UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

OR

Commission file number: 000-50574

Symbion, Inc.

(615) 234-5900
(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 x No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

     As of October 31, 2004, there were 21,000,607 shares of the registrant’s common stock outstanding.

Table of Contents

PART I FINANCIAL INFORMATION

Item 1. Financial Statements.

SYMBION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes.

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SYMBION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

2

SYMBION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See accompanying notes.

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SYMBION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
September 30, 2004

1. Organization

     Symbion, Inc. (the “Company”), through its wholly-owned subsidiaries, owns interests in limited partnerships and limited liability companies which own and operate surgery centers in joint-ownership with physicians and physician groups, hospitals and hospital networks. As of September 30, 2004, the Company owned and operated 42 surgery centers and managed nine additional surgery centers in 20 states. The Company owns a majority interest in 31 of the 42 surgery centers and consolidates 36 of these centers for financial reporting purposes. The Company’s surgery centers include three facilities that are licensed as hospitals, two of which are owned and one of which is managed. In addition to the surgery centers, the Company also operates two diagnostic centers and manages three physician networks, including two physician networks in markets in which the Company also operates surgery centers.

2. Significant Accounting Policies and Practices

Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the accompanying unaudited condensed consolidated financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All adjustments are of a normal, recurring nature. Certain amounts from the previous period have been reclassified to conform to the current year presentation. Operating results for the quarter and nine months ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Principles of Consolidation

     The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, as well as its interest in limited partnerships and limited liability companies controlled by the Company through ownership of a majority voting interest or other rights granted to the Company by contract as the sole general partner to manage and control the ordinary course of the affiliate’s business. The accompanying unaudited condensed consolidated financial statements also include the accounts of a variable interest entity in which the Company is the primary beneficiary. The limited partner or minority member responsibilities are to supervise the delivery of medical services with their rights being restricted to those that protect their financial interests. Under certain of the partnership and operating agreements governing these limited partnerships and limited liability companies, the Company could be removed as the sole general partner or managing member for certain events such as material breach, gross negligence or bankruptcy. These protective rights do not preclude consolidation of the respective limited partnerships and limited liability companies. All significant intercompany balances and transactions are eliminated in consolidation.

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Accounts Receivable

     Accounts receivable consist of receivables from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, employers and patients. The Company recognizes that revenues and receivables from government agencies are significant to its operations, but it does not believe that there are significant credit risks associated with these government agencies. Concentration of credit risk with respect to other payors is limited because of the large number of such payors. Accounts receivable are recorded net of contractual adjustments and allowances for doubtful accounts to reflect accounts receivable at net realizable value. Accounts receivable at December 31, 2003 and September 30, 2004, respectively, were as follows (in thousands):

     The following table sets forth by type of payor the percentage of the Company’s accounts receivable for consolidated surgery centers as of December 31, 2003 and September 30, 2004:

Goodwill

     Goodwill represents the excess of the purchase price over the fair value of net identifiable assets acquired. Through December 31, 2001, goodwill was amortized on a straight-line basis over the expected periods to be benefited, generally twenty years. In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interests method of accounting for those business combinations. Effective January 1, 2002, the amortization of all goodwill was discontinued upon the adoption of SFAS No. 142. SFAS No. 142 no longer permits the amortization of goodwill and other indefinite lived intangible assets over a set period; rather these assets must be tested for impairment at least annually using a fair value method. The Company will perform a goodwill impairment test whenever events or changes in facts or circumstances indicate that impairment may exist, or at least annually during the fourth quarter each year.

     Changes in the carrying amount of goodwill are as follows (in thousands):

     The purchase price allocation of $47.5 million includes $31.8 million related to the Company’s Series A convertible preferred stock and Series B convertible preferred stock which converted into common stock and the right to receive cash upon completion of the Company’s initial public offering as discussed in Note 6. The purchase price allocation of $47.5 million also includes $3.7 million of goodwill related to 204,500 shares of the Company’s common stock that were issued to the former stockholders of Physicians Surgical Care, Inc. (“PSC”) pursuant to an earn-out provision in the Company’s purchase agreement with PSC. The earn-out was based on the 2003 financial results of one of the surgery centers acquired from PSC in March

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2002. In addition, the purchase price allocation of $47.5 million includes $12.0 million primarily related to the four surgery centers the Company purchased during the three months ended September 30, 2004 as discussed in Note 4.

Revenues

     Revenues consist of the following for the three months and nine months ended September 30, 2003 and 2004, respectively (in thousands):

     The following table sets forth by type of payor the percentage of the Company’s patient service revenues generated for the three months and nine months ended September 30, 2003 and 2004, respectively, for surgery centers in which the Company owned an interest as of September 30, 2003 and 2004, respectively:

Stock-Based Compensation

     SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has elected to record stock options in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations thereof and, accordingly, recognizes no compensation expense for options granted when the exercise price equals, or is greater than, the market price of the underlying stock on the date of grant (the “intrinsic value method”).

     Had the Company used the Black-Scholes estimates to determine compensation expense for options granted, net income and net income per share attributable to common stockholders would have been reduced to the following pro forma amounts (in thousands, except per share amounts):

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Use of Estimates

     The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying unaudited condensed consolidated financial statements and notes. Actual results could differ from those estimates.

Recent Accounting Standards

     In December 2003, the FASB issued Interpretation No. 46(R), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. FIN 46(R) requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46(R) was effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46(R) for public companies must be applied for the first interim or annual period beginning after March 15, 2004, with early adoption allowed. The Company adopted FIN 46(R) on December 31, 2003. The Company has not entered into or acquired any VIEs subsequent to January 31, 2003. The Company has determined that it is the primary beneficiary of a VIE created on July 31, 2002. The Company entered into a development agreement with a group of physicians to develop a surgery center in which the Company has no ownership interest. The surgery center opened on October 16, 2002. Under the development agreement, a limited liability company in which the Company owns a majority of the ownership interests manages the surgery center, leases certain fixed assets to the surgery center and provides working capital to the surgery center. In addition, the investors in the surgery center have insufficient equity at risk. At December 31, 2003, the Company began consolidating this VIE in the accompanying condensed consolidated balance sheets. The Company, as permitted by FIN 46(R), did not restate prior period information upon adoption. The adoption of FIN 46(R) did not have a material effect on the Company’s results of operations.

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement generally requires liability classification for two broad classes of financial instruments. Under SFAS No. 150, instruments that represent, or are indexed to, an obligation to buy back the issuer’s shares, regardless of whether the instrument is settled on a net-cash or gross physical basis are required to be classified as liabilities. Obligations that can be settled in shares, but either derive their value predominately from some other underlying, have a fixed value, or have a value to the counterparty that moves in the opposite direction as the issuer’s shares, are also required to be classified as liabilities under this statement. SFAS No. 150 must be applied immediately to instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. On November 5, 2003 the FASB agreed to defer indefinitely the effective date of the statement for certain types of noncontrolling interests that are classified as equity in the financial statements of subsidiaries, but are classified as liabilities in the financial statements of related parent companies. As a result of the deferral, companies should continue to account for these interests as minority interests. The Company does not expect SFAS No. 150 to have a material impact on its consolidated financial position or results of operations.

3. Reverse Stock Split and Initial Public Offering

     On February 5, 2004, the Company’s Board of Directors approved a 1-for-4.4303 reverse stock split of the Company’s common stock in connection with its initial public offering. All information related to common stock, options to purchase common stock, warrants to purchase common stock and earnings per share data presented in the accompanying unaudited condensed consolidated financial statements and related notes have been restated to reflect the effect of the reverse stock split of the Company’s common stock.

     On February 11, 2004, the Company completed an initial public offering of 8,280,000 shares of its common stock at a price of $15.00 per share, including 1,080,000 shares sold following exercise in full by the underwriters of an option granted to them by the Company to purchase the additional shares to cover over-allotments. The Company received net proceeds of $115.5 million in the offering, after deducting underwriting discounts and commissions. The Company used the net proceeds to repay indebtedness and to pay holders of the Company’s Series A and Series

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B convertible preferred stock in connection with the conversion of those shares to common stock upon the completion of the offering as discussed in Note 6.

4. Acquisitions, Developments and Dispositions

     During the second quarter of 2003, the Company opened two newly developed surgery centers. One of the newly developed surgery centers, located in Knoxville, Tennessee, replaced a surgery center that the Company managed in the same market. The other newly developed surgery center is located in Worcester, Massachusetts and opened in May 2003. The Company entered into management contracts with both of these newly developed surgery centers. The Company has a majority interest in the surgery center located in Worcester, Massachusetts and consolidates this surgery center for financial reporting purposes. The Company has a 25% ownership interest in the surgery center located in Knoxville, Tennessee and accounts for this surgery center under the equity method.

     During the third quarter of 2003, the Company opened two newly developed surgery centers. The newly developed surgery centers are located in Vincennes, Indiana and Largo, Florida. The Company has a majority interest in both of the newly developed surgery centers. The Company consolidates both newly developed surgery centers for financial reporting purposes. The Company entered into management contracts with both of these newly developed surgery centers. In addition, during September 2003, the Company acquired an additional 39% ownership interest in Dry Creek Imaging Center, a diagnostic imaging center that is adjacent to the Company’s surgery center in the Denver, Colorado market, for approximately $1.5 million in cash. Also in September 2003, the Company acquired an additional 16.4% ownership interest in Village SurgiCenter in Erie, Pennsylvania, for approximately $1.0 million in cash.

     During the second quarter of 2004, the Company acquired a minority interest in Valley Ambulatory Surgery Center, L.P. for approximately $6.5 million, using cash from operations. The center has six operating suites and one minor procedure room. The center is a multi-specialty ambulatory surgery center located in a suburb of Chicago, Illinois. Subject to certain conditions, including regulatory approvals, the Company agreed to purchase the capital stock of the general partner of the center for an additional $7.0 million. At the time the Company purchases the capital stock of the general partner, the Company expects to consolidate this facility for financial reporting purposes.

     During the third quarter of 2004, the Company acquired a majority ownership in four surgery centers for a total of approximately $12.6 million, using cash from operations and funds available under the Company’s senior secured credit facility (the “Senior Credit Facility”). The Company paid approximately $1.2 million for a surgery center located in Savannah, Georgia. The Savannah surgery center is a single-specialty surgery center with one operating suite. The Company paid approximately $6.7 million for a surgery center located in Steubenville, Ohio. The Steubenville surgery center is a multi-specialty surgery center with three operating suites and one minor procedure room. The Company paid approximately $1.6 million for a surgery center located in New Albany, Indiana. The New Albany surgery center is a multi-specialty surgery center with four operating suites and one minor procedure room. The Company paid approximately $3.0 million for a surgery center located in Hammond, Louisiana. The Hammond surgery center is a multi-specialty surgery center with four operating suites and two minor procedure rooms. The Company consolidates all four newly-acquired surgery centers for financial reporting purposes and entered into management contracts with all four of these centers.

     During the third quarter of 2004, the Company also opened a newly developed surgery center located in Memphis, Tennessee. The Memphis surgery center is a single-specialty surgery center with one minor procedure room. The Memphis surgery center was developed through a partnership with one of our existing physician networks. In addition, the Company signed an agreement to manage the DeSoto Surgery Center. The DeSoto Surgery Center is an affiliate of Baptist Memorial Health Services, Inc. in Memphis, Tennessee.

     During the third quarter of 2004, the Company restructured its Physicians SurgiCenter of Houston partnership in Houston, Texas, creating a joint venture with the American Institute of Gastric Banding Ltd., a privately held single procedure focused surgical company based in Dallas, Texas. Subsequent to the restructuring, the Company retained a 10% ownership in the surgery center and the Company no longer consolidates the surgery center for financial reporting purposes.

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     During the third quarter of 2004, the Company opened the newly developed Erie Imaging Center in Erie, Pennsylvania. Erie Imaging Center is a diagnostic imaging center and is located in a market in which the Company owns and operates a surgery center.

     All of our acquisitions were accounted for under the purchase method of accounting and, accordingly, the results of operations of these acquired surgery centers are reflected on a consolidated basis in our consolidated financial statements from the respective dates of their acquisitions.

5. Long-Term Debt and Convertible Debentures

     The Company’s long-term debt is summarized as follows (in thousands):

     The Company’s Senior Credit Facility provides senior secured financing of up to $110.0 million, through a revolving credit line. The Senior Credit Facility terminates and is due and payable on July 18, 2006. At December 31, 2003, the Company had $63.6 million of outstanding debt under the Senior Credit Facility. The Company used $63.6 million of the proceeds from the initial public offering to repay indebtedness outstanding under the Senior Credit Facility. At September 30, 2004, the Company had $21.0 million of outstanding debt under the Senior Credit Facility. At the Company’s option, loans under the Senior Credit Facility bear interest at Bank of America’s base rate or the Eurodollar rate in effect on the applicable borrowing date, plus an applicable margin. Both the applicable base rate margin and applicable Eurodollar rate margin will vary depending upon the ratio of the Company’s consolidated funded indebtedness to earnings before income taxes and depreciation and amortization (“EBITDA”). During the first quarter of 2004, the Company entered into the First Amendment to the Senior Credit Facility, which changed certain financial covenants and definitions. Availability of funds under the Senior Credit Facility is limited by, among other things, the Company’s ratio of indebtedness to EBITDA.

     Secured term loans include the Company’s outstanding loan and security agreements with DVI Financial Services, Inc. (the “DVI Loans”). The proceeds of the DVI Loans were used to finance tenant improvements, medical, surgical and office equipment, and working capital. The DVI Loans bear interest ranging from 8.5% to 11.5% per year. At December 31, 2003, the Company had $6.2 million of outstanding debt under the secured term loans. During the third quarter of 2004, the Company used cash from operations to reduce the outstanding DVI Loans by $4.8 million in addition to normal principal payments. At September 30, 2004, the Company had approximately $1.0 million of outstanding debt available under the secured term loans.

     In July 2003, the Company entered into an agreement through which DLJ Investment Partners II, L.P. and its affiliates agreed to purchase the Company’s 14 3/4% Senior Subordinated Notes due 2008 in the aggregate principal amount of up to $40.0 million. During 2003, the Company issued notes in the aggregate principal amount of about $29.1 million, and may issue up to an additional $10.9 million of notes at any time before July 18, 2005. At December 31, 2003, the outstanding balance of the Senior Subordinated Notes was $29.1 million. The Company used proceeds from the initial public offering and certain borrowings under the Senior Credit Facility to repay all outstanding indebtedness under the Senior Subordinated Notes. At September 30, 2004, the Company had no outstanding indebtedness under the Senior Subordinated Notes.

     In connection with the 2002 acquisition of PSC, the Company issued convertible debentures totaling $3.2 million to various persons in exchange for additional ownership interests in certain of PSC’s surgery centers. The convertible debentures bore interest at 4.0% per year and would have matured on April 1, 2005. The convertible debentures

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automatically converted into shares of common stock at $13.87 per share upon the completion of the Company’s initial public offering.

     At September 30, 2004, the Company was in material compliance with all covenants required by each long-term debt agreement.

6. Series A Convertible Preferred Stock and Series B Convertible Preferred Stock

     The Company issued Series A convertible preferred stock and Series B convertible preferred stock in April 2002 in connection with the PSC acquisition. The Series A convertible preferred stock and Series B convertible preferred stock automatically converted into shares of common stock upon the completion of the Company’s initial public offering. When converted, each share of Series A convertible preferred stock and Series B convertible preferred stock entitled the holder to receive 0.2257 of a share of common stock and a cash payment of $4.20 for the Series A holders and $5.22 for the Series B holders, for a total cash payment of $31.8 million. The cash payment of $31.8 million was reflected as additional purchase price for PSC and recorded as an addition to goodwill during the first quarter of 2004 upon completion of the initial public offering.

7. Earnings Per Share

     Basic and diluted income per share are based on the weighted average number of common shares outstanding and the dilutive impact of outstanding options and warrants to purchase shares (net income in thousands):