UNITED SURGICAL PARTNERS INTERNATIONAL INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 000-32837

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

Delaware (State or other jurisdiction of incorporation or organization)		75-2749762 (IRS Employer Identification Number)
15305 Dallas Parkway, Suite 1600 Addison, Texas (Address of principal executive offices)		75001 (Zip Code)

(972) 713-3500
(Registrant's telephone number, including area code)

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

At August 8, 2002 there were 24,446,435 shares of Common Stock outstanding.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX

PART I. Financial Information
	Item 1.	Financial Statements	3
		Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001	3
		Consolidated Statements of Income (unaudited) for the three months and six months ended June 30, 2002 and 2001	5
		Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three months and six months ended June 30, 2002 and 2001	6
		Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2002 and 2001	7
		Notes to Consolidated Financial Statements (unaudited)	8
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	20
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
PART II. Other Information
	Item 1.	Legal Proceedings	28
	Item 4.	Submission of Matters to a Vote of Security Holders	28
	Item 6.	Exhibits and Reports on Form 8-K	28
Signature			30

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

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)

		June 30, 2002		December 31, 2001
		(unaudited)
Assets
Cash and cash equivalents		$	25,083	$	33,881
Patient receivables, net of allowance for doubtful accounts of $4,672 and $4,726 respectively			37,368		27,546
Other receivables			31,439		30,579
Inventories of supplies			6,782		5,685
Deferred tax asset			6,450		6,571
Prepaids and other current assets			6,073		6,191

	Total current assets	$	113,195	$	110,453
Property and equipment, net			244,928		211,601
Investments in affiliates			16,515		12,328
Intangible assets, net			250,136		215,809
Other assets			7,894		6,666

	Total assets	$	632,668	$	556,857

Liabilities and Stockholders' Equity
Accounts payable		$	23,429	$	20,633
Accrued salaries and benefits			15,071		13,760
Due to affiliates			7,034		5,513
Accrued interest			1,433		1,822
Current portion of long-term debt			10,538		10,640
Other accrued expenses			20,249		17,007
Deferred tax liability			831		793

	Total current liabilities	$	78,585	$	70,168
Long-term debt, less current portion			263,678		228,041
Other long-term liabilities			3,450		3,130
Deferred tax liability, net			16,137		12,916

	Total liabilities	$	361,850	$	314,255
Minority interests			18,184		16,075

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets (Continued)
(in thousands, except per share amounts)

			June 30, 2002			December 31, 2001
			(unaudited)
Stockholders' equity:
	Common stock:
		Other, $0.01 par value; 200,000 shares authorized; 24,824 and 24,436 shares issued at June 30, 2002 and December 31, 2001, respectively		248			244
	Additional paid-in capital			269,722			265,809
	Treasury stock, at cost, 326 and 334 shares at
	June 30, 2002 and December 31, 2001, respectively			(6,050	)		(5,909	)
	Deferred compensation			(1,267	)		(369	)
	Receivables from sales of common stock			(267	)		(1,174	)
	Accumulated other comprehensive loss, net of tax			(4,068	)		(15,592	)
	Accumulated deficit			(5,684	)		(16,482	)

		Total stockholders' equity		252,634			226,527

		Total liabilities and stockholders' equity	$	632,668		$	556,857

See accompanying notes to consolidated financial statements.

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

			Three months ended June 30,						Six months ended June 30,
			2002			2001			2002			2001
Net patient service revenue			$	74,393		$	50,615		$	139,421		$	98,287
Management and administrative services revenue				8,363			7,033			15,686			11,528
Equity in earnings of unconsolidated affiliates				2,397			1,756			4,493			2,865
Other income				688			492			1,319			1,054

		Total revenues		85,841			59,896			160,919			113,734
Salaries, benefits, and other employee costs				20,852			15,699			39,968			29,900
Medical services and supplies				16,759			11,683			31,155			23,361
Other operating expenses				15,319			11,462			29,019			20,794
General and administrative expenses				6,383			4,970			12,279			10,181
Provision for doubtful accounts				1,570			615			2,698			1,177
Depreciation and amortization				6,321			6,174			11,978			11,764

		Total operating expenses		67,204			50,603			127,097			97,177

		Operating income		18,637			9,293			33,822			16,557
Interest income				81			220			389			469
Interest expense				(6,283	)		(5,735	)		(12,211	)		(10,514	)
Other				(26	)		6			(73	)		(10	)

		Total other expense, net		(6,228	)		(5,509	)		(11,895	)		(10,055	)
		Income before minority interest		12,409			3,784			21,927			6,502
Minority interest in income of consolidated subsidiaries				(3,418	)		(1,765	)		(6,106	)		(3,201	)

		Income before income taxes		8,991			2,019			15,821			3,301
Income tax expense				(2,877	)		(266	)		(5,003	)		(1,027	)

		Net income		6,114			1,753			10,818			2,274
Preferred stock dividends				—			(835	)		—			(1,748	)

		Net income attributable to common stockholders	$	6,114		$	918		$	10,818		$	526

Net income per share attributable to common stockholders
	Basic		$	0.25		$	0.06		$	0.45		$	0.04
	Diluted		$	0.24		$	0.06		$	0.43		$	0.04
Weighted average number of common shares
	Basic			24,270			14,805			24,189			12,480
	Diluted			25,655			15,693			25,430			13,303

See accompanying notes to consolidated financial statements.

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

		Three months ended June 30,						Six months ended June 30,
		2002			2001			2002			2001
Net income		$	6,114		$	1,753		$	10,818		$	2,274
Other comprehensive income (loss), before taxes:
	Foreign currency translation adjustments		20,732			(3,160	)		17,729			(10,406	)
	Income tax (expense) benefit related to other comprehensive income (loss)		(7,256	)		1,106			(6,205	)		3,642

	Other comprehensive income (loss)		13,476			(2,054	)		11,524			(6,764	)

	Comprehensive income (loss)	$	19,590		$	(301	)	$	22,342		$	(4,490	)

See accompanying notes to consolidated financial statements.

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

					Six months ended June 30,
					2002			2001
Cash flows from operating activities:
	Net income				$	10,818		2,274
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for doubtful accounts				2,698		1,177
		Depreciation and amortization				11,978		11,764
		Amortization of debt issue costs and discount				748		156
		Equity in earnings of unconsolidated affiliates				(4,493	)	(2,865	)
		Minority interest in income of consolidated subsidiaries				6,106		3,201
		Amortization of deferred compensation				145		63
		Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses:
			Patient receivables			(7,534	)	(4,839	)
			Other receivables			1,509		1,158
			Inventories of supplies, prepaids and other current assets			111		(228	)
			Accounts payable and accrued expenses			(426	)	(2,242	)
			Other long-term liabilities			2,386		619

				Net cash provided by operating activities		24,046		10,238

Cash flows from investing activities:
	Purchases of new businesses and equity interests, net of cash received					(34,653	)	(6,629	)
	Purchases of property and equipment					(11,140	)	(11,438	)
	Sales of property					789		—
	Decrease (increase) in deposits and notes receivable					140		(874	)
	Cash released from escrow					—		1,664

				Net cash used in investing activities		(44,864	)	(17,277	)

Cash flows from financing activities:
	Proceeds from long-term debt					35,289		19,960
	Payments on long-term debt					(24,938	)	(99,828	)
	Proceeds from issuances of common stock					2,860		130,682
	Payments to repurchase common stock					—		(104	)
	Payments for the redemption and dividends of preferred stock					—		(33,878	)
	Distributions on investments in affiliates					(1,281	)	(676	)

				Net cash provided by financing activities		11,930		16,156

Effect of exchange rate changes on cash						90		(108	)

Net increase (decrease) in cash and cash equivalents						(8,798	)	9,009
Cash and cash equivalents at beginning of period						33,881		3,451

Cash and cash equivalents at end of period					$	25,083		12,460

Supplemental information:
	Interest paid				$	12,016		13,927
	Income taxes paid					1,246		—
	Non-cash transactions:
		Sale of common stock for notes receivable from employees, net			$	—		315
		Common stock issued for purchases of new businesses				—		48,301
		Conversion of Series C convertible preferred stock to common stock				—		20,341
		Accrued dividends on preferred stock				—		1,008
		Assets acquired under capital lease obligations				530		153
		Conversion of subordinated notes to Series D preferred stock				—		20,000
		Conversion of subordinated debt to common stock				—		3,287
		Issuance of common stock for service contracts				761		—

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)

(1) Basis of Presentation

United Surgical Partners International, Inc. and subsidiaries (USPI or the Company), a Delaware company, was formed in February 1998 for the primary purpose of ownership and operation of surgery centers, private surgical hospitals and related businesses in the United States and Europe. At June 30, 2002, USPI, headquartered in Dallas, Texas, operated 47 surgical facilities in the United States. Of these 47 facilities, USPI consolidates the results of 22, owns a minority or otherwise noncontrolling equity interest in 23, which are accounted for under the equity method, and holds no ownership interest in the remaining two centers, which are operated by USPI under management contracts. In addition, United Surgical Partners Europe, S.L. (USPE), a company incorporated in Spain and wholly-owned by USPI, managed and owned a majority interest in seven private surgical hospitals, two surgery centers, and one diagnostic facility in Spain at June 30, 2002. Global Healthcare Partners Limited (Global), a company incorporated in England and majority-owned by USPI, managed two wholly-owned private surgical hospitals in the United Kingdom at June 30, 2002.

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

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

(2) Acquisitions

Effective February 1, 2002, the Company acquired 100% of a surgical hospital in Murcia, Spain, for total consideration of approximately $8.2 million in cash (of which $7.5 million was paid at the time of acquisition and $0.7 million will be paid on the first anniversary following consummation of the acquisition) and approximately $12.6 million in assumed capital lease obligations.

The Company acquired, through a merger on March 27, 2002, Surgicoe Corporation, which owns, manages, and develops surgical facilities in Georgia, Oklahoma, and Texas. The Company paid the shareholders of Surgicoe approximately $5.3 million in cash. The terms of the agreement provide for the Company to make additional payments in the future should certain facilities, including some that are operational and some that are currently under development, meet specified performance targets.

Effective May 1, 2002, the Company acquired a 67% interest in an ambulatory surgery center in Corpus Christi for $10.8 million in cash. Effective June 1, 2002, the Company acquired a 57% interest in an ambulatory surgery center in Middleburg Heights, Ohio, a suburb of Cleveland, for $2.1 million in cash.

Following are the unaudited pro forma results for the six months ended June 30, 2002 and 2001 as if the acquisitions discussed above had occurred on January 1, 2001 (in thousands, except per share amounts):

	Six months ended June 30,
	2002		2001
Net revenues	$	166,782	$	124,272
Net income		10,513		2,073
Net income attributable to common stockholders		10,513		325
Basic earnings per share		0.43		0.03
Diluted earnings per share		0.41		0.02

The Company also engages in investing transactions that are not business combinations. These transactions 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 six months ended June 30, 2002, these individually immaterial other investing transactions resulted in cash outflows from USPI in an aggregate net amount of $9.0 million.

(3) Earnings Per Share

Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of convertible preferred stock, convertible debt, and outstanding options, warrants and restricted stock, except where such effect would be antidilutive. Net income attributable to common stockholders and net income per common share include preferred stock dividends for purposes of this computation for the three months and six months ended June 30, 2001. No preferred stock dividends are included in this computation for the three months and six months ended June 30, 2002 as all preferred shares were redeemed prior to January 1, 2002. The

following table sets forth the computation of basic and diluted earnings per share for the three months and six months ended June 30, 2002 and 2001 (in thousands, except per share amounts):

		Three months ended June 30,						Six months ended June 30,
		2002			2001			2002			2001
Net income attributable to common shareholders		$	6,114		$	918		$	10,818		$	526
Weighted average common shares outstanding			24,270			14,805			24,189			12,480
Effect of dilutive securities:
	Stock options		1,081			615			945			551
	Warrants and restricted stock		304			273			296			272
	Convertible subordinated debt		(B	)		(A	)		(B	)		(A	)
	Series C convertible preferred stock		(B	)		(A	)		(B	)		(A	)

Shares used for diluted earnings per share			25,655			15,693			25,430			13,303

Basic earnings per share		$	0.25		$	0.06		$	0.45		$	0.04
Diluted earnings per share		$	0.24		$	0.06		$	0.43		$	0.04

(A): No incremental shares are included because the effect would be antidilutive.
(B): No securities of this type were outstanding during this period.

The convertible subordinated debt and Series C convertible preferred stock, which were excluded from the computation of 2001 earnings per share because their effect would be antidilutive, were converted to common stock during 2001 and therefore will not affect earnings per share in the future.

(4) Segment Disclosure

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

reportable segments consist of (1) U.S. based facilities and (2) Western Europe based facilities, including those in Spain and the United Kingdom.

				Western Europe
Three months ended June 30, 2002 (unaudited)	U.S.			Spain			United Kingdom			Western Europe Total			Total
Net patient service revenue	$	39,369		$	23,353		$	11,671		$	35,024		$	74,393
Other revenue		10,762			686			—			686			11,448

Total revenues	$	50,131		$	24,039		$	11,671		$	35,710		$	85,841

Depreciation and amortization	$	3,878		$	1,632		$	811		$	2,443		$	6,321
Operating income		13,179			3,085			2,373			5,458			18,637
Net interest expense		(5,184	)		(437	)		(581	)		(1,081	)		(6,202	)
Total assets		382,000			157,715			92,953			250,668			632,668
Capital expenditures		2,072			1,341			3,526			4,867			6,939
Three months ended June 30, 2001 (unaudited)
Net patient service revenue	$	23,702		$	17,935		$	8,978		$	26,913		$	50,615
Other revenue		8,871			410			—			410			9,281

Total revenues	$	32,573		$	18,345		$	8,978		$	27,323		$	59,896

Depreciation and amortization	$	3,430		$	1,888		$	856		$	2,744		$	6,174
Operating income		6,820			1,222			1,251			2,473			9,293
Net interest income (expense)		(3,879	)		(819	)		(817	)		(1,636	)		(5,515	)
Total assets		260,027			112,650			94,934			207,584			467,611
Capital expenditures		2,361			617			2,679			3,296			5,657
Six months ended June 30, 2002 (unaudited)
Net patient service revenue	$	73,007		$	43,117		$	23,297		$	66,414		$	139,421
Other revenue		20,270			1,228			—			1,228			21,497

Total revenues	$	93,277		$	44,345		$	23,297		$	67,642		$	160,918

Depreciation and amortization	$	7,106		$	3,309		$	1,562		$	4,871		$	11,977
Operating income		23,813			5,054			4,955			10,009			33,822
Net interest expense		(9,988	)		(676	)		(1,158	)		(1,834	)		(11,822	)
Total assets		382,000			157,715			92,953			250,668			632,668
Capital expenditures		4,289			2,195			5,186			7,381			11,670
Six months ended June 30, 2001 (unaudited)
Net patient service revenue	$	42,380		$	36,680		$	19,227		$	55,907		$	98,287
Other revenue		14,556			891			—			891			15,447

Total revenues	$	56,936		$	37,571		$	19,227		$	56,798		$	113,734

Depreciation and amortization	$	6,260		$	3,819		$	1,685		$	5,504		$	11,764
Operating income		10,460			2,616			3,481			6,097			16,557
Net interest expense		(6,815	)		(1,510	)		(1,720	)		(3,230	)		(10,045	)
Total assets		260,027			112,650			94,934			207,584			467,611
Capital expenditures		5,458			1,598			4,535			6,133			11,591

(5) Goodwill and Intangible Assets

On July 20, 2001 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 142, Accounting for Goodwill and Other Intangible Assets (SFAS 142). SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized but instead tested for impairment at least annually at the reporting unit level (defined as an operating segment or one level below an operating segment). SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective useful lives to their estimated residual values. The Company fully adopted the provisions of SFAS No. 142 effective January 1, 2002.

Under SFAS No.142, the Company is required to perform transitional impairment tests by identified reporting unit for its goodwill and certain other intangible assets as of the date of adoption. The Company has determined that its reporting units are at the operating segment (country) level. The Company completed the required transitional impairment tests during the six months ended June 30, 2002. No impairment losses were identified in any reporting unit as a result of these tests.

The table below shows the Company's net income and earnings per share for the three month and six month periods ended June 30, 2002 and 2001 on a pro forma basis as if the cessation of amortization of goodwill and indefinite-lived intangible assets had occurred January 1, 2001 (in thousands, except per share amounts):

	Three months ended June 30,				Six months ended June 30,
	2002		2001		2002		2001
Net income attributable to common shareholders, as reported	$	6,114	$	918	$	10,818	$	526
Amortization of goodwill and indefinite-lived intangible assets, net of applicable income tax benefits		—		1,628		—		3,099

Net income attributable to common shareholders, as reported	$	6,114	$	2,546	$	10,818	$	3,625

Diluted earnings per share, as reported	$	0.24	$	0.06	$	0.43	$	0.04
Amortization of goodwill and indefinite-lived intangible assets, net of applicable income tax benefits		—		0.10		—		0.23

Pro forma diluted earnings per share	$	0.24	$	0.16	$	0.43	$	0.27

Intangible assets, net of accumulated amortization, consisted of the following:

		June 30, 2002		December 31, 2001
Goodwill		$	179,866	$	151,804
Other intangible assets			70,270		64,005

	Total	$	250,136	$	215,809

The following is a summary of changes in the carrying amount of goodwill by operating segment and reporting unit for the six months ended June 30, 2002 (in thousands):

			Western Europe
	U.S.		Spain		United Kingdom		Western Europe Total		Total
Balance at December 31, 2001	$	106,579	$	26,914	$	18,311	$	45,225	$	151,804
Additions		16,530		7,797		—		7,797		24,327
Other		—		2,851		884		3,735		3,735

Balance at June 30, 2002	$	123,109	$	37,562	$	19,195	$	56,757	$	179,866

Goodwill additions during the six months ended June 30, 2002 resulted primarily from business combinations completed during 2002. Other changes to the carrying amount of goodwill were primarily due to foreign currency translation adjustments.

Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values. The majority of the Company's management contracts have evergreen renewal provisions and consequently have indefinite useful lives. Effective January 1, 2002, intangible assets with indefinite useful lives are not amortized but instead tested for impairment at least

annually. The following is a summary of intangible assets at December 31, 2001 and June 30, 2002 (in thousands):

		December 31, 2001
		Gross Carrying Amount		Accumulated Amortization			Total
Definite Useful Lives
Management Contracts		$	23,174	$	(3,746	)	$	19,427
Other			7,831		(717	)		7,114

	Total	$	31,005	$	(4,464	)	$	26,541

Indefinite Useful Lives
Management Contracts							$	37,362
Other								102

	Total						$	37,464

	Total intangible assets						$	64,005

		June 30, 2002
		Gross Carrying Amount		Accumulated Amortization			Total
Definite Useful Lives
Management Contracts		$	25,402	$	(4,847	)	$	20,555
Other			9,939		(1,552	)		8,387

	Total	$	35,341	$	(6,399	)	$	28,942

Indefinite Useful Lives
Management Contracts							$	41,190
Other								138

	Total						$	41,328

	Total intangible assets						$	70,270

Amortization expense related to intangible assets with definite useful lives was $0.6 million and $0.5 million for the three months ended June 30, 2002 and 2001, respectively, and $1.1 million and $0.7 million for the six months ended June 30, 2002 and June 30, 2001, respectively. The following

table provides estimated amortization expense related to intangible assets with definite useful lives for each of the years in the five year period ending December 31, 2006:

Remainder of 2002	$	1,355
2003		2,155
2004		1,650
2005		1,499
2006 and thereafter		13,994

	$	20,653

(6) Condensed Consolidating Financial Statements

The following information is presented as required by regulations of the Securities and Exchange Commission in connection with the Company's publicly traded Senior Subordinated Notes. This information is not routinely prepared for use by management. The operating and investing activities of the separate legal entities included in the consolidated financial statements are fully interdependent and integrated. Accordingly, the operating results of the separate legal entities are not representative of what the operating results would be on a stand-alone basis. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other services.

The $150 million 10% Senior Subordinated Notes due 2011 were issued in a private offering on December 19, 2001 and subsequently registered as publicly traded securities through a Form S-4 effective January 15, 2002 by USPI's wholly-owned finance subsidiary, United Surgical Partners Holdings, Inc. (USPH), which was created in 2001. The notes are guaranteed by USPI, which does not have independent assets or operations, and USPI's wholly-owned subsidiaries domiciled in the United States. USPI's investees in Spain and the United Kingdom are not guarantors of the obligation. USPI's investees in the United States in which USPI owns less than 100% are not guarantors of the obligation. The financial positions and results of operations (below, in thousands) of the respective guarantors are based upon the guarantor relationship at the end of the period presented.

Condensed Consolidating Balance Sheets:

As of June 30, 2002		USPI and Wholly-owned U.S. Subsidiaries		Non-participating Investees			Consolidation Adjustments			Consolidated Total
Assets:
Current assets:
Cash and cash equivalents		$	10,435	$	14,648		$	—		$	25,083
Accounts receivable, net			13		37,765			(410	)		37,368
Other receivables			48,651		(10,417	)		(6,795	)		31,439
Inventories of supplies			225		6,557			—			6,782
Other			9,639		2,884			—			12,523

	Total current assets		68,963		51,437			(7,205	)		113,195
Property and equipment, net			40,148		205,383			(603	)		244,928
Investments in affiliates			171,893		123			(155,501	)		16,515
Intangible assets, net			142,578		108,828			(1,270	)		250,136
Other			91,709		42,682			(126,497	)		7,894

	Total assets	$	515,291	$	408,453		$	(291,076	)	$	632,668

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable		$	1,120	$	22,296		$	13		$	23,429
Accrued expenses			26,170		17,816			632			44,618
Current portion of long-term debt			1,712		9,752			(926	)		10,538

	Total current liabilities		29,002		49,864			(281	)		78,585
Long-term debt			172,976		219,745			(129,043	)		263,678
Other liabilities			4,883		14,704			—			19,587
Minority interests			—		6,683			11,501			18,184
Redeemable preferred stock			—		—			—			—
Stockholders' equity			308,430		117,457			(173,253	)		252,634

	Total liabilities and stockholders' equity	$	515,291	$	408,453		$	(291,076	)	$	632,668

As of December 31, 2001		USPI and Wholly-owned U.S. Subsidiaries		Non-participating Investees			Consolidation Adjustments			Consolidated Total
Assets:
Current assets:
Cash and cash equivalents		$	20,396	$	13,485		$	—		$	33,881
Accounts receivable, net			418		27,538			(410	)		27,546
Other receivables			47,087		(11,174	)		(5,334	)		30,579
Inventories of supplies			223		5,462			—			5,685
Other			9,298		3,464			—			12,762

	Total current assets		77,422		38,775			(5,744	)		110,453
Property and equipment, net			41,767		170,449			(615	)		211,601
Investments in affiliates			165,437		170			(153,279	)		12,328
Intangible assets, net			119,596		97,350			(1,137	)		215,809
Other			88,148		33,777			(115,259	)		6,666

	Total assets	$	492,370	$	340,521		$	(276,034	)	$	556,857

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable		$	2,121	$	18,512		$	—		$	20,633
Accrued expenses			24,758		13,733			404			38,895
Current portion of long-term debt			2,433		8,841			(634	)		10,640

	Total current liabilities		29,312		41,086			(230	)		70,168
Long-term debt			158,170		186,093			(116,222	)		228,041
Other liabilities			1,936		14,110			—			16,046
Minority interests			—		5,958			10,117			16,075
Redeemable preferred stock			—		—			—			—
Stockholders' equity			302,952		93,274			(169,699	)		226,527

	Total liabilities and stockholders' equity	$	492,370	$	340,521		$	(276,034	)	$	556,857

Condensed Consolidating Statements of Income

Six months ended June 30, 2002	USPI and Wholly-owned U.S. Subsidiaries			Non-participating Investees			Consolidation Adjustments			Consolidated Total
Revenues	$	32,708		$	131,921		$	(3,710	)	$	160,919
Operating expenses, excluding depreciation and amortization		23,269			95,501			(3,651	)		115,119
Depreciation and amortization		4,686			7,304			(12	)		11,978

Operating income (loss)		4,753			29,116			(47	)		33,822
Interest expense, net		(6,775	)		(5,047	)		—			(11,822	)
Other expense		136			(73	)		(136	)		(73	)

Income (loss) before minority interests		(1,886	)		23,996			(183	)		21,927
Minority interests in income of consolidated subsidiaries		—			(2,975	)		(3,131	)		(6,106	)
Income (loss) before income taxes		(1,886	)		21,021			(3,314	)		15,821
Income tax expense		(3,619	)		(1,384	)		—			(5,003	)

Net income (loss)	$	(5,505	)	$	19,637		$	(3,314	)	$	10,818

Six months ended June 30, 2001	USPI and Wholly-owned U.S. Subsidiaries			Non-participating Investees			Consolidation Adjustments			Consolidated Total
Revenues	$	25,413		$	91,529		$	(3,208	)	$	113,734
Operating expenses, excluding depreciation and amortization		19,159			68,845			(2,591	)		85,413
Depreciation and amortization		4,234			7,572			(42	)		11,764

Operating income (loss)		2,020			15,112			(575	)		16,557
Interest expense, net		(5,011	)		(4,998	)		(36	)		(10,045	)
Other expense		129			(19	)		(120	)		(10	)

Income (loss) before minority interests		(2,862	)		10,095			(731	)		6,502
Minority interests in income of consolidated subsidiaries		—			(1,603	)		(1,598	)		(3,201	)
Income (loss) before income taxes		(2,862	)		8,492			(2,329	)		3,301
Income tax expense		(160	)		(867	)		—			(1,027	)

Net income (loss)	$	(3,022	)	$	7,625		$	(2,329	)	$	2,274

Condensed Consolidating Statements of Cash Flows:

Six months ended June 30, 2002		USPI and Wholly-owned U.S. Subsidiaries			Non-participating Investees			Consolidation Adjustments			Consolidated Total
Cash flows from operating activities:
Net income (loss)		$	(5,505	)	$	19,637		$	(3,314	)	$	10,818
Changes in operating and intercompany assets and liabilities and noncash items included in net income (loss)			11,241			(1,277	)		3,264			13,228

	Net cash provided by (used in) operating activities		5,736			18,360			(50	)		24,046
Cash flows from investing activities:
Purchases of property and equipment, net			(1,966	)		(9,174	)		—			(11,140	)
Purchases of new businesses			(27,157	)		(7,580	)		84			(34,653	)
Other items			(518	)		1,447			—			929

	Net cash provided by (used in) investing activities		(29,641	)		(15,307	)		84			(44,864	)
Cash flows from financing activities:
Long-term borrowings, net			12,365			(2,014	)		—			10,351
Proceeds from issuance of common stock			2,860			84			(84	)		2,860
Other items			(1,281	)		—			—			(1,281	)

	Net cash provided by (used in) financing activities		13,944			(1,930	)		(84	)		11,930
Effect of exchange rate changes on cash			—			40			50			90
Net increase (decrease) in cash			(9,961	)		1,163			—			(8,798	)
Cash at the beginning of the period			20,396			13,485			—			33,881

Cash at the end of the period		$	10,435		$	14,648		$	—		$	25,083

Six months ended June 30, 2001		USPI and Wholly-owned U.S. Subsidiaries			Non-participating Investees			Consolidation Adjustments			Consolidated Total
Cash flows from operating activities:
Net income (loss)		$	(3,022	)	$	7,625		$	(2,329	)	$	2,274
Changes in operating and intercompany assets and liabilities and noncash items included in net income (loss)			2,934			2,589			2,441			7,964

	Net cash provided by (used in) operating activities		(88	)		10,214			112			10,238
Cash flows from investing activities:
Purchases of property and equipment, net			(4,869	)		(6,569	)		—			(11,438	)
Purchases of new businesses			(6,756	)		—			127			(6,629	)
Other items			790			—			—			790

	Net cash provided by (used in) investing activities		(10,835	)		(6,569	)		127			(17,277	)
Cash flows from financing activities:
Long-term borrowings, net			(78,034	)		(1,834	)		—			(79,868	)
Proceeds from issuance of common stock			130,682			239			(239	)		130,682
Other items			(34,658	)		—			—			(34,658	)

	Net cash provided by (used in) financing activities		17,990			(1,595	)		(239	)		16,156
Effect of exchange rate changes on cash			—			(108	)		—			(108	)
Net increase in cash			7,067			1,942			—			9,009
Cash at the beginning of the period			765			2,686			—			3,451

Cash at the end of the period		$	7,832		$	4,628		$	—		$	12,460

(7) Subsequent Events

The Company has entered into letters of intent with various entities regarding possible joint venture, development, or acquisition projects. These projects are in various stages of negotiation.

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company's unaudited Consolidated Financial Statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

Forward-Looking Statements

Certain statements contained or incorporated by reference in this Quarterly Report on Form 10-Q, including without limitation statements containing the words "believes," "anticipates," "expects", "continues," "will," "may," "should," "estimates," "intends," "plans," and similar expressions, and statements regarding the Company's 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 management's 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 Company's 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: general economic and business conditions, both nationally and regionally; demographic changes; changes in, or the failure to comply with, laws and governmental regulations; the ability to enter into managed care provider arrangements on acceptable terms; changes in Medicare, Medicaid and other government funded payments or reimbursement; 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 personnel, included physicians, nurses and other health care professionals; our significant indebtedness; the availability of suitable acquisition opportunities and the length of time it takes to accomplish acquisitions; our ability to integrate new 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 Quarterly Report on Form 10-Q and the documents incorporated herein by reference. Given these uncertainties, investors and prospective investors are cautioned not to rely on such forward-looking statements. 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.

Overview

The Company operates surgery centers and private surgical hospitals in the United States and Western Europe. As of June 30, 2002, the Company operated 58 surgical facilities, consisting of 47 in the United States, nine in Spain, and two in the United Kingdom. Of the 47 U.S. facilities, the Company operates 23 through strategic relationships with eleven major not-for-profit healthcare system partners. Overall, the Company holds ownership in 56 of the facilities and operates the remaining two facilities, both in the United States, under management contracts.

Critical Accounting Policies

Management of the company is required to make certain estimates and assumptions during the preparation of our consolidated financial statements in accordance with generally accepted accounting principles. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. They also impact the reported amount of net earnings during any period. Actual results could differ from those estimates. Certain of our accounting policies have a more significant impact on our financial statements than others due to the size of the underlying financial statement elements.

Our determination of whether to consolidate an entity in which we hold an investment, account for it under the equity method, or carry it at cost has a significant impact on our financial statements because of the typical business model under which we operate, particularly in the United States, where the majority of the facilities we operate are partially owned by not-for-profit hospital systems, physicians, and other parties. These quarterly financial statements have been prepared using the same consolidation policy as was used in the Company's latest audited financial statements.

Our revenue recognition policy and method of accounting for income taxes involve significant judgments and estimates. There have been no significant changes in assumptions, estimates, and judgments in the preparation of these quarterly financial statements from the assumptions, estimates, and judgments used in the preparation of the Company's latest audited financial statements.

Beginning January 1, 2002, we also consider our accounting policy regarding intangible assets to be a critical accounting policy given the significance of intangible assets as compared to the total assets of the Company and the recent changes in accounting for intangible assets required under Statement of Financial Accounting Standards No. 142, Accounting for Goodwill and Other Intangible Assets (SFAS 142), which was issued by the Financial Accounting Standards Board on July 20, 2001 and was adopted by the Company as of January 1, 2002. SFAS 142 requires the cessation of amortization of goodwill and identifiable intangible assets which do not have finite lives and requires that all intangible assets be tested for impairment at least annually.

Acquisitions, Equity Investments and Development Projects

In February 2002, we acquired a surgical hospital in Murcia, Spain for total consideration of approximately $8.2 million in cash (of which $7.5 million was paid prior to March 31, 2002 and $0.7 million will be paid on the first anniversary following consummation of the acquisition) and approximately $12.6 million in assumed capital lease obligations.

In March 2002, we acquired Surgicoe Corporation, which owns, manages, and develops surgical facilities in Georgia, Oklahoma, and Texas. The Company paid the shareholders of Surgicoe approximately $5.3 million in cash. The terms of the agreement provide for the Company to make additional payments in the future should certain facilities, including some that are operational and some that are currently under development, meet specified performance targets.

During February and March 2002, two surgery centers developed by the Company in the United States opened and began performing cases.

In May 2002, we acquired a 67% interest in an ambulatory surgery center in Corpus Christi for $10.8 million in cash. In June 2002, we acquired a 57% interest in an ambulatory surgery center in Middleburg Heights, Ohio, a suburb of Cleveland, for $2.1 million in cash.

We also engage in investing transactions that are not business combinations, consisting of purchases and sales of noncontrolling equity interests in surgical facilities and the investment of additional cash in surgical facilities under development. During the second quarter of 2002, these transactions resulted in cash outflows in an aggregate net amount of $9.0 million. The most notable of these transactions were our acquisition of a noncontrolling interest in an ambulatory surgery center in Austintown, Ohio and our acquisition, through a newly formed joint venture with Robert Wood Johnson University Hospital, of a noncontrolling interest in an ambulatory surgery center in East Brunswick, New Jersey.

Sources of Revenue

Revenues primarily include:

•: net patient services revenues for the facilities that we consolidate for financial reporting purposes, which are typically those in which we have ownership interests of greater than 50% or maintain effective control, and
•: management and administrative service fees earned from the non-consolidated facilities that we account for under the equity method of accounting as well as facilities that we operate under management contracts or to which we provide contracted services, but have no ownership; and
•: our share of net income of the non-consolidated facilities that we account for under the equity method of accounting. These amounts are included in revenues as these operations are central to our business strategy.

The following table summarizes our revenues by type as a percentage of total revenue for the periods presented:

	Three months ended June 30,				Six months ended June 30,
	2002		2001		2002		2001
Net patient service revenue	86.7	%	84.5	%	86.7	%	86.4	%
Management and administrative services revenue	9.7		11.8		9.7		10.2
Equity in earnings of unconsolidated affiliates	2.8		2.9		2.8		2.5
Other income	0.8		0.8		0.8		0.9

Total revenue	100.0	%	100.0	%	100.0	%	100.0	%

The percentage of our total revenue that was derived from net patient service revenue increased from 84.5% and 86.4% for the three months and six months ended June 30, 2001, respectively, to 86.7% for the three months and six months ended June 30, 2002, with a corresponding decrease in the percentage of our total revenue that was derived from management and administrative services revenue, primarily as a result of our acquiring majority interests in seven surgery centers and one private hospital since June 30, 2001. Our management and administrative services revenues are derived from entities in which we hold less than a controlling ownership interest.

The following table reflects the summarized results of the non-consolidated facilities that we account for under the equity method of accounting (in thousands, except number of facilities):

	Three months ended June 30,				Six months ended June 30,
	2002		2001		2002		2001
Total revenues	$	35,606	$	19,449	$	64,306	$	38,122
Net income		10,145		4,537		18,269		9,164
USPI's equity in earnings of unconsolidated affiliates		2,397		1,756		4,493		2,865
Unconsolidated facilities operated at period end		23		14		23		14

For the three months ended June 30, 2002 and 2001, approximately 58% and 54% of our revenues were generated from operations in the United States and 42% and 46% from Western Europe, respectively. For the six months ended June 30, 2002 and 2001, approximately 58% and 50% of our revenues were generated from operations in the United States and 42% and 50% from Western Europe, respectively. The increase in the percentage of our revenues generated in the United States and corresponding decrease in Western Europe resulted from our development and acquisition activities being concentrated in the United States during the twelve months ended June 30, 2002. We

continue to evaluate acquisition and development opportunities in all three countries in which we currently operate as well as in other selected nations in Western Europe.

Results of Operations

The following table summarizes certain statements of income items expressed as a percentage of revenues for the periods indicated:

	Three months ended June 30,				Six months ended June 30,
	2002		2001		2002		2001
Total revenues	100.0	%	100.0	%	100.0	%	100.0	%
Operating expenses, excluding depreciation and amortization	70.9		74.2		71.5		75.1

EBITDA(a)	29.1		25.8		28.5		24.9
Minority interests in income of consolidated entities	4.0		2.9		3.8		2.8

EBITDA less minority interest	25.1		22.9		24.7		22.1
Depreciation and amortization	7.4		10.3		7.5		10.3
Interest and other expense, net	7.2		9.2		7.4		8.9

Income before income taxes	10.5		3.4		9.8		2.9
Income tax expense	3.4		0.5		3.1		0.9

Net income	7.1		2.9		6.7		2.0

(a): EBITDA is calculated as operating income plus depreciation and amortization. EBITDA should not be considered in isolation or as a substitute for net income, operating income, cash flows from operating activities or any other measure of operating performance calculated in accordance with generally accepted accounting principles. EBITDA is widely used by financial analysts as a measure of financial performance. Our calculation of EBITDA may not be comparable to similarly titled measures reported by other companies.

Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001

Revenues increased by $25.9 million, or 43%, to $85.8 million for the three months ended June 30, 2002 from $59.9 million for the three months ended June 30, 2001. Of this increase in revenues, $12.4 million was contributed by facilities acquired or opened since June 30, 2001. The exchange rate of the European currencies to the U.S. dollar was higher in the three months ended June 30, 2002 as compared to the same period in the prior year, resulting in a positive impact of $1.4 million on year over year revenues for the facilities in Western Europe that were owned in both 2002 and 2001 ("same store" facilities). Absent this foreign exchange impact, same store facilities in Western Europe contributed $4.6 million more to consolidated revenue in the three months ended June 30, 2002 as compared to the same period in 2001. The remaining increase in revenues was contributed by same store U.S. facilities, which performed approximately 18.4% more cases in the three months ended June 30, 2002 as compared to the three months ended June 30, 2001.

Operating expenses, excluding depreciation and amortization, increased by $16.5 million, or 37%, to $60.9 million for the three months ended June 30, 2002 from $44.4 million for the three months ended June 30, 2001. Operating expenses, excluding depreciation and amortization, as a percentage of revenues, decreased to 70.9% for the three months ended June 30, 2002 from 74.2% for the three months ended June 30, 2001, primarily as a result of operating efficiencies at our facilities and improved economies of scale as we expanded.

EBITDA less minority interest increased $7.8 million, or 57%, to $21.5 million for the three months ended June 30, 2002 from $13.7 million for the three months ended June 30, 2001. Of this increase in EBITDA less minority interest, $4.5 million was contributed by facilities acquired or opened since June 30, 2001. EBITDA less minority interest, as a percentage of revenues, increased to 25.1% for the three months ended June 30, 2002 from 22.9% for the three months ended June 30, 2001, primarily as a result of improved operating margins at our facilities and the leveraging of our corporate overhead expenses over the increased revenue.

Depreciation and amortization increased $0.1 million, or 2%, to $6.3 million for the three months ended June 30, 2002 from $6.2 million for the three months ended June 30, 2001. This amount remained virtually constant because the reduction in expense resulting from the cessation of goodwill amortization required under SFAS 142 largely offset the additional depreciation on tangible assets added through acquisitions. Depreciation and amortization, as a percentage of revenues, decreased to 7.4% for the three months ended June 30, 2002 from 10.3% for the three months ended June 30, 2001.

Interest expense, net of interest income, increased 12% to $6.2 million for the three months ended June 30, 2002 from $5.5 million for the three months ended June 30, 2001 primarily as a result of higher levels of outstanding debt during the three months ended June 30, 2002 than during the prior year period. We used a portion of the proceeds of our initial public offering of common stock to repay senior and subordinated indebtedness in June 2001 and have incurred debt to fund a portion of our acquisition and development program since that time.

Provision for income taxes and our overall effective tax rates were $2.9 million and 32% for the three months ended June 30, 2002, compared to $0.3 million and 13% for the three months ended June 30, 2001, respectively. The increase in our overall effective tax rate primarily resulted from the U.S. operations no longer having net operating loss carryforwards to offset current period income in 2002. Our overall effective tax rate in 2002 remains lower than statutory rates primarily as a result of our Spain operations continuing to utilize net operating loss carryforwards to offset current period income.

Net income was $6.1 million for the three months ended June 30, 2002 compared to $1.8 million for the three months ended June 30, 2001. This $4.3 million improvement primarily results from the increased revenues and improved operating efficiencies and economies of scale related to expenses discussed above.

Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001

Revenues increased by $47.2 million, or 41%, to $160.9 million for the six months ended June 30, 2002 from $113.7 million for the six months ended June 30, 2001. Of this increase in revenues, $20.4 million was contributed by facilities acquired or opened since June 30, 2001. An additional $5.5 million of the increase is attributed to including a full six months of operations of OrthoLink, which merged with USPI on February 12, 2001 and therefore was only included for approximately four and one-half of the six months ended June 30, 2001. The exchange rate of the European currencies to the U.S. dollar was higher in the six months ended June 30, 2002 as compared to the same period in the prior year, resulting in a positive impact of $0.1 million on year over year revenues for the facilities in Western Europe that were owned in both 2002 and 2001 ("same store" facilities). Absent this foreign exchange impact, same store facilities in Western Europe contributed $7.0 million more to consolidated revenue in the six months ended June 30, 2002 as compared to the same period in 2001. The remaining increase in revenues was contributed by same store U.S. facilities, which performed approximately 17.6% more cases in the six months ended June 30, 2002 as compared to the six months ended June 30, 2001.

Operating expenses, excluding depreciation and amortization, increased by $29.7 million, or 35%, to $115.1 million for the six months ended June 30, 2002 from $85.4 million for the six months ended

June 30, 2001. Operating expenses, excluding depreciation and amortization, as a percentage of revenues, decreased to 71.5% for the six months ended June 30, 2002 from 75.1% for the six months ended June 30, 2001, primarily as a result of operating efficiencies at our facilities and improved economies of scale as we expanded.

EBITDA less minority interest increased $14.6 million, or 58%, to $39.7 million for the six months ended June 30, 2002 from $25.1 million for the six months ended June 30, 2001. Of this increase in EBITDA less minority interest, $6.9 million was contributed by facilities acquired or opened since June 30, 2001 and an additional $2.6 million was attributed to OrthoLink being included for a full six months in 2002. EBITDA less minority interest, as a percentage of revenues, increased to 24.7% for the six months ended June 30, 2002 from 22.1% for the six months ended June 30, 2001, primarily as a result of improved operating margins at our facilities and the leveraging of our corporate overhead expenses over the increased revenue.

Depreciation and amortization increased $0.2 million, or 2%, to $12.0 million for the six months ended June 30, 2002 from $11.8 million for the six months ended June 30, 2001. This amount remained virtually constant because the reduction in expense resulting from the cessation of goodwill amortization required under SFAS 142 largely offset the additional depreciation on tangible assets acquired through acquisitions. Depreciation and amortization, as a percentage of revenues, decreased to 7.5% for the six months ended June 30, 2002 from 10.3% for the six months ended June 30, 2001.

Interest expense, net of interest income, increased 18% to $11.8 million for the six months ended June 30, 2002 from $10.0 million for the six months ended June 30, 2001 primarily as a result of higher levels of outstanding debt during the six months ended June 30, 2002 than during the prior year period. We used a portion of the proceeds of our initial public offering of common stock to repay senior and subordinated indebtedness in June 2001 and have incurred debt to fund a portion of our acquisition and development program since that time.

Provision for income taxes and our overall effective tax rates were $5.0 million and 32% for the six months ended June 30, 2002, compared to $1.0 million and 31% for the six months ended June 30, 2001, respectively. Our overall effective tax rate in 2002 remains lower than statutory rates primarily as a result of our Spain operations continuing to utilize net operating loss carryforwards to offset current period income.

Net income was $10.8 million for the six months ended June 30, 2002 compared to $2.3 million for the six months ended June 30, 2001. This $8.5 million improvement primarily results from the increased revenues and improved operating efficiencies and economies of scale related to expenses discussed above.

Liquidity and Capital Resources

During the six months ended June 30, 2002, the Company generated $24.0 million of cash flows from operations as compared to $10.2 million during the six months ended June 30, 2001.

During the six months ended June 30, 2002, the Company's net cash required for investing activities was $44.9 million, consisting primarily of $34.7 million for the purchase of businesses and $11.1 million for the purchase of property and equipment. The $34.7 million primarily represents purchases of new businesses, net of cash acquired, and incremental investments in unconsolidated affiliates. Most of these transactions are individually insignificant; the most significant amounts are the $10.8 million paid for the surgery center in Corpus Christi, Texas, the $7.5 million paid for the surgical hospital in Murcia, Spain, and the $5.3 million paid to acquire Surgicoe. Approximately $3.8 million of the property and equipment purchases related to ongoing development projects. The $44.9 million of cash required for investing activities was funded primarily with cash flows from operations and additionally with borrowings and a reduction of cash on hand. Net cash provided by financing activities

during the six months ended June 30, 2002 totaled $11.9 million. Cash and cash equivalents were $25.1 million at June 30, 2002 as compared to $33.9 million at December 31, 2001, and net working capital excluding cash and cash equivalents was $9.5 million at June 30, 2002 as compared to $6.4 million at December 31, 2001.

In December 2001, we entered into an amended and restated credit facility with a group of commercial lenders providing us with the ability to borrow up to $85.0 million for acquisitions and general corporate purposes in the United States and Spain or for any new subsidiary that becomes a guarantor of the facility. A total of $10 million of borrowings under the facility may be used by subsidiaries that are not guarantors, including subsidiaries in the United Kingdom. Borrowings under our amended and restated credit facility mature on December 19, 2004. As of June 30, 2002, $16.4 million was outstanding under this facility and the remaining $68.6 million was available for borrowing based on actual reported consolidated financial results. Availability under the facility is based upon pro forma EBITDA including EBITDA from acquired entities. Assuming historical purchase multiples of annual EBITDA of potential acquisition targets, the entire $85.0 million would be available for borrowing to finance acquisitions as of June 30, 2002, of which $16.4 million was drawn at June 30, 2002. The indenture governing our Senior Subordinated Notes and our amended and restated credit facility contain various restrictive covenants including covenants that limit our ability and the ability of certain of our subsidiaries to borrow money or guarantee other indebtedness, grant liens on our assets, make investments, use assets as security in other transactions, pay dividends on stock, enter into sale and leaseback transactions or sell assets or capital stock.

Additionally, one of our U.K. subsidiaries has a credit agreement with a commercial lender in the United Kingdom that provides for total borrowings of £42.0 million (approximately $64.0 million as of June 30, 2002) under three separate facilities. At June 30, 2002, total outstanding borrowings under this term facility were approximately $47.1 million and approximately $7.8 million was available for borrowings. Borrowings under this agreement bear interest at rates of 1.50% to 2.00% over LIBOR and mature in April 2010. The Company pledged the capital stock of its U.K. subsidiaries to secure borrowings under this agreement. The Company was in compliance with all debt covenants as of June 30, 2002.

Our operating subsidiaries, many of which have minority owners who share in the cash flow of these entities, also have debt, consisting primarily of capitalized lease obligations. This debt is non-recourse to USPI, the parent company, and is secured by the assets of those operating entities. The total amount of these obligations, which was $61.8 million at June 30, 2002, is included in our consolidated balance sheet because the borrower or obligated entity meets the requirements for consolidated financial reporting. Additionally, our unconsolidated affiliates that we account for under the equity method have non-recourse debt and capitalized lease obligations that are not included in our consolidated financial statements. At June 30, 2002, the total obligations of these unconsolidated affiliates under debt and capital lease obligations was approximately $46.4 million. Our average percentage ownership, weighted based on the individual affiliate's amount of debt and capitalized lease obligations, of these unconsolidated affiliates was 29.2% at June 30, 2002.

Our acquisition and development program will require substantial capital resources, which we estimate to range from $50.0 million to $60.0 million per year over the next three years, including an estimated $2.2 million related to additional consideration to the sellers of acquired facilities based upon those facilities achieving certain financial targets. In addition, the operations of our existing surgical facilities will require ongoing capital expenditures. We believe that existing funds, cash flows from operations and borrowings under our credit facilities will provide sufficient liquidity for the next twelve months. Thereafter, it is likely that we will require additional debt or equity financing for our acquisitions and development projects. There are no assurances that the needed capital will be available on acceptable terms, if at all. If we are unable to obtain funds when needed or on acceptable terms, we will be required to curtail our acquisition and development program.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

We have exposure to interest rate risk related to our financing, investing, and cash management activities. Historically, we have not held or issued derivative financial instruments other than the use of variable-to-fixed interest rate swaps for portions of our borrowings under credit facilities with commercial lenders as required by the credit agreements. We do not use derivative instruments for speculative purposes. Our financing arrangements with commercial lenders are based on the spread over Prime, LIBOR or Euribor. At June 30, 2002, $148.9 million of our total outstanding debt was the Senior Subordinated Notes, which were issued in December 2001 at a 0.8% discount and bear interest at a fixed rate of 10%, $4.6 million was in other fixed rate instruments and the remaining $66.2 million was in variable rate instruments. Accordingly, a hypothetical 100 basis point increase in market interest rates would result in additional annual expense of $0.7 million. The Senior Subordinated Notes, which represent 97% of our total fixed rate debt at June 30, 2002, are considered to have a fair value, based upon recent trading, of $154.9 million, which is approximately $6.0 million higher than the carrying value at June 30, 2002.

Our international revenues are a significant portion of our total revenues. We are exposed to risks associated with operating internationally, including:

•: foreign currency exchange risk; and
•: taxes and regulatory changes.

Our international operations operate in a natural hedge to a large extent because both expenses and revenues are denominated in local currency. Additionally, our borrowings in the United Kingdom are currently denominated in local currency. Historically, the cash generated from our operations in Spain and the United Kingdom have been utilized within each of those countries to finance development and acquisition activity as well as for repayment of debt denominated in local currency. Accordingly, we have not utilized financial instruments to hedge our foreign currency exchange risk.

Inflation and changing prices have not significantly affected our operating results or the markets in which we perform services.

PART II—OTHER INFORMATION

ITEM 1. Legal Proceedings

From time to time, the Company is involved in litigation incidental to its business. In the Company's opinion, no litigation to which the Company is currently a party is likely to have a material adverse effect on the Company's results of operations, cash flows or financial condition.

ITEM 4. Submission of Matters to a Vote of Security Holders

At the Annual Meeting of Stockholders held on May 15, 2002, the following proposals were submitted to stockholders with the following results:

1.: Election of Class I directors of the Company to hold office until the Annual Meeting of Stockholders of the Company in 2005 and until their respective successors are elected and qualified or until their earlier death, resignation, or removal from office, as follows:

	Number of Shares
	For	Withheld
James C. Crews	19,567,310	204,559
John C. Garrett, M.D.	19,567,560	204,309
William H. Wilcox	19,567,560	204,309

2.: Ratification of the selection of KPMG LLP as the independent accountants of the Company for the fiscal year ending December 31, 2002:

		Number of Shares
For		19,754,196
Against		11,816
Abstain		5,857

ITEM 6. Exhibits and Reports on Form 8-K

(a): Exhibits:

10.1	*	Supplemental Retirement Plan, dated as of February 12, 2002
99.1	*	Certification of Chief Executive Officer Pursuant to 18 U.S.C. §1350
99.2	*	Certification of Chief Financial Officer Pursuant to 18 U.S.C. §1350

* Filed herewith.

(b): Reports on Form 8-K:

The Company filed a report on Form 8-K dated April 11, 2002, to report the Company's acquisition of SURGICOE Corporation, a significant acquisition under Item 2. The Company filed a report on Form 8-K/A dated June 10, 2002 to furnish the required audited and pro forma financial statements.

The Company filed a report on Form 8-K dated April 16, 2002 to furnish, pursuant to Regulation FD, a news release describing the Company's acquisition of a minority ownership interest in an ambulatory surgery center in Austintown, Ohio.

The Company filed a report on Form 8-K dated May 1, 2002 to furnish, pursuant to Regulation FD, a news release describing the Company's first quarter results and a schedule of cases and adjusted admissions for the Company's consolidated facilities for each quarter of 2001.

The Company filed a report on Form 8-K dated May 2, 2002 to furnish, pursuant to Regulation FD, a news release describing the Company's acquisition of a majority ownership interest in an ambulatory surgery center in Corpus Christi, Texas.

The Company filed a report on Form 8-K dated June 20, 2002 to furnish, pursuant to Regulation FD, a news release describing the Company's acquisition of a majority ownership interest in an ambulatory surgery center in Middleburg Heights, Ohio, a suburb of Cleveland.

The Company filed a report on Form 8-K dated June 26, 2002 to furnish, pursuant to Regulation FD, a news release describing the Company's formation of a joint venture with Robert Wood Johnson University Hospital to operate East Brunswick, New Jersey-based Robert Wood Johnson Surgery Center.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
	By:	/s/ MARK A. KOPSER Mark A. Kopser Senior Vice President and Chief Financial Officer (Principal Financial Officer and duly authorized to sign this report on behalf of the Registrant)
	By:	/s/ JOHN J. WELLIK John J. Wellik Senior Vice President, Accounting and Administration (Principal Accounting Officer)
Date: August 12, 2002