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3-Nov-2009
Quarterly Report
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 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: our significant indebtedness, general economic and business conditions, including without limitation the condition of financial markets, both nationally and internationally; foreign currency fluctuations; geographic concentrations of certain of our operations; changes in, or the failure to comply with, laws and governmental regulations; the ability to enter into or renew managed care provider arrangements on acceptable terms; changes in Medicare, Medicaid and other government funded payments or reimbursement in the United States and the United Kingdom; the effects of insurers, healthcare providers and others to contain healthcare costs; the possible enactment of federal or state healthcare reform; liability and other claims asserted against us; the highly competitive nature of the healthcare industry; changes in business strategy or development plans of healthcare systems with which we partner; the ability to attract and retain qualified physicians and personnel, including nurses and other health care professionals; the availability of suitable acquisition and development opportunities and the length of time it takes to accomplish acquisitions and developments; our ability to integrate new businesses with our existing operations; the availability and terms of capital to fund the expansion of our business, including the acquisition and development of additional facilities and certain additional factors, risks, and uncertainties discussed in this Quarterly Report on Form 10-Q. Given these uncertainties, investors and prospective investors are cautioned not to rely on such forward-looking statements. We disclaim any obligation and make no promise to update any such factors or forward-looking statements or to publicly announce the results of any revisions to any such factors or forward-looking statements, whether as a result of changes in underlying factors, to reflect new information as a result of the occurrence of events or developments or otherwise.
Overview
We operate ambulatory surgery centers and surgical hospitals in the United States and the United Kingdom. As of September 30, 2009, we operated 167 facilities, consisting of 163 in the United States and four in the United Kingdom. All 163 of our U.S. facilities include local physician owners, and 103 of these facilities are also partially owned by various not-for-profit healthcare systems (hospital partners). In addition to facilitating the joint ownership of most of our existing facilities, our agreements with hospital partners provide a framework for the planning and construction of additional facilities in the future, including the facility we are currently constructing as well as the seven additional projects under development. We opened two de novo facilities in October 2009, both of which have a hospital partner.
Our U.S. facilities, consisting of ambulatory surgery centers and surgical hospitals, specialize in non-emergency surgical cases. Due in part to advancements in medical technology, the volume of surgical cases performed in an outpatient setting has steadily increased over the past two decades. Our facilities earn a fee from patients, insurance companies, or other payers in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. In addition, we earn a monthly fee from each facility we operate in exchange for managing its operations. All but four of our facilities are located in the U.S., where we have focused increasingly on partnering our facilities with hospital partners, which we believe improves the long-term profitability and potential of our facilities.
In the United Kingdom we operate three hospitals and an oncology clinic, which supplement the services provided by the government-sponsored healthcare system. Our patients choose to receive care at private facilities primarily because of waiting lists to receive diagnostic procedures or elective surgery at government-sponsored facilities and pay us either from personal funds or through private insurance, which is offered by many employers as a benefit to their employees. Since acquiring our first two hospitals in the United Kingdom in 2000, we have expanded selectively by acquiring a third hospital and increasing the capacity and services offered at each facility, including the construction of an oncology clinic near the campus of one of our hospitals.
Our growth and success depends on our ability to continue to grow volumes at our existing facilities, to successfully open new facilities we develop, to successfully integrate acquired facilities into our operations, and to maintain productive relationships with our physician and hospital partners. We believe we will have significant opportunities to operate more facilities with hospital partners in the future in existing and new markets.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition, results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of consolidated financial statements under GAAP requires our management to make certain estimates and assumptions that impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. These estimates and assumptions also impact the reported amount of net earnings during any period. Estimates are based on information available as of the date financial statements are prepared. Accordingly, actual results could differ from those estimates. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and that require management's most subjective judgments. Our critical accounting policies and estimates include our policies and estimates regarding consolidation, revenue recognition, income taxes and intangible assets.
Our determination of whether to consolidate an entity in which we hold an investment, account for it under the equity method, or carry it at cost has a significant impact on our consolidated 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 hospital partners, physicians, and other parties. These quarterly consolidated financial statements have been prepared using the same consolidation policy as that used in our latest audited consolidated 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. There have been no significant changes in our application of GAAP to intangible assets since the preparation of our latest audited consolidated financial statements.
Our revenue recognition and accounts receivable policy and our 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 consolidated financial statements from the assumptions, estimates, and judgments used in the preparation of our latest audited consolidated financial statements, except as noted below.
Our income tax policy is to record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and the bases of those assets and liabilities as reported in our consolidated balance sheets. This estimation process requires that we evaluate the need for a valuation allowance against deferred tax assets, based on factors such as historical financial information, expected timing of future events, the probability of expected future taxable income and available tax planning opportunities.
In conjunction with Welsh Carson's acquisition of our Company in April 2007, which increased the our debt, caused the us to generate U.S. taxable losses, and reduced the likelihood of us generating U.S. taxable income, we established a valuation allowance against our U.S. deferred tax assets. Since the acquisition, we have continued to establish a full valuation allowance against newly generated U.S. deferred tax assets and have continuously assessed the likelihood of the assets being realized at a future date.
During the third quarter of 2009, we determined, based on factors such as those described above, including recent favorable operating trends, expected future taxable income, and other factors, that it is more likely than not that the majority of these assets, which include net operating loss carryforwards and other items, will be realized in the future. Accordingly, our results of operations for the three months ended September 30, 2009 include an income tax benefit of $31.5 million related to the reversal of a majority of our valuation allowance against our deferred tax assets. We still carry a valuation allowance totaling $7.6 million against certain of our deferred tax assets, of which $2.1 million is expected to be reversed into income by December 31, 2009. The remaining $5.5 million in valuation allowance relates to deferred tax assets that have restrictions as to use and are not considered more likely than not to be realized. If our estimates related to the above items change significantly, we may need to alter the amount of our valuation allowance in the future through a favorable or unfavorable adjustment to net income.
Acquisitions, Equity Investments and Development Projects
As part of our growth strategy, we acquire interests in existing surgical facilities from third parties and invest in new facilities that we develop in partnership with hospital partners and local physicians. While many of these transactions have historically resulted in our controlling the acquired entity (business combinations), we did not obtain controlling interests in any of the four facilities in which we acquired ownership during the first nine months of 2009.
We regularly engage in the purchase and sale of equity interests with respect to our investments in unconsolidated affiliates that do not result in a change of control. These transactions are primarily the acquisitions and sales of equity interests in unconsolidated surgical facilities and the investment of additional cash in surgical facilities under development. During the nine months ended September 30, 2009, these transactions resulted in a cash outflow of approximately $11.8 million, which is summarized below:
Effective Date Facility Location Amount
Investments
February 2009 Granbury, Texas(1) $ 2.0 million
February 2009 Stockton, California(1) 2.5 million
May 2009 St. Louis, Missouri(2) 0.9 million
Various Various(3) 6.4 million
Total $ 11.8 million
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(1) Acquisition of a noncontrolling interest in and right to manage a surgical facility in which we previously had no involvement. This facility is jointly owned with one of our hospital partners and local physicians.
(2) Acquisition of the right to manage a surgical facility in which we previously had no involvement. We have a purchase option to acquire a 20% equity interest in the facility within one year, and after approximately three years, an option to purchase an additional 20% equity interest.
(3) Represents the purchase of additional ownership and equity contributions in various unconsolidated affiliates, including $2.2 million to purchase additional ownership in three facilities in the Dallas/Fort Worth area.
Additionally, effective January 1, 2009, we acquired noncontrolling equity interests in and rights to manage two surgical facilities in which we previously had no involvement. These facilities are jointly owned with one of our hospital partners and local physicians. The total purchase price of $2.2 million was paid in December 2008.
We control and therefore consolidate the results of 60 of our 167 facilities. Similar to our investments in unconsolidated affiliates, we regularly engage in the purchase and sale of equity interests in our consolidated subsidiaries that do not result in a change of control. These types of transactions are accounted for as equity transactions, as they are undertaken among us, our consolidated subsidiaries, and noncontrolling interests.
During the nine months ended September 30, 2009, we purchased and sold equity interests in various consolidated subsidiaries in the amounts of $2.0 million and $3.8 million, respectively. The difference between our carrying amount and the proceeds received or paid in each transaction is recorded as an adjustment to our additional
paid-in capital. These transactions resulted in a $6.6 million decrease to our additional paid-in capital during the nine months ended September 30, 2009.
Discontinued Operations, Other Dispositions, and Deconsolidations During the nine months ended September 30, 2009, we sold our ownership interests in four facilities as summarized below. Effective Date Facility Location Proceeds (Loss) February 2009 Las Cruces, New Mexico(1) $ - $ - February 2009 East Brunswick, New Jersey(1) 0.7 million (2.6) million July 2009 Cleveland, Ohio(2) 1.0 million - September 2009 San Antonio, Texas(1) - (2.6) million Total $ 1.7 million $ (5.2) million |
(1) Because these investments were accounted for under the equity method, the results of operations of these facilities are not reported as discontinued operations. The loss on the disposal of these facilities is recorded in "Other, net" in the accompanying consolidated statements of income.
(2) We financed the entire purchase price with the buyer and have a security interest in the facility's assets until the note, which matures in December 2009, is collected. As a result, we deferred the gain, which is estimated at $0.6 million. Because this investment was accounted for under the equity method, the results of operations of this facility are not reported as discontinued operations.
In addition to the sale of ownership interests described above, we sold a controlling interest in an entity to a hospital partner in March 2009. The hospital partner already had a 49% ownership interest in this entity, which owns and manages two surgical facilities in the Phoenix, Arizona area and through the transaction acquired an additional 1.1% interest. We received proceeds of approximately $0.1 million and recorded a pretax loss of approximately $8.2 million, which was primarily related to the revaluation of our remaining investment in the entity to fair value. Our continuing involvement as an equity method investor and manager of the facilities precludes the classification of this transactions as discontinued operations. The loss on this transaction is recorded in "Other, net" in the accompanying consolidated statements of income. During the third quarter of 2009, we recorded an impairment charge related to our rights to manage this facility, the value of which is carried as an indefinite-lived intangible asset on our consolidated balance sheet. This charge was triggered by a reduction in our expected earnings under the contract. As a result, an impairment charge of $3.6 million was recorded and represents the difference between the intangible's carrying value and estimated fair value. The impairment is recorded in "Other, net" in the accompanying consolidated statements of income.
During the third quarter of 2009, we and other owners of a facility consolidated by us agreed to merge the facility into another entity in which we hold an investment accounted for under the equity method. We received proceeds of approximately $0.2 million and recorded a loss, included in "Other, net" in the accompanying consolidated statements of income, of $0.6 million on the sale and deconsolidation of the facility together with the impairment of the Company's indefinite-lived intangible asset related to the Company's rights to manage the facility.
Sources of Revenue
Revenues primarily include the following:
• net patient service revenues of the facilities that we consolidate for financial reporting purposes, which are typically those facilities in which we have ownership interests of greater than 50% or otherwise maintain effective control.
• management and contract service revenues, consisting of the fees that we earn from managing the facilities that we do not consolidate for financial reporting purposes and the fees we earn from providing certain consulting and administrative services to physicians and hospitals. Our consolidated revenues and expenses
do not include the management fees we earn from operating the facilities that we consolidate for financial reporting purposes as those fees are charged to subsidiaries and thus eliminate in consolidation.
The following table summarizes our revenues by type and as a percentage of total revenue for the periods presented:
Three Months Nine Months
Ended Ended
September 30, September 30,
2009 2008 2009 2008
Net patient service revenues 85 % 88 % 85 % 88 %
Management and contract service revenues 13 12 13 11
Other revenues 2 - 2 1
Total revenues 100 % 100 % 100 % 100 %
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Net patient service revenues consist of the revenues earned by facilities we consolidate for financial reporting purposes. As a percent of our total revenues, these revenues decreased to 85% of our total revenues for the three and nine months ended September 30, 2009. This decrease is due in part to the U.S. dollar strengthening against the British pound, and also is due to shifting of more of our facilities to joint ventures with hospital partners, which usually requires us to account for the facility under the equity method of accounting. With respect to facilities accounted for under the equity method of accounting, we do not include the facilities' net patient service revenues in our financial results; instead, our consolidated financial statements reflect revenues we earn for our management and contract services, as noted below. Our share of the revenues, net of expenses, of equity method facilities, is reported in our consolidated financial statements as "equity in earnings of unconsolidated affiliates," which is displayed between revenues and expenses.
Our management and contract service revenues are earned from the following types of activities (in thousands):
Nine Months
Three Months Ended
Ended September 30, September 30,
2009 2008 2009 2008
Management of surgical facilities $ 11,527 $ 9,784 $ 34,194 $ 29,430
Contract services provided to hospitals,
physicians and related entities 7,994 7,973 23,379 24,485
Total management and contract service revenues $ 19,521 $ 17,757 $ 57,573 $ 53,915
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As described above, our primary business is the operation of surgical facilities. In addition, we earn contract service revenues from other parties, primarily from hospitals through an endoscopy services business we acquired in 2006.
The following table summarizes our revenues by operating segment:
Three Months Nine Months
Ended Ended
September 30, September 30,
2009 2008 2009 2008
United States 82 % 80 % 83 % 80 %
United Kingdom 18 20 17 20
Total 100 % 100 % 100 % 100 %
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Between September 30, 2008 and September 30, 2009, the value of the British pound as compared to the U.S. dollar weakened approximately 21%. This decrease in value resulted in the proportion of our total revenues derived from U.K. operations as stated in U.S. dollars to decrease in the three and nine months ended September 30, 2009, as compared to the corresponding prior year periods.
Equity in Earnings of Unconsolidated Affiliates
Our business model of partnering with not-for-profit hospitals and physicians results in our accounting for 106 of our U.S. surgical facilities under the equity method rather than consolidating their results. The following table reflects the summarized results of the unconsolidated facilities that we account for under the equity method of accounting (amounts are in thousands, except number of facilities, and reflect 100% of the investees' results on an aggregated basis):
Three Months Nine Months
Ended Ended
September 30, September 30,
2009 2008 2009 2008
Revenues $ 293,207 $ 248,691 $ 852,679 $ 721,048
Operating expenses:
Salaries, benefits, and other employee costs 71,391 62,743 204,485 180,196
Medical services and supplies 68,086 52,796 194,973 151,574
Other operating expenses 68,718 62,783 200,531 183,818
Depreciation and amortization 12,645 11,839 37,474 36,490
Total operating expenses 220,840 190,161 637,463 552,078
Operating income 72,367 58,530 215,216 168,970
Interest expense, net (6,041 ) (6,103 ) (18,312 ) (18,307 )
Other 838 865 2,177 2,301
Income before income taxes $ 67,164 $ 53,292 $ 199,081 $ 152,964
Long-term debt $ 280,217 $ 274,243 $ 280,217 $ 274,243
USPI's equity in earnings of unconsolidated
affiliates 14,913 11,420 43,110 32,563
USPI's imputed weighted average ownership
percentage based on affiliates' pre-tax
income(1) 22.2 % 21.4 % 21.7 % 21.3 %
USPI's imputed weighted average ownership
percentage based on affiliates' debt(2) 25.0 % 25.1 % 25.0 % 25.1 %
Unconsolidated facilities operated at period end 106 98 106 98
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(1) Our weighted average percentage ownership in our unconsolidated affiliates is calculated as USPI's equity in earnings of unconsolidated affiliates divided by the total net income of unconsolidated affiliates for each respective period. There is no comparable GAAP measure but management believes this percentage provides further useful information about its involvement in equity method investments.
(2) Our weighted average percentage ownership in our unconsolidated affiliates is calculated as the total debt of each unconsolidated affiliate, multiplied by the percentage ownership USPI held in the affiliate as of the end of each respective period, divided by the total debt of all of the unconsolidated affiliates as of the end of each respective period. There is no comparable GAAP measure but management believes this percentage provides further useful information about its involvement in equity method investments.
Results of Operations
The following table summarizes certain statement of income items expressed as a
percentage of revenues for the periods indicated:
Three Months Nine Months
Ended September 30, Ended September 30,
2009 2008 2009 2008
Total revenues 100 % 100 % 100 % 100 %
Equity in earnings of unconsolidated affiliates 9.8 7.4 9.3 6.8
Operating expenses, excluding depreciation and amortization (67.7 ) (71.3 ) (67.2 ) (70.8 )
Depreciation and amortization (5.8 ) (5.8 ) (5.8 ) (5.8 )
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