UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

OR

Commission file number: 000-50574

Symbion, Inc.

(615) 234-5900
(Registrant’s Telephone Number, Including Area Code)

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

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

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

Table of Contents

PART I FINANCIAL INFORMATION

Item 1. Financial Statements.

SYMBION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes.

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SYMBION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

2

SYMBION, INC.

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

See accompanying notes.

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SYMBION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
September 30, 2004

1. Organization

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

2. Significant Accounting Policies and Practices

Basis of Presentation

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

Principles of Consolidation

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

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Accounts Receivable

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

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

Goodwill

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

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

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

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

Revenues

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

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

Stock-Based Compensation

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

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

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Use of Estimates

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

Recent Accounting Standards

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

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

3. Reverse Stock Split and Initial Public Offering

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

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

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

4. Acquisitions, Developments and Dispositions

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

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

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

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

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

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

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

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

5. Long-Term Debt and Convertible Debentures

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

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

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

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

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

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

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

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

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

7. Earnings Per Share

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

     The effects of warrants to purchase 19,643 shares of common stock for the three months and nine months ended September 30, 2003 were not included in the computation of diluted earnings per share because their effects would have been anti-dilutive.

8. Commitments and Contingencies

Professional, General and Workers Compensation Liability Risks

     The Company is subject to claims and legal actions in the ordinary course of business, including claims relating to patient treatment, employment practices and personal injuries. To cover these types of claims, the Company maintains general liability and professional liability insurance in excess of self-insured retentions through a commercial insurance carrier in amounts that the Company believes to be sufficient for its operations, although,

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potentially, some claims may exceed the scope of coverage in effect. This insurance coverage is on a claims-made basis. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. The Company is not aware of any such proceedings that would have a material adverse affect on the Company’s business, financial condition or results of operations. The Company expenses the costs under the self-insured retention exposure for general and professional liability claims which relate to (i) deductibles on claims made during the policy period, and (ii) an estimate of claims incurred but not yet reported that are expected to be reported after the policy period expires. These expenses are based on various assumptions. A change in one or more of these assumptions could materially change the Company’s consolidated financial position or results of operations.

Current Operations

     Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties and exclusion from the Medicare, Medicaid and other federal health care programs. From time to time, governmental regulatory agencies may conduct inquiries of the Company’s facilities. It is the Company’s current practice and intent to cooperate fully with such inquiries. The Company is not aware of any such inquiry that would have a material adverse effect on the Company’s consolidated financial position or results of operations.

Acquired Centers

     The Company, through its wholly-owned subsidiaries or controlled partnerships and limited liability companies, has acquired and will continue to acquire surgical and diagnostic centers with prior operating histories. Such centers may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although the Company attempts to assure itself that no such liabilities exist and obtains indemnification from prospective sellers covering such matters and institutes policies designed to conform centers to its standards following completion of acquisitions, there can be no assurance that the Company will not become liable for past activities that may later be asserted to be improper by private plaintiffs or government agencies. There can be no assurance that any such matter will be covered by indemnification or, if covered, that the liability sustained will not exceed contractual limits or the financial capacity of the indemnifying party.

     The Company cannot predict whether federal or state statutory or regulatory provisions will be enacted that would prohibit or otherwise regulate relationships which the Company has established or may establish with other health care providers or have materially adverse effects on its business or revenues arising from such future actions. The Company believes, however, that it will be able to adjust its operations so as to be in compliance with any regulatory or statutory provision as may be applicable.

Potential Physician Investor Liability

     Each physician investor in the partnerships and limited liability companies which operate surgery centers carries general and professional liability insurance or provides other protection against losses as required by state guidelines. Each investor in a partnership or limited liability company may, however, be liable for damages to persons or property arising from occurrences at the surgery centers. Although the various physician investors and other surgeons are required to obtain general and professional liability insurance or provide other protection against losses, such coverage or protection may be insufficient to cover all potential liability. Since most insurance policies contain exclusions, the physician investor will not be insured against all possible occurrences. In the event of an uninsured or underinsured loss, the value of an investment in the partnership interests or limited liability company membership units and the amount of distributions could be adversely affected.

9. Subsequent Events

     Subsequent to September 30, 2004, the Company acquired a majority ownership interest in two surgery centers in Alabama and one surgery center in Missouri. The Birmingham Endoscopy Center, located in Birmingham, Alabama, is a single-specialty surgery center with three operating rooms. The Company intends to convert this center into a multi-specialty surgery center. The North River Surgical Center, located in Tuscaloosa, Alabama, is a

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multi-specialty surgery center with two operating rooms. The Surgery Center of Kirkwood, located in Kirkwood, Missouri, is a multi-specialty surgery center with three operating rooms and one minor procedure room. The Company acquired these interests for an aggregate of approximately $43.0 million and will consolidate all three surgery centers for financial reporting purposes. Also subsequent to September 30, 2004, the Company acquired the general partner of Valley Ambulatory Surgery Center, L.P. for $7.0 million. This acquisition brings the Company’s total ownership of the Valley center to 40.0% and the Company will begin consolidating this surgery center in the fourth quarter of 2004.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes included in Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

     This report contains forward-looking statements, which are based on our current expectations, estimates and assumptions about future events. All statements other than statements of current or historical fact contained in this report, including statements regarding our future financial position, business strategy, budgets, effective tax rate, projected costs and plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” and similar expressions are generally intended to identify forward-looking statements. These statements involve risks, uncertainties and other factors that may cause actual results to differ from the expectations expressed in the statements. Many of these factors are beyond our ability to control or predict. These factors include, without limitation:

•

our dependence on payments from third-party payors, including government health care programs and managed care organizations;

•

our ability to acquire and develop additional surgery centers on favorable terms and to integrate their business operations successfully;

•

our ability to enter into strategic alliances with health care systems and other health care providers that are leaders in their markets;

•

efforts to regulate the construction, acquisition or expansion of health care facilities;

•

our ability to attract and maintain good relationships with physicians who use our facilities;

•

our ability to enhance operating efficiencies at our surgery centers;

•

uncertainty associated with legislative and regulatory initiatives relating to privacy and security of patient health information and standards for electronic transactions;

•

our ability to comply with applicable laws and regulations, including physician self-referral laws and laws relating to illegal remuneration under the Medicare, Medicaid or other governmental programs;

•

risks related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, which could restrict our ability to operate our facilities licensed as hospitals and could adversely impact our reimbursement revenues;

•

the possibility of adverse changes in federal, state or local regulations affecting the health care industry;

•

the risk of changes to laws governing the corporate practice of medicine that may require us to restructure some of our relationships, which could result in a significant loss of revenues and divert other resources;

•

our ability to incur significant indebtedness;

•

the intense competition for physicians, strategic relationships, acquisitions and managed care contracts, which may result in a decline in our revenues, profitability and market share;

•

the geographic concentration of our operations, which makes us particularly sensitive to regulatory, economic and other conditions in those states;

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•

our dependence on our senior management; and

•

other risks and uncertainties described in this report or detailed from time to time in our filings with the Securities and Exchange Commission.

     In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report.

     These forward-looking statements speak only as of the date made. Other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Executive Overview

     As of September 30, 2004, we owned and operated 42 surgery centers and managed nine additional surgery centers in 20 states. We own a majority interest in 31 of the 42 surgery centers and consolidate 36 of these centers for financial reporting purposes. Our surgery centers include three facilities that are licensed as hospitals, two of which we own and one of which we manage. In addition to our surgery centers, we also operate two diagnostic centers and manage three physician networks, including two physician networks in markets in which we operate surgery centers.

     On February 11, 2004, we completed an initial public offering of 8,280,000 shares of common stock at a price of $15.00 per share, which included 1,080,000 shares sold following exercise in full by the underwriters of an option to purchase the additional shares that we granted to the underwriters to cover over-allotments. We received net proceeds of $115.5 million in the offering, after deducting underwriting discounts and commissions. We used the net proceeds to repay indebtedness and to pay holders of our Series A and Series B convertible preferred stock in connection with the conversion of those shares to common stock upon the completion of the offering.

     We generate revenues and cash primarily through patient service revenues. We also generate revenues and cash through physician service revenues and other service revenues. Patient service revenues are revenues from surgical or diagnostic procedures performed in each of the surgery centers that we consolidate for financial reporting purposes. The fee charged for a procedure varies depending on the procedure, but usually includes all charges for usage of an operating room, a recovery room, special equipment, supplies, nursing staff and medications. The fee does not include professional fees charged by the patient’s surgeon, anesthesiologist or other attending physician, which are billed directly by such physicians to the patient or third-party payor. Patient service revenues are recognized on the date of service, net of estimated contractual adjustments and discounts for third-party payors, including Medicare and Medicaid. Changes in estimated contractual adjustments and discounts are recorded in the period of change. Physician service revenues are revenues from physician networks for which we have a contractual obligation to provide capital and additional assets in addition to management services. Physician service revenues consist of reimbursed expenses, plus participation in the excess of revenues over expenses of the physician networks, as provided for in our service agreements with our physician networks. Reimbursed expenses include the costs of personnel, supplies and other expenses incurred to provide the management services to the physician networks. We recognize physician service revenues in the period in which reimbursable expenses are incurred and in the period in which we have the right to receive a percentage of the amount by which a physician network’s revenues exceed its expenses. Physician service revenues are based on net billings with any changes in estimated contractual adjustments reflected in service revenues in the subsequent period. Other service revenues consists of management and administrative service fees derived from the non-consolidated facilities that we account for under the equity method, management of surgery centers in which we do not own an interest and management services we provide to physician networks for which we are not required to provide capital or additional assets.

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     Revenues

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

     Case Mix

     The following table sets forth the percentage of cases in each specialty performed during the three months and nine months ended September 30, 2003 and 2004, respectively, at surgery centers in which we owned an interest as of September 30, 2003 and 2004, respectively:

     The changes in case mix from the periods ended September 30, 2003 to the periods ended September 30, 2004, including the increase in gastrointestinal cases as a percentage of total cases and the decrease in orthopedic cases as a percentage of total cases, were primarily the result of our surgery center acquisitions and developments since September 30, 2003.

     Case Growth

     The following table sets forth information from facilities that we owned and managed (which we refer to as “same store” facilities) throughout the three months and nine months ended September 30, 2003 and 2004, respectively:

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     The following table sets forth information from consolidated facilities throughout the three months and nine months ended September 30, 2003 and 2004, respectively:

     Payor Mix

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

Acquisitions, Developments and Divestitures

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

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

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     The results of operations for the three months and nine months ended September 30, 2004 also reflect acquisitions and divestitures we made subsequent to September 30, 2003. During the fourth quarter of 2003, we acquired five centers, including one licensed as a hospital, and opened one newly developed surgery center. We entered into management agreements with each of these surgery centers and have a majority ownership interest in four of these centers. We consolidate four of these centers for financial reporting purposes. In addition, we assumed a management agreement for one additional surgery center licensed as a hospital.

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

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

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

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

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

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

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Results of Operations

     The following tables contain unaudited summary statements of operations for each of the three months and nine months ended September 30, 2003 and 2004. The tables also show the percentage relationship to total revenues for the periods indicated:

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     (1) Adjusted net income is not a measurement of financial performance or liquidity under generally accepted accounting principles. Adjusted net income reflects an income tax rate of 38.5% for the periods ended September 30, 2003 and 2004 and excludes the non-recurring prepayment charges incurred in the first quarter of 2004 and the third quarter of 2003. We believe that adjusted net income provides a better measurement of our ongoing performance and provides a more useful period-to-period comparison to investors because it excludes non-recurring items not related to our core business operations. Adjusted net income should not be considered in isolation or as a substitute for net income, operating income, cash flows from operating, investing or financing activities or any other measure calculated in accordance with generally accepted accounting principles. Our calculation of adjusted net income may not be comparable to similarly titled measures reported by other companies.

     The following table reconciles adjusted net income to net income (in thousands):

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Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003

     During the three months ended September 30, 2004, our revenues increased 20.1% to $52.0 million from $43.3 million for the three months ended September 30, 2003. Net income increased to $3.3 million from $1.9 million for the three months ended September 30, 2003. Our financial results for the three months ended September 30, 2004 compared to the three months ended September 30, 2003 reflect the addition of twelve owned surgery centers, two surgery centers we manage without owning an interest and one diagnostic center. Our financial results for the three months ended September 30, 2004 compared to the three months ended September 30, 2003 also reflect case growth at our existing centers. In addition, results for the three months ended September 30, 2004 reflect the consolidation of one variable interest entity as required by Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. The adoption of FIN 46(R) did not have an impact on our net income or liquidity. Results for the three months ended September 30, 2004 include an effective tax rate of 38.5% compared to an effective tax rate of 19.3% during the three months ended September 30, 2003.

     Revenues. Revenues increased 20.1% from $43.3 million for the three months ended September 30, 2003 to $52.0 million for the three months ended September 30, 2004. This increase was primarily the result of a $6.8 million increase in patient service revenues from surgery centers acquired or developed since July 1, 2003 and a $2.6 million increase in patient service revenues from facilities that we owned and managed throughout the three months ended September 30, 2004 and 2003 (which we refer to as “same store” facilities). The increase in same store revenues was primarily the result of an increase in the number of cases performed during the three months ended September 30, 2004 compared to the three months ended September 30, 2003. In addition, the $2.6 million increase was also the result of patient service revenues of $1.2 million from the consolidation of the variable interest entity, which was recorded as other service revenues during the three months ended September 30, 2003. Other service revenues decreased $1.2 million for the three months ended September 30, 2004 compared to the three months ended September 30, 2003 primarily as a result of consolidation of the variable interest entity pursuant to FIN 46(R). If we had adopted FIN 46(R) effective January 1, 2003, revenues would have increased 19.8% from $43.4 million for the three months ended September 30, 2003 to $52.0 million for the three months ended September 30, 2004.

     Cost of Revenues. Cost of revenues increased 14.1% from $30.4 million for the three months ended September 30, 2003 to $34.7 million for the three months ended September 30, 2004. The increase was primarily the result of a $5.0 million increase in cost of revenues from surgery centers acquired or developed since July 1, 2003. The increase of $5.0 million was partially offset by a $0.8 million decrease in cost of revenues from same store facilities. The decrease in same store cost of revenues was primarily the result of higher general and professional liability expense for the three months ended September 30, 2003 compared to the three months ended September 30, 2004. The general and liability expense includes reserves for an estimate of losses limited to deductibles and self insured retention related to claims incurred and reported in the policy period and an estimate for unlimited losses related to claims incurred but not yet reported during the policy period. The $0.8 million decrease in same store cost of revenues consists of increases in salaries and benefits of $15,000, an increase in rent and lease expense of $142,000, a decrease in supplies expense of $53,000, a decrease in professional and medical fees of $129,000 and a decrease in other cost of revenues of $806,000. As a percentage of revenues, cost of revenues decreased from 70.1% for the three months ended September 30, 2003 to 66.7% for the three months ended September 30, 2004, primarily as a result of consolidation of the variable interest entity and partially offset by surgery centers acquired or developed since July 1, 2003. If we had adopted FIN 46(R) effective January 1, 2003, cost of revenues would have increased 12.3% from $30.9 million for the three months ended September 30, 2003 to $34.7 million for the three months ended September 30, 2004. In addition, as a percentage of revenues, cost of revenues would have decreased from 71.0% for the three months ended September 30, 2003 to 66.7% for the three months ended September 30, 2004.

     General and Administrative Expense. General and administrative expense increased 21.6% from $3.7 million for the three months ended September 30, 2003 to $4.5 million for the three months ended September 30, 2004. The increase was primarily related to the overall growth in the number of surgery centers. As a percentage of revenues, general and administrative expense remained constant at 8.6% for the three months ended September 30, 2003 and September 30, 2004.

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     Depreciation and Amortization. Depreciation and amortization expense increased 21.7% from $2.3 million for the three months ended September 30, 2003 to $2.8 million for the three months ended September 30, 2004. The increase was primarily related to surgery centers acquired or developed since July 1, 2003. As a percentage of revenues, depreciation and amortization expense increased slightly from 5.4% for the three months ended September 30, 2003 to 5.5% for the three months ended September 30, 2004.

     Provision for Doubtful Accounts. Provision for doubtful accounts increased from $756,000 for the three months ended September 30, 2003 to $995,000 for the three months ended September 30, 2004. This increase is primarily attributed to the surgery centers acquired or developed since July 1, 2003. As a percentage of revenues, the provision for doubtful accounts increased slightly from 1.7% for the three months ended September 30, 2003 to 1.9% for the three months ended September 30, 2004.

     Operating Income. Operating income increased 54.1% from $6.1 million for the three months ended September 30, 2003 to $9.4 million for the three months ended September 30, 2004. This increase was primarily the result of an increase of $2.0 million from same store facilities and a $1.3 million increase from surgery centers acquired or developed since July 1, 2003. As a percentage of revenues, operating income increased from 14.2% for the three months ended September 30, 2003 to 18.0% for the three months ended September 30, 2004. If we had adopted FIN 46(R) effective January 1, 2003, operating income would have increased 64.9% from $5.7 million for the three months ended September 30, 2003 to $9.4 million for the three months ended September 30, 2004.

     Minority Interests in Income of Consolidated Subsidiaries. Minority interests in income of consolidated subsidiaries increased from $1.8 million for the three months ended September 30, 2003 to $3.2 million for the three months ended September 30, 2004. This increase was primarily the result of a $1.2 million increase in minority interests for same store facilities due to the consolidation of the variable interest entity and a $195,000 increase in minority interests for surgery centers acquired or developed since July 1, 2003.

     Interest Expense, Net of Interest Income. Interest expense, net of interest income, decreased from $2.0 million for the three months ended September 30, 2003 to $718,000 for the three months ended September 30, 2004. Interest expense was higher in the third quarter of 2003 because of prepayment penalties incurred during the third quarter of 2003 related to our repayment of certain indebtedness with the proceeds from our senior credit facility. The decrease in interest expense was also the result of decreased outstanding indebtedness for the three months ended September 30, 2003 compared to the three months ended September 30, 2004. Total outstanding indebtedness decreased during 2004 because we used a portion of the proceeds of our initial public offering to repay indebtedness during the first quarter of 2004.

     Provision for Income Taxes. The provision for income taxes increased from $455,000 for the three months ended September 30, 2003 to $2.1 million for the three months ended September 30, 2004. Our effective tax rate increased from 19.3% for the three months ended September 30, 2003 to 38.5% for the three months ended September 30, 2004. The effective income tax rate for the three months ended September 30, 2004 was higher than the effective income tax rate for the three months ended September 30, 2003 because the net operating loss carryforwards utilized during 2003 were not available during 2004. We anticipate an effective tax rate of approximately 38.5% for the twelve months ending December 31, 2004.

     Net Income. Net income increased from $1.9 million for the three months ended September 30, 2003 to $3.3 million for the three months ended September 30, 2004. Net income increased primarily as a result of surgery centers acquired or developed since July 1, 2003 and an increase in net income from same store facilities. These increases were offset by an increase in the provision for income taxes of $1.6 million.

     Adjusted Net Income. Adjusted net income increased from $1.9 million for the three months ended September 30, 2003 to $3.3 million for the three months ended September 30, 2004. The increase was primarily related to increased net income from surgery centers acquired or developed since July 1, 2003 and an increase in net income from same store facilities.

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Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003

     During the nine months ended September 30, 2004, our revenues increased 21.7% to $156.7 million from $128.8 million for the nine months ended September 30, 2003. Net income decreased to $9.5 million from $10.3 million for the nine months ended September 30, 2003. Our financial results for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 reflect the addition of twelve owned surgery centers, two surgery centers we manage without owning an interest and one diagnostic center. Our financial results for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 also reflect case growth at our existing centers. In addition, results for the nine months ended September 30, 2004 reflect the consolidation of one variable interest entity as required by FIN 46(R). The adoption of FIN 46(R) did not have an impact on our net income or liquidity. Results for the nine months ended September 30, 2004 include an effective tax rate of 38.5% compared to an effective tax rate of 8.5% during the nine months ended September 30, 2003.

     Revenues. Revenues increased 21.7% from $128.8 million for the nine months ended September 30, 2003 to $156.7 million for the nine months ended September 30, 2004. This increase was primarily the result of a $20.0 million increase in patient service revenues from surgery centers acquired or developed since July 1, 2003 and a $10.8 million increase in patient service revenues from same store facilities for the nine months ended September 30, 2004 and 2003. The increase in same store revenues was primarily the result of an increase in the number of cases performed during the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003. In addition, the $10.8 million increase was also the result of patient service revenues of $3.6 million from the consolidation of the variable interest entity, which was recorded as other service revenues during the nine months ended September 30, 2003. Other service revenues decreased $3.6 million for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 primarily as a result of the consolidation of the variable interest entity pursuant to FIN 46(R). If we had adopted FIN 46(R) effective January 1, 2003, revenues would have increased 22.5% from $127.9 million for the nine months ended September 30, 2003 to $156.7 million for nine months ended September 30, 2004.

     Cost of Revenues. Cost of revenues increased 21.2% from $85.4 million for the nine months ended September 30, 2003 to $103.5 million for the nine months ended September 30, 2004. The increase was primarily the result of a $14.3 million increase in cost of revenues from surgery centers acquired or developed since July 1, 2003 and a $3.4 million increase in cost of revenues from same store facilities. The increase in same store cost of revenues was primarily the result of the increase in the number of cases performed during the nine months ended September 30, 2004 compared with the nine months ended September 30, 2003. The $3.4 million increase in same store cost of revenues consists of increases in salaries and benefits of $1.8 million, supplies expense of $1.2 million, professional and medical fees of $63,000, rent and lease expense of $296,000 and other cost of revenues of $100,000. As a percentage of revenues, cost of revenues decreased slightly from 66.3% for the nine months ended September 30, 2003 to 66.1% for the nine months ended September 30, 2004. If we had adopted FIN 46(R) effective January 1, 2003, cost of revenues would have increased 19.5% from $86.6 million for the nine months ended September 30, 2003 to $103.5 million for the nine months ended September 30, 2004. In addition, as a percentage of revenues, cost of revenues would have decreased from 67.7% for the nine months ended September 30, 2003 to 66.1% for the nine months ended September 30, 2004.

     General and Administrative Expense. General and administrative expense increased 16.1% from $11.8 million for the nine months ended September 30, 2003 to $13.7 million for the nine months ended September 30, 2004. The increase was primarily related to the overall growth in the number of surgery centers. As a percentage of revenues, general and administrative expense decreased from 9.2% for the nine months ended September 30, 2003 to 8.7% for the nine months ended September 30, 2004. This decrease was primarily the result of improved economies of scale.

     Depreciation and Amortization. Depreciation and amortization expense increased 22.2% from $6.9 million for the nine months ended September 30, 2003 to $8.3 million for the nine months ended September 30, 2004. The increase was primarily related to surgery centers acquired or developed since July 1, 2003. As a percentage of revenues, depreciation and amortization expense decreased slightly from 5.3% for the nine months ended September 30, 2003 to 5.2% for the nine months ended September 30, 2004.

     Provision for Doubtful Accounts. Provision for doubtful accounts increased from $1.8 million for the nine months ended September 30, 2003 to $2.5 million for the nine months ended September 30, 2004. This increase is

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primarily attributed to the surgery centers acquired or developed since July 1, 2003. As a percentage of revenues, the provision for doubtful accounts increased from 1.4% for the nine months ended September 30, 2003 to 1.6% for the nine months ended September 30, 2004.

     Operating Income. Operating income increased 28.6% from $23.1 million for the nine months ended September 30, 2003 to $29.7 million for the nine months ended September 30, 2004. This increase was primarily the result of an increase of $4.3 million from surgery centers acquired or developed since July 1, 2003 and a $2.3 million increase from same store facilities. As a percentage of revenues, operating income increased from 17.9% for the nine months ended September 30, 2003 to 18.9% for the nine months ended September 30, 2004. If we had adopted FIN 46(R) effective January 1, 2003, operating income would have increased 43.5% from $20.7 million for the nine months ended September 30, 2003 to $29.7 million for the nine months ended September 30, 2004.

     Minority Interests in Income of Consolidated Subsidiaries. Minority interests in income of consolidated subsidiaries increased 32.5% from $7.7 million for the nine months ended September 30, 2003 to $10.2 million for the nine months ended September 30, 2004. This increase was primarily the result of a $1.7 million increase in minority interests for same store facilities due to the consolidation of the variable interest entity and an $700,000 increase in minority interests for surgery centers acquired or developed since July 1, 2003.

     Interest Expense, Net of Interest Income. Interest expense, net of interest income, decreased slightly from $4.1 million for the nine months ended September 30, 2003 to $4.0 million for the nine months ended September 30, 2004. Interest expense for both periods in 2003 and 2004 includes non-recurring prepayment charges of approximately $700,000 as a result of the repayment of indebtedness.

     Provision for Income Taxes. The provision for income taxes increased from $959,000 for the nine months ended September 30, 2003 to $6.0 million for the nine months ended September 30, 2004. Our effective tax rate increased from 8.5% for the nine months ended September 30, 2003 to 38.5% for the nine months ended September 30, 2004. The effective income tax rate for the nine months ended September 30, 2004 was higher than the effective income tax rate for the nine months ended September 30, 2003 because the net operating loss carryforwards utilized during 2003 were not available during 2004. We anticipate an effective tax rate of approximately 38.5% for the twelve months ending December 31, 2004.

     Net Income. Net income decreased from $10.3 million for the nine months ended September 30, 2003 to $9.5 million for the nine months ended September 30, 2004. Net income decreased primarily as a result of an increase in the provision for income taxes of $5.0 million. The increase in the provision for income taxes was partially offset by increased net income of surgery centers acquired or developed since July 1, 2003 and an increase in net income from same store facilities.

     Adjusted Net Income. Adjusted net income increased 35.1% from $7.4 million for the nine months ended September 30, 2003 to $10.0 million for the nine months ended September 30, 2004. The increase was primarily related to increased net income from surgery centers acquired or developed since July 1, 2003 and an increase in net income from same store facilities.

Liquidity and Capital Resources

     On February 11, 2004, we received net proceeds of $115.5 million, after deducting underwriting discounts and commissions, from our initial public offering of 8,280,000 shares of common stock, which included 1,080,000 shares attributable to the underwriters’ exercise of their over-allotment option. We used the net proceeds to repay indebtedness and to pay holders of Series A and Series B convertible preferred stock in connection with the conversion of those shares to common stock upon the completion of the offering.

Cash Flow Statement Information

     During the nine months ended September 30, 2004, we generated operating cash flow of $18.6 million. Net cash used in investing activities during the nine months ended September 30, 2004 was $57.3 million, including $31.8 million of payments related to the conversion of Series A and Series B convertible preferred stock. The $57.3 million used in investing activities also includes approximately $19.1 million paid in connection with acquisitions.

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Also, the $57.3 million used in investing activities includes $7.7 million used for purchase of property and equipment. Our net cash provided by financing activities during the nine months ended September 30, 2004 was $38.9 million, primarily related to proceeds of $115.5 million from our initial public offering which were partially offset by $105.3 million of payments on long-term debt. The $38.9 million of cash provided by financing activities also includes $27.0 million of proceeds from debt issuances.

Long-Term Debt

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

     In July 2003, we entered into an agreement through which DLJ Investment Partners II, L.P. and its affiliates agreed to purchase our 14¾% Senior Subordinated Notes due 2008 in the aggregate principal amount of up to $40.0 million. During 2003, we issued notes in the aggregate principal amount of about $29.1 million, and may issue up to an additional $10.9 million of notes at any time before July 18, 2005. At December 31, 2003, the outstanding balance of the Senior Subordinated Notes was $29.1 million. We used proceeds from the initial public offering and certain borrowings under the Senior Credit Facility to repay all outstanding indebtedness under the Senior Subordinated Notes. At September 30, 2004, we had no outstanding indebtedness under the Senior Subordinated Notes.

Convertible Debentures

     In connection with the 2002 acquisition of PSC, we issued convertible debentures totaling $3.2 million to various persons in exchange for additional ownership interests in certain of PSC’s surgery centers. The convertible debentures bore interest at 4.0% per year and would have matured on April 1, 2005. The convertible debentures automatically converted into shares of common stock at $13.87 per share upon the completion of our initial public offering.

     Earnings Before Interest, Taxes, Depreciation and Amortization Less Minority Interests

     EBITDA less minority interest increased 34.3% from $6.7 million for the three months ended September 30, 2003 to $9.0 million for the three months ended September 30, 2004. EBITDA less minority interest increased 25.2% from $22.2 million for the nine months ended September 30, 2003 to $27.8 million for the nine months ended September 30, 2004. These increases in EBITDA less minority interests were the result of surgery centers acquired or developed since July 1, 2003 and growth at same store facilities.

     When the term EBITDA is used, it refers to operating income plus depreciation and amortization. EBITDA less minority interests represents our portion of EBITDA, after subtracting the interests of third parties that own interests in surgery centers that we consolidate for financial reporting purposes. Our operating strategy involves sharing ownership of our surgery centers with physicians, physician groups and hospitals, and these third parties own an interest in all but two of our centers. We believe that it is preferable to present EBITDA less minority interests because it excludes the portion of EBITDA attributable to these third-party interests and clarifies for investors our portion of EBITDA generated by our surgery centers and other operations.

     We use EBITDA and EBITDA less minority interests as measures of liquidity. We have included them in this report because we believe that they provide investors with additional information about our ability to incur and service debt and make capital expenditures. We also use EBITDA, with some variation in the calculation, to determine compliance with some of the covenants under our Senior Credit Facility, as well as to determine the interest rate and commitment fee payable under the Senior Credit Facility. EBITDA and EBITDA less minority

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interests are not measurements of financial performance or liquidity under generally accepted accounting principles. They should not be considered in isolation or as a substitute for net income, operating income, cash flows from operating, investing or financing activities, or any other measure calculated in accordance with generally accepted accounting principles. The items excluded from EBITDA and EBITDA less minority interests are significant components in understanding and evaluating financial performance and liquidity. Our calculation of EBITDA and EBITDA less minority interests may not be comparable to similarly titled measures reported by other companies.

     The following table reconciles EBITDA and EBITDA less minority interests to net cash provided by operating activities (in thousands):

Summary

     We believe that existing funds, cash flows from operations and borrowings under our Senior Credit Facility will provide sufficient liquidity for the next 12 to 18 months. We will need to incur additional debt or issue additional equity or debt securities in the future to fund our acquisitions and development projects. We cannot assure that 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. Our ability to meet our funding needs could be adversely affected if we suffer adverse results from our operations, or if we violate the covenants and restrictions to which we are subject under our Senior Credit Facility and Senior Subordinated Notes.

Inflation

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

Recent Accounting Standards

     In December 2003, the FASB issued Interpretation No. 46(R), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. FIN 46(R) requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46(R) is effective for all new

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VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46(R) for public companies must be applied for the first interim or annual period beginning after March 15, 2004, with early adoption allowed. The Company adopted FIN 46(R) on December 31, 2003. The Company has not entered into or acquired any VIEs subsequent to January 31, 2003. The Company has determined that it is the primary beneficiary of a VIE created on July 31, 2002. The Company entered into a development agreement with a group of physicians to develop a surgery center in which it has no ownership interest. The surgery center opened on October 16, 2002. Under the development agreement, a limited liability company in which the Company owns a majority of the ownership interests manages the surgery center, leases certain fixed assets to the surgery center and provides working capital needs to the surgery center. In addition, the investors in the surgery center have insufficient equity at risk. At December 31, 2003, the Company began consolidating this VIE in the accompanying condensed consolidated balance sheets. The adoption of FIN 46(R) did not have an impact on the Company’s net income or liquidity.

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

     Item 3. Quantitative and Qualitative Disclosures about Market Risk.

     We are exposed to market risk related to changes in prevailing interest rates. Historically, we have not held or issued derivative financial instruments, including interest rate swaps. Our outstanding debt to commercial lenders is generally based on a predetermined percentage above LIBOR or the lenders’ prime rate. At September 30, 2004, $21.0 million of our total long-term debt was subject to variable rates of interest, while the remaining $6.2 million of our total long-term debt was subject to fixed rates of interest. A hypothetical 100 basis point increase in market interest rates would result in additional annual interest expense of approximately $210,000. The fair value of our long-term debt, based on a discounted cash flow analysis, approximates its carrying value as of September 30, 2004.

Item 4. Controls and Procedures

(a)		Evaluation of Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us (including our consolidated subsidiaries) in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported in a timely manner.
(b)		Changes in Internal Control Over Financial Reporting. There has been no change in our internal control over financial reporting that occurred during the third quarter of 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II OTHER INFORMATION

     Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

     For the three months ended September 30, 2004, we issued the following securities that were not registered under the Securities Act of 1933, as amended. Each of the transactions described below was conducted in reliance upon the exemptions from registration provided in Sections 3(b) and 4(2) of the Securities Act and Regulation D and the other rules and regulations promulgated thereunder. Each of these issuances was made without the use of an underwriter, and the certificates and other documentation evidencing the securities issued in connection with these transactions bear a restrictive legend permitting transfer of the securities only upon registration under the Securities Act or pursuant to an exemption from registration.

•

On July 15, 2004, we issued 822 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers in a cashless exercise of warrants.

•

On July 15, 2004, we issued 2,832 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers in a cashless exercise of warrants.

•

On July 15, 2004, we issued 1,810 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers in a cashless exercise of warrants.

•

On July 15, 2004, we issued 1,899 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers in a cashless exercise of warrants.

•

On August 11, 2004, we issued 3,402 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers for $27,658 upon exercise of warrants.

•

On August 11, 2004, we issued 5,417 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers for $44,040 upon exercise of warrants.

•

On August 11, 2004, we issued 27,255 shares of our common stock to a corporation in a cashless exercise of warrants.

•

On August 17, 2004, we issued 645 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers for cashless exercise of warrants.

•

On September 14, 2004, we issued 9,021 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers for an aggregate of $73,341 upon exercise of warrants.

•

On September 14, 2004, we issued 2,373 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers for an aggregate of $19,292 upon exercise of warrants.

     Item 6. Exhibits.

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SIGNATURES

     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.

Symbion, Inc.

Date: November 12, 2004

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EXHIBIT INDEX

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