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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2005

Commission file No. 000-32837

UNITED SURGICAL PARTNERS INTERNATIONAL, INC.

(Exact name of Registrant as specified in its charter)


Delaware		75-2749762
(State of Incorporation)		(I.R.S. Employer Identification No.)


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)

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

Common Stock, par value $.01 per share Rights to Purchase Series A Junior Participating Preferred Stock, par value $.01 per share		The Nasdaq Stock Market The Nasdaq Stock Market

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $1,498,275,198 based on the closing sale price as reported on the National Association of Securities Dealers Automated Quotation System National Market System.

As of February 24, 2006, 44,326,291 shares of the Registrant’s Common Stock, were outstanding

Documents Incorporated by Reference

Part III — Portions of the registrant’s definitive proxy statement to be filed pursuant to Regulation 14A for the Annual Meeting of Stockholders to be held May 3, 2006.

FORWARD LOOKING STATEMENTS

Certain statements contained in this Annual Report on Form 10-K, and the document incorporated herein by reference, including, without limitation, statements containing the words “believes”, “anticipates”, “expects”, “continues”, “will”, “may”, “should”, “estimates”, “intends”, “plans” and similar expressions, and statements regarding the Company’s business strategy and plans, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on management’s current expectations and involve known and unknown risks, uncertainties and other factors, many of which the Company is unable to predict or control, that may cause the Company’s actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions, both nationally and regionally; foreign currency fluctuations; demographic changes; changes in, or the failure to comply with, laws and governmental regulations; the ability to enter into and retain managed care provider arrangements on acceptable terms; changes in Medicare, Medicaid and other government funded payments or reimbursement in the U.S. and the United Kingdom; 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 physicians, nurses, other health care professionals and other personnel; our significant indebtedness; the availability of suitable acquisition and development opportunities and the length of time it takes to accomplish acquisitions and developments; our ability to integrate new and acquired 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 Annual Report on Form 10-K. 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.

PART I


Item 1.	*Business*

General

United Surgical Partners International, Inc. (together with its subsidiaries, “we”, the “Company” or “USPI”) owns and operates short stay surgical facilities including surgery centers and private surgical hospitals in the United States and the United Kingdom. We focus on providing high quality surgical facilities that meet the needs of patients, physicians and payors better than hospital-based and other outpatient surgical facilities. We believe that our facilities (1) enhance the quality of care and the healthcare experience of patients, (2) offer significant administrative, clinical and economic benefits to physicians, (3) offer a strategic approach for our health system partners to expand capacity and access within the markets they serve and (4) offer an efficient and low cost alternative to payors. We acquire and develop our facilities through the formation of strategic relationships with physicians and not-for-profit healthcare systems to better access and serve the communities in our markets. Our operating model is efficient and scalable, and we have adapted it to each of our markets. We believe that our acquisition and development strategy and operating model enable us to continue to grow by taking advantage of highly-fragmented markets and an increasing demand for short stay surgery.

Donald E. Steen, our chairman, and a private equity firm formed USPI in February 1998. We operate surgery centers and private surgical hospitals in the United States and the United Kingdom. As of December 31, 2005, we operated 99 facilities, consisting of 96 in the United States and three in the United Kingdom. Of the 96 U.S. facilities, 66 are jointly owned with major not-for-profit healthcare systems. Overall, as of December 31,

2005, we held ownership interests in 98 of the facilities and operated the remaining facility under a service and management contract. Our revenues for 2005 were $474.7 million, up 22% from $389.5 million for 2004.

Available Information

We file proxy statements and annual, quarterly and current reports with the Securities and Exchange Commission. You may read and copy any document that we file at the SEC’s public reference room located at 450 Fifth Street N.W., Washington, D.C. 20549. You may also call the Securities and Exchange Commission at 1-800-SEC-0330 for information on the operation of the public reference room. Our SEC filings are also available to you free of charge at the SEC’s web site at http://www.sec.gov. We also maintain a web site at http://www.unitedsurgical.com that includes links to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. These reports are available on our website without charge as soon as reasonably practicable after such reports are filed with or furnished to the SEC. We post our audit and compliance committee, options and compensation committee, and nominating and corporate governance committee charters, our corporate governance guidelines, and our financial code of ethics applicable to senior financial officers on our web site. These documents are available free of charge to any stockholder upon request. Information on our web site is not deemed incorporated by reference into this Form 10-K.

Industry Background

We believe many physicians prefer surgery centers and private surgical hospitals over general acute care hospitals. We believe that this is due to the elective nature of the procedures performed at our surgery centers and private surgical hospitals, which allows physicians to schedule their time more efficiently and therefore increase the number of surgeries they can perform in a given amount of time. In addition, outpatient facilities usually provide physicians with greater scheduling flexibility, more consistent nurse staffing and faster turnaround time between cases. While surgery centers and private surgical hospitals generally perform scheduled surgeries, private acute care hospitals and national health service facilities generally provide a broad range of services, including high priority and emergency procedures. Medical emergencies often demand the unplanned use of operating rooms and result in the postponement or delay of scheduled surgeries, disrupting physicians’ practices and inconveniencing patients. Surgery centers and private surgical hospitals in the United States and the United Kingdom are designed to improve physician work environments and improve physician efficiency. In addition, many physicians choose to perform surgery in facilities like ours because their patients prefer the comfort of a less institutional atmosphere and the convenience of simplified admissions and discharge procedures.

United States

According to Verispan’s 2005 Outpatient Surgery Center Market Report, the number of outpatient surgery centers increased 73% from 2,900 in 2000 to 4,950 in 2005. New surgical techniques and technology, as well as advances in anesthesia, have significantly expanded the types of surgical procedures that are being performed in surgery centers and have helped drive the growth in outpatient surgery. Lasers, arthroscopy, enhanced endoscopic techniques and fiber optics have reduced the trauma and recovery time associated with many surgical procedures. Improved anesthesia has shortened recovery time by minimizing post-operative side effects such as nausea and drowsiness, thereby avoiding the need for overnight hospitalization in many cases. In addition, some states in the United States permit surgery centers to keep a patient for up to 23 hours. This allows more complex surgeries, previously only performed in an inpatient setting, to be performed in a surgery center.

In addition to these technological and other clinical advancements, a changing payor environment has contributed to the rapid growth in outpatient surgery in recent years. Government programs, private insurance companies, managed care organizations and self-insured employers have implemented cost containment measures to limit increases in healthcare expenditures, including procedure reimbursement. These cost containment measures have contributed to the significant shift in the delivery of healthcare services away from traditional inpatient hospitals to more cost-effective alternate sites, including surgery centers. We believe that surgery performed at a surgery center is generally less expensive than hospital-based outpatient surgery because of lower facility development costs, more efficient staffing and space utilization and a specialized operating environment focused on cost containment.

Today, large healthcare systems in the United States generally offer both inpatient and outpatient surgery on site. In addition, a number of not-for-profit healthcare systems have begun to expand their portfolios of facilities and services by entering into strategic relationships with specialty operators of surgery centers in order to expand capacity and access in the markets they serve. These strategic relationships enable not-for-profit healthcare systems to offer patients, physicians and payors the cost advantages, convenience and other benefits of outpatient surgery in a freestanding facility. Further, these relationships allow the not-for-profit healthcare systems to focus their attention and resources on their core business without the challenge of acquiring, developing and operating these facilities.

United Kingdom

The United Kingdom provides government-funded healthcare to all of its residents through a national health service. However, due to funding and capacity limitations, the demand for healthcare services exceeds the public system’s capacity. In response to these shortfalls, private healthcare networks and private insurance companies have developed in the United Kingdom. Approximately 11% of the U.K. population has private insurance to cover elective surgical procedures, and another rapidly growing segment of the population pays for elective procedures from personal funds. For the year ended December 31, 2005, in the United Kingdom, we derived approximately 55% of our revenues from private insurance, approximately 39% from self-pay patients, who typically arrange for payment prior to surgery being performed, and approximately 6% from government payors.

Our Business Strategy

Our goal is to steadily increase our revenues and cash flows by becoming a leading operator of surgery centers and private surgical hospitals in the United States and the United Kingdom. The key elements of our business strategy are to:


	•	attract and retain top quality surgeons and other physicians;

	•	pursue strategic relationships with not-for-profit healthcare systems;

	•	expand our presence in existing markets;

	•	expand selectively in new markets; and

	•	enhance operating efficiencies.

Attract and retain top quality surgeons and other physicians

Since physicians provide and influence the direction of healthcare in the U.S. and U.K., we have developed our operating model to encourage physicians to affiliate with us and to use our facilities as an extension of their practices. We believe we attract physicians because we design our facilities, structure our strategic relationships and adopt staffing, scheduling and clinical systems and protocols to increase physician productivity and promote their professional and financial success. We believe this focus on physicians, combined with providing high quality healthcare in a friendly and convenient environment for patients, will continue to increase case volumes at our facilities. In addition, in the United States, we generally offer physicians the opportunity to purchase equity interests in the facilities they use as an extension of their practices. We believe this opportunity attracts quality physicians to our facilities and ownership increases the physicians’ involvement in facility operations, enhancing quality of patient care, increasing productivity and reducing costs.

Pursue strategic relationships with not-for-profit healthcare systems

Through strategic relationships with us, not-for-profit healthcare systems can benefit from our operating expertise and create a new cash flow opportunity with limited capital expenditures. We believe that these relationships also allow not-for-profit healthcare systems to attract and retain physicians and improve their hospital operations by focusing on their core business. We also believe that strategic relationships with these healthcare systems help us to more quickly develop relationships with physicians, communities, and payors. Generally, the healthcare systems with which we develop relationships have strong local market positions and excellent reputations that we use in branding our facilities. In addition, our relationships with not-for-profit healthcare systems enhance our acquisition and development efforts by (1) providing opportunities to acquire facilities the systems may own, (2) providing access to physicians already affiliated with the systems, (3) attracting additional

physicians to affiliate with newly developed facilities, and (4) encouraging physicians who own facilities to consider a strategic relationship with us.

Expand our presence in existing markets

Our primary strategy is to grow selectively in markets in which we already operate facilities. We believe that selective acquisitions and development of new facilities in existing markets allow us to leverage our existing knowledge of these markets and to improve operating efficiencies. In particular, our experience has been that newly developed facilities in markets where we already have a presence and a not-for-profit hospital partner are the best use of the company’s invested capital.

Expand selectively in new markets

We may continue to enter targeted markets by acquiring and developing surgical facilities. In the United States, we expect to do this primarily in conjunction with a local healthcare system or hospital. We typically target the acquisition or development of multi-specialty centers that perform high volume, non-emergency, lower risk procedures requiring lower capital and operating costs than hospitals. In addition, we will also consider the acquisition of multi-facility companies.

In determining whether to enter a new market, we examine numerous criteria, including:


	•	the potential to achieve strong increases in revenues and cash flows;

	•	whether the physicians, healthcare systems and payors in the market are receptive to surgery centers;

	•	the size of the market;

	•	the number of surgical facilities in the market;

	•	the number and nature of outpatient surgical procedures performed in the market;

	•	the case mix of the facilities to be acquired;

	•	whether the facility is well-positioned to negotiate agreements with insurers and other payors; and

	•	licensing and other regulatory considerations.

Upon identifying a target facility, we conduct financial, legal and compliance, operational, technology and systems reviews of the facility and conduct interviews with the facility’s management, affiliated physicians and staff. Once we acquire or develop a facility, we focus on upgrading systems and protocols, including implementing our proprietary methodology of defined processes and information systems, to increase case volume and improve operating efficiencies.

Enhance operating efficiencies

Once we acquire a new facility in the U.S., we integrate it into our existing network by implementing a specific action plan to support the local management team and incorporate the new facility into our group purchasing contracts. We also implement our systems and protocols to improve operating efficiencies and contain costs. Our most important operational tool is our management system “Every Day Giving Excellence,” which we refer to as USPI’s EDGE. This proprietary measurement system allows us to track our clinical, service and financial performance, best practices and key indicators in each of our facilities. Our goal is to use USPI’s EDGE to ensure that we provide each of the patients using our facilities with high quality healthcare, offer physicians a superior work environment and eliminate inefficiencies. Using USPI’s EDGE, we track and monitor our performance in areas such as (1) providing surgeons the equipment, supplies and surgical support they need, (2) starting cases on time, (3) minimizing turnover time between cases, and (4) providing efficient case and personnel schedules. USPI’s EDGE compiles and organizes the specified information on a daily basis and is easily accessed over the Internet by our facilities on a secure basis. The information provided by USPI’s EDGE enables our employees, facility administrators and management to analyze trends over time and share processes and best practices among our facilities. In addition, the information is used as an evaluative tool by our administrators and as a budgeting and planning tool by our management. USPI’s EDGE is now deployed in all of our U.S. facilities.

Recent Developments

Effective January 1, 2006 the Company acquired five ambulatory surgery centers in the St. Louis, Missouri area for approximately $50.3 million in cash, of which $8.3 million was paid in December 2005.

On January 27, 2006, the Company signed an agreement to acquire Surgis, Inc. in a cash merger transaction in which the enterprise value for Surgis was $200 million. Surgis operates 24 surgery centers and has seven additional facilities under development. Twenty of those facilities are in markets where we or one of our not-for-profit healthcare system partners already operate. The closing, which is subject to certain closing conditions, including regulatory approval, is expected to occur in April 2006.

In addition, on February 21, 2006, the Company executed a new revolving credit facility with SunTrust Bank as administrative agent. The new facility provides for borrowings of up to $200 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”

Operations

Operations in the United States

Our operations in the United States consist primarily of our ownership and management of surgery centers. As of December 31, 2005, we have ownership interests in 85 surgery centers and ten private surgical hospitals and operate, through a long-term service agreement, one additional surgery center. Additionally, we acquired interests in five facilities in the St. Louis, Missouri area effective January 1, 2006, opened a new facility in Fort Worth, Texas during February 2006, and have announced the pending Surgis acquisition. We also own interests in and expect to operate four more surgery centers that are currently under construction and have nine projects under development, all of which include a hospital partner, and numerous other potential projects in various stages of consideration, which may result in our adding additional facilities during 2006. Over 4,500 physicians have privileges to use our facilities. Our surgery centers are licensed outpatient surgery centers, and our private surgical hospitals are licensed as hospitals. Each of these facilities is generally equipped and staffed for multiple surgical specialties and located in freestanding buildings or medical office buildings. Our average surgery center has approximately 13,000 square feet of space with four operating rooms, as well as ancillary areas for preparation, recovery, reception and administration. Our surgery center facilities range from a 4,000 square foot, one operating room facility to a 33,000 square foot, nine operating room facility. Our surgery centers are normally open weekdays from 7:00 a.m. to approximately 5:00 p.m. or until the last patient is discharged. We estimate that a surgery center with four operating rooms can accommodate up to 6,000 procedures per year. Our surgical hospitals average 40,000 square feet of space with six operating rooms, ranging in size from 17,000 to 68,000 square feet and having from 4 to 8 operating rooms.

Our surgery center support staff typically consists of registered nurses, operating room technicians, an administrator who supervises the day-to-day activities of the surgery center, and a small number of office staff. Each center also has appointed a medical director, who is responsible for and supervises the quality of medical care provided at the center. Use of our surgery centers is generally limited to licensed physicians, podiatrists and oral surgeons who are also on the medical staff of a local accredited hospital. Each center maintains a peer review committee consisting of physicians who use our facilities and who review the professional credentials of physicians applying for surgical privileges.

All but two of our surgical facilities are accredited by either the Joint Commission on Accreditation of Healthcare Organizations or by the Accreditation Association for Ambulatory Healthcare or are in the process of applying for such accreditation. We believe that accreditation is the quality benchmark for managed care organizations. Many managed care organizations will not contract with a facility until it is accredited. We believe that our historical performance in the accreditation process reflects our commitment to providing high quality care in our surgical facilities.

Generally, our surgical facilities are limited partnerships, limited liability partnerships or limited liability companies in which ownership interests are also held by local physicians who are on the medical staff of the centers. Our ownership interests in the facilities range from 9% to 80%. Our partnership and limited liability company agreements typically provide for the monthly or quarterly pro rata distribution of cash equal to net profits from operations, less amounts held in reserve for expenses and working capital. Our facilities derive their operating cash flow by collecting a fee from patients, insurance companies, or other payors in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. Our billing systems estimate revenue and

generate contractual adjustments based on a fee schedule for over 80% of the total cases performed at our facilities. For the remaining cases, the contractual allowance is estimated based on the historical collection percentages of each facility by payor group. The historical collection percentage is updated quarterly for each facility. We estimate each patient’s financial obligation prior to the date of service. We request payment of that obligation at the time of service. Any amounts not collected at the time of service are subject to our normal collection and reserve policy. We also have a management agreement with each of the facilities under which we provide day-to-day management services for a management fee that is typically a percentage of the net revenues of the facility.

Our business depends upon the efforts and success of the physicians who provide medical services at our facilities and the strength of our relationships with these physicians. Our business could be adversely affected by the loss of our relationship with, or a reduction in use of our facilities by, a key physician or group of physicians. The physicians that affiliate with us and use our facilities are not our employees. However, we generally offer the physicians the opportunity to purchase equity interests in the facilities they use.

Strategic Relationships

A key element of our business strategy is to pursue strategic relationships with not-for-profit healthcare systems (hospital partners) in selected markets. Of our 96 U.S. facilities, 66 are jointly-owned with not-for-profit healthcare systems. Our strategy involves developing these relationships in three primary ways. One way is by adding new facilities in existing markets with our existing hospital partners. An example of this is our relationship with the Baylor Health Care System in Dallas, Texas. Our joint ventures with Baylor own a network of 22 operational surgical facilities that serve the approximately four million people in the Dallas / Fort Worth area. These joint ventures have added new facilities each year since their inception in 1999, including two during 2005, and we opened our newest facility, in Fort Worth, Texas, during February 2006, expanding our network with Baylor to 23 facilities.

Another way we develop these relationships is through expansion into new markets, both with existing hospital partners and with new partners. An example of this strategy with an existing partner is our expansion into new markets with Catholic Healthcare West (CHW). Our relationship with CHW began in 1998 with a facility in Las Vegas, Nevada, expanded into Phoenix, Arizona with three facilities, two of which were newly developed during 2003, and continues as we enter new markets in California, where during 2005, we have opened two newly developed facilities and acquired one. Currently, we have three facilities under development with CHW. Another example of this strategy is our relationship with Ascension Health, with whom we jointly own facilities in Nashville, Tennessee and with whom we entered the Baltimore, Maryland market through the acquisition of an equity interest in a facility during 2004. In 2005 we expanded this relationship into the Austin, Texas and Kansas City, Missouri markets with the opening of two new (de novo) facilities. During 2004 we entered the Oklahoma market with a new partner, INTEGRIS Health, through the acquisition of equity interests in two facilities, and opened facilities with CHRISTUS Health in San Antonio, Texas, with Bon Secours Health System in Newport News, Virginia, and Providence Health System, in Mission Hills, California. In 2005, we contributed one of our San Antonio facilities into the Christus relationship and opened one de novo facility with Bon Secours. We also added a partnership with North Kansas City Hospital in connection with the acquisition of two Kansas City facilities.

A third way we develop our strategic relationships with not-for-profit healthcare systems is through the contribution of our ownership interests in existing facilities to a joint venture relationship. During 2003 and 2004 we added a not-for-profit hospital partner to six facilities we had previously operated without a hospital partner. During 2005 we added a not-for-profit hospital partner to seven facilities, the most significant of which was the partnership with Evanston Northwest Healthcare in four of our Chicago facilities. We expect to add a not-for-profit hospital partner in the future to some of the remaining 30 facilities that do not yet have such a partner.

Operations in the United Kingdom

We operate three private hospitals in greater London. We acquired Parkside Hospital and Holly House Hospital in 2000 and Highgate Hospital in 2003. Parkside Hospital, located in Wimbledon, a suburb southwest of London, has 72 registered acute care beds, including four high dependency beds and four operating theatres, one of which is a dedicated endoscopy suite. Parkside also has its own on-site pathology laboratory which provides services to the on-site cancer treatment center. The imaging department, which has been extensively upgraded in the past three

years, has an MRI scanner, CT scanner, and two X-ray screening rooms, plus mammography, dental and ultrasound services available. Approximately 420 surgeons, anesthesiologists, and physicians have admitting privileges to the hospital. Parkside’s key specialties include orthopedics, oncology, gynecology, neurosurgery, ear-nose-throat, endoscopy and general surgery, and the hospital is currently expanding its day case capacity.

Parkside Oncology Clinic opened in August 2003 and has state of the art equipment designed to provide a wide range of cancer treatments. The pre-treatment and planning suite houses a dedicated CT scanner, which, along with the linear accelerators and virtual simulation software, is linked to the department’s planning system. The clinic also has its own pharmacy aseptic suite which provides chemotherapy to the day case unit at the hospital.

Holly House Hospital, located in a suburb northeast of London near Essex, has 55 registered acute care beds, including three high dependency beds. The hospital has three operating theatres and its own on-site pathology laboratory and pharmacy. A diagnostic suite houses MRI and CT scanners, X-ray screening rooms, mammography, ultrasound, and other imaging services. Over 270 surgeons, anesthesiologists, and physicians have admitting privileges at the hospital, and there are well-established orthopedic, plastic, in vitro fertilization, and general surgery practices.

Highgate Hospital is a 32 bed acute care hospital located in the affluent Highgate area of London. The hospital has an established cosmetic surgery business and additional practices including endoscopy and general surgery are being developed.

Case Mix

The following table sets forth the percentage of our revenues determined based on internally reported case volume from our U.S. facilities and internally reported revenue from our U.K. facilities for the year ended December 31, 2005 from each of the following specialties:


Specialty	U.S.			U.K.

Orthopedic		23	%		25	%
Pain management		19			1
Gynecology		3			12	(1)
General surgery		5			16
Ear, nose and throat		6			2
Gastrointestinal		17			1
Plastic surgery		5			21
Ophthalmology		10			2
Other		12			20

Total		100	%		100	%


(1)		Also includes in vitro fertilization.

Payor Mix

The following table sets forth the percentage of our revenues determined based on internally reported case volume from our U.S. surgical facilities and internally reported revenue from our U.K. facilities for the year ended December 31, 2005 from each of the following payors:


Payor	U.S.			U.K.

Private insurance		66	%		55	%
Self-pay		4			39
Government		28	(1)		6
Other		2			—

Total		100	%		100	%


(1)		Based solely on case volume. Because government payors typically pay less than private insurance, the percentage of our U.S. revenue attributable to government payors is approximately 11% for Medicare and 1% for Medicaid.

The following table sets forth information relating to the not-for-profit healthcare systems with which we were affiliated as of December 31, 2005:


		Number of
		Facilities
Healthcare System	Geographical Focus	Operated with USPI

Single Market Systems:
Baylor Health Care System	Dallas/Fort Worth, Texas		22
Memorial Hermann Healthcare System	Houston, Texas		6
Evanston Northwestern Healthcare	Chicago, Illinois		4
Meridian Health System	New Jersey		4
INTEGRIS Health	Oklahoma		2
Covenant Health:	Eastern Tennessee		1
Fort Sanders Parkwest Medical Center	Knoxville, Tennessee
Decatur General Hospital	Decatur, Alabama		1
Mountain States Health Alliance:	Northeast Tennessee		1
Johnson City Medical Center	Johnson City, Tennessee
Northside Cherokee Hospital	Canton, Georgia		1
Robert Wood Johnson University Hospital	East Brunswick, New Jersey		1
Sarasota Memorial Hospital	Sarasota, Florida		1
McLaren Health Care Corporation	Michigan			(a)
North Kansas City Hospital	Kansas City, Missouri		2


		Number of
		Facilities
Healthcare System	Geographical Focus	Operated with USPI

Multi-Market Systems:
Adventist Health System:	12 states (b)			(a)
Huguley Memorial Medical Center	Fort Worth, Texas
Ascension Health:	19 states and D.C. (c)		8
Carondelet Health System (1 facility)	Blue Springs, Missouri
St. Thomas Health Services System (5 facilities)	Middle Tennessee
St. Agnes Healthcare (1 facility)	Baltimore, Maryland
Seton Healthcare Network (1 facility)	Austin, Texas
Bon Secours Health System:	Nine eastern states (d)		2
Mary Immaculate Hospital	Newport News, Virginia
Memorial Regional Medical Center	Richmond, Virginia
Catholic Healthcare West:	California, Arizona, Nevada		7
Mercy Hospital of Folsom (1 facility)	Sacramento, California
San Gabriel Valley Medical Center (1 facility)	San Gabriel, California
St. John’s Regional Medical Center (1 facility)	Oxnard, California
St. Joseph’s Hospital and Medical Center (1 facility) and Arizona Orthopedic Surgical Hospital (2 facilities)	Phoenix, Arizona
St. Rose Dominican Hospital (1 facility)	Henderson, Nevada
CHRISTUS Health:	Seven states (e)		2
Christus Santa Rosa Health Corporation	San Antonio, Texas
Providence Health System:	Four western states (f)		1
Providence Holy Cross Medical Center	Mission Hills, California

Totals			66


(a)		A joint venture agreement has been signed and projects have been initiated, but no facilities in this joint venture are yet operational.

(b)		Colorado, Florida, Georgia, Illinois, Indiana, Kansas, Kentucky, Michigan, North Carolina, Tennessee, Texas and Wisconsin.

(c)		Alabama, Arkansas, Arizona, Connecticut, District of Columbia, Florida, Georgia, Idaho, Illinois, Indiana, Louisiana, Maryland, Michigan, Missouri, New York, Pennsylvania, Tennessee, Texas, Washington, and Wisconsin.

(d)		Florida, Kentucky, Maryland, Michigan, New Jersey, New York, Pennsylvania, South Carolina, and Virginia.

(e)		Arkansas, Georgia, Louisiana, Missouri, Oklahoma, Texas, and Utah.

(f)		Alaska, California, Oregon, and Washington.

Facilities

The following table sets forth information relating to the facilities that we operated as of December 31, 2005:


	Date of			Number of		Percentage
	Acquisition or			Operating		Owned by
Facility	Affiliation			Rooms		USPI

United States
Atlanta
*Advanced Surgery Center of Georgia, Canton, Georgia (1)		3/27/02			3		31
East West Surgery Center, Austell, Georgia		9/1/00	(2)		3		48
Lawrenceville Surgery Center, Lawrenceville, Georgia		8/1/01			2		15
Northwest Georgia Surgery Center, Marietta, Georgia		11/1/00	(2)		2		15
Orthopaedic South Surgical Center, Morrow, Georgia		11/28/03			2		15
Resurgens Surgical Center, Atlanta, Georgia		10/1/98	(2)		4		48
Roswell Surgery Center, Roswell, Georgia		10/1/00	(2)		3		15
Chicago
*Same Day Surgery 25 East, Chicago, Illinois		10/15/04			4		74
*Same Day Surgery Elmwood Park, Elmwood Park, Illinois		10/15/04			3		60
*Same Day Surgery North Shore, Evanston, Illinois		10/15/04			2		72
*Same Day Surgery River North, Chicago, Illinois		10/15/04			4		55
Same Day Surgery Six Corners, Chicago, Illinois (5)		10/15/04			4		50
Dallas/Fort Worth
*Baylor Medical Center at Frisco, Frisco, Texas (3)		9/30/02			6		25
*Baylor Surgicare, Dallas, Texas (1)		6/1/99			6		27
*Baylor Surgicare at Denton, Denton, Texas (1)		2/1/99			4		27
*Baylor Surgicare at Grapevine, Grapevine, Texas		2/16/02			4		29
*Baylor Surgicare at Lewisville, Lewisville, Texas (1)		9/16/02			6		35
*Bellaire Surgery Center, Fort Worth, Texas		10/15/02			4		25
*Heath Surgicare, Rockwall, Texas		11/1/04			3		30
*Irving-Coppell Surgical Hospital, Irving, Texas(3)		10/20/03			5		7
*Mary Shiels Hospital, Dallas, Texas (3)		4/1/03			5		27
*Medical Centre Surgical Hospital, Fort Worth, Texas (3)		12/18/98			8		43
*Metroplex Surgicare, Bedford, Texas (1)		12/18/98			5		43
*North Central Surgery Center, Dallas, Texas		12/12/05			5		14
*North Garland Surgery Center, Garland, Texas		5/1/05			6		25
*North Texas Surgery Center, Dallas, Texas (1)		12/18/98			4		44
*Park Cities Surgery Center, Dallas, Texas (1)		6/9/03			4		41
*Physicians Day Surgery Center, Dallas, Texas		10/12/00			4		27
*Physicians Surgical Center of Fort Worth, Fort Worth, Texas		7/13/04			4		9
*Premier Ambulatory Surgery Center of Garland, Garland, Texas		2/1/99			2		35
*Surgery Center of Arlington, Arlington, Texas (1)		2/1/99			6		41
*Texas Surgery Center, Dallas, Texas (1)		6/1/99			4		27
*Trophy Club Medical Center, Trophy Club, Texas (3)		5/3/04			6		36
*Valley View Surgery Center, Dallas, Texas		12/18/98			4		34


	Date of			Number of		Percentage
	Acquisition or			Operating		Owned by
Facility	Affiliation			Rooms		USPI

Houston
*Doctors Outpatient Surgicenter, Pasadena, Texas		9/1/99			5		46
*Memorial Hermann Surgery Center Northwest, Houston, Texas		9/1/04			5		11
*Memorial Hermann Surgery Center — The Woodlands, The Woodlands, Texas		8/9/05			4		10
*Sugar Land Surgical Hospital, Sugar Land, Texas (3)		12/28/02			4		13
*TOPS Surgical Specialty Hospital, Houston, Texas (3)		7/1/99			7		46
*United Surgery Center — Southeast, Houston, Texas (1)		9/1/99			3		37
Kansas City
*Briarcliff Surgery Center, Kansas City, Missouri		6/1/05			2		29
Creekwood Surgery Center, Kansas City, Missouri (1)		7/29/98			4		62
*Liberty Surgery Center, Liberty, Missouri		6/1/05			2		30
*Saint Mary’s Surgical Center, Blue Springs, Missouri		5/1/05			4		21
Los Angeles
Coast Surgery Center of South Bay, Torrance, California (1)		12/18/01			3		61
Pacific Endo-Surgical Center, Torrance, California		8/1/03			1		60
*San Fernando Valley Surgery Center, Mission Hills, California		11/1/04			4		34
*San Gabriel Ambulatory Surgery Center, San Gabriel, California		4/1/05			3		41
San Gabriel Valley Surgical Center, West Covina, California		11/16/01			4		59
The Center for Ambulatory Surgical Treatment, Los Angeles, California		11/14/02			4		63
Nashville
*Baptist Ambulatory Surgery Center, Nashville, Tennessee		3/1/98	(2)		6		22
*Baptist Plaza Surgicare, Nashville, Tennessee		12/3/03			9		20
*Middle Tennessee Ambulatory Surgery Center, Murfreesboro, Tennessee		7/29/98			4		38
*Physicians Pavilion Surgery Center, Smyrna, Tennessee		7/29/98			4		50
*Saint Thomas Surgicare, Nashville, Tennessee		7/15/02			5		22
New Jersey
*Central Jersey Surgery Center, Eatontown, New Jersey		11/1/04			3		47
*Robert Wood Johnson Surgery Center, East Brunswick, New Jersey		6/26/02			5		44
*Shore Outpatient Surgicenter, Lakewood, New Jersey		11/1/04			3		56
*Shrewsbury Surgery Center, Shrewsbury, New Jersey		4/1/99			4		28
*Toms River Surgery Center, Toms River, New Jersey		3/15/02			4		31
Oklahoma City
Oklahoma Center for Orthopedic MultiSpecialty Surgery, Oklahoma City, Oklahoma (3)		8/2/04			4		24
*Southwest Orthopaedic Ambulatory Surgery Center, Oklahoma City, Oklahoma		8/2/04			2		24
Specialists Surgery Center, Oklahoma City, Oklahoma (1)		3/27/02			4		49
Phoenix
*Arizona Orthopedic Surgical Hospital, Chandler, Arizona (3)		5/19/04			6		37
*St. Joseph’s Outpatient Surgery Center, Phoenix, Arizona (1)		9/2/03			9		41
*Warner Outpatient Surgery Center, Chandler, Arizona		7/1/99			4		28


	Date of			Number of		Percentage
	Acquisition or			Operating		Owned by
Facility	Affiliation			Rooms		USPI

San Antonio
*Alamo Heights Surgery Center, San Antonio, Texas		12/1/04			3		53
*Christus Santa Rosa Surgery Center, San Antonio, Texas		5/3/04			5		21
San Antonio Endoscopy Center, San Antonio, Texas		5/1/05			1		49
Additional Markets
Austintown Ambulatory Surgery Center, Austintown, Ohio (1)		4/12/02			5		69
*Cape Surgery Center, Sarasota, Florida		10/18/04			6		45
*Cedar Park Surgery Center, Cedar Park (Austin), Texas		11/22/05			2		25
Corpus Christi Outpatient Surgery Center, Corpus Christi, Texas (1)		5/1/02			5		67
Day-Op Center of Long Island, Mineola, New York (4)		12/4/98			4		0
*Decatur Ambulatory Surgery Center, Decatur, Alabama (1)		7/29/98			3		64
Destin Surgery Center, Destin, Florida		9/25/02			2		31
*Folsom Outpatient Surgery Center, Folsom, California		6/1/05			2		30
Greater Baton Rouge Surgical Hospital, Baton Rouge, Louisiana (3)		10/11/05			4		40
Las Cruces Surgical Center, Las Cruces, New Mexico		2/1/01			3		50
*Mary Immaculate Ambulatory Surgical Center, Newport News, Virginia		7/19/04			3		20
*Memorial Ambulatory Surgery Center, Mechanicsville (Richmond), Virginia		12/30/05			5		16
*Mountain Empire Surgery Center, Johnson City, Tennessee		2/20/00	(2)		4		20
New Mexico Orthopaedic Surgery Center, Albuquerque, New Mexico		2/29/00	(2)		5		51
*Parkway Surgery Center, Henderson (Las Vegas), Nevada		8/3/98			5		45
*Parkwest Surgery Center, Knoxville, Tennessee		7/26/01			5		22
Reading Surgery Center, Spring Township, Pennsylvania		7/1/04			3		65
*Saint Agnes Surgery Center, Ellicott City (Baltimore), Maryland		10/01/04			4		74
*Saint John’s Outpatient Surgery Center, Oxnard, California		12/5/05			4		35
The Surgery Center, Middleburg Heights, Ohio (1)		6/19/02			7		69
Surgi-Center of Central Virginia, Fredericksburg, Virginia		11/29/01			4		74
Surgery Center of Fort Lauderdale, Fort Lauderdale, Florida		11/1/04			4		61
Teton Outpatient Services, Jackson, Wyoming		8/1/98	(2)		2		52
Texan Surgery Center, Austin, Texas		6/1/03			3		60
Tulsa Outpatient Surgery Center, Tulsa, Oklahoma		11/1/04			4		30
University Surgical Center, Winter Park, Florida		10/15/98			3		40
Zeeba Surgery Center, Lyndhurst, Ohio		10/11/02			5		80
United Kingdom
Parkside Hospital, Wimbledon		4/6/00			4		100
Holly House Hospital, Essex		4/6/00			3		100
Highgate Private Clinic, Highgate		4/29/03			3		100


*		Facilities jointly owned with not-for-profit hospital systems.


(1)		Certain of our surgery centers are licensed and equipped to accommodate 23-hour stays.

(2)		Indicates date of acquisition by OrthoLink Physician Corporation. We acquired OrthoLink in February 2001.

(3)		Surgical hospitals, all of which are licensed and equipped for overnight stays.

(4)		Operated through a consulting and administrative agreement.


(5)		During January 2006 we sold our ownership in this center and exited the management contract.

We lease the majority of the facilities where our various surgery centers and private surgical hospitals conduct their operations. Our leases have initial terms ranging from one to twenty years and most of the leases contain options to extend the lease period for up to ten additional years.

Our corporate headquarters is located in a suburb of Dallas, Texas. We currently lease approximately 48,000 square feet of space at 15305 Dallas Parkway, Addison, Texas. The lease expires in April 2011.

Our administrative office in the United Kingdom is located in London. We currently lease 1,900 square feet. The lease expires in February 2014.

We also lease approximately 18,000 square feet of total additional space in Brentwood, Tennessee, Chicago, Illinois, Houston, Texas and Pasadena, California for regional offices. These leases expire between November 2008 and May 2015.

Acquisitions and Development

During January 2006 we acquired interests in five surgery centers in the St. Louis, Missouri area and announced the pending acquisition of Surgis, Inc., which is expected to be completed in March 2006. Surgis operates 24 facilities and has an additional seven under development. Since 20 of these facilities are located in markets where we or one our hospital partners already operates, we believe we will add some of these facilities to our hospital joint ventures at some point in the future.

During February 2006, we opened a de novo surgical facility in Fort Worth, Texas, through our joint venture with Baylor Health Care System and Adventist Health System. Additionally, the following table sets forth information relating to facilities that are currently under construction:

Expected

Number of

Hospital

Opening

Operating

Facility Location

Partner

Type

Date

Rooms

Santa Clarita, California

Providence

Surgery Center

1Q06

3 OR’s

Manalapan, New Jersey

Meridian

Surgery Center

2Q06

2 OR’s

Houston, Texas

Memorial Hermann

Surgery Center

3Q06

4 OR’s

Desert Ridge, Arizona

CHW

Surgery Center

4Q06

4 OR’s

We also have nine additional projects under development, all of which involve a hospital partner. It is possible that some of these projects, as well as other projects which are in various stages of negotiation with both current and prospective joint venture partners, will result in our operating additional facilities sometime in 2006. While our history suggests that many of these projects will culminate with the opening of a profitable surgical facility, we can provide no assurance that any of these projects will reach that stage or will be successful thereafter.

Marketing

Our sales and marketing efforts are directed primarily at physicians, who are principally responsible for referring patients to our facilities. We market our facilities to physicians by emphasizing (1) the high level of patient and physician satisfaction with our surgery centers, which is based on surveys we take concerning our facilities, (2) the quality and responsiveness of our services, (3) the practice efficiencies provided by our facilities and (4) the benefits of our affiliation with our hospital partners. We also directly negotiate, together in some instances with our hospital partners, agreements with third-party payors, which generally focus on the pricing, number of facilities in the market and affiliation with physician groups in a particular market. Maintaining access to physicians and patients through third-party payor contracting is essential for the economic viability of most of our facilities.

Competition

In all of our markets, our facilities compete with other providers, including major acute care hospitals and other surgery centers. Hospitals have various competitive advantages over us, including their established managed care contracts, community position, physician loyalty and geographical convenience for physicians’ inpatient and outpatient practices. However, we believe that, in comparison to hospitals with which we compete, our surgery centers and private surgical hospitals compete favorably on the basis of cost, quality, efficiency and responsiveness to physician needs in a more comfortable environment for the patient.

We compete with other providers in each of our markets for patients, physicians and for contracts with insurers or managed care payors. Competition for managed care contracts with other providers is focused on the pricing, number of facilities in the market and affiliation with key physician groups in a particular market. We believe that our relationships with our hospital partners enhance our ability to compete for managed care contracts. We also encounter competition with other companies for acquisition and development of facilities and in the United States for strategic relationships with not-for-profit healthcare systems and physicians.

There are several publicly-held companies, or divisions of large publicly-held companies, that acquire and develop freestanding multi-specialty surgery centers and private surgical hospitals. Some of these competitors have greater resources than we do. The principal competitive factors that affect our ability and the ability of our competitors to acquire surgery centers and private surgical hospitals are price, experience, reputation and access to capital. Further, in the United States many physician groups develop surgery centers without a corporate partner, and this presents a competitive threat to the Company.

In the United Kingdom, we face competition from both the national health service and other privately operated hospitals. Across the United Kingdom, a large number of private hospitals are owned by the four largest hospital operators. In addition, the two largest payors account for over half of the privately insured market. We believe our hospitals can effectively compete in this market due to location and specialty mix of our facilities. Our hospitals also have a higher portion of self pay business than the overall market. Self pay business is not influenced by the private insurers.

Employees

As of December 31, 2005, we employed approximately 4,200 people, 3,600 of whom are full-time employees and 600 of whom are part-time employees. Of these employees, we employ approximately 3,400 in the United States and 800 in the United Kingdom. The physicians that affiliate with us and use our facilities are not our employees. However, we generally offer the physicians the opportunity to purchase equity interests in the facilities they use.

Professional and General Liability Insurance

In the United States, we maintain professional liability insurance that provides coverage on a claims made basis of $1.0 million per incident and $7.5 million in annual aggregate amount with retroactive provisions upon policy renewal. We also maintain general liability insurance coverage of $1.0 million per occurrence and $7.5 million in annual aggregate amount, as well as business interruption insurance and property damage insurance. In addition, we maintain umbrella liability insurance in the aggregate amount of $25.0 million. The governing documents of each of our surgical facilities require physicians who conduct surgical procedures at those facilities to maintain stated amounts of insurance. In the United Kingdom, we maintain general public insurance in the amount of £5.0 million, malpractice insurance in the amount of £3.0 million and property and business interruption insurance. Our insurance policies are generally subject to annual renewals. We believe that we will be able to renew current policies or otherwise obtain comparable insurance coverage at reasonable rates. However, we have no control over the insurance markets and can provide no assurance that we will economically be able to maintain insurance similar to our current policies.

Government Regulation

United States

The healthcare industry is subject to extensive regulation by federal, state and local governments. Government regulation affects our business by controlling growth, requiring licensing or certification of facilities, regulating how facilities are used, and controlling payment for services provided. Further, the regulatory environment in which we operate may change significantly in the future. While we believe we have structured our agreements and operations in material compliance with applicable law, there can be no assurance that we will be able to successfully address changes in the regulatory environment.

Every state imposes licensing and other requirements on healthcare facilities. In addition, many states require regulatory approval, including certificates of need, before establishing or expanding various types of healthcare facilities, including surgery centers and private surgical hospitals, offering services or making capital expenditures

in excess of statutory thresholds for healthcare equipment, facilities or programs. We may become subject to additional regulations as we expand our existing operations and enter new markets.

In addition to extensive existing government healthcare regulation, there have been numerous initiatives on the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services. We believe that these healthcare reform initiatives will continue during the foreseeable future. If adopted, some aspects of previously proposed reforms, such as further reductions in Medicare or Medicaid payments, or additional prohibitions on physicians’ financial relationships with facilities to which they refer patients, could adversely affect us.

We believe that our business operations materially comply with applicable law. However, we have not received a legal opinion from counsel or from any federal or state judicial or regulatory authority to this effect, and many aspects of our business operations have not been the subject of state or federal regulatory scrutiny or interpretation. Some of the laws applicable to us are subject to limited or evolving interpretations; therefore, a review of our operations by a court or law enforcement or regulatory authority might result in a determination that could have a material adverse effect on us. Furthermore, the laws applicable to us may be amended or interpreted in a manner that could have a material adverse effect on us. Our ability to conduct our business and to operate profitably will depend in part upon obtaining and maintaining all necessary licenses, certificates of need and other approvals, and complying with applicable healthcare laws and regulations.

Licensure and certificate-of-need regulations

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

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

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

Our healthcare facilities are also subject to state and local licensing regulations ranging from the adequacy of medical care to compliance with building codes and environmental protection laws. To assure continued compliance with these regulations, governmental and other authorities periodically inspect our facilities. The failure to comply with these regulations could result in the suspension or revocation of a healthcare facility’s license.

Our healthcare facilities receive accreditation from the Joint Commission on Accreditation of Healthcare Organizations or the Accreditation Association for Ambulatory Health Care, Inc., nationwide commissions which establish standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of various types of healthcare facilities. Generally, our healthcare facilities must be in operation for at least six months before they are eligible for accreditation. As of December 31, 2005, all but two of our eligible healthcare facilities had been accredited by either the Joint Commission on Accreditation of Healthcare Organizations or the Accreditation Association for Ambulatory Health Care, Inc. or are in the process of applying for such accreditation.

Many managed care companies and third-party payors require our facilities to be accredited in order to be considered a participating provider under their health plans.

Medicare and Medicaid Participation in Surgery Centers

Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are 65 or older or who are disabled. Medicaid is a health insurance program jointly funded by state and federal governments that provides medical assistance to qualifying low income persons. Each state Medicaid program has the option to provide payment for surgery center services. All of the states in which we currently operate cover Medicaid surgery center services; however, these states may not continue to cover surgery center services and states into which we expand our operations may not cover or continue to cover surgery center services.

Medicare payments for procedures performed at surgery centers are not based on costs or reasonable charges. Instead, Medicare prospectively determines fixed payment amounts for procedures performed at surgery centers. These amounts are adjusted for regional wage variations. The various state Medicaid programs also pay us a fixed payment for our services, which amount varies from state to state. A portion of our revenues are attributable to payments received from the Medicare and Medicaid programs. For the years ended December 31, 2005, 2004, and 2003, 28%, 27%, and 25%, respectively, of our domestic case volumes were attributable to Medicare and Medicaid payments, although the percentage of our overall revenues these cases represent is significantly less because government payors typically pay less than private insurers. For example, approximately 11% and 1% of our 2005 domestic patient service revenues were contributed by Medicare and Medicaid, respectively, despite those cases representing a total of 28% of our domestic case volume.

To participate in the Medicare program and receive Medicare payment, our facilities must comply with regulations promulgated by the Department of Health and Human Services. Among other things, these regulations, known as “conditions of participation,” relate to the type of facility, its equipment, its personnel and its standards of medical care, as well as compliance with state and local laws and regulations. Our surgery centers must also satisfy the conditions of participation in order to be eligible to participate in the Medicaid program. All of our surgery centers and private surgical hospitals in the United States are certified or, with respect to newly acquired or developed surgery centers and private surgical hospitals, awaiting certification to participate in the Medicare program. These facilities are subject to annual on-site surveys to maintain their certification. Failure to comply with Medicare’s conditions of participation may result in loss of program payment or other governmental sanctions. We have established ongoing quality assurance activities to monitor and ensure our facilities’ compliance with these conditions of participation.

The Department of Health and Human Services and the states in which we perform surgical procedures for Medicaid patients may revise the Medicare and Medicaid payments methods or rates in the future. Any such changes could have a negative impact on the reimbursements we receive for our surgical services from the Medicare program and the state Medicaid programs. We do not know at this time when or to what extent revisions to such payment methodologies will be implemented.

As with most government programs, the Medicare and Medicaid programs are subject to statutory and regulatory changes, possible retroactive and prospective rate adjustments, administrative rulings, freezes and funding reductions, all of which may adversely affect the level of payments to our surgery centers. Currently, Medicare reimbursement rates are frozen pending completion of a cost survey, to be completed no later than 2008. In late 2005, Congress enacted legislation that reduced reimbursement for certain surgery center procedures, primarily gastrointestinal and ophthalmology procedures, to the lower of the rate for surgery centers or the rate for hospital outpatient departments. Reductions or changes in Medicare or Medicaid funding could significantly affect our results of operations. We cannot predict at this time whether additional healthcare reform initiatives will be implemented or whether there will be other changes in the administration of government healthcare programs or the interpretation of government policies that would adversely affect our business.

Federal Anti-Kickback Law

State and federal laws regulate relationships among providers of healthcare services, including employment or service contracts and investment relationships. These restrictions include a federal criminal law, referred to herein

as the Anti-Kickback Statute, that prohibits offering, paying, soliciting, or receiving any form of remuneration in return for:


	•	referring patients for services or items payable under a federal healthcare program, including Medicare or Medicaid, or

	•	purchasing, leasing, or ordering, or arranging for or recommending purchasing, leasing, or ordering any good, facility, service or item for which payment may be made in whole or in part by a federal healthcare program.

A violation of the Anti-Kickback Statute constitutes a felony. Potential sanctions include imprisonment of up to five years, criminal fines of up to $25,000, civil money penalties of up to $50,000 per act plus three times the remuneration offered or three times the amount claimed and exclusion from all federally funded healthcare programs, including the Medicare and Medicaid programs. The applicability of these provisions to many business transactions in the healthcare industry has not yet been subject to judicial or regulatory interpretation.

Pursuant to the Anti-Kickback Statute, and in an effort to reduce potential fraud and abuse relating to federal healthcare programs, the federal government has announced a policy of increased scrutiny of joint ventures and other transactions among healthcare providers. The Office of the Inspector General of the Department of Health and Human Services closely scrutinizes healthcare joint ventures involving physicians and other referral sources. In 1989, the Office of the Inspector General published a fraud alert that outlined questionable features of “suspect” joint ventures, and the Office of the Inspector General has continued to rely on fraud alerts in later pronouncements. The Office of the Inspector General has also published regulations containing numerous “safe harbors” that exempt some practices from enforcement under the Anti- Kickback Statute. These safe harbor regulations, if fully complied with, assure participants in particular types of arrangements that the Office of the Inspector General will not treat their participation as a violation of the Anti-Kickback Statute. The safe harbor regulations do not expand the scope of activities that the Anti-Kickback Statute prohibits, nor do they provide that failure to satisfy the terms of a safe harbor constitutes a violation of the Anti-Kickback Statute. The Office of the Inspector General has, however, indicated that failure to satisfy the terms of a safe harbor may subject an arrangement to increased scrutiny.

Our partnerships and limited liability companies that are providers of services under the Medicare and Medicaid programs, and their respective partners and members, are subject to the Anti-Kickback Statute. A number of the relationships that we have established with physicians and other healthcare providers do not fit within any of the safe harbor regulations issued by the Office of the Inspector General. All of the 95 surgical facilities in the United States in which we hold an ownership interest are owned by partnerships, limited liability partnerships or limited liability companies, which include as partners or members physicians who perform surgical or other procedures at the facilities.

On November 19, 1999, the Office of the Inspector General promulgated rules setting forth certain safe harbors under the Anti-Kickback Statute, including a safe harbor applicable to surgery centers. The surgery center safe harbor generally protects ownership or investment interests in a center by physicians who are in a position to refer patients directly to the center and perform procedures at the center on referred patients, if certain conditions are met. More specifically, the surgery center safe harbor protects any payment that is a return on an ownership or investment interest to an investor if certain standards are met in one of four categories of ambulatory surgery centers (1) surgeon-owned surgery centers, (2) single-specialty surgery centers, (3) multi-specialty surgery centers, and (4) hospital/physician surgery centers.

For multi-specialty ambulatory surgery centers, for example, the following standards, among others, apply:

(1) all of the investors must either be physicians who are in a position to refer patients directly to the center and perform procedures on the referred patients, group practices composed exclusively of those physicians, or investors who are not employed by the entity or by any of its investors, are not in a position to provide items or services to the entity or any of its investors, and are not in a position to make or influence referrals directly or indirectly to the entity or any of its investors;

(2) at least one-third of each physician investor’s medical practice income from all sources for the previous fiscal year or twelve-month period must be derived from performing outpatient procedures that require a surgery center or private specialty hospital setting in accordance with Medicare reimbursement rules; and

(3) at least one third of the Medicare-eligible outpatient surgery procedures performed by each physician investor for the previous fiscal year or previous twelve-month period must be performed at the surgery center in which the investment is made.

Similar standards apply to each of the remaining three categories of surgery centers set forth in the regulations. In particular, each of the four categories includes a requirement that no ownership interests be held by a non-physician or non-hospital investor if that investor is (a) employed by the center or another investor, (b) in a position to provide items or services to the center or any of its other investors, or (c) in a position to make or influence referrals directly or indirectly to the center or any of its investors.

Since one of our subsidiaries is an investor in each partnership or limited liability company that owns one of our surgery centers, and since this subsidiary provides management and other services to the surgery center, our arrangements with physician investors do not fit within the specific terms of the surgery center safe harbor or any other safe harbor.

In addition, because we do not control the medical practices of our physician investors or control where they perform surgical procedures, it is possible that the quantitative tests described above will not be met, or that other conditions of the surgery center safe harbor will not be met. Accordingly, while the surgery center safe harbor is helpful in establishing that a physician’s investment in a surgery center should be considered an extension of the physician’s practice and not as a prohibited financial relationship, we can give you no assurances that these ownership interests will not be challenged under the Anti-Kickback Statute. However, we believe that our arrangements involving physician ownership interests in our surgery centers do not fall within the activities prohibited by the Anti-Kickback Statute.

In addition, with regard to our surgical hospitals, the Office of Inspector General has not adopted any safe harbor regulations under the Anti-Kickback Statute for physician investments in surgical hospitals. Each of our surgical hospitals is held in partnership with physicians who are in a position to refer patients to the hospital. There can be no assurances that these relationships will not be found to violate the Anti-Kickback Statute or that there will not be regulatory or legislative changes that prohibit physician ownership of surgical hospitals.

While several federal court decisions have aggressively applied the restrictions of the Anti-Kickback Statute, they provide little guidance regarding the application of the Anti-Kickback Statute to our partnerships and limited liability companies. We believe that our operations do not violate the Anti-Kickback Statute. However, a federal agency charged with enforcement of the Anti-Kickback Statute might assert a contrary position. Further, new federal laws, or new interpretations of existing laws, might adversely affect relationships we have established with physicians or other healthcare providers or result in the imposition of penalties on us or some of our facilities. Even the assertion of a violation could have a material adverse effect upon us.

Federal Physician Self-Referral Law

Section 1877 of the Social Security Act, commonly known as the “Stark Law,” prohibits any physician from referring patients to any entity for the furnishing of certain “designated health services” otherwise payable by Medicare or Medicaid, if the physician or an immediate family member has a financial relationship with the entity, unless an exception applies. As defined by the Stark Law, the term “financial relationship” includes both ownership (or investment) interests and compensation arrangements. Persons who violate the Stark Law are subject to potential civil money penalties of up to $15,000 for each bill or claim submitted in violation of the Stark Law and up to $100,000 for each “circumvention scheme” they are found to have entered into, and potential exclusion from the Medicare and Medicaid programs. In addition, the Stark Law requires the denial (or, refund, as the case may be) of any Medicare and Medicaid payments received for designated health services that result from a prohibited referral.

The list of designated health services under the Stark Law does not include ambulatory surgery services as such. However, some of the ten types of designated health services are among the types of services furnished by our surgery centers. The Department of Health and Human Services, acting through the Centers for Medicare and Medicaid Services, has promulgated regulations implementing the Stark Law. These regulations exclude health services provided by an ambulatory surgery center from the definition of “designated health services” if the services are included in the surgery center’s composite Medicare payment rate. Therefore, the Stark Law’s self-referral prohibition generally does not apply to health services provided by a surgery center, unless the surgery center separately bills Medicare for the services. We believe that our operations do not violate the Stark Law, as currently

interpreted. However, it is possible that the Centers for Medicare and Medicaid Services will further address the exception relating to services provided by a surgery center in the future. Therefore, we cannot assure you that future regulatory changes will not result in our surgery centers becoming subject to the Stark Law’s self-referral prohibition.

Ten of our U.S. facilities are surgical hospitals rather than outpatient surgery centers. The Stark Law includes an exception for physician investments in hospitals if the physician’s investment is in the entire hospital and not just a department of the hospital. We believe that the physician investments in our surgical hospitals fall within the exception and are therefore permitted under the Stark Law. However, over the past few years there have been various legislative attempts to change the way the hospital exception applies to physician investments in “specialty hospitals”. In December 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 created an 18-month moratorium, beginning on the date of enactment, during which physicians could not refer Medicare or Medicaid patients to “specialty hospitals” in which they had an ownership or investment interest. The moratorium did not apply to hospitals that were in operation prior to, or under development as of, November 18, 2003, as long as certain other criteria were met. This moratorium lapsed in June 2005. In addition, in February 2006 Congress passed a budget reconciliation bill which contained certain provisions related to specialty hospitals. Specifically, the bill directed the Department of Health and Human Services (i) not to issue Medicare provider numbers to new specialty hospitals for a period of six months and (ii) to develop a strategic plan to address investment criteria, disclosure and enforcement with respect to specialty hospitals. All of USPI’s surgical hospitals had Medicare provider numbers prior to the adoption of this bill.

False and Other Improper Claims

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

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

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

State Anti-Kickback and Physician Self-Referral Laws

Many states, including those in which we do or expect to do business, have laws that prohibit payment of kickbacks or other remuneration in return for the referral of patients. Some of these laws apply only to services reimbursable under state Medicaid programs. However, a number of these laws apply to all healthcare services in

the state, regardless of the source of payment for the service. Based on court and administrative interpretations of the federal Anti-Kickback Statute, we believe that the Anti-Kickback Statute prohibits payments only if they are intended to induce referrals. However, the laws in most states regarding kickbacks have been subjected to more limited judicial and regulatory interpretation than federal law. Therefore, we can give you no assurances that our activities will be found to be in compliance with these laws. Noncompliance with these laws could subject us to penalties and sanctions and have a material adverse effect on us.

A number of states, including those in which we do or expect to do business, have enacted physician self-referral laws that are similar in purpose to the Stark Law but which impose different restrictions. Some states, for example, only prohibit referrals when the physician’s financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Some states do not prohibit referrals, but require that a patient be informed of the financial relationship before the referral is made. We believe that our operations are in material compliance with the physician self-referral laws of the states in which our facilities are located.

Health Information Security and Privacy Practices

The Health Insurance Portability and Accountability Act of 1996 contains, among other measures, provisions that require many organizations, including us, to employ systems and procedures designed to protect each patient’s individual healthcare information. The Health Insurance Portability and Accountability Act of 1996 requires the Department of Health and Human Services to issue rules to define and implement patient privacy and security standards. Among the standards that the Department of Health and Human Services has adopted pursuant to the Health Insurance Portability and Accountability Act of 1996 are standards for the following:


	•	electronic transactions and code sets;

	•	unique identifiers for providers, employers, health plans and individuals;

	•	security and electronic signatures;

	•	privacy; and

	•	enforcement.

On August 17, 2000, the Department of Health and Human Services finalized the transaction standards. We were required to and did comply with these standards by October 16, 2003. The transaction standards require us to use standard code sets established by the rule when transmitting health information in connection with some transactions, including health claims and health payment and remittance advices.

On February 20, 2003, the Department of Health and Human Services issued a final rule that establishes, in part, standards for the security of health information by health plans, healthcare clearinghouses and healthcare providers that maintain or transmit any health information in electronic form, regardless of format. We are an affected entity under the rule. These security standards require affected entities to establish and maintain reasonable and appropriate administrative, technical and physical safeguards to ensure integrity, confidentiality and the availability of the information. The security standards were designed to protect the health information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. Although the security standards do not reference or advocate a specific technology, and affected entities have the flexibility to choose their own technical solutions, the security standards required us to implement significant systems and protocols. We were required to and did comply with these regulations by April 20, 2005.

On December 28, 2000, the Department of Health and Human Services published a final rule establishing standards for the privacy of individually identifiable health information. This rule was amended May 31, 2002 and August 14, 2002. We complied with the rule, as amended, by the deadline, which was April 14, 2003. These privacy standards apply to all health plans, all healthcare clearinghouses and many healthcare providers, including healthcare providers that transmit health information in an electronic form in connection with certain standard transactions. We are a covered entity under the final rule. The privacy standards protect individually identifiable health information held or disclosed by a covered entity in any form, whether communicated electronically, on paper or orally. These standards not only require our compliance with rules governing the use and disclosure of protected health information, but they also require us to impose those rules, by contract, on any business associate to

whom such information is disclosed. A violation of the privacy standards could result in civil money penalties of $100 per incident, up to a maximum of $25,000 per person per year per standard. The final rule also provides for criminal penalties of up to $50,000 and one year in prison for knowingly and improperly obtaining or disclosing protected health information, up to $100,000 and five years in prison for obtaining protected health information under false pretenses, and up to $250,000 and ten years in prison for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm.

European Union and United Kingdom

The European Commission’s Directive on Data Privacy went into effect in October 1998 and prohibits the transfer of personal data to non-European Union countries that do not meet the European “adequacy” standard for privacy protection. The European Union privacy legislation requires, among other things, the creation of government data protection agencies, registration of databases with those agencies, and in some instances prior approval before personal data processing may begin.

The U.S. Department of Commerce, in consultation with the European Commission, recently developed a “safe harbor” framework to protect data transferred in trans Atlantic businesses like ours. The safe harbor provides a way for us to avoid experiencing interruptions in our business dealings in the European Union. It also provides a way to avoid prosecution by European authorities under European privacy laws. By certifying to the safe harbor, we will notify the European Union organizations that we provide “adequate” privacy protection, as defined by European privacy laws. To certify to the safe harbor, we must adhere to seven principles. These principles relate to notice, choice, onward transfer or transfers to third parties, access, security, data integrity and enforcement.

We intend to satisfy the requirements of the safe harbor. Even if we are able to formulate programs that attempt to meet these objectives, we may not be able to execute them successfully, which could have a material adverse effect on our revenues, profits or results of operations.

While there is no specific anti-kickback legislation in the United Kingdom that is unique to the medical profession, general criminal legislation prohibits bribery and corruption. Our private surgical hospitals in the United Kingdom do not pay commissions to or share profits with referring physicians, who invoice patients or insurers directly for fees relating to the provision of their services. Private surgical hospitals in the United Kingdom are required to register with the local Social Services Authority pursuant to the Care Standards Act of 2000, which provides for regular inspections of the facility by the registering authority. The operation of a private surgical hospital without registration is a criminal offense. Under the Misuse of Drugs Act 1971, the supply, possession or production of controlled drugs without a license from the Secretary of State is a criminal offense. The Data Protection Act 1998 requires private surgical hospitals to register as “data controllers.” The processing of personal data, such as patient information and medical records, without prior registration is a criminal offense. We believe that our operations in the United Kingdom are in material compliance with the laws referred to in this paragraph.

Item 1A. Risk Factors

An investment in United Surgical Partners International, Inc. involves certain risks. You should carefully read the risks and uncertainties described below and the other information included or incorporated by reference in this report.

We depend on payments from third party payors, including government healthcare programs. If these payments are reduced, our revenue will decrease.

We are dependent upon private and governmental third party sources of payment for the services provided to patients in our surgery centers and private surgical hospitals. The amount of payment a surgery center or private surgical hospital receives for its services may be adversely affected by market and cost factors as well as other factors over which we have no control, including Medicare and Medicaid regulations and the cost containment and utilization decisions of third party payors. In the United Kingdom, a significant portion of our revenues result from referrals of patients to our hospitals by the national health system. We have no control over the number of patients that are referred to the private sector annually. Fixed fee schedules, capitation payment arrangements, exclusion from participation in or inability to reach agreement with managed care programs or other factors affecting payments for healthcare services over which we have no control could also cause a reduction in our revenues.

If we are unable to acquire and develop additional surgery centers or private surgical hospitals on favorable terms, we may be unable to execute our acquisition and development strategy, which could limit our future growth.

Our strategy is to increase our revenues and earnings by continuing to acquire surgical facility companies, groups of surgical facilities and individual surgical facilities and to develop additional surgical facilities, primarily in collaboration with our hospital partners. Our efforts to execute our acquisition and development strategy may be affected by our ability to identify suitable candidates and negotiate and close acquisition and development transactions. We are currently evaluating potential acquisitions and development projects and expect to continue to evaluate acquisitions and development projects in the foreseeable future. The surgical facilities we develop typically incur losses in their early months of operation (more so in the case of surgical hospitals) and, until their case loads grow, they generally experience lower total revenues and operating margins than established surgical facilities, and we expect this to continue to be the case. Historically, each of our newly developed facilities has generated positive cash flow within the first 12 months of operations. We may not be successful in acquiring other companies or additional surgical facilities, developing surgical facilities or achieving satisfactory operating results at acquired or newly developed facilities. Further, the companies or assets we acquire in the future may not ultimately produce returns that justify our related investment. If we are not able to execute our acquisition and development strategy, our ability to increase revenues and earnings through future growth would be impaired.

If we are not successful in integrating the operations of Surgis, Inc., which we anticipate acquiring in April 2006, with our own, we may not realize the potential benefits of our acquisition of Surgis.

Our anticipated acquisition of Surgis will require the integration of two companies that previously operated independently. If we are not able to integrate the two companies’ operations and personnel in a timely and efficient manner, then the potential benefits of the transaction may not be realized. Further, any delays or unexpected costs incurred in connection with the integration could have a material adverse effect on our operations and earnings. In particular, if the operations and personnel of the two companies are not compatible, if we experience the loss of key personnel or if the effort devoted to the integration of the two companies diverts significant management or other resources from other operational activities, our operations could be impaired.

If we incur material liabilities as a result of acquiring companies or surgical facilities, our operating results could be adversely affected.

Although we conduct extensive due diligence prior to the transactions and seek indemnification from prospective sellers covering unknown or contingent liabilities, we may acquire companies and surgical facilities that have material liabilities for failure to comply with healthcare laws and regulations or other past activities. Although we maintain professional and general liability insurance, we do not currently maintain insurance specifically covering any unknown or contingent liabilities that may have occurred prior to the acquisition of companies and surgical facilities. If we incur these liabilities and are not indemnified or insured for them, our operating results and financial condition could be adversely affected.

If we are unable to manage growth, we may be unable to achieve our growth strategy.

We have acquired interests in or developed all of our surgery centers and private surgical hospitals since our inception in February 1998. We expect to continue to expand our operations in the future. Our rapid growth has placed, and will continue to place, increased demands on our management, operational and financial information systems and other resources. Further expansion of our operations will require substantial financial resources and management attention. To accommodate our past and anticipated future growth, and to compete effectively, we will need to continue to implement and improve our management, operational and financial information systems and to expand, train, manage and motivate our workforce. Our personnel, systems, procedures or controls may not be adequate to support our operations in the future. Further, focusing our financial resources and management attention on the expansion of our operations may negatively impact our financial results. Any failure to implement and improve our management, operational and financial information systems, or to expand, train, manage or motivate our workforce, could reduce or prevent our growth.

We depend on our relationships with not-for-profit healthcare systems and their ability to assist in negotiating managed care contracts on behalf of the surgical facilities that we jointly own with healthcare systems. If we are not able to maintain our strategic alliances with these not-for-profit healthcare systems, or enter into new alliances, we may be unable to implement our business strategies successfully.

Our domestic business depends in part upon the efforts and success of the not-for-profit healthcare systems with which we have strategic alliances and the strength of our alliances with those healthcare systems. Our business could be adversely affected by any damage to those healthcare systems’ reputations or to our alliances with them. We may not be able to maintain our existing alliance agreements on terms and conditions favorable to us or enter into alliances with additional not-for-profit healthcare systems. If we are unable to maintain our existing arrangements on terms favorable to us or enter into alliances with additional not-for-profit healthcare systems, we may be unable to implement our business strategies successfully.

If we and our not-for-profit healthcare system partners are unable to successfully negotiate contracts and maintain satisfactory relationships with managed care organizations or other third party payors, our revenues may decrease.

Our competitive position has been, and will continue to be, affected by initiatives undertaken during the past several years by major domestic purchasers of healthcare services, including federal and state governments, insurance companies and employers, to revise payment methods and monitor healthcare expenditures in an effort to contain healthcare costs. As a result of these initiatives, managed care companies such as health maintenance and preferred provider organizations, which offer prepaid and discounted medical service packages, represent a growing segment of healthcare payors, the effect of which has been to reduce the growth of domestic healthcare facility margins and revenue. Similarly, in the United Kingdom, most patients at private surgical hospitals have private healthcare insurance, either paid for by the patient or received as part of their employment compensation. Our private surgical hospitals in the United Kingdom contract with healthcare insurers on an annual basis to provide services to insured patients.

As an increasing percentage of domestic patients become subject to healthcare coverage arrangements with managed care payors, we believe that our success will continue to depend upon our and our not-for-profit healthcare system partners’ ability to negotiate favorable contracts on behalf of our facilities with managed care organizations, employer groups and other private third party payors. If we are unable to enter into these arrangements on satisfactory terms in the future we could be adversely affected. Many of these payors already have existing provider structures in place and may not be able or willing to change their provider networks. Similarly, if we fail to negotiate contracts with healthcare insurers in the United Kingdom on favorable terms, or if we fail to remain on insurers’ networks of approved hospitals, such failure could have a material adverse effect on us. We could also experience a material adverse effect to our operating results and financial condition as a result of the termination of existing third party payor contracts.

We depend on our relationships with the physicians who use our facilities. Our ability to provide medical services at our facilities would be impaired and our revenues reduced if we are not able to maintain these relationships.

Our business depends upon the efforts and success of the physicians who provide medical and surgical services at our facilities and the strength of our relationships with these physicians. Our revenues would be reduced if we lost our relationship with one or more key physicians or group of physicians or such physicians or groups reduce their use of our facilities. In addition, any failure of these physicians to maintain the quality of medical care provided or to otherwise adhere to professional guidelines at our surgical facilities or any damage to the reputation of a key physician or group of physicians could damage our reputation, subject us to liability and significantly reduce our revenues.

Our United Kingdom operations are subject to unique risks, any of which, if they actually occur, could adversely affect our results.

We expect that revenue from our United Kingdom operations will continue to account for a significant percentage of our total revenue. Further, we may pursue additional acquisitions in the United Kingdom, which would require substantial financial resources and management attention. This focus of financial resources and

management attention could have an adverse effect on our financial results. Our United Kingdom operations are subject, and as they continue to develop may become increasingly subject, to risks such as:


	•	competition with government sponsored healthcare systems;

	•	unforeseen changes in foreign regulatory requirements or domestic regulatory requirements affecting our foreign operations;

	•	identifying, attracting, retaining and working successfully with qualified local management;

	•	fluctuations in exchange rates;

	•	difficulties in staffing and managing geographically and culturally diverse, multinational operations; and

	•	the possibility of an economic downturn in the United Kingdom, which could adversely affect the ability or willingness of employers and individuals in these countries to purchase private health insurance.

These or other factors could have a material adverse effect on our ability to successfully operate in the United Kingdom and our financial condition and operations.

Our significant indebtedness could limit our flexibility.

We are significantly leveraged and will continue to have significant indebtedness in the future. Our acquisition and development program requires substantial capital resources, estimated to range from $60 million to $80 million per year over the next three years, although the range could be exceeded if attractive multi-facility acquisition opportunities are identified. The operations of our existing surgical facilities also require ongoing capital expenditures. We believe that our cash on hand, cash flows from operations and available borrowings under our revolving credit facility will be sufficient to fund our acquisition and development activities in 2006, but if we identify favorable acquisition and development opportunities that require additional resources, we may be required to incur additional indebtedness in order to pursue these opportunities.

However, we may be unable to obtain sufficient financing on terms satisfactory to us, or at all. As a result, our acquisition and development activities would have to be curtailed or eliminated and our financial results would be adversely affected. The degree to which we are leveraged could have other important consequences to you, including the following:


	•	we must dedicate a substantial portion of our cash flows from operations to the payment of principal and interest on our indebtedness, reducing the funds available for our operations;

	•	a portion of our borrowings are at variable rates of interest, making us vulnerable to increases in interest rates;

	•	we may be more highly leveraged than some of our competitors, which could place us at a competitive disadvantage;

	•	our degree of leverage may make us more vulnerable to a downturn in our business or the economy generally; and

	•	the terms of our existing credit arrangements contain numerous financial and other restrictive covenants, including restrictions on paying dividends, incurring additional indebtedness and selling assets.

Our revenues may be reduced by changes in payment methods or rates under the Medicare or Medicaid programs.

The Department of Health and Human Services and the states in which we perform surgical procedures for Medicaid patients may revise the Medicare and Medicaid payment methods or rates in the future. Any such changes could have a negative impact on the reimbursements we receive for our surgical services from the Medicare program and the state Medicaid programs. We do not know at this time when or to what extent revisions to such payment methodologies will be implemented.

Efforts to regulate the construction, acquisition or expansion of healthcare facilities could prevent us from acquiring additional surgery centers or private surgical hospitals, renovating our existing facilities or expanding the breadth of services we offer.

Many states in the United States require prior approval for the construction, acquisition or expansion of healthcare facilities or expansion of the services they offer. When considering whether to approve such projects, these states take into account the need for additional or expanded healthcare facilities or services. In a number of states in which we operate, we are required to obtain certificates of need for capital expenditures exceeding a prescribed amount, changes in bed capacity or services offered and under various other circumstances. Other states in which we now or may in the future operate may adopt certificate of need legislation or regulatory provisions. Our costs of obtaining a certificate of need have ranged up to $500,000. Although we have not previously been denied a certificate of need, we may not be able to obtain the certificates of need or other required approvals for additional or expanded facilities or services in the future. In addition, at the time we acquire a facility, we may agree to replace or expand the acquired facility. If we are unable to obtain the required approvals, we may not be able to acquire additional surgery centers or private surgical hospitals, expand the healthcare services provided at these facilities or replace or expand acquired facilities.

New federal and state legislative and regulatory initiatives relating to patient privacy and electronic data security could require us to expend substantial sums acquiring and implementing new information and transaction systems, which could negatively impact our financial results.

There are currently numerous legislative and regulatory initiatives at the U.S. state and federal levels addressing patient privacy concerns and standards for the exchange of electronic health information. These provisions are intended to enhance patient privacy and the effectiveness and efficiency of healthcare claims and payment transactions. In particular, the Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996 required us to implement new systems and to adopt business procedures designed to protect the privacy of each of our patient’s individual health information.

On August 17, 2000, the Department of Health and Human Services issued final regulations establishing electronic data transmission standards that healthcare providers must use when submitting or receiving certain healthcare data electronically. We were required to and did comply with these regulations by October 16, 2003.

On February 20, 2003, the Department of Health and Human Services issued final regulations to protect the security of health-related information. These security standards require healthcare providers to implement organizational and technical practices to protect the security of patient information. We were required to and did comply with these regulations by April 20, 2005.

On December 28, 2000, the Department of Health and Human Services released final regulations regarding the privacy of healthcare information. We complied with these privacy regulations by the deadline, which was April 14, 2003. The privacy regulations extensively regulate the use and disclosure of individually identifiable healthcare information, whether communicated electronically, on paper or verbally. The regulations also provide patients with significant new rights related to understanding and controlling how their health information is used or disclosed.

We believe that we are in material compliance with existing state and federal regulations relating to patient privacy. However, if we fail to comply with the federal privacy regulations, we could incur civil penalties up to $25,000 per calendar year for each violation and criminal penalties with fines up to $250,000 per violation.

If we fail to comply with applicable laws and regulations, we could suffer penalties or be required to make significant changes to our operations.

We are subject to many laws and regulations at the federal, state and local government levels in the jurisdictions in which we operate. These laws and regulations require that our healthcare facilities meet various licensing, certification and other requirements, including those relating to:


	•	physician ownership of our domestic facilities;

	•	the adequacy of medical care, equipment, personnel, operating policies and procedures;

	•	building codes;

	•	licensure, certification and accreditation;


	•	billing for services;

	•	maintenance and protection of records; and

	•	environmental protection.

We believe that we are in material compliance with applicable laws and regulations. However, if we fail or have failed to comply with applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in Medicare, Medicaid and other government sponsored healthcare programs. A number of initiatives have been proposed during the past several years to reform various aspects of the healthcare system, both domestically and in the United Kingdom. In the future, different interpretations or enforcement of existing or new laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. Current or future legislative initiatives or government regulation may have a material adverse effect on our operations or reduce the demand for our services.

In pursuing our growth strategy, we may expand our presence into new geographic markets. In entering a new geographic market, we will be required to comply with laws and regulations of jurisdictions that may differ from those applicable to our current operations. If we are unable to comply with these legal requirements in a cost-effective manner, we may be unable to enter new geographic markets.

If a federal or state agency asserts a different position or enacts new laws or regulations regarding illegal remuneration under the Medicare or Medicaid programs, we may be subject to civil and criminal penalties, experience a significant reduction in our revenues or be excluded from participation in the Medicare and Medicaid programs.

The federal Anti-Kickback Statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for referring items or services payable by Medicare, Medicaid, or any other federally funded healthcare program. Additionally, the Anti-Kickback Statute prohibits any form of remuneration in return for purchasing, leasing, or ordering or arranging for or recommending the purchasing, leasing or ordering of items or services payable by Medicare, Medicaid or any other federally funded healthcare program. The Anti-Kickback Statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by existing case law or regulations. Violations of the Anti-Kickback Statute may result in substantial civil or criminal penalties, including criminal fines of up to $25,000 and civil penalties of up to $50,000 for each violation, plus three times the remuneration involved or the amount claimed and exclusion from participation in the Medicare and Medicaid programs. The exclusion, if applied to our surgery centers or private surgical hospitals, could result in significant reductions in our revenues, which could have a material adverse effect on our business.

In July 1991, the Department of Health and Human Services issued final regulations defining various “safe harbors.” Two of the safe harbors issued in 1991 apply to business arrangements similar to those used in connection with our surgery centers and private surgical hospitals: the “investment interest” safe harbor and the “personal services and management contracts” safe harbor. However, the structure of the partnerships and limited liability companies operating our surgery centers and private surgical hospitals, as well as our various business arrangements involving physician group practices, do not satisfy all of the requirements of either safe harbor. Therefore, our business arrangements with our surgery centers, private surgical hospitals and physician groups do not qualify for “safe harbor” protection from government review or prosecution under the Anti-Kickback Statute. Since there is no legal requirement that transactions with referral sources fit within a safe harbor, a business arrangement that does not substantially comply with the relevant safe harbor is not necessarily illegal under the Anti-Kickback Statute.

On November 19, 1999, the Department of Health and Human Services promulgated final regulations creating additional safe harbor provisions, including a safe harbor that applies to physician ownership of or investment interests in surgery centers. The surgery center safe harbor protects four types of investment arrangements: (1) surgeon owned surgery centers; (2) single specialty surgery centers; (3) multi-specialty surgery centers; and (4) hospital/physician surgery centers. Each category has its own requirements with regard to what type of physician may be an investor in the surgery center. In addition to the physician investor, the categories permit an “unrelated” investor, who is a person or entity that is not in a position to provide items or services related to the surgery center or its investors. Our business arrangements with our surgery centers typically consist of one of our subsidiaries being an investor in each partnership or limited liability company that owns the surgery center, in addition to providing

management and other services to the surgery center. As a result, these business arrangements do not comply with all the requirements of the surgery center safe harbor, and, therefore, are not immune from government review or prosecution.

Although we believe that our business arrangements do not violate the Anti-Kickback Statute, a government agency or a private party may assert a contrary position. Additionally, new domestic federal or state laws may be enacted that would cause our relationships with the physician investors to become illegal or result in the imposition of penalties against us or our facilities. If any of our business arrangements with physician investors were deemed to violate the Anti-Kickback Statute or similar laws, or if new domestic federal or state laws were enacted rendering these arrangements illegal, our business could be adversely affected.

Also, most of the states in which we operate have adopted anti-kickback laws, many of which apply more broadly to all third-party payors, not just to federal healthcare programs. Many of the state laws do not have regulatory safe harbors comparable to the federal provisions and have only rarely been interpreted by the courts or other governmental agencies. We believe that our business arrangements do not violate these state laws. Nonetheless, if our arrangements were found to violate any of these anti-kickback laws, we could be subject to significant civil and criminal penalties that could adversely affect our business.

If physician self-referral laws are interpreted differently or if other legislative restrictions are issued, we could incur significant sanctions and loss of reimbursement revenues.

The U.S. federal physician self-referral law, commonly referred to as the Stark Law, prohibits a physician from making a referral for a “designated health service” to an entity if the physician or a member of the physician’s immediate family has a financial relationship with the entity, unless an exception applies. The list of designated health services under the Stark Law does not include ambulatory surgery services as such. However, some of the ten types of designated health services are among the types of services furnished by our surgery centers.

The Department of Health and Human Services, acting through the Centers for Medicare and Medicaid Services, has promulgated regulations implementing the Stark Law. These regulations exclude health services provided by an ambulatory surgery center from the definition of “designated health services” if the services are included in the surgery center’s composite Medicare payment rate. Therefore, the Stark Law’s self-referral prohibition generally does not apply to health services provided by a surgery center, unless the surgery center separately bills Medicare for the services. We believe that our operations do not violate the Stark Law, as currently interpreted.

In addition, we believe that physician ownership of surgery centers is not prohibited by similar self-referral statutes enacted at the state level. However, the Stark Law and similar state statutes are subject to different interpretations with respect to many important provisions. Violations of these self-referral laws may result in substantial civil or criminal penalties, including large civil monetary penalties and exclusion from participation in the Medicare and Medicaid programs. Exclusion of our surgery centers or private surgical hospitals from these programs through future judicial or agency interpretation of existing laws or additional legislative restrictions on physician ownership or investments in healthcare entities could result in significant loss of reimbursement revenues.

Companies within the healthcare industry continue to be the subject of federal and state investigations, which increases the risk that we may become subject to investigations in the future.

Both federal and state government agencies, as well as private payors, have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations. These investigations relate to a wide variety of topics, including the following:


	•	cost reporting and billing practices;

	•	quality of care;

	•	financial reporting;

	•	financial relationships with referral sources; and

	•	medical necessity of services provided.

In addition, the Office of the Inspector General of the Department of Health and Human Services and the Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific

billing practices or other suspected areas of abuse. Moreover, another trend impacting healthcare providers is the increased use of the federal False Claims Act, particularly by individuals who bring actions under that law. Such “qui tam” or “whistleblower” actions allow private individuals to bring actions on behalf of the government alleging that a healthcare provider has defrauded the federal government. If the government intervenes and prevails in the action, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil monetary penalties of between $5,500 and $11,000 for each false claim submitted to the government. As part of the resolution of a qui tam case, the party filing the initial complaint may share in a portion of any settlement or judgment. If the government does not intervene in the action, the qui tam plaintiff may pursue the action independently. Additionally, some states have adopted similar whistleblower and false claims provisions. Although companies in the healthcare industry have been, and may continue to be, subject to qui tam actions, we are unable to predict the impact of such actions on our business, financial position or results of operations.

If laws governing the corporate practice of medicine change, we may be required to restructure some of our domestic relationships which may result in significant costs to us and divert other resources.

The laws of various domestic jurisdictions in which we operate or may operate in the future do not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business practices, such as fee-splitting with physicians. The interpretation and enforcement of these laws vary significantly from state to state. We are not required to obtain a license to practice medicine in any jurisdiction in which we own or operate a surgery center or private surgical hospital because our facilities are not engaged in the practice of medicine. The physicians who utilize our facilities are individually licensed to practice medicine. In most instances, the physicians and physician group practices performing medical services at our facilities do not have investment or business relationships with us other than through the physicians’ ownership interests in the partnerships or limited liability companies that own and operate our facilities and the service agreements we have with some of those physicians.

As a result of our acquisition of OrthoLink, we provide consulting and administrative services to a number of physicians and physician group practices affiliated with OrthoLink. Although we believe that our arrangements with these and other physicians and physician group practices comply with applicable laws, a government agency charged with enforcement of these laws, or a private party, might assert a contrary position. If our arrangements with these physicians and physician group practices were deemed to violate state corporate practice of medicine, fee-splitting or similar laws, or if new laws are enacted rendering our arrangements illegal, we may be required to restructure these arrangements, which may result in significant costs to us and divert other resources.

If domestic regulations change, we may be obligated to purchase some or all of the ownership interests of the physicians affiliated with us.

Upon the occurrence of various fundamental regulatory changes, we could be obligated to purchase some or all of the ownership interests of the physicians affiliated with us in the partnerships or limited liability companies that own and operate our surgery centers and private surgical hospitals. The regulatory changes that could create this obligation include changes that:


	•	make illegal the referral of Medicare or other patients to our surgical facilities by physicians affiliated with us;

	•	create the substantial likelihood that cash distributions from the limited partnerships or limited liability companies through which we operate our surgical facilities to physicians affiliated with us would be illegal; or

	•	make illegal the ownership by the physicians affiliated with us of interests in the partnerships or limited liability companies through which we own and operate our surgical facilities.

At this time, we are not aware of any regulatory amendments or proposed changes that would trigger this obligation. Typically, our partnership and limited liability company agreements allow us to use shares of our common stock as consideration for the purchase of a physician’s ownership interest. The use of shares of our common stock for that purpose would dilute the ownership interests of our common stockholders. In the event that we are required to purchase all of the physicians’ ownership interests and our common stock does not maintain a

sufficient valuation, we could be required to use our cash resources for the acquisitions, the total cost of which we estimate to be up to $215 million. The creation of these obligations and the possible termination of our affiliation with these physicians could have a material adverse effect on us.

Recently adopted legislation could restrict our ability to operate our domestic surgical hospitals.

The Stark Law includes an exception that permits physicians to refer Medicare and Medicaid patients to hospitals in which they have an ownership interest under certain circumstances. However, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, signed into law in December 2003, created an 18-month moratorium, beginning on the date of enactment, during which physicians could not refer Medicare or Medicaid patients to “specialty hospitals” in which they had an ownership interest. The moratorium did not apply to hospitals that were in operation prior to, or under development as of, November 18, 2003, as long as certain other criteria were met. This moratorium lapsed in June 2005. In addition, in February 2006 Congress passed a budget reconciliation bill which contained certain provisions related to specialty hospitals. Specifically the bill directed the Department of Health and Human Services (i) not to issue Medicare provider numbers to new specialty hospitals for a period of six months and (ii) to develop a strategic plan to address investment criteria, disclosure and enforcement with respect to specialty hospitals. All of USPI’s surgical hospitals had Medicare provider numbers prior to the adoption of this bill.

If, as a result of the recent legislation or otherwise, future legislation is enacted that prohibits physician referrals to surgical hospitals in which the physicians own an interest, our surgical hospitals could be materially adversely affected. In addition, future legislation or regulatory requirements resulting from the Department of Health and Human Services plan described above could materially affect our surgical hospitals.

If we become subject to significant legal actions, we could be subject to substantial uninsured liabilities.

In recent years, physicians, hospitals and other healthcare providers have become subject to an increasing number of legal actions alleging malpractice, product liability or related legal theories. Many of these actions involve large monetary claims and significant defense costs. We do not employ any of the physicians who conduct surgical procedures at our facilities and the governing documents of each of our surgery centers require physicians who conduct surgical procedures at our surgery centers to maintain stated amounts of insurance. Additionally, to protect us from the cost of these claims, we maintain professional malpractice liability insurance and general liability insurance coverage in amounts and with deductibles that we believe to be appropriate for our operations. If we become subject to claims, however, our insurance coverage may not cover all claims against us or continue to be available at a cost allowing us to maintain adequate levels of insurance. If one or more successful claims against us were not covered by or exceeded the coverage of our insurance, we could be adversely affected.

If we are unable to effectively compete for physicians, strategic relationships, acquisitions and managed care contracts, our business could be adversely affected.

The healthcare business is highly competitive. We compete with other healthcare providers, primarily hospitals and other ambulatory surgery centers, in recruiting physicians and contracting with managed care payors in each of our markets. In the United Kingdom, we also compete with their national health system in recruiting healthcare professionals. There are major unaffiliated hospitals in each market in which we operate. These hospitals have established relationships with physicians and payors. In addition, other companies either are currently in the same or similar business of developing, acquiring and operating surgery centers and private surgical hospitals or may decide to enter our business. Many of these companies have greater financial, research, marketing and staff resources than we do. We may also compete with some of these companies for entry into strategic relationships with not-for-profit healthcare systems and healthcare professionals. If we are unable to compete effectively with any of these entities, we may be unable to implement our business strategies successfully and our business could be adversely affected.

Because our senior management has been key to our growth and success, we may be adversely affected if we lose any member of our senior management.

We are highly dependent on our senior management, including Donald E. Steen, who is our chairman, and William H. Wilcox, who is our president and chief executive officer. Although we have employment agreements with Mr. Steen and Mr. Wilcox and other senior managers, we do not maintain “key man” life insurance policies on

any of our officers. Because our senior management has contributed greatly to our growth since inception, the loss of key management personnel or our inability to attract, retain and motivate sufficient numbers of qualified management or other personnel could have a material adverse effect on us.

We may have a special legal responsibility to the holders of ownership interests in the entities through which we own surgical facilities, and that responsibility may prevent us from acting solely in our own best interests or the interests of our stockholders.

Our ownership interests in surgery centers and private surgical hospitals generally are held through limited partnerships, limited liability partnerships or limited liability companies. We typically maintain an interest in a limited partnership, limited liability partnership or limited liability company in which physicians or physician practice groups hold limited partnership, limited liability partnership or membership interests. As general partner or manager of these entities, we may have a special responsibility, known as a fiduciary duty, to manage these entities in the best interests of the other interest holders. We also have a duty to operate our business for the benefit of our stockholders. As a result, we may encounter conflicts between our responsibility to the other interest holders and our responsibility to our stockholders. For example, we have entered into management agreements to provide management services to our domestic surgery centers in exchange for a fee. Disputes may arise as to the nature of the services to be provided or the amount of the fee to be paid. In these cases, we are obligated to exercise reasonable, good faith judgment to resolve the disputes and may not be free to act solely in our own best interests or the interests of our stockholders. Disputes may also arise between us and our affiliated physicians with respect to a particular business decision or regarding the interpretation of the provisions of the applicable limited partnership agreement or limited liability company agreement. If we are unable to resolve a dispute on terms favorable or satisfactory to us, our business may be adversely affected.

We do not have exclusive control over the distribution of revenues from some of our domestic operating entities and may be unable to cause all or a portion of the revenues of these entities to be distributed.

All of the domestic surgery centers in which we have ownership interests are limited partnerships, limited liability partnerships or limited liability companies in which we own, directly or indirectly, partnership or membership interests. Our limited partnership, limited liability partnership and limited liability company agreements, which are typically with the physicians who perform procedures at our surgery centers, usually provide for the monthly or quarterly pro-rata cash distribution of net profits from operations, less amounts to satisfy obligations such as the entities’ non-recourse debt and capitalized lease obligations, operating expenses and working capital. The creditors of each of these limited partnerships, limited liability partnerships and limited liability companies are entitled to payment of the entities’ obligations to them, when due and payable, before ordinary cash distributions or distributions in the event of liquidation, reorganization or insolvency may be made. We generally control the entities that function as the general partner of the limited partnerships or the managing member of the limited liability companies through which we conduct operations. However, we do not have exclusive control in some instances over the amount of net revenues distributed from some of our operating entities. If we are unable to cause sufficient revenues to be distributed from one or more of these entities, our relationships with the physicians who have an interest in these entities may be damaged and we could be adversely affected. We may not be able to resolve favorably any dispute regarding revenue distribution or other matters with a healthcare system with which we share control of one of these entities. Further, the failure to resolve a dispute with these healthcare systems could cause the entity we jointly control to be dissolved.

Provisions of our charter documents, Delaware law and our stockholder rights plan could discourage a takeover you may consider favorable or the removal of our current management.

Some provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that you may consider favorable or the removal of our current management. These provisions:


	•	authorize the issuance of “blank check” preferred stock;

	•	provide for a classified board of directors with staggered, three-year terms;

	•	prohibit cumulative voting in the election of directors;

	•	prohibit our stockholders from acting by written consent without the approval of our board of directors;


	•	limit the persons who may call special meetings of stockholders; and

	•	establish advance notice requirements for nominations for election to the board of directors or for proposing matters to be approved by stockholders at stockholder meetings.

In addition, our certificate of incorporation prohibits the amendment of many of these provisions in our certificate of incorporation by our stockholders unless the amendment is approved by the holders of at least 80% of our shares of common stock.

Delaware law may also discourage, delay or prevent someone from acquiring or merging with us. In addition, purchase rights distributed under our stockholder rights plan will cause substantial dilution to any person or group attempting to acquire us without conditioning the offer on our redemption of the rights. As a result, our stock price may decrease and you might not receive a change of control premium over the then-current market price of the common stock.


Item 1B.	*Unresolved Staff Comments*

None.


Item 2.	*Properties*

The response to this item is included in Item 1.


Item 3.	*Legal Proceedings*

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*

None.

PART II


Item 5.	*Market for Registrant’s Common Equity and Related Stockholder Matters*

Market for Common Stock. Our common stock has traded on the Nasdaq National Market under the symbol “USPI” since June 8, 2001. As of February 24, 2006, there were approximately 161 record holders of our common stock. The following table sets forth for the periods indicated the high and low sales price per share of our common stock as reported on the Nasdaq National Market.


	High(1)		Low(1)

Year Ended December 31, 2004:
First Quarter	$	26.58	$	21.34
Second Quarter		27.43		22.27
Third Quarter		26.67		21.71
Fourth Quarter		28.52		21.09
Year Ended December 31, 2005:
First Quarter	$	31.17	$	24.72
Second Quarter		35.99		28.50
Third Quarter		40.07		32.25
Fourth Quarter		39.72		31.57


(1)		Restated to reflect the 3 for 2 stock split, which was effective July 15, 2005.

We have not declared or paid any dividends on our common stock and do not anticipate doing so in the foreseeable future. We currently intend to retain all future earnings to fund the development and growth of our business. The payment of any future dividends will be at the discretion of our board of directors and will depend on:


	•	any applicable contractual restrictions limiting our ability to pay dividends;


	•	our earnings;

	•	our financial condition;

	•	our ability to fund our capital requirements; and

	•	other factors our board deems relevant.

The indenture governing the senior subordinated notes of our wholly owned finance subsidiary, United Surgical Partners Holdings, Inc., places restrictions on our ability to pay cash dividends on our common stock.

Recent Sales of Unregistered Securities. During 2005, the Company did not issue or sell any securities that were not registered under the Securities Act.


Item 6.	*Selected Consolidated Financial Data*

The selected consolidated statement of operations data set forth below for the years ended December 31, 2005, 2004, 2003, 2002, and 2001, and the consolidated balance sheet data at December 31, 2005, 2004, 2003, 2002, and 2001, are derived from our consolidated financial statements, which have been audited by KPMG LLP, our independent registered public accounting firm.

The historical results presented below are not necessarily indicative of results to be expected for any future period. The comparability of the financial and other data included in the table is affected by our loss on early retirement of debt in 2001 and 2004 and various acquisitions completed during the years presented. Our Spanish operations, which we sold during 2004, have been reclassified to “discontinued operations” for all data presented in the table below except for the “consolidated balance sheet data”, which includes our Spanish operations for all years before 2004. For a more detailed explanation of this financial data, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this report.


	Years Ended December 31,
	2005			2004			2003			2002			2001
	(In thousands, except number of facilities and per share data)

Consolidated Statement of Income Data:
Total revenues	$	474,741		$	389,530		$	310,564		$	243,814		$	167,043
Equity in earnings of unconsolidated affiliates		23,998			18,626			15,074			9,454			5,879
Operating expenses excluding depreciation and amortization		(332,466	)		(273,614	)		(216,213	)		(170,193	)		(123,030	)
Depreciation and amortization		(31,406	)		(27,209	)		(22,700	)		(19,123	)		(18,042	)

Operating income		134,867			107,333			86,725			63,952			31,851
Other income (expense):
Interest income		4,455			1,591			1,015			774			758
Interest expense		(27,708	)		(26,720	)		(24,863	)		(23,307	)		(14,834	)
Loss on early retirement of debt		—			(1,635	)		—			—			(5,166	)
Other		533			247			733			(11	)		133

Income before minority interests		112,147			80,816			63,610			41,408			12,742
Minority interests in income of consolidated subsidiaries		(38,835	)		(30,441	)		(23,959	)		(14,809	)		(7,339	)
Income tax (expense) benefit		(26,173	)		(17,867	)		(14,934	)		(9,923	)		1,446

Income from continuing operations		47,139			32,508			24,717			16,676			6,850
Earnings (loss) from discontinued operations, net of tax		155			53,667			5,159			2,924			(4,100	)

Net income	$	47,294		$	86,175		$	29,876		$	19,600		$	2,750

Net income attributable to common stockholders (a)	$	47,294		$	86,175		$	29,876		$	19,600		$	66


	Years Ended December 31,
	2005		2004		2003		2002		2001
	(In thousands, except number of facilities and per share data)

Share Data (c):
Net income (loss) per share attributable to common stockholders:
Basic:
Continuing operations	$	1.10	$	0.78	$	0.61	$	0.45	$	0.15
Discontinued operations		—		1.28		0.12		0.07		(0.15	)

Total	$	1.10	$	2.06	$	0.73	$	0.52	$	—
Diluted:
Continuing operations	$	1.05	$	0.74	$	0.58	$	0.43	$	0.14
Discontinued operations		—		1.22		0.12		0.07		(0.14	)

Total	$	1.05	$	1.96	$	0.70	$	0.50	$	—
Weighted average number of common shares
Basic shares		42,994		41,913		40,699		37,387		27,570
Diluted shares		44,977		43,948		42,366		39,085		28,936
Other Data:
Number of facilities operated as of the end of period (b)		99		87		65		56		41
Cash flows from operating activities	$	107,905	$	81,751	$	66,206	$	46,725	$	35,478


	As of December 31,
	2005		2004		2003		2002		2001
	(Dollars in thousands)

Consolidated Balance Sheet Data:
Working capital	$	90,946	$	87,178	$	29,957	$	51,412	$	40,285
Cash and cash equivalents		130,440		93,467		28,519		47,571		33,881
Total assets		1,028,841		922,304		870,509		728,758		556,857
Total debt		286,486		288,485		304,744		276,703		238,681
Total stockholders’ equity		531,050		474,609		390,655		322,261		226,527


(a)		Includes preferred stock dividends of $2,684 for the year ended December 31, 2001. No preferred stock dividends were declared in 2005, 2004, 2003, or 2002. No common stock dividends were declared or paid in any period.

(b)		Does not include Spanish facilities. Not derived from audited financial statements.

(c)		Share and per share data are adjusted and restated to give effect to a three-for-two stock split effected during 2005.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operation*

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes included elsewhere in this report.

Overview

We operate ambulatory surgery centers and private surgical hospitals in the United States and the United Kingdom. As of December 31, 2005, we operated 99 facilities, consisting of 96 in the United States and three in the United Kingdom. All 96 of our U.S. facilities are jointly owned with local physicians, and 66 of these facilities are also partially owned by various not-for-profit healthcare systems. In addition to facilitating the joint ownership of most of our existing facilities, our agreements with these healthcare systems provide a framework for the planning

and construction of additional facilities in the future, including all four facilities we are currently constructing as well as additional projects under development.

Our U.S. facilities, consisting of ambulatory surgery centers and private surgical hospitals (each are generally referred to herein as “short-stay surgical facilities”), specialize in non-emergency surgical cases, the volume of which has steadily increased over the past two decades due in part to advancements in medical technology. These facilities earn a fee from patients, insurance companies, or other payors in exchange for providing the facility and related services a surgeon requires in order to perform a surgical case. In addition, we in turn earn a monthly fee from each facility we operate in exchange for managing its operations. All but three of our facilities are located in the U.S., where we have focused increasingly on adding facilities with not-for-profit healthcare system partners (hospital partners). At December 31, 2002, 48% of our U.S. facilities were jointly owned with a hospital partner. By December 31, 2005, this proportion had grown to 69%.

In the United Kingdom we operate private hospitals, which supplement the services provided by the government-sponsored healthcare system. Our patients choose to receive care at private hospitals 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 an increasing number of employers as a benefit to their employees. Since acquiring our first two facilities in the United Kingdom in 2000, we have expanded selectively by adding a third facility and increasing the capacity and services offered at each facility.

Our continued 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 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 which 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 and accounts receivable, income taxes, and goodwill and intangible assets.

Consolidation

We own less than 100% of each facility we operate. As discussed in “Results of Operations”, we operate all of our U.S. facilities through joint ventures with physicians. Increasingly, these joint ventures also include a not-for-profit healthcare system as a partner. We generally have a leadership role in these facilities through a significant voting and economic interest and a contract to manage each facility’s operations, but the degree of control we have varies from facility to facility. Accordingly, as of December 31, 2005, we consolidated the financial results of 42 of the facilities we operate, including one in which we hold no ownership but control through a long-term service agreement, and account for 57 under the equity method.

Our determination of the appropriate consolidation method to follow with respect to our investments in subsidiaries and affiliates is based on the amount of control we have, combined with our ownership level, in the underlying entity. Our consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, and other investees over which we have control. Investments in companies we do not control, but over whose operations we have the ability to exercise significant influence (including investments where have less than 20% ownership), are accounted for under the equity method.

Accounting for an investment as consolidated versus equity method has no impact on our net income or stockholders’ equity in any accounting period, but it does impact individual income statement and balance sheet balances. Under either consolidation or equity method accounting, the investor effectively records its share of the underlying entity’s net income or loss based on its ownership percentage. At December 31, 2005, all of the Company’s investments in unconsolidated affiliates are accounted for using the equity method.

Revenue Recognition and Accounts Receivable

We recognize revenue in accordance with Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as updated, which has four criteria that must be met before revenue is recognized:


	•	Existence of persuasive evidence that an arrangement exists;

	•	Delivery has occurred or services have been rendered;

	•	The seller’s price to the buyer is fixed and determinable; and

	•	Collectibility is reasonably assured.

Our revenue recognition policies are consistent with these criteria. Over 80% of our facilities’ surgical cases are performed under contracted or government mandated fee schedules or discount arrangements. The patient service revenues recorded for these cases are recorded at the contractually defined amount at the time of billing. The predictability of the remaining revenue, for which contractual adjustments are estimated based on historical collections, is such that adjustments to these estimates in subsequent periods have not had a material impact in any period presented. If the discount percentage used in estimating revenues for the cases not billed pursuant to fee schedules were changed by 1%, our 2005 after-tax net income would change by less than $100,000. The collection cycle for patient services revenue is relatively short, typically ranging from 30 to 60 days depending upon payor and geographic norms, which allows us to evaluate our estimates frequently. Our revenues earned under management and other service contracts are typically based upon objective formulas driven by an entity’s financial performance and are generally earned and paid monthly.

Our accounts receivable are comprised of receivables from both the United Kingdom and the United States. As of December 31, 2005, approximately 19% of our total accounts receivable were attributable to our U.K. business. Because our U.K. facilities only treat patients who have a demonstrated ability to pay, our U.K. patients arrange for payment prior to treatment and our bad debt expense in the U.K. is very low. In 2005 it was only $208,000, which is 0.2% of our total U.K. revenues of $89.5 million. In addition, our average days sales out standing in the U.K. was 37 as of December 31, 2005.

Our U.S. accounts receivable were approximately 81% of our total accounts receivable as of December 31, 2005. In 2005, uninsured or self-pay revenues only accounted for 3% of our U.S. revenue and 11% of our accounts receivable balance was comprised of amounts owed from patients, including the patient portion of amounts covered by insurance. Insurance revenues (including government payors) accounted for 97% of our 2005 U.S. revenue and 89% of our accounts receivable balance was comprised of amounts owed from contracted payors. Our U.S. facilities primarily perform routine elective surgery that is scheduled in advance by physicians who have already seen the patient. As part of our internal control processes, we verify benefits, obtain insurance authorization, calculate patient financial responsibility and notify the patient of their responsibility, all prior to surgery. The nature of our business is such that we do not have any significant receivables that are pending approval from third party payors. We also focus our collection efforts on aged accounts receivable. However, due to complexities involved in insurance reimbursements and inherent limitations in verification procedures, our business will always have some level of bad debt expense. In both 2005 and 2004, our bad debt expense attributable to U.S. revenue was 2.4%. In addition, as of December 31, 2005, our average days sales outstanding in the U.S. was 38, and the aging of our U.S. accounts receivable was: 69% less than 60 days old, 14% between 60 and 120 days and 17% over 120 days old. Our U.S. bad debt allowance at December 31, 2005 represented 15% of our U.S. accounts receivable balance.

Due to the nature of our business, management relies upon the aging of accounts receivable as its primary tool to estimate bad debt expense. Therefore, we reserve for bad debt based solely upon the aging of accounts receivable, without differentiating by payor source. We write off accounts on an individual basis based on that aging. We believe our reserve policy allows us to accurately estimate our allowance for doubtful accounts and bad debt expense.

Income Taxes

We account for income taxes under the asset and liability method. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income by taxing jurisdiction during the periods in which those temporary differences become deductible. If, in our opinion, it is more likely than not that some or all of the deferred tax assets may not be realized, deferred tax assets are reduced by a valuation allowance.

Goodwill and Intangible Assets

Given the significance of our intangible assets as a percentage of our total assets, we also consider our accounting policy regarding goodwill and intangible assets to be a critical accounting policy. Consistent with Statement of Financial Accounting Standards No. 142, Accounting for Goodwill and Intangible Assets (SFAS No. 142), we do not amortize goodwill or indefinite-lived intangibles but rather test them for impairment annually or more often when circumstances change in a manner that indicates they may be impaired. Intangible assets with definite lives are amortized over the estimated useful life and tested for impairment when circumstances change in a manner that indicates their carrying values may not be recoverable. Impairment tests occur at the reporting unit level for goodwill; our reporting units are defined as our operating segments (countries), and we have never recorded a goodwill impairment charge. Our intangible assets consist primarily of rights to manage individual surgical facilities and predominantly have indefinite lives. The values of these rights are tested individually, and no impairment charges have been recorded with respect to these assets.

Discontinued Operations

Effective September 9, 2004, we sold our Spanish operations, receiving proceeds of $141.1 million, net of a $22.2 million tax payment made in the fourth quarter of 2004. Collection of a portion of the sales proceeds was deferred until January 2007, at which time we expect to collect an additional $19.8 million in cash. In 2004, we recorded an after tax gain of $50.3 million on the sale, which is reflected in discontinued operations. During 2005 we finalized the calculation of the tax liability arising from our sale of the Spanish operations, and provided for additional legal costs associated with the sale, which resulted in a $0.2 million increase to the net gain on the sale. The results of our Spanish operations are classified as discontinued operations for all periods presented.

Acquisitions, Equity Investments and Development Projects

During 2005, eight surgery centers and one surgical hospital developed by us in the United States opened and began performing cases.

Effective January 1, 2005, we acquired a controlling interest in an ambulatory surgery center in Westwood, California in which we had previously owned a noncontrolling interest, for $7.4 million in cash.

Effective May 1, 2005, we acquired a controlling interest in an ambulatory surgery center in San Antonio, Texas, for $10.9 million in cash.

We also engage 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 year ended December 31, 2005, these transactions resulted in a net cash outflow of $38.7 million, of which


	•	$34.0 million was paid to acquire additional ownership in nine facilities we operate in the Dallas/Fort Worth market, net of proceeds from the sale of a portion of three other facilities in this same market,

	•	$5.2 million was paid for equity method investments in two surgery centers near Kansas City, Missouri,

	•	$4.7 million was paid for an equity method investment in a surgery center in the Sacramento, California area,

	•	$5.5 million was paid to acquire additional ownership in a facility the we operate in New Jersey, and

	•	$12.0 million was received from three not-for-profit healthcare systems for noncontrolling interests in six facilities we already operated. Included in these transactions are call options allowing the healthcare systems to acquire additional noncontrolling ownership interests in each facility in 2006. With respect to four of the facilities, the approximate sales price is $10.2 million and we have a put option with the same terms. With


		respect to the other two facilities, the systems have call options that, for one facility, fix the price at $2.0 million and in the other case base the price on a multiple of earnings when the option is exercised. We have no put options with respect to these two facilities, and


	•	$1.3 million of other net purchases of equity interests.

We also paid a total of $3.6 million to various sellers related to the resolution of contingencies that had existed at the time we made certain acquisitions. In addition, in December 2005 we made an advance payment of $8.3 million to the sellers of an ambulatory surgery center in St. Louis, Missouri. This transaction was effective January 1, 2006.

During 2004, six surgery centers and two surgical hospitals developed by us in the United States opened and began performing cases.

Effective December 1, 2004 we acquired a controlling interest in an ambulatory surgery center in San Antonio, Texas, for approximately $16.6 million in cash.

Effective November 1, 2004, we acquired Specialty Surgicenters, Inc., which operates four surgical centers, and concurrently acquired a portion of the minority ownership interests in one of these facilities for aggregate consideration of approximately $21.0 million in cash. We subsequently acquired a portion of the minority ownership interest in another one of these facilities for approximately $12.0 million.

Effective October 15, 2004, we acquired Same Day Surgery, L.L.C., which owns five multi-specialty surgery centers in metropolitan Chicago, and concurrently acquired a portion of the minority ownership interests in four of these facilities for approximately $36.2 million in cash.

Effective August 1, 2004, we acquired a controlling interest in an ambulatory surgery center in Dallas, Texas in which we had previously owned a noncontrolling interest, for $3.2 million in cash.

Effective July 1, 2004, we acquired a controlling interest in an ambulatory surgery center in Reading, Pennsylvania, for approximately $14.6 million in cash.

Effective May 1, 2004, we acquired a controlling interest in an ambulatory surgery center in Austintown, Ohio, in which we had previously owned a noncontrolling interest, for $6.4 million in cash.

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

During the year ended December 31, 2004, investing transactions that were not business combinations resulted in net cash outflows totaling $21.1 million, of which $13.3 million was paid to acquire a noncontrolling interest in a surgical hospital and an ambulatory surgery center in Oklahoma City, Oklahoma, $4.0 million to acquire additional ownership in a surgery center in Westwood, California, and $1.6 million to acquire a noncontrolling interest in a surgery center near Baltimore, Maryland.

During 2003, three surgery centers and one surgical hospital developed by us in the United States opened and began performing cases.

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

During April 2003, we acquired a private surgical hospital in London, England for approximately £8.7 million ($13.8 million), in cash.

Sources of Revenue

Revenues primarily include:


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

	•	management and administrative services revenue, consisting of the fees that we earn from managing the facilities that we do not consolidate for financial reporting purposes and the fees we earn from providing certain consulting and administrative services to physicians. Our consolidated revenues and expenses do not


		include the management fees we earn from operating the facilities that we consolidate for financial reporting purposes as those fees are charged to subsidiaries and thus eliminate in consolidation.

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


	Years Ended December 31,
	2005			2004			2003

Net patient service revenue		92	%		90	%		88	%
Management and administrative services revenue		8			10			12

Total revenue		100	%		100	%		100	%

Net patient service revenue consists of the revenues earned by facilities we consolidate for financial reporting purposes. These revenues increased as a percentage of our total revenues for the year-ended December 31, 2005, as compared to the corresponding prior year period, primarily as a result of our acquisition of seven consolidating facilities during the fourth quarter of 2004. While we did not increase our consolidated facility count in 2005, these seven facilities now have a full year of activity reflected in our results. This percentage increased for the twelve-month period December 31, 2004 as compared to the prior twelve month period, due to increasing the number of facilities we consolidate for financial reporting purposes by eleven from December 31, 2003 to December 31, 2004. While we also added eleven unconsolidated facilities during this time period, the revenues we derive from unconsolidated facilities are limited to fees we earn for managing their operations, and thus adding an unconsolidated facility generally increases our revenues by far less than adding a consolidated facility.

Our management and administrative services revenues are earned from the following types of activities:


	Years Ended
	December 31,
	2005		2004		2003

Management of surgical facilities	$	20,069	$	18,115	$	15,169
Consulting and other services provided to physicians and related entities		15,835		19,527		21,036

Total management and administrative service revenues	$	35,904	$	37,642	$	36,205

The following table summarizes our revenues by operating segment:


	Years Ended December 31,
	2005			2004			2003

United States		81	%		78	%		80	%
United Kingdom		19			22			20

Total		100	%		100	%		100	%

Revenues earned in the United States increased as a percentage of our overall revenues in 2005 due to the growth of consolidated revenue in the U.S. as discussed above. In 2004, revenues earned in the United Kingdom increased as a percentage of our overall revenues, primarily due to the weakening U.S. dollar. The dollar weakened against the British pound by 12.1% during 2004.

Equity in Earnings of Unconsolidated Affiliates

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


	Years Ended December 31,
	2005			2004			2003

Revenues	$	443,292		$	339,109		$	240,848
Equity in earnings of unconsolidated affiliates		27			—			—
Operating expenses:
Salaries, benefits, and other employee costs		109,734			79,917			55,480
Medical services and supplies		86,573			62,213			43,079
Other operating expenses		111,140			77,820			54,499
Depreciation and amortization		20,287			15,480			11,538

Total operating expenses		327,734			235,430			164,596

Operating income		115,585			103,679			76,252
Interest expense, net		(10,560	)		(9,297	)		(7,246	)
Other		772			826			(64	)

Income before income taxes	$	105,797		$	95,208		$	68,942

Long-term debt		118,458			100,443			77,899
USPI’s equity in earnings of unconsolidated affiliates		23,998			18,626			15,074
USPI’s implied weighted average ownership percentage based on affiliates’ pre-tax income(1)		22.7	%		19.6	%		21.9	%
USPI’s implied weighted average ownership percentage based on affiliates’ debt(2)		28.1	%		24.0	%		23.9	%
Unconsolidated facilities operated at period end		57			44			33


(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. This percentage is higher in 2005 due primarily to our acquisition of additional ownership in facilities we account for under the equity method. For the twelve months ended December 31, 2004, this percentage is lower as compared to the previous twelve months primarily as a result of losses incurred at facilities that were recently opened or under development.

(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. This percentage is higher in 2005 due primarily to our acquisition of additional ownership in facilities we account for under the equity method.

Results of Operations

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


	Years Ended December 31,
	2005			2004			2003

Total revenues		100.0	%		100.0	%		100.0	%
Equity in earnings of unconsolidated affiliates		5.1			4.8			4.9
Operating expenses, excluding depreciation and amortization		(70.1	)		(70.2	)		(69.6	)
Depreciation and amortization (7)		(6.6	)		(7.0	)		(7.4	)

Operating income		28.4			27.6			27.9
Minority interests in income of consolidated subsidiaries		(8.2	)		(7.8	)		(7.7	)
Interest and other expense, net		(4.7	)		(6.9	)		(7.5	)

Income from continuing operations before income taxes		15.5			12.9			12.7
Income tax expense		(5.5	)		(4.6	)		(4.8	)

Income from continuing operations		10.0			8.3			7.9
Earnings from discontinued operations		—			13.8			1.7

Net income		10.0	%		22.1	%		9.6	%

Executive Summary

We continue to grow our existing facilities, develop new facilities, and add others selectively through acquisition. On an overall basis, we continue to experience increases in the volume of services provided and in the average rates at which our facilities are reimbursed for those services, resulting in revenue growth at the facilities we owned during both applicable periods in 2004 and 2005 (same store facilities). During late 2004 and 2005, we deployed all of the proceeds from our September sale of our discontinued Spanish operations. The facilities we acquired, all of which are in the United States, also contributed greatly to our revenues and earnings in 2005.

An increasing proportion of our facilities are accounted for under the equity method. Generally, this results from our strategy of partnering with not-for-profit hospitals and local physicians, which we believe improves the long-term profitability and potential of our facilities. All of our U.S. facilities are co-owned with physicians, and more than two-thirds of our U.S. facilities also include a not-for-profit hospital partner. During the twelve-month period ended December 31, 2005 we added 13 facilities and sold our interest in one facility. The number of facilities we co-own with a hospital partner increased by 18, as 11 of the newly added facilities included a hospital partner and we added a hospital partner in 2005 to seven facilities we had acquired during 2004. We account for 15 of these 18 facilities under the equity method. Because so much of our business is conducted through unconsolidated investees, our discussion and analysis of results of operations includes same-store facility growth rates, ignoring how much we own of each facility, to help explain the underlying businesses that are driving our consolidated results. Additionally, we provide aggregated condensed financial statements for our unconsolidated affiliates.

In 2005, these indicators demonstrate that, while consolidated revenues increased 22% over 2004, our core growth rates were slower than in recent years due to our increasing size and several factors affecting the volume of services we provided and the rates at which we were reimbursed. While same store growth was slower than in prior years, it was within the range we predicted for 2005, as were our overall earnings from continuing operations, which grew 45% in 2005.

Revenues

Our consolidated revenues have increased compared to the prior year mostly as a result of newly developed or acquired U.S. facilities, driven in part by our reinvesting the cash proceeds of our September 2004 sale of the Spanish operations in U.S. facilities. However, we believe that our continued growth and success depends heavily on the performance of facilities we already operate, including those accounted for under the equity method as well as facilities that we consolidate for financial reporting purposes. Our revenue from same store facilities has

continued to increase in 2005, driven by increases in the volume of surgical cases in the U.S. and of patient admissions for our hospitals in the United Kingdom, as well as an increase in the average rate of reimbursement for the surgeries performed at our U.S. facilities, most notably at three large facilities we opened during the second quarter of 2004.

The rate of same store revenue growth was slower than in prior years, but within the 9% — 12% range that management expected at the beginning of 2005. The most significant factor reducing same store revenue growth from the 17% rate experienced in 2004 is the composition of the same store group of facilities. While we constructed new facilities largely as planned (14 facilities) during 2003-2004, we operate more facilities each year, which means that the higher-growth second and third year facilities comprise a smaller percentage of our overall facility count. Acquiring existing facilities, as we did, for example, in the fourth quarter of 2004 (10 facilities) and the first half of 2005 (4 facilities), also contributes to the lowering of our same store revenue growth because we add these relatively established facilities (including their prior year performance) to our same store statistics.

Other factors contributing to slower growth in 2005 were the continuing effect of a lapsed managed care contract in a major market, reductions in workers’ compensation reimbursement rates in Texas, California, and Tennessee, and generally slower case volume growth, which we believe is driven by increasing levels of competition in many markets in which we operate. With the exception of the Tennessee rate reductions, which went into effect July 1, 2005, the other rate of reimbursement factors described above had reached their one-year anniversary by December 31, 2005 and thus would not be expected to adversely impact 2006 same store revenue growth rates. In addition, the lapsed managed care contract was addressed in the fourth quarter of 2005 through the establishment of a new contract with this payor.

The following table summarizes the revenue growth at our same store facilities:


	Years Ended December 31,
	2005		2004		2003

United States facilities:
Net revenue		9%		17%		19%
Surgical cases		4%		7%		9%
Net revenue per case(1)		5%		9%		10%
United Kingdom facilities:
Net revenue using actual exchange rates		6%		32%		19%
Net revenue using constant exchange rates(2)		7%		18%		9%
All same store facilities:
Net revenue using actual exchange rates		9%		19%		19%


(1)		Our overall domestic same store growth in net revenue per case was favorably impacted by the growth at our nine same store surgical hospitals, which on average perform more complex cases than ambulatory surgery centers. For the year ended 2005, the net revenue per case of our same store ambulatory surgery centers (excluding surgical hospitals) increased 1% compared to the corresponding prior year period. This rate of growth was slower than in prior years largely as a result of the workers compensation reimbursement changes and lapse of the managed care contract described above.

(2)		Measures current year using prior year exchange rates.

Joint Ventures with Not-for-Profit Hospitals

The addition of new facilities continues to be more heavily weighted to U.S. surgical facilities with a hospital partner, both as we initiate joint venture agreements with new systems and as we add facilities to our existing arrangements. Facilities have been added to hospital joint ventures both through construction of new facilities (de novos) and through our contribution of our equity interests in existing facilities into a hospital joint venture structure, effectively creating three-way joint ventures by sharing our ownership in these facilities with a hospital partner while leaving the existing physician ownership intact. All four of the facilities we are currently constructing involve a hospital partner, as do all nine of the other projects currently in the earlier stages of development. The following table summarizes our facilities as of December 31, 2005, 2004, and 2003:


	2005			2004		2003

United States facilities(1):
With a hospital partner		66			48		35
Without a hospital partner(2)		30			36		27

Total U.S. facilities		96			84		62
United Kingdom facilities		3			3		3

Total facilities operated		99			87		65

Change from prior year-end:
De novo (newly constructed)		9			9
Acquisition		4			13
Disposals(3)		(1	)		—

Total increase in number of facilities		12			22


(1)		At December 31, 2005, physicians own a portion of all of these facilities.

(2)		We acquired 11 facilities without a hospital partner in 2004. Seven of these had a hospital partner by December 31, 2005 as a result of our selling a portion of the equity interests we had acquired in 2004.

(3)		We sold our ownership interest in a facility in Cottonwood, Arizona during the first quarter of 2005.

Facility Operating Margins

U.S. same store operating margins received downward pressure during the twelve months ended 2005 as compared to the prior twelve month period, due primarily to the revenue factors discussed above, which caused revenue growth to slow and to no longer outpace our facilities’ growth in operating expenses. While the issue of the lapsed managed care contract was resolved during the fourth quarter of 2005, it negatively affected year over year comparisons for most of 2005. Many of our same store facilities were adversely impacted by the workers compensation rate reductions in Texas and Tennessee. All of the facilities affected by the lapsed contract are co-owned with a not-for-profit hospital partner, as are most facilities being adversely impacted by the workers’ compensation rate reductions. In addition to these factors, the average operating margin of our same store facilities with a hospital partner is being adversely impacted by the higher number of facilities we opened with hospital partners in 2004 as compared to earlier periods. As these facilities are added to the same store group in 2005, they reduce the average margin of the “with a hospital partner” group. This occurs because these facilities, while earning higher margins in 2005 than during 2004, are not yet earning margins as high as our more mature facilities. This effect is particularly significant for three large facilities we opened during the second quarter of 2004, which were added to the same store group in 2005. In our experience larger facilities take longer to earn a positive margin, the impact of which can be significant given that they also earn higher revenues than a smaller facility.

Our U.K. facilities, which comprise 3 of our 99 facilities overall, experienced a decrease in the overall facility margins as a result of an unfavorable payer mix affecting one facility and a drop in referrals from the National Health Service.

The following table summarizes our same store operating margins (see footnote 1 below):


	Year Ended December 31,
	2005			2004			2003

United States facilities:
With a hospital partner		(270	)bps		250	bps		420	bps
Without a hospital partner		(20	)		30			170
Total U.S. facilities		(200	)		230			310
United Kingdom facilities		(90	)bps		(10	)bps		260	bps


(1)		Operating margin is calculated as operating income divided by total revenues. This table aggregates all of the same store facilities we operate using 100% of their results. This does not represent the overall margin for USPI’s operations in either the U.S. or U.K. because we have a variety of ownership levels in the facilities we operate, and facilities open for less than a year are excluded from same store calculations.

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Revenues increased by $85.2 million, or 21.9%, to $474.7 million for the year ended December 31, 2005 from $389.5 million for the year ended December 31, 2004. This increase consisted primarily of revenues of newly constructed or acquired facilities and additionally growth of our same store facilities. The net addition of consolidating facilities from December 31, 2004 to December 31, 2005 caused an increase of approximately $52.0 million of revenues, while revenues from same store facilities drove most of the remaining $33.2 million of revenue growth. The U.S. same store facilities performed approximately 4% more surgical cases and received an average of approximately 5% more per case during the year ended December 31, 2005 than in the corresponding prior year period. The revenues of same store United Kingdom facilities, when measured using 2004 exchange rates for both periods, were $5.7 million higher during the year ended December 31, 2005 than in the corresponding prior year period. The U.S. dollar being stronger relative to the British pound in 2005 than in the corresponding prior year period resulted in a $0.7 million decrease in U.K. revenues.

Equity in earnings of unconsolidated affiliates increased by $5.4 million, or 28.8% to $24.0 million for the year ended December 31, 2005 from $18.6 million for the year ended December 31, 2004. This increase is primarily attributed to our increased focus on joint ventures with hospital partners, the ramp up of facilities opened in 2004, and increased ownership in nine facilities we operate in the Dallas/Fort Worth market.

Operating expenses, excluding depreciation and amortization, increased by $58.9 million, or 21.5%, to $332.5 million for the year ended December 31, 2005 from $273.6 million for the year ended December 31, 2004. Operating expenses, excluding depreciation and amortization, decreased as a percentage of revenues to 70.0% for the year ended 2005, from 70.2% for the year ended 2004. This decrease as a percentage of revenues is primarily attributable to the growth in facilities opened in 2004 and our leveraging corporate overhead over a larger number of facilities.

Depreciation and amortization increased $4.2 million, or 15.4%, to $31.4 million for the year ended December 31, 2005 from $27.2 million for the year ended December 31, 2004. This amount increased due primarily as a result of depreciation of assets added through acquisitions and newly opened facilities. Depreciation and amortization as a percentage of revenues decreased to 6.6% for the year ended December 31, 2005 from 7.0% for the year ended December 31, 2004 due to our increased revenue.

Operating income increased $27.6 million, or 25.7%, to $134.9 million for the year ended December 31, 2005 from $107.3 million for the year ended December 31, 2004. Operating income, as a percentage of revenues, increased to 28.4% for the year ended December 31, 2005 from 27.6% for the prior year, primarily as a result of our leveraging corporate overhead and the growth in margins at facilities opened in 2004.

Interest expense, net of interest income, decreased $1.8 million, or 7.5%, to $23.3 million for the year ended December 31, 2005 from $25.1 million for the year ended December 31, 2004, primarily as a result of additional interest income earned on our increased cash balance, which resulted from the sale of our Spanish operations during 2004, more than offsetting our subsidiaries borrowing a portion of the costs of developing and expanding facilities.

Other expense, net of other income decreased $1.9 million, or 138.4%, to $0.5 million of other income for the year ended December 31, 2005 from $1.4 million of expense for the year ended December 31, 2004, primarily due to the 2004 loss of $1.6 million related to the early termination of a credit facility.

Minority interests in income of consolidated subsidiaries increased $8.4 million, or 27.6%, to $38.8 million for the year ended December 31, 2005 from $30.4 million for the year ended December 31, 2004, primarily as a result of our adding seven consolidating facilities in the fourth quarter of 2004 and additionally due to the increased profitability of our existing facilities.

Provision for income taxes was $26.2 million, representing an effective tax rate of 35.7%, for the year ended December 31, 2005, compared to $17.9 million, representing an effective tax rate of 35.5%, for the year ended December 31, 2004.

Net income from continuing operations was $47.1 million for the year ended December 31, 2005 compared to $32.5 million for the year ended December 31, 2004. This increase of 45.0%, or $14.6 million, results primarily from the increases in revenues, equity in earnings of unconsolidated affiliates and improved economies of scale related to expenses discussed above.

Effective September 9, 2004 we sold our Spanish operations. As a result, our income statement reflects the historical results of our Spanish operations in discontinued operations for both years. During 2005 we finalized the calculation of the tax liability arising from our sale of the Spanish operations, and provided for additional legal costs associated with the sale, which resulted in a $0.2 million increase to the net gain on the sale.

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

Revenues increased by $79.0 million, or 25.4%, to $389.5 million for the year ended December 31, 2004 from $310.6 million for the year ended December 31, 2003. This increase was primarily driven by growth of our U.S. same store facilities, which performed 7% more surgical cases and received an average of approximately 9% more per case in 2004 than in 2003. This U.S. growth rate was slower than in the prior year largely as a result of decreases in rates of reimbursement for workers’ compensation cases in California and Texas and due to the lapse of a managed care contract in one market. Our same store U.K. facilities’ revenue excluding exchange rate fluctuations increased 18% in 2004 as activity increased at the hospital and cancer center we added during 2003. Additionally, revenues increased by $22.6 million in 2004 due to our acquiring facilities or significantly increasing our ownership level in facilities we already operated, and by $9.1 million due to the U.S. dollar being weaker against the British pound in 2004 than in 2003.

Equity in earnings of unconsolidated affiliates increased by $3.5 million, or 23.6% to $18.6 million for the year ended December 31, 2004 from $15.1 million for the year ended December 31, 2003, primarily as a result of growth in case volumes and improved operating margins at our same store facilities.

Operating expenses, excluding depreciation and amortization, increased by $57.4 million, or 26.5%, to $273.6 million for the year ended December 31, 2004 from $216.2 million for the year ended December 31, 2003. Operating expenses, excluding depreciation and amortization, increased as a percentage of revenues from 69.6% to 70.2% primarily as a result of our same facility margin improvement and leveraging of corporate overhead being more than offset by the unfavorable impact of two surgical hospitals we opened during the second quarter of 2004, which are not yet operating at capacity. Our new and newly expanded facilities, particularly the surgical hospitals, hire staff and become fully equipped for a relative high number of surgical cases in their initial months of operations, but the case volumes are not high enough initially to result in operating margins that are as favorable as those generated by our more mature facilities. In addition, we experienced revenue reductions due to reimbursement factors discussed above and due to the relocation of two facilities that were not accompanied by proportional decreases in operating expenses.

Depreciation and amortization increased $4.5 million, or 19.9%, to $27.2 million for the year ended December 31, 2004 from $22.7 million for the year ended December 31, 2003. This amount increased due primarily as a result of depreciation of assets added through acquisitions and newly opened facilities. Depreciation and amortization as a percentage of revenues decreased to 7.0% for the year ended December 31, 2004 from 7.3% for the year ended December 31, 2003 due to our increased revenue.

Operating income increased $20.6 million, or 23.8%, to $107.3 million for the year ended December 31, 2004 from $86.7 million for the year ended December 31, 2003. Operating income, as a percentage of revenues, decreased to 27.6% for the year ended December 31, 2004 from 27.9% for the prior year, primarily as a result of our improved same facility operating margins and leveraging of corporate overhead being more than offset by the lower margins generated at our recently opened facilities and the slower growth of revenues discussed above.

Interest expense, net of interest income, increased $1.3 million, or 5.4%, to $25.1 million for the year ended December 31, 2004 from $23.9 million for the year ended December 31, 2003, primarily as a result of our borrowing a portion of the costs of developing and expanding facilities.

Other expense, net of other income increased $2.1 million, or 289.4%, to $1.4 million of other expense for the year ended December 31, 2004 from $0.7 million of other income for the year ended December 31, 2003, primarily due to the $1.6 million loss on early termination of credit facility, which management elected to terminate upon receiving net cash proceeds of $141.1 million from the sale of the Spanish operations.

Minority interests in income of consolidated subsidiaries increased $6.5 million, or 27.1%, to $30.4 million for the year ended December 31, 2004 from $24.0 million for the year ended December 31, 2003, primarily as a result of our adding a net total of 11 consolidated facilities during 2004 and additionally due to the increased profitability of our existing facilities.

Provision for income taxes was $17.9 million, representing an effective tax rate of 36.5%, for the year ended December 31, 2004, compared to $14.9 million, representing an effective tax rate of 37.7%, for the year ended December 31, 2003. The lower tax rate in 2004 resulted from revisions in estimates of various federal and state tax deductions made in connection with the preparation of our tax returns for 2003.

Net income from continuing operations was $32.5 million for the year ended December 31, 2004 compared to $24.7 million for the year ended December 31, 2003. This increase of 31.5%, or $7.8 million, results primarily from the increased revenues and improved economies of scale related to expenses discussed above.

Effective September 9, 2004 we sold our Spanish operations. As a result, our income statement reflects the historical results of our Spanish operations in discontinued operations for both years. In addition, our 2004 income statement reflects, in discontinued operations, the $50.3 million gain on the sale of the Spanish operations. Including the gain on the sale of our Spanish operations, our net income increased from $29.9 million in 2003 to $86.2 million for the year ended December 31, 2004.

Liquidity and Capital Resources

During the year ended December 31, 2005, we generated $107.9 million of cash flows from operating activities as compared to $81.8 million during 2004 and $66.2 million during 2003. Included in the $66.2 million from 2003 is a benefit of $11.0 million, which is not expected to recur, resulting from the collection of receivables in connection with our modifying contracts under which we provide certain administrative services to physicians, eliminating the financing of accounts receivable from the scope of services we provide. As discussed more fully in Note 1 to our consolidated financial statements for the year ended December 31, 2005, we have reclassified the consolidated impact of cash distributions of our facilities’ earnings from financing activities to operating activities. We believe that this treatment best represents the character of these cash flow amounts by netting them with the related accruals of equity in earnings of unconsolidated affiliates and minority interests in income of consolidated subsidiaries, which enter into the determination of our net income. We believe recent interpretations provided by the SEC with respect to our industry support our classification of these cash flows within operating activities.

A significant element of our cash flows from operating activities is the collection of accounts receivable. Collections efforts for accounts receivable are conducted primarily by our personnel at each facility or in centralized service centers for some metropolitan areas with multiple facilities. These collection efforts are facilitated by our patient accounting system, which prompts individual account follow-up through a series of phone calls and/or collection letters written 30 days after a procedure is billed and at 30 day intervals thereafter. Bad debt reserves are established in increasing percentages by aging category based on historical collection experience. Generally, the entire amount of all accounts remaining uncollected 180 days after the date of service are written off as bad debt and sent to an outside collection agency. Net amounts received from collection agencies are recorded as recoveries of bad debts.

During the year ended December 31, 2005, our net cash required for investing activities was $102.4 million, consisting primarily of $60.6 million for the purchase of businesses and $30.9 million for the purchase of property and equipment. The $60.6 million primarily represents purchases of new businesses, net of cash received, and incremental investments in unconsolidated affiliates. The most significant of these transactions were:


	•	$34.0 million was paid to acquire additional ownership in nine facilities the Company operates in the Dallas/Fort Worth market, net of proceeds from the sale of a portion of three other facilities in this same market,

	•	$10.9 million was paid to acquire a controlling interest in an ambulatory surgery center in San Antonio, Texas,

	•	$7.4 million was paid to acquire a controlling interest in an ambulatory surgery center in Westwood, California in which we previously owned a noncontrolling interest,

	•	$5.5 million was paid to acquire additional ownership in a facility the Company operates in New Jersey,

	•	$5.2 million was paid for equity method investments in two surgery centers near Kansas City, Missouri,

	•	$4.7 million was paid for an equity method investment in a surgery center in the Sacramento, California area,

	•	$12.0 million was received from three not-for-profit healthcare systems for noncontrolling interests in facilities already operated by the Company. Included in these transactions are call options allowing the healthcare systems to acquire additional noncontrolling ownership interests in each facility in 2006. With respect to four of the facilities, the approximate sales price is $10.2 million and the Company has a put option with the same terms. With respect to the other two facilities, the systems have call options that, for one facility, fix the price at $2.0 million and in the other case base the price on a multiple of earnings when the option is exercised. The Company has no put options with respect to these two facilities, and

	•	$4.9 million of other transactions.

Approximately $12.4 million of the property and equipment purchases related to ongoing development projects, and the remaining $18.5 million primarily represents purchases of equipment at existing facilities. Investing cash flows also include an advance payment of $8.3 million that was paid to the sellers of an ambulatory surgery center in St. Louis, Missouri for a transaction that was effective January 1, 2006. The $102.4 million of cash used in investing activities was funded primarily with the proceeds of the sale of our Spanish operations and the cash flows from operations noted above. Net cash provided during the year ended December 31, 2005 by financing activities totaled $31.6 million and resulted primarily from our sweeping the cash of our unconsolidated affiliates together with cash proceeds from issuances of stock under our employee stock purchase plan and from exercises of employee stock options. Cash and cash equivalents were $130.4 million at December 31, 2005 as compared to $93.5 million at December 31, 2004 and net working capital was $90.9 million at December 31, 2005 as compared to $87.2 million in the prior year.

On February 21, 2006, we entered into a revolving credit facility with a group of commercial lenders providing us with the ability to borrow up to $200 million for acquisitions and general corporate purposes in the United States. Under the terms of the facility, we may invest up to a total of $20 million in subsidiaries that are not guarantors, including subsidiaries in the United Kingdom. Borrowings under our credit facility will bear interest at rates of 1.00% to 2.25% over LIBOR and will mature on February 21, 2011. Currently, no amounts are outstanding under this facility, although we anticipate borrowing up to $100 million in April to fund the Surgis acquisition. The credit agreement contains 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.

Our credit agreement in the United Kingdom provides for total borrowings of £55.0 million (approximately $94.5 million as of December 31, 2005) under four separate facilities. At December 31, 2005, total outstanding borrowings under this credit agreement were approximately $64.4 million which represents total borrowings net of scheduled repayments of $24.0 million that have been made under the agreement, and approximately $6.1 million was available for borrowing, primarily for capital projects specified in the agreement. Borrowings under the United Kingdom credit facility 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 the United Kingdom credit facility. We were in compliance with all covenants under our credit agreements as of December 31, 2005.

In December 2001, a wholly-owned subsidiary of the Company issued $150 million in aggregate principal amount of 10% Senior Subordinated Notes due 2011. We received net proceeds of $143.5 million after offering costs of $5.3 million and a discount of $1.2 million. The notes, which mature on December 15, 2011, accrue interest at 10% payable semi-annually on June 15 and December 15 commencing on June 15, 2002 and were issued at a discount of $1.2 million, resulting in an effective interest rate of 10.125%. The Senior Subordinated Notes are subordinate to all senior indebtedness and are guaranteed by USPI and USPI’s wholly owned subsidiaries domiciled in the United States.

The Company may redeem all or part of the notes on or after December 15, 2006 upon not less than 30 nor more than 60 days notice. The redemption price would be the following percentages of principal amount, if redeemed during the 12-month period commencing on December 15 of the years set forth below:


Period	Redemption Price

2006		105.000	%
2007		103.333	%
2008		101.667	%
2009		100.000	%
2010		100.000	%

The Company may also redeem the notes at any time prior to December 15, 2006, by paying the principal amount of all outstanding notes plus the greater of (a) 1% of the principal amount or (b) the excess of the present value of the notes and all interest that would accrue through December 14, 2006 over the principal amount of the notes. The Company is obligated to offer to purchase the notes at 101% of the principal amount upon the occurrence of certain change of control events. In addition, the Company was obligated to apply the proceeds of the sales of the Spanish operations within one year to the Company’s operations or to repurchase the notes. The Company was successful in applying all $141.1 million of the proceeds to the acquisition and development of surgical facilities in the United States within this time period, and is therefore not obligated to repurchase the notes. Any redemptions of the notes require payment of all amounts of accrued but unpaid interest. We were in compliance with all covenants related to our Senior Subordinated Notes as of December 31, 2005.

Our contractual cash obligations as of December 31, 2005 may be summarized as follows:


	Payments Due by Period
Contractual Cash Obligations	Total		Within 1 Year		Years 2 and 3		Years 4 and 5		Beyond 5 Years
	(In Thousands)

Long term debt obligations (principal plus interest)(1):
Senior Subordinated Notes	$	240,000	$	15,000	$	30,000	$	30,000	$	165,000
U.K. credit facility		78,163		8,175		23,560		46,428		—
Other debt at operating subsidiaries		25,848		5,988		11,039		6,600		2,221
Capitalized lease obligations		104,317		9,626		16,376		12,547		65,768
Operating lease obligations		54,832		10,491		17,735		12,149		14,457

Total contractual cash obligations	$	503,160	$	49,280	$	98,710	$	107,724	$	247,446


(1)		Amounts shown for long-term debt obligations and capital lease obligations include the associated interest. For variable rate debt, the interest is calculated using the December 31, 2005 rates applicable to each debt instrument.

Our operating subsidiaries, many of which have minority interest holders 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 $72.9 million at December 31, 2005, 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 49.6% at December 31, 2005. 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.

Currently, USPI and its affiliates have four surgery centers under construction and nine additional surgery centers in the development stage in the United States. Costs to develop a short-stay surgical facility, which include construction, equipment and initial operating losses, vary depending on the range of specialties that will be undertaken at the facility. Our affiliates have budgeted an average of $5.0 million for development costs for each of the four surgery center projects. Development costs are typically funded with approximately 50% debt at the entity level with the remainder provided as equity from the owners of the entity. We have made substantially all of the equity contributions to which we are obligated for three of these projects under construction and are obligated to invest an additional $0.3 million for the other project under construction, but we may choose to invest additional funds in these or other projects in 2006. Additionally, as each of these facilities becomes operational, each will have obligations associated with debt and capital lease arrangements.

Generally, we estimate that we will add 12 to 15 facilities per year, with the majority being new facilities developed by us. This program will continue to require substantial capital resources, which for this number of facilities we would estimate to range from $60.0 million to $80.0 million per year over the next three years. If we identify strategic acquisition opportunities that are larger than usual for us, then these costs could increase greatly. For example, during January 2006 we acquired interests in five surgery centers in the St. Louis market for approximately $50.3 million, of which $8.3 million was paid in December 2005, and entered into an agreement to acquire Surgis, which operates 24 facilities and has an additional 7 under development, for approximately $200 million. We expect to acquire an additional 4 facilities in greater St. Louis later in 2006. While our acquisition of these four facilities, and the Surgis facilities, may not be successfully completed, they represent potential additional uses of our capital that we would have to fund.

Other than the specific transactions described above, our acquisition and development activities primarily include the development of new facilities, buyups of additional ownership in facilities we already operate, and acquisitions of additional facilities. These activities also include, in some cases, payments of additional purchase price to the sellers of acquired facilities based upon the resolution of certain contingencies or based upon acquired facilities achieving certain financial targets. We currently estimate that we will pay approximately $2.2 million related to these obligations which is payable during 2006, is based on contingencies that have been resolved, and accordingly has been accrued as an increase to intangible assets and other accrued expenses in our December 31, 2005 balance sheet. It is also possible we may have to pay the buyers of our Spanish operations up to approximately €1 million ($1.2 million) plus interest related to a Spanish tax contingency for which we indemnified the buyers, although we do not presently believe the likelihood of our making any such payment is probable, as discussed more fully in the notes to our financial statements. In addition, the operations of our existing surgical facilities will require ongoing capital expenditures.

Absent transactions that cause us to exceed our generally expected capital uses, such as the St. Louis and Surgis acquisitions, we believe that existing funds, cash flows from operations, borrowings under our credit facilities, and borrowings under capital lease arrangements at newly developed or acquired facilities will provide sufficient liquidity for the next twelve months. Thereafter, such as to complete the pending Surgis and St. Louis transactions, we may require additional debt or equity financing for our acquisitions and development projects. There are no assurances that needed capital will be available on acceptable terms, if at all. If we are unable to obtain funds when needed or on acceptable terms, we will be required to curtail our acquisition and development program.

Off-Balance Sheet Arrangements

As a result of our strategy of partnering with physicians and not-for-profit health systems, we do not own controlling interests in most of our facilities. We account for 57 of our 99 surgical facilities under the equity method.

Similar to our consolidated facilities, our unconsolidated facilities have debts, including capitalized lease obligations, that are generally non-recourse to USPI. With respect to our unconsolidated facilities, these debts are not included in our consolidated financial statements. At December 31, 2005, the total debt on the balance sheets of our unconsolidated affiliates was approximately $118.5 million. Our average percentage ownership, weighted based on the individual affiliate’s amount of debt, of these unconsolidated affiliates was 28.1% at December 31, 2005. USPI or one of its wholly-owned subsidiaries had collectively guaranteed $16.6 million of the $118.5 million in total debt of our unconsolidated affiliates as of December 31, 2005. In addition, our unconsolidated affiliates have obligations under operating leases, of which USPI or a wholly-owned subsidiary had guaranteed $18.4 million as of December 31, 2005. Some of the facilities we are currently developing will be accounted for under the equity method. As these facilities become operational, they will have debt and lease obligations.

As described above, our unconsolidated affiliates own operational surgical facilities or surgical facilities that are under development. These entities are structured as limited partnerships, limited liability partnerships, or limited liability companies. None of these affiliates provide financing, liquidity, or market or credit risk support for us. They also do not engage in hedging, 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 and related disclosures. Except as noted above with respect to guarantees, 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.

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS No. 123R). SFAS No. 123R eliminates the ability to account for share-based payments using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), which has been the basis of our accounting through December 31, 2005, and instead requires companies to recognize compensation expense using a fair-value based method for costs related to share-based payments including stock options and employee stock purchase plans. The expense will be measured as the fair value of the award at its grant date based on the estimated number of awards that are expected to vest, and recorded over the applicable service period. In the absence of an observable market price for a share-based award, the fair value would be based upon a valuation methodology that takes into consideration various factors, including the exercise price of the award, the expected term of the award, the current price of the underlying shares, the expected volatility of the underlying share price, the expected dividends on the underlying shares and the risk-free interest rate.

The requirements of SFAS No. 123R are effective for our first quarter beginning January 1, 2006 and apply to all awards granted, modified or cancelled after that date. The standard also provides for different transition methods for past award grants. We plan to use the modified retrospective method, which involves the restatement of prior period results. SFAS No. 123R will adversely impact our consolidated net income in 2006, and the amount is expected to be significant. On an overall basis, our equity-based compensation is expected to increase somewhat in 2006 as our company continues to grow. However, much of this expense relates to awards for which the accounting is not significantly changed under SFAS No. 123R, namely restricted stock awards. In recent years we have shifted from granting primarily stock options, the expense of which has merely been disclosed, to granting primarily restricted stock awards, the expense of which has been reflected in our income statement even prior to the adoption of SFAS No. 123R. Consequently, our pro forma stock option expense has been decreasing in recent quarters as the estimated service periods are completed for outstanding options and their value thus becomes fully amortized. By the time we adopt SFAS No. 123R in 2006, we expect that the incremental expense related to the adoption of the standard will therefore be less than our recent pro forma expense disclosures related to stock options, as more stock options vest and become fully amortized.

In March 2005, the FASB issued Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement Obligations, to clarify the requirement to record liabilities stemming from a legal obligation to perform an asset retirement activity in which the timing or method of settlement is conditional on a future event. The effect of our adopting FIN 47 for the year ended December 31, 2005 was determined to be immaterial.

In June 2005, the FASB ratified the conclusions of Emerging Issues Task Force No. 04-5 (EITF 04-5), Determining Whether a General Partner or the General Partners as a Group, Controls a Limited Partnership or

Similar Entity When the Limited Partners Have Certain Rights. EITF No. 04-5 provides a framework for determining whether a general partner controls, and should consolidate, a limited partnership or similar entity. EITF No. 04-5 is effective for all limited partnerships formed after June 29, 2005 and for any limited partnerships in existence on June 29, 2005 that modify their partnership agreements after that date, and our adoption of EITF 04-5 with respect to these entities did not materially impact our financial position or results of operations. EITF No. 04-5 is effective for all limited partnerships beginning January 1, 2006, and we do not expect this phase of adopting EITF 04-5 to have a material impact on our financial position or results of operations.


Item 7A.	*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 December 31, 2005, $149.2 million of our total outstanding notes payable 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%, $15.5 million was in other fixed rate instruments and the remaining $70.2 million was in variable rate instruments. Accordingly, a hypothetical 100 basis point increase in market interest rates would result in additional annual expense of $0.7 million. The Senior Subordinated Notes, which represent 91% of our total fixed rate debt at December 31, 2005, are considered to have a fair value, based upon recent trading, of $160.9 million, which is approximately $11.7 million higher than the carrying value at December 31, 2005.

Our United Kingdom 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 United Kingdom operations operate in a natural hedge to a large extent because both expenses and revenues are denominated in local currency. Additionally, our borrowings and capital lease obligations in the United Kingdom are currently denominated in local currency. Historically, the cash generated from our operations in the United Kingdom has been utilized within that country to finance development and acquisition activity as well as for repayment of debt denominated in local currency. Accordingly, we have not generally utilized financial instruments to hedge our foreign currency exchange risk. In September 2004, we sold our Spanish operations. By agreement with the buyer, we will not receive approximately €16.0 million related to the sale until January 2007. In September 2004, we entered into a forward contract with a currency broker to lock in the receipt of $19.8 million in January 2007, when we receive the euro-denominated payment of €16.0 million.

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


Item 8.	*Financial Statements and Supplementary Data*

For the financial statements and supplementary data required by this Item 8, see the Index to Consolidated Financial Statements included elsewhere in this Form 10-K.


Item 9.	*Changes in and Disagreements with Accountants on Accounting and Financial Disclosure*

None.


Item 9A.	*Controls and Procedures*

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Commission. Such information is accumulated and communicated to our management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this Annual Report on Form 10-K, we have carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design

and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2005, our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our reports filed with the Commission. There have been no significant changes in our internal controls which could significantly affect the internal controls subsequent to the date of their evaluation in connection with the preparation of this Annual Report on Form 10-K.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Our internal control over financial reporting includes those policies and procedures that:


	•	Pertain to the maintenance of records that in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets.

	•	Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and board of directors; and

	•	Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. Management’s assessment included an evaluation of the design and testing of the operational effectiveness of the Company’s internal control over financial reporting. USPI acquired several subsidiaries and equity method investments during 2005. Accordingly, management’s evaluation excluded the following subsidiaries and equity method investments acquired during 2005, with total assets of $24.9 million and total revenues of $3.9 million included in the Company’s consolidated financial statements as of and for the year ended December 31, 2005:


	•	USP San Antonio, Inc. (Investment in San Antonio Endoscopy, L.P.)

	•	USP North Kansas City, Inc. (Investments in Briarcliff Ambulatory Surgery Center, L.P., and Liberty Ambulatory Surgery Center, L.P.)

	•	USP Kansas City, Inc. (Investment in St. Mary’s Surgical Center, L.L.C.)

	•	USP Sacramento, Inc. (Investment in Folsom Outpatient Surgery Center, L.P.)

	•	USP Cedar Park, Inc. (Investment in Cedar Park Surgery Center, L.P.)

Based on this assessment, management did not identify any material weakness in the Company’s internal control, and management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005.

KPMG LLP, the registered public accounting firm that audited the Company’s financial statements included in this report, has issued an attestation report on management’s assessment of internal control over financial reporting, a copy of which is included with the Company’s financial statements in Item 15(a)(1).

Limitations on the Effectiveness of Controls

Our management, including the Chief Executive Officer and the Chief Financial Officer, recognizes that any set of controls and procedures, no matter how well-designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance

that all control issues and instances of fraud, if any, with the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls. For these reasons, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation described above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


Item 9B.	*Other Information*

None.

PART III


Item 10.	*Directors and Executive Officers of the Registrant*