UNITED SURGICAL PARTNERS INTERNATIONAL INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 000-32837

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

Delaware (State or other jurisdiction of incorporation or organization)		75-2749762 (IRS Employer Identification Number)
15305 Dallas Parkway, Suite 1600 Addison, Texas (Address of principal executive offices)		75001 (Zip Code)
(972) 713-3500 (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

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

At May 12, 2003 there were 27,179,558 shares of Common Stock outstanding.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX

PART I.	Financial Information
	Item 1.	Financial Statements (unaudited)	3
		Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002	3
		Consolidated Statements of Income for the three months ended March 31, 2003 and 2002	5
		Consolidated Statements of Comprehensive Income for the three months ended March 31, 2003 and 2002	6
		Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002	7
		Notes to Consolidated Financial Statements	8
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	18
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
	Item 4.	Controls and Procedures	26
PART II.	Other Information
	Item 1.	Legal Proceedings	27
	Item 6.	Exhibits and Reports on Form 8-K	27
Signatures			28
Management Certifications			29

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

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.

AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited—in thousands, except per share amounts)

		March 31, 2003		December 31, 2002
Assets
Cash and cash equivalents		$	44,390	$	47,571
Patient receivables, net of allowance for doubtful accounts of $7,393 and $7,154, respectively			45,222		39,176
Other receivables			33,716		34,735
Inventories of supplies			7,613		7,756
Deferred tax asset, net			5,657		5,657
Prepaids and other current assets			8,541		7,001

	Total current assets		145,139		141,896
Property and equipment, net			290,414		270,387
Investments in affiliates			19,776		18,696
Intangible assets, net			288,596		287,584
Other assets			14,678		8,722

	Total assets	$	758,603	$	727,285

Liabilities and Stockholders' Equity
Accounts payable		$	26,701	$	25,989
Accrued salaries and benefits			20,756		20,322
Due to affiliates			7,161		6,890
Accrued interest			5,356		1,650
Current portion of long-term debt			13,592		13,132
Other accrued expenses			26,524		22,501

	Total current liabilities		100,090		90,484
Long-term debt, less current portion			269,274		263,571
Other long-term liabilities			8,074		4,532
Deferred tax liability, net			19,950		19,577

	Total liabilities		397,388		378,164
Minority interests			29,047		26,860

Stockholders' equity:
	Common stock:
		Other, $0.01 par value; 200,000 shares authorized; 27,365 and 27,306 shares issued at March 31, 2003 and December 31, 2002, respectively		274			273
	Additional paid-in capital			321,707			320,750
	Treasury stock, at cost, 199 and 202 shares at March 31, 2003 and December 31, 2002, respectively			(3,670	)		(3,733	)
	Deferred compensation			(2,016	)		(1,226	)
	Receivables from sales of common stock			(78	)		(191	)
	Accumulated other comprehensive income, net of tax			5,731			3,290
	Retained earnings			10,220			3,098

		Total stockholders' equity		332,168			322,261

		Total liabilities and stockholders' equity	$	758,603		$	727,285

See accompanying notes to consolidated financial statements.

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

			Three months ended March 31,
			2003			2002
Net patient service revenue			$	90,471		$	65,028
Management and administrative services revenue				8,037			7,323
Equity in earnings of unconsolidated affiliates				2,541			2,096
Other income				1,010			631

		Total revenues		102,059			75,078
Salaries, benefits, and other employee costs				25,496			19,116
Medical services and supplies				19,903			14,396
Other operating expenses				18,016			13,701
General and administrative expenses				6,714			5,896
Provision for doubtful accounts				1,548			1,129
Depreciation and amortization				7,437			5,656

		Total operating expenses		79,114			59,894

		Operating income		22,945			15,184
Interest income				316			308
Interest expense				(6,874	)		(5,928	)
Other				7			(47	)

		Total other expense, net		(6,551	)		(5,667	)
		Income before minority interests		16,394			9,517
Minority interests in income of consolidated subsidiaries				(5,011	)		(2,688	)

		Income before income taxes		11,383			6,829
Income tax expense				(4,261	)		(2,126	)

		Net income	$	7,122		$	4,703

Net income per share attributable to common stockholders
	Basic		$	0.26		$	0.20
	Diluted		$	0.26		$	0.19
Weighted average number of common shares
	Basic			27,047			24,107
	Diluted			27,757			25,124

See accompanying notes to consolidated financial statements.

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

		March 31,
		2003			2002
Net income		$	7,122		$	4,703
Other comprehensive income (loss), net of taxes:
	Foreign currency translation adjustments		2,564			(1,952	)
	Net unrealized losses on securities		(123	)		—

	Other comprehensive income (loss)		2,441			(1,952	)

	Comprehensive income	$	9,563		$	2,751

See accompanying notes to consolidated financial statements.

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

					Three months ended March 31,
					2003			2002
Cash flows from operating activities:
	Net income				$	7,122		$	4,703
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for doubtful accounts				1,548			1,129
		Depreciation and amortization				7,437			5,656
		Amortization of debt issue costs and discount				457			363
		Equity in earnings of unconsolidated affiliates				(2,541	)		(2,096	)
		Minority interests in income of consolidated subsidiaries				5,011			2,688
		Amortization of deferred compensation				122			59
		Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses:
			Patient receivables			(6,835	)		(5,165	)
			Other receivables			1,338			2,299
			Inventories of supplies, prepaids and other current assets			(1,815	)		(250	)
			Accounts payable and accrued expenses			6,190			4,832
			Other long-term liabilities			481			(256	)

				Net cash provided by operating activities		18,515			13,962

Cash flows from investing activities:
	Purchases of new businesses and equity interests, net of cash received					(9,307	)		(14,484	)
	Purchases of property and equipment					(9,476	)		(4,508	)
	Sales of property					—			789
	Increase in deposits and notes receivable					—			(1,656	)
	Cash placed in escrow					(3,145	)		—

				Net cash used in investing activities		(21,928	)		(19,859	)

Cash flows from financing activities:
	Proceeds from long-term debt					10,228			1,876
	Payments on long-term debt					(8,388	)		(4,931	)
	Proceeds from issuances of common stock					159			792
	Distributions on investments in affiliates					(1,468	)		(320	)

				Net cash provided by (used in) financing activities		531			(2,583	)

Effect of exchange rate changes on cash						(299	)		(63	)

Net decrease in cash and cash equivalents						(3,181	)		(8,543	)
Cash and cash equivalents at beginning of period						47,571			33,881

Cash and cash equivalents at end of period					$	44,390		$	25,338

Supplemental information:
	Interest paid				$	2,645		$	2,231
	Income taxes paid					1,236			—
	Non-cash transactions:
		Assets acquired under capital lease obligations			$	1,456		$	223
		Issuance of common stock for service contracts				63			—
		Issuance of restricted stock awards				914			1,087

See accompanying notes to consolidated financial statements

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. (together with its subsidiaries, USPI or the Company), a Delaware company, was formed in February 1998 for the primary purpose of ownership and operation of surgery centers, private surgical hospitals and related businesses in the United States and Western Europe. At March 31, 2003, USPI, headquartered in Dallas, Texas, operated 54 surgical facilities in the United States. Of these 54 facilities, USPI consolidates the results of 25, owns a minority or otherwise noncontrolling equity interest in 26, which are accounted for under the equity method, and holds no ownership interest in the remaining three centers, which are operated by USPI under management contracts. In addition, United Surgical Partners Europe, S.L. (USPE), a company incorporated in Spain and wholly owned by USPI, managed and owned a majority interest in eight private surgical hospitals and one surgery center in Spain at March 31, 2003. Global Healthcare Partners Limited (Global), a company incorporated in England and majority owned by USPI, managed and wholly owned two private surgical hospitals in the United Kingdom at March 31, 2003.

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

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

(b): Equity Based Compensation

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. As such, USPI generally does not record compensation expense because USPI generally issues options whereby 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 Disclosure, established accounting and disclosure requirements of SFAS No. 123. 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:

		Three months ended March 31,
		2003			2002
Net income attributable to common stockholders
	As reported	$	7,122		$	4,703
	Add: Total stock-based employee compensation expense included in reported net income, net of taxes		308			103
	Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of taxes		(1,310	)		(744	)

	Pro forma	$	6,120		$	4,062

Basic earnings per share
	As reported		0.26			0.20
	Pro forma		0.23			0.17
Diluted earnings per share
	As reported		0.26			0.19
	Pro forma		0.22			0.16

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging 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

In March 2003, the Company acquired 100% of a private surgical hospital in Marbella, Spain, for approximately 8.4 million euros ($9.0 million) in cash. In addition, the Company agreed to pay up to an additional total of 4.3 million euros ($4.6 million) to the sellers, depending on the resolution of certain contingencies over the next four years, of which $3.1 million has been placed in escrow and is included in other assets in the Company's balance sheet at March 31, 2003.

Following are the unaudited pro forma results for the three months ended March 31, 2003 and 2002 as if the acquisition discussed above had occurred on January 1, 2002 (in thousands, except per share amounts):

	Three months ended March 31,
	2003		2002
Net revenues	$	102,880	$	76,070
Net income		7,098		4,968
Basic earnings per share		0.26		0.21
Diluted earnings per share		0.26		0.20

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, 2003, these resulted in net cash outflows from USPI in an aggregate net amount of $0.3 million.

(3) Earnings Per Share

Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of 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, 2003 and 2002 (in thousands, except per share amounts):

		Three months ended March 31,
		2003		2002
Net income attributable to common shareholders		$	7,122	$	4,703
Weighted average common shares outstanding			27,047		24,107
Effect of dilutive securities:
	Stock options		431		732
	Warrants and restricted stock		279		285

Shares used for diluted earnings per share			27,757		25,124

Basic earnings per share		$	0.26	$	0.20
Diluted earnings per share		$	0.26	$	0.19

(4) Segment Disclosures

Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments in financial statements. USPI's business is the operation of surgery centers, private surgical hospitals and related businesses in the United States and Western Europe. USPI's chief operating decision maker, as that term is defined in the accounting standard, regularly reviews financial information about its surgery centers and private surgical hospitals for assessing performance and allocating resources both domestically and abroad. Accordingly, USPI's reportable segments consist of (1) U.S. based facilities and (2) Western Europe based facilities, including those in Spain and the United Kingdom.

				Western Europe
Three months ended March 31, 2003 (unaudited)	U.S.			Spain			United Kingdom			Western Europe Total			Total
Net patient service revenue	$	49,006		$	27,615		$	13,850		$	41,465		$	90,471
Other revenue		10,887			701			—			701			11,588

Total revenues	$	59,893		$	28,316		$	13,850		$	42,166		$	102,059

Depreciation and amortization	$	4,239		$	2,158		$	1,040		$	3,198		$	7,437
Operating income		16,348			3,332			3,265			6,597			22,945
Net interest expense		(5,148	)		(781	)		(629	)		(1,410	)		(6,558	)
Income tax expense		(3,078	)		(504	)		(679	)		(1,183	)		(4,261	)
Total assets		424,848			197,044			136,711			333,755			758,603
Capital expenditures		4,016			2,692			4,224			6,916			10,932
Three months ended March 31, 2002 (unaudited)
Net patient service revenue	$	33,638		$	19,764		$	11,626		$	31,390		$	65,028
Other revenue		9,508			542			—			542			10,050

Total revenues	$	43,146		$	20,306		$	11,626		$	31,932		$	75,078

Depreciation and amortization	$	3,227		$	1,678		$	751		$	2,429		$	5,656
Operating income		10,633			1,968			2,583			4,551			15,184
Net interest expense		(4,805	)		(237	)		(578	)		(815	)		(5,620	)
Income tax expense		(1,570	)		39			(595	)		(556	)		(2,126	)
Total assets		357,850			138,240			85,051			223,291			581,141
Capital expenditures		2,217			854			1,660			2,514			4,731

(5) Condensed Consolidating Financial Statements

The following information is presented as required by regulations of the Securities and Exchange Commission in connection with the Company's publicly traded Senior Subordinated Notes. This information is not routinely prepared for use by management. The operating and investing activities of the separate legal entities included in the consolidated financial statements are fully interdependent and integrated. Accordingly, the operating results of the separate legal entities are not representative of what the operating results would be on a stand-alone basis. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other services. The $150 million 10% Senior Subordinated Notes due 2011 were issued in a private offering on December 19, 2001 and subsequently registered as publicly traded securities through a Form S-4 effective January 15, 2002 by USPI's wholly-owned finance subsidiary, United Surgical Partners Holdings, Inc. (USPH), which was formed in 2001. The notes are guaranteed by USPI, which does not have independent assets or operations, and USPI's wholly-owned subsidiaries domiciled in the United States. USPI's investees in Spain and the United Kingdom are not guarantors of the obligation. USPI's investees in the United States in which USPI owns less than 100% are not guarantors of the obligation. The financial positions and results of operations (below, in thousands) of the respective guarantors are based upon the guarantor relationship at the end of the period presented.

Condensed Consolidating Balance Sheets: