Medcath 10K 2009 Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K


(Mark One)
þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended September 30, 2009
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number000-33009

MedCath Corporation

(Exact name of registrant as specified in its charter)


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

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

(704) 815-7700

(Registrant’s telephone number, including area code)

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

None

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

Common Stock, $0.01 par value

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” inRule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o	Accelerated filer þ	Non-accelerated filer o	Smaller reporting company o

(Do not check if a smaller reporting company)

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

As of December 10, 2009 there were 20,654,264 shares of the Registrant’s Common Stock outstanding. The aggregate market value of the Registrant’s common stock held by non-affiliates as of March 31, 2009 was approximately $115.8 million (computed by reference to the closing sales price of such stock on the Nasdaq Global Market^® on such date).

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s proxy statement for its annual meeting of stockholders to be held on March 3, 2010 are incorporated by reference into Part III of this Report.

MEDCATH CORPORATION

FORM 10-K

TABLE OF CONTENTS


		Page

PART I
Item 1.	Business		1
Item 1A.	Risk Factors		19
Item 1B.	Unresolved Staff Comments		29
Item 2.	Properties		29
Item 3.	Legal Proceedings		29
Item 4.	Submission of Matters to a Vote of Security Holders		29

PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		30
Item 6.	Selected Financial Data		32
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		33
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		52
Item 8.	Financial Statements and Supplementary Data		53
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		102
Item 9A.	Controls and Procedures		102
Item 9B.	Other Information		104

PART III
Item 10.	Directors, Executive Officers and Corporate Governance		105
Item 11.	Executive Compensation		105
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stock-holder Matters		105
Item 13.	Certain Relationships and Related Transactions, and Director Independence		105
Item 14.	Principal Accounting Fees and Services		105

PART IV
Item 15.	Exhibits, Financial Statements Schedules		105
SIGNATURES			109
EX-21.1
EX-23.1
EX-23.2
EX-31.1
EX-31.2
EX-32.1
EX-32.2

FORWARD-LOOKING STATEMENTS

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


	•	the impact of federal and state healthcare reform initiatives,

	•	changes in Medicare and Medicaid reimbursement levels,

	•	the impact of governmental entity audits,

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

	•	difficulties in executing our strategy,

	•	our relationships with physicians who use our facilities,

	•	competition from other healthcare providers,

	•	our ability to attract and retain nurses and other qualified personnel to provide quality services to patients in our facilities,

	•	our information systems,

	•	existing governmental regulations and changes in, or failure to comply with, governmental regulations,

	•	liabilities and other claims asserted against us,

	•	changes in medical devices or other technologies, and

	•	market-specific or general economic downturns.

Although these statements are made in good faith based upon assumptions our management believes are reasonable on the date they are made, 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 its 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 before making an investment decision with respect to our debt and equity securities.

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


	•	the terms the “Company,” “MedCath,” “we,” “us” and “our” refer to MedCath Corporation and its consolidated subsidiaries; and

	•	references to fiscal years are to our fiscal years ending September 30. For example, “fiscal 2009” refers to our fiscal year ended September 30, 2009.

PART I


Item 1.	*Business*

Overview

We were incorporated in Delaware in 2001 as a healthcare provider and are focused primarily on providing high acuity services, including 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. We opened our first hospital in 1996 and currently have ownership interests in and operate ten hospitals, including eight in which we own a majority interest. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services with a majority focus on cardiovascular care. Each of our hospitals has a24-hour emergency room staffed by emergency department physicians. The hospitals in which we have ownership interests have a total of 825 licensed beds and are located in predominantly high growth markets in seven states: Arizona, Arkansas, California, Louisiana, New Mexico, South Dakota, and Texas. During May 2009 we completed our 79 licensed bed expansion at Louisiana Medical Center and Heart Hospital and built space for an additional 40 beds at that hospital. During October 2009 we opened a new acute care hospital in Kingman, Arizona. This hospital is designed to accommodate a total of 106 licensed beds, with an initial opening of 70 of its licensed beds.

In addition to our hospitals, we currently ownand/or manage 16 cardiac diagnostic and therapeutic facilities. Ten of these facilities are located at hospitals operated by other parties. These facilities offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining six facilities are not located at hospitals and offer only diagnostic procedures. We refer to our diagnostics division as “MedCath Partners.” For financial data and other information of this and other segments of our business see Note 19 to our consolidated financial statements for financial information by segment.

We are subject to the informational requirements of the Securities Exchange Act of 1934 (the “Exchange Act”) and therefore, we file reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Such reports may be read and copied at the Public Reference Room of the SEC at 100 F Street NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at (800) SEC-0330. In addition, the SEC maintains a website atwww.sec.govthat contains reports, proxy and information statements and other information regarding issuers that file electronically.

We maintain a website atwww.medcath.comthat investors and interested parties can access and obtain copies,free-of-charge, of all reports, proxy and information statements and other information that the Company submits to the SEC as soon as reasonably practicable after we electronically submit such material to the SEC. This information includes copies of our proxy statements, annual reports onForm 10-K, quarterly reports onForm 10-Q, current reports onForm 8-K, and amendments to those reports filed or furnished pursuant to the Exchange Act.

Investors and interested parties can also submit electronic requests for information directly to the Company at the followinge-mail address:ir@medcath.com.Alternatively, communications can be mailed to the attention of “Investor Relations” at the Company’s executive offices.

Information on our website is not incorporated into thisForm 10-K or our other securities filings and is not a part of this or them.

Our Strengths

Leading Local Market Positions in Growing Markets. We believe all of our seven majority-owned hospitals that have been open for at least three years are ranked number one or two in the local market based on procedures performed in our core cardiovascular diagnosis-related group (“DRG”), based on the latest data available for each market at time of publication as reported by Thomson Reuters, a leading source of healthcare business information. For Arizona, California, and Texas, the original source is state-collected data through all or part of 2008. For Louisiana, Arkansas, New Mexico, and San Diego, the latest original source data available to us is 2007 Medicare Provider Analysis and Review data. Historically, 75% of patients treated in our hospitals reside in markets where the

population of those 55 years and older, the primary recipients of cardiac care services, is anticipated to increase on average by 18.6%, from 2009 to 2013, versus the national average of 16.1%, according to Thomson Reuters.

Efficient Quality Care Delivery Model. Our hospitals have innovative facility designs and operating characteristics that we believe enhance the quality of patient care and service and improve physician and staff productivity. The innovative characteristics of our hospital designs include:


	•	fully-equipped patient rooms capable of providing the majority of services needed during a patient’s entire length of stay;

	•	centrally located inpatient ancillary services that reduce the amount of transportation patients must endure; and

	•	focus on resource allocation and care management through the use of protocols for more consistent and predictable outcomes and expenses.

We believe our care delivery model leads to a high level of patient satisfaction and quality care. We selected NRC Picker to administer our inpatient satisfaction surveys beginning January 1, 2006. We have performed well when compared to NRC Picker’s national database. For the most recent available calendar year, 2008, our hospitals had an overall satisfaction score of 83.7% compared to 60.3% for the NRC Picker national comparison group. Our most recently reported overall satisfaction score, for the second quarter of 2009, was 82.9% compared to 61.1% for the national comparison group.

Proven Ability to Partner with Physicians and Community Hospital Systems. We partner with physicians and share capital commitments in all of our hospitals and many of our cardiac diagnostic and therapeutic facilities. We also have management and partnership arrangements with community hospital systems both in the hospitals operated by these community hospitals and in certain of our hospitals. Physicians practicing at our hospitals participate in shared governance where decisions are made on a wide range of strategic and operational matters, such as development of clinical care protocols, patient procedure scheduling, development of hospital formularies, selection of vendors for high-cost supplies and devices, review of annual operating budgets and significant capital expenditures. The opportunity to have a role in how our hospitals are managed empowers physicians and encourages them to share new ideas, concepts and practices. We attribute our success in partnering with physicians to our ability to develop and effectively manage facilities in a manner that promotes physician productivity, satisfaction and professional success while enhancing the quality and efficiency of patient care services that we provide.

Strong Management Team. Our management team has extensive experience and relationships in the healthcare industry. Our president and chief executive officer, O. Edwin French, was appointed to this position in February 2006 and has over 40 years of experience in the healthcare industry, most recently serving as president of the Acute Care Hospital Division for Universal Health Services. On September 1, 2009 David Bussone was named executive vice president and president overseeing the Hospital Division and Service Center departments in Charlotte and Dallas that support operations, such as physician recruiting, management engineering, supply chain management and marketing. Mr. Bussone has over 30 years of experience in the healthcare industry, most recently serving as a senior vice president for Universal Health Services, Inc.’s acute division. On September 22, 2009 Art Parker was appointed executive vice president and chief financial officer. Mr. Parker has been with the Company for over 8 years serving as interim chief financial officer since June 2009, as senior vice president finance and development, and as senior vice president and treasurer. Prior to joining the Company, Mr. Parker worked for Bank of America for 14 years holding posts related to the management of commercial banking relationships and serving as a high yield bond research analyst covering the healthcare and other industries.

Our Strategy

Key components of our strategy include:

Diversify the Business Through Expanded Services at Existing Hospitals. While we continue to grow our core business lines, we recognize that the continued diversification of healthcare services performed at our hospitals is necessary for long-term earnings growth. We invested in certain of our facilities to build out existing capacity and

broaden the scope of services provided based on the needs of the communities we serve. While we continue to operate some of our facilities with a primary focus on serving the unique needs of patients suffering from cardiovascular disease, we have expanded our service offerings to improve the performance of some of our facilities by utilizing our expertise in partnering with physicians and operating hospitals and by broadening our services to include other high acuity surgical and medical services.

Selectively Evaluate General Acute Care Acquisitions. We may selectively evaluate acquisitions of general acute care facilities in attractive markets throughout the United States. We may consider acquisitions of facilities where we believe we can improve clinical outcomes and operating performance. Acquiring such facilities would continue to add to a more diverse offering of services and we believe will contribute to achieving earnings stability and growth. Any acquisition opportunity will be carefully evaluated to ensure it meets our overall long-term strategic objectives.

Maximize Return by Evaluating the Long-term Prospects of our Assets. We also may consider opportunistic dispositions of hospitals or other facilities where a motivated buyer emerges or the facility does not meet our overall growth or financial return objectives to maximize the long-term return of our assets. We will employ a disciplined approach to evaluating and qualifying disposition opportunities and will look to redeploy capital from divested assets into new assets.

Continue to Improve Operating Performance at Our Existing Facilities. In markets where we have well-established hospitals and cardiac diagnostic and therapeutic facilities, we intend to continue to focus on strengthening management processes and systems in an effort to improve operating performance. We will continue to:


	•	improve labor efficiencies by staffing to patient volumes and clinical needs;

	•	proactively manage the delivery of healthcare to achieve appropriate and efficient lengths of stay through the application of technology, medicines, and other resources which have a positive impact on the quality and cost of healthcare;

	•	control supplies expense through more favorable group purchasing arrangements and inventory management;

	•	focus efforts on the management of bad debt through improvement in our registration process and upfront collections as well as continued refinement of our business office operations after discharge; and

	•	improve the systems related to patient registration, billing, collections and managed care contracting to improve revenue cycle management.

Develop New Relationships with Physicians in Our Existing Markets. We intend to develop new relationships with physicians to strengthen our competitive position in certain of our existing markets. We believe that our relationships with physicians who have a reputation for clinical excellence give us important insights into the operation and management of our facilities and provide further resources to provide quality, cost-effective healthcare. Further, as we strengthen our market position, we believe we will improve our ability to develop favorable managed care relationships with, and market the quality of our services to, the communities we serve.

Pursue Growth Opportunities in New Markets with Physicians and Community Hospital Systems. We intend to pursue growth opportunities in new markets by partnering with physicians and community hospital systems if the opportunity is in line with our long-term strategy. These opportunities are expected to support our diversification strategy by broadening our services to include other high acuity surgical and medical services. We completed the development of our 106 licensed bed general acute care hospital in Kingman, Arizona, which opened with 70 of its licensed beds in October 2009. The hospital is jointly owned by us and local physician investors.

Our Hospitals

We currently have ownership interests in and operate ten hospitals. The following table identifies key characteristics of these hospitals.


		MedCath				Licensed			Cath		Operating
Hospital	Location	Ownership			Opening Date	Beds			Labs		Rooms

Arkansas Heart Hospital	Little Rock, AR		70.3	%	March 1997		112			6		3
Arizona Heart Hospital	Phoenix, AZ		70.6	%	June 1998		59			3		4
Heart Hospital of Austin	Austin, TX		70.9	%	January 1999		58			6		4
Bakersfield Heart Hospital	Bakersfield, CA		53.3	%	October 1999		47			4		3
Heart Hospital of New Mexico	Albuquerque, NM		75.0	%	October 1999		55			4		3
Avera Heart Hospital of South Dakota(1)	Sioux Falls, SD		33.3	%	March 2001		55			4		3
Harlingen Medical Center(1)	Harlingen, TX		34.8	%	October 2002		112			2		10
Louisiana Medical Center and Heart Hospital	St. Tammany Parish, LA		89.2	%	February 2003		137			3		7
TexSAn Heart Hospital	San Antonio, TX		69.0	%	January 2004		120			4		4
Hualapai Mountain Medical Center	Kingman, AZ		79.2	%	October 2009		70	(2)		1		4


(1)		Avera Heart Hospital of South Dakota and Harlingen Medical Center are the only hospitals in which we do not have a majority ownership interest as of September 30, 2009. We use the equity method of accounting for these hospitals, which means that we include in our consolidated statements of income only a percentage of the hospitals’ reported net income (loss) for each reporting period. Harlingen Medical Center was consolidated prior to July 2007 and is included in the consolidated statements of income for the first three quarters of fiscal 2007 as a consolidated hospital.

(2)		Hualapai Mountain Medical Center is designed to accommodate 106 inpatient beds, but initially opened with 70 licensed beds.

Diagnostic and Therapeutic Facilities

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

Managed Diagnostic and Therapeutic Facilities. Currently we ownand/or manage the operations of 16 cardiac diagnostic and therapeutic facilities. The following table provides information about these facilities.


					MedCath		Termination
					Management		or Next
		MedCath			Commencement		Renewal
Facility/Entity	Location	Ownership			Date		Date

Joint Ventures:
Greensboro Heart Center, LLC	Greensboro, NC		51.0	%		2001		July 2031
Center for Cardiac Sleep Medicine, LLC(1)	Lacombe, LA		51.0	%		2004		Dec. 2013
Blue Ridge Cardiology Services, LLC(1)	Morganton, NC		50.0	%		2004		Dec. 2014
Central New Jersey Heart Services, LLC (1,3,4)	Trenton, NJ		14.8	%		2007		Mar 2017
Coastal Carolina Heart, LLC(1,4)	Wilmington, NC		9.2	%		2007		July 2010
Southwest Arizona Heart and Vascular, LLC (1,3,4)	Yuma, AZ		27.0	%		2008		Dec 2068
Tri-County Heart Services	Edison, NJ		33.3	%		2005		Jan 2018
Wilmington Heart Services, LLC (1,3,4)	Wilmington, DE		15.0	%		2007		July 2017

Managed Ventures:
Heart Institute of Northern Arizona, LLC(1)	Kingman, AZ		100	%(2)		1994		Month-to-month
Johnston Memorial Hospital	Smithfield, NC		100	%(2)		2002		Month-to-month
Watauga Medical Center(1)	Boone, NC		100	%(2)		2003		Month-to-month
Margaret R. Pardee Memorial Hospital(1)	Hendersonville, NC		100	%(2)		2004		Month-to-month
Duke Health Raleigh Hospital(1)	Raleigh, NC		100	%(2)		2006		Dec. 2012
Caldwell Cardiology Services	Lenoir, NC		100	%(2)		2006		Mar. 2012

Professional Services Agreements:
Greater Philadelphia Cardiology Assoc., Inc.	Philadelphia, PA		100	%(2)		2002		June 2012
VNC Sleep(1)	Annandale, VA		100	%(2)		2004		Sept. 2011


(1)		Our management agreement with each of these facilities includes an option for us to extend the initial term at increments ranging from one to 10 years, through an aggregate of up to an additional 40 years for some of the facilities.

(2)		The ownership interest percentage refers to the fact that we own 100% of the entity that has the management agreement with the facility.

(3)		Calendar year.

(4)		As a result of Stark Law III provisions we are renegotiating these management agreements.

Except when the requirements of applicable law require us to modify our services or when physicians have an ownership interest in a joint venture providing management services to hospitals, our management services generally include providing all non-physician personnel required to deliver patient care and the administrative, management and support functions required in the operation of the facility. The physicians who supervise or perform diagnostic and therapeutic procedures at these facilities have complete control over the delivery of cardiovascular healthcare services. In some cases, the management agreements for these centers have an extended initial term and several renewal options ranging from one to 10 years each. The physicians and hospitals with which we have contracts to operate these centers may terminate the agreements under certain circumstances. Either party may terminate most of these agreements for cause or upon the occurrence of specified material adverse changes in the business of the facilities. We intend to develop with hospitals and physician groups, or acquire contracts to manage, additional diagnostic and therapeutic facilities in the future.

Interim Mobile Catheterization Labs. We maintain a rental fleet of mobile and modular cardiac catheterization laboratories. We lease these laboratories on a short-term basis to hospitals while they are either adding capacity to their existing facilities or replacing or upgrading their equipment. We also lease these laboratories to hospitals that experience a higher demand for cardiac catheterization procedures during a particular season of the

year and choose not to expand their own facilities to meet peak period demand. Our rental and modular laboratories are manufactured by leading original equipment manufacturers and have advanced technology and enable cardiologists to perform both diagnostic and interventional therapeutic procedures. Each of our rental units is generally in service for an average of nine months of the year. These units enable us to be responsive to immediate demand and create flexibility in our operations.

Major Procedures Performed at Our Facilities

Our hospitals offer a wide range of inpatient and outpatient medical services. These services can include cardiology, surgery, orthopedics, diagnostic and emergency room services, laboratory, radiology, respiratory, nutrition/dietary, intensive care units and pharmacy.

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

Invasive Procedures

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

Percutaneous cardiac intervention,including the following:


	•	Atherectomy: a technique using a cutting device to remove plaque from an artery. This technique can be used for coronary and non-coronary arteries.

	•	Angioplasty: a method of treating narrowing of a vessel using a balloon catheter to dilate the narrowed vessel. If the procedure is performed on a coronary vessel, it is commonly referred to as a percutaneous transluminal coronary angioplasty, or PTCA.

	•	Percutaneous balloon angioplasty: the insertion of one or more balloons across a stenotic heart valve.

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

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

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


	•	Cardiac ablation: removal of a part, pathway or function of the heart by surgery, chemical destruction, electrocautery or radio frequency.

	•	Pacemaker implant: an electrical device that can substitute for a defective natural pacemaker and control the beating of the heart by a series of rhythmic electrical discharges.

	•	Automatic Internal Cardiac Defibrillator: cardioverter implanted in patients at high risk for sudden death from ventricular arrhythmias.

	•	Cardiac assist devices: a mechanical device placed inside of a person’s chest where it helps the heart pump oxygen rich blood throughout the body.

Coronary artery bypass graft surgery: a surgical establishment of a shunt that permits blood to travel from the aorta to a branch of the coronary artery at a point past the obstruction.

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

Non-Invasive Procedures

Cardiac magnetic resonance imaging: a test using a powerful magnet to produce highly detailed, accurate and reproducible images of the heart and surrounding structures as well as the blood vessels in the body without the need for contrast agents.

Echocardiogram with color flow doppler, or ultrasound test: a test which produces real time images of the interior of the heart muscle and valves, which are used to accurately evaluate heart valve and muscle problems and measure heart muscle damage.

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

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

Ultrafast computerized tomography: a test which can detect the buildup of calcified plaque in coronary arteries before the patient experiences any symptoms.

Employees

As of September 30, 2009, we employed 3,299 persons, including 2,472 full-time and 827 part-time employees. None of our employees is a party to a collective bargaining agreement and we consider our relationships with our employees to be good. There currently is a nationwide shortage of nurses and other medical support personnel, which makes recruiting and retaining these employees difficult. We believe we offer our employees competitive wages and benefits and offer a professional work environment that we believe helps us recruit and retain the staff we need to operate our hospitals and other facilities.

Our hospitals are staffed by licensed physicians who have been admitted to the medical staffs of individual hospitals. Any licensed physician — not just our physician partners — may apply to be admitted to the medical staff of any of our hospitals, but admission to the staff must be approved by the hospital’s medical staff and governing board in accordance with established credentialing criteria, and policies and procedures.

Environmental Matters

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

Insurance

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

We can offer no assurances that our professional liability and general liability insurance, nor our recorded reserves for self-insured retention, will cover all claims against us or continue to be available at reasonable costs for us to maintain adequate levels of insurance in the future.

Competition

In executing our business strategy, we compete primarily with other cardiovascular care providers, principally for-profit andnot-for-profit general acute care hospitals. We also compete with other companies pursuing strategies similar to ours, and withnot-for-profit general acute care hospitals that may elect to develop a hospital. In most of our markets we compete for market share of cardiovascular procedures with two to three hospitals. Some of the hospitals that compete with our hospitals are owned by governmental agencies ornot-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Some of our competitors are larger and are more established than we are and, have greater geographic coverage, offer a wider range of services or have more capital or other resources than we do. If our competitors are able to finance capital improvements, recruit physicians, expand services or obtain favorable managed care contracts at their facilities, we may experience a decline in market share. In operating our hospitals, particularly in performing outpatient procedures, we compete with free-standing diagnostic and therapeutic facilities located in the same markets.

Reimbursement

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

Medicare payments for inpatient acute services are generally made pursuant to a prospective payment system (“PPS”). Under this system, hospitals are paid a prospectively determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a DRG. Based upon the patient’s condition and treatment during the relevant inpatient stay, each DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. The DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The update factor is determined, in part, by the projected increase in the cost of goods and services that are purchased by hospitals, referred to as the market basket index. DRG payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, such payments are adjusted by a predetermined geographic adjustment factor assigned to the geographic area in which the hospital is located.

While hospitals generally do not receive direct payments in addition to a DRG payment, hospitals may qualify for an outlier payment when the relevant patient’s treatment costs are extraordinarily high and exceed a specified threshold. Outlier payments, which were established by Congress as part of the DRG prospective payment system, are additional payments made to hospitals for treating patients who are costlier to treat than the average patient. In general, a hospital receives outlier payments when its costs, as determined by using gross charges adjusted by the hospital’scost-to-charge ratio, exceed a certain threshold established annually by the Centers for Medicare and Medicaid Services (“CMS”). Outlier payments are currently subject to multiple factors including but not limited to: (1) the hospital’s estimated operating costs based on its historical ratio of costs to gross charges; (2) the patient’s case acuity; (3) the CMS established threshold; and, (4) the hospital’s geographic location. CMS is required by law to limit total outlier payments to between five and six percent of total DRG payments. CMS periodically changes the threshold in order to bring expected outlier payments within the mandated limit. An increase to the cost threshold reduces total outlier payments by (1) reducing the number of cases that qualify for outlier payments and (2) reducing the dollar amount hospitals receive for those cases that qualify. CMS historically has used a hospital’s most recently settled cost report to set the hospital’scost-to-charge ratios. Those cost reports are typically two to three years old.

On August 22, 2007, CMS issued its final inpatient hospital prospective payment system rule for fiscal year 2008, which began October 1, 2007. The final rule continues major DRG reforms designed to improve the accuracy of hospital payments. As introduced in the fiscal year 2007 final rule, CMS will continue to use hospital costs rather than charges to set payment rates. For fiscal year 2008, hospitals were paid based upon a blend of1/3 charge-based weights and2/3 hospital cost-based weights for DRGs. Additionally, CMS adopted its proposal to restructure the current 538 DRGs to 745 MS-DRGs (severity-adjusted DRGs) to better recognize severity of patient illness. These MS-DRGs are being phased in over a two-year period.

CMS published the inpatient prospective payment system rule (“IPPS”) for 2009 on August 19, 2008. In addition to provisions which relate to IPPS payments, the 2009 IPPS final rule also contained provisions related to the Emergency Medical Treatment and Active Labor Act (“EMTALA”) and the Section 1877 of the Social Security Act, commonly known as the Stark Law, which will be discussed under the applicable EMTALA and Stark sections of this document. CMS also expanded the list of codes of hospital-acquired conditions for which CMS will not pay as secondary diagnoses unless the condition was present on admission. Due to the late enactment of the Medicare Improvements for Patient and Providers Act (“MIPPA”), CMS was unable to publish final rates in the 2009 IPPS final rule.

CMS issued the IPPS rule for 2010 on July 31, 2009. The Final IPPS rule for 2010 provides acute care hospitals with an inflation update of 2.1 percent in their 2010 payment rates. The Final IPPS rule also adds four new measures for which hospitals must submit data under the Reporting Hospital Quality Data for Annual Payment Update (“RHQDAPU”) program to receive the full market basket update.

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

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

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

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

Utilization Review. Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients meet professionally recognized standards and are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admissions of Medicare and Medicaid patients be reviewed by quality improvement organizations that analyze the appropriateness of Medicare and Medicaid patient admissions and discharges, quality of care provided, validity of DRG classifications and appropriateness of cases of extraordinary length of stay or cost. Quality improvement organizations may deny payment for services provided, assess fines and recommend to the Department of Health and Human Services (HHS) that a provider not in substantial compliance with the standards of the quality improvement organization be excluded from participation in the Medicare program. Most non-governmental managed care organizations also require utilization review. As noted above, the Final IPPS rule also adds four new measures for which hospitals must submit data under the RHQDAPU program to receive the full market basket update.

Annual Cost Reports. Hospitals participating in the Medicare and some Medicaid programs, whether paid on a reasonable cost basis or under a prospective payment system, are required to meet certain financial reporting requirements. Federal and, where applicable, state regulations require submission of annual cost reports identifying

medical costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medicaid recipients.

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

Program Adjustments. The Medicare, Medicaid and other federal healthcare programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, and requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payment to facilities. The final determination of amounts earned under the programs often requires many years, because of audits by the program representatives, providers’ rights of appeal and the application of numerous technical reimbursement provisions. We believe that we have made adequate provision for such adjustments. Until final adjustment, however, previously determined allowances could become either inadequate or more than ultimately required.

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

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

Regulation

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

The Medicare Modernization Act and Other Healthcare Reform Initiatives

The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Medicare Modernization Act”) made significant changes to the Medicare program, particularly with respect to the coverage of prescription

drugs. These modifications also include provisions affecting Medicare coverage and reimbursement to general acute care hospitals, as well as other types of providers.

The healthcare industry continues to attract much legislative interest and public attention. In recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that, like the Medicare Modernization Act, would effect major changes in the healthcare system. Proposals that have been considered include changes in Medicare, Medicaid, and other state and federal programs, cost controls on hospitals and mandatory health insurance coverage for individuals. The U.S. Senate is currently debating the Patient Protection and Affordable Care Act, which proposes significant changes to the healthcare payment system. We cannot predict the course of this or other future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs and the effect that any legislation, interpretation, or change may have on us. Such effects may include material and adverse changes to the amounts of reimbursement received by our facilities.

Licensure and Certification

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

Certification. In order to participate in the Medicare and Medicaid programs, each provider must meet applicable regulations of the HHS and similar state entities relating to, among other things, the type of facility, equipment, personnel, standards of medical care and compliance with applicable federal, state and local laws. As part of such participation requirements and effective October 1, 2007, all physician-owned hospitals are required to provide written notice to patients that the hospital is physician-owned. Additionally, as part of a patient safety measure, all Medicare-participating hospitals must provide written notice to patients if a doctor is not present in the hospital 24 hours per day, 7 days a week. All our hospitals and our freestanding diagnostic and therapeutic facilities are certified to participate or are enrolled in the Medicare and Medicaid programs.

Emergency Medical Treatment and Active Labor Act. The Emergency Medical Treatment and Active Labor Act impose requirements as to the care that must be provided to anyone who seeks care at facilities providing emergency medical services. In addition, CMS issued final regulations clarifying those areas within a hospital system that must provide emergency treatment, procedures to meet on-call requirements, as well as other requirements under EMTALA. CMS clarified the requirements related to the availability of on call physicians and obligations of recipient hospitals with specialized capabilities in the 2009 IPPS Final Rule. Sanctions for failing to fulfill these requirements include exclusion from participation in the Medicare and Medicaid programs and civil monetary penalties. In addition, the law creates private civil remedies that enable an individual who suffers personal harm as a direct result of a violation of the law to sue the offending hospital for damages and equitable relief. A hospital that suffers a financial loss as a direct result of another participating hospital’s violation of the law also has a similar right. Although we believe that our emergency care practices are in compliance with the law and applicable regulations, we cannot assure you that governmental officials responsible for enforcing the law or others will not assert that we are in violation of these laws nor what obligations may be imposed by regulations to be issued in the future.

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

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

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

Fraud and Abuse Laws

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

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

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

The OIG is primarily responsible for enforcing the anti-kickback statute and generally for identifying fraud and abuse activities affecting government programs. In order to fulfill its duties, the OIG performs audits and investigations. In addition, the agency provides guidance to healthcare providers by issuing Special Fraud Alerts

and Bulletins that identify types of activities that could violate the anti-kickback statute and other fraud and abuse laws. The OIG has identified the following arrangements with physicians as potential violations of the statute:


	•	payment of any incentive by the hospital each time a physician refers a patient to the hospital,

	•	use of free or significantly discounted office space or equipment for physicians,

	•	provision of free or significantly discounted billing, nursing, or other staff services,

	•	free training for a physician’s office staff including management and laboratory techniques,

	•	guarantees which provide that if the physician’s income fails to reach a predetermined level, the hospital will pay any portion of the remainder,

	•	low-interest or interest-free loans, or loans which may be forgiven if a physician refers patients to the hospital,

	•	payment of the costs of a physician’s travel and expenses for conferences,

	•	payment of services which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of the services rendered, or

	•	purchasing goods or services from physicians at prices in excess of their fair market value.

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

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

As discussed, there are various ownership and compensation arrangement exceptions to the Stark Law. In addressing the whole hospital exception, the Stark regulations specifically reiterate the statutory requirements for the exception. Additionally, the exception requires that the hospital qualify as a “hospital” under the Medicare program. The Stark Law and the Stark Regulations may also apply to certain compensation arrangements between hospitals and physicians.

The Deficit Reduction Act of 2005 (“DRA”) required the Secretary of HHS to develop a plan addressing several issues concerning physician investment in specialty hospitals. In August 2006, HHS submitted its required final report to Congress addressing: (1) proportionality of investment return; (2) bona fide investment; (3) annual disclosure of investment; (4) provision of care to Medicaid beneficiaries; (5) charity care; and (6) appropriate enforcement. The report reaffirms HHS’ intention to implement reforms to increase Medicare payment accuracy in the hospital inpatient prospective and ambulatory surgical center payment systems. HHS also has implemented certain “gainsharing” demonstrations are required by the DRA and other value-based payment approaches designed to align physician and hospital incentives while achieving measurable improvements in quality to care. In addition, HHS now requires transparency in hospital financial arrangements with physicians. Currently, all hospitals are required to provide HHS information concerning physician investment and compensation arrangements that potentially implicate the physician self-referral statute, and to disclose to patients whether they have physician investors. Hospitals that do not comply in a timely manner with this new disclosure requirement may face civil penalties of $10,000 per day that they are in violation. HHS also announced its position that non-proportional returns on investments and non-bona fide investments may violate the physician self-referral statute and are suspect under the anti-kickback statute. Other components of the plan include providing further guidance concerning what is expected of hospitals that do not have emergency departments under EMTALA and changes in the Medicare enrollment form to identify specialty hospitals. Issuance of the strategic plan coincided with the sunset of a DRA provision suspending enrollment of new specialty hospitals into the Medicare program.

In July 2007 as part of proposed revisions to the Medicare physician fee schedule for fiscal year 2008, CMS proposed certain additional changes to the Stark Law. In particular, the proposed rule would revise the Stark Law exception for space and equipment rentals. In instances where a physician leases space or equipment to an entity who accepts patients referred by that physician, the CMS proposal would no longer allowunit-of-service or “per click” payments for such leases. Additionally, the proposed rule would no longer treat “under arrangements” between hospitals and physician-owned entities as compensation instead of ownership relationships. CMS finalized these proposed changes to the Stark Law in the 2009 IPPS final rule published on August 19, 2008. These changes are effective October 1, 2009. Specifically, the 2009 IPPS final rule limits the ability of hospitals to enter into under arrangements with physicians and physician-owned entities and thus, physician-owned joint venture entities deemed to be “performing DHS” will have to comply with one of the more limited Stark Law “ownership” exceptions, rather than the previously acceptable Stark Law “compensation” exceptions. In addition, the 2009 IPPS final rule finalized the prohibition on per unit compensation in space and equipment lease transactions. Effective October 1, 2009, we restructured certain equipment lease transactions with physicians that include per unit or per use compensation as well as certain of our arrangements with community hospitals in order to comply with these new rules and regulations. While we believe that such restructured arrangements comply with applicable law, we cannot be assured, however, that if reviewed, government officials will agree with our interpretation of applicable law. We cannot yet know with certainty the full impact of this restructuring on the financial performance of the Company.

There have been few enforcement actions taken and relatively few cases interpreting the Stark Law to date. As a result, there is little indication as to how courts will interpret and apply the Stark Law; however, enforcement is expected to increase. We believe we have structured our financial arrangements with physicians to comply with the statutory exceptions included in the Stark Law and the Stark regulations. In particular, we believe that our physician ownership arrangements meet the whole hospital exception. In addition, we expect to meet the exception for publicly traded securities or indirect compensation arrangements, as appropriate. The freestanding diagnostic and other facilities that we own do not furnish any designated health services as defined under the Stark Law, and thus referrals to them are not subject to the Stark Law’s prohibitions. Similarly, our consulting and management services to physician group practices are not subject to the Stark Law’s prohibitions.

Possible amendments to the Stark Law, including any modification or revocation of the whole hospital exception upon which we rely in establishing many of our relationships with physicians, could require us to change or adversely impact the manner in which we establish relationships with physicians to develop and operate a facility, as well as our other business relationships such as joint ventures and physician practice management arrangements. We note that legislation has been introduced in Congress recently and in the past seeking to limit or restrict the whole hospital exception. Specifically, the Patient Protection and Affordable Care Act now under debate in the U.S. Senate, provides that the whole hospital exception would only be available to hospitals having physician ownership and a Medicare provider number as of February 1, 2010 and that meet certain other specified requirements. One such requirement is that physician owners could not own more than the percentage of the value of the physician ownership as of the date of the enactment of the bill. The proposed legislation would also restrict expansion of hospitals that meet the requirements referred to above. There can be no assurance that future legislation will not seek to modify, limit, restrict, or revoke the whole hospital exception. There also can be no assurance the CMS will not promulgate additional regulations under the Stark Law that may change or adversely impact our arrangements with referring physicians.

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

Civil Monetary Penalties. The Social Security Act contains provisions imposing civil monetary penalties for various fraudulentand/or abusive practices, including, among others, hospitals which knowingly make payments to a physician as an inducement to reduce or limit medically necessary care or services provided to Medicare or Medicaid beneficiaries. In July 1999, the OIG issued a Special Advisory Bulletin on gainsharing arrangements. The bulletin warns that clinical joint ventures between hospitals and physicians may implicate these provisions as well as the anti-kickback statute, and specifically refers to specialty hospitals, which are marketed to physicians in a position to refer patients to the hospital, and structured to take advantage of the whole hospital exception. Hospitals specializing in heart, orthopedic, and maternity care are mentioned, and the bulletin states that these hospitals may induce investor-physicians to reduce services to patients through participation in profits generated by cost savings, in violation of a civil monetary penalty provision. Despite this initial broad interpretation of this civil monetary penalty law, since 2005 the OIG has issued nine advisory opinions which declined to sanction a particular gainsharing arrangement under this civil monetary penalty provision, or the anti-kickback statute, because of the specific circumstances and safeguards built into the arrangement. We believe that the ownership distributions paid to physicians by our hospitals do not constitute payments made to physicians under gainsharing arrangements. We cannot assure you, however, that government officials will agree with our interpretation of applicable law.

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

A number of states, including states in which we operate, have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court. In fact, the DRA contains provisions which create incentives for states to enact anti-fraud legislation modeled after the federal False Claims Act.

Healthcare Industry Investigations

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

A number of healthcare investigations are national initiatives in which federal agencies target an entire segment of the healthcare industry. One example involved the federal government’s initiative regarding hospitals’ improper requests for separate payments for services rendered to a patient on an outpatient basis within three days prior to the patient’s admission to the hospital, where reimbursement for such services is included as part of the reimbursement for services furnished during an inpatient stay. The government targeted all hospital providers to ensure conformity with this reimbursement rule. Further, the federal government continues to investigate Medicare overpayments to prospective payment system hospitals that incorrectly report transfers of patients to other prospective payment system hospitals as discharges. Law enforcement authorities, including the OIG and the United States Department of Justice, are also increasing scrutiny of various types of arrangements between healthcare providers and potential referral sources, including so-called contractual joint ventures, to ensure that the arrangements are not designed as a mechanism to exchange remuneration for patient care referrals and business opportunities. Investigators have also demonstrated a willingness to look behind the formalities of a business transaction to determine the underlying purpose of payments between healthcare providers and potential referral sources. Recently, the OIG has also begun to investigate certain hospitals with a particularly high proportion of Medicare reimbursement resulting from outlier payments. The OIG’s workplan has indicated its intention to review hospital privileging activities within the context of Medicare conditions of participation.

It is possible that governmental or regulatory authorities could initiate investigations on these or other subjects at our facilities and such investigations could result in significant costs in responding to such investigations and penalties to us, as well as adverse publicity, declines in the value of our equity and debt securities and lawsuits brought by holders of those securities. It is also possible that our executives, managers and hospital board members, many of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigations or named as defendants in private litigation. The positions taken by authorities in any investigations of us, our executives, managers, hospital board members or other healthcare providers, and the liabilities or penalties that may be imposed could have a material adverse effect on our business, financial condition and results of operations.

Clinical Trials at Hospitals

Our hospitals serve as research sites for physician clinical trials sponsored by pharmaceutical and device manufacturers and therefore may perform services on patients enrolled in those studies, including implantation of experimental devices. Only physicians who are members of the medical staff of the hospital may participate in such studies at the hospital. All trials are approved by an Institutional Review Board (“IRB”), which has the

responsibility to review and monitor each study pursuant to applicable law and regulations. Such clinical trials are subject to numerous regulatory requirements.

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

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


	•	complying with specific regulations governing the selection of qualified investigators,

	•	obtaining specific written commitments from the investigators,

	•	disclosure of financialconflicts-of-interest,

	•	verifying that patient informed consent is obtained,

	•	instructing investigators to maintain records and reports,

	•	verifying drug or device safety and efficacy, and

	•	permitting appropriate governmental authorities access to data for their review.

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

Failure to comply with new or revised applicable federal, state, and international clinical trial laws existing laws and regulations could subject us and physician investigators to loss of the right to conduct research, civil fines, criminal penalties, and other enforcement actions.

Finally, the Administrative Simplification Subtitle of HIPAA and related privacy and security regulations also require healthcare entities engaged in clinical research to maintain the privacy of patient identifiable medical information. See“— Privacy and Security Requirements.” We have implemented policies in an attempt to comply with these rules as they apply to clinical research, including procedures to obtain all required patient authorizations. However, there is little or no guidance available as to how these rules will be enforced.

Privacy and Security Requirements

HIPAA requires the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically. These provisions are intended to encourage electronic commerce in the healthcare industry. HHS has adopted final regulations establishing electronic data transmission standards

that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. We believe we have complied in all material respects with these electronic data transmission standards.

HHS has also adopted final regulations containing privacy standards as required by HIPAA. The privacy regulations extensively regulate the use and disclosure of individually identifiable health-related information. We have taken measures to comply with the final privacy regulations, but since there is little guidance about how these regulations will be enforced by the government, we cannot predict whether the government will agree that our healthcare facilities are in compliance.

HHS has adopted final regulations regarding security standards. These security regulations require healthcare providers to implement organizational and technical practices to protect the security of electronically maintained or transmitted health-related information. We believe we have complied in all material respects with these security standards.

The Health Information Technology for Economic and Clinical Health Act (“HITECH Act”), which is part of the American Recovery and Reinvestment Act signed into law on February 17, 2009, included provisions that expand the scope of the privacy and security requirements of HIPAA. In addition, the HITECH Act contains enhanced enforcement provisions, including: (i) increased civil monetary penalties; (ii) allowing state attorneys general to bring civil actions for HIPAA violations; and (iii) requiring HHS to conduct audits of covered entities, such as the hospitals, to determine their compliance with HIPAA. The HITECH Act’s changes may require significant and costly changes for us, although the exact extent of the actions that will be required is not known at this time because the HITECH Act directs the Secretary of HHS (HHS Secretary) to amend existing privacy and security standards and issue new standards as necessary, and these regulations have not been issued to date.

In addition, our facilities continue to remain subject to state laws that may be more restrictive than the regulations issued under HIPAA. These statutes vary by state and could impose additional penalties.

Electronic health record technology

We are considering acquiring electronic health record (“EHR”) technology. The HITECH Act provides for incentive payments to eligible hospitals to encourage the acquisition and use of EHR systems. The amount of incentive payments a hospital may receive is based on a formula that considers the hospital’s share of Medicare patients and when the hospital satisfies all of the relevant requirements for the incentive payments. Hospitals will have to demonstrate compliance with a number of requirements in order to receive incentive payments, including without limitation, (i) meaningful use of certified EHR technology; (ii) connectivity of certified EHR technology in a manner that provides for the electronic exchange of information to improve the quality of healthcare; and (iii) submission of information to HHS on clinical quality and other measures determined by HHS. The HITECH Act directs the HHS Secretary to determine what constitutes meaningful use and connectivity, as well as to develop quality measures to be reported, and the HHS Secretary has not issued regulations or other guidance on these requirements to date. We do not know when or if EHR technology acquired by us would enable us to qualify for incentive payments under the HITECH Act, and if we did qualify for such payments, we do not know when such payments would be received or the amounts of such payments. Finally, the HITECH Act provides that hospitals that do not satisfy requirements related to EHR technology and submission of quality data by 2015 will be subject to reductions in reimbursement.

Compliance Program

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

We have established a reporting system, auditing and monitoring programs, and a disciplinary system to enforce the code of ethics, and other compliance policies. Auditing and monitoring activities include claims

preparation and submission, and cover numerous issues such as coding, billing, cost reporting, and financial arrangements with physicians and other referral sources. These areas are also the focus of training programs.

Our policy is to require our officers and all employees to participate in compliance training programs. The board of directors has established a compliance committee, which oversees implementation of the compliance program.

The committee consists of three outside directors, and is chaired by Galen Powers, a former chief counsel for the Health Care Financing Administration (now known as CMS), where he was responsible for providing legal advice on federal healthcare programs, particularly Medicare and Medicaid. The compliance committee of the board meets at least quarterly.

The Chief Clinical and Compliance Officer reports to the chief executive officer forday-to-day compliance matters and at least quarterly to the compliance committee of the board. Each hospital has its own compliance committee and compliance officer that reports to its governing board. The compliance committee of the board of directors assesses each hospital’s compliance program at least annually. The corporate compliance officer annually assesses the hospitals for compliance reviews, provides an audit guide to the hospitals to evaluate compliance with our policies and procedures and serves on the compliance committee of each hospital.

The objective of the program is to ensure that our operations at all levels are conducted in compliance with applicable federal and state laws regarding both public and private healthcare programs.


Item 1A.	*Risk Factors*

You should carefully consider and evaluate all of the information included in this report, including the risk factors set forth below before making an investment decision with respect to our securities. The following is not an exhaustive discussion of all of the risks facing our company. Additional risks not presently known to us or that we currently deem immaterial may impair our business operations and results of operations.

If the anti-kickback, physician self-referral or other fraud and abuse laws are modified, interpreted differently or if other regulatory restrictions become effective, we could incur significant civil or criminal penalties and loss of reimbursement or be required to revise or restructure aspects of our business arrangements.

The federal anti-kickback statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for referring items or services payable by Medicare, Medicaid or any other federal healthcare program. The anti-kickback statute also prohibits any form of remuneration in return for purchasing, leasing or ordering or arranging for or recommending the purchasing, leasing or ordering of items or services payable by these programs. The anti-kickback statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by existing case law, regulations or advisory opinions.

Violations of the anti-kickback statute may result in substantial civil or criminal penalties, including criminal fines of up to $25,000 for each violation or imprisonment and civil penalties of up to $50,000 for each violation, plus three times the amount claimed and exclusion from participation in the Medicare, Medicaid and other federal healthcare reimbursement programs. Any exclusion of our hospitals or diagnostic and therapeutic facilities from these programs would result in significant reductions in revenue and would have a material adverse effect on our business.

The requirements of the physician self-referral statute, or Stark Law, are very complex and while federal regulations have been issued to implement all of its provisions, proper interpretation and application of the statute remains challenging. The Stark Law prohibits a physician who has a “financial relationship” with an entity from referring Medicare or Medicaid patients to that entity for certain “designated health services.” A “financial relationship” includes a direct or indirect ownership or investment interest in the entity, and a compensation arrangement between the physician and the entity. Designated health services include some radiology services and inpatient and outpatient services.

There are various ownership and compensation arrangement exceptions to this self-referral prohibition. Our hospitals rely upon the whole hospital exception to allow referrals from physician investors. Under this ownership exception, physicians may make referrals to a hospital in which he or she has an ownership interest if (1) the physician is authorized to perform services at the hospital and (2) the ownership interest is in the entire hospital, as opposed to a department or a subdivision of the hospital. Another exception for ownership of publicly traded securities permits physicians who own shares of our common stock to make referrals to our hospitals, provided our stockholders’ equity exceeded $75.0 million at the end of our most recent fiscal year or on average during the three previous fiscal years. This exception applies if, prior to the time the physician makes a referral for a designated health service to a hospital, the physician acquired the securities on terms generally available to the public and the securities are traded on one of the major exchanges.

In July 2007 as part of proposed revisions to the Medicare physician fee scheduled for fiscal year 2008, CMS proposed certain additional changes to the Stark Law. In particular, the proposed rule would revise the Stark Law exception for space and equipment rentals. In instances where a physician leases space or equipment to an entity who accepts patients referred by that physician, the CMS proposal would no longer allowunit-of-service or “per click” payments for such leases. Additionally, the proposed rule would no longer treat “under arrangements” between hospitals and physician-owned entities as compensation instead of ownership relationships. Specifically, the proposal would revise the definition of “entity” under the Stark Law to include not only the entity billing for the service but also the entity that has performed the designated health service CMS finalized these proposed changes to the Stark Law in the 2009 IPPS final rule published on August 19, 2008. These changes are effective October 1, 2009. Specifically, the 2009 IPPS final rule limits the ability of hospitals to enter into under arrangements with physicians and physician-owned entities and thus, physician-owned joint venture entities deemed to be “performing Designated Health Services (DHS)” will have to comply with one of the more limited Stark Law “ownership” exceptions, rather than the previously acceptable Stark Law “compensation” exceptions. In addition, the 2009 IPPS final rule finalized the prohibition on per unit compensation in space and equipment lease transactions. We have restructured certain space and equipment lease transactions with physicians that include per unit or per use compensation effective October 1, 2009 as well certain arrangements with community hospitals. We cannot yet predict the full impact of this restructuring on our financial performance. While we believe that such restructured arrangements comply with applicable law, we cannot be assured, however, that government officials will agree with our interpretation of applicable law.

Reductions or changes in reimbursement from government or third-party payors could adversely impact our operating results.

Historically, Congress and some state legislatures have, from time to time, proposed significant changes in the healthcare system. Many of these changes have resulted in limitations on, and in some cases, significant reductions in the levels of, payments to healthcare providers for services under many government reimbursement programs. In addition, many payors, including Medicare and other government payors, are increasingly developing payment policies that result in more procedures being performed on an outpatient basis rather than on an inpatient basis. Such

policies will result in decreased revenues for our hospitals, since outpatient procedures are generally reimbursed at a lower rate than inpatient procedures. Recent budget proposals, if enacted in their current form, would freezeand/or reduce reimbursement for inpatient and outpatient hospital services. The Medicare hospital inpatient prospective payment system is evaluated on an annual basis. On August 22, 2007, CMS issued its final inpatient hospital prospective payment system rule for fiscal year 2008, which begins October 1, 2007. The final rule continues major DRG reforms designed to improve the accuracy of hospital payments. As introduced in the fiscal year 2007 final rule, CMS will continue to use hospital costs rather than charges to set payment rates. For fiscal year 2008, hospitals will be paid based upon a blend of 1/3 charge-based weights and2/3 hospital cost-based weights for DRGs. Additionally, CMS adopted its proposal to restructure the current 538 DRGs to 745 MS-DRGs (severity-adjusted DRGs) to better recognize severity of patient illness. These MS-DRGs were phased in over a two-year period. Effective fiscal year 2009, CMS has identified eight conditions that will not be paid at a higher rate unless they were present on admission, including three serious preventable events deemed “never events.” CMS published the inpatient prospective payment system rule for 2009 on August 19, 2008. Due to the late enactment of the Medicare Improvements for Patient and Providers Act (“MIPPA”), CMS did not publish the final wage indices and payment rates for the 2009 IPPS final rule until October 2008. CMS issued the IPPS rule for 2010 on July 31, 2009. The Final IPPS rule for 2010 provides acute care hospitals with an inflation update of 2.1 percent in their 2010 payment rates. The Final IPPS rule also adds four new measures for which hospitals must submit data under the RHQDAPU program to receive the full market basket update

During the fiscal years ended September 30, 2009 and 2008, we derived 55.4% and 55.6%, respectively, of our net revenue from the Medicare and Medicaid programs. Changes in laws or regulations governing the Medicare and Medicaid programs or changes in the manner in which government agencies interpret them could materially and adversely affect our operating results or financial position.

Our relationships with third-party payors are generally governed by negotiated agreements or out of network arrangements. These agreements set forth the amounts we are entitled to receive for our services. Third-party payors have undertaken cost-containment initiatives during the past several years, including different payment methods, monitoring healthcare expenditures and anti-fraud initiatives, that have made these relationships more difficult to establish and less profitable to maintain. We could be adversely affected in some of the markets where we operate if we are unable to establish favorable agreements with third-party payors or satisfactory out of network arrangements.

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

We are required to comply with extensive and complex laws and regulations at the federal, state and local government levels. These laws and regulations relate to, among other things:


	•	licensure, certification and accreditation,

	•	billing, coverage and reimbursement for supplies and services,

	•	relationships with physicians and other referral sources,

	•	adequacy and quality of medical care,

	•	quality of medical equipment and services,

	•	qualifications of medical and support personnel,

	•	confidentiality, maintenance and security issues associated with medical records,

	•	the screening, stabilization and transfer of patients who have emergency medical conditions,

	•	building codes,

	•	environmental protection,

	•	clinical research,


	•	operating policies and procedures, and

	•	addition of facilities and services.

Many of these laws and regulations are expansive, and we do not always have the benefit of significant regulatory or judicial interpretation of them. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs, operating procedures, and contractual arrangements.

If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including:


	•	criminal penalties,

	•	civil penalties, including monetary penalties and the loss of our licenses to operate one or more of our facilities, and

	•	exclusion of one or more of our facilities from participation in the Medicare, Medicaid and other federal and state healthcare programs.

A number of initiatives have been proposed during the past several years to reform various aspects of the healthcare system at the federal level and in the states in which we operate. The U.S. Senate is currently debating the Patient Protection and Affordable Care Act, which proposes significant changes to the healthcare payment system. Current or future legislative initiatives, government regulations or other government actions may have a material adverse effect on us.

Companies within the healthcare industry continue to be the subject of federal and state investigations.

Both federal and state government agencies as well as private payors have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations including hospital companies. Like others in the healthcare industry, we receive requests for information from these governmental agencies in connection with their regulatory or investigative authority which, if determined adversely to us, could have a material adverse effect on our financial condition or our results of operations.

In addition, the Office of Inspector General and the U.S. Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Moreover, healthcare providers are subject to civil and criminal false claims laws, including the federal False Claims Act, which allows private parties to bring what are called whistleblower lawsuits against private companies doing business with or receiving reimbursement under government programs. These are sometimes referred to as “qui tam” lawsuits.

Because qui tam lawsuits are filed under seal, we could be named in one or more such lawsuits of which we are not aware or which cannot be disclosed until the court lifts the seal from the case. Defendants determined to be liable under the False Claims Act may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Typically, each fraudulent bill submitted by a provider is considered a separate false claim, and thus the penalties under a false claim case may be substantial. Liability arises when an entity knowingly submits a false claim for reimbursement to a federal healthcare program. In some cases, whistleblowers or the federal government have taken the position that providers who allegedly have violated other statutes, such as the anti-kickback statute or the Stark Law, have thereby submitted false claims under the False Claims Act. Thus, it is possible that we have liability exposure under the False Claims Act.

Some states have adopted similar state whistleblower and false claims provisions. Publicity associated with the substantial amounts paid by other healthcare providers to settle these lawsuits may encourage current and former employees of ours and other healthcare providers to seek to bring more whistleblower lawsuits. Some of our activities could become the subject of governmental investigations or inquiries. Any such investigations of us, our executives or managers could result in significant liabilities or penalties to us, as well as adverse publicity.

In October 2007, we reached an agreement with the DOJ and the United States Attorneys’ Office in Phoenix, Arizona regarding clinical trials at the Arizona Heart Hospital, one of the ten hospitals in which we own an interest. The settlement concerns Medicare claims submitted between June 1998 and October 2002 for physician services involving the implantation of certain endoluminal graft devices (utilized to treat aneurysms) that had not received final marketing approval from the FDA, and allegedly were either implanted without an approved investigational device exception (“IDE”) or were implanted outside of the approved IDE protocol. The DOJ allegations did not involve patient care and related solely to whether the procedures were properly reimbursable by Medicare. The parties reached a settlement of the allegations to avoid the delay, uncertainty, inconvenience, and expense of protracted litigation. Further, the hospital denies engagement in any wrongdoing or illegal conduct, and the settlement agreement does not contain any admission of liability. As disclosed in previous filings, the hospital agreed to pay approximately $5.8 million to settle and obtain a release from any civil or administrative monetary claims related to the DOJ’s investigation. Additionally, the hospital has entered into a five-year corporate integrity agreement with the OIG under which the hospital will continue to maintain its existing corporate compliance program and which relates to clinical trials conducted at the hospital. The $5.8 million was paid to the United States in November 2007.

During fiscal years 2009 and 2008 we refunded certain reimbursements to CMS related to carotid artery stent procedures performed during prior fiscal years at two of the Company’s consolidated subsidiary hospitals. The DOJ initiated an investigation related to our return of these reimbursements. As a result of the DOJ’s investigation, the Company began negotiating a settlement agreement during the third quarter of fiscal 2009 with the DOJ whereby we are expected to pay approximately $0.8 million to settle and obtain a release from any federal civil false claims liability related to the DOJ’s investigation. The DOJ allegations do not involve patient care, and relate solely to whether the procedures were properly reimbursable by Medicare. The settlement would not include any finding of wrong-doing or any admission of liability. As part of the settlement, we are also negotiating with the Department of Health and Human Services, Office of Inspector General (“OIG”), to obtain a release from any federal healthcare program permissive exclusion actions to be instituted by the OIG. As of September 30, 2009 we had reserved $0.8 million related to this matter.

Medicare Recovery Audit Contractor

In 2005, CMS began using Recovery Audit Contractors (“RAC”) to detect Medicare overpayments not identified through existing claims review mechanisms. The RAC program relies on private auditing firms to examine Medicare claims filed by healthcare providers. Fees to the RACs are paid on a contingency basis. The RAC program began as a demonstration project in 2005 in three states (New York, California and Florida) which was expanded into the three additional states of Arizona, Massachusetts and South Carolina in July 2007. No RAC audits, however, were initiated at our Arizona or California hospitals during the demonstration project. The program was made permanent by the Tax Relief and Health Care Act of 2006 enacted in December 2006. CMS announced in March 2008 the end of the demonstration project and the commencement of the permanent program by the expansion of the RAC program to additional states beginning in the summer and fall 2008 and its plans to have RACs in place in all 50 states by 2010.

RACs perform post-discharge audits of medical records to identify Medicare overpayments resulting from incorrect payment amounts, non-covered services, incorrectly coded services, and duplicate services. CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007. Claims identified as overpayments will be subject to the Medicare appeals process.

Even though we believe the claims for reimbursement submitted to the Medicare program by our facilities have been accurate, we are unable to reasonably estimate what the potential result of future RAC audits or other reimbursement matters could be.

If laws governing the corporate practice of medicine change, we may be required to restructure some of our relationships.

The laws of various states in which we operate or may operate in the future do not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business

practices, such as fee-splitting with physicians. The interpretation and enforcement of these laws vary significantly from state to state. We are not required to obtain a license to practice medicine in any jurisdiction in which we own or operate a hospital or other facility because our facilities are not engaged in the practice of medicine. The physicians who use our facilities to provide care to their patients are individually licensed to practice medicine. In most instances, the physicians and physician group practices are not affiliated with us other than through the physicians’ ownership interests in the facility or other joint ventures and through the service and lease agreements we have with some of these physicians. Should the interpretation, enforcement or laws of the states in which we operate or may operate change, we cannot assure you that such changes would not require us to restructure some of our physician relationships.

If government laws or regulations change or the enforcement or interpretation of them change, we may be obligated to purchase some or all of the ownership interests of the physicians associated with us.

Changes in government regulation or changes in the enforcement or interpretation of existing laws or regulations could obligate us to purchase at the then fair market value some or all of the ownership interests of the physicians who have invested in the ventures that own and operate our hospitals and other healthcare businesses. Regulatory changes that could create this obligation include changes that:


	•	make illegal the referral of Medicare or other patients to our hospitals and other healthcare businesses by physicians affiliated with us,

	•	create the substantial likelihood that cash distributions from the hospitals and other healthcare businesses to our physician partners will be illegal, or

	•	make illegal the ownership by our physician partners of their interests in the hospitals and other healthcare businesses.

From time to time, we may voluntarily seek to increase our ownership interest in one or more of our hospitals and other healthcare businesses, in accordance with any applicable limitations. We may seek to use shares of our common stock to purchase physicians’ ownership interests instead of cash. If the use of our stock is not permitted or attractive to us or our physician partners, we may use cash or promissory notes to purchase the physicians’ ownership interests. Our existing capital resources may not be sufficient for the acquisition or the use of cash may limit our ability to use our capital resources elsewhere, limiting our growth and impairing our operations. The creation of these obligations and the possible adverse effect on our affiliation with these physicians could have a material adverse effect on us.

We may have fiduciary duties to our partners that may prevent us from acting solely in our best interests.

We hold our ownership interests in hospitals and other healthcare businesses through ventures organized as limited liability companies or limited partnerships. As general partner, manager or owner of the majority interest in these entities, we may have special legal responsibilities, known as fiduciary duties, to our partners who own an interest in a particular entity. Our fiduciary duties include not only a duty of care and a duty of full disclosure but also a duty to act in good faith at all times as manager or general partner of the limited liability company or limited partnership. This duty of good faith includes primarily an obligation to act in the best interest of each business, without being influenced by any conflict of interest we may have as a result of our own business interests.

We also have a duty to operate our business for the benefit of our stockholders. As a result, we may encounter conflicts between our fiduciary duties to our partners in our hospitals and other healthcare businesses, and our responsibility to our stockholders. For example, we have entered into management agreements to provide management services to our hospitals in exchange for a fee. Disputes may arise with our partners as to the nature of the services to be provided or the amount of the fee to be paid. In these cases, as manager or general partner we may be obligated to exercise reasonable, good faith judgment to resolve the disputes and may not be free to act solely in our own best interests or the interests of our stockholders. We cannot assure you that any dispute between us and our partners with respect to a particular business decision or regarding the interpretation of the provisions of the hospital operating agreement will be resolved or that, as a result of our fiduciary duties, any dispute resolution will be on terms favorable or satisfactory to us.

Material decisions regarding the operations of our facilities require consent of our physician and community hospital partners, and we may be unable as a result to take actions that we believe are in our best interest.

The physician and community hospital partners in our healthcare businesses participate in material strategic and operating decisions we make for these facilities. They may do so through their representatives on the governing board of the subsidiary that owns the facility or a requirement in the governing documents that we obtain the consent of their representatives before taking specified material actions. We generally must obtain the consent of our physician and other hospital partners or their representatives before making any material amendments to the operating or partnership agreement for the venture or admitting additional members or partners. Although they have not done so to date, these rights to approve material decisions could in the future limit our ability to take actions that we believe are in our best interest and the best interest of the venture. We may not be able to resolve favorably, or at all, any dispute regarding material decisions with our physician or other hospital partners.

We may experience difficulties in executing our growth strategy.

Our growth strategy depends on our ability to identify attractive markets in which to expand existing facilities and establish new business ventures and to identify attractive acquisition opportunities. We may have difficulty in identifying potential markets that satisfy our criteria for expansion, for acquisition, or for developing a new facility or for entering into other business arrangements. Identifying physician and community hospital partners and negotiating and implementing the terms of an agreement with them can be a lengthy and complex process. As a result, we may not be able to develop new business ventures at the rate we currently anticipate. Our growth strategy also involves the expansion of several of our hospitals. The success of these expansions is dependant on increased regional support in each respective market. If the market conditions in these regions deteriorate, these expansion costs may not be recoverable. If we acquire an existing facility, there is no assurance that we will be able to operate it profitably.

Our growth strategy will also increase demands on our management, operational and financial information systems and other resources. To accommodate our growth, we will need to continue to implement operational and financial information systems and controls, and expand, train, manage and motivate our employees. Our personnel, information systems, procedures or controls may not adequately support our operations in the future. Failure to recruit and retain strong management, implement operational and financial information systems and controls, or expand, train, manage or motivate our workforce, could lead to delays in developing and achieving expected operating results for new facilities.

Unfavorable or unexpected results at one of our hospitals or in one of our markets could significantly impact our consolidated operating results.

Each of our individual hospitals comprise a significant portion of our operating results and a majority of our hospitals are located in the southwestern United States. Any material change in the current demographic, economic, competitive or regulatory conditions in this region, a particular market in which one of our other hospitals operates or the United States in general could adversely affect our operating results. In particular, if economic conditions deteriorate in one or more of these markets, we may experience a shift in payor mix arising from patients’ loss of or changes in employer-provided health insurance resulting in higher co-payments and deductibles or an increased number of uninsured patients.

Growth of self-pay patients and a deterioration in the collectability of these accounts could adversely affect our results of operations.

We have experienced growth in our self-pay patients, which includes situations in which each patient is responsible for the entire bill, as well as cases where deductibles are due from insured patients after insurance pays. We may have greater amounts of uninsured receivables in the future and if the collectability of those uninsured receivables deteriorates, increases in our allowance for doubtful accounts may be required, which could materially adversely impact our operating results and financial condition.

Our hospitals and other facilities face competition for patients from other healthcare companies.

The healthcare industry is highly competitive. Our facilities face competition for patients from other providers in our markets. In most of our markets we compete for market share of cardiovascular and other healthcare procedures that are the focus of our facilities with two to three providers. As we expand the scope of hospital services at our hospitals we may face even greater levels of competition from other larger general acute care hospitals in our markets that also provide those services. Some of these providers are part of large for-profit ornot-for-profit hospital systems with greater financial resources than we have available to us and have been operating in the markets they serve for many years. Some of the hospitals that we compete against in certain of our markets and elsewhere have attempted to use their market position and managed care networks to influence physicians not to enter into or to abandon joint ventures that own facilities such as ours by, for example, revoking the admission privileges of our physician partners at the competing hospital. These practices of “economic credentialing” appear to be on the increase. Although these practices have not been successful to date in either preventing us from developing new ventures with physicians or causing us to lose existing investors, the future inability to attract new investors or loss of a significant number of our physician partners in one or more of our existing ventures could have a material adverse effect on our business and operating results.

We depend on our relationships with the physicians who use our facilities.

Our business depends upon the efforts and success of the physicians who provide healthcare services at our facilities and the strength of our relationships with these physicians. Each member of the medical staffs at our hospitals may also serve on the medical staffs of, and practice at, hospitals not owned by us.

At each of our hospitals, our business could be adversely affected if a significant number of key physicians or a group of physicians:


	•	terminated their relationship with, or reduced their use of, our facilities,

	•	failed to maintain the quality of care provided or to otherwise adhere to the legal professional standards or the legal requirements to obtain privileges at our hospitals or other facilities,

	•	suffered any damage to their reputation,

	•	exited the market entirely,

	•	experienced financial issues within their medical practice or other major changes in its composition or leadership, or

	•	align with another healthcare provider resulting in significant reduction in use of our facilities.

Historically, the medical staff at each hospital ranges from approximately 150 to 400 physicians depending upon the size of the hospital and the number of practicing physicians in the market. If we fail to maintain our relationships with the physicians in this group at a particular hospital, many of whom are investors in our hospitals, the revenues of that hospital would be reduced. None of the physicians practicing at our hospitals has a legal commitment, or any other obligation or arrangement that requires the physician to refer patients to any of our hospitals or other facilities.

From time to time physicians who are leaders of their medical groups and who use our hospitals may retire or otherwise cease practicing medicine or using our facilities for a variety of reasons. Those medical groups may not replace those physician leaders or may replace them with physicians who choose not to use our hospitals. Losing the utilization of our hospitals by those physicians and other physicians in their medical groups may result in material decreases in our revenue and financial performance.

A hospital system with which one of our established hospitals competes recently announced a collaboration with one of the leading cardiac services physician groups in that market, some of whose physicians have historically used our hospital and are investors in that hospital. It is possible this collaboration could result in a decrease in the use of our hospital by those physicians, with a resulting decrease in the revenue and financial performance of that hospital. Similar transactions in other markets may occur in the future and could have similar negative impacts on our other facilities and the Company.

A shortage of qualified nurses could affect our ability to grow and deliver quality, cost-effective care services.

We depend on qualified nurses to provide quality service to patients in our facilities. There is currently a shortage of qualified nurses in certain markets where we operate our facilities. This shortage of qualified nurses and the more stressful working conditions it creates for those remaining in the profession are increasingly viewed as a threat to patient safety and may trigger the adoption of state and federal laws and regulations intended to reduce that risk. For example, some states have adopted or are considering legislation that would prohibit forced overtime for nursesand/or establish mandatory staffing level requirements. Growing numbers of nurses are also joining unions that threaten and sometimes call work stoppages.

In response to the shortage of qualified nurses, we have increased and are likely to have to continue to increase our wages and benefits to recruit and retain nurses or to engage expensive contract nurses until we hire permanent staff nurses. We may not be able to increase the rates we charge to offset increased costs. The shortage of qualified nurses has in the past and may in the future delay our ability to achieve our operational goals at a hospital by limiting the number of patient beds available during thestart-up phase of the hospital. The shortage of nurses also makes it difficult for us in some markets to reduce personnel expense at our facilities by implementing a reduction in the size of the nursing staff during periods of reduced patient admissions and procedure volumes.

We rely heavily on our information systems and if our access to this technology is impaired or interrupted, or if such technology does not perform as warranted by the vendor, our business could be harmed and we may not comply with applicable laws and regulations.

Increasingly, our business depends in large part upon our ability to store, retrieve, process and manage substantial amounts of information. To achieve our strategic objectives and to remain in compliance with various regulations, we must continue to develop and enhance our information systems, which may require the acquisition of equipment and third-party software. Our inability to implement and utilize, in a cost-effective manner, information systems that provide the capabilities necessary for us to operate effectively, or any interruption or loss of our information processing capabilities, for any reason including if such systems, or systems acquired in the future, do not perform appropriately, could harm our business, results of operations or financial condition.

We are considering acquiring EHR technology. The HITECH Act provides for incentive payments to eligible hospitals to encourage the acquisition and use of EHR systems. The amount of incentive payments a hospital may receive is based on a formula that considers the hospital’s share of Medicare patients and when the hospital satisfies all of the relevant requirements for the incentive payments. Hospitals will have to demonstrate compliance with a number of requirements in order to receive incentive payments, including without limitation, (i) meaningful use of certified EHR technology; (ii) connectivity of certified EHR technology in a manner that provides for the electronic exchange of information to improve the quality of healthcare; and (iii) submission of information to HHS on clinical quality and other measures determined by HHS. The HITECH Act directs the HHS Secretary to determine what constitutes meaningful use and connectivity, as well as to develop quality measures to be reported, and the HHS Secretary has not issued regulations or other guidance on these requirements to date. We do not know when or if EHR technology acquired by us would enable us to qualify for incentive payments under the HITECH Act, and if we did qualify for such payments, we do not know when such payments would be received or the amounts of such payments. Finally, the HITECH Act provides that hospitals that do not satisfy requirements related to EHR technology and submission of quality data by 2015 will be subject to reductions in reimbursement.

Uninsured risks from legal actions related to professional liability could adversely affect our cash flow and operating results.

In recent years, physicians, hospitals, diagnostic centers and other healthcare providers have become subject, in the normal course of business, to an increasing number of legal actions alleging negligence in performing services, negligence in allowing unqualified physicians to perform services or other legal theories as a basis for liability. Many of these actions involve large monetary claims and significant defense costs. We may be subject to such legal actions even though a particular physician at one of our hospitals or other facilities is not our employee and the governing documents for the medical staffs of each of our hospitals require physicians who provide services,

or conduct procedures, at our hospitals to meet all licensing and specialty credentialing requirements and to maintain their own professional liability insurance.

We have established a reserve for malpractice claims based on actuarial estimates using our historical experience with malpractice claims and assumptions about future events. Due to the considerable variability that is inherent in such estimates, including such factors as changes in medical costs and changes in actual experience, there is a reasonable possibility that the recorded estimates will change by a material amount in the near term. Also, there can be no assurance that the ultimate liability we experience under our self-insured retention for medical malpractice claims will not exceed our estimates. It is also possible that such claims could exceed the scope of coverage, or that coverage could be denied.

Our results of operations may be adversely affected from time to time by changes in treatment practice and new medical technologies.

One major element of our business model is to focus on the treatment of patients suffering from cardiovascular disease. Our commitment and that of our physician partners to treating cardiovascular disease often requires us to purchase newly approved pharmaceuticals and devices that have been developed by pharmaceutical and device manufacturers to treat cardiovascular disease. At times, these new technologies receive required regulatory approval and become widely available to the healthcare market prior to becoming eligible for reimbursement by government and other payors. In addition, the clinical application of existing technologies may expand, resulting in their increased utilization. We cannot predict when new technologies will be available to the marketplace, the rate of acceptance of the new technologies by physicians who practice at our facilities, and when or if, government and third-party payors will provide adequate reimbursement to compensate us for all or some of the additional cost required to purchase new technologies. As such, our results of operations may be adversely affected from time to time by the additional, unreimbursed cost of these new technologies.

In addition, advances in alternative cardiovascular treatments or in cardiovascular disease prevention techniques could reduce demand or eliminate the need for some of the services provided at our facilities, which could adversely affect our results of operations. Further, certain technologies may require significant capital investments or render existing capital obsolete which may adversely impact our cash flows or operations.

California state law may impact our operations.

Effective January 1, 2009, California licensed general acute hospitals are subject to increased administrative penalties associated with survey deficiencies impacting the health or safety of a patient, the unlawful or unauthorized access, use, or disclosure of a patient’s medical information and are required to screen specific patients for certain hospital-related infections and must maintain an infection control policy. Deficiencies constituting immediate jeopardy to the health or safety of a patient are subject to graduated penalties of up to a maximum $100,000 per violation (up from a maximum of $25,000 per violation). Deficiencies not constituting immediate jeopardy to the health or safety of a patient are subject to penalties up to a maximum of $25,000 per violation (up from a maximum of $17,500 per violation). Penalties for violation of the unlawful or unauthorized access are up to $25,000 per patient and a maximum of $17,500 for each subsequent access, use or disclosure of the patient’s medical information.

We believe we are or will be in compliance with this new California provisions, but there can be no assurance that applicable regulatory agencies or individuals may challenge that assertion.

On January 8, 2009, the California Supreme Court ruled inProspect Medical Group, Inc., et al. v. Northridge Emergency Medical Group, et al.(2009) 45 Cal. 4^th 497, that under California’s Knox-Keene statute, healthcare providers may not bill patients for covered emergency out patient services for which health plans or capitated payors are invoiced by the provider but fail to pay the provider. The California Supreme Court held that the only recourse for healthcare providers is to pursue the payors directly. TheProspectdecision does not apply to amounts that the health plan or capitated payor is not obligated to pay under the terms of the insured’s policy or plan. Although the decision only considered emergency providers and referred to HMOs and capitated payors, future court decisions on how the so-called “balance billing” statute is interpreted does pose a risk to healthcare providers that perform emergency or other out-patient services in the state of California.

A purported class action law suit was recently filed by an individual against the Bakersfield Heart Hospital. In the complaint the plaintiff alleges that under California law, and specifically under the Knox-Keene Healthcare Service Plan Act of 1975, and under the Health and Safety Code of California that California prohibits the practice of “balance billing” patients who are provided “emergency services” as defined under California law. A class has not been certified by the court in this case. We are currently evaluating the claims asserted in this cause as well as the defense we may assert in this matter.


Item 1B.	*Unresolved Staff Comments*

None.


Item 2.	*Properties*

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

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


Item 3.	*Legal Proceedings*

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


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

No matters were submitted to a vote of security holders during the fourth quarter of 2009.

PART II


Item 5.	*Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities*

Our common stock trades on the Nasdaq Global Market^® under the symbol “MDTH.” At December 10, 2009, there were 20,654,264 shares of common stock outstanding, the sale price of our common stock per share was $6.95, and there were 44 holders of record. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported by the Nasdaq Global Market^®:


Year Ended September 30, 2009	High		Low

First Quarter	$	18.28	$	5.89
Second Quarter		10.47		5.70
Third Quarter		12.86		7.02
Fourth Quarter		13.63		8.43


Year Ended September 30, 2008	High		Low

First Quarter	$	29.98	$	21.40
Second Quarter		27.00		18.02
Third Quarter		23.07		16.09
Fourth Quarter		22.69		16.97

We have not declared or paid any cash dividends on our common stock and do not anticipate paying cash dividends on our common stock for the foreseeable future. The terms of our credit agreement restricts our ability to pay and the amount of any cash dividends or other distributions to our stockholders, and limits the amounts and extent for which we can repurchase our common stock. Under the terms of our credit agreement, we may only pay dividends if there is no default or event of default and we are in compliance with the restricted payment covenant and the financial ratio covenant after giving effect to the dividend. See Note 9 to our consolidated financial statements contained elsewhere in this report. We anticipate that we will retain all earnings, if any, to develop and expand our business. See“Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”Payment of dividends in the future will be at the discretion of our board of directors and will depend upon our financial condition and operating results.

During August 2007, our board of directors approved a stock repurchase program of up to $59.0 million. The purchases will be made from time to time in the open market or in privately negotiated transactions in accordance with applicable federal and state securities laws and regulations. The extent to which we repurchase common shares and the timing of such repurchases will depend upon stock price, general economic and market conditions and other corporate considerations. The repurchase program may be discontinued at any time. Subsequent to the approval of the stock repurchase program, the Company has repurchased 1,885,461 shares of common stock at a total cost of $44.4 million, with a remaining $14.6 million available to be repurchased under the approved stock repurchase program. No shares were repurchased during fiscal 2009.

The following graph illustrates, for the period from September 30, 2004 through September 30, 2009, the cumulative total shareholder return of $100 invested (assuming that all dividends, if any, were reinvested) in (1) our common stock, (2) the NASDAQ Composite Stock Index and (3) the S&P Health Care Facilities Index.

The comparisons in this table are required by the rules of the Securities and Exchange Commission and, therefore, are not intended to forecast or be indicative of possible future performance of our common stock.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among MedCath Corporation, The NASDAQ Composite Index
And The S&P Health Care Facilities Index


*	$100 invested on9/30/04 in stock or index, including reinvestment of dividends. Fiscal year ending September 30.


Item 6.	*Selected Financial Data*

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

The following table sets forth our selected consolidated financial data as of and for the years ended September 30, 2009, 2008, 2007, 2006 and 2005.


	Year Ended September 30,
	2009			2008			2007			2006			2005

Consolidated Statement of Operations Data:
(in thousands, except per share data)
Net revenue	$	602,042		$	591,611		$	636,526		$	618,940		$	579,507
Impairment of long-lived assets and goodwill	$	60,174		$	—		$	—		$	458		$	2,662
(Loss) income from continuing operations before minority interest, income taxes and discontinued operations	$	(47,890	)	$	34,293		$	33,524		$	13,608		$	10,164
(Loss) income from continuing operations	$	(58,418	)	$	12,373		$	12,731		$	2,982		$	1,624
Income (loss) from discontinued operations	$	8,136		$	8,617		$	(1,204	)	$	9,594		$	7,167
Net (loss) income	$	(50,282	)	$	20,990		$	11,527		$	12,576		$	8,791
(Loss) earnings from continuing operations per share, basic	$	(2.97	)	$	0.62		$	0.61		$	0.16		$	0.09
(Loss) earnings from continuing operations per share, diluted	$	(2.97	)	$	0.61		$	0.59		$	0.15		$	0.08
(Loss) earnings per share, basic	$	(2.55	)	$	1.05		$	0.56		$	0.67		$	0.48
(Loss) earnings per share, diluted	$	(2.55	)	$	1.04		$	0.54		$	0.64		$	0.45
Weighted average number of shares, basic(a)		19,684			19,996			20,872			18,656			18,286
Weighted average number of shares, diluted(a)		19,684			20,069			21,511			19,555			19,470

Balance Sheet and Cash Flow Data:
(in thousands)
Total assets	$	590,448		$	653,456		$	678,567		$	785,849		$	763,205
Total long-term obligations	$	115,231		$	121,989		$	148,484		$	286,928		$	297,275
Net cash provided by operating activities	$	63,633		$	52,008		$	58,225		$	65,634		$	61,247
Net cash (used in) provided byinvesting activities	$	(63,790	)	$	(5,805	)	$	(28,591	)	$	10,064		$	22,802
Net cash used in financing activities	$	(50,210	)	$	(78,028	)	$	(80,116	)	$	(22,165	)	$	(12,645	)

Selected Operating Data (consolidated)(b):
Number of hospitals		7			7			7			8			8
Licensed beds(c)		588			509			421			533			533
Staffed and available beds(d)		502			464			404			516			499
Admissions(e)		26,812			29,243			35,373			37,901			36,274
Adjusted admissions(f)		40,964			40,971			48,306			49,622			47,234
Patient days(g)		103,342			107,353			120,556			124,358			126,240
Adjusted patient days(h)		157,638			150,559			164,131			162,813			163,420
Average length of stay(i)		3.85			3.66			3.41			3.28			3.48
Occupancy(j)		56.4	%		63.4	%		81.8	%		66.0	%		69.3	%
Inpatient catheterization procedures(k)		13,257			15,979			17,925			19,072			18,595
Inpatient surgical procedures(l)		8,181			8,383			9,481			9,973			9,936
Hospital net revenue	$	578,432		$	565,787		$	607,551		$	586,941		$	549,313


(a)		See Note 14 to the consolidated financial statements included elsewhere in this report.

(b)		Selected operating data includes consolidated hospitals in operation as of the end of the period reported in continuing operations but does not include hospitals which were accounted for using the equity method or as discontinued operations in our consolidated financial statements. During the fourth quarter of fiscal 2007, Harlingen Medical Center ceased to be a consolidated subsidiary due to the sale of a portion of the hospital.


(c)		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.

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

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

(f)		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.

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

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

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

(j)		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.

(k)		Inpatients with a catheterization procedure represent the number of inpatients with a procedure performed in one of the hospitals’ catheterization labs during the period.

(l)		Inpatient surgical procedures represent the number of surgical procedures performed on inpatients during the period.


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

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

Overview

We are a healthcare provider focused primarily on providing high acuity services, predominantly 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. We also have partnerships with community hospital systems, and we manage the cardiovascular program of various hospitals operated by other parties. We opened our first hospital in 1996 and currently have ownership interests in and operate ten hospitals, including eight in which we own a majority interest. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services with a focus on cardiovascular care. Each of our hospitals has a twenty-four hour emergency room staffed by emergency department physicians. The hospitals in which we have ownership interests have a total of 825 licensed beds and are located predominately in high growth markets in seven states: Arizona, Arkansas, California, Louisiana, New Mexico, South Dakota, and Texas. During May 2009 we completed our 79 bed expansion at Louisiana Medical Center and Heart Hospital, with remaining capacity for an additional 40 beds at that hospital. During October 2009 we opened a new acute care hospital in Kingman, Arizona. This hospital is designed to accommodate a total of 106 licensed beds, with an initial opening of 70 of its licensed beds.

In addition to our hospitals, we currently ownand/or manage 16 cardiac diagnostic and therapeutic facilities or programs. Ten of these programs are located at hospitals operated by other parties. These facilities offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining six facilities are not located at hospitals and offer only diagnostic procedures.

We believe our facilities provide superior clinical outcomes, which, together with our ability to provide management capabilities and capital resources, positions us to expand upon our relationships with physicians and community hospitals to increase our presence in existing and new markets.

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 hospitals in which we hold a minority interest are excluded from the net revenue and operating results of our consolidated company and our consolidated hospital division. During the fourth quarter of fiscal 2007, we sold a portion of our equity interest in Harlingen Medical Center; therefore, beginning in July 2007, we began excluding this hospital from net revenue and operating results of our consolidated company and our consolidated hospital division. Similarly, a number of our diagnostic and therapeutic facilities are excluded from the net revenue and operating results of our consolidated company and our consolidated MedCath Partners division. Our minority interest in the results of operations for the periods discussed for these entities is recognized as part of the equity in net earnings of unconsolidated affiliates in our statements of income in accordance with the equity method of accounting.

We sold our equity interests in Heart Hospital of Lafayette and Cape Cod Cardiology Services LLC in fiscal 2008 and 2009, respectively, and the net assets of Dayton Heart Hospital and Sun City Cardiac Center Associates in fiscal 2008 and 2009, respectively. Accordingly, for all periods presented, the results of operations for these entities have been excluded from continuing operations and are reported in income (loss) from discontinued operations, net of taxes.

Same Facility Hospitals. Our policy is to include, on a same facility basis, 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 fiscal year ended September 30, 2007, we exclude the results of operations of Harlingen Medical Center, which, during the fourth quarter of fiscal 2007 and the entire fiscal 2008 and 2009, ceased to be a consolidated subsidiary due to the sale of a portion of the hospital, as discussed in theBasis of Consolidationabove.

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 indicated below.


	Year Ended September 30,
Division	2009			2008			2007

Hospital		96.8	%		96.2	%		95.8	%
MedCath Partners		3.1	%		3.4	%		3.8	%
Corporate and other		0.1	%		0.4	%		0.4	%

Net Revenue		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 each of our last three fiscal years.


	Year Ended September 30,
Payor	2009			2008			2007

Medicare		52.4	%		52.2	%		49.1	%
Medicaid		3.0	%		3.4	%		4.8	%
Commercial and other, including self-pay		44.6	%		44.4	%		46.1	%

Total consolidated net revenue		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, and 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. 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 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 possibility that recorded estimates will change by a material amount in the near term. See Item 1Businessand Item 1ARisk Factors.

Critical Accounting Policies and Estimates

General. The discussion and analysis of our financial condition and results of operations are based on our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our consolidated financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on a regular basis and make changes as experience develops or new information becomes known. Actual results may differ from these estimates under different assumptions or conditions.

We define critical accounting policies as those that (1) involve significant judgments and uncertainties, (2) require estimates that are more difficult for management to determine and (3) have the potential to result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are those described below. For a detailed discussion of the application of these and other accounting policies, see Note 2 to the consolidated financial statements included elsewhere in this report.

Revenue Recognition. Amounts we receive for treatment of patients covered by governmental programs such as Medicare and Medicaid and other third-party payors such as commercial insurers, health maintenance organizations and preferred provider organizations are generally less than our established billing rates. Payment arrangements with third-party payors may include prospectively determined rates per discharge or per visit, a discount from established charges, per diem payments, reimbursed costs (subject to limits)and/or other similar contractual arrangements. As a result, net revenue for services rendered to patients is reported at the estimated net realizable amounts as services are rendered. We account for the difference between the estimated realizable rates under the reimbursement program and the standard billing rates as contractual adjustments.

The majority of our contractual adjustments are system-generated at the time of billing based on either government fee schedules or fee schedules contained in our managed care agreements with various insurance plans. Portions of our contractual adjustments are performed manually and these adjustments primarily relate to patients that have insurance plans with whom our hospitals do not have contracts containing discounted fee schedules, also referred to as non-contracted payors and patients that have secondary insurance plans following adjudication by the primary payor. Estimates of contractual adjustments are made on a payor-specific basis and based on the best information available regarding our interpretation of the applicable laws, regulations and contract terms. While subsequent adjustments to the systematic contractual allowances can arise due to denials, short payments deemed immaterial for continued collection effort and a variety of other reasons, such amounts have not historically been significant.

We continually review the contractual estimation process to consider and incorporate updates to the laws and regulations and any changes in the contractual terms of our programs. Final settlements under some of these programs are subject to adjustment based on administrative review and audit by third parties, which can take several years to determine. From a procedural standpoint, for government payors, primarily Medicare, we recognize estimated settlements in our consolidated financial statements based on filed cost reports. We subsequently adjust those settlements as we obtain new information from audits or reviews by the fiscal intermediary and, if the result of the fiscal intermediary audit or review impacts other unsettled and open cost reports, then we recognize the impact of those adjustments. We estimate current year settlements based on models designed to approximate our cost report filings and revise our estimates in February of each year upon completion of the actual cost report and tentative settlement. 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.

We provide care to patients who meet certain criteria under our charity care policy without charge or at amounts less than our established rates. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported as net revenue.

Our managed diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories operate under various contracts where management fee revenue is recognized under fixed-rate andpercentage-of-income arrangements as services are rendered. In addition, certain diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories recognize additional revenue under cost reimbursement and equipment lease arrangements. Net revenue from our owned diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories is reported at the estimated net realizable amounts due from patients, third party payors, and others as services are rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors.

Allowance for Doubtful Accounts. Accounts receivable primarily consist of amounts due from third-party payors and patients in our hospital division. The remainder of our accounts receivable principally consist of amounts due from billings to hospitals for various cardiovascular care services performed in our MedCath Partners Division and amounts due under consulting and management contracts. To provide for accounts receivable that could become uncollectible in the future, we establish an allowance for doubtful accounts to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance based on such factors as payor mix, aging and the historical collection experience and write-offs of our respective hospitals and other business units. Adverse changes in business office operations, payor mix, economic conditions or trends in federal and state governmental healthcare reimbursement could affect our collection of accounts receivable.

When possible, we will attempt to collect co-payments from patients prior to admission for inpatient services as a part of the pre-registration and registration processes. If unsuccessful, we will also attempt to reach a mutuallyagreed-upon payment arrangement at that time. To the extent possible, the estimated amount of the patient’s financial responsibility is determined based on the services to be performed, the patient’s applicable co-payment amount or percentage and any identified remaining deductible and co-insurance percentages. If payment arrangements are not provided upon admission or only a partial payment is obtained, we will attempt to collect any estimated remaining patient balance upon discharge. We also comply with the requirements under applicable law concerning collection of Medicare co-payments and deductibles. Patients who come to our hospitals for outpatient services are expected to make payment or adequate financial arrangements before receiving services. Patients who come to the emergency room are screened and stabilized to the extent of the hospital’s capability for any emergency medical condition in accordance with applicable laws, rules and other regulations in order that financial arrangements do not delay such screening, stabilization, and appropriate disposition.

General and Professional Liability Risk. We are self-insured for medical malpractice, workers’ compensation healthcare and dental coverage up to certain maximum liability amounts. Although the amounts accrued are actuarially determined based on analysis of historical trends of losses, settlements, litigation costs and other factors, the amounts we will ultimately disburse could differ from such accrued amounts.

Goodwill. Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill is required to be evaluated for impairment at the same time every year and when an event occurs or circumstances

change that, more likely than not, reduce the fair value of the reporting unit below its carrying value. A two-step method is used for determining if goodwill is impaired. Step one is to compare the fair value of the reporting unit with the unit’s carrying value, including goodwill. If this test indicates the fair value is less than the carrying value, then step two is required to compare the implied fair value of the reporting unit’s goodwill with the carrying value of the reporting unit’s goodwill. We have selected September 30th as our annual testing date.

Due to overall market conditions during the first quarter of fiscal 2009 resulting in a decline in our market capitalization, we performed an interim impairment test of goodwill as of December 31, 2008. The fair value of the reporting unit (our Hospital Division) was determined using a combination of a discounted cash flow, market multiple and comparable transaction methods. These methods are based on our best estimate of future revenues and operating costs, comparable transactions that have taken place in the market place and are reconciled to our market capitalization. The results of our interim analysis concluded that the fair value of the reporting unit was in excess of its carrying value.

We performed our annual impairment analysis of goodwill as of September 30, 2009 utilizing the same historical methods as discussed above. Initially our analysis resulted in a fair value for which we could not satisfactorily reconcile to our market capitalization. During the fourth quarter of fiscal 2009, our stock price underperformed comparable companies as well as the broader markets, and we also experienced a decline in our fourth quarter operating results. As a result of these events we placed greater weight on the discounted cash flow method, which resulted in a fair value that was below the carrying value of the reporting unit at September 30, 2009.

The second step of the impairment testing process involved the allocation of the fair value of the reporting unit derived in the first step of the impairment test to the fair value of the reporting unit’s assets and liabilities. This process requires significant management estimates and judgments, and is used to determine the implied fair value of the reporting unit’s goodwill. The fair value in excess of amounts allocated to such net assets represented the implied fair value of goodwill for the reporting unit. As a result goodwill was written down to its implied fair value of zero, derived in the second step, causing the entire balance of $60.2 million of goodwill to be impaired during the fourth quarter of fiscal 2009. The non-cash impairment expense did not affect our operations, cash flow, cash position or access to our bank facility.

Long-Lived Assets. Long-lived assets, which include finite lived intangible assets, are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset and its eventual disposition are less than its carrying amount. The determination of whether or not long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated future cash flows expected to result from the use of those assets. Changes in our strategy, assumptionsand/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of long-lived assets.

Earnings Allocated to Minority Interests. Earnings allocated to minority interests represent the allocation of profits and losses to minority owners in our consolidated subsidiaries. Because our hospitals are owned as joint ventures, each hospital’s earnings and losses are generally allocated for accounting purposes to us and our physician and community hospital partners on a pro-rata basis in accordance with the respective ownership percentages in the hospital. If, however, the cumulative net losses of a hospital exceed its initial capitalization and committed capital obligations of our partners, then we recognize a disproportionately higher share, up to 100%, of the hospital’s losses, instead of the smaller pro-rata share of the losses that normally would be allocated to us based upon our percentage ownership. The disproportionate allocation to us of a hospital’s losses would reduce our consolidated net income in that reporting period. When the same hospital has earnings in a subsequent period, a disproportionately higher share, up to 100%, of the hospital’s earnings will be allocated to us to the extent we have previously recognized a disproportionate share of that hospital’s losses. The disproportionate allocation to us of a hospital’s earnings would increase our consolidated net income in that reporting period.

The determination of disproportionate losses to be allocated is based on the specific terms of each hospital’s operating agreement, including each partner’s contributed capital, obligation to contribute additional capital to provide working capital loans, or to guarantee the outstanding obligations of the hospital. During each of our fiscal

years 2009, 2008 and 2007, our disproportionate recognition of earnings and losses in our hospitals had a net positive/(negative) impact of $(2.2) million, $0.6 million, and $(0.2) million, respectively, on our reported income from continuing operations before income taxes and discontinued operations.

We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate lossesand/or recoveries thereof through disproportionate profits of our hospitals. As of September 30, 2009, we have $2.0 million of cumulative disproportionate losses allocated to us. We could also be required to recognize disproportionate losses at our other hospitals not currently in a disproportionate allocation position depending on their results of operations in future periods.

Income Taxes. Income taxes are computed on the pretax income based on current tax law. Deferred income taxes are recognized for the expected future tax consequences or benefits of differences between the tax bases of assets or liabilities and their carrying amounts in the consolidated financial statements. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before we are able to realize their benefit or their future deductibility is uncertain.

Developing the provision for income taxes requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets. Our judgments and tax strategies are subject to audit by various taxing authorities. While we believe we have provided adequately for our income tax liabilities in our consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on our consolidated financial condition and results of operations.

Share-Based Compensation — Compensation expense for share-based awards made to employees and directors are recognized based on the estimated fair value of each award over the awards’ vesting period. We estimate the fair value of share-based payment awards on the date of grant using, either an option-pricing model for stock options or the closing market value of our stock for restricted stock and restricted stock units, and expense the value of the portion of the award that is ultimately expected to vest over the requisite service period in the Company’s statement of operations.

We calculated the share-based compensation expense for each stock option on the date of grant by using a Black-Scholes option pricing model. The key assumptions used in the Black-Scholes option pricing model are the expected life of the stock option, the risk free interest rate and expected volatility. The expected volatility used in the Black-Scholes option pricing model incorporates historical share-price volatility and was based on an analysis of historical prices of our stock. The expected volatility reflects the historical volatility for a duration consistent with the contractual life of the options. The expected life of the stock options granted represents the period of time that the options are expected to be outstanding. The risk-free interest rates are based on zero-coupon United States Treasury yields in effect at the date of grant consistent with the expected exercise timeframes.

Stock options awarded to employees are fully vested at the time of grant, with the condition that the optionee is prohibited from selling the share of stock acquired upon exercise of the option for a specified period of time. As a result, total share-based compensation is recorded for stock options on the option grant date.

During fiscal 2009 we granted shares of restricted stock and restricted stock units to employees and directors, respectively. Restricted stock granted to employees, excluding executives of the Company, vest in equal annual installments over a three year period. Executives of the Company (defined by us as vice president or higher) received two restricted stock grants. The first grant of restricted stock vests in equal annual installments over a three year period. The second grant of restricted stock vests over a three year period based on established performance conditions. Restricted stock units granted to directors are fully vested at the date of grant and are paid in the form of common stock upon each applicable director’s termination of service on the board.

Recent Accounting Pronouncements: See Note 2 of our consolidated financial statements included elsewhere in this report for additional disclosures.

Results of Operations

Fiscal Year 2009 Compared to Fiscal Year 2008

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


	Year Ended September 30,
													% of Net
							Increase/Decrease						Revenue
	2009			2008			$			%			2009			2008
	(In thousands except percentages)

Net revenue	$	602,042		$	591,611		$	10,431			1.8	%		100.0	%		100.0	%
Operating expenses:
Personnel expense		200,927			197,850			3,077			1.6	%		33.4	%		33.4	%
Medical supplies expense		171,451			161,880			9,571			5.9	%		28.5	%		27.4	%
Bad debt expense		49,421			43,671			5,750			13.2	%		8.2	%		7.4	%
Other operating expenses		127,043			118,378			8,665			7.3	%		21.1	%		20.1	%
Pre-opening expenses		3,563			786			2,777			353.3	%		0.6	%		0.1	%
Depreciation		31,755			30,041			1,714			5.7	%		5.3	%		5.1	%
Amortization		1,121			84			1,037			1234.5	%		0.2	%		0.0	%
Loss on disposal of property, equipment and other assets		271			248			23			9.3	%		0.0	%		0.0	%
Impairment of goodwill		60,174			—			60,174			100.0	%		10.0	%		—

Income from operations		(43,684	)		38,673			(82,357	)		(213.0	)%		(7.3	)%		6.5	%
Other income (expenses):
Interest expense		(6,798	)		(14,300	)		7,502			52.5	%		(1.1	)%		(2.4	)%
Loss on early extinguishment of debt		(6,702	)		—			(6,702	)		(100.0	)%		(1.1	)%		—
Interest and other income, net		237			2,029			(1,792	)		(88.3	)%		0.0	%		0.4	%
Equity in net earnings of unconsolidated affiliates		9,057			7,891			1,166			14.8	%		1.5	%		1.3	%

(Loss) income from continuing operations before minority interest, income taxes and discontinued operations		(47,890	)		34,293			(82,183	)		(239.6	)%		(8.0	)%		5.8	%
Minority interest share of earnings of consolidated subsidiaries		(9,328	)		(12,546	)		3,218			25.6	%		(1.5	)%		(2.1	)%

(Loss) income from continuing operations before income taxes and discontinued operations		(57,218	)		21,747			(78,965	)		(363.1	)%		(9.5	)%		3.7	%
Income tax expense		1,200			9,374			(8,174	)		(87.2	)%		0.2	%		1.6	%

(Loss) income from continuing operations		(58,418	)		12,373			(70,791	)		(572.1	)%		(9.7	)%		2.1	%
Income from discontinued operations, net of taxes		8,136			8,617			(481	)		(5.6	)%		1.3	%		1.4	%

Net (loss) income	$	(50,282	)	$	20,990		$	(71,272	)		(339.6	)%		(8.4	)%		3.5	%

Net revenue. Below is selected procedural and net revenue data for the fiscal years ended September 30, 2009 and 2008.


	Hospital Division Continuing Operations
	Year Ended September 30,
													Increase
	2009			%			2008			%			(Decrease)

Admissions and Principal Procedures(1):
Inpatient admissions		26,812			28	%		29,243			32	%		(8.3	)%
Outpatient procedures(2)		32,664			34	%		29,240			32	%		11.7	%
Emergency department and heart saver program		37,041			38	%		33,633			36	%		10.1	%

Total procedures		96,517			100	%		92,116			100	%		4.8	%

MDC 5 procedures(3)		19,860						22,544						(11.9	)%
Inpatient Drug Eluting Stents		2,733						2,758						(0.9	)%
Inpatient Bare Metal Stents		1,781						3,112						(42.8	)%
Outpatient Drug Eluting Stents		1,935						1,036						86.8	%
Outpatient Bare Metal Stents		1,432						901						58.9	%
Non MDC 5 procedures		76,657						69,572						10.2	%
Emergency department visits		28,719						25,828						11.2	%
Net Revenue:
Inpatient net revenue		69.3	%					75.0	%					(7.6	)%
Outpatient net revenue(1)		24.4	%					19.1	%					27.7	%
Emergency department and HeartSaver CT program		6.3	%					5.9	%					6.8	%

Total net revenue		100.0	%					100.0	%

Total charity care	$	6,132					$	14,475						(57.6	)%


(1)		Procedures refer to the total cases billed and revenues recognized.


(2)		Excludes emergency department and our HeartSaver CT program.


(3)		Major Diagnostic Category (“MDC”) 5 corresponds to a circulatory system principal diagnosis. We have historically referred to MDC 5 procedures as our “core procedures.”

Net revenue increased 1.8% to $602.0 million for our fiscal year ended September 30, 2009 from $591.6 million for our fiscal year ended September 30, 2008. Of this $10.4 million increase in net revenue, our Hospital Division generated a $12.1 million increase, our MedCath Partners Division generated a $1.6 million decrease and our Corporate and other Division generated a $0.1 million decrease. The Hospital Division increase was comprised of an $11.0 million increase in net patient revenue and a $1.1 million increase in other operating revenue.

We continued to experience a shift in inpatient to outpatient procedures in our Hospital Division during fiscal 2009. Our inpatient admissions were down 8.3% for the 2009 fiscal year compared to the 2008 fiscal year; however our outpatient procedures, taking into consideration outpatient visits excluding emergency department visits, increased 11.7% as a result of the shift from inpatient to outpatient procedures. Our emergency department visits increased 11.2% during fiscal 2009 compared to fiscal 2008, driven primarily by our expansion and marketing efforts. Total outpatient net patient revenue excluding emergency department and our Heart Saver program net revenue increased from 19.1% of total hospital net revenue for fiscal 2008 to 24.4% for fiscal 2009.

During 2009 we established a consolidated primary care physician group at one of our hospitals. Net revenue for fiscal 2009 includes $1.0 million related to this new group. The related expenses are also reported as a component of income from operations.

Our net revenue was positively impacted by an overall decrease in deductions for uncompensated care of 57.6% or $8.4 million. We commonly refer to these deductions as charity care. Charity care was $6.1 million for

fiscal 2009 compared to $14.4 million for fiscal 2008. Charity care is recorded for patients that meet certain federal poverty guidelines and request charity consideration in line with our policy. The number of patients that qualified for charity care decreased during fiscal 2009 compared to fiscal 2008.

During fiscal 2009 and 2008, we recognized net negative contractual adjustments to our net revenue of $4.5 million and $1.4 million, respectively, related to the filing of prior years Medicare cost reports as well as other Medicare and Medicaid settlement adjustments. Therefore, these adjustments had a year over year negative impact of $3.1 million to net revenue.

Personnel expense. Personnel expense increased 1.6% to $200.9 million for fiscal 2009 from $197.9 million for fiscal 2008. As a percentage of net revenue, personnel expense remained flat at 33.4% for the comparable periods.

We recognized share-based compensation expense of $2.4 million and $5.0 million for the fiscal years ended September 2009 and 2008, respectively. The $2.6 million decrease in share-based compensation expense was offset by an increase in personnel expense related to cost of living wage adjustments made during the first quarter of fiscal 2009 and an increase in our Hospital Division benefit costs related to our self-insured medical plan due to an increase in employee related medical claims during fiscal 2009.

Medical supplies expense. Medical supplies expense increased 5.9% to $171.5 million, or 28.5% of net revenue, for fiscal 2009 from $161.9 million, or 27.4% of net revenue, for fiscal 2008. We experienced an increase in expense related to AICD’s, heart valves, drug-eluting stents and vascular graft supplies during fiscal 2009 offset by a reduction in expense for bare metal stents, orthopedic and chargeable medical supplies. The increase in AICD’s, heart valves, drug-eluting stents and vascular graft supplies was directly related to a combination of a higher utilization of supplies per procedure, an increase in the number of procedures performed or the use of higher cost supplies for these procedures. Conversely, the reduction in bare metal stents and orthopedic supplies is the direct result of lower utilization of supplies per procedure and lower cost for the units used per procedure.

Bad debt expense. Bad debt expense increased 13.2% to $49.4 million for fiscal 2009 from $43.7 million for fiscal 2008. Total uncompensated care, which includes charity care deductions recorded as a reduction to patient revenue and bad debt expense, was $55.4 million for fiscal 2009, or 9.6% of Hospital Division net patient revenue, compared to $58.0 million, or 10.1% of Hospital Division net patient revenue for fiscal 2008. We have experienced an increase in bad debt expense primarily related to an increase in the uncollectibility of the self-pay balance after insurance and a reduction in patients that qualify for charity careand/or government assistance. The reduction in total uncompensated care to net revenue is due to improved collections during fiscal 2009. Our days sales outstanding were 43 for fiscal 2009 compared to 46 for fiscal 2008 (same facility basis).

Other operating expenses. Other operating expenses increased 7.3% to $127.0 million for fiscal 2009 from $118.4 million for fiscal 2008. This increase is mainly driven by clinical and non-clinical contract services due to the growth in volume at several of our facilities, particularly emergency department visits, as well as increased maintenance costs at our hospitals as machinery warranties have expired at several of our facilities. These increases have been offset by a decline in administrative contract services and collection agency fees as these services are brought in-house to control costs and gain efficiencies. In addition, we incurred a $1.3 million increase in costs related to a new primary care physician group at one of our hospitals.

We also incurred $0.8 million in penalty expense for the anticipated settlement of regulatory claims at two of our hospitals related to the identification, return and self-reporting of $0.7 million in reimbursement for certain procedures performed at those hospitals in prior fiscal years, $1.1 million in professional fees associated with an internal assessment of certain controls and procedures completed during the quarter and $0.4 million in severance fees for fiscal 2009. However, these expenses were offset by lower Corporate and other and Partner Division costs for medical claims and decreased salaries and wages related to a reduction of employees in the Partners Division.

Pre-opening expenses. We incurred approximately $3.6 million and $0.8 million in pre-opening expenses during fiscal 2009 and 2008. Pre-opening expenses represent costs specifically related to projects under development. As of September 30, 2009 and 2008, we had one hospital under development, Hualapai Medical Center in Kingman, Arizona, which opened on October 15, 2009. 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 increased 5.7% to $31.8 million for the fiscal year ended September 30, 2009 as compared to $30.0 million for the fiscal year ended September 30, 2008. The increase in depreciation is the direct result of expansion at several of our facilities as well as the purchase of newer computer equipment to replace outdated hardware.

Interest expense. Interest expense decreased 52.5% to $6.8 million for fiscal 2009 compared to $14.3 million for fiscal 2008. This $7.5 million decrease in interest expense is primarily attributable to the overall reduction in our outstanding debt, a decrease in the interest rate on our outstanding debt, and the capitalization of interest on our capital expansion projects. Capitalized interest was $2.7 million for fiscal 2009 compared to $1.3 million for fiscal 2008.

Loss on early extinguishment of debt. During December 2008, we redeemed all of our outstanding 97/8% Senior Notes for $111.2 million, which included the payment of a repurchase premium of $5.0 million and accrued interest of $4.2 million. The Senior Notes were redeemed through borrowings under the Senior Secured Credit Facility and available cash on hand. In addition, we incurred $2.0 million in expenses related to the write-off of previously incurred financing costs associated with the Senior Notes. There was no loss on early extinguishment of debt for fiscal 2008.

Interest and other income, net. Interest and other income, net decreased 88.3% to $0.2 million for fiscal 2009 compared to $2.0 million for fiscal 2008. The decrease is a result of the decrease in cash balances and the decrease in interest earned on cash balances during fiscal 2009.

Equity in net earnings of unconsolidated affiliates. Equity in net earnings of unconsolidated affiliates increased $1.2 million to $9.1 million in fiscal 2009 from $7.9 million in fiscal 2008. The increase is attributable to a $1.6 million growth in earnings for our unconsolidated affiliates related to our Partners Division offset by a reduction of $0.4 million related to the Hospital Division. The increase for our Partners Division is the result of a new minority owned venture that had a full year of operations in fiscal 2009. The decline for our Hospital Division is the result of an overall net decrease in income from our two minority owned hospitals.

Minority interest share of earnings of consolidated subsidiaries. Minority interest share of earnings of consolidated subsidiaries decreased $3.2 million in fiscal 2009 compared to fiscal 2008. The decline is the result of an overall net decrease in income before minority interest of certain of our established hospitals. We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate lossesand/or recoveries thereof through disproportionate profit recognition.

Income tax expense. Income tax expense was $1.2 million for fiscal 2009 compared to $9.4 million for fiscal 2008, which represented an effective tax rate of 2.1% and 43.1%, respectively. The fiscal 2009 effective rate is below our federal statutory rate of 35% primarily due to the non-deductibility for income tax purposes of a majority of the $60.2 million impairment expense related to goodwill.

Income (loss) from discontinued operations, net of taxes. Income from discontinued operations, net of taxes, reflects the results of Dayton Heart Hospital, Cape Cod Cardiology Services LLC, Sun City Cardiac Center Associates and the Heart Hospital of Lafayette for fiscal 2008 and fiscal 2009. Net income from discontinued operations was $8.1 million for fiscal 2009 compared to $8.6 million for fiscal 2008. Income from discontinued operations, net of taxes, includes the gains on the sale of Cape Cod Cardiology Services LLC and Sun City Cardiac Center Associates for fiscal 2009 offset by operating losses of other discontinued entities. Income from discontinued operations, net of taxes, for fiscal 2008 includes the gain recorded as a result of the sale of certain assets of Dayton Heart Hospital offset by operating losses of Dayton Heart Hospital prior to the sale.

Fiscal Year 2008 Compared to Fiscal Year 2007

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


	Year Ended September 30,
							Increase/Decrease						% of Net Revenue
	2008			2007			$			%			2008			2007
	(In thousands except percentages)

Net revenue	$	591,611		$	636,526		$	(44,915	)		(7.1	)%		100.0	%		100.0	%
Operating expenses:
Personnel expense		197,850			205,567			(7,717	)		(3.8	)%		33.4	%		32.3	%
Medical supplies expense		161,880			166,641			(4,761	)		(2.9	)%		27.4	%		26.2	%
Bad debt expense		43,671			51,318			(7,647	)		(14.9	)%		7.4	%		8.0	%
Other operating expenses		118,378			127,915			(9,537	)		(7.5	)%		20.1	%		20.1	%
Pre-opening expenses		786			555			231			41.6	%		0.1	%		0.1	%
Depreciation		30,041			30,950			(909	)		(2.9	)%		5.1	%		4.9	%
Amortization		84			154			(70	)		(45.5	)%		0.0	%		0.0	%
Loss on disposal of property, equipment and other assets		248			1,447			(1,199	)		82.9	%		0.0	%		0.2	%

Income from operations		38,673			51,979			(13,306	)		(25.6	)%		6.5	%		8.2	%
Other income (expenses):
Interest expense		(14,300	)		(22,055	)		7,755			35.2	%		(2.4	)%		(3.5	)%
Loss on early extinguishment of debt		—			(9,931	)		9,931			100.0	%		—			(1.5	)%
Interest and other income, net		2,029			7,792			(5,763	)		(74.0	)%		0.4	%		1.2	%
Equity in net earnings of unconsolidated affiliates		7,891			5,739			2,152			37.5	%		1.3	%		0.9	%

Income from continuing operations before minority interest, income taxes and discontinued operations		34,293			33,524			769			2.3	%		5.8	%		5.3	%
Minority interest share of earnings of consolidated subsidiaries		(12,546	)		(10,462	)		(2,084	)		(19.9	)%		(2.1	)%		(1.7	)%

Income from continuing operations before income taxes and discontinued operations		21,747			23,062			(1,315	)		(5.7	)%		3.7	%		3.6	%
Income tax expense		9,374			10,331			(957	)		(9.3	)%		1.6	%		1.6	%

Income from continuing operations		12,373			12,731			(358	)		(2.8	)%		2.1	%		2.0	%
Income (loss) from discontinued operations, net of taxes		8,617			(1,204	)		9,821			815.7	%		1.4	%		(0.2	)%

Net income	$	20,990		$	11,527			9,463			82.1	%		3.5	%		1.8	%

During the fourth quarter of fiscal 2007, we completed a recapitalization of Harlingen Medical Center. As part of the recapitalization, our ownership in Harlingen Medical Center was reduced from a majority ownership of 51.0% to a minority ownership of 35.6%. Due to this change in ownership, we began accounting for Harlingen Medical Center as an equity investment at the beginning of the fiscal quarter ended September 30, 2007 as opposed to including Harlingen Medical Center in our consolidated results of operations. As such, our fiscal year 2008 and our fourth quarter of fiscal 2007 consolidated results exclude the financials results of Harlingen Medical Center. The following management discussion and analysis focuses on same facility results of operations and, therefore, excludes Harlingen Medical Center from the results of both fiscal 2008 and fiscal 2007 when appropriate.

Net revenue. Net revenue decreased 7.1% to $591.6 million for our fiscal year ended September 30, 2008 from $636.5 million for our fiscal year ended September 30, 2007. Of this $44.9 million decrease in net revenue, our hospitals generated a $41.4 million decrease, our MedCath Partners division generated a $3.7 million decrease, our cardiology consulting and management operations generated a $0.3 million increase, and our corporate and other division generated a $0.1 million decrease.

On a same facility basis our net revenue increased $16.1 million, or 2.8% from the prior fiscal year.

We experienced a shift in inpatient to outpatient procedures during fiscal 2008. On a same facility basis our admissions were down 1.8% for the 2008 fiscal year compared to the 2007 fiscal year, however our adjusted admissions, which take into consideration outpatient visits, increased 3.8% as a result of the shift from inpatient to outpatient procedures. During fiscal 2008 we experienced an increase in net revenues of 66% and 67% from outpatient drug-eluting stents and bare metal stents, respectively, when compared to fiscal 2007. Net revenue from inpatient drug-eluting stents and bare metal stents were down 4.8% and 6.9%, respectively, on a same facility basis in fiscal 2008 compared to fiscal 2007.

Our net revenue has been negatively impacted by an overall increase in deductions for uncompensated care. We commonly refer to these deductions as charity care. Charity care was $14.5 million for fiscal 2008 compared to $4.9 million for fiscal 2007. Charity care is recorded for patients that meet certain federal poverty guidelines. The number of patients that qualified for charity care increased during fiscal 2008 compared to fiscal 2007.

During fiscal 2007, we recognized net negative contractual adjustments to our net revenue of $0.7 million related to the filing of our 2006 Medicare cost reports as well as other Medicare and Medicaid settlement adjustments. Further, the fiscal year ended September 30, 2007 was negatively impacted as a result of recording a $5.8 million reduction in net revenue for a portion of certain federal healthcare billings reimbursed in prior years. See Note 12 —Contingencies and Commitmentsof our consolidated financial statements. In contrast, we recognized negative contractual adjustments to our net revenue of $2.0 million during fiscal 2008 related to our Medicare cost reports and other Medicare and Medicaid settlement adjustments for prior fiscal periods.

Personnel expense. Personnel expense decreased 3.8% to $197.9 million for fiscal 2008 from $205.6 million for fiscal 2007. As a percentage of net revenue, personnel expense increased to 33.4% from 32.3% for the comparable periods.

On a same facility basis, personnel expense increased to 33.4% of net revenue for the fiscal year ended September 30, 2008 from 32.3% for the fiscal year ended September 30, 2007. This increase is mainly due to cost of living wage adjustments made during the first quarter of fiscal 2008 and an increase in labor costs due to the continued demand for nurses and other technicians in several of our markets.

We recognized share-based compensation of $5.0 million and $4.3 million for the fiscal year ended September 2008 and 2007, respectively.

Medical supplies expense. Medical supplies expense decreased 2.9% to $161.9 million for fiscal 2008 from $166.6 million for fiscal 2007.

Medical supplies expense on a same facility basis increased slightly to 27.4% from 27.3% as a percentage of net revenue for the fiscal year ending September 30, 2008 compared to the fiscal year ending September 30, 2007. Medical supplies expense as a percentage of adjusted admission has remained flat on a same facility basis year over year.

Bad debt expense. Bad debt expense decreased 14.9% to $43.7 million for fiscal 2008 from $51.3 million for fiscal 2007. Same facility bad debt expense increased 12.9% to $43.7 million for fiscal 2008 compared to $38.7 million for fiscal 2007. Same facility bad debt expense also increased to 7.4% of net revenue for the fiscal year ending September 30, 2008 compared to 6.7% for the fiscal year ended September 30, 2007 due to a decrease in payments and write-offs as a percentage of patient billings. We have experienced an unfavorable trend regarding the collection of the portion of the amount due from patients after insurance and a decrease in the number of patients that qualify for Medicaid.

Other operating expenses. Other operating expenses decreased 7.5% to $118.4 million for fiscal 2008 from $127.9 million for fiscal 2007. Same facility other operating expenses increased 3.2% to $118.4 million for fiscal 2008 compared to $115.0 million for fiscal 2007. We continue to see an increase in contract services due to the growth in volume at several of our facilities as well as increased maintenance costs at our hospitals as machinery warranties have expired at several of our facilities.

Pre-opening expenses. We incurred approximately $0.8 million and $0.6 million in pre-opening expenses during fiscal 2008 and 2007. Pre-opening expenses represent costs specifically related to projects under development, primarily new hospitals. As of September 30, 2008 and 2007, we have one hospital under development, Hualapai Medical Center in Kingman, Arizona. 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 2.9% to $30.0 million for the fiscal year ended September 30, 2008 as compared to $31.0 million for the fiscal year ended September 30, 2007.

On a same facility basis, depreciation increased 10.9% to $30.0 million for fiscal 2008 compared to $27.1 million for fiscal 2007. The depreciation increase is a result of the expansion and the investment in support software at several of our facilities.

Loss (gain) on disposal of property, equipment and other assets. We incurred a loss on the disposal of property, equipment and other assets of $1.5 million in fiscal 2007 compared to a loss of $0.2 million in fiscal 2008. The 2007 loss was higher as a result of assets that were disposed and replaced with improved technology to ensure the highest state of the art care for our patients. The loss for fiscal 2008 is also due to the replacement of aged assets offset by a $0.2 gain on the sale of equipment by one of our managed ventures.

Interest expense. Interest expense decreased 35.2% to $14.3 million for fiscal 2008 compared to $22.1 million for fiscal 2007. This $7.8 million decrease in interest expense is primarily attributable to the overall reduction in our outstanding debt as we repurchased approximately $36.2 million of our senior notes, repaid $21.2 million of our REIT loan at one of our facilities, repaid $11.1 million of our equipment loan at another of our facilities, and repaid $39.9 million of our senior secured credit facility during the fiscal year ended September 30, 2007.

Loss on early extinguishment of debt. Loss on early extinguishment of debt for fiscal 2007 was $9.9 million for fiscal 2007. During the fiscal year ended September 30, 2007, this loss consisted of a $3.5 million repurchase premium and the write off of approximately $1.0 million of deferred loan acquisition costs related to the prepayment of a portion of our senior notes in December 2006. We also wrote off $0.5 million in deferred loan acquisition costs during fiscal 2007 related to the prepayment of $39.9 million of our senior secured credit facility. Further, upon early repayment of $11.1 million of our equipment loan at one of our facilities, we expensed approximately $0.2 million of deferred loan acquisition costs, and as part of the Harlingen Medical Center recapitalization transaction, we incurred a $3.5 million repurchase premium and expensed approximately $1.2 million of deferred loan acquisition costs. There was no loss on early extinguishment of debt for fiscal 2008.

Interest and other income, net. Interest and other income, net decreased 74.0% to $2.0 million for fiscal 2008 compared to $7.8 million for fiscal 2007. The decrease is a result of the decrease in cash and the decrease in interest earned on cash balances during fiscal 2008.

Equity in net earnings of unconsolidated affiliates. Equity in net earnings of unconsolidated affiliates increased to $7.9 million in fiscal 2008 from $5.7 million in fiscal 2007. The increase is attributable to growth in earnings for our unconsolidated affiliates related to our Hospital Division of $0.7 million and an increase in earnings for several new ventures in our MedCath Partners division. Equity in net earnings of unconsolidated affiliates related to our MedCath Partners division was $0.3 million for fiscal 2007 compared to $2.2 million for fiscal 2008.

Minority interest share of earnings of consolidated subsidiaries. Minority interest share of earnings of consolidated subsidiaries decreased $2.1 million in fiscal 2008 compared to fiscal 2007. Our minority interest share of earnings can fluctuate as a result of our disproportionate share accounting for our partnership interests. Our partnership operating agreements may call for the recognition of losses or profits at amounts that are disproportionate to our partnership interest.

Income tax expense. Income tax expense was $9.4 million for fiscal 2008 compared to $10.3 million for fiscal 2007, which represented an effective tax rate of approximately 43.1% and 44.8%, respectively. The decrease in the effective tax rate is due to the reduced impact of one-time permanent adjustments to derive taxable income.

Income (loss) from discontinued operations, net of taxes. Income from discontinued operations, net of taxes, reflects the results of Dayton Heart Hospital, Heart Hospital of Lafayette, Cape Cod Cardiology Services and Sun City Cardiac Center Associates for fiscal 2007, fiscal 2008 and fiscal 2009. Net income from discontinued operations was $8.6 million for fiscal 2008 compared to a loss of $1.2 million for fiscal 2007. The Company evaluated the carrying value of the long-lived assets related to Heart Hospital of Lafayette during fiscal 2007 and determined that the carrying value was in excess of the fair value. Accordingly, an impairment charge of $4.1 million was recorded during the first quarter of fiscal 2007. The $4.1 million impairment charge was offset by net income related to Dayton Heart Hospital for fiscal 2007. Income from discontinued operations, net of taxes, for fiscal 2008 includes the gain recorded as a result of the sale of certain assets of Dayton Heart Hospital offset by operating losses of Dayton Heart Hospital prior to the sale.

Selected Quarterly Results of Operations

The following table sets forth quarterly consolidated operating results for each of our last five quarters. We have prepared this information on a basis consistent with our audited consolidated financial statements and included all adjustments that we consider necessary for a fair presentation of the data. These quarterly results are not necessarily indicative of future results of operations. This information should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report.


	Three Months Ended
	September 30,			June 30,			March 31,			December 31,			September 30,
	2009			2009			2009			2008			2008
	(In thousands)

Statement of Operations Data:
Net revenue	$	147,966		$	148,149		$	155,682		$	150,245		$	145,511
Impairment of goodwill		60,174			—			—			—			—
(Loss) income from operations		(62,794	)		1,384			10,733			6,993			4,362
Equity in net earnings of unconsolidated affiliates		2,013			2,265			2,714			2,065			1,049
Minority interest share of earnings of consolidated subsidiaries		(872	)		(1,896	)		(4,197	)		(2,363	)		(1,181	)
(Loss) income from continuing operations		(61,900	)		306			5,090			(1,914	)		155
Income from discontinued operations		3,294			190			492			4,160			314
Net (loss) income	$	(58,606	)	$	496		$	5,582		$	2,246		$	469
Earnings (loss) per share, basic
Continuing operations	$	(3.14	)	$	0.02		$	0.26		$	(0.11	)	$	0.01
Discontinued operations		0.17			0.01			0.02			0.22			0.01

Earnings (loss) per share, basic	$	(2.97	)	$	0.03		$	0.28		$	0.11		$	0.02

Earnings (loss) per share, diluted
Continuing operations	$	(3.14	)	$	0.02		$	0.26		$	(0.11	)	$	0.01
Discontinued operations		0.17			0.01			0.02			0.22			0.01

Earnings (loss) per share, diluted	$	(2.97	)	$	0.03		$	0.28		$	0.11		$	0.02

Weighted average number of shares, basic		19,740			19,733			19,664			19,599			19,590
Dilutive effect of stock options and restricted stock		—			—			26			—			65

Weighted average number of shares, diluted		19,740			19,733			19,690			19,599			19,655

Cash Flow Data:
Net cash provided by operating activities	$	10,463		$	18,584		$	17,670		$	16,916		$	14,526
Net cash provided by provided by (used in) investing activities	$	408		$	(17,780	)	$	(23,390	)	$	(23,028	)	$	(34,729	)
Net cash used in financing activities	$	(2,080	)	$	(3,308	)	$	(8,506	)	$	(36,316	)	$	(5,494	)

Our results of operations historically have fluctuated on a quarterly basis and can be expected to continue to be subject to quarterly fluctuations. Cardiovascular procedures can often be scheduled ahead of time, permitting some

patients to choose to undergo the procedure at a time and location of their preference. Some of the types of trends that we have experienced in the past and may experience again in the future include:


	•	the markets where some of our hospitals are located are susceptible to seasonal population changes with part-time residents living in the area only during certain months of the year;

	•	patients choosing to schedule procedures around significant dates, such as holidays; and

	•	physicians in the market where a hospital is located schedule vacation from their practice during the summer months of the year, around holidays and for various professional meetings held throughout the world during the year.

To the extent these types of events occur in the future, as in the past, we expect they will affect the quarterly results of operations of our hospitals.

Liquidity and Capital Resources

Working Capital and Cash Flow Activities. Our consolidated working capital was $60.2 million at September 30, 2009 and $115.1 million at September 30, 2008. The decrease of $54.9 million in working capital primarily resulted from cash outflows for capital expenditures as a result of our hospital expansions, the repurchase of our Senior Notes, and the payment of federal and state income taxes offset by cash flows from operations.

At September 30, 2008 $3.2 million of cash was restricted and held in escrow as required by the city of Kingman, Arizona in conjunction with the Company’s development of the Hualapai Mountain Medical Center. The escrowed funds were released during the fourth quarter of fiscal 2009 upon our completion of the common infrastructure construction projects affecting the city of Kingman.

During the second quarter of fiscal 2007, we were informed by one of our Medicare fiscal intermediaries that outlier payments received prior to January 1, 2004 would not be disputed; therefore, we reversed $2.2 million that was originally recorded to account for outlier payments that had been received in 2003. At September 30, 2009 and 2008, we carried a reserve of $9.6 million and $9.1 million, respectively, for the outlier payments received in 2004.

The cash provided by operating activities from continuing operations was $64.8 million and $43.2 million for the years ending September 30, 2009 and 2008, respectively. The $21.6 million increase is primarily attributed to the decrease in federal and state income tax payments made during fiscal 2009 compared to fiscal 2008, offset by cash flows from operations.

Our investing activities from continuing operations used net cash of $89.0 million for fiscal 2009 compared to net cash used of $82.0 million for fiscal 2008. Net cash used by investing activities for fiscal 2009 and 2008 was primarily capital expenditures for the development of our hospital in Kingman, Arizona and expansion projects at two of our existing hospitals.

Our financing activities from continuing operations used net cash of $45.6 million during fiscal 2009 compared to net cash used of $60.2 million during fiscal 2008. The $14.6 decrease of net cash used for financing activities is due to the repurchase of common stock under our repurchase program during fiscal 2008 and a decrease in minority interest distributions; offset by an increase in overall long-term debt payments in fiscal 2009 related to the repurchase of our outstanding Senior Notes as further discussed in Note 9 of the consolidated financial statements included elsewhere in this report.

Capital Expenditures. Cash paid for property and equipment for fiscal years 2009 and 2008 was $94.0 million and $66.7 million, respectively, primarily related to the development of our hospital in Kingman, Arizona and the expansion projects at two of our existing hospitals, which began during the year ended September 30, 2007. All expansion projects were completed during fiscal 2009, and our hospital in Kingman, Arizona opened in October 2009.

Obligations, Commitments and Availability of Financing. As described more fully in the notes to our consolidated financial statements included elsewhere in this report, we had certain cash obligations at September 30, 2009, which are due as follows (in thousands):


	Payments Due by Fiscal Year
	2010		2011		2012		2013		2014		Thereafter		Total

Long-term debt	$	19,491	$	14,063	$	52,500	$	—	$	—	$	35,308	$	121,362
Obligations under capital leases		1,752		1,782		1,346		864		602		53		6,399

Total debt		21,243		15,845		53,846		864		602		35,361		127,761
Other long-term obligations(1)		7,618		4,942		2,716		55		—		—		15,331
Interest on indebtedness(2)		6,208		5,479		3,788		3,070		3,024		4,251		25,820
Operating leases		2,231		1,936		1,747		1,722		1,206		492		9,334

Total	$	37,300	$	28,202	$	62,097	$	5,711	$	4,832	$	40,104	$	178,246


(1)		Other long-term obligations contain revenue guarantees related to contracts for physician services or to physician recruiting arrangements. In addition the Company may have recorded off-setting assets associated with these guarantees, see Note 12.

(2)		In addition, we have $0.5 million in unrecognized tax benefits.

During November 2008, we amended and restated our Senior Secured Credit Facility (the “Amended Credit Facility”). The Amended Credit Facility provides for a three-year term loan facility in the amount of $75.0 million (the “Term Loan”) and a revolving credit facility in the amount of $85.0 million (the “Revolver”), which includes a $25.0 millionsub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 millionsub-limit for swing-line loans. At our request and approval from our lenders, the aggregate amount available under the Amended Credit Facility may be increased by an amount up to $50.0 million. Borrowings under the Amended 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 Amended Credit Facility continues to be guaranteed jointly and severally by us and certain of our existing and future, direct and indirect, wholly owned subsidiaries and continues to be secured by a first priority perfected security interest in all of the capital stock or other ownership interests owned by us and our subsidiary guarantors in each of their subsidiaries, and, subject to certain exceptions in the credit facility, all other present and future assets and properties of the MedCath and the subsidiary guarantors and all intercompany notes.

The Amended Credit Facility requires compliance with certain financial covenants including a consolidated senior secured leverage ratio test, a consolidated fixed charge coverage ratio test and a consolidated total leverage ratio test. The amended credit facility also contains customary restrictions on, among other things, our and our subsidiaries’ ability to incur liens; engage in mergers, consolidations and sales of assets; incur debt; declare dividends; redeem stock and repurchase, redeemand/or repay other debt; make loans, advances and investments and acquisitions; and entering into transactions with affiliates.

The Amended Credit Facility contains events of default, including cross-defaults to certain indebtedness, change of control events, and events of default customary for syndicated commercial credit facilities. Upon the occurrence of an event of default, we could be required to immediately repay all outstanding amounts under the Amended Credit Facility.

We are required to make mandatory prepayments of principal in specified amounts upon the occurrence of certain events identified in the Amended Credit Facility and are permitted to make voluntary prepayments of principal under the Amended Credit Facility. The Term Loan is subject to amortization of principal in quarterly installments commencing on March 31, 2010. The maturity date of both the Term Loan and Revolver is November 10, 2011.

During December 2008 we redeemed our outstanding 97/8% senior notes (the “Senior Notes”) issued by MedCath Holdings Corp., a wholly owned subsidiary of us, for $111.2 million, which included the payment of a repurchase premium of $5.0 million and accrued interest of $4.2 million. The Senior Notes were redeemed through borrowings under the Amended Credit Facility and available cash on hand. In addition to the aforementioned repurchase premium we incurred $2.0 million in expense related to the write-off of previously incurred financing costs associated with the Senior Notes. The repurchase premium and write off of previously incurred financing costs have been included in the consolidated statement of income as loss on early extinguishment of debt.

At September 30, 2009, we had $127.8 million of outstanding debt, $21.2 million of which was classified as current. Of the outstanding debt, $80.0 million was outstanding under our Amended Credit Facility, $47.7 million was outstanding to various lenders to our hospitals, and the remaining $0.1 million of debt was outstanding to lenders for MedCath Partners’ diagnostic services under capital leases. Of the $80.0 million outstanding under our Amended Credit Facility, $5.0 million was outstanding under the Revolver. The maximum availability under the Revolver is $85.0 million which is reduced by the aforementioned outstanding borrowings under the Revolver and outstanding letters of credit totaling $3.5 million.

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 September 30, 2009, TexSAn Heart Hospital was in violation of financial covenants which govern its equipment loans outstanding. Accordingly, the total outstanding balance of $6.1 million for these loans has been included in the current portion of long-term debt and obligations under capital leases in our consolidated balance sheet for fiscal 2009. The covenant violations did not result in any other non-compliance related to the covenants governing our other outstanding debt arrangements.

At September 30, 2009, 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.

See Note 9 to the consolidated financial statements included elsewhere in this report for additional discussion of the terms, covenants and repayment schedule surrounding our debt.

We believe that internally generated cash flows and available borrowings under our Amended Credit Facility will be sufficient to finance our business plan, capital expenditures and our working capital requirements for the next 12 to 18 months.

Intercompany Financing Arrangements. We provide secured real estate, equipment and working capital financings to our majority-owned hospitals. The aggregate amount of the intercompany real estate, equipment and working capital and other loans outstanding as of September 30, 2009 and 2008 were $305.6 million and $253.6 million, respectively.

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 typically matures in 2 to 10 years and accrues interest at variable rates based on LIBOR plus an applicable margin or a fixed rate similar to terms commercially available.

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 5 to 7 years. The intercompany equipment loans accrue interest at rates ranging from 3.50% to 8.58%. The weighted average interest rate for the intercompany equipment loans at September 30, 2009 was 6.61%.

We typically receive a fee from the minority partners in the subsidiary hospitals as consideration for providing these intercompany real estate and equipment loans.

We also use intercompany financing arrangements to provide cash support to individual hospitals for their working capital and other corporate needs. 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 subordinate to each hospital’s

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 certain of the borrowing hospital’s assets. 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 September 30, 2009 and 2008, we held $25.7 million and $19.8 million, respectively, of intercompany working capital and other notes and related accrued interest, net of advances from our hospitals.

Because these intercompany notes receivable and related interest income are eliminated with the corresponding notes payable and interest expense at our consolidating hospitals in the process of preparing our consolidated financial statements the amounts outstanding under these notes do not appear in our consolidated financial statements or accompanying notes. Information about the aggregate amount of these notes outstanding from time to time may be helpful, however, in understanding the amount of our total investment in our hospitals. In addition, we believe investors and others will benefit from a greater understanding of the significance of the priority rights we have under these intercompany notes receivable to distributions of cash by our hospitals as funds are generated from future operations, a potential sale of a hospital, or other sources. Because these notes receivable are senior to the equity interests of MedCath and our partners in each hospital, in the event of a sale of a hospital, the hospital would be required first to pay to us any balance outstanding under its intercompany notes prior to distributing any of the net proceeds of the sale to any of the hospital’s equity investors as a return on their investment based on their pro-rata ownership interests. Also, appropriate payments to us to amortize principal balances outstanding and to pay interest due under these notes are generally made to us from a hospital’s available cash flows prior to any pro-rata distributions of a hospital’s earnings to the equity investors in the hospitals.

Off-Balance Sheet Arrangements. The Company’s off-balance sheet arrangements consist of guarantees of consolidated and unconsolidated subsidiary equipment loans and operating leases that are reflected in the table above and as discussed in Notes 9 and 12, respectively, in the consolidated financial statements.

Reimbursement, Legislative and Regulatory Changes

Legislative and regulatory action has resulted in continuing changes in reimbursement under the Medicare and Medicaid programs that will continue to limit payments we receive under these programs. Within the statutory framework of the Medicare and Medicaid programs, there are substantial areas subject to legislative and regulatory changes, administrative rulings, interpretations, and discretion which may further affect payments made under those programs, and the federal and state governments may, in the future, reduce the funds available under those programs or require more stringent utilization and quality reviews of our hospitals or require other changes in our operations. Additionally, there may be a continued rise in managed care programs and future restructuring of the financing and delivery of healthcare in the United States. These events could have an adverse effect on our future financial results. SeeItem 1A: Risk Factors — Reductions or changes in reimbursement from government or third-party payors could adversely impact our operating results.

Inflation

The healthcare industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages, such as the growing nationwide shortage of qualified nurses, occur in the marketplace. In addition, suppliers pass along rising costs to us in the form of higher prices. We have implemented cost control measures, including our case and resource management program, to curb increases in operating costs and expenses. We have, to date, offset increases in operating costs by increasing reimbursement for services and expanding services. However, we cannot predict our ability to cover, or offset, future cost increases.


Item 7A.	*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 (freestanding derivatives), or contracts or instruments containing features or terms that behave in a manner similar to derivative instruments (embedded derivatives) 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. Currently one of our hospitals in which we have a minority interest and account for under the equity method entered into an interest rate swap during fiscal 2006 for purposes of hedging variable interest payments on long term debt outstanding for that hospital. The interest rate swap is accounted for as a cash flow hedge by the hospital whereby changes in the fair value of the interest rate swap flow through comprehensive income of the hospital. Potential losses of earnings and cash flows due to the market risk of the aforementioned interest rate swap are immaterial.

Interest Rate Risk

Our Amended Credit Facility borrowings expose us to risks caused by fluctuations in the underlying interest rates. The total outstanding balance of our Amended Credit Facility was $80.0 million at September 30, 2009. A change of 100 basis points in the underlying interest rate would have caused a change in interest expense of approximately $0.7 million during the fiscal year ended September 30, 2009.


Item 8.	*Financial Statements and Supplementary Data*

INDEX TO FINANCIAL STATEMENTS

MEDCATH CORPORATION AND SUBSIDIARIES


	Page

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		54
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of September 30, 2009 and 2008		55
Consolidated Statements of Operations for the Years Ended September 30, 2009, 2008 and 2007		56
Consolidated Statements of Stockholders’ Equity for the Years Ended September 30, 2009, 2008 and 2007		57
Consolidated Statements of Cash Flows for the Years Ended September 30, 2009, 2008 and 2007		58
Notes to Consolidated Financial Statements		59

HEART HOSPITAL OF SOUTH DAKOTA, LLC


	Page

INDEPENDENT AUDITORS’ REPORT		90
FINANCIAL STATEMENTS:
Balance Sheets as of September 30, 2009 and 2008		91
Statements of Income for the Years Ended September 30, 2009, 2008 and 2007		92
Statements of Members’ Capital for the Years Ended September 30, 2009, 2008 and 2007		93
Statements of Cash Flows for the Years Ended September 30, 2009, 2008 and 2007		94
Notes to Financial Statements		95

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

MedCath Corporation

Charlotte, North Carolina

We have audited the accompanying consolidated balance sheets of MedCath Corporation and subsidiaries (the “Company”) as of September 30, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2009, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2009, based on the criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 14, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

Charlotte, North Carolina

December 14, 2009

MEDCATH CORPORATION

CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)


	September 30,
	2009			2008

Current assets:
Cash and cash equivalents	$	32,014		$	93,836
Restricted cash		—			3,154
Accounts receivable, net		70,410			82,324
Income tax receivable		—			3,091
Medical supplies		18,261			15,340
Deferred income tax assets		12,201			9,769
Prepaid expenses and other current assets		13,969			9,756
Current assets of discontinued operations		30,011			22,506

Total current assets		176,866			239,776
Property and equipment, net		385,926			323,094
Investments in affiliates		14,055			15,285
Goodwill		—			60,174
Other intangible assets, net		378			1,133
Other assets		13,223			8,378
Long-term assets of discontinued operations		—			5,616

Total assets	$	590,448		$	653,456


Current liabilities:
Accounts payable	$	40,979		$	41,404
Income tax payable		642			—
Accrued compensation and benefits		18,744			16,744
Other accrued liabilities		24,860			23,322
Current portion of long-term debt and obligations under capital leases		21,243			31,920
Current liabilities of discontinued operations		10,165			11,282

Total current liabilities		116,633			124,672
Long-term debt		101,871			115,628
Obligations under capital leases		4,647			2,087
Deferred income tax liabilities		13,874			12,352
Other long-term obligations		8,893			4,454

Total liabilities		245,918			259,193

Commitments and contingencies (See Note 12)

Minority interest in equity of consolidated subsidiaries		25,632			24,667

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; 21,595,880 issued and 20,150,556 outstanding at September 30, 2009 21,553,054 issued and 19,598,693 outstanding at September 30, 2008		216			216
Paid-in capital		455,259			455,494
Accumulated deficit		(91,420	)		(41,138	)
Accumulated other comprehensive loss		(360	)		(179	)
Treasury stock, at cost; 1,445,324 shares at September 30, 2009 1,954,361 shares at September 30, 2008		(44,797	)		(44,797	)

Total stockholders’ equity		318,898			369,596

Total liabilities and stockholders’ equity	$	590,448		$	653,456

See notes to consolidated financial statements.

MEDCATH CORPORATION

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


	Year Ended September 30,
	2009			2008			2007

Net revenue	$	602,042		$	591,611		$	636,526
Operating expenses:
Personnel expense		200,927			197,850			205,567
Medical supplies expense		171,451			161,880			166,641
Bad debt expense		49,421			43,671			51,318
Other operating expenses		127,043			118,378			127,915
Pre-opening expenses		3,563			786			555
Depreciation		31,755			30,041			30,950
Amortization		1,121			84			154
Loss on disposal of property, equipment and other assets		271			248			1,447
Impairment of goodwill		60,174			—			—

Total operating expenses		645,726			552,938			584,547

(Loss) Income from operations		(43,684	)		38,673			51,979
Other income (expenses):
Interest expense		(6,798	)		(14,300	)		(22,055	)
Loss on early extinguishment of debt		(6,702	)		—			(9,931	)
Interest and other income		237			2,029			7,792
Equity in net earnings of unconsolidated affiliates		9,057			7,891			5,739

Total other expense, net		(4,206	)		(4,380	)		(18,455	)

(Loss) income from continuing operations before minority interest and incomes taxes		(47,890	)		34,293			33,524
Minority interest share of earnings of consolidated subsidiaries		(9,328	)		(12,546	)		(10,462	)

(Loss) income from continuing operations before income taxes		(57,218	)		21,747			23,062
Income tax expense		1,200			9,374			10,331

(Loss) income from continuing operations		(58,418	)		12,373			12,731
Income (loss) from discontinued operations, net of taxes		8,136			8,617			(1,204	)

Net (loss) income	$	(50,282	)	$	20,990		$	11,527

Earnings (loss) per share, basic
Continuing operations	$	(2.97	)	$	0.62		$	0.61
Discontinued operations		0.42			0.43			(0.05	)

Earnings (loss) per share, basic	$	(2.55	)	$	1.05		$	0.56

Earnings (loss) per share, diluted
Continuing operations	$	(2.97	)	$	0.61		$	0.59
Discontinued operations		0.42			0.43			(0.05	)

Earnings (loss) per share, diluted	$	(2.55	)	$	1.04		$	0.54

Weighted average number of shares, basic		19,684			19,996			20,872
Dilutive effect of stock options and restricted stock		—			73			639

Weighted average number of shares, diluted		19,684			20,069			21,511

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)


											Accumulated
											Other
	Common Stock				Paid-in			Accumulated			Comprehensive			Treasury Stock
	Shares		Par Value		Capital			Deficit			Loss			Shares			Amount			Total

Balance, September 30, 2006		19,160	$	192	$	391,261		$	(73,348	)	$	(51	)		69		$	(394	)	$	317,660
Exercise of stock options, including income tax benefit		411		4		7,879			—			—			—			—			7,883
Secondary public offerring		1,700		17		39,641			—			—			—			—			39,658
Share-based compensation expense		—		—		4,338			—			—			—			—			4,338
Gain on capital transaction of subsidiary, net of tax		—		—		4,569			—			—			—			—			4,569
Comprehensive income:																					—
Net income		—		—		—			11,527			—			—			—			11,527
Change in fair value of interest rate swaps, net of income tax benefit(*)		—		—		—			—			(11	)		—			—			(11	)

Total comprehensive income																					11,516

Balance, September 30, 2007		21,271		213		447,688			(61,821	)		(62	)		69			(394	)		385,624
Cumulative impact of change in accounting principle		—		—		—			(307	)		—			—			—			(307	)
Exercise of stock options, including income tax benefit		282		3		4,741			—			—			—			—			4,744
Share buy back		—		—		—			—			—			1,885			(44,403	)		(44,403	)
Share-based compensation expense		—		—		4,978			—			—			—			—			4,978
Tax imp act of cancellation of stock options		—		—		(1,913	)		—			—			—			—			(1,913	)
Comprehensive income:
Net income		—		—		—			20,990			—			—			—			20,990
Change in fair value of interest rate swaps, net of income tax benefit(*)		—		—		—			—			(117	)		—			—			(117	)

Total comprehensive income																					20,873

Balance, September 30, 2008		21,553		216		455,494			(41,138	)		(179	)		1,954			(44,797	)		369,596
Stock awards, including cancelations and income tax effects		43		—		(1,826	)		—			—			—			—			(1,826	)
Restricted stock awards, including cancelations		—		—		1,591			—			—			(509	)		—			1,591
Comprehensive loss:
Net loss		—		—		—			(50,282	)		—			—			—			(50,282	)
Change in fair value of interest rate swap, net of income tax benefit(*)		—		—		—			—			(181	)		—			—			(181	)

Total comprehensive loss																					(50,463	)

		21,596	$	216	$	455,259		$	(91,420	)	$	(360	)		1,445		$	(44,797	)	$	318,898


(*)		Tax benefits were $121, $77, and $7 for the years ended September 30, 2009, 2008 and 2007, respectively.

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


	Year Ended September 30,
	2009			2008			2007

Net (loss) income	$	(50,282	)	$	20,990		$	11,527
Adjustments to reconcile net income to net cash provided by operating activities:
(Income) loss from discontinued operations, net of taxes		(8,136	)		(8,617	)		1,204
Bad debt expense		49,421			43,671			51,318
Depreciation		31,755			30,041			30,950
Amortization		1,121			84			154
Excess income tax benefit on stock awards and options		—			(608	)		(2,080	)
Loss on disposal of property, equipment and other assets		271			248			1,447
Share-based compensation expense		2,390			4,978			4,338
Loss on early extinguishment of debt		6,702			—			—
Amortization of loan acquisition costs		952			879			3,858
Equity in earnings of unconsolidated affiliates, net of distributions received		928			(224	)		(2,458	)
Impairment of goodwill		60,174			—			—
Minority interest share of earnings of consolidated subsidiaries		9,328			12,546			10,462
Other		(46	)		—			—
Deferred income taxes		(3,322	)		3,032			(6,037	)
Change in assets and liabilities that relate to operations:
Accounts receivable		(37,671	)		(42,073	)		(56,236	)
Medical supplies		(2,876	)		(2,066	)		695
Prepaids and other assets		(547	)		1,031			1,146
Accounts payable and accrued liabilities		4,587			(20,722	)		3,289

Net cash provided by operating activities of continuing operations		64,749			43,190			53,577
Net cash (used in) provided by operating activities of discontinued operations		(1,116	)		8,818			4,648

Net cash provided by operating activities		63,633			52,008			58,225
Investing activities:
Purchases of property and equipment		(93,912	)		(66,653	)		(36,360	)
Proceeds from sale of property and equipment		1,781			1,009			4,541
Changes in cash restricted for investment		3,154			(3,154	)
Investments in affiliates		—			(9,530	)		—
Purchase of equity interest		—			(3,694	)		—

Net cash used in investing activities of continuing operations		(88,977	)		(82,022	)		(31,819	)
Net cash provided by investing activities of discontinued operations		25,187			76,217			3,228

Net cash used in investing activities		(63,790	)		(5,805	)		(28,591	)
Financing activities:
Proceeds from issuance of long-term debt		83,479			—			—
Repayments of long-term debt		(116,300	)		(2,879	)		(112,969	)
Repayments of obligations under capital leases		(1,342	)		(1,348	)		(1,557	)
Distributions to minority partners		(11,770	)		(16,446	)		(9,437	)
Investment from minority partners		207			—			2,688
Proceeds from exercised stock options		77			4,317			5,803
Purchase of treasury shares		—			(44,403	)		—
Proceeds from issuance of common stock		—			—			39,658
Excess income tax benefit on stock awards and options		—			608			2,080

Net cash used in financing activities of continuing operations		(45,649	)		(60,151	)		(73,734	)
Net cash used in financing activities of discontinued operations		(4,561	)		(17,877	)		(6,382	)

Net cash used in financing activities		(50,210	)		(78,028	)		(80,116	)

Net decrease in cash and cash equivalents		(50,367	)		(31,825	)		(50,482	)
Cash and cash equivalents:
Beginning of period		112,068			143,893			194,375

End of period	$	61,701		$	112,068		$	143,893

Cash and cash equivalents of continuing operations		32,014			93,836			138,784
Cash and cash equivalents of discontinued operations		29,687			18,232			5,109

See notes to consolidated financial statements.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All tables in thousands, except per share amounts)


1.	Business and Organization

MedCath Corporation (the “Company”) primarily focuses on providing high acuity services, predominately the diagnosis and treatment of cardiovascular disease. The Company owns and operates hospitals in partnership with physicians, most of whom are cardiologists and cardiovascular surgeons. While each of the Company’s majority-owned hospitals (collectively, the “Hospital Division”) is licensed as a general acute care hospital, the Company focuses on serving the unique needs of patients suffering from cardiovascular disease. As of September 30, 2009, the Company owned and operated ten hospitals, together with its partners or members, who own an equity interest in the hospitals where they practice. The Company’s existing hospitals had a total of 755 licensed beds, of which 665 were staffed and available, and were located in seven states: Arizona, Arkansas, California, Louisiana, New Mexico, South Dakota and Texas.

The Company accounts for all but two of its owned and operated hospitals as consolidated subsidiaries. The Company owns a minority interest in Avera Heart Hospital of South Dakota and Harlingen Medical Center as of September 30, 2009. Therefore, the Company is unable to consolidate the hospitals’ results of operations and financial position, but rather is required to account for its minority ownership interest in these hospitals as an equity investment. Harlingen Medical Center was a consolidated entity for the first three quarters of fiscal 2007. In July 2007, the Company sold a portion of its equity interest in Harlingen Medical Center; therefore, the Company no longer is its primary beneficiary and accounts for its minority ownership interest in the hospital as an equity investment.

In addition to its hospitals, the Company provides cardiovascular care services in diagnostic and therapeutic facilities in various locations and through mobile cardiac catheterization laboratories and also provides management services to non owned facilities (the “MedCath Partners Division”). 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 and Estimates

Basis of Consolidation — The consolidated financial statements include the accounts of the Company and its subsidiaries that are wholly and majority ownedand/or over which it exercises substantive control, including variable interest entities in which the Company is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation. The Company uses the equity method of accounting for entities, including variable interest entities, in which the Company holds less than a 50% interest, has significant influence but does not have control, and is not the primary beneficiary.

Reclassifications — The Company has classified the results of operations, the assets and liabilities of consolidated subsidiaries held for sale, as well as the impacts from the collections and payments of the remaining assets and liabilities associated with the entities divested, as discontinued operations for all periods presented. During fiscal 2008, the Company sold its equity interest in Heart Hospital of Lafayette and certain assets of Dayton Heart Hospital. During fiscal 2009 the Company sold its equity interest in Cape Cod Cardiology Services, LLC (“Cape Cod”) and the net assets of Sun City Cardiac Center Associates (“Sun City”). The results of operations of these entities for the years ended September 30, 2009, 2008 and 2007 are reported as discontinued operations for all periods presented. The Company uses judgment in determining whether an entity will be reported as continuing or discontinued operations under the provisions of accounting principles generally accepted in the United States (“GAAP”). Such judgments include whether an entity will be sold, the period required to complete the disposition and the likelihood of changes to a plan for sale. If in future periods the Company determines that an entity should be either reclassified from continuing operations to discontinued operations or from discontinued operations to continuing operations, previously reported consolidated statements of income are reclassified in order to reflect the current classification. See Note 3.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Use of Estimates — The preparation of financial statements in conformity with GAAP 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.

Fair Value of Financial Instruments — The Company considers the carrying amounts of significant classes of financial instruments on the consolidated balance sheets to be reasonable estimates of fair value due either to their length to maturity or the existence of variable interest rates underlying such financial instruments that approximate prevailing market rates at September 30, 2009 and 2008. The estimated fair value of long-term debt, including the current portion, at September 30, 2009 is approximately $127.6 million as compared to a carrying value of approximately $121.4 million. At September 30, 2008, the estimated fair value of long-term debt, including the current portion, was approximately $152.8 million as compared to a carrying value of approximately $146.4 million. Fair value of the Company’s fixed rate debt was estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of arrangements and market information. The fair value of the Company’s variable rate debt was determined to approximate its carrying value, due to the underlying variable interest rates.

Concentrations of Credit Risk — Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents and accounts receivable. Cash and cash equivalents are maintained with several large financial institutions. Deposits held with financial institutions typically exceed the insurance provided by the Federal Deposit Insurance Corporation. The Company has not experienced any losses on its deposits of cash and cash equivalents.

The Company grants credit without collateral to its patients, most of whom are insured under payment arrangements with third party payors, including Medicare, Medicaid and commercial insurance carriers. The Company has not experienced significant losses related to receivables from individual patients or groups of patients in any particular industry or geographic area. Accounts receivable of the Hospital Division represents 92.7% and 93.1% of total accounts receivable for the Company as of September 30, 2009 and 2008, respectively. The following table summarizes the percentage of net accounts receivable from all payors for the Hospital Division at September 30:


	2009			2008

Medicare and Medicaid		43	%		40	%
Commercial and Other		42	%		47	%
Self-pay		15	%		13	%

		100	%		100	%

Cash and Cash Equivalents — The Company considers currency on hand, demand deposits, and all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash and cash equivalents.

Restricted Cash — At September 30, 2008 the Company had $3.2 million of restricted cash held in escrow as required by the city of Kingman, Arizona in conjunction with the Company’s development of the Hualapai Mountain Medical Center. The escrowed funds were released to the Company upon the completion of common infrastructure construction projects affecting the city of Kingman during fiscal 2009.

Allowance for Doubtful Accounts — Accounts receivable primarily consist of amounts due from third-party payors and patients in the Company’s Hospital Division. The remainder of the Company’s accounts receivable principally consists of amounts due from billings to hospitals for various cardiovascular care services performed in its MedCath Partners Division and amounts due under consulting and management contracts. To provide for accounts receivable that could become uncollectible in the future, the Company establishes an allowance for doubtful accounts to reduce the carrying value of such receivables to their estimated net realizable value. The

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Company estimates this allowance based on such factors as payor mix, aging and the historical collection experience and write-offs of its respective hospitals and other business units.

Medical Supplies — Medical supplies consist primarily of supplies necessary for diagnostics, catheterization and surgical procedures and general patient care and are stated at the lower offirst-in, first-out cost or market.

Property and Equipment — Property and equipment are recorded at cost and are depreciated principally on a straight-line basis over the estimated useful lives of the assets, which generally range from 25 to 40 years for buildings and improvements, 15 to 25 years for land improvements, and from 3 to 10 years for equipment, furniture and software. Repairs and maintenance costs are charged to operating expense while betterments are capitalized as additions to the related assets. Retirements, sales, and disposals are recorded by removing the related cost and accumulated depreciation with any resulting gain or loss reflected in income from operations. Amortization of property and equipment recorded under capital leases is included in depreciation expense. Interest expense incurred in connection with the construction of hospitals is capitalized as part of the cost of construction until the facility is operational, at which time depreciation begins using the straight-line method over the estimated useful life of the applicable constructed assets. The Company capitalized interest of $2.7 million and $1.3 million, respectively, during the years ended September 30, 2009 and 2008. The Company did not capitalize any interest during the year ended September 30, 2007.

Goodwill and Intangible Assets — Goodwill represents acquisition costs in excess of the fair value of net identifiable tangible and intangible assets of businesses purchased. All of the Company’s goodwill was recorded within the Hospital Division segment, see Note 19. Other intangible assets primarily consist of the value of management contracts. With the exception of goodwill, intangible assets are being amortized over periods ranging from 11 to 29 years. The Company evaluates goodwill annually on September 30 for impairment, or earlier if indicators of potential impairment exist. The determination of whether or not goodwill has become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the value of the Company’s reporting unit. Changes in the Company’s strategy, assumptionsand/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of intangible assets. See Note 4 for additional disclosure related to the Company’s annual impairment evaluation of goodwill.

Other Assets — Other assets primarily consist of loan acquisition costs, prepaid rent under a long-term operating lease for land at one of the Company’s hospitals and intangible assets associated with physician related revenue guarantees. See Note 12 for further discussion of these guarantees. Loan acquisition costs (“Loan Costs”) are costs associated with obtaining long-term financing. Loan Costs, net of accumulated amortization, were $2.2 million and $2.1 million as of September 30, 2009 and 2008, respectively. Loan Costs are being amortized using the straight-line method, which approximates the effective interest method, as a component of interest expense over the life of the related debt. Amortization expense recognized for Loan Costs totaled $1.0 million, $0.9 million, and $3.9 million for the years ended September 30, 2009, 2008 and 2007, respectively. Prepaid rent is being amortized using the straight-line method over the lease term, which extends through December 11, 2065. The Company recognizes the amortization of prepaid rent as a component of other operating expense.

Long-Lived Assets — Long lived assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset and its eventual disposition are less than its carrying amount. The determination of whether or not long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated future cash flows expected to result from the use of those assets. Changes in the Company’s strategy, assumptionsand/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of long-lived assets. See Note 3 for further discussion of the impairment of certain assets associated with the Company’s discontinued operations.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Other Long-Term Obligations — Other long-term obligations consist of physician revenue guarantees and other long term contracts. See Note 12 for further discussion of these physician guarantees.

Market Risk Policy — The Company’s policy for managing risk related to its exposure to variability in interest rates, commodity prices, and other relevant market rates and prices includes consideration of entering into derivative instruments (freestanding derivatives), or contracts or instruments containing features or terms that behave in a manner similar to derivative instruments (embedded derivatives) in order to mitigate its risks. In addition, the Company may be required to hedge some or all of its market risk exposure, especially to interest rates, by creditors who provide debt funding to the Company. The Company recognizes all derivatives as either assets or liabilities on the balance sheets and measures those instruments at fair value.

Comprehensive Income (Loss) — Comprehensive income or loss is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources.

Revenue Recognition — Amounts the Company receives for treatment of patients covered by governmental programs such as Medicare and Medicaid and other third-party payors such as commercial insurers, health maintenance organizations and preferred provider organizations are generally less than established billing rates. Payment arrangements with third-party payors may include prospectively determined rates per discharge or per visit, a discount from established charges, per diem payments, reimbursed costs (subject to limits)and/or other similar contractual arrangements. As a result, net revenue for services rendered to patients is reported at the estimated net realizable amounts as services are rendered. The Company accounts for the differences between the estimated realizable rates under the reimbursement program and the standard billing rates as contractual adjustments.

The majority of the Company’s contractual adjustments are system-generated at the time of billing based on either government fee schedules or fee schedules contained in managed care agreements with various insurance plans. Portions of the Company’s contractual adjustments are performed manually and these adjustments primarily relate to patients that have insurance plans with whom the Company’s hospitals do not have contracts containing discounted fee schedules, also referred to as non-contracted payors, and patients that have secondary insurance plans following adjudication by the primary payor. Estimates of contractual adjustments are made on a payor-specific basis and based on the best information available regarding the Company’s interpretation of the applicable laws, regulations and contract terms. While subsequent adjustments to the systematic contractual allowances can arise due to denials, short payments deemed immaterial for continued collection effort and a variety of other reasons, such amounts have not historically been significant.

The Company continually reviews the contractual estimation process to consider and incorporate updates to the laws and regulations and any changes in the contractual terms of its programs. Final settlements under some of these programs are subject to adjustment based on audit by third parties, which can take several years to determine. From a procedural standpoint, for governmental payors, primarily Medicare, the Company recognizes estimated settlements in its consolidated financial statements based on filed cost reports. The Company subsequently adjusts those settlements as new information is obtained from audits or reviews by the fiscal intermediary and, if the result of the fiscal intermediary audit or review impacts other unsettled and open cost reports, the Company recognizes the impact of those adjustments. As such, the Company recognized adjustments that decreased net revenue by $5.2 million, $2.0 million and $0.7 million for continuing operations in the years ended September 30, 2009, 2008 and 2007, respectively. The Company recognized adjustments that increased net revenue by $0.4 million and $2.2 million for discontinued operations in the years ended September 30, 2008 and 2007, respectively. No adjustments were recognized for discontinued operations in the year ended September 30, 2009.

A significant portion of the Company’s net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid, which, combined, accounted for 55.4%, 55.6% and 53.9% of the Company’s net revenue during the years ended September 30, 2009, 2008 and 2007, respectively. Medicare payments for inpatient acute services and certain outpatient services are generally made pursuant to a prospective

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

payment system. Under this system, hospitals are paid a prospectively-determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a diagnosis-related group (“DRG”). Based upon the patient’s condition and treatment during the relevant inpatient stay, each DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. The DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The update factor is determined, in part, by the projected increase in the cost of goods and services that are purchased by hospitals, referred to as the market basket index. DRG payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, DRG payments are adjusted by a predetermined adjustment factor assigned to the geographic area in which the hospital is located.

While hospitals generally do not receive direct payment in addition to a DRG payment, hospitals may qualify for additional capital-related cost reimbursement and outlier payments from Medicare under specific circumstances. In addition, some hospitals with high levels of low income patients qualify for Medicare Disproportionate Share Hosptial (“DSH”) reimbursement as an add on to DRG payments. Medicare payments for most outpatient services are based on prospective payments using ambulatory payment classifications (“APCs”). Other outpatient services, including outpatient clinical laboratory, are reimbursed through a variety of fee schedules. The Company is reimbursed for DSH payments and cost-reimbursable items at tentative rates, with final settlement determined after submission of annual cost reports by the Company and audits thereof by the Medicare fiscal intermediary.

Medicaid payments for inpatient and outpatient services are based upon methodologies specific to the state in which hospitals are located and are made at prospectively determined amounts, such as DRGs; reasonable costs or charges; or fee schedule. Depending upon the state in which hospitals are located, Medicaid payments may be made at tentative rates with final settlement determined after submission of annual cost reports by the hospitals and audits or reviews thereof by the states’ Medicaid agencies.

The Company’s managed diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories operate under various contracts where management fee revenue is recognized under fixed-rate andpercentage-of-income arrangements as services are rendered. In addition, certain diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories recognize additional revenue under cost reimbursement and equipment lease arrangements. Net revenue from the Company’s owned diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories is reported at the estimated net realizable amounts due from patients, third-party payors, and others as services are rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors.

Segment Reporting. Operating segments are components of an enterprise about which separate financial information is available and evaluated regularly by the chief operating decision maker in deciding how to allocate resources and evaluate performance. Two or more operating segments may be aggregated into a single reportable segment if the segments have similar economic and overall industry characteristics, such as customer class, products and service. There is no aggregation within the Company’s reportable segments. The description of the Company’s reportable segments, consistent with how business results are reported internally to management and the disclosure of segment information is discussed in Note 19.

Advertising — Advertising costs are expensed as incurred. During the years ended September 30, 2009, 2008 and 2007, the Company incurred approximately $4.2 million, $3.9 million and $3.6 million of advertising expenses, respectively.

Pre-opening Expenses — Pre-opening expenses consist of operating expenses incurred during the development of new ventures prior to opening for business. Such costs specifically relate to the Company’s development of the Hualapai Mountain Medical Center in Kingman, Arizona and are expensed as incurred. The Company incurred approximately $3.6 million, $0.8 million and $0.6 million, respectively, of pre-opening expenses during the years ended September 30, 2009, 2008 and 2007.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Interest and other income — Interest and other income are predominantly comprised of interest income. Interest income recorded in the consolidated statements of income was $0.2 million, $1.9 million, and $7.6 million for the years ended September 30, 2009, 2008, and 2007, respectively.

Income Taxes — Income taxes are computed on the pretax income based on current tax law. Deferred income taxes are recognized for the expected future tax consequences or benefits of differences between the tax bases of assets or liabilities and their carrying amounts in the consolidated financial statements. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize their benefit or that future deductibility is uncertain.

Members’ and Partners’ Share of Hospital’s Net Income and Loss — Each of the Company’s consolidated hospitals is organized as a limited liability company or limited partnership, with one of the Company’s wholly-owned subsidiaries serving as the manager or general partner and holding from 53.3% to 89.2% of the ownership interest in the entity. In most cases, physician partners or members own the remaining ownership interests as members or limited partners. In some instances, the Company may organize a hospital with a community hospital investing as an additional partner or member. In those instances, the Company may hold a minority interest in the hospital with the community hospital and physician partners owning the remaining interests also as minority partners. In such instances, the hospital is accounted for under the equity method of accounting. Profits and losses of hospitals accounted for under either the consolidated or equity methods are allocated to their owners based on their respective ownership percentages. If the cumulative losses of a hospital exceed its initial capitalization and committed capital obligations of the partners or members, the Company will recognize a disproportionate share of the hospital’s losses that otherwise would be allocated to all of its owners on a pro rata basis. In such cases, the Company will recognize a disproportionate share of the hospital’s future profits to the extent the Company has previously recognized a disproportionate share of the hospital’s losses.

Share-Based Compensation — Compensation expense for share-based awards made to employees and directors are recognized based on the estimated fair value of each award over each applicable awards vesting period. The Company estimates the fair value of share-based payment awards on the date of grant using, either an option-pricing model for stock options or the closing market value of the Company’s stock for restricted stock and restricted stock units, and expenses the value of the portion of the award that is ultimately expected to vest over the requisite service period in the Company’s statement of operations.

The Company used the Black-Scholes option pricing model with the range of weighted-average assumptions used for option grants noted in the following table. The expected life of the stock options represents the period of time that options granted are expected to be outstanding and the range given below results from certain groups of employees exhibiting different behavior with respect to the options granted to them and has been determined based on an annual analysis of historical and expected exercise and cancellation behavior. The risk-free interest rate is based on the US Treasury yield curve in effect on the date of the grant. The expected volatility is based on the historical volatilities of the Company’s common stock and the common stock of comparable publicly traded companies.


	Year Ended September 30,
	2009	2008	2007

Expected life	5-8 years	5-8 years	5-8 years
Risk-free interest rate	1.36-3.59%	2.34-4.56%	4.12-5.17%
Expected volatility	44-49%	33-41%	37-43%

During fiscal 2009 the Company granted shares of restricted stock and restricted stock units to employees and directors, respectively. Restricted stock granted to employees, excluding executives of the Company, vest in equal

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

annual installments over a three year period. Executives of the Company defined by the Company as vice president or higher, received two separately equal grants. The first grant of restricted stock vests in equal annual installments over a three year period, the second grant of restricted stock vests over a three year period based on established performance conditions. Restricted stock units granted to directors are fully vested at the date of grant and are paid in the form of common stock upon each applicable director’s termination of service on the board.

Subsequent Events — In connection with preparation of the consolidated financial statements for fiscal year ended September 30, 2009, the Company has evaluated subsequent events for potential recognition and disclosures through December 14, 2009, the date these consolidated financial statements were issued, as filed inForm 10-K with the Securities and Exchange Commission (“SEC”).

Recently Adopted Accounting Pronouncements — Effective the fourth quarter of fiscal 2009 the Company adopted the provisions of the Accounting Standards Codification (“ASC”) issued by the Financial Accounting Standards Board (“FASB”). The ASC has become the single source of authoritative U.S. generally accepted accounting principles recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP recognized by the FASB for SEC registrants, such as the Company. The ASC did not change or alter existing GAAP. The adoption of the ASC had no impact on the Company’s consolidated financial statements.

Effective the first quarter of fiscal 2009 the Company adopted a new accounting standard issued by the FASB that defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. In February 2008, the FASB delayed the effective date of this new standard for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company has elected to defer implementation of this new standard until the first quarter of fiscal 2010 as it relates to the Company’s non-financial assets and non-financial liabilities that are not permitted or required to be measured at fair value on a recurring basis. The Company is evaluating the impact, if any, this new standard will have on those non-financial assets and liabilities. The adoption of this new standard in regard to financial assets and liabilities, did not have an impact on the Company’s consolidated financial statements as the Company did not have any financial assets or liabilities that were required to be re-measured and reported at fair value as of and for the fiscal year ended September 30, 2009.

Effective the first quarter of fiscal 2009 the Company adopted a new accounting standard issued by the FASB that permits entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The Company has elected to not apply the fair value option to any “eligible items”, as defined by the FASB.

Effective the second quarter of fiscal 2009 the Company adopted a new accounting standard issued by the FASB that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, the new accounting standard sets forth the following: (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SeeSubsequent Eventsabove.

Recent Accounting Pronouncements — In December 2007, the FASB issued a new accounting standard that addresses the recognition and accounting for identifiable assets acquired, liabilities assumed, and noncontrolling interests in business combinations. This standard will require more assets and liabilities to be recorded at fair value and will require expense recognition (rather than capitalization) of certain pre-acquisition costs. This standard also will require any adjustments to acquired deferred tax assets and liabilities occurring after the related allocation period to be made through earnings. Furthermore, this standard requires this treatment of acquired deferred tax

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

assets and liabilities also be applied to acquisitions occurring prior to the effective date of this standard. This new accountnig standard is effective for fiscal years beginning after December 15, 2008, fiscal 2010 for the Company and is required to be adopted prospectively with no early adoption permitted. The Company expects this new accounting standard will have an impact on accounting for business combinations, but the effect will be dependent upon any potential future acquisitions.

In December 2007, the FASB issued a new accounting standard that establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. This new accounting standard also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The new accounting standard is effective for fiscal years beginning on or after December 15, 2008, fiscal 2010 for the Company. In fiscal 2010, the Company will report non-controlling interests (previously referred to as minority interests) as a component of equity in the consolidated financial statements. The adoption will primarily impact the presentation of the consolidated financial statements including all comparable periods.

In April 2008, the FASB issued a new accounting standard which amends the list of factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets. The new accounting standard applies to intangible assets that are acquired individually or with a group of other assets and intangible assets acquired in both business combinations and asset acquisitions. The new accounting standard is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years, fiscal 2010 for the Company. The impact of this new accounting standard will be dependent upon any potential future acquisitions.

In June 2009, the FASB issued a new accounting standard that amends the consolidation guidance that applies to variable interest entities (“VIE”). The amendments will significantly affect the overall consolidation analysis. The provisions of this new accounting standard revise the definition and consideration of VIEs, primary beneficiary, and triggering events in which a company must re-evaluate its conclusions as to the consolidation of an entity. This new accounting standard is effective as of the beginning of the first fiscal year after November 15, 2009, fiscal 2011 for the Company. The Company is evaluating the potential impacts the adoption of this new standard will have on its consolidated financial statements.


3.	Discontinued Operations

During September 2009 the MedCath Partners Division of the Company sold the assets of Sun City for $16.9 million which resulted in a gain of $3.2 million, net of taxes. The associated gain from the sale has been included in income (loss) from discontinued operations on the consolidated statement of operations for the year ended September 30, 2009.

During December 2008 the MedCath Partners Division of the Company sold its equity interest in Cape Cod for $6.9 million, which resulted in a gain of $4.0 million, net of taxes. The associated gain from the sale has been included in income (loss) from discontinued operations on the consolidated statement of operations for the year ended September 30, 2009.

During May 2008, the Hospital Division of the Company sold the net assets of Dayton Heart Hospital (“DHH”) to Good Samaritan Hospital for $47.5 million pursuant to a definitive agreement entered into during the year ended September 30, 2008. The total gain recognized, net of tax, was $3.4 million and is included in income (loss) from discontinued operations on the consolidated statement of operations for the year ended September 30, 2008.

In accordance with the terms of the sale, DHH and Good Samaritan Hospital entered into an indemnification agreement for a period of eighteen months from the date of the sale. DHH agreed to indemnify Good Samaritan Hospital from certain exposures arising subsequent to the date of sale, including environmental exposure and

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

exposure resulting from the breach of representations or warranties made in accordance with the sale. The maximum exposure associated with the indemnity agreement is $10 million. The estimated fair value of this indemnification is insignificant. Additionally, as a condition to the sale and as part of the indemnification agreement, the Company has entered into a non-compete agreement for a period of five years from the date of the sale. The Company was paid $5.0 million under the non-compete agreement, resulting in the Company recording $3.1 million, net of tax, related to the non-compete agreement as part of income (loss) from discontinued operations in the consolidated statement of operations for the year ended September 30, 2008.

As of September 30, 2009 and 2008 the Company had reserved $9.6 million and $9.1 million, respectively, for Medicare outlier payments received by DHH during the year ended September 30, 2004, which are included in current liabilities of discontinued operations in the consolidated balance sheets.

During September 2006, the Company sought to dispose of its interest in the Heart Hospital of Lafayette (“HHLf”) and entered into a confidentiality and exclusivity agreement with a potential buyer at a purchase price in excess of the carrying value including goodwill. During fiscal 2007 the Company determined that the carrying value of HHLf was in excess of its fair value based on a new purchase price with a different buyer at a price below the carrying value including goodwill and recorded an impairment charge of $4.1 million, which is included in the income (loss) from discontinued operations in the consolidated statement of operations for the fiscal year 2007. The sale of HHLf was completed during the year ended September 30, 2008, resulting in an immaterial loss recorded as part of income (loss) from discontinued operations for the year ended September 30, 2008.

The results of operations and the assets and liabilities of discontinued operations included in the consolidated statements of operations and consolidated balance sheets are as follows:


	Year Ended September 30,
	2009		2008		2007

Net revenue	$	13,520	$	62,016	$	117,328
Gain from sale of DHH		—		3,399		—
Gain from sale of Sun City		5,415		—		—
Gain from sale of Cape Cod		6,640		—		—
Income before income taxes		13,702		16,248		3,977
Income tax expense		5,566		7,631		5,181

Net income (loss)	$	8,136	$	8,617	$	(1,204	)


	Year Ended September 30,
	2009		2008

Cash and cash equivalents	$	29,687	$	18,232
Accounts receivable, net		324		3,407
Other current assets		—		867

Current assets of discontinued operations	$	30,011	$	22,506

Property and equipment, net	$	—	$	686
Other intangible assets, net		—		4,930

Long-term assets of discontinued operations	$	—	$	5,616

Accounts payable	$	9,898	$	9,705
Accrued liabilities		267		1,577

Current liabilities of discontinued operations	$	10,165	$	11,282

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


4.	Goodwill and Other Intangible Assets

During the year ended September 30, 2008, $4.6 million of goodwill was written off as part of the gain resulting from the disposition of the Dayton Heart Hospital which is included within income (loss) from discontinued operations. See Note 3.

During the year ended September 30, 2008 the Company purchased additional equity interests in the Heart Hospital of New Mexico and TexSAn Heart Hospital resulting in an increase to goodwill of $1.3 million and $0.7 million, respectively, see Note 5.

Due to overall market conditions that existed during the first quarter of fiscal 2009, which caused a decline in the Company’s market capitalization, the Company performed an interim impairment test as of December 31, 2008. The fair value of the Company’s Hospital Division reporting unit was determined using a combination of a discounted cash flow, market multiple, and comparable transaction methods. The interim analysis resulted in a fair value of the Hospital Division reporting unit that was in excess of its carrying value, and for which the Company was able to satisfactorily reconcile to its market capitalization. As a result the interim impairment test indicated no impairment existed as of that date.

The first step of the Company’s annual impairment test was performed as of September 30, 2009, initially using the valuation methods, as discussed above. However, the reconciliation of the fair value of the Hospital Division reporting unit to the Company’s market capitalization at September 30, 2009, resulted in a fair value that indicated an implied control premium that did not appear reasonable. During the fourth quarter of fiscal 2009, the Company’s stock price underperformed comparable companies as well as the broader markets, and the Company experienced a decline in its fourth quarter operating results. As a result of these events, the Company placed more reliance on the discounted cash flow method and used this method to estimate the fair value which resulted in a fair value that was below the carrying value of the Hospital Division reporting unit.

The second step of the Company’s impairment analysis involved allocating the fair value of the Hospital Division reporting unit, as derived in the first step discussed above, to the assets and liabilities of the Hospital Division reporting unit. This process requires significant management estimates and judgments, and is used to determine the implied fair value of the Hospital Division reporting unit’s goodwill. The Company incorporated recent appraisals and other information in its analysis, and concluded the implied fair value of goodwill was zero. As a result the entire balance of $60.2 million of goodwill was impaired in the fourth quarter of fiscal 2009.

During the fourth quarter of fiscal 2009 the MedCath Partners Division of the Company wrote off $0.7 million of intangible assets associated with the termination of certain management contracts.

As of September 30, 2009 and 2008, the Company’s other intangible assets, net, included the following:


	September 30, 2009					September 30, 2008
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
	Amount		Amortization			Amount		Amortization

Management contracts	$	—	$	—		$	8,609	$	(7,917	)
Other		730		(352	)		655		(214	)

Total	$	730	$	(352	)	$	9,264	$	(8,131	)

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The estimated aggregate amortization expense for each of the five fiscal years succeeding the Company’s most recent fiscal year ended September 30, 2009 is as follows:


	Estimated Amortization
Fiscal Year	Expense

2010	$	77
2011		57
2012		38
2013		32
2014		32


5.	Business Combinations and Hospital Development

New Hospital Development — In August 2007, the Company announced a venture to construct a new 106 inpatient bed capacity general acute care hospital, Hualapai Mountain Medical Center, which is located in Kingman, Arizona. The hospital is accounted for as a consolidated subsidiary since the Company, through its wholly-owned subsidiary, owns 79.2% of the interest in the venture with physician partners owning the remaining 20.8%. Further, the Company exercises substantive control over the hospital. Construction of Hualapai Mountain Medical Center began during fiscal year 2007. The facility was completed and opened during October 2009 with 70 licensed beds, and the capacity for an additional 36 beds to facilitate future growth.

In May 2007, the Company and its physician partners announced a 119 bed general acute care expansion of its hospital located in St. Tammany Parish, Louisiana. The expansion was completed during May 2009, with 79 patient rooms being completed initially and capacity for 40 patient rooms being available for future growth. To recognize its expanded service capabilities, the hospital, which opened in February 2003, was renamed the Louisiana Medical Center and Heart Hospital.

In April 2007, the Company and its physician partners announced the expansion of Arkansas Heart Hospital, located in Little Rock, Arkansas. The expansion converted shelled space into 28 inpatient beds, added a 130 space parking garage to the campus and supported the renovation of the hospital’s annex building to accommodate non-clinical services.

Prior to July 2007, the Company consolidated Harlingen Medical Center (“HMC”). The Company’s interest in HMC was diluted from 51.0% to 36.0% effective for the fourth quarter of fiscal year 2007. The Company recorded a gain from the transaction that resulted from the difference between the carrying amount of the Company’s investment in HMC prior to the issuance of units and the Company’s equity investment immediately following the issuance of units. The Company determined that recognition of the gain as a capital transaction was appropriate because HMC had historically experienced net losses, and because of uncertainty regarding the possible future occurrence of transactions that may involve further dilution of the Company’s equity interest in HMC. Future issuances of units to third parties, if any, will further dilute the Company’s ownership percentage and may give rise to additional gains or losses based on the offering price in comparison to the carrying value of the Company’s investment.

Purchase of Additional Interests in Hospitals — During June 2008 the Company acquired an additional 14.29% ownership interest in the TexSAn Heart Hospital, a consolidated subsidiary hospital, by converting $9.5 million of intercompany debt to equity. Additionally, during September 2008 the Company purchased an additional 3.7% ownership interest in the TexSAn Heart Hospital for $1.2 million.

During July 2008 the Company purchased an additional 3.0% interest in the Heart Hospital of New Mexico, a consolidated subsidiary hospital, for $2.5 million.

Diagnostic and Therapeutic Facilities Development — During April 2008 the Company paid $8.5 million to acquire a 27.4% interest in Southwest Arizona Heart and Vascular LLC a joint venture with the Heart Lung Vascular

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Center of Yuma. The joint venture provides cardiac catheterization lab services to Yuma Regional Medical Center in Arizona.

During February 2008 the Company paid $1.0 million to acquire a 33.33% interest in a joint venture with Solaris Health Systems LLC and individual physician members to manage two cardiac catheterization laboratories located in New Jersey.


6.	Accounts Receivable

Accounts receivable, net, consist of the following:


	September 30,
	2009			2008

Receivables, principally from patients and third-party payors	$	150,476		$	131,915
Receivables, principally from billings to hospitals for various cardiovascular procedures		1,494			2,609
Amounts due under management contracts		228			2,036
Other		6,094			3,461

		158,292			140,021
Less allowance for doubtful accounts		(87,882	)		(57,697	)

Accounts receivable, net	$	70,410		$	82,324

Activity for the allowance for doubtful accounts is as follows:


	Year Ended September 30,
	2009			2008

Balance, beginning of year	$	57,697		$	45,238
Bad debt expense		49,421			43,671
Write-offs, net of recoveries		(19,236	)		(31,212	)

Balance, end of year	$	87,882		$	57,697


7.	Property and Equipment

Property and equipment, net, consists of the following:


	September 30,
	2009			2008

Land	$	32,681		$	26,457
Buildings		304,615			224,806
Equipment		252,547			242,593
Construction in progress		17,682			41,533

Total, at cost		607,525			535,389
Less accumulated depreciation		(221,599	)		(212,295	)

Property and equipment, net	$	385,926		$	323,094

Substantially all of the Company’s property and equipment is either pledged as collateral for various long-term obligations or assigned to lenders under the Senior Secured Credit Facility as intercompany collateral liens, see Note 9.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


8.	Investments in Affiliates

The Company’s determination of the appropriate consolidation method to follow with respect to investments in affiliates is based on the amount of control the Company has and the ownership level in the underlying entity. Investments in entities that the Company does not control, but over whose operations the Company has the ability to exercise significant influence (including investments where the Company has a less than 20% ownership), are accounted for under the equity method. The Company additionally considers if it is the primary beneficiary of (and therefore should consolidate) any entity whose operations the Company does not control. At September 30, 2009, all of the Company’s investments in unconsolidated affiliates are accounted for using the equity method.

Variable Interest Entities

During the year ended September 30, 2007 the Company’s interest in HMC was diluted from 51.0% to 36.0%, see Note 5 for further discussion of this transaction. Prior to the fourth quarter of fiscal 2007 the Company consolidated the results of HMC. Upon dilution, the Company began accounting for HMC as an equity investment as the Company determined that HMC was a variable interest entity and that the Company was not the primary beneficiary. HMC is an acute care hospital facility in which the Company acts as manager of the facility and provides support services as necessary. The Company’s maximum exposure to losses from its involvement with HMC is the Company’s net investment in HMC, as presented below, and $0.6 million of outstanding fees as discussed in Note 17.

Investments in unconsolidated affiliates accounted for under the equity method consist of the following:


	Year Ended September 30,
	2009			2008

Avera Heart Hospital of South Dakota	$	9,143		$	9,888
Harlingen Medical Center		5,621			6,635
HMC Realty, LLC		(11,909	)		(11,686	)
Southwest Arizona Heart and Vascular, LLC		8,757			8,766
Other		2,443			1,682

	$	14,055		$	15,285

The Company’s ownership percentage for each investment accounted for under the equity method is presented in the table below:


Investee	Ownership

Blue Ridge Cardiology Services, LLC(a)(c)		50.0	%
Austin Development Holding, Inc.(a)		50.0	%
HMC Realty LLC(b)		36.1	%
Harlingen Medical Center(b)		34.8	%
Tri-County Heart New Jersey LLC(a)(c)		33.3	%
Avera Heart Hospital of South Dakota(b)		33.3	%
Southwest Arizona Heart and Vascular, LLC(c)		27.0	%
Wilmington Heart Services, LLC(a)(c)		15.0	%
Central New Jersey Heart Services, LLC(a)(c)		15.0	%
Coastal Carolina Heart, LLC(a)(c)		9.2	%


(a)		Included in Other

(b)		Included in the Hospital Division

(c)		Included in MedCath Partners Division

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Accumulated deficit includes $9.3 million, $10.3 million, and $8.1 million of undistributed earnings from unconsolidated affiliates accounted for under the equity method for the years ended September 30, 2009, 2008, and 2007, respectively. Distributions received from unconsolidated affiliates accounted for under the equity method were $10.0 million, $7.7 million and $3.3 million during the years ended September 30, 2009, 2008 and 2007, respectively.

The following tables represents summarized combined financial information of the Company’s unconsolidated affiliates accounted for under the equity method


	Year Ended September 30,
	2009		2008		2007

Net revenue	$	228,765	$	220,244	$	102,031
Income from operations	$	47,857	$	43,921	$	20,352
Net income	$	38,906	$	34,686	$	13,514


	September 30,
	2009		2008

Current assets	$	68,675	$	70,921
Long-term assets	$	149,194	$	153,766
Current liabilities	$	25,967	$	28,958
Long-term liabilities	$	122,685	$	123,356


9.	Long-Term Debt

Long-term debt consists of the following:


	September 30,
	2009			2008

Senior Notes	$	—		$	101,961
Credit Facility		80,000			—
REIT Loan		35,308			35,308
Notes payable to various lenders		6,054			9,107

		121,362			146,376
Less current portion		(19,491	)		(30,748	)

Long-term debt	$	101,871		$	115,628

Senior Notes — During the year ended September 30, 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”). The proceeds, net of fees, of $145.5 million were used to repay a significant portion of the Company’s then outstanding debt and obligations under capital leases. The Senior Notes, which were to mature on July 15, 2012, paid interest semi-annually, in arrears, on January 15 and July 15 of each year. The Senior Notes were 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 could have redeemed 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 was required to 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.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During fiscal 2007, the Company repurchased $36.2 million of its outstanding Senior Notes using the proceeds from the Company’s secondary public offering which was declared effective by the SEC on November 6, 2006. The Company incurred a repurchase premium of $3.5 million and approximately $1.0 million of deferred loan acquisition costs were written off in connection with the repurchase. These costs are reported as a loss on early extinguishment of debt in the Company’s statement of operations for the year ended September 30, 2007.

During December 2008 the Company redeemed its outstanding Senior Notes for $111.2 million, which included the payment of a repurchase premium of $5.0 million and accrued interest of $4.2 million. The Senior Notes were redeemed through borrowings under the Amended Credit Facility and available cash on hand. See theSenior Secured Credit Facilitybelow for further discussion of the Amended Credit Facility. In addition to the aforementioned repurchase premium the Company incurred $2.0 million in expense related to the write-off of previously incurred financing costs associated with the Senior Notes. The repurchase premium and write off of previously incurred financing costs have been included in the consolidated statement of income as loss on early extinguishment of debt for the year ended September 30, 2009.

Senior Secured Credit Facility — Concurrent with the offering of the Senior Notes, 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 included a $25.0 millionsub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 millionsub-limit for swing-line loans, and is collateralized by patient accounts receivable and certain other assets of the Company.

Borrowings under the Senior Secured Credit Facility, excluding swing-line loans, bore 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 bore 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, a 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 Senior Secured Credit Facility is guaranteed, jointly and severally, by the Parent and all wholly 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, redeemand/or repay other debt; make loans, advances and investments and acquisitions; make capital expenditures; and enter into transactions with affiliates.

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)

During January 2007, the Company paid off its outstanding $39.9 million Term Loan under the Senior Secured Credit Facility. In connection with the early repayment, the Company wrote off approximately $0.5 million in deferred loan acquisition costs. These costs are reported as a loss on early extinguishment of debt in the Company’s consolidated statement of operations for the year ended September 30, 2007.

During November 2008, the Company amended and restated the Senior Secured Credit Facility (the “Amended Credit Facility”). The Amended Credit Facility provides for a three-year term loan facility in the amount of $75.0 million (the “Amended Term Loan”) and a revolving credit facility in the amount of $85.0 million (the “Revolver”), which includes a $25.0 millionsub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 millionsub-limit for swing-line loans. At the request of the Company and approval from its lenders, the aggregate amount available under the Amended Credit Facility may be increased by an amount up to $50.0 million. Borrowings under the Amended 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. At September 30, 2009 the Amended Term Loan bore interest at 3.25% and the Revolver bore interest at 2.75%.

The Amended Credit Facility continues to be guaranteed jointly and severally by the Company and certain of the Company’s existing and future, direct and indirect, wholly owned subsidiaries and continues to be secured by a first priority perfected security interest in all of the capital stock or other ownership interests owned by the Company and subsidiary guarantors in each of their subsidiaries, and, subject to certain exceptions in the credit facility all other present and future assets and properties of the Company and the subsidiary guarantors and all intercompany notes.

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

The Amended Credit Facility contains events of default, including cross-defaults to certain indebtedness, change of control events and other events of default customary for syndicated commercial credit facilities. Upon the occurrence of an event of default, the Company could be required to immediately repay all outstanding amounts under the amended credit facility.

The Company is required to make mandatory prepayments of principal in specified amounts upon the occurrence of certain events identified in the Amended Credit Facility and is permitted to make voluntary prepayments of principal under the Amended Credit Facility. The Amended Term Loan is subject to amortization of principal in quarterly installments commencing on March 31, 2010. The maturity date of both the Amended Term Loan and Revolver is November 10, 2011.

Of the $80.0 million outstanding under the Amended Credit Facility at September 30, 2009, $5.0 million was outstanding under the Revolver. The maximum availability under the Revolver is $85.0 million which is reduced by the aforementioned outstanding borrowings under the Revolver and outstanding letters of credit totaling $3.5 million.

Real Estate Investment Trust (REIT) Loans — The Company’s REIT Loan balance included the outstanding indebtedness of one hospital. The interest rates on the outstanding REIT Loans were based on a rate index tied to U.S. Treasury Notes plus a margin that was determined on the completion date of the hospital, and subsequently increased per year by 20 basis points. The principal and interest on the REIT Loans were payable monthly over seven-year terms from the completion date of the hospital using extended period amortization schedules and included balloon payments at the end of the terms. Borrowings under this REIT Loan were collateralized by a pledge of the Company’s interest in the related hospital’s property, equipment and certain other assets. The REIT Loan, which was previously scheduled to mature during the second quarter of fiscal 2006, was refinanced in

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

February 2006. Under the terms of the new financing, the loan requires monthly, interest-only payments for ten years, at which time the loan is due in full, maturing January 2016. The interest rate on this loan is 81/2%. Borrowings under this REIT Loan are collateralized by a pledge of the Company’s interest in the related hospital’s property, equipment and certain other assets.

Notes Payable to Various Lenders — The Company acquired various medical and other equipment for a hospital with installment notes payable to an equipment lender collateralized by the related equipment. Amounts borrowed under these notes are payable in monthly installments of principal and interest over a 7 year term with fixed interest rates of 6.74% to 7.71%. The Company has guaranteed these 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, see Note 17. 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.

During March 2007, the Company paid off $11.1 million of equipment debt outstanding at one of its hospitals. Due to the early prepayment, the Company wrote off approximately $0.1 million of deferred loan acquisition costs and incurred approximately $0.1 million in early prepayment fees. These costs are reported as a loss on early extinguishment of debt in the consolidated statement of operations for the year ended September 30, 2007.

At September 30, 2009, the total amount of notes payable to various lenders was approximately $6.1 million, of which $3.6 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 — The Company was in compliance with all covenants in the instruments governing its outstanding debt as of September 30, 2008. At September 30, 2009, the Company was in violation of financial covenants under equipment loans at its consolidated subsidiary TexSAn Heart Hospital. Accordingly, the total outstanding balance of $6.1 million for these loans has been included in the current portion of long-term debt and obligations under capital leases on the Company’s consolidated balance sheet. The covenant violations did not result in any other non-compliance related to the remaining covenants governing the Company’s outstanding debt; therefore the Company was in compliance with all other covenants.

Interest Rate Swaps — During the year ended September 30, 2006 one of the hospitals in which the Company has a minority interest and consequently accounts for under the equity method, entered into an interest rate swap for purposes of hedging variable interest payments on long term debt outstanding for that hospital. The interest rate swap is accounted for as a cash flow hedge by the hospital whereby changes in the fair value of the interest rate swap flow through comprehensive income of the hospital. The Company recorded its proportionate share of comprehensive income within stockholders’ equity in the consolidated balance sheets based on the Company’s ownership interest in that hospital.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Future Maturities — Presented below are the future maturities of long-term debt at September 30, 2009, inclusive of payments under the Amended Credit Facility, discussed above.


	Debt
Fiscal Year	Maturity

2010	$	19,491
2011		14,063
2012		52,500
2013		—
2014		—
Thereafter		35,308

	$	121,362


10.	Obligations Under Capital Leases

The Company currently leases several diagnostic and therapeutic facilities, mobile catheterization laboratories, office space, computer software and hardware, equipment and certain vehicles under capital leases expiring through fiscal year 2015. Some of these leases contain provisions for annual rental adjustments based on increases in the consumer price index, renewal options, and options to purchase during the lease terms. Amortization of the capitalized amounts is included in depreciation expense. Total assets under capital leases (net of accumulated depreciation of approximately $3.7 million and $4.6 million) at September 30, 2009 and 2008, respectively, are approximately $3.3 million and $3.7 million, respectively, and are included in property and equipment on the consolidated balance sheets. Lease payments during the years ended September 30, 2009, 2008, and 2007 were $1.4 million, $1.5 million and $1.8 million, respectively, and include interest of approximately $0.2 million, $0.2 million, and $0.2 million, respectively.

Future minimum lease payments at September 30, 2009 are as follows:


	Minimum
Fiscal Year	Lease Payment

2010	$	2,123
2011		2,036
2012		1,483
2013		933
2014		625
Thereafter		53

Total future minimum lease payments		7,253
Less amounts representing interest		(854	)

Present value of net minimum lease payments		6,399
Less current portion		(1,752	)

	$	4,647


11.	Liability Insurance Coverage

During June 2009 and 2008, the Company entered into a one-year claims-made policy providing coverage for medical malpractice claim amounts in excess of $2.0 million of retained liability per claim. The Company also purchased additional insurance to reduce the retained liability per claim to $250,000 for the MedCath Partners Division, for each respective fiscal year.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Because of the Company’s self-insured retention levels, the Company is required to recognize an estimated expense/liability for the amount of retained liability applicable to each malpractice claim. As of September 30, 2009 and September 30, 2008, 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 $4.9 million and $4.6 million, respectively, which is included in other accrued liabilities in the consolidated balance sheets. The Company maintains this reserve based on actuarial estimates using the Company’s historical experience with claims and assumptions about future events.

In addition to reserves for medical malpractice, the Company also maintains reserves for self-insured workman’s compensation, healthcare and dental coverage. The total estimated reserve for self-insured liabilities for workman’s compensation, employee health and dental claims was $3.5 million and $3.2 million as of September 30, 2009 and September 30, 2008, respectively, which is included in other accrued liabilities in the consolidated balance sheets. The Company maintains this reserve based on historical experience with claims. The Company maintains commercial stop loss coverage for health and dental insurance program of $175,000 per plan participant.


12.	Commitments and Contingencies

Operating Leases — The Company currently leases several cardiac diagnostic and therapeutic facilities, mobile catheterization laboratories, office space, computer software and hardware equipment, certain vehicles and land under noncancelable operating leases expiring through fiscal year 2017. Total rent expense under noncancelable rental commitments was approximately $2.4 million, $2.6 million and $2.3 million for the years ended September 30, 2009, 2008 and 2007, respectively, and is included in other operating expenses in the accompanying consolidated statements of income.

The approximate future minimum rental commitments under noncancelable operating leases as of September 30, 2009 are as follows:


	Rental
Fiscal Year	Commitment

2010	$	2,231
2011		1,936
2012		1,747
2013		1,722
2014		1,206
Thereafter		492

	$	9,334

Contingencies — 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 the Company. In addition, reimbursement is generally subject to adjustment following audit by third party payors, including the fiscal intermediaries who administer the Medicare program, the Centers 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. The Company believes that adequate provisions have 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 net revenue, there is a possibility that recorded estimates will change by a material amount in the future.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In 2005, CMS began using recovery audit contractors (“RAC”) to detect Medicare overpayments not identified through existing claims review mechanisms. The RAC program relies on private auditing firms to examine Medicare claims filed by healthcare providers. Fees to the RACs are paid on a contingency basis. The RAC program began as a demonstration project in 2005 in three states (New York, California and Florida) which was expanded into the three additional states of Arizona, Massachusetts and South Carolina in July 2007. No RAC audits, however, were initiated at the Company’s Arizona or California hospitals during the demonstration project. The program was made permanent by the Tax Relief and Health Care Act of 2006 enacted in December 2006. CMS announced in March 2008 the end of the demonstration project and the commencement of the permanent program by the expansion of the RAC program to additional states beginning in the summer and fall of 2008 and its plans to have RACs in place in all 50 states by 2010.

The Company believes the claims for reimbursement submitted to the Medicare program by the Company’s facilities have been accurate, however the Company is unable to reasonably estimate what the potential result of future RAC audits or other reimbursement matters could be.

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 by various claimants and additional claims that may be asserted for known incidents through September 30, 2009. These claims and legal actions are in various stages, and some may ultimately be brought to trial. Moreover, additional claims arising from services provided to patients in the past and other legal actions may be asserted in the future. The Company is protecting its interests in all such claims and actions and does not expect the ultimate resolution of these matters to have a material adverse impact on the Company’s consolidated financial position, results of operations or cash flows.

A joint venture in our Partners Division provides cardiac care services to a hospital pursuant to a management and services agreement. The joint venture and the hospital disagreed regarding the interpretation of certain provisions in the management and services agreement. During August 2008 the two parties reached an agreement as to settlement, resulting in the Company recording a liability of $0.7 million which is included within accrued liabilities in the consolidated balance sheet at September 30, 2008. During November 2008 the entire settlement amount was paid by the Company.

The U.S. Department of Justice (“DOJ”) conducted an investigation of a clinical trial conducted at one of our hospitals. The investigation concerned alleged improper federal healthcare program billings from1998-2002 because certain endoluminal graft devices were implanted either without an approved investigational device exception or outside of the approved protocol. The DOJ reached a settlement under the False Claims Act with the medical practice whose physicians conducted the clinical trial. The hospital entered into an agreement with the DOJ under which it paid $5.8 million to the United States to settle, and obtain a release from any federal civil false claims related to DOJ’s investigation. The settlement and release cover both the hospital and the physician who conducted the clinical trial, and does not include any finding of wrong doing or any admission of liability. The Company recorded a $5.8 million reduction in net revenue for the year ended September 30, 2007, to establish a reserve for repayment of a portion of Medicare reimbursement related to hospital inpatient services provided to patients from1998-2002. The $5.8 million settlement was paid to the United States in November 2007.

During fiscal years 2009 and 2008 the Company refunded certain reimbursements to CMS related to carotid artery stent procedures performed during prior fiscal years at two of the Company’s consolidated subsidiary hospitals. The DOJ initiated an investigation related to the Company’s return of these reimbursements. As a result of the DOJ’s investigation, the Company began negotiating a settlement agreement during the third quarter of fiscal

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2009 with the DOJ whereby the Company is expected to pay approximately $0.8 million to settle and obtain a release from any federal civil false claims liability related to the DOJ’s investigation. The DOJ allegations do not involve patient care, and relate solely to whether the procedures were properly reimbursable by Medicare. The settlement would not include any finding of wrong-doing or any admission of liability. As part of the settlement, the Company is also negotiating with the Department of Health and Human Services, Office of Inspector General (“OIG”), to obtain a release from any federal healthcare program permissive exclusion actions to be instituted by the OIG. As of September 30, 2009 the Company had accrued $0.8 million within other accrued liabilities on the consolidated balance sheet.

On January 8, 2009, the California Supreme Court ruled inProspect Medical Group, Inc., et al. v. Northridget Emergency Medical Group, et al.(2009) 45 Cal. 4^th 497, that under California’s Knox-Keene statute healthcare providers may not bill patients for covered emergency out patient services for which health plans or capitated payors are invoiced by the provider but fail to pay the provider. The California Supreme Court held that the only recourse for healthcare providers is to pursue the payors directly. TheProspectdecision does not apply to amounts that the health plan or capitated payor is not obligated to pay under the terms of the insured’s policy or plan. Although the decision only considered emergency providers and referred to HMOs and capitated payors, future court decisions on how the so-called “balance billing” statute is interpreted does pose a risk to healthcare providers that perform emergency or other out-patient services in the state of California.

On or about October 6, 2009, a purported class action law suit was filed by an individual against the Bakersfield Heart Hospital. In the complaint the plaintiff alleges that under California law, and specifically under the Knox-Keene Healthcare Service Plan Act of 1975, and under the Health and Safety Code of California that California prohibits the practice of “balance billing” patients who are provided “emergency services” as defined under California law. A class has not been certified by the court in this case. We are unable to predict with certainty the outcome of this case or, if the plaintiff prevails whether the amount due to the Plaintiff could be material.

Commitments — The Company’s consolidated subsidiary hospitals provide guarantees to certain physician groups for funds required to operate and maintain services for the benefit of the hospital’s patients including emergency care and anesthesiology services, among other services. These guarantees extend for the duration of the underlying service agreements. As of September 30, 2009, the maximum potential future payments that the Company could be required to make under these guarantees was approximately $33.6 million through October 2012. At September 30, 2009 the Company had total liabilities of $15.3 million for the fair value of these guarantees, of which $7.6 million is in other accrued liabilities and $7.7 million is in other long term obligations. Additionally, the Company had assets of $15.3 million representing the future services to be provided by the physicians, of which $7.7 million is in prepaid expenses and other current assets and $7.6 million is in other assets.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


13.	Income Taxes

The components of income tax expense (benefit) are as follows:


	Year Ended September 30,
	2009			2008			2007

Current tax expense
Federal	$	3,080		$	4,913		$	16,544
State		1,245			2,854			3,206

Total current tax expense		4,325			7,767			19,750
Deferred tax expense (benefit)
Federal		(3,302	)		2,365			(7,864	)
State		177			(758	)		(1,555	)

Total deferred tax expense (benefit)	$	(3,125	)	$	1,607		$	(9,419	)

Total income tax expense	$	1,200		$	9,374		$	10,331

The components of net deferred taxes are as follows:


	Year Ended September 30,
	2009			2008

Deferred tax liabilities:
Property and equipment	$	24,481		$	20,227
Equity investments		2,151			1,844
Management contracts		—			1,225
Gain on sale of partnership units		2,461			2,461
Other		568			253

Total deferred tax liabilities		29,661			26,010

Deferred tax assets:
Net operating and economic loss carryforward		4,447			4,356
Basis difference in investment in subsidiaries		5,642			4,636
Allowances for doubtful accounts and other reserves		8,859			6,946
Accrued liabilities		3,736			2,924
Intangibles		2,293			100
Share based compensation expense		4,531			6,081
Management contracts		586			—
Other		585			547

Total deferred tax assets		30,679			25,590
Valuation allowance		(2,691	)		(2,163	)

Net deferred tax asset (liability)	$	(1,673	)	$	(2,583	)

As of September 30, 2009 and 2008, the Company had recorded a valuation allowance of $2.7 million and $2.2 million, respectively, primarily related to state net operating loss carryforwards. The valuation allowance increased by approximately $0.5 million during the year ended September 30, 2009 due to a current year loss incurred in certain states.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company has state net operating loss carryforwards of approximately $108.7 million that began to expire in 2009.

The differences between the U.S. federal statutory tax rate and the effective rate are as follows.


	Year Ended September 30,
	2009			2008			2007

Statutory federal income tax rate		(35.0	)%		35.0	%		35.0	%
State income taxes, net of federal effect		1.7	%		4.3	%		7.9	%
Share-based compensation expense		—			1.7	%		2.0	%
Penalties		0.4	%		—			1.3	%
Goodwill		35.0	%		—			—
Other non-deductible expenses and adjustment		—			2.1	%		(1.4	)%

Effective income tax rate		2.1	%		43.1	%		44.8	%

In June 2006, the FASB issued a new accounting standard that established a single model to address the accounting for uncertain tax positions. The new accounting standard clarified the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The new accounting standard also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company adopted the new accounting standard effective October 1, 2007. As a result of the implementation, the Company recognized a $0.3 million net increase to the reserves for uncertain tax positions. This increase was accounted for as a cumulative effect adjustment and recognized as a reduction in beginning retained earnings in the consolidated balance sheet. Including the cumulative effect adjustment, the Company had approximately $2.4 million of unrecognized tax benefits as of October 1, 2007 and $0.5 million and $1.2 million as of September 30, 2009 and 2008, respectively, recorded in other accrued liabilities on the consolidated balance sheets. Of the balance at September 30, 2009 and 2008, $0.3 million and $0.5 million, respectively, represented the amount of unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate in any future periods. It is expected that the amount of unrecognized tax benefits will change in the next twelve months; however the Company does not expect the change to have a significant impact on the results of operations or the financial position of the Company.

The Company includes interest related to tax issues as part of interest expense in the consolidated financial statements. The Company records applicable penalties, if any, related to tax issues within the income tax provision. The Company had $0.2 million and $0.4 million accrued for interest as of September 30, 2009 and 2008, respectively. The interest impact for the unrecognized tax liabilities was $(0.2) million to the consolidated financial results for fiscal 2009. There were no penalties recorded for the unrecognized tax benefits.

Following is a reconciliation of the Company’s unrecognized tax benefits:


	Year Ended September 30,
	2009			2008

Beginning Balance	$	1,234		$	2,424
Additions based on tax positions of prior years		—			640
Settlements		(514	)		—
Reductions for positions of prior years		(201	)		(1,830	)

Ending Balance	$	519		$	1,234

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Due to the utilization of all federal net operating losses in the past three years, the Company may be subject to examination by the Internal Revenue Service (“IRS”) back to September 30, 2000. In addition, the Company files income tax returns in multiple states and local jurisdictions. Generally, the Company is subject to state and local audits going back to years ended September 30, 2006; however, due to existing net operating loss carryforwards, the IRS can audit back to September 30, 1998 and September 30, 1999 in a few significant states.

In the ordinary course of the Company’s business there are transactions where the ultimate tax determination is uncertain. The Company believes that is has adequately provided for income tax issues not yet resolved with federal, state and local tax authorities. If an ultimate tax assessment exceeds the Company’s estimate of tax liabilities, an additional charge to expense would result.


14.	Per Share Data

The calculation of diluted earnings (loss) per share considers the potential dilutive effect of options to purchase 1,027,387, 1,776,837, and 1,727,112 shares of common stock at prices ranging from $9.95 to $33.05, which were outstanding at September 30, 2009, 2008 and 2007, respectively, as well as 552,827 and 123,982 shares of restricted stock which were outstanding at September 30, 2009 and 2008, respectively. Of the outstanding stock options and restricted stock, 1,580,214, 947,000, and 135,000 have not been included in the calculation of diluted earnings (loss) per share at September 30, 2009, 2008 and 2007, respectively, because the options and restricted stock were anti-dilutive.


15.	Stock Compensation Plans

On July 28, 1998, the Company’s board of directors adopted a stock option plan (the “1998 Stock Option Plan”) under which it may grant incentive stock options and nonqualified stock options to officers and other key employees. Under the 1998 Stock Option Plan, the board of directors may grant option awards and determine the option exercise period, the option exercise price, and other such conditions and restrictions on the grant or exercise of the option as it deems appropriate. The 1998 Stock Option Plan provides that the option exercise price may not be less than the fair value of the common stock as of the date of grant and that the options may not be exercised more than ten years after the date of grant. Options that have been granted during the years ended September 30, 2009, 2008 and 2007 were granted at an option exercise price equal to or greater than fair market value of the underlying stock at the date of the grant and become exercisable on grading and fixed vesting schedules ranging from 4 to 8 years subject to certain performance acceleration features. As further discussed in Note 2, effective September 30, 2005, the compensation committee of the board of directors approved a plan to accelerate the vesting of substantially all unvested stock options previously awarded to employees, subject to a Restriction Agreement. No options may be granted under the 1998 Stock Option Plan after July 31, 2008. At September 30, 2009, 513,387 options were outstanding under the 1998 Option Plan.

On July 23, 2000, the Company adopted an outside director’s stock option plan (the “Director’s Plan”) under which nonqualified stock options may be granted to non-employee directors. Under the Director’s Plan, grants of 2,000 options were granted to each new director upon becoming a member of the board of directors and grants of 2,000 options were made to each continuing director on October 1, 1999 (the first day of the fiscal year ended September 30, 2000). Effective September 15, 2000, the Director’s Plan was amended to increase the number of options granted for future awards from 2,000 to 3,500. Further, effective September 30, 2007, the Director’s Plan was amended to increase the number of options granted for future awards from 3,500 to 8,000. All options granted under the Director’s Plan through September 30, 2009 have been granted at an exercise price equal to or greater than the fair market value of the underlying stock at the date of the grant. Options are exercisable immediately upon the date of grant and expire ten years from the date of grant. Effective March 5, 2008, the Director’s Plan was amended to increase the maximum number of common stock shares which can be issued under the Director’s Plan by 300,000. The maximum number of shares of common stock which can be issued through awards granted under the Director’s Plan was 550,000, of which 145,500 were outstanding as of September 30, 2009.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Effective October 1, 2005, the Company adopted the MedCath Corporation 2006 Stock Option and Award Plan (the “Stock Plan”), which provides for the issuance of stock options, restricted stock and restricted stock units to employees of the Company. The Stock Plan is administered by the compensation committee of the board of directors, who has the authority to select the employees eligible to receive awards. This committee also has the authority under the Stock Plan to determine the types of awards, select the terms and conditions attached to all awards, and, subject to the limitation on individual awards in the Stock Plan, determine the number of shares to be awarded. At September 30, 2009, the maximum number of shares of common stock which can be issued through awards granted under the Stock Plan was 1,750,000 of which 1,022,827 were outstanding as of September 30, 2009.

Stock options granted to employees under the Stock Plan have an exercise price per share that represents the fair market value of the common stock of the Company on the respective dates that the options are granted. The options expire ten years from the grant date, are fully vested as of the date of grant, and are exercisable at any time. Subsequent to the exercise of stock options, the shares of stock acquired upon exercise may be subject to certain sale restrictions depending on the optionee’s employment status and length of time the options were held prior to exercise.

The Company recognized share-based compensation expense for the fiscal years ended September 30, 2009, 2008 and 2007 of $2.4 million, $5.0 million and $4.3 million, respectively. The associated tax benefits related to the compensation expense recognized for fiscal 2009, 2008 and 2007 was $1.0 million, $2.0 million and $1.9 million, respectively. The weighted-average grant-date fair value of options granted during the fiscal years ended September 30, 2009, 2008 and 2007 was $9.75, $10.53 and $12.80, respectively. The total intrinsic value of options exercised during fiscal 2009 was immaterial. The total intrinsic value of options exercised during fiscal 2008 and fiscal 2007 were $1.4 million and $5.5 million, respectively. The total intrinsic value of options outstanding at September 30, 2009 was $(13.9) million.

Stock Options

Stock option activity for the Company’s stock compensation plans during the years ended September 30, 2009, 2008 and 2007 was as follows:


				Weighted-
	Number of			Average
	Options			Exercise Price

Outstanding options, September 30, 2006		2,070,472		$	18.80
Granted		243,000			29.22
Exercised		(411,146	)		14.03
Cancelled		(175,214	)		22.95

Outstanding options, September 30, 2007		1,727,112		$	19.11
Granted		480,000			24.51
Exercised		(269,996	)		15.99
Cancelled		(160,279	)		26.93

Outstanding options, September 30, 2008		1,776,837		$	22.15
Granted		82,000			17.46
Exercised		(7,000	)		10.95
Cancelled		(824,450	)		21.65

Outstanding options, September 30, 2009		1,027,387		$	22.25

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table summarizes information for options outstanding and exercisable at September 30, 2009:


Options Outstanding and Exercisable
	Number of
	Options		Weighted-		Weighted-
	Outstanding		Average		Average
Range of	and		Remaining		Exercise
Prices	Exercisable		Life (years)		Price

9.95 - 15.80		108,137		5.38	$	13.67
16.10 - 18.26		32,500		4.43		16.86
19.00 - 20.07		56,500		3.65		19.24
21.01 - 21.49		510,000		6.44		21.48
21.66 - 23.65		40,500		4.96		22.30
23.79 - 27.71		164,750		6.77		26.53
27.80 - 29.68		50,000		7.42		29.15
30.35 - 33.05		65,000		7.54		31.72

$ 9.95 - 33.05		1,027,387		6.22	$	22.25

Restricted Stock Awards

During the year ended September 30, 2006, the Company granted to employees 270,836 shares of restricted stock units, which vest at various dates through March 2009. The compensation expense, which represents the fair value of the stock measured at the market price at the date of grant, less estimated forfeitures, is recognized on a straight-line basis over the vesting period. Unamortized compensation expense related to restricted stock units amounted to $0.3 million and $1.8 million at September 30, 2008 and 2007, respectively.

During fiscal 2009, the Company granted to employees 599,645 shares of restricted stock. Restricted stock granted to employees, excluding executives of the Company, vest in equal annual installments over a three year period. Executives of the Company, defined by the Company as vice president or higher, received two restricted stock equal grants. The first grant of restricted stock vests in equal annual installments over a three year period, the second grant of restricted stock vests over a three year period based on established performance conditions. During fiscal 2009, the Company granted 101,500 shares of restricted stock units to directors, which were fully vested at the date of grant and are paid in shares of common stock upon each applicable director’s termination of service on the board. Compensation expense, derived from the market price of the Company’s stock at the date of grant, less estimated forfeitures, is recognized on a straight-line basis over the vesting period. At September 30, 2009 the Company had $3.2 million of unrecognized compensation expense associated with restricted stock awards.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Activity for the Company’s restricted stock issued under the Stock Plan during the years ended September 30, 2009, 2008 and 2007 was as follows:


	Number of			Weighted-
	Restricted			Average
	Stock Units			Grant Price

Outstanding restricted stock units, September 30, 2006		216,835		$	19.80
Cancelled		(22,853	)		20.50

Outstanding restricted stock units, September 30, 2007		193,982		$	19.72
Vested		(21,448	)		20.50
Cancelled		(48,552	)		20.50

Outstanding restricted stock units, September 30, 2008		123,982		$	19.28
Granted		701,145			9.00
Vested		(52,106	)		20.50
Cancelled		(118,694	)		11.19

Outstanding restricted stock units, September 30, 2009		654,327		$	9.64


16.	Employee Benefit Plan

The Company has a defined contribution retirement savings plan (the “401(k) Plan”) which covers all employees. The 401(k) Plan allows employees to contribute from 1% to 50% of their annual compensation on a pre-tax basis. The Company, at its discretion, may make an annual contribution of up to 40% of an employee’s pretax contribution, up to a maximum of 6% of compensation. This annual contribution percentage was increased to 40% for the year ended September 30, 2008 from 30% for the year ended September 30, 2007. The Company’s contributions to the 401(k) Plan for the years ended September 30, 2009, 2008 and 2007 were approximately $2.4 million, $2.3 million and $1.7 million, respectively.


17.	Related Party Transactions

During the year ended September 30, 2007 the Company incurred $0.1 million in insurance and related risk management fees to its principal stockholders and their affiliates. No amounts were incurred in insurance and related risk management fees to its principal stockholders and their affiliates during the years ended September 30, 2009 and 2008. No consulting fees were paid to any directors during the years ended September 30, 2009, 2008 and 2007.

As compensation for the Company’s guarantee of certain unconsolidated affiliate hospitals long term debt, the Company receives a debt guarantee fee; see Note 9 for further discussion. Debt guarantee fees recorded in net revenues in the consolidated statement of operations were $0.4 million, $0.4 million and $0.5 million for the years ended September 30, 2009, 2008 and 2007, respectively. Additionally the Company receives a management fee from unconsolidated affiliates. Management fees recorded within net revenues in the consolidated statement of operations were $5.6 million, $6.0 million, and $3.6 million for the years ended September 30, 2009, 2008 and 2007, respectively. At September 30, 2009 and 2008 the Company had $1.6 million and $2.1 million of outstanding fees recorded of which $1.0 million and $0.8 million was recorded within accounts receivable, net and $0.5 million and $1.3 million within prepaid expenses and other current assets, respectively, in the consolidated balance sheets primarily related to management, insurance and legal fees charged to unconsolidated affiliates, see Note 8 for further discussion regarding unconsolidated affiliates of the Company.

One of the Company’s consolidated hospitals leases certain office space to a physician group, which is a partner in the aforementioned hospital, under a noncancelable operating lease. Total rental income recorded under this lease was $501,000, $475,000 and $475,000 during the years ended September 30, 2009, 2008 and 2007,

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

respectively, and is included in net revenue. The lease terminates during October 2009, with future minimum payments of $42,000 to be received during the year ended September 30, 2010.


18.	Summary of Quarterly Financial Data (Unaudited)

Summarized quarterly financial results were as follows:


	Year Ended September 30, 2009
	First			Second		Third		Fourth
	Quarter			Quarter		Quarter		*Quarter ()**

Net revenue	$	150,245		$	155,682	$	148,149	$	147,966
Operating expenses		143,252			144,949		146,765		210,760
Income (loss) from operations		6,993			10,733		1,384		(62,794	)
(Loss) Income from continuing operations		(1,914	)		5,090		306		(61,900	)
Income from discontinued operations		4,160			492		190		3,294
Net income (loss)	$	2,246		$	5,582	$	496	$	(58,606	)
Earnings (loss) per share, basic
Continuing operations	$	(0.11	)	$	0.26	$	0.02	$	(3.14	)
Discontinued operations		0.22			0.02		0.01		0.17

Earnings (loss) per share, basic	$	0.11		$	0.28	$	0.03	$	(2.97	)

Earnings (loss) per share, diluted
Continuing operations	$	(0.11	)	$	0.26	$	0.02	$	(3.14	)
Discontinued operations		0.22			0.02		0.01		0.17

Earnings (loss) per share, diluted	$	0.11		$	0.28	$	0.03	$	(2.97	)

Weighted average number of shares, basic		19,599			19,664		19,733		19,740
Dilutive effect of stock options and restricted stock		—			26		—		—

Weighted average number of shares, diluted		19,599			19,690		19,733		19,740


(*)		The fourth quarter of fiscal 2009 includes the $60.2 million impairment of goodwill as discussed in Note 4.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Year Ended September 30, 2008
	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter

Net revenue	$	143,728	$	151,022	$	151,350	$	145,511
Operating expenses		135,233		137,774		138,782		141,149
Income from operations		8,495		13,248		12,568		4,362
Income from continuing operations		2,071		5,270		4,877		155
Income from discontinued operations		993		415		6,895		314
Net income	$	3,064	$	5,685	$	11,772	$	469
Earnings per share, basic
Continuing operations	$	0.09	$	0.27	$	0.25	$	0.01
Discontinued operations	$	0.05	$	0.02		0.35		0.01

Earnings per share, basic	$	0.14	$	0.29	$	0.60	$	0.02

Earnings per share, diluted
Continuing operations	$	0.09	$	0.26	$	0.25	$	0.01
Discontinued operations	$	0.04	$	0.03		0.35		0.01

Earnings per share, diluted	$	0.13	$	0.29	$	0.60	$	0.02

Weighted average number of shares, basic		21,028		19,841		19,524		19,590
Dilutive effect of stock options and restricted stock		263		121		107		65

Weighted average number of shares, diluted		21,291		19,962		19,631		19,655


19.	Reportable Segment Information

The Company’s reportable segments consist of the Hospital Division and the MedCath Partners Division. The Hospital Division consists of freestanding, licensed general acute care hospitals that provide a wide range of health services with a focus on cardiovascular care. MedCath Partners Division consists of cardiac diagnostic and therapeutic facilities that are either freestanding or located within unrelated hospitals. MedCath Partners Division provides management services to facilities or operates facilities directly on a contracted basis.

There is no aggregation of operating segments within each reportable segment. The Company believes these reportable business segments properly align the various operations of the Company with how the chief operating decision maker views the business. The Company’s chief operating decision maker regularly reviews financial information about each of these reportable business segments in deciding how to allocate resources and evaluate performance.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Financial information concerning the Company’s operations by each of the reportable segments as of and for the years ended September 30 are as follows:


	Year Ended September 30,
	2009			2008			2007

Net revenue:
Hospital Division	$	582,679		$	568,625		$	610,008
MedCath Partners Division		18,946			20,585			24,260
Corporate and other		417			2,401			2,258

Consolidated totals	$	602,042		$	591,611		$	636,526

(Loss) income from operations:
Hospital Division (*)	$	(33,357	)	$	68,726		$	64,132
MedCath Partners Division		(1,545	)		(148	)		1,125
Corporate and other		(8,782	)		(29,905	)		(13,278	)

Consolidated totals	$	(43,684	)	$	38,673		$	51,979

Depreciation and amortization:
Hospital Division	$	27,456		$	25,232		$	25,703
MedCath Partners Division		4,769			4,120			4,914
Corporate and other		651			773			487

Consolidated totals	$	32,876		$	30,125		$	31,104

Interest expense (income) including intercompany, net:
Hospital Division	$	17,175		$	19,955		$	29,408
MedCath Partners Division		5			(5	)		47
Corporate and other		(10,599	)		(7,589	)		(14,898	)

Consolidated totals	$	6,581		$	12,361		$	14,557

Equity in net earnings of unconsolidated affiliates:
Hospital Division	$	5,045		$	5,502		$	5,200
MedCath Partners Division		3,785			2,157			337
Corporate and other		227			232			202

Consolidated totals	$	9,057		$	7,891		$	5,739

Capital expenditures:
Hospital Division	$	89,157		$	78,862		$	31,340
MedCath Partners Division		—			1,890			838
Corporate and other		4,755			3,891			4,182

Consolidated totals	$	93,912		$	84,643		$	36,360


(*)		The Hospital Division (loss) income from operations for fiscal 2009 includes the $60.2 million impairment of goodwill as discussed in Note 4.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	September 30,
	2009		2008

Aggregate identifiable assets:
Hospital Division	$	517,849	$	546,665
MedCath Partners Division		27,205		38,719
Corporate and other		45,394		68,072

Consolidated totals	$	590,448	$	653,456

Investments in affiliates:
Hospital Division	$	2,834	$	4,219
MedCath Partners Division		11,075		11,147
Corporate and other		146		(81	)

Consolidated totals	$	14,055	$	15,285

Substantially all of the Company’s net revenue in its Hospital Division and MedCath Partners Division is derived directly or indirectly from patient services. The amounts presented for corporate and other primarily include management and consulting fees, general overhead and administrative expenses, financing activities, certain cash and cash equivalents, prepaid expenses, other assets and operations of the business not subject to separate segment reporting.


20.	Treasury Stock

During fiscal 2007, the board of directors approved a stock repurchase program of up to $59.0 million. During fiscal 2008 1,885,461 million shares of common stock, with a total cost of $44.4 million, were repurchased by the Company under this program. There were no repurchases of common stock during fiscal 2009.


21.	Supplemental Cash Flow Disclosures

Supplemental disclosures of cash flow information for the years ended September 30, 2009, 2008 and 2007 are presented below.


	Year Ended September 30,
	2009		2008		2007

Supplemental disclosure of cash flow information:
Interest paid	$	10,537	$	14,725	$	23,065
Income taxes paid	$	6,212	$	26,777	$	10,927
Supplemental schedule of noncash investing and financing activities:
Capital expenditures financed by capital leases	$	4,489	$	1,582	$	1,645
Accrued capital expenditures	$	7,960	$	15,185	$	—
Subsidiary stock issued in exchange for services at fair market value	$	—	$	—	$	240

INDEPENDENT AUDITORS’ REPORT

To Heart Hospital of South Dakota, LLC:

We have audited the accompanying balance sheets of Heart Hospital of South Dakota, LLC (the “Company”) as of September 30, 2009 and 2008, and the related statements of income, members’ capital, and cash flows for each of the three years in the period ended September 30, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2009, in conformity with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

Charlotte, North Carolina

December 14, 2009

HEART HOSPITAL OF SOUTH DAKOTA, LLC

BALANCE SHEETS

(In thousands)


	September 30,
	2009		2008

Current assets:
Cash	$	14,202	$	16,542
Accounts receivable, net		5,918		7,081
Medical supplies		1,211		1,202
Prepaid expenses and other current assets		1,429		1,323

Total current assets		22,760		26,148
Property and equipment, net		33,769		33,360
Other assets		901		1,426

Total assets	$	57,430	$	60,934

Current liabilities:
Accounts payable	$	1,910	$	2,946
Accrued compensation and benefits		2,543		2,871
Accrued property taxes		690		697
Other accrued liabilities		1,153		1,162
Current portion of long-term debt		2,064		1,739

Total current liabilities		8,360		9,415
Long-term debt		19,390		19,967
Other long-term obligations		2,250		1,888

Total liabilities		30,000		31,270
Members’ capital		27,430		29,664

Total liabilities and members’ capital	$	57,430	$	60,934

See notes to financial statements.

HEART HOSPITAL OF SOUTH DAKOTA, LLC

STATEMENTS OF INCOME

(In thousands)


	Year Ended September 30,
	2009			2008			2007

Net revenue	$	66,962		$	67,041		$	66,342
Operating expenses:
Personnel expense		21,707			22,308			21,246
Medical supplies expense		15,047			14,627			15,917
Bad debt expense		2,457			1,036			1,721
Other operating expenses		9,721			9,365			9,979
Depreciation		2,615			2,139			1,915
Loss on disposal of property, equipment and other assets		10			140			33

Total operating expenses		51,557			49,615			50,811

Income from operations		15,405			17,426			15,531
Other income (expenses):
Interest expense		(1,322	)		(1,441	)		(1,711	)
Interest and other income, net		159			453			617

Total other expenses, net		(1,163	)		(988	)		(1,094	)

Net income	$	14,242		$	16,438		$	14,437

See notes to financial statements.

HEART HOSPITAL OF SOUTH DAKOTA, LLC

STATEMENTS OF MEMBERS’ CAPITAL

(In thousands)


										Accumulated Other
	Sioux Falls									Comprehensive Income (Loss)
	Hospital			North Central						Sioux Falls			North Central
	Management,			Heart Institute			Avera			Hospital			Heart Institute			Avera
	Inc.			Holdings, PLLC			McKennan			Management, Inc.			Holdings, PLLC			McKennan			Total

Balance, September 30, 2006	$	7,436		$	7,436		$	7,436		$	(74	)	$	(74	)	$	(74	)	$	22,086
Distributions to members		(3,299	)		(3,299	)		(3,298	)		—			—			—			(9,896	)
Comprehensive income:
Net income		4,813			4,812			4,812			—			—			—			14,437
Change in fair value of interest rate swap		—			—			—			(20	)		(20	)		(20	)		(60	)

Total comprehensive income																				14,377

Balance, September 30, 2007	$	8,950		$	8,949		$	8,950		$	(94	)	$	(94	)	$	(94	)	$	26,567
Distributions to members		(4,254	)		(4,253	)		(4,253	)		—			—			—			(12,760	)
Comprehensive income:
Net income		5,480			5,479			5,479			—			—			—			16,438
Change in fair value of interest rate swap		—			—			—			(194	)		(194	)		(193	)		(581	)

Total comprehensive income																				15,857

Balance, September 30, 2008	$	10,176		$	10,175		$	10,176		$	(288	)	$	(288	)	$	(287	)	$	29,664
Distributions to members		(5,189	)		(5,189	)		(5,189	)		—			—			—			(15,567	)
Comprehensive income:
Net income		4,747			4,748			4,747			—			—			—			14,242
Change in fair value of interest rate swap		—			—			—			(303	)		(303	)		(303	)		(909	)

Total comprehensive income																				13,333

Balance, September 30, 2009	$	9,734		$	9,734		$	9,734		$	(591	)	$	(591	)	$	(590	)	$	27,430

See notes to financial statements.

HEART HOSPITAL OF SOUTH DAKOTA, LLC

STATEMENTS OF CASH FLOWS

(In thousands)


	Year Ended September 30,
	2009			2008			2007

Net income	$	14,242		$	16,438		$	14,437
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt expense		2,457			1,036			1,721
Depreciation		2,615			2,139			1,915
Amortization of loan acquisition costs		39			39			38
Loss on disposal of property, equipment and other assets		10			140			33
Change in assets and liabilities that relate to operations:
Accounts receivable		(1,294	)		(909	)		(1,706	)
Medical supplies		(9	)		(90	)		218
Prepaid expenses and other assets		856			(87	)		(71	)
Accounts payable and accrued liabilities		(1,830	)		117			1,055
Due to affiliates		—			—			40

Net cash provided by operating activities		17,086			18,823			17,680
Investing activities:
Purchases of property and equipment		(3,613	)		(2,112	)		(1,240	)
Proceeds from sale of property and equipment		6			18			(7	)

Net cash used in investing activities		(3,607	)		(2,094	)		(1,247	)
Financing activities:
Proceeds from issuance of long-term debt		1,780			—			347
Repayments of long-term debt		(2,032	)		(1,586	)		(3,057	)
Distributions to members		(15,567	)		(12,760	)		(9,896	)

Net cash used in financing activities		(15,819	)		(14,346	)		(12,606	)

Net change in cash		(2,340	)		2,383			3,827
Cash:
Beginning of year		16,542			14,159			10,332

End of year	$	14,202		$	16,542		$	14,159

Supplemental cash flow disclosures:
Interest paid	$	1,322		$	1,441		$	1,677

See notes to financial statements.

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS

(All tables in thousands)


1.	Organization

Heart Hospital of South Dakota, LLC, doing business as Avera Heart Hospital of South Dakota, (the “Company”) is a North Carolina limited liability company that was formed on June 18, 1999 to develop, own, and operate an acute-care hospital located in South Dakota, specializing in all aspects of cardiology and cardiovascular surgery. The hospital commenced operations on March 20, 2001. At September 30, 2009 and 2008, Sioux Falls Hospital Management, Inc., North Central Heart Institute Holdings, PLLC, and Avera McKennan each held a 331/3% interest in the Company.

Sioux Falls Hospital Management, Inc., an indirectly wholly owned subsidiary of MedCath Corporation (“MedCath”), acts as the managing member in accordance with the Company’s operating agreement. The Company will cease to exist on December 31, 2060, unless the members elect earlier dissolution. The termination date may be extended for up to an additional 40 years in five-year increments at the election of the Company’s board of directors.


2.	Summary of Significant Accounting Policies

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

Fair Value of Financial Instruments — The Company considers the carrying amounts of significant classes of financial instruments on the balance sheets to be reasonable estimates of fair value at September 30, 2009 and 2008.

Cash — Cash consists of currency on hand and demand deposits with financial institutions.

Concentrations of Credit Risk — The Company grants credit without collateral to its patients, most of whom are insured under payment arrangements with third-party payors, including Medicare, Medicaid, and commercial insurance carriers. The following table summarizes the percentage of net accounts receivable from all payors at September 30:


	2009			2008

Medicare and Medicaid		42	%		38	%
Commercial and Other		51	%		47	%
Self-pay		7	%		15	%

		100	%		100	%

Allowance for Doubtful Accounts —Accounts receivable primarily consist of amounts due from third-party payors and patients. To provide for accounts receivable that could become uncollectible in the future, the Company establishes an allowance for doubtful accounts to reduce the carrying value of such receivables to their estimated net realizable value. The Company estimates this allowance based on such factors as payor mix, aging and its historical collection experience and write-offs.

Medical Supplies —Medical supplies consist primarily of supplies necessary for diagnostics, catheterization and surgical procedures and general patient care and are stated at the lower offirst-in, first-out cost or market.

Property and Equipment —Property and equipment are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which generally range from 25 to 40 years for buildings and improvements, 25 years for land improvements, and from 3 to 10 years for equipment and software. Repairs and maintenance costs are charged to operating expense while betterments are capitalized as additions to the related

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS — (Continued)

assets. Retirements, sales and disposals of assets are recorded by removing the related cost and accumulated depreciation with any resulting gain or loss reflected in income from operations.

Long-Lived Assets —Long-lived assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of these assets and their eventual disposition are less than their carrying amount. The determination of whether or not long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated future cash flows expected to result from the use of those assets. Changes in the Company’s strategy, assumptionsand/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of long-lived assets. No impairment charges of long-lived assets were necessary for the years ended September 30, 2009 and 2008.

Other Assets —Other assets primarily consist of loan acquisition costs, which are costs associated with obtaining long-term financing (“Loan Costs”). Loan Costs, net of accumulated amortization, were $0.2 million and $0.3 million as of September 30, 2009 and 2008, respectively. The Loan Costs are being amortized using the straight-line method, which approximates the effective interest method, as a component of interest expense over the life of the related debt. Amortization expense recognized for Loan Costs totaled $39,000 for the years ended September 30, 2009 and 2008 and $38,000 for the year ended September 30, 2007.

Revenue Recognition —Amounts the Company receives for treatment of patients covered by governmental programs such as Medicare and Medicaid and other third-party payors such as commercial insurers, health maintenance organizations and preferred provider organizations are generally less than established billing rates. Payment arrangements with third-party payors may include prospectively determined rates per discharge or per visit, a discount from established charges, per diem payments, reimbursed costs (subject to limits)and/or other similar contractual arrangements. As a result, net revenue for services rendered to patients is reported at the estimated net realizable amounts as services are rendered. The Company accounts for the differences between the estimated realizable rates under the reimbursement program and the standard billing rates as contractual adjustments.

The majority of the Company’s contractual adjustments are system-generated at the time of billing based on either government fee schedules or fee schedules contained in managed care agreements with various insurance plans. Portions of the Company’s contractual adjustments are performed manually and these adjustments primarily relate to patients that have insurance plans with whom the Company does not have contracts containing discounted fee schedules, also referred to as non-contracted payors, patients that have secondary insurance plans following adjudication by the primary payor, uninsured self-pay patients and charity care patients. Estimates of contractual adjustments are made on a payor-specific basis and based on the best information available regarding the Company’s interpretation of the applicable laws, regulations and contract terms. While subsequent adjustments to the systematic contractual allowances can arise due to denials, short payments deemed immaterial for continued collection effort and a variety of other reasons, such amounts have not historically been significant.

A significant portion of the Company’s net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid, which, combined, accounted for 51%, 53% and 53%, respectively, of the Company’s net revenue during the years ended September 30, 2009, 2008 and 2007. Medicare payments for inpatient acute services and certain outpatient services are generally made pursuant to a prospective payment

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS — (Continued)

system. Under this system, a hospital is paid a prospectively-determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a Medicare severity diagnosis-related group (“MS-DRG”). Based upon the patient’s condition and treatment during the relevant inpatient stay, each MS-DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. The MS-DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The update factor is determined, in part, by the projected increase in the cost of goods and services that are purchased by hospitals, referred to as the market basket index. MS-DRG payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, MS-DRG payments are adjusted by a predetermined adjustment factor assigned to the geographic area in which the hospital is located.

While hospitals generally do not receive direct payment in addition to a MS-DRG payment, hospitals may qualify for additional capital-related cost reimbursement and outlier payments from Medicare under specific circumstances. Medicare payments for non-acute services, certain outpatient services, medical equipment, and education costs are made based on a cost reimbursement methodology and are under transition to various methodologies involving prospectively determined rates. The Company is reimbursed for cost-reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports by the Company and audits thereof by the Medicare fiscal intermediary. Medicaid payments for inpatient and outpatient services are made at prospectively determined amounts and cost based reimbursement, respectively.

The Company provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the Company does not pursue collection of amounts determined to qualify as charity care, they are not reported as net revenue.

Advertising —Advertising costs are expensed as incurred. During the years ended September 30, 2009, 2008 and 2007, the Company incurred $0.5 million, $0.3 million and $0.6 million, respectively, of advertising expenses.

Income Taxes —The Company has elected to be treated as a limited liability company for federal and state income tax purposes. As such, all taxable income or loss of the Company is included in the income tax returns of the respective members. Accordingly, no provision has been made for federal or state income taxes in the accompanying financial statements.

Members’ Share of Net Income and Loss — In accordance with the membership agreement, net income and loss are first allocated to the members based on their respective ownership percentages. If the cumulative losses of the Company exceed its initial capitalization and committed capital obligations of its members, Sioux Falls Hospital Management, Inc., the Company’s managing member, in accordance with accounting principles generally accepted in the United States of America, will recognize a disproportionate share of the Company’s losses that otherwise would be allocated to all of its members on a pro rata basis. In such cases, Sioux Falls Hospital Management, Inc. will recognize a disproportionate share of the Company’s future profits to the extent it has previously recognized a disproportionate share of the Company’s losses.

Subsequent Events — In connection with preparation of the financial statements for the year ended September 30, 2009, the Company has evaluated subsequent events for potential recognition and disclosures through December 14, 2009, the date these financial statements were issued.

New Accounting Pronouncements — Effective during the year ended September 30, 2009 the Partnership adopted the provisions of the Accounting Standards Codification (“ASC”) issued by the Financial Accounting Standards Board (“FASB”). The ASC has become the source of authoritative U.S. generally accepted accounting principles recognized by the FASB to be applied by nongovernmental entities. The ASC did not change or alter existing GAAP. The adoption of the ASC had no impact on the Partnership’s financial statements.

Effective during the year ended September 30, 2009 the Partnership adopted a new accounting standard issued by the FASB that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, the new

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS — (Continued)

accounting standard sets forth the following: (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SeeSubsequent Eventsabove.

Market Risk — The Company’s policy for managing risk related to its exposure to variability in interest rates, commodity prices, and other relevant market rates and prices includes consideration of entering into derivative instruments (freestanding derivatives), or contracts or instruments containing features or terms that behave in a manner similar to derivative instruments (embedded derivatives) in order to mitigate its risks. In addition, the Company may be required to hedge some or all of its market risk exposure, especially to interest rates, by creditors who provide debt funding to the Company. The Company recognizes derivatives and measures those instruments at fair value .


3.	Accounts Receivable

Accounts receivable, net, at September 30 is as follows:


	2009			2008

Receivables, principally from patients and third-party payors	$	7,213		$	7,720
Other receivables		86			125

		7,299			7,845
Allowance for doubtful accounts		(1,381	)		(764	)

Accounts receivable, net	$	5,918		$	7,081

Activity for the allowance for doubtful accounts for the years ended September 30 is as follows:


	2009			2008

Balance, beginning of year	$	764		$	1,182
Bad debt expense		2,457			1,036
Write-offs, net of recoveries		(1,840	)		(1,454	)

Balance, end of year	$	1,381		$	764


4.	Property and Equipment

Property and equipment, net, at September 30 is as follows:


	2009			2008

Land and improvements	$	1,384		$	1,327
Buildings and improvements		32,161			31,642
Equipment and software		23,007			21,541
Construction in progress		—			20

		56,552			54,530
Less accumulated depreciation		(22,783	)		(21,170	)

	$	33,769		$	33,360

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS — (Continued)


5.	Long-Term Debt

Long-term debt at September 30 is as follows:


	2009			2008

Bank mortgage loan	$	19,200		$	20,706
Equipment loans		2,254			1,000

		21,454			21,706
Less current portion		(2,064	)		(1,739	)

	$	19,390		$	19,967

Bank Mortgage Loan — The Company’s bank mortgage loan used to finance its building and land, was refinanced during February 2006 to extend its maturity date through December 2015 with an interest rate of the LIBOR rate plus an applicable margin of 1.25%. At September 30, 2009 and 2008, the interest rate on this loan was 1.56% and 3.74%, respectively.

During the year ended September 30, 2006 the Company entered into an interest rate swap (the “Swap”), to fix the LIBOR at 5.21% for approximately 80% of the bank mortgage loan’s outstanding balance. The Company accounts for the Swap as a cash flow hedge. At both September 30, 2009 and 2008, the Company’s effective interest rate on the notional amount of the Swap is 5.76% and 6.46%, respectively. During fiscal 2009 and 2008, the Company recognized interest expense based upon the fixed interest rate provided under the Swap, while the change in the fair value of the Swap is recorded as other comprehensive income (loss) and as an adjustment to the derivative liability in the balance sheets. The derivative liability was $1,772,000 and $863,000 at September 30, 2009 and 2008, respectively, and is included in other long-term obligations on the balance sheets. Future changes in the fair value of the Swap will be recorded based upon the variability in the market interest rates until maturity in December 2015.

The bank mortgage loan agreement contains certain restrictive covenants, which require the maintenance of specific financial ratios and amounts. The Company was in compliance with these restrictive covenants at September 30, 2009.

Notes Payable to Equipment Lenders —The Company has acquired equipment under equipment loans collateralized by the related equipment, which had a net book value of approximately $2.2 million and $2.0 million at September 30, 2009 and 2008, respectively. During January and October 2008, the Company entered into an additional $0.8 million note and $1.8 million note, respectively, collateralized by the related equipment. Amounts borrowed under these notes are payable in monthly installments of principal and interest over five-year and eight-year terms. The notes have annual fixed rates of interest ranging from 5.0% to 6.4%.

The Company also had a $2.5 million working capital line of credit that was provided by the real estate lender, and was subject to the interest rate, covenants, guarantee and collateral of the real estate loan which was scheduled to expire in June 2006 but during fiscal 2006 was extended to December 2008. During fiscal 2009 it was extended again to December 2010. No amounts were outstanding under this line of credit at September 30, 2009 or 2008.

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS — (Continued)

Future maturities of long-term debt, as of September 30, 2009, are as follows:


Fiscal Year:
2010	$	2,064
2011		2,095
2012		2,127
2013		1,957
2014		1,540
Thereafter		11,671

	$	21,454


6.	Commitments and Contingencies

Operating Leases —Total rent expense under operating leases was $43,000 during the year ended September 30, 2008 and is included in other operating expenses. There was no rent expense for noncancelable operating leases during the year ended September 30, 2009.

The Company leased certain medical equipment under noncancelable operating leases. The leases commenced during September 2009, with payment beginning in fiscal 2010. The future minimum payments to be received under these noncancelable operating leases as of September 30, 2009, are as follows:


Fiscal year:
2010	$	20
2011		22
2012		22
2013		2

Total	$	66

Commitments —The Company provides guarantees to certain non-investor physician groups for funds required to operate and maintain services for the benefit of the hospital’s patients. These guarantees extend for the duration of the underlying service agreements and the maximum potential future payments that the Company could be required to make under these guarantees was approximately $2.7 million through March 2011 as of September 30, 2009. At September 30, 2009 the Company has recorded a liability of $1.4 million for the fair value of these guarantees, of which $0.9 million is in other accrued liabilities and $0.5 million is in other long-term obligations. Additionally, the Company has recorded an asset of $1.4 million representing the future services to be provided by the physicians, of which $0.9 million is in prepaid expenses and other current assets and $0.5 million is in other assets.

Contingencies — 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. However, 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. Medicare and Medicaid cost reports have been audited by the fiscal intermediary through September 30, 2006 and September 30, 2004, respectively.

The Company is involved in various claims and legal actions in the ordinary course of business. Moreover, claims arising from services provided to patients in the past and other legal actions may be asserted in the future. The Company is protecting its interests in all such claims and actions.

Management does not believe, taking into account the applicable liability insurance coverage and the expectations of counsel with respect to the amount of potential liability, the outcome of any such claims and

100

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO FINANCIAL STATEMENTS — (Continued)

litigation, individually or in the aggregate, will have a materially adverse effect on the Company’s financial position or results of operations.


7.	Related-Party Transactions

MedCath provides working capital to the Company under a revolving credit note with a maximum borrowing limit of $12.0 million. The loan is collateralized by the Company’s accounts receivable from patient services. There are no amounts outstanding under the working capital loan as of September 30, 2009 and 2008. No interest was paid in fiscal 2009, 2008 or 2007 because the working capital loan was paid off monthly.

At September 30, 2008 MedCath and Avera McKennan each guaranteed 30% of $22,000 of the Company’s outstanding equipment debt During July 2009 the guaranteed equipment note was paid in full, and as of September 30, 2009 MedCath and Avera McKennan no longer guarantee any equipment debt. The total amounts of such debt guarantee fees are immaterial for the years ended September 30, 2009 and 2008. No amounts are due as of September 30, 2009 and 2008.

MedCath allocated corporate expenses to the Company for costs in the following categories, which are included in operating expenses in the statements of income, during the years ended September 30:


	2009		2008		2007

Management fees	$	1,330	$	1,349	$	1,296
Hospital employee group insurance		4,674		4,621		4,130
Other		104		81		28

	$	6,108	$	6,051	$	5,454

The other category above consists primarily of support services provided by MedCath and consolidated purchased services paid for by MedCath for which it receives reimbursement at cost in lieu of the Company’s incurring these services directly. Support services include but are not limited to training, treasury, and development. Consolidated purchased services include, but are not limited to insurance coverage, professional services, software maintenance and licenses purchased by MedCath under its consolidated purchasing programs and agreements with third-party vendors for the direct benefit of the Company. At September 30, 2009 and 2008, $30,000 was outstanding for these corporate allocated expenses and are included in other accrued liabilities.

The Company pays Avera McKennan and North Central Heart Institute Holdings, PLLC for various services, including labor, supplies and equipment purchases. The amounts paid during the years ended September 30, were as follows:


	2009		2008		2007

Avera McKennan	$	1,023	$	999	$	1,018
North Central Heart Institute Holdings		391		546		779

Total	$	1,414	$	1,545	$	1,797


8.	Employee Benefit Plan

The Company participates in MedCath’s defined contribution retirement savings plan (the 401(k) Plan), which covers all employees. The 401(k) Plan allows eligible employees to contribute from 1% to 50% of their annual compensation on a pretax basis. The Company, at its discretion, may make an annual contribution of up to 40% of an employee’s pretax contribution, up to a maximum of 6% of compensation. This annual contribution percentage was increased to 40% for fiscal 2008 from 30% for fiscal 2007. The Company’s contributions to the 401(k) Plan were $0.3 million during the years ended September 30, 2009 and 2008 and $0.2 million for the year ended September 30, 2007.

101


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

None.


Item 9A.	*Controls and Procedures.*

The President and 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 of the Company’s disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report onForm 10-K, that the Company’s disclosure controls and procedures were effective as of the end of the fiscal year covered by this report 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 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 most recent fiscal quarter covered by this report that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company (as defined in Securities Exchange ActRule 13a-15(f)). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and the reliability of financial reporting. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2009. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, the Company’s internal control over financial reporting was effective as of September 30, 2009 based on those criteria.

Deloitte & Touche LLP, an independent registered public accounting firm, which audited the consolidated financial statements included in this Annual Report onForm 10-K, has issued an attestation report on our internal control over financial reporting, which is included below.

102

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

MedCath Corporation

Charlotte, North Carolina

We have audited the internal control over financial reporting of MedCath Corporation and subsidiaries (the “Company”) as of September 30, 2009, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2009, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of September 30, 2009 and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended and our report dated December 14, 2009 expressed an unqualified opinion on those financial statements.

DELOITTE & TOUCHE LLP

Charlotte, North Carolina

December 14, 2009

103


Item 9B.	*Other Information*

None.

104

PART III


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

The information required by this Item with respect to directors is incorporated by reference to information provided under the headings “Election of Directors,” “Corporate Governance,” “Other Matters-Section 16(a) Beneficial Ownership Compliance”, “Accounting and Audit Matters-Audit Committee Financial Expert”, “Executive Compensation and Other Information”, and elsewhere in the Company’s proxy statement to be filed with the Commission on or before January 28, 2010 in connection with the Annual Meeting of Stockholders of the Company scheduled to be held on March 3, 2010 (the “2010 Proxy Statement”).


Item 11.	*Executive Compensation.*

The information required by this Item is incorporated by reference to information provided under the headings “Executive Compensation and Other Information” and “Corporate Governance-Compensation of Directors” and elsewhere in the 2010 Proxy Statement.


Item 12.	*Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.*

The information required by this Item is incorporated by reference to information provided under the headings “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation and Other Information-Equity Compensation Plan Information” and elsewhere in the 2010 Proxy Statement.


Item 13.	*Certain Relationships and Related Transactions.*

The information required by this Item is incorporated by reference to information provided under the heading “Certain Transactions” and elsewhere in the 2010 Proxy Statement.


Item 14.	*Principal Accounting Fees and Services.*

The information required by this Item is incorporated by reference to information provided under the heading “Accounting and Audit Matters” and elsewhere in the 2010 Proxy Statement.

PART IV


Item 15.	*Exhibits, Financial Statement Schedules.*

(a) (1) The financial statements as listed in the Index under Part II, Item 8, are filed as part of this report.

(2) Financial Statement Schedules. All schedules have been omitted because they are not required, are not applicable or the information is included in the selected consolidated financial data or notes to consolidated financial statements appearing elsewhere in this report.

(3) The following list of exhibits includes both exhibits submitted with this report and those incorporated by reference to other filings:


Exhibit
No.				Description

	3	.1	—	Amended and Restated Certificate of Incorporation of MedCath Corporation(1)
	3	.2	—	Bylaws of MedCath Corporation(1)
	4	.1	—	Specimen common stock certificate(1)
	4	.2	—	Stockholders’ Agreement dated as of July 31, 1998 by and among MedCath Holdings, Inc., MedCath 1998 LLC, Welsh, Carson, Anderson & Stowe VII, L.P. and the several other stockholders (the Stockholders’ Agreement)(1)
	4	.3	—	First Amendment to Stockholder’s agreement dated as of June 1, 2001 by and among MedCath Holdings, Inc., the KKR Fund and the WCAS Stockholders(1)

105


Exhibit
No.				Description

	4	.4	—	Registration Rights Agreement dated as of July 31, 1998 by and among MedCath Holdings, Inc., MedCath 1998 LLC, Welsh, Carson, Anderson & Stowe VII, L.P., WCAS Healthcare Partners, L.P. And the several stockholders parties thereto (the Registration Rights Agreement)(1)
	4	.5	—	First Amendment to Registration Rights Agreement dated as of June 1, 2001 by and among MedCath Holdings, Inc. and the persons listed in Schedule I attached hereto(1)
	4	.6	—	Amended and Restated Credit Agreement, dated as of November 10, 2008, among MedCath Corporation, as a parent guarantor, MedCath Holdings Corp., as the borrower, certain of the subsidiaries of MedCath Corporation party thereto from time to time, as subsidiary guarantors, Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer, and each of the lenders party thereto from time to time.(15)
	4	.7	—	Collateral Agreement, dated as of July 7, 2004, by and among MedCath Corporation, MedCath Holdings Corp., the Subsidiary Guarantors, as identified on the signature pages thereto and any Additional Grantor (as defined therein) who may become party to the Collateral Agreement, in favor of Bank of America, N.A., as administrative agent for the ratable benefit of the banks and other financial institutions from time to time parties to the Credit Agreement, dated as of July 7, 2004, by and among the MedCath Corporation, MedCath Holdings Corp. and the lenders party thereto(8)
	10	.1	—	Operating Agreement of the Little Rock Company dated as of July 11, 1995 by and among MedCath of Arkansas, Inc. and several other parties thereto (the Little Rock Operating Agreement)(1)(6)
	10	.2	—	First Amendment to the Little Rock Operating Agreement dated as of September 21, 1995(1)(6)
	10	.3	—	Amendment to Little Rock Operating Agreement effective as of January 20, 2000(1)(6)
	10	.4	—	Amendment to Little Rock Operating Agreement dated as of April 25, 2001(1)
	10	.5	—	Operating Agreement of Arizona Heart Hospital, LLC entered into as of January 6, 1997 (the Arizona Heart Hospital Operating Agreement)(1)(6)
	10	.6	—	Amendment to Arizona Heart Hospital Operating Agreement effective as of February 23, 2000(1)(6)
	10	.7	—	Amendment to Operating Agreement of Arizona Heart Hospital, LLC dated as of April 25, 2001(1)
	10	.8	—	Agreement of Limited Partnership of Heart Hospital IV, L.P. as amended by the First, Second, Third and Fourth Amendments thereto entered into as of February 22, 1996 (the Austin Limited Partnership Agreement)(1)(6)
	10	.9	—	Fifth Amendment to the Austin Limited Partnership Agreement effective as of December 31, 1997(1)(6)
	10	.10	—	Amendment to Austin Limited Partnership Agreement effective as of July 31, 2000(1)(6)
	10	.11	—	Amendment to Austin Limited Partnership Agreement dated as of March 30, 2001(1)
	10	.12	—	Amendment to Austin Limited Partnership Agreement dated as of May 3, 2001(1)
	10	.13	—	Guaranty made as of November 11, 1997 by MedCath Incorporated in favor of HCPI Mortgage Corp(1)
	10	.14	—	Operating Agreement of Heart Hospital of BK, LLC amended and restated as of September 26, 2001(the Bakersfield Operating Agreement)(2)(6)
	10	.15	—	Second Amendment to Bakersfield Operating Agreement effective as of December 1, 1999(1)(6)
	10	.16	—	Amended and Restated Operating Agreement of effective as of September 6, 2002 of Heart Hospital of DTO, LLC (the Dayton Operating Agreement)(7)(6)
	10	.17	—	Amendment to New Mexico Operating Agreement and Management Services Agreement) effective as of October 1, 1998(1)(6)
	10	.18	—	Amended and Restated Operating Agreement of Heart Hospital of New Mexico, LLC.(3)(6)
	10	.19	—	Amended and Restated Guaranty made as of October 1, 2001 by MedCath Incorporated, St. Joseph Healthcare System, SWCA, LLC and NMHI, LLC in favor of Health Care Property Investors, Inc.(3)
	10	.20	—	Termination and Release dated October 1, 2000 by and among Heart Hospital of DTO, LLC, DTO Management, Inc., Franciscan Health Systems of the Ohio Valley, Inc. and ProWellness Health Management Systems, Inc(1)(6)
	10	.21	—	Operating Agreement of Heart Hospital of South Dakota, LLC effective as of June 8, 1999 Sioux Falls Hospital Management, Inc. and North Central Heart Institute Holdings, PLLC (the Sioux Falls Operating Agreement)(1)(6)

106


Exhibit
No.				Description

	10	.22	—	First Amendment to Sioux Falls Operating Agreement of Heart Hospital of South Dakota, LLC effective as of July 31, 1999(1)(6)
	10	.23	—	Limited Partnership Agreement of Harlingen Medical Center LP effective as of June 1, 1999 by and between Harlingen Hospital Management, Inc. and the several partners thereto(1)(6)
	10	.24	—	Operating Agreement of Louisiana Heart Hospital, LLC effective as of December 1, 2000 by and among Louisiana Hospital Management, Inc. and the several parties thereto (Louisiana Operating Agreement)(1)(6)
	10	.25	—	Amendment to Louisiana Operating Agreement effective as of December 1, 2000(1)(6)
	10	.26	—	Second Amendment to Louisiana Operating Agreement effective as of December 1, 2000(1)(6)
	10	.27	—	Limited Partnership Agreement of San Antonio Heart Hospital, L.P. effective as of September 17, 2001(2)(6)
	10	.28	—	1998 Stock Option Plan for Key Employees of MedCath Holdings, Inc. and Subsidiaries(1)
	10	.29	—	Outside Directors’ Stock Option Plan(1)
	10	.30	—	Amended and Restated Directors Option Plan(4)
	10	.31	—	Form of Heart Hospital Management Services Agreement(1)
	10	.32	—	Employment Agreement dated June 23, 2008 by and between MedCath Corporation and Jeffrey L. Hinton(16)
	10	.33	—	Amended and Restated Employment Agreement dated September 30, 2005 by and between MedCath Corporation and Joan McCanless(9)
	10	.34	—	Sample Agreement to Accelerate Vesting of Stock Options and Restrict Sale of Related Stock Effective September 30, 2005(9)
	10	.35	—	Guaranty made as of December 28, 2005 by MedCath Corporation and Harlingen Medical Center Limited Partnership in favor of HCPI Mortgage Corp.(10)
	10	.36	—	Employment agreement dated February 21, 2006, by and between MedCath Corporation and O. Edwin French(11)
	10	.37	—	MedCath Corporation 2006 Stock Option and Award Plan effective March 1, 2006(14)
	10	.38	—	Consulting agreement effective August 4, 2006 by and between MedCath Incorporated and SSB Solutions(12)
	10	.39	—	First Amendment to the September 30, 2005 Amended and Restated Employment Agreement by and between MedCath Corporation and Joan McCanless dated September 1, 2006(14)
	10	.40	—	First Amendment to the February 21, 2006 Employment Agreement by and between MedCath Corporation and O. Edwin French dated September 1, 2006(14)
	10	.41	—	LLC Interest Purchase Agreement, dated as of August 14, 2006, by and among Carondelet Health Network, an Arizona non-profit corporation, Southern Arizona Heart, Inc., a North Carolina corporation, and MedCath Incorporated, a North Carolina corporation(13)
	10	.42	—	Operating Agreement of HMC Management Company, LLC, effective as of June 29, 2007(6)
	10	.43	—	Amended and Restated Operating Agreement of Coastal Carolina Heart, LLC, effective as of July 1, 2007(6)
	10	.44	—	Amended and Restated Limited Partnership Agreement of Harlingen Medical Center, Limited Partnership, effective as of July 10, 2007(6)
	10	.45	—	Amended and Restated Operating Agreement of HMC Realty, LLC, effective as of July 10, 2007(6)
	10	.46	—	Amendment to Amended and Restated Outside Directors’ Stock Option Plan(17)
	10	.47	—	Asset Purchase Agreement By and Between Heart Hospital of DTO, LLC and Good Samaritan Hospital(17)
	10	.48	—	Assignment and Assumption Agreement by and between MedCath Partners, LLC, a North Carolina limited partnership, Cape Cod Cardiac Cath, Inc., a Massachusetts charitable corporation, Cape Cod Hospital, a Massachusetts charitable corporation and Cape Cod Cardiology Services, LLC, a North Carolina limited liability company.(18)
	10	.49	—	Employment Agreement dated June 23, 2008 by and between MedCath Corporation and David Bussone(19)

107


Exhibit
No.				Description

	10	.50	—	Amended and Restated Employment Agreement dated August 14, 2009 by and between MedCath Corporation and James A. Parker(19)
	10	.51	—	Asset Purchase Agreement by and among Sun City Cardiac Center Associates, Sun City Cardiac Center, Inc., MedCath Partners, LLC, MedCath Incorporated, and Banner Health(20)
	21	.1	—	List of Subsidiaries
	23	.1	—	Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
	23	.2	—	Consent of Deloitte & Touche LLP, Independent Auditors
	31	.1	—	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31	.2	—	Certification of Chief 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


(1)		Incorporated by reference from the Company’s Registration Statement onForm S-1 (File no.333-60278).

(2)		Incorporated by reference from the Company’s Annual Report onForm 10-K for the fiscal year ended September 30, 2001.

(3)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q for the quarter ended December 31, 2001.

(4)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q for the quarter ended March 31, 2002.

(5)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q for the quarter ended June 30, 2002.

(6)		Certain portions of these exhibits have been omitted pursuant to a request for confidential treatment filed with the Commission.

(7)		Incorporated by reference from the Company’s Annual Report onForm 10-K for the fiscal year ended September 30, 2003.

(8)		Incorporated by reference from the Company’s Registration Statement onForm S-4 (File No.333-119170).

(9)		Incorporated by reference from the Company’s Annual Report onForm 10-K for the year ended September 30, 2005.

(10)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q for the quarter ended December 31, 2005.

(11)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q for the quarter ended March 31, 2006.

(12)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q for the quarter ended June 30, 2006.

(13)		Incorporated by reference from the Company’s Current Report onForm 8-K filed September 7, 2006.

(14)		Incorporated by reference from the Company’s Annual Report onForm 10-K for the year ended September 30, 2006.

(15)		Incorporated by reference from the Company’s Current Report onForm 8-K filed November 14, 2008.

(16)		Incorporated by reference from the Company’s Current Report onForm 8-K filed June 25, 2008.

(17)		Incorporated by reference from the Company’s Quarterly Report onForm 10-Q/A for the quarter ended March 31, 2008.

(18)		Incorporated by reference from the Company’s Current Report onForm 8-K filed January 5, 2009

(19)		Incorporated by reference from the Company’s Current Report onForm 8-K filed August 17, 2009

(20)		Incorporated by reference from the Company’s Current Report onForm 8-K filed October 1, 2009

108

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Medcath Corporation


	By:	/s/ O. Edwin French

O. Edwin French

President, Chief Executive Officer

(principal executive officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Name	Title	Date


/s/ O. Edwin French O. Edwin French	President and Chief Executive Officer (principal executive officer)	December 14, 2009

/s/ James A. Parker James A. Parker	Executive Vice President and Chief Financial Officer (principal financial officer)	December 14, 2009

/s/ Lora Ramsey Lora Ramsey	Vice President — Controller (principal accounting officer)	December 14, 2009

/s/ Pamela G. Bailey Pamela G. BAILEY	Director	December 14, 2009

/s/ Edward R. Casas Edward R. Casas	Director	December 14, 2009

/s/ Woodrin Grossman Woodrin Grossman	Director	December 14, 2009

/s/ Robert S. Mccoy, Jr. Robert S. Mccoy, Jr.	Director	December 14, 2009

/s/ James A. Deal James A. Deal	Director	December 14, 2009

/s/ Galen D. POWERS Galen D. Powers	Director	December 14, 2009

/s/ Jacque J. Sokolov, Md Jacque J. Sokolov, Md	Director	December 14, 2009

/s/ John T. Casey John T. Casey	Director	December 14, 2009

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Medcath (MDTH) 10-K2009 FY Annual report

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