Medcath 10K/A 2003 Annual report (amended)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K/A

Amendment

No. 1


(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, 2003

or

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

Commission File Number 000-33009

MedCath Corporation

(Exact name of registrant as specified in its charter)


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

10720 Sikes Place

Charlotte, North Carolina 28277

(Address of principal executive offices, including zip code)

(704) 708-6600

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

MEDCATH CORPORATION

FORM 10-K/A

TABLE OF CONTENTS


		Page

PART II
Item 6.	Selected Financial Data		1
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		3
Item 8.	Financial Statements and Supplementary Data		30
PART III
Item 10.	Directors and Executive Officers of the Registrant		63
Item 11.	Executive Compensation		63
Item 12.	Security Ownership of Certain Beneficial Owners and Management		63
PART IV
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K		63
Signature			69

EXPLANATORY NOTE

This Amendment No. 1 to MedCath Corporation’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003 filed with the Securities and Exchange Commission on December 22, 2003 is filed to reflect minor technical modifications to Part II, Item 6, “Selected Financial Data,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data,” as follows:


	•	in Item 6“SELECTED FIVE-YEAR FINANCIAL DATA”, the line items “INCOME (LOSS) FROM CONTINUING OPERATIONS PER SHARE, BASIC” and “INCOME (LOSS) FROM CONTINUING OPERATIONS PER SHARE, DILUTED” has been deleted from “CONSOLIDATED STATEMENT OF OPERATIONS DATA” in the table and “AVERAGE LENGTH OF STAY” for fiscal year 2001 of 3.90 has been changed to 3.94;

	•	in Item 7.“MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – REVENUES SOURCES, TRENDS AND UNCERTAINTIES – REVENUE TRENDS AND UNCERTAINTIES” in the sixth paragraph the phrase “we estimate the cumulative negative impact for fiscal years 2004 through 2009” has been changed to “we estimate the cumulative negative impact for fiscal years 2005 through 2009”;

	•	in Item 7.“MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – CRITICAL ACCOUNTING POLICIES – GENERAL LIABILITY AND PROFESSIONAL LIABILITY RISK” the phrase “From June 1, 2002 through May 31, 2003” has been changed to “From June 1, 2002 through June 7, 2003” and the phrase “Effective June 1, 2003,” has been changed to “Effective June 8, 2003,”;

	•	in Item 7.“MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – CRITICAL ACCOUNTING POLICIES – EARNINGS ALLOCATED TO MINORITY INTEREST” the phrases “our reported earnings allocated to minority interests of $5.5 million, $10.5 million, $14.2 million, respectively, would have been $512,000, $12.5 million and $16.7 million had we not recognized disproportionate allocations as described above. Therefore, for the fiscal years 2003, 2002 and 2001, our reported income (loss) before income taxes of $(60.0) million, $27.3 million and $1.4 million, respectively, would have been $(55.0) million, $25.3 million and $(1.1) million.)” have been changed to “disproportionate recognition of earnings (losses) in our hospitals had a positive (negative) impact of $(5.0) million, $2.0 million and $2.5 million, respectively, on our reported income (loss) before taxes.”;

	•	in Item 7.“MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – FISCAL YEAR 2003 COMPARED TO FISCAL 2002”under earnings allocated to minority interest the phrases “our reported earnings allocated to minority interests of $5.5 million would have been an earnings allocation of $512,000 had we not recognized disproportionate allocations at our hospitals. Therefore, our reported loss before income taxes of $60.0 million would have been a loss of $55.0 million.” have been changed to “disproportionate recognition of losses in our hospitals had a negative impact of $5.0 million on our reported loss before income taxes. During fiscal 2002, disproportionate recognition of earnings in our hospitals had a positive impact of $2.0 million on our reported income from operations.”;

	•	in Item 8.“FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA – FOOTNOTE 10. LIABILITY INSURANCE COVERAGE”the phrase “From June 1, 2002 through May 31, 2003” has been changed to “From June 1, 2002 through June 7, 2003” and the phrase “Effective June 1, 2003,” has been changed to “Effective June 8, 2003,”; and

	•	in Item 8.“FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA – FOOTNOTE 14. STOCK OPTION PLANS”a table that was omitted has been included in the footnote disclosure.

Although Part II, Items 6, 7 and 8 are included in their entirety, this Amendment No. 1 does not amend any other part of Items 6, 7 and 8. Part III, Items 10, 11 and 12 are included in this amendment to modify heading references to the registrant’s 2004 Proxy Statement.


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 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes, appearing elsewhere in this report.

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



	Year Ended September 30,

	2003			2002			2001			2000			1999

Consolidated Statement of Operations Data:
Net revenue	$	542,986		$	477,637		$	377,007		$	332,337		$	255,756
Income (loss) from operations	$	(33,740	)	$	55,784		$	40,848		$	18,543		$	(9,865	)
Net income (loss)	$	(60,306	)	$	24,351		$	1,051		$	(13,635	)	$	(39,930	)
Earnings (loss) per share, basic	$	(3.35	)	$	1.35		$	0.08		$	(1.15	)	$	(3.37	)
Earnings (loss) per share, diluted	$	(3.35	)	$	1.34		$	0.08		$	(1.15	)	$	(3.37	)
Weighted average number of shares, basic(a)		17,989			18,012			13,007			11,837			11,836
Weighted average number of shares, diluted(a)		17,989			18,117			13,107			11,837			11,836
Cash Flow and Other Data:
Net cash provided by operating activities	$	42,588		$	69,692		$	44,836		$	16,626		$	9,988
Net cash provided by (used in) investing activities	$	(112,091	)	$	(90,751	)	$	11,222		$	(13,163	)	$	(57,571	)
Net cash provided by (used in) financing activities	$	44,934		$	25,470		$	50,678		$	(24,274	)	$	50,430
Adjusted EBITDA(b)	$	66,928		$	92,380		$	66,740		$	55,142		$	32,944
Adjusted EBITDA, before pre-opening expenses(b)	$	77,023		$	100,719		$	68,230		$	55,691		$	39,591
Selected Operating Data (consolidated):
Number of hospitals(c)		9			7			6			6			4
Licensed beds(d)		580			410			355			355			261
Staffed and available beds(e)		493			404			355			355			261
Admissions(f)		32,998			28,535			23,474			20,511			14,054
Adjusted admissions(g)		41,213			34,683			28,408			25,213			16,512
Patient days(h)		117,615			106,118			92,588			85,239			62,765
Average length of stay(i)		3.56			3.72			3.94			4.20			4.50
Occupancy(j)		65.4	%		72.0	%		71.5	%		65.8	%		65.9	%
Inpatient catheterization procedures		17,537			15,839			11,950			10,821			7,687
Inpatient surgical procedures		8,750			7,288			6,577			6,354			4,657



	September 30,

	2003		2002		2001		2000		1999

Consolidated Balance Sheet Data:
Cash and cash equivalents	$	94,199	$	118,768	$	114,357	$	7,621	$	28,432
Working capital	$	63,918	$	97,825	$	114,891	$	13,895	$	35,435
Total assets	$	749,297	$	741,041	$	606,619	$	485,667	$	472,285
Long-term debt and capital leases, excluding current maturities	$	311,698	$	271,456	$	210,747	$	248,101	$	235,698
Other long-term obligations	$	7,164	$	5,818	$	3,643	$	151	$	3,295



		Year Ended September 30,

		2003			2002			2001			2000			1999

Reconciliation of Non-GAAP Financial Measures
Net income (loss)		$	(60,306	)	$	24,351		$	1,051		$	(13,635	)	$	(39,930	)
Add:
	Income tax expense (benefit)		305			2,920			317			(24	)		(1,338	)
	Minority interest share of earnings of consolidated subsidiaries		5,524			10,451			14,160			3,305			6,322
	Equity in net (earnings) losses of unconsolidated affiliates		(3,541	)		(3,007	)		2,119			2,011			5,640
	Other income (expense), net		(206	)		(190	)		327			(301	)		(168	)
	Interest income		(1,373	)		(2,337	)		(3,521	)		(3,428	)		(2,533	)
	Interest expense		25,857			23,596			26,395			30,615			22,142
	Impairments of goodwill and long-lived assets		58,865			—			985			—			10,935
	Gain on sale of hospital		—			—			(13,461	)		—			—
	Loss on debt refinancing		—			—			1,560			—			—
	Loss (gain) on disposal of property, equipment and other assets		258			(1,047	)		162			(69	)		1,314
	Amortization		1,441			2,367			6,649			6,591			5,289
	Depreciation		40,104			35,276			29,997			30,077			25,271

Adjusted EBITDA(b)		$	66,928		$	92,380		$	66,740		$	55,142		$	32,944
	Pre-opening expenses		10,095			8,339			1,490			549			6,647

Adjusted EBITDA, before pre-opening expenses(b)		$	77,023		$	100,719		$	68,230		$	55,691		$	39,591


(a)		See Note 13 to the consolidated financial statements included elsewhere in this report.

(b)		We use Adjusted EBITDA and Adjusted EBITDA, before pre-opening expenses to measure the performance of our various operating entities, to compare actual results to historical and budgeted results, and to make capital allocations. We provide Adjusted EBITDA to investors to assist them in performing their analysis of our historical operating results. Further, we believe that many of our investors also invest in or have knowledge of, other healthcare companies that use Adjusted EBITDA as a financial performance measure. Because Adjusted EBITDA is a non-GAAP measure, Adjusted EBITDA, as defined above, and Adjusted EBITDA, before pre-opening expenses, as defined above, may not be comparable to other similarly titled measures of other companies. We provide Adjusted EBITDA, before pre-opening expenses to investors to provide a financial measure of our operations that excludes the effect of the hospitals under development during the reporting period. Included in the tables above is a schedule that reconciles Adjusted EBITDA and Adjusted EBITDA, before pre-opening expenses to our net income (loss).

(c)		Selected operating data includes consolidated hospitals in operation as of the end of period but does not include hospitals, which were accounted for using the equity method in our consolidated financial statements.

(d)		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.

(e)		Staffed and available beds represent the weighted average number of beds that are readily available for patient use during the period.

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

(g)		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.

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

(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.


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

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

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

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

Hospital Ownership and Capital Structure

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

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



					MedCath Ownership %
					September 30,
			Opening Date
Hospital	Location		(Scheduled Opening Date)		2003			2002			2001

Arkansas Heart Hospital		Little Rock, AR		Mar. 1997		70.3	%		70.3	%		70.3	%
Tucson Heart Hospital		Tucson, AZ		Oct. 1997		58.8	%		58.8	%		58.6	%
Arizona Heart Hospital		Phoenix, AZ		Jun. 1998		70.6	%		70.6	%		70.6	%
Heart Hospital of Austin		Austin, TX		Jan. 1999		70.9	%		70.9	%		70.9	%
Dayton Heart Hospital		Dayton, OH		Sept. 1999		66.5	%		66.5	%		66.5	%
Bakersfield Heart Hospital		Bakersfield, CA		Oct. 1999		53.3	%		53.3	%		53.3	%
Heart Hospital of New Mexico		Albuquerque, NM		Oct. 1999		72.0	%		69.0	%		24.0	%
Heart Hospital of South Dakota		Sioux Falls, SD		Mar. 2001		33.3	%		33.3	%		33.3	%
Harlingen Medical Center		Harlingen, TX		Oct. 2002		51.1	%		51.0	%		51.0	%
Louisiana Heart Hospital		St. Tammany Parish, LA		Feb. 2003		51.1	%		52.6	%		53.0	%
The Heart Hospital of Milwaukee		Glendale, WI		Oct. 2003		60.3	%		60.3	%		—
TexSAn Heart Hospital		San Antonio, TX		(Jan. 2004)		51.0	%		51.4	%		51.8	%
Heart Hospital of Lafayette		Lafayette, LA		(Mar. 2004)		55.8	%		59.1	%		—

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

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

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

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

New Hospital Development

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

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

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

Revenue Sources, Trends and Uncertainties

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

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		2003			2002			2001*

Hospital			87.8	%		83.7	%		81.6	%
Diagnostic services			9.3	%		11.9	%		12.1	%
Corporate and other			2.9	%		4.4	%		6.3	%

	Net revenue		100.0	%		100.0	%		100.0	%


*	Fiscal year 2001 is provided on a pro forma basis to reflect the sale of our McAllen Heart Hospital and the consolidation of Tucson Heart Hospital resulting from the transactions discussed above.

Sources of Revenue 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 older people, 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 our hospital division’s net revenue we earned by category of payor in each of our last three fiscal years.



		Hospital Division
		Year Ended September 30,

Payor		2003			2002			2001

Medicare and Medicaid			58.3	%		60.7	%		61.1	%
Commercial and other			41.7	%		39.3	%		38.9	%

	Total hospital division net revenue		100.0	%		100.0	%		100.0	%

Payments we receive from the Medicare and Medicaid programs for services rendered to patients also comprise a significant part of our total net revenue. The following table sets forth the percentage of consolidated net revenue we earned by category of payor in our last three fiscal years.



		Consolidated
		Year Ended September 30,

Payor		2003			2002			2001

Medicare and Medicaid			51.6	%		52.1	%		50.3	%
Commercial and other			48.4	%		47.9	%		49.7	%

	Total consolidated net revenue		100.0	%		100.0	%		100.0	%

We are reimbursed by non-governmental payors using a variety of payment methodologies, such as fee-for-service charges and rates based on diagnosis related groups. We limit the number of per diem contracts we accept from managed care organizations because we believe these contracts do not reimburse us sufficiently for the efficiencies that we achieve in our hospitals. We do not accept capitation contracts from any payors.

Revenue Trends and Uncertainties. We expect the net revenue that we receive from the Medicare program as a percentage of total consolidated net revenue to remain significant in future periods because the percentage of our total consolidated net revenue generated by our hospital division will continue to increase as we open new hospitals.

The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, court decisions, executive orders and freezes and funding reductions, all of which may significantly affect our business. In addition, reimbursement is generally subject to adjustment following audit by third party payors, including the fiscal intermediaries who administer the Medicare program for the Center for Medicare and Medicaid Services (CMS). Final determination of amounts due providers under the Medicare program often takes several years because of such audits, as well as resulting provider appeals and the application of technical reimbursement provisions. We believe that adequate provision has been made for any adjustments that might result from these programs; however, due to the complexity of laws and regulations governing the Medicare and Medicaid programs, the manner in which they are interpreted and the other complexities involved in estimating our net revenue, there is a reasonable possibility that recorded estimates will change by a material amount in the near term. See“Item 1. Business — Reimbursement” and “— Regulation.”

We expect that the changes in the outlier formula will decrease our outlier payments in fiscal 2004 by approximately $10.0 million to $11.0 million. We also expect that the increase in payment rates and revised wage indexes in fiscal 2004 will increase our net revenue by approximately $12.0 million to $13.0 million. However, because the regulations are subject to change, and 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 the impact of these announced changes on our net revenue, there is a reasonable possibility that our estimates will change by a material amount in the near future.

Medicare reimburses hospitals for capital-related costs using one of two alternative methodologies based upon how the hospital is categorized under CMS regulations. We sought and received a written determination from one of our Medicare fiscal intermediaries on October 11, 2002 regarding the capital cost reimbursement methodology applicable to four of our hospitals. The fiscal intermediary’s October 2002 written determination confirmed the methodology being applied by those hospitals. We recorded and collected net revenue for services rendered by these hospitals at the estimated net realizable amount determined in accordance with the capital cost reimbursement methodology provided by the fiscal intermediary in its October 2002 determination. On August 11, 2003, we were notified by the fiscal intermediary that it had been directed by CMS to change, on a retroactive and prospective basis, the methodology confirmed by the fiscal intermediary in its October 2002 determination. We believe that the position taken by the fiscal intermediary in October 2002 was based upon a correct interpretation of applicable CMS regulations and intend to vigorously pursue our administrative, judicial and other remedies to reverse any final determination contrary to that position. If CMS does not revert to the determination made by the fiscal intermediary in October 2002, or maintains that it is appropriate to apply the change in methodology on a retroactive basis, we would be required to repay the Medicare program for the resulting reduction in previously reimbursed capital costs. If required, such repayments would be recorded as a change in accounting estimate and could result in a material reduction in our net revenue in the period recorded. Such change in reimbursement methodology could also have a material adverse impact on net revenue in future periods.

In regards to the retroactive component, the fiscal intermediary has not advised us of the amount of reimbursement associated with the change in methodology. In addition to beginning the administrative process to challenge the August 11, 2003 determination, we have been, and remain, actively involved in negotiations with CMS to resolve this matter. Management believes based on the advice of counsel and the status of the negotiations with CMS, that we will not be required to repay the retroactive amount of reimbursement associated with the change in methodology. Accordingly, we have not recognized a contingent liability for the retroactive reimbursement in accordance with SFAS No. 5,Accounting for Contingencies.

In regards to the prospective component, the fiscal intermediary began making payments for capital cost reimbursement under the new methodology for all claims submitted after August 11, 2003. The impact of this change for fiscal 2003 was a $1.2 million reduction in our net revenue. In addition, we estimate the impact of this change in reimbursement will be approximately $7.2 million in fiscal 2004. The impact will diminish rapidly in future years, based on how reimbursement is calculated, and we estimate that the cumulative negative impact for fiscal years 2005 through 2009 will be from $15.0 million to $16.0 million. While this prospective treatment is subject to our administrative challenges and negotiations with CMS, we have not recognized a contingent receivable for the decrease in the prospective reimbursement from August 11, 2003 through September 30, 2003. This accounting treatment is in accordance with SFAS No. 5, which does not permit contingent gains to be recorded until such amounts are realized. If we ultimately recover all, or some portion, of the decrease in prospective reimbursement, the amount will be recognized in the future period in which the settlement occurs.

During fiscal 2003 and 2002, we owned and managed Gaston Cardiology Services, LLC, which generated net revenue of $8.3 million and $7.4 million, respectively. In November 2003, our partner in this venture exercised an option to terminate the arrangement. Consequently, our net revenue and operating results in fiscal 2004 will reflect the termination of this venture.

Critical Accounting Policies

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, which are accrued on an estimated basis in the period that the related services are rendered and adjusted in future periods as adjustments become known and final settlements are determined. 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. 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. We record adjustments to the estimated billings as contractual adjustments in the periods that such adjustments become known or as the service years are no longer subject to audit, review or investigation. 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 also 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 and percentage-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.

Our consulting and management operations, which are included in our corporate and other division, operate under various contracts where management fee revenue is recognized under various percentage-of-income and cost-reimbursement arrangements and consulting and other revenue under service contractual arrangements as services are rendered.

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 diagnostics division and amounts due under consulting and management contracts in our cardiology consulting and management operations. 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. Within our hospital

division, which comprised 89.5% of our accounts receivable at September 30, 2003 and 87.8% of our net revenue for fiscal 2003, we rely on periodic detailed reviews of historical collections and write-offs at each of our hospitals to estimate this allowance. Adverse changes in business office operations, payor mix, economic conditions or trends in federal and state governmental health care reimbursement could affect our collection of accounts receivable.

General and Professional Liability Risk. On June 1, 2002, our three-year combined insurance policy that provided medical malpractice claims coverage on a claims-made, first-dollar basis, expired and we entered into a new partially self-insured coverage program. At that time, we purchased a tail insurance policy to provide first-dollar coverage for claims incurred prior to June 1, 2002, but not reported as of that date under the expired claims-made policy. We recognized the full cost of the tail insurance policy as an operating expense in the third quarter of fiscal 2002 as required by generally accepted accounting principles in the United States. From June 1, 2002 through June 7, 2003, we were partially self-insured under a claims-made policy providing coverage for claim amounts in excess of $2.0 million of retained liability per claim. Effective June 8, 2003, we entered into a new one-year claims-made policy providing coverage for claim amounts in excess of $3.0 million of retained liability per claim, subject to $5.0 million of retained liability per claim for the first two claims reported during the policy year at one of our hospitals. Because of our self-insured retention levels, we are required to recognize an estimated expense/liability for the amount of our retained liability applicable to each malpractice claim. As of September 30, 2003, the total estimated liability for our self-insured retention on medical malpractice claims, including an estimated amount for incurred but not reported claims, was approximately $3.7 million, which is included in current liabilities in our consolidated balance sheet. We maintain this reserve based on actuarial estimates prepared by an independent third party, who bases the estimates on our historical experience with claims and assumptions about future events.

In addition to reserves for medical malpractice, we also maintain reserves for our self-insured healthcare and dental coverage provided to our employees. As of September 30, 2003, our total estimated reserve for self-insured liabilities on employee health and dental claims was $2.3 million, which is included in current liabilities in our consolidated balance sheet. We maintain this reserve based on our historical experience with claims. We also maintain commercial stop loss coverage for our health and dental insurance program of $100,000 per plan participant.

We continually review our estimates for self-insured liabilities and record adjustments as experience develops or new information becomes known. The changes to the estimated liabilities are included in current operating results. 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 will not exceed our estimates.

We expect both the premium costs and the self-insured retention under our various general and professional liability risk programs will increase our other operating expenses during the next twelve months. As we open new hospitals and diagnostic and therapeutic centers, we also expect to incur additional premium costs and self-insured retention costs to reflect the additional risk exposure.

Impairment of Long-Lived Assets. Effective October 1, 2002, the beginning of our fiscal year 2003, we adopted Statement of Financial Accounting Standards (SFAS) No. 144,Accounting for the Impairment of Long-Lived Assets,which superceded SFAS No. 121. In accordance with SFAS No. 144, we assess the carrying value of long-lived assets, other than goodwill and other intangible assets, for potential impairment whenever events or changes in circumstances indicate that the carrying value of the asset, or related group of assets, may not be recoverable. We continually consider internal and external factors such as hospital and physician contract changes, local market developments, changes in third-party reimbursement methodologies, national health care trends, and other publicly available information. Measurement of the amount of the impairment, if any, may be based on quoted market prices, if available, or an estimate based on valuation techniques available in the circumstances, including discounted cash flows using our cost of capital. The estimates of these future cash flows are based on assumptions and projections that we believe to be reasonable and supportable. As considerable judgment is necessary to estimate future cash flows and fair values, there is a reasonable possibility that actual

results may vary significantly from such estimates. No impairment charges were recognized for our fiscal years 2003 and 2002. An impairment charge of $985,000 was recognized during our fiscal year 2001.

Goodwill. Goodwill arising from business combinations completed after June 30, 2001 is accounted for under the provisions of SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill and Other Intangibles. Also effective October 1, 2001, the beginning of our fiscal year 2002, we adopted the remaining provisions of SFAS No. 142. Accordingly, we do not amortize goodwill, but rather we subject our goodwill to an annual test (at September 30) for potential impairment by comparing the estimated fair value of each of our reporting units to its carrying amount, including goodwill. We will also test goodwill of our reporting units between annual tests if an event occurs, or circumstances change, that indicate an impairment may exist, in accordance with SFAS No. 142. We estimate the fair value of our reporting units principally using discounted cash flows and multiples of earnings valuation methods. We typically also engage independent third-party valuation experts to assist in calculating the fair value of our reporting units, and the fair values of our reporting units’ tangible and identifiable intangible assets to the extent necessary to determine the amount of any impairment charges.

During fiscal year 2003, we subjected our goodwill to both an interim test in March 2003 and an annual test at September 30, 2003. In March 2003, we determined that the decline in our market capitalization, as measured by our common stock price, since September 30, 2002 represented an event requiring an interim goodwill impairment test to be performed. The results of this test concluded no goodwill impairment existed at March 2003. In September 2003, we performed another goodwill impairment test. This testing date was consistent with both our designated annual testing date under SFAS No. 142 and a new triggering event, which was the preparation of our fiscal 2004 financial budget during the fourth quarter of fiscal 2003. The results of this test concluded our goodwill was impaired, and based on the hypothetical purchase price methodology required under SFAS No. 142, we determined the amount of the goodwill impairment to be approximately $58.9 million at September 30, 2003. The $58.9 million impairment charge consisted of $43.5 million related to our hospital division reporting unit, which reduced its remaining goodwill to $75.0 million at September 30, 2003, and $15.4 million related to our diagnostics division reporting unit, which reduced its remaining goodwill to $0 at September 30, 2003.

Earnings Allocated to Minority Interests. Earnings allocated to minority interests represent the allocation of profits and losses to minority owners in our consolidated subsidiaries. With respect to our consolidated hospitals, each hospital’s profits and losses are generally allocated for accounting purposes to us and our minority partners on a pro rata basis in accordance with the respective ownership percentages. However, if the cumulative losses of a hospital exceed its initial capitalization and committed capital obligations of our partners, then we are required, due to the respective at risk capital positions, by accounting principles generally accepted in the United States to recognize a disproportionate share of the hospital’s losses that otherwise would be allocated to all owners on a pro rata basis. In such cases, we will then recognize a disproportionate share of the hospital’s future profits to the extent we have previously recognized a disproportionate share of the hospital’s losses. The determination of at-risk capital position is based on the specific terms of each hospital’s operating agreement, including each partner’s contributed capital, obligation to provide working capital loans, to contribute additional capital, or to guarantee the outstanding obligations of the hospital. During each of our fiscal years 2003, 2002 and 2001, disproportionate recognition of earnings (losses) in our hospitals had a positive (negative) impact of $(5.0) million, $2.0 million, and $2.5 million, respectively, on our reported income (loss) before income taxes.

We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate losses and/or recoveries thereof through disproportionate profits of our hospitals. As of September 30, 2003, we had remaining cumulative disproportionate loss allocations of approximately $21.5 million that we may recover in future periods, or be required to recognize additional disproportionate losses, depending on the results of operations of each of our hospitals. We could also be required to recognize disproportionate losses at our other hospitals not currently in disproportionate allocation depending on their results of operations in future periods.

Income Taxes. Income taxes are provided for under the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between

the tax basis 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.

During fiscal 2003, our effective income tax rate was 0.5%, which was below our statutory rate of 33.7% due primarily to non-deductibility for income tax purposes of the $58.9 million impairment of goodwill. In future periods we expect our effective income tax rate, and related income tax expense or benefit, to increase and more closely approximate our statutory rate. In addition, the amount of current income tax liability we will have in future periods may be offset by $22.1 million and $50.0 million of gross federal and state, respectively, net operating loss carryforwards from prior periods we have available as of September 30, 2003.

Results of Operations

The following table presents, for the periods indicated, information expressed as a percentage of net revenue. This information has been derived from the audited consolidated statements of operations included elsewhere in this report.



		Year Ended September 30,

		2003			2002			2001

Net revenue			100.0	%		100.0	%		100.0	%
Operating expenses:
	Personnel expense		31.7	%		28.9	%		28.3	%
	Medical supplies expense		25.2	%		22.8	%		24.2	%
	Bad debt expense		4.9	%		4.7	%		5.4	%
	Other operating expenses		24.0	%		22.5	%		23.9	%
	Pre-opening expenses		1.9	%		1.7	%		0.4	%
	Depreciation		7.4	%		7.4	%		8.0	%
	Amortization		0.3	%		0.5	%		1.8	%
	Loss (gain) on disposal of property, equipment and other assets		0.0	%		(0.2	)%		0.0	%
	Loss on debt refinancing		—			—			0.4	%
	Gain on sale of hospital		—			—			(3.57	)%
	Impairment of goodwill and long-lived assets		10.8	%		—			0.3	%
(Loss) income from operations			(6.2	)%		11.7	%		10.8	%
Other income (expenses):
	Interest expense		(4.8	)%		(4.9	)%		(7.0	)%
	Interest income		0.3	%		0.5	%		0.9	%
	Other income, net		0.0	%		0.0	%		(0.1	)%
	Equity (loss) in net earnings of unconsolidated affiliates		0.7	%		0.6	%		(0.6	)%
(Loss) income before minority interest and income taxes			(10.0	)%		7.9	%		4.1	%
Minority interest share of earnings of consolidated subsidiaries			(1.0	)%		(2.2	)%		(3.8	)%
(Loss) income before income taxes			(11.1	)%		5.7	%		0.4	%
Income tax expense			(0.1	)%		(0.6	)%		(0.1	)%
Net (loss) income			(11.1	)%		5.1	%		0.3	%

Fiscal Year 2003 Compared to Fiscal Year 2002

Net revenue increased $65.4 million, or 13.7%, to $543.0 million for our fiscal year ended September 30, 2003 from $477.6 million for our fiscal year ended September 30, 2002. The $65.4 million increase in net revenue resulted from a $77.1 million increase generated by our hospital division, offset in part by an $6.0 million decrease in our diagnostics division and a $5.8 million decrease in our corporate and other division, which includes our cardiology consulting and management operations.

The $77.1 million increase in our hospital division’s net revenue was primarily attributable to the opening of Harlingen Medical Center on October 2, 2002 and the opening of Louisiana Heart Hospital on February 28, 2003. Harlingen Medical Center and Louisiana Heart Hospital generated $58.8 million of the $77.1 million increase in our hospital division’s net revenue during fiscal 2003. The $6.0 million decrease in our diagnostic services division was primarily the result of the $9.7 million of net revenue arising from management fees that we recognized in the second quarter of fiscal 2002 as a result of the favorable settlement of the Sun City Cardiac Center billing dispute. Excluding the effect of this favorable settlement, our diagnostics division generated a $3.7 million increase in net revenue during fiscal 2003 compared to fiscal 2002. This $3.7 million increase was primarily due to the increase in net revenue generated by new diagnostic and therapeutic facilities opened since fiscal 2002, offset in part by a decrease in net revenue in our mobile cardiac catheterization laboratories and in one of our hospital-based cardiac diagnostic and therapeutic facilities due to a decline in the number of procedures performed during fiscal 2003 compared to fiscal 2002. The $5.7 million decrease in our corporate and other division’s net revenue was primarily due to a decrease in our cardiology consulting and management operations and included a $1.0 million decrease due to the expiration of a management contract during fiscal 2002 and a $4.7 million decrease due to the restructuring of one of our two physician management contracts in the third quarter of fiscal 2003. The restructuring of the physician management contracts during the third quarter of fiscal 2003 reduced management fee revenue, but more significantly eliminated the cost reimbursement arrangement whereby we were previously reimbursed for costs on a pass through basis. The change of the reimbursement terms of this contract reduced both net revenue and certain of our operating expenses by corresponding amounts, and therefore had no impact on our consolidated loss from operations or our consolidated net loss for fiscal 2003.

On a same facility basis in our hospital division, net revenue increased $19.1 million, or 4.8%, to $418.1 million for fiscal 2003 from $399.0 million for 2002. This $19.1 million increase includes the impact of an additional $2.2 million of net revenue that was recognized in the third quarter of fiscal 2002 by one of our hospitals as a result of a favorable settlement of a billing dispute with a managed care provider. Excluding this $2.2 million of additional net revenue from the third quarter of fiscal 2002, our hospital division’s net revenue increased $21.3 million. This increase in net revenue was due to an increase in the number of procedures performed and an increase in billing rates in our same facility hospitals during fiscal 2003 compared to fiscal 2002. This increase in net revenue was achieved after the impact of a $1.2 million reduction in our net revenue during the fourth quarter of fiscal 2003 resulting from an unanticipated change by one of our Medicare fiscal intermediaries in their interpretation of how the capital cost reimbursement methodology should be applied at four of our hospitals See“Revenue Sources, Trends and Uncertainties — Revenue Trends and Uncertainties”. On a same facility basis in our hospital division, admissions decreased 0.9% and adjusted admissions declined 0.1%. These operating measures reflect the impact of events at two of our hospitals. The first was lower patient volume at Bakersfield Heart Hospital during the first six months of fiscal 2003 due to the transition associated with the reopening of the hospital’s emergency department during the second quarter of fiscal 2003. The second was lower inpatient volumes and net revenue in Tucson Heart Hospital during fiscal 2003 due to: (i) an increase in emergency room capacity in the market by competitors; (ii) an increase in the number of patients using the hospital’s outpatient services; (iii) an apparent reduction in the number of winter visitors in the market for healthcare, which we believe is related to the poor economy, and (iv) a mild flu season in the market. On a same facility basis excluding the impact of these two hospitals, admissions increased 2.7% and adjusted admissions increased 2.0% for fiscal 2003 compared to 2002.

Also on a same facility basis, inpatient catheterization procedures increased 4.7% and inpatient surgical procedures increased 6.4% for fiscal 2003 compared to fiscal 2002. Average length of stay in our same facility hospitals decreased to 3.61 days for fiscal 2003 compared to 3.72 days for fiscal 2002.

A significant portion of our net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid, which represented 51.6% and 52.1% of our net revenue for fiscal 2003 and 2002, respectively. See“Revenue Sources, Trends and Uncertainties — Revenue Trends and Uncertainties”.

Personnel expense increased $34.2 million, or 24.8%, to $172.3 million for fiscal 2003 from $138.1 million for fiscal 2002. The $34.2 million increase in personnel expense was primarily due to a $36.2 million increase generated by our hospital division, which included a $24.4 million increase attributable to the results of operations of Harlingen Medical Center and Louisiana Heart Hospital during fiscal 2003. The remaining $11.8 million increase in our same facility hospitals was primarily due to higher wage rates and benefit costs, offset in part by a decrease in the use of contract nurses in our same facility hospitals during fiscal 2003 compared to fiscal 2002 and a decrease in staffing at one of our hospitals related to the decline in admissions and procedures performed in that hospital, primarily related to the closing of the emergency department as previously discussed, during the first six months of fiscal 2003. The increase in the hospital division’s personnel expense was offset in part by a decrease in our corporate and other division’s personnel expense due to the change in the physician management contract in our cardiology consulting and management operations whereby certain reimbursable costs are no longer being passed through our operations, as previously discussed. As a percentage of net revenue, personnel expense increased to 31.7% for fiscal 2003 from 28.9% for fiscal 2002. Excluding the results of operations of Harlingen Medical Center and Louisiana Heart Hospital from fiscal 2003 and excluding the $9.7 million of net revenue resulting from the Sun City settlement and the $2.2 million of net revenue resulting from the settlement of a billing dispute with a managed care provider from fiscal 2002, personnel expense represented 30.5% of net revenue for fiscal 2003 compared to 29.6% for fiscal 2002.

Medical supplies expense increased $27.8 million, or 25.5%, to $136.7 million for fiscal 2003 from $108.9 million for fiscal 2002. Of this $27.8 million increase in medical supplies expense, our hospital division generated a $24.8 million increase that included an increase of $11.1 million attributable to the results of operations of Harlingen Medical Center and Louisiana Heart Hospital during fiscal 2003. The remaining increase of $13.7 million in our same facility hospitals was primarily due to a 6.4% increase in surgical procedures and a 4.7% increase in catheterization procedures performed during fiscal 2003 compared to fiscal 2002 combined with the increase in costs resulting from the introduction of drug eluting stents in April 2003. The increase in surgical procedures during 2003 included a significant increase in procedures that use higher cost medical devices and supplies, such as automatic interior cardiac devices (AICD) and pacemaker procedures. Surgical procedures typically involve higher cost medical devices and supplies than catheterization procedures, and certain surgical procedures such as AICDs and pacemaker procedures involve high-cost devices, which makes our medical supplies expense sensitive to changes in case mix of procedures at each of our individual hospitals. In addition, the introduction of drug eluting stents in April 2003 contributed to higher supply cost during the last five months of fiscal 2003. The remaining $3.0 million increase in medical supplies expense was incurred by our diagnostics division and was primarily due to the net revenue growth in its operations, a change in procedure mix in one of our diagnostic centers, and the increased costs associated with drug eluting stents during fiscal 2003. Under the agreements with our hospital customers where we operate cardiac diagnostic and therapeutic centers, we are typically able to pass through most of the increased costs associated with drug eluting stents. As a percentage of net revenue, medical supplies expense increased to 25.2% for fiscal 2003 from 22.8% for fiscal 2002. Excluding the results of operations of Harlingen Medical Center and Louisiana Heart Hospital from fiscal 2003 and excluding the $9.7 million of net revenue resulting from the Sun City settlement and the $2.2 million of net revenue resulting from the settlement of a billing dispute with a managed care provider from fiscal 2002, medical supplies expense represented 25.9% of net revenue for fiscal 2003 compared to 23.4% for fiscal 2002. We expect our same facilities medical supplies expense to continue to increase as new technologies are introduced into the cardiovascular care market and as we experience increased utilization of AICD and pacemaker procedures that use high-cost devices. The amount of increase in our medical supplies expense, and the relationship to net revenue, in future periods will depend on many factors such as the introduction, availability, cost and utilization of the specific technology by physicians in providing patient care, as well as any changes in reimbursement amounts we may receive from Medicare and other payors. Also as previously discussed, we expect our medical supplies expense in future periods will remain sensitive to changes in case mix of procedures at our hospitals.

Bad debt expense increased $4.5 million, or 20.2%, to $26.8 million for fiscal 2003 from $22.3 million for fiscal 2002. This $4.5 million increase was primarily due to the results of operations of Harlingen Medical Center and Louisiana Heart Hospital during fiscal 2003, offset in part by a decrease in bad debt expense of our same facility hospitals due to the continued improvement in the receivables collection procedures and the decline in our hospital division’s days of net revenue in accounts receivable. Our same facility hospitals’ days of net revenue in accounts receivable, based on fiscal year net revenue, was 50 days as of September 30, 2003 compared to 56 days as of September 30, 2002. We primarily attribute the decline in days of net revenue in accounts receivable and the decline in bad debt expense in our same facility hospitals to the receivables collection procedures and other processes we implemented in our business offices during fiscal 2002. As a percentage of net revenue, bad debt expense increased to 4.9% for fiscal 2003 from 4.7% for fiscal 2002. Excluding the results of operations of Harlingen Medical Center and Louisiana Heart Hospital from fiscal 2003 and excluding the $9.7 million of net revenue resulting from the Sun City settlement and the $2.2 million of net revenue resulting from the settlement of a billing dispute with a managed care provider from fiscal 2002, bad debt expense represented 4.0% of net revenue for fiscal 2003 compared to 4.8% for fiscal 2002. We expect our bad debt expenses to increase in fiscal 2004 compared to fiscal 2003 due to an increase in operating activity related to the opening of the hospitals we currently have under development.

Other operating expenses increased $22.6 million, or 21.0%, to $130.2 million for fiscal 2003 from $107.6 million for fiscal 2002. Other operating expenses include primarily maintenance, rent, property taxes, insurance, utilities, advertising, travel, professional fees, contract services and support services provided to operating divisions by our corporate office. Of the $22.6 million increase in other operating expenses, our hospital division generated a $23.6 million increase and our diagnostics division generated a $676,000 increase, which were partially offset by a $1.7 million decrease in our corporate and other division. The $23.6 million increase in our hospital division’s other operating expenses included a $17.3 million increase attributable to the results of operations of Harlingen Medical Center and Louisiana Heart Hospital during fiscal 2003. The remaining $6.3 million increase in our hospital division’s other operating expenses was primarily due to an overall increase in our insurance costs, primarily medical malpractice insurance costs, including both premiums and self-insured retention, of our same facility hospitals during fiscal 2003 compared to fiscal 2002, see “Critical Accounting Policies — General and Professional Liability Risk”and“Item 1. Business — Insurance” and an increase in the maintenance expense at some of our same facility hospitals. The $676,000 increase in our diagnostic services division’s other operating expenses was primarily due to the increase in insurance costs and net revenue growth in the division’s operations, as previously discussed, offset in part by a decrease in legal expenses during fiscal 2003 compared to fiscal 2002. The decrease in the diagnostics division’s legal expenses was attributable to an unusually high amount of legal expenses incurred during fiscal 2002 relating to the Sun City settlement. The $1.7 million decrease in other operating expenses of our corporate and other division was primarily due to the expiration of a management contract during fiscal 2002 and the change in a physician management contract in the third quarter of fiscal 2003 in our cardiology consulting and management operations, as previously discussed. These decreases in other operating expenses were offset in part by increases resulting from severance costs recognized for certain of our previous executive officers, net of bonuses not paid, and costs associated with an offering of debt securities that we elected to delay during the fourth quarter of fiscal 2003. As a percentage of net revenue, other operating expenses increased to 24.0% for fiscal 2003 from 22.5% for fiscal 2002. Excluding the results of operations of Harlingen Medical Center and Louisiana Heart Hospital from fiscal 2003 and excluding the $9.7 million of net revenue and the $1.1 million of legal expense resulting from the Sun City settlement and the $2.2 million of net revenue resulting from the settlement of a billing dispute with a managed care provider from fiscal 2002, other operating expense represented 23.3% of net revenue for fiscal 2003 compared to 22.9% for fiscal 2002.

Pre-opening expenses increased $1.8 million, or 21.7%, to $10.1 million for fiscal 2003 from $8.3 million for fiscal 2002. Pre-opening expenses represent expenses specifically related to projects under development, primarily new hospitals. As of September 30, 2003, we had three hospitals under development, including The Heart Hospital of Milwaukee, TexSAn Heart Hospital and Heart Hospital of Lafayette. We opened The Heart Hospital of Milwaukee on October 14, 2003 and expect to open TexSAn Heart Hospital in January 2004 and Heart Hospital of Lafayette in March 2004. We expect pre-opening expenses for these three hospitals will range from approximately $3.5 million to $5.0 million per hospital. Historically, based on our six most recently

developed majority-owned hospitals, approximately 54% of our pre-opening expenses for a new hospital have been for personnel and 7% for marketing and advertising. The remaining costs have been distributed among several categories including staff recruitment, office and equipment rentals, travel and other operating expenses such as legal expense and utilities. While we incur pre-opening expenses throughout the development process, we expect to incur the majority of these expenses during the six to eight month period immediately prior to the opening of the hospital. As of September 30, 2002, we had five hospitals under development.

We expect pre-opening expenses to decrease for fiscal 2004 compared to fiscal 2003 as development activity related to our hospitals remaining under development will be completed during the first six months of fiscal 2004. In addition, The United States Congress recently passed and President Bush signed into law the Medicare Modernization Act, which imposes an 18-month moratorium on the development of new physician-owned “specialty hospitals,” as such hospitals are defined in the statute and interpretative regulations we expect to be issued by the Department of Health and Human Services. Although the Medicare Modernization Act will not affect our ability to open our two hospitals currently under development, it is expected to prohibit our hospital development activities as currently configured through June 8, 2005, the expiration date of the moratorium. See“Business — Regulation — Fraud and Abuse Laws — Physician self-referral laws”.

Depreciation increased $4.8 million, or 13.6%, to $40.1 million for fiscal 2003 from $35.3 million for fiscal 2002. This increase in depreciation primarily occurred in our hospital division and was due to the depreciation of assets placed in service upon the opening of Harlingen Medical Center and Louisiana Heart Hospital, offset in part by a decrease related to equipment that became fully depreciated since fiscal 2002 at some of our older hospitals. We expect depreciation expense to be higher for fiscal 2004 compared to fiscal 2003 due to the opening of our two new hospitals during fiscal 2003 and the openings of three additional new hospitals during the first six months of fiscal 2004.

Amortization decreased approximately $1.0 million, or 41.7%, to $1.4 million for fiscal 2003 from $2.4 million for fiscal 2002. This decrease was primarily due to the write-off of other intangible assets in connection with the settlement and expiration of a management contract during fiscal 2002 and a change in the estimated useful life of certain intangible assets related to the change in the physician management contract in our cardiology consulting and management operations during the third quarter of fiscal 2003. The decrease was also partially due to other intangible assets that became fully amortized during the fourth quarter of fiscal 2002 in our corporate and other division.

During fiscal 2002, we recognized a $1.2 million gain on the settlement of a management contract in our cardiology consulting and management operations that occurred in December 2001. This gain is included in gain on sale of property, equipment and other assets in our consolidated financial statements.

In September 2003, we performed a goodwill impairment test in accordance with SFAS No. 142, which requires that we do not amortize goodwill, but rather subject our goodwill to an impairment test on an annual basis (at September 30 under our accounting policies), and between annual dates if an event occurs, or circumstances change, that indicate an impairment may exist. The results of this test concluded our goodwill was impaired, and based on the hypothetical purchase price methodology required under SFAS No. 142, we determined the amount of the goodwill impairment to be approximately $58.9 million at September 30, 2003. After recognizing this impairment, we have remaining goodwill of $75.0 million related to our hospital division, which will continue to be subject to periodic impairment tests, and could result in material charges if such amounts are determined to be impaired in future periods.

Interest expense increased by $2.3 million, or 9.7%, to $25.9 million for fiscal 2003 from $23.6 million for fiscal 2002. This increase in interest expense was primarily due to the operations of Harlingen Medical Center and Louisiana Heart Hospital, offset in part by a decrease in interest expense of our same facility hospitals resulting from a decrease in outstanding debt through scheduled principal payment reductions and lower interest rates on our variable rate debt during fiscal 2003 compared to 2002. In addition, we capitalized approximately $1.4 million and $1.1 million of interest expense as part of the capitalized construction costs of our hospitals under development, which was not included in interest expense recognized for fiscal 2003 and fiscal 2002, respectively. Interest income decreased to $1.4 million for fiscal 2003 from $2.3 million for fiscal 2002, which was primarily due to the decline in interest rates and balance of our variable rate short-term investments, which

are included in cash and cash equivalents in our consolidated balance sheets. We expect the total amount of our outstanding indebtedness will increase in future periods as a result of the debt we will incur to finance the development of our hospitals currently under development and any others that we may begin to develop in future periods. Accordingly, we expect our interest expense to increase in future periods consistent with the increase in our indebtedness and changes in market interest rates.

Equity in earnings of unconsolidated affiliates increased $534,000, or 17.8%, to $3.5 million for fiscal 2003 from $3.0 million for fiscal 2002, which was primarily due to improved operating results from our unconsolidated affiliate hospital. We have only one hospital in which we hold less than a 50.0% equity interest and over which we do not have substantive control, such that we were required to account for as an equity investment during fiscal 2003 and 2002. We also continue to hold a small number of additional equity investments in our diagnostic services division, our corporate and other division, and in one of our hospitals.

Earnings allocated to minority interests decreased $5.0 million, or 47.6%, to $5.5 million for fiscal 2003 from $10.5 million for fiscal 2002. Excluding the effect of the $3.0 million allocated to minority interests during fiscal 2002 resulting from the Sun City settlement, earnings allocated to minority interests decreased $2.0 million for fiscal 2003 compared to fiscal 2002. This $2.0 million decrease was primarily due to the losses allocated to minority interest in Harlingen Medical Center and Louisiana Heart Hospital, losses allocated in our hospitals under development resulting from the increase in pre-opening expenses at those hospitals, and a decline in the operating results of one of our same facility hospitals during fiscal 2003 compared to fiscal 2002. These decreases to minority interest were offset in part by an increase in minority interest in the earnings of one of our hospitals in which we recognized a disproportionate share of the profits during fiscal 2002 compared to our pro rata share during fiscal 2003. During fiscal 2003, disproportionate recognition of losses in our hospitals had a negative impact of $5.0 million on our reported loss before income taxes. During fiscal 2002, disproportionate recognition of earnings in our hospitals had a positive impact of $2.0 million on our reported income from operations. See additional discussion of disproportionate allocations under the caption above“Critical Accounting Policies — Earnings Allocated to Minority Interests”.

Income tax expense decreased to $305,000 for fiscal 2003 from $2.9 million for fiscal 2002. Our effective tax rate for fiscal 2003 was 0.5% compared to an effective tax rate of 10.7% for fiscal 2002. For fiscal 2003, our reported loss before income taxes of $60.0 million included a $58.9 million impairment of goodwill, which is non-deductible on a permanent basis for tax purposes. Accordingly, our loss before income taxes that was subject to current and deferred taxes was only $1.1 million, and we recognized income tax expense of $305,000, which was comprised of $846,000 of current income tax expense offset by $541,000 of deferred income tax benefit during fiscal 2003. Because we continue to have federal and state net operating loss carryforwards available from prior periods to offset our current tax liability, we have no material current cash income tax liability and the majority of our income tax expense is deferred. In future periods we expect our effective income tax rate, and related income tax expense or benefit, to increase to more closely approximate our statutory rate. In addition, the amount of current income tax liability we will have in future periods may be offset by $22.1 million and $50.0 million of gross federal and state, respectively, net operating loss carryforwards from prior periods we have available as of September 30, 2003.

Fiscal Year 2002 Compared to Fiscal Year 2001

Net revenue increased $100.6 million, or 26.7%, to $477.6 million in our fiscal year ended September 30, 2002 from $377.0 million in our fiscal year ended September 30, 2001. Of the $100.6 million increase in net revenue, our hospital division generated a $92.4 million increase and our diagnostics division generated an $11.0 million increase. These increases were partially offset by a $2.8 million decrease in our corporate and other division, which includes our cardiology consulting and management operations.

The $92.4 million increase in our hospital division’s net revenue includes the effect of four events. In March 2001, we sold our McAllen Heart Hospital, in July 2001, we began consolidating the financial results of our Tucson Heart Hospital, and on October 1, 2001, we began consolidating the financial results of our Heart Hospital of New Mexico. These three events in our hospital division combined for a net increase of $72.9 million in net revenue during fiscal 2002 from fiscal 2001. Lastly, in June 2002, one of our hospitals reached a favorable

settlement of a billing dispute with a managed care provider, which resulted in that hospital recognizing an additional $2.2 million of net revenue for fiscal 2002. The remaining $17.3 million increase in our hospital division’s net revenue was primarily attributable to a 1.1% increase in adjusted admissions and a 5.1% increase in revenue per adjusted admission.

The $11.0 million increase in our diagnostics division includes the effect of two events. In the third quarter of fiscal 2001, we received an arbitration award involving a billing dispute with our hospital joint venture partner in one of our diagnostic and therapeutic centers, which increased net revenue for fiscal 2001 by $3.2 million. In the second quarter of fiscal 2002, we recognized a $9.7 million increase in net revenue from management fees resulting from the favorable settlement of a billing dispute between one of our managed diagnostic centers, Sun City Cardiac Center, and Sun Health Corporation, which owns and operates the hospital where the center is located. Under the terms of the settlement, Sun City Cardiac Center was awarded total proceeds of $11.2 million relating to service fees, attorney fees and interest costs owed during the period of the contractual dispute. We own a 65% interest in Sun City Cardiac Associates, which manages Sun City Cardiac Center and receives management fees for performing such services. Excluding the effect of these two events, our diagnostic services division generated a $4.5 million increase in net revenue for fiscal 2002 compared to fiscal 2001. This $4.5 million increase was primarily due to rate increases over the prior year, including those resulting from a new services agreement executed with the Sun City Cardiac Center, an increase in the number of diagnostic procedures over the prior year in several of our diagnostic and therapeutic centers, and to the opening of three new diagnostic and therapeutic centers during the second quarter of fiscal 2002. These increases in net revenue were partially offset by a decrease attributable to the curtailment of procedures in one of our diagnostic and therapeutic centers that we elected to close in October 2002 due to the center’s results of operations not meeting our long-term strategic objectives.

The $2.8 million decrease in our corporate and other division’s net revenue was due to the settlement and expiration of one management contract during the third quarter of fiscal 2001 and another management contract during the first quarter of fiscal 2002, offset in part by an increase in management fees and consulting fees we received from physicians remaining under management in our cardiology consulting and management operations.

On a same facility basis in our hospital division, which includes Tucson Heart Hospital and excludes Heart Hospital of New Mexico and McAllen Heart Hospital, net revenue increased $19.0 million, or 5.8%, to $345.8 million for fiscal 2002 from $326.8 million for fiscal 2001. Admissions decreased 5.6% and adjusted admission declined 2.9%. These operating measures reflect the impact of certain events at two of our hospitals. The first was our decision to convert the emergency department to a chest pain clinic at Bakersfield Heart Hospital. The primary reason we converted the emergency department to a chest pain clinic was in response to a payment dispute with a large managed care provider in that market. As we anticipated at the time of the conversion, the hospital experienced a decline in overall admissions after the conversion. During the third quarter of fiscal 2002, we reached a favorable settlement with the managed care provider. As a result of this settlement and other factors, we evaluated whether to reopen the emergency department provided it would not detract us from our primary mission of providing quality cardiovascular care. In December 2002, Bakersfield Heart Hospital’s board of directors approved such a plan to reopen the emergency department, and we reopened the emergency department during the second quarter of fiscal 2003. The second event affecting our same facility operating measures was our decision to terminate several managed care relationships, primarily associated with our Tucson Heart Hospital, that we determined no longer met our long-term strategic objectives. The final event impacting our same facility operating measures was a reduction in available beds during the fourth quarter of fiscal 2002 at two of our hospitals due to renovations and repairs being performed at these facilities. These renovations resulted in 36 fewer beds being available at these two hospitals during the fourth quarter of fiscal 2002 compared to the fourth quarter of fiscal 2001. All of these 36 beds were placed back in service by the end of the first quarter of fiscal 2003.

Also on a same facility basis, inpatient catheterization procedures increased 4.5% while inpatient surgical procedures decreased 6.4% for fiscal 2002 compared to fiscal 2001. Average length of stay in our same facility hospitals decreased 2.9% to 3.65 days for fiscal 2002 compared to 3.76 days for fiscal 2001.

Personnel expense increased $31.4 million, or 29.4%, to $138.1 million for fiscal 2002 from $106.7 million for fiscal 2001. The $31.4 million increase was primarily incurred by our hospital division and included $23.2 million that was attributable to the net increase resulting from the consolidations of the financial results of our Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in part by the decrease resulting from the sale of our McAllen Heart Hospital. The remaining increase of $8.2 million was primarily due to higher wage rates and benefit costs at our other hospitals, and an increase in use of contract nurses in certain of our hospitals during fiscal 2002 compared to fiscal 2001. As a percentage of net revenue, personnel expense increased slightly to 28.9% for fiscal 2002 from 28.3% for fiscal 2001. Excluding the $2.2 million of net revenue resulting from the Bakersfield Heart Hospital billing dispute settlement, and the $9.7 million of net revenue resulting from the Sun City Cardiac Center settlement, personnel expense represented 29.6% of net revenue for fiscal 2002. Similarly, excluding the $3.2 million of net revenue from the arbitration award in our diagnostics division, personnel expense represented 28.5% of net revenue for fiscal 2001.

Medical supplies expense increased $17.5 million, or 19.1%, to $108.9 million for fiscal 2002 from $91.4 million for fiscal 2001. This $17.5 million increase was primarily incurred by our hospital division, and included a net increase of $17.2 million resulting from the consolidations of the financial results of our Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in part by the decrease resulting from the sale of McAllen Heart Hospital. The remaining increase of $300,000 in our other hospitals was primarily due to the increased number of procedures performed during fiscal 2002 compared to fiscal 2001, offset in part by the improved pricing realized from volume purchasing opportunities and vendor consolidation initiatives in our hospital division. As a percentage of net revenue, medical supplies expense decreased to 22.8% for fiscal 2002 from 24.2% for fiscal 2001. Excluding the $2.2 million of net revenue resulting from the Bakersfield Heart Hospital billing dispute settlement, and the $9.7 million of net revenue resulting from the Sun City Cardiac Center settlement, medical supplies expense represented 23.4% of net revenue for fiscal 2002. Similarly, excluding the $3.2 million of net revenue from the arbitration award in our diagnostic services division, medical supplies expense represented 24.5% of net revenue for fiscal 2001.

Bad debt expense increased $1.8 million, or 8.8%, to $22.3 million for fiscal 2002 from $20.5 million for fiscal 2001. This $1.8 million increase in bad debt expense was due to a $3.8 million net increase resulting from the consolidations of the financial results of our Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in part by the decrease resulting from the sale of McAllen Heart Hospital. This $3.8 million increase was partially offset by a $2.0 million decrease in bad debt expense at our other hospitals. Our hospital division’s days of net revenue in accounts receivable were 56 days as of September 30, 2002 compared to 67 days as of September 30, 2001. We attribute this decline in days and the decrease in our same facility hospitals’ bad debt expense to improved receivables collection procedures and other processes we have implemented in our business offices and the decline in aged receivables resulting from the Bakersfield Heart Hospital billing dispute settlement. As a percentage of net revenue, bad debt expense decreased to 4.7% for fiscal 2002 from 5.4% for fiscal 2001. Excluding the $2.2 million of net revenue resulting from the Bakersfield Heart Hospital billing dispute settlement, and the $9.7 million of net revenue resulting from the Sun City Cardiac Center settlement, bad debt expense represented 4.8% of net revenue for fiscal 2002. Similarly, excluding the $3.2 million of net revenue from the arbitration award in our diagnostic services division, bad debt expense represented 5.5% of net revenue for fiscal 2001.

Other operating expenses increased $17.4 million, or 19.3%, to $107.6 million for fiscal 2002 from $90.2 million for fiscal 2001. Other operating expenses include primarily maintenance, rent, property taxes, insurance, utilities, advertising, travel, professional fees, contract services and support services provided to operating divisions by our corporate office. Of the $17.4 million increase in other operating expenses, $15.6 million occurred within our hospital division, of which $13.0 million was due to the consolidations of the financial results of our Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in part by the decrease resulting from the sale of McAllen Heart Hospital. The remaining $2.6 million increase in our hospital division’s other operating expenses was primarily due to an increase in the medical malpractice insurance costs of our other hospitals resulting from the change in our insurance program during the third quarter of fiscal 2001 See“— Critical Accounting Policies — General and Professional Liability Risk”. Also contributing to this remaining increase in other operating expense was an increase in maintenance expense in our oldest hospital, an increase in

property taxes in certain of our markets, and an increase in unreimbursed costs, primarily legal expense, incurred in connection with the Bakersfield Heart Hospital billing dispute settlement. These increases were offset in part by a decrease in sales and use and gross receipts taxes in one of our hospitals resulting from a favorable ruling by the state taxing authority in which that hospital operates that this hospital was exempt from the related taxes.

The diagnostics division’s other operating expenses increased $727,000 due to the combined effect of the increased costs of medical malpractice coverage, as previously discussed, in that division and the net revenue growth in its operations, offset in part by cost reductions from exiting certain low margin services in that division. The remaining $1.1 million increase in other operating expenses occurred in our corporate and other division, and was due to an increase in our corporate expenses to support the growth in our operating divisions for fiscal 2002 compared to fiscal 2001, offset in part by a decrease in the expenses of our cardiology consulting and management operations consistent with its decline in operations for fiscal 2002 compared to fiscal 2001. As a percentage of net revenue, other operating expenses decreased to 22.5% for fiscal 2002 compared to 23.9% for fiscal 2001. Excluding the $2.2 million of net revenue resulting from the Bakersfield Heart Hospital billing dispute settlement, and the $9.7 million of net revenue resulting from the Sun City Cardiac Center settlement, other operating expenses represented 22.9% of net revenue for fiscal 2002. Similarly, excluding the $3.2 million of net revenue from the arbitration award in our diagnostics division, other operating expenses represented 24.1% of net revenue for fiscal 2001.

Pre-opening expenses increased $6.8 million, or 453.3%, to $8.3 million for fiscal 2002 from $1.5 million for fiscal 2001. Pre-opening expenses represent expenses specifically related to projects under development, primarily new hospitals. As of September 30, 2002, we had five hospitals under development, including Harlingen Medical Center, Louisiana Heart Hospital, Heart Hospital of San Antonio, The Heart Hospital of Milwaukee and Heart Hospital of Lafayette. As of September 30, 2001, we had three hospitals under development.

Depreciation increased $5.3 million, or 17.7%, to $35.3 million for fiscal 2002 from $30.0 million for fiscal 2001. Of this $5.3 million increase, $4.7 million was due to the net increase resulting from the consolidations of the financial results of our Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in part by the decrease resulting from the sale of McAllen Heart Hospital. The remaining increase was primarily due to depreciation on capital expenditures related to equipment and information systems made since fiscal 2001.

Amortization decreased $4.2 million, or 63.6%, to $2.4 million for fiscal 2002 from $6.6 million for fiscal 2001. This decrease was primarily due to our adoption of SFAS No. 142 on October 1, 2001. Under the new accounting rules, we were required to discontinue goodwill amortization at the beginning of our fiscal 2002 and subject our goodwill to an annual impairment test, which was performed on a transitional basis as of October 1, 2001 and on a recurring annual basis as of September 30, 2002, and which did not result in any impairment losses. For fiscal 2001, we recognized goodwill amortization of approximately $3.0 million. The remaining decrease in amortization occurred in our corporate and other division and was due to the impairment of other intangible assets recognized in the second quarter of fiscal 2002, and the write-off of other intangible assets in connection with the settlement and expiration of another management contract in our cardiology consulting and management operations during the third quarter of fiscal 2002.

During fiscal 2002, we recognized an approximately $1.2 million gain on the partial settlement of a cardiology management contract that occurred in December 2001. This gain is included in gain on sale of property, equipment and other asserts in our consolidated financial statements.

Interest expense decreased $2.8 million, or 10.6%, to $23.6 million for fiscal 2002 from $26.4 million for fiscal 2001. This decrease in interest expense occurred despite a $4.9 million net increase in interest expense resulting from the consolidations of the financial results of our Tucson Heart Hospital and Heart Hospital of New Mexico, offset in part by the decrease resulting from the sale of McAllen Heart Hospital. The decrease in interest expense excluding the effect of these three events was due to a general reduction in our variable rate interest costs and a reduction in our average total outstanding indebtedness during fiscal 2002 compared to fiscal 2001. The debt reduction was primarily due to the use of proceeds from the sale of McAllen Heart Hospital in March 2001 and our initial public offering in July 2001 to repay all amounts outstanding under our revolving credit facility. Also in July 2001, three of our hospitals reduced their interest expense by refinancing approximately

$79.6 million of their mortgage debt. Interest income decreased to $2.3 million for fiscal 2002 from $3.5 million for fiscal 2001, which was primarily due to the consolidations of the financial results of our Tucson Heart Hospital and our Heart Hospital of New Mexico. Upon consolidation of each of these hospitals, we were required under accounting principles generally accepted in the United States to begin eliminating interest income in our corporate division on working capital advances outstanding to these hospitals.

Equity in earnings of unconsolidated affiliates increased $5.1 million, or 242.9%, to $3.0 million for fiscal 2002 from a loss of $2.1 million for fiscal 2001. Equity in net earnings of unconsolidated affiliates represents our share of the net earnings of hospitals in which we own less than a 50.0% equity interest and over which we do not exercise substantive control. In July 2001, we began consolidating the financial results of our Tucson Heart Hospital, and in October 2001, we began consolidating the financial results of our Heart Hospital of New Mexico after completing acquisitions that increased our ownership interests in each of these hospitals to a majority position. We had previously been required to account for our minority investment in each of these hospitals using the equity method of accounting. We have only one hospital in which we hold less than a 50.0% equity interest and over which we do not have substantive control that we were required to account for as an equity investment during fiscal 2002. This hospital commenced operations in March 2001. We also continue to hold a small number of additional equity investments, primarily in our diagnostics division.

Earnings allocated to minority interests decreased $3.7 million, or 26.1%, to $10.5 million for fiscal 2002 from $14.2 million for fiscal 2001. The $3.7 million decrease in earnings allocated to minority interests includes the effect of $7.6 million recognized in the second quarter of fiscal 2001 resulting from the sale of McAllen Heart Hospital, $1.5 million recognized in the third quarter of fiscal 2001 resulting from the amounts we received in the arbitration award involving a billing dispute with our hospital joint venture partner in one of our diagnostic and therapeutic centers, and the $3.0 million recognized in the second quarter of fiscal 2002 resulting from the Sun City Cardiac settlement. Excluding these three events, earnings allocated to minority interests increased approximately $2.4 million for fiscal 2002 compared to fiscal 2001. Of this $2.4 million increase, $1.3 million was due to the consolidations of the financial results of our Tucson Heart Hospital and Heart Hospital of New Mexico, as previously discussed. The remaining $1.1 million increase was due to improved operating results in our other consolidated hospitals and improved operating results in certain joint ventures in our diagnostics division, offset in part by the increase in pre-opening expenses for hospitals under development.

Income tax expense increased to $2.9 million for fiscal 2002 from $317,000 for fiscal 2001. During fiscal 2001, we had net deferred tax assets, primarily resulting from net operating loss carryforwards that were fully offset by valuation allowances. These offset net deferred tax assets also included the deferred tax asset related to our minority equity investment in our one remaining unconsolidated affiliate hospital. During fiscal 2002, we determined all of our valuation allowances were no longer required and reversed the allowances in accordance with accounting principles generally accepted in the United States. As a result of generating income before income taxes of $27.3 million during fiscal 2002 and the reversal of all of our valuation allowances, we recognized $2.4 million of deferred income tax expense along with $535,000 of current income tax expense during fiscal 2002. Because we continued to have net operating loss carryforwards available from prior periods, we had no material income tax liability in fiscal 2002.

Selected Quarterly Results of Operations.

The following table sets forth unaudited 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, consisting only of normal recurring 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,
	2003			2003			2003			2002			2002

Statement of Operations Data:
Net revenue	$	144,355		$	142,343		$	135,187		$	121,101		$	110,473
Income (loss) from operations	$	(56,488	)	$	8,680		$	7,551		$	6,517		$	7,378
Equity in net earnings of unconsolidated affiliates	$	648		$	1,075		$	1,064		$	754		$	593
Minority interest	$	(534	)	$	(2,288	)	$	(1,811	)	$	(891	)	$	(1,231	)
Net income (loss)	$	(62,062	)	$	778		$	588		$	390		$	1,396
Cash Flow and Other Data:
Net cash provided by operating activities	$	10,480		$	16,279		$	14,706		$	1,123		$	18,374
Net cash used in investing activities	$	(41,069	)	$	(22,259	)	$	(23,776	)	$	(24,987	)	$	(28,056	)
Net cash provided by financing activities	$	13,713		$	11,535		$	4,488		$	15,198		$	9,603

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 $63.9 million at September 30, 2003 and $97.8 million at September 30, 2002. The decrease of $33.9 million in working capital resulted primarily from a decrease in cash and cash equivalents combined with increases in accounts payable, accrued compensation and benefits, accrued property taxes, other accrued liabilities and current portion of long-term debt, offset in part by increases in accounts receivable, net, medical supplies and current deferred income tax assets combined with decreases in short-term borrowings and accrued construction and developments costs.

The decrease in cash and cash equivalents primarily resulted from the repayment of a third-party working capital loan at one of our hospitals, working capital needs related to Harlingen Medical Center and Louisiana

Heart Hospital, repayments of obligations under capital leases, distributions to minority partners, cash used to acquire an increased ownership interest in one of our hospitals, purchases of common stock for treasury and capital expenditures principally related to Harlingen Medical Center, Louisiana Heart Hospital and our three hospitals under development at September 30, 2003. The capital expenditure for our hospitals under development included $8.0 million of cash used to fund construction costs at Heart Hospital of Lafayette, which were subsequently funded through mortgage debt borrowings during October 2003. These decreases to cash and cash equivalents were partially offset by cash flows provided by operations, net proceeds from borrowings to fund the capital expenditures for Harlingen Medical Center, Louisiana Heart Hospital and our three hospitals under development, as well as a net decrease in investments in and advances to our unconsolidated affiliate hospital.

The increase in accounts payable was primarily due to the timing of our payment cycle, which resulted in an increase in unpaid vendor invoices as of September 30, 2003 compared to the number of unpaid vendor invoices as of September 30, 2002, and an increase in activity at The Heart Hospital of Milwaukee during the fourth quarter of fiscal 2003 in preparation of its October 2003 opening. The increase in accrued compensation and benefits at September 30, 2003 was primarily due to several factors, including an increase in deferred compensation under nurse retention arrangements at two of our hospitals, an increase in accrued severance for certain of our previous executive officers, net of bonuses not paid, and an increase in accrued salaries and benefits due to higher staffing levels at several of our hospitals. The increases in staffing included Harlingen Medical Center and Louisiana Heart Hospital related to the ramp up of these two new hospitals, Bakersfield Heart Hospital related to the reopening of its emergency department and The Heart Hospital of Milwaukee related to its October 2003 opening. The increase in other accrued liabilities primarily resulted from the increase in medical malpractice reserves, the opening of Harlingen Medical Center and Louisiana Heart Hospital and the increase in the level of pre-opening activities in our three hospitals under development as of September 30, 2003.

The increase in current portion of long-term debt during fiscal 2003 was primarily due to the reclassifying $11.8 million of long-term debt to current portion of long-term debt at Bakersfield Heart Hospital and an increase at Harlingen Medical Center and Louisiana Heart Hospital, which began making principal payments toward their outstanding debt during fiscal 2003. As discussed below, the amended loan terms for Bakersfield Heart Hospital resulted in a principal prepayment of approximately $11.8 million on December 1, 2003. Because this prepayment was due and paid within the twelve-month period following September 30, 2003, we are required under accounting principles generally accepted in the United States of America to classify the amount as current in our consolidated balance sheet at September 30, 2003.

The increase in accounts receivable, net, resulted from the opening of Harlingen Medical Center and Louisiana Heart Hospital during fiscal 2003 and growth in our net revenue during the fourth quarter of fiscal 2003 compared to the fourth quarter of fiscal 2002, offset in part by increased collections in our hospital division due to procedures and processes we have implemented in our business offices. The increase in medical supplies primarily resulted from the opening of Harlingen Medical Center and Louisiana Heart Hospital and purchases of inventory at The Heart Hospital of Milwaukee during the fourth quarter of fiscal 2003 in preparation of its October 2003 opening. The decrease in the short-term borrowings at September 30, 2003 compared to September 30, 2002 was due to the repayment of a working capital loan at one of our hospitals during fiscal 2003. The decrease in accrued construction and development costs resulted from the financing of equipment purchases that were accrued at September 30, 2002 with borrowings under equipment notes payable during fiscal 2003 at Harlingen Medical Center, offset in part by increased construction activity at our three hospitals under development at September 30, 2003.

A significant portion of our changes in working capital was due to the opening and subsequent operating activities of Harlingen Medical Center and Louisiana Heart Hospital. Consistent with this trend from September 30, 2002 to September 30, 2003, we expect our working capital to fluctuate as our hospitals under development progress through the development period and ramp-up period. Specifically, we expect our working capital to decrease as accounts payable and accrued liabilities increase as each hospital nears its opening and working capital to increase subsequent to each hospital’s opening as accounts receivable, net, increase from its operating activities.

Our operating activities provided net cash of $42.6 million for fiscal 2003 compared to net cash of $69.7 million for fiscal 2002. The $42.6 million net cash provided by operating activities for fiscal 2003 was the result of cash flow provided by our operations and the net changes in our working capital as discussed above. The $69.7 million of net cash provided by operating activities for fiscal 2002 was primarily the result of cash flow provided by our operations which included the favorable settlement of the Sun City Cardiac Center billing dispute and the favorable settlement of a billing dispute with a managed care company and a net decrease in our working capital. The decrease in working capital during fiscal 2002 resulted primarily from increases in accrued construction and development costs, short-term borrowings, accounts payable, accrued compensation and benefits and current portion of long-term debt, offset in part by increases in cash and cash equivalents, accounts receivable, net, medical supplies, deferred tax assets and prepaid expenses and other current assets combined with a decrease in accrued property taxes and other accrued liabilities.

Our investing activities used net cash of $112.1 million for fiscal 2003 compared to $90.8 million for fiscal 2002. The $112.1 million of net cash used by investing activities in fiscal 2003 was primarily due to our capital expenditures, which were principally for Harlingen Medical Center, Louisiana Heart Hospital and our three hospitals under development as of September 30, 2003. The $90.9 million of net cash used by investing activities for fiscal 2002 was primarily due to our capital expenditures principally related to our hospitals under development, our acquisition of the increased ownership in Heart Hospital of New Mexico and our acquisition of a management contract, offset in part by a net decrease in investments in and advances to our unconsolidated affiliate hospital and proceeds from the settlement of a management contract. We expect to continue to invest cash in our hospital under development in fiscal 2004.

Our financing activities provided net cash of $44.9 million for fiscal 2003 compared to $25.5 million for fiscal 2002. The $44.9 million of net cash provided by financing activities for fiscal 2003 was primarily the result of proceeds from the issuance of long-term debt, net of loan acquisition costs, of $87.5 million, offset in part by repayments of short-term borrowings, long-term debt and capital lease obligations of $34.9 million, distributions to, net of investments by, minority partners of $7.4 million and purchases of common stock for treasury of $394,000. The $25.5 million of net cash provided by financing activities for fiscal 2002 was primarily the result of proceeds from the issuance of short-term borrowings and long-term debt, net of loan acquisition costs of $56.1 million offset in part by repayments of long-term debt and capital lease obligations of $28.2 million and distributions to, net of investments by, minority partners of $2.8 million. We expect to continue to obtain capital principally through proceeds from issuance of long-term debt related to our hospitals under development.

Capital Expenditures. Expenditures for property and equipment for fiscal years 2003 and 2002 were $113.5 million and $81.5 million, respectively. Included in the $113.5 million of capital expenditures for fiscal 2003 were capital expenditures of $89.8 million for Harlingen Medical Center, Louisiana Heart Hospital and our hospitals under development. Included in the $81.5 million of capital expenditures for fiscal 2002 were capital expenditures of $62.1 million for Harlingen Medical Center, Louisiana Heart Hospital and our hospitals under development at that time. In addition, we incurred $4.6 million and $3.0 million of capital lease obligations during fiscal 2003 and fiscal 2002, respectively. We also accrued $10.8 million and $22.0 million of capital expenditures for construction and development costs related to our hospitals under development at September 30, 2003 and 2002. We expect our capital expenditures for our hospitals under development will decrease for fiscal 2004 compared to fiscal 2003 due to the anticipated completion of our remaining hospitals under development during the first six months of fiscal 2004. Future capital expenditures will depend upon the level of development activity we engage in and the level of replacement of existing property and equipment required in future periods.

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, 2003, which are due as follows (in thousands):


		2004		2005		2006		2007		Thereafter		Total

Long-term debt		$	45,612	$	48,270	$	218,203	$	22,403	$	12,008	$	346,496
Obligations under capital leases		$	3,675	$	3,727	$	4,141	$	1,871	$	1,075	$	14,489

	Total debt	$	49,287	$	51,997	$	222,344	$	24,274	$	13,083	$	360,985
Other long-term obligations, excluding interest rate swaps(1)		$	—	$	442	$	26	$	—	$	4,247	$	4,715
Operating leases, net of rental income		$	1,952	$	1,591	$	1,141	$	649	$	4,117	$	9,450

	Total	$	51,239	$	54,030	$	223,511	$	24,923	$	21,447	$	375,150

(1)

Other long-term obligations, excluding interest rate swaps, consists of non-current portion of deferred compensation under nurse retention arrangements at two of our hospitals and a working capital note due to a hospital investor partner at one of our hospitals. The working capital note obligation is due as funds are available and therefore is included in the “Thereafter” category in the above table.

At September 30, 2003, we had $361.0 million of outstanding debt, $49.3 million of which was classified as current. Of the $361.0 million of outstanding debt, $352.1 million was outstanding to lenders to our hospitals and included $6.4 million outstanding under capital leases. The remaining $8.9 million of debt was outstanding to lenders to our diagnostic services and corporate and other divisions under capital leases and other miscellaneous indebtedness, primarily equipment notes payable and capital leases. No amounts were outstanding to lenders under our $100.0 million revolving credit facility at September 30, 2003. At the same date, however, we had letters of credit outstanding of $9.5 million, which reduced our availability under this facility to $90.5 million.

In addition to the $361.0 million of outstanding debt at September 30, 2003, we had a $4.2 million working capital note due to a hospital investor partner at one of our hospitals that will be repaid as funds are available and is included in other long-term obligations.

In addition to the debt described above and our cash obligations under operating leases, we expect to incur additional indebtedness during fiscal 2004 as we anticipate completing the development of our new hospitals. The development and construction of the hospitals we had under development at September 30, 2003 in Texas, Louisiana and Wisconsin will require us to incur additional long-term debt of between $70.0 million and $80.0 million during the next 12 months. We expect approximately $28.0 million of this additional long-term debt will be mortgage debt, all of which is available from designated, but unused, commitments and remaining undesignated borrowings available under the master credit facility as of September 30, 2003. We expect the remaining approximately $48.0 million of additional long-term debt will be equipment debt primarily financed through a combination of debt and capital leases provided by lenders affiliated with the equipment vendors.

We became a party to a new $189.6 million master credit facility in July 2001 in connection with our initial public offering. In addition to providing a source of capital to refinance approximately $79.6 million of the indebtedness of three of our existing hospitals, the master credit facility provided us with $110.0 million to finance the construction and development of new hospitals under our hospital development program. In March 2003, the master credit facility was amended to increase borrowings by $35.0 million thereby providing a total of $145.0 million of available debt to finance our hospital development program. As of September 30, 2003, $111.9 million of the initial $145.0 million had been designated, of which $101.5 million had been borrowed to finance the development of Harlingen Medical Center, Louisiana Heart Hospital, TexSAn Heart Hospital and The Heart Hospital of Milwaukee. In October 2003, $18.4 million of the $145.0 million available for this purpose was designated for use in funding the development of Heart Hospital of Lafayette. As of October 30, 2003, $14.7 million of the $145.0 million remains available to finance other hospital projects that we may begin in

future periods. The master credit facility matures on July 27, 2006 and borrowings bear interest at LIBOR plus a margin that ranges from 2.5% to 3.5%. We are required to pay an unused commitment fee each month at a rate of 0.5%. The master credit facility includes covenants that require maintenance of certain financial ratios regarding leverage levels and debt service coverage as well as various restrictive covenants.

In May 2002, Harlingen Medical Center obtained a debt commitment of up to $20 million to finance its equipment. Amounts funded under the loan accrue interest at a fixed rate of interest equal to a specific Treasury Note yield, plus a margin. Upon the conversion of the loan to a fixed rate of interest, the principal amount outstanding will be repaid over a time period equal to either five or seven years, depending on the type and manufacturer of equipment originally purchased under the facility. As of September 30, 2003, Harlingen Medical Center had borrowed $19.4 million of the $20.0 million available and the remaining $600,000 unused portion of the commitment expired.

In December 2002, Louisiana Heart Hospital, which opened February 28, 2003, obtained a debt commitment to finance its equipment that allows the hospital to borrow up to $18.0 million. Until December 2003, interest on borrowings made under this commitment will accrue at 90-day LIBOR plus 3.95%. After such date, amounts funded under the loan shall accrue interest at either a fixed rate equal to a specific Treasury Note yield, plus a margin, or 90-day LIBOR, plus a margin, depending on the manufacturer of the equipment originally purchased under the facility. Beginning in December 2003, the principal amount of the loan will be repaid over a six-year period. As of September 30, 2003, Louisiana Heart Hospital had borrowed $15.3 million of the $18.0 million available. In October 2003, Louisiana Heart Hospital borrowed an additional $1.5 million of the $18.0 million commitment and the remaining $1.2 million unused portion of the commitment expired.

In July 2003, TexSAn Heart Hospital obtained a debt commitment of up to $20.0 million to finance its equipment purchases. Until March 2004, interest on borrowings made under this commitment shall accrue at Prime, plus a margin. Beginning in March 2004, borrowings shall bear interest at a fixed rate of interest equal to a specific Treasury Note yield, plus a margin. Principal shall be payable in 78 months beginning in September 2004. As of September 30, 2003, no borrowings were outstanding under the commitment.

In November 2003, Milwaukee Heart Hospital obtained a $15.0 million debt commitment to finance equipment purchases. Amounts borrowed under this commitment shall accrue at a base rate, plus a margin, or LIBOR, plus a margin. Principal amount borrowed under this commitment are due March 2004.

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


	Amount		Amount		Amount
	Committed		Paid		Accrued

Louisiana Heart Hospital	$	21.9	$	20.5	$	1.0
TexSAn Heart Hospital	$	27.4	$	23.7	$	2.9
The Heart Hospital of Milwaukee	$	15.6	$	13.8	$	1.2
Heart Hospital of Lafayette	$	13.2	$	8.4	$	2.4

Separate from our master credit facility as discussed above, our revolving credit facility provides $100.0 million in availability, $10.0 million of which is designated for short-term borrowings and $25.0 million of which is available to issue letters of credit. As of September 30, 2003, we had used $9.5 million of this availability to issue letters of credit and consequently had availability for additional borrowings of $90.5 million under the revolving credit facility, of which $15.5 million is available for additional letters of credit. The revolving credit facility matures on January 31, 2005 and borrowings under the facility bear interest at either the LIBOR or the prime rate plus various applicable margins that are based upon financial covenant ratio tests. We are required to pay a quarterly unused commitment fee at a rate of 0.325% for available, but unused, long-term borrowings and 0.375% for available, but unused, short-term borrowings under the revolving credit facility. The revolving credit facility includes various restrictive covenants, including restrictions on certain types of additional indebtedness, investments, asset sales, capital expenditures, dividends, sale and leasebacks, contingent obliga-

tions, transactions with affiliates, changes in our corporate structure, and fundamental changes. The covenants also require maintenance of various ratios regarding leverage levels and debt service coverage.

At September 30, 2003, we were in violation of certain financial ratio covenants related to the real estate mortgage loans at Arizona Heart Hospital, Tucson Heart Hospital and Heart Hospital of Austin. We were also not in compliance with certain guarantor financial ratio covenants related to the real estate loans at Heart Hospital of Austin and Heart Hospital of New Mexico. We received waivers of the covenant breaches from each lender. In addition, the lender at Tucson Heart Hospital agreed to waive compliance with certain of its financial covenants through, and including, March 31, 2004, and the lender at Arizona Heart Hospital agreed to modify the terms of its financing to accommodate the hospital’s anticipated future operating performance. Also, at December 31, 2002, Bakersfield Heart Hospital was not in compliance with one of its financial ratio covenants. The mortgage lender granted a waiver for the breach at December 31, 2002 and agreed to amend the terms of the loan to replace the financial ratio covenant with a minimum financial performance covenant at June 30, 2003 and September 30, 2003. Under the amended loan terms, the financial ratio covenant would have become effective again December 31, 2003 and would have determined the amount of a potential prepayment of the loan’s principal balance. In November 2003, the mortgage lender agreed to further amend the terms of the loan to accommodate a potential change in capital reimbursement at the hospital. Under the terms of the November 2003 amendment, the mortgage lender agreed to amend both the financial ratio covenants and the minimum financial performance covenants. In consideration of the amendment, we remitted a prepayment of approximately $11.8 million on December 1, 2003. Accordingly, we have classified this amount of Bakersfield Heart Hospital’s mortgage debt as current in the accompanying consolidated balance sheet at September 30, 2003. Except as noted above, we were in compliance with all other covenants in the instruments governing our outstanding debt at September 30, 2003.

We guarantee either all or a portion of the obligations of our subsidiary hospitals for bank mortgage loans. We also guarantee a portion of the obligations of our subsidiary hospitals for equipment and other notes payable. We provide these guarantees in accordance with the related hospital operating agreements, and we receive a fee for providing these guarantees from the hospitals or the physician investors.

We also guarantee approximately 50% of the real estate and 40% of the equipment debt of Heart Hospital of South Dakota, the one hospital in which we owned a minority interest at September 30, 2003, and therefore do not consolidate the hospital’s results of operation and financial position. We provide such guarantee in exchange for a fee from the hospital.

We believe that internally generated cash flows and available borrowings under our revolving credit facility of $90.5 million, together with the remaining net proceeds of our initial public offering of $61.3 million, borrowings available under the master credit facility not yet designated for a development hospital of $14.7 million, borrowings available under equipment debt commitments of $35.0 million, cash balances in our development hospitals of $1.2 million, and other long-term debt and capital leases we expect to incur will be sufficient to finance our hospital development program, other capital expenditures and our working capital requirements for the next 12 to 18 months. While we believe the aforementioned capital resources are sufficient to fund our hospital development program, other capital expenditures and working capital requirements for the specified period, we periodically may evaluate and pursue other financing alternatives, including amending or replacing our bank debt or issuing additional equity or debt securities, to supplement or replace our current sources of capital.

Intercompany Financing Arrangements.MedCath Corporation uses intercompany financing arrangements to provide cash support to individual hospitals for their working capital and other corporate needs, including the needs of our new hospitals during the ramp-up period and any periodic or ongoing needs of our other hospitals. We provide these working capital loans pursuant to the terms of the operating agreements between our physician and hospital investor partners and us at each of our hospitals. These intercompany loans are evidenced by promissory notes that establish borrowing limits and provide for a market rate of interest to be paid to MedCath Corporation on outstanding balances. These intercompany loans are subordinated to each hospital’s mortgage and equipment debt outstanding, but are senior to our equity interests and those of our partners in the hospital. They are secured in each instance by a junior lien on the borrowing hospital’s accounts receivable. As of September 30, 2003 and 2002, we held a total of $88.0 million and $72.7 million, respectively, of these intercompany notes.

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 in accordance with accounting principles generally accepted in the United States of America, 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 note 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.

The aggregate amount of these intercompany loans outstanding fluctuates from time to time depending upon our hospitals’ needs for capital resources. We have during fiscal 2003, and will continue in future periods, provided information on a quarterly basis about the aggregate amount of these intercompany loans outstanding to assist investors in better understanding the total amount of our investment in our hospitals, our claim to the future cash flows of our hospitals, and our capital structure.

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.

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.

Recent and Proposed Accounting Pronouncements

In November 2002, the FASB issued Interpretation No. (FIN) 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The objective of FIN 45 is to record the fair value of a guarantee at inception and require disclosure of all such guarantees in interim and annual financial statements. The initial recognition and initial fair value measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Our adoption and application of FIN 45 did not have any material impact on the Company’s financial position and results of operations as of and for the year ended September 30, 2003. See Note 8 to the consolidated financial statements included elsewhere in this report for disclosures regarding our guarantees as required by FIN 45.

In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation. This Statement amended SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement also amended the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on the reported results of operations. The transition provisions of this Statement were effective us beginning December 15, 2002, but did not have any impact on the our financial position, results of operations and cash flows for the year ended September 30, 2003 as we continued to account for stock options in accordance with APB No. 25, as previously described. We elected to early adopt the remaining disclosure requirements of SFAS No. 148. See Notes 2 and 14 to the consolidated financial statements for additional information on our stock options and the pro forma disclosures required by SFAS No. 123 and SFAS No. 148.

In January 2003, the FASB issued FIN 46,Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either: (i) does not have equity investors with voting rights, the obligation to absorb expected losses, and the right to receive expected residual returns; or (ii) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the expected losses or residual returns from the variable interest entity’s activities or both. Since issuing FIN 46, the FASB has proposed various amendments to the Interpretation and has twice deferred the effective dates. Most recently on December 17, 2003, the FASB approved a partial deferral of FIN 46 and announced that it expects to release the revised version of FIN 46 (hereinafter, FIN 46-R) before December 31, 2003. This partial deferral established the effective dates for public entities to apply FIN 46 and FIN 46-R based on the nature of the variable interest entity and the date upon which the public company became involved with the variable interest entity. In general, the deferral provides that (i) for variable interest entities created after February 1, 2003, a public entity must apply FIN 46-R at the end of the first interim or annual period ending after March 15, 2004, and may be required to apply FIN 46 at the end of the first interim or annual period ending after December 15, 2003 if the variable interest entity is a special purpose entity, and (ii) for variable interest entities created after January 31, 2003, a public company must apply FIN 46 at the end of the first interim or annual period ending after December 15, 2003, as previously required, and then apply FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004. As of September 30, 2003, we did not have any variable interest entities created after January 31, 2003. We are currently in the process of applying FIN 46 to our entities created before February 1, 2003 to determine which, if any, are variable interest entities and the impact on our financial position, results of operations and cash flows.

In April 2003, the FASB issued SFAS No. 149,Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities.This Statement amends and clarifies the accounting for and definition of derivative instruments and hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003 and should generally be applied prospectively. Our adoption and application of SFAS No. 149 did not have any material impact on our financial position and results of operations as of and for the year ended September 30, 2003.

In May 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Generally, this Statement was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003, for all other instruments. In November 2003, the FASB deferred the effective dates for certain mandatory redeemable financial instruments of certain nonpublic entities and certain mandatory redeemable noncontrolling interests under SFAS No. 150. As of September 30, 2003, we did not have any financial instruments outstanding that were subject to SFAS No. 150, other than those subject to the deferred effective dates and additional guidance expected from the FASB.

Item 8. Financial Statements and Supplementary Data

MEDCATH CORPORATION

INDEX TO FINANCIAL STATEMENTS


		Page

INDEPENDENT AUDITORS’ REPORT			31
CONSOLIDATED FINANCIAL STATEMENTS:
	Consolidated Balance Sheets as of September 30, 2003 and 2002		32
	Consolidated Statements of Operations for the Years Ended September 30, 2003, 2002 and 2001		33
	Consolidated Statements of Stockholders’ Equity for the Years Ended September 30, 2003, 2002 and 2001		34
	Consolidated Statements of Cash Flows for the Years Ended September 30, 2003, 2002 and 2001		35
	Notes to Consolidated Financial Statements		36

INDEPENDENT AUDITORS’ REPORT

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, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2003. 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 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, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 3 to the consolidated financial statements, effective October 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets.


	/s/ DELOITTE & TOUCHE LLP

December 19, 2003

Charlotte, North Carolina

MEDCATH CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



			September 30,

			2003			2002

Current assets:
	Cash and cash equivalents		$	94,199		$	118,768
	Accounts receivable, net			86,306			70,890
	Medical supplies			16,424			13,566
	Due from affiliates			187			20
	Deferred income tax assets			3,145			1,977
	Prepaid expenses and other current assets			7,668			8,112

		Total current assets		207,929			213,333
Property and equipment, net				436,947			368,424
Investments in and advances to affiliates, net				5,486			3,234
Goodwill, net				75,000			132,168
Other intangible assets, net				17,095			19,280
Other assets				6,840			4,602

		Total assets	$	749,297		$	741,041

Current liabilities:
	Short-term borrowings		$	—		$	4,500
	Accounts payable			42,360			31,708
	Income tax payable			278			609
	Accrued compensation and benefits			20,356			15,806
	Accrued property taxes			4,723			3,090
	Accrued construction and development costs			15,340			24,317
	Other accrued liabilities			11,667			7,241
	Current portion of long-term debt and obligations under capital leases			49,287			28,237

		Total current liabilities		144,011			115,508
Long-term debt				300,884			261,009
Obligations under capital leases				10,814			10,447
Deferred income tax liabilities				3,951			2,194
Other long-term obligations				7,164			5,818

		Total liabilities		466,824			394,976
Minority interest in equity of consolidated subsidiaries				17,419			20,375
Stockholders’ equity:
	Preferred stock, $0.01 par value, 10,000,000 shares authorized; none issued			—			—
	Common stock, $0.01 par value, 50,000,000 shares authorized; 18,011,520 issued and 17,942,620 outstanding at September 30, 2003; 18,011,520 issued and outstanding at September 30, 2002			180			180
	Paid-in capital			357,707			357,707
	Accumulated deficit			(91,092	)		(30,786	)
	Accumulated other comprehensive loss			(1,347	)		(1,411	)
	Treasury stock, at cost, 68,900 shares held at September 30, 2003			(394	)		—

		Total stockholders’ equity		265,054			325,690

		Total liabilities, minority interest and stockholders’ equity	$	749,297		$	741,041

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)



			Year Ended September 30,

			2003			2002			2001

Net revenue			$	542,986		$	477,637		$	377,007
Operating expenses:
	Personnel expense			172,318			138,067			106,682
	Medical supplies expense			136,681			108,896			91,374
	Bad debt expense			26,791			22,319			20,545
	Other operating expenses			130,173			107,636			90,176
	Pre-opening expenses			10,095			8,339			1,490
	Depreciation			40,104			35,276			29,997
	Amortization			1,441			2,367			6,649
	Loss (gain) on disposal of property, equipment and other assets			258			(1,047	)		162
	Loss on debt refinancing			—			—			1,560
	Gain on sale of hospital			—			—			(13,461	)
	Impairments of goodwill and long-lived assets			58,865			—			985

		Total operating expenses		576,726			421,853			336,159

Income (loss) from operations				(33,740	)		55,784			40,848
Other income (expenses):
	Interest expense			(25,857	)		(23,596	)		(26,395	)
	Interest income			1,373			2,337			3,521
	Other income (expense), net			206			190			(327	)
	Equity in net earnings (losses) of unconsolidated affiliates			3,541			3,007			(2,119	)

		Total other expenses, net		(20,737	)		(18,062	)		(25,320	)

Income (loss) before minority interest and income taxes				(54,477	)		37,722			15,528
Minority interest share of earnings of consolidated subsidiaries				(5,524	)		(10,451	)		(14,160	)

Income (loss) income before income taxes				(60,001	)		27,271			1,368
Income tax expense				(305	)		(2,920	)		(317	)

Net income (loss)			$	(60,306	)	$	24,351		$	1,051

Earnings (loss) per share, basic			$	(3.35	)	$	1.35		$	0.08

Earnings (loss) per share, diluted			$	(3.35	)	$	1.34		$	0.08

Weighted average number of shares, basic				17,989			18,012			13,007
	Dilutive effect of stock options			—			105			100

Weighted average number of shares, diluted				17,989			18,117			13,107

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)


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

Balance, September 30, 2000				11,837		$	119	$	216,694	$	(56,188	)	$	—			—	$	—		$	160,625
	Exercise of stock options			43			—		794		—			—			—		—			794
	Public offering of common stock			6,000			60		135,837		—			—			—		—			135,897
	Issuance of common stock in exchange transaction			132			1		3,289		—			—			—		—			3,290
	Comprehensive income:
		Net income		—			—		—		1,051			—			—		—			1,051
		Change in fair value of interest rate swaps		—			—		—		—			(693	)		—		—			(693	)

		Total comprehensive income																				358

Balance, September 30, 2001				18,012			180		356,614		(55,137	)		(693	)		—		—			300,964
	Public offering tax benefit (Note 1)			—			—		800		—			—			—		—			800
	Public offering reduction of expenses (Note 1)			—			—		293		—			—			—		—			293
	Comprehensive income:																					—
		Net income		—			—		—		24,351			—			—		—			24,351
		Change in fair value of interest rate swaps, net of income tax benefit		—			—		—		—			(718	)		—		—			(718	)

		Total comprehensive income																				23,633

Balance, September 30, 2002				18,012			180		357,707		(30,786	)		(1,411	)		—		—			325,690
	Purchase of treasury stock			(69	)		—		—		—			—			69		(394	)		(394	)
	Comprehensive income:
		Net loss		—			—		—		(60,306	)		—			—		—			(60,306	)
		Change in fair value of interest rate swaps, net of income tax expense		—			—		—		—			64			—		—			64

		Total comprehensive loss																				(60,242	)

Balance, September 30, 2003				17,943		$	180	$	357,707	$	(91,092	)	$	(1,347	)		69	$	(394	)	$	265,054

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



				Year Ended September 30,

				2003			2002			2001

Net income (loss)				$	(60,306	)	$	24,351		$	1,051
Adjustments to reconcile net income to net cash provided by operating activities:
	Bad debt expense				26,791			22,319			20,545
	Depreciation and amortization expense				41,545			37,643			36,646
	Loss (gain) on disposal of property, equipment and other assets				258			(1,047	)		162
	Loss on debt refinancing				—			—			1,560
	Gain on sale of hospital				—			—			(13,461	)
	Impairments of goodwill and long-lived assets				58,865			—			985
	Amortization of loan acquisition costs				1,458			1,314			1,519
	Equity in net (earnings) losses of unconsolidated affiliates				(3,541	)		(3,007	)		2,119
	Minority interest share of earnings of consolidated subsidiaries				5,524			10,451			14,160
	Deferred income taxes				(541	)		2,385			—
	Change in assets and liabilities that relate to operations:
		Accounts receivable, net			(42,207	)		(19,255	)		(22,670	)
		Medical supplies			(2,858	)		(4,355	)		(2,012	)
		Due from affiliates			(167	)		(10	)		(89	)
		Prepaid expenses and other current assets			424			(3,056	)		(1,544	)
		Other assets			(2,607	)		(304	)		478
		Accounts payable and accrued liabilities			19,950			2,263			6,552

			Net cash provided by operating activities		42,588			69,692			44,836

Investing activities:
	Purchases of property and equipment				(113,482	)		(81,523	)		(14,465	)
	Proceeds from sale of property and equipment				746			1,242			1,557
	Proceeds from sale of hospital				—			—			53,798
	Loans under management agreements				—			(61	)		(378	)
	Repayments of loans under management agreements				169			461			1,499
	Acquisition of management contracts				—			(1,451	)		—
	Proceeds from settlement of management contract				—			1,825			—
	Acquisition of other intangible assets				—			(480	)		—
	Investments in and advances to affiliates, net				1,052			6,339			(5,765	)
	Cash acquired upon consolidation of equity method investees				—			151			279
	Acquisition of increased ownership in hospitals				(811	)		(17,395	)		(25,374	)
	Other investing activities				235			141			71

			Net cash provided by (used in) investing activities		(112,091	)		(90,751	)		11,222

Financing activities:
	Short-term debt borrowings (repayments), net				(4,500	)		4,500			(2,127	)
	Proceeds from issuance of long-term debt				88,510			52,395			116,785
	Repayments of long-term debt				(27,069	)		(26,075	)		(186,149	)
	Repayments of obligations under capital leases				(3,277	)		(2,105	)		(3,477	)
	Payment of loan acquisition costs				(998	)		(778	)		(3,522	)
	Investments by minority partners				567			6,465			4,965
	Distributions to minority partners				(7,905	)		(9,225	)		(12,488	)
	Purchase of common stock for treasury				(394	)		—			—
	Proceeds from exercised stock options				—			—			794
	Proceeds from initial public offering				—			293			135,897

			Net cash provided by financing activities		44,934			25,470			50,678

	Net increase (decrease) in cash and cash equivalents				(24,569	)		4,411			106,736
	Cash and cash equivalents:
			Beginning of year		118,768			114,357			7,621

			End of year	$	94,199		$	118,768		$	114,357

Supplemental disclosure of cash flow information:
	Interest paid			$	24,908		$	20,926		$	26,176
	Income taxes paid (refunded), net				1,166			149			69
Supplemental schedule of noncash investing and financing activities:
	Capital expenditures financed by capital leases				4,649			3,012			10,495
	Capital expenditures included in accrued construction and development costs				10,815			21,991			2,326
	Distributions to minority partners declared but not paid				980			—			—
	Common stock issued for acquisitions				—			—			3,290

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 the diagnosis and treatment of cardiovascular disease. The Company designs, develops, owns and operates hospitals in partnership with physicians, most of whom are cardiologists and cardiovascular surgeons. While each of the Company’s 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, 2003, the Company owned and operated ten hospitals, together with its physician partners, who own an equity interest in the hospital where they practice. The Company’s existing hospitals have a total of 635 licensed beds, of which 548 were staffed and available, and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota and Texas. In October 2003, the Company opened its eleventh hospital, which is located in the city of Glendale, near Milwaukee, Wisconsin. This hospital has 32 licensed beds. The Company is currently in the process of developing two hospitals, which include a hospital located in Lafayette, Louisiana and a hospital located in San Antonio, Texas. The Company expects to open these hospitals during the first quarter of calendar 2004.

The Company accounts for all but one of its owned and operated hospitals as consolidated subsidiaries. The Company owns a minority interest in Heart Hospital of South Dakota and does not have substantive control over the hospital, and therefore is unable to consolidate the hospital’s results of operations and financial position, but rather is required to account for its minority ownership interest in the hospital as an equity investment.

In addition to its hospitals, the Company provides cardiovascular care services in diagnostic and therapeutic facilities located in various locations and through mobile cardiac catheterization laboratories (the Diagnostics Division). The Company also provides consulting and management services (CCM) tailored primarily to cardiologists and cardiovascular surgeons, which is included in the corporate and other division.

The Company completed its initial public offering (the Offering) in July 2001, by issuing 6,000,000 new shares of common stock at a price of $25.00 per share. At the time of the Offering, the Company recognized net proceeds from the Offering of approximately $135.9 million after deducting the underwriters’ discounts and commissions and other offering expenses. During the fiscal year ended September 30, 2002, the Company recognized two transactions that increased the net proceeds from the Offering by approximately $1.1 million to $137.0 million. Both of these transactions were recorded in paid-in capital as an increase in the net proceeds of the Offering.

Concurrent with the Offering, the Company completed a series of transactions to prepare for the Offering and to increase its ownership interest in some of its hospitals. First, the Company, MedCath Corporation, was established as the new holding company by issuing 11,879,918 shares of its common stock in exchange for all of the outstanding shares of common stock of the predecessor holding company, MedCath Holdings, Inc. Second, the Company completed a series of transactions in which it issued 131,602 shares of common stock valued at the public offering price and paid approximately $25.4 million cash to acquire additional ownership interests in five of its hospitals from its physician and hospital partners in each of those respective hospitals. As a result of the increase in its ownership interest in Tucson Heart Hospital from a minority to a majority ownership position, the Company obtained substantive control of the hospital and began to consolidate its results of operations and financial position from the date of acquisition. Before acquiring this additional ownership interest, the Company was required to account for its investment in Tucson Heart Hospital using the equity method of accounting. The shares of common stock issued in these transactions were in addition to the shares sold in the Offering. The cash paid in these transactions was financed with a portion of the net proceeds from the Offering.

On October 1, 2001, the Company acquired an additional ownership interest in Heart Hospital of New Mexico from its physician and hospital partners. As a result of this transaction (see Note 4), the Company increased its ownership interest from a minority to a majority ownership position and obtained substantive control

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of the hospital. Accordingly, the Company began to consolidate this hospital’s results of operations and financial position on October 1, 2001. Prior to acquiring this additional ownership interest, the Company was required to account for its investment in Heart Hospital of New Mexico using the equity method of accounting.


2.	Summary of Significant Accounting Policies

Basis of Consolidation — The consolidated financial statements include the accounts of the Company and its subsidiaries that are wholly and majority owned and/or over which it exercises substantive control. All intercompany accounts and transactions have been eliminated in consolidation. Investments in unconsolidated affiliates, in which the Company has 20% or more ownership interest and has the ability to exercise significant influence, but not substantive control, over the affiliates’ operating and financial policies and activities, are accounted for using the equity method of accounting.

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

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

Cash and Cash Equivalents — Cash consists of currency on hand and demand deposits with financial institutions. Cash equivalents include investments in highly liquid instruments with original maturities of three months or less.

Medical Supplies — Medical supplies consist primarily of laboratory and surgical supplies, contrast media, and catheters and are stated at the lower of first-in, first-out (FIFO) 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, 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 the building until the facility is operational, at which time depreciation begins using the straight-line method over the estimated useful life of the building. During the years ended September 30, 2003, 2002 and 2001, the Company capitalized interest expense of $1.4 million, $1.1 million and $1.0 million, respectively.

Impairment of Long-Lived Assets — Effective October 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement (i) superceded SFAS No. 121, although it retained most of the basic requirements of SFAS No. 121 regarding long-lived assets to be held and used; (ii) resolved some implementation issues related to SFAS No. 121; and (iii) superceded the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30 for the disposal of a segment of a business to establish a single accounting model, based on the framework of SFAS No. 121, for long-lived assets to be disposed of by sale. This Statement also amended Accounting Research Bulletin (ARB) No. 51,Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. In accordance with SFAS No. 144, the Company assesses the carrying value of long-lived assets other than goodwill and intangible assets (See Note 3) whenever events or changes in circumstances indicate that the carrying value of assets, or related group of assets,

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

may not be recoverable. The Company continually considers internal and external factors such as hospital and physician contract changes, local market developments, changes in third-party reimbursement methodologies, national health care trends, and other publicly available information. Measurement of the amount of the impairment, if any, may be based on quoted market prices, if available, or an estimate based on valuation techniques available in the circumstances, including discounted cash flows using the Company’s cost of capital. The estimates of these future cash flows are based on assumptions and projections that the Company believes to be reasonable and supportable. As considerable judgment is necessary to estimate future cash flows and fair values, there is a reasonable possibility that actual results may vary significantly from such estimates. No impairment charges related to SFAS No. 144 were necessary for the years ended September 30, 2003 and 2002.

Prior to adopting SFAS No. 144, the Company followed the provisions of SFAS No. 121 as required. Based on negotiations in March 2001 with a physician group under management contract in CCM, the Company determined that the carrying value of certain long-lived assets may not be recoverable. The Company assessed the recoverability of these assets at March 31, 2001 by comparing the revised expected future cash flows to the carrying value and concluded the carrying value had become impaired. Accordingly, the Company recognized a noncash impairment charges totaling approximately $985,000 during its second quarter ended March 31, 2001 to adjust the long-lived assets to the anticipated future cash flows discounted using the Company’s cost of capital

Other Long-Term Obligations — Other long-term obligations consist of a working capital note due to a hospital investor partner in one of the Company’s hospitals; the Company’s liabilities for its interest rate swap derivatives, which are recognized at their fair market value as of the balance sheet date; and the Company’s noncurrent obligation under certain deferred compensation arrangements.

Market Risk Policy — The Company’s policy for managing risk related to its exposure to variability in interest rates, foreign currency exchange 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 in the balance sheet and measures those instruments at fair value in accordance with SFAS No 133,Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138,Accounting for Derivative Instruments and Hedging Activities (an amendment of SFAS Statement No. 133). See also Note 8.

In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149,Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities.This Statement amends and clarifies the accounting for and definition of derivative instruments and hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003 and should generally be applied prospectively. The Company’s adoption and application of SFAS No. 149 did not have any material impact on the Company’s financial position and results of operations as of and for the year ended September 30, 2003.

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 its 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 difference between the estimated realizable rates under the reimbursement program and the standard billing rates as contractual adjustments, which are accrued on an estimated basis in the period that the related services are rendered and adjusted in future periods as adjustments become known and final settlements are determined. Estimates of

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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. 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 administrative review and audit by third parties, which can take several years to determine the final amounts earned under the programs. The Company records adjustments to the estimated billings as contractual adjustments in the periods that such adjustments become known or as the service years are no longer subject to audit, review or investigation.

A significant portion of the Company’s net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid, which accounted for 51.6%, 52.1% and 50.3% of the Company’s net revenue during the years ended September 30, 2003, 2002 and 2001, respectively. Medicare payments for inpatient acute services and certain outpatient services are generally made pursuant to a prospective payment system. Under this system, hospitals are paid a prospectively-determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a diagnosis-related group (DRG). Based upon the patient’s condition and treatment during the relevant inpatient stay, each DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. Such payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, DRG payments are adjusted by a predetermined adjustment factor assigned to the geographic area in which the hospital is located. 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. While hospitals generally do not receive direct payment in addition to a DRG payment, hospitals may qualify for additional capital-related costs 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’s managed diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories operate under various contracts where management fee revenue is recognized under fixed-rate and percentage-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.

The Company’s CCM operations, which are included in the Company’s corporate and other division, operate under various contracts where management fee revenue is recognized under various percent-of-income and cost-reimbursement arrangements and consulting and other revenues under service contractual arrangements as services are rendered. The Company’s management fee for the services provided to the physician practices under management is calculated as a percentage of operating income of the practice, ranging from approximately 10% to 16%, plus reimbursement of certain expenses incurred in managing the practice. The total net revenue derived from the Company’s CCM operations represented approximately 2.7%, 4.3%, and 6.0% of the Company’s consolidated net revenue for the years ended September 30, 2003, 2002 and 2001, respectively.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Advertising — Advertising costs are expensed as incurred. During the years ended September 30, 2003, 2002 and 2001, the Company incurred approximately $7.3 million, $4.4 million and $2.7 million of advertising expenses, respectively.

Pre-opening Expenses — Pre-opening expenses consist of operating expenses incurred during the development of a new venture and prior to its opening for business. Such costs specifically relate to ventures under development and are expensed as incurred. The Company recognized pre-opening expenses of approximately $10.1 million, $8.3 million and $1.5 million for the years ended September 30, 2003, 2002 and 2001, respectively.

Income Taxes — Income taxes are provided for under the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences 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 typically holding from 51% to 72% 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, local market conditions have made it advantageous for the Company to 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 generally accounted for under the equity method of accounting. Profits and losses of hospitals accounted for under either the consolidated or equity methods are generally allocated to its 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 is required, due to at risk capital position, by accounting principles generally accepted in the United States, to 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.

Stock-Based Compensation — The Company grants stock options and issues shares under option plans described in Note 14. The Company accounts for stock options in accordance with APB Opinion No. 25,Accounting for Stock Issued to Employees, as permitted under SFAS No. 123,Accounting for Stock-Based Compensation. Under APB Opinion No. 25, compensation cost is determined using the intrinsic value of the equity instrument awarded; and accordingly, no compensation cost is recognized for options granted with an exercise price equal to the fair value of the underlying shares at the date of grant.

In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation. This Statement amended SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement also amended the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on the reported results of operations. The transition provisions of this Statement were effective for the Company beginning December 15, 2002, but did not have any impact on the Company’s financial position, results of operations and cash flows for the year ended September 30, 2003 as the Company continued to account for its stock options in accordance with APB No. 25, as previously described. The Company elected to early adopt the remaining disclosure requirements of SFAS No. 148. See Note 14 for additional information and disclosures on the Company’s stock options.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Had compensation expense for the Company’s stock options been recognized based on the fair value on the grant date under the methodology prescribed by SFAS No. 123, the Company’s net income (loss) for the years ended September 30, 2003, 2002 and 2001 would have been impacted as follows:



		Year Ended September 30,

		2003			2002			2001

Net income (loss), as reported		$	(60,306	)	$	24,351		$	1,051
	Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects	$	(1,424	)	$	(1,236	)	$	(1,566	)

	Pro forma net (loss) income	$	(61,730	)		23,115		$	(515	)

Earnings (loss) per share, basic:
	As reported	$	(3.35	)	$	1.35		$	0.08
	Pro forma	$	(3.43	)	$	1.28		$	(0.04	)
Earnings (loss) per share, diluted:
	As reported	$	(3.35	)	$	1.34		$	0.08
	Pro forma	$	(3.43	)	$	1.28		$	(0.04	)

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following range of assumptions used for the option grants which occurred during 2003, 2002 and 2001:

Year Ended September 30,

2003

2002

2001

Expected life

8 years

Risk-free interest rate

2.87 - 4.21%

4.22 - 5.09%

4.78 - 5.83%

Expected volatility

52%

52 - 54%

54%

Segment Reporting — The Company applies SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information, which establishes standards for a public company to report annual and interim financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker(s) in deciding how to allocate resources and in assessing performance. SFAS No. 131 allows aggregation of similar operating segments into a single operating segment if the businesses have similar economic characteristics and are considered similar under the criteria established by SFAS No. 131. The description of the Company’s reportable segments and the disclosure of segment information pursuant to SFAS No. 131 are presented in Note 20.

Accounting Changes and Recent Accounting Pronouncements — In April 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. Other than the provisions related to the rescission of SFAS No. 4, the Company adopted and applied the provision of this Statement for transactions occurring and financial statements issued after May 15, 2002, as required by the Statement. The Company adopted the provisions related to the rescission of SFAS No. 4, which change the accounting for the classification of gains or losses from extinguishment of debt, effective October 1, 2002, also as required by the Statement. Accordingly, the Company changed the classification of a $1.56 million loss on debt refinancing for the year ended September 30, 2001 from an extraordinary loss, net of minority interest and tax benefit, as previously reported under SFAS No. 4, to an operating expense as currently reported under SFAS No. 145.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

In November 2002, the FASB issued Interpretation No. (FIN) 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The objective of FIN 45 is to record the fair value of a guarantee at inception and require disclosure of all such guarantees in interim and annual financial statements. The initial recognition and initial fair value measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company’s adoption and application of FIN 45 did not have any material impact on the Company’s financial position and results of operations as of and for the year ended September 30, 2003. See Note 8 for disclosures regarding the Company’s guarantees as required by FIN No. 45.

In January 2003, the FASB issued FIN 46,Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either: (i) does not have equity investors with voting rights, the obligation to absorb expected losses, and the right to receive expected residual returns; or (ii) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the expected losses or residual returns from the variable interest entity’s activities or both. Since issuing FIN 46, the FASB has proposed various amendments to the Interpretation and has twice deferred the effective dates. Most recently on December 17, 2003, the FASB approved a partial deferral of FIN 46 and announced that it expects to release the revised version of FIN 46 (hereinafter, FIN 46-R) before December 31, 2003. This partial deferral established the effective dates for public entities to apply FIN 46 and FIN 46-R based on the nature of the variable interest entity and the date upon which the public company became involved with the variable interest entity. In general, the deferral provides that (i) for variable interest entities created after February 1, 2003, a public entity must apply FIN 46-R at the end of the first interim or annual period ending after March 15, 2004, and may be required to apply FIN 46 at the end of the first interim or annual period ending after December 15, 2003 if the variable interest entity is a special purpose entity, and (ii) for variable interest entities created after January 31, 2003, a public company must apply FIN 46 at the end of the first interim or annual period ending after December 15, 2003, as previously required, and then apply FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004. As of September 30, 2003, the Company did not have any variable interest entities created after January 31, 2003. The Company is currently in the process of applying FIN 46 to its entities created before February 1, 2003 to determine which, if any, are variable interest entities and the impact on its financial position, results of operations and cash flows.

In May 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Generally, this Statement was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003, for all other instruments. In November 2003, the FASB deferred the effective dates for certain mandatory redeemable financial instruments of certain nonpublic entities and certain mandatory redeemable noncontrolling interests under SFAS No. 150. As of September 30, 2003, the Company did not have any financial instruments outstanding that were subject to SFAS No. 150, other than those subject to the deferred effective dates and additional guidance expected from the FASB.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


3.	Goodwill and Other Intangibles — Adoption of SFAS No. 142

In July 2001, the FASB issued SFAS No. 142,Goodwill and Other Intangibles,which requires, among other things, the discontinuance of goodwill amortization, an annual impairment test of goodwill, reclassification of certain existing recognized intangibles as goodwill, and reassessment of the useful lives of existing recognized intangibles. The nonamortization and amortization provisions of SFAS No. 142 were effective for business combinations completed after June 30, 2001. The Company’s business combinations completed in July 2001, concurrent with the Offering, and its acquisition of an additional ownership interest in Heart Hospital of New Mexico on October 1, 2001 (see Note 4) were subject to these provisions, and accordingly, none of the approximately $27.4 million and $16.5 million, respectively, of goodwill arising from these transactions was amortized during the year ended September 30, 2002 and none will be amortized in future periods.

As permitted, the Company elected to early adopt the remaining provisions of SFAS No. 142 on October 1, 2001, the beginning of fiscal year 2002. At that time, the Company reassessed the useful lives of its intangible assets and established finite and infinite useful lives as appropriate under SFAS No, 142, which were generally consistent with the existing useful lives. The Company also completed the transitional goodwill impairment test and its annual goodwill impairment test of all its reporting units as required by SFAS No. 142, which did not result in any impairment loss as measured on October 1, 2001 and September 30, 2002, respectively. Therefore, the only significant impact adopting SFAS No. 142 had on the Company’s financial position, results of operations and cash flows was the immediate discontinuance of goodwill amortization of the approximately $132.2 million of recorded net goodwill at October 1, 2001. The Company designated September 30, its fiscal year end, as the date to perform the annual goodwill impairment test for all of its reporting units as required by SFAS No. 142. Goodwill of a reporting unit will also be tested between annual tests if an event occurs or circumstances change that indicate an impairment may exist.

In March 2003, the Company determined that the decline in its market capitalization, as measured by its public stock price, since September 30, 2002 represented an event requiring an interim goodwill impairment test to be performed as required by SFAS No. 142. Accordingly, the Company engaged an independent third-party valuation firm to assist in performing the goodwill impairment test, specifically as it related to calculating the fair value of each of the Company’s reporting units as of the March 1, 2003 testing date pursuant to SFAS No. 142. The results of this independent valuation concluded that the calculated fair value of each of the Company’s reporting units exceeded the carrying value. Thus, no goodwill impairment existed at that date.

In September 2003, the Company performed another goodwill impairment test. This testing date was consistent with both its designated annual testing date under SFAS No. 142 and a new triggering event, which was the Company’s preparation of its fiscal 2004 financial budget during the fourth quarter of its fiscal year. Consistent with the previous testing approach, the Company engaged a third-party valuation firm to assist in performing the goodwill impairment test. The results of this independent valuation concluded that the calculated fair value of both of the Company’s reporting units did not exceed their carrying value, thus impairment existed. Accordingly, the Company completed a hypothetical purchase price analysis to determine the amount of the goodwill impairment required under SFAS No. 142. The Company also utilized the assistance of the third-party valuation firm to calculate the fair value of certain tangible and identifiable intangible assets. As a result of the analyses, the Company recorded a goodwill impairment loss of $58.9 million at September 30, 2003, which consisted of $43.5 million and $15.4 million relating to the hospital division and diagnostics division reporting

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

units, respectively. The changes in the carrying amount of goodwill for the years ended September 30, 2003, 2002 and 2001 are as follows:


								Corporate
		Hospital			Diagnostics			and
		Division			Division			Other		Total

Balance, September 30, 2001		$	100,314		$	15,374		$	—	$	115,688
	Goodwill from acquisitions		16,480			—			—		16,480

Balance, September 30, 2002			116,794			15,374			—		132,168
	Goodwill from acquisitions		1,697			—			—		1,697
	Impairment		(43,491	)		(15,374	)		—		(58,865	)

Balance, September 30, 2003		$	75,000		$	—		$	—	$	75,000

The Company’s reported net income (loss) for the year ended September 30, 2001, adjusted for amortization expense recognized in that period related to goodwill that is no longer being amortized, compared to the Company’s reported net income for the year ended September 30, 2003 and 2002 is as follows:



		Year Ended September 30,

		2003			2002		2001

Net income (loss):
	As reported	$	(60,306	)	$	24,351	$	1,051
	Add back: goodwill amortization		—			—		2,962

	Adjusted		(60,306	)		24,351		4,013

Diluted earnings (loss) per share:
	As reported	$	(3.35	)	$	1.34	$	0.08
	Add back: goodwill amortization	$	—		$	—	$	0.23

	Adjusted	$	(3.35	)	$	1.34	$	0.31

As of September 30, 2003 and 2002, the Company’s other intangible assets, net, included the following:



			September 30, 2003					September 30, 2002

			Gross					Gross
			Carrying		Accumulated			Carrying		Accumulated
			Amount		Amortization			Amount		Amortization

Amortized other intangible assets:
	Management contracts		$	20,598	$	(9,716	)	$	20,853	$	(8,532	)
	Loan acquisition costs			12,251		(7,063	)		11,253		(5,326	)
	Other			1,446		(421	)		2,166		(1,134	)

		Total	$	34,295	$	(17,200	)	$	34,272	$	(14,992	)

Amortization expense recognized for the management contracts and other intangible assets totaled $1.4 million, $2.4 million and $3.7 million for the years ended September 30, 2003, 2002 and 2001, respectively. During the year ended September 30, 2003, the Company restructured one of its two physician management contracts in its CCM operations. In connection with this contract change, the Company determined it was necessary and appropriate under SFAS No. 142 to extend the useful lives of its intangible assets related to its physician management contracts. As of September 30, 2003, the remaining useful lives for these intangible assets was 39 months.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company recognizes amortization expense for loan acquisition costs as a component of interest expense. For the years ended September 30, 2003, 2002 and 2001, amortization expense for loan acquisition costs was $1.5 million, $1.3 million and $1.5 million, respectively. The estimated aggregate amortization expense, including amortization expense for loan acquisition costs, for each of the five fiscal years succeeding the Company’s most recent fiscal year ended September 30, 2003 is as follows:



	Estimated Expense

Fiscal Year:	Amortization		Interest		Total

2004	$	1,129	$	1,507	$	2,636
2005		1,129		1,428		2,557
2006		1,129		844		1,973
2007		754		276		1,030
2008		628		234		862


4.	Business Combinations and Hospital Development

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

Acquisitions Completed During Fiscal Year 2002 — On October 1, 2001, the Company acquired an additional 45.0% ownership interest in Heart Hospital of New Mexico from its physician and hospital partners. The Company paid cash of approximately $17.4 million for this additional ownership interest, using a portion of the net proceeds from the Offering. As a result of the increase in the Company’s ownership interest from a 24.0% minority ownership position to a 69.0% majority ownership position, the Company obtained substantive control of the hospital. Accordingly, the Company began to consolidate in its financial statements the hospital’s results of operations and financial position from October 1, 2001. Prior to acquiring this additional interest, the Company was required to account for its investment in Heart Hospital of New Mexico using the equity method of accounting.

Because the carrying amount of the hospital’s net assets underlying the additional ownership interest the Company acquired, which primarily consisted of accounts receivable, medical supplies, property and equipment, current liabilities and long-term debt and capital leases, approximated their fair value at the date of acquisition, the application of purchase accounting did not result in any significant adjustment to the carrying amount of those assets. As part of this transaction, the Company assumed all interests, rights or obligations of the ownership interest acquired relating to capital investment and surplus in the hospital. In the initial application of purchase accounting, the Company recognized total goodwill arising from the acquisition of the additional interest in Heart Hospital of New Mexico of approximately $16.9 million. During the year ended September 30, 2002, the Company adjusted goodwill to $16.5 million in connection with recognizing additional deferred tax assets related to Heart Hospital of New Mexico.

Acquisitions Completed During Fiscal Year 2001 — As summarized in Note 1, concurrent with the Offering in July 2001, the Company offered its physician and community hospital partners in some of its hospitals the opportunity to either exchange a portion of their ownership interests in those hospitals for shares of the Company’s common stock valued at the price of the shares sold in the Offering or to sell a portion of their ownership interests to the Company for cash. The Company also entered into a separate agreement with its physician partners in one of its hospitals to purchase additional ownership interests from them for cash. The Company issued a total of 131,602 shares of common stock and paid $25.4 million cash to the partners in the five hospitals who elected to participate in these exchange transactions. The shares of common stock issued in these

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

transactions were in addition to the shares sold in the Offering, and the cash paid was financed with a portion of the proceeds from the Offering. The table below indicates the Company’s ownership interests in these five hospitals before and after these exchange transactions.



		MedCath Ownership

		Before			After
Heart Hospital	Location	Exchange			Exchange

Arizona Heart Hospital	Phoenix, AZ		51.0	%		70.6	%
Arkansas Heart Hospital	Little Rock, AR		51.0	%		70.3	%
Dayton Heart Hospital	Dayton, OH		52.5	%		66.5	%
Heart Hospital of Austin	Austin, TX		51.5	%		70.9	%
Tucson Heart Hospital	Tucson, AZ		33.3	%		58.6	%

As a result of the increase in its ownership interest in Tucson Heart Hospital from a minority to a majority ownership position, the Company obtained substantive control of the hospital and began to consolidate in its financial statements the hospital’s results of operations and financial position from the date of acquisition. Prior to this exchange transaction, the Company accounted for its investment in Tucson Heart Hospital using the equity method of accounting.

Because the carrying amount of the hospitals’ net assets underlying the additional ownership interests acquired, which primarily consisted of accounts receivable, medical supplies, property and equipment, current liabilities and long-term debt and capital leases, approximated their fair value at the date of acquisition, the application of purchase accounting did not result in any significant adjustment to the carrying amount of those net assets. As a result of these exchange transactions, the Company assumed all interests, rights and obligations related to the additional ownership interests being acquired from the partners, including any and all existing rights or obligations relating to capital investment, surplus or deficit in the hospital. The total goodwill arising from these exchange transactions was approximately $27.4 million.

New Hospital Development — On October 14, 2003, the Company opened The Milwaukee Heart Hospital in Glendale, Milwaukee. This hospital focuses primarily on cardiovascular care. On October 24, 2003, The Milwaukee Heart Hospital received its Medicare certification. The Milwaukee Heart Hospital is accounted for as a consolidated subsidiary because the Company, through its wholly-owned subsidiaries, owns an approximate 60.3% interest in the venture, with physician investors owning the remaining 39.7%, and the Company exercises substantive control over the hospital.

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

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

In October 2001, the Company announced a venture to develop and construct TexSAn Heart Hospital, which will be located in San Antonio, Texas. TexSAn Heart Hospital is accounted for as a consolidated subsidiary since the Company, through its wholly-owned subsidiaries, owns a 51% or greater interest in the venture, with

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

physician investors owning up to the remaining 49%, and the Company exercises substantive control over the hospital. Construction of TexSAn Heart Hospital began in June 2002. Due to the need to repair damages from a fire that occurred in March 2003, the Company expects TexSAn Heart Hospital’s original opening date of October 2003 to be delayed until January 2004. The Company believes it is adequately insured for the majority of the property damages.

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


	Amount		Amount		Amount
	Committed		Paid		Accrued

Louisiana Heart Hospital	$	21,861	$	20,523	$	1,027
TexSAn Heart Hospital	$	27,438	$	23,700	$	2,876
The Heart Hospital of Milwaukee	$	15,619	$	13,824	$	1,216
Heart Hospital of Lafayette	$	13,247	$	8,418	$	2,370

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

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

In March 2002 and April 2002, the Company opened two new fixed-site catheterization labs as joint ventures with physicians, one in Greensboro, North Carolina and the other in Wilmington, North Carolina, respectively. The Company owns an approximate 51% interest and exercise substantive control over each of these ventures.

During January 2002, the Company acquired a 100% interest in a nuclear management company, which manages a diagnostic facility that performs nuclear medical procedures in Metuchen, New Jersey. The Company paid a total of approximately $1.5 million to acquire the interest in this management company and recorded the acquisition as a management contract, which is a component of other intangible assets, net.

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

Closure of Diagnostic and Therapeutic Facilities — Effective May 2003, the Company received notification from its hospital partner of its intent to exercise its option to require the dissolution of Gaston Cardiology Services, LLC, and to terminate all agreements with the hospital, Gaston Cardiology Services, LLC and the Company. The effective date of the dissolution and the termination of the agreements was November 2003.

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

Termination of Management Contract — During fiscal 2002, the Company recognized a gain on the settlement of a management contract in CCM that was terminated effective December 31, 2001. The gain of approximately $1.2 million is included in gain on the sale of property, equipment and other assets in the accompanying consolidated statement of operations for the year ended September 30, 2002.

Disposition of McAllen Heart Hospital — On March 1, 2001, McAllen Heart Hospital, in which the Company owned a 50.2% majority interest, was sold to an affiliate of Universal Health Services, Inc. for approximately $56.0 million. Approximately $38.0 million of the sale proceeds were used to repay the hospital’s long-term debt, including intercompany amounts paid to the Company, which the Company then used to repay amounts outstanding under its revolving credit facility. After the write-off of approximately $10.3 million of

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

goodwill and purchase accounting valuation adjustments in McAllen Heart Hospital, which arose from a 1998 merger transaction, the Company recognized a net gain of $13.5 million in its consolidated results of operations for the year ended September 30, 2001. Approximately $8.0 million was recognized in earnings allocated to minority interests as a result of the sale. This minority interest amount was determined before the write-off of the Company’s goodwill and the purchase accounting valuation adjustments and after the allocation of amounts to the Company for recovery of disproportionate losses of McAllen Heart Hospital, which had previously been recognized in the Company’s consolidated results of operations.


5.	Equity Investments

Investments in and advances to unconsolidated affiliates accounted for under the equity method consist of the following at September 30:



	2003						2002

	Investment		Advances		Net		Investment		Advances		Net

Heart Hospital of South Dakota		4,654		7		4,661		1,328		1,059		2,387
Other		825		—		825		847		—		847

	$	5,479	$	7	$	5,486	$	2,175	$	1,059	$	3,234

Advances to unconsolidated affiliates bear interest at prime plus 1% (5.0% and 5.75% at September 30, 2003 and 2002, respectively), and are payable on demand and prior to any distributions of earnings.

The combined results of operations and financial position of the Company’s unconsolidated affiliate hospitals are summarized below:



		Year Ended September 30,

		2003		2002		2001

Condensed Statement of Operations Information:
	Net revenue	$	58,190	$	50,173	$	110,073
	Income from operations		12,935		9,619		7,280
	Net income (loss)		3,328		2,834		(2,199	)
Condensed Balance Sheet Information:
	Current assets		19,304		9,797		16,788
	Noncurrent assets		40,410		43,851		80,035
	Current liabilities		9,503		8,471		13,556
	Noncurrent liabilities		36,250		41,193		83,230
	Minority interest		9,308		2,657		949
	Net equity (deficit)		4,654		1,327		(912	)

As discussed in Notes 1 and 4, the Company began consolidating Tucson Heart Hospital upon acquiring a majority ownership interest in and substantive control of the hospital in July 2001. From July 1999 through July 2001, the Company accounted for its minority investment in Tucson Heart Hospital using the equity method of accounting. Prior to July 1999, the Company consolidated Tucson Heart Hospital. The Company deconsolidated Tucson Heart Hospital as of July 31, 1999 upon entering into an agreement whereby a third-party community hospital investor, Carondelet Health Network, obtained a 33 1/3% ownership interest in Tucson Heart Hospital, which reduced the Company’s interest from a majority position to a minority position.

As discussed in Notes 1 and 4, the Company began consolidating the Heart Hospital of New Mexico effective October 1, 2001 (the first day of the Company’s fiscal year 2002) as a result of acquiring a majority

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

interest in and substantive control of the hospital on that date. Prior to October 1, 2001, the Company accounted for its minority interest investment in Heart Hospital of New Mexico using the equity method of accounting.

In 1999, the Company entered into a venture with physicians and a community hospital partner to construct and operate the Heart Hospital of South Dakota in Sioux Falls, South Dakota. The Heart Hospital of South Dakota commenced operations in March 2001. The Company accounts for its approximately 33.3% minority investment in the Heart Hospital of South Dakota using the equity method of accounting.


6.	Accounts Receivable

Accounts receivable, net, consists of the following:



	September 30,

	2003			2002

Receivables, principally from patients and third-party payors	$	89,372		$	66,596
Receivables, principally from billings to hospitals for various cardiovascular procedures		7,071			6,247
Amounts due under management contracts		598			1,455
Other		2,746			4,410

		99,787			78,708
Less allowance for doubtful accounts		(13,481	)		(7,818	)

Accounts receivable, net	$	86,306		$	70,890

Activity for the allowance for doubtful accounts was as follows:



		Year Ended September 30,

		2003		2002		2001

Balance, beginning of year		$	7,818	$	8,659	$	13,622
	Bad debt expense		26,791		22,319		20,545
	Increase due to acquisition		—		4,860		2,844
	Write-off, net of recoveries		21,128		28,020		28,352

Balance, end of year		$	13,481	$	7,818	$	8,659

7. Property and Equipment

Property and equipment, net, consists of the following:



	September 30,

	2003			2002

Land	$	30,796		$	28,412
Buildings		246,457			188,493
Equipment		273,510			228,790
Construction in progress		61,833			63,172

Total, at cost		612,596			508,867
Less accumulated depreciation		(175,649	)		(140,443	)

Property and equipment, net	$	436,947		$	368,424

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Substantially all of the Company’s property and equipment is pledged as collateral for various long-term obligations (see Notes 8 and 9).

8. Short-Term Borrowings and Long-Term Debt

Short-term borrowings at September 30, 2002 consist of amounts outstanding under a commercial revolving note at one of the Company’s hospitals. No amounts were outstanding under this revolving note at September 30, 2003. This revolving note provided up to $10.0 million of total available borrowings and expired on October 31, 2003. The interest rate was the bank’s prime rate plus 0.25% (5.0% at September 30, 2002). The revolving note was renewable annually at the lender’s discretion and was secured by the hospital’s patient accounts receivable. Available borrowings under the revolving note were based on a formula of the hospital’s eligible patients accounts receivable.

Long-term debt consists of the following:



	September 30,

	2003			2002

Master credit facility and bank mortgage loans	$	172,460		$	120,809
Pre-existing bank mortgage loan		20,378			22,298
Real estate investment trust (REIT) loans		75,448			76,512
Revolving credit facility		—			—
Notes payable to various lenders		76,009			62,270
Other		2,201			4,653

		346,496			286,542
Less current portion		(45,612	)		(25,533	)

Long-term debt	$	300,884		$	261,009

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

As required by the terms of the Master Credit Facility, the three hospitals that refinanced were required to have in place fixed interest rate swaps, for 50% of the refinanced amount, within 90 days of the closing. Accordingly, in September 2001, the Company’s three hospitals entered into fixed interest rate swaps for notional amounts of 50% of the outstanding balances of the bank mortgage loans under the Master Credit Facility, which effectively fixed the interest rate on the hedged portion of these bank mortgage loans at 4.92% plus the applicable margin for two of the hospitals and at 4.6% plus the applicable margin for the other hospital. In accordance with SFAS No. 133 and the Company’s market risk policy as discussed in Note 2, the swaps qualify for cash flow hedge accounting. The Company recognizes interest expense based upon the fixed interest rates provided under the swaps, while the changes in fair value of the swaps ($64,000 gain and $718,000 loss for the years ended September 30, 2003 and 2002, respectively) are recorded as other comprehensive income (loss) with the corresponding charge recorded as an adjustment to the derivative liability in the consolidated balance sheet, which is included in other long-term obligations at September 30, 2003 and 2002. Future changes on the fair value of the swaps will be recorded based upon the variability in market interest rates through July 2006, the termination date of the swaps and the Master Credit Facility.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of September 30, 2003, $111.9 million of the $145.0 million initially available to finance the Company’s hospital development program had been designated to finance the development of Harlingen Medical Center, Louisiana Heart Hospital, TexSAn Heart Hospital and The Heart Hospital of Milwaukee. Of this $111.9 million of designated financing, $101.5 million had been borrowed as of September 30, 2003. In October 2003, the Company designated approximately $18.4 million to finance the development of Heart Hospital of Lafayette. The Company anticipates the remaining $14.7 million of undesignated funds will remain available to finance other future projects in the Company’s hospital development program.

Each loan under the Master Credit Facility is separately documented and secured by the assets of the borrowing hospital only. Each loan under the Master Credit Facility amortizes based on a 20-year term, matures on July 27, 2006, and accrues interest at variable rates on either a defined base rate plus an applicable margin, or Eurodollar Rate (LIBOR) plus an applicable margin. The weighted average interest rate for the loans under the Master Credit Facility was 4.44% and 5.02% at September 30, 2003 and 2002, respectively. The Company is required to pay a monthly unused commitment fee at a rate of 0.5%.

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

Pre-existing Bank Mortgage Loan — At September 30, 2003 and 2002, the Company’s Pre-existing Bank Mortgage Loan balance includes the outstanding indebtedness of only one hospital. The mortgage loan payments are based on a 20-year amortization schedule with the remaining principal due in full on March 31, 2007. The interest rate on this bank mortgage loan is LIBOR plus three hundred fifty basis points. At September 30, 2003 and 2002, the interest rate on the mortgage loan was 4.62% and 5.31%, respectively, and the loan is collateralized by a pledge of the Company’s interest in the related hospital, the hospital’s land, buildings, fixtures, and certain other assets. The Company has guaranteed 71% of the outstanding balance of the mortgage loan.

REIT Loans — From 1994 to 1997, the Company entered into mortgage loans with real estate investment trusts for the purpose of financing the land acquisition and construction costs for several of its hospitals. As of September 30, 2002, the Company’s REIT Loan balance includes the outstanding indebtedness of three hospitals, one of which the Company began consolidating on October 1, 2001. The interest rates on the outstanding REIT Loans were based on a rate index tied to U.S. Treasury Notes plus a margin, that is determined on the completion date of the hospital, and subsequently increases per year by 20 basis points for two of the hospitals and 27 basis points for the other hospital. The principal and interest on the REIT Loans are payable monthly over seven-year terms from the completion date of each hospital using extended period amortization schedules and include balloon payments at the end of each respective term. One loan is subject to extension for an additional seven years at the option of the Company. Borrowings under the REIT Loans are collateralized by a pledge of the Company’s interest in the related hospitals’ property, equipment and certain other assets. At September 30, 2003, the Company guaranteed 100% of the outstanding balances of the REIT Loans. The average interest rate as of September 30, 2003 and 2002 on the REIT Loans were 10.24% and 10.00%, respectively.

Revolving Credit Facility — The Company entered into a $100.0 million revolving credit facility (the Revolver) dated as of July 31, 1998, with a syndicate of banks, the proceeds of which are to be used for general corporate purposes. All outstanding borrowings under the Revolver are payable on January 31, 2005. The

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Revolver is collateralized by all shares of MedCath Intermediate Holdings, Inc. (a wholly owned subsidiary of the Company), all intercompany debt owed by each of its present and future subsidiaries, and all proceeds from the sales of its present and future subsidiaries. Borrowings under the Revolver bear interest at variable rates based, at the Company’s option, on LIBOR plus an additional margin ranging from .875% to 2.25%, based on the Company’s performance, or the prime rate plus an additional margin ranging to 1.00%, based on the Company’s performance. As of September 30, 2003 and 2002, the applicable interest rates on available funds were 4.0% and 6.50%, respectively.

Of the $100.0 million in availability under the Revolver, $10 million is designated for short-term borrowings and $25.0 million is available for letters of credit. At September 30, 2003 and 2002, no amounts were outstanding under the short-term borrowings portion of the Revolver. Short-term borrowings bear interest at the prime rate plus 0.75%. As of September 30, 2003, $9.5 million had been used for letters of credit, for which the Company is required to pay a commission fee of 1.875%. The Company is also required to pay quarterly unused commitment fees at a rate of 0.325% for available, but unused, long-term borrowings and 0.375% for available, but unused, short-term borrowings under the Revolver.

Notes Payable — The Company has acquired substantially all of the medical and other equipment for its hospitals and certain diagnostic and therapeutic facilities and mobile cardiac catheterization laboratories under installment notes payable to equipment lenders collateralized by the related equipment. Two facilities in the diagnostic division also have leasehold improvements funded through notes payable collateralized by real estate. Amounts borrowed under these notes are payable in monthly installments of principal and interest over 4 to 7 year terms. Interest is at fixed and variable rates ranging from 3.87% to 9.84%. The Company has guaranteed between 50% and 100% of certain of its subsidiary hospitals’ equipment loans. The Company receives a fee from the minority partners in the subsidiary hospitals as consideration for providing guarantees in excess of the Company’s ownership percentage in the subsidiary hospitals. These guarantees expire concurrent with the terms of the related equipment loans and would require the Company to perform under the guarantee in the event of the subsidiaries’ failure to perform under the related loan. At September 30, 2003, the total amount of notes payable was approximately $76.0 million, of which $40.0 million was guaranteed by the Company. Because the Company consolidates the subsidiary hospitals’ results of operations and financial position, both the assets and the accompanying liabilities are included in the assets and long-term debt on the Company’s consolidated balance sheets.

In December 2002, Louisiana Heart Hospital, which opened February 28, 2003, obtained a debt commitment to finance its equipment that allows the hospital to borrow up to $18.0 million. Until December 2003, interest on borrowings made under this commitment will accrue at 90-day LIBOR plus 3.95%. After such date, amounts funded under the loan shall accrue interest at either a fixed rate equal to a specific Treasury Note yield, plus a margin, or 90-day LIBOR, plus a margin, depending on the manufacturer of equipment originally purchased under the facility. Beginning in April 2004, the principal amount of the loan will be required to be repaid over a six-year period. The debt is secured by the related equipment in the hospital and is guaranteed by the Company, as discussed above. As of September 30, 2003, Louisiana Heart Hospital had borrowed $15.3 million of the $18.0 million available.

Debt Covenants — Covenants related to the Company’s long-term debt restrict the payment of dividends and require the maintenance of specific financial ratios and amounts and periodic financial reporting. At September 30, 2003, Arizona Heart Hospital, Tucson Heart Hospital and Heart Hospital of Austin were not in compliance with certain of their financial ratio covenants related to the real estate mortgage loans. For the real estate

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

mortgage loans at Heart Hospital of Austin and Heart Hospital of New Mexico, the Company was also not in compliance with certain guarantor financial ratio covenants. The Company received waivers of the covenant breaches from each lender. In addition, the lender at Tucson Heart Hospital agreed to waive compliance with certain of its financial ratio covenants through, and including, March 31, 2004, and the lender at Arizona Heart Hospital agreed to modify the terms of its financing to accommodate the hospital’s anticipated operating performance. The Company was in compliance with all other covenants in the instruments governing its outstanding debt at September 30, 2003 except as noted above. Also, at December 31, 2002, Bakersfield Heart Hospital was not in compliance with one of its interim financial ratio covenants. The mortgage lender granted a waiver for the breach at December 31, 2002 and agreed to amend the terms of the loan to replace the financial ratio covenant with a minimum financial performance covenant at June 30, 2003 and September 30, 2003. Under the amended loan terms, the financial ratio covenant would have become effective again December 31, 2003 and would have determined the amount of a potential prepayment of the loan’s principal balance. In November 2003, the mortgage lender agreed to further amend the terms of the loan to accommodate a potential change in capital reimbursement at the hospital. Under the terms of the November 2003 amendment, the mortgage lender agreed to amend both the financial ratio covenants and the minimum financial performance covenants. In consideration of the amendment, the Company remitted a prepayment of approximately $11.8 million on December 1, 2003. Accordingly, the Company has classified this amount of Bakersfield Heart Hospital’s mortgage debt as current in the accompanying consolidated balance sheet at September 30, 2003.

Guarantees of Unconsolidated Affiliate’s Debt — The Company has guaranteed approximately 50% of the real estate and 40% of the equipment debt of the one affiliate hospital in which the Company has a minority ownership interest and therefore does not consolidate the hospital’s results of operations and financial position. The Company provides these guarantees in exchange for a fee from that affiliate hospital. At September 30, 2003, the affiliate hospital was in compliance with all covenants in the instruments governing its debt. The total amount of the affiliate hospital’s real estate and equipment debt was approximately $28.2 million and $11.4 million at September 30, 2003. Accordingly, the real estate debt and the equipment debt guaranteed by the Company was approximately $14.1 million and $4.6 million, respectively, at September 30, 2003. These guarantees expire concurrent with the terms of the related real estate and equipment loans and would require the Company to perform under the guarantee in the event of the affiliate hospital’s failure to perform under the related loan. The total amount of this affiliate hospital’s debt is secured by the hospital’s underlying real estate and equipment, which were financed with the proceeds from the debt. Because the Company does not consolidate the affiliate hospital’s results of operations and financial position, neither the assets nor the accompanying liabilities are included in the value of the assets and liabilities on the Company’s balance sheets.

Future Maturities — Future maturities of long-term debt at September 30, 2003 are as follows:


Fiscal Year

2004	$	45,612
2005		48,270
2006		218,203
2007		22,403
2008		5,588
Thereafter		6,420

	$	346,496


9.	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 noncancelable capital

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

leases expiring through fiscal year 2008. 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 $6.6 million and $9.7 million) at September 30, 2003 and 2002, were approximately $21.8 million and $15.6 million, respectively, and are included in property and equipment. Lease payments during the years ended September 30, 2003 and 2002 were $4.4 million and $3.1 million, respectively, and include interest of approximately $1.2 million and $1.0 million, respectively.

Future minimum lease payments at September 30, 2003 are as follows:


Fiscal Year

2004	$	4,796
2005		4,542
2006		3,855
2007		2,839
2008		710
Thereafter		—

Total future minimum lease payments		16,742
Less amounts representing interest		(2,253	)

Present value of net minimum lease payments		14,489
Less current portion		(3,675	)

	$	10,814


10.	Liability Insurance Coverage

On June 1, 2002, the Company’s three-year combined insurance policy that provided medical malpractice claims coverage on a claims-made, first-dollar basis expired, and the Company entered into a new partially self-insured coverage program. At that time, the Company purchased a tail insurance policy to provide first-dollar coverage for claims incurred prior to June 1, 2002, but not reported as of that date under the expired claims-made policy. The Company recognized the full cost of the tail insurance policy as an operating expense in the third quarter of fiscal 2002 as required by generally accepted accounting principles in the United States. From June 1, 2002 through June 7, 2003, the Company was partially self-insured under a claims-made policy providing coverage for claim amounts in excess of $2.0 million of retained liability per claim. Effective June 8, 2003, the Company entered into a new one-year claims-made policy providing coverage for claim amounts in excess of $3.0 million of retained liability per claim, subject to $5.0 million of retained liability per claim for the first two claims reported during the policy year at one of its hospitals. Because of the Company’s self-insured retention levels, the Company is required to recognize an estimated expense/liability for the amount of the Company’s retained liability applicable to each malpractice claim. As of September 30, 2003 and 2002, the total estimated liability for the Company’s self-insured retention on medical malpractice claims, including an estimated amount for incurred but not reported claims, was approximately $3.7 million and $858,000, respectively, which is included in current liabilities in the Company’s consolidated balance sheet. The Company maintains this reserve based on actuarial estimates prepared by an independent third party, who bases the estimates on the Company’s historical experience with claims and assumptions about future events. Due to the considerable variability that is inherent in such estimates, including such factors as changes in medical costs and changes in actual experience, there is a reasonable possibility that the recorded estimates will change by a material amount in the near term. Also, there can be no assurance that the ultimate liability will not exceed the Company’s estimates.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


11.	Commitments and Contingencies

Operating Leases — One of the Company’s subsidiaries leases certain office space to a physician group under a noncancelable operating lease, which commenced in fiscal year 2000. During fiscal years 2003, 2002 and 2001, the Company received approximately $544,000, $485,000 and $485,000, respectively, annually in rental income from this lease.

The Company currently leases several cardiac diagnostic and therapeutic facilities, mobile catheterization laboratories, office space, computer software and hardware equipment, and certain vehicles under noncancelable operating leases expiring through fiscal year 2029. Total rent expense under all rental commitments was approximately $4.2 million, $3.8 million and $3.3 million for the years ended September 30, 2003, 2002 and 2001, respectively.

The approximate future minimum rental income and commitments under noncancelable operating leases as of September 30, 2003 are as follows:


		Rental		Rental
Fiscal Year		Income		Commitment

2004		$	626	$	2,578
2005			554		2,145
2006			544		1,685
2007			544		1,193
2008			544		664
	Thereafter		—		3,997

		$	2,812	$	12,262

Compliance — Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation and may be modified. The Company believes that it is in compliance with such laws and regulations and it is not aware of any investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, 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.

Contingency, CMS change in Medicare capital cost reimbursement — Medicare reimburses hospitals for capital-related costs using one of two alternative methodologies based upon how the hospital is categorized under CMS regulations. The Company sought and received a written determination from its Medicare fiscal intermediary on October 11, 2002 regarding the applicable capital cost reimbursement methodology. The fiscal intermediary’s October 2002 written determination confirmed the methodology being applied by the Company. The Company recorded and collected net revenue for services rendered at the estimated net realizable amount determined in accordance with the capital cost reimbursement methodology provided by the fiscal intermediary in its October 2002 determination. On August 11, 2003, the Company was notified by the fiscal intermediary that it had been directed by CMS to change, on a retroactive and prospective basis, the methodology confirmed by the fiscal intermediary in its October 2002 determination. The Company believes that the position taken by the fiscal intermediary in October 2002 was based upon a correct interpretation of applicable CMS regulations and the Company has begun pursuing its administrative, judicial and other remedies to reverse any final determination contrary to that position. If CMS does not revert to the determination made by the fiscal intermediary in October 2002, or maintains that it is appropriate to apply the change in methodology on a retroactive basis, the Company would be required to repay the Medicare program for the resulting reduction in previously reimbursed capital costs. If required, such retroactive repayments would be recorded as a change in accounting estimate and could

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

result in a material reduction in the Company’s net revenue in the period recorded. The prospective change in reimbursement methodology could also have a material adverse impact on net revenue in future periods.

In regards to the retroactive component, the fiscal intermediary has not advised the Company of the amount of reimbursement associated with the change in methodology. In addition to beginning the administrative process to challenge the August 11, 2003 determination, the Company has been, and remains, actively involved in negotiations with CMS to resolve this matter. Management believes based on the advice of counsel and the status of the negotiations with CMS, that the Company will not be required to repay the retroactive amount of reimbursement associated with the change in methodology. Accordingly, the Company has not recognized a contingent liability for the retroactive reimbursement in accordance with SFAS No. 5,Accounting for Contingencies.

In regards to the prospective component, the fiscal intermediary began making payments for capital cost reimbursement under the new methodology for all claims submitted after August 11, 2003. The impact of this change for the year ended September 30, 2003 was a $1.2 million reduction in the Company’s net revenue. While this prospective treatment is subject to the Company’s administrative challenges and negotiations with CMS, the Company has not recognized a contingent receivable for the decrease in the prospective reimbursement from August 11, 2003 through September 30, 2003. This accounting treatment is in accordance with SFAS No. 5, which does not permit contingent gains to be recorded until such amounts are realized. If the Company ultimately recovers all, or some portion, of the decrease in prospective reimbursement, the amount will be recognized in the period in which the settlement occurs.


12.	Income Taxes

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



			Year Ended September 30,

			2003			2002			2001

Current tax expense:
	Federal		$	283		$	—		$	—
	State			563			535			317

		Total current tax expense		846			535			317
Deferred tax (benefit) expense:
	Federal			(235	)		3,300			—
	State			(306	)		(915	)		—

		Total deferred tax (benefit) expense		(541	)		2,385			—

		Total income tax expense	$	305		$	2,920		$	317

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The components of net deferred taxes as of September 30, 2003 and 2002 are as follows:


			2003		2002

Deferred tax liabilities:
	Excess of book over tax bases of property and equipment		$	25,119	$	19,643
	Excess of book over tax bases in equity investments			627		145
	Management contracts			2,594		3,009
	Other			1,846		1,281

		Total deferred tax liabilities		30,186		24,078

Deferred tax assets:
	Net operating and economic loss carryforward			10,021		12,768
	AMT credit carryforward			1,489		1,336
	Management contracts			35		94
	Nondeductible allowances			2,815		1,171
	Nondeductible accruals			4,861		2,546
	Organization and start-up costs			5,812		3,279
	Derivative swap			859		902
	Other			3,488		1,765

		Total deferred tax assets		29,380		23,861

		Net deferred tax balance	$	806	$	217

The Company has determined that no valuation allowance is necessary as the deferred tax liabilities, combined with current and projected net earnings, provided sufficient positive evidence to support the recognition of the gross deferred tax assets.

The Company has gross federal net operating loss carryforwards of $22.1 million, which will begin to expire in 2018 and state net operating loss carryforwards of approximately $50 million that will begin to expire in 2004. In addition, the Company has alternative minimum tax carryforwards of $1.5 million.

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


	2003			2002			2001

Statutory federal income tax rate		(34.0	)%		34.0	%		34.0	%
State income taxes		0.3	%		1.5	%		91.9	%
Goodwill		33.4	%		—			312.0	%
Decrease in valuation allowance		—			(23.5	)%		(538.3	)%
Other		0.8	%		(1.3	)%		123.6	%

Effective income tax rate		0.5	%		10.7	%		23.2	%


13.	Per Share Data and Share Repurchase Plan

The calculation of diluted net income (loss) per share considers the potential dilutive effect of options to purchase 3,037,872, 2,413,095 shares and 2,291,595 shares of common stock at prices ranging from $4.75 to $25.00 which were outstanding at September 30, 2003, 2002 and 2001, respectively. Of these options, 3,037,872 shares, 2,140,730 shares, and 2,150,230 shares have not been included in the calculation of diluted net income (loss) per share at September 30, 2003, 2002 and 2001, respectively, because the options were anti-dilutive.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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


14.	Stock Option 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 such other 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, 2003, 2002 and 2001 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. At September 30, 2003, the maximum number of shares of common stock, which can be issued through awards granted under the 1998 Option Plan is 3,000,000.

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 nonemployee 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. Grants of 3,500 options were made to each continuing director on October 1, 2002, 2001 and 2000 (the first day of the fiscal years ended September 30, 2003, 2002 and 2001, respectively. All options granted under the Director’s Plan through September 30, 2003 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. The maximum number of shares of common stock which can be issued through awards granted under the Director’s Plan is 250,000.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Activity for the option plans during the years ended September 30, 2003, 2002 and 2001 was as follows:


		Number of			Weighted-Average		Options		Weighted-Average
		Options			Exercise Price		Exercisable		Exercise Price

Outstanding options,
	September 30, 2000		2,178,722		$	18.10		551,337	$	15.44
	Granted		267,500			19.67
	Exercised		(42,927	)		18.48
	Canceled		(111,700	)		19.00

Outstanding options,
	September 30, 2001		2,291,595		$	18.23		938,141	$	16.93
	Granted		176,500			17.26
	Canceled		(55,000	)		18.59

Outstanding options,
	September 30, 2002		2,413,095		$	18.15		118,951	$	17.34
	Granted		852,000			9.78
	Canceled		(227,223	)		17.38

Outstanding options,
	September 30, 2003		3,037,872		$	15.86		1,423,808	$	17.46

The following table summarizes information for options outstanding and exercisable at September 30, 2003:



Options Outstanding							Options Exercisable

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

4.75		131,472		4.8		4.75		131,472		4.75
17.65 - 19.46		1,943,257		5.7		18.99		1,205,443		19.00
25.00		30,000		7.5		25.00		10,000		25.00
15.80 - 17.44		103,750		8.2		17.10		40,000		16.68
$10.80 - 12.00		268,393		8.7	$	10.90		30,893	$	11.56
14.95		10,000		8.8		14.95		2,500		14.95
5.97		25,000		9.7		5.97		—		0.00
9.34		526,000		9.9		9.34		3,500		9.34

$4.75 - 25.00		3,037,872			$	15.86		1,423,808	$	17.46

The Company accounts for its stock option plans in accordance with APB Opinion No. 25 as discussed in Note 2. No compensation expense has been recognized in the statements of operations for the stock-based awards for the years ended September 30, 2003, 2002 and 2001, as all options awarded under the stock option plans have been granted at an exercise price equal to or greater than the fair market value of the Company’s stock at the date of the grant.

The weighted average fair value of options granted during the year ended September 30, 2003 and 2002 with an exercise price equal to the fair value of the Company’s stock at the date of grant was $9.78 and $10.81, respectively. The weighted average fair value of options granted during the years ended September 30, 2001 with an exercise price greater than the fair value of the Company’s stock at the date of grant was $10.77.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


15.	Employee Benefit Plan

The Company has a defined contribution retirement savings plan (the 401(k) Plan) which covers all employees who meet minimum service requirements. The 401(k) Plan allows eligible employees to contribute from 1% to 25% of their annual compensation on a pre-tax basis. The Company, at its discretion, may make an annual contribution of up to 25% of an employee’s pre-tax contribution, up to a maximum of 6% of compensation. The Company’s contributions to the 401(k) Plan for the years ended September 30, 2003, 2002 and 2001 were approximately $1.2 million, $1.1 million and $969,000, respectively.


16.	Related Party Transactions

During the fiscal year ended September 2003, 2002, and 2001 the Company incurred $0, $0 and $245,000, respectively, in monitoring fees and $55,100, $155,000 and $186,000, respectively, in insurance and related risk management fees to its principal stockholders and their affiliates.


17.	Litigation and Settlement of Contract Disputes

Litigation — The Company is involved in various claims and legal actions in the ordinary course of business, including malpractice claims arising from services provided to patients that have been asserted by various claimants, and additional claims that may be asserted for known incidents through September 30, 2003. These claims and legal actions are in various stages, and some may ultimately be brought to trial. Moreover, additional claims arising form 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, based on advice of counsel and the Company’s experience with past lawsuits and claims that, taking into account the applicable liability insurance coverage, the outcome of any such claims and litigation, individually or in the aggregate, will have a materially adverse effect on the Company’s financial position or future results of operations and cash flows.

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

Settlement of Contract Disputes — In June 2002, the Company received a favorable settlement of a lawsuit against a managed care company in which the Company was seeking payment for services rendered by its Bakersfield Heart Hospital. Under the terms of the settlement, Bakersfield Heart Hospital received approximately $7.1 million relating to payment for services and reimbursement of certain expenses, primarily legal expenses, owed during the period of dispute. The Company’s results of operations for fiscal 2002 included $2.2 million of net revenue and $2.1 of million income before income taxes attributable to the favorable settlement of this lawsuit.

In March 2002, one of the Company’s managed diagnostic centers, Sun City Cardiac Center, received a favorable settlement of a billing dispute involving Sun Health Corporation, which owns and operates the hospital where the center is located. Under the terms of the settlement, Sun City Cardiac Center was awarded total proceeds of $11.2 million relating to service fees, attorney fees and interest costs owed during the period of the contractual dispute. The Company owns a 65% interest in Sun City Cardiac Associates, which manages the Sun City Cardiac Center and receives a management fee for such services. The Company’s results of operations for fiscal 2002 included $9.7 million of net revenue, $1.2 million of operating expenses and $3.0 million of minority interest, thereby resulting in $5.5 million of income before income taxes attributable to this settlement.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In April 2001, the Company received an arbitration award related to a billing dispute with its joint venture hospital partner in one of its diagnostic and therapeutic centers. As a result of the award, the Company recognized an additional $3.2 million of net revenue and $300,000 of expenses in its results of operations during fiscal 2001. Of the net $2.9 million recognized in operations, $1.5 million was allocated to minority interests during the period, thereby resulting in $1.4 million of income before income taxes attributable to this award.


18.	Fair Value of Financial Instruments

The Company considers the carrying amounts of significant classes of financial instruments on the consolidated balance sheets, including cash and cash equivalents, accounts receivable, net, due from affiliates, short-term borrowings, accounts payable, income taxes payable, accrued liabilities, obligations under capital leases, and other long-term obligations 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, 2003 and 2002. The estimated fair value of long-term debt, including the current portion, at September 30, 2003 is approximately $358.1 million as compared to a carrying value of approximately $346.5 million. At September 30, 2002, the estimated fair value of long-term debt, including the current portion, approximated the carrying value of $286.5 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 the fair value of the Company’s variable rate debt was determined to approximate its carrying value, due to the underlying variable interest rates.


19.	Summary of Quarterly Financial Data (Unaudited)

Summarized quarterly financial results were as follows:


	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter

Year Ended September 30, 2003:
Net revenue	$	121,101	$	135,187	$	142,343	$	144,355
Operating expense		114,584		127,636		133,663		200,843
Income from operations		6,517		7,551		8,680		(56,488	)
Net income (loss)		390		588		778		(62,062	)
Earnings (loss) per share, basic	$	0.02	$	0.03	$	0.04	$	(3.46	)
Earnings (loss) per share, diluted	$	0.02	$	0.03	$	0.04	$	(3.46	)


	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter

Year Ended September 30, 2002:
Net revenue	$	114,950	$	131,731	$	120,483	$	110,473
Operating expense		103,068		107,154		108,536		103,095
Income from operations		11,882		24,577		11,947		7,378
Net income		5,295		14,003		3,657		1,396
Earnings (loss) per share, basic	$	0.29	$	0.78	$	0.20	$	0.08
Earnings (loss) per share, diluted	$	0.29	$	0.77	$	0.20	$	0.08


20.	Reportable Segment Information

The Company’s reportable segments consist of the Hospital Division and the Diagnostics Division. The CCM Division has been combined with Corporate and other, as the CCM Division does not meet the materiality thresholds for separate disclosure as specified in SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information.

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,

	2003			2002			2001

Net revenue:
Hospital Division	$	476,971		$	399,872		$	307,447
Diagnostics Division		50,767			56,751			45,699
Corporate and other		15,248			21,014			23,861

Consolidated totals	$	542,986		$	477,637		$	377,007

Income (loss) from operations:
Hospital Division	$	(19,287	)	$	42,650		$	38,560
Diagnostics Division		(4,609	)		21,016			9,128
Corporate and other		(9,844	)		(7,882	)		(6,840	)

Consolidated totals	$	(33,740	)	$	55,784		$	40,848

Depreciation and amortization:
Hospital Division	$	32,841		$	28,497		$	24,582
Diagnostics Division		6,969			6,884			8,138
Corporate and other		1,735			2,262			3,926

Consolidated totals	$	41,545		$	37,643		$	36,646

Interest expense (income), net:
Hospital Division		28,249		$	26,041		$	28,136
Diagnostics Division		701			676			563
Corporate and other		(4,466	)		(5,458	)		(5,825	)

Consolidated totals	$	24,484		$	21,259		$	22,874

Capital expenditures:
Hospital Division	$	98,274		$	75,743		$	11,874
Diagnostics Division		8,832			4,263			1,643
Corporate and other		6,376			1,517			948

Consolidated totals	$	113,482		$	81,523		$	14,465

Aggregate identifiable assets:
Hospital Division	$	602,007		$	506,225		$	388,525
Diagnostics Division		46,847			58,880			57,533
Corporate and other		100,443			175,936			160,561

Consolidated totals	$	749,297		$	741,041		$	606,619

Substantially all of the Company’s net revenue in its Hospital Division and Diagnostics Division is derived directly or indirectly from patient services. The amounts presented for Corporate and other primarily include management and consulting fees from CCM, general overhead and administrative expenses, financing activities, certain cash and cash equivalents (including the remaining proceeds from the Offering), prepaid expenses, goodwill, other assets and operations of the business not subject to segment reporting.

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” and “Accounting and Audit Matters — Audit Committee Financial Expert” in the Company’s proxy statement to be filed with the Commission on or before January 28, 2004 in connection with the Annual Meeting of Stockholders of the Company held on March 2, 2004 (the 2004 Proxy Statement). Some of the information required by this Item with respect to executive officers is provided under the heading “Executive Officers of the Registrant” in Part I of this report.


Item 11.	*Executive Compensation.*

The information required by this Item is incorporated by reference to information provided under the headings “Executive Compensation”, “Corporate Governance — Compensation of Directors” and ”Corporate Governance — Employment Agreement with Stephen R. Puckett” in the 2004 Proxy Statement.


Item 12.	*Security Ownership of Certain Beneficial Owners and Management.*

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 — Equity Compensation Plan Information” in the 2004 Proxy Statement.

PART IV


Item 15.	*Exhibits, Financial Statement Schedules, and Reports on Form 8-K*

(a)(1) The following financial statements are filed as part of this amended report:


	•	Consolidated Balance Sheets as of September 30, 2003 and 2002

	•	Consolidated Statements of Operations for the Years Ended September 30, 2003, 2002 and 2001

	•	Consolidated Statements of Stockholders’ Equity for the Years Ended September 30, 2003, 2002 and 2001

	•	Consolidated Statements of Cash Flows for the Years Ended September 30, 2003, 2002 and 2001

	•	Notes to Consolidated Financial Statements

(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 amended report.

(3) The following list of exhibits includes both exhibits submitted with this amended 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)


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, and 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 Management Stockholder’s Agreement entered into as of July 18, 2001 between MedCath Corporation and David Crane (1)
	4.7	—	Amended and Restated Management Stockholder’s Agreement entered into as of July 18, 2001 between MedCath Corporation and Stephen R. Puckett, P IV Limited Partnership and P V Limited Partnership(1)
	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	—	Amended and Restated Operating Agreement of MedCath of Tucson, L.L.C. effective as of July 31, 1999 (the Tucson Operating Agreement)(1)(6)
	10.6	—	Amendment to Tucson Operating Agreement dated as of April 25, 2001(1)
	10.7	—	Second Amendment to Tucson Operating Agreement(1)(6)
	10.8	—	Guaranty Agreement made as of July 18, 1996 by MedCath Incorporated in favor of CapStone Capital Corporation(1)
	10.9	—	Operating Agreement of Arizona Heart Hospital, LLC entered into as of January 6, 1997 (the Arizona Heart Hospital Operating Agreement)(1)(6)
	10.10	—	Amendment to Arizona Heart Hospital Operating Agreement effective as of February 23, 2000(1)(6)
	10.11	—	Amendment to Operating Agreement of Arizona Heart Hospital, LLC dated as of April 25, 2001(1)
	10.12	—	Guaranty dated as of March 2, 2000 by Arizona Heart Hospital, L.L.C., MedCath Incorporated, AHH Management, Inc., MedCath of Arizona, Inc., MedCath of Kingman, Inc., MedCath of Massachusetts, Inc., MedCath of New Jersey, Inc., MedCath Diagnostics, LLC, Heart Research Centers International, LLC and MedCath Physician Management, Inc. in favor of Heller Financial Leasing, Inc(1)
	10.13	—	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)
	10.14	—	Fifth Amendment to the Austin Limited Partnership Agreement effective as of December 31, 1997(1)(6)
	10.15	—	Amendment to Austin Limited Partnership Agreement effective as of July 31, 2000(1)(6)
	10.16	—	Amendment to Austin Limited Partnership Agreement dated as of March 30, 2001(1)
	10.17	—	Amendment to Austin Limited Partnership Agreement dated as of May 3, 2001(1)
	10.18	—	Guaranty made as of November 11, 1997 by MedCath Incorporated in favor of HCPI Mortgage Corp(1)
	10.19	—	Operating Agreement of Heart Hospital of BK, LLC amended and restated as of September 26, 2001(the Bakersfield Operating Agreement)(2)(6)
	10.20	—	Second Amendment to Bakersfield Operating Agreement effective as of December 1, 1999(1)(6)
	10.21	—	Amended and Restated Operating Agreement of effective as of September 6, 2002 of Heart Hospital of DTO, LLC (the “Dayton Operating Agreement”) (6)
	10.22	—	Amendment to New Mexico Operating Agreement and Management Services Agreement) effective as of October 1, 1998(1)(6)


Exhibit
No.			Description

	10.23	—	Amended and Restated Operating Agreement of Heart Hospital of New Mexico, LLC.(3)(6)
	10.24	—	Guaranty made as of September 24, 1998 by MedCath Incorporated, St. Joseph Healthcare System, SWCA, LLC and NMHI, LLC in favor of Health Care Property Investors, Inc (1)
	10.25	—	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)
	10.26	—	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)
	10.27	—	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)
	10.28	—	First Amendment to Sioux Falls Operating Agreement of Heart Hospital of South Dakota, LLC effective as of July 31, 1999(1)(6)
	10.29	—	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)
	10.30	—	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)
	10.31	—	Amendment to Louisiana Operating Agreement effective as of December 1, 2000(1)(6)
	10.32	—	Second Amendment to Louisiana Operating Agreement effective as of December 1, 2000(1)(6)
	10.33	—	Limited Partnership Agreement of San Antonio Heart Hospital, L.P. effective as of September 17, 2001 (2)(6)
	10.34	—	Operating Agreement of The Heart Hospital of Milwaukee, LLC effective as of October 11, 2001 (“Milwaukee Operating Agreement).(4)(6)
	10.35	—	First Amendment to Milwaukee Operating Agreement effective as of October 11, 2001.(4)(6)
	10.36	—	Second Amendment to Milwaukee Operating Agreement effective as of October 11, 2001.(4)(6)
	10.37	—	Management Services Agreement for The Heart Hospital of Milwaukee, LLC dated December 12, 2001.(4)(6)
	10.38	—	Operating Agreement of Heart Hospital of Lafayette, LLC effective as of December 5, 2001 (“Lafayette Operating Agreement).(4)(6)
	10.39	—	First Amendment to Lafayette Operating Agreement effective as of December 5, 2001.(4)(6)
	10.40	—	Second Amendment to Lafayette Operating Agreement effective as of December 5, 2001.(4)(6)
	10.41	—	Third Amendment to Lafayette Operating Agreement effective as of December 5, 2001.(4)(6)
	10.42	—	Management Services Agreement for the Heart Hospital of Lafayette. LLC dated September 5, 2001.(4)(6)
	10.43	—	Credit Agreement dated as of July 31, 1998 among MedCath Intermediate Holdings, Inc., the Initial Lenders and Initial Issuing Bank, Bank of America N.A. (formerly Nations Bank, N.A.) and Banc of America Securities LLC (formerly NationsBanc Montgomery Securities LLC)(1)
	10.44a	—	Commitment Agreement dated as of July 27, 2001 by and among, MedCath Incorporated, a North Carolina corporation, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Bankers Trust Company, as Syndication Agent for the Lenders, and First Union National Bank, as Documentation Agent for the Lenders(1)
	10.44b	—	Amended and Restated Loan Agreement dated as of July 27, 2001 by and among MedCath of Little Rock, L.L.C., a North Carolina limited liability company, as Borrower, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Bankers Trust Company, as Syndication Agent for the Lenders, and First Union National Bank, as Documentation Agent for the Lenders(1)


Exhibit
No.			Description

	10.44c	—	Amended and Restated Loan Agreement dated as of July 27, 2001 by and among Heart Hospital of DTO, LLC, a North Carolina limited liability company, as Borrower, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Bankers Trust Company, as Syndication Agent for the Lenders, and First Union National Bank, as Documentation Agent for the Lenders(1)
	10.44d	—	Amended and Restated Loan Agreement dated as of July 27, 2001 by and among Heart Hospital of BK, LLC, a North Carolina limited liability company, as Borrower, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Bankers Trust Company, as Syndication Agent for the Lenders, and First Union National Bank, as Documentation Agent(1)
	10.44e	—	Guaranty Agreement dated as of July 27, 2001 made by MedCath Corporation, a Delaware corporation, and certain subsidiaries, in favor of Bank of America, N.A., a national banking association, as Administrative Agent for the ratable benefit of itself and the financial institutions from time to time party to the Loan Agreement(1)
	10.44f	—	Guaranty Agreement dated as of July 27, 2001 made by MedCath Corporation, a Delaware corporation, and certain subsidiaries, in favor of Bank of America, N.A., a national banking association, as Administrative Agent for the ratable benefit of itself and the financial institutions from time to time party to the Loan Agreement(1)
	10.44g	—	Guaranty Agreement dated as of July 27, 2001 made by MedCath Corporation, a Delaware corporation, and certain subsidiaries, in favor of Bank of America, N.A., a national banking association, as Administrative Agent for the ratable benefit of itself and the financial institutions from time to time party to the Loan Agreement(1)
	10.45	—	Amended and Restated Loan Agreement, dated as of the 21st day of November, 2001, by and among Harlingen Medical Center, Limited Partnership, a North Carolina limited partnership, as Borrower, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Bankers Trust Company, as Syndication Agent for the Lenders, and First Union National Bank, as Documentation Agent, Bank of America Securities, LLC and Deutsche Banc Alex, Brown Inc., as co-lead arrangers and co-book mangers.(3)(6)
	10.46	—	Amended and Restated Loan Agreement dated as of April 24, 2002 by and among Louisiana Heart Hospital, LLC, Bank of America, N.A., Bankers Trust Company, Wachovia Bank, National Association, Banc of America Securities, LLC and Deutsche Banc Alex. Brown Inc.(5)
	10.47	—	Employment Agreement made as of July 31, 1998 by and between MedCath Incorporated and Stephen R. Puckett(1)
	10.48	—	Amendment to Employment Agreement effective as of January 1, 2000 by and between MedCath Incorporated and Stephen R. Puckett(1)
	10.49	—	Employment Agreement made as of October 8, 1999 by and between MedCath Incorporated and James Harris(1)
	10.50	—	1998 Stock Option Plan for Key Employees of MedCath Holdings, Inc. and Subsidiaries(1)
	10.51	—	Outside Directors’ Stock Option Plan(1)
	10.52	—	Amended and Restated Directors Option Plan.(4)
	10.54	—	Employment Agreement dated as of September 3, 2003 by and between MedCath Incorporated and John T. Casey(10)
	10.55	—	Letter agreement dated September 3, 2003 by and between MedCath Incorporated and John T. Casey(10)
	10.56	—	Employment Agreement dated as of September 3, 2003 by and between MedCath Incorporated and Charles R. Slaton(10)


Exhibit
No.			Description

	10.57	—	Amended and Restated Loan Agreement, dated as of the 7th day of November, 2002, by and among Heart Hospital of San Antonio, Limited Partnership, a Texas limited partnership, as Borrower, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Deutsche Bank Trust Company Americas, a Syndication Agent for the Lenders, and Wachovia Bank, National Association, as Documentation Agent, Bank of America Securities, LLC and Deutsche Banc Alex. Brown Inc., as co-lead arrangers and co-book managers(7)
	10.58	—	Guaranty Agreement dated as of November 7, 2002 made by MedCath Corporation, a Delaware corporation, and certain subsidiaries, in favor of Bank of America, N.A., a national banking association, as Administrative Agent for the ratable benefit of itself and the financial institutions from time to time party to the Loan Agreement(7)
	10.59	—	Fourth Amendment to the Operating Agreement of Heart Hospital of Lafayette, LLC as of February 7, 2003(8)
	10.60	—	The First Amendment to Commitment Agreement, dated as of March 28, 2003, by and among MedCath Incorporated, a North Carolina corporation, the Lenders party to this Commitment Agreement, Bank of America, N.A., as Administrative Agent for the Lenders, Deutsche Bank Trust Company Americas, as Syndication Agent for the Lenders, and Wachovia Bank, National Association, as Documentation Agent for the Lenders(8)
	10.61	—	Amended and Restated Loan Agreement, dated as of the 27th day of June, 2003, by and among The Heart Hospital of Milwaukee, LLC, a Delaware limited liability company, as Borrower, the lenders who are or may become a party to this Agreement, as Lenders, Bank of America, N.A., as Administrative Agent for the Lenders, Bankers Trust Company, as Syndication Agent for the Lenders, and Wachovia Bank, National Association, as Documentation Agent (9)
	10.62	—	Fifth Amendment to the Operating Agreement of Lafayette Heart Hospital, LLC(6)(9)
	21.1	—	List of Subsidiaries(10)
	31.1	—	Rule 13a-14(a) Certification of Chief Executive Officer
	31.2	—	Rule 13a-14(a) Certification of Chief Financial Officer
	32.1	—	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	—	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	99.1	—	Risk Factors(10)


	(1)	Incorporated by reference from the Company’s Registration Statement on Form S-1 (File no. 333-60278).

	(2)	Previously filed with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2001.

	(3)	Previously filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2001.

	(4)	Previously filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002.

	(5)	Previously filed with the Company’s Quarterly Report on Form 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)	Previously filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2002.

	(8)	Previously filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003.


	(9)	Previously filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003.


	(10)	Previously filed with the Company’s Annual Report on Form 10-K for the year ended September 30, 2003.


	(b)	Reports on Form 8-K. On August 6, 2003, the Company filed a Current Report on Form 8-K reporting the issuance of its earnings release for the three months and nine months ended June 30, 2003.

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amendment to be signed on its behalf by the undersigned, thereunto duly authorized.


	MEDCATH CORPORATION


	BY:	/s/ JAMES E. HARRIS



	James E. Harris
	Executive Vice President and
	Chief Financial Officer

Date: June 17, 2004

Medcath (MDTH) 10-K/A2003 FY Annual report (amended)