Form 10-K

(Mark One)

Commission file number: 000-50574

Symbion, Inc.

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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

     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 þ   No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

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

     The aggregate market value of the shares of the registrant’s common stock (based upon the closing price of these shares on the Nasdaq National Market on June 30, 2004) held by non-affiliates as of June 30, 2004, was approximately $218,848,365.

     As of February 28, 2005, 21,101,331 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive proxy statement for our annual meeting of stockholders to be held on May 10, 2005 are incorporated by reference into Part III of this report.

Table of Contents

Cautionary Note Regarding Forward-Looking Statements

     This Annual Report on Form 10-K contains forward-looking statements 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, 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. In particular, these include, among other things, statements relating to:

	•	our ability to attract and maintain good relationships with physicians who use our facilities;
	•	our ability to acquire and develop additional facilities on favorable terms and to integrate their business operations;
	•	our ability to enter into strategic alliances with health care systems and other health care providers that are leaders in their markets;
	•	our ability to negotiate favorable contracts on behalf of our facilities with managed care organizations or other third-party payors; and
	•	our ability to enhance operating efficiencies.

     These forward-looking statements involve various risks and uncertainties, some of which are beyond our control. Any or all of our forward-looking statements in this report may turn out to be wrong. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. They can be affected by inaccurate assumptions we might make or by known or unknown risks, uncertainties and assumptions, including the risks, uncertainties and assumptions described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors.”

     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.

     Our 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.

PART I

Item 1. Business

Overview

     We own and operate a network of surgery centers in 21 states. Our surgery centers provide non-emergency surgical procedures across many specialties. We offer services designed to meet the health care needs of the communities in which we operate and seek to develop strong relationships with physicians and other health care providers in these markets. We believe that one of our competitive advantages is the experience of our senior management team, with four of our executive officers having an average of over 25 years of experience in the health care industry, including senior management positions at public and private health care companies. The remaining six members of our senior management team have an average of over 20 years of experience in the health care industry. As of March 15, 2005, we owned and operated 47 surgery centers and managed nine additional surgery centers. Our surgery centers include three facilities that are licensed as hospitals, two of which we own and one of which we

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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 September 16, 2002, we reincorporated in Delaware. We were originally incorporated in Tennessee in January 1996 under the name UniPhy Healthcare, Inc. and focused on the development and management of physician networks. On June 25, 1999, we acquired Ambulatory Resource Centres, Inc., an owner and operator of surgery centers, and changed our name to Symbion, Inc. Since our acquisition of Ambulatory Resource Centres, we have focused on developing, acquiring and managing surgery centers, and have grown our operations from 14 to 56 surgery centers. During that period, we terminated all but three of our management agreements with physician networks and transferred our assets and liabilities relating to those terminated agreements to the physician networks in exchange for cash and our previously issued securities. We also modified our agreements with two of the remaining physician networks to require us to provide only management services. As a result of these actions, we now focus our business on developing, acquiring and managing surgery centers and it may be difficult to compare our historical operating results from period to period.

Surgery Center Industry

     Outpatient surgery has experienced tremendous growth since 1970, when the first surgery center opened in the United States, according to Verispan, L.L.C., an independent health care market research and information firm. Surgery centers are facilities where physicians can perform surgical procedures that generally do not require the patient to stay overnight. According to Verispan, about 3,957 outpatient surgery centers were operating in the United States as of February 2004, an increase of more than 50% since 1996. Based on data compiled by Verispan, the number of outpatient surgery cases performed annually in U.S. outpatient surgery centers increased from an estimated 4.3 million in 1996 to an estimated 8.3 million in 2004, representing a compound annual growth rate of about 9%.

     We believe that the following factors have contributed to the growth in surgery centers and outpatient surgical procedures:

	•	Physician and Patient Preference for Surgery Centers. Physicians often prefer to operate in surgery centers, as compared to acute care hospitals, because of the efficiency and convenience that surgery centers afford. Procedures performed at surgery centers are typically non-emergency, so physicians can schedule their time more efficiently and increase the number of procedures that they can perform in a given period. Surgery centers also provide physicians with greater scheduling flexibility, more consistent nurse staffing and faster turnaround time between cases, as compared to acute care hospitals. In addition, we believe patients prefer the comfort of a less institutional setting and the more convenient process for scheduling and registration available in surgery centers, as compared to acute care hospitals.
	•	Lower Cost Alternative. Based upon our management’s experience in the health care industry, we believe that surgeries performed in surgery centers are generally less expensive than those performed in acute care hospitals because of lower facility development costs, the focus on non-emergency procedures and more efficient staffing and work flow processes. We believe that cost-conscious payors are attracted to the lower costs afforded by surgery centers, as compared to acute care hospitals.
	•	Advanced Technology and Improved Anesthesia. Advancements in medical technology such as lasers, arthroscopy, fiber optics and enhanced endoscopic techniques have reduced the trauma of surgery and the amount of recovery time required by patients following a surgical procedure. Improvements in anesthesia also have shortened the recovery time for many patients and have reduced post-operative side effects such as pain, nausea and drowsiness. These medical advancements have enabled more patients to undergo surgery without an overnight stay and reduced the need for hospitalization following surgery.

     With an estimated 3,957 outpatient surgery centers operating in the United States as of February 2004, we believe significant opportunities exist for consolidation in this industry. The five largest national operators of outpatient surgery centers by number of centers represented an aggregate of less than 15% of the total number of outpatient surgery centers in the United States as of February 2004, according to Verispan. We believe that the surgery center industry will continue to consolidate because of the increasing complexity of the regulatory and

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managerial aspects of health care delivery, the growing influence of managed care, the rising cost of technology and the need for capital. We believe there are many surgery centers that are seeking to affiliate with experienced operators of facilities with access to capital, management expertise and other resources.

Our Strategy

     We intend to expand our network of surgery centers in attractive markets throughout the United States by acquiring established centers and developing new centers while enhancing the performance of our existing centers. We also seek to provide patients with high-quality surgical services across many specialties. When attractive opportunities arise, we may acquire or develop other types of facilities, including diagnostic centers. The key components of our strategy are to:

	•	Identify, recruit and retain leading surgeons and other physicians for our surgery centers. We believe that establishing and maintaining strong relationships with surgeons and other physicians is a key factor to our success in acquiring, developing and operating surgery centers. We identify and partner with surgeons and other physicians that we believe have established reputations for clinical excellence in their communities. We believe that we have had success in recruiting and retaining physicians because of the ownership structure of our surgery centers and our staffing, scheduling and clinical systems that are designed to increase physician productivity, promote physicians’ professional success and enhance the quality of patient care. We also believe that forming relationships with health care systems and other health care providers can enhance our ability to recruit physicians. We currently have strategic relationships with six health care systems.
	•	Capitalize on our experienced management team to pursue multiple growth opportunities in the surgery center market. We believe that the experience and capabilities of our senior management team provide a strategic advantage in improving the operations of our surgery centers, attracting physicians and identifying new development and acquisition opportunities. Four of our executive officers have an average of over 25 years of experience in the health care industry, including senior management positions at public and private health care companies. The remaining six members of our senior management team have an average of over 20 years of experience in the health care industry. Our management’s broad industry experience has allowed them to establish strong relationships with participants throughout the health care industry. These relationships are helpful in forming leads for acquisitions, and in making decisions about expanding into new markets and services. The experience and capabilities of our management team also enable us to pursue multiple growth strategies in the surgery center market, including acquisitions of established surgery centers, de novo developments in attractive markets, strategic relationships with prominent hospitals and other health care providers and turnaround opportunities in connection with underperforming facilities. We have successfully executed each of these growth strategies, and intend to pursue each of them in the future.
	•	Pursue a disciplined strategy of acquiring and developing surgery centers. Since January 1999, we have acquired 35 surgery centers and developed 15 surgery centers, including three surgery centers that we subsequently divested. We anticipate acquiring about three to four centers and developing three to four centers annually during the next three to five years. We seek to acquire and develop both single and multi-specialty surgery centers that meet our criteria, including prominence and quality of physician partners, specialty mix, opportunities for growth, level of competition in the local market, level of managed care penetration and our ability to access managed care organizations. Our acquisition and development team conducts extensive due diligence and applies a financial model that targets a threshold return on invested capital over a period of five years. Once we acquire a surgery center, our team establishes a strategic plan to improve the center’s operating systems, physician recruitment and facilities, and capitalize on the center’s competitive strengths. We have historically targeted majority ownership in our facilities and currently hold majority ownership interests in over 74% of the surgery centers in which we own an interest. Majority ownership allows us to make and execute managerial decisions which we believe provides greater opportunity for growth and higher returns. We also believe that by starting with majority ownership of a center, we can benefit by capturing a greater share of the value we create in managing and improving the center. We intend to continue to target majority ownership in our facilities. However, when attractive opportunities arise, we may acquire minority interests in surgery centers. When appropriate, we also may reduce our interest in majority owned surgery centers.

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Increase revenues and profitability of existing surgery centers through operational focus. We seek to increase revenues, profitability and return on our invested capital at all of our centers by focusing on operations. We have a dedicated team that is responsible for implementing best practices, cost controls and overall efficiencies at each of our surgery centers. Our centers benefit from our network of facilities by sharing best practices and participating in group purchasing agreements designed to reduce the cost of supplies and equipment. We intend to continue to recruit additional physicians and expand the range of services offered at our surgery centers to increase the number and types of surgeries performed in our centers. We are committed to enhancing programs and services for our physicians and patients by providing advanced technology, quality care, cost-effective service and convenience.

Operations

   Surgery Center Operations

     As of March 15, 2005, we owned and operated 47 surgery centers and managed nine surgery centers. Three of our facilities are licensed as hospitals, two of which we own and one of which we manage. Our typical surgery center is a freestanding facility with about 14,000 square feet of space and four fully equipped operating rooms, two treatment rooms and ancillary areas for preparation, recovery, reception and administration. Our surgery centers provide non-emergency surgical procedures among many specialties, including orthopedic, obstetrics/gynecology, general surgery, ear, nose and throat, pain management, gastrointestinal, plastic surgery and ophthalmology. Our surgery centers that are licensed as hospitals may also provide additional services such as diagnostic imaging, pharmacy, laboratory and obstetrical services. In certain markets where we believe it is appropriate, we operate surgery centers that focus on a single specialty.

     Our surgery centers are generally located in close proximity to physicians’ offices. Each facility typically employs a staff of about 30, depending on its size, the number of cases and the type of services provided. Our staff at each center generally includes a center administrator, a business manager, a medical director, registered nurses, operating room technicians and clerical workers. At each of our surgery centers, we have arrangements with anesthesiologists to provide anesthesiology services. We also provide each of our surgery centers with a full range of financial, marketing and operating services. For example, our regional managed care directors assist the local management team at each of our centers in developing relationships with managed care providers and negotiating managed care contracts.

     All of our surgery centers are Medicare certified. To ensure that a high level of care is provided, we implement quality assurance procedures at each of our surgery centers. Each of our surgery centers is available for use only by licensed physicians who have met professional credentialing requirements established by the center’s medical advisory committee. In addition, each center’s medical director supervises and is responsible for the quality of medical care provided at the center.

   Surgery Center Ownership Structure

     We own and operate our surgery centers through partnerships or limited liability companies. Local physicians or physician groups also own an interest in most of our surgery centers. In some cases, a hospital may own an interest in our surgery center. One of our wholly-owned subsidiaries typically serves as the general partner or majority member of our surgery centers. We generally own a majority interest in our surgery centers, or otherwise have sufficient control over the centers to be able to consolidate the financial results of operations of the centers with ours. In some instances, we will acquire an ownership interest in a surgery center with the prior owners retaining an ownership interest, and, in some cases, we offer new ownership interests to other physicians or hospital partners. We own a majority interest in 35 of the 47 surgery centers in which we own an interest. We typically guarantee all of the debts of these partnerships and limited liability companies, even though we do not own all of the ownership interests in the surgery centers. We also have a management arrangement with each of the surgery centers, under which we provide day-to-day management services for a management fee, which is typically based on a percentage of the revenues of the center.

     Each of the partnerships and limited liability companies through which we own and operate our surgery centers is governed by a partnership or operating agreement. These partnership and operating agreements typically provide,

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among other things, for voting rights and limited transfer of ownership interests. The partnership and operating agreements also provide for the distribution of available cash to the owners, in some cases on a quarterly basis. In addition, the agreements typically restrict the physician owners from owning an interest in a competing surgery center during the period in which the physician owns an interest in our center and for one year after that period. The partnership and operating agreements for our centers typically provide that the centers will purchase all of the physicians’ ownership interests if certain adverse regulatory events occur, such as it becoming illegal for the physicians to own an interest in a surgery center, refer patients to a center or receive cash distributions from a surgery center. The purchase price that we would be required to pay for these ownership interests is based on pre-determined formulas, typically either a multiple of the center’s EBITDA (defined as operating income (loss) plus depreciation and amortization) or the fair market value of the ownership interests as determined by a third-party appraisal. Some of these agreements require us to make a good faith effort to restructure our relationships with the physician investors in a manner that preserves the economic terms of the relationship prior to purchasing these interests. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors” and “— Government Regulation.” In certain circumstances, we have the right to purchase a physician’s ownership interests, including upon a physician’s breach of the noncompetition provisions of a partnership or operating agreement. In some cases, we have the right to require the physician owners to purchase our ownership interest in the event our management agreement with a center is terminated. In one center, the physician owners have the right to purchase our ownership interest upon a change in our control.

     We currently manage seven surgery centers without owning an interest in them through a strategic alliance with a hospital system located in the Memphis, Tennessee area. We also manage a surgery center licensed as a hospital located in Kansas City, Kansas in which we have no ownership interest. In addition, we own an interest in a limited liability company which assisted in the development of a surgery center in Lynbrook, New York and which provides administrative services to the surgery center.

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Surgery Centers

     The following table sets forth information regarding each of our surgery centers as of February 28, 2005:

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   Case Mix

     The following table sets forth the percentage of cases in each specialty performed in 2004 and 2003 at surgery centers in which we owned an interest as of December 31, 2004 and December 31, 2003:

     The changes in case mix from 2003 to 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 during 2003 and 2004.

   Case Growth

     The following table sets forth information from facilities in which we owned an interest and managed throughout the years ended December 31, 2004 and 2003, respectively:

     The following table sets forth information from facilities that we consolidate for financial reporting purposes (which includes surgery centers we have acquired or developed since January 1, 2003) for the years ended December 31, 2004 and 2003, respectively:

   Payor Mix

     The following table sets forth by type of payor the percentage of our patient service revenues generated in 2004 for surgery centers in which we owned an interest as of December 31, 2004:

   Strategic Relationships

     When attractive opportunities arise, we may develop, acquire or operate surgery centers through strategic alliances with health care systems and other health care providers. We believe that forming a relationship with a medical center can enhance our ability to recruit physicians and access managed care contracts for our facilities in that market. We currently have strategic relationships with:

	•	Vanderbilt Health Services, Inc., with which we own and operate a surgery center in Franklin, Tennessee;
	•	Vanguard Health Systems, Inc., with which we own and operate a surgery center in San Antonio, Texas;
	•	Baptist Memorial Health Services, Inc., for which we manage seven surgery centers in Memphis, Tennessee and surrounding areas;
	•	University Health System, Inc., with which we own and operate a surgery center in Knoxville, Tennessee;
	•	Harris Methodist Ft. Worth, with which we own and operate a surgery center in Fort Worth, Texas; and
	•	Maury Regional Healthcare System, with which we own and operate a surgery center in Columbia, Tennessee.

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     The strategic relationships through which we own and operate surgery centers are governed by partnership and operating agreements that are generally comparable to the partnership and operating agreements of the other surgery centers in which we own an interest. The primary difference between the structure of these strategic relationships and the other surgery centers in which we own an interest is that, in the strategic relationships, a health care system holds an ownership interest in the surgery center, in addition to physician investors. For a general description of the terms of our partnership and operating agreements, see “— Operations — Surgery Center Ownership Structure.” In each of these strategic relationships, we have also entered into a management agreement under which we provide day-to-day management services for a management fee based on a percentage of the revenues of the surgery center. The terms of those management agreements are comparable to the terms of our management agreements with other surgery centers in which we own an interest.

     We manage seven surgery centers owned by Baptist Memorial Health Services, Inc. under management agreements with Baptist Memorial, in exchange for a management fee based on a percentage of the revenues of these surgery centers. The management agreements terminate on various dates from March 2006 to June 2008 and may be terminated earlier by either party for material breach after notice and an opportunity to cure. We have also entered into a development agreement with Baptist Memorial under which we are to provide development support for new surgery centers that may be developed by Baptist Memorial in exchange for a development fee negotiated for each developed center.

   Acquisition and Development of Surgery Centers

     We intend to expand our presence in the surgery center market by making strategic acquisitions of existing surgery centers and by developing new surgery centers in cooperation with local physician partners and, when appropriate, with hospitals and other strategic partners.

     Acquisition Program. We employ a dedicated acquisition team with experience in health care services. Our team seeks to acquire surgery centers that meet our criteria, including prominence and quality of physician partners, specialty mix, opportunities for growth, level of competition in the local market, level of managed care penetration and our ability to access managed care organizations. Our team utilizes their extensive industry contacts, as well as referrals from current physician partners and other sources, to identify, contact and develop potential acquisition candidates.

     We believe there are numerous acquisition opportunities that would pass our general screening criteria. We carefully evaluate each of our acquisition opportunities through an extensive due diligence process to determine which facilities have the greatest potential for growth and profitability improvements under our operating structure. In many cases, the acquisition team identifies specific opportunities to enhance a center’s productivity post-acquisition. For example, we may renovate or construct additional operating or treatment rooms in existing facilities to meet anticipated demand for procedures based on analysis of local market characteristics. Our team may also identify opportunities to recruit additional physicians to increase the acquired facility’s revenues and profitability. Once we decide to proceed with an acquisition proposal, we use a pricing strategy that targets a threshold return on invested capital over a period of five years. We have acquired 35 surgery centers since January 1999 and anticipate acquiring about three to four centers annually during the next three to five years.

     Development Program. We develop surgery centers in markets in which we anticipate substantial interest by physicians and payors. We have experience in developing both single and multi-specialty surgery centers. When we develop a new surgery center, we generally provide all of the services necessary to complete the project. We offer in-house capabilities for structuring partnerships and financing facilities and work with architects and construction firms in the design and development of facilities. Before and during the development phase of a new center, we analyze the competitive environment in the local market, review market data to identify appropriate services to provide, prepare and analyze financial forecasts, evaluate regulatory and licensing issues and assist in designing the center and identifying appropriate equipment to purchase or lease. After the surgery center is developed, we generally provide startup operational support, including information systems, equipment procurement and financing. We have developed 15 surgery centers since January 1999 and anticipate developing about three to four centers annually during the next three to five years.

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     Development and construction of a surgery center generally takes us from 12 to 18 months, depending on whether we are building the facility or improving available space. Estimated construction costs generally total from $1.0 million to $2.5 million for improving existing space. Equipment and other furnishing costs generally range from $1.0 million to $3.0 million. In addition, working capital of approximately $1.0 million to $1.5 million is generally required to sustain operations for the initial six to 12 months of operations. We historically financed these costs through capital contributions from investors in the center, borrowings under our facility loan agreements and long-term facility lease agreements. We expect to finance these costs in the future with borrowings under our senior credit facility and capital contributions from investors in the centers. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Other Services

     Although our business is primarily focused on owning and operating surgery centers, we also provide other services that complement our core surgery center business.

   Diagnostic Centers

     We operate Dry Creek Imaging Center, a diagnostic imaging center that is adjacent to our surgery center in the Denver, Colorado market. We own a 90% interest in the diagnostic imaging center through a joint venture with Touchstone Medical Imaging, LLC. Dry Creek Imaging Center currently provides MRI, CT, ultrasound and mammography procedures. Touchstone and Dry Creek Imaging Center have entered into a management agreement, under which Touchstone provides daily management and administrative services to the diagnostic center in exchange for a percentage of the diagnostic center’s net revenues. The initial term of the management agreement expires in 2006, and may be renewed for additional renewal terms of one year each. We believe the services provided by this diagnostic center complement and support the services provided by our surgery center in this market.

     We also operate Erie Imaging Center, a diagnostic imaging center that is adjacent to our surgery center in Erie, Pennsylvania. We own a 51% interest in this diagnostic center through a joint venture with Touchstone. This diagnostic imaging center opened during the third quarter of 2004. The joint venture has entered into a management agreement with Touchstone under which Touchstone provides daily management and administrative services to the diagnostic center in exchange for a percentage of the diagnostic center’s net revenues. The initial term of the management agreement expires on December 19, 2008 and may be renewed for additional renewal terms of one year each. After December 19, 2005, either party to the management agreement has the right to terminate the management agreement. In the event that we terminate the management agreement without cause, Touchstone has the right to require us to repurchase its ownership interest in the joint venture. We believe the services provided by this diagnostic center complement and support the services provided by our surgery center in this market.

     We may explore the possibility of selectively purchasing and developing additional diagnostic centers in the markets in which we operate surgery centers.

   Physician Networks

     We currently manage physician networks in Memphis, Tennessee, Johnson City, Tennessee and Louisville, Kentucky. Each of these physician networks has entered into an agreement with us, which provides, among other things, that we will provide billing, financial services and other business management services in exchange for a management fee. One of the physician networks is an independent practice association, or IPA, of health care providers located in the greater Louisville, Kentucky area. We believe this network is complementary to our local surgery center by providing the center with greater access to managed care contracts.

Information Systems and Controls

     Each of our surgery centers uses a standard financial reporting system that provides information to our corporate office to track financial performance on a timely basis. In addition, each of our facilities uses an operating system to manage its business that provides critical support in areas such as scheduling, billing and collection, accounts receivable management, purchasing and other essential operational functions. We have implemented a standardized

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system to support all of our facilities and to enable us to access more easily information about our centers on a timely basis. The information system has been installed in all of our surgery centers, except for those facilities we acquired recently.

     We calculate net revenues through a combination of manual and system-generated processes. Our operating systems include insurance modules that allow us to establish profiles of insurance plans and their respective payment rates. The systems then match the charges with the insurance plan rates and compute a contractual adjustment estimate for each patient account. We then manually review the reasonableness of the systems’ contractual adjustment estimate using the insurance profiles. This estimate is adjusted, if needed, when the insurance payment is received and posted to the account. Net revenue is computed and reported by the systems as a result of this activity.

     It is our policy to collect co-payments and deductibles prior to providing services. It is also our policy to verify a patient’s insurance 72 hours prior to the patient’s procedure. Because our services are non-emergency, our facilities have the ability to control these processes. We do not track exceptions to these policies, but we believe that they occur infrequently and involve insignificant amounts. When they do occur, we require patients whose insurance coverage is not verified to assume full responsibility for the fees prior to services being rendered and we seek prompt payment of co-payments and deductibles and verification of insurance following the procedure.

     We manually input each patient’s account record and the associated billing codes. Our operating systems then calculate the amount of fees for that patient and the amount of the contractual adjustments. Claims are submitted electronically if the payor accepts electronic claims. We use clearinghouses for electronic claims, which then forward the claims to the respective payors. Payments are manually input to the respective patient accounts.

     We have developed proprietary measurement tools to track key operating statistics at each of our surgery centers by integrating data from our local operating systems and our standardized financial system. Management uses these tools to measure operating results against target thresholds and to identify, monitor and adjust areas such as specialty mix, staffing, operating costs, employee expenses and accounts receivable management. Our corporate and facility-level management team is compensated in part using performance-based incentives focused on revenue growth and improvement in operating income.

Marketing

     Our sales and marketing efforts are directed primarily at physicians, who are responsible for referring patients to our facilities. Marketing activities directed at physicians and other health care providers are coordinated locally by the individual facility and are supplemented by dedicated corporate personnel. These activities generally emphasize the benefits offered by our surgery centers compared to other facilities in the market, such as the proximity of our facilities to physicians’ offices, the ability to schedule consecutive cases without preemption by inpatient or emergency procedures, the efficient turnaround time between cases, our advanced surgical equipment and our simplified administrative procedures. Although the facility administrator is the primary point of contact, physicians who utilize our surgery centers are important sources of recommendations to other physicians regarding the benefits of using our facilities. Each facility administrator develops a target list of physicians and we continually review these marketing lists and the facility administrator’s progress in contacting and successfully attracting additional local physicians.

     We also market our surgery centers directly to payors, including HMOs, PPOs and other managed care organizations, employers and other payors. Payor marketing activities conducted by our corporate office management and facility administrators emphasize the high quality of care, cost advantages and convenience of our facilities, and are focused on making each facility an approved provider under local managed care plans.

Competition

     In each market in which we operate a surgery center, we compete with hospitals and operators of other surgery centers to attract physicians and patients. We believe that the competitive factors that affect our centers’ ability to compete for physicians are convenience of location of the surgery center, access to capital and participation in managed care programs. We believe that our centers attract patients based upon our quality of care, the specialties

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and reputations of the physicians who operate in our centers, participation in managed care programs, ease of access and convenient scheduling and registration procedures.

     In developing or acquiring existing surgery centers, we compete with other public and private surgery center and hospital companies. Several large national companies own and/or manage surgery centers and surgical hospitals, including HEALTHSOUTH Corporation, HCA Inc., Universal Health Services, Inc., AmSurg Corp. and United Surgical Partners International, Inc. In general, these companies have greater resources and access to capital than we do. We also face competition from local hospitals, physician groups and other providers who may compete with us in the ownership and operation of surgery centers.

Employees

     At December 31, 2004, we had about 2,300 employees, of which about 1,450 were full-time employees. None of our employees are represented by a collective bargaining agreement. We believe that we have a good relationship with our employees.

Environmental

     We are subject to various federal, state and local laws and regulations relating to the protection of the environment and human health and safety, including those governing the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. Our operations include the use, generation and disposal of hazardous materials. We may, in the future, incur liability under environmental statutes and regulations with respect to contamination of sites we own or operate (including contamination caused by prior owners or operators of such sites, abutters or other persons) and the off-site disposal of hazardous substances. We believe that we have been and are in substantial compliance with the terms of all applicable environmental laws and regulations and that we have no liabilities under environmental requirements that we would expect to have a material adverse effect on our business, results of operations or financial condition.

Insurance

     We maintain liability insurance in amounts that we believe are appropriate for our operations. Currently, we maintain professional and general liability insurance that provides coverage on a claims made basis of $1.0 million per occurrence and $3.0 million in annual aggregate coverage per facility. We also maintain business interruption insurance and property damage insurance, as well as an additional umbrella liability insurance policy in the aggregate amount of $10.0 million. Coverage under certain of these policies is contingent upon the policy being in effect when a claim is made regardless of when the events which caused the claim occurred. The cost and availability of such coverage has varied widely in recent years. While we believe that our insurance policies are adequate in amount and coverage for our anticipated operation, we cannot assure you that the insurance coverage is sufficient to cover all future claims or will continue to be available in adequate amounts or at a reasonable cost.

Reimbursement

     Payments under the Medicare program to ambulatory surgery centers are made under a system whereby the Secretary of Health and Human Services determines payment amounts prospectively for various categories of medical services performed in ambulatory surgery centers, subject to an inflation adjustment. The various state Medicaid programs also pay us a fixed payment for our services, which amount varies from state to state. About 19.1% of our patient service revenues during 2004 were attributable to Medicare and Medicaid payments.

     The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, commonly referred to as the Medicare Modernization Act, limits increases in Medicare reimbursement rates for ambulatory surgery centers. Under the Medicare Modernization Act, the 2% increase in Medicare reimbursement rates for ambulatory surgery centers that became effective on October 1, 2003 was limited beginning April 1, 2004 to an amount equal to the increase in the Consumer Price Index for all urban consumers as estimated by the Secretary of the Department of Health and Human Services for the 12-month period ended March 31, 2003, minus 3.0 percentage points. The Medicare Modernization Act also provides that there will be no increase in these rates during the years 2005 through 2009. The Medicare Modernization Act also directs the General Accounting Office to conduct a study comparing

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the cost of procedures in surgery centers to the cost of procedures performed in hospital outpatient departments. The General Accounting Office was directed to submit the results of its study to the Centers for Medicare and Medicaid Services, or CMS, by no later than January 1, 2005. However, no report had been publicly released as of March 25, 2005. CMS is directed to develop a new ambulatory surgery center payment system based upon the Medicare hospital outpatient department payment system so that it is effective on or after January 1, 2006 and no later than January 1, 2008. The Medicare Modernization Act provides that, in the year that the new payment system is implemented, it must be designed to result in the same aggregate amount of expenditures for surgical services provided at ambulatory surgery centers as would be made if the new system were not adopted. The rate changes mandated by the Medicare Modernization Act could have a material adverse effect on the revenues of our centers, but we cannot predict the full effect of the payment rate revisions.

     A rule proposed by CMS would make substantial changes to the rate-setting methodology, payment rates, payment policies and the list of covered surgical procedures for ambulatory surgery centers. Among the proposed changes is a shift from eight payment groups to 105 ambulatory payment classifications. To date, CMS has not implemented this payment methodology, and in light of the payment study mandated by the Medicare Modernization Act, it is uncertain whether this proposed surgery center payment methodology will be implemented. If implemented in its proposed form, the change in payment methodology could reduce our Medicare revenues, depending on the volume and type of procedures performed at a particular facility. The proposed rule does not apply to our facilities licensed as hospitals.

     The Medicare Payment Advisory Commission, or MedPAC, and the Office of the Inspector General of the Department of Health and Human Services, or OIG, have both recently recommended changes to the Medicare payment methodology for ambulatory surgery centers. MedPAC is a congressional advisory board charged with advising Congress on Medicare payment issues, while the OIG is a governmental agency responsible for investigating and monitoring Medicare, Medicaid and other Department of Health and Human Services programs. Generally, MedPAC and the OIG have recommended that reimbursement levels for ambulatory surgery center procedures be reduced. These are recommendations only and it is uncertain if Congress will act on either or both recommendations. If these recommendations become effective, our revenue and profitability could be adversely affected. While most of our existing surgery center surgical procedures are generally reimbursed at levels lower than hospital outpatient departments, some of our existing surgical procedures are reimbursed at higher levels. These recommended changes do not apply to our facilities licensed as hospitals. A reduction in reimbursement levels could have a material adverse effect on the revenues of our centers.

     Three of our facilities, including one managed facility, are licensed as hospitals. The Medicare program pays hospitals on a prospective payment system for acute inpatient services. Under this prospective payment system, a hospital receives a fixed amount for inpatient hospital services based on each patient’s final diagnosis. These payments do not consider a specific hospital’s costs, but are national rates adjusted for area wage differentials and case-mix index. For several years, the percentage increases to the prospective payment rates have been generally lower than the percentage increases in the costs of goods and services by hospitals. Most outpatient services provided by hospitals are reimbursed by Medicare under the outpatient prospective payment system. The Balanced Budget Act of 1997 mandated the implementation of the prospective payment system for Medicare outpatient services. This outpatient prospective payment system is based on a system of Ambulatory Payment Categories. Each Ambulatory Payment Category represents a bundle of outpatient services, and each Ambulatory Payment Category has been assigned a fully prospective reimbursement rate.

     Most private third-party payors pay a facility fee to freestanding surgery centers for the use of the facility in addition to paying professional fees directly to the physicians performing the medical services. We received approximately 74% of our revenue in 2004 from private third-party payors. Market and cost factors affecting the fee structure, cost containment and utilization decisions of third-party payors and other payment factors over which we have no control may affect the revenues of our centers.

     Our centers also provide services to injured workers and receive payment from workers’ compensation payors pursuant to the workers’ compensation laws of the various states. Workers’ compensation payment amounts are subject to legislative, regulatory, and other payment changes over which we have no control. A reduction in workers’ compensation payment amounts could have a material adverse effect on the revenues of our centers.

     We cannot predict what further legislation may be enacted or what regulations or guidelines may be established concerning third-party reimbursement by state, federal or private programs. Reductions or changes in these programs could have a material adverse affect on our business.

Governmental Regulation

   General

     The health care industry is highly regulated, and we cannot assure you that the regulatory environment in which we operate will not change significantly in the future or that we will be able to successfully address changes in the regulatory environment. In addition to extensive, existing government health care regulation, there continues to be numerous initiatives on the federal and state levels affecting the payment for and availability of health care services. We believe that these health care initiatives will continue during the foreseeable future. Some of the reform initiatives proposed in the past, such as further reductions in Medicare and Medicaid payments and additional

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prohibitions on physician ownership of facilities to which they refer patients, could, if adopted, adversely affect us and our business.

     Every state imposes licensing requirements on individual physicians and health care facilities. In addition, federal and state laws regulate HMOs and other managed care organizations. Many states require regulatory approval, including certificates of need, before establishing certain types of health care facilities, including surgery centers offering services we offer, or making expenditures in excess of statutory thresholds for health care equipment, facilities or programs. We believe that outpatient surgery and diagnostic services will continue to be subject to intense regulation at the federal and state levels.

     Our ability to operate profitably will depend in part upon all of our facilities obtaining and maintaining all necessary licenses, certificates of need and other approvals and operating in compliance with applicable health care regulations. If we fail to obtain any necessary licenses or certifications or fail to maintain our existing licenses and certifications, it could have a material adverse effect on our business.

     The laws of many states prohibit physicians from splitting fees with non-physicians, prohibit non-physician entities (such as us) from practicing medicine and prohibit referrals to facilities in which physicians have a financial interest. We believe our activities do not violate these state laws; however, we cannot assure you that future interpretations of, or changes in, these laws might require structural and organizational modifications of our existing relationships with our facilities and physician networks, and we cannot assure you that we would be able to appropriately modify such relationships. In addition, statutes in some states could restrict our expansion into those states.

     Our facilities are subject to federal, state and local laws dealing with issues such as occupational safety, employment, medical leave, insurance regulations, civil rights, discrimination, building codes, and medical waste and other environmental issues. Federal, state and local governments are expanding the regulatory requirements on businesses. The imposition of these regulatory requirements may have the effect of increasing operating costs and reducing the profitability of our operations.

     We are unable to predict what additional government regulations, if any, affecting our business may be enacted in the future or how existing or future laws and regulations might be interpreted. If we, or any of our facilities, fail to comply with applicable laws, it might have a material adverse effect on our business.

   Licensure and Certificates of Need

     Capital expenditures for the construction of new facilities, the addition of beds or the acquisition of existing facilities may be reviewable by state regulators under statutory schemes that are sometimes referred to as certificate of need laws. States with certificate of need laws place limits on the construction and acquisition of health care facilities and the expansion of existing facilities and services. In these states, approvals are required for capital expenditures exceeding amounts that involve certain facilities or services, including surgery centers.

     State certificate of need laws generally provide that, prior to the addition of new beds, the construction of new facilities or the introduction of new services, a designated state health planning agency must determine that a need exists for those beds, facilities or services. The certificate of need process is intended to promote comprehensive health care planning, assist in providing high quality health care at the lowest possible cost and avoid unnecessary duplication by ensuring that only those health care facilities that are needed will be built.

     Typically, the provider of services submits an application to the appropriate agency with information concerning the area and population to be served, the anticipated demand for the facility or service to be provided, the amount of capital expenditure, the estimated annual operating costs, the relationship of the proposed facility or service to the overall state health plan and the cost per patient day for the type of care contemplated. The issuance of a certificate of need is based upon a finding of need by the agency in accordance with criteria set forth in certificate of need laws and state and regional health facilities plans. If the proposed facility or service is found to be necessary and the applicant to be the appropriate provider, the agency will issue a certificate of need containing a maximum amount of expenditure and a specific time period for the holder of the certificate of need to implement the approved project.

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     Our health care facilities are also subject to state licensing requirements for medical providers. Our surgery centers have licenses to operate as ambulatory surgery centers in the states in which they operate, except for one facility in Kansas, one facility in Louisiana and one facility in Oklahoma that are licensed as hospitals. Even though these facilities licensed as hospitals provide surgical services, they must meet all applicable requirements for general hospital licensure. Our surgery centers that are licensed as ambulatory surgery centers must meet all applicable requirements for ambulatory surgery centers. To assure continued compliance with these regulations, governmental and other authorities periodically inspect our facilities. The failure to comply with these regulations could result in the suspension or revocation of a facility’s license.

   Medicare and Medicaid Participation

     The majority of our revenues are expected to continue to be received through third-party reimbursement programs, including state and federal programs, such as Medicare and Medicaid, and private health insurance programs. Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are 65 or older or who are disabled. Medicaid is a health insurance program jointly funded by state and federal governments that provides medical assistance to qualifying low income persons. Each state Medicaid program covers in-patient hospital services and has the option to provide payment for surgery center services. The Medicaid programs of all of the states in which we currently operate cover surgery center services; however, these states may not continue to cover surgery center services and states into which we expand our operations may not cover or continue to cover surgery center services.

     To participate in the Medicare program and receive Medicare payment, our facilities must comply with regulations promulgated by the Department of Health and Human Services. Among other things, these regulations, known as “conditions of participation,” relate to the type of facility, its equipment, its personnel and its standards of medical care, as well as compliance with state and local laws and regulations. Our facilities must also satisfy the conditions of participation in order to be eligible to participate in the Medicaid program. The requirements for certification under Medicare and Medicaid are subject to change and, in order to remain qualified for these programs, we may have to make changes from time to time in our facilities, equipment, personnel or services. Although we intend to continue to participate in these reimbursement programs, we cannot assure you that our facilities will continue to qualify for participation.

     The ambulatory surgery center Medicare conditions of participation prohibit surgery centers from performing surgical procedures on Medicare patients if it is anticipated that the patient will require overnight recovery. Historically, however, CMS has permitted ambulatory surgery centers to keep non-Medicare patients for up to 23 hours. On March 11, 2004, CMS issued a Memorandum to State Survey Agency Directors stating that an ambulatory surgery center that routinely provides 23 hour recovery services to non-Medicare patients will jeopardize the facility’s Medicare certification. CMS is expected to clarify or revise this new interpretation of the Medicare ambulatory surgery center regulations. If CMS does not modify this interpretation, our centers would be unable to routinely offer services to patients requiring extended recovery time, and our revenues could decrease as a consequence.

   Antitrust Laws

     Federal and state antitrust laws prohibit price fixing among competitors. Independent physicians who are not economically integrated through a group practice or some other method of sharing substantial financial risk may be considered “competitors” under antitrust laws and subject to prohibitions on price fixing. Price fixing is considered a per se violation of federal antitrust laws. The Federal Trade Commission, or FTC, and the Department of Justice have the authority to bring civil and criminal enforcement actions against persons and entities who violate federal antitrust laws. Moreover, competitors and customers who are injured by activities that violate federal antitrust laws may bring civil actions against the alleged violator. In some cases, treble damages are available to an injured competitor or customer.

     Networks of physicians, such as the IPA that we manage, involve price discussions among competitors, which create antitrust concerns. In recognition of the beneficial nature of these entities in a changing health care

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environment, the FTC and the Department of Justice have issued several joint policy statements regarding enforcement in the health care industry that set forth “antitrust safety zones” in which a network may safely operate.

     The IPA that we manage may not fit within a safety zone. However, the policy statements issued by the Department of Justice and the FTC provide that the failure of an IPA to meet all of the requirements of a safety zone will not render the activities of the IPA per se illegal. The government will examine IPA arrangements on a case by case or “rule of reason” basis to determine if the IPA can demonstrate that its members are economically or clinically integrated and that the pro-competitive aspects of the IPA outweigh the anti-competitive aspects. If there are sufficient pro-competitive aspects to the IPA, it should not be held to be illegal. The FTC and the Department of Justice will provide advisory opinions regarding the compliance of physician network arrangements with the antitrust statutes; however, we have not sought such an opinion.

   Medicare Fraud and Abuse and Anti-Referral Laws

     The Social Security Act includes provisions addressing false statements, illegal remuneration and other fraud. These provisions are commonly referred to as the Medicare Fraud and Abuse Laws, and include the statute commonly referred to as the federal anti-kickback statute. The federal anti-kickback statute prohibits providers and others from, among other things, soliciting, receiving, offering or paying, directly or indirectly, any remuneration in return for either making a referral for a service or item covered by a federal health care program or ordering or arranging for or recommending the order of any covered service or item. Violations of the federal anti-kickback statute are punishable by a fine of up to $50,000 or imprisonment for each violation, as well as damages up to three times the total amount of remuneration.

     In addition, the Medicare Patient and Program Protection Act of 1987, as amended by the Health Insurance Portability and Accountability Act of 1996, commonly referred to as HIPAA, and the Balanced Budget Act of 1997, imposes civil monetary penalties for a violation of the Medicare Fraud and Abuse Laws, as well as exclusion from federal health care programs. Pursuant to the enactment of HIPAA, as of June 1, 1997, the Secretary of Health and Human Services may, and in some cases must, exclude individuals and entities from participating in any government health care program that the Secretary determines have “committed an act” in violation of the Medicare Fraud and Abuse Laws or have improperly filed claims in violation of the Medicare Fraud and Abuse Laws. HIPAA also expanded the Secretary’s authority to exclude a person involved in fraudulent activity from participation in a program providing health benefits, whether directly or indirectly, which is funded directly, in whole or in part, by the U.S. government.

     Because physician-investors in our surgery centers are in a position to generate referrals to the centers, the distribution of available cash to those investors could come under scrutiny under the federal anti-kickback statute. The U.S. Court of Appeals for the Third Circuit has held that the federal anti-kickback statute is violated if one purpose (as opposed to a primary or sole purpose) of a payment to a provider is to induce referrals. Other federal circuit courts have followed this decision. None of these cases involved a joint venture such as those owning and operating our surgery centers and it is not clear how a court would apply these holdings to our activities. It is clear, however, that a physician’s investment income from a surgery center may not vary with the number of his or her referrals to the surgery center, and we comply with this prohibition.

     In a case involving a physician-owned joint venture, the U.S. Court of Appeals for the Ninth Circuit held that the federal anti-kickback statute is violated when a person or entity (1) knows that the statute prohibits offering or paying remuneration to induce referrals and (2) engages in prohibited conduct with the specific intent to violate the law. In that case, the joint venture was determined to have violated the law because its agent solicited prospective limited partners by implying that eligibility to purchase shares in the limited partnership was dependent on an agreement to refer business to it, told prospective limited partners that the number of shares they would be permitted to purchase would depend on the volume of business they referred, and stated that partners who did not refer business would be pressured to leave the partnership. The joint venture was vicariously liable for the actions of its agents, notwithstanding that the agent’s actions were contrary to the principal’s stated policy.

     Further, under HIPAA, individuals who hold a direct or indirect ownership or controlling interest in an entity that is found to violate the Medicare Fraud and Abuse Laws may also be excluded from the Medicare and Medicaid programs if the individual knew or should have known of the activity leading to the conviction or exclusion of the

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entity, or where the individual is an officer or managing employee of the entity. Under HIPAA, the term “should know” means that a person acts in deliberate ignorance or reckless disregard of the truth or falsity of the information. This standard does not require that specific intent to defraud be proven by the OIG.

     Under regulations issued by the OIG, certain categories of activities are deemed not to violate the federal anti-kickback statute. According to the preamble to these safe harbor regulations, the failure of a particular business arrangement to comply with the regulations does not determine whether the arrangement violates the federal anti-kickback statute. The safe harbors do not make conduct illegal, but instead outline standards that, if complied with, protect conduct that might otherwise be deemed in violation of the federal anti-kickback statute.

     One earlier safe harbor protects profit distributions to investors in small entity joint ventures, such as limited partnerships, if certain conditions are met. However, we believe that our ownership and operation of our facilities, will not satisfy this safe harbor for small entity joint ventures, because this safe harbor requires that no more than 40% of the value of each class of investment interests be held by investors in a position to make or influence referrals or to generate business for the entity, and we anticipate that our facilities will not meet this requirement.

     The OIG published an expanded listing of safe harbors under the federal anti-kickback statute on November 19, 1999. The new, expanded provisions include a safe harbor designed to protect distributions to physician investors in ambulatory surgery centers who refer patients directly to the center and personally perform the procedures as an extension of their practice. The safe harbor for surgery center ownership protects four categories of investors, including facilities owned by general surgeons, single-specialty physicians, multi-specialty physicians and hospital/physician ventures, provided that certain requirements are satisfied.

     The requirements include the following:

     1. The center must be an ambulatory surgery center certified to participate in the Medicare program and its operating and recovery room space must be dedicated exclusively to the surgery center and not a part of a hospital (although such space may be leased from a hospital if such lease meets the requirements of the safe harbor for space rental).

     2. Each investor must be either (a) a physician who derived at least one-third of his or her medical practice income for the previous fiscal year or 12-month period from performing procedures on the list of Medicare-covered procedures for ambulatory surgery centers, (b) a hospital, or (c) a person or entity not in a position to make or influence referrals to the center, nor to provide items or services to the center, nor employed by the center or any investor.

     3. Unless all physician-investors are members of a single specialty, each physician-investor must perform at least one-third of his or her procedures at the center each year. (This requirement is in addition to the requirement that the physician-investor has derived at least one-third of his or her medical practice income for the past year from performing procedures.)

     4. Physician-investors must have fully informed their referred patients of the physician’s investment interest.

     5. The terms on which an investment interest is offered to an investor are not related to the previous or expected volume of referrals, services furnished or the amount of business otherwise generated from that investor to the entity.

     6. Neither the center nor any other investor may loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest.

     7. The amount of payment to an investor in return for the investment interest is directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor.

     8. All physician-investors, any hospital-investor and the center agree to treat patients receiving medical benefits or assistance under the Medicare or Medicaid programs.

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     9. All ancillary services performed at the center for beneficiaries of federal health care programs must be directly and integrally related to primary procedures performed at the center, and may not be billed separately.

     10. No hospital-investor may include on its cost report or any claim for payment from a federal health care program any costs associated with the center.

     11. The center may not use equipment owned by or services provided by a hospital-investor unless such equipment is leased in accordance with a lease that complies with the equipment rental safe harbor and such services are provided in accordance with a contract that complies with the personal services and management contracts safe harbor.

     12. No hospital-investor may be in a position to make or influence referrals directly or indirectly to any other investor or the center.

     We believe that the ownership and operations of our surgery centers will not fully satisfy this safe harbor for investment interests in ambulatory surgery centers because, among other reasons, we or one of our subsidiaries generally will be an investor in each surgery center and provide management services to the surgery center. We cannot assure you that the OIG would view our activities favorably even though they are intended to achieve compliance with the remaining elements of this safe harbor. In addition, although we expect each physician-investor to utilize the surgery center as an extension of his practice, we cannot assure you that all physician-investors will perform one-third of their procedures at the surgery center or inform their referred patients of their investment interests.

     We own an interest in one surgery center in which a physician group that includes primary care physicians who do not use the center also owns an interest. In OIG Advisory Opinion 03-5 (February 6, 2003), the OIG declined to grant a favorable opinion to a proposed ambulatory surgery center structure that would be jointly owned by a hospital and a multi-specialty group practice composed of a substantial number of primary care physicians who would not personally use the center. According to the opinion, the fact that interests in the center would be indirectly owned by physicians who would not personally practice at the center precluded the OIG from determining that the proposed arrangement poses a minimal risk of fraud and abuse. The OIG concluded that the proposed structure could potentially generate prohibited remuneration under the federal anti-kickback statute. We believe that the ownership of our center complies with the federal anti-kickback statute because the physician group that owns an interest in our center is structured to fit within the definition of a unified group practice under the federal law prohibiting physician self-referrals, commonly known as the Stark law, and the income distributions of the group practice comply with the Stark law’s acceptable methods of income distribution. No physician in the group practice receives an income distribution that is based directly on his referrals to the center. We believe that the group’s ownership of the center is no different than its ownership of other ancillary services common in physician practices. Nevertheless, there can be no assurance that the proposed arrangement will not be determined to be in violation of the law.

     We have entered into management agreements to manage many of our surgery centers, as well as three physician networks. Most of these agreements call for our subsidiary to be paid a percentage-based management fee. Although there is a safe harbor for personal services and management contracts, this safe harbor requires, among other things, that the aggregate compensation paid to the manager over the term of the agreement be set in advance. Because our management fee may be based on a percentage of revenues, it does not meet this requirement. However, we believe that our management arrangements satisfy the other requirements of the safe harbor for personal services and management contracts and that they comply with the federal anti-kickback statute. The OIG has taken the position that percentage-based management agreements are not protected by a safe harbor, and consequently, may violate the federal anti-kickback statute. On April 15, 1998, the OIG issued Advisory Opinion 98-4 which reiterates this proposition. This opinion focused on areas the OIG considers problematic in a physician practice management context, including financial incentives to increase patient referrals, no safeguards against overutilization and incentives to increase the risk of abusive billing. The opinion reiterated that proof of intent to violate the federal anti-kickback statute is the central focus of the OIG. We have implemented formal compliance programs designed to safeguard against overbilling and otherwise assure compliance with the federal anti-kickback statute and other laws, but we cannot assure you that the OIG would find our compliance programs to be adequate.

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     In some cases, we guarantee a surgery center’s debt financing and lease obligations as part of our obligations under a management agreement. Physician-investors are generally not required to enter into similar guarantees. The OIG might take the position that the failure of the physician investors to enter into similar guarantees represents a special benefit to the physician investors given to induce referrals and that such failure would result in a violation of the federal anti-kickback statute. We believe that the management fees (and in some cases guarantee fees) are adequate compensation to us for the credit risk associated with the guarantee and that the failure of the physician investors to enter into similar guarantees does not create a material risk of violating the federal anti-kickback statute. However, the OIG has not issued any guidance in this regard.

     The OIG is authorized to issue advisory opinions regarding the interpretation and applicability of the federal anti-kickback statute, including whether an activity constitutes grounds for the imposition of civil or criminal sanctions. We have not, however, sought such an opinion regarding any of our arrangements. If it were determined that our activities, or those of our facilities, violate the federal anti-kickback statute, we, our subsidiaries, our officers, our directors and each surgery center investor could be subject, individually, to substantial monetary liability, prison sentences and/or exclusion from participation in any health care program funded in whole or in part by the U.S. government, including Medicare, CHAMPUS or state health care programs.

   Federal Anti-Referral Laws

     Physician self-referral laws have been enacted by the U.S. Congress and many states prohibiting certain self-referrals for health care services. The federal prohibition prohibits a practitioner, including a physician, dentist or podiatrist, from referring patients for certain “designated health services” provided by an entity with which the practitioner or a member of his immediate family has a “financial relationship” if those services are paid in whole or in part by Medicare or Medicaid unless an exception exists. The term “financial relationship” is broadly defined and includes most types of ownership and compensation relationships. The Stark law also prohibits the entity from seeking payment from Medicare or Medicaid for services rendered through a prohibited referral. If an entity is paid for services rendered through a prohibited referral, it may be required to refund the payments. Violations of the Stark law may also result in damages of three times the amount claimed, civil penalties of up to $15,000 per prohibited claim and $100,000 per prohibited scheme and exclusion from participating in Medicare and Medicaid. “Designated health services” include:

	•	clinical laboratory services;
	•	physical therapy services;
	•	occupational therapy services;
	•	radiology services, including magnetic resonance imaging, computerized axial tomography scan and ultrasound services;
	•	radiation therapy services and supplies;
	•	durable medical equipment and supplies;
	•	parenteral and enteral nutrients, equipment and supplies;
	•	prosthetics, orthotics and prosthetic devices and supplies;
	•	home health services;
	•	outpatient prescription drugs; and
	•	inpatient and outpatient hospital services.

     The list of designated health services includes imaging services and other diagnostic services provided by our diagnostic centers. However, the Stark law is implicated only if the referring physician or a member of his

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immediate family has a financial relationship with the provider of designated health services. There is no physician ownership (or physician family member ownership) in our diagnostic centers. Any compensation relationships between our diagnostic centers and physicians are set forth in writing, provide for a fair market value compensation and are otherwise structured to fit within applicable exceptions to the Stark law.

     The list of designated health services does not include surgical services provided in an ambulatory surgery center. Furthermore, in final Stark law regulations published by the Department of Health and Human Services on January 4, 2001, the term “designated health services” was defined as not including services that are reimbursed by Medicare as part of a composite rate, such as services provided in an ambulatory surgery center.

     However, if designated health services are provided by an ambulatory surgery center and separately billed, referrals to the surgery center by a physician investor would be prohibited by the Stark law. Because our facilities that are licensed as ambulatory surgery centers do not have independent laboratories and do not provide designated health services apart from surgical services, we do not believe referrals to these facilities by physician investors are prohibited.

     If legislation or regulations are implemented that prohibit physicians from referring patients to surgery centers in which the physician has a beneficial interest, our business and financial results would be adversely affected.

     Additionally, the physician networks we manage must comply with an exception of the Stark law allowing physicians to make referrals to in-office ancillary providers, such as laboratory or diagnostic imaging facilities. We believe that these physician networks operate in compliance with the language of statutory exceptions to the Stark law, including the exceptions for services provided by physicians within a group practice or in-office ancillary services.

     Three of our facilities, including one managed facility, are licensed as hospitals. The Stark law includes an exception relating to physician ownership of a hospital, provided that the physician’s ownership interest is in the whole hospital and the physician is authorized to perform services at the hospital. Physician investment in our facilities licensed as hospitals meet this requirement. However, the Medicare Modernization Act amended the Stark law to provide that an exception in the Stark law relating to physician ownership in hospitals does not apply to specialty hospitals for a period of 18 months following November 18, 2003. Specialty hospitals are defined in the Medicare Modernization Act as hospitals that are primarily or exclusively engaged in the care and treatment of (1) patients with a cardiac condition, (2) patients with an orthopedic condition, (3) patients receiving a surgical procedure or (4) any other specialized category of services that the Secretary of the Department of Health and Human Services designates as inconsistent with the purpose of the hospital ownership exception. The 18-month moratorium does not apply to specialty hospitals that were in existence or under development on November 18, 2003, as long as: (a) the total number of physician investors in the hospital does not increase from the number of physician investors on November 18, 2003; (b) the hospital does not change the type of specialty services that it provides from the types that it provided on November 18, 2003; and (c) the hospital does not increase its number of beds by more than 5% or five beds, whichever is greater. The Medicare Modernization Act also directs the Department of Health and Human Services and MedPAC to conduct studies of specialty hospitals by February 2005, and to prepare reports to Congress recommending any needed legislative or administrative changes in the Stark law’s exception for physician ownership in hospitals. As of March 25, 2005, the Department of Health and Human Services had not publicly released its report. MedPAC recently conducted its study and recommended to the Congress that the 18-month moratorium on new specialty hospitals be extended for an additional 18 months. Congress has not yet acted on MedPAC’s recommendations. However, the issue of specialty hospitals continues to be a high profile issue with the Congress. Congressional committees have met to consider MedPAC’s recommendation and are expected to introduce bills to implement MedPAC’s recommendations. Moreover, bills have been introduced in past Congressional sessions that would eliminate the Stark whole hospital exception altogether, and it is possible that similar bills could be introduced in the current Congress.

     Two of our facilities licensed as hospitals, including the managed facility, currently fit within the Medicare Modernization Act’s definition of “specialty hospital.” Our other facility licensed as a hospital, in which we own a 42% interest, primarily provides obstetrical and other women’s health services and could be designated in the future by the Secretary of the Department of Health and Human Services as a specialty hospital. However, none of our facilities are subject to the specialty hospital moratorium because they were in existence on November 18, 2003.

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Consequently, the current physician investors in these facilities can refer to the hospitals and fit within the Stark law’s whole hospital exception. The Medicare Modernization Act, however, will prevent us from increasing the number of physician investors in these facilities, significantly increasing the number of licensed beds or changing the types of specialty services that we provide. These legal constraints on the operation of these facilities could have an adverse financial effect. In addition, there is no guarantee that the MedPAC and Department of Health and Human Services specialty hospital reports to Congress will be favorable, or that future legislation will not be enacted that would prevent us from operating specialty hospitals with physician investors. If future legislation were to be enacted that prohibits all physician referrals to specialty hospitals in which the physicians own an interest, even if those facilities already exist, our specialty hospitals could be materially adversely affected.

   False and Other Improper Claims

     The U.S. government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for payment from the Medicare or Medicaid programs. Claims filed with private insurers can also lead to criminal and civil penalties, including, but not limited to, penalties relating to violations of federal mail and wire fraud statutes. While the criminal statutes are generally reserved for instances of fraudulent intent, the U.S. government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances. For example, the government has taken the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant merely should have known the services were unnecessary, even if the government cannot demonstrate actual knowledge. The government has also taken the position that claiming payment for low-quality services is a violation of these statutes if the claimant should have known that the care was substandard. In addition, some courts have held that a violation of the Stark law can result in liability under the federal False Claims Act.

     Over the past several years, the U.S. government has accused an increasing number of health care providers of violating the federal False Claims Act. The False Claims Act prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the U.S. government. The statute defines “knowingly” to include not only actual knowledge of a claim’s falsity, but also reckless disregard for or intentional ignorance of the truth or falsity of a claim. Because our facilities perform hundreds of similar procedures a year for which they are paid by Medicare, and there is a relatively long statute of limitations, a billing error or cost reporting error could result in significant civil or criminal penalties.

     Under the qui tam, or whistleblower, provisions of the False Claims Act, private parties may bring actions on behalf of the U.S. government. These private parties, often referred to as relators, are entitled to share in any amounts recovered by the government through trial or settlement. Both direct enforcement activity by the government and whistleblower lawsuits have increased significantly in recent years and have increased the risk that a health care company, like us, will have to defend a false claims action, pay fines or be excluded from the Medicare and Medicaid programs as a result of an investigation resulting from a whistleblower case. Although we believe that our operations materially comply with both federal and state laws, they may nevertheless be the subject of a whistleblower lawsuit, or may otherwise be challenged or scrutinized by governmental authorities. A determination that we have violated these laws could have a material adverse effect on us.

     We are also subject to various state insurance statutes and regulations that prohibit us from submitting inaccurate, incorrect or misleading claims. We believe that our surgery centers are in compliance with all state insurance laws and regulations regarding the submission of claims. We cannot assure you, however, that none of our centers’ insurance claims will ever be challenged. If we were found to be in violation of a state’s insurance laws or regulations, we could be forced to discontinue the practice in violation, which could have an adverse effect on our business and operating results, and we could be subject to fines and criminal penalties.

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   Health Information Practices

     There are currently numerous laws at the state and federal levels addressing patient privacy concerns. Federal regulations issued pursuant to HIPAA contain, among other measures, provisions that require many organizations, including us, to implement very significant and potentially expensive new computer systems, employee training programs and business procedures. The federal regulations are intended to encourage electronic commerce in the health care industry.

     Among other things, HIPAA requires health care facilities to use standard data formats and code sets established by Department of Health and Human Services when electronically transmitting information in connection with several transactions, including health claims and equivalent encounter information, health care payment and remittance advice and health claim status. We have implemented or upgraded computer systems, as appropriate, at our facilities and at our corporate headquarters to comply with the new transaction and code set regulations and have tested these systems with several of our payors.

     HIPAA also requires the Department of Health and Human Services to issue regulations establishing standard unique health identifiers for individuals, employers, health plans and health care providers to be used in connection with the standard electronic transactions. All health care providers, including our facilities, will be required to obtain a new National Provider Identifier (“NPI”) to be used in standard transactions instead of other numerical identifiers beginning no later than May 23, 2007; health care providers may begin applying for NPIs on May 23, 2005. We cannot predict whether our facilities may experience payment delays during the transition to the new identifier. Our facilities have fully implemented use of the Employer Identification Number as the standard unique health identifier for employers. The Department of Health and Human Services has not yet issued proposed rules that establish the standard for unique health identifiers for health plans or individuals. Once these regulations are issued in final form, we expect to have approximately two years to become fully compliant, but cannot predict the impact of such changes at this time.

     HIPAA regulations also require our facilities to comply with standards to protect the confidentiality, availability and integrity of patient health information, by establishing and maintaining reasonable and appropriate administrative, technical and physical safeguards to ensure the integrity, confidentiality and the availability of electronic health and related financial information. The security standards were designed to protect electronic information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. We expect that the security standards will require our facilities to implement significant new systems, business procedures and training programs, though the regulations do not mandate use of a specific technology. We must comply with these security regulations by April 21, 2005, and we expect that all our facilities will be in compliance at that time.

     DHHS has also established standards for the privacy of individually identifiable health information. These privacy standards apply to all health plans, all health care clearinghouses and health care providers, such as our facilities, that transmit health information in an electronic form in connection with standard transactions, and apply to individually identifiable information held or disclosed by a covered entity in any form. These standards impose extensive administrative requirements on our facilities and require compliance with rules governing the use and disclosure of this health information, and they require our facilities to impose these rules, by contract, on any business associate to whom we disclose such information in order to perform functions on their behalf. In addition, our facilities will continue to remain subject to any state laws that are more restrictive than the privacy regulations issued under HIPAA. These laws vary by state and could impose additional penalties.

     A violation of the HIPAA regulations could result in civil money penalties of $100 per incident, up to a maximum of $25,000 per person per year per standard. HIPAA also provides for criminal penalties of up to $50,000 and one year in prison for knowingly and improperly obtaining or disclosing protected health information, up to $100,000 and five years in prison for obtaining protected health information under false pretenses, and up to $250,000 and ten years in prison for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm. Since there is no significant history of enforcement efforts by the federal government at this time, it is not possible to ascertain the likelihood of enforcement efforts in connection with the HIPAA regulations or the potential for fines and penalties, which may result from the violation of the regulations.

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     We believe all of our facilities are in compliance with the privacy standards and we have made significant commitment and taken action to implement the HIPAA privacy standards. We have appointed members of our management team to direct our compliance with these standards. We have appointed a privacy officer, prepared privacy policies, trained our workforce on these policies and entered into business associate agreements with the appropriate vendors. We expect to have ongoing HIPAA compliance costs. In addition, because some of the HIPAA regulations are proposed regulations, we cannot predict the total financial impact of the regulations on our operations.

   Health Care Regulations Affecting Our New York Operations

     Laws in the State of New York require that corporations have natural persons as stockholders in order to be approved by the New York Department of Health as a licensed health care facility. Accordingly, we are not able to own interests in a limited partnership or limited liability company that owns an interest in a health care facility located in New York. Laws in the State of New York also prohibit the delegation of certain management functions by a licensed health care facility. The law does permit a licensed facility to lease premises and obtain various services from non-licensed entities; however, it is not clear what types of delegation constitute a violation. We own an interest in a limited liability company which provides administrative services to a surgery center located in New York. Although we believe that our operations and relationships in New York are in compliance with these laws, if New York regulatory authorities or a third party asserts a contrary position, we may be unable to continue or expand our operations in New York.

Available Information

     Our website is www.symbion.com. We make available free of charge on this website under “Investor Relations – SEC Filings” our periodic and other reports and amendments to those reports filed with or furnished to the Securities and Exchange Commission (“SEC”) as soon as reasonably practicable after we electronically file or furnish such materials.

Item 2. Properties

     Our corporate headquarters are located in Nashville, Tennessee in 43,772 square feet of leased office space, under a ten-year lease that commenced on November 1, 2002. We sublease 1,827 square feet of the 43,772 square feet to a third party.

     Typically, our surgery centers are located on real estate leased by the partnership or limited liability company that owns the center. These leases generally have initial terms of ten years, but range from two to 15 years. Most of the leases contain options to extend the lease period for up to ten additional years. The surgery centers are generally responsible for property taxes, property and casualty insurance and routine maintenance expenses. Three of our surgery centers are located on real estate owned by the limited partnership or limited liability company that owns the surgery center. We generally guarantee the lease obligations of the partnerships and limited liability companies that own our surgery centers.

     Additional information about our surgery centers and our other properties can be found in Item 1 of this report under the caption, “Business — Operations.”

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Item 3. Legal Proceedings

     We are, from time to time, subject to claims and suits arising in the ordinary course of business, including claims for damages for personal injuries, breach of management contracts and employment related claims. In certain of these actions, plaintiffs request payment for damages, including punitive damages, that may not be covered by insurance.

     On February 4, 2005, MediSphere Health Partners, Inc. filed a breach of contract action against Symbion Ambulatory Resource Centres, Inc., a subsidiary of the Company, in the Chancery Court for Davidson County, Tennessee. MediSphere seeks in the lawsuit to recover $1,062,857 (plus attorneys fees), which it claims to be due pursuant to the terms of a Stock Purchase Agreement between Symbion Ambulatory Resource Centres, Inc. and MediSphere dated November 4, 2003. On March 21, 2005, Symbion Ambulatory Resource Centres, Inc. filed an answer to the complaint. In the answer, we denied that any amounts are due under the terms of the Stock Purchase Agreement, and asserted a counterclaim against MediSphere. In the counterclaim, we seek to recover in excess of $3,000,000 in damages arising out of MediSphere’s breach of certain of the representations and warranties contained in the Stock Purchase Agreement, and MediSphere’s intentional concealment and misrepresentation of facts material to the Stock Purchase Agreement and the November 17, 2003 closing of the transactions contemplated therein. We have also asserted a counterclaim against certain of MediSphere’s preferred shareholders. We dispute MediSphere’s claims that any amounts are due under the terms of the Stock Purchase Agreement and intend to defend the case vigorously.

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

     No matters were submitted to a vote of the stockholders during the fourth quarter ended December 31, 2004.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     Market for Common Stock. Until February 6, 2004, there was no established public trading market for our common stock. On February 6, 2004, our common stock commenced trading on the Nasdaq National Market under the symbol “SMBI.” The following table sets forth for the periods indicating the high and low bid prices per share of our common stock as reported on the Nasdaq National Market.

     On March 15, 2005, the last reported sales price for our common stock on the Nasdaq National Market was $21.26 per share. At March 15, 2005, there were approximately 222 stockholders of record.

     Dividends. We have never declared or paid dividends on our common stock. We intend to retain future earnings to finance the growth and development of our business and, accordingly, do not currently intend to declare or pay any dividends on our common stock. Our board of directors will evaluate our future earnings, results of operations, financial condition and capital requirements in determining whether to declare or pay cash dividends. Delaware law prohibits us from paying any dividends unless we have capital surplus or net profits available for this purpose. In addition, our credit facility imposes restrictions on our ability to pay dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

     Recent Sales of Unregistered Securities. During the three months ended December 31, 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 October 1, 2004, we issued 10,208 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers for an aggregate of $82,991 upon exercise of warrants.
	•	On November 15, 2004, we issued 2,315 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers upon a cashless exercise of warrants.
	•	On December 8, 2004, we issued 2,881 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers upon a cashless exercise of warrants.
	•	On December 20, 2004, we issued 2,492 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers upon a cashless exercise of warrants.
	•	On December 20, 2004, we issued 3,056 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers upon a cashless exercise of warrants.
	•	On December 30, 2004, we issued 800 shares of our common stock to an individual who holds an ownership interest in one of our surgery centers upon a cashless exercise of warrants.

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Item 6. Selected Financial Data

     The following selected consolidated financial and other data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes included elsewhere in this report. The selected consolidated statement of operations data set forth below for each of the three years in the period ended December 31, 2004, and the selected consolidated balance sheet data set forth below at December 31, 2004 and 2003, are derived from our audited consolidated financial statements that are included elsewhere in this report. The selected consolidated statement of operations data set forth below for the years ended December 31, 2001 and 2000, and the selected consolidated balance sheet data set forth below at December 31, 2002, 2001 and 2000, are derived from our audited consolidated financial statements that are not included in this report.

     The historical results presented below are not necessarily indicative of the results to be expected for any future period.

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Item 7. 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 “Selected Financial Data” and our audited consolidated financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. For additional information regarding some of the risks and uncertainties that affect our business and the industry in which we operate, please read “— Risk Factors.” Our actual results may differ materially from those estimated or projected in any of these forward-looking statements.

Executive Overview

     Our Company

     We own and operate a network of surgery centers in 21 states. As of March 15, 2005, we owned and operated 47 surgery centers and managed nine additional surgery centers. We own a majority interest in 35 of the 47 surgery centers in which we own an interest, and consolidate 41 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.

     We anticipate acquiring about three to four centers and developing three to four centers annually during the next three to five years. A typical surgery center costs us between $3.0 million and $7.0 million to develop and equip, excluding costs of real estate. This cost varies depending on the range of specialties that will be provided at the facility and the number of operating and treatment rooms. We typically fund about 70% of the development costs of a new surgery center with borrowings under our senior credit facility, and the remainder with equity contributed by us and the other owners of the center. Our ownership interests in surgery centers that we have developed range from 25% to 82%, although we anticipate that we will own primarily majority interests in future developments. The remaining owners are typically local physicians, physician groups or hospitals. We expect that our acquisition and development program will require substantial capital resources, which we estimate to range from $35.0 million to $65.0 million per year over the next three years. In addition, the operations of our existing facilities will require ongoing capital expenditures. We expect that our capital needs will be financed through a combination of cash flow from operations, bank debt and the issuance of debt and equity securities.

     We generate revenue and cash through patient service revenues, physician service revenues and other service revenues. Patient service revenues are revenues for 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 consisting of reimbursed expenses, plus participation in the excess of revenue 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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     The following table summarizes our revenues by service type as a percentage of revenues for the periods indicated:

     Competition

     In developing or acquiring existing surgery centers, we compete with other public and private surgery center and hospital companies. Several large national companies own and/or manage surgery centers and surgical hospitals, including HEALTHSOUTH Corporation, HCA Inc., Universal Health Services, Inc., AmSurg Corp. and United Surgical Partners International, Inc. Many of these companies have greater resources and access to capital than we do. In addition, local hospitals, physician groups and other providers may compete with us in the ownership and operation of surgery centers. The number of physicians that perform outpatient surgeries in an office-based setting is expected to rise in the upcoming years.

     Operating Trends

     We intend to increase revenues by increasing the number of cases performed at each surgery center. We also intend to increase revenues by acquiring additional surgery centers and developing new surgery centers. As a result of the increased revenues, we expect our EBITDA margin to increase due to operating efficiencies and economies of scale as a result of leveraged general and administrative expenses. Our success in the future will be determined by the continued success of our current surgery centers as well as our ability to acquire and incorporate new facilities.

Acquisitions, Developments and Divestitures

Acquisitions and Developments

     During 2004, we acquired six centers, developed three additional surgery centers, opened one imaging center and entered into a management agreement for one additional surgery center. We entered into management agreements with each of these centers. One of our newly-developed surgery centers was developed through a partnership with one of our existing physician networks. Our investment related to these centers was about $66.3 million. We paid for these investments using cash from operations and funds available under our senior secured credit facility.

     During 2003, we acquired five centers, including one licensed as a hospital, opened five newly-developed surgery centers and assumed a management agreement for one additional surgery center licensed as a hospital. We entered into management agreements with each of these surgery centers and have a majority ownership interest in four of these centers. Our investment related to these centers was about $52.6 million. We paid for these investments using primarily funds available under our senior credit facility. In addition, we issued warrants to purchase 14,101 shares of our common stock.

     In addition, during 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 about $1.5 million in cash. We now own 90% of the center. We also acquired an additional 16.4% ownership interest in Village SurgiCenter in Erie, Pennsylvania, for about $1.0 million in cash. We now own an 82% interest in the center.

     In April 2002, we acquired Physicians Surgical Care, Inc., which had ownership interests in and managed seven surgery centers, including one licensed as a hospital. A subsidiary of Physicians Surgical Care assisted in the development of an additional surgery center to which we began providing administrative services when it opened in

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October 2002. In connection with the acquisition, we issued an aggregate of 624,919 shares of our common stock, 4,341,726 shares of our Series A convertible preferred stock and 2,604,590 shares of our Series B convertible preferred stock. In addition, during 2004, we issued an additional 204,500 shares of our common stock to the former stockholders of Physicians Surgical Care based on the 2003 financial results of one of the Physicians Surgical Care surgery centers.

     In addition to Physicians Surgical Care, we acquired ownership interests in three additional surgery centers and opened two newly-developed surgery centers during 2002. We entered into management agreements with each of these surgery centers and have majority ownership interests in four of the centers. Our total investment related to these centers was about $24.6 million, including about $16.8 million funded with debt.

     Divestitures

     During 2004, after purchasing the outstanding ownership interests from our prior physician and hospital partners, we restructured our 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 (“AIGB”). In connection with the restructuring, we retained a 10% ownership in the surgery center and we no longer manage or consolidate the surgery center for financial reporting purposes. Subsequent to December 31, 2004, we entered into discussions with AIGB relating to the possible disposition of our 10% ownership in the surgery center.

     Effective May 20, 2003, the surgery center we managed in Knoxville, Tennessee closed following the opening of the new surgery center in this market we developed with the same organization, University Health System, Inc. We have a 25% ownership interest in the new surgery center.

     Effective September 6, 2002, we sold all of our ownership interest in a surgery center and terminated our management agreement with the surgery center. In consideration for our ownership interest and termination of the management agreement, we received about $1.4 million in cash in October 2002. In addition, we were released from a guaranty of about $4.6 million of debt incurred by the center. We recorded a charge in 2002 of about $380,000 in connection with this transaction.

     Effective May 31, 2002, we sold all of our ownership interest in a surgery center and terminated our management agreement with the surgery center. In consideration for our ownership interest, we were released from a guaranty of the facility lease for the surgery center and the purchaser assumed about $1.1 million of liabilities. We recorded a net loss in 2002 of about $8,000 in connection with this transaction.

Critical Accounting Policies

     Our accounting policies are described in Note 2 of our consolidated financial statements included elsewhere in this report. In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, our management must make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Certain accounting estimates are particularly sensitive because of their complexity and the possibility that future events affecting them may differ materially from our current judgments and estimates. Our actual results could differ from those estimates. We believe that the following critical accounting policies are important to the portrayal of our financial condition and results of operations, and require our management’s subjective or complex judgment because of the sensitivity of the methods, assumptions and estimates used. This listing of critical accounting policies is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment regarding accounting policy.

     Consolidation and Control

     Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, as well as our interests in facilities that we control through our ownership of a majority voting interest or other rights granted to us by contract as the sole general partner or manager to manage and control the business. The rights of the

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limited partners or minority members in these surgery centers are generally limited to those that protect their ownership interests, including the right to approve of the issuance of new ownership interests, and those that protect their financial interests, including the right to approve the acquisition or divestiture of significant assets or the incurrence of debt that physician limited partners or members are required to guarantee on a pro rata basis based upon their respective ownership interests or that exceeds 20% of the fair market value of the center’s assets. All significant intercompany balances and transactions, including management fees from consolidated centers, are eliminated in consolidation.

     We also hold non-controlling interests in some surgery centers over which we exercise significant influence. Significant influence includes financial interests ranging from 10% to 42% and duties, rights and responsibilities for the day-to-day management of the surgery center. These non-controlling interests are accounted for under the equity method.

     In addition, on December 31, 2003, as a result of Interpretation No. 46, “Consolidation of Variable Interest Entities (“VIEs”), an Interpretation of Accounting Research Bulletin No. 51” (“FIN 46”), we consolidated for financial reporting purposes a surgery center in which we do not own an interest. Under FIN 46, the surgery center is considered a VIE and we are the primary beneficiary. Therefore, under FIN 46 we are required to consolidate this surgery center for financial reporting purposes. We currently do not expect the consolidation of this surgery center to have a material impact on our results of operations.

     Revenue Recognition

     Our revenues are comprised of patient service revenues, physician service revenues and other service revenues. Our patient service revenues relate to fees charged for surgical or diagnostic procedures performed at facilities that we consolidate for financial reporting purposes. These fees are billed either to the patient or a third-party payor. Our fees vary depending on the procedure, but usually include all charges for usage of an operating room, a recovery room, equipment, supplies, nursing staff and medications. Our fees do not include professional fees charged by the patient’s surgeon, anesthesiologist or other attending physician, which are billed directly by the physicians to the patient or third-party payor. We recognize patient service revenues when the related procedures are performed.

     Our physician service revenues relate to fees we derive from managing physician networks for which we also have a contractual obligation to provide capital and additional assets. Currently we have such an obligation to only one group of six physicians included in one of the three physician networks we manage. We expect our physician service revenues to decline as a percentage of our total revenues as we continue to focus on our surgery center business. Physician service revenues consist of reimbursed expenses and a percentage of the amount by which each physician network’s revenues exceed its expenses, as defined by our management agreement with each physician network. We recognize physician service revenues in the period in which reimbursable expenses are incurred and the period in which we have rights to a percentage of the amount by which a physician network’s revenues exceed its expenses.

     Our other service revenues are comprised of management and administrative service fees we derive from 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. The fees we derive from these management arrangements are based on a pre-determined percentage of the revenues of each surgery center and physician network. We recognize other service revenues in the period in which services are rendered.

     Allowance for Contractual Adjustments and Doubtful Accounts

     Our patient service revenues are recorded net of estimated contractual allowances from third-party payors, which we estimate based on the historical trend of our surgery centers’ cash collections and contractual write-offs, accounts receivable agings, established fee schedules, relationships with payors and procedure statistics. We estimate our allowances for bad debts using similar information and analysis. While we believe that our allowances for contractual adjustments and bad debts are adequate, if the actual write-offs are significantly different from our estimates, our results of operations may, in turn, be significantly impacted. Our net accounts receivable reflected allowances for doubtful accounts of $13.7 million and $12.5 million at December 31, 2004 and 2003, respectively.

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     We derive all of our physician service revenues from physician networks with which we have service agreements. Physician service revenues from physician networks consist of reimbursable expenses plus participation in the excess of revenue over expenses of the physician networks as provided for in the service agreements. Reimbursed expenses include the costs of our 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 rights to a percentage of the amount by which a physician network’s revenues exceed its expenses. The participation component of physician service revenues is based on net billings of the physician network. Changes in estimated contractual adjustments and bad debts are reflected in physician service revenues in subsequent periods. Our physician service revenues would be impacted by changes in estimated contractual adjustments and bad debts recorded by the physician networks.

     The following table summarizes our day’s sales outstanding as of the dates indicated:

     Our target for day’s sales outstanding related to patient service revenues ranges from 40 days to 47 days. Our day’s sales outstanding for the dates presented in the table above are within the target range.

     Our collection policies and procedures are based on the type of payor, size of claim and estimated collection percentage for each patient account. The operating systems used to manage our patient accounts provide for an aging schedule in 30-day increments, by payor, physician and patient. The operating systems generate reports that assist in the collection efforts by prioritizing patient accounts. Collection efforts include direct contact with insurance carriers or patients, written correspondence and the use of legal or collection agency assistance, as required.

     We review the standard aging schedule, by facility, to determine the appropriate provision for doubtful accounts. This review is supported by an analysis of the actual net revenues, contractual adjustments and cash collections received. If our internal collection efforts are unsuccessful, we manually review patient accounts with balances of $25 or more. We then classify the accounts based on any external collection efforts we deem appropriate. An account is written-off only after we have pursued collection with legal or collection agency assistance or otherwise deemed an account to be uncollectible. Typically, accounts will be outstanding a minimum of 120 days before being written-off.

     Income Taxes

     We use the asset and liability method to account for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If a net operating loss carryforward exists, we make a determination as to whether that net operating loss carryforward will be utilized in the future. A valuation allowance will be established for certain net operating loss carry forwards where their recoverability is deemed to be uncertain. The carrying value of the net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions. If these estimates and related assumptions change in the future, we will be required to adjust our deferred tax valuation allowances.

     Long-lived Assets, Goodwill and Intangible Assets

     When events, circumstances or operating results indicate that the carrying values of certain long-lived assets and the related identifiable intangible assets might be impaired, we assess whether the carrying value of the assets will be recovered through undiscounted future cash flows expected to be generated from the use of the assets and their eventual disposition. If the assessment indicates that the recorded cost will not be recoverable, that cost will be reduced to estimated fair value. Estimated fair value will be determined based on a discounted future cash flow analysis. During 2004, we recorded an impairment charge of $271,000 primarily related to the write down of

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obsolete medical equipment. During 2003, we recorded an impairment charge of $275,000 related to software that we purchased but no longer intended to use. We believe that there has been no other impairment.

     Goodwill represents the excess of purchase price over fair value of net tangible and identifiable intangible assets acquired. Goodwill and indefinite lived intangible assets are tested for impairment at least annually using a fair value method. Impairment is measured at the reporting unit level using a discounted cash flows model to determine the fair value of the reporting units. We will perform a goodwill impairment test between annual impairment tests whenever events or changes in facts or circumstances indicate that impairment may exist, or at least annually during the fourth quarter each year. During the fourth quarter of 2004, the Company completed its annual impairment test and there was no indication of impairment.

     Professional Liability Insurance Claims

     We are subject to claims and legal actions in the ordinary course of our business, including claims relating to patient treatment, employment practices and personal injuries. To cover these claims, we maintain general and professional liability insurance in excess of self-insured retentions through a third party commercial insurance carrier in amounts we believe to be sufficient for its operations. We expense 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. Reserves and provisions for professional liability are based upon actuarially determined estimates. These balances for professional liability represent the estimated costs of all reported and unreported losses incurred through the respective consolidated balance sheet dates. The reserves are estimated using individual case-basis valuations and actuarial analysis. Changes to the estimated reserve amounts are included in current operating results.

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Results of Operations

     The following table summarizes certain statements of operations items for each of the three years ended December 31, 2004, 2003 and 2002. The table also shows the percentage relationship to total revenues for the periods indicated:

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

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Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

     Overview. In 2004, our revenues increased 22.7% to $216.3 million from $176.3 million for 2003. Net income decreased 22.3% to $13.6 million for 2004 from $17.5 million for 2003. Our financial results in 2004 were driven by the addition of six newly-acquired surgery centers, three newly-developed surgery centers and one newly-developed diagnostic center. Our results were also impacted by the organic growth at existing centers. Results for 2003 included a benefit for income taxes of approximately $2.2 million, which primarily related to the recognition of deferred tax assets of approximately $3.1 million. The 2003 results also included the impact of higher interest expense and prepayment penalties incurred in connection with the refinancing of outstanding indebtedness, which was completed in the third quarter of 2003. We paid off the higher cost indebtedness with the proceeds from our initial public offering completed in February 2004.

     Revenues. Revenues for the year ended December 31, 2004 as compared to the year ended December 31, 2003 were as follows (dollars in thousands):

     We consider same store facilities as those centers that we consolidate for financial reporting purposes throughout 2004 and 2003. The increase in same store revenues was primarily the result of a 5.0% increase in the number of cases during 2004. The remaining increase in patient service revenues is related to surgery centers acquired or developed since January 1, 2003. In addition, the $13.1 million increase in same store patient service revenues was also the result of $4.8 million from the consolidation of the variable interest entity, which was recorded as other service revenues during 2003. Other service revenues decreased $4.8 million for 2004 compared to 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, same store revenues would have increased 7.6% from $154.4 million for 2003 to $166.1 million for 2004. If we had adopted FIN 46(R) effective January 1, 2003, total revenues would have increased 23.1% from $175.7 million for 2003 to $216.3 million for 2004.

     Cost of Revenues. Cost of revenues for the year ended December 31, 2004 as compared to the year ended December 31, 2003 were as follows (dollars in thousands):

     The increase in same store cost of revenues was primarily the result of the increase in the number of cases performed during 2004 as compared to 2003. This increase was partially offset by lower general and professional liability expense during 2004 as compared to 2003. The general and professional 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. We base our accrual for general and professional liability expense on management’s analysis of an independent actuarial study performed during 2004 and 2003 by Casualty Actuarial Consultants, Inc. The remaining $19.6 million increase in cost of revenues was the result of surgery centers acquired or developed since January 1,

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2003. As a percentage of revenues, total cost of revenues decreased to 65.5% for 2004 from 66.5% for 2003. If we had adopted FIN 46(R) effective January 1, 2003, total cost of revenues would have increased 19.1% to $141.8 million for 2004 from $119.1 million for 2003. In addition, as a percentage of revenues, cost of revenues would have decreased to 65.5% for 2004 from 67.8% for 2003.

     General and Administrative Expenses. General and administrative expenses increased 15.7% to $18.4 million for 2004 from $15.9 million for 2003. The increase in general and administrative expense was primarily related to the overall growth in the number of surgery centers. As a percentage of revenues, general and administrative expense decreased to 8.5% for 2004 from 9.0% for 2003. This decrease was primarily the result of improved economies of scale.

     Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2004 as compared to the year ended December 31, 2003 were as follows (dollars in thousands):

     As a percentage of revenues, depreciation and amortization expense decreased to 5.0% for 2004 from 5.3% for 2003.

     Provision for Doubtful Accounts. Provision for doubtful accounts increased $1.3 million to $4.0 million for 2004 from $2.7 million for 2003. This increase is primarily attributed to the surgery centers acquired or developed since January 1, 2003. As a percentage of revenues, the provision for doubtful accounts increased to 1.8% for 2004 from 1.6% for 2003.

     Income on Equity Investments. Income on equity investments represents the net income of certain investments we have in surgery centers. These surgery centers are not consolidated for financial reporting purposes. The increase is primarily attributable to investments we made in surgery centers during 2004 and the fourth quarter of 2003.

     Operating Income. Operating income increased $10.8 million to $42.4 million for the year ended December 31, 2004 from $31.6 million for the year ended December 31, 2003. The increase in operating income is primarily attributable to $8.8 million from surgery centers acquired or developed since January 1, 2003. Same store operating income increased $4.1 million for 2004 as a result of an increase in cases and improved economies of scale. This increase in same store operating income was partially offset by a $2.5 million increase in general and administrative expenses during 2004. As a percentage of revenues, operating income increased to 19.6% for 2004 from 17.9% for 2003.

     Minority Interests in Income of Consolidated Subsidiaries. Minority interests in income of consolidated subsidiaries for the year ended December 31, 2004 as compared to the year ended December 31, 2003 were as follows (dollars in thousands):

     Minority interests in income of consolidated subsidiaries for same store facilities increased as a result of improved operations at the same store facilities and as a result of the consolidation of the variable interest entity pursuant to FIN 46(R). Minority interest expense represents the portion of the surgery center’s net income that is

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attributable to the surgery center’s minority owners. Consequently, as the net income of the surgery centers increase, the corresponding minority interest expense will increase. As a percentage of revenues, minority interests in income from consolidated subsidiaries increased to 7.2% for 2004 from 5.9% for 2003.

     Interest Expense, Net of Interest Income. Interest expense, net of interest income, decreased 15.5% to $4.9 million for 2004 from $5.8 million for 2003. The decrease in interest expense was primarily the result of higher interest expense and prepayment penalties incurred in connection with our senior subordinated notes we issued to refinance outstanding indebtedness during 2003. We paid off the senior subordinated notes in the first quarter of 2004 with proceeds from our initial public offering completed in February 2004.

     Provision (Benefit) for Income Taxes. The provision (benefit) for income taxes increased to a $8.5 million provision for 2004 as compared to a $2.2 million benefit for 2003. The 2003 results included the recognition of deferred tax assets of approximately $3.1 million. Similar to 2004, we anticipate an effective tax rate of approximately 38.5% during 2005.

     Net Income. Net income decreased $3.9 million to $13.6 million for 2004 from $17.5 million for 2003. This decrease was primarily the result of the $2.2 million benefit for income taxes recorded during 2003. The change in the effective income tax rate in 2004 as compared to 2003 was partially offset by the increase in net income resulting from surgery centers acquired or developed since January 1, 2003 and an increase in cases performed in 2004 compared to 2003. As a percentage of revenues, net income decreased to 6.3% in 2004 from 9.9% for 2003.

     Adjusted Net Income. Adjusted net income increased $4.1 million to $14.0 million for 2004 from $9.9 million for 2003 for the same reasons net income increased. As a percentage of revenues, adjusted net income increased to 6.5% in 2004 from 5.6% for 2003.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

     Overview. In 2003, our revenues increased 21.8% to $176.3 million from $144.7 million for 2002. Net income increased 42.3% to $17.5 million for 2003 from $12.3 million for 2002. Our financial results in 2003 were driven by the addition of ten new centers and organic growth at existing centers. Results for 2003 included a benefit for income taxes of approximately $2.2 million, which primarily related to the recognition of deferred tax assets of approximately $3.1 million. The 2003 results also included the impact of higher interest expense and prepayment penalties incurred in connection with the refinancing of outstanding indebtedness, which was completed in the third quarter of 2003. We paid off the higher cost indebtedness with the proceeds from our initial public offering completed in February 2004.

     Revenues. Revenues for the year ended December 31, 2003 as compared to the year ended December 31, 2002 were as follows (dollars in thousands):

     We consider same store surgery centers as those centers that we consolidate for financial reporting purposes throughout 2003 and 2002. The increase in same store revenues was primarily the result of a 5.0% increase in the number of cases during 2003. The remaining increase in patient service revenues is related to surgery centers acquired or developed since January 1, 2002.

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     Cost of Revenues. Cost of revenues for the year ended December 31, 2003 as compared to the year ended December 31, 2002 were as follows (dollars in thousands):

     The increase in same store cost of revenues was primarily the result of the increase in the number of cases performed during 2003 as compared to 2002 and a $1.0 million increase in general and professional liability expense during 2003. The general and professional 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 accrual for general and professional liability expense was increased during the third quarter of 2003 based on management’s analysis of an independent actuarial study performed in the third quarter of 2003 by Casualty Actuarial Consultants, Inc. As a percentage of revenues, total cost of revenues increased to 66.5% for 2003 from 64.8% for 2002, primarily as a result of surgery centers acquired or developed during 2003 and the increase in general and professional liability expense.

     General and Administrative Expenses. General and administrative expenses increased 11.2% to $15.9 million for 2003 from $14.3 million for 2002. The increase in general and administrative expense was primarily related to the overall growth in the number of surgery centers. As a percentage of revenues, general and administrative expense decreased to 9.0% for 2003 from 9.9% for 2002. This decrease was primarily the result of improved economies of scale.

     Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2003 as compared to the year ended December 31, 2002 were as follows (dollars in thousands):

     As a percentage of revenues, depreciation and amortization expense decreased to 5.3% for 2003 from 5.4% for 2002.

     Provision for Doubtful Accounts. Provision for doubtful accounts decreased $2.1 million to $2.7 million for 2003 from $4.8 million for 2002. This decrease can be attributed to improved cash collections primarily in the earlier months of 2003, related to the conversion of surgery centers we acquired in 2002 to our cash collections processes and improved collections of older accounts receivable from our same store facilities. As a percentage of revenues, the provision for doubtful accounts decreased to 1.6% for 2003 from 3.3% for 2002.

     Operating Income. Operating income increased $7.1 million to $31.6 million for the year ended December 31, 2003 from $24.5 million for the year ended December 31, 2002. The increase in operating income is primarily attributable to an increase of $5.5 million due to surgery centers acquired or developed and an increase of $3.2 million from our same store facilities. Operating income also increased due to improved collections of older accounts receivables. This increase in same store operating income was partially offset by an increase in general and administrative expenses during 2003. As a percentage of revenues, operating income increased to 17.9% for 2003 from 16.9% for 2002.

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     Minority Interests in Income of Consolidated Subsidiaries. Minority interests in income of consolidated subsidiaries for the year ended December 31, 2003 as compared to the year ended December 31, 2002 were as follows (dollars in thousands):

     Minority interests in income of consolidated subsidiaries for same store facilities increased due to improved operations at the same store facilities. Minority interest expense represents the portion of the surgery center’s net income that is attributable to the surgery center’s minority owners. Consequently, as the net income of the surgery centers increase, the corresponding minority interest expense will increase. As a percentage of revenues, minority interests in income from consolidated subsidiaries increased to 5.9% for 2003 from 5.1% for 2002.

     Interest Expense, Net of Interest Income. Interest expense, net of interest income, increased 26.1% to $5.8 million for 2003 from $4.6 million for 2002. The increase in interest expense was primarily the result of higher interest expense and prepayment penalties incurred in connection with the refinancing of outstanding indebtedness during 2003.

     Provision (Benefit) for Income Taxes. The provision (benefit) for income taxes decreased to a $2.2 million benefit for 2003 compared to a $215,000 provision for 2002. The 2003 results included the recognition of deferred tax assets of approximately $3.1 million.

     Net Income. Net income increased 42.3% to $17.5 million for 2003 from $12.3 million for 2002, primarily as a result of surgery centers acquired or developed since January 1, 2002. The increase is also the result of an increase in cases performed in 2003 compared to 2002, improved economies of scale and the $3.1 million deferred tax assets recorded during 2003. As a percentage of revenues, net income increased to 9.9% for 2003 from 8.5% for 2002.

     Adjusted Net Income. Adjusted net income increased $2.2 million to $9.9 million for 2003 from $7.7 million for 2002 for the same reasons net income increased. As a percentage of revenues, adjusted net income increased to 5.6% in 2003 from 5.3% for 2002.

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Quarterly Results of Operations

     The following tables present a summary of our unaudited quarterly consolidated results of operations for each of the four quarters in 2004 and 2003. The unaudited financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of such information when read in conjunction with our audited consolidated financial statements and related notes. Our quarterly operating results have varied in the past, may continue to do so and are not necessarily indicative of results for any future period.

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