UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 000-32837

United Surgical Partners International, Inc.

(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 x No o

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

     At April 28, 2004 there were 28,113,256 shares of Common Stock outstanding.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES

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

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

4

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES

See accompanying notes to consolidated financial statements

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1)

Basis of Presentation

(a)

Description of Business

		United Surgical Partners International, Inc., a Delaware Corporation, and subsidiaries (USPI or the 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 March 31, 2004, USPI, headquartered in Addison, Texas, operated 74 short-stay surgical facilities. Of these 74 facilities, USPI consolidates the results of 41, accounts for 32 under the equity method, and holds no ownership in the remaining facility, which is operated by USPI under a management contract. USPI operates in three countries, with 62 of its 74 facilities located in the United States of America. Most of the Company’s U.S. facilities are jointly owned with local physicians and a not-for-profit healthcare system that has other healthcare businesses in the region. At March 31, 2004, the Company had agreements with 16 not-for-profit healthcare systems providing for the joint ownership of 35 of the Company’s 62 U.S. facilities and also providing a framework for the planning and construction of additional facilities in the future. All of the Company’s U.S. facilities include physician owners.
		The Company operates 12 facilities in Spain and the United Kingdom. USPI’s majority-owned subsidiary, United Surgical Partners Europe, S.L. (USPE), a Spanish corporation, managed and owned a majority interest in eight private surgical hospitals and one ambulatory surgery center at March 31, 2004. Global Healthcare Partners Limited (Global), incorporated in England and majority-owned by USPI, managed and wholly owned three private surgical hospitals in the greater London area at March 31, 2004.
		USPI is subject to changes in government legislation that could impact Medicare, Medicaid, and foreign government reimbursement levels and is also subject to increased levels of managed care penetration and changes in payor patterns that may impact the level and timing of payments for services rendered.
		USPI maintains its books and records on the accrual basis of accounting, and the consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements and notes should be read in conjunction with the Company’s Form 10-K. It is management’s opinion that the accompanying consolidated financial statements reflect all adjustments (which are normal recurring adjustments) necessary for a fair presentation of the results for the interim period and the comparable period presented. The results of operations for any interim period are not necessarily indicative of results for the full year.

(b)

Equity-Based Compensation

USPI applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option grants to employees. Accordingly, USPI generally does not record compensation expense related to stock option grants because USPI generally issues options for which the option exercise price equals the current market price of the underlying stock on the date of grant. SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, established accounting and disclosure requirements using a fair value based method of accounting for stock-based employee compensation plans. As permitted under SFAS No. 123, the Company has elected to continue to apply the intrinsic value based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148. Had USPI determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, USPI’s net income would have been the pro forma amounts indicated below (in thousands, except per share amounts):

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		The fair values in the table above were estimated at the date of grant using the Black-Scholes valuation model with the following assumptions: risk-free interest rates ranging from 2.1% to 6.3%, expected dividend yield of zero, expected volatility of the market price of the Company’s common stock of 40%, and an expected life of the option ranging from three to five years.
		Total stock-based employee compensation expense included in net income, as reported, primarily consists of expense related to grants to employees of the Company’s common stock and a December 2000 grant of stock options at a price lower than the current market price at the date of grant. The compensation amounts related to these grants are being amortized into expense over the estimated service periods.
		The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.
(2)		Acquisitions and Equity Method Investments

		Effective January 1, 2004, the Company acquired a controlling interest in an ambulatory surgery center in Torrance, California in which the Company had previously owned a noncontrolling interest. The $9.8 million cost was paid in cash in December 2003.
		Following are the unaudited pro forma results for the three months ended March 31, 2003 as if the acquisition discussed above had occurred on January 1, 2003 (in thousands, except per share amounts):

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		The Company also engages in investing transactions that are not business combinations. These transactions primarily consist of acquisitions and sales of noncontrolling equity interests in surgical facilities and the investment of additional cash in surgical facilities under development. During the three months ended March 31, 2004, these transactions resulted in a net cash outflow from USPI of $1.3 million.
		The Company controls a significant number of its investees and therefore consolidates their results. Additionally, the Company invests in a significant number of facilities in which the Company has significant influence but does not have control; the Company uses the equity method to account for these investments. The majority of these investees are partnerships or limited liability companies, which require the associated tax benefit or expense to be recorded by the partners or members. Summarized financial information for the Company’s equity method investees on a combined basis was as follows (income statement amounts are in thousands and reflect 100% of the investees’ results on an aggregated basis):

(3)		Earnings Per Share
		Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding options, warrants and restricted stock, except where such effect would be antidilutive. The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2004 and 2003 (in thousands, except per share amounts):

(4)		Segment Disclosures
		Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments in financial statements. USPI’s business is the operation of surgery centers, private surgical hospitals and related businesses in the United States and Western Europe. USPI’s chief operating decision maker, as that term is defined in the accounting standard, regularly reviews financial information about its surgical facilities 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.

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

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Condensed Consolidating Statements of Income:

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Condensed Consolidating Statements of Cash Flows:

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(6)

Commitments and Contingencies

		As of March 31, 2004, the Company had issued guarantees of the indebtedness of its investees to third parties which could potentially require the Company to make maximum aggregate payments totaling approximately $41.1 million. Of the total, $24.3 million relates to the debt of consolidated subsidiaries, whose debt is included in the Company’s consolidated balance sheet, and the remaining $16.8 million relates to the debt of unconsolidated affiliated companies, whose debt is not included in the Company’s consolidated balance sheet. In accordance with Financial Accounting Standards Board Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company has recorded long-term liabilities totaling approximately $0.1 million related to the guarantees the Company has issued to unconsolidated affiliates after December 31, 2002, and has not recorded any liabilities related to guarantees issued prior to January 1, 2003. Generally, these arrangements (a) consist of guarantees of real estate and equipment financing, (b) are secured by the related property and equipment, (c) require payments by the Company, when the collateral is insufficient, in the event of a default by the investee primarily obligated under the financing, (d) expire as the underlying debt matures at various dates through 2022, and (e) provide no recourse for the Company to recover any amounts from third parties.
(7)		Subsequent Events
		The Company has entered into letters of intent with various entities regarding possible joint venture, development, or other transactions. These possible joint ventures, developments, or other transactions are in various stages of negotiation.

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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; foreign currency fluctuations; 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 in the United States and Western Europe; 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, including physicians, nurses and other health care professionals; our significant indebtedness; the availability of suitable acquisition and development opportunities and the length of time it takes to accomplish acquisitions and developments; 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

     We operate ambulatory surgery centers and private surgical hospitals in the United States and Western Europe. As of March 31, 2004, we operated 74 facilities, consisting of 62 in the United States, nine in Spain, and three in the United Kingdom. Most of our U.S. facilities are jointly owned with local physicians and a not-for-profit healthcare system that has other healthcare businesses in the region. At March 31, 2004, we had agreements with 16 not-for-profit healthcare systems providing for the joint ownership of 35 of our 62 U.S. facilities and also providing a framework for the planning and construction of additional facilities in the future. All of our U.S. facilities include physician owners.

     Our U.S. facilities, consisting of ambulatory surgery centers and private surgical hospitals (collectively “short-stay surgical facilities”), specialize in non-emergency surgical cases, the volume of which has steadily increased over the past two decades due in part to advancements in medical technology. These 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 in turn earn a monthly fee from each facility we operate in exchange for managing its operations. Approximately 84% of our facilities are located in the U.S., where we have focused increasingly on adding facilities with not-for-profit healthcare system partners (“hospital partners”). From December 31, 2001 to March 31, 2004, 92% of the increase in the number of facilities we operate has occurred in the United States. During this period, the number of facilities we own jointly with not-for-profit healthcare systems increased from 19 to 35, an increase of 84%.

     In Spain and the United Kingdom we operate private hospitals which supplement the services provided by the government-sponsored healthcare systems in each country. Our patients choose our facilities 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, offered by an increasing number of employers as a benefit to their employees. We have expanded selectively in these two countries.

Critical Accounting Policies and Estimates

     Our discussion and analysis of our 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 which impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities

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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 management’s most subjective judgments. Our critical accounting policies and estimates include our policies and estimates regarding consolidation, revenue recognition, income taxes, and intangible assets.

     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.

     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 No. 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. There have been no significant changes in the application of SFAS No. 142 since the preparation of the Company’s latest audited financial statements.

Acquisitions, Equity Investments and Development Projects

     Effective January 1, 2004, we acquired a controlling interest in an ambulatory surgery center in Torrance, California in which we had previously owned a noncontrolling interest. The $9.8 million cost was paid in cash in December 2003.

     We also engage in purchases and sales of noncontrolling interests in facilities we already operate and invest additional cash in surgical facilities under development. These transactions resulted in a net cash outflow of $1.3 million during the three months ended March 31, 2004.

Sources of Revenue

     Revenues primarily include the following:

•

net patient service revenue of the facilities that we consolidate for financial reporting purposes, which are typically those facilities in which we have ownership interests of greater than 50% or otherwise maintain effective control.

•		management and administrative services revenue, consisting of the fees that we earn from managing the facilities that we do not consolidate for financial reporting purposes and the fees we earn from providing certain consulting and administrative services to physicians. Our consolidated revenues and expenses do not include the management fees we earn from operating the facilities that we consolidate for financial reporting purposes as those fees are charged to subsidiaries and thus eliminate in consolidation.
•		our share of the net income or loss of the unconsolidated 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. Through our contracts to manage these facilities, we have an active role in their operations. The level of our corporate resources devoted to fulfilling these responsibilities is significant and generally equal to that devoted to the operations of the facilities we consolidate for financial reporting purposes.

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

     Equity in earnings of unconsolidated affiliates, which is our share of the net income of the facilities we do not consolidate for financial reporting purposes, increased as a percentage of our total revenues in the three months ended March 31, 2004. This increase reflects the overall improved profitability of these 32 facilities, 24 of which are operated jointly with not-for-profit healthcare systems. Our profit margins in these joint ventures have been better than in facilities without a hospital partner. Additionally, the majority of our newly constructed facilities, whose growth rates are faster than for more established facilities, are accounted for under the equity method. Our management and administrative services revenues are earned from the following types of activities (dollars in thousands):

     The following table reflects the summarized results of the unconsolidated facilities that we account for under the equity method of accounting (dollars in thousands):

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     The following table summarizes our revenues by operating segment:

     The proportion of our revenues earned in Western Europe was higher during the three months ended March 31, 2004 than in the prior year period because we consolidate both of the overseas facilities we have acquired since December 31, 2002, whereas our U.S. acquisition and development activity, while involving more facilities, has more predominantly involved equity method facilities, for which our revenues are only impacted by our share of the underlying facilities’ net income. Additionally, the dollar was weaker against the eurodollar and British pound in 2004 than in 2003, which had a favorable impact on our revenues in 2004.

Results of Operations

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

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     The following table reconciles EBITDA and EBITDA less minority interests to net income and to net cash provided by operating activities:

     The key trends in our results of operations for the three months ended March 31, 2004 continued to be increases in revenue, operating margins and overall profitability. The increases in revenue are driven most significantly by growth in our existing facilities. Facilities that we owned during both the three month period ended March 31, 2004 and the three month period ended March 31, 2003 (“same store facilities”) continued the trend from earlier years of performing more surgical cases than in the prior year, and our facilities also received higher rates of reimbursement per case, on average, than in the prior year. As in 2003, these increases in revenues outpaced increases in operating expenses, resulting in improved operating margins.

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     Increases in the volume of surgical cases in the U.S. and of patient admissions for our hospitals in Western Europe continue to drive increases in our revenues, as does an increase in the average reimbursement for the surgeries (in all countries) and other services (in Western Europe) that we provide. The growth of our same store facilities, summarized in the following table, continues to be the most significant component of our overall increase in revenues.

     The addition of new facilities continues to be more heavily weighted to U.S. surgical facilities with a not-for-profit healthcare system partner (“hospital partner”), both as we initiate joint venture agreements with new systems and as we add facilities to our arrangements with existing systems. 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. We also have selectively added facilities in Western Europe through acquisition and construction. The following table summarizes our facilities as of March 31, 2004 and 2003:

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     Operating expenses have increased at lower rates than revenue, resulting in improved operating margins. This relationship results from the double digit percentage growth in the same store revenues exceeding the volume-driven and inflation-driven increases in most operating expenses, including the costs of personnel, supplies, and facility costs, and also, we believe, from implementing our proprietary management and measurement system, USPI’s EDGE, in newly acquired facilities, which we believe improves operating efficiencies. The following table summarizes changes in our same store EBITDA margins (1), comparing the three months ended March 31, 2004 to the three months ended March 31, 2003: