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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number 000-33009

MedCath Corporation

10720 Sikes Place

(704) 708-6600

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

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

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

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).     Yes o          No þ

      As of December 10, 2003, there were 17,942,620 shares of the Registrant’s Common Stock outstanding. The aggregate market value of the Registrant’s common stock held by non-affiliates as of March 31, 2003 was approximately $30.9 million (computed by reference to the closing sales price of such stock on the Nasdaq National Market® on such date).

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Registrant’s proxy statement for its annual meeting of stockholders to be held on March 2, 2004 are incorporated by reference into Part III of this Report.

MEDCATH CORPORATION

FORM 10-K

TABLE OF CONTENTS

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MARKET, RANKING AND OTHER DATA

      The data included in this report regarding markets and ranking, including the size of certain markets and our position and the position of our competitors within these markets, are based on independent industry publications, reports of government agencies or other published industry sources and estimates based on management’s knowledge and experience in the markets in which we operate. Our estimates have been based on information obtained from our customers, suppliers, trade and business organizations and other contacts in the markets in which we operate. We believe these estimates to be accurate as of the date of this report. However, this information may prove to be inaccurate because of the method by which we obtained some of the data for our estimates or because this information cannot always be verified with complete certainty due to the limits on the availability and reliability of raw data, the voluntary nature of the data gathering process and other limitations and uncertainties. As a result, you should be aware that market, ranking and other similar data included in this report, and estimates and beliefs based on that data, may not be reliable.

      In particular, we make reference in this report to reports prepared by The Lewin Group, a nationally recognized consultant to the health and human services industries. In 1999, we engaged The Lewin Group to determine how cardiac care services provided in seven of our hospitals compared on measures of patient severity, quality and community impact to cardiac services provided in 1,192 peer community hospitals across the United States that perform open-heart surgery. The study, which has been updated annually, analyzed publicly available Medicare data for federal fiscal years 1999, 2000 and 2001 using an all procedures defined-diagnosis related group cardiac mix index. Cardiac case mix index calculations were based on Medicare discharges and were calculated using the general approach used by the Centers for Medicare and Medicaid Services. Quality of care was measured through an analysis of in-hospital mortality, average length of stay, discharge destination and patient complications.

FORWARD-LOOKING STATEMENTS

      Some of the statements and matters discussed in this report constitute forward-looking statements. Words such as expects, anticipates, approximates, believes, estimates, intends and hopes and variations of such words and similar expressions are intended to identify such forward-looking statements. We have based these statements on our current expectations and projections about future events. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these statements. The forward-looking statements contained in this report include, among others, statements about the following:

	•	the impact of the Medicare Prescription Drug Improvement and Modernization Act of 2003 and other healthcare reform initiatives,
	•	the availability and terms of capital to fund our development strategy,
	•	changes in Medicare and Medicaid payment levels,
	•	our ability to successfully develop additional hospitals, open them according to plan and gain significant market share in the market,
	•	our relationships with physicians who use our hospitals,
	•	competition from other hospitals,
	•	our ability to attract and retain nurses and other qualified personnel to provide quality services to patients in our hospitals,
	•	our information systems,
	•	existing governmental regulations and changes in, or failure to comply with, governmental regulations,
	•	liability and other claims asserted against us,
	•	changes in medical or other technology and reimbursement rates for new technologies,

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	•	demographic changes,
	•	changes in accounting principles generally accepted in the United States and
	•	our ability, when appropriate, to enter into managed care provider arrangements and the terms of those arrangements.

      Although we believe that these statements are based upon reasonable assumptions, we cannot assure you that we will achieve our goals. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur. Our forward-looking statements speak only as of the date of this report or the date they were otherwise made. Other than as may be required by federal securities laws to disclose material developments related to previously disclosed information, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We urge you to review carefully all of the information in this report and the discussion of risk factors filed as Exhibit 99.1 to this report, before making an investment decision with respect to our common stock.

      Unless otherwise noted, the following references in this report will have the meanings below:

	•	For periods subsequent to July 27, 2001, the terms the Company, MedCath, we, us and our refer to MedCath Corporation and its consolidated subsidiaries;
	•	for the period from July 31, 1998 to July 27, 2001, such terms refer to MedCath Corporation’s predecessor company, MedCath Holdings, Inc., and its consolidated subsidiaries and unconsolidated affiliates;
	•	for periods prior to July 31, 1998, such terms refer to MedCath Incorporated and its consolidated subsidiaries, which was acquired from its public stockholders by several private investment partnerships sponsored by Kohlberg Kravis Roberts & Co., L.P. and Welsh, Carson, Anderson & Stowe; and
	•	references to fiscal years are to our fiscal years ending September 30. For example, fiscal 2003 refers to our fiscal year ended September 30, 2003.

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PART I

Overview

      MedCath is a healthcare provider focused primarily on the diagnosis and treatment of cardiovascular disease. We design, develop, own and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services, and the medical staff at each of our hospitals includes qualified physicians in various specialties.

      We opened our first hospital in 1996, and currently have an ownership interest in 11 operating hospitals. These hospitals have a total of 667 licensed beds and are located in nine states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, Texas, and Wisconsin. We have a majority interest in ten of these hospitals and a minority interest in the eleventh, Heart Hospital of South Dakota. We also have a majority interest in two additional hospitals that are under development in Texas (TexSAn Heart Hospital) and Louisiana (Heart Hospital of Lafayette) that are expected to open in January 2004 and March 2004, respectively. These hospitals are designed to accommodate a total of 152 inpatient beds and will initially open with 92 licensed beds.

      In addition to our hospitals, we provide cardiovascular care services in 23 cardiac diagnostic and therapeutic facilities. Of these 23 facilities, 11 are located at hospitals operated by other parties and offer invasive diagnostic and sometimes therapeutic procedures. We have partners in four of these 11 facilities or the management companies that manage the facilities. The remaining 12 facilities are not located at hospitals and offer only diagnostics services. We have partners in five of these 12 facilities or the companies that manage or provide professional services to these facilities.

      The United States Congress recently passed and President Bush signed into law the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Medicare Modernization Act), which imposes an 18-month moratorium on the development of new physician-owned “specialty hospitals,” as such hospitals are defined in the statute, and in regulations we expect to be issued by the Department of Health and Human Services. The Medicare Modernization Act will not have an immediate impact on our operations. It does not affect our ability to open the two hospitals we have under development, and no additional hospitals were planned for the period covered by the moratorium. Management is currently conducting an in-depth, strategic review process to determine what changes to the Company’s basic business model are appropriate in response to the Medicare Modernization Act and other regulatory and operational developments. This process is expected to be completed during the second fiscal quarter of 2004, and will identify and access potential growth opportunities that meet our internal requirements, allow us to leverage our core strengths and provide adequate returns on invested capital. While we cannot project the specific nature of our growth opportunities at this time, we believe they will continue to involve the participation of physicians and other healthcare providers in a meaningful manner. Among other matters, we expect to consider investment opportunities in the treatment of additional disease categories, the acquisition of existing healthcare facilities and partnering with other providers to expand existing services or initiate new services.

Our Strengths

      Geographically Diversified Portfolio of Hospitals. We currently have ownership interests in and operate 11 hospitals in nine states, which diversifies our revenue base and reduces our exposure to any one geographic market. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that includes an emergency department, operating rooms, catheterization laboratories, pharmacy, laboratory, and a radiology department, and is capable of providing a wide range of health services. While we focus on cardiovascular care, in fiscal 2003 approximately 61% of patient cases that entered our emergency departments required health services not related to cardiac care. We treated over 97% of these cases at our hospitals.

      Leading Local Market Positions. Based on 2001 Medicare reimbursement data, each of our seven majority-owned hospitals that has been open more than 18 months has achieved a number one or two ranking in

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      Superior Clinical Outcomes. We believe our hospitals, on average, achieve lower mortality rates and a shorter average length of stay, adjusted for severity, for patients with higher patient acuity levels as compared to our competitors. In 2002, we engaged The Lewin Group, a national health and human services consulting group, to conduct a study on cardiovascular patient outcomes based on 2001 Medicare reimbursement data. For more information regarding The Lewin Group study, see “Market, Ranking and Other Data” in the forepart of this report. The Lewin Group’s most recent report, which is entitled “A Comparative Study of Patient Severity, Quality of Care and Community Impact at MedCath Heart Hospitals,” indicated that in fiscal 2001, on average, MedCath hospitals, compared to the peer community hospitals:

	•	as a group, have 20.3% higher case mix severity for cardiac patients;
	•	after adjusting for risk of mortality, exhibit a 17.1% lower in-hospital mortality rate for Medicare cardiac cases;
	•	have shorter lengths of stay for cardiac cases (3.84 days versus 4.81 days), on a severity adjusted basis;
	•	discharge a higher proportion of patients to their homes (91.4% versus 72.5%) and transfer a lower proportion of patients to other facilities or home health agencies; and
	•	rank near the middle of their respective markets for the total volume of inpatient cardiac care provided to Medicaid and uninsured patients.

      Active Physician Participation. Physicians practicing at our hospitals participate in decisions on a wide range of strategic and operational matters such as development of clinical care protocols, patient procedure scheduling, hospital marketing plans, annual operating budgets and large capital expenditures. The opportunity to have a role in how our hospitals are managed empowers physicians and encourages them to share new ideas, concepts and practices. We believe physicians take pride and interest in our hospitals and that the influence they have over decisions on a wide range of operational and strategic matters provides further motivation for them to provide quality, cost-effective healthcare.

      Efficient, Quality Care Delivery Model. Our hospitals have innovative facility designs and operating characteristics that we believe enhance the quality of care, enable efficient patient care and improve physician and staff productivity. The innovative characteristics of our hospital designs include: fully-equipped patient rooms capable of providing the majority of services needed during a patient’s entire length of stay; centrally located inpatient services such as radiology, pharmacy and laboratories that reduce the amount of transportation patients must endure; strategically located nursing stations that serve specific patients and are located in close proximity to their rooms between procedures, which allows the same nursing rotation to serve the patient from admittance to discharge; and efficiently arranged departments and services that interact frequently. As a result of the innovative characteristics of our hospital design, we believe we have a cost-efficient operating environment due to: elimination of duplicative layers of administrative and support personnel; hospital staffing with only four non-caregiver executives; use of working team leaders to supervise nurses, medical technical personnel, as well as other departments throughout the hospital; centralization of non-clinical support services; investment in leading technology; and cardiovascular care training for our clinical employees.

      We believe the benefits of both our facility design and operating characteristics include superior clinical outcomes, reduced patient waiting time, lower patient and family anxiety, increased physician productivity, elimination of costly patient transportation staff, fewer scheduling conflicts, better resource allocation and lower non-clinical staffing ratios. As a result, our average labor costs as a percentage of revenue is approximately 30% versus, we believe, approximately 40% for for-profit hospitals and approximately 45 - 50% for not-for-profit hospitals. Furthermore, our patient surveys have consistently demonstrated a high level of satisfaction with our facilities, staff and care coordination. For example, during fiscal 2002, 98% of our patients who completed these

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      Proven Ability to Develop, Open, and Operate New Hospitals. Since we began constructing our first hospital in 1994, we have successfully developed, opened, and operated 12 hospitals in nine states. Each of our hospitals is accredited by the Joint Commission on the Accreditation of Healthcare Organizations.

      Strong Management Team. Our management team has extensive experience in the healthcare industry. Our chief executive officer and chief operating officer each has over 18 years of experience in the healthcare industry. John T. Casey was named MedCath’s president and chief executive officer in September 2003. Prior to joining MedCath, Mr. Casey served in senior executive positions with a number of healthcare companies, including Physician Reliance Network, Inc., that was, prior to its merger with US Oncology, Inc., the largest oncology practice management company in the United States; Intecare, LLC, a company formed for the purpose of developing joint venture partnerships with hospitals and integrated healthcare systems; and American Medical International, which, during Mr. Casey’s tenure there, was the third largest publicly held owner and operator of hospitals in the country. American Medical International merged with National Medical Enterprises to create Tenet Healthcare Corporation (Tenet), where Mr. Casey served as vice-chairman. Charles R. Slaton was named MedCath’s executive vice president and chief operating officer in September 2003. Prior to joining MedCath, Mr. Slaton was a senior manager for nine years at Tenet, where he most recently served as senior vice president, with financial and operational responsibilities for 15 acute and rehabilitation hospitals in Texas. Before joining Tenet, Mr. Slaton was part of an executive management team turnaround of Santa Rosa Memorial Hospital in Santa Rosa, California.

Our Strategy

      Partner with Highly Regarded Physicians. We partner with cardiologists, cardiovascular surgeons, and many other physicians whom we believe have established reputations for clinical excellence. As a result of our reputation for providing quality cardiovascular care, we are often contacted by physicians interested in exploring the development of a hospital with us in the markets where they practice. Typically, each of our hospitals has approximately 250 to 300 total physicians on the medical staff, of which 15 to 70 are physician investors.

      Provide a Differentiated Standard of Care. Our philosophy is to provide patient-focused care, which involves centering care around the patient rather than expecting the patient to adapt to our facilities and staff. We have developed an innovative facility design around the requirements of our patients and invest in leading-edge equipment and technology to achieve a differentiated standard of care and improve their hospital experience. For example, our large, single-patient rooms are capable of addressing most of our patients’ cardiovascular and associated needs during their entire stay. This “universal” room design reduces the need to move patients during their stay. By moving patients less frequently, we believe we improve the quality of care, increase physician and staff efficiency, provide necessary patient services on time and generally avoid unnecessarily long lengths of stay. We monitor the quality of cardiovascular care — that is, the degree to which our services increase the likelihood of desired patient outcomes — by measuring key quality criteria, including mortality rates, patient acuity, average length of stay and patient satisfaction. We operate all of our hospitals under a quality improvement program to provide a comprehensive assessment of the quality of the services we provide.

      Achieve Best Practices and Economies of Scale. Our hospital management and physicians have the opportunity to share information regularly and implement best practices, which is facilitated by our standard hospital design and operational similarities. Information is shared through regular meetings of our hospital management teams to enable them to discuss new practices and methodologies such as clinical protocols, supply selection and management, as well as scheduling efficiencies. We also coordinate opportunities for our physicians to discuss — both on an informal basis and at periodic meetings — such matters as clinical protocols, patient management and procedure techniques. These efforts have enabled our hospitals to benefit from the innovations at one hospital and our hospital managers and physicians to become more productive. Additionally, we plan to continue to achieve greater economies of scale in the future through our centralized billing services, creating a

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      Focus Primarily on Cardiovascular Disease. Each of our majority-owned hospitals is licensed as a general acute care hospital and ten of them are designed and operated with a focus on serving the unique needs of patients suffering from cardiovascular disease. By focusing primarily on a single disease category, our physicians, nurses, medical technicians and other staff members are able to concentrate on and enhance their professional cardiovascular care skills, thereby enabling staff members to schedule patient procedures more efficiently and better serve the needs of cardiovascular patients in the community. We believe our focused approach increases patient, physician and staff satisfaction and enables us to provide quality, cost-effective patient care.

Our Hospitals

      We currently have ownership interests in and operate 11 hospitals, including our newest hospital near Milwaukee, Wisconsin, which opened in October 2003. We also have two hospitals under development. One is in San Antonio, Texas and the other is in Lafayette, Louisiana.

      The following table identifies key characteristics of our 11 hospitals in operation and two hospitals under development, including our ownership percentages as of September 30, 2003.

(1)	Heart Hospital of South Dakota is the only hospital in which we do not have a majority ownership interest. We use the equity method of accounting for this hospital, which means that we include in our consolidated statement of operations only a percentage of the hospital’s reported net income or loss for each reporting period. Heart Hospital of South Dakota is licensed as a specialized hospital under state law.
(2)	These hospitals are under development and are scheduled to open in the month indicated.
(3)	TexSAn Heart Hospital is designed to accommodate 120 inpatient beds and will initially open with 60 licensed beds.

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      Before designing and constructing our first hospital in 1994, we consulted with our physician partners to analyze the operations, facilities and work flow of existing hospitals and found what we believed to be many inefficiencies in the way cardiovascular care was provided in existing hospitals. Based upon this analysis, we designed a hospital that we believed would enhance physician and staff productivity and allow for the provision of patient-focused care. Using subsequent operating experience and further input from physicians at our other hospitals, we have further refined our basic hospital layout to allow us to combine site selection, facility size and layout, staff and equipment to deliver quality cardiovascular care.

      The innovative characteristics of our hospitals include:

      Universal Patient Rooms. Our large, single-patient rooms enable our staff to provide all levels of care required for our patients during their entire hospital stay, including critical care, telemetry and post-surgical care. Each room is equipped as an intensive care unit, which enables us to keep a patient in the same room throughout their recovery. This approach differs from the general acute care hospital model of moving patients, potentially several times, as they recover from surgical procedures.

      Centrally Located Inpatient Services. We have centrally located all services required for inpatients, including radiology, laboratory, pharmacy and respiratory therapy, in close proximity to the patient rooms, which are usually all located on a single floor in the hospital. This arrangement reduces scheduling conflicts and patient waiting time. Additionally, this eliminates the need for costly transportation staff to move patients from floor to floor and department to department.

      Strategically Placed Nursing Stations. Unlike traditional hospitals with large central nursing stations which serve as many as 30 patients, we have corner configuration nursing stations on our patient floors where each station serves six to eight patients and is located in close proximity to the patient rooms. This design provides for excellent visual monitoring of patients, allows for flexibility in staffing to accommodate the required levels of care, shortens travel distances for nurses, allows for fast response to patient calls and offers proximity to the nursing station for family members.

      Efficient Workflow. We have designed and constructed our various procedure areas in close proximity to each other allowing for both patient safety and efficient staff work flow. For example, our cardiac catheterization laboratories are located in close proximity to our operating rooms, outpatient services are located immediately next to procedure areas and emergency services are located off the staff work corridor leading directly to the diagnostic and treatment areas.

      Additional Capacity for Critical Cardiac Procedures. We design and construct our hospitals with more operating rooms and cardiac catheterization laboratories than we believe are available in the program of a typical general acute care hospital and we believe this increases physician productivity and patient satisfaction. This feature of our hospitals ensures that the physicians practicing in our hospitals will experience fewer conflicts in scheduling procedures for their patients. In addition, all of our operating rooms are designed primarily for cardiovascular procedures, which allows them to be used more efficiently by physicians and staff.

Our Hospital Development Program

      An important step in developing a new hospital is establishing relationships with physicians providing cardiovascular care that we believe have established reputations for clinical excellence. We regularly receive unsolicited inquiries from groups of physicians interested in partnering with us to take advantage of our hospital development and management expertise and access to capital. We also receive referrals to potential partners from our physician partners in our existing hospitals and from the leaders of physician groups to which we provide cardiovascular care consulting services. Our experience has been that physician groups most interested in partnering with us are those whose members wish to improve their current practice environment. Since these physicians frequently have pre-existing relationships with our existing physician partners in other markets, they can quickly conduct their own informal evaluation to understand the benefits of partnering with us to develop a hospital.

      An equally important step in developing a new hospital is performing a detailed market analysis using publicly available data from a number of sources. We use a disciplined, data-driven process, which includes

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	•	overall market size for cardiovascular care, including the surrounding communities,
	•	projected population growth in the market, particularly for the population group over the age of 55 because they are the primary recipients of cardiovascular care services,
	•	Medicare reimbursement rates, which vary depending upon the wage index for the market,
	•	effect on reimbursement due to payor mix, including managed care penetration of the market,
	•	competitive strengths and weaknesses of each hospital in the market, and
	•	licensing and regulatory requirements, including certificate of need requirements.

      The United States Congress recently passed and President Bush signed into law the Medicare Modernization Act, which imposes an 18-month moratorium on the development of new physician-owned “specialty hospitals,” as such hospitals are defined in the statute, and in regulations we expect to be issued by the Department of Health and Human Services. Although the Medicare Modernization Act will not affect our ability to open the two hospitals we have under development, it is expected to prohibit our hospital development activities as currently configured through June 8, 2005, the expiration date of the moratorium. See “— Regulation — Fraud and Abuse Laws — Physician self-referral law.”

Diagnostic and Therapeutic Facilities

      We have participated in the development of or have acquired interests in, and provide management and professional services to facilities where physicians diagnose and treat cardiovascular disease and manage hospital-based cardiac catheterization laboratories. We also own and operate a fleet of mobile cardiac catheterization laboratories serving hospital networks and maintain a number of mobile and modular cardiac catheterization laboratories in a rental fleet that we lease on a short-term basis. These diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories are equipped to allow the physicians using them to employ a range of diagnostic and treatment options for patients suffering from cardiovascular disease.

      Managed Diagnostic and Therapeutic Facilities. We currently own and/or manage the operations of 23 cardiac diagnostic and therapeutic facilities. The following table provides information about these facilities.

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(1)	Our management agreement with each of these facilities includes an option for us to extend the initial term at increments ranging from one to 10 years, through an aggregate of up to an additional 40 years for some of the facilities.
(2)	The management agreement with each of these facilities includes an early termination provision upon notice.
(3)	The ownership interest refers to our ownership in the entities that have entered into, and provided services to, the facilities under management services agreements or professional services agreements.

      We also owned and managed the operations of Gaston Cardiology Services, LLC during fiscal 2003. Effective May 2003, we received notification from our hospital partner of its intent to exercise its option to require the dissolution of Gaston Cardiology Services, LLC, and to terminate all agreements with the hospital, Gaston Cardiology Services, LLC and us. The effective date of the dissolution and the termination of the agreements was November 2003.

      Our management services generally include providing all non-physician personnel required to delivering patient care and the administrative, management and support functions required in the operation of the facility. The physicians who supervise or perform diagnostic and therapeutic procedures at these facilities have complete control over the delivery of cardiovascular healthcare services. The management agreements for each of these centers generally have an extended initial term and several renewal options ranging from one to ten years each. The physicians and hospitals with which we have contracts to operate these centers may terminate the agreements under certain circumstances. We may terminate most of these agreements for cause or upon the occurrence of specified material adverse changes in the business of the centers. We intend to develop with hospitals and physician groups, or acquire contracts to manage, additional diagnostic and therapeutic facilities in the future.

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      Interim Mobile Catheterization Labs. We maintain a rental fleet of mobile and modular cardiac catheterization laboratories. We lease these laboratories on a short-term basis to hospitals while they are either adding capacity to their existing facilities or replacing or upgrading their equipment. We also lease these laboratories to hospitals that experience a higher demand for cardiac catheterization procedures during a particular season of the year and choose not to expand their own facilities to meet peak period demand. Our rental and modular laboratories are manufactured by leading original equipment manufacturers and have advanced technology and enable cardiologists to perform both diagnostic and interventional therapeutic procedures. Each of our rental units is generally in service for at least nine months of the year. These units allow us to be responsive to immediate demand and create flexibility in our operations.

      Mobile Catheterization Laboratories Serving Hospital Networks. We also provide mobile catheterization services to hospital networks. Mobile laboratories serving hospital networks are moved, usually on a daily basis, from one hospital to another in a particular hospital network or geographic area. Each mobile laboratory is fully equipped and operated by our medical technicians and nurses, which provides a hospital or physician group with a turnkey catheterization laboratory. Our mobile laboratories permit a group of hospitals located in geographic proximity to one another, each with limited cardiovascular patient volume, to offer cardiovascular services through shared access to equipment and personnel. This also allows hospitals and physicians to offer cardiovascular care services while avoiding the substantial capital expenditures and operating expenses needed to purchase and operate the equipment required to perform these services. We currently have contracts with 19 hospitals for our mobile laboratories. These hospitals pay for the use of our mobile laboratories on a fixed fee-per-procedure basis and reimburse us for most of the costs incurred in performing procedures. In most instances, the hospitals are obligated to pay a minimum monthly amount regardless of the number of procedures performed in the mobile laboratories while they are located at the hospital.

Major Procedures Performed at Our Facilities

      The following is a brief description of the major cardiovascular procedures physicians perform at our hospitals and other facilities.

     Invasive Procedures

      Cardiac Catheterization: Percutaneous intravascular insertion of a catheter into any chamber of the heart or great vessels for diagnosis, assessment of abnormalities, interventional treatment, and evaluation of the effects of pathology on the heart and great vessels.

      Percutaneous Cardiac Intervention, including the following:

	•	Atherectomy: A technique using a cutting device to remove plaque from an artery. This technique can be used for coronary and non-coronary arteries.
	•	Angioplasty: A method of treating narrowing of a vessel using a balloon catheter to dilate the narrowed vessel. If the procedure is performed on a coronary vessel, it is commonly referred to as a percutaneous transluminal coronary angioplasty, or PTCA.
	•	Percutaneous Balloon Angioplasty: The insertion of one or more balloons across a stenotic heart valve.

      Stent: A small expandable wire tube, usually stainless steel, with a self-expanding mesh introduced into an artery. It is used to prevent lumen closure, or restenosis. Stents can be placed in coronary arteries as well as renal, aortic and other peripheral arteries. A drug-eluting stent is coated with a drug that is intended to prevent the stent from reclogging with scar tissue within six to nine months after a procedure.

      Brachytherapy: A radiation therapy using implants of radioactive material placed inside a coronary stent with restenosis.

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      Electrophysiology Study: A diagnostic study of the electrical system of the heart. Procedures include the following:

	•	Cardiac Ablation: Removal of a part, pathway or function by surgery, chemical destruction, electrocautery, or radio frequency.
	•	Pacemaker Implant: An electrical device that can substitute for a defective natural pacemaker and control the beating of the heart by a series of rhythmic electrical discharges.
	•	Automatic Internal Cardiac Defibrillator: Cardioverter implanted in patients at high risk for sudden death from ventricular arrhythmias.
	•	Cardiac Assist Devices: A mechanical device placed inside of a person’s chest where it helps the heart pump oxygen rich blood throughout the body.

      Coronary Artery Bypass Graft Surgery: A surgical establishment of a shunt that permits blood to travel from the aorta to a branch of the coronary artery at a point past the obstruction.

      Valve Replacement Surgery: Valve replacement is an open-heart surgical procedure involving the replacement of valves that regulate the flow of blood between chambers in the heart, which have become narrowed or ineffective due to the build-up of calcium or scar tissue or the presence of some other physical damage.

      Cardiac Magnetic Resonance Imaging: This test uses a powerful magnet to produce highly detailed, accurate and reproducible images of the heart and surrounding structures as well as the blood vessels in the body without the need for contrast agents.

      Echocardiogram with Color Flow Doppler, or Ultrasound Test: This test produces real time images of the interior of the heart muscle and valves, which are used to accurately evaluate heart valve and muscle problems and measure heart muscle damage.

      Nuclear Treadmill Exercise Test, or Nuclear Angiogram: This test, which involves the injection of a low level radioactive tracer isotope into the patient’s bloodstream during exercise on a motorized treadmill, frequently is used to screen patients who may need cardiac catheterization and to evaluate the results in patients who have undergone angioplasty or cardiac surgery.

      Standard Treadmill Exercise Test: This test, which involves a patient exercising on a motorized treadmill while the electrical activity of the patient’s heart is measured, frequently is used to screen for heart disease.

      Ultrafast Computerized Tomography: This test detects the buildup of calcified plaque in coronary arteries before the patient experiences any symptoms.

Cardiology Consulting and Management Services

      We provide business consulting and management services to primarily cardiovascular physician group practices nationwide. Services provided include primarily business process reengineering, strategic planning and ancillary development. The physicians in the practices who supervise or provide healthcare services have complete control over the delivery of healthcare services.

Employees

      As of September 30, 2003, we employed 4,124 persons, including 3,002 full-time and 1,122 part-time employees. None of our employees is a party to a collective bargaining agreement, and we consider our relationship with our employees to be good. There currently is a nationwide shortage of nurses and other medical support personnel, which makes recruiting and retaining these employees difficult. We provide competitive wages and benefits and offer our employees a professional work environment that we believe helps us recruit and retain the staff we need to operate our hospitals and other facilities.

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      We do not employ any practicing physicians at any of our hospitals or other facilities, except in one instance, where one of our hospitals employs a physician for an outlying clinic. Our hospitals are staffed by licensed physicians who have been admitted to the medical staffs of individual hospitals. Any licensed physician — not just our physician partners — may apply to be admitted to the medical staff of any of our hospitals, but admission to the staff must be approved by the hospital’s medical staff and governing board in accordance with established credentialing criteria.

Environmental Matters

      We are subject to various federal, state and local laws and regulations governing the use, storage, discharge and disposal of hazardous materials, including medical waste products. We believe that all of our facilities and practices comply with these laws and regulations and we do not anticipate that any of these laws will have a material adverse effect on our operations. We cannot predict, however, whether environmental issues may arise in the future.

Insurance

      Like most health care providers, we are subject to claims and legal actions in the ordinary course of business. To cover these claims, we maintain professional malpractice liability insurance and general liability insurance in amounts and with deductibles and levels of self-insured retention that we believe are sufficient for our operations. We also maintain umbrella liability coverage to cover claims not covered by our professional malpractice liability or general liability insurance policies. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — General and Professional Liability Risk.”

      Due to unfavorable pricing and availability trends in the general and professional liability insurance markets, the cost of commercial professional and general liability insurance coverage has risen significantly in recent years. As a result, we expect our total insurance premiums, including professional and general liability, property, business, auto, directors and officers, workers compensation and other coverages to increase approximately $2.5 million to $3.5 million in fiscal 2004 compared to fiscal 2003. In addition, we expect to assume a greater portion of the risk, through self-insured retention and higher deductibles, under our new commercial insurance policies during fiscal 2004 than in prior fiscal years.

      As we open new hospitals and diagnostic and therapeutic centers, we expect to incur additional premium costs and self-insured retention costs to reflect the additional risk exposure. Lastly, we cannot be assured that our professional liability and general liability insurance, nor our recorded reserves for self-insured retention, will cover all claims against us or continue to be available at reasonable costs for us to maintain adequate levels of insurance in the future.

Competition

      In executing our business strategy, we compete primarily with other cardiovascular care providers, principally for-profit and not-for-profit general acute care hospitals. We also compete with other companies pursuing strategies similar to ours, and with not-for-profit general acute care hospitals that may elect to develop a hospital. In some of our markets, such as Sioux Falls, South Dakota, we may have only one competitor. In other markets, such as Phoenix, Arizona, our hospitals compete for patients with the heart programs of numerous other hospitals in the same market. In most of our markets we compete for market share of cardiovascular procedures with three to six hospitals. Some of the hospitals that compete with our hospitals are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Some of our competitors are larger, are more established, have greater geographic coverage, offer a wider range of services or have more capital or other resources than we do. If our competitors are able to finance capital improvements, recruit physicians, expand services or obtain favorable managed care contracts at their facilities, we may experience a decline in market share. In operating our hospitals, particularly in performing outpatient procedures, we compete with free-standing

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Reimbursement

      Medicare. Medicare is a federal program that provides hospital and medical insurance benefits to persons age 65 and over, some disabled persons and persons with end-stage renal disease. Under the Medicare program, we are paid for certain inpatient and outpatient services performed by our hospitals and also for services provided at our diagnostic and therapeutic facilities.

      Medicare payments for inpatient acute services are generally made pursuant to a prospective payment system. Under this system, hospitals are paid a prospectively determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a diagnosis-related group (DRG). Based upon the patient’s condition and treatment during the relevant inpatient stay, each DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. Such payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, DRG payments are adjusted by a predetermined geographic adjustment factor assigned to the geographic area in which the hospital is located.

      While hospitals generally do not receive direct payments in addition to a DRG payment, hospitals may qualify for an outlier payment when the relevant patient’s treatment costs are extraordinarily high and exceed a specified threshold. The DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The update factor is determined, in part, by the projected increase in the cost of goods and services that are purchased by hospitals, referred to as the market basket index. Outlier payments, which were established

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      Outpatient services are also subject to a prospective payment system. Services provided at our freestanding diagnostic facilities are typically reimbursed on the basis of the physician fee schedule, which is revised periodically, and bases payment on various factors including resource-based practice expense relative value units and geographic practice cost indices.

      The Medicare Modernization Act reduces the prospective payment update by 0.4% in fiscal years 2005, 2006, or 2007 for hospitals that fail to furnish certain quality data to the Centers for Medicare and Medicaid Services (CMS). Other provisions will, among other things, increase payments to hospitals for indirect medical education, improve the treatment of new technologies under the inpatient prospective payment system, establish a commuting wage adjustment, allow hospitals to appeal their wage index classification, and temporarily increase disproportionate share hospital allotments. Many of these provisions will be clarified and implemented through the subsequent issuance of regulations. Therefore, we cannot predict with certainty how implementation of the reimbursement provisions of the Medicare Modernization Act will impact our operations at this time.

      Future legislation may modify Medicare reimbursement for inpatient and outpatient services provided at our hospitals or services provided at our diagnostic and therapeutic facilities, but we are not able to predict the method or amount of any such reimbursement changes or the effect that such changes will have on us.

      Prior to 1991, Medicare reimbursed hospitals for a portion of their actual capital costs using a formula based on the proportion of hospital days spent treating Medicare beneficiaries. In 1991, Medicare implemented a prospective payment system that established a standard amount to be paid for each discharge to cover capital costs directly related to inpatient hospital care. The standard rate is adjusted for such factors as the hospital’s particular mix of cases, its geographic location, and a disproportionate number of low income patients. The 1991 regulations contained a 10-year transition period that established different reimbursement methodologies for existing hospitals and new hospitals, as defined in the regulations. A new hospital is paid 85% of its allowable actual Medicare capital related costs through the cost reporting periods ending at least two years after the hospital accepts its first patient. For the third year through the remainder of the ten-year transition period, such hospitals

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      Medicaid. Medicaid is a state-administered program for low income individuals, which is funded jointly by the federal and individual state governments. Most state Medicaid payments for hospitals are made under a prospective payment system or under programs that negotiate payment levels with individual hospitals. Medicaid reimbursement is often less than a hospital’s cost of services. States periodically consider significantly reducing Medicaid funding, while at the same time in some cases expanding Medicaid benefits. This could adversely affect future levels of Medicaid payments received by our hospitals. We are unable to predict what impact, if any, future Medicaid managed care systems might have on our operations.

      The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, court decisions, executive orders and freezes and funding reductions, all of which may adversely affect our business. There can be no assurance that payments for hospital services and cardiac diagnostic and other procedures under the Medicare and Medicaid programs will continue to be based on current methodologies or remain comparable to present levels. In this regard, we may be subject to rate reductions as a result of federal budgetary or other legislation related to the Medicare and Medicaid programs. In addition, various state Medicaid programs periodically experience budgetary shortfalls, which may result in Medicaid payment reductions and delays in payment to us.

      Utilization Review. Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients meet professionally recognized standards and are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admissions of Medicare and Medicaid patients be reviewed by quality improvement organizations that analyze the appropriateness of Medicare and Medicaid patient admissions and discharges, quality of care provided, validity of DRG classifications and appropriateness of cases of extraordinary length of stay or cost. Quality improvement organizations may deny payment for services provided, assess fines and recommend to the Department of Health and Human Services that a provider not in substantial compliance with the standards of the quality improvement organization be excluded from participation in the Medicare program. Most non-governmental managed care organizations also require utilization review.

      Annual Cost Reports. Hospitals participating in the Medicare and some Medicaid programs, whether paid on a reasonable cost basis or under a prospective payment system, are required to meet certain financial reporting requirements. Federal and, where applicable, state regulations require submission of annual cost reports identifying medical costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medicaid recipients.

      Annual cost reports required under the Medicare and some Medicaid programs are subject to routine governmental audits. These audits may result in adjustments to the amounts ultimately determined to be due to us under these reimbursement programs and result in a recoupment of monies paid. Finalization of these audits and determination of amounts earned under these programs often takes several years. Providers can appeal any final determination made in connection with an audit.

      Program Adjustments. The Medicare, Medicaid and other federal health care programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, and requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payment to facilities. The final determination of amounts earned under the programs often requires many years, because of audits by the program representatives, providers’ rights of appeal and the application of numerous technical reimbursement provisions. Management believes that the Company has made adequate provision for such adjustments. Until final

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      Managed Care. The percentage of admissions and net revenue attributable at our hospitals and other facilities to managed care plans has increased as a result of pressures to control the cost of healthcare services. We expect that the trend toward increasing percentages related to managed care plans will continue in the future. Generally, we receive lower payments from managed care plans than from traditional commercial/indemnity insurers; however, as part of our business strategy, we intend to take steps to improve our managed care position.

      Commercial Insurance. Our hospitals provide services to individuals covered by private healthcare insurance. Private insurance carriers pay our hospitals or in some cases reimburse their policyholders based upon the hospital’s established charges and the coverage provided in the insurance policy. Commercial insurers are trying to limit the costs of hospital services by negotiating discounts, and including the use of prospective payment systems, which would reduce payments by commercial insurers to our hospitals. Reductions in payments for services provided by our hospitals to individuals covered by commercial insurers could adversely affect us. We cannot predict whether or how payment by third party payors for the services provided by all hospitals and other facilities may change. Modifications in methodology or reductions in payment could adversely affect us.

Regulation

      Overview. The healthcare industry is required to comply with extensive government regulation at the federal, state, and local levels. Under these laws and regulations, hospitals must meet requirements to be licensed under state law and be certified to participate in government programs, including the Medicare and Medicaid programs. These requirements relate to matters such as the adequacy of medical care, equipment, personnel, operating policies and procedures, emergency medical care, maintenance of records, relationships with physicians, cost reporting and claim submission, rate-setting, compliance with building codes, and environmental protection. There are also extensive government regulations that apply to our owned and managed diagnostic facilities and the physician practices that we manage. If we fail to comply with applicable laws and regulations, we could be subject to criminal penalties and civil sanctions, our hospitals and other facilities could lose their licenses, and their ability to participate in the Medicare, Medicaid and other federal and state health care programs. In addition, government laws and regulations, or the interpretation of such laws and regulations, may change. If that happens, we may have to make changes in our facilities, equipment, personnel, services or business structures so that our hospitals and other healthcare facilities remain qualified to participate in these programs. We believe that our hospitals and other health care facilities are in substantial compliance with current federal, state, and local regulations and standards.

      The recently enacted Medicare Modernization Act makes significant changes to the Medicare program, particularly with respect to the coverage of prescription drugs. These modifications also include provisions affecting Medicare coverage and reimbursement to general acute care hospitals, as well as other types of providers. In addition, the Medicare Modernization Act contains provisions that restrict reliance upon an exception to the federal physician self-referral law for an 18-month period that will have a significant impact on our development activities. See “— Fraud and Abuse Laws — Physician self-referral law.”

      The healthcare industry continues to attract much legislative interest and public attention. In recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that, like the Medicare Modernization Act, would effect major changes in the healthcare system. Proposals that have been considered include changes in Medicare, Medicaid, and other state and federal programs, cost controls on hospitals and mandatory health insurance coverage for employees. We cannot predict the course of future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs and the effect that any legislation, interpretation, or change may have on us.

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      Licensure and Accreditation. Our hospitals are subject to state and local licensing requirements. In order to verify compliance with these requirements, our hospitals are subject to periodic inspection by state and local authorities. All of our majority-owned hospitals are licensed as general acute care hospitals under applicable state law. In addition, our hospitals are accredited by the Joint Commission on Accreditation of Healthcare Organizations, a nationwide commission which establishes standards relating to physical plant, administration, quality of patient care and operation of hospital medical staffs.

      Certification. In order to participate in the Medicare program, each provider must meet applicable regulations of the Department of Health and Human Services relating to, among other things, the type of facility, equipment, personnel, standards of medical care and compliance with applicable federal, state and local laws. All hospitals and our diagnostic and therapeutic facilities are certified to participate in the Medicare and Medicaid programs.

      Emergency Medical Treatment and Active Labor Act. The Emergency Medical Treatment and Active Labor Act (EMTALA) imposes requirements as to the care that must be provided to anyone who seeks care at facilities providing emergency medical services. In addition, CMS has issued final regulations clarifying those areas within a hospital system that must provide emergency treatment, procedures to meet on-call requirements, as well as other requirements under EMTALA. Sanctions for failing to fulfill these requirements include exclusion from participation in the Medicare and Medicaid programs and civil money penalties. In addition, the law creates private civil remedies that enable an individual who suffers personal harm as a direct result of a violation of the law to sue the offending hospital for damages and equitable relief. A hospital that suffers a financial loss as a direct result of another participating hospital’s violation of the law also has a similar right. Although we believe that our emergency care practices are in compliance with the law and applicable regulations, we cannot assure you that governmental officials responsible for enforcing the law or others will not assert that we are in violation of these laws nor what obligations may be imposed by regulations to be issued in the future.

      Certificate of Need Laws. In some states, the construction of new facilities, the acquisition of existing facilities or the addition of new beds or services may be subject to review by state regulatory agencies under a certificate of need program. These laws generally require appropriate state agency determination of public need and approval prior to the addition of beds or services. Currently, we do not operate any hospitals in states that have adopted certificate of need laws. However, these laws may limit our ability to acquire or develop new facilities in states that have such laws. We operate diagnostic facilities in some states with certificate of need laws and we believe they are operated in compliance with applicable requirements or are exempt from such requirements. However, we cannot assure you that government officials will agree with our interpretation of these laws.

      Professional Licensure. Healthcare professionals who perform services at our hospitals and diagnostic and therapeutic facilities are required to be individually licensed or certified under applicable state law. Our facilities are required to have by-laws relating to the credentialing process, or otherwise document appropriate medical staff credentialing. We take steps to ensure that our employees and agents and physicians on each hospital’s medical staff have all necessary licenses and certifications, and we believe that the medical staff members, as well as our employees and agents comply with all applicable state licensure laws as well as any hospital by-laws applicable to credentialing activities. However, we cannot assure you that government officials will agree with our position.

      Corporate Practice of Medicine and Fee-Splitting. Some states have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians. Some states also have adopted laws that prohibit direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these restrictions include loss of a physician’s license, civil and criminal penalties, and rescission of the business arrangements. These laws vary from state to state, are often vague, and in most states have seldom been interpreted by the courts or regulatory agencies. We have attempted to structure our arrangements with healthcare providers to comply with the relevant state law. However, we cannot assure you that governmental officials charged with responsibility for enforcing these laws will not assert that we,

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      Overview. Various federal and state laws govern financial and other arrangements among healthcare providers and prohibit the submission of false or fraudulent claims to the Medicare, Medicaid and other government healthcare programs. Penalties for violation of these laws include civil and criminal fines, imprisonment and exclusion from participation in federal and state healthcare programs. The Health Insurance Portability and Accountability Act of 1996 (HIPPA) broadened the scope of certain fraud and abuse laws by adding several civil and criminal statutes that apply to all healthcare services, whether or not they are reimbursed under a federal healthcare program. Among other things, HIPPA established civil monetary penalties for certain conduct, including upcoding and billing for medically unnecessary goods or services. In addition, the federal False Claims Act allows an individual to bring a lawsuit on behalf of the government, in what are known as qui tam or whistleblower actions, alleging false Medicare or Medicaid claims or other violations of the statute. The use of these private enforcement actions against healthcare providers has increased dramatically in the recent past, in part because the individual filing the initial complaint may be entitled to share in a portion of any settlement or judgment.

      Anti-Kickback Statute. The federal anti-kickback statute prohibits providers of healthcare and others from soliciting, receiving, offering, or paying, directly or indirectly, any type of remuneration in connection with the referral of patients covered by the federal healthcare programs. Violations of the anti-kickback statute may be punished by a criminal fine of up to $25,000 or imprisonment for each violation, civil fines of up to $50,000, damages of up to three times the total dollar amount involved, and exclusion from federal healthcare programs, including Medicare and Medicaid.

      As authorized by Congress, the Office of Inspector General of the Department of Health and Human Services (the OIG) has published safe harbor regulations that describe activities and business relationships that are deemed protected from prosecution under the anti-kickback statute. However, the failure of a particular activity to comply with the safe harbor regulations does not mean that the activity violates the anti-kickback statute. There are safe harbors for various types of arrangements, including those for personal services and management contracts and others for investment interests, such as stock ownership in companies with more than $50 million in undepreciated net tangible assets related to healthcare items and services. This publicly traded company safe harbor contains additional criteria, including that the stock must be obtained on terms and at a price equally available to the public when trading on a registered securities exchange.

      The OIG is primarily responsible for enforcing the anti-kickback statute and generally for identifying fraud and abuse activities affecting government programs. In order to fulfill its duties, the OIG performs audits and investigations. In addition, the agency provides guidance to healthcare providers by issuing Special Fraud Alerts and Bulletins that identify types of activities that could violate the anti-kickback statute and other fraud and abuse laws. The OIG has identified the following arrangements with physicians as potential violations of the statute:

	•	payment of any incentive by the hospital each time a physician refers a patient to the hospital,
	•	use of free or significantly discounted office space or equipment for physicians,
	•	provision of free or significantly discounted billing, nursing, or other staff services,
	•	free training for a physician’s office staff including management and laboratory techniques,
	•	guarantees which provide that if the physician’s income fails to reach a predetermined level, the hospital will pay any portion of the remainder,
	•	low-interest or interest-free loans, or loans which may be forgiven if a physician refers patients to the hospital,
	•	payment of the costs of a physician’s travel and expenses for conferences,

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	•	payment of services which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of the services rendered, or
	•	purchasing goods or services from physicians at prices in excess of their fair market value.

      We have a variety of financial relationships with physicians who refer patients to our hospitals and our other facilities. Physicians own interests in each of our hospitals and some of our cardiac catheterization laboratories. Physicians may also own our stock. We also have contracts with physicians providing for a variety of financial arrangements, including leases, management agreements, independent contractor agreements, right of first refusal agreements, and professional service agreements. Although we believe that our arrangements with physicians have been structured to comply with the current law and available interpretations, some of our arrangements do not expressly meet the requirements for safe harbor protection. We cannot assure you that regulatory authorities will not determine that these arrangements violate the anti-kickback statute or other applicable laws. Also, most of the states in which we operate have adopted anti-kickback laws, some of which apply more broadly to all payors, not just to federal health care programs. Many of these state laws do not have safe harbor regulations comparable to the federal anti-kickback law and have only rarely been interpreted by the courts or other government agencies. If our arrangements were found to violate any of these anti-kickback laws we could be subject to criminal and civil penalties and/or possible exclusion from participating in Medicare, Medicaid, or other governmental healthcare programs.

      Physician Self-Referral Law. Section 1877 of the Social Security Act, commonly known as the Stark Law, prohibits physicians from referring Medicare and Medicaid patients for certain designated health services to entities in which they or any of their immediate family members have a direct or indirect ownership or compensation arrangement unless an exception applies. The initial Stark Law applied only to referrals of clinical laboratory services. The statute was expanded in Stark II to apply to ten additional “designated health services,” including inpatient and outpatient hospital services, and some radiology services. Sanctions for violating the Stark Law include civil monetary penalties, including up to $15,000 for each improper claim and $100,000 for any circumvention scheme, and exclusion from the Medicare or Medicaid programs. There are various ownership and compensation arrangement exceptions to the self-referral prohibition, including an exception for a physician’s ownership in an entire hospital — as opposed to an ownership interest in a hospital department — if the physician is authorized to perform services at the hospital. This exception is commonly referred to as the “whole hospital exception.” There is also an exception for ownership of publicly traded securities in a company that has stockholder equity exceeding $75 million at the end of its most recent fiscal year or on average during the three previous fiscal years, as long as the physician acquired the securities on terms generally available to the public and the securities are traded on one of the major exchanges. Exceptions are also provided for many of the customary financial arrangements between physicians and providers, including employment contracts, personal service arrangements, isolated financial transactions, payments by physicians, leases, and recruitment agreements, as long as these arrangements meet certain conditions.

      The Medicare Modernization Act contains a provision that restricts reliance upon the whole hospital exception for an 18-month period by new “specialty hospitals.” In addition, the Medicare Modernization Act prohibits an existing specialty hospital from increasing the number of physician investors existing as of November 18, 2003, changing or increasing its area of specialization; expanding beyond its main campus or increasing the total number of beds more than 50% above the number of beds as of November 18, 2003. The Medicare Modernization Act defines the term “specialty hospital” as a hospital primarily or exclusively engaged in the care and treatment of certain specified patients, including those with a cardiac condition, and directs the Secretary of the Department of Health and Human Services, (HHS), to issue regulations interpreting this and other provisions of the Medicare Modernization Act. Although we do not yet know how the HHS regulations will interpret the definition of “specialty hospital,” it is likely that most if not all of our hospitals will fall within the final definition. However, the limitations imposed by the Medicare Modernization Act on the whole hospital exception do not apply to specialty hospitals that were in operation or under development on November 18, 2003. Thus, even if our hospitals are categorized as specialty hospitals for purposes of the Medicare Modernization Act, we do not believe the law will restrict the operations, as they currently exist, of our eleven hospitals in operation nor the opening and operation of our hospitals under development in San Antonio, Texas and Lafayette, Louisiana. Assuming each of our hospitals in operation or under development at November 18, 2003 is

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	•	increasing the number of physician investors in any hospital;
	•	increasing by more than 50% the number of beds in any hospital; or
	•	changing or adding to the areas of specialization of any hospital.

      During the moratorium period, the Medicare Payment Advisory Commission, (MedPac), in consultation with the Comptroller General of the United States, and the Secretary of HHS are to conduct studies and develop recommendations addressing various aspects of specialty hospital operations and their relationship to full-service community hospitals. Absent further congressional action, the limitations on use of the whole hospital exception and the limitations on the operation of specialty hospitals in existence or under development on November 18, 2003 will lapse automatically on June 8, 2005. The reports on specialty hospitals to be issued by MedPac and HHS may contain findings, which will influence future legislative and regulatory developments. Moreover, the regulations to be promulgated by HHS that will interpret the Medicare Modernization Act, amendments to the Medicare Modernization Act, the Stark Law or other legislation including, but not limited to, an expansion or extension of the 18-month moratorium, could require us to modify the manner in which we establish relationships with physicians and operate or develop our hospitals.

      Phase I of the final Stark regulations was issued in January 2001, and largely went into effect on January 4, 2002, except for one provision interpreting the requirement in many Stark Law exceptions that a physician’s compensation must be “set in advance.” The anticipated release date for the interpretation of this term in the Phase I regulations, which would have precluded certain percentage compensation arrangements from qualifying for these exceptions, has now been extended, and, therefore, the effective date of that portion of Phase I has been extended to January 7, 2004. CMS has not yet finalized the balance of the regulations. Phase II is expected to be published in 2004 and will address those exceptions not addressed in Phase I, application of the law under the Medicaid program, and issues under Phase I regulations that have arisen since the issuance of the Phase I regulation. Until the Phase II regulations are issued, the government has indicated that it will accept any reasonable interpretation of the statutory language. There have been few enforcement actions taken and relatively few cases interpreting the Stark Law to date, although one case struck down an aspect of the Phase I regulations relating to the Stark Law’s applicability to certain types of services. As a result, there is little indication as to how courts will interpret and apply the Stark Law; however, enforcement is expected to increase. We believe we have structured our financial arrangements with physicians to comply with the statutory exceptions included in the Stark Law and the regulatory exceptions in Phase I of the final regulations. In particular, we believe that our physician ownership arrangements meet the whole hospital exception. In addition, we expect to meet the exception for publicly traded securities. The diagnostic and other facilities that we own do not furnish any designated health services as defined under the Phase I regulations, and thus referrals to them are not subject to the Stark Law’s prohibitions. We cannot predict the final form that such regulations will take or the effect those regulations will have on us or our arrangements with physicians.

      States in which we operate periodically consider adopting physician self-referral laws, which may prohibit certain physician referrals or require certain disclosures. Some of these state laws would apply regardless of the source of payment for care. These statutes typically provide criminal and civil penalties as well as loss of licensure and may have broader prohibitions than the Stark Law or more limited exceptions. While there is little precedent for the interpretation or enforcement of these state laws, we believe we have structured our financial relationships with physicians and others to comply with applicable state laws. In addition, existing state self-referral laws may be amended. We cannot predict whether new state self-referral laws or amendments to existing laws will be enacted or, once enacted, their effect on us, and we have not researched pending legislation in all the states in which our hospitals are located.

      Civil Monetary Penalties. The Social Security Act contains provisions imposing civil monetary penalties for various fraudulent and/or abusive practices, including, among others, hospitals which knowingly make payments to a physician as an inducement to reduce or limit medically necessary care or services provided to Medicare or Medicaid beneficiaries. In July 1999, the OIG issued a Special Advisory Bulletin on gainsharing

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      False Claims Prohibitions. False claims are prohibited by various federal criminal and civil statutes. In addition, the federal False Claims Act prohibits the submission of false or fraudulent claims to the Medicare, Medicaid, and other government healthcare programs. Penalties for violation of the False Claims Act include substantial civil and criminal fines, including treble damages, imprisonment, and exclusion from participation in federal health care programs. In addition, the False Claims Act allows an individual to bring lawsuits on behalf of the government, in what are known as qui tam or whistleblower actions, alleging false Medicare or Medicaid claims or other violations of the statute.

      A number of states, including states in which we operate, have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court.

      The federal government, private insurers, and various state enforcement agencies have increased their scrutiny of providers’ business arrangements and claims in an effort to identify and prosecute fraudulent and abusive practices. There are ongoing federal and state investigations in the healthcare industry regarding multiple issues including cost reporting, billing and charge-setting practices, unnecessary utilization, physician recruitment practices, physician ownership of healthcare providers, and joint ventures with hospitals. Certain of these investigations have targeted hospitals and physicians. We have substantial Medicare, Medicaid, and other governmental billings, which could result in heightened scrutiny of our operations. We continue to monitor these and all other aspects of our business and have developed a compliance program to assist us in gaining comfort that our business practices are consistent with both legal requirements and current industry standards. However, because the federal and state fraud and abuse laws are complex and constantly evolving, we cannot assure you that government investigations will not result in interpretations that are inconsistent with industry practices, including ours. Evolving interpretations of current, or the adoption of new, federal, or state laws or regulations could affect many of the arrangements entered into by each of our hospitals. In public statements surrounding current investigations, governmental authorities have taken positions on a number of issues, including some for which little official interpretation previously has been available, that appear to be inconsistent with practices that have been common within the industry and that previously have not been challenged in this manner. In some instances, government investigations that in the past have been conducted under the civil provisions of federal law may now be conducted as criminal investigations.

      A number of healthcare investigations are national initiatives in which federal agencies target an entire segment of the healthcare industry. One example involved the federal government’s initiative regarding hospitals’ improper requests for separate payments for services rendered to a patient on an outpatient basis within three days prior to the patient’s admission to the hospital, where reimbursement for such services is included as part of the reimbursement for services furnished during an inpatient stay. The government targeted all hospital providers to ensure conformity with this reimbursement rule. Further, the federal government continues to investigate Medicare overpayments to prospective payment system hospitals that incorrectly report transfers of patients to other prospective payment system hospitals as discharges. Law enforcement authorities, including the OIG and the United States Department of Justice (DOJ), are also increasing scrutiny of various types of arrangements between healthcare providers and potential referral sources, including so-called contractual joint ventures, to

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      It is possible that governmental or regulatory authorities could initiate investigations on these or other subjects in the future at our facilities and that such investigations could result in significant costs in responding to such investigations and penalties to us, as well as adverse publicity, declines in stock value and lawsuits brought by shareholders. It is also possible that our executives, managers, and hospital board members, many of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigations or named as defendants in private litigation. We are not aware of any material governmental investigations involving any of our facilities, our executives, managers or hospital board members. The positions taken by authorities in any future investigations of us, our executives, managers, hospital board members or other healthcare providers, and the liabilities or penalties that may be imposed could have a material adverse effect on our business, financial condition, and results of operations.

      Our hospitals serve as research sites for physician clinical trials sponsored by pharmaceutical and device manufacturers and therefore may perform services on patients enrolled in those studies, including implantation of experimental devices. Only physicians who are members of the medical staff of the hospital may participate in such studies at the hospital. All trials are approved by an Institutional Review Board (IRB), which has the responsibility to review and monitor each study pursuant to applicable law and regulations. Such clinical trials are subject to numerous regulatory requirements.

      The industry standard for conducting preclinical testing is embodied in the investigational new drug regulations administered by the federal Food and Drug Administration (the FDA). Research conducted at institutions supported by funds from the National Institutes of Health must also comply with multiple project assurance agreements and with regulations and guidelines governing the conduct of clinical research that are administered by the National Institutes of Health, the HHS Office of Research Integrity, and the Office of Human Research Protection. Research funded by the National Institutes of Health must also comply with the federal financial reporting and record keeping requirements incorporated into any grant contract awarded. The requirements for facilities engaging in clinical trials are set forth in the code of federal regulations and published guidelines. Regulations related to good clinical practices and investigational new drugs have been mandated by the FDA and have been adopted by similar regulatory authorities in other countries. These regulations contain requirements for research, sponsors, investigators, IRBs, and personnel engaged in the conduct of studies to which these regulations apply. The regulations require that written protocols and standard operating procedures are followed during the conduct of studies and for the recording, reporting, and retention of study data and records. CMS also imposes certain requirements for billing of services provided in connection with clinical trials.

      The FDA and other regulatory authorities require that study results and data submitted to such authorities are based on studies conducted in accordance with the provisions related to good clinical practices and investigational new drugs. These provisions include:

	•	complying with specific regulations governing the selection of qualified investigators,
	•	obtaining specific written commitments from the investigators,
	•	disclosure of financial conflicts-of-interest,
	•	verifying that patient informed consent is obtained,
	•	instructing investigators to maintain records and reports,

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	•	verifying drug or device safety and efficacy, and
	•	permitting appropriate governmental authorities access to data for their review.

      Records for clinical studies must be maintained for specific periods for inspection by the FDA or other authorities during audits. Non-compliance with the good clinical practices or investigational new drug requirements can result in the disqualification of data collected during the clinical trial. It may also lead to debarment of an investigator or institution or False Claims Act allegations if fraud or substantial non-compliance is detected, and subject a hospital to a recoupment of payments for services that are not covered by federal health care programs. Finally, non-compliance could lead to revocation or non-renewal of government research grants.

      Although we believe that we are currently in compliance in all material respects with applicable federal, state, and international clinical trial laws, such laws may be modified, interpreted, or enforced differently in the future. Failure to comply with new or revised existing laws and regulations could subject us and physician investigators to loss of the right to conduct research, civil fines, criminal penalties, and other enforcement actions.

      Finally, new final rules have been adopted by HHS related to the responsibilities of healthcare entities to maintain the privacy of patient identifiable medical information. See “— Privacy and Security Requirements.” We have implemented new policies in an attempt to comply with these rules as they apply to clinical research, including procedures to obtain all required patient authorizations. However, there is little or no guidance available as to how these rules will be enforced.

      The Health Insurance Portability and Accountability Act of 1996, or HIPPA, requires the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically. These provisions are intended to encourage electronic commerce in the healthcare industry. On August 17, 2000, HHS published final regulations establishing electronic data transmission standards that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. Compliance with these regulations was required by October 16, 2003 for our healthcare facilities. We believe we have complied with the electronic data transmission standards.

      HIPPA also requires HHS to adopt standards to protect the security and privacy of health-related information. HHS released final regulations containing privacy standards on December 28, 2000. These privacy regulations were effective April 14, 2001, but compliance with these regulations was not required until April 14, 2003. The government issued further modifications to these regulations on August 14, 2002. The privacy regulations extensively regulate the use and disclosure of individually identifiable health-related information. We have taken extensive measures to comply with the final privacy regulations, but since there is little guidance about how these regulations will be enforced by the government, we cannot predict whether the government will agree that our healthcare facilities are in compliance.

      HHS issued regulations adopting security standards on February 20, 2003 and final regulations on February 20, 2003. These security regulations require healthcare providers to implement organizational and technical practices to protect the security of electronically maintained or transmitted health-related information and will be enforced as to our healthcare facilities on and after April 21, 2005. At this time, we cannot predict the full impact that the security regulations will have on our operations.

      Violations of the Administrative Simplification Provisions of HIPPA could result in civil penalties of up to $25,000 per type of violation in each calendar year and criminal penalties of up to $250,000 per violation. In addition, our facilities will continue to remain subject to state laws that may be more restrictive than the regulations issued under HIPPA. These statutes vary by state and could impose additional penalties.

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      The OIG has issued guidelines to promote voluntarily developed and implemented compliance programs for the healthcare industry. In February 1998, the OIG issued compliance program guidance for hospitals. In response to the original 1998 guidelines, we adopted a code of ethics, designated compliance officers at the parent company level and individual hospitals, established a toll-free compliance line, which permits anonymous reporting, implemented various compliance training programs, and developed a process for screening all employees through applicable federal and state databases.

      We have established a reporting system, auditing and monitoring programs, and a disciplinary system to enforce the code of ethics, and other compliance policies. Auditing and monitoring activities include claims preparation and submission, and cover numerous issues such as coding, billing, cost reporting, and financial arrangements with physicians and other referral sources. These areas are also the focus of training programs.

      Our policy is to require our officers and employees to participate in compliance training programs. The board of directors has established a compliance committee, which oversees implementation of the compliance program. The committee consists of three outside directors, and is chaired by Galen Powers, a former chief counsel for the Health Care Financing Administration (now known as CMS), where he was responsible for providing legal advice on federal healthcare programs, particularly Medicare and Medicaid. The compliance committee of the board meets at least quarterly.

      The corporate compliance officer is appointed by the board, and reports to the chief executive officer and to the compliance committee of the board at least quarterly. The corporate compliance officer is a senior vice president, and has a background in nursing and hospital administration. Each hospital has its own compliance committee that reports to its governing board. The hospital president serves as the hospital’s compliance officer. The compliance committee of the board of directors assesses each hospital’s compliance program at least annually. The corporate compliance officer annually visits the hospitals for compliance reviews, provides an audit guide to the hospitals to evaluate compliance with our policies and procedures, and serves on the compliance committee of each hospital.

      The objective of the program is to ensure that our operations at all levels are conducted in compliance with applicable federal and state laws regarding both public and private healthcare programs. The OIG has announced that it is considering revisions to its compliance guidance for hospitals, and if revisions are published, we will endeavor to modify our compliance program accordingly.

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EXECUTIVE OFFICERS OF THE REGISTRANT

      The following table sets forth information regarding MedCath’s executive officers.

      Stephen R. Puckett has served as MedCath’s chairman of the board since founding MedCath in 1988. He served as president and chief executive officer until January 2000. From 1984 to 1989, Mr. Puckett served as executive vice president and chief operating officer of the Charlotte Mecklenburg Hospital Authority, a large multi-hospital system, and from 1981 to 1983, he served as its senior vice president. Mr. Puckett serves as a director of Pharmanetics, Inc. Mr. Puckett received his undergraduate degree from the University of Alabama and a masters degree in health management from the University of Alabama at Birmingham.

      John T. Casey has served as MedCath’s president and chief executive officer since September 2003 and as a director since May 2000. From 1997 to 1999, Mr. Casey served as chairman and chief executive officer of Physician Reliance Network, Inc., a publicly traded company that was, prior to its merger with US Oncology, Inc., the largest oncology practice management company in the United States. From 1995 to 1997, Mr. Casey was the chief executive officer of Intecare, LLC, a company formed for the purpose of developing joint venture partnerships with hospitals and integrated healthcare systems. From 1991 to 1995, he served as president and chief operating officer of American Medical International, which, at that time, was the third largest publicly held owner and operator of hospitals in the country. In 1995, American Medical International merged with National Medical Enterprises to create Tenet Healthcare Corporation (“Tenet”), where Mr. Casey served as vice-chairman until 1997. He received an undergradute degree in economics from Auburn University and a masters degree in hospital and health care administration from the University of Alabama at Birmingham.

      Charles R. Slaton has served as MedCath’s executive vice president and chief operating officer since September 2003. Prior to joining MedCath, Mr. Slaton was a senior manager for nine years at Tenet, where he most recently served as senior vice president, with financial and operational responsibilities for 15 acute and rehabilitation hospitals in Texas. Before joining Tenet, Mr. Slaton was part of an executive management team turnaround of Santa Rosa Memorial Hospital in Santa Rosa, California. He began his career as vice president of imaging and surgery centers for Saint Mary’s Hospital in Lubbock, Texas. Mr. Slaton received his bachelor’s degree and a masters degree in business administration from Texas Tech University.

      James E. Harris has served as MedCath’s executive vice president and chief financial officer since December 1999. From 1998 to 1999, Mr. Harris was chief financial officer of Fresh Foods, Inc., a manufacturer of fully cooked food products. From 1987 to 1998, Mr. Harris served in several different officer positions with The Shelton Companies, Inc., a private investment company. Prior to joining The Shelton Companies, Inc., Mr. Harris spent two years with Ernst & Young LLP as a senior accountant. Mr. Harris received his undergraduate degree from Appalachian State University and a masters degree in business administration from Wake Forest University’s Babcock School of Management. Mr. Harris is a director of Coca-Cola Bottling Co. Consolidated.

      Thomas K. Hearn III has served as MedCath’s president of the diagnostics division since November 1995. From August 1993 to November 1995, Mr. Hearn served as president of Decision Support Systems, Inc., a healthcare software and consulting firm that he co-founded. Mr. Hearn was employed from 1987 to 1993 by the

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      Joan McCanless has served as MedCath’s senior vice president of risk management and decision support since 1996 and corporate compliance officer since January 1999. From 1993 to 1996, Ms. McCanless served as a principal of Decision Support Systems, Inc., a healthcare software and consulting firm that she co-founded. Prior to that, she was employed at the Charlotte Mecklenburg Hospital Authority where she served as vice president of administration, a department director, head nurse and staff nurse. Ms. McCanless received her undergraduate degree in nursing from the University of North Carolina at Charlotte.

Item 2.     Properties

      Our executive offices are located in Charlotte, North Carolina in approximately 32,580 square feet of leased commercial office space.

      Each of the ventures we have formed to develop a hospital owns the land and buildings of the hospital, with the exception of the land underlying the Heart Hospital of Austin, which we lease. Each hospital has pledged its interest in the land and hospital building to secure the long-term debt incurred to develop the hospital, and substantially all the equipment located at these hospitals is pledged as collateral to secure long-term debt. Each entity formed to own and operate a diagnostic and therapeutic facility leases its facility.

      We are involved in various litigation and proceedings in the ordinary course of our business. We do not believe, based on advice of counsel, our experience with past litigation, and taking into account our applicable insurance coverage, the outcome of any such litigation, individually or in the aggregate, will have a material adverse effect upon our business, financial condition or results of operations.

      We made a written demand of our former chief executive officer, David Crane, to exercise options to purchase 175,000 shares of our common stock at a price of $19 per share which we believe Mr. Crane was obligated to do upon the termination of his employment in accordance with the terms of a contract to purchase stock Mr. Crane entered into with the Company in 2001. Mr. Crane does not believe the contract is enforceable and has refused to exercise such options. While we believe that all other matters with respect to Mr. Crane’s severance have been resolved, we currently intend to file a lawsuit seeking to require Mr. Crane to exercise these options in accordance with the terms of the contract.

      None.

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PART II

      Our common stock began trading on July 24, 2001, on the Nasdaq National Market® under the symbol “MDTH.” At December 10, 2003, there were 17,942,620 shares of common stock outstanding, 83 holders of record. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported by the Nasdaq National Market:

      We have not declared or paid any cash dividends on our common stock and do not anticipate paying cash dividends on our common stock for the foreseeable future. The terms of our credit agreements also restrict us from paying cash dividends and making other distributions to our stockholders. We anticipate that we will retain all earnings, if any, to develop and expand our business. Payment of dividends in the future will be at the discretion of our board of directors and will depend upon our financial condition and operating results.

      The shares of common stock sold in our initial public offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (File No. 333-60278) that was declared effective by the Securities and Exchange Commission on July 23, 2001. Of the net proceeds of approximately $137.0 million from the offering, we immediately used approximately $25.4 million to increase our ownership interest in five of our heart hospitals and approximately $18.0 million to pay all amounts outstanding under a $100.0 million credit facility. In October 2001, we used $17.4 million to increase our ownership interest in the Heart Hospital of New Mexico. In April 2003, we used $800,000 of the net proceeds from the offering to acquire an additional three percent ownership interest in Heart Hospital of New Mexico from its hospital investor partner. We have also invested approximately $14.1 million of the net proceeds from the public offering in our hospital development program. We expect to use the remaining approximate $61.3 million of net proceeds from the offering for development activities, working capital and other corporate purposes. Although we have identified these intended uses of the remaining proceeds, we have broad discretion in the use of the net proceeds from the offering. Pending those uses, we are investing the funds, along with our operating cash, in money market funds or similar short-term interest bearing, investment-grade securities, which are included in cash and cash equivalents in our consolidated balance sheet.

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      The selected consolidated financial data have been derived from our audited consolidated financial statements. The selected consolidated financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes, appearing elsewhere in this report.

      The following table sets forth our selected consolidated financial data as of and for the years ended September 30, 2003, 2002, 2001, 2000, and 1999.

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      The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.

Overview

      We are a healthcare provider primarily focused on the diagnosis and treatment of cardiovascular disease. We design, develop, own, and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services, and the medical staff at each of our hospitals includes qualified physicians in various specialties. As of September 30, 2003, we owned and operated ten hospitals. These hospitals have a total of 635 licensed beds, of which 548 were staffed and available, and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota and Texas. In October 2003, we opened our eleventh hospital, which is located in the city of Glendale, near Milwaukee, Wisconsin. This hospital has 32 licensed beds. We are currently in the process of developing two hospitals, one in San Antonio, Texas and the other in Lafayette, Louisiana. We expect these to open in January 2004 and March 2004, respectively. These hospitals are designed to accommodate a total of 152 inpatient beds and will initially open with 92 licensed beds. Our hospital division accounted for 87.8% of our net revenue in fiscal 2003.

      In the discussions below, the results of operations for our hospital division exclude Heart Hospital of South Dakota, as we do not consolidate this hospital’s results of operations and financial position. We own a minority interest in this hospital and do not have substantive control over it, and therefore account for our minority ownership interest as an equity investment.

      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.

      We completed our initial public offering in July 2001 by issuing 6,000,000 new shares of common stock, The offering generated net proceeds of approximately $137.0 million. Concurrent with the public offering, we completed a series of transactions that we undertook to prepare for the public offering and to increase our ownership interest in some of our hospitals. First, we established MedCath Corporation as a new holding company by issuing 11,879,918 shares of our common stock in exchange for all of the outstanding shares of common stock of our predecessor holding company, MedCath Holdings, Inc. Second, we completed a series of transactions in which we issued 131,602 shares of our common stock valued at the public offering price and paid approximately $25.4 million cash to acquire additional ownership interests in five hospitals from our physician and other partners in each of those hospitals. The cash paid in these transactions was financed with a portion of the net proceeds from the public offering.

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Hospital Ownership and Capital Structure

      Each of our hospitals is organized as either a limited liability company or limited partnership, with one of our wholly-owned subsidiaries serving as the manager or general partner and typically holding from 51% to 72% of the ownership interest in the entity. In most cases, our physician partners own the remaining ownership interests as members or limited partners. In some instances, local market conditions have made it advantageous for us to organize a hospital with a community hospital investing as a partner in addition to physicians. In two of our hospitals, there currently are hospital partners that hold ownership interests of 20% and 33%, respectively. We include in our consolidated financial statements hospitals over which we exercise substantive control, including all hospitals in which we own more than a 50% interest. We use the equity method of accounting for hospitals in which we hold less than a 50% interest and over which we do not exercise substantive control.

      The following table identifies our hospital ownership percentages as of the end of each of our three most recent fiscal years.

      We increased our ownership interest in Tucson Heart Hospital from a minority to a majority ownership position in July 2001 and obtained substantive control of that hospital and began consolidating in our financial statements the hospital’s results of operations and financial position from the date of acquisition. We had previously been required to use the equity method of accounting for Tucson Heart Hospital, which means that we included in our consolidated statement of operations only a percentage of the hospital’s reported net income or loss for each reporting period as equity in net earnings (losses) of unconsolidated affiliates.

      Effective October 1, 2001, we used approximately $17.4 million of the net proceeds from the public offering to acquire an additional 45.0% ownership interest in the Heart Hospital of New Mexico from our physician and hospital partners. The acquisition increased our ownership interest in the Heart Hospital of New Mexico from a 24.0% minority ownership position to a 69.0% majority ownership position, and we obtained substantive control of the hospital. Accordingly, we began to consolidate in our financial statements the hospital’s results of operations and financial position from October 1, 2001 (the first day of our fiscal year 2002). Before acquiring this additional interest, we were required to account for our investment in the Heart Hospital of New Mexico using the equity method of accounting. We acquired an additional three percent interest in this hospital in April 2003 for $800,000 in cash.

      During fiscal 2000, we were approached with two offers to buy the McAllen Heart Hospital, in which we owned a 50.2% interest. On March 1, 2001, we sold the hospital to an affiliate of Universal Health Services, Inc. for approximately $56.0 million. Approximately $38.0 million of the sale proceeds were used to repay the hospital’s long-term debt, including intercompany debt. The majority of the net proceeds from this sale were distributed to the owners of the hospital based on their respective ownership percentages. The balance of the net

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      Hospitals under development are typically capitalized with a mix of debt and equity. Equity represents approximately 15% to 20% of a new hospital’s anticipated development costs and pre-opening expenses. Development costs include real estate acquisition, construction costs, and equipment purchases with debt accounting for the remainder of the project costs. Commercial banks or real estate investment trusts (REITS) typically provide financing to fund a portion of a hospital’s real estate acquisition, construction and related costs, while lenders affiliated with our equipment vendors typically provide debt financing for a hospital’s equipment needs.

New Hospital Development

      On October 2, 2002, we opened Harlingen Medical Center in Harlingen, Texas. This hospital, which represents our ninth hospital in operation, focuses on cardiovascular care as well as orthopedics, neurology, obstetrics and gynecology. On February 28, 2003, we opened Louisiana Heart Hospital in St. Tammany Parish just north of New Orleans, Louisiana. On October 14, 2003, we opened The Heart Hospital of Milwaukee. We currently have two additional hospitals remaining under development. One of the hospitals is located in San Antonio, Texas, which we expect to open in January 2004, and the other hospital is located in Lafayette, Louisiana, which we expect to open in March 2004.

      Once the entity that will own a new hospital is formed and the partners have contributed their capital, it typically takes approximately 18 to 24 months to develop the hospital. As of September 30, 2003 the development costs for our six most recently opened hospitals, including the cost of equipment and capitalized construction period interest, have ranged from $35.7 million to $56.5 million depending on the size of the hospital and its location. These costs were incurred throughout the construction period, with approximately 55% of the costs being incurred in the last six months before opening the hospital. In addition, we incur pre-opening expenses throughout the development process, with the majority of these expenses incurred during the six to eight month period immediately prior to opening the hospital. Pre-opening expenses for our six most recently opened hospitals have ranged between $3.3 million and $6.5 million per hospital. Approximately 54% of these pre-opening expenses were for personnel and 7% for marketing and advertising. The balance was distributed among several categories including staff recruitment and relocation, office and equipment rentals, travel and meals for the staff and other operating expenses such as property taxes, legal expenses, insurance and utilities.

      The United States Congress recently passed and President Bush signed into law the Medicare Modernization Act, which imposes an 18-month moratorium on the development of new physician-owned “specialty hospitals,” as such hospitals are defined in the statute, and in regulations we expect to be issued by the Department of Health and Human Services. Although the Medicare Modernization Act will not affect our ability to open the two hospitals we have under development, it is expected to prohibit our hospital development activities as currently configured through June 8, 2005, the expiration date of the moratorium. See “Business — Regulation — Fraud and Abuse Laws — Physician self-referral laws.” Management is currently conducting an in-depth, strategic review process to determine what changes to the Company’s new hospital development strategy are appropriate in response to the Medicare Modernization Act and other regulatory and operational developments. See “Business — Overview.”

Revenue Sources, Trends and Uncertainties

      Revenue Sources by Division. The largest percentage of our net revenue is attributable to our hospital division. Based on our continued investment in the development of hospitals, we believe our hospital division’s percentage of consolidated net revenue will continue to increase in future periods.

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      The following table sets forth the percentage contribution of each of our consolidating divisions to consolidated net revenue in the periods indicated below.