UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2010
Commission file No. 333-144337
UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
(Registrants telephone number, including area code)
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None of the registrants common stock is held by non-affiliates.
As of February 25, 2011, 100 shares of the Registrants common stock were outstanding.
Documents Incorporated by Reference
UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
2010 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
FORWARD LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K, including, without limitation, statements containing the words believes, anticipates, expects, continues, will, may, should, estimates, intends, plans and similar expressions, and statements regarding the Companys business strategy and plans, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on managements current expectations and involve known and unknown risks, uncertainties and other factors, many of which the Company is unable to predict or control, that may cause the Companys actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Such factors include, among others, the following: our significant indebtedness; general economic and business conditions, including without limitation the condition of the financial markets, both nationally and internationally; foreign currency fluctuations; demographic changes; changes in, or the failure to comply with, laws and governmental regulations; the ability to enter into or renew managed care provider arrangements on acceptable terms; changes in Medicare, Medicaid and other government funded payments or reimbursement in the United States (U.S.) and the United Kingdom (U.K.); the efforts of insurers, healthcare providers and others to contain healthcare costs; the impact of federal healthcare reform; liability and other claims asserted against us; the highly competitive nature of healthcare; changes in business strategy or development plans of healthcare systems with which we partner; the ability to attract and retain qualified physicians and personnel, including nurses and other health care professionals and other personnel; the availability of suitable acquisition and development opportunities and the length of time it takes to complete acquisitions and developments; our ability to integrate new and acquired businesses with our existing operations; the availability and terms of capital to fund the expansion of our business, including the acquisition and development of additional facilities and certain additional factors, risks and uncertainties discussed in this Annual Report on Form 10-K. We disclaim any obligation and make no promise to update any such factors or forward-looking statements or to publicly announce the results of any revisions to any such factors or forward-looking statements, whether as a result of changes in underlying factors, to reflect new information as a result of the occurrence of events or developments or otherwise. Given these uncertainties, investors and prospective investors are cautioned not to rely on such forward-looking statements.
United Surgical Partners International, Inc. (together with its subsidiaries, we, the Company or USPI) owns and operates short stay surgical facilities including surgery centers and hospitals in the United States and the United Kingdom. We focus on providing high quality surgical facilities that meet the needs of patients, physicians and payors better than hospital-based and other outpatient surgical facilities. We believe that our facilities (1) enhance the quality of care and the healthcare experience of patients, (2) offer significant administrative, clinical and economic benefits to physicians, (3) offer a strategic approach for our health system partners to expand capacity and access within the markets they serve, and (4) offer an efficient and low cost alternative for payors. We acquire and develop our facilities through the formation of strategic relationships with physicians and not-for-profit healthcare systems to better access and serve the communities in our markets. Our operating model is efficient and scalable, and we have adapted it to each of our markets. We believe that our acquisition and development strategy and operating model enable us to continue to grow by taking advantage of highly-fragmented markets and an increasing demand for short stay surgery.
Since physicians are critical to the direction of healthcare in the U.S. and U.K., we have developed our operating model to encourage physicians to affiliate with us and to use our facilities as an extension of their practices. We operate our facilities, structure our strategic relationships and adopt staffing, scheduling and clinical systems and protocols with the goal of increasing physician productivity. We believe that our focus on physician satisfaction, combined with providing high quality healthcare in a friendly and convenient environment for patients, will continue to increase the number of procedures performed at our facilities each year.
As of December 31, 2010, we operated 189 facilities, consisting of 185 in the United States and four in the United Kingdom. Of the 185 U.S. facilities, 132 are jointly owned with major not-for-profit healthcare systems. Overall, as of December 31, 2010, we held ownership interests in 188 of the facilities and operated one under a service and management contract. Due in large part to our partnerships with physicians and not-for-profit healthcare systems, we do not consolidate the financial results of 130 of the 188 facilities in which we have ownership, meaning that while we record a share of their net profit within our operating income, we do not include their revenues and expenses in the consolidated revenue and expense line items of our consolidated financial statements.
This trend in our business contributed to our consolidated revenues decreasing from $593.5 million in 2009 to $576.7 million in 2010, even as our operating income increased from $198.3 million to $210.5 million during the same period. To help understand this relationship in our consolidated financial statements, we review an operating measure called systemwide revenue growth, which includes both consolidated and unconsolidated facilities. While revenues of our unconsolidated facilities are not recorded as revenues by USPI, we believe the information is important in understanding USPIs financial performance because these revenues are the basis for calculating our management services revenues and, together with the expenses of our unconsolidated facilities, are the basis for USPIs equity in earnings of unconsolidated affiliates. In addition, we disclose growth rates and operating margins for the facilities that were operational in both the current and prior year periods, a group we refer to as same store facilities.
Donald E. Steen, who is our chairman, formed USPI with the private equity firm Welsh, Carson, Anderson & Stowe in February 1998. USPI had publicly traded equity securities from June 2001 until April 2007. Pursuant to an Agreement and Plan of Merger (the merger) dated as of January 7, 2007, with an affiliate of Welsh, Carson, Anderson & Stowe X, L.P. (Welsh Carson), we became a wholly owned subsidiary of USPI Holdings, Inc. on April 19, 2007. USPI Holdings, Inc. is a wholly owned subsidiary of USPI Group Holdings, Inc., which is owned by an investor group that includes affiliates of Welsh Carson, members of our management and other investors. As a result of the merger, we no longer have publicly traded equity securities. In this Form 10-K, we have reported our operating results and financial position for the period subsequent to the merger date of April 19, 2007, as the Successor Period and all periods prior to April 19, 2007, as Predecessor Periods.
We file annual, quarterly and current reports with the Securities and Exchange Commission. You may read and copy any document that we file at the SECs public reference room located at 100 F Street, N.E., Washington, D.C. 20549. You may also call the Securities and Exchange Commission at 1-800-SEC-0330 for information on the operation of the public reference room. Our SEC filings are also available to you free of charge at the SECs web site at http://www.sec.gov. We also maintain a web site at http://www.uspi.com that includes links to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. These reports are available on our website without charge as soon as reasonably practicable after such reports are filed with or furnished to the SEC. Information on our web site is not deemed incorporated by reference into this Form 10-K.
We believe many physicians prefer surgery centers and surgical hospitals over general acute care hospitals. We believe that this is due to the non-emergency nature of the procedures performed at our surgery centers and surgical hospitals, which allows physicians to schedule their time more efficiently and therefore increase the number of surgeries they can perform in a given amount of time. In addition, outpatient facilities usually provide physicians with greater scheduling flexibility, more consistent nurse staffing and faster turnaround time between cases. While surgery centers and surgical hospitals generally perform scheduled surgeries, acute care hospitals and national health service facilities generally provide a broad range of services, including high priority and emergency procedures. Medical emergencies often demand the unplanned use of operating rooms and result in the postponement or delay of scheduled surgeries, disrupting physicians practices and inconveniencing patients. Surgery centers and surgical hospitals in the United States and the United Kingdom are designed to improve physician work environments and improve physician efficiency. In addition, many physicians choose to perform surgery in facilities like ours because their patients prefer the comfort of a less institutional atmosphere and the convenience of simplified admissions and discharge procedures.
New surgical techniques and technology, as well as advances in anesthesia, have significantly expanded the types of surgical procedures that are being performed in surgery centers and have helped drive the growth in outpatient surgery. Lasers, arthroscopy, enhanced endoscopic techniques and fiber optics have reduced the trauma and recovery time associated with many surgical procedures. Improved anesthesia has shortened recovery time by minimizing post-operative side effects such as nausea and drowsiness, thereby avoiding the need for overnight hospitalization in many cases. In addition, some states in the United States permit surgery centers to keep a patient for up to 23 hours. This allows more complex surgeries, previously only performed in an inpatient setting, to be performed in a surgery center.
In addition to these technological and other clinical advancements, a changing payor environment has contributed to the rapid growth in outpatient surgery in recent years. Government programs, private insurance companies, managed care organizations and self-insured employers have implemented cost containment measures to limit increases in healthcare expenditures, including procedure reimbursement. These cost containment measures have contributed to the significant shift in the delivery of healthcare services away from traditional inpatient hospitals to more cost-effective alternate sites, including surgery centers. We believe that surgery performed at a surgery center is generally less expensive than hospital-based outpatient surgery because of lower facility development costs, more efficient staffing and space utilization and a specialized operating environment focused on quality of care and cost containment.
Today, large healthcare systems in the United States generally offer both inpatient and outpatient surgery on site. In addition, a number of not-for-profit healthcare systems have begun to expand their portfolios of facilities and services by entering into strategic relationships with specialty operators of surgery centers in order to expand capacity and access in the markets they serve. These strategic relationships enable not-for-profit healthcare systems to offer patients, physicians and payors the cost advantages, convenience and other benefits of outpatient surgery in a freestanding facility. Further, these relationships allow the not-for-profit healthcare systems to focus their attention and resources on their core business without the challenge of acquiring, developing and operating these facilities.
The United Kingdom provides government-funded healthcare to all of its residents through the National Health Service. However, due to funding and capacity limitations, the demand for healthcare services exceeds the public systems capacity. In response to these shortfalls, private healthcare networks and private insurance companies have developed in the United Kingdom. Approximately 12% of the U.K. population has private insurance to cover elective surgical procedures, and another segment of the population pays for elective procedures from personal funds. For the year ended December 31, 2010, in the United Kingdom, we derived 67% of our revenues from private insurance, 25% from self-pay patients, who typically arrange for payment prior to surgery being performed, 4% from government payors, and 4% from other payors.
Our Business Strategy
Our goal is to steadily increase our revenues and cash flows. The key elements of our business strategy are to:
Attract and retain top quality surgeons and other physicians
Since physicians are critical to the direction of healthcare in the U.S. and U.K., we have developed our operating model to encourage physicians to affiliate with us and to use our facilities as an extension of their practices. We believe we attract physicians because we design our facilities, structure our strategic relationships and adopt staffing, scheduling and clinical systems and protocols to increase physician productivity and promote their professional and financial success. We believe this focus on physicians, combined with providing high quality healthcare in a friendly and convenient environment for patients, will continue to increase case volumes at our facilities. In addition, in the United States, we generally offer physicians the opportunity to purchase equity interests in the facilities they use as an extension of their practices. We believe this opportunity attracts quality physicians to our facilities and ownership increases the physicians involvement in facility operations, enhancing quality of patient care, increasing productivity and reducing costs.
Pursue strategic relationships with not-for-profit healthcare systems
Through strategic relationships with us, not-for-profit healthcare systems can benefit from our operating expertise and create a new cash flow opportunity with limited capital expenditures. We believe that these relationships also allow not-for-profit healthcare systems to attract and retain physicians and improve their hospital operations by focusing on their core business. We also believe that strategic relationships with these healthcare systems help us to more quickly develop relationships with physicians, communities, and payors. Generally, the healthcare systems with which we develop relationships have strong local market positions and excellent reputations that we use in branding our facilities. In addition, our relationships with not-for-profit healthcare systems enhance our acquisition and development efforts by (1) providing opportunities to acquire facilities the systems may own, (2) providing access to physicians already affiliated with the systems, (3) attracting additional physicians to affiliate with newly developed facilities, and (4) encouraging physicians who own facilities to consider a strategic relationship with us.
Expand our presence in existing markets
Our primary strategy is to grow selectively in markets in which we already operate facilities. We believe that selective acquisitions and development of new facilities in existing markets allow us to leverage our existing knowledge of these markets and to improve operating efficiencies. In particular, our experience has been that newly developed facilities in markets where we already have a presence and a not-for-profit hospital partner are the best use of our invested capital.
Expand selectively in new markets
We may continue to enter targeted markets by acquiring and developing surgical facilities. In the United States, we expect to do this primarily in conjunction with a local not-for-profit healthcare system or hospital. We typically target the acquisition or development of multi-specialty centers that perform high volume, non-emergency, lower risk procedures requiring lower capital and operating costs than hospitals. In addition, we will also consider the acquisition of multi-facility companies.
In determining whether to enter a new market, we examine numerous criteria, including:
Upon identifying a target facility, we conduct financial, legal and compliance, operational, technology and systems reviews of the facility and conduct interviews with the facilitys management, affiliated physicians and staff. Once we acquire or develop a facility, we focus on upgrading systems and protocols, including implementing our proprietary methodology of defined processes and information systems, to increase case volume and improve operating efficiencies.
Enhance operating efficiencies
Once we acquire a new facility in the U.S., we integrate it into our existing network by implementing a specific action plan to support the local management team and incorporate the new facility into our group purchasing contracts. We also implement our systems and protocols to improve operating efficiencies and contain costs. Our most important operational tool is our management system Every Day Giving Excellence, which we refer to as USPIs EDGE. This proprietary measurement system allows us to track our clinical, service and financial performance, best practices and key indicators in each of our facilities. Our goal is to use USPIs EDGE to ensure that we provide each of the patients using our facilities with high quality healthcare, offer physicians a superior work environment and eliminate inefficiencies. Using USPIs EDGE, we track and monitor our performance in areas such as (1) providing surgeons the equipment, supplies and surgical support they need, (2) starting cases on time, (3) minimizing turnover time between cases, and (4) providing efficient case and personnel schedules. USPIs EDGE compiles and organizes the specified information on a daily basis and is easily accessed over the Internet by our facilities on a secure basis. The information provided by USPIs EDGE enables our employees, facility administrators and management to analyze trends over time and share processes and best practices among our facilities. In addition, the information is used as an evaluative tool by our administrators and as a budgeting and planning tool by our management. USPIs EDGE is now deployed in substantially all of our U.S. facilities. In addition to continuing to invest in USPIs EDGE, we are currently investing in other tools that will allow us to better manage our facilities.
Operations in the United States
Our operations in the United States consist primarily of our ownership and management of surgery centers. As of December 31, 2010, we had ownership interests in 171 surgery centers and 13 surgical hospitals and operate, through a service and management agreement, one additional surgery center. We also own interests in and expect to
operate five more surgical facilities that are currently under construction and have one additional project under development, and numerous other potential projects in various stages of consideration, which may result in our adding additional facilities during 2011. All of the facilities under construction and in the earlier stages of development include a not-for-profit hospital partner. Approximately 8,000 physicians have privileges to use our facilities. Our surgery centers are licensed outpatient surgery centers, and our surgical hospitals are licensed as hospitals. Each of our facilities is generally equipped and staffed for multiple surgical specialties and located in freestanding buildings or medical office buildings. Our average surgery center has approximately 12,000 square feet of space with three operating rooms, as well as ancillary areas for preparation, recovery, reception and administration. Our surgery center facilities range from a 4,000 square foot, one operating room facility to a 33,000 square foot, nine operating room facility. Our surgery centers are normally open weekdays from 7:00 a.m. to approximately 5:00 p.m. or until the last patient is discharged. We estimate that a surgery center with four operating rooms can accommodate up to 6,000 procedures per year. Our surgical hospitals average 56,000 square feet of space with seven operating rooms, ranging in size from 30,000 to 167,000 square feet and having from four to eleven operating rooms.
Our surgery center support staff typically consists of registered nurses, operating room technicians, an administrator who supervises the day-to-day activities of the surgery center, and a small number of office staff. Each center also has appointed a medical director, who is responsible for and supervises the quality of medical care provided at the center. Use of our surgery centers is generally limited to licensed physicians, podiatrists and oral surgeons who are also on the medical staff of a local accredited hospital. Each center maintains a peer review committee consisting of physicians who use our facilities and who review the professional credentials of physicians applying for surgical privileges.
All of our U.S. surgical facilities are accredited by either the Joint Commission on Accreditation of Healthcare Organizations or by the Accreditation Association for Ambulatory Healthcare or are in the process of applying for such accreditation. We believe that accreditation is the quality benchmark for managed care organizations. Many managed care organizations will not contract with a facility until it is accredited. We believe that our historical performance in the accreditation process reflects our commitment to providing high quality care in our surgical facilities.
Generally, our surgical facilities are limited partnerships, limited liability partnerships or limited liability companies in which ownership interests are also held by local physicians who are on the medical staff of the facilities. Our ownership interests in the facilities range from 5% to 99%, with our average ownership being approximately 28%. Our partnership and limited liability company agreements typically provide for the monthly or quarterly pro rata distribution of cash equal to net profits from operations, less amounts held in reserve for expenses and working capital. Our facilities derive their operating cash flow by collecting a fee from patients, insurance companies, or other payors in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. Our billing systems estimate revenue and generate contractual adjustments based on a fee schedule for over 80% of the total cases performed at our facilities. For the remaining cases, the contractual allowance is estimated based on the historical collection percentages of each facility by payor group. The historical collection percentage is updated quarterly for each facility. We estimate each patients financial obligation prior to the date of service. We request payment of that obligation at the time of service. Any amounts not collected at the time of service are subject to our normal collection and reserve policy. We also have a management agreement with each of the facilities under which we provide day-to-day management services for a management fee that is typically a percentage of the net revenues of the facility.
Our business depends upon the efforts and success of the physicians who provide medical services at our facilities and the strength of our relationships with these physicians. Our business could be adversely affected by the loss of our relationship with, or a reduction in use of our facilities by, a key physician or group of physicians. The physicians that affiliate with us and use our facilities are not our employees. However, we generally offer the physicians the opportunity to purchase equity interests in the facilities they use.
A key element of our business strategy is to pursue strategic relationships with not-for-profit healthcare systems (hospital partners) in selected markets. Of our 185 U.S. facilities, 132 are jointly-owned with not-for-profit healthcare systems. Our strategy involves developing these relationships in three primary ways. One way is by adding new facilities in existing markets with our existing hospital partners. An example of this is our relationship with the Baylor Health Care System (Baylor) in Dallas, Texas. Our joint ventures with Baylor own a network of 27 surgical facilities that serve the approximately six million people in the Dallas / Fort Worth area. These joint ventures have added new facilities each year since their inception in 1999, including five during 2010. Another example of a growing single-market relationship is our network of facilities in Houston, Texas with Memorial Hermann Healthcare System, with whom we opened our first facility in 2003 and with whom we now operate 20 facilities, including three added during 2010.
A second way we develop these relationships is through expansion into new markets, both with existing hospital partners and with new partners. A good long-term example of this strategy is our relationship with Ascension Health, with whom we initially owned a single facility in Nashville, Tennessee and now have a total of 19 facilities in four states. Similarly, with Catholic Healthcare West (CHW) we began with one facility, which was in a suburb of Las Vegas, Nevada. This relationship has expanded to a total of 16 facilities, including seven in various California markets and seven in the Phoenix, Arizona market. During 2008, we entered into a new partnership with Legacy Health in Portland, Oregon where we now have ownership in and manage two surgical facilities. Also during 2008, we entered into a new partnership with Centura Health in Colorado where we now have ownership in and manage four surgical facilities, one of which was added in December 2010.
A third way we develop our strategic relationships with not-for-profit healthcare systems is through the contribution of our ownership interests in existing facilities to a joint venture relationship. For example, during 2007, we added a hospital partner, CHRISTUS Spohn, to two of our facilities in Corpus Christi, Texas. We engaged in similar transactions with existing partners, Memorial Hermann and CHW, during 2008 and 2010. We expect to add a not-for-profit hospital partner in the future to some of the remaining 53 facilities that do not yet have such a partner.
Operations in the United Kingdom
We operate three hospitals and an oncology center in greater London. We acquired Parkside Hospital and Holly House Hospital in 2000 and Highgate Hospital in 2003. In January 2011, we acquired an ownership interest in a diagnostic and surgery center in Edinburgh, Scotland. Parkside Hospital, located in Wimbledon, a suburb southwest of London, has 72 registered acute care beds, including four high dependency beds and four operating theatres, one of which is a dedicated endoscopy suite and an outpatient surgery unit. Parkside also has its own on-site pathology laboratory which provides services to the on-site cancer treatment center. The imaging department, which has been extensively upgraded in the past four years, has two MRI scanners, a CT scanner, and two X-ray screening rooms, plus mammography, dental and ultrasound services available. Over 500 surgeons, anesthesiologists, and physicians have admitting privileges to the hospital. Parksides key specialties include orthopedics, oncology, gynecology, neurosurgery, ear-nose-throat, endoscopy and general surgery. The expansion of Parksides outpatient clinic was completed in August 2010, and the refurbishment of a portion of the hospital is expected to be completed in the second quarter of 2011.
Cancer Centre London opened in August 2003. In 2010 we partnered with local physicians who purchased a 24% ownership in the centre, which has a state of the art equipment designed to provide a wide range of cancer treatments. The pre-treatment and planning suite houses a dedicated CT scanner, which, along with the linear accelerators and virtual simulation software, is linked to the departments planning system. The centre provides inverse planned intensity-modulated radiation therapy (IMRT). The centre has its own pharmacy aseptic suite which provides chemotherapy to the day case unit at the hospital. The centre also has a nuclear medicine unit.
Holly House Hospital, located in a suburb northeast of London near Essex, has 55 registered acute care beds, including the ability to provide high dependency care. The hospital has three operating theatres and its own on-site pathology laboratory and pharmacy. A diagnostic suite houses MRI and CT scanners, X-ray screening rooms, mammography, ultrasound, and other imaging services. Approximately 300 surgeons, anesthesiologists, and
physicians have admitting privileges at the hospital, and there are well-established orthopedic, cosmetic, in vitro fertilization, and general surgery practices. We have started a refurbishment and expansion program at Holly House which is due to be completed by late 2012. This expansion will provide three new operating theater suites, an endoscopy suite, ten additional patient rooms, an eight bed day unit, and six additional consulting rooms.
Highgate Hospital is a 32 bed acute care hospital located in the affluent Highgate area of London. The hospital has an established cosmetic surgery business and additional practices including endoscopy and general surgery. Approximately 200 surgeons, anesthesiologists, and physicians have admitting privileges at the hospital.
The following table sets forth the percentage of the internally reported case volume of our U.S. facilities and internally reported revenue from our U.K. facilities for the year ended December 31, 2010 from each of the following specialties:
The following table sets forth the percentage of the internally reported case volume of our U.S. surgical facilities and internally reported revenue from our U.K. facilities for the year ended December 31, 2010 from each of the following payors:
The following table sets forth information relating to the not-for-profit healthcare systems with which we were affiliated as of December 31, 2010:
The following table sets forth information relating to the facilities that we operated as of December 31, 2010:
We lease the majority of the facilities where our various surgery centers and surgical hospitals conduct their operations. Our leases have initial terms ranging from one to twenty years and most of the leases contain options to extend the lease period, in some cases for up to ten additional years.
Our corporate headquarters is located in a suburb of Dallas, Texas. We currently lease approximately 83,000 square feet of space at 15305 Dallas Parkway, Addison, Texas. The lease expires in October 2020.
Our administrative office in the United Kingdom is located in London. We currently lease 2,300 square feet. The lease expires in October 2013.
We also lease approximately 40,000 square feet of total additional space in Brentwood, Tennessee; Chicago, Illinois; Houston, Texas; St. Louis, Missouri; Denver, Colorado; and Pasadena, California for regional offices. These leases expire between November 2012 and March 2021.
Acquisitions and Development
The following table sets forth information relating to facilities that are currently under construction at December 31, 2010:
The hospital under construction in Dallas, Texas at December 31, 2010 is a replacement facility for an existing facility. The new facility opened in January 2011. We also have additional projects under development, all of which involve a hospital partner. It is possible that some of these projects, as well as other projects which are in various stages of negotiation with both current and prospective joint venture partners, will result in our operating additional facilities sometime in 2011. While our history suggests that many of these projects will culminate with the opening of a profitable surgical facility, we can provide no assurance that any of these projects will reach that stage or will be successful thereafter.
Our sales and marketing efforts are directed primarily at physicians, who are principally responsible for referring patients to our facilities. We market our facilities to physicians by emphasizing (1) the high level of patient and physician satisfaction with our facilities, which is based on surveys we take concerning our facilities, (2) the quality and responsiveness of our services, (3) the practice efficiencies provided by our facilities, and (4) the benefits of our affiliation with our hospital partners, if applicable. We also directly negotiate, together in some instances with our hospital partners, agreements with third-party payors, which generally focus on the pricing, number of facilities in the market and affiliation with physician groups in a particular market. Maintaining access to physicians and patients through third-party payor contracting is essential for the economic viability of most of our facilities.
In all of our markets, our facilities compete with other providers, including major acute care hospitals and other surgery centers. Hospitals have various competitive advantages over us, including their established managed care contracts, community position, physician loyalty and geographical convenience for physicians inpatient and outpatient practices. However, we believe that, in comparison to hospitals with which we compete, our surgery centers and surgical hospitals compete favorably on the basis of cost, quality, efficiency and responsiveness to physician needs in a more comfortable environment for the patient.
We compete with other providers in each of our markets for patients, physicians and for contracts with insurers or managed care payors. Competition for managed care contracts with other providers is focused on the pricing, number of facilities in the market and affiliation with key physician groups in a particular market. We believe that our relationships with our hospital partners enhance our ability to compete for managed care contracts. We also encounter competition with other companies for acquisition and development of facilities and in the United States for strategic relationships with not-for-profit healthcare systems and physicians.
There are several companies, both public and private, that acquire and develop freestanding multi-specialty surgery centers and surgical hospitals. Some of these competitors have greater resources than we do. The principal
competitive factors that affect our ability and the ability of our competitors to acquire surgery centers and surgical hospitals are price, experience, reputation and access to capital. Further, in the United States many physician groups develop surgery centers without a corporate partner, and this presents a competitive threat to the Company.
In the United Kingdom, we face competition from both the National Health Service and other privately operated hospitals. Across the United Kingdom, a large number of private hospitals are owned by the four largest hospital operators. In addition, the two largest payors account for over half of the privately insured market. We believe our hospitals can effectively compete in this market due to location and specialty mix of our facilities. Our hospitals also have a higher portion of self pay business than the overall market. Although self pay business is not influenced by the private insurers, it is more dramatically affected by a downturn in the economy.
As of December 31, 2010, we employed approximately 7,100 people, 6,100 of whom are full-time employees and 1,000 of whom are part-time employees. Of these employees, we employ approximately 6,000 in the United States and 1,100 in the United Kingdom. The physicians that affiliate with us and use our facilities are not our employees. However, we generally offer the physicians the opportunity to purchase equity interests in the facilities they use.
Professional and General Liability Insurance
In the United States, we maintain professional and general liability insurance through a wholly-owned captive insurance company. We make premium payments to the captive insurance company and accrue for claims costs based on actuarially predicted ultimate losses and the captive insurance company then pays administrative fees and the insurance claims. We also maintain business interruption, property damage and umbrella insurance with third party providers. The governing documents of each of our surgical facilities require physicians who conduct surgical procedures at those facilities to maintain stated amounts of insurance. In the United Kingdom, we maintain general public insurance, malpractice insurance and property and business interruption insurance. Our insurance policies are generally subject to annual renewals. We believe that we will be able to renew current policies or otherwise obtain comparable insurance coverage at reasonable rates. However, we have no control over the insurance markets and can provide no assurance that we will economically be able to maintain insurance similar to our current policies.
The healthcare industry is subject to extensive regulation by federal, state and local governments. Government regulation affects our business by controlling growth, requiring licensing or certification of facilities, regulating how facilities are used and controlling payment for services provided. Further, the regulatory environment in which we operate may change significantly in the future. While we believe we have structured our agreements and operations in material compliance with applicable law, there can be no assurance that we will be able to successfully address changes in the regulatory environment.
Every state imposes licensing and other requirements on healthcare facilities. In addition, many states require regulatory approval, including certificates of need, before establishing or expanding various types of healthcare facilities, including ambulatory surgery centers and surgical hospitals, offering services or making capital expenditures in excess of statutory thresholds for healthcare equipment, facilities or programs. In addition, the federal Medicare program imposes additional conditions for coverage and payment rules for services furnished to Medicare beneficiaries. We may become subject to additional regulations as we expand our existing operations and enter new markets.
In addition to extensive existing government healthcare regulation, there have been numerous initiatives on the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services. We believe that these healthcare reform initiatives will continue during the foreseeable future. If adopted, some aspects of proposed reforms, such as further reductions in Medicare or Medicaid payments, or additional
prohibitions on physicians financial relationships with facilities to which they refer patients, could adversely affect us.
We believe that our business operations materially comply with applicable law. However, we have not received a legal opinion from counsel or from any federal or state judicial or regulatory authority to this effect, and many aspects of our business operations have not been the subject of state or federal regulatory scrutiny or interpretation. Some of the laws applicable to us are subject to limited or evolving interpretations; therefore, a review of our operations by a court or law enforcement or regulatory authority might result in a determination that could have a material adverse effect on us. Furthermore, the laws applicable to us may be amended or interpreted in a manner that could have a material adverse effect on us. Our ability to conduct our business and to operate profitably will depend in part upon obtaining and maintaining all necessary licenses, certificates of need and other approvals, and complying with applicable healthcare laws and regulations.
The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (the Acts) were signed into law on March 23, 2010 and March 30, 2010, respectively, although a majority of the measures contained in the Acts do not take effect until 2014. The Acts are intended to provide coverage and access to substantially all Americans, to increase the quality of care provided and to reduce the rate of growth in healthcare expenditures. The changes include, among other things, reducing payments to Medicare Advantage plans (which require the federal government to contract with private health insurance payors to provide inpatient and outpatient benefits to beneficiaries who enroll in such plans), expanding Medicares use of value-based purchasing programs, tying facility payments to the satisfaction of certain quality criteria, bundling payments to hospitals and other providers, reducing Medicare and Medicaid payments, including disproportionate share payments, expanding Medicare and Medicaid eligibility, requiring many health plans (including Medicare) to cover, without cost-sharing, certain preventative services, and expanding access to health insurance. The Acts also place limitations on the Stark Law exception that allows physicians to have ownership interests in hospitals, referred to as the whole hospital exception. Among other things, the Acts prohibit hospitals from increasing the percentages of the total value of the ownership interests held in the hospital by physicians after March 23, 2010, as well as place restrictions on the ability of a hospital subject to the whole hospital exception to add operating rooms, procedure rooms and beds.
The Acts make several significant changes to health care fraud and abuse laws, provide additional enforcement tools to the government, increase cooperation between agencies by establishing mechanisms for the sharing of information and enhance criminal and administrative penalties for non-compliance. For example, the Acts: (i) provide $350 million in increased federal funding over the next 10 years to fight health care fraud, waste and abuse; (ii) expand the scope of the recovery audit contractor program to include Medicaid and Medicare Advantage plans; (iii) authorize the Department of Health and Human Services, in consultation with the Office of Inspector General, to suspend Medicare and Medicaid payments to a provider of services or a supplier pending an investigation of a credible allegation of fraud; (iv) provide Medicare contractors with additional flexibility to conduct random prepayment reviews; and (iv) strengthen the rules for returning overpayments made by governmental health programs, including expanding False Claims Act liability to extend to failures to timely repay identified overpayments.
As a result of the Acts, we also expect enhanced scrutiny of healthcare providers compliance with state and federal regulations, infection control standards and other quality control measures. Effective January 15, 2009, CMS promulgated three national coverage determinations that prevent Medicare from paying for certain serious, preventable medical errors performed in any healthcare facility, such as surgery performed on the wrong patient. Several commercial payors also do not reimburse providers for certain preventable adverse events. In addition, federal law authorizes CMS to require ambulatory surgery centers to submit data on certain quality measures. Ambulatory surgery centers that fail to submit the required data would face a two percentage point reduction in their annual reimbursement rate increase. CMS has not yet implemented the quality measure reporting requirement, but has announced that it expects to do so in future rulemaking. In addition, the Acts require the Department of Health and Human Services to present a plan to Congress in early 2011 for implementing a value-based purchasing system that would tie Medicare payments to ambulatory surgery centers to quality and efficiency measures. The Acts also require the Department of Health and Human Services to study whether to expand to ambulatory surgery centers its
current policy of not paying additional amounts for care provided to treat conditions acquired during an inpatient hospital stay.
The Acts also require the Department of Health and Human Services to establish a Medicare Shared Savings Program to promote the coordination of care through Accountable Care Organizations (ACOs) by no later than January 1, 2012. The program will allow providers (including hospitals), physicians and other designated professionals and suppliers to form ACOs and work together to invest in infrastructure and redesign delivery processes with the goal of increasing the quality and efficient delivery of services. The program is intended to produce savings as a result of improved quality and operational efficiency. ACOs that achieve quality performance standards established by the Department of Health and Human Services will be eligible to share in a portion of the amounts saved by the Medicare program.
Licensure and certificate-of-need regulations
Capital expenditures for the construction of new facilities, the addition of capacity 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 healthcare facilities and the expansion of existing facilities and services. In these states, approvals are required for capital expenditures exceeding certain specified amounts and that involve certain facilities or services, including ambulatory surgery centers and surgical hospitals.
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 healthcare planning, assist in providing high quality healthcare at the lowest possible cost and avoid unnecessary duplication by ensuring that only those healthcare 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 healthcare facilities are also subject to state and local licensing regulations ranging from the adequacy of medical care to compliance with building codes and environmental protection laws. 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 healthcare facilitys license.
Our U.S. healthcare facilities receive accreditation from the Joint Commission on Accreditation of Healthcare Organizations or the Accreditation Association for Ambulatory Health Care, Inc., nationwide commissions which establish standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of various types of healthcare facilities. Generally, our healthcare facilities must be in operation for at least six months before they are eligible for accreditation. As of December 31, 2010, all of our eligible healthcare facilities had been accredited by either the Joint Commission on Accreditation of Healthcare Organizations or the Accreditation Association for Ambulatory Health Care, Inc. or are in the process of applying for such accreditation. Many managed care companies and third-party payors require our facilities to be accredited in order to be considered a participating provider under their health plans.
Medicare and Medicaid Participation in Short Stay Surgical Facilities
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 has the option to determine coverage for ambulatory surgery center services and to determine payment rates for those services. All of the states in which we currently operate cover Medicaid short stay surgical facility services; however, these states may not continue to cover short stay surgical facility services and states into which we expand our operations may not cover or continue to cover short stay surgical facility services.
Medicare prospectively determines fixed payment amounts for procedures performed at short stay surgical facilities. These amounts are adjusted for regional wage variations. The various state Medicaid programs also pay us a fixed payment for our services, which amount varies from state to state. A portion of our revenues are attributable to payments received from the Medicare and Medicaid programs. For the years ended December 31, 2010, 2009 and 2008, 31%, 28%, and 26%, respectively, of our domestic case volumes were attributable to Medicare and Medicaid payments, although the percentage of our overall revenues these cases represent is significantly less because government payors typically pay less than private insurers. For example, approximately 16% and 2% of our 2010 domestic patient service revenues were contributed by Medicare and Medicaid, respectively, despite those cases representing a total of 31% of our domestic case volume during 2010.
In order to participate in the Medicare program, our facilities must satisfy regulations known as conditions of participation (COPs) for hospitals and conditions for coverage (CFCs) for ambulatory surgery centers. Each facility can meet this requirement through accreditation with the Joint Commission on Accreditation of Healthcare Organizations or other CMS-approved accreditation organizations, or through direct surveys at the direction of CMS. All of our short stay surgical facilities in the United States are certified or, with respect to newly acquired or developed facilities, are awaiting certification to participate in the Medicare program. We have established ongoing quality assurance activities to monitor and ensure our facilities compliance with these COPs or CFCs. Any failure by a facility to maintain compliance with these COPs or CFCs as determined by a survey could result in the loss of the facilitys provider agreement with CMS, which would prohibit reimbursement for services rendered to Medicare or Medicaid beneficiaries until such time as the facility is found to be back in compliance with the COPs or CFCs. This could have a material adverse affect on the individual facilitys billing and collections.
As with most government programs, the Medicare and Medicaid programs are subject to statutory and regulatory changes, possible retroactive and prospective rate adjustments, administrative rulings, freezes and funding reductions, all of which may adversely affect the level of payments to our short stay surgical facilities. Beginning in 2008, CMS began transitioning Medicare payments to ambulatory surgery centers to a system based upon the hospital outpatient prospective payment system. In 2011, that transition is now complete and payments to ambulatory surgery centers will be solely based on the outpatient prospective payment system (OPPS) relative weights. CMS has cautioned that the final OPPS relative weights may result in payment rates for the year being less than the payment rates for the preceding year. On November 2, 2010, CMS issued a final rule to update the Medicare programs payment policies and rates for ambulatory surgery centers for 2011. The final rule applies a 0.2% increase to the ASC payment rate. The final rule will also add six procedures to the list of procedures for which Medicare will reimburse when performed in an ASC. The Acts require the Department of Health and Human Services to issue a plan in early 2011 for developing a value-based purchasing program for ambulatory surgery centers. Such a program may further impact Medicare reimbursement of ambulatory surgery centers or increase our operating costs in order to satisfy the value-based standards. For federal fiscal year 2011 and each subsequent federal fiscal year, the Acts provide for the annual market basket update to be reduced by a productivity adjustment. The amount of that reduction will be the projected nationwide productivity gains over the preceding 10 years. To determine the projection, the Department of Health and Human Services will use the Bureau of Labor Statistics 10-year moving average of changes in specified economy-wide productivity. The ultimate impact of the changes in Medicare reimbursement will depend on a number of factors, including the procedure mix at the centers and our ability to realize an increased procedure volume.
Federal Anti-Kickback Law
State and federal laws regulate relationships among providers of healthcare services, including employment or service contracts and investment relationships. These restrictions include a federal criminal law, referred to herein
as the anti-kickback statute, that prohibits offering, paying, soliciting or receiving any form of remuneration in return for:
A violation of the anti-kickback statute constitutes a felony. Potential sanctions include imprisonment of up to five years, criminal fines of up to $25,000, civil money penalties of up to $50,000 per act plus three times the remuneration offered or three times the amount claimed and exclusion from all federally funded healthcare programs. The applicability of these provisions to some forms of business transactions in the healthcare industry has not yet been subject to judicial or regulatory interpretation. Moreover, several federal courts have held that the anti-kickback statute can be violated if only one purpose (not necessarily the primary purpose) of the transaction is to induce or reward a referral of business, notwithstanding other legitimate purposes.
Pursuant to the anti-kickback statute, and in an effort to reduce potential fraud and abuse relating to federal healthcare programs, the federal government has announced a policy of a high level of scrutiny of joint ventures and other transactions among healthcare providers. The Office of the Inspector General of the Department of Health and Human Services closely scrutinizes healthcare joint ventures involving physicians and other referral sources. The Office of the Inspector General published a fraud alert that outlined questionable features of suspect joint ventures in 1989 and a Special Advisory Bulletin related to contractual joint ventures in 2003, and the Office of the Inspector General has continued to rely on fraud alerts in later pronouncements.
The anti-kickback statute contains provisions that insulate certain transactions from liability. In addition, pursuant to the provisions of the anti-kickback statute, the Health and Human Services Office of the Inspector General has also published regulations that exempt additional practices from enforcement under the anti-kickback statute. These statutory exceptions and regulations, known as safe harbors, if fully complied with, assure participants in particular types of arrangements that the Office of the Inspector General will not treat their participation in that arrangement as a violation of the anti-kickback statute. The statutory exceptions and safe harbor regulations do not expand the scope of activities that the anti-kickback statute prohibits, nor do they provide that failure to satisfy the terms of a safe harbor constitutes a violation of the anti-kickback statute. The Office of the Inspector General has, however, indicated that failure to satisfy the terms of an exception or a safe harbor may subject an arrangement to increased scrutiny. Therefore, if a transaction or relationship does not fit within an exception or safe harbor, the facts and circumstances as well as intent of the parties related to a specific transaction or relationship must be examined to determine whether or not any illegal conduct has occurred.
Our partnerships and limited liability companies that are providers of services under the Medicare and Medicaid programs, and their respective partners and members, are subject to the anti-kickback statute. A number of the relationships that we have established with physicians and other healthcare providers do not fit within any of the statutory exceptions or safe harbor regulations issued by the Office of the Inspector General. All of the 184 surgical facilities in the United States in which we hold an ownership interest are owned by partnerships or limited liability companies, which include as partners or members physicians who perform surgical or other procedures at the facilities.
On November 19, 1999, the Office of the Inspector General promulgated regulations setting forth certain safe harbors under the anti-kickback statute, including a safe harbor applicable to surgery centers. The surgery center safe harbor generally protects ownership or investment interests in a center by physicians who are in a position to refer patients directly to the center and perform procedures at the center on referred patients, if certain conditions are met. More specifically, the surgery center safe harbor protects any payment that is a return on an ownership or investment interest to an investor if certain standards are met in one of four categories of ambulatory surgery centers (1) surgeon-owned surgery centers, (2) single-specialty surgery centers, (3) multi-specialty surgery centers, and (4) hospital/physician surgery centers.
For multi-specialty ambulatory surgery centers, for example, the following standards, among several others, apply:
(1) all of the investors must either be physicians who are in a position to refer patients directly to the center and perform procedures on the referred patients, group practices composed exclusively of those physicians, or investors who are not employed by the entity or by any of its investors, are not in a position to provide items or services to the entity or any of its investors, and are not in a position to make or influence referrals directly or indirectly to the entity or any of its investors;
(2) at least one-third of each physician investors medical practice income from all sources for the previous fiscal year or twelve-month period must be derived from performing outpatient procedures that require an ambulatory surgery center or specialty hospital setting in accordance with Medicare reimbursement rules; and
(3) at least one third of the Medicare-eligible outpatient surgery procedures performed by each physician investor for the previous fiscal year or previous twelve-month period must be performed at the ambulatory surgery center in which the investment is made.
Similar standards apply to each of the remaining three categories of ambulatory surgery centers set forth in the regulations. In particular, each of the four categories includes a requirement that no ownership interests be held by a non-physician or non-hospital investor if that investor is (a) employed by the center or another investor, (b) in a position to provide items or services to the center or any of its other investors, or (c) in a position to make or influence referrals directly or indirectly to the center or any of its investors.
Because one of our subsidiaries is an investor in each partnership or limited liability company that owns one of our ambulatory surgery centers, and since this subsidiary provides management and other services to the surgery center, our arrangements with physician investors do not fit within the specific terms of the ambulatory surgery center safe harbor or any other safe harbor.
In addition, because we do not control the medical practices of our physician investors or control where they perform surgical procedures, it is possible that the quantitative tests described above will not be met, or that other conditions of the surgery center safe harbor will not be met. Accordingly, while the surgery center safe harbor is helpful in establishing that a physicians investment in a surgery center should be considered an extension of the physicians practice and not as a prohibited financial relationship, we can give no assurances that these ownership interests will not be challenged under the anti-kickback statute. In an effort to monitor our compliance with the safe harbors extension of practice requirement, we have implemented an internal certification process, which tracks each physicians annual extension of practice certification. While this process provides support for physician compliance with the safe harbors quantitative tests, we can give no assurance of such compliance. However, we believe that our arrangements involving physician ownership interests in our ambulatory surgery centers do not fall within the activities prohibited by the anti-kickback statute.
With regard to our hospitals, the Office of Inspector General has not adopted any safe harbor regulations under the anti-kickback statute for physician investments in hospitals. Each of our hospitals is held in partnership with physicians who are in a position to refer patients to the hospital. There can be no assurances that these relationships will not be found to violate the anti-kickback statute or that there will not be regulatory or legislative changes that prohibit physician ownership of hospitals.
While several federal court decisions have aggressively applied the restrictions of the anti-kickback statute, they provide little guidance regarding the application of the anti-kickback statute to our partnerships and limited liability companies. We believe that our operations do not violate the anti-kickback statute. However, a federal agency charged with enforcement of the anti-kickback statute might assert a contrary position. Further, new federal laws, or new interpretations of existing laws, might adversely affect relationships we have established with physicians or other healthcare providers or result in the imposition of penalties on us or some of our facilities. Even the assertion of a violation could have a material adverse effect upon us.
Federal Physician Self-Referral Law
Section 1877 of the Social Security Act, commonly known as the Stark Law, prohibits any physician from referring patients to any entity for the furnishing of certain designated health services otherwise payable by Medicare or Medicaid, if the physician or an immediate family member has a financial relationship such as an ownership interest or compensation arrangement with the entity that furnishes services to Medicare beneficiaries, unless an exception applies. Persons who violate the Stark Law are subject to potential civil money penalties of up to $15,000 for each bill or claim submitted in violation of the Stark Law and up to $100,000 for each circumvention scheme they are found to have entered into, and potential exclusion from the Medicare and Medicaid programs. In addition, the Stark Law requires the denial (or, refund, as the case may be) of any Medicare and Medicaid payments received for designated health services that result from a prohibited referral.
The list of designated health services under the Stark Law does not include ambulatory surgery services as such. However, some of the ten types of designated health services are among the types of services furnished by our ambulatory surgery centers. The Department of Health and Human Services, acting through the Centers for Medicare and Medicaid Services, has promulgated regulations implementing the Stark Law. These regulations exclude health services provided by an ambulatory surgery center from the definition of designated health services if the services are included in the surgery centers composite Medicare payment rate. Therefore, the Stark Laws self-referral prohibition generally does not apply to health services provided by an ambulatory surgery center. However, if the ambulatory surgery center is separately billing Medicare for designated health services that are not covered under the ambulatory surgery centers composite Medicare payment rate, or if either the ambulatory surgery center or an affiliated physician is performing (and billing Medicare) for procedures that involve designated health services that Medicare has not designated as an ambulatory surgery center service, the Stark Laws self-referral prohibition would apply and such services could implicate the Stark Law. We believe that our operations do not violate the Stark Law, as currently interpreted. However, it is possible that the Centers for Medicare and Medicaid Services will further address the exception relating to services provided by an ambulatory surgery center in the future. Therefore, we cannot assure you that future regulatory changes will not result in our ambulatory surgery centers becoming subject to the Stark Laws self-referral prohibition.
Thirteen of our U.S. facilities are hospitals rather than ambulatory surgery centers. The Stark Law includes an exception for physician investments in hospitals if the physicians investment is in the entire hospital and not just a department of the hospital. We believe that the physician investments in our hospitals fall within the exception and are therefore permitted under the Stark Law. However, over the past few years there have been various legislative attempts to change the way the hospital exception applies to physician investments in hospitals and it is possible that there could be another legislative attempt to alter this exception in the future. See Risk Factors Future Legislation could restrict our ability to operate our domestic surgical hospitals.
False and Other Improper Claims
The federal government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for payment from the Medicare or Medicaid programs. Claims filed with private insurers can also lead to criminal and civil penalties, including, but not limited to, penalties relating to violations of federal mail and wire fraud statutes. While the criminal statutes are generally reserved for instances of fraudulent intent, the government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances. For example, the government has taken the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant merely should have known the services were unnecessary, even if the government cannot demonstrate actual knowledge. The government has also taken the position that claiming payment for low-quality services is a violation of these statutes if the claimant should have known that the care was substandard.
Over the past several years, the government has accused an increasing number of healthcare providers of violating the federal False Claims Act. The False Claims Act prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the U.S. government. The statute defines knowingly to include not only actual knowledge of a claims falsity, but also reckless disregard for or intentional ignorance of the truth or falsity of a claim. Because our facilities perform hundreds of similar procedures a year for which they are
paid by Medicare, and there is a relatively long statute of limitations, a billing error or cost reporting error could result in significant penalties. Additionally, anti-Kickback or Stark Law claims can be bootstrapped to claims under the False Claims Act on the theory that, when a provider submits a claim to a federal health care program, the claim includes an implicit certification that the provider is in compliance with the Medicare Act, which would require compliance with other laws, including the anti-kickback statute and the Stark Law. As a result of this bootstrap theory, the U.S. government can collect additional civil penalties under the False Claims Act for claims that have been tainted by the anti-kickback or Stark Law violation. In addition, under the Acts, civil penalties may be imposed for the failure to report and return an overpayment within 60 days of identifying the overpayment or by the date a corresponding cost report is due, whichever is later.
Under the qui tam, or whistleblower, provisions of the False Claims Act, private parties may bring actions on behalf of the federal government. Such private parties, often referred to as relators, are entitled to share in any amounts recovered by the government through trial or settlement. Both direct enforcement activity by the government and whistleblower lawsuits have increased significantly in recent years and have increased the risk that a healthcare company, like us, will have to defend a false claims action, pay fines or be excluded from the Medicare and Medicaid programs as a result of an investigation resulting from a whistleblower case. Although we believe that our operations materially comply with both federal and state laws, they may nevertheless be the subject of a whistleblower lawsuit, or may otherwise be challenged or scrutinized by governmental authorities. A determination that we have violated these laws could have a material adverse effect on us.
State Anti-Kickback and Physician Self-Referral Laws
Many states, including those in which we do or expect to do business, have laws that prohibit payment of kickbacks or other remuneration in return for the referral of patients. Some of these laws apply only to services reimbursable under state Medicaid programs. However, a number of these laws apply to all healthcare services in the state, regardless of the source of payment for the service. Based on court and administrative interpretations of the federal anti-kickback statute, we believe that the federal anti-kickback statute prohibits payments only if they are intended to induce referrals. However, the laws in most states regarding kickbacks have been subjected to more limited judicial and regulatory interpretation than federal law. Therefore, we can give you no assurances that our activities will be found to be in compliance with these laws. Noncompliance with these laws could subject us to penalties and sanctions and have a material adverse effect on us.
A number of states, including those in which we do or expect to do business, have enacted physician self-referral laws that are similar in purpose to the Stark Law but which impose different restrictions. Some states, for example, only prohibit referrals when the physicians financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Some states do not prohibit referrals, but require that a patient be informed of the financial relationship before the referral is made. We believe that our operations are in material compliance with the physician self-referral laws of the states in which our facilities are located.
Health Information Security and Privacy Practices
The regulations promulgated under the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA) contain, among other measures, provisions that require many organizations, including us, to employ systems and procedures designed to protect the privacy and security of each patients individual healthcare information. Among the standards that the Department of Health and Human Services has adopted pursuant to HIPAA are standards for the following:
In August 2000, the Department of Health and Human Services finalized the transaction standards, with which we are in material compliance. The transaction standards require us to use standard code sets established by the rule when transmitting health information in connection with some transactions, including health claims and health payment and remittance advices.
The Department of Health and Human Services has also published a rule establishing standards for the privacy of individually identifiable health information, with which we are in material compliance. These privacy standards apply to all health plans, all healthcare clearinghouses and many healthcare providers, including healthcare providers that transmit health information in an electronic form in connection with certain standard transactions. We are a covered entity under the final rule. The privacy standards protect individually identifiable health information held or disclosed by a covered entity in any form, whether communicated electronically, on paper or orally. These standards not only require our compliance with rules governing the use and disclosure of protected health information, but they also require us to impose those rules, by contract, on any business associate to whom such information is disclosed. A violation of the privacy standards could result in civil money penalties of $100 per incident, up to a maximum of $25,000 per person per year per standard. The final rule also provides for criminal penalties of up to $50,000 and one year in prison for knowingly and improperly obtaining or disclosing protected health information, up to $100,000 and five years in prison for obtaining protected health information under false pretenses, and up to $250,000 and ten years in prison for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm.
Finally, the Department of Health and Human Services has also issued a rule establishing, in part, standards for the security of health information by health plans, healthcare clearinghouses and healthcare providers that maintain or transmit any health information in electronic form, regardless of format. We are an affected entity under the rule. These security standards require affected entities to establish and maintain reasonable and appropriate administrative, technical and physical safeguards to ensure integrity, confidentiality and the availability of the information. The security standards were designed to protect the health information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. Although the security standards do not reference or advocate a specific technology, and affected entities have the flexibility to choose their own technical solutions, the security standards required us to implement significant systems and protocols. We also comply with these regulations.
Signed into law on February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) broadened the scope of the HIPAA privacy and security regulations. Among other things, the ARRA extends the application of certain provisions of the security and privacy regulations to business associates (entities that handle identifiable health information on behalf of covered entities) and subjects business associates to civil and criminal penalties for violation of the regulations. Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties, and the ARRA has strengthened the enforcement provisions of HIPAA, which may result in increased enforcement activity. The ARRA increased the amount of civil penalties, with penalties now ranging up to $50,000 per violation for a maximum civil penalty of $1,500,000 in a calendar year for violations of the same requirement. In addition, the ARRA authorized state attorneys general to bring civil actions seeking either injunction or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents.
In addition to HIPAA, many states have enacted their own security and privacy provisions concerning a patients health information. These state privacy provisions will control whenever they provide more stringent privacy protections than HIPAA. Therefore, a health care facility could be required to meet both federal and state privacy provisions if it is located in a state with strict privacy protections.
All of our hospitals in the United States are subject to the Emergency Medical Treatment and Active Labor Act (EMTALA). This federal law requires any hospital participating in the Medicare program to conduct an appropriate medical screening examination of every individual who presents to the hospitals emergency room for treatment and, if the individual is suffering from an emergency medical condition, to either stabilize the condition or make an appropriate transfer of the individual to a facility able to handle the condition. The obligation
to screen and stabilize emergency medical conditions exists regardless of an individuals ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer an individual or if the hospital delays appropriate treatment in order to first inquire about the individuals ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured individual, the individuals family or a medical facility that suffers a financial loss as a direct result of a hospitals violation of the law can bring a civil suit against the hospital. We believe our hospitals are in material compliance with EMTALA.
European Union and United Kingdom
The European Commissions Directive on Data Privacy has been implemented in national EU data protection laws (such as the Data Protection Act of 1998). EU data protection legislation prohibits the transfer of personal data to non-EEA countries that do not meet the European adequacy standard for privacy protection. The European Union privacy legislation requires, among other things, the creation of government data protection agencies, registration of processing with those agencies, and in some instances prior approval before personal data processing may begin.
The U.S. Department of Commerce, in consultation with the European Commission, developed a safe harbor framework to protect data transferred in trans-Atlantic businesses like ours. The safe harbor provides a way for us to avoid experiencing interruptions in our business dealings in the European Union. It also provides a way to avoid prosecution by European authorities under European privacy laws. By certifying to the safe harbor, we will notify the European Union organizations that we provide adequate privacy protection, as defined by European privacy laws, in relation to international data transfers to the USA. To certify to the safe harbor, we must adhere to seven principles. These principles relate to notice, choice, onward transfer or transfers to third parties, access, security, data integrity and enforcement.
We intend to satisfy the requirements of the safe harbor. Even if we are able to formulate programs that attempt to meet these objectives, we may not be able to execute them successfully, which could have a material adverse effect on our revenues, profits or results of operations.
While there is no specific anti-kickback legislation in the United Kingdom that is unique to the medical profession, general criminal legislation prohibits bribery and corruption. Our hospitals in the United Kingdom do not pay commissions to or share profits with referring physicians who invoice patients or insurers directly for fees relating to the provision of their services, although we have explored the possibility of syndicating ownership in certain facilities in the U.K. with physicians. Hospitals in the United Kingdom are required to register with the Healthcare Commission pursuant to the Care Standards Act 2000, as amended by the Health and Social Care (Community Health and Standards) Act 2003, which provides for regular inspections of the facility by representatives of the Healthcare Commission. Beginning April 1, 2009, these registration and inspection functions will transfer to the Care Quality Commission established under the Health and Social Care Act 2008. Hospitals are also required to comply with the Private and Voluntary Health Care (England) Regulations 2001. The operation of a hospital without registration is a criminal offense. Under the Misuse of Drugs Act 1971, the supply, possession or production of controlled drugs without a license from the Secretary of State is a criminal offense. The Data Protection Act 1998 requires hospitals to register as data controllers. The processing of personal data, such as patient information and medical records, without prior registration or maintaining an inaccurate registration is a criminal offense. We believe that our operations in the United Kingdom are in material compliance with the laws referred to in this paragraph.
You should carefully read the risks and uncertainties described below and the other information included in this report. Any of the following risks could materially and adversely affect our business, financial condition or results of operations. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially and adversely affect our business, financial condition or results of operations.
We depend on payments from third party payors, including government healthcare programs. If these payments are reduced, our revenue will decrease.
We are dependent upon private and governmental third party sources of payment for the services provided to patients in our surgery centers and surgical hospitals. The amount of payment a surgical facility receives for its services may be adversely affected by market and cost factors as well as other factors over which we have no control, including Medicare and Medicaid regulations and the cost containment and utilization decisions of third party payors. In the United Kingdom, a significant portion of our revenues result from referrals of patients to our hospitals by the national health system. We have no control over the number of patients that are referred to the private sector annually. Fixed fee schedules, capitation payment arrangements, exclusion from participation in or inability to reach agreement with managed care programs or other factors affecting payments for healthcare services over which we have no control could also cause a reduction in our revenues.
If we are unable to acquire and develop additional surgical facilities on favorable terms, are not successful in integrating operations of acquired surgical facilities, or are unable to manage growth, we may be unable to execute our acquisition and development strategy, which could limit our future growth.
Our strategy is to increase our revenues and earnings by continuing to acquire and develop additional surgical facilities, primarily in collaboration with our hospital partners. Our efforts to execute our acquisition and development strategy may be affected by our ability to identify suitable candidates and negotiate and close acquisition and development transactions. We are currently evaluating potential acquisitions and development projects and expect to continue to evaluate acquisitions and development projects in the foreseeable future. The surgical facilities we develop typically incur losses in their early months of operation (more so in the case of surgical hospitals) and, until their case loads grow, they generally experience lower total revenues and operating margins than established surgical facilities, and we expect this trend to continue. Historically, most of our newly developed facilities have generated positive cash flow within the first 12 months of operations. We may not be successful in acquiring surgical facilities, developing surgical facilities or achieving satisfactory operating results at acquired or newly developed facilities. Further, the companies or assets we acquire in the future may not ultimately produce returns that justify our related investment. If we are not able to execute our acquisition and development strategy, our ability to increase revenues and earnings through future growth would be impaired.
If we are not successful in integrating newly acquired surgical facilities, we may not realize the potential benefits of such acquisitions. Likewise, if we are not able to integrate acquired facilities operations and personnel with ours in a timely and efficient manner, then the potential benefits of the transaction may not be realized. Further, any delays or unexpected costs incurred in connection with integration could have a material adverse effect on our operations and earnings. In particular, if we experience the loss of key personnel or if the effort devoted to the integration of acquired facilities diverts significant management or other resources from other operational activities, our operations could be impaired.
We have acquired interests in or developed all of our surgical facilities since our inception. We expect to continue to expand our operations in the future. Our rapid growth has placed, and will continue to place, increased demands on our management, operational and financial information systems and other resources. Further expansion of our operations will require substantial financial resources and management attention. To accommodate our past and anticipated future growth, and to compete effectively, we will need to continue to improve our management, operational and financial information systems and to expand, train, manage and motivate our workforce. Our personnel, systems, procedures or controls may not be adequate to support our operations in the future. Further, focusing our financial resources and management attention on the expansion of our operations may negatively impact our financial results. Any failure to improve our management, operational and financial information systems, or to expand, train, manage or motivate our workforce, could reduce or prevent our growth.
Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our debt obligations.
We have a substantial amount of indebtedness. As of December 31, 2010, we had $1.1 billion of total indebtedness and a total indebtedness to total capitalization percentage ratio of approximately 54%.
Our and our subsidiaries high degree of leverage could have important consequences to you. For example, it:
Our significant indebtedness could limit our flexibility.
We are significantly leveraged and will continue to have significant indebtedness in the future. Our acquisition and development program requires substantial capital resources, estimated to range from $60.0 million to $100.0 million per year over the next three years, although the range could be exceeded if we identify attractive multi-facility acquisition opportunities. The operations of our existing surgical facilities also require ongoing capital expenditures. We believe that our cash on hand, cash flows from operations and available borrowings under our revolving credit facility will be sufficient to fund our acquisition and development activities in 2010, but if we identify favorable acquisition and development opportunities that require additional resources, we may be required to incur additional indebtedness in order to pursue these opportunities. However, we may be unable to obtain sufficient financing on terms satisfactory to us, or at all, especially given the current uncertainty in the credit markets. In that event, our acquisition and development activities would have to be curtailed or eliminated and our financial results could be adversely affected.
Our debt agreements contain restrictions that limit our flexibility in operating our business.
The operating and financial restrictions and covenants in our debt instruments, including our senior secured credit facilities and the indenture governing our senior subordinated notes, may adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our interest. For example, our senior secured credit facility restricts, subject to certain exceptions, our and our subsidiaries ability to, among other things:
In addition, the senior secured U.K. credit facility restricts, subject to certain exceptions, the ability of certain of our subsidiaries existing in the United Kingdom to, among other things:
The indenture governing our senior subordinated notes includes similar restrictions. Our senior secured credit facility also requires us to comply with a financial covenant with respect to the revolving credit facility that becomes more restrictive over time and the senior secured U.K. credit facility requires certain of our subsidiaries in the United Kingdom to comply with certain financial covenants, including a maximum leverage ratio test, a debt service coverage ratio test and an interest coverage ratio test. Our and our subsidiaries ability to comply with these covenants and ratios may be affected by events beyond our control. A breach of any covenant or required financial ratio could result in a default under the senior secured credit facilities. In the event of any default under the senior secured credit facilities, the applicable lenders could elect to terminate borrowing commitments and declare all borrowings and accrued interest and fees to be due and payable, to require us to apply all available cash to repay these borrowings or to prevent us from making or permitting subsidiaries to make distributions or dividends, the proceeds of which are used by us to make debt service payments on our senior subordinated notes, any of which would be an event of default under the notes.
If we incur material liabilities as a result of acquiring surgical facilities, our operating results could be adversely affected.
Although we conduct extensive due diligence prior to the acquisition of surgical facilities and seek indemnification from prospective sellers covering unknown or contingent liabilities, we may acquire surgical facilities that have material liabilities for failure to comply with healthcare laws and regulations or other past activities. Although we maintain professional and general liability insurance, we do not currently maintain insurance specifically covering any unknown or contingent liabilities that may have occurred prior to the acquisition of surgical facilities. If we incur these liabilities and are not indemnified or insured for them, our operating results and financial condition could be adversely affected.
We depend on our relationships with not-for-profit healthcare systems. If we are not able to maintain our relationships with these not-for-profit healthcare systems, or enter into new relationships, we may be unable to implement our business strategies successfully.
Our domestic business depends in part upon the efforts and success of our not-for-profit healthcare system partners and the strength of our relationships with those healthcare systems. Our business could be adversely
affected by any damage to those healthcare systems reputations or to our relationships with them. We may not be able to maintain our existing agreements on terms and conditions favorable to us or enter into relationships with additional not-for-profit healthcare systems. Our relationships with not-for-profit healthcare systems and the joint venture agreements that represent these relationships are structured to comply with current revenue rulings published by the Internal Revenue Service as well as case law relevant to joint ventures between for-profit and not-for-profit healthcare entities. Material changes in these authorities could adversely affect our relationships with not-for-profit healthcare systems. If we are unable to maintain our existing arrangements on terms favorable to us or enter into relationships with additional not-for-profit healthcare systems, we may be unable to implement our business strategies successfully.
If we and our not-for-profit healthcare system partners are unable to successfully negotiate contracts and maintain satisfactory relationships with managed care organizations or other third party payors, our revenues may decrease.
Our competitive position has been, and will continue to be, affected by initiatives undertaken during the past several years by major domestic purchasers of healthcare services, including federal and state governments, insurance companies and employers, to revise payment methods and monitor healthcare expenditures in an effort to contain healthcare costs. As a result of these initiatives, managed care companies such as health maintenance and preferred provider organizations, which offer prepaid and discounted medical service packages, represent a growing segment of healthcare payors, the effect of which has been to reduce the growth of domestic healthcare facility margins and revenue. Similarly, in the United Kingdom, most patients at hospitals have private healthcare insurance, either paid for by the patient or received as part of their employment compensation. Our hospitals in the United Kingdom contract with healthcare insurers on an annual basis to provide services to insured patients.
As an increasing percentage of domestic patients become subject to healthcare coverage arrangements with managed care payors, we believe that our success will continue to depend upon our and our not-for-profit healthcare system partners ability to negotiate favorable contracts on behalf of our facilities with managed care organizations, employer groups and other private third party payors. We have structured our ventures with not-for-profit healthcare system partners in a manner we believe to be consistent with applicable regulatory requirements. If applicable regulatory requirements were interpreted to require changes to our existing arrangements, or if we are unable to enter into these arrangements on satisfactory terms in the future, we could be adversely affected. Many of these payors already have existing provider structures in place and may not be able or willing to change their provider networks. Similarly, if we fail to negotiate contracts with healthcare insurers in the United Kingdom on favorable terms, or if we fail to remain on insurers networks of approved hospitals, such failure could have a material adverse effect on us. We could also experience a material adverse effect to our operating results and financial condition as a result of the termination of existing third party payor contracts.
We depend on our relationships with the physicians who use our facilities. Our ability to provide medical services at our facilities would be impaired and our revenues reduced if we are not able to maintain these relationships.
Our business depends upon the efforts and success of the physicians who provide medical and surgical services at our facilities and the strength of our relationships with these physicians. Our revenues would be reduced if we lost our relationship with one or more key physicians or group of physicians or such physicians or groups reduce their use of our facilities. Any failure of these physicians to maintain the quality of medical care provided or to otherwise adhere to professional guidelines at our surgical facilities or any damage to the reputation of a key physician or group of physicians could also damage our reputation, subject us to liability and significantly reduce our revenues.
In addition, healthcare reform may contribute to increased physician employment with hospitals, which could weaken our relationships with these physicians. The Acts creation of ACOs may cause physicians to accept employment to become part of a network that includes an ACO. In addition, the Acts focus on investing in infrastructure to increase efficiencies may further contribute to shifting physicians practice patterns from private practice to employment with hospitals and ACOs. ACOs that achieve quality performance standards established by the Department of Health and Human Services will be eligible to share in a portion of the amounts saved by the Medicare program. Because an individual physician may view the costs associated with investing in technology and
processes to increase efficiencies as too large to bear individually, the physician may turn to employment as a means to participate in the Medicare savings and the capital investments required by the Acts. Physicians who accept employment may be restricted from owning interests in or utilizing our facilities.
Our surgical facilities face competition for patients from other health care providers.
The health care business is highly competitive, and competition among hospitals and other health care providers for patients has intensified in recent years. Generally, other facilities in the local communities served by our facilities provide services similar to those offered by our surgery centers and surgical hospitals. In addition, the number of freestanding surgical hospitals and surgery centers in the geographic areas in which we operate has increased significantly. As a result, most of our surgery centers and surgical hospitals operate in a highly competitive environment. Some of the hospitals that compete with our facilities are owned by governmental agencies or not-for-profit corporations supported by endowments, charitable contributions and/or tax revenues and can finance capital expenditures and operations on a tax-exempt basis. Our surgery centers and surgical hospitals are facing increasing competition from unaffiliated physician-owned surgery centers and surgical hospitals for market share in high margin services and for quality physicians and personnel. If our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their facilities than our surgery centers and surgical hospitals, we may experience an overall decline in patient volume.
Current economic conditions may adversely affect our financial condition and results of operations.
The current economic conditions will likely have an impact on our business. We regularly monitor quantitative as well as qualitative measures to identify changes in our business in order to react accordingly. The most likely impact on us from weakening economic conditions would be lower case volumes as elective procedures may be deferred or cancelled, which could have an adverse effect on our financial condition and results of operations.
Our United Kingdom operations are subject to unique risks, any of which, if they actually occur, could adversely affect our results.
We expect that revenue from our United Kingdom operations will continue to account for a significant percentage of our total revenue. Further, we may pursue additional acquisitions in the United Kingdom, which would require substantial financial resources and management attention. This focus of financial resources and management attention could have an adverse effect on our financial results. In addition, our United Kingdom operations are subject to risks such as:
These or other factors could have a material adverse effect on our ability to successfully operate in the United Kingdom and our financial condition and operations.
Our revenues may be reduced by changes in payment methods or rates under the Medicare or Medicaid programs.
The Department of Health and Human Services and the states in which we perform surgical procedures for Medicaid patients may revise the Medicare and Medicaid payment methods or rates in the future. Any such changes
could have a negative impact on the reimbursements we receive for our surgical services from the Medicare program and the state Medicaid programs. In addition, the Acts requirement that the Department of Health and Human Services develop a value-based purchasing program for Ambulatory surgery centers may further impact Medicare reimbursement of ambulatory surgery centers or increase our operating costs in order to satisfy the value-based standards. The ultimate impact of the changes in Medicare reimbursement will depend on a number of factors, including the procedure mix at the centers and our ability to realize an increased procedure volume.
Efforts to regulate the construction, acquisition or expansion of healthcare facilities could prevent us from acquiring additional surgical facilities, renovating our existing facilities or expanding the breadth of services we offer.
Many states in the United States require prior approval for the construction, acquisition or expansion of healthcare facilities or expansion of the services they offer. When considering whether to approve such projects, these states take into account the need for additional or expanded healthcare facilities or services. In a number of states in which we operate, we are required to obtain certificates of need for capital expenditures exceeding a prescribed amount, changes in bed capacity or services offered and under various other circumstances. Other states in which we now or may in the future operate may adopt certificate of need legislation or regulatory provisions. Our costs of obtaining a certificate of need have ranged up to $500,000. Although we have not previously been denied a certificate of need, we may not be able to obtain the certificates of need or other required approvals for additional or expanded facilities or services in the future. In addition, at the time we acquire a facility, we may agree to replace or expand the acquired facility. If we are unable to obtain the required approvals, we may not be able to acquire additional surgery centers or surgical hospitals, expand the healthcare services provided at these facilities or replace or expand acquired facilities.
Failure to comply with federal and state statutes and regulations relating to patient privacy and electronic data security could negatively impact our financial results.
There are currently numerous federal and state statutes and regulations that address patient privacy concerns and federal standards that address the maintenance of the security of electronically maintained or transmitted electronic health information and the format of transmission of such information in common health care financing information exchanges. These provisions are intended to enhance patient privacy and the effectiveness and efficiency of healthcare claims and payment transactions. In particular, the Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996 required us to implement new systems and to adopt business procedures for transmitting health care information and for protecting the privacy and security of individually identifiable information.
We believe that we are in material compliance with existing state and federal regulations relating to patient privacy, security and with respect to the format for electronic health care transactions. However, if we fail to comply with the federal privacy, security and transactions and code sets regulations, we could incur significant civil and criminal penalties. Failure to comply with state laws related to privacy could, in some cases, also result in civil fines and criminal penalties.
If we fail to comply with applicable laws and regulations, we could suffer penalties or be required to make significant changes to our operations.
We are subject to many laws and regulations at the federal, state and local government levels in the jurisdictions in which we operate. These laws and regulations require that our healthcare facilities meet various licensing, certification and other requirements, including those relating to:
We believe that we are in material compliance with applicable laws and regulations. However, if we fail or have failed to comply with applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in Medicare, Medicaid and other government sponsored healthcare programs. A number of initiatives have been proposed during the past several years to reform various aspects of the healthcare system, both domestically and in the United Kingdom. In the future, different interpretations or enforcement of existing or new laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. Current or future legislative initiatives or government regulation may have a material adverse effect on our operations or reduce the demand for our services.
In pursuing our growth strategy, we may expand our presence into new geographic markets. In entering a new geographic market, we will be required to comply with laws and regulations of jurisdictions that may differ from those applicable to our current operations. If we are unable to comply with these legal requirements in a cost-effective manner, we may be unable to enter new geographic markets.
If a federal or state agency asserts a different position or enacts new laws or regulations regarding illegal remuneration under the Medicare or Medicaid programs, we may be subject to civil and criminal penalties, experience a significant reduction in our revenues or be excluded from participation in the Medicare and Medicaid programs.
The federal anti-kickback statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for referrals for items or services payable by Medicare, Medicaid, or any other federally funded healthcare program. Additionally, the anti-kickback statute prohibits any form of remuneration in return for purchasing, leasing or ordering, or arranging for or recommending the purchasing, leasing or ordering of items or services payable by Medicare, Medicaid or any other federally funded healthcare program. The anti-kickback statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by existing case law or regulations. Moreover, several federal courts have held that the anti-kickback statute can be violated if only one purpose (not necessarily the primary purpose) of a transaction is to induce or reward a referral of business, notwithstanding other legitimate purposes. Violations of the anti-kickback statute may result in substantial civil or criminal penalties, including up to five years imprisonment and criminal fines of up to $25,000 and civil penalties of up to $50,000 for each violation, plus three times the remuneration involved or the amount claimed and exclusion from participation in all federally funded healthcare programs. An exclusion, if applied to our surgery centers or surgical hospitals, could result in significant reductions in our revenues, which could have a material adverse effect on our business.
In July 1991, the Department of Health and Human Services issued final regulations defining various safe harbors. Two of the safe harbors issued in 1991 apply to business arrangements similar to those used in connection with our surgery centers and surgical hospitals: the investment interest safe harbor and the personal services and management contracts safe harbor. However, the structure of the partnerships and limited liability companies operating our surgery centers and surgical hospitals, as well as our various business arrangements involving physician group practices, do not satisfy all of the requirements of either safe harbor. Therefore, our business arrangements with our surgery centers, surgical hospitals and physician groups do not qualify for safe harbor protection from government review or prosecution under the anti-kickback statute. When a transaction or relationship does not fit within a safe harbor, it does not mean that an anti-kickback violation has occurred; rather, it means that the facts and circumstances as well as the intent of the parties related to a specific transaction or relationship must be examined to determine whether or not any illegal conduct has occurred.
On November 19, 1999, the Department of Health and Human Services promulgated final regulations creating additional safe harbor provisions, including a safe harbor that applies to physician ownership of or investment
interests in surgery centers. The surgery center safe harbor protects four types of investment arrangements: (1) surgeon owned surgery centers; (2) single specialty surgery centers; (3) multi-specialty surgery centers; and (4) hospital/physician surgery centers. Each category has its own requirements with regard to what type of physician may be an investor in the surgery center. In addition to the physician investor, the categories permit an unrelated investor, who is a person or entity that is not in a position to provide items or services related to the surgery center or its investors. Our business arrangements with our surgical facilities typically consist of one of our subsidiaries being an investor in each partnership or limited liability company that owns the facility, in addition to providing management and other services to the facility. As a result, these business arrangements do not comply with all the requirements of the surgery center safe harbor, and, therefore, are not immune from government review or prosecution.
Although we believe that our business arrangements do not violate the anti-kickback statute, a government agency or a private party may assert a contrary position. Additionally, new domestic federal or state laws may be enacted that would cause our relationships with the physician investors to become illegal or result in the imposition of penalties against us or our facilities. If any of our business arrangements with physician investors were deemed to violate the anti-kickback statute or similar laws, or if new domestic federal or state laws were enacted rendering these arrangements illegal, our business could be adversely affected.
Also, most of the states in which we operate have adopted anti-kickback laws, many of which apply more broadly to all third-party payors, not just to federal or state healthcare programs. Many of the state laws do not have regulatory safe harbors comparable to the federal provisions and have only rarely been interpreted by the courts or other governmental agencies. We believe that our business arrangements do not violate these state laws. Nonetheless, if our arrangements were found to violate any of these anti-kickback laws, we could be subject to significant civil and criminal penalties that could adversely affect our business.
If physician self-referral laws are interpreted differently or if other legislative restrictions are issued, we could incur significant sanctions and loss of reimbursement revenues.
The U.S. federal physician self-referral law, commonly referred to as the Stark law, prohibits a physician from making a referral for a designated health service to an entity to furnish an item or service payable under Medicare if the physician or a member of the physicians immediate family has a financial relationship with the entity such as an ownership interest or compensation arrangement, unless an exception applies. The list of designated health services under the Stark law does not include ambulatory surgery services as such. However, some of the designated health services are among the types of services furnished by our facilities.
The Department of Health and Human Services, acting through the Centers for Medicare and Medicaid Services, has promulgated regulations implementing the Stark law. These regulations exclude health services provided by an ambulatory surgery center from the definition of designated health services if the services are included in the facilitys composite Medicare payment rate. Therefore, the Stark laws self-referral prohibition generally does not apply to health services provided by a surgery center. However, if the surgery center is separately billing Medicare for designated health services that are not covered under the surgery centers composite Medicare payment rate, or if either the surgery center or an affiliated physician is performing (and billing Medicare) for procedures that involve designated health services that Medicare has not designated as an ambulatory surgery center service, the Stark laws self-referral prohibition would apply and such services could implicate the Stark law. We believe that our operations do not violate the Stark Law, as currently interpreted.
In addition, we believe that physician ownership of surgery centers is not prohibited by similar self-referral statutes enacted at the state level. However, the Stark law and similar state statutes are subject to different interpretations with respect to many important provisions. Violations of these self-referral laws may result in substantial civil or criminal penalties, including large civil monetary penalties and exclusion from participation in the Medicare and Medicaid programs. Exclusion of our surgery centers or surgical hospitals from these programs through future judicial or agency interpretation of existing laws or additional legislative restrictions on physician ownership or investments in healthcare entities could result in significant loss of reimbursement revenues.
Companies within the healthcare industry continue to be the subject of federal and state audits and investigations, which increases the risk that we may become subject to investigations in the future.
Both federal and state government agencies, as well as private payors, have heightened and coordinated audits and administrative, civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations. These investigations relate to a wide variety of topics, including the following:
In addition, the Office of the Inspector General of the Department of Health and Human Services and the Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Moreover, another trend impacting healthcare providers is the increased use of the federal False Claims Act, particularly by individuals who bring actions under that law. Such qui tam or whistleblower actions allow private individuals to bring actions on behalf of the government alleging that a healthcare provider has defrauded the federal government. If the government intervenes and prevails in the action, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil monetary penalties of between $5,500 and $11,000 for each false claim submitted to the government. As part of the resolution of a qui tam case, the party filing the initial complaint may share in a portion of any settlement or judgment. If the government does not intervene in the action, the qui tam plaintiff may pursue the action independently. Additionally, some states have adopted similar whistleblower and false claims provisions. Although companies in the healthcare industry have been, and may continue to be, subject to qui tam actions, we are unable to predict the impact of such actions on our business, financial position or results of operations.
If laws governing the corporate practice of medicine change, we may be required to restructure some of our domestic relationships which may result in significant costs to us and divert other resources.
The laws of various domestic jurisdictions in which we operate or may operate in the future do not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business practices, such as fee-splitting with physicians. The interpretation and enforcement of these laws vary significantly from state to state. We are not required to obtain a license to practice medicine in any jurisdiction in which we own or operate a surgery center or surgical hospital because our facilities are not engaged in the practice of medicine. The physicians who utilize our facilities are individually licensed to practice medicine. In most instances, the physicians and physician group practices performing medical services at our facilities do not have investment or business relationships with us other than through the physicians ownership interests in the partnerships or limited liability companies that own and operate our facilities and the service agreements we have with some of those physicians.
Through our OrthoLink subsidiary, we provide consulting and administrative services to a number of physicians and physician group practices affiliated with OrthoLink. Although we believe that our arrangements with these and other physicians and physician group practices comply with applicable laws, a government agency charged with enforcement of these laws, or a private party, might assert a contrary position. If our arrangements with these physicians and physician group practices were deemed to violate state corporate practice of medicine, fee-splitting or similar laws, or if new laws are enacted rendering our arrangements illegal, we may be required to restructure these arrangements, which may result in significant costs to us and divert other resources.
If domestic regulations change, we may be obligated to purchase some or all of the ownership interests of the physicians affiliated with us.
Upon the occurrence of various fundamental regulatory changes, we could be obligated to purchase some or all of the ownership interests of the physicians affiliated with us in the partnerships or limited liability companies that own and operate our surgery centers and surgical hospitals. The regulatory changes that could create this obligation include changes that:
At this time, we are not aware of any regulatory amendments or proposed changes that would trigger this obligation. Typically, our partnership and limited liability company agreements allow us to use shares of our common stock as consideration for the purchase of a physicians ownership interest. The use of shares of our common stock for that purpose would dilute the ownership interests of our common stockholders. In the event that we are required to purchase all of the physicians ownership interests and our common stock does not maintain a sufficient valuation, we could be required to use our cash resources for the acquisitions, the total cost of which we estimate to be up to approximately $469.0 million at December 31, 2010. The creation of these obligations and the possible termination of our affiliation with these physicians could have a material adverse effect on us.
Healthcare reform has restricted our ability to operate our domestic surgical hospitals.
The Acts provide, among other things: (i) a prohibition on hospitals from having any physician ownership unless the hospital already had physician ownership as of March 23, 2010 and a Medicare provider agreement in effect on December 31, 2010; (ii) a limitation on the percentage of total physician ownership in the hospital to the percentage of physician ownership as of March 23, 2010; (iii) a requirement for written disclosures of physician ownership interests, along with an annual report to the government detailing such ownership; and (iv) severe restrictions on the ability of a hospital subject to the whole hospital exception to add operating rooms, procedure rooms and beds.
All of our existing hospitals and our hospital under construction in Dallas, Texas were grandfathered at the dates of enactment of the Acts, although they are largely prohibited from expanding their physical plants. Our hospital under development in Phoenix, Arizona will not be allowed to have any physician ownership unless the Acts, which are currently subject to certain judicial challenges, are overturned or otherwise amended. As a result, we may be required to purchase our share of the physician owners interest in the hospital for approximately $4.0 million in cash. If future legislation were to be enacted by Congress that prohibits physician referrals to hospitals in which the physicians own an interest, or that otherwise further limits physician ownership in existing facilities, our financial condition and results of operations could be materially adversely affected.
If we become subject to significant legal actions, we could be subject to substantial uninsured liabilities.
In recent years, physicians, surgery centers, hospitals and other healthcare providers have become subject to an increasing number of legal actions alleging malpractice or related legal theories. Many of these actions involve large monetary claims and significant defense costs. In particular, since all of our hospitals maintain emergency departments, there is an increased risk of claims at these facilities because of the nature of the cases seen in the emergency departments. We do not employ any of the physicians who conduct surgical procedures at our facilities and the governing documents of each of our facilities require physicians who conduct surgical procedures at our facilities to maintain stated amounts of insurance. Additionally, to protect us from the cost of these claims, we maintain (through a captive insurance company) professional malpractice liability insurance and general liability insurance coverage in amounts and with deductibles that we believe to be appropriate for our operations. Although
we have excess coverage beyond our captive, we are effectively self-insured up to the excess. If we become subject to claims, however, our insurance coverage may not cover all claims against us or continue to be available at adequate levels of insurance. If one or more successful claims against us were not covered by or exceeded the coverage of our insurance, we could be adversely affected.
If we are unable to effectively compete for physicians, strategic relationships, acquisitions and managed care contracts, our business could be adversely affected.
The healthcare business is highly competitive. We compete with other healthcare providers, primarily other surgery centers and hospitals, in recruiting physicians and contracting with managed care payors in each of our markets. In the United Kingdom, we also compete with their national health system in recruiting healthcare professionals. There are major unaffiliated hospitals in each market in which we operate. These hospitals have established relationships with physicians and payors. In addition, other companies either are currently in the same or similar business of developing, acquiring and operating surgery centers and surgical hospitals or may decide to enter our business. Many of these companies have greater financial, research, marketing and staff resources than we do. We may also compete with some of these companies for entry into strategic relationships with not-for-profit healthcare systems and healthcare professionals. If we are unable to compete effectively with any of these entities, we may be unable to implement our business strategies successfully and our business could be adversely affected.
Because our senior management has been key to our growth and success, we may be adversely affected if we lose any member of our senior management.
We are highly dependent on our senior management, including Donald E. Steen, who is our chairman, and William H. Wilcox, who is our president and chief executive officer. Although we have employment agreements with Mr. Steen and Mr. Wilcox and other senior managers, we do not maintain key man life insurance policies on any of our officers. Because our senior management has contributed greatly to our growth since inception, the loss of key management personnel or our inability to attract, retain and motivate sufficient numbers of qualified management or other personnel could have a material adverse effect on us.
The growth of patient receivables and a deterioration in the collectability of these accounts could adversely affect our results of operations.
The primary collection risks of our accounts receivable relate to patient receivables for which the primary insurance carrier has paid the amounts covered by the applicable agreement but patient responsibility amounts (deductibles and copayments) remain outstanding. The allowance for doubtful accounts relates primarily to amounts due directly from patients.
We provide for bad debts principally based upon the aging of accounts receivable and use specific identification to write-off amounts against our allowance for doubtful accounts, without differentiation between payor sources. Our U.S. doubtful account allowance at December 31, 2010 and 2009, represented approximately 15% and 16% of our U.S. accounts receivable balance, respectively. Due to the difficulty in assessing future trends, we could be required to increase our provisions for doubtful accounts. A deterioration in the collectability of these accounts could adversely affect our collection of accounts receivable, cash flows and results of operations.
We may have a special legal responsibility to the holders of ownership interests in the entities through which we own surgical facilities, and that responsibility may prevent us from acting solely in our own best interests or the interests of our stockholders.
Our ownership interests in surgery centers and surgical hospitals generally are held through partnerships or limited liability companies. We typically maintain an interest in a partnership or limited liability company in which physicians or physician practice groups also hold interests. As general partner or manager of these entities, we may have a special responsibility, known as a fiduciary duty, to manage these entities in the best interests of the other owners. We also have a duty to operate our business for the benefit of our stockholders. As a result, we may encounter conflicts between our responsibility to the other owners and our responsibility to our stockholders. For example, we have entered into management agreements to provide management services to our domestic facilities
in exchange for a fee. Disputes may arise as to the nature of the services to be provided or the amount of the fee to be paid. In these cases, we are obligated to exercise reasonable, good faith judgment to resolve the disputes and may not be free to act solely in our own best interests. Disputes may also arise between us and our affiliated physicians with respect to a particular business decision or regarding the interpretation of the provisions of the applicable partnership or limited liability company agreement. If we are unable to resolve a dispute on terms favorable or satisfactory to us, our business may be adversely affected.
We do not have exclusive control over the distribution of revenues from some of our domestic operating entities and may be unable to cause all or a portion of the revenues of these entities to be distributed.
All of the domestic surgical facilities in which we have ownership interests are partnerships or limited liability companies in which we own, directly or indirectly, ownership interests. Our partnership, and limited liability company agreements, which are typically with the physicians who perform procedures at our surgical facilities, usually provide for the monthly or quarterly pro-rata cash distribution of net profits from operations, less amounts to satisfy obligations such as the entities non-recourse debt and capitalized lease obligations, operating expenses and working capital. The creditors of each of these partnerships and limited liability companies are entitled to payment of the entities obligations to them, when due and payable, before ordinary cash distributions or distributions in the event of liquidation, reorganization or insolvency may be made. We generally control the entities that function as the general partner of the partnerships or the managing member of the limited liability companies through which we conduct operations. However, we do not have exclusive control in some instances over the amount of net revenues distributed from some of our operating entities. If we are unable to cause sufficient revenues to be distributed from one or more of these entities, our relationships with the physicians who have an interest in these entities may be damaged and we could be adversely affected. We may not be able to resolve favorably any dispute regarding revenue distribution or other matters with a healthcare system with which we share control of one of these entities. Further, the failure to resolve a dispute with these healthcare systems could cause the entity we jointly control to be dissolved.
Welsh Carson controls us and may have conflicts of interest with us or you in the future.
An investor group led by Welsh Carson owns substantially all of the outstanding equity securities of our Parent, USPI Group Holdings, Inc. Welsh Carson controls a majority of the voting power of such outstanding equity securities and therefore ultimately controls all of our affairs and policies, including the election of our board of directors, the approval of certain actions such as amending our charter, commencing bankruptcy proceedings and taking certain corporate actions (including, without limitation, incurring debt, issuing stock, selling assets and engaging in mergers and acquisitions), and appointing members of our management. The interests of Welsh Carson could conflict with your interests.
Additionally, Welsh Carson is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Welsh Carson may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as investment funds associated with or designated by Welsh Carson continue to indirectly own a significant amount of our capital stock, even if such amount is less than 50% of our outstanding common stock on a fully-diluted basis, Welsh Carson will continue to be able to strongly influence or effectively control our decisions.
The response to this item is included in Item 1.
From time to time, we may be named as a party to legal claims and proceedings in the ordinary course of business. We are not aware of any claims or proceedings against us or our subsidiaries that might have a material adverse impact on us.
We are wholly-owned by USPI Holdings, Inc., which is wholly-owned by USPI Group Holdings, Inc., both of which are privately owned corporations. There is no public trading market for our equity securities or those of USPI Holdings, Inc. or USPI Group Holdings, Inc. As of February 25, 2011, there were 106 holders of USPI Group Holdings, Inc. common stock.
The selected consolidated statement of operations data set forth below for the years ended December 31, 2010, 2009 and 2008, (Successor), the periods January 1 through April 18, 2007 (Predecessor) and April 19 through December 31, 2007 (Successor) and for the year ended December 31, 2006 (Predecessor), and the consolidated balance sheet data at December 31, 2010, 2009, 2008 and 2007 (Successor) and December 31, 2006 (Predecessor) are derived from our consolidated financial statements.
The historical results presented below are not necessarily indicative of results to be expected for any future period. The comparability of the financial and other data included in the table is affected by our merger transaction in 2007, loss on early retirement of debt in 2007 and 2006 and various acquisitions completed during the years presented. In addition, the results of operations of subsidiaries sold by us have been reclassified to discontinued operations for all data presented in the table below except for the consolidated balance sheet data. For a more detailed explanation of this financial data, see Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and related notes included elsewhere in this report.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Selected Financial Data and our consolidated financial statements and related notes included elsewhere in this report.
We operate ambulatory surgery centers and surgical hospitals in the United States and the United Kingdom. As of December 31, 2010, we operated 189 facilities, consisting of 185 in the United States and four in the United Kingdom. All 185 of our U.S. facilities include local physician owners, and 132 of these facilities are also partially owned by various not-for-profit healthcare systems (hospital partners). In addition to facilitating the joint ownership of the majority of our existing facilities, our agreements with these healthcare systems provide a framework for the planning and construction of additional facilities in the future. All six facilities we are currently developing include a hospital partner.
Our U.S. facilities, consisting of ambulatory surgery centers and surgical hospitals, specialize in non-emergency surgical cases. Due in part to advancements in medical technology, the volume and complexity of surgical cases performed in an outpatient setting has steadily increased over the past two decades. Our facilities earn a fee from patients, insurance companies, or other payors in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. In addition, we earn a monthly fee from each facility we operate in exchange for managing its operations. All but four of our facilities are located in the U.S., where we have focused increasingly on adding facilities with hospital partners, which we believe improves the long-term profitability and potential of our facilities.
In the United Kingdom we operate three hospitals and an oncology clinic, which supplement the services provided by the government-sponsored healthcare system. Our patients choose to receive care at private hospitals primarily because of waiting lists to receive diagnostic procedures or elective surgery at government-sponsored facilities and pay us either from personal funds or through private insurance, which is offered by some employers as a benefit to their employees. Since acquiring our first two facilities in the United Kingdom in 2000, we have expanded selectively by adding a third facility and increasing the capacity and services offered at each facility, including the construction of an oncology clinic near the campus of one of our hospitals. In January 2011, we acquired an equity interest in a diagnostic and surgery center located in Edinburgh, Scotland.
Our growth and success depends on our ability to continue to grow volumes at our existing facilities, to successfully open new facilities we develop, to successfully integrate acquired facilities into our operations, and to maintain productive relationships with our physician and hospital partners. We believe we will have significant opportunities to operate more facilities in the future in existing and new markets and that many of these will include hospital partners.
Due in large part to our partnerships with physician and hospital partners, we do not consolidate 130 of the 188 facilities in which we have ownership interests. To help analyze our results of operations, we disclose an operating measure we refer to as systemwide revenue growth, which includes both consolidated and unconsolidated facilities. While revenues of our unconsolidated facilities are not recorded as revenues by USPI, we believe the information is important in understanding USPIs financial performance because these revenues are the basis for calculating the Companys management services revenues and, together with the expenses of our unconsolidated facilities, are the basis for USPIs equity in earnings of unconsolidated affiliates. In addition, USPI discloses growth rates and operating margins (both consolidated and unconsolidated) for the facilities that were operational in both the current and prior year periods, a group the Company refers to as same store facilities.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition, results of operations and liquidity and capital resources are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of consolidated financial statements under GAAP requires our management to make certain estimates and assumptions that impact the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. These estimates and assumptions also impact the reported amount of net earnings during any period. Estimates are based on information available as of the date financial statements are prepared. Accordingly, actual results could differ from those estimates. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and that require managements most subjective judgments. Our critical accounting policies and estimates include our policies and estimates regarding consolidation, revenue recognition and accounts receivable, income taxes, and goodwill and intangible assets.
We own less than 100% of each U.S. facility we operate. As discussed in Results of Operations, we operate all of our U.S. facilities through joint ventures with physicians. Increasingly, these joint ventures also include a hospital partner. We generally have a leadership role in these facilities through a significant voting and economic interest and a contract to manage each facilitys operations, but the degree of control we have varies from facility to facility. Accordingly, as of December 31, 2010, we consolidated the financial results of 58 of the facilities we operate, account for 130 under the equity method and operate one facility under a service and management contract.
Our consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, and other investees over which we have control or of which the Company is the primary beneficiary. Investments in companies that we neither control nor are the primary beneficiary, but over whose operations we have the ability to exercise significant influence (including investments where we have less than 20% ownership), are accounted for under the equity method. We also consider the relevant sections of the Financial Accounting Standards Boards Accounting Standards Codification, Topic 810, Consolidation to determine if we are the primary beneficiary of (and therefore should consolidate) any entity whose operations we do not control with voting rights. At December 31, 2010, we consolidated one entity as a result of being its primary beneficiary. See further discussion in Note 5 to the consolidated financial statements.
Accounting for an investment as consolidated versus equity method has no impact on our net income (loss) or stockholders equity in any accounting period, but it does impact individual balances within the statement of operations and balance sheet. Under either consolidation or equity method accounting, the investors results of operations includes its share of the investee entitys net income or loss based generally on its ownership percentage.
Revenue Recognition and Accounts Receivable
We recognize revenue in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements, as updated, which has four criteria that must be met before revenue is recognized:
Our revenue recognition policies are consistent with these criteria. Over 80% of our facilities surgical cases are performed under contracted or government mandated fee schedules or discount arrangements. The patient service revenues recorded for these cases are recorded at the contractually defined amount at the time of billing. We estimate the remaining revenue based on historical collections, and adjustments to these estimates in subsequent periods have not had a material impact in any period presented. If the discount percentage used in estimating revenues for the cases not billed pursuant to fee schedules were changed by 1%, our 2010 after-tax net income would change by approximately $0.2 million. The collection cycle for patient services revenue is relatively short, typically ranging from 30 to 60 days depending upon payor and geographic norms, which allows us to evaluate our estimates frequently. Our revenues earned under management and other service contracts are typically based upon objective formulas driven by an entitys financial performance and are generally earned and paid monthly.
Our accounts receivable are comprised of receivables in both the United Kingdom and the United States. As of December 31, 2010, approximately 21% of our total accounts receivable were attributable to our U.K. business. Because our U.K. facilities only treat patients who have a demonstrated ability to pay, our U.K. patients arrange for payment prior to treatment and our bad debt expense in the U.K. is low. In 2010, U.K. bad debt expense was less than $0.1 million, as compared to our total U.K. revenues of $102.7 million. Our average days sales outstanding in the U.K. were 38 and 52 as of December 31, 2010 and 2009, respectively. The decrease in U.K. days sales outstanding was caused by the receipt of several payments made by large payors on December 31, 2010.
Our U.S. accounts receivable were approximately 79% of our total accounts receivable as of December 31, 2010. In 2010, uninsured or self-pay revenues only accounted for 2% of our U.S. revenue and approximately 6% of our accounts receivable balance was comprised of amounts owed from patients, including the patient portion of amounts covered by insurance. Insurance revenues (including government payors) accounted for 98% of our 2010 U.S. revenue and approximately 94% of our accounts receivable balance was comprised of amounts owed from contracted payors. Our U.S. facilities primarily perform surgery that is scheduled in advance by physicians who have already seen the patient. As part of our internal control processes, we verify benefits, obtain insurance authorization, calculate patient financial responsibility and notify the patient of their responsibility, usually prior to surgery. The nature of our business is such that we do not have any significant receivables that are pending approval from third party payors. We also focus our collection efforts on aged accounts receivable. However, due to complexities involved in insurance reimbursements and inherent limitations in verification procedures, our business will always have some level of bad debt expense. In both 2010 and 2009, our bad debt expense attributable to U.S. revenue was approximately 2%. In addition, as of December 31, 2010 and 2009, our average days sales outstanding in the U.S. were 33 and 34 days, respectively. The aging of our U.S. accounts receivable at December 31, 2010 was: 67% less than 60 days old, 13% between 60 and 120 days and 20% over 120 days old. Our U.S. bad debt allowance at December 31, 2010 and 2009 represented approximately 15% and 16% of our U.S. accounts receivable balance, respectively.
Due to the nature of our business, management relies upon the aging of accounts receivable as its primary tool to estimate bad debt expense. Therefore, we reserve for bad debt based principally upon the aging of accounts receivable, without differentiating by payor source. We write off accounts on an individual basis based on that aging. We believe our reserve policy allows us to accurately estimate our allowance for doubtful accounts and bad debt expense.
Our income tax policy is to record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and the bases of those assets and liabilities as reported in our consolidated balance sheets. This estimation process requires that we evaluate the need for a valuation allowance against deferred tax assets, based on factors such as historical financial information, expected timing of future events, the probability of expected future taxable income and available tax planning opportunities. While we recognized the benefit of the
majority of our deferred tax assets in 2009, we still carry a valuation allowance against deferred tax assets that have restrictions as to use and are not considered more likely than not to be realized. If our estimates related to the above items change significantly, we may need to alter the amount of our valuation allowance in the future through a favorable or unfavorable adjustment to net income.
Goodwill and Intangible Assets
Given the significance of our intangible assets as a percentage of our total assets, we also consider our accounting policy regarding goodwill and intangible assets to be a critical accounting policy. Consistent with GAAP, we do not amortize goodwill or indefinite-lived intangibles but rather test them for impairment annually or more often when circumstances change in a manner that indicates they may be impaired. Impairment tests occur at the reporting unit level for goodwill; our reporting units are defined as our operating segments (United States and United Kingdom). Our intangible assets consist primarily of indefinite-lived rights to manage individual surgical facilities. The values of these rights are tested individually. Intangible assets with definite lives primarily consist of rights to provide management and other contracted services to surgical facilities, hospitals, and physicians. These assets are amortized over their estimated useful lives, and the portfolios are tested for impairment when circumstances change in a manner that indicates their carrying values may not be recoverable.
To determine the fair value of our reporting units, we generally use a present value technique (discounted cash flow) corroborated by market multiples when available and as appropriate. The factor most sensitive to change with respect to our discounted cash flow analyses is the estimated future cash flows of each reporting unit which is, in turn, sensitive to our estimates of future revenue growth and margins for these businesses. If actual revenue growth and/or margins are lower than our expectations, the impairment test results could differ. We base our fair value estimates on assumptions we believe to be reasonable and consistent with market participant assumptions, but that are unpredictable and inherently uncertain. The fair value of an indefinite-lived intangible asset is compared to its carrying amount. If the carrying amount of an indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized. Fair values for indefinite-lived intangible assets are estimated based on market multiples and discounted cash flow models which have been derived based on our experience in acquiring surgical facilities, market participant assumptions and third party valuations we have obtained with respect to such transactions.
Based on the results of our 2010 goodwill impairment testing, both of our reporting units estimated fair values substantially exceed their carrying values. During 2010, we recorded a $5.9 million impairment charge related to six indefinite-lived intangible assets (management contracts) as further discussed in Note 8 to our consolidated financial statements.
USPI had publicly traded equity securities from June 2001 through April 2007. Pursuant to an Agreement and Plan of Merger (the merger) dated as of January 7, 2007, between an affiliate of Welsh, Carson, Anderson & Stowe X, L.P. (Welsh Carson), we became a wholly owned subsidiary of USPI Holdings, Inc. on April 19, 2007. USPI Holdings is a wholly owned subsidiary of USPI Group Holdings, Inc. (Parent), which is owned by an investor group that includes affiliates of Welsh Carson, members of our management and other investors.
Acquisitions, Equity Investments and Development Projects
As part of our growth strategy, we acquire interests in existing surgical facilities from third parties and invest in new facilities that we develop in partnership with hospital partners and local physicians. Some of these transactions result in our controlling the acquired entity (business combinations). During the year ended December 31, 2010, we obtained control of the following entities:
We also regularly engage in the purchase and sale of equity interests with respect to our investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in surgical facilities under development. During the year ended December 31, 2010, these transactions resulted in a net cash outflow of approximately $21.3 million, which is summarized below:
Similar to our investments in unconsolidated affiliates, we regularly engage in the purchase and sale of equity interests in our consolidated subsidiaries that do not result in a change of control. These types of transactions are accounted for as equity transactions, as they are undertaken among us, our consolidated subsidiaries, and noncontrolling interests. During the year ended December 31, 2010, we purchased and sold equity interests in various consolidated subsidiaries in the amounts of $2.9 million and $4.0 million, respectively. The difference between our carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to our additional paid-in capital. These transactions resulted in a $7.2 million decrease to our additional paid-in capital during the year ended December 31, 2010.
As further described in the section, Discontinued Operations and Other Dispositions, during 2010, we received proceeds of $32.5 million related to our sale of our wholly-owned subsidiary, American Endoscopy Services, Inc. (AES). We also received cash proceeds of $0.6 million related to the sale of a controlling interest in one facility to a hospital partner.
During 2009, we acquired interests in existing surgical facilities from third parties and invested in new facilities that we are developing in partnership with hospital partners and local physicians. Some of these transactions result in our controlling the acquired entity (business combinations). In December 2009, we invested $9.9 million in a subsidiary jointly operated with one of our hospital partners, which the subsidiary used to acquire a controlling interest in a facility in Houston, Texas.
We also regularly engage in the purchase and sale of equity interests with respect to our investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in surgical facilities under development. During the year ended December 31, 2009, these transactions resulted in a net cash outflow of approximately $47.4 million, which is summarized below:
Additionally, effective January 1, 2009, we acquired noncontrolling equity interests in and rights to manage two surgical facilities in which we previously had no involvement. These facilities are jointly owned with one of our hospital partners and local physicians. The total purchase price of $2.2 million was paid in December 2008.
Similar to our investments in unconsolidated affiliates, we regularly engage in the purchase and sale of equity interests in our consolidated subsidiaries that do not result in a change of control. These types of transactions are accounted for as equity transactions, as they are undertaken among us, our consolidated subsidiaries, and noncontrolling interests. During the year ended December 31, 2009, we purchased and sold equity interests in various consolidated subsidiaries in the amounts of $9.4 million and $7.4 million, respectively. The $9.4 million of purchases includes the partial exercise of our purchase option in one of our existing centers in St. Louis for $7.1 million. The difference between our carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to our additional paid-in capital. These transactions resulted in a $14.3 million decrease to our additional paid-in capital during the year ended December 31, 2009.
We engaged in the following business combinations and transactions, formerly known as step acquisitions, during the year ended December 31, 2008:
We also engaged in transactions that are not business combinations or step acquisitions. 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 year ended December 31, 2008, these transactions resulted in a net cash outflow of approximately $35.6 million, which is summarized below.
As further described in the section, Discontinued Operations and Other Dispositions, during 2008, we received proceeds of $3.4 million related to our sale of all our ownership interests in five facilities. We also received cash proceeds of $5.2 million related to the sale of noncontrolling interests in five facilities to various not-for-profit hospital partners.
Discontinued Operations and Other Dispositions
Sales of consolidated subsidiaries in which we have no continuing involvement are classified as discontinued operations, as are consolidated subsidiaries that are held for sale. The gains or losses on these transactions are classified within discontinued operations in our consolidated statements of income. Also, we have reclassified our historical results of operations to remove the operations of these entities from our revenues and expenses, collapsing the net income or loss from these operations into a single line within discontinued operations.
Discontinued operations are as follows :
Equity method investments that are sold do not represent discontinued operations under GAAP. We did not sell any equity method investments during 2010. During 2009 and 2008, we completed sales of investments in ten facilities operated through unconsolidated affiliates, including our equity ownership in these entities as well as the related rights to manage the facilities. Gains and losses on the disposals of these investments are classified within Losses on deconsolidations, disposals and impairments in the accompanying consolidated statements of income. These transactions are summarized below:
As further described in Note 5 to our consolidated financial statements, in 2010, we sold approximately 50% of our ownership interests in an entity that was developing and constructing a new hospital for one of our unconsolidated affiliates. We received $3.1 million in cash related to this sale.
In addition to the sales of ownership interests noted above, we sold controlling interests to various hospital partners during 2010, 2009, and 2008 which are described below, as part of our strategy for partnering with these systems. Our continuing involvement as an equity method investor and manager of the facilities precludes classification of these transactions as discontinued operations. Gains and losses are classified within Losses on deconsolidations, disposals and impairments in the accompanying consolidated statements of income.
Sources of Revenue
Revenues primarily include the following:
The following table summarizes our revenues by type and as a percentage of total revenue for the periods presented:
As a percentage of total revenues, net patient service revenues remained consistent at 88% of our total revenues for the years ended December 31, 2010 and 2009. Our net patient services revenues decreased to 88% of total revenues in 2009 from 90% in 2008. This decrease was due in part to the U.S. dollar being stronger on average against the British pound in 2009 compared to 2008, and also is due to shifting of more of our facilities to joint ventures with hospital partners, which usually requires us to account for the facility under the equity method of accounting (as an unconsolidated affiliate). As we execute our strategy of partnering with not-for-profit healthcare systems, more of our business is being conducted through unconsolidated affiliates. With respect to unconsolidated facilities, we do not include the facilities net patient service revenues in our financial results; instead; our consolidated financial statements reflect revenues we earn for our management and contract services as noted below. Our share of the revenues, net of expenses of unconsolidated facilities, is reported in our consolidated financial statements as equity in earnings of unconsolidated affiliates, which is displayed between revenues and operating expenses. The percentage of our U.S. facilities we account for under the equity method was 70%, 64%, and 63% at December 31, 2010, 2009, and 2008, respectively.
Our management and contract service revenues are earned from the following types of activities (in thousands):
The following table summarizes our revenues by operating segment:
The proportion of our total revenues derived from U.K. operations as stated in U.S. dollars remained constant at 18% for the years ended December 31, 2010 and 2009. From 2008 to 2009, the proportion of out total revenues derived from U.K. operations decreased from 20% to 18%, respectively. The decrease was primarily caused by the average value of the British pound as compared to the U.S. dollar weakening approximately 15% between December 31, 2008 and December 31, 2009.
Results of Operations
The following table summarizes certain consolidated statements of income items expressed as a percentage of revenues for the periods indicated:
Our business model of partnering with not-for-profit hospitals and physicians results in our accounting for 130 of our surgical facilities under the equity method rather than consolidating their results. The following table reflects the summarized results of the unconsolidated facilities that we account for under the equity method of accounting (amounts are expressed as a percentage of unconsolidated affiliates revenues, and reflect 100% of the investees results on an aggregated basis):
Our strategy continues to focus on growing the profits of our existing facilities, developing new facilities with hospital partners, and adding other facilities selectively through acquisition. We added 27 facilities during 2010 and operated 189 facilities at year-end, up from 169 at the end of 2009. Consistent with our primary strategy, we continued to focus on partnering both existing facilities and newly acquired or constructed facilities with a not-for-profit health system (hospital partner). The number of facilities with hospital partners increased by 23 during 2010. We also sold two facilities and an endoscopy business and designated two additional facilities as held for sale at December 31, 2010. Our operating results were not as strong as in recent years, but improved during the course of the year.
Surgical case volumes and profits at our facilities decreased slightly in the early part of 2010 but improved during the year. Overall for 2010, this translated to a 5% year-over-year increase in the revenues of facilities we
operated in both 2009 and 2010 (same store facilities), as compared to 8% for 2009 and 11% for 2008. However, in 2010 the volumes and revenues of our same store facilities improved during the year, with the fourth quarter growth rate of 8% representing a significant improvement over earlier quarters, particularly compared to the 2% rate we experienced during the first quarter of 2010. Factoring in acquisitions, our overall systemwide revenues increased 7% for the year (13% in the fourth quarter).
While our systemwide revenues grew, USPIs 2010 reported revenues, which consist only of consolidated businesses, decreased compared to prior year by 3%. This decrease was driven by two factors related to the deployment of our primary business model, which is jointly owning our facilities with prominent local physicians and a hospital partner. We generally do not consolidate the businesses in these structures, but our profits from them, which are reflected in equity in earnings of unconsolidated affiliates, increased 13% in 2010. Excluding the impact of an impairment charge with respect to one investment, our equity in earnings of unconsolidated affiliates increased 19%. The revenues of these facilities, which are not included in USPIs reported revenues, are growing more than our consolidated facilities; the revenues of the unconsolidated facilities we owned in both years increased $97.1 million during 2010 as compared to the prior year, and additionally increased through acquisitions and as a result of our partnering four of these facilities with a hospital partner in 2010, thereby deconsolidating them, which moves their revenues out of our consolidated revenues and into the revenues of our unconsolidated group of facilities. Our consolidated revenues decreased primarily due to these deconsolidation transactions, which moved $14.6 million from the consolidated to the unconsolidated group, and additionally due to declines in operational results ($9.4 million).
Operating income increased 6% year-over-year and was significantly impacted by several amounts not directly related to our facilities operating results. Excluding these amounts, shown below, operating income and margin were up 2% and 180 basis points, respectively (in millions):
While this increase in operating margin reflects some leveraging of our consolidated operating expenses, we additionally focus on U.S. same store facility level operating income margins (which reflect all facilities results, consolidated and unconsolidated) as indicators of the trend of our business, because our earnings and cash flows are heavily driven by the results at those facilities, whether we consolidate them or not. For the full year, those margins actually decreased slightly, reflecting the slower revenue growth described above. Because of relationships like these (differences in the magnitude or direction of consolidated versus systemwide revenues and margins), which often are driven by deconsolidations such as those described above, we supplementally focus on systemwide revenues and facility level operating income margins as important indicators for our business, given that our earnings ultimately are driven heavily by facility level revenues and operating margins. Facility level operating income margins were down 60 basis points year-over-year, but as with revenues the results improved as the year progressed, culminating in facility operating income margins for the fourth quarter being 60 basis points higher than the fourth quarter of 2009.
As noted above, we continued to acquire and develop facilities in 2010, acquiring 25 existing facilities and opening two newly constructed facilities. Our U.S. development strategy continues to focus most heavily on markets in which we have a significant presence with prominent local physicians and often a hospital partner. We also invest capital selectively in our U.K. market and in new markets. Pursuing this strategy also leads us to deconsolidate or divest of centers from time to time, as we did in 2009 and 2010.
Also impacting year-over-year comparisons in 2010 was the 2009 recognition of a $31.2 million tax benefit reflecting the Companys expectation that the majority of its U.S. deferred tax assets would be utilized prior to their expiration.
Our Business and Key Measures
We operate surgical facilities in partnership with local physicians and, in the majority of cases, a not-for-profit health system partner. We hold an ownership interest in each facility, each being operated through a separate legal entity owned by us, the health systems and physicians. We operate each facility on a day-to-day basis through a management services contract. Our sources of earnings from each facility consist of:
Our role as an owner and day-to-day manager provides us with significant influence over the operations of each facility. In a growing majority of our facilities (currently 130 of our 189 facilities), this influence does not represent control of the facility, so we account for our investment in the facility under the equity method, i.e., as an unconsolidated affiliate. Of the remaining facilities, we control 58 facilities and account for these investments as consolidated subsidiaries and operate one facility under a service and management contract.
Our net earnings from a facility are the same under either method, but the classification of those earnings differs. For consolidated subsidiaries, our financial statements reflect 100% of the revenues and expenses of the subsidiaries, after the elimination of intercompany amounts. The net profit attributable to owners other than us is classified within net income attributable to noncontrolling interests.
For unconsolidated affiliates, our consolidated statements of income reflect our earnings in only two line items:
In summary, USPIs operating income is driven by the performance of all facilities we operate and by our ownership interest in those facilities, but USPIs individual revenue and expense line items only contain consolidated businesses, which represent less than half of our operations. This translates to trends in operating income that often do not correspond with changes in revenues and expenses. The divergence in these relationships is particularly significant when our strategy is heavily weighted to unconsolidated affiliates, as it has been in recent years during the ongoing deployment of our strategy to partner with not-for-profit health systems. Accordingly, we review several types of information in order to monitor and analyze USPIs results of operations, including:
Our Consolidated and Unconsolidated Results
The following table shows USPIs results of operations and the results of operations of USPIs unconsolidated affiliates.
The following table provides other information regarding our unconsolidated affiliates (in thousands):
One of our unconsolidated affiliates, Texas Health Ventures Group, L.L.C., is considered significant to our consolidated financial statements under regulations of the SEC. As a result, we have filed Texas Health Ventures Group, L.L.C.s consolidated financial statements with this Form 10-K for the appropriate periods.
As shown above, USPIs consolidated net patient service revenues for the year ended December 31, 2010 decreased $19.1 million compared to the prior year, and the net patient service revenues of USPIs unconsolidated affiliates increased $151.2 million. These variances are analyzed more extensively in the Revenues section, but in general they reflect the fact that we are conducting more of our operations through unconsolidated affiliates. The increase in revenues of these unconsolidated affiliates, net of their expenses, led to the affiliates earning $33.2 million more compared to the prior year. The affiliates increase in net income, once allocated to USPI and the affiliates other investors, led to USPIs equity in earnings of unconsolidated affiliates increasing by $8.1 million, which represents nearly 67% of the increase in USPIs operating income from 2009 to 2010.
When comparing 2009 and 2008, the relationships were similar. USPIs consolidated net patient services revenues decreased $30.5 million for the year ended December 31, 2009 compared to 2008, and the net patient service revenues of USPIs unconsolidated affiliates increased $174.9 million, driving a $64.0 million increase in the net income of the unconsolidated affiliates and an overall increase of $14.7 million in USPIs equity in earnings of unconsolidated affiliates.
Our Ownership Interests in the Facilities We Operate
Our earnings are predominantly driven by our investments in the facilities we operate, so we focus on those businesses performance together with the percentage ownership interest we hold in them to help us understand our results of operations. Our average ownership interest in the U.S. surgical facilities we operate is as follows:
Our average ownership interest for each group of facilities is determined by many factors, including the ownership levels we negotiate in our acquisition and development activities, the relative performance of facilities in which we own percentages higher or lower than average, and other factors. As described earlier, our increased focus on partnering our facilities with hospital partners in addition to physicians generally leads to our accounting for
more facilities under the equity method (unconsolidated), and we have moved three facilities from consolidated to unconsolidated during 2010 and four facilities during each of 2009 and 2008. Accordingly, our consolidated financial statements show decreases in revenues and most expense line items compared to the respective prior year. However, since our average ownership in our facilities, as shown in the table above, did not significantly change from the respective prior year, our success in growing our facilities profits (whether consolidated or unconsolidated) translated to increases in USPIs operating income in 2010, 2009 and 2008.
While our ownership interests remained higher for consolidated facilities than for unconsolidated facilities, our average ownership in our consolidated facilities decreased from 2009 to 2010 due to relative performance of certain consolidated facilities, namely that one markets facilities, in which our ownership is higher than average, experienced steeper than average drops in profitability compared to our other consolidated facilities due to the execution of a long-term payor contract.
USPIs consolidated net revenues decreased approximately 3% during the year ended December 31, 2010, as compared to the year ended December 31, 2009. However, our operating income increased 6%. The table below quantifies several significant items impacting year over year growth.
The reason for the discrepancy between revenue growth and income growth is the increased proportion of our business being conducted through unconsolidated affiliates. Growing the volume and profits of unconsolidated facilities has relatively little impact on our consolidated revenues, but our share of their increasing net income (equity in earnings of unconsolidated affiliates, which grew by 13%, 31% and 39% in 2010, 2009 and 2008, respectively) is reflected in our operating income and net income. Accordingly, as described above, we focus on our systemwide results in order to understand where our growth in income is coming from. Our systemwide revenues, which include revenues of facilities we account for under the equity method as well as facilities we consolidate, grew by rates more commensurate with our overall income growth: 7%, 9% and 14% during the years ended December 31, 2010, 2009 and 2008, respectively. As depicted above, a major component of the decrease in consolidated revenues was the deconsolidation of facilities, which caused a corresponding increase in the revenues of unconsolidated affiliates. However, operations also were a significant factor, although differently for each of the two groups (consolidated and equity method). Despite only slight growth in case volumes, a shift to more complex surgical cases in several equity method facilities, and the resulting increased revenue per case, actually caused an approximate $97.1 million increase in the revenues of this group of facilities, whereas the consolidated facilities experienced decreases in average reimbursement as well as case volumes. These factors combined to reduce consolidated revenues by approximately $9.4 million.
As described above, our systemwide revenues (consisting of both consolidated subsidiaries and unconsolidated affiliates) grew 7% and 9% during 2010 and 2009. While systemwide revenue growth was partially driven by acquisitions and development of new facilities, the most significant component continued to be the results of facilities that have been open for more than one year (same store facilities). This group of facilities experienced revenue growth of 5% and 8% during 2010 and 2009, respectively. The growth in these facilities was driven more by increases in net revenue per case than by increases in volume. While some of this shift reflects increases in rates we negotiate with payors, we believe a more significant portion of the increase is driven by the type of cases we performed, which continue to shift to more complex cases on average, particularly at several of our larger facilities. Our U.S. case volumes started the year sluggishly, decreasing 2% in the first quarter on a year-over-year basis, but improved during the year, culminating in a 3% year-over-year growth rate in the fourth quarter. While the fourth quarter growth rate compares favorably with our 2% annual growth rates for the full years 2008 and 2009, U.S. cases for the full year 2010 were essentially flat as a result of the sluggish early months. We believe this overall lower case volume growth could have resulted from several factors, including changes to health insurance plans to require more patient responsibility for healthcare expenses and a generally soft economy.
Our United Kingdom facilities revenues, when measured in local currency (or constant exchange rate), declined 1% during 2010 as compared to 2009. This decline is largely due to a decrease in the National Health Service business and in self-pay business. While self-pay business represents only 2% of our U.S. business, it represents 25% of our U.K. business. Self-pay business is generally considered more susceptible to changes in general economic conditions, as the cost of care is borne entirely by the patient rather than shared with private insurers or borne by the National Health Service. The strengthening of the U.S. dollar versus the British pound caused a significant drop (approximately $19.0 million) in reported revenues during 2009 as compared to 2008, but in local currency, our U.K. facilities continued to generate revenue growth in 2009.
The following table summarizes our same store facility growth rates, as compared to the corresponding prior year period:
Joint Ventures with Not-for-Profit Hospitals
Our addition of new facilities continues to be more heavily weighted to U.S. surgical facilities with a hospital partner, both as we initiate joint venture agreements with new systems and as we add facilities to our existing arrangements. Facilities have been added to hospital joint ventures both through construction of new facilities (de novos) and through our contribution of our equity interests in existing facilities into a hospital joint venture structure, effectively creating three-way joint ventures by sharing our ownership in these facilities with a hospital partner while leaving the existing physician ownership intact.
Consistent with this strategy, our overall number of facilities increased by 20 from December 31, 2009 to December 31, 2010, driven by a net increase of 23 facilities partnered with not-for-profit hospitals and local physicians. All five facilities under construction at December 31, 2010, involve a hospital partner, and we continue to explore affiliating more facilities with hospital partners, especially for facilities in markets where we already operate other facilities with a hospital partner.
The following table summarizes the facilities we operated as of December 31, 2010, 2009, and 2008:
Facility Operating Margins
Same store U.S. facility operating margins decreased 60 basis points for the year ended December 31, 2010 as compared to 2009. The decrease was broad-based, and was largely due to lower case volumes early in the year that were not offset by a proportionate decrease in operating expenses. Following the pattern of same facility revenues, and driven by similar factors, margins improved during the year, recovering from a 240 basis point drop in year-over-year margins for the first quarter of 2010 to finish the year down 60 basis points on a full year basis, due to an improvement each quarter ending with a fourth quarter that was up 60 basis points over prior year. Continuing a
trend we experienced in 2008 and 2009, the year-over-year change in the operating margins of facilities partnered with a not-for-profit healthcare system was more favorable (or, in the case of 2010, less unfavorable) than the change experienced by the facilities that do not have a hospital partner.
In 2009, same store U.S. facility operating margins increased 250 basis points, largely driven by continued revenue growth together with cost saving measures introduced during 2009 at our facilities. While the improvement was broad-based, it was particularly notable in the group of facilities jointly owned with hospital partners, the margins of which improved 340 basis points. The margins of facilities we operate without a hospital partner did not fare as well, but were up 20 basis points as compared to the year ended December 31, 2008. We believe this disparity in recent years generally reflects the benefits of our increased focus on developing some of our larger markets, where we more often have a hospital partner. During 2008, same store U.S. facility operating margins increased slightly (10 basis points) largely due to improved leveraging of expenses at some of our larger facilities, which underwent expansions during 2007.
Our U.K. facilities, which comprise four of our 189 facilities at December 31, 2010, experienced a decrease in overall facility margins in 2010 as compared to 2009, also due to lower volumes that were not offset by a proportionate decrease in operating expenses. While margins were still down, expenses were controlled more successfully in 2010 than in 2009.
The following table summarizes our year-over-year increases (decreases) in same store operating margins (see footnote 1 below):
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
As discussed more fully in Revenues, our consolidated revenues decreased by $16.8 million, or 2.8%, to $576.7 million for the year ended December 31, 2010 from $593.5 million for the year ended December 31, 2009 as our business continued to shift to unconsolidated affiliates, whose revenues increased 13% but are not included in our consolidated revenues. The number of facilities we account for under the equity method increased by 21 from December 31, 2009 to December 31, 2010; the number of facilities we consolidate decreased by two during this period.
Equity in earnings of unconsolidated affiliates increased by $8.1 million, or 13.2% to $69.9 million for the year ended December 31, 2010 from $61.8 million for the year ended December 31, 2009. Excluding an impairment charge we recorded on an equity method investment during 2010 of $3.7 million, our equity in earnings increased 19%, driven by the growth in revenues of our unconsolidated affiliates.
Operating income increased 6% year-over-year and was significantly impacted by several items described in Executive Summary, the most significant of which were losses on deconsolidations, disposals, and impairments, which decreased $22.8 million to $6.4 million for the year ended December 31, 2010 from $29.2 million for the year ended December 31, 2009. During 2010, we recorded impairment charges of $5.9 million on six indefinite lived management contracts. These impairment charges were partially offset by a net gain on the sale or deconsolidation of various facilities of approximately $1.7 million. In 2009, we recorded approximately $21.4 million in losses on the sale or deconsolidation of various facilities, impairment charges totaling $5.7 million related to three management contracts and $2.1 million of termination fees related to two acquisitions we made in 2007. We elected not to purchase additional ownership in these facilities and expensed the termination fee. Operating expenses, like our revenues, were also reduced due to deconsolidations. This was the primary factor in the $1.4 million, or 4.3%, decrease in depreciation and amortization to $29.8 million for the year ended December 31, 2010 from $31.2 million for the year ended December 31, 2009.
Interest expense, net of interest income, increased $1.6 million to $69.2 million for the year ended December 31, 2010 from $67.6 million for the year ended December 31, 2009. While market interest rates and our debt balance were lower in 2010 than 2009, the $1.6 million increase can primarily be attributed to a $0.8 million interest income on a settlement we received in the second quarter of 2009 from the British tax authority related to the VAT noted above, whereas in the first quarter of 2010, we recorded a $0.8 million expense as the British tax authority reclaimed the amount.
Provision for income taxes was an income tax expense of $32.3 million for the year ended December 31, 2010 as compared to a $0.9 million benefit for the year ended December 31, 2009. The benefit in 2009 was primarily the result of our reversing the valuation allowance ($31.2 million) against a majority of our U.S. deferred tax assets. During the third quarter of 2009, we determined it was more likely than not that we would generate taxable income to recover these assets in future periods. Our effective tax rate for the year ended December 31, 2010 was approximately 40%. Our effective tax rate, excluding the benefit of reversing the deferred tax asset allowance, was approximately 45% for the year ended December 31, 2009.
Total (loss) gain from discontinued operations was a loss of $7.0 million for the year ended December 31, 2010 as compared to earnings of $1.5 million for the year ended December 31, 2009. The $7.0 million represents loss from discontinued operations of $0.2 million and a loss on disposal of discontinued operations of $6.8 million. We sold two entities in 2010 and designated two others as held for sale. Because these entities are classified as discontinued operations, our consolidated statements of income and the year over year comparisons reflect the historical results of their operations in discontinued operations for all periods presented.
Net income was $102.7 million for the year ended December 31, 2010 as compared to $133.4 million for the year ended December 31, 2009. While our surgical facilities earned more in 2010 than 2009, the factors described above, such as the 2009 tax benefit and 2010 loss on discontinued operations, resulted in our net income decreasing compared to 2009.
Net income attributable to noncontrolling interests decreased $3.2 million, or 5.0%, to $60.6 million for the year ended December 31, 2010 from $63.7 million for the year ended December 31, 2009, as a result of more of our profits coming from unconsolidated affiliates and less from consolidated subsidiaries, as discussed above.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Revenues decreased by $21.6 million, or 3.5%, to $593.5 million for the year ended December 31, 2009 from $615.1 million for the year ended December 31, 2008. This decrease was primarily the result of our selling a partial interest in four of our consolidated facilities, which resulted in our deconsolidating the facilities. This $42.4 million decrease, together with a decrease in U.K. revenues of $18.9 million as a result of the U.S. dollar strengthening against the British pound, more than offset the increases from growth in facilities we consolidated in both years or
acquired during late 2008 or 2009. As described above, the fact that we account for the majority of our U.S. facilities under the equity method means that our growth in net income generally outpaces our growth in reported revenues.
Equity in earnings of unconsolidated affiliates increased by $14.7 million, or 31.3% to $61.8 million for the year ended December 31, 2009 from $47.0 million for the year ended December 31, 2008. This increase in equity in earnings was primarily driven by same store growth ($10.9 million), acquisitions of additional facilities we account for under the equity method ($3.6 million) and the deconsolidation of four facilities which we now account for under the equity method ($0.2 million). The number of facilities we account for under the equity method increased by eight from December 31, 2008 to December 31, 2009.
Operating expenses, excluding depreciation and amortization and losses on deconsolidations, disposals and impairments, decreased by $33.3 million, or 7.7%, to $396.6 million for the year ended December 31, 2009 from $429.9 million for the year ended December 31, 2008. This decrease was largely driven by the deconsolidation of four facilities (approximately $28.5 million) and the recovery of $1.0 million in value added tax previously expensed by our U.K. subsidiary. Operating expenses, excluding depreciation and amortization and losses on deconsolidations, disposals and impairments, decreased as a percentage of revenues to 66.8% for the year ended 2009, from 69.9% for the year ended 2008. This decrease as a percentage of revenues is primarily attributable to cost saving measures being employed across our facilities.
Losses on deconsolidations, disposals and impairments increased $27.3 million to $29.2 million for the year ended December 31, 2009 from $1.8 million for the year ended December 31, 2008. In 2009, we recorded approximately $21.4 million in losses on the sale or deconsolidation of various facilities, impairment charges totaling $5.7 million related to three management contracts and $2.1 million of termination fees related to two acquisitions we made in 2007. We elected not to purchase additional ownership in these facilities and expensed the termination fee. In 2008, the components were a $1.9 million loss on the sale of equity interests in four facilities offset by $1.0 million of other income related to a terminated administrative service contract and by a $0.8 million impairment of one of our management contracts.
Depreciation and amortization decreased $1.1 million, or 3.5%, to $31.2 million for the year ended December 31, 2009 from $32.3 million for the year ended December 31, 2008, primarily as a result of the deconsolidation of four facilities whose deprecation expense is no longer included in our consolidated statements of income. Depreciation and amortization, as a percentage of revenues, was 5.3% for the year ended December 31, 2009 and 5.2% for the year ended December 31, 2008.
Operating income increased $0.2 million to $198.3 million for the year ended December 31, 2009 from $198.1 million for the year ended December 31, 2008. Operating income, as a percentage of revenues, increased to 33.4% for the year ended December 31, 2009 from 32.2% for the prior year, primarily as a result of the growth in our equity in earnings of unconsolidated affiliates and cost saving measures, which was mostly offset by losses on deconsolidations, disposal and impairments of $29.2 million noted above.
Interest expense, net of interest income, decreased $14.0 million to $67.6 million for the year ended December 31, 2009 from $81.6 million for the year ended December 31, 2008, primarily due to lower interest rates and additionally due to lower overall debt balances as compared to the prior period.
Income from continuing operations before income taxes increased $14.6 million, or 12.5%, to $131.1 million for the year ended December 31, 2009 from $116.5 million for the year ended December 31, 2008, increased primarily as a result of the growth in our equity in earnings of unconsolidated affiliates and cost saving measures, which was mostly offset by losses on deconsolidations, disposal and impairments of $29.2 million noted above, and benefited from lower net interest expense of $14.0 million.
Provision for income taxes was a $0.9 million benefit for the year ended December 31, 2009, compared to $22.7 million of tax expense for the year ended December 31, 2008. The benefit in 2009 was primarily the result of our reversing the valuation allowance ($31.2 million) against a majority of our U.S. deferred tax assets. During the third quarter of 2009, we determined it was more likely than not that we would generate taxable income to recover these assets in future periods. Our effective tax rate in 2008 was 36.9%. Our effective tax rate, excluding the benefit of reversing the deferred tax asset allowance, was 47.6% at December 31, 2009.
Total (loss) gain from discontinued operations was earnings of $1.5 million for the year ended December 31, 2009 as compared to a loss of $1.2 million for the year ended December 31, 2008. The $1.5 million represents the net earnings of four facilities we are accounting for as discontinued operations at December 31, 2010. In 2008, we classified the operations of surgery center as discontinued operations. We recorded a loss of approximately $0.6 million, net of tax, related to the sale of this facility and a net loss of $0.6 million on its operations.
Net income was $133.4 million for the year ended December 31, 2009 as compared to $92.7 million for the year ended December 31, 2008. Represents the net effect of many factors described above, including an increase in equity in earnings of unconsolidated affiliates ($14.7 million), a decrease in interest expense ($14.0 million), and the recognition of the benefit of U.S. deferred tax assets ($31.2 million), which together more than offset $29.2 million in losses on disposals, deconsolidations, and impairments. In addition, despite our U.K. operations growing their profits in local currency, the strengthening U.S. dollar decreased our reported net income by $2.2 million.
Net income attributable to noncontrolling interests increased $8.6 million, or 15.6%, to $63.7 million for the year ended December 31, 2009 from $55.1 million for the year ended December 31, 2008. The increase was due to increased profitability of certain of our existing consolidated facilities and our acquisition activities, which primarily involve our acquiring less than 100% ownership.
Liquidity and Capital Resources
At December 31, 2010, we had cash and cash equivalents totaling $60.3 million, as compared to $34.9 million at December 31, 2009. A more detailed discussion of changes in our liquidity follows.
Our cash flows from operating activities were $169.1 million, $180.6 million, and $142.1 million in the years ended December 31, 2010, 2009, and 2008, respectively. Operating cash flows in 2010 were lower than 2009 by $11.5 million, or 6.4%, primarily due to the Company utilizing U.S. net operating loss carryforwards to settle the bulk of its U.S. federal tax liability in 2009. Operating cash flows in 2009 were higher than 2008 primarily due to lower interest costs during 2009, facility-wide cost reductions and the timing of distributions of earnings to our unconsolidated affiliates. Operating cash flows in 2008 were also impacted by these factors, but the impact on 2008 was unfavorable.
A significant element of our cash flows from operating activities is the collection of patient receivables and the timing of payments to our vendors and service providers. Collections efforts for patient receivables are conducted primarily by our personnel at each facility or in centralized service centers for some metropolitan areas with multiple facilities. These collection efforts are facilitated by our patient accounting system, which prompts individual account follow-up through a series of phone calls and/or collection letters written 30 days after a procedure is billed and at 30 day intervals thereafter. Bad debt reserves are established in increasing percentages by aging category based on historical collection experience. Generally, the entire amount of all accounts remaining uncollected 180 days after the date of service are written off as bad debt and sent to an outside collection agency. Net amounts received from collection agencies are recorded as recoveries of bad debts. Our operating cash flows, including changes in accounts payable and other current liabilities, are impacted by the timing of payments to our vendors. We typically pay our vendors and service providers in accordance with invoice terms and conditions, and take advantage of invoice discounts when available. In 2010, 2009 and 2008, we did not make any significant changes to our payment timing to our vendors.
Our net working capital deficit was $100.2 million at December 31, 2010 as compared to a net working capital deficit of $113.0 million in the prior year. The overall negative working capital position at December 31, 2010 and 2009 is primarily the result of $116.1 million and $129.3 million due to affiliates associated with our cash management system being employed for our unconsolidated facilities. As discussed further below, we have sufficient availability under our revolving credit agreement, together with our expected future operating cash flows, to service our obligations.
During the years ended December 31, 2010, 2009 and 2008, respectively, our net cash used for investing activities was $72.0 million, $85.8 million and $100.9 million, respectively. The majority of the cash used in our investing activities relates to our purchases of businesses, incremental investment in unconsolidated affiliates and purchases of property and equipment and was funded by cash flows from operating activities. The cash used in investing activities was funded primarily from cash on hand as well as draws upon the revolving feature of our senior secured credit facility.
Acquisitions and Sales
During the year ended December 31, 2010, we invested $33.3 million, net of cash received, for the purchase and sales of businesses and investments in unconsolidated affiliates. These 2010 transactions are described earlier in this Item 7 under the captions Acquisitions, Equity Investments and Development Projects and Discontinued Operations and Other Dispositions. These transactions are summarized below:
During the years 2009 and 2008, we invested $59.5 million and $64.3 million, respectively (all net of cash acquired) to make similar acquisitions. These transactions are summarized in this Item 7 under the caption Acquisitions, Equity Investments and Development Projects.
As part of our business strategy, we have made, and expect to continue to make, selective acquisitions in existing markets to leverage our existing knowledge of these markets and to improve operating efficiencies. Additionally, we may also make acquisitions in new markets. In making such acquisitions, we may use available cash on hand or draw upon our revolving credit facility as discussed below.
Property and Equipment/Facilities under Development
During the year ended December 31, 2010, approximately $21.3 million of the property and equipment purchases related to expansion and development projects, and the remaining $18.7 million primarily represents purchase of equipment at existing facilities. We added $29.7 million of property and equipment in the year 2009, of which $14.7 million related to expansion and development projects and the remaining $15.0 million related to purchases at existing facilities. Additionally, in 2008, we added $17.4 million of property and equipment for expansion and development projects and purchased $13.3 million of property and equipment for existing facilities. Approximately $8.1 million of the property and equipment purchases was paid to acquire property adjacent to one of our London facilities.
At December 31, 2010, we and our affiliates had five surgical facilities under construction and one additional facility in the development stage in the United States; one of these facilities opened in January 2011. Costs to develop a short-stay surgical facility, which include construction, equipment and initial operating losses, vary depending on the range of specialties that will be undertaken at the facility. Our affiliates have budgeted a total of $80.0 million for development costs for the projects under construction. Development costs are typically funded with approximately 50% debt at the entity level with the remainder provided as equity from the owners of the entity. Additionally, as each of these facilities becomes operational, each will have obligations associated with debt and capital lease arrangements.
Generally, we estimate that we will add 12 to 15 facilities per year through a combination of acquisition and de novo projects. This program will continue to require substantial capital resources, which for this number of facilities we would estimate to range from $60.0 million to $100.0 million per year over the next three years. If we identify strategic acquisition opportunities that are larger than usual for us, then these costs could increase greatly.
Other than the specific transactions described above, our acquisition and development activities primarily include the development of new facilities, buyups of additional ownership in facilities we already operate, and acquisitions of additional facilities. In addition, the operations of our existing surgical facilities will require ongoing capital expenditures. The amount and timing of these purchases and related cash outflows in future periods is difficult to predict and is dependent on a number of factors including hiring of employees, the rate of change in technology/equipment used in our business and our business outlook.
Cash flows used in financing activities were $74.0 million, $111.2 million and $70.2 million in the years ended December 31, 2010, 2009 and 2008, respectively. Historically, our cash flows from financing activities have been received through proceeds from long-term debt, offset by payments on long-term debt, as well as proceeds received from the issuance of our common stock. We also manage the cash of our unconsolidated affiliates. C