UNITED SURGICAL PARTNERS INTERNATIONAL INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to to

Commission file number 000-32837

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

Delaware (State or other jurisdiction of incorporation or organization)		75-2749762 (IRS Employer Identification Number)
15305 Dallas Parkway, Suite 1600 Addison, Texas (Address of principal executive offices)		75001 (Zip Code)
(972) 713-3500 (Registrant's telephone number, including area code)

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

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

At August 5, 2003 there were 27,265,734 shares of Common Stock outstanding.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX

PART I.	Financial Information
	Item 1.	Financial Statements (unaudited)	3
		Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002	3
		Consolidated Statements of Income for the three months and six months ended June 30, 2003 and 2002	4
		Consolidated Statements of Comprehensive Income for the three months and six months ended June 30, 2003 and 2002	5
		Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
	Item 4.	Controls and Procedures	29
PART II.	Other Information
	Item 1.	Legal Proceedings	30
	Item 4.	Submission of Matters to a Vote of Security Holders	30
	Item 6.	Exhibits and Reports on Form 8-K	30
Signatures			32

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

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

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

			June 30, 2003			December 31, 2002
Assets
Cash and cash equivalents			$	34,444		$	47,571
Patient receivables, net of allowance for doubtful accounts of $7,232 and $7,154, respectively				49,282			39,176
Other receivables				25,805			34,735
Inventories of supplies				8,142			7,756
Deferred tax asset, net				5,701			5,657
Prepaids and other current assets				9,453			7,001

	Total current assets			132,827			141,896
Property and equipment, net				315,992			270,387
Investments in affiliates				21,875			18,696
Intangible assets, net				309,488			287,584
Other assets				19,483			8,722

	Total assets		$	799,665		$	727,285

Liabilities and Stockholders' Equity
Accounts payable			$	31,222		$	25,989
Accrued salaries and benefits				20,551			20,322
Due to affiliates				8,287			6,890
Accrued interest				1,600			1,650
Current portion of long-term debt				15,465			13,132
Other accrued expenses				24,254			22,501

	Total current liabilities			101,379			90,484
Long-term debt, less current portion				281,560			263,571
Other long-term liabilities				8,447			4,532
Deferred tax liability, net				25,039			19,577

	Total liabilities			416,425			378,164
Minority interests				32,413			26,860
Stockholders' equity:
	Common stock:
		Other, $0.01 par value; 200,000 shares authorized; 27,385 and 27,306 shares issued at June 30, 2003 and December 31, 2002, respectively		274			273
	Additional paid-in capital			321,748			320,750
	Treasury stock, at cost, 137 and 202 shares at June 30, 2003 and December 31, 2002, respectively			(2,522	)		(3,733	)
	Deferred compensation			(2,050	)		(1,226	)
	Receivables from sales of stock			(22	)		(191	)
	Accumulated other comprehensive income, net of tax			15,018			3,290
	Retained earnings			18,381			3,098

		Total stockholders' equity		350,827			322,261

		Total liabilities and stockholders' equity	$	799,665		$	727,285

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.

AND SUBSIDIARIES

Consolidated Statements of Income

(Unaudited—in thousands, except per share amounts)

		Three months ended June 30,						Six months ended June 30,
		2003			2002			2003			2002
Net patient service revenue		$	98,094		$	74,393		$	188,564		$	139,421
Management and administrative services revenue			9,161			8,363			17,198			15,686
Equity in earnings of unconsolidated affiliates			3,265			2,397			5,806			4,493
Other income			1,024			688			2,035			1,319

	Total revenues		111,544			85,841			213,603			160,919
Salaries, benefits, and other employee costs			27,407			20,852			52,903			39,968
Medical services and supplies			21,129			16,759			41,032			31,155
Other operating expenses			19,955			15,319			37,971			29,019
General and administrative expenses			7,373			6,383			14,087			12,279
Provision for doubtful accounts			1,994			1,570			3,542			2,698
Depreciation and amortization			7,870			6,321			15,307			11,978

	Total operating expenses		85,728			67,204			164,842			127,097

	Operating income		25,816			18,637			48,761			33,822
Interest income			194			81			511			389
Interest expense			(6,860	)		(6,283	)		(13,734	)		(12,211	)
Other			103			(26	)		109			(73	)

	Total other expense, net		(6,563	)		(6,228	)		(13,114	)		(11,895	)
	Income before minority interests		19,253			12,409			35,647			21,927
Minority interests in income of consolidated subsidiaries			(6,178	)		(3,418	)		(11,188	)		(6,106	)

	Income before income taxes		13,075			8,991			24,459			15,821
Income tax expense			(4,902	)		(2,877	)		(9,164	)		(5,003	)

	Net income	$	8,173		$	6,114		$	15,295		$	10,818

Net income per share attributable to common stockholders
	Basic	$	0.30		$	0.25		$	0.57		$	0.45
	Diluted	$	0.29		$	0.24		$	0.55		$	0.43
Weighted average number of common shares
	Basic		27,064			24,270			27,055			24,189
	Diluted		27,950			25,655			27,854			25,430

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.

AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited—in thousands)

		Three months ended June 30,				Six months ended June 30,
		2003		2002		2003		2002
Net income		$	8,173	$	6,114	$	15,295	$	10,818
Other comprehensive income, net of taxes:
	Foreign currency translation adjustments		9,149		13,476		11,713		11,524
	Net unrealized gains on securities		138		—		15		—

	Other comprehensive income		9,287		13,476		11,728		11,524

	Comprehensive income	$	17,460	$	19,590	$	27,023	$	22,342

See accompanying notes to consolidated financial statements.

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.

AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited—in thousands)

					Six months ended June 30,
					2003			2002
Cash flows from operating activities:
	Net income				$	15,295		$	10,818
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for doubtful accounts				3,542			2,698
		Depreciation and amortization				15,307			11,978
		Amortization of debt issue costs and discount				905			748
		Equity in earnings of unconsolidated affiliates				(5,806	)		(4,493	)
		Minority interests in income of consolidated subsidiaries				11,188			6,106
		Amortization of deferred compensation				279			145
		Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses:
			Patient receivables			(11,261	)		(7,534	)
			Other receivables			9,919			1,509
			Inventories of supplies, prepaids and other current assets			(2,324	)		111
			Accounts payable and other current liabilities			2,979			(426	)
			Other long-term liabilities			4,933			2,386

				Net cash provided by operating activities		44,956			24,046

Cash flows from investing activities:
	Purchases of new businesses and equity interests, net of cash received					(35,307	)		(34,653	)
	Purchases of property and equipment					(20,720	)		(11,140	)
	Sales of property					—			789
	Decrease (increase) in deposits and notes receivable					(4,256	)		140
	Cash placed in escrow					(3,145	)		—

				Net cash used in investing activities		(63,428	)		(44,864	)

Cash flows from financing activities:
	Proceeds from long-term debt					37,341			35,289
	Payments on long-term debt					(29,006	)		(24,938	)
	Proceeds from issuances of common stock					965			2,860
	Distributions on investments in affiliates					(3,766	)		(1,281	)

				Net cash provided by (used in) financing activities		5,534			(11,930	)

Effect of exchange rate changes on cash						(189	)		90

Net decrease in cash and cash equivalents						(13,127	)		(8,798	)
Cash and cash equivalents at beginning of period						47,571			33,881

Cash and cash equivalents at end of period					$	34,444		$	25,083

Supplemental information:
	Interest paid				$	13,092		$	12,016
	Income taxes paid					1,814			1,246
	Non-cash transactions:
		Assets acquired under capital lease obligations				1,669			530
		Issuance of common stock for service contracts				254			761
		Issuance of restricted stock awards				1,103			—

See accompanying notes to consolidated financial statements

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1) Basis of Presentation

(a): Description of Business

United Surgical Partners International, Inc. (together with its subsidiaries, USPI or the Company), a Delaware company, was formed in February 1998 for the primary purpose of ownership and operation of surgery centers, private surgical hospitals and related businesses in the United States and Western Europe. At June 30, 2003, USPI, headquartered in Dallas, Texas, operated 56 surgical facilities in the United States. Of these 56 facilities, USPI consolidates the results of 26, owns a minority or otherwise noncontrolling equity interest in 29, which are accounted for under the equity method, and holds no ownership interest in the remaining facility, which is operated by USPI under a management contract. In addition, United Surgical Partners Europe, S.L. (USPE), a company incorporated in Spain and majority owned by USPI, managed and owned a majority interest in eight private surgical hospitals and one surgery center in Spain at June 30, 2003. Global Healthcare Partners Limited (Global), a company incorporated in England and majority owned by USPI, managed and wholly owned three private surgical hospitals in the United Kingdom at June 30, 2003.

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

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

(b): Equity Based Compensation

USPI applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option grants to employees. As such, USPI generally does not record compensation expense because USPI generally issues options whereby the option exercise price equals the current market price of the underlying stock on the date of grant. SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, established accounting and disclosure requirements using a fair value based method of accounting for stock-based employee compensation plans. As permitted under SFAS No. 123, the Company has elected to continue to apply the intrinsic value based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123. Had USPI determined compensation cost based on the fair value at the grant date

for its stock options under SFAS No. 123, USPI's net income would have been the pro forma amounts indicated below:

		Three months ended June 30,						Six months ended June 30,
		2003			2002			2003			2002
Net income attributable to common stockholders
	As reported	$	8,173		$	6,114		$	15,295		$	10,818
	Add: Total stock-based employee compensation expense included in reported net income, net of taxes		451			120			759			223
	Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of taxes		(1,520	)		(798	)		(2,830	)		(1,543	)

	Pro forma	$	7,104		$	5,436		$	13,224		$	9,498

Basic earnings per share
	As reported	$	0.30		$	0.25		$	0.57		$	0.45
	Pro forma		0.26			0.22			0.49			0.39
Diluted earnings per share
	As reported		0.29			0.24			0.55			0.43
	Pro forma		0.25			0.21			0.47			0.37

The fair values in the table above were estimated at the date of grant using the Black-Scholes valuation model with the following assumptions: risk-free interest rates ranging from 2.3% to 6.3%, expected dividend yield of zero, expected volatility of the market price of the Company's common stock of 40%, and an expected life of the option ranging from three to five years.

Total stock-based employee compensation expense included in net income, as reported, primarily consists of expense related to grants to employees of the Company's common stock and a December 2000 grant of stock options at a price lower than the current market price at the date of grant. The compensation amounts related to these grants are being amortized into expense over the estimated service periods.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

(2) Acquisitions

In March 2003, the Company acquired 100% of a private surgical hospital in Marbella, Spain, for approximately €8.4 million ($9.0 million) in cash. In addition, the Company agreed to pay up to an additional total of €4.3 million ($4.9 million) to the sellers, depending on the resolution of certain

contingencies over the next four years, of which €2.9 million ($3.4 million) has been placed in escrow and is included in other assets in the Company's balance sheet at June 30, 2003.

During April 2003, the Company acquired a private surgical hospital in London, England for approximately £8.7 million ($13.8 million), of which the payment of approximately £0.5 million ($0.8 million) has been deferred pending the resolution of certain contingencies.

During June 2003, the Company acquired a 65% interest in an ambulatory surgery center in Austin, Texas for $10.8 million in cash.

Following are the unaudited pro forma results for the three months and six months ended June 30, 2003 and 2002 as if the acquisitions discussed above had occurred on January 1, 2002 (in thousands, except per share amounts):

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Net revenues	$	112,638	$	89,867	$	218,174	$	168,440
Net income		8,199		6,849		15,555		12,187
Basic earnings per share		0.30		0.28		0.57		0.50
Diluted earnings per share		0.29		0.27		0.56		0.48

The Company also engages in investing transactions that are not business combinations. These transactions primarily consist of acquisitions and sales of noncontrolling equity interests in surgical facilities and the investment of additional cash in surgical facilities under development. During the six months ended June 30, 2003, these transactions resulted in net cash outflows from USPI in an aggregate amount of $1.7 million.

(3) Earnings Per Share

Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding options, warrants and restricted stock, except where such effect would be antidilutive. The following table sets forth the

computation of basic and diluted earnings per share for the three months and six months ended June 30, 2003 and 2002 (in thousands, except per share amounts):

		Three months ended June 30,				Six months ended June 30,
		2003		2002		2003		2002
Net income attributable to common shareholders		$	8,173	$	6,114	$	15,295	$	10,818
Weighted average common shares outstanding			27,064		24,270		27,055		24,189
Effect of dilutive securities:
	Stock options		589		1,081		512		945
	Warrants and restricted stock		297		304		287		296

Shares used for diluted earnings per share			27,950		25,655		27,854		25,430

Basic earnings per share		$	0.30	$	0.25	$	0.57	$	0.45
Diluted earnings per share		$	0.29	$	0.24	$	0.55	$	0.43

(4) Other Receivables

During the second quarter, the Company modified some of the agreements under which the Company provides certain administrative services to physicians, eliminating the financing of accounts receivable from the scope of administrative services provided by the Company. As a result, the Company collected approximately $7.0 million of the outstanding other receivables from these physicians.

(5) Segment Disclosures

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

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

				Western Europe
Three months ended June 30, 2003 (unaudited)	U.S.			Spain			United Kingdom			Western Europe Total			Total
Net patient service revenue	$	53,493		$	30,398		$	14,203		$	44,601		$	98,094
Other revenue		12,764			686			—			686			13,450

Total revenues	$	66,257		$	31,084		$	14,203		$	45,287		$	111,544

Depreciation and amortization	$	4,411		$	2,369		$	1,090		$	3,459		$	7,870
Operating income		20,155			3,759			1,902			5,661			25,816
Net interest expense		(4,090	)		(2,095	)		(481	)		(2,576	)		(6,666	)
Income tax expense		(4,004	)		(617	)		(281	)		(898	)		(4,902	)
Total assets		441,221			211,279			147,165			358,444			799,665
Capital expenditures		3,024			3,470			4,963			8,433			11,457

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

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

Depreciation and amortization	$	3,878		$	1,632		$	811		$	2,443		$	6,321
Operating income		13,179			3,085			2,373			5,458			18,637
Net interest expense		(5,184	)		(437	)		(581	)		(1, 081	)		(6,202	)
Income tax benefit (expense)		(2,487	)		45			(435	)		(390	)		(2,877	)
Total assets		382,000			157,715			92,953			250,668			632,668
Capital expenditures		2,072			1,341			3,526			4,867			6,939

				Western Europe
Six months ended June 30, 2003 (unaudited)	U.S.			Spain			United Kingdom			Western Europe Total			Total
Net patient service revenue	$	102,498		$	58,013		$	28,053		$	86,066		$	188,564
Other revenue		23,652			1,387			—			1,387			25,039

Total revenues	$	126,150		$	59,400		$	28,053		$	87,453		$	213,603

Depreciation and amortization	$	8,649		$	4,528		$	2,130		$	6,658		$	15,307
Operating income		36,503			7,092			5,166			12,258			48,761
Net interest expense		(8,169	)		(3,944	)		(1,110	)		(5,054	)		(13,223	)
Income tax expense		(7,081	)		(1,122	)		(961	)		(2,083	)		(9,164	)
Total assets		441,221			211,279			147,165			358,444			799,665
Capital expenditures		7,040			6,162			9,187			15,349			22,389

				Western Europe
Six months ended June 30, 2002 (unaudited)	U.S.			Spain			United Kingdom			Western Europe Total			Total
Net patient service revenue	$	73,007		$	43,117		$	23,297		$	66,414		$	139,421
Other revenue		20,270			1,228			—			1,228			21,497

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

Depreciation and amortization	$	7,107		$	3,309		$	1,562		$	4,871		$	11,978
Operating income		23,813			5,054			4,955			10,009			33,822
Net interest expense		(9,988	)		(676	)		(1,158	)		(1,834	)		(11,822	)
Income tax benefit (expense)		(4,057	)		84			(1,030	)		(946	)		(5,003	)
Total assets		382,000			157,715			92,953			250,668			632,668
Capital expenditures		4,289			2,195			5,186			7,381			11,670

(6) Condensed Consolidating Financial Statements

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

Condensed Consolidating Balance Sheets:

As of June 30, 2003		USPI and Wholly-owned U.S. Subsidiaries		Non-participating Investees			Consolidation Adjustments			Consolidated Total
Assets:
Current assets:
Cash and cash equivalents		$	10,806	$	23,638		$	—		$	34,444
Accounts receivable, net			96		48,636			550			49,282
Other receivables			54,032		7,057			(35,284	)		25,805
Inventories of supplies			242		7,900			—			8,142
Other			10,409		4,745			—			15,154

	Total current assets		75,585		91,976			(34,734	)		132,827
Property and equipment, net			38,805		277,775			(588	)		315,992
Investments in affiliates			165,229		(329	)		(143,025	)		21,875
Intangible assets, net			176,113		134,512			(1,137	)		309,488
Other			109,651		15,986			(106,154	)		19,483

	Total assets	$	565,383	$	519,920		$	(285,638	)	$	799,665

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable		$	1,740	$	29,469		$	13		$	31,222
Accrued expenses			28,938		25,022			732			54,692
Current portion of long-term debt			2,666		13,845			(1,046	)		15,465

	Total current liabilities		33,344		68,336			(301	)		101,379
Long-term debt			163,570		254,966			(136,976	)		281,560
Other liabilities			13,019		20,467			—			33,486
Minority interests			—		10,084			23,008			33,092
Stockholders' equity			355,450		166,067			(171,369	)		350,148

	Total liabilities and stockholders' equity	$	565,383	$	519,920		$	(285,638	)	$	799,665

As of December 31, 2002		USPI and Wholly-owned U.S. Subsidiaries		Non-participating Investees		Consolidation Adjustments			Consolidated Total
Assets:
Current assets:
Cash and cash equivalents		$	24,712	$	22,859	$	—		$	47,571
Accounts receivable, net			90		39,086		—			39,176
Other receivables			46,983		9,281		(21,529	)		34,735
Inventories of supplies			280		7,476		—			7,756
Other			10,235		2,423		—			12,658

	Total current assets		82,300		81,125		(21,529	)		141,896
Property and equipment, net			39,236		231,743		(592	)		270,387
Investments in affiliates			172,050		375		(153,729	)		18,696
Intangible assets, net			166,036		122,685		(1,137	)		287,584
Other			98,647		5,204		(95,129	)		8,722

	Total assets	$	558,269	$	441,132	$	(272,116	)	$	727,285

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable		$	1,357	$	24,619	$	13		$	25,989
Accrued expenses			28,543		22,769		51			51,363
Current portion of long-term debt			2,453		11,937		(1,258	)		13,132

	Total current liabilities		32,353		59,325		(1,194	)		90,484
Long-term debt			158,199		216,621		(111,249	)		263,571
Other liabilities			7,936		16,173		—			24,109
Minority interests			—		7,387		19,473			26,860
Stockholders' equity			359,781		141,626		(179,146	)		322,261

	Total liabilities and stockholders' equity	$	558,269	$	441,132	$	(272,116	)	$	727,285

Condensed Consolidating Statements of Income:

Six months ended June 30, 2003	USPI and Wholly-owned U.S. Subsidiaries			Non-participating Investees			Consolidation Adjustments			Consolidated Total
Revenues	$	38,612		$	181,159		$	(6,168	)	$	213,603
Operating expenses, excluding depreciation and amortization		25,662			130,746			(6,873	)		149,535
Depreciation and amortization		4,980			10,331			(4	)		15,307

Operating income		7,970			40,082			709			48,761
Interest expense, net		(5,822	)		(7,402	)		—			(13,223	)
Other expense		157			107			(155	)		109

Income before minority interests		2,305			32,788			554			35,647
Minority interests in income of consolidated subsidiaries		—			(5,225	)		(5,963	)		(11,188	)
Income (loss) before income taxes		2,305			27,563			(5,409	)		24,459
Income tax expense		(6,912	)		(2,252	)		—			(9,164	)

Net income (loss)	$	(4,607	)	$	25,311		$	(5,409	)	$	15,295

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

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

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

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

Condensed Consolidating Statements of Cash Flows:

Six months ended June 30, 2003		USPI and Wholly-owned U.S. Subsidiaries			Non-participating Investees			Consolidation Adjustments			Consolidated Total
Cash flows from operating activities:
Net income (loss)		$	(4,605	)	$	25,309		$	(5,409	)	$	15,295
Changes in operating and intercompany assets and liabilities and noncash items included in net income(loss)			10,174			(12,513	)		32,000			29,661

	Net cash provided by operating activities		5,569			12,796			26,591			44,956
Cash flows from investing activities:
Purchases of property and equipment, net			(3,281	)		(17,439	)		—			(20,720	)
Purchases of new businesses			(13,549	)		(21,758	)		—			(35,307	)
Other items			(4,257	)		(3,144	)		—			(7,401	)

	Net cash used in investing activities		(21,087	)		(42,341	)		—			(63,428	)
Cash flows from financing activities:
Long-term borrowings, net			4,413			30,513			(26,591	)		8,335
Proceeds from issuance of common stock			965			—			—			965
Other items			(3,766	)		—			—			(3,766	)

	Net cash provided by (used in) financing activities		1,612			30,513			(26,591	)		5,534
Effect of exchange rate changes on cash			—			(189	)		—			(189	)
Net increase (decrease) in cash			(13,906	)		779			—			(13,127	)
Cash at the beginning of the period			24,712			22,859			—			47,571

Cash at the end of the period		$	10,806		$	23,638			—		$	34,444

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

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

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

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

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

(7) Commitments and Contingencies

(a): Financial Guarantees

As of June 30, 2003, the Company had issued guarantees of the indebtedness of its investees to third parties which could potentially require the Company to make maximum aggregate payments totaling approximately $31.1 million. Of the total, $20.2 million relates to the debt of consolidated subsidiaries, whose debt is included in the Company's consolidated balance sheet, and the remaining $10.9 million relates to the debt of unconsolidated affiliated companies, whose debt is not included in the Company's consolidated balance sheet. In accordance with Financial Accounting Standards Board Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company has recorded long-term liabilities totaling approximately $0.1 million related to the guarantees the Company has issued to unconsolidated affiliates after December 31, 2002, and has not recorded any liabilities related to guarantees issued prior to January 1, 2003. Generally, these arrangements (a) consist of guarantees of real estate and equipment financing, (b) are secured by the related property and equipment, (c) require payments by the Company, when the collateral is insufficient, in the event of a default by the investee primarily obligated under the financing, (d) expire as the underlying debt matures at various dates through 2022, and (e) provide no recourse for the Company to recover any amounts from third parties.

(b): Litigation and Professional Liability Claims

The Company has been named as a defendant in a lawsuit filed by former shareholders of SURGICOE Corporation, which the Company acquired in March 2002. The suit alleges that the Company failed to discharge certain post-closing obligations under the acquisition agreement. The Company's management believes the suit is wholly without merit, and the Company is vigorously defending the suit.

Additionally, in its normal course of business, USPI is subject to claims and lawsuits relating to patient treatment. USPI believes that its liability for damages resulting from such claims and lawsuits is adequately covered by insurance or is adequately provided for in its consolidated financial statements.

(8) Subsequent Events

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

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

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

Forward-Looking Statements

Certain statements contained or incorporated by reference in this Quarterly Report on Form 10-Q, including without limitation statements containing the words "believes," "anticipates," "expects," "continues," "will," "may," "should," "estimates," "intends," "plans," and similar expressions, and statements regarding the Company's business strategy and plans, constitute "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on management's current expectations and involve known and unknown risks, uncertainties and other factors, many of which the Company is unable to predict or control, that may cause the Company's actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions, both nationally and regionally; demographic changes; changes in, or the failure to comply with, laws and governmental regulations; foreign currency fluctuations; the ability to enter into managed care provider arrangements on acceptable terms; changes in Medicare, Medicaid and other government funded payments or reimbursement; liability and other claims asserted against us; the highly competitive nature of healthcare; changes in business strategy or development plans of healthcare systems with which we partner; the ability to attract and retain qualified personnel, including physicians, nurses and other health care professionals; our significant indebtedness; the availability of suitable acquisition opportunities and the length of time it takes to accomplish acquisitions; our ability to integrate new businesses with our existing operations and certain additional factors, risks, and uncertainties discussed in this Quarterly Report on Form 10-Q. Given these uncertainties, investors and prospective investors are cautioned not to rely on such forward-looking statements. We disclaim any obligation and make no promise to update any such factors or forward-looking statements or to publicly announce the results of any revisions to any such factors or forward-looking statements, whether as a result of changes in underlying factors, to reflect new information as a result of the occurrence of events or developments or otherwise.

Overview

The Company operates surgery centers and private surgical hospitals in the United States and Western Europe. As of June 30, 2003, the Company operated 68 surgical facilities, consisting of 56 in the United States, nine in Spain, and three in the United Kingdom. Of the 56 U.S. facilities, the Company jointly operates 28 with twelve major not-for-profit healthcare systems. Overall, the Company holds ownership in 67 of the facilities and operates the remaining facility, which is in the United States, under a management contract.

Critical Accounting Policies

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

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

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

We also consider our accounting policy regarding intangible assets to be a critical accounting policy given the significance of intangible assets as compared to the total assets of the Company and the recent changes in accounting for intangible assets required under Statement of Financial Accounting Standards No. 142, Accounting for Goodwill and other Intangible Assets (SFAS No. 142), which was issued by the Financial Accounting Standards Board on July 20, 2001 and was adopted by the Company as of January 1, 2002. There have been no significant changes in the application of SFAS No. 142 since the preparation of the Company's latest audited financial statements.

Acquisitions, Equity Investments and Development Projects

In March 2003, we acquired a surgical hospital in Marbella, Spain, for approximately €8.4 million ($9.0 million) in cash. In addition, we agreed to pay up to an additional total of €4.3 million ($4.9 million), depending on the resolution of certain contingencies over the next four years.

During April 2003, we acquired a private surgical hospital in London, England for approximately £8.7 million ($13.8 million), of which the payment of approximately £0.5 million ($0.8 million) has initially been deferred pending the resolution of certain contingencies.

During June 2003, we acquired a 65% interest in an ambulatory surgery center in Austin, Texas for $10.8 million in cash.

We also engage in investing transactions that are not business combinations, consisting primarily of purchases and sales of noncontrolling equity interests in surgical facilities and the investment of additional cash in surgical facilities under development. During the six months ended June 30, 2003, these transactions resulted in net cash outflows of $1.7 million.

Sources of Revenue

Revenues primarily include:

•: net patient service revenue at the facilities that we consolidate for financial reporting purposes, which are typically those in which we have ownership interests of greater than 50% or otherwise maintain effective control:
•: management and administrative services revenue earned from management contracts, whereby we manage the operations of surgical facilities in which we have varying levels of ownership, and from contracts to provide consulting and specific administrative services to physicians. Management service revenue and expenses earned from and incurred by facilities that we consolidate for financial reporting purposes are eliminated in consolidation and therefore not included in management service revenue or operating expenses in our consolidated income statements and accordingly have no impact on consolidated net income; and
•: our share of the net income or loss of the unconsolidated facilities that we account for under the equity method of accounting. These amounts are included in revenues as these operations

are central to our business strategy. Through our contracts to manage these facilities, we have an active role in their operations. The level of our corporate resources devoted to fulfilling these responsibilities is significant and generally equal to that devoted to the operations of the facilities we consolidate for financial reporting purposes.

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

		Three months ended June 30,				Six months ended June 30,
		2003		2002		2003		2002
Net patient service revenue		88	%	86	%	88	%	86	%
Management and administrative services revenue		8		10		8		10
Equity in earnings of unconsolidated affiliates		3		3		3		3
Other income		1		1		1		1

	Total revenues	100	%	100	%	100	%	100	%

The percentage of our total revenues that was earned from net patient service revenue increased from 86% for the three months and six months ended June 30, 2002 to 88% for the three months and six months ended June 30, 2003, with a corresponding decrease in the percentage of our total revenue that was earned from management and administrative services revenue, primarily as a result of our acquiring majority interests in nine surgical facilities since December 31, 2001. Our management and administrative services revenues are earned from the following types of activities (dollars in thousands):

		Three months ended June 30,				Six months ended June 30,
		2003		2002		2003		2002
Management of surgical facilities		$	3,836	$	2,488	$	6,951	$	4,348
Consulting and other services provided to physicians and related entities			5,325		5,875		10,247		11,338

	Total management and administrative service revenues	$	9,161	$	8,363	$	17,198	$	15,686

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

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Total revenues	$	56,051		$	35,606		$	102,588		$	64,306
Depreciation and amortization		2,761			1,783			5,248			3,021
Operating income		16,657			11,517			29,809			20,347
Interest expense, net		1,744			1,137			3,421			1,700
Net income		14,725			10,145			25,781			18,269
Long-term debt		82,079			46,435			82,079			46,435
USPI's equity in earnings of unconsolidated affiliates		3,265		$	2,397			5,806			4,493
USPI's imputed weighted average ownership percentage based on affiliates' net income(1)		22.2	%		23.6	%		22.5	%		24.5	%
USPI's imputed weighted average ownership percentage based on affiliates' debt(2)		23.5	%		29.2	%		23.5	%		29.2	%
Unconsolidated facilities operated at period end		29			23			29			23

(1): Calculated by dividing USPI's equity in earnings of unconsolidated affiliates by the total net income of the affiliates for each respective period.
(2): Calculated by multiplying the total debt of each affiliate by the percentage ownership USPI held in the affiliate as of the end of each respective period.

For the three months and six months ended June 30, 2003 and 2002, approximately 59% and 58% of our revenues were generated from operations in the United States and 41% and 42% from Western Europe, respectively. The increase in the percentage of our revenues generated in the United States and corresponding decrease in Western Europe resulted from focusing our development and acquisition activities more heavily in the United States than in Western Europe during the period from December 31, 2001 to June 30, 2003.

Results of Operations

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

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Total revenues	100	%	100.0	%	100	%	100.0	%
Operating expenses, excluding depreciation and amortization	69.8		70.9		70.0		71.5
Depreciation and amortization	7.1		7.4		7.2		7.5

Operating income	23.1		21.7		22.8		21.0
Minority interests in income of consolidated entities	5.5		4.0		5.2		3.8
Interest and other expense, net	5.9		7.2		6.1		7.4

Income before income taxes	11.7		10.5		11.5		9.8
Income tax expense	(4.4	)	(3.4	)	(4.3	)	(3.1	)

Net income	7.3		7.1		7.2		6.7

EBITDA less minority interests(a)	24.7		25.1		24.8		24.7

(a): EBITDA is calculated as operating income plus depreciation and amortization. We use EBITDA and EBITDA less minority interests as analytical indicators for purposes of allocating resources and assessing performance. EBITDA is commonly used as an analytical indicator within the health care industry and also serves as a measure of leverage capacity and debt service ability. EBITDA should not be considered as a measure of financial performance under generally accepted accounting principles, and the items excluded from EBITDA are significant components in understanding and assessing financial performance. Because EBITDA is not a measurement determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculation methods, EBITDA as presented by us may not be comparable to similarly titled measures of other companies.

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

		Three months ended June 30,						Six months ended June 30,
		2003			2002			2003			2002
Net income		$	8,173		$	6,114		$	15,295		$	10,818
	Income tax expense		4,902			2,877			9,164			5,003
	Interest and other non-operating expense		6,563			6,228			13,114			11,895
	Depreciation and amortization		7,870			6,321			15,307			11,978

EBITDA less minority interests			27,508			21,540			52,880			39,694
	Minority interests in income of consolidated subsidiaries		6,178			3,418			11,188			6,106

EBITDA			33,686			24,958			64,068			45,800
	Provision for doubtful accounts		1,994			1,570			3,542			2,698
	Amortization of debt issue costs, discount, and deferred compensation		605			471			1,184			893
	Interest and other nonoperating expense		(6,563	)		(6,228	)		(13,114	)		(11,895	)
	Income tax expense		(4,902	)		(2,877	)		(9,164	)		(5,003	)
	Equity in earnings of unconsolidated affiliates		(3,265	)		(2,397	)		(5,806	)		(4,493	)
	Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses		4,886			(5,413	)		4,246			(3,954	)

Net cash provided by operating activities		$	26,441		$	10,084		$	44,956		$	24,046

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002

Revenues increased by $25.7 million, or 30%, to $111.5 million for the three months ended June 30, 2003 from $85.8 million for the three months ended June 30, 2002. Of this increase in revenues, $11.2 million was contributed by facilities acquired or opened since March 31, 2002. The U.S. dollar was weaker relative to the Eurodollar and the British pound during the three months ended June 30, 2003 as compared to the same period in the prior year, resulting in a positive impact of $7.4 million on year over year revenues for the facilities in Western Europe that were owned in both 2003 and 2002 ("same store" facilities). Absent this foreign exchange impact, same store facilities in Western Europe contributed $0.4 million more to consolidated revenues in the three months ended June 30, 2003 as compared to the same period in 2002. The remaining increase in revenues was contributed by same store U.S. facilities, which performed approximately 7% more cases in the three months ended June 30, 2003 as compared to the three months ended June 30, 2002.

Operating expenses, excluding depreciation and amortization, increased by $17.0 million, or 28%, to $77.9 million for the three months ended June 30, 2003 from $60.9 million for the three months ended June 30, 2002. Operating expenses, excluding depreciation and amortization, as a percentage of revenues, decreased to 69.8% for the three months ended June 30, 2003 from 70.9% for the three months ended June 30, 2002, primarily as a result of operating efficiencies at our facilities and improved economies of scale as we expanded.

Depreciation and amortization increased $1.6 million, or 25%, to $7.9 million for the three months ended June 30, 2003 from $6.3 million for the three months ended June 30, 2002, primarily as a result of additional depreciation on tangible assets added through acquisitions and the effect of the weaker U.S. dollar. Depreciation and amortization, as a percentage of revenues, decreased to 7.1% for the three months ended June 30, 2003 from 7.4% for the three months ended June 30, 2002.

Operating income increased $7.2 million, or 39%, to $25.8 million for the three months ended June 30, 2003 from $18.6 million for the three months ended June 30, 2002, primarily as a result of the impact of acquisitions and improved operating margins at our facilities, as discussed above. Operating income, as a percentage of revenues, increased to 23.1% for the three months ended June 30, 2003 from 21.7% for the three months ended June 30, 2002, primarily as a result of improved operating margins at our facilities and the leveraging of our corporate overhead expenses over the increased revenue.

Interest expense, net of interest income, increased 7% to $6.7 million for the three months ended June 30, 2003 from $6.2 million for the three months ended June 30, 2002 primarily as a result of interest expense on debt of facilities acquired since March 31, 2002.

Provision for income taxes and our overall effective tax rates were $4.9 million and 37% for the three months ended June 30, 2003, compared to $2.9 million and 32% for the three months ended June 30, 2002, respectively. The increase in our actual provision for income taxes and in our overall effective tax rate primarily results from our accruing no net income tax expense in Spain prior to January 1, 2003, at which time we began accruing taxes at rates approximating statutory rates. We began utilizing net operating loss carryforwards (NOLs) to offset current taxable income as our Spain operations achieved profitability for the first time during 2002, and during the fourth quarter of 2002 we recognized the benefit of a portion of our Spain NOLs generated during our initial years of operations as the realization of a portion of our Spain NOLs was deemed "more likely than not."

Net income was $8.2 million for the three months ended June 30, 2003 compared to $6.1 million for the three months ended June 30, 2002. This $2.1 million improvement primarily results from the increased revenues and improved operating efficiencies and economies of scale related to expenses discussed above.

EBITDA less minority interests increased $6.0 million, or 28%, to $27.5 million for the three months ended June 30, 2003 from $21.5 million for the three months ended June 30, 2002. Of this increase in EBITDA less minority interests, $2.7 million was contributed by facilities acquired or opened since March 31, 2002. EBITDA less minority interests, as a percentage of revenues, decreased to 24.7% for the three months ended June 30, 2003 from 25.1% for the three months ended June 30, 2002, primarily as a result of increased minority interest expense due to our holding a smaller ownership interest in certain facilities in 2003 as compared to the prior year period. The impact of these ownership changes was partially offset by improved operating margins at our facilities.

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

Revenues increased by $52.7 million, or 33%, to $213.6 million for the six months ended June 30, 2003 from $160.9 million for the six months ended June 30, 2002. Of this increase in revenues, $22.6 million was contributed by facilities acquired or opened since December 31, 2001. The U.S. dollar was weaker relative to the Eurodollar and the British pound during the three months ended June 30, 2003 as compared to the same period in the prior year, resulting in a positive impact of $13.9 million on year over year revenues for the facilities in Western Europe that were owned in both 2003 and 2002 ("same store" facilities). Absent this foreign exchange impact, same store facilities in Western Europe contributed $3.0 million more to consolidated revenues in the six months ended June 30, 2003 as compared to the same period in 2002. The remaining increase in revenues was contributed by same store U.S. facilities, which performed approximately 9% more cases in the six months ended June 30, 2003 as compared to the six months ended June 30, 2002.

Operating expenses, excluding depreciation and amortization, increased by $34.4 million, or 30%, to $149.5 million for the six months ended June 30, 2003 from $115.1 million for the six months ended June 30, 2002. Operating expenses, excluding depreciation and amortization, as a percentage of revenues, decreased to 70.0% for the six months ended June 30, 2003 from 71.5% for the six months

ended June 30, 2002, primarily as a result of operating efficiencies at our facilities and improved economies of scale as we expanded.

Depreciation and amortization increased $3.3 million, or 28%, to $15.3 million for the six months ended June 30, 2003 from $12.0 million for the six months ended June 30, 2002, primarily as a result of additional depreciation on tangible assets added through acquisitions and the effect of the weaker U.S. dollar. Depreciation and amortization, as a percentage of revenues, decreased to 7.2% for the six months ended June 30, 2003 from 7.5% for the six months ended June 30, 2002.

Operating income increased $15.0 million, or 44%, to $48.8 million for the six months ended June 30, 2003 from $33.8 million for the six months ended June 30, 2002, primarily as a result of the impact of acquisitions and improved operating margins at our facilities, as discussed above. Operating income, as a percentage of revenues, increased to 22.8% for the six months ended June 30, 2003 from 21.0% for the six months ended June 30, 2002, primarily as a result of improved operating margins at our facilities and the leveraging of our corporate overhead expenses over the increased revenue.

Interest expense, net of interest income, increased 12% to $13.2 million for the six months ended June 30, 2003 from $11.8 million for the six months ended June 30, 2002 primarily as a result of interest expense on debt of facilities acquired since December 31, 2001.

Provision for income taxes and our overall effective tax rates were $9.2 million and 37% for the six months ended June 30, 2003, compared to $5.0 million and 32% for the six months ended June 30, 2002, respectively. The increase in our actual provision for income taxes and in our overall effective tax rate primarily results from our accruing no net income tax expense in Spain prior to January 1, 2003, at which time we began accruing taxes at rates approximating statutory rates. We began utilizing net operating loss carryforwards (NOLs) to offset current taxable income as our Spain operations achieved profitability for the first time during 2002, and during the fourth quarter of 2002 we recognized the benefit of a portion of our Spain NOLs generated during our initial years of operations as the realization of a portion of our Spain NOLs was deemed "more likely than not."

Net income was $15.3 million for the six months ended June 30, 2003 compared to $10.8 million for the six months ended June 30, 2002. This $4.5 million improvement primarily results from the increased revenues and improved operating efficiencies and economies of scale related to expenses discussed above.

EBITDA less minority interests increased $13.2 million, or 33%, to $52.9 million for the six months ended June 30, 2003 from $39.7 million for the six months ended June 30, 2002. Of this increase in EBITDA less minority interests, $5.4 million was contributed by facilities acquired or opened since December 31, 2001. EBITDA less minority interests, as a percentage of revenues, increased to 24.8% for the six months ended June 30, 2003 from 24.7% for the six months ended June 30, 2002, primarily as a result of improved operating margins at our facilities and the leveraging of our corporate overhead expenses over the increased revenue.

Liquidity and Capital Resources

During the six months ended June 30, 2003, the Company generated $45.0 million of cash flows from operations as compared to $24.0 million during the six months ended June 30, 2002. Of this $21.0 million improvement, approximately $7.0 million resulted from the collection of receivables from physician groups to whom we provide certain administrative services. This collection resulted from the modification of our agreements with those physicians, whereby the financing of accounts receivable was eliminated from the scope of administrative services provided by us.

During the six months ended June 30, 2003, the Company's net cash used in investing activities was $63.4 million, consisting primarily of $35.3 million for the purchase of businesses and equity interests, net of cash received, and $20.7 million for the purchase of property and equipment. The

$35.3 million primarily consists of $9.0 million paid for the acquisition of a private surgical hospital in Marbella, Spain, $13.8 million paid for the acquisition of a private surgical hospital in London, England, $10.8 million paid for the acquisition of an ambulatory surgery center in Austin, Texas, and net incremental investments in unconsolidated affiliates of $1.7 million. Approximately $10.9 million of the property and equipment purchases related to ongoing development projects and the remaining $9.8 million represents purchases of equipment at existing facilities. The $63.4 million of cash used in investing activities was funded primarily with cash flows from operations and additionally through a reduction in cash on hand and borrowings under our credit facilities. Net cash provided by financing activities during the six months ended June 30, 2003 was $5.5 million. Cash and cash equivalents were $34.4 million at June 30, 2003 as compared to $47.6 million at December 31, 2002, and net working capital was $31.4 million at June 30, 2003 as compared to $51.4 million at December 31, 2002.

In November 2002, we entered into a revolving credit facility with a group of commercial lenders providing us with the ability to borrow up to $115.0 million for acquisitions and general corporate purposes in the United States and Spain or for any new subsidiary that becomes a guarantor of the facility. Under the terms of the facility, the Company may invest up to a total of $25.0 million in subsidiaries that are not guarantors, including subsidiaries in the United Kingdom. Borrowings under our credit facility mature on November 7, 2005. As of June 30, 2003, $5.6 million was outstanding under this facility and $42.3 million was available for borrowing based on actual reported consolidated financial results. Maximum availability under the facility is based upon pro forma EBITDA including EBITDA from acquired entities. Assuming historical purchase multiples of annual EBITDA of potential acquisition targets, approximately $84.7 million would be available for borrowing to finance acquisitions as of June 30, 2003, of which $5.6 million was drawn at June 30, 2003. Our credit agreement and the indenture governing our Senior Subordinated Notes contain various restrictive covenants, including covenants that limit our ability and the ability of certain of our subsidiaries to borrow money or guarantee other indebtedness, grant liens on our assets, make investments, use assets as security in other transactions, pay dividends on stock, enter into sale and leaseback transactions or sell assets or capital stock.

Additionally, one of our U.K. subsidiaries has a credit agreement with a commercial lender in the United Kingdom that provides for total borrowings of £52.0 million (approximately $86.0 million as of June 30, 2003) under four separate facilities, the fourth of which was added during the second quarter of 2003, increasing the agreement's total borrowing capacity by £10.0 million from its previous total of £42.0 million. At June 30, 2003, total outstanding borrowings under this credit agreement were approximately $60.1 million, which represents total borrowings net of scheduled repayments of $12.4 million that have been made under the agreement, and approximately $13.5 million was available for borrowings, primarily for capital projects specified under the agreement. Borrowings under this agreement bear interest at rates of 1.50% to 2.00% over LIBOR and mature in April 2010. We pledged the capital stock of our U.K. subsidiaries to secure borrowings under this agreement.

We were in compliance with all debt covenants as of June 30, 2003.

		Payments Due by Period (In Thousands)
Contractual Cash Obligations		Total		Within 1 year		1 to 3 years		4 to 5 years		Beyond 5 years
Long term debt
	Senior Subordinated Notes	$	150,000	$	—	$	—	$	—	$	150,000
	U.S. Credit Facility		5,600		—		5,600		—		—
	U.K. Credit Facility		60,101		4,463		10,496		15,537		29,605
	Loans from former owners of subsidiaries		1,156		1,053		103		—		—
	Other debt at operating subsidiaries		18,062		4,149		8,129		4,070		1,714
Capitalized lease obligations:
	U.S. operating subsidiaries		49,030		8,382		13,014		3,671		23,963
	Western Europe operating Subsidiaries		91,192		4,616		8,313		7,693		70,570
Operating lease obligations:
	U.S. operating subsidiaries		49,155		6,568		11,927		10,686		19,974
	Western Europe operating Subsidiaries		12,263		1,601		2,652		2,280		5,730

Total contractual cash obligations		$	436,559	$	30,832	$	60,234	$	43,937	$	301,556

Our operating subsidiaries, many of which have minority owners who share in the cash flow of these entities, have debt consisting primarily of capitalized lease obligations. This debt is generally non-recourse to USPI, the parent company, and is generally secured by the assets of those operating entities. The total amount of these obligations, which was $82.4 million at June 30, 2003, is included in our consolidated balance sheet because the borrower or obligated entity meets the requirements for consolidated financial reporting. Our average percentage ownership, weighted based on the individual subsidiary's amount of debt and capitalized leased obligations, of these consolidated subsidiaries was 84.4% at June 30, 2003. Additionally, our unconsolidated affiliates that we account for under the equity method have debt and capitalized lease obligations that are generally non-recourse to USPI and are not included in our consolidated financial statements. At June 30, 2003, the total obligations of these unconsolidated affiliates under debt and capital lease obligations was approximately $82.1 million. Our average percentage ownership, weighted based on the individual affiliate's amount of debt and capitalized lease obligations, of these unconsolidated affiliates was 23.5% at June 30, 2003. USPI or one of its wholly owned subsidiaries had collectively guaranteed $10.9 million in total debt and capital lease obligations of our unconsolidated affiliates as of June 30, 2003.

These unconsolidated affiliates are limited partnerships, limited liability partnerships or limited liability companies that own operational surgical facilities or surgical facilities that are under development. None of these affiliates provide financing, liquidity, or market or credit risk support for us. They also do not engage in leasing, hedging or research and development services with us. Moreover, we do not believe that they expose us to any of their liabilities that are not otherwise reflected in our consolidated financial statements. We are not obligated to fund losses or otherwise provide additional funding to these affiliates other than as we determine to be economically required in order to successfully implement our development plans.

Our acquisition and development program will require substantial capital resources, which we estimate to range from $40.0 million to $60.0 million per year over the next three years, including an estimated $3.3 million related to additional consideration to the sellers of acquired facilities based upon those facilities achieving certain financial targets and potentially an additional €4.3 million (approximately $5.0 million as of June 30, 2003) related to the resolution of certain contingencies related to the Marbella acquisition, of which €2.9 million (approximately $3.4 million as of June 30, 2003) million has been placed in escrow and is reported in other assets in our consolidated balance sheet. In addition, the operations of our existing surgical facilities will require ongoing capital

expenditures. We believe that existing funds, cash flows from operations and borrowings under our credit facilities will provide sufficient liquidity for at least the next twelve months.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

We have exposure to interest rate risk related to our financing, investing, and cash management activities. Historically, we have not held or issued derivative financial instruments other than the use of variable-to-fixed interest rate swaps for portions of our borrowings under credit facilities with commercial lenders as required by the credit agreements. We do not use derivative instruments for speculative purposes. Our financing arrangements with commercial lenders are based on the spread over Prime, LIBOR or Euribor. At June 30, 2003, $148.9 million of our total outstanding debt was the Senior Subordinated Notes, which were issued in December 2001 at a 0.8% discount and bear interest at a fixed rate of 10%, $5.2 million was in other fixed rate instruments and the remaining $76.1 million was in variable rate instruments. Accordingly, a hypothetical 100 basis point increase in market interest rates would result in additional annual expense of $0.8 million. The Senior Subordinated Notes, which represent 97% of our total fixed rate debt at June 30, 2003, are considered to have a fair value, based upon recent trading, of $161.4 million, which is approximately $12.5 million higher than the carrying value at June 30, 2003.

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

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

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

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

ITEM 4. Controls and Procedures

The Chairman and Chief Executive Officer and Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined by SEC Rules) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information required to be included in the Company's periodic SEC filings. There have been no significant changes in the Company's internal controls over financial reporting (as defined by SEC Rules) that occurred during the Company's fiscal quarter ended June 30, 2003 that have materially affected or are reasonably likely to materially affect, the Company's internal controls over financial reporting.

PART II—OTHER INFORMATION

ITEM 1. Legal Proceedings

We have been named as a defendant in a lawsuit filed by former shareholders of Surgicoe Corporation, which we acquired in March 2002. The suit alleges that we failed to discharge certain post-closing obligations under the acquisition agreement. We believe that the suit is wholly without merit, and we are vigorously defending the suit. In addition, from time to time, we may be named as a party to legal claims and proceedings in the ordinary course of business. We are not aware of any other claims or proceedings against us or our subsidiaries that might have a material adverse impact on us.

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

At the annual Meeting of Stockholders held on May 12, 2003, the following proposals were submitted to stockholders with the following results:

1.: Election of Class II directors of the Company to hold office until the Annual Meeting of Stockholders of the Company in 2006 and until their respective successors are elected and qualified or until their earlier death, resignation, or removal from office, as follows:

	Number of Shares
	For	Withheld
Joel T. Allison	20,767,385	33,066
D. Scott Mackesy	20,252,964	547,487
Jerry P. Widman	20,738,746	61,705
David P. Zarin, M.D.	17,919,844	2,880,607

2.: Ratification of the selection of KPMG LLP as the independent accountants of the Company for the fiscal year ending December 31, 2003:

		Number of Shares
For		20,484,441
Against		266,504
Abstain		167,856

ITEM 6. Exhibits and Reports on Form 8-K

(a): Exhibits:

Exhibit Number		Description
3.1		Second Amended and Restated Certificate of Incorporation (previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-55442) and incorporated herein by reference).
3.2		Amended and Restated Bylaws (previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-55442) and incorporated herein by reference).
4.1		Form of Common Stock Certificate (previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-55442) and incorporated herein by reference).

4.2		Indenture, dated as of December 19, 2001, among United Surgical Partners Holdings, Inc., the guarantor parties thereto and U.S. Trust Company of Texas, N.A. (previously filed as Exhibit 4.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference).
31.1*		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certification of Chief Financial Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*

Filed herewith.

(b): Reports on Form 8-K:

The Company filed a report on Form 8-K dated April 28, 2003 to furnish, pursuant to Regulation FD, a news release announcing the Company's results for the quarter ended March 31, 2003.

The Company filed a report on Form 8-K dated May 7, 2003 to furnish, pursuant to Regulation FD, a copy of materials dated May 2003 and prepared with respect to presentations to investors and others that may be made by senior officers of the Company.

SIGNATURES

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

	UNITED SURGICAL PARTNERS INTERNATIONAL, INC.
Date: August 8, 2003	By:	/s/ MARK A. KOPSER Mark A. Kopser Senior Vice President and Chief Financial Officer (Principal Financial Officer and duly authorized to sign this report on behalf of the Registrant)
	By:	/s/ JOHN J. WELLIK John J. Wellik Senior Vice President, Accounting and Administration, Compliance Officer and Secretary (Principal Accounting Officer)

Exhibit Index

Exhibit Number		Description
3.1		Second Amended and Restated Certificate of Incorporation (previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-55442) and incorporated herein by reference).
3.2		Amended and Restated Bylaws (previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-55442) and incorporated herein by reference).
4.1		Form of Common Stock Certificate (previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-55442) and incorporated herein by reference).
4.2		Indenture, dated as of December 19, 2001, among United Surgical Partners Holdings, Inc., the guarantor parties thereto and U.S. Trust Company of Texas, N.A. (previously filed as Exhibit 4.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference).
31.1*		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certification of Chief Financial Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*: Filed herewith.

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UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES INDEX
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Unaudited—in thousands, except per share amounts)
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Statements of Income (Unaudited—in thousands, except per share amounts)
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Unaudited—in thousands)
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Unaudited—in thousands)
UNITED SURGICAL PARTNERS INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited)

Condensed Consolidating Statements of Income

Condensed Consolidating Statements of Cash Flows

SIGNATURES
Exhibit Index