Form 10-K

(Mark One)

For the fiscal year ended December 31, 2003

For the transition period from ______ to _____

Commission file number: 000-50574

Symbion, Inc.

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

     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.

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

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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:

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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.

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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.

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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.

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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.

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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

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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:

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  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:

  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:

  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

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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

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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.

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     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.

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     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.

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     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.

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  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

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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.

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  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