MEDCATH CORP - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2005

Commission File Number 000-33009

MEDCATH CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		56-2248952
(State or other jurisdiction of		(IRS Employer Identification No.)
incorporation or organization)

10720 Sikes Place, Suite 300
Charlotte, North Carolina 28277
(Address of principal executive offices, including zip code)

(704) 708-6600
(Registrant’s telephone number, including area code)

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

Yes þ No o

As of April 29, 2005, there were 18,448,710 shares of $0.01 par value common stock outstanding.

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

MEDCATH CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)


	March 31,			September 30,
	2005			2004
	(Unaudited)
Current assets:
Cash and cash equivalents	$	129,466		$	72,310
Accounts receivable, net		100,988			92,797
Medical supplies		22,266			22,205
Deferred income tax assets		9,759			11,972
Prepaid expenses and other current assets		7,071			7,938
Current assets of discontinued operations		1,776			2,403

Total current assets		271,326			209,625
Property and equipment, net		402,320			410,908
Investments in and advances to affiliates, net		4,990			6,029
Goodwill		70,100			70,100
Other intangible assets, net		10,166			10,746
Other assets		12,660			13,473
Long-term assets of discontinued operations		296			33,355

Total assets	$	771,858		$	754,236


Current liabilities:
Accounts payable	$	48,749		$	46,372
Income tax payable		1,697			533
Accrued compensation and benefits		24,772			25,914
Accrued property taxes		4,213			6,565
Other accrued liabilities		17,853			15,968
Current portion of long-term debt and obligations under capital leases		49,250			9,872
Current liabilities of discontinued operations		419			1,720

Total current liabilities		146,953			106,944
Long-term debt		308,957			346,006
Obligations under capital leases		4,725			5,641
Deferred income tax liabilities		11,665			9,494
Other long-term obligations		829			7,330

Total liabilities		473,129			475,415

Minority interest in equity of consolidated subsidiaries		20,635			15,173
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value, 10,000,000 shares authorized; none issued		—			—
Common stock, $0.01 par value, 50,000,000 shares authorized; 18,437,610 issued and 18,368,710 outstanding at March 31, 2005; 18,090,186 issued and 18,021,286 outstanding at September 30, 2004		184			181
Paid-in capital		364,668			358,656
Accumulated deficit		(86,372	)		(94,715	)
Accumulated other comprehensive income (loss)		8			(80	)
Treasury stock, 68,900 shares at cost		(394	)		(394	)

Total stockholders’ equity		278,094			263,648

Total liabilities and stockholders’ equity	$	771,858		$	754,236

See notes to consolidated financial statements.

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


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Net revenue	$	192,014		$	168,680		$	376,774		$	323,803
Operating expenses:
Personnel expense		59,402			52,415			116,615			99,427
Medical supplies expense		55,564			45,980			108,050			87,957
Bad debt expense		11,947			9,475			23,431			23,263
Other operating expenses		37,505			36,595			75,905			68,115
Pre-opening expenses		—			2,087			—			5,103
Depreciation		9,431			10,430			19,167			20,153
Amortization		290			290			580			580
Loss (gain) on disposal of property, equipment and		71			33			74			(51	)
other assets

Total operating expenses		174,210			157,305			343,822			304,547

Income from operations		17,804			11,375			32,952			19,256
Other income (expenses):
Interest expense		(7,775	)		(6,742	)		(15,773	)		(13,062	)
Interest and other income, net		621			161			1,016			396
Equity in net earnings of unconsolidated affiliates		886			1,147			1,655			1,724

Total other expenses, net		(6,268	)		(5,434	)		(13,102	)		(10,942	)

Income from continuing operations before minority interest, income taxes and discontinued operations		11,536			5,941			19,850			8,314
Minority interest share of (earnings) losses of consolidated subsidiaries		(4,402	)		65			(8,401	)		(1,026	)

Income from continuing operations before income taxes and discontinued operations		7,134			6,006			11,449			7,288
Income tax expense		2,856			2,292			4,579			2,809

Income from continuing operations		4,278			3,714			6,870			4,479
Income (loss) from discontinued operations, net of		(475	)		(1,073	)		1,473			(2,771	)

taxes
Net income	$	3,803		$	2,641		$	8,343		$	1,708


Earnings (loss) per share, basic
Continuing operations	$	0.24		$	0.21		$	0.38		$	0.25
Discontinued operations		(0.03	)		(0.06	)		0.08			(0.15	)

Earnings per share, basic	$	0.21		$	0.15		$	0.46		$	0.10

Earnings (loss) per share, diluted
Continuing operations	$	0.22		$	0.20		$	0.36		$	0.24
Discontinued operations		(0.02	)		(0.06	)		0.07			(0.15	)

Earnings per share, diluted	$	0.20		$	0.14		$	0.43		$	0.09


Weighted average number of shares, basic		18,177			17,985			18,110			17,967
Dilutive effect of stock options		1,285			514			1,139			300

Weighted average number of shares, diluted		19,462			18,499			19,249			18,267

See notes to consolidated financial statements.

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


	Six Months Ended March 31,
	2005			2004
Net income	$	8,343		$	1,708
Adjustments to reconcile net income to net cash
provided by operating activities:
Bad debt expense		23,431			23,263
Depreciation and amortization expense		19,747			20,733
Loss (gain) on disposal of property, equipment and other assets		74			(51	)
Amortization of loan acquisition costs		801			845
Equity in earnings of unconsolidated affiliates, net of dividends received		1,033			1,636
Minority interest share of earnings of consolidated subsidiaries		8,401			1,026
Change in fair value of interest rate swaps		(770	)		—
Deferred income taxes		5,098			503
Change in assets and liabilities that relate to operations:
Accounts receivable		(31,622	)		(37,842	)
Medical supplies		(61	)		(3,506	)
Prepaids and other assets		964			555
Accounts payable and accrued liabilities		1,092			9,186

Net cash provided by operating activities of continuing operations		36,531			18,056
Net cash used in operating activities of discontinued operations		(9,501	)		(2,872	)

Net cash provided by operating activities		27,030			15,184


Investing activities:
Purchases of property and equipment		(11,146	)		(33,186	)
Proceeds from sale of property and equipment		184			2,316
Proceeds from sale of discontinued components		42,500			—
Other investing activities		6			90

Net cash provided by (used in) investing activities of continuing operations		31,544			(30,780	)
Net cash used in investing activities of discontinued operations		—			(12,115	)

Net cash provided by (used in) investing activities		31,544			(42,895	)


Financing activities:
Proceeds from issuance of long-term debt		2,150			47,699
Repayments of long-term debt		(4,045	)		(37,624	)
Repayments of obligations under capital leases		(1,355	)		(2,005	)
Payments of loan acquisition costs		—			(227	)
Investments by minority partners		3,639			851
Distributions to minority partners		(7,140	)		(7,052	)
Repayments from minority partners		97			61
Proceeds from exercised stock options		5,236			237

Net cash (used in) provided by financing activities of continuing operations		(1,418	)		1,940
Net cash provided by financing activities of discontinued operations		—			14,111

Net cash (used in) provided by financing activities		(1,418	)		16,051


Net increase (decrease) in cash and cash equivalents		57,156			(11,660	)
Cash and cash equivalents:
Beginning of period		72,310			93,231

End of period	$	129,466		$	81,571


Supplemental schedule of noncash investing and financing activities:
Capital expenditures financed by capital leases	$	505		$	853
Deferred tax asset related to exercised stock options		776			79
Distributions to minority partners declared but not paid		—			359

See notes to consolidated financial statements.

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

1. Business and Organization

MedCath Corporation (the Company) is a healthcare provider focused primarily on the diagnosis and treatment of cardiovascular disease. The Company owns and operates hospitals in partnership with physicians whom it believes have established reputations for clinical excellence as well as with community hospital systems. Each of the Company’s majority-owned hospitals (collectively, the Hospital Division) is a freestanding licensed general acute care hospital, that provides a wide range of health services, and the medical staff at each hospital includes qualified physicians in various specialties. The Company opened its first hospital in 1996, and as of March 31, 2005 has ownership interests in and operates twelve hospitals. These hospitals include eleven majority-owned hospitals and one in which the Company owns a minority interest. The Company’s twelve hospitals have a total of 727 licensed beds, of which 686 were staffed and available at March 31, 2005, and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas.

In addition to its hospitals, the Company owns and/or manages cardiac diagnostic and therapeutic facilities (the Diagnostics Division). The Company began its cardiac diagnostic and therapeutic business in 1989, and as of March 31, 2005 owns and/or manages thirty cardiac diagnostic and therapeutic facilities. Thirteen of these facilities are located at hospitals operated by other parties and offer invasive diagnostic and sometimes therapeutic procedures. The remaining facilities are not located at hospitals and offer only diagnostic services. The Company also provides consulting and management services tailored primarily to cardiologists and cardiovascular surgeons, which is included in the corporate and other division.

2. Summary of Significant Accounting Policies

Basis of Presentation - The Company’s unaudited interim consolidated financial statements as of March 31, 2005 and for the three and six months ended March 31, 2005 and 2004 have been prepared in accordance with accounting principles generally accepted in the United States of America (hereafter, generally accepted accounting principles) and pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These unaudited interim consolidated financial statements reflect, in the opinion of management, all material adjustments (consisting only of normal recurring adjustments) necessary to fairly state the results of operations and financial position for the periods presented. All intercompany transactions and balances have been eliminated. The results of operations for the three and six months ended March 31, 2005 are not necessarily indicative of the results expected for the full fiscal year ending September 30, 2005 or future fiscal periods.

Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the SEC, although the Company believes the disclosure is adequate to make the information presented not misleading. The unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2004. During the three months and six months ended March 31, 2005, the Company has not made any material changes in the selection or application of its critical accounting policies as set forth its Annual Report on Form 10-K for the year ended September 30, 2004.

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

Stock-Based Compensation - As of March 31, 2005, the Company has two stock-based compensation plans: a stock option plan under which it may grant incentive stock options and nonqualified stock options to officers and other key employees and an outside director’s stock option plan under which it may grant nonqualified stock options to nonemployee directors. The Company accounts for stock options under both of these plans in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, as permitted under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. The Company also provides prominent disclosure of the information required by SFAS No. 148, Accounting for Stock-Based Compensation, in its annual and interim financial statements.

Under APB Opinion No. 25, compensation cost is determined based on the intrinsic value of the equity instrument award. No stock-based employee compensation cost is reflected in net income for the three or six months ended March 31, 2005 and 2004, as all options granted during those periods under the Company’s stock option plans had an exercise price equal to the market value of the underlying shares of common stock at the date of grant.

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

Had compensation expense for the Company’s stock options been recognized based on the fair value of the option award at the grant date under the methodology prescribed by SFAS No. 123, the Company’s net income would have been impacted as follows:


	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Net income, as reported	$	3,803	$	2,641	$	8,343	$	1,708
Deduct: Total stock-based employee compensation expense determined under fair value method, net of related income taxes		424		497		1,043		951

Proforma net income	$	3,379	$	2,144	$	7,300	$	757


Earnings per share, basic
As reported	$	0.21	$	0.15	$	0.46	$	0.10
Pro forma	$	0.19	$	0.12	$	0.40	$	0.04

Earnings per share, diluted
As reported	$	0.20	$	0.14	$	0.43	$	0.09
Pro forma	$	0.17	$	0.12	$	0.38	$	0.04

New Accounting Pronouncement — In December 2004, the Financial Accounting Standard Board (the FASB) issued Statement 123R, Share-Based Payment, to be effective for interim or annual periods beginning after June 15, 2005. This Statement was further revised in April 2005 to be effective for annual periods beginning after June 15, 2005. Accordingly, Statement 123R will become effective during the first quarter of fiscal 2006 for the Company. Statement 123R requires all share-based payments to employees, including grants of employee stock options and purchases under employee stock purchase plans, to be recognized as an operating expense in the statement of operations. The expense is recognized over the requisite service period based on fair values measured on grant dates and the new standard may be adopted using either the modified prospective transition method or the modified retrospective transition method. The Company is currently evaluating its share-based employee compensation programs, alternative adoption methods and the potential impact of Statement 123R on its consolidated financial position and results of operations.

3. Discontinued Operations

On November 5, 2004, the Company and local Milwaukee physicians, who jointly owned The Heart Hospital of Milwaukee (HHM), entered into an agreement with Columbia St. Mary’s, a Milwaukee-area hospital group, to close HHM and sell certain assets, primarily comprised of real property and equipment, to Columbia St. Mary’s for $42.5 million. The sale was completed on December 1, 2004 and the Company recognized a gain on the sale of the assets, net of allocated goodwill, of approximately $9.3 million.

In connection with the agreement to sell the assets of HHM, the Company closed the facility prior to the completion of the sale. As a part of the closure, the Company incurred termination benefits and contract termination costs of approximately $2.2 million. In addition, the Company wrote-off approximately $1.4 million related to the net book value of certain assets abandoned as a part of the closure of the facility.

Transaction proceeds were used by HHM to pay intercompany secured debt, which totaled approximately $37.0 million on the date of the closing, as well as transaction costs and hospital operating expenses of approximately $2.0 million. The remaining proceeds from the divestiture, combined with proceeds from the liquidation of the assets not sold to Columbia St. Mary’s, will be used to satisfy certain liabilities of HHM and to return a portion of the original capital contribution to the investors.

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

The results of operations of HHM are as follows:


	Six Months Ended March 31,
	2005			2004
Net revenue	$	2,003		$	6,109
Restructuring and write-off charges		(3,635	)		—
Operating expenses		(3,345	)		(11,017	)


Loss from operations		(4,977	)		(4,908	)
Other income (expense):
Gain/(loss) on sale of assets		9,301			(1	)
Minority interest and other, net		(604	)		335
Income tax (expense) benefit		(2,247	)		1,803

Net income (loss)	$	1,473		$	(2,771	)

The principal balance sheet items of HHM, including allocated goodwill and excluding intercompany debt, is as follows:


	March 31,		September 30,
	2005		2004
Cash and cash equivalents	$	1,582	$	462
Accounts receivable, net		194		851
Other current assets		—		1,090

Current assets	$	1,776	$	2,403


Property and equipment, net	$	296	$	28,455
Goodwill		—		4,900

Noncurrent assets	$	296	$	33,355


Accounts payable	$	310	$	605
Accrued liabilities		109		1,115

Total current liabilities	$	419	$	1,720

4. Accounts Receivable

Accounts receivable, net, consists of the following:


	March 31,			September 30,
	2005			2004
Receivables, principally from patients and third-party payors	$	113,149		$	102,485
Receivables, principally from billings to hospitals for various cardiovascular procedures		4,368			3,990
Amounts due under management contracts		3,621			2,698
Other		2,199			2,095

		123,337			111,268
Less allowance for doubtful accounts		(22,349	)		(18,471	)

Accounts receivable, net	$	100,988		$	92,797

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

5. Equity Investments

The Company owns minority interests in Avera Heart Hospital of South Dakota and certain diagnostic ventures and neither has substantive control over the businesses nor is the primary beneficiary under the revised version of FASB Interpretation No. 46 Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. Therefore, the Company does not consolidate the results of operations and financial position of these entities, but rather accounts for its minority ownership interest in the hospital and other ventures as equity investments.

The following represents summarized financial information of Avera Heart Hospital of South Dakota:


	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Net revenue	$	14,861	$	14,352	$	30,058	$	27,717
Operating income	$	3,053	$	2,574	$	5,856	$	4,859
Net income	$	2,475	$	1,915	$	4,697	$	3,526


	March 31,		September 30,
	2005		2004
Current assets	$	14,598	$	19,592
Non-current assets	$	36,476	$	36,620
Current liabilities	$	10,651	$	10,085
Non-current liabilities	$	28,136	$	30,984

6. Goodwill and Other Intangible Assets

As required by SFAS No. 142, Goodwill and Other Intangibles, the Company has designated September 30, its fiscal year end, as the date on which it will perform the annual goodwill impairment test for all of its reporting units. Goodwill of a reporting unit will also be tested between annual tests if an event occurs or circumstances change that indicate that impairment may exist. During the three and six months ended March 31, 2005 and 2004, no events or circumstances changed that indicated interim impairment testing was necessary and as such, no impairment was recognized during the respective periods.

The Company’s other intangible assets, net, included the following:


	March 31, 2005					September 30, 2004
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
	Amount		Amortization			Amount		Amortization
Management contracts	$	20,598	$	(11,409	)	$	20,598	$	(10,844	)
Other		1,446		(469	)		1,446		(454	)

Total	$	22,044	$	(11,878	)	$	22,044	$	(11,298	)

Amortization expense recognized for the management contracts and other intangible assets totaled $0.3 million and $0.6 million for the three and six months ended March 31, 2005 and 2004, respectively.

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

7. Long-Term Debt

Long-term debt consists of the following:


	March 31,			September 30,
	2005			2004

Senior notes	$	150,000		$	150,000
Senior secured credit facility		99,250			99,750
Real estate investment trust loans		57,434			57,899
Notes payable to various lenders		48,857			45,628

		355,541			353,277
Less current portion		(46,584	)		(7,271	)

Long-term debt	$	308,957		$	346,006

Senior Notes — On July 7, 2004, the Company’s wholly-owned subsidiary, MedCath Holdings Corp. (the Issuer), completed an offering of $150.0 million in aggregate principal amount of 9 7/8% senior notes (the Senior Notes) in a private placement to qualified institutional buyers. In November 2004, the unregistered Senior Notes were exchanged for registered Senior Notes. The Senior Notes, which mature on July 15, 2012, pay interest semi-annually, in arrears, on January 15 and July 15 of each year. The Senior Notes are redeemable, in whole or in part, at any time on or after July 15, 2008 at a designated redemption amount, plus accrued and unpaid interest and liquidated damages, if any, to the applicable redemption date. The Company may redeem up to 35% of the aggregate principal amount of the Senior Notes on or before July 15, 2007 with the net cash proceeds from certain equity offerings. In event of a change in control in the Company or the Issuer, the Company must offer to purchase the Senior Notes at a purchase price of 101% of the aggregate principal amount, plus accrued and unpaid interest and liquidated damages, if any, to the date of redemption.

The Senior Notes are general unsecured unsubordinated obligations of the Issuer and are fully and unconditionally guaranteed, jointly and severally, by MedCath Corporation (the Parent) and all 95% or greater owned existing and future domestic subsidiaries of the Issuer (the Guarantors). The guarantees are general unsecured unsubordinated obligations of the Guarantors.

The Senior Notes include covenants that restrict, among other things, the Company’s and its subsidiaries’ ability to make restricted payments, declare or pay dividends, incur additional indebtedness or issue preferred stock, incur liens, merge, consolidate or sell all or substantially all of the assets, engage in certain transactions with affiliates, enter into various transactions with affiliates, enter into sale and leaseback transactions or engage in any business other than a related business.

Senior Secured Credit Facility — Concurrent with the offering of the Senior Notes, on July 7, 2004, the Issuer entered into a $200.0 million senior secured credit facility (the Senior Secured Credit Facility) with a syndicate of banks and other institutional lenders. The Senior Secured Credit Facility provides for a seven-year term loan facility (the Term Loan) in the amount of $100.0 million and a five-year senior secured revolving credit facility (Revolving Facility) in the amount of $100.0 million, which includes a $25.0 million sub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 million sub-limit for swing-line loans. There were no borrowings under the Revolving Facility at March 31, 2005; however, the Company has letters of credit outstanding of $1.5 million, which reduces availability under the Revolving Facility to $98.5 million.

Borrowings under the Senior Secured Credit Facility, excluding swing-line loans, bear interest per annum at a rate equal to the sum of LIBOR plus the applicable margin or the alternate base rate plus the applicable margin. The applicable margin is different for the Revolving Facility and the Term Loan and varies for the Revolving Facility depending on the Company’s financial performance. Swing-line borrowings under the Revolving Facility bear interest at the alternate base rate which is defined as the greater of the Bank of America, N.A. prime rate or the federal funds rate plus 0.5%. The Issuer is required to pay quarterly, in arrears, 0.5% per annum commitment fee equal to the unused commitments under the Senior Secured Credit Facility. The Issuer is also required to pay quarterly, in arrears, a fee on the stated amount of each issued and outstanding letter of credit ranging from 200 to 300 basis points depending upon the Company’s financial performance.

The Issuer is required to make mandatory prepayments of principal in specified amounts upon the occurrence of excess cash flows and other certain events, as defined by the Senior Secured Credit Facility, and is permitted to make voluntary prepayments of principal under the Senior Secured Credit Facility. The Term Loan is subject to amortization of principal in quarterly installments of $250,000 for each of the first five years, with the remaining balance payable in the final two years.

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

The Senior Secured Credit Facility is guaranteed, jointly and severally, by the Parent and all 95% or greater owned existing and future direct and indirect domestic subsidiaries of the Issuer and is secured by a first priority perfected security interest in all of the capital stock or other ownership interests owned by the Issuer in each of its subsidiaries, all other present and future assets and properties of the Parent, the Issuer and the subsidiary guarantors and all the intercompany notes.

The Senior Secured Credit Facility requires compliance with certain financial covenants including a senior secured leverage ratio test, a fixed charge coverage ratio test, a tangible net worth test and a total leverage ratio test. The Senior Secured Credit Facility also contains customary restrictions on, among other things, the Company’s ability and its subsidiaries’ ability to incur liens; engage in mergers, consolidations and sales of assets; incur debt; declare dividends, redeem stock and repurchase, redeem and/or repay other debt; make loans, advances and investments and acquisitions; make capital expenditures; and transactions with affiliates.

Real Estate Investment Trust (REIT) Loans — From 1994 to 1997, the Company entered into mortgage loans with real estate investment trusts for the purpose of financing the land acquisition and construction costs for several of its hospitals. As of March 31, 2005, the Company’s REIT loan balance includes the outstanding indebtedness of two hospitals. The interest rates on the outstanding REIT loans are based on a rate index tied to U.S. Treasury Notes plus a margin that is determined on the completion date of the hospital, and subsequently increases per year by 20 basis points. The principal and interest on the REIT loans are payable monthly over seven-year terms from the completion date of each hospital using extended period amortization schedules and include balloon payments at the end of each respective term. One loan is subject to extension for an additional seven years at the option of the Company. Borrowings under the REIT loans are collateralized by a pledge of the Company’s interest in the related hospitals’ property, equipment and certain other assets. One of the REIT loans is due in full in January 2006 and therefore, the outstanding balance is included in current portion of long-term debt and obligations under capital leases as of March 31, 2005.

As of March 31, 2005, in accordance with the related hospital operating agreements and as required by the lenders, the Company guaranteed 100% of the obligations of its subsidiary hospitals for the bank mortgage loans made under the REIT loans. The Company receives a fee from the minority partners in the subsidiary hospitals as consideration for providing guarantees in excess of the Company’s ownership percentage in the subsidiary hospitals. The guarantees expire concurrent with the terms of the related real estate loans and would require the Company to perform under the guarantee in the event of the subsidiary hospitals failing to perform under the related loans. The total amount of this real estate debt is secured by the subsidiary hospitals’ underlying real estate, which was financed with the proceeds from the debt. The average interest rate as of March 31, 2005 and September 30, 2004 on the REIT loans were 10.41% and 10.29%, respectively. Because the Company consolidates the subsidiary hospitals’ results of operations and financial position, both the assets and the accompanying liabilities are included in the assets and long-term debt on the Company’s consolidated balance sheets.

Notes Payable to Various Lenders — The Company acquired substantially all of the medical and other equipment for its hospitals and certain diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories under installment notes payable to equipment lenders collateralized by the related equipment. In addition, two facilities in the Diagnostics Division financed leasehold improvements through notes payable collateralized by the improvements. Amounts borrowed under these notes are payable in monthly installments of principal and interest over four to seven year terms. Interest is at fixed and variable rates ranging from 5.47% to 9.57%. The Company has guaranteed certain of its subsidiary hospitals’ equipment loans. The Company receives a fee from the minority partners in the subsidiary hospitals as consideration for providing guarantees in excess of the Company’s ownership percentage in the subsidiary hospitals. These guarantees expire concurrent with the terms of the related equipment loans and would require the Company to perform under the guarantee in the event of the subsidiaries’ failure to perform under the related loan. At March 31, 2005, $40.9 million was guaranteed by the Company. Because the Company consolidates the subsidiary hospitals’ results of operations and financial position, both the assets and the accompanying liabilities are included in the assets and long-term debt on the Company’s consolidated balance sheets. These notes payable contain various covenants and restrictions including the maintenance of specific financial ratios and amounts and payment of dividends.

Debt Covenants — At March 31, 2005, the Company was in violation of a certain financial ratio related to an equipment loan at Louisiana Heart Hospital. The equipment lender has granted a waiver for the breach at March 31, 2005. The Company was in compliance with all other covenants in the instruments governing its outstanding debt at March 31, 2005.

Guarantees of Unconsolidated Affiliate’s Debt — The Company has guaranteed approximately 50% of the real estate and 30% of the equipment debt of its unconsolidated affiliate hospital. The Company provides these guarantees in exchange for a fee from that affiliate hospital. At March 31, 2005, the affiliate hospital was in compliance with all covenants in the instruments governing its debt. The total amount of the affiliate hospital’s real estate and equipment debt was approximately $26.0 million and $7.3 million at March 31, 2005. Accordingly, the real estate debt and the equipment debt guaranteed by the Company was approximately $13.0 million and $2.2 million, respectively, at March 31, 2005. These guarantees expire concurrent with the terms of the related real estate and equipment loans and would require the Company to perform under the guarantee in the event of the affiliate hospital’s failure to perform under the related loan. The total amount of this affiliate hospital’s debt is secured by the hospital’s underlying real estate and equipment, which were financed with the proceeds from the debt. Because the Company does not consolidate the affiliate hospital’s results of operations and financial position, neither the assets nor the accompanying liabilities are included in the value of the assets and liabilities on the Company’s balance sheets.

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

Interest Rate Swaps — Three of the Company’s consolidated hospitals entered into fixed interest rate swaps during fiscal year 2001. These fixed interest rate swaps effectively fixed the interest rate on the hedge portion of the related debt at 4.92% plus an applicable margin for two of the hospitals and at 4.60% plus an applicable margin for the other hospital. These interest rate swaps were accounted for as cash flow hedges prior to the repayment of the outstanding balances of the bank mortgage debt for these three hospitals as part of the July 7, 2004 financing transaction. The Company did not terminate the interest rate swaps as part of the financing transaction. Since July 7, 2004, the fixed interest rate swaps have not been utilized as a hedge of variable rate debt obligations, and accordingly, changes in the valuation of the interest rate swaps have been recorded directly to earnings as a component of interest expense. The fair value of the interest rate swaps at March 31, 2005 was an obligation of $0.4 million resulting in an unrealized gain of approximately $0.4 million and $0.8 million during the three and six months ended March 31, 2005, respectively.

8. Liability Insurance Coverage

On June 30, 2004, the Company entered into a new one-year claims-made policy providing coverage for claim amounts in excess of $3.0 million of retained liability per claim, subject to an additional amount of retained liability of $2.0 million per claim and $4.0 million in the aggregate for claims reported during the policy year at one of its hospitals. Because of the Company’s self-insured retention levels, the Company recognizes a liability for its estimate of amounts, up to the amount of the Company’s retained liability it believes may be paid to resolve each malpractice claim. As of March 31, 2005 and September 30, 2004, the total estimated liability for the Company’s self-insured retention on medical malpractice claims, including an estimated amount for incurred but not reported claims, was approximately $5.9 million and $5.4 million, respectively, which is included in current liabilities in the Company’s consolidated balance sheets.

9. Per Share Data

The calculation of diluted earnings per share considers the potentially dilutive effect of options to purchase 2,492,543 and 3,149,550 shares of common stock outstanding at March 31, 2005 and 2004, respectively, at prices ranging from $4.75 to $26.46. Of these options, 120,000 and 1,374,300 were not included in the calculation of diluted earnings per share for the three months ended March 31, 2005 and 2004, respectively, and 120,000 and 1,390,300 were not included for the six months ended March 31, 2005 and 2004, respectively, as such shares were anti-dilutive for the periods.

10. Commitments and Contingencies

Compliance — Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation and may be modified. The Company believes that it is in compliance with such laws and regulations and it is not aware of any investigations involving allegations of potential wrongdoing. Compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including substantial fines and criminal penalties, as well as repayment of previously billed and collected revenue from patient services and exclusion from the Medicare and Medicaid programs.

Contingencies — The Company is involved in various claims and legal actions in the ordinary course of business, including malpractice claims arising from services provided to patients that have been asserted against the Company by various claimants, and additional claims that may be asserted for known incidents through March 31, 2005. These claims and legal actions are in various stages, and some may ultimately be brought to trial. Moreover, additional claims arising from services provided to patients in the past and other legal actions may be asserted in the future. The Company is attempting to protect its interests in all such claims and actions.

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

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

11. Reportable Segment Information

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


	Three Months ended March 31,						Six months ended March 31,
	2005			2004			2005			2004
Net revenue:
Hospital Division	$	178,244		$	155,019		$	349,473		$	294,949
Diagnostics Division		12,827			11,754			25,456			25,115
Corporate and other		943			1,907			1,845			3,739

Consolidated totals	$	192,014		$	168,680		$	376,774		$	323,803


Income (loss) from operations:
Hospital Division	$	18,064		$	11,445		$	33,231		$	18,138
Diagnostics Division		2,548			1,924			4,305			4,627
Corporate and other		(2,808	)		(1,994	)		(4,584	)		(3,509	)

Consolidated totals	$	17,804		$	11,375		$	32,952		$	19,256


Depreciation and amortization:
Hospital Division	$	7,897		$	8,909		$	16,124			17,020
Diagnostics Division		1,541			1,533			3,051			3,133
Corporate and other		283			278			572			580

Consolidated totals	$	9,721		$	10,720		$	19,747		$	20,733


Interest expense (income), net:
Hospital Division	$	7,477		$	7,745		$	15,180		$	14,855
Diagnostics Division		59			156			132			315
Corporate and other		(374	)		(1,318	)		(542	)		(2,498	)

Consolidated totals	$	7,162		$	6,583		$	14,770		$	12,672


Capital expenditures:
Hospital Division	$	4,938		$	12,662		$	8,829		$	28,635
Diagnostics Division		438			736			1,400			1,293
Corporate and other		519			344			917			3,258

Consolidated totals	$	5,895		$	13,742		$	11,146		$	33,186


	March 31,		September 30,
	2005		2004

Aggregate identifiable assets:
Hospital Division	$	595,211	$	623,527
Diagnostics Division		42,798		43,215
Corporate and other		133,849		87,494

Consolidated totals	$	771,858	$	754,236

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

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

12. Guarantor/Non-Guarantor Financial Statements

The following table presents the condensed consolidated financial information for each of the Parent, the Issuer, the Guarantors and the subsidiaries of the Issuer that are not Guarantors (the Non-Guarantors), together with consolidating eliminations, as of and for the periods indicated.

MEDCATH CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
March 31, 2005


								Non-
	Parent		Issuer		Guarantors			Guarantors			Eliminations			MedCath
Current assets:
Cash and cash equivalents	$	—	$	—	$	106,876		$	22,590		$	—		$	129,466
Accounts receivable, net		—		—		3,838			97,150			—			100,988
Medical supplies		—		—		107			22,159			—			22,266
Deferred income tax assets		—		—		9,759			—			—			9,759
Intercompany notes and other receivables		—		—		17,578			—			(17,578	)		—
Prepaid expenses and other current assets		—		—		3,790			3,281			—			7,071
Current assets of discontinued operations		—		—		—			1,776			—			1,776

Total current assets		—		—		141,948			146,956			(17,578	)		271,326
Property and equipment, net		—		—		22,059			380,261			—			402,320
Investments in and advances to affiliates, net		—		—		4,173			817			—			4,990
Investments in subsidiaries		278,094		278,094		(16,174	)		(62	)		(539,952	)		—
Goodwill		—		—		70,100			—			—			70,100
Other intangible assets, net		—		—		9,189			977			—			10,166
Intercompany notes receivable		—		—		321,108			—			(321,108	)		—
Other assets		—		—		9,153			3,507			—			12,660
Long-term assets of discontinued operations		—		—		—			296			—			296

Total assets	$	278,094	$	278,094	$	561,556		$	532,752		$	(878,638	)	$	771,858


Current liabilities:
Accounts payable	$	—	$	—	$	1,290		$	47,459		$	—		$	48,749
Income tax payable				—		1,697			—						1,697
Accrued compensation and benefits		—		—		7,309			17,463			—			24,772
Accrued property taxes		—		—		100			4,113			—			4,213
Other accrued liabilities		—		—		8,880			8,973			—			17,853
Intercompany notes and other payables		—		—		—			17,578			(17,578	)		—
Current portion of long- term debt and obligations under capital leases		—		—		2,012			47,238			—			49,250
Current liabilities of discontinued operations		—		—		—			419			—			419

Total current liabilities		—		—		21,288			143,243			(17,578	)		146,953
Long- term debt		—		—		248,085			60,872			—			308,957
Obligations under capital leases		—		—		2,424			2,301			—			4,725
Intercompany notes payable		—		—		—			321,108			(321,108	)		—
Deferred income tax liabilities		—		—		11,665			—			—			11,665
Other long- term obligations		—		—		—			829			—			829
Long term liabilities of discontinued operations		—		—		—			—			—			—

Total liabilities		—		—		283,462			528,353			(338,686	)		473,129
Minority interest in equity of consolidated subsidiaries		—		—		—			—			20,635			20,635
Total stockholders’ equity		278,094		278,094		278,094			4,399			(560,587	)		278,094

Total liabilities and stockholders’ equity	$	278,094	$	278,094	$	561,556		$	532,752		$	(878,638	)	$	771,858

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2004


								Non-
	Parent		Issuer		Guarantors			Guarantors			Eliminations			MedCath
Current assets:
Cash and cash equivalents	$	—	$	—	$	56,122		$	16,188		$	—		$	72,310
Accounts receivable, net		—		—		3,784			89,013			—			92,797
Medical supplies		—		—		106			22,099			—			22,205
Deferred income tax assets		—		—		11,972			—			—			11,972
Intercompany notes and other receivables		—		—		23,274			—			(23,274	)		—
Prepaid expenses and other current assets		—		—		5,259			2,679			—			7,938
Current assets of discontinued operations		—		—		—			2,403			—			2,403

Total current assets		—		—		100,517			132,382			(23,274	)		209,625
Property and equipment, net		—		—		23,297			387,611			—			410,908
Investments in and advances to affiliates, net		—		—		5,212			817			—			6,029
Investments in subsidiaries		263,648		263,648		(28,741	)		(31	)		(498,524	)		—
Goodwill		—		—		70,100			—			—			70,100
Other intangible assets, net		—		—		9,753			993			—			10,746
Intercompany notes receivables		—		—		349,370			—			(349,370	)		—
Other assets		—		—		9,898			3,575			—			13,473
Long-term assets of discontinued operations		—		—		4,900			28,455			—			33,355

Total assets	$	263,648	$	263,648	$	544,306		$	553,802		$	(871,168	)	$	754,236


Current liabilities:
Accounts payable	$	—	$	—	$	697		$	45,675		$	—		$	46,372
Income tax payable		—		—		533			—			—			533
Accrued compensation and benefits		—		—		8,641			17,273			—			25,914
Accrued property taxes		—		—		53			6,512			—			6,565
Other accrued liabilities		—		—		7,519			8,449			—			15,968
Intercompany notes and other payables		—		—		—			20,955			(20,955	)		—
Current portion of long- term debt and obligations under capital leases		—		—		2,010			7,862			—			9,872
Current liabilities of discontinued operations		—		—		—			4,039			(2,319	)		1,720

Total current liabilities		—		—		19,453			110,765			(23,274	)		106,944
Long- term debt		—		—		248,750			97,256			—			346,006
Obligations under capital leases		—		—		2,961			2,680			—			5,641
Intercompany notes payable		—		—		—			315,126			(315,126	)		—
Deferred income tax liabilities		—		—		9,494			—			—			9,494
Other long- term obligations		—		—		—			7,330			—			7,330
Long-term liabilities of discontinued operations		—		—		—			34,244			(34,244	)		—

Total liabilities		—		—		280,658			567,401			(372,644	)		475,415

Minority interest in equity of consolidated subsidiaries		—		—		—			—			15,173			15,173
Total stockholders’ equity		263,648		263,648		263,648			(13,599	)		(513,697	)		263,648

Total liabilities and stockholders’ equity	$	263,648	$	263,648	$	544,306		$	553,802		$	(871,168	)	$	754,236

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended March 31, 2005


	Parent		Issuer		Guarantors			Non- Guarantors			Eliminations			MedCath
Net revenue	$	—	$	—	$	8,383		$	186,167		$	(2,536	)	$	192,014
Total operating expenses						11,228			165,518			(2,536	)		174,210

Income (loss) from operations		—		—		(2,845	)		20,649			—			17,804
Interest expense		—		—		(5,503	)		(2,272	)		—			(7,775	)
Interest and other income (expense), net		—		—		5,820			(5,199	)		—			621
Equity in net earnings of unconsolidated affiliates		3,803		3,803		9,872			—			(16,592	)		886

Income before minority interest, income taxes and discontinued operations		3,803		3,803		7,344			13,178			(16,592	)		11,536
Minority interest share of earnings of consolidated subsidiaries		—		—		—			—			(4,402	)		(4,402	)

Income before income taxes and discontinued operations		3,803		3,803		7,344			13,178			(20,994	)		7,134
Income tax expense		—		—		(2,856	)		—			—			(2,856	)

Income from continuing operations		3,803		3,803		4,488			13,178			(20,994	)		4,278
Income (loss) from discontinued operations		—		—		(685	)		210			—			(475	)

Net income	$	3,803	$	3,803	$	3,803		$	13,388		$	(20,994	)	$	3,803

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended March 31, 2004


	Parent		Issuer		Guarantors			Non- Guarantors			Eliminations			MedCath
Net revenue	$	—	$	—	$	8,312		$	162,527		$	(2,159	)	$	168,680
Total operating expenses						10,871			148,593			(2,159	)		157,305

Income (loss) from operations		—		—		(2,559	)		13,934			—			11,375
Interest expense		—		—		(382	)		(6,360	)		—			(6,742	)
Interest and other income (expense), net		—		—		1,544			(1,383	)		—			161
Equity in net earnings of unconsolidated affiliates		2,641		2,641		5,668			442			(10,245	)		1,147

Income before minority interest, income taxes and discontinued operations		2,641		2,641		4,271			6,633			(10,245	)		5,941
Minority interest share of losses of consolidated subsidiaries		—		—		—			—			65			65

Income before income taxes and discontinued operations		2,641		2,641		4,271			6,633			(10,180	)		6,006
Income tax expense		—		—		(2,292	)		—			—			(2,292	)

Income from continuing operations		2,641		2,641		1,979			6,633			(10,180	)		3,714
Income (loss) from discontinued operations		—		—		662			(1,735	)		—			(1,073	)

Net income	$	2,641	$	2,641	$	2,641		$	4,898		$	(10,180	)	$	2,641

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended March 31, 2005


	Parent		Issuer		Guarantors			Non- Guarantors			Eliminations			MedCath
Net revenue	$	—	$	—	$	16,398		$	365,354		$	(4,978	)	$	376,774
Total operating expenses						21,379			327,421			(4,978	)		343,822

Income (loss) from operations		—		—		(4,981	)		37,933			—			32,952
Interest expense		—		—		(11,036	)		(4,737	)		—			(15,773	)
Interest and other income (expense), net		—		—		11,456			(10,440	)		—			1,016
Equity in net earnings of unconsolidated affiliates		8,343		8,343		24,630			—			(39,661	)		1,655

Income before minority interest, income taxes and discontinued operations		8,343		8,343		20,069			22,756			(39,661	)		19,850
Minority interest share of earnings of consolidated subsidiaries		—		—		—			—			(8,401	)		(8,401	)

Income before income taxes and discontinued operations		8,343		8,343		20,069			22,756			(48,062	)		11,449
Income tax expense		—		—		(4,579	)		—			—			(4,579	)

Income from continuing operations		8,343		8,343		15,490			22,756			(48,062	)		6,870
Income (loss) from discontinued operations		—		—		(7,147	)		8,620			—			1,473

Net income	$	8,343	$	8,343	$	8,343		$	31,376		$	(48,062	)	$	8,343

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended March 31, 2004


	Parent		Issuer		Guarantors			Non- Guarantors			Eliminations			MedCath
Net revenue	$	—	$	—	$	16,377		$	311,474		$	(4,048	)	$	323,803
Total operating expenses						21,220			287,375			(4,048	)		304,547

Income (loss) from operations		—		—		(4,843	)		24,099			—			19,256
Interest expense		—		—		(784	)		(12,278	)		—			(13,062	)
Interest and other income (expense), net		—		—		2,966			(2,570	)		—			396
Equity in net earnings of unconsolidated affiliates		1,708		1,708		5,375			442			(7,509	)		1,724

Income before minority interest, income taxes and discontinued operations		1,708		1,708		2,714			9,693			(7,509	)		8,314
Minority interest share of earnings of consolidated subsidiaries		—		—		—			—			(1,026	)		(1,026	)

Income before income taxes and discontinued operations		1,708		1,708		2,714			9,693			(8,535	)		7,288
Income tax expense		—		—		(2,809	)		—			—			(2,809	)

Income (loss) from continuing operations		1,708		1,708		(95	)		9,693			(8,535	)		4,479
Income (loss) from discontinued operations		—		—		1,803			(4,574	)		—			(2,771	)

Net income	$	1,708	$	1,708	$	1,708		$	5,119		$	(8,535	)	$	1,708

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Six Months Ended March 31, 2005


						Non-
	Parent			Guarantors		Guarantors			Eliminations			MedCath
Net cash provided by (used in) operating activities	$	—		$	4,686	$	22,344		$	—		$	27,030
Net cash provided by (used in) investing activities		(6,012	)		14,468		28,656			(5,568	)		31,544
Net cash provided by (used in) financing activities		6,012			31,600		(44,598	)		5,568			(1,418	)

Increase in cash and cash equivalents		—			50,754		6,402			—			57,156
Cash and cash equivalents:
Beginning of period		—			56,122		16,188			—			72,310

End of period	$	—		$	106,876	$	22,590		$	—		$	129,466

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Six Months Ended March 31, 2004


							Non-
	Parent			Guarantors			Guarantors			Eliminations			MedCath
Net cash provided by (used in) operating activities	$	—		$	(82	)	$	16,862		$	(1,596	)	$	15,184
Net cash provided by (used in) investing activities		(316	)		7,713			(41,287	)		(9,005	)		(42,895	)
Net cash provided by (used in) financing activities		316			(19,044	)		24,178			10,601			16,051

Decrease in cash and cash equivalents		—			(11,413	)		(247	)		—			(11,660	)
Cash and cash equivalents:
Beginning of period		—			77,911			15,320			—			93,231

End of period	$	—		$	66,498		$	15,073		$	—		$	81,571

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

The following discussion and analysis of our results of operations and financial condition should be read in conjunction with the interim unaudited consolidated financial statements and related notes included elsewhere in this report, as well as the audited consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.

Overview

General. We are a healthcare provider focused primarily on the diagnosis and treatment of cardiovascular disease. We own and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence as well as with community hospital systems. We opened our first hospital in 1996 and currently have ownership interests in and operate twelve hospitals. We have majority ownership of eleven of these hospitals and a minority interest in one. 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. Our hospitals have a total of 727 licensed beds and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas.

In addition to our hospitals, we own and/or manage cardiac diagnostic and therapeutic facilities. We began our cardiac diagnostic and therapeutic business in 1989. We currently own and/or manage thirty cardiac diagnostic and therapeutic facilities. Thirteen of these facilities are located at hospitals operated by other parties and offer invasive diagnostic and sometimes therapeutic procedures. The remaining facilities are not located at hospitals and offer only diagnostic services. We also provide consulting and management services tailored primarily to cardiologists and cardiovascular surgeons.

Basis of Consolidation. We have included in our consolidated financial statements hospitals and cardiac diagnostic and therapeutic facilities over which we exercise substantive control, including all entities in which we own more than a 50% interest, as well as variable interest entities in which we are the primary beneficiary. We have used the equity method of accounting for entities, including variable interest entities, in which we hold less than a 50% interest and over which we do not exercise substantive control and are not the primary beneficiary. Accordingly, the one hospital in which we hold a minority interest at March 31, 2005, Avera Heart Hospital of South Dakota, is excluded from the net revenue and operating expenses of our consolidated company and our consolidated hospital division. Similarly, a number of our diagnostic and therapeutic facilities are not consolidated. Our minority interest in these entities’ results of operations for the periods discussed is recognized as part of the equity in net earnings of unconsolidated affiliates in our statements of operations in accordance with the equity method of accounting.

During the first quarter of fiscal 2005, we closed The Heart Hospital of Milwaukee and sold substantially all of the hospital’s assets. Accordingly, for the three and six months ended March 31, 2005 and 2004, the results of operations and the related gain on the sale of the assets, have been excluded from continuing operations and instead, are reported in income (loss) from discontinued operations.

Same Facility Hospitals. We include in our same facility data only those facilities that were open and operational during the full current and prior fiscal year comparable periods. For example, on a same facility basis for our consolidated hospital division for the three and six months ended March 31, 2005, we exclude the results of operations of Texsan Heart Hospital, which opened in January 2004, and Heart Hospital of Lafayette, which opened in March 2004.

Revenue Sources by Division. The largest percentage of our net revenue is attributable to our hospital division. The following table sets forth the percentage contribution of each of our consolidating divisions to consolidated net revenue in the periods presented.


	Three Months Ended March 31,						Six Months Ended March 31,
Division	2005			2004			2004			2003
Hospital		92.8	%		91.9	%		92.8	%		91.1	%
Diagnostics		6.7			7.0			6.8			7.8
Corporate and other		0.5			1.1			0.4			1.1

Net Revenue		100.0	%		100.0	%		100.0	%		100.0	%

Revenue Sources by Payor. We receive payments for our services rendered to patients from the Medicare and Medicaid programs, commercial insurers, health maintenance organizations and our patients directly. Generally, our net revenue is determined by a number of factors, including the payor mix, the number and nature of procedures performed and the rate of payment for the procedures. Since cardiovascular disease disproportionately affects those age 55 and older, the proportion of net revenue we derive from the Medicare program is higher than that of most general acute care hospitals. The following table sets forth the percentage of consolidated net revenue we earned by category of payor in the periods indicated.


	Three Months Ended March 31,						Six Months Ended March 31,
Payor	2005			2004			2005			2004
Medicare		49.1	%		49.1	%		49.1	%		47.4	%
Medicaid		4.0			4.5			4.2			4.3
Commercial and other, including self-pay		46.9			46.4			46.7			48.3

Total consolidated net revenue		100.0	%		100.0	%		100.0	%		100.0	%

A significant portion of our net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid. We expect the net revenue that we receive from the Medicare program as a percentage of total consolidated net revenue will remain significant in future periods; however, our payor mix may fluctuate in future periods due to changes in reimbursement, market and industry trends with self-pay patients and other similar factors.

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 significantly affect our business. In addition, reimbursement is generally subject to adjustment following audit by third party payors, including the fiscal intermediaries who administer the Medicare program for the Center for Medicare and Medicaid Services (CMS). Final determination of amounts due providers under the Medicare program often takes several years because of such audits, as well as resulting provider appeals and the application of technical reimbursement provisions. We believe that adequate provision has been made for any adjustments that might result from these programs; however, due to the complexity of laws and regulations governing the Medicare and Medicaid programs, the manner in which they are interpreted and the other complexities involved in estimating our net revenue, there is a reasonable possibility that recorded estimates will change by a material amount in the near term.

Results of Operations

Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004

Statement of Operations Data. The following table presents, for the periods indicated, our results of operations in dollars and as a percentage of net revenue:


	Three Months Ended March 31,
							Increase / Decrease						% of Net Revenue
	2005			2004			$			%			2005			2004
				(in thousands)
Net revenue	$	192,014		$	168,680		$	23,334			13.8	%		100.0	%		100.0	%
Operating expenses:
Personnel expense		59,402			52,415			6,987			13.3			30.9			31.1
Medical supplies expense		55,564			45,980			9,584			20.8			28.9			27.3
Bad debt expense		11,947			9,475			2,472			26.1			6.2			5.6
Other operating expenses		37,505			36,595			910			2.5			19.6			21.7
Pre-opening expenses		—			2,087			(2,087	)		(100.0	)		—			1.2
Depreciation		9,431			10,430			(999	)		(9.6	)		4.9			6.2
Amortization		290			290			—			—			0.2			0.2
Loss on disposal of property, equipment and other assets		71			33			38			115.2			—			—

Total operating expenses		174,210			157,305			16,905			10.7			90.7			93.3

Income from operations		17,804			11,375			6,429			56.5			9.3			6.7
Other income (expenses):
Interest expense		(7,775	)		(6,742	)		(1,033	)		(15.3	)		(4.0	)		(4.0	)
Interest and other income, net		621			161			460			285.7			0.3			0.1
Equity in net earnings of unconsolidated affiliates		886			1,147			(261	)		(22.8	)		0.4			0.7

Total other expenses, net		(6,268	)		(5,434	)		(834	)		(15.3	)		(3.3	)		(3.2	)

Income from continuing operations before minority interest, income taxes and discontinued operations		11,536			5,941			5,595			94.2			6.0			3.5
Minority interest share of (earnings) losses of consolidated subsidiaries		(4,402	)		65			(4,467	)		(6872.3	)		(2.3	)		—

Income from continuing operations before income taxes and discontinued operations		7,134			6,006			1,128			18.8			3.7			3.5
Income tax expense		2,856			2,292			564			24.6			1.5			1.3

Income from continuing operations		4,278			3,714			564			15.2			2.2			2.2
Loss from discontinued operations, net of taxes		(475	)		(1,073	)		598			55.7			(0.2	)		(0.6	)

Net income	$	3,803		$	2,641		$	1,162			44.0	%		2.0	%		1.6	%

The following tables present, for the periods indicated, selected operating data on a consolidated basis and same facility basis:


	Three Months Ended March 31,
	2005			2004			% Change
Selected Operating Data (consolidated) ( a ):
Number of hospitals		11			11
Licensed beds ( b )		672			672
Staffed and available beds ( c )		631			585
Admissions ( d )		11,719			10,627			10.3	%
Adjusted admissions ( e )		15,617			13,386			16.7	%
Patient days ( f )		42,503			37,571			13.1	%
Adjusted patient days ( g )		56,521			47,252			19.6	%
Average length of stay (days) ( h )		3.63			3.54			2.5	%
Occupancy ( i )		74.8	%		70.6	%
Inpatient catheterization procedures		5,891			5,453			8.0	%
Inpatient surgical procedures		3,151			2,688			17.2	%
Hospital division revenue	$	178,244		$	155,019			15.0	%


	Three Months Ended March 31,
	2005			2004			% Change
Selected Operating Data (same facility):
Number of hospitals		9			9
Licensed beds ( b )		580			580
Staffed and available beds ( c )		547			531
Admissions ( d )		10,499			10,338			1.6	%
Adjusted admissions ( e )		14,206			13,037			9.0	%
Patient days ( f )		38,076			36,621			4.0	%
Adjusted patient days ( g )		51,401			46,110			11.5	%
Average length of stay (days) ( h )		3.63			3.54			2.5	%
Occupancy ( i )		77.3	%		75.8	%
Inpatient catheterization procedures		5,041			5,248			(3.9	)%
Inpatient surgical procedures		2,870			2,603			10.3	%
Hospital division revenue	$	157,803		$	149,927			5.3	%

(a)   Selected operating data includes consolidated hospitals as of the end of the period reported in continuing operations but does not include hospitals which are accounted for using the equity method or as discontinued operations in our consolidated financial statements.

(b)   Licensed beds represent the number of beds for which the appropriate state agency licenses a facility regardless of whether the beds are actually available for patient use.

(c)   Staffed and available beds represent the number of beds that are readily available for patient use at the end of the period.

(d)   Admissions represent the number of patients admitted for inpatient treatment.

(e)   Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by admissions.

(f)   Patient days represent the total number of days of care provided to inpatients.

(g)   Adjusted patient days is a general measure of combined inpatient and outpatient days. We computed adjusted patient days by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by patient days.

(h)   Average length of stay (days) represents the average number of days inpatients stay in our hospitals.

(i)   We computed occupancy by dividing patient days by the number of days in the period and then dividing the quotient by the number of staffed and available beds.

Net Revenue. Net revenue increased 13.8% or $23.3 million for the three months ended March 31, 2005, the second quarter of our fiscal year 2005, from $168.7 million for the three months ended March 31, 2004, the second quarter of our fiscal year 2004. The

growth was comprised of a $23.2 million increase in our hospital division and a $1.1 million increase in our diagnostics division, both of which were partially offset by a $1.0 million decrease in our cardiology consulting and management operations.

Of the $23.2 million increase in hospital division net revenue, $15.3 million was attributable to net revenue growth from our two new hospitals: Texsan Heart Hospital, which opened January 13, 2004, and Heart Hospital of Lafayette, which opened March 2, 2004. The remaining $7.9 million increase in hospital division net revenue was due to growth among our same facility hospitals. Included in these results is the fact that during the second quarter of fiscal 2005, we filed Medicare cost reports for fiscal year 2004 and as a result of changes in our estimates of final settlements based on additional information, we recognized contractual allowance adjustments that increased net revenue by approximately $1.7 million. Similarly, during the second quarter of fiscal 2004 we filed Medicare cost reports for fiscal year 2003 and recognized adjustments that increased net revenue by approximately $1.4 million.

On a consolidated basis, hospital admissions increased 10.3% and adjusted admissions increased 16.7% for the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004. Also on a consolidated basis, inpatient catheterization procedures increased 8.0% and inpatient surgical procedures increased 17.2% for the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004. Average length of stay increased slightly to 3.63 days for the current fiscal quarter compared to 3.54 days for the same prior fiscal quarter. The net $7.9 million increase in net revenue contributed by our same facility hospitals, along with the overall increases in admissions of 1.6%, adjusted admissions of 9.0% and inpatient surgical procedures of 10.3% at these hospitals, was largely due to the growth in volume at substantially all of our facilities period over period.

The $1.1 million increase in our diagnostics division net revenue was primarily driven by the ramp up or introduction of new facilities. New diagnostic and therapeutic businesses developed and opened in the second quarter of 2004 and since such time contributed incremental revenue of $0.8 million. Same facility revenue increased by $0.3 million, which was primarily the net result of growth in the number of procedures performed at our facilities, including new services added, partially offset by of a decline in the number of procedures performed in our mobile cardiac catheterization laboratories during the second three months of fiscal 2005 compared to the second three months of fiscal 2004.

Personnel expense. Personnel expense increased 13.3% to $59.4 million for the second quarter of fiscal 2005 from $52.4 million for the second quarter of fiscal 2004. As a percentage of net revenue, personnel expense decreased to 30.9% from 31.1% for the comparable periods. The $7.0 million increase in personnel expense was principally incurred in our hospital division, with our two new hospitals accounting for $3.2 million of the increase and our same facility hospitals accounting for an additional $4.5 million increase. The growth in personnel expense at our same facility hospitals was primarily attributable to the additional staffing to support the increase in admissions and surgical procedures in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004, as well as cost of living adjustments given to employees during the first quarter of 2005. The increase in the hospital division personnel costs was offset in part due to a change in the physician management contracts in our cardiology consulting and management operations whereby certain reimbursed costs are no longer being passed through our operations.

Medical supplies expense. Medical supplies expense increased 20.8% to $55.6 million for the second quarter of fiscal 2005 from $46.0 million for the second quarter of fiscal 2004. This $9.6 million increase in medical supplies expense was primarily incurred in our hospital division, with our two new hospitals and our same facility hospitals accounting for $4.1 million and $5.3 million of the increase, respectively. The increase in same facility hospitals’ medical supplies expense was largely attributable to the increase in surgical procedures performed during the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004. In addition, during 2005 these procedures were disproportionately comprised of cardiac procedures that use high-cost medical devices and supplies, such as automatic implantable cardioverter defibrillators (AICD) and drug-eluting stents. During the second quarter of fiscal 2005, we experienced a 30.3% increase in the number of AICD procedures compared to the second quarter of fiscal 2004. We have experienced a general trend over recent fiscal quarters in which the number of surgical procedures involving AICD and other higher cost medical devices and supplies has increased as a component of our mix of procedures. In addition, the increased usage of drug-eluting stents contributed to higher medical supplies expense during the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004. We estimate that in our hospital division, during the second quarter of fiscal 2005, 79.7% of our cardiac procedures involving stents utilized drug-eluting stents compared to 50.7% in the second quarter of fiscal 2004. In addition, our average utilization rate for drug-eluting stents in this division was 1.4 stents per case during the second quarter of fiscal 2005.

As a percentage of net revenue, medical supplies expense increased to 28.9% for the second quarter of fiscal 2005 from 27.3% for the second quarter of fiscal 2004. Our medical supplies expense may continue to increase in future periods as new technologies are introduced into the cardiovascular care market and as we continue to experience increased utilization of AICD and drug-eluting stents that use high-cost devices. The amount of increase in our medical supplies expense and the relationship to net revenue in future periods will depend on many factors such as the introduction, availability, cost and utilization of the specific new technology by physicians in providing patient care, as well as any changes in reimbursement amounts we may receive from Medicare and other payors. Our medical supplies expense in future periods will remain sensitive to changes in case mix of procedures at our hospitals as surgical procedures typically involve higher cost medical supplies than catheterization procedures.

Bad debt expense. Bad debt expense increased 26.1% to $11.9 million for the second quarter of fiscal 2005 from $9.5 million for the second quarter of fiscal 2004. This $2.4 million increase in bad debt expense was primarily driven by our new facility hospitals, which had a $1.8 million increase. Our same facilities experienced a $0.6 million increase in bad debt expense period to period. The

increase in our same facility hospitals’ bad debt expense was primarily attributable to growth in net revenue, combined with a high percentage of self-pay patients at certain facilities, offset in part by overall positive cash collections during the second quarter of 2005 at our other facilities. As a percentage of net revenue, bad debt expense was 6.2% for the second quarter of fiscal 2005 as compared to 5.6% for the second quarter of fiscal 2004. While payor mix has a significant impact on bad debt expense, we anticipate future bad debt expense as a percentage of revenue to approximate or be slightly higher than those recognized in the second quarter of 2005.

Pre-opening expenses. There were no pre-opening expenses incurred for the second quarter of fiscal 2005 versus $2.1 million that was incurred for the second quarter of fiscal 2004. Pre-opening expenses represent expenses specifically related to projects under development, primarily new hospitals. Upon opening Heart Hospital of Lafayette during the second quarter of fiscal 2004, we have completed our hospital expansion plans that commenced in 2001 following completion of our initial public offering, and we do not currently have any other hospitals under development. Accordingly, we are no longer incurring pre-opening expenses. The amount of pre-opening expenses, if any, we incur in future periods will depend on the nature, timing and size of our development activities.

Depreciation. Depreciation decreased 9.6% to $9.4 million for the second quarter of fiscal 2005 as compared to $10.4 million for the second quarter of fiscal 2004. This $1.0 million decrease is the net result of a decrease of $1.3 million in depreciation at our same facilities, offset by a $0.3 million increase at our two new hospitals. Depreciation at our same facilities decreased due to certain equipment at these locations becoming fully depreciated during fiscal 2004 or during the first quarter of fiscal 2005.

Interest expense. Interest expense increased 15.3% to $7.8 million for the second quarter of fiscal 2005 compared to $6.7 million for the second quarter of fiscal 2004. This $1.1 million increase in interest expense was primarily attributable to the fact that as a result of the July 7, 2004 refinancing transaction, our overall cost of borrowings on debt increased compared to the debt that was repaid. In addition, we capitalized approximately $0.2 million of interest expense as part of the capitalized construction costs of our hospital that was still under development during part of the second quarter of fiscal 2004.

Equity in net earnings of unconsolidated affiliates. Equity in net earnings of unconsolidated affiliates decreased to $0.9 million in the second quarter of fiscal 2005 from $1.1 million in the second quarter of 2004. During the three months ended March 31, 2004, equity in earnings included a $0.4 million gain associated with sale of land by an unconsolidated affiliate. Excluding this transaction, net earnings increased $0.2 million period to period, which is primarily attributed to growth in earnings at the one hospital in which we hold less than a 50% interest.

Earnings allocated to minority interests. Earnings allocated to minority interests were $4.4 million for the second quarter of fiscal 2005 as compared to a loss allocation of $0.1 million for the second quarter of fiscal 2004. This $4.5 million shift was primarily due to changes in the operating results of our individual hospitals and the respective basis for allocating such earnings or losses among us and our partners on either a pro rata basis or disproportionate basis during the second quarter of fiscal 2005 compared to the same period of fiscal 2004. Our earnings allocated to minority interests increased partially due to an increase in earnings of certain of our same facility hospitals which were allocated to our minority partners on a pro rata basis. In addition, during the second quarter of 2004, we shared losses at our two newest hospitals with our minority partners on a pro rata basis; however, during the second quarter of 2005, we were required to recognize a disproportionate 100% of the hospitals losses such that no amounts were allocated to our minority partners. For a more complete discussion of our accounting for minority interests, including the basis for the disproportionate allocation accounting, see “Critical Accounting Policies” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.

We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate losses and/or recoveries thereof through disproportionate profit recognition. As of March 31, 2005, we had remaining cumulative disproportionate loss allocations of approximately $28.1 million that we may recover in future periods. However, we may be required to recognize additional disproportionate losses, depending on the results of operations of each of our hospitals. We could also be required to recognize disproportionate losses at our other hospitals not currently in disproportionate allocation depending on their results of operations in future periods.

Income taxes. Income tax expense was $2.9 million for the second quarter of fiscal 2005 compared to $2.3 million for the second quarter of fiscal 2004, which represents an effective tax rate of approximately 40% and 38%, respectively. The increase in income tax expense in the comparable periods reflects the overall increase in taxable income for the second quarter of 2005 as compared to the second quarter of 2004. The Company continues to have federal and state net operating loss carry forwards available from prior periods to offset the majority of its current tax liabilities.

Loss from discontinued operations. During the first quarter of 2005, the Company closed and sold substantially all of the assets of The Heart Hospital of Milwaukee. Accordingly, The Heart Hospital of Milwaukee is accounted for as discontinued operations. The loss from discontinued operations in the second quarter of 2005 mainly represents the net impact of revisions to certain liabilities and allowances, primarily income taxes, associated with the closure of the facility. The loss from discontinued operations in the second quarter of 2004 represents the operating losses, net of the tax benefit of such losses, of the facility during the period.

Results of Operations

Six Months Ended March 31, 2005 Compared to Six Months Ended March 31, 2004

Statement of Operations Data. The following table presents, for the periods indicated, our results of operations in dollars and as a percentage of net revenue:


	Six Months Ended March 31,
							Increase / Decrease						% of Net Revenue
	2005			2004			$			%			2005			2004
				(in thousands)
Net revenue	$	376,774		$	323,803		$	52,971			16.4	%		100.0	%		100.0	%
Operating expenses:
Personnel expense		116,615			99,427			17,188			17.3			31.0			30.7
Medical supplies expense		108,050			87,957			20,093			22.8			28.7			27.2
Bad debt expense		23,431			23,263			168			0.7			6.2			7.2
Other operating expenses		75,905			68,115			7,790			11.4			20.1			21.0
Pre-opening expenses		—			5,103			(5,103	)		(100.0	)		—			1.6
Depreciation		19,167			20,153			(986	)		(4.9	)		5.1			6.2
Amortization		580			580			—			—			0.2			0.2
Loss (gain) on disposal of property, equipment and other		74			(51	)		125			245.1			—			—

assets
Total operating expenses		343,822			304,547			39,275			12.9			91.3			94.1

Income from operations		32,952			19,256			13,696			71.1			8.7			5.9
Other income (expenses):
Interest expense		(15,773	)		(13,062	)		(2,711	)		(20.8	)		(4.2	)		(4.0	)
Interest and other income, net		1,016			396			620			156.6			0.3			0.1
Equity in net earnings of unconsolidated affiliates		1,655			1,724			(69	)		(4.0	)		0.4			0.6

Total other expenses, net		(13,102	)		(10,942	)		(2,160	)		(19.7	)		(3.5	)		(3.3	)

Income from continuing operations before minority interest, income taxes and discontinued operations		19,850			8,314			11,536			138.8			5.2			2.6
Minority interest share of earnings of consolidated subsidiaries		(8,401	)		(1,026	)		(7,375	)		718.8			(2.2	)		(0.3	)

Income from continuing operations before income taxes and discontinued operations		11,449			7,288			4,161			57.1			3.0			2.3
Income tax expense		4,579			2,809			1,770			63.0			1.2			0.9

Income from continuing operations		6,870			4,479			2,391			53.4			1.8			1.4
Income (loss) from discontinued operations, net of taxes		1,473			(2,771	)		4,244			(153.2	)		0.4			(0.9	)

Net income	$	8,343		$	1,708		$	6,635			388.5	%		2.2	%		0.5	%

The following tables present, for the periods indicated, selected operating data on a consolidated basis and same facility basis:


	Six Months Ended March 31,
	2005			2004			% Change

Selected Operating Data (consolidated) ( a ):
Number of hospitals		11			11
Licensed beds ( b )		672			672
Staffed and available beds ( c )		631			585
Admissions ( d )		22,602			20,213			11.8	%
Adjusted admissions ( e )		29,893			25,470			17.4	%
Patient days ( f )		79,661			71,659			11.2	%
Adjusted patient days ( g )		104,878			90,154			16.3	%
Average length of stay (days) ( h )		3.52			3.55			(0.8	)%
Occupancy ( i )		69.4	%		66.9	%
Inpatient catheterization procedures		11,699			10,107			15.8	%
Inpatient surgical procedures		5,926			5,010			18.3	%
Hospital division revenue	$	349,473		$	294,949			18.5	%


	Six Months Ended March 31,
	2005			2004			% Change

Selected Operating Data (same facility):
Number of hospitals		9			9
Licensed beds ( b )		580			580
Staffed and available beds ( c )		547			531
Admissions ( d )		20,365			19,924			2.2	%
Adjusted admissions ( e )		27,320			25,121			8.8	%
Patient days ( f )		71,420			70,709			1.0	%
Adjusted patient days ( g )		95,414			89,012			7.2	%
Average length of stay (days) ( h )		3.51			3.55			(1.1	)%
Occupancy ( i )		71.7	%		72.8	%
Inpatient catheterization procedures		10,141			9,902			2.4	%
Inpatient surgical procedures		5,401			4,925			9.7	%
Hospital division revenue	$	310,872		$	289,856			7.3	%

Net Revenue. Net revenue increased 16.4% to $376.8 million for the six months ended March 31, 2005 from $323.8 million for the six months ended March 31, 2004. The $53.0 million growth was comprised of a $54.5 million increase in our hospital division and a $0.3 million increase in our diagnostics division, both of which were partially offset by a $1.9 million decrease in our cardiology consulting and management operations.

Of the $54.5 million increase in hospital division net revenue, $33.5 million was attributable to net revenue growth from our two new hospitals. The remaining $21.0 million increase in hospital division net revenue was due to growth among our same facility hospitals. On a consolidated basis, hospital admissions increased 11.8% and adjusted admissions increased 17.4% for the first half of fiscal 2005 compared to the same period in fiscal 2004. Also on a consolidated basis, inpatient catheterization procedures increased 15.8% and inpatient surgical procedures increased 18.3% for the comparable six-month periods in fiscal 2005 and fiscal 2004. Average length of stay decreased slightly to 3.52 days for the current fiscal period compared to 3.55 days for the same prior fiscal period.

The $21.0 million increase in net revenue contributed by our same facility hospitals, along with the overall increases in admissions of 2.2%, adjusted admissions of 8.8%, inpatient catheterization procedures of 2.4% and inpatient surgical procedures of 9.7% at these hospitals, was largely due to the growth in volume at substantially all of our facilities period over period.

The $0.3 million increase in our diagnostics division net revenue was primarily driven by the ramp up or introduction of new facilities. New diagnostic and therapeutic businesses developed and opened in the first half of 2004 and since such time contributed incremental revenue of $1.5 million, respectively. This increase was partially offset by a $1.2 million decrease in diagnostics revenue due to the dissolution of one of our hospital-based facilities in November 2003.

Personnel expense. Personnel expense increased 17.3% to $116.6 million for the first six months of fiscal 2005 from $99.4 million for the first six months of fiscal 2004. As a percentage of net revenue, personnel expense increased to 31.0% from 30.7% for the comparable periods. The $17.2 million increase in personnel expense was principally incurred in our hospital division, with our two new hospitals accounting for $10.6 million of the increase and our same facility hospitals accounting for an additional $8.0 million increase. The growth in personnel expense at our same facility hospitals was primarily attributable to the additional staffing to support the increase in admissions and surgical procedures in the first half of fiscal 2005 compared to the first half of fiscal 2004, as well as cost of living adjustments given to employees during the first quarter of 2005. The increase in the hospital division personnel costs was offset in part due to a change in the physician management contracts in our cardiology consulting and management operations whereby certain reimbursed costs are no longer being passed through our operations.

Medical supplies expense. Medical supplies expense increased 22.8% to $108.1 million for six months ended March 31, 2005 from $88.0 million for the six months ended March 31, 2004. This $20.1 million increase in medical supplies expense was primarily incurred in our hospital division, with our two new hospitals and our same facility hospitals accounting for $8.9 million and $11.1 million of the increase, respectively. The increase in same facility hospitals’ medical supplies expense was largely attributable to the increase in catheterization and surgical procedures performed during the first six months of fiscal 2005 compared to the same period in fiscal 2004. In addition, during 2005 these procedures were disproportionately comprised of cardiac procedures that use high-cost medical devices and supplies, such as AICD and drug-eluting stents. During the first half of fiscal 2005, we experienced a 27.7% increase in the number of AICD procedures compared to the first half of fiscal 2004. We have experienced a general trend over recent fiscal quarters in which the number of surgical procedures involving AICD and other higher cost medical devices and supplies has increased as a component of our mix of procedures. In addition, the increased usage of drug-eluting stents contributed to higher medical supplies expense during the six-month period of fiscal 2005 compared to the same period in fiscal 2004. We estimate in our hospital division that, during the first half of fiscal 2005, 80.6% of our cardiac procedures involving stents utilized drug-eluting stents compared to 47.5% in the first half of fiscal 2004. In addition, our average utilization rate for drug-eluting stents in this division was 1.4 stents per case during the six-month period of fiscal 2005. As a percentage of net revenue, medical supplies expense increased to 28.7% for the first six months of fiscal 2005 from 27.2% for the first six months of fiscal 2004.

Bad debt expense. Bad debt expense increased 0.7% to $23.4 million for the first half of fiscal 2005 from $23.3 million for the first half of fiscal 2004. This $0.1 million net increase in bad debt expense was comprised of a $3.0 million increase in expense driven by our new facility hospitals, offset by a $2.9 million decrease at our same facilities period to period. The $2.9 million decrease in our same facility hospitals’ bad debt expense was partially driven by a significant increase of self-pay admissions and emergency room visits in one of our markets during the first quarter of 2004. We have since improved the Medicaid qualification process at this hospital. Overall, we have also seen a decrease in admissions from payors that typically result in difficult co-pay collections during the comparable six-month periods. In addition, our same facility hospitals’ days of net revenue in accounts receivable, based on the six-month net revenue, was 44 days as of March 31, 2005 compared to 52 days as of March 31, 2004. Partially due to these factors, as a percentage of net revenue, bad debt expense decreased to 6.2% for the first half of fiscal 2005 as compared to 7.2% for the first half of fiscal 2004. While payor mix has a significant impact on bad debt expense, we anticipate future bad debt expense as a percentage of revenue to approximate or be slightly higher than those recognized in to date in fiscal 2005.

Other operating expenses. Other operating expenses increased 11.4% to $75.9 million for the six months ended March 31, 2005 from $68.1 million for the six months ended March 31, 2004. The $7.8 million increase in other operating expense was due to overall increases in the hospital, diagnostic and corporate and other divisions of $6.4 million, $0.4 million and $1.1 million respectively. The $6.4 million increase in our hospital division was primarily due to costs associated with the two new facilities. The $0.4 million increase in our diagnostics division other operating expenses period to period was due to the businesses developed and opened during and since the first half of fiscal 2004. The increase in our corporate and other division’s other operating expense was principally due to $0.6 million of consulting and other expenses incurred to support our effort to ensure compliance with the provisions of the Sarbanes-Oxley Act during the first half of 2005. In addition, we incurred incremental expenses for corporate activities to support the overall growth in operations.

Pre-opening expenses. There were no pre-opening expenses incurred for the first and second quarters of fiscal 2005 versus $5.1 million that was incurred for the same periods of fiscal 2004. Pre-opening expenses represent expenses specifically related to projects under development, primarily new hospitals. Upon opening Heart Hospital of Lafayette during the second quarter of fiscal 2004, we have completed our hospital expansion plans that commenced in 2001 following completion of our initial public offering, and we do not currently have any other hospitals under development. Accordingly, we are no longer incurring pre-opening expenses. The amount of pre-opening expenses, if any, we incur in future periods will depend on the nature, timing and size of our development activities.

Interest expense. Interest expense increased 20.8% to $15.8 million for the six-month period in fiscal 2005 compared to $13.1 million for the six-month period in fiscal 2004. This $2.7 million increase in interest expense was primarily attributable to the fact that as a result of the July 7, 2004 refinancing transaction, our overall cost of borrowings on debt increased compared to the debt that was repaid. In addition, we capitalized approximately $0.6 million of interest expense as part of the capitalized construction costs of our hospitals that were still under development during part the first half of fiscal 2004.

Earnings allocated to minority interests. Earnings allocated to minority interests increased to $8.4 million for the first six months of fiscal 2005 from $1.0 million for the first six months of fiscal 2004. This $7.4 million increase in earnings allocated to minority interests was primarily due to changes in the operating results of our individual hospitals and the respective basis for allocating such

earnings or losses among us and our partners on either a pro rata basis or disproportionate basis during the first half of fiscal 2005 compared to the same period of fiscal 2004. Our earnings allocated to minority interests increased partially due to an increase in earnings of certain of our same facility hospitals which were allocated to our minority partners on a pro rata basis. In addition, during the first six months of 2004, we shared losses at our two newest hospitals with our minority partners on a pro rata basis; however, during the same period in 2005, we were required to recognize a disproportionate 100% of the hospitals losses such that no amounts were allocated to our minority partners. For a more complete discussion of our accounting for minority interests, including the basis for the disproportionate allocation accounting, see “Critical Accounting Policies” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.

Income taxes. Income tax expense was $4.6 million for the first half of fiscal 2005 compared to $2.8 million for the first half of fiscal 2004, which represents an effective tax rate of approximately 40% and 38.5%, respectively. The increase in income tax expense in the comparable periods reflects the overall increase in taxable income in 2005 as compared to 2004. The Company continues to have federal and state net operating loss carry forwards available from prior periods to offset the majority of its current tax liabilities.

Income (loss) from discontinued operations. During the first quarter of 2005, the we closed and sold substantially all of the assets of The Heart Hospital of Milwaukee. Accordingly, The Heart Hospital of Milwaukee is accounted for as discontinued operations. Income from discontinued operations in the first half of 2005 reflects the gain on the sale of the assets of approximately $9.3 million, partially offset by operating losses, shut-down costs and the overall income tax expense associated with the facility. The loss from discontinued operations in the first half of 2004 represents the operating losses, net of the tax benefit of such losses, of the facility during the period.

Liquidity and Capital Resources

Working Capital and Cash Flow Activities. Our consolidated working capital was $124.4 million at March 31, 2005 and $102.7 million at September 30, 2004. The increase of $21.7 million in working capital primarily resulted from increases in cash and cash equivalents and accounts receivable, offset in part by an increase in current portion of long-term debt and obligations under capital leases. The mortgage loan at one of our of facilities matures in January 2006 and therefore, is considered current as of March 31, 2005, whereas the amount was still considered long-term as of September 30, 2004.

The increase in cash and cash equivalents was driven by the gross cash received of $42.5 million as a result of the sale of The Heart Hospital of Milwaukee during the first quarter of fiscal 2005 and the cash received as proceeds from the exercise of stock options during the second quarter of fiscal 2005. The increase in accounts receivable was primarily attributable to the growth in our net revenue during the first six months of fiscal 2005 as compared to the last six months of fiscal 2004.

Our operating activities provided net cash of $27.0 million for the first six months of fiscal 2005 compared to net cash provided of $15.2 million for the first six months of fiscal 2004. The improvement in operating cash flow is a direct result of the overall improvement in the net income period to period and improved collections on receivables. This improvement was partially offset by various fluctuations in components of working capital in the periods.

Our investing activities provided net cash of $31.5 million for the first six months of fiscal 2005 compared to net cash used of $42.9 million for the first six months of fiscal 2004. The $31.5 million of net cash provided by investing activities in the first six months of fiscal 2005 was primarily due to the proceeds from the sale of The Heart Hospital of Milwaukee, offset in part by capital expenditures for the period. The $42.9 million of net cash used by investing activities for the first six months of fiscal 2004 was primarily due to our capital expenditures, related mostly to our hospitals under development, including $12.1 million of cash used for The Heart Hospital of Milwaukee. This use of cash was partially offset by the proceeds from the sale of certain property and equipment. Even though we have completed our hospital expansion plans and we do not currently have any other hospitals under development, we expect to continue to use cash in investing activities in future periods. The amount will depend largely on the type and size of strategic investments we make in future periods.

Our financing activities used net cash of $1.4 million for the first six months of fiscal 2005 compared to net cash provided of $16.1 million for the first six months of fiscal 2004. The $1.4 million of net cash used by financing activities for the first six months of fiscal 2005 was primarily the result of distributions to, net of investments by, minority partners and the repayment of long-term debt and obligations under capital leases partially offset by proceeds from exercised stock options. The $16.1 million of net cash provided by financing activities for the first six months of fiscal 2004 was the result of proceeds from the issuance of long-term debt, inclusive of debt transactions included as a part of discontinued operations, offset in part by repayments of long-term debt and obligations under capital leases obligations as well as distributions to minority partners.

Capital Expenditures. Expenditures for property and equipment for the first six months of fiscal years 2005 and 2004 were $11.1 million and $33.2 million, respectively. For the first six months of fiscal 2005, our capital expenditures principally were focused on improvements to and expansion of our same facilities, whereas approximately $23.6 million of expenditures where made in the first six months of 2004 for our two newest facilities. We expect our capital expenditures will continue to decrease for the third quarter of fiscal 2005 as compared to the same period in fiscal 2004, as we opened our last hospital under development in March 2004. The amount of capital expenditures we incur in future periods will depend largely on the type and size of strategic investments we make in future periods.

Obligations and Availability of Financing. At March 31, 2005, we had $362.9 million of outstanding debt, $49.3 million of which was classified as current. Of the $362.9 million of outstanding debt, $150.0 million was outstanding under our 9 7/8% senior notes, $99.3 million was outstanding under our new credit facility and $109.2 million was outstanding to lenders to our hospitals. The remaining $4.4 million of debt was outstanding to lenders to our diagnostic services and corporate and other divisions under capital leases and other miscellaneous indebtedness, primarily equipment notes payable. The $109.2 million outstanding to lenders to our hospitals included $11.7 million borrowed under a $12.0 million debt commitment to finance Heart Hospital of Lafayette’s equipment purchases, $3.3 million of a working capital note due to a community hospital investor partner at one of our hospitals and $3.9 million outstanding under capital lease obligations.

No amounts were outstanding under our $100.0 million revolving credit facility at March 31, 2005. At the same date, however, we had letters of credit outstanding of $1.5 million, which reduced our availability under this facility to $98.5 million, subject to limitations on our total indebtedness as stipulated under other debt agreements.

Covenants related to our long-term debt restrict the payment of dividends and require the maintenance of specific financial ratios and amounts and periodic financial reporting. At March 31, 2005, we were in violation of a certain financial ratio related to an equipment loan at Louisiana Heart Hospital. The equipment lender has granted a waiver for the breach at March 31, 2005. We were in compliance with all other covenants in the instruments governing our outstanding debt at March 31, 2005.

At March 31, 2005, we guaranteed either all or a portion of the obligations of our subsidiary hospitals for equipment and other notes payable. We provide these guarantees in accordance with the related hospital operating agreements, and we receive a fee for providing these guarantees from the hospitals or the physician investors.

We also guarantee approximately 50% of the real estate and 30% of the equipment debt of Avera Heart Hospital of South Dakota, the one hospital in which we owned a minority interest at March 31, 2005. We provide such guarantee in exchange for a fee from the hospital. At March 31, 2005, Avera Heart Hospital of South Dakota was in compliance with all covenants in the instruments governing its debt. The total amount of the affiliate hospital’s real estate and equipment debt was approximately $26.0 million and $7.3 million, respectively, at March 31, 2005. Accordingly, the real estate debt and the equipment debt guaranteed by us was approximately $13.0 million and $2.2 million, respectively, at March 31, 2005.

We believe that cash on hand, internally generated cash flows and available borrowings under our new credit facility will be sufficient to finance execution of our business plan, capital expenditures and our working capital requirements for the next 12 to 18 months.

Intercompany Financing Arrangements. Concurrent with our new financing, we provided secured real estate and equipment financings to our majority-owned hospitals. The aggregate amount of the intercompany real estate, equipment and working capital loans outstanding as of March 31, 2005 was $350.6 million.

Each intercompany real estate loan is separately documented and secured with a lien on the borrowing hospital’s real estate, building and equipment and certain other assets. Each intercompany real estate loan amortizes based on a 20-year term, matures on June 30, 2011 and accrues interest at variable rates based on LIBOR plus an applicable margin. The weighted average interest rate for the intercompany real estate loans at March 31, 2005 was 6.29%.

Each intercompany equipment loan is separately documented and secured with a lien on the borrowing hospital’s equipment and certain other assets. Amounts borrowed under the intercompany equipment loans are payable in monthly installments of principal and interest over terms that range from 1 to 7 years. The intercompany equipment loans accrue interest at fixed rates ranging from 5.75% to 7.50% or variable rates based on LIBOR plus and applicable margin. The weighted average interest rate for the intercompany equipment loans at March 31, 2005 was 6.64%.

We receive a fee from the minority partners in the subsidiary hospitals as consideration for providing these intercompany real estate and equipment loans. We use intercompany financing arrangements to provide cash support to individual hospitals for their working capital needs, including the needs of our new hospitals during the ramp-up period and any periodic or on-going needs of our hospitals. We provide these working capital loans pursuant to the terms of the operating agreements between our physician and hospital investor partners and us at each of our hospitals. These intercompany loans are evidenced by promissory notes that establish borrowing limits and provide for a market rate of interest to be paid to us on outstanding balances. These intercompany loans are subordinated to each hospital’s third-party mortgage and equipment debt outstanding, but are senior to our equity interests and our partners equity interests in the hospital venture and are secured, subject to the prior rights of the senior lenders, in each instance by a pledge of the borrowing hospital’s accounts receivable. Also as part of our intercompany financing and cash management structure, we sweep cash from individual hospitals as amounts are available in excess of the individual hospital’s working capital needs. These funds are advanced pursuant to cash management agreements with the individual hospital that establish the terms of the advances and provide for a rate of interest to be paid consistent with the market rate earned by us on the investment of its funds. These cash advances are due back to the individual hospital on demand and are subordinate to our equity investment in the hospital venture. As of March 31, 2005 and September 30, 2004, we held $96.1 million and $88.8 million, respectively, of intercompany notes and related

accrued interest, net of advances from our hospitals. The increase of approximately $7.3 million was primarily attributable to the funding of working capital at our newer hospitals. The aggregate amount of these intercompany loans and cash advances outstanding fluctuates from time to time depending upon our hospitals’ needs for capital resources.

On December 1, 2004, we completed the sale of certain assets of The Heart Hospital of Milwaukee for $42.5 million. Of the proceeds received, approximately $37.0 million was used to repay The Heart Hospital of Milwaukee’s intercompany secured loans, thereby increasing our consolidated cash position on such date. As part of the terms of the sale, we were required to close the hospital. As such, we incurred costs associated with the closing of the hospital, in addition to costs associated with completing the sale and additional operating expenses. As stipulated by the covenants of our Senior Credit Facility, within 300 days after the receipt of the net proceeds, we may use the proceeds for capital expenditures or other permitted investments, or identify a similar usage of the proceeds, so long as such usage occurs within 300 days of the date identified. Any net proceeds not identified or invested within this time period will then be used to repay principal of senior secured indebtedness.

Forward-Looking Statements

Some of the statements and matters discussed in our Annual Report on Form 10-K for the year ended September 30, 2004, in this report and in exhibits to these reports 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 and its exhibits 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,

•   changes in Medicare and Medicaid reimbursement levels,

•   unanticipated delays in achieving expected operating results at our newest hospitals,

•   difficulties in executing our strategies,

•   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

•   market specific or general economic downturns.

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 and exhibits 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 — Risk Factors to our Annual Report on Form 10-K for the year ended September 30, 2004, before making an investment decision with respect to our common stock. A copy of this annual report, including exhibits, is available on the internet site of the SEC at http://www.sec.gov or through our website at http://www.medcath.com.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We maintain a policy for managing risk related to exposure to variability in interest rates, commodity prices and other relevant market rates and prices, which includes considering entering into derivative instruments or contracts or instruments containing features or terms that behave in a manner similar to derivative instruments in order to mitigate our risks. In addition, we may be

required to hedge some or all of our market risk exposure, especially to interest rates, by creditors who provide debt funding to us. To date, we have only entered into the fixed interest rate swaps as discussed below.

As required by their mortgage loans, three of our consolidated hospitals entered into fixed interest rate swaps during fiscal year 2001. These fixed interest rate swaps effectively fixed the interest rate on the hedged portion of the related debt at 4.92% plus the applicable margin for two of the hospitals and at 4.60% plus the applicable margin for the other hospital. These interest rate swaps were accounted for as cash flow hedges prior to the repayment of the outstanding balances of the mortgage debt for these three hospitals as part of the July 7, 2004 financing transaction. We did not terminate the interest rate swaps as part of the financing transaction. Since July 7, 2004, the fixed interest rate swaps have not been utilized as a hedge of variable debt obligations, and accordingly, changes in the valuation of the interest rate swaps have been recorded directly to earnings as a component of interest expense. The fair value of the interest rate swaps at March 31, 2005 was an obligation of approximately $0.4 million. We recognized an unrealized gain of approximately $0.4 million and $0.8 million for the three and six months ended March 31, 2005, respectively, due to changes in the fair value of these swaps.

Our primary market risk exposure relates to interest rate risk exposure through that portion of our borrowings that bear interest based on variable rates. Our debt obligations at March 31, 2005 included approximately $114.5 million of variable rate debt at an approximate average interest rate of 5.40%. A one hundred basis point change in interest rates on our variable rate debt would have resulted in interest expense fluctuating approximately $0.6 million for the three months ended March 31, 2005.

Item 4. Controls and Procedures

The chief executive officer and the executive vice president and chief financial officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation, as of March 31, 2005, that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to the Company’s management, including the chief executive officer and executive vice president and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

No change in the company’s internal control over financial reporting was made during the fiscal quarter ended March 31, 2005 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On July 27, 2001, we completed an initial public offering of our common stock pursuant to our Registration Statement on Form S-1 (File No. 333-60278) that was declared effective by the SEC on July 23, 2001. We expect to use the remaining approximate $11.0 million of proceeds from the offering to fund development activities, working capital requirements and other corporate purposes. Although we have identified these intended uses of the remaining proceeds, we have broad discretion in the allocation of the net proceeds from the offering. Pending this application, we will continue to invest the net proceeds of the offering in cash and cash-equivalents, such as money market funds or short-term interest bearing, investment-grade securities.

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

The Company’s annual meeting of stockholders was held on March 1, 2005. The stockholders elected all of the nominees for Class I Director. The stockholders also ratified the selection of Deloitte & Touche LLP as independent accountants for the fiscal year ending September 30, 2005. The votes cast on these proposals were as follows:

1. Election of Class I Directors:


	For		Withheld
Robert S. McCoy Jr.		17,396,568		77,201
John B. McKinnon		17,282,923		190,846
Galen D. Powers		17,420,120		53,649

2. Ratification of selection of Deloitte & Touche LLP as independent auditors for fiscal year ending September 30, 2005:


For:			17,461,538
Against:			7,716
Abstain:			4,515


Exhibit
No.		Description

31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


	MEDCATH CORPORATION
Dated: May 5, 2005	By:	/s/ JOHN T. CASEY
		John T. Casey
		Chief Executive Officer and Director (principal executive officer)


	By:	/s/ JAMES E. HARRIS
		James E. Harris
		Executive Vice President and Chief Financial Officer (principal financial officer)


	By:	/s/ GARY S. BRYANT
		Gary S. Bryant
		Vice President - Controller (principal accounting officer)


		Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2005 and September 30, 2004		3

Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2005 and 2004		4

Consolidated Statement of Stockholders’ Equity for the Six Months Ended March 31, 2005		5

Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2005 and 2004		6

Notes to Consolidated Financial Statements		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3. Quantitative and Qualitative Disclosures About Market Risk		30

Item 4. Controls and Procedures		31

PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		31

Item 4. Submission of Matters to a Vote of Security Holders		31

Item 6. Exhibits		32

SIGNATURES		33


										Accumulated
										Other
	Common Stock				Paid-in		Accumulated			Comprehensive			Treasury Stock
	Shares		Par Value		Capital		Deficit			Income (Loss)			Shares		Amount			Total
Balance, September 30, 2004		18,022	$	181	$	358,656	$	(94,715	)	$	(80	)		69	$	(394	)	$	263,648
Exercise of stock options		347		3		6,012		—			—			—		—			6,015
Comprehensive income:
Net income		—		—		—		8,343			—			—		—			8,343
Change in fair value of interest rate swaps, net of income tax expense		—		—		—		—			88			—		—			88

Total comprehensive income																			8,431

Balance, March 31, 2005		18,369	$	184	$	364,668	$	(86,372	)	$	8			69	$	(394	)	$	278,094

(a)	Selected operating data includes consolidated hospitals as of the end of the period reported in continuing operations but does not include hospitals which are accounted for using the equity method or as discontinued operations in our consolidated financial statements.

(b)	Licensed beds represent the number of beds for which the appropriate state agency licenses a facility regardless of whether the beds are actually available for patient use.

(c)	Staffed and available beds represent the number of beds that are readily available for patient use at the end of the period.

(d)	Admissions represent the number of patients admitted for inpatient treatment.

(e)	Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by admissions.

(f)	Patient days represent the total number of days of care provided to inpatients.

(g)	Adjusted patient days is a general measure of combined inpatient and outpatient days. We computed adjusted patient days by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by patient days.

(h)	Average length of stay (days) represents the average number of days inpatients stay in our hospitals.

(i)	We computed occupancy by dividing patient days by the number of days in the period and then dividing the quotient by the number of staffed and available beds.

	•	the impact of the Medicare Prescription Drug Improvement and Modernization Act of 2003 and other healthcare reform initiatives,

	•	changes in Medicare and Medicaid reimbursement levels,

	•	unanticipated delays in achieving expected operating results at our newest hospitals,

	•	difficulties in executing our strategies,

	•	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

	•	market specific or general economic downturns.