UNITED SURGICAL PARTNERS INTERNATIONAL INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
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 000-32837

United Surgical Partners International, Inc.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		75-2749762 (IRS Employer Identification Number)
15305 Dallas Parkway, Suite 1600 Addison, Texas (Address of principal executive offices)		75001 (Zip Code)

(972) 713-3500
(Registrant's telephone number, including area code)

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 ý No o

At November 4, 2002 there were 27,038,911 shares of Common Stock outstanding.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES

INDEX

PART I.	Financial Information
Item 1.	Financial Statements	3
	Consolidated Balance Sheets as of September 30, 2002 (unaudited) and December 31, 2001	3
	Consolidated Statements of Income (unaudited) for the three months and nine months ended September 30, 2002 and 2001	4
	Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three months and nine months ended September 30, 2002 and 2001	5
	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2002 and 2001	6
	Notes to Consolidated Financial Statements (unaudited)	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	30
PART II.	Other Information	30
Item 1.	Legal Proceedings	30
Item 6.	Exhibits and Reports on Form 8-K	31
Signatures		32

Note: Items 2, 3, 4 and 5 of Part II are omitted because they are not applicable.

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)

			September 30, 2002			December 31, 2001
			(unaudited)
Assets
Cash and cash equivalents			$	32,135		$	33,881
Patient receivables, net of allowance for doubtful accounts of $5,172 and $4,726 respectively				34,408			27,546
Other receivables				32,611			30,579
Inventories of supplies				6,924			5,685
Deferred tax asset, net				7,453			6,571
Prepaids and other current assets				5,309			6,191

		Total current assets	$	118,840		$	110,453
Property and equipment, net				256,222			211,601
Investments in affiliates				17,182			12,328
Intangible assets, net				260,028			215,809
Other assets				8,231			6,666

		Total assets	$	660,503		$	556,857

Liabilities and Stockholders' Equity
Accounts payable			$	21,198		$	20,633
Accrued salaries and benefits				17,964			13,760
Due to affiliates				6,865			5,513
Accrued interest				5,278			1,822
Current portion of long-term debt				11,013			10,640
Other accrued expenses				21,354			17,007
Deferred tax liability				893			793

		Total current liabilities	$	84,565		$	70,168
Long-term debt, less current portion				270,738			228,041
Other long-term liabilities				3,527			3,130
Deferred tax liability, net				19,433			12,916

		Total liabilities	$	378,263		$	314,255
Minority interests				23,539			16,075
Stockholders' equity:
	Common stock:
		Other, $0.01 par value; 200,000 shares authorized; 24,834 and 24,436 shares issued at September 30, 2002 and December 31, 2001, respectively		248			244
	Additional paid-in capital			269,981			265,809
	Treasury stock, at cost, 272 and 334 shares at September 30, 2002 and December 31, 2001, respectively			(5,050	)		(5,909	)
	Deferred compensation			(1,319	)		(369	)
	Receivables from sales of common stock			(146	)		(1,174	)
	Accumulated other comprehensive loss, net of tax			(2,369	)		(15,592	)
	Accumulated deficit			(2,644	)		(16,482	)

		Total stockholders' equity		258,701			226,527

		Total liabilities and stockholders' equity	$	660,503		$	556,857

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited—in thousands, except per share amounts)

			Three months ended September 30,						Nine months ended September 30,
			2002			2001			2002			2001
Net patient service revenue			$	75,234		$	51,829		$	214,655		$	150,113
Management and administrative services revenue				7,765			7,202			23,451			18,731
Equity in earnings of unconsolidated affiliates				2,100			1,269			6,593			4,134
Other income				732			483			2,051			1,537

		Total revenues		85,831			60,783			246,750			174,515
Salaries, benefits, and other employee costs				23,216			16,738			63,184			46,636
Medical services and supplies				16,324			11,743			47,479			35,104
Other operating expenses				16,139			11,596			45,159			32,392
General and administrative expenses				5,889			5,390			18,168			15,571
Provision for doubtful accounts				1,502			949			4,200			2,126
Depreciation and amortization				6,942			7,239			18,920			19,190

		Total operating expenses		70,012			53,655			197,110			151,019

		Operating income		15,819			7,128			49,640			23,496
Interest income				256			228			645			696
Interest expense				(6,734	)		(3,407	)		(18,945	)		(13,734	)
Other				—			(39	)		(74	)		(49	)

		Total other expense, net		(6,478	)		(3,218	)		(18,374	)		(13,087	)
		Income before minority interest		9,341			3,910			31,266			10,409
Minority interest in income of consolidated subsidiaries				(4,066	)		(1,974	)		(10,172	)		(5,175	)

		Income before income taxes		5,275			1,936			21,094			5,234
Income tax expense				(2,235	)		(212	)		(7,238	)		(1,238	)

		Net income		3,040			1,724			13,856			3,996
Preferred stock dividends				—			(503	)		—			(2,251	)

		Net income attributable to common stockholders	$	3,040		$	1,221		$	13,856		$	1,745

Net income per share attributable to common stockholders
	Basic		$	0.12		$	0.05		$	0.57		$	0.11
	Diluted		$	0.12		$	0.05		$	0.54		$	0.10
Weighted average number of common shares
	Basic			24,472			24,285			24,284			16,458
	Diluted			25,762			25,480			25,529			17,374

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited—in thousands)

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
Net income		$	3,040		$	1,724		$	13,856		$	3,996
Other comprehensive income (loss), before taxes:
	Foreign currency translation adjustments		2,614			7,462			20,343			(2,945	)
	Income tax (expense) benefit related to other comprehensive income (loss)		(915	)		(2,612	)		(7,120	)		1,031

	Other comprehensive income (loss)		1,699			4,850			13,223			(1,914	)

	Comprehensive income	$	4,739		$	6,574		$	27,079		$	2,082

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited—in thousands)

					Nine months ended September 30,
					2002			2001
Cash flows from operating activities:
	Net income				$	13,856		$	3,996
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for doubtful accounts				4,200			2,126
		Depreciation and amortization				18,920			19,190
		Amortization of debt issue costs and discount				1,134			236
		Equity in earnings of unconsolidated affiliates				(6,593	)		(4,134	)
		Minority interest in income of consolidated subsidiaries				10,172			5,175
		Amortization of deferred compensation				285			95
		Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses:
			Patient receivables			(5,598	)		(3,667	)
			Other receivables			(903	)		2,032
			Inventories of supplies, prepaids and other current assets			(460	)		(454	)
			Accounts payable and accrued expenses			5,000			(1,740	)
			Other long-term liabilities			5,140			(332	)

				Net cash provided by operating activities		45,153			22,523

Cash flows from investing activities:
	Purchases of new businesses and equity interests, net of cash received					(39,780	)		(26,132	)
	Purchases of property and equipment					(18,909	)		(15,706	)
	Sales of property					789			—
	Decrease (increase) in deposits and notes receivable					215			(826	)
	Cash released from escrow					—			1,664

				Net cash used in investing activities		(57,685	)		(41,000	)

Cash flows from financing activities:
	Proceeds from long-term debt					53,964			42,056
	Payments on long-term debt					(44,424	)		(108,949	)
	Proceeds from issuances of common stock					2,879			131,465
	Payments to repurchase common stock					—			(104	)
	Payments for the redemption and dividends of preferred stock					—			(33,878	)
	Distributions on investments in affiliates					(1,753	)		(6	)

				Net cash provided by financing activities		10,666			30,584

Effect of exchange rate changes on cash						120			14

Net increase (decrease) in cash and cash equivalents						(1,746	)		12,121
Cash and cash equivalents at beginning of period						33,881			3,451

Cash and cash equivalents at end of period					$	32,135		$	15,572

Supplemental information:
	Interest paid				$	14,607		$	15,702
	Income taxes paid					2,548			—
	Non-cash transactions:
		Sale of common stock for notes receivable from employees, net			$	—		$	315
		Common stock issued for purchases of new businesses and equity interests				1,170			48,301
		Conversion of Series C convertible preferred stock to common stock				—			20,341
		Accrued dividends on preferred stock				—			1,510
		Assets acquired under capital lease obligations				1,705			562
		Conversion of subordinated notes to Series D preferred stock				—			20,000
		Conversion of subordinated debt to common stock				—			3,287
		Issuance of common stock for service contracts				761			—

See accompanying notes to consolidated financial statements

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1) Basis of Presentation

United Surgical Partners International, Inc. and subsidiaries (USPI or the Company), a Delaware company, was formed in February 1998 for the primary purpose of ownership and operation of surgery centers, private surgical hospitals and related businesses in the United States and Western Europe. At September 30, 2002, USPI, headquartered in Dallas, Texas, operated 51 surgical facilities in the United States. Of these 51 facilities, USPI consolidates the results of 23, owns a minority or otherwise noncontrolling equity interest in 25, which are accounted for under the equity method, and holds no ownership interest in the remaining three centers, which are operated by USPI under management contracts. In addition, United Surgical Partners Europe, S.L. (USPE), a company incorporated in Spain and wholly-owned by USPI, managed and owned a majority interest in seven private surgical hospitals, one surgery center, and one diagnostic facility in Spain at September 30, 2002. Global Healthcare Partners Limited (Global), a company incorporated in England and majority-owned by USPI, managed two wholly-owned private surgical hospitals in the United Kingdom at September 30, 2002.

USPI is subject to changes in government legislation that could impact Medicare, Medicaid, and foreign government reimbursement levels and is also subject to increased levels of managed care penetration and changes in payor patterns that may impact the level and timing of payments for services rendered.

USPI maintains its books and records on the accrual basis of accounting, and the consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements and notes should be read in conjunction with the Company's Form 10-K. It is management's opinion that the accompanying consolidated financial statements reflect all adjustments (which are normal recurring adjustments) necessary for a fair presentation of the results for the interim period and the comparable period presented. The results of operations for any interim period are not necessarily indicative of results for the full year.

(2) Acquisitions

Effective February 1, 2002, the Company acquired 100% of a surgical hospital in Murcia, Spain, for total consideration of approximately $8.2 million in cash (of which $7.5 million was paid at the time of acquisition and $0.7 million will be paid on the first anniversary following consummation of the acquisition) and approximately $12.6 million in assumed capital lease obligations.

The Company acquired, through a merger on March 27, 2002, Surgicoe Corporation, which owns, manages, and develops surgical facilities in Georgia, Oklahoma, and Texas. The Company paid the shareholders of Surgicoe approximately $5.3 million in cash. The terms of the agreement provide for the Company to make additional payments in the future should certain facilities, including some that are operational and some that are currently under development, meet specified performance targets.

Effective May 1, 2002, the Company acquired a 67% interest in an ambulatory surgery center in Corpus Christi, Texas for $10.8 million in cash. Effective June 1, 2002, the Company acquired a 57% interest in an ambulatory surgery center in Middleburg Heights, Ohio, a suburb of Cleveland, for $2.1 million in cash.

Effective July 1, 2002, the Company acquired an additional 35% interest in a surgery center in Arlington, Texas (Arlington) for total consideration of $8.0 million, consisting of $6.9 million of cash

and $1.1 million of the Company's common stock, bringing the Company's total ownership interest in the center to 45%.

Prior to the transaction, the Company accounted for its investment in Arlington under the equity method. Effective with this July 1, 2002 transaction, the Company consolidates the results of Arlington's operations because the Company owns a majority of a subsidiary that owns a majority of the surgery center and maintains effective control through this ownership interest and through its operation of the center pursuant to a management contract.

Following are the unaudited pro forma results for the nine months ended September 30, 2002 and 2001 as if the acquisitions discussed above had occurred on January 1, 2001 (in thousands, except per share amounts):

	Nine months ended September 30,
	2002		2001
Net revenues	$	256,696	$	194,456
Net income		13,920		3,380
Net income attributable to common stockholders		13,920		1,129
Basic earnings per share		0.57		0.07
Diluted earnings per share		0.54		0.06

The Company also engages in investing transactions that are not business combinations. These transactions primarily consist of acquisitions and sales of noncontrolling equity interests in surgical facilities and the investment of additional cash in surgical facilities under development. During the nine months ended September 30, 2002, these resulted in net cash outflows from USPI in an aggregate net amount of $7.2 million.

(3) Earnings Per Share

Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of convertible preferred stock, convertible debt, and outstanding options, warrants and restricted stock, except where such effect would be antidilutive. Net income attributable to common stockholders and net income per common share include preferred stock dividends for purposes of this computation for the three months and nine months ended September 30, 2001. No preferred stock dividends are included in this computation for the three months and nine months ended September 30, 2002 as all convertible preferred stock was redeemed prior to January 1, 2002. The following table sets forth the computation of basic and diluted earnings

per share for the three months and nine months ended September 30, 2002 and 2001 (in thousands, except per share amounts):

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
Net income attributable to common shareholders		$	3,040		$	1,221		$	13,856		$	1,745
Weighted average common shares outstanding			24,472			24,285			24,284			16,458
Effect of dilutive securities:
	Stock options		997			914			951			640
	Warrants and restricted stock		293			281			294			276
	Convertible subordinated debt		(B	)		(B	)		(B	)		(A	)
	Series C convertible preferred stock		(B	)		(B	)		(B	)		(A	)

Shares used for diluted earnings per share			25,762			25,480			25,529			17,374

Basic earnings per share		$	0.12		$	0.05		$	0.57		$	0.11
Diluted earnings per share		$	0.12		$	0.05		$	0.54		$	0.10

(A): No incremental shares are included because the effect would be antidilutive.
(B): No securities of this type were outstanding during this period.

The convertible subordinated debt and Series C convertible preferred stock, which were excluded from the computation of 2001 earnings per share because their effect would be antidilutive, were converted to common stock during 2001 and therefore will not affect earnings per share in the future.

(4) Segment Disclosure

Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments in financial statements. USPI's business is the operation of surgery centers, private surgical hospitals and related businesses in the United States and Western Europe. USPI's chief operating decision maker, as that term is defined in the accounting standard, regularly reviews financial information about its surgery centers and private surgical hospitals for assessing performance and allocating resources both

domestically and abroad. Accordingly, USPI's reportable segments consist of (1) U.S. based facilities and (2) Western Europe based facilities, including those in Spain and the United Kingdom.

			Western Europe
Three months ended September 30, 2002 (unaudited)	U.S.		Spain		United Kingdom		Western Europe Total		Total
Net patient service revenue	$	43,906	$	19,270	$	12,058	$	31,328	$	75,234
Other revenue		9,975		622