Edgar Filing: NOVAMED INC

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X]

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

For the fiscal year ended December 31, 2003

Commission File Number: 0-26625

NOVAMED, INC.

(Exact name of registrant as specified in its charter)

Delaware				36-4116193
(State or other jurisdiction of incorporation or organization)				(I.R.S. Employer Identification No.)

980 North Michigan Avenue, Suite 1620, Chicago, Illinois 60611
(Address of principal executive offices) (zip code)

Registrant’s telephone number, including area code: (312) 664-4100

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)

Preferred Stock Purchase Rights
(Title of Class)

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

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. [X]

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

The aggregate market value of the registrant’s 17,651,138 shares of voting stock held by non-affiliates of the registrant, based upon the last reported sale price of the registrant’s Common Stock on June 30, 2003 was $23,122,991. The number of shares outstanding of the registrant’s Common Stock, par value $.01, as of March 19, 2004 was 21,343,599.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement in connection with the registrant’s 2004 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report on Form 10-K.

PART I

This Annual Report on Form 10-K (the “Form 10-K”) contains, and incorporates by reference, certain “forward-looking statements” (as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended) that reflect our current expectations regarding our future results of operations, performance and achievements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We have tried, wherever possible, to identify these forward-looking statements by using words such as “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends” and similar expressions. These statements reflect our current beliefs and are based on information currently available to us. Accordingly, these statements are subject to certain risks, uncertainties and contingencies that could cause our actual results, performance or achievements in 2004 and beyond to differ materially from those expressed in, or implied by, such statements. These risks and uncertainties include: our ability to acquire, develop or manage a sufficient number of profitable surgical facilities, including facilities that are not exclusively dedicated to eye related procedures; reduced prices and reimbursement rates for surgical procedures; our ability to maintain successful relationships with the physicians who use our surgical facilities; our future profitability could decrease because of existing agreements with physicians that may require us to sell additional equity interests in our ASCs at varying future intervals; the application of existing or proposed government regulations, or the adoption of new laws and regulations, that could limit our business operations and require us to incur significant expenditures; the continued acceptance of laser vision correction and other refractive surgical procedures; and demand for elective surgical procedures generally and in response to a protracted economic downturn. These factors and others are more fully set forth under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors.” You should not place undue reliance on any forward-looking statements. We undertake no obligation to update or revise any such forward-looking statements that may be made to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

Unless the context requires otherwise, you should understand all references to “we,” “us” and “our” to include NovaMed, Inc. and its consolidated subsidiaries.

Item 1. Business

General

We are a health care services company and an owner and operator of ambulatory surgery centers (ASCs). Our primary focus and strategy is to acquire, develop and operate ASCs in joint ownership with physicians throughout the United States. As of March 15, 2004, we own and operate 17 ASCs located in 14 states. Currently, most of our ASCs are single-specialty ophthalmic surgical facilities where ophthalmologists perform surgical procedures — primarily cataract and laser vision correction (LVC) surgery. Most of our ASCs are also practice-based facilities — meaning that they are located adjacent to or near a physician practice. As of March 15, 2004, we own a majority interest in 14 of our ASCs, with physicians owning the remaining equity interests. We own all of the equity interests in our other three ASCs; however, in the future we may either elect, or be required pursuant to existing agreements, to sell to physicians a minority interest in these facilities.

On March 26, 2004, we changed our name from NovaMed Eyecare, Inc. to NovaMed, Inc. We changed our name to reflect our strategy to expand our surgical facilities business into additional medical specialties. We continue to explore opportunities to acquire ASCs offering differing types of medical specialties. We are also exploring ways to efficiently add new specialties to our existing ASCs.

In addition to having surgical equipment in our ASCs, we also provide excimer lasers to ophthalmologists for their use in performing laser vision correction surgery in their offices. We provide these excimer lasers and other services pursuant to laser services agreements.

We also own and operate optical laboratories, an optical products purchasing organization and a marketing products and services business.

In addition to our surgical facilities and optical products businesses, we provide management services to two eye care practices pursuant to long-term service agreements. Under these service agreements, we provide business,

information technology, administrative and financial services to these practices in exchange for a management fee. One practice is an optometric practice with an optical retail store located in the Chicago market. The other practice is primarily an ophthalmology practice with multiple locations in Georgia.

We were originally organized as a Delaware limited liability company in March 1995, under the name, NovaMed Eyecare Management, LLC. In connection with a capital infusion from venture capital investors in November 1996, NovaMed Holdings Inc., an Illinois corporation, was formed to serve as a holding company, responsible for overall strategic planning, with NovaMed Eyecare Management, LLC as our principal operating subsidiary. In May 1999, NovaMed Holdings Inc. reincorporated as a Delaware corporation and changed its name to NovaMed Eyecare, Inc. In August 1999, we consummated our initial public offering of common stock. On March 26, 2004, we changed our name to NovaMed, Inc. We also changed the name of one of our principal operating subsidiaries from NovaMed Eyecare Services, LLC to NovaMed Management Services, LLC.

Information Available

Our corporate headquarters are located at 980 North Michigan Avenue, Suite 1620, Chicago, Illinois 60611, and our website is www.novamed.com. We file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”). The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.

We also make available free of charge on or through our Internet website (http://www.novamed.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC.

Discontinued Operations

In October 2001, we announced our intentions to discontinue our management services business. In assessing our overall business, our Board of Directors determined that we should focus our business strategy primarily on the acquisition, development and operation of surgical facilities. Our surgical facilities segment was historically more efficient than our other business segments, requiring relatively lower operating costs and producing our highest operating margins. In reviewing our management services business, our Board determined that, although the segment had been historically profitable, the returns did not justify the high overhead and capital spending necessary to operate the business. Beginning in the third quarter of 2001, we reflected the management services business as discontinued operations in our financial statements.

We completed our discontinued operations plan in December 2003 when we divested our last physician practice remaining in discontinued operations. The only matters remaining in our discontinued operations reserves on our consolidated financial statements relate to any ongoing commitments that we have with respect to these discontinued business operations. These commitments primarily include ongoing office lease obligations (to the extent we have been unable thus far to negotiate subleases or early lease terminations) and severance obligations. From December 2001 to December 2003, we negotiated and closed 19 divestiture transactions in which we: (a) terminated or assigned the service agreement with our affiliated practices; (b) terminated or transferred all employees providing services at these practice locations; (c) closed or relocated our regional business offices; (d) sold practice-based assets including fixed assets, equipment and accounts receivable; and (e) terminated or transferred certain corporate employees who provided services primarily to the management services business.

From the 19 divestiture transactions that we completed, we have received in the aggregate as of March 15, 2004, approximately $18.2 million in cash proceeds, promissory notes under which approximately $800,000 of principal remains payable to us in installments over periods ranging from one to five years, and approximately 2.7 million shares of our common stock. In addition, certain of the buyers assumed various liabilities, including equipment and office leases. As part of these transactions, we generally required our former affiliated physicians

to enter into multi-year restrictive covenants precluding them from owning and operating ASCs and other licensed surgical facilities. In addition, depending on the particular characteristics of the affiliated practice, we entered into multi-year optical products supply agreements and multi-year refractive service agreements. Under these agreements, we are continuing to provide services to these practices from our continuing business segments. Under our refractive service agreements, we have contracted with these practices to be their exclusive provider of current and future refractive technology. With our optical products supply agreements, our optical products purchasing organization and optical laboratories are the primary providers of optical products and supplies to these entities.

In addition to our divestiture transactions, we also sold minority equity interests in certain of our existing ASCs to various physician-owners of our former affiliated practices. During 2003, we sold minority interests in four ASCs in exchange for approximately $1.9 million in cash and 261,000 shares. In early 2004, we sold minority interests in another ASC to various physicians in the local marketplace. With these minority interest sales, we have now sold minority interests in 10 of our ASCs since January 1, 2002. In return, we received in the aggregate approximately $4.9 million in cash proceeds and approximately one million shares of our common stock.

Industry Overview

Ambulatory Surgery Center Industry

The term “ambulatory surgery” refers to procedures performed on a nonhospitalized patient who is able to return home the same day. Since the inception of outpatient surgery centers in the early 1970s, the ambulatory surgery center industry has grown consistently, with 3,644 ASCs in business in the United States as of February 2003 according to Verispan, L.L.C., an independent health care market research and information firm. Improved surgical techniques and technologies, including improved anesthesia techniques, have contributed to the expansion of surgical procedures that can be performed in an ASC. According to Verispan, L.L.C., an estimated 7.8 million surgeries were projected to be performed in the U.S. at ASCs in 2003, up an estimated 8.3% from 2002. Ophthalmology is the largest single type of outpatient surgery performed in ASCs, representing approximately 27% of all ASC surgeries performed in 2002. Eye surgery is performed in approximately 50% of all ASCs.

We believe that the convenience and efficiencies offered by an ASC setting have also contributed to the growth in ASC procedures. We believe that many physicians prefer an ASC to a hospital because of greater scheduling flexibility, faster turnaround time between cases and more efficient nurse staffing. Patients prefer the experience of a surgical facility dedicated to their specialized surgery that is free from disruptions or scheduling conflicts that often arise in hospitals due to emergency procedures or more complex surgical procedures that run longer than expected. Moreover, we believe third party payors recognize the cost-effective benefits of ASCs.

Cataract Surgery. Cataract surgery is currently the most widely performed surgical procedure in the U.S., with an estimated 2.8 million cataract surgeries in 2003, an increase of approximately 3% over 2002. A cataract occurs when the normally transparent lens of the eye becomes cloudy as part of the aging process. In cataract surgery, the ophthalmologist removes the clouded natural lens and replaces it with a synthetic intraocular lens. Cataract surgery is typically performed on an outpatient basis using local anesthesia, and the procedure time is typically less than 30 minutes. Cataract procedures are expected to continue to increase for many years, driven primarily by the aging of the population and the introduction of improved technologies and surgical techniques. With the vast majority of cataract surgery patients being over the age of 65, the Medicare program has been the primary source of reimbursement for cataract surgery providers. According to the U.S. Department of Health and Human Services, approximately 36 million people in the U.S. are age 65 or older. By 2010, this age group is expected to reach approximately 40 million.

Vision Correction Surgery. According to the National Eye Institute, an estimated 150 million people in the U.S. use eyeglasses or contact lenses to correct refractive errors. Refractive errors are optical defects that result in light not being properly focused on the eye’s retina. If the cornea’s curvature is not correct, the cornea cannot properly focus the light passing through it onto the retina, and the person will see a blurred image. The three most common refractive errors are:

•

myopia, commonly referred to as nearsightedness, which is caused by a steepening of the cornea, resulting in the blurring of distant objects

•

hyperopia, commonly referred to as farsightedness, which is caused by a flattening of the cornea, resulting in the blurring of close objects

•

astigmatism, in which images are not focused on any point due to the varying curvature of the eye along different axes, which results in a distorted view of images

New surgical technologies and techniques have been developed over the years to correct some of these common refractive errors that result from the improper curvature of the cornea. Laser In-Situ Keratomileusis, or LASIK, was introduced in 1996, leading to a dramatic increase in the popularity of laser vision correction surgery. The introduction of LASIK offered significant benefits to ophthalmologists over preceding refractive surgical techniques such as Radial Keratotomy, or RK, and the first vision correction surgery that used laser technology, Photorefractive Keratectomy, or PRK. Relative to the earlier refractive surgical techniques, the LASIK procedure provides significant reductions in patient pain or discomfort, patient recovery times ranging from a few hours after the procedure to two weeks, and reduced complication rates.

Although the number of laser vision correction procedures performed in the U.S. grew rapidly between 1996 and 2000, the number of annual procedures has declined over the past three years. In 2003, ophthalmologists performed an estimated 1.15 million laser vision correction surgery procedures in the U.S., representing a decrease of approximately 2% from 2002.

Optical Products and Services Industry

The eye care market consists of a large, diverse group of services and products. The eye care services market includes routine eye examinations as well as diagnostic and surgical procedures that address complex eye and vision conditions. The most common conditions addressed by eye care professionals are nearsightedness, farsightedness and astigmatism as described above. Other frequently treated conditions include cataracts, glaucoma, macular degeneration and diabetic retinopathy. Eye and vision conditions are typically treated with surgery, pharmaceuticals, prescription glasses, contact lenses or some combination of these treatments. Additional services offered by eye care professionals include research services for eye care devices or pharmaceuticals being developed or tested in clinical trials. The optical products market consists of the manufacture, distribution and sale of optical goods including corrective lenses, eyeglasses, frames, contact lenses and other optical products and accessories.

While the number of patient options for vision correction has increased with improved surgical vision correction technologies and techniques, the market for basic optical goods including corrective lenses, eyeglass frames, contact lenses and other optical products and accessories, remains a significant market. Eyeglass frames are typically sold through retail optical outlets located in optometrist and ophthalmologist clinics, as well as through retail stores.

Our Business Model

With the divestiture of our management services business behind us, we are now focused primarily on acquiring, developing and operating ASCs within new and existing markets. We believe that our experience in operating ASCs, when coupled with our management services experience in working with doctors, will provide our physician-partners with an efficient operating environment to maximize quality patient care.

Surgical Facilities

As of March 15, 2004, we own and operate 17 ASCs, each of which is a state-licensed and Medicare-certified ASC focused primarily on eye care procedures. Ophthalmologists perform cataract, laser vision correction and other eye related surgical procedures in our ASCs. We generally own and operate our surgical facilities through joint ownership arrangements in which we own a majority interest in the facility and minority equity interests are held by physicians living in the ASC’s local community. These arrangements are principally structured as limited liability companies with one of our subsidiaries serving as the manager of the entity. In certain instances, we may own the facility through a limited partnership with one of our subsidiaries serving as the general partner. Currently, we own majority equity interests in 14 of our ASCs. We wholly own the remaining three ASCs.

In addition to owning and operating ASCs, we also are parties to laser services agreements pursuant to which we provide excimer lasers and various services to ophthalmologists for their use in performing laser vision correction surgery. In response to the declining demand for laser vision correction surgery, during 2002 and 2003 we closed 10 laser vision correction centers and restructured the manner in which we provided this equipment and these services to minimize our fixed costs. Our excimer lasers are either located in our ASCs or provided to physicians for use in their medical practices through these laser services agreements.

We have a nonexclusive supply agreement with Alcon Laboratories, Inc. pursuant to which we can procure and utilize excimer lasers and other equipment manufactured by Alcon. The agreement sets forth pricing terms for our APEX/Infinity lasers, as well as the procurement and pricing terms for Alcon’s most technologically advanced laser, the LADARVision System. During the term of this agreement, which expires December 31, 2006, we will pay Alcon monthly based on the number of procedures performed on each laser, with minimum annual procedure requirements for each LADARVision System procured under the agreement. As of March 15, 2004, we have eight LADARVision Systems covered by the agreement. Alcon may terminate the agreement if we fail, after reasonable cure periods, to comply with the material terms of the agreement. We may terminate the agreement if the U.S. Food and Drug Administration (FDA), withdraws or materially restricts its approval of the use of any laser covered by the agreement or if patent issues or changes render the lasers unusable.

Product Sales

We own and operate an optical laboratory business that specializes in surfacing, finishing and distributing corrective eyeglass lenses. Our laboratories have in excess of 350 active customers, including ophthalmologists, optometrists, opticians and optical retail chains. Our optical products purchasing organization allows eye care professionals to purchase optical products through us from more than 100 suppliers. We process consolidated monthly billing for over 1,500 customers that utilize our purchasing organization. Customers of these businesses include our former affiliated doctors who are a party to multi-year optical supply agreements with us pursuant to which our group purchasing organization and optical laboratories are the primary providers of optical products and supplies to these doctors. Generally, these supply agreements will expire between March 2007 and May 2009, and the product sales revenue generated from these customers in 2003 constituted less than three percent of our total product sales revenue.

In addition, our marketing products and services business provides eye care professionals with a range of products and services including brochures, videos, advertising and website design, education and training programs, and consulting services.

We also have a long-term service agreement with an optometric practice located in Illinois. The optometric practice also has a retail optical outlet that sells eyeglasses and other products to patients. We provide all of the services, facilities and equipment necessary to operate this optometric practice under a 25-year service agreement. The services include:

•

billing, collection and cash management services

•

procuring and maintaining all office space, equipment and supplies

•

subject to federal and state law, recruiting, employing, supervising and training all non-professional personnel

•

assisting in recruiting additional doctors

•

all administrative and support services

•

information technology services

Other

We have a 40-year service agreement in place with an ophthalmology practice with multiple locations in Georgia. This service agreement also covered a practice location in Tennessee during 2003; however, we sold our practice operations in Tennessee effective as of February 1, 2004. We provide all of the services, facilities and

equipment necessary to operate this medical practice, including services identical in nature to those described above with respect to our Illinois affiliated optometric practice. We also have a five-year administrative services agreement with a former affiliated practice under which we provide limited administrative and financial services to the practice.

Our Growth Strategy

Surgical Facilities

We are focused on acquiring, developing and operating ASCs. Currently, all of our ASCs provide primarily eye surgical services, but we have started to introduce other specialties such as pain management and podiatry in some of our centers. Although we intend to continue to pursue the acquisition and development of eye care ASCs, we are also pursuing the acquisition and development of ASCs in other specialties. The key elements of our growth strategy are:

•

Acquiring majority equity interests in ASCs in partnership with physician-owners;

•

Developing newly constructed ASCs through joint ownership arrangements with physicians; and

•

Increasing the revenue and profitability of our existing ASCs.

Acquiring Majority Interests in ASCs

We have a development staff that is responsible for identifying, evaluating and negotiating the acquisition of majority interests in ASCs in new or existing markets. In certain instances, we may also consider acquiring a minority, rather than a majority, equity interest. The acquisition of a well-established, single-specialty ASC is an attractive means of entry into a new market, particularly in states that require a certificate of need, or CON, for development. In analyzing potential transactions, the evaluation of our prospective doctor-partners is a critical factor. We recognize that the success of the targeted ASC is tied directly to the success of our doctor-partners and their practices. We believe our management services experience greatly enhances our doctor evaluation process.

We also assess the target facility’s potential for future growth. We identify opportunities to add new doctors or surgical procedures, or to improve managed care participation. We also examine the opportunities to reduce expenses through improved staff efficiency, better doctor scheduling and reduced supply costs. Our development staff and operations personnel work closely to formulate a growth strategy for each newly acquired facility to maximize our return on investment.

We currently intend to finance our future acquisitions of equity interests in ASCs using our existing cash balance, cash generated from our operations and amounts borrowed under our credit facility. We renegotiated our credit facility during 2003, and our new facility expires on June 30, 2006.

Developing Newly Constructed ASCs

Our development staff is also responsible for identifying potential opportunities to build new ASCs with physician partners. These projects involve partnering with one or more physicians in a local community that is either underserved from a facility standpoint, or involve physicians who don’t have the resources, productivity or expertise to construct a facility on their own and need a corporate partner to help finance, structure and oversee the project. Generally, development of a new ASC can be an attractive alternative in states that do not require a CON to build a new center. During 2003, we opened a new ASC in Missouri that we developed with one of our physician-partners. This ASC is licensed as a multi-specialty facility but is presently focused primarily on eye care procedures. During 2003, we also began developing with two new physician partners an ASC specializing in pain management procedures. This center is awaiting state licensure approval and has not yet opened as of March 15, 2004.

Increasing Revenue and Profitability of our Existing ASCs

The revenue generated by our ASCs is driven by the surgical procedures performed by physicians. Revenue growth in our existing ASCs will be derived from an increase in surgical procedures performed at each facility, whether this increase is from the existing physicians or new physicians utilizing the facility. All of our ASCs currently have the capacity to handle additional procedures. Given this capacity, we attempt to introduce the benefits

of our facilities to new doctors who may be using other less efficient and convenient facilities. We believe the efficiency and convenience of an ASC, and the opportunity to work in facilities affiliated with a national ASC operator with significant management expertise, are appealing to physicians and their patients and provides a more attractive setting than hospitals. We also work with our physicians in identifying new procedures, technologies or equipment to integrate into our facilities and expanding the scope of surgical services available in a cost-effective manner. Moreover, with a substantial portion of our ASC revenue derived from government and private third party payors, we are continuously evaluating and attempting to increase the levels of our managed care panel participation.

With our existing centers that currently provide predominantly eye-related surgical services, we are also exploring efficient ways to add new surgical specialties. During 2003, for example, we added pain management procedures to one of our ASCs. We believe pain management and podiatry are attractive specialties that we can add to some of our existing ASCs in an effort to increase capacity in a relatively cost-effective manner. We are often required to get state licensure approval to add other specialties to our existing centers. The likelihood of our success in receiving these approvals will vary by state.

Eleven of our 17 ASCs are currently accredited by the Accreditation Association for Ambulatory Health Care, or AAAHC. We believe that many managed care panels use AAAHC accreditation as a quality benchmark. Because some managed care panels do not contract with a facility that is not accredited, we believe our emphasis on having our facilities accredited in certain competitive managed care markets will maximize our managed care panel participation and also reflects our commitment to providing high quality patient care.

Staffing and medical supply costs are generally an ASC’s two largest expense categories. We analyze staffing schedules and work with physicians to schedule surgeries in a manner that maximizes staff efficiency and optimizes staffing costs. We also have negotiated purchasing contracts with many of our largest vendors and we educate our doctors on lower cost supply alternatives that still maintain high patient care standards.

Product Sales

We believe there are opportunities to grow our optical products and services business by adding ophthalmologists and optometrists as customers, as well as offering a broader range of products and services to our existing customer base.

Competition

Surgical Facilities

In acquiring and developing ASCs, we compete with both corporations and physicians. There are several publicly held and private companies actively engaged in the acquisition, development and operation of ASCs. Some of these companies may acquire and develop multi-specialty ASCs, practice-based ASCs focusing on varying specialties, or a combination of the two. Moreover, some of these companies have the acquisition and development of ASCs as their core business, while other competitors are larger, publicly held companies that have subsidiaries or divisions engaged in this business. Many of these competitors have greater resources than us. Our primary competitors in acquiring, owning and operating ASCs are AmSurg Corp., United Surgical Partners International, Inc., HealthSouth Corporation and Symbion, Inc.

Product Sales

Our two optical laboratories face a variety of national, regional and local competitors. We compete in the optical laboratory market on the bases of quality of service, breadth of services, reputation and price.

In the market for providing optical group purchasing services, we primarily compete with national and regional buying groups, as well as large vendors. Competition in this market is based upon service, price, and the strength of the purchasing organization, including the ability to negotiate discounts with suppliers.

Other

Our management services are provided to eye care professionals through long-term affiliations. The market for these management services is fragmented, and we do not face any single, dominant U.S. national competitor. Eye care professionals may seek a corporate partner to assist them in the growth and development of their practices, as well as with the day-to-day management and administration of their businesses. Factors that may influence an eye care professional’s decision to retain a corporate partner to provide management services are the corporate partner’s experience and scope and quality of services offered, the eye care professional’s need for these services, and the price for such services.

Employees

As of March 15, 2004, we had approximately 341 employees, 244 of whom are full-time employees. We are not a party to any collective bargaining agreements and we consider our relations with our employees to be good.

Many of our ASCs are located adjacent to a physician practice. In a few instances, our ASCs may lease from the physician practice some or all of the individuals who provide services in the ASC on our behalf. This is typically only done when the ASC may provide surgical services on a limited schedule. This leasing model allows us to staff these centers in a more cost-effective manner.

Governmental Regulation

As a participant in the health care industry, our operations are subject to extensive and increasing regulation by governmental entities at the federal, state and local levels. Many of these laws and regulations are subject to varying interpretations, and we believe courts and regulatory authorities generally have provided little clarification. Moreover, state and local laws and interpretations vary from jurisdiction to jurisdiction. As a result, we may not always be able to accurately predict interpretations of applicable law.

We believe our business practices comply in all material respects with applicable federal, state and local laws and regulations. If the legal compliance of any of our activities were challenged, however, we might have to divert substantial time, attention and resources from running our business to defend against these challenges regardless of their merit. If we do not successfully defend these challenges, we might face a variety of adverse consequences including losing our ASC licenses, losing our eligibility to participate in Medicare, Medicaid or other federal or state health care programs, or losing other contracting privileges and, in some instances, civil or criminal fines. Any of these consequences could have a material adverse effect on our business, financial condition and results of operations.

The regulatory environment in which we operate may change significantly in the future. Numerous legislative proposals have been introduced in the U.S. Congress and in various state legislatures over the past several years that could cause major reforms of the U.S. health care system. In addition, several sets of regulations have been recently adopted that may require substantial changes in the way health care providers operate over the coming years. In response to new or revised laws, regulations or interpretations, we could be required to revise the structure of our legal arrangements, repurchase minority equity interests in our ASCs that are owned by physicians, incur substantial legal fees, fines or other costs, or curtail our business activities, reducing the potential profit to us of some of our legal arrangements, any of which could have a material adverse effect on our business, financial condition and results of operations.

The following is a summary of some of the health care regulatory issues affecting our operations and us.

Federal Law

Anti-Kickback Statute. The federal anti-kickback statute prohibits the knowing and willful solicitation, receipt, offer or payment of any direct or indirect remuneration in return for the referral of patients or the ordering or purchasing of items or services payable under Medicare, Medicaid or other federal health care programs. Violations of this statute may result in criminal penalties, including imprisonment or criminal fines of up to $25,000 per violation, civil penalties of up to $50,000 per violation plus up to three times the amount of the underlying remuneration, and exclusion from federal or state programs including Medicare or Medicaid.

The federal anti-kickback statute contains a number of exceptions. In order to address the problems created by the broad language of the statute, Congress directed the Department of Health and Human Services, or DHHS, to develop regulatory exceptions, known as safe harbors, to the federal anti-kickback statute’s referral prohibitions. When possible, we have attempted to structure our business operations within a safe harbor. However, some aspects of our business either do not meet the prescribed safe harbor standards, or relate to practices for which no safe harbor standards exist. Because there is no legal requirement that relationships fit within a safe harbor, a business arrangement that does not comply with the relevant safe harbor, or for which a safe harbor does not exist, does not necessarily violate the anti-kickback statute.

Included among the safe harbors to the anti-kickback statute are certain safe harbors for investment interests in general, and for investment interests in ASCs, specifically. As of February 1, 2004 we co-own 14 of our ASCs with one or more physicians, and we will likely co-own with physicians most of the ASCs that we will acquire in the future. We will also likely be selling interests in our existing wholly-owned ASCs to physicians in the near- to intermediate-term. It is unlikely that our co-ownership will meet all of the parameters of the general investment interest safe harbors or the ASC investment interest safe harbors. As discussed above, however, an arrangement that does not fit squarely within a safe harbor is not per se unlawful under the anti-kickback statute. It is our intent to structure all such co-ownership arrangements in a manner that complies with as many of the safe harbor components as possible, that meets the objectives of the anti-kickback statute, and that follows the other available regulatory guidance regarding ASC co-ownership arrangements to the greatest extent possible.

The applicable regulatory authorities have provided limited guidance regarding ASC ownership arrangements that are permissible under the anti-kickback statute. Based on the guidance that is available, we believe that our joint ownership complies with the anti-kickback law based on, among other things, the following factors: all of the jointly owned ASCs are Medicare certified; patients referred to an ASC by an investor are informed of the referring physician’s investment interest in the ASC; the terms on which an investment interest in the ASC is offered to an investor are not related to the previous or expected volume of referrals or services by, or other business with, the investor; neither any of the investors (including us) nor the ASC entity will loan money to any investors or guarantee debt of any investors incurred to purchase the investment interest; the return on investment in the ASC is directly proportional to the investors’ investment interests; the ASCs treat federal health program beneficiaries in a non-discriminatory manner; and Medicare-recognized surgical procedures account for a significant portion of the investor-physicians’ medical practice income.

Self-Referral Law. Subject to limited exceptions, the federal self-referral law, known as the “Stark Law,” prohibits physicians and optometrists from referring their Medicare or Medicaid patients for the provision of “designated health services” to any entity with which they or their immediate family members have a financial relationship. “Financial relationships” include both compensation and ownership relationships. “Designated health services” include clinical laboratory services, radiology and ultrasound services, durable medical equipment and supplies, and prosthetics, orthotics and prosthetic devices, as well as seven other categories of services. The term “designated health service” does not include surgical services. Physicians do not currently refer to our ASCs for the provision of “designated health services” that are not otherwise excepted or protected under the Stark Law.

The Stark law does not prohibit physician ownership or investment interests in ASCs to which they refer patients. The Centers for Medicare and Medicaid Services clarified this in the Phase I regulations interpreting the Stark law by providing that services that would otherwise constitute a “designated health service,” but that are paid by Medicare as part of composite rate, will not be considered designated health services for purposes of the Stark Law. Thus, when an intraocular lens, or IOL, used in cataract surgery, or another service or item that would otherwise qualify as a “designated health service,” is included in an ASC composite payment rate, the IOL (or other such item or service) will not be considered to be a “designated health service.”

Violating the Stark Law may result in denial of payment for the designated health services performed, civil fines of up to $15,000 for each service provided pursuant to a prohibited referral, a fine of up to $100,000 for participation in a circumvention scheme, and exclusion from the Medicare, Medicaid and other federal health care programs. The Stark Law is a strict liability statute. Any referral made where a financial relationship exists that fails to meet an exception constitutes a violation of the law.

Civil False Claims Act. The Federal Civil False Claims Act prohibits knowingly presenting or causing to be presented any false or fraudulent claim for payment by the government, or using any false or fraudulent record in order to have a false or fraudulent claim paid. Violations of the law may result in repayment of three times the damages suffered by the government and penalties from $5,000 to $10,000 per false claim. Collateral consequences of a violation of the False Claims Act include administrative penalties and possible exclusion from participation in Medicare, Medicaid and other federal health care programs.

Health Insurance Portability and Accountability Act. In August of 1996, Congress enacted the Health Insurance Portability and Accountability Act of 1996 (HIPAA). Included within HIPAA’s health care reform provisions are its “administrative simplification” provisions, which require that health care transactions be conducted in a standardized format, and that the privacy and security of certain individually identifiable health information be protected. Proposed rules for many of the administrative simplification subject areas have been published.

Final rules covering “Standards for Electronic Transactions and Code Sets” were published on August 17, 2000, and set forth the standardized billing codes and formats that we must use when conducting certain health care transactions and activities. The effective date of these final rules was October 16, 2000. Compliance with these rules was required by October 16, 2002, but by filing an extension plan by October 16, 2002, we extended this compliance date to October 16, 2003 for our ASCs. Notwithstanding these deadlines, CMS announced on September 23, 2003 that it would establish a contingency plan for accepting non-standard transactions after October 16, 2003. This contingency plan remains in effect, however it was modified in February 2004 to state that providers submitting non-standard Medicare claims as of July 2004 can be expected to wait an additional 13 days for payment of each such claim. Our ASCs are utilizing standard transactions whenever possible and stand ready to convert to standard transactions with all payors as such payors become ready, or to utilize paper claims in limited circumstances, all in compliance with HIPAA.

On December 28, 2000, as modified on May 31, 2002 and August 14, 2002, the DHHS published final rules addressing “Standards for Privacy of Individually Identifiable Health Information” under HIPAA’s administrative simplification provisions. Compliance with these rules was required by April 14, 2003. These rules create substantial compliance issues for all “covered entities” — which include health care providers, health plans, and health care clearinghouses — that engage in regulated transactions and activities. Operations of our ASCs are covered by the final rules. We believe our ASCs are in substantial compliance with these final rules.

Final rules addressing the “Security Standards” under HIPAA’s administrative simplification provisions were published on February 20, 2003. Our ASCs must comply with these regulations by April 21, 2005. We are still in the process of determining what impact these rules will have on our operations.

On January 23, 2004, DHHS published the final rule on “Standard Unique Health Identifiers for Health Care Providers.” Under this final rule, all HIPAA covered entities — which includes our ASCs — must apply for a National Provider Identifier (NPI) in order to be able to transmit any health information in electronic form. Application may be made beginning on, but not earlier than, May 23, 2005. As this final rule was issued only recently, we do not yet know the time or expense that we can expect when applying for NPIs.

Violations of HIPAA’s administrative simplification provisions can result in civil penalties of up to $25,000 per person per year for each violation or criminal penalties of up to $250,000 and/or up to 10 years in prison per violation.

State Law

Facility Licensure and Certificate of Need. We are required to obtain and maintain licenses from the state departments of health in states where we open, acquire and operate ASCs. We believe that we have obtained and that we maintain the necessary licenses in states where licenses are required. With respect to future expansion, we cannot assure you that we will be able to obtain the required licenses without unreasonable expense or delay. In addition, we cannot assure you that we will be able to maintain licenses for all of our operating ASCs. We believe our ASCs are in compliance with all applicable state licensure requirements, but we cannot guaranty that the state departments of health will continue to view our facilities as being in compliance.

Some states require a Certificate of Need, or CON, prior to the construction or modification of an ASC or the purchase of specified medical equipment in excess of a dollar amount set by the state. We believe that we have obtained the necessary CONs in states where a CON is required. However, we believe courts and state regulatory authorities generally have provided little clarification as to some of the regulations governing the need for CONs. It is possible that a state regulatory authority could challenge our determination. With respect to our future development of new ASCs or expansion of existing ASCs, we cannot assure you that we will be able to acquire a CON in all states where a CON is required.

Anti-Kickback Laws. In addition to the federal anti-kickback law, a number of states have enacted laws that prohibit payment for referrals and other types of kickback arrangements. Some of these state laws apply to all patients regardless of their source of payment, while others limit their scope to patients whose care is paid for by particular payors.

Self-Referral Laws. In addition to the Federal Stark Law, a number of states have enacted laws that require disclosure of or prohibit referrals by health care providers to entities in which the providers have an investment interest or with which the providers have a compensation relationship. In some states, these restrictions apply regardless of the patient’s source of payment.

State Privacy Laws. Numerous states have enacted privacy laws that have similar objectives to the Federal HIPAA privacy regulations. These laws, which vary from state to state, require that certain protective measures be taken in connection with the disclosure of a patient’s identifying information.

Corporate Practice of Medicine. A number of states have enacted laws that prohibit, or have common law that prohibits, the corporate practice of medicine. These laws are designed to prevent interference in the medical decision-making process by anyone who is not a licensed physician. Application of the corporate practice of medicine prohibition varies from state to state. Although we neither employ physicians nor provide professional medical services, we continue to provide services to physicians in connection with their performance of surgical procedures through laser services agreements and through our remaining management services agreements. To the extent any act or service to be performed by us is construed by a court or enforcement agency to constitute the practice of medicine, we cannot be sure that a particular state court or enforcement agency may not construe our arrangements as violating that jurisdiction’s corporate practice of medicine doctrine. In such an event, we may be required to redesign or reformulate our relationships with these eye care professionals and there is a possibility that some provisions of our agreements may not be enforceable.

Fee-Splitting Laws. The laws of some states prohibit providers from dividing with anyone, other than providers who are part of the same group practice, any fee, commission, rebate or other form of compensation for any services not actually and personally rendered. Penalties for violating these fee-splitting statutes or regulations may include revocation, suspension or probation of a provider’s license, or other disciplinary action. In addition, courts have refused to enforce contracts found to violate state fee-splitting prohibitions. The precise language and judicial interpretation of fee-splitting prohibitions varies from state to state. Courts in some states have interpreted fee-splitting statutes to prohibit all percentage of gross revenue and percentage of net profit management fee arrangements. Other state statutes only prohibit fee splitting in return for referrals. To the extent any of our contractual arrangements are construed by a court or enforcement agency to violate the jurisdiction’s fee-splitting laws, we may be required to redesign or reformulate our arrangements and there is a possibility that some provisions of our agreements may not be enforceable.

Excimer Laser Regulation

Medical devices, including the excimer lasers used in our ASCs, are subject to regulation by the FDA. Medical devices may not be marketed for commercial sale in the U.S. until the FDA grants pre-market approval for the device.

Failure to comply with applicable FDA requirements could subject us or laser manufacturers to enforcement action, product seizures, recalls, withdrawal of approvals and civil and criminal penalties. Further, failure to comply with regulatory requirements, or any adverse regulatory action, could result in a limitation on or prohibition of our use of excimer lasers.

Government Regulation — Management Services

Our management services business and the operations of our affiliated providers are also subject to extensive and continuing regulation by governmental entities at the federal, state and local levels. The following is a summary of the health care regulatory issues affecting our management services business, both with respect to our affiliated providers and us:

Federal Law

Anti-Kickback Statute. As discussed above, there are safe harbor regulations to the federal anti-kickback statute. When possible, we have attempted to structure our management services business and our relationships with our affiliated providers within a safe harbor. Some aspects of our management services business, the business of our affiliated providers, and our relationships with our affiliated providers either do not meet the prescribed safe harbor standards, or relate to practices for which no safe harbor standards exist. Because there is no legal requirement that relationships fit within a safe harbor, a business arrangement that does not comply with the relevant safe harbor, or for which a safe harbor does not exist, does not necessarily violate the anti-kickback statute.

Self-Referral Law. Our affiliated providers provide limited categories of designated health services, specifically, diagnostic radiology services, including A-scans and B-scans, and prosthetic devices, including eyeglasses and contact lenses furnished to patients following cataract surgery. We believe the provision of these designated health services meets with an exception to the Stark Law. In addition, compensation arrangements between our affiliated providers and their employers have historically been structured to comply with the Stark Law.

Health Insurance Portability and Accountability Act. The operations of our affiliated providers are covered by HIPAA. We have taken actions to assist our remaining affiliated providers with their HIPAA compliance efforts.

State Law

State Privacy Laws. State health information privacy laws may also apply to the activities of our affiliated providers. There is very little guidance regarding the application of these state privacy laws. We cannot be sure that the privacy measures taken by our affiliated providers will be construed as complying with these laws. In the event the privacy measures taken by these professionals are deemed not to comply with a particular state’s health privacy laws, we may need to incur significant time, effort and expense to establish compliance.

Corporate Practice of Medicine Laws. Although we neither employ doctors nor provide professional medical services, to the extent any portion of the comprehensive management services that we provide under our service agreements with our affiliated providers is construed by a court or enforcement agency to constitute the practice of medicine, our service agreements provide that our obligations to perform the act or service is waived. We cannot be sure that a particular state court or enforcement agency may not construe our arrangements as violating that jurisdiction’s corporate practice of medicine doctrine. In such an event, we may be required to redesign or reformulate our relationships with our affiliated providers and there is a possibility that some provisions of our service agreements may not be enforceable.

Fee-Splitting Laws. We believe our management fee arrangements with our affiliated providers differ from those invalidated as unlawful fee splits because they establish a flat monthly fee that is subject to adjustment based on the degree to which actual practice revenues or expenses vary from budget. However, there is some risk that our arrangements could be construed by a state court or enforcement agency to run afoul of state fee-splitting prohibitions. Accordingly, all of our service agreements contain either a reformation provision or a mechanism establishing an alternative fee structure, or both.

Item 2. Properties

We do not own any real property. We lease space for our corporate offices in Chicago, our ASCs and our optical services operations. As part of our management services business, we also continue to lease the clinics of our affiliated providers. In some cases, these facilities are leased from related parties. See “Item 13 — Certain Relationships and Related Transactions.” Our corporate offices in the Chicago metropolitan area currently consist of 8,150 square feet in downtown Chicago, and 5,923 square feet in Des Plaines, Illinois.

The terms and conditions of our real property leases vary. The forms of lease range from “modified triple net” to “gross” leases, with terms generally ranging from month-to-month to ten years, with certain leases having multiple five-year renewal terms at our option. Generally, our ASCs and eye care clinics are located in medical complexes, office buildings or free-standing buildings. The square footage of these offices range from 500 square feet to approximately 15,000 square feet, and the terms of these leases have expiration dates ranging from January 2005 to March 2012. Depending on state licensing and certificate of need issues, expanding the space in any of our ASCs may require state regulatory approval.

The following tables list the locations of our ASCs:

Location
Colorado Springs, CO	2	51	%
Atlanta, GA	2	100	%
Columbus, GA	3	100	%
Chicago, IL	1	79.5	%
Maryville, IL	1	80	%
River Forest, IL	2	75	%(1)
Merrillville, IN	2	51	%(1)
New Albany, IN	2	80	%(1)
Overland Park, KS	3	51	%(1)
Thibodaux, LA	1	60	%
Florissant, MO	1	100	%(1)
Kansas City, MO	2	80	%
Kansas City, MO	2	51	%
St. Joseph, MO	1	80	%
Chattanooga, TN	1	77.5	%
Tyler, TX	2	60	%
Richmond, VA	1	80	%

(1)

All or a portion of our existing ownership interests in these facilities may potentially be sold to one or more physicians pursuant to option agreements if the physician(s) elect to exercise their option to purchase, or in certain instances we elect to sell, the interests. See “Item 7 — Liquidity and Capital Resources.”

Item 3. Legal Proceedings

We are not a party to any lawsuits or administrative actions pending, or to our knowledge, threatened, which we would expect to have a material adverse effect upon our business, financial condition or results of operations.

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

We did not submit any matter to a vote of our security holders during the fourth quarter of 2003.

PART II

Item 5.

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

Price Range of Common Stock

Since August 18, 1999, our common stock has been traded on the Nasdaq National Market under the symbol NOVA. The following table sets forth, for the periods indicated, the range of high and low sale prices for our common stock on the Nasdaq National Market:

	High		Low
Fiscal year ending December 31, 2003:
First Quarter	$	1.44	$	1.05
Second Quarter	$	1.52	$	0.97
Third Quarter	$	2.40	$	1.20
Fourth Quarter	$	4.09	$	1.91

Fiscal year ending December 31, 2002:
First Quarter	$	1.45	$	0.52
Second Quarter	$	1.13	$	0.67
Third Quarter	$	1.55	$	0.65
Fourth Quarter	$	1.75	$	1.11

On March 15, 2004, the last reported sale price of our common stock was $4.529, and there were approximately 364 holders of record of our common stock. This figure does not consider the number of individual holders of securities that are held in the “street name” of a securities dealer. The quotations listed above do not reflect retail mark-ups or commissions and may not necessarily represent actual transactions.

Dividends

We have never paid a cash dividend on our common stock. We plan to retain all future earnings to finance the development and growth of our business. Therefore, we do not currently anticipate paying any cash dividends on our common stock. Any future determination as to the payment of dividends will be at our board of directors’ discretion and will depend on our results of operations, financial condition, capital requirements and other factors our board of directors considers relevant. Moreover, our credit agreement prohibits the payment of dividends on our common stock.

Item 6. Selected Financial Data

The consolidated statement of operations data set forth below for the years ended December 31, 2003, 2002 and 2001 and the balance sheet data at December 31, 2003 and 2002, are derived from our respective audited consolidated financial statements which are included elsewhere herein. The consolidated statement of operations data set forth below with respect to the years ended December 31, 2000 and 1999 and the consolidated balance sheet data at December 31, 2001, 2000 and 1999 are derived from our audited financial statements which are not included in this Form 10-K.

The data set forth below should be read in conjunction with the consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.

	Year Ended December 31,
	2003		2002		2001			2000		1999
										(unaudited)
	(in thousands, except per share and other data)
Consolidated Statement of Operations Data:
Net revenue	$	55,506	$	53,773	$	53,440		$	50,987	$	36,541
Net income (loss) from continuing operations (a) (b)	$	3,484	$	3,657	$	(7,093	)	$	2,256	$	(831	)
Net income (loss) from continuing operations per dilutive share (a) (b)	$	0.16	$	0.15	$	(0.29	)	$	0.09	$	(0.27	)

Other Data:
ASCs operated at end of period		17		16		14			13		11
Number of surgical procedures performed:
Cataracts		24,268		20,689		18,323			15,925		14,450
LVC		5,974		8,385		15,199			20,045		12,586
Other		14,435		10,070		9,609			7,275		7,308
Total		44,677		39,144		43,131			43,245		34,344

	As of December 31,
	2003		2002		2001		2000		1999
									(unaudited)
	(in thousands)
Consolidated Balance Sheet Data:
Working capital	$	16,892	$	7,226	$	12,698	$	23,725	$	11,973
Total assets		63,888		64,128		92,252		120,913		88,251
Total debt, excluding current portion		74		11		20,708		26,184		188
Total stockholders’ equity		50,113		48,648		50,579		82,864		74,781

Notes:

(a)

In connection with our discontinued operations and restructuring plan announced in October 2001, we recorded certain restructuring and other charges related to the closure of certain facilities and the reorganization and downsizing of our information technology function.

(b)

In connection with our initial public offering consummated on August 18, 1999 (IPO), we recorded noncash, nonrecurring charges for compensation expense related to stock options and a discount to the IPO offering price upon the exchange of subordinated notes for common stock. In addition, we recorded accretion of Series C and Series D convertible preferred stock to increase the carrying value of such stock to its potentially redeemable value.

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis presents our consolidated financial condition at December 31, 2003 and 2002 and the results of operations for the years ended December 31, 2003, 2002 and 2001. You should read the following discussion together with the “Selected Financial Data,” our consolidated financial statements and the related notes and other financial data contained elsewhere in this annual report. In addition to the historical information provided below, we have made certain estimates and forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated or implied by these estimates and forward-looking statements as a result of certain factors, including those discussed in the section captioned “Risk Factors,” the introductory paragraph to Part I, and elsewhere in this annual report.

Overview

We consider our core business to be the ownership and operation of ambulatory surgery centers (ASCs). As of December 31, 2003, we owned and operated 17 ASCs of which 13 were jointly owned with physician-partners. We also own other businesses including an optical laboratory, an optical products purchasing organization, and a marketing products and services company. We also provide management services to two eye care practices.

2003 Financial Highlights:

•

Consolidated revenue increased 3.2% to $55.5 million. Surgical facilities revenue increased 8.2% to $36.4 million.

•

Income from operations increased 42.9% to $7.4 million.

•

Positive operating cash flow of $9.6 million.

•

Cash balance of $11.8 million with zero debt outstanding under our credit facility at December 31, 2003.

•

Sold minority interests in four ASCs resulting in cash proceeds of $1.9 million.

•

Completed all of our remaining discontinued operations divestiture transactions.

ASC Strategy. We measure the success of our ASC strategy based on our ability to achieve or exceed the following key objectives:

•

Acquire and develop new ASCs. We consider the acquisition and development of new ASCs a key element of our long-term growth strategy. We currently have personnel dedicated to identifying acquisition and development opportunities.

•

Strengthen and build relationships with existing and new physician-partners. Our physician-partners play a significant role in the success of our ASCs. We share a common goal with our physician-partners which is to operate efficient, productive and profitable ASCs. Our objective is to own greater than 50% of each ASC but less than 100%. We believe that owning ASCs in partnership with physicians maximizes our opportunity for growth and profitability. During 2002 and 2003 we have sold minority interests in nine of our ASCs to achieve this objective. Although the sale of minority interests may result in a reduction to our consolidated earnings, we believe that the joint ownership model will enhance shareholder value over the long-term.

•

Continue to increase revenue and operating margins in our existing ASCs. The primary source of revenue at our ASCs is derived from surgical procedures performed. Profitable growth within our existing ASCs is determined by our ability to maximize efficiency and utilization, expand into medical procedures beyond eye care, and provide quality service to our physicians and their patients.

In addition to the above key ASC objectives, our overall strategy also includes maintaining a strong balance sheet, continuing to grow the other segments of our business, and attracting and retaining employees to help us achieve our growth objectives.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We annually review our financial reporting and disclosure practices and accounting policies to ensure that our financial reporting and disclosures provide accurate and transparent information relative to the current economic and business environment. We believe that of our significant accounting policies (see Note 2 in the Notes to the Consolidated Financial Statements beginning on page F-6), the following policies involve a higher degree of judgment and/or complexity.

Revenue Recognition and Accounts Receivable, Net of Allowances. Revenue from surgical procedures performed at our surgical facilities and patient visits to our eye care practices, net of contractual allowances and a provision for doubtful accounts, is recognized at the time the service is performed. The contractual allowance is the difference between the fee we charge and the amount we expect to be paid by the patient or the applicable third-party payor, which includes Medicare and private insurance. We base our estimates for the contractual allowance on the Medicare reimbursement rates when Medicare is the payor, our contracted rate with other third party payors or our historical experience when we do not have a specific contracted rate. We base our estimate for doubtful accounts on the aging category and our historical collection experience. Our optical products purchasing organization negotiates buying discounts with optical product manufacturers. The buying discounts and any handling charges billed to the members of the buying group represent the revenue recognized. Product sales revenue from our optical laboratories and marketing products and services business, net of an allowance for returns and discounts, is recognized when the product is shipped or service is provided to the customer. We base our estimates for sales returns and discounts on historical experience and have not experienced significant fluctuations between estimated and actual return activity and discounts given.

Accounts receivable have been reduced by the reserves for estimated contractual allowances and doubtful accounts noted above.

Asset impairment. In assessing the recoverability of our fixed assets, goodwill and other noncurrent assets, we consider changes in economic conditions and make assumptions regarding estimated future cash flows and other factors. If these estimates or their related assumptions change in the future, we may be required to record impairment charges.

Restructuring and discontinued operations reserves. In 2001, we recorded a $10.9 million pretax charge related to our restructuring plan and a $27.2 million net loss to account for the contemplated disposal of our discontinued operations. These estimated losses were based on the information available to management at the date the plan of discontinued operations and restructuring was announced. We evaluate our remaining restructuring and discontinued operations reserves quarterly. Future revisions to the reserves will be reflected in the financial statements in the period they occur.

Income taxes. We record a valuation allowance to reduce our deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized. While we have considered future taxable income and ongoing feasible tax strategies in assessing the need for the valuation allowance, if these estimates and assumptions change in the future, we may be required to adjust our valuation allowance. This could result in a charge to, or an increase in, income in the period such determination is made.

Results of Operations

The following table summarizes our operating results as a percentage of net revenue for the years indicated.


Net Revenue:
Surgical facilities	65.6	%	62.6	%	63.2	%
Product sales and other	34.4		37.4		36.8
Total net revenue	100.0		100.0		100.0

Operating expenses:
Salaries, wages and benefits	36.6		37.5		40.0
Cost of sales and medical supplies	24.1		26.3		26.0
Selling, general and administrative	21.2		21.4		22.2
Depreciation and amortization	4.8		4.6		8.2
Restructuring charges	—		(1.9	)	20.4
Other charges	—		—		3.2
Goodwill impairment charge	—		2.5		—
Total operating expenses	86.7		90.4		120.0
Income (loss) from continuing operations	13.3		9.6		(20.0	)

Other (income) expense:
Interest expense	.2		.8		1.8
Interest income	(.3	)	(.3	)	(.1	)
Minority interests in earnings of consolidated entities	4.8		1.7		.1
Gain on sale of minority interests	(1.6	)	(3.0	)	—
Other	(.3	)	(.9	)	.1
Total other (income) expense	2.8		(1.7	)	1.9
Income (loss) from continuing operations before income taxes	10.5		11.3		(21.9	)
Income tax provision (benefit)	4.2		4.5		(8.6	)
Net income (loss) from continuing operations	6.3		6.8		(13.3	)
Net income from discontinued operations, net of tax	—		.4		3.2
Net loss on disposal of discontinued operations, net of tax	—		(3.4	)	(50.9	)
Cumulative effect of change in accounting principal, net of tax	—		(3.4	)	—
Net income (loss)	6.3	%	.4	%	(61.0	)%

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

Net Revenue

Consolidated. Total net revenue increased 3.2% from $53.8 million to $55.5 million. Net revenue by segment is discussed below.

Surgical Facilities. The table below summarizes surgical facilities net revenue and procedures performed for 2002 and 2003. Revenues generated from surgical facilities are derived from the fees charged for the procedures performed in our ASCs and through our laser services agreements. Our procedure volume is directly impacted by the number of ASCs we operate, the number of excimer lasers in service, and their respective utilization rates. Net surgical facilities revenue increased 8.2% from $33.7 million to $36.4 million. This increase was primarily the result of a $3.4 million increase from ASCs acquired or developed since January 1, 2002 (“new ASCs”) and a $1.9 million increase from ASCs that we owned for the entire comparable reporting periods, in this case since January 1, 2002 (“same-facility”). The increase in same-facility revenue was primarily the result of an increase in the number of procedures performed. This increase was partially offset by fewer LVC procedures performed in 2003. The reduction in LVC procedures performed was due to both economic conditions and fewer excimer lasers in operation resulting from the closure of 10 LVC centers and the termination of four laser services agreements during 2002 and 2003.

*Dollars in millions*	2003		2002		Increase/ (Decrease)
Net Surgical Facilities Revenue:
Same-facility:
Cataracts	$	19.4	$	17.9	$	1.5
Other		7.8		7.4		.4
		27.2		25.3		1.9
New ASCs:
Cataracts		4.0		1.7		2.3
Other		1.9		.8		1.1
		5.9		2.5		3.4
Excimer lasers:
LVC		3.3		5.9		(2.6	)
Total Net Surgical Facilities Revenue	$	36.4	$	33.7	$	2.7
Number of Surgical Facilities Procedures:
Same-facility:
Cataracts		20,082		18,929		1,153
Other		11,854		8,962		2,892
		31,936		27,891		4,045
New ASCs:
Cataracts		4,186		1,760		2,426
Other		2,581		1,108		1,473
		6,767		2,868		3,899
Excimer lasers:
LVC		5,974		8,385		(2,411	)
Total Number of Surgical Facilities Procedures		44,677		39,144		5,533

Government and other third-party payors pay for the majority of the cataract and other surgical procedures performed in our ASCs. LVC procedures are generally paid for by patients with their own funds. Medicare, our primary government payor, pays in accordance with predetermined fee schedules. On October 1, 2003, our ASCs received an approximate 2% price increase from Medicare. Because of federal legislation adopted in December 2003, however, this increase will be eliminated effective April 1, 2004 resulting in an approximate 2% price decrease. These reduced rates may remain frozen through 2009. Although pricing trends from other third-party payors are uncertain at this time, we do not anticipate that price increases will make a significant contribution to the growth of our surgical facilities revenue in the future.

The retention of physicians who utilize our ASCs is important for us to sustain and grow our surgical procedure volume and surgical facilities revenue. Physicians who utilize our ASCs use the facilities as an extension of their medical practice and many of them have ownership interests in our ASCs. We also generally enter into restrictive covenants with our physician-partners that prohibit them from owning a competing ASC within a defined geographic radius. We cannot, however, restrict the physicians from performing surgery elsewhere. Many different factors may influence a physician’s decision on where to perform surgical procedures. In early 2004, two of our physician-partners in one of our Kansas City, Missouri ASCs informed us that they intended to begin doing their surgical procedures at a new ASC that was being developed closer to their practice locations. From these discussions, we entered into an agreement with these physicians in which they purchased from us a release from their restrictions on owning competing facilities. We also agreed to repurchase their equity interests in the ASC later in 2004. In 2003, these two physicians performed the majority of the surgical procedures at this ASC and their departure will have a negative impact on procedure volume, revenue and income at this ASC until new physicians begin to use this facility. The negative financial impact will be mitigated, in part, by the payments they will make for the release of their restrictive covenants. Unless we identify new physicians who choose to perform surgical procedures at this ASC, it may not generate positive cash flow.

Product Sales and Other. The table below summarizes net product sales and other revenue by significant business component. Product sales and other revenue decreased 5.0% from $20.1 million to $19.1 million. Net revenue at our optical laboratory business decreased $1.2 million, or 19.5%, from 2002 which management believes is due to competitive and economic conditions. The optical laboratory business customer base, consisting primarily of private practice doctors, has continued to lose market share to large optical retailers. This decrease was partially offset by a $0.3 million increase in net revenue at our marketing products and services business. Other revenue decreased $0.2 million primarily due to the loss of a physician at one of our practices.

*Dollars in millions*	2003		2002		Increase/ (Decrease)
Product Sales:
Optical laboratories	$	5.1	$	6.3	$	(1.2	)
Optical products purchasing organization		2.1		2.1		—
Marketing products and services		1.9		1.6		.3
Optometric practice/retail store		1.8		1.7		.1
		10.9		11.7		(.8	)
Other:
Ophthalmology practice		7.6		7.9		(.3	)
Other		.6		.5		.1
		8.2		8.4		(.2	)
Total Net Product Sales and Other Revenue	$	19.1	$	20.1	$	(1.0	)

Salaries, Wages and Benefits

Consolidated. Salaries, wages and benefits expense increased 0.7% from $20.2 million to $20.3 million. As a percentage of net revenue, salaries, wages and benefits expense decreased from 37.5% to 36.6%. Salaries, wages and benefits expense by segment is discussed below.

Surgical Facilities. Salaries, wages and benefits expense in our surgical facilities segment decreased 2.1% from $7.7 million to $7.5 million. The decrease was the result of the closure of 10 LVC centers and five regional administrative offices during 2002 and 2003. The regional administrative office activities were absorbed by corporate personnel in 2003. This decrease was partially offset by costs attributed to new ASCs.

Product Sales and Other. Salaries, wages and benefits expense in our product sales and other segments decreased 5.2% from $8.6 million to $8.2 million. The decrease was primarily the result of staff reductions within the optical laboratory and optical products purchasing businesses.

Corporate. Salaries, wages and benefits expense increased 19.5% from $3.9 million to $4.6 million. The increase is due to additional headcount resulting from the centralization of some administrative services, annual salary increases and the costs of providing health insurance benefits to our employees.

Cost of Sales and Medical Supplies

Consolidated. Cost of sales and medical supplies expense decreased 5.3% from $14.1 million to $13.4 million. In 2002, corporate cost of sales and supplies included a $0.2 million credit relating to a vendor rebate program. As a percentage of net revenue, cost of sales and medical supplies expense decreased from 26.3% to 24.1%. The decrease as a percentage of revenue is due to our lower profit margin product sales and other revenue decreasing to 34.4% of total revenue in 2003, down from 37.4% in 2002. Cost of sales and supplies expense by segment is discussed below.

Surgical Facilities. Cost of sales and medical supplies expense in our surgical facilities segment decreased 1.8% from $8.6 million to $8.4 million. As a percentage of net revenue, cost of sales and medical supplies expense decreased from 25.6% to 23.2%. The decrease was the result of fewer LVC procedures performed and the closure of LVC centers during 2002 and 2003. The decrease was partially offset by costs associated with new ASCs and an increase in procedures performed at same-facility ASCs.

Product Sales and Other. Cost of sales and medical supplies expense in our product sales and other segments decreased 28.7% from $5.8 million to $5.0 million. This decrease is primarily a result of a reduction in the costs of sales at our optical laboratory business due to the decrease in revenues.

Selling, General and Administrative

Consolidated. Selling, general and administrative expense increased 2.1% from $11.5 million to $11.8 million. As a percentage of net revenue, selling, general and administrative expense decreased from 21.4% to 21.2%. Selling, general and administrative expense by segment is discussed below.

Surgical Facilities. Selling, general and administrative expense in our surgical facilities segment increased 23.7% from $5.9 million to $7.3 million. The increase is due to costs associated with new ASCs, increased professional liability insurance premiums and our decision in late 2002 to beginning charging a management fee and billing/collections fee to the ASCs for services rendered by certain corporate personnel. The increase relating to the management fee and billing/collections fee resulted in a corresponding $1.5 million decrease in corporate expenses. The increase in expense was partially offset by reductions related to the closure of LVC centers during 2002 and 2003.

Product Sales and Other. Selling, general and administrative expense in our product sales and other segments increased 2.2% from $3.5 million to $3.6 million. Approximately $0.3 million of the increase resulted from our decision in late 2002 to beginning charging a management fee to the operating segments for services rendered by certain corporate personnel. This increase was partially offset by cost reductions at our optical laboratory business and a $0.3 million reduction in bad debt expense within our optical products purchasing organization.

Corporate. Corporate selling, general and administrative expense decreased 59.1% from $2.1 million to $.9 million. Approximately $1.8 million of the decrease related to our decision in late 2002 to beginning charging a management fee and billing/collections fee to the operating segments for services rendered by certain corporate personnel. This decrease was partially offset by increased costs associated with the required re-audit of the 2000 and 2001 financial statements due to the change in external auditors and an increase in the premium for directors and officers liability insurance. Due to the increasing regulation imposed by the SEC on public companies such as the Sarbanes-Oxley Act, we anticipate that we will incur additional costs associated with being a public company in 2004 and in future years.

Depreciation and Amortization. Depreciation and amortization expense increased 8.8% from $2.5 million to $2.7 million. The increase is due to new ASCs and increased capital expenditures at our same-facility ASCs.

Restructuring and Other Charges. We evaluated our restructuring reserve requirements at the end of 2003 and determined that the balance was adequate to cover the remaining costs associated with our restructuring plan. During 2002 we recorded the reversal of excess reserves of $1.0 million.

Other (Income) Expense. We recognized $1.6 million of other expense during 2003 versus $0.9 million of other income during 2002. The 2003 expense includes $2.7 million of minority interest in the earnings of our ASCs compared to $0.9 million in 2002. Minority interest is offset by a $0.9 million gain on the sales of minority interests in our ASCs compared to $1.6 million in 2002. Minority interest is expected to be higher in 2004 due to the full year impact of the 2003 minority interest sales and additional minority interest sales in 2004. Interest expense decreased by $0.3 million due to significantly less bank borrowings during 2003. Other income in 2002 also includes $0.4 million of income from proceeds received from the settlement of a class action lawsuit.

Provision for Income Taxes. Our effective tax rate was unchanged at 40.0%. Our effective tax rate is affected by expenses that are deducted from operations in arriving at pre-tax income that are not allowed as a deduction on our federal income tax return.

Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001

Net Revenue. Net revenue increased 0.6% from $53.4 million to $53.8 million. Surgical facilities revenue decreased 0.4% from $33.8 million to $33.7 million, primarily due to a decrease in surgical procedures performed, offset by an increase in net revenue per procedure. In 2001, net revenue per procedure was reduced by the establishment of additional contractual allowance reserves of $1.4 million. In 2002, total surgical procedures performed in our surgical facilities decreased 9.2% from 43,131 to 39,144. LVC procedures decreased 44.8%, cataract procedures increased 12.9% and other procedures increased 4.8%, compared to 2001. The increase in procedures came from newly acquired ASCs. Management believes that the demand for elective LVC surgery continues to be negatively impacted by the general economic conditions. Due to the decrease in demand, we have closed eight LVC centers since the announcement of our discontinued operations and restructuring plan. Product sales and other revenue increased 2.3% from $19.7 million to $20.1 million. Net revenues at our optical products purchasing organization increased 18.0% over 2001. This increase was offset by a 28.3% decrease in revenue at our marketing products business, which has sold products primarily to the laser vision correction market. Management believes the downturn in the LVC market was the cause of the decline in revenue of this business.

Salaries, Wages and Benefits. Salaries, wages and benefits expense decreased 5.6% from $21.4 million to $20.2 million. As a percentage of revenue, salaries, wages and benefits expense decreased from 40.0% to 37.5%. The decrease in salaries, wages and benefits expense is the result of certain corporate salaries being charged to the discontinued operations reserves in accordance with the discontinued operations and restructuring plan, staff reductions at some surgical facilities in response to the reduction in LVC procedures and the closure of several LVC centers in the fourth quarter of 2001 and during 2002. These decreases were offset, in part, by the increase in salaries, wages and benefits expense from the acquisitions we made in 2002.

Cost of Sales and Medical Supplies. Cost of sales and medical supplies expense increased 1.7% from $13.9 million to $14.1 million. As a percentage of revenue, cost of sales and medical supplies expense increased from 26.0% to 26.3%. The absolute increase in cost of sales and medical supplies expense is primarily a result of 2002 acquisitions offset in part by the closure of under-performing LVC centers. The increase in cost of sales and medical supplies as a percentage of revenue is due to our lower profit margin product sales and other revenue increasing to 37.4% of total revenue in 2002, up from 36.8% in 2001.

Selling, General and Administrative. Selling, general and administrative expense decreased 2.9% from $11.9 million to $11.5 million. As a percentage of revenue, selling, general and administrative expense decreased from 22.2% to 21.4%. The decrease was the result of a $1.3 million reduction in corporate administrative expenses and bad debt expense, offset by expenses from our 2002 acquisitions.

Restructuring and Other Charges. We reevaluated our restructuring plan at the end of 2002 and determined we had excess reserves of $1.0 million. The excess reserves were primarily due to better than expected results resolving outstanding lease obligations and the decision to retain one ASC slated for closure.

Depreciation and Amortization. Depreciation and amortization expense decreased 43.9% from $4.4 million to $2.5 million. The required cessation of goodwill amortization as of January 1, 2002 contributed $1.1 million of this decrease. The remainder of the decrease is due to the write-off of assets at the end of our 2001 third quarter related to our discontinued operations and restructuring plan.

Other (Income) Expense. We recognized $0.9 million of other income during 2002 versus $1.0 million of other expense during 2001. The current year income includes an aggregate gain of $1.6 million from the sales of minority interests in our ASCs and $0.4 million of income from proceeds received from a class action lawsuit settlement. There is $0.9 million of minority interest in the earnings of our ASCs reported in 2002. Interest expense decreased by $0.5 million, the result of lower average interest rates during 2002 (5.1%) as compared to 2001 (6.5%) as well as lower average borrowing of $10.2 million during 2002 as compared to $25.7 million during 2001.

Provision for Income Taxes. Our effective tax rate increased to 40.0% from 39.3%. Our effective tax rate is affected by expenses that are deducted from operations in arriving at pre-tax income that are not allowed as a deduction on our federal income tax return.

Liquidity and Capital Resources

Operating activities for 2003 generated $9.6 million in cash flow from continuing operations compared to $12.4 million in 2002. The decrease in operating cash flow from continuing operations resulted primarily from an increase in accounts receivable and cash distributions to our minority interest partners. The increase in accounts receivable related to higher billings and a reduction in our bad debt reserve requirements within the product sales segment. The decrease in operating cash flow was partially offset by a $3.6 million tax refund received during 2003 compared to the $1.5 million received during 2002.

Investing activities in 2003 resulted in positive cash flow of $13,000. Investing activities include proceeds from the sale of minority equity interests in our ASCs of $1.9 million and proceeds from a new minority interest partner in conjunction with the development of a new ASC of $0.7 million. These proceeds were offset by the purchase of property and equipment of $2.9 million, $1.3 million of which relates to the new ASC referred to above. We also received 261,000 shares of our common stock from the sale of minority interests in three of our ASCs. As of December 31, 2003 and 2002, we had cash and cash equivalents of $11.8 million and $2.0 million, respectively, and working capital of $16.9 million and $7.2 million, respectively.

During 2003, we completed five divestiture transactions and received total cash proceeds of $1.7 million and 756,500 shares of our common stock. We also received as consideration 227,300 shares of our common stock in repayment of a note receivable from one of our 2002 divestiture transactions.

At December 31, 2003, we had no borrowings outstanding under our revolving credit facility. We entered into a new amended and restated credit facility effective June 26, 2003. The maximum commitment available under our facility is $30 million. Interest on borrowings under the credit agreement is payable at an annual rate equal to our lender’s published base rate plus the applicable borrowing margin ranging from 0% to .5% or LIBOR plus a range from 1.25% to 2.0%, varying upon our ability to meet financial covenants. In addition, a fee ranging from .175% to .250% is charged on the unused portion of the commitment. The credit agreement contains covenants that include limitations on indebtedness, liens, capital expenditures, acquisitions and affiliations and ratios that define borrowing availability and restrictions on the payment of dividends. As of December 31, 2003, we were in compliance with all of our credit agreement covenants. The credit agreement expires on June 30, 2006.

We expect our cash flow from operations, our existing cash balance and funds available under our existing credit facility to be sufficient to fund our operations for at least 12 months. Our future capital requirements and the adequacy of our available funds will depend on many factors, including the timing of our acquisition and expansion activities, capital requirements associated with our surgical facilities, and the future cost of surgical equipment.

We are a party to option agreements with various physicians pursuant to which the physicians have the right to purchase or sell equity interests in six of our 17 ASCs. These are summarized as follows:

•

An entity owned in part by two former affiliated doctors has the option to purchase a 10% interest in our New Albany, IN ASC by April 1, 2004. We have received notice of their intention to purchase and anticipate finalizing the transaction on or before April 1, 2004;

•

One of our former affiliated physicians who owns a 5% interest in our River Forest, IL ASC has the option to acquire an additional 5% interest, exercisable on or before July 1, 2005;

•

Two of our former affiliated physicians who own a 49% interest in our Overland Park, KS ASC have an option to purchase our remaining 51% interest, exercisable on April 15, 2005;

•

One of our former affiliated physicians who owns a 49% interest in our Merrillville, IN ASC has an option to purchase our remaining 51% interest, exercisable at periodic intervals beginning March 1, 2005 through March 1, 2008;

•

One of our existing physician-partners who owns a 40% interest in our Thibodaux, LA ASC has the right to sell us up to a 10% interest in the ASC in November 2004 and up to an additional 10% interest in November 2006; and

•

One of our former affiliated physicians has an option to purchase a 10% interest in our wholly owned Florissant, MO ASC, exercisable on or before July 31, 2004.

In the event these options are exercised, we will receive cash proceeds from these sales. In many of these instances, we also have corresponding rights to sell the stated equity interests to the physicians at the same timing intervals. Moreover, depending on the circumstances, we may also agree in the future from time to time to sell equity interests in one or more of our ASCs to the physicians who are parties to these option agreements on terms and at timing intervals different than those set forth in these agreements.

We have a nonexclusive supply agreement with Alcon Laboratories, Inc. pursuant to which we can procure and utilize excimer lasers and other equipment manufactured by Alcon. Through the termination date of December 31, 2006, we will pay Alcon monthly based on the number of procedures performed on each of our APEX/Infinity lasers and LADARVision Systems. We are required to pay for a minimum number of annual procedures on each LADARVision System during the remaining term, whether or not these procedures are performed. Assuming we don’t procure additional LADARVision Systems under the agreement, the annual minimum commitment for each of the next three years commencing with 2004 would be approximately $1.0 million, $1.2 million and $0.9 million, respectively.

Contractual Obligations and Commitments

We have various contractual obligations which are recorded as liabilities in our consolidated financial statements. Other items, such as certain purchase commitments are not recognized as liabilities in our consolidated financial statements but are required to be disclosed. For example, we are contractually committed to make certain minimum lease payments for the use of property under operating lease agreements. The following table summarizes our significant contractual obligations and commitments at December 31, 2003 and the future periods in which such obligations are expected to be settled in cash.

	Payments due by period (dollars in thousands)
Contractual Obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Capital lease	$	165	$	86	$	79	$	—	$	—
Operating lease		11,013		2,838		4,289		2,477		1,409
Purchase commitments		3,566		1,280		2,286		—		—
Total	$	14,744	$	4,204	$	6,654	$	2,477	$	1,409

	Expiration by period (dollars in thousands)
Commercial Commitments	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Letter of Credit	$	215	$	215	$	—	$	—	$	—
Total	$	215	$	215	$	—	$	—	$	—

New Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). In December 2003, the FASB issued a new version of FIN 46. FIN 46, in both its original and revised versions, provides a framework for identifying variable interest entities (“VIEs”) and determining when a company should consolidate a VIE for financial reporting purposes. FIN 46 was initially effective for VIEs created after January 31, 2003, with the provisions of the revised FIN 46 effective for periods ending after December 15, 2003. The adoption of FIN 46 did not have an impact on our financial position or results of operations.

In December 2002, the FASB Issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123. This pronouncement provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS 123 to require prominent disclosure of the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. We have elected to continue to apply APB Opinion 25 and account for stock-based compensation under the intrinsic value method. We have amended our disclosures to those required by SFAS 148.

Risk Factors

The following factors should be considered in evaluating our company and our business. These factors may have a significant impact on our business, operating results and financial condition.

Exhibit Number		Exhibit
3.1	†	Amended and Restated Certificate of Incorporation of the
		Registrant
3.2	††	Amended and Restated Bylaws of the Registrant
3.3		Certificate of Ownership and Merger
4.1	†	Specimen stock certificate representing Common Stock
4.2	†	Registrant’s Rights Agreement
10.1	††	Registrant’s Amended and Restated Stock Incentive Plan
10.2	†	Registrant’s Amended and Restated 1999 Stock Purchase Plan
10.3	†	Indemnification Agreement
10.4	†	Registration Rights Agreement
10.5	†	Subordinated Registration Rights Agreement
10.15	†	Registrant’s 401(k) Plan
10.23	†††*	Alcon Laboratories, Inc. Agreement
10.24	††††	Employment Agreement dated August 17, 2001 with Stephen J. Winjum
10.25	††††	Employment Agreement dated August 17, 2001 with E. Michele Vickery
10.27	†††††	Employment Agreement dated October 16, 2001 with Scott T. Macomber
10.31	††††††††	Registrant’s 2000 Employee Stock Incentive Plan
10.32	††††††††	Registrant’s 2001 Employee Stock Incentive Plan
10.33	††††††*	Amendment No. 1 to Alcon Laboratories, Inc. Agreement
10.34	†††††††	Third Amended and Restated Credit Agreement dated as of June 26, 2003
21		Subsidiaries of the Registrant
23.1		Consent of PricewaterhouseCoopers LLP
31.1		Certification by the CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification by the CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Certification of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	December 31, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents, including $149 and $143 of restricted cash, respectively	$	11,801		$	1,957
Accounts receivable, net of allowances of $7,611 and $6,033, respectively		8,219			7,060
Notes and amounts due from affiliated providers		1,089			1,280
Notes receivable from related parties		597			1,289
Inventory		1,397			1,020
Current deferred tax assets, net and tax receivables		542			2,940
Other current assets		1,107			1,175
Current assets of discontinued operations		—			2,575
Total current assets		24,752			19,296
Property and equipment, net		7,918			7,008
Intangible assets, net		26,749			26,756
Noncurrent deferred tax assets, net		4,130			7,861
Other assets, net		339			1,406
Noncurrent assets of discontinued operations, net		—			1,801
Total assets	$	63,888		$	64,128

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,078		$	4,033
Accrued expenses		2,374			3,317
Restructuring reserves		260			784
Current maturities of long-term debt		80			92
Current liabilities of discontinued operations		1,068			3,844
Total current liabilities		7,860			12,070
Long-term debt, net of current maturities		74			11
Minority interest		5,841			3,399
Commitments and contingencies
Stockholders’ equity:
Series E Junior Participating Preferred Stock, $0.01 par value, 1,912,000 shares authorized, none outstanding at December 31, 2003 and 2002, respectively		—			—
Common stock, $0.01 par value, 81,761,465 shares authorized, 25,046,195 and 24,905,507 shares issued at December 31, 2003 and 2002, respectively		250			249
Additional paid-in-capital		77,964			77,753
Accumulated deficit		(23,641	)		(27,132	)
Treasury stock, at cost, 3,843,399 and 2,473,640 shares at December 31, 2003 and 2002, respectively		(4,460	)		(2,222	)
Total stockholders’ equity		50,113			48,648
Total liabilities and stockholders’ equity	$	63,888		$	64,128

	Years Ended December 31,
	2003			2002			2001
Net revenue:
Surgical facilities	$	36,410		$	33,665		$	33,786
Product sales and other		19,096			20,108			19,654
Total net revenue		55,506			53,773			53,440
Operating expenses:
Salaries, wages and benefits		20,297			20,158			21,359
Cost of sales and medical supplies		13,395			14,146			13,905
Selling, general and administrative		11,760			11,515			11,856
Depreciation and amortization		2,677			2,461			4,390
Restructuring charges		—			(1,005	)		10,912
Other charges		—			—			1,710
Goodwill impairment charge		—			1,336			—
Total operating expenses		48,129			48,611			64,132
Income (loss) from continuing operations		7,377			5,162			(10,692	)
Other (income) expense:
Interest expense		119			414			965
Interest income		(131	)		(157	)		(58	)
Minority interests in earnings of consolidated entities		2,656			906			28
Gain on sale of minority interests		(892	)		(1,584	)		—
Other		(181	)		(513	)		57
Total other (income) expense		1,571			(934	)		992
Income (loss) from continuing operations before income taxes		5,806			6,096			(11,684	)
Income tax provision (benefit)		2,322			2,439			(4,591	)

Net income (loss) from continuing operations		3,484			3,657			(7,093	)
Net income from discontinued operations, net of tax		7			206			1,709
Net loss on disposal of discontinued operations, net of tax		—			(1,850	)		(27,213	)
Cumulative effect of change in accounting principle, net of tax		—			(1,803	)		—
Net income (loss)	$	3,491		$	210		$	(32,597	)

Net earnings (loss) per common share from continuing operations:
Basic	$	0.16		$	0.15		$	(0.29	)
Diluted	$	0.16		$	0.15		$	(0.29	)
Net earnings (loss) per common share:
Basic	$	0.16		$	0.01		$	(1.32	)
Diluted	$	0.16		$	0.01		$	(1.32	)

	Years Ended December 31,
	2003			2002			2001
Cash flows from operating activities:
Net income (loss) from continuing operations	$	3,484		$	3,657		$	(7,093	)
Adjustments to reconcile net income (loss) to net cash provided by continuing operations, net of effects of purchase transactions:
Depreciation and amortization		2,677			2,461			4,390
Restructuring and other charges		—			(1,005	)		12,622
Impairment charge		—			1,336			—
Gain on sale of minority interests		(892	)		(1,584	)		—
Deferred taxes		2,322			2,439			(5,357	)
Minority interests		2,656			906			28
Distributions to minority partners		(2,212	)		(109	)		—
Changes in operating assets and liabilities —
Accounts receivable		(1,095	)		1,702			2,661
Inventory		(342	)		33			729
Other current assets		3,900			1,445			75
Other noncurrent assets		221			(41	)		(561	)
Accounts payable, accrued expenses and income taxes payable		(1,122	)		1,167			(2,528	)
Net cash provided by continuing operations		9,597			12,407			4,966
Cash flows from investing activities:
Purchases of property and equipment		(2,893	)		(1,844	)		(1,300	)
Acquisitions of and affiliations with entities, net		—			(6,151	)		(1,360	)
Proceeds from sale of minority interests		2,575			2,797			—
Proceeds from sale of property and equipment		331			—			—
Issuance of notes receivable to affiliated providers		—			—			(37	)
Net cash provided by (used in) investing activities		13			(5,198	)		(2,697	)
Cash flows from financing activities:
Borrowings under revolving credit agreement		825			33,085			42,515
Payments under revolving credit agreement		(825	)		(53,780	)		(48,213	)
Proceeds from the issuance of stock, net of issuance costs		171			44			236
Other long-term debt and capital lease obligations		(170	)		(465	)		(255	)
Net cash provided by (used in) financing activities		1			(21,116	)		(5,717	)
Cash flows from discontinued operations:
Operating activities		(2,496	)		2,164			4,722
Investing activities		2,729			12,766			(1,060	)
Financing activities		—			(33	)		(32	)
Net cash provided by discontinued operations		233			14,897			3,630
Net increase in cash and cash equivalents		9,844			990			182
Cash and cash equivalents, beginning of year		1,957			967			785
Cash and cash equivalents, end of year	$	11,801		$	1,957		$	967

Year ended December 31 (in thousands),	2003		2002
Optical products	$	902	$	717
Surgical supplies		395		238
Other		100		65
Total inventory	$	1,397	$	1,020

	Common Stock									Treasury Stock
	Shares		Par Value		Additional Paid-In Capital		Retained Earnings (Accumulated) (Deficit)			Shares			At Cost			Total Stockholders’ Equity
Balance, December 31, 2000		24,679	$	247	$	77,362	$	5,255			—		$	—		$	82,864
Stock options exercised/sold		79		1		193		—			—			—			194
Shares issued — employee stock purchase plan		77		—		118		—			—			—			118
Net loss		—		—		—		(32,597	)		—			—			(32,597	)
Balance, December 31, 2001		24,835		248		77,673		(27,342	)		—			—			50,579
Shares received as consideration in divestiture transactions		—		—		—		—			(2,473	)		(2,222	)		(2,222	)
Stock options granted		—		—		36		—			—			—			36
Shares issued — employee stock purchase plan		70		1		44		—			—			—			45
Net income		—		—		—		210			—			—			210
Balance, December 31, 2002		24,905		249		77,753		(27,132	)		(2,473	)		(2,222	)		48,648
Shares received as consideration in divestiture transactions		—		—		—		—			(1,370	)		(2,238	)		(2,238	)
Stock options exercised		101		1		171		—			—			—			172
Shares issued — employee stock purchase plan		40		—		40		—			—			—			40
Net income		—		—		—		3,491			—			—			3,491
Balance, December 31, 2003		25,046	$	250	$	77,964	$	(23,641	)		(3,843	)	$	(4,460	)	$	50,113

	2003			2002			2001
Net income (loss) — as reported	$	3,491		$	210		$	(32,597	)
Deduct: Total stock-based employee compensation expense, net of related tax effects		(1,452	)		(1,461	)		(1,633	)
Pro forma net income (loss)	$	2,039		$	(1,251	)	$	(34,230	)
Earnings (loss) per share:
Basic — as reported	$	0.16		$	0.01		$	(1.32	)
Basic — pro forma	$	0.09		$	(0.05	)	$	(1.38	)
Diluted — as reported	$	0.16		$	0.01		$	(1.32	)
Diluted — pro forma	$	0.09		$	(0.05	)	$	(1.38	)


Expected option life in years	4		4		4
Risk-free interest rate	2.44	%	4.30	%	4.36	%
Dividend yield	—		—		—
Expected volatility	.830		.940		1.00

	December 31, 2003		December 31, 2002
Accounts and notes receivable	$	—	$	2,190
Inventories		—		242
Other current assets		—		143
Current assets of discontinued operations	$	—	$	2,575
Net property and equipment	$	—	$	756
Intangible assets		—		1,045
Noncurrent assets of discontinued operations	$	—	$	1,801
Accounts payable	$	—	$	216
Accrued expenses		—		356
Notes payable and capitalized lease obligations		—		1
Discontinued operations reserves		1,068		3,271
Current liabilities of discontinued operations	$	1,068	$	3,844

Acquisition	Location	Effective Date	Purchase Price
2002
ASC (51%)	Colorado Springs, CO	June 2002	$1.4 million
ASC (60%)	Tyler, TX	September 2002	$4.7 million
2001
ASC (60%)	Thibodaux, LA	November 2001	$1.4 million

	Year ended December 31,
	2002		2001
Pro forma net revenue	$	57,091	$	54,199
Pro forma continuing net income (loss)		4,120		(6,997	)
Pro forma continuing earnings (loss) per common share:
Basic		0.17		(0.28	)
Diluted		0.17		(0.28	)

Location
Richmond, VA	10	%	January 2003
Chicago, IL	17.5	%	February 2003
Maryville, IL	10	%	February 2003
Richmond, VA	10	%	September 2003
Maryville, IL	10	%	September 2003
Kansas City, MO	49	%	October 2003
Chicago, IL	3	%	December 2003
New Albany, IN	20	%	December 2003

	2003			2002
Equipment	$	12,882		$	11,945
Information technology		1,729			831
Furniture and fixtures		905			720
Leasehold improvements		2,959			1,662
		18,475			15,158
Less—Accumulated depreciation and amortization		(10,557	)		(8,150	)
	$	7,918		$	7,008

	Unamortized Goodwill
	Surgical Facilities			Product Sales			Other			Total			Amortized Intangibles
Balance January 1, 2001	$	14,744		$	9,899		$	980		$	25,623		$	—
Acquisition of ASCs		1,251			—			—			1,251			—
Goodwill written-off — restructuring		(866	)		—			—			(866	)		—
Amortization		(665	)		(334	)		(39	)		(1,038	)		—
Balance December 31, 2001		14,464			9,565			941			24,970			—
Acquisition of ASCs		5,876			—			—			5,876			—
Impairment losses		—			(4,090	)		—			(4,090	)		—
Balance December 31, 2002		20,340			5,475			941			26,756			—
Two year non-compete agreement		—			—			—			—			43
Purchase price adjustments		(29	)		—			—			(29	)		—
Amortization		—			—			—			—			(21	)
Balance December 31, 2003	$	20,311		$	5,475		$	941		$	26,727		$	22

	2003		2002
Accrued payroll and related benefits	$	779	$	883
Accrued incentive compensation		722		922
Accrued business taxes		243		413
Accrued professional fees, deferred revenue and other		630		1,099
	$	2,374	$	3,317

	Lease Commitments			Asset Impairments			Contract Termination			Other			Total
Initial reserves	$	2,224		$	6,599		$	1,851		$	238		$	10,912
Charges utilized in 2001		(51	)		(6,396	)		(15	)		(141	)		(6,603	)
Balance December 31, 2001		2,173			203			1,836			97			4,309
Charges utilized in 2002		(729	)		(53	)		(1,702	)		(36	)		(2,520	)
Reversal of excess reserves		(851	)		(95	)		(134	)		75			(1,005	)
Balance December 31, 2002		593			55			—			136			784
Charges utilized in 2003		(320	)		(5	)		—			(199	)		(524	)
Re-evaluated requirements		(130	)		44			—			86			—
Balance December 31, 2003	$	143		$	94		$	—		$	23		$	260

	2003		2002		2001
Current
Federal	$	—	$	—	$	(972	)
State		—		—		(129	)
		—		—		(1,101	)
Deferred
Federal		1,967		2,134		(3,083	)
State		355		305		(407	)
		2,322		2,439		(3,490	)
	$	2,322	$	2,439	$	(4,591	)


Tax expense at U.S. statutory rate	34.0	%	34.0	%	34.0	%
Intangible asset amortization	—		—		(1.5	)
State taxes, net	4.8		4.8		4.5
Other	1.2		1.2		2.3
Provision for income taxes	40.0	%	40.0	%	39.3	%

	2003			2002
Current deferred tax assets (liabilities)
Discontinued operations and restructuring	$	742		$	2,793
Receivable and inventory reserves		126			216
Net operating loss carryback claim		—			204
Compensation expense		56			159
Prepaid expense		(383	)		(463	)
Other		1			31
		542			2,940
Long-term deferred tax assets (liabilities)
Discontinued operations and restructuring		3,358			3,895
Depreciation and amortization		(2,038	)		(1,592	)
Goodwill impairment charges		1,613			1,527
Net operating loss carryforward / carryback		2,038			4,730
Capital loss carryforward		1,589			1,847
Compensation expense related to stock options		369			357
Discount on conversion of notes		267			299
AMT credit		208			—
Other		51			123
		7,455			11,186
Valuation allowance		(3,325	)		(3,325	)
		4,130			7,861
	$	4,672		$	10,801

	2003			2002
Capital lease obligations (see Note 12)	$	154		$	103
Less — Current maturities		(80	)		(92	)
	$	74		$	11

	Operating Leases			Capital Leases
2004	$	2,838		$	86
2005		2,413			41
2006		1,876			38
2007		1,342			—
2008 and thereafter		2,544			—
Minimum lease payments		11,013			165
Less: sublease receipts		(296	)		—
Total minimum lease payments	$	10,717			165
Less: amount representing interest					(11	)
Total obligation under capital leases				$	154

			Price Per Share		Weighted Average Exercise Price
Balance at December 31, 2000	5,481,442		$	1.06–$14.94	$	4.53
Granted	1,953,000		$	1.15–$ 2.84	$	1.63
Exercised	(79,074	)	$	1.25–$ 1.88	$	1.48
Canceled	(1,076,777	)	$	1.25–$13.88	$	4.99

Balance at December 31, 2001	6,278,591		$	1.06–$14.94	$	3.52
Granted	1,148,500		$	0.74–$ 1.10	$	0.80
Exercised	—					—
Canceled	(1,109,136	)	$	0.74–$14.94	$	4.24

Balance at December 31, 2002	6,317,955		$	0.74–$12.61	$	2.90
Granted	523,000		$	1.27–$ 2.15	$	1.37
Exercised	(100,550	)	$	0.78–$ 1.75	$	1.30
Canceled	(605,926	)	$	0.78–$12.00	$	5.56

Balance at December 31, 2003	6,134,479		$	0.74–$12.61	$	2.53

	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number Outstanding at 12/31/03		Average Life		Average Exercise Price		Number Exercisable at 12/31/03		Average Exercise Price
$ 0.74–$ 1.10		1,040,876		8.3	$	0.80		433,253	$	0.80
$ 1.15–$ 1.70		1,803,491		5.9		1.33		1,134,294		1.32
$ 1.75–$ 2.50		2,216,088		4.9		1.87		1,862,260		1.88
$ 2.74–$ 4.00		195,250		4.0		3.44		185,145		3.48
$ 4.38–$ 6.00		340,634		5.1		5.15		340,471		5.15
$ 6.75–$10.00		199,296		5.9		8.24		188,027		8.25
$12.00–$12.61		338,844		6.1		12.02		318,109		12.02
$0.74–$12.61		6,134,479		5.8	$	2.53		4,461,559	$	2.94

(in thousands)	Surgical Facilities		Product Sales		Other			Corporate			Total
2003
Net revenue	$	36,410	$	10,871	$	8,225		$	—		$	55,506
Earnings (loss) before taxes		9,383		2,150		(164	)		(5,563	)		5,806
Depreciation and amortization		1,778		287		131			481			2,677
Interest income		2		1		—			128			131
Interest expense		2		—		1			116			119
Capital expenditures		2,524		143		87			139			2,893
Identifiable assets		30,539		10,720		2,521			20,108			63,888
2002
Net revenue	$	33,665	$	11,649	$	8,459		$	—		$	53,773
Earnings (loss) before taxes		10,349		81		484			(4,818	)		6,096
Depreciation and amortization		1,481		274		121			585			2,461
Interest income		7		1		—			149			157
Interest expense		6		—		1			407			414
Capital expenditures		1,444		278		73			49			1,844
Identifiable assets		29,208		10,151		2,234			22,535			64,128
2001
Net revenue	$	33,786	$	11,740	$	7,914		$	—		$	53,440
Earnings (loss) before taxes		9,049		819		721			(22,273	)		(11,684	)
Depreciation and amortization		2,617		595		124			1,054			4,390
Interest income		—		4		—			54			58
Interest expense		12		2		—			951			965
Identifiable assets		24,391		13,790		2,989			51,082			92,252

	Quarter
2003	First		Second		Third		Fourth
Net revenue	$	13,503	$	14,018	$	14,374	$	13,611
Income from continuing operations		1,396		1,978		2,175		1,828
Net income from operations:
Continuing		559		790		799		1,336
Discontinued		4		—		1		2
Net income (loss)		563		790		800		1,338
Basic earnings (loss) per share		0.03		0.04		0.04		0.06
Diluted earnings (loss) per share		0.03		0.04		0.04		0.06

Allowance for contractual adjustments and bad debt	Balance at beginning of period					Balance at end of period
2001	$	3,697	30,838	(26,525	)	$	8,010
2002	$	8,010	35,850	(37,827	)	$	6,033
2003	$	6,033	52,582	(51,004	)	$	7,611

				NOVAMED, INC.

				By: /S/ STEPHEN J. WINJUM Stephen J. Winjum President, Chief Executive Officer and Chairman of the Board of Directors

Signature				Title
/S/ STEPHEN J. WINJUM Stephen J. Winjum				President, Chief Executive Officer (Principal Executive Officer), Chairman of the Board of Directors, and a Director
/S/ SCOTT T. MACOMBER Scott T. Macomber				Executive Vice President and Chief Financial Officer (Principal Financial Officer)
/S/ JOHN P. HART John P. Hart				Vice President Corporate Controller (Principal Accounting Officer)
/S/ R. JUDD JESSUP R. Judd Jessup				Director
/S/ SCOTT H. KIRK Scott H. Kirk, M.D.				Director
/S/ STEVEN V. NAPOLITANO Steven V. Napolitano				Director
/S/ C.A. LANCE PICCOLO C.A. Lance Piccolo				Director