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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
(Mark One)    
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the quarterly period ended March 31, 2005
 
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
   75-2749762
(State or other jurisdiction of
incorporation or organization)		   (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 þ          No o
      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o
      At April 25, 2005 there were 28,827,623 shares of Common Stock outstanding.
 
 

UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
             
 PART I. Financial Information
   Financial Statements (unaudited)     3  
     Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004     3  
     Consolidated Statements of Income for the three months ended March 31, 2005 and 2004     4  
     Consolidated Statements of Comprehensive Income for the three months ended March 31, 2005 and 2004     5  
     Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004     6  
     Notes to Consolidated Financial Statements     7  
   Management’s Discussion and Analysis of Financial Condition and Results of Operations     18  
   Quantitative and Qualitative Disclosures About Market Risk     27  
   Controls and Procedures     27  
 PART II. Other Information
   Legal Proceedings     27  
   Exhibits and Reports on Form 8-K     28  
 Signatures     29  
 Certification of CEO Pursuant to Section 302
 Certification of CFO Pursuant to Section 302
 Certification of CEO Pursuant to Section 906
 Certification of CFO Pursuant to Section 906
Note: Items 2, 3, 4 and 5 of Part II are omitted because they are not applicable.

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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited — in thousands, except per share amounts)
                     
    March 31,   December 31,
    2005   2004
         
ASSETS
Cash and cash equivalents
   $ 102,439     $ 93,467  
Patient receivables, net of allowance for doubtful accounts of $8,001 and $7,277, respectively
     43,318       43,591  
Other receivables
     12,962       20,293  
Inventories of supplies
     7,545       7,188  
Deferred tax asset, net
     8,089       7,393  
Prepaids and other current assets
     7,872       7,035  
             
   
Total current assets
     182,225       178,967  
Property and equipment, net
     263,602       265,889  
Investments in affiliates
     62,215       43,402  
Intangible assets, net
     406,180       402,355  
Other assets
     31,675       31,691  
             
   
Total assets
   $ 945,897     $ 922,304  
             
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable
   $ 16,918     $ 18,048  
Accrued salaries and benefits
     22,580       20,582  
Due to affiliates
     15,213       12,805  
Accrued interest
     5,309       1,856  
Current portion of long-term debt
     16,891       15,316  
Other accrued expenses
     26,066       23,182  
             
   
Total current liabilities
     102,977       91,789  
Long-term debt, less current portion
     268,106       273,169  
Other long-term liabilities
     2,320       2,624  
Deferred tax liability, net
     33,563       31,846  
             
   
Total liabilities
     406,966       399,428  
Minority interests
     51,382       48,267  
Stockholders’ equity:
                
 
Common stock, $0.01 par value; 200,000 shares authorized; 28,816 and 28,660 shares issued at March 31, 2005 and December 31, 2004, respectively
     288       287  
 
Additional paid-in capital
     352,587       349,191  
 
Treasury stock, at cost, 28 and 14 shares at March 31, 2005 and December 31, 2004, respectively
     (855 )     (320 )
 
Deferred compensation
     (7,060 )     (7,689 )
 
Accumulated other comprehensive income, net of tax
     13,111       14,420  
 
Retained earnings
     129,478       118,720  
             
   
Total stockholders’ equity
     487,549       474,609  
             
   
Total liabilities and stockholders’ equity
   $ 945,897     $ 922,304  
             
See accompanying notes to consolidated financial statements.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited — in thousands, except per share amounts)
                       
    Three Months Ended
    March 31,
     
    2005   2004
         
Revenues:
                
 
Net patient service revenue
   $ 106,194     $ 80,655  
 
Management and administrative services revenue
     9,325       9,505  
 
Other revenue
     167       212  
             
   
Total revenues
     115,686       90,372  
Equity in earnings of unconsolidated affiliates
     5,103       5,310  
Operating expenses:
                
 
Salaries, benefits, and other employee costs
     30,174       22,635  
 
Medical services and supplies
     19,602       14,434  
 
Other operating expenses
     21,388       16,724  
 
General and administrative expenses
     7,602       6,795  
 
Provision for doubtful accounts
     2,874       2,012  
 
Depreciation and amortization
     7,719       6,350  
             
   
Total operating expenses
     89,359       68,950  
             
Operating income
     31,430       26,732  
 
Interest income
     887       168  
 
Interest expense
     (6,887 )     (6,408 )
 
Other
     242       7  
             
   
Total other expense, net
     (5,758 )     (6,233 )
Income before minority interests
     25,672       20,499  
 
Minority interests in income of consolidated subsidiaries
     (8,838 )     (7,928 )
             
Income from continuing operations before income taxes
     16,834       12,571  
 
Income tax expense
     (6,076 )     (4,723 )
             
Income from continuing operations
     10,758       7,848  
 
Income from discontinued operations, net of tax
     —       2,154  
             
Net income
   $ 10,758     $ 10,002  
             
Net income per share attributable to common stockholders
                
 
Basic:
                
   
Continuing operations
   $ 0.38     $ 0.28  
   
Discontinued operations
     —       0.08  
             
     
Total
   $ 0.38     $ 0.36  
             
 
Diluted:
                
   
Continuing operations
   $ 0.36     $ 0.27  
   
Discontinued operations
     —       0.07  
             
     
Total
   $ 0.36     $ 0.34  
             
Weighted average number of common shares
                
 
Basic
     28,362       27,720  
 
Diluted
     29,657       29,178  
See accompanying notes to consolidated financial statements.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Unaudited — in thousands)
                   
    Three Months Ended
    March 31,
     
    2005   2004
         
Net income
   $ 10,758     $ 10,002  
Other comprehensive income (loss), net of taxes:
                
 
Foreign currency translation adjustments
     (1,309 )     (757 )
 
Net unrealized gains on securities
     —       34  
             
 
Other comprehensive income (loss)
     (1,309 )     (723 )
             
 
Comprehensive income
   $ 9,449     $ 9,279  
             
See accompanying notes to consolidated financial statements.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited — in thousands)
                         
    Three Months Ended
    March 31,
     
    2005   2004
         
Cash flows from operating activities:
                
 
Income from continuing operations
   $ 10,758     $ 7,848  
 
Adjustments to reconcile net income to net cash provided by operating activities:
                
   
Provision for doubtful accounts
     2,874       2,012  
   
Depreciation and amortization
     7,719       6,350  
   
Amortization of debt issue costs and discount
     190       541  
   
Deferred income tax expense
     1,122       (101 )
   
Equity in earnings of unconsolidated affiliates
     (5,103 )     (5,310 )
   
Minority interests in income of consolidated subsidiaries
     8,838       7,928  
   
Equity-based compensation
     921       730  
   
Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses:
                
     
Patient receivables
     (2,472 )     (2,152 )
     
Other receivables
     6,436       1,873  
     
Inventories of supplies, prepaids and other current assets
     17       281  
     
Accounts payable and other current liabilities
     9,990       10,763  
     
Long-term liabilities
     631       117  
             
       
Net cash provided by operating activities
     41,921       30,880  
             
Cash flows from investing activities:
                
 
Purchases of new businesses and equity interests, net of cash received
     (20,967 )     (1,266 )
 
Purchases of property and equipment
     (5,541 )     (5,110 )
 
(Increase) decrease in deposits and notes receivable
     (973 )     1,771  
             
       
Net cash used in investing activities
     (27,481 )     (4,605 )
             
Cash flows from financing activities:
                
 
Proceeds from long-term debt
     102       15  
 
Payments on long-term debt
     (4,185 )     (3,309 )
 
Proceeds from issuances of common stock
     2,341       1,895  
 
Distributions on investments in affiliates
     (3,713 )     (1,597 )
             
       
Net cash used in financing activities
     (5,455 )     (2,996 )
             
Net cash used in discontinued operations
     —       (138 )
             
Effect of exchange rate changes on cash
     (13 )     (4 )
             
Net increase in cash and cash equivalents
     8,972       23,137  
Cash and cash equivalents at beginning of period
     93,467       28,519  
             
Cash and cash equivalents at end of period
   $ 102,439     $ 51,656  
             
Supplemental information:
                
 
Interest paid
   $ 3,345     $ 2,038  
 
Income taxes paid
     1,101       262  
 
Non-cash transactions:
                
   
Assets acquired under capital lease obligations
   $ 386     $ 177  
   
Issuance of common stock to employees
     —       1,846  
See accompanying notes to consolidated financial statements

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(1) Basis of Presentation
     (a) Description of Business
      United Surgical Partners International, Inc., a Delaware Corporation, and subsidiaries (USPI or the Company) was formed in February 1998 for the primary purpose of ownership and operation of surgery centers, private surgical hospitals and related businesses in the United States and Europe. At March 31, 2005, USPI, headquartered in Dallas, Texas, operated 86 short-stay surgical facilities. Of these 86 facilities, USPI consolidates the results of 42, accounts for 43 under the equity method, and holds no ownership in the remaining facility, which is operated by USPI under a management contract. USPI operates in two countries, with 83 of its 86 facilities located in the United States of America; the remaining three facilities are located in the United Kingdom. Most of the Company’s U.S. facilities are jointly owned with local physicians and a not-for-profit healthcare system that has other healthcare businesses in the region. At March 31, 2005, the Company had agreements with not-for-profit healthcare systems providing for joint ownership of 48 of the Company’s 83 U.S. facilities and also providing a framework for the planning and construction of additional facilities in the future. All of the Company’s U.S. facilities include physician owners.
      Through its majority-owned subsidiary Global Healthcare Partners Limited (Global), incorporated in England, USPI manages and wholly owns three private surgical hospitals in the greater London area.
      During September 2004, the Company completed the sale of its Spanish operations. At the time of the sale, the Company managed and owned a majority interest in eight private surgical hospitals and one ambulatory surgery center in Spain. The results of the Spanish operations for the quarter ended March 31, 2004 have been reclassified to discontinued operations.
      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 (GAAP). 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.
     (b) Equity-Based Compensation
      As discussed in Note 19 to USPI’s 2004 financial statements on Form 10-K, USPI had planned to adopt a new accounting standard regarding its accounting for some types of equity-based compensation effective July 1, 2005. During April 2005, the Securities and Exchange Commission deferred the implementation date of this accounting standard. As a result, USPI now plans to adopt the new accounting standard effective January 1, 2006. Until that date USPI will continue to follow its historic policy in accounting for its equity-based compensation, as discussed below.
      USPI applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option grants to employees. Accordingly, USPI generally does not record compensation expense related to stock option grants because USPI generally issues options for which the option exercise price equals the current market price of the underlying stock on the date of grant. SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited) — (Continued)
Disclosure, established accounting and disclosure requirements using a fair value based method of accounting for stock-based employee compensation plans. As permitted under SFAS No. 123, the Company has elected to continue to apply the intrinsic value based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148. Had USPI determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, USPI’s net income would have been the pro forma amounts indicated below (in thousands, except per share amounts):
                   
    Three Months Ended
    March 31,
     
    2005   2004
         
Net income:
                
 
As reported
   $ 10,758     $ 10,002  
 
Add: Total stock-based employee compensation expense included in reported net income, net of taxes
     599       474  
 
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of taxes
     (1,559 )     (1,459 )
             
 
Pro forma
   $ 9,798     $ 9,017  
             
Basic earnings per share
                
 
As reported
   $ 0.38     $ 0.36  
 
Pro forma
     0.35       0.33  
Diluted earnings per share
                
 
As reported
   $ 0.36     $ 0.34  
 
Pro forma
     0.33       0.31  
      The fair values in the table above were estimated at the date of grant using the Black-Scholes valuation model with the following assumptions: risk-free interest rates ranging from 2.1% to 4.9%, expected dividend yield of zero, expected volatility of the market price of the Company’s common stock of 40%, and an expected life of the option ranging from three to five years.
      Total stock-based employee compensation expense included in net income, as reported, primarily consists of expense under the Company’s Deferred Compensation Plan, grants of restricted stock to employees, and continued amortization of expense related to a December 2000 grant of stock options at a price lower than the current market price at the date of grant. The compensation amounts related to these grants are being amortized into expense over the estimated service periods.
      The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.
(2) Acquisitions and Equity Method Investments
      Effective January 1, 2005, the Company acquired a controlling interest in an ambulatory surgery center in Westwood, California in which the Company had previously owned a noncontrolling interest, for $7.4 million in cash.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited) — (Continued)
      Following are the unaudited pro forma results for the three months ended March 31, 2004 as if this acquisition had occurred on January 1, 2004 (in thousands, except per share amounts):
         
    Three Months Ended
    March 31, 2004
     
Net revenues
   $ 92,929  
Income from continuing operations
     8,195  
Diluted earnings per share from continuing operations
   $ 0.28  
      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 three months ended March 31, 2005, these transactions resulted in a net cash outflow of $13.6 million. The most significant of these transactions were the Company’s acquisition of additional ownership in eight facilities it operates in the Dallas/ Fort Worth market, which, together with the Company selling a portion of a ninth facility in this market, resulted in a net cash outflow of approximately $13.4 million.
      The Company controls a significant number of its investees and therefore consolidates their results. Additionally, the Company invests in a significant number of facilities in which the Company has significant influence but does not have control; the Company uses the equity method to account for these investments. The majority of these investees are partnerships or limited liability companies, which require the associated tax benefit or expense to be recorded by the partners or members. Summarized financial information for the Company’s equity method investees on a combined basis was as follows (income statement amounts are in thousands and reflect 100% of the investees’ results on an aggregated basis):
                   
    Three Months Ended
    March 31,
     
    2005   2004
         
Unconsolidated facilities operated at period end
     43       32  
Income statement information:
                
 
Revenues
   $ 97,589     $ 78,877  
 
Operating income
     24,881       27,823  
 
Net income
     22,027       25,530  

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited) — (Continued)
(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 outstanding options, warrants and restricted stock, except where such effect would be antidilutive. The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2005 and 2004 (in thousands, except per share amounts):
                     
    Three Months Ended
    March 31,
     
    2005   2004