First Amendment to Credit Agreement, dated January 30, 2004, among Symbion, Inc., various
lenders party thereto and Bank of America, N.A., as Administrative Agent and as Issuing
Bank (b)10.16

    
    
    Limited Guaranty and Suretyship Agreement, dated as of July 24, 2001, by PSC Development
Company, L.L.C. to and for the benefit of DVI Financial Services Inc. (a)10.17

    
    
    Limited Guaranty and Suretyship Agreement, dated as of July 24, 2001 by PSC of New York,
L.L.C. to and for the benefit of DVI Financial Services Inc. (a)10.18

    
    
    Lease Agreement, dated June 26, 2001, between Burton Hills IV Partners and Symbion, Inc. (a)10.19

    
    
    First Amendment to Lease Agreement, dated February 9, 2004, between Burton Hills IV
Partners and Symbion, Inc.10.20

    
    
    Lease Agreement, dated June 6, 1997, between Physicians Surgical Care, Inc. and San Felipe
Plaza, Ltd. (a)10.21

    
    
    Escrow Agreement, dated as of March 7, 2002, among Symbion, Inc., Physicians Surgical Care,
Inc., J. H. Whitney Equity Partners III, L.L.C., Bank of America, N.A. and the stockholders
named therein (a)10.22

    
    
    Amended and Restated Ambulatory Resource Centres, Inc. 1997 Stock Option Plan (a) (e)10.23

    
    
    Ambulatory Resource Centres, Inc. Nonqualified Initial Option Plan (a) (e)10.24

    
    
    Symbion Stock Incentive Plan (a) (e)10.25

    
    
    Symbion Non-Employee Directors Stock Option Plan (a) (e)10.26

    
    
    Symbion Employee Stock Purchase Plan (a) (e)




---



##### Table of Contents



No.

    
    
    Description10.27

    
    
    First Amendment to Symbion Employee Stock Purchase Plan (a) (e)10.28

    
    
    Executive Change in Control Severance Plan, dated December 11, 1997 (a) (e)21.1

    
    
    Subsidiaries of Registrant (b)23.1

    
    
    Consent of Ernst & Young LLP23.2

    
    
    Consent of Casualty Actuarial Consultants, Inc.31.1

    
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 200231.2

    
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 200232.1

    
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2

    
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   (a)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form S-1 (Registration No. 333-89554).(b)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form S-1 (Registration No. 333-110555).(c)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form S-8 (Registration No. 333-113272).(d)
    
    Incorporated by reference to exhibits filed with the Registrants
Registration Statement on Form 8-A filed with the Securities and Exchange
Commission on February 6, 2004 (Registration No. 000-50574).(e)
    
    Compensation plan or arrangement.