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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

____________________

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2003

Commission File Number 000-33009

____________________

MEDCATH CORPORATION

10720 Sikes Place, Suite 300
Charlotte, North Carolina 28277

(704) 708-6600

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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o      No x

As of July 31, 2003, there were 17,942,620 shares of $0.01 par value common stock outstanding.

MEDCATH CORPORATION

FORM 10-Q

TABLE OF CONTENTS

2

PART 1. FINANCIAL INFORMATION

MEDCATH CORPORATION

See notes to consolidated financial statements.

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MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

See notes to consolidated financial statements.

4

MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
(Unaudited)

See notes to consolidated financial statements.

5

MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

See notes to consolidated financial statements.

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All tables in thousands, except per share)

1.   Business and Organization

     MedCath Corporation (the Company) primarily focuses on the diagnosis and treatment of cardiovascular disease. The Company designs, develops, owns and operates hospitals in partnership with physicians, most of whom are cardiologists and cardiovascular surgeons. While each of the Company’s hospitals (collectively, the Hospital Division) is licensed as a freestanding, licensed general acute care hospital that includes an emergency department, pharmacy, clinical laboratory, radiology department, cardiac catheterization laboratories and operating rooms and is capable of providing a full complement of health services, the Company focuses on serving the unique needs of patients suffering from cardiovascular disease. As of June 30, 2003, the Company owned and operated ten hospitals, together with its physician partners, who own an equity interest in the hospital where they practice. The Company accounts for all but one of its owned and operated hospitals as consolidated subsidiaries. The Company owns a minority interest in Heart Hospital of South Dakota and does not have substantive control over the hospital, and therefore is unable to consolidate the hospital’s results of operations and financial position, but rather is required to account for its minority ownership interest in the hospital as an equity investment. The Company’s ten existing hospitals have a total of 635 licensed beds, of which 540 were staffed and available as of June 30, 2003. These hospitals are located in Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota and Texas. The Company is currently in the process of developing three hospitals, which include a hospital located in the city of Glendale, near Milwaukee, Wisconsin, a hospital located in Lafayette, Louisiana and a hospital located in San Antonio, Texas. In addition to its hospitals, the Company provides cardiovascular care services in diagnostic and therapeutic facilities in various locations and through mobile cardiac catheterization laboratories (the Diagnostics Division). The Company also provides consulting and management services (CCM) tailored primarily to cardiologists and cardiovascular surgeons, which is included in the corporate and other division.

2.   Summary of Significant Accounting Policies

     Basis of Presentation - The Company’s unaudited interim consolidated financial statements as of June 30, 2003 and for the three months and nine months ended June 30, 2003 and 2002, have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These unaudited interim consolidated financial statements reflect, in the opinion of management, all material adjustments (consisting only of normal recurring adjustments) necessary to fairly state the results of operations and financial position for the periods presented. All intercompany transactions and balances have been eliminated. The results of operations for the three months and nine months ended June 30, 2003 are not necessarily indicative of the results expected for the full fiscal year ending September 30, 2003 or future fiscal periods.

     Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the SEC, although the Company believes the disclosure is adequate to make the information presented not misleading. The accompanying unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002.

     Reclassifications – Certain prior period amounts have been reclassified to conform to the current period presentation.

     Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. There is a reasonable possibility that actual results may vary significantly from those estimates.

     Pre-opening Expenses – Pre-opening expenses consist of operating expenses incurred during the development of a new venture and prior to its opening for business. Such costs specifically relate to ventures under development and are expensed as incurred. The Company recognized pre-opening expenses of approximately $1.9 million and $2.0 million during the three months ended June 30, 2003 and 2002, respectively, and $7.0 million and $4.1 million during the nine months ended June 30, 2003 and 2002, respectively.

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

     Stock-Based Compensation – At June 30, 2003, the Company has two stock-based compensation plans, including a stock option plan under which it may grant incentive stock options and nonqualified stock options to officers and other key employees and an outside director’s stock option plan under which it may grant nonqualified stock options to nonemployee directors. The Company accounts for stock options under both of these plans in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, as permitted by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Under APB Opinion No. 25, compensation cost is determined based on the intrinsic value of the equity instrument award. No stock-based employee compensation cost is reflected in net income for the three months and nine months ended June 30, 2003 and 2002, as all options granted during those periods under the Company’s stock option plans had an exercise price equal to the market value of the underlying common stock at the date of grant. If the Company had applied the fair value recognition provisions of SFAS No. 123 to account for its stock option plans, then the Company’s net income and earnings per share for the three months and nine months ended June 30, 2003 and 2002 would have been as follows:

     Accounting Changes – Effective October 1, 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement (i) superceded SFAS No. 121, although it retained most of the basic requirements of SFAS No. 121 regarding long-lived assets to be held and used; (ii) resolved some implementation issues related to SFAS No. 121; and (iii) superceded the accounting and reporting provisions of APB Opinion No. 30 for the disposal of a segment of a business to establish a single accounting model, based on the framework of SFAS No. 121, for long-lived assets to be disposed of by sale. This Statement also amended ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company’s adoption and application of SFAS No. 144 did not have any impact on its financial position and results of operations as of and for the three months and nine months ended June 30, 2003.

     In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. Other than the provisions related to the rescission of SFAS No. 4, the Company adopted and applied the provision of this Statement for transactions occurring and financial statements issued after May 15, 2002, as required by the Statement. The Company adopted the provisions related to the rescission of SFAS No. 4, which change the accounting for the classification of gains or losses from extinguishment of debt, effective October 1, 2002, also as required by the Statement. The Company’s adoption and application of these remaining provisions of SFAS No. 145 did not have any impact on its financial position and results of operations as of and for the three months and nine months ended June 30, 2003.

     In November 2002, the FASB issued Interpretation (FIN) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of SFAS No. 5, 57, and 107 and rescission of FIN No. 34. The objective of FIN No. 45 is to record the fair value of a guarantee at

8

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

inception and require disclosure of all such guarantees in interim and annual financial statements. The initial recognition and initial fair value measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company’s adoption and application of FIN No. 45 did not have any material impact on the Company’s financial position and results of operations as of and for the three months and nine months ended June 30, 2003. See Note 5 for disclosures regarding the Company’s guarantees as required by FIN No. 45.

     In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation. This Statement amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results of operations. The transition provisions of this Statement were effective for the Company beginning December 15, 2002, but did not have any significant impact on the Company’s financial position and results of operations for the three months and nine months ended June 30, 2003 as the Company continued to account for its stock options in accordance with APB No. 25. The Company elected to early adopt the remaining disclosure requirements of this Statement, which are provided above for the three months and nine months ended June 30, 2003.

     In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and it establishes that fair value is the objective for initial measurement of the liability. This Statement nullifies Emerging Issues Task Force Issue (EITF) No. 94-3. Under the previous guidance of EITF No. 94-3, a liability for certain exit costs, as defined in that Issue, was recognized at the date of an entity’s commitment to an exit plan, which is generally before an actual liability has been incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. As of and for the six months ended June 30, 2003, the Company was not engaged in any exit or disposal activities.

     Recent Accounting Pronouncements – In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (i) does not have equity investors with voting rights or (ii) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. FIN No. 46 is effective for variable interest entities created after January 31, 2003. FIN No. 46 applies in the first full fiscal year or interim period beginning after June 15, 2003 for older variable interest entities, with public companies required to apply FIN No. 46 as of the beginning of that applicable interim or annual period. The Company is currently evaluating the impact, if any, of the adoption of FIN No. 46.

     In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies the accounting for and definition of derivative instruments and hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003 and should generally be applied prospectively. The Company does not expect the adoption and application of SFAS No. 149 will have a significant impact on its financial position, results of operation and cash flows.

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, for all other instruments. As of June 30, 2003, the Company does not have any financial instruments outstanding that are subject to SFAS No. 150, and therefore does not expect the adoption and application of SFAS No. 150 will have a significant impact on its financial position, results of operation and cash flows.

9

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

3.   Goodwill and Other Intangible Assets – SFAS No. 142

     The Company elected to early adopt SFAS No. 142 on October 1, 2001, the beginning of fiscal year 2002. At that time, the Company reassessed the useful lives of its intangible assets and concluded that the existing finite useful lives were reasonable and appropriate. The Company also completed the transitional goodwill impairment test and its annual goodwill impairment test of all of its reporting units as required by SFAS No. 142, which did not result in any impairment loss as measured on October 1, 2001 and September 30, 2002, respectively. Therefore, the only impact adopting SFAS No. 142 had on the Company’s financial position, results of operations and cash flows was the immediate discontinuance of amortization on approximately $132.6 million of recorded goodwill at October 1, 2001. The Company has designated September 30, its fiscal year end, as the date it will perform the annual goodwill impairment test for all of its reporting units as required by SFAS No. 142. Goodwill of a reporting unit will also be tested between annual tests if an event occurs or circumstances change that indicate an impairment may exist. In March 2003, the Company determined that the decline in its market capitalization, as measured by its public stock price, since September 30, 2002 represented an event requiring an interim goodwill impairment test to be performed as required by SFAS No. 142. Accordingly, the Company engaged an independent third-party valuation firm to assist in performing the goodwill impairment test, specifically as it related to calculating the fair value of each of the Company’s reporting units as of the March 1, 2003 testing date pursuant to SFAS No. 142. The results of this independent valuation concluded that the calculated fair value of each of the Company’s reporting units exceeded their carrying value, thus no goodwill impairment existed under SFAS No. 142. The Company will perform its next goodwill impairment test as of September 30, 2003, consistent with its previously designated annual testing date, unless other events occur or circumstances change that indicate an impairment may exist before that date.

     During the three months ended June 30, 2003, the Company restructured one of its two physician management contracts in its CCM operations. In connection with this contract change, the Company determined it was necessary and appropriate under SFAS No. 142 to extend the useful lives of its intangible assets related to its physician management contracts. As of June 30, 2003, the remaining useful lives for these intangible assets was 45 months.

4.   Business Development and Changes in Operations

     Acquisitions During the Nine Months Ended June 30, 2003 – Effective April 1, 2003, the Company acquired an additional 3% ownership interest in Heart Hospital of New Mexico from its hospital investor partner for $800,000. As a result of this transaction, the hospital investor partner no longer holds any ownership interest in Heart Hospital of New Mexico, and the Company’s ownership interest increased from 69.0% to 72.0%, with the physician investors owning the remaining 28.0%.

     New Hospital Development – On February 28, 2003, the Company opened Louisiana Heart Hospital in St. Tammany Parish just north of New Orleans, Louisiana. This hospital focuses primarily on cardiovascular care. On March 27, 2003, Louisiana Heart Hospital received its Medicare certification. Louisiana Heart Hospital is accounted for as a consolidated subsidiary because the Company, through its wholly-owned subsidiaries, owns an approximate 51% interest in the venture, with physician investors owning the remaining 49%, and the Company exercises substantive control over the hospital.

     On October 2, 2002, the Company opened Harlingen Medical Center in Harlingen, Texas. This hospital focuses on cardiovascular care as well as orthopedics, neurology, obstetrics and gynecology. On October 23, 2002, Harlingen Medical Center received its Medicare certification. Harlingen Medical Center is accounted for as a consolidated subsidiary because the Company, through its wholly-owned subsidiaries, owns an approximate 51% interest in the venture, with physician investors owning the remaining 49%, and the Company exercises substantive control over the hospital.

     In February 2002, the Company announced a venture to develop and construct the Heart Hospital of Lafayette, which will be located in Lafayette, Louisiana. Heart Hospital of Lafayette is accounted for as a consolidated subsidiary since the Company, through its wholly-owned subsidiaries, owns a 51% or greater interest in the venture, with physician investors owning up to the remaining 49%, and the Company will exercise substantive control over the hospital. Construction of Heart Hospital of Lafayette began in December 2002 and the hospital is expected to open in the first calendar quarter of 2004.

10

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

     In January 2002, the Company announced a venture to develop and construct The Heart Hospital of Milwaukee, which will be located in the city of Glendale, near Milwaukee, Wisconsin. The Heart Hospital of Milwaukee is accounted for as a consolidated subsidiary since the Company, through its wholly-owned subsidiaries, owns a 51% or greater interest in the venture, with physician investors owning up to the remaining 49%, and the Company will exercise substantive control over the hospital. Construction of The Heart Hospital of Milwaukee began in August 2002 and the hospital is expected to open during October 2003.

     In October 2001, the Company announced a venture to develop and construct TexSAn Heart Hospital, which will be located in San Antonio, Texas. TexSAn Heart Hospital is accounted for as a consolidated subsidiary since the Company, through its wholly-owned subsidiaries, owns an approximate 51% interest in the venture, with physician investors owning the remaining 49%, and the Company exercises substantive control over the hospital. Construction of TexSAn Heart Hospital began in June 2002. Due to the need to repair damages from a fire that occurred in March 2003, the Company expects TexSAn Heart Hospital’s original opening date of October 2003 to be delayed until the first calendar quarter of 2004. The Company believes it is adequately insured for the majority of the property damages.

     As of June 30, 2003, the three hospitals the Company is developing and Louisiana Heart Hospital were committed (and had paid and accrued amounts) under their construction contracts as set forth in the table below:

     For the three months and nine months ended June 30, 2003, the Company capitalized approximately $257,000 and $951,000, respectively, of interest expense as part of the capitalized costs of its hospitals under development during those periods.

     Diagnostic and Therapeutic Facilities Development – In April 2003, the Company opened a new nuclear testing facility in Fairfax, Virginia. The Company owns 100% of this nuclear testing facility, which provides testing services to various cardiologists in that market.

     In November 2002, the Company opened a new nuclear testing facility in Philadelphia, Pennsylvania. The Company owns 100% of this nuclear testing facility, which has a professional services agreement with various cardiologists in that market.

     In addition, during the nine months ended June 30, 2003, the Company entered into management services agreements with four hospitals to manage their cardiac catheterization laboratories.

     Closure of Diagnostic and Therapeutic Facilities – During June 2003, the Company’s hospital partner in the Gaston Cardiology Services Diagnostic Center exercised the early termination option under the partnership agreement, which provides for an effective date of termination in November 2003.

     Effective October 2002, the Company exercised its option to terminate early the management agreement for Wake Heart Cardiac Diagnostic Center due to the center’s operations not meeting the Company’s objectives.

5.   Short Term Borrowings and Long-Term Debt

     Short-term borrowings at September 30, 2002 consist of amounts outstanding under a commercial revolving note at one of the Company’s hospitals. No amounts were outstanding under this revolving note at June 30, 2003. This revolving note provides up to $10.0 million of total available borrowings, expires on August 30, 2003, and bears interest at the bank’s prime rate plus 0.25% (4.25% at June 30, 2003). The revolving note is renewable annually at the

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

lender’s discretion and is secured by the hospital’s patient accounts receivable. Available borrowings under the revolving note are based on a formula of the hospital’s eligible patient accounts receivable.

     Long-term debt consists of the following:

     Master Credit Facility and Bank Mortgage Loans – In July 2001, the Company became a party to a $189.6 million master credit facility (the Master Credit Facility), which provided a source of capital to refinance approximately $79.6 million of the real estate indebtedness of three of the Company’s existing hospitals and provided the Company with $110.0 million of available debt capital to finance its hospital development program. In March 2003, the Master Credit Facility was amended to increase available borrowings by $35.0 million thereby providing a total of $145.0 million of available debt to finance its hospital development program.

     As of June 30, 2003, $111.9 million of the $145.0 million available to finance the Company’s hospital development program had been designated to finance the development of Harlingen Medical Center, Louisiana Heart Hospital, TexSAn Heart Hospital and The Heart Hospital of Milwaukee (see Note 4). Of this $111.9 million of designated financing, $92.0 million had been borrowed as of June 30, 2003. Of the $33.1 million of undesignated financing as of June 2003, the Company anticipates designating approximately $15.0 million to $16.0 million to finance the development of Heart Hospital of Lafayette. The Company anticipates the remaining $17.1 million to $18.1 million of undesignated funds will remain available to finance other future projects in the Company’s hospital development program.

     Each loan under the Master Credit Facility is separately documented and secured by the assets of the borrowing hospital only. Each loan under the Master Credit Facility amortizes based on a 20-year term, matures on July 27, 2006, and accrues interest at variable rates on either a defined base rate plus an applicable margin, or Eurodollar Rate (LIBOR) plus an applicable margin. The weighted average interest rate for the loans under the Master Credit Facility was 4.65% and 5.02% at June 30, 2003 and September 30, 2002, respectively. The Company is required to pay a monthly unused commitment fee at a rate of 0.5%.

     In accordance with the related hospital operating agreements and as required by the lenders, the Company has guaranteed 100% of the obligations of its subsidiary hospitals for bank mortgage loans made under the Master Credit Facility and REIT loans and 71% of the obligation for another bank mortgage loan at June 30, 2003. The Company receives a fee from the minority partners in the subsidiary hospitals as consideration for providing guarantees in excess of the Company’s ownership percentage in the subsidiary hospitals. These guarantees expire concurrent with the terms of the related real estate loans and would require the Company to perform under the guarantee in the event of the subsidiary hospitals failing to perform under the related loans. The total amount of this real estate debt is secured by the subsidiary hospitals’ underlying real estate, which was financed with the proceeds from the debt. Because the Company consolidates the subsidiary hospitals’ results of operations and financial position, both the assets and the accompanying liabilities are included in the assets and long-term debt on the Company’s consolidated balance sheets.

     Notes Payable – The Company has acquired substantially all of the medical and other equipment for its hospitals and certain diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories under installment notes

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

payable to equipment lenders collateralized by the related equipment. Amounts borrowed under these notes are payable in monthly installments of principal and interest over 4 to 7 year terms. Interest is at fixed and variable rates ranging from 4.07% to 9.84%. The Company has guaranteed between 50% and 100% of certain of its subsidiary hospitals’ equipment loans. The Company receives a fee from the minority partners in the subsidiary hospitals as consideration for providing guarantees in excess of the Company’s ownership percentage in the subsidiary hospitals. These guarantees expire concurrent with the terms of the related equipment loans and would require the Company to perform under the guarantee in the event of the subsidiaries’ failure to perform under the related loan. At June 30, 2003, the total amount of notes payable was approximately $66.0 million, of which $39.0 million was guaranteed by the Company. Because the Company consolidates the subsidiary hospitals’ results of operations and financial position, both the assets and the accompanying liabilities are included in the assets and long-term debt on the Company’s consolidated balance sheets.

     In December 2002, Louisiana Heart Hospital, which opened February 28, 2003, obtained a debt commitment to finance its equipment that allows the hospital to borrow up to $18.0 million. Until December 2003, interest on borrowings made under this commitment will accrue at 90-day LIBOR plus 3.95%. After such date, amounts funded under the loan shall accrue interest at either a fixed rate equal to a specific Treasury Note yield, plus a margin, or 90-day LIBOR, plus a margin, depending on the manufacturer of equipment originally purchased under the facility. Beginning in December 2003, the principal amount of the loan will be required to be repaid over a six-year period. The debt is secured by the related equipment in the hospital and is guaranteed by the Company, as discussed above. As of June 30, 2003, Louisiana Heart Hospital had borrowed $9.9 million of the $18.0 million available.

     Debt Covenants – Covenants related to the Company’s long-term debt restrict the payment of dividends and require the maintenance of specific financial ratios and amounts and periodic financial reporting. The Company was in compliance with all covenants in the instruments governing its outstanding debt at June 30, 2003 with the exception of certain financial ratio covenants related to the real estate mortgage loans at Tucson Heart Hospital and at Arizona Heart Hospital. The Company was also not in compliance with certain financial ratio covenants related to the real estate mortgage loan at Tucson Heart Hospital in the previous reporting period ended March 31, 2003, at which time the Company reclassified the debt from long-term to current portion in its consolidated balance sheet. The mortgage lender at Tucson Heart Hospital granted a waiver to the hospital for the breach of the covenants at both June 30, 2003 and March 31, 2003. The mortgage lender at Arizona Heart Hospital granted a waiver to the hospital for the breach of the covenants at June 30, 2003 and agreed to amend the financial ratios through March 2007, the end of the mortgage loan. Accordingly, Tucson Heart Hospital and Arizona Heart Hospital debt are classified as long-term in the Company’s consolidated balance sheet as of June 30, 2003. Also, at December 31, 2002, Bakersfield Heart Hospital was not in compliance with one of its financial ratio covenants. The mortgage lender granted a waiver for the breach at December 31, 2002 and agreed to amend the terms of the loan to replace the financial ratio covenant with a minimum financial performance covenant at June 30, 2003 and September 30, 2003. Bakersfield Heart Hospital was in compliance with the required minimum financial performance covenant at June 30, 2003. Under the amended terms of the loan, the financial ratio covenant becomes effective again at December 31, 2003 and will determine the amount of a potential prepayment of the loan’s principal balance. Based on current estimates of Bakersfield Heart Hospital’s operating performance through December 31, 2003, the Company anticipates that a prepayment of approximately $11.8 million of the loan’s principal balance will be due on or about December 31, 2003. Accordingly, the Company has classified this amount of Bakersfield Heart Hospital’s mortgage debt as current in the accompanying consolidated balance sheet at June 30, 2003.

     Guarantees of Unconsolidated Affiliate’s Debt – The Company has guaranteed approximately 50% of the real estate debt and 40% of the equipment debt of the one affiliate hospital in which the Company has a minority ownership interest and therefore does not consolidate the hospital’s results of operations and financial position. The Company receives a fee from the affiliate hospital as consideration for providing these guarantees. At June 30, 2003, the affiliate hospital was in compliance with all covenants in the instruments governing its debt. The total amount of the affiliate hospital’s real estate and equipment debt was approximately $28.6 million and $12.0 million, respectively, at June 30, 2003. Accordingly, the real estate debt and the equipment debt guaranteed by the Company was approximately $14.3 million and $4.8 million, respectively, at June 30, 2003. The total amount of this affiliate hospital’s debt is secured by the hospital’s underlying real estate and equipment, which were financed with the proceeds from the debt. Because the Company does not consolidate the affiliate hospital’s results of operations and financial position, neither the assets nor the accompanying liabilities are included in the assets and liabilities on the Company’s balance sheets.

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

6.   Liability Insurance Coverage

     On June 1, 2002, the Company’s three-year combined insurance policy that provided medical malpractice claims coverage on a claims-made, first-dollar basis expired, and the Company entered into a new partially self-insured coverage program. At that time, the Company purchased a tail insurance policy to provide first-dollar coverage for claims incurred prior to June 1, 2002, but not reported as of that date under the expired claims-made policy. The Company recognized the full cost of the tail insurance policy as an operating expense in the third quarter of fiscal 2002 as required by generally accepted accounting principles in the United States. From June 1, 2002 through May 31, 2003, the Company was partially self-insured under a claims-made policy providing coverage for claim amounts in excess of $2.0 million of retained liability per claim. Effective June 1, 2003, the Company entered into a new one-year claims-made policy providing coverage for claim amounts in excess of $3.0 million of retained liability per claim, subject to $5.0 million of retained liability per claim for the first two claims reported during the policy year at one of its hospitals. Because of the Company’s self-insured retention levels, the Company is required to recognize an estimated expense/liability for the amount of the Company’s retained liability applicable to each malpractice claim. As of June 30, 2003, the total estimated liability for the Company’s self-insured retention on medical malpractice claims, including an estimated amount for incurred but not reported claims, was approximately $3.4 million, which is included in current liabilities in the Company’s consolidated balance sheet. The Company maintains this reserve based on actuarial estimates prepared by an independent third party, who bases the estimates on the Company’s historical experience with claims and assumptions about future events. Due to the considerable variability that is inherent in such estimates, including such factors as changes in medical costs and changes in actual experience, there is a reasonable possibility that the recorded estimates will change by a material amount in the near terms. Also, there can be no assurance that the ultimate liability will not exceed our estimates.

7.   Income Taxes

     Income tax expense was $1.3 million for the nine months ended June 30, 2003 and $2.7 million for the nine months ended June 30, 2002. The Company’s estimated effective tax rate for the nine months ended June 30, 2003 was 42.4% compared to an effective tax rate of 10.6% for the nine months ended June 30, 2002. Prior to the three months ended June 30, 2002, the Company was in a net deferred tax asset position, primarily resulting from net operating loss carryforwards, and its net deferred tax assets were fully offset by valuation allowances. During the three months ended June 30, 2002, the Company determined that its valuation allowances were no longer required, reversed the allowances, and began to accrue deferred income tax expense in accordance with accounting principles generally accepted in the United States of America. Because the Company continues to have federal and state net operating loss carryforwards available from prior periods to offset its current tax liabilities, it has no material current cash income tax liability and the majority of its income tax expense is deferred.

8.   Per Share Data and Share Repurchase Plan

     The calculation of diluted net income per share considers the potentially dilutive effect of options to purchase 2,733,595 and 2,402,262 shares of common stock outstanding at June 30, 2003 and 2002, respectively, at prices ranging from $4.75 to $25.00. Of these options, 2,577,123 and 2,162,897 were not included in the calculation of diluted earnings per share at June 30, 2003 and 2002, respectively, as such shares were anti-dilutive for the periods.

     In May 2003, the Company’s board of directors approved a share repurchase plan, authorizing the Company to repurchase up to $7.5 million of its common stock. Under the program, shares may be repurchased from time to time at various prices in the open market or through private transactions in compliance with the SEC’s rule 10b-18, subject to applicable legal requirements. As of June 30, 2003, the Company had repurchased 68,900 shares of its common stock at a cost of approximately $394,000, which is included in treasury stock on the Company’s balance sheets.

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

9.   Comprehensive Income

     The components of comprehensive income are as follows:

10.   Litigation

     Litigation – The Company is involved in various claims and legal actions in the ordinary course of business, including malpractice claims arising from services provided to patients that have been asserted against the Company by various claimants, and additional claims that may be asserted for known incidents through June 30, 2003. These claims and legal actions are in various stages, and some may ultimately be brought to trial. Moreover, additional claims arising from services provided to patients in the past and other legal actions may be asserted in the future. The Company is protecting its interests in all such claims and actions.

     Management believes, based on advice of counsel and the Company’s experience with past lawsuits and claims, that, taking into account the applicable liability insurance coverage and recorded reserves, the results of those lawsuits and potential lawsuits will not have a materially adverse effect on the Company’s financial position or future results of operations and cash flows.

11.   Reportable Segment Information

     The Company’s reportable segments consist of the Hospital Division and the Diagnostics Division. Financial information concerning the Company’s operations by each of the reportable segments as of and for the periods indicated is as follows:

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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

     Substantially all of the Company’s net revenue in its Hospital Division and Diagnostics Division is derived directly or indirectly from patient services. The amounts presented for Corporate and other primarily include general overhead and administrative expenses, cash and cash equivalents, other assets and operations of the Company not subject to separate segment reporting.

12.   Subsequent Event

     A significant portion of the Company’s net revenue is derived from federal healthcare programs, including Medicare. Medicare reimburses hospitals for the operating costs of inpatient services pursuant to a prospective payment system applied on a per discharge basis. Medicare also reimburses hospitals for capital-related costs using one of two alternative methodologies based upon how the hospital is categorized under regulations promulgated by the Centers for Medicare & Medicaid Services (CMS). The Company sought and received a written determination from one of its Medicare fiscal intermediaries on October 11, 2002 regarding the capital cost reimbursement methodology applicable to four of its hospitals. The fiscal intermediary’s October 2002 written determination confirmed the methodology being applied by the hospitals in question. The Company recorded and collected net revenue for services rendered by these hospitals at the estimated net realizable amount determined in accordance with the capital cost reimbursement methodology provided by the fiscal intermediary in its October 2002 determination.

     On August 11, 2003, the Company was notified by the fiscal intermediary that it had been directed by CMS to change, on a retroactive and prospective basis, the methodology confirmed by the fiscal intermediary in its October 2002 determination and currently being used to determine the capital cost reimbursement amounts for the four hospitals in question. The Company believes that the position taken by the fiscal intermediary in October 2002 was based upon a correct interpretation of applicable CMS regulations and intends to vigorously pursue the Company’s administrative, judicial and other remedies to reverse any final determination contrary to that position. If CMS does not revert to the determination made by the fiscal intermediary in October 2002, or maintains that it is appropriate to apply the change in methodology on a retroactive basis, the Company would be required to repay the Medicare program for the resulting reduction in previously reimbursed capital costs. If required, such repayments would be recorded as a change in accounting estimate and could result in a material reduction in the Company’s net revenue in the period recorded. Such change in reimbursement methodology could also have a material adverse impact on net revenue in future periods. The fiscal intermediary has not yet advised the Company of the amount of reimbursement associated with the change in methodology and the amount cannot be reasonably estimated.

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion and related financial data should be read in conjunction with the interim unaudited consolidated financial statements and related notes included elsewhere in this report and the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002, which includes a description of the critical accounting policies the Company uses in preparing its financial statements.

Overview

     We primarily focus on the diagnosis and treatment of cardiovascular disease. We design, develop, own and operate hospitals in partnership with physicians, most of whom are cardiologists and cardiovascular surgeons. While each of our hospitals is a freestanding, licensed general acute care hospital that includes an emergency department, pharmacy, clinical laboratory, radiology department, cardiac catheterization laboratories and operating rooms and is capable of providing a full complement of health services, we focus on serving the unique needs of patients suffering from cardiovascular disease. As of June 30, 2003, we owned and operated ten hospitals, together with our physician partners, who own an equity interest in the hospital where they practice. We account for all but one of our owned and operated hospitals as consolidated subsidiaries. We own a minority ownership interest in Heart Hospital of South Dakota and do not have substantive control over the hospital, and therefore are unable to consolidate the hospital’s results of operations and financial position, but rather are required to account for our minority ownership interest in the hospital as an equity investment. Our ten existing hospitals have a total of 635 licensed beds, of which 540 were staffed and available as of June 30, 2003. These hospitals are located in Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota and Texas. We are currently developing three hospitals, which include a hospital located in the city of Glendale, near Milwaukee, Wisconsin, a hospital located in Lafayette, Louisiana and a hospital located in San Antonio, Texas. The construction at The Heart Hospital of Milwaukee and Heart Hospital of Lafayette is currently on schedule and we expect to open these hospitals during October 2003 and the first calendar quarter of 2004, respectively. Due to the need to repair damages from a fire that occurred in March 2003, we expect TexSAn Heart Hospital’s original opening date of October 2003 to be delayed until the first calendar quarter of 2004. These three hospitals are expected to have a combined total of 124 licensed beds. Our hospital division accounted for 88.5% of our net revenue for the three months ended June 30, 2003 and 87.2% of our net revenue for the nine months ended June 30, 2003.

     In the discussions below, the results of operations for our hospital division include only those hospitals that we account for as consolidated subsidiaries. On a same facility basis for our consolidated hospital division, we exclude the results of operations of Harlingen Medical Center and Louisiana Heart Hospital, which opened in October 2002 and February 2003, respectively.

     In addition to our hospitals, we provide cardiovascular care services in diagnostic and therapeutic facilities in various locations and through mobile cardiac catheterization laboratories. We also provide consulting and management services tailored primarily to cardiologists and cardiovascular surgeons.

Results of Operations

     The following table presents, for the periods indicated, our statements of operations for three and nine months ended June 30, 2003 and 2002, as a percentage of net revenue.

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